**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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**FORM 10-K**

 

**ý****                                ****ANNUAL REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For The Fiscal Year Ended March 31, 2003**

 

**OR**

 

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

 

**For The Transition PeriodFrom                   To                   **

 

**Commission File Number 0-11071**

 

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| **IMAGE ENTERTAINMENT, INC.**                                 |
|---------------------------------------------------------------|
| (Exact name of registrant as specified in  its charter)       |
|                                                          |   |   |
| **California**                                                |   | **84-0685613** |
| (State or other jurisdiction of  incorporation)               |   | (I.R.S. Employer Identification Number) |
|                                                          |   |   |
| **9333 Oso Avenue, 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 Section12(b) of the Act:  **None**

 

Securities registered pursuant to Section12(g) of the Act:  **Common Stock, no par value**

 

Indicate bycheck mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filing requirementsfor the past 90 days. YES ý  NO o

 

Indicate bycheck mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

 

Indicate bycheck mark whether the registrant is an accelerated filer (as defined in Rule12b-2 of the Act).  YES o  NO ý

 

At June 2, 2003, 18,225,408 shares of Common Stock were outstanding,and the aggregate market value of the shares of Common Stock held by theregistrant’s nonaffiliates was approximately $17,721,422 (based upon theclosing price of the Common Stock on the NASDAQ National Market System on suchdate), excluding shares of Common Stock held by the registrant’s directors,executive officers and 5% or more shareholders.  Their holdings have been excluded in that such persons may be deemedaffiliates.  This determination of affiliatestatus is not necessarily a conclusive determination for other purposes.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III – Proxy Statement for Registrant’s 2003 Annual Meeting ofShareholders to be filed within 120 days of fiscal year-end.

 

 

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**IMAGE ENTERTAINMENT, INC.**

**Form 10-K Annual Report**

**For The Fiscal Year Ended March 31, 2003**

 

**TABLE OF CONTENTS**

 
| PART I     |
|------------|
|       |   |   |
|       | ITEM 1. | Business |
|       | ITEM 2. | Properties |
|       | ITEM 3. | Legal Proceedings |
|       | ITEM 4. | Submission of Matters to a Vote of Security  Holders |
|       |   |   |
| PART II    |
|       |   |   |
|       | ITEM 5. | Market for Registrant’s Common Equity and  Related Stockholder Matters |
|       | ITEM 6. | Selected Financial Data |
|       | ITEM 7. | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
|       | ITEM 7A. | Quantitative and Qualitative Disclosures  About Market Risk |
|       | ITEM 8. | Financial Statements and Supplementary Data |
|       | ITEM 9. | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure |
|       |   |   |
| PART III   |
|       |   |   |
|       | ITEM 10. | Directors and Executive Officers of the  Registrant |
|       | ITEM 11. | Executive Compensation |
|       | ITEM 12. | Security Ownership of Certain Beneficial  Owners and Management |
|       | ITEM 13. | Certain Relationships and Related  Transactions |
|       | ITEM 14. | Controls and Procedures |
|       |   |   |
| PART IV    |
|       |   |   |
|       | ITEM 15. | Exhibits, Financial Statement Schedules and  Reports on Form 8-K |
|       |   |   |
| SIGNATURES |

 

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**PART I**

 

**ITEM 1.              BUSINESS.**

 

**GENERAL**

 

Image Entertainment, Inc. (“Image”) is an integrated entertainmentcompany, primarily engaged in the business of licensing and distributing homeentertainment programming.  We acquireand exploit exclusive rights to a diverse array of general and specialtyentertainment programming, such as music concerts, urban and lifestyledocumentaries, and feature films, in DVD and other home entertainmentformats.  In addition to our currentcore business of domestic DVD distribution, we also acquire and, in some cases,exploit exclusive broadcast rights, including video-on-demand, broadbandstreaming, digital download, pay-per-view, in-flight, radio, satellite, cableand broadcast television.  Image primarilyacquires programming by entering into exclusive licensing or distributionarrangements with third parties.  Wealso produce our own original entertainment programming focused on DVD liveperformance music concerts and urban genre programming.  Additionally, we design and produceadditional content and value-added features for our DVD programming such asinteractive menus, audio commentaries, packaging and marketing materials.  Although we license and distributeprogramming across many genres, we are foremost a leading provider ofmusic-related DVD programming.  Asreported in the DVD Release Report – Revised: February 19, 2003, a DVD industrypublication which tracks DVD titles released by program supplier, Image was thetop source of music programming on DVD through the calendar year ended December31, 2002, with a 19% market share of music related DVD programming titlesreleased.  It additionally was reportedthat Image was the market leader in special interest DVD titles releasedthrough December 31, 2002, with a 10% market share in that category.

 

Within this document, unless the context indicates otherwise, allreferences herein to the “Company,” “we,” “us,” and “our” refer collectively toImage, its wholly-owned subsidiary DVDPlanet.com, Inc., a Californiacorporation (“DVDPlanet”), and Image’s 50%-owned joint venture, AvivaInternational, LLC, a California limited liability company (“Aviva”).

 

Image was incorporated in Colorado as Key International FilmDistributors, Inc. in April 1975, our present name was adopted in 1983, and wereincorporated in California in November 1989. Our principal executive offices are located at 9333 Oso Avenue,Chatsworth, California 91311, telephone (818) 407-9100.  We maintain Web sites atwww.image-entertainment.com and www.dvdplanet.com.  The content of these sites does not constitute a part of thisAnnual Report.

 

Our businessstrategy is to pursue, secure and exploit exclusive rights to as many differenttypes of home entertainment programming, for as many formats and distributionmethods, in as many territories, and for the longest term feasible.  We strive to grow a stream of revenues bybuilding a strong customer base and a library of evergreen titles that can beexploited in existing home entertainment formats such as DVD, VHS, and CD andexpanding distribution channels such as video-on-demand, Internet digitaldownload and broadband streaming media.

 

We have a current catalog of over 2,500 exclusive titles indistribution, with approximately 450 additional exclusive titles scheduled forrelease over the next twelve months. Some of the exclusive titles currently available or soon to be releasedby Image include:  *Cher: The Farewell Tour*, an expandededition of one of the highest-rated television specials of the 2002-2003television season; several programs from urban impresario Russell Simmons, of *Def Comedy Jam* fame; a series of programsfrom the internationally renowned urban brand, Ruff Ryders; *Beef*, “an insightful look at the realworld of MC battles,” from Quincy Jones III’s QD3 Entertainment; the newBroadway cast recording of *Nine*,starring Antonio Banderas; the recent Tony AwardÒ-winningrevival of Cole Porter’s *Kiss Me, Kate*;a special edition of Stephen Sondheim’s Tony AwardÒ-winning*Passion*; the entire collection ofepisodes from the classic television series, *TheDick Van Dyke Show*; and the video debut of the notorious 1970snetwork television series *The Richard PryorShow*, featuring Robin Williams.

 

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The following table sets forth the percentage of consolidated netrevenues derived from the distribution of entertainment programming by formatfor our last three fiscal years.  Theinformation in the table below does not represent segment data, but rather ispresented for purposes of explaining certain trends within net revenues:

 
|                 |   | **Fiscal  Years Ended  March 31,** |    |
|----------------------|--------|------------------------------------|---------|
| **(in thousands)**   |   | **2003**                           |    | **2002** |   | **2001** |   |
|                 |   |                               |    |   |   |   |   |   |   |   |   |   |   |
| DVD                  |   | $                                  | 98,023  |   | 90.6 | % | $ | 84,905 |   | 89.6 | % | $ | 90,205 |   | 90.2 | % |
| VHS                  |   | 3,593                              |    | 3.3 |   | 4,678 |   | 4.9 |   | 4,114 |   | 4.1 |   |
| CD                   |   | 2,947                              |    | 2.7 |   | 1,500 |   | 1.6 |   | 413 |   | 0.4 |   |
| Broadcast/Sublicense |   | 3,825                              |    | 3.5 |   | 3,066 |   | 3.2 |   | 2,985 |   | 3.0 |   |
| Laserdisc            |   | 0                                  |    | 0.0 |   | 321 |   | 0.3 |   | 1,794 |   | 1.8 |   |
| Other                |   | (195                               | )       | (0.1 | ) | 343 |   | 0.4 |   | 522 |   | 0.5 |   |
| TOTAL                |   | $                                  | 108,193 |   | 100.0 | % | $ | 94,813 |   | 100.0 | % | $ | 100,033 |   | 100.0 | % |

 

**BUSINESS SEGMENTS**

 

We currently have three business segments:

 

•                                          *Domestic Wholesale Distribution*

* *

*•**                                          RetailDistribution*

* *

*•**                                          InternationalWholesale Distribution*

 

Our Domestic Wholesale Distribution segment includes program licensing,distribution and production.  Our RetailDistribution segment, which is operated by Image’s wholly-owned subsidiary,DVDPlanet, distributes programming direct-to-consumer, in conjunction withImage’s fulfillment operation and a third-party fulfillment company.  Our International Wholesale Distributionsegment includes international sublicensing and worldwide broadcast rightsexploitation.

 

The following table presents consolidated net revenues, net ofeliminations, by reportable business segment for the periods presented:

 
|                                 |   | **Fiscal  Years Ended  March 31,** |    |     |   |
|--------------------------------------|--------|------------------------------------|---------|----------|--------|
|                                 |   | **2003**                           |    | **2002** |   | **% Change** |   |
| Net revenues: *(in thousands)*       |   |                               |    |     |   |   |   |
| Domestic Wholesale Distribution      |   | $                                  | 77,484  |     | $      | 66,376 |   | 16.7 | % |
| Retail Distribution                  |   | 21,264                             |    | 18,678   |   | 13.8 |   |
| International Wholesale Distribution |   | 9,445                              |    | 9,759    |   | (3.2 | ) |
| Consolidated                         |   | $                                  | 108,193 |     | $      | 94,813 |   | 14.1 | % |

 

***Domestic WholesaleDistribution***

 

Most of the product we sell is in the DVD format.  According to industry estimates, there arecurrently more than 22,000 DVD titles available in the domestic market, ofwhich approximately 2,500 are exclusively licensed to or exclusivelydistributed through Image.  Image hasdeveloped a specialty niche in distribution of exclusive music-related entertainmentprogramming.  We are a leadingindependent supplier of DVD programming in the music, episodic television,special interest, urban and lifestyle genres.

 

According toVideo Store Magazine market research (April 13-19, 2003), total video sales(DVD and VHS) were $12.1 billion in calendar 2002, a 12.2% increase from theprior year, with DVD alone providing the growth.  

 

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While domestic sales of VHS declined nearly 40% to $3.4 billion in2002, domestic sales of DVD jumped 67% to $8.7 billion and represented about72% of the $12.1 billion that consumers spent buying video, up from 48% in2001.  Consumers spent $21 billionrenting and buying videos in 2002, primarily as a result of the surge in popularityof DVD.  Many retailers are scaling backtheir shelf space allotted to VHS in favor of more DVD.

 

According to the Consumer Electronics Association, consumers boughtmore than 25 million DVD players in 2002, a 50% increase over 2001.  According to the DVD Entertainment Group, aLos Angeles nonprofit marketing group comprised of consumer electronics andhome entertainment companies, the number of U.S. homes with a DVD playerincreased to 40 million in 2002.  Morethan 10 million homes boasted two or more DVD players and there were 95 millionDVD-capable machines (including PCs and game consoles).  DVD household penetration could reach the50% mark by the end of 2003, equal to 55 million U.S. households.

 

Image believes that the value gained through the ability to entertainpeople at home for a reasonable price at convenient times, the opportunity tochoose from a very broad selection of programming, the unique and compellinginteractive experience of DVD menus, and the ability to control the viewingexperience with the remote control, will continue to make DVD a preferredprepackaged software medium of home entertainment for millions ofconsumers.  Many DVDs also offer specialfeatures, enhancements and ancillary materials, such as special menu design, multipleaudio tracks, behind-the-scenes footage, director commentaries, interviews anddiscographies, all of which Image is able to develop in-house for its exclusivetitles.

 

We believe that the major studios’ promotion of DVDs for sale, and thevalue of the programming and ancillary features received, has served toaccelerate consumer awareness of and interest in the DVD format.  Because of Image’s growing library ofexclusive titles in a wide variety of genres, we believe that we are positionedto benefit from the market growth of the DVD format.  We intend to continue expansion of our DVD library throughout thecoming year.

 

*Exclusive Acquisition.*  We generally acquire exclusive rights to ourprogramming.  Image has an existingcatalog of over 2,500 exclusive titles and currently releases an average of30-40 new exclusive titles each month. We typically acquire our exclusive titles from independent programsuppliers, producers, music artists, record labels and artist management.  We produce, market and sell our exclusiveprogramming according to exclusive license or distribution agreements.  Image actively pursues and secures bothdomestic (U.S. and Canadian) and international rights to its exclusive titles.

 

In return for exclusive license rights, Image pays royalties to thelicensors.  Royalties are expressed as apercentage of our wholesale net revenues derived from program sales.  Typically, we pay royalty advances that arerecouped 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 fora minimum distribution term of at least five years and often considerablylonger.  Some license agreements containprovisions for an extension of the distribution term if we meet specifiedperformance plateaus.

 

In return for exclusive distribution rights, Image generally tendersnet wholesale revenues to program suppliers, which are expressed as apercentage of wholesale revenues, after subtracting Image’s distribution feeand recouping costs such as production, manufacturing, music publishing, andmarketing.  In some cases, the netprofit of a title is split between Image and the program supplier.  In many such cases, advances on an exclusivedistribution deal are paid and recouped by Image similar to an exclusivelicensing arrangement.

 

Under our exclusive license and distribution arrangements, we oftensecure the right to distribute entertainment programming in a range of homeentertainment formats, which may include all or any combination of DVD, VHS,CD, and other formats.  We also pursueand secure exclusive broadcast rights which include exploitation via broadcasttelevision, cable, satellite, pay-per-view, video-on-demand, in-flight, radioand other broadcast media.  The rightswe acquire may also encompass Internet streaming and digital downloading.  For a discussion regarding our exploitationof international wholesale, sublicensing and worldwide broadcast rights, see“International Wholesale Distribution” below.

 

While our core business remains the domestic wholesale distribution ofDVDs, we seek to secure and exploit the broadest grant of rights of homeentertainment programming feasible.  Aspart of our strategic goal to secure the broadest possible range of rights forexclusive programming, we may finance all or part of the production of some ofour entertainment programs.  Theprograms Image produces are generally one-time, special event live musicconcerts or

 

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urban genre programming, produced for the express purpose of exclusiveexploitation by Image in all home entertainment and broadcast markets.  The rights we retain in connection with ourself-financed productions generally cover, in perpetuity, all territoriesthroughout the world and all now-known and hereafter-devised home entertainmentformats, including video, broadcast, audio, in-flight, Internet streaming,digital downloading, direct response, sponsorship and bundling rights.

 

*Nonexclusive Distribution*.  The Company does not generally distributenonexclusive programming on a domestic wholesale basis.  However, as a requested service to seven ofour largest national accounts (Alliance Entertainment, Best Buy, Borders, Musicland,Tower, Trans World and Virgin) the Company acts as a distributor for about 40lines of smaller independent programming to these accounts.

 

We previously acquired and distributed nonexclusive DVD programming,but we stopped doing so for the majority of nonexclusive programming as ofDecember 31, 2002.  See “Item7.  Management’s Discussion and Analysisof Financial Condition and Operations – Change in the Company’s WholesaleDistribution of Nonexclusive DVD Programming.”

 

*Additional Services.*  Image provides a variety of value-addedservices relative to its licensed programs and many of its exclusivelydistributed programs, including: creation of packaging, DVD authoring and compression, menu design, videomaster quality control, manufacturing, marketing, sales, music clearance,warehousing, distribution, and, for some titles, the addition of enhancementssuch as multiple audio tracks, commentaries, foreign language tracks, and otherancillary materials (behind-the-scenes footage, interviews,discographies).  All of these servicesare typically performed by Image in-house, with the exception of musicclearance, disc manufacturing and tape replication, package printing andpackaging of the finished product, which are performed by third party vendors.

 

*Manufacturing.*  Typically a program supplier delivers atitle master and artwork to Image.  Ourin-house post-production facility creates a submaster with specifications forthe necessary format and on-screen menus for each title.  Image’s in-house authoring and compressionteam then typically performs the work necessary to prepare a DVD master formanufacturing.  Occasionally, because ofthe large volume of exclusive Image releases, we may use an outside facility toperform such services.  Our in-housecreative services department, staffed with graphic designers, creates originaland innovative packaging fundamental to the marketing success of ourproduct.  Image currently exclusivelyengages Deluxe Media Services, Inc. formerly Ritek Global Media (“Deluxe”) tomanufacture and package our domestic DVD and CD programming as well as someinternational DVD programming.

 

*Marketing.*  Image’s in-house marketing division directsmarketing efforts toward consumers and video software and hardwareretailers.  Our marketing effortsinvolve point-of-sale advertising, print advertising in trade and consumerpublications, national television and radio advertising campaigns, directresponse campaigns, dealer incentive programs, trade show exhibits andbulletins featuring new releases and catalogue promotions.  Image has also instituted account-specificmarketing programs under which we work directly with retailers to optimize andcustomize print advertising and other advertising programs to promote ourexclusive product.  The creation ofspecialized in-store displays and celebrity appearances are other examples ofaccount-specific marketing programs. Image also implements Internet promotional activities that includeproduct tie-ins, sweepstakes and give-aways associated with online retailcustomers, and the creation of genre-specific “boutiques” withindirect-to-consumer Web sites.

 

We spent approximately $2,103,000 for product promotion, advertising intrade and consumer publications, and advertising over the radio in fiscal 2003(approximately $339,000 of which represents expenditures by the RetailDistribution and International Wholesale Distribution segments) andapproximately $2,623,000 for product promotion and advertising in trade andconsumer publications in fiscal 2002. Additionally, our market development expenditures for account-specificand other marketing programs were approximately $1,886,000 for fiscal 2003 and$1,019,000 for fiscal 2002.

 

Image maintains a Web site at www.image-entertainment.com to helppromote and sell our products to retailers. The Web site also includes information regarding our exclusive titles,information of general interest to the home entertainment consumer, and pressreleases.

 

*Customers.*  We sell our product to retailers (includingInternet retailers), distributors and via alternative distribution (whichinclude direct-to-consumer print catalogues, direct response campaigns andother non-traditional 

 

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sales channels).  Domesticdelivery of all of our product is effected through our distribution facility inLas Vegas, Nevada.  See“International Wholesale Distribution” below for information regarding ourinternational distribution.

 

We sell direct to many large and small retailers.  Some of Image’s key sell-through customers(excluding DVDPlanet) include AEC One Stop, Amazon.com, Best Buy, Borders,Columbia House, Ingram Entertainment, The Musicland Group, Tower Records &Video, Trans World Entertainment, VidCanada and Wal-Mart.  In addition, Image sells to rental-retailhybrid customers Blockbuster Video, Hollywood Video, Movie Gallery and onlinerental-only customer Netflix.  Over thelast several years, many of our sell-through and rental-retail customers havehelped grow our audio revenues by purchasing audio CDs from Image as well ashome video product.  Our special marketsdivision is designed to take advantage of Image’s large and diverse catalog andspecifically targets “niche” sales opportunities.  Special markets’ retailers to whom we have sold product includethe Metropolitan Opera Guild, the Gene Autry Museum, Crutchfield Corporation,Surf Video Network, Doubleday, and the Lucy/Desi Museum.  On a consolidated basis, Best Buy and TheMusicland Group (which was owned by Best Buy through June 16, 2003) accountedfor 20.4% and 19.1% of fiscal 2003 and fiscal 2002 net revenues,respectively.  No other customersaccounted for net revenues individually in excess of 10% of Image’s total netrevenues for fiscal 2003 and 2002.

 

Image allows retail customers to return a portion of their inventory ona quarterly basis.  Image reserves forestimated returns at the time the sale is recognized.  Stock returns, other than for defective product, amounted to approximately12.2% of net revenues in fiscal 2003, approximately 10.3% of net revenues infiscal 2002, and approximately 8.4% of net revenues in fiscal 2001.  Returns of defective product have beenminimal and are generally covered by manufacturers’ warranties.

 

As of June 11, 2003, Image had approximately $4.0 million of backlogorders (96% from DVD product) from domestic wholesale customers compared withapproximately $4.1 million of backlog orders (92% from DVD product) as of June10, 2002.  We expect to fill 100% of thebacklog orders, less any cancelled orders, within the current fiscal year.

 

***Retail Distribution***

 

We sell directly to consumers through our wholly-owned subsidiary,DVDPlanet.  DVDPlanet sells most of theDVD titles available as well as those distributed by Image.  In fiscal 2003 and 2002, DVDPlanet’s salesaccounted for 19.7% of our consolidated net revenues.  DVDPlanet was one of Image’s largest customers during fiscal 2003and made the majority of its purchases from Image.  In fiscal 2004, DVDPlanet will purchase the majority of itsprogramming from a third-party fulfillment company.  See “Fulfillment” below.

 

DVDPlanet specializes in DVD software retailing through itswww.dvdplanet.com Web site.  At over21,000 titles, DVDPlanet offers one of the largest online selections ofDVDs.  DVDPlanet.com providesproprietary information about DVD releases, including titles, synopses,supplemental features, technical details and MPAA ratings.  Further, the site features a search enginethat allows customers to find product and features in genre-specific boutiqueswithin the Web site.  Online purchasesmay only be made with a major credit card. The site includes secure payment systems that protect the customer’sname, address and credit card number. DVDPlanet currently sells the majority of its product at a uniformdiscount from the suggested retail price.

 

DVDPlanet also owns and operates an 8,500 square foot DVD retail storein a shopping center in Huntington Beach, California.

 

*Fulfillment. *Effective June 2003, I-Serve DirectCommerce Services, Inc. (“I-Serve”), a wholly-owned subsidiary of InfinityResources, Inc., provides consumer fulfillment for DVDPlanet.  I-Serve ships products out of its Illinoiswarehouse and distribution center for orders received by DVDPlanet and billsDVDPlanet per shipment on a cost of goods basis plus fees (which cover productreceiving and storage, pick, pack, sort and ship, packaging, labels andinventory management system expenses). I-Serve also charges DVDPlanet monthly product sourcing fulfillmentadministration services fees (which cover product forecasts, product ordering,vendor records maintenance, sales and inventory monitoring).

 

I-Serve also manages customer returns processing, and fulfills certainof DVDPlanet’s retail store nonexclusive product needs.  Should DVDPlanet later choose, I-Serve hasthe ability to provide customer service for an additional fee.

 

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Prior to June 2003, fulfillment for DVDPlanet was handled by Imagethrough its Las Vegas, Nevada distribution facility.  See “Item 7. Management’s Discussion and Analysis of Financial Condition andOperations – Change in the Company’s Wholesale Distribution of Nonexclusive DVDProgramming.”

 

*Online Promotion.*  DVDPlanet has an established Internetaffiliate program whereby other Web sites refer customers to the DVDPlanet siteand in return receive a fee based on sales generated from that referral.  DVDPlanet has partnered with Be Free!, Inc.(www.befree.com), in an effort to focus DVDPlanet’s program on targetedaffiliates, to increase sales volume and to improve DVDPlanet’s share ofaffiliate business.  DVDPlanet providescustomers with weekly email updates on new product releases and sponsorpromotions at other entertainment content Web sites.

 

*Radio Advertising.*  DVDPlanet has an ongoing radio advertisingcampaign utilizing Los Angeles-based radio stations with a focus on drivingsales at the DVDPlanet retail store. Throughout the continuing period of radio advertising, revenues for theretail store have shown favorable growth as a result of the advertising.  The retail store has registered many newaccounts and the online business has generated new accounts that customersattributed to DVDPlanet’s radio advertising.

 

*Print Media.*  DVDPlanet purchased print advertising in the3rd and 4th quarters of the fiscal year ended March 31,2003.  These purchases were funded inpart with advertising support funds collected from DVDPlanet’s major studiopartners.  Eight page circulars weredistributed to DVDPlanet customers via direct mail and in Sunday editions ofthe *Orange County Register*.

 

DVDPlanet has implemented a number of operational changes over the lastfiscal year in an effort to reduce costs and increase margins.  See “Item 7.  Management’s Discussion and Analysis ofFinancial Condition and Operations – Changes at DVDPlanet.”

 

***InternationalWholesale Distribution***

 

*International Sublicensing.*  Image has a DVD sublicense agreement withBMG Music International Service, GmbH (“BMG”) for the exclusive distribution ofImage’s video programming, primarily DVD, throughout Europe (except France andSpain, until existing subdistribution agreements expire June 30 and December31, 2003, respectively), the Middle East (excluding Israel and Turkey) andAfrica.  The agreement contains termsand conditions similar to those governing Image’s underlying rightsagreements.  BMG pays Image a royalty onwholesale revenues it generates and is responsible for all sales, marketing,manufacturing and distribution of Image’s programming in the territories.  For distribution to a large portion of theremainder of the world, Image currently has similar sublicenses with otherthird parties.

 

Our International Wholesale Distribution segment activities werepreviously handled by Aviva, and our DVD programming was previously distributedinternationally through a network of independent subdistributors.  See “Note 3.  Aviva International, LLC” to theaccompanying consolidated financial statements.

 

*Worldwide Broadcast.*  Buyers of Image’s broadcast rights aretypically cable, pay-per-view, video-on-demand or satellite broadcasters, andsometimes terrestrial (free) television or in-flight broadcasters.  With the exception of pay-per-view andvideo-on-demand, under a typical broadcast license we receive payment of aone-time, fixed, non-refundable fee for a multi-year exploitation term and inmany instances for a specified number of airings.  With respect to pay-per-view and video-on-demand, we typicallyreceive a non-refundable advance against royalties that are based on a percentageof customer buys.  Our obligations underbroadcast licensing are usually only to provide a broadcast master of theprogram and to ensure that all music synchronization rights are secured.

 

Image has asales agency agreement with London-based NBD Television LTD (“NBD”) torepresent Image as its exclusive sales agent for worldwide broadcast televisionsublicenses of the majority of the current catalogue of programming for whichImage holds broadcast rights (in excess of 60 programs) as well as Image’s newrelease acquisitions which feature broadcast rights.  NBD represents Image for conventional television broadcast sales,including cable, pay-per-view and video-on-demand; satellite television; andsales to non-theatrical venues. Internet rights (video-on-demand via the Internet, digital downloadingand streaming) are excluded from the NBD agreement.  Programs that were sublicensed to third parties for broadcastprior to January 2003 will be handled by NBD upon the expiration of theexisting licenses.

 

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Historically, Aviva acted as Image’s sales agent to secure broadcastrights sublicenses both domestically and internationally.  See “Note 3.  Aviva International, LLC” to theaccompanying consolidated financial statements.

 

**COMPETITION**

 

With respect to our ability to sell our exclusive product, our foremostcompetition is from the major motion picture studios, (Fox, Universal, Disney,Columbia Tri-Star, Warner, MGM and Dreamworks), the “mini-majors” (Artisan andNew Line), major music labels (WEA, BMG, Universal and Sony) and otherindependent suppliers with sales models and structures similar to Image.  We compete with these other programsuppliers for limited “open to buy” dollars, retail shelf space and consumerdollars spent on home entertainment products. Most of these studios and labels are subsidiaries of media conglomeratesthat have far greater financial resources than we do.  However, Image as an independent program supplier, can offer itslicensors unique and specialized products, as well as highly focused marketingcampaigns for titles that may otherwise be deemed too small by the majorstudios or may be neglected by a corporate conglomerate.

 

As the DVD Industry matures, with penetration of U.S. televisionhouseholds nearing 50%, and new space being allocated for DVD programming, thecompetition level will continue to rise. The major studios remain consistent and prolific in their ability tobring new theatrical programming to retailers. They have large libraries of classic programming to release on DVD.  New independent suppliers are continuallyemerging, further adding to the competition. The additional promotional opportunities and “open to buy” dollars,while greater now than ever before, may be severely compromised by the newmajor theatrical programming, new independent suppliers and the vast cataloglibraries from the major studios.  Ourexclusive programming competes for a finite amount of shelf space, against agrowing supply of entertainment programming.

 

DVDPlanetfaces competition from online and traditional retailers, including mail orderhouses, video clubs and retail stores. Online DVD retailers now compete with a wide spectrum of retailers frommass merchants and other online retailers to supermarkets all of which offer awide selection of DVDs, often at loss-leader prices.  Additionally, online DVD retailers compete with the growingpopularity of online rental-by-mail providers. According to Video Store Magazine, more than 40 Web sites offering DVDrental by mail have entered the marketplace since 1998, including recent entryWal-Mart.

 

Image faces competition in securing exclusive license and distributionrights from other independent distribution companies as well as major motionpicture studios and music labels. Historically, we have paid significant up-front advances against futureroyalties and distribution fees to secure exclusive DVD and other homeentertainment format distribution rights. Our procedures designed to ensure timely recoupment of advances limitthe amount of advances we are willing to pay to secure certain rights.  We may not be able to remain competitiveagainst advance offers from licensing and other acquisition entities who arewilling to pay larger advances or have greater financial resources.  However, we believe that we will continue tosuccessfully compete in obtaining exclusive rights to home entertainmentprogramming because of our ability to offer an array of other assets to ourprogram suppliers including, but not limited to:  the high quality of expertise and the service our employeesprovide; our superior reputation within the home entertainment industry; ournotable ability to obtain and sustain ongoing relationships with valuablesuppliers of entertainment programming; the quality of our finished product;our wide-ranging in-house services and our direct and long-standingrelationships with traditional and online retailers of entertainmentprogramming.

 

Finally, management believes that Image’s status as an independentprogram supplier capable of exploiting programming in all home entertainmentand broadcast formats on a worldwide basis is attractive to potential licensorsthereby making the Company a leading “one-stop” provider of entertainmentrights exploitation.  See “RiskFactors” below.

 

**TRADEMARKS**

 

The Company has obtained Federal registrations of the trademark “Image”and the trademark and service mark “DVDPlanet” from the United States Patentand Trademark Office.  Additionally, thetrademark and service mark “DVDPlanet Your Online Source!” has been allowed bythe United States Patent and Trademark Office. The Company also has pending applications for Federal registrations ofthe trademark “Image Distributing” and the trademark and service mark “ImageEntertainment.”  It is the Company’spolicy to fully protect and vigorously defend its trademark rights in allapplicable classes of goods and services.

 

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**EMPLOYEES**

 

As of June 2, 2003, Image had 173 full-time employees and 6 part-timeemployees, DVDPlanet had 39 full-time employees and 29 part-time employees, andAviva had no full-time employees or part-time employees.

 

**AVAILABLE INFORMATION**

 

The address of our Internet Web site is www.image-entertainment.com.Through links on the Investor Relations portion of our Web site, we makeavailable free of charge our annual report on Form 10-K, quarterly reports onForm 10-Q and current reports on Form 8-K, as well as any amendments to thosereports, filed or furnished pursuant to Section 13(a) or 15(d) of theSecurities Exchange Act of 1934.  Suchmaterial is made available through our Web site as soon as reasonablypracticable after we electronically file the material with or furnish thematerial to the SEC.

 

**RISK FACTORS**

 

Forward-Looking Statements.

 

This Annual Report contains forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995.  These include statements regarding ourintent, belief and current expectations about the Company’s strategic direct,prospective and future results.  In somecases forward-looking statements may be identified by words like “may,”“should,” “expect,” “anticipate,” “believe,” “estimate,” “continue,” or similarwords.  Forward-looking statementsinvolve risks and uncertainties that are inherently difficult to predict, whichcould cause actual outcomes and results to differ materially from ourexpectations, forecasts and assumptions. The Company has made forward-looking statements in this Item 1 andsubsequent Items (including but not limited to Item 7) of this Annual Reportconcerning, among other things:

 

•                                          Changesin Company-wide or business-unit strategies, which may result in changes in thetypes or mix of businesses in which the Company is involved or chooses toinvest;

•                                          Changesin U.S. and global financial and equity markets, including market disruptionsand significant interest rate fluctuations, which may impede the Company’saccess to, or increase the cost of, external financing for its operations andinvestments;

•                                          Increasedcompetitive pressures, both domestically and internationally, which may, amongother things, affect the performance of the Company’s business operations andprofit margins;

•                                          Legaland regulatory developments that may affect Internet activities or theprotection of intellectual property; the imposition by foreign countries oftrade restrictions on motion picture or television content requirements orquotas, and changes in international tax laws or currency controls;

•                                          Theimposition by foreign countries of trade restrictions on motion picture ortelevision content requirements or quotas, and changes in international taxlaws or currency controls;

•                                          Technologicaldevelopments that may affect the distribution of the Company’s products orcreate new risks to the Company’s ability to protect its intellectual property;and

•                                          Changingpublic and consumer taste, which may among other things, affect theentertainment and consumer products businesses generally.

 

This list of factors that may affect future performance and theaccuracy of forward-looking statements is illustrative, but by no meansexhaustive.  Accordingly, allforward-looking statements should be evaluated with the understanding ofinherent uncertainty.  The inclusion ofsuch forward-looking information should not be regarded as a representation bythe Company, its management or any other person that the future events, plansor expectations contemplated by the Company will be achieved.  Unless otherwise required by law, theCompany undertakes no obligation to release publicly any updates or revisionsto any such forward-looking statements that may reflect events or circumstancesoccurring after the date of this Annual Report.  Important factors that could cause or contribute to such materialdifferences include, but are not limited to, those discussed below and thosedescribed under the heading “Competition” above.  You are cautioned not to place undue reliance on suchforward-looking statements, which speak only as of their dates.

 

We further caution you that the matters set forth below constitutecautionary statements with respect to our forward-looking statements, includingrisks and uncertainties that could cause our actual results, performance or

 

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achievements to differ materially from those expressed in, or impliedby, our forward-looking statements.  Anyof the matters set forth below could have a material adverse effect on ourbusiness, prospects, financial condition and results of operations.

 

Cautionary Statements Relating to OurBusiness in General.

 

**We May Not Be Able to Keep Pace withTechnological Advances.**  The entertainment industry in general, and the music and motionpicture industries in particular, are continuing to undergo significantchanges, primarily due to technological developments.  As an independent distributor, Image believes we have a superiorability to adapt to changing formats and distribution methods, as we did whenshifting our focus from laserdiscs to DVDs, and that our high quality customerservice and loyal customer base will continue to purchase programming fromImage through new distribution methods. However, because of the rapid growth of technology, shifting consumertastes and the popularity and availability of other forms of entertainment, itis impossible to predict the overall effect these factors will have onpotential revenue from and profitability of distributing entertainmentprogramming, or the Company’s ability to compete effectively in a changingmarket.

 

**If We Cannot Maintain Relationships with OurProgram Suppliers and Vendors, Our Business May Be Adversely Affected.**  We receive a significant amount of ourrevenue from the distribution of those DVDs for which we have exclusiveagreements with program suppliers.  Wecannot be certain that we will be able to renew these exclusive rights asexisting agreements with program suppliers expire.  We also cannot assure you that our current program suppliers willcontinue to support the DVD format in accordance with our exclusive agreements,that our current program suppliers will continue to license titles to us on thecurrent terms or on terms favorable to us, or that we will be able to establishnew supplier relationships to ensure acquisition of exclusive titles in atimely and efficient manner.

 

**Our Success Depends on the UnpredictableCommercial Success of Our Programming.**  Operating in the entertainment industryinvolves a substantial degree of risk. Each music performance, feature film or other programming title is anindividual artistic work, and unpredictable audience reactions primarilydetermine commercial success.  Thecommercial success of a title also depends upon the quality and acceptance ofother competing programs or titles released into the marketplace, criticalreviews, the availability of alternative forms of entertainment and leisureactivities, general economic conditions and other tangible and intangiblefactors, all of which are subject to change and cannot be predicted withcertainty.  Our success will depend inpart on the popularity of our programming. Even if a film achieves success during its theatrical release, thepopularity of a particular program and its ratings may diminish over time andmay have a material adverse affect on our business, results of operations orfinancial condition.

 

**Others’ Failure to Promote Our ProgrammingMay Adversely Affect Our Business.**  Decisions regarding the timing of releaseand promotional support of programming which we license and distribute areimportant in determining the success of a particular music concert, featurefilm or related product.  We may notcontrol the manner in which a particular artist, film or related product ismarketed and promoted, and we may not be able to fully control ourcorresponding home video or CD release. Although artists, record companies, studios and producers have afinancial interest in the success of any such concerts or films distributed byImage, any marketing or promotional decision or restriction by such persons maynegatively affect the success of our titles.

 

**If DVD Cannot Compete Successfully with OtherFormats of Home Entertainment, Our Revenues May Be Negatively Impacted.**  The DVD format competes with other formatsof in-home entertainment, such as VHS, network, syndicated, cable andpay-per-view television and home satellite systems.  The DVD format also competes with new and emerging technologiesin the entertainment industry, such as entertainment programming on theInternet, video-on-demand, high-definition television, digital videotape andoptical discs with greater storage capacity. While we are actively seeking to exploit these alternate formats ofleisure-time entertainment and novel means of content delivery, they couldnegatively impact the overall market for DVD sales and the Company.  In addition, emerging technology may allowconsumers to download audio or entertainment programming directly to theconsumer’s home computer, or television set-top recording device, from theInternet (or other broadband delivery system) and store such products on arecordable disc or hard-drive.  We maybe unable to continue to adapt and exploit the development and advancement ofsuch technology.

 

**DVD Sales May Not Sustain the Same Level ofGrowth.**  Webelieve that consumer interest in the DVD format is due in part to interest inbuilding the consumer’s personal DVD library of desired entertainmentprogramming.  Although Image’s exclusivetitles have generally shown stable sales over extended periods, as consumersbuild their 

 

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DVD libraries, or with the introduction of new home entertainmentformats, DVD sales may decline and adversely affect our operations.  In addition, consumers areincreasingly downloading entertainment and computer software directly via theInternet.  Piracy and unauthorizedrecording, transmission and distribution of content are increasing challenges.

 

****Decreasing Retail Prices for DVDs May Negatively Impact Our Revenues.****  Thehome entertainment programming market in which we compete is rapidly evolvingand intensely competitive.  Many of ourcompetitors, including major studios, are increasingly offering programming,particularly DVD programming, at lower prices. They may be able to produce or secure programming on more favorableterms and may be able to adopt more aggressive pricing policies than we areable to do.  Also, many of ourcompetitors endeavor to offer our customers the lowest possible prices, andinclude free or discounted shipping. While we strive to improve our operating efficiencies and leverage ourfixed costs so that we can afford to pass along these savings to our customersin the form of lower prices, the industry trend of lowering prices may, overtime, lead to lost sales, decreased profit margins or decreased overallrevenues.

 

**We May Not Possess Satisfactory Rights in OurProperties.** Although we require satisfactory chain of title information to ourexclusively licensed properties, the risk exists that some programs may have adefective chain of title.  The validityand ownership of rights to certain titles can be uncertain and may be contestedby third parties.

 

**Our Results of Operations Fluctuate Based onSeasonality and Variability.**  We have generally experienced higher sales of DVDs in thequarters ended December 31 and March 31 due to increased consumer spendingassociated with the year-end holidays. Accordingly, our revenues and results of operations may vary significantlyfrom period to period, and the results of any one period may not be indicativeof the results of any future periods. In addition to seasonality issues, other factors have contributed tovariability in our DVD net revenues on a quarterly basis.  These factors include:

 

•                                          thepopularity of exclusive titles in release during the quarter;

•                                          ourmarketing and promotional activities;

•                                          ourrights and distribution activities;

•                                          theextension, termination or non-renewal of existing license and distribution rights;and

•                                          generaleconomic changes affecting the buying habits of our customers, particularlythose changes affecting consumer demand for home entertainment hardware andsoftware.

 

**If We Do Not Effectively Implement Our Salesand Marketing Efforts, Our Profitability May Suffer.**  We have increased our internal sales staffin order to enhance our sales efforts. We cannot assure you that our sales team can successfully competeagainst the more extensive and well-funded sales operations of our current andfuture competitors.

 

**We Face Risks Associated with Deluxes’sPerformance under the Company’s Manufacturing Services Agreement.**  Any failure of Deluxe to manufacture anddeliver our product in a timely manner and with the same consistent quantityand quality that we and our customers have come to expect may adversely affectour revenues and profits.  Although webelieve we have the ability to shift our product manufacturing from Deluxe toanother facility should the need arise, we may be adversely affected from theperiod of time that we would need to direct manufacturing duties to anothercompany.

 

**Occurrence of Events for Which We Are NotInsured May Adversely Affect Our Business.**  We maintain insurance to protect ourselvesagainst certain risks related to our operations.  This insurance is maintained in types and amounts that we believeto be reasonable depending upon the circumstances surrounding each identifiedrisk.  However, we may elect to limitcoverage or not to carry insurance for certain risks because of the highpremiums (or rates) associated with insuring those risks or for various otherreasons.  Occurrence of events for whichwe are not insured may affect our cash flows and overall profitability.

 

**Protecting and Defending against IntellectualProperty Claims May Have a Material Adverse Effect on Our Business.**  Our ability to compete in the homeentertainment industry depends, in part, upon successful protection of ourproprietary and intellectual property. We protect our property rights to our productions through availablecopyright and trademark laws and licensing and distribution arrangements withreputable international companies in specific territories and media for limiteddurations.  Despite these precautions,existing copyright and trademark laws

 

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afford only limited practical protection in certain jurisdictions.  In certain jurisdictions of ourdistribution, there are no copyright and/or trademark protectionsavailable.  As a result, it may bepossible for unauthorized third parties to copy and distribute our productionsor certain portions or applications of our intended productions.

 

In addition, litigation may be necessary in the future to enforce ourintellectual property rights, to protect our trade secrets, to determine thevalidity and scope of the proprietary rights of others or to defend againstclaims of infringement or invalidity. Any such litigation could result in substantial costs and the diversionof resources could have a material adverse effect on our business, operatingresults or financial condition.  Fromtime to time, we may also receive claims of infringement of other parties’proprietary rights.  Regardless of thevalidity or the success of the claims, we could incur significant costs anddiversion of resources in defending against such claims, which could have amaterial adverse effect on our business, financial condition or results ofoperations.

 

**If Our Key Personnel Leave Us, Our BusinessMay Be Adversely Affected.**  Our success greatly depends on the performance of our executivemanagement, including the President and Chief Executive Officer, ChiefOperating Officer and Chief Financial Officer. The loss of the services of key persons of our executive management couldhave an adverse material effect on the Company’s operating results andfinancial condition.

 

**If We Do Not Successfully Optimize andOperate Our Distribution Facility, Our Business Could Be Harmed.**  Domestic wholesale distribution of ourexclusive programming is fulfilled from a single distribution facility in LasVegas, Nevada.  If we are unable tooperate this facility for any reason, it could significantly limit our abilityto meet customer demand.  Because it isdifficult to predict sales increases or declines, we may not manage ourfacility in an optimal way, which may result in excess inventory, warehousingand distribution dilemmas.  Our failureto properly handle inventory could result in unexpected costs, delays and harmto our business and reputation.

 

Cautionary Statements Relating to DomesticWholesale Distribution.

 

**If We Cannot Continue to Secure DVD Licenseand Distribution Rights, Our Business May Be Materially Adversely Affected.**  We cannot assure you that we will be able tocontinue to secure DVD and other license and distribution rights on termsacceptable to us.  See“Competition.”  We expect to continue tolicense exclusive DVD and other home entertainment format programming, but wecannot assure you that we can remain competitive against licensing entitieswith greater financial resources or that independent program suppliers will notdistribute their programming themselves. In addition, our success will continue to be dependent upon our abilityto identify and secure rights to exclusive programming that appeals toconsumers.  Major motion picture studioshave not granted exclusive DVD licenses to Image for their new releases andmost popular catalogue titles.  Instead,the major motion picture studios sell DVD programming directly to retailers.

 

**We May Need Additional Funding to ContinueAcquiring Desirable Programming.**  Availability of working capital is asubstantial factor in the Company’s ability to license new programming.  Therefore, maximizing available workingcapital is critical to Image’s business operations.  We may need to raise additional funds to acquire the rights toprogramming we find desirable.  Shouldadditional funds be raised through the issuance of equity or convertible debtsecurities, the percentage ownership of our existing stockholders may bereduced.  If adequate funds are notavailable or unavailable on acceptable terms, we may find we are unable to fundexpansion, continue to offer products and services, take advantage ofacquisition opportunities, develop or enhance services or products, and/orrespond to competitive pressures in the industry.

 

**If Music Entertainment Programming CannotContinue to Compete Successfully in the Home Entertainment Industry, OurBusiness May Be Adversely Affected.**  Although we make efforts to diversify ourexclusive programming, approximately 16.7% of our revenue generated in fiscal2003 was derived from sales of exclusively licensed and distributed music DVDentertainment programming.  We cannotassure you that the music industry in general will continue to prosper or thatmusic entertainment programming will continue to compete successfully againstother home entertainment programming, including but not limited to, film,television, and interactive gaming.  Ifmusic programming cannot compete successfully in the home entertainment market,our business may be adversely affected.

 

Cautionary Statements Relating to RetailDistribution.

 

**If We Cannot Compete Successfully in theInternet Commerce Industry, Our Retail Sales May Be Adversely Affected.**  We cannot assure you that the DVDPlanet.comWeb site will be able to compete successfully

 

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against current or future online and traditional retailers.  See “Competition.”  The market for commerce over the Internet isevolving and competitive and very few online retailers achieveprofitability.  We compete with avariety of other companies for sales of DVDs over the Internet.  Some of these competitors are able to devotesubstantial resources to Internet commerce. The DVDPlanet.com Web site also competes with traditional retailers ofDVDs.

 

We believe that the principal competitive factors faced in selling DVDsthrough the DVDPlanet.com Web site include price of product, product selectionand availability, brand recognition, customer service, effectiveness ofadvertising, technical expertise, convenience, accessibility, quality of searchtools, quality of editorial and site content, and reliability and speed offulfillment.  Some of the current andpotential competitors of DVDPlanet have large customer bases, greater brandrecognition and significantly greater financial, marketing and other resourcesthan DVDPlanet.  In addition, somecompetitors may be able to obtain merchandise from vendors on more favorableterms, devote greater resources to marketing and promotional campaigns, adoptmore aggressive pricing or inventory availability policies, and devote moreresources to Web site systems and development than the Company.  The DVDPlanet.com Web site could sufferreduced operating margins, market share and brand recognition as a result ofincreased competition.

 

**If We Cannot Keep Pace with RapidTechnological Change, Our Retail Sales May Be Adversely Affected.**  We cannot assure you that we will successfullyuse new technologies effectively or adapt the DVDPlanet.com Web site or itssystems to meet customer preferences, requirements or emerging industrystandards.  The technology drivingInternet commerce changes rapidly.  Thisrapid change results in the availability of many new products and services, newindustry standards and frequent changes in user and customer preferences andrequirements.  The success of theDVDPlanet.com Web site depends, in part, on our ability to do the following:

 

•                                          licenseleading technologies useful in the Internet revenues business;

•                                          enhancethe DVDPlanet.com Web site’s existing services;

•                                          developnew services and technology that address the increasingly sophisticated andvaried needs of our customers; and

•                                          respondto technological advances and emerging industry standards and practices on acost-effective and timely basis.

 

**If Internet Commerce Does Not Continue toGrow, Our Internet Sales Business May Be Adversely Affected.**  Rapid growth in the use of and interest in theWorld Wide Web, Internet and other online services as media of consumercommerce is a recent phenomenon. Potential future revenues and profits from sales over the Internetsubstantially depend on the widespread acceptance and use of the Internet as aneffective medium of commerce by consumers. We cannot assure you that the acceptance and use of the Internet willcontinue to develop or that a sufficiently broad base of consumers will adoptand use the Internet as a medium of commerce. For the DVDPlanet.com Web site to be successful, consumers who havehistorically used traditional means of commerce to purchase merchandise mustaccept and utilize this novel way of conducting business and exchanginginformation.

 

Also, if the Internet continues to experience significant growth in thenumber of users, the frequency of use or larger bandwidth requirements, theinfrastructure for the Internet could be adversely affected by capacityconstraints.  In addition, the Internetcould lose its viability due to delays in the development or adoption of newstandards and protocols required to handle increased levels of serviceactivity.  Changes in or insufficientavailability of telecommunications services to support the Internet also couldresult in slower response times and could adversely affect consumer usage ofthe Internet.  Our business, prospects,financial condition and results of operations could be materially adverselyaffected if use of the Internet does not continue to grow or grows more slowlythan expected.  If the infrastructurefor the Internet does not effectively support growth that may occur or if theInternet does not become a viable commercial marketplace, we could be adverselyaffected.

 

**We Face Security Risks in Selling Productover the Internet.**  Secure transmission of confidential information over publicnetworks is a significant barrier to Internet commerce.  Advances in computer “hacker” capabilities,new discoveries in the field of cryptography or other developments couldcompromise the security measures we employ to protect customer transactiondata.  In addition, concerns over thesecurity of transactions conducted on the Internet and the privacy of users ingeneral may inhibit the growth of Internet commerce.  To the extent that our activities or the activities ofthird-party contractors involve the storage and transmission of proprietaryinformation, such as credit card numbers, security breaches could damage ourreputation and expose us to a risk of loss or litigation and possible liability.  We may be required to expend significantcapital and other resources to protect 

 

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against such security breaches or to alleviate security-relatedproblems, and we cannot assure you that our security measures will preventsecurity breaches.  Any compromise ofour security systems could have a material adverse effect on our reputation,business, prospects, financial conditions and results of operations.

 

**We May Experience Capacity Constraints andOther System Development Problems Relating to the Operation of the DVDPlanetWeb Site.**  Akey element of our business strategy is generating a high level of use of theDVDPlanet.com Web site.  We believe itis important to our online reputation and the ability to attract customers thatthe DVDPlanet.com Web site offers superior customer service as well asreliability and availability of the related transaction-processing systems andnetwork infrastructure.  While webelieve that we will be able to upgrade or install new hardware and softwarethat will be sufficient to accommodate the anticipated traffic on theDVDPlanet.com Web site, we cannot assure you that periodic system interruptionswill not occur even after any such upgrade or installation.  Any substantial increase in the volume oftraffic on the DVDPlanet.com Web site or substantial increase in the number oforders placed by customers will require us to further expand and upgrade ourtechnology, including our transaction-processing systems and network infrastructure.  In addition, we are dependent upon Webbrowser companies and Internet service providers to generate traffic to the Website that will allow consumer access to our products and services.  Viewers have experienced in the past and mayexperience in the future difficulties due to system or software failures orincompatibilities not within our control. Any system interruptions that result in the unavailability of theDVDPlanet.com Web site or reduced order fulfillment performance would reducethe volume of goods sold and the attractiveness of our online product andservice offerings, which could have a material adverse effect on us.

 

**New Laws or Regulations Pertaining to theInternet, or the Application or Interruption of Existing Laws Could AdverselyAffect Our Business.** We could be materially adversely affected by any new legislation orregulation or by the application or interpretation of existing laws related tothe Internet.  Federal, state andforeign governmental organizations are currently considering many suchlegislative and regulatory proposals. If a government authority were to adopt laws or regulations that coverInternet-related issues such as user privacy, pricing and characteristics andquality of products and services provided, the growth of the Internet could beadversely affected.  This could lead toa decrease in demand for products offered over the Internet, including thosethat the DVDPlanet.com Web site offers, and could increase the cost of doingbusiness on the Internet.  In addition,it is currently unclear how existing laws governing issues such as propertyownership, copyright, trade secret, libel and personal privacy will be appliedto the rapidly-changing Internet landscape. Laws and regulations directly applicable to Internet communications,commerce and advertising are becoming more prevalent, but remain largelyunsettled.

 

Cautionary Statements Relating toInternational Wholesale Distribution & Broadcast Rights Exploitation.

 

**We Face Risks in Distributing Our ProgrammingInternationally.** We distribute our programming internationally and derive an increasingpercentage of our revenues from sales activity outside the United States.  As a result, our business may be subject tocertain risks inherent in international trade, many of which are beyond ourcontrol.  Risks faced in distributingour programming internationally include: cancellation or renegotiation of contracts, changes in laws and policiesaffecting international trade (including taxes), credit risk, fluctuatingforeign exchange rates and controls, civil strife, acts of war, guerillaactivities, insurrection, terrorism, changing retailer and consumer tastes andpreferences with regard to our programming, differing degrees of protection ofour intellectual property, cultural barriers, and potential instability offoreign economies and governments.

 

**ITEM2.              PROPERTIES.**

 

Image’s headquarters are located in Chatsworth, California and consistof two adjacent buildings (containing 30,080 and 15,440 square feet, respectively)that are leased from the same landlord. Both leases terminate on April 30, 2004.  The monthly rent for the larger building is approximately $19,000(subject to annual adjustment based on increases in the consumer priceindex).  The monthly rent for thesmaller building is approximately $11,000 (with scheduled yearly increases).

 

Image leases its 76,000 square foot warehouse and distribution facilitylocated in Las Vegas, Nevada.  Themonthly rent is approximately $38,000 (subject to annual adjustment based onincreases in the consumer price index) and the lease will terminate on November4, 2012.  In addition, Image leasesapproximately 4.07 acres of vacant land in Las Vegas adjacent to the warehouseand distribution facility.  The monthlyrent is approximately $9,000 and the lease will terminate on November 4, 2007.

 

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DVDPlanet leases approximately 8,500 square feet of retail space inHuntington Beach, California.  The leaseprovides for monthly rent of approximately $15,000 (subject to annualadjustment based on increases in the consumer price index) commencing inJanuary 2003 for five years with two five-year options to extend the term.  In addition, DVDPlanet maintains itscorporate offices in leased space of approximately 6,500 square feet inHuntington Beach, California for monthly rent of approximately $13,000 (subjectto annual adjustment based on increases in the consumer price index).  The lease will expire in April 2004.

 

Aviva leased approximately 2,300 square feet of office space inBelmont, California at a monthly rent of approximately $4,000 through December31, 2002, at which time Aviva ceased operations.  The property is subleased to Michael Lopez, former generalmanager of Aviva, through the expiration of the lease on October 31, 2003.

 

**ITEM3.              LEGAL PROCEEDINGS.**

 

In the normal course of business, the Company is subject toproceedings, lawsuits and other claims, including proceedings under governmentlaws and regulations relating to employment and tax matters.  While it is not possible to predict theoutcome of these matters, it is the opinion of management, based onconsultations with legal counsel, that the ultimate disposition of knownproceedings will not have a material adverse impact on the Company’s financialposition, results of operations or liquidity.

 

**ITEM 4.              SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS.**

 

None.

 

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**EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Executive officers serve at the pleasure of Image’s board ofdirectors.  There is no familyrelationship between any executive officer or director.  The following table sets forth the positionand age of Image’s executive officers at June 1, 2003 and their businessexperience for at least the prior five years:

 
| **Executive Officer** |   | **Age** |   | **Position & Background**                                                                                                                                                                                                                                                                                                                                                                                                   |
|-----------------------|--------|---------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Martin W. Greenwald   |   | 61      |   | Chairman of the Board, Chief Executive Officer and President since  April 1981.                                                                                                                                                                                                                                                                                                                                                 |
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| David A. Borshell     |   | 38      |   | Chief Operating Officer since July 2000; Senior Vice President,  Sales, Marketing and Operations from December 1994 to June 2000.  Prior to 1994, Mr. Borshell has held  various positions at Image since starting as an Account Executive in February  1986.  Mr. Borshell is a member of the  DVD Entertainment Group, an industry trade association devoted to fostering  consumer awareness of the DVD format.    |
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Jeff M. Framer        |   | 42      |   | Chief Financial Officer since April 1993; Controller from September  1990 to March 1993; Senior Manager, KPMG LLP, from July 1989 to September  1990; and Manager, KPMG LLP, from July 1988 to June 1989.  Mr. Framer received his B.S. degree in  Business Administration and Accounting Theory and Practice from California  State University at Northridge in 1984.   Mr. Framer is a Certified Public Accountant. |

 

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**PART II**

 

**ITEM 5.****                                           MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.**

 

Image’s common stock trades on The Nasdaq Stock Market under the symbolDISK.  Image’s common stock has beenincluded on the Nasdaq National Market since February 19, 1991.  The table below presents the quarterly highand low closing prices on the Nasdaq National Market during the past two fiscalyears.

 
| ***Fiscal Year Ended March 31, 2003*** |   | ***High*** |   | ***Low*** |   |
|----------------------------------------|--------|------------|--------|-----------|--------|
| Quarter ended June 30, 2002            |   | $          | 2.810  |      | $      | 1.660 |   |
| Quarter ended September 30, 2002       |   | $          | 1.700  |      | $      | 0.940 |   |
| Quarter ended December 31, 2002        |   | $          | 2.480  |      | $      | 1.060 |   |
| Quarter ended March 31, 2003           |   | $          | 2.830  |      | $      | 1.670 |   |

 
| ***Fiscal Year Ended March 31, 2002*** |   | ***High*** | *** *** | ***Low*** | *** *** |
|----------------------------------------|--------|------------|--------------|-----------|--------------|
| Quarter ended June 30, 2001            |   | $          | 3.730        |      | $            | 1.870 |   |
| Quarter ended September 30, 2001       |   | $          | 3.060        |      | $            | 1.490 |   |
| Quarter ended December 31, 2001        |   | $          | 2.555        |      | $            | 1.700 |   |
| Quarter ended March 31, 2002           |   | $          | 3.040        |      | $            | 2.040 |   |

 

As of June 2, 2003, there were 1,438 holders of record of Image’scommon stock.

 

Image has never paid a cash dividend on its common stock and presentlyintends to retain any future earnings for business development.  In addition, Image is party to loanagreements which prohibit Image’s payment of dividends.

 

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**ITEM 6.****                                           SELECTEDFINANCIAL DATA.**

 

The selected financial data presented below was derived from theconsolidated financial statements of the Company and should be read inconjunction with the financial statements, the notes thereto and the otherfinancial information included therein.

 
| **(In thousands, except per share  data)**                         |     | **Years Ended March 31,** |     |
|--------------------------------------------------------------------|----------|---------------------------|----------|
|                                                               | **2003** |                      | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Statement of Operations Data:**                                  |     |                      |     |   |   |   |   |   |   |   |   |
| Net revenues                                                       |     | $                         | 108,193  |   | $ | 94,813 |   | $ | 100,033 |   | $ | 84,413 |   | $ | 76,888 |   |
| Operating costs and expenses                                       |     | 105,807                   | (1)      | 93,050 | (2) | 94,162 |   | 82,751 |   | 74,210 |   |
| Earnings from operations                                           |     | 2,386                     |     | 1,763 |   | 5,871 |   | 1,662 |   | 2,678 |   |
| Interest expense                                                   |     | 1,454                     |     | 1,806 |   | 1,724 |   | 1,562 |   | 882 |   |
| Other expense (income)                                             |     | 698                       |     | 192 |   | (289 | ) | (1,315 | )(3) | — |   |
| Earnings (loss) before income taxes                                |     | 234                       |     | (235 | ) | 4,436 |   | 1,415 |   | 1,796 |   |
| Income tax expense (benefit)                                       |     | 688                       | (4)      | (40 | ) | (3,996 | )(5) | — | (6) | 90 | (6) |
| Earnings (loss) before cumulative effect of  accounting change     |     | (454                      | )        | (195 | ) | 8,432 |   | 1,415 |   | 1,706 |   |
| Cumulative effect of accounting change                             |     | (3,766                    | )        | — |   | — |   | — |   | — |   |
| Net earnings (loss)                                                |     | $                         | (4,220   | ) | $ | (195 | ) | $ | 8,432 |   | $ | 1,415 |   | $ | 1,706 |   |
| Earnings (loss) per share:                                         |     |                      |     |   |   |   |   |   |   |   |   |
| Net earnings (loss) before cumulative  effect of accounting change |     |                      |     |   |   |   |   |   |   |   |   |
| Basic                                                              |     | $                         | (.03     | ) | $ | (.01 | ) | $ | .52 |   | $ | .09 |   | $ | .12 |   |
| Diluted                                                            |     | $                         | (.03     | ) | $ | (.01 | ) | $ | .50 |   | $ | .09 |   | $ | .12 |   |
| Cumulative effect of accounting change                             |     | $                         | (.22     | ) | — |   | — |   | — |   | — |   |
| Net earnings (loss) per share:                                     |     |                      |     |   |   |   |   |   |   |   |   |
| Basic                                                              |     | $                         | (.25     | ) | $ | (.01 | ) | $ | .52 |   | $ | .09 |   | $ | .12 |   |
| Diluted                                                            |     | $                         | (.25     | ) | $ | (.01 | ) | $ | .50 |   | $ | .09 |   | $ | .12 |   |
| Weighted average shares outstanding                                |     |                      |     |   |   |   |   |   |   |   |   |
| Basic                                                              |     | 16,812                    |     | 15,821 |   | 16,257 |   | 16,452 |   | 14,185 |   |
| Diluted                                                            |     | 16,812                    |     | 15,821 |   | 17,637 |   | 16,490 |   | 14,309 |   |

 
| **(In thousands)**            |     | **March 31,** |     |
|-------------------------------|----------|---------------|----------|
|                          | **2003** |          | **2002** |   | **2001** |   | **2000** |   | **1999** |   |
| **Balance Sheet Data:**       |     |          |     |   |   |   |   |   |   |   |   |
| Total assets                  |     | $             | 74,495   |   | $ | 81,898 |   | $ | 74,991 |   | $ | 65,395 |   | $ | 56,445 |   |
| Total liabilities             |     | 42,830        |     | 49,390 |   | 42,516 |   | 39,554 |   | 32,113 |   |
| Net shareholders’ equity |     | 31,665        |     | 32,508 |   | 32,475 |   | 25,842 |   | 24,332 |   |
|                               |          |               |          |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)  Includes the reduction togross profit margin of $480,000 for estimated subdistributor returns as aresult of the Company’s transition from direct international distribution toEuropean sublicense.

(2)  Includes $1,818,000 inone-time noncash credit relating to the discontinuation of the Company’slaserdisc operations and a $696,000 write-down of advance royalties, relatingto a line of programming, to estimated fair value.

(3)  Includes $899,000 inproceeds from settlements of litigation.

(4)  Includes a provision for avaluation allowance against deferred tax assets of $551,000 relating to foreigntax credits.

(5)  Income tax benefits reflectthe elimination of the valuation allowance recorded against deferred tax assetsas a result of management’s estimate that future taxable income will besufficient to utilize the entire benefit of the deferred tax assets.

(6)  Minimal or no income taxexpenses were recorded due to the utilization of net operating losses to offsettaxable income.

 

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**ITEM 7.****                                           MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

The following discussion and analysis should be read together with“Item 6.  Selected Financial Data” andthe Company’s consolidated financial statements, the related notes thereto andother financial information contained elsewhere in this Form 10-K.

 

**General**

 

We are an integrated entertainment company, primarily engaged in thebusiness of licensing and distributing home entertainment programming.  We acquire and exploit exclusive rights to adiverse array of general and specialty entertainment programming, such as musicconcerts, urban and lifestyle documentaries, and feature films, in DVD andother home entertainment formats.  Inaddition to our current core business of domestic DVD distribution, we alsoacquire and, in some cases, exploit exclusive broadcast rights, includingvideo-on-demand, broadband streaming, digital download, pay-per-view,in-flight, radio, satellite, cable and broadcast television.  Image primarily acquires programming byentering into exclusive licensing or distribution arrangements with thirdparties.  We also produce our ownoriginal entertainment programming focused on DVD live performance musicconcerts and urban genre programming. Additionally, we design and produce additional content and value-addedfeatures for our DVD programming such as interactive menus, audio commentaries,packaging and marketing materials. Although we license and distribute programming across many genres, weare foremost a leading provider of music-related DVD programming.

 

The Company’s three reportable business segments are Domestic WholesaleDistribution, including program acquisition and production; RetailDistribution, which distributes programming direct-to-consumer; andInternational Wholesale Distribution, including sublicensing and worldwidebroadcast rights exploitation. Management currently analyzes the financial performance of thesebusiness segments based primarily on net revenues, operating costs and expensesand income (loss) before income taxes, to evaluate and allocate Companyresources.

 

**Critical Accounting Policies**

 

The Securities and Exchange Commission’s (“SEC”) Financial ReportingRelease No. 60, *Cautionary Advice RegardingDisclosure About Critical Accounting Policies* (“FRR 60”), suggestscompanies provide additional disclosure and commentary on those accountingpolicies considered most critical.  FRR60 considers an accounting policy to be critical if it is important to theCompany’s financial condition and results, and requires significant judgmentand estimates on the part of management in its application.  The Company believes the following representthe critical accounting policies of the Company as contemplated by FRR 60.  Decisions involved in our criticalaccounting policies are based on management’s exercise of judgment.  For a summary of all the Company’ssignificant accounting policies, including the critical accounting policiesdiscussed below, see “Note 1. Basis of Presentation and Summary of Significant Accounting Policies” tothe accompanying consolidated financial statements.

 

*Royalty and Distribution Fee Advances andProduction Costs*

 

For each reporting period, management estimates the total revenues tobe received throughout a title’s exclusive license or distribution period fromexploitation of that title in multiple home entertainment formats.  While royalty and distribution fee advancesand production costs are charged to operations as related revenues are earned,estimates of ultimate revenues are important in determining whether additionalroyalty and distribution fee expense or amortization of production costs shouldbe recorded as cost of sales in any given reporting period.  Royalty and distribution fee advances andproduction costs are amortized to expense in the same ratio that the currentperiod revenues for a title or group of titles bear to the estimated remainingunrecognized ultimate revenues for that title. Additionally, when estimates of total revenues and costs indicate that atitle will result in an ultimate loss, additional amortization is recognized tothe extent that capitalized advance royalty and distribution fees andproduction costs exceed their estimated fair value in the period whenestimated.

 

Management bases its estimates of ultimate revenue for each title onthe historical performance of that title and of similar titles.  Management updates such estimates based uponthe actual results of each format’s exploitation.

 

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*Inventory Valuation*

 

For each reporting period, we evaluate our ending inventories forexcess quantities and obsolescence. This evaluation includes analysis of historical sales levels by titleand by format and projections of future demand.  In addition, we write off inventories that are consideredobsolete.  Remaining inventory balancesare adjusted to approximate the lower of our cost or market value and result ina new basis in such inventory until sold. If future demand or market conditions are less favorable than ourprojections, additional inventory write-downs may be required, and would bereflected in cost of sales in the period the revision is made.

 

*Allowance for Sales Returns and DoubtfulAccounts Receivable*

 

For each reporting period, management evaluates product sales andaccounts receivables to estimate their effect on revenues due to productreturns and delinquent accounts. Management’s estimate of product sales that will be returned and theamount of receivables that will ultimately be collected requires the exerciseof judgment and affects reported revenues and net income.  In determining the estimate of product salesthat will be returned, management analyzes historical returns, historicalpricing and other credit memo data, current economic trends and changes incustomer demand and acceptance of Image’s products.  Based on this information, management reserves a percentage ofeach dollar of product sales that provides the customer with the right ofreturn as well as the right to take pricing or other credit memo items.  Actual returns could be different from ourestimates and current provisions for sales returns and allowances, resulting infuture charges to earnings.

 

Similarly, management evaluates accounts receivables to determine ifthey will ultimately be collected.  Inperforming this evaluation, significant judgments and estimates are involved, includingan analysis of specific risks on a customer-by-customer basis for Image’slarger customers and an analysis of the length of time receivables have beenpast due.  Based on the information,management reserves an amount that is believed to be doubtful ofcollection.  If the financial conditionof our customers were to deteriorate or if economic conditions worsened,additional allowances may be required in the future.

 

*Revenue Recognition*

 

We recognize revenue in accordance with SEC Staff Accounting Bulletin(“SAB”) No. 101, *Revenue Recognition in Financial Statements*, as amended bySAB No. 101A and No. 101B.  SAB No. 101requires that four basic criteria must be met before revenue can be recognized:(1) persuasive evidence of an arrangement exists; (2) delivery has occurred orservices rendered; (3) the fee is fixed and determinable; and (4)collectibility is reasonably assured. Determination of criteria (3) and (4) require management’s judgmentsregarding the fixed nature of the fee charged for services rendered andproducts delivered and the collectibility of those fees. To satisfy thecriteria, we: (1) input orders based upon receipt of a customer purchase order;(2) record revenue upon shipment of goods when risk of loss and title transferunder our arrangements with customers or otherwise complying with the terms ofthe purchase order (in cases in which title does not transfer until the productis received by the customer, revenue is recognized at the time it is receivedby the customer); (3) confirm pricing through the customer purchase order; and(4) validate creditworthiness through past payment history, credit agencyreports and other financial data. Should changes in conditions cause management to determine the revenuerecognition criteria are not met for certain future transactions, such as adetermination that an outstanding account receivable has become uncollectible,revenue recognized for any reporting period could be adversely affected.

 

*Impairment of Long-Lived Assets*

 

At March 31, 2002, we had $6.0 million of goodwill, accounting for 7.3%of our total assets.  Effective April 1,2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets,*which requires us to analyze goodwill for impairment upon adoption, and then onat least an annual basis thereafter. Upon adoption of SFAS No. 142, werecognized a $6.0 million impairment charge related to goodwill that isreflected as a cumulative effect of accounting change in the consolidated statementsof operations for the year ended March 31, 2003. For a further discussion ofSFAS No. 142, see “Note 1.  Basisof Presentation and Summary of Significant Accounting Policies” to theaccompanying consolidated financial statements.

 

*Accounting for Income Taxes*

 

As part of the process of preparing our consolidated financialstatements, we are required to estimate our income taxes.  This process involves our estimating ouractual current tax exposure together with assessing temporary differencesresulting from differing treatment of items, such as deferred revenue, for taxand accounting purposes.  

 

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These differences result in deferred tax assets and liabilities, whichare included in our consolidated balance sheet.  We then assess the likelihood that our deferred tax assets willbe recovered from future taxable income. To the extent we believe that recovery is not likely, we must establisha valuation allowance.  To the extent weestablish a valuation allowance or increase this allowance in a period, we mustinclude an expense within the tax provision in the statement of operations.

 

Significant management judgment is required in determining ourprovision for income taxes, deferred tax assets and liabilities and anyvaluation allowance recorded against our net deferred tax assets.  During the year ended March 31, 2003, theCompany recorded a valuation allowance of $551,000 related to foreign taxcredits which may not be utilized prior to their expiration.  We believe we currently have the ability toutilize our remaining deferred tax assets before they expire.  In the event that actual results differ fromthese estimates or we adjust these estimates, in future periods, we may need toestablish a valuation allowance which could materially impact our financialposition and results of operations.

 

**Change in International Video Distribution**

 

In January 2003, Image entered into an exclusive five-yearinternational DVD sublicense agreement with Bertelsmann Music InformationServices, GmbH, for the exclusive distribution of Image’s video programming,primarily DVD, throughout Europe, the Middle East  (excluding Israel and Turkey) and Africa upon the expiration ofImage’s current international subdistribution agreements.  The agreement was later amended to changethe licensing party from Bertelsmann Music Information Services GmbH to BMGMusic International Service, GmbH (“BMG”).

 

Image’s DVD programming has historically been distributed in Europe andSouth Africa through a network of independent subdistributors and studios,including BMG.  The subdistributionterms of all territories expired on March 31, 2003, except France, which willexpire June 30, 2003, and Spain, which will expire December 31, 2003.

 

BMG will be responsible for all sales, marketing, manufacturing anddistribution of Image’s programming in the territories.  BMG began releasing Image’s new release DVDprogramming in March 2003.  There wereapproximately 100 Image DVD catalogue titles in release throughout the new BMGsublicense territories.  In April 2003,Image and BMG structured a marketing and re-release plan focusing onreintroducing Image’s catalogue programming into the international marketplaceunder the BMG label.

 

Image received a $3.0 million royalty advance under the BMG agreementin March 2003, fully recoupable from revenues generated by BMG againstquarterly royalties due to Image under the agreement.  Based upon actual quarterly sales of Image programming in theterritories, BMG will recoup quarterly royalties from the $3.0 millionpreviously advanced to Image.  BMG willprovide additional quarterly royalty advances such that for the first threeyears of the agreement term, the outstanding royalty advance to Image at anygiven time will be a constant $3.0 million. The Company used the $3.0 million initially received to pay down itsoutstanding borrowings under its revolving credit facility with Wells FargoFoothill.  During the first threequarters of the fourth year of the term, BMG will reduce, through recoupment,the outstanding royalty advance to Image to $1.5 million.  Once the entire royalty advance is recouped,BMG will continue to pay quarterly royalties to Image based on revenue generated.  During the fourth quarter of the fourthyear, BMG may recoup the entire remaining balance of $1.5 million by notre-advancing royalties quarterly.  Theagreement contains a formula to pay an additional lesser advance at thebeginning of the fifth and final year of the term which is to be recouped byBMG during that year.  Image must repayany outstanding unrecouped royalty advance within 30 days following the finalBMG reporting at the conclusion of BMG’s sell-off period following theexpiration of the five-year term.

 

To facilitate an orderly transition to BMG from our previous network ofindependent subdistributors, the Company contractually elected to purchase anyproduct inventory from our subdistributors (including any of their customerreturns) upon the expiration of their respective terms (plus an additional timeperiod to allow for their customer returns) rather than allow thesubdistributors to exercise a six-month nonexclusive sell-off period.

 

Under the agreement, BMG has committed to purchase the Company’sinternational DVD inventory, which would include any inventory repurchased fromthe subdistributors, at the Company’s manufacturing price (for disc and caseonly—excluding booklets and inserts). The Company recorded a charge for the three months ended March 31, 2003,to provide for the difference between the ultimate purchase price of theinventory paid or credited to the subdistributors upon the expiration of theirrespective terms and the manufacturing cost paid to the Company by BMG

 

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for that inventory.  At March31, 2003, the Company has an accrual for estimated subdistributor returnsresulting in a reduction of revenues and gross profit margin of $831,000 and$278,000, respectively, and accrued for the writedown (to BMG purchase cost) ofthe estimated inventory to be returned by the subdistributors representing anincremental charge to cost of sales of $202,000 during the fourth quarter endedMarch 31, 2003.

 

The Company’s accounting will differ under the BMG agreement because itis a sublicense agreement, rather than the subdistribution agreementspreviously in place.  Under itssubdistribution agreements, Image recorded net revenues based upon the sellingprice of its programming sold to its distribution network customers.  Image recorded as cost of sales, the actualmanufacturing/packaging cost, shipping cost, royalties/distribution fees andmusic publishing.  Under the BMGagreement, Image records royalty income as revenue based upon royalties itreceives from BMG.  Revenue will berecorded in the period in which the product is sold by BMG.  Image will report as cost of goods sold, theroyalties or distribution fees it will owe its licensors or program suppliersas calculated against the royalties Image receives from BMG.

 

*Aviva International, LLC*

 

Our International Wholesale Distribution segment activities werepreviously handled by Image’s 50%-owned, joint venture, Aviva International,LLC (“Aviva”).  On December 31, 2002,Aviva ceased operations.  See“Note 3.  Aviva International, LLC” tothe accompanying consolidated financial statements.

 

**Change in International BroadcastExploitation**

 

In January 2003, the Company entered into a five-year sales agencyagreement with London-based NBD Television LTD (“NBD”).  NBD is the Company’s exclusive sales agentfor worldwide broadcast television sales for the majority of Image’s currentcatalogue of broadcast programming (in excess of 60 programs) and new releasebroadcast acquisitions.  NBD alsorepresents the Company for conventional television broadcast sales includingcable, pay-per-view and video-on-demand; satellite television; and sales tonon-theatrical venues.  Internet rightsare excluded from the agreement including video-on-demand via the Internet anddigital downloading and streaming. Program broadcast rights that are currently licensed to other partieswill be handled by NBD upon the expiration of the existing licenses.  NBD will retain a percentage-basedcommission and other expenses from the sales it generates on the Company’sbehalf and will remit the balance to the Company on a quarterly basis.

 

**Changein the Company’s Wholesale Distribution of Nonexclusive DVD Programming**

 

Over the past several years, the Company has placed an increasingcorporate focus and emphasis on the growth of Image’s exclusively licensed anddistributed DVD programming, which provides the Company with significantlyhigher margins as compared to the margins for nonexclusive programming.

 

Nonexclusive DVD revenues, excluding sales made to DVDPlanet, wereapproximately $6.4 million, or 5.9%, of the Company’s net revenues for thefiscal year ended March 31, 2003 and $8.9 million, or 9.3%, of the Company’snet revenues for the fiscal year ended March 31, 2002.  However, of the $6.4 million in net revenuesfor fiscal 2003, approximately $3.0 million was derived from sales made toseven national accounts (Alliance Entertainment, Best Buy, Borders, Musicland,Tower, Trans World, and Virgin).  Of the$8.9 million in net revenues for fiscal 2002, approximately $1.1 million wasderived from sales made to the seven national accounts.  These sales were of programming fromapproximately 40 of the more than 150 nonexclusive lines the Companydistributes. These 40 lines of programming come to Image from smaller, independentsuppliers generally unable to sell direct to these retailers. Image typicallyreceives higher profit margins on these lines of programming in exchange forImage’s ability to place the programming at these retail accounts.

 

On June 30, 2002, Columbia TriStar Home Entertainment (“CTHE”)implemented changes to its distribution policies that preclude the Company’sability to offer CTHE DVD products for resale to the Company’s customer base,excluding DVDPlanet.  On October 29,2002, Warner Home Video (“WHV”) implemented similar changes for itsproduct.  The changes to CTHE and WHVpolicies were not solely directed at the Company; many other wholesaledistributors similarly situated as the Company were also affected.  The Company believes that the new policiesimplemented by CTHE and WHV were a result of wholesale consolidation trendswithin the video industry and that other major studios may adopt similarchanges to their distribution policies.

 

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In light of these changes and for the other reasons discussed below,the Company stopped serving as a wholesale distributor for the majority ofnonexclusive programming, effective at the end of the Company’s fiscal thirdquarter ended December 31, 2002.  However,as a requested service to the seven national accounts noted above, the Companycurrently continues to act as a distributor for about 40 lines of smallerindependent programming to these accounts.

 

Management believes that ending wholesale distribution of nonexclusiveprogramming (with the exception of nonexclusive sales made to our sevennational accounts), which accounted for approximately $3.4 million in netrevenues at an average 8.9% gross profit margin for fiscal 2003 and accountedfor approximately $7.8 million in net revenues at an average 8.2% gross profitmargin in fiscal 2002, will empower the Company’s sales team to focus onincreasing sales of Image’s exclusive higher-margin programming.  Management believes that increasedhigher-margin sales have the potential to offset the gross profit loss from thelost sales of lower-margin nonexclusive product.  In an effort to maximize this potential, the Company reorganizedits sales department during the third quarter ended December 31, 2002.  As a result of this new strategy the Companywill carry less lower-margin producing inventory and will no longer distributethis programming to the Company’s customer base.  Management believes it has the potential to realize reducedinventory carrying costs, cost efficiencies in its warehousing and distributionoperations and other benefits in the future.

 

*Consumer Fulfillment Agreement*

 

On June 1, 2003, the Company entered into a Fulfillment and CustomerService Services Agreement with I-Serve Direct Commerce Services, Inc.(“I-Serve”), a wholly-owned subsidiary of Infinity Resources, Inc.  The term of the agreement is three yearsfrom the date of the first shipment which occurred in June 2003.

 

Prior to I-Serve, Image fulfilled for DVDPlanet out of its Las Vegas,Nevada warehouse and distribution facility. Under the terms of the agreement, I-Serve will provide all consumerfulfillment for DVDPlanet from its warehousing and distribution facility inIllinois.  I-Serve will also manage allcustomer returns processing.

 

DVDPlanet will continue to be the primary obligor on all transactionsand continue to have the following responsibilities with respect to itsInternet operations:

 

•                  DVDPlanet.comWeb site operations;

•                  Salesto its Internet customers through its DVDPlanet.com Web site;

•                  Consumerbilling and collection/Credit card processing; and

•                  Customerservice responsibilities.

 

I-Serve will ship products out of its warehouse and distribution centerpursuant to orders received by DVDPlanet and bill DVDPlanet per shipment on acost of goods basis plus fees (which cover product receiving and storage, pick,pack, sort and ship, packaging, labels and inventory management systemexpenses).  I-Serve will also chargeDVDPlanet a monthly product sourcing fulfillment administration services fee(which cover product forecasts, product ordering, vendor records maintenance,sales and inventory monitoring etc.).

 

Under the terms of the agreement, I-Serve will purchase both Image andDVDPlanet’s existing nonexclusive inventories up to a combined $2.2 million atapproximately the Company’s recorded actual cost.  I-Serve will pay for the purchase in six approximately equalmonthly installments.  I-Serve willutilize the purchased inventory to fulfill sales (first out of this inventoryrather than their own inventory) for DVDPlanet.com, I-Serve’s own Web sites,DeepDiscountDVD.com, CriticsChoiceVideo.com and DigitalEyes.net, and its owncatalog business, Critics Choice Video. If inventory remains on January 1, 2004, I-Serve may require that theCompany repurchase it at the cost originally paid by I-Serve to acquire it fromthe Company.

 

I-Serve also fulfills some of DVDPlanet’s retail store nonexclusiveproduct needs.  Should DVDPlanet laterchoose, I-Serve has the ability to provide customer service services at anadditional fee.

 

After this transaction and after Image returns any remainingnonexclusive product back to its suppliers, neither Image nor DVDPlanet.comwill physically carry and offer for sale nonexclusive product inventory.  The only exceptions are the approximate 40lines of programming Image will continue to carry as discussed above.  Currently, I-Serve inventories music CDs forits DeepDiscountCD.com Web site.  Thiswill allow DVDPlanet to initiate selling CDs from the DVDPlanet.com Web site inthe near future.  Management believesthe Company, on a consolidated basis,

 

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should benefit from operational and space efficiencies (from carryingapproximately 4,000 titles rather than approximately 22,000 titles) and lowerlabor costs.  Image is currently leasingvacant land adjacent to its Las Vegas distribution facility for futureexpansion purposes at $108,000 per year. For additional cost savings, management is exploring options toterminate the lease.  On a consolidatedbasis, management expects to save up to $800,000 in annual operational expensesincluding overtime, temporary labor and other distribution related expenses.  Management further believes that expectedgross profit margin from potential future CD sales could offset incrementalfulfillment charges paid to I-Serve.

 

**Changesat DVDPlanet**

 

*Personnel*.  In November 2002, DVDPlanet terminated itsemployment agreement with General Manager and Vice President, Ken Crane,Jr.  Image accrued a charge of $264,000for compensation, including estimated bonus, due over the remainder of theagreement term as of the date of termination. The provision is classified as a component of selling expenses forfiscal 2003.

 

Effective July 29, 2002, Image hired PaulRamaker for the newly created position of President of DVDPlanet.  Prior to joining DVDPlanet, Mr. Ramakerserved as Vice President of Merchandising for the Wherehouse Music chain, previouslyholding executive positions with DVDExpress.com and The Musicland Group.  Mr. Ramaker is overseeing all day-to-dayactivities of DVDPlanet’s Internet and retail store operations.

 

*Operational Initiatives*.  In conjunction with Image’s management, Mr.Ramaker has performed a detailed review of DVDPlanet’s operations in an effortto increase revenues, increase gross margins, increase operational efficienciesand reduce operating costs.

 

Initiatives that were implemented during thefiscal third quarter ended December 31, 2002 included: (1) a reduction inpersonnel costs needed to effectively manage DVDPlanet’s retail store andcustomer service operations, (2) a reduction in online advertising expendituresand (3) the securing of co-op and market development funds from DVDPlanet’sproduct suppliers.

 

Management believes these initiatives shouldbenefit DVDPlanet’s future operational results in the form of reducedoperational costs and higher gross margins. However, the current Internet retailing trend of increased pricediscounting of pre-ordered new DVD releases and free shipping offers maypotentially offset the gross margin benefit of market development fundsDVDPlanet may receive from its product suppliers, should DVDPlanet furtherreduce its Internet pricing.

 

*Online Promotion.*  DVDPlanet has an established Internetaffiliate program whereby other Web sites refer customers to the DVDPlanet siteand in return receive a fee based on sales generated from to thatreferral.  DVDPlanet partnered with BeFree!, Inc. (www.befree.com), in an effort to focus DVDPlanet’s program ontargeted affiliates, to increase sales volume and to improve DVDPlanet’s shareof affiliate business.  DVDPlanetprovides customers with weekly email updates on new product releases andsponsor promotions at other entertainment content Web sites.

 

DVDPlanet implemented a review of all Internet marketing programs inthe second half of fiscal 2003.  It wasdetermined that the advertising expenditures in this channel, excluding theaffiliate program, did not generate an acceptable return on investment.  All programs have been either discontinuedor restructured to provide both improved return on investment and greaterability to adapt to changes in the business climate.

 

*Radio Advertising.*  Beginning in late November 2001, DVDPlanetbegan an ongoing radio advertising campaign. The radio campaign utilizes Los Angeles-based radio stations with afocus on driving sales at the DVDPlanet retail store.  Throughout the continuing period of radio advertising, revenuesfor the retail store have shown favorable growth as a result of theadvertising.  The retail store hasregistered many new accounts and the online business has generated new accountsthat customers attributed to DVDPlanet’s radio advertising.

 

*Print Media.*  DVDPlanet purchased print advertising in the3rd and 4th quarters of fiscal 2003.  These purchases were funded in part withadvertising support funds collected from DVDPlanet’s major studiopartners.  Eight page circulars weredistributed to DVDPlanet customers via direct mail and in Sunday editions ofthe *Orange County Register*.

 

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*New Retail Location*.  In September 2002, DVDPlanet entered into alease for approximately 8,500 square feet located in a shopping center in HuntingtonBeach, California.  The new locationbenefits from a more efficient floor plan for a retail store than did ourprevious Westminster, California retail location.  The term of the new lease is five years commencing January 2003,with two five-year options to extend the term. Minimum monthly rent is approximately $15,000, and Image commencedmonthly rent payments on the lease in January 2003.  DVDPlanet received a tenant improvement allowance of $42,500 fromthe landlord, which DVDPlanet amortizes as a reduction to rent expense over theinitial term of the lease.  DVDPlanet isresponsible for its pro rata share of common area insurance, property taxes andmaintenance costs, currently estimated to be approximately $1,300 permonth.  The new DVDPlanet location wasopen and operational in February 2003.

 

DVDPlanet’s Westminster location was closed February 9, 2003, a dayprior to the opening of the new Huntington Beach location.  The lease on the Westminster storesubsequently ended in March 2003.

 

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**Results of Operations**

 

***Fiscal Year EndedMarch 31, 2003 Compared to Fiscal Year Ended March 31, 2002***

 

The following tables present consolidated net revenues by format andnet revenues by format as a percentage of total consolidated net revenues forthe fiscal years ended March 31, 2003 and 2002.  The information in the table below does not represent segmentdata, but rather is presented for purposes of explaining certain trends withinnet revenues:

 
|                                           |   | **Fiscal Years Ended  March 31,** |    |     |   |
|------------------------------------------------|--------|-----------------------------------|---------|----------|--------|
|                                           |   | **2003**                          |    | **2002** |   | **% Change** |   |
|                                           |   | **(in thousands)**                |    |     |   |
| Net revenues:                                  |   |                              |    |     |   |   |   |
| DVD                                            |   | $                                 | 98,023  |     | $      | 84,905 |   | 15.5 | % |
| VHS                                            |   | 3,593                             |    | 4,678    |   | (23.2 | ) |
| CD                                             |   | 2,947                             |    | 1,500    |   | 96.5 |   |
| Broadcast/Sublicense                           |   | 3,825                             |    | 3,066    |   | 24.8 |   |
| Laserdisc                                      |   | 0                                 |    | 321      |   | (100.0 | ) |
| Other                                          |   | (195                              | )       | 343      |   | (156.9 | ) |
|                                           |   | $                                 | 108,193 |     | $      | 94,813 |   | 14.1 | % |
|                                           |   |                              |    |     |   |   |   |
| As a percentage of consolidated net  revenues: |   |                              |    |     |   |   |   |
| DVD                                            |   | 90.6                              | %       | 89.6     | %      | 1.0 | % |
| VHS/CD                                         |   | 6.0                               |    | 6.5      |   | (0.5 | ) |
| Broadcast/Sublicense                           |   | 3.5                               |    | 3.2      |   | 0.3 |   |
| Laserdisc                                      |   | 0.0                               |    | 0.3      |   | (0.3 | ) |
| Other                                          |   | (0.1                              | )       | 0.4      |   | (0.5 | ) |
|                                           |   | 100.0                             | %       | 100.0    | %      | — | % |

 

The following table presents consolidated net revenues by reportablebusiness segment for the fiscal years ended March 31, 2003 and 2002:

 
|                                 |   | **Fiscal Years Ended  March 31,** |    |     |   |
|--------------------------------------|--------|-----------------------------------|---------|----------|--------|
|                                 |   | **2003**                          |    | **2002** |   | **% Change** |   |
|                                 |   | **(in thousands)**                |    |     |   |
| Net revenues:                        |   |                              |    |     |   |   |   |
| Domestic Wholesale Distribution      |   | $                                 | 77,484  |     | $      | 66,376 |   | 16.7 | % |
| Retail Distribution                  |   | 21,264                            |    | 18,678   |   | 13.8 |   |
| International Wholesale Distribution |   | 9,445                             |    | 9,759    |   | (3.2 | ) |
| Consolidated                         |   | $                                 | 108,193 |     | $      | 94,813 |   | 14.1 | % |

 

Consolidated net revenues for all segments for the fiscal year endedMarch 31, 2003 increased 14.1% to $108,193,000, from $94,813,000 for the fiscalyear ended March 31, 2002.  Factors thatcontributed to the increase are detailed below.

 

Net revenues for our Domestic Wholesale Distribution segment for the2003 fiscal year increased 16.7% to $77,484,000, from net revenues of$66,376,000 for the 2002 fiscal year. Management believes this segment’s revenue performance was positivelyimpacted by the growing popularity of the DVD format.  The growing DVD market coupled with wholesale and retailacceptance of our growing catalogue of exclusive DVD programming contributed tothe 16.7% increase in segment net revenues. The segment experienced its growth primarily through sales ofprogramming under exclusive distribution agreements.  Revenues from exclusively distributed programming increased 77.6%to $26,651,000 for fiscal 2003 from $15,009,000 for fiscal 2002.  Management believes that future revenue growthwill be primarily dependent upon Image’s ability to continue to acquiredesirable new exclusive programming 

 

25

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and to renew existing exclusive license and distribution agreementsupon their expiration.  Additionally,competition for retail shelf space could limit the levels of our future revenuegrowth.  See “Item 1.  Business – Competition.”

 

Net revenuesfor DVDPlanet, our Retail Distribution segment, for the fiscal year ended March31, 2003 increased 13.8% to $21,264,000, from net revenues of $18,678,000 forthe prior fiscal year.  Net revenuesfrom Internet distribution increased 6.2% to $13,744,000 for fiscal 2003, from$12,941,000 for fiscal 2002.  Managementbelieves DVDPlanet also benefited from the growing popularity of the DVDformat.  Management believes DVDPlanet’scompetition, which continues to offer aggressive pre-order pricing and freeshipping in selected instances, has limited DVDPlanet’s growth.  Shipping fees charged customers totaled$1,343,000 for fiscal 2003, up 16.2% from $1,156,000 for fiscal 2002.  Growing competition from a wide spectrum ofDVD retailers, online retailers and rental retailers (including a growingpresence online) has also limited DVDPlanet’s growth.  Revenues generated by the retail store were up 34.8%, to$6,177,000 for fiscal 2003, from $4,582,000 for fiscal 2002, primarily as aresult of its radio advertising campaign. DVDPlanet moved its retail location from Westminster, California toHuntington Beach, California in February 2003. Management believes that the larger location will be more efficient interms of size, product layout and merchandising.  Management expects the new location to ultimately provide forincreased revenues from the store.

 

Net revenuesfor our International Wholesale Distribution segment for the fiscal year endedMarch 31, 2003 were down 3.2% to $9,445,000, from net revenues of $9,759,000for the fiscal year ended March 31, 2002. For fiscal 2003 and 2002, revenues of approximately $7,721,000 and$8,412,000, respectively, were derived from international wholesaledistribution of Image’s licensed DVD and VHS programming, either throughEuropean subdistribution or international sublicenses.  For the fiscal years ended March 31, 2003and 2002, revenues of approximately $1,724,000 and $1,347,000, respectively,were derived from international and domestic broadcast exploitation of theImage’s licensed programming.  Thereduction in comparative fiscal revenues was due to additional sales returnsreserves recorded for estimated subdistributor returns totaling $831,000 as aresult of the change in method of international distribution.  See “Change in International VideoDistribution.”  Our transition fromEuropean subdistribution to sublicensed European distribution will initiallyresult in reduced top-line revenues. Under the new sublicense agreement with BMG, we will report as top-linerevenue, the royalty income we receive from BMG.  BMG will distribute our selected exclusive programming throughoutEurope.  Prior to the BMG sublicensearrangement, we sold our exclusive programming directly to a network ofEuropean subdistributors.  Revenue wasrecognized based on the selling price to our customers, net of marketdevelopment funds provided to these customers. Management believes that the resources of BMG’s European sales forceshould provide a more efficient and coordinated marketing effort throughoutEurope with respect to our exclusive DVD programming.  Management further believes we are now better positioned for ourexclusive DVD programming to benefit from the growth in popularity of DVD inEurope, which we believe lags the U.S. in growth by one to two years.  We continue to sublicense our exclusive programminginternationally to other territories of the world.  We have also transitioned from distributing our broadcast rightsthrough Aviva and our own internal sales personnel to using NBD as itsexclusive worldwide sales agent. Management’s goal of this transition is to have the experienced andcoordinated sales force of NBD maximize the revenue potential of our catalogueof broadcast rights.  See “Changein International Video Distribution.”

 

The following tables present consolidated cost of sales by reportablebusiness segment and as a percentage of related segment net revenues for thefiscal years ended March 31, 2003, and 2002:

 
|                                 |   | **Fiscal Years Ended  March 31,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
|                                 |   | **2003**                          |   | **2002** |   |
|                                 |   | **(in thousands)**                |   |
| Cost of sales:                       |   |                              |   |   |   |
| Domestic Wholesale Distribution      |   | $                                 | 55,537 |   | $ | 43,882 |   |
| Retail Distribution                  |   | 17,488                            |   | 15,377 |   |
| International Wholesale Distribution |   | 6,630                             |   | 7,381 |   |
| Consolidated                         |   | $                                 | 79,655 |   | $ | 66,640 |   |

 
|                                     |   |   |   |   |   | **% Change** |   |
|------------------------------------------|--------|--------|--------|--------|--------|--------------|--------|
| As a percentage of segment net revenues: |   |   |   |   |   |         |   |
| Domestic Wholesale Distribution          |   | 71.7   | %      | 66.1   | %      | 5.6          | %      |
| Retail Distribution                      |   | 82.2   |   | 82.3   |   | (0.1         | )      |
| International Wholesale Distribution     |   | 70.2   |   | 75.6   |   | (5.4         | )      |
| Consolidated                             |   | 73.6   | %      | 70.3   | %      | 3.3          | %      |

 

26

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Consolidated cost of sales for fiscal 2003 was $79,655,000, or 73.6% ofnet revenues, compared to $66,640,000, or 70.3% of net revenues, for fiscal2002.  Accordingly, consolidated grossprofit margins were 26.4% and 29.7% for fiscal 2003 and fiscal 2002,respectively.  Several factors leadingto the decrease in consolidated gross profit margin are addressed below.

 

In general,our cost of sales, as a percentage of net revenues, will vary from period toperiod depending on the mix of revenue recognized from various distributionformats and other factors.  Revenuesthat typically generate the highest gross profit margins are from domesticdistribution of exclusively licensed programming.  International distribution of exclusive programming has typicallygenerated somewhat lower gross profit margins due to lower internationalselling prices for DVD and VHS programming as compared to the U.S.  Revenues from non-licensed exclusivelydistributed programming also generate lower gross profit margins thanexclusively licensed programming. Revenues recognized from international sublicense of video programmingand revenues recognized from domestic and international broadcast also generatelower gross profit margins than direct distribution of exclusive videoprogramming due to normally higher royalty rates specific to those revenues.  Revenues that generate the Company’s lowestgross profit margins are from nonexclusive distribution of video programming.

 

Gross margins for the Domestic Wholesale Distribution segment, as apercentage of segment revenues, decreased by 5.6% to 28.3% for fiscal 2003, from33.9% for fiscal 2002.  The decrease ingross profit margin was due to a higher percentage of segment revenues derivedfrom exclusively distributed programming (which generates comparatively lowergross profit margins than our distribution of exclusively licensed programming)during fiscal 2003 as compared to fiscal 2002. Additionally, the segment’s gross profit margins were lower due toincreased charges to cost of sales (accelerated amortization of royalty advancesand distribution fee advances) as a result of lower ultimate revenue forecastsfor some of our exclusive DVD and VHS titles. For comparative purposes, fiscal 2002 segment gross profit marginincluded a credit of $1,818,000 (or a benefit to gross profit margin of 2.7%)for eliminated reserves related to the discontinuation of our domesticlaserdisc distribution operations.

 

Gross marginsfor the Retail Distribution segment slightly improved by 0.1% to 17.8% forfiscal 2003, from 17.7% for fiscal 2002. Although DVDPlanet’s gross profit margin remained consistent, marketpricing trends are placing downward pressure on Internet revenue-related grossprofit margins.  DVDPlanet hasexperienced a shift in sales mix toward higher-discounted pre-ordered new DVDreleases.  Offsetting these greater discounts,on a gross profit margin basis, are increased levels of market developmentfunds provided by product suppliers (which are recorded as a reduction to costof sales) to DVDPlanet.  Managementbelieves the current Internet retailing trend of increased price discounting ofpre-ordered new DVD releases and free shipping offers will continue for theforeseeable future.  To the extentDVDPlanet further reduces its Internet pricing to meet its competition, itsgross profit margins on Internet sales will be negatively impacted in thefuture, potentially offsetting the gross margin benefit of receiving marketdevelopment funds from its product suppliers.

 

Gross margins for the International Wholesale Distribution segmentincreased by 5.4% to 29.8% for fiscal 2003, from 24.4% for fiscal 2002.  In fiscal 2002, we recorded an impairmentwrite-down of $696,000 in advance royalties paid for the internationaldistribution rights to a line of programming to the estimated fair value basedon lower revised estimated ultimate revenues. Fiscal 2003 gross profit margins were negatively affected by adjustmentsresulting from the change in method of international video distribution.  We adjusted gross profit lower byapproximately $278,000 associated with the additional sales returns reservesrecorded for estimated subdistributor returns as well recorded inventorywrite-downs of $202,000.  See  “Change in International VideoDistribution.”  Also, contributing tolower fiscal 2003 gross profit margins were nonaccountable advertising andpromotional allowances offered to our international subdistributors duringfiscal 2003.  We record these allowancesas a reduction of net revenues in accordance with Emerging Issues Task Force(“EITF”) 01-09, *Accounting for ConsiderationGiven by a Vendor to a Customer or a Reseller of the Vendor’s Products*.  During fiscal 2002, advertising andpromotional expenses were only deducted from purchases after review andapproval by the Company and, accordingly, were classified as selling expensesrather than a reduction of revenues. Although royalties payable to our exclusive program suppliers will behigher on BMG generated sublicense income, as compared to revenues generatedfrom our direct European subdistribution of our exclusive programming, we willno longer be obligated to accrue and pay international music publishing fees onexclusive releases as a cost of sales. The obligation to discharge music publishing to the international musicpublishing rights societies is now BMG’s as part of their sublicense agreementwith the Company.  Additionally, as aresult of the BMG’s responsibilities under the sublicense agreement, we will nolonger manufacture

 

27

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and package the majority of our exclusive programming for Europeanrelease (and charge cost of sales upon sale of the programming).  See “Changes in International VideoDistribution.”

 

The following tables present consolidated selling expenses byreportable business segment and as a percentage of related segment net revenuesfor the fiscal years ended March 31, 2003 and 2002:

 
|                                     |   | **Fiscal Years Ended  March 31,** |   |     |   |
|------------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                     |   | **2003**                          |   | **2002** |   | **% Change** |   |
|                                     |   | **(in  thousands)**               |   |     |   |
| Selling expenses:                        |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | $                                 | 5,247  |     | $      | 4,712 |   | 11.4 | % |
| Retail Distribution                      |   | 3,371                             |   | 2,327    |   | 44.9 |   |
| International Wholesale Distribution     |   | 934                               |   | 1,819    |   | (48.7 | ) |
| Consolidated                             |   | $                                 | 9,552  |     | $      | 8,858 |   | 7.8 | % |
|                                     |   |                              |   |     |   |   |   |
| As a percentage of segment net revenues: |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | 6.8                               | %      | 7.1      | %      | (0.3 | )% |
| Retail Distribution                      |   | 15.9                              |   | 12.5     |   | 3.4 |   |
| International Wholesale Distribution     |   | 9.9                               |   | 18.6     |   | (8.7 | ) |
| Consolidated                             |   | 8.8                               | %      | 9.3      | %      | (0.5 | )% |

 

Consolidated selling expenses increased 7.8% to $9,552,000 for fiscal2003, from $8,858,000 for fiscal 2002. As a percentage of consolidated net revenues, consolidated sellingexpenses decreased by 0.5% to 8.8% for fiscal 2003, from 9.3% for fiscal2002.  Factors that led to the decreasein consolidated selling expenses as a percentage of consolidated net revenuesfor fiscal 2003 as compared to fiscal 2002 are detailed below.

 

Sellingexpenses for our Domestic Wholesale Distribution segment were up 11.4% to$5,247,000 for fiscal 2003, from $4,712,000 for fiscal 2002.  As a percentage of segment net revenues,selling expenses for fiscal 2003 were down by 0.3% to 6.8%, from 7.1% forfiscal 2002.  Several of the moresignificant factors contributing to the increase in absolute dollar segmentselling expenses for fiscal 2003, as compared to fiscal 2002 are asfollows:  Image incurred increasedpersonnel costs (higher by $621,000, including commissions) from addingregional sales personnel and exclusive brand managers during fiscal 2003 aswell as annual salary increases.  Theregional sales managers were added to seek new customer accounts and moreefficiently handle certain territories. The exclusive brand managers were added to focus specifically onmarketing specific brands we exclusively acquire and distribute.  The increase in selling expenses for fiscal2003 was partially offset by a reduction in annual advertising expense (lowerby $149,000).  Our advertisingexpenditures on a specific title and line of programming basis will depend onthe titles in release and the programs created by the marketingdepartment.  Management believes thathigher fiscal 2004 segment advertising expenditures will be necessary to keepImage’s exclusive titles competitive in the retail marketplace with programmingreleased by the major motion picture studios as well as other programsuppliers.

 

Selling expenses for our Retail Distribution segment increased 44.9% to$3,371,000 for fiscal 2003, from $2,327,000 for fiscal 2002.  As a percentage of segment net revenues,selling expenses were up by 3.4% to 15.9%, from 12.5% for fiscal 2002.  The segment incurred increased personnelcosts (higher by $635,000, including a $264,000 charge associated with thetermination of DVDPlanet’s former General Manager and Vice President),increased expenditures relating to DVDPlanet’s radio campaign, online advertisingand affiliate programs, and other promotional campaigns (higher by $259,000)and other general individually insignificant increases in segment sellingexpenses during fiscal 2003, as compared to fiscal 2002.

 

Selling expenses for our International Wholesale Distribution segmentdecreased 48.7% to $934,000 for fiscal 2003, from $1,819,000 for fiscal2002.  As a percentage of segment netrevenues, selling expenses were down by 8.7% to 9.9%, from 18.6% for fiscal 2002.  The segment incurred reduced expensesgenerated by Aviva totaling $431,000, primarily from lower personnel costs andtrade show related expenses.  TheCompany completed its consolidation of Aviva’s operational responsibilitiesduring the quarter ended December 31, 2002. Additionally, the segment incurred reduced advertising and promotionalexpenses recorded as selling expenses during fiscal 2003 (lower by $619,000).These expense reductions were offset, in part, by increased segment personnelcosts including Image sales personnel responsible for broadcast sales (now theresponsibility of NBD) (higher by $144,000) during fiscal 2003, as compared

 

28

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to fiscal 2002.  In fiscal 2003,we provided our European subdistributors market development funds totaling$508,000 based upon a percentage of their purchases, which are recorded as areduction of revenues recognized.

 

The following tables present consolidated general and administrativeexpenses by reportable business segment and as a percentage of related segmentnet revenues for the fiscal years ended March 31, 2003 and 2002:

 
|                                     |   | **Fiscal Years Ended  March 31,** |   |     |   |
|------------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                     |   | **2003**                          |   | **2002** |   | **% Change** |   |
|                                     |   | **(in thousands)**                |   |     |   |
| General and administrative expenses:     |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | $                                 | 9,137  |     | $      | 9,064 |   | 0.8 | % |
| Retail Distribution                      |   | 2,023                             |   | 2,040    |   | (0.8 | ) |
| International Wholesale Distribution     |   | 1,153                             |   | 874      |   | 31.9 |   |
| Consolidated                             |   | $                                 | 12,313 |     | $      | 11,978 |   | 2.8 | % |
|                                     |   |                              |   |     |   |   |   |
| As a percentage of segment net revenues: |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | 11.8                              | %      | 13.7     | %      | (1.9 | )% |
| Retail Distribution                      |   | 9.5                               |   | 10.9     |   | (1.4 | ) |
| International Wholesale Distribution     |   | 12.2                              |   | 9.0      |   | 3.2 |   |
| Consolidated                             |   | 11.4                              | %      | 12.6     | %      | (1.2 | )% |

 

Consolidated general and administrative expenses for fiscal 2003increased 2.8% to $12,313,000, from $11,978,000 for fiscal 2002.  As a percentage of consolidated netrevenues, consolidated general and administrative expenses decreased by 1.2% to11.4% for fiscal 2003, from 12.6% for fiscal 2002.  Factors that led to the decrease in consolidated general andadministrative expenses as a percentage of consolidated net revenues for fiscal2003 as compared to fiscal 2002 are detailed below.

 

General andadministrative expenses for our Domestic Wholesale Distribution segment were up0.8% to $9,137,000 for fiscal 2003, from $9,064,000 for fiscal 2002.  As a percentage of segment net revenues,general and administrative expenses for fiscal 2003 were 11.8%, down from 13.7%for fiscal 2002, with part of the decrease due to spreading of fixed costs overhigher revenues.  The significantfluctuations in segment general and administrative expense line items forfiscal 2003 as compared to fiscal 2002 are as follows:  The segment incurred increased insurancepremiums (higher by $239,000) primarily for directors and officers, errors andomissions and property coverage; increased professional fees (higher by$213,000) and increased personnel costs (higher by $203,000) primarily forincreased headcount, annual raises, severance and recruitment fees and othergeneral individually insignificant increases in segment general andadministrative expenses.  Offsetting thenoted expense increases were significant expensed items in fiscal 2002 that didnot occur in fiscal 2003.  In fiscal2002, the segment incurred increased bad debt expense (higher by $557,000)primarily for the provision associated with the Valley Media chapter 11bankruptcy filing, an unfavorable litigation settlement for $310,000 and awrite-off of an investment totaling $150,000.

 

General and administrative expenses for our Retail Distribution segmentdecreased 0.8% to $2,023,000 for fiscal 2003, from $2,040,000 for fiscal2002.  As a percentage of segment netrevenues, general and administrative expenses were down by 1.4% to 9.5%, from10.9% for fiscal 2002.  There were nosignificant individual fluctuations in segment general and administrativeexpenses for fiscal 2003 as compared to fiscal 2002.

 

General and administrative expenses for our International WholesaleDistribution segment increased 31.9% to $1,153,000 for fiscal 2003, from$874,000 for fiscal 2002.  As apercentage of segment net revenues, general and administrative expenses were upby 3.2% to 12.2%, from 9.0% for fiscal 2002. The segment incurred higher personnel costs associated with additionaldedicated segment personnel located at Image (higher by $349,000) and higherlegal and tax professional fees (higher by $99,000) offset, in part, by reducedexpenses generated by Aviva (lower by $291,000), primarily salaries.  We completed our consolidation of Aviva’soperational responsibilities into Image during the quarter ended December 31,2002.

 

Amortization of production costs for fiscal 2003 decreased 15.4% to$4,287,000, or 4.0% of consolidated net revenues for fiscal 2003, from$5,065,000, or 5.3% of consolidated net revenues for fiscal 2002.  This decrease was 

 

29

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primarily due to reduced per-title production costs charged by DeluxeMedia Services, LLC (formerly Ritek Global Media), the Company’s exclusive DVDand CD manufacturer.

 

Other expenses for fiscal 2003 were $698,000 and consisted of animpairment charge of $322,000 as a result of the Company’s sale and leasebackof its Las Vegas, Nevada real estate, minority interest in the net earnings ofAviva of $573,000, and $121,000 representing the fair value (based on aBlack-Scholes valuation) of the warrant issued to IIC in connection with thepartial conversion of their subordinated note payable in March 2003, net offoreign currency transaction gains for fiscal 2003 of $318,000.  Other expense for fiscal 2002 was $192,000which represents foreign currency transaction losses of $210,000, net of$18,000 of minority interest expense in the net loss of Aviva.

 

Interest expense, net of interest income of $8,000, decreased 19.5% to$1,454,000, or 1.3% of consolidated net revenues, for fiscal 2003, from$1,806,000, net of interest income of $4,000, or 1.9% of consolidated netrevenues for fiscal 2002.  The decreasewas attributable to lower weighted average outstanding debt and interest ratelevels during 2003 as compared to fiscal 2002. Our weighted average interest rate for fiscal 2003 and fiscal 2002 was6.7% and 7.0%, respectively.

 

We recorded income tax expense of $688,000 for fiscal 2003 based on aconsolidated effective tax rate of approximately 58.5% on income before incometaxes and cumulative effect on a change in accounting principle.  Included as a component of income taxexpense is a provision for a valuation allowance against our deferred taxassets of $551,000.  The valuationallowance fully reserves foreign tax credit carryforwards which have a 5-yearlife.  We believe the carryforwardperiod may not be long enough to realize the tax benefits of the carryforwardthrough future taxable earnings generated by the Company.  Also increasing the fiscal 2003 effectiveincome tax rate were the size of non-tax deductible expenses in relation to$234,000 in pretax earnings for fiscal 2003. Income tax benefit of $40,000 for fiscal 2002 was based on aconsolidated effective tax rate of approximately 17%.  The effective tax rate was lower in fiscal 2002 due to thedisallowance of 45% of the state net operating loss carryforwards negativelyimpacting the deferred tax asset benefit. The effective tax rate is subject to ongoing review by management on aregular basis.

 

In June 2001, the Financial Accounting Standards Board issued Statementof Financial Accounting Standards (“SFAS”) No. 141, *Business Combinations*, andStatement No. 142, *Goodwill and Other Intangible Assets*.  SFAS No. 141 requires that the purchasemethod be used for all business combinations initiated after June 30,2001.  SFAS No. 142 requires thatgoodwill no longer be amortized to earnings, but instead be reviewed forimpairment.  The amortization ofgoodwill ceases upon adoption of SFAS No. 142. Image adopted the new rules for measuring the impairment of goodwill andcertain intangible assets on April 1, 2002. The adoption of SFAS No. 142 resulted in a one-time charge of$3,766,000, or $.22 per basic and diluted share, net of an income tax benefitof $2,231,000.  The impairment charge isrecorded as a cumulative effect of a change in accounting principle, net of thetax effect, in the accompanying consolidated statement of operations for fiscal2003.  As a result of this writedown,DVDPlanet has no remaining goodwill. Goodwill amortization included in fiscal 2002 was $422,000 net of tax.  On a comparative basis, without goodwillamortization expense in fiscal 2002, diluted earnings per share would have been$.02 versus the reported loss per share of $.01.

 

Consolidated loss before cumulative effect of accounting change forfiscal 2003 was $454,000, or $.03 per diluted share.  Consolidated net loss for fiscal 2002 was $195,000, or $.01 perdiluted share.  During fiscal 2003 acumulative effect of accounting change of $3,766,000, or $.22 per dilutedshare, net of income tax benefit of $2,231,000, was recorded resulting in aconsolidated net loss of $4,220,000, or $.25 per diluted share.

 

30

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***Fiscal Year EndedMarch 31, 2002 Compared to Fiscal Year Ended March 31, 2001***

 

The following tables present consolidated net revenues by format andnet revenues by format as a percentage of total consolidated net revenues forthe fiscal years ended March 31, 2002 and 2001.  The information in the table below does not represent segmentdata, but rather is presented for purposes of explaining certain trends withinnet revenues:

 
|                                           |   | **Fiscal Years Ended  March 31,** |   |     |   |
|------------------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                           |   | **2002**                          |   | **2001** |   | **% Change** |   |
|                                           |   | **(in thousands)**                |   |     |   |
| Net revenues:                                  |   |                              |   |     |   |   |   |
| DVD                                            |   | $                                 | 84,905 |     | $      | 90,205 |   | (5.9 | )% |
| VHS/CD                                         |   | 6,178                             |   | 4,527    |   | 36.5 |   |
| Broadcast/Sublicense                           |   | 3,066                             |   | 2,985    |   | 2.7 |   |
| Laserdisc                                      |   | 321                               |   | 1,794    |   | (82.1 | ) |
| Other                                          |   | 343                               |   | 522      |   | (34.3 | ) |
|                                           |   | $                                 | 94,813 |     | $      | 100,033 |   | (5.2 | )% |
|                                           |   |                              |   |     |   |   |   |
| As a percentage of consolidated net  revenues: |   |                              |   |     |   |   |   |
| DVD                                            |   | 89.6                              | %      | 90.2     | %      | (0.6 | )% |
| VHS/CD                                         |   | 6.5                               |   | 4.5      |   | 2.0 |   |
| Broadcast/Sublicense                           |   | 3.2                               |   | 3.0      |   | 0.2 |   |
| Laserdisc                                      |   | 0.3                               |   | 1.8      |   | (1.5 | ) |
| Other                                          |   | 0.4                               |   | 0.5      |   | (0.1 | ) |
|                                           |   | 100.0                             | %      | 100.0    | %      | — | % |

 

The following table presents consolidated net revenues by reportablebusiness segment for the fiscal years ended March 31, 2002 and 2001:

 
|                                 |   | **Fiscal Years Ended  March 31,** |   |     |   |
|--------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                 |   | **2002**                          |   | **2001** |   | **% Change** |   |
|                                 |   | **(in thousands)**                |   |     |   |
| Net revenues:                        |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution      |   | $                                 | 66,376 |     | $      | 76,485 |   | (13.2 | )% |
| Retail Distribution                  |   | 18,678                            |   | 16,886   |   | 10.6 |   |
| International Wholesale Distribution |   | 9,759                             |   | 6,662    |   | 46.5 |   |
| Consolidated                         |   | $                                 | 94,813 |     | $      | 100,033 |   | (5.2 | )% |

 

Consolidated net revenues for all segments for the fiscal year endedMarch 31, 2002 decreased 5.2% to $94,813,000, from $100,033,000 for the fiscalyear ended March 31, 2001.  Factors thatcontributed to the decrease in consolidated net revenues for the fiscal yearended March 31, 2002, as compared to the fiscal year ended March 31, 2001, aredetailed below.

 

Net revenues for our Domestic Wholesale Distribution segment for thefiscal year ended March 31, 2002 decreased 13.2% to $66,376,000, from netrevenues of $76,485,000, for the fiscal year ended March 31, 2001.  Management believes this segment’s revenueperformance was negatively impacted by economic weakness in the retail sectorover the first half of fiscal 2002, coupled with the loss of exclusive revenuesfrom the license agreements with Orion and Universal which expired at the endof the last fiscal year.  Revenuegenerated from these two agreements totaled $12,924,000 and $9,143,000 forfiscal 2001 and 2000, respectively. There was no revenue generated from these agreements in fiscal 2002.

 

Net revenues for DVDPlanet, our Retail Distribution segment, for thefiscal year ended March 31, 2002 increased 10.6% to $18,678,000, from netrevenues of $16,886,000, for the fiscal year ended March 31, 2001.  Net revenues of DVD programming sold via theInternet increased 15.5% to $12,746,000 for fiscal 2002, from $11,034,000

 

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for fiscal 2001.  During fiscal2002, DVDPlanet increased its selling prices to customers as well as shippingfees charged customers.  Shipping feescharged customers totaled $840,000 for fiscal 2002, up 52.2% from $552,000 forfiscal 2001.

 

Net revenues for our International Wholesale Distribution segment forthe fiscal year ended March 31, 2002 were up 46.5% to $9,759,000, from netrevenues of $6,662,000, for the fiscal year ended March 31, 2001.  For fiscal 2002 and 2001, revenues ofapproximately $8,412,000 and $5,299,000, respectively, were derived frominternational wholesale distribution of Image’s licensed DVD and VHSprogramming, either through international distribution or internationalsublicenses.  For the fiscal years endedMarch 31, 2002 and 2001, revenues of approximately $1,347,000 and $1,363,000,respectively, were derived from international and domestic broadcastexploitation of the Image’s licensed programming.

 

The following tables present consolidated cost of sales by reportablebusiness segment and as a percentage of related segment net revenues for thefiscal years ended March 31, 2002, and 2001:

 
|                                 |   | **Fiscal Years Ended  March 31,** |   |
|--------------------------------------|--------|-----------------------------------|--------|
|                                 |   | **2002**                          |   | **2001** |   |
|                                 |   | **(in thousands)**                |   |
| Cost of sales:                       |   |                              |   |   |   |
| Domestic Wholesale Distribution      |   | $                                 | 43,882 |   | $ | 51,007 |   |
| Retail Distribution                  |   | 15,377                            |   | 15,014 |   |
| International Wholesale Distribution |   | 7,381                             |   | 4,630 |   |
| Consolidated                         |   | $                                 | 66,640 |   | $ | 70,651 |   |

 
|                                     |   |   |   |   |   | **% Change** |   |
|------------------------------------------|--------|--------|--------|--------|--------|--------------|--------|
| As a percentage of segment net revenues: |   |   |   |   |   |         |   |
| Domestic Wholesale Distribution          |   | 66.1   | %      | 66.7   | %      | (0.6         | )%     |
| Retail Distribution                      |   | 82.3   |   | 88.9   |   | (6.6         | )      |
| International Wholesale Distribution     |   | 75.6   |   | 69.5   |   | 6.1          |   |
| Consolidated                             |   | 70.3   | %      | 70.6   | %      | (0.3         | )%     |

 

Consolidated cost of sales for fiscal 2002 was $66,640,000, or 70.3% ofnet revenues, compared to $70,651,000 or 70.6% of net revenues, for fiscal2001.  Accordingly, consolidated grossprofit margins were 29.7% and 29.4% for fiscal 2002 and fiscal 2001,respectively.  For comparative purposes,exclusive of a fiscal 2002 $1,818,000 credit to cost of sales for theelimination of  reserves related to thediscontinuation of our domestic laserdisc distribution operations and a$696,000 charge to cost of sales related to the write-down to estimated netrealizable value of advance royalties paid for international distributionrights for a line of programming, consolidated gross profit margin would havebeen 28.5%, or 0.9% lower than fiscal 2001. Several factors leading to the decrease in gross profit margin areaddressed below.

 

Gross margins for our Domestic Wholesale Distribution segment, as apercentage of segment revenues, increased by 0.6% to 33.9% for fiscal 2002,from 33.3% for fiscal 2001.  Exclusiveof the aforementioned credit to cost of sales related to laserdiscdistribution, gross margins for the segment decreased by 2.2% to 31.1% forfiscal 2002 from 33.3% for fiscal 2001. The decrease was a result of lower revenues from the sale of exclusiveprogramming, due to the loss of the Orion and Universal agreements, in fiscal2002 compared to fiscal 2001, offset, in part, by lower manufacturing costs forexclusive programming during fiscal 2002.

 

Gross margins for our Retail Distribution segment improved by 6.6% to17.7% for fiscal 2002, from 11.1% for fiscal 2001.  The 6.6% improvement in gross profit margin was primarily due tothe increase in selling prices to customers as well as an increase in shippingfees charged to customers.

 

Gross margins for our International Wholesale Distribution segmentdecreased by 6.1% to 24.4% for fiscal 2002, from 30.5% for fiscal 2001.  For comparative purposes, excluding animpairment write-down of $696,000 in advance royalties paid for theinternational distribution rights to a line of programming to the estimatedfair value of the distribution rights, gross profit margins increased to 31.5%for fiscal 2002, from 30.5% for fiscal 2001. The increase in gross margins was due to a more favorable sales mix ofhigher-margin direct European distribution revenues during fiscal 2002 comparedto fiscal 2001.

 

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The following tables present consolidated selling expenses byreportable business segment and as a percentage of related segment net revenuesfor the fiscal years ended March 31, 2002 and 2001:

 
|                                     |   | **Fiscal Years Ended  March 31,** |   |     |   |
|------------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                     |   | **2002**                          |   | **2001** |   | **% Change** |   |
|                                     |   | **(in thousands)**                |   |     |   |
| Selling expenses:                        |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | $                                 | 4,712  |     | $      | 4,177 |   | 12.8 | % |
| Retail Distribution                      |   | 2,327                             |   | 2,506    |   | (7.1 | ) |
| International Wholesale Distribution     |   | 1,819                             |   | 1,536    |   | 18.4 |   |
| Consolidated                             |   | $                                 | 8,858  |     | $      | 8,219 |   | 7.8 | % |
|                                     |   |                              |   |     |   |   |   |
| As a percentage of segment net revenues: |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | 7.1                               | %      | 5.5      | %      | 1.6 | % |
| Retail Distribution                      |   | 12.5                              |   | 14.8     |   | (2.3 | ) |
| International Wholesale Distribution     |   | 18.6                              |   | 23.1     |   | (4.5 | ) |
| Consolidated                             |   | 9.3                               | %      | 8.2      | %      | 1.1 | % |

 

Consolidated selling expenses increased 7.8% to $8,858,000 for fiscal2002, from $8,219,000 for fiscal 2001. As a percentage of consolidated net revenues, consolidated sellingexpenses increased by 1.1% to 9.3% for fiscal 2002, from 8.2% for fiscal2001.  Factors that led to the increasein consolidated selling expenses as a percentage of consolidated net revenuesfor fiscal 2002 as compared to fiscal 2001 are detailed below.

 

Selling expenses for our Domestic Wholesale Distribution segment wereup 12.8% to $4,712,000 for fiscal 2002, from $4,177,000 for fiscal 2001.  As a percentage of segment net revenues,selling expenses for fiscal 2002 were 7.1%, up from 5.5% for fiscal 2001.  During fiscal 2002, Image incurredcomparatively higher advertising and product promotional expenditures (higherby $420,000) and increased personnel costs (higher by $180,000), offset, inpart, by reduced trade show convention expenditures (lower by $125,000).  Image incurred higher advertising andpromotional expenditures on a specific title and line of programming basis.

 

Selling expenses for our Retail Distribution segment decreased 7.1% to$2,327,000 for fiscal 2002, from $2,506,000 for fiscal 2001.  As a percentage of segment net revenues,selling expenses were down by 2.3% to 12.5%, from 14.8% for fiscal 2001.  The decrease, as a percentage of net sales,was due to a staffing reduction, staffing redeployment and reduced promotionalcharges initiated in the fourth quarter of fiscal 2001.

 

Selling expenses for our International Wholesale Distribution segmentincreased 18.4% to $1,819,000 for fiscal 2002, from $1,536,000 for fiscal2001.  As a percentage of segment netrevenues, selling expenses were down by 4.5% to 18.6%, from 23.1% for fiscal2001.  The decrease, as a percentage ofnet sales, was due, in part, to spreading of fixed segment costs over highercomparative fiscal revenues.  On anabsolute dollar basis, fiscal 2002 had comparatively higher personnel and tradeshow convention expenses (higher by $332,000) offset, in part by reducedadvertising and promotion expenses (lower by $122,000).

 

The following tables present consolidated general and administrativeexpenses by reportable business segment and as a percentage of related segmentnet revenues for the fiscal years ended March 31, 2002 and 2001:

 
|                                     |   | **Fiscal Years Ended  March 31,** |   |     |   |
|------------------------------------------|--------|-----------------------------------|--------|----------|--------|
|                                     |   | **2002**                          |   | **2001** |   | **% Change** |   |
|                                     |   | **(in thousands)**                |   |     |   |
| General and administrative expenses:     |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | $                                 | 9,064  |     | $      | 7,937 |   | 14.2 | % |
| Retail Distribution                      |   | 2,040                             |   | 1,557    |   | 31.0 |   |
| International Wholesale Distribution     |   | 874                               |   | 422      |   | 107.1 |   |
| Consolidated                             |   | $                                 | 11,978 |     | $      | 9,916 |   | 20.8 | % |
|                                     |   |                              |   |     |   |   |   |
| As a percentage of segment net revenues: |   |                              |   |     |   |   |   |
| Domestic Wholesale Distribution          |   | 13.7                              | %      | 10.4     | %      | 3.3 | % |
| Retail Distribution                      |   | 10.9                              |   | 9.2      |   | 1.7 |   |
| International Wholesale Distribution     |   | 9.0                               |   | 6.3      |   | 2.7 |   |
| Consolidated                             |   | 12.6                              | %      | 9.9      | %      | 2.7 | % |

 

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Consolidated general and administrative expenses for fiscal 2002increased 20.8% to $11,978,000 for fiscal 2002, from $9,916,000 for fiscal2001.  As a percentage of consolidatednet revenues, consolidated general and administrative expenses increased by2.7% to 12.6% for fiscal 2002, from 9.9% for fiscal 2001.  Factors that led to the increase inconsolidated general and administrative expenses as a percentage ofconsolidated net revenues for fiscal 2002 as compared to fiscal 2001 aredetailed below.

 

General and administrative expenses for our Domestic WholesaleDistribution segment were up 14.2% to $9,064,000 for fiscal 2002, from$7,937,000 for fiscal 2001.  As apercentage of segment net revenues, general and administrative expenses forfiscal 2002 were 13.7%, up from 10.4% for fiscal 2001, with part of theincrease due to spreading of fixed costs over lower revenues.  The increase in absolute dollar general andadministrative expenses for fiscal 2002 results, in part, from higherdepreciation and amortization expense (higher by $423,000), a one-timelitigation settlement expense accrual (including associated legal fees)totaling $310,000, higher other legal fees (higher by $231,000), higherpersonnel costs (higher by $225,000), higher professional fess (higher by$169,000) and a write off of an investment of $150,000.  These increased fiscal 2002 expenses wereoffset, in part, by lower performance-based bonuses in fiscal 2002 as comparedto fiscal 2001 (lower by $584,000).

 

General and administrative expenses for our Retail Distribution segmentincreased 31.0% to $2,040,000 for fiscal 2002, from $1,557,000 for fiscal2001.  As a percentage of segment netrevenues, general and administrative expenses were up by 1.7% to 10.9%, from9.2% for fiscal 2001.  The increase, asa percentage of net sales, was primarily due to the higher costs related topersonnel (including management information systems and third-party computerprogrammer service-higher by $208,000), higher depreciation and amortizationexpenses (higher by $120,000), higher bank credit card servicing fees (higherby $73,000) and higher rent expense (higher by $64,000) for fiscal 2002.

 

General and administrative expenses for our International WholesaleDistribution segment increased 107.1% to $874,000 for fiscal 2002, from$422,000 for fiscal 2001.  As apercentage of segment net revenues, general and administrative expenses were upby 2.7% to 9.0%, from 6.3% for fiscal 2001. The increase in absolute dollar general and administrative expenses wasprimarily due to increased personnel costs (higher by $336,000).

 

Amortization of production costs for fiscal 2002 increased 4.1% to$5,065,000, or 5.3% of consolidated net revenues for fiscal 2002, from$4,867,000, or 4.9% of consolidated net revenues for fiscal 2001.  This increase resulted primarily from anincrease in exclusive programming released internationally during fiscal 2002compared to fiscal 2001.  Amortizationof production costs for fiscal 2002 included $854,000 attributable to theInternational Wholesale Distribution segment as compared to $647,000 for fiscal2001.

 

Interest expense, net of interest income of $4,000, for fiscal 2002increased 4.8% to $1,806,000, or 1.9% of consolidated net revenues, from$1,724,000, net of interest income of $26,000, or 1.7% of consolidated netrevenues for fiscal 2001.  The increaseis attributable to higher weighted average outstanding debt levels offset, inpart, by lower weighted average interest rate levels during 2002 as compared tofiscal 2001.  Our weighted averageinterest rate for fiscal 2002 and fiscal 2001 was 7.0% and 9.1%, respectively.

 

Other expense for fiscal 2002 was $192,000, which represents foreigncurrency transaction losses of $210,000 net of $18,000 minority interest in thenet loss of Aviva.  Other income forfiscal 2001 consisted of a gain on sale of land in Nevada of $499,000, net offoreign currency transaction losses of $179,000 and minority interest in thenet earnings of Aviva of $31,000.

 

We recorded an income tax benefit of $40,000 for fiscal 2002 based on aconsolidated effective tax rate of approximately 17%.  The effective tax rate was lower than the previously estimated36% due to the disallowance of 45% or the state net operating losscarryforwards negatively impacting the deferred tax asset benefit.  Income tax benefit of $3,996,000 for fiscal2001 reflects the elimination of the valuation allowance recorded against thedeferred

 

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tax assets as a result of management’s estimates that future taxableincome will be sufficient to utilize the entire benefit of the deferred taxassets.  The effective tax rate issubject to on going review by management on a regular basis.

 

Consolidated net loss for fiscal 2002 of $195,000, or $.01 per dilutedshare, compared to consolidated net earnings for fiscal 2001 of $8,432,000, or$.50 per diluted share.

 

**Inflation**

 

Management believes that inflation is not a material factor in theoperation of our business at this time.

 

**Recently Issued Accounting Pronouncements**

 

In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 141, *Business Combinations*, and SFAS No. 142, *Goodwill andOther Intangible Assets*. SFAS No. 141 requires that the purchase method be used for all businesscombinations initiated after June 30, 2001. SFAS No. 142 requires that goodwill no longer be amortized to earnings,but instead be reviewed for impairment. The amortization of goodwill ceases upon adoption of SFAS No. 142.  Image adopted the new rules for measuringthe impairment of goodwill and certain intangible assets on April 1, 2002.  The adoption of SFAS No. 142 resulted in aone-time, noncash, charge of $3,766,000, or $.22 per diluted share, net of anincome tax benefit of $2,231,000.  Theimpairment charge is recorded as a cumulative effect of a change in accountingprinciple, net of the tax benefit, in the accompanying consolidated statementof operations for fiscal 2003.  As aresult of this writedown, DVDPlanet has no remaining goodwill.  Goodwill amortization for fiscal 2002 was$422,000 net of related tax benefit or $.03 per diluted share.  Reported loss per share of $.01 for fiscal2002 would have been earnings per diluted share of $.02 exclusive of the impactof goodwill amortization.

 

In August 2001, the FASB issued SFAS No. 144,*Accountingfor the Impairment or Disposal of Long-Lived Assets*, whichsupersedes both SFAS No. 121, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to be Disposed Of* and the accounting andreporting provisions of Accounting Principles Board (“APB”) Opinion No. 30, *Reportingthe Results of Operations - Reporting the Effects of Disposal of a Segment of aBusiness, and Extraordinary, Unusual and Infrequently Occurring Events andTransactions*, for the disposal of a segment of a business (aspreviously defined in that Opinion). SFAS No. 144 retains the fundamental provisions of SFAS No. 121 forrecognizing and measuring impairment losses on long-lived assets held for useand long-lived assets to be disposed of by sale, while also resolvingsignificant implementation issues associated with SFAS No. 121.  The Company adopted the provisions of SFASNo. 144 during the quarter ended June 30, 2002.  The adoption of SFAS No. 144 did not have a material impact onthe Company’s financial statements because the impairment assessment under SFASNo. 144 is largely unchanged from SFAS No. 121.

 

On July 30, 2002, the FASB issued SFAS No.146, *Accountingfor Costs Associated with Exit or Disposal Activities.*  SFAS No. 146 nullifies Emerging Issues TaskForce (“EITF”) Issue No. 94-3, *Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in Restructuring).* SFAS No. 146 requires that a liability be recognized for those costsonly when the liability is incurred, that is, when it meets the definition of aliability in FASB’s conceptual framework. SFAS No. 146 also establishes a fair value as the objective for initialmeasurement of liabilities related to exit or disposal activities.  SFAS No. 146 is effective for exit ordisposal activities that are initiated after December 31, 2002.  The adoption of SFAS No. 146 did not have amaterial impact on the Company’s financial position or results of operations.

 

In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*.This interpretation elaborates on the disclosures to be made by a guarantor inits interim and annual financial statements about its obligations under certainguarantees that it has issued. It also clarifies that a guarantor is requiredto recognize, at the inception of a guarantee, a liability for the fair valueof the obligation undertaken in issuing the guarantee. The disclosurerequirements of FIN 45 are effective for interim and annual periods beginningafter December 15, 2002. The initial recognition and initial measurementrequirements of FIN 45 are effective prospectively for guarantees issued ormodified after December 31, 2002. The adoption of the recognition and initialmeasurement requirements of FIN 45 did not have a material impact on theCompany’s financial position, cash flows or results of operations.

 

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In December2002, the FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation-Transition and Disclosure-an amendment of FASB No.123*.  SFAS No. 148 amendsSFAS No. 123, *Accounting for Stock-BasedCompensation*, to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation. In addition, SFAS No. 148 amends the disclosurerequirements of SFAS No. 123 to require prominent disclosures in both annualand interim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results andhave been included herein.  Thedisclosure requirements shall be effective for financial statements for fiscalyears ending after December 15, 2002. The interim disclosure provisions are effective for financial statementsfor interim periods beginning after December 15, 2002.

 

In January 2003, the FASB issued FIN 46, *Consolidation of Variable Interest Entities*. This interpretation clarifies the application of Accounting Research Bulletin No. 51, *Consolidated Financial Statements*, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The recognition and measurement provisions of FIN 46 are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities on the first interim or annual reporting period beginning after June 15, 2003. We do not expect the adoption of FIN 46 to have a material impact on our consolidated financial statements.

 

In March 2003, the EITF reached a consensus on Issue No. 02-16, *Accounting by a Customer (including a Reseller) forConsideration Received from a Vendor*.  According to EITF No. 02-16, vendor allowances are to berecognized as a reduction in cost of sales, unless the allowance represents areimbursement of a specific, incremental and identifiable cost incurred to sellthe vendor’s products.  This guidance isconsistent with the Company’s recording of consideration received from avendor.

 

In April 2003, the FASB issued SFAS No. 149, *Amendment of Statement 133 on Derivative Instruments and Hedging Activities*.  SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133. *Accounting for Derivative Instruments and Hedging Activities*.  SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003.  Since we do not currently transact in such instruments nor undertake hedging transactions, we do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.

 

In May 2003, the FASB issued SFAS No.150, *Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity*.  SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  We do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.

 

**Liquidity and Capital Resources**

 

Our working capital requirements vary primarily with the level of ourprogram acquisition, production and distribution activities.  Recurring principal uses of working capitalin the Company’s operations are for acquiring exclusive programming (i.e., royaltypayments, including advance payment against future royalties to programsuppliers), advance payments under exclusive distribution agreements,manufacturing and production costs, costs of acquiring finished programming forexclusive and nonexclusive distribution, selling, general and administrativeexpenses and debt service.

 

Availability of working capital is asubstantial factor in Image’s ability to acquire new programming.  Therefore, maximizing available workingcapital is critical to our business operations.  Our financial resources are limited and in the future we may needto raise additional funding to continue expanding operations and acquiringdesirable programming.  Shouldadditional funds be raised through the issuance of equity or convertible debtsecurities, the percentage ownership of Image’s existing stockholders may bereduced.  Should additional funds beraised through the issuance of debt, our interest expense would increase.  If adequate funds are not available or areunavailable on

 

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acceptable terms, the Company may find it is unable to fund expansionof operations, take advantage of acquisition opportunities, develop or enhanceprogramming or services, or respond to competitive pressures in the industry.

 

The following table summarizes the Company’scontractual obligations at March 31, 2003 and the effects of such obligationsare expected to have on liquidity and cash flow in future periods:

 
|                                             |   | **Payments  due by period** |   |
|--------------------------------------------------|--------|-----------------------------|--------|
| **(in thousands)**                               |   | **Total**                   |   | **Less than  1 year** |   | **1-3 years** |   | **3-5 years** |   | **More than   5 years** |   |
| Contractual obligations:                         |   |                        |   |   |   |   |   |   |   |   |   |
| Long-term debt obligations                       |   | $                           | 4,407  |   | $ | 1,591 |   | $ | 2,816 |   | $ | — |   | $ | — |   |
| Capital lease obligations                        |   | 925                         |   | 569 |   | 356 |   | — |   | — |   |
| Operating lease obligations                      |   | 6,365                       |   | 930 |   | 1,214 |   | 1,243 |   | 2,978 |   |
| Licensing and exclusive distribution  agreements |   | 10,933                      |   | 5,016 |   | 5,717 |   | 200 |   | — |   |
| Total                                            |   | $                           | 22,630 |   | $ | 8,106 |   | $ | 10,103 |   | $ | 1,443 |   | $ | 2,978 |   |

 

***Sources and Uses ofWorking Capital for Fiscal 2003.***

 

Our cash balance increased to $2,672,000 at March 31, 2003, from$303,000 at March 31, 2002.  The primaryreasons for the increase are as follows: Net cash provided by operating activities in fiscal 2003 was$5,269,000.  In March 2003, we receiveda $3 million royalty advance from BMG (see “Royalty Advance from BMG”below).  Accrued music publishing feesincreased to $4.3 million at March 31, 2003, from $3.2 million at March 31,2002.  Through our representatives, weare working with the respective domestic music publishers and internationalpublishing rights societies to solidify rates on music programming released inthe DVD and VHS formats.  The Companyhas recorded the accruals based upon its best estimates of the liabilities(utilizing supporting contractual rates, current industry trends and historicalactivity).  The Company expects toultimately finalize rates on the majority of its releases and schedule thepay-down of accrual to date in the coming fiscal year.  Net cash provided by investing activities infiscal 2003 was $3,821,000.  We receivedapproximately $5.7 million from the sale of property in Las Vegas, Nevada (see“Sale and Leaseback of Las Vegas, Nevada Property” below). We incurred$1,847,000 of capital expenditures during fiscal 2003.  Net cash used in financing activities infiscal 2003 was $6,721,000. We raised $2.0 million in a private placement (see“Private Placement of Common Stock” below). We reduced our interest-bearingdebt during fiscal 2003.  Scheduledprincipal payments reduced the outstanding balances of our subordinated notewith Ritek Taiwan, our equipment note payable with Bank of America and ourcapital lease obligations. Additionally, during fiscal 2003, we retired ourconvertible subordinated note payable to Image Investors Co. through acombination of cash payment and issuance of common stock (see “Retirement ofIIC Convertible Subordinated Note Payable” below).

 

***TheCompany’s Liquidity Position at March 31, 2003***

 

At March 31, 2003, we had cash of $2,672,000 and borrowing availabilityof $6,527,000 and $1,000,000, respectively, under our revolving credit and termloan facilities with Wells Fargo Foothill (“Foothill”).  Our revolving credit obligation to Foothillwas $10,520,000 and we had one outstanding standby letter of credit for$150,000 issued by Foothill to secure trade payables to a programsupplier.  Our future fiscal obligationsfor royalty advances, distribution fees, minimum guarantees and other feestotaled $5,016,000 due during fiscal 2004, $3,976,000 due in fiscal 2005,$1,741,000 due in fiscal 2006, $100,000 due in fiscal 2007 and $100,000 due infiscal 2008.  These advances andguarantees are recoupable against future royalties and distribution fees earnedby our exclusive program suppliers in connection with revenues generated bythose rights.

 

Image faces competition in securing exclusive rights from independentdistribution companies as well as major motion picture studios and musiclabels.  Historically, we have paidsignificant up-front advances against future royalties and distribution fees tosecure exclusive DVD and other home entertainment format distributionrights.  Continued availability ofsufficient working capital is a substantial factor in our ability to license andproduce new exclusive programming and acquire programming for exclusivedistribution.  Therefore, maximizingavailable working capital is critical to our business operations.  Without sufficient working capital, we maynot be able to remain competitive with advance offers from competitors who mightbe willing to pay larger advances or who have greater financial resources.  During the prior three fiscal quarters, weimplemented steps to provide additional working capital and reduce debtincluding  (1) increasing the maximumborrowing availability under our revolving credit facility with Foothill by$2.0 million (from $15.0 million to $17.0 million), (2) receiving $5.7 millionfrom the sale and leaseback of

 

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our Las Vegas, Nevada distribution facility and adjacent vacant land,(3) raising $2.0 million through a private placement sale of Image’s commonstock, (4) receiving a $3.0 million initial advance from BMG and (5) converting$1.05 million of the remaining $2.55 million due Image Investors Co. (“IIC”)under the convertible subordinated note payable to common stock and repayingthe remaining $1.5 million due under the note. We will continue to focus on effectively managing our capital resourcesand seeking appropriate financing when necessary in order to acquire rights tothe programming we desire in order to fully execute on our business plans.

 

Sale and Leaseback of Las Vegas, NevadaProperty.  OnSeptember 3, 2002, Image entered into an agreement to sell and leaseback itsLas Vegas, Nevada distribution facility and adjacent vacant land to SpencerStreet Investors, LLC, an affiliate of RDS Investment & Development, LLC,an unrelated third party.  On November8, 2002, escrow on the sale closed on approximately 8.11 acres, consisting ofImage’s 76,000 square foot warehouse and distribution facility on 4.04 acres,and the adjacent 4.07 acres of vacant land for $6.0 million.

 

We received net proceeds of approximately $3.0 million, after deductingtransactional costs (such as sales commissions and escrow fees, etc.) andapproximately $2.7 million, which was paid to Bank of America in Nevada toretire the Company’s revolving credit facility that was secured by the realestate sold.  Image used the netproceeds from the transaction to pay down $1.0 million of the outstandingbalance under the IIC loan and approximately $2.0 million of thethen-outstanding balance under the Foothill revolving credit and term loanfacilities.  See “Note 5.  Property, Equipment and Improvements” to theaccompanying consolidated financial statements.

 

Private Placement of Common Stock.  On September 25, 2002, Image closed its saleof $2.0 million of common stock in a private placement to Standard BroadcastingCorporation Limited, the largest privately-owned multi-media company in Canadaand the ultimate parent of Image’s exclusive Canadian distributor.  Image used the net proceeds from thetransaction to pay down $750,000 of the outstanding balance under the IIC loanand approximately $1.25 million of the then-outstanding balance under theFoothill revolving credit and term loan facilities.  See “Note 9. Private Placement of Common Stock” to the accompanying consolidatedfinancial statements.

 

Royalty Advance from BMG.  Under the January 2003 agreement with BMG,Image received a $3.0 million royalty advance in March 2003, fully recoupableby BMG against quarterly royalties due to Image under the agreement.  The Company used the funds to pay down itsoutstanding borrowings under its revolving credit facility with Foothill.  Based upon actual quarterly sales of Imageprogramming in the territories, BMG will recoup quarterly royalties from the $3million previously advanced to Image. BMG will provide additional quarterly royalty advances so that for thefirst three years of the agreement term, the outstanding royalty advance toImage at any given time will be a constant $3 million.  During the first three quarters of thefourth year of the term, BMG will reduce the outstanding royalty advance toImage to $1.5 million by not re-advancing royalties quarterly.   During the fourth quarter of the fourthyear, BMG may recoup the entire remaining balance of $1.5 million.  The agreement contains a formula to pay anadditional lesser advance at the beginning of the final fifth year which is tobe recouped by BMG in the final year of the term.  Image must repay any outstanding unrecouped royalty advancewithin 30 days following the final BMG reporting at the conclusion of BMG’ssell-off period following the expiration of the five-year term.

 

Retirement of IIC Convertible SubordinatedNote Payable. In March 2003, the Company and Image Investors Co. (“IIC”) reached anagreement to retire early the remaining balance due under Image’s convertiblesubordinated note payable to IIC with a combination of cash and Image commonstock.  IIC is Image’s largestshareholder, and is owned and controlled by John W. Kluge and Stuart Subotnick.

 

To retire theobligation early, the Company paid $1,500,000 in cash, plus accrued interest of$54,000.  Image issued 567,568 shares ofits common stock at $1.85 per share to satisfy the remaining $1,050,000 inprincipal due.  In connection with thepartial conversion of the balance due under the note into common stock, Imageissued IIC a five-year warrant to purchase up to 100,000 more shares at $2.04per share. The warrant is exercisable beginning one year from itsissuance.  The restricted stock will beunregistered and subject to Rule 144 under the Securities Act of 1933, as amended.  IIC will have limited registration rights.  Image recorded a charge of $121,000 as acomponent of other expenses, in the accompanying statement of operations forfiscal 2003 for the estimated fair value of the warrant (valued using theBlack-Scholes valuation model)

 

Conclusion.  Management believes that projected cashflows from operations, borrowing availability under its revolving lines ofcredit, cash on hand and trade credit will provide the necessary capital tomeet the Company’s projected cash requirements for at least the next 12 months.  However, any projections of future cashneeds and cash flows are subject to substantial uncertainty.  See “Forward-Looking Statements.”

 

38

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**ITEM 7A.           QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Market risk is the potential loss arising from adverse changes inmarket rates and prices, such as interest rates and foreign currency exchangerates.  Changes in interest rates and,in the future, changes in foreign currency exchange rates have and will have animpact on our results of operations.

 

**Interest Rate Fluctuations.**  At March 31, 2003, approximately $11.0million of our outstanding borrowings are subject to changes in interest rates;however, we do not use derivatives to manage this risk.  This exposure is linked to the prime rateand LIBOR.  We believe that moderatechanges in the prime rate or LIBOR would not materially affect the operatingresults or financial condition of the Company. For example, a 1% change in interest rates would result in anapproximate $110,000 annual impact on pretax income (loss) based upon thoseoutstanding borrowings at March 31, 2003.

 

**Foreign Exchange Rate Fluctuations.**  At March 31, 2003, approximately $2.7million of our accounts receivables related to international distribution anddenominated in foreign currencies are subject to foreign exchange rate risk inthe future.  We distribute certain ofour licensed DVD and VHS programming (for which the Company has internationaldistribution rights) internationally through international subdistributors andsublicensees.  Additionally, we exploitinternational broadcast rights to its licensed entertainment programming (forwhich we have international broadcast rights). We believe that moderate changes in the foreign exchange rates will notmaterially affect the operation results or financial condition of theCompany.  For example, a 10% change inexchange rates would result in an approximate $270,000 impact on pretax income(loss) based upon those outstanding receivables at March 31, 2003.  To date, the Company has not entered intoforeign currency exchange contracts.

 

39

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**ITEM 8.              FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA.**

 
| **INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**                                                          |
|---------------------------------------------------------------------------------------------------------|
|                                                                                                    |
| Independent Auditors’ Report                                                                       |
|                                                                                                    |
| Consolidated Balance Sheets at March 31, 2003 and 2002                                                  |
|                                                                                                    |
| Consolidated Statements of Operations for  the years ended March 31, 2003, 2002 and 2001                |
|                                                                                                    |
| Consolidated Statements of Shareholders’  Equity for the years ended March 31, 2003, 2002 and 2001 |
|                                                                                                    |
| Consolidated Statements of Cash Flows for  the years ended March 31, 2003, 2002 and 2001                |
|                                                                                                    |
| Notes to Consolidated Financial Statements                                                              |
|                                                                                                    |
| Schedule II – Valuation and Qualifying Accounts for the years ended  March 31, 2003, 2002 and 2001 |

 

40

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**INDEPENDENT AUDITORS’ REPORT**

 

 

The Board of Directors and Shareholders

Image Entertainment, Inc.:

 

 

We have audited the accompanying consolidated financial statements ofImage Entertainment, Inc. and subsidiaries as listed in the accompanyingindex.  In connection with our audits ofthe consolidated financial statements, we also have audited the accompanyingfinancial statement schedule, as listed in the accompanying index.  These consolidated financial statements andfinancial statement schedule are the responsibility of the Company’smanagement.  Our responsibility is toexpress an opinion on these consolidated financial statements and financialstatement schedule based on our audits.

 

We conducted our audits in accordance with auditing standards generallyaccepted in the United States of America. Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the consolidated financial statements arefree of material misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to abovepresent fairly, in all material respects, the financial position of ImageEntertainment, Inc. and subsidiaries as of March 31, 2003 and 2002 and theresults of their operations and their cash flows for each of the years in thethree-year period ended March 31, 2003, in conformity with accountingprinciples generally accepted in the United States of America.  Also, in our opinion, the related financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly, in all materialrespects, the information set forth therein.

 

On April 1, 2002, the Company adopted Financial Accounting StandardsBoard Statement No. 142, *Accounting forGoodwill*.

 

 

/s/ KPMG LLP

 

 

Los Angeles, California

June 13, 2003

 

41

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**CONSOLIDATED BALANCESHEETS**

 

### **March 31**,2003 and 2002

 

**ASSETS**

 
| **(In  thousands)**                                                                |   | **2003** |   | **2002** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Current assets:                                                                    |   |     |   |     |   |
| Cash                                                                               |   | $        | 2,672  |     | $      | 303 |   |
| Accounts receivable, net of allowances of  $6,070 – 2003;  $5,374 – 2002 |   | 20,454   |   | 18,376   |   |
| Inventories (Note 4)                                                               |   | 15,613   |   | 15,663   |   |
| Royalty and distribution fee advances                                              |   | 8,666    |   | 8,065    |   |
| Prepaid expenses and other assets                                                  |   | 803      |   | 1,732    |   |
| Deferred tax assets, net (Note 12)                                                 |   | 1,535    |   | 1,593    |   |
| Total current assets                                                               |   | 49,743   |   | 45,732   |   |
| Noncurrent inventories, principally production  costs (Note 4)                     |   | 2,755    |   | 3,091    |   |
| Noncurrent royalty and distribution  advances                                      |   | 10,118   |   | 10,040   |   |
| Noncurrent deferred tax assets, net (Note  12)                                     |   | 4,709    |   | 2,832    |   |
| Property, equipment and improvements, net  (Notes 5 and 7)                         |   | 6,850    |   | 13,851   |   |
| Other assets                                                                       |   | 320      |   | 355      |   |
| Goodwill, net of accumulated amortization  of  $1,632 – 2002 (Note 1)         |   | —   |   | 5,997    |   |
|                                                                               |   | $        | 74,495 |     | $      | 81,898 |   |

 

*See accompanying notes to consolidated financial statements.*

 

42

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**LIABILITIESAND SHAREHOLDERS’ EQUITY**

 
| **(In  thousands, except share data)**                                                                                                            |   | **2003** |   | **2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Current liabilities:                                                                                                                              |   |     |   |     |   |
| Accounts payable                                                                                                                                  |   | $        | 9,771  |     | $      | 13,902 |   |
| Accrued liabilities                                                                                                                               |   | 2,919    |   | 2,843    |   |
| Accrued royalties and distribution fees                                                                                                           |   | 7,032    |   | 3,827    |   |
| Accrued music publishing fees                                                                                                                     |   | 4,256    |   | 3,193    |   |
| Deferred revenue – BMG (Note 2)                                                                                                              |   | 3,000    |   | —   |   |
| Revolving credit facility (Note 6)                                                                                                                |   | 10,520   |   | 9,834    |   |
| Current portion of long-term debt (Note 6)                                                                                                        |   | 1,591    |   | 2,370    |   |
| Current portion of capital lease  obligations (Note 7)                                                                                            |   | 569      |   | 619      |   |
| Total current liabilities                                                                                                                         |   | 39,658   |   | 36,588   |   |
| Long-term debt, less current portion (Note  6)                                                                                                    |   | 2,816    |   | 11,859   |   |
| Capital lease obligations, less current  portion (Note 7)                                                                                         |   | 356      |   | 943      |   |
| Total liabilities                                                                                                                                 |   | 42,830   |   | 49,390   |   |
| Commitments and Contingencies (Notes 6 and  8)                                                                                                    |   |     |   |     |   |
| Shareholders’ equity (Notes 6, 9 and 10):                                                                                                    |   |     |   |     |   |
| Preferred stock, $1 par value, 3,366,000  shares authorized;  none issued and outstanding                                                         |   | —   |   | —   |   |
| Common stock, no par value, 30,000,000  shares authorized;  18,225,000 and 15,828,000 issued and outstanding  in 2003 and 2002, respectively |   | 32,916   |   | 29,850   |   |
| Additional paid-in capital                                                                                                                        |   | 3,774    |   | 3,463    |   |
| Accumulated deficit                                                                                                                               |   | (5,025   | )      | (805     | )      |
| Net shareholders’ equity                                                                                                                     |   | 31,665   |   | 32,508   |   |
|                                                                                                                                              |   | $        | 74,495 |     | $      | 81,898 |   |

 

*See accompanying notes to consolidated financial statements.*

 

43

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 

### **For the**Years Ended March 31, 2003, 2002 and 2001

 
| **(In  thousands, except per share data)**                                      |   | **2003** |    | **2002** |   | **2001** |   |
|---------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| NET REVENUES                                                                    |   | $        | 108,193 |     | $      | 94,813   |   | $ | 100,033 |   |
|                                                                            |   |     |    |     |   |     |   |
| OPERATING COSTS AND EXPENSES:                                                   |   |     |    |     |   |     |   |
| Cost of sales                                                                   |   | 79,655   |    | 66,640   |   | 70,651   |   |
| Selling expenses                                                                |   | 9,552    |    | 8,858    |   | 8,219    |   |
| General and administrative expenses                                             |   | 12,313   |    | 11,978   |   | 9,916    |   |
| Amortization of production costs                                                |   | 4,287    |    | 5,065    |   | 4,867    |   |
| Amortization of goodwill                                                        |   | —   |    | 509      |   | 509      |   |
|                                                                            |   | 105,807  |    | 93,050   |   | 94,162   |   |
|                                                                            |   |     |    |     |   |     |   |
| EARNINGS FROM OPERATIONS                                                        |   | 2,386    |    | 1,763    |   | 5,871    |   |
|                                                                            |   |     |    |     |   |     |   |
| OTHER EXPENSES (INCOME):                                                        |   |     |    |     |   |     |   |
| Interest expense                                                                |   | 1,454    |    | 1,806    |   | 1,724    |   |
| Other (Notes 3, 5 and 13)                                                       |   | 698      |    | 192      |   | (289     | )      |
|                                                                            |   | 2,152    |    | 1,998    |   | 1,435    |   |
| EARNINGS (LOSS) BEFORE INCOME TAXES AND  CUMULATIVE EFFECT OF ACCOUNTING CHANGE |   | 234      |    | (235     | )      | 4,436    |   |
|                                                                            |   |     |    |     |   |     |   |
| INCOME TAX EXPENSE (BENEFIT) (Notes 12 and  13)                                 |   | 688      |    | (40      | )      | (3,996   | )      |
|                                                                            |   |     |    |     |   |     |   |
| EARNINGS (LOSS) BEFORE CUMULATIVE EFFECT OF  ACCOUNTING CHANGE                  |   | (454     | )       | (195     | )      | 8,432    |   |
|                                                                            |   |     |    |     |   |     |   |
| CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET  OF INCOME TAX BENEFIT OF $2,231    |   | (3,766   | )       | —   |   | —   |   |
|                                                                            |   |     |    |     |   |     |   |
| NET EARNINGS (LOSS)                                                             |   | $        | (4,220  | )        | $      | (195     | )      | $ | 8,432 |   |
|                                                                            |   |     |    |     |   |     |   |
| NET EARNINGS (LOSS) PER SHARE BEFORE  CUMULATIVE EFFECT OF ACCOUNTING CHANGE:   |   |     |    |     |   |     |   |
| Basic                                                                           |   | $        | (.03    | )        | $      | (.01     | )      | $ | .52 |   |
| Diluted                                                                         |   | $        | (.03    | )        | $      | (.01     | )      | $ | .50 |   |
| CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET                                     |   | (.22     | )       | —   |   | —   |   |
|                                                                            |   |     |    |     |   |     |   |
| NET EARNINGS (LOSS) PER SHARE:                                                  |   |     |    |     |   |     |   |
| Basic                                                                           |   | $        | (.25    | )        | $      | (.01     | )      | $ | .52 |   |
| Diluted                                                                         |   | $        | (.25    | )        | $      | (.01     | )      | $ | .50 |   |
|                                                                            |   |     |    |     |   |     |   |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:                                     |   |     |    |     |   |     |   |
| Basic                                                                           |   | 16,812   |    | 15,821   |   | 16,257   |   |
| Diluted                                                                         |   | 16,812   |    | 15,821   |   | 17,637   |   |

 

*See accompanying notes to consolidated financial statements.*

 

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**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY (Notes 6, 9, 10 and 12)**

 

**Forthe Years Ended March 31, 2003, 2002 and 2001**

 
| **(In  thousands)**                                                  |       | **Common Stock** |       | **Additional  Paid-In  Capital** |   | **Accumulated  Deficit** |   |
|----------------------------------------------------------------------|------------|------------------|------------|----------------------------------|--------|--------------------------|--------|
|                                                                 |       |             |       |
|                                                                 | **Shares** |             | **Amount** |                             |   |                     |
| BALANCES, March 31, 2000                                             |       | 16,462           |       | $                                | 31,819 |                     | $      | 3,064 |   | $ | (9,042 | ) |
| Issuance of restricted stock units                                   |       | 35               |       | 246                              |   | —                   |   | — |   |
| Repurchase of common stock                                           |       | (648             | )          | (2,300                           | )      | —                   |   | — |   |
| Elimination of valuation allowance – stock  option compensation |       | —           |       | —                           |   | 256                      |   | — |   |
| Net earnings                                                         |       | —           |       | —                           |   | —                   |   | 8,432 |   |
|                                                                 |       |             |       |                             |   |                     |   |   |   |
| BALANCES, March 31, 2001                                             |       | 15,849           |       | 29,765                           |   | 3,320                    |   | (610 | ) |
| Repurchase of common stock                                           |       | (47              | )          | (114                             | )      | —                   |   | — |   |
| Issuance of restricted stock units                                   |       | 26               |       | 199                              |   | —                   |   | — |   |
| Issuance of stock warrant                                            |       | —           |       | —                           |   | 143                      |   | — |   |
| Net loss                                                             |       | —           |       | —                           |   | —                   |   | (195 | ) |
|                                                                 |       |             |       |                             |   |                     |   |   |   |
| BALANCES, March 31, 2002                                             |       | 15,828           |       | 29,850                           |   | 3,463                    |   | (805 | ) |
| Issuance of common stock                                             |       | 2,369            |       | 2,861                            |   | —                   |   | — |   |
| Issuance of restricted stock units                                   |       | 26               |       | 201                              |   | —                   |   | — |   |
| Exercise of options                                                  |       | 2                |       | 4                                |   | —                   |   | — |   |
| Issuance of stock warrants                                           |       | —           |       | —                           |   | 311                      |   | — |   |
| Net loss                                                             |       | —           |       | —                           |   | —                   |   | (4,220 | ) |
|                                                                 |       |             |       |                             |   |                     |   |   |   |
| BALANCES, March 31, 2003                                             |       | 18,225           |       | $                                | 32,916 |                     | $      | 3,774 |   | $ | (5,025 | ) |

 

*See accompanying notes to consolidated financial statements.*

 

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

### **For the Years Ended March 31, 2003, 2002 and2001**

 
| **(In  thousands)**                                                                                          |   | **2003** |    | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                        |   |     |    |     |   |     |   |
| Net earnings (loss)                                                                                          |   | $        | (4,220  | )        | $      | (195     | )      | $ | 8,432 |   |
| Adjustments to reconcile net earnings  (loss) to net cash  provided by (used  in) operating activities: |   |     |    |     |   |     |   |
| Cumulative effect of accounting change, net  of deferred tax benefit of $2,231                               |   | 3,766    |    | —   |   | —   |   |
| Amortization of production costs                                                                             |   | 4,287    |    | 5,065    |   | 4,867    |   |
| Amortization of goodwill                                                                                     |   | —   |    | 509      |   | 509      |   |
| Depreciation and other amortization                                                                          |   | 2,752    |    | 2,682    |   | 2,128    |   |
| Amortization of stock warrant and  restricted stock units                                                    |   | 394      |    | 286      |   | 255      |   |
| Provision for lower of cost or market  inventory writedowns                                                  |   | 307      |    | 324      |   | 148      |   |
| Provision for estimated doubtful accounts  receivable                                                        |   | 108      |    | 597      |   | 555      |   |
| Impairment charge- Las Vegas, Nevada real  estate                                                            |   | 322      |    | —   |   | (499     | )      |
| Loss on disposal of assets                                                                                   |   | 106      |    | —   |   | —   |   |
| Deferred income taxes – continuing  operations                                                          |   | 412      |    | (171     | )      | (3,998   | )      |
| Changes in assets and liabilities  associated with operating activities:                                     |   |     |    |     |   |     |   |
| Accounts receivable                                                                                          |   | (2,186   | )       | (4,580   | )      | (1,491   | )      |
| Inventories                                                                                                  |   | 187      |    | (778     | )      | 169      |   |
| Royalty and distribution fee advances                                                                        |   | (680     | )       | (4,496   | )      | (4,011   | )      |
| Production cost expenditures                                                                                 |   | (4,395   | )       | (4,743   | )      | (5,925   | )      |
| Prepaid expenses and other assets                                                                            |   | 894      |    | (23      | )      | 134      |   |
| Accounts payable, accrued royalties, fees  and liabilities                                                   |   | 215      |    | 48       |   | 3,805    |   |
| Deferred revenue – BMG                                                                                  |   | 3,000    |    | —   |   | —   |   |
| Net cash provided by (used in) operating  activities                                                         |   | 5,269    |    | (5,475   | )      | 5,078    |   |
|                                                                                                         |   |     |    |     |   |     |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                        |   |     |    |     |   |     |   |
| Capital expenditures                                                                                         |   | (1,847   | )       | (609     | )      | (3,520   | )      |
| Net proceeds from sale of land                                                                               |   | 5,668    |    | —   |   | 1,399    |   |
| Net cash provided by (used in) investing  activities                                                         |   | 3,821    |    | (609     | )      | (2,121   | )      |
|                                                                                                         |   |     |    |     |   |     |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                        |   |     |    |     |   |     |   |
| Borrowings under revolving credit facility                                                                   |   | $        | 106,592 |     | $      | 93,716   |   | $ | 95,555 |   |
| Repayments of borrowings under revolving  credit facility                                                    |   | (106,192 | )       | (86,199  | )      | (103,742 | )      |
| Repayments of long-term debt                                                                                 |   | (8,487   | )       | (1,451   | )      | (172     | )      |
| Principal payments under capital lease  obligations                                                          |   | (637     | )       | (415     | )      | (371     | )      |
| Borrowings under long-term debt                                                                              |   | —   |    | 244      |   | 7,147    |   |
| Issuance of common stock                                                                                     |   | 2,000    |    | —   |   | —   |   |
| Repurchase of common stock                                                                                   |   | —   |    | (114     | )      | (2,300   | )      |
| Other                                                                                                        |   | 3        |    | —   |   | —   |   |
| Net cash (used in) provided by financing  activities                                                         |   | (6,721   | )       | 5,781    |   | (3,883   | )      |
| NET INCREASE (DECREASE) IN CASH:                                                                             |   | 2,369    |    | (303     | )      | (926     | )      |
| Cash at beginning of year                                                                                    |   | 303      |    | 606      |   | 1,532    |   |
| Cash at end of year                                                                                          |   | 2,672    |    | 303      |   | 606      |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                          |   |     |    |     |   |     |   |
| Cash paid during the year for:                                                                               |   |     |    |     |   |     |   |
| Interest                                                                                                     |   | $        | 1,481   |     | $      | 1,311    |   | $ | 1,714 |   |
| Income taxes                                                                                                 |   | $        | 10      |     | $      | —   |   | $ | — |   |

 

*See accompanying notes to consolidated financial statements*

 

46

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SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCINGACTIVITIES:

 

In March 2003, the Company issued 567,568 shares of its unregisteredcommon stock to retire the remaining $1,050,000 in principal due under theconvertible subordinated note payable with Image Investors Co., the Company’slargest shareholder.  In connection withthe partial conversion of the note, the Company issued Image Investors Co. awarrant to purchase up to 100,000 shares of the Company’s unregistered commonstock at $2.04. The fair value of the warrant on the issuance date, $121,000,was calculated using the Black-Scholes valuation model and was recorded asother expenses in the accompanying consolidated statement of operations forfiscal 2003 and additional paid in capital in the accompanying consolidatedbalance sheet at March 31, 2003.  See“Note 6. Debt-Convertible Subordinated Note Payable”.

 

In September 2002, the Company issued Standard Broadcasting CorporationLimited a warrant to purchase up to 270,198 shares of the Company’sunregistered common stock at $1.22 per share. The fair value of the warrant on the issuance date, $189,000, wascalculated using the Black-Scholes valuation model and was recorded inshareholders’ equity as part of the $2.0 million net proceeds of the relatedprivate placement.

 

On July 1, 2002, July 9, 2001 and June 30, 2000, the Company issued19,884, 19,884 and 28,674 shares of common stock, respectively, to officers(net of shares withheld for payment of related income taxes) in connection withthe vesting of restricted stock units. The Company increased common stock at July 1, 2002, July 9, 2001 andJune 30, 2000 by approximately $190,000, $173,000 and $215,000, respectively,such amounts representing the value of the total vested shares as of therespective grant dates less the value of shares withheld for payment of relatedincome taxes on the vesting dates.

 

In October 2001, the Company issued Lighthouse Capital ManagementCorp., a financial consultant, a warrant to purchase 150,000 shares of theCompany’s unregistered common stock at specified price points and valued atapproximately $143,000 using the Black-Scholes valuation model on the issuancedate.  The warrant value was recorded asa component of prepaid expenses and other assets and additional paid-in capitalin the accompanying consolidated balance sheet at March 31, 2002.  See “Note 10.  Stock Awards, Options and Warrants.”

 

In January and October 2001, the Company issued 6,720 shares of commonstock to certain members of the Company’s Board of Directors, respectively, inconnection with the vesting of restricted stock units.  The Company increased common stock inJanuary and October 2001 by approximately $31,000 and $26,000, respectively,the value of the total vested shares as of the grant dates.

 

In July 2001, the Company leased DVD production equipment totaling$915,000.

 

During fiscal 2001, the Company recorded an increase in additionalpaid-in capital of $256,000 which represents the benefit from net operatingloss carryforwards created by the exercise of non-qualified stock optionspreviously exercised.

 

*See accompanying notes to consolidated financial statements*

 

47

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NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

**Note1.  Basis of Presentation and Summary ofSignificant Accounting Policies.**

 

**Basis of Presentation and Principles ofConsolidation.** The accompanying consolidated financial statements include the accountsof Image Entertainment, Inc. (“Image”), its wholly-owned subsidiary,DVDPlanet.com, Inc. (“DVDPlanet”), and Image’s controlled 50%-owned jointventure, Aviva International, LLC (“Aviva”) (collectively, the “Company”).  All significant inter-company balances andtransactions have been eliminated in consolidation.  DVDPlanet was acquired in January 1999 and Aviva was formed inJune 1999.  Aviva ceased activeoperations effective December 31, 2002.

 

**Business.**  The Company is engaged primarily in theworldwide distribution of a broad range of entertainment programming on DVD andin other home entertainment formats under exclusive license and distributionagreements.  To a lesser extent, theCompany also distributes DVD and other types of home entertainment programmingon a nonexclusive basis domestically.

 

**Use of Estimates in Preparation of FinancialStatements.** The preparation of the Company’s consolidated financial statements inconformity with generally accepted accounting principles requires management tomake estimates and assumptions that affect the amounts reported in thefinancial statements.  The significantareas requiring the use of management estimates are related to provisions forlower of cost or market inventory writedowns, doubtful accounts receivables,unrecouped royalty and distribution fee advances and sales returns.  Although these estimates are based onmanagement’s knowledge of current events and actions management may undertakein the future, actual results may ultimately differ from those estimates.

 

**Fair Value of Financial Instruments.**  The carrying amount of the Company’sfinancial instruments, which principally include cash, trade receivables,accounts payable and accrued expenses, approximates fair value due to therelatively short maturity of such instruments.

 

The fair value of the Company’s debt instruments approximate the amountof future cash flows associated with each instrument.  At March 31, 2003 and 2002, the carrying value of all financialinstruments was not materially different from fair value, as the fixed ratedebt approximates rates currently available to the Company.

 

**Revenue Recognition.**  All revenue is recognized upon meeting allthe recognition requirements of American Institute of Certified PublicAccountants Statement of Position (“SOP”) 00-2, *Accounting by Producers or Distributors of Films*.  Revenues from home video distribution arerecognized, net of an allowance for estimated returns, as well as relatedcosts, in the period in which the product is available for sale by theCompany’s customers.  Revenues fromdomestic and international broadcast licensing and home video sublicensing, aswell as associated costs, are recognized when the programming is available tothe licensee and other recognition requirements of SOP 00-2 are met.  Revenue from retail sales is recognized atthe point of sale to the customer. Revenue from wholesale sales of product inventory is recognized at thepoint that title and risk of loss transfer to the customer, which is generallyupon receipt by the customer.  Revenuefrom Internet sales is recognized at the point that title and risk of losstransfer to the customer, which is generally upon receipt by the customer.  Fees received in advance of availability aredeferred until other revenue recognition requirements have been satisfied.  As of March 31, 2003, deferred revenuetotaled $3,855,000.  In all instances,provisions for uncollectible accounts receivable are provided at the time ofsale.

 

**Inventories.**  Inventories consist primarily of finishedproducts for sale (which are stated at the lower of cost or market, with costbeing determined on an average cost basis) and unamortized capitalizedproduction costs.

 

**Production Costs.**  The costs to produce licensed programmingfor domestic and international distribution include the cost of converting filmprints or tapes into the optical disc format. Costs also include menu design, authoring, compression, subtitling,closed captioning, service charges related to disc manufacturing, ancillarymaterial production, product packaging design and related services and theoverhead of the Company’s creative services and production departments.  A percentage of the capitalized productioncosts is amortized to expense each month based upon (i) a projected revenuestream resulting from distribution of new and previously released exclusiveprogramming related to such production costs and (ii) management’s estimate ofthe ultimate net realizable value of the production costs.  Estimates of future revenues are reviewedperiodically and amortization of production costs is adjusted accordingly.  If estimated future revenues are notsufficient to recover the unamortized balance of production costs, such costsare reduced to their estimated net realizable value.

 

**Royalty and Distribution Fee Advances.**  Royalty and distribution fee advancesrepresent fixed minimum payments made to program suppliers for exclusiveprogramming distribution rights.  Aprogram supplier’s share of 

 

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exclusive program distribution revenues is retained by the Companyuntil the share equals the advance(s) paid to the program supplier.  Thereafter, any excess is paid to theprogram supplier.  In the event of anexcess, the Company records, as a cost of sales, an amount equal to the programsupplier’s share of the net distribution revenues.  Royalty and distribution fee advances are charged to operationsas revenues are earned.  Royalty anddistribution fee advances are amortized to expense in the same ratio thatcurrent period revenue for a title or group of titles bear to the estimatedremaining unrecognized ultimate revenue for that title (the“Individual-Film-Forecast-Computation Method”).  Revenue and cost forecasts are continually reviewed by managementand revised when warranted by changing conditions.  When estimates of total revenues and costs indicated that anindividual title or group of cross-collateralized titles which the Companyexploits via home entertainment formats such as home video, CD or broadcast,will result in an ultimate loss, additional amortization is recognized to theextent that capitalized advance royalties and distribution fees exceedestimated fair value in the period when estimated.

 

**Property, Equipment and Improvements.**  Property, equipment and improvements arestated at cost less accumulated depreciation and amortization.  Major renewals and improvements arecapitalized; minor replacements, maintenance and repairs are charged to currentoperations.  Certain costs in developingthe DVDPlanet Web site, as well as costs incurred for the development ofinternal use software associated with operation of Image’s fulfillment anddistribution facility, were capitalized pursuant to the SOP 98-1, *Accounting for Costs of Computer Software Developedor Obtained for Internal Use*. Depreciation and amortization are computed by applying the straight-linemethod over the estimated useful lives of the machinery, equipment and software(3-7 years).  Leasehold improvements areamortized over the shorter of the useful life of the improvement or the life ofthe related lease.

 

**Advertising Costs.**  The Company’s advertising expense comprisesexpenditures related to advertising in trade and consumer publications, productbrochures and catalogs, booklets for sales promotion, radio advertising andother promotional costs.  In accordancewith SOP 93-7, *Reporting on AdvertisingCosts*, the Company expenses advertising costs in the period in whichthe advertisement takes place.  Thecosts of trade and consumer advertising space is capitalized and reported asexpense in the period the space is used. Product brochures and catalogs and certain other promotional costs arecapitalized and amortized over the expected period of future benefit, butgenerally not exceeding six months.  AtMarch 31, 2003 and 2002, prepaid advertising costs for Image were $271,000 and$451,000, respectively.  For fiscal 2003,2002 and 2001, advertising and promotion expense was $2,103,000, $2,623,000 and$2,156,000, respectively.

 

**Market Development Funds.**  In accordance with Emerging Issues TaskForce (“EITF”) 01-09, *Accounting forConsideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts*, the Company has classified market development fundsdeducted from payment for purchases by customers as a reduction torevenues.  All prior periods presentedhave been reclassified to comply with the guidelines of this issue.  Previously, the Company had classifiedmarket development funds as selling expenses in the statement ofoperations.  The following reductions toconsolidated net revenues and selling expenses have been made in accordancewith the guidelines of this issue: $1,886,000 for 2003, $1,019,000 for 2002 and $736,000 for 2001,respectively.

 

**Allowances Received From Vendors.**  In accordance with EITF 02-16, *Accounting by a Customer (Including a Reseller) forCertain Consideration Received from a Vendor*, the Company classifiesconsideration received as a reduction in cost of sales in the accompanyingstatements of operations unless the Company receives an identifiable benefit inexchange for the consideration or the consideration represents a reimbursementof a specific identifiable cost incurred by the Company in selling the vendor’sproduct.

 

**Shipping Income and Expenses.**  In accordance with EITF 00-10, *Accounting for Shipping and Handling Fees and Costs*,the Company classifies amounts billed to customers for shipping fees asrevenues, and classifies costs related to shipping as cost of sales in theaccompanying statements of earnings.

 

**Major Customers.**  On a consolidated basis, Best Buy andMusicland (which was owned by Best Buy through June 16, 2003) togetheraccounted for 20.4% and 19.1% of fiscal 2003 and 2002 net revenues, respectively.  No other customers accounted for more than10% of net revenues in fiscal 2003 and 2002.

 

**Goodwill.**  In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 141, *Business Combinations*,and No. 142, *Goodwill and other IntangibleAssets*.  SFAS No. 141requires that the purchase method be used for all business combinationsinitiated after June 30, 2001.  SFAS No.142 requires that goodwill no longer be amortized to earnings, but instead bereviewed for impairment.  The 

 

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amortization of goodwill ceases upon adoption of SFAS No. 142.  Image adopted the new rules for measuringthe impairment of goodwill and certain intangible assets on April 1, 2002.

 

During its fourth quarter ended March 31, 2002, Image engaged HoulihanLokey Howard & Zukin, an independent financial advisory services company,to prepare certain analyses as a valuation basis for goodwill impairmenttesting and financial reporting purposes. Specifically, they were engaged to express their conclusions as of April1, 2002, regarding (i) the fair value of DVDPlanet (a Reporting Unit as definedby SFAS No. 142) on an enterprise value basis to be used to determine whetherthe carrying value of goodwill is impaired and (ii) the fair value of thematerial identifiable intangible assets and goodwill of DVDPlanet for use indetermining the amount of goodwill impairment.

 

Based on their findings, the carrying value of Image’s acquiredgoodwill was determined to be impaired pursuant to the new valuation guidelinesof SFAS No. 142.  The adoption of SFASNo. 142 resulted in a charge of $3,766,000, or $.22 per diluted share, net ofan income tax benefit of $2,231,000. The impairment charge is recorded as a cumulative effect of a change inaccounting principle, net of the income tax benefit, in the accompanyingconsolidated statement of operations for fiscal 2003.  As a result of this writedown, DVDPlanet has no remaining goodwill.  Prior to the adopting the new valuationguidelines of SFAS No. 142, the Company accounted for goodwill under SFAS No.121.  Under SFAS No. 121, projectedundiscounted cash flows expected from DVDPlanet exceeded the recorded carryingvalue of DVDPlanet.  Accordingly, theCompany did not have impairment of goodwill at March 31, 2002.

 

**Long-Lived Assets.**  The Company reviews for the impairment oflong-lived and certain identifiable intangible assets whenever events orchanges in circumstances indicate the carrying amount of an asset may not berecoverable.  An impairment loss wouldbe recognized when estimated undiscounted future cash flows expected to resultfrom the use of the asset and its eventual disposition is less than itscarrying amount.  Prior to the ultimatesale of the Company’s Las Vegas, Nevada distribution facility and adjacentvacant land, the Company wrote down the net book value of the land and buildingto approximate the estimated sales price less estimated related transactionalcosts.  The impairment charge totaled$322,000 and is included as a component of other expenses in the accompanyingstatement of operations for fiscal 2003. See “Note 5.  Property,Equipment and Improvements.”  Noimpairment charge was recorded at March 31, 2002.

 

**Foreign Currency Transactions.**  Foreign currency denomination transactionsare recorded at the exchange rate in effect at the time of occurrence, and thegains or losses resulting from subsequent translation at current exchange ratesare included as a component of other income and expenses in the accompanyingstatements of operations.

 

**Income Taxes.**  The Company accounts for income taxespursuant to the provisions of SFAS No. 109, *Accountingfor Income Taxes*, whereby deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amount of existing assets and liabilities andtheir respective tax bases and the future tax benefits derived from operatingloss and tax credit carryforwards.  TheCompany provides a valuation allowance on its deferred tax assets when there isan uncertainty regarding their future realizability.

 

**Earnings Per Share.**  Basic earnings per share is computed usingthe weighted average number of common shares outstanding during theperiod.  Diluted earnings per share iscomputed using the combination of dilutive common share equivalents and theweighted average shares outstanding during the period.

 

**Comprehensive Income.**  Comprehensive income is the change in equityof a business enterprise during a period resulting from transactions and allother events and circumstances from non-owner sources.  The Company did not have components ofcomprehensive income other than net earnings, during the three years endedMarch 31, 2003.

 

**Stock Options.**  The Company accounts for its stock optiongrants in accordance with the provisions of Accounting Principles Board (“APB”)Opinion No. 25, *Accounting for Stock Issuedto Employees*, and related interpretations including FASBInterpretation No. (“FIN”) 44, *Accountingfor Certain Transactions Involving Stock Compensation*.  As such, compensation expense is generallyrecorded on the date of grant only if the current market price of theunderlying stock exceeded the exercise price or in connection with themodification to outstanding awards and/or changes in grantee status. Noemployee stock option compensation expense is reflected in the consolidated netearnings (loss) from continuing operations, as all options granted under thoseplans had an exercise price equal to the market value of the underlying commonstock on the date of grant.   Total 

 

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compensation cost recognized for stock-based employee compensationawards under restricted stock grants, net of cancellations, is added back tothe consolidated net earnings (loss), and reported in the table below.

 

Compensation expense related to stock optionsgranted to non-employees is accounted for under SFAS No. 123, *Accounting for Stock-Based Compensation*which requires entities to recognize an expense based on the fair value of therelated awards.  The following tableillustrates the effect on the consolidated net earnings (loss) and basic anddiluted net earnings (loss) per share if the Company had applied the fair valuerecognition provisions of SFAS No. 123 to stock-based employee compensation forthe three years ended March 31, 2003:

 
| **(In thousands, except per share  data)**                                                                                                          |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                                                                                |   |     |   |     |   |     |   |
| Consolidated net earnings (loss), as  reported                                                                                                      |   | $        | (4,220 | )        | $      | (195     | )      | $ | 8,432 |   |
| 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 |   | (195     | )      | (296     | )      | (259     | )      |
|                                                                                                                                                |   |     |   |     |   |     |   |
| Pro forma consolidated net earnings (loss)                                                                                                          |   | $        | (4,415 | )        | $      | (491     | )      | $ | 8,173 |   |
|                                                                                                                                                |   |     |   |     |   |     |   |
| Consolidated net earnings (loss) per share:                                                                                                         |   |     |   |     |   |     |   |
| As reported                                                                                                                                         |   |     |   |     |   |     |   |
| Basic                                                                                                                                               |   | $        | (.25   | )        | $      | (.01     | )      | $ | .52 |   |
| Diluted                                                                                                                                             |   | $        | (.25   | )        | $      | (.01     | )      | $ | .50 |   |
| Pro forma                                                                                                                                           |   |     |   |     |   |     |   |
| Basic                                                                                                                                               |   | $        | (.26   | )        | $      | (.03     | )      | $ | .50 |   |
| Diluted                                                                                                                                             |   | $        | (.26   | )        | $      | (.03     | )      | $ | .46 |   |

 

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

 
|                  |   | **2003** |   | **2002** |   | **2001** |   |
|-----------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected life (years) |   | 5.0      |   | 5.0      |   | 5.0      |   |
| Interest rate         |   | 1.20     | %      | 3.91     | %      | 5.25     | %      |
| Volatility            |   | 79       | %      | 83       | %      | 73       | %      |
| Dividend yield        |   | 0.00     | %      | 0.00     | %      | 0.00     | %      |

 

**Recently Issued Accounting Standards.**  In June 2001, FASB issued SFAS No. 141, *BusinessCombinations*, and SFAS No. 142, *Goodwill and Other Intangible Assets*.  SFAS No. 141 requires that the purchasemethod be used for all business combinations initiated after June 30,2001.  SFAS No. 142 requires thatgoodwill no longer be amortized to earnings, but instead be reviewed forimpairment.  The amortization ofgoodwill ceases upon adoption of SFAS No. 142. Image adopted the new rules for measuring the impairment of goodwill andcertain intangible assets on April 1, 2002. The adoption of SFAS No. 142 resulted in a one-time, noncash, charge of$3,766,000, or $.22 per diluted share, net of an income tax benefit of$2,231,000.  The impairment charge isrecorded as a cumulative effect of a change in accounting principle, net of thetax benefit, in the accompanying consolidated statement of operations forfiscal 2003.  As a result of thiswritedown, DVDPlanet has no remaining goodwill.

 

The following table summarizes the impact of the implementation of SFASNo. 142 on the Company’s statements of operations:

 

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| **(In thousands, except per share  data)**                                                                                 |   | **2003** |   | **Fiscal  Year-Ended   March 31,  2002** |   | **2001** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|------------------------------------------|--------|----------|--------|
|                                                                                                                       |   |     |   |                                     |   |     |   |
| Reported earnings (loss) before cumulative  effect of accounting change                                                    |   | $        | (454   | )                                        | $      | (195     | )      | $ | 8,432 |   |
| Add back: goodwill amortization, net of  related $87,000 and $245,000 tax benefits for fiscal 2002 and 2001,  respectively |   | —   |   | 422                                      |   | 264      |   |
| Adjusted earnings (loss) before cumulative  effect of accounting change                                                    |   | (454     | )      | 227                                      |   | 8,696    |   |
| Cumulative effect of accounting change, net  of tax benefit of $2,231                                                      |   | (3,766   | )      | —                                   |   | —   |   |
| Adjusted net earnings (loss)                                                                                               |   | $        | (4,220 | )                                        | $      | 227      |   | $ | 8,696 |   |
|                                                                                                                       |   |     |   |                                     |   |     |   |
| Diluted earnings (loss) per share:                                                                                         |   |     |   |                                     |   |     |   |
| Reported earnings (loss) before cumulative  effect of accounting change                                                    |   | $        | (.03   | )                                        | $      | (.01     | )      | $ | .50 |   |
| Goodwill amortization, net of tax benefit                                                                                  |   | —   |   | .03                                      |   | .01      |   |
| Adjusted earnings (loss) before cumulative  effect of accounting change                                                    |   | (.03     | )      | .02                                      |   | .51      |   |
| Cumulative effect of accounting change                                                                                     |   | (.22     | )      | —                                   |   | —   |   |
| Adjusted net earnings (loss) per share                                                                                     |   | $        | (.25   | )                                        | $      | .02      |   | $ | .51 |   |

 

In August 2001, the FASB issued SFAS No. 144, *Accounting for the Impairment orDisposal of Long-Lived Assets*, which supersedes both SFAS No. 121, *Accountingfor the Impairment of Long-Lived Assets and for Long-Lived Assets to beDisposed Of* and the accounting and reporting provisions ofAccounting Principles Board Opinion No. 30 (“APB No. 30”), *Reporting the Results of Operations -Reporting the Effects of Disposal of a Segment of a Business, andExtraordinary, Unusual and Infrequently Occurring Events and Transactions*,for the disposal of a segment of a business (as previously defined in thatOpinion).  SFAS No. 144 retains thefundamental provisions of SFAS No. 121 for recognizing and measuring impairmentlosses on long-lived assets held for use and long-lived assets to be disposedof by sale, while also resolving significant implementation issues associatedwith SFAS No. 121.  The Company adoptedthe provisions of SFAS No. 144 during the quarter ended June 30, 2002.  The adoption of SFAS No. 144 did not have amaterial impact on the Company’s financial statements because the impairmentassessment under SFAS No. 144 is largely unchanged from SFAS No. 121.

 

On July 30, 2002, the FASB issued SFAS No. 146, *Accounting for Costs Associated withExit or Disposal Activities.* SFAS No. 146 nullifies EITF Issue No. 94-3, *Liability Recognition for CertainEmployee Termination Benefits and Other Costs to Exit an Activity (includingCertain Costs Incurred in Restructuring).*  SFAS No. 146 requires that a liability be recognized for thosecosts only when the liability is incurred, that is, when it meets thedefinition of a liability in FASB’s conceptual framework.  SFAS No. 146 also establishes a fair valueas the objective for initial measurement of liabilities related to exit ordisposal activities.  SFAS No. 146 iseffective for exit or disposal activities that are initiated after December 31,2002.  The adoption of SFAS No. 146 didnot have a material impact on the Company’s financial position or results ofoperations.

 

InNovember 2002, the FASB issued Interpretation Number 45, *Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*(FIN 45). This interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantoris required to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee. Thedisclosure requirements of FIN 45 are effective for interim and annual periodsbeginning after December 15, 2002. The initial recognition and initialmeasurement requirements of FIN 45 are effective prospectively for guaranteesissued or modified after December 31, 2002. The adoption of the recognition andinitial measurement requirements of FIN 45 did not have a material impacton the Company’s financial position, cash flows or results of operations.

 

In December2002, the FASB issued SFAS No. 148, *Accountingfor Stock-Based Compensation-Transition and Disclosure-an amendment of FASB No.123*.  SFAS No. 148 amendsSFAS No. 123, *Accounting for Stock-BasedCompensation*, to provide alternative methods of transition for avoluntary change to the fair value based method of accounting for stock-basedemployee compensation. In addition, SFAS No. 148 amends the disclosurerequirements of SFAS No. 123 to require prominent disclosures in both annualand interim financial statements about the method of accounting for stock-basedemployee compensation and the effect of the method used on reported results.  The disclosure requirements shall beeffective for financial statements for fiscal years ending after December 15,2002.  The interim disclosure provisionsare effective for financial statements for interim periods beginning afterDecember 15,

 

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2002. The Company adopted the disclosure of provisions of SFAS No. 148 in thethird quarter of fiscal 2003 and required disclosures are included herein.

 

In January 2003, the FASB issued FIN 46, *Consolidation of Variable Interest Entities. *This interpretation clarifies the application of Accounting Research Bulletin No. 51, *Consolidated Financial Statements*, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The recognition and measurement provisions of FIN 46 are effective for newly created variable interest entities formed after January 31, 2003, and for existing variable interest entities on the first interim or annual reporting period beginning after June 15, 2003. We do not expect the adoption of FIN 46 to have a material impact on our consolidated financial statements.

 

In March 2003, the EITF reached a consensus on Issue No. 02-16, *Accounting by a Customer (including a Reseller) forConsideration Received from a Vendor*.  According to EITF No. 02-16, vendor allowances are to berecognized as a reduction in cost of sales, unless the allowance represents areimbursement of a specific, incremental and identifiable cost incurred to sellthe vendor’s products.  This guidance isconsistent with the Company’s recording of consideration received from avendor.

 

In April 2003, the FASB issued SFAS No. 149, *Amendment of Statement 133 on Derivative Instruments and Hedging Activities.*  SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, *Accounting for Derivative Instruments and Hedging Activities*. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, except for certain hedging relationships designated after June 30, 2003.  Since we do not currently transact in such instruments nor undertake hedging transactions, we do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity*.  SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003.  We do not expect the adoption of this statement to have a material impact on our financial condition or results of operations.

 

**Reclassifications.**  Certain fiscal 2002 balances have beenreclassified to conform with the fiscal 2003 presentation.

 

**Note2.  International Video and BroadcastDistribution.**

 

**Change in International Video Distribution. **In January 2003, Image entered into anexclusive five-year international DVD sublicense agreement with BertelsmannMusic Information Services, GmbH for the exclusive distribution of Image’svideo programming, primarily DVD, throughout Europe, the Middle East (excludingIsrael and Turkey) and Africa upon the expiration of Image’s currentinternational subdistribution agreements. The agreement was later amended to change the licensing party fromBertelsmann Music Information Services GmbH to BMG Music International Service,GmbH (“BMG”).

 

Image’s DVDprogramming has historically been distributed in Europe and South Africathrough a network of independent subdistributors and studios, includingBMG.  The subdistribution terms of allterritories expired on March 31, 2003, except France, which will expire June30, 2003, and Spain, which will expire December 31, 2003.

 

BMG will beresponsible for all sales marketing, manufacturing and distribution of Image’sprogramming in the territories.  BMGbegan releasing Image’s new release DVD programming in March 2003.  There were approximately 100 Image DVDcatalogue titles in release throughout the new BMG sublicense territories.  In April 2003, Image and BMG structured amarketing and re-release plan focusing on reintroducing Image’s catalogueprogramming into the international marketplace under the BMG label.

 

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Image receiveda $3.0 million royalty advance under the BMG agreement in March 2003, fullyrecoupable from revenues generated by BMG against quarterly royalties due toImage under the agreement.  Based uponactual quarterly sales of Image programming in the territories, BMG will recoupquarterly royalties from the $3.0 million previously advanced to Image.  BMG will provide additional quarterlyroyalty advances so that for the first three years of the agreement term, theoutstanding royalty advance to Image at any given time will be a constant $3.0million.  The Company used the $3.0 millionreceived to pay down its outstanding borrowings under its revolving creditfacility with Wells Fargo Foothill. During the first three quarters of the fourth year of the term, BMG willreduce, through recoupment, the outstanding royalty advance to Image to $1.5million.  Once the entire royaltyadvance is recouped, BMG will continue to pay quarterly royalties to Imagebased on revenues generated.  During thefourth quarter of the fourth year, BMG may recoup the entire remaining balanceof $1.5 million by not re-advancing royalties quarterly.  The agreement contains a formula to pay anadditional lesser advance at the beginning of the fifth and final year of theterm which is to be recouped by BMG during that year.  Image must repay any outstanding unrecouped royalty advancewithin 30 days following the final BMG reporting at the conclusion of BMG’ssell-off period following the expiration of the five-year term.

 

To facilitatean orderly transition to BMG from our previous network of independent subdistributors,the Company contractually elected to purchase any product inventory from oursubdistributors (including any of their customer returns) upon the expirationof their respective terms (plus an additional time period to allow for theircustomer returns) rather than allow the subdistributors to exercise a six-monthnonexclusive sell-off period.

 

Under the BMGagreement, BMG has committed to purchase the Company’s international DVDinventory, which would include any inventory repurchased from the subdistributors,at the Company’s manufacturing price (for disc and case only—excluding bookletsand inserts).  The Company recorded acharge for the three months ended March 31, 2003 of $174,000, to provide forthe difference between the ultimate purchase price of the inventory paid orcredited to the subdistributors upon the expiration of their respective termsand the manufacturing cost paid to the Company by BMG for that inventory.  At March 31, 2003, the Company has anaccrual for estimated subdistributor returns resulting in a reduction ofrevenues and gross profit margin of $831,000 and $278,000, respectively, andaccrued for the writedown (to BMG purchase cost) of the estimated inventory tobe returned by the subdistributors, as well as inventory held at Germanmanufacturing facility, representing an incremental charge to cost of sales of$202,000 during the fourth quarter ended March 31, 2003.

 

The Company’saccounting will differ under the BMG agreement because it is a sublicenseagreement, rather than the subdistribution agreements previously in place.  Under its subdistribution agreements, Imagerecorded net revenues based upon the selling price of its programming sold toits distribution network customers. Image recorded as cost of sales, the actual manufacturing/packagingcost, shipping cost, royalties/distribution fees and music publishing.  Under the BMG agreement, Image recordsroyalty income as revenue based upon royalties it receives from BMG.  Revenue will be recorded in the period inwhich the product is sold by BMG.  Imagewill report as cost of goods sold, the royalties or distribution fees it willowe its licensors or program suppliers as calculated against the royaltiesImage receives from BMG.

 

**Change in International BroadcastExploitation.  **InJanuary 2003, the Company entered into a five-year sales agency agreement withLondon-based NBD Television LTD (“NBD”). NBD is the Company’s exclusive sales agent for worldwide broadcasttelevision sales for Image’s current catalogue of broadcast programming (inexcess of 60 programs) and new release broadcast acquisitions.  NBD also represents the Company forconventional television broadcast sales including cable, pay-per-view andvideo-on-demand; satellite television; and sales to non-theatrical venues.  Internet rights are excluded from theagreement including video-on-demand via the Internet and digital downloadingand streaming.  Programs that arecurrently licensed to other parties will be handled by NBD upon the expirationof the existing licenses.  NBD willretain a percentage-based commission and other expenses from the sales itgenerates on the Company’s behalf and will remit the balance to the Company ona quarterly basis.

 

**Note 3. Aviva International, LLC.**

 

In June 1999, Image formed Aviva International, LLC (“Aviva”) withMichael Lopez, President of International Consulting & BusinessManagement.  Aviva is 50% owned by eachof Image and Mr. Lopez.  Prior to December31, 2002, Aviva acted as international sales agent for Image’s licensed programmingfor which it holds distribution rights for worldwide broadcast andinternational home video.  Mr. Lopezserved as Manager of Aviva and supervised the day-to-day operations.  Aviva receives a percentage of the netdistribution revenues generated by the 

 

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exploitation of Image’s international distribution rights (representing100% of Aviva’s revenues).  Both Imageand Mr. Lopez have contributed funds to Aviva in the form of interest-bearingloans to be used for working capital. Mr. Lopez remains contingently liable for his share of the obligationsof Aviva.  The Aviva loan payable toImage totaled approximately $168,000 at March 31, 2003.  Loans from Image and Mr. Lopez are beingrepaid by Aviva prior to any profit distributions to Image or Mr. Lopez.  Although Image owns only 50% of the jointventure, it exercises control over the operations of Aviva.  Image had final approval for all hiring,capital budgeting and expenditure decisions. Image had final approval for all negotiated international exploitationagreements for Image-licensed programming and the authority to compel Aviva toadd/reduce staff or reorganize the operations of the joint venture.  Accordingly, Aviva’s operating profits andlosses, since its formation, are consolidated with the Company’s consolidatedstatements of operations for the fiscal years ended March 31, 2003, 2002, and2001; and a minority interest representing Mr. Lopez’s share of profits andlosses is reflected in the Company’s consolidated financial statements.  The financial results of Aviva and theinternational operations of Image have been consolidated for segment reportingpurposes under the operating segment International Wholesale Distribution.

 

Other expenses in the accompanying statements of operations for fiscal2003 and fiscal 2001 reflects minority interest expenses of $573,000 and$31,000, respectively, representing Aviva’s share of operating income of$954,000 and $52,000, respectively. Other income for fiscal 2002 reflects minority interest income of$18,000 representing Aviva’s share of operating expenses of $30,000.

 

During the quarter ended December 31, 2002, Image completed theconsolidation of Aviva’s international wholesale home video broadcast and sublicensedistribution activities into Image because management believed that itsexisting infrastructure, sublicensing of European DVD distribution to BMG andappointing of NBD as its exclusive worldwide broadcast sales agent could moreeffectively and efficiently manage international distribution operations ratherthan shared responsibility with the staff at Aviva.  Through the nine months ended December 31, 2002, Aviva downsizedoperations, reduced staff and transferred international home video sublicenseand broadcast sales responsibilities to Image. Aviva continues to receive its percentage of net revenues generated bythe exploitation of Image’s international distribution rights (excluding rightsexploited by BMG and NBD) until its debt obligations to Image and Mr. Lopez arefully repaid.  Management expects theloans to be repaid out of Aviva’s share of the internationally generatedrevenues by December 31, 2003.  Severancecosts related to staff reductions at Aviva totaled approximately $29,000 and wereaccrued as selling and general and administrative expenses in the accompanyingstatements of operations for fiscal 2002. Image remains financially responsible for monthly lease payments of$4,000 on Aviva’s Belmont, California leased office space throughOctober 31, 2003, the end of the lease term.  The Company is subleasing the space through the reminder of thelease period and has accrued the loss on the shortfall between sublease incomeand the rent expense.

 

**Note4.  Inventories.**

 

Inventories at March 31, 2003 and 2002 are summarized as follows:

 
| **(In thousands)**                                    |   | **2003** |   | **2002** |   |
|-------------------------------------------------------|--------|----------|--------|----------|--------|
| DVD                                                   |   | $        | 11,806 |     | $      | 12,485 |   |
| Other                                                 |   | 820      |   | 635      |   |
|                                                  |   | 12,626   |   | 13,120   |   |
| Production costs, net                                 |   | 5,742    |   | 5,634    |   |
|                                                  |   | 18,368   |   | 18,754   |   |
| Less current portion of inventories                   |   | 15,613   |   | 15,663   |   |
| Noncurrent inventories, principally  production costs |   | $        | 2,755  |     | $      | 3,091 |   |

 

Production costs are net of accumulated amortization of $14,462,000 and$10,959,000 at March 31, 2003 and 2002, respectively.  The Company expects to amortize approximately 91.8% of the March31, 2003 unamortized production costs by March 31, 2006.

 

**Note 5. Property, Equipment and Improvements.**

 

**Saleand Leaseback of Land and Distribution Facility.**  On September 3, 2002, Image entered into anagreement with Spencer Street Investors, LLC, an affiliate of RDS Investment& Development, LLC, an unrelated real estate developer, to sell andleaseback its Las 

 

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Vegas, Nevada distribution facility andadjacent vacant land.  On November 8,2002, escrow on the sale closed for approximately 8.11 acres, consisting ofImage’s 76,000 square foot warehouse and distribution facility on 4.04 acres,and the adjacent 4.07 acres of vacant land for $6.0 million.

 

Image receivednet proceeds of approximately $3.0 million, after deducting transactional costs(such as sales commissions and escrow fees, etc.) and approximately $2.7million which was paid to Bank of America in Nevada to retire the Company’srevolving credit facility that was secured by the real estate sold.

 

The Companywrote down the net book value of the land and building to approximate the salesprice less the estimated related transactional costs.  The impairment charge totaled $322,000 and is included as acomponent of other expenses in the accompanying statement of operations forfiscal 2003.  The gain on the salestransaction was nominal.

 

On November 8,2002, Image entered into two lease agreements with the buyer: a ten-yearbuilding lease for the existing warehouse and distribution facility with threefive-year extension options, and a five-year lease for the adjacent vacant landwhich may be used for future expansion of the warehouse and distributionfacility, if necessary.  The monthly rentunder the warehouse and distribution facility lease is $38,000.  This lease contains annual 3.0% rentescalations.  The monthly rent under thevacant land lease is $9,000 per month. The monthly rent approximates market rent charged for like properties inthe Las Vegas, Nevada area.

 

In August 2000, the Company sold the approximately 4.7 acres of excessvacant land adjacent to the Company’s then-8.11 acre distribution andfulfillment facility site in Las Vegas, Nevada for net proceeds ofapproximately $1,399,000.  The resultingpretax gain on sale of $499,000 was recorded as other income in theaccompanying consolidated statement of operations for the year ended March 31,2001.

 

Property, equipment and improvements at March 31, 2003 and 2002 aresummarized as follows:

 
| **(In thousands)**                              |   | **2003** |   | **2002** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| Machinery, equipment and software               |   | $        | 15,652 |     | $      | 16,151 |   |
| Land                                            |   | —   |   | 2,033    |   |
| Building                                        |   | —   |   | 4,487    |   |
| Leasehold improvements                          |   | 1,026    |   | 794      |   |
| Other                                           |   | 383      |   | 374      |   |
|                                            |   | 17,061   |   | 23,839   |   |
| Less accumulated depreciation and  amortization |   | 10,211   |   | 9,988    |   |
|                                            |   | $        | 6,850  |     | $      | 13,851 |   |

 

**Note6.  Debt.**

 

**Revolving Credit and Term Loan Facilities.**  In September 2002, the Company and WellsFargo Foothill, formerly Foothill Capital Corporation (“Foothill”), furtheramended its Loan and Security Agreement dated December 28, 1998, asamended.  The maximum borrowing limitfor the revolving credit facility component of the Foothill agreement wasraised from $15,000,000 to $17,000,000; and the agreement term was extendedthrough December 29, 2005 (the agreement contains an automatic renewalprovision for successive one-year periods thereafter unless terminated byeither party).  Borrowings under theagreement are limited to the “borrowing base”, as defined therein, are securedby substantially all of the Company’s assets and bear interest at the lender’sprime rate plus .75%.  At March 31,2003, borrowings bore interest at the higher Foothill agreement interest rate‘floor” of 5.75%, per annum and payable monthly.  At March 31, 2003, the Company had $10,520,000 outstanding underthe Foothill revolving credit facility. The Company had no borrowings outstanding under its Foothill $1,000,000capital expenditures facility at March 31, 2003.  At March 31, 2003, the Company had borrowing availability of$6,527,000 under the revolving credit facility (based on its borrowing base),net of $150,000 reserved for a standby letter of credit to a product supplier,and $1,000,000 under the term loan facility.

 

The agreement imposes restrictions on such items as encumbrances andliens, payment of dividends, other indebtedness, stock repurchases and capitalexpenditures.  The agreement alsorequires the Company to comply with certain financial and operatingcovenants.  Effective beginning with theCompany’s fiscal third quarter ended December 31, 2002,

 

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the Company and Foothill have further amended the agreement requiringImage to achieve a cumulative minimum earnings before interest, taxes,depreciation and amortization, as defined (“EBITDA”) and a minimum level oftangible net worth, as defined.  Theamended EBITDA covenant is no longer a minimum cumulative (twelve-month)quarterly measurement but rather a stand-alone quarterly minimum measurement.  The amended EBITDA and tangible net worthcovenant levels for the three months ended March 31, 2003 were $1,163,000and $21,805,000, respectively.  At March31, 2003, the Company was in compliance with all financial and operatingcovenants.

 

**Subordinated Note Payable – Ritek Taiwan.**  In March 2002, the Company amended theprovisions of its note payable with Ritek Corporation, a Taiwanese Corporationand former parent of Ritek Global Media (now Deluxe Global Media Services – theCompany’s exclusive DVD and CD manufacturer). The amended note is payable in equal monthly installments ofapproximately $111,000 plus accrued interest at the fixed rate of 6% per annumthrough its maturity on March 1, 2006. Outstanding balances under the note are subordinate to all of Image’ssenior debt obligations and all replacements and refinancing of such debt.  At March 31, 2003, $3,898,000 wasoutstanding under the note.

 

**Real Estate Credit Facility.**  In conjunction with the November 2002closing of the Company’s sale and lease back of its Las Vegas, Nevadadistribution facility and adjacent vacant land, the Company repaid theapproximate $2.7 million in outstanding borrowings to retire its revolvingcredit facility with Bank of America National Trust and Savings Association inNevada (which was secured by the real estate sold).

 

**Note Payable to Bank.**  On June 28, 2000, Image entered into aBusiness Loan Agreement with Bank of America, N.A. in Nevada for an equipmentline of credit.  On September 30, 2001,this line was converted into a note payable. Outstanding borrowings are repaid in equal monthly installments throughFebruary 28, 2005 and bear interest at LIBOR plus 2.50% (3.81% at March 31,2003), per annum, payable monthly. Outstanding borrowings are secured by the related equipmentpurchased.  Image had $509,000 outstandingunder this note at March 31, 2003.

 

**Convertible Subordinated Note Payable.**  In March 2003, the Company and ImageInvestors Co. (“IIC”) entered into a Termination and Exchange Agreement whichterminated the September 29, 1997 Credit Agreement.  IIC is Image’s largest shareholder, and is owned and controlledby John W. Kluge and Stuart Subotnick. The Termination Agreement early retiresthe remaining balance due under the convertible subordinated note payable toIIC with a combination of cash and Image common stock.

 

To retire the obligation early, the Company paid $1,500,000 in cash,plus accrued interest of $54,000.  Imageissued 567,568 shares of its common stock at $1.85 per share to satisfy theremaining $1,050,000 in principal due. In connection with the partial conversion of the balance due under thenote into common stock, Image issued IIC a five-year warrant to purchase up to100,000 more shares at $2.04 per share. The warrant is exercisable beginningone year from its issuance.  Therestricted stock will be unregistered and subject to Rule 144 under theSecurities Act of 1933, as amended.  IICwill have limited registration rights. Image recorded a charge of $121,000 as a component of other expenses inthe accompanying statement of operations for fiscal 2003 for the estimated fairmarket value of the warrant (valued using the Black-Scholes valuation model).

 

Long-term debt at March 31, 2003 and 2002 consists of the following:

 
| **(In thousands)**                               |   | **2003** |   | **2002** |   |
|--------------------------------------------------|--------|----------|--------|----------|--------|
| Subordinated note payable – Ritek Taiwan    |   | $        | 3,898  |     | $      | 5,347 |   |
| Note payable to bank                             |   | 509      |   | 763      |   |
| Convertible subordinated note payable – IIC |   | —   |   | 5,000    |   |
| Real estate credit facility                      |   | —   |   | 2,833    |   |
| Term loan facility – Foothill               |   | —   |   | 286      |   |
|                                             |   | 4,407    |   | 14,229   |   |
| Current portion of long-term debt                |   | 1,591    |   | 2,370    |   |
|                                             |   |     |   |     |   |
| Long-term debt less current portion              |   | $        | 2,816  |     | $      | 11,859 |   |

 

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The following is a schedule by year of required minimum debt principalpayment and maturities under the Company’s debt agreements above:

 
| **(in thousands)  Fiscal** |   | **Amount** |   |
|----------------------------|--------|------------|--------|
| 2004                       |   | $          | 1,591  |   |
| 2005                       |   | 1,591      |   |
| 2006                       |   | 1,225      |   |
|                       |   | $          | 4,407  |   |

 

**Note7.  Capital Lease Obligations.**

 

Image’s Lease Intended as Security Agreement with BankAmerica Leasingand Capital Corporation provided for advances to purchase distributionmachinery and equipment utilized in the Company’s Las Vegas, Nevadadistribution facility.  There were$340,000 in borrowings outstanding under the lease at March 31, 2003.  Outstanding borrowings are repaid inquarterly installments through October 1, 2003, down to a $1 purchase option,bearing interest at 7.72% per annum. The lease is accounted for as a capital lease.

 

Borrowings under this agreement are secured by the underlying equipmentleased.  The lease contains cross-defaultprovisions with other borrowing agreements and early termination charges.  This agreement requires the Company to meetthe same quarterly financial and operating covenants contained in the revolvingline with Bank of America National Trust and Savings Association above.  At March 31, 2003, the Company was incompliance with all such financial and operating covenants.

 

The Company’sJuly 2001 capital lease agreement with General Electric Capital Corporationbears interest at a fixed 7.58% per annum, payable monthly and expiresSeptember 2005.  At March 31, 2003,$585,000 was outstanding under the lease.

 

Machinery and equipment under capital leases at March 31, 2003 and 2002are summarized as follows:

 
| **(In thousands)**                              |   | **2003** |   | **2002** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| Machinery, equipment and software               |   | $        | 2,686  |     | $      | 2,686 |   |
| Less accumulated depreciation and  amortization |   | 1,405    |   | 968      |   |
|                                            |   | $        | 1,281  |     | $      | 1,718 |   |

 

Future minimum lease payments by year at March 31, 2003 for propertyunder capital leases are as follows:

 
| **Fiscal**                                            |   | **Amount**         |   |
|-------------------------------------------------------|--------|--------------------|--------|
|                                                  |   | **(in thousands)** |   |
| 2004                                                  |   | $                  | 619    |   |
| 2005                                                  |   | 266                |   |
| 2006                                                  |   | 111                |   |
| Total minimum lease payments                          |   | 996                |   |
| Less amount representing interest at 7.58%  and 7.72% |   | 71                 |   |
| Present value of minimum lease payments               |   | 925                |   |
| Less current portion                                  |   | 569                |   |
| Noncurrent portion                                    |   | $                  | 356    |   |

 

**Note8.  Commitments and Contingencies.**

 

**Operating Leases.**

 

The Companyleases corporate headquarters for Image, DVDPlanet and Aviva as well as Image’sdistribution facility and adjacent land in Las Vegas, Nevada under operatingleases.  Future minimum annual rentalpayments by year under operating leases at March 31, 2003 are approximately asfollows:

 

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| **Fiscal** |   | **Amount**         |     |
|------------|--------|--------------------|----------|
|       |   | **(in thousands)** | * * |
| 2004       |   | $                  | 930      |   |
| 2005       |   | 615                |     |
| 2006       |   | 599                |     |
| 2007       |   | 614                |     |
| 2008       |   | 629                |     |
| Thereafter |   | 2,978              |     |
|       |   | $                  | 6,365    |   |

 

Rent expense was $934,000, $643,000 and $472,000 for fiscal 2003, 2002and 2001, respectively.

 

**Other.**  At March 31, 2003, the Company’s futureobligations by year for royalty advances, minimum royalty guarantees and exclusivedistribution fee guarantees under the terms of Image’s existing licenses andexclusive distribution agreements, respectively, are as follows:

 
| **Fiscal** |   | **Amount**         |   |
|------------|--------|--------------------|--------|
|       |   | **(in thousands)** |   |
| 2004       |   | $                  | 5,016  |   |
| 2005       |   | 3,976              |   |
| 2006       |   | 1,741              |   |
| 2007       |   | 100                |   |
| 2008       |   | 100                |   |
|       |   | $                  | 10,933 |   |

 

At March 31, 2003, Image had a $150,000 outstanding standby letter ofcredit issued by Foothill which expires on November 18, 2003.  This letter of credit secures balances dueto a nonexclusive program supplier.

 

**Note9.   Private Placement of Common Stock.**

 

On September25, 2002, the Company closed its sale of $2.0 million of Image common stock toStandard Broadcasting Corporation Limited (“Standard Broadcasting”) in aprivate placement.  StandardBroadcasting is the largest privately-owned multi-media company in Canada.  Video One, a wholly-owned subsidiary ofStandard Broadcasting and the parent company of VID CANADA, is Canada’s largestdistributor of pre-recorded home entertainment programming, including DVD, VHSand video games.  VID CANADA is Image’sexclusive distributor of its exclusive home entertainment programming inCanada.  Contemporaneous with theprivate placement, Image and VID CANADA extended the term of their exclusivedistribution agreement from June 2003 to October 2007.

 

The $2.0million transaction represented a purchase of 1,801,315 shares of Image commonstock at $1.11 per share, the closing price of Image’s common stock onSeptember 10, 2002.  Additionally, Imageissued Standard Broadcasting a five-year warrant to purchase up to 270,198additional shares at $1.22 per share. The fair value of the warrant, using the Black-Scholes valuation model,is $189,000 and has been  recorded inshareholders’ equity as part of the $2.0 million net proceeds.  Because they are not registered under theSecurities Act of 1933, as amended (the “Act”), the stock and shares underlyingthe warrant are restricted and subject to Rule 144 promulgated under theAct.  Standard Broadcasting will havelimited registration rights after one year.

 

**Note 10. Stock Awards, Options and Warrants.**

 

In September 1998, Image’s shareholders approved an incentive plan (the“1998 Plan”) pursuant to which approximately 1,160,000 shares of Image’s commonstock were made available for awards, including options, thereunder.  No new options would be granted underImage’s other plans.  The 1998 Planprovides for awards to employees and directors of Image.  Options (incentive as well as nonqualified),restricted stock units, stock appreciation rights, performance share awards,stock bonuses and stock units can be awarded under the 1998 Plan.  The 1998 Plan requires that the exerciseprice for any nonqualified option be at least 85% of the closing price ofImage’s common stock on the date such option is granted.  The maximum term allowed for an option is 10years and a stock unit shall either vest or be forfeited not more than 10 yearsfrom the date of grant.  The 1998 Plancontemplates annual automatic grants of restricted stock units payable inshares of Image’s common stock to certain directors of Image in lieu of the 

 

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15,000 share option grants under the then-existing directors’ stockoption plan.  The 1998 Plan terminateson June 30, 2008.

 

In July 1999 and 1998 an aggregate 91,662 and 88,359, respectively,restricted stock units were granted to officers of Image under the 1998Plan.  These grants vest annually inincrements of 20% over the five-year period commencing June 30, 2000 and 1999,respectively.  There were no restrictedstock units granted to officers in fiscal 2003, 2002 and 2001.  Accelerated vesting may occur if certainfiscal defined financial performance targets are achieved.  The number of restricted stock units awardedto officers was determined by multiplying a specified percentage of base salaryby the officer’s base salary as of the beginning of the period and dividing theresults by the average trading price of the stock determined as of the date ofgrant ($6.78 per share in fiscal 2000 and $6.70 per share in fiscal 1999) todetermine the number of restricted stock units.  These restricted stock units are payable solely in shares.  The Company amortizes the total value of therestricted stock units on the date of grant ($622,000 for the fiscal 2000 grantand $592,000 for the fiscal 1999 grant) ratably over the five-year vestingperiod as compensation expense. Compensation expense relating to these stock units for fiscal 2003, 2002and 2001 was approximately $195,000, $195,000 and $227,000, respectively.

 

In October 2001 and 2000, the automatic annual awards to directorsaggregating 6,720 restricted stock units for each year were granted.  These grants vested on a pro rata basis overa one-year period commencing on the grant date.  These restricted stock units are payable solely in shares.  The Company amortized the total value of therestricted stock units on the date of the grant ratably over the one-yearvesting period as compensation expense. Compensation expense relating to these restricted stock units for fiscal2003, 2002 and 2001 was approximately $6,000, $19,000 and $28,000,respectively.

 

Stock option transactions, including Image’s former plans, for thethree years ended March 31, 2003 are as follows:

 
| **(In thousands, except per share data)** |   | **Shares** |   | **Per Share  Price Range** |       | **Weighted   Average Price  Per Share** |   |
|-------------------------------------------|--------|------------|--------|----------------------------|------------|-----------------------------------------|--------|
| Outstanding, March 31, 2000               |   | 1,167      |   | $                          | 3.25-10.25 |                                    | 6.950  |   |
| Granted                                   |   | 382        |   | 3.75                       |       | 3.750                                   |   |
| Canceled                                  |   | (47        | )      | 4.938-7.191                |       | 6.043                                   |   |
| Outstanding, March 31, 2001               |   | 1,502      |   | 3.25-10.25                 |       | 6.164                                   |   |
| Granted                                   |   | 378        |   | 1.75                       |       | 1.750                                   |   |
| Canceled                                  |   | (258       | )      | 3.75-10.25                 |       | 6.221                                   |   |
| Outstanding, March 31, 2002               |   | 1,622      |   | 1.75-9.75                  |       | 5.124                                   |   |
| Granted                                   |   | 156        |   | 1.68-1.78                  |       | 1.767                                   |   |
| Exercised                                 |   | (2         | )      | 1.75                       |       | 1.750                                   |   |
| Canceled                                  |   | (17        | )      | 1.75-9.75                  |       | 7.595                                   |   |
| Outstanding, March 31, 2003               |   | 1,759      |   | 1.68-8.75                  |       | 4.806                                   |   |
|                                           |        |            |        |                            |            |                                         |        |  |

 

Of the options reflected as outstanding on March 31, 2003, options topurchase approximately 1,323,000 shares of common stock were exercisable.  At March 31, 2003, there were approximately156,000 shares of common stock available for new awards, including stockoptions, to directors and employees of Image.

 

The following table summarized significant ranges of outstanding andexercisable options at March 31, 2003:

 
|                           |   | **Options  Outstanding**    |   | **Options  Exercisable**                        |   |
|--------------------------------|--------|-----------------------------|--------|-------------------------------------------------|--------|
| **Range of   Exercise Prices** |   | **Shares   (In thousands)** |   | **Weighted  Average Remaining   Life**(Years)** |   | **Weighted   Average  Exercise   Price** |   | **Shares  (In thousands)** |   | **Weighted   Average   Exercise   Price** |   |
| Under $2.00                    |   | 529                         |   | 8.9                                             |   | $ | 1.755 |   | 164 |   | $ | 1.750 |   |
| $ 2.01 to $4.00                |   | 358                         |   | 7.1                                             |   | 3.729 |   | 302 |   | 3.725 |   |
| $ 4.01 to $6.00                |   | 97                          |   | 1.1                                             |   | 5.525 |   | 96 |   | 5.522 |   |
| $ 6.01 to $8.00                |   | 700                         |   | 3.0                                             |   | 7.168 |   | 686 |   | 7.179 |   |
| Over $8.00                     |   | 75                          |   | 1.3                                             |   | 8.500 |   | 75 |   | 8.500 |   |
|                           |   | 1,759                       |   |                                            |   |   |   | 1,323 |   |   |   |
|                                |        |                             |        |                                                 |        |  |  |  |  |  |  |  |  |

 

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On October 5, 2001, the Company issued Lighthouse Capital ManagementCorp. (“Lighthouse”), a financial consultant, a warrant to purchase 150,000shares of the Company’s unregistered common stock (the “Lighthouse Warrant”) aspartial consideration for the services to be performed by Lighthouse under anonexclusive consulting agreement between Lighthouse and the Company.  On the date of issuance, the Company’s fairvalue of its common stock was $1.975. The exercise prices of the shares underlying the Lighthouse Warrant are50,000 shares at $1.975, 50,000 shares at $2.275 and 50,000 shares at$2.575.  The term of the LighthouseWarrant is 5 years.  On the date ofissuance, the Company valued the shares underlying the Lighthouse Warrant forfinancial statement purposes using the Black-Scholes valuation model.  Accordingly, the Company increasedadditional paid-in capital, by the estimated Lighthouse Warrant valuation ofapproximately $143,000.  The Companyamortizes the Lighthouse Warrant value over the expected term of the relatedconsulting agreement.  Amortizationtotaled approximately $72,000 and $71,000 for fiscal years 2003 and 2002,respectively and was recorded as a component of general and administrativeexpenses in the accompanying consolidated statements of operations.

 

**Note 11. Net Earnings (Loss) Per Share Data.**

 

The following is a reconciliation of the numerators and denominatorsused in computing basic and diluted net earnings (loss) per share for the threeyears ended March 31, 2003:

 
| **(In thousands, except per share  data)**                                          |   | **2003** |   | **2002** |   | **2001** |   |
|-------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                                |   |     |   |     |   |     |   |
| Earnings (loss) before cumulative effect of  accounting change                      |   | $        | (454   | )        | $      | (195     | )      | $ | 8,432 |   |
| Cumulative effect of accounting change, net  of tax benefit                         |   | (3,766   | )      | —   |   | —   |   |
| Net earnings (loss) – basic numerator                                          |   | $        | (4,220 | )        | $      | (195     | )      | $ | 8,432 |   |
| Interest, net of taxes, on assumed  conversion of dilutive security                 |   | —   |   | —   |   | 400      |   |
| Net earnings (loss) – diluted numerator                                        |   | $        | (4,220 | )        | $      | (195     | )      | $ | 8,832 |   |
| Weighted average common shares outstanding  – basic denominator                |   | 16,812   |   | 15,821   |   | 16,257   |   |
| Effect of dilutive securities                                                       |   | —   |   | —   |   | 1,380    |   |
| Weighted average common shares outstanding  – diluted denominator              |   | 16,812   |   | 15,821   |   | 17,637   |   |
| Basic earnings (loss) per share before  cumulative effect of an accounting change   |   | $        | (.03   | )        | $      | (.01     | )      | $ | .52 |   |
| Diluted earnings (loss) per share before  cumulative effect of an accounting change |   | $        | (.03   | )        | $      | (.01     | )      | $ | .50 |   |
| Cumulative effect of an accounting change,  net of tax benefit                      |   | (.22     | )      | —   |   | —   |   |
| Basic net earnings (loss) per share                                                 |   | $        | (.25   | )        | $      | (.01     | )      | $ | .52 |   |
| Diluted net earnings (loss) per share                                               |   | $        | (.25   | )        | $      | (.01     | )      | $ | .50 |   |

 

Outstanding common stock options not included in the computation ofdiluted net earnings (loss) per share totaled 1,759,000, 1,622,000 and1,487,000, respectively, for the years ended March 31, 2003, 2002 and2001.  For fiscal 2001, the stockoptions were excluded because their exercise prices were greater than theaverage market price of the common stock and the assumed exercise would beantidilutive.  For fiscal 2003 and 2002,they were excluded as their effect would be antidilutive.  The common shares underlying the convertiblesubordinated note payable were excluded in fiscal 2003 and 2002 because theassumed conversion would be antidilutive.

 

**Note 12. Income Taxes.**

 

Income tax expense (benefit), including the benefit attributable to thecumulative effect of accounting change, for the years ended March 31, 2003 and2002 are summarized as follows:

 

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| **(In thousands)** |   | **2003** |   | **2002** |   |
|--------------------|--------|----------|--------|----------|--------|
| Current            |   |     |   |     |   |
| Federal            |   | $        | (9     | )        | $      | (93 | ) |
| State              |   | 4        |   | (47      | )      |
| Foreign            |   | 280      |   | 271      |   |
|               |   | 275      |   | 131      |   |
| Deferred           |   |     |   |     |   |
| Federal            |   | (1,552   | )      | (239     | )      |
| State              |   | (266     | )      | 68       |   |
|               |   | (1,818   | )      | (171     | )      |
| Total              |   |     |   |     |   |
| Federal            |   | (1,561   | )      | (332     | )      |
| State              |   | (262     | )      | 21       |   |
| Foreign            |   | 280      |   | 271      |   |
|               |   | $        | (1,543 | )        | $      | (40 | ) |

 

The components of the tax benefit attributable to the cumulative effectof the accounting change are as follows:

 
|      |   | **2003** |   | **2002** |   |
|-----------|--------|----------|--------|----------|--------|
| Deferred: |   |     |   |     |   |
| Federal   |   | $        | (2,039 | )        | — |   |
| State     |   | (192     | )      | —   |   |
|      |   | $        | (2,231 | )        | — |   |

 

The tax effects of temporary differences that give rise to asignificant portion of the net deferred tax assets at March 31, 2003 and 2002are presented below:

 
| **(In thousands)**                                          |   | **2003** |   | **2002** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|
| Deferred tax assets:                                        |   |     |   |     |   |
| Provision for lower of cost or market  inventory writedowns |   | $        | 530    |     | $      | 261 |   |
| Net operating loss carryforwards                            |   | 3,240    |   | 3,204    |   |
| Allowance for sales returns                                 |   | 8        |   | 495      |   |
| Writedowns of royalty advances                              |   | 329      |   | 289      |   |
| Allowance for doubtful accounts receivable                  |   | 294      |   | 548      |   |
| Tax credits                                                 |   | 796      |   | 516      |   |
| Depreciation and amortization                               |   | 1,122    |   | —   |   |
| Other                                                       |   | 621      |   | —   |   |
| Deferred tax assets                                         |   | 6,940    |   | 5,313    |   |
| Less valuation allowance                                    |   | (551     | )      | —   |   |
| Net deferred tax assets                                     |   | 6,389    |   | 5,313    |   |
|                                                        |   |     |   |     |   |
| Deferred tax liabilities:                                   |   |     |   |     |   |
| Depreciation and amortization                               |   | —   |   | (682     | )      |
| Other                                                       |   | (145     | )      | (206     | )      |
| Deferred tax liabilities                                    |   | (145     | )      | (888     | )      |
|                                                        |   |     |   |     |   |
| Net deferred tax assets                                     |   | $        | 6,244  |     | $      | 4,425 |   |

 

The Company provides a valuation allowance on the deferred tax assetswhere there is uncertainty regarding their future realizability.  In assessing the realizability of deferredtax assets, management considered whether it is more likely than not that someportion or all of the deferred tax assets will be realized.  The ultimate realization of deferred taxassets is dependent on the generation of future taxable income during theperiods in which those temporary differences become deductible.  Management considers the projected futuretaxable income and tax-planning strategies in making this assessment.  The Company has recorded a valuationallowance against its deferred tax assets of $551,000 

 

62

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at March 31, 2003.  Thisvaluation allowance fully reserves foreign tax credit carryforwards which havea 5-year life.  The Company believes thatthe carryforward period may not be long enough to realize the tax benefits ofthe carryforward through future taxable earnings generated by the Company.

 

As of March 31, 2003, the Company had net operating loss carryforwardsfor Federal and state income tax purposes of $8,966,000 and $3,287,000,respectively, which are available to offset future taxable income through 2023and 2010, respectively.

 

Expected income tax expense (benefit) based on Federal statutory ratesfor the three years ended March 31, 2003 differed from actual tax expense(benefit) as follows:

 
| **(In thousands, except per share  data)**                                     |   | **2003** |   | **2002** |   | **2001** |   |
|--------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected income tax expense (benefit)                                          |   | $        | (1,959 | )        | $      | (83      | )      | $ | 1,508 |   |
| State income taxes, net of Federal benefit                                     |   | (174     | )      | (4       | )      | 552      |   |
| Disallowance of state net operating loss  carryforward, net of Federal benefit |   | —   |   | 18       |   | —   |   |
| Change in valuation allowance                                                  |   | 551      |   | —   |   | (6,135   | )      |
| Non-deductible expenses                                                        |   | 25       |   | 26       |   | —   |   |
| Other                                                                          |   | 14       |   | 3        |   | 79       |   |
|                                                                           |   | $        | (1,543 | )        | $      | (40      | )      | $ | (3,996 | ) |

 

The reconciliation of expected to actual income tax expense (benefit)for the year ended March 31, 2003, broken down between continuing operationsand the cumulative effect of accounting change is as follows:

 
|                                |   | **Continuing  Operations** |   | **Cumulative  Effect of   Accounting Change** |   |
|-------------------------------------|--------|----------------------------|--------|-----------------------------------------------|--------|
| Expected income tax expense benefit |   | $                          | 80     |                                          | $      | (2,039 | ) |
| State taxes, net of Federal benefit |   | 18                         |   | (192                                          | )      |
| Non deductible expenses             |   | 25                         |   | —                                        |   |
| Change in valuation allowance       |   | 551                        |   | —                                        |   |
| Other                               |   | 14                         |   | —                                        |   |
|                                |   | $                          | 688    |                                          | $      | (2,231 | ) |

 

The change in the valuation allowance for the year ended March 31, 2001was $6,391,000 of which $6,135,000 reduced income tax expense for theyear.  The remaining $256,000 wascredited to additional paid-in capital which was the amount attributable to netoperating losses created by the exercise of stock options previouslyunrecognized.

 

**Note 13. Other Items – Statement of Operations**

 

**Fourth Quarter Adjustments.**

 

Fiscal 2003.  In March 2003, the Company accrued forestimated subdistributor returns resulting in a reduction of revenues and grossprofit margin of $346,000 and $116,000, respectively during the fourth quarterended March 31, 2003 and for the writedown (to BMG purchase cost) of theestimated inventory to be returned by the subdistributors representing anincremental charge to cost of sales of $202,000 during the fourth quarter endedMarch 31, 2003.

 

During the fourth quarter, the Company revised its operatingprojections as a result of recent changes to its revenues.  As a result of the revised projections, itwas determined that a valuation allowance was required on certain tax creditsexpiring within five years.

 

Fiscal 2002.  During fiscal 2002, the Company, throughDVDPlanet, officially exited the laserdisc distribution business, selling itslast unit of programming, in the old home entertainment format oflaserdisc.  Additionally, during fiscal2002, the Company destroyed its remaining laserdisc inventory.  During the fourth quarter of fiscal 2002, theCompany reversed, as a credit to cost of sales, recorded reserves relating to itsdomestic laserdisc distribution operations 

 

63

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which management determined were unnecessary.  Approximately $1,818,000 was recorded as a pretax credit to costof sales in the accompanying consolidated statement of operations for fiscal2002.

 

During the fourth quarter of fiscal 2002, the Company, after meetingwith its international distributors in February 2002, has revised its estimateof the fair value of a royalties paid in advance for the internationaldistribution rights to a particular line of programming.  In accordance with SOP-002, the Companywrote off to cost of sales, the difference between the unamortized carryingvalue of the royalty advance and the revised estimate of fair value.  A pretax charge totaling $696,000 wasincluded in cost of sales in the accompanying statement of operations forfiscal 2002.

 

Fiscal 2001.  The Company eliminated the valuationallowance recorded against the deferred tax assets in the fourth quarter offiscal 2001.  See “Note 12.  Income Taxes.”

 

**Note 14. Employee Benefit Plan.**

 

The Company has a 401(k) savings plan covering substantially all of itsemployees.  Eligible employees maycontribute through payroll deductions. The Company matches employees’ contributions at the rate of 50% of thefirst 4% of salary contributed.  TheCompany’s 401(k) savings plan matching expenses for fiscal 2003, 2002 and 2001were $136,000, $125,000 and $112,000, respectively.

 

**Note 15. Segment Information.**

 

In accordance with the requirements of SFAS No. 131, *Disclosures about Segments of and Enterprises andRelated Information*, selected financial information regarding theCompany’s reportable business segments, Domestic Wholesale Distribution, RetailDistribution, and International Wholesale Distribution, are presentedbelow.  The largest business segment isDomestic Wholesale Distribution of entertainment programming (primarilyDVD).  Management currently evaluatessegment performance based primarily on net revenues, operation costs andexpenses and income (loss) before income taxes.  Interest income and expense is evaluated on a consolidated basisand not allocated to the Company’s business segments.

 

For the Year Ended March 31, 2003:

 
|                                |   | **2003**                               |
|-------------------------------------|--------|----------------------------------------|
| **(In thousands)**                  |   | **Domestic  Wholesale   Distribution** |   | **Retail  Distribution** |   | **International    Wholesale   Distribution** |   | **Inter-segment    Eliminations** |   | **Consolidated** |   |
| NET REVENUES                        |   | $                                      | 92,482 |   | $ | 21,264 |   | $ | 9,445 |   | $ | (14,998 | ) | $ | 108,193 |   |
| OPERATING COSTS AND EXPENSES        |   | 88,317                                 |   | 22,882 |   | 9,620 |   | (15,012 | ) | 105,807 |   |
| EARNINGS (LOSS) FROM OPERATIONS     |   | 4,165                                  |   | (1,618 | ) | (175 | ) | 14 |   | 2,386 |   |
| OTHER EXPENSES (INCOME)             |   | 1,879                                  |   | — |   | (300 | ) | 573 |   | 2,152 |   |
| EARNINGS (LOSS) BEFORE INCOME TAXES |   | $                                      | 2,286 |   | $ | (1,618 | ) | $ | 125 |   | $ | (559 | ) | $ | 234 |   |

 

For the Year Ended March 31, 2002:

 
|                                |   | **2002**                                |
|-------------------------------------|--------|-----------------------------------------|
| **(In thousands)**                  |   | **Domestic   Wholesale   Distribution** |   | **Retail   Distribution** |   | **International    Wholesale  Distribution** |   | **Inter-segment  Eliminations** |   | **Consolidated** |   |
| NET REVENUES                        |   | $                                       | 80,546 |   | $ | 18,678 |   | $ | 9,759 |   | $ | (14,170 | ) | $ | 94,813 |   |
| OPERATING COSTS AND EXPENSES        |   | 76,091                                  |   | 20,253 |   | 10,928 |   | (14,222 | ) | 93,050 |   |
| EARNINGS (LOSS) FROM OPERATIONS     |   | 4,455                                   |   | (1,575 | ) | (1,169 | ) | 52 |   | 1,763 |   |
| OTHER EXPENSES                      |   | 1,806                                   |   | — |   | 210 |   | (18 | ) | 1,998 |   |
| EARNINGS (LOSS) BEFORE INCOME TAXES |   | $                                       | 2,649 |   | $ | (1,575 | ) | $ | (1,379 | ) | $ | 70 |   | $ | (235 | ) |

 

64

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For the Year Ended March 31, 2001:

 
|                                |   | **2001**                             |   |
|-------------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                  |   | **Domestic  Wholesale Distribution** |   | **Retail  Distribution** |   | **International  Wholesale Distribution** |   | **Inter-segment  Eliminations** |   | **Consolidated** |   |
| NET REVENUES                        |   | $                                    | 90,512 |   | $ | 16,886 |   | $ | 6,662 |   | $ | (14,027 | ) | $ | 100,033 |   |
| OPERATING COSTS AND EXPENSES        |   | 81,329                               |   | 19,586 |   | 7,235 |   | (13,988 | ) | 94,162 |   |
| EARNINGS (LOSS) FROM OPERATIONS     |   | 9,183                                |   | (2,700 | ) | (573 | ) | (39 | ) | 5,871 |   |
| OTHER EXPENSES                      |   | 1,225                                |   | — |   | 179 |   | 31 |   | 1,435 |   |
| EARNINGS (LOSS) BEFORE INCOME TAXES |   | $                                    | 7,958  |   | $ | (2,700 | ) | $ | (752 | ) | $ | (70 | ) | $ | 4,436 |   |

 
|                                 |   | **As of  March 31,** |   |
|--------------------------------------|--------|----------------------|--------|
| **(In thousands)**                   |   | **2003**             |   | **2002** |   |
| TOTAL ASSETS:                        |   |                 |   |   |   |
| DOMESTIC WHOLESALE DISTRIBUTION      |   | $                    | 67,373 |   | $ | 66,773 |   |
| RETAIL DISTRIBUTION                  |   | 3,248                |   | 9,649 |   |
| INTERNATIONAL WHOLESALE DISTRIBUTION |   | 4,791                |   | 5,601 |   |
| INTER-SEGMENT ELIMINATIONS           |   | (917                 | )      | (125 | ) |
| CONSOLIDATED TOTAL ASSETS            |   | $                    | 74,495 |   | $ | 81,898 |   |

 

65

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**Note 16. Quarterly Financial Data.  (Unaudited)**

 

Summarized quarterly consolidated financial data for fiscal 2003 and2002 is as follows:

 
|                                                                                   |   | **Quarter  Ended** |   |
|----------------------------------------------------------------------------------------|--------|--------------------|--------|
|                                                                                   |   | **June 30,**       |   | **September  30,** |   | **December  31,** |   | **March 31,** |   |
| **(In thousands, except per share  data)**                                             |   | **2002**           |   | **2001** |   | **2002** |   | **2001** |   | **2002** |   | **2001** |   | **2003** |   | **2002** |   |
|                                                                                   |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenues                                                                           |   | $                  | 23,775 |   | $ | 20,371 |   | $ | 26,262 |   | $ | 20,864 |   | $ | 31,159 |   | $ | 26,861 |   | $ | 26,997 |   | $ | 26,717 |   |
| Earnings (loss) from operations                                                        |   | (391               | )      | (319 | ) | 253 |   | (739 | ) | 1,481 |   | 1,436 |   | 1,043 |   | 1,385 |   |
| Earnings (loss) before cumulative effect of  accounting change                         |   | (427               | )      | (493 | ) | (513 | ) | (856 | ) | 804 |   | 602 |   | (318 | ) | 552 |   |
| Cumulative effect of accounting change, net                                            |   | (3,766             | )      | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Net earnings (loss)                                                                    |   | (4,193             | )      | (493 | ) | (513 | ) | (856 | ) | 804 |   | 602 |   | (318 | ) | 552 |   |
| Earnings (loss) per share before cumulative  effect of accounting change:              |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                      |   | (.03               | )      | (.03 | ) | (.03 | ) | (.05 | ) | .05 |   | .04 |   | (.02 | ) | .03 |   |
| Cumulative effect of accounting change, net                                            |   | (.24               | )      | — |   | — |   | — |   | — |   | — |   | — |   | — |   |
| Net earnings (loss) per share before  cumulative effect of accounting change(1) – |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                  |   | $                  | (.27   | ) | $ | (.03 | ) | $ | (.03 | ) | $ | (.05 | ) | $ | .05 |   | $ | .04 |   | $ | (.02 | ) | $ | .03 |   |
| Diluted                                                                                |   | $                  | (.27   | ) | $ | (.03 | ) | $ | (.03 | ) | $ | (.05 | ) | $ | .05 |   | $ | .04 |   | $ | (.02 | ) | $ | .03 |   |
| Shares used in computation of net earnings  (loss) per share –                    |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                  |   | 15,828             |   | 15,803 |   | 16,064 |   | 15,821 |   | 17,655 |   | 15,827 |   | 17,702 |   | 15,828 |   |
| Diluted                                                                                |   | 15,828             |   | 15,803 |   | 16,064 |   | 15,821 |   | 17,737 |   | 15,889 |   | 17,702 |   | 15,978 |   |

 

----

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

 

66

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**ITEM9.              CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**PART III**

 

**ITEM 10.            DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT.**

 

The information required by this item is incorporated by reference fromthe information contained under the caption entitled “Election of Directors” inthe Company’s definitive proxy statement to be filed with the Securities andExchange Commission in connection with the Company’s 2003 Annual Meeting ofShareholders.  See also, Part I“Executive Officers of the Registrant.”

 

**ITEM11.            EXECUTIVE COMPENSATION.**

 

The information required by this item is incorporated by reference fromthe information contained under the caption entitled “Executive Compensation”in the Company’s definitive proxy statement to be filed with the Securities andExchange Commission in connection with the Company’s 2003 Annual Meeting ofShareholders.

 

**ITEM12.            SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT.**

 

The information required by this item is incorporated by reference fromthe information contained under the caption entitled “Security Ownership ofCertain Beneficial Owners and Management” in the Company’s definitive proxy statementto be filed with the Securities and Exchange Commission in connection with theCompany’s 2003 Annual Meeting of Shareholders.

 

**ITEM 13.            CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS.**

 

The information required by this item is incorporated by reference fromthe information contained under the caption entitled “Certain Relationships andRelated Transactions” in the Company’s definitive proxy statement to be filedwith the Securities and Exchange Commission in connection with the Company’s2003 Annual Meeting of Shareholders.

 

**ITEM14.            CONTROLS AND PROCEDURES.**

 

Within 90 days prior to the date of this report, we carried out anevaluation, under the supervision and with the participation of our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures.  Based on this evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that our disclosurecontrols and procedures are effective in timely alerting them to materialinformation required to be included in our periodic SEC reports.  It should be noted that the design of anysystem of controls is based in part upon certain assumptions, and there can beno assurance that any design will succeed in achieving its stated goals.

 

In addition, we reviewed our internal controls, and there have been nosignificant changes in our internal controls or in other factors that couldsignificantly affect those controls subsequent to the date of this most recentevaluation.

 

67

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**PART IV**

 

**ITEM15.            EXHIBITS, FINANCIALSTATEMENT SCHEDULES AND REPORTS ON FORM 8-K.**

 
| (a)    | THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT. |
|--------|-------------------------------------------------------------|
|   |                                                        |   |
|   | 1.                                                          | Financial Statements: |
|   |                                                        | Independent Auditors’ Report |
|   |                                                        | Consolidated Balance Sheets at March 31, 2003 and 2002 |
|   |                                                        | Consolidated Statements of Operations for  the years ended March 31, 2003, 2002 and 2001 |
|   |                                                        | Consolidated Statements of Shareholders’  Equity for the years ended March 31, 2003, 2002 and 2001 |
|   |                                                        | Consolidated Statements of Cash Flows for  the years ended March 31, 2003, 2002 and 2001 |
|   |                                                        | Notes to Consolidated Financial Statements |
|   |                                                        |   |
|   | 2.                                                          | Financial Statement Schedule: |
|   |                                                        | Schedule II - Valuation and Qualifying Accounts |
|   |                                                        |   |
|   | 3.                                                          | Exhibits: |
|   |                                                        | See the Exhibit Index on pages i - vii. |
|        |                                                             |  |  |  |

 

(b)           REPORTS ON FORM 8-K.

 

On January 8, 2003, we filed a Form 8-K pursuant toItem 9 regarding our press release announcing an exclusive five-yearinternational DVD sublicense agreement with Bertelsmann Music InformationServices, GmbH.  On January 10, 2003, wefiled a Form 8-K pursuant to Item 9 regarding the our telephonic conferencecall and simultaneous Web cast to discuss our recently signed international DVDsublicense agreement with Bertelsmann Music Information Services, GmbH. OnMarch 26, 2003, we filed a Form 8-K pursuant to Item 5 describing our retiringa $2,550,000 unsecured, subordinated promissory note to the Company’s largestshareholder, Image Investors Co.

 

68

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**SCHEDULEII**

**– Valuation and Qualifying Accounts –**

**For the Years Ended March 31, 2003, 2002 and2001**

 
|                               |   | **Allowance  for Doubtful Accounts** |   |
|------------------------------------|--------|--------------------------------------|--------|
| **(In thousands)**                 |   | **Balance at  Beginning   of Year**  |   | **Additions  Charged to   Costs and  Expenses** |   | **Amounts   Written-Off** |   | **Balance at    End of Year** |   |
|                               |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2003: |   | $                                    | 1,474  |   | $ | 108 |   | $ | (562 | ) | $ | 1,020 |   |
|                               |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2002: |   | $                                    | 1,020  |   | $ | 597 |   | $ | (143 | ) | $ | 1,474 |   |
|                               |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2001  |   | $                                    | 551    |   | $ | 555 |   | $ | (86 | ) | $ | 1,020 |   |

 
|                               |   | **Allowance  for Sales Returns**      |   |
|------------------------------------|--------|---------------------------------------|--------|
| **(In thousands)**                 |   | **Balance at    Beginning   of Year** |   | **Additions   Charged to   Costs and**

** Expenses** |   | **Amounts   Written-Off** |   | **Balance at    End of Year** |   |
|                               |   |                                  |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2003: |   | $                                     | 3,900  |   | $ | 15,381 |   | $ | (14,231 | ) | $ | 5,050 |   |
|                               |   |                                  |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2002: |   | $                                     | 3,450  |   | $ | 10,507 |   | $ | (10,057 | ) | $ | 3,900 |   |
|                               |   |                                  |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2001  |   | $                                     | 3,113  |   | $ | 9,011 |   | $ | (8,674 | ) | $ | 3,450 |   |

 

Reconciliation to Consolidated Balance Sheets

 
|                             |   | **At March  31,** |   |
|----------------------------------|--------|-------------------|--------|
| **(In thousands)**               |   | **2003**          |   | **2002** |   |
| Allowance for Doubtful Accounts: |   |              |   |   |   |
| Balance at End of Year           |   | $                 | 1,020  |   | $ | 1,474 |   |
| Allowance for Sales Returns:     |   |              |   |   |   |
| Balance at End of Year           |   | 5,050             |   | 3,900 |   |
| Allowances                       |   | $                 | 6,070  |   | $ | 5,374 |   |

 

69

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**SIGNATURES**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|   |                       |   | IMAGE ENTERTAINMENT, INC.                                    |
|--------|----------------------------|--------|--------------------------------------------------------------|
|   |                       |   | A California corporation                                     |
|   |                       |   |                                                         |
|   |                       |   |                                                         |
|   | Dated:  June 27, 2003 |   | */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 theregistrant and in the capacities and on the dates indicated.

 
|   | Dated:  June 27, 2003 |   | */s/ MARTIN W. GREENWALD*                                            |   |
|--------|----------------------------|--------|----------------------------------------------------------------------|--------|
|   |                       |   | MARTIN W. GREENWALD                                                  |
|   |                       |   | Chairman of the Board, President and Chief Executive Officer         |
|   |                       |   |                                                                 |
|   | Dated:  June 27, 2003 |   | */s/ JEFF M. FRAMER*                                                 |   |
|   |                       |   | JEFF M. FRAMER                                                       |
|   |                       |   | Chief Financial Officer (Principal Financial and Accounting Officer) |
|   |                       |   |                                                                 |
|   | Dated:  June 27, 2003 |   | */s/ IRA EPSTEIN*                                                    |   |
|   |                       |   | IRA EPSTEIN                                                          |
|   |                       |   | Director                                                             |
|   |                       |   |                                                                 |
|   | Dated:  June 27, 2003 |   | */s/ M. TREVENEN HUXLEY*                                             |   |
|   |                       |   | M. TREVENEN HUXLEY                                                   |
|   |                       |   | Director                                                             |
|   |                       |   |                                                                 |
|   | Dated:  June 27, 2003 |   | */s/ ROBERT J. MCCLOSKEY*                                            |   |
|   |                       |   | ROBERT J. MCCLOSKEY                                                  |
|   |                       |   | Director                                                             |

 

70

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**IMAGE ENTERTAINMENT, INC.**

 

**CERTIFICATIONS PURSUANT TO SECTION 302 OF**

**THE SARBANES OXLEY ACT OF 2002**

 

**CERTIFICATION**

 

I, Martin W. Greenwald, Chairman and ChiefExecutive Officer of Image Entertainment, Inc., certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Image Entertainment, Inc.;

 

2.                                       Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a.                                       designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiary and jointventure, is made known to us by others, within those entities, particularlyduring the period in which this annual report is being prepared;

b.                                      evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the “EvaluationDate”); and,

c.                                       presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors:

 

a.                                       allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

b.                                      anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officer and I have indicated in this annual reportwhether or not there were significant changes in internal controls or in otherfactors that could significantly affect internal controls subsequent to thedate of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
|   | /s/ MARTIN W. GREENWALD              |   |
|--------|--------------------------------------|--------|
|   | Martin W. Greenwald                  |
|   | Chairman and Chief Executive Officer |
|   |                                 |
|   | June 27, 2003                        |

 

71

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**IMAGE ENTERTAINMENT, INC.**

 

**CERTIFICATIONS PURSUANT TO SECTION 302 OFTHE SARBANES OXLEY ACT OF 2002**

 

**CERTIFICATION**

 

I, Jeff M. Framer, Chief Financial Officer ofImage Entertainment, Inc., certify that:

 

1.                                       Ihave reviewed this annual report on Form 10-K of Image Entertainment, Inc.;

 

2.                                       Basedon my knowledge, this annual report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this annual report;

 

3.                                       Basedon my knowledge, the financial statements, and other financial informationincluded in this annual report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this annual report;

 

4.                                       Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a.                                       designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiary and jointventure, is made known to us by others, within those entities, particularlyduring the period in which this annual report is being prepared;

b.                                      evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this annual report (the “EvaluationDate”); and,

c.                                       presentedin this annual report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.                                       Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors:

 

a.                                       allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

b.                                      anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal controls; and

 

6.                                       Theregistrant’s other certifying officer and I have indicated in this annualreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
|   | /s/ JEFF M. FRAMER      |   |
|--------|-------------------------|--------|
|   | Jeff M. Framer          |
|   | Chief Financial Officer |
|   |                    |
|   | June 27, 2003           |

 

72

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**EXHIBITS**

 
| 2.1             |   | Asset Purchase Agreement, dated as of  August 20, 1998, by and between Image Newco, Inc. and Ken Crane’s Magnavox  City, Inc.  Filed as Exhibit 2.1 to  Image’s Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                                           |
|-----------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 2.1(a)          |   | First Amendment to Asset Purchase Agreement, dated as of October 3,  1998, by and between Image Newco, Inc. and Ken Crane’s Magnavox City,  Inc.  Filed as Exhibit 2.2 to Image’s  Registration Statement on Form S-2 (No. 333-65611), effective December 21,  1998, and incorporated by reference herein.                                        |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 3.1             |   | Restated Articles of Incorporation.   Filed as Exhibit 3.1 of Image’s Form 10-K for the year ended March 31,  1995, and incorporated by reference herein.                                                                                                                                                                                              |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 3.2             |   | Bylaws.  Filed as Exhibit 3.2  of Image’s Form 10-K for the year ended March 31, 1995, and incorporated by  reference herein.                                                                                                                                                                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.1             |   | Specimen Common Stock certificate.   Filed as Exhibit 4 to Image’s Registration Statement on Fomr S-2 (No.  333-65611), effective December 21, 1998, and incorporated by reference  herein.                                                                                                                                                            |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.2             |   | Convertible Subordinated Promissory Note, dated October 29, 1997,  issued to Image Investors Co. pursuant to that certain Credit Agreement,  dated as of September 29, 1997, by an between Image and Image Investors  Co.  Filed as Exhibit 4.2 to Image’s  Form 10-K for the fiscal year ended March 31, 1999, and incorporated by reference  herein. |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.3             |   | Warrant dated as of October 5, 2001 between Image and Lighthouse  Capital Management Corp.  Filed as  Exhibit 4.1 to Image’s Form 10-Q for the quarter ended December 31, 2001, and  incorporated by reference herein.                                                                                                                                 |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.4             |   | Warrant dated as of September 25, 2002 between Image and Standard  Broadcasting Corporation Limited.   Filed as Exhibit 99.2 to Image’s Form 8-K dated September 12, 2002,  and incorporated by reference herein.                                                                                                                                      |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.5             |   | Form of Registration Rights Agreement dated as of September 25, 2002  between Image and Standard Broadcasting Corporation Limited.  Filed as Exhibit 4.1 to Image’s Form 8-K  dated September 12, 2002, and incorporated by reference herein.                                                                                                          |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 4.6             |   | Form of Registration Rights Agreement dated as of March 24, 2003  between Image and Image Investors Co.   Filed as Exhibit 4.1 to Image’s Form 8-K dated March 24, 2003, and  incorporated by reference herein.                                                                                                                                        |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.1 **†** |   | Image’s Restated 1989 Incentive Stock Option Plan.  Filed as Exhibit 10.1 of Image’s Form 10-K  for the fiscal year ended March 31, 1992, and incorporated by reference  herein.                                                                                                                                                                  |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.2 **†** |   | Image’s 1990 Stock Option Plan.   Filed as Exhibit A of Image’s Proxy Statement dated December 27, 1990,  and incorporated by reference herein.                                                                                                                                                                                                   |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.3 **†** |   | Image’s Restated 1992 Stock Option Plan.  Filed as Exhibit A of Image’s Proxy Statement dated September  9, 1994, and incorporated by reference herein.                                                                                                                                                                                           |
|            |   |                                                                                                                                                                                                                                                                                                                                                             |
| 10.4 **†** |   | Image’s 1994 Eligible Directors Stock Option Plan and Form of  Eligible Director Non-Qualified Stock Option Agreement.  Filed as Exhibit 10.4 of Image’s Form 10-K  for the fiscal year ended March 31, 1995, and incorporated by reference  herein.                                                                                              |

 

i

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| 10.5 **†**  |   | Image’s 1998 Incentive Plan.   Filed as Exhibit A to Image’s Notice of Annual Meeting and Proxy  Statement dated July 29, 1998, and incorporated herein by this reference  (make consistent with above?).                                                                                                                                                                                                     |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.5(a)          |   | Form of Employee (Nonqualified) Stock Option Grant Agreement under  Image’s 1998 Incentive Plan.  Filed as  Exhibit 10.5(a) to Image’s Form 10-K for the fiscal year ended March 31,  1999, and incorporated by reference herein.                                                                                                                                                                             |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.6 **†**  |   | Eligible Director Non-Qualified Stock Option Agreement, dated as of  July 22, 1998, between Image and Stuart Segall.  Filed as Exhibit 10.9 to Image’s Registration Statement on Form  S-2 (No. 333-65611), effective December 21, 1998, and incorporated by  reference herein.                                                                                                                                    |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.7 **†**  |   | Eligible Director Non-Qualified Stock Option Agreement, dated as of  September 17, 1998, between Image and Mark Trevenen Huxley.  Filed as Exhibit 10.10 to Image’s  Registration Statement on Form S-2 (No. 333-65611), effective December 21,  1998, and incorporated by reference herein.                                                                                                                       |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.8 **†**  |   | Form of Option Agreement, dated October 15, 1991, between Image and  Martin W. Greenwald.  Filed as Exhibit  10.3 of Image’s Form 10-Q for the quarter ended September 30, 1991, and  incorporated by reference herein.                                                                                                                                                                                            |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.9 **†**  |   | Form of Option granted, dated August 13, 1992, by Image to Cheryl  Lee.  Filed as Exhibit 10.12 of  Image’s Form 10-K for the fiscal year ended March 31, 1994, and incorporated  by reference herein.                                                                                                                                                                                                             |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.10 **†** |   | Form of Option granted May 19, 1994 to Jeff Framer, Cheryl Lee and  David Borshell.  Filed as Exhibit  10.24 to Image’s Form 10-K for the year ended March 31, 1994, and  incorporated by reference herein.                                                                                                                                                                                                        |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.11 **†** |   | Form of Termination Agreement between Image and each of Martin W.  Greenwald, Cheryl Lee, Jeff Framer and David Borshell (relating to the  termination of their former employment agreements).  File as Exhibit 10.11 to Image’s Registration Statement on Form  S-2 (NO. 333-65611), effective December 21, 1998, and incorporated by  reference herein.                                                          |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.12 **†** |   | Employment Agreement, dated as of July 1, 1998, between Image and  Martin W. Greenwald.  Filed as Exhibit  10.12 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.13 **†** |   | Employment Agreement, dated as of July 1, 1998, between Image and  David Borshell.  Filed as Exhibit  10.15 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                                     |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.14 **†** |   | Employment Agreement, dated as of July 1, 1998, between Image and  Jeff Framer.  Filed as Exhibit 10.14  to Image’s Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                                                                                                                                                        |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.15 **†** |   | Employment Agreement, dated as of July 1, 1998, between Image and  Cheryl Lee.  Filed as Exhibit 10.13 to  Image’s Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                                                                                                                                                         |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.16 **†** |   | Form of 1998 Performance Restricted Stock Unit Award Agreement (and  related General Provisions), between Image and each of Martin W. Greenwald,  Cheryl Lee, Jeff Framer and David Borshell (appended as Exhibit A to Exhibits  10.12 through 10.15).  Filed as  Exhibit 10.16 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein. |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                         |
| 10.17 **†** |   | Form of 1999 Performance Restricted Stock Unit Award Agreement dated  as of July 1, 1999 (and related 1999 General Provisions), between Image and  each of Martin W. Greenwald, Cheryl Lee, Jeff Framer                                                                                                                                                                                                                      |

 

ii

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|             |   | and David Borshell.  Filed as  Exhibit 10.1 to Image’s Form 10-Q for the quarter ended June 30, 1999, and  incorporated by reference herein.                                                                                                                                                                                                                                                                                                                                                                                                 |
|------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.18 **†** |   | Loan Agreement, dated as of August 18, 2000, by and between Image and  Martin W. Greenwald.  Filed as Exhibit  10.1 to Image’s Form 10-Q for the quarter ended September 30, 2000, and  incorporated by reference herein.                                                                                                                                                                                                                                                                                                                    |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.19 **†** |   | Form of Director Stock Unit Award Agreement, dated as of October 1,  1999, between Image and each of Ira Epstein, M. Trevenen Huxley and Stuart  Segall.  Filed as Exhibit 10.18 to  Image’s Form 10-K for the fiscal year ended March 31, 2000, and incorporated  by reference herein.                                                                                                                                                                                                                                                      |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.20 **†** |   | Form of Director Stock Unit Award Agreement, dated as of October 1,  2000, between Image and each of Ira Epstein, M. Trevenen Huxley and Stuart  Segall.  Filed as Exhibit 10.1 to  Image’s Form 10-Q for the quarter ended December 31, 2000, and incorporated  by reference herein.                                                                                                                                                                                                                                                        |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.21 **†** |   | Form of Indemnity Agreement between Image and its directors and  officers.  Filed as Exhibit F of  Image’s Proxy Statement dated September 5, 1989, and incorporated by  reference herein.                                                                                                                                                                                                                                                                                                                                                   |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.22            |   | Stock Purchase Agreement among Image, Directors of Image and various  Buyers dated December 29, 1987.  Filed  as Exhibit 4.3 of Image’s Form 8-K dated December 29, 1987, and incorporated  by reference herein.                                                                                                                                                                                                                                                                                                                             |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.22(a)         |   | Form of First Amendment, dated July 7, 1992, to the Stock Purchase  Agreement among Image, Directors of Image and various Buyers dated December  29, 1987.  Filed as Exhibit 10.5 of  Image’s Form 10-Q for the quarter ended September 30, 1992, and  incorporated by reference herein.                                                                                                                                                                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.23            |   | Stock Purchase Agreement among Image, Directors of Image and Image  Investors Co. dated June 27, 1990.  Filed  as Exhibit 10.53 of Image’s Form 10-K for the fiscal year ended March 31,  1990.  Image and Image Investors Co.  are parties to Stock Purchase Agreements dated July 14, 1988, November 30,  1988, January 11, 1989, February 14, 1989, May 10, 1989 and June 20, 1990,  which are virtually identical to this Exhibit except for the number of shares  of Common Stock purchased, and incorporated by reference herein. |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.24            |   | Stock Purchase Agreement between Image and Image Investors Co. dated  December 30, 1992, including Warrant.   Filed as Exhibit 10.6 of Image’s Form 10-Q for the quarter ended  December 31, 1992, and incorporated by reference herein.                                                                                                                                                                                                                                                                                                     |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.25            |   | Standard Industrial Lease for 9333 Oso Avenue, Chatsworth,  California, dated December 1, 1993 and effective April 1, 1994, by and  between Image and P&R Investment Company.  Filed as Exhibit 10.1 of Image’s Form 10-Q for the quarter  ended December 31, 1993, and incorporated by reference herein.                                                                                                                                                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.25(a)         |   | First Amendment dated August 20, 1996 to Standard Industrial Lease  for 9333 Oso Avenue, Chatsworth, California, dated December 1, 1993 and  effective April 1, 1994, by and between Image and P&R Investment  Company.  Filed as Exhibit 10.24(a) to  Image’s Form 10-K for the fiscal year ended March 31, 1999, and incorporated  by reference herein.                                                                                                                                                                                |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.25(b)         |   | Second Amendment dated March 1, 1999 to Standard Industrial Lease for  9333 Oso Avenue, Chatsworth, California, dated December 1, 1993 and effective  April 1, 1994, by and between Image and P&R Investment Company.  Filed as Exhibit 10.24(b) to Image’s Form  10-K for the fiscal year ended March 31, 1999, and incorporated by reference  herein.                                                                                                                                                                                  |
|             |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
| 10.26            |   | Standard Industrial Lease for 9349 Oso Avenue, Chatsworth,  California, dated March 1, 1999 and effective May 1, 1990, between Image and  P&R Investment Company.  Filed as  Exhibit 10.25 to Image’s Form 10-K for the fiscal year ended March 31, 1999,  and incorporated by reference herein.                                                                                                                                                                                                                                         |

 

iii

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| 10.27    |   | Business Loan Agreement between Image and Bank of America National  Trust and Savings Association dated March 10, 1997.  Filed as Exhibit 10.23 to Image’s Form  10-K for the fiscal year ended March 31, 1998, and incorporated by reference  herein.                                                     |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.27(a) |   | Amendment No. 1 dated as of February 4, 1998 to Business Loan  Agreement between Image and Bank of America National Trust and Savings  Association dated March 10, 1997.   Filed as Exhibit 10.23(a) to Image’s Form 10-K for the fiscal year  ended March 31, 1998, and incorporated by reference herein.      |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.27(b) |   | Amendment No. 2 dated as of June 29, 1998 to Business Loan Agreement,  dated March 10, 1997, by and between Image and Bank of America National Trust  and Savings Association.  Filed as  Exhibit 10.3 to Image’s Form 10-Q for the quarter ended June 30, 1998, and  incorporated by reference herein.         |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.27(c) |   | Amendment No. 3 dated as of November 3, 1999 to Business Loan  Agreement, dated March 10, 1997, by and between Image and Bank of America  National Trust and Savings Association.   Filed as Exhibit 10.2 to Image’s Form 10-Q for the quarter ended  September 30, 1999, and incorporated by reference herein. |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.28    |   | Business Loan Agreement between Image and Bank of America, N.A. dated  June 28, 2000.  Filed as Exhibit 10.2  to Image’s Form 10-Q for the quarter ended June 30, 2000, and incorporated by  reference herein.                                                                                                  |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.29    |   | Intercreditor Agreement between Bank of America, N.A. and Foothill  Capital Corporation dated June 28, 2000.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended June  30, 2000, and incorporated by reference herein.                                                                           |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.30    |   | Lease Intended as Security between Image and BA Leasing & Capital  Corporation dated March 19, 1997.   Filed as Exhibit 10.24 to Image’s Form 10-K for the fiscal year ended March  31, 1998, and incorporated by reference herein.                                                                         |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.30(a) |   | (First) Amendment, dated March 19, 1997, to Lease Intended as  Security between Image and BA Leasing & Capital Corporation dated March  19, 1997.  Filed as Exhibit 10.24(a)  to Image’s Form 10-K for the fiscal year ended March 31, 1998, and  incorporated by reference herein.                    |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.30(b) |   | Second Amendment, dated February 8, 1998, to Lease Intended as  Security between Image and BA Leasing & Capital Corporation dated March  19, 1997.  Filed as Exhibit 10.24(b)  to Image’s Form 10-K for the fiscal year ended March 31, 1998, and  incorporated by reference herein.                   |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.30(c) |   | Third Amendment, dated September 25, 1998, to Lease Intended as  Security between Image and BA Leasing & Capital Corporation dated March  19, 1997.  Filed as Exhibit 10.1 to  Image’s Form 10-Q for the quarter ended September 30, 1998, and  incorporated by reference herein.                      |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.31    |   | Loan Agreement between Image and Union Bank of California, N.A.,  dated as of December 17, 1996.  Filed  as Exhibit 10.20 of Image’s Form 10-K for the fiscal year ended March  31, 1997, and incorporated by reference herein.                                                                            |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.31(a) |   | Amendment No. 1, dated as of February 5, 1997, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.20.A of Image’s Form 10-K for the fiscal year ended March 31, 1997,  and incorporated by reference herein.                |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.31(b) |   | Amendment No. 2, dated as of February 25, 1997, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.20.B of Image’s Form 10-K for the fiscal year ended March 31, 1997,  and incorporated by reference herein.               |
|     |   |                                                                                                                                                                                                                                                                                                                      |
| 10.31(c) |   | Amendment No. 3, dated as of September 27, 1997, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.26(c) of Image’s Form 10-K for the fiscal year ended March 31, 1998,  and incorporated by reference herein.             |

 

iv

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| 10.31(d) |   | Amendment No. 4, dated as of October 31, 1997, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.26(d) of Image’s Form 10-K for the fiscal year ended March 31, 1998,  and incorporated by reference herein.                           |
|----------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.31(e) |   | Amendment No. 5, dated as of January 28, 1998, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.26(e) of Image’s Form 10-K for the fiscal year ended March 31, 1998,  and incorporated by reference herein.                           |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.31(f) |   | Amendment No. 6, dated as of June 18, 1998, to Loan Agreement, dated  as of December 17, 1996, by and between Image and Union Bank of California,  N.A.  Filed as Exhibit 10.26(f) of  Image’s Form 10-K for the fiscal year ended March 31, 1998, and  incorporated by reference herein.                              |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.31(g) |   | Amendment No. 7, dated as of July 13, 1998, to Loan Agreement, dated  as of December 17, 1996, by and between Image and Union Bank of California,  N.A.  Filed as Exhibit 10.2 of Image’s  Form 10-Q for the quarter ended June 30, 1998, and incorporated by  reference herein.                                       |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.31(h) |   | Amendment No. 8, dated as of October 23, 1998, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.2 of Image’s Form 10-Q for the quarter ended September 30, 1998, and  incorporated by reference herein.                               |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.32    |   | Credit Agreement, dated as of September 29, 1997, by and between  Image and Image Investors Co.  Filed  as Exhibit 10.27 to Image’s Form 10-K for the fiscal year ended March  31, 1998, and incorporated by reference herein.                                                                                         |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.32(a) |   | Amendment No. 1, dated as of July 9, 2002, to Credit Agreement, dated  as of September 29, 1997, by and between Image and Image Investors Co.  Filed as Exhibit 10.1 to Image’s Form 10-Q  for the quarter ended June 30, 2002, and incorporated by reference herein.                                                       |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.32(b) |   | Amendment No. 2, dated as of September 30, 2002, to Credit Agreement,  dated as of September 29, 1997, by and between Image and Image Investors  Co.  Filed as Exhibit 10.4 to Image’s  Form 10-Q for the quarter ended September 30, 2002, and incorporated by  reference herein.                                     |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33    |   | Loan and Security Agreement, dated as of December 28, 1998, by and  between Image and Foothill Capital Corporation, including Capital Expenditure  Loan Note and Trademark Security Agreement.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended December  31, 1998, and incorporated by reference herein. |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33(a) |   | Amendment No. 1, dated as of November 1, 1999, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.1 to Image’s Form 10-Q for the quarter ended September 30, 1999, and  incorporated by reference herein.                        |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33(b) |   | Amendment No. 2, dated as of February 8, 2000, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.1 to Image’s Form 10-Q for the quarter ended December 31, 1999, and  incorporated by reference herein.                         |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33(c) |   | Amendment No. 3, dated as of August 28, 2001, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.2 to Image’s Form 10-Q for the quarter ended September 30, 2001, and  incorporated by reference herein.                         |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33(d) |   | Amendment No. 4, dated as of September 30, 2001, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.3 to Image’s Form 10-Q for the quarter ended September 30, 2001, and incorporated  by reference herein.                      |
|     |   |                                                                                                                                                                                                                                                                                                                                  |
| 10.33(e) |   | Amendment No. 5, dated as of February 28, 2002, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.1 to Image’s Form 10-Q for the quarter ended September 30, 2002, and  incorporated by reference herein.                       |

 

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| 10.33(f) |   | Amendment No. 6, dated as of August 1, 2002, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.2 to Image’s Form 10-Q for the quarter ended September 30, 2002, and  incorporated by reference herein.                               |
|----------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.33(g) |   | Amendment No. 7, dated as of September 30, 2002, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.3 to Image’s Form 10-Q for the quarter ended September 30, 2002, and  incorporated by reference herein.                           |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.33(h) |   | Amendment No. 8, dated as of December 31, 2002, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and Foothill  Capital Corporation.  Filed as Exhibit  10.1 to Image’s Form 10-Q for the quarter ended December 31, 2002, and  incorporated by reference herein.                             |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.34    |   | Limited Liability Company Operating Agreement of Aviva International,  LLC, dated as of June 21, 1999, by and between Image and Michael Lopez.  Filed as Exhibit 10.2 to Image’s Form 10-Q  for the quarter ended June 30, 1999, and incorporated by reference herein.                                                           |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.34(a) |   | First Amendment, dated as of April 28, 2000, to Limited Liability  Company Operating Agreement of Aviva International, LLC, dated as of June 21,  1999, by and between Image and Michael Lopez.  Filed as Exhibit 10.30(a) to Image’s Form 10-K for the fiscal  year ended March 31, 2000, and incorporated by reference herein. |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.35    |   | Optical Disc Replication and Loan Agreement dated March 13, 2001, by  and between Image and MRT Technology, LLC.   Filed as Exhibit 10.35 to Image’s Form 10-K for the fiscal year ended  March 31, 2001, and incorporated by reference herein.                                                                                  |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.35(a) |   | Amendment No. 1., dated as of March 26, 2002, to Optical Disc  Replication and Loan Agreement dated March 13, 2001, by and between Image and  MRT Technology LLC.  Filed as Exhibit  10.35(a) to Image’s Form 10-K for the fiscal year ended March 31, 2002, and  incorporated by reference herein.                              |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.36    |   | Subordination Agreement dated March 13, 2001, by and between Image,  MRT Technology, LLC and Bank of America, N.A.  Filed as Exhibit 10.36 to Image’s 10-K for the fiscal year  ended March 31, 2001, and incorporated by reference herein.                                                                                      |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.36(a) |   | First Amendment, dated March 26, 2002, to Subordination Agreement,  dated March 13, 2001, by and between Image, MRT Technology, LLC and Bank of America,  N.A.  Filed as Exhibit 10.36(a) to  Image’s Form 10-K for the fiscal year ended March 31, 2002, and incorporated  by reference herein.                                 |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.37    |   | Subordination Agreement dated March 13, 2001 by and between Image,  MRT Technology, LLC and Foothill Capital Corporation.  Filed as Exhibit 10.37 to Image’s Form  10-K for the fiscal year ended March 31, 2001, and incorporated by reference  herein.                                                                         |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.37(a) |   | Amendment Number One, dated March 26, 2002, to Subordination  Agreement dated March 13, 2001, by and between Image, MRT Technology, LLC and  Foothill Capital Corporation.  Filed  as Exhibit 10.37(a) to Image’s Form 10-K for the fiscal year ended March 31,  2002, and incorporated by reference herein.                     |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.38    |   | Master Lease Agreement, dated as of July 25, 2001, by and between  Image and General Electric Capital Corporation.  Filed as Exhibit 10.4 to Image’s Form 10-Q for quarter ended  September 30, 2001, and incorporated by reference herein.                                                                                      |
|     |   |                                                                                                                                                                                                                                                                                                                                       |
| 10.39    |   | Stock Purchase Agreement dated as of September 10, 2002 between Image  and Standard Broadcasting Corporation Limited.  Filed as Exhibit 99.1 to Image’s Form 8-K dated September 12,  2002, and incorporated by reference herein.                                                                                                |

 

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| 10.40  |   | Termination and Exchange Agreement entered into on March 24, 2003,  effective as of March 14, 2003, between Image and Image Investors Co.  Filed as Exhibit 99.1 to Image’s Form 8-K  dated March 24, 2003, and incorporated by reference herein. |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                        |
| 10.41  |   | Form of Warrant, dated March 24, 2003, between Image and Image  Investors Co.  Filed as Exhibit 99.2  to Image’s Form 8-K dated March 24, 2003, and incorporated by reference  herein.                                                            |
|   |   |                                                                                                                                                                                                                                                        |
| 21*    |   | Subsidiaries of the Registrant.                                                                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                        |
| 23*    |   | Consent Letter of KPMG LLP, Independent Certified Public Accountants.                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                        |
| 99.1*  |   | Certification pursuant to 18 U.S.C. Section 1360, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, dated June 27, 2003, by  Chief Executive Officer.                                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
| 99.2*  |   | Certification pursuant to 18 U.S.C. Section 1360, as adopted pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002, dated June 27, 2003, by  Chief Financial Officer.                                                                                  |
|   |   |                                                                                                                                                                                                                                                        |
|        |
|   |   | ***   Exhibit(s) not  previously filed with the Securities and Exchange Commission.**                                                                                                                                                        |
|   |   | **†   Management Contracts,  Compensatory Plans or Arrangements.**                                                                                                                                                                      |

 

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