**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

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**FORM 10-K**

 
| **ý** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934** |
|------------|------------------------------------------------------------------------------------------------|
|       | **For The Fiscal Year  Ended March 31, 2004**                                             |

 

**OR**

 
| **o**  | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                             |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   | **For The Transition  Period  From                  To                  ** |

 

**CommissionFile Number 0-11071**

 

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**IMAGE ENTERTAINMENT, INC.**

(Exact name of registrant as specified in itscharter)

 
| **California**                                                                                         |   | **84-0685613**                          |
|--------------------------------------------------------------------------------------------------------|--------|-----------------------------------------|
| (State or other jurisdiction of  incorporation)                                                        |   | (I.R.S. Employer Identification Number) |
|                                                                                                   |   |                                    |
| **9333 Oso Avenue, Chatsworth, California  91311**                                                     |
| (Address of principal executive offices,  including zip code)                                          |
|                                                                                                   |   |                                    |
| **(818) 407-9100**                                                                                     |
| (Registrant’s telephone number, including  area code)                                             |
|                                                                                                   |   |                                    |
| Securities registered pursuant to  Section 12(b) of the Act:  **None**                       |
|                                                                                                   |   |                                    |
| Securities registered pursuant to  Section 12(g) of the Act:  **Common Stock, no par value** |

 

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  YES ýNO o

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theAct).  YES oNO ý

 

At June 2, 2004, 18,268,073 shares of the registrant’s commonstock were outstanding, and the aggregate market value of the common stock heldby nonaffiliates of the registrant was approximately $35,055,000 (based on the$3.64 closing price on the NASDAQ National Market on such date), excludingshares of common stock held by the registrant’s directors, executive officers,5% or more shareholders, and their affiliates. Their holdings have been excluded in that such persons may be deemedaffiliates.  This determination ofaffiliate status is not necessarily a conclusive determination for otherpurposes.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Part III – Portions of the registrant’s proxy statement for its 2004Annual Meeting of Shareholders to be held on September 10, 2004, areincorporated by reference into Part III of this report.

 

 

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**IMAGE ENTERTAINMENT, INC.**

**Form 10-K Annual Report**

**For The Fiscal Year Ended March 31, 2004**

 

**TABLE OF CONTENTS**

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

 

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**PART I**

 

**ITEM1.****                                                     BUSINESS**

 

**OVERVIEW**

 

We are a home entertainment company primarily engaged in the domesticacquisition and wholesale distribution of programming for release on DVD.  We acquire and exploit exclusive distributionrights to a diverse array of general and specialty programming, including musicconcerts, urban, youth culture/lifestyle, stand-up comedy, television andtheatrical, foreign and silent films, in DVD, CD and other home entertainmentformats.  We may also acquire relatedbroadcast rights, including video-on-demand, broadband streaming, digitaldownload, pay-per-view, in-flight, radio, satellite, cable and broadcasttelevision, and we exploit and plan to exploit these rights as opportunitiesand technologies allow.  We acquireprogramming mainly by entering into exclusive licensing or distributionarrangements with producers and other content providers, which we oftensupplement by designing and producing additional content and value-addedfeatures, such as:

 

•                                          interactivemenus;

•                                          audiocommentaries;

•                                          packaging;and

•                                          marketingmaterials.

 

We also produce our own original entertainment programming, focused onDVD live performance music concerts and urban genre programming.  We will seek to co-produce live-actionhorror and animated titles through a “first-look” deal we entered into withDark Horse Entertainment, Inc.  Welicense and distribute programming across many genres and in many formats,although we specialize in music-related and special interest DVDprogramming.  We strive to grow a streamof revenues by maintaining and building a library of titles that can beexploited in a variety of formats and distribution channels.  Our active catalogue currently contains over2,600 exclusive DVD titles.

 

We were incorporated in Colorado as Key International FilmDistributors, Inc. in April 1975, our present name was adopted in 1983,and we reincorporated in California in November 1989.  Our principal executive offices are locatedat 9333 Oso Avenue, Chatsworth, California 91311, telephone (818)407-9100.  Beginning July 1, 2004,we plan to relocate our principal executive offices to 20525 Nordhoff Street,Suite 200, Chatsworth, California 91311, and expect to complete the relocationby the end of August 2004.  Wemaintain a Web site at www.image-entertainment.com.  The content of this site does not constitute a part of thisreport.

 

The following table sets forth the percentage of consolidated netrevenues derived from the distribution of entertainment programming by formatfor our last three fiscal years.  Thefinancial information presented excludes that of our wholly-owned subsidiary,DVDPlanet, Inc., whose assets we sold in September 2003.  See “Discontinued Operations”below.  The information does not representour business segments, but rather shows net revenue trends by product category:

 
|               |   | **Fiscal  Years Ended  March 31,** |   |
|--------------------|--------|-----------------------------------------|--------|
| **(in thousands)** |   | **2004**                                |   | **2003** |   | **2002** |   |
|               |   |                                    |   |   |   |   |   |   |   |   |   |   |   |
| DVD                |   | $                                       | 70,859 |   | 83.5 | % | $ | 76,142 |   | 87.6 | % | $ | 66,675 |   | 87.6 | % |
| VHS                |   | 1,415                                   |   | 1.7 |   | 3,593 |   | 4.1 |   | 4,678 |   | 6.1 |   |
| CD                 |   | 5,591                                   |   | 6.6 |   | 2,947 |   | 3.4 |   | 1,500 |   | 2.0 |   |
| Sublicense         |   | 5,607                                   |   | 6.6 |   | 2,101 |   | 2.4 |   | 1,719 |   | 2.2 |   |
| Broadcast          |   | 544                                     |   | 0.6 |   | 1,724 |   | 2.0 |   | 1,347 |   | 1.8 |   |
| Other              |   | 824                                     |   | 1.0 |   | 422 |   | 0.5 |   | 216 |   | 0.3 |   |
| TOTAL              |   | $                                       | 84,840 |   | 100 | % | $ | 86,929 |   | 100 | % | $ | 76,135 |   | 100 | % |

 

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**DISCONTINUEDOPERATIONS**

 

On September 23, 2003, we sold substantially all of the assets ofour wholly-owned subsidiary DVDPlanet, Inc. This marked our departure from the direct-to-consumer retaildistribution business.  We incurred aloss of approximately $699,000 on the sale, and we expensed approximately$293,000 in severance-related compensation liability in connection with the sale.  Our accrued liability for severance-relatedcompensation is $206,000 at March 31, 2004, which will be paid in equalmonthly installments through December 2004.  DVDPlanet’s financial results have beenclassified separately as discontinued operations in our consolidated financialstatements for all periods presented.

 

**BUSINESS SEGMENTS**

 

We currently have two business segments:

 

•                                          *Domestic*

 

•                                          *International*

 

Our domestic segment primarily consists of acquisition, production anddistribution of exclusive DVD programming. Our international segment includes international sublicensing andworldwide broadcast rights exploitation.

 

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

 
|                           |   | **Fiscal  Years Ended  March 31,** |   |     |   |
|--------------------------------|--------|-----------------------------------------|--------|----------|--------|
|                           |   | **2004**                                |   | **2003** |   | **% Change** |   |
| Net revenues: *(in thousands)* |   |                                    |   |     |   |   |   |
| Domestic                       |   | $                                       | 78,370 |     | $      | 77,484 |   | 1.1 | % |
| International                  |   | 6,470                                   |   | 9,445    |   | (31.5 | ) |
| Consolidated                   |   | $                                       | 84,840 |     | $      | 86,929 |   | (2.4 | )% |

 

***Domestic***

 

Most of the product we sell is in the DVD format.  According to industry estimates, there arecurrently more than 34,000 DVD titles available in the domestic market, ofwhich approximately 2,600 are actively and exclusively licensed to (orexclusively distributed through) Image. We have developed a specialty niche in distribution of exclusivemusic-related entertainment programming. We are currently a leading independent supplier of DVD programming inthe music, special interest, episodic television, urban and lifestyle genres.  The following chart reflects the number ofcumulative titles we have released by type of programming, compared with thecumulative DVD software titles released by the industry (including discontinuedtitles) through the week of June 4, 2004. The following chart does not intend to indicate Image’s market share ofDVD revenues, only cumulative titles released.

 
| **Type of DVD Programming**                     |   | **Total  Number  of DVD Titles** |   | **Number of  Image Titles** |   | **Image  Percentage** |   |
|-------------------------------------------------|--------|----------------------------------|--------|-----------------------------|--------|-----------------------|--------|
| Music                                           |   | 3,918                            |   | 527                         |   | 13                    | %      |
| Special Interest                                |   | 5,751                            |   | 453                         |   | 8                     | %      |
| Theatrical Catalog (pre-1997)                   |   | 7,311                            |   | 380                         |   | 5                     | %      |
| Foreign Language (including distributed  lines) |   | 2,691                            |   | 320                         |   | 12                    | %      |
| Television Programming                          |   | 1,588                            |   | 107                         |   | 7                     | %      |
| Direct to DVD                                   |   | 5,236                            |   | 320                         |   | 6                     | %      |
| All Other                                       |   | 8,484                            |   | 1,165                       |   | 14                    | %      |
| Total Releases – Cumulative through 6/4/04 |   | 34,979                           |   | 3,272                       |   | 9                     | %      |

 

*Source:  DVD Release ReportRevised 6/2/04*

 

We believe that the value gained through the ability to entertainpeople at home for a reasonable price at convenient times, the opportunity tochoose from a very broad selection of programming, the unique and compellinginteractive experience of DVD menus, and the audio and video quality of the DVDformat, will continue to make DVD

 

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a preferred, prepackaged software medium of home entertainment formillions of consumers.  Many DVDs alsooffer special features, enhancements and ancillary materials, such as specialmenu design, multiple audio tracks, behind-the-scenes footage, directorcommentaries, interviews and discographies, all of which we are able to developin-house for our exclusive titles.  Wealso believe that the major studios’ promotion of DVDs for sale and rental hasserved to accelerate consumer awareness of and interest in the DVD format.

 

*Exclusive Acquisition.*  We generally acquire exclusive rights to ourprogramming.  Our active catalogcurrently contains over 2,600 exclusive DVD titles, and we currently release anaverage of over 40 new exclusive DVD titles each month.  We typically acquire our exclusive titlesfrom a wide range of content holders, including independent program suppliers,producers, music artists, record labels and artist management.  We produce, market and sell our exclusiveprogramming according to exclusive license or distribution agreements.  We actively pursue and secure both domestic(i.e. U.S. and Canadian) and international rights to its exclusive titles.

 

In return for exclusive license rights, we pay royalties to ourlicensors.  Royalties are expressed as apercentage of our wholesale net revenues derived from program sales.  Typically, we pay royalty advances that arerecouped against royalties earned on a title-by-title basis or, if“cross-collateralized,” against groups of licensed titles from the samelicensor.  Our license agreementsgenerally provide for a minimum distribution term of at least five years andoften considerably longer.  Some licenseagreements contain provisions for an extension of the distribution term if wemeet specified performance plateaus.

 

In return for exclusive distribution rights, we generally tender netwholesale revenues to program suppliers, which are expressed as a percentage ofwholesale revenues, after subtracting our distribution fee and recouping costsallocated to the content owner, such as production, manufacturing, musicpublishing, and marketing fees.  In somecases, the net profit of a title is split (according to the contractualpercentage) between Image and the program supplier.  In many such cases, advances on an exclusive distribution dealare paid and recouped by Image similar to an exclusive licensing arrangement.

 

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

 

While our core business remains the domestic acquisition anddistribution of DVDs, we seek to secure and exploit the broadest possible grantof home entertainment programming rights. As part of our strategic goal to secure the broadest possible range ofrights for exclusive programming, we may finance all or part of the productionof some of our entertainment programs. The programs we produce are generally one-time, special event, livemusic concerts or urban genre programming, produced for the express purpose ofexclusive exploitation by Image in all home entertainment and broadcastmarkets.  Through a “first-look” deal weentered into with Dark Horse Entertainment, we will seek to co-producelive-action horror and animated titles. The rights we retain in connection with our self-financed productionsgenerally cover, in perpetuity, all territories throughout the world and allnow-known and hereafter-devised home entertainment formats, including video,broadcast, audio, in-flight, Internet streaming, digital downloading, directresponse, sponsorship and bundling rights.

 

Because of our growing library of exclusive titles in a wide variety ofgenres, we believe that we are positioned to benefit from the market growth ofthe DVD format.  We intend to continueexpansion of our exclusive DVD library throughout the coming year.

 

*Nonexclusive Distribution*.  We do not generally distribute nonexclusiveprogramming.  However, as a requestedservice to seven of our largest domestic accounts (Alliance Entertainment, BestBuy, Borders, Musicland, Tower, Trans World and Virgin), we act as a supplierto these accounts for approximately six lines of smaller independentprogramming.

 

*Additional Services.*  We provide a variety of value-added servicesrelative to our licensed programs and many of our exclusively distributedprograms, including: creation of packaging, DVD authoring and compression, menudesign, video master quality control, manufacturing, marketing, sales, musicclearance, warehousing, distribution, and,

 

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for some titles, the addition of enhancements such as multiple audiotracks, commentaries, foreign language tracks, and other ancillary materials(behind-the-scenes footage, interviews, discographies).  All of these services are typically performedin-house, with the exception of some music clearance, disc manufacturing andtape replication, package printing and packaging of the finished product, whichare performed by third party vendors.

 

*Manufacturing.*  Typically, a program supplier delivers atitle master and artwork to us, and our in-house post-production facilitycreates a submaster with specifications for the necessary format and on-screenmenus for each title.  Our in-houseauthoring and compression team then typically performs the work necessary toprepare a DVD master for manufacturing. Occasionally, because of the large volume of our exclusive releases, wemay use an outside facility to perform such services.  Our in-house creative services department, staffed with graphicdesigners, copywriters and proofreaders, creates original and innovativepackaging fundamental to the marketing success of our product.  Deluxe Media Services, Inc., formerly RitekGlobal Media, manufactures and packages our domestic DVD programming.  We use two other vendors for CDmanufacturing, L&M Optical West and Sony DADC Global.

 

*Marketing.*  Our in-house marketing department directsmarketing efforts toward consumers, audio and video software retailers, andhardware retailers.  Our marketingefforts involve point-of-sale advertising, print advertising in trade andconsumer publications, national television and radio advertising campaigns,direct response campaigns, dealer incentive programs, trade show exhibits andbulletins featuring new releases and catalogue promotions.  We have also instituted account-specificmarketing programs where we work directly with retailers to optimize andcustomize print advertising and other advertising programs to promote ourexclusive product.  The creation ofspecialized in-store displays and celebrity appearances are other examples ofaccount-specific marketing programs.  Wealso implement Internet promotional activities that include product tie-ins,sweepstakes, and giveaways associated with online retail customers, and thecreation of genre-specific “boutiques” within direct-to-consumer Web sites.

 

We spent approximately $2,445,000, or 2.9% of net revenues, for productpromotion, advertising in trade and consumer publications in fiscal 2004,almost entirely for domestic wholesale distribution, and approximately$1,530,000, or 1.8% of net revenues, for product promotion and advertising intrade and consumer publications in fiscal 2003.  Additionally, our market development expenditures for account-specificand other marketing programs were approximately $2,437,000 and $1,886,000, or2.8% and 2.1% of net revenues before reduction for such market developmentfunds, for fiscal 2004 and 2003, respectively.

 

We maintain a Web site at www.image-entertainment.com to help promoteImage and our products.  The Web siteincludes press releases, information regarding our exclusive titles, andinformation of general interest to the home entertainment consumer.

 

*Customers.*  We sell our product to retailers (includingInternet retailers), distributors and via alternative distribution (includingdirect-to-consumer print catalogues, direct response campaigns and othernon-traditional sales channels). Domestic delivery of our product is typically effected through ourwarehouse and distribution facility in Las Vegas, Nevada.

 

We sell directly to many large and small retailers.  Some of our key sell-through customersinclude AEC One Stop, Amazon.com, Best Buy, Borders, Columbia House, IngramEntertainment, The Musicland Group, Tower Records & Video, Trans WorldEntertainment, VidCanada and Wal-Mart. In addition, we sell to rental-retail hybrid customers BlockbusterVideo, Hollywood Video, Movie Gallery and online rental-only customer Netflix.  Over the last several years, many of oursell-through and rental-retail customers have helped grow our audio revenues bypurchasing audio CDs in addition to home video product.  Our special markets division is designed totake advantage of our large and diverse catalog and specifically targets nichesales opportunities.  Special markets’retailers to whom we have sold product include Barjan, Crutchfield Corporation,Doubleday, the Gene Autry Museum, Guitar Center, Hot Topic, KSG Distribution,the Lucy/Desi Museum, the Metropolitan Opera Guild, and Surf Video Network.  On a consolidated basis, Best Buy and AECOne Stop accounted for 16.5% and 12.0%, respectively, of fiscal 2004 netrevenues.  Best Buy and The MusiclandGroup (which was owned by Best Buy through June 16, 2003) accounted for21.1% and 19.1% of fiscal 2003 and fiscal 2002 net revenues, respectively.  No other customers accounted for netrevenues individually in excess of 10% of our total net revenues for fiscal2004, 2003 and 2002.

 

We allow retail customers to return a portion of their inventory on aquarterly basis.  We reserve forestimated returns at the time the sale is recognized, based in part upon ourhistorical returns experience and knowledge of specific product movement withindistribution channels.  Stock returns,other than for defective product, amounted to approximately 19.3% of netrevenues in fiscal 2004, approximately 15.5% of net revenues in fiscal 2003,and

 

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approximately 12.5% of net revenues in fiscal 2002.  Returns of defective product have beenminimal and are generally covered by manufacturers’ warranties.

 

As of June 17, 2004, we had approximately $5.3 million of backlogorders (71% from DVD product) from domestic wholesale customers compared withapproximately $4.0 million of backlog orders (96% from DVD product) as ofJune 11, 2003.  We expect to fill100% of the backlog orders, less any cancelled orders, this fiscal year.

 

***International***

 

*International Sublicensing.*  We have an exclusive sublicense agreementfor our video programming (primarily music-related DVDs) with BMG MusicInternational Service, GmbH for Europe, the Middle East (excluding Israel andTurkey) and Africa, and an exclusive subdistribution agreement with BMGEntertainment Mexico, S.A. for Mexico and Central America.  The sublicense agreement contains terms andconditions similar to those governing our underlying rights agreements.  BMG pays a royalty on wholesale revenues itgenerates, and is responsible for all sales (including taxes), marketing,publishing, manufacturing (except for Mexico and Central America, where weprovide finished goods) and distribution of our programming in theterritories.  For distribution to alarge portion of the rest of the world, we have similar sublicenses with otherthird parties.

 

*Worldwide Broadcast.*  Buyers of our standard and high-definitionbroadcast rights are typically cable, pay-per-view, video-on-demand orsatellite broadcasters, and sometimes terrestrial (free) television orin-flight broadcasters.  Under a typicalbroadcast license we receive payment of a one-time, fixed, non-refundable feefor a multi-year exploitation term and in many instances for a specified numberof airings.  With respect topay-per-view and video-on-demand, we typically receive a non-refundable advanceagainst royalties that are based on a percentage of customer buys.  Our obligations under broadcast licensingare usually only to provide a broadcast master of the program and to ensurethat all music synchronization rights are secured.

 

We have an exclusive salesagency agreement with London-based NBD Television LTD for worldwide broadcasttelevision sublicenses of the majority of the current catalogue of programmingfor which we hold broadcast rights (in excess of 200 programs) as well as ournew release acquisitions which feature broadcast rights.  NBD represents us for conventionaltelevision broadcast sales (whether standard or high-definition), includingcable, pay-per-view, video-on-demand, satellite television, and sales tonon-theatrical venues.  Internet rights(video-on-demand via the Internet, digital downloading and streaming) areexcluded from the NBD agreement. Programs that were sublicensed to third parties for broadcast prior toJanuary 2003 will be handled by NBD upon the expiration of the existinglicenses.

 

**COSTSTRUCTURE**

 

Our most significant costs and cash expenditures relate to acquiringcontent for exclusive distribution and, more recently, the funding of contentproduction or co-production for exclusive distribution.  Agreements to acquire programming typicallycome in the form of either an exclusive license agreement, where we payroyalties for the exclusive distribution rights, or an exclusive distributionagreement, where we generally receive distribution fees and pay net profitsafter recoupment of our upfront costs. We generally base our offers of upfront royalties or (for distributionagreements) net profit payments on the expected success of a title’sperformance at retail, actual cost of the production, and competition for thetitle’s exclusive distribution rights.

 

Under a typical exclusive license agreement, we pay, in advance,royalties which normally become due to the content supplier upon the sale ofDVD, CD or VHS units of the program to our retail customers.  Royalties are contractually expressed as apercentage of net revenues.  Upon ourrecoupment of the advance, we pay the content supplier royalty overages at thesame rate.  If we do not recoup ourinitial advance by the end of the agreement’s term, the content supplierreceives no additional royalties but is not typically liable for reimbursementof our unrecouped advance.  Royaltyadvances may be used by the content supplier to actually produce the content incases where the content has not yet been created.  Under these exclusive license agreements, we are responsible formanufacturing, packaging, music publishing (in the case of music DVDs and CDs),menu production, authoring and compression, package design and layout, selling,marketing and distribution expenses.

 

Under a typical exclusive distribution agreement, we may pay upfrontfees, which are expressed as advances against future net profits, or we may payfor the cost of the content’s production in advance.  Our net profits for these

 

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deals are usually the profits remaining after we recoup our incurredcosts and additional costs such as the cost of the content’s production.  We may receive a distribution fee from therevenues we generate from distribution of the programming and may also splitnet profits according to contractual percentages.  If net profits are not achieved, the content supplier receivesonly the production costs or distribution fees advanced.  We recoup all of our incurred costs beforeany net profit disbursement is made to the content supplier.

 

In addition to advances, upfront fees and production costs, the othersignificant costs we incur are for

 

•                  DVD and CDreplication

•                  Packaging

•                  Music publishing

•                  Advertising, andmarket development funds provided retail customers

•                  Domesticshipping costs from self-distribution of exclusive programming

•                  Personnel costs

 

Our financial focus is on achieving long-term, sustainable growth andprofitability.  We also seek to improveour cash flow position in order to continue licensing (or entering intoexclusive distribution agreements for) high quality DVD and other entertainmentprogramming and funding operations.

 

**COMPETITION**

 

We continue to face increasing competition from major motion picturestudios, independent DVD suppliers and other home entertainment providers forprogramming, retailer “open to buy” dollars (which are the purchasing budgetsthat retailers allocate to purchase new release or catalogue programming) andlimited retail shelf space as new DVD releases often exceed 250 titles a week.

 

***Competition forProgramming***

 

We face increasing competition in securing exclusive license anddistribution rights, from other independent distribution companies as well asmajor motion picture studios and music labels. As retail shelf space for home video formats increases, more and morecompanies view DVD licensing and distribution as an attractive business.  Many, including Navarre Corporation, LionsGate and several of the major studios, are launching or expanding efforts inthe DVD licensing market, sometimes in the form of direct-to-video motionpictures.  Because the home video rightsto most newly released and catalogue motion pictures are already owned by themajor studios, the market for high-profile DVD programming is limited.  Moreover, the market for available,high-profile music DVD programming is also limited as major record labelscontinue to increase the number of music titles released on DVD through theirown labels.

 

In light of the increase in demand and limitation in supply, obtainingquality DVD programming at reasonable prices is more challenging.  Our internal analyses and procedures, whichare designed with the goal of timely recoupment, limit the up-front advancesagainst future royalties or (for distribution agreements) net profit paymentswe are willing to pay to secure distribution rights.  Accordingly, we may not be able to remain competitive againstadvance offers from competitors with greater financial resources or who arewilling to pay larger advances.  Thischallenge is compounded when competitors who lack broad expertise in the fieldof DVD licensing occasionally offer advances or other terms for programmingwhich we believe to be unrealistic. Although such unrealistic offers might have adverse effects on thesecompetitors’ businesses in the medium- and long- term, the short-term effectappears to be an artificial inflation in valuations, which effectivelydecreases the availability of quality programming.

 

We believe that we will continue to compete successfully in obtainingexclusive rights to home entertainment programming.  This is due in large part to our ability to offer an array ofother assets to our program suppliers, including:

 

•                                          thehigh quality of expertise and the service our employees provide;

•                                          oursuperior, long-standing reputation within the home entertainment industry;

•                                          ournotable ability to obtain and sustain ongoing relationships with valuablesuppliers of entertainment programming;

•                                          thequality of our finished product;

 

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•                                          ourwide-ranging in-house services; and

•                                          ourdirect and long-standing relationships with traditional and online retailers ofentertainment programming.

 

***Competition forRetailer Open to Buy Dollars***

 

With respect to our ability to sell our exclusive product to retailers,our foremost competition is from the major motion picture studios (ColumbiaTri-Star, Disney, Dreamworks, Fox, MGM, Paramount, Universal and Warner), the“mini-majors” (Lions Gate (which recently purchased Artisan), Miramax and NewLine), major music labels (BMG, Sony, Universal and Warner Music Group) andother independent suppliers with sales models and structures similar to ours.

 

We compete with these other program suppliers for limited open to buydollars allocated by retailers to purchase new release or catalogueprogramming.  Open to buy dollars arebecoming more scarce for independents like Image, since such dollars are oftendevoted to high-profile new releases from major studios, particularly duringthe holiday season.  Reduced wholesaleDVD pricing instituted by the major studios and labels, coupled with theirongoing catalogue campaigns, has also increased competition for open to buydollars.

 

Most studios and labels are subsidiaries of much larger mediaconglomerates that have a great deal of financial resources.  As an independent program supplier, however,we can offer our licensors unique and specialized products, as well as highlyfocused marketing campaigns, for titles that may otherwise be deemed too smallby the major studios, or neglected by a corporate conglomerate.  We believe that our status as a worldwide,independent program supplier capable of exploiting content in all homeentertainment and broadcast formats effectively makes us a “one-stop” providerof entertainment rights exploitation, which is often attractive to potentiallicensors.

 

***Competition forRetail Shelf Space***

 

Our exclusive programming competes for a finite amount of shelf spaceagainst a growing supply of entertainment programming.  We believe this competition can beespecially challenging for independent labels like us, because the new DVDreleases of major studios often have extremely high visibility and salesvelocity in the millions of units, which typically require more shelf space tosupport.  In light of the impact ofmajor studio releases, our expenses with respect to providing marketdevelopment funds and cooperative advertising dollars to our retail customersfor items such as in-store displays and store circulars continue to increase,even as the availability of these opportunities continues to decrease.  This selling of shelf real estate, whetherreal or virtual, is becoming more expensive as the total number of DVD releasescontinues to grow.  With the exceptionof our more popular new titles and top-selling catalogue, it can be a challengeto obtain the product placement necessary to maximize sales, particularly amongthe limited number of major retailers that are our core customers.

 

Retailers are increasingly looking for studios and independents to payto secure display and shelf space within their stores.  Even some successful Internet retailers nowrequire paid participation in these types of programs in order to ensure visibilityand positioning on their Web sites. Some of these programs can cost as much as 6% of a retailer’s totalorder, although we may also realize significant advertising and marketingbenefits from such programs, especially if they grant competitive benefits overother studios and independents that are unable or unwilling to pay.  One example of such a program in which weare participating is the “vendor alliance program” of Best Buy, our largestcustomer.  As competition in ourindustry continues to increase, we expect that more retailers will adopt thesetypes of programs, which would result in decreased gross margins.

 

***IncreasingCompetition***

 

As the DVD industry matures, with penetration of U.S. televisionhouseholds having exceeded 50%, and new space being allocated for DVDprogramming, the competition level will continue to rise.  The major studios remain consistent andprolific in their ability to bring new theatrical programming to retailers.  They have large libraries of classicprogramming to release on DVD.  Newindependent suppliers are continually emerging, further adding to thecompetition.  The additional promotionalopportunities and open to buy dollars may be severely compromised by the newmajor theatrical programming, new independent suppliers and the vast cataloguelibraries from the major studios.

 

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**INDUSTRY TRENDS**

 

According to Video Store Magazine market research of consumer buyingpatterns (April 25-May 1, 2004), total video sales (DVD and VHS) were $14billion in calendar 2003, a 15.8% increase from the prior year.  While domestic sales of VHS titles declinedover 35% to $2.2 billion in 2003, domestic sales of DVD jumped over 35% to$11.8 billion and represented about 84% of the $14 billion that consumers spentbuying video.  Consumers spent $24.7billion buying as well as renting videos in 2003, primarily as a result of thesurge in popularity of DVD, and many retailers are scaling back their shelfspace allotted to VHS in favor of more DVD. According to the Digital Entertainment Group, a not-for-profit marketinggroup comprised of consumer electronics and home entertainment companies (ofwhich we are a member), consumers bought over 33 million DVD players in 2003,an over 34% increase over 2002.  Alsoaccording to the Digital Entertainment Group, by the end of 2003, DVD householdpenetration passed the 50% mark, with the number of U.S. homes with a DVDplayer increasing to 57 million, and with more than 20 million of those homesboasting two or more DVD players.

 

The overall economic climate and the uncertainty surrounding someretailers’ efforts to reorganize or restructure their businesses may lead to anincreased risk of customer bankruptcy within the DVD retail space as well as anincreased percentage of product returns to Image.  In particular, DVD retailers who also specialize in CD sales arebecoming increasingly vulnerable to mounting pressure from warehouse-style andonline discounters, who now routinely offer CDs for sale, and from illegaldownloading of music from the Internet and other CD piracy.  Many CD retailers have tried to reduce theimpact of these downward pressures by also selling DVDs, video games and othermerchandise.  Nevertheless, theaforementioned reorganizations and restructurings, as well as a significantnumber of store closures among CD retailers, appear to support an industrytrend toward consolidations and reductions within the retail space, includingretail space dedicated to DVD.

 

The consumer DVD buying pattern is rapidly shifting from the catalogueprogramming-focused early adopter to more of a mass market consumer driven byhigh-profile, big-budget theatrical films. Both major studio and independent DVD suppliers now see that the primarydrivers of revenues are new releases, which generate both retail and consumerinterest and also help drive the sale of catalogue programming.  We have a diverse catalogue of programming,and according to DVD Release Report Revised 6/2/04, Image is the top source formusic on DVD with 527 titles released, and the top source for special interestprogramming on DVD with 453 titles released. We typically add an average of over 40 DVD titles per month to ourcurrent catalogue of over 2,600 active DVD titles.  Sales of our catalogue programming are affected by the strengthof our new releases, the availability of retail shelf space and retailer opento buy dollars.  With major studio DVDsuppliers releasing both their hit new releases as well as their deep catalogueof programming, the competition for available retail shelf space isincreasingly challenging.

 

**TRADEMARKS**

 

We have obtained federal registrations of the trademarks “Image” and“Image Entertainment,” and have a pending application for the trademark “ImageMusic Group.”  It is our policy toprotect and defend our trademark rights in all applicable classes of goods andservices.

 

**EMPLOYEES**

 

As of June 5, 2004, we had 179 full-time employees and twopart-time employees.  Approximately 12of our employees, including all of our executive officers and most of our otherofficers, are currently covered by employment agreements, with the remainderbeing at-will employees.

 

**AVAILABLE INFORMATION**

 

The address of our Internet Web site is www.image-entertainment.com.

 

**FACTORS THAT MAY AFFECT FUTURE RESULTS**

 

Youshould carefully consider and evaluate all of the information in this report,including the risk factors listed below. If any of these risks occur, our business, results of operations andfinancial condition could be harmed, the price of our common stock coulddecline, and future events and circumstances could differ significantly fromthose anticipated in the forward-looking statements contained in this report.

 

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Risks Relating to Our Business.

 

**InventoryObsolescence Poses a Significant Risk to Us.**  We maintain a substantial investment inproduct inventory, and if we overestimate the demand for a particular title, wemay retain significant quantities of that title in our warehouse.  Retained inventory occupies valuable storagespace and may become obsolete as our distribution term for the titleexpires.  Although we may sell suchinventory at a steeply discounted price toward the end of the distribution termin order to recoup our manufacturing, storage and other costs, there is noguarantee that a market will exist for a given title, even at the steeplydiscounted price.  Additionally, ourlicense and/or distribution agreements sometimes contain terms, such as minimumroyalties per unit and music publishing fees, which effectively prevent us fromsteeply discounting the price on some titles.

 

**IfWe Do Not Effectively Implement Our Transition to Oracle, Our Business May BeAdversely Affected.** Efficient processing of our customer orders, purchase orders, credits,royalty payments, and other accounting and administrative functions iscritically important to our business. The transition from our aging, legacy Qantel applications system to amuch more powerful suite of applications from Oracle is expected to providesignificant long-term benefits to efficiency. Nevertheless, the implementation of Oracle has been a time-consuming,lengthy and expensive process that has experienced numerous problems.  Although we have resolved these problems asthey have arisen, there is no guarantee that we will be able to resolve futureproblems with the speed and thoroughness we might desire.  Failure or delay in transitioning to Oraclewould likely result in a material adverse effect upon our business.

 

**IfWe Do Not Effectively Implement the Relocation of Our Corporate Headquarters,Our Business May Be Adversely Affected.**  The relocation of our corporate headquarterswill affect every one of our departments except for our warehouse and  distribution facility in Las Vegas,Nevada.  Although we have plannedextensively for the relocation, there is no guarantee that we will be able toaccomplish it without delay or significant difficulty.  Failure or delay in relocating our corporateheadquarters would likely result in a material adverse effect upon ourbusiness.

 

**We May NotReceive Lender Covenant Violation Waivers in the Future. **Losses in prior periods caused us not to be in compliance with ourlender’s financial covenants.  Althoughwe have amended our covenants on a go-forward basis as of December 31,2003, and as of March 31, 2004, to be more favorable to us, we cannotprovide assurances that we will continue to be in compliance with thecovenants, as amended.  Although we havealways received waivers of noncompliance in the past, we cannot provideassurances that we will receive waivers of any future violations.  Should we not receive a waiver, we would bein default, which would trigger cross-defaults under other debtagreements.  This would have a materialadverse affect on our financial condition and our ability to operate ourbusiness effectively.

 

**We Have aHigh Concentration of Sales to Relatively Few Customers. **Best Buy and AEC One Stop together accounted for approximately 28% ofour net revenues for the year ended March 31, 2004.  Additionally, five customers (including thepreviously mentioned customers) accounted for over 50% of our fiscal 2004 netrevenues.  Any combination of thesecustomers filing for bankruptcy or significantly reducing their purchases ofour programming could have a material adverse effect on our financialcondition, results of operations and liquidity.** **We are not an exclusive supplier to any of ourcustomers, and there is no guarantee that we will continue recognizingsignificant revenue from sales to any particular customer.  If we are unable to maintain the sale of ourproducts at their current levels to any or all of these three customers, andare unable to find other customers to replace these sales, there would be anadverse impact on our revenues and future profitability.

 

**We Face Risks Associated with Deluxe’sPerformance Under Our Manufacturing Services Agreement.**  We currently source substantially all of ourDVD replication from Deluxe.  Anyfailure of Deluxe to manufacture and deliver our product in a timely manner andwith the same consistent quantity and quality that we and our customers havecome to expect may adversely affect our revenues and profits.  Additionally, although we believe we havethe ability to shift our product manufacturing from Deluxe to another facilityshould the need arise, we may be adversely affected by the period of time thatwe would need to direct manufacturing duties to another company.

 

**We Face Risks in Distributing Our ProgrammingInternationally.** We distribute our programming internationally and derive an increasingpercentage of our revenues from sales activity outside the United States.  As a result, our business may be subject tovarious risks inherent in international trade, many of which are beyond ourcontrol.  Risks faced in distributingour programming internationally include: cancellation or renegotiation of contracts,

 

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changes in laws and policies affecting international trade (includingtaxes), credit risk, fluctuating foreign exchange rates and controls, civilstrife, acts of war, guerilla activities, insurrection, terrorism, changingretailer and consumer tastes and preferences with regard to our programming, differingdegrees of protection of our intellectual property, cultural barriers, andpotential instability of foreign economies and governments.

 

**TheMajority of International Revenues Are Generated By One Sublicensee. **Revenues generated from international distribution are primarily fromthe manufacturing, marketing and distribution efforts of BMG.  Should BMG default on its sublicenseagreement with us or fail to successfully perform, an important part of ourbusiness strategy, financial condition, results of operations and cash flowswould be negatively impacted.

 

**We HaveDirect and Indirect Foreign Currency Exchange Risk. **Althoughour BMG sublicense agreement is U.S. Dollar denominated, with BMG reporting tous and paying us in U.S. Dollars, the underlying BMG sales transactions are inEuros.  The Euro is currently 120% ofthe U.S. Dollar.  Should the U.S. Dollarstrengthen compared to the Euro, BMG’s reported royalties to us on atitle-by-title basis and in the aggregate would decline (assuming consistent unitsales) and thus reduce our revenues recognized.

 

**We Have anAccumulated Deficit and May Incur Additional Losses. **Overthe last two fiscal years we have not been able to sustain consistentprofitability.  Our accumulated deficitat March 31, 2004, was $14,581,000. While we have made changes to our business that we hope willsuccessfully lead to consistent profitability, we may incur losses again in thefuture.

 

**If We Cannot Maintain Relationships with OurProgram Suppliers and Vendors, Our Business May Be Adversely Affected.**  We receive a significant amount of ourrevenue from the distribution of those DVDs for which we already have exclusiveagreements with program suppliers.  Wecan give no assurances, however, that titles in production which have beenfinanced by Image will be delivered as agreed or accepted by the consumer.  We also cannot be sure that we will be ableto renew these exclusive rights as existing agreements with program suppliersexpire.  We also cannot assure you thatour current program suppliers will continue to support the DVD format inaccordance with our exclusive agreements, that our current program supplierswill continue to license titles to us on the current terms or on termsfavorable to us, or that we will be able to establish new supplierrelationships to ensure acquisition of exclusive titles in a timely andefficient manner.

 

**We May Need Additional Funding to ContinueAcquiring Desirable Programming.**  Availability of working capital is asubstantial factor in the Company’s ability to license new programming.  Therefore, maximizing available workingcapital is critical to Image’s business operations.  At March 31, 2004, the Company had $10,218,000 outstandingunder its $17.0 million revolving credit facility with Foothill bearinginterest at the “floor” interest rate of 5.75%.  The Company had no borrowings outstanding under its $1.0 millioncapital expenditure term loan facility with Foothill.  The Company had borrowing availability of $6,245,000 under therevolving credit facility and $1,000,000 under the term loan facility.  We may need to raise additional funds toacquire the rights to programming we find desirable.  Should additional funds be raised through the issuance of equityor convertible debt securities, the percentage ownership of our existingstockholders may be reduced.  Ifadequate funds are not available or unavailable on acceptable terms, we mayfind we are unable to fund expansion, continue offering products and services,take advantage of acquisition opportunities, develop or enhance services orproducts, and/or respond to competitive pressures in the industry.

 

**If Music Entertainment Programming CannotContinue to Compete Successfully in the Home Entertainment Industry, OurBusiness May Be Adversely Affected.**  Although we have made efforts to diversifyour exclusive programming, approximately 22% of our revenue generated in fiscal2004 was derived from sales of exclusively licensed and distributed music DVDentertainment programming.  We cannotassure you that the music industry in general will continue to prosper or thatmusic entertainment programming will continue to compete successfully againstother home entertainment programming. If music programming cannot compete successfully in the homeentertainment market, our business may be adversely affected.

 

**TheFull Exploitation of Our Rights Requires Us to Conduct Business in Areas WhereOur Expertise Is Limited.**  In order to fully exploit some of the rights we have acquired, weare required to conduct business in sectors (e.g. audio, Internet, rental,broadcast, video-on-demand, in-flight, satellite) where we are not asexperienced as we are in the DVD and home video sectors.  Accordingly, when exploiting such sectors inwhich we are less experienced, we

 

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may realize a greater proportion of costs, or we may not realize asmuch of a proportion of revenue, as we would in the DVD and home video sectors.

 

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

 

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

 

**If We Do Not Successfully Optimize and OperateOur Warehouse and Distribution Facility, Our Business Could Be Harmed.**  Domestic wholesale distribution of ourexclusive programming is fulfilled from a single warehouse and distributionfacility in Las Vegas, Nevada.  If weare unable to operate this facility for any reason, it could significantlylimit our ability to meet customer demand. Because it is difficult to predict sales increases or declines, we maynot manage our facility in an optimal way, which may result in excessinventory, warehousing and distribution dilemmas.  Our failure to properly handle inventory could result inunexpected costs, delays and harm to our business and reputation.

 

Risks Relating to Our Industry.

 

**We May Not Be Able to Keep Pace withTechnological Advances.**  The entertainment industry in general, and the music and motionpicture industries in particular, are continuing to undergo significantchanges, primarily due to technological developments.  As an independent distributor, we believe we have a superiorability to adapt to changing formats and distribution methods, as we did whenshifting our focus from laserdiscs to DVDs, and that our high quality customerservice and loyal customer base will continue to purchase programming from usthrough new distribution methods.  However,because of the rapid growth of technology, shifting consumer tastes and thepopularity and availability of other forms of entertainment, it is impossibleto predict the overall effect these factors could have on potential revenuefrom, and profitability of, distributing entertainment programming.  It is also impossible to predict the overalleffect these factors could have on our ability to compete effectively in achanging market.

 

**IllegalPiracy May Reduce Our Revenues. **Themusic industry is currently facing a major challenge in the form of illegalpiracy resulting from Internet downloading and/or CD recorders.  This piracy has negatively affected industryrevenues and profits.  Although wecurrently derive only 6.6% of our revenues from audio CDs, we expect that ourproportional revenues in this sector will increase.  Additionally, DVD recorders are gradually gaining greater marketpenetration, with DVD recorder shipments increasing more than 200% in 2003, andmore than 50 million DVD recorders expected to ship in 2007, according toIn-Stat/MDR as reported in Video Store Magazine (February 22-28,2004).  As DVD recorders 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.

 

**ReturnsPose a Significant Risk to Us. **Aswith many other companies in this industry, we experience a relatively highlevel of product returns as a percentage of our revenues.  Although our past experience indicates thatour allowances for sales returns are adequate to cover potential returns, therecan be no assurance that these reserves will be adequate in the future, in thecase of consolidation within the home video retail marketplace which, when itoccurs, tends to result in inventory consolidation and increased returns.

 

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

 

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sometimes also relevant to a program’s success, especially when theprogram concerns a recent event or historically relevant material (e.g. ananniversary of a historical event which focuses media attention on the eventand accordingly spurs interest in related programming).

 

**Others’ Failure to Promote Our ProgrammingMay Adversely Affect Our Business.**  Decisions regarding the timing of releaseand promotional support of programming which we license and distribute areimportant in determining the success of a particular music concert, featurefilm or related product.  We may notcontrol the manner in which a particular artist, film or related product ismarketed and promoted, and we may not be able to fully control ourcorresponding home video or CD release. Although artists, record companies, studios and producers have afinancial interest in the success of any such concerts or films distributed byImage, any marketing or promotional decision or restriction by such persons maynegatively affect the success of our titles. Additionally, the availability of retailer programs relating to productplacement, co-op advertising and market development funds, and our ability andwillingness to pay for such programs, are also important with respect topromoting our programming.

 

**If DVD Cannot Compete Successfully with OtherFormats of Home Entertainment, Our Revenues May Be Negatively Impacted.**  The DVD format competes with other formatsof in-home entertainment, such as network, syndicated, cable and pay-per-viewtelevision and home satellite systems. The DVD format also competes with new and emerging technologies in theentertainment industry, such as entertainment programming on the Internet,video-on-demand, high-definition television, digital videotape and opticaldiscs with greater storage capacity. While we are actively seeking to exploit these alternate homeentertainment formats and emerging content delivery technologies, theynevertheless could negatively impact the overall market for our DVD sales, especiallyif we are unable to continue to adapt and exploit the development andadvancement of such technology.

 

**DVD Sales May Not Sustain the Same Level ofGrowth.**  Webelieve that consumer interest in the DVD format is due partly to interest inbuilding the consumer’s personal DVD library of desired entertainmentprogramming.  Although Image’s exclusivetitles have generally shown stable sales over extended periods, as consumersbuild their DVD libraries, or with the introduction of new home entertainmentformats, DVD sales may decline and adversely affect our operations.

 

**Decreasing Retail Prices for DVDs MayNegatively Impact Our Revenues.**  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 programming on more favorable terms and may be able to adoptmore aggressive pricing policies than we are able to do.  While we strive to improve our operatingefficiencies and leverage our fixed costs so that we can afford to pass alongthese savings to our customers in the form of lower prices, the industry trendof lowering prices may, over time, lead to higher levels of competition and,therefore, lost sales, decreased profit margins or decreased overall revenues.

 

**Occurrence of Events for Which We Are NotInsured May Adversely Affect Our Business.**  We maintain insurance to protect ourselvesagainst various risks related to our operations.  This insurance is maintained in types and amounts that we believeto be reasonable depending upon the circumstances surrounding each identifiedrisk.  However, we may elect to limitcoverage or not to carry insurance for some risks because of the high premiums(or rates) associated with insuring those risks or for various otherreasons.  For example, we do notcurrently carry earthquake insurance in light of the steep increase in premiumsin Southern California after the Northridge earthquake on January 17,1994.  Occurrence of events for which weare not insured may affect our cash flows and overall profitability.

 

**If We Cannot Continue to Secure DVD Licenseand Distribution Rights, Our Business May Be Materially Adversely Affected.**  We cannot assure you that we will be able tocontinue to secure DVD and other license and distribution rights on termsacceptable to us.  See“Competition” above.  Major motionpicture studios have not granted, nor are they expected to grant, exclusive DVDlicenses to us for new releases and popular catalogue titles.  Instead, the major motion picture studioswill most likely continue to sell DVD programming directly to retailers.  We expect to continue to license exclusive DVDand other home entertainment format programming, but we cannot assure you thatwe can remain competitive against licensing entities with greater financialresources or that independent

 

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program suppliers will not distribute their programmingthemselves.  In addition, our successwill continue to be dependent upon our ability to identify and secure rights toexclusive programming that appeals to consumers.

 

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

 

**Our Results of Operations Fluctuate Based onSeasonality and Variability.**  We have generally experienced higher sales of DVDs in thequarters ended December 31 and March 31 due to increased consumerspending associated with the year-end holidays.  Accordingly, our revenues and results of operations may varysignificantly from period to period, and the results of any one period may notbe indicative of the results of any future periods.  In addition to seasonality issues, other factors have contributedto variability in our DVD net revenues on a quarterly basis.  These factors include:

 

•                                          thepopularity of exclusive titles in release during the quarter;

•                                          ourmarketing and promotional activities;

•                                          ourrights and distribution activities;

•                                          thelevel of retailer open to buy dollars;

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

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

 

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

 

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

 

Risks Relating to Our Stock.

 

**OurStock Price May Be Subject to Substantial Volatility, and You May Lose All or aSubstantial Part of Your Investment.**  Our common stock is traded on the NasdaqNational Market.  There is a limitedpublic float, and trading volume historically has been limited andsporadic.  As a result, the currentprice for our common stock is not necessarily a reliable indicator of our fairmarket value.  The price at which ourcommon stock will trade may be highly volatile and may fluctuate as a result ofa number of factors, including, without limitation, the number of sharesavailable for sale in the market, quarterly variations in our operatingresults, and actual or anticipated announcements of new releases by us orcompetitors, the gain or loss of significant customers, changes in theestimates of our operating performance, market conditions in our industry andthe economy as a whole.

 

**ITEM2.****                                                     PROPERTIES**

 

Our headquarters are currently located in Chatsworth, California andconsist of two adjacent buildings at 9333 Oso Avenue and 9349 Oso Avenue(containing 30,080 and 15,440 square feet, respectively) that are leased fromthe same landlord.  These leases wereinitially scheduled to terminate in April 2004, but were extended throughJuly 2004 and August 2004, respectively.  The monthly rent for these buildings is $0.70 per square foot ona triple-net basis, or approximately $19,000 for the larger building and$12,000 for the smaller building.  On agross basis, however, the rent for the

 

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buildings has ranged from approximately $1.18 to $.94 per square foot,or approximately $54,000 to $43,000 per month over the prior two fiscal years.

 

OnJanuary 7, 2004, we entered into a new corporate office lease to relocateour two existing corporate office facilities to a new office facility inChatsworth.  The new facility consistsof approximately 62,000 square feet and is located on one floor of amulti-tenant building.  The monthly rentis $1.23 per square foot (on a gross basis), or approximately $76,000 permonth, and increases approximately 3% annually.  Accordingly, our cash outlay will initially increase byapproximately $33,000 per month above current costs, including rent for theincreased square footage, utilities, insurance, taxes, building and common areamaintenance.  The new office lease hasan initial 10-year term with two five-year options.  The lease will start upon completion of the landlord’sapproximately $1.5 million in tenant improvements, currently expected to beJuly 1, 2004.  The tenantimprovement expenses are being borne entirely by the landlord, except for apotential $75,000 charge which is currently under discussion.

 

We lease our 76,000 square footwarehouse and distribution facility located in Las Vegas, Nevada.  The monthly rent is approximately $39,000(subject to annual adjustment based on increases in the consumer price index)and the lease will terminate on November 4, 2012.  In addition, we lease approximately 4.07acres of adjacent vacant land in the event we need to expand our currentwarehouse and distribution facility. The monthly rent is approximately $9,000 and the lease will terminate onNovember 4, 2007.  Beginning inJanuary 2004, we leased an additional 10,000 square foot warehouse storagespace in Las Vegas, Nevada for a monthly rent of approximately $5,000 for aterm of two years.

 

DVDPlanet leased approximately 8,500 square feet of retail space inHuntington Beach, California at a monthly rent of approximately $15,000 throughSeptember 2003, at which time the lease was assigned to PlanetEntertainment, Inc. in conjunction with the sale of most of the assets ofDVDPlanet.  See “DiscontinuedOperations” above.  We remain aguarantor in the event that Planet Entertainment and its parent InfinityResources, Inc. default.  The remainingpayments total approximately $669,000 through December 2007.  In addition, DVDPlanet maintained itscorporate offices in leased space of approximately 6,500 square feet inHuntington Beach, California for monthly rent of approximately $13,000 throughSeptember 2003, at which time the lease was assigned to PlanetEntertainment.  That lease has nowexpired.

 

**ITEM3.****                                                     LEGALPROCEEDINGS**

 

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

 

**ITEM4.****                                                     SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

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**EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Executive officers serve at the pleasure of our board ofdirectors.  There is no familyrelationship between any executive officer or director.  The following table sets forth informationregarding our executive officers at June 1, 2004:

 
| **Executive Officer** |   | **Age** |   | **Position  & Background**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|-----------------------|--------|---------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| Martin W. Greenwald   |   | 62      |   | Chairman of the Board, Chief Executive Officer and President since  April 1981.                                                                                                                                                                                                                                                                                                                                                                                                                              |
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| David A. Borshell     |   | 39      |   | Chief Operating Officer since July 2000; Senior Vice President,  Sales, Marketing and Operations from December 1994 to  June 2000.  Prior to 1994, Mr.  Borshell has held various positions at Image since starting as an Account  Executive in February 1986.  Mr.  Borshell is a contributor to the Digital Entertainment Group, an industry  trade association devoted to fostering consumer awareness of the DVD format,  as well as future digital home entertainment formats. |
|                  |   |    |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| Jeff M. Framer        |   | 43      |   | Chief Financial Officer since April 1993; Controller from  September 1990 to March 1993; Senior Manager, KPMG LLP, from  July 1989 to September 1990; and Manager, KPMG LLP, from  July 1988 to June 1989.  Mr.  Framer received his B.S. degree in Business Administration and Accounting  Theory and Practice from California State University at Northridge in  1984.  Mr. Framer is a Certified  Public Accountant.                                              |

 

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**PART II**

 

**ITEM5.****                                                     MARKETFOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

 

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

 
| **Fiscal Year Ended March 31,  2004** |   | **High** |   | **Low** |   |
|--------------------------------------------|--------|----------|--------|---------|--------|
| Quarter ended June 30, 2003           |   | $        | 2.340  |    | $      | 1.860 |   |
| Quarter ended September 30, 2003      |   | $        | 3.140  |    | $      | 2.200 |   |
| Quarter ended December 31, 2003       |   | $        | 4.980  |    | $      | 2.750 |   |
| Quarter ended March 31, 2004          |   | $        | 4.040  |    | $      | 2.720 |   |

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

 

As of June 2, 2004, there were 1,394 holders of record of ourcommon stock.  As of May 28, 2004, weestimate there were 3,806 beneficial owners of our common stock.

 

We have never paid a cash dividend on our common stock and we presentlyintend to retain any future earnings for business development.  In addition, we are party to loan agreementswhich prohibit our payment of dividends.

 

16

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**ITEM6.****                                                     SELECTEDFINANCIAL DATA**

 

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

 
|                                                            |   | **Years  Ended March 31,** |   |
|-----------------------------------------------------------------|--------|---------------------------------|--------|
| **(In  thousands, except per share data)**                      |   | **2004**                        |   | **2003** |   | **2002** |   | **2001** |   | **2000** |   |
| **Statement of  Operations Data:**                              |   |                            |   |   |   |   |   |   |   |   |   |
| Net revenues                                                    |   | $                               | 84,840 |   | $ | 86,929 |   | $ | 76,135 |   | $ | 83,147 |   | $ | 68,576 |   |
| Operating costs and expenses                                    |   | 85,106                          |   | 82,924 | (1) | 72,797 | (2) | 74,576 |   | 64,864 |   |
| Earnings (loss) from operations                                 |   | (266                            | )      | 4,005 |   | 3,338 |   | 8,571 |   | 3,712 |   |
| Interest expense                                                |   | 818                             |   | 1,359 |   | 1,711 |   | 1,629 |   | 1,467 |   |
| Other expense (income)                                          |   | (213                            | )      | 698 |   | 192 |   | (289 | ) | (1,315 | )(3) |
| Earnings (loss) from continuing operations  before income taxes |   | (871                            | )      | 1,948 |   | 1,435 |   | 7,231 |   | 3,560 |   |
| Income tax expense (benefit)                                    |   | 6,244                           | (4)    | 1,306 | (5) | 562 |   | (2,981 | )(6) | — | (7) |
| Earnings (loss) from continuing operations                      |   | (7,115                          | )      | 642 |   | 873 |   | 10,212 |   | 3,560 |   |
| Loss from discontinued operations                               |   | 2,441                           |   | 1,096 |   | 1,068 |   | 1,780 |   | 2,145 |   |
| Earnings (loss) before cumulative effect of  accounting change  |   | (9,556                          | )      | (454 | ) | (195 | ) | 8,432 |   | 1,415 |   |
| Cumulative effect of accounting change                          |   | —                          |   | (3,766 | ) | — |   | — |   | — |   |
| Net earnings (loss)                                             |   | $                               | (9,556 | ) | $ | (4,220 | ) | $ | (195 | ) | $ | 8,432 |   | $ | 1,415 |   |
| Earnings (loss) per share:                                      |   |                            |   |   |   |   |   |   |   |   |   |
| Continuing operations                                           |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                           |   | $                               | (.39   | ) | $ | .04 |   | $ | .06 |   | $ | .63 |   | $ | .21 |   |
| Diluted                                                         |   | $                               | (.39   | ) | $ | .04 |   | $ | .06 |   | $ | .60 |   | $ | .21 |   |
| Discontinued operations                                         |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                           |   | $                               | (.13   | ) | $ | (.07 | ) | $ | (.07 | ) | $ | (.11 | ) | $ | (.13 | ) |
| Diluted                                                         |   | $                               | (.13   | ) | $ | (.07 | ) | $ | (.07 | ) | $ | (.10 | ) | $ | (.13 | ) |
| Earnings (loss) before cumulative effect of  accounting change  |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                           |   | $                               | (.52   | ) | $ | (.03 | ) | $ | (.01 | ) | $ | .52 |   | $ | .09 |   |
| Diluted                                                         |   | $                               | (.52   | ) | $ | (.03 | ) | $ | (.01 | ) | $ | .50 |   | $ | .09 |   |
| Cumulative effect of accounting change                          |   | $                               | — |   | $ | (.22 | ) | — |   | — |   | — |   |
| Net earnings (loss) per share:                                  |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                           |   | $                               | (.52   | ) | $ | (.25 | ) | $ | (.01 | ) | $ | .52 |   | $ | .09 |   |
| Diluted                                                         |   | $                               | (.52   | ) | $ | (.25 | ) | $ | (.01 | ) | $ | .50 |   | $ | .09 |   |
| Weighted average shares outstanding                             |   |                            |   |   |   |   |   |   |   |   |   |
| Basic                                                           |   | 18,250                          |   | 16,812 |   | 15,821 |   | 16,257 |   | 16,452 |   |
| Diluted                                                         |   | 18,250                          |   | 17,002 |   | 15,898 |   | 17,637 |   | 16,490 |   |

 

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(1) Includes the reduction to gross margin of $480,000 for estimatedsubdistributor returns and inventory writedowns as a result of the Company’stransition from direct European distribution to European sublicense.

(2) Includes $1,818,000 in one-time noncash credit relating to thediscontinuation of the Company’s laserdisc operations and a $696,000 writedownof advance royalties, relating to a line of programming, to estimated fairvalue.

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

(4) Income tax expense reflects establishing a valuation allowanceagainst 100% of net deferred tax assets.

(5) Includes a provision for a valuation allowance against deferred taxassets of $551,000 relating primarily to foreign tax credits.

(6) Income tax benefit reflects the elimination of the valuationallowance recorded against deferred tax assets.

(7) Minimal or no income tax expense was recorded due to theutilization of net operating losses, which previously were fully offset by avaluation reserve, to offset taxable income.

 

17

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|                          |   | **March 31,** | ** ** |
|-------------------------------|--------|--------------------|------------|
| **(In thousands)**            |   | **2004**           | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Balance Sheet Data:**       |   |               |       |   |   |   |   |   |   |   |   |
| Total assets                  |   | $                  | 64,132     |   | $ | 74,251 |   | $ | 81,898 |   | $ | 74,991 |   | $ | 65,395 |   |
| Total liabilities             |   | 41,797             |       | 42,586 |   | 49,390 |   | 42,516 |   | 39,554 |   |
| Net shareholders’ equity |   | 22,335             |       | 31,665 |   | 32,508 |   | 32,475 |   | 25,841 |   |
|                               |        |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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

 

The following discussion and analysis should be read together with “Item6.  Selected Financial Data” and theconsolidated financial statements, the related notes thereto and otherfinancial information contained elsewhere in this report.

 

**Forward-LookingStatements**

 

This report includes forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Other than statements of historical fact, all statements made inthis 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.  In some cases forward-looking statements maybe identified by words such as “will,” “should,” “expect,” “anticipate,”“believe,” “estimate,” “continue,” “future,” “intend” or similar words.  Forward-looking statements involve risks anduncertainties that are inherently difficult to predict, which could cause actualoutcomes and results to differ materially from our expectations, forecasts andassumptions.  The following importantfactors, in addition to those discussed above, could affect our future resultsand could cause those results to differ materially from those expressed in suchforward-looking statements:

 

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

•                                          Changesin U.S. and global financial and equity markets, including market disruptionsand significant interest rate fluctuations, which may impede our access to, orincrease the cost of, external financing for its operations and investments;

•                                          Increasedcompetitive pressures, both domestically and internationally, which may, among otherthings, affect the performance of our business operations and profit margins;

•                                          Changesin the mix of titles sold to customers and/or customer spending patterns;

•                                          Legaland regulatory developments that may affect the protection of intellectualproperty;

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

•                                          Technologicaldevelopments that may affect the distribution of our products or create newrisks to our ability to protect our intellectual property; and

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

 

This list of factors that may affect future performance and theaccuracy of forward-looking statements is illustrative, but by no meansexhaustive.  Accordingly, allforward-looking statements should be evaluated with the understanding of inherentuncertainty.  The inclusion of such forward-lookingstatements should not be regarded as a representation that contemplated futureevents, plans or expectations will be achieved.  Unless otherwise required by law, we undertake no obligation torelease publicly any updates or revisions to any such forward-lookingstatements that may reflect events or circumstances occurring after the date ofthis report.  Important factors thatcould cause or contribute to such material differences include, but are not limitedto, those discussed in Item 1.  “FactorsThat May Affect Future Results” and “Competition” above.  You are cautioned not to place unduereliance on such forward-looking statements, which speak only as of theirdates.

 

**Overview**

 

*Sources of Revenue*

 

Our primary source of revenues is the acquisition and distribution ofexclusive DVD programming in North America, which accounted for 84% of ouroverall net sales in fiscal 2004.  Wemarket, sell and self-distribute our programming to retail chains, mass merchantsincluding clubs, video and music distributors, specialty DVD outlets, videorental chains and Internet retailers. These customers buy our new and previously–released programming from ourlibrary of exclusive programming.  To alesser extent, we also generate revenues from the domestic sales of exclusiveprogramming in our growing CD and declining VHS formats.  We have recently entered into revenuesharing

 

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agreements with domestic video rental stores and DVD clubs, althoughrevenue generated under those agreements has not, to date, been material.

 

Internationally, we primarily rely on sublicensees, including BMG, todistribute our exclusive DVD content. We receive revenues in the form of recoupable advances and royaltyincome.  We also rely on our exclusivesales agent NBD to sell our exclusive content for broadcast, and we receiverevenues from its broadcast sales, net of sales commissions.

 

*Cost Structure*

 

Our most significant costs and cash expenditures relate to acquiringcontent for exclusive distribution and, more recently, the funding of contentproduction or co-production for exclusive distribution.

 

We generally base our offer of upfront royalties or (for distributionagreements) net profit payments on the expected success of a title’sperformance at retail, the actual cost of the production, and competition forthe title’s exclusive distribution rights. With the popularity of DVD growing, the cost of acquiring content forexclusive distribution is also growing. Additionally, the cost of product placement, co-op advertising andmarket development funds provided our retail customers is also increasing.

 

Our financial focus is on achieving long-term, sustainable growth andprofitability.  We also seek to improveour cash flow position in order to continue licensing (or entering intoexclusive distribution agreements for) high quality DVD and other entertainmentprogramming and funding operations.

 

*Competition*

 

We continue to face increasing competition from major motion picturestudios, music labels and other independent distribution companies forprogramming, retailer open to buy dollars and limited retail shelf space.  Home video rights to most motion picturesare owned by major studios, record labels continue to increase titles releasedthrough their own labels, and obtaining quality DVD programming at reasonableprices is becoming more challenging.

 

Available open to buy dollars allocated by retailers to purchaseprogramming are becoming more scarce, since they are often devoted tohigh-profile new releases from major studios. Our exclusive programming competes for a finite amount of shelf space,against a growing supply of entertainment programming.  We believe our expenses to provide marketdevelopment funds and cooperative advertising dollars to our retail customerswill continue to increase, and availability of opportunities will continue todecrease.

 

*Acquisition Strategy*

 

Our acquisition strategy has expanded to include DVD programmingcategories such as urban, youth culture/lifestyle, extreme sports, comedy, andclassic television programming.  Weintend to maintain our focus on genres that have been successful in the past,as well as to seek out early trend opportunities in advance of mainstreamacceptance in an effort to keep acquisition costs lower by bringing titles tomarket before spikes in demand.  Forexample, our success in the urban video market with titles such as *Thug Angel*,*Beef*and *JamieFoxx: I Might Need Security* has led to a recent multi-titleagreement with hip-hop impresario Russell Simmons’ Simmons-Lathan Entertainmentwhich, along with our output agreement with Quincy Jones III’s QD3Entertainment, should continue to provide us with high-quality urbanprogramming.  We also have a successfultrack record of releasing television programming on DVD, with our success ontitles such as *The Twilight Zone*, *The Richard Pryor Show* and *The Dick VanDyke Show* resulting in new opportunities to release populartelevision shows such as *Pee-wee’s Playhouse*, *Combat*, *Saved by the Bell: The College Years*and *TheNick & Jessica Variety Hour*.

 

Our comedy titles include stand-up comedy shows for both the DVD andbroadcast markets, including new shows from comedians Larry the Cable Guy and aclassic show from Jeff Foxworthy, and upcoming shows from Bill Engvall and RonWhite.  Collectively, these “Blue CollarComedians” represent millions of audio CDs sold through third-party labels, oneof the biggest comedy tours of all time in 2003, and a recently announcednetwork TV series for the group. Multi-title deals with National Lampoon and Jamie Foxx’s *Laffapalooza*series should also drive future new release sales in this genre.

 

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Our music DVD business should remain robust in an increasinglycompetitive market, with upcoming releases from Macy Gray, The Ramones, MC5,the Vans Warped Tour and Dion.  Othernew initiatives include the development of “multi-cultural” niches includingLatin/Hispanic product, Asian titles such as Hong Kong cinema and Japaneseanime/animation, and “Bollywood” films from India.

 

We are also seeking to expand our sales of audio CD programming, withtitles such as *Show Me How* by Lorrie Morgan, the cast album of theGrammy nominated Broadway musical *Nine*,starring Antonio Banderas, this year’s cast album of *Fiddler on the Roof*, starring Alfred Molina, the cast albumfor Stephen Sondheim’s multi-Tony Award winning *Assassins*, *Ronnie MilsapLive*, the *Live at BillyBob’s**Texas* country music series, and audio soundtrack companionsto our video releases.  We also recentlysigned an agreement with The Source magazine to distribute their *Hip Hop Hits*series, as well as the *30th Anniversary of Hip-Hop*.

 

*Sales and MarketingInitiatives*

 

In order to deal with increasing competition more effectively, we aredeveloping new marketing initiatives, including revenue growth-relatedincentives to encourage retailers to carry our titles.  We are also adjusting our price points onnew release programming and selectively repricing and repositioning oursecondary and tertiary catalogue programming, which, when coupled with specificpromotions, should help to drive revenues. For example, while retailers are sometimes hesitant to bring in newindividual titles, we believe they are more receptive to newly-designed boxsets.  These compilations have a higherperceived value among retailers and consumers, making both shelf space andretail sales easier to obtain.  Repackagingexisting product in this manner also typically creates higher margins.  Accordingly, we have created and releasedadditional box sets to better exploit our existing catalogue, such as *The Endless Summer Collection*. Other box sets scheduled for upcoming release include a newlyremastered collection of Rod Serling’s classic television series *The Twilight Zone*, Windows Media 9 high-definition remastered titles originally createdfor exhibition in IMAX theaters, and cult horror favorites from the *Something Weird* collection.

 

We will continue seeking high-quality programming to market anddistribute in all genres.  The followinglist identifies some of our higher-profile titles for fiscal year 2004, as wellas some projected high-profile titles for fiscal 2005.

 

*High-Profile Titlesfor Fiscal Year 2004*

*(all titles DVDunless otherwise indicated)*

 

Beef

Caligula

Cher: The Farewell Tour

Dick Van Dyke, Seasons 1-3, box sets

Eagles: Hell Freezes Over

Heart: Alive in Seattle

I Claudius

Jamie Foxx: I Might Need Security

Lorrie Morgan: Show Me How (Audio CD)

Oklahoma

Richard Pryor box set

Roy Orbison: Black and White Nights

Sarah McLachlan: VH1 Storytellers

Selena Live: The Last Concert

Stephen Sondheim box set

Twilight Zone box set

War & Peace

 

*ProjectedHigh-Profile Titles for Fiscal Year 2005*

*(all titles DVDunless otherwise indicated)*

 

30th Anniversary of Hip-Hop (Audio CD)

Assassins (Audio CD)

Beef 2

Bill Engvall: Here’s Your Sign

Combat (classic TV)

Dick Van Dyke, Seasons 4-5, box sets

Dirty States (DVD and Audio CD)

F.E.D.S. (Simmons-Lathan)

Fiddler on the Roof (Audio CD)

The Hillz (with Paris Hilton)

Hip Hop Hits, Volumes 8 and 9 (Audio CDs)

Kel Videos: Is That the Mitchell’s Boy

Kel Videos: This Face Belongs on the Tube

Laffapalooza 1-4 (Jamie Foxx)

Larry the Cable Guy: “Git-R-Done”

Macy Gray: A Day in the Life

MC 5: Sonic Revolution

Nick & Jessica Variety Hour

Pee-wee’s Playhouse

Ramones: Raw

Ron White: They Call Me “Tater Salad”

Ronnie Milsap (Audio CD)

Saved by the Bell: The College Years

Vans Warped Tour

 

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**Liquidity and Capital Resources**

 

***Sources and Uses ofWorking Capital for Fiscal 2004.***

 

Ourpretax net loss from continuing operations was $871,000 for fiscal 2004.  Cash on hand, cash provided by continuingoperating activities and proceeds from the sale of DVDPlanet afforded us theability to reduce interest bearing debt, including obligations under capitalleases, by approximately $2.5 million during fiscal 2004.  Our accrued royalties, distribution andmusic publishing fees increased $2.7 million. The increase was primarily due to the growth in fiscal 2004 fourthquarter exclusive revenues over fiscal 2003. At March 31, 2004, our cash on hand was down to $540,000, ascompared to $2.7 million at March 31, 2003, while our net receivables werehigher.  At March 31, 2004, our royaltiesand distribution fee advances and inventory balances are comparable to those atMarch 31, 2003.  Capitalexpenditures were approximately $2.1 million for fiscal 2004, compared to $1.5million for the prior fiscal year.  Weincurred expenditures for distribution system enhancements, informationtechnology infrastructure improvements and Oracle financial and ordermanagement modules.

 

Our working capital currently comes from two sources: (1) operatingcash flows; and (2) availability under our revolving line of credit and termloan facilities with Wells Fargo Foothill, Inc.  At March 31, 2004, we had cash of $540,000 and borrowingavailability of $6,245,000 and $1,000,000, respectively, under our revolving creditand term loan facilities with Foothill.

 

Our working capital requirements vary primarily with the level of ourprogram acquisition, production and distribution activities.  Recurring principal uses of working capitalin our operations are for acquiring exclusive programming (royalty payments, includingadvance payment against future royalties to program suppliers), advancepayments under exclusive distribution agreements, music publishing payments,manufacturing and production costs, costs of acquiring finished programming forexclusive distribution, selling, general and administrative expenses and debtservice.  Availability of sufficientworking capital is a substantial factor in our ability to acquire popular newprogramming upon which our continued success depends.  Therefore, maximizing available working capital is critical toour business operations.

 

We face increasing competition in securing exclusive rights from otherindependent distribution companies as well as major motion picture studios andmusic labels.  Without sufficientworking capital, we may not be able to remain competitive with advance offersfrom competitors who are willing to pay more or who have greater financialresources.  We will continue to focus oneffectively managing our capital resources and seeking appropriate financing inorder to acquire rights to the programming we desire in order to fully executeon our growth plans.

 

In order to most efficiently manage our cash flow, we strive toconservatively value the sales potential of a given title by polling retailers,comparing like titles, quantifying the relevance of the content and generallysummarizing the sales potential based on our experience and expertise.  By identifying trends in advance, keepingacquisition costs in line with sales projections, and avoiding higher-profileshows whose owners demand excessive advances, we seek to focus our limitedresources on acquiring and promoting opportunities that will be profitable andproduce a continued revenue stream upon recoupment.

 

We believe that projected cash flows from operations, borrowingavailability under our revolving line of credit, cash on hand, and trade creditwill provide the necessary capital to meet our projected cash requirements forat least the next 12 months.  However,any projections of future cash needs and cash flows are subject to substantialuncertainty.  Should we be in a positionto acquire significantly higher-profile content or library of content forexclusive distribution, or should we find an attractive synergistic corporateacquisition, we would need to seek additional debt or equity financing in orderfund the transactions.  We believe anysuch financing could come in the form of vendor debt financing or convertibledebt, convertible preferred stock or straight equity issuance through a privateinvestment in public equity investor, however there are no assurances that suchfinancing would be available, or available on terms acceptable or favorable tous.

 

Contractual Obligations and Commercial Commitments.  The following table summarizes the Company’scontractual obligations at March 31, 2004, and the effects suchobligations are expected to have on liquidity and cash flow in future periods:

 

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| **(in thousands)  Contractual obligations:**     |     | **Payments  due by period** |     |
|--------------------------------------------------|----------|-----------------------------|----------|
|                                             | **2005** |                        | **2006** |   | **2007** |   | **2008** |   | **2009** |   | **Thereafter** |   | **Total** |   |
| Long-term debt obligations                       |     | $                           | 1,592    |   | $ | 1,224 |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 2,816 |   |
| Capital lease obligations                        |     |                        | 247      |   | 109 |   | — |   | — |   | — |   | — |   | 356 |   |
| Operating lease obligations                      |     |                        | 1,346    |   | 1,531 |   | 1,573 |   | 1,615 |   | 1,658 |   | 8,100 |   | 15,823 |   |
| Licensing and exclusive distribution  agreements |     |                        | 9,077    |   | 2,467 |   | 120 |   | 100 |   | — |   | — |   | 11,764 |   |
| Employment Agreements                            |     |                        | 2,276    |   | 1,199 |   | 1,173 |   | — |   | — |   | — |   | 4,648 |   |
| Total                                            |     | $                           | 14,538   |   | $ | 6,530 |   | $ | 2,866 |   | $ | 1,715 |   | $ | 1,658 |   | $ | 8,100 |   | $ | 35,407 |   |

 

Advances and guarantees included in the table above, under licensingand exclusive distribution agreements, are recoupable against future royaltiesand distribution fees earned by our exclusive program suppliers in connectionwith revenues generated by those rights. As we have historically, we expect to fund these commitments throughrecoupment of existing advances, existing bank lines of credit, and otherworking capital.

 

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

 

Lease Guarantee.  In connection with the asset sale of DVDPlanet, PlanetEntertainment assumed the obligations under DVDPlanet’s leases for its retailstore and various other liabilities related to the assets being acquired andits parent Infinity Resources guaranteed Planet Entertainment’sobligations.  We remain a guarantor inthe event that Planet Entertainment and Infinity default on their financialobligations under the lease.  Theremaining payments under the lease total approximately $669,000 throughDecember 2007.

 

Long-TermDebt. Long-term debt at March 31, 2004 and March 31, 2003, consistedof the following:

 
| **(In thousands)**                            |   | **March 31,  2004** |   | **March 31,  2003** |   |
|-----------------------------------------------|--------|--------------------------|--------|--------------------------|--------|
| Subordinated note payable – Ritek Taiwan |   | $                        | 2,561  |                     | $      | 3,898 |   |
| Note payable to bank                          |   | 255                      |   | 509                      |   |
|                                          |   | 2,816                    |   | 4,407                    |   |
| Current portion of long-term debt             |   | 1,592                    |   | 1,591                    |   |
| Long-term debt less current portion           |   | $                        | 1,224  |                     | $      | 2,816 |   |

 

Other DebtInstruments and Related Covenants.  Our loan agreements with Foothill require usto comply with minimum financial and operating covenants.  We received consecutive waivers of ournoncompliance with financial covenants contained in our revolving credit andterm loan facilities as of and for the quarters ended June 30,September 30, and December 31, 2003. The waivers of our noncompliance were for failing to meet a minimumquarterly EBITDA (earnings before interest, taxes, depreciation and amortization,as defined in the loan agreement) and a minimum tangible net worth, asdefined.  Our failure to meet thecovenant minimums was primarily due to the negative impact of DVDPlanetoperations and loss on its sale, the negative impact upon consolidated financialperformance of the slower than expected transition of European distribution ofour exclusive programming to BMG, intense competition, and losses during thenine months ended December 31, 2003.

 

At our request, Foothill waived our compliance with both covenants forprior periods and, effective as of December 31, 2003, amended our Loan andSecurity Agreement dated December 28, 1998, as follows:  (1) the tangible net worth covenant wasredefined, decreasing the minimum required levels that we must maintainquarterly; and (2) the EBITDA covenant was redefined, decreasing the minimumrequired levels measured on a stand-alone quarterly basis.  At March 31, 2004, again at ourrequest, Foothill further amended the minimum stand-alone quarterly EBITDAcovenant changing the measurement to a cumulative quarterly minimum level.  The quarterly EBITDA minimums, as amended inDecember 2003, were not changed. The first EBITDA measurement was for the March 2004 quarter.  The second will be for the six months endingJune 30, 2004.  The third will befor the nine months ending September 30, 2004.  The fourth will be for the twelve months ending December 31,2004.  Thereafter, the measurement willbe a rolling twelve months EBITDA.

 

As of March 31, 2004, we were in compliance with all covenants, asamended, and believe that we will be able to achieve the minimum requirementsgoing forward.  In the event of anyfuture covenant noncompliance, however, should Foothill not provide a waiver,our outstanding borrowings would become immediately due and the default would

 

23

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cause cross-default on other debt agreements.  We believe that we would be able to secure replacementasset-based financing should this occur, but can give no assurance that wewould be successful, or that, if successful, the terms would be as favorable.

 

Relocation ofCompany Headquarters. On January 7, 2004, we entered into a new corporate office lease torelocate our two existing corporate office facilities (totaling 45,000 squarefeet) located in Chatsworth, California. The new office facility consists of approximately 62,000 square feet ina multi-tenant building in Chatsworth. The initial cost of the new office space is $1.23 per square foot on agross basis and increases approximately 3% annually.

 

The new officelease has an initial 10-year term with two five-year options.  The start date of the new lease will bearound July 1, 2004, when the landlord is expected to complete theapproximately $1.5 million in tenant improvements for which the landlord isresponsible, except for a potential $75,000 charge which is currently underdiscussion.  Our existing office leasesat 9349 Oso Avenue and 9333 Oso Avenue terminate on July 31, 2004, andAugust 31, 2004, respectively.  Therent for our current office space is $0.70 per square foot on a triple-netbasis, which has equated to approximately $1.18 to $.94 per square foot on agross basis over the prior two fiscal years. Accordingly, our cash outlay will initially increase by approximately$33,000 per month above current costs, including rent for the increased squarefootage, utilities, insurance, taxes, building and common area maintenance.

 

We anticipatethat relocation-related expenses (such as cabling and wiring, furniture,computers, phone system) will be approximately $1.3 million, which will becapitalized (to the extent allowable by U.S. GAAP) and amortized over theuseful life of the related assets, or the lease term (if a leaseholdimprovement and if the lease term is shorter than the useful life of theimprovement).  We are currentlyattempting to finance a portion of these costs under our capital expendituresfacility with Foothill.

 

InfrastructureImprovements. During the year ended March 31, 2004, we made significantinvestments in information technology personnel, hardware, software andconsulting services.  Much of ourcapital expenditures have been used in connection with two informationtechnology initiatives.  The first hasbeen the replacement of our aging, legacy Qantel applications system withOracle Enterprise Applications software to improve scalability, security,internal controls, integration, reporting and provide the ability to enhanceour business processes.  We successfullyconverted our finance, purchasing and inventory control systems inNovember 2003.  The cumulative costto implement the initial phase of Oracle applications (including software cost)totaled approximately $1,343,000 over the last two fiscal years through May2004.  To complete the migration toOracle, we are working to convert existing order management andproduction/creative services tracking systems by late calendar 2004.  We expect the final phase of the migrationto Oracle to cost approximately $847,000, primarily in consulting fees, ofwhich $402,000 has been spent through May 2004.  We expect to finance these expenditures through working capitaland our existing bank line of credit.  Thesecond initiative has been technology infrastructure.  Expenditures towards improvements in system security,policies/procedures, email, file storage and networking will continue through2004.

 

We are alsoautomating returns processing operations in our Las Vegas distribution center.Coordinated investments in hardware, software and consulting services are beingapplied with the goal of reducing labor costs, increasing customer service andstreamlining operating procedures related to returns processing.  We expect this initiative to cost approximately$433,000 and be completed in 2004. Through May 2004, we have spent $373,000 of this total.  We were unable to finance these expendituresthrough Bank of America in Nevada due to the high proportion of “soft costs”such as consulting fees.

 

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

 

***Significant Sourcesof Working Capital for Fiscal 2003.***

 

Retirement of IIC Convertible Subordinated Note Payable.  In March 2003, we reached an agreementwith Image Investors Co. (IIC) to retire early the remaining balance due underour convertible subordinated note payable to IIC with a combination of cash andcommon stock.  IIC is our largestshareholder, and is owned and controlled by John W. Kluge and Stuart Subotnick.

 

To retire the obligation early,we paid $1,500,000 in cash, plus accrued interest of $54,000.  We issued 567,568 shares of our common stockat $1.85 per share to satisfy the remaining $1,050,000 in principal due.  In connection with the partial conversion ofthe balance due under the note into common stock, we issued IIC a five-yearwarrant to purchase up to 100,000 more shares at $2.04 per share. The warranthas been exercisable since March 24, 2004.  The

 

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restricted stock will be unregistered andsubject to Rule 144 under the Securities Act of 1933, as amended.  IIC will have limited registrationrights.  We recorded a charge of$121,000 as a component of other expenses, in the accompanying statement ofoperations for fiscal 2003 for the estimated fair value of the warrant (valuedusing the Black-Scholes valuation model)

 

Royalty Advance from BMG.  Under the January 2003 agreement withBMG, we received a $3.0 million royalty advance in March 2003, fullyrecoupable by BMG against quarterly royalties due under the agreement.  See “Transition of InternationalSales to BMG” below.  We used the fundsto pay down outstanding borrowings under our revolving credit facility withFoothill.

 

**Critical Accounting Policies**

 

The discussion and analysis of our financial condition and results ofoperations are based upon our financial statements, which have been prepared inaccordance with accounting principles generally accepted in the UnitedStates.  Generally accepted accountingprinciples require management to make estimates, judgments and assumptions thataffect the reported amounts of assets, liabilities, revenues and expenses, andthe disclosure of contingent assets and liabilities.  We base our estimates on experience and on various otherassumptions that we believe to be reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying valuesof assets and liabilities that may not be readily apparent from othersources.  Our actual results may differfrom those estimates.

 

We consider our critical accounting policies to be those that involvesignificant uncertainties, require judgments or estimates that are moredifficult for management to determine or that may produce materially differentresults when using different assumptions. We consider the following accounting policies to be critical:

 

*Revenue Recognition*

 

We recognize revenue upon meeting all the recognition requirements ofAmerican Institute of Certified Public Accountants Statement of Position (SOP)00-2, *Accounting by Producers orDistributors of Films* andStaff Accounting Bulletin No. 104, *RevenueRecognition*.  Werecognize revenues from home video distribution, net of an allowance forestimated returns, as well as related costs, in the period in which the productis available for sale by our customers (at the point that title and risk ofloss transfer to the customer, which is generally upon receipt by the customer,and in the case of new releases after “street date” restrictions lapse).  We recognize revenues from domestic andinternational broadcast licensing and home video sublicensing, as well asassociated costs, when the programming is available to the licensee and otherrecognition requirements of SOP 00-2 are met. We defer fees received in advance of availability, usually in the caseof advances received from BMG, other international sublicensees and forprogramming broadcast, until other revenue recognition requirements have beensatisfied.  In all instances, provisionsfor uncollectible accounts receivable are provided at the time of sale.  As of March 31, 2004, deferred revenuetotaled $3,360,000.

 

*Royalty and Distribution Fee Advances*

 

For each reporting period, we estimate the total revenues to bereceived throughout a title’s exclusive license or distribution period fromexploitation of that title in multiple home entertainment formats.  While we charge royalty and distribution feeadvances to operations as related revenues are earned, estimates of ultimaterevenues are important in determining whether we should record additionalroyalty and distribution fee expense as cost of sales in any given reportingperiod.  We amortize royalty anddistribution fee advances to expense in the same ratio that the current periodrevenues for a title or group of titles bear to the estimated remainingunrecognized ultimate revenues for that title. Additionally, in circumstances required by SOP 00-2, we recognizeadditional amortization to the extent that capitalized advance royalty anddistribution fees exceed their estimated fair value in the period whenestimated.

 

We base our estimates of ultimate revenue for each title on thehistorical performance of that title and of similar titles.  We update such estimates based upon theactual results of each format’s exploitation. Estimates of ultimate revenues on a title-by-title basis are subject tosubstantial uncertainty.  Factorsaffecting future actual performance include focus from the sales and marketingdepartment (including advertising, promotions and price reductions),availability of retail shelf space, retail customer product placement andadvertising, maintenance of adequate inventory levels, concert touring by theartist (in the case of music DVDs and CDs), retail sell-through, and ultimatelycontinued end-use consumer demand. 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,

 

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causing unamortized costs to be overstated and increased amortizationof costs in a later period. Underestimation of ultimate revenues would cause unamortized costs to beamortized more quickly until ultimate revenue estimates are increased, causingunamortized costs to be understated and decreased amortization of costs in alater period.

 

*Inventory Valuation*

 

For each reporting period, we evaluate our ending inventories forexcess quantities and obsolescence. This evaluation includes analysis of historical sales levels by titleand by format, and projections of future demand.  In addition, we write off inventories that are consideredobsolete or overstocked.  Remaininginventory balances are adjusted to approximate the lower-of-cost or marketvalue, and result in a new basis in such inventory until sold.  If future demand or market conditions areless favorable than our projections, additional inventory writedowns may berequired, and would be reflected in cost of sales in the period the revision ismade.  Future demand will be dependentupon the continued retail customer acceptance of the programming, future demandby end-use consumer, unplanned future promotions, market conditions (eitherfavorable or unfavorable) and future warehouse storage limitations.  Should projections of future inventorydemand be overstated, the value of inventory would be overstated and currentcost of sales understated (with future cost of sales overstated). Conversely,should projections of future demand be understated, the value of inventorywould be understated and the current cost of sales overstated (with future costof sales understated).

 

*Allowance for Sales Returns and DoubtfulAccounts Receivable*

 

For each reporting period, we evaluate product sales and accountsreceivable to estimate their effect on revenues due to product returns anddelinquent accounts.  Our estimates ofproduct sales that will be returned and the amount of receivables that willultimately be collected require the exercise of judgment, and affect reportedrevenues and net earnings.  Indetermining the estimate of product sales that will be returned, we analyzehistorical returns (quantity of returns and time to receive returned product),historical pricing and other credit memo data, current economic trends andchanges in customer demand and acceptance of our products, including reorderactivity.  Based on this information, wereserve a percentage of each dollar of product sales where the customer has theright to return such product and receive either a pricing or credit memo.  Actual returns could be different from ourestimates and current provisions for sales returns and allowances, resulting infuture charges to earnings.  Estimatesof future sales returns and other credits are subject to substantialuncertainty.  Factors affecting actualreturns include retailer financial difficulties, the perception ofcomparatively poor retail performance in one or several retailer locations,limited retail shelf space at various times of the year, inadequate advertisingor promotions, retail prices being too high for the perceived quality of thecontent, 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 receivables to determine if they willultimately be collected.  In performingthis evaluation, 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 the information, wereserve an amount that we believe to be doubtful of collection.  If the financial condition of our customerswere to deteriorate or if economic conditions worsened, additional allowancesmay 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 ofDeferred Income Taxes*

 

Income taxesare accounted 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 assessthe likelihood that our deferred tax assets will be recovered from futuretaxable income, and to the extent that it is more likely than not that all, ora portion, of such deferred tax assets will not be realized, we must establisha valuation allowance.  Theestablishment, or increase, of a valuation allowance increases income taxexpense for such year.

 

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**DiscontinuedOperations – Sale of DVDPlanet**

 

On September 23, 2003, our wholly-owned subsidiary DVDPlanet soldsubstantially all of its assets, marking our departure from thedirect-to-consumer retail distribution business.  In fiscal 2004, we incurred a loss of $699,000 on the sale, andwe expensed approximately $293,000 in severance-related compensation liabilityin connection with the sale.  As ofMarch 31, 2004, our remaining liability for severance-related compensationis $206,000, and will be paid in equal monthly installments throughDecember 2004.

 

DVDPlanet’s business did not meet our financial objectives.  The DVDPlanet asset sale allows us to focuson our core business, which has a stronger potential to increase our exclusiveprogramming revenues and reach our near-term goal of consistentprofitability.  Unless otherwise noted,the remainder of this MD&A relates only to results from continuingoperations.  All periods presentedreflect the classification of DVDPlanet’s financial results as discontinuedoperations.

 

**Establishment ofValuation Allowance on Net Deferred Tax Assets**

 

Duringour third quarter ended December 31, 2003, we established a valuationallowance against 100% of our net deferred tax assets, which are composedprimarily of net operating loss (NOL) carryforwards, resulting in the recordingof an income tax expense equal to the net deferred tax assets as ofMarch 31, 2003.  The valuation allowancewas recorded in the third quarter primarily as a result of operating lossessustained during our normally seasonally strong third quarter as well as itsthen-expected impact on the full fiscal year results of operations.  Income tax expense relating to ourestablishment of a valuation allowance totaled $6,244,000 for the year endedMarch 31, 2004.  Even though wehave fully reserved these net deferred tax assets for book purposes, we wouldstill be able to utilize them to reduce future income taxes payable, should wehave future earnings.  To the extentsuch deferred tax assets relate to NOL carryforwards, the ability to use suchNOLs against future earnings will be subject to applicable carryforwardperiods.

 

**Transition ofInternational Sales to BMG**

 

As of March 31, 2004, we substantially completed our internationaltransition from various local, third party international subdistributors to BMGMusic International Service, GmbH (BMG). Beginning in March 2003 for new releases and April 2003for catalogue programming, BMG commenced distribution of our programmingthroughout the same (and some additional) European territories under asublicense agreement.  Although comparative revenues are primarily loweras a result of the accounting under this new distribution arrangement(described below), we no longer have the expenses associated with directdistribution to the European territories, such as manufacturing/packaging,shipping, music publishing, selling and advertising expenses and severalsalaries for full-time employees previously dedicated to our formerinternational efforts.  BMG has strategically reintroduced our programmingthroughout the European territories to ultimately maximize sales, andmanagement believes our available programming is fully represented for salethroughout the European territories.

 

We received a$3.0 million initial royalty advance under the BMG agreement inMarch 2003, fully recoupable from revenues generated by BMG againstquarterly royalties due to Image under the agreement.  Based upon actual quarterly sales of our programming in theterritories, BMG recoups quarterly royalties from the $3.0 million previouslyadvanced.  BMG provides additionalquarterly royalty advances such that for the first three years of the agreementterm, the outstanding royalty advance to Image at any given time will be aconstant $3.0 million.  We used the $3.0million initially received to pay down our outstanding borrowings under ourrevolving credit facility.  During thefirst three quarters of the fourth year of the term, BMG will reduce, throughrecoupment, the outstanding royalty advance to $1.5 million.  Once the entire royalty advance is recouped,BMG will continue to pay quarterly royalties based on revenue generated.  During the fourth quarter of the fourthyear, BMG may recoup the entire remaining balance of $1.5 million by notre-advancing royalties quarterly.  Theagreement contains a formula to pay an additional lesser advance at thebeginning of the fifth and final year of the term which is to be recouped byBMG during that year.  We must repay anyoutstanding unrecouped royalty advance within 30 days following the final BMGreporting at the conclusion of BMG’s sell-off period after expiration of thefive-year term, but at this time we do not expect any such unrecouped balance.

 

Our accountingfor international revenues differs under the BMG agreement because revenues aregenerated under a sublicense agreement, rather than the subdistributionagreements previously in place.  Underour previous subdistribution agreements, we recorded net revenues based uponthe selling price of its programming sold to our distribution networkcustomers.  We recorded as cost ofsales, the actual manufacturing/packaging cost, shipping cost,royalties/distribution fees and music publishing.  Under the BMG agreement, we record royalty income as revenue

 

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based upon royalties we receivefrom BMG.  Revenue is recorded in theperiod in which the product is sold by BMG. We report as cost of goods sold the royalties or distribution fees weowe our licensors or program suppliers as calculated against the royalties wereceive from BMG.  The majority ofinternational selling and marketing expenses are now borne by BMG.  Additionally, BMG is responsible formanufacturing and packaging costs as well as music publishing.

 

**Results of Operations**

 

***Revenue***

 

Over 90% ofconsolidated net revenues were generated from the sale of DVD programming.  Based on consumer buying trends in theindustry, we anticipate that our sales of VHS will continue to decline, and oursales of DVD and CD will continue to rise. The following table presents consolidated net revenues by reportablebusiness segment for the years ended March 31, 2004, 2003 and 2002,respectively:

 
|          |   | **2004**           |   | **2003** |   | **% Change**       |   | **2003** |   | **2002** |   | **% Change** |   |
|---------------|--------|--------------------|--------|----------|--------|--------------------|--------|----------|--------|----------|--------|--------------|--------|
|          |   | **(in thousands)** |   |     |   | **(in thousands)** |   |     |   |
| Net revenues: |   |               |   |     |   |               |   |     |   |     |   |         |   |
| Domestic      |   | $                  | 78,370 |     | $      | 77,484             |   | 1.1      | %      | $        | 77,484 |         | $      | 66,376 |   | 16.7 | % |
| International |   | 6,470              |   | 9,445    |   | (31.5              | )      | 9,445    |   | 9,759    |   | (3.2         | )      |
| Consolidated  |   | $                  | 84,840 |     | $      | 86,929             |   | (2.4     | )%     | $        | 86,929 |         | $      | 76,135 |   | 14.2 | % |

 

*Fiscal 2004 Compared to 2003*

 

*Domestic Revenue*

 

The1.1% increase in domestic net revenues for the year ended March 31, 2004,was primarily due to the comparative strength of our exclusive DVD programming,offset almost entirely by a combination of reduced nonexclusive DVD revenues,reduced VHS revenues, increased market development funds provided customers(recorded as a reduction of revenues in accordance with Emerging Issues TaskForce (EITF) 01-09, *Accounting for Consideration Given by a Vendor to aCustomer or Reseller of the Vendor’s Products*) and an increasedallowance for sales returns and credits, as compared to fiscal 2003.  The increase in our allowance for salesreturns and credits in fiscal 2004 was due in part to a change in our customermix which has increased the lag time between sale and return.

 

*International Revenue*

 

The 31.5%reduction in international net revenues is primarily a result of the change inour method of European distribution, specifically transitioning internationaldistribution of our exclusive programming from local subdistributors to BMGthrough our sublicense.  In the priorfiscal years, revenue was recorded at the higher selling price to oursubdistributors.  During fiscal 2004, werecorded the lower royalty income received from BMG as our revenues.  In addition, during fiscal 2004, BMGstrategically reintroduced our programming throughout its territories in aneffort ultimately to maximize revenues. All of our DVD programming is now fully represented within BMGterritories.  Our ability to continue toacquire programming that will be successful internationally will have a directeffect on future international revenue growth. As long as we continue to supply BMG and our other sublicensees withcommercially successful programming, and as BMG becomes more adept with ourproduct catalogue, we believe our international revenues will grow.

 

Broadcastsales decreased to $544,000 for the year ended March 31, 2004, compared to$1,724,000 for the prior fiscal year. We continue to place less of an emphasis on acquiring broadcast rightsfor music programming, due to the high cost of music clearance in relation tothe fees broadcasters are willing to pay to air the programming.

 

*Fiscal 2003 Compared to 2002*

 

*Domestic Revenue*

 

We primarilyattribute the 16.7% growth in domestic revenues in fiscal 2003 to continuedunit sales growth of our DVD catalogue and the overall growth in DVD’spopularity.

 

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*International Revenue*

 

The 3.2%reduction in comparative international net revenues was primarily due to anadditional allowance for sales returns recorded for then-estimatedsubdistributor returns as a result of the impending change of Europeandistribution from a network of independent subdistributors to BMG.

 

Althoughbroadcast revenues were higher in fiscal 2003 than 2002, we began to place lessof an emphasis on broadcast rights.

 

***GrossMargins***

 

The followingtable presents consolidated cost of sales by reportable business segment and asa percentage of related segment net revenues for the years ended March 31,2004, 2003 and 2002, respectively:

 
|           |   | **2004** |       | **2003** |       |   |   | **2003** |       | **2002** |       |   |       |
|----------------|--------|----------|------------|----------|------------|--------|--------|----------|------------|----------|------------|--------|------------|
|           |   |     | ** ** |     | ** ** |   |   |     | ** ** |     | ** ** |   | ** ** |
| Cost of sales: |   |     |       |     |       |   |   |     |       |     |       |   |       |
| Domestic       |   | $        | 57,983     |     | $          | 55,536 |   |     |       | $        | 55,536     |   | $          | 43,882 |   |   |   |
| International  |   | 4,655    |       | 6,630    |       |   |   | 6,630    |       | 7,381    |       |   |       |
| Consolidated   |   | $        | 62,638     |     | $          | 62,166 |   |     |       | $        | 62,166     |   | $          | 51,263 |   |   |   |

 
|                                     |   |   | ** ** |   | ** ** | **% Change** | ** ** |   | ** ** |   | ** ** | **% Change** | ** ** |
|------------------------------------------|--------|--------|------------|--------|------------|--------------|------------|--------|------------|--------|------------|--------------|------------|
| As a percentage of segment net revenues: |   |   |       |   |       |         |       |   |       |   |       |         |       |
| Domestic                                 |   | 74.0   | %          | 71.7   | %          | 2.3          | %          | 71.7   | %          | 66.1   | %          | 5.6          | %          |
| International                            |   | 71.9   |       | 70.2   |       | 1.7          |       | 70.2   |       | 75.6   |       | (5.4         | )          |
| Consolidated                             |   | 73.8   | %          | 71.5   | %          | 2.3          | %          | 71.5   | %          | 67.3   | %          | 4.2          | %          |

 

Consolidatedcost of sales for the year ended March 31, 2004, were $62,638,000, or 73.8%of net revenues, compared to $62,166,000, or 71.5% of net revenues, for theyear ended March 31, 2003. Consolidated cost of sales for the year ended March 31, 2002 were$51,263,000, or 67.3% of net revenues.

 

*Fiscal 2004 Compared to 2003*

 

*Domestic Gross Margins*

 

The 2.3%reduction in domestic gross margins for fiscal 2004 was primarily due toincreased charges to segment cost of sales from increased amortization ofroyalty advances and adjustments to fair value as a result of lower ultimaterevenue forecasts for some of our exclusive programming.  Additionally, the increased marketdevelopment funds we provide to our retail customers, recorded by us as areduction to revenues, and writedowns of some inventory titles to thelower-of-cost or market value, also contributed to the decrease in segmentgross margins.  We are establishing adedicated group within our sales department to focus exclusively on ourextensive library of previously released programming in an effort to increasecatalogue revenues in fiscal 2005.

 

*International Gross Margins*

 

Gross marginsas a percentage of net revenues for our international segment decreased 1.7%for fiscal 2004.  Royalties anddistribution fees accrued to program suppliers on sublicense and broadcastrevenues are higher than those on subdistribution revenues.  For fiscal 2003, gross margins were not onlygenerated from sublicense and broadcast revenues, but also from subdistributionrevenues.  Cost of sales of this segmentin fiscal 2004 was primarily impacted by fluctuations in the royalties anddistribution fees, the primary components of fiscal 2004 cost of sales.  Cost of sales for this segment in fiscal2003 was impacted not only by fluctuations in royalties and distribution fees,but also by manufacturing costs, music publishing fees and market developmentfunds provided to subdistributors for marketing.  Cost of sales and conversely gross margins will fluctuate in thefuture based upon revenue performance of individual titles and royalties anddistribution fees on a title-by-title basis.

 

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*Fiscal 2003 Compared to 2002*

 

*Domestic Gross Margins*

 

The 5.6% decrease in domestic gross margins was due to a higherpercentage of segment revenues derived from exclusively distributed programming(which generates comparatively lower gross margins than our distribution ofexclusively licensed programming) during fiscal 2003 as compared to fiscal2002.  Additionally, the segment’s grossmargins were lower due to increased charges to cost of sales (increasedamortization of royalty advances and distribution fee advances and adjustmentsto fair value) as a result of lower ultimate revenue forecasts for some of ourexclusive DVD and VHS titles.  Forcomparative purposes, fiscal 2002 segment gross margins included a benefit togross margin of 2.7% for eliminated reserves related to the discontinuation ofour domestic laserdisc distribution operations.

 

*International Gross Margins*

 

Gross marginsfor our international segment increased by 5.4% for fiscal 2003 as compared tothe prior year.  In fiscal 2002, werecorded an impairment writedown of $696,000 for the advance royalties paid forthe international distribution rights to a line of programming.  The writedown was to the estimated fairvalue based on lower revised estimated ultimate revenues.  Fiscal 2003 gross margins were negativelyaffected by adjustments resulting from the change in our method ofinternational video distribution.  Weexpensed approximately $278,000 to cost of sales for additional sales returnswe expect to receive from subdistributors as well as a charge to cost of salesof $202,000 for inventory lower-of-cost or market writedowns.  Also, contributing to lower fiscal 2003 grossmargins were nonaccountable advertising and promotional allowances offered toour international subdistributors during fiscal 2003.  We recorded these allowances as a reduction of net revenues inaccordance with EITF 01-09.  Duringfiscal 2002, advertising and promotional expenses were only deducted frompurchases after review and approval by the Company and, accordingly, wereclassified as selling expenses rather than a reduction of revenues.

 

***SellingExpenses***

 

The followingtables present consolidated selling expenses by reportable business segment andas a percentage of related segment net revenues for the years endedMarch 31, 2004, 2003 and 2002, respectively:

 
|                                     |   | **2004**            |   | **2003** |   | **% Change**        |   | **2003** |   | **2002** |   | **% Change** |   |
|------------------------------------------|--------|---------------------|--------|----------|--------|---------------------|--------|----------|--------|----------|--------|--------------|--------|
|                                     |   | **(in  thousands)** |   |     |   | **(in  thousands)** |   |     |   |
| Selling expenses:                        |   |                |   |     |   |                |   |     |   |     |   |         |   |
| Domestic                                 |   | $                   | 5,902  |     | $      | 5,010               |   | 17.8     | %      | $        | 5,010  |         | $      | 4,471 |   | 12.1 | % |
| International                            |   | 184                 |   | 934      |   | (80.3               | )      | 934      |   | 1,819    |   | (48.7        | )      |
| Consolidated                             |   | $                   | 6,086  |     | $      | 5,944               |   | 2.4      | %      | $        | 5,944  |         | $      | 6,290 |   | (5.5 | )% |
|                                     |   |                |   |     |   |                |   |     |   |     |   |         |   |
| As a percentage of segment net revenues: |   |                |   |     |   |                |   |     |   |     |   |         |   |
| Domestic                                 |   | 7.5                 | %      | 6.5      | %      | 1.0                 | %      | 6.5      | %      | 6.7      | %      | (0.2         | )%     |
| International                            |   | 2.8                 |   | 9.9      |   | (7.1                | )      | 9.9      |   | 18.6     |   | (8.7         | )      |
| Consolidated                             |   | 7.2                 | %      | 6.8      | %      | 0.4                 | %      | 6.8      | %      | 8.3      | %      | (1.5         | )%     |

 

*Fiscal 2004 Compared to 2003*

 

*Domestic Selling Expenses*

 

The17.8% increase in domestic selling expenses was primarily due to increasedadvertising expenses, specifically print and co-op advertisements promoting ourexclusive DVD and CD programming.  Weexpect advertising and promotional expenditures to continue to increase, asretailers insist on marketing support for our programming once they havecommitted to purchasing it.  Print andco-op advertising are all increasingly important to creating consumer awarenessof our products.  The likelihood ofplacing product in significant quantity is enhanced with a convincing outlay ofmarketing funds to increase product awareness and sales.  It is common and increasingly more necessaryto spend from seventy cents to in excess of one dollar per unit in order toeffectively promote the availability of a higher-profile title at retail.

 

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*International Selling Expenses*

 

Internationalselling expenses for fiscal 2004 were 80.3% lower than fiscal 2003 primarilydue to expense savings from the closing of the offices of Aviva International,LLC, our 50% controlled joint venture that ceased operations at the end of ourthird fiscal quarter ended December 31, 2002.  Additional segment expense reductions came from the repurposingof employees previously classified as international selling to the programacquisitions and business development department, classified as general andadministrative expenses.  We havesignificantly reduced marketing and promotion expenditures during fiscal 2004as a result of the BMG sublicense agreement. The majority of expenses relating to international DVD sellingactivities, including marketing and promotion (which were our expenses infiscal 2003), were borne by BMG as our sublicensee for fiscal 2004.

 

*Fiscal 2003 Compared to 2002*

 

*Domestic Selling Expenses*

 

Several of themore significant factors contributing to the 12.1% increase in absolute dollardomestic segment selling expenses for fiscal 2003, as compared to fiscal 2002are as follows:  Image incurred $621,000higher personnel costs from adding regional sales personnel and exclusive brandmanagers during fiscal 2003 as well as annual salary increases.  The regional sales managers were added toseek new customer accounts and more efficiently handle specificterritories.  The exclusive brandmanagers were added to focus on marketing specific brands we exclusivelyacquire and distribute.  The increase inselling expenses for fiscal 2003 was partially offset by a $149,000 reductionin annual advertising expense.  Ouradvertising expenditures, on a specific title and line of programming basis,depend on the titles in release and the programs created by the marketingdepartment.

 

*International Selling Expenses*

 

Selling expenses for our international segment decreased 48.7% for fiscal2003, and as a percentage of segment net revenues, selling expenses were downby 8.7% from fiscal 2002.  We incurredreduced expenses generated by Aviva totaling $431,000, primarily from lowerpersonnel costs and trade show related expenses.  We completed our consolidation of Aviva’s operationalresponsibilities during the quarter ended December 31, 2002.  Additionally, we reduced advertising andpromotional expenses recorded as selling expenses by $619,000. These expensereductions were offset, in part, by a $144,000 increase in segment personnelcosts including Image sales personnel responsible for broadcast sales duringfiscal 2003 as compared to fiscal 2002. In fiscal 2003, we provided our European subdistributors marketdevelopment funds totaling $508,000 based upon a percentage of their purchases,which were recorded as a reduction of revenues recognized.

 

***Generaland Administrative Expenses***

 

The followingtables present consolidated general and administrative expenses by reportablebusiness segment and as a percentage of related segment net revenues for theyears ended March 31, 2004, 2003 and 2002, respectively:

 
|                                     |   | **2004**            |   | **2003** |   | **% Change**        |   | **2003** |   | **2002** |   | **% Change** |   |
|------------------------------------------|--------|---------------------|--------|----------|--------|---------------------|--------|----------|--------|----------|--------|--------------|--------|
|                                     |   | **(in  thousands)** |   |     |   | **(in  thousands)** |   |     |   |
| General and administrative expenses:     |   |                |   |     |   |                |   |     |   |     |   |         |   |
| Domestic                                 |   | $                   | 11,937 |     | $      | 9,374               |   | 27.3     | %      | $        | 9,374  |         | $      | 9,305 |   | 0.7 | % |
| International                            |   | 488                 |   | 1,153    |   | (57.7               | )      | 1,153    |   | 874      |   | 31.9         |   |
| Consolidated                             |   | $                   | 12,425 |     | $      | 10,527              |   | 18.0     | %      | $        | 10,527 |         | $      | 10,179 |   | 3.4 | % |
|                                     |   |                |   |     |   |                |   |     |   |     |   |         |   |
| As a percentage of segment net revenues: |   |                |   |     |   |                |   |     |   |     |   |         |   |
| Domestic                                 |   | 15.2                | %      | 12.1     | %      | 3.1                 | %      | 12.1     | %      | 14.0     | %      | (1.9         | )%     |
| International                            |   | 7.5                 |   | 12.2     |   | (4.7                | )      | 12.2     |   | 9.0      |   | 3.2          |   |
| Consolidated                             |   | 14.6                | %      | 12.1     | %      | 2.5                 | %      | 12.1     | %      | 13.4     | %      | (1.3         | )%     |

 

*Fiscal 2004 Compared to 2003*

 

*Domestic General and Administrative Expenses*

 

General andadministrative expenses for our domestic segment for the year endedMarch 31, 2004, were up 27.3% from the year ended March 31,2003.  We incurred significant expensesin personnel and consulting services in

 

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connection with the replacementof our legacy applications system and improvements in our technologyinfrastructure for the year ended March 31, 2004.  The migration to and maintenance of theOracle Enterprise Applications software has required us to add additionaltechnical resources, including both internal hires and externalconsulting.  The continuinginfrastructure improvements include a program to upgrade desktop computers, email,data storage and networks.  Many of theseexpenditures are not capitalizable in accordance with our capitalization policyand include maintenance contracts.  Weincurred higher general and administrative expenses in these areas duringfiscal 2004 as compared to fiscal 2003 as follows: information technologydepartment personnel costs of $380,000 (additional headcount); outside labor,including consulting, of $172,000; and recruitment, computer maintenance,uncapitalized information technology purchases, and training of $210,000.

 

We have repurposedemployees previously dedicated to our international distribution segment aswell as our domestic sales department and transferred them to our programacquisitions and business development department.  With BMG now responsible for European distribution of ourexclusive titles, we wanted to strengthen our internal efforts to acquirecommercially compelling exclusive programming in multiple genres.  Accordingly, related increased personnelcosts of approximately $451,000, previously classified as international segmentselling and general and administrative expenses and domestic selling expenses,are now included in this domestic segment general and administrative expenses.

 

We alsoincreased our personnel costs (including recruitment, consulting and temporarylabor expenses) in our accounting and finance departments to handle theincreased workload associated with the accounting and reporting requirements ofthe exclusive distribution agreements added during the current year as well asin the area of credit and collections. We incurred higher general and administrative expenses in these areasduring fiscal 2004 as compared to fiscal 2003 as follows: accounting andfinance department personnel costs of $206,000 (additional headcount); outsidelabor, including consulting and recruitment, of $142,000.

 

We haveincurred increased across-the-board insurance premium costs, which were higherby $372,000 for the year ended March 31, 2004, and increased legalexpenses, primarily associated with our efforts to protect our rights to ourexclusive programming from infringers, which were higher by $171,000 for theyear ended March 31, 2004.

 

The increasedexpenses described above as well as general wage increases of $259,000 were theprimary reasons for the increase in segment general and administrative expensesfor the year ended March 31, 2004. The trend of higher segment general and administrative expenses isexpected to continue for the foreseeable future due to the nature of ourinitiatives.  Once our information systemsare fully upgraded and specific processes are automated, we will expect theinformation technology and accounting and finance department costs tostabilize.

 

*International General and AdministrativeExpenses*

 

The 57.7%international segment general and administrative expense reduction for fiscalyear 2004 was primarily due to the repurposing of employees into the programacquisitions and business development department within the domestic segment asdiscussed above.

 

*Fiscal 2003 Compared to 2002*

 

*Domestic General and Administrative Expenses*

 

General and administrativeexpenses for our domestic segment were up 0.7% for fiscal 2003.  As a percentage of segment net revenues,general and administrative expenses for fiscal 2003 were 12.1%, down from 14.0%for fiscal 2002, with part of the decrease due to spreading of fixed costs overhigher revenues.  The significantfluctuations in segment general and administrative expense line items forfiscal 2003 as compared to fiscal 2002 are as follows:  the segment incurred a $239,000 increase ininsurance premiums, primarily for directors and officers, errors and omissionsand property coverage; a $213,000 increase in professional fees; and a $203,000increase in personnel costs, primarily for increased headcount, annual raises,severance and recruitment fees and other general individually insignificantincreases in segment general and administrative expenses.  Offsetting the noted expense increases weresignificant expensed items in fiscal 2002 that did not occur in fiscal2003.  In fiscal 2002, the segmentincurred a $557,000 bad debt expense increase, primarily for the provisionassociated with the Valley Media chapter 11 bankruptcy filing, a litigationsettlement for $310,000 and a write-off of an investment totaling $150,000.

 

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*International General and AdministrativeExpenses*

 

General and administrative expenses for our international segmentincreased 31.9% for fiscal 2003.  As apercentage of segment net revenues, general and administrative expenses were upby 3.2% from fiscal 2002.  The segmentincurred a $349,000 increase in personnel costs associated with additionaldedicated segment personnel and a $99,000 increase in legal and taxprofessional fees, offset by a $291,000 reduction in expenses generated byAviva, primarily salaries.  We completedour consolidation of Aviva’s operational responsibilities into Image during thequarter ended December 31, 2002.

 

***Amortizationof Production Costs***

 

Amortizationof production costs for the year ended March 31, 2004, decreased 7.7% to$3,957,000, or 4.7% of consolidated net revenues, from $4,287,000, or 4.9% ofconsolidated net revenues, for the year ended March 31, 2003.  Amortization of production costs for theyear ended March 31, 2003, decreased 15.4% from $5,065,000, or 6.7% ofconsolidated net revenues, for the year ended March 31, 2002.  The decrease for fiscal 2004 was primarilydue to reduced expenditures relating to work performed on our international DVDtitles, which results in reduced amortization. The decrease in fiscal 2003 was primarily due to reduced per-titleproduction costs charged by Deluxe Media Services, LLC (formerly Ritek GlobalMedia), our exclusive DVD manufacturer.

 

***OtherIncome and Expenses***

 

Other incomefor the year ended March 31, 2004, primarily represents foreign currencytransaction gains and a minority interest in the net loss of Aviva.  Other expenses for the year endedMarch 31, 2003, primarily consisted of an impairment charge of $322,000 asa result of the sale and leaseback of our Las Vegas, Nevada real estate, aminority interest in the net earnings of Aviva of $573,000, and $121,000representing the fair value (based on a Black-Scholes valuation) of the warrantissued to IIC in connection with the partial conversion of their subordinatednote payable in March 2003, net of foreign currency transaction gains forfiscal 2003 of $318,000.  Other expensefor fiscal 2002 was $192,000 which represents foreign currency transactionlosses of $210,000, net of $18,000 of minority interest expense in the net lossof Aviva.

 

***InterestExpense***

 

Interestexpense, net of interest income, for the year ended March 31, 2004,decreased 39.8% to $818,000, or 1.0% of consolidated net revenues, from$1,359,000, or 1.6% of consolidated net revenues, for the year endedMarch 31, 2003.  Interest expense,net of interest income, for the year ended March 31, 2003, decreased 20.6%from $1,711,000, or 2.2% of consolidated net revenue for fiscal 2002.  The decrease was attributable to lowerweighted average outstanding debt levels during fiscal 2004 compared to fiscal2003 and weighted average debt and interest rate levels during fiscal 2003 ascompared to fiscal 2002.  Our weightedaverage interest rate for fiscal 2003 and fiscal 2002 was 6.7% and 7.0%,respectively.

 

***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 statementcarrying amounts of existing assets and liabilities and their respective taxbases and operating loss and tax credit carryforwards.  Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled.   We must assess the likelihoodthat our deferred tax assets will be recovered from future taxable income, andto the extent that it is more likely than not that all, or a portion, of suchdeferred tax assets will not be realized, we must establish a valuationallowance.  The establishment, orincrease, of a valuation allowance increases income tax expense for such year.

 

In assessing therealizability of a deferred tax asset, Statement of Financial AccountingStandards (SFAS) No. 109 requires that all available evidence, both positiveand negative, be considered to determine whether, based on the weight of thatevidence, a valuation allowance is needed. SFAS No. 109 further provides that “cumulative losses in recent years”are significant pieces of negative evidence to overcome when determiningwhether it is “more likely than not” that the recorded deferred tax assets willbe realized in the future by reducing future income taxes payable.  Such cumulative losses from prior years mustbe considered on a pretax consolidated basis from all operations.  In addition to

 

33

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current year pretax losses for both continuingand discontinued operations, we also incurred aggregate net pretax losses forfiscal years 2003 and 2002. Accordingly, during the current fiscal year we established a valuationallowance against 100% of our net deferred tax assets, which are composedprimarily of operating loss carryforwards, resulting in a current year taxexpense of $6,244,000.  The valuationallowance was recorded in the third quarter primarily as a result of operatinglosses sustained during our normally seasonally strong third quarter as well asits then-expected impact on the full fiscal year results of operations.

 

Even though we have fullyreserved our net deferred tax assets for book purposes, we would still be ableto utilize 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.

 

Werecorded income tax expense from continuing operations of $1,306,000 for fiscalyear 2003.  Included as a component ofincome tax expense is a provision for a valuation allowance against ourdeferred tax assets of $551,000.  Thevaluation allowance fully reserved foreign tax credit carryforwards which have a5-year carryforward period.    Alsoduring 2003 we allocated an income tax benefit of $618,000 to discontinuedoperations.  We recorded income taxexpense of $562,000 for fiscal year 2002 and allocated an income tax benefit of$602,000 to discontinued operations.

 

***Earnings(Loss) from Continuing Operations***

 

Loss fromcontinuing operations, including the tax expense to record a valuationallowance against our deferred tax assets, was $7,115,000, or $.39 per dilutedshare, for the year ended March 31, 2004. Earnings from continuing operations were $642,000, or $.04 per dilutedshare, for the year ended March 31, 2003. Earnings from continuing operations were $873,000, or $.06 perdiluted share, for the year ended March 31, 2002.

 

***Lossfrom Discontinued Operations***

 

Loss from discontinuedoperations of $2,441,000 comprises a loss from operations of $1,742,000 and aloss on sale of $699,000 for the year ended March 31, 2004, as compared toa pretax loss from operations of $1,714,000 for the year ended March 31,2003.  Pretax loss from operations forfiscal 2002 was $1,670,000.  Duringfiscal 2003 and 2002, an income tax benefit of $618,000 and $602,000,respectively, was allocated to discontinued operations.

 

***ConsolidatedLosses***

 

Consolidatedloss before cumulative effect of accounting change for fiscal 2004 and 2003 was$9,556,000, or $.52 per diluted share, and $454,000, or $.03 per diluted share,respectively.  During fiscal 2003 acumulative effect of accounting change of $3,766,000, or $.22 per diluted share,net of income tax benefit of $2,231,000, was recorded resulting in aconsolidated net loss of $4,220,000, or $.25 per diluted share.  The consolidated net loss for fiscal 2002was $195,000, or $.01 per diluted share.

 

**Inflation**

 

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

 

**Recently Issued Accounting Pronouncements**

 

In December 2003, the SEC issued Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition*, which codifies, revises and rescinds portions of SAB No. 101, *Revenue Recognition*, in order to make this interpretive guidance consistent with current authoritative accounting and auditing guidance and SEC rules and regulations. The changes noted in SAB No. 104 did not have a material effect on our consolidated results of operations, consolidated financial position or consolidated cash flows.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity*.  SFAS No. 150 establishes standards for how an issuer classifies and measures financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances).  SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of

 

34

 

the first interim period beginning after June 15, 2003.  The adoption of this statement did not have a material impact on our financial condition or results of operations.

 

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

 

In January 2003, the FASB issued FASB Interpretation No. 46 (FIN46), *Consolidationof Variable Interest Entities, an Interpretation of Accounting Research BoardNo. 51*, which addresses consolidation by business enterprises ofvariable interest entities (VIEs) either: (1) that do not have sufficientequity investment at risk to permit the entity to finance its activitieswithout additional subordinated financial support; or (2) in which the equityinvestors lack an essential characteristic of a controlling financial interest.In December 2003, the FASB completed deliberations of proposedmodifications to FIN 46 (Revised Interpretations) resulting in multipleeffective dates based on the nature as well as the creation date of the VIE.VIEs created after January 31, 2003, but prior to January 1, 2004,may be accounted for either based on the original interpretation or the RevisedInterpretations.  VIEs created afterJanuary 1, 2004, must be accounted for under the Revised Interpretations.Special Purpose Entities (SPEs) created prior to February 1, 2003, may beaccounted for under the original or revised interpretation’s provisions.  Non-SPEs created prior to February 1,2003, should be accounted for under the Revised Interpretation’s provisions.The Revised Interpretations are effective for periods after June 15, 2003,for VIEs in which the Company holds a variable interest it acquired beforeFebruary 1, 2003. For entities acquired or created before February 1,2003, the Revised Interpretations are effective no later than the end of thefirst reporting period that ends after March 15, 2004, except for thoseVIEs that are considered to be special-purpose entities, for which theeffective date is no later that the end of the first reporting period that endsafter December 31, 2003. The adoption of FIN 46 and the RevisedInterpretations did not have an impact on the consolidated financial statements.

 

**ITEM7A.****                                            QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

**Interest Rate Fluctuations.**  At March 31, 2004, approximately $10.5million of our outstanding borrowings are subject to changes in interest rates;however, we do not use derivatives to manage this risk.  This exposure is linked to the prime rateand LIBOR.  We believe that moderatechanges in the prime rate or LIBOR would not materially affect the operatingresults or financial condition of the Company. For example, a 1% change in interest rates would result in anapproximate $105,000 annual impact on pretax income (loss) based upon thoseoutstanding borrowings at March 31, 2004.

 

**Foreign Exchange Rate Fluctuations.**  At March 31, 2004, approximately$50,000 of our accounts receivable related to international distribution andwere denominated in foreign currencies subject to future foreign exchange raterisk.  We distribute some of ourlicensed DVD and VHS programming (for which we have international distributionrights) internationally through international subdistributors andsublicensees.  Additionally, we exploitinternational broadcast rights to our licensed entertainment programming (forwhich we have international broadcast rights). We believe that moderate changes in the foreign exchange rates will notmaterially affect our operation results or financial condition.  For example, a 10% change in exchange rateswould result in an approximate $5,000 impact on pretax income (loss) based uponthose outstanding receivables at March 31, 2004.  To date, we have not entered into foreign currency exchangecontracts.

 

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**ITEM8.****                                                     FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 
| **INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**                                                                     |   |
|--------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                               |   |
| Report of Independent Registered Public  Accounting Firm                                                           |   |
|                                                                                                               |   |
| Consolidated Balance Sheets at March 31, 2004 and 2003                                                        |   |
|                                                                                                               |   |
| Consolidated Statements of Operations for  the years ended March 31, 2004, 2003 and 2002                      |   |
|                                                                                                               |   |
| Consolidated Statements of Shareholders’  Equity for the years ended March 31, 2004, 2003 and 2002       |   |
|                                                                                                               |   |
| Consolidated Statements of Cash Flows for  the years ended March 31, 2004, 2003 and 2002                      |   |
|                                                                                                               |   |
| Notes to Consolidated Financial Statements                                                                         |   |
|                                                                                                               |   |
| Schedule II  – Valuation and Qualifying Accounts for the years ended March 31, 2004,  2003 and 2002 |   |

 

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**Report of IndependentRegistered Public** Accounting Firm

 

 

TheBoard of Directors and Shareholders

ImageEntertainment, Inc.:

 

Wehave audited the consolidated financial statements of Image Entertainment, Inc.and subsidiaries as listed in the accompanying index.  In connection with our audits of the consolidated financialstatements, we also have audited the financial statement schedule as listed inthe accompanying index.  Theseconsolidated financial statements and financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express an opinion on these consolidatedfinancial statements and financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Image Entertainment, Inc. and subsidiaries as ofMarch 31, 2004 and 2003, and the results of their operations and theircash flows for each of the years in the three-year period ended March 31,2004 in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, the related financial statementschedule, when considered in relation to the basic consolidated financialstatements taken as a whole, presents fairly, in all material respects, theinformation set forth therein.

 

OnApril 1, 2002, the Company adopted Financial Accounting Standards BoardStatement No. 142, *Accounting for Goodwill*.

 

 
| (signed)  KPMG LLP |   |
|--------------------|--------|

 

 

LosAngeles, CA

June 25,2004

 

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**CONSOLIDATED BALANCESHEETS**

 

### **March 31, 2004 and 2003**

 

**ASSETS**

 
| **(In thousands)**                                                                 |   | **2004** |   | **2003** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Current assets:                                                                    |   |     |   |     |   |
| Cash                                                                               |   | $        | 540    |     | $      | 2,672 |   |
| Accounts receivable, net of allowances of  $7,413 – 2004;  $6,070 – 2003 |   | 21,742   |   | 20,454   |   |
| Inventories (Note 5)                                                               |   | 13,725   |   | 13,275   |   |
| Royalty and distribution fee advances                                              |   | 7,540    |   | 8,666    |   |
| Prepaid expenses and other assets                                                  |   | 887      |   | 719      |   |
| Deferred tax assets, net (Note 13)                                                 |   | —   |   | 1,535    |   |
| Assets held for sale or abandoned                                                  |   | —   |   | 2,944    |   |
| Total current assets                                                               |   | 44,434   |   | 50,265   |   |
| Noncurrent inventories, principally  production costs (Note 5)                     |   | 2,604    |   | 2,755    |   |
| Noncurrent royalty and distribution  advances                                      |   | 11,037   |   | 10,230   |   |
| Noncurrent deferred tax assets, net (Note  13)                                     |   | —   |   | 4,709    |   |
| Property, equipment and improvements, net  (Notes 6 and 9)                         |   | 5,782    |   | 5,972    |   |
| Other assets                                                                       |   | 275      |   | 320      |   |
|                                                                               |   | $        | 64,132 |     | $      | 74,251 |   |

 

*See accompanying notes to consolidated financial statements.*

 

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**CONSOLIDATEDBALANCE SHEETS**

 

### **March 31, 2004 and 2003**

 

**LIABILITIESAND SHAREHOLDERS’ EQUITY**

 
| **(In thousands, except share data)**                                                                                                            |   | **2004** |   | **2003** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|
| Current liabilities:                                                                                                                             |   |     |   |     |   |
| Accounts payable                                                                                                                                 |   | $        | 8,124  |     | $      | 8,934 |   |
| Accrued liabilities                                                                                                                              |   | 2,472    |   | 2,211    |   |
| Accrued royalties and distribution fees                                                                                                          |   | 9,255    |   | 7,496    |   |
| Accrued music publishing fees                                                                                                                    |   | 5,196    |   | 4,256    |   |
| Deferred revenue (Note 3)                                                                                                                        |   | 3,360    |   | 3,837    |   |
| Revolving credit facility (Note 7)                                                                                                               |   | 10,218   |   | 10,520   |   |
| Current portion of long-term debt (Note 8)                                                                                                       |   | 1,592    |   | 1,591    |   |
| Current portion of capital lease  obligations (Note 9)                                                                                           |   | 247      |   | 569      |   |
| Total current liabilities                                                                                                                        |   | 40,464   |   | 39,414   |   |
| Long-term debt, less current portion (Note  8)                                                                                                   |   | 1,224    |   | 2,816    |   |
| Capital lease obligations, less current  portion (Note 9)                                                                                        |   | 109      |   | 356      |   |
| Total liabilities                                                                                                                                |   | 41,797   |   | 42,586   |   |
| Commitments and Contingencies (Notes 7, 8,  9 and 10)                                                                                            |   |     |   |     |   |
| Shareholders’ equity (Notes 8 and 11):                                                                                                      |   |     |   |     |   |
| Preferred stock, $1 par value, 3,366,000  shares authorized; none issued and outstanding                                                         |   | —   |   | —   |   |
| Common stock, no par value, 30,000,000  shares authorized; 18,268,000 and 18,225,000 issued and outstanding  in 2004 and 2003, respectively |   | 33,142   |   | 32,916   |   |
| Additional paid-in capital                                                                                                                       |   | 3,774    |   | 3,774    |   |
| Accumulated deficit                                                                                                                              |   | (14,581  | )      | (5,025   | )      |
| Net shareholders’ equity                                                                                                                    |   | 22,335   |   | 31,665   |   |
|                                                                                                                                             |   | $        | 64,132 |     | $      | 74,251 |   |

 

*See accompanying notes to consolidated financial statements.*

 

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**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

 

### **For the Years Ended March 31, 2004, 2003and 2002**

 
| **(In thousands, except per share  data)**                                                                                                  |   | **2004** |   | **2003** |   | **2002** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| NET REVENUES                                                                                                                                |   | $        | 84,840 |     | $      | 86,929   |   | $ | 76,135 |   |
| OPERATING COSTS AND EXPENSES:                                                                                                               |   |     |   |     |   |     |   |
| Cost of sales                                                                                                                               |   | 62,638   |   | 62,166   |   | 51,263   |   |
| Selling expenses                                                                                                                            |   | 6,086    |   | 5,944    |   | 6,290    |   |
| General and administrative expenses                                                                                                         |   | 12,425   |   | 10,527   |   | 10,179   |   |
| Amortization of production costs                                                                                                            |   | 3,957    |   | 4,287    |   | 5,065    |   |
| Amortization of goodwill                                                                                                                    |   | —   |   | —   |   | —   |   |
|                                                                                                                                        |   | 85,106   |   | 82,924   |   | 72,797   |   |
| EARNINGS (LOSS) FROM OPERATIONS                                                                                                             |   | (266     | )      | 4,005    |   | 3,338    |   |
| OTHER EXPENSES (INCOME):                                                                                                                    |   |     |   |     |   |     |   |
| Interest expense                                                                                                                            |   | 818      |   | 1,359    |   | 1,711    |   |
| Other (Notes 4, 6 and 14)                                                                                                                   |   | (213     | )      | 698      |   | 192      |   |
|                                                                                                                                        |   | 605      |   | 2,057    |   | 1,903    |   |
| EARNINGS (LOSS) FROM CONTINUING OPERATIONS  BEFORE INCOME TAXES                                                                        |   | (871     | )      | 1,948    |   | 1,435    |   |
| INCOME TAX EXPENSE (Notes 13 and 14)                                                                                                        |   | 6,244    |   | 1,306    |   | 562      |   |
| EARNINGS (LOSS) FROM CONTINUING OPERATIONS                                                                                                  |   | (7,115   | )      | 642      |   | 873      |   |
| DISCONTINUED OPERATIONS:                                                                                                                    |   |     |   |     |   |     |   |
| Loss from operations of discontinued retail  distribution segment (less applicable income tax benefit of $618 in 2003 and  of $602 in 2002) |   | (1,742   | )      | (1,096   | )      | (1,068   | )      |
| Loss on sale of retail distribution segment                                                                                                 |   | (699     | )      | —   |   | —   |   |
| LOSS FROM DISCONTINUED OPERATIONS                                                                                                           |   | (2,441   | )      | (1,096   | )      | (1,068   | )      |
| LOSS BEFORE CUMULATIVE EFFECT OF ACCOUNTING  CHANGE                                                                                         |   | (9,556   | )      | (454     | )      | (195     | )      |
| CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET  OF INCOME TAX BENEFIT OF $2,231                                                                |   | —   |   | (3,766   | )      | —   |   |
| NET LOSS                                                                                                                                    |   | $        | (9,556 | )        | $      | (4,220   | )      | $ | (195 | ) |
| NET EARNINGS (LOSS) PER SHARE:                                                                                                              |   |     |   |     |   |     |   |
| Continuing operations – basic and diluted                                                                                              |   | $        | (.39   | )        | $      | .04      |   | $ | .06 |   |
| Discontinued operations – basic and diluted                                                                                            |   | (.13     | )      | (.07     | )      | (.07     | )      |
| Cumulative effect of accounting change, net  – basic and diluted                                                                       |   | —   |   | (.22     | )      | —   |   |
| Net loss – basic and diluted                                                                                                           |   | $        | (.52   | )        | $      | (.25     | )      | $ | (.01 | ) |
| WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:                                                                                                 |   |     |   |     |   |     |   |
| Basic                                                                                                                                       |   | 18,250   |   | 16,812   |   | 15,821   |   |
| Diluted                                                                                                                                     |   | 18,250   |   | 17,002   |   | 15,898   |   |

 

*See accompanying notes to consolidated financial statements.*

 

40

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**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY (Notes 8, 11 and 13)**

 

**For the Years Ended March 31, 2004, 2003and 2002**

 
| **(In thousands)**                 |       | **Common Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Deficit** | ** ** |
|------------------------------------|------------|------------------|------------|----------------------------------|------------|--------------------------|------------|
| **Shares**                         | ** ** | **Amount**       |
| BALANCES, March 31, 2001      |       | 15,849           |       | $                                | 29,765     |                     | $          | 3,320 |   | $ | (610 | ) |
| Repurchase of common stock         |       | (47              | )          | (114                             | )          | —                   |       | — |   |
| Issuance of restricted stock units |       | 26               |       | 199                              |       | —                   |       | — |   |
| Issuance of stock warrant          |       | —           |       | —                           |       | 143                      |       | — |   |
| Net loss                           |       | —           |       | —                           |       | —                   |       | (195 | ) |
|                               |       |             |       |                             |       |                     |       |   |   |
| BALANCES, March 31, 2002      |       | 15,828           |       | 29,850                           |       | 3,463                    |       | (805 | ) |
| Issuance of common stock           |       | 2,369            |       | 2,861                            |       | —                   |       | — |   |
| Issuance of restricted stock units |       | 26               |       | 201                              |       | —                   |       | — |   |
| Exercise of options                |       | 2                |       | 4                                |       | —                   |       | — |   |
| Issuance of stock warrants         |       | —           |       | —                           |       | 311                      |       | — |   |
| Net loss                           |       | —           |       | —                           |       | —                   |       | (4,220 | ) |
|                               |       |             |       |                             |       |                     |       |   |   |
| BALANCES, March 31, 2003      |       | 18,225           |       | 32,916                           |       | 3,774                    |       | (5,025 | ) |
| Issuance of restricted stock units |       | 20               |       | 186                              |       | —                   |       | — |   |
| Exercise of options                |       | 23               |       | 40                               |       | —                   |       | — |   |
| Net loss                           |       | —           |       | —                           |       | —                   |       | (9,556 | ) |
|                               |       |             |       |                             |       |                     |       |   |   |
| BALANCES, March 31, 2004      |       | 18,268           |       | $                                | 33,142     |                     | $          | 3,774 |   | $ | (14,581 | ) |

 

*See accompanying notes to consolidated financial statements.*

 

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

### **For the Years Ended March 31, 2004, 2003and 2002**

 
| **(In thousands)**                                                                                           |   | **2004** |   | **2003** |   | **2002** |   |
|--------------------------------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| CASH FLOWS FROM CONTINUING OPERATING  ACTIVITIES:                                                            |   |     |   |     |   |     |   |
| Net loss                                                                                                     |   | $        | (9,556 | )        | $      | (4,220   | )      | $ | (195 | ) |
| Adjustments to reconcile net loss to net  cash  provided by (used in) continuing  operating activities: |   |     |   |     |   |     |   |
| Loss from discontinued operations, net of  tax benefit in 2003 and 2002                                      |   | 1,742    |   | 1,096    |   | 1,068    |   |
| Loss on sale of discontinued retail  distribution segment                                                    |   | 699      |   | —   |   | —   |   |
| Cumulative effect of accounting change, net  of deferred tax benefit of $2,231                               |   | —   |   | 3,766    |   | —   |   |
| Amortization of production costs                                                                             |   | 3,957    |   | 4,287    |   | 5,065    |   |
| Amortization of goodwill                                                                                     |   | —   |   | —   |   | 509      |   |
| Depreciation and other amortization                                                                          |   | 2,313    |   | 2,314    |   | 2,222    |   |
| Amortization of stock warrant and  restricted stock units                                                    |   | 132      |   | 394      |   | 286      |   |
| Provision for lower of cost or market  inventory writedowns                                                  |   | 766      |   | 307      |   | 324      |   |
| Provision for estimated doubtful accounts  receivable                                                        |   | 72       |   | 108      |   | 597      |   |
| Impairment charge- Las Vegas, Nevada real  estate                                                            |   | —   |   | 322      |   | —   |   |
| Loss on disposal of assets                                                                                   |   | 7        |   | 106      |   | —   |   |
| Deferred income taxes – continuing  operations                                                          |   | 6,244    |   | 1,030    |   | 431      |   |
| Changes in assets and liabilities  associated with continuing operating activities:                          |   |     |   |     |   |     |   |
| Accounts receivable                                                                                          |   | (1,360   | )      | (2,232   | )      | (4,698   | )      |
| Inventories                                                                                                  |   | (1,694   | )      | (333     | )      | (304     | )      |
| Royalty and distribution fee advances                                                                        |   | 319      |   | (680     | )      | (4,496   | )      |
| Production cost expenditures                                                                                 |   | (3,328   | )      | (4,395   | )      | (4,743   | )      |
| Prepaid expenses and other assets                                                                            |   | (123     | )      | 914      |   | (12      | )      |
| Accounts payable, accrued royalties, fees  and liabilities                                                   |   | 2,204    |   | (572     | )      | (11      | )      |
| Deferred revenue                                                                                             |   | (477     | )      | 3,837    |   | —   |   |
| Net cash provided by (used in) continuing  operating activities                                              |   | 1,917    |   | 6,049    |   | (3,957   | )      |
| CASH FLOWS FROM CONTINUING INVESTING  ACTIVITIES:                                                            |   |     |   |     |   |     |   |
| Capital expenditures                                                                                         |   | (2,140   | )      | (1,463   | )      | (187     | )      |
| Net proceeds from sale of land                                                                               |   | —   |   | 5,668    |   | —   |   |
| Net cash provided by (used in)  continuing  investing activities                                        |   | (2,140   | )      | 4,205    |   | (187     | )      |
| CASH FLOWS FROM CONTINUING FINANCING  ACTIVITIES:                                                            |   |     |   |     |   |     |   |
| Borrowings under revolving credit facility                                                                   |   | $        | 92,874 |     | $      | 106,592  |   | $ | 93,716 |   |
| Repayments of borrowings under revolving  credit facility                                                    |   | (93,176  | )      | (106,192 | )      | (86,199  | )      |
| Repayments of long-term debt                                                                                 |   | (1,591   | )      | (8,487   | )      | (1,451   | )      |
| Principal payments under capital lease  obligations                                                          |   | (569     | )      | (637     | )      | (415     | )      |
| Borrowings under long-term debt                                                                              |   | —   |   | —   |   | 244      |   |
| Issuance of common stock                                                                                     |   | —   |   | 2,000    |   | —   |   |
| Repurchase of common stock                                                                                   |   | —   |   | —   |   | (114     | )      |
| Exercise of employee stock option                                                                            |   | 40       |   | 3        |   | —   |   |
| Net cash (used in) provided by continuing  financing activities                                              |   | (2,422   | )      | (6,721   | )      | 5,781    |   |
| INCREASE (DECREASE) IN CASH:                                                                                 |   | (2,645   | )      | 3,533    |   | 1,637    |   |
| Cash provided by (used in) discontinued  operations                                                          |   | 513      |   | (1,164   | )      | (1,940   | )      |
| NET INCREASE (DECREASE) IN CASH:                                                                             |   | (2,132   | )      | 2,369    |   | (303     | )      |
| Cash at beginning of year                                                                                    |   | 2,672    |   | 303      |   | 606      |   |
| Cash at end of year                                                                                          |   | $        | 540    |     | $      | 2,672    |   | $ | 303 |   |
| SUPPLEMENTAL DISCLOSURES OF CASH FLOW  INFORMATION:                                                          |   |     |   |     |   |     |   |
| Cash paid during the year for:                                                                               |   |     |   |     |   |     |   |
| Interest                                                                                                     |   | $        | 833    |     | $      | 1,481    |   | $ | 1,311 |   |
| Income taxes                                                                                                 |   | $        | 6      |     | $      | 10       |   | $ | — |   |

 

*See accompanying notes to consolidated financial statements*

 

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SUPPLEMENTAL DISCLOSURES OF NONCASH OPERATING, INVESTING AND FINANCINGACTIVITIES:

 

In March 2003, the Company issued 567,568 shares of itsunregistered common stock to retire the remaining $1,050,000 in principal dueunder the convertible subordinated note payable with Image Investors Co., theCompany’s largest shareholder.  Inconnection with the partial conversion of the note, the Company issued ImageInvestors Co. a warrant to purchase up to 100,000 shares of the Company’s unregisteredcommon stock at $2.04. The fair value of the warrant on the issuance date,$121,000, was calculated using the Black-Scholes valuation model and wasrecorded as other expenses in the accompanying consolidated statement ofoperations for fiscal 2003 and additional paid in capital in the accompanyingconsolidated balance sheets at March 31, 2004 and 2003.

 

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

 

On June 30, 2003 and July 1, 2002, the Company issued 19,577and 19,884 shares of common stock, respectively, to officers (net of shareswithheld for payment of related income taxes) in connection with the vesting ofrestricted stock units.  The Companyincreased common stock at June 30, 2003 and July 1, 2002 byapproximately $186,000 and $190,000, respectively, such amounts representingthe value of the total vested shares as of the respective grant dates less thevalue of shares withheld for payment of related income taxes on the vestingdates.

 

*See accompanying notes to consolidated financial statements*

 

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NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

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

 

*Basis of Presentation and Principles ofConsolidation.* The accompanying consolidated financial statements include the accountsof Image Entertainment, Inc. (“Image”), its subsidiaries DVDPlanet, Inc. andAviva International, LLC (collectively, “Image” or the “Company”).  All significant inter-company balances andtransactions have been eliminated in consolidation.  Aviva International, LLC ceased active operations effectiveDecember 31, 2002.  DVDPlanetceased operations in December 2003 subsequent to the sale of substantiallyall of its assets.  See “Note 2.Discontinued Operations – Sale of DVD Planet” and “Note 4. Current Status ofAviva International, LLC Operations”.

 

*Business.*  The Company is engaged primarily in thedomestic acquisition and wholesale distribution of a broad range of programmingfor release on DVD and in other home entertainment formats, via exclusivelicense and distribution agreements.  Wealso distribute our exclusive DVD programming internationally, primarily byrelying on sublicensees (particularly BMG), from whom we receive revenues inthe form of royalty income.

 

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

 

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

 

The fair value of the Company’s debt instruments approximate the amountof future cash flows associated with each instrument.  At March 31, 2004 and 2003, the carrying value of allfinancial instruments was not materially different from fair value, as thefixed rate debt approximates rates currently available to the Company.

 

*Revenue Recognition.*  All revenue is recognized upon meeting allthe recognition requirements of American Institute of Certified PublicAccountants Statement of Position (“SOP”) 00-2, *Accounting by Producers or Distributors of Films* and Staff Accounting Bulletin (“SAB”) No.104, *Revenue Recognition*.  Revenues from home video distribution arerecognized, net of an allowance for estimated returns, as well as relatedcosts, in the period in which the product is available for sale by theCompany’s customers (at the point that title and risk of loss transfer to thecustomer, which is generally upon receipt by the customer and in the case ofnew releases, after “street date” restrictions lapse).  Revenues from domestic and internationalbroadcast licensing and home video sublicensing, as well as associated costs,are recognized when the programming is available to the licensee and otherrecognition requirements of SOP 00-2 are met. Fees received in advance of availability, usually in the case ofadvances received from BMG, other international sublicensees and for broadcastprogramming, are deferred until other revenue recognition requirements havebeen satisfied.  As of March 31,2004, deferred revenue totaled $3,360,000. In all instances, provisions for uncollectible accounts receivable areprovided 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.

 

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

 

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*Royalty and Distribution Fee Advances,Recoupable Production Advances.*  Royalty and distribution fee advancesrepresent fixed minimum payments made to program suppliers for exclusiveprogramming distribution rights.  Aprogram supplier’s share of exclusive program distribution revenues is retainedby the Company until the share equals the advance(s) paid to the programsupplier plus recoupable production costs. Thereafter, any excess is paid to the program supplier.  In the event of an excess, the Companyrecords, as a cost of sales, an amount equal to the program supplier’s share ofthe net distribution revenues.  Royaltyand distribution fee advances are charged to operations as revenues areearned.  Royalty distribution feeadvances and recoupable production costs are amortized to expense in the sameratio that current period revenue for a title or group of titles bear to theestimated remaining unrecognized ultimate revenue for that title.  Revenue and cost forecasts are continuallyreviewed by management and revised when warranted by changing conditions.  When estimates of total revenues and costsindicated that an individual title or group of cross-collateralized titleswhich the Company exploits via home entertainment formats such as home video,CD or broadcast, will result in an ultimate loss, an impairment charge isrecognized to the extent that capitalized advance royalties and distributionfees and recoupable production costs exceed estimated fair value, based ondiscounted cash flows, in the period when estimated.

 

*Property, Equipment and Improvements.*  Property, equipment and improvements arestated at cost less accumulated depreciation and amortization.  Major renewals and improvements arecapitalized; minor replacements, maintenance and repairs are charged to currentoperations.  Some costs in developinginternal use software are capitalized pursuant to the SOP 98-1, *Accounting for Costs of Computer Software Developedor Obtained for Internal Use*. Depreciation and amortization are computed by applying the straight-linemethod over the estimated useful lives of the machinery, equipment and software(3-7 years).  Leasehold improvements areamortized over the shorter of the useful life of the improvement or the life ofthe related lease.

 

*Advertising Costs.*  The Company’s advertising expense comprisesexpenditures related to advertising in trade and consumer publications, productbrochures and catalogs, booklets for sales promotion, radio advertising andother promotional costs.  In accordancewith SOP 93-7, *Reporting on AdvertisingCosts*, the Company expenses advertising costs in the period in whichthe advertisement takes place.  Thecosts of trade and consumer advertising space is capitalized and reported asexpense in the period the space is used. Product brochures and catalogs and various other promotional costs arecapitalized and amortized over the expected period of future benefit, butgenerally not exceeding six months.  AtMarch 31, 2004 and 2003, prepaid advertising costs for Image were $224,000and $271,000, respectively.  For fiscal2004, 2003 and 2002, advertising and promotion expense was $2,445,000,$1,530,000 and $2,341,000, respectively.

 

*Market Development Funds.*  In accordance with Emerging Issues TaskForce (“EITF”) 01-09, *Accounting forConsideration Given by a Vendor to a Customer or a Reseller of the Vendor’sProducts*, the Company has classified market development funds,including funds for specific product positioning, deducted from payment forpurchases by customers as a reduction to revenues.  The following reductions to consolidated net revenues and sellingexpenses have been made in accordance with the guidelines of this issue:  $2,437,000 for 2004, $1,886,000 for 2003 and$1,019,000 for 2002.

 

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

 

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

 

*Major Customers.*  On a consolidated basis, Best Buy and AECOne-Stop accounted for 16.5% and 12.0% of fiscal 2004 sales, respectively.  Best Buy and Musicland (which was owned byBest Buy through June 16, 2003) together accounted for 21.1% and 19.1% offiscal 2003 and 2002 net revenues, respectively.  No other customers accounted for more than 10% of net revenues infiscal 2004, 2003 and 2002.

 

*Goodwill.*  In June 2001, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards(“SFAS”) No. 141, *Business Combinations*,and No. 142, *Goodwill and other IntangibleAssets*.

 

45

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SFAS No. 141 requires that the purchase method be used for all businesscombinations initiated after June 30, 2001.  SFAS No. 142 requires that goodwill no longer be amortized toearnings, but instead be reviewed for impairment.  The amortization of goodwill ceases upon adoption of SFAS No.142.  Image adopted the new rules formeasuring the impairment of goodwill and various intangible assets onApril 1, 2002.

 

During its fourth quarter ended March 31, 2002,  the carrying value of Image’s acquiredgoodwill was determined to be impaired pursuant to the new valuation guidelinesof SFAS No. 142.  The adoption of SFASNo. 142 resulted in a charge of $3,766,000, or $.22 per diluted share, net ofan income tax benefit of $2,231,000. The impairment charge was recorded as a cumulative effect of a change inaccounting principle, net of the income tax benefit, in the accompanyingconsolidated statement of operations for fiscal 2003.  As a result of this writedown, DVDPlanet has no remaininggoodwill.  Prior to the adopting the newvaluation guidelines of SFAS No. 142, the Company accounted for goodwill underSFAS No. 121.  Under SFAS No. 121,projected undiscounted cash flows expected from DVDPlanet exceeded the recordedcarrying value of DVDPlanet. Accordingly, the Company did not have any goodwill in periods subsequentto the impairment.

 

*Long-Lived Assets.*  The Company reviews for the impairment oflong-lived and specific, identifiable intangible assets whenever events orchanges in circumstances indicate the carrying amount of an asset may not berecoverable.  An impairment loss wouldbe recognized when estimated undiscounted future cash flows expected to resultfrom the use of the asset and its eventual disposition is less than itscarrying amount.

 

Prior to the ultimate sale of the Company’s Las Vegas, Nevada warehouseand distribution facility and adjacent vacant land, the Company wrote down thenet book value of the land and building to approximate the estimated salesprice less estimated related transactional costs.  The impairment charge totaled $322,000 and is included as acomponent of other expenses in the accompanying statement of operations forfiscal 2003.  See “Note 6.  Property, Equipment and Improvements.”  No impairment charges were recorded duringfiscal 2004 and 2002.

 

*Foreign Currency Transactions.*  Foreign currency denominated transactionsare recorded 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.

 

*Income Taxes.*  The Company accounts for income taxespursuant to the provisions of SFAS No. 109, *Accountingfor Income Taxes*, whereby deferred tax assets and liabilities arerecognized for the future tax consequences attributable to differences betweenthe financial statement carrying amount of existing assets and liabilities andtheir respective tax bases and the future tax benefits derived from operatingloss and tax credit carryforwards.  TheCompany provides a valuation allowance on its deferred tax assets when it ismore likely than not that such deferred tax assets will not be realized.  The Company has provided a valuationallowance against 100% of its net deferred tax assets as of March 31,2004.

 

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

 

*Comprehensive Income.*  Comprehensive income is the change in equityof a business enterprise during a period resulting from transactions and allother events and circumstances from non-owner sources.  The Company did not have components ofcomprehensive income during the three years ended March 31, 2004.

 

*Stock Options.*             The Company accountsfor stock options granted to employees in accordance with Accounting PrinciplesBoard Opinion No. 25, *Accounting for Stock Issued to Employees*,and related interpretations.  Becausethe exercise price of all options granted by the Company was greater than orequal to the market price of the underlying common stock on the date of thegrant, no compensation expense is recognized. Total compensation cost recognized for stock-based employee compensationawards under restricted stock grants, net of cancellations, is added

 

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back to the Company’s consolidated net loss, and reported in the tablebelow.  Compensation expense related tostock options granted to non-employees is accounted for under SFAS No. 123, *Accountingfor Stock-Based Compensation*, which requires us to recognize anexpense based on the fair value of the related awards.  If the Company had accounted for stockoptions issued to employees in accordance with SFAS No. 123, its pro forma netincome and earnings per share would have been reported as follows:

 
| **(In thousands, except per share  data)**                                                                                                          |   | **2004** |    | **2003** |   | **2002** |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------|---------|----------|--------|----------|--------|
|                                                                                                                                                |   |     |    |     |   |     |   |
| Consolidated net loss, as reported                                                                                                                  |   | $        | (9,556  | )        | $      | (4,220   | )      | $ | (195 | ) |
| Add:   Stock-based employee compensation expense included in the reported  consolidated net earnings (loss), net of related tax effects        |   | —   |    | —   |   | —   |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value based method for all awards, net of related tax effects |   | (536     | )       | (195     | )      | (296     | )      |
|                                                                                                                                                |   |     |    |     |   |     |   |
| Pro forma consolidated net loss                                                                                                                     |   | $        | (10,092 | )        | $      | (4,415   | )      | $ | (491 | ) |
|                                                                                                                                                |   |     |    |     |   |     |   |
| Consolidated net loss per share:                                                                                                                    |   |     |    |     |   |     |   |
| As reported                                                                                                                                         |   |     |    |     |   |     |   |
| Basic                                                                                                                                               |   | $        | (.52    | )        | $      | (.25     | )      | $ | (.01 | ) |
| Diluted                                                                                                                                             |   | $        | (.52    | )        | $      | (.25     | )      | $ | (.01 | ) |
| Pro forma                                                                                                                                           |   |     |    |     |   |     |   |
| Basic                                                                                                                                               |   | $        | (.55    | )        | $      | (.26     | )      | $ | (.03 | ) |
| Diluted                                                                                                                                             |   | $        | (.55    | )        | $      | (.26     | )      | $ | (.03 | ) |

 

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

 
|                  |   | **2004**  |   | **2003** |   | **2002** |   |
|-----------------------|--------|-----------|--------|----------|--------|----------|--------|
| Expected life (years) |   | 5.0       |   | 5.0      |   | 5.0      |   |
| Interest rate         |   | 3.03-3.52 | %      | 1.20     | %      | 3.91     | %      |
| Volatility            |   | 74-79     | %      | 79       | %      | 83       | %      |
| Dividend yield        |   | 0.00      | %      | 0.00     | %      | 0.00     | %      |

 

*Recently Issued Accounting Standards.*  In December 2003, the SEC issued SABNo. 104, *Revenue Recognition*,which codifies, revises and rescinds portions of SAB No. 101, RevenueRecognition, in order to make this interpretive guidance consistent withcurrent authoritative accounting and auditing guidance and SEC rules andregulations. The changes noted in SAB No. 104 did not have a material effect onour consolidated results of operations, consolidated financial position orconsolidated cash flows.

 

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

 

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

 

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN46”), *Consolidationof Variable Interest Entities, an Interpretation of Accounting Research BoardNo. 51*, which addresses consolidation by business enterprises ofvariable interest entities ( “VIEs”) either: (1) that do not have sufficientequity investment at risk to permit the entity to finance its activitieswithout additional subordinated financial support; or (2) in which the equityinvestors lack an essential characteristic of a controlling financial interest.In December 2003, the FASB completed deliberations of proposedmodifications to FIN 46 (“Revised Interpretations”) resulting in multipleeffective dates based on the nature as well as the creation date of the VIE.VIEs created after January 31, 2003, but prior to January 1, 2004,may be accounted for either based on the original interpretation or the RevisedInterpretations.  VIEs created afterJanuary 1,

 

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2004 must be accounted for under the Revised Interpretations. SpecialPurpose Entities (“SPEs”) created prior to February 1, 2003 may beaccounted for under the original or revised interpretation’s provisions.  Non-SPEs created prior to February 1,2003, should be accounted for under the Revised Interpretation’s provisions.The Revised Interpretations are effective for periods after June 15, 2003for VIEs in which the Company holds a variable interest it acquired beforeFebruary 1, 2003. For entities acquired or created before February 1,2003, the Revised Interpretations are effective no later than the end of thefirst reporting period that ends after March 15, 2004, except for thoseVIEs that are considered to be special-purpose entities, for which theeffective date is no later that the end of the first reporting period that endsafter December 31, 2003. The adoption of FIN 46 and the RevisedInterpretations did not have an impact on the consolidated financial statements.

 

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

 

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

 
|                                                                                  |   | **Fiscal  Year-Ended   March 31,** |   |
|---------------------------------------------------------------------------------------|--------|-----------------------------------------|--------|
| **(In  thousands, except per share data)**                                            |   | **2004**                                |   | **2003** |   | **2002** |   |
|                                                                                  |   |                                    |   |   |   |   |   |
| Reported loss before cumulative effect of  accounting change                          |   | $                                       | (9,556 | ) | $ | (454 | ) | $ | (195 | ) |
| Add back: goodwill amortization, net of  related $183,000 tax benefit for fiscal 2002 |   | —                                  |   | — |   | 326 |   |
| Adjusted earnings (loss) before cumulative  effect of accounting change               |   | (9,556                                  | )      | (454 | ) | 131 |   |
| Cumulative effect of accounting change, net  of tax benefit of $2,231                 |   | —                                  |   | (3,766 | ) | — |   |
| Adjusted net earnings (loss)                                                          |   | $                                       | (9,556 | ) | $ | (4,220 | ) | $ | 131 |   |
|                                                                                  |   |                                    |   |   |   |   |   |
| Diluted earnings (loss) per share:                                                    |   |                                    |   |   |   |   |   |
| Reported earnings (loss) before cumulative  effect of accounting change               |   | $                                       | (.52   | ) | $ | (.03 | ) | $ | (.01 | ) |
| Goodwill amortization, net of tax benefit                                             |   | —                                  |   | — |   | .02 |   |
| Adjusted earnings (loss) before cumulative  effect of accounting change               |   | (.52                                    | )      | (.03 | ) | .01 |   |
| Cumulative effect of accounting change                                                |   | —                                  |   | (.22 | ) | — |   |
| Adjusted net earnings (loss) per share                                                |   | $                                       | (.52   | ) | $ | (.25 | ) | $ | .01 |   |

 

*Reclassifications.*  Some fiscal 2003 balances have beenreclassified to conform with the fiscal 2004 presentation.

 

**Note 2. Discontinued Operations – Sale of DVDPlanet.**

 

On September 23, 2003, Image’s wholly-owned subsidiary DVDPlanet,Inc., sold substantially all of its assets to Planet Entertainment, Inc., asubsidiary of Infinity Resources, Inc. (“Infinity”) for approximately$2,644,000 in net proceeds in connection with the sale: $1,655,000 from thesale of the net assets, and $989,000 in accelerated payments for purchasedinventory under the June 2003 fulfillment agreement between DVDPlanet andI-Serve Direct Commerce Services, Inc. (also a subsidiary of Infinity).  Image received $2,354,000 onSeptember 23, 2003, ($1,424,000 of which was attributable to the assetsale), and $290,000 in October 2003 ($231,000 of which represented theremaining amount due on the sale). DVDPlanet’s cash, accounts receivable, accounts payable and accruedexpenses on the date of sale were retained by the Company.  The Company incurred a loss ofapproximately $699,000 on the sale of the assets.  The Company expensed approximately $293,000 in remainingseverance-related compensation liability in connection with the sale during thequarter ended December 31, 2003, which is included as a component of theloss from discontinued operations for the year ended March 31, 2004.

 

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The following is summary financial information for the Company’s discontinuedretail distribution segment for the three years ended March 31, 2004:

 
| **(In thousands)**                                            |   | **2004** |   | **2003** |   | **2002** |   |
|---------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                          |   |     |   |     |   |     |   |
| Net revenues                                                  |   | $        | 8,991  |     | $      | 21,264   |   | $ | 18,678 |   |
| Pretax loss from discontinued operations                      |   | (1,742   | )      | (1,714   | )      | (1,670   | )      |
| Pretax loss from the sale of the retail  distribution segment |   | (699     | )      | —   |   | —   |   |
| Income tax benefit                                            |   | —   |   | 618      |   | 602      |   |
| Net loss from discontinued operations                         |   | $        | (2,441 | )        | $      | (1,096   | )      | $ | (1,068 | ) |

 

Assets held for sale orabandoned with respect to the discontinued retail distribution segment includedin the consolidated balance sheets as of March 31, 2004 and 2003 were asfollows:

 
| **(In thousands)**                 |   | **2004** |   | **2003** |   |
|------------------------------------|--------|----------|--------|----------|--------|
| Accounts receivable                |   | $        | — |     | $      | — |   |
| Inventories                        |   | —   |   | 1,982    |   |
| Property, plant and equipment, net |   | —   |   | 878      |   |
| Other                              |   | —   |   | 84       |   |
| Assets held for sale or abandoned  |   | $        | — |     | $      | 2,944 |   |

 

**Note 3. Transition of International Sales to BMG.**

 

During fiscal 2004, we completed our transition of internationaldistribution of our exclusive DVD programming previously performed by a networkof independent subdistributors to BMG Music International Service, GmbH (“BMG”)under a January 2003 five-year sublicense agreement.

 

Image receivedan initial $3.0 million royalty advance under the BMG agreement inMarch 2003, fully recoupable from revenues generated by BMG againstquarterly royalties due to Image under the agreement.  Based upon actual quarterly sales of Image programming in theterritories, BMG recoups quarterly royalties due Image from the $3.0 millionpreviously advanced to Image.  BMG providesadditional quarterly royalty advances so that for the first three years of theagreement term, the outstanding royalty advance to Image at any given time is aconstant $3.0 million.  During the firstthree quarters of the fourth year of the term, BMG will reduce, throughrecoupment, the outstanding royalty advance to Image to $1.5 million.  Once the entire royalty advance is recouped,BMG will continue to pay quarterly royalties to Image based on revenues generated.  During the fourth quarter of the fourthyear, BMG may recoup the entire remaining balance of $1.5 million by notre-advancing royalties quarterly.  Theagreement contains a formula to pay an additional lesser advance at thebeginning of the fifth and final year of the term which is to be recouped byBMG during that year.  Image must repayany outstanding unrecouped royalty advance within 30 days following the finalBMG reporting at the conclusion of BMG’s sell-off period following theexpiration of the five-year term. Royalty advances received from BMG are recorded as deferred revenueuntil earned.

 

To facilitatean orderly transition to BMG from our previous network of independentsubdistributors, the Company contractually elected to purchase any productinventory from our subdistributors (including any of their customer returns)upon the expiration of their respective terms (plus an additional time periodto allow for their customer returns) rather than allow the subdistributors toexercise a six-month nonexclusive sell-off period.

 

Under the BMGagreement, BMG committed to purchase the Company’s international DVD inventory,which would include any inventory repurchased from the subdistributors, at theCompany’s manufacturing price (for disc and case only—excluding booklets andinserts).  The Company recorded a chargeduring fiscal 2003 of $174,000, to provide for the difference between theultimate purchase price of the inventory paid or credited to thesubdistributors upon the expiration of their respective terms and themanufacturing cost paid to the Company by BMG for that inventory.  At March 31, 2003, the Company accruedfor estimated subdistributor returns resulting in a reduction of revenues andgross margin of $831,000 and $278,000, respectively, and accrued for thewritedown (to BMG purchase cost) of the inventory to be returned by thesubdistributors, as well as inventory held at our Germany-based warehousingagent, representing an incremental charge to cost of sales of $202,000 duringthe fourth quarter ended March 31, 2003.

 

The Company’saccounting for international generated revenues differs under the BMG agreementbecause the revenues are generated under a sublicense agreement, rather thanthe subdistribution agreements previously in place.

 

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Under its subdistributionagreements, Image recorded net revenues based upon the selling price of itsprogramming sold to its distribution network customers.  Image recorded as cost of sales, the actualmanufacturing/packaging cost, shipping cost, royalties/distribution fees andmusic publishing.  Under the BMGagreement, Image records royalty income as revenue based upon royalties itreceives from BMG.  Royalty income isrecorded in the period in which the product is sold by BMG.  Image reports as cost of goods sold, theroyalties or distribution fees accrued to its licensors or program suppliers ascalculated against the royalties Image receives from BMG.  The majority of international selling and marketingexpenses are now borne by BMG.  Additionally,BMG is responsible for manufacturing and packaging costs as well as musicpublishing.

 

**Note 4. Current Status of Aviva International, LLC Operations.**

 

In June 1999, Image formed Aviva International, LLC (“Aviva”) withMichael Lopez, President of International Consulting & BusinessManagement.  Aviva, 50% owned by each ofImage and Mr. Lopez, acted as international sales agent for Image’s licensedprogramming for which it holds distribution rights for worldwide broadcast andinternational home video prior to December 31, 2002. Mr. Lopez served asManager of Aviva and supervised the day-to-day operations.  During the quarter ended December 31,2002, Image completed the consolidation of Aviva’s international wholesale homevideo, broadcast and sublicense distribution activities into Image because webelieved that our existing infrastructure, the sublicensing of European DVDdistribution to BMG and the engaging of NBD Television LTD (“NBD”) as ourexclusive worldwide broadcast sales agent could more effectively andefficiently manage international distribution operations (rather than sharedresponsibility with the staff at Aviva).

 

Through the nine months ended December 31, 2002, Aviva downsizedoperations, reduced staff and transferred international home video sublicenseand broadcast sales responsibilities to Image.    Severance costs related to staff reductions at Aviva wereminimal.  The lease for the Aviva’sBelmont offices expired in October 2003. At March 31, 2004, Aviva had no employees.  Aviva’s only assets were cash and tradeaccounts receivable and Aviva’s only liabilities were amounts due toLLC-members Image and Mr. Lopez.  Imageis currently collecting the remaining Aviva receivables due from the network ofindependent subdistributors generated prior to the commencement of BMG’s andNBD’s distribution and sales agency, respectively.

 

**Note 5. Inventories.**

 

Inventories at March 31, 2004 and 2003 are summarized as follows:

 
| **(In thousands)**                                                   |   | **2004** |   | **2003** |   |
|----------------------------------------------------------------------|--------|----------|--------|----------|--------|
| DVD                                                                  |   | $        | 10,037 |     | $      | 9,468 |   |
| Other                                                                |   | 1,180    |   | 820      |   |
|                                                                 |   | 11,217   |   | 10,288   |   |
| Production costs, net                                                |   | 5,112    |   | 5,742    |   |
|                                                                 |   | 16,329   |   | 16,030   |   |
| Less current portion of inventories                                  |   | 13,725   |   | 13,275   |   |
| Noncurrent inventories, principally  non-recoupable production costs |   | $        | 2,604  |     | $      | 2,755 |   |

 

Non-recoupable production costs are net of accumulated amortization of$16,422,000 and $14,462,000 at March 31, 2004 and 2003, respectively.  The Company expects to amortizeapproximately 77.6% of the March 31, 2004 unamortized production costs byMarch 31, 2006.

 

**Note 6.  Property, Equipment and Improvements.**

 

Property, equipment and improvements at March 31, 2004 and 2003are summarized as follows:

 
| **(In thousands)**                              |   | **2004** |   | **2003** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| Machinery, equipment and software               |   | $        | 15,584 |     | $      | 13,844 |   |
| Leasehold improvements                          |   | 791      |   | 780      |   |
| Other                                           |   | 124      |   | 376      |   |
|                                            |   | 16,499   |   | 15,000   |   |
| Less accumulated depreciation and  amortization |   | 10,717   |   | 9,028    |   |
|                                            |   | $        | 5,782  |     | $      | 5,972 |   |

 

*Sale and Leaseback of Land andDistribution Facility in Fiscal 2003.*  OnSeptember 3, 2002, Image entered into an agreement with Spencer StreetInvestors, LLC, an affiliate of RDS Investment & Development, LLC, anunrelated real estate developer, to sell and leaseback its Las Vegas, Nevadawarehouse and distribution facility and adjacent vacant

 

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land.  On November 8, 2002,escrow on the sale closed for approximately 8.11 acres, consisting of Image’s76,000 square foot warehouse and distribution facility on 4.04 acres, and theadjacent 4.07 acres of vacant land for $6.0 million.  Image received net proceeds of approximately $3.0 million, afterdeducting transactional costs (such as sales commissions and escrow fees, etc.)and approximately $2.7 million which was paid to Bank of America in Nevada toretire the Company’s revolving credit facility that was secured by the realestate sold.  The Company wrote down thenet book value of the land and building to approximate the sales price less theestimated related transactional costs. The impairment charge totaled $322,000 and is included as a component ofother expenses in the accompanying statement of operations for fiscal2003.  The gain on the sales transactionwas nominal.

 

On November 8, 2002, Imageentered into two lease agreements with the buyer: a ten-year building lease forthe existing warehouse and distribution facility with three five-year extensionoptions, and a five-year lease for the adjacent vacant land which may be usedfor future expansion of the warehouse and distribution facility, if necessary.  The monthly rent approximates market rentcharged for like properties in the Las Vegas, Nevada area.

 

**Note 7. Revolving Credit and Term Loan Facilities.**

 

*Revolving Credit and Term Loan Facilities.* The Company’s Loan and Security Agreement dated December 28, 1998,with Wells Fargo Foothill, Inc. requires the Company to comply with financialand operating covenants.  AtDecember 31, 2003, at our request, Foothill amended two financialcovenants on a go-forward basis.  Theamended covenants are as follows:  (1)the existing tangible net worth covenant was redefined, decreasing the minimumrequired levels which the Company must maintain quarterly; and (2) the existingEBITDA (earnings before interest, taxes, depreciation and amortization)covenant was redefined, decreasing the minimum required levels measured on astand-alone quarterly basis.  AtMarch 31, 2004, again at our request, Foothill further amended the minimumstand-alone quarterly EBITDA covenant changing the measurement to a cumulativequarterly minimum level.  The quarterlyEBITDA minimums, as amended in December 2003, were not changed.  The first EBITDA measurement was for theMarch 2004 quarter.  The secondwill be for the six months ending June 30, 2004.  The third will be for the nine months ending September 30,2004.  The fourth will be for the twelvemonths ending December 31, 2004. Thereafter, the measurement will be a rolling twelve months EBITDA.  As of March 31, 2004, the Company wasin compliance with all financial and operating covenants, as amended, includingtangible net worth exceeding the $19,262,000 minimum and EBITDA, as defined,exceeding the $1,105,000 minimum as of and for the three months endedMarch 31, 2004, respectively. Because Foothill maintains a lockbox arrangement, applies collections onreceivables to amounts outstanding under the loan agreement and has the benefitof a subjective acceleration clause, amounts outstanding have been classifiedas a current liability in the consolidated balance sheets.

 

At March 31, 2004, the Company had $10,218,000 outstanding underits $17.0 million revolving credit facility with Foothill bearing interest atthe “floor” interest rate of 5.75%.  TheCompany had no borrowings outstanding under its $1.0 million capital expenditureterm loan facility with Foothill.  TheCompany had borrowing availability of $6,245,000 under the revolving creditfacility and $1,000,000 under the term loan facility.

 

The agreement imposes restrictions on such items as encumbrances andliens, payment of dividends, other indebtedness, stock repurchases and capitalexpenditures.  The Company would need toobtain Foothill’s approval prior to any future debt or equity financing or anycorporate acquisitions or investments. The term of these facilities ends on December 29, 2005, and containsrenewal provisions.

 

**Note 8.  Long-Term Debt.**

 

*Subordinated Note Payable – Ritek Taiwan.*  In March 2002, the Company amended theprovisions of its note payable with Ritek Corporation, a Taiwanese Corporationand former parent of Ritek Global Media (now Deluxe Media Services – theCompany’s exclusive DVD manufacturer). The amended note is payable in equal monthly installments ofapproximately $111,000 plus accrued interest at the fixed rate of 6% per annumthrough its maturity on March 1, 2006. Outstanding balances under the note are subordinate to all of Image’ssenior debt obligations and all replacements and refinancing of such debt.  At March 31, 2004, $2,561,000 wasoutstanding under the note.

 

*Note Payable to Bank.*  On June 28, 2000, Image entered into aBusiness Loan Agreement with Bank of America, N.A. in Nevada for an equipmentline of credit.  On September 30,2001, this line was converted into a note payable.  Outstanding borrowings are repaid in equal monthly installmentsthrough February 28, 2005 and bear interest at LIBOR plus 2.50% (3.59% atMarch 31, 2004), per annum, payable monthly.  Outstanding borrowings are secured by the related equipmentpurchased.  Image had $255,000outstanding under this note at March 31, 2004.

 

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*Convertible Subordinated Note Payable.*  This debt was repaid in fiscal 2003.  In March 2003, the Company and ImageInvestors Co. (“IIC”) entered into a Termination and Exchange Agreement whichterminated the September 29, 1997 Credit Agreement.  IIC is Image’s largest shareholder, and isowned and controlled by John W. Kluge and Stuart Subotnick. The TerminationAgreement early retires the remaining balance due under the convertiblesubordinated note payable to IIC with a combination of cash and Image commonstock.

 

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

 

Long-term debt at March 31, 2004 and 2003 consists of thefollowing:

 
| **(In thousands)**                            |   | **2004** |   | **2003** |   |
|-----------------------------------------------|--------|----------|--------|----------|--------|
| Subordinated note payable – Ritek Taiwan |   | $        | 2,561  |     | $      | 3,898 |   |
| Note payable to bank                          |   | 255      |   | 509      |   |
|                                          |   | $        | 2,816  |     | $      | 4,407 |   |
| Current portion of long-term debt             |   | $        | 1,592  |     | $      | 1,591 |   |
|                                          |   |     |   |     |   |
| Long-term debt less current portion           |   | $        | 1,224  |     | $      | 2,816 |   |

 

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

 
| **(in thousands)  Fiscal** |   | **Amount** |   |
|----------------------------|--------|------------|--------|
| 2005                       |   |       | $      | 1,592 |   |
| 2006                       |   |       | 1,224  |   |
| 2007                       |   |       | — |   |
|                       |   | $          | 2,816  |   |

 

**Note 9. Capital Lease Obligations.**

 

The Company’s July 2001capital lease agreement with General Electric Capital Corporation bearsinterest at a fixed 7.58% per annum, payable monthly and expiresSeptember 2005.  At March 31,2004, $356,000 was outstanding under the lease.

 

Machinery and equipment under capital leases at March 31, 2004 and2003 are summarized as follows:

 
| **(In thousands)**                              |   | **2004** |   | **2003** |   |
|-------------------------------------------------|--------|----------|--------|----------|--------|
| Machinery, equipment and software               |   | $        | 915    |     | $      | 2,686 |   |
| Less accumulated depreciation and  amortization |   | 583      |   | 1,405    |   |
|                                            |   | $        | 332    |     | $      | 1,281 |   |

 

Future minimum lease payments by year at March 31, 2004 forproperty under capital leases are as follows:

 
| **Fiscal**                                 |   | **Amount**          |   |
|--------------------------------------------|--------|---------------------|--------|
|                                       |   | **(in  thousands)** |   |
| 2005                                       |   | $                   | 266    |   |
| 2006                                       |   | 111                 |   |
| 2007                                       |   | —              |   |
| Total minimum lease payments               |   | 377                 |   |
| Less amount representing interest at 7.58% |   | 21                  |   |
| Present value of minimum lease payments    |   | 356                 |   |
| Less current portion                       |   | 247                 |   |
| Noncurrent portion                         |   | $                   | 109    |   |

 

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**Note 10. Commitments and Contingencies.**

 

**Operating Leases.**

 

*New Corporate Offices.*  On January 7, 2004 the Company enteredinto a new corporate office lease to relocate our two existing corporate officefacilities (totaling 45,000 square feet) located in Chatsworth,California.  The new office facility,also located in Chatsworth, California, consists of approximately 62,000 squarefeet and is located in a multi-tenant building.  The initial cost of the new office space is $1.23 per square footon a gross basis and increases approximately 3% annually.

 

The new officelease has an initial 10-year term with two five-year options.  The start date of the lease is currentlyprojected to be on or around July 1, 2004.  Our existing office leases at 9349 Oso Avenue and 9333 Oso Avenueterminate on July 31, 2004, and August 31, 2004, respectively.  The rent for our current office space is$0.70 per square foot on a triple-net basis, which has equated to approximately$1.18 to $.94 per square foot on a gross basis over the prior two fiscalyears.  Our rent for the increased squarefootage will now include the cost of utilities, building insurance, propertytaxes, building and common area maintenance, previously Image’s financialresponsibility under its previous corporate office lease.

 

The Company leases corporateheadquarters for Image, storage space for Las Vegas, and Image’s distributionfacility and adjacent land in Las Vegas, Nevada under operating leases.

 

Future minimum annual rentalpayments by year under operating leases at March 31, 2004 areapproximately as follows:

 
| **Fiscal** |   | **Amount**         |   |
|------------|--------|--------------------|--------|
|       |   | **(in thousands)** |   |
| 2005       |   |               | $      | 1,346 |   |
| 2006       |   |               | 1,531  |   |
| 2007       |   |               | 1,573  |   |
| 2008       |   |               | 1,615  |   |
| 2009       |   |               | 1,658  |   |
| Thereafter |   |               | 8,100  |   |
|       |   | $                  | 15,823 |   |

 

Rent expense was $911,000, $562,000 and $320,000 for fiscal 2004, 2003,and 2002, respectively.

 

*Lease Guarantee.*  In connection with the asset sale of DVDPlanet, PlanetEntertainment assumed the obligations under DVDPlanet’s leases for its retailstore and various other liabilities related to the assets being acquired andits parent Infinity Resources guaranteed Planet Entertainment’s obligations.  We remain a guarantor in the event thatPlanet Entertainment and Infinity default on their financial obligations underthe lease.  The remaining payments underthe lease total approximately $669,000 through December 2007.

 

*Other.*  At March 31, 2004, the Company’s futureobligations by year for royalty advances, minimum royalty guarantees andexclusive distribution fee guarantees under the terms of Image’s existinglicenses and exclusive distribution agreements, respectively, are as follows:

 
| **Fiscal** |   | **Amount**         |   |
|------------|--------|--------------------|--------|
|       |   | **(in thousands)** |   |
| 2005       |   |               | $      | 9,077 |   |
| 2006       |   |               | 2,467  |   |
| 2007       |   |               | 120    |   |
| 2008       |   |               | 100    |   |
| 2009       |   |               | — |   |
| Thereafter |   |               | — |   |
|       |   |               | $      | 11,764 |   |

 

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**Note 11. Shareholders’ Equity.**

 

*Stock Awards,Options, and Warrants*

 

In September 1998, Image’s shareholders approved an incentive plan(the “1998 Plan”) pursuant to which approximately 1,160,000 shares of Image’scommon stock were made available for awards, including options, thereunder.  No new options would be granted underImage’s other plans.  The 1998 Planprovides for awards to employees and directors of Image.  Options (incentive as well as nonqualified),restricted stock units, stock appreciation rights, performance share awards,stock bonuses and stock units can be awarded under the 1998 Plan.  The 1998 Plan requires that the exerciseprice for any nonqualified option be at least 85% of the closing price ofImage’s common stock on the date such option is granted.  The maximum term allowed for an option is 10years and a stock unit shall either vest or be forfeited not more than 10 yearsfrom the date of grant.  The 1998 Plancontemplates annual automatic grants of restricted stock units payable inshares of Image’s common stock to directors of Image in lieu of the 15,000share option grants under the then-existing directors’ stock option plan.  The 1998 Plan terminates on June 30,2008.

 

In July 1999 and 1998 an aggregate 91,662 and 88,359,respectively, restricted stock units were granted to officers of Image underthe 1998 Plan.  These grants vestannually in increments of 20% over the five-year period commencingJune 30, 2000 and 1999, respectively. There were no restricted stock units granted to officers during fiscal2001 through 2004.  Accelerated vestingmay occur if specific fiscal defined financial performance targets areachieved.  The number of restrictedstock units awarded to officers was determined by multiplying a specifiedpercentage of base salary by the officer’s base salary as of the beginning of theperiod and dividing the results by the average trading price of the stockdetermined as of the date of grant ($6.78 per share in fiscal 2000 and $6.70per share in fiscal 1999) to determine the number of restricted stock units.  These restricted stock units are payablesolely in shares.  The Company amortizesthe total value of the restricted stock units on the date of grant ($622,000for the fiscal 2000 grant and $592,000 for the fiscal 1999 grant) ratably overthe five-year vesting period as compensation expense.  Compensation expense relating to these stock units for fiscal2004, 2003 and 2002 was approximately $132,000, $195,000 and $195,000,respectively.

 

In October 2001, 2000 and 1999, the automatic annual awards to theBoard of Directors aggregating 6,720 restricted stock units for each year weregranted.  These grants vested on a prorata basis over a one-year period commencing on the grant date.  These restricted stock units were paid inshares.  The Company amortized the totalvalue of the restricted stock units on the date of the grant ratably over theone-year vesting period as compensation expense ending in fiscal 2003.  Compensation expense relating to theserestricted stock units for fiscal 2003 and 2002 was approximately $6,000 and$19,000, respectively.

 

Stock option transactions, including Image’s former plans, for thethree years ended March 31, 2004 are as follows:

 
| **(In thousands, except per share  data)** |   | **Shares** |   | **Per Share  Price Range** |   | **Weighted  Average  Price Per Share** |   |
|--------------------------------------------|--------|------------|--------|----------------------------|--------|----------------------------------------|--------|
| Outstanding, March 31, 2001           |   | 1,502      |   | 3.25-10.25                 |   | 6.164                                  |   |
| Granted                                    |   | 378        |   | 1.75                       |   | 1.750                                  |   |
| Canceled                                   |   | (258       | )      | 3.75-10.25                 |   | 6.221                                  |   |
| Outstanding, March 31, 2002           |   | 1,622      |   | 1.75-9.75                  |   | 5.124                                  |   |
| Granted                                    |   | 156        |   | 1.68-1.78                  |   | 1.767                                  |   |
| Exercised                                  |   | (2         | )      | 1.75                       |   | 1.750                                  |   |
| Canceled                                   |   | (17        | )      | 1.75-9.75                  |   | 7.595                                  |   |
| Outstanding, March 31, 2003           |   | 1,759      |   | 1.68-8.75                  |   | 4.806                                  |   |
| Granted                                    |   | 45         |   | 2.256-2.96                 |   | 2.655                                  |   |
| Exercised                                  |   | (23        | )      | 1.75                       |   | 1.750                                  |   |
| Canceled                                   |   | (184       | )      | 1.68-7.94                  |   | 5.143                                  |   |
| Outstanding, March 31, 2004           |   | 1,597      |   | 1.68-8.75                  |   | 4.752                                  |   |

 

Of the options reflected as outstanding on March 31, 2004, optionsto purchase approximately 1,385,000 shares of common stock wereexercisable.  At March 31, 2004,there were approximately 164,000 shares of common stock available for newawards, including stock options, to directors and employees of Image.

 

The following table summarized significant ranges of outstanding andexercisable options at March 31, 2004:

 

54

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|                          |   | **Options  Outstanding** |   | **Options  Exercisable**                       |   |
|-------------------------------|--------|--------------------------|--------|------------------------------------------------|--------|
| **Range of  Exercise Prices** |   | **Shares**               |   | **Weighted  Average  Remaining  Life (Years)** |   | **Weighted  Average  Exercise Price** |   | **Shares** |   | **Weighted  Average  Exercise Price** |   |
|                          |   | **(In thousands)**       |   |                                           |   |   |   | **(In thousands)** |   |   |   |
| Under $2.00                   |   | 473                      |   | 7.9                                            |   | $ | 1.756 |   | 305 |   | $ | 1.753 |   |
| $2.01 to $4.00                |   | 382                      |   | 6.5                                            |   | 3.602 |   | 338 |   | 3.706 |   |
| $4.01 to $6.00                |   | 21                       |   | 3.2                                            |   | 5.830 |   | 21 |   | 5.830 |   |
| $6.01 to $8.00                |   | 646                      |   | 2.0                                            |   | 7.154 |   | 646 |   | 7.154 |   |
| Over $8.00                    |   | 75                       |   | 0.3                                            |   | 8.500 |   | 75 |   | 8.500 |   |
|                          |   | 1,597                    |   |                                           |   |   |   | 1,385 |   |   |   |
|                               |        |                          |        |                                                |        |  |  |  |  |  |  |  |  |

 

*Warrant Issued to IIC in Fiscal 2003*

 

See “Note 8.  Long-Term Debt — *Convertible Subordinated Note Payable*.”

 

*Private Placement ofCommon Stock and Warrant in Fiscal 2003*

 

On September 25, 2002, theCompany closed its sale of $2.0 million of Image common stock to StandardBroadcasting Corporation Limited (“Standard Broadcasting”) in a privateplacement.  Standard Broadcasting is thelargest privately-owned multi-media company in Canada.  Video One, a wholly-owned subsidiary of StandardBroadcasting and the parent company of VidCanada, is Canada’s largest distributorof pre-recorded home entertainment programming, including DVD, VHS and videogames.  VidCanada is Image’s exclusivedistributor of its exclusive home entertainment programming in Canada.  Contemporaneous with the private placement,Image and VidCanada extended the term of their exclusive distribution agreementfrom June 2003 to October 2007.

 

The $2.0 million transactionrepresented a purchase of 1,801,315 shares of Image common stock at $1.11 pershare, the closing price of Image’s common stock on September 10,2002.  Additionally, Image issuedStandard Broadcasting a five-year warrant to purchase up to 270,198 additionalshares at $1.22 per share.  The fairvalue of the warrant, using the Black-Scholes valuation model, is $189,000 andhas been recorded in shareholders’ equity as part of the $2.0 million netproceeds.  Because they are notregistered under the Securities Act of 1933, as amended (the “Act”), the stockand shares underlying the warrant are restricted and subject to Rule 144promulgated under the Act.  StandardBroadcasting has limited registration rights.

 

*Warrant Issued inFiscal 2002*

 

On October 5, 2001, the Company issued Lighthouse CapitalManagement Corp. (“Lighthouse”), a financial consultant, a warrant to purchase150,000 shares of the Company’s unregistered common stock (the “LighthouseWarrant”) as partial consideration for the services to be performed byLighthouse under a nonexclusive consulting agreement between Lighthouse and theCompany.  On the date of issuance, theCompany’s fair value of its common stock was $1.975.  The exercise prices of the shares underlying the LighthouseWarrant are 50,000 shares at $1.975, 50,000 shares at $2.275 and 50,000 sharesat $2.575.  The term of the LighthouseWarrant is 5 years.  On the date ofissuance, the Company valued the shares underlying the Lighthouse Warrant forfinancial statement purposes using the Black-Scholes valuation model.  Accordingly, the Company increasedadditional paid-in capital, by the estimated Lighthouse Warrant valuation ofapproximately $143,000.  The Companyamortized the Lighthouse Warrant value over the term of the related consultingagreement.  The warrant was fullyamortized by March 31, 2003. Amortization totaled approximately $72,000 and $71,000 for fiscal years2003 and 2002, respectively and was recorded as a component of general andadministrative expenses in the accompanying consolidated statements ofoperations.

 

**Note 12. Net Earnings (Loss) Per Share Data.**

 

The following is a reconciliation of the numerators and denominatorsused in computing basic and diluted net earnings (loss) per share for the threeyears ended March 31, 2004:

 

55

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| **(In thousands, except per share  data)**                                         |   | **2004** |   | **2003** |   | **2002** |   |
|------------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
|                                                                               |   |     |   |     |   |     |   |
| Earnings (loss) from continuing operations                                         |   | $        | (7,115 | )        | $      | 642      |   | $ | 873 |   |
| Loss from discontinued operations                                                  |   | (2,441   | )      | (1,096   | )      | (1,068   | )      |
| Earnings (loss) before cumulative effect of  accounting change                     |   | (9,556   | )      | (454     | )      | (195     | )      |
| Cumulative effect of accounting change, net  of tax benefit                        |   | —   |   | (3,766   | )      | —   |   |
| Net earnings (loss) – basic numerator                                         |   | $        | (9,556 | )        | $      | (4,220   | )      | $ | (195 | ) |
| Interest, net of taxes, on assumed  conversion of dilutive security                |   | —   |   | —   |   | —   |   |
| Net earnings (loss) – diluted numerator                                       |   | $        | (9,556 | )        | $      | (4,220   | )      | $ | (195 | ) |
| Weighted average common shares outstanding  – basic denominator               |   | 18,250   |   | 16,812   |   | 15,821   |   |
| Effect of dilutive securities                                                      |   | —   |   | 190      |   | 77       |   |
| Weighted average common shares outstanding  – diluted denominator             |   | 18,250   |   | 17,002   |   | 15,898   |   |
| Basic and diluted net loss per share:                                              |   |     |   |     |   |     |   |
| Continuing operations                                                              |   | (.39     | )      | .04      |   | .06      |   |
| Discontinued operations                                                            |   | (.13     | )      | (.07     | )      | (.07     | )      |
| Basic and diluted loss per share before  cumulative effect of an accounting change |   | $        | (.52   | )        | $      | (.03     | )      | $ | (.01 | ) |
| Cumulative effect of an accounting change,  net of tax benefit                     |   | —   |   | (.22     | )      | —   |   |
| Basic and diluted net loss per share                                               |   | $        | (.52   | )        | $      | (.25     | )      | $ | (.01 | ) |

 

Outstanding common stock options and warrants not included in thecomputation of diluted net earnings (loss) per share totaled 1,079,000,1,480,000 and 1,243,000, respectively, for the years ended March 31, 2004,2003 and 2002.  For fiscal 2004, 2003and 2002, they were excluded as their effect would be antidilutive.  The common shares underlying the convertiblesubordinated note payable were excluded in fiscal 2003 and 2002 because theassumed conversion would be antidilutive.

 

**Note 13. Income Taxes.**

 

Income tax expense (benefit), including the benefits attributable todiscontinued operations and the cumulative effect of accounting change, for theyears ended March 31, 2004, 2003 and 2002 are summarized as follows:

 
| **(In thousands)**                         |   | **2004** |   | **2003** |   | **2002** |   |
|--------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Current                                    |   |     |   |     |   |     |   |
| Federal                                    |   | $        | — |     | $      | (9       | )      | $ | (56 | ) |
| State                                      |   | —   |   | 4        |   | 1        |   |
| Foreign                                    |   | —   |   | 280      |   | 270      |   |
|                                       |   | —   |   | 275      |   | 215      |   |
| Deferred                                   |   |     |   |     |   |     |   |
| Federal                                    |   | 5,593    |   | 1,022    |   | 117      |   |
| State                                      |   | 651      |   | 9        |   | 230      |   |
|                                       |   | 6,244    |   | 1,031    |   | 347      |   |
| Total Tax Expense                          |   | 6,244    |   | 1,306    |   | 562      |   |
|                                       |   |     |   |     |   |     |   |
| Discontinued Operations                    |   |     |   |     |   |     |   |
| Current                                    |   |     |   |     |   |     |   |
| Federal                                    |   | —   |   | —   |   | (84      | )      |
| State                                      |   | —   |   | —   |   | —   |   |
| Foreign                                    |   | —   |   | —   |   | —   |   |
|                                       |   | —   |   | —   |   | (84      | )      |
|                                       |   |     |   |     |   |     |   |
| Deferred                                   |   |     |   |     |   |     |   |
| Federal                                    |   | —   |   | (535     | )      | (437     | )      |
| State                                      |   | —   |   | (83      | )      | (81      | )      |
|                                       |   | —   |   | (618     | )      | (518     | )      |
| Total Tax Benefit                          |   | —   |   | (618     | )      | (602     | )      |
|                                       |   |     |   |     |   |     |   |
| Cumulative Effect – Accounting Change |   |     |   |     |   |     |   |
| Deferred                                   |   |     |   |     |   |     |   |
| Federal                                    |   | —   |   | (2,039   | )      | —   |   |
| State                                      |   | —   |   | (192     | )      | —   |   |
| Total Tax Benefit                          |   | —   |   | (2,231   | )      | —   |   |
|                                       |   |     |   |     |   |     |   |
| Total Tax Expense (Benefit)                |   | $        | 6,244  |     | $      | (1,543   | )      | $ | (40 | ) |

 

56

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The tax effects of temporary differences that give rise to a significantportion of the net deferred tax assets at March 31, 2004 and 2003 arepresented below:

 
| **(In thousands)**                                          |   | **2004** |   | **2003** |   |
|-------------------------------------------------------------|--------|----------|--------|----------|--------|
| Deferred tax assets:                                        |   |     |   |     |   |
| Provision for lower of cost or market  inventory writedowns |   | $        | 406    |     | $      | 530 |   |
| Net operating loss carryforwards                            |   | 6,061    |   | 3,240    |   |
| Allowance for sales returns                                 |   | 325      |   | 8        |   |
| Writedowns of royalty advances                              |   | —   |   | 329      |   |
| Allowance for doubtful accounts receivable                  |   | 373      |   | 294      |   |
| Tax credits                                                 |   | 738      |   | 796      |   |
| Depreciation and amortization                               |   | —   |   | 1,122    |   |
| Other                                                       |   | 410      |   | 621      |   |
| Deferred tax assets                                         |   | 8,313    |   | 6,940    |   |
| Less valuation allowance                                    |   | (7,987   | )      | (551     | )      |
| Net deferred tax assets                                     |   | 326      |   | 6,389    |   |
|                                                        |   |     |   |     |   |
| Deferred tax liabilities:                                   |   |     |   |     |   |
| Depreciation and amortization                               |   | 300      |   | —   |   |
| Other                                                       |   | 26       |   | 145      |   |
| Deferred tax liabilities                                    |   | 326      |   | 145      |   |
| Net deferred tax assets                                     |   | $        | — |     | $      | 6,244 |   |

 

SFASNo. 109 requires that we assess the likelihood that our deferred tax assets arerealizable, and to the extent that it is more likely than not that all, or aportion, of such deferred tax assets will not be realized, a valuationallowance, increasing tax expense for the year, must be established.

 

Inassessing the realizability of a deferred tax asset, SFAS No. 109 requires thatall available evidence, both positive and negative, be considered to determinewhether, based on the weight of that evidence, a valuation allowance isneeded.  SFAS No. 109 further providesthat “cumulative losses in recent years” are significant pieces of negativeevidence to overcome when determining whether it is “more likely than not” thatthe recorded deferred tax assets will be realized.  Such cumulative losses from prior years must be considered on apretax consolidated basis from all operations. In addition to current year, pretax losses for both continuing anddiscontinued operations, we also incurred aggregate net pretax losses forfiscal years 2003 and 2002. Accordingly, during the current fiscal year, we established a valuationallowance against 100% of our net deferred tax assets, which are composedprimarily of NOL carryforwards, resulting in a current year tax expense of$6,244,000.  The valuation allowance wasrecorded in the third quarter primarily as a result of operating lossessustained during our normally seasonally strong third quarter as well as itsthen-expected impact on the full fiscal year results of operations.

 

Eventhough we have fully reserved our net deferred tax assets, we would still beable to utilize them to reduce future income taxes payable, should we havefuture earnings.  To the extent suchdeferred tax assets relate to NOL carryforwards, the ability to use such NOLsagainst future earnings will be subject to applicable carryforward periods.

 

As of March 31, 2004, the Company had net operating losscarryforwards for Federal and state income tax purposes of $16,812,000 and$5,905,000, respectively, which are available to offset future taxable incomethrough 2024 and 2011, respectively.

 

Expected income tax expense (benefit) based on Federal statutory ratesfor the three years ended March 31, 2004 differed from actual tax expense(benefit) as follows:

 
| **(In thousands, except per share  data)**                                     |   | **2004** |   | **2003** |   | **2002** |   |
|--------------------------------------------------------------------------------|--------|----------|--------|----------|--------|----------|--------|
| Expected income tax benefit                                                    |   | $        | (1,126 | )        | $      | (1,959   | )      | $ | (83 | ) |
| State income taxes, net of Federal benefit                                     |   | 2        |   | (174     | )      | (4       | )      |
| Disallowance of state net operating loss  carryforward, net of Federal benefit |   | —   |   | —   |   | 18       |   |
| Change in valuation allowance                                                  |   | 7,422    |   | 551      |   | —   |   |
| Non-deductible expenses                                                        |   | 26       |   | 25       |   | 26       |   |
| Other                                                                          |   | (80      | )      | 14       |   | 3        |   |
|                                                                           |   | $        | 6,244  |     | $      | (1,543   | )      | $ | (40 | ) |

 

57

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**Note 14. Other Items – Statement of Operations**

 

**Fourth Quarter Adjustments.**

 

Fiscal 2004. None.

 

Fiscal 2003. In March 2003, the Company accrued for estimated subdistributorreturns resulting in a reduction of revenues and gross margin of $346,000 and$116,000, respectively during the fourth quarter ended March 31, 2003 andfor the writedown (to BMG purchase cost) of the inventory to be returned by thesubdistributors representing an incremental charge to cost of sales of $202,000during the fourth quarter ended March 31, 2003.

 

During the fourth quarter offiscal 2003, the Company revised its operating projections as a result ofrecent changes to its revenues.  As aresult of the revised projections, it was determined that a valuation allowancewas required on some tax credits expiring within five years.

 

Fiscal 2002. During fiscal 2002, the Company, through DVDPlanet, officially exitedthe laserdisc distribution business, selling its last unit of programming, inthe old home entertainment format of laserdisc.  Additionally, during fiscal 2002, the Company destroyed itsremaining laserdisc inventory.  Duringthe fourth quarter of fiscal 2002, the Company reversed, as a credit to cost ofsales, recorded reserves relating to its domestic laserdisc distributionoperations which management determined were unnecessary.  Approximately $1,818,000 was recorded as apretax credit to cost of sales in the accompanying consolidated statement ofoperations for fiscal 2002.

 

During the fourth quarter of fiscal 2002, the Company, after meetingwith its international distributors in February 2002, has revised itsestimate of the fair value of a royalties paid in advance for the internationaldistribution rights to a particular line of programming.  In accordance with SOP 00-2, the Companywrote off to cost of sales, the difference between the unamortized carryingvalue of the royalty advance and the revised estimate of fair value.  A pretax charge totaling $696,000 wasincluded in cost of sales in the accompanying statement of operations forfiscal 2002.

 

**Note 15. Employee Benefit Plan.**

 

The Company has a 401(k) savings plan covering substantially all of itsemployees.  Eligible employees maycontribute through payroll deductions. The Company matches employees’ contributions at the rate of 50% of thefirst 4% of salary contributed.  TheCompany’s 401(k) savings plan matching expenses for fiscal 2004, 2003 and 2002were $149,000, $125,000 and $116,000, respectively.

 

58

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**Note 16. Segment Information.**

 

In accordance with the requirements of SFAS No. 131, *Disclosures about Segments of and Enterprises andRelated Information*, selected financial information regarding theCompany’s reportable business segments, domestic and international, arepresented below.  Domestic wholesaledistribution of home entertainment programming on DVD accounted for over 90% ofthe Company’s net revenue for the three years ended March 31, 2004.  Management currently evaluates segment performancebased primarily on net revenues, operation costs and expenses and income (loss)before income taxes.  Interest incomeand expense is evaluated on a consolidated basis and not allocated to theCompany’s business segments.

 

For the Year Ended March 31, 2004:

 
|                                                            |   | **2004**     |       |
|-----------------------------------------------------------------|--------|--------------|------------|
| **(In  thousands)**                                             |   | **Domestic** |       | **International** |   | **Inter-segment  Eliminations** |   | **Consolidated** |   |
| NET REVENUES                                                    |   | $            | 78,370     |   | $ | 6,470 |   | $ | 0 |   | $ | 84,840 |   |
| OPERATING COSTS AND EXPENSES                                    |   | 79,169       |       | 5,937 |   | 0 |   | 85,106 |   |
| EARNINGS (LOSS) FROM OPERATIONS                                 |   | (799         | )          | 533 |   | 0 |   | (266 | ) |
| OTHER EXPENSES (INCOME)                                         |   | 818          |       | (67 | ) | (146 | ) | 605 |   |
| EARNINGS (LOSS) FROM CONTINUING OPERATIONS  BEFORE INCOME TAXES |   | $            | (1,617     | ) | $ | 600 |   | $ | 146 |   | $ | (871 | ) |
|                                                            |   |         |       |   |   |   |   |   |   |
| For the Year Ended March 31, 2003:                         |   |         |       |   |   |   |   |   |   |
|                                                            |   |         |       |   |   |   |   |   |   |
|                                                            |   | **2003**     | ** ** |
| **(In  thousands)**                                             |   | **Domestic** | ** ** | **International** | ** ** | **Inter-segment  Eliminations** | ** ** | **Consolidated** | ** ** |
| NET REVENUES                                                    |   | $            | 77,484     |   | $ | 9,445 |   | $ | 0 |   | $ | 86,929 |   |
| OPERATING COSTS AND EXPENSES                                    |   | 73,304       |       | 9,620 |   | 0 |   | 82,924 |   |
| EARNINGS (LOSS) FROM OPERATIONS                                 |   | 4,180        |       | (175 | ) | 0 |   | 4,005 |   |
| OTHER EXPENSES (INCOME)                                         |   | 1,784        |       | (300 | ) | 573 |   | 2,057 |   |
| EARNINGS (LOSS) FROM CONTINUING OPERATIONS  BEFORE INCOME TAXES |   | $            | 2,396      |   | $ | 125 |   | $ | (573 | ) | $ | 1,948 |   |
|                                                            |   |         |       |   |   |   |   |   |   |
| For the Year Ended March 31, 2002:                         |   |         |       |   |   |   |   |   |   |
|                                                            |   |         |       |   |   |   |   |   |   |
|                                                            |   | **2002**     | ** ** |
| **(In  thousands)**                                             |   | **Domestic** | ** ** | **International** | ** ** | **Inter-segment  Eliminations** | ** ** | **Consolidated** | ** ** |
| NET REVENUES                                                    |   | $            | 66,376     |   | $ | 9,759 |   | $ | 0 |   | $ | 76,135 |   |
| OPERATING COSTS AND EXPENSES                                    |   | 61,869       |       | 10,928 |   | 0 |   | 72,797 |   |
| EARNINGS (LOSS) FROM OPERATIONS                                 |   | 4,507        |       | (1,169 | ) | 0 |   | 3,338 |   |
| OTHER EXPENSES (INCOME)                                         |   | 1,711        |       | 210 |   | (18 | ) | 1,903 |   |
| EARNINGS (LOSS) FROM CONTINUING OPERATIONS  BEFORE INCOME TAXES |   | $            | 2,796      |   | $ | (1,379 | ) | $ | 18 |   | $ | 1,435 |   |

 
|                      |   | **As of  March 31,** |   |
|---------------------------|--------|---------------------------|--------|
| **(In  thousands)**       |   | **2004**                  |   | **2003** |   |
| TOTAL ASSETS:             |   |                      |   |   |   |
| DOMESTIC                  |   | $                         | 62,638 |   | $ | 69,460 |   |
| INTERNATIONAL             |   | 1,494                     |   | 4,791 |   |
| CONSOLIDATED TOTAL ASSETS |   | $                         | 64,132 |   | $ | 74,251 |   |

 

59

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**Note 17. Quarterly Financial Data. (Unaudited)**

 

Summarized quarterly consolidated financial data for fiscal 2004 and2003 is as follows:

 
|                                                                                        |   | **Quarter  Ended** |   |
|---------------------------------------------------------------------------------------------|--------|--------------------|--------|
|                                                                                        |   | **June 30,**  |   | **September 30,** |   | **December 31,** |   | **March 31,** |   |
| **(In  thousands, except per share data)**                                                  |   | **2003**           |   | **2002** |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   | **2004** |   | **2003** |   |
|                                                                                        |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net revenues                                                                                |   | $                  | 15,164 |   | $ | 18,424 |   | $ | 20,316 |   | $ | 21,195 |   | $ | 22,791 |   | $ | 25,317 |   | $ | 26,569 |   | $ | 21,993 |   |
| Earnings (loss) from continuing operations  before income tax                          |   | (1,401             | )      | (282 | ) | (55 | ) | (115 | ) | (388 | ) | 1,702 |   | 973 |   | 643 |   |
| Earnings (loss) from continuing operations  net of tax                                 |   | (893               | )      | (178 | ) | (35 | ) | (101 | ) | (7,160 | ) | 1,108 |   | 973 |   | (187 | ) |
| Loss from discontinued operations, net of  taxes                                       |   | (301               | )      | (249 | ) | (999 | ) | (412 | ) | (1,141 | ) | (304 | ) | — |   | (131 | ) |
| Earnings (loss) before cumulative effect of  accounting change                              |   | (1,194             | )      | (427 | ) | (1,034 | ) | (513 | ) | (8,301 | ) | 804 |   | 973 |   | (318 | ) |
| Cumulative effect of accounting change, net                                                 |   | —             |   | (3,766 | ) | — |   | — |   | — |   | — |   | — |   | — |   |
| Net earnings (loss)                                                                         |   | (1,194             | )      | (4,193 | ) | (1,034 | ) | (513 | ) | (8,301 | ) | 804 |   | 973 |   | (318 | ) |
| Net earnings (loss) per share:                                                              |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations – basic and diluted                                              |   | (.05               | )      | (.01 | ) | (.00 | ) | (.00 | ) | (.39 | ) | .06 |   | .05 |   | (.01 | ) |
| Loss from discontinued operations – basic  and diluted                            |   | (.02               | )      | (.02 | ) | (.06 | ) | (.03 | ) | (.06 | ) | (.01 | ) | — |   | (.01 | ) |
| Earnings (loss) per share before cumulative effect  of accounting change:                   |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic and diluted                                                                           |   | (.07               | )      | (.03 | ) | (.06 | ) | (.03 | ) | (.45 | ) | .05 |   | .05 |   | (.02 | ) |
| Cumulative effect of accounting change, net                                                 |   | —             |   | (.24 | ) | — |   | — |   | — |   | — |   | — |   | — |   |
| Net earnings (loss) per share(1) –                                                     |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                       |   | $                  | (.07   | ) | $ | (.27 | ) | $ | (.06 | ) | $ | (.03 | ) | $ | (.45 | ) | $ | .05 |   | $ | .05 |   | $ | (.02 | ) |
| Diluted                                                                                     |   | $                  | (.07   | ) | $ | (.27 | ) | $ | (.06 | ) | $ | (.03 | ) | $ | (.45 | ) | $ | .05 |   | $ | .05 |   | $ | (.02 | ) |
| Weighted average common shares used in computation  of net earnings (loss) per share – |   |               |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                       |   | 18,225             |   | 15,828 |   | 18,248 |   | 16,064 |   | 18,262 |   | 17,655 |   | 18,266 |   | 17,702 |   |
| Diluted                                                                                     |   | 18,225             |   | 15,828 |   | 18,248 |   | 16,064 |   | 18,262 |   | 17,737 |   | 18,795 |   | 17,702 |   |

 

----

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

 

60

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

 

None.

 
| **ITEM 9A.** | **CONTROLS AND PROCEDURES** |
|--------------|-----------------------------|

 

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

 

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

 

**PART III**

 

Theinformation required by Items 10 through 14 of Part III is incorporated byreference from Item 1 of this report and from registrants’ proxy statement thatwill be mailed to shareholders in connection with the registrant’s 2004 annualmeeting of shareholders.

 

61

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**PART IV**

 

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

 
| (a)    | THE FOLLOWING DOCUMENTS ARE FILED AS A PART OF THIS REPORT. |                          |
|--------|-------------------------------------------------------------|-------------------------------|
|   |                                                        |                          |   |   |
|   | 1.                                                          | Financial Statements:         |   |
|   |                                                        |                          | Report of  Independent Registered Public Accounting Firm |   |
|   |                                                        |                          | Consolidated Balance Sheets at March 31, 2004 and 2003 |   |
|   |                                                        |                          | Consolidated Statements of Operations for  the years ended  March 31, 2004, 2003 and 2002 |   |
|   |                                                        |                          | Consolidated Statements of Shareholders’  Equity for the years ended  March 31, 2004, 2003 and 2002 |   |
|   |                                                        |                          | Consolidated Statements of Cash Flows for  the years ended  March 31, 2004, 2003 and 2002 |   |
|   |                                                        |                          | Notes to Consolidated Financial Statements |   |
|   |                                                        |                          |   |   |
|   | 2.                                                          | Financial Statement Schedule: |   |
|   |                                                        |                          | Schedule II  – Valuation and Qualifying Accounts |   |
|   |                                                        |                          |   |   |
|   | 3.                                                          | Exhibits:                     |   |
|   |                                                        |                          | See  the Exhibit Index on pages i – vii. |   |
|   |                                                        |                          |   |   |
| (b)    | REPORTS ON FORM 8-K.                                        |                          |

 

On February 12, 2004, we filed a Form 8-Kpursuant to Item 12 regarding our press release, telephonic conference call andsimultaneous Web cast to discuss our third quarter financial results.  On November 13, 2003, we filed a Form8-K pursuant to Items 9 and 12 regarding our press release, telephonicconference call and simultaneous Web cast to discuss our second quarterfinancial results.  On October 8,2003, we filed a Form 8-K/A pursuant to Items 2 and 7 regarding ourpresentation of Pro Forma financial information for the transaction reported onSeptember 23, 2003.  OnSeptember 23, 2003, we filed a Form 8-K pursuant to Items 2, 9 and 12regarding our disposition of substantially all of the assets of the Company’swholly-owned subsidiary, DVDPlanet, Inc., on that date.  On August 13, 2003, we filed a Form 8-Kpursuant to Items 9 and 12 regarding our press release, telephonic conferencecall and simultaneous Web cast to discuss our first quarter financialresults.  On April 4, 2003, wefiled a Form 8-K pursuant to Item 9 regarding our press release announcing theresignation of Stuart Segall from the Company’s Board of Directors.

 

62

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**SCHEDULE II**

**– Valuation and Qualifying Accounts –**

**For the Years Ended March 31, 2004, 2003and 2002**

 
|                                    |   | **Allowance  for Doubtful Accounts** |   |
|-----------------------------------------|--------|--------------------------------------|--------|
| **(In  thousands)**                     |   | **Balance at  Beginning  of Year**   |   | **Additions  Charged to  Costs and  Expenses** |   | **Amounts  Written-Off** |   | **Balance at  End of Year** |   |
|                                    |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2004: |   | $                                    | 1,020  |   | $ | 72 |   | $ | (90 | ) | $ | 1,002 |   |
|                                    |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2003: |   | $                                    | 1,474  |   | $ | 108 |   | $ | (562 | ) | $ | 1,020 |   |
|                                    |   |                                 |   |   |   |   |   |   |   |
| For the Year Ended March 31, 2002  |   | $                                    | 1,020  |   | $ | 597 |   | $ | (143 | ) | $ | 1,474 |   |

 
|                                    |   | **Allowance  for Sales Returns**   | ** ** |
|-----------------------------------------|--------|------------------------------------|------------|
| **(In  thousands)**                     |   | **Balance at  Beginning  of Year** | ** ** | **Additions  Charged to  Costs and  Expenses** | ** ** | **Amounts  Written-Off** | ** ** | **Balance at  End of Year** | ** ** |
|                                    |   |                               |       |   |   |   |   |   |   |
| For the Year Ended March 31, 2004: |   | $                                  | 5,050      |   | $ | 20,091 |   | $ | (18,730 | ) | $ | 6,411 |   |
|                                    |   |                               |       |   |   |   |   |   |   |
| For the Year Ended March 31, 2003: |   | $                                  | 3,900      |   | $ | 17,486 |   | $ | (16,336 | ) | $ | 5,050 |   |
|                                    |   |                               |       |   |   |   |   |   |   |
| For the Year Ended March 31, 2002  |   | $                                  | 3,450      |   | $ | 11,030 |   | $ | (10,580 | ) | $ | 3,900 |   |

 

Reconciliation to Consolidated Balance Sheets

 
|                             |   | **At  March 31,** |   |
|----------------------------------|--------|------------------------|--------|
| **(In  thousands)**              |   | **2004**               |   | **2003** |   |
| Allowance for Doubtful Accounts: |   |                   |   |   |   |
| Balance at End of Year           |   | $                      | 1,002  |   | $ | 1,020 |   |
| Allowance for Sales Returns:     |   |                   |   |   |   |
| Balance at End of Year           |   | 6,411                  |   | 5,050 |   |
| Allowances                       |   | $                      | 7,413  |   | $ | 6,070 |   |

 

63

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**SIGNATURES**

 

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

 
|                                                                                                                                                                                                            | IMAGE ENTERTAINMENT, INC.                                            |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------|
|                                                                                                                                                                                                            | A California corporation                                             |
|                                                                                                                                                                                                            |                                                                 |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ MARTIN W. GREENWALD*                                            |   |
|                                                                                                                                                                                                            | MARTIN W. GREENWALD                                                  |
|                                                                                                                                                                                                            | Chairman of the Board, President and Chief Executive Officer         |
|                                                                                                                                                                                                            |                                                                 |
|                                                                                                                                                                                                            |                                                                 |
| Pursuant to the requirements of the Securities Exchange Act of 1934,  this report has been signed below by the following persons on behalf of the  registrant and in the capacities and on the dates indicated. |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ MARTIN W. GREENWALD*                                            |   |
|                                                                                                                                                                                                            | MARTIN W. GREENWALD                                                  |
|                                                                                                                                                                                                            | Chairman of the Board, President and Chief Executive Officer         |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ JEFF M. FRAMER*                                                 |   |
|                                                                                                                                                                                                            | JEFF M. FRAMER                                                       |
|                                                                                                                                                                                                            | Chief Financial Officer (Principal Financial and Accounting Officer) |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ IRA EPSTEIN*                                                    |   |
|                                                                                                                                                                                                            | IRA EPSTEIN                                                          |
|                                                                                                                                                                                                            | Director                                                             |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ M. TREVENEN HUXLEY*                                             |   |
|                                                                                                                                                                                                            | M. TREVENEN HUXLEY                                                   |
|                                                                                                                                                                                                            | Director                                                             |
|                                                                                                                                                                                                            |                                                                 |
| Dated:  June 29, 2004                                                                                                                                                                                 | */s/ ROBERT J. MCCLOSKEY*                                            |   |
|                                                                                                                                                                                                            | ROBERT J. MCCLOSKEY                                                  |
|                                                                                                                                                                                                            | Director                                                             |

 

64

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**EXHIBITS**

 
| 2.1             | Asset Purchase Agreement, dated as of  August 20, 1998, by and between Image Newco, Inc. and Ken Crane’s  Magnavox City, Inc.  Filed as Exhibit  2.1 to Image’s Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                                                |
|-----------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 2.1(a)          | First Amendment to Asset Purchase Agreement, dated as of  October 3, 1998, by and between Image Newco, Inc. and Ken Crane’s  Magnavox City, Inc.  Filed as Exhibit  2.2 to Image’s Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                             |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 2.2             | Asset Purchase Agreement dated September 22, 2003, between  DVDPlanet, Inc. and Planet Entertainment, Inc.  Filed as Exhibit 2.1 to Image’s Form 8-K dated September 23,  2003, and incorporated by reference herein.                                                                                                                                       |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 3.1             | Restated Articles of Incorporation.   Filed as Exhibit 3.1 of Image’s Form 10-K for the year ended  March 31, 1995, and incorporated by reference herein.                                                                                                                                                                                                        |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 3.2             | Bylaws.  Filed as Exhibit 3.2  of Image’s Form 10-K for the year ended March 31, 1995, and incorporated  by reference herein.                                                                                                                                                                                                                                    |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.1             | Specimen Common Stock certificate.   Filed as Exhibit 4 to Image’s Registration Statement on Form S-2 (No.  333-65611), effective December 21, 1998, and incorporated by reference  herein.                                                                                                                                                                      |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.2             | Convertible Subordinated Promissory Note, dated October 29,  1997, issued to Image Investors Co. pursuant to that certain Credit  Agreement, dated as of September 29, 1997, by an between Image and Image  Investors Co.  Filed as Exhibit 4.2 to  Image’s Form 10-K for the fiscal year ended March 31, 1999, and  incorporated by reference herein. |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.3             | Warrant dated as of October 5, 2001 between Image and Lighthouse  Capital Management Corp.  Filed as  Exhibit 4.1 to Image’s Form 10-Q for the quarter ended December 31,  2001, and incorporated by reference herein.                                                                                                                                      |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.4             | Warrant dated as of September 25, 2002 between Image and  Standard Broadcasting Corporation Limited.   Filed as Exhibit 99.2 to Image’s Form 8-K dated September 12,  2002, and incorporated by reference herein.                                                                                                                                           |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.5             | Form of Registration Rights Agreement dated as of September 25,  2002 between Image and Standard Broadcasting Corporation Limited.  Filed as Exhibit 4.1 to Image’s Form 8-K  dated September 12, 2002, and incorporated by reference herein.                                                                                                               |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 4.6             | Form of Registration Rights Agreement dated as of March 24, 2003  between Image and Image Investors Co.   Filed as Exhibit 4.1 to Image’s Form 8-K dated March 24, 2003,  and incorporated by reference herein.                                                                                                                                             |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 10.1 **†** | Image’s Restated 1989 Incentive Stock Option Plan.  Filed as Exhibit 10.1 of Image’s Form 10-K  for the fiscal year ended March 31, 1992, and incorporated by reference  herein.                                                                                                                                                                            |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 10.2 **†** | Image’s 1990 Stock Option Plan.   Filed as Exhibit A of Image’s Proxy Statement dated December 27,  1990, and incorporated by reference herein.                                                                                                                                                                                                             |
|            |                                                                                                                                                                                                                                                                                                                                                                            |
| 10.3 **†** | Image’s Restated 1992 Stock Option Plan.  Filed as Exhibit A of Image’s Proxy Statement dated  September 9, 1994, and incorporated by reference herein.                                                                                                                                                                                                     |

 

i

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| 10.4 **†**  | Image’s 1994 Eligible Directors Stock Option Plan and Form of  Eligible Director Non-Qualified Stock Option Agreement.  Filed as Exhibit 10.4 of Image’s Form 10-K  for the fiscal year ended March 31, 1995, and incorporated by reference  herein.                                                                                                                                                          |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.5 **†**  | Image’s 1998 Incentive Plan.   Filed as Exhibit A to Image’s Notice of Annual Meeting and Proxy  Statement dated July 29, 1998, and incorporated herein by this  reference.                                                                                                                                                                                                                                   |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.5(a)          | Form of Employee (Nonqualified) Stock Option Grant Agreement under  Image’s 1998 Incentive Plan.  Filed as  Exhibit 10.5(a) to Image’s Form 10-K for the fiscal year ended March 31,  1999, and incorporated by reference herein.                                                                                                                                                                             |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.6 **†**  | Eligible Director Non-Qualified Stock Option Agreement, dated as of July 22,  1998, between Image and Stuart Segall.   Filed as Exhibit 10.9 to Image’s Registration Statement on Form S-2  (No. 333-65611), effective December 21, 1998, and incorporated by  reference herein.                                                                                                                              |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.7 **†**  | Eligible Director Non-Qualified Stock Option Agreement, dated as of  September 17, 1998, between Image and Mark Trevenen Huxley.  Filed as Exhibit 10.10 to Image’s  Registration Statement on Form S-2 (No. 333-65611), effective  December 21, 1998, and incorporated by reference herein.                                                                                                                  |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.8 **†**  | Form of Option Agreement, dated October 15, 1991, between Image  and Martin W. Greenwald.  Filed as  Exhibit 10.3 of Image’s Form 10-Q for the quarter ended September 30,  1991, and incorporated by reference herein.                                                                                                                                                                                       |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.9 **†**  | Form of Option granted, dated August 13, 1992, by Image to  Cheryl Lee.  Filed as Exhibit 10.12 of  Image’s Form 10-K for the fiscal year ended March 31, 1994, and  incorporated by reference herein.                                                                                                                                                                                                        |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.10 **†** | Form of Option granted May 19, 1994 to Jeff Framer, Cheryl Lee and  David Borshell.  Filed as Exhibit  10.24 to Image’s Form 10-K for the year ended March 31, 1994, and  incorporated by reference herein.                                                                                                                                                                                                        |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.11 **†** | Form of Termination Agreement between Image and each of Martin W.  Greenwald, Cheryl Lee, Jeff Framer and David Borshell (relating to the  termination of their former employment agreements).  File as Exhibit 10.11 to Image’s Registration Statement on Form  S-2 (NO. 333-65611), effective December 21, 1998, and incorporated by  reference herein.                                                          |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.12 **†** | Employment Agreement, dated as of July 1, 1998, between Image  and Martin W. Greenwald.  Filed as  Exhibit 10.12 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                           |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.13 **†** | Employment Agreement, dated as of July 1, 1998, between Image  and David Borshell.  Filed as Exhibit  10.15 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                                |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.14 **†** | Employment Agreement, dated as of July 1, 1998, between Image  and Jeff Framer.  Filed as Exhibit  10.14 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                                   |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.15 **†** | Employment Agreement, dated as of July 1, 1998, between Image  and Cheryl Lee.  Filed as Exhibit  10.13 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein.                                                                                                                                                                    |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.16 **†** | Form of 1998 Performance Restricted Stock Unit Award Agreement (and  related General Provisions), between Image and each of Martin W. Greenwald,  Cheryl Lee, Jeff Framer and David Borshell (appended as Exhibit A to Exhibits  10.12 through 10.15).  Filed as  Exhibit 10.16 to Image’s Registration Statement on Form S-2 (No. 333-65611),  effective December 21, 1998, and incorporated by reference herein. |

 

ii

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| 10.17 **†** | Form of 1999 Performance Restricted Stock Unit Award Agreement dated  as of July 1, 1999 (and related 1999 General Provisions), between Image  and each of Martin W. Greenwald, Cheryl Lee, Jeff Framer and David  Borshell.  Filed as Exhibit 10.1 to  Image’s Form 10-Q for the quarter ended June 30, 1999, and incorporated  by reference herein.                                                                                                                                                                                                                  |
|------------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.18 **†** | Loan Agreement, dated as of August 18, 2000, by and between  Image and Martin W. Greenwald.  Filed  as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended September 30,  2000, and incorporated by reference herein.                                                                                                                                                                                                                                                                                                                                              |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.19 **†** | Form of Director Stock Unit Award Agreement, dated as of  October 1, 1999, between Image and each of Ira Epstein, M. Trevenen  Huxley and Stuart Segall.  Filed as  Exhibit 10.18 to Image’s Form 10-K for the fiscal year ended March 31,  2000, and incorporated by reference herein.                                                                                                                                                                                                                                                                                |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.20 **†** | Form of Director Stock Unit Award Agreement, dated as of  October 1, 2000, between Image and each of Ira Epstein, M. Trevenen  Huxley and Stuart Segall.  Filed as  Exhibit 10.1 to Image’s Form 10-Q for the quarter ended December 31,  2000, and incorporated by reference herein.                                                                                                                                                                                                                                                                                  |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.21 **†** | Form of Indemnity Agreement between Image and its directors and  officers.  Filed as Exhibit F of  Image’s Proxy Statement dated September 5, 1989, and incorporated by  reference herein.                                                                                                                                                                                                                                                                                                                                                                                  |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.22            | Stock Purchase Agreement among Image, Directors of Image and various  Buyers dated December 29, 1987.   Filed as Exhibit 4.3 of Image’s Form 8-K dated December 29, 1987,  and incorporated by reference herein.                                                                                                                                                                                                                                                                                                                                                       |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.22(a)         | Form of First Amendment, dated July 7, 1992, to the Stock  Purchase Agreement among Image, Directors of Image and various Buyers dated  December 29, 1987.  Filed as  Exhibit 10.5 of Image’s Form 10-Q for the quarter ended September 30,  1992, and incorporated by reference herein.                                                                                                                                                                                                                                                                          |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.23            | Stock Purchase Agreement among Image, Directors of Image and Image  Investors Co. dated June 27, 1990.   Filed as Exhibit 10.53 of Image’s Form 10-K for the fiscal year ended  March 31, 1990.  Image and Image  Investors Co. are parties to Stock Purchase Agreements dated July 14,  1988, November 30, 1988, January 11, 1989, February 14, 1989,  May 10, 1989 and June 20, 1990, which are virtually identical to this  Exhibit except for the number of shares of Common Stock purchased, and  incorporated by reference herein. |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.24            | Stock Purchase Agreement between Image and Image Investors Co. dated  December 30, 1992, including Warrant.   Filed as Exhibit 10.6 of Image’s Form 10-Q for the quarter ended  December 31, 1992, and incorporated by reference herein.                                                                                                                                                                                                                                                                                                                               |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.25            | Standard Industrial Lease for 9333 Oso Avenue, Chatsworth, California,  dated December 1, 1993 and effective April 1, 1994, by and between  Image and P&R Investment Company.   Filed as Exhibit 10.1 of Image’s Form 10-Q for the quarter ended  December 31, 1993, and incorporated by reference herein.                                                                                                                                                                                                                                                    |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.25(a)         | First Amendment dated August 20, 1996 to Standard Industrial  Lease for 9333 Oso Avenue, Chatsworth, California, dated December 1,  1993 and effective April 1, 1994, by and between Image and P&R  Investment Company.  Filed as Exhibit  10.24(a) to Image’s Form 10-K for the fiscal year ended March 31, 1999,  and incorporated by reference herein.                                                                                                                                                                                                |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.25(b)         | Second Amendment dated March 1, 1999 to Standard Industrial  Lease for 9333 Oso Avenue, Chatsworth, California, dated December 1,  1993 and effective April 1, 1994, by and between Image and P&R  Investment Company.  Filed as Exhibit  10.24(b) to Image’s Form 10-K for the fiscal year ended March 31, 1999,  and incorporated by reference herein.                                                                                                                                                                                                 |
|             |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
| 10.26            | Standard Industrial Lease for 9349 Oso Avenue, Chatsworth,  California, dated March 1, 1999 and effective May 1, 1990, between Image  and P&R Investment Company.  Filed  as Exhibit 10.25 to Image’s Form 10-K for the fiscal year ended  March 31, 1999, and incorporated by reference herein.                                                                                                                                                                                                                                                                   |

 

iii

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

 

iv

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| 10.31(c) | Amendment No. 3, dated as of September 27, 1997, to Loan  Agreement, dated as of December 17, 1996, by and between Image and Union  Bank of California, N.A.  Filed as  Exhibit 10.26(c) of Image’s Form 10-K for the fiscal year ended  March 31, 1998, and incorporated by reference herein.                         |
|----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.31(d) | Amendment No. 4, dated as of October 31, 1997, to Loan  Agreement, dated as of December 17, 1996, by and between Image and Union  Bank of California, N.A.  Filed as  Exhibit 10.26(d) of Image’s Form 10-K for the fiscal year ended  March 31, 1998, and incorporated by reference herein.                           |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.31(e) | Amendment No. 5, dated as of January 28, 1998, to Loan  Agreement, dated as of December 17, 1996, by and between Image and Union  Bank of California, N.A.  Filed as  Exhibit 10.26(e) of Image’s Form 10-K for the fiscal year ended  March 31, 1998, and incorporated by reference herein.                           |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.31(f) | Amendment No. 6, dated as of June 18, 1998, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.26(f) of Image’s Form 10-K for the fiscal year ended March 31, 1998,  and incorporated by reference herein.                              |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.31(g) | Amendment No. 7, dated as of July 13, 1998, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.2 of Image’s Form 10-Q for the quarter ended June 30, 1998, and  incorporated by reference herein.                                       |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.31(h) | Amendment No. 8, dated as of October 23, 1998, to Loan Agreement,  dated as of December 17, 1996, by and between Image and Union Bank of  California, N.A.  Filed as Exhibit  10.2 of Image’s Form 10-Q for the quarter ended September 30, 1998, and  incorporated by reference herein.                               |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.32    | Credit Agreement, dated as of September 29, 1997, by and between  Image and Image Investors Co.  Filed  as Exhibit 10.27 to Image’s Form 10-K for the fiscal year ended  March 31, 1998, and incorporated by reference herein.                                                                                              |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.32(a) | Amendment No. 1, dated as of July 9, 2002, to Credit Agreement,  dated as of September 29, 1997, by and between Image and Image Investors  Co.  Filed as Exhibit 10.1 to Image’s  Form 10-Q for the quarter ended June 30, 2002, and incorporated by  reference herein.                                                |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.32(b) | Amendment No. 2, dated as of September 30, 2002, to Credit  Agreement, dated as of September 29, 1997, by and between Image and  Image Investors Co.  Filed as Exhibit  10.4 to Image’s Form 10-Q for the quarter ended September 30, 2002, and incorporated  by reference herein.                                     |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.33    | Loan and Security Agreement, dated as of December 28, 1998, by  and between Image and Foothill Capital Corporation, including Capital  Expenditure Loan Note and Trademark Security Agreement.  Filed as Exhibit 10.1 to Image’s Form 10-Q  for the quarter ended December 31, 1998, and incorporated by reference  herein. |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.33(a) | Amendment No. 1, dated as of November 1, 1999, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended  September 30, 1999, and incorporated by reference herein.                   |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.33(b) | Amendment No. 2, dated as of February 8, 2000, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended  December 31, 1999, and incorporated by reference herein.                    |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.33(c) | Amendment No. 3, dated as of August 28, 2001, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.2 to Image’s Form 10-Q for the quarter ended  September 30, 2001, and incorporated by reference herein.                    |
|     |                                                                                                                                                                                                                                                                                                                                            |
| 10.33(d) | Amendment No. 4, dated as of September 30, 2001, to Loan and Security  Agreement, dated as of December 28, 1998, by and between Image and  Foothill Capital Corporation.  Filed  as Exhibit 10.3 to Image’s Form 10-Q for the quarter ended September 30,  2001, and incorporated by reference herein.                 |

 

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| 10.33(e)  | Amendment No. 5, dated as of February 28, 2002, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended  September 30, 2002, and incorporated by reference herein.                                                      |
|-----------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(f)  | Amendment No. 6, dated as of August 1, 2002, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.2 to Image’s Form 10-Q for the quarter ended  September 30, 2002, and incorporated by reference herein.                                                         |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(g)  | Amendment No. 7, dated as of September 30, 2002, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.3 to Image’s Form 10-Q for the quarter ended  September 30, 2002, and incorporated by reference herein.                                                     |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(h)  | Amendment No. 8, dated as of December 31, 2002, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Foothill Capital Corporation.   Filed as Exhibit 10.1 to Image’s Form 10-Q for the quarter ended  December 31, 2002, and incorporated by reference herein.                                                       |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(i)  | Amendment No. 9, effective as of September 22, 2003, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Wells Fargo Foothill, Inc. (formerly known as Foothill Capital  Corporation).  Filed as Exhibit 10.1  to Image’s Form 10-Q for the quarter ended September 30, 2003, and  incorporated by reference herein. |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(j)  | Amendment No. 10, effective as of December 31, 2003, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Wells Fargo Foothill, Inc. (formerly known as Foothill Capital  Corporation).  Filed as Exhibit 10.1  to Image’s Form 10-Q for the quarter ended December 31, 2003, and  incorporated by reference herein.  |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.33(k)* | Amendment No. 11, effective as of March 31, 2004, to Loan and  Security Agreement, dated as of December 28, 1998, by and between Image  and Wells Fargo Foothill, Inc. (formerly known as Foothill Capital  Corporation).                                                                                                                                                 |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.34     | Limited Liability Company Operating Agreement of Aviva International,  LLC, dated as of June 21, 1999, by and between Image and Michael  Lopez.  Filed as Exhibit 10.2 to  Image’s Form 10-Q for the quarter ended June 30, 1999, and incorporated  by reference herein.                                                                                        |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.34(a)  | First Amendment, dated as of April 28, 2000, to Limited  Liability Company Operating Agreement of Aviva International, LLC, dated as  of June 21, 1999, by and between Image and Michael Lopez.  Filed as Exhibit 10.30(a) to Image’s Form  10-K for the fiscal year ended March 31, 2000, and incorporated by  reference herein.                          |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.35     | Optical Disc Replication and Loan Agreement dated March 13,  2001, by and between Image and MRT Technology, LLC.  Filed as Exhibit 10.35 to Image’s Form 10-K for the fiscal year  ended March 31, 2001, and incorporated by reference herein.                                                                                                                  |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.35(a)  | Amendment No. 1., dated as of March 26, 2002, to Optical Disc  Replication and Loan Agreement dated March 13, 2001, by and between  Image and MRT Technology LLC.  Filed  as Exhibit 10.35(a) to Image’s Form 10-K for the fiscal year ended  March 31, 2002, and incorporated by reference herein.                                                        |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.36     | Subordination Agreement dated March 13, 2001, by and between  Image, MRT Technology, LLC and Bank of America, N.A.  Filed as Exhibit 10.36 to Image’s 10-K for  the fiscal year ended March 31, 2001, and incorporated by reference  herein.                                                                                                                    |
|      |                                                                                                                                                                                                                                                                                                                                                                                |
| 10.36(a)  | First Amendment, dated March 26, 2002, to Subordination  Agreement, dated March 13, 2001, by and between Image, MRT Technology,  LLC and Bank of America, N.A.  Filed  as Exhibit 10.36(a) to Image’s Form 10-K for the fiscal year ended  March 31, 2002, and incorporated by reference herein.                                                           |

 

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| 10.37                | Subordination Agreement dated March 13, 2001 by and between  Image, MRT Technology, LLC and Foothill Capital Corporation.  Filed as Exhibit 10.37 to Image’s Form  10-K for the fiscal year ended March 31, 2001, and incorporated by  reference herein.                                                          |
|----------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.37(a)             | Amendment Number One, dated March 26, 2002, to Subordination  Agreement dated March 13, 2001, by and between Image, MRT Technology,  LLC and Foothill Capital Corporation.   Filed as Exhibit 10.37(a) to Image’s Form 10-K for the fiscal year  ended March 31, 2002, and incorporated by reference herein. |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.38                | Master Lease Agreement, dated as of July 25, 2001, by and  between Image and General Electric Capital Corporation.  Filed as Exhibit 10.4 to Image’s Form 10-Q  for quarter ended September 30, 2001, and incorporated by reference  herein.                                                                      |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.39                | Stock Purchase Agreement dated as of September 10, 2002 between  Image and Standard Broadcasting Corporation Limited.  Filed as Exhibit 99.1 to Image’s Form 8-K  dated September 12, 2002, and incorporated by reference herein.                                                                                 |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.40                | Termination and Exchange Agreement entered into on March 24,  2003, effective as of March 14, 2003, between Image and Image Investors  Co.  Filed as Exhibit 99.1 to Image’s  Form 8-K dated March 24, 2003, and incorporated by reference herein.                                                           |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.41                | Form of Warrant, dated March 24, 2003, between Image and Image  Investors Co.  Filed as Exhibit 99.2  to Image’s Form 8-K dated March 24, 2003, and incorporated by reference  herein.                                                                                                                            |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.42* **†**    | Employment Agreement, dated as of April 1, 2004, between Image  and Martin W. Greenwald.                                                                                                                                                                                                                                         |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.42(a)* **†** | Amendment No. 1, dated as of  June 1, 2004, to Employment Agreement, dated as of April 1, 2004,  by and between Image and Martin W. Greenwald.                                                                                                                                                                              |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.43* **†**    | Employment Agreement, dated as of April 1, 2004, between Image  and David Borshell.                                                                                                                                                                                                                                              |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.44* **†**    | Employment Agreement, dated as of April 1, 2004, between Image  and Jeff Framer.                                                                                                                                                                                                                                                 |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 10.45*               | Code of Ethics Policy.                                                                                                                                                                                                                                                                                                                |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 21*                  | Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                       |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 23*                  | Consent Letter of KPMG LLP, Independent Registered Public Accounting  Firm.                                                                                                                                                                                                                                                           |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 31.1*                | Certification by the Chief Executive Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 31.2*                | Certification by the Chief Financial Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 32.1*                | Certification by the Chief Executive Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |
|                 |                                                                                                                                                                                                                                                                                                                                  |
| 32.2*                | Certification by the Chief Financial Officer, pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                   |

 

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***  Exhibit(s) not previously filed with the Securities and ExchangeCommission.**

**†  Management Contracts, Compensatory Plans or Arrangements.**

 

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