Table of Contents

 

 

 

**UNITEDSTATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM 10-K**

 

**T****         ANNUAL REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**for the Fiscal Year Ended****March 31,2010**

 

**OR**

 

**£****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**for the Transition Period from                 To                 **

 

**Commission File Number****000-11071**

 

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**IMAGEENTERTAINMENT, INC.**

(Exact name of registrant as specified in its charter)

 

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

 

**20525Nordhoff Street, Suite 200, Chatsworth, California 91311**

(Address of principal executive offices, including zip code)

 

**(818) 407-9100**

(Registrant’s telephone number, including area code)

 

Securities registeredpursuant to Section 12(b) of the Act: **None**

 

Securities registeredpursuant to Section 12(g) of the Act: ****Common Stock, parvalue $0.0001**

 

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the SecuritiesAct.  YES o  NO x

 

Indicate by check mark if the registrant is notrequired to file report pursuant to Section 13 or Section 15(d) ofthe Act.  YES o  NO x

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  YES x  NO o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, everyInteractive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).  YES o  NO o

 

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of the registrant’s knowledge, in definitiveproxy or information statements incorporated by reference in Part III ofthis Form 10-K or any amendment to this Form 10-K.  o

 

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

 

| Large accelerated filer  o          |   | Accelerated filer  o         |
|-----------------------------------------------|--------|----------------------------------------|
|                                          |   |                                   |
| Non-accelerated filer  o            |   | Smaller reporting company  x |
| (Do not check if a smaller reporting company) |   |                                   |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).  YES o  NO x

 

The aggregate market value of the common stock heldby non-affiliates of the registrant, based upon the closing price of $0.85 forshares of the registrant’s common stock on September 30, 2009, the lastbusiness day of the registrant’s most recently completed second fiscal quarteras reported by The NASDAQ Global Market®, was approximately $11,351,515.  In calculating such aggregate market value,shares of common stock owned of record or beneficially by officers, directorsand persons known to the registrant to own more than five percent of the registrant’svoting securities (other than such persons of whom the registrant became awareonly through the filing of a Schedule 13G filed with the Securities andExchange Commission) were excluded because such persons may be deemed to beaffiliates.

 

The number of shares outstanding of the registrant’scommon stock as of June 15, 2010: 26,605,718

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

None.

 

 

 

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**IMAGEENTERTAINMENT, INC.**

**Form 10-K Annual Report**

**For The Fiscal Year Ended March 31, 2010**

 

**TABLE OF CONTENTS**

 
| PART I   |                                                                                                                | 3      |
|---------------|---------------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                                |   |
| ITEM 1.       | Business                                                                                                            | 3      |
| ITEM  1A.     | Risk  Factors                                                                                                       | 12     |
| ITEM 1B.      | Unresolved Staff  Comments                                                                                          | 23     |
| ITEM  2.      | Properties                                                                                                          | 23     |
| ITEM 3.       | Legal Proceedings                                                                                                   | 23     |
| ITEM 4.       | Removed and Reserved                                                                                                | 23     |
|          |                                                                                                                |   |
| PART II  |                                                                                                                | 24     |
|          |                                                                                                                |   |
| ITEM 5.       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 24     |
| ITEM 6.       | Selected Financial  Data                                                                                            | 24     |
| ITEM 7.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 25     |
| ITEM 7A.      | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 41     |
| ITEM 8.       | Financial  Statements and Supplementary Data                                                                        | 42     |
| ITEM 9.       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                               | 78     |
| ITEM 9A(T).   | Controls and  Procedures                                                                                            | 78     |
| ITEM 9B.      | Other Information                                                                                                   | 79     |
|          |                                                                                                                |   |
| PART III |                                                                                                                | 80     |
|          |                                                                                                                |   |
| ITEM 10.      | Directors,  Executive Officers and Corporate Governance                                                             | 80     |
| ITEM 11.      | Executive  Compensation                                                                                             | 80     |
| ITEM 12.      | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 80     |
| ITEM 13.      | Certain  Relationships and Related Transactions, and Director Independence                                          | 80     |
| ITEM 14.      | Principal  Accountant Fees and Services                                                                             | 80     |
|          |                                                                                                                |   |
| PART IV  |                                                                                                                | 81     |
|          |                                                                                                                |   |
| ITEM 15.      | Exhibits  and Financial Statement Schedules                                                                         | 81     |
|          |                                                                                                                |   |
| SIGNATURES    |                                                                                                                | 87     |

 

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**PART I**

 

**ITEM 1.  BUSINESS**

 

**Overview**

 

ImageEntertainment, Inc. (or *Image*, the *Company*, *we*, *us* or *our*) wasincorporated in Colorado as Key International Film Distributors, Inc. in April 1975.  In 1983, we changed our name to ImageEntertainment, Inc.  Wereincorporated in California in November 1989 and reincorporated again inDelaware in September 2005.  Ourprincipal executive offices are located at 20525 Nordhoff Street, Suite 200,Chatsworth, California 91311.

 

Weare a leading independent licensee and distributor of entertainment programmingin North America.  We release our library of exclusive content on avariety of formats and platforms, including DVD, Blu-ray Disc® (or *Blu-ray*), digital (video-on-demand (or *VOD*),electronic sell-through and streaming), broadcast television, cable orsatellite (including VOD and pay-per-view), theatrical and non-theatrical(airplanes, libraries, hotels and cruise ships) exploitation.

 

Ourfocus is on a diverse array of general and specialty content, including:

 
| · | Feature  films  |   | · | Theatrical  catalogue films |
|--------|-----------------|--------|--------|-----------------------------|
| · | Comedy          |   | · | Independent  films          |
| · | Music  concerts |   | · | Foreign  films              |
| · | Urban           |   | · | Youth  culture/lifestyle    |
| · | Theatre         |   | · | Television                  |
| · | Documentaries   |   | · | Gospel                      |

 

Wealso acquire exclusive rights to audio content for distribution via digitalplatforms and on CD spread across a variety of genres and configurations.  We strive to grow a stream of revenue bymaintaining and building a library of titles that can be exploited in a varietyof formats and distribution channels. Our active library currently contains:

 
| · | Approximately  3,000 exclusive DVD titles |
|--------|-------------------------------------------|
| · | Approximately  340 CD titles              |
| · | Digital  rights to                        |
|   | ·                                    | Over  2,100 video programs |
|   | ·                                    | Approximately  400 audio titles containing more than 5,600 individual tracks |

 

Eachmonth, we release an average of 15-20 exclusive DVD titles, most of which alsoinclude digital, broadcast, and VOD rights.

 

**Strategy**

 

InJanuary 2010 we adjusted our strategy following the changes in ourmanagement and Board of Directors, that resulted from the transaction with JHPartners (described in “Management’s Discussion and Analysis of FinancialCondition and Results of Operations — Recent Events”).  We believe our current strategy, which insome respects departs from our prior strategy, will allow us to be moreflexible and act upon opportunities at a more rapid pace.

 

Ourstrategy for fiscal year 2011 is composed of the following:

 

·                  Pursuing Exclusive Content Acquisition —continue actively pursuing complementary content and catalogue opportunities byfocusing on (i) cast-driven products resulting in fewer new titles butpotentially higher recognition, (ii) obtaining well-known talent-drivenmusic and comedy selections, (iii) balancing profit margin opportunitieswith potential risks, (iv) pursuing film, television and specialitylibraries of all sizes, and (v) acquiring the greatest variety ofdistribution rights, DVD, Blu-ray, broadcast, VOD and digital, bothdomestically and internationally.

 

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·                  Pursuing Strategic Opportunities —acquiringaccretive businesses and entering into joint ventures and other creativepartnering arrangements.  Our management team’s significant network ofrelationships and depth of expertise provide unique opportunities for us togrow in areas we know best.

 

·                  Reducing Expenses; Outsourcing —leveragingour significant cost savings achieved over the past year by right-sizingheadcount relative to our operational needs; pursuing outsourcing opportunitiesin the manufacturing and distribution areas; and evaluating all areas ofexpense for reduction opportunities.

 

·                  Expanding Distribution Opportunities into NewSegments and Mediums — taking advantage of non-tangible means of distributionthat have opened significant new opportunities, many of which have not yetrealized their full potential.

 

·                  Reassuring Existing and Potential ContentSuppliers — reassuring our existing and potential content suppliers that we areadequately capitalized and that we have the depth, breadth and expertise tomonetize their licensed content assets.

 

Theforegoing will allow us to focus on our core competency of acquiring exclusivelicensed content and distributing such content.

 

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***Partial List of Titles Released in Fiscal 2010***

 

**Features/Other:**

 

*Management*(starring Jennifer Aniston, Steve Zahn, Woody Harrelson)

*The Other Man*(starring Antonio Banderas, Liam Neeson, Laura Linney)

*Powder Blue*(starring Jessica Biel, Ray Liotta, Eddie Redmayne, Forest Whitaker, KrisKristofferson, Lisa Kudrow, Patrick Swayze)

*American Violet*(starring Nicole Beharie, Alfre Woodard, Will Patton)

*The Edge of Love*(starring Keira Knightley, Sienna Miller, Matthew Rhys)

*Incendiary*(starring Michelle Williams, Ewan McGregor)

*The Ramen Girl*(starring Brittany Murphy)

*The Last Word*(starring Winona Ryder, Wes Bentley, Ray Romano)

*Housebroken*(starring Danny Devito, Katey Sagal)

*Phoebe in Wonderland*(starring Felicity Huffman, Elle Fanning, Bill Pullman)

*Across the Hall*(starring Brittany Murphy)

*The Vicious Kind*

*Knut & Friends*

*Nine Dead*

*Lost in Austen*

*Franklyn*

*Body Armour*

*Dare*

*Forest of Death*

*Hearts of War*

*The Boxer*

*Unknown Woman*

*Everest*

*The Echo*

*Narrows*

*Bridge to Nowhere*

*Alien Trespass*

*Adam Resurrected*

*Seamstress*

*The Crew*

*Billy Jack Collection*

 

**CriterionBranded:**

 

*AK 100: 25 Films by Akira Kurosawa*

*Wings of Desire*

*Roman Polanski’s Repulsion*

*Gomorrah*

*Science is Fiction: 23 Films by Jean Painleve*

*The Hit*

*Empire of Passion*

*In the Realm of the Senses*

*Eclipse Series 16: Alexander Korda’s PrivateLives*

*Wise Blood*

*Friends of Eddie Coyle*

*Paris, Texas*

*Days of Heaven*

*The Last Days of Disco*

*Monsoon Wedding*

*Pigs, Pimps and Prostitutes: 3 Films by ShoheiImamura*

 

**Comedy:**

 

*Terry Fator: Live from Las Vegas*

*Artie Lange: Jack and Coke*

*Greg Behrendt: Is That Guy from That Thing*

*Charlie Murphy: I Will Not Apologize*

*Adam Ferrara: Funny As Hell*

*Ralphie May: Austin-tatious*

*Michael Loftus: You’ve Changed*

*Margaret Cho: Beautiful*

** **

**Urban:**

* *

*I Do...I Did*

*Truth Hall*

*The Greatest Song*

*Stick Up Kids*

*Che*(2008)

*There’s a Stranger in my House*

*Kiss and Tail: Hollywood Jump Off*

*2 Turntables and a Microphone: The Life and Death ofJam Master Jay*

*Applause for Miss E*

*Mothers Prayer*

 

**TV:**

 

*One Way Out*

*Man vs. Wild: Season 3*

*Man vs. Wild: Stranded Around the World*

*Shark Week: The Great Bites Collection*

*Dirty Jobs: Something Fishy*

*Golden Age of Television*

*Time Warp: Season 1*

*Survivorman: Season 3*

*Extreme Engineering: Collection 2*

*Mythbusters: Collection 4*

*The Future: A 360 Degree View*

*Iditarod: The Toughest Race on Earth*

*Deadliest Catch: Seasons 4 & 5*

*Wreckreation Nation: Season 1*

*Ghost Hunters: Season 5, Part 1*

 

**Music-Related:**

 

*Engelbert Humperdinck: Greatest Performances:1966-1977*

*Taylor Hicks: Whomp at the Warfield*

*Yes: Keys to Ascension*

*Starting Line: Somebodys Going to Miss Us*

*Bad Company: Hard Rock Live*

 

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***Partial List of Projected Titles for Release in Fiscal 2011***

** **

**Features/Other:**

* *

*$5 A Day* (starring Christopher Walken, Sharon Stone, AmandaPeet)

*Storm Seekers* (starring Daryl Hannah)

*Don McKay*(starring Thomas Haden Church, Elisabeth Shue)

*Disgrace* (starring John Malkovich)

*Middle of Nowhere* (starring Susan Sarandon, Anton Yelchin, EvaAmurri)

*44 Inch Chest* (starring Ray Winstone, Ian McShane,John Hurt)

*Crimes of Fashion* (starring Megan Fox, Kaley Cuoco)

*Accidents Happen* (starring Geena Davis)

*Fallen* (starring Paul Wesley, Tom Skerritt, BryanCranston)

*Tornado Valley* (starring Meredith Monroe)

*Skellig: The Owl Man* (starring Tim Roth)

*Multiple Sarcasms* (starring Timothy Hutton, Mira Sorvino, DanaDelaney, Mario Van Peebles, Stockard Channing)

*That Evening Sun*(starring Hal Holbrook)

*The Lightkeepers* (starring Richard Dreyfuss, Bruce Dern,Blythe Danner)

*Chain Letter*

*Daisy Chain*

*Owl & The Sparrow*

*Bare Knuckles*

*Eyeborgs*

*Bangkok Adrenaline*

** **

**Urban:**

* *

*Blood Done Sign My Name* (starring Rick Schroder,Nate Parker)

*Fade to Black* (starring Christopher Walken, Danny Huston,Paz Vega)

*Perfect Combination*

*Just Another Day*

*Don’t Let Me Drown*

*Kings of the Underground: The Dramatic Journey of UGK*

*David E. Talbert’s Love in the Nick of Tyme*

*David E. Talbert’s Mr. Right Now*

*Rain*

** **

**Comedy:**

* *

*Danny Bhoy: Subject To Change*

*Bobby Slayton: Born To Be Bobby*

*Steve Byrne: Byrne Identity*

*Loni Love: America’s Sister*

*Janeane Graofalo*

*Kathleen Madigan*

*Donnell Rawlings*

*Bill Burr: Let It Go*

 

**TV:**

* *

*The New Adventures of Black Beauty Season 2*

*Ghost Hunters: Season 5 Part 2*

*Ghost Hunters: Military Investigations*

*Ghost Hunters International: Season 1 Part 2*

*Thriller: The Complete Series*

*Twilight Zone: Seasons 1 & 2 (Blu-rayversion)*

*Twilight Zone: Fan Favorites (special edition tin)*

 

**CriterionBranded:**

* *

*Summer Hours*

*Vivre Sa Vie*

*Ride with the Devil*

*The Fugitive Kind*

*Walkabout*

*By Brakhage: An Anthology Volumes 1 & 2*

*Mystery Train*

*Close-Up*

*Red Desert*

*Stagecoach*

*Night Train to Munich*

*The Leopard*

*Everlasting Moments*

*House*

*The Thin Red Line*

 

**SpecialInterest:**

* *

*UFC Presents WEC: Aldo vs. Faber*

*UFC Presents: The Best of WEC*

*National Parks: Yosemite National Park*

*Visions of Nature: Timescapes*

*Hawaii: An Island Symphony*

*Robin Hood*(animated)

*Animation Express*

*Legends of the Canyon: Classic Artists*

 

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**Business Segments**

 

Wehave three business segments:

 

·                  Domestic (U.S. and Canada)

·                  Digital

·                  International

 

Ourdomestic segment primarily consists of the acquisition, content enhancement anddistribution of exclusive DVD/Blu-ray content in North America, and theexploitation of our North American broadcast, including cable and satellite,rights. Our digital segment consists of revenues generated by the digital distributionof our exclusive content via video-on-demand, streaming video anddownloading.  Our international segmentincludes the international video sublicensing of all formats and exploitationof all broadcast rights outside of North America.

 

Sincefiscal 2008, we began including the financial results of revenues generated byexploitation of our North American broadcast and non-theatrical rights as acomponent of the domestic segment, exploitation outside of North America as acomponent of our international segment, and we have reflected our digitalfinancial results as a separate segment.

 

***Domestic (U.S.and Canada)***

 

Mostof the product we release is in the standard DVD format.  We are a leading independent supplier of DVDcontent in the music, comedy, special interest, episodic television and urbangenres.  The following table reflects theaggregate number of titles we have in active release by content type, comparedwith the aggregate number of DVD software titles released by the industry,through the week ended June 11, 2010, excluding discontinued titles, usingdata compiled monthly in the *DVD &Blu-ray Release Report*.

 
| **Type  of DVD Content**                                     | ** ** | **Total Number  of DVD Titles** | ** ** | **Number of  Image Titles** | ** ** | **Percentage of Total  Number of Titles  Released by Image** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------|------------|--------------------------------------------------------------|------------|
| Music                                                        |       | 13,509                          |       | 626                         |       | 4.6                                                          | %          |
| Special Interest                                             |       | 30,868                          |       | 640                         |       | 2.1                                                          | %          |
| Theatrical Catalog (pre-1997)                                |       | 14,051                          |       | 502                         |       | 3.6                                                          | %          |
| Direct to DVD                                                |       | 11,730                          |       | 523                         |       | 4.5                                                          | %          |
| Foreign Language (including distributed lines)               |       | 10,699                          |       | 333                         |       | 3.1                                                          | %          |
| Television Programming                                       |       | 6,852                           |       | 266                         |       | 3.9                                                          | %          |
| All Other                                                    |       | 25,828                          |       | 110                         |       | 0.4                                                          | %          |
| Total Releases — Cumulative through June 11,  2010 |       | 113,537                         |       | 3,000                       |       | 2.6                                                          | %          |

 

*Source:  DVD &Blu-ray Release Report Revised June 10, 2010.*

 

Webelieve that the DVD format continues to be the preferred medium of homeentertainment for consumers, however Blu-ray continues to gain industryacceptance.  As consumers continue topurchase high-definition televisions and become exposed to high-definitioncontent through satellite and cable, they will expect the same level of qualityfrom their video movie rentals and purchases. Additionally, high-definition video-on-demand continues to gain tractionwith consumers and we provide high-definition source materials for this formatas well.  Titles scheduled in fiscal 2011for release in the Blu-ray format include: *Don McKay*,starring Thomas Haden Church and Elisabeth Shue, Criterion’s *Stagecoach*, directed by John Ford, and the complete *Twilight Zone* television series.

 

Manyof our DVD/Blu-ray titles include special features, enhancements and ancillarymaterials, such as multiple audio tracks, behind-the-scenes footage, directorcommentaries, interviews and discographies, some of which we create through ourmanaged value-added services.

 

*Exclusive Acquisition.*  We generally acquire exclusive distributionrights to our content across multiple entertainment formats.  We acquire our exclusive titles from a widerange of content holders and those who represent content holders, including:

 

·                  independent content suppliers;

·                  producers;

·                  music artists and record labels;

·                  artist management and talent agencies; and

·                  foreign sales companies.

 

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Wemarket and exploit our exclusive content according to exclusive royalty ordistribution fee agreements.  Ouragreements provide for a specified distribution term typically ranging fromfive to 25 years.

 

*New Library Acquisition Strategy.*  Since January 2010, we have broadenedour content acquisition focus to include complete libraries from both studiosand independents, such as the Handmade Films library (announced in March 2010),or strategically aligned companies.

 

*Mining of Image’s Library.*  We continue to create new and specialeditions of previously released content that will encourage consumers torepurchase the product in these technically superior versions.  We also continue to expand on strategies thatextend the life cycle of our titles, including “second bite” strategies thatfocus on repricing and/or remarketing and repromotion; increased focus onbudget product and shippers; and product shipped with merchandising displays.

 

*Theatrical Distribution**.*  In some cases, a limitedtheatrical release (playing on between two to 200 screens, in two to 20markets), which includes an outlay of prints and advertising costs, may berequired of us by the licensor as part of the acquisition deal.

 

*Managed Value-Added and Distribution Services.*  We manage a full range of value-addedservices for our licensed content and for many of our exclusively distributedtitles, including:

 

·                  packagingdesign;

·                  DVD/Blu-rayauthoring and compression;

·                  menu design;

·                  video masterquality control;

·                  manufacturing;

·                  marketing;

·                  sales;

·                  musicclearance;

·                  warehousing;

·                  distribution;and

·                  for sometitles, the addition of enhancements such as:

·                  multiple audio tracks;

·                  commentaries;

·                  foreign language tracks;

·                  behind-the-scenes footage;

·                  interviews; and

·                  discographies.

 

InFebruary 2010, as part of our revised strategy, we began outsourcing thepost-production and creative services necessary to prepare a DVD master andpackaging/advertising materials for manufacturing and marketing of ourproducts.  We previously performed the majority of these functionsin-house.  These services now are performed by in-house personnelresponsible for the management of third-party vendors.  Our warehousing and distribution services arecurrently provided from a facility located in Pleasant Prairie, Wisconsin,which is owned and operated by our DVD manufacturer, Arvato Digital Services(or *Arvato*).

 

*Criterion Distribution Agreement.*  We have a long-term exclusive home videodistribution agreement with The Criterion Collection to distribute its specialedition DVDs through July 2013.  TheCriterion Collection, including its related labels Eclipse and Janus Films,currently contains approximately 470 active DVD titles. The CriterionCollection and its related labels release approximately 50 titles annually.

 

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*Marketing.*  Our in-house marketing department directsmarketing efforts toward consumers as well as DVD, CD and digitalretailers.  Our marketing effortsinvolve:

 

·                  point-of-saleadvertising;

·                  printadvertising in trade and consumer publications;

·                  television andradio advertising campaigns;

·                  Internetadvertising, including viral and social network marketing campaigns;

·                  minimal directresponse campaigns;

·                  dealerincentive programs;

·                  trade showexhibits; and

·                  bulletinsfeaturing new releases and catalogue promotions.

 

*Customers.*  We sell our products to traditionalretailers, specialty retailers, rental customers, Internet retailers,wholesale distributors and alternative distribution, which includesdirect-to-consumer print catalogs, direct response campaigns, subscriptionservice/club sales, home shopping television channels, other non-traditionalsales channels, kiosks and sub-distributors.

 

Examplesof our key sell-through customers are Amazon.com, Inc., Best Buy Co., Inc.and Wal-Mart.  Examples of our keydistribution customers are Alliance Entertainment LLC (or *AEC*),E1 Entertainment, VPD and Ingram Entertainment, Inc.  Examples of our key rental customers areBlockbuster Inc., Netflix, Inc. and the rental kiosk business of Redbox.

 

Weallow retail customers to return a portion of unsold inventory on a quarterlybasis.  We reserve for estimated returnsat the time the sale is recognized, based in part upon our historical returnsexperience and knowledge of specific product movement within distributionchannels.  Our inventory returns, as apercentage of our gross distribution revenues, were 24.0% in fiscal 2010 and20.9% in fiscal 2009.  Returns ofdefective product have been minimal and are generally covered by manufacturers’warranties.

 

*Special Markets.* Our special marketsdivision (or *Special Markets*) is designed totake advantage of our large and diverse catalog and specifically targets nichesales opportunities.  Special Marketsencompasses all sales channels outside the traditional marketplace. WithinSpecial Markets, examples of our key customers are Olive Films, Midwest Tapesand Waxworks.

 

***Digital***

 

Weengage in the exclusive wholesale distribution of the digital rights to ourlibrary of audio and video content.  The demand for the types ofprogramming found in our library continues to increase as new retailers enterthis primarily online marketplace.  We seek to differentiate ourselvescompetitively by being a one-stop source for these retailers for the large anddiverse collection of entertainment represented by our digital library.

 

Weenter into non-exclusive distribution arrangements with retail andconsumer-direct entities whose business models include the digital delivery ofcontent.

 

Weaggressively continue to add numerous video and audio titles to our growinglibrary of exclusive digital rights each month. We strive to grow a stream of revenues by maintaining and building alibrary of titles that can be exploited in a variety of formats anddistribution channels.  Our current digital video library contains over2,100 individual video programs.  Ourinteraction with digital retail outlets is much more dynamic due to the overallsize of our library available to each retailer.

 

Weare actively participating in many digital business models, includingsell-through, rental, subscription and advertising-supported streaming. As consumers adopt these (or future) models, we believe we are well-positioned togrow along with our retail partners.  The near-term challenges faced byall digital distributors are to develop ways to increase consumer awareness andintegrate this awareness into their buying and consumption habits. Additionally, we support several technology companies and original equipmentmanufacturer device manufacturers with programming in an effort to generateconsumer interest in digital distribution and increase awareness and demand forour titles.  Examples of our digitalretail accounts are iTunes (audio and video, ringtones), Amazon.com (audio andvideo) Microsoft Zune (audio and video), Hulu (video) and Sony Playstation(video).

 

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***International***

 

We also hold international distribution rights tomore than 450 of our titles currently exploited on DVD and approximately 90 ofour CD titles to countries outside of North America.  Outside North America, we sublicensedistribution in the areas of home entertainment, television and digital,primarily music and urban-related DVDs, through distribution partners such asUniversal Music Group International, Digital Site and Warner Music Australia,who pay us a royalty for their distribution of our products.

 

***Broadcast (Domestic and InternationalBusiness Segments)***

 

Revenuesgenerated from North American broadcasts are included in our domesticsegment.  Revenues generated from outsideNorth America are included in our international segment.

 

Wehave a television division responsible for all forms of televisiondistribution, including the worldwide sales of our content across broadcasttelevision, pay-per-view (or *PPV*), VOD andnon-theatrical platforms.

 

*Worldwide Television*.  Buyers of our standard and high-definitioncontent are typically cable, PPV or satellite broadcasters, and sometimesterrestrial (free) television broadcasters.  Examples of our key broadcastsublicensees are BET and BET International, PBS and Showtime.

 

*Worldwide PPV and VOD**.  *With respect to PPV, VOD andEST, we are proceeding under a two-pronged approach.  We continue to expand our directrelationships as opposed to working through intermediaries.  In North America, we have direct relationshipswith InDemand, Avail-TVN and Echostar (Dish Net) along with several specialtylabels such as Sky Angel and Eurocinema. Revenue is typically derived on a revenue-sharing basis.

 

Thesecond prong is a North American sales agency agreement with Warner DigitalDistribution, a division of Time-Warner, Inc. (or *Warner*).  Warner, on our behalf, sublicenses many ofour premier, high-end programs to cable, satellite and hotel/motel operatorswho are in the VOD and EST businesses. Revenue is typically derived on a revenue-sharing basis.

 

Internationally,we work with North American-based outlets that already have internationaloperations in addition to opening discussions with a variety of internationallybased entities.

 

*Worldwide Hotel/Motel For Performance Properties.*  We continue to pursue direct relationshipswith those entities that are in the business of providing entertainment to thehotel/motel market.

 

InNorth America, we work with Warner and Avail-TVN and have direct relationshipswith several entities providing entertainment to the hotel/ motel arena.  For exploitation of our music and stand-upcomedy programs for hotels and motels, we have a non-exclusive output agreementwith Instant Media Network (or *IMN*).  IMN is partially owned by Lodgenet/On Command— the largest distributor of entertainment product to the hotel/motel industryin North America.  In addition, anon-exclusive output agreement has recently been entered into with VODI for alltypes and genres of programming.

 

Likewith PPV and VOD, internationally we work with North American-based outletsthat have existing international operations as well as internationally basedoutlets.

 

**Competition**

 

We face competition fromother independent distribution companies, major motion picture studios and musiclabels in securing exclusive content distribution rights.  Our DVD and Blu-ray products compete for afinite amount of retail and rental shelf space. Consumers can choose from a large supply of competing entertainmentcontent from other suppliers.  Digitaldownloading, streaming, and other broadcast formats, while in their infancy,are also increasing competition for the delivery of content.  We also face competition for consumers’ timeand money from alternate forms of entertainment and leisure activities.  The success of any of our products dependsupon consumer acceptance of that product in relation to current events as wellas the other products released into the marketplace at or around the same time.

 

Our ability to continue tosuccessfully compete is largely dependent upon our ability to anticipate andrespond to various competitive and other factors affecting the industry,including new or changing product formats, changes in consumer preferences,regional and local economic conditions, discount pricing strategies andcompetitors’ promotional activities.

 

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**Industry Trends**

 

Accordingto The Digital Entertainment Group (or *DEG*), Blu-raycontinued to grow during calendar 2009****and provedpopular among consumers spending on software sales and rental transactions,reaching $1 billion. According to the DEG, 50% more Blu-ray discs shipped toretail in calendar 2009 versus calendar 2008, and combined DVD and Blu-raysales remained resilient, with consumer rental and sell-through spending on allformats of approximately $20 billion for the year.

 

WhileU.S. sales of DVD and Blu-ray were down by 13% at $11.4 billion in calendar2009, rental spending increased 4.2% to $6.5 billion. The growth in Blu-rayhelped offset the maturing DVD market, bringing the overall category to asingle-digit drop of 4.8% in total consumer spending in calendar 2009 versus2008.  In the first calendar quarter of2010, Blu-ray hardware sales grew 125% from the first calendar quarter of 2009.The DEG also reported that consumer purchases of packaged media units,including DVD and Blu-ray, exceeded $2.5 billion for the first calendar quarter2010, an 11% decline compared to the same period last year primarily due to anational retailer undergoing a chain-wide liquidation, which included releasingunexpected quantities of packaged media units into the market.  However, first calendar quarter 2010 sales ofBlu-ray were up 74% and digital distribution, which includes electronicsell-through (EST) and video-on-demand (VOD), was up 27% to $617 million forthe period.

 

Fromthe launch of the DVD format in spring 1997 through calendar 2009, the DEG reportsapproximately 277 million DVD players, including set-top and portable DVDplayers, Home-Theater-in-a-Box systems, TV/DVD and DVD/VCR combination players,have sold to consumers, bringing the number of DVD households to approximately92 million (adjusting for households with more than one player). The DEGestimates that 67 % of DVD owners have more than one player.

 

TheDEG reports sales of Blu-ray playback devices, including set-top boxes and gameconsoles, sold 17.3 million units since launch in 2006.  There were 4.5 million devices sold in thefourth quarter of 2009 alone, bringing total units sold to eight million incalendar 2009.

 

TheDEG estimates that more than 71 million high-definition television (or *HDTV*) sets have been sold to consumers, bringing the numberof HDTV households to nearly 48 million. The DEG further estimates that 33% ofthese households have more than one set.  An HDTV set provides the optimalmedium for playback of Blu-ray.

 

**Trademarks**

 

Wehave U.S. federal registrations for the following trademarks: Image, ImageEntertainment, the Image Entertainment logo (two trademarks), Image MusicGroup, the Egami Media logo, Image Entertainment Japan, Home Vision HVEEntertainment, and One Village Entertainment.

 

Ingeneral, trademarks remain valid and enforceable as long as the marks are usedin connection with the related products and services and the requiredregistration renewals are filed.  Webelieve our trademarks have value in the marketing of our products.  It is our policy to protect and defend ourtrademark rights.

 

**Employees**

 

Asof June 15, 2010, we had 74 employees, all of whom are full-time.

 

**Available Information**

 

Underthe menu “Investors—SEC Filings” on our Web site at *www.image-entertainment.com*, we provide free access to ourAnnual Reports on Form 10-K, Quarterly Reports on Form 10-Q, CurrentReports on Form 8-K and all amendments to those reports as soon asreasonably practicable after such material is electronically filed with or furnishedto the SEC.  The information contained on our Web site is not incorporatedherein by reference and should not be considered part of this Annual Report.

 

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**ITEM 1A.****                                           ****RISK FACTORS**

 

**Forward-Looking Statements**

 

ThisAnnual Report on Form 10-K for the fiscal year ended March 31, 2010(or *Annual Report*) includes forward-lookingstatements that involve risks and uncertainties within the meaning of the PrivateSecurities Litigation Reform Act of 1995. Other than statements of historical fact, all statements made in thisAnnual Report are forward-looking, including, but not limited to, statementsregarding industry prospects, future results of operations or financialposition, and statements of our intent, belief and current expectations aboutour strategic direction, prospective and future results and condition.  In some cases, forward-looking statements maybe identified by words such as “will,” “should,” “expect,” “plan,” “anticipate,”“believe,” “estimate,” “continue,” “future,” “intend,” “project” 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. Unless otherwise required by law, we undertake no obligation to releasepublicly any updates or revisions to any such forward-looking statements thatmay reflect events or circumstances occurring after the date of this AnnualReport.

 

Youshould carefully consider and evaluate all of the information in this AnnualReport, including the risk factors listed below.  If any of these risks occur, our business,results of operations and financial condition could be harmed, the price of ourcommon stock could decline and you maylose all or part of your investment, and future events and circumstancescould differ significantly from those anticipated in the forward-lookingstatements contained in this Annual Report.

 

**Risks Relating to Our Business**

 

**The report of our independent registered public accountingfirm contains an explanatory paragraph expressing substantial doubt about ourability to continue as a going concern. **Because of ourlimited capital resources, coupled with a history of losses, negative workingcapital, maturing loan agreement on October 25, 2010 and negative cashflows, our independent registered public accounting firm has included anexplanatory paragraph in its report on our consolidated financial statementsfound elsewhere in this Annual Report that expresses substantial doubtregarding our ability to continue as a going concern (or *GoingConcern Opinion*). Theaccompanying consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty. The accompanyingconsolidated financial statements have been prepared assuming that we willcontinue as a going concern, which contemplates the realization of assets andthe settlement of liabilities in the normal course of business.

 

Infuture years, the receipt of a Going Concern Opinion from our independentregistered public accounting firm would result in a default under our loanagreement, as amended, with Wachovia Capital Finance Corporation (Western), aWells Fargo Company (or *Wachovia*), upondelivery of the opinion to Wachovia for any fiscal year other than fiscal2010.  Wachovia provided us with a waiverthat the Going Concern Opinion for the fiscal year ended March 31, 2010 willnot, in and of itself, result in an event of default under the loanagreement.  However, any future defaultsunder our loan agreement, if not waived or cured, would automatically trigger across-default under our other debt agreements, thereby adversely impacting ourability to continue as a going concern. Substantial doubt about our ability to continue as a going concern couldalso adversely affect our relationships with suppliers or customers, whichcould further exacerbate our current liquidity issues and impact our ability tocontinue as a going concern, and negatively impact the trading price of ourcommon stock.

 

Whileour use of cash declined in fiscal 2010, our sales were insufficient to improveour liquidity.  There is a significantrisk that we may not be able to generate or raise enough additional funds toremain operational for an indefinite period of time.

 

**Our liquidity substantially depends on our ability to borrow againstour revolving line of credit.**  Ourcash collections are deposited into a lockbox with Wachovia, the lender underour revolving line of credit.  Thedeposited cash receipts are automatically swept to reduce our outstanding loanbalance.  Currently, all of our operatingworking capital needs are financed through borrowings under our line ofcredit.  If Wachovia does not providefunding under our line of credit due to (i) the occurrence of an event ofdefault, as defined in the loan agreement, (ii) non-compliance with ourcovenants, or (iii) our borrowing to the fullest extent of the line, ourliquidity, business, results of operations and financial condition would bematerially adversely affected and we may not be able to continue as a goingconcern.  Additionally, delays or anyfailure to collect our trade accounts receivable, upon which our borrowingavailability is entirely based, would have a negative impact on our borrowingavailability and liquidity.  If we areunable to obtain funding under our line of credit, we will have to seekadditional sources of financing, which may not be available on acceptable termsor at all.

 

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**Failure to replace our revolving line of credit would negatively impactour business, results of operations and liquidity**. Our revolvingline of credit with Wachovia currently expires on October 25, 2010.  While we are reviewing revolving credit lineoptions, including negotiating a new agreement with Wachovia, we may not beable to replace the line of credit, and any new revolving credit line may be onless favorable terms and conditions compared to our current creditfacility.  Failure to obtain areplacement revolving line of credit would negatively impact our business,results of operations and liquidity because our revolving line of credit hasbeen one of our primary sources of liquidity. If we are unable to replace ourexpiring revolving line of credit, we will need to seek additional debt orequity financing on terms that may be less favorable to us than the currentline of credit and which may result in increased fiscal interest paymentobligations, restrictive covenants, dilution to our stockholders and thegranting of superior rights to the investors.

 

**Our credit facility contains covenants that may limit the waywe conduct business. **Our $20 millioncredit facility with Wachovia contains various covenants limiting our abilityto:

 

·                  incur or guarantee additional indebtedness;

·                  pay dividends and make other distributions;

·                  pre-pay any subordinated indebtedness;

·                  make investments and other restrictedpayments;

·                  make capital expenditures;

·                  enter into merger or acquisition transactions;and

·                  sell assets.

 

Thesecovenants may prevent us from raising additional debt financing, competingeffectively or taking advantage of new business opportunities.

 

Underour credit facility, we are also required to maintain a minimum amount ofborrowing availability.  At March 312010, we had availability in excess of the minimum amount of borrowingavailability.  As of June 1, 2010,our borrowing ability was $2.0 million ($3.5 million based upon eligibleaccounts receivable less the current $1.5 million minimum requirement).

 

Additionally,our credit facility includes language that states that a material adversechange in our business, assets or prospects would be considered an “event ofdefault.”  If we are unable to complywith the covenants, or satisfy the financial ratio and other tests, or shouldan event of default occur, as determined and invoked by Wachovia, a default mayoccur under our credit facility.  Unlesswe are able to negotiate an amendment, forbearance or waiver with Wachovia, wecould be required to repay all amounts then outstanding, which could have amaterial adverse effect on our liquidity, business, results of operations andfinancial condition, depending upon our outstanding balance at the time.

 

**We have a history of (and may continue to incur) losses, limitedworking capital and limited access to financing.  We will need additional funding to continueacquiring desirable programming and to continue as a going concern.**** **We sustained operating and net losses infiscal 2010 and 2009. We had an accumulated deficit of $54.1 million and aworking capital deficit of $6.2 million at March 31, 2010.  Our cash requirements continue to exceed thelevel of cash generated by operations. We are past due on our trade accounts payable and royalty anddistribution fee obligations. Accordingly, we have limited working capital.  We must raise additional funds to acquire therights to content or to create content we find desirable, particularly withrespect to our competition for home entertainment rights to feature films, andto continue as a going concern. Therefore, maximizing available working capital is critical to ourbusiness operations.

 

Because of our history oflosses and negative cash flows, our ability to obtain adequate financing on satisfactoryterms may be limited.  Our ability toraise financing through sales of equity securities depends on general marketconditions and the demand for our common stock. We may be unable to raise adequate capital through the sale of equitysecurities, and if our stock has a low market price at the time of any sale,our existing stockholders could experience substantial dilution.  If adequate financing is not available orunavailable on acceptable terms, we may find we are unable to fund expansion,continue offering products and services, take advantage of acquisitionopportunities, develop or enhance services or products, or respond tocompetitive pressures in the industry, which may further jeopardize our abilityto continue operations as a going concern.

 

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**We generate significant amounts of net revenue forprogramming from one content supplier, the loss of which would adversely impactour business.** We depend onthe exclusive distribution of programming from The Criterion Collection, whichcontributed approximately 29% and 24% of our net revenues from programming infiscal 2010 and fiscal 2009, respectively. Should liquidity issues cause us to default on our payment obligationsunder our exclusive distribution agreement, Criterion may terminate ourdistribution rights, which would adversely impact our business, results ofoperations and financial condition.

 

**The current economic slowdown may continue to adverselyimpact our business, results of operations and financial condition.**  The current global economic downturn has hada significant negative impact on our revenues and may continue to do so. Asconsumers have reduced spending and scaled back purchases of our programming,our retail customers have reacted with increased product returns and reducedfuture purchases of our programming, which has adversely impacted our revenuesand results of operations during this fiscal year.  Weak consumer demand for our product maycontinue in the future and may adversely impact our business, results ofoperations, financial condition and ability to continue as a going concern.

 

**A further tightening of the credit markets may have anadverse effect on our ability to obtain financing.** The recent recession and instability in theglobal economy has resulted in tightening of the credit markets, more stringentlending standards and terms and higher volatility in interest rates.  Persistence of these conditions could have amaterial adverse effect on our access to financing and the terms and cost ofthat financing. As a result, we may not be able to secure additional financingin a timely manner, or at all, to meet our future capital needs, which may havean adverse effect on our business, operating results, financial condition andability to continue as a going concern.

 

**Failure to secure DVD distribution rights may adverselyimpact our business, results of operations and financial condition.**  Given our current liquidity issues, we may beunable to continue to secure DVD and other distribution rights on termsacceptable to us, which may adversely impact our business, results ofoperations and financial condition. Acquiring distribution rights to desirable high-profile content requiressignificant advance payment, which we may not be able to make.  For more information regarding our continuingability to obtain DVD distribution rights, see “Business — Competition”above.  Major motion picture studios havenormally not granted, nor are they expected to grant, exclusive DVD licenses tous for new releases and popular catalogue titles.  Instead, the major motion picture studioswill most likely continue to sell DVD titles directly to retailers.  As our liquidity condition allows, we expectto continue to license exclusive DVD and other home entertainment formatcontent, but we may not remain competitive against licensing entities withgreater financial resources, and independent program suppliers may distributetheir programming themselves rather than through us.  In addition, our success will continue todepend upon our ability to identify and secure rights to exclusive content thatappeals to consumers.

 

**We have a high concentration of sales to relatively fewcustomers, the loss of which may adversely impact our liquidity, business,results of operations and financial condition.**  In fiscal 2010, Amazon.com, Inc. and AECaccounted for approximately 17% and 14% of our net revenues, respectively.  In fiscal 2009, Amazon.com, Inc.accounted for approximately 14% of our net revenues.  Additionally, our top five customersaccounted for over 53% of our fiscal 2010 net revenues.

 

Wemay be unable to maintain favorable relationships with our retailers anddistributors.  Further, our retailers anddistributors may be adversely affected by economic conditions.  For example, the parent of AEC underwent abankruptcy reorganization in 2009.  If welose any of our top customers or if any of these customers reduces or cancels asignificant order, it could have an adverse effect on our liquidity, business,results of operations and financial condition.

 

**Our high concentration of sales to relatively few customers may resultin significant uncollectible accounts receivable exposure, which may adverselyimpact our liquidity, business, results of operations and financial condition.**  At March 31, 2010, Amazon.com, Inc.and AEC accounted for 18% and 13%, respectively, of our gross accountsreceivable.  At March 31, 2009,Anderson Merchandisers, AEC and Amazon.com, Inc. accounted forapproximately 12%, 11%, and 10%, respectively, of our gross accountsreceivable.

 

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Dueto the concentration of sales to relatively few customers, we face creditexposure from our retail customers and may experience uncollectible receivablesfrom these customers should they face financial difficulties.  If these customers fail to pay their accountsreceivable, file for bankruptcy or significantly reduce their purchases of ourprogramming, it would have an adverse effect on our business, financialcondition, results of operations, and liquidity.

 

**We have a high concentration of sales from relatively fewtitles, which may impact future net revenues if we do not acquire additionaltitles.**  Our top five fiscal 2010 newrelease exclusive titles**on**DVD accounted for approximately 14% ofour fiscal 2010 net revenues.  Our topten fiscal 2010 new release exclusive titles on DVD accounted for approximately18% of our fiscal 2010 net revenues. Sales for these catalogue titles have decreased over time and willprobably continue to do so until our rights expire.  If we are unable to acquire titles of equalor greater strength and popularity to replace the revenue provided by ourexisting titles, our future net revenues will be negatively impacted.

 

**Our acquisition of cast-driven finished feature film contentmay not be successful, which could adversely impact our business, results ofoperations and financial condition.**  We are primarily known as an aggregator ofexclusive distribution rights for eclectic, non-feature film entertainmentprogramming.  In our effort to focus oncast-driven finished feature films, we face competition from other distributionentities that are well known for acquiring and distributing this genre ofprogramming.  We face competition frombetter-capitalized entities, including the major motion picture and independentstudios, and may be unable to offer the same upfront money required to securethe rights for certain available programming. While we have key members of management and staff with feature filmacquisition, sales and marketing talent and experience, we may not beultimately successful in acquiring or selling feature film contentcompetitively or to the extent of our current plans.  With the maturation of the DVD market, ourinability to successfully acquire or sell feature film content could adverselyimpact our business, results of operations and financial condition.

 

**We are subject to risks associated with our strategy of pursuingacquisitions, joint ventures and partnering arrangements.**  A key element of our current business strategyis acquiring accretive businesses and entering into joint ventures and othercreative partnering arrangements, which pose unique risks.  For example, regardless of whether wecomplete any such transaction, its negotiation, as well as the integration ofany acquired business, could require us to incur significant costs and causediversion of management’s time and resources. We may not realize the anticipated benefit from any of the transactionswe pursue.  Further, any such transactioncould also potentially result in the future impairment of goodwill and otherintangibles, development write-offs and other related expenses. Any of theforegoing could have a material adverse effect on our business, results ofoperations and financial condition.

 

**Our inability to gauge and predict the commercial success ofour programming could adversely impact our business, results of operations andfinancial condition.**  Operating inthe entertainment industry involves a substantial degree of risk.  Each music performance, feature film or otherprogramming title is an individual artistic work, and unpredictable audiencereactions primarily determine commercial success.  The commercial success of a title alsodepends upon the quality and acceptance of other competing programs or titlesreleased into the marketplace, critical reviews, the availability ofalternative forms of entertainment and leisure activities, general economicconditions and other tangible and intangible factors, all of which are subjectto change and cannot be predicted with certainty.  Timing is also sometimes relevant to aprogram’s success, especially when the program concerns a recent event orhistorically relevant material (e.g., an anniversary of a historical eventwhich focuses media attention on the event and accordingly spurs interest inrelated content).  Our success willdepend in part on the popularity of our content which, in turn, depends on ourability to gauge and predict expected popularity.  Even if a film achieves success during itstheatrical release, the popularity of a particular program and its ratings maydiminish over time.  Our inability togauge and predict the commercial success of our programming could adverselyimpact our business, results of operations and financial condition.

 

**Our current DVD and CD genre revenue concentrations maybecome unpopular with our retail customers and end-consumers, which mayadversely impact our business.**  During fiscal 2010 and 2009, our DVD saleswere heavily weighted toward comedy, music and television-related DVDprogramming and feature film programming. We may not be able to successfully continue producing or acquiringcontent in the same genres, or achieve the same strength within these genres.  If we are unable to compete successfully inthe home entertainment market for higher-profile DVD and CD content, ourbusiness may be adversely impacted.

 

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**Inventory obsolescence may adversely impact our business,results of operations and financial condition.**  We maintain a substantial investment in DVDand CD inventory.  If we overestimate thedemand for a particular title, we may warehouse significant quantities of thattitle.  Retained inventory occupiesvaluable storage space and may become obsolete as our distribution term for thetitle expires.  Although we may sell theinventory at a deeply discounted price toward the end of the distribution termto recoup our manufacturing, storage and other costs, there is no guaranteethat a market will exist for a given title, even at the deeply discountedprice.  Alternatively, we may want torenew the exclusive distribution rights to an expiring title, but there is noguarantee that we will be able to do so, or do so on terms acceptable tous.  Additionally, our royalty anddistribution fee agreements sometimes contain terms, such as minimum royaltiesper unit and music publishing fees, which effectively prevent us from steeplydiscounting the price on some titles. Failure to sell obsolete inventory may adversely impact our business,results of operations and financial condition.

 

**We may be unable to recoup advances paid to secure exclusivedistribution rights.**  Our mostsignificant costs and cash expenditures relate to acquiring content forexclusive distribution.  Most agreementsto acquire content require upfront advances against royalties or net profitsexpected to be earned from future distribution. The advance amounts are derived from our estimate of net revenues thatwill be realized from our distribution of the title.  Although these estimates are based onmanagement’s knowledge of current events and actions management may undertakein the future, actual results will differ from those estimates.  If sales do not meet our original estimates,we may (i) not recognize the expected gross margin or net profit, (ii) notrecoup our advance or (iii) record accelerated amortization and/or fairvalue write-downs of film costs, including the advances paid.  We recorded accelerated amortization and fairvalue write-downs of film costs in the amounts of $5.5 million and $6.7 millionin fiscal 2010 and fiscal 2009, respectively. Any of these events may adversely impact our business, results ofoperations and financial condition.

 

**Risks associated with distributing our programminginternationally may adversely impact our business, results of operations andfinancial condition.**  Wedistribute our programming internationally. As a result, our business may be subject to various risks inherent ininternational trade, many of which are beyond our control.  Risks faced in distributing our programminginternationally include:

·                  cancellation orrenegotiation of contracts;

·                  changes in lawsand policies affecting international trade (including taxes);

·                  credit risk;

·                  fluctuatingforeign exchange rates and controls;

·                  civil strife;

·                  acts of war;

·                  guerillaactivities;

·                  insurrection;

·                  terrorism;

·                  changingretailer and consumer tastes and preferences with regard to our programming;

·                  differingdegrees of protection of our intellectual property;

·                  culturalbarriers; and

·                  potentialinstability of foreign economies and governments.

 

Anyof the foregoing risks may adversely impact our international sales, which mayadversely impact our business, results of operations and financial condition.

 

**Inability to maintain relationships with our programsuppliers and vendors may adversely impact our business.**  We receive a significant amount of ourrevenue from the distribution of those DVDs for which we already have exclusiveagreements with program suppliers. However, those titles in production which have been financed by us maynot be timely delivered as agreed or be of expected quality.  Delays or inadequacies in delivery of titles,including rights clearances, could negatively impact the performance of anygiven quarter or fiscal year.  Inaddition, our business, results of operations and financial condition may beadversely impacted if:

 

·                  we are unable to renew our existingagreements as they expire;

·                  our current program suppliers do not continueto support the DVD format in accordance with our exclusive agreements;

·                  our current content suppliers do not continueto license titles to us on terms favorable to us; or

·                  we are unable to establish new beneficialsupplier relationships to ensure acquisition of exclusive titles in a timelyand efficient manner.

 

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**We may not be able to keep pace with technological advances,which may adversely impact our business, results of operations and financialcondition.**  Theentertainment industry in general, and the music and motion picture industriesin particular, are continuing to undergo significant changes, primarily due totechnological developments, including Blu-ray and digital delivery.  Because of the rapid growth of technology,shifting consumer tastes and the popularity and availability of other forms ofentertainment, it is impossible to predict the overall effect these factorscould have on potential revenue from, and profitability of, distributingentertainment programming.  If we areunable to keep pace with accepted technological advances in deliveringentertainment programming, our business, results of operations and financialcondition may be adversely impacted.

 

**Failure by third parties to promote our programming mayadversely impact our business.**  Decisions regarding the timing of release andpromotional support of the programming we license and distribute are importantin determining the success of a particular music concert, feature film orrelated product.  We may not control themanner in which a particular artist, film or related product is marketed andpromoted, and we may not be able to fully control our corresponding DVD or CDreleases.  Although artists, recordcompanies, studios and producers have a financial interest in the success ofany concerts or films distributed by us, any marketing or promotional decisionor restriction by such persons may negatively affect the success of our titles.

 

**An increase in product returns may adversely impact ourbusiness, results of operations and financial condition. **As with the major studiosand other independent companies in this industry, we experience a relativelyhigh level of product returns as a percentage of our revenues. Our allowancesfor sales returns may not be adequate to cover potential returns in the future,particularly in the case of consolidation within the home video retailmarketplace which, when it occurs, tends to result in inventory consolidationand increased returns.  Our experienceover two of the past three years has been one of increasing return rates, andwe expect this trend to continue.  Acontinuation of increasing return rates may adversely impact our business,results of operations and financial condition.

 

**We may not possess satisfactory rights in our properties, whichmay adversely impact our business, results of operations and financialcondition.**  Although werequire satisfactory chain of title information to our exclusively licensedcontent, as well as errors and omissions insurance and indemnification from ourcontent providers, the risk exists that some programs may have a defectivechain of title.  The validity andownership of rights to some titles can be uncertain and may be contested bythird parties, which may result in litigation that could result in substantialcosts and the diversion of resources, and could have a material adverse impacton our business, results of operations and financial condition.

 

**Protecting and defending against intellectual property claimsmay have a material adverse impact on our business, results of operations andfinancial condition.**  Our abilityto compete in the home entertainment industry depends, in part, upon successfulprotection of our intellectual property rights. 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 afford only limited practical protectionin some jurisdictions.  In somejurisdictions of our distribution, there are no copyright and/or trademarkprotections available.  As a result, itmay be possible for unauthorized third parties to copy and distribute ourproductions or portions or applications of our intended productions.

 

Inaddition, litigation may be necessary in the future to enforce our intellectualproperty rights, to protect our trade secrets, to determine the validity andscope of the proprietary rights of others or to defend against claims ofinfringement or invalidity.  Any suchlitigation could result in substantial costs and the resulting diversion ofresources could have an adverse effect on our business, results of operationsor 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 anadverse effect on our business, financial condition or results of operations.

 

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**We depend on key and highly skilled personnel to operate our business,and if we are unable to retain our current personnel or hire additionalpersonnel, our ability to develop and successfully market our business could beharmed. **Our success continues todepend to a significant extent on our ability to identify, attract, hire, trainand retain qualified professional, creative, technical and managerialpersonnel.  Moreover, we believe that oursuccess greatly depends on the contributions of our executive management, includingChief Executive Officer Theodore S. Green, Chief Operating Officer and ChiefFinancial Officer John P. Avagliano, Vice Chairman John W. Hyde, ChiefAcquisitions Officer Bill Bromiley, Executive Vice President Raymond Gagnon andExecutive Vice President, Operations Rick Eiberg.  Although we have employment agreements withexecutive management, any of our employees may terminate their employmentrelationship with us at any time, and their knowledge of our business andindustry would be extremely difficult to replace.  The loss of any key employees or theinability to attract or retain qualified personnel could delay the acquisitionof content and harm the market’s perception of us.  Competition for the caliber of talentrequired to acquire and distribute content continues to increase.  If we are unable to attract and retain thequalified personnel we need to succeed, our business, results of operations andfinancial condition will suffer.

 

**The occurrence of uninsured events may adversely impact ourbusiness, results of operations and financial condition.**  We maintain insurance to protect us againstvarious risks related to our operations. This insurance is maintained in types and amounts that we believe to bereasonable.  However, we may elect tolimit coverage or not to carry insurance for some risks because of the highpremiums associated with insuring those risks or for various otherreasons.  For example, we do not carryearthquake insurance in light of the steep increase in premiums in SouthernCalifornia after the Northridge earthquake in January 1994.  The occurrence of uninsured events or eventsfor which we are not adequately insured may adversely impact our business,results of operations and financial condition.

 

**We face direct and indirect foreign currency exchangerisk. **We distribute some of ourlicensed DVD programming (for which we hold international distribution rights)internationally through sub-licensees such as Universal Music GroupInternational and Digital Site, and the sales transactions underlying theserelationships are denominated in currencies other than the U.S. Dollar.  Although we receive payments in U.S. Dollarsfrom our sublicensors, fluctuations in foreign currencies relative to the U.S.Dollar could affect the amount of these payments.  For example, if the U.S. Dollar strengthenscompared to either the Euro or the Yen, our sublicensors’ reported royalties tous on a title-by-title basis and in the aggregate would decline (assumingconsistent unit sales) and thus reduce our revenues.  To date, we have not entered into foreigncurrency exchange contracts.  Even if wewere to implement hedging strategies to mitigate this risk, these strategiesmight not eliminate our exposure to foreign exchange rate fluctuations andwould involve costs and risks of their own, including ongoing management timeand expertise, external costs to implement the hedging activities and potentialaccounting implications.

 

**We depend on third-party shipping and fulfillment companiesfor the delivery of our products.  Ifthese companies experience operational difficulties or disruptions, ourbusiness could be adversely impacted. **We rely onArvato Digital Services, our disc replication and fulfillment partner, todetermine the best delivery method for our products.  Arvato relies entirely on arrangements withthird-party shipping companies, principally UPS and Federal Express, for smallpackage deliveries and less-than-truckload service carriers for largerdeliveries, for the delivery of our products. The termination of arrangementsbetween Arvato and one or more of these third-party shipping companies, or thefailure or inability of one or more of these third-party shipping companies todeliver products on a timely or cost-efficient basis from Arvato to our customers,could disrupt our business, reduce net sales and harm our reputation.  Furthermore, an increase in the amountcharged by these shipping companies could negatively affect our gross marginsand earnings.

 

**Legislative actions, higher directors’ and officers’insurance costs and potential new accounting pronouncements are likely to causeour general and administrative expenses to increase and impact our futurefinancial condition and results of operations. **In order to comply with the Sarbanes-Oxley Act of 2002, as well asongoing changes to rules adopted by the Securities and ExchangeCommission, we have been required to strengthen our internal controls, hireadditional personnel and retain additional legal, accounting and advisoryservices, all of which have caused, and could continue to cause, our generaland administrative costs to increase.  Inaddition, insurers have increased and could continue to increase premiums forour directors’ and officers’ insurance policies.  As a result, it may be more expensive for usto attract and retain qualified individuals to serve on our Board of Directorsor as our executive officers.

 

Ourfinancial statements are prepared in accordance with U.S. generally acceptedaccounting principles.  These principlesare subject to interpretation by various governing bodies, including theFinancial Accounting Standards Board, the Public Company Accounting OversightBoard, and the Securities and Exchange Commission, which create and interpretappropriate accounting standards.  Changes in or new accounting standards couldhave a significant adverse effect on our results of operations.

 

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**Risks Relating to Our Industry**

 

**The standard DVD format has matured.**  During calendar 2009, the DVD marketplaceexperienced the third straight year-over-year decline for the category sincethe format debuted in 1997.  Home MediaMagazine and Strategic Analytics reported in the fourth quarter of our fiscal2010 a noticeable decline in packaged media units (including DVD and Blu-ray)actually sold globally to consumers in 2009. We generated approximately 87% and 89% of our net revenue in fiscal 2010and 2009, respectively, from the sale of standard DVDs.  The continued maturation of the standard DVDformat may adversely impact our business, results of operations and financialcondition.  For more informationregarding the trend of the DVD format maturation, see “Business — IndustryTrends” above.

 

**Decreasing retail prices for DVDs may negatively impact ourrevenues and gross profit margins.**  The home entertainment programming market inwhich we compete is rapidly evolving and intensely competitive.  Many of our competitors, including majorstudios, are increasingly offering programming, particularly DVD programming,at lower prices.  They may be able toproduce or secure content on more favorable terms and may be able to adopt moreaggressive pricing policies than us. 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 higher levels of competition and, therefore, lost sales,decreased profit margins or decreased overall revenues.

 

**Decreasing retail shelf space for our industry may limitsales of our programming, which may adversely impact our business, results ofoperations and financial condition**.  We face increasing competition from majormotion picture studios, music labels and other independent content suppliersfor limited retail shelf space and retailer open to buy dollars.  Our exclusive content competes for a finiteamount of shelf space against a large supply and diversity of entertainmentcontent from other suppliers.  New DVDreleases generally exceed several hundred titles a week.  We believe this competition can be especiallychallenging for independent labels like us, because the new DVD releases ofmajor studios often have extremely high visibility and sales rates in themillions of units, and typically require much more shelf space to support.

 

Shelfspace limitations at our “brick and mortar” retail customers are exacerbated bythe arrival of a sole high-definition DVD format - Blu-ray.  The combination of standard discs, premiumdiscs and special-edition boxed sets across up to two formats means that arelease can come in as many six different configurations.  With the possible exception of our mostpopular new release titles and top-selling catalogue titles, it can be achallenge to obtain the product placement necessary to maximize sales,particularly among the limited number of major retailers who comprise our core “brickand mortar” customers.  The continuedretailer trend toward greater visibility for titles at the expense of quantity(i.e., “face out” rather than “spine out” DVD placement) has the effect ofreducing the total number of titles actually carried by a retailer.  For more information regarding decreasingretail shelf space due to DVD releases of major studios, see “Business —Competition” above.

 

Forretailers, reconciling the expanding DVD catalog with limited shelf space isbecoming increasingly urgent.  Meanwhile,rights holders like Image and other non-studio content providers have a growingconcern that many titles are simply not strong enough to secure shelfspace.  If we are unable to securesufficient shelf space for our programming, our business, results of operationsand financial condition may be adversely impacted.

 

**Illegal piracy may reduce our revenues and adversely impactour results of operation. **The musicindustry is facing a major challenge in the form of illegal piracy resulting fromInternet downloading and CD recorders. This piracy has negatively affected industry revenues and profits.  As DVD recorders, DVRs and high-speedInternet connections become more popular, and the storage capacity of personalcomputers increases, we may face greater piracy concerns with respect to ourcore DVD business.  Motion picture piracyis already extensive in many parts of the world and is made easier because oftechnological advances and the conversion of motion pictures into digitalformats.  The proliferation ofunauthorized copies of these products may reduce the revenue we receive fromour products, which may cause an adverse material impact on our business.  In order to contain this problem, we require ourretail distribution partners to implement elaborate and costly security andanti-piracy measures such as geo-filtering, which could result in significantexpenses and loss of revenue.  Even withsuch security and anti-piracy measures, we may be unable to prevent illegalpiracy.

 

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**If DVD cannot compete successfully with other formats of homeentertainment, our revenues may be adversely impacted.**  The DVD format competes with other formats ofin-home entertainment, including network, syndicated, cable and pay-per-viewtelevision, home satellite systems and video gaming systems.  The DVD format also competes with new andemerging technologies in the entertainment industry, including Blu-ray,entertainment programming on the Internet, video-on-demand, high-definitiontelevision, and optical discs with greater storage capacity.  These alternate home entertainment formatsand emerging content delivery technologies may adversely impact the overallmarket for our DVD sales, especially if we are unable to continue to adapt andexploit the development and advancement of emerging technology.

 

**The motion picture industry is rapidly evolving, and recent trends haveshown that audience response to both traditional and emerging distributionchannels is volatile and difficult to predict.**The entertainment industryin general and the motion picture industry in particular continue to undergosignificant changes, due both to shifting consumer tastes and to technologicaldevelopments.  New technologies, such asvideo-on-demand and Internet distribution of films, have provided motionpicture companies with new channels through which to distribute theirfilms.  Accurately forecasting both thechanging expectations of movie audiences and market demand within these newchannels has proven challenging.

 

Wecannot accurately predict the overall effect shifting audience tastes,technological change or the availability of alternative forms of entertainmentmay have on the distributor.  In additionto uncertainty regarding the DVD market, there is uncertainty as to whetherother developing distribution channels and formats, including video-on-demand, Internetdistribution of films and high-definition, will attain expected levels ofpublic acceptance or, if such channels or formats are accepted by the public,whether we will be successful in exploiting the business opportunities theyprovide.  Moreover, to the extent thatthese emerging distribution channels and formats gain popular acceptance, thedemand for delivery through DVDs may decrease.

 

**Risks Relating to Our Stock**

 

**Our recent issuance of preferred stock resulted insubstantial dilution to our stockholders, and the rights of the holders ofpreferred stock could render future financings and merger and acquisitiontransactions more difficult.**On January 8, 2010, weraised gross proceeds of $22.0 million through the sale and issuance toaffiliates of JH Partners, LLC (or *JH Partners*) of22,000 shares of newly designated Series B Cumulative Preferred Stock and196,702 shares of newly designated Series C Junior Participating PreferredStock.  The initial Series CPreferred Stock sold to these investors would convert into 196,702,000 sharesof our common stock (subject to adjustment upon any stock dividends, stocksplits or other similar recapitalization with respect to the Series CPreferred Stock).  While this privateplacement provided us with additional working capital required to repayoutstanding indebtedness and fund continuing operations, the transaction wasextremely dilutive to our existing stockholders, and the agreements with thepurchasers contain terms and covenants that could result in additional dilutionto our stockholders due to a remaining purchase right, as of the time of thisfiling, to acquire up to 3,700 additional shares of Series B PreferredStock and 33,081.7 additional shares of Series C Preferred Stock(convertible into an additional 33,081,700 shares of common stock, subject toadjustment upon the occurrence of certain events), all of which could renderfuture financings and merger and acquisition transactions more difficult.

 

Inthe event of any merger or acquisition of Image, each share of Series BPreferred Stock will be entitled to receive an amount in cash equal to the sumof (i) a liquidation preference of $1,000 per share (subject to adjustmentupon any stock dividend, stock split, combination or other similarrecapitalization with respect to the Series B Preferred Stock) and(ii) the amount per share equal to accrued but unpaid dividends, whichaccrue on a cumulative compounding basis at a rate of 12% per annum on theliquidation preference of $1,000 per share. If we enter into an acquisition ormerger transaction in which shares of our common stock are exchanged for orconverted or changed into other stock or securities, cash or any otherproperty, then each share of Series C Preferred Stock will be similarlyexchanged, converted or changed into an amount per share equal to 1,000 timesthe aggregate amount of stock, securities, cash or other property into whicheach share of our common stock is converted, changed or exchanged (subject toadjustment upon the occurrence of certain events).

 

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**Because of its significant stock ownership, our largeststockholders can exert significant influence over our future direction.**On January 8, 2010, affiliates of JH Partners purchased 22,000shares of newly designated Series B Preferred Stock and 196,702 shares ofnewly designated Series C Preferred Stock. After subsequent transactions involving our capital stock, the Series CPreferred Stock currently held by JH Partners affiliates is convertible, at theoption of the holders, into 176,137,700 shares of our common stock (subject toadjustment upon the occurrence of certain events), representing approximately77.03% of our outstanding voting securities as of June 1, 2010.  As of the time of this filing, the investorshave a remaining purchase right acquire up to 3,700 additional shares of Series BPreferred Stock and 33,081.7 additionalshares of Series C Preferred Stock (convertible into an additional 33,081,700shares of common stock (subject toadjustment upon the occurrence of certain events)) that could further increasetheir ownership. Prior to conversion, the Series C Preferred Stock votestogether as one class with the holders of our common stock (except as providedby law or our certificate of incorporation) and each share of Series CPreferred Stock entitles the holder to 1,000 votes (subject to adjustment uponthe occurrence of certain events) on all matters submitted to a vote ofstockholders. In connection with the sale of the shares, the affiliates of JHPartners appointed the three current members of our board of directors, two ofwhom work for JH Partners. Therefore, JH Partners is able to significantlyinfluence all matters requiring approval by our stockholders, including theelection of directors, the approval of mergers or other business combinationtransactions or a sale of all or substantially all of our assets. The interestsof JH Partners may not coincide with the interests of other holders of ourcommon stock.

 

**As a result of our delisting from The Nasdaq StockMarket, we are not currently subject to its corporate governance requirementsand you may not have the same protections afforded to stockholders of listedcompanies.**Effective as of February 3, 2010, trading inour common stock was suspended from trading on The Nasdaq Global Market due to,among things, failure to satisfy certain corporate governance requirements forcontinued listing. The Nasdaq Stock Market imposes certain corporate governancerequirements on listed companies. For example, listed companies must, amongother things, have a majority of independent board members and fullyindependent audit, nominating and compensation committees.  As a result of our sale of preferred stock tocertain affiliates of JH Partners in January 2010, our board was replacedin its entirety with individuals that were nominated by the affiliates of JHPartners. Our current board of directors consists of three members — TheodoreS. Green, our Chief Executive Officer and Chairman of the Board, and Patrick M.Collins and Michael J. John, each of whom is employed by JH Partners. None ofthe new directors are “independent” as that term is defined for board and auditcommittee members by the listing rules of The Nasdaq Stock Market andRule 10A-3 of the Securities Exchange Act of 1934. The new board ofdirectors has not formed a separate audit committee and, therefore, the entireboard of directors is acting as the audit committee until we can find andappoint independent directors to form a separate audit committee comprisedsolely of independent directors. While we are in the process of findingindependent directors to serve on the board and to comprise a separate auditcommittee, we may not find a sufficient number of qualified individuals willingto serve. In addition, the new board has not formed separate compensation ornominating committees. Accordingly, you may not have the same protectionsafforded to stockholders of companies that are subject to, and in fullcompliance with, the corporate governance requirements of a securitiesexchange.

 

**Our stock price may be subject to substantial volatility, andyou may lose all or a substantial part of your investment.**  Our common stock currently trades in theover-the-counter market on the OTCQB marketplace.  There is a limited public float, and tradingvolume historically has been limited and sporadic.  From June 1, 2009 through June 1,2010, the closing price of our common stock ranged between $0.17 and $1.16 pershare on volume ranging from none to over 2.3 million shares per day.  As a result, the market price for our commonstock may not necessarily be a reliable indicator of our fair market value.  The price at which our common stock willtrade may be highly volatile and may fluctuate as a result of a number offactors, including the number of shares available for sale in the market,quarterly variations in our operating results, actual or anticipatedannouncements of new releases by us or competitors, the gain or loss ofsignificant customers, changes in the estimates of our operating performance,and market conditions in our industry and the economy as a whole.

 

**You may find it difficult to dispose of your shares. **There is currently a limitedtrading market for our common stock on the OTCQB marketplace. The ability totrade our common stock on the OTCQB marketplace depends on the presence andinvestment decisions of willing buyers and sellers. Therefore, the market ofinvestors who are willing to purchase our common stock is limited, the volumeof our common stock traded on a daily basis is low, and the liquidity of ourcommon stock is constrained. Prices for securities traded solely on the OTCQBmarketplace may be difficult to obtain. This very limited liquidity, marketability, the reduced public access toprice quotations and lack of a regular trading market may depress the marketprice of our common stock.  As a result,an investor might find it more difficult to dispose of, or obtain accuratequotations for the price of, our common stock.

 

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Tradingin our common stock might also become subject to the requirements of certain rules promulgatedunder the Securities Exchange Act of 1934, which require additional disclosureby broker-dealers in connection with any trade involving a stock defined as a “pennystock” (generally, any equity security not listed on a national securitiesexchange that has a market price of less than $5.00 per share, subject tocertain exceptions).  Many brokeragefirms are reluctant to recommend low-priced stocks to their clients.  Moreover, various regulations and policiesrestrict the ability of shareholders to borrow against or “margin” low-pricedstocks, and declines in the stock price below certain levels may triggerunexpected margin calls.  Additionally,because brokers’ commissions on low-priced stocks generally represent a higherpercentage of the stock price than commissions on higher-priced stocks, thecurrent price of the common stock can result in an individual shareholderpaying transaction costs that represent a higher percentage of total sharevalue than would be the case if our share price were higher.  This factor may also limit the willingness ofinstitutions to purchase our common stock. Finally, the additional burdens imposed upon broker-dealers by theserequirements could discourage broker-dealers from facilitating trades in ourcommon stock, which could severely limit the market liquidity of the stock andthe ability of investors to trade our common stock.

 

**The delisting of our common stock from The NasdaqGlobal Market could result in loss of investors, increased obligations understate securities laws, decreased coverage by securities analysts and a highercost of capital.**Effective as of February 3, 2010, trading inour common stock was suspended from trading on The Nasdaq Global Market. Thequotations for our common stock now appear on the OTCQB marketplace of Pink OTCMarkets Inc.  Delisting from The NasdaqGlobal Market subjects us to numerous consequences that may adversely affectour business, including the loss of investors. Further, delisting may result indecreased coverage by securities analysts.

 

Inaddition, our ability to raise additional capital through equity financing, andattract and retain personnel by means of equity compensation, may be impaired.Furthermore, we may experience decreases in institutional and other investordemand, analyst coverage, market-making activity, and information availableconcerning trading prices and volume, and fewer broker-dealers may be willingto execute trades with respect to our common stock. The delisting may decreasethe attractiveness of our common stock and cause the trading volume of ourcommon stock to decline significantly, which could result in a significantdecline in the market price of our common stock.

 

Weintend to seek to be relisted on a securities exchange at some point in thefuture; however, we may not be able to satisfy the standards for listing on anexchange, an exchange may not approve our listing and the timing of anyrelisting is uncertain.

 

**Any future sales of equity may significantly impact themarket price of our common stock.**  Future sales of substantial amounts of ourcommon stock, including significant equity compensation grants we agreed toaward our executive management subsequent to March 31, 2010, shares thatwe may issue upon exercise of outstanding options, warrants and otherconvertible securities, and shares issuable upon conversion of outstandingshares of our Series C Preferred Stock, could adversely impact the marketprice of our common stock.  Further, ifwe raise additional funds through the issuance of common stock or securitiesconvertible into or exercisable for common stock, the percentage ownership ofour stockholders will be reduced and the price of our common stock may fall.

 

**If we are unable to conclude that our internal control overfinancial reporting is effective, our stock price may be negatively impacted.**  Section 404 of the Sarbanes-Oxley Act of2002 and the accompanying rules and regulations promulgated by the SEC toimplement it require us to include in our Form 10-K an annual report byour management regarding the effectiveness of our internal control overfinancial reporting.  The reportincludes, among other things, an assessment of the effectiveness of ourinternal control over financial reporting as of the end of our fiscalyear.  This assessment must includedisclosure of any material weaknesses in our internal control over financialreporting identified by management. During this process, if our management identifies one or more materialweaknesses in our internal control over financial reporting that cannot beremediated in a timely manner, we will be unable to assert such internalcontrol is effective.  While we currentlybelieve our internal control over financial reporting is effective, theeffectiveness of our internal controls in future periods is subject to the riskthat our controls may become inadequate because of changes in conditions, and,as a result, the degree of compliance of our internal control over financialreporting with the applicable policies or procedures may deteriorate.  If we are unable to conclude that ourinternal control over financial reporting is effective (or if, as of our fiscalyear ending March 31, 2011, our independent registered public accountingfirm disagree with our conclusion), we could lose investor confidence in theaccuracy and completeness of our financial reports, which may have an adverseimpact on our stock price.

 

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**Certain provisions in our charter documents and Delaware law,as well as our stockholder rights plan, could discourage takeover attempts andlead to management entrenchment.** Our certificate of incorporation and bylawscontain provisions that could have the effect of delaying or preventing changesin control or changes in our management without the consent of our board ofdirectors.  These provisions include:

 

·                  no cumulative voting in the election ofdirectors, which limits the ability of minority stockholders to elect directorcandidates;

 

·                  a classified board of directors withthree-year staggered terms, which may delay the ability of stockholders tochange the membership of a majority of our board of directors;

 

·                  the exclusive right of our board of directorsto elect a director to fill any vacancies, which prevents stockholders frombeing able to fill vacancies on our board of directors;

 

·                  the ability of our board of directors todetermine to issue shares of preferred stock and to determine the price andother terms of those shares, including preferences and voting rights, withoutstockholder approval, which could be used to significantly dilute the ownershipof a hostile acquirer;

 

·                  a prohibition on stockholder action bywritten consent or electronic transmission, which forces stockholder action tobe taken at an annual or special meeting of our stockholders;

 

·                  the requirement that, except as required bylaw and subject to any rights of holders of preferred stock, a special meetingof stockholders may be called only by the chairman of the board of directors,the chief executive officer, the president and the secretary, in each casepursuant to a resolution of the board of directors, which may delay the abilityof our stockholders to force consideration of a proposal or to take action,including the removal of directors; and

 

·                  advance notice procedures that stockholdersmust comply with in order to nominate candidates to our board of directors orto propose matters to be acted upon at a stockholders’ meeting, which maydiscourage or deter a potential acquirer from conducting a solicitation ofproxies to elect the acquirer’s own slate of directors or otherwise attemptingto obtain control of us.

 

Weare also subject to certain anti-takeover provisions under Delaware law.  Under Delaware law, a corporation may not, ingeneral, engage in a business combination with any holder of 15% or more of itscapital stock unless the holder has held the stock for three years or, amongother things, the board of directors has approved the transaction.

 

**ITEM 1B.****                                           ****UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM 2.****                                                    ****PROPERTIES**

 

Ourheadquarters are located in Chatsworth, California and consist of approximately30,000 square feet leased on one floor of a multi-tenant building.  The monthly rent is approximately $46,000 permonth, on a gross basis.  The office lease,as amended, has an initial 10-year term expiring June 30, 2014 with twofive-year options.  Although a base levelof operating expenses is included in the rent payment, we are responsible for apercentage of actual annual operating expense increases, capped at 5%annually.  All of our business segmentsare located in the Chatsworth facility.

 

Webelieve that our current office is adequate to meet our needs, and thatadditional facilities will be available for lease, if necessary, to meet ourfuture needs.

 

**ITEM 3.****                                                    ****LEGAL PROCEEDINGS**

 

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

 

**ITEM 4.****                                                    ****REMOVED AND RESERVED**

 

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**PART II**

 

**ITEM 5.****                                                ****MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS ANDISSUER PURCHASES OF EQUITY SECURITIES**

 

**MarketInformation**

 

Ourcommon stock began trading on the OTCQB Marketplace of the Pink OTC MarketsInc. beginning on February 3, 2010. Prior to that date, we traded on The NASDAQ Global Market® under the symbol “DISK.”  The table below presents the quarterly highand low sales prices as reported by Pink OTC Markets Inc. and The NASDAQ GlobalMarket during the past two fiscal years. Quotations from Pink OTC Markets Inc. reflect inter-dealer prices,without retail mark-up, markdown or commission, and may not necessarilyrepresent actual transactions.

 
| **Fiscal Year Ended March 31, 2010** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------|------------|----------|------------|---------|------------|
| Quarter ended June 30, 2009          |       | $        | 1.630      |    | $          | 0.810 |   |
| Quarter ended September 30, 2009     |       | $        | 0.930      |    | $          | 0.625 |   |
| Quarter ended December 31, 2009      |       | $        | 0.860      |    | $          | 0.210 |   |
| Quarter ended March 31, 2010         |       | $        | 0.354      |    | $          | 0.170 |   |

 
| **Fiscal Year Ended March 31, 2009** | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------|------------|----------|------------|---------|------------|
| Quarter ended June 30, 2008          |       | $        | 1.850      |    | $          | 0.800 |   |
| Quarter ended September 30, 2008     |       | $        | 1.290      |    | $          | 0.750 |   |
| Quarter ended December 31, 2008      |       | $        | 2.150      |    | $          | 0.410 |   |
| Quarter ended March 31, 2009         |       | $        | 2.390      |    | $          | 0.730 |   |

 

**Stockholders**

 

Asof June 15, 2010, there were approximately 26,605,718 shares of our commonstock issued and outstanding, which were held by 950 holders of record.  The number of holders of record does notinclude the number of persons whose stock is in nominee or “street name”accounts through brokers.

 

**Dividend Policy**

 

Exceptas described below, our loan agreement with Wachovia prohibits the payment ofdividends.  For more information on theserestrictions, please refer to “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations — Liquidity and CapitalResources.”  We have never paid a cashdividend on our common stock, and we presently intend to retain all futureearnings, if any, for business development.

 

Underthe terms of our Series B preferred stock, we are required to accruedividends at a rate of 12% per year. These dividends are accrued, but may not be declared and paid withoutWachovia’s approval.  So long as anyshares of Series B Preferred Stock are outstanding and until all dividendson the Series B Preferred Stock have been paid or declared and set asidefor payment, we are prohibited from, among other things, declaring or payingany dividend (whether in cash or property) and from making any otherdistribution on any shares of our preferred stock or common stock.  Our ability to satisfy our dividendobligations, including making the payments described above, will depend uponour future operating performance on economic, financial, competitive, and otherfactors, many of which may be beyond our control.

 

**ITEM 6.****                                                 ****SELECTED FINANCIAL DATA**

 

Notapplicable.

 

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

 

*The following discussion and analysis of our financialcondition and results of operations contains forward-looking statements thatinvolve risks and uncertainties, such as statements of our plans, objectives,expectations and intentions.  As described in Item 1A of this AnnualReport under the heading “Forward-Looking Statements,” our actual results coulddiffer materially from those anticipated in these forward-looking statements. Factors that could contribute to such differences include those discussedelsewhere in Item 1A of this Annual Report under the heading “Risk Factors.” You should not place undue reliance on these forward-looking statements,which apply only as of the date of this Annual Report.  Except as may berequired under federal law, we undertake no obligation to update publicly anyforward-looking statements for any reason, even if new information becomesavailable or other events occur*

 

*You should read the following discussion and analysis inconjunction with our consolidated financial statements and related footnotesincluded in Item 8 of this Annual Report.*

 

**Overview**

 

***General***

 

Weare a leading independent licensee and distributor of home entertainmentprogramming in North America.  We havethree business segments:

 

·                  Domestic (U.S.and Canada)

·                  Digital

·                  International

 

Ourdomestic segment primarily consists of the acquisition, production anddistribution of exclusive DVD/Blu-ray content in North America and theexploitation of our North American broadcast and non-theatrical rights.  Our digital segment consists of revenuesgenerated by the digital distribution of our exclusive content viavideo-on-demand, streaming video and downloading.  Our international segment includes theinternational video sublicensing of all formats and exploitation of broadcastrights outside of North America.  Formore information on our business segments, see “Business—BusinessSegments” elsewhere in this Annual Report.

 

***Revenue Sources***

 

Our primary source of revenues continues to be from theacquisition and distribution of exclusive DVD content, including Blu-ray, inNorth America, which accounted for approximately 87% and 89% of ourconsolidated net revenues in fiscal 2010 and 2009, respectively. Theacquisition and distribution of exclusive Blu-ray content in North Americaaccounted for approximately 10% and 6% of our consolidated net revenue infiscal 2010 and 2009, respectively.

 

Revenuesderived from the digital distribution of our exclusive content rights continueto grow as a percentage of revenues.  Netrevenues from our digital segment accounted for approximately 4.5% and 3.2%****of our consolidated net revenue in fiscal 2010 and 2009,respectively.

 

Revenuesderived outside the U.S. and Canada are considered international and primarilyrepresent proceeds from sublicenses with Universal Music Group International,Warner Music Australia and Digital Site for their distribution of our exclusiveDVD content.

 

Wealso derive revenues from broadcast of our content, distribution of CDs and theatricaland non-theatrical revenue streams.

 

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***Cost Structure***

 

Ourmost significant costs and cash expenditures relate to acquiring content forexclusive distribution and, to a lesser extent recently, the funding of contentproduction or co-production for exclusive distribution.  Additionally, we incurred substantial legal,investment banking and other expenses during fiscal 2010 and prior fiscal yearsrelated to the investment transactions described below, a proxy contest andnegotiation-related disputes, and the eventual termination of proposed mergeragreements between us and potential acquirers.

 

Weare acquiring primarily North American distribution rights to completed featurefilms while maintaining our focus on acquiring distribution rights to genresthat have been successful in the past. We continue to seek early trend opportunities in advance of mainstreamacceptance in an effort to keep acquisition costs lower by bringing titles tomarket before spikes in demand drive up acquisition costs.

 

Wegenerally acquire programming through exclusive license agreements, whereby weeither pay royalties or receive distribution fees and pay net profits afterrecoupment of our upfront costs.  Uponentering into a typical royalty agreement, we pay, as an advance, royaltieswhich normally become due to the content supplier 45 days following the quarterin which the sale of the title to our retail customers has occurred.  Under a typical exclusive distributionagreement, we may pay upfront fees, which are expressed as advances againstfuture net profits, or we may pay for the cost of the content’s production inadvance.

 

Inaddition to advances, upfront fees and production costs, the other significantcosts we incur are:

 

·                  DVD/BDreplication;

·                  packaging;

·                  advertising,promotion, and market development funds provided to retail customers;

·                  domesticshipping costs from self-distribution of exclusive content;

·                  personnel; and

·                  musicpublishing on exclusive music-related DVD/BD and CD titles.

 

Wefocus on achieving long-term, sustainable growth and profitability.  We also seek to improve our cash flowposition in order to continue funding operations and licensing, or enteringinto exclusive distribution agreements, for high-quality entertainment content.

 

**Fiscal 2010 Highlights**

 

·                  Consolidatednet revenues decreased 28.8% to $93,070,000 for fiscal 2010, from $130,691,000for fiscal 2009.

 

·                  Digital distribution revenues decreased 0.6%to $4,171,000, from $4,198,000 in fiscal 2009.

·                  Domestic DVD revenues decreased 33.9% to$71,248,000, from $107,776,000 in fiscal 2009.

·                  Domestic Blu-ray revenues increased 17.0% to$9,463,000, from $8,090,000 in fiscal 2009.

·                  Broadcast revenues decreased 15.8% to$4,159,000, from $4,942,000 in fiscal 2009.

 

·                  Consolidatedgross profit margins were 20.1% for fiscal 2010, compared to 21.0% for fiscal2009.

 

·                  The gross profit margins in fiscal 2010include a $2.8 million fourth quarter charge representing acceleratedamortization and fair value write-downs, down from a fourth quarter fiscal 2009charge for accelerated amortization and fair value write-downs of $4.8million.  See “— Trends ImpactingOur Business” below.  The fourth quarterfiscal 2010 charge negatively impacted fiscal 2010 gross margins by 3.0%, downfrom 3.7% for the fourth quarter fiscal 2009 charge.

 

·                  Consolidatedselling expenses were 12.1% and 10.9% of net revenues for fiscal 2010 and 2009,respectively.

 

·                  Consolidatedgeneral and administrative expenses were $18,614,000 for fiscal 2010, up 10.3%from $16,879,000 for fiscal 2009.  See“—Results of Operations—General and Administrative Expense” below.

 

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·                  Noncashinterest expense for fiscal 2010 associated with our manufacturing advance andconvertible note totaled $675,000, down 53.8% from $1,461,000 in fiscal 2009.

 

·                  Our net lossapplicable to common shareholders for fiscal 2010 was $6,950,000 ($0.31 perdiluted share), compared to a net loss of $1,804,000 ($0.08 per diluted share)for fiscal 2009.

 

·                  We executed astrategic realignment plan and cost reduction plan.  See “—Liquidity and Capital Resources —Liquidity — Strategic Realignment and Cost Reduction Plan” below.

 

·                  We completed a saleof preferred stock to JH Partners.  See“—Recent Events—Transaction with JH Partners” below.

 

·                  In March 2009,we announced the departure of then-President and Chief Financial Officer, JeffM. Framer.  Mr. Framer was replacedby Mr. Theodore S. Green, Chairman and Chief Executive Officer and John P.Avagliano, Chief Operating Officer and Chief Financial Officer, who wereappointed by the new Board of Directors following the JH Partners transaction.

 

Thehighlights above and the discussion under “Recent Events” below are intended toidentify some of our more significant events and transactions during our fiscalyear ended March 31, 2010, but should be read in conjunction with thediscussions below under “—Results of Operations” and “—Liquidity and CapitalResources” and with our consolidated financial statements and footnotesincluded in Item 8 of this Annual Report.

 

**Recent Events**

 

***Transaction with JH Partners***

 

On January 8, 2010, wesold to JH Partners Evergreen Fund, L.P. (or *JH Evergreen*),JH Investment Partners III, L.P. (or *JH Investment III*)and JH Investment Partners GP Fund III, LLC (or *JHInvestment GP Fund*, and together with JH Evergreen and JH InvestmentIII, the *Investors*) 22,000 shares of a newlyauthorized series of our capital stock entitled Series B CumulativePreferred Stock, par value $0.0001 per share (or *Series BPreferred*), and 196,702 shares of a newly authorized series of ourcapital stock entitled Series C Junior Participating Preferred Stock, parvalue $0.0001 per share (or *Series C Preferred*,and together with the Series B Preferred, the *PreferredShares*), for an aggregate purchase price of $22.0 million.  Inconnection with our sale to the Investors of the Preferred Shares, theInvestors acquired control of Image.  Due to the voting rights associatedwith the Series C Preferred as discussed below, after the issuance of the Series CPreferred and the issuance of 3.5 million shares of our common stock, par value$0.0001 per share (or the *Common Stock*),to retire the senior convertible note, as amended, held by Portside Growth andOpportunity Fund (or *Amended Note*)on January 8, 2010, the Investors collectively owned approximately 88.6%of our post-transaction outstanding voting securities.  After subsequent transactions involving our capitalstock, the Investors owned approximately 77.0% of outstanding voting securitiesas of June 1, 2010.

 

After payment to JHPartners, LLC, investor representative of the Investors, of a $1 milliontransaction fee, akin to an investment banking fee, reimbursement of $650,000of the Investors’ expenses and payment of other transaction-related expenses,we received net proceeds of approximately $19.0 million from the sale of thePreferred Shares.  In connection with the closing of the sale of thePreferred Shares on January 8, 2010, we used $15.0 million of the netproceeds, along with the issuance of 3.5 million shares of Common Stock, torepay in full and retire the Amended Note.  The remainder of the netproceeds were used to repay other outstanding indebtedness and liabilities andfor general working capital.

 

Pursuant to the SecuritiesPurchase Agreement dated December 21, 2009 with the Investors (as amended,the *SPA*), we agreed to pay JH Partners, LLC,as investor representative of the Investors or its designee a management fee of$300,000 on each of December 31, 2010 and December 31, 2011.

 

Pursuant to the SPA, we alsogranted the Investors the right (or the *Purchase Right*)to purchase up to an additional 7,400 shares of Series B Preferred and66,163.4 shares of Series C Preferred for an aggregate purchase price of$7.4 million.  The Purchase Right has expired with respect to an initialtranche of 3,700 shares of Series B Preferred and 33,081.7 shares of Series CPreferred.  At any time during the period commencing on January 8,2010 and ending at 5:00 p.m., Pacific time, on the date that is 360 daysafter January 8, 2010, the Investors may exercise the remaining

 

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tranche as to 3,700 sharesof Series B Preferred and 33,081.7 shares of Series C Preferred inwhole or in part and in one or more instances.  The decision to exercisethe Purchase Right will be made by the Investors in their sole discretion andthe Investors are not required to exercise the Purchase Right.  The net proceeds from the sale of anyadditional Preferred Shares may only be used by us to (i) acquire rightsto additional audio and video entertainment programming, (ii) repay anyover-advance under the Loan Agreement or (iii) repay accounts payableincurred by us in the ordinary course of business.

 

Pursuant to the SPA, theInvestors initially provided to Wachovia Capital Finance Corporation (Western),a Wells Fargo Company (or *Wachovia*), a$5.0 million irrevocable standby letter of credit for 90 days, which was thenextended through October 30, 2010, as credit support for our revolvingline of credit.  We are in discussionswith Wachovia for an extension of the revolving line of credit, which expireson October 25, 2010, but cannot guarantee that we will be able to agree toan extension with Wachovia on acceptable terms or at all.

 

The Series C Preferredis convertible, at the holder’s option, into shares of Common Stock at a ratioof 1,000 shares of Common Stock for each share of Series C Preferred(subject to adjustment upon the occurrence of certain events).  Unless the conversion ratio is adjusted, theconversion of the initial 196,702 shares of Series C Preferred sold to theInvestors would result in the issuance of 196,702,000 shares of Common Stockand the conversion of all of the additional 33,081.7 shares of Series CPreferred subject to the Purchase Right would result in the issuance of 33,081,700shares of Common Stock, for a total of 262,865,400 shares of Common Stock.

 

On January 8, 2010 inconnection with the closing of the sale of the Preferred Shares as discussedabove, we entered into a Registration Rights Agreement (or *RRA*)with the Investors.  Pursuant to the RRA,we agreed to register under the Securities Act of 1933 the shares of CommonStock issuable upon conversion of the Series C Preferred under certaincircumstances.  In connection with theexecution of the SPA and RRA, the Rights Agreement providing for preferredstock purchase rights for our stockholders was terminated pursuant to itsterms.  As a result of the termination ofthe Rights Agreement, the holders of the preferred stock purchase rights issuedpursuant to the Rights Agreement and are no longer entitled to the rights setforth in the Rights Agreement.

 

***New Board of Directors and Management***

 

On January 7, 2010, ourthen-current board of directors appointed Theodore S. Green, Patrick M. Collinsand Michael J. John to our board of directors effective immediately after theclosing of the sale of the Preferred Shares on January 8, 2010.  Effective January 8, 2010, our existingboard of directors resigned.  Messrs. Collinsand John are each employed by JH Partners, LLC.

 

On January 9, 2010, ourboard of directors appointed Theodore S. Green as our Chairman of the Board andChief Executive Officer, John Avagliano as our Chief Financial Officer andChief Operating Officer and John Hyde as our Vice Chairman.

 

***Nasdaq Delisting***

 

Our Common Stock wassuspended from trading on Nasdaq effective on February 3, 2010.  The Common Stock is currently quoted on theOTCQB Marketplace of the Pink OTC Markets Inc. (or *OTCQB*),a centralized electronic quotation service for over-the-counter securities.  Noassurance can be given that the market makers will continue to make a market inthe Common Stock or that the Common Stock will continue to be quoted on theOTCQB.

 

***Movie Gallery’s Bankruptcy Filing***

 

OnFebruary 2, 2010, Movie Gallery Inc., owner of rental chain HollywoodVideo, filed for Chapter 11 bankruptcy protection.  Both Movie Gallery and Hollywood Video arecustomers of Image.  Net revenues fromMovie Gallery and Hollywood Video for fiscal 2010 were $697,000 and $856,000,respectively.  As of March 31, 2010,we recorded an aggregate reserve of $948,000 for potential uncollectiblereceivables from Movie Gallery and Hollywood Video, which was the net amountdue at March 31, 2010 less payments received prior to their bankruptcyfiling.  It is unclear as to whether wewill recover any of the monies owed to us by Movie Gallery or Hollywood Video.

 

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**InventoryWrite-Down to Fair Value**

 

Duringcalendar 2009, the DVD marketplace experienced the third straightyear-over-year decline for the category since the format debuted in 1997.  Home Media Magazine and Strategic Analyticsreported in the fourth quarter of our fiscal 2010 a noticeable decline inpackaged media units (including DVD and Blu-ray) actually sold globally toconsumers in 2009.

 

Image,with its catalog of approximately 3,000 DVD titles and rights to hundreds ofhigh-definition masters that will be released in the new Blu-ray format, isprimarily a non-”hits” exclusive DVD distributor.  Our sales of previously released (or *catalogue*) titles continue to be negatively impacted by notonly the maturation of the DVD marketplace and with it, declining shelf spacededicated to previously released programming, but also by the economicslowdown, which has sharply curtailing retailer purchases from us.  The continued effects of the global economicslowdown has led a greater focus by our customers on inventory management andrelated cash flows.

 

Withretail shelf space declining and more space being allocated for major studioreleases and the increased success of Blu-ray, we are focusing more on growingsales to our Internet retailers, with virtual shelf space and sophisticatedsearch engines, to replace declining catalogue sales from our traditional “brickand mortar” retail customers.  We areadditionally focusing on growing digital revenues.  While we are encouraged by the growth in ourInternet channel and digital distribution, these activities have not — and arenot expected in the near term to — entirely offset the contraction in our DVDsales to retailers.  Shelf spaceallocated to CD titles also continues to shrink as full album CD sales arenegatively impacted by less expensive direct digital downloading on asong-by-song basis.

 

Webelieve that the current effects of the economic slowdown will ultimately end,and that today’s supply chains may have overreacted in preparing for an evengreater slowdown.  Lack of visibility asto the end of the slowdown, combined with concern over increasing inventorylevels, may have caused our customers to overreact by significantly reducingorders.  However, management believes it isprudent at this time to more significantly adjust estimates of future revenuesby re-evaluating the lifecycle of our DVD and CD content.  This re-evaluation is based on currenthistorical title revenue performance during the last 12 months, including thenegative impact of the economic slowdown on our sales.  For more information on industry trends, see “Item1. Business — Industry Trends” above.

 

Weregularly re-evaluate our revenue projections. Such re-evaluation has resulted in fair value write-downs of CD and DVDcarrying costs, as well as accelerated amortization and fair value write-downsof other film costs, such as unrecouped advance royalties and distributionfees, unrecouped production costs and advance music publishing.  These accelerated amortization and fair valuewrite-downs have significantly contributed to our losses over the last severalyears. For fiscal 2010, we recorded $5.5 million in accelerated amortizationand fair value write-downs of our film costs, representing $3.8 million inaccelerated amortization and fair value write-downs of advance royalty anddistribution fees and $1.7 million in fair value write-downs of inventory.  Of those amounts, $1.8 million and $1.0million, respectively, were recorded in the fourth quarter. Many of thewrite-downs adjustments were for deeper catalogue titles, for which inventoryand unrecouped advance royalties and distribution fees were paid in priorfiscal years.

 

Thesales lifecycle of a title, on average, follows a curve that begins at newrelease peak levels, followed by phases in which sales diminish, ultimately “tailing”off as the title approaches the end of its agreement term.  The decreases in sales after the first yearare significantly less than after initial release, resulting in what is oftencalled the “long tail” of the entertainment lifecycle.  As the majority of our catalog ofapproximately 3,000 active DVD titles was released over a year ago, most titlesfall into the category of catalogue or “long tail” product.  While we experience continuing “tail” sales,with shelf space becoming continually more constrained, we expect a muchthinner “tail” or, depending on the title’s historical sales, no “tail.”

 

**Liquidity and Capital Resources**

 

***Going Concern and Liquidity***

 

Our consolidated financial statements have beenprepared assuming that we will continue as a going concern, which contemplatesthe realization of assets and the settlement of liabilities in the normalcourse of business.  For several years we have incurred significantlosses, have not generated sufficient cash to sustain our operations, and haverelied on financing activities to supplement cash fromoperations.  Based on these factors and the coming expiration of theWachovia loan agreement, the report of our independent registeredpublic accounting firm included elsewhere in this Annual Report contains anexplanatory paragraph expressing substantial doubt regarding our ability tocontinue as a going concern (or *Going Concern Opinion*).  Theaccompanying consolidated financial statements do not include any adjustmentsthat might result from the outcome of this uncertainty.

 

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Ifour losses and negative cash flows continue, we risk defaulting on the terms ofour revolving credit facility.  A defaulton our revolving credit facility, if not waived by our lender, could cause allof our long-term obligations to be accelerated, making further borrowingdifficult and more expensive, and jeopardize our ability to continue as a goingconcern.  If we are unable to rely solelyon existing debt financing, we may find it necessary to raise additionalcapital in the future through the sale of equity or debt securities, which mayresult in increased fiscal interest payment obligations, restrictive covenants,further dilution to our stockholders and the granting of superior rights to theinvestors.  There can be no assurancethat additional financing will be available on acceptable terms, if at all.

 

Duringfiscal 2010, we defaulted on our senior convertible note, which causedcross-defaults on our revolving line of credit and replication and distributionagreement with our exclusive disc manufacturer Arvato, and we weresignificantly past due in our trade payables, including Arvato.  At the end of fiscal 2010, we retired oursenior secured convertible note, significantly reduced our vendor obligations,and removed defaults under our revolving credit facility and the replicationand distribution agreement.  Wachoviaprovided us with a waiver that the Going Concern Opinion for the fiscal yearended March 31, 2010 will not, in and of itself, result in an event ofdefault under the loan agreement. Although we remained past due in our obligations to other creditors at March 31,2010, we were not significantly past due. The substantial doubt about our ability to continue as a going concernimpacted our relationship with our trade and content suppliers during thefiscal year and their willingness to continue to conduct business with us onterms consistent with historical practice. As a result, our need for cash intensified in the fourth fiscal quarter,and as of March 31, 2010 we were unable to make all payments to all of oursuppliers as they became due.  The substantial doubt about our ability tocontinue as a going concern may continue to affect our relationship with ourtrade and content suppliers. These suppliers might respond to an apparentweakening of our liquidity position and, to address their own liquidity needs,may request faster payment of invoices, new or increased deposits or otherassurances.  If this were to happen, our need for cash would beintensified and we might be unable to make payments to our suppliers as theybecome due.

 

Akey part of our plan to stabilize and improve our financial condition, amongother things, was to recapitalize, retire our senior convertible note withPortside Growth and Opportunity Fund (or *Portside*), cureoutstanding defaults under our debt agreements, and improve liquidity.

 

***Reasons for Constrained Liquidity***

 

Inaddition to the 29% decrease in our net revenues for fiscal 2010, our liquidityis constrained because of the following:

 

·                  costlyterminated merger processes

·                  our January 30,2009 principal payment to Portside

·                  significantadvance payments made for high-profile content not yet released on DVD

·                  the economicslowdown’s negative impact on our customers’ buying habits

 

*Costly Terminated Merger Processes*

 

Overthe last few years, we have operated through a contentious proxy contest andtwo terminated merger processes, the last of which terminated in April 2009.  Our Board of Directors terminated the twomergers after the prospective buyers failed to secure the ultimate financingnecessary to close the transactions.  Weincurred substantial legal, investment banking and other merger process-relatedfees. Additionally, we believe the processes, both of which were extended andthen terminated, had a negative impact on our perceived financial and operatingstability with our major customers and suppliers.  Merger-related costs, including legal,investment banking and other related costs, for fiscal 2010 and fiscal 2009totaled $805,000 and $1.2 million, respectively.  Settlement and business interruption feesreceived by us for the two terminated mergers totaled $1.5 million in fiscal2010 and $3.0 million in fiscal 2009.

* *

*Our January 30, 2009 Principal Payment to Portside*

 

InJanuary 2009, after strong net revenue performance during the first ninemonths of fiscal 2009, we paid the first $4 million bi-annual principal paymentdue under the Portside note.  This $4million payment caused cash constraints throughout fiscal 2010.  If the Company had been able to amend thenote, pushing the due date of this payment further into the future, the Companywould have had the capital resources required to acquire additional content fordistribution, thereby increasing the potential revenues generated.

 

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*Significant Advance Payments Made For High-Profile ContentNot Yet Released on DVD/Blu-ray*

 

Wehave made significant advance payments to secure new cast-driven titlesfeaturing well-known stars such as Sharon Stone that have not yet released onDVD/Blu-ray and accordingly not yet generated revenues. We expect to releasesuch content on DVD/Blu-ray beginning in our second quarter ending September 30,2010.

 

*The Economic Slowdown’s Negative Impact on our Customers’Buying Habits*

 

Theglobal economic slowdown has forced retailers to take a hard look at theiroperations.  Since January 1, 2009,we have experienced a significant reduction in purchases by our retailcustomers.  Our customers have conservedcash, including reducing their inventories by buying less, taking all availablecredits due them and returning inventory.

 

Tofund our operations, we rely on receivable collections and bank borrowingsunder our revolving line of credit.  Availability under our revolving line ofcredit is based almost entirely on eligible trade accounts receivables.  As a result, decreased sales limit ourborrowing availability and therefore our liquidity.

 

***Plans to Improve Our Liquidity***

 

We seek to overcome this substantial doubtconcerning our ability to continue as going concern by focusing on ourstrategic operating goals of acquiring and distributing high-profile content inmultiple formats while continuing to reduce our cost structure.  At the beginning of the 2010 calendar year,we closed our recapitalization with the Investors and commenced a strategicrealignment and cost reduction plan. Subsequent to March 31, 2010, we extended the term of our revolvingcredit facility.  The term of therevolving credit facility currently expires on October 25, 2010.  We are reviewing revolving credit lineoptions, including negotiating a new revolving credit agreement with Wachovia.

 

*Engagement of Investment BankingFirm and Sale of Equity in Company*

 

InMay 2009, we retained Houlihan Lokey Howard & Zukin Capital, Inc.as our exclusive financial advisor to assist us in analyzing a wide range ofstrategic alternatives, including potential financing or sale transactions.

 

On January 8, 2010, we sold newly authorized sharesof preferred stock to the Investors that represented approximately 88.6% of ourpost-transaction outstanding voting securities for an aggregate purchase priceof $22.0 million.  Concurrent with thetransaction, we retired our senior secured convertible note with a portion ofthe net proceeds and shares of our common stock.  This recapitalization provided additionalliquidity and allowed us to extinguish our senior convertible note withPortside Growth and Opportunity Fund.

 

Our new management team has successfullyimplemented a number of cost savings initiatives, including settlement of pastpayables at reduced amounts, reduced infrastructure costs and continuedreductions of other expenses.

 

*Strategic Realignment and CostReduction Plan.*

 

Concurrentwith our January 2010 recapitalization, Arvato waived a cross-default onour manufacturing agreement, Wachovia waived the cross-default under ourrevolving credit facility and we subsequently repaid the remaining $1.8 millionoutstanding manufacturing advance to Arvato. We have negotiated reductions in outstanding obligations with certaincreditors and vendors.  These negotiatedreductions resulted in aggregate debt forgiveness of $5.2 million.  An additional annual reduction of rentexpense of approximately $500,000 was achieved as the result of a negotiatedreduction in the monthly cost for our corporate headquarters.  Management believes that continuing to pursueits strategic operating goals of acquiring and distributing high-profilecontent in multiple formats while significantly reducing our cost structure,along with the recent transaction with JH Partners, the repayment of ouroutstanding manufacturing advance to Arvato, the retirement of our seniorsecured convertible note and the reduction of other outstanding obligations,will improve our liquidity.

 

Wehave continued acquisition of cast-driven feature films supported by a corerevenue base of branded lines of content, including The Criterion Collection,Ghost Hunters, programs created for IMAX exhibition and other types of programswith proven historical results.  Thisallows us to reduce the number of programs we release each month and thereforereduce our costs.  Our goal is to shortenour timeline for return on investment on titles, which needs to be the mostcritical element in selecting titles for acquisition.

 

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Wehave also begun executing a cost reduction plan which includes reducingpersonnel, benefit costs, advertising and other marketing expenditures, traveland trade show expenditures and third-party commissions.

 

·                  In fiscal 2010,we reduced corporate headcount from 126 employees to 74, saving approximately$5 million in annual personnel costs, including benefits. In May 2010, anadditional reduction in force represented savings of approximately $616,000 inannual personnel costs, including benefits.

·                  Other costreductions are estimated to save an additional $1.9 million in annual generaland administrative and selling expenses. Cost reduction areas include discretionary advertising, trade shows,travel, health care costs, discretionary information technology expendituresand sales commission restructuring.

 

Wecan provide no assurance that the results of our strategic realignment and costreduction plan will be successful enough to provide us liquidity relief and accordinglyovercome the substantial doubt about our ability to continue as a goingconcern.

 

***Working Capital***

 

At March 31, 2010, we had a working capitaldeficit of $6.3 million.  At May 31,2010, we had a working capital deficit of $6.9 million.

 

Ourworking capital has historically been generated from the following sources:

 

·                  operating cashflows;

·                  availabilityunder our revolving line of credit;

·                  privateplacement of debt and equity instruments;

·                  advances fromour disc manufacturer, sublicensors, subdistributors; and

·                  trade credit.

 

Themore significant sources of working capital during fiscal 2010 were:

 

·                  businessinterruption fee of $1.5 million in connection with the termination of themerger agreement with Nyx Acquisitions, Inc.;

·                  receipt of netproceeds of $19.0 million in connection with the sale of preferred stock to theInvestors, net of transaction fees;

·                  $1.5 millionadvance on future royalties received from an international sales agent; and

·                  $1.7 millionreceived for sale of inventory and assignment of rights recorded as deferredrevenues.

 

Themore significant uses of working capital during fiscal 2010 were:

 

·                  long-term debtrepayments of $15.0 million as a result of full satisfaction of the seniorconvertible note and related debt forgiveness in connection with the sale ofpreferred stock to the Investors;

·                  net repaymentsof $4.6 million under our revolving line of credit as a result of the sale ofpreferred stock to the Investors;

·                  decreasedaccounts payable, accrued royalties, fees and liabilities as a result of theuse of the proceeds from the sale of preferred stock to the Investors; and

·                  principalpayments of $3.4 million under our manufacturing advance obligation (includingremaining balance at January 8, 2010 of $1.8 million in connection withsale of preferred stock to the Investors).

 

***CapitalResources***

 

*Cash. *As of March 31,2010, we had cash of $460,000, as compared to $802,000 as of March 31,2009.  As of May 31, 2010, we hadcash of $653,000.

 

*Revolving Credit Facility.*  We have a revolving line of credit of up to$20 million with Wachovia. Actual borrowing availability under the line isbased upon our level of eligible accounts receivable.  Eligible accounts receivable primarilyinclude receivables generated by domestic sales of DVD and exclude receivablesgenerated from broadcast, digital and other revenue streams. The term of therevolving credit facility currently expires on October 25, 2010.

 

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Borrowingsbear interest at either the Prime Rate plus up to 1.5% (4.75% at March 31,2010) or, at our option, LIBOR plus up to 4.0% (three month LIBOR — 4.3% at March 31,2010), subject to minimum borrowing levels. The level of interest rate marginto Prime Rate or LIBOR is dependent upon our future financial performance asmeasured by EBITDA (earnings before interest, taxes, depreciation andamortization).

 

Weare required to maintain a minimum fixed charge coverage ratio, cumulativelyyear to date, for each month on or after June 30, 2010, of 1.1 to 1.0.

 

Weare required to maintain a minimum borrowing availability equal to, or greaterthan, $2.5 million.  At March 312010, we had availability in excess of the minimum amount of borrowingavailability.  Accordingly, at March 31,2010, our borrowing availability was $3.8 million ($6.3 million based uponeligible accounts receivable less the $2.5 million minimum requirement).  On April 15, 2010, the loan was amendedto lower the minimum amount of borrowing availability to $1.5 million, amongother things.  As of June 1, 2010,our borrowing availability was $2.0 million ($3.5 million based upon eligibleaccounts receivable less the $1.5 million minimum requirement).  Accordingly, we currently have limitedworking capital available under the revolving credit facility.

 

Additionally,our credit facility states that a material adverse change in our business,assets or prospects would be considered an “event of default.”  If we are unable to comply with thecovenants, or satisfy the financial ratio and other tests, or should an eventof default occur, as determined and invoked by Wachovia, a default may occurunder our credit facility.  Unless we areable to negotiate an amendment, forbearance or waiver with Wachovia, we couldbe required to repay all amounts then outstanding, which could have a materialadverse effect on our liquidity, business, results of operations and financialcondition.

 

AtMarch 31, 2010 we had $6.4 million outstanding under the revolving line ofcredit.  As of May 31, 2010 we had$5.5 million outstanding.

 

Therevolving credit facility contains early termination fees, based upon themaximum facility amount of $20 million, of 0.75% if terminated within thethree-year term.  The agreement alsoimposes restrictions on such items as encumbrances and liens, payment ofdividends, incurrence of other indebtedness, stock repurchases and capital expendituresand requires us to comply with minimum financial and operating covenants.  Any outstanding borrowings are secured by ourassets.

 

Wewere in compliance with all financial and operating covenants under the LoanAgreement, as amended, at March 31, 2010. Given our current liquidity constraints, it is not possible to determinewhether we will be in compliance with all financial and operating covenants inthe future.

 

Thereceipt of a Going Concern Opinion from our independent registered publicaccounting firm would result in a default under our Loan Agreement, as amended,with Wachovia upon delivery of the opinion to Wachovia, for any fiscal yearother than fiscal 2010, due to the waiver of event of default received fromWachovia.  Accordingly, the receipt ofthe Going Concern Opinion will not result in an event of default under the LoanAgreement upon delivery of the fiscal 2010 opinion.  However, any future defaults under our LoanAgreement, if not waived or cured, would automatically trigger a cross-defaultunder our other debt agreements thereby adversely impacting our ability tocontinue as a going concern.

 

*Private Placement of Senior Convertible Note and Warrant.* On August 30,2006, we issued to Portside a senior convertible note in the principal amountof $17,000,000 and a related warrant (which was subsequently replaced) topurchase 1,000,000 shares of our common stock. The warrant was exercisable for an aggregate of 1,000,000 shares of ourcommon stock at an exercise price of $4.25 per share, subject to antidilutionadjustments, which were triggered as a result of the transaction with JHPartners.  As a result, the warrant isnow exercisable for 8,018,868 shares of our common stock at an exercise priceof $0.53 per share.  The warrant has aterm of five years from the issuance date.

 

InJanuary 2009, we paid the first $4 million bi-annual principal payment dueunder the note.  Portside entered into anAmendment to extend the due date of a required July 30, 2009 payment to November 15,however when that payment was not made, Portside declared a default.  On January 8, 2010, in connection withthe JH Partners transaction, the Portside senior convertible note was paid infull for $15.0 million in cash and 3.5 million shares of common stock.  The warrant was adjusted according to itsantidilution provisions and remains outstanding.

 

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*Disc Replication Advance.*  Arvato exclusively manufactures our DVDs andmanufactures the majority of our CDs.  OnJune 30, 2006, we received an interest-free $10 million advance againstfuture DVD manufacturing from Arvato, to be repaid at $0.20 per DVDmanufactured, plus payment of a $0.04 administrative fee per DVD manufactureduntil the advance is repaid.

 

Theremaining outstanding advance of $1.8 million was paid on January 25, 2010pursuant to an agreement with Arvato made in connection with the JH Partnerstransaction.  At March 31, 2010, wehad no remaining outstanding under the advance from Arvato.

 

**Results of Operations**

 

***Net Revenues***

 

Thefollowing table presents consolidated net revenues by reportable businesssegment for the fiscal years ended March 31:

 
| ** **    | ** ** | **2010**           | ** ** | **2009**   | ** ** | **% Change** | ** ** |
|---------------|------------|--------------------|------------|------------|------------|--------------|------------|
| ** **    | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Net revenues: |       |               |       |       |       |         |       |
| Domestic      |       | $                  | 87,793     |       | $          | 124,410      |       | (29.4 | )% |
| Digital       |       | 4,182              |       | 4,198      |       | (0.4         | )          |
| International |       | 1,095              |       | 2,083      |       | (47.4        | )          |
| Consolidated  |       | $                  | 93,070     |       | $          | 130,691      |       | (28.9 | )% |

 

*Domestic Revenues.*  During fiscal 2010, we retained HoulihanLokey, a financial advisor, to review strategic alternatives.  Uncertainty surrounding the outcome of thesestrategic alternatives affected our ability to acquire both feature film andnon-feature film programming.  As aresult, our release schedule of new titles and our highest profile catalogueprogramming was weaker in fiscal 2010 as compared to fiscal 2009.  In addition, revenues derived fromdistribution of CD programming decreased 59.1% to $1.3 million in fiscal 2010from $3.2 million in fiscal 2009.

 

Ourtop performing 30 new release titles for fiscal 2010 and fiscal 2009 generatednet revenues of $25.2 million and $37.2 million, respectively.  Our 30 top performing titles, whetherreleased new in the fiscal year or in prior fiscal years, generated netrevenues of $33.2 million and $50.7 million in fiscal 2010 and fiscal 2009, respectively.The decrease in fiscal 2010 as compared to fiscal 2009 was due to changes inthe way one of our largest customers buys from suppliers, the bankruptcyreorganization of one of our largest customers, and weaker programming asdescribed above.

 

Domesticbroadcast sales were $4,068,000 and $4,693,000 for fiscal 2010 and fiscal 2009,respectively.  The division isresponsible for all forms of television distribution, including the sales ofour content across broadcast television, pay-per-view (or *PPV*),VOD and non-theatrical platforms.

 

*Digital Revenues.*  Revenues generated by digital distributionwere comparable at $4.2 million in fiscal 2010 and 2009, respectively.

 

Wecontinue to be a valued provider of digital content in several key categories,including stand-up comedy, long-form music, titles filmed for the IMAX formatand now feature films. Digital rental (VOD) has been particularly strong due tothe higher profile features. Many of our titles have consistently made toprental charts on key retail sites. 

 

Wehave also experienced increased revenue streams from advertising-supportedmodels like Hulu and YouTube, which look promising, especially for catalogueproduct.

 

Domesticconsumption of mobile video has been concentrated in more channel-orientedcontent like Sprint Movies, FloTV, ESPN and CNN. While some genre-basedsubscription channels exist, the mobile network has not yet been able toprovide a true broadband experience, and in turn mobile video growth has notmet projections. We currently provide programming to two mobile aggregators whomanage channels on all four major mobile carriers. 

 

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Certainprograms have had success, but the overall number of available programs isrelatively small and current growth is modest at best.

 

Ingeneral we have seen the strongest growth on the VOD and Subscription VOD (or *SVOD*) side with steady growth on the Electronic Sell-Through(or *EST*) side. This is consistent withconsumer adoption trends. As retailers continue to offer consumer-friendlydevices that make access to these on-demand services easier, including allowingconsumption in the consumer’s living room, we are well-positioned to capturethat growing segment.

 

*International Revenues.*  Our internationally generated revenuesdecreased in fiscal 2010 as a result of decreased international broadcastsales.  International broadcast saleswere $91,000 and $249,000 for fiscal 2010 and fiscal 2009, respectively.  The decrease in fiscal 2010 from fiscal 2009resulted from the uncertainty surrounding our future as a result of strategicalternatives, as well as the decreased number of acquired titles withinternational rights.

 

Wecontinue our efforts to acquire programming with international rights.  Music-related DVDs have performed extremelywell for us internationally.  To date,most of the feature films we have acquired do not include international rights.

 

***Cost of Sales***

 

Thefollowing table presents consolidated cost of sales by reportable businesssegment and as a percentage of related-segment net revenues for the fiscalyears ended March 31:

 
| ** **                               | ** ** | **2010**           | ** ** | **2009**   | ** ** | ** **        | ** ** |
|------------------------------------------|------------|--------------------|------------|------------|------------|-------------------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Cost of sales:                           |       |               |       |       |       |              |       |
| Domestic                                 |       | $                  | 71,189     |       | $          | 99,362            |       |   |   |
| Digital                                  |       | 2,275              |       | 2,338      |       |              |       |
| International                            |       | 873                |       | 1,537      |       |              |       |
| Consolidated                             |       | $                  | 74,337     |       | $          | 103,237           |       |   |   |
|                                     |       |               |       |       |       |              |       |
| ** **                               | ** ** | ** **         | ** ** | ** ** | ** ** | **% Change** | ** ** |
| As a percentage of segment net revenues: |       |               |       |       |       |              |       |
| Domestic                                 |       | 81.1               | %          | 79.9       | %          | 1.2               | %          |
| Digital                                  |       | 54.4               |       | 55.7       |       | (1.3              | )          |
| International                            |       | 79.7               |       | 73.8       |       | 5.9               |       |
| Consolidated                             |       | 79.9               | %          | 79.0       | %          | 0.9               | %          |

 

Ourconsolidated cost of sales for fiscal 2010 was $74,337,000, or 79.9% of netrevenues, compared to $103,237,000, or 79.0% of net revenues, for fiscal2009.  Minimal fluctuation inconsolidated cost of sales as percentage of consolidated net revenue isincorporated in the gross margin discussion below.

 

***Gross Margin***

 

Ourconsolidated gross margins for fiscal 2010 were $18,733,000, or 20.1% ofconsolidated net revenues, compared to $27,454,000, or 21.0% of consolidatednet revenues, for fiscal 2009.

 

*Domestic Gross Margin.* The decrease in gross margins for our domesticsegment, as a percentage of segment net revenues, is primarily related tohigher pricing discounts and market development funds provided customers.  In general, each of our exclusive agreementshas differing terms.

 

Itemsaffecting our gross margins included:

 

·                  the sales mix of individual titles (becauseeach of our exclusive agreements has differing terms);

·                  the strength of a title’s sales performance;

·                  the selling price of a title;

·                  the costs that we are responsible for,including disc manufacturing costs; and

·                  third-party net profit participations,specifically the royalty rates, distribution fees retained and profit splitsinherent in the agreements.

 

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Domesticsegment gross profit margin, as a percentage of segment net revenues, forfiscal 2010 declined by 1.2%, to 18.9%, from 20.1% for fiscal 2009.  A reconciliation of the factors contributingto the decrease in gross margin percentage follows:

 
| (1.6 | )%     | Higher pricing discounts  and market development funds provided customers |   |
|------|--------|---------------------------------------------------------------------------|--------|
| (0.5 | )      | Product  and format mix resulting in lower margins                        |   |
| 0.9  |   | Lower  freight and fulfillment expenses                                   |   |
| (1.2 | )%     | Decrease  in gross profit margin                                          |   |

 

*Digital Gross Margin.* The increase in gross margin for fiscal 2010is primarily related to a more favorable sales mix of programming.

 

*International Gross Margin.*  The decrease in gross marginfor fiscal 2010 is attributable to fairly fixed amortization of film costs overreduced revenue base.

 

***Selling Expenses***

 

Thefollowing tables present consolidated selling expenses by reportable businesssegment and as a percentage of related segment net revenues for the fiscalyears ended March 31:

 
| ** **                               | ** ** | **2010**           | ** ** | **2009**   | ** ** | **%  Change** | ** ** |
|------------------------------------------|------------|--------------------|------------|------------|------------|---------------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Selling expenses:                        |       |               |       |       |       |          |       |
| Domestic                                 |       | $                  | 10,744     |       | $          | 13,352        |       | (19.5 | )% |
| Digital                                  |       | 214                |       | 327        |       | (34.6         | )          |
| International                            |       | 314                |       | 546        |       | (42.5         | )          |
| Consolidated                             |       | $                  | 11,272     |       | $          | 14,225        |       | (20.8 | )% |
|                                     |       |               |       |       |       |          |       |
| As a percentage of segment net revenues: |       |               |       |       |       |          |       |
| Domestic                                 |       | 12.2               | %          | 10.7       | %          | 1.5           | %          |
| Digital                                  |       | 5.1                |       | 7.8        |       | (2.7          | )          |
| International                            |       | 28.7               |       | 26.2       |       | 2.5           |       |
| Consolidated                             |       | 12.1               | %          | 10.9       | %          | 1.2           | %          |

 

*Domestic Selling Expenses. *Domesticselling expenses for fiscal 2010, as a percentage of revenues, increased to12.2% from 10.7% for fiscal 2009 primarily due to reduced revenue base andincrease in advertising and promotional expense related to the theatricalrelease of *Management*described below.  Domestic advertising and promotional expenses(a component of domestic selling expenses) increased to $5.7 million in fiscal2010 compared to $6.4 million in fiscal 2009, and as a percentage of revenuesincreased from 6.5% from 5.2% in fiscal 2009. A substantial portion of these increases in domestic selling expensesand advertising and promotional expenses is related to the theatrical releaseof one title.  Advertising andpromotional expenditures related to the theatrical release of *Management*, expensed during the three months ended June 30,2009, totaled $1.9 million, or 2.2% of domestic net revenues for fiscal2010.  If the *Management*expenditures are excluded, selling expenses and advertising and promotionalexpenses for fiscal 2010 decreased to $8.8 million and $3.7 million,respectively, and as a percentage of revenues, to 10.0% and 4.3%,respectively.  We believe that providinganalysis of these expenses that excludes Management expenditures promotescomparability and provides meaningful information to investors.

 

Personnelcosts were lower by $1.2 million, travel expenses were lower by $275,000 andoutside commissions were lower by $227,000 for fiscal 2010 as compared to theprior year as a result of our cost reduction efforts discussed under “Liquidityand Capital Resources—Plans to Improve Our Liquidity” above.

 

*Digital and International Selling Expenses. *The decrease in digital andinternational selling expenses is a result of the strategic realignment of ouroperations.  We have reduced personnelspecifically allocated to our digital and international operations, thereforereducing the costs of these segments.

 

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***General andAdministrative Expenses***

 

Thefollowing tables present consolidated general and administrative expenses byreportable business segment and as a percentage of related segment net revenuesfor the fiscal years ended March 31:

 
| ** **                               | ** ** | **2010**           | ** ** | **2009**   | ** ** | **% Change** | ** ** |
|------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|
| ** **                               | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| General and administrative expenses:     |       |               |       |       |       |         |       |
| Domestic                                 |       | $                  | 18,317     |       | $          | 15,793       |       | 16.0 | % |
| Digital                                  |       | 280                |       | 772        |       | (63.7        | )          |
| International                            |       | 17                 |       | 314        |       | (94.6        | )          |
| Consolidated                             |       | $                  | 18,614     |       | $          | 16,879       |       | 10.3 | % |
|                                     |       |               |       |       |       |         |       |
| As a percentage of segment net revenues: |       |               |       |       |       |         |       |
| Domestic                                 |       | 20.9               | %          | 12.7       | %          | 8.2          | %          |
| Digital                                  |       | 6.7                |       | 18.4       |       | (11.7        | )          |
| International                            |       | 1.6                |       | 15.1       |       | (13.5        | )          |
| Consolidated                             |       | 20.0               | %          | 12.9       | %          | 7.1          | %          |

 

*Domestic General and Administrative Expenses.*  The increase in domestic general andadministrative expenses for fiscal 2010 as compared to fiscal 2009 wasprimarily due to severance accruals related to staff reductions and anincreased reserve for potential uncollectible receivables from Movie Galleryand Hollywood Video of $948,000. See “Recent Events—Movie Gallery’sBankruptcy Filing” above.   Partiallyoffsetting the above increases was decreased expenses associated with mergerprocesses compared fiscal 2009.

 

Theincrease in domestic general and administrative expenses for fiscal 2010 ascompared to the fiscal 2009 was due to the following:

 

·                  severance accruals of $1.2 million related tothe June 2009 and February 2010 staff reductions and $673,000 relatedto the departure of former President and Chief Financial Officer in March 2010for fiscal 2010, compared to severance accruals of $439,000 related to the February 2009staff reduction and $499,000 related to the departure of the former Presidentin March 2009 for fiscal 2009;

·                  reserve for potential uncollectablereceivables of $1.2 million;

·                  accrual of estimated legal settlement of$675,000; and

·                  write-off of unamortized paid premiuminsuring the previous board members and officers of $340,000.

 

Offsettingthe above increases were:

 

·                  lower legal expenses related to evaluatingstrategic alternatives, merger processes, and distribution agreement and theresolution of the related disputes of $727,000;

·                  lower travel expenses by $208,000;

·                  lower temporary labor by $205,000; and

·                  lower property and equipment depreciation andamortization by $201,000.

 

*Digital and International General and Administrative Expenses. *The decrease in digital andinternational general and administrative expenses is a result of the strategicrealignment of our operations.  We havereduced personnel specifically allocated to our digital and internationaloperations, therefore reducing the costs of these segments.

 

***OtherExpenses/Income***

 

*Interest Expense, Net*

 
| ** **                                       | ** ** | **2010**           | ** ** | **2009**   | ** ** | **% Change** | ** ** |
|--------------------------------------------------|------------|--------------------|------------|------------|------------|--------------|------------|
| ** **                                       | ** ** | **(in thousands)** | ** ** | ** ** | ** ** |
| Noncash amortization of debt discount            |       | $                  | 321        |       | $          | 1,081        |       | (70.3 | )% |
| Noncash amortization of deferred financing costs |       | 354                |       | 380        |       | (6.8         | )          |
| Interest expense, net of interest income         |       | 1,470              |       | 1,859      |       | (20.9        | )          |
| Interest expense, net                            |       | $                  | 2,145      |       | $          | 3,320        |       | (35.4 | )% |
|                                             |       |               |       |       |       |         |       |
| As a percentage of net revenues                  |       | 2.3                | %          | 2.5        | %          | (0.2         | )%         |

 

Interestexpense, net, for fiscal 2010 decreased as compared to fiscal 2009 primarily asa result of reduced interest-bearing debt levels.  Net noncash charges to interest expense,representing amortization of the Arvato manufacturing advance debt discount,convertible note debt discount and deferred financing costs, for fiscal 2010and 2009, totaled $675,000 and $1,461,000, respectively.  See “Note 9—Long-Term Debt” for moreinformation on the amortization and deferred financing costs.

 

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*Loss on Extinguishment of Debt*

 

Thenet loss on extinguishment of debt for fiscal 2010 was $277,000, related to theamendment of our senior secured convertible note in July 2009 on substantiallydifferent terms and the subsequent note retirement in January 2010.  See “Note 9 — Long-Term Debt— SeniorConvertible Note — Loss on Extinguishment of Debt.”

 

*Other Income*

 

Otherincome, net of $7,751,000 for fiscal 2010 included:

·                  $5,218,000 million forgiveness of debt fromvarious vendors;

·                  $1,469,000 in business interruption fees inaccordance with the Merger Agreement that was terminated in April 2009;

·                  $334,000 of deferred rent written-off as aresult of the renegotiation of the long-term lease, which does not include arent escalation clause;

·                  $570,000 in noncash income resulting from thechange in fair value of a warrant, purchase rights and embedded derivatives;and

·                  $161,000 gain on disposal of assets.

 

Otherincome (expense), net for fiscal 2009 includes:

 

·                  $2.0 million pursuant to a settlementagreement and mutual release relating to a terminated merger agreement anddistribution agreement.

·                  $1.0 million in non-refundable considerationfor the extension of the closing date of a merger agreement subsequentlyterminated in April 2009.

·                  $2.4 million pursuant to the termination ofan agreement with a content supplier.

·                  ($209,000) in noncash expense resulting fromthe change in fair value of a warrant and embedded derivatives.

 

***Income Taxes***

 

Wehave recorded state income and franchise and foreign taxes for fiscal 2010 and2009.

 

Even though we have fully reserved our net deferred tax assets, suchtax assets may be available to reduce future income taxes payable should wehave future earnings. To the extent such deferred tax assets relate to NOLcarryforwards, the ability to use such NOL carryforwards against futureearnings will be subject to applicable carryforward periods and limitationssubsequent to a change in ownership.

 

As of March 31, 2010, we had NOL carryforwards for federal andstate income tax purposes of $35.2 million and $24.0 million, respectively;however, due to the limitations on the utilization of the federal and state NOLcarryforwards as a result of the change in ownership that occurred during theyear, the maximum NOL carryforwards that may be available to offset futuretaxable income through 2030 were reduced to $9.9 million and $15.2 million,respectively.

 

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**Off-Balance Sheet Arrangements**

 

We do not have any off-balance sheet arrangements.

 

**Critical Accounting Policies**

 

Thediscussion and analysis of our financial condition and results of operationsare based upon our financial statements, which have been prepared in accordancewith accounting principles generally accepted in the United States.  Generally accepted accounting principlesrequire management to make estimates, judgments and assumptions that affect thereported amounts of assets, liabilities, revenues and expenses, and thedisclosure of contingent assets and liabilities.  We base our estimates on experience and onvarious other assumptions that we believe to be reasonable under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that may not be readily apparentfrom other sources.  Our actual resultsmay differ from those estimates.

 

Weconsider our critical accounting policies to be those that involve significantuncertainties, require judgments or estimates that are more difficult formanagement to determine, or that may produce materially different results whenusing different assumptions.  We considerthe following accounting policies to be critical:

 

*RevenueRecognition*.  Inaccordance with applicable Financial Accounting Standards Board (or *FASB*) guidance, we recognize revenues from home videodistribution net of an allowance for estimated returns, as well as relatedcosts, in the period in which the product is available for sale by ourcustomers (at the point that title and risk of loss transfer to the customer,which is generally upon receipt by the customer, and in the case of new releases,after “street date” restrictions lapse). Rental revenue under revenue sharing arrangements are recognized when weare entitled to receipts and such receipts are determinable.  We recognize revenues from domestic andinternational broadcast licensing and home video sublicensing, as well asassociated costs, when the titles are available to the licensee and other FASBrecognition requirements are met.  Wedefer fees received in advance of availability, usually in the case of advancesreceived from Universal Music Group International, Digital Site, Warner MusicAustralia and other international home video sublicensees, and for broadcast,until other revenue recognition requirements have been satisfied.  Provisions for uncollectible accountsreceivable are provided at the time of sale. As of March 31, 2010, deferred revenue totaled $6,571,000, up 30.5%from March 31, 2009.

 

*Royalty and Distribution Fees(including Recoupable Production Costs)*.  For each reporting period, we estimate theultimate total revenues to be received throughout a title’s exclusivedistribution term from exploitation of that title in multiple homeentertainment formats.  While we chargeroyalty and distribution fee advances to operations as related revenues areearned, estimates of ultimate revenues are important in determining whether weshould record additional royalty and distribution fee expense as cost of salesin any given reporting period.  Weamortize royalty and distribution fee advances to expense in the same ratiothat the current period revenues for a title or group of titles bear to theestimated remaining unrecognized ultimate revenues for that title.  Additionally, in circumstances required byFASB Accounting Standards Codification (or *ASC*) 926, *Entertainment—Films*, we recognize additional amortization tothe extent that capitalized advance royalty and distribution fees exceed theirestimated fair value in the period when estimated.

 

We base our estimates of ultimate revenue for each title on thehistorical performance of that title, similar titles and specific genreperformance.  We attempt to reflect inour estimates the most current available information on the title.  We update such estimates based upon theactual results of each format’s revenue performance.  Estimates of ultimate revenues on atitle-by-title basis are subject to substantial uncertainty.  Factors affecting future actual performanceinclude focus from the sales and marketing department (including advertising,promotions and price reductions), availability of retail shelf space, retailcustomer product placement and advertising, maintenance of adequate inventorylevels, concert touring by the artist in the case of music-related DVDs andCDs, retail sell-through, and ultimately continued end-user consumer demand.  Any of the above factors can contribute to atitle’s actual performance exceeding our expectations prior to release orfailure to meet pre-release expectations. Overestimation of ultimate revenues would cause unamortized costs to beamortized at a slower rate or a delay in adjusting costs to their fair valueuntil such time estimates are reduced, causing unamortized costs to beoverstated and increased amortization of costs in a later period.  Underestimation of ultimate revenues wouldcause unamortized costs to be amortized more quickly until ultimate revenueestimates are increased, causing unamortized costs to be understated anddecreased amortization of costs in a later period. See “Trends Impactingour Business” above under Recent Events.

 

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*InventoryValuation*.  For each reporting period, we evaluate ourending inventories for excess quantities and obsolescence.  This evaluation includes analysis ofhistorical sales levels by title, format and genre, and projections of futuredemand.  In addition, we write downinventories that are considered obsolete or overstocked.  Remaining inventory balances are adjusted toapproximate the lower-of-cost or market value, and result in a new basis insuch inventory until sold.  If futuredemand or market conditions are less favorable than our projections, additionalinventory write-downs may be required, and would be reflected in cost of salesin the period the revision is made. Future demand will be dependent upon the continued retail customeracceptance of our content, future demand by end-user consumer, advertising,promotions and price reductions, market conditions (either favorable orunfavorable) and future warehouse storage limitations.  Should projections of future inventory demandbe overstated, the value of inventory would be overstated and current cost ofsales understated, with future cost of sales overstated.  Conversely, should projections of futuredemand be understated, the value of inventory would be understated and thecurrent cost of sales overstated, with future cost of sales understated. See“Trends Impacting our Business” above under Recent Events.

 

*Allowance for Sales Returns andDoubtful Accounts Receivable*.  For each reporting period, we evaluateproduct sales and accounts receivable to estimate their effect on revenues dueto product returns, sales allowances and other credits given, and delinquent accounts.  Our estimates of product sales that will bereturned and the amount of receivables that will ultimately be collectedrequire the exercise of judgment and affect reported revenues and net earnings.  In determining the estimate of product salesthat will be returned, we analyze historical returns (quantity of returns andtime to receive returned product), historical pricing and other credit memodata, current economic trends, and changes in customer demand and acceptance ofour products, including reorder activity. Based on this information, we reserve a percentage of each dollar ofproduct sales where the customer has the right to return such product andreceive a credit memo.  Actual returnscould be different from our estimates and current provisions for sales returnsand allowances, resulting in future charges to earnings.  Estimates of future sales returns and othercredits are subject to substantial uncertainty. Factors affecting actual returns include retailer financialdifficulties, the perception of comparatively poor retail performance in one orseveral retailer locations, limited retail shelf space at various times of theyear, inadequate advertising or promotions, retail prices being too high forthe perceived quality of the content or other comparable content, the near-termrelease of similar titles, and poor responses to package designs.  Underestimation of product sales returns andother credits would result in an overstatement of current revenues and lowerrevenues in future periods.  Conversely,overestimation of product sales returns would result in an understatement ofcurrent revenues and higher revenues in future periods.

 

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

 

*Valuation of Deferred Income Taxes. *Income taxes are accountedfor under the asset and liability method. Deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statement carryingamounts of existing assets and liabilities and their respective tax bases andoperating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax ratesexpected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled.  We must assess the likelihood that ourdeferred tax assets will be recovered from future taxable income, and to theextent that it is more likely than not that such deferred tax assets will notbe realized, we must establish a valuation allowance.  The establishment, or increase, of avaluation allowance increases income tax expense for such year. We have avaluation allowance against 100% of our net deferred tax assets, which arecomprised primarily of NOL carryforwards. Even though we have fully reservedthese net deferred tax assets for book purposes, we would still be able toutilize them to reduce future income taxes payable should we have futureearnings.  To the extent such deferredtax assets relate to NOL carryforwards, the ability to use such NOLs againstfuture earnings will be subject to applicable carryforward periods. As of March 31,2010, we had NOL carryforwards for federal and state tax purposes of $9.9million and $15.2 million, respectively, which may be available to offsettaxable income through 2030.  Theseamounts available reflect the limitations in the utilization of our NOLcarryforwards as a result of a change in ownership that occurred during theyear.

 

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*Derivatives. *We adopted ASC820, *Fair Value Measurements and Disclosures*,on April 1, 2008, which did nothave a material impact on our financial statements.  ASC 820 defines fair value,establishes a framework for measuring fair value under generally acceptedaccounting principles and enhances disclosures about fair value measurements.Fair value is defined under ASC 820 as the exchange price that would bereceived for an asset or paid to transfer a liability (an exit price) in theprincipal or most advantageous market for the asset or liability in an orderlytransaction between market participants on the measurement date. Valuation techniquesused to measure fair value under ASC 820 must maximize the use of observableinputs and minimize the use of unobservable inputs. The standard describes afair value hierarchy based on three levels of inputs, of which the first twoare considered observable and the last unobservable, that may be used tomeasure fair value as follows:

 

***Level 1***—Quoted prices in activemarkets for identical assets or liabilities.

 

***Level 2***—Inputs other than Level 1that are observable, either directly or indirectly, such as quoted prices forsimilar assets or liabilities; quoted prices in markets that are not active; orother inputs that are observable or can be corroborated by observable marketdata for substantially the full term of the assets or liabilities.

 

***Level 3***—Unobservable inputs thatare supported by little or no market activity and that are significant to thefair value of the assets or liabilities.

 

InOctober 2008, the FASB clarified the application of ASC 820 in a marketthat is not active and provides an example to illustrate key considerations indetermining the fair value of a financial asset when the market for thatfinancial asset is not active.  It waseffective upon issuance, including prior periods for which financial statementshave not been issued.  Our adoption didnot have a material impact on our consolidated financial statements.

 

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

 

Marketrisk is the potential loss arising from adverse changes in market rates andprices, such as interest rates and foreign currency exchange rates.  We are exposed to market risk in the ordinarycourse of our business, including interest rates and foreign currency exchangerates.

 

**Interest Rate Fluctuation Risk**

 

AtMarch 31, 2010 and 2009, approximately $6.4 million and $10.9 million,respectively, of our outstanding borrowings were subject to changes in interestrates.  We do not use derivatives tomanage this risk.  This exposure islinked to the Prime Rate and LIBOR.

 

Managementbelieves that moderate changes in the Prime Rate or LIBOR would not materiallyimpact our operating results or financial condition.  For example, a 10.0% increase in fiscal yearend interest rates would result in (i) an approximate $30,000 annualincrease in pre-tax loss based upon our outstanding borrowings at March 31,2010 and (ii) an approximate $44,000 annual impact on pre-tax loss basedupon our outstanding borrowings at March 31, 2009.

 

**Foreign Exchange Rate Fluctuation Risk**

 

AtMarch 31, 2010 and 2009, our accounts receivable related to internationaldistribution and denominated in foreign currencies were minimal.  These receivables are subject to futureforeign exchange rate risk and could become significant in the future.  We distribute some of our licensed DVDprogramming (for which we hold international distribution rights)internationally through sub-licensees. Additionally, we exploit international broadcast rights to some of our exclusiveentertainment programming (for which we hold international broadcastrights).  Management believes thatmoderate changes in foreign exchange rates will not materially affect ouroperating results or financial condition. To date, we have not entered into foreign currency exchange contracts.

 

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** **

**ITEM8.               FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 
| **INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**                                                                    | ** ** | **Page** |
|-------------------------------------------------------------------------------------------------------------------|------------|----------|
|                                                                                                              |       |     |
| Report of Independent  Registered Public Accounting Firm                                                          |       | 43       |
|                                                                                                              |       |     |
| Consolidated Balance Sheets as of  March 31, 2010 and 2009                                                   |       | 44       |
|                                                                                                              |       |     |
| Consolidated Statements of  Operations for the years ended March 31, 2010 and 2009                           |       | 46       |
|                                                                                                              |       |     |
| Consolidated  Statements of Stockholders’ (Deficit) Equity for the years ended  March 31, 2010 and 2009 |       | 47       |
|                                                                                                              |       |     |
| Consolidated  Statements of Cash Flows for the years ended March 31, 2010 and 2009                           |       | 48       |
|                                                                                                              |       |     |
| Notes to  Consolidated Financial Statements                                                                       |       | 51       |

 

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**IMAGE ENTERTAINMENT, INC. AND SUBSIDIARIES**

**Report of Independent Registered Public Accounting Firm**

 

Boardof Directors and Shareholders

ImageEntertainment, Inc.

Chatsworth,California

 

Wehave audited the consolidated balance sheets of Image Entertainment, Inc.and Subsidiaries (the Company) as of March 31, 2010 and 2009, and therelated consolidated statements of operations, stockholders’ (deficit) equity,and cash flows for the years then ended. These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinionon these consolidated financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  The Company isnot required to have, nor were we engaged to perform, an audit of its internalcontrol over financial reporting.  Ouraudits included consideration of internal control over financial reporting as abasis for designing audit procedures that are appropriate in the circumstances,but not for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of Image Entertainment, Inc.and Subsidiaries as of March 31, 2010 and 2009, and the results of itsoperations and its cash flows for the years then ended in conformity with accountingprinciples generally accepted in the United States of America.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As discussed in Note 2 to theconsolidated financial statements, the Company has suffered recurring lossesfrom operations and negative cash flows that raise substantial doubt about itsability to continue as a going concern. Management’s plans in regard to thesematters are also described in Note 2. The consolidated financial statements donot include any adjustments that might result from the outcome of thisuncertainty.

 

/s/BDO SEIDMAN LLP

 

LosAngeles, California

June 29,2010

 

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**IMAGE ENTERTAINMENT, INC.**

** **

**CONSOLIDATED BALANCE SHEETS**

 

March 31, 2010 and 2009

 

**ASSETS**

 
| **(In thousands)**                                                                   | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Current assets:                                                                      |       |     |       |     |       |
| Cash                                                                                 |       | $        | 460        |     | $          | 802 |   |
| Accounts receivable, net of allowances of   $8,688 – 2010   $10,217 – 2009 |       | 17,676   |       | 19,376   |       |
| Inventories                                                                          |       | 12,659   |       | 14,629   |       |
| Royalty and distribution fee advances                                                |       | 10,979   |       | 16,570   |       |
| Prepaid expenses and other assets                                                    |       | 847      |       | 1,545    |       |
| Total current assets                                                                 |       | 42,621   |       | 52,922   |       |
| Noncurrent inventories, principally production  costs                                |       | 2,201    |       | 2,506    |       |
| Noncurrent royalty and distribution advances                                         |       | 15,669   |       | 21,188   |       |
| Property, equipment and improvements, net                                            |       | 1,105    |       | 2,161    |       |
| Goodwill                                                                             |       | 5,715    |       | 5,715    |       |
| Other assets                                                                         |       | 86       |       | 221      |       |
| Total assets                                                                         |       | $        | 67,397     |     | $          | 84,713 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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**IMAGE ENTERTAINMENT, INC.**

** **

**CONSOLIDATED BALANCE SHEETS, CONTINUED**

 

March 31, 2010 and 2009

 

**LIABILITIES, PREFERRED STOCK AND STOCKHOLDERS’(DEFICIT) EQUITY**

 
| **(In thousands, except share data)**                                                                                                                                                                                         | ** ** | **2010** | ** ** | **2009** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Current liabilities:                                                                                                                                                                                                          |       |     |       |     |       |
| Accounts payable                                                                                                                                                                                                              |       | $        | 6,803      |     | $          | 12,761 |   |
| Accrued liabilities                                                                                                                                                                                                           |       | 8,638    |       | 5,626    |       |
| Accrued royalties and distribution fees                                                                                                                                                                                       |       | 14,048   |       | 20,777   |       |
| Accrued music publishing fees                                                                                                                                                                                                 |       | 5,846    |       | 6,222    |       |
| Deferred revenue                                                                                                                                                                                                              |       | 6,571    |       | 5,035    |       |
| Revolving credit facility                                                                                                                                                                                                     |       | 6,380    |       | 10,933   |       |
| Current portion of long-term debt, less debt  discount                                                                                                                                                                        |       | —   |       | 10,094   |       |
| Series B cumulative preferred stock dividends  payable                                                                                                                                                                   |       | 616      |       | —   |       |
| Total current liabilities                                                                                                                                                                                                     |       | 48,902   |       | 71,448   |       |
| Long-term debt, less current portion, less debt  discount                                                                                                                                                                     |       | —   |       | 5,663    |       |
| Other long-term liabilities, less current portion                                                                                                                                                                             |       | 2,442    |       | 2,105    |       |
| Total liabilities                                                                                                                                                                                                             |       | 51,344   |       | 79,216   |       |
| Commitments and Contingencies (Note 12)                                                                                                                                                                                       |       |     |       |     |       |
| Series B preferred stock, $0.0001 par value,  30,000 shares authorized; 22,600 and none issued and outstanding at  March 31, 2010 and 2009, respectively   Liquidation preference of $23,216 and none, respectively |       | 6,019    |       | —   |       |
| Series C convertible preferred stock, $0.0001  par value, 270,000 shares authorized; 202,066.6 and none issued and  outstanding at March 31, 2010 and 2009, respectively                                            |       | 10,895   |       | —   |       |
| Stockholders’ (deficit) equity:                                                                                                                                                                                          |       |     |       |     |       |
| Common stock, $.0001 par value, 100 million shares  authorized; 25,356,000 and 21,856,000 issued and outstanding in 2010 and  2009, respectively                                                                              |       | 3        |       | 2        |       |
| Additional paid-in capital                                                                                                                                                                                                    |       | 53,284   |       | 52,693   |       |
| Accumulated deficit                                                                                                                                                                                                           |       | (54,148  | )          | (47,198  | )          |
| Net stockholders’ (deficit) equity                                                                                                                                                                                       |       | (861     | )          | 5,497    |       |
| Total liabilities, preferred stock and  stockholders’ (deficit) equity                                                                                                                                                   |       | $        | 67,397     |     | $          | 84,713 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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**IMAGE ENTERTAINMENT, INC.**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

 

For the Years Ended March 31, 2010 and 2009

 
| **(In thousands, except per share data)**          | ** ** | **2010** | ** ** | **2009** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|
| NET REVENUES                                       |       | $        | 93,070     |     | $          | 130,691 |   |
| COST OF SALES                                      |       | 74,337   |       | 103,237  |       |
| Gross margin                                       |       | 18,733   |       | 27,454   |       |
| SELLING, GENERAL AND ADMINISTRATIVE EXPENSES:      |       |     |       |     |       |
| Selling expenses                                   |       | 11,272   |       | 14,225   |       |
| General and administrative expenses                |       | 18,614   |       | 16,879   |       |
| Total selling, general and administrative expenses |       | 29,886   |       | 31,104   |       |
| LOSS FROM OPERATIONS                               |       | (11,153  | )          | (3,650   | )          |
| OTHER EXPENSES (INCOME):                           |       |     |       |     |       |
| Interest expense, net                              |       | 2,145    |       | 3,320    |       |
| Loss on extinguishment of debt                     |       | 277      |       | —   |       |
| Other income                                       |       | (7,751   | )          | (5,205   | )          |
|                                               |       | (5,329   | )          | (1,885   | )          |
| LOSS BEFORE PROVISION FOR INCOME TAXES             |       | (5,824   | )          | (1,765   | )          |
| PROVISION FOR INCOME TAXES                         |       | 98       |       | 39       |       |
| NET LOSS                                           |       | (5,922   | )          | (1,804   | )          |
| Dividend on Series B preferred stock          |       | (616     | )          | —   |       |
| Deemed dividend on Series C preferred stock   |       | (412     | )          | —   |       |
| NET LOSS APPLICABLE TO COMMON SHAREHOLDERS         |       | $        | (6,950     | )        | $          | (1,804 | ) |
| NET LOSS PER COMMON SHARE:                         |       |     |       |     |       |
| Net loss per common share – basic and diluted |       | $        | (0.31      | )        | $          | (0.08 | ) |
| WEIGHTED-AVERAGE COMMON SHARES OUTSTANDING:        |       |     |       |     |       |
| Basic and diluted                                  |       | 22,644   |       | 21,856   |       |

 

*See accompanying notes to consolidated financial statements.*

 

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**IMAGE ENTERTAINMENT, INC.**

 

**CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ (DEFICIT)EQUITY**

 

For the Years Ended March 31, 2010 and2009

 
| ** **                                    | ** ** | **Common Stock** | ** ** | ** **     | ** ** | ** **                      | ** ** | ** **              | ** ** |
|-----------------------------------------------|------------|------------------|------------|----------------|------------|---------------------------------|------------|-------------------------|------------|
| **(In thousands)**                            | ** ** | **Shares**       | ** ** | **Par  Value** | ** ** | **Additional Paid-In  Capital** | ** ** | **Accumulated Deficit** | ** ** | **Total** | ** ** |
|                                          |       |             |       |           |       |                            |       |                    |       |   |   |   |   |   |   |
| Balance at March 31, 2008                |       | 21,856           |       | $              | 2          |                            | $          | 52,618                  |       | $ | (45,394 | ) | $ | 7,227 |   |
| Net loss                                      |       | —           |       | —         |       | —                          |       | (1,804                  | )          | (1,804 | ) |
| Share-based compensation                      |       | —           |       | —         |       | 75                              |       | —                  |       | 75 |   |
|                                          |       |             |       |           |       |                            |       |                    |       |   |   |
| Balance at March 31, 2009                |       | 21,856           |       | 2              |       | 52,693                          |       | (47,198                 | )          | 5,497 |   |
| Issuance of stock                             |       | 3,500            |       | 1              |       | 226                             |       | —                  |       | 227 |   |
| Series C preferred stock deemed dividend |       | —           |       | —         |       | —                          |       | (412                    | )          | (412 | ) |
| Series B preferred stock dividend        |       | —           |       | —         |       | —                          |       | (616                    | )          | (616 | ) |
| Share-based compensation                      |       | —           |       | —         |       | 365                             |       | —                  |       | 365 |   |
| Net loss                                      |       | —           |       | —         |       | —                          |       | (5,922                  | )          | (5,922 | ) |
| Balance at March 31, 2010                |       | 25,356           |       | $              | 3          |                            | $          | 53,284                  |       | $ | (54,148 | ) | $ | (861 | ) |

 

*See accompanying notes to consolidated financialstatements.*

 

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**IMAGE ENTERTAINMENT, INC.**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 

For the Years Ended March 31, 2010 and 2009

 
| **(In thousands)**                                                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                        |       |     |       |     |       |
| Net loss                                                                                     |       | $        | (5,922     | )        | $          | (1,804 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities:             |       |     |       |     |       |
| Amortization of production costs                                                             |       | 4,346    |       | 4,881    |       |
| Depreciation and other amortization                                                          |       | 1,759    |       | 2,757    |       |
| Provision for lower of cost or market inventory  write-downs                                 |       | 1,714    |       | 2,559    |       |
| Provision (benefit) for doubtful accounts, sales  returns and other credits                  |       | (2,048   | )          | 1,692    |       |
| Accelerated amortization and fair value write-down  of advance royalty and distribution fees |       | 2,276    |       | 3,866    |       |
| Loss on extinguishment of debt                                                               |       | 277      |       | —   |       |
| Gain on forgiveness of liabilities                                                           |       | (5,218   | )          | —   |       |
| Change in fair value of warrant, purchase rights  and embedded derivatives                   |       | (570     | )          | 209      |       |
| Stock-based compensation expense                                                             |       | 365      |       | 75       |       |
| Noncash consideration from disposal of property,  equipment and improvements                 |       | 200      |       | —   |       |
| Gain on disposal of property, equipment and  improvements                                    |       | (161     | )          | —   |       |
| Noncash consideration for investment banking  services received                              |       | 597      |       | —   |       |
| Changes in assets and liabilities associated with  operating activities:                     |       |     |       |     |       |
| Accounts receivable                                                                          |       | 3,748    |       | (3,638   | )          |
| Inventories                                                                                  |       | (1       | )          | (560     | )          |
| Royalty and distribution fee advances                                                        |       | 2,940    |       | (3,930   | )          |
| Production cost expenditures                                                                 |       | (3,784   | )          | (5,004   | )          |
| Prepaid expenses and other assets                                                            |       | 288      |       | 78       |       |
| Accounts payable, accrued royalties, fees and  liabilities                                   |       | 1,226    |       | 5,126    |       |
| Deferred revenue                                                                             |       | 1,536    |       | (5,120   | )          |
| Net cash provided by operating activities                                                    |       | 3,568    |       | 1,187    |       |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                        |       |     |       |     |       |
| Purchase of property, equipment and improvements                                             |       | (68      | )          | (368     | )          |
| Net cash used in investing activities                                                        |       | (68      | )          | (368     | )          |
|                                                                                              |            |          |            |          |            |  |  |

 

*See accompanying notes to consolidated financialstatements.*

 

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**IMAGE ENTERTAINMENT, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED****x**

 

For the Years Ended March 31, 2010 and 2009

 
| **(In thousands)**                                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|-----------------------------------------------------------|------------|----------|------------|----------|------------|
| CASH FLOWS FROM FINANCING ACTIVITIES:                     |       |     |       |     |       |
| Borrowings under revolving credit facility                |       | $        | 86,996     |     | $          | 131,964 |   |
| Repayments of borrowings under revolving credit  facility |       | (91,549  | )          | (126,196 | )          |
| Repayments of long-term debt                              |       | (18,197  | )          | (7,391   | )          |
| Net proceeds from issuance of preferred stock             |       | 18,908   |       | —   |       |
| Net cash used in financing activities                     |       | (3,842   | )          | (1,623   | )          |
| DECREASE IN CASH:                                         |       | (342     | )          | (804     | )          |
| Cash at beginning of year                                 |       | 802      |       | 1,606    |       |
| Cash at end of year                                       |       | $        | 460        |     | $          | 802 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:        |       |     |       |     |       |
| Cash paid during the year for:                            |       |     |       |     |       |
| Interest                                                  |       | $        | 1,334      |     | $          | 1,913 |   |
| Income taxes                                              |       | $        | (75        | )        | $          | 324 |   |

 

*See accompanying notes to consolidated financialstatements.*

 

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**IMAGE ENTERTAINMENT, INC.**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED**

 

For the Years Ended March 31, 2010 and 2009

 

SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING ANDFINANCING ACTIVITIES:

 

Asof March 31, 2010 and 2009, we accrued approximately $1.1 million and $5.5million, respectively, for royalty advances and distribution fees for committedunpaid royalty and production advances where future payment is based upon therelease of the program or the passage of time. As of March 31, 2010, we accrued approximately $616,000 forundeclared dividends on Series B preferred stock.

 

*See accompanying notes to consolidated financialstatements.*

 

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IMAGE ENTERTAINMENT, INC.

NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

 

**Note 1.****          ****Basis ofPresentation and Summary of Significant Accounting Policies.**

 

*Basis of Presentation and Principles ofConsolidation.*  Theaccompanying consolidated financial statements include the accounts of ImageEntertainment, Inc. and its subsidiaries Egami Media, Inc. and ImageEntertainment (UK), Inc. (or collectively, *we*,*our* or *us*)as of March 31, 2010.  Effective June 30, 2010, we plan tomerge our wholly owned subsidiaries, Egami Media, Inc. and ImageEntertainment (UK), Inc., into the parent corporation, ImageEntertainment, Inc.  Allsignificant former intercompany balances and transactions have been eliminatedin consolidation.

 

OnJanuary 8, 2010, we issued JH Partners certain shares of preferred stockin exchange for an aggregate purchase price of $22.0 million (see Notes 18 and19).  The transaction resulted in JH Partners obtaining approximately88.6% of the voting control of the Company.  Because JH Partners acquiredless than 95% voting control, we have elected not to apply the push-downaccounting and therefore there was no fair value adjustment to the Company’sassets or liabilities.  If the JHPartners investment in the Company control increases to 95% or more, we willevaluate the Company’s assets and liabilities at that time.

 

*Business.*  We engage primarily in the domesticacquisition and wholesale distribution of home entertainment content forrelease on DVD, digitally and in other home entertainment formats, viaexclusive distribution and royalty agreements. We also distribute our exclusive DVD programming internationally,primarily by relying on sublicensees (particularly Universal Music GroupInternational, Warner Music Australia and Digital Site), from whom we receiverevenues in the form of royalty income.

 

*Use of Estimates in Preparation of FinancialStatements.*  Thepreparation of our consolidated financial statements in conformity with UnitedStates generally accepted accounting principles (or *U.S. GAAP*)requires management to make estimates and assumptions that affect the amountsreported in the financial statements. The significant areas requiring the use of management estimates arerelated to provisions for lower-of-cost or market inventory write-downs,accounts receivable doubtful debt and sales returns reserves, unrecoupedroyalty and distribution fee advances, valuation of deferred taxes, andvaluation of warrants, preferred stock and share based compensationexpense.  Although these estimates arebased on management’s knowledge of current events and actions management mayundertake in the future, actual results may ultimately differ materially fromthose estimates.

 

*Cash*.  At times our cash deposits may be in excessof the Federal Deposit Insurance Corporation (or *FDIC*)insurance limit.

 

*Fair Value of Financial Instruments.*  The carrying amount of our financialinstruments, which principally include cash, trade receivables, accountspayable and accrued expenses, approximates fair value due to the relativelyshort maturity of such instruments. The fair value of our debt instrumentsapproximates the amount of future discounted cash flows associated with eachinstrument.

 

Weadopted Financial Accounting Standards Board (or *FASB*)Accounting Standards Codification (or *ASC*) 820, *Fair Value Measurements and Disclosures*, on April 1,2008, which did not have a material impact on our financial statements.  ASC820 defines fair value, establishes a framework for measuring fair value undergenerally accepted accounting principles and enhances disclosures about fairvalue measurements. Fair value is defined under ASC 820 as the exchange pricethat would be received for an asset or paid to transfer a liability (an exitprice) in the principal or most advantageous market for the asset or liabilityin an orderly transaction between market participants on the measurement date.Valuation techniques used to measure fair value under ASC 820 must maximize theuse of observable inputs and minimize the use of unobservable inputs. Thestandard describes a fair value hierarchy based on three levels of inputs, ofwhich the first two are considered observable and the last unobservable, thatmay be used to measure fair value as follows:

 

***Level 1***—Quoted prices in activemarkets for identical assets or liabilities.

 

***Level 2***—Inputs other than Level 1that are observable, either directly or indirectly, such as quoted prices forsimilar assets or liabilities; quoted prices in markets that are not active; orother inputs that are observable or can be corroborated by observable marketdata for substantially the full term of the assets or liabilities.

 

***Level 3***—Unobservable inputs thatare supported by little or no market activity and that are significant to thefair value of the assets or liabilities. Liabilities valued with level 3 inputs are described in “Note 11 —Long-Term Debt — Derivative Liabilities — Stock Warrant and EmbeddedDerivatives” below.

 

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IMAGE ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

InOctober 2008, the FASB clarified the application of ASC 820 in a marketthat is not active and provides an example to illustrate key considerations indetermining the fair value of a financial asset when the market for thatfinancial asset is not active.  It waseffective upon issuance, including prior periods for which financial statementshave not been issued.  Our adoption didnot have a material impact on our consolidated financial statements.

 

*Revenue Recognition.*  Revenue is recognized upon meeting therecognition requirements of ASC 926, *Entertainment—Films*and ASC 605, *Revenue Recognition*.  Revenues from home video distribution arerecognized net of an allowance for estimated returns, as well as related costs,in the period in which the product is available for sale by our customers (atthe point that title and risk of loss transfer to the customer, which isgenerally upon receipt by the customer and in the case of new releases, after “streetdate” restrictions lapse).  Rentalrevenues under revenue sharing arrangements are recognized when we are entitledto receipts and such receipts are determinable. Revenues from domestic and international broadcast licensing and homevideo sublicensing, as well as associated costs, are recognized when the programmingis available to the licensee and other FASB recognition requirements aremet.  Fees received in advance ofavailability, usually in the case of advances received from Universal MusicGroup International, Digital Site, and other international home videosublicensees and for broadcast programming, are deferred until earned and allrevenue recognition requirements have been satisfied.  Provisions for uncollectible accountsreceivable are provided at the time of sale.

 

*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 non-recoupableproduction costs.  See “Non-RecoupableProduction Costs” below.

 

*Allowances for Sales Returns andDoubtful Accounts Receivable.*  For each reporting period, we evaluateproduct sales and accounts receivable to estimate their effect on revenues dueto product returns, sales allowances and other credits given, and delinquentaccounts.  Our estimates of product salesthat will be returned and the amount of receivables that will ultimately becollected require the exercise of judgment and affect reported revenues and netearnings.  In determining the estimate ofproduct sales that will be returned, we analyze historical returns (quantity ofreturns and time to receive returned product), historical pricing and othercredit memo data, current economic trends, and changes in customer demand andacceptance of our products, including reorder activity.  Based on this information, we reserve apercentage of each dollar of product sales where the customer has the right toreturn such product and receive a credit memo. Actual returns could be different from our estimates and currentprovisions for sales returns and allowances, resulting in future charges toearnings.  Estimates of future salesreturns and other credits are subject to substantial uncertainty.  Factors affecting actual returns includeretailer financial difficulties, the perception of comparatively poor retailperformance in one or several retailer locations, limited retail shelf space atvarious times of the year, inadequate advertising or promotions, retail pricesbeing too high for the perceived quality of the content or other comparablecontent, the near-term release of similar titles, and poor responses to packagedesigns.  Underestimation of productsales returns and other credits would result in an overstatement of currentrevenues and lower revenues in future periods. Conversely, overestimation of product sales returns would result in anunderstatement of current revenues and higher revenues in future periods.

 

Similarly,we evaluate accounts receivable to determine if they will ultimately becollected.  In performing thisevaluation, significant judgments and estimates are involved, including ananalysis of specific risks on a customer-by-customer basis for our largercustomers and an analysis of the length of time receivables have been pastdue.  Based on this information, we reservean amount that we believe to be doubtful of collection.  If the financial condition of our customerswere to deteriorate or if economic conditions were to worsen, additionalallowances might be required in the future. Underestimation of this allowance would cause accounts receivable to be overstatedand current period expenses to be understated. Overestimation of this allowance would cause accounts receivable to beunderstated and current period expenses to be overstated.

 

*Non-Recoupable Production Costs.*  The costs to produce licensed content fordomestic 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 our creative services and production departments.  A percentage of the capitalized productioncosts are amortized to expense each month based upon:  (i) a projected revenue stream resultingfrom distribution of new and previously released exclusive programming relatedto such production costs; and (ii) management’s estimate of the ultimatenet realizable value of the production costs. Estimates of future revenues are reviewed periodically and amortizationof production costs is adjusted accordingly. If estimated future revenues are not sufficient to recover theunamortized balance of production costs, such costs are reduced to theirestimated fair value.

 

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IMAGE ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

*Royalty and Distribution Fee Advances, RecoupableProduction Advances.* Royalty and distribution fee advances represent fixed minimum paymentsmade to program suppliers for exclusive content distribution rights.  A program supplier’s share of exclusiveprogram distribution revenues is retained by us until the share equals theadvance(s) paid to the program supplier plus recoupable productioncosts.  Thereafter, any excess is paid tothe program supplier.  In the event of anexcess, we record, as a cost of sales, an amount equal to the program supplier’sshare of the net distribution revenues. Royalty and distribution fee advances are charged to operations asrevenues are earned.  Royaltydistribution fee advances and recoupable production costs are amortized toexpense in the same ratio that current period revenue for a title or group oftitles bears to the estimated remaining unrecognized ultimate revenue for thattitle.  Revenue and cost forecasts arecontinually reviewed by management and revised when warranted by changingconditions.  When estimates of totalrevenues and costs indicate that an individual title or group ofcross-collateralized titles which we exploit via home entertainment formats(such as DVD, Blu-ray, digital, CD or broadcast) will result in an ultimateloss, an impairment charge is recognized to the extent that capitalized advanceroyalties and distribution fees and recoupable production costs exceedestimated fair value, based on discounted cash flows, in the period whenestimated.

 

*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. Depreciation and amortization are computed by applying thestraight-line method over the estimated useful lives of the machinery,equipment and software (3-7 years). Leasehold improvements are amortized over the shorter of the useful lifeof the improvement or the 10-year life of the related leases.

 

*Advertising Costs.*  Our advertising expense consists ofexpenditures related to advertising in trade and consumer publications, productbrochures and catalogs, booklets for sales promotion, radio advertising andother promotional costs.  In accordancewith ASC 720-35, *Other Expenses—Advertising Costs*,and ASC 340-20, *Other Assets and Deferred Costs—CapitalizedAdvertising Costs*, we expense advertising costs in the period inwhich the advertisement first takes place. Product brochures and catalogs and various other promotional costs arecapitalized and amortized over the expected period of future benefit, butgenerally not exceeding six months.  Ourco-op advertising is expensed in accordance with ASC 605-50, *Revenue Recognition—Customer Payment and Incentives*.  We had minimal prepaid advertising costs at March 31,2010 and 2009.  For fiscal 2010 and 2009,advertising and promotion expense was $5,706,000 and $6,478,000, respectively.

 

*Market Development Funds.*  In accordance with ASC 605-50, marketdevelopment funds, including funds for specific product positioning, taken as adeduction from payment for purchases by customers are classified by us as areduction to revenues. The following reductions to consolidated net revenueshave been made in accordance with the guidelines of this issue: $8,590,000 forfiscal 2010 and $9,014,000 for fiscal 2009.

 

*Allowances Received From Vendors.*  In accordance with ASC 605-50, we classifyconsideration received as a reduction in cost of sales in the accompanyingstatements of operations unless we receive an identifiable benefit in exchangefor the consideration, or the consideration represents reimbursement of aspecific, identifiable cost incurred by us in selling the vendor’s product.

 

*Shipping Income and Expenses.*  In accordance with ASC 605-45, *Revenue Recognition—Principal Agent Considerations*, weclassify amounts billed to customers for shipping fees as revenues, andclassify costs related to shipping as cost of sales in the accompanyingstatements of operations.

 

*Major Customers and Suppliers.*  Amazon.com, Inc. and AllianceEntertainment LLC (or *AEC*) accountedfor approximately 17% and 14%, respectively, of our net revenues for the yearended March 31, 2010.  Amazon.com, Inc.accounted for approximately 14% of our net revenues for the year ended March 31,2009.  No other customers accounted formore than 10% of our net revenues in fiscal 2010 and 2009.  At March 31, 2010, Amazon and AECaccounted for approximately 18% and 13%, respectively, of our gross accountsreceivables.  At March 31, 2009,Anderson Merchandisers, AEC and Amazon.com, Inc. accounted forapproximately 12%, 11% and 10%, respectively, of our gross accountsreceivables.  Our content supplied byCriterion represented approximately 23% and 19% of our fiscal 2010 and 2009 netrevenues, respectively.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Wesource primarily all of our DVD and CD manufacturing with Arvato DigitalServices (formerly known as Sonopress LLC) (or *Arvato*).  See “Note 11. Long-Term Debt - DiscReplication Agreement and Related Advance.”

 

*Goodwill.*  Goodwill is not amortized, but instead istested for impairment at least annually. We performed our annual test of goodwill impairment and have concludedthat there was no impairment.

 

*Impairment of Long-Lived Assets.*  We review for the impairment of long-livedand specific, identifiable intangible assets whenever events or changes incircumstances indicate the carrying amount of an asset may not berecoverable.  An impairment loss would berecognized when estimated undiscounted future cash flows expected to resultfrom the use of the asset and its eventual disposition is less than itscarrying amount.  We have no intangibleassets with indefinite useful lives.

 

*Foreign Currency Transactions.*  Foreign currency-denominated transactions arerecorded at the exchange rate in effect at the time of occurrence, and thegains or losses resulting from subsequent translation of the correspondingreceivable or payable at current exchange rates are included as a component ofother income and expenses in the accompanying statements of operations.  To date, we have not entered into foreigncurrency exchange contracts.

 

*Income Taxes.*  We account for income taxes pursuant to theprovisions of ASC 740, *Income Taxes*,whereby deferred tax assets and liabilities are recognized for the future taxconsequences attributable to differences between the financial statementcarrying amount of existing assets and liabilities and their respective taxbases and the future tax benefits derived from operating loss and tax creditcarryforwards.  We provide a valuationallowance on our deferred tax assets when it is more likely than not that suchdeferred tax assets will not be realized. We have a valuation allowance against 100% of our net deferred tax assetsat March 31, 2010 and 2009.

 

Effective April 1,2007, we adopted the provisions of ASC 740. The first step is to determine whether or not a tax benefit should berecognized.  A tax benefit will berecognized if the weight of available evidence indicates that the tax positionis more likely than not to be sustained upon examination by the relevant taxauthorities.  The recognition andmeasurement of benefits related to our tax positions requires significantjudgment as uncertainties often exist with respect to new laws, newinterpretations of existing laws, and rulings by taxing authorities.  Differences between actual results and ourassumptions, or changes in our assumptions in future periods, are recorded inthe period they become known.

 

*Earnings/Loss per Share.*  Basic earnings/loss per share is computedusing the weighted-average number of common shares outstanding during theperiod.  Diluted earnings per share arecomputed using the combination of dilutive common share equivalents and theweighted-average shares outstanding during the period.  Diluted loss per share is equivalent to basicloss per share as inclusion of common share equivalents would be antidilutive.

 

*Series B Preferred Stock Dividends.*  We record preferred stock dividends on our Series BPreferred Stock in our consolidated statements of operations based on the valueof dividends at each dividend accrual date. Our Preferred Stock has a cumulative compounding dividend rate equal to12% per year of the liquidation preference of $1,000 per share (subject toadjustment upon any stock dividend, stock split or similar event).  Dividends will accrue automatically on adaily basis, but will be payable in cash only when, and if, declared by theBoard.  Accrued dividends will becompounded quarterly with the effect that an additional dividend will accrue oneach share of Series B Preferred at the dividend rate on the amount socompounded until such amount is actually paid.

 

*Stock Options.*  ASC 718, *Compensation—StockCompensation*, establishes standards with respect to the accountingfor transactions in which an entity exchanges its equity instruments for goodsor services, or incurs liabilities in exchange for goods or services, that arebased on the fair value of the entity’s equity instruments, focusing primarilyon accounting for transactions in which an entity obtains employee services inshare-based payment transactions.  ASC718 requires public entities to measure the cost of employee services receivedin exchange for an award of equity instruments based on the grant-date fairvalue of the award (with limited exceptions) and recognize the cost over theperiod during which an employee is required to provide service in exchange forthe award.

 

*Restricted Stock Units. *There were norestricted stock units awarded during the years ended March 31, 2010 and2009.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

*Stock-Based Compensation Valuation and Expense Information. *The fair value of eachoption award is estimated on the date of grant using a closed-form optionvaluation model (Black-Scholes) based on the assumptions noted in the followingtable.  Expected volatilities are basedon historical volatility of our stock and other factors.  The expected term of options grantedrepresents the period of time that options granted are expected to beoutstanding.  The following tablerepresents the assumptions used in the Black-Scholes option-pricing model foroptions granted during fiscal 2010 and 2009:

 
| ** **                      | ** ** | **Fiscal Year Ended March 31, 2010** | ** ** | **Fiscal Year Ended March 31, 2009** | ** ** |
|---------------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
|                            |       |                                      |       |                                      |       |
| Risk-free interest rate         |       | 1.68% - 1.89%                             |       | 3.18% - 3.39%                             |       |
| Expected term (in years)        |       | 3.9 to 4.6 years                          |       | 3.9 to 4.6 years                          |       |
| Expected volatility for options |       | 96%-103%                                  |       | 68%-70%                                   |       |
| Expected dividend yield         |       | 0%                                        |       | 0%                                        |       |

 

Theexpected term assumption uses historical exercise and option expiration datafor Black-Scholes grant-date valuation purposes.  We believe this historical data is currentlythe best estimate of the expected term of a new option.  We have identified two groups, management andnon-management, to determine historical patterns.  Expected volatility uses our stock’shistorical volatility for the same period of time as the expected term.  We have no reason to believe our futurevolatility will differ from the past. The risk-free interest rate is based on the U.S. Treasury rate in effectat the time of grant for the same period of time as the expected term.  Expected dividend yield is zero, as we havehistorically not paid dividends.

 

Stock-basedcompensation expense during fiscal 2010 and 2009 was $365,000 and $75,000,respectively.

 

*Recently Issued Accounting Standards.*

 

OnJune 29, 2009, the FASB issued ASC 105, *GenerallyAccepted Accounting Principles*. This standard establishes the FASBAccounting Standards CodificationTM (or the *Codification*) as the source of authoritative U.S. GAAPrecognized by the FASB to be applied by nongovernmental entities. Rules andinterpretive releases of the Securities and Exchange Commission (or the *SEC*) under authority of federal securities laws are alsosources of authoritative U.S. GAAP for SEC registrants. Content contained inthe SEC Sections of the Codification is provided for convenience and relatesonly to SEC registrants. The SEC Sections are not the authoritative sources ofsuch content and do not contain the entire population of SEC rules,regulations, interpretive releases, and staff guidance. Content in the SEC Sectionsis expected to change over time, and there may be delays between SEC and staffchanges to guidance and Accounting Standards Updates. The Codification does notreplace or affect guidance issued by the SEC or its staff for public entitiesin their filings with the SEC. On the effective date of this guidance, theCodification will supersede all then-existing non-SEC accounting and reportingstandards. All other nongrandfathered non-SEC accounting literature notincluded in the Codification will become nonauthoritative. This guidance iseffective for financial statements issued for interim and annual periods endingafter September 15, 2009. The Codification was effective for our secondfiscal quarter ended September 30, 2009, and its application did not have amaterial impact on our consolidated financial statements.

 

OnApril 1, 2009, we adopted ASC 815-40, *Derivatives and Hedging —Contracts in Entity’s Own Entity*.  The objective is toprovide guidance for determining whether an equity-linked financial instrument(or embedded feature) is indexed to an entity’s own stock.  ASC815-40 applies to any freestanding financial instrument or embedded featurethat has all the characteristics of a derivative described in ASC 815-10 *Derivatives and Hedging*, for purposes of determining whetherthat instrument or embedded feature qualifies for the first part of the scopeexception in section 15 of ASC 815-10. ASC 815-10-15 specifies that a contractthat would otherwise meet the definition of a derivative under that guidanceissued or held by the reporting entity that is both (a) indexed to its ownstock and (b) classified in stockholders’ equity in its statement offinancial position shall not be considered a derivative financial instrumentfor purposes of applying that guidance.  If a freestanding financialinstrument (for example, a stock purchase warrant) meets the scope exception inASC 815-10-15, it is classified as an equity instrument and is not accountedfor as a derivative instrument.  ASC 815-10-15 also applies to anyfreestanding financial instrument that is potentially settled in an entity’sown stock, regardless of whether the instrument has all the characteristics ofa derivative, for purposes of determining whether the instrument is within thescope of ASC 815-40.  The provisions of this issue did not have amaterial impact on our consolidated financial position and results ofoperations.

 

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OnApril 1, 2009, we adopted ASC 470-20, *Debt — Debt withConversion and Other Options*. ASC 470-20 requires enhanced disclosures about an entity’s derivativeand hedging activities and thereby improves the transparency of financialreporting.  In addition, this topicprovides that issuers of such instruments should separately account for theliability and equity components of those instruments by allocating the proceedsat the date of issuance of the instrument between the liability component andthe embedded conversion option (the equity component).  The equity component is recorded in equityand the reduction in the principal amount (debt discount) is amortized as interestexpense over the expected life of the instrument using the interestmethod.  The adoption of ASC 470-20 didnot have a material impact on our consolidated financial position and resultsof operations.

 

OnApril 1, 2009, we adopted ASC 805, *Business Combinations*,and ASC 810, *Consolidation*.  These new standards are the U.S. GAAP outcomeof a joint project with the International Accounting Standards Board (or *IASB*).  ASC 805 andASC 810 introduce significant changes in the accounting for and reporting ofbusiness acquisitions and noncontrolling interests in a subsidiary.  ASC 805 and ASC 810 continue the movementtoward the greater use of fair values in financial reporting and increasedtransparency through expanded disclosures. ASC 805 changes how business acquisitions are accounted for and willimpact financial statements at the acquisition date and in subsequentperiods.  ASC 810 requires noncontrollinginterests (previously referred to as minority interests) to be reported as acomponent of equity, which changes the accounting for transactions withnoncontrolling interest holders.  Theadoption of ASC 805 and ASC 810 has not had any impact on our consolidatedfinancial position, results of operations and cash flows.

 

OnApril 1, 2009, we adopted ASC 350-30, *Intangibles —Goodwill and Other — General Intangibles Other than Goodwill*.  ASC 350-30 amends the factors that should beconsidered in developing renewal or extension assumptions used to determine theuseful life of a recognized intangible asset under ASC 350, *Intangibles — Goodwill and Other*.  The intent of ASC 350-30 is to improve theconsistency between the useful life of a recognized intangible asset under ASC350 and the period of expected cash flows used to measure the fair value of theasset under ASC 805 and other applicable accounting literature.  The adoption of this statement did not have amaterial impact on our consolidated financial position or results ofoperations.

 

Weadopted ASC 855, *Subsequent Events*, during thefiscal first quarter ended June 30, 2009. ASC 855 establishes standards of accounting for and disclosure of eventsthat occur after the balance sheet dated but before financial statements areissued.  In February 2010, the FASBissued ASU No. 2010-09, *Subsequent Events (Topic855)*.  ASU 2010-09 amends ASC855, which requires us to evaluate subsequent events through the date that thefinancial statements are issued, however, we are not required to disclose thatdate.  ASC 2010-09 is effective uponissuance and we have conformed our disclosure in the accompanying financialstatements.  See “Note 20Subsequent Events” for additional information.

 

InJune 2009, the FASB issued ASC 860-10, *Transfers and Servicing —Sales of Financial Assets.* This statement eliminates the concept ofa qualified special-purpose entity, changes the requirements for derecognizingfinancial assets and requires additional disclosures in order to enhanceinformation reported to users of financial statements by providing greatertransparency about transfers of assets, including securitization transactions,and an entity’s continuing involvement in and exposure to the risks related totransferred financial assets. This guidance must be applied as of the beginningof each reporting entity’s first annual reporting period that begins after November 15,2009, for interim periods within that first annual reporting period and forinterim and annual reporting periods thereafter. Earlier application isprohibited. We do not believe that the provisions of this guidance, wheneffective, will result in a significant impact to our consolidated financialstatements.

 

InJune 2009, the FASB amended ASC 810 *Consolidation.*FASB’s objective in issuing this guidance is to improve financial reporting byenterprises involved with variable interest entities. FASB undertook thisproject to address (1) the effects on certain provisions of ASC 810 as a result of the elimination ofthe qualifying special-purpose entity concept in ASC 860-10 (2) constituentconcerns about the application of certain key provisions of ASC 810, includingthose in which the accounting and disclosures under the guidance do not alwaysprovide timely and useful information about an enterprise’s involvement in avariable interest entity. This guidance shall be effective as of the beginningof each reporting entity’s first annual reporting period that begins after November 15,2009, for interim periods within that first annual reporting period, and forinterim and annual reporting periods thereafter. Earlier application isprohibited. We do not believe that the provisions of this guidance, wheneffective, will result in a significant impact to our consolidated financialstatements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

InAugust 2009, the FASB issued ASU No. 2009-05, *Fair ValueMeasurements and Disclosures (Topic 820) — Measuring Liabilities at Fair Value*.This ASU amends Subtopic 820-10, Fair Value Measurements andDisclosures-Overall, for the fair value measurement of liabilities, andprovides clarification regarding required valuations techniques forcircumstances in which a quoted price in an active market for the identicalliability is not available. We adopted ASU 2009-05 during the quarter ended September 30,2009, and its application did not have a material impact on our consolidatedfinancial statements.

 

InJanuary 2010, the FASB issued ASU No. 2010-06, *Fair ValueMeasurements and Disclosures (Topic 820): Improving Disclosures about FairValue Measurements*.  ASU2010-06 amends ASC 820 and clarifies and provides additional disclosurerequirements related to recurring and non-recurring fair value measurements andemployers’ disclosures about postretirement benefit plan assets. We will adoptASU 2010-06 effective as of January 1, 2010. We do not currentlyanticipate that it will have a material impact on our consolidated financialstatements upon adoption.

 

InFebruary 2010, the FASB issued ASU No. 2010-08, *TechnicalCorrections to Various Topics*. The purpose of ASU 2010-08 is to eliminate GAAP inconsistencies, updateoutdated provisions, and provide needed clarifications. The adoption of ASU No. 2010-08will not have a material impact on the Company’s financial statements.

 

InFebruary 2010, the FASB issued ASU No. 2010-10, *Consolidations(Topic 810)*.  ASU 2010-10amends (i) the requirements for evaluating whether a decision maker or servicecontract is a variable interest to clarify that a quantitative approach shouldnot be the sole consideration in assessing the criteria and (2) clarifiesthat related parties should be considered in applying all of the decision makerand service contract criteria.  Theadoption of ASC No. 2010-10 is not expected to have a material impact onthe Company’s financial statements.

 

InFebruary 2010, the FASB issued ASU No. 2010-11, *Derivativesand Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives*.ASU No. 2010-11 clarifies the type of embedded credit derivative that isexempt from embedded derivative bifurcation requirements. Specifically, onlyone form of embedded credit derivative qualifies for the exemption — one thatis related only to the subordination of one financial instrument to another. Asa result, entities that have contracts containing an embedded credit derivativefeature in a form other than such subordination may need to separately accountfor the embedded credit derivative feature. The amendments in ASU No. 2010-11are effective for each reporting entity at the beginning of its first fiscalquarter beginning after June 15, 2010. The adoption of ASC No. 2010-11is not expected to have a material impact on the Company’s financialstatements.

 

InApril 2010, the FASB issued ASU 2010-13, *Compensation-StockCompensation (Topic 718): Effect of Denominating the Exercise Price of aShare-Based Payment Award in the Currency of the Market in Which the UnderlyingEquity Security Trades - a consensus of the FASB Emerging Issues Task Force*.  The amendments in this Update are effectivefor fiscal years, and interim periods within those fiscal years, beginning onor after December 15, 2010.  Theadoption of ASC No. 2010-13 is not expected to have a material impact onthe Company’s financial statements.

 

**Note 2.****          ****GoingConcern and Liquidity**

 

The accompanying consolidated financial statementshave been prepared assuming that we will continue as a going concern, whichcontemplates the realization of assets and the settlement of liabilities in thenormal course of business.  For several years we have incurredsignificant losses, have not generated sufficient cash to sustain ouroperations, and have relied on financing activities to supplement cash fromoperations.  Based on these factors and the coming expiration of theWachovia loan agreement, the report of our independent registered publicaccounting firm included elsewhere in the Annual Report contains an explanatoryparagraph expressing substantial doubt regarding our ability to continue as agoing concern (or *Going Concern Opinion*).  The accompanying consolidated financialstatements do not include any adjustments that might result from the outcome ofthis uncertainty.

 

During fiscal 2010, we defaulted on our senior convertible note, whichcaused cross-defaults on our revolving line of credit and replication anddistribution agreement with our exclusive disc manufacturer Arvato DigitalServices (or *Arvato*), and we weresignificantly past due in our trade payables, including Arvato.  At the end of fiscal 2010, we retired oursenior secured convertible note, significantly reduced our vendor obligations,and removed defaults under 

 

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ourrevolving credit facility and the replication and distribution agreement.  Wachovia provided us with a waiver that theGoing Concern Opinion for the fiscal year ended March 31, 2010 will not,in and of itself, result in an event of default under the loan agreement.  Although we remained past due in ourobligations to other creditors at March 31, 2010, we were notsignificantly past due.  The substantialdoubt about our ability to continue as a going concern may continue to affectour relationship with our trade and content suppliers.  As a result, our need for cash intensified inthe fourth fiscal quarter, and as of March 31, 2010 we were unable to makeall payments to all of our suppliers as they become due.  The substantial doubt about ourability to continue as a going concern could also affect our relationship withour trade and content suppliers and their willingness to continue to conductbusiness with us on terms consistent with historical practice. These suppliersmight respond to an apparent weakening of our liquidity position and, toaddress their own liquidity needs, may request faster payment of invoices, newor increased deposits or other assurances.  If this were to happen,our need for cash would be intensified and we might be unable to make paymentsto our suppliers as they become due.

 

Akey part of our plan to stabilize and improve our financial condition, amongother things, was to recapitalize the Company. Recapitalization retired the senior convertible note with PortsideGrowth and Opportunity Fund (or *Portside*),cured outstanding defaults under our debt agreements, and improved liquidity.

 

In addition to the 29% decrease in our net revenues for fiscal 2010 to$93 million, from $131 million for fiscal 2009, which is discussed in moredetail below, our liquidity is constrained because of the following:

 

·               costly terminated mergerprocesses

·               our January 30, 2009principal payment to Portside

·               significant advance paymentsmade for high-profile content not yet released on DVD

·               the economic slowdown’snegative impact on our customers’ buying habits

 

*Costly Terminated Merger Processes*

 

Over the last few years, we have operated through a contentious proxycontest and two terminated merger processes, the last of which terminated in April 2009.  Our Board of Directors terminated the twomergers after the prospective buyers failed to secure the ultimate financingnecessary to close the transactions.  Weincurred substantial legal, investment banking and other merger process-relatedfees. Additionally, we believe the processes, both of which were extended andthen terminated, had a negative impact on our perceived financial and operatingstability with our major customers and suppliers.  Merger-related costs, including legal,investment banking and other related costs, for fiscal 2010 and fiscal 2009totaled $805,000 and $1.2 million, respectively.  Settlement and business interruption feesreceived by us for the two terminated mergers totaled $1.5 million in fiscal2010 and $3.0 million in fiscal 2009.

 

*Our January 30, 2009 Principal Payment toPortside*

 

InJanuary 2009, after strong net revenue performance during the first ninemonths of fiscal 2009, we paid the first $4 million bi-annual principal paymentdue under the Portside note.  This $4million payment caused cash constraints throughout fiscal 2010.  If the Company had been able to amend thenote, pushing the due date of this payment further into the future, the Companywould have had the capital resources required to acquire additional content fordistribution, thereby increasing the potential revenues generated.

 

*Significant Advance Payments Made For High-ProfileContent Not Yet Released on DVD/Blu-ray*

 

We have made significant advance payments to secure new cast-driventitles featuring well-known stars such as Sharon Stone that have not yetreleased on DVD/Blu-ray and accordingly not yet generated revenues. We expectto release such content on DVD/Blu-ray beginning in our second quarter ending September 30,2010.

 

*The Economic Slowdown’s Negative Impact on ourCustomers’ Buying Habits*

 

Theglobal economic slowdown has forced retailers to take a hard look at theiroperations.  Since January 1, 2009,we have experienced a significant reduction in purchases by our retailcustomers.  Our customers have conservedcash by all means possible, including reducing their inventories by buyingless, taking all available credits due them and returning stock.

 

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Tofund our operations, we rely on receivable collections and bank borrowingsunder our revolving line of credit. Availability under our revolving line of credit is based entirely oneligible trade accounts receivables.  Asa result, slower sales limit our borrowing availability and therefore ourliquidity.

 

***Plans to Improve Our Liquidity***

 

We seek to overcome this substantial doubtconcerning our ability to continue as going concern by focusing on ourstrategic operating goals of acquiring and distributing high-profile content inmultiple formats while significantly reducing our cost structure.  At the beginning of the 2010 fiscal year, weengaged a nationally recognized investment bank to explore strategicalternatives for us, which resulted in a sale of equity and recapitalizationwith the Investors and the implementation of a strategic realignment and costreduction plan.  Subsequent to March 31,2010, we extended the term of our revolving credit facility.  The term of the revolvingcredit facility currently expires on October 25, 2010.  We are reviewing revolving credit lineoptions, including negotiating a new revolving credit agreement with Wachovia.

 

*Engagement of Investment BankingFirm and Sale of Equity in Company*

 

In May 2009, we retained Houlihan Lokey Howard & ZukinCapital, Inc. as our exclusive financial advisor to assist us in analyzinga wide range of strategic alternatives, including potential financing or saletransactions.

 

On January 8, 2010, we sold newly authorizedshares of preferred stock to the Investors that represented approximately 88.6%of our post-transaction outstanding voting securities for an aggregate purchaseprice of $22.0 million.  Concurrent withthe transaction, we retired our senior secured convertible note with a portionof the net proceeds and shares of our common stock.  This recapitalization provided additionalliquidity for the Company and allowed us to satisfy the senior convertible notewith Portside Growth and Opportunity Fund.

 

Further, on January 9, 2010, our new board ofdirectors appointed in connection with the transaction with JH Partners, LLCappointed a new management team.  The newmanagement team successfully implemented a number of cost savings initiatives,including settlement of past payables at reduced amounts, reducedinfrastructure costs and continued reductions of other expenses.

 

*Strategic Realignment andCost Reduction Plan.*

 

Concurrent with our January 2010 recapitalization, Arvato waived across-default on our manufacturing agreement, Wachovia waived the cross-defaultunder our revolving credit facility and we subsequently repaid the remaining$1.8 million outstanding manufacturing advance to Arvato.  We have negotiated reductions in outstandingobligations with certain creditors and vendors. These negotiated reductions resulted in aggregate debt forgiveness of$5.2 million.  An additional annualreduction of rent expense of approximately $500,000 was recognized as theresult of a negotiated reduction in the monthly cost for our corporateheadquarters.  Management believes thatcontinuing to pursue its strategic operating goals of acquiring anddistributing high-profile content in multiple formats while significantlyreducing Image’s cost structure, along with the recent transaction with JHPartners, the repayment of our outstanding manufacturing advance to Arvato, theretirement of our senior secured convertible note and the reduction of otheroutstanding obligations, will improve Image’s liquidity.

 

We have continued acquisition of cast-driven feature films supported bya core revenue base of branded lines of content, including The CriterionCollection, Ghost Hunters, programs created for IMAX exhibition and other typesof programs with proven historical results. This allows us to reduce the number of programs we release each monthand therefore reduce our costs.  Our goalis to shorten our timeline for return on investment on titles, which needs tobe the most critical element in selecting titles for acquisition.

 

We have also begun executing a cost reduction plan which includesreducing personnel, benefit costs, advertising and other marketingexpenditures, travel and trade show expenditures and third-party commissions.

 

·                  In fiscal 2010,we reduced corporate headcount from 126 employees to 74, saving approximately$5 million in annual personnel costs, including benefits.  In May 2010, an additional reduction inforce represented savings of approximately $616,000 in annual personnel costs,including benefits.

·                  Other costreductions in selling, general and administrative expenses includediscretionary advertising, trade shows, travel, health care costs,discretionary information technology expenditures and sales commissionrestructuring.

 

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NOTESTO CONSOLIDATED FINANCIAL STATEMENTS

 

We can provide no assurancethat the results of our strategic realignment and cost reduction plan or theefforts of our investment banking firm will be successful enough to provide usliquidity relief and accordingly overcome the substantial doubt about ourability to continue as a going concern.

 

**Note 3.           Terminated Merger Agreement with NyxAcquisitions, Inc.**

 

On November 20, 2008,we entered into an Agreement and Plan of Merger (or *Nyx Merger Agreement*) with Nyx Acquisitions, Inc., aDelaware corporation (or *Nyx*),and The Conceived Group, Inc., a Delaware corporation and wholly ownedsubsidiary of Nyx (or *TCG*).  Pursuant to the terms of the Nyx MergerAgreement, TCG was to merge with and into us (or *Nyx Merger*), and we would have continued as the survivingcorporation and as a wholly owned subsidiary of Nyx.  Our stockholders approved the Nyx MergerAgreement at a special meeting of stockholders held on February 24, 2009.

 

On March 24, 2009, pursuant to the second amendment tothe merger agreement and in partial consideration for further extending themerger closing date to April 6, 2009, Nyx agreed to release to us $1.0 millionof $2.5 million then being held in a trust account.  The payment was nonrefundable to Nyx and hadno effect on the purchase price. On March 25, 2009, we received $1.0 millionfrom the trust account.  Accordingly, werecorded the $1 million as other income for fiscal 2009.

 

Pursuant to the Nyx Merger Agreement, Nyx had theoption to extend the scheduled closing date of the Nyx Merger from April 6,2009 to April 20, 2009 if Nyx, among other things, paid us an additional amountof $1.0 million on April 17, 2009.  Nyxfailed to deliver the $1.0 million payment, and therefore was in breach of itsobligation to consummate the Nyx Merger no later than the scheduled closingdate of April 6, 2009.  In accordancewith our rights under the Nyx Merger Agreement, we terminated the Nyx MergerAgreement on April 17, 2009. 

 

Following the termination ofthe Nyx Merger Agreement, the remaining $1.5 million from the businessinterruption account became due to us and was received on April 21, 2009.  We recorded the $1.5 million received fromNyx in April 2009 as other income.

 

Expensesrelated to the terminated Nyx Merger totaled $1.1 million for fiscal 2009 andminimal for fiscal 2010.

 

**Note 4.****                                 ****Film Cost Accelerated Amortization and Fair Value Write-downs.**

 

During calendar 2009, theDVD marketplace experienced the third straight year-over-year decline for thecategory since the format debuted in 1997. Home Media Magazine and Strategic Analytics reported in the fourth quarterof our fiscal 2010 a noticeable decline in DVD units sold globally to consumersin 2009.  Fiscal 2010 continued the trendof consumer spending on DVD declining, even with growth in industry wideBlu-ray sales.

 

With our catalog ofapproximately 3,000 DVD titles and rights to hundreds of high-definitionmasters that will be released in Blu-ray format, we are primarily a non-”hits”exclusive DVD distributor.  Our sales ofpreviously released (or *catalogue*)titles continue to be negatively impacted by not only the maturation of the DVDmarketplace and the declining shelf space dedicated to previously releasedprogramming, but also by the continuing economic slowdown that has sharplycurtailed retailer purchases from us. The continuing economic slowdown leads to our customer’s greater focuson inventory management and related cash flows.

 

With retail shelf spacecontinuing to decline and more space being allocated for major studio releasesand the high-definition format winner, Blu-ray, we are relying on growing salesto our Internet retailers, with virtual shelf space and sophisticated searchengines, to replace declining catalogue sales from our traditional “brick andmortar” retail customers.  We areadditionally relying on growing digital revenues to replace declining cataloguesales.  While our digital revenues aregrowing substantially year over year, they have not grown fast enough in termsof absolute dollar growth to replace declining catalogue sales to our “brickand mortar” retail customers.  Given theimmaturity of the digital industry, we cannot use significantly higherforecasts of our expected digital revenue growth to offset what we now see tobe permanent declines in our packaged goods catalogue revenues.  Shelf space allocated to CD titles continuesto shrink as full album CD sales are negatively impacted by less expensivedirect digital downloading on a song-by-song basis.

 

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IMAGEENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Our further re-evaluation isbased on current historical title revenue performance during the last 12months, including the negative impact of the economic slowdown on our sales.

 

ASC 926, *Entertainment—Films*, requires thatmanagement re-evaluate ultimate revenue projections on a periodic basis, whichwe have done for every past publicly reported period-end.  Such re-evaluation has resulted in fair valuewrite-downs of DVD and CD carrying costs as well as accelerated amortizationand fair value write-downs of other film costs, such as unrecouped advanceroyalties and distribution fees, unrecouped production costs and advance musicpublishing.  These acceleratedamortization and fair value write-downs have significantly contributed to ourlosses over the last several years.  Forfiscal 2010, we recorded $5.5 million in accelerated amortization and fairvalue write-downs of our film costs, representing $3.8 million in acceleratedamortization and fair value write-downs of advance royalty and distributionfees and $1.7 million in fair value write-downs of inventory.  Of those amounts, $1.8 million and $1.0million, respectively, were recorded in the fourth quarter.  For fiscal 2009, we recorded $6.7 million inaccelerated amortization and fair value write-down of our film costs,representing $4.1 million in accelerated amortization and fair valuewrite-downs of advance royalty and distribution fees and $2.6 million in fairvalue write-downs of inventory.  Of thoseamounts, $3.3 million and $1.5 million were recorded in the fourth quarter,respectively.

 

The sales lifecycle of atitle, on average, follows a curve that begins at new release peak levels,followed by phases in which sales diminish, ultimately “tailing” off as thetitle approaches the end of its agreement term. The decreases in sales after the first year are significantly less thanafter initial release, resulting in what is often called the “long tail” of theentertainment lifecycle.  As the majorityof our catalogue of approximately 3,000 DVD titles was released over a yearago, most titles fall into the category of catalogue or “long tail”product.  While we experience continuing “tail”sales, with shelf space becoming continually more constrained, we expect a muchthinner “tail” or, depending on the title’s historical sales, no “tail.”

 

Much of the fiscal 2010 and2009 adjustments were for deeper catalogue titles, which inventory andunrecouped advance royalties and distribution fees were paid for in priorfiscal years.

 

At the end of each reportingperiod, we forecast the remaining future revenues for each title orcross-collateralized group of titles by distributed format, including DVD,Blu-ray, revenue share on rental titles, CD, digital (including download-to-ownand download-to-rent), broadcast (including video-on-demand) and internationalsublicense.  The remaining distributionterm for which revenues are projected is limited to the lesser of (a) theremainder of the title’s or cross-collateralized group of titles’ relateddistribution term or (b) ten years. We determine the present value of the forecasted remaining futurerevenues by using an approximate 8% discount rate.  The discount rate assumption reflectshistorical pre-tax borrowing cost for Image and yields of Baa corporatebonds.  The additional risk factorsrelated to the ultimate revenues are built into the analysis by adjusting therevenue streams before discounting.  Foreach title or cross-collateralized group of titles included in the forecastedrevenues, we determine whether the unamortized related costs on the balancesheet, including royalty and distribution fee advances and inventories arerecoverable.  We believe the amountsrecorded on the balance sheet as of March 31, 2010 for inventories androyalty and distribution fee advances are recoverable based upon our multiplerevenue streams per unrecouped/unreleased title or cross-collateralized groupof titles, the length of applicable distribution rights agreements and the fairvalue analysis as described above.

 

**Note 5.****                                 ****Customer’s Bankruptcy Filings**

 

In April 2009, SourceInterlink Companies Inc. (or *SourceInterlink*), parent of AEC, one of our largest customers, filed forChapter 11 bankruptcy protection.  Netrevenues from AEC for fiscal 2010 and 2009 were $13.4 million and $11.8million, respectively.  Also in April 2009,two days after their filing, Source Interlink obtained Bankruptcy Courtapproval to pay its pre-petition creditors, including us, in the ordinarycourse of business.  In May 2009,the Bankruptcy Court approved Source Interlink’s Disclosure Statement, whichprovided for the payment in full of our claim, along with all of SourceInterlink’s general unsecured creditors. As of June 15, 2009, AEC had paid down the pre-petition balance by$1.1 million leaving an outstanding balance of $2.4 million.  We did not record a reserve for potentialuncollectible receivables from AEC at March 31, 2009.  As of March 31, 2010,  the pre-petition balance was paid in full.

 

On February 2, 2010,Movie Gallery Inc., owner of rental chain Hollywood Video, filed for Chapter 11bankruptcy protection.  Both MovieGallery and Hollywood Video are customers of Image.  Net revenues from Movie Gallery and HollywoodVideo for fiscal 2010 to date were $697,000 and $856,000, respectively.  As of March 31, 2010,

 

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IMAGEENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

we recorded an aggregatereserve of $948,000 for potential uncollectible receivables from Movie Galleryand Hollywood Video, which was the net amount due at March 31, 2010 lesspayments received prior to their bankruptcy filing.  It is unclear as to whether we will recoverany of the monies owed to us by Movie Gallery or Hollywood Video.  As of March 31, 2010, receivables duefrom Movie Gallery were $948,000, of which $706,000 was less than 30 days pastdue.

 

**Note 6.****                                 ****Fiscal 2010 and 2009 Charges Relating to Executive Officer Departures.**

 

*Fiscal2010.*

 

On March 26, 2010, weannounced that effective March 23, 2010, Jeff Framer had resigned as ourPresident and Chief Financial Officer. We accrued for Mr. Framer’s severance package payment of twelvemonths of base salary equivalent to $400,000, paid bi-weekly in accordance withour normal payroll practices and continued perquisites for six months. Theoverall value of the package of approximately $673,000, including relatedemployer taxes, was accrued as a liability at March 31, 2010.

 

In June 2009, as partof a cost reduction plan, we laid off 18 employees.  In February 2010, we laid off 35employees.  Accrued severance-relatedcharges totaled $1,232,000 and are included in general and administrativeexpenses for fiscal 2010.

 

Of the total $1,905,000 inseverance above, $544,000 had been paid through March 31, 2010 and$1,361,000 had been accrued at March 31, 2010.

 

*Fiscal2009.*

 

On March 16, 2009, weannounced the departure of former President David Borshell.  Mr. Borshell’s severance package,totaling $499,000, including related employer taxes, was accrued as a liabilityat March 31, 2009 and recorded as a charge to general and administrativeexpenses for the fiscal year ended March 31, 2009.

 

In February 2009, aspart of a cost reduction plan, we laid off 14 employees.  Accrued severance-related charges totaled$439,000 and are included in general and administrative expenses for fiscal2009.

 

As of March 31, 2010,$53,000 of the fiscal 2009 severance remains accrued.

 

**Note 7.           Inventories.**

 

Inventories at March 31,2010 and 2009 are summarized as follows:

 
| **(In  thousands)**                                                  | ** ** | **2010** | ** ** | **2009** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|
| DVD                                                                  |       | $        | 8,208      |     | $          | 9,458 |   |
| Other                                                                |       | 2,095    |       | 2,558    |       |
|                                                                 |       | 10,303   |       | 12,016   |       |
| Production  costs, net                                               |       | 4,557    |       | 5,119    |       |
|                                                                 |       | 14,860   |       | 17,135   |       |
| Less  current portion of inventories                                 |       | 12,659   |       | 14,629   |       |
| Noncurrent  inventories, principally non-recoupable production costs |       | $        | 2,201      |     | $          | 2,506 |   |

 

Non-recoupable productioncosts are net of accumulated amortization of $12,003,000 and $11,356,000 at March 31,2010 and 2009, respectively.  We expectto amortize approximately 80% of the March 31, 2010 unamortized productioncosts by March 31, 2012.

 

**Note 8.           Investment in Film Production.**

 

Investment in filmproduction for released productions, net of accumulated amortization, at March 31,2010 and 2009 was $829,000 and $2,148,000, respectively.  Investment in film production costs areincluded as a component of royalty and distribution fee advances in theconsolidated balance sheets.  Remaininginvestment in film production to be amortized over the next 12 months is$278,000.  We are not currently investingin feature film production.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

**Note 9.           Property, Equipment and Improvements.**

 

Property, equipment andimprovements at March 31, 2010 and 2009, are summarized as follows:

 
| **(In  thousands)**                             | ** ** | **2010** | ** ** | **2009** | ** ** |
|-------------------------------------------------|------------|----------|------------|----------|------------|
| Machinery,  equipment and software              |       | $        | 6,791      |     | $          | 8,195 |   |
| Leasehold  improvements                         |       | 934      |       | 927      |       |
| Other                                           |       | 30       |       | 60       |       |
|                                            |       | 7,755    |       | 9,182    |       |
| Less  accumulated depreciation and amortization |       | 6,650    |       | 7,021    |       |
|                                            |       | $        | 1,105      |     | $          | 2,161 |   |

 

Depreciation andamortization expense for the years ended March 31, 2010 and 2009 was$1,088,000 and $1,296,000, respectively.

 

**Note 10.         Revolving Credit Facility.**

 

Our Loan and SecurityAgreement, as amended (or *Loan Agreement*),with Wachovia Capital Finance Corporation (Western), a Wells Fargo Company (or *Wachovia*), provides us with a revolvingline of credit of up to $20 million. Actual borrowing availability under theline is based upon our level of eligible accounts receivable.  Eligible accounts receivable primarilyincludes receivables generated by domestic sales of DVD and excludesreceivables generated from broadcast, digital and other revenue streams. TheLoan Agreement expires on October 25, 2010.

 

Borrowings bear interest ateither the Prime Rate plus up to 1.5% (4.75% at March 31, 2010) or, at ouroption, LIBOR plus up to 4.0% (three month LIBOR — 4.3% at March 31,2010), subject to minimum borrowing levels. The level of interest rate marginto Prime Rate or LIBOR is dependent upon our future financial performance asmeasured by EBITDA, earnings before interest, taxes, depreciation andamortization, as defined in the Loan Agreement.

 

We are required to maintaina minimum fixed charge coverage ratio of 1.1 to 1.0 commencing June 30,2010, measured at the end of each month on a fiscal year-to-date basis.

 

If we maintain minimumborrowing availability equal to, or greater than, $2.5 million, our fixedcharge coverage ratio is not tested.  At March 312010, we were not tested for such covenant compliance because we hadavailability in excess of the required $2.5 million minimum.  Had we been tested, our negative EBITDA wouldhave resulted in a fixed charge coverage ratio less than the required 1.0 to1.0. At March 31, 2010, our borrowing availability was $3.8 million ($6.3million based upon eligible accounts receivable less the $2.5 million minimumrequirement).

 

Additionally, our creditfacility states that a material adverse change in our business, assets orprospects would be considered an “event of default.”  If we are unable to comply with thecovenants, or satisfy the financial ratio and other tests, or should an eventof default occur, as determined and invoked by Wachovia, a default may occurunder our credit facility.  Unless we areable to negotiate an amendment, forbearance or waiver with Wachovia, we couldbe required to repay all amounts then outstanding, which could have a materialadverse effect on our liquidity, business, results of operations and financialcondition.

 

AtMarch 31, 2010 we had $6.4 million outstanding under the revolving line ofcredit.

 

The Loan Agreement containsearly termination fees, based upon the maximum facility amount of $20 million,of 0.75% if terminated within the three-year term.  The agreement also imposes restrictions on suchitems as encumbrances and liens, payment of dividends, incurrence of otherindebtedness, stock repurchases and capital expenditures and requires us tocomply with minimum financial and operating covenants.  Under the terms of our Series BPreferred Stock, we are required to pay dividends at a rate of 12% peryear.  These dividends are accrued, butmay not be issued without Wachovia’s approval. Any outstanding borrowings are secured by our assets.

 

We were in compliance withall financial and operating covenants under the Loan Agreement, as amended, at March 31,2010.  The subsequent receipt of a GoingConcern Opinion from our independent registered public accounting firm wouldresult in a default under our Loan Agreement, as amended, upon delivery of theopinion to Wachovia, however, Wachovia provided us with a waiver that the GoingConcern Opinion for fiscal year ended March 31, 2010 will not, in and ofitself, result in an event of default under the Loan Agreement.  However, any future defaults under our LoanAgreement, if not waived or cured, would automatically trigger a cross-defaultunder our other debt agreements thereby adversely impacting our ability tocontinue as a going concern.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Subsequent to March 31,2010, the Loan Agreement was amended on April 15, 2010 and May 3,2010.  For a description of theseamendments, see “Note 20. Subsequent Events — Amendments to Loan Agreement”below.

 

**Note 11.         Long-Term Debt.**

 

Disc Replication Agreementand Related Advance.  Arvatoexclusively manufactures our DVDs and manufactures the majority of ourCDs.  On June 30, 2006, we receivedan interest-free $10.0 million advance against future DVD manufacturing fromArvato, to be repaid at $0.20 per DVD manufactured, plus payment of a $0.04administrative fee per DVD manufactured until the advance is repaid.  Arvato has a security interest in all of ourassets in second position behind Wachovia. As the obligation is non-interest bearing, we initially imputed andrecorded a debt discount of $1,945,000 to the $10.0 million face amount of theadvance based upon our then-borrowing rate with our bank and recorded adeferred manufacturing credit, classified in other long-term liabilities.  We were amortizing the debt discount, usingthe effective interest method, to interest expense.  We were amortizing the deferred manufacturingcredit as a reduction to the DVD disc purchase cost based upon actual discsmanufactured by Arvato.  The $0.04administrative fee per disc manufactured was being recorded as an additionalinventory manufacturing cost.  On December 14,2009, a cross-default occurred under our replication agreement with Arvato as aresult of our default under our senior secured convertible note.  On January 8, 2010, Arvato waived thedefault subject to certain conditions, including repayment of the remainingmanufacturing advance.  On January 25,2010, we repaid the remaining $1.8 million manufacturing advance pursuant tothis waiver agreement.

 

At March 31, 2010,there was no amount outstanding under the advance from Arvato, exclusive of thedebt discount.  Amortization of therelated debt discount is a noncash interest expense and totaled $180,000 and$525,000 for fiscal 2010 and 2009, respectively.  Amortization of the related deferredmanufacturing credit totaled $503,000 and $579,000 for fiscal 2010 and 2009,respectively.

 

Senior Convertible Note andWarrant.  On August 30,2006, we issued to Portside a senior convertible note in the principal amountof $17,000,000 and a related warrant to purchase 1,000,000 shares of our commonstock.  On November 10, 2006, weentered into an Amendment and Exchange Agreement with Portside, which agreementmodified the transaction documents and provided for a replacement warrant to beissued in exchange for the warrant previously issued to Portside.  The note accrued interest at a rate of 7.875%per annum with accrued interest payable quarterly in arrears in either cash orstock.  The note had a term of five yearsand was initially convertible into 4,000,000 shares of our common stock at aconversion price of $4.25 per share, subject to antidilution adjustments.  Portside had a security interest in all ofour assets in third position behind Wachovia and Arvato.  The related warrant has been recorded as a componentof long-term liabilities.  The warranthas a term of five years from the issuance date and was exercisable for anaggregate of 1,000,000 shares of our common stock at an exercise price of $4.25per share, subject to antidilution adjustments, which were triggered as aresult of the transaction with JH Partners. As a result of the antidilution adjustment, the warrant is nowexercisable for 8,018,868 shares of our common stock at an exercise price of$0.53 per share.  See “DerivativeLiabilities – Stock Warrant, Purchase Rights and Embedded Derivatives” belowfor a description of the valuation method. 

 

Direct costs of $1,187,000incurred in August 2006 relating to this senior convertible note were recordedas asset-deferred financing costs and are amortized as additional noncashinterest expenses using the effective interest rate method over the life of therelated private placement debt. Amortization of the debt discount and the deferred financing costs usingthe effective interest rate method is a noncash charge to interest expense andtotaled $343,000 and $903,000 for fiscal 2010 and 2009, respectively.  As of March 31, 2010, there was no remainingunamortized balance.

 

In January 2009, wepaid the first $4 million bi-annual principal payment due under the note.  Portside had the ability to request bi-annualprincipal payments for fiscal 2010 each in the amount of $4 million ofprincipal plus interest, subject to meeting certain financial covenants underour Loan Agreement, which would have been due on July 30, 2009 and January 30,2010.

 

*Amendmentsof the Original Note*

 

On July 30, 2009, thepotential due date for a bi-annual $4 million principal payment under theOriginal Note, we entered into a Second Amendment and Exchange Agreement (or *Second Exchange Agreement*) with Portside,pursuant to which we exchanged the Original Note solely for an 8.875% amendedrestated senior convertible note in the principal amount of $15,701,000 (or *Amended Note*).  At the time we entered into the SecondExchange Agreement, the outstanding principal amount of the Original Note was$13 million. The $2,701,000 principal increase represented 20% of theprincipal and accrued interest under the Original Note as of and through July 30,2009.

 

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The Amended Note wasconvertible into up to 3,694,346 shares of our common stock at a conversionprice of $4.25 per share, subject to antidilution and other adjustments.  We were permitted to force conversion if theclosing sales price of our common stock was at least 180% of the then-effectiveconversion price for 20 consecutive trading days.

 

OnOctober 28, 2009, we entered into an Amendment Agreement with Portside tofurther amend the Amended Note to change the dates on which Portside mayrequest the next $4 million principal payment under the Amended Note from October 30,2009 to November 15, 2009 or, under certain circumstances, November 30,2009.

 

OnNovember 12, 2009, Portside provided notice of its election to require usto make a $4 million principal payment (plus accrued interest) on November 15,2009.  On November 15, 2009, weentered into a Second Amendment Agreement with Portside to further amend theAmended Note to further change the dates on which Portside may request the next$4 million principal payment under the Amended Note from November 15, 2009to December 11, 2009 or, under certain circumstances, January 30,2010 and to rescind the November 12, 2009 notice.  Pursuant to the Second Amendment Agreement,we agreed to reimburse Portside for the actual and anticipated legal fees andexpenses of its counsel and any third party advisors incurred through December 11,2009, such fees not to exceed an aggregate of $150,000.  We paid the first $100,000 installment on November 16,2009.  The remaining $50,000 was paid on December 21,2009.

 

OnDecember 9, 2009, Portside provided notice of its election to require usto make a $4 million principal payment (plus accrued interest) on December 11,2009.  On December 11, 2009, weentered into a Third Amendment Agreement with Portside to further amend theAmended Note to change the date on which we must pay the $4 million installmentpayment from December 11, 2009 to December 14, 2009 and to eliminateour ability to further defer payment of the installment payment under certaincircumstances.

 

OnDecember 14, 2009, we were unable to make the $4 million principalpayment (plus accrued interest), which resulted in an event of default underthe Amended Note.  The event of defaultunder the Amended Note caused cross-defaults under the Loan Agreement and underour Replication Agreement with Arvato. The event of default caused (i) the interest rate to increase from8.875% to 12% per annum from December 14, 2009 until the default was curedand (ii) pay a late charge at the rate of 15% per annum on the $4 millionprincipal (plus interest accrued on the installment) from December 14,2009 until the installment amount was paid in full.

 

Upondelivery of appropriate notice, Portside could have required additional $4million principal payments (plus accrued interest) on January 30, 2010, January 30,2011 and July 30, 2011.

 

*Payoff of the Amended Note*

 

On January 7, 2010, weentered into a Payoff Letter with Portside.  The Payoff Letter confirmedPortside’s agreement that upon receipt of $15.0 million in cash (or *Cash Payment*) and 3.5 million shares ofCommon Stock (or *Payoff Shares*and together with the Cash Payment, the *PayoffAmount*) and execution of an exchange agreement between us andPortside at the closing of the sale of preferred stock to JH Partners (furtherinformation disclosed in Note 18 below), all of our obligations under theAmended Note would be terminated and all security interests and other liensgranted to or held by Portside under the security documents securing theAmended Note would be forever satisfied, released and discharged withoutfurther action.  The Payoff Shares were to be issued to Portside inexchange for $10,000 in principal amount of the Amended Note pursuant to anexchange agreement to be reasonably agreed between us and Portside.

 

On January 8, 2010, weentered into an Exchange Agreement with Portside (or *Exchange Agreement*).  Pursuant to the ExchangeAgreement, we agreed to issue the Payoff Shares to Portside at the closing ofthe sale of the Preferred Shares in exchange for $10,000 in principal amount ofthe Amended Note.  On January 8, 2010, immediately after the closingof the sale of the Preferred Shares, we paid to Portside the Cash Payment andissued to Portside the Payoff Shares in accordance with the Payoff Letter andthe Exchange Agreement thereby retiring the Amended Note.

 

*Net Losson Extinguishments of Debt*

 

During the fiscal year, theCompany had two extinguishments of debt, one in July 2009 and one in January 2010,which resulted in a net loss on extinguishments of debt.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

*July 30, 2009 Extinguishment of Debt*

 

Asa result of the July 30, 2009 Second Exchange Agreement the issuance ofthe Amended Note is accounted for as an extinguishment of debt, as the terms ofthe Amended Note were deemed to be substantially different, as defined in ASC470-50 *Debt — Modifications andExtinguishments*,****fromthe terms of the Original Note. Accordingly, the Amended Note was recorded at fair value and wascompared to the carrying value of the Original Note including any bifurcatedderivative to determine the debt extinguishment gain or loss to be recognized.

 

The difference in fair valueof the Amended Note and the Original Note was recorded as an extinguishment ofdebt with a loss on extinguishment.  The Amended Note value was recordedat $15,701,000 (fair value) and was used to determine the debt extinguishmentloss to be recognized at the effective rate of the new instrument.  Thebook value (including the remaining unamortized debt discount associated withthe issuance of the warrant of approximately $306,000) of $12,694,000, whencompared to the Amended Note value of $15,701,000 yielded a loss onextinguishment of debt of approximately $3,007,000.

 

Thedifference in fair value of the derivatives, impacted by the amendment, at July 30,2009 (immediately prior to the amendment) and the fair value at July 30,2009 (immediately after the amendment) resulted in a gain on extinguishment of$1,018,000.

 

AtJuly 30, 2009, unamortized deferred financing costs related to theOriginal Note were $192,000.  Theseamounts were written off during the fiscal year ended March 31, 2010 as aloss on extinguishment of debt.  Costsincurred with third parties (i.e., other than the lender) associated with theAmended Note of $114,000 were capitalized and amortized over the term of theAmended Note using the effective interest method.

 

Thenet loss on extinguishment of debt at July 30, 2009 was $2,181,000.

 

*January 8, 2010 Extinguishment of Debt*

 

OnJanuary 8, 2010, as a result of both the $15.0 million Cash Payment and theissuance of 3.5 million shares of Common Stock with a fair value of $215,000 toPortside to retire the Amended Note, the book value of the Amended Note of$15,701,000 and related accrued interest of $427,000 were extinguished.  We recognized gain on the extinguishment ofdebt $888,000.  The valuation of the 3.5million shares of Common Stock was included in methodology used in the valuationof the January 2010 Series B preferred stock, Series C preferred stock andpurchase rights as described below under “Purchase Rights” and “Note 19.Preferred Stock.” 

 

Thedifference in fair value of the derivatives, impacted by the payoff, at January 7,2009 (immediately prior to the payoff) and the fair value at January 8,2009 (immediately after the payoff) resulted in a gain on extinguishment of$1,016,000.

 

Thenet gain on extinguishment of debt at January 8, 2010 was $1,904,000.

 

Thenet loss on both extinguishments of debt for the fiscal year ended March 31,2010 was $277,000 and reflects the $2,119,000 loss from the change in fairvalue of the notes, $192,000 in previously unamortized deferred financing costsand the $2,034,000 gain from the change in fair value of the embeddedderivatives.

 

Derivative Liabilities —Stock Warrant, Purchase Rights and Embedded Derivatives

 

We currently do not usehedging contracts to manage the risk of our overall exposure to interest rateand foreign currency changes. The derivative liabilities described below arenot hedging instruments.

 

*Stock Warrant*

 

In connection with theissuance of the Original Note on August 30, 2006, Portside was issued awarrant to purchase 1,000,000 shares of our common stock.  The warrant had a term of five years and anexercise price of $4.25 per share.  Inthe event of a change of control, the warrant must be settled in cash using theBlack-Scholes model in accordance with the underlying terms contained in thewarrant agreement.  The transaction withJH Partners triggered the antidilution provisions contained in thewarrant.  As a result, the warrant is nowexercisable for 8,018,868 shares of our common stock at an exercise price of$0.53 per share.  Other instrumentsissued in connection with the Original

 

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Note, as amended, containseveral embedded derivatives, including redemption rights associated with achange of control transaction, principal prepayment provisions linked to ourshare price and forced conversion provisions linked to our share price.  The initial fair value of the warrantliability was determined by using the Black-Scholes valuation method as of August 30,2006.  For each subsequent reportingperiod, the fair value of the warrant was determined by using the Black-Scholesvaluation method as of the end of such reporting period.  The assumptions used included the closingprice of our common stock on the valuation date, the strike price of thewarrant, the risk-free rate equivalent to the U.S. Treasury maturities, thehistorical volatility of our common stock and the remaining term of thewarrant.  The assumptions used as of March 31,2010 and 2009 are as follows:

 
| ** **                | ** ** | **Fiscal  Year Ended March 31, 2010** | ** ** | **Fiscal  Year Ended March 31, 2009** | ** ** |
|---------------------------|------------|--------------------------------------------|------------|--------------------------------------------|------------|
|                      |       |                                       |       |                                       |       |
| Risk-free  interest rate  |       | 0.66%                                      |       | 0.97%                                      |       |
| Expected  term (in years) |       | 1.42 years                                 |       | 2.42 years                                 |       |
| Expected  volatility      |       | 162.37%                                    |       | 119.00%                                    |       |

 

*Purchase Rights*

 

In connection with January2010 sale of preferred stock to JH Partners, Purchase Rights were granted topurchase additional 7,400 shares of Series B Preferred and 66,163.4 shares ofSeries C Preferred for an aggregate purchase price of $7.4 million divided intwo equal tranches. These Purchase Rights were classified as liabilities due tothe existence of events outside of the Company’s control that give rise to thepossibility for ultimate settlement by a transfer of assets or cash and havebeen recorded as a component of long-term liabilities.  The tranches may be exercised in whole or inpart and in one or more instances.  Thefirst tranche was exercisable by 120 days after the January 8, 2010 transactiondate and the second tranche may be exercised 360 days after the January 8, 2010transaction date.  We hired a third partyvaluation service provider to determine the fair value of the Series BPreferred and Series C Preferred price per share and exercise price at January8, 2010 and at March 31, 2010 using an option pricing model.  The initial fair value and subsequent changein fair value of the Purchase Rights liability was determined by using theBlack-Scholes option pricing model based on the following inputs:

 
| ** **                                   | ** ** | **March 31, 2010** | ** ** | **January 8, 2010** | ** ** |
|----------------------------------------------|------------|--------------------|------------|---------------------|------------|
|                                         |       |               |       |                |       |
| Series B Preferred price per share           |       | $313.89            |       | $ 315.98       |       |
| Series C Preferred price per share           |       | $59.15             |       | $61.55              |       |
| Series B Preferred exercise price per  share |       | $372.47            |       | $364.76             |       |
| Series C Preferred exercise price per  share |       | $70.19             |       | $71.05              |       |
| Risk-free interest rate                      |       | 0.2%-0.4%          |       | 0.1%-0.4%           |       |
| Expected term (in years)                     |       | 0.75-0.80 years    |       | 0.33-1.0 years      |       |
| Expected volatility for purchase rights      |       | 120%-150%          |       | 165%-200%           |       |
| Expected dividend yield                      |       | 0%-12%             |       | 0%-12%              |       |

 

The combined fair value ofboth tranches of Purchase Rights was $2,942,000 at January 8, 2010 and$1,538,000 at March 31, 2010.  Thechange in fair value of $1,404,000 was recorded as a component of other incomeduring the fiscal year ended March 31, 2010.  We include these Purchase Rights in thetables below within Stock Warrant Liabilities.

 

Subsequent to March 31,2010, the Purchase Right expired with respect to an initial tranche of 3,700shares of Series B Preferred and 33,081.7 shares of Series CPreferred.

 

In accordance with ASC 820, “*Fair Value Measurements and Disclosures,*”the fair value of the stock warrant, purchase rights and embedded derivativesare adjusted to their fair value at the end of each reporting period, withliability increases and decreases recorded as other income or expense duringthe reporting period.  The fair value ofthe stock warrant is estimated by using the Black-Scholes pricing model wherethe inputs are consistently applied and reflect the contractual terms of thewarrant, including the period to maturity, and market-based parameters such asinterest rates, and volatility.  This model does not contain a high levelof subjectivity as the valuation techniques used do not require significantjudgment, and inputs thereto are readily observable from actively quotedmarkets.  The fair value of the embeddedderivatives are estimated by using pricing models, where some of the inputs tothose models are based on readily observable market parameters and some inputsrequire valuation techniques using subjectivity and judgment.

 

Long-term liabilities on thebalance sheet at March 31, 2009 represented the fair value of the stockwarrant and the embedded derivatives.  AtMarch 31, 2010, other current liabilities on the balance sheet representedthe stock warrant, purchase rights and embedded derivatives.  For this presentation, the stock warrantliability and purchase rights liabilities are included together in stockwarrant liabilities.  Included in thetable below is the change in fair value recorded as a component of other incomeduring the fiscal year ended March 31, 2010 and 2009.

 

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| **(In  thousands)**             | ** ** | **Stock  Warrant Liabilities** | ** ** | **Embedded  Derivatives  Liability** | ** ** |
|---------------------------------|------------|--------------------------------|------------|--------------------------------------|------------|
| Balance,  March 31, 2008   |       | $                              | 490        |                                 | $          | 1,406 |   |
| Change  in fair value           |       | 60                             |       | 149                                  |       |
| Balance,  March 31, 2009   |       | $                              | 550        |                                 | $          | 1,555 |   |
|                            |       |                           |       |                                 |       |
| Balance,  March 31, 2009   |       | $                              | 550        |                                 | $          | 1,555 |   |
| Issuance  of purchase rights    |       | 2,942                          |       | —                               |       |
| Gain  on extinguishment of debt |       | —                         |       | (2,034                               | )          |
| Change  in fair value           |       | (1,050                         | )          | 479                                  |       |
| Balance,  March 31, 2010   |       | $                              | 2,442      |                                 | $          | — |   |

 

In accordance with ASC 820,the following table represents our fair value hierarchy for our financialliabilities measured at fair value on a recurring basis as of March 31,2010 and 2009. There were no financial assets subject to the provisions of ASC820 as of March 31, 2010 and 2009.

 
| **(In  thousands)**                             | ** ** | **Level  1** | ** ** | **Level  2** | ** ** | **Level  3** | ** ** | **Total** | ** ** |
|-------------------------------------------------|------------|--------------|------------|--------------|------------|--------------|------------|-----------|------------|
| Derivative  liabilities:                        |       |         |       |         |       |         |       |      |       |
| Stock  warrant as of March 31, 2010        |       | $            | —     |         | $          | 904          |       | $         | 1,538      |   | $ | 2,442 |   |
| Stock  warrant as of March 31, 2009        |       | $            | —     |         | $          | 550          |       | $         | —     |   | $ | 550 |   |
|                                            |       |         |       |         |       |         |       |      |       |
| Embedded  derivatives as of March 31, 2010 |       | $            | —     |         | $          | —       |       | $         | —     |   | $ | — |   |
| Embedded  derivatives as of March 31, 2009 |       | $            | —     |         | $          | —       |       | $         | 1,555      |   | $ | 1,555 |   |

 

During fiscal 2010 and 2009,other expense related to the fluctuation in the fair value of the warrant,purchase rights and the convertible note’s embedded derivatives was recorded asnon-operating expense included as a component of other expense in theaccompanying consolidated statements of operations.  For fiscal 2010 and 2009, the related amountsincluded in other income and expense was $570,000 and $209,000,respectively.  The related accruedwarrant, purchase rights and embedded derivatives liability together totaled$2,442,000 and $2,105,000 at March 31, 2010 and 2009, respectively, and isincluded as a component of other long-term liabilities in the consolidatedbalance sheets.

 

Long-term debt at March 31,2010 and March 31, 2009 consisted of the following:

 
| **(In  thousands)**                                                                                                       | ** ** | **March 31,  2010** | ** ** | **March 31,  2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|--------------------------|------------|
| Subordinated  senior convertible note, less debt discount of none-March 31, 2010;  $447-March 31, 2009          |       | $                        | —     |                     | $          | 12,553 |   |
| Subordinated  manufacturing advance obligation, less debt discount of none-March 31,  2010; $180-March 31, 2009 |       | —                   |       | 3,204                    |       |
|                                                                                                                      |       | —                   |       | 15,757                   |       |
| Current  portion of long-term debt, less debt discount of none-March 31, 2010;  $514-March 31, 2009             |       | —                   |       | 10,094                   |       |
| Long-term  debt less current portion and debt discount                                                                    |       | $                        | —     |                     | $          | 5,663 |   |

 

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**Note 12.         Commitments and Contingencies.**

 

*OperatingLeases*

 

Our headquarters are locatedin Chatsworth, California, and consist of approximately 30,000 square feet onone floor of a multi-tenant building.  Inconjunction with the transaction with JH Partners, we negotiated a reduction inthe monthly cost for our headquarters from approximately $87,000 to $46,000 forapproximately half of the leased space beginning in January 2010.  After amendments effective January and May 2010,the monthly rent is $46,000 per month, on a gross basis.  The office lease, as amended, has an initial10-year term expiring June 30, 2014 with two five-year options.  Although a base level of operating expensesis included in the rent payment, we are responsible for a percentage of actualannual operating expense increases capped at 5% annually, excluding utilities,insurance and real estate taxes.

 

Future minimum annual rentalpayments by year under operating leases at March 31, 2010, areapproximately as follows:

 
| **Fiscal** | ** ** | **Amount**              | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **(In thousands)** | ** ** |
| 2011       |       | $                       | 552        |   |
| 2012       |       | 552                     |       |
| 2013       |       | 552                     |       |
| 2014       |       | 552                     |       |
| Thereafter |       | 138                     |       |
|       |       | $                       | 2,346      |   |

 

Rent expense was $961,000and $1,090,000 for fiscal 2010 and 2009, respectively.

 

*EmploymentAgreements.*  At March 31,2010, our future contractual obligations under six employment (including oneconsulting) agreements are $1,458,000, $887,000, $836,000 and $21,000 for thefiscal years ending March 31, 2011, 2012, 2013 and 2014, respectively.

 

*Other*.  At March 31, 2010, our futureobligations by year for royalty advances, minimum royalty guarantees andexclusive distribution fee guarantees under the terms of our existing licensesand exclusive distribution agreements were as follows:

 
| **Fiscal** | ** ** | **Amount**              | ** ** |
|------------|------------|-------------------------|------------|
| ** ** | ** ** | **(in thousands)** | ** ** |
| 2011       |       | $                       | 19,994     |   |
| 2012       |       | 16,848                  |       |
| 2013       |       | 16,348                  |       |
| 2014       |       | 5,248                   |       |
| 2015       |       | —                  |       |
|       |       | $                       | 53,438     |   |

 

At March 31, 2010, wehad accrued $1.1 million of the fiscal 2011 obligation above as the contentsuppliers have met their related contractual requirements.

 

**Note 13.         Stockholders’ Equity.**

 

*StockAwards, Options and Warrants**. *As of March 31, 2010,we had two equity compensation plans: the Image Entertainment, Inc. 2008Stock Awards and Incentive Plan (or *2008Plan*) and the Image Entertainment, Inc. 2004 Incentive CompensationPlan (or *2004 Plan*, and togetherwith the 2008 Plan, the *Plans*).  The 2008 Plan provides for equity awards,including stock options, stock appreciation rights, restricted stock awards,performance awards, phantom stock awards, or stock units.  The 2004 Plan provides for equity awards,including stock options and restricted stock units.  At March 31, 2010, there wereapproximately 575,000 shares available for future grants under the 2008 Planand 342,430 shares available for future grants under the 2004 Plan.

 

The sale of the preferredstock to JH Partners constituted a change in control transaction under ourequity compensation plans as the investors acquired more than 50% of our votingsecurities.  As a result, on January 8,2010, the vesting was accelerated for 107,776 unvested options under the 1998Incentive Plan (or *1998 Plan*).  Thereafter, all 1,187,996 outstanding optionsunder the 1998 Plan were terminated and therefore the options are no longerexercisable.  On January 8, 2010,the vesting was accelerated for 362,532 unvested options outstanding under the2008 Plan and the options became immediately exercisable.  There were no unvested awards outstandingunder the 2004 Plan.  The awards underthe 2004 Plan and 2008 Plan were not terminated.

 

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Themaximum term allowed for an option is 10 years and a stock unit shall eithervest or be forfeited not more than 10 years from the date of grant.

 

During fiscal 2010, wegranted 445,000 options on April 29, 2009 at an exercise price of $0.86per share, which was the closing stock price on the date of grant.  During fiscal 2009, we granted 343,000options on June 12, 2008 at an exercise price of $1.14 per share, whichwas the closing stock price on the date of grant.  At March 31, 2009, options grantedtotaling 68,859 shares had vested. Options are valued using the Black Scholes method as described in “Note1. Basis of Presentation.”  Theweighted-average grant-date fair value of the options granted was $0.62 pershare.  There were no options grantedsubsequent to the April 29, 2009 grant, through March 31, 2010.

 

Stock option activityunder the Plans and 1998 Plan for the fiscal year ended March 31, 2010,and changes during the year then ended are presented below:

 
| **Options**                         | ** ** | **Shares  (000)** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining  Contractual Term** | ** ** | **Aggregate  Intrinsic Value  ($000)** | ** ** |
|-------------------------------------|------------|-------------------|------------|--------------------------------------|------------|---------------------------------------------------|------------|----------------------------------------|------------|
|                                |       |              |       |                                 |       |                                              |       |                                   |       |
| Outstanding  at March 31, 2009 |       | 2,327             |       | $                                    | 3.062      |                                              |       |                                   |       |   |
| Granted                             |       | 445               |       | 0.860                                |       |                                              |       |                                   |       |
| Exercised                           |       | —            |       | —                               |       |                                              |       |                                   |       |
| Forfeited  or Expired               |       | 1,742             |       | 2.714                                |       |                                              |       |                                   |       |
| Outstanding  at March 31, 2010 |       | 1,030             |       | $                                    | 2.699      |                                              | 3.462      |                                   | $          | — |   |
|                                |       |              |       |                                 |       |                                              |       |                                   |       |
| Exercisable  at March 31, 2010 |       | 1,030             |       | $                                    | 2.699      |                                              | 3.462      |                                   | $          | — |   |

 

The aggregate intrinsicvalue of our outstanding options represents the total pre-tax intrinsic value,based on our options with an exercise price less than Image’s closing stockprice of $0.22 as of March 31, 2010, which theoretically could have beenreceived by the option holders had all option holders exercised their optionsas of that date.  At March 31, 2010,there was no aggregate intrinsic value of options outstanding or exercisable asthere were no in-the-money options exercisable as of March 31, 2010 and2009.  There were no options exercised,and thus no aggregate intrinsic value of options exercised, during the fiscalyear ended March 31, 2010 and 2009.

 

The weighted-averagegrant-date fair value of options granted during the fiscal years 2010 and 2009was $0.600 and $0.617, respectively.  Ofthe options reflected as outstanding on March 31, 2010, options topurchase approximately 1,029,500 shares of common stock were exercisable.  At March 31, 2010, there were approximately917,430 shares of common stock available for new awards, including stockoptions, to our directors and employees.

 

A summary of the statusof nonvested shares at March 31, 2010, and changes during the year thenended, are presented below:

 
| **Nonvested  Shares**             | ** ** | **Shares  (000)** | ** ** | **Weighted-Average Grant-Date  Fair Value** | ** ** |
|-----------------------------------|------------|-------------------|------------|---------------------------------------------|------------|
|                              |       |              |       |                                        |       |
| Nonvested  at March 31, 2009 |       | 267               |       | $                                           | 0.617      |   |
| Granted                           |       | 445               |       | 0.602                                       |       |
| Vested                            |       | 651               |       | 0.607                                       |       |
| Forfeited                         |       | 61                |       | 0.611                                       |       |
| Nonvested  at March 31, 2010 |       | —            |       | $                                           | —     |   |

 

As of March 31, 2010,there were no unvested stock options remaining therefore there was no remainingunamortized stock based compensation expense.

 

During fiscal 2010 andfiscal 2009 there were no exercises of stock options.  There was no excess tax benefit recorded forthe tax deductions related to stock options during fiscal 2010 and 2009.

 

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The following tablesummarized significant ranges of outstanding and exercisable options at March 31,2010:

 
| ** **                    | ** ** | **Options Outstanding**                                       | ** ** | **Options Exercisable**                                    | ** ** |
|-------------------------------|------------|---------------------------------------------------------------|------------|------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number  of Shares at  March 31, 2010  (In thousands)** | ** ** | **Weighted-Average  Remaining  Contractual Life  (Years)** | ** ** | **Weighted-  Average  Exercise Price** | ** ** | **Number  of Shares at  March 31, 2010  (In thousands)** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| Under  $2.00                  |       | 425                                                           |       | 1.8                                                        |       | $ | 0.860 |   | 425 |   | $ | 0.860 |   |
| $2.01  to $4.00               |       | 475                                                           |       | 4.6                                                        |       | 3.708 |   | 475 |   | 3.708 |   |
| $4.01  to $6.00               |       | 130                                                           |       | 4.5                                                        |       | 5.030 |   | 130 |   | 5.030 |   |
|                          |       | 1,030                                                         |       |                                                       |       |   |   | 1,030 |   |   |   |
|                               |            |                                                               |            |                                                            |            |  |  |  |  |  |  |  |  |

 

The following tablereflects outstanding and exercisable warrants at March 31, 2010:

 
| ** **         | ** ** | **Warrants Outstanding and Exercisable** | ** ** |
|--------------------|------------|------------------------------------------|------------|
| **Exercise Price** | ** ** | **Shares (In thousands)**                | ** ** | **Weighted-  Average  Remaining  Life (Years)** | ** ** | **Weighted-  Average  Exercise Price** | ** ** |
| $                  | 0.53       |                                     | 8,019      |   | 1.42 |   | $ | 0.53 |   |
|                    |            |                                          |            |  |  |  |  |  |  |

 

*StockholderRights Plan. *On October 31,2005, we adopted a stockholder rights plan intended to protect the interests ofthe stockholders from coercive, abusive or unfair takeover tactics.

 

On January 8, 2010,in connection with the JH Partners transaction, this stockholders rights planwas terminated.

 

*ConvertibleNote Payable in Common Stock*.  As of January 8, 2010, the seniorconvertible note was satisfied in full in connection with the JH Partnerstransaction.  In connection with the notepayoff, 3.5 million common shares were issued. See “Note 11. Long-Term Debt - Senior Convertible Note andWarrant.”

 

*PreferredStock*.  Fora full description of the Company’s preferred stock, see “Note 20. PreferredStock” below.

 

**Note 14.         Net Loss per Share Data.**

 

The following is areconciliation of the numerators and denominators used in computing basic anddiluted net loss per share for the years ended March 31, 2010 and 2009:

 
| **(In thousands, except per share data)**                              | ** ** | **2010** | ** ** | **2009** | ** ** |
|------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                   |       |     |       |     |       |
| Net  loss — basic and diluted numerator                           |       | $        | (5,922     | )        | $          | (1,804 | ) |
| Add:  Dividend on Series B preferred stock                        |       | (616     | )          | —   |       |
| Add:  Deemed dividend on Series C preferred stock                      |       | (412     | )          | —   |       |
| Net  loss per common — basic and diluted numerator                |       | $        | (6,950     | )        | $          | (1,804 | ) |
| Weighted-average  common shares outstanding — basic denominator   |       | 22,644   |       | 21,856   |       |
| Effect  of dilutive securities                                         |       | —   |       | —   |       |
| Weighted-average  common shares outstanding — diluted denominator |       | 22,644   |       | 21,856   |       |
| Net  loss per share:                                                   |       |     |       |     |       |
| Basic  and diluted net loss per share                                  |       | $        | (0.31      | )        | $          | (0.08 | ) |

 

Outstanding common stockoptions and warrants not included in the computation of diluted net loss pershare totaled 9,049,000 and 3,327,000, respectively, for the years ended March 31,2010 and 2009 as their effect would be antidilutive.

 

**Note 15.         Income Taxes.**

 

On April 1, 2007 weadopted the provisions of ASC 740, *Income Taxes*.  ASC 740 requires that we recognize in theconsolidated financial statements the impact of a tax position that is morelikely than not to be sustained upon examination based on the technical meritsof the position.  ASC 740 also prescribesa recognition threshold and measurement attribute for the financial statementrecognition and measurement of each tax position taken or expected to be takenin a tax return.  Under ASC 740, acompany can recognize the benefit of an income tax position only if it is morelikely than not (greater than 50%) that the tax position will be sustained upontax examination, based solely on the technical merits of the tax position.  Otherwise, no benefit can be recognized.  The tax benefits recognized are measured

 

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based on the largest benefit that has a greater than 50% likelihood ofbeing realized upon ultimate settlement. Additionally, companies are required to accrue interest and relatedpenalties, if applicable, on all tax exposures for which reserves have beenestablished consistent with jurisdictional tax laws.

 

We do not believe that wehave included any “uncertain tax positions” in our federal income tax return orany of the state income tax returns we are currently filing.  We have made an evaluation of the potentialimpact of additional state taxes being assessed by jurisdictions in which wenot currently consider ourselves liable. We do not anticipate that such additional taxes, if any, would result ina material change to our financial position. Upon adoption of ASC 740, we recorded an increase of $69,000 toaccumulated deficit and income taxes payable at April 1, 2007 to providefor the additional state tax liabilities and interest.  A reconciliation of the beginning and endingamount of unrecognized tax benefits is as follows:

 
| Balance  at March 31, 2009                        |   | $      | 105    |   |
|--------------------------------------------------------|--------|--------|--------|--------|
| Additions  based on current year tax positions         |   | 39     |   |
| Additions  for prior year tax positions                |   | — |   |
| Reductions  related to lapse of statute of limitations |   | (27    | )      |
| Balance  at March 31, 2010                        |   | $      | 117    |   |

 

If recognized, the entireamount of unrecognized tax benefits would be recorded as a reduction in incometax expense. The amount accrued for payment of interest as of March 31,2010 and 2009 was $12,000 and $17,000, respectively. We do not expect the totalamount of unrecognized tax benefits to significantly increase or decreasewithin the next twelve months.

 

We file income taxreturns in the U.S. federal jurisdiction and various state and foreignjurisdictions.  Tax years ended on orafter March 31, 2007 remain open to examination by federalauthorities.  Tax years ended on or afterMarch 31, 2006 remain open to examination by state authorities.  We classify any interest and penaltiesrelated to income taxes assessed by a jurisdiction as part of income taxexpense.  Interest and penalties were immaterial during fiscal 2010 and2009.

 

*Valuationof Deferred Income Taxes*

 

Income taxes areaccounted for under the asset and liability method.  Deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective tax bases and operating loss and tax creditcarryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  We must assess thelikelihood that our deferred tax assets will be recovered from future taxableincome, and to the extent that it is more likely than not that such deferredtax assets will not be realized, we must establish a valuation allowance.  The establishment, or increase, of avaluation allowance increases income tax expense for such year.  We have a valuation allowance against 100% ofour net deferred tax assets, which are composed primarily of net operating loss(or *NOL*) carryforwards.  Even though we have fully reserved these netdeferred tax assets for book purposes, we would still be able to utilize themto reduce future income taxes payable should we have future earnings.  To the extent such deferred tax assets relateto NOL carryforwards, the ability to use such NOLs against future earnings willbe subject to applicable carryforward periods. As of March 31, 2010, we had NOL carryforwards for Federal andstate tax purposes of $9.9 million and $15.2 million, respectively, which areavailable to offset taxable income through 2030.  These amounts reflect that the utilization ofthe Company’s net operating losses carry forwards is subject to a substantialannual limitation due to ownership change limitations as required by Section382 of the Internal Revenue Code of 1986, as amended (the “Code”), as well assimilar state limitations.  This resultedin approximately $25.3 million and $22.7 million of federal and state netoperating loss carryforwards, respectively, being subject to limitations thatwill cause these carryforwards to expire without utilization. As a result, theCompany has written-off the deferred tax assets associated with the excess netoperating losses, along with the corresponding valuation allowance.

 

Income tax expense(benefit) for each of the years ended March 31, 2010 and 2009, issummarized as follows:

 
| **(In thousands)** | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------|------------|----------|------------|----------|------------|
| Current            |       |     |       |     |       |
| Federal            |       | $        | —     |     | $          | — |   |
| State              |       | 93       |       | 36       |       |
| Foreign            |       | 5        |       | 3        |       |
|               |       | 98       |       | 39       |       |
| Deferred           |       |     |       |     |       |
| Federal            |       | —   |       | —   |       |
| State              |       | —   |       | —   |       |
|               |       | —   |       | —   |       |
|               |       |     |       |     |       |
| Total  Tax Expense |       | $        | 98         |     | $          | 39 |   |

 

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The tax effects oftemporary differences that give rise to a significant portion of the netdeferred tax assets at March 31, 2010 and 2009, are presented below:

 
| **(In thousands)**                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred tax  assets:                                        |       |     |       |     |       |
| Provision for  lower of cost or market inventory write-downs |       | $        | 4,180      |     | $          | 3,426 |   |
| Net operating  loss carryforwards                            |       | 4,206    |       | 12,909   |       |
| Allowance for  sales returns                                 |       | 76       |       | 2,198    |       |
| Deferred revenue                                             |       | 142      |       | —   |       |
| Allowance for  doubtful accounts receivable                  |       | 463      |       | 64       |       |
| Unrealized  gain/loss                                        |       | —   |       | 79       |       |
| Accrued  compensation and benefits                           |       | 462      |       | —   |       |
| Legal settlement  accrual                                    |       | 19       |       | 213      |       |
| Depreciation and  amortization                               |       | 750      |       | —   |       |
| Tax credits                                                  |       | 693      |       | 708      |       |
| Stock options                                                |       | 114      |       | —   |       |
| Write-down of  royalty and distribution fee advances         |       | —   |       | 91       |       |
| Other                                                        |       | 60       |       | 17       |       |
| Deferred tax  assets                                         |       | 11,165   |       | 19,705   |       |
| Less valuation  allowance                                    |       | (10,304  | )          | (19,387  | )          |
| Deferred tax  assets                                         |       | 861      |       | 318      |       |
|                                                         |       |     |       |     |       |
| Deferred tax  liabilities:                                   |       |     |       |     |       |
| Unrealized  gain/loss                                        |       | (845     | )          | —   |       |
| Depreciation and  amortization                               |       | —   |       | (124     | )          |
| Other                                                        |       | (16      | )          | (194     | )          |
| Deferred tax  liabilities                                    |       | (861     | )          | (318     | )          |
| Net deferred tax  assets                                     |       | $        | —     |     | $          | — |   |

 

Expected income taxexpense (benefit) based on federal statutory rates for the years ended March 31,2010 and 2009, differed from actual income tax expense (benefit) as follows:

 
| **(In thousands, except per share data)**         | ** ** | **2010** | ** ** | **2009** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Expected  income tax benefit                      |       | $        | (1,980     | )        | $          | (600 | ) |
| State  income tax benefit, net of Federal benefit |       | 60       |       | (54      | )          |
| Change in  valuation allowance                    |       | (9,083   | )          | 354      |       |
| Reduction of net  operating loss carryforwards    |       | 10,618   |       |     |       |
| Non-deductible  expenses                          |       | 487      |       | 61       |       |
| Provision to  Return Adjustments                  |       | 45       |       | 240      |       |
| Other                                             |       | (49      | )          | 38       |       |
|                                              |       | $        | 98         |     | $          | 39 |   |

 

**Note 16.         Other Items — Statements of Operations.**

 

*Other Income (Expense)*

 

Other income (expense),net for fiscal 2010 includes:

 

·                  $5,218,000million forgiveness of debt from various vendors:

·                  $1,469,000in business interruption fees in accordance with the Merger Agreement that wasterminated in April 2009;

·                  $334,000of deferred rent written-off as a result of renegotiation of long-term lease;and

·                  $570,000in noncash income resulting from the change in fair value of a warrant,purchase rights and embedded derivatives; and

·                  $161,000gain on disposal of assets.

 

Other income (expense),net for fiscal 2009 includes:

 

·                  $2.0million pursuant to a settlement agreement and mutual release relating to theBTP Merger Agreement and related Distribution Agreement.

·                  $1.0million in non-refundable consideration for an extension of the closing date ofa merger agreement subsequently terminated in April 2009.

·                  $2.4million pursuant to the termination of an agreement with a content supplier.

·                  ($209,000)in noncash expense resulting from the change in fair value of a warrant andembedded derivatives.

 

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**Note 17.         Employee Benefit Plan.**

 

Effective February 1,2003, we established the Image Entertainment Investment Plan, a defined contribution401(k) plan for the benefit of employees meeting certain eligibilityrequirements.  Under the plan,participants may contribute a portion of their earnings on a pre-taxbasis.  Employee contributions areforwarded to the plan administrator and invested in various funds at thediscretion of the employee.  Initially wematched some portion of those contributions based upon the employee’scompensation status in accordance with the U.S. Internal Revenue Code.  The plan was amended on January 29,2010.  Effective for payroll periods onor after March 1, 2010, the employer matching contributions to the 401(k) planwere suspended.  Matching contributionsfor payroll periods before that date were not affected.  As a result of the amendment, in accordance withthe Internal Revenue Service guidelines, the contributions of the highlycompensated employees will be capped annually. The cap will be determined based on the results of the actual deferraland contribution percentage discrimination testing requirements of CodeSections 401(k) and (m).  Weincurred 401(k) savings plan expenses of $126,000 and $179,000 for fiscal2010 and 2009, respectively.

 

**Note 18.****                           RelatedParty Transactions with JH Partners LLC and Affiliates.**

 

On December 21, 2009, we entered into a SecuritiesPurchase Agreement, as amended on December 24, 2009, December 30, 2009 andJanuary 20, 2010 (as amended, the *SPA*)  withJH Partners, LLC, as the investor representative (or *InvestorRepresentative*), and JH Partners Evergreen Fund, L.P. (or *JH Evergreen*), JH Investment Partners III, L.P. (or *JH Investment III*) and JH Investment Partners GP Fund III,LLC (or *JH Investment GP Fund* and together withJH Evergreen and JH Investment III, the *Investors*).   Pursuant to the SPA, on January 8, 2010, we sold22,000 shares of a newly authorized series of our capital stock entitled SeriesB Cumulative Preferred Stock, par value $0.0001 per share (or *Series B Preferred*), and 196,702 shares of a newlyauthorized series of our capital stock entitled Series C Junior ParticipatingPreferred Stock, par value $0.0001 per share (or *Series CPreferred* and together with the Series B Preferred, the *Preferred Shares*), for an aggregate purchase price of $22.0million.  In connection with our sale to the Investors of the PreferredShares, the Investors acquired control of Image.  Due to the voting rightsassociated with the Series C Preferred as discussed below, after the issuanceof the Series C Preferred and the issuance of 3.5 million shares of our commonstock, par value $0.0001 per share (or *Common Stock*),to retire the Amended Note on January 8, 2010, the Investors collectively ownedapproximately 88.6% of our post-transaction outstanding voting securities.  After subsequent transactions involving ourcapital stock, the Investors owned approximately 77.0% of outstanding votingsecurities as of June 1, 2010.

 

After payment to the Investor Representative of a $1million transaction fee, akin to an investment banking fee, reimbursement of$650,000 of the Investors’ expenses and payment of other transaction-relatedexpenses, we received net proceeds of approximately $19.0 million from the saleof the Preferred Shares.  In connection with the closing of the sale ofthe Preferred Shares on January 8, 2010, we used $15.0 million of the netproceeds, along with the issuance of 3.5 million shares of Common Stock, torepay in full and retire the Amended Note.  The remainder of the netproceeds will be used to repay other outstanding indebtedness and outstandingliabilities and for general working capital.  Pursuant to the SPA, weagreed to pay the Investor Representative or its designee a management fee of$300,000 on each of December 31, 2010 and December 31, 2011.

 

Pursuant to the closing conditions of the SPA, on January 7,2010, each member of our then-current board of directors resigned from theboard of directors which became effective immediately after the closing of thesale of the Preferred Shares to the Investors.  On January 7, 2010,our then-current board of directors appointed Theodore S. Green, Patrick M.Collins and Michael J. John to our board of directors effective immediatelyafter the closing of the sale of the Preferred Shares on January 8,2010.  Messrs. Collins and John are each employed by the InvestorRepresentative.

 

On January 9, 2010, our board of directorsappointed Theodore S. Green as our Chairman of the Board and Chief ExecutiveOfficer, John Avagliano as our Chief Financial Officer and Chief OperatingOfficer and John Hyde as our Vice Chairman.

 

On January 8, 2010 in connection with the closingof the sale of the Preferred Shares as discussed above, we entered into aRegistration Rights Agreement (or *RRA*) with theInvestor Representative and the Investors. Pursuant to the RRA, we agreed to register under the Securities Act of1933 the shares of Common Stock issuable upon conversion of the Series CPreferred under certain circumstances.

 

Pursuant to the SPA, the Investors initially providedto Wachovia a $5.0 million irrevocable standby letter of credit for 90 days,which was then extended through October 30, 2010, as credit support for ourrevolving line of credit.  

 

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IMAGE ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

**Note 19.         Preferred Stock (including restrictionson dividends).**

 

The Series B Preferred bears a cumulativedividend equal to 12% per annum of the liquidation preference of $1,000 pershare (subject to adjustment upon any stock dividend, stock split, combinationor other similar recapitalization with respect to the Series B Preferred)compounding quarterly.  Dividends willaccrue automatically on a daily basis whether or not declared by our board ofdirectors, but will be payable in cash only when, and if, declared by theboard.  If not declared and paid earlier,such dividends will be paid upon liquidation. So long as any shares of Series B Preferred are outstanding anduntil all dividends on the Series B Preferred have been paid or declaredand set aside for payment, we will be prohibited from (i) declaring orpaying any dividend (whether in cash or property) on any shares of ourpreferred stock or Common Stock, and (ii) subject to certain exceptions,redeeming any shares of our preferred stock or Common Stock.  The Series B Preferred also hasliquidation preference with priority over liquidating distributions to holdersof Common Stock or any capital stock that ranks junior to the Series BPreferred equal to the sum of (i) $1,000 per share (subject to adjustmentupon any stock dividend, stock split, combination or other similarrecapitalization with respect to the Series B Preferred) (or *Liquidation Preference*) and (ii) an amount equal to allaccrued but unpaid dividends thereon.  Inthe event of any merger of Image with or into another person or of any personwith or into Image, any sale, transfer, lease or conveyance to another personof all or substantially all of our property or any statutory share exchange ofImage with another person, each share of Series B Preferred will beentitled to receive an amount in cash equal to the sum of (y) theLiquidation Preference and (z) the amount per share equal to accrued butunpaid dividends.  Certain internalreorganization transactions will not trigger the foregoing payment right.  Holders of Series B Preferred do nothave any voting rights, including the right to elect directors, other thanthose rights required by law but do have limited voting rights with respect tomatters affecting the rights and privileges of the Series BPreferred.  The Series B Preferredis not redeemable by us or the Investors and is not convertible.

 

Subject to the rights of holders of any shares ofpreferred stock ranking prior to the Series C Preferred, the Series CPreferred is entitled to receive, when declared by our board of directors outof funds legally available therefore, dividends in an amount per share equal to1,000 times the aggregate per share amount of all cash and non-cash dividendsor other distributions (other than a dividend payable in shares of Common Stockor a subdivision of the outstanding shares of Common Stock) declared on theCommon Stock.  This amount is subject toadjustment in the event of a stock dividend, stock split, combination or othersimilar recapitalization with respect to the Common Stock that is not similarlyeffected with respect to Series C Preferred.  Until all declared and unpaid dividends onthe Series C Preferred outstanding have been paid in full, we will beprohibited from (i) declaring or paying dividends on any shares of stockranking junior or on a parity with the Series C Preferred (exceptdividends paid ratably on the shares of Series C Preferred and all suchparity stock) or (ii) subject to certain exceptions, redeeming any sharesof any of our stock ranking junior to or on parity with the Series CPreferred.  In the event of anyliquidation, dissolution or winding up of Image, we will be prohibited, subjectto certain exceptions, from making any distribution to holders of stock rankingjunior to, or on parity with, the Series C Preferred.  If we enter into a consolidation, merger,combination or other transaction in which shares of Common Stock are exchangedfor other securities, cash or any other property, then each share ofSeries C Preferred will be similarly exchanged, for an amount per shareequal to 1,000 times the aggregate amount of securities, cash or other propertyfor which each share of Common Stock is exchanged (subject to adjustment uponthe occurrence of the same events set forth above for adjustments to thedividend amount to which holders are entitled). The Series C Preferred votes together as one class with the CommonStock (except as provided by law or our certificate of incorporation), andentitles the holder to 1,000 votes for each share held (subject to adjustmentupon the occurrence of the same events set forth above for adjustments to thedividend amount to which holders are entitled), on all matters submitted to avote of stockholders.  The Series CPreferred is not redeemable.  TheSeries C Preferred is convertible, at the holder’s option, into shares ofCommon Stock at a ratio of 1,000 shares of Common Stock for each share ofSeries C Preferred (subject to adjustment upon the occurrence of certainevents).  The Series C Preferredwill automatically convert into shares of the Common Stock when there aresufficient authorized but unissued shares of Common Stock to effect theconversion in full of the Series C Preferred after taking into accountshares reserved for issuance upon exercise of outstanding rights, warrants andoptions and upon conversion of outstanding convertible securities.  As of March 31, 2010, we did not havesufficient authorized but unissued shares of Common Stock available to effectthe conversion in full of the outstanding shares of Series C Preferred.

 

 

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IMAGE ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

In connection with the Investors’ purchase of Series BPreferred and Series C Preferred, we also granted the Investors the right(or the *Purchase Right*) to purchase up to anadditional 7,400 shares of Series B Preferred and 66,163.4 shares of Series CPreferred for an aggregate purchase price of $7.4 million.  The preferred stock purchase rights werevalued in accordance with ASC 820, *Fair Value Measurementsand Disclosures*.  See “Note11. Long-Term Debt — Derivative Liabilities — Stock Warrant, Purchase Rightsand Embedded Derivatives” for further details.

 

Subsequent to March 31, 2010, the Purchase Rightexpired with respect to an initial tranche of 3,700 shares of Series BPreferred and 33,081.7 shares of Series C Preferred.

 

The Company employed an option pricing model todetermine the relative fair value of the Series B Preferred, Series C Preferredand the Purchase Rights.  The Series BPreferred and Series C Preferred have been classified as mezzanine equity.  The Series B preferred stock was classifiedas mezzanine equity due to the clause in the Certificate of Designation, whichprovides upon a merger or other reorganization events, as defined, the Series Bpreferred stock is cash settled.  Thisredemption event would likely be outside of the Company’s control.  The Series C preferred stock was classifiedas mezzanine equity due to certain obligations under the RRA, which would notbe in the Company’s control.  As thepotential penalty for any breach of the RRA is not explicitly stated or definedand is not solely within the Company’s control, it is assumed there would be aredemption event for the Series C Preferred. The costs associated with the transaction reimbursed to the Investorsreduced the proceeds received by the Company and impact the calculation of thefair value of Series C Preferred.  Thecalculated impact was recorded as a deemed dividend on Series B Preferred.

 

**Note 20.         Subsequent Events.**

 

Wehave performed an evaluation of subsequent events through the date we issuedthese financial statements.

 

*Employment and Consulting Agreements*

 

On April 14, 2010, we entered into employment agreements withChairman of the Board and Chief Executive Officer, Theodore Green, and ChiefFinancial Officer and Chief Operating Officer, John Avagliano.  TheCompany also entered into a consulting agreement with its Vice Chairman, JohnHyde and his wholly owned consulting business, Producers SalesOrganization.  Messrs. Green, Avagliano and Hyde were appointedexecutive officers of the Company (collectively, the *ExecutiveOfficers*) on January 9, 2010. Each agreement has an initial three-year term and, subject toadvance-notice termination, renews automatically for successive one-yearterms.  These employment and consulting agreements each provide for, amongother things, an annual base salary or consulting fee, as applicable, of$300,000, cash bonus eligibility, severance benefits, reimbursement ofcommuting and relocation expenses, and certain tax gross-up payments.

 

*Stockholders’ Agreement*

 

On April 14, 2010, the Company entered into a Stockholders’ Agreement (orthe *Stockholders’ Agreement*) with JHEvergreen, JH Investment III, JH Investment GP Fund (together with JH Evergreenand JH Investment III, the *JH Stockholders*),Messrs. Green and Avagliano, Producers Sales, and Ray Gagnon, an executive ofthe Company (together with Messrs. Green and Avagliano and Producers Sales, the*Management Stockholders*, and theManagement Stockholders and JH Stockholders collectively, the *Stockholders*). In addition to imposing customary transferrestrictions on Company capital stock held by the Stockholders, theStockholders’ Agreement includes agreements among the Stockholders regardingtag-along rights, drag-along rights, and approval of a new equity incentiveplan pursuant to which the Management Stockholders will receive stock optionsand restricted stock awards.  Inaddition, the Stockholders’ Agreement gives the Company a call option on capitalstock and vested options held by each of the Management Stockholders,exercisable within 90 days of the termination of employment or consultingengagement of the Management Stockholder. The exerciseprice of the call option is based on the fair market value of the underlyingshares at the time of exercise, except in the case of termination for “cause,”in which case shares underlying equity compensation awards may be purchased atthe original acquisition price, if lower.

 

The Stockholders’ Agreement was entered into in connection with the April 14,2010 purchase by the Management Stockholders of an aggregate of 2,300 shares ofthe Company’s Series B Preferred Stock and 20,564.3 shares of Series CPreferred Stock from the JH Stockholders. In connection with such purchase, the Management Stockholders alsobecame parties to the Company’s Registration Rights Agreement dated January 8,2010.

 

*Amendments to Loan Agreement*

 

On April 15, 2010 and May 3, 2010, we entered into theFifth Amendment and Sixth Amendment to the Loan Agreement with Wachovia.  The amendments extended the maturity of ourrevolving line of credit from May 4, 2010 to October 25, 2010 and modified thecalculation of the borrowing base.

 

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IMAGE ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

*Merger of Subsidiaries*

 

Effective June 30, 2010, we plan to merge our wholly ownedsubsidiaries, Egami Media, Inc. and Image Entertainment (UK), Inc.,into the parent corporation, Image Entertainment, Inc.  We will continue to own the trademark forEgami Media, Inc. and use it as a trade name.

 

**Note 21.         Segment Information.**

 

In accordance with therequirements of ASC “*Segment Reporting,*”selected financial information regarding our reportable business segments,domestic, digital and international, are presented below.  Our domestic segment primarily consists ofacquisition, production and distribution of exclusive DVD content in NorthAmerica and exploitation of North American broadcast rights.  Our digital segment consists of revenuesgenerated by digital distribution of our exclusive content via video on demand,streaming video and downloading.  Our internationalsegment includes international video sublicensing of all formats andexploitation of broadcast rights outside of North America.

 

Management currentlyevaluates segment performance based primarily on net revenues, operation costsand expenses and loss before income taxes. Interest income and expense is evaluated on a consolidated basis and isnot allocated to our business segments.

 

For the Year EndedMarch 31, 2010:

 
| ** **                           | ** ** | **2010**     | ** ** |
|--------------------------------------|------------|--------------|------------|
| **(In  thousands)**                  | ** ** | **Domestic** | ** ** | **Digital** | ** ** | **International** | ** ** | **Consolidated** | ** ** |
| Net  revenues                        |       | $            | 87,793     |   | $ | 4,182 |   | $ | 1,095 |   | $ | 93,070 |   |
| Operating  costs and expenses        |       | 100,250      |       | 2,769 |   | 1,204 |   | 104,223 |   |
| Earnings  (loss) from operations     |       | (12,457      | )          | 1,413 |   | (109 | ) | (11,153 | ) |
| Other  expense                       |       | (5,329       | )          | — |   | — |   | (5,329 | ) |
| Earnings  (loss) before income taxes |       | $            | (7,128     | ) | $ | 1,413 |   | $ | (109 | ) | $ | (5,824 | ) |

 

For the Year EndedMarch 31, 2009:

 
| ** **                           | ** ** | **2009**     | ** ** |
|--------------------------------------|------------|--------------|------------|
| **(In thousands)**                   | ** ** | **Domestic** | ** ** | **Digital** | ** ** | **International** | ** ** | **Consolidated** | ** ** |
| Net  revenues                        |       | $            | 124,410    |   | $ | 4,198 |   | $ | 2,083 |   | $ | 130,691 |   |
| Operating  costs and expenses        |       | 128,507      |       | 3,437 |   | 2,397 |   | 134,341 |   |
| Earnings  (loss) from operations     |       | (4,097       | )          | 761 |   | (314 | ) | (3,650 | ) |
| Other  (income)                      |       | (1,885       | )          | — |   | — |   | (1,885 | ) |
| Earnings  (loss) before income taxes |       | $            | (2,212     | ) | $ | 761 |   | $ | (314 | ) | $ | (1,765 | ) |

 
| ** **                 | ** ** | **As of March 31,** | ** ** |
|----------------------------|------------|--------------------------|------------|
| **(In  thousands)**        | ** ** | **2010**                 | ** ** | **2009** | ** ** |
| Total  assets:             |       |                     |       |   |   |
| Domestic                   |       | $                        | 66,266     |   | $ | 83,188 |   |
| Digital                    |       | 701                      |       | 800 |   |
| International              |       | 430                      |       | 725 |   |
| Consolidated  total assets |       | $                        | 67,397     |   | $ | 84,713 |   |

 

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

 

None.

 

**ITEM 9A(T).****        ****CONTROLS AND PROCEDURES**

 

**Disclosure Controls and Procedures**

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the reports that we file or submitunder the Securities Exchange Act of 1934, as amended (or *Exchange Act*),is recorded, processed, summarized and reported within the time periodsspecified in the SEC’s rules and forms, and that such information isaccumulated and communicated to our management, including our principalexecutive and principal financial officers, or persons performing similarfunctions, as appropriate to allow timely decisions regarding requireddisclosure.  We periodically review thedesign and effectiveness of our disclosure controls and internal control overfinancial reporting.  We makemodifications to improve the design and effectiveness of our disclosurecontrols and internal control structure, and may take other corrective action,if our reviews identify a need for such modifications or actions.

 

Asof the end of the period covered by this Annual Report, we evaluated, under thesupervision and with the participation of our Chairman and Chief ExecutiveOfficer, and Chief Operating Officer and Chief Financial Officer, theeffectiveness of our disclosure controls and procedures.  Based on that evaluation, our Chairman andChief Executive Officer and Chief Operating Officer and Chief Financial Officerhave concluded that our disclosure controls and procedures were effective as ofthe end of the period covered by this Annual Report.

 

**Internal Control Over Financial Reporting**

 

***Management’s Annual Report on InternalControl Over Financial Reporting***

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting for our company.  Our internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof our financial reporting and the preparation of financial statements forexternal purposes in accordance with United States generally acceptedaccounting principles.  Internal controlover financial reporting includes policies and procedures that:

 

·                  concern the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of our assets;

 

·                  provide reasonable assurance that(a) transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and (b) that our receipts and expenditures are being recordedand made only in accordance with management’s authorizations; and

 

·                  provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof our assets.

 

Acontrol system, no matter how well designed and operated, can provide onlyreasonable, not absolute, assurance that the objectives of the control systemare met.  Because of the inherentlimitations, internal controls over financial reporting may not prevent ordetect misstatements.  Projections of anyevaluation of the effectiveness of internal control over financial reporting tofuture periods are subject to the risks that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

 

Managementconducted an evaluation of the effectiveness of our internal control overfinancial reporting at March 31, 2010. In conducting this evaluation, management used the criteria set forth bythe Committee of Sponsoring Organizations of the Treadway Commission in *Internal Control—Integrated Framework*.  Based on that evaluation under thosecriteria, management concluded that, at March 31, 2010, our internalcontrol over financial reporting was effective.

 

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Thisannual report does not include an attestation report of our registered publicaccounting firm regarding internal control over financial reporting.  Management’s report was not subject toattestation by our registered public accounting firm pursuant to temporary rules ofthe SEC that permit us to provide only management’s report in this annualreport.

 

***Changes in Internal Control over FinancialReporting***

 

Asrequired by Rule 13a-15(d) of the Exchange Act, we have evaluated,under the supervision and with the participation of our Chairman and ChiefExecutive Officer, and Chief Operating Officer and Chief Financial Officer,whether any changes occurred to our internal control over financial reportingduring our fourth fiscal quarter that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.  Based on that evaluation,there have been no such changes during our fourth fiscal quarter.

 

**ITEM 9B.****              ****OTHER INFORMATION**

 

None.

 

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**PART III**

 

**ITEM 10.               DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE**

 

Theadditional information required by this Item will be included in an amendmentto this Annual Report on Form 10-K.

 

Wehave a Code of Ethics Policy that applies to all of our employees, includingour principal executive officer, principal financial officer and principalaccounting officer, and a Code of Conduct that applies to our directors,officers and employees.  We have postedthe Code of Ethics Policy and the Code of Conduct under the menu “Investors—CorporateGovernance” on our Web site at *www.image-entertainment.com*.  If we waive any material portion of our Codeof Ethics Policy that applies to our principal executive officer, principalfinancial officer or principal accounting officer or amend the Code of EthicsPolicy (other than technical, administrative or other non-substantiveamendments), we will disclose that fact on our website at *www.image-entertainment.com*within four business days.

 

**ITEM 11.****              ****EXECUTIVECOMPENSATION**

 

Theinformation required by this Item will be included in an amendment to thisAnnual Report on Form 10-K.

 

**ITEM 12.****              ****SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Theinformation required by this Item will be included in an amendment to thisAnnual Report on Form 10-K.

 

**ITEM 13.****              ****CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

Theinformation required by this Item will be included in an amendment to thisAnnual Report on Form 10-K.

 

**ITEM 14.****              ****PRINCIPALACCOUNTANT FEES AND SERVICES**

 

Theinformation required by this Item will be included in an amendment to thisAnnual Report on Form 10-K.

 

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**PART IV**

 
| **Item 15.** | **Exhibits And Financial Statements** |
|--------------|---------------------------------------|

 
| ** ** | ** ** | ** **                                                   | **Page**                                                                                                         |
|------------|------------|--------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------|
|       | (a)        | The  following documents are filed as a part of this report: |                                                                                                             |
|       |       |                                                         |                                                                                                             |
|       |       | 1.                                                           | Financial  Statements.                                                                                           |   |
|       |       |                                                         |                                                                                                             |   |
|       |       |                                                         | Report of Independent Registered Public Accounting  Firm                                                         | [43] |
|       |       |                                                         | Consolidated  Balance Sheets as of March 31, 2010 and 2009                                                  | [44] |
|       |       |                                                         | Consolidated Statements of Operations for the years  ended March 31, 2010 and 2009                          | [46] |
|       |       |                                                         | Consolidated Statements of Stockholders’ (Deficit)  Equity for the years ended March 31, 2010 and 2009 | [47] |
|       |       |                                                         | Consolidated Statements of Cash Flows for the years  ended March 31, 2010 and 2009                          | [48] |
|       |       |                                                         | Notes to Consolidated Financial Statements                                                                       | [51] |

 
|   | (b)    | Exhibits.                                                                                                                                                                                                                                                                                                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 2.1    | Agreement  and Plan of Merger, dated as of November 20, 2008, among Nyx  Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc. (incorporated by reference to Exhibit 2.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on November 21, 2008).          |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 2.1(a) | First  Amendment to Agreement and Plan of Merger, dated February 27, 2009, among  Nyx Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc. (incorporated by reference to Exhibit 2.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on March 4, 2009). |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 2.1(b) | Second  Amendment to Agreement and Plan of Merger, dated March 24, 2009, among  Nyx Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc. (incorporated by reference to Exhibit 2.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on March 25, 2009).  |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 2.1(c) | Third  Amendment to Agreement and Plan of Merger, dated April 8, 2009, among  Nyx Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc. (incorporated by reference to Exhibit 2.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on April 10, 2009).    |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 2.1(d) | Fourth  Amendment to Agreement and Plan of Merger, dated April 14, 2009, among  Nyx Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc. (incorporated by reference to Exhibit 2.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on April 17, 2009).  |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 3.1    | Certificate  of Incorporation of Image Entertainment, Inc. (incorporated by reference  to Exhibit 3.1 to the Registrant’s Annual Report on Form 10-K (File  No. 000-11071) filed on June 29, 2009).                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 3.2    | Certificate  of Designation of Series A Junior Participating Preferred Stock  (incorporated herein by reference to Exhibit A to Exhibit 4.1 to  the Registrant’s Current Report on Form 8-K/A (File No. 000-11071)  filed with on November 2, 2005).                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 3.3    | Certificate  of Designations of Series B Cumulative Preferred Stock, par value  $0.0001 per share, of Image Entertainment, Inc. (incorporated by  reference to Exhibit 3.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on January 14, 2010).                                            |

 

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|   | 3.4    | Certificate  of Designation of Series C Junior Participating Preferred Stock of Image  Entertainment, Inc. (incorporated by reference to Exhibit 3.2 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on January 14, 2010).                                                                 |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 3.5    | Bylaws  of Image Entertainment, Inc., as amended (incorporated by reference to  Exhibit 3.1 to the Registrant’s Quarterly Report on Form 10-Q (File  No. 000-11071) filed on February 12, 2010).                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.1    | Specimen  Common Stock certificate (incorporated by reference to Exhibit 4.1 to  the Registrant’s Registration Statement on Form S-3 (File  No. 333-138701) filed on November 14, 2006).                                                                                                                                         |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2    | Rights  Agreement dated as of October 31, 2005, by and between Image  Entertainment, Inc. and Computershare Trust Company, Inc.  (incorporated by reference to Exhibit 4.1 to the Registrant’s Current  Report on Form 8-K/A (File No. 000-11071) filed on November 2,  2005).                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2(a) | Amendment  No. 1 to Rights Agreement, dated as of March 29, 2007, by and  between Image Entertainment, Inc. and Computershare Trust Company, N.A.,  as Rights Agent (incorporated by reference to Exhibit 4.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on April 2, 2007).      |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2(b) | Amendment  No. 2 to Rights Agreement, dated as of June 25, 2007, by and between  Image Entertainment, Inc. and Computershare Trust Company, N.A., as  Rights Agent (incorporated by reference to Exhibit 4.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on July 2, 2007).        |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2(c) | Amendment  No. 3 to Rights Agreement, dated as of February 2, 2008, by and  between Image Entertainment, Inc. and Computershare Trust Company, N.A.,  as Rights Agent (incorporated by reference to Exhibit 4.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on February 6, 2008). |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2(d) | Amendment  No. 4 to Rights Agreement, dated as of November 20, 2008, between  Image Entertainment, Inc. and Computershare Trust Company, N.A., as  Rights Agent (incorporated by reference to Exhibit 4.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on November 21, 2008).      |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.2(e) | Amendment  No. 5 to Rights Agreement, dated as of December 21, 2009, between  Image Entertainment, Inc. and Computershare Trust Company, N.A.  (incorporated by reference to Exhibit 4.1 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on December 22,  2009).                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.3    | Securities  Purchase Agreement, dated as of August 30, 2006, between Image  Entertainment, Inc. and the buyers named therein (incorporated by  reference to Exhibit 10.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on August 31, 2006).                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.4    | Registration  Rights Agreement, dated as of August 30, 2006, between Image  Entertainment, Inc. and the buyers named therein (incorporated by  reference to Exhibit 10.4 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on August 31, 2006).                                               |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.5    | Form of  Senior Convertible Note (incorporated by reference to Exhibit 10.2 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on August 31, 2006).                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.6    | Form of  Warrant (incorporated by reference to Exhibit 10.3 to the Registrant’s  Current Report on Form 8-K (File No. 000-11071) filed on  August 31, 2006).                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                      |
|   | 4.7    | Amendment  and Exchange Agreement, dated November 10, 2006, by and between Image  Entertainment, Inc. and Portside Growth and Opportunity Fund  (incorporated by reference to Exhibit 4.6 to the Registrant’s  Registration Statement on Form S-3 (No. 333-138701) filed on November 14,  2006).                       |

 

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|   | 4.8               | Warrant  Issued Pursuant to Amendment and Exchange Agreement (incorporated by  reference to Exhibit 4.7 to the Registrant’s Registration Statement on  Form S-3 (No. 333-138701) filed on November 14, 2006).                                                                                                                                                                                |
|--------|-------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.9               | Second  Amendment and Exchange Agreement, dated July 30, 2009, by and among  Image Entertainment, Inc. and Portside Growth and Opportunity Fund  (incorporated by reference to Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on July 31,  2009).                                                                                         |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.10              | Amended  and Restated Senior Secured Convertible Note, dated July 30, 2009  (incorporated by reference to Exhibit 10.1 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on July 31,  2009).                                                                                                                                                                   |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.11              | Amendment  Agreement, dated as of October 28, 2009, by and among Image  Entertainment, Inc. and Portside Growth and Opportunity Fund (incorporated  by reference to Exhibit 4.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on October 29, 2009).                                                                                                   |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.12              | Second  Amendment Agreement, dated as of November 15, 2009, by and among Image  Entertainment, Inc. and Portside Growth and Opportunity Fund  (incorporated by reference to Exhibit 4.4 to the Registrant’s Quarterly  Report on Form 10-Q (File No. 000-11071) filed on November 16,  2009).                                                                                      |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.13              | Third  Amendment Agreement, dated as of December 11, 2009, by and among Image  Entertainment, Inc. and Portside Growth and Opportunity Fund  (incorporated by reference to Exhibit 4.1 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on December 15,  2009).                                                                                          |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.14              | Registration  Rights Agreement, dated as of January 8, 2010, by and among Image  Entertainment, Inc., JH Partners, LLC, JH Partners Evergreen Fund, LP,  JH Investment Partners III, LP and JH Investment Partners GP Fund III, LLC.  (incorporated by reference to Exhibit 10.4 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on January 14,  2010). |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 4.14(a)*          | Amendment  Number 1 to Registration Rights Agreement, dated as of March 8, 2010, by  and among Image Entertainment, Inc., JH Partners, LLC, JH Partners  Evergreen Fund, LP, JH Investment Partners III, LP and JH Investment Partners  GP Fund III, LLC.                                                                                                                                                   |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.1**†**    | Employment  Letter Agreement, dated as of April 1, 2008, between Image  Entertainment, Inc. and Jeff M. Framer (incorporated by reference to  Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 11, 2008).                                                                                                                          |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.1(a)**†** | Amendment  to Employment Letter Agreement, dated as of December 22, 2008, between  Image Entertainment, Inc. and Jeff Framer (incorporated by reference to  Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on December 29, 2008).                                                                                                         |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.2**†**    | Employment  Agreement, dated as of March 31, 2009, between Image  Entertainment, Inc. and Jeff M. Framer (incorporated by reference to  Exhibit 10.1 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 10, 2009).                                                                                                                                |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.3**†**    | Employment  Letter Agreement, dated as of April 1, 2008, between Image  Entertainment, Inc. and Bill Bromiley (incorporated by reference to  Exhibit 10.3 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 11, 2008).                                                                                                                           |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.3(a)**†** | Amendment  to Employment Letter Agreement, dated as of December 22, 2008, between  Image Entertainment, Inc. and Bill Bromiley (incorporated by reference  to Exhibit 10.3 to the Registrant’s Current Report on Form 8-K  (File No. 000-11071) filed on December 29, 2008).                                                                                                       |
|   |              |                                                                                                                                                                                                                                                                                                                                                                                                                  |
|   | 10.4**†**    | Employment  Agreement, dated as of March 31, 2009, between Image  Entertainment, Inc. and Bill Bromiley (incorporated by reference to  Exhibit 10.3 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 10, 2009).                                                                                                                                 |

 

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|       | 10.5**†**    | Employment  Letter Agreement, dated as of April 1, 2008, between Image  Entertainment, Inc. and Derek Eiberg (incorporated by reference to  Exhibit 10.4 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 11, 2008).                                                                                                                                                                                                                                |
|------------|-------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.5(a)**†** | Amendment  to Employment Letter Agreement, dated as of December 22, 2008, between  Image Entertainment, Inc. and Derek Eiberg (incorporated by reference to  Exhibit 10.4 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on December 29, 2008).                                                                                                                                                                                                            |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.6**†**    | Employment  Agreement, dated as of March 31, 2009, between Image  Entertainment, Inc. and Derek Eiberg (incorporated by reference to  Exhibit 10.2 to the Registrant’s Current Report on Form 8-K (File  No. 000-11071) filed on April 10, 2009).                                                                                                                                                                                                                                      |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.7**†**    | Form of  Indemnification Agreement, between the Registrant and its directors and  officers (incorporated by reference to Exhibit 10.1 to the Registrant’s  Current Report on Form 8-K (File No. 000-11071) filed on  October 24, 2005).                                                                                                                                                                                                                                                     |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.8**†**    | Image  Entertainment, Inc. 2004 Incentive Compensation Plan (incorporated by  reference to Exhibit A to the Registrant’s Definitive Proxy Statement on  Form DEF 14A (File No. 000-11071) filed on July 29, 2004).                                                                                                                                                                                                                                                                          |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.9**†**    | Form of  Stock Unit Award Grant Notice and Agreement for the Image  Entertainment, Inc. 2004 Incentive Compensation Plan (incorporated by  reference to Exhibit 10.4 to the Registrant’s Quarterly Report on  Form 10-Q (File No. 000-11071) filed on February 14, 2007).                                                                                                                                                                                                              |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.10**†**   | Form of  Option Agreement Amendment (incorporated by reference to Exhibit 10.1 to  the Registrant’s Current Report on Form 8-K (File No. 000-11071)  filed on March 31, 2006).                                                                                                                                                                                                                                                                                                              |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.11**†**   | Image  Entertainment, Inc. 2008 Stock Awards and Incentive Plan (as amended and  restated on May 1, 2009) (incorporated by reference to  Exhibit 10.13 to the Registrant’s Annual Report on Form 10-K (File  No. 000-11071) filed on June 29, 2009).                                                                                                                                                                                                                                   |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| ** ** | 10.12**†**   | Form of Nonqualified Stock Option Agreement  for the Image Entertainment, Inc. 2008 Stock Awards and Incentive Plan  (incorporated by reference to Exhibit 10.14 to the Registrant’s Annual  Report on Form 10-K (File No. 000-11071) filed on June 29,  2009).                                                                                                                                                                                                                        |
| ** ** |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
| ** ** | 10.13**†**   | Form of Incentive Stock Option Agreement for  the Image Entertainment, Inc. 2008 Stock Awards and Incentive Plan  (incorporated by reference to Exhibit 10.15 to the Registrant’s Annual  Report on Form 10-K (File No. 000-11071) filed on June 29,  2009).                                                                                                                                                                                                                           |
| ** ** |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.14             | Loan  and Security Agreement, dated as of May 4, 2007, by and between Wachovia  Capital Finance Corporation (Western) and Image Entertainment, Inc., as  Administrative Borrower, Egami Media, Inc., Image Entertainment (UK), Inc.  and Home Vision Entertainment, Inc., as Guarantors, and the Lenders  named therein (incorporated by reference to Exhibit 10.21 to the  Registrant’s Annual Report on Form 10-K (File No. 000-11071) filed  on June 29, 2007). |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.14(a)          | First  Amendment to Loan and Security Agreement, dated as of April 28, 2008, by  and between Wachovia Capital Finance Corporation (Western) and Image  Entertainment, Inc. (incorporated by reference to  Exhibit 10.25(a) to the Registrant’s Annual Report on  Form 10-K (File No. 000-11071) filed on June 30, 2008).                                                                                                                                                          |
|       |              |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |
|       | 10.14(b)          | Second  Amendment to Loan and Security Agreement, dated as of June 23, 2009,  between Wachovia Capital Finance Corporation (Western), Image  Entertainment, Inc., Egami Media, Inc. and Image Entertainment  (UK), Inc. (incorporated by reference to Exhibit 10.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on June 25, 2009).                                                                                                       |

 

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|   | 10.14(c)        | Third  Amendment to Loan and Security Agreement, dated as of July 30, 2009,  between Wachovia Capital Finance Corporation (Western), Image  Entertainment, Inc., Egami Media, Inc. and Image Entertainment  (UK), Inc. (incorporated by reference to Exhibit 10.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on July 31, 2009).                                                      |
|--------|-----------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.14(d)        | Fourth  Amendment to Loan and Security Agreement, dated as of January 8, 2010,  between Wachovia Capital Finance Corporation (Western), Image  Entertainment, Inc., Egami Media, Inc. and Image Entertainment  (UK), Inc. (incorporated by reference to Exhibit 10.5 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on January 14, 2010).                                                |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.15           | Securities  Purchase Agreement, dated December 21, 2009, by and between Image  Entertainment, Inc., JH Partners, LLC, as the Investor Representative,  and JH Investment Partners Evergreen Fund, L.P., JH Investment Partners III,  L.P. and JH Investment Partners GP Fund III, LLC. (incorporated by reference  to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K  (File No. 000-11071) filed on December 22, 2009). |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.16           | Amendment  to Securities Purchase Agreement, dated December 24, 2009, by and  between Image Entertainment, Inc. and JH Partners, LLC. (incorporated by  reference to Exhibit 10.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on December 31, 2009).                                                                                                                                                  |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.17           | Amendment  Number 2 to Securities Purchase Agreement, dated December 30, 2009, by  and between Image Entertainment, Inc. and JH Partners, LLC.  (incorporated by reference to Exhibit 10.2 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on December 31,  2009).                                                                                                                                        |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.18           | Amendment  Number 3 to Securities Purchase Agreement, dated January 20, 2010, by  and between Image Entertainment, Inc. and JH Partners, LLC (incorporated  by reference to Exhibit 10.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on January 20, 2010).                                                                                                                                            |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.19*          | Amendment  Number 4 to Securities Purchase Agreement, dated March 8, 2010, by and  between Image Entertainment, Inc. and JH Partners, LLC.                                                                                                                                                                                                                                                                                                                    |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.20           | Payoff  Letter between Image Entertainment, Inc. and Portside Growth and  Opportunity Fund (incorporated by reference to Exhibit 10.1 to the  Registrant’s Current Report on Form 8-K (File No. 000-11071) filed  on January 13, 2010).                                                                                                                                                                                                   |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.21           | Exchange  Agreement, dated January 8, 2010, by and between Image  Entertainment, Inc. and Portside Growth and Opportunity Fund  (incorporated by reference to Exhibit 10.6 to the Registrant’s Current  Report on Form 8-K (File No. 000-11071) filed on January 14,  2010).                                                                                                                                                         |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.22           | Consulting  Agreement, dated as of April 1, 2009, by and between Image  Entertainment, Inc. and EIM Capital Management, Inc. (incorporated  by reference to Exhibit 10.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on April 3, 2009).                                                                                                                                                          |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 10.23**†** | Waiver  and Release Agreement, dated as of June 11, 2009, by and between Image  Entertainment, Inc. and David Borshell (incorporated by reference to  Exhibit 10.21 to the Registrant’s Annual Report on Form 10-K (File  No. 000-11071) filed on June 29, 2009).                                                                                                                                                                    |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 21.1*****       | Subsidiaries  of the Registrant.                                                                                                                                                                                                                                                                                                                                                                                                                                        |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 23.1*****       | Consent  of BDO Seidman LLP, Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                                                                                        |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 31.1*****       | Rule 13a-14(a)/15d-14(a) Certification  of President and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                             |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 32.1*****       | Section 1350  Certification of President and Chief Financial Officer.                                                                                                                                                                                                                                                                                                                                                                                              |
|   |            |                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   | 99.1            | Notice  of termination of the Agreement and Plan of Merger, among Nyx  Acquisitions, Inc., The Conceived Group, Inc., and Image  Entertainment, Inc., sent by the Registrant on April 17, 2009                                                                                                                                                                                                                                                      |

 

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|   |   | (incorporated  by reference to Exhibit 99.1 to the Registrant’s Current Report on  Form 8-K (File No. 000-11071) filed on April 23, 2009).                                                    |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                   |
|   | 99.2   | Press  Release, dated November 16, 2009 (incorporated by reference to  Exhibit 99.1 to the Registrant’s Quarterly Report on Form 10-Q  (File No. 000-11071) filed on November 16, 2009). |

 

----

***   Filed herewith.**

 

**†   Management contract or compensatory plan orarrangement.**

 

**p****  Certain information in this exhibit has beenomitted and filed separately with the SEC pursuant to a confidential treatmentrequest that has been granted by the SEC.**

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
|                      |   | IMAGE ENTERTAINMENT, INC.                       |
|---------------------------|--------|------------------------------------------------------|
|                      |   | A Delaware corporation                               |
|                      |   |                                                 |
|                      |   |                                                 |
| Dated: June 29, 2010 |   | */s/ THEODORE S. GREEN*                              |
|                      |   | THEODORE  S. GREEN                                   |
|                      |   | Chairman  and Chief Executive Officer                |
|                      |   | (Principal  Executive Officer)                       |
|                      |   |                                                 |
|                      |   |                                                 |
| Dated: June 29, 2010 |   | */s/ JOHN P. AVAGLIANO*                              |
|                      |   | JOHN  P. AVAGLIANO                                   |
|                      |   | Chief  Operating Officer and Chief Financial Officer |
|                      |   | (Principal  Financial and Accounting Officer)        |

 

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities and on the dates indicated.

 
| Dated: June 29, 2010 |   | */s/ THEODORE S. GREEN*                              |
|---------------------------|--------|------------------------------------------------------|
|                      |   | THEODORE  S. GREEN                                   |
|                      |   | Chairman  and Chief Executive Officer                |
|                      |   | (Principal  Executive Officer)                       |
|                      |   |                                                 |
|                      |   |                                                 |
| Dated: June 29, 2010 |   | */s/ JOHN P. AVAGLIANO*                              |
|                      |   | JOHN  P. AVAGLIANO                                   |
|                      |   | Chief  Operating Officer and Chief Financial Officer |
|                      |   | (Principal  Financial and Accounting Officer)        |
|                      |   |                                                 |
|                      |   |                                                 |
| Dated: June 29, 2010 |   | */s/ PATRICK M. COLLINS*                             |
|                      |   | PATRICK  M. COLLINS                                  |
|                      |   | Director                                             |
|                      |   |                                                 |
|                      |   |                                                 |
| Dated: June 29, 2010 |   | */s/ MICHAEL J. JOHN*                                |
|                      |   | MICHAEL  J. JOHN                                     |
|                      |   | Director                                             |

 

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