Attached files

file filename
EX-31.2 - EXHIBIT 31.2 - RLJ ENTERTAINMENT, INC.ex31_2.htm
EX-32.1 - EXHIBIT 32.1 - RLJ ENTERTAINMENT, INC.ex32_1.htm
EX-31.1 - EXHIBIT 31.1 - RLJ ENTERTAINMENT, INC.ex31_1.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 

 
FORM 10-Q
 
Mark one)
 
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2015.
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________.

Commission File Number 001-35675
 

 
RLJ ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
 

 
Nevada
 
45-4950432
(State or other jurisdiction of incorporation)
 
(IRS Employer Identification Number)

8515 Georgia Avenue, Suite 650
Silver Spring, Maryland
 
20910
(Address of principal executive offices)
 
(Zip Code)

(301) 608-2115
(Registrant’s telephone number, including area code)

None
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES      NO
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES     NO
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

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

Number of shares outstanding of the issuer’s common stock on November 9, 2015:  12,877,064
 


RLJ ENTERTAINMENT, INC.
INDEX TO FORM 10-Q
 
PART I.
FINANCIAL INFORMATION
 
     
Item 1.
 
     
   4
     
   5
      
   6
      
   7
      
   8
      
   9
      
Item 2.
 26
     
Item 3.
 38
     
Item 4.
 38
     
PART II.
OTHER INFORMATION
 
     
Item 1.
 40
     
Item 1A.
 40
     
Item 6.
 41
     
    42
 
2

FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2015, includes forward-looking statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Other than statements of historical fact, all statements made in this Quarterly Report are forward-looking, including, but not limited to, statements regarding industry prospects, future results of operations or financial position, and statements of our intent, belief and current expectations about our strategic direction, prospective and future results and condition.  In some cases, forward-looking statements may be identified by words such as “will,” “should,” “could,” “may,” “might,” “expect,” “plan,” “possible,” “potential,” “predict,” “anticipate,” “believe,” “estimate,” “continue,” “future,” “intend,” “project” or similar words.
 
Forward-looking statements involve risks and uncertainties that are inherently difficult to predict, which could cause actual outcomes and results to differ materially from our expectations, forecasts and assumptions.  Factors that might cause such differences include, but are not limited to:
 
· Our financial performance, including our ability to achieve revenue growth, margins or earnings before income tax, depreciation, amortization, adjusted for cash investment in content, interest expense, transaction and restructuring costs, warrants and other derivatives and stock-based compensation (or Adjusted EBITDA);
· The effects of limited cash liquidity on operational performance;
· Our obligations under our credit agreement, including our principal repayment obligations;
· Our ability to satisfy financial ratios;
· Our ability to fund planned capital expenditures and development efforts;
· Our inability to gauge and predict the commercial success of our programming;
· The ability of our officers and directors to generate a number of potential investment opportunities;
· Our ability to maintain relationships with customers and suppliers;
· Delays in the release of new titles or other content;
· The effects of disruptions in our supply chain;
· The loss of key personnel;
· Our public securities’ limited liquidity and trading; or
· Our ability to meet the NASDAQ Capital Market continuing listing standards and maintain our listing.
 
All forward-looking statements should be evaluated with the understanding of inherent uncertainty.  The inclusion of such forward-looking statements should not be regarded as a representation that contemplated future events, plans or expectations will be achieved.  Unless otherwise required by law, we undertake no obligation to release publicly any updates or revisions to any such forward-looking statements that may reflect events or circumstances occurring after the date of this Quarterly Report.  Important factors that could cause or contribute to such material differences include those discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K filed on May 8, 2015.  You are cautioned not to place undue reliance on such forward-looking statements.
 
3

PART I - FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
RLJ ENTERTAINMENT, INC.
 
CONSOLIDATED BALANCE SHEETS
 
September 30, 2015 (unaudited) and December 31, 2014
 

 
(In thousands, except share data)
 
September 30,
2015
   
December 31,
2014
 
ASSETS
       
Cash
 
$
1,807
   
$
6,662
 
Accounts receivable, net
   
14,254
     
17,389
 
Inventories, net
   
11,625
     
13,029
 
Investments in content, net
   
67,422
     
67,525
 
Prepaid expenses and other assets
   
2,727
     
2,633
 
Property, equipment and improvements, net
   
2,214
     
2,372
 
Equity investment in affiliate
   
20,758
     
22,281
 
Other intangible assets, net
   
12,601
     
15,272
 
Goodwill
   
44,891
     
44,891
 
Total assets
 
$
178,299
   
$
192,054
 
LIABILITIES AND EQUITY
               
Accounts payable and accrued liabilities
 
$
18,037
   
$
24,582
 
Accrued royalties and distribution fees
   
49,539
     
42,493
 
Deferred revenue
   
2,393
     
5,006
 
Debt, net of discount
   
62,304
     
80,913
 
Deferred tax liability
   
2,002
     
2,002
 
Stock warrant and other derivative liabilities
   
6,920
     
601
 
Total liabilities
   
141,195
     
155,597
 
Mandatorily redeemable convertible preferred stock, $0.001 par value, 1,000,000 shares authorized; 31,046 shares issued and outstanding at September 30, 2015; and no shares issued and outstanding at December 31, 2014
   
20,245
     
 
Equity:
               
Common stock, $0.001 par value, 250,000,000 shares authorized, 13,724,756 shares issued at September 30, 2015 and December 31, 2014; 12,877,064 shares outstanding at September 30, 2015 and 13,335,258 shares outstanding at December 31, 2014
   
13
     
14
 
Additional paid-in capital
   
86,395
     
87,706
 
Accumulated deficit
   
(68,856
)
   
(50,534
)
Accumulated other comprehensive loss
   
(693
)
   
(729
)
Treasury shares, at cost, 847,692 shares at September 30, 2015 and 389,498 shares at December 31, 2014
   
     
 
Total equity
   
16,859
     
36,457
 
Total liabilities and equity
 
$
178,299
   
$
192,054
 
 
 
See accompanying notes to consolidated financial statements.
 
4

RLJ ENTERTAINMENT, INC.
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three and Nine Months Ended September 30, 2015 and 2014
 

 
(In thousands, except share data)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Revenues
 
$
32,549
   
$
37,123
   
$
82,778
   
$
99,478
 
Cost of sales
                               
Content amortization and royalties
   
12,676
     
18,911
     
36,355
     
44,979
 
Manufacturing and fulfillment
   
9,423
     
9,238
     
24,734
     
29,542
 
Total cost of sales
   
22,099
     
28,149
     
61,089
     
74,521
 
Gross profit
   
10,450
     
8,974
     
21,689
     
24,957
 
                                 
Selling expenses
   
5,989
     
5,411
     
17,628
     
17,448
 
General and administrative expenses
   
4,791
     
4,661
     
14,796
     
14,466
 
Depreciation and amortization
   
1,444
     
1,301
     
3,819
     
4,258
 
Total operating expenses
   
12,224
     
11,373
     
36,243
     
36,172
 
LOSS FROM OPERATIONS
   
(1,774
)
   
(2,399
)
   
(14,554
)
   
(11,215
)
                                 
Equity earnings of affiliate
   
188
     
1,190
     
876
     
2,540
 
Interest expense, net
   
(2,223
)
   
(2,557
)
   
(7,747
)
   
(6,560
)
Change in fair value of stock warrants and other derivatives
   
(2,506
)
   
(1,599
)
   
5,131
     
(2,277
)
Loss on extinguishment of debt
   
     
(1,457
)
   
     
(1,457
)
Other expense
   
(782
)
   
(1,141
)
   
(1,397
)
   
(655
)
LOSS BEFORE (PROVISION) BENEFIT FOR INCOME TAXES
   
(7,097
)
   
(7,963
)
   
(17,691
)
   
(19,624
)
(Provision) Benefit for income taxes
   
(49
)
   
164
     
(631
)
   
(524
)
NET LOSS
   
(7,146
)
   
(7,799
)
   
(18,322
)
   
(20,148
)
Accretion on preferred stock
   
(1,066
)
   
     
(1,525
)
   
 
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS
 
$
(8,212
)
 
$
(7,799
)
 
$
(19,847
)
 
$
(20,148
)
Net loss per common share:
                               
Basic and diluted
 
$
(0.64
)
 
$
(0.62
)
 
$
(1.56
)
 
$
(1.61
)
                                 
Weighted average shares outstanding:
                               
Basic and diluted
   
12,799
     
12,557
     
12,728
     
12,502
 
 
 
See accompanying notes to consolidated financial statements.
 
5

RLJ ENTERTAINMENT, INC.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
 
Three and Nine Months Ended September 30, 2015 and 2014
 

 
(In thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Net loss
 
$
(7,146
)
 
$
(7,799
)
 
$
(18,322
)
 
$
(20,148
)
Other comprehensive (loss) income:
                               
Foreign currency translation (loss) gain
   
(607
)
   
(852
)
   
36
     
(343
)
Total comprehensive loss
 
$
(7,753
)
 
$
(8,651
)
 
$
(18,286
)
 
$
(20,491
)
 
 
See accompanying notes to consolidated financial statements.
 
6

RLJ ENTERTAINMENT, INC.
 
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
 
Nine Months Ended September 30, 2015 and 2014


 
   
Common Stock
               
Treasury Stock
     
(In thousands)
 
Shares
   
Par
Value
   
Additional
Paid-in
Capital
   
Accumulated
Deficit
    
Accumulated
Other
Comprehensive
 Loss
    
Shares
   
At
Cost
   
Total
 Equity
 
Balance at January 1, 2015
   
13,335
   
$
14
   
$
87,706
   
$
(50,534
)
 
$
(729
)
  
390
    
$
   
$
36,457
 
Issuance of restricted common stock for services
   
15
     
     
     
     
     
(15
)
   
     
 
Forfeiture of restricted common stock
   
(36
)
   
     
     
     
     
36
     
     
 
Forfeiture of founder shares
   
(437
)
   
(1
)
   
1
     
     
     
437
     
     
 
Accretion on  preferred stock
   
     
     
(1,525
)
   
     
     
     
     
(1,525
)
Stock-based compensation
   
     
     
213
     
     
     
     
     
213
 
Foreign currency translation
   
     
     
     
     
36
     
     
     
36
 
Net loss
   
     
     
     
(18,322
)
   
     
     
     
(18,322
)
Balance at September 30, 2015
   
12,877
   
$
13
   
$
86,395
   
$
(68,856
)
 
$
(693
)
   
848
   
$
   
$
16,859
 
 
   
Common Stock
               
Treasury Stock
     
(In thousands)
 
Shares
   
Par
Value
   
Additional
Paid-in
 Capital
   
Accumulated
 Deficit
    
Accumulated
Other
Comprehensive
Income
    
Shares
   
At
Cost
   
Total
Equity
 
Balance at January 1, 2014
   
13,701
   
$
13
   
$
86,938
   
$
(29,334
)
 
$
310
         
$
   
$
57,927
 
Issuance of restricted common stock for services
   
190
     
     
     
     
     
(166
)
   
     
 
Forfeiture of restricted common stock
   
(83
)
   
     
     
     
     
83
     
     
 
Forfeiture of founder shares
   
(449
)
   
     
     
     
     
449
     
     
 
Stock-based compensation
   
     
     
683
     
     
     
     
     
683
 
Foreign currency translation
   
     
     
     
     
(343
)
   
     
     
(343
)
Net loss
   
     
     
     
(20,148
)
   
     
     
     
(20,148
)
Balance at September 30, 2014
   
13,359
   
$
13
   
$
87,621
   
$
(49,482
)
 
$
(33
)
   
366
   
$
   
$
38,119
 
 
 
See accompanying notes to consolidated financial statements.
 
7

RLJ ENTERTAINMENT, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended September 30, 2015 and 2014
 

 
(In thousands)
 
Nine Months Ended September 30,
 
   
2015
   
2014
 
CASH FLOWS FROM OPERATING ACTIVITIES:
       
Net loss
 
$
(18,322
)
 
$
(20,148
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Equity earnings of affiliate
   
(876
)
   
(2,540
)
Content amortization and royalties
   
36,355
     
44,979
 
Depreciation and amortization
   
3,819
     
4,258
 
Foreign currency exchange (gain) loss
   
1,102
     
405
 
Fair value adjustment of stock warrant and other derivative liabilities
   
(5,131
)
   
2,277
 
Non-cash interest expense
   
2,516
     
1,925
 
Loss on extinguishment of debt
   
     
1,457
 
Stock-based compensation expense
   
213
     
683
 
Changes in assets and liabilities:
               
Accounts receivable, net
   
2,957
     
6,930
 
Inventories, net
   
1,339
     
3,061
 
Investments in content, net
   
(29,597
)
   
(37,618
)
Prepaid expenses and other assets
   
(389
)
   
(1,156
)
Accounts payable and accrued liabilities
   
(6,242
)
   
(5,519
)
Deferred revenue
   
(2,575
)
   
606
 
Net cash used in operating activities
   
(14,831
)
   
(400
)
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Capital expenditures
   
(1,297
)
   
(1,580
)
Dividends received from affiliate
   
1,729
     
2,947
 
Net cash provided by investing activities
   
432
     
1,367
 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from issuance of preferred stock and warrants
   
22,500
     
 
Proceeds from senior debt, net of discount and deferred financing costs
   
     
63,801
 
Repayment of senior debt
   
(11,837
)
   
(48,280
)
Repayments of borrowings under revolving credit facility
   
     
(14,949
)
Proceeds from production loan
   
     
9,865
 
Repayment of production loan
   
     
(10,602
)
Payment of preferred stock and warrant issuance costs
   
(783
)
   
 
Payment of senior debt modification costs
   
(450
)
   
 
Cash paid to extinguish debt
   
     
(30
)
Net cash provided by (used in) financing activities
   
9,430
     
(195
)
Effect of exchange rate changes on cash
   
114
     
(272
)
NET (DECREASE) INCREASE IN CASH:
   
(4,855
)
   
500
 
Cash at beginning of period
   
6,662
     
7,674
 
Cash at end of period
 
$
1,807
   
$
8,174
 
 
 
See accompanying notes to consolidated financial statements.
 
8

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1. DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION
 
Description of Business
 
RLJ Entertainment, Inc. (or RLJE) is a global entertainment company with a direct presence in North America, the United Kingdom (or U.K.) and Australia with strategic sublicense and distribution relationships covering Europe, Asia and Latin America.  RLJE was incorporated in Nevada in April 2012.  On October 3, 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media), which is referred to herein as the “Business Combination.”  Acorn Media includes its subsidiaries RLJE International Ltd (or RLJE U.K.), RLJ Entertainment Australia Pty Ltd. (or RLJE Australia) and RLJ Entertainment Ltd (or RLJE Ltd.).  In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL).  References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC.  “We,” “our” or “us” refers to RLJE and its subsidiaries unless otherwise noted.  Our principal executive offices are located in Silver Spring, Maryland, with additional locations in Woodland Hills, California, Stillwater, Minnesota, and international locations in London, England and Sydney, Australia.
 
We acquire content rights in various categories including, British mysteries and dramas, urban programming, and full-length independent motion pictures.  We acquire this content in two ways:
 
· through long-term exclusive licensing agreements where we secure multiple rights to third-party programs, and;
 
· through development, production, and ownership of original drama television programming through our wholly-owned subsidiary, RLJE Ltd., and our majority-owned subsidiary, ACL, as well as fitness programs through our Acacia brand.
 
We market our products through a multi-channel strategy encompassing (1) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, RLJE Ltd., and our majority-owned subsidiary, ACL, (our Intellectual Property, or IP, Licensing segment); (2) wholesale exploitation through partners covering broadcast/cable, digital, mobile, ecommerce and brick and mortar outlets (our Wholesale segment); and (3) direct relations with consumers via proprietary ecommerce, catalog and subscription-based video on demand (or SVOD) channels (our Direct-to-Consumer segment).
 
Our wholesale partners are broadcasters, digital outlets and major retailers in the United States of America (or U.S.), Canada, U.K. and Australia, including, among others, Amazon, Netflix, Walmart, Target, Costco, Barnes & Noble, iTunes, BET, Showtime, PBS, DirecTV and Hulu.
 
Our Direct-to-Consumer segment includes the sale of video content and complementary merchandise directly to consumers through proprietary ecommerce websites, and catalogs and the continued roll-out of our proprietary subscription-based SVOD channels, such as Acorn TV, Acacia TV and UMC (or Urban Movie Channel).
 
RLJE’s management views our operations based on these three distinctive reporting segments: (1) IP Licensing, (2) Wholesale and (3) Direct-to-Consumer.  Operations and net assets that are not associated with any of these stated segments are reported as “Corporate” when disclosing and discussing segment information.  The IP Licensing segment includes intellectual property rights that we own or create and then sublicense for exploitation worldwide.  Our Wholesale and Direct-to-Consumer segments consist of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including broadcast (which includes cable and satellite), DVD, Blu-ray, digital, video-on-demand (or VOD), SVOD, downloading and sublicensing.  The Wholesale segment exploits content through third-party vendors, while the Direct-to-Consumer segment exploits the same content and digitally streaming channels.
 
Basis of Presentation
 
Unaudited Interim Financial Statements
 
The financial information presented in the accompanying unaudited interim consolidated financial statements as of September 30, 2015 and for the three and nine months ended September 30, 2015 and 2014 has been prepared in accordance with accounting principles generally accepted in the United States (or U.S. GAAP) and with the Securities and Exchange Commission’s (or SEC) instructions for interim financial reporting instructions for the Form 10-Q and Article 10 of Regulation S-X of the SEC.  Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete financial statements.
 
9

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
In management’s opinion, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included.  Due to the seasonal nature of our business, with a disproportionate amount of sales occurring in the fourth quarter and other factors, including our content release schedule, interim results are not necessarily indicative of the results that may be expected for the entire fiscal year.  The accompanying unaudited financial information should, therefore, be read in conjunction with the consolidated financial statements and the notes thereto in our Annual Report on Form 10-K filed on May 8, 2015 (or 2014 Form 10-K).  Note 2, Summary of Significant Accounting Policies, of our audited consolidated financial statements included in our 2014 Form 10-K contains a summary of our significant accounting policies.  As of September 30, 2015, we have made no material changes to our significant accounting policies disclosed in our 2014 Form 10-K.
 
Fair Value of Financial Instruments
 
The carrying amount of our financial instruments, which principally include cash, trade receivables, accounts payable and accrued expenses, approximates fair value due to the relative short maturity of such instruments.  The carrying amount of our debt under our senior credit agreement approximates fair value as the debt bears market rates of interest.  The carrying amount of our subordinated debt is approximately $1.7 million more than its fair value as a result of its reduced interest rate from 12.0% to 1.5% for two years beginning January 1, 2015.  The fair value of subordinated debt was determined by discounting future interest and principal payments by an estimated market rate of interest of 12.0%.  This fair value assessment of our subordinated debt is a level 3 measurement as provided by Accounting Standards Codification (or ASC) 820, “Fair Value Measurements and Disclosures.
 
Accounting and Reporting Pronouncements Issued
 
On April 7, 2015 the Financial Accounting Standards Board (or FASB) issued Accounting Standards Update (or ASU) No. 2015-3, Interest – Imputation of Interest (the Update).  The Update requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts.  The amendments in this Update are effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.  We will adopt this Update beginning January 1, 2016 by applying the new guidance on a retroactive basis.  As of September 30, 2015 and December 31, 2014, we have unamortized debt issuance costs of $0.9 million and $1.2 million, respectively, that are currently recorded within prepaid expenses and other assets.
 
On April 12, 2015, the FASB deferred the effective date of ASU No. 2014-09, Revenues from Contracts with Customers, for one year from January 1, 2017 to January 1, 2018.
 
Reclassifications and Adjustment
 
Certain amounts reported previously in our consolidated financial statements have been reclassified or adjusted to be comparable with the classifications used for our 2015 consolidated financial statements.  We are now reporting our cost of sales in two components, which are (a) content amortization and royalties and (b) manufacturing and fulfillment.  We are now reporting amortization of deferred financing costs as interest expense.  Previously, we were reporting amortization of deferred financing costs as general and administrative expenses.
 
Principles of Consolidation
 
The investment in ACL is accounted for using the equity method of accounting given the voting control of the board of directors by the minority shareholder.  As such, we have included our share of ACL’s operating results as a separate line item in our consolidated financial statements.
 
Our consolidated financial statements include the accounts of all majority-owned subsidiary companies, except for ACL.  We carry the investment in ACL as a separate asset on our consolidated balance sheet at cost adjusted for our share of the equity in undistributed earnings.  Except for dividends and changes in ownership interest, we report changes in equity in undistributed earnings of ACL in our consolidated statements of operations.  All intercompany transactions and balances have been eliminated.
 
10

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Liquidity
 
For the nine months ended September 30, 2015 and 2014, we recognized a net loss of $18.3 million and $20.1 million, respectively.  During the nine months ended September 30, 2015 and 2014, we used cash in operating activities of $14.8 million and $400,000, respectively.  At September 30, 2015, our cash balance was $1.8 million.  At September 30, 2015, we had $62.3 million of term debt outstanding (see Note 7, Debt).  We continue to experience liquidity constraints and we are dependent upon growth in sales and margins to meet our liquidity needs and our debt covenants for the next twelve months.  There can be no assurances that we will be successful in realizing this growth or meeting our future covenant requirements within our amended credit agreement.  To address our liquidity risk, on May 20, 2015, we completed a $31.0 million capital restructuring transaction that addressed two fundamental areas: (a) deleveraging the balance sheet and (b) providing new working capital.  As part of the capital restructure, we amended our credit agreement and other notes payable by (i) reducing our minimum cash requirement by $2.5 million, thus making this cash available for operational needs, (ii) modifying certain financial covenants for better operating flexibility in meeting future covenants and maintaining compliance, and (iii) amending our unsecured subordinated seller notes to convert 50% or $8.5 million of the outstanding principal and accrued interest into preferred stock and warrants and reduce the applicable interest rate from 12.0% to 1.5% on the remaining balance through 2016.  The capital restructure improved our liquidity by selling shares of preferred stock and warrants for a total of $31.0 million ($22.5 million in cash and $8.5 million in converted subordinated notes).  The proceeds received were used to make an accelerated principal payment of $10.0 million under our credit agreement and pay fees and expenses incurred of approximately $1.9 million.  The remaining $10.6 million was available for content investment and working capital needs.  By reducing our debt balances and the applicable interest rate on the unsecured subordinated seller notes for two years, our future, annual cash interest expense has been reduced by approximately $2.0 million.  We believe that our current financial position combined with our forecasted operational results will be sufficient to meet our commitments.
 
Goodwill
 
Goodwill is the second largest asset on our balance sheet of which $43.0 million is recorded in our Wholesale reportable segment and $1.9 million is recorded in our Direct-to-Consumer reportable segment.  We assess goodwill for impairment every year in the fourth quarter and when events and circumstances indicate that goodwill may be impaired.  Our common stock price decreased 75% from $1.99 per share as of December 31, 2014 to $0.50 per share as of September 30, 2015.  The decrease occurred primarily during the second quarter of 2015 and was largely due to the issuance of our preferred stock in May 2015, which represents approximately 71% of our outstanding equity securities computed on a fully-diluted basis.  During the third quarter of 2015, our stock price increased 28% from $0.39 to $0.50 per share.
 
We considered the decrease in our common stock price to be an indicator that our goodwill may be impaired.  As a result, management updated its prior year goodwill impairment testing, which is to compare the fair value of our reporting units that have goodwill to the reporting unit’s carrying value.  When computing fair value of the reporting units, management used a discounted cash flow approach and discounted the future cash flows of its reporting units.  Significant assumptions incorporated in the valuation were the reporting unit’s future cash flows and appropriate discount rates (primarily ranging from 18% to 21%).  When doing this fair-value assessment, we also considered our current market capitalization comparing it to the combined fair values of our reporting units.  Significant assumptions that were incorporated in this market capitalization analysis were estimates of the fair values of our debt and preferred stock, as well as appropriate discounts for a minority interest position, limited trading volume and the effects of the issued and outstanding warrants have on our common stock price.
 
The results of our impairment testing indicate that for one of our reporting units, which has $38.9 million of goodwill and is part of our Wholesale segment, the margin by which the unit’s estimated fair value exceeds its carrying value significantly decreased during the nine months ended September 30, 2015.  Currently, the margin expressed as a percentage of fair value is less than 5%.  For our other reporting units that have goodwill their margins are in excess of 25% as of September 30, 2015.
 
Because our analysis and valuation is a level 3 valuation within the valuation hierarchy, which incorporates inputs that are inherently judgmental in nature, when performing our annual assessment in the fourth quarter, with the assistance of outside valuation professionals, we may conclude differently and record a charge for impairment of goodwill.  Further, if our common stock price falls during the fourth quarter or if our future operating results differ significantly from our current forecasts, then we may also conclude in the near future that our goodwill is impaired.  Because our current margin is less than 5% for the reporting unit that has the majority of our recorded goodwill, a change in assumptions and estimates could likely trigger an impairment that could be material.
 
11

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Other Intangible Assets
 
During the third quarter of 2015, we committed to using the RLJE brand for all new feature-film content.  We will continue to brand all previously released feature-film content with the Image brand.  As a result of this change, we reassessed the useful life of our Image brand and concluded that the brand's life has been reduced to a trailing eight-year period, with a disproportionate amount of brand benefit being realized during the first three years.  Therefore, we have changed our amortization assumptions.  We were amortizing the carrying value of our Image brand on a straight-line basis over 15 years, with 12 years remaining.  Now we are amortizing the carrying value of our Image brand over the remaining eight years with increased amortization in the earlier years.  The change in amortization assumptions resulted in $208,000 of increased amortization during the current quarter.  The change will result in increased amortization expense through 2019, and then reduced amortization expense thereafter, as follows:
 
(In thousands)
 
Revised
Amortization
   
Original
Amortization
   
Difference
 
             
Fourth Quarter 2015
 
$
307
   
$
52
   
$
255
 
2016
   
620
     
209
     
411
 
2017
   
384
     
209
     
175
 
2018
   
294
     
209
     
85
 
2019
   
226
     
209
     
17
 
2020
   
182
     
209
     
(27
)
Thereafter
   
291
     
1,415
     
(1,124
)
 
 
We assessed whether the Image brand was impaired during the third quarter of 2015 and concluded that the estimated future cash flows from the Image brand exceed the brand’s carrying value; therefore we did not recognize an impairment charge.
 
NOTE 2. SEGMENT INFORMATION
 
In accordance with the requirements of the ASC 280 Segment Reporting” selected financial information regarding our three reportable business segments is presented below.  Our reportable segments are determined based on the distinct nature of their operation.  Each segment is a strategic business unit that is managed separately and either exploits our content over a different customer base or acquires content differently.  Our IP Licensing segment includes intellectual property (or content) owned or created by us, other than certain fitness related content, that is licensed for exploitation worldwide.  The IP Licensing segment also includes our investment in ACL.  Our Wholesale segment consists of the acquisition, enhancement and worldwide exploitation of exclusive content in various formats, including DVD, Blu-ray, digital, broadcast (including cable and satellite), VOD, streaming video, downloading and sublicensing.  Our Direct-to-Consumer segment consists of our mail-order catalog and ecommerce businesses and our proprietary digital streaming channels.
 
Management currently evaluates segment performance based primarily on revenues and operating income (loss), including earnings from ACL.  Operating costs and expenses attributable to our Corporate segment include only those expenses incurred by us at the parent corporate level, which are not allocated to our reporting segments and include costs associated with RLJE’s corporate functions such as finance and accounting, human resources, legal and information technology departments.  Interest expense, change in the fair value of stock warrants and other derivatives, other income (expense) and provision for income taxes are evaluated by management on a consolidated basis and are not allocated to our reportable segments.
 
12

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following tables summarize the segment contribution for the three-month periods ended September 30, 2015 and 2014:
 
(In thousands)
 
Three Months Ended September 30, 2015
 
   
IP
Licensing
   
Wholesale
   
Direct-to-Consumer
   
Corporate
   
Total
 
                     
Revenues
 
$
2,046
   
$
21,545
   
$
8,958
   
$
   
$
32,549
 
Operating costs and expenses
   
(1,330
)
   
(17,892
)
   
(10,685
)
   
(2,972
)
   
(32,879
)
Depreciation and amortization
   
(44
)
   
(650
)
   
(610
)
   
(140
)
   
(1,444
)
Share in ACL earnings
   
188
     
     
     
     
188
 
Segment contribution (loss)
 
$
860
   
$
3,003
   
$
(2,337
)
 
$
(3,112
)
 
$
(1,586
)
 
 
(In thousands)
 
Three Months Ended September 30, 2014
 
   
IP
Licensing
   
Wholesale
   
Direct-to-Consumer
   
Corporate
   
Total
 
                     
Revenues
 
$
8,674
   
$
22,003
   
$
6,446
   
$
   
$
37,123
 
Operating costs and expenses
   
(6,373
)
   
(22,491
)
   
(6,935
)
   
(2,422
)
   
(38,221
)
Depreciation and amortization
   
(30
)
   
(334
)
   
(864
)
   
(73
)
   
(1,301
)
Share in ACL earnings
   
1,190
     
     
     
     
1,190
 
Segment contribution (loss)
 
$
3,461
   
$
(822
)
 
$
(1,353
)
 
$
(2,495
)
 
$
(1,209
)
 
 
In July of 2014, our IP Licensing segment released the most recent season of Foyle’s War.
 
The following tables summarize the segment contribution for the nine-month periods ended September 30, 2015 and 2014:
 
(In thousands)
 
Nine Months Ended September 30, 2015
 
   
IP
Licensing
   
Wholesale
   
Direct-to-Consumer
   
Corporate
   
Total
 
                     
Revenues
 
$
2,504
   
$
57,325
   
$
22,949
   
$
   
$
82,778
 
Operating costs and expenses
   
(1,883
)
   
(55,371
)
   
(27,762
)
   
(8,497
)
   
(93,513
)
Depreciation and amortization
   
(105
)
   
(1,373
)
   
(1,967
)
   
(374
)
   
(3,819
)
Share in ACL earnings
   
876
     
     
     
     
876
 
Segment contribution (loss)
 
$
1,392
   
$
581
   
$
(6,780
)
 
$
(8,871
)
 
$
(13,678
)
 
 
(In thousands)
 
Nine Months Ended September 30, 2014
 
   
IP
Licensing
   
Wholesale
   
Direct-to-Consumer
   
Corporate
   
Total
 
                     
Revenues
 
$
8,687
   
$
66,777
   
$
24,014
   
$
   
$
99,478
 
Operating costs and expenses
   
(6,883
)
   
(63,952
)
   
(26,800
)
   
(8,800
)
   
(106,435
)
Depreciation and amortization
   
(85
)
   
(1,125
)
   
(2,648
)
   
(400
)
   
(4,258
)
Share in ACL earnings
   
2,540
     
     
     
     
2,540
 
Segment contribution (loss)
 
$
4,259
   
$
1,700
   
$
(5,434
)
 
$
(9,200
)
 
$
(8,675
)
 
13

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
A reconciliation of total segment contribution (loss) to loss before provision for income taxes is as follows:
 
(In thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Total segment loss
 
$
(1,586
)
 
$
(1,209
)
 
$
(13,678
)
 
$
(8,675
)
Interest expense, net
   
(2,223
)
   
(2,557
)
   
(7,747
)
   
(6,560
)
Change in fair value of stock warrants and other derivatives
   
(2,506
)
   
(1,599
)
   
5,131
     
(2,277
)
Loss on extinguishment of debt
   
     
(1,457
)
   
     
(1,457
)
Other income (expense)
   
(782
)
   
(1,141
)
   
(1,397
)
   
(655
)
Loss before provision for income taxes
 
$
(7,097
)
 
$
(7,963
)
 
$
(17,691
)
 
$
(19,624
)
 
 
Total assets for each segment primarily include accounts receivable, inventory and investments in content.  The Corporate segment primarily includes assets not fully allocated to any other segment including consolidated cash accounts, certain prepaid assets and fixed assets used across all segments.
 
Total assets by segment are as follows:
 
(In thousands)
 
September 30,
2015
   
December 31,
2014
 
         
IP Licensing
 
$
23,607
   
$
30,197
 
Wholesale
   
140,088
     
140,935
 
Direct-to-Consumer
   
11,075
     
12,049
 
Corporate
   
3,529
     
8,873
 
   
$
178,299
   
$
192,054
 
 
 
NOTE 3. EQUITY EARNINGS OF AFFILIATE
 
In 2012, Acorn Media acquired a 64% interest in ACL for total purchase consideration of £13.7 million, or approximately $21.9 million, excluding direct transaction costs.  The acquisition gave Acorn Media a majority ownership of ACL’s extensive works including a variety of short story collections, more than 80 novels, 19 plays and a film library of over 100 made-for-television films.
 
We account for our investment in ACL using the equity method of accounting because (1) Acorn Media is only entitled to appoint one-half of ACL’s board members and (2) in the event the board is deadlocked, the chairman of the board, who is appointed by the directors elected by the minority shareholders, casts a deciding vote.
 
As of the Business Combination, our 64% share of the difference between ACL’s fair value and the amount of underlying equity in ACL’s net assets was approximately $18.7 million.  This step-up basis difference is primarily attributable to the fair value of ACL’s copyrights, which expire in 2046.  We are amortizing the basis difference through 2046 using the straight-line method.  Basis difference amortization is recorded against our share of ACL’s net income in our consolidated statements of operations; however this amortization is not included within ACL’s financial statements.
 
14

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following summarized financial information is derived from the unaudited financial statements of ACL:
 
(In thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
                 
Revenues
 
$
11,907
   
$
4,634
   
$
16,546
   
$
11,385
 
Film cost amortization
   
(9,891
)
   
(932
)
   
(10,787
)
   
(2,833
)
General, administrative and other expenses
   
(1,270
)
   
(1,075
)
   
(3,110
)
   
(2,699
)
Income from operations
 
$
746
   
$
2,627
   
$
2,649
   
$
5,853
 
Net income
 
$
580
   
$
2,101
   
$
2,085
   
$
4,665
 
 
 
ACL's functional currency is the British Pound Sterling (GBP).  Amounts have been translated from GBP to U.S. dollar using the average exchange rate for the periods presented.  The above operating results of ACL do not include step-up basis amortization resulting from the Business Combination.
 
NOTE 4. ACCOUNTS RECEIVABLE
 
Accounts receivable are primarily derived from:  (1) the sale of physical content (DVDs) to retailers and wholesale distributors who ship to mass retailers, (2) direct-to-consumer, ecommerce, catalog and download-to-own sales and (3) video content we license to broadcast, cable/satellite providers and digital subscription platforms such as Netflix and Amazon.  Our accounts receivable typically trend with retail seasonality.
 
(In thousands)
 
September 30,
2015
   
December 31,
2014
 
         
Wholesale
 
$
18,580
   
$
23,922
 
IP Licensing
   
     
608
 
Direct-to-Consumer
   
607
     
762
 
Accounts receivable before allowances and reserves
   
19,187
     
25,292
 
Less:  reserve for returns
   
(4,899
)
   
(7,870
)
Less:  allowance for doubtful accounts
   
(34
)
   
(33
)
Accounts receivable, net
 
$
14,254
   
$
17,389
 
 
 
Wholesale receivables are primarily billed and collected by our U.S. distribution facilitation partner.  Each month, our distribution partner preliminarily settles our wholesale receivables assuming a timing lag on collections and an average-return rate.  When actual returns differ from the amounts previously assumed, adjustments are made that give rise to payables and receivables between us and our distribution partners.  Amounts vary and tend to be seasonal following our sales activity.  As of September 30, 2015 and December 31, 2014, we owed our distribution partners $2.0 million and $3.1 million, respectively, for receivables settled as of period-end.
 
The wholesale receivables are reported net of amounts we owe to our distribution partner as these amounts are offset against each other when settling receivables in accordance with the contract.  As of September 30, 2015 and December 31, 2014, the net wholesale receivables with our distribution partner were $3.7 million and $6.6 million, respectively, which is included in accounts receivable.
 
Our Direct-to-Consumer receivable represents amounts due to us from our merchant bank related to our credit card transactions processed as of period end.
 
15

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 5. INVENTORIES
 
Inventories are summarized as follows:
 
(In thousands)
 
September 30,
2015
   
December 31,
2014
 
         
Packaged discs
 
$
8,117
   
$
9,580
 
Packaging materials
   
948
     
1,309
 
Other merchandise (1)
   
2,560
     
2,140
 
Inventories, net
 
$
11,625
   
$
13,029
 
 
 
(1) Other merchandise primarily consists of gifts, jewelry and home accents purchased from third-parties.
 
During the three and nine months ended September 30, 2015 and 2014, we reduced our inventories with adjustments for lower of cost or market valuation, shrinkage, and excess and obsolescence.  Impairment charges for the three months ended September 30, 2015 and 2014 were $307,000 and $712,000, respectively, and for the nine months ended September 30, 2015 and 2014, they were $1.4 million and $1.9 million, respectively.  These charges are included in cost of sales as manufacturing and fulfillment cost.
 
NOTE 6. INVESTMENTS IN CONTENT
 
(In thousands)
 
September 30,
2015
   
December 31,
2014
 
         
Released
 
$
52,518
   
$
57,766
 
Completed, not released
   
13,439
     
7,205
 
In-production
   
1,465
     
2,554
 
Investments in content, net
 
$
67,422
   
$
67,525
 
 
 
Investments in content are stated at the lower of unamortized cost or estimated fair value.  The valuation of investments in content is reviewed on a title-by-title basis when an event or change in circumstances indicates that the fair value of content is less than its unamortized cost.  For the three months ended September 30, 2015 and 2014, impairment charges were $462,000 and $1.4 million, respectively.  For the nine months ended September 30, 2015 and 2014, impairment charges were $2.7 million and $2.7 million, respectively.  These charges are included in the cost of sales as content amortization and royalties.
 
In determining the fair value of content for impairments (Note 10, Fair Value Measurements), we employ a discounted cash flows (DCF) methodology.  Key inputs employed in the DCF methodology include estimates of ultimate revenue and costs as well as a discount rate.  The discount rate utilized in the DCF analysis is based on a market participant's weighted average cost of capital plus a risk premium representing the risk associated with producing a particular type of content.
 
16

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 7.
DEBT
 
Debt consists of the following:
 
(In thousands)
Maturity
Date
 
Interest
Rate
 
September 30,
2015
   
December 31,
2014
 
               
Senior term notes
September 11, 2019
 
LIBOR + 10.64%
 
$
57,550
   
$
69,388
 
Less: debt discount
         
(3,792
)
   
(4,509
)
Total senior-term notes, net of discount
         
53,758
     
64,879
 
Subordinated notes payable to prior Image shareholders
October 3, 2018
 
1.5% through 2016 then 12%
   
8,546
     
16,034
 
Total debt
        
$
62,304
   
$
80,913
 
 
 
Future minimum principal payments of our debt as of September 30, 2015 are as follows:
 
(In thousands)
 
Senior Notes
   
Subordinated
Notes
   
Total
 
             
2015
 
$
612
   
$
   
$
612
 
2016
   
2,975
     
     
2,975
 
2017
   
4,375
     
     
4,375
 
2018
   
49,588
     
8,546
     
58,134
 
   
$
57,550
   
$
8,546
   
$
66,096
 
 
 
The subordinated notes mature in 2018 and the senior notes mature in 2019; however, if we do not subsequently extend the subordinated debt maturity, then the new senior notes’ maturity would accelerate in conjunction with the repayment of the subordinated notes in 2018.  The above table reflects the assumption that no extension of the subordinated notes occurs.  The senior notes’ minimum principal payments in 2018 would be $5.3 million if the senior notes’ maturity is not accelerated.
 
Senior Term Notes
 
On September 11, 2014, we entered into a $70.0 million Credit and Guaranty Agreement (the Credit Agreement) with a syndicate of lenders led by McLarty Capital Partners, as administrative agent.  This agreement was amended as described below.  The Credit Agreement, as amended, consists of a term loan totaling $70.0 million with a maturity of five years, at an interest rate equal to LIBOR plus 10.64%.  LIBOR has a floor of 0.25%.  Principal payment obligations as a percentage of the amount initially borrowed are 3.5% per annum paid quarterly for the first two years, 5.0% for the third year and 7.5% for the remaining term with any unpaid principal balance due at maturity.  The obligations under the Credit Agreement are secured by a lien on substantially all of our consolidated assets pursuant to the Pledge and Security Agreement, dated as of September 11, 2014.
 
Under the Credit Agreement, interest and principal is payable quarterly with principal payments beginning on December 31, 2014.  Beginning in 2016, we are obligated to make certain accelerated principal payments annually which are contingent upon: (1) the occurrence of consolidated excess cash flows, as defined in the Credit Agreement, and (2) only to the extent at which such excess cash flows are above our minimum cash threshold of $12.0 million.  We are permitted to make additional voluntary principal payments under the Credit Agreement, but prepayments are subject to an applicable prepayment premium of:  (a) 5% if prepaid during the first year, (b) 3% if prepaid during the second year, and (c) 1.5% if prepaid during the third year.  The first $5.0 million of voluntary prepayment is not subject to any prepayment premium.
 
17

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
On April 15, 2015, we entered into an agreement with the lenders to amend the Credit Agreement.  The principal terms of the amendment are as follows:
 
(a) a reduction of the Minimum Cash Balance (as defined in the Credit Agreement) that we are required to maintain from $3.5 million to $1.0 million, thus providing access to $2.5 million of cash previously restricted,
 
(b) a waiver of certain Defaults (as defined in the Credit Agreement) and Events of Default (as defined in the Credit Agreement) caused by, or that would be caused by the breach of certain financial covenants under the Credit Agreement;
 
(c) amendments of the Credit Agreement (i) modifying the interest rate to equal LIBOR plus 10.64%, (ii) modifying certain financial statement and other reporting and lender communication requirements, (iii) increasing the covenant ratio thresholds for March 31 and June 30, 2015; and
 
(d) the consent of the lenders to the issuance of the preferred stock and warrants, as well as the use of the proceeds from the issuance of the preferred stock and warrants (i) to pay $10.0 million of the amounts outstanding pursuant to the Credit Agreement, (ii) to pay certain fees and costs associated with the issuance of the preferred stock, and (iii) for working capital purposes.
 
The Credit Agreement, as amended, contains certain financial and non-financial covenants beginning on December 31, 2014.  Financial covenants are assessed quarterly and are based on Adjusted EBITDA, as defined in the Credit Agreement.  Financial covenants vary each quarter and generally become more restrictive over time.
 
Financial covenants, as amended, include the following:
 
   
December 31,
2014
 
Second Half
of 2015
 
2016
 
Thereafter
Leverage Ratios:
               
Senior debt-to-Adjusted EBITDA
 
4.64 : 1.00
 
Ranges from 4.47 : 1.00 to 4.03 : 1.00
 
Ranges from 3.83 : 1:00 to 2:67 : 1.00
 
2.67 : 1.00
Total debt-to-Adjusted EBITDA
 
5.71 : 1.00
 
Ranges from 5.56 : 1.00 to 5.06 : 1.00
 
Ranges from 4.82 : 1:00 to 3.44 : 1.00
 
3.44 : 1.00
Fixed charge coverage ratio
 
1.10 : 1.00
 
Ranges from 1.13 : 1.00 to 1.20 : 1.00
 
Ranges from 1.24 : 1.00 to 1.59 : 1.00
 
1.59 : 1.00
 
 
We are also obligated to maintain a minimum valuation ratio computed on the outstanding principal balance of our senior debt compared to the sum of our valuations of our content library and our investment in ACL.  To the extent the valuation ratio exceeds the allowed threshold; we are obligated to make an additional principal payment such that the threshold would not be exceeded after giving effect to this payment.  The valuation threshold is 83% as long as the unpaid principal balance exceeds $65.0 million and 75% thereafter.
 
The Credit Agreement contains events of default that include, among others, non-payment of principal, interest or fees, violation of covenants, inaccuracy of representations and warranties, bankruptcy and insolvency events, material judgments, cross defaults to certain other contracts (including, for example, business arrangements with our U.S. distribution facilitation partner and other material contracts) and indebtedness and events constituting a change of control or a material adverse effect in any of our results of operations or conditions (financial or otherwise).  The occurrence of an event of default would increase the applicable rate of interest and could result in the acceleration of our obligations under the Credit Agreement.
 
The Credit Agreement imposes restrictions on such items as encumbrances and liens, payments of dividends, other indebtedness, stock repurchases, capital expenditures and entering into new lease obligations.  Additional covenants restrict our ability to make certain investments, such as loans and equity investments, or investments in content that are not in the ordinary course of business.  Pursuant to the amended Credit Agreement, we must maintain at all times a cash balance of $1.0 million.  As of September 30, 2015, we were in compliance with all covenants as stipulated in the amended Credit Agreement.
 
18

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Subordinated Notes Payable
 
In October 2012, we issued unsecured subordinated promissory notes in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image (or Subordinated Note Holders).  The subordinated promissory notes mature on the earlier of October 3, 2018 or six months after the latest stated maturity of the senior debt issued pursuant to the Credit Agreement.  The unsecured subordinated promissory notes currently bear an interest rate of 1.5% per an annum, of which 45% is payable in cash annually and the balance is accrued and added to the principal, which is payable upon maturity.
 
On April 15, 2015, we entered into an agreement to amend the subordinated promissory notes (the Note Amendment) that were issued to the Subordinated Note Holders.  The principal terms of the Note Amendment are as follows:
 
(a) an agreement by the Subordinated Note Holders to convert 50% of the outstanding balance under the subordinated notes into shares of preferred stock and warrants;
 
(b) amendments to the subordinated notes (i) changing the interest rate payable from 12% to 1.5% per annum for the 24-month period commencing on January 1, 2015, and then 12% per annum thereafter; and (ii) specifying that 45% of the interest due will be payable in cash and the remainder of the accrued interest will be payable in the form of additional subordinated notes; and
 
(c) a waiver of any existing defaults and events of default.
 
We are providing interest expense on our subordinated notes payable using the effective interest rate method at an annual interest rate of approximately 5 percent.
 
In connection with the sale of preferred stock and warrants, the Subordinated Note Holders exchanged approximately $8.5 million of subordinated notes for 8,546 shares of preferred stock and 2,563,873 warrants (see Note 9, Stock Warrants).
 
NOTE 8. MANDATORILY REDEEMABLE CONVERTIBLE PREFERRED STOCK AND EQUITY
 
Mandatorily Redeemable Convertible Preferred Stock
 
On May 20, 2015, we closed a transaction in which we sold 31,046 shares of preferred stock and warrants to acquire 9,313,873 shares of common stock for $22.5 million in cash and the exchange of $8.5 million in subordinated notes.  Of the preferred shares and warrants sold, 16,500 shares of preferred stock and warrants to acquire 4,950,000 shares of common stock were sold to certain board members or their affiliated companies.  We used $10.0 million of the cash proceeds from this sale to make partial payment on our Credit Agreement and approximately $1.9 million for prepayment penalties, legal and accounting fees, which include fees associated with our registration statement filed in July 2015 and other expenses associated with the transaction.  The balance of the net cash proceeds is intended to be used for working capital purposes.  Of the fees incurred, $878,000 was recorded against the proceeds received, $450,000 was recorded as additional debt discounts, $250,000 was included as interest expense and the balance was included in other expense.
 
The preferred stock has the following rights and preferences:
 
· Rank – the preferred stock ranks higher than other company issued equity securities in terms of distributions and dividends.
 
· Dividends – the preferred stock is entitled to cumulative dividends at a rate of 8% per annum of a preferred share’s stated value ($1,000 per share plus any unpaid dividends).  The first dividend payment is due July 1, 2017 and then payments are to be made quarterly thereafter.  At our discretion, dividend payments are payable in either cash or common stock, or added to the preferred share’s stated value.
 
· Conversion – at the preferred stockholder’s discretion, each share of preferred stock is convertible into 1,000 shares of our common stock, subject to adjustment for any unpaid dividends.  The conversion rate is subject to anti-dilution protection including adjustments for offerings consummated at a per-share price of less than $1.00 per common share.
 
19

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
· Mandatory Redemption – unless previously converted, on May 20, 2020, at our option we will either redeem the preferred stock with (a) cash equal to $1,000 per share plus any unpaid dividends (Redemption Value), or (b) shares of common stock determined by dividing the Redemption Value by a conversion rate equal to the lower of (i) the conversion rate then in effect (which is currently $1.00) or (ii) 85% of the then trading price, as defined, of our common stock.
 
· Voting – except for certain matters that require the approval of the preferred stockholders, such as changes to the rights and preferences of the preferred stock, the preferred stock does not have voting rights.  However, the holders of the preferred stock are entitled to appoint two board members, and under certain circumstances, appoint a third member.
 
Dividends are recognized using the effective interest-rate method and are recorded against additional paid-in capital.  During the three months ended September 30, 2015, we accreted $1.1 million of dividends and during the nine months ended September 30, 2015, we accreted $1.5 million of dividends.
 
Because the conversion rate is contingent upon our common stock price at the time of redemption, we cannot conclude that we have enough authorized, unissued shares of common stock to settle the mandatory redemption with shares of equity.  Therefore we have recorded the preferred stock separate from our permanent equity.  Also, because of the potential adjustments to the conversion rate, including adjustments for offerings consummated at a per-share price of less than $1.00 per common share, we have bifurcated the conversion feature from its host instrument (a preferred share) and we are accounting for the conversion feature as a derivative liability in accordance with ASC 815-40, Contracts in Entity’s Own Equity.
 
In connection with the sale, the holders of the preferred stock appointed two board members temporarily increasing the board to 11 members.  On June 4, 2015, four board members resigned thus reducing the board size to seven members, which we committed to when issuing the preferred stock.
 
The warrants issued with the preferred stock have a term of five years and an exercise price of $1.50 per share.  The exercise price is subject to standard anti-dilution protection including adjustments for offerings consummated at a per-share price of less than $1.50 per common share.  Additionally, if we were to consummate certain fundamental transactions, such as a business combination or other change-in-control transactions, the warrant holders may require, under certain conditions, that we repurchase the warrants with cash equal to the warrants’ then fair value as determined using the Black Scholes valuation model.
 
On July 9, 2015, we filed a registration statement with the Securities and Exchange Commission to register the shares issuable upon conversion of the preferred stock and exercise of the warrants.  The registration statement was declared effective in July 2015.  We will use our best efforts to keep the registration statement effective.  If we are in default of the registration rights agreement, and as long as the event of default is not cured, then we are required to pay, in cash, partial liquidation damages, which in total are not to exceed 6% of the aggregated subscription amount of $31.0 million.  We are accreting the carrying value of our preferred stock up to its redemption value over a period of time beginning from the issuance on May 20, 2015 to the required redemption date of May 20, 2020.
 
Common Stock
 
Included in our common shares outstanding at December 31, 2014 were 437,241 shares held by certain founding shareholders as part of the initial public offering of RLJE.  These shares were subject to forfeiture over a two-year period if certain stock price targets were not achieved.  All shares were forfeited and returned in January 2015.
 
Restricted Stock-Based Compensation Grants
 
Compensation expense relating to our restricted stock awards for the three months ended September 30, 2015 and 2014 was $59,000 and $227,000, respectively, and for the nine months ended September 30, 2015 and 2014 stock-based compensation was $213,000 and $683,000, respectively.  Compensation expense related to restricted stock awards is included in general and administrative expenses.  On June 30, 2015, we allowed 57,224 shares of common stock to vest that were granted to those board members who resigned on June 4, 2015 (see Mandatorily Redeemable Convertible Preferred Stock above).  We accounted for this as a modification of vesting provisions and revalued these shares as of June 30, 2015.  This revaluation resulted in a reduction in share-based compensation expense of $146,000 during the nine months ended September 30, 2015.
 
20

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
During the nine months ended September 30, 2015, 15,136 shares of restricted stock were granted to a director, 162,939 shares were vested and 36,089 shares of restricted stock were forfeited.  The shares granted during 2015 were fair valued, on the date of grant, using our publicly traded stock price of $0.76 per share.  Of the shares forfeited, 28,633 shares of restricted stock were forfeited based upon the failure to achieve the 2014 performance criteria and the remainder of the forfeitures were due to employee terminations.  During the nine months ended September 30, 2014, 190,280 shares of restricted stock were granted, 182,206 shares were vested and 82,838 shares were forfeited.  Of the 190,280 shares granted in 2014, 164,780 shares were granted to executive officers and directors and 25,500 shares were granted to other members of management.  Of the 82,838 shares forfeited, 66,244 shares of restricted stock were forfeited based upon the failure to achieve the 2013 performance criteria and the remainder of the forfeitures were due to employee terminations.  The shares granted during 2014 were fair valued on the date of grant with a range of $3.49 ‑ $5.00 per share, for a total value of approximately $766,000.  A summary of the activity since December 31, 2014 is as follows:
 
(In thousands, except per share data)
 
Service Shares
   
Performance Shares
 
Restricted Stock-Based
Compensation Award Activity
 
Shares
   
Weighted-
Average Grant
Date Fair
Value
   
Shares
   
Weighted-
Average Grant
Date Fair
 Value
 
                 
Nonvested shares at December 31, 2014
   
179
   
$
4.13
     
56
   
$
5.09
 
Granted
   
15
   
$
0.76
     
   
$
 
Vested
   
(163
)
 
$
3.65
     
   
$
 
Forfeited
   
(4
)
 
$
5.85
     
(32
)
 
$
5.19
 
Nonvested shares at September 30, 2015
   
27
   
$
5.00
     
24
   
$
5.00
 
 
 
The performance shares vest if certain performance criteria are achieved contingent upon the grantees being employed by RLJE when the performance criteria are evaluated.  Vesting for the outstanding restricted performance shares is contingent upon achieving 2015 targets.
 
As of September 30, 2015, there is $30,000 of unamortized compensation that will vest solely on completion of future services over the next six months, with a weighted-average remaining vesting period of four months.  As of September 30, 2015, there is $28,000 of unamortized compensation that will vest based on achieving certain performance and service criteria over the next six months, with a weighted-average remaining vesting period of four months.
 
NOTE 9. STOCK WARRANTS
 
RLJE had the following warrants outstanding:
 
   
September 30, 2015
(In thousands, except per share data)
 
Shares
   
Exercise
Price e
 
Remaining Life
2012 Warrants:
           
Registered warrants
   
15,375
   
$
12.00
 
2.00 years
Sponsor warrants
   
3,817
   
$
12.00
 
2.00 years
Unregistered warrants
   
1,850
   
$
12.00
 
2.00 years
2015 Warrants:
                   
Unregistered warrants
   
9,314
   
$
1.50
 
4.63 years
     
30,356
            
 
 
We issued warrants with a term of five years beginning October 3, 2012 that provide the warrant holder the right to acquire a share of our common stock for $12.00 per share (the 2012 Warrants).  The warrants are redeemable by us for $0.01 per warrant share if our common stock trades at $17.50 or more per share for 20 out of 30 trading days. The warrants contain standard anti-dilution provisions.
 
21

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The 2012 Warrants contain a provision whereby the exercise price will be reduced if RLJE reorganized as a private company.  The reduction in exercise price depends upon the amount of other consideration, if any, received by the warrant holders in the reorganization and how many years after the Business Combination reorganization is consummated.  Generally, the reduction in exercise price would be between $6.00 and $9.00 assuming no additional consideration was received.  Because of this provision, all warrants are being accounted for as a derivative liability in accordance with ASC 815-40, Contracts in Entity’s Own Equity.
 
On May 20, 2015, we issued warrants to acquire 9.3 million shares of our common stock (the 2015 Warrants).  The terms are described in Note 8, Convertible Preferred Stock and Equity.  We are accounting for these warrants as a derivative liability because the warrants contain a provision that allows the warrant holders to sell, at their discretion, their warrants back to us upon the consummation of certain fundamental transactions, such as a business combination or other change-in-control transactions, at a cash purchase price equal to the warrants’ then fair value.
 
NOTE 10.
FAIR VALUE MEASUREMENTS
 
Stock Warrant and Other Derivative Liabilities
 
We have warrants outstanding to purchase 30,355,540 shares of our common stock, which are recorded at fair value on the consolidated balance sheets.  We issued the 2012 Warrants to purchase 21,041,667 shares of our common stock in 2012 and we issued the 2015 Warrants to purchase 9,313,873 shares of our common stock in 2015.
 
Of the 2012 Warrants, 15,375,000 are registered under the Securities Act and are available for trading on the over-the-counter market.  Since the first quarter of 2014, there has been a lack of trading activity for the registered warrants, and as such, when assessing their fair value we transferred them from Level 1 to Level 3 within the fair-value hierarchy.  As of September 30, 2015 and December 31, 2014, we determined the fair value of the registered warrants using a Monte Carlo simulation model.  Inputs to the model are stock volatility, contractual warrant terms (which are remaining life of the warrant, the redemption feature, the exercise price, and assumptions for the reduction in exercise price if we were to reorganize as a private company), the risk-free interest rate, and a discount for the lack of marketability (DLOM) pertaining to the underlying common stock as the shares acquirable are not registered.  We use the closing market price of our common stock to compute stock volatility.  The DLOM is determined using the Finnerty Average-Strike Put Option Marketability Discount Model (Finnerty Model), which takes into consideration the discount period, stock dividend rates, and stock volatility.  We used a DLOM rate of 13.3% as of September 30, 2015 and 11.2% as of December 31, 2014.  Assumptions regarding adjustments to the exercise price are based on management’s best estimates of the likelihood of reorganizing as a private company and the amount of the resulting exercise-price adjustment.
 
The remaining 2012 Warrants, consisting of Sponsor warrants of 3,816,667 and unregistered warrants of 1,850,000, are classified as Level 3 within the fair-value hierarchy.  Because RLJE has agreed not to exercise its redemption right pertaining to certain warrants held by RLJ SPAC Acquisition LLC (or the Sponsor) and because the unregistered warrants generally have a discounted fair value as compared to the registered warrants, the valuation of the sponsor warrants and the unregistered warrants has always been a Level 3 measurement.  We determined the fair value of the Sponsor warrants using a Monte Carlo simulation model and using the same assumptions used for the registered warrants, except we did not include the redemption feature.
 
The unregistered 2012 Warrants differ from the registered warrants in that they have not been registered under the Securities Act and are not available for trading.  As of September 30, 2015 and December 31, 2014, we determined the fair value of these warrants by taking the fair value of a registered warrant and discounting it using the Finnerty Model for the lack of marketability as these warrants are not registered.  We used a DLOM rate of 18.2% as of September 30, 2015 and 17.8% as of December 31, 2014.  The 2012 Warrants decreased in fair value from $601,000 as of December 31, 2014 to zero as of September 30, 2015.
 
We are using the Black Scholes option valuation model to value the 2015 Warrants, which is classified as Level 3 within the fair-value hierarchy.  Inputs to the model are stock volatility, contractual warrant terms (which are remaining life of the warrant and the exercise price) and the risk-free interest rate.  We use the closing market price of our common stock to compute stock volatility.  The 2015 Warrants decreased in fair value since issuance from $2.1 million as of May 20, 2015 to $1.3 million as of September 30, 2015.
 
We are using the Black Scholes option valuation model to value the preferred stock’s embedded conversion feature, which is classified as Level 3 within the fair-value hierarchy.  Inputs to the model are stock volatility, contractual terms (which are remaining life of the conversion option and the conversion rate) and the risk-free interest rate.  We use the closing market price of our common stock to compute stock volatility.  The fair value of the embedded conversion feature decreased since issuance from $9.4 million as of May 20, 2015 to $5.6 million as of September 30, 2015.
 
22

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

We are using the Black Scholes option valuation model to value the preferred stock’s embedded conversion feature, which is classified as Level 3 within the fair-value hierarchy.  Inputs to the model are stock volatility, contractual terms (which are remaining life of the conversion option and the conversion rate) and the risk-free interest rate.  We use the closing market price of our common stock to compute stock volatility.  The fair value of the embedded conversion feature decreased since issuance from $9.4 million as of May 20, 2015 to $5.6 million as of September 30, 2015.

The following tables represent the valuation of our warrant and other derivative liabilities within the fair-value hierarchy:

(In thousands)
 
September 30, 2015
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                 
Stock warrant and other derivative liabilities
 
$
   
$
   
$
6,920
   
$
6,920
 

 
(In thousands)
 
December 31, 2014
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                 
Stock warrant and other derivative liabilities
 
$
   
$
   
$
601
   
$
601
 
 
 
The following tables include a roll-forward of liabilities classified within Level 1 and Level 3:

(In thousands)
 
Nine Months Ended September 30, 2015
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                 
Stock warrant and other derivative liabilities at December 31, 2014
 
$
   
$
   
$
601
   
$
601
 
Issuance of warrants and other derivatives
   
     
     
11,450
     
11,450
 
Change in fair value
   
     
     
(5,131
)
   
(5,131
)
Stock warrant and other derivative liabilities at September 30, 2015
 
$
   
$
   
$
6,920
   
$
6,920
 

 
(In thousands)
 
Nine Months Ended September 30, 2014
 
   
Level 1
   
Level 2
   
Level 3
   
Total
 
                 
Stock warrant and other derivative liabilities at December 31, 2013
 
$
2,630
   
$
   
$
1,493
   
$
4,123
 
Change in fair value hierarchy
   
(2,755
)
   
     
2,755
     
 
Change in fair value
   
125
     
     
2,152
     
2,277
 
Stock warrant and other derivative liabilities at September 30, 2014
 
$
   
$
   
$
6,400
   
$
6,400
 
 
 
23

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Investments in Content

When events and circumstances indicate that investments in content are impaired, we determine the fair value of the investment; and if the fair value is less than the carrying amount, we recognize additional amortization expense equal to the excess.  Our nonrecurring fair value measurement of assets and liabilities is classified in the tables below:

(In thousands)
 
Nine Months Ended September 30, 2015
 
   
Level 1
   
Level 2
   
Level 3
   
Total
   
Loss
 
                     
Investments in content
 
$
   
$
   
$
3,504
   
$
3,504
   
$
2,730
 
 
 
(In thousands)
 
Nine Months Ended September 30, 2014
 
   
Level 1
   
Level 2
   
Level 3
   
Total
   
Loss
 
                     
Investments in content
 
$
   
$
   
$
11,223
   
$
11,223
   
$
2,743
 
 
 
During the nine months ended September 30, 2015 and 2014, the investments in content were written down by $2.7 million and $2.7 million, respectively.  In determining the fair value, we employ a DCF methodology.  Key inputs employed in the DCF methodology include estimates of a film's ultimate revenue and costs as well as a discount rate.  The discount rate utilized in the DCF analysis is based on our weighted average cost of capital plus a risk premium representing the risk associated with producing a particular film or television program.  As the primary determination of fair value is determined using a DCF model, the resulting fair value is considered a Level 3 measurement.

NOTE 11. NET LOSS PER COMMON SHARE DATA

We have outstanding warrants to acquire 30,355,540 shares of common stock that are not included in the computation of diluted net loss per common share as the effect would be anti-dilutive because their exercise prices, which range from $1.50 to $12.00 per share exceed the fair value of our common stock.  For the nine-month period ended September 30, 2015, we had weighted average outstanding shares of approximately 48,000 which were held by founding shareholders that were forfeited in January 2015 and that were not included in the computation of basic or diluted net loss per share as the effect would be anti-dilutive.  For the three and nine months ended September 30, 2015, we have 79,000 and 161,000 shares, respectively, of compensatory restricted common stock that are not included in the computation of basic and diluted net loss per share as the effect would be anti-dilutive.  For the three and nine months ended at September 30, 2014, we have weighted average outstanding shares of approximately 758,000 and 991,000, respectively, of restricted common stock, which includes shares forfeitable shares held by certain founding shareholders that are not included in the computation of basic or diluted net loss per share as the effect would be anti-dilutive.

NOTE 12. STATEMENTS OF CASH FLOWS

Supplemental Disclosures

(In thousands)
 
Nine Months Ended
September 30,
 
   
2015
   
2014
 
Cash paid during the period for:
       
Interest
 
$
6,321
   
$
4,830
 
Income taxes
 
$
140
   
$
180
 
Non-cash investing and financing activities:
               
Subordinated notes payable exchanged for preferred stock and warrants
 
$
8,546
   
$
 
Accretion on preferred stock
 
$
1,525
   
$
 
Preferred stock issuance costs accrued for in accounts payable and accrued liabilities
 
$
95
   
$
 
Capital expenditures accrued for in accounts payable and accrued liabilities
 
$
5
   
$
 

 
24

RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 13. COMMITMENTS AND CONTINGENCIES

In the normal course of business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to employment and tax matters.  While it is not possible to predict the outcome of these matters, the opinion of management is, based on consultations with internal and external legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on our financial condition, results of operations or liquidity.  Accordingly, we record a charge to earnings based on the probability of settlement and determination of an estimated amount.  These charges were not material to our results.

NOTE 14. RELATED PARTY TRANSACTIONS

Equity Investment in Affiliate

ACL was charged overhead and personnel costs for the three months ended September 30, 2015 and 2014, of approximately $74,000 and $578,000, respectively, and for the nine months ended September 30, 2015 and 2014, of approximately $976,000 and $1.6 million, respectively.  Amounts were recorded as a reduction in general and administrative expenses in the accompanying consolidated statements of operations.

ACL paid dividends to RLJE Ltd of $1.7 million and $2.9 million during the nine months ended September 30, 2015 and 2014, respectively.  We record dividends received as a reduction to the ACL investment account.  There were no dividends received during the three-month periods ended September 30, 2015 and 2014.

On October 13, 2015, RLJE Ltd received dividends of $1.6 million from ACL.

We have advanced ACL $2.6 million for distribution rights for Partners in Crime.  During the quarter ended September 30, 2015, we received the title from ACL and began distributing it with third parties.  For the three months ended September 30, 2015, we recognized content amortization and royalty expense of $1.3 million, which is included in our cost of goods sold.  As of September 30, 2015, our remaining unamortized content advance is $1.3 million.

Foreign Currency

We recognize foreign currency gains and losses as a component of other expense on net amounts lent by Acorn Media to RLJE Ltd and RLJE Australia.  As of September 30, 2015, Acorn Media had lent its U.K. subsidiaries approximately $10.0 million and its Australian subsidiary approximately $4.0 million.  Amounts lent will be repaid in U.S. dollars based on available cash.  Movement in exchange rates between the U.S. dollar and the functional currencies (which are the British Pound Sterling and the Australian Dollar) of those subsidiaries that were lent the monies will result in foreign currency gains and losses.  During the three months ended September 30, 2015 and 2014, we recognized losses of $820,000 and $928,000, respectively.  During the nine months ended September 30, 2015 and 2014, we recognized a loss of $1.1 million and of $405,000, respectively.

The RLJ Companies, LLC

In June 2013, The RLJ Companies, LLC (whose sole manager and voting member is the chairman of our board of directors) purchased from one of our vendors $3.5 million of contract obligations that we owed to the vendor.  These purchased liabilities, which are now owed to The RLJ Companies, LLC, are included in accrued royalties and distribution fees in the accompanying consolidated balance sheets.

RLJ SPAC Acquisition, LLC

The chairman of our board of directors, Mr. Robert L. Johnson, through his company, RLJ SPAC Acquisition, LLC announced his intention to purchase up to $2.0 million of our outstanding common stock from time to time over a 24-month period beginning June 19, 2013.  From June 2013 through January 2015, $1.7 million of common stock was purchased under this plan, which expired with an unused balance in June 2015.  All purchases were made at the discretion of Lazard Capital Markets LLC in the open market or in privately negotiated transactions in compliance with applicable laws and regulations.

Sale of Preferred Stock and Warrants

On May 20, 2015, certain board members and their affiliate companies, including RLJ SPAC Acquisition, LLC, purchased 16,500 shares of preferred stock and warrants to acquire 4,950,000 share of common stock from us for $16.5 million.
 
25

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

The following discussion and analysis of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions.  As described at the beginning of this Quarterly Report under the heading “Forward-Looking Statements,” our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could contribute to such differences include those discussed elsewhere in this Quarterly Report under the heading “Forward-Looking Statements.”  You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report.  Except as may be required under federal law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur.

You should read the following discussion and analysis in conjunction with our consolidated financial statements and related footnotes included in Item 1 of this Quarterly Report and with our audited consolidated financial statements and notes thereto, and with the information under the headings entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in our Annual Report on Form 10-K filed on May 8, 2015.

OVERVIEW

General

RLJ Entertainment, Inc. (or RLJE) is a global entertainment company with a direct presence in North America, the United Kingdom (or U.K.) and Australia. We also have strategic sublicense and distribution relationships covering Europe, Asia and Latin America.  RLJE was incorporated in Nevada in April 2012.  In October 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media or Acorn), which is referred to herein as the “Business Combination.”  Acorn Media includes its subsidiaries RLJE International Ltd (or RLJE U.K.), RLJ Entertainment Australia Pty Ltd. (or RLJE Australia) and RLJ Entertainment Ltd (or RLJE Ltd).  In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL).  References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC.  “We,” “our” or “us” refers to RLJE and its subsidiaries, unless otherwise noted.  Our principal executive offices are located in Silver Spring, Maryland, with additional U.S. locations in Woodland Hills, California; Stillwater, Minnesota; and international locations in London, England and Sydney, Australia.

RLJE is a global media company for distinct, passionate audiences.  We strive to be a preferred source and destination for entertainment for a variety of distinct audiences with particular and special programming interests.  We acquire, develop and exploit television, film and other media content agnostically across all platforms of distribution.  We actively manage all windows of exploitation to optimize the reach of our promotional efforts and maximize the value of our releases.

We acquire content rights in various categories, with particular focus on British mysteries and dramas, urban programming, and full-length independent motion pictures.  We also develop, produce and own original programming through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, in addition to the development and production of fitness titles through our Acacia brand.  We have a library of titles segmented into genre-based brands such as Acorn (British drama and mystery television), Urban Movie Channel, or “UMC” (urban), Acacia (fitness), Athena (life-long learning documentaries), Madacy (uniquely packaged collections of classic television, historical footage and films) and our former Image brand (action, thriller and horror feature films).  Our owned content includes 28 Foyle’s War made-for-TV films, multiple fitness/wellness titles, and through our 64% ownership of ACL, the vast majority of the works of Agatha Christie.

We exploit our products through a multi-channel strategy encompassing (1) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, (IP Licensing segment); (2) wholesale exploitation through partners covering broadcast and cable, digital, online, and retail outlets (Wholesale segment); and (3) direct relations with consumers via proprietary ecommerce, mail‑order catalog, and SVOD channels (Direct-to-Consumer segment).

RLJE Ltd manages our British drama productions, including Foyle’s War, which is one of our most successful Acorn television series.  ACL is home to some of the world’s greatest works of mystery fiction, including Murder on the Orient Express and Death on the Nile and includes all development rights to iconic sleuths such as Hercule Poirot and Miss Marple.  The Agatha Christie library includes a variety of short story collections, more than 80 novels, 19 plays and a film library of over 100 made-for-television films.  In 2013, ACL commissioned a new writer to expand the Agatha Christie library content, and in the third quarter of 2014, ACL published The Monogram Murders, its first book since the death of Agatha Christie.
 
26

Our wholesale partners are broadcasters, digital outlets and major retailers in the U.S., Canada, United Kingdom and Australia, including, among others:  DirecTV, Showtime, BET, PBS, Netflix, Amazon, Hulu, Walmart, Target, Costco, Barnes & Noble, HMV and iTunes.  We work closely with our wholesale partners to outline and implement release and promotional campaigns customized to the different audiences we serve and the program genres we exploit.

Our Direct-to-Consumer segment includes our proprietary SVOD channels, which are Acorn TV, Acacia TV and UMC, and the sale of video content and complementary merchandise directly to consumers through proprietary ecommerce websites and mail‑order catalogs.  As of September 30, 2015, Acorn TV had over 167,000 paying subscribers.  In late 2014, we launched our urban content SVOD channel, UMC.  In response to the strategic opportunity brought by the convergence of television and the internet, we expect to continue to invest in more exclusive and appealing content programming, greater marketing support and an expanded IT infrastructure for our SVOD channels.  We also plan to develop other audience-based, premium SVOD channels based on our existing content library.

RLJE’s management views our operations based on these three distinctive reporting segments: (1) IP Licensing; (2) Wholesale; and (3) Direct-to-Consumer.  Operations and net assets that are not associated with any of these stated segments are reported as “Corporate” when disclosing and discussing segment information.  The IP Licensing segment includes intellectual property rights that we own or create and then sublicense for exploitation worldwide.  Our Wholesale and Direct-to-Consumer segments consist of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including broadcast, DVD and Blu-ray, and digital (which includes VOD, SVOD, streaming, and downloading).  We also sublicense certain distribution rights to others to cover territories outside the U.S., the U.K. and Australia.  The Wholesale segment exploits content through third-party vendors such as DirecTV, Showtime, BET, Netflix, Amazon, Walmart, Best Buy, Target and Costco, while the Direct-to-Consumer segment exploits the same content and complementary merchandise directly to consumers through our proprietary ecommerce websites, mail-order catalogs and digitally streaming channels.

FINANCIAL HIGHLIGHTS

Highlights and significant events for the three and nine months ended September 30, 2015 and 2014 are as follows:

· Revenues declined by $4.6 million to $32.5 million for the three-month period ended September 30, 2015 as compared to the third quarter of 2014 and by $16.7 million to $82.8 million for the nine months ended September 30, 2015 when compared to the nine months ended September 30, 2014.  During the third quarter last year, we released the latest season of Foyle’s War whereby we recognized $8.7 million in revenues.  We had no comparable releases this quarter.  Our year-to-date decline is driven by our release schedule.  This year we have released 66 titles compared to 98 titles last year.  We expect our fourth quarter revenues to increase as compared to the fourth quarter last year as we plan to release two larger theatrical feature films compared to no similar releases for the same period last year.

· The gross margin improved to 32.1% for the three months ended September 30, 2015 compared to 24.2% for the three months ended September 30, 2014.  The gross margin improved to 26.2% for the nine months ended September 30, 2015 compared to 25.1% for the nine months ended September 30, 2014.  This improvement in margin is primarily attributable to lower impairments as well as lower step-up amortization resulting from our Business Combination consummated in October 2012.

· Selling, general and administrative expenses (or SG&A) increased by 7.5% for the three months ended September 30, 2015 as compared to the three months ended September 30, 2014 and increased by 0.2% when comparing the nine months ended September 30, 2015 to the nine months ended September 30, 2014.  The year-to-date increase in our SG&A costs is primarily attributable to increased internet support costs of $917,000, due to subscriber growth at Acorn TV, offset by other reduced costs.

· Acorn TV’s paid subscribers increased 49.1% to over 167,000 subscribers as of September 30, 2015 compared to over 112,000 as of September 30, 2014.

· Adjusted EBITDA decreased from $6.6 million for the three months ended September 30, 2014 to $510,000 for the three months ended September 30, 2015, and decreased from a gain of $3.0 million for the nine months ended September 30, 2014 to a loss of $3.5 million for the nine months ended September 30, 2015.  The decreases are due to the release of Foyle’s War last year with no comparable releases this year and lower equity earnings from ACL.
 
27

The highlights above and the discussion below are intended to identify some of our more significant results and transactions during the three and nine months ended September 30, 2015 and should be read in conjunction with our consolidated financial statements and related discussions within this Quarterly Report.

RESULTS OF OPERATIONS

A summary of our results of operations for the three and nine months ended September 30, 2015 and 2014, as disclosed in our consolidated financial statements in Item 1, Financial Statements, is as follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(In thousands)
 
2015
   
2014
   
2015
   
2014
 
                 
Revenues
 
$
32,549
   
$
37,123
   
$
82,778
   
$
99,478
 
Costs of sales
   
22,099
     
28,149
     
61,089
     
74,521
 
Gross profit
   
10,450
     
8,974
     
21,689
     
24,957
 
Operating expenses
   
12,224
     
11,373
     
36,243
     
36,172
 
Loss from operations
   
(1,774
)
   
(2,399
)
   
(14,554
)
   
(11,215
)
Equity in earnings of affiliate
   
188
     
1,190
     
876
     
2,540
 
Interest expense, net
   
(2,223
)
   
(2,557
)
   
(7,747
)
   
(6,560
)
Change in fair value of stock warrants and other derivatives
   
(2,506
)
   
(1,599
)
   
5,131
     
(2,277
)
Loss on extinguishment of debt
   
     
(1,457
)
   
     
(1,457
)
Other expense
   
(782
)
   
(1,141
)
   
(1,397
)
   
(655
)
(Provision) Benefit for income taxes
   
(49
)
   
164
     
(631
)
   
(524
)
Net loss
 
$
(7,146
)
 
$
(7,799
)
 
$
(18,322
)
 
$
(20,148
)
 
 
 
Revenues

A summary of net revenues by segment for the three and nine months ended September 30, 2015 and 2014 is as follows:

(In thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Wholesale:
               
U.S.
 
$
19,110
   
$
19,749
   
$
47,826
   
$
57,306
 
International
   
2,435
     
2,254
     
9,499
     
9,471
 
Total Wholesale
   
21,545
     
22,003
     
57,325
     
66,777
 
Direct-to-Consumer:
                               
Ecommerce Catalog U.S.
   
6,586
     
4,806
     
16,323
     
19,665
 
Proprietary Digital Channels
   
1,965
     
1,162
     
5,183
     
2,769
 
International Ecommerce
   
407
     
478
     
1,443
     
1,580
 
Total Direct-to-Consumer
   
8,958
     
6,446
     
22,949
     
24,014
 
Intellectual Property
   
2,046
     
8,674
     
2,504
     
8,687
 
Total revenues
 
$
32,549
   
$
37,123
   
$
82,778
   
$
99,478
 
 
 
28

Revenues decreased $4.6 million for the three months ended September 30, 2015 compared to the same period in 2014.  The decrease in revenues is primarily driven by our IP Licensing segment, which declined by $6.6 million.  The decrease in our IP Licensing segment is attributable to the U.K. broadcast release of the latest season of Foyle’s War during the third quarter last year with no similar releases this quarter.  The initial broadcast revenues for Foyle’s War last year were $8.7 million.  During the current quarter, our IP Licensing segment did release a new series, Partners in Crime, which was produced by ACL and is being distributed in part by RLJE Ltd.  However, for this new title, the initial broadcast revenues are being recognized by ACL and therefore those revenues are excluded from our consolidated revenue amounts.  This decline in revenues from our IP Licensing segment was partially offset by an increase in revenues of $2.5 million in our Direct-to-Consumer segment.  The increase in Direct-to-Consumer revenues is due to (1) increased subscribers to our proprietary digital channels (primarily Acorn TV), which increased by approximately $803,000 or 69.1% over the same period last year, and (2) increase revenues in our ecommerce catalog business in the US, which increased by $1.8 million over last year.  The increased revenue in our ecommerce catalog business is related to marketing changes that resulted in a change in the timing of our catalog circulation, whereby we moved certain mailings from the first part of the current year to the latter part of the year.  As a result, the Acorn catalog circulation was higher during the third quarter of 2015 as compared to the third quarter of 2014.  Our Wholesale segment revenues were consistent this quarter compared to the same period last year.

Revenues decreased $16.7 million for the nine months ended September 30, 2015 compared to the same period in 2014.  The decrease in revenues is driven by decreases in our Wholesale, Direct-to-Consumer, and IP licensing segments of $9.4 million, $1.1 million, and $6.2 million, respectively.  Our Wholesale segment’s revenues decline is mostly attributed to the timing of scheduled content releases year over year.  During the first three quarters of 2015, our US Wholesale segment released 66 titles versus 98 titles being released during the same period last year.  We expect our fourth quarter 2015 US Wholesale revenues to increase as compared to the fourth quarter of 2014 as we plan to release two larger theatrical feature films compared to no similar releases for the same period last year.  We generally acquire film or television content approximately six months ahead of the planned release date due to the time necessary to prepare marketing materials and meet our distribution partners’ scheduling requirements.  The change in timing of releases for 2015 is primarily the result of our prior year’s liquidity constraints while refinancing our secured debt during the second and third quarters of 2014.

The decrease in our Direct-to-Consumer segment revenue of $1.1 million for the nine-month period ended September 30, 2015 as compared to 2014 was primarily due to reduced revenues from our ecommerce catalog business offset by revenue growth in our proprietary digital channels.  The decrease in our ecommerce catalog revenues is related to marketing changes compared to the prior year primarily resulting in a reduction of our catalog circulation in the first quarter of 2015 as compared to the same period in 2014 as a result of our liquidity constraints. 

Our proprietary digital channel revenues currently accounts for approximately 22.6% of the segment’s revenues compared to 11.5% last year.  The increase in our proprietary digital channel revenues of 87.2% for the nine-month period ended September 30, 2015, as compared to the same period last year, is driven primarily by our British mystery and drama channel, Acorn TV.  As of September 30, 2015, the subscribers for Acorn TV have grown to over 167,000 subscribers, which is an increase of 49.1% since September 30, 2014 and an increase of 41.5% since December 31, 2014.

Cost of Sales (“COS”)

A summary of COS by segment for the three and nine months ended September 30, 2015 and 2014 is as follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(In thousands)
 
2015
   
2014
   
2015
   
2014
 
                 
IP Licensing
 
$
1,243
   
$
6,278
   
$
1,587
   
$
6,557
 
Wholesale
   
15,441
     
18,230
     
46,104
     
54,517
 
Direct-to-Consumer
   
5,415
     
3,641
     
13,398
     
13,447
 
COS by segment
 
$
22,099
   
$
28,149
   
$
61,089
   
$
74,521
 
 
 
COS decreased by $6.1 million to $22.1 million for the three months ended September 30, 2015, compared to the same period in 2014.  The decrease in COS is attributed to lower sales during the period, lower impairment charges and lower step-up amortization resulting from the Business Combination.  Impairment charges and step-up amortization are recorded in our Wholesale segment.  Our impairment charges recorded for content investments and inventories total $768,000 and $2.1 million for the three months ended September 30, 2015 and 2014, respectively.  Approximately 70% of our impairment charge is associated with five content suppliers.  Our step-up amortization decreased during the three months ended September 30, 2015 compared to 2014 due to decreased revenues.  Our step-up amortization was $861,000 and $1.3 million for 2015 and 2014 periods, respectively.
 
29

As a percentage of revenues, our gross margin improved by 7.9% percentage points to 32.1% for the three-month period end September 30, 2015 compared to the same period last year.  The improvement is attributable primarily to our Wholesale and IP Licensing segments.  Our Wholesale segment margin improved primarily as a result of lower impairments and lower step-up amortization.  Our IP Licensing margin improved because we are forecasting, on an ultimate basis, a higher margin for our new release, Partners in Crime, as compared to the latest season of Foyle’s War, which was released last year.

COS decreased by $13.4 million to $61.1 million for the nine months ended September 30, 2015, compared to the same period in 2014.  The decrease in COS is primarily attributed to lower sales during the period and to lower impairment charges and step-up amortization, which are recorded in our Wholesale segment.  Our impairment charges recorded for content investments and inventories totaled $4.1 million and $4.6 million for the nine months ended September 30, 2015 and 2014, respectively.  Our step-up amortization decreased during the nine months ended September 30, 2015 compared to 2014 due to decreased revenues.  Step-up amortization within our Wholesale segment was $3.5 million and $5.3 million for 2015 and 2014 periods, respectively. 

As a percentage of revenues, our gross margin remained relatively unchanged at approximately 25% to 26% for the current nine-month period compared to prior year.  Overall, we realized slightly better margins at our IP licensing segment, for the reasons stated above, offset by slightly lower margins at our other segments, which is primarily due to differences in sales mix as each product sold bears its own cost including its specific royalty rate.

Selling, General and Administrative Expenses (“SG&A”)

A summary of SG&A expenses for the three and nine months ended September 30, 2015 and 2014 is as follows:

   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
(In thousands)
 
2015
   
2014
   
2015
   
2014
 
                 
Selling expenses
 
$
5,989
   
$
5,411
   
$
17,628
   
$
17,448
 
General and administrative expenses
   
4,791
     
4,661
     
14,796
     
14,466
 
Depreciation and amortization
   
1,444
     
1,301
     
3,819
     
4,258
 
Total selling, general and administrative expenses
 
$
12,224
   
$
11,373
   
$
36,243
   
$
36,172
 
 
 
SG&A increased by $851,000 for the three-month period ended September 30, 2015 compared to the same period in 2014 and increased by $71,000 for the nine-month period ended September 30, 2015 compared to the same period in 2014.  The current quarter increase in SG&A is primarily related to increased catalog costs of $655,000 resulting from an increase in the catalog circulation during the current quarter.  However, on a year-to-date basis, our catalog circulation continues to remain at levels lower than the prior year.  The year-to-date increase in SG&A is due to increased internet support costs of $917,000 primarily for Acorn TV, which is due to subscriber growth, offset by lower catalog costs of $679,000 and lower depreciation and amortization of $439,000.

Equity Earnings of Affiliate

Equity earnings of affiliate for the three and nine months ended September 30, 2015 were $188,000 and $876,000, respectively, as compared to $1.2 million and $2.5 million for the three and nine-month periods ended September 30, 2014, respectively.  The decrease in equity earnings in affiliate (which is ACL) is attributed to greater ACL gross margins (revenues less film cost amortization) during 2014 versus 2015 related to television series that were released during 2013.  Revenues are generally higher at the time of release and diminish thereafter over time.  During the current quarter, ACL did release its first television series since 2013, yet ACL is recognizing lower margins on this release as the initial broadcaster did not exercise its option for a second season.  ACL is in process of completing the production of another made-for-television movie, which has not yet been released.

Interest Expense

Interest expense for the quarter ended September 30, 2015 was $2.2 million compared to $2.6 million for the same period in 2014.  Interest expense increased $1.2 million to $7.7 million for the nine months ended September 30, 2015 as compared to the same period in 2014.  Interest expense decreased during the three-month period due to lower debt balances being outstanding offset by an increase in the Credit Agreement’s interest rate (currently LIBOR plus 10.64%) when compared to the prior agreement (which was approximately LIBOR plus 7.0%).  For the nine-month period, the increase is attributable to the increased interest rate as well as an increase in the  average outstanding balance due under the Credit Agreement when compared to our credit facility that was in place last year.
 
30

Change in Fair Value of Stock Warrants and Other Derivatives

The change in the fair value of our warrant and other derivative liabilities impacts the statement of operations.  A decrease in the fair value of the liabilities results in the recognition of income, while an increase in the fair value of the liabilities results in the recognition of expense.  For the three months ended September 30, 2015 and 2014, the fair value of our stock warrants and other derivative liabilities increased by $2.5 million and $1.6 million, respectively.  For the nine months ended September 30, 2015 and 2014, the fair value of our warrants and other derivative liabilities decreased by $5.1 million and increased by $2.3 million, respectively.  Changes in fair values of our warrants and other derivative liabilities are primarily driven by changes in our common stock price and its volatility.

Other Income (Expense)

Other income (expense) primarily consists of foreign currency gains and losses resulting primarily from advances and loans by our U.S. subsidiaries to our foreign subsidiaries that have not yet been repaid.  Our foreign currency gains and losses are primarily impacted by changes in the exchange rate of the British Pound Sterling (or the Pound) relative to the U.S. Dollar (or the Dollar).  As the Pound strengthens relative to the Dollar, we recognize other income; and as the Pound weakens relative to the Dollar, we recognize other expense.  For the first nine months of 2015, the Pound weakened relative to the Dollar, mainly during the current quarter, resulting in us recognizing a loss of $1.1 million of which $820,000 was recognized in the current quarter.  From January through July of 2014, the Pound was strengthening relative to the Dollar, yet these gains were entirely reversed in August and September of 2014.  As a result, we recorded losses of $928,000 and $405,000 during the three and nine months ended September 30, 2014, respectively.

During the second quarter of 2015, we also incurred $312,000 of legal fees and other costs to modify our debt arrangements.  These expenses were recorded as other expense.

Income Taxes

We have fully reserved our net U.S. deferred tax assets which may be available to reduce future income taxes payable should we have U.S. taxable income in the future.  To the extent such deferred tax assets relate to net operating loss (or NOL) carryforwards, the ability to use our NOL carryforwards against future earnings will be subject to applicable carryforward periods and other limitations.

We recorded income tax expense (benefit) of $49,000 and ($164,000) for the three-month periods ended September 30, 2015 and 2014, respectively, and $631,000 and $524,000 for the nine-month periods ended September 30, 2015 and 2014, respectively.  We generally provide income tax expense on pre-tax income from our consolidated U.K. subsidiaries at an effective tax rate of approximately 20%.  However, for 2015 our effective U.K. tax rate is approximately 10%.  The decrease in the U.K. effective tax rate is due to the U.K. reducing its corporate tax rates and the impact this has on our previously recorded deferred tax liabilities.  We are not providing a tax provision (benefit) on our U.S. and Australian operations as we have historically had and continue to provide a full valuation allowance on their net operating losses.

ADJUSTED EBITDA

Management believes Adjusted EBITDA to be a meaningful indicator of our performance that provides useful information to investors regarding our financial condition and results of operations because it removes material noncash items that allows investors to analyze the operating performance of the business using the same metric management uses.  The exclusion of noncash items better reflects our ability to make investments in the business and meet obligations.  Presentation of Adjusted EBITDA is a non-GAAP financial measure commonly used in the entertainment industry and by financial analysts and others who follow the industry to measure operating performance. The Company uses this measure to assess operating results and performance of its business, perform analytical comparisons, identify strategies to improve performance and allocate resources to its business segments. While management considers Adjusted EBITDA to be important measures of comparative operating performance, it should be considered in addition to, but not as a substitute for, net income and other measures of financial performance reported in accordance with U.S. GAAP. Not all companies calculate Adjusted EBITDA in the same manner and the measure as presented may not be comparable to similarly-titled measures presented by other companies.
 
31

The following table includes the reconciliation of our consolidated U.S. GAAP net loss to our consolidated Adjusted EBITDA:

(In thousands)
 
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2015
   
2014
   
2015
   
2014
 
Net loss
 
$
(7,146
)
 
$
(7,799
)
 
$
(18,322
)
 
$
(20,148
)
Amortization of content
   
12,676
     
18,911
     
36,355
     
44,979
 
Cash investment in content
   
(11,545
)
   
(11,467
)
   
(29,597
)
   
(37,618
)
Depreciation and amortization
   
1,444
     
1,301
     
3,819
     
4,258
 
Interest expense
   
2,223
     
2,557
     
7,747
     
6,560
 
Loss on extinguishment of debt
   
     
1,457
     
     
1,457
 
Provision for income taxes
   
49
     
(164
)
   
631
     
524
 
Transaction costs and restructuring
   
244
     
     
751
     
 
Warrant and other derivative liability fair value adjustment
   
2,506
     
1,599
     
(5,131
)
   
2,277
 
Stock-based compensation
   
59
     
227
     
213
     
683
 
Adjusted EBITDA
 
$
510
   
$
6,622
   
$
(3,534
)
 
$
2,972
 

 
Adjusted EBITDA decreased by $6.1 million for the three months ended September 30, 2015 compared to the same period in 2014 and decreased by $6.5 million for the nine months ended September 30, 2015.  The decrease during the three- and nine-month periods ended September 30, 2015 versus 2014 is primarily driven by lower revenues from our IP Licensing segment and lower ACL earnings.

A reconciliation of Adjusted EBITDA to our net (decrease) increase in cash as reported in our consolidated statements of cash flows is as follows:

(In thousands)
 
Nine Months Ended
September 30,
 
   
2015
   
2014
 
         
Adjusted EBITDA
 
$
(3,534
)
 
$
2,972
 
Cash interest expense
   
(5,231
)
   
(4,635
)
Income tax provision
   
(631
)
   
(524
)
Transaction costs and restructuring
   
(751
)
   
 
Proceeds from issuance of preferred stock and warrants
   
22,500
     
 
Proceeds from debt borrowings less net principal payments
   
(11,837
)
   
(165
)
Payment of preferred stock issuance and senior debt modification costs
   
(1,233
)
   
(30
)
ACL dividends in excess of earnings
   
853
     
407
 
Capital expenditures
   
(1,297
)
   
(1,580
)
Changes in working capital
   
(4,910
)
   
3,922
 
Foreign currency impact on cash flows
   
1,216
     
133
 
Net (decrease) increase in cash
 
$
(4,855
)
 
$
500
 
 
 
BALANCE SHEET ANALYSIS

Assets

Total assets at September 30, 2015 and December 31, 2014, were $178.3 million and $192.0 million, respectively.  The decline of $13.7 million in assets is mostly attributed to (i) a decrease in our IP Licensing segment related to content amortization recognized during the current period for Foyle’s War and Partners in Crime and recognition of dividends received from ACL and (ii) lower cash balances held at corporate.
 
32