---

# UNITED
STATESSECURITIES AND EXCHANGE COMMISSION  Washington, D.C. 20549

_________________

# FORM 10-K

||X| | ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the
Fiscal Year Ended March 31, 2007
|--- | -----------------------------------------------------------------------------------------------------------------------------

OR

|[_] | 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
000-11071

_________________



|IMAGE ENTERTAINMENT, INC.                             
|------------------------------------------------------
|(Exact name of registrant as specified in its charter)

_________________

|Delaware                                       | 84-0685613                             
|---------------------------------------------- | ---------------------------------------
|(State or other jurisdiction of incorporation) | (I.R.S. Employer Identification Number)

20525 Nordhoff
Street, Suite 200, Chatsworth, California 91311 (Address of principal executive
offices, including zip code)

(818)
           407-9100 (Registrants telephone number, including area code)

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

|Title of Each Class             | Name of Each Exchange on Which Registered
|------------------------------- | -----------------------------------------
|Common Stock, par value $0.0001 | The NASDAQ Stock Market LLC              

Securities registered
pursuant to Section 12(g) of the Act: None

Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act.  YES [   ] NO |X|

Indicate
by check mark if the registrant is not required to file report pursuant to Section 13 or
Section 15(d) of the Act.  YES [   ] NO |X|

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

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

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

Large Accelerated filer
 [   ]                Accelerated Filer  [   ]                Non- Accelerated Filer  |X|

Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). YES [   ] NO |X|

The
aggregate market value of the common stock held by non-affiliates of the registrant, based
upon the closing price of $3.48 for shares of the registrants common stock on
September 29, 2006, the last business day of the registrants most recently completed
second fiscal quarter as reported by the NASDAQ National Market®, was approximately
$31,798,782. In calculating such aggregate market value, shares of common stock owned of
record or beneficially by officers, directors and persons known to the registrant to own
more than five percent of the registrants voting securities (other than such persons
of whom the registrant became aware only through the filing of a Schedule 13G filed with
the Securities and Exchange Commission) were excluded because such persons may be deemed
to be affiliates. The registrant disclaims the existence of control or any admission
thereof for any other purpose.

The
number of shares outstanding of the registrants common stock as of June 11, 2007:
21,717,955

# DOCUMENTS INCORPORATED
BY REFERENCE

Part
III of the Annual Report on Form 10-K incorporates by reference information (to the extent
specific sections are referred to herein) from the Registrants Proxy Statement for
its 2007 Annual Meeting.

---

---

# IMAGE ENTERTAINMENT,
INC. Form 10-K Annual ReportFor The Fiscal Year Ended March 31, 2007

# TABLE OF CONTENTS

|           |          |                                                                           |   
|---------- | -------- | ------------------------------------------------------------------------- | --
|PART I     |          |                                                                           | 3 
|           | ITEM 1.  | Business                                                                  | 3 
|           | ITEM 1A. | Risk Factors                                                              | 20
|           | ITEM 1B. | Unresolved Staff Comments                                                 | 29
|           | ITEM 2.  | Properties                                                                | 29
|           | ITEM 3.  | Legal Proceedings                                                         | 30
|           | ITEM 4.  | Submission of Matters to a Vote of Security Holders                       | 30
|PART II    |          |                                                                           | 31
|           | ITEM 5.  | Market for Registrants Common Equity, Related Stockholder Matters       
|           |          | and Issuer Purchases of Equity Securities                                 | 31
|           | ITEM 6.  | Selected Financial Data                                                   | 33
|           | ITEM 7.  | Managements Discussion and Analysis of Financial Condition and Results  
|           |          | of Operations                                                             | 35
|           | ITEM 7A. | Quantitative and Qualitative Disclosures About Market Risk                | 54
|           | ITEM 8.  | Financial Statements and Supplementary Data                               | 55
|           | ITEM 9.  | Changes in and Disagreements with Accountants on Accounting and          
|           |          | Financial Disclosure                                                      | 83
|           | ITEM 9A. | Controls and Procedures                                                   | 83
|           | ITEM 9B. | Other Information                                                         | 83
|PART III   |          |                                                                           | 84
|           | ITEM 10. | Directors, Executive Officers and Corporate Governance                    | 84
|           | ITEM 11. | Executive Compensation                                                    | 84
|           | ITEM 12. | Security Ownership of Certain Beneficial Owners and Management and       
|           |          | Related Stockholder Matters                                               | 84
|           | ITEM 13. | Certain Relationships and Related Transactions, and Director Independence | 84
|           | ITEM 14. | Principal Accountant Fees and Services                                    | 84
|PART IV    |          |                                                                           | 85
|           | ITEM 15. | Exhibits and Financial Statement Schedules                                | 85
|SIGNATURES |          | 90                                                                       

---

|
|
|

# FORWARD-LOOKING
STATEMENTS

This
Annual Report on Form 10-K for the fiscal year ended March 31, 2007 (Annual
Report) of Image Entertainment, Inc. (we, us,
our, or Image) includes forward-looking statements that involve
risks and uncertainties within the meaning of the Private Securities Litigation Reform Act
of 1995. Other than statements of historical fact, all statements made in this Annual
Report are forward-looking, including, but not limited to, statements regarding industry
prospects, future results of operations or financial position, and statements of our
intent, belief and current expectations about our strategic direction, prospective and
future results. In some cases, forward-looking statements may be identified by words such
as will, should, expect, anticipate,
believe, estimate, continue, future,
intend or similar words. Forward-looking statements involve risks and
uncertainties that are inherently difficult to predict, which could cause actual outcomes
and results to differ materially from our expectations, forecasts and assumptions. The
following important factors, in addition to those discussed above, could affect our future
results and could cause those results to differ materially from those expressed in such
forward-looking statements:

| |  | changes
in company-wide or business-unit strategies, which may result in changes in the types or
mix of                   businesses in which we are involved or choose to invest;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes
in U.S. and global financial and equity markets, including market disruptions and
significant                   interest rate fluctuations, which may impede our access to,
or increase the cost of,                   external financing for our operations and
investments;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | increased
competitive pressures, both domestically and internationally, which may, among other
things, affect the performance of our business operations and profit margins;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changes
in the mix of titles sold to customers and/or customer-spending patterns;
| | - | ---------------------------------------------------------------------------------

| |  | legal
and regulatory developments that may affect the protection of intellectual property;
| | - | ------------------------------------------------------------------------------------------

| |  | the
imposition by foreign countries of trade restrictions on motion picture or television
content requirements or quotas, and changes in international tax laws or currency
controls;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | technological
developments that may affect the distribution of our products or create new risks to our
                  ability to protect our intellectual property; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | changing
public and consumer taste, which may among other things, affect the entertainment and
consumer products businesses generally.
| | - | --------------------------------------------------------------------------------------------------------------------------------------

All
forward-looking statements should be evaluated with the understanding of inherent
uncertainty. The inclusion of such forward-looking statements should not be regarded as a
representation that contemplated future events, plans or expectations will be achieved.
Unless otherwise required by law, we undertake no obligation to release publicly any
updates or revisions to any such forward-looking statements that may reflect events or
circumstances occurring after the date of this Annual Report. Important factors that could
cause or contribute to such material differences include those discussed in Item 1A.
Risk Factors. You are cautioned not to place undue reliance on such forward-looking
statements.

# ITEM 1.        BUSINESS

# RECENT EVENTS

On
March 29, 2007, we entered into a definitive agreement with BTP Acquisition Company, LLC (BTP),
an investor group led by David Bergstein, to sell Image in a transaction valued at
approximately $132 million, including the assumption of a replication advance in excess
of $9 million and the repayment of approximately $24 million of debt. Under the terms of
the agreement, Image stockholders will receive $4.40 per share in cash. The agreed-upon
acquisition price represents a 27% premium to Images closing share price of $3.46
on March 29, 2007, and a 35% premium to the 30-day average price ended March 29, 2007.
Stockholders owning a total of approximately 38% of our outstanding shares of common
stock have agreed to vote their shares in favor of the transaction. Completion of the
transaction is subject to customary closing conditions, including regulatory review and
the approval of the transaction by our stockholders.

On
June 27, 2007, we amended our merger agreement with BTP.  Under the terms of the amended
merger agreement, our stockholders will receive the same aggregate cash consideration as
under the original merger agreement, plus they will retain between 5% and 9% of their
shares in the surviving company.  The exact percentage of shares that will be retained by
our stockholders will be determined by BTP not later than two business days prior to the
filing of our definitive Proxy Statement with the Securities and Exchange Commission (SEC)
in connection with the transaction.  BTP will base its determination on, among other
things, the ability to meet the applicable listing standards for continued listing of our
common stock on the NASDAQ National Market (NASDAQ) following the closing of the merger.
 The transaction is expected to close by September 30, 2007.

The
buyer group is led by film financier and producer David Bergstein, who recently purchased
U.K.-based Capitol Films, an international film distributor, and Thinkfilm, a North
American film distributor. Our board of directors (Board) unanimously
approved the merger agreement and the amended merger agreement, and has recommended that our stockholders vote in favor of
the transaction. For more information on this potential transaction, please refer to our
Current Report on Form 8-K filed with the SEC
on April 2, 2007. For more information on the risks related
to this potential transaction, please refer to Item 1A. Risk Factors.

|                         
|-------------------------
|Image Entertainment, Inc.

---

On
April 10, 2007, a purported class action shareholder complaint entitled Henzel v. Image
Entertainment, Inc., et al. was filed against us and certain of our officers and
members of our Board in the Superior Court of the State of California, County of Los
Angeles. The named plaintiff proposes to represent a class of our stockholders and claims,
among other things, that in connection with the proposed business combination transaction
with BTP, our directors breached their fiduciary duties of due care, good faith and
loyalty by failing to maximize stockholder value and by creating deterrents to third-party
offers. Among other things, the complaint seeks class action status, and a court order
enjoining the consummation of the merger and directing us to take appropriate steps to
maximize stockholder value. While the lawsuit is in its preliminary stage, we believe that
the claims in the lawsuit are without merit and intend to vigorously defend it. Under our
directors and officers liability insurance policies, we will be financially responsible
for legal fees defending this lawsuit up to our $250,000 deductible, which we currently
anticipate that we will equal or exceed. We have tendered this claim to our insurers.

# OVERVIEW

We
are a vertically-integrated independent home entertainment content supplier engaged in the
acquisition, production and worldwide distribution of exclusive content for release on a
variety of formats and platforms, including:

| |  | DVD             |  | Broadcast                   
| | - | --------------- | - | ----------------------------
| |  | CD              |   | °      Traditional          
| |  | HD-DVD          |   | °      Cable                
| |  | Blu-ray Disc(R) |   | °      Satellite            
| |  | UMD             |   | °      Video-On-Demand (VOD)
| |  | VHS             |  | Theatrical                  

We
are primarily engaged in the domestic acquisition and wholesale distribution of content
for release on DVD. We acquire and exploit, on DVD and other home entertainment formats,
exclusive distribution rights to a diverse array of general and specialty content,
including:

| |  | Comedy         |  | Theatrical catalog films
| | - | -------------- | - | ------------------------
| |  | Music concerts |  | Independent films       
| |  | Urban          |  | Foreign and silent films
| |  | Latin          |  | Youth culture/lifestyle 
| |  | Theatre        |  | Television              
| |  | Country        |  | Gospel                  

We
also acquire exclusive rights to audio content for distribution on CD spread across a
variety of genres and configurations, including:

| |  | Albums                   |  | Broadway original cast   
| | - | ------------------------ | - | -------------------------
| |  | Compilation CDs          |   | recordings               
| |  | TV and movie soundtracks |  | Audio recordings from our
| |  | Stand-up comedy programs |   | live concert event DVDs  

Through
our wholly-owned subsidiary, Egami Media, Inc. (Egami), we are focused on the
acquisition and exploitation of content in the expanding digital distribution marketplace
for delivery systems such as:

| |  | Download-to-rent (VOD)              
| | - | ------------------------------------
| |   | °      A la carte download-to-rent
| |   | °      Subscription rental          
| |   | °      Ad-supported rental          
| |  | Electronic sell-through             

| 
|-
|4

---

Egami
aggressively continues to add numerous video and audio titles to its growing library of
exclusive digital rights each month. Egami has established direct relationships with many
digital industry-retailers and continues to seek additional distribution partners as they
emerge.

We
strive to grow a stream of revenues by maintaining and building a library of titles that
can be exploited in a variety of formats and distribution channels. Our active library
currently contains:

| |  | Over
2,800 exclusive DVD titles
| | - | -------------------------------

| |  | Approximately
250 CD titles
| | - | ---------------------------

| |  | Digital
rights to
| | - | -----------------

| | ° | Nearly
2,000 video titles
| | - | -------------------------

| | ° | Over
250 audio titles
| | - | ---------------------

| |  | Containing
more than 4,000 individual tracks
| | - | --------------------------------------------

We
currently release an average of approximately 30-35 new exclusive DVD titles and five new
exclusive CD titles each month.

We
acquire programming mainly by entering into exclusive licensing or distribution
arrangements with producers and other content providers. We typically supplement such
content by designing and producing additional value-added features. We routinely produce
our own original entertainment programming, focused on DVD live performance music concerts
and comedy events with some of the most recognizable names in each industry, and also
various forms of urban genre content. We are also co-producing feature horror and other
genre specific titles with budgets from less than $500,000 to $3.5 million through
co-production agreements with:

| |  | Dark
Horse Entertainment
| | - | ------------------------

| |  | Graymark
Productions
| | - | --------------------

| |  | Amicus
Entertainment
| | - | --------------------

In
addition, we co-produced with Sisters Wooster, Inc. a thriller feature film,Sisters, which is a remake of the classic Brian De Palma film. We will also look to
co-produce individual films with other established independent producers as such
opportunities may arise.

We
were incorporated in Colorado as Key International Film Distributors, Inc. in April 1975,
our present name was adopted in 1983, we reincorporated in California in November 1989 and
reincorporated again in Delaware in September 2005. Our principal executive offices are
located at 20525 Nordhoff Street, Suite 200, Chatsworth, California 91311. We maintain a
Web site at www.image-entertainment.com. Except as specifically noted, the content
of this site is not incorporated by reference and does not constitute a part of this
Annual Report.

The
following table sets forth the percentage of consolidated net revenues derived from the
distribution of entertainment content by format for our last three fiscal years. The
information does not represent our business segments, but rather shows net revenue trends
by product category:

|(in thousands) | Fiscal Years Ended
March 31,
|-------------- | ----------------------------
|2007           | 2006                        
|DVD            |                             
|CD             |                             
|Sublicense     |                             
|UMD            |                             
|VHS            |                             
|Broadcast      |                             
|               |                             
|TOTAL          |                             
|               |                             

|                         
|-------------------------
|Image Entertainment, Inc.

---

# BUSINESS SEGMENTS

We
currently have two business segments:

| |  | Domestic
(U.S. and Canada)
| | - | --------------------------

| |  | International
| | - | -------------

Our
domestic segment primarily consists of acquisition, production and distribution of
exclusive DVD content and, through Egami, exclusive content for digital distribution via
video on demand, streaming video and download. Our international segment includes
international video sublicensing and exploitation of worldwide broadcast rights. The
following table presents consolidated net revenues, net of eliminations, by reportable
business segment for the periods presented:

|               |      |     
|-------------- | ---- | ----
|(in thousands) | 2007 | 2006
|Net revenues:  |      |     
|Domestic       |      |     
|International  |      |     
|               |      |     
|Consolidated   |      |     
|               |      |     

See Note 18. Segment
Information in the Notes to Consolidated Financial Statements for earnings, loss,
and total assets for each segment.

Domestic

Most
of the product we release is in the DVD format. According to industry estimates, there are
currently more than 72,000 DVD titles available in the domestic market, of which more than
2,800 are actively and exclusively distributed by us. We are a leading independent
supplier of DVD content in the music, comedy, special interest, episodic television, urban
and lifestyle genres. The following chart reflects the number of cumulative titles we have
released by content type, compared with the cumulative DVD software titles released by the
industry through the week ended May 11, 2007, excluding discontinued titles. The following
chart does not intend to indicate our market share of DVD revenues, only cumulative titles
released.

|Type of DVD Content                            | Total Number of
DVD Titles | Number of Image
Titles | Image 
Percentage
|---------------------------------------------- | -------------------------- | ---------------------- | -----------------
|Music                                          | 9,316                      | 602                    | 6.5%             
|Special Interest                               | 16,674                     | 495                    | 3.0%             
|Theatrical Catalog (pre-1997)                  | 10,719                     | 481                    | 4.5%             
|Foreign Language (including distributed lines) | 6,244                      | 278                    | 4.5%             
|Television Programming                         | 4,253                      | 173                    | 4.1%             
|Direct to DVD                                  | 8,029                      | 421                    | 5.2%             
|All Other                                      | 17,346                     | 391                    | 2.3%             
|                                               |                            |                        |                  
|Total Releases - Cumulative through 5/11/07    | 72,581                     | 2,841                  | 3.9%             
|                                               |                            |                        |                  

| | Source:
 DVD Release Report Revised 5/9/07
| | ------------------------------------------

We
believe that the value gained through the ability to entertain people at home for a
reasonable price at convenient times, the opportunity to choose from a very broad
selection of programming, the ability to select specific scenes quickly from interactive
DVD menus, and the audio and video quality of the DVD format, will continue to make DVD a
preferred medium of home entertainment for millions of consumers. Many of our DVDs also
offer special features, enhancements and ancillary materials, such as multiple audio
tracks, behind-the-scenes footage, director commentaries, interviews and discographies,
all of which we develop in-house.

Exclusive
Acquisition. We generally acquire exclusive distribution rights to our
content. We acquire our exclusive titles from a wide range of content holders, including:

| 
|-
|6

---

| |  | independent
content suppliers
| | - | -----------------------------

| |  | producers
| | - | ---------

| |  | music
artists
| | - | -------------

| |  | record
labels
| | - | -------------

| |  | artist
management
| | - | -----------------

We
also produce our own original entertainment content focused on DVD live performance
stand-up comedy events, music concerts, urban genre content, and feature horror and other
genre films. We produce, market and sell our exclusive content according to exclusive
license or distribution agreements. We actively pursue and secure both domestic (U.S. and
Canada) and international distribution rights to exclusive titles across multiple home
entertainment formats.

In
return for exclusive license rights, we pay royalties to our licensors. Royalties are
expressed as a percentage of our wholesale net revenues derived from title sales.
Typically, we pay royalty advances that are recouped against royalties earned on a
title-by-title basis or, if cross-collateralized, against groups of licensed titles from
the same licensor. Our license agreements generally provide for a minimum distribution
term of five years but we often obtain considerably longer terms. Some license agreements
contain provisions for an extension of the distribution term if we meet specified
financial performance milestones or if we are still unrecouped at the end of the
distribution term.

In
return for exclusive distribution rights, we generally tender net wholesale revenues to
content suppliers, which are expressed as a percentage of wholesale revenues after
subtracting our distribution fee and recouping costs allocated to the content owner such
as production, manufacturing, music publishing, and marketing fees. In some cases, the net
profit of a title is split between us and the content supplier according to a contractual
percentage. In many cases, we pay and recoup advances or minimum guarantees on an
exclusive distribution deal in a manner similar to an exclusive licensing arrangement.

With
content acquisition being our lifeblood, we have made several internal restructurings such
that our key genres and areas of expertise are allowed to grow with an even greater focus
and determination. Additional emphasis has been placed on stronger content with the
potential of wider market penetration and larger unit sales. Individuals have been
selected to spearhead programming opportunities throughout our key genres, which include
Comedy, Urban, Latin, Music, Feature Film and Special Interest.

Our
content category acquisition teams partner with product development teams (which attempt
to determine the best strategies for creating the most viable and marketable products
based on consumer tastes and market demands) prior to the acquisition of programming, and
also with marketing teams after the acquisition has been finalized, to determine optimal
ways of maximizing revenue across all channels of distribution, including hard goods,
conventional broadcast, digital distribution and other areas of exploitation.

While
our core business remains the domestic acquisition and distribution of content on DVD, we
seek to secure and exploit exclusive content with the broadest possible grant of home
entertainment programming rights. As part of our strategic goal, we may finance all or
part of the production of some of our entertainment content. The rights we retain in
connection with our self-financed productions generally cover all territories throughout
the world, all now-known and hereafter-devised home video entertainment formats, and other
formats for an extended term.

Because
of our growing library of exclusive titles in a wide variety of genres, we believe that we
are positioned to benefit from the widespread support of the traditional DVD format and
the HD-DVD and/or Blu-ray Disc® high-definition formats. We intend to continue
expanding our exclusive DVD library.

Mining
of Images Vast Library.Throughout the coming year, we plan
to create new and special editions of previously released content that will encourage
consumers to repurchase the product in these technically superior versions. We also plan
to expand on strategies that extend the life cycle of our titles, including second
bite strategies that focus on repricing and/or remarketing and repromotion;
increased focus on budget product and shippers; and product shipped with merchandising
displays. We have been encouraged by the success of these programs with mass merchant
retailers such as Wal-Mart, and we are also implementing liquidation strategies to turn
deep inventory overstocks, often for titles which are soon expiring, into cash.

|                         
|-------------------------
|Image Entertainment, Inc.

---

We
plan to create multi-title DVD sets by placing the greatest amount of content on the
smallest number of discs for a price that will entice consumers to buy. We began
distributing double, triple, and multi-title features in our fourth quarter ended March
31, 2007, and we anticipate a steady stream of this product throughout the rest of the
calendar year. In addition to the new budget product, we are also focusing our sales
efforts to include specialty video outlets such as sporting goods, apparel and
youth-culture stores. We have realized great success with lifestyle products at a number
of these accounts, and they are often sold at a higher price with greater margins.

Images
Participation in the High Definition DVD Market.We recently
released our first three HD-DVD titles: Manilow Live; Heart Alive in
Seattle; and Chicago & Earth Wind & Fire. The choice to launch with the
HD-DVD format was due to our long-standing relationship with Memory Tech in Japan, with
whom we entered into a special financial arrangement allowing Memory Tech to provide us
with the authoring and compression services for these three titles at a cost that was
highly advantageous to us. In January 2007, we released four high-definition titles from
our recently announced agreement with Discovery Communications. The programs were from
Discovery Channels acclaimed Atlas series (China
Revealed, Australia Revealed, Italy Revealed,
and Brazil Revealed) and were released in both HD-DVD and Blu-ray
Disc® editions. Authoring and compression for the titles were provided through
Discovery Communications. We believe current compression and authoring costs for both
high-definition formats (running anywhere between $20,000 and $70,000 per title depending
on content length, number of audio streams, and complexity of menus) are too high for us
to pay for the types of titles we carry, especially based on the relatively low volume of
titles and units currently being purchased by retailers. Additionally, the authoring tools
available right now for both formats are relatively new and constantly evolving, so we are
not currently contemplating the purchase of equipment or software necessary to compress or
author HD programming in-house.

Nevertheless,
we have over 120 high-definition masters that can be used for release on the HD-DVD and
Blu-ray Disc® formats, and through the conversion process we also have access to many
more titles in our catalog.  Many of our programs originated on high definition video,
but we can also convert to HD-DVD or Blu-ray Disc® any content that was shot on film,
which is actually capable of greater resolution than the current HD formats. In order to
convert elements that were shot on film, they must first be sent to a post-production
facility specializing in transferring the film to a high definition video format, usually
1920 x 1080p, and a typical transfer can cost anywhere from several thousand dollars to
more than $30,000, depending on the amount of supervision, color correction, and
restoration work required.

HD-DVD
and Blu-ray Disc® are similar in that both utilize the same audio and video encoding
formats, resulting in almost identical picture and sound quality for the end user. The
video compression formats available for both HD-DVD and Blu-ray Disc® are VC-1, MPEG 4
AVC, and MPEG 2. The audio compression formats available are variations of Dolby Digital
(Standard, Plus and True HD), DTS (Standard, HD High Resolution, and HD Master Audio) and
uncompressed PCM. We anticipate that there will be two competing high-definition formats
for the foreseeable future.

As
consumers continue to purchase high-definition capable televisions, become more exposed to
high-definition content through satellite and cable, and begin to appreciate the
advantages that high-definition offers over standard definition, they will expect to
obtain the same level of quality from their video movie rentals and purchases. With a
viable high-definition video-on-demand solution probably several years away, there is
plenty of time for one or both of these new optical disc formats to take hold with
consumers. As successful and ubiquitous as DVD is right now, many people forget that the
format lacked full studio support until well after its launch, to the extent that many in
the industry referred to DVD as Doubtful Very Doubtful.

Egamis
Digital Distribution Activities. Our wholly-owned subsidiary, Egami,
engages in the exclusive wholesale distribution of the digital rights to our catalogue of
audio and video content. The demand for the types of programming found in our catalogue
continues to increase as new retailers enter this primarily online marketplace. Egami
seeks to differentiate itself competitively by being a one-stop source for these
retailers, for the large and diverse collection of entertainment represented by our
digital catalogue.

Egami
enters into nonexclusive distribution arrangements with retail and consumer-direct
entities whose business models include the digital delivery of content. Delivery is
typically in the form of secure encoded files with playback options being controlled by
embedded Digital Rights Management (DRM). In video, the consumer will find various
purchasing options that include:

| 
|-
|8

---

| |  | download-to-rent
(VOD)
| | - | ----------------------

| | ° | a
la carte download-to-rent
| | - | -----------------------------

| | ° | subscription
rental
| | - | -------------------

| | ° | ad-supported
rental
| | - | -------------------

| |  | download-to-own
or electronic sell-through (EST)
| | - | ------------------------------------------------

Download-to-Rent
is also referred to as VOD and is becoming a key transactional component to most of our
partner retailers. Subscription-based rental models are essentially the digital equivalent
of a club-type model, where users pay recurring monthly fees in exchange for access to a
library without individual transaction charges. Ad-supported rental is a developing model
that relies on users viewing advertisements in order to view the programming they desire.
Electronic sell-through, or download-to-own, is essentially the digital equivalent of
buying a DVD.

Egami
aggressively continues to add numerous video and audio titles to its growing library of
exclusive digital rights each month. Over the past two years, Egami has established direct
relationships with many digital industry-retailers and continues to seek additional
distribution partners as they emerge.

We
strive to grow a stream of revenues by maintaining and building a library of titles that
can be exploited in a variety of formats and distribution channels. Our current digital
video library contains almost 2,000 individual video programs with an option to exploit
another 400 in certain limited ways based on the content owners restrictions. We
have active distribution of approximately 900 programs with another 400 in various stages
of encoding or delivery. The balance of our digital library is either a pending new
release or a recent catalog acquisition that will be solicited to retailers as soon as it
is ready.

Egamis
interaction with retail is much more dynamic due to the overall size of the library
confronting each retailer. A recently executed deal with a new retailer who wants to
actively sell our entire library will take several months to fully deliver and integrate.
The delay is typically on the retailers end as it takes time to activate all of the
titles. We are constantly adding new releases and catalog titles to our ever-growing
library of digital rights.

Generally,
Egamis digital library is comparable to our overall DVD library, with particular
strengths in music and comedy, although we have programming from all genres. Retailers are
typically quite impressed when they see the breadth of our programming, and we commonly
hear that we carry something for everyone. We do not typically possess digital
rights to the types of high-profile titles produced by the major studios, broadcast
suppliers and labels, but that is unsurprising given these entities similar and
competing interests in the digital realm.

Egami
is actively participating in many different digital business models, including
sell-through, rental, subscription and advertising-supported rental. As the consumers
adopt one or more of these (or future) models, we believe Egami is well-positioned to
adapt along with our retail partners. We have established good working relationships with
our retailers, and continue to be a key source of independent content for them. The
near-term challenges presented by the dynamic digital marketplace are increasing awareness
of the marketplace by the consumer and integrating it into their buying and consumption
habits, as well as retaining the attention of the retailer who is chasing the entire
breadth and depth of the DVD marketplace in an effort to build a digital library which
appeals to consumers. Egami continues to work with our content suppliers in order to
increase the number of our active digital titles. Additionally, Egami supports several
technology companies and OEM device manufacturers with programming in an effort to
generate consumer interest in digital distribution and increase awareness and demand for
our titles.

Focus
on Feature Film DVD Distribution.Our agreement with
Relativity Media, LLC (Relativity Media) (See Exclusive Distribution
Agreement with Relativity Media below) has attracted interest from film producers
who have funding for new productions and/or finished content and are looking for a home
entertainment distribution alternative to the major studios. Many of them are seeking to
be more hands on and retain control of their DVD and digital distribution
rights. We are in discussions with such parties on terms similar to our distribution
agreement with Relativity Media, with the potential for our co-ownership of the titles,
but without giving up any of our common stock or other equity securities as we did with
Relativity Media. Home video distribution of feature films theoretically allows us to
realize significantly higher per-title revenues, negotiate superior revenue sharing
agreements with rental retailers, and command more shelf space at traditional brick
and mortar retailers. Success with feature film DVDs should also allow us to
participate in Wal-Marts VMI program, which is a goal we have not yet achieved.

|                         
|-------------------------
|Image Entertainment, Inc.

---

Under
our agreement with Dark Horse Entertainment (Dark Horse), we have received
delivery of three feature films, Driftwood, a ghost story about a boys
reformatory directed by Tim Sullivan (2001 Maniacs, Detroit Rock City),
Splinter, a multicultural action-adventure supernatural thriller starring Edward
James Olmos and Tom Sizemore, and Monarch of the Moon, a stylized feature designed
to pay homage to the classic science-fiction movies of the 1950s. Through Dark Horse, we
also acquired Destination Mars, a feature similar to Monarch of the Moon.
Monarch of the Moon and Destination Mars have been released on DVD, and we
are currently investigating the possibility of limited theatrical releases for
Driftwood and Splinter. We are also in post-production onMy Name Is
Bruce, starring and directed by renowned genre actor Bruce Campbell (Evil Dead
series, Army of Darkness,and Bubba Ho-tep).

Our
agreement with Graymark Productions (Graymark) has yielded four delivered
films. These films include the horror film The Hunt directed by Fritz Kiersch
(Children of the Corn) and starring veteran actor Cliff De Young (The
Hunger), the thriller Surveillance starring Emmy award-winning actor Armand
Assante (Paradise Alley, Unfaithfully Yours, Private Benjamin, The
Mambo Kings, Fatal Instinct, Judge Dredd) and directed by Mr. Kiersch, the
vampire horror movie Souls Midnight starring Mr. Assante, and the urban legend
ghost story Fingerprints, the debut film of up-and-coming actress Kristin Cavallari
(Laguna Beach), which also stars Lou Diamond Phillips (La Bamba, Stand
and Deliver). The Hunt has been released on DVD, Surveillance and
Souls Midnight are scheduled for release on DVD later in calendar year 2007, and we
are currently investigating the possibility of a limited theatrical release for
Fingerprints.

With
Amicus Entertainment (Amicus), we are in post-production on one horror film.
The film, based on the true story of a woman who hits a homeless man with her car and then
lets him die in her garage while he is still stuck in her windshield, is appropriately
entitled Stuck, and is written and directed by well-known horror director Stuart
Gordon (Re-Animator, From Beyond, Dolls).

An
agreement with ContentFilm has focused primarily on content acquisition, as the
co-production portion of our agreement has been assigned to highly successful independent
film producer Edward R. Pressman (Bad Lieutenant, Conan the Barbarian, The Cooler, The
Crow, Das Boot, Sisters, Talk Radio, Thank You For Smoking). With ContentFilm, we have
acquired the feature films Evil Aliens, which was given a limited theatrical
release and is scheduled for release on DVD later in calendar year 2007, and Wilderness
Survival for Girls, which has been released on DVD. We have received delivery on the
remake of Brian De Palmas classic thriller Sisters, executive produced by Mr.
Pressman, and we are currently investigating the possibility of a limited theatrical
release for the film.

We
are solely responsible for financing the film budgets for the Dark Horse co-productions
and are co-financiers of our other co-productions. For our theatrical co-productions, we
usually receive a longer distribution term and a share of the pictures copyright.

Film
Co-Production Budgets

| | Dark
Horse          Driftwood - $1.25 million          Monarch of the Moon - $111,000
         Splinter - $437,000          My Name is Bruce - $1,850,000
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | Graymark
         The Hunt - $427,000 (our funded commitment $214,000)          Surveillance -
$629,000 (our funded commitment $314,000)          Souls Midnight - $650,000 (our funded
commitment $171,000)          Fingerprints - $650,000 (our funded commitment $291,000)
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Amicus
         Stuck - $2.8 million (our funded commitment $447,000)
| | ---------------------------------------------------------------------

| | Sisters
Wooster          Sisters $3.5 million (our funded commitment $1,395,000)
| | --------------------------------------------------------------------------------

|  
|--
|10

---

Nonexclusive
Distribution. Except for a small number of titles from New Video (the
A&Echannel line) and Acorn Media, and a small number of digital titles
distributed by Egami, we do not generally distribute nonexclusive content, such as DVD
releases of major motion pictures.

Additional
Value-Added Services. We provide a full range of value-added services
relative to our licensed content and many of our exclusively distributed titles,
including:

| |  | creation
of packaging
| | - | ---------------------

| |  | DVD
authoring and compression
| | - | -----------------------------

| |  | menu
design
| | - | -----------

| |  | video
master quality control
| | - | ----------------------------

| |  | manufacturing
| | - | -------------

| |  | marketing
| | - | ---------

| |  | sales
| | - | -----

| |  | music
clearance
| | - | ---------------

| |  | warehousing
| | - | -----------

| |  | distribution
| | - | ------------

| |  | for
some titles, the addition of enhancements such as:
| | - | ------------------------------------------------------

| | ° | multiple
audio tracks
| | - | ---------------------

| | ° | commentaries
| | - | ------------

| | ° | foreign
language tracks
| | - | -----------------------

| | ° | behind-the-scenes
footage
| | - | -------------------------

| | ° | interviews
| | - | ----------

| | ° | discographies
| | - | -------------

These
services are typically performed in-house, with the exception of DVD, CD and UMD disc
manufacturing and tape replication, package printing, and packaging of the finished
product which are generally performed by third party vendors. We are currently in the
process of transitioning our warehousing and distribution services from our Las
Vegas-based distribution facility to a facility located in Pleasant Prairie, Wisconsin,
which is owned and operated by our DVD replicator, Sonopress LLC (Sonopress)
under our March 29, 2007, exclusive distribution services agreement detailed below.

Home
Vision Acquisition and Criterion Library of Special Edition DVD
Programming. In August 2005, we acquired Home Vision Entertainment, Inc.
(Home Vision), a publisher and distributor of home entertainment programming
with 130 active DVD titles, for $8.0 million in cash. In connection with the acquisition,
we signed a long-term exclusive distribution agreement with The Criterion Collection for
the remaining distribution rights (which were controlled by Home Vision) to
Criterions then-290-title DVD library. Prior to the signing of the agreement, we
shared distribution of Criterions programming with Home Vision.

Distribution
Services.We have historically distributed our own product via our in-house Las
Vegas-based distribution facility.  In the fall of 2006, however, our new DVD
replicator Sonopress approached us with the concept of moving our warehousing and
distribution services to a facility they were in the process of purchasing as part of a
new initiative by Sonopress to offer these services to their replication customers. 
The new initiative is staffed in significant part by key people from our previous
replicator, Deluxe Media Services, Inc. (Deluxe), who sold the facility to
Sonopress.  Sonopress proposal was received around the same time we were making
plans for our November 2006 layoff, which also contemplated cost cutting measures. 
After receiving price quotes at preferential rates from Sonopress, we conducted an
extensive internal analysis of potential cost savings, expenses relating to the
prospective closure of our Las Vegas facility, freight savings from the ability to ship
from centrally-located Wisconsin compared to West Coast-located Las Vegas, and,
importantly in light of our plans to distribute major feature films on DVD, the potential
scalability of distribution services in each location.  Ultimately, on March 29,
2007, we entered into an agreement whereby Sonopress would become our exclusive provider
of warehousing and distribution services.  We are currently in the process of
integrating Sonopress logistics and warehouse management systems with our order
management and inventory control software as well as transitioning all of our warehousing
and distribution services to Sonopress facility in Pleasant Prairie. We anticipate
this process will be complete by July 31, 2007.  We are also in the process of
closing and subleasing our Las Vegas facility, and we anticipate this process will be
complete by September 30, 2007.  We have retained a commercial real estate agent to
sublease our Las Vegas warehouse, and since we have been told by real estate professionals
that our rent is currently at below-market rates, we are optimistic about the prospects of
subleasing our facility at or above our current lease costs.

|                         
|-------------------------
|Image Entertainment, Inc.

---

Manufacturing.           Typically,
a content supplier delivers a title master and artwork to us, and our           in-house
post-production facility creates a sub master with specifications for           the
necessary format and on-screen menus for each title. Our in-house authoring           and
compression team then generally performs the work necessary to prepare a DVD
          master for manufacturing. Occasionally, because of a large volume of exclusive
          releases at any given time, we may use an outside facility to perform such
          services. Our in-house creative services department, staffed with graphic
          designers, copywriters and proofreaders, creates original and innovative
          packaging fundamental to the marketing success of our product. During fiscal
          2007 and in the years prior, we used Deluxe to manufacture and package our
          domestic DVD programming. Now, Sonopress performs our manufacturing and
          packaging services and we are currently in the process of transitioning our
          warehousing and distribution services to them as well. We primarily use
          Sonopress and U-Tech Media USA dba Glory Tech LLC (U-Tech) for CD
          manufacturing, although we are currently in the process of transitioning all of
          our CD manufacturing remaining at U-Tech to Sonopress.

Marketing.          Our
in-house marketing department directs marketing efforts toward consumers as
          well as DVD and CD software and hardware retailers. Our marketing efforts
          involve:

| |  | point-of-sale
advertising
| | - | -------------------------

| |  | print
advertising in trade and consumer publications
| | - | ----------------------------------------------------

| |  | national
television and radio advertising campaigns
| | - | ---------------------------------------------------

| |  | Internet
advertising, including viral and social network marketing campaigns
| | - | ----------------------------------------------------------------------------

| |  | minimal
direct response campaigns
| | - | ---------------------------------

| |  | dealer
incentive programs
| | - | -------------------------

| |  | trade
show exhibits
| | - | -------------------

| |  | bulletins
featuring new releases and catalogue promotions
| | - | ---------------------------------------------------------

We
also have account-specific marketing programs where we work directly with retailers to
optimize and customize print advertising and other advertising programs to promote our
exclusive product. The creation of specialized in-store displays and celebrity appearances
are other examples of account-specific marketing programs. We occasionally implement
Internet promotional activities that include product tie-ins, sweepstakes, and giveaways
associated with online retail customers, and the creation of genre-specific boutiques
within direct-to-consumer Web sites.

Our
Web site at www.image-entertainment.com helps promote us and our exclusive content.
The Web site includes press releases, information regarding our exclusive titles, and
information of general interest to the home entertainment consumer.

Customers.          We
sell our products to:

| |  | traditional
retailers
| | - | ---------------------

| |  | specialty
retailers
| | - | -------------------

| |  | Internet
retailers
| | - | ------------------

| |  | wholesale
distributors
| | - | ----------------------

| |  | alternative
distribution
| | - | ------------------------

| | ° | direct-to-consumer
print catalogs
| | - | ---------------------------------

| | ° | direct
response campaigns
| | - | -------------------------

| | ° | subscription
service/club sales
| | - | -------------------------------

| | ° | home
shopping television channels
| | - | ---------------------------------

| | ° | other
non-traditional sales channels
| | - | ------------------------------------

Some
of our key sell-through customers in alphabetical order include:

| |  | AEC
One Stop Group
| | - | ------------------

| |  | Amazon.com,
Inc.
| | - | ----------------

| |  | Barnes
& Noble
| | - | --------------

|  
|--
|12

---

| |  | Baker
& Taylor
| | - | --------------

| |  | Best
Buy Co., Inc.
| | - | ------------------

| |  | Borders
Group Inc.
| | - | ------------------

| |  | Costco
| | - | ------

| |  | Handleman
Company
| | - | -----------------

| |  | Infinity
Resources (Critics Choice Video, Inc., DeepDiscount.com (f/k/a Deep Discount DVD and
CD.com)                   and DVDPlanet.com)
| | - | -------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ingram
Entertainment, Inc.
| | - | --------------------------

| |  | K-Mart
| | - | ------

| |  | Paradox
Entertainment (f/k/a Vid Canada)
| | - | ----------------------------------------

| |  | Sears
| | - | -----

| |  | Target
| | - | ------

| |  | Trans
World Entertainment
| | - | -------------------------

| |  | Wal-Mart
(Anderson Merchandisers)
| | - | ---------------------------------

In
addition, our key rental-retail hybrid customers are:

| |  | Blockbuster
Inc.
| | - | ----------------

| |  | Movie
Gallery, Inc. (including Hollywood Video)
| | - | -----------------------------------------------

| |  | Netflix,
Inc.
| | - | -------------

Our
special markets division is designed to take advantage of our large and diverse catalog
and specifically targets niche sales opportunities. Special markets retailers to whom we
have sold product in alphabetical order include:

| |  | Army
and Air Force Exchange Service (a.k.a. AAFES)
| | - | --------------------------------------------------

| |  | Big
Island Publishing
| | - | ---------------------

| |  | Columbia
House
| | - | --------------

| |  | Crutchfield
Corporation
| | - | -----------------------

| |  | Discovery
Channel
| | - | -----------------

| |  | Dynamic
Disc Distribution
| | - | -------------------------

| |  | Guitar
Center
| | - | -------------

| |  | Hot
Topic
| | - | ---------

| |  | Island
View Entertainment
| | - | -------------------------

| |  | Metropolitan
Opera Guild
| | - | ------------------------

| |  | Movies
4 Sale
| | - | -------------

| |  | Overstock.com
| | - | -------------

| |  | Video
Action Sports (Champs, Dicks, Foot Locker, Sport Chalet, Sportmart, etc.)
| | - | --------------------------------------------------------------------------------

On
a consolidated basis, Amazon.com, Inc., AEC One Stop Group and Anderson Merchandisers (who
supplies Wal-Mart) accounted for 12%, 12% and 10%, respectively, of our fiscal 2007 net
revenues. In fiscal 2006, Anderson Merchandisers accounted for 11% of our net revenues,
and in fiscal 2005, Anderson Merchandisers, Best Buy and AEC One Stop accounted for 17%,
12% and 10%, respectively, of our net revenues. No other customers accounted for net
revenues individually in excess of 10% of our total net revenues for fiscal 2007, 2006 or
2005.

We
allow retail customers to return a portion of their unsold inventory on a quarterly basis.
We reserve for estimated returns at the time the sale is recognized, based in part upon
our historical returns experience and knowledge of specific product movement within
distribution channels. Our inventory returns, as a percentage of our gross (as opposed to
net) distribution revenues, were 23.0% in fiscal 2007, 21.9% in fiscal 2006 and 18.8% in
fiscal 2005, respectively. Returns of defective product have been minimal and are
generally covered by manufacturers warranties.

As
of June 13, 2007, we had approximately $3.7 million of backlog orders, of which 96% of the
backlog was attributable to domestic DVD product, compared with approximately $3.9 million
of backlog orders as of June 1, 2006, of which 98% of the backlog was attributable to
domestic DVD product. We expect to fill 100% of the backlog orders, less any cancelled
orders, in the current fiscal year.

|                         
|-------------------------
|Image Entertainment, Inc.

---

International

International
Sublicensing. We hold worldwide distribution rights to over 450 of our DVD
titles and over 130 of our CD titles. We have an exclusive sublicense agreement for the
distribution of our DVD content, primarily music-related DVDs, with Sony BMG for Europe,
Africa, and most of the Middle East, an exclusive sublicense agreement with Digital Site,
an affiliate of Ray Corporation, for Japan, and an exclusive sublicense agreement with
Warner Music Group for Australia and New Zealand. These agreements contain terms and
conditions similar to those governing our underlying rights agreements. Sony BMG, Digital
Site and Warner Music pay royalties based on either retail or wholesale revenues they
generate, and are responsible for sales, taxes, marketing, publishing, manufacturing and
distribution of our content in their respective territories. We have similar sublicenses
with others for smaller territories.

Worldwide
Broadcast. Buyers of our standard and high-definition broadcast content are
typically cable, pay-per-view, or satellite broadcasters, and sometimes terrestrial (free)
television or in-flight/on-ship broadcasters. Under a typical broadcast license we receive
payment of a one-time, fixed, non-refundable fee for a multi-year exploitation term and in
many instances for a specified number of airings. With respect to pay-per-view, we
typically receive a non-refundable advance against royalties that are based on a
percentage of customer buys. Our obligations under broadcast licensing are usually only to
provide a broadcast master of the title and to ensure that music synchronization rights
are secured.

We
have an exclusive worldwide sales agency agreement with London-based NBD Television Ltd.
(NBD), which has sublicensed to third parties on a territory by territory
basis approximately 100 of our current 270 title broadcast television catalogue, as well
as our new release broadcast television acquisitions. NBD represents us for conventional
television broadcast sales, whether standard or high-definition, including cable,
pay-per-view, video-on-demand, satellite television, and sales to non-theatrical venues.
Our agreement with NBD expires in January 2008.

# COST STRUCTURE

Our
most significant costs and cash expenditures relate to acquiring content for exclusive
distribution and, more recently, the funding of content production or co-production for
exclusive distribution. Additionally, we incurred extraordinary legal, investment banking
and other expenses during this fiscal year related to the shareholder lawsuit filed
against us by Lions Gate Entertainment Corp. (Lions Gate), the strategic
process of the special committee of our Board, and the negotiation and execution of the
definitive agreements between us and BTP providing for our merger into a
company controlled by BTP.

Agreements
to acquire programming typically come in the form of either an exclusive license
agreement, where we pay royalties for the exclusive distribution rights, or an exclusive
distribution agreement, where we generally receive distribution fees and pay net profits
after recoupment of our upfront costs. We generally base our offers of advances against
future royalties (or, for distribution agreements, advances against future net profit
payments and in many cases production funding) on the expected success of a titles
performance at retail, actual cost of the production, and competition for the titles
exclusive distribution rights.

Upon
entering into a typical exclusive license agreement, we pay, as an advance, royalties
which normally become due to the content supplier 45 days following the quarter in which
the sale of units of the title to our retail customers has occurred. Royalties are
contractually expressed as a percentage of net revenues. Upon our recoupment of the
advance, we pay the content supplier royalty overages at the same rate. If we do not
recoup our initial advance by the end of the agreements term, the content supplier
receives no additional royalties but is not typically liable for reimbursement of our
unrecouped advance. Royalty advances may be used by the content supplier in certain cases
to actually produce the content in cases where the content has not yet been completed or
even created. Under these exclusive license agreements, we are responsible for
manufacturing, packaging, menu design, authoring and compression, package design and
layout, selling, marketing and distribution expenses, and sometimes for music publishing
in the case of music-related DVDs and CDs.

Under
a typical exclusive distribution agreement, we may pay upfront fees, which are expressed
as advances against future net profits, or we may pay for the cost of the contents
production in advance. Our net profits for these deals usually take the form of our
distribution fee which is deducted first. Any remaining net profits after we recoup our
incurred costs and additional costs such as the cost of the contents production are
generally paid to the content supplier. We may also split any remaining net profits with
the content supplier according to contractual percentages. If net profits are not
achieved, the content supplier receives only the production costs or distribution fees
advanced, if any. Again, we recoup our incurred costs before any net profit disbursement
is made to the content supplier.

|  
|--
|14

---

In
addition to advances, upfront fees and production costs, the other significant costs we
incur are for:

| |  | DVD
and CD replication
| | - | ----------------------

| |  | packaging
| | - | ---------

| |  | advertising,
promotion, and market development funds provided to retail customers
| | - | ---------------------------------------------------------------------------------

| |  | domestic
shipping costs from self-distribution of exclusive content
| | - | -------------------------------------------------------------------

| |  | personnel
| | - | ---------

| |  | music
publishing on exclusive music-related DVD and CD titles
| | - | -------------------------------------------------------------

Our
financial focus is on achieving long-term, sustainable growth and profitability. We also
seek to improve our cash flow position in order to continue funding operations and
licensing, or entering into exclusive distribution agreements for, high quality DVD and
other entertainment content.

# COMPETITION

When
acquiring distribution rights for exclusive content, we continue to face increasing
competition from:

| |  | Major
Motion Picture Studios
| | - | ----------------------------

| | ° | Sony
Pictures
| | - | -------------

| | ° | Disney
| | - | ------

| | ° | Fox
| | - | ---

| | ° | Paramount
| | - | ---------

| | ° | Universal
| | - | ---------

| | ° | Warner
| | - | ------

| |  | Mini-Majors
| | - | -----------

| | ° | Lions
Gate
| | - | ----------

| | ° | The
Weinstein Company
| | - | ---------------------

| | ° | New
Line
| | - | --------

| |  | Major
Music Labels
| | - | ------------------

| | ° | Sony
BMG
| | - | --------

| | ° | EMI
| | - | ---

| | ° | Universal
| | - | ---------

| | ° | Warner
Music Group
| | - | ------------------

| |  | Independent
Music Labels
| | - | ------------------------

| |  | Independent
DVD and CD Content Suppliers
| | - | ----------------------------------------

For
limited retail shelf space, we also continue to face increasing competition from:

| |  | major
motion picture studios
| | - | ----------------------------

| |  | independent
DVD and CD suppliers
| | - | --------------------------------

| |  | major
and independent music labels who offer DVD content
| | - | --------------------------------------------------------

| |  | other
home entertainment providers
| | - | ----------------------------------

Besides
limited retail shelf space, we also face competition for retailer open to buy
dollars, which are the purchasing budgets that retailers allocate to purchase new release
or catalogue titles.

Competition for Content

We
face increasing competition from other independent distribution companies, major motion
picture studios and music labels in securing exclusive content license and distribution
rights. Although DVD player-household penetration (through sales of stand-alone DVD
players and DVD-based video game player systems) and retail shelf space for home video
formats have started to reach a saturation point, DVD licensing and distribution is still
an attractive business. Many, including New Line, Lions Gate, and several of the major
studios, are expanding efforts in the DVD licensing market, sometimes in the form of
direct-to-video motion pictures. Because the home video rights to most newly released and
catalogue motion pictures are already controlled by the major studios, the market for
high-profile DVD content available to an independent supplier is somewhat limited.
Moreover, the market for high-profile music-related DVD content is also limited as major
and independent record labels continue to increase the number of music-related titles
released on DVD through their own labels.

|                         
|-------------------------
|Image Entertainment, Inc.

---

In
light of the increase in demand and limitation in supply, obtaining quality DVD content at
reasonable prices is becoming ever more challenging. Our internal analyses and forecasts,
which are designed with the goal of timely recoupment of advances, attempt to limit the
upfront advances against future royalties or, for distribution agreements, production and
net profit payments we are willing to pay to secure content rights. Accordingly, we may
not be able to remain competitive against offers from competitors who may at times be
willing to pay larger advances. This challenge is compounded when competitors who lack
broad expertise in the field of DVD licensing occasionally offer advances or other terms
for content which we believe to be unrealistic based upon our own internal forecasts and
historical experience in particular genres. Although such unrealistic offers might have
adverse effects on these competitors businesses in the medium- and long-term, the
short-term effect appears to be an artificial inflation in the price of content, which
effectively decreases our ability to obtain quality content at a reasonable price.
Additionally, as we see more and more opportunities for higher-profile content, we are
increasingly finding ourselves in competition with major motion picture studios, the
mini-majors and major music labels, who tend to have greater financial
resources and the ability to offer higher advances by leveraging their market power
(including significant influence on retailer shelf space allotment) with retailers in
order to obtain larger quantities of product purchases.

The
strategic process of the special committee of our Board has also created uncertainty in
certain licensors and prospective licensors who are comfortable with us, but who might not
be comfortable with one or more of our actual, potential or speculated buyers. Although we
believe this problem has abated with the execution of the merger agreement with BTP, it
has likely resulted in certain failures by us to obtain desired programming.

Despite
these factors, we believe that we will continue to compete successfully in obtaining
exclusive rights to home entertainment content. This is due in large part to our ability
to offer an array of other assets to our program suppliers, including:

| |  | the
high quality of expertise and service our employees provide
| | - | ---------------------------------------------------------------

| |  | our
status as an independent which allows freedom from the major labels, more creative
control to the content creator, comparatively fewer obstacles in content creation,
marketing and distribution, and comparatively simpler accounting for royalties and net
profits to the supplier
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
long history and solid reputation of working effectively with artists, their management
and other valuable suppliers of entertainment programming
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
quality of our finished titles
| | - | ----------------------------------

| |  | our
specialized marketing expertise in areas such as comedy, urban, Latin, music-related,
Broadway and                   special interest titles
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
wide-ranging in-house services
| | - | ----------------------------------

| |  | our
direct and long-standing relationships with mass merchants and traditional and online
retailers of                   entertainment titles
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------

Competition for Retail
Shelf Space

Changing
Landscape of DVD Retailers. We believe the contraction in retail DVD store fronts
(specifically the January and August 2006 bankruptcies of Musicland and Tower), deep price
discounting on previously released DVDs from the major studios, and the selling of our
catalog product by the liquidator who purchased Towers entire inventory, have all
contributed to our reduced sales. In addition, Musiclands inventory of our product
was purchased by our customer Trans World through Musiclands bankruptcy proceeding,
which has negatively impacted Trans Worlds catalog reorders from us. Both Musicland
and Tower were among the strongest supporters of our catalog, buying our product
across-the-board, including premium-priced special edition titles from The Criterion
Collection. On a positive note, our sales to Trans World during fiscal 2007 have been
significantly higher than the prior-year period primarily due to their acquisition of
approximately 400 Musicland stores. Our sales to Internet retailers such as Amazon,
Infinity Resources and NetFlix have also increased significantly. These Internet retailers
offer virtual shelf space, which is critical for us and our near 3,000 title-library.
These increased sales have not replaced the overall lost revenues related to the Musicland
and Tower bankruptcies, however.

|  
|--
|16

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Change
in Buying Patterns  Best Buy Vendor Managed Inventory (VMI) Program. During the
past year, one of our largest DVD customers, Best Buy, has reduced the number of DVD
titles that they carry, with more emphasis being placed on mainstream studio product.
Content from independent suppliers, including our content, has been significantly reduced.
On the other hand, the titles remaining in their stores have been given greater prominence
by being better displayed than before (i.e. face out rather than spine
out DVD placement). In conjunction with this move, Best Buy went to a mandatory VMI
(Vendor Managed Inventory) control system. In the process of implementing this system,
Best Buy returned to us the inventories of our programming which were previously held in
their distribution centers. These new buying practices ensured automatic replenishment,
but also raised the bar in terms of minimum sell-through quantities. In addition, VMI
initial orders, which generally are targeted to provide only a three-week supply of
inventory, are much smaller than non-VMI initial orders. The VMI system results in smaller
initial order quantities, but with steadier replenishment and fewer returns. The current
slate of content managed under VMI at Best Buy is performing well. Not only are we
properly controlling our product and inventory profiles at these stores, but any returns
associated with VMI titles are minimal. Furthermore, we have formed a VMI consortium with
one of the industrys largest wholesale distributors in which our shipments to Best
Buy are combined with numerous other DVD vendors, and costs of servicing the Best Buy
account are now significantly less because of decreases in freight charges. Accordingly,
our acquisition efforts will be geared more toward higher profile titles that will better
complement not only the Best Buy model, but also the current and emerging models of the
other large retailers. We have also deployed VMI systems with two other customers on a
direct shipment basis with no supplier partners, and we will evaluate additional VMI
deployments as the opportunities arise.

Change
in Buying Patterns  Traditional Brick and Mortar Retail Customers.
In addition to Best Buy reducing their initial orders of our new release programming under
VMI, we have seen similar buying patterns emerge at certain other retailers as well. In
the past, some of our retail customers would stock four to six weeks of inventory in their
warehouses, but these customers are now limiting their on-hand stock to three weeks, with
vendors like us being responsible for subsequent replenishment in the event that a title
meets or exceeds sales projections. If a title does not perform up to expectations within
those three weeks, however, it is taken off the shelves within 30 days and has a greatly
reduced chance for future replenishment. On the positive side, the potential for returns
is generally less. We have historically replicated DVDs and stocked our warehouse in
preparation for impending replenishments. In order to offset this emerging change,
however, we have adjusted our inventory replication and stocking procedures. Now, we are
chasing successful titles with manufacturing reorders, rather than risking
significant overstock.

As
shelf space at brick and mortar accounts decreases,  we are
experiencing growth in our sales to online businesses such as Amazon, Infinity Resources
and NetFlix, which possess practically unlimited virtual shelf space.
Generally, since these accounts purchase inventory as it is needed, we have experienced
dramatically fewer returns compared to traditional brick and mortar retail
businesses. By placing a greater emphasis on Internet marketing, we are driving a
significant number of consumers toward these online companies.

Our
exclusive content competes for a finite amount of shelf space against a growing supply and
diversity of entertainment content from other suppliers. New DVD releases generally exceed
200 titles a week. We believe this competition can be especially challenging for
independent labels like us, because the new DVD releases of major studios often have
extremely high visibility and sales velocity in the millions of units, and typically
require much more shelf space to support. In light of the impact of major studio releases,
our expenses with respect to providing market development funds and cooperative
advertising dollars to our retail customers for items such as in-store displays and store
circulars continue to increase, even as the availability of these opportunities continues
to decrease. This shelf real estate, whether real or virtual, is becoming more expensive
as the total number of DVD releases continues to grow. With the exception of our more
popular new release titles and top-selling catalogue titles, it can be a challenge to
obtain the product placement necessary to maximize sales, particularly among the limited
number of major retailers who comprise our core customers. Additionally, even though the
shelf space in many retail stores may not be shrinking, it is no longer growing at the
rates we had previously experienced, and we are also beginning to perceive a retailer
trend toward greater visibility for titles at the expense of quantity (i.e. face
out rather than spine out DVD placement). This has the effect of
reducing the total number of titles actually carried by a retailer, and since we tend to
carry and acquire many different titles, typically with lower sales velocity, this trend
may have a disproportionate effect on us compared to the major studios.

|                         
|-------------------------
|Image Entertainment, Inc.

---

Retailers
are also increasingly expecting studios and independents to pay to secure display and
shelf space within their stores. Even some successful Internet retailers now require paid
participation in these types of programs in order to ensure visibility and positioning on
their Web sites. Some of these programs can cost as much as 6% or more of a
retailers total order, although we may also realize significant advertising and
marketing benefits from such programs, especially if they grant competitive benefits over
other studios and independents that are unable or unwilling to participate. As competition
in our industry continues to increase, we expect that more retailers will adopt these
types of programs, which would result in downward pressure on our gross margins.

Vendor
Managed Inventory (VMI).Under a VMI system, product suppliers are responsible for
monitoring, stocking, and fulfilling directly to individual retail stores and outlets.
Larger retailers, who have been transacting business via VMI with the major studios for
years, are starting to require smaller independents (i.e. product suppliers other than
major studios, music labels and mini-majors) to adopt this method of inventory
management. See Change in Buying Patterns  Best Buy Vendor Managed
Inventory (VMI) Program above.

Our
VMI systems provide timely and accurate sales and inventory data as well as empower us to
maintain proper stocking levels at retail. In our largest consortium-based VMI engagement,
with Best Buy, we have seen reduced returns and increased inventory turns. With respect to
long-term benefits, we expect the implementation of VMI relationships with retail
customers to:

| |  | sell
more units and reduce returned items by better matching inventory to real-time demand
| | - | ------------------------------------------------------------------------------------------

| |  | reduce
potential overproduction and excess inventory quantities by more accurately forecasting
orders
| | - | -----------------------------------------------------------------------------------------------------

| |  | reduce
processing and warehousing fees by maintaining a leaner supply chain
| | - | ---------------------------------------------------------------------------

| |  | increase
our importance as a direct supplier of participating retail partners
| | - | -----------------------------------------------------------------------------

Competition for Retailer
Open to Buy Dollars

We
compete with other content suppliers for limited open to buy dollars allocated
by retailers to purchase new release or catalogue DVD and CD titles. Open to buy dollars
are becoming more scarce for independents like us, since such dollars are often devoted to
high-profile new releases from major studios, particularly during the holiday season.
Reduced wholesale DVD pricing instituted by the major studios and labels, coupled with
their ongoing catalogue campaigns and marketing muscle, has also increased competition for
open to buy dollars. Most studios and labels are subsidiaries of much larger media
conglomerates that have financial resources far greater than ours. Moreover, the strategic
process of the special committee of our board of directors has created significant
uncertainty among our customers, who have expressed concern about whether we would be
continuing as an independent entity, and specifically whether we  or any potential
buyer  would stand by our currently permissive return policies. From our perception,
our sales over the past fiscal year have suffered as a result.

Nevertheless,
we believe that titles from an independent content supplier like us continue to be
attractive to retailers because of the gross margins retained by the retailers from the
sale of independent titles. In contrast, there is a great deal of pricing competition
among retailers for the new release theatrical blockbusters, since such major hits are
often advertised as loss leaders to bring in retail traffic. We do not currently sell new
release major theatrical motion picture titles.

Increasing Competition

As
our industry matures, with DVD set-top penetration of U.S. television households having
exceeded 79% at the close of calendar 2006, and the amount of retail space allocated for
DVD programming leveling off, the competition level among content suppliers will continue
to rise. The major studios remain consistent and prolific in their ability to bring new
theatrical titles to retailers. They have large libraries of content to release on DVD.
New independent suppliers are continually emerging, further adding to the competition. The
additional promotional opportunities and open to buy dollars may be severely compromised
by the new major theatrical programming, new independent suppliers and the vast catalogues
of content controlled by the major studios.

Industry Trends

According
to The Digital Entertainment Group (DEG), a Los Angeles-based, industry-funded
nonprofit corporation that among other things provides updated information regarding
entertainment formats to both the media and retail trade, total consumer spending on DVD
(sell-through and rental) in calendar 2006 increased 5.7% to $24.1 billion, from $22.8
billion in calendar 2005. The Los Angeles Daily News reported that some consumers may not
be buying recently introduced high definition DVDs because of the ongoing format war
between supporters of the Blu-ray Disc® camp and the HD-DVD camp, which started last
year. The belief is that consumers may be confused by the different formats, and also do
not want to risk buying a particular format only to see the other prevail, as was the case
during the VHS/Betamax format war over two decades ago. Accordingly, the high-definition
DVD industry continues to show slow growth.

|  
|--
|18

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DVD
remains popular, with the DEG reporting that 33 million DVD players were sold to consumers
in 2006. The market for DVD is maturing, if not already matured. The DEG reports that, of
the approximately 88 million homes with DVD players, 55% have more than one player when
you include set-top DVD, portable DVD, and TV/DVD and DVD/VCR combination players. Many
media analysts have predicted, and we concur, that both DVD hardware and software will
grow at a far slower pace than it did during the first five years since DVDs
introduction.

The
DEG reports that more than 30 million U.S. homes now have HDTV with an estimated 12.5
million sets sold in 2006 and nearly 5 million in the fourth quarter alone. Since the DVD
format was launched in 1997, more than 34.5 million HDTV sets have been sold to consumers,
and it is estimated that 11% of HDTV owners have more than one set. An estimated 750,000
high definition DVD players and high definition DVD/video game consoles were sold in 2006.
There are currently 12 models of high-definition players, including Blu-ray Disc® and
HD-DVD. At the January 2007 Consumer Electronics Show in Las Vegas, Nevada, Warner Bros.
introduced the Total HD Disc, a hybrid double-sided Blu-ray Disc®/HD-DVD disc that
should arrive at approximately the same time that LG Electronics makes available a DVD
player capable of playing both formats. This hybrid technology is meant to attract
consumers who are wary of buying technology that might become obsolete, similar to when
Betamax lost the format battle to VHS.

According
to Adams Media Research (Hollywood Aftermarket reports dated January 31 and February 28,
2007), DVD set-top penetration of television households will reach 84.3% of the estimated
113.1 million television households through December 31, 2007, excluding DVD game players.
Adams Media Research expects this penetration to reach 89.3% by the end of calendar 2011.
This represents an estimated 2.5% annual compound growth rate in DVD set-top player
households. Additionally, according to Adams Media Research, high definition video set-top
penetration of television households will reach 1.1 million households through December
31, 2007. Adams Media Research expects this penetration to reach 28.3 million households
by the end of calendar 2011, and that high definition video households of all types
(including high definition video, game and PC) will reach 41.3% of all television
households by the end of 2011.

According
to Adams Media Research, sell-through video (VHS/DVD/Hi-Def DVD combined units) consumer
spending is expected to grow 18.9% from 16.45 billion at December 31, 2006 to 19.56
billion by the end of 2011, a compound annual growth rate of approximately 3.5%. Net
supplier revenue from sell-through video is expected to grow 23.6%, from $12.9 billion at
the end of 2006, to $15.9 billion through 2011, a compound annual growth rate of
approximately 4.3%. Net supplier revenue from sell-through and rental video is expected to
grow 23.8%, from $14.9 billion at the end of 2006, to $18.5 billion through 2011, a
compound annual growth rate of approximately 4.4%.

Adams
Media Research estimates that annual DVD disc buys per DVD set-top household were 12.8
discs in 2006, slightly lower than 13.5 discs in 2005. VHS sell-through consumer spending
continues to decline rapidly, down from $1.2 billion in 2004 to $463 million in 2005 and
to $89 million in 2006. According to the DVD Release Report Revised 5/09/07, the average
consumer cost for all DVD releases regardless of genre was $22.35 per disc for calendar
2006, up slightly from $21.23 for calendar 2005. Approximately 34% of DVDs had an average
consumer cost of less than $15 in 2006, down from approximately 40% in 2005.

The
typical DVD buying consumer has largely shifted from a catalogue programming-focused early
adopter to a mass market buyer driven primarily by high-profile, big-budget theatrical
films. Both major studio and independent DVD suppliers now see that the primary drivers of
revenues are new releases, which generate both retail and consumer interest and also help
drive the sale of catalogue programming. We have a diverse catalogue of content, and
according to the DVD Release Report Revised 5/09/07, we are the fourth-largest source for
music on DVD with 602 titles in active release (behind only the majors Sony
BMG and Universal and independent supplier MVD Entertainment), the second largest source
of direct to DVD programming with 421 titles in active release, the third largest source
of foreign language programming on DVD with 278 titles in active release, and the third
largest source for special interest programming on DVD with 495 titles in active release.
We typically add an average of 30-35 new DVD titles per month, with content spanning many
genres, to our current catalogue of over 2,800 active DVD titles. In addition, we
typically add an average of five new CD titles per month, and our current active catalogue
contains approximately 250 audio titles. Sales of our catalogue titles are affected by the
strength of our new releases, continued customer demand and the availability of retail
shelf space and retailer open to buy dollars.

|                         
|-------------------------
|Image Entertainment, Inc.

---

For
more information on risks relating to competition, please refer to Item 1A. Risk
FactorsRisks Relating to Our Business and Risks Relating to Our
Industry.

# TRADEMARKS

We
have obtained U.S. federal registrations for the following trademarks:

| |  | Image
| | - | -----

| |  | Image
Entertainment
| | - | -------------------

| |  | the
Image Entertainment logo
| | - | ----------------------------

| |  | Image
Music Group
| | - | -----------------

| |  | the
Egami Media logo
| | - | --------------------

| |  | Image
Entertainment Japan
| | - | -------------------------

We have also filed a U.S. federal
trademark application for Home Vision Entertainment. Our only foreign
trademark is a Japanese trademark for Image Entertainment Japan. It is our policy to
protect and defend our trademark rights.

# EMPLOYEES

As
of June 1, 2007, we had 159 full-time employees and one part-time employee employed by us
(including Egami). Within the next several months, we will be closing our Las Vegas
distribution facility, which will decrease our headcount to 124 full-time employees. Nine
of our employees, including all of our executive officers, are covered by employment
agreements, with the remainder being at-will employees.

# SEASONALITY

Our
Results of Operations Fluctuate Based on Seasonality and Variability. We
have generally experienced higher sales of DVDs and CDs in the quarters ended December 31
and March 31 due to increased consumer spending associated with the year-end holidays.
Accordingly, our revenues and results of operations may vary significantly from period to
period, and the results of any one period may not be indicative of the results of any
future periods. In addition to seasonality issues, other factors have contributed to
variability in our DVD and CD net revenues on a quarterly basis. These factors include:

| |  | the
popularity of exclusive titles in release during the quarter
| | - | ----------------------------------------------------------------

| |  | timing
of delivery or non-delivery of DVD or CD content or rights clearances by our content
providers
| | - | -----------------------------------------------------------------------------------------------------

| |  | our
marketing and promotional activities
| | - | ----------------------------------------

| |  | our
rights and distribution activities
| | - | --------------------------------------

| |  | the
availability of retailer shelf-space
| | - | ----------------------------------------

| |  | the
level of retailer open to buy dollars
| | - | -----------------------------------------

| |  | the
extension, termination or non-renewal of existing license and distribution rights
| | - | -------------------------------------------------------------------------------------

| |  | general
economic changes affecting the buying habits of our customers, particularly those changes
affecting consumer demand for home entertainment hardware, packaged media and digital
content
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

# ITEM 1A.      RISK FACTORS

You
should carefully consider and evaluate all of the information in this Annual Report,
including the risk factors listed below. If any of these risks occur, our business,
results of operations and financial condition could be harmed, the price of our common
stock could decline, and future events and circumstances could differ significantly from
those anticipated in the forward-looking statements contained in this Annual Report.

|  
|--
|20

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Risks Relating to Our
Business

The
Residual Effects of the Prolonged Proxy Contest with Our Former Second-Largest Shareholder
and Our Special Committees Strategic Process May Adversely Affect Our Retail
Sales.As a result of the proxy contest with our former second-largest
shareholder, Lions Gate, and our special committees strategic process, retail sales
may be adversely affected due to retail buyers uncertainty regarding our
future.  Consequently, retail buyers may further reduce their new purchases and
existing inventories of our programming in order to address this uncertainty and this may
have negative result on our business and results of operations.  There can be no
assurance that we will be able to persuade our retail buyers of our ability to operate
independently, or that our retail buyers will increase their purchases of our programming
in the future.

The
Transitioning of Our Warehousing and Distribution Services to Sonopress May Disrupt or
Delay Our Business Activities. We are currently in the process of transitioning all of
our warehousing and distribution services to Sonopress facility in Pleasant Prairie,
Wisconsin. Although we have an existing relationship with Sonopress, who replicates our
DVDs, and although Sonopress has hired key people from our previous replicator who were
already very familiar with our company and business, distribution is still a new business
initiative for Sonopress. Accordingly, there may be delays and inefficiencies as they
enter into this sector. Additionally, as with any major transition, there may be delays
and inefficiencies inherent within the transitioning process. Any failure of Sonopress to
warehouse and distribute our products in a timely manner and with the same consistent
quantity and quality that we and our customers have come to expect, may adversely affect
our revenues and profits.

We
Have a High Concentration of Sales to Relatively Few Customers Which May Result In
Significant Uncollectible Accounts Receivable Exposure. For the year ended March 31,
2007, Amazon.com, Inc., AEC One Stop Group, and Anderson Merchandisers (who supplies
Wal-Mart) accounted for 12%, 12% and 10%, respectively, of our net revenues. For the year
ended March 31, 2006, Anderson Merchandisers accounted for 11% of our net revenues. For
the year ended March 31, 2005, Anderson Merchandisers, Best Buy and AEC One Stop Group
accounted for approximately 17%, 12%, and 10%, respectively, of our net revenues. At March
31, 2007, AEC One Stop Group and Anderson Merchandisers accounted for 20% and 17%,
respectively, of our gross accounts receivables. At March 31, 2006, Anderson Merchandisers
and AEC One Stop accounted for 13% and 12%, respectively, of our gross accounts
receivables. Additionally, our top five customers accounted for over 42% of our fiscal
2007 net revenues. Any combination of these customers filing for bankruptcy or
significantly reducing their purchases of our programming would have an adverse effect on
our financial condition, results of operations, and liquidity. Our top 25 customers
accounted for approximately 82% of our fiscal 2007 net revenues.

We
are not an exclusive supplier to any of our retail customers, and there is no guarantee
that we will continue recognizing significant revenue from sales to any particular
customer. If we are unable to maintain the sale of our titles at their current levels to
any these five customers, and are unable to find other customers to replace these sales,
there would be a negative impact on our revenues and future profitability. In addition, we
face credit exposure from our retail customers and may experience uncollectible
receivables from these customers should they face financial difficulties. On August 20,
2006, our long-term customer MTS, Inc., parent of Tower Records, filed for Chapter 11
bankruptcy. We estimated our net expense relating to the ultimate uncollectible accounts
receivables from Tower and recorded a net charge of $432,000. Our net revenues with Tower
for the six months ended September 30, 2006, were $987,000, or 2.2% of overall net
revenues.  Our net revenues with Tower for the fiscal year ended March 31, 2006, were
$4.3 million, or 3.9% of our overall net revenues for the year. Tower represents the
second of our significant retail customers to recently file for bankruptcy. Musicland
Stores filed bankruptcy in January 2006 and we took a net charge to expense of $1.6
million. With a high concentration of sales to relatively few customers, we cannot assure
you that our other retail customers will not experience financial difficulties leading to
uncollectible accounts receivable.

Our
Recent Layoff May Disrupt or Delay Our Business Activities.  On November 9, 2006,
we eliminated 29 positions, including our UK office, and lost six employees through
attrition, representing approximately 17% of our total personnel.  Although we have
reassigned the duties associated with these eliminated positions to other personnel,
inefficiencies related to task unfamiliarity, heavier workloads, loss of knowledge and
unfilled gaps may arise, especially if we are unable to effectively manage and implement
the transition.  Any such inefficiency may cause disruption or delay in our business
activities.

Relativity
Medias Failure to Deliver the Expected Number or Quality of Motion Pictures May
Adversely Affect Our Business.   We do not control the timing or manner in
which Relativity Media will finance, produce and deliver programs to us.  Relativity
Medias decisions regarding the selection, delivery and timing of release of
theatrical and direct-to-video motion picture titles will have a significant effect on our
future revenues.  We also do not control the theatrical distributors level of
promotion of major motion pictures, and domestic box office performance is likely to
affect the films subsequent performance in home video.  Any decision by
producers or theatrical distributors not to deliver, distribute or adequately promote
films, or to promote our competitors motion pictures to a greater extent than they
promote ours, could have a material adverse effect on our business, results of operations
and financial condition.

|                         
|-------------------------
|Image Entertainment, Inc.

---

In
addition, due to the substantially higher projected revenues from home video distribution
of theatrical motion pictures, our distribution costs for each film will be greater, thus
exposing us to greater risk in the event that any or all of the pictures do not sell as
well as projected.  Our success depends on the commercial success of motion pictures
which is unpredictable, and failure to achieve projected sales could have a material
adverse effect on our business, results of operations and financial condition.

Failure
to Effectively Manage Any Potential Future Growth from the Relativity Media Agreement or
the Merger with BTP, or Both, May Adversely Affect Our Business. We will face
substantial challenges in expanding our distribution capabilities to adequately meet the
anticipated increase in our average sales per title and our overall sales as a result of
major motion pictures to be delivered to us for home video and digital distribution over
the ten-year term of our agreement with Relativity Media, and as a result of our expected
merger with BTP.  Expanding to meet these needs could require us to incur significant
costs and cause the diversion of managements time and resources.  We may not
handle the expansion effectively and efficiently, it may be unsuccessful or take longer
than anticipated, and we may not realize the anticipated benefits from the transaction,
which could result in write-offs and other related expenses.  Any of the foregoing
could have a material adverse effect on our business, results of operations and financial
condition.

In
addition, we will be financially responsible for the funding of post production,
development of ancillary materials, package design, disc replication, marketing and
advertising and distribution costs for each of the Relativity Media and BTP-controlled
titles. We may require increased funding to meet our increased requirements, which we may
not be able to obtain in sufficient time, on acceptable terms, or at all.  Our
ability to grow, maintain and expand our distribution of motion pictures and fund
increased operating expenses may depend upon our ability to obtain funds through equity
financing, debt financing (including credit facilities) or the sale or syndication of some
or all of our interests in film projects or other assets.  If we do not have access
to financing, and if other funding does not become available on terms acceptable to us,
there could be a material adverse effect on our business, results of operations and
financial condition.

Failure
of Our Strategic Alliances Could Have a Material Adverse Affect on Our Business. We
have co-produced motion pictures with Dark Horse, Graymark, Amicus and Sisters Wooster,
Inc., and, should we have adequate capital resources, we plan to continue our strategy of
developing key alliances with other third party content producers. We will rely on our
co-producers to develop and produce films. Particularly when produced by independent
filmmakers, each film is a separate business venture with its own management, employees,
equipment and budgetary requirements. There are substantial risks associated with film
production, including contract problems with, or disability of, directors, actors and
other key artistic and technical personnel, weather and other delays, damage to sets,
equipment or film, and the inability of production personnel to comply with budgetary or
scheduling requirements. Such problems could materially increase the cost of production,
increase the amount of time between our expenditure of funds and receipt of revenues, or
cause the project to be abandoned at any stage if further expenditures do not appear
commercially feasible. Accordingly, there is no assurance that we will be successful in
our strategic alliances, and any failure of our present and future alliances to produce
commercially viable content at an acceptable cost could have a material adverse effect on
our business. Additionally, there is no assurance that we will be able to find further
desirable strategic alliances as we continue pursuing new co-production deals and similar
relationships, or have sufficient capital to fund them.

We
Have a High Concentration of Sales From Relatively Few Titles. Our top five fiscal
2007 new release exclusive titles Jeff Dunham: Arguing with MyselfDVD and CD,
Katt Williams Live DVD and CD, the original Twilight Zone TV
series: Complete Definitive CollectionDVD, Yanni Live: The Concert Event
DVD and CD and Criterions Dazed and Confused DVD accounted for approximately
11% of our fiscal 2007 net revenues. Our top ten fiscal 2007 new release exclusive titles
accounted for approximately 17% of our fiscal 2007 net revenues. Although catalogue sales
of these titles continue to be relatively strong, sales for these titles nevertheless have
decreased over time and will probably continue to do so until our rights expire. Net
revenues from new release DVD titles, where a new release title is defined as released
during fiscal 2007, accounted for approximately 58% of fiscal 2007 net DVD revenues and
net revenues from catalogue DVD titles, where catalogue is defined as a title first
released in a previous fiscal year, accounted for approximately 42% of fiscal 2007 net DVD
revenues. Revenues from new release DVD titles accounted for approximately 51% and 65% of
fiscal 2006 and 2005 net DVD revenues, respectively. Revenues from catalogue DVD titles
accounted for 49% and 35% of fiscal 2006 and 2005 net DVD revenues, respectively. If we
cannot acquire titles of equal or greater strength and popularity, our future net revenues
would be negatively impacted.

|  
|--
|22

---

We
May Need Additional Funding to Continue Acquiring Desirable Programming. Availability
of working capital is a substantial factor in our ability to produce and/or acquire new
content. Therefore, maximizing available working capital is critical to our business
operations. We may need to raise additional funds to acquire the rights to content or to
create content we find desirable. Should additional funds be raised through the issuance
of equity or convertible debt securities, the percentage ownership of our existing
stockholders may be reduced. If adequate funds are not available or unavailable on
acceptable terms, we may find we are unable to fund expansion, continue offering products
and services, take advantage of acquisition opportunities, develop or enhance services or
products, and/or respond to competitive pressures in the industry.

Our
Current DVD and CD Genre Revenue Concentrations May Become Unpopular With Our Retail
Customers and End-Consumers, Which May Adversely Affect Our Business. During fiscal
2007 and 2006, our DVD title genre revenue concentration was heavily weighted toward
comedy, music and television-related DVD programming. In 2005, our DVD title genre revenue
concentration was heavily weighted toward music-related DVD programming. We may not be
able to successfully continue producing or acquiring content in the same genres, or
achieve the same strength within the genres we were successful with in fiscal 2007. If we
cannot compete successfully in the home entertainment market for higher-profile DVD and CD
content, our business may be adversely affected.

Inventory
Obsolescence May Adversely Affect Our Business. We maintain a substantial investment
in DVD and CD inventory, and if we overestimate the demand for a particular title, we may
retain significant quantities of that title in our warehouse. Retained inventory occupies
valuable storage space and may become obsolete as our distribution term for the title
expires. Although we may sell such inventory at a deeply discounted price toward the end
of the distribution term in order to recoup our manufacturing, storage and other costs,
there is no guarantee that a market will exist for a given title, even at the deeply
discounted price. Alternatively, we may renew the exclusive distribution rights to an
expiring title, but there is no guarantee that we will be able to do so, or do so on terms
acceptable to us. Additionally, our license and/or distribution agreements sometimes
contain terms, such as minimum royalties per unit and music publishing fees, which
effectively prevent us from steeply discounting the price on some titles. We have a strong
history of renewing our exclusive rights under license and distribution agreements.

Problems
Distributing Our Programming Internationally May Adversely Affect Our Business. We
distribute our programming internationally. As a result, our business may be subject to
various risks inherent in international trade, many of which are beyond our control. Risks
faced in distributing our programming internationally include: cancellation or
renegotiation of contracts, changes in laws and policies affecting international trade
(including taxes), credit risk, fluctuating foreign exchange rates and controls, civil
strife, acts of war, guerilla activities, insurrection, terrorism, changing retailer and
consumer tastes and preferences with regard to our programming, differing degrees of
protection of our intellectual property, cultural barriers, and potential instability of
foreign economies and governments, which may adversely affect our international sales. To
date, we have not entered into foreign currency exchange contracts.

The
Majority of International Revenues Are Generated By Three Sublicensees.Revenues
generated from our international business segment are primarily derived from the sales
efforts of Sony BMG, Warner Music Group and Digital Site. Should any of Sony BMG, Warner
or Digital Site default on their respective sublicense agreements with us or fail to
successfully perform, an important part of our business strategy, financial condition,
results of operations and cash flows could be negatively impacted.

We
Have Direct and Indirect Foreign Currency Exchange Risk.Although our Sony BMG and
Digital Site sublicense agreements are U.S. Dollar denominated, with these parties
reporting to us and paying us in U.S. Dollars, the underlying Sony BMG sales transactions
are in Euros and the underlying Digital Site sales transactions are in Yen. On June 9,
2007, the Euro was equivalent to approximately U.S. $1.34 and the Yen was equivalent to
approximately U.S. $0.00824. Should the U.S. Dollar strengthen compared to either the Euro
or the Yen, our sublicensors reported royalties to us on a title-by-title basis and
in the aggregate would decline (assuming consistent unit sales) and thus reduce our
revenues recognized.

|                         
|-------------------------
|Image Entertainment, Inc.

---

We
Have an Accumulated Deficit and May Incur Additional Losses.We sustained net losses
in fiscal 2007 and 2006, and were profitable in fiscal 2005. Our accumulated deficit at
March 31, 2007 was $22.3 million. Due to the inherent unpredictability of high-profile
content acquisition and competition for limited retail shelf space, we may incur losses
again in the future.

Inability
to Maintain Relationships with Our Program Suppliers and Vendors May Adversely Affect Our
Business. We receive a significant amount of our revenue from the distribution of
those DVDs for which we already have exclusive agreements with program suppliers. We can
give no assurances, however, that titles in production which have been financed by us will
be timely delivered as agreed or of the expected quality. Delays or inadequacies in
delivery, including rights clearances, could negatively impact the performance of any
given quarter or fiscal year. We can give no assurance that such content will ultimately
be purchased in internally forecasted quantities by our retail customers or ultimately
desired by end-consumers. We also cannot assure you that we will be able to renew these
exclusive rights as existing agreements with program suppliers expire, that our current
program suppliers will continue to support the DVD format in accordance with our exclusive
agreements, that our current content suppliers will continue to license titles to us on
the current terms or on terms favorable to us, or that we will be able to establish new
beneficial supplier relationships to ensure acquisition of exclusive titles in a timely
and efficient manner.

The
Full Exploitation of Our Rights Requires Us to Conduct Business in Areas Where Our
Expertise Is Limited. In order to fully exploit some of the rights we have acquired,
we are required to conduct business in sectors (e.g. Internet, rental, broadcast, video on
demand, in-flight, satellite) where we are not as experienced as we are in the DVD and
home video sectors. Accordingly, when exploiting such sectors in which we are less
experienced, we may realize a greater proportion of costs, or we may not realize as much
of a proportion of revenue, as we would in the DVD and home video sectors.

Loss
of Key Personnel May Adversely Affect Our Business. Our success greatly depends on the
performance of our executive management, including President and Chief Executive Officer
Martin Greenwald, Chief Operating Officer David Borshell and Chief Financial Officer Jeff
Framer. The loss of the services of key persons of our executive management could have a
material adverse effect on our operating results and financial condition.

Occurrence
of Events for Which We Are Not Insured May Adversely Affect Our Business. We maintain
insurance to protect ourselves against various risks related to our operations. This
insurance is maintained in types and amounts that we believe to be reasonable depending
upon the circumstances surrounding each identified risk. However, we may elect to limit
coverage or not to carry insurance for some risks because of the high premiums associated
with insuring those risks or for various other reasons. For example, we do not carry
earthquake insurance in light of the steep increase in premiums in Southern California
after the Northridge earthquake on January 17, 1994. Occurrence of events for which we are
not insured may affect our cash flows and overall profitability.

Risks Relating to Our
Industry

DVD
Sales Are Not Sustaining the Same Level of Growth as Before. We believe that consumer
interest in the DVD format is partly due to interest in building the consumers
personal DVD library of desired entertainment programming. Although our exclusive titles
have generally shown stable sales over extended periods, as consumers build their DVD
libraries, or with the introduction of new home entertainment formats, DVD sales may
decline and adversely affect our operations. In addition, the leveling off of DVD player
penetration has clearly resulted in a similar leveling off in DVD sales growth. For more
information regarding the trend of DVD sales growth, see Item 1. Business
 Industry Trends above.

Decreasing
Retail Prices for DVDs May Negatively Impact Our Revenues. The home entertainment
programming market in which we compete is rapidly evolving and intensely competitive. Many
of our competitors, including major studios, are increasingly offering programming,
particularly DVD programming, at lower prices. They may be able to produce or secure
content on more favorable terms and may be able to adopt more aggressive pricing policies
than we are able to adopt. While we strive to improve our operating efficiencies and
leverage our fixed costs so that we can afford to pass along these savings to our
customers in the form of lower prices, the industry trend of lowering prices may, over
time, lead to higher levels of competition and, therefore, lost sales, decreased profit
margins or decreased overall revenues.

|  
|--
|24

---

Failure
to Effectively Expand Vendor Managed Inventory (VMI) May Adversely Affect Our
Business. Many large retailers allow approved suppliers to manage inventory within VMI
systems whereby suppliers like us are responsible for planning, monitoring, stocking and
fulfilling directly to individual retail stores and outlets.  We have fully
implemented all of the necessary VMI software and systems and are currently engaged in
providing this service to three significant customers who require VMI in order to continue
direct shipments with them.  We are evaluating additional opportunities to deploy our
VMI system with other retail customers.  We cannot assure you that implementation of
VMI with other customers will be done in a timely or effective manner, or that the VMI
software we have implemented will be acceptable to other retail customers. Implementation
of VMI requires capital expenditures for initial setup, installation and integration. In
addition, we are incurring ongoing fees for software maintenance and support, item
planning, order management and picking, packing, labeling and shipping of product. Failure
to implement VMI in a timely manner with other customers could result in decreased
opportunities for shelf space or decreased margins, and may require us to sell to VMI
customers indirectly through third-parties who have already implemented VMI. While we
should be able to add other customers without significant additional costs or time, there
can be no assurance this will be the case, and VMI implementation may require additional
freight charges as inventory is sent directly to retail stores and outlets in smaller
packages with greater frequency.

Our
Success Depends on the Commercial Success of Our Programming. Operating in the
entertainment industry involves a substantial degree of risk. Each music performance,
feature film or other programming title is an individual artistic work, and unpredictable
audience reactions primarily determine commercial success. The commercial success of a
title also depends upon the quality and acceptance of other competing programs or titles
released into the marketplace, critical reviews, the availability of alternative forms of
entertainment and leisure activities, general economic conditions and other tangible and
intangible factors, all of which are subject to change and cannot be predicted with
certainty. Our success will depend in part on the popularity of our content which, in
turn, depends on our ability to gauge and predict expected popularity. Even if a film
achieves success during its theatrical release, the popularity of a particular program and
its ratings may diminish over time, which may have a material adverse affect on our
business, results of operations or financial condition. Timing and timeliness are also
sometimes relevant to a programs success, especially when the program concerns a
recent event or historically relevant material (e.g. an anniversary of a historical event
which focuses media attention on the event and accordingly spurs interest in related
content).

Decreasing
Retail Shelf Space May Limit Sales of Our Programming. We face increasing competition
from major motion picture studios, music labels and other independent content suppliers
for limited retail shelf space and retailer open to buy dollars. Although the amount of
retail shelf space for DVDs had previously been growing in approximate correlation to the
growth rate in penetration of DVD players, the leveling off of DVD player penetration has
resulted in a similar leveling off in retail shelf space growth. It is within this
changing environment that our exclusive content competes for a finite amount of shelf
space against a growing supply of entertainment content. Because the new DVD releases of
major studios often have extremely high visibility and sales velocity in the millions of
units, which typically require more shelf space to support, we may not be able to afford
or obtain the product placement necessary to maximize sales, particularly among the
limited number of major retailers that are our core customers, which could result in
decreased revenues and gross margins. For more information regarding decreasing retail
shelf space due to DVD releases of major studios, see Item 1. Business 
Competition above.

Our
Film Production Efforts May Not be Financially Successful. Our co-produced films are
more expensive to create than our music and stand-up comedy event DVD co-productions, and
the time between our expenditure of funds and receipt of revenues is longer. While much of
our programming is sold to retailers on a sell-through basis, the financial success of our
filmed programming will depend on our ability to generate higher sales to retailers who
primarily rent programming such as Blockbuster, Movie Gallery, Hollywood Entertainment
(now a wholly-owned subsidiary of Movie Gallery) and Netflix, as well as to mass merchants
such as Wal-Mart, Costco and Target. Our filmed programming may not ultimately be as
desirable to our target customers as we would hope, which would lead to lower than
expected sales, decreased profit margins or losses.

Conflicting
High-Definition DVD Formats May Cause Inefficiencies. Currently, two major platforms
are competing to become the dominant high-definition format, and talks to unify the
platforms have been unsuccessful. The HD-DVD and Blu-ray Disc® platforms have both
recently launched. For many of our titles, we hold rights to both platforms, but
simultaneously supporting both platforms will cause increased production costs and
decreased efficiencies with respect to inventory management and sales. Moreover, competing
platforms may cause a delay in high-definition player market penetration, and mainstream
acceptance of high-definition DVD in general, as consumers may decide to wait and see
which platform prevails before purchasing a player.

|                         
|-------------------------
|Image Entertainment, Inc.

---

We
May Not Be Able to Keep Pace with Technological Advances. The entertainment industry
in general, and the music and motion picture industries in particular, are continuing to
undergo significant changes, primarily due to technological developments. Because of the
rapid growth of technology, shifting consumer tastes and the popularity and availability
of other forms of entertainment, it is impossible to predict the overall effect these
factors could have on potential revenue from, and profitability of, distributing
entertainment programming. It is also impossible to predict the overall effect these
factors could have on our ability to compete effectively in a changing market.

An
Increase In Product Returns May Adversely Affect Our Business.As with the major
studios and other independent companies in this industry, we experience a relatively high
level of product returns as a percentage of our revenues. Our allowances for sales returns
may not be adequate to cover potential returns in the future, particularly in the case of
consolidation within the home video retail marketplace which, when it occurs, tends to
result in inventory consolidation and increased returns. Our experience over two of the
past three years has been one of increasing return rates, and we expect this trend to
continue.

Illegal
Piracy May Reduce Our Revenues.The music industry is facing a major challenge in the
form of illegal piracy resulting from Internet downloading and/or CD recorders. This
piracy has negatively affected industry revenues and profits. Although we currently derive
only 4% of our revenues from audio CDs, we are hopeful that our proportional revenues in
this sector will increase. Additionally, according to Nielsen Media Research, just over
17% of U.S. TV households now have a digital video recorder (DVR). According to In-Stat,
DVRs are gradually gaining greater market penetration: shipments of DVRs are estimated to
be 19.8 million units for calendar 2006. As DVD recorders, DVRs and high-speed Internet
connections become more popular, and the storage capacity of personal computers increases,
we may face greater piracy concerns with respect to our core DVD business.

Others
Failure to Promote Our Programming May Adversely Affect Our Business. Decisions
regarding the timing of release and promotional support of programming which we license
and distribute are important in determining the success of a particular music concert,
feature film or related product. We may not control the manner in which a particular
artist, film or related product is marketed and promoted, and we may not be able to fully
control our corresponding DVD or CD release. Although artists, record companies, studios
and producers have a financial interest in the success of any such concerts or films
distributed by us, any marketing or promotional decision or restriction by such persons
may negatively affect the success of our titles. Additionally, the availability of
retailer programs relating to product placement, co-op advertising and market development
funds, and our ability and willingness to pay for such programs, are also important with
respect to promoting our exclusive titles.

If
DVD Cannot Compete Successfully with Other Formats of Home Entertainment, Our Revenues May
Be Negatively Impacted. The DVD format competes with other formats of in-home
entertainment, such as network, syndicated, cable and pay-per-view television, and home
satellite systems. The DVD format also competes with new and emerging technologies in the
entertainment industry, such as entertainment programming on the Internet, video on
demand, high-definition television, digital videotape, and optical discs with greater
storage capacity. These alternate home entertainment formats and emerging content delivery
technologies could negatively impact the overall market for our DVD sales, especially if
we are unable to continue to adapt and exploit the development and advancement of such
technology.

If
We Cannot Continue to Secure DVD License and Distribution Rights, Our Business May Be
Materially Adversely Affected. We cannot assure you that we will be able to continue
to secure DVD and other license and distribution rights on terms acceptable to us. For
more information regarding our continuing ability to obtain DVD license and distribution
rights, see Item 1. Business  Competition above. Major motion
picture studios have normally not granted, nor are they expected to grant, exclusive DVD
licenses to us for new releases and popular catalogue titles. Instead, the major motion
picture studios will most likely continue to sell DVD titles directly to retailers. We
expect to continue to license exclusive DVD and other home entertainment format content,
but we cannot assure you that we can remain competitive against licensing entities with
greater financial resources or that independent program suppliers will not distribute
their programming themselves. In addition, our success will continue to be dependent upon
our ability to identify and secure rights to exclusive content that appeal to consumers.

|  
|--
|26

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We
May Not Possess Satisfactory Rights in Our Properties. Although we require
satisfactory chain of title information to our exclusively licensed content, the risk
exists that some programs may have a defective chain of title. The validity and ownership
of rights to some titles can be uncertain and may be contested by third parties.

Protecting
and Defending against Intellectual Property Claims May Have a Material Adverse Effect on
Our Business. Our ability to compete in the home entertainment industry depends, in
part, upon successful protection of our proprietary and intellectual property. We protect
our property rights to our productions through available copyright and trademark laws and
licensing and distribution arrangements with reputable international companies in specific
territories and media for limited durations. Despite these precautions, existing copyright
and trademark laws afford only limited practical protection in some jurisdictions. In some
jurisdictions of our distribution, there are no copyright and/or trademark protections
available. As a result, it may be possible for unauthorized third parties to copy and
distribute our productions or portions or applications of our intended productions. In
addition, litigation may be necessary in the future to enforce our intellectual property
rights, to protect our trade secrets, to determine the validity and scope of the
proprietary rights of others or to defend against claims of infringement or invalidity.
Any such litigation could result in substantial costs and the resulting diversion of
resources could have an adverse effect on our business, operating results or financial
condition. From time to time, we may also receive claims of infringement of other
parties proprietary rights. Regardless of the validity or the success of the claims,
we could incur significant costs and diversion of resources in defending against such
claims, which could have an adverse effect on our business, financial condition or results
of operations.

Risks Relating to Our
Stock

Failure
to Consummate the Merger with BTP May Result in a Material Decrease in the Market Price
of Our Common Stock. The announcement of our execution of the merger agreement with
BTP on March 29, 2007, resulted in a jump in our stock price to levels approaching the
$4.40 per share described in the merger agreement.  In the event we are unable to consummate the merger
with BTP for any reason, our stock price may drop to the prices we were trading at prior
to the announcement of the merger agreement with BTP, or perhaps even lower, and you may
lose all or a substantial part of your investment.

Our
Stock Price May Be Subject to Substantial Volatility, and You May Lose All or a
Substantial Part of Your Investment. Our common stock is traded on The NASDAQ Global
Market®. There is a limited public float, and trading volume historically
has been limited and sporadic. Over the last year through June 14, 2007, the closing price
of our common stock ranged between $3.05 and $4.29 per share on volume ranging from 1,350
to over 5.3 million shares per day. As a result, the current price for our common stock is
not necessarily a reliable indicator of our fair market value. The price at which our
common stock will trade may be highly volatile and may fluctuate as a result of a number
of factors, including, without limitation, the number of shares available for sale in the
market, quarterly variations in our operating results, actual or anticipated announcements
of new releases by us or competitors, the gain or loss of significant customers, changes
in the estimates of our operating performance, and market conditions in our industry and
the economy as a whole.

Any
Future Sales of Equity May Significantly Impact the Market Price of Our Common Stock.
We currently have S-3 and S-4 registration statements for the issuance of our securities
in exchange for either cash or other securities on file with the SEC. Future sales of
substantial amounts of our common stock, including shares that we may issue upon exercise
of outstanding options and warrants, could adversely affect the market price of our common
stock. Further, if we raise additional funds through the issuance of common stock or
securities convertible into or exercisable for common stock, the percentage ownership of
our stockholders will be reduced and the price of our common stock may fall.

|                         
|-------------------------
|Image Entertainment, Inc.

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We
May Incur Increased Costs as a Result of Laws and Regulations Relating to Corporate
Governance Matters. Laws and regulations affecting public companies, including the
provisions of the Sarbanes-Oxley Act of 2002 and rules adopted or proposed by the SEC and
by NASDAQ, will result in increased costs to us as we evaluate the implications of any new
rules and respond to their requirements.  We will become subject to additional
regulatory requirements in our next annual report, including Section 404 of
Sarbanes-Oxley which will require us to include in our annual report for the period
ending March 31, 2008, a report by management on our internal controls over financial
reporting. The additional costs and efforts to do so could be substantial.  New rules
could make it more difficult or more costly for us to obtain certain types of insurance,
including director and officer liability insurance, and we may be forced to accept reduced
policy limits and coverage or incur substantially higher costs to obtain the same or
similar coverage. The impact of these events could also make it more difficult for us to
attract and retain qualified persons to serve on our Board, our Board committees or as
executive officers. We cannot predict or estimate the amount of the additional costs we
may incur or the timing of such costs to comply with any new rules and regulations.

Risks Relating to the
Proposed Merger with BTP

As
described elsewhere in this Annual Report, we have entered into an agreement to merge with
BTP. Our ability to complete the merger with BTP is subject to risks and uncertainties,
including, but not limited to, the risk that a condition to closing of the transaction may
not be satisfied, the risk that a regulatory approval that may be required for the
transaction is not obtained or is obtained subject to conditions that are not anticipated,
and other risks to consummation of the transaction. Additional risk factors associated
with the proposed merger with BTP are as follows.

Our
Business Could Be Adversely Impacted By Uncertainty Related to the Proposed Merger with
BTP.Whether or not the merger is completed, the announcement and pendency of the
merger could impact or cause disruptions in our business, which could have an adverse
effect on our results of operations and financial condition, including:

| |  | our
current clients may experience uncertainty associated with the merger and may attempt to
negotiate changes in existing business relationships and/or consider entering into
business relationships with parties other than us, either before or after completion of
the merger, and we may face additional challenges in competing for new and renewal
business;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | our
employees may experience uncertainty about their future roles with the combined company,
which might adversely affect our ability to retain and hire key managers and other
employees;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
attention of our management may be directed toward the completion of the merger and
                  transaction-related considerations and may be diverted from the
day-to-day business operations                   of our business; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
uncertainty of retaining business with our suppliers and vendors can be further
exacerbated by the merger, and delay in the completion of the merger or termination of
the merger agreement could have an adverse effect on our business, financial condition,
results of operations or prospects if the merger is not completed.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Failure
To Complete the Merger Could Negatively Impact Our Stock Price and Our Future Business and
Financial Results. If the proposed merger is not completed, our business may be
adversely affected and we will be subject to several risks, including:

| |  | being
required, under certain circumstances under the BTP merger agreement, to pay a
termination fee;
| | - | -----------------------------------------------------------------------------------------------------

| |  | having
incurred certain costs relating to the proposed merger that are payable whether or not
the merger                   is completed;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------

| |  | the
attention of our management will have been diverted to the merger instead of on our
operations and pursuit of other opportunities that could have been beneficial to us; and
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | customer
perception may be negatively impacted which could affect our ability to compete for, or
to win, new and renewable business in the marketplace.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

|  
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|28

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Even
If the Proposed Merger is Completed, the Combined Company Will Be Subject to Certain Risks
Associated with the Merger.In particular, the stock price and the business of the
combined company could be adversely affected by certain risks associated with the merger,
including:

| |  | the
combined company may be unable to successfully integrate ours and BTPs operations or to
realize the                   anticipated cost savings and other benefits of the merger;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
combined company may be unable to retain key employees, and key employees may depart
because of issues relating to uncertainty or difficulty of integration or a desire not to
remain with the combined company; and
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | the
combined company will incur significant transaction and merger related costs in
connection with the merger.
| | - | ---------------------------------------------------------------------------------------------------------------

|ITEM 1B. | UNRESOLVED
STAFF COMMENTS
|-------- | -------------------------

None.

|ITEM 2. | PROPERTIES
|------- | ----------

Our
headquarters are located in Chatsworth, California and consist of approximately 62,000
square feet on one floor of a multi-tenant building. The monthly rent is $1.29 per square
foot, on a gross basis, or approximately $80,000 per month, and increases approximately 3%
annually. The office lease has an initial 10-year term with two five-year options. The
lease commenced on July 1, 2004. Although a base level of operating expenses is included in the rent payment, we
will be responsible for a percentage of actual annual operating expense increases capped
at 5% annually.

We
also lease our 76,000 square foot warehouse and distribution facility located in Las
Vegas, Nevada. The monthly rent is approximately $43,000, subject to annual adjustment
based on increases in the consumer price index. The lease expires on November 4, 2012. In
addition, we lease approximately 4.07 acres of adjacent vacant land in the event we need
to expand our current warehouse and distribution facility. The monthly rent for the vacant
land is approximately $9,000 and the lease expires on November 4, 2007. Beginning in
January 2004, we leased an additional 10,000 square foot warehouse storage space in Las
Vegas, Nevada for a monthly rent of approximately $6,000 for an initial term of two years
and later extended to April 30, 2007. We moved all inventory from this storage space to
Sonopress as of the lease termination date on April 30, 2007. Beginning in October 2005,
we leased an additional 5,000 square foot warehouse storage space in Las Vegas, Nevada for
a monthly rent of approximately $3,000 on a month to month basis. As of May 31, 2007, the
inventory from this storage space was shipped to Sonopress and we then terminated this
lease. As discussed above, we are closing our warehouse and distribution facility and
Sonopress will be warehousing and fulfilling our DVD and CD orders out of its facility in
Pleasant Prairie, Wisconsin. On March 29, 2007, we notified our Las Vegas landlord of our
intent to vacate the facility and sublease the space. Our landlord is open to various
options, including potential termination of the lease, if an appropriate new tenant is
found.

We
signed an exclusive representation agreement with IPG, a commercial real estate broker,
for the potential sublease of the facility on or about May 11, 2007. Fees to the agent
will be 5% of lease rentals or 4% if both sides of the sublease transaction are done by
IPG. We have been informed by Las Vegas-based real estate professionals that our lease is
below current market rates, thus providing compelling sublease and/or lease exit options
for us. Beginning at the end of May 2007, IPG began marketing the facility to prospective
tenants under a sublease. It is currently anticipated that the facility will be available
to a new tenant, assuming one is found, by October 2007.

Image
UK leases office space located at 77 Oxford Street, London W1D 2ES. The lease term is one
year and commenced on August 28, 2006, at a rate of approximately £4,750
(approximately $9,000) per month, which rate includes VAT, utilities, cleaning, security,
insurance and other fees. As of December 2006, Image removed all property from this
location in connection with the layoffs and closure of the Image UK office. Image will
continue to pay the lease through its expiration in August 2007.

We
believe that our current office and warehouse space is adequate to meet our needs, and
that additional facilities will be available for lease, if necessary, to meet our future
needs.

|                         
|-------------------------
|Image Entertainment, Inc.

---

|ITEM 3. | LEGAL
PROCEEDINGS
|------- | -----------------

On
April 10, 2007, a purported class action shareholder complaint entitled Henzel v. Image
Entertainment, Inc., et al. was filed against us and certain of our officers and
members of our Board in the Superior Court of the State of California, County of Los
Angeles. The named plaintiff proposes to represent a class of our stockholders and claims,
among other things, that in connection with the proposed business combination transaction
with BTP, the directors breached their fiduciary duties of due care, good faith and
loyalty by failing to maximize stockholder value and by creating deterrents to third-party
offers. Among other things, the complaint seeks class action status, and a court order
enjoining the consummation of the merger and directing us to take appropriate steps to
maximize stockholder value. While the lawsuit is in its preliminary stage, we believe that
the claims in the lawsuit are without merit and intend to vigorously defend it.

In
the normal course of business, we are subject to proceedings, lawsuits and other claims,
including proceedings under government laws and regulations relating to employment and tax
matters. While it is not possible to predict the outcome of these matters, it is the
opinion of management, based on consultations with legal counsel, that the ultimate
disposition of known proceedings will not have a material adverse impact on our financial
position, results of operations or liquidity.

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

None.

|  
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|30

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|
|
|

|ITEM 5. | MARKET
FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF
EQUITY  SECURITIES
|------- | -------------------------------------------------------------------------------------------------------------

Our
common stock trades on The NASDAQ National Market® under the symbol DISK.
The table below presents the quarterly high and low closing prices on the NASDAQ during
the past two fiscal years.

|Fiscal Year Ended March 31, 2007 | High       | Low       
|-------------------------------- | ---------- | ----------
|Quarter ended June 30, 2006      | $    3.950 | $    3.500
|Quarter ended September 30, 2006 | $    3.850 | $    3.420
|Quarter ended December 31, 2006  | $    3.650 | $    3.260
|Quarter ended March 31, 2007     | $    4.190 | $    3.050

|Fiscal Year Ended March 31, 2006 | High       | Low       
|-------------------------------- | ---------- | ----------
|Quarter ended June 30, 2005      | $    5.360 | $    2.700
|Quarter ended September 30, 2005 | $    4.430 | $    2.680
|Quarter ended December 31, 2005  | $    4.150 | $    3.020
|Quarter ended March 31, 2006     | $    3.730 | $    3.200

# Stockholders

As
of June 11, 2007, there were approximately 21,717,955 shares of our common stock issued
and outstanding, which were held by approximately 1,218 holders of record. As of June 1,
2007, we estimate there were 2,755 beneficial owners of our common stock.

# Dividend Policy

Our
Amended and Restated Loan and Security Agreement with Wells Fargo Foothill (Wells
Fargo), which was replaced in May 2007 by our Loan and Security Agreement with
Wachovia Capital Finance Corporation (Western) (Wachovia), both prohibit our
payment of dividends. For more information on these restrictions, please refer to
Item 7. Managements Discussion and Analysis of Financial Condition and
Results of Operations  Liquidity and Capital Resources. We have never paid a
cash dividend on our common stock, and we presently intend to retain future earnings (if
any) for business development.

# Stock Performance Graph

The
graph below compares our cumulative total return, the NASDAQ U.S. Market Index and our
selected peer group for the five-year period ended March 31, 2007.  The new peer group
consists of Handleman Company, Trans World Entertainment Corporation, Navarre
Corporation, Lions Gate Entertainment Corp. and Genius Products, Inc.  We added Genius Products, Inc., an
entertainment products distribution company that distributes, licenses, acquires and
produces entertainment programming on DVD and emerging entertainment platforms.  Genius
Products was added to our new peer group as most of their business parallels our own.
 The old peer group consisted of Handleman Company, Trans World Entertainment
Corporation, Navarre Corporation and Lions Gate Entertainment Corp.  The graph assumes an initial investment
in us of $100 on March 31, 2002, in the NASDAQ U.S. Market Index, and in the peer group.
 The graph also assumes reinvestment of dividends, if any.  The stockholder return shown
on the graph below should not be considered indicative of future stockholder returns, and
we will not make or endorse any predictions of future stockholder returns.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# COMPARISON OF FIVE
YEAR CUMULATIVE TOTAL RETURN*                           AMONG IMAGE ENTERTAINMENT, INC.,
THE NASDAQ U.S. MARKET INDEX,                                      OUR NEW PEER GROUP AND
OUR OLD PEER GROUP



* $100 invested on
3/31/02 in stock or index-including reinvestment of dividends. Fiscal year ending March
31.

|                         
|-------------------------
|
|Image Entertainment, Inc.
|NASDAQ U.S. Market Index 
|New Peer Group           
|Old Peer Group           

|  
|--
|32

---

# ITEM 6.      SELECTED
FINANCIAL DATA

The
selected financial data presented below was derived from our consolidated financial
statements and should be read in conjunction with the financial statements, the notes
thereto and the other financial information included therein, all of which is contained in
complete form in Item 8. Financial Statements and Supplementary Data.

|                                                              | Years Ended March 31,
|------------------------------------------------------------- | ---------------------
|(In thousands, except per share data)                        
|Statement of Operations Data:                                 |                      
|Net revenues                                                  |                      
|Operating costs and expenses                                  |                      
|Earnings (loss) from operations                               |                      
|Interest expense, net                                         |                      
|Other expense (income)                                        |                      
|Earnings (loss) from continuing operations before income      |                      
|taxes                                                         |                      
|Income tax expense                                            |                      
|Earnings (loss) from continuing operations                    |                      
|Loss from discontinued operations                             |                      
|Earnings (loss) before cumulative effect of accounting change |                      
|Cumulative effect of accounting change                        |                      
|Net earnings (loss)                                           |                      
|Earnings (loss) per share:                                    |                      
|Continuing operations                                         |                      
|Basic                                                         |                      
|Diluted                                                       |                      
|Discontinued operations                                       |                      
|Basic and diluted                                             |                      
|Earnings (loss) before cumulative                             |                      
|effect of accounting change                                   |                      
|Basic                                                         |                      
|Diluted                                                       |                      
|Cumulative effect of accounting                               |                      
|change                                                        |                      
|Net earnings (loss) per share:                                |                      
|Basic                                                         |                      
|Diluted                                                       |                      
|Weighted average shares outstanding                           |                      
|Basic                                                         |                      
|Diluted                                                       |                      

---

| | 1 | Includes a $2.2 million write-off of assets relating to our distribution
               agreement with Source Entertainment, Inc. which filed for bankruptcy protection
               in May 2007. Also includes $1.4 million in legal, investment banking and other
               expenses associated with negotiating the BTP merger agreement. Also includes
               $634,000 in fees and expenses associated with the Lions Gate proxy contest
               and special committee of our Board. Also includes $488,000 in severance and UK
               office closure costs associated with a November 2006 cost reduction plan. Also
               includes a net $432,000 charge associated with the Chapter 11 filing MTS (Tower
               Records).
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 2 | Includes a $1,566,000 charge associated with the Chapter 11 filing of Musicland
               Holding Corp. and a $248,000 impairment charge associated with software not
               utilized. Also includes a $562,000 credit to cost of sales from the reversal of
               an over accrual for music publishing liabilities associated with a DVD series.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 3 | Includes a $499,000 non-recurring noncash credit related to the discontinuation
               of our international distribution of DVDs through subdistributors.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 4 | Income tax expense reflects the use of net operating losses against taxable
               income.
| | - | --------------------------------------------------------------------------------------------------

| | 5 | Income tax expense reflects establishing a valuation allowance against 100% of
               net deferred tax assets.
| | - | ----------------------------------------------------------------------------------------------------------------------

| | 6 | Includes the reduction to gross margin of $480,000 for estimated subdistributor
               returns and inventory write downs as a result of our transition from direct
               European distribution to European sublicense.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

| | 7 | Includes a provision for a valuation allowance against deferred tax assets of
               $551,000 relating primarily to foreign tax credits.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

|                                                             | March 31,
|------------------------------------------------------------ | ---------
|(In thousands)                                              
|Balance Sheet Data:                                          |          
|Total assets                                                 |          
|Long-term debt and capital leases, excluding current portion |          
|Net stockholders equity                                     |          

|  
|--
|34

---

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

The
following discussion and analysis should be read together with our disclaimer on
Forward-Looking Statements, Item 1. Business, Item 1A. Risk
Factors, Item 6. Selected Financial Data and the consolidated financial
statements, the related notes thereto and other financial information contained elsewhere
in this Annual Report.

# Overview

Revenue
Sources. Our primary source of revenues continues to be derived from the acquisition
and distribution of exclusive DVD content in North America, which accounted for approximately 93%
of our overall net sales in fiscal 2007. A complementary source of revenues in fiscal 2007
was derived from the distribution of CD content in North America, which accounted for over
4% of our fiscal 2007 net revenues.

Internationally,
we primarily receive royalty income from sublicenses with Sony BMG, Warner Music and
Digital Site for the distribution of our exclusive DVD content.

Revenues
from digital distribution of our exclusive content rights are beginning to grow. Net
revenues generated by Egami totaled $1,214,000 in fiscal 2007, up 582% from $178,000 in
fiscal 2006, Egamis first full year of operation.

Cost
Structure. Our most significant costs and cash expenditures relate to acquiring
content for exclusive distribution and, more recently, the funding of content production
or co-production for exclusive distribution, and expenses related to the Lions Gate
lawsuit, the proxy contest and our proposed merger with BTP. Additionally, the costs of
consumer advertising, product promotion and market development funds provided to our
retail customers continue to increase. Other significant costs include DVD and CD
manufacturing, employee compensation and freight expense.

Acquisition
of Exclusive Rights. We intend to maintain our content rights acquisition focus on
genres that have been successful in the past, even while seeking out early trend
opportunities in advance of mainstream acceptance in an effort to keep acquisition costs
lower by bringing titles to market before spikes in demand drive up acquisition costs,
especially in growing genres such as urban and Latin where we possess significant
expertise. We obtain our content from a variety of sources, including, but not limited to,
content rights holders, producers, business management firms, law firms, talent agencies,
independent film studios and record labels, the artists themselves and content finders.

Fiscal 2007 Highlights:

| |  | Net
revenues decreased 10.9% to $99,751,000, compared to $111,902,000 in fiscal 2006.
| | - | -------------------------------------------------------------------------------------

| | ° | Digital
distribution revenues grew to $1,214,000, compared to $178,000.
| | - | -----------------------------------------------------------------------

| | ° | We
experienced a lack of break-out titles in fiscal 2007, compared to the BBCs
television production of The Chronicles of Narnia in fiscal 2006.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Gross
profit margins decreased 7% to 17.8%, compared to 24.8% for fiscal 2006.
| | - | ------------------------------------------------------------------------------

| | ° | The
gross profit margins above are inclusive of the $2.2 million write-off of assets relating
to our distribution agreement with Source Entertainment, Inc., which filed for bankruptcy
protection in May 2007.  The
Source asset impairment write-down negatively impacted gross profit margins by 2.2%.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Selling
expenses increased to 10.5% of net revenues, up from 9.6% of net revenues for fiscal
2006.
| | - | --------------------------------------------------------------------------------------------------

| | ° | These
expenses include $225,000 in employee termination costs in accordance with managements
November 2006 cost reduction plan.
| | - | --------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

| |  | General
and administrative expenses were $17,407,000 in absolute dollars for fiscal 2007, as
compared to $16,460,000 for fiscal 2006. Significant comparative differences in the
expenses in fiscal 2007 versus 2006 are as follows:
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | $1.4
million in legal and investment banking expense associated with negotiating the BTP
merger agreement in fiscal 2007.
| | - | -------------------------------------------------------------------------------------------------------------------------

| | ° | $634,000
in expenses and fees associated with the process of evaluating strategic alternatives,
including our potential sale, and the Lions Gate contested proxy vote in fiscal 2007
compared to $247,000 in fiscal 2006.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | $432,000
net charge as a result of retail customer Tower Records bankruptcy filing in fiscal
2007 compared to a $1.6 million net charge as a result of retail customer Musicland Stores bankruptcy
filing in fiscal 2006.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | $263,000
in employee termination and UK office closure costs in accordance with managements November
2006 cost reduction plan.
| | - | -------------------------------------------------------------------------------------------------------------------------------

| | ° | $90,000
in fees associated with investment banker analysis of the Relativity Media agreement.
| | - | ---------------------------------------------------------------------------------------------

| | ° | $248,000
asset impairment write-down in fiscal 2006 relating to abandoned software.
| | - | -----------------------------------------------------------------------------------

| |  | Non-cash
interest expense totaled $1,071,000 associated with our manufacturing advance and
convertible debt and warrant issues. See Disc Replication Agreement and Related
Advance and Private Placement of Senior Convertible Note and Warrant below.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Net
loss was $12,611,000, or $.59 per diluted share, compared to net loss of $207,000, or
$.01 per diluted share for fiscal 2006.
| | - | ---------------------------------------------------------------------------------------------------------------------------------

| | ° | Net
loss in fiscal 2007 includes:
| | - | ---------------------------------

| |  | $.10
per diluted share for the Source asset impairment write-down.
| | - | ------------------------------------------------------------------

| |  | $.03
for legal and investment banking expenses associated with the special committee process
and the Lions Gate proxy contest.
| | - | -------------------------------------------------------------------------------------------------------------------------------

| |  | $.06
per diluted share for legal and investment banking expenses associated with the
negotiation of the BTP merger agreement.
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | $.02
in severance and office closure costs associated with managements November 2006
plan to reduce operating costs.
| | - | ---------------------------------------------------------------------------------------------------------------------

| |  | $.05
in non-cash interest costs associated with our manufacturing advance and convertible debt
and warrant issues.
| | - | ------------------------------------------------------------------------------------------------------------------

| | ° | Net
loss in fiscal 2006 includes a $.07 charge per diluted share as a result of the January
12, 2006, Chapter 11 bankruptcy filing by our customer Musicland Holding Corp.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Total
liabilities increased to $61.1 million as compared to $46.0 million for fiscal 2006.
| | - | ------------------------------------------------------------------------------------------

| |  | On
June 30, 2006, we received an interest-free $10 million advance from Sonopress against
future replication, to be repaid at $0.20 per disc manufactured plus a $0.042
administrative charge per disc manufactured until the advance is fully repaid.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
August 11, 2006, we entered into a 10-year exclusive distribution agreement with
Relativity Media for the DVD and digital rights to a minimum of three Relativity Media
motion pictures in calendar 2007 and a minimum of seven thereafter.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
August 20, 2006, our retail customer Tower Records filed for bankruptcy.
| | - | ---------------------------------------------------------------------------

| |  | On
August 30, 2006, in a private offering, we issued to Portside Growth and Opportunity Fund
(Portside) a senior convertible note in the principal amount of $17 million
and a related warrant to purchase 1,000,000 shares of our common stock, and on November
10, 2006, we entered into an Amendment and Exchange Agreement with Portside, which
agreement modified certain terms in the transaction documents and provided for a
replacement warrant to be issued in exchange for the warrant previously issued to
Portside.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|  
|--
|36

---

| |  | On
October 10, 2006, our stockholders elected our members of the Board, ending the proxy
contest with Lions Gate.
| | - | -----------------------------------------------------------------------------------------------------------------

| |  | On
November 9, 2006, we put in place certain cost cutting initiatives, which are more fully
described under Update on Managements Plan to Reduce Operating Costs below.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
January 5, 2007, we sent a 120-day notice of termination to Wells Fargo to terminate our
revolving line of credit facility, and on January 11, 2007, we further amended our credit
facility to reduce the availability during the remaining term of the loan.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
March 15, 2007, we received a commitment letter from Wachovia to replace our existing
revolving line of credit facility with Wells Fargo.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
March 29, 2007, we entered into a merger agreement with BTP, which was subsequently amended on June 27, 2007. The merger remains subject to
stockholder approval.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | On
May 4, 2007, we entered into a three-year Loan and Security Agreement
with Wachovia, which provides us with a revolving line of credit of up to $15
million based upon eligible receivables.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The
highlights above are intended to identify some of our more significant events and
transactions during our fiscal year 2007, and recent events which occurred after the
fiscal year end. However, these highlights are not intended to be a full discussion of our
results for the year.  These highlights should be read in conjunction with the
following discussion of Results of Operations and Liquidity and Capital
Resources and with our consolidated financial statements and footnotes accompanying
this Annual Report.

We
will continue seeking the highest-quality programming available to independents such as
ourselves to market and distribute in many genres. The following list identifies some of
our higher-profile titles released in fiscal 2007, as well as some projected
higher-profile titles scheduled for release in fiscal 2008:

See following page

|                         
|-------------------------
|Image Entertainment, Inc.

---

|Titles Released in Fiscal Year 2007                         | Features/Other:                                                        
|----------------------------------------------------------- | -----------------------------------------------------------------------
|DVD Titles                                                  | Bullet Boy                                                             
|                                                            | Men Cry in the Dark                                                    
|Comedy:                                                     | Evil Aliens (ContentFilm)                                              
|                                                            | Wilderness Survival for Girls (ContentFilm)                            
|Jeff Dunham: Arguing with Myself                            | The Hunt (Graymark)                                                    
|Katt Williams: Live                                         | Patlabor: The Movie 1 & 2 (Anime)                                      
|Wanda Sykes: Sick and Tired                                 | Her Majesty                                                            
|Jamie Kennedy: Unwashed: The Stand-Up Special               | Goodnight, Joseph Parker                                               
|The Pee-wee Herman Show: Live at the Roxy Theatre           | Rising Son: The Legend of Skateboarder Christian Hosoi (QD3 Collection)
|The Complete Kathy and Mo Show                             
|Bob & Tom Radio: The Comedy Tour                            | Criterion Branded:                                                     
|TV:                                                         | Seven Samurai / Reissue                                                
|                                                            | Mr. Arkadin: The Complete (Orson Welles)                               
|Discovery Channels Deadliest Catch: Season 1               | Essential Arthouse: 50 Years of Janus Films                            
|Elvis Presley: The Ed Sullivan Shows                        | YoJimbo/Sanjuro: 2 Films by Kurosawa                                   
|Twilight Zone: Complete Definitive Collection               | Double Life of Veronique                                               
|Tommy Lee Goes to College                                   | Grey Gardens 2-Disc Edition                                            
|Combat!: Best of Series                                   | Brazil / Reissue                                                       
|                                                            | Fists in the Pocket                                                    
|Music-Related:                                              | Eric Rohmers Six Moral Tales                                          
|                                                            | Pandoras Box                                                          
|Chuck Berry: Hail! Hail! Rock n Roll                      | Monsters & Madmen                                                      
|R. Kelly Live!: The Light It Up Tour                        | Dazed and Confused                                                     
|Korn: Live on the Other Side                                | Harlan County USA                                                      
|Yanni: Live! The Concert Event                              | Kicking and Screaming                                                  
|Megadeth: That One Night Live                              
|Bastards of Young                                           | CD Titles                                                              
|Austin City Limits Music Festival 2005                     
|Yes: 9012 Live                                              | Yanni: Live from Las Vegas                                             
|Four Tops: 50th Anniversary Concert                         | Tamia: Between Friends                                                 
|Who the Hell is Pete Doherty?                               | KRS One: Life                                                          
|                                                            | Grey Gardens: Original Cast Recording                                  
|Urban:                                                      | Phil Lesh and Friends: Live at the Warfield                            
|                                                            | Billboard Latin Music Awards                                           
|Russell Simmons Presents: Hip Hop Laws of Success           | Austin City Limits Music Festival 2005                                 
|One Love 3: Pure Heat                                       | Gigantour                                                              
|Just For Kicks.                                             | Englebert Humperdinck: Totally Amazing                                 
|Black and Blue: Legends Of The Hip-Hop Cop (QD3 Collection) | John Popper                                                            
|Art of 16 Bars (QD3 Collection)                             | Jamie Kennedy: Unwashed: The Stand-Up Special                          
|Beef Box Set (QD3 Collection)                               | Billy Gilman                                                           
|                                                            | Live at Billy Bobs Texas: Multiple Titles                             

|  
|--
|38

---

|Projected Titles for Fiscal Year 2008                   |                                                                          
|------------------------------------------------------- | -------------------------------------------------------------------------
|DVD Titles                                             
|                                                        | Features/Other:                                                          
|Comedy:                                                
|                                                        | Bugs (Created for IMAX Theatres)                                        
|Jeff Dunham: Spark of Insanity                          | Darwins Nightmare (HVE)                                                 
|Joe Rogan Live                                          | David and Lisa (HVE)                                                     
|The Axis of Evil Comedy Tour                            | Zatoichi: The Blind Swordsman Vol. 1-4 (HVE)                             
|Comedians of Comedy                                     | Hunchback of Notre Dame: The Ultimate Edition (Silent Lon Chaney Classic)
|Steven Wright: When the Leaves Blow Away                | Shaolin Family Soccer (Foreign)                                          
|Daniel Tosh: Completely Serious                         | 51 Birch Street                                                          
|Gabriel Iglesias: Hot & Fluffy                          | Cabinet of Dr. Caligari (2005)                                           
|Mike Marino: New Jerseys Bad Boy of Comedy             | Nailed (Horror)                                                          
|Bob & Tom Comedy All Stars Tour                         | Surveillance (Graymark)                                                  
|Tommy Tiernan: Something Mental                         | Splinter (Dark Horse)                                                    
|Doug Stanhope: No Refunds                               | Souls Midnight (Graymark)                                               
|Bill Burr                                               | Caligula: Imperial Edition                                               
|Kevin Hart                                              | Driftwood (Dark Horse)                                                   
|TV (Discovery Channel):                                 | Criterion Branded:                                                       
|Survivorman                                             | The Last Emperor                                                         
|Shark Week: 20th Anniversary Collection                 | Stranger Than Paradise                                                   
|Dirty Jobs Collections 1 & 2                            | Sansho the Bailiff                                                       
|Man vs. Wild                                            | The Third Man                                                            
|Mythbusters: Collection 2                               | Ace in the Hole                                                          
|Deadliest Catch: Seasons 2 & 3                          | La Jetee: Sans Soleil                                                    
|Passport to Europe with Samantha Brown: Multiple Titles | House of Games                                                           
|                                                        | Army of Shadows                                                          
|Music-Related:                                          | Robinson Crusoe on Mars                                                  
|Dinosaur Jr.: Live in the Middle East                   | CD Titles                                                                
|Sammy Hagar: Live in St. Louis                         
|Beatles Biggest Secrets                                | Megadeth: That One Night: Live in Buenos Aires                           
|Moody Blues: Classic Artists                            | Tamias Christmas                                                        
|Yes: Classic Artists                                    | Mint Condition (Second Studio Album)                                     
|Gigantour 2                                             | Willie Nelson: Live at Billy Bobs Texas: Limited Edition CD/DVD         
|Dionne Warwick Live                                     | Gigantour 2                                                              
|Junior Wells: Blues Legends                             | The Source Presents Hip Hop Hits Volume 11                               
|Urban:                                                 
|The Notorious B.I.G.: Bigger Than Life                 
|Beef 4 (QD3 Collection)                                
|Holla at Me                                            
|Lord Help Us                                           
|Ganked                                                 
|Bling                                                  
|Death Toll (DMX)                                       

# Update on
Managements Plan to Reduce Operating Costs

In
an effort to reduce operating costs and achieve profitability, management embarked on
several initiatives that are expected to reduce annual expenses by approximately $3.8
million.

| |  | On
November 9, 2006, we laid off 27 employees spread throughout various departments. Along
with an additional six employees who recently left us through attrition and were not
replaced, our overall personnel headcount was reduced by 33, resulting in an
approximately 16% reduction in our U.S.-based workforce. Annual expense savings from this
reduction in force, including salary and benefits, total an estimated $2.2 million. The
expense savings will be reflected primarily in selling and general and administrative
expenses and amortization of non-recoupable production costs (cost of sales) on a
go-forward basis.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

| |  | We
laid off both of our two UK employees and closed our Image UK content acquisitions office
in November 2006, saving annual expenses of approximately $400,000. Of the $400,000 in
savings, $235,000 is compensation related and is not included in the $2.2 million in
annual expense savings from reduced headcount discussed above. The expense savings will
be reflected in general and administrative expenses on a go-forward basis. The UK office
was used primarily as a focal point for the acquisition of programming outside of North
America. We believe that a realignment of our acquisition strategy allowed us to close
this satellite office without any material negative effect on our overall acquisition
efforts. We are continuing to use one of the employees as a consultant tasked with the
acquisition of programming outside of North America.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
made changes in our freight policy and reduced distribution facility expenses, such as
temporary labor, employee overtime, utilities and cost of supplies. We expect an
immediate annual expense savings from these initiatives of approximately $500,000. The
expense savings will be reflected in cost of sales on a go-forward basis.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
successfully implemented our vendor management inventory (VMI) system, which affords us
approximately $200,000 in annual savings based upon overall reduced freight costs.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
appointed Sonopress as our exclusive provider of warehousing and distribution services,
which we expect to reduce our replication and distribution costs. See Sonopress
Fulfillment Services Agreement and Planned Closure of Las Vegas Facility below.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
have reduced third-party professional services that will save us approximately $180,000
annually beginning January 1, 2007.
| | - | ------------------------------------------------------------------------------------------------------------------------------

| |  | We
have implemented our content rights management system and expect future comparative
savings from outside consultants to be $300,000 annually beginning in our fourth quarter
ended March 31, 2007.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
recorded one-time charges for severance associated with the layoff of our employees and
accrued for the remaining rent of our Image UK office totaling approximately $488,000 in
our third quarter ended December 31, 2006. The one-time charges were reflected in selling
expenses in the amount of approximately $225,000, and general and administrative expenses
in the amount of approximately $263,000, in the statements of operations for fiscal 2007.

# Disc Replication
Agreement and Related Advance

On
June 30, 2006, we entered into a five-year disc replication agreement with Sonopress.
Sonopress serves as the exclusive manufacturer of our DVDs. This will ultimately include
the HD-DVD and Blu-ray Disc® high-definition formats as well. Sonopress is also the
primary manufacturer of our CD requirements. On June 30, 2006, we received an
interest-free $10 million advance against future DVD manufacturing from Sonopress, to be
repaid at $0.20 per DVD manufactured, plus payment of a $0.04 administrative fee per DVD
manufactured until the advance is fully repaid. See Liquidity and Capital
Resources below.

# Sonopress Fulfillment
Services Agreement and Planned Closure of Las Vegas Facility

In
conjunction with our July 2006 strategy to transition replication services from Deluxe to
Sonopress, we conducted a strategic analysis that assessed the potential benefits of also
transferring all warehousing and distribution operations from our Las Vegas distribution
center to a distribution facility located in Pleasant Prairie, Wisconsin (previously owned
and operated by Deluxe) that Sonopress acquired on April 1, 2007. Our analysis showed
expanded distribution capabilities and reduced operating expenses and freight costs.
Moreover, the potential scalability of distribution services without corresponding capital
expenditures was extremely attractive to us, especially as we seek to move into home video
distribution of theatrical motion pictures.

We
expect to realize freight savings as a result of the move to Sonopress facility
being centrally located in the Midwest, and because of the help from Sonopress
well-developed transportation management services group. In addition, we anticipate that
operating expenses will decrease as a result of the termination of approximately 45
full-time employees plus temporary labor in Las Vegas, the anticipated sublease of our Las
Vegas facility, and the elimination of costs related thereto. Ultimately, the recently
acquired yet historically tested Sonopress facility provides us with a strategic means to
increase our distribution throughput, eliminate capital expenditure requirements and
capitalize on cost savings.

|  
|--
|40

---

One-time
termination benefits totaling approximately $365,000 will be provided to current employees
who are involuntarily terminated under the terms of this restructuring. These employees
will be required to render service until a specific date in order to receive the
termination benefits. In accordance with Statement of Financial Accounting Standards
(SFAS) No. 146 Accounting for Costs Associated with Exit or Disposal
Activities, a liability for the termination benefits shall be measured initially
at the communication date, which was April 20, 2007, based on the fair value of the
liability as of the termination date. The resulting liability will be recognized ratably
over the future service period.

We
plan on using our warehouse assets as we to continue to store and distribute our products
until the transfer of inventories to Sonopress is complete, now estimated to be by July
31, 2007. The decision to restructure our distribution operations by engaging Sonopress
triggered an asset impairment as determined under SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. Much of our warehouse and
distribution equipment will be abandoned before the end of its previously estimated useful
life. In accordance with SFAS No. 146, depreciation and amortization estimates will be
revised to reflect the use of the assets over their shortened useful lives. At March 31,
2007, the net book value of assets that we estimate will be abandoned after the cessation
of warehousing and distribution activities in Nevada totaled approximately $620,000. We
continue to classify these assets as a component of property, equipment and improvements
and separately classify the accelerated depreciation expense as Restructuring
Expense within continuing operating expenses. As this is not a discontinued
operation, but rather a closing of a plant and related activities, the net book value will
be amortized and depreciated down to its estimated salvage value.

We
notified our Las Vegas landlord of our intent to vacate the facility and sublease the
space on March 29, 2007. Our landlord is open to various options, including potential
termination of the lease, if an appropriate new tenant is found. We signed an exclusive
representation agreement with IPG, a commercial real estate broker, for the potential
sublease of the facility on or about May 11, 2007. Fees to the agent will be 5% of lease
rentals or 4% if both sides of the sublease transaction are completed by IPG. We have been
informed by Las Vegas-based real estate professionals that our lease is below current
market rates, thus providing compelling sublease and/or lease exit options for us.
Beginning at the end of May 2007, IPG began marketing the facility to prospective tenants
under a sublease. It is currently anticipated that the facility will be available to a new
tenant, assuming one is found, by October 2007. In accordance with SFAS No. 13
Accounting for Leases, we will recognize a liability at the date we
cease using the facility at its fair value. As the lease is an operating lease, we will
determine fair value based on the remaining lease payments reduced by actual or estimated
sublease rentals. We estimate our cease-use date to be September 30, 2007.

# Private Placement of
Senior Convertible Note and Warrant

On
August 30, 2006, in a private offering, we issued to Portside a senior convertible note in
the principal amount of $17,000,000 and a related warrant to purchase 1,000,000 shares of
our common stock, and on November 10, 2006, we entered into an Amendment and Exchange
Agreement with Portside, which agreement modified certain terms in the transaction
documents and provided for a replacement warrant to be issued in exchange for the warrant
previously issued to Portside. See Liquidity and Capital Resources
below.

# Exclusive Distribution
Agreement with Relativity Media and Planned Issuance of Common Shares

Distribution
Agreement.On August 11, 2006, we entered into a 10-year distribution
agreement with Relativity Media. The agreement calls for Relativity Media to provide us
with the exclusive home video and digital distribution rights to motion pictures wholly
financed through or otherwise under the control of Relativity Media, in exchange for which
we will be solely responsible for all distribution services for the DVD home video and
digital release of each film.

Relativity
Media is a financing, consulting and production company that utilizes both traditional and
non-traditional channels in order to raise production and distribution funds, both for
major studios and independent production entities. To date, Relativity Media has
structured and consummated more that $4 billion in production slate financings. It most
recently provided financing for:

|                         
|-------------------------
|Image Entertainment, Inc.

---

| |  | Smokin Aces
| | - | ------------

| |  | Catch
and Release
| | - | -----------------

| |  | Talladega
Nights: The Ballad of Ricky Bobby
| | - | -------------------------------------------

| |  | RV
| | - | --

| |  | The
Fast and Furious: Tokyo Drift
| | - | ---------------------------------

| |  | Monster
House
| | - | -------------

Based
in part on the advice of our financial advisors and our expectations of the production
budget size and type of talent associated with the titles that are to be delivered under
the agreement, we project this North American home video and digital distribution output
agreement will generate significant DVD and digital revenues over the next few years,
assuming Relativity Media delivers titles to us per our contract.

The
agreement called for Relativity Media to provide us with the names of three titles within
seven days after the execution of the agreement. Relativity Media has not yet delivered
titles for us to release under the agreement. The first group of theatrical motion
pictures to be released by us under the agreement was initially projected to be in the
second half of calendar 2007, or during our fiscal 2008. This timing is dependent upon
Relativity securing titles for us in the near term.

The
agreement calls for us to exclusively distribute all home video and digital video formats
for motion pictures controlled by Relativity Media that are not part of a finance package
provided to a major studio or their affiliates, propelling us beyond our existing position
as a leading supplier of independent DVD programming to become a significant provider of
major motion pictures to the home entertainment industry. Per the agreement, Relativity
Media is to deliver us a minimum of three titles in calendar 2007, and a minimum of seven
titles each year thereafter. Each title distributed throughout the ten-year output term
will carry a ten-year exclusive distribution term from the date of release. We will
oversee post productionspecifically authoring and compression and development of
ancillary materialscreative design, replication, marketing and advertising, sales,
distribution and collections for each picture.

On
August 16, 2006, in connection with the Relativity Media agreement, we issued a warrant to
a third-party exclusive rights finder. The term of the warrant was 4.37 years and had a
strike price of $3.81, the closing price of our common stock on the date of grant. The
fair value of the warrant was $194,000, using the Black-Scholes valuation model. The
warrant has been converted via cashless exercise into 11,230 shares of our common stock as
of June 12, 2007. We capitalized the fair value of the warrant as a component of other
assets with a corresponding credit to additional paid in capital. We will amortize the
asset to cost of sales over the related revenues generated from the Relativity Media titles.

Stock
Purchase Agreement. As a material inducement to enter into the distribution agreement,
we agreed to issue Relativity Media 3,400,000 shares of our common stock, which are
registered on a registration statement on Form S-3. In order to secure Relativity
Medias performance under our agreement, we have been granted a security interest in
the shares pursuant to a security agreement, the shares have been pledged to us pursuant
to a stock pledge agreement, and a restrictive legend will be placed on the stock
certificates representing the shares restricting their transfer until designated title
delivery, box office performance, financial and/or payment requirements are met. To date,
Relativity Media has not provided us with the first titles to be released under the
agreement and to date, we have not physically issued the shares to Relativity Media.

# Liquidity and Capital
Resources

Our
working capital has historically been generated from the following sources:

| |  | operating
cash flows
| | - | --------------------

| |  | availability
under our revolving line of credit
| | - | -----------------------------------------------

| |  | private
placement of debt and equity instruments
| | - | ------------------------------------------------

| |  | advances
from our disc manufacturer
| | - | -----------------------------------

|  
|--
|42

---

Sony
BMG Recoupment of Royalty Advance for International Sublicense Rights.We received
a $3.0 million initial royalty advance under the Sony BMG agreement in March 2003, fully
recoupable from revenues generated by Sony BMG against quarterly royalties due to us under
the agreement. Based upon actual quarterly sales of our programming in the territories,
Sony BMG recoups quarterly royalties from the $3.0 million previously advanced. Sony BMG
had provided additional quarterly royalty advances such that for the first three years of
the agreement term through December 31, 2005, the advance outstanding to us at any given
time was maintained at $3.0 million.

During
fiscal 2007 and according to our agreement, Sony BMG reduced, through recoupment, the
outstanding royalty advance without making additional quarterly royalty advances. Once the
entire royalty advance is recouped, Sony BMG will continue to pay quarterly royalties
based on revenues generated. We must repay any outstanding unrecouped royalty advance
within 30 days following the final Sony BMG reporting at the end of Sony BMGs term
and sell-off period. At March 31, 2007, approximately $800,000 of the last $3 million
advance is classified as a component of deferred revenue in the accompanying balance
sheet.

Subsequent
Event  New Revolving Credit and Term Loan Facility. On May 4, 2007,
we entered into a three-year Loan and Security Agreement with Wachovia, which provides us
with a revolving line of credit up to $15 million, with an accordion feature to increase
the line to $20 million at our option, subject to the terms and conditions of the
agreement. Actual borrowing availability is based on eligible trade accounts receivable
levels. The Wachovia revolving credit facility replaces the existing facility with Wells
Fargo.

Borrowings
bear interest at either the Prime Rate plus up to 0.25% or, at our option, LIBOR plus up
to 2.25%, subject to minimum borrowing levels. The level of interest rate margin to Prime
or LIBOR is dependent upon our future financial performance as measured by EBITDA,
earnings before interest, taxes, depreciation and amortization, as defined in the
agreement. The targets under the agreement exempt certain expenses, including costs
incurred in our corporate sale process.

The
Wachovia agreement is subject to early termination fees, based upon the initial maximum
facility amount of $15 million, of 1% if terminated within the first year of the term and
0.75% if terminated thereafter through the end of the three-year term. The agreement also
imposes restrictions on such items as encumbrances and liens, payment of dividends, other
indebtedness, stock repurchases and capital expenditures and requires us to comply with
minimum financial and operating covenants. Any outstanding borrowings are secured by our
assets.

At
March 31, 2007, we had cash of $2,341,000 and borrowing availability of $5.0 million under
our revolving credit facility with our then-lender Wells Fargo. Comparatively, at March
31, 2006, we had cash of $1,079,000 and borrowing availability of $6.6 million and $1
million, respectively, under our revolving credit and term loan facilities with Wells
Fargo. At March 31, 2007, we had no borrowings under the revolving credit facility with
Wells Fargo.

Other
Sources and Uses of Working Capital for Fiscal 2007.The following factors
contributed to the use of $11.3 million in operating cash and $1.6 million in investing
cash during fiscal 2007:

| |  | Our
pretax loss from operations was $12.6 million for fiscal 2007.
| | - | ------------------------------------------------------------------

| | ° | Includes
the write-off of $2.2 million in assets associated with our distribution agreement with
Source Entertainment as a result of their bankruptcy filing.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | Includes
legal, investment banking and other expenses of $1.4 million associated with the
negotiation of the BTP merger agreement.
| | - | ----------------------------------------------------------------------------------------------------------------------------------

| | ° | Includes
$634,000 in expenses associated with the Lions Gate proxy contest and special committee
of our Board, as well as the ongoing process of evaluating strategic alternatives,
including our potential sale.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
funded feature film production of $2.9 million.
| | - | --------------------------------------------------

| |  | We
had a $3.9 million increase in trade payables and accrued liabilities offset in part by
our paid down of accrued royalties, distribution fees and music publishing fees by $3.4
million.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Approximately
$1.5 million in royalties previously advanced to us and classified as deferred revenues
were recouped by Sony BMG during fiscal 2007.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | Beginning
with our fourth quarter ended March 31, 2006, and in accordance with our agreement, Sony
BMG has been recouping their initial $3 million royalty advance to us and not providing
us with replacement advances as they had done prior to the quarter ended March 31, 2006.
Through March 31, 2007, Sony BMG has recouped $2.2 million, instead of re-advancing us
this amount.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

| |  | We
incurred $1.6 million in capital expenditures in our continuing effort to improve our
information technology and distribution system infrastructure.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Adding
to the uses of cash above, our gross trade accounts receivables (gross of reserves for
sales returns and allowances, and doubtful accounts) increased to $28.3 million at March
31, 2007, compared to $26.3 million at March 31, 2006, as a result of timing of sales
within the March quarter.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We
financed these expenditures through operating cash flows, our revolving line of credit,
borrowings from our new disc manufacturer Sonopress and a private placement of debt. While
we had no current outstanding borrowings under our revolving line of credit with Wells
Fargo (since replaced by our new Wachovia line), our long-term outstanding borrowings from
the private placement and the manufacturing advance from Sonopress totaled $26.9 million
(of which $1.2 million in related fees were deducted from the proceeds of the private
placement). The $26.9 million outstanding, of which $17 million may incrementally become
due beginning in February 2009 and $10 million of which is incrementally due as discs are
manufactured (we estimate $2.3 million will be due in the next 12 months) represents an
increase of approximately $28.3 million from the $11.5 million borrowed and classified as
a current liability at March 31, 2006.

We
believe that projected cash flows from operations, borrowing availability under our
revolving line of credit, cash on hand, and trade credit will provide the necessary
capital to meet our projected cash requirements for at least the next 12 months. Should we
find attractive corporate acquisitions, we may seek additional debt or equity financing in
order to fund the transaction, in the form of bank financing, convertible debt, or the
issuance of convertible preferred or common stock.

Contractual
Obligations and Commercial Commitments. The following table summarizes our
contractual obligations at March 31, 2007, and the effects such obligations are expected
to have on liquidity and cash flow in future periods:

|(in thousands)              | Payments due by period
|--------------------------- | ----------------------
|Contractual obligations:    | 2008                  
|Operating lease obligations |                       
|Capital lease obligations   |                       
|Long-term debt obligations  |                       
|Interest-convertible debt   |                       
|obligations                 |                       
|Licensing and exclusive     |                       
|distribution obligations    |                       
|Employment obligations      |                       
|                            |                       
|Total                       |                       
|                            |                       

Advances
and guarantees included in the table above, under Licensing and exclusive
distribution agreements, are prepaid and thus recoupable against future royalties,
distribution fees and profit participations earned by our exclusive program suppliers in
connection with revenues generated by those rights. As we have historically, we expect to
fund these commitments through recoupment of existing advances, our existing bank line of
credit, and other working capital.

We
do not expect our obligations for property and equipment expenditures, including
information technology related expenditures, to exceed $2.5 million per year.

Vendor
Managed Inventory.Under the VMI system, product suppliers are responsible for
monitoring, stocking, and fulfilling directly to individual retail stores and outlets.
Larger retailers, who have been transacting business via VMI with the major studios for
years, are starting to require smaller independents (i.e. product suppliers other than
major studios, music labels and mini-majors) to adopt this method of inventory
management. See Change in Buying Patterns  Best Buy Vendor Managed
Inventory (VMI) Program above.

Our
VMI systems provide timely and accurate sales and inventory data and allow us to maintain
proper stocking levels at retail. In our largest consortium-based VMI engagement, with
Best Buy, we have seen reduced returns and increased inventory turns. With respect to
long-term benefits, we expect the implementation of VMI relationships with retail
customers to:

|  
|--
|44

---

| |  | sell
more units and reduce returned items by better matching inventory to real-time demand
| | - | ------------------------------------------------------------------------------------------

| |  | reduce
potential overproduction and excess inventory quantities by more accurately forecasting
orders
| | - | -----------------------------------------------------------------------------------------------------

| |  | reduce
processing and warehousing fees by maintaining a leaner supply chain
| | - | ---------------------------------------------------------------------------

| |  | increase
our importance as a direct supplier of participating retail partners
| | - | -----------------------------------------------------------------------------

Source Entertainment, Inc. Chapter 11 Bankruptcy Filing and Related Asset
Impairment. We have written down the net book value of assets related to
our distribution agreement with Source Entertainment at March 31, 2007, as facts and
circumstances lead us to conclude that recoverability of the net book value is in now in
doubt.

We
have paid and accrued approximately $1.6 million for mechanical licensing fees for audio
programs that we now believe have not been paid by Source as contractually required. In
previous reported periods we also recorded a corresponding recoupable music publishing
advance for these anticipated music publishing payments, which we were to recoup according
to a February 8, 2006 settlement agreement with Source. This agreement granted us the
exclusive right to distribute as many additional Source-branded titles as necessary to
fully recoup any outstanding unpaid mechanical licensing and other unrecouped costs. Under
the settlement agreement, we would have continued to receive our standard distribution fee
on all units sold. The agreement also gave us the right but not the obligation to
discharge any unpaid music publishing fees required. As we were in control of future
Source-branded programming and could cross-promote our CD compilation releases within
Sources periodic magazine, we believed we could recover all of the distribution and
music publishing advances through profit participations from future titles and future
sales of previously released titles from Source-branded programming.

The
Source affiliate with whom we have the settlement agreement filed for Chapter 11
bankruptcy in May 2007. While we will continue to seek to operate under the terms of the
settlement agreement, we will attempt to perfect this agreement within the bankruptcy
courts. In January 2006, we purchased all of Sources rights in the Source Programs
at a UCC sale. Through this foreclosure sale, we purchased Sources entire right,
title and interest in the already released The Source Presents Hip Hop Hits Volumes 8, 9
and 10 and the yet to be produced future titles The Source Presents Hip Hop Hits Volume
11, 5 Mics, 25th Anniversary and 30th Anniversary CDs (four titles yet to be
released).  Given the uncertainty associated with the Sources bankruptcy, we
believe that the net book value of our Source-related assets is now impaired. Accordingly,
we have written down the unamortized assets related to our expectation of future profits
associated with the release of the four titles we purchased in the foreclosure sale.
Accordingly, we recorded a write-down of $2.2 million in the fourth quarter of fiscal
2007. The expense is included in cost of sales in the accompanying statement of operations
for fiscal 2007.

Long-Term
Debt. Long-term debt at March 31, 2007 and 2006 consisted of the following:

|(In thousands)                                                        | 2007 | 2006
|--------------------------------------------------------------------- | ---- | ----
|Subordinated senior convertible note, net of $1,570 discount          |      |     
|Subordinated manufacturing advance obligation, net of $1,411 discount |      |     
|                                                                      |      |     
|                                                                      |      |     
|                                                                      |      |     
|Less current portion of long-term debt, net of $588 discount          |      |     
|                                                                      |      |     
|Long-term debt less current portion and debt discounts                |      |     
|                                                                      |      |     

Debt
Instruments and Related Covenants. Our loan agreement with Wachovia
requires us to comply with minimum financial and operating covenants. We were not required
to be in compliance with the covenant establishing a minimum EBITDA, as defined by
Wachovia, as of March 31, 2007. We were in compliance with all financial and operating
covenants at March 31, 2007, and expect to be in compliance with all covenants for the
foreseeable future.

Off-Balance
Sheet Arrangements. We currently do not have any off-balance sheet
arrangements.

# Critical Accounting
Policies

The
discussion and analysis of our financial condition and results of operations are based
upon our financial statements, which have been prepared in accordance with accounting
principles generally accepted in the United States. Generally accepted accounting
principles require management to make estimates, judgments and assumptions that affect the
reported amounts of assets, liabilities, revenues and expenses, and the disclosure of
contingent assets and liabilities. We base our estimates on experience and on various
other assumptions that we believe to be reasonable under the circumstances, the results of
which form the basis for making judgments about the carrying values of assets and
liabilities that may not be readily apparent from other sources. Our actual results may
differ from those estimates.

|                         
|-------------------------
|Image Entertainment, Inc.

---

We
consider our critical accounting policies to be those that involve significant
uncertainties, require judgments or estimates that are more difficult for management to
determine, or that may produce materially different results when using different
assumptions. We consider the following accounting policies to be critical:

Revenue
Recognition. We recognize revenue upon meeting the recognition requirements of
American Institute of Certified Public Accountants Statement of Position (SOP)
00-2, Accounting by Producers or Distributors of Films and Staff
Accounting Bulletin (SAB) No. 104, Revenue Recognition.
Revenues from home video distribution are recognized net of an allowance for estimated
returns, as well as related costs, in the period in which the product is available for
sale by our customers (at the point that title and risk of loss transfer to the customer,
which is generally upon receipt by the customer, and in the case of new releases, after
street date restrictions lapse). We recognize revenues from domestic and
international broadcast licensing and home video sublicensing, as well as associated
costs, when the titles are available to the licensee and other recognition requirements of
SOP 00-2 are met. We defer fees received in advance of availability, usually in the case
of advances received from Sony BMG, Digital Site, Warner Music Group and other
international home video sublicensees, and for broadcast, until other revenue recognition
requirements have been satisfied. Provisions for uncollectible accounts receivable are
provided at the time of sale. As of March 31, 2007, deferred revenue totaled $5,039,000,
down from $5,751,000, at March 31, 2006.

Royalty
and Distribution Fees. For each reporting period, we estimate the ultimate total
revenues to be received throughout a titles exclusive license or distribution period
from exploitation of that title in multiple home entertainment formats. While we charge
royalty and distribution fee advances to operations as related revenues are earned,
estimates of ultimate revenues are important in determining whether we should record
additional royalty and distribution fee expense as cost of sales in any given reporting
period. We amortize royalty and distribution fee advances to expense in the same ratio
that the current period revenues for a title or group of titles bear to the estimated
remaining unrecognized ultimate revenues for that title. Additionally, in circumstances
required by SOP 00-2, we recognize additional amortization to the extent that capitalized
advance royalty and distribution fees exceed their estimated fair value in the period when
estimated.

We
base our estimates of ultimate revenue for each title on the historical performance of
that title, similar titles and specific genre performance. We attempt to reflect in our
estimates the most current available information on the title. We update such estimates
based upon the actual results of each formats revenue performance. Estimates of
ultimate revenues on a title-by-title basis are subject to substantial uncertainty.
Factors affecting future actual performance include focus from the sales and marketing
department (including advertising, promotions and price reductions), availability of
retail shelf space, retail customer product placement and advertising, maintenance of
adequate inventory levels, concert touring by the artist in the case of music-related DVDs
and CDs, retail sell-through, and ultimately continued end-user consumer demand. Any of
the above factors can contribute to a titles actual performance exceeding our
expectations prior to release or failure to meet pre-release expectations. Overestimation
of ultimate revenues would cause unamortized costs to be amortized at a slower rate or a
delay in adjusting costs to their fair value until such time estimates are reduced,
causing unamortized costs to be overstated and increased amortization of costs in a later
period. Underestimation of ultimate revenues would cause unamortized costs to be amortized
more quickly until ultimate revenue estimates are increased, causing unamortized costs to
be understated and decreased amortization of costs in a later period.

Inventory
Valuation. For each reporting period, we evaluate our ending inventories for excess
quantities and obsolescence. This evaluation includes analysis of historical sales levels
by title, format and genre, and projections of future demand. In addition, we write down
inventories that are considered obsolete or overstocked. Remaining inventory balances are
adjusted to approximate the lower-of-cost or market value, and result in a new basis in
such inventory until sold. If future demand or market conditions are less favorable than
our projections, additional inventory write downs may be required, and would be reflected
in cost of sales in the period the revision is made. Future demand will be dependent upon
the continued retail customer acceptance of our content, future demand by end-user
consumer, advertising, promotions and price reductions, market conditions (either
favorable or unfavorable) and future warehouse storage limitations. Should projections of
future inventory demand be overstated, the value of inventory would be overstated and
current cost of sales understated, with future cost of sales overstated. Conversely,
should projections of future demand be understated, the value of inventory would be
understated and the current cost of sales overstated, with future cost of sales
understated.

|  
|--
|46

---

Allowance
for Sales Returns and Doubtful Accounts Receivable. For each reporting period, we
evaluate product sales and accounts receivable to estimate their effect on revenues due to
product returns, sales allowances and other credits given and delinquent accounts. Our
estimates of product sales that will be returned and the amount of receivables that will
ultimately be collected require the exercise of judgment and affect reported revenues and
net earnings. In determining the estimate of product sales that will be returned, we
analyze historical returns (quantity of returns and time to receive returned product),
historical pricing and other credit memo data, current economic trends, and changes in
customer demand and acceptance of our products, including reorder activity. Based on this
information, we reserve a percentage of each dollar of product sales where the customer
has the right to return such product and receive a credit memo. Actual returns could be
different from our estimates and current provisions for sales returns and allowances,
resulting in future charges to earnings. Estimates of future sales returns and other
credits are subject to substantial uncertainty. Factors affecting actual returns include
retailer financial difficulties, the perception of comparatively poor retail performance
in one or several retailer locations, limited retail shelf space at various times of the
year, inadequate advertising or promotions, retail prices being too high for the perceived
quality of the content or other comparable content, the near term release of similar
titles, and poor responses to package designs. Underestimation of product sales returns
and other credits would result in an overstatement of current revenues and lower revenues
in future periods. Conversely, overestimation of product sales returns would result in an
understatement of current revenues and higher revenues in future periods.

Similarly,
we evaluate accounts receivable to determine if they will ultimately be collected. In
performing this evaluation, significant judgments and estimates are involved, including an
analysis of specific risks on a customer-by-customer basis for our larger customers and an
analysis of the length of time receivables have been past due. Based on this information,
we reserve an amount that we believe to be doubtful of collection. If the financial
condition of our customers were to deteriorate or if economic conditions were to worsen,
additional allowances might be required in the future. Underestimation of this allowance
would cause accounts receivable to be overstated and current period expenses to be
understated. Overestimation of this allowance would cause accounts receivable to be
understated and current period expenses to be overstated.

Valuation
of Deferred Income Taxes.Income taxes are accounted for under the asset and liability
method. Deferred tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. We must assess the likelihood that our deferred tax
assets will be recovered from future taxable income, and to the extent that it is more
likely than not that such deferred tax assets will not be realized, we must establish a
valuation allowance. The establishment, or increase, of a valuation allowance increases
income tax expense for such year. We have a valuation allowance against 100% of our net
deferred tax assets, which are composed primarily of net operating loss (NOL)
carryforwards. Even though we have fully reserved these net deferred tax assets for book
purposes, we would still be able to utilize them to reduce future income taxes payable
should we have future earnings. To the extent such deferred tax assets relate to NOL
carryforwards, the ability to use such NOLs against future earnings will be subject to
applicable carryforward periods. As of March 31, 2007, we had NOL carryforwards for
Federal and state tax purposes of $16,653,000 and $4,837,000, respectively, which are
available to offset taxable income through 2027 and 2017, respectively.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# Results of Operations

# Net Revenues

Approximately
94% of consolidated net revenues were generated from our worldwide sale of DVDs during
fiscal 2007, compared to 90% and 89% in fiscal 2006 and 2005, respectively. CDs
contributed approximately 4% of consolidated net revenues for fiscal 2007, compared to 8%
and 10% of fiscal 2006 and 2005, respectively. The following table presents consolidated
net revenues by reportable business segment for the fiscal years ended March 31:

|               |                |  |  
|-------------- | -------------- |  | -
|% Change       | % Change      
|(in thousands) | (in thousands)
|Net revenues:  |                |  |  
|Domestic       |                |  | $
|International  |                |  |  
|               |                |  |  
|Consolidated   |                |  | $
|               |                |  |  

Fiscal 2007 Compared to
2006 and 2005

Domestic
Revenues. During fiscal 2007, our DVD and CD new release schedules did not perform as
well as expected and were not as strong as fiscal 2006 and 2005. Our catalogue revenues
were also lower, most likely the result of the factors discussed below. Our top ten new
release DVD and CD titles for fiscal 2007, 2006 and 2005 together generated net revenues
of $16.5 million, $18.8 million and $33.2 million, respectively. New releases totaled
$59.2 million, $61.1 million and $76.8 million for fiscal 2007, 2006 and 2005,
respectively.

We
had a great deal of success during the fiscal 2006 holiday selling season third quarter,
with such higher-priced boxed sets as the BBC production of The Chronicles of Narnia
(containingThe Lion The Witch And The Wardrobe, The Silver Chair and Prince
Caspian and The Voyage Of The Dawn Treader), The Bill Jeff Larry and RonBox
Set(Featuring Bill Engvall, Jeff Foxworthy, Larry the Cable Guy and Ron White) and
the Twilight Zone: Definitive Edition Seasons 4 and 5. We could not capitalize
similarly on our fiscal 2007 holiday selling season third quarter due to a weaker
performing release schedule.

The
DVD marketplace for independent DVD suppliers such as us has been negatively impacted by a
maturing and slowing DVD sell-through market. Major motion picture studios are offering
more of their catalogue programming to retail at reduced prices, taking up more precious
shelf space from the independent suppliers. The larger retailers use discounted DVDs to
drive consumer traffic to their stores which have weakened other stand-alone DVD and CD
retailers. Retail shelf space is at a premium and with the January 2006 and August 2006
bankruptcy filings of Musicland and Tower (both significant customers of ours), the number
of retail store fronts has decreased.

Our
customer Trans World Entertainment purchased approximately 400 of the approximately 800
Musicland stores, closed approximately 55 of those purchased and absorbed the inventories
from all of the purchased stores, which included inventories originally purchased by
Musicland from us. While our sales of product to Trans World have increased for fiscal
2007, as compared to fiscal 2006, they have not covered the revenues lost as a result of
Musicland bankruptcy.

Tower
was purchased by a liquidator which liquidated the chain with going-out-of-business sales.
Towers inventory, including inventories originally purchased by Tower from us, was
deeply discounted to consumers during our third quarter of fiscal 2007.

As
retail store fronts shrink and shelf space becomes more constrained, we are seeing sales
to our Internet retailers growing. Sales to Amazon, Infinity Resources (including
Critics Choice Video and DeepDiscount.com), and NetFlix have increased for fiscal
2007, by 17.6%, 9.6% and 74.9%, respectively, as compared to fiscal 2006. Internet
retailers offer virtual shelf space, which is of critical importance to an independent
software supplier.

Finally,
we believe that the uncertainty of our future as an independent supplier of DVD
programming has created retail buyer insecurity. As a result, we believe retailers have
decreased their inventories of our programming and reduced new purchases of our
programming since Lions Gate launched their proxy contest. In multiple face-to-face
meetings with retail buyers, our sales force has been asked to comment on
whats going on with Lions Gate and has also been asked in various ways
whether or not we would continue operating distinctly as Image Entertainment in any
post-acquisition scenario. Retailers want assurances that they will be able to return
unsold inventory, and we believe retail buyers do not like the uncertainty that
accompanies the possibility of new ownership. In the absence of such assurances, retail
outlets have reacted to this insecurity by limiting their inventory and purchasing of our
programming  thus reducing their financial exposure  until they are reassured
as to our future.

|  
|--
|48

---

We
anticipate that the high definition DVD market will ultimately help energize overall DVD
sales, as well as generate revenues for us from our high definition assets. We have over
120 high-definition masters that can be released on either the HD-DVD or Blu-ray Disc®
formats, and through the conversion process we also have access to many more titles in our
catalog.

Digital
Distribution Revenues. Egami offers near- and medium-term opportunities. Increasing
broadband Internet access and the consumers growing expectation that they will be
able to consume entertainment content exactly the way they want, where they want, and how
they want, will play an extremely important role in how quickly digital distribution
grows. We believe the speed in which key industry players move to embrace the transition
to digital distribution will most likely determine how quickly video on demand, digital
download and streaming revenues grow. Our wholly-owned subsidiary Egami Media is growing
its revenues as the digital video market continues to develop. Our digital distribution
revenues for fiscal 2007 grew to $1,214,000, from $178,000 in fiscal 2006, Egamis
first full year of operations. We anticipate continued growth of both our digital library
and digital revenues.

International
Revenues. Our internationally generated revenues have significantly decreased over the
last several years due to lower royalty revenues reported by our international
sublicensees. Because of language barriers and cultural differences, much of our
successful new release programming  particularly urban and comedy titles  has
not been released internationally or has not sold as well as in North America.

We
continue our efforts to acquire programming that sells well not only domestically, but
also internationally. Music-related DVDs have done well internationally and we believe the
urban music and documentary genres have revenue growth potential overseas.

Broadcast
sales were $970,000, $494,000, and $487,000 for fiscal 2007, 2006 and 2005, respectively.
Fiscal 2007 benefited from higher revenues generated from HVE, comedy and music event
titles.

# Cost of Sales

The
following table presents consolidated cost of sales by reportable business segment and as
a percentage of related-segment net revenues for the fiscal years ended March 31:

|               |                |  |  
|-------------- | -------------- |  | -
|               |               
|(in thousands) | (in thousands)
|Cost of sales: |                |  |  
|Domestic       |                |  | $
|International  |                |  |  
|               |                |  |  
|Consolidated   |                |  | $
|               |                |  |  

|                                         |  |  |  |     
|---------------------------------------- |  |  |  | ----
|As a percentage of segment net revenues: |  |  |  |     
|Domestic                                 |  |  |  | 82.9
|International                            |  |  |  | 61.8
|                                         |  |  |  |     
|Consolidated                             |  |  |  | 82.2
|                                         |  |  |  |     

Domestic
Gross Profit Margins. Gross margins for the domestic segment, as a percentage of
segment net revenues, decreased to 17.8% for fiscal 2007, from 24.8% for fiscal 2006 and
25.3% for fiscal 2005. The $2.2 million write-down of assets related to our distribution
agreement with Source Entertainment negatively impacted gross margins for the domestic
segment, as a percentage of segment net revenues, by 2.3% for fiscal 2007. See
Liquidity and Capital Resources  Source Entertainment, Inc. Chapter 11
Bankruptcy Filing and Related Asset Impairment above.

Our
gross margins are impacted by the sales mix of titles within the respective periods. Each
of our exclusive agreements has differing terms. We have exclusive license agreements and
exclusive distribution agreements. For license agreements, which typically generate higher
gross margins, we pay a royalty based on sales, and for distribution agreements we
generally retain a fee, recoup our costs and split back-end profits, if any. The average
gross margin recognized is then reduced by expenses classified as cost of sales, such as
the expenses generated by our distribution facility, amortization of non-recoupable
production costs, freight out and market development funds contributed to our retailers to
get placement for our product. When the average gross margin for a period is lower, these
additional costs of sales items will further reduce the gross margins recognized.

|                         
|-------------------------
|Image Entertainment, Inc.

---

Other
items affecting our average gross margins include:

| |  | the
strength of a titles sales performance
| | - | -------------------------------------------

| |  | the
selling price of a title
| | - | ----------------------------

| |  | the
costs that we are responsible for, including disc manufacturing costs
| | - | -------------------------------------------------------------------------

| |  | third
party net profit participations, specifically the royalty rates, distribution fees
retained and          profit splits inherent in the agreements
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | increased
amortization of recoupable production costs and royalty advances as a result of reducing
ultimate revenue projections for a title or a cross-collateralized group of titles
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Some
specific factors contributing to the decrease in segment gross profit margins for fiscal
2007, as compared to fiscal 2006 and fiscal 2005 were:

| |  | As
a percentage of net revenues, we experienced a significant increase in net revenues
generated by exclusively distributed content in fiscal 2007 versus exclusively licensed
content, as compared to fiscal 2006 and 2005. Historically, a higher percentage of
revenues are generated from higher-margin exclusively-licensed titles. Because our
revenues included such a high percentage of lower-margin exclusively distributed
programming, our average gross margins for all of our titles were lower, prior to the
deduction of the other cost of sales items discussed above.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
experienced lower gross margins on some of our exclusively distributed DVD and CD
product, attributable to higher amortization of recoupable production costs as a result
of lowering ultimate revenue forecasts in light of recent, slowing DVD marketplace
trends.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | At
lower revenue levels, fixed costs included in cost of sales represent a higher percentage
of net revenues, negatively impacting our gross margin percentage.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | We
increased the amount of market development funds provided to our customers, which is
recorded as a reduction of revenues and thus has a negative effect on gross margins.
These market development fund expenditures, as percentages of domestic net revenues, were
4.8%, 4.7% and 3.8%, before reduction for such market development funds, for fiscal 2007,
2006 and 2005, respectively. We expect the trend of increased market development funds
paid to customers to continue for the foreseeable future.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

International
Gross Profit Margins. Gross margins for the international segment are based upon
royalty income generated by sales of our exclusive programming by our sublicensees. The
gross margins we report will fluctuate depending upon the sales mix of titles sold by our
sublicensees and royalty rates to our content suppliers based upon those reported
royalties. We expect gross margins for this segment to continue to fluctuate higher and
lower in future periods as a result of the factors mentioned above.

Selling Expenses

The
following tables present consolidated selling expenses by reportable business segment and
as a percentage of related segment net revenues for the fiscal years ended March 31:

|  
|--
|50

---

|                                         |                | 
|---------------------------------------- | -------------- | 
|% Change                                 | % Change      
|(in thousands)                           | (in thousands)
|Selling expenses:                        |                | 
|Domestic                                 |                | 
|International                            |                | 
|                                         |                | 
|Consolidated                             |                | 
|                                         |                | 
|As a percentage of segment net revenues: |                | 
|Domestic                                 |                | 
|International                            |                | 
|                                         |                | 
|Consolidated                             |                | 
|                                         |                | 

Fiscal 2007 Compared to
2006 and 2005

Domestic
Selling Expenses. The reduction in selling expenses in absolute dollars for fiscal 2007
as compared to fiscal 2006 was primarily due to the following factors:

| |  | Severance
costs incurred from the November 9, 2006, involuntary termination of employees as part of
managements plan to reduce operating costs totaled $225,000 for fiscal 2007.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Our
compensation expense, exclusive of severance costs, was down $108,000 for fiscal 2007 as
compared to fiscal 2006 as a result of our November 2006 plan to reduce operating costs.
Fiscal 2006 compensation expense was up $486,000 over fiscal 2005 due to additional
personnel and annual raises.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Advertising
and promotional expenses were down approximately $642,000 due to reduced customer
advertising and fewer shipments of screeners, catalogs and mailers, offset by greater
third-party publicity consultants on several of our new DVD and CD releases for fiscal
2007.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | As
a percentage of revenues, advertising and promotional expenses were 4.3% of segment net
revenues, down slightly from 4.4% for fiscal 2006, due primarily to lower consumer
advertising in 2007.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | Domestic
selling expenses for fiscal 2006 reflect higher advertising expenses as a percentage of
net revenues than fiscal 2005, primarily television and radio spots and co-op advertising
expenses, offset by lower expenses for print advertising and mailers.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Egami
selling expenses were up $113,000 in fiscal 2007 as compared to 2006, primarily due to
increased compensation expenses.
| | - | -----------------------------------------------------------------------------------------------------------------------------

| | ° | Egami
selling expenses were $196,000 for fiscal 2006, its first full year of operation,
consisting primarily of personnel costs. There were minimal Egami selling expenses in
fiscal 2005.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Domestic
selling expenses were higher in fiscal 2007, as a percentage of segment revenues, due to
the allocation of comparable absolute dollars over comparatively lower revenues for
fiscal 2007.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

International
Selling Expenses. Our international selling expenses are not significant because Sony
BMG, Digital Site and Warner Music Group, our primary international sublicensees, are
responsible for the majority of selling expenses relating to sales of our programming
internationally.

General and
Administrative Expenses

The
following tables present consolidated general and administrative expenses by reportable
business segment and as a percentage of related segment net revenues for the fiscal years
ended March 31:

|                                         |                | 
|---------------------------------------- | -------------- | 
|% Change                                 | % Change      
|(in thousands)                           | (in thousands)
|General and administrative expenses:     |                | 
|Domestic                                 |                | 
|International                            |                | 
|                                         |                | 
|Consolidated                             |                | 
|                                         |                | 
|As a percentage of segment net revenues: |                | 
|Domestic                                 |                | 
|International                            |                | 
|                                         |                | 
|Consolidated                             |                | 
|                                         |                | 

|                         
|-------------------------
|Image Entertainment, Inc.

---

Fiscal 2007 Compared to
2006 and 2005

Domestic
General and Administrative Expenses. General and administrative expenses were higher in
absolute dollars yet higher as a percentage of net revenues for fiscal 2007 as compared to
fiscal 2006 and 2005. The changes in expenses for fiscal 2007 as compared to fiscal 2006
and 2005 are discussed below:

| |  | Legal
and investment banking expenses associated with the BTP acquisition agreement of $1.4
million during fiscal 2007.
| | - | -----------------------------------------------------------------------------------------------------------------------

| |  | Expenses
associated with the Lions Gate proxy contest and special committee of our Board totaling
$634,000 and $247,000 for fiscal 2007 and 2006. These costs include investment banking,
special committee and legal fees in 2007 and 2006 and proxy solicitor fees, financial
printer fees, press release costs, and independent proxy vote processor fees in 2007.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Net
charge of $496,000 associated with Towers bankruptcy filing in
fiscal 2007. In November 2006, we assigned our right, title and interest in our general
unsecured trade receivable bankruptcy claim against Tower to a third-party financial
institution for a cash payment of approximately $135,000. Accordingly, we recorded a
$64,000 recovery of the previously written off bad debt charge as a credit to general and
administrative expenses for fiscal 2007.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | In
fiscal 2006, we incurred a bad debt charge of $1.6 million as a result of the January 12,
2006, bankruptcy filing of Musicland.
| | - | ----------------------------------------------------------------------------------------------------------------------------------

| |  | Temporary
labor expenses of $438,000 for fiscal 2007 associated with inputting and auditing the
data entered into our content rights management system and for the auditing of
contractual data prior to it being entered into our new royalty and distribution system.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Severance
and UK office closure costs related to the November 9, 2006, involuntary termination of
employees as part of managements plan to reduce operating costs totaled $263,000.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In
fiscal 2007, we had increased expenses of $145,000 for consulting and professional
services in connection with information technology systems and accounting.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | In
fiscal 2006 we had reduced expenses in this category as compared to fiscal 2005.
| | - | -----------------------------------------------------------------------------------

| |  | Insurance
expenses, primarily for medical and directors and officers liability, were higher by
$125,000 in fiscal 2007 as compared to fiscal 2006.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Compensation
expense, exclusive of severance and UK office closure costs, were up approximately
$86,000 in fiscal 2007 as compared to fiscal 2006, reflecting savings from our November
2006 plan to reduce operating costs.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | In
fiscal 2006, we incurred increased personnel costs of $484,000 due to additional
personnel and annual raises as compared to fiscal 2005.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------

| | ° | In
fiscal 2006, we did not have performance-based bonuses. This resulted in compensation
expense savings of $679,000 as compared to fiscal 2005.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Investment
banking fees and expenses of $90,000 associated with an investment banking firms
review of the Relativity Media agreement in the third quarter of fiscal 2007.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | In
fiscal 2006, we incurred an impairment charge for the cumulative cost of a third-party
software program totaling $248,000.
| | - | -----------------------------------------------------------------------------------------------------------------------------

| |  | Egami
general and administrative expenses were up $95,000 in fiscal 2007 as compared to 2006,
primarily due to increased compensation expense.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------

| | ° | In
fiscal 2006, our general and administrative expenses of Egami and Image UK totaled
$202,000 and $409,000, respectively, their first full year of operation. Expenses for
Egami are primarily personnel and expenses for Image UK are primarily personnel and rent
and utilities associated with the leased office space. There were minimal fiscal 2005
general and administrative expenses associated with Egami and Image UK.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Depreciation
expense was down $700,000 in fiscal 2007 as compared to fiscal 2006. Many Las Vegas
distribution facility assets became fully depreciated in fiscal 2007, reducing
comparative depreciation expense in fiscal 2007.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For
more information on our general and administrative expenses for fiscal 2007, see
Update on Management Plan to Reduce Operating Costs above.

|  
|--
|52

---

Other Income and Expenses

We
had no other income in fiscal 2007. Other income for fiscal 2006 was minimal. Other
expenses for fiscal 2005 consisted primarily of losses on disposal of fixed assets.

Interest Expense

|                                         |                | 
|---------------------------------------- | -------------- | 
|% Change                                 | % Change      
|(in thousands)                           | (in thousands)
|Interest expense, net of interest income |                | 
|                                         |                | 
|As a percent of net  revenues            |                | 
|                                         |                | 

Interest
expense for fiscal 2007 was higher as a result of higher weighted-average interest bearing
debt levels and interest rates for the period, as well as significant noncash interest
expense recorded from the amortization of debt discounts and deferred financing costs. Net
noncash charges to interest expense, representing amortization of the Sonopress
manufacturing advance debt discount, convertible note debt discount and deferred financing
costs for fiscal 2007, totaled $1,273,000. We expensed approximately $152,000 of our
remaining Wells Fargo unamortized deferred financing costs as a result of accelerating the
maturity of our revolving line of credit during fiscal 2007. Noncash amortization of the
Wells Fargo deferred financing costs to interest expense for fiscal 2007 totaled $202,000.
Of our total interest expense for fiscal 2007, 52% represented noncash interest expense.

Income Taxes

We
recorded a Federal tax benefit in fiscal 2007 for alternative minimum taxes recorded in
fiscal 2006 and recorded state minimum income and franchise taxes for fiscal 2007. In
fiscal 2006 and 2005, we recorded Federal and California state alternative minimum taxes as
we utilized NOL carryforwards to offset taxable earnings which we anticipated would result
in alternative minimum tax due to limitations on the utilization of these NOLs.

Even
though we have fully reserved our net deferred tax assets for book purposes, we would
still be able to utilize them to reduce future income taxes payable, should we have future
earnings. To the extent such deferred tax assets relate to NOL carryforwards, the ability
to use such NOL carryforwards against future earnings will be subject to applicable
carryforward periods. As of March 31, 2007, we had NOL carryforwards for Federal and state
tax purposes of $16,653,000 and $4,837,000 respectively, which are available to offset
taxable income through 2027 and 2017, respectively.

Consolidated Net Earnings
(Loss)

Net
loss for fiscal 2007 and 2006 was $12,611,000, or $.59 per diluted share, and $207,000, or
$.01 per diluted share, respectively. Net earnings for fiscal 2005 were $5,127,000, or
$.26 per diluted share.

# Recently Issued
Accounting Pronouncements

In
February 2007, the Financial Accounting Standards Board (FASB) issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities.  SFAS No. 159 permits
entities to choose to measure many financial instruments and certain other items at fair
value.  The objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring related
assets and liabilities differently without having to apply complex hedge accounting
provisions.  SFAS No. 159 is effective for financial statements issued for fiscal years
beginning after November 15, 2007.  Early adoption is permitted as of the beginning of a
fiscal year that begins on or before November 15, 2007, provided we also elect to apply
the provisions of SFAS No. 157, Fair Value Measurements.  We have not yet determined
the impact of adopting SFAS No. 159 on our financial position.

In
September 2006, the FASB issued
SFAS No. 157, Fair Value Measurements. SFAS No. 157
defines fair value, establishes a framework for measuring fair value in GAAP and requires
enhanced disclosures about fair value measurements. SFAS No. 157 does not
require any new fair value measurements. The pronouncement is effective for fiscal years
beginning after November 15, 2007. The guidance in SFAS No. 157 will be
applied prospectively with the exception of: (i) block discounts of financial
instruments; and (ii) certain financial and hybrid instruments measured at initial
recognition under SFAS No. 133, Accounting for Derivative Instruments
and Hedging Activities. These exceptions are to be applied retrospectively as of
the beginning of initial adoption (a limited form of retrospective application). We will
change how we estimate fair value starting in fiscal 2009.

In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxesan interpretation of FASB Statement
No. 109 (FIN 48), which clarifies the accounting for
uncertainty in income tax positions. This Interpretation requires that we recognize in our
consolidated financial statements the impact of a tax position that is more likely than
not to be sustained upon examination based on the technical merits of the position. FIN 48
contains extensive disclosure requirements. The provisions of FIN 48 will be effective as
of the beginning of our 2008 fiscal year (April 1, 2007), with the cumulative effect of
the change in accounting principle recorded as an adjustment to opening retained earnings.
We are currently evaluating the impact of adopting FIN 48 on our consolidated financial
statements.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# ITEM 7A.      QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market
risk is the potential loss arising from adverse changes in market rates and prices, such
as interest rates and foreign currency exchange rates. Changes in interest rates and
changes in foreign currency exchange rates have an impact on our results of operations.

# Interest Rate
Fluctuations

At
March 31, 2007, we did not have any outstanding borrowings subject to changes in interest
rates. Borrowings under our Wachovia revolving line of credit will be subject to changes
in interest rates. We presently do not use derivatives to manage this risk.

Management
believes that moderate changes in the prime rate would not materially affect our operating
results or financial condition.

# Foreign Exchange Rate
Fluctuations

At
March 31, 2007, our accounts receivable related to international distribution and
denominated in foreign currencies were minimal. They are subject to future foreign
exchange rate risk and could become significant in the future. We distribute some of our
licensed DVD programming (for which we hold international distribution rights)
internationally through sublicensees. Additionally, we exploit international broadcast
rights to some of our exclusive entertainment programming (for which we hold international
broadcast rights). Management believes that moderate changes in foreign exchange rates
will not materially affect our operating results or financial condition. To date, we have
not entered into foreign currency exchange contracts.

|  
|--
|54

---

# ITEM 8.      FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA

|INDEX TO CONSOLIDATED FINANCIAL STATEMENTS                                                        | Page
|------------------------------------------------------------------------------------------------- | ----
|Report of Independent Registered Public Accounting Firm                                           | 56  
|Consolidated Balance Sheets as of March 31, 2007 and 2006                                         | 57  
|Consolidated Statements of Operations for the years ended March 31, 2007, 2006 and 2005           | 59  
|Consolidated Statements of Shareholders Equity for the years ended March 31, 2007, 2006 and 2005 | 60  
|Consolidated Statements of Cash Flows for the years ended March 31, 2007, 2006 and 2005           | 61  
|Notes to Consolidated Financial Statements                                                        | 64  
|Schedule II - Valuation and Qualifying Accounts for the years ended March 31, 2007, 2006 and 2005 | 89  

|                         
|-------------------------
|Image Entertainment, Inc.

---

# Report of Independent
Registered Public Accounting Firm

Board of Directors and
ShareholdersImage Entertainment, Inc.Chatsworth, California

We have audited the accompanying
consolidated balance sheets of Image Entertainment, Inc. as of March 31, 2007 and 2006,
and the related consolidated statements of operations, shareholders equity and cash
flows for the years ended March 31, 2007, 2006 and 2005. We also have audited the schedule
as listed in the accompanying index. These consolidated financial statements and schedule
are the responsibility of the Companys management. Our responsibility is to express
an opinion on these consolidated financial statements and schedule based on our audits.

We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit included
consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Companys internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated
financial statements referred to above present fairly, in all material respects, the
financial position of Image Entertainment, Inc. as of March 31, 2007 and 2006, and the
results of its operations and its cash flows for each of the years then ended in
conformity with accounting principles generally accepted in the United States of America.
 Also, in our opinion, the schedule presents fairly, in all material respects, the
information set forth therein.

As discussed in the notes to the
consolidated financial statements, effective April 1, 2006, the Company adopted the
provisions of the Statement of Financial Accounting Standard No. 123(R) - An Amendment
of FASB Statement No. 123.

/s/ BDO SEIDMAN LLP

Los Angeles, CaliforniaJune 29, 2007

|  
|--
|56

---

# CONSOLIDATED BALANCE
SHEETS

# March 31, 2007 and 2006

---

# ASSETS

|(In thousands)                                                 | 2007 | 2006
|-------------------------------------------------------------- | ---- | ----
|Current assets:                                                |      |     
|Cash and cash equivalents                                      |      |     
|Accounts receivable, net of allowances of                      |      |     
|$8,956 - 2007                                                  |      |     
|$9,172 - 2006                                                  |      |     
|Inventories (Notes 2, 5 and 8)                                 |      |     
|Royalty and distribution fee advances (Notes 9, 11, 12 and 16) |      |     
|Prepaid expenses and other assets                              |      |     
|                                                               |      |     
|Total current assets                                           |      |     
|                                                               |      |     
|Noncurrent inventories, principally production costs           |      |     
|Noncurrent royalty and distribution advances                   |      |     
|Property, equipment and improvements, net (Notes 2 and 10)     |      |     
|Goodwill                                                       |      |     
|Other assets                                                   |      |     
|                                                               |      |     
|                                                               |      |     
|                                                               |      |     

See accompanying
notes to consolidated financial statements.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# CONSOLIDATED BALANCE
SHEETS, CONTINUED

# March 31, 2007 and 2006

---

# LIABILITIES AND
SHAREHOLDERS EQUITY

|(In thousands, except share data)                                                | 2007 | 2006
|-------------------------------------------------------------------------------- | ---- | ----
|Current liabilities:                                                             |      |     
|Accounts payable                                                                 |      |     
|Accrued liabilities                                                              |      |     
|Accrued royalties and distribution fees (Note 12)                                |      |     
|Accrued music publishing fees (Notes 11 and 12)                                  |      |     
|Deferred revenue (Note 7)                                                        |      |     
|Revolving credit facility (Note 6)                                               |      |     
|Current portion of long-term debt, less debt discount                            |      |     
|                                                                                 |      |     
|Total current liabilities                                                        |      |     
|                                                                                 |      |     
|Long-term debt, less current portion, less debt discount                         |      |     
|Other long-term liabilities, less current portion                                |      |     
|                                                                                 |      |     
|Total liabilities                                                                |      |     
|                                                                                 |      |     
|Commitments and Contingencies (Notes 5, 6 and 12)                                |      |     
|Shareholders equity (Notes 4, 5 and 13):                                        |      |     
|Preferred stock, $.0001 par value, 25 million shares authorized; none issued and |      |     
|outstanding                                                                      |      |     
|Common stock, $.0001 par value, 100 million shares authorized; 21,577,000 and    |      |     
|21,296,000 issued and outstanding in 2007 and 2006, respectively                 |      |     
|Additional paid-in capital                                                       |      |     
|Accumulated other comprehensive income (loss)                                    |      |     
|Accumulated deficit                                                              |      |     
|                                                                                 |      |     
|Net shareholders equity                                                         |      |     
|                                                                                 |      |     
|                                                                                 |      |     
|                                                                                 |      |     

See accompanying
notes to consolidated financial statements.

|  
|--
|58

---

# CONSOLIDATED
STATEMENTS OF OPERATIONS

# For the Years Ended
March 31, 2007, 2006 and 2005

---

|(In thousands, except per share data)                | 2007 | 2006 | 2005
|---------------------------------------------------- | ---- | ---- | ----
|NET REVENUES                                         |      |      | $   
|                                                     |      |      |     
|OPERATING COSTS AND EXPENSES:                        |      |     
|Cost of sales (Notes 11 and 16)                      |      |      |     
|Selling expenses                                     |      |      |     
|General and administrative expenses (Notes 3 and 16) |      |      |     
|                                                     |      |      |     
|                                                     |      |      |     
|                                                     |      |      |     
|EARNINGS (LOSS) FROM OPERATIONS                      |      |      |     
|OTHER EXPENSES (INCOME):                             |      |     
|Interest expense, net                                |      |      |     
|Other expense (income)                               |      |      |     
|                                                     |      |      |     
|                                                     |      |      |     
|                                                     |      |      |     
|EARNINGS (LOSS) BEFORE INCOME TAXES                  |      |      |     
|INCOME TAX EXPENSE (Note 15)                         |      |      |     
|                                                     |      |      |     
|NET EARNINGS (LOSS)                                  |      |      | $   
|                                                     |      |      |     
|NET EARNINGS (LOSS) PER SHARE:                       |      |     
|Net earnings (loss) - basic                          |      |     
|                                                     |      |      | $   
|Net earnings (loss) - diluted                        |      |     
|                                                     |      |      | $   
|                                                     |      |      |     
|WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:          |      |     
|Basic                                                |      |      |     
|                                                     |      |      |     
|Diluted                                              |      |      |     
|                                                     |      |      |     

See accompanying
notes to consolidated financial statements.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# CONSOLIDATED
STATEMENTS OF SHAREHOLDERS EQUITY

# For the Years Ended
March 31, 2007, 2006 and 2005

---

|                                  
|----------------------------------
|(In thousands)                    
|BALANCES, March 31, 2004          
|Issuance of common stock          
|Issuance of restricted stock units
|Exercise of options               
|Return of Aviva investment to     
|member                            
|Exercise of stock warrant         
|Net earnings                      
|                                  
|BALANCES, March 31, 2005          
|Exercise of options               
|Exercise of stock warrant         
|Acceleration of vesting of stock  
|options                           
|Foreign currency translation loss 
|Net loss                          
|                                  
|BALANCES, March 31, 2006          
|Issuance of stock warrant         
|Exercise of options               
|Exercise of stock warrant         
|Foreign currency translation gain 
|Net loss                          
|                                  
|BALANCES, March 31, 2007          
|                                  

See accompanying
notes to consolidated financial statements.

|  
|--
|60

---

# CONSOLIDATED
STATEMENTS OF CASH FLOWS

# For the Years Ended
March 31, 2007, 2006 and 2005

---

|(In thousands)                                                         | 2007 | 2006 | 2005
|---------------------------------------------------------------------- | ---- | ---- | ----
|CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES:                       |      |      |     
|Net earnings (loss)                                                    |      |      | $   
|Adjustments to reconcile net earnings (loss) to net cash               |      |     
|provided by (used in) continuing operating activities:                 |      |     
|Amortization of production costs                                       |      |      |     
|Depreciation and other amortization                                    |      |      |     
|Amortization of restricted stock units                                 |      |      |     
|Provision for lower of cost or market inventory                        |      |     
|write-downs                                                            |      |      |     
|Provision for doubtful accounts, sales returns and other credits       |      |      |     
|Asset impairment write-off                                             |      |      |     
|Loss on disposal of assets                                             |      |      |     
|Acceleration of vesting of employee stock options                      |      |      |     
|Changes in assets and liabilities associated with continuing operating |      |     
|activities:                                                            |      |     
|Accounts receivable                                                    |      |      |     
|Inventories                                                            |      |      |     
|Royalty and distribution fee advances                                  |      |      |     
|Production cost expenditures                                           |      |      |     
|Prepaid expenses and other assets                                      |      |      |     
|Accounts payable, accrued royalties, fees and                          |      |     
|liabilities                                                            |      |      |     
|Deferred revenue                                                       |      |      |     
|                                                                       |      |      |     
|Net cash (used in) provided by continuing                              |      |     
|operating activities                                                   |      |      |     
|                                                                       |      |      |     
|CASH FLOWS FROM CONTINUING INVESTING ACTIVITIES:                       |      |     
|Capital expenditures                                                   |      |      |     
|Acquisition of business, net of cash acquired                          |      |      |     
|                                                                       |      |      |     
|Net cash used in continuing                                            |      |     
|investing activities                                                   |      |      |     
|                                                                       |      |      |     

See accompanying
notes to consolidated financial statements.

|                         
|-------------------------
|Image Entertainment, Inc.

---

# CONSOLIDATED
STATEMENTS OF CASH FLOWS, CONTINUED

# For the Years Ended
March 31, 2007, 2006 and 2005

---

|(In thousands)                                           | 2007 | 2006 | 2005
|-------------------------------------------------------- | ---- | ---- | ----
|CASH FLOWS FROM CONTINUING FINANCING ACTIVITIES:         |      |      |     
|Borrowings under revolving credit facility               |      |      | $   
|Repayments of borrowings under revolving credit facility |      |      |     
|Proceeds from issuance of long-term debt, net of costs   |      |      |     
|Repayments of long-term debt                             |      |      |     
|Principal payments under capital lease obligations       |      |      |     
|Issuance of common stock                                 |      |      |     
|Foreign currency translation                             |      |      |     
|Proceeds from exercise of common stock warrant           |      |      |     
|Proceeds from exercise of employee stock option          |      |      |     
|                                                         |      |      |     
|Net cash provided by continuing financing activities     |      |      |     
|                                                         |      |      |     
|INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS:        |      |      |     
|Cash and cash equivalents at beginning of year           |      |      |     
|                                                         |      |      |     
|Cash and cash equivalents at end of year                 |      |      | $   
|                                                         |      |      |     
|SUPPLEMENTAL DISCLOSURES OF CASH                         |      |     
|FLOW INFORMATION:                                        |      |     
|Cash paid during the year for:                           |      |     
|Interest                                                 |      |      | $   
|                                                         |      |      |     
|Income taxes                                             |      |      | $   
|                                                         |      |      |     

See accompanying
notes to consolidated financial statements.

|  
|--
|62

---

# CONSOLIDATED
STATEMENTS OF CASH FLOWS, CONTINUED

# For the Years Ended
March 31, 2007, 2006 and 2005

---

SUPPLEMENTAL DISCLOSURES OF NONCASH
OPERATING, INVESTING AND FINANCING ACTIVITIES:

As
of March 31, 2007 and 2006, we accrued approximately $1.5 million and $3.8 million,
respectively, to accrue royalty advances and distribution fees for committed unpaid
royalty and production advances where future payment is based upon the release of the
program or the passage of time.

In
August 2006, we issued warrants with a fair value of $1,900,000 in connection with a
convertible debt financing. The warrant was recorded as a discount to the related $17
million debt and a long-term liability. See Note 5. Long-Term Debt  Private
Placement of Senior Convertible Note and Warrant.

In
August 2006, we issued a warrant to a finder in connection with the Relativity Media
agreement. The warrant had a fair value of $194,000 and was recorded as a component of
other assets and as additional paid in capital. See Note 4. Exclusive
Distribution Agreement with Relativity Media and Planned Issuance of Common Shares.

In
June 2006, we recorded a deferred manufacturing credit of $1,945,000 with an offsetting
discount on the $10 million manufacturing advance from Sonopress. See Note 5.
Long-Term Debt  New Disc Replication Agreement and Related Advance.

On
March 29, 2006, the Compensation Committee of our Board of Directors and our full Board
approved the acceleration of vesting for all outstanding unvested stock options granted
under our equity compensation plans. In connection with the vesting acceleration we
recorded a charge of $16,100 based on our estimate that 10% of employees with options will
terminate their employment prior to the end of the original vesting periods. We accrued
the charge to additional paid in capital at March 31, 2006.

As
of March 31, 2006, we accrued approximately $1.6 million for music publishing fees for
audio programs that we believe were not paid by our content provider Source Entertainment
as contractually required.  We recorded a corresponding recoupable music publishing
advance included as a component of royalty and distribution fee advances in the
accompanying balance sheet, as of March 31, 2006.

During
fiscal 2006, a former financial consultant exercised their warrant to purchase 100,000
shares issued in fiscal 2002 by surrendering approximately 58,000 shares in a cashless
exercise, an option in the original warrant agreement. The value of the original warrant
was fully amortized by March 31, 2003.

On
August 1, 2005, we acquired Home Vision Entertainment for $8,000,000 in cash.

|(In thousands)                                                                        |  |  |   |        |  
|------------------------------------------------------------------------------------- |  |  | - | ------ | -
|Fair value of tangible assets acquired                                                |  |  | $ | 7,102  |  
|Fair value of intangible assets acquired                                              |  |  |   | 600    |  
|Excess of purchase price over fair value of net assets acquired, recorded as goodwill |  |  |   | 5,715  |  
|Cash paid for net assets acquired                                                     |  |  |   | (8,000 | )
|Expenses incurred in connection with the acquisition                                  |  |  |   | (241   | )
|                                                                                      |  | 
|Liabilities assumed                                                                   |  |  | $ | 5,176  |  
|                                                                                      |  | 

See accompanying
notes to consolidated financial statements.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 1. Basis of
Presentation and Summary of Significant Accounting Policies.

Basis
of Presentation and Principles of Consolidation. The accompanying
consolidated financial statements include the accounts of Image Entertainment, Inc., its
subsidiaries Egami Media, Inc., Image Entertainment (UK), Inc., Home Vision Entertainment,
Inc., DVDPlanet, Inc. (which was dissolved as of December 31, 2004) and Aviva
International, LLC (which was dissolved as of December 31, 2004) (collectively,
we, our or us). All significant inter-company balances
and transactions have been eliminated in consolidation. Aviva International, LLC ceased
active operations effective December 31, 2002. DVDPlanet ceased operations for us in
December 2003 subsequent to the sale of substantially all of its assets in September 2003.

Business.        We
engage primarily in the domestic acquisition and wholesale distribution of           home
entertainment content for release on DVD, and in other home entertainment
          formats, via exclusive license and distribution agreements. We also distribute
          our exclusive DVD programming internationally, primarily by relying on
          sublicensees (particularly Sony BMG, Warner Music Group and Digital Site), from
          whom we receive revenues in the form of royalty income.

Use
of Estimates in Preparation of Financial Statements. The preparation of our
consolidated financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the amounts
reported in the financial statements. The significant areas requiring the use of
management estimates are related to provisions for lower-of-cost or market inventory write
downs, doubtful accounts receivable, unrecouped royalty and distribution fee advances,
valuation of deferred taxes, and sales returns. Although these estimates are based on
managements knowledge of current events and actions management may undertake in the
future, actual results may ultimately differ from those estimates.

Cash
and Cash Equivalents. Cash and cash equivalents include all cash balances
and highly liquid investments with an initial maturity of three months or less. We place
our temporary cash investments with high credit quality financial institutions. At times
our cash deposits may be in excess of the Federal Deposit Insurance Corporation (FDIC)
insurance limit.

Fair
Value of Financial Instruments. The carrying amount of our financial
instruments, which principally include cash, trade receivables, accounts payable and
accrued expenses, approximates fair value due to the relatively short maturity of such
instruments. The fair value of our debt instruments approximate the amount of future cash
flows associated with each instrument.

Revenue
Recognition. Revenue is recognized upon meeting the recognition
requirements of American Institute of Certified Public Accountants Statement of Position
(SOP) 00-2, Accounting by Producers or Distributors of Films and Staff
Accounting Bulletin (SAB) No. 104, Revenue Recognition. Revenues from
home video distribution are recognized net of an allowance for estimated returns, as well
as related costs, in the period in which the product is available for sale by our
customers (at the point that title and risk of loss transfer to the customer, which is
generally upon receipt by the customer and in the case of new releases, after street
date restrictions lapse). Revenues from domestic and international broadcast
licensing and home video sublicensing, as well as associated costs, are recognized when
the programming is available to the licensee and other recognition requirements of SOP
00-2 are met. Fees received in advance of availability, usually in the case of advances
received from Sony BMG, Digital Site, other international home video sublicensees and for
broadcast programming, are deferred until earned and all revenue recognition requirements
have been satisfied. Provisions for uncollectible accounts receivable are provided at the
time of sale. As of March 31, 2007, and March 31, 2006, deferred revenue totaled
$5,039,000 and $5,751,000, respectively.

Inventories.       Inventories
consist primarily of finished products for sale (which are stated at           the
lower-of-cost or market, with cost being determined on an average cost           basis)
and unamortized non-recoupable production costs (which are stated at fair
          value).

Non-Recoupable
Production Costs.  The costs to produce licensed content for domestic and
international distribution include the cost of converting film prints or tapes into the
optical disc format. Costs also include menu design, authoring, compression, subtitling,
closed captioning, service charges related to disc manufacturing, ancillary material
production, product packaging design and related services, and the overhead of our
creative services and production departments. A percentage of the capitalized production
costs is amortized to expense each month based upon: (i) a projected revenue stream
resulting from distribution of new and previously released exclusive programming related
to such production costs; and (ii) managements estimate of the ultimate net
realizable value of the production costs. Estimates of future revenues are reviewed
periodically and amortization of production costs is adjusted accordingly. If estimated
future revenues are not sufficient to recover the unamortized balance of production costs,
such costs are reduced to their estimated fair value.

|  
|--
|64

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Royalty
and Distribution Fee Advances, Recoupable Production Advances. Royalty and
distribution fee advances represent fixed minimum payments made to program suppliers for
exclusive content distribution rights. A program suppliers share of exclusive
program distribution revenues is retained by us until the share equals the advance(s) paid
to the program supplier plus recoupable production costs. Thereafter, any excess is paid
to the program supplier. In the event of an excess, we record, as a cost of sales, an
amount equal to the program suppliers share of the net distribution revenues.
Royalty and distribution fee advances are charged to operations as revenues are earned.
Royalty distribution fee advances and recoupable production costs are amortized to expense
in the same ratio that current period revenue for a title or group of titles bears to the
estimated remaining unrecognized ultimate revenue for that title. Revenue and cost
forecasts are continually reviewed by management and revised when warranted by changing
conditions. When estimates of total revenues and costs indicate that an individual title
or group of cross-collateralized titles which we exploit via home entertainment formats
(such as home video, CD or broadcast) will result in an ultimate loss, an impairment
charge is recognized to the extent that capitalized advance royalties and distribution
fees and recoupable production costs exceed estimated fair value, based on discounted cash
flows, in the period when estimated.

Property,
Equipment and Improvements.  Property, equipment and improvements are stated
at cost less accumulated depreciation and amortization. Major renewals and improvements
are capitalized; minor replacements, maintenance and repairs are charged to current
operations. Some costs in developing internal use software are capitalized pursuant to the
SOP 98-1, Accounting for Costs of Computer Software Developed or Obtained for Internal
Use. Depreciation and amortization are computed by applying the straight-line method
over the estimated useful lives of the machinery, equipment and software (3-7 years).
Leasehold improvements are amortized over the shorter of the useful life of the
improvement or the 10-year life of the related leases. See Note 2. Sonopress
Fulfillment Services Agreement and Planned Closure of Las Vegas Facility.

Advertising
Costs. Our advertising expense consists of expenditures related to
advertising in trade and consumer publications, product brochures and catalogs, booklets
for sales promotion, radio advertising and other promotional costs. In accordance with SOP
93-7, Reporting on Advertising Costs, we expense advertising costs in the period in
which the advertisement first takes place. Product brochures and catalogs and various
other promotional costs are capitalized and amortized over the expected period of future
benefit, but generally not exceeding six months. Our co-op advertising is expensed in
accordance with Emerging Issues Task Force (EITF) 01-09, Accounting for
Consideration Given by a Vendor to a Customer or a Reseller of the Vendors
Products. At March 31, 2007 and 2006, there were no prepaid advertising costs. For
fiscal 2007, 2006 and 2005, advertising and promotion expense was $4,319,000, $4,904,000
and $4,632,000, respectively.

Market
Development Funds. In accordance with EITF 01-09, Accounting for
Consideration Given by a Vendor to a Customer or a Reseller of the Vendors
Products, market development funds, including funds for specific product positioning,
taken as a deduction from payment for purchases by customers are classified by us as a
reduction to revenues. The following reductions to consolidated net revenues have been
made in accordance with the guidelines of this issue: $5,036,000 for fiscal 2007,
$5,329,000 for fiscal 2006 and $4,530,000 for fiscal 2005.

Allowances
Received From Vendors. In accordance with EITF 02-16, Accounting by a
Customer (Including a Reseller) for Certain Consideration Received from a Vendor, we
classify consideration received as a reduction in cost of sales in the accompanying
statements of operations unless we receive an identifiable benefit in exchange for the
consideration, or the consideration represents reimbursement of a specific, identifiable
cost incurred by us in selling the vendors product.

Shipping
Income and Expenses. In accordance with EITF 00-10, Accounting for
Shipping and Handling Fees and Costs, we classify amounts billed to customers for
shipping fees as revenues, and classify costs related to shipping as cost of sales in the
accompanying statements of operations.

Major
Customers and Suppliers. Amazon.com, Inc., AEC One Stop Group, and Anderson
Merchandisers (who supplies Wal-Mart) accounted for 12%, 12% and 10%, respectively, of our
net revenues for the year ended March 31, 2007. Anderson Merchandisers accounted for 11%
of our net revenues for the year ended March 31, 2006. Anderson Merchandisers, Best Buy
and AEC One Stop Group accounted for approximately 17%, 12%, and 10%, respectively, of our
net revenues for the year ended March 31, 2005. No other customers accounted for more than
10% of net revenues in fiscal 2007, 2006 and 2005. At March 31, 2007, AEC One Stop Group
and Anderson Merchandisers accounted for 20% and 17%, respectively, of our gross accounts
receivables. At March 31, 2006, Anderson Merchandisers and AEC One Stop accounted for 13%
and 12%, respectively, of our gross accounts receivables.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

In
June 2006, we entered into an agreement with Sonopress LLC for a five-year replication
agreement to replace Deluxe as our exclusive manufacturer of DVD product. We source all of
our DVD manufacturing with Sonopress. See Note 5. Long-Term Debt  New
Disc Replication Agreement and Related Advance.

Goodwill.         Goodwill
is not amortized, but instead is tested for impairment at least           annually.
Intangible assets continue to be amortized over their respective           estimated
useful lives ranging from three to five years. We have no intangible           assets
with indefinite useful lives.

Impairment
of Long-Lived Assets. We review for the impairment of long-lived and
specific, identifiable intangible assets whenever events or changes in circumstances
indicate the carrying amount of an asset may not be recoverable. An impairment loss would
be recognized when estimated undiscounted future cash flows expected to result from the
use of the asset and its eventual disposition is less than its carrying amount. We
incurred an impairment charge for the cumulative cost of a third-party software program
totaling $248,000 during our quarter ended December 31, 2005. The third-party developer
has failed to provide adequate resources necessary to cause the software to function as
designed. It was unclear as to whether they had the ability and resources to continue to
support the process necessary to correct functionality to original design specifications
and provide adequate future maintenance had we ultimately gone into live production. As a
result of increased uncertainty experienced by us during the December 2005 quarter, we
believed it was prudent to take the charge.

In
May 2007, a content provider, Source Entertainment, filed for bankruptcy protection.
Accordingly, we recognized an impairment loss equal to approximately $2.2 million.
See Note 11. Source Entertainment Inc. Chapter 11 Bankruptcy Filing and
Related Asset Impairment Write-Down.

On
March 29, 2007, we entered into a fulfillment services agreement with our DVD and CD
manufacturer Sonopress and plan to close our Las Vegas Nevada warehouse and distribution
facility. See Note 2. Sonopress Fulfillment Services Agreement and Planned
Closure of Las Vegas Facility.

Foreign
Currency Transactions. Foreign currency denominated transactions are
recorded at the exchange rate in effect at the time of occurrence, and the gains or losses
resulting from subsequent translation of the corresponding receivable or payable at
current exchange rates are included as a component of other income and expenses in the
accompanying statements of operations. To date, we have not entered into foreign currency
exchange contracts.

Income
Taxes. We account for income taxes pursuant to the provisions of SFAS No.
109, Accounting for Income Taxes, whereby deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between the
financial statement carrying amount of existing assets and liabilities and their
respective tax bases and the future tax benefits derived from operating loss and tax
credit carryforwards. We provide a valuation allowance on our deferred tax assets when it
is more likely than not that such deferred tax assets will not be realized. We have a
valuation allowance against 100% of our net deferred tax assets at March 31, 2007 and
2006.

Earnings/Loss
per Share. Basic earnings/loss per share are computed using the weighted
average number of common shares outstanding during the period. Diluted earnings per share
are computed using the combination of dilutive common share equivalents and the weighted
average shares outstanding during the period. Diluted loss per share is equivalent to
basic loss per share as inclusion common share equivalents would be anti-dilutive.

Comprehensive
Income (Loss). Comprehensive income (loss) consists of two components, net
income (loss) and other comprehensive income (loss). Other comprehensive income (loss)
refers to revenue, expenses, gains and losses that under generally accepted accounting
principles are recorded as an element of stockholders equity but are excluded from
net income (loss). Our other comprehensive income (loss) is comprised of foreign currency
translation adjustments arising from cash accounts maintained in England by our subsidiary
Image UK. Our comprehensive loss was $12,608,000 and $211,000 for the years ended March
31, 2007 and 2006, respectively. Comprehensive income was $5,127,000 for the year ended
March 31, 2005.

|  
|--
|66

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Stock
Options. In December 2004, the Financial Accounting Standards Board (FASB)
issued revised Statement of Financial Accounting Standards (SFAS) No. 123(R) (123R)
Share-Based Payment  an Amendment of SFAS No.s 123 and 95.
SFAS 123(R) establishes standards with respect to the accounting for transactions in which
an entity exchanges its equity instruments for goods or services, or incurs liabilities in
exchange for goods or services, that are based on the fair value of the entitys
equity instruments, focusing primarily on accounting for transactions in which an entity
obtains employee services in share-based payment transactions. SFAS No. 123(R) requires
public entities to measure the cost of employee services received in exchange for an award
of equity instruments based on the grant-date fair value of the award (with limited
exceptions) and recognize the cost over the period during which an employee is required to
provide service in exchange for the award. Through March 31, 2006, we accounted for stock
options granted to employees in accordance with Accounting Principles Board Opinion (APB)
No. 25, Accounting for Stock Issued to Employees, and related interpretations.

On
April 1, 2006, we adopted SFAS No. 123R using the modified prospective method.
Under this method, SFAS No. 123R requires that we measure the cost of employee services
received in exchange for an award of equity instruments based on the fair value of the
award on the grant date for all awards granted after March 31, 2006. Such cost will be
recognized over the period during which an employee of ours is required to provide service
in exchange for the award (i.e. the vesting period). Subsequent to our adoption of SFAS
No. 123R, we have not granted any stock-based compensation except for standard grants of
Restricted Stock Units to our Board and our Chief Marketing Officer, and we are currently
evaluating our future plans to do so, which at this time do not include issuing
stock-based compensation in the form of employee stock options.

On
March 29, 2006, the Compensation Committee of our Board of Directors approved, and our
full Board ratified, the acceleration of vesting for all outstanding unvested stock
options granted under our equity compensation plans. In connection with the vesting
acceleration, the Compensation Committee and the Board also imposed a holding period on
the shares underlying the accelerated options, which would prevent the sale or other
transfer of such shares until the date the shares would have vested under the original
vesting schedule of the respective option, except that the holding period will end upon
the close of a change in control transaction. Approximately 402,500 unvested stock options
were accelerated with an exercise price below the closing price of $3.73 on March 29, 2006
(i.e. in-the-money), and approximately 724,830 unvested stock options were accelerated
with an exercise price above the closing price (i.e. out-of-the-money). The action to
accelerate the vesting of unvested stock options enables us to minimize recognizing future
compensation expense associated with our outstanding options upon our adoption of SFAS No.
123R. The fair value of such stock-based compensation that would have been recorded as
compensation expense over the remaining vesting periods for the fiscal 2006-2011 periods,
had we not accelerated the vesting, totaled $1,883,000 (approximately $650,000 for our
2007 fiscal year, beginning April 1, 2006, and approximately $1,233,000 over the remaining
vesting period of the options). The pro-forma compensation expense is reflected in the
table below, which illustrates the effect on net earnings (loss) and earnings (loss) per
share for fiscal year 2006 as if Image had applied the fair value recognition provisions
of SFAS No. 123R to stock-based employee compensation. The weighted average difference
between the exercise price of the 402,500 in-the-money option shares and the closing stock
price on March 29, 2006, was $0.40 per share, and totaled $161,000 for all shares. Based
on an estimated 10% of employees with options who we estimate will terminate their
employment prior to the end of the original vesting periods, we expensed $16,100 during
the fourth quarter ended March 31, 2006.

There
were no stock option grants in fiscal 2007, other than a grant to a former member of the
Board that was subsequently cancelled. We granted restricted stock units for 25,920 shares
during fiscal 2007. The closing market price of those shares on the date of grant are
being amortized to general and administrative expense over their respective vesting
periods.

As
noted above, prior to April 1, 2006, we accounted for stock options granted to employees
in accordance with APB No. 25. Because the exercise price of all options granted by us was
greater than or equal to the market price of the underlying common stock on the date of
the grant, no compensation expense was recognized. If we had accounted for stock options
issued to employees in accordance with SFAS No. 123R, our pro forma net earnings (loss)
and net earnings (loss) per share would have been reported as follows:

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

|(In thousands, except per share data)                                 | 2007 | 2006 | 2005
|--------------------------------------------------------------------- | ---- | ---- | ----
|Consolidated net earnings (loss), as reported                         |      |      | $   
|Add: Stock-based employee compensation expense included in the        |      |     
|reported consolidated net earnings (loss), net of related tax effects |      |      |     
|Deduct: Total stock-based employee compensation expense               |      |     
|determined under fair value based method for all awards, net of       |      |     
|related tax effects                                                   |      |      |     
|                                                                      |      |      |     
|Pro forma consolidated net earnings (loss)                            |      |      | $   
|                                                                      |      |      |     
|Consolidated net earnings (loss) per share:                           |      |     
|As reported                                                           |      |     
|Basic                                                                 |      |      | $   
|Diluted                                                               |      |      | $   
|                                                                      |      |      |     
|Pro forma                                                             |      |     
|Basic                                                                 |      |      | $   
|Diluted                                                               |      |      | $   
|                                                                      |      |      |     

The
fair value of the options at the date of grant was estimated using the Black-Scholes model
with the following assumption:

|                                                               | 
|-------------------------------------------------------------- | 
|Expected life (years)                                          | 
|Interest rate                                                  | 
|Volatility                                                     | 
|Dividend yield                                                 | 
|Weighted-average fair value of options granted during the year | 

Recently
Issued Accounting Standards.  In February 2007, the Financial Accounting
Standards Board (FASB) issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities.  SFAS No. 159 permits entities to
choose to measure many financial instruments and certain other items at fair value.  The
objective is to improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting provisions.
 SFAS No. 159 is effective for financial statements issued for fiscal years beginning
after November 15, 2007.  Early adoption is permitted as of the beginning of a fiscal
year that begins on or before November 15, 2007, provided we also elect to apply the
provisions of SFAS No. 157, Fair Value Measurements.  We have not yet
determined the impact of adopting SFAS No. 159 on our financial position.

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.
SFAS 157 defines fair value, establishes a framework for measuring fair value in
GAAP and requires enhanced disclosures about fair value measurements. SFAS 157 does
not require any new fair value measurements. The pronouncement is effective for fiscal
years beginning after November 15, 2007. The guidance in SFAS 157 will be
applied prospectively with the exception of: (i) block discounts of financial
instruments; and (ii) certain financial and hybrid instruments measured at initial
recognition under SFAS 133. These exceptions are to be applied retrospectively as of
the beginning of initial adoption (a limited form of retrospective application). We will
change how we estimate fair value starting in fiscal 2009.

In
July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxesan interpretation of FASB Statement No. 109(FIN
48), which clarifies the accounting for uncertainty in income tax positions. This
Interpretation requires that we recognize in the consolidated financial statements the
impact of a tax position that is more likely than not to be sustained upon examination
based on the technical merits of the position. FIN 48 contains extensive disclosure
requirements. The provisions of FIN 48 will be effective as of the beginning of our 2008
fiscal year, with the cumulative effect of the change in accounting principle recorded as
an adjustment to opening retained earnings. We are currently evaluating the impact of
adopting FIN 48 on the consolidated financial statements.

Reclassifications.          Some
fiscal 2006 and 2005 balances have been reclassified to conform to the           fiscal
2007 presentation.

# Note 2. Sonopress
Fulfillment Services Agreement and Planned Closure of Las Vegas Facility.

On
March 29, 2007, we entered into an agreement whereby Sonopress would become our exclusive
provider of warehousing and distribution services.  We are currently in the process
of integrating Sonopress logistics and warehouse management systems with
Images order management and inventory control software as well as transitioning all
of our warehousing and distribution services to Sonopress facility in Pleasant
Prairie Wisconsin.

One-time
termination benefits totaling approximately $365,000 will be provided to current employees
who are involuntarily terminated under the terms of this restructuring. These employees
will be required to render service until a specific date in order to receive the
termination benefits. In accordance with SFAS No. 146 Accounting for Costs
Associated with Exit or Disposal Activities, a liability for the termination
benefits shall be measured initially on the April 20, 2007, communication date to our employees based on
the fair value of the liability as of the termination date. The resulting liability will
be recognized ratably over the future service period.

|  
|--
|68

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

We
plan on using our warehouse assets as we to continue to store and distribute our products
until the transfer of inventories to Sonopress is complete, now estimated to be by July
31, 2007. The decision to restructure our distribution operations by engaging Sonopress
triggered an asset impairment as determined under SFAS No. 144 Accounting for the
Impairment or Disposal of Long-Lived Assets. Much of our warehouse and
distribution equipment will be abandoned before the end of its previously estimated useful
life. In accordance with SFAS No. 146, depreciation and amortization estimates will be
revised to reflect the use of the assets over their shortened useful lives. At March 31,
2007, the net book value of assets that we estimate will be abandoned after the cessation
of warehousing and distribution activities in Nevada totaled approximately $620,000. We
continue to classify these assets as a component of property, equipment and improvements
and separately classify the accelerated depreciation expense as Restructuring
Expense within continuing operating expenses. This is not a discontinued operation
but rather a closing of a plant and related activities. The net book value will be
amortized and depreciated down to its estimated salvage value.

We
notified our Las Vegas landlord of our intent to vacate the facility and sublease the
space on March 29, 2007. In accordance with SFAS No. 13 Accounting for
Leases, we will recognize a liability at the date we cease using the facility at
its fair value. As the lease is an operating lease, we will determine fair value based on
the remaining lease payments reduced by actual or estimated sublease rentals. We estimate
our cease-use date to be September 30, 2007.

# Note 3. Fiscal 2007 and
2006 Bad Debt Charges Due to Bankruptcy Filings.

MTS
Incorporated and its subsidiaries and divisions, including Tower Records
(Tower), an independent music and entertainment retailer which owned and
operated 89 Tower Records stores in 20 states nationwide, announced on August 20, 2006,
its intent to sell the company through a process under Section 363 of the Bankruptcy Code.
As of the bankruptcy date, we had approximately $883,000 in trade receivables outstanding
from Tower. During our second quarter ended September 30, 2006, we recorded a bad debt
charge of approximately $496,000 to general and administrative expenses. This charge
reflected the net expense after reversing royalties and distribution fees otherwise
payable by us had we collected the Tower trade receivable. We wrote off as uncollectible
the entire Tower trade receivable balance at September 30, 2006. In November 2006, we
assigned our right, title and interest in our general unsecured trade receivable
bankruptcy claim against MTS to a third-party financial institution for a cash payment of
approximately $135,000. Accordingly, we recorded a $64,000 recovery of the previously
written off bad debt charge as a credit to general and administrative expenses for the
fiscal year ended March 31, 2007.

On
January 12, 2006, Musicland Holding Corp. filed for Chapter 11 bankruptcy protection. We
had approximately $2.6 million in trade receivables outstanding from Musicland at December
31, 2005. We have recorded a bad debt charge of approximately $1.6 million to general and
administrative expenses for the year ended March 31, 2006. This charge reflects the net
expense, after reversing royalties and distribution fees otherwise payable by us had we
collected the Musicland trade receivable. We wrote off as uncollectible the entire
Musicland trade receivable balance at March 31, 2006.

# Note 4. Exclusive
Distribution Agreement with Relativity Media and Planned Issuance of Common Shares

On
August 11, 2006, we entered into a 10-year distribution agreement with Relativity Media,
LLC. The agreement calls for Relativity to provide us with the exclusive home video and
digital distribution rights to motion pictures wholly financed through or otherwise under
the control of Relativity, in exchange for which we will be solely responsible for all
distribution services for the DVD home video and digital release of each film.

As
a material inducement to enter into the distribution agreement, we agreed to issue
Relativity 3,400,000 shares of our common stock, which are registered on our Form S-3
shelf registration statement. In order to secure Relativitys performance under our
agreement, we have been granted a security interest in the shares pursuant to a security
agreement, the shares have been pledged to us pursuant to a stock pledge agreement, and a
restrictive legend will be placed on the stock certificates representing the shares and
restricting their transfer until designated title delivery, box office performance,
financial and/or payment requirements are met.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Shares
will be released to Relativity as follows:

A.                 1,800,000
shares upon the earlier of any of the following:

(1)       Qualifying
Pictures. 100,000 shares, upon our home video release of each           qualifying
picture (that achieved at least $25 million in reported gross           domestic box
office in its initial release) through December 31, 2010, after our           release of
the first 50 qualifying pictures;

(2)       Annual
Profits. One share, for each $38.00 by which our annual net           profits from
Relativity pictures for any calendar year through December 31, 2010           exceed $50
million;

(3)       Cumulative
Profits. One share, for each $38.00 by which our cumulative           net profits
from Relativity pictures at any time through December 31, 2010           exceeds $150
million;

(4)       Payment
and Delivery. 60,000 shares, upon delivery to us of each           theatrical picture
at any time through December 31, 2010, upon payment of a           release amount of
$3.80 per share within four years after the delivery of each           picture; and

(5)       Change
in Control. 1,800,000 shares, upon a change in control at any time           through
December 31, 2010, upon payment of a release amount of $3.80 per share.

B.                 600,000
shares, upon payment of a release amount of $3.80 per share at any time           through
December 31, 2010.

C.                 1,000,000
shares upon the earlier of any of the following:

|  
|--
|70

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

(1)       Cumulative
Profits. 1,000,000 shares, upon our earning total cumulative           net profits
from Relativity pictures of at least $500 million at any time prior           to the end
of the term;

(2)       Cumulative
Box Office. 1,000,000 shares, upon delivery of pictures to           Image with total
cumulative box office of at least $5 billion at any time prior           to the end of
the term; and

(3)       Change
in Control. 1,000,000 shares, upon the closing of a change of           control
during the term of the distribution agreement, plus payment of a release           amount
equal to the number of such shares multiplied by the greater of $4.00 or           the
following percentage of the total consideration per share received in
          connection with or as a result of the change of control:

| | (a) | 80%,
if on or before December 31, 2007;
| | --- | ---------------------------------------

| | (b) | 60%,
if on or before December 31, 2008; and
| | --- | -------------------------------------------

| | (c) | 40%
thereafter.
| | --- | ---------------

Any of the shares provided for above
that are not released to Relativity by the end of each of the specified periods will be
transferred back to Image.

As
we are to receive motion pictures for DVD and digital exploitation in exchange for common
stock which is deemed unvested and forfeitable for accounting purposes in accordance with
Emerging Issues Task Force (EITF) No. 96-18 Accounting for Equity Instruments That Are
Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services, we will treat our common stock as unissued for accounting purposes until
each title is delivered. Consequently, there will be no recognition at the measurement
date and no entry will be recorded.

The
stock issued to Relativity will be included in the computation of basic earnings per share
as of the date that all necessary conditions have been satisfied. With respect to diluted
earnings per share, the Relativity stock will be included in the computation of diluted
earnings per share when contingencies other than payment of the release amount for the
shares have been satisfied. To date, Relativity has not provided us the first titles to be
released under the agreement and to date, we have not issued the shares to Relativity.

On
August 16, 2006, in connection with the Relativity agreement, we issued a warrant to a
third party exclusive rights finder. The term of the warrant was 4.37 years and had a
strike price of $3.81, the closing price of our common stock on the date of grant. The
fair value of the warrant was $194,000, using the Black-Scholes valuation model. The
warrant has been converted via cashless exercise into 11,230 shares of our common stock as
of June 12, 2007. We capitalized the fair value of the warrant as a component of other
assets with a corresponding credit to additional paid in capital. We will amortize the
asset to cost of sales over the related revenues generated from the Relativity titles.

# Note 5. Long-Term Debt.

New
Disc Replication Agreement and Related Advance. On June 30, 2006, we entered into a
five-year disc replication agreement with Sonopress LLC. Sonopress serves as our exclusive
manufacturer of our DVD requirements. This includes the HD-DVD and Blu-ray Disc®
high-definition formats. They also manufacture the majority of our CD requirements. On
June 30, 2006, we received an interest-free $10 million advance against future DVD
manufacturing from Sonopress, to be repaid at $0.20 per DVD manufactured, plus payment of
a $0.04 administrative fee per DVD manufactured until the advance is repaid. In July 2006,
the proceeds from the Sonopress advance were used to reduce then-outstanding borrowings
under our revolving line of credit facility. All outstanding amounts under the advance are
subordinated to all of our obligations outstanding to Wachovia Capital Corporation
(Western). Sonopress has taken a security interest in all of our assets in second position
behind Wachovia. As the obligation is non-interest bearing, we initially imputed and
recorded a debt discount of $1,945,000 to the $10 million face amount of the advance based
upon our then-borrowing rate with our bank. The deferred manufacturing credit is
classified in other long-term liabilities, net of current portion, at March 31, 2007. We
amortize the deferred credit as a reduction to inventory purchase cost based upon actual
discs manufactured by Sonopress. Additionally, we amortize the debt discount, using the
effective interest method, to interest expense. We additionally record the $0.04
administrative fee per disc manufactured as an additional inventory manufacturing cost.
Amortization of the debt discount is a noncash interest expense and totaled $534,000 for
the fiscal 2007. Amortization of the deferred manufacturing credit totaled $195,000 for
fiscal 2007.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Private
Placement of Senior Convertible Note and Warrant. On August 30, 2006, we issued to
Portside Growth and Opportunity Fund (Portside or holder), in a
private placement, a senior convertible note in the principal amount of $17,000,000 and a
related warrant to purchase 1,000,000 shares of our common stock, and on November 10,
2006, we entered into an Amendment and Exchange Agreement with Portside, which agreement
modified certain terms in the transaction documents and provided for a replacement warrant
to be issued in exchange for the warrant previously issued to Portside. The note accrues
interest at a rate of 7.875% per annum with accrued interest payable quarterly in arrears
in either cash or stock. The note has a term of five years and is convertible into
4,000,000 shares of our common stock at a conversion price of $4.25 per share, subject to
the antidilution adjustments. The related warrant is exercisable for an aggregate of
1,000,000 shares of our common stock at an exercise price of $4.25 per share, subject to
the antidilution adjustments described below. The warrant has a term of five years from
the issuance date. Portside has taken a security interest in all of our assets in third
position behind Wachovia Capital Corporation (Western) and Sonopress.

Beginning
thirty months following closing, the holder may require bi-annual payments, each in the
amount of $4,000,000 principal, plus interest. If the average weighted trading price of
our common stock is greater than $4.00 per share for the twenty trading days immediately
prior to the due date for the first payment, then we can delay the first payment until the
thirty-sixth month following the closing.

Following
the first anniversary of the closing but before the second anniversary, we may force
conversion if the weighted average trading price is at least $6.38 per share (or 150% of
the then-conversion price) for twenty trading days. Following the second anniversary of
the closing, we may force conversion if the weighted average trading price is at least
$7.65 per share (or 180% of the then-conversion price) for twenty trading days. In no
event can we force the holder to acquire by conversion more than 4.99% of the issued and
outstanding shares of our common stock.

If
we sell new securities during the first year following closing for a price less than $4.25
(or such other conversion or exercise price then in effect), then the conversion price of
the note and exercise price of the warrant will be reduced to an amount equal to the price
of the new securities sold. If we sell new securities after the first year following
closing for a price less than $4.25 (or such other conversion or exercise price then in
effect), then the conversion price of the note and exercise price of the warrant will be
reduced to a weighted average amount pursuant to the formula contained in the note and
warrant; provided, however, the exercise price of the warrant has a floor price of $3.67
until we receive any necessary stockholder approval as provided in the warrant. The holder
has the right to participate in any future sale of securities for two years following
closing. Pursuant to a registration rights agreement, during the December 2006 quarter, we
filed a registration statement for the resale of the shares underlying the note and
warrant.

In
the event of a change of control, the holder has the right to redeem the outstanding
principal balance of the note at 120% of par and the warrant at the then-current Black
Scholes value. On November 10, 2006, at our request, the holder amended the note and
warrant, which, among other provisions, gives Image the right but not the obligation, in
the event of a change of control with a private acquiring company, to redeem the
outstanding principal balance of the note at 125% of par and the warrant at the
then-current Black Scholes value. The amendment also removes restrictive covenants from
the note in a change of control transaction, should the note be assumed by the acquiring
company.

The
instruments issued as part of this transaction contain several embedded derivatives which
we have valued in accordance FASB Statement No. 133, Derivative Instruments and Hedging
Activities. The embedded derivatives included the holders right to redeem the note
in the event of a change of control and Images right to redeem the note in the event
of a change of control to a private company. KPMG LLPs Economic and Valuation
Services practice assisted in the valuation of warrant and derivatives. The net fair value
of all of the derivatives was not material. The fair value of the warrant was $1,900,000,
which was recorded as a discount on the $17 million note liability with an offsetting
credit to warrant liability in accordance with SFAS 150 Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity and FSP
150-1 Issuers Accounting for Freestanding Financial Instruments Composed of More
Than One Option or Forward Contract Embodying Obligations under FASB Statement No.
150. The accrued warrant liability is included as a component of other long-term
liabilities in the accompanying balance sheet at March 31, 2007. We will revalue at least
annually and when circumstances indicate the value would materially change. We will
re-address liability classification each quarterly reporting period.

|  
|--
|72

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Additionally,
direct costs of $1,187,000 relating to the private placement were recorded as
asset-deferred financing costs and are amortized as additional noncash interest expenses
using the effective interest rate method over the life of the related private placement
debt. Amortization of the debt discount and the deferred financing costs using the
effective interest method is a noncash charge to interest expense and totaled $537,000 for
fiscal 2007.

Long-term
debt at March 31, 2007 and 2006, consisted of the following:

|(In thousands)                                                              | 2007 | 2006
|--------------------------------------------------------------------------- | ---- | ----
|Subordinated senior convertible note, less debt discount of $1,570          |      |     
|Subordinated manufacturing advance obligation, less debt discount of $1,411 |      |     
|                                                                            |      |     
|                                                                            |      |     
|                                                                            |      |     
|Current portion of long-term debt, less debt discount of $588               |      |     
|                                                                            |      |     
|Long-term debt less current portion, less debt discount                     |      |     
|                                                                            |      |     

# Note 6. Subsequent Event
 New Revolving Credit Facility.

We
entered into a three-year Loan and Security Agreement dated as of May 4, 2007, with
Wachovia Capital Finance Corporation (Western) (Wachovia). The agreement
provides us with an up to $15 million revolving line of credit, with an accordion feature
to increase such amount to $20 million at our option, subject to the terms and conditions
of the agreement. Actual borrowing availability is based on eligible trade accounts
receivable levels.

Borrowings
bear interest at either the Prime Rate plus up to 0.25% or, at our option, LIBOR plus up
to 2.25%, subject to minimum borrowing levels. The level of interest rate margin to Prime
or LIBOR is dependent upon our future financial performance as measured by EBITDA,
earnings before interest, taxes, depreciation and amortization, as defined in the
Agreement. The targets under the Agreement exempt certain expenses, including costs
incurred in our corporate sale process.

The
Wachovia revolving credit facility replaced our facility with Wells Fargo Foothill, Inc.

The Agreement
is subject to early termination fees, based upon the initial maximum facility amount of
$15 million, of 1% if terminated within the first year of the term and 0.75% if terminated
thereafter through the end of the three-year term.

The
Agreement imposes restrictions on such items as encumbrances and liens, payment of
dividends, other indebtedness, stock repurchases and capital expenditures. Any outstanding
borrowings are secured by our assets. The Agreement also requires us to comply with
minimum financial and operating covenants.

At
March 31, 2007, we had cash of $2,341,000 and borrowing availability of $5 million under
our revolving credit facility with our then-lender Foothill. Comparatively, at March 31,
2006, we had cash of $1,079,000 and borrowing availability of $6.6 million and $1 million,
respectively, under our revolving credit and term loan facilities with Foothill. At March
31, 2007, we had no borrowings under the revolving credit facility with our then lender
Foothill.

# Note 7. Recoupment of
Sony BMG Royalty Advance Received for International Sublicense Rights.

We
received a $3.0 million initial royalty advance under the Sony BMG agreement in March
2003, fully recoupable from revenues generated by Sony BMG against quarterly royalties due
to us under the agreement. Based upon actual quarterly sales of our programming in the
territories, Sony BMG recoups quarterly royalties from the $3.0 million previously
advanced. Sony BMG had provided additional quarterly royalty advances such that for the
first three years of the agreement term through December 31, 2005, the advance outstanding
to us at any given time was maintained at $3.0 million.

During
fiscal 2007 and according to our agreement, Sony BMG reduced, through recoupment, the
outstanding royalty advance without making additional quarterly royalty advances. Once the
entire royalty advance is recouped, Sony BMG will continue to pay quarterly royalties
based on revenues generated. We must repay any outstanding unrecouped royalty advance
within 30 days following the final Sony BMG reporting at the conclusion of Sony BMGs
sell-off period after expiration of the five-year term. At March 31, 2007, approximately
$800,000 of the last $3 million advance is classified as a component of deferred revenue
in the accompanying balance sheet.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 8. Inventories.

Inventories
at March 31, 2007 and 2006, are summarized as follows:

|(In thousands)                                                      | 2007 | 2006
|------------------------------------------------------------------- | ---- | ----
|DVD                                                                 |      |     
|Other                                                               |      |     
|                                                                    |      |     
|                                                                    |      |     
|Production costs, net                                               |      |     
|                                                                    |      |     
|                                                                    |      |     
|Less current portion of inventories                                 |      |     
|                                                                    |      |     
|Noncurrent inventories, principally non-recoupable production costs |      |     
|                                                                    |      |     

Non-recoupable
production costs are net of accumulated amortization of $10,553,000 and $11,485,000 at
March 31, 2007 and 2006, respectively. We expect to amortize approximately 71% of the
March 31, 2007 unamortized production costs by March 31, 2009.

# Note 9. Investment in
Film Production.

Investment
in film production at March 31, 2007 and 2006, are summarized as follows:

|(In thousands)                           | 2007 | 2006
|---------------------------------------- | ---- | ----
|Completed and substantially not released |      |     
|In process                               |      |     
|In development                           |      |     
|                                         |      |     
|                                         |      |     
|                                         |      |     

At
March 31, 2007, we have completed eight motion pictures. We released our lowest budget
films, Monarch of the Moon and The Hunt (our funded budget commitment was $111,000 and
$214,000, respectively), on DVD during the fourth quarter ended March 31, 2007. We plan to
release Surveillance and Souls Midnight on DVD during fiscal 2008 and are
investigating the possibility of limited theatrical releases for Splinter, Sisters,
Driftwood and Fingerprints. The eight completed titles
are as follows:

| |  | Sistersproduced
by Ed Pressman and starring Stephen Rea (V For Vendetta) and Chloe Sevigny (Big
Love  TV series)
| | - | ------------------------------------------------------------------------------------------------------------------

| |  | Dark
Horse Entertainment:
| | - | -------------------------

| | ° | Driftwood,directed by Tim Sullivan (2001 Maniacs), starring Ricky Ullman (Phil of the Future
-TV series), Talan Torriero (Laguna Beach TV series) and Diamond Dallas
Page (WWF and WCW Professional Wrestler)
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | Splinter,
 directed by Michael D. Olmos,  starring Tom  Sizemore  (Saving  Private  Ryan) and
Edward James  Olmos (Battlestar Galactica TV series)
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------

| | ° | Monarch
of the Moon
| | - | -------------------

| |  | Graymark
Productions:
| | - | ---------------------

| | ° | Surveillance,
directed by Fritz Kiersch (Children of the Corn) and starring Armand Assante
| | - | ------------------------------------------------------------------------------------------

| | ° | The
Hunt, directed by Fritz Kiersch
| | - | -----------------------------------

| | ° | Souls
Midnight, starring Armand Assante
| | - | ----------------------------------------

| | ° | Fingerprints,
starring Kristin Cavallari (Laguna Beach - TV series) and Lou Diamond Phillips
| | - | --------------------------------------------------------------------------------------------

We
have two titles in post production. They are:

| |  | Dark
Horse  Entertainments  My Name is Bruce,  directed by and starring Bruce Campbell (Evil
Dead series,          Army of Darkness, and Bubba Ho-tep)
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Amicus
 Entertainments  Stuck, directed by Stuart Gordon (Re-Animator and Masters of Horror)
and starring          Mena Suvari (American Beauty) and Stephen Rea
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------

|  
|--
|74

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 10. Property,
Equipment and Improvements.

Property,
equipment and improvements at March 31, 2007 and 2006, are summarized as follows:

|(In thousands)                                 | 2007 | 2006
|---------------------------------------------- | ---- | ----
|Machinery, equipment and software              |      |     
|Leasehold improvements                         |      |     
|Other                                          |      |     
|                                               |      |     
|                                               |      |     
|Less accumulated depreciation and amortization |      |     
|                                               |      |     
|                                               |      |     
|                                               |      |     

Depreciation
and amortization expense for the years ended March 31, 2007, 2006 and 2005, was
$1,902,000, $2,603,000 and $2,568,000, respectively. See Note 2. Sonopress
Fulfillment Services Agreement and Planned Closure of Las Vegas Facility for a
discussion regarding the asset impairment triggered by our restructuring of our
warehousing and distribution operations in Las Vegas, Nevada.

# Note 11. Source
Entertainment, Inc Chapter 11 Bankruptcy Filing and Related Asset Impairment Write-Down

In
May 2007, our content provider Source Entertainment filed for bankruptcy protection.
Accordingly, we believe there is substantial doubt as to the recoverability of the net
book value of assets associated with the exclusive distribution agreement. During the
fourth quarter of fiscal 2007, we recognized an impairment loss equal to the difference
between the present value of expected profits to be recognized on two Source-branded
titles that we expect to release in the coming twelve months and the net book value of
assets related to the exclusive distribution agreement. The write-down totaled $2.2
million and is recorded as a component of cost of sales for fiscal 2007.

# Note 12. Commitments and
Contingencies.

# Operating Leases

Our
headquarters are located in Chatsworth, California and consist of approximately 62,000
square feet on one floor of a multi-tenant building. The monthly rent is $1.29 per square
foot, on a gross basis, or approximately $80,000 per month, and increases approximately 3%
annually. The office lease has an initial 10-year term with two five-year options. The
lease commenced on July 1, 2004. Although a base level of operating expenses is included in the rent payment, we
will be responsible for a percentage of actual annual operating expense increases capped
at 5% annually, excluding utilities, insurance and real estate taxes.

We
also lease our 76,000 square foot warehouse and distribution facility located in Las
Vegas, Nevada. The monthly rent is approximately $43,000, subject to annual adjustment
based on increases in the consumer price index. The lease expires on November 4, 2012. In
addition, we lease approximately 4.07 acres of adjacent vacant land in the event we need
to expand our current warehouse and distribution facility. The monthly rent for the vacant
land is approximately $9,000 and the lease expires on November 4, 2007. Beginning in
January 2004, we leased an additional 10,000 square foot warehouse storage space in Las
Vegas, Nevada for a monthly rent of approximately $6,000 for an initial term of two years
and later extended to April 30, 2007. We moved all inventory from this storage space to
Sonopress as of the lease termination date of April 30, 2007. Beginning in October 2005,
we leased an additional 5,000 square foot warehouse storage space in Las Vegas, Nevada for
a monthly rent of approximately $3,000 on a month to month basis. As of May 31, 2007, the
inventory from this storage space was shipped to Sonopress and we then terminated this
lease. As previously discussed, we are closing our warehouse and distribution facility and
Sonopress will be warehousing and fulfilling our DVD and CD orders out of its facility in
Pleasant Prairie, Wisconsin. On March 29, 2007, we notified our Las Vegas landlord of our
intent to vacate the facility and sublease the space. Our landlord is open to various
options, including potential termination of the lease, if an appropriate new tenant is
found.

We
signed an exclusive representation agreement with IPG, a commercial real estate broker,
for the potential sublease of the facility on or about May 11, 2007. It is currently
anticipated that the facility will be available to a new tenant by October 2007.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

Future
minimum annual rental payments by year under operating leases at March 31, 2007, are
approximately as follows:

|Fiscal         |  | Amount
|-------------- |  | ------
|(In thousands)
|2008           |  |       
|2009           |  |       
|2010           |  |       
|2011           |  |       
|2012           |  |       
|Thereafter     |  |       
|               |  |       
|               |  |       
|               |  |       

Rent
expense was $1,689,000, $1,553,000 and $1,455,000 for fiscal 2007, 2006, and 2005,
respectively.

Lease
Guarantee. In connection with the fiscal 2004 asset sale of DVDPlanet,
Planet Entertainment assumed the obligations under DVDPlanets leases for its retail
store and various other liabilities related to the assets being acquired and its parent
Infinity Resources guaranteed Planet Entertainments obligations. We remain a
guarantor in the event that Planet Entertainment and Infinity default on their financial
obligations under the lease. The remaining payments under the lease total approximately
$89,000 through December 2007.

Employment
Agreements. Future contractual obligations under employment agreements
totaled $2,469,000 and $1,293,000 for fiscal years ending March 31, 2008 and 2009,
respectively.

Other.
          At March 31, 2007, our future obligations by year for royalty advances, minimum
          royalty guarantees and exclusive distribution fee guarantees under the terms of
          our existing licenses and exclusive distribution agreements, respectively, are
          as follows:

|Fiscal         |  | Amount
|-------------- |  | ------
|(In thousands)
|2008           |  |       
|2009           |  |       
|               |  |       
|               |  |       
|               |  |       

Legal
Proceedings. On April 10, 2007, a purported class action shareholder
complaint entitled Henzel v. Image Entertainment, Inc., et al. was filed against Image and
certain of its officers and members of its board of directors in the Superior Court of the
State of California, County of Los Angeles. The named plaintiff proposes to represent a
class of Images stockholders and claims, among other things, that in connection with
the proposed business combination transaction with BTP, the directors breached their
fiduciary duties of due care, good faith and loyalty by failing to maximize stockholder
value and by creating deterrents to third party offers. Among other things, the complaint
seeks class action status, and a court order enjoining the consummation of the merger and
directing the defendants to take appropriate steps to maximize stockholder value. While
the lawsuit is in its preliminary stage, we believe that the claims in the lawsuit are
without merit and intend to vigorously defend it.

In
the normal course of business, we are subject to proceedings, lawsuits and other claims,
including proceedings under government laws and regulations relating to employment and tax
matters. While it is not possible to predict the outcome of these matters, it is the
opinion of management, based on consultations with legal counsel, that the ultimate
disposition of known proceedings will not have a material adverse impact on our financial
position, results of operations or liquidity.

# Note 13.
Shareholders Equity.

Convertible
Note Payable in Image Common Stock. On August 30, 2006, we signed a
Convertible Note with Portside Growth and Opportunity Fund for gross proceeds of $17
million convertible into 4,000,000 shares of our common stock valued at $4.25 per share.
See Note 5. Long-Term Debt Private Placement of Senior Convertible Note and Warrant.

Agreement
to Issue Common Stock. On August 11, 2006, we entered into an agreement to
issue 3,400,000 restricted shares of our common stock in exchange for the rights to
distribute selected titles for Relativity Media. In order to secure Relativitys
performance under our agreement, we have been granted a security interest in the shares
pursuant to a security agreement, the shares have been pledged to us pursuant to a stock
pledge agreement, and a restrictive legend will be placed on the stock certificates
representing the shares restricting their transfer until designated title delivery, box
office performance, financial and/or payment requirements are met. To date, Relativity has
not provided us the first titles to be released under the agreement and to date, we have
not physically issued the shares to Relativity. See Note 4. Exclusive
Distribution Agreement with Relativity Media and Planned Issuance of Common Shares.

|  
|--
|76

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

On
August 16, 2006, in connection with the Relativity agreement, we issued a warrant to a
third party exclusive rights finder. The term of the warrant is 4.37 years and has a
strike price of $3.81, the closing price of our common stock on the date of grant. The
fair value of the warrant was $194,000, using the Black-Scholes valuation model. The
warrant has been converted via cashless exercise into 11,230 shares of our common stock as
of June 12, 2007. We have capitalized the fair value of the warrant as a component of
other assets with a corresponding credit to additional paid in capital. We will amortize
the asset to cost of sales over the related revenues generated from the Relativity titles.

Fiscal
2005 Private Placement of Image Common Stock. On December 20, 2004, we sold
2,904,763 shares of our common stock in a private placement at $5.25 per share for gross
proceeds of $15.25 million. We also issued three-year warrants to the investors to
purchase up to 726,189 shares at $6.56 per share. The warrants are currently exercisable.
The expenses of the private placement were approximately $1,052,000, which includes the
cash fee paid to our exclusive placement agent, and legal, accounting and other related
expenses. We also issued the placement agent a three-year warrant to purchase up to 58,095
shares of common stock on the same terms as the investors, except this warrant includes a
cashless exercise provision. We used the net proceeds of the transaction to pay down
outstanding obligations under our credit facility with Wells Fargo Foothill, Inc. The
remaining proceeds were used for working capital and general corporate purposes, including
content acquisition.

Stock
Awards, Options and Warrants.In September 2004, our shareholders approved an
incentive compensation plan (the 2004 Plan) pursuant to which an additional
1,000,000 shares of our common stock were made available for annual incentive and specific
performance awards, including options. The 2004 Plan provides for awards to our employees
and directors. Options (incentive as well as non-qualified), restricted stock units, stock
appreciation rights, performance share awards, stock bonuses and stock units can be
awarded under the 2004 Plan. The limitation on overall number of shares of stock reserved
and available for delivery in connection with awards under the 2004 Plan shall be the sum
of 1,000,000 shares, plus the number of shares with respect to awards previously granted
under the 2004 Plan that terminate without being exercised, expire, are forfeited or
canceled, and the number of shares of stock that are surrendered in payment of any awards,
or any tax withholding with regard thereto. The 2004 Plan requires that the exercise price
for any incentive or non-qualified option be at least 100% of the closing price of our
common stock on the date such option is granted. The maximum term allowed for an option is
10 years and a stock unit shall either vest or be forfeited not more than 10 years from
the date of grant.

In
October 2006, an aggregate of 19,104 shares of restricted stock units were granted to our
directors under our 2004 Plan, and subsequently 3,184 restricted stock units were
cancelled due to a director resignation. In October 2006, we began amortizing the fair
value of the restricted stock units as of the date of grant of $55,000 ratably over the
one-year vesting period. In January 2007, an aggregate of 10,000 shares of restricted
stock units were granted to our newly hired officer under our 2004 Plan. In January 2007,
we began amortizing the total value of $35,000 for the restricted stock units on the date
of grant ratably over the three-year vesting period. These restricted stock units were
payable solely in common shares. Compensation expense relating to these stock units for
fiscal 2007 was approximately $26,000.

In
July 1999 and 1998, an aggregate of 91,662 and 88,359 shares, respectively, of restricted
stock units were granted to our officers under our 1998 incentive plan. These grants
vested annually in increments of 20% over the five-year period commencing June 30, 2000
and 1999, respectively. There were no restricted stock units granted to officers during
fiscal 2001 through 2006. These restricted stock units were payable solely in shares. We
amortized the total value of the restricted stock units on the date of grant ($622,000 for
the fiscal 2000 grant and $592,000 for the fiscal 1999 grant) ratably over the five-year
vesting period as compensation expense. Compensation expense relating to these stock units
for fiscal 2005 was approximately $25,000.

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

See
Note 1. Basis of Presentation and Summary of Significant Accounting Policies 
Stock Options regarding our acceleration of vesting of all outstanding unvested
stock options on March 29, 2006.

Stock
option transactions, including our former plans, for the three years ended March 31, 2007,
are as follows:

|(In thousands, except per share data) | Shares | Per Share
Price Range | Weighted Average Price
Per Share
|------------------------------------- | ------ | --------------------- | --------------------------------
|Outstanding, March 31, 2004           |        |                       |                                 
|Granted                               |        |                       |                                 
|Exercised                             |        |                       |                                 
|Canceled                              |        |                       |                                 
|                                      |        |                       |                                 
|Outstanding, March 31, 2005           |        |                       |                                 
|Granted                               |        |                       |                                 
|Exercised                             |        |                       |                                 
|Canceled                              |        |                       |                                 
|                                      |        |                       |                                 
|Outstanding, March 31, 2006           |        |                       |                                 
|Granted                               |        |                       |                                 
|Exercised                             |        |                       |                                 
|Canceled                              |        |                       |                                 
|                                      |        |                       |                                 
|Outstanding, March 31, 2007           |        |                       |                                 
|                                      |        |                       |                                 

Of
the options reflected as outstanding on March 31, 2007, options to purchase approximately
2,429,000 shares of common stock were exercisable. At March 31, 2007, there were
approximately 256,000 shares of common stock available for new awards, including stock
options, to our directors and employees.

The
following table summarized significant ranges of outstanding and exercisable options at
March 31, 2007:

|                        
|------------------------
|Range of
Exercise Prices
|Under $2.00             
|$2.01 to $4.00          
|$4.01 to $6.00          
|$6.01 to $8.00          
|                        
|                        
|                        

The
following table summarized significant ranges of outstanding and exercisable warrants at
March 31, 2007:

|                        
|------------------------
|Range of
Exercise Prices
|$2.04                   
|$3.81                   
|$4.25                   
|$6.56                   
|                        
|                        
|                        

Stockholder
Rights Plan.On October 31, 2005, we adopted a stockholder rights plan. The plan
is intended to protect the interests of the stockholders from coercive, abusive or unfair
takeover tactics. We believe the rights plan represents a sound and reasonable means of
addressing the complex issues of corporate policies. Issuance of the rights does not in
any way adversely affect our financial strength or interfere with our business plan. The
issuance of the rights has no dilutive effect, will not affect reported earnings per
share, is not taxable to the company or to stockholders, and will not change the way in
which stockholders can trade our shares. The rights will only become exercisable upon the
occurrence of certain triggering events, and are then intended to operate to protect
stockholders against being deprived of their rights so they can share in the full measure
of our long-term potential.

Shelf
Registrations.We continue to seek out viable acquisition targets to enhance our
library of exclusive programming, distribution channels and sources of revenue. On
September 23, 2005, we filed a shelf registration statement that gives us the ability to
sell our common stock in one or more offerings to raise cash for acquisitions, debt
repayment or working capital and other general corporate purposes. We also filed an
acquisition shelf registration statement with the Securities and Exchange Commission to
ensure that registered shares of our common stock are available to use as consideration in
connection with our acquisition of the assets, businesses or securities of other
companies, whether by purchase, merger or other form of business combination. The shares
may be offered in separate transactions or, in the aggregate, in a single transaction.

|  
|--
|78

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 14. Net Earnings
(Loss) per Share Data.

The
following is a reconciliation of the numerators and denominators used in computing basic
and diluted net earnings (loss) per share for the three years ended March 31, 2007:

|(In thousands, except per share data)                            | 2007 | 2006 | 2005
|---------------------------------------------------------------- | ---- | ---- | ----
|Net earnings (loss) - basic and diluted numerator                |      |      | $   
|                                                                 |      |      |     
|Weighted average common shares outstanding - basic denominator   |      |      |     
|Effect of dilutive securities                                    |      |      |     
|                                                                 |      |      |     
|Weighted average common shares outstanding - diluted denominator |      |      |     
|                                                                 |      |      |     
|Net earnings (loss) per share:                                   |      |     
|                                                                 |      |      |     
|Basic net earnings (loss) per share                              |      |      | $   
|                                                                 |      |      |     
|Diluted net earnings (loss) per share                            |      |      | $   
|                                                                 |      |      |     

Outstanding
common stock options and warrants not included in the computation of diluted net earnings
(loss) per share totaled 2,429,000, 2,538,000 and 1,443,000, respectively, for the years
ended March 31, 2007, 2006 and 2005 as their effect would be antidilutive.

# Note 15. Income Taxes.

Income
tax expense (benefit) for the years ended March 31, 2007, 2006 and 2005, are summarized as
follows:

|(In thousands)    | 2007 | 2006 | 2005
|----------------- | ---- | ---- | ----
|Current           |      |      |     
|Federal           |      |      | $   
|State             |      |      |     
|Foreign           |      |      |     
|                  |      |      |     
|                  |      |      |     
|                  |      |      |     
|Deferred          |      |     
|Federal           |      |      |     
|State             |      |      |     
|                  |      |      |     
|                  |      |      |     
|                  |      |      |     
|                  |      |      |     
|Total Tax Expense |      |      | $   
|                  |      |      |     

The
tax effects of temporary differences that give rise to a significant portion of the net
deferred tax assets at March 31, 2007 and 2006, are presented below:

|(In thousands)                                              | 2007 | 2006
|----------------------------------------------------------- | ---- | ----
|Deferred tax assets:                                        |      |     
|Provision for lower of cost or market inventory write downs |      |     
|Net operating loss carryforwards                            |      |     
|Allowance for sales returns                                 |      |     
|Allowance for doubtful accounts receivable                  |      |     
|Tax credits                                                 |      |     
|Write-down of royalty and distribution fee advances         |      |     
|Other                                                       |      |     
|                                                            |      |     
|Deferred tax assets                                         |      |     
|Less valuation allowance                                    |      |     
|                                                            |      |     
|Deferred tax assets                                         |      |     
|                                                            |      |     
|Deferred tax liabilities:                                   |      |     
|Depreciation and amortization                               |      |     
|Write downs of royalty advances                             |      |     
|Other                                                       |      |     
|                                                            |      |     
|Deferred tax liabilities                                    |      |     
|                                                            |      |     
|Net deferred tax assets                                     |      |     
|                                                            |      |     

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

SFAS
No. 109 requires that we assess the likelihood that our deferred tax assets are
realizable, and to the extent that it is more likely than not that all, or a portion, of
such deferred tax assets will not be realized, a valuation allowance, increasing tax
expense for the year, must be established. We have had pretax losses in five of our last
six years and accordingly maintain a valuation allowance against 100% of our net deferred
assets.

Even
though we have fully reserved our net deferred tax assets, we would still be able to
utilize them to reduce future income taxes payable should we have future earnings. To the
extent such deferred tax assets relate to net operating loss (NOL)
carryforwards, the ability to use such NOL carryforwards against future earnings will be
subject to applicable carryforward periods.

As
of March 31, 2007, we had NOL carryforwards for Federal and state income tax purposes of
$16,653,000 and $4,837,000 , respectively, which are available to offset future taxable
income through 2027 and 2017, respectively.

Expected
income tax expense (benefit) based on Federal statutory rates for the three years ended
March 31, 2007, differed from actual tax expense (benefit) as follows:

|(In thousands, except per share data)                      | 2007 | 2006 | 2005
|---------------------------------------------------------- | ---- | ---- | ----
|Expected income tax expense (benefit)                      |      |      | $   
|State income tax expense (benefit), net of Federal benefit |      |      |     
|Change in valuation allowance                              |      |      |     
|Non-deductible expenses                                    |      |      |     
|Other                                                      |      |      |     
|                                                           |      |      |     
|                                                           |      |      | $   
|                                                           |      |      |     

# Note 16. Other Items
 Statements of Operations.

# Fourth Quarter
Adjustments

Fiscal
2007. During the fourth quarter we wrote-off $2.2 million of asset net book value
relating to our distribution agreement with Source Entertainment which filed for
bankruptcy protection in May 2007.

Additionally,
during the fourth quarter we incurred $1.2 million in legal, investment banking and other
expenses associated with negotiating the BTP agreement to acquire Image.

Fiscal
2006. During the fourth quarter we reversed an overaccrual of music publishing
liabilities on a DVD series. During the fourth quarter we were notified by a content
holder that the actual negotiated music publishing rate for DVD titles licensed from this
content supplier was lower than the rate at which we accrued. Without the actual rate
known at the time of release of the related DVDs, we accrue music publishing liability at
the estimated maximum rate as we sell the programs. Accordingly, we reversed approximately
$562,000 in accrued music publishing as a credit to cost of sales during the fourth
quarter to reflect the comparably lower actual negotiated music publishing rate.

Fiscal
2005. During the fourth quarter we reduced estimated publishing liabilities relating
to our international distribution of DVDs through subdistributors. Approximately $499,000
was recorded as non-recurring, noncash, pretax credit to cost of sales in the accompanying
consolidated statement of operations for fiscal 2005. Our joint venture Aviva
International, LLC was dissolved and Sony BMG became responsible for publishing for the
European territories under our sublicense agreement.

# Note 17. Employee
Benefit Plan.

We
have a 401(k) savings plan covering substantially all of our employees. Eligible employees
may contribute through payroll deductions. We match employees contributions at the
rate of 50% of the first 4% of salary contributed. Our 401(k) savings plan matching
expenses for fiscal 2007, 2006 and 2005 were $117,000, $120,000 and $143,000,
respectively.

|  
|--
|80

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 18. Segment
Information.

In
accordance with the requirements of SFAS No. 131, Disclosures about Segments of and
Enterprises and Related Information, selected financial information regarding our
reportable business segments, domestic and international, are presented below. Domestic
wholesale distribution of home entertainment programming on DVD accounted for
approximately 90% of our net revenue for fiscal 2007, 87% for fiscal 2006 and 85% for
fiscal 2005. Management currently evaluates segment performance based primarily on net
revenues, operation costs and expenses and income (loss) before income taxes. Interest
income and expense is evaluated on a consolidated basis and not allocated to our business
segments.

For the Year Ended March
31, 2007:

|                                   
|-----------------------------------
|(In thousands)                     
|NET REVENUES                       
|OPERATING COSTS AND EXPENSES       
|                                   
|EARNINGS (LOSS) FROM OPERATIONS    
|OTHER EXPENSES (INCOME)            
|                                   
|EARNINGS (LOSS) BEFORE INCOME TAXES
|                                   

For the Year Ended March
31, 2006:

|                                   
|-----------------------------------
|(In thousands)                     
|NET REVENUES                       
|OPERATING COSTS AND EXPENSES       
|                                   
|EARNINGS FROM OPERATIONS           
|OTHER EXPENSES                     
|                                   
|EARNINGS (LOSS) BEFORE INCOME TAXES
|                                   

For the Year Ended March
31, 2005:

|                            
|----------------------------
|(In thousands)              
|NET REVENUES                
|OPERATING COSTS AND EXPENSES
|                            
|EARNINGS FROM OPERATIONS    
|OTHER EXPENSES (INCOME)     
|                            
|EARNINGS BEFORE INCOME TAXES
|                            

|                          |     
|------------------------- | ----
|(In thousands)            | 2007
|TOTAL ASSETS:             |     
|DOMESTIC                  |     
|INTERNATIONAL             |     
|                          |     
|CONSOLIDATED TOTAL ASSETS |     
|                          |     

|                         
|-------------------------
|Image Entertainment, Inc.

---

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

---

# Note 19. Quarterly
Financial Data. (Unaudited)

Summarized quarterly consolidated
financial data for fiscal 2007 and 2006 is as follows:

|                                                         
|---------------------------------------------------------
|June 30,                                                 
|(In thousands, except per share data)                    
|Net revenues                                             
|Earnings (loss) before income tax                        
|Net earnings (loss)                                      
|Net earnings (loss) per share1 -                         
|Basic and diluted                                        
|Weighted average common shares used in computation of net
|earnings (loss) per share:                               
|Basic and diluted                                        
|Diluted                                                  

---

|1 | Net
earnings (loss) per share are computed independently for each of the
               quarters represented in accordance with SFAS No. 128. Therefore, the sum
of the                quarterly net earnings (loss) per share may not equal the total
computed for the                fiscal year or any cumulative interim period.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2 | Includes
a $562,000 credit to cost of sales from the reversal of an overaccrual                for
music publishing liabilities associated with a DVD series.
|- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|3 | Includes
a $2.2 million write-off of assets relating to our distribution                agreement
with Source Entertainment, Inc. which filed for bankruptcy protection                in
May 2007 and $1.2 million in legal, investment banking and other expenses
               associated with negotiating the BTP agreement to acquire Image in fiscal
2007.
|- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|  
|--
|82

---

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

None.

# ITEM 9A. CONTROLS AND
PROCEDURES

As
of the end of the period covered by this Annual 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 this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are effective in
timely alerting them to material information required to be included in our periodic
Securities and Exchange Commission reports.

There
have been no changes in our internal controls over financial reporting or in other factors
that has materially affected, or is reasonably likely to materially affect, those controls
subsequent to the date of this most recent evaluation.

# ITEM 9B. OTHER
INFORMATION

None.

|                         
|-------------------------
|Image Entertainment, Inc.

---

|
|
|

The
information required by Items 10 through 14 of Part III is incorporated herein by
reference to our definitive Proxy Statement to be filed with the SEC pursuant to
Regulation 14A for our 2007 Annual Meeting of Stockholders. Such Proxy Statement involves
the election of directors and we tentatively plan to file such Proxy Statement no later
than 120 days after our 2007 fiscal year end. If the Proxy Statement is not filed with the
SEC within such 120-day period, the items comprising the Part III information will be
filed as an amendment to this Annual Report no later than the end of the 120-day period.

Our
Code of Ethics Policy which is applicable to all employees including our principal
executive officer, principal financial officer and principal accounting officer, as well
as our Insider Trading Policy, Corporate Governance Guidelines, the written Charters for
our Audit, Compensation, and Nominations and Governance Committees, and periodic and
current reports filed with the SEC are available on our website
www.image-entertainment.com, and are available in print to any shareholder upon
request. Such information is incorporated herein by reference.

|  
|--
|84

---

|
|
|

# ITEM 15. EXHIBITS AND
FINANCIAL STATEMENT SCHEDULES

|THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT. | Page
|----------------------------------------------------------- | ----

| | (a) | Financial Statements:                                               |   
| | --- | ------------------------------------------------------------------- | --
| |     | Report of Independent Registered Public Accounting Firm             | 56
| |     | Consolidated Balance Sheets as of March 31, 2007 and 2006           | 57
| |     | Consolidated Statements of Operations for the years ended          
| |     | March 31, 2007, 2006 and 2005                                       | 59
| |     | Consolidated Statements of Shareholders Equity for the years ended
| |     | March 31, 2007, 2006 and 2005                                       | 60
| |     | Consolidated Statements of Cash Flows for the years ended          
| |     | March 31, 2007, 2006 and 2005                                       | 61
| |     | Notes to Consolidated Financial Statements                          | 64

| | (b) | Financial Statement Schedule:                   |   
| | --- | ----------------------------------------------- | --
| |     | Schedule II - Valuation and Qualifying Accounts | 89
| | (c) | Exhibits:                                      

|2.1 | Agreement
and Plan of Merger, dated as of March 29, 2007, among BTP Acquisition Company, LLC a
Delaware limited liability company, IEAC, Inc., a Delaware corporation and a wholly-owned
subsidiary of BTP Acquisition Company, LLC, and the Registrant. Filed as Exhibit 2.1 to
the Registrants Form 8-K dated April 2, 2007, and incorporated by reference herein.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.1 | Certificate
of Incorporation. Filed as Exhibit B of Appendix B of the Registrants Proxy
Statement dated July 29, 2005, as amended by a certificate of correction as reflected in
the Registrants Form 8-K filed on May 15, 2006, each incorporated by reference
herein.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3.2 | Bylaws.
Filed as Exhibit C of Appendix B of the Registrants Proxy Statement dated July 29,
2005, and incorporated by reference herein.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|4.1 | Specimen
Common Stock certificate.  Filed as Exhibit 4.1 to the Registrants Registration
                  Statement on Form S-3/A (No. 333-128487), effective October 21, 2005,
and to the Registrants                   Registration Statement on Form S-3 (No.
333-138701), effective December 13, 2006, and                   incorporated by reference
herein.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2 | Rights
Agreement dated as of October 31, 2005, by and between the Registrant and Computershare
Trust Company, Inc. Filed as Exhibit 4.1 to the Registrants Form 8-K/A dated
November 2, 2005, and incorporated by reference herein.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.2(a) | Amendment
No. 1 to Rights Agreement, dated as of March 29, 2007, by and between                the
Registrant and Computershare Trust Company, N.A., a Delaware corporation, as
               Rights Agent. Filed as Exhibit 4.1 to the Registrants Form 8-K dated
April                2, 2007, and incorporated by reference herein.
|------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.3 | Securities
Purchase Agreement, dated as of August 30, 2006, between the Registrant and the buyers
named therein. Filed as Exhibit 10.1 to the Registrants Form 8-K dated August 31,
2006, and incorporated by reference herein.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.4 | Registration
Rights Agreement, dated as of August 30, 2006, between the Registrant and the buyers
named therein. Filed as Exhibit 10.4 to the Registrants Form 8-K dated August 31,
2006, and incorporated by reference herein.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

|4.5 | Form
of Senior Convertible Note.  Filed as Exhibit 10.2 to the Registrants Form 8-K dated
                  August 31, 2006, and incorporated by reference herein.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.6 | Form
of Warrant.  Filed as Exhibit 10.3 to the Registrants Form 8-K dated August 31, 2006,
and                   incorporated by reference herein.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------

|4.7 | Amendment
and Exchange Agreement, dated November 10, 2006, by and between the Registrant and
                  Portside Growth and Opportunity Fund.  Filed as Exhibit 4.6 to the
Registrants Registration                   Statement on Form S-3 (No. 333-138701),
effective December 13, 2006, and incorporated by                   reference herein.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4.8 | Warrant
Issued Pursuant to Amendment and Exchange Agreement.  Filed as Exhibit 4.7 to the
                  Registrant's Registration Statement on Form S-3 (No. 333-138701),
effective December 13, 2006,                   and incorporated by reference herein.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.1 | Amended
and Restated Loan and Security Agreement, dated as of August 10, 2005, by and between the
Registrant and Wells Fargo Foothill, Inc. Filed as Exhibit 10.1 to the Registrants
Form 10-Q for the quarter ended June 30, 2005, and incorporated by reference herein.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.2 | Amendment
No. 1 to Amended and Restated Loan and Security Agreement, dated as of November 3,
                  2005, by and between the Registrant and Wells Fargo Foothill, Inc.
 Filed as Exhibit 10.1 to                   the Registrants Form 10-Q for the quarter
ended September 30, 2005, and incorporated by                   reference herein.
|---- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.3 | Amendment
No. 2 to Amended and Restated Loan and Security Agreement, dated as of June 23, 2006, by
and between the Registrant and Wells Fargo Foothill, Inc. Filed as Exhibit 10.3 to the
Registrants Form 10-K for the fiscal year ended March 31, 2006, and incorporated by
reference herein.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.4 | Amendment
No. 3 to Amended and Restated Loan and Security Agreement, dated as of August 9,
                  2006, by and between the Registrant and Wells Fargo Foothill, Inc.
 Filed as Exhibit 10.1 to                   the Registrants Form 10-Q for the quarter
ended June 30, 2006, and incorporated by reference                   herein.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5 | Amendment
No. 4 to Amended and Restated Loan and Security Agreement, dated as of November 13,
                  2006, by and between the Registrant and Wells Fargo Foothill, Inc.
 Filed as Exhibit 10.1 to                   the Registrants Form 10-Q for the quarter
ended September 30, 2006, and incorporated by                   reference herein.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.6 | Amendment
No. 5 to Amended and Restated Loan and Security Agreement, dated as of January 11,
                  2007, by and between the Registrant and Wells Fargo Foothill, Inc.
 Filed as Exhibit 10.1 to                   the Registrants Form 10-Q for the quarter
ended December 31, 2006, and incorporated by                   reference herein.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.7 | Amendment
No. 6 to Amended and Restated Loan and Security Agreement, dated as of January 11,
                  2007, by and between the Registrant and Wells Fargo Foothill, Inc.
 Filed as Exhibit 10.2 to                   the Registrants Form 10-Q for the quarter
ended December 31, 2006, and incorporated by                   reference herein.
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.8 | Warrant,
dated March 24, 2003, between the Registrant and Image Investors Co. Filed as Exhibit
99.2 to the Registrants Form 8-K dated March 26, 2003, and incorporated by
reference herein.
|---- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.9 | Employment
Agreement, dated as of April 1, 2004, between the Registrant and Martin W.
                  Greenwald.  Filed as Exhibit 10.42 to the Registrants Form 10-K for
the fiscal year ended                   March 31, 2004, and incorporated by reference
herein.
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|  
|--
|86

---

|10.9(a) | Amendment
No. 1 to Employment Agreement, dated as of June 1, 2004, by and between the
                  Registrant and Martin W. Greenwald.  Filed as Exhibit 10.42(a) to the
Registrants Form 10-K                   for the fiscal year ended March 31, 2004, and
incorporated by reference herein.
|-------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.9(b) | Amendment
to Employment Agreement, dated as of March 29, 2007, by and between the Registrant
                  and Martin W. Greenwald.  Filed as Exhibit 10.1 to the Registrants
Form 8-K dated April 2,                   2007, and incorporated by reference herein.
|-------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.9(c) | Amendment
to Employment Agreement, dated as of May 31, 2007, by and between the Registrant and
                  Martin W. Greenwald.  Filed as Exhibit 10.1 to the Registrants Form
8-K dated June 1, 2007,                   and incorporated by reference herein.
|-------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10 | Employment
Agreement, dated as of April 1, 2004, between the Registrant and David A. Borshell.
                  Filed as Exhibit 10.43 to the Registrants Form 10-K for the fiscal
year ended March 31, 2004,                   and incorporated by reference herein.
|------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10(a) | Amendment
to Employment Agreement, dated as of March 29, 2007, by and between the Registrant and
David Borshell. Filed as Exhibit 10.2 to the Registrants Form 8-K dated April 2,
2007, and incorporated by reference herein.
|--------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.10(b) | Amendment
to Employment Agreement, dated as of May 31, 2007, by and between the Registrant and
David Borshell. Filed as Exhibit 10.2 to the Registrants Form 8-K dated June 1,
2007, and incorporated by reference herein.
|--------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11 | Employment
Agreement, dated as of April 1, 2004, between the Registrant and Jeff M. Framer.
                  Filed as Exhibit 10.44 to the Registrant's Form 10-K for the fiscal
year ended March 31, 2004,                   and incorporated by reference herein.
|------ | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11(a) | Amendment
to Employment Agreement, dated as of March 29, 2007, by and between the Registrant and
Jeff Framer. Filed as Exhibit 10.3 to the Registrants Form 8-K dated April 2, 2007,
and incorporated by reference herein.
|--------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.11(b) | Amendment
to Employment Agreement, dated as of May 31, 2007, by and between the Registrant and Jeff
Framer. Filed as Exhibit 10.3 to the Registrants Form 8-K dated June 1, 2007, and
incorporated by reference herein.
|--------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.12 | Employment
Agreement, dated as of January 22, 2007, between the Registrant and Jeffrey Fink. Filed
as Exhibit 10.3 to the Registrants Form 10-Q for the quarter ended December 31,
2006, and incorporated by reference herein.
|------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.13 | Form
of Purchase Agreement, dated December 20, 2004, between the Registrant and investors.
Filed as Exhibit 99.1 to the Registrants Form 8-K dated December 21, 2004, and
incorporated by reference herein.
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.14 | Form
of Warrant, dated December 20, 2004, between the Registrant and investors. Filed as
Exhibit 99.2 to the Registrants Form 8-K dated December 21, 2004, and incorporated
by reference herein.
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.15 | Image
Entertainment, Inc. 2004 Incentive Compensation Plan.  Filed as Exhibit A to the
                  Registrants Notice of Annual Meeting and Proxy Statement dated July
29, 2004, and incorporated                   herein by this reference.
|------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.16 | Egami
Media, Inc. 2005 Incentive Compensation Plan.  Filed as Exhibit 10.14 to the Registrants
                  Form 10-K for the fiscal year ended March 31, 2005, and incorporated by
reference herein.
|------ | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.17 | Form
of Indemnification Agreement, between the Registrant and its directors and officers.
Filed as Exhibit 10.1 to the Registrants Form 8-K dated October 24, 2005, and
incorporated by reference herein.
|------ | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         
|-------------------------
|Image Entertainment, Inc.

---

|10.18 | Form
of Stock Unit Award Grant Notice and Agreement for the Image Entertainment, Inc. 2004
                  Incentive Compensation Plan.  Filed as Exhibit 10.4 to the Registrants
Form 10-Q for the                   quarter ended December 31, 2006, and incorporated by
reference herein.
|----- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.19 | Form
of Option Agreement Amendment, between the Registrant and its optionees. Filed as Exhibit
10.1 to the Registrants Form 8-K dated March 29, 2006, and incorporated by
reference herein.
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.20 | Form
of Support Agreement by and between BTP Acquisition Company, LLC, a Delaware limited
liability company, and certain of the Registrants stockholders. Filed as Exhibit
99.2 to the Registrants Form 8-K dated April 2, 2007, and incorporated by reference
herein.
|----- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|10.21* | Loan
and Security Agreement, dated as of May 4, 2007, by and between Wachovia Capital Finance
Corporation (Western) and the Registrant.
|------ | ---------------------------------------------------------------------------------------------------------------------------------------

|14.1 | Code
of Ethics Policy, dated November 1, 2003. Filed as Exhibit 10.45 to the Registrants
Form 10-K for the fiscal year ended March 31, 2004, and incorporated by reference herein.
|---- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|21* | Subsidiaries
of the Registrant.
|--- | -------------------------------

|23.1* | Consent
Letter of BDO Seidman LLP, Independent Registered Public Accounting Firm.
|----- | ---------------------------------------------------------------------------------

|31.1* | Certification
by the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|31.2* | Certification
by the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|32.1* | Certification
by the Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------

|32.2* | Certification
by the Chief Financial Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002.
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------

| | * | Exhibit(s)
not previously filed with the Securities and Exchange Commission.
| | - | ----------------------------------------------------------------------------

| |  | Management
Contracts, Compensatory Plans or Arrangements.
| | - | ---------------------------------------------------------

|  
|--
|88

---

# SCHEDULE II   Valuation
and Qualifying Accounts For the Years Ended March 31, 2007, 2006 and 2005

---

|                                  
|----------------------------------
|(In thousands)                    
|For the Year Ended March 31, 2007:
|                                  
|For the Year Ended March 31, 2006:
|                                  
|For the Year Ended March 31, 2005:
|                                  

|                                  
|----------------------------------
|(In thousands)                    
|For the Year Ended March 31, 2007:
|                                  
|For the Year Ended March 31, 2006:
|                                  
|For the Year Ended March 31, 2005:
|                                  

|                                  
|----------------------------------
|(In thousands)                    
|For the Year Ended March 31, 2007:
|                                  
|For the Year Ended March 31, 2006:
|                                  
|For the Year Ended March 31, 2005:
|                                  

Reconciliation to
Consolidated Balance Sheets

|                                
|--------------------------------
|(In thousands)                  
|Allowance for Doubtful Accounts:
|Balance at End of Year          
|Allowance for Sales Returns:    
|Balance at End of Year          
|                                
|Allowances                      
|                                

|                         
|-------------------------
|Image Entertainment, Inc.

---

|
|
|

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

| |                       | IMAGE ENTERTAINMENT, INC.                                   
| | --------------------- | ------------------------------------------------------------
| |                       | A Delaware corporation                                      
| | Dated:  June 29, 2007 | /s/ MARTIN W. GREENWALD                                     
| |                       | MARTIN W. GREENWALD                                         
| |                       | Chairman of the Board, President and Chief Executive Officer

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

| | Dated:  June 29, 2007 | /s/ MARTIN W. GREENWALD                                             
| | --------------------- | --------------------------------------------------------------------
| |                       | MARTIN W. GREENWALD                                                 
| |                       | Chairman of the Board, President and Chief Executive Officer        
| |                       | (Principal Executive Officer)                                       
| | Dated:  June 29, 2007 | /s/ JEFF M. FRAMER                                                  
| |                       | JEFF M. FRAMER                                                      
| |                       | Chief Financial Officer (Principal Financial and Accounting Officer)
| | Dated:  June 29, 2007 | /s/ DAVID CORIAT                                                    
| |                       | DAVID CORIAT                                                        
| |                       | Director                                                            
| | Dated:  June 29, 2007 | /s/ IRA EPSTEIN                                                     
| |                       | IRA EPSTEIN                                                         
| |                       | Director                                                            
| | Dated:  June 29, 2007 | /s/ GARY HABER                                                      
| |                       | GARY HABER                                                          
| |                       | Director                                                            
| | Dated:  June 29, 2007 | /s/ M. TREVENEN HUXLEY                                              
| |                       | M. TREVENEN HUXLEY                                                  
| |                       | Director                                                            
| | Dated:  June 29, 2007 | /s/ ROBERT J. MCCLOSKEY                                             
| |                       | ROBERT J. MCCLOSKEY                                                 
| |                       | Director                                                            

|  
|--
|90