UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

For the Fiscal Year Ended December 31, 2017

OR

 

For the Transition Period from            to           

Commission File Number 001-35675

 

RLJ ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

 

 

 

8515 Georgia Avenue, Suite 650, Silver Spring, Maryland, 20910

(Address of principal executive offices, including zip code)

(301) 608-2115

(Registrant’s telephone number, including area code)

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

 

 

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

None

 

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

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

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

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

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.   ☐

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

The aggregate market value of the voting stock held by non-affiliates computed on June 30, 2017, based on the sales price of $3.31 per share:  Common Stock - $10,958,026.  All directors and executive officers have been deemed, solely for the purpose of the foregoing calculation, to be “affiliates” of the registrant; however, this determination does not constitute an admission of affiliate status for any of these shareholders.

The number of shares outstanding of the registrant’s common stock as of February 28, 2018:  14,564,678

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

 

 

 

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RLJ ENTERTAINMENT, INC.

Form 10-K Annual Report

For the Year Ended December 31, 2017

TABLE OF CONTENTS

 

 

 

 

 

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FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K for the year ended December 31, 2017 (or Annual Report) includes forward-looking statements that involve risks and uncertainties within the meaning of the Private Securities Litigation Reform Act of 1995. Other than statements of historical fact, all statements made in this Annual Report are forward-looking, including, but not limited to, statements regarding industry prospects, future results of operations or financial position, and statements of our intent, belief and current expectations about our strategic direction, prospective and future results 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. The use of “we,” “our” or “us” within this Annual Report is referring to RLJ Entertainment, Inc. and its subsidiaries.

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:

You should carefully consider and evaluate all of the information in this Annual Report, including the risk factors listed above and elsewhere, including “Item 1A. Risk Factors” below. If any of these risks occur, our business, results of operations and financial condition could be harmed, the price of our common stock could decline, and you may lose all or part of your investment, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this Annual Report. Unless otherwise required by law, we undertake no obligation to release publicly any updates or revisions to any such forward-looking statements that may reflect events or circumstances occurring after the date of this Annual Report.

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PART I

 

 

RLJ Entertainment, Inc. (RLJE or the Company) is a premium digital channel company serving distinct audiences through its proprietary subscription-based digital channels, Acorn TV and UMC or Urban Movie Channel. Acorn TV features high-quality British and international mysteries and dramas. UMC showcases compelling urban programming including feature films, documentaries, original series, stand-up comedy and other exclusive content for African-American and urban audiences. The digital channels have consistently experienced substantial year-over-year growth rate since launch in 2011 and 2015, respectively. The table below shows quarterly subscriber growth from December 2015 to December 2017.

We exclusively control, co-produce, and own a large library of content primarily consisting of British mysteries and dramas, independent feature films and urban content. In addition to supporting our digital channels, the value of our content library is monetized through our intellectual property (or IP) licensing and wholesale distribution operations. These activities allow us to control all windows of exploitation of our content. Our IP licensing operations consist of content that we own and includes our 64% investment in Agatha Christie Ltd. (or ACL), while our wholesale distribution operations consist of content we license from others.

Strategic Growth of the Company

We expect to increase our subscriber growth to one million subscribers within 12 to 18 months. To that end, our growth initiatives include the following:

We believe that the convergence of television (TV) and the internet will promote the continued migration of consumers from bundled offerings to a la carte subscriptions significantly benefitting digital over-the-top (or OTT) platforms like Acorn TV and UMC. As a result, we have aligned our goals to (i) continue to develop unique brands that appeal to and capture dedicated audiences, (ii) develop strong content offerings that consumers are willing to purchase and (iii) provide superior service. Our goal is to continue to develop strong media brands that are a preferred destination and a “must-have” subscription for our audiences.

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Investments in Content

We develop or acquire content that is intended to satisfy the desire of our niche audiences. We also acquire finished programs through long-term exclusive contracts. We invest in content that we believe will increase our digital channel subscribers’ interests and subscriptions as well as exceed our internal return-on-investment.

Sales and Marketing

We maintain our own sales force and also direct selling relationships with the majority of our broadcast and cable/satellite partners and retail customers. Our in-house marketing department manages promotional efforts across a wide range of off-line and online platforms. 

Segments

Management views our operations based on three distinct reporting segments: (1) the Digital Channels segment; (2) the IP Licensing segment; and (3) the Wholesale Distribution segment. Operations and net assets that are not associated with any of these operating segments are reported as “Corporate” when disclosing and discussing segment information. The Digital Channels segment distributes film and television content through our proprietary subscription-based digital channels, Acorn TV and UMC. The IP Licensing segment includes intellectual property rights that we own, produce and then license; and includes our 64% ownership of ACL. Our Wholesale Distribution segment consists of the worldwide exploitation of exclusive content in various formats including digital (download-to-rent and electronic sell-through, or EST), television video on demand (VOD) through cable and satellite, broadcast, streaming, and DVD and Blu-ray through third-party media and retail outlets. The Wholesale Distribution and IP Licensing segments exploit content to third parties such as Amazon, Best Buy, iTunes, Netflix, Target and Walmart.

Total revenues by reporting segment for the periods presented are as follows:

 

 

Our reported revenues exclude the revenues of ACL as we account for ACL using the equity method of accounting. ACL’s net revenues were $18.5 million and $19.5 million for the years ended December 31, 2017 and 2016, respectively.

Total assets for each reporting segment and Corporate as of December 31, 2017 and 2016 are as follows:

 

 

Digital Channels

A summary of the Digital Channels segment’s revenues and expenses is as follows:

 

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The Digital Channels segment exploits much of the same film and television content as the Wholesale Distribution segment but exploits the content to consumers through various proprietary subscription video on demand (or SVOD) channels. To date, we have two primary digital channels, which are Acorn TV and UMC. We are continually rolling-out new programming on our digital channels and attracting new subscribers. As of December 31, 2017, our Digital Channels segment had over 680,000 subscribers compared to 457,000 subscribers at December 31, 2016.

IP Licensing

A summary of the IP Licensing segment’s revenues and expenses is as follows:

 

 

Our IP Licensing segment includes our 64% interest in ACL and owned intellectual property that is either owned or created by us and is licensed for exploitation worldwide.

Wholesale Distribution

A summary of the Wholesale Distribution segment’s revenues and expenses is as follows:

 

 

The Wholesale Distribution segment consists of worldwide exploitation of exclusive content in various formats through third party media and retail outlets.

Outside North America and the United Kingdom (or U.K.), we sublicense distribution in the areas of television, digital and home entertainment through distribution partners such as Universal Music Group International, Universal Pictures Australia and Warner Music Australia, each of which pays us a royalty for their distribution of our products.

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Our Primary Brands

We focus on compelling British mystery and drama television, action and thriller independent feature films and diverse urban content, and documentaries. We exploit our titles through our various brands as follows:

 

Our subsidiaries with a permanent presence in the U.K. television programming community, provide us access to new content and manage and develop our intellectual property rights. Our owned content includes 28 Foyle’s War made-for-TV films and, through our 64% ownership interest in ACL, the Agatha Christie branded library. The bestselling novelist of all time, Agatha Christie has sold more than 2 billion books, and her work contains a variety of short story collections, more than 80 novels, 19 plays and a film library of over 100 TV productions. Acorn is known for mystery and drama franchises and has been releasing TV movie adaptations featuring Agatha Christie’s two most famous characters, Hercule Poirot and Miss Marple, for over a decade with both series ranking among our all-time bestselling lines. Through ACL, we manage the vast majority of Agatha Christie publishing and television/film assets worldwide and across all mediums and actively develop new content and productions. In addition to film and television projects, in 2014, ACL published its first book since the death of Agatha Christie, The Monogram Murders, and has subsequently published its second book, Closed Casket, in 2016. The Agatha Christie family retains a 36% holding, and James Prichard, Agatha Christie’s great-grandson, is the Chairman of ACL.

 

 

Trademarks

We currently use several registered trademarks including: RLJ Entertainment, Acorn, Acorn Media, Acorn TV and UMC - Urban Movie Channel. We also currently use registered trademarks through our 64%-owned subsidiary ACL including: Agatha Christie, Miss Marple and Poirot.

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The above-referenced trademarks, among others, are registered with the U.S. Patent and Trademark Office and various international trademark authorities. In general, trademarks remain valid and enforceable as long as the marks are used in connection with the related products and services and the required registration renewals are filed. We believe our trademarks have value in the marketing of our products. It is our policy to protect and defend our trademark rights.

Outsourced Services

Under a Distribution Services and License Agreement with Sony Pictures Home Entertainment (or SPHE), SPHE acts as our exclusive manufacturer in North America to meet our physical goods manufacturing requirements (DVD and Blu-ray) and to provide related fulfillment and other logistics services in exchange for certain fees. Our agreement with SPHE expires in August 2019. SPHE also provides certain operational services, including credit and collections, merchandising, returns processing and certain information technology (IT) functions. Under our relationship with SPHE, we are responsible for the credit risk from the end customer with respect to accounts receivable and also the risk of inventory loss with respect to the inventory they manage on our behalf.

On June 24, 2016, we entered into a licensing agreement with USA whereby USA took over our Acorn U.S. catalog/ecommerce business and became the official, exclusive, direct-to-consumer seller of Acorn product in the U.S.

In the U.S., we outsource our video delivery, streaming services and cloud hosting for our web portfolio and digital channels.

In the U.K., we have a fulfillment and logistics services arrangement with Sony DADC UK Limited, which is similar to the arrangement we have with SPHE in North America. Australian fulfilment and logistics are provided by Regency Media Pty Ltd.

Seasonality

Our subscriber growth and our Wholesale Distribution segment revenues exhibit a seasonal pattern. For our Digital Channels segment, the seasonality exists because of variations in when consumers buy internet-connected screens and when they tend to increase their viewing. For our Wholesale Distribution segment, the release timing of certain high-profile content as well as the holiday season impact the revenue stream. The fourth quarter typically represents our strongest quarter in terms of Wholesale Distribution segment revenues.

Competition

The market for entertainment video is intensely competitive and subject to rapid change. We face competition from other digital channels with similar genre and target audiences, independent distribution companies, major motion picture studios and broadcast and internet outlets in securing exclusive content distribution rights.

We also face competition from online and direct-to-consumer retailers, as well as alternative forms of leisure entertainment, including video games, the internet and other computer-related activities. Consumers can choose from a large supply of competing entertainment content from other suppliers. The success of any of our titles depends upon audience acceptance of a given program in relation to consumer tastes and cultural trends as well as the other titles released into the marketplace at or around the same time. Many of these competitors are larger than us.

Sales of digital downloading, streaming, VOD and other broadcast formats are largely driven by what is visually available to the consumer, which can be supported by additional placement fees or previous sales success. Programming is available online, delivered to smartphones, tablets, laptops, personal computers, or direct to the consumers’ TV set through multiple internet-ready devices, cable or satellite VOD and other subscription-based digital channels. For our physical wholesale distribution, our DVD and Blu-ray products compete for a finite amount of brick-and-mortar retail and rental shelf space.

Our ability to continue to successfully compete in our markets is largely dependent upon our ability to develop and secure unique and appealing content, and to anticipate and respond to various competitive factors affecting the industry, including new or changing program formats, changes in consumer preferences, regional and local economic conditions, discount pricing strategies and competitors’ promotional activities.

Industry Trends

Juniper Research reports that OTT revenues will hit $120 billion by 2020 and over 25% of households will subscribe to SVOD services by 2022.

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According to The Digital Entertainment Group (or DEG), consumer home entertainment spending in calendar 2017 exceeded $20.5 billion, up 5% from 2016. This increase was driven by the 20% increase in total digital spending showing that consumers are continuing to build their digital film libraries.

Total digital-format revenues include EST (digital ownership), VOD (digital rental) and subscription-based streaming. EST revenues for 2017 increased by 6% compared to 2016. VOD revenues decreased 7% in 2017 compared to 2016. Total subscription VOD increased by 31% in 2017 compared to 2016.

DEG reported that in 2016 the number of U.S. households with Blu-ray playback devices, including set-top boxes and game consoles, was 88 million. DEG also reported that the number of households with HDTV (including 4K UHD) is now more than 120 million, including 30 million 4K Ultra HD TVs.

Research and Markets’ report, “Global Blu-ray Media and Players Market, Forecast to 2023”, predicts a decline of the DVD format sales as a result of increased 4K UHD players and lower physical media demand. Unit shipments for the global Blu-ray media market are expected to decrease from 595 million in 2017 to 516 million in 2023.

Employees

As of March 1, 2018, we had 98 total employees. Of these employees, 76 are based in the US and 22 are based internationally in the U.K. and Australia.

Other Information

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 or Acorn), which is referred to herein as the “Business Combination.” We have a direct presence in North America, the U.K. and Australia with strategic sublicense and distribution relationships covering Europe, Asia and Latin America.

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A summary of our significant corporate entities and structure is as follows:

 

 

Under the menu “Investors—SEC Filings” on our website at www.rljentertainment.com, we provide free access to our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information contained on our website is not incorporated herein by reference and should not be considered part of this Annual Report.

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Risks Relating to Our Liquidity and Credit Agreement

Our Credit Agreement contains covenants that may limit the way we conduct business. Our Credit Agreement contains various covenants limiting our ability to:

These covenants may have an impact on our ability to raise additional debt or equity financing, compete effectively or take advantage of new business opportunities.

Our Credit Agreement includes covenants that require us to maintain specified financial ratios. Our ability to satisfy those financial ratios can be affected by events beyond our control, and we cannot be certain we will satisfy those ratios. Although we are currently in compliance with such financial ratios, there is no assurance that our financial results during the current fiscal year will enable us to meet these ratios or that the lender under the Credit Agreement will agree to modify these ratios in the future should we be unable to comply with them.

Our Credit Agreement provides that an “event of default” will occur under a number of circumstances, including (i) the failure to make payments when due, (ii) acceleration of payment obligations under other agreements, (iii) the failure to comply with the financial ratios and other covenants, (iv) breach of a representation or warranty in a material respect, (v) bankruptcy, (vi) judgments against RLJE or any of its subsidiaries over $250,000 individually or $500,000 in the aggregate at any time, (vii) a change of control, or (viii) a default under the investment documents with AMC Networks Inc. (or AMC). If an event of default occurs, the lender under our Credit Agreement may, unless we are able to negotiate an amendment, forbearance or waiver, require us to repay all amounts then outstanding under the Credit Agreement, which would have a material adverse effect on our liquidity, business, results of operations and financial condition.

We may not be able to generate the amount of cash needed to fund our future operations. Our ability to fund planned capital expenditures and development efforts will depend on our ability to generate cash in the future. Our ability to generate cash is in part subject to general economic, financial, competitive, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations to fund our liquidity needs.

Our liquidity depends on our cash-on-hand, operating cash flows and ability to collect cash receipts. At December 31, 2017, our cash and cash equivalents were approximately $6.2 million. Under the Credit Agreement, we are required to maintain $2.0 million for the fiscal year ending December 31, 2017 and $3.5 million for the fiscal year ending December 31, 2018 and all fiscal years thereafter for the term of the agreement. We rely on our cash-on-hand, operating cash flows and ability to collect cash receipts to fund our operations and meet our financial obligations. Delays or any failure to collect our trade accounts receivable would have a negative effect on our liquidity and could lead to an event of default under the Credit Agreement.

We have pledged our intellectual property assets to secure our Credit Agreement, and this represents a risk to our business, results of operations and financial condition. In order to secure the financing necessary to operate our business, we pledged all of our intellectual property rights as collateral to secure our obligations under the Credit Agreement. If we were to default on our obligations under the Credit Agreement, we could forfeit our intellectual property and, thereby, a primary source of revenue. This could have a material adverse effect on our business, results of operations and financial condition.

We may not be able to generate sufficient cash to service all our indebtedness, and we may be forced to take other actions, which may or may not be successful, to satisfy our obligations under our indebtedness. Our ability to make scheduled payments under our senior secured Credit Agreement depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal and interest due under the Credit Agreement or any future debt agreement. However, during 2017 we amended our senior secured Credit Agreement whereby

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all interest payments are to be settled with shares of common stock, and principal debt payments are not required until 2020. If our cash flows and capital resources are insufficient to fund our future debt service and other obligations, we could face substantial liquidity problems and could be forced to reduce or delay capital expenditures and development efforts, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements, including the Credit Agreement.

Risks Relating to Our Business

We have limited working capital and limited access to financing. Our cash requirements, at times, may exceed the level of cash generated by operations. Accordingly, we may have limited working capital.

Our ability to obtain adequate additional financing on satisfactory terms may be limited. With respect to debt financing, our Credit Agreement restricts us from incurring additional indebtedness. With respect to equity financing, our ability to sell our equity securities depends on general market conditions, including the demand for our common stock. We may be unable to raise capital through the sale of equity securities, and if we were able to sell equity, our existing stockholders could experience substantial dilution. If adequate financing is not available at all or is unavailable on acceptable terms, we may find we are unable to fund expansion, continue offering products and services, take advantage of acquisition opportunities, develop or enhance services or products, or respond to competitive pressures in the industry.

Our business requires a substantial investment of capital. The production, acquisition and distribution of programming require a significant amount of capital. Capital available for these purposes will be reduced to the extent that we are required to use funds otherwise budgeted for capital investment to fund our operations. Curtailed content investment over a sustained period could have a material adverse effect on future operating results and cash flows. Further, a significant amount of time may elapse between our expenditure of funds and the receipt of revenues from our television programs or motion pictures. This time lapse requires us to fund a significant portion of our capital requirements from our operating cash flow and from other financing sources. Although we intend to continue to mitigate the risks of our production exposure through pre-sales to broadcasters and distributors, tax credit programs, government and industry programs, co-financiers and other sources, we cannot assure you that we will continue to successfully implement these arrangements or that we will not be subject to substantial financial risks relating to the production, acquisition, completion and release of new television programs and motion pictures. In addition, if we increase (through internal growth or acquisition) our production slate or our production budgets, we may be required to increase overhead and/or make larger up-front payments to talent and, consequently, bear greater financial risks. Any of the foregoing could have a material adverse effect on our business, financial condition, operating results, liquidity and prospects.

Changes in competitive offerings for entertainment video could adversely impact our business. The market for entertainment video is intensely competitive and subject to rapid change. Through new and existing distribution channels, consumers have increasing options to access entertainment video. Traditional providers of entertainment video, including broadcasters and cable network operators, as well as internet-based ecommerce or entertainment video providers are increasing their internet-based video offerings. Several of these competitors have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may secure better terms from suppliers, adopt more aggressive pricing and devote more resources to product development, technology, infrastructure, content acquisitions and marketing. New entrants may enter the market or existing providers may adjust their services with unique offerings or approaches to providing entertainment video. Companies also may enter into business combinations or alliances that strengthen their competitive positions. If we are unable to successfully or profitably compete with current and new competitors, our business will be adversely affected, and we may not be able to increase or maintain market share, revenues or profitability.

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

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We may be unable to recoup advances paid to secure exclusive distribution rights. Our most significant costs and cash expenditures relate to acquiring content for exclusive distribution. Most agreements to acquire content require upfront advances against royalties or net profits participations expected to be earned from future distribution. The amount we are willing to advance is derived from our estimate of net revenues that will be realized from our distribution of the title. Although these estimates are based on management’s knowledge of competitive title performance, current events and actions management may undertake in the future, actual results will differ from those estimates. If sales do not meet our original estimates, we may (i) not recognize the expected gross margin or net profit, (ii) not recoup our advances or (iii) record accelerated amortization and/or fair value write-downs of advances paid. We recorded impairments related to our investments in content of $1.6 million during 2017 and $2.8 million during 2016.

Our inability to maintain relationships with our program suppliers and vendors may adversely affect our business. We receive a significant amount of our revenues from the distribution of content for which we already have exclusive agreements with program suppliers. However, titles which have been financed by us may not be timely delivered as agreed or may not be of the expected quality. Delays or inadequacies in delivery of titles, including rights clearances, could negatively affect the performance of any given quarter or year. In addition, results of operations and financial condition may be materially adversely affected if:

Disputes over intellectual property rights could adversely affect our business, results of operations and financial condition. Our sales and net revenues depend heavily on the exploitation of intellectual property owned by us or third parties from whom we have licensed intellectual property. Should a dispute arise over, or a defect be found in, the chain of title in any of our key franchises, this could result in either a temporary suspension of distribution or an early termination of our distribution license. This could have a material adverse impact on our business, results of operations and financial condition.

We, and third parties that manage portions of our secure data, are subject to cybersecurity risks and incidents. Our direct-to-consumer business involves the storage and transmission of customers' personal information, shopping preferences and credit card information, in addition to employee information and our financial and strategic data. The protection of our customer, employee and company data is vitally important to us. While we have implemented measures to prevent security breaches and cyber incidents, any failure of these measures and any failure of third parties that assist us in managing our secure data could materially adversely affect our business, financial condition and results of operations.

A high rate of product returns may adversely affect our business, results of operations and financial condition. As with the major studios and other independent companies in this industry, we face the risk of experiencing a relatively high level of product returns as a percentage of our revenues for a given title. Additionally, our allowances for sales returns may not be adequate to cover any potential returns resulting from future retailer consolidation events within the home-video retail marketplace. When these occur the risk of inventory consolidation and higher returns increases. Having experienced a high rate of product returns over the past three years, 2017 saw a significant decline in returns. Changes in our business practices lead us to expect these levels to remain lower, but the risk of retail consolidation still exists.

We depend on third-party shipping and fulfillment companies for the delivery of our products. If these companies experience operational difficulties or disruptions, our business could be adversely affected. We rely on SPHE, our distribution facilitation and manufacturing partner in North America, and Sony DADC UK Limited in the U.K. to determine the best delivery method for our products. These partners rely entirely on arrangements with third-party shipping companies, principally Federal Express and UPS, for small package deliveries and less-than-truckload service carriers for larger deliveries, for the delivery of our products. The termination of arrangements between our partners and one or more of these third-party shipping companies, or the failure or inability of one or more of these third-party shipping companies to deliver products on a timely or cost-efficient basis from our partners to our customers, could disrupt our business, reduce net sales and harm our reputation. Furthermore, an increase in the amount charged by these shipping companies could negatively affect our gross margins and earnings.

Economic weakness may adversely affect our business, results of operations and financial condition. An economic downturn would have a significant negative effect on our revenues. As consumers reduce spending and scale back purchases of our products, we may experience higher product returns and lower sales, which would adversely affect our revenues and results of operations. Although domestic consumer spending has been strong over the last few years, weak consumer demand for our products may occur and may adversely affect our business, results of operations and financial condition.

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Our high concentration of sales to and receivables from relatively few customers (and use of a third-party to manage collection of substantially all packaged goods receivables) may result in significant uncollectible accounts receivable exposure, which may adversely affect our liquidity, business, results of operations and financial condition. During 2017, sales to one customer accounted for 24.6% of our Wholesale Distribution segment revenues. Our top five customers accounted for approximately 55.0% of our Wholesale Distribution segment revenues during 2017. One customer accounted for 37.5% of revenues reported within our Digitals Channels segment during 2017. At December 31, 2017, Amazon, SPHE, Hulu, and Netflix accounted for approximately 25.0%, 22.2%, 15.2% and 13.9%, respectively, of our gross accounts receivable.

We may be unable to maintain favorable relationships with our retailers and distribution facilitators including SPHE and Sony DADC UK Limited. Further, our retailers and distribution facilitators may be adversely affected by economic conditions. If we lose any of our top customers or distribution facilitators, or if any of these customers reduces or cancels a significant order, it could have a material adverse effect on our liquidity, business, results of operations and financial condition.

We face credit exposure from our retail customers and may experience uncollectible receivables from these customers should they face financial difficulties. If these customers fail to pay their accounts receivable, file for bankruptcy or significantly reduce their purchases of our programming, it would have a material adverse effect on our business, financial condition, results of operations and liquidity.

A high concentration of our gross accounts receivables is attributable to SPHE and Sony DADC UK Limited, as they are our vendor of record for shipments of physical product to North American and U.K. retailers and wholesalers. As part of our arrangement with our distribution facilitation partners, SPHE and Sony DADC UK Limited collect the receivables from our end customers, provide us with monthly advance payments on such receivables (less a reserve), and then true up the accounts receivables accounting quarterly. While we remain responsible for the credit risk from the end customer, if SPHE or Sony DADC UK Limited should fail to adequately collect and pay us the accounts receivable they collect on our behalf, whether due to inadequate processes and procedures, inability to pay, bankruptcy or otherwise, our financial condition, results of operations and liquidity would be materially adversely affected.

We do not control the timing of dividends paid by ACL, which could negatively impact our cash flow. Although we hold a 64% interest in ACL, we do not control the board of directors of ACL. The members of the Agatha Christie family, who hold the remaining 36% interest in ACL, have the right to appoint the same number of directors as us and, in the event of deadlock on any decision of the board, also have a second or casting vote exercised by their appointee as chairman of ACL, which allows them to exercise control of ACL’s board of directors.

Under English law, the amount, timing and form of payment of any dividends or other distributions is a matter for ACL’s board of directors to determine, and, as a result, we cannot control when these distributions are made. If ACL’s board of directors decides not to authorize distributions, our cash flow may decrease, materially adversely affecting our business, results of operations, liquidity and financial condition.

Our business plan and future growth depend in part on our ability to commercialize the IP owned by ACL based on commissions for new programming from broadcasters, over whom we have no control. If we are unable to successfully implement this strategy, the results of operations and financial condition could be materially adversely affected. Our financial condition and results of operation will depend, in part, on our ability to commercialize the IP owned by ACL. Whether we are able to successfully commercialize the IP owned by ACL, including the creation of new content, will depend, in part, on ACL obtaining commissions for new programming from broadcasters (such as ITV, BBC and Sky in the U.K., and Fox, Disney and other studios in the U.S.). The ability to obtain commissions for new programming from broadcasters will depend on many factors outside of our control, including audience preferences and demand, financial condition of the broadcasters, the broadcasters’ budgets and access to financing, competitive pressures and the impact of actual and projected general economic conditions. We cannot guarantee that we will be able to obtain such commissions for new programming within our anticipated timeframe or at all. Without such commissions for new programming, we may not be able to successfully commercialize the IP of ACL in a timely or cost-effective manner, if at all. Failure to obtain commissions for new programming could adversely affect our market share, revenue, financial condition, results of operations, relationships with our distributors and retailers and our ability to expand our market, all of which would materially adversely affect our business, revenues and financial results.

The synergies and other efficiencies anticipated in connection with the transaction with AMC may not be realized. We expect, in conjunction with AMC, to pursue the aggregation of proprietary subscription video on demand activities and economies of scale with respect to manufacturing, sales and distribution of physical products. Although we believe that realizing these synergies would be beneficial to both us and AMC, the parties have not entered into a contract to pursue or otherwise implement these synergies. Accordingly, there is a risk that we and AMC may not agree on the means or terms to implement these synergies or that AMC, whether due to differing business interests or other reasons, may not pursue these synergies in the manner or at the

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level we desire. AMC has investments in other media companies which may conflict or compete with our business. In addition, the integration of these operations will be a complex, costly and time-consuming process. As a result, we will be required to devote significant management attention and resources to integrating these operations.

We depend on key and highly skilled personnel to operate our business, and if we are unable to retain our current personnel or hire additional personnel, our ability to develop and successfully market our business could be harmed. Our success continues to depend to a significant extent on our ability to identify, attract, hire, train and retain qualified professional, creative, technical and managerial personnel. Moreover, we believe that our success greatly depends on the contributions of our Chairman, Robert L. Johnson, executive officers including Chief Executive Officer, Miguel Penella, Chief Financial Officer, Nazir Rostom, and other key executives. Although we have employment agreements with Messrs. Penella and Rostom, any of our employees may terminate their employment relationship with us at any time, and their knowledge of our business and industry would be extremely difficult to replace. The loss of any key employees or the inability to attract or retain qualified personnel could delay the acquisition of content and harm the market's perception of us. Competition for the caliber of talent required to acquire and exploit content continues to increase. If we are unable to attract and retain the qualified personnel we need to succeed, our business, results of operations and financial condition could suffer.

We face risks from doing business internationally. We exploit and derive revenues from television programs and feature films outside the U.S., directly in the U.K. and in Australia, and through various third-party licensees elsewhere. As a result, our business is subject to certain risks inherent in international business, many of which are beyond our control. These risks include:

Events or developments related to these and other risks associated with international trade could adversely affect our revenues from non-U.S. sources, which could have a material adverse effect on our business, financial condition, operating results, liquidity and prospects.

Changes to existing accounting pronouncements or taxation rules or practices may affect how we conduct our business and affect our reported results of operations. New accounting pronouncements or tax rules and varying interpretations of accounting pronouncements or taxation practice have occurred and may occur in the future. A change in accounting pronouncements or interpretations or taxation rules or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. Changes to existing rules and pronouncements, future changes, if any, or the questioning of current practices or interpretations may materially adversely affect our reported financial results or the way we conduct our business.

Changes in, or interpretations of, tax rules and regulations, and changes in geographic operating results, may adversely affect our effective tax rates. We are subject to income taxes in the U.S. and foreign tax jurisdictions. Our future effective tax rates could be affected by changes in tax laws or the interpretation of tax laws, by changes in the amount of revenues or earnings that we derive from international sources in countries with high or low statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities. Unanticipated changes in our tax rates could affect our future results of operations.

In addition, we may be subject to examination of our income tax returns by federal, state and foreign tax jurisdictions. We regularly assess the likelihood of outcomes resulting from possible examinations to determine the adequacy of our provision for income taxes. In making such assessments, we exercise judgment in estimating our provision for income taxes. While we believe our estimates are reasonable, we cannot assure you that final determinations from any examinations will not be materially different from those reflected in our historical income tax provisions and accruals. Any adverse outcome from any examinations may have a material adverse effect on our business and operating results.

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The effects of the Tax Cuts and Jobs Act on our business have not yet been fully analyzed and could have an adverse effect on our net income. On December 22, 2017, the Tax Cuts and Jobs Act (the Act) was signed into law. The Act reduces the corporate tax rate to 21 percent from 35 percent, among other things. On that same day, Staff Accounting Bulletin No. 118 (or SAB 118) was issued to address the application of accounting principles generally accepted in the United States of America (or US GAAP) in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act.. In accordance with SAB 118, we determined that the deferred tax expense recorded in connection with the remeasurement of certain deferred tax assets and liabilities was a provisional amount and a reasonable estimate at December 31, 2017. Additional work is necessary to do a more detailed analysis and any subsequent adjustment to these amounts will be recorded in 2018 when the analysis is complete.

Risks Relating to Our Industry

Our revenues and results of operations may fluctuate significantly. Our results of operations are difficult to predict and depend on a variety of factors. Our results of operations depend significantly upon the commercial success of the television programming and feature films that we exploit, which cannot be predicted with certainty. In particular, the underperformance in any given window or format of one or more motion pictures or television programs in any period may cause our revenues and earnings results for that period (and potentially, subsequent periods) to be less than anticipated, in some instances to a significant extent. Accordingly, our results of operations may fluctuate significantly from period to period, and the results of any one period may not be indicative of the results for any future periods.

Our results of operations also fluctuate due to the timing, mix, number and availability of our broadcast, home entertainment and theatrical motion picture releases, as well as license periods for our content. Our operating results may increase or decrease during a particular period or year due to differences in the number and/or mix of films released compared to the corresponding period in the prior year.

We may not be able to continue to attract and retain subscribers to our digital channels. We have experienced significant subscriber growth since we began our digital channels in 2011. Our ability to continue to attract subscribers will depend in part on our ability to consistently provide our subscribers with a valuable and quality streaming experience. Furthermore, the relative service levels, content offerings, pricing and related features of our competitors may adversely impact our ability to attract and retain subscribers. We compete for screen viewing time with traditional broadcast and cable, video-on-demand, internet-based movie and TV content providers, including both those that provide legal and illegal (or pirated) streaming video content, and streaming video retail stores, among others. If consumers do not perceive our service offering to be of value, or if we introduce new or adjust existing features or change the mix of content in a manner that is not favorably received by them, we may not be able to attract and retain subscribers.

Revenues from the sale of DVDs are declining. During calendar 2017, DVD continued to experience a decline in revenues for the category since the format debuted in 1997. We estimate that approximately 41% of our 2017 net revenue base is generated from the sale of physical goods, which includes revenues from the sale of DVDs, compared to 51% in 2016. The continued maturation of the standard DVD format may continue to adversely affect our business, results of operations and financial condition.

Decreasing retail shelf space for our industry may limit sales of our programming, which may adversely affect our business, results of operations and financial condition. We face increasing competition from major motion picture studios and other independent content suppliers for limited retail shelf space, which space has been shrinking in absolute terms as brick and mortar retailers have fewer stores and smaller space allocations for the home-video space within their stores. We believe competition can be especially challenging for independent labels like us, because the new releases of major studios often have extremely high visibility, greater marketing support and sales projections in the millions of units, which typically require much more shelf space to support.

It can be a challenge to obtain the product placement necessary to maximize sales, particularly among the limited number of major retailers who comprise our core brick and mortar customers. The continued retailer trend toward greater visibility for titles at the expense of quantity (i.e., “face out” rather than “spine out” placement) has the effect of reducing the total number of titles actually carried by a retailer.

We cannot accurately predict the overall effect shifting audience tastes, technological change or the availability of alternative forms of entertainment may have on distributors. In addition to uncertainty regarding the DVD market, there is uncertainty as to whether other developing distribution channels and formats, such as VOD and internet distribution of television and films, will widely accepted by consumers or provide us with opportunities for successful business exploitation. Moreover, to the extent that these emerging distribution channels and formats gain popular acceptance, the demand for delivery through DVDs may decrease.

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Risks Relating to Our Stock

Our stock price may be subject to substantial volatility, and stockholders may lose all or a substantial part of their investment. Our common stock currently trades on the Nasdaq Capital Market (NASDAQ). There is limited public float, and trading volume historically has been low and sporadic, making it difficult to buy or sell our stock. As a result of the low trading volume, the market price for our common stock may not necessarily be a reliable indicator of our fair market value. The price at which our common stock trades may fluctuate as a result of a number of factors, including the number of shares available for sale in the market, quarterly variations in our operating results, actual or anticipated announcements of new releases by us or competitors, the gain or loss of significant customers, changes in the estimates of our operating performance, fluctuations in the fair value of our common stock warrant liability and market conditions in our industry and the economy as a whole.

Any future issuances of equity may significantly affect the market price of our common stock. Future issuances of substantial amounts of our common stock, including shares that we may issue upon conversion or redemption of outstanding preferred stock, exercise of outstanding warrants, or conversion of other convertible securities, if any, could adversely affect the market price of our common stock. The amount of common stock issuable upon redemption of our preferred stock, although subject to a floor price, is not fixed in all circumstances, and therefore the actual amount of common stock issuable upon redemption cannot currently be determined. Similarly, the amount of common stock issuable upon exercise of one of the three warrants issued to AMC is not fixed in all circumstances, and therefore the actual amount of common stock issuable upon exercise cannot currently be determined. Additionally, our senior secured Credit Agreement with AMC requires us to settle all interest due with shares of common stock at a rate of $3.00 per share. The number of shares issuable to settle interest is therefore dependent upon when the Credit Agreement loans are repaid. Further, if we raise additional funds through the issuance of common stock or securities convertible into or exercisable for common stock, our stockholders may experience substantial dilution and the price of our common stock may fall. New equity securities issued may also have greater rights, preferences or privileges than our existing common stock.

Additional authorized shares of common stock available for issuance may adversely affect the market. We are authorized to issue 250,000,000 shares of our common stock. As of March 1, 2018, we had 14,564,678 shares of our common stock outstanding, excluding shares issuable upon conversion of our outstanding preferred stock and exercise of our outstanding warrants. As of March 1, 2018, we had outstanding preferred stock convertible into approximately 5,880,000 shares of our common stock, including dividends, at a conversion price of $3.00 per share and warrants to purchase 1,349,111 shares of common stock at $1.50 per share, warrants to purchase 150,000 shares of common stock at $2.37 per share, warrants to purchase 1,500,000 shares of common stock at $3.00, and warrants to purchase 18,333,000 shares of common stock at $3.00, respectively. To the extent the shares of common stock are issued, preferred stock is converted or warrants are exercised, holders of our common stock will experience dilution.

Provisions in our amended and restated articles of incorporation and Nevada law may inhibit a takeover of us, which could limit the price investors might be willing to pay in the future for our common stock and could entrench management. Our amended and restated articles of incorporation contain provisions that may discourage unsolicited takeover proposals that stockholders may consider to be in their best interests. These provisions include the ability of the board of directors to designate the terms of and issue new series of preferred shares, which may make more difficult the removal of management and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our securities.

We are also subject to anti-takeover provisions under Nevada law, which could delay or prevent a change of control. Together these provisions may make more difficult the removal of management and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our securities.

None.

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Our principal executive office is located in Silver Spring, Maryland. We also maintain offices in Woodland Hills, California; London, England and Sydney, Australia with varying terms and expiration dates. All locations are leased. A summary of our locations is as follows:

 

 

We believe that our current offices are adequate to meet our business needs, and our properties and equipment have been well maintained.

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

Not applicable.

 

 

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PART II

Market Information

Our common stock is traded on The NASDAQ Capital Market^® under the symbol “RLJE”. The table below presents the quarterly high and low closing sales prices of our common stock reported by NASDAQ.

 

 

Stockholders

As of December 31, 2017, there were:

The number of holders of record does not include the number of persons whose securities are in nominee or “street name” accounts through brokers.

Dividend Policy

We have not paid any cash dividends on our common stock to date. The payment of cash dividends in the future will be dependent upon our revenues and earnings, if any, capital requirements and general financial condition. The payment of any dividends will be within the discretion of our board of directors at such time. It is the present intention of our board of directors to retain all earnings for use in our business operations and, accordingly, our board of directors does not anticipate declaring any dividends in the foreseeable future. In addition, our senior secured credit agreement with AMC restricts our ability to pay dividends on our common stock. For more information on these restrictions, please refer to Note 10, Debt of our consolidated financial statements and in the Liquidity and Capital Resources sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations (or MD&A).

Securities Authorized for Issuance Under Equity Compensation Plans

See table under Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters in the Equity Compensation Plan Information section.

Additional information with respect to the shares of our common stock that may be issued under our existing stock-based compensation plans is disclosed in our consolidated financial statements in Note 14, Stock-Based Compensation.

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Item 6. Selected Financial Data is not required for smaller reporting companies.

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 under the heading "Forward-Looking Statements" of this Annual Report, our actual results could differ materially from those anticipated in our forward-looking statements. Factors that could contribute to such differences include those discussed elsewhere in this Annual Report, including in Item 1A of this Annual Report under the heading “Risk Factors.” You should not place undue reliance on our forward-looking statements, which apply only as of the date of this Annual 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 8 of this Annual Report.

OVERVIEW

General

RLJ Entertainment, Inc. (RLJE or the Company) 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 United Kingdom (or U.K.) subsidiaries RLJ Entertainment Ltd (or RLJE Ltd.), Acorn Media Enterprises Limited (or AME), and RLJE International Ltd (collectively, RLJE UK), as well as RLJ Entertainment Australia Pty Ltd (or RLJE Australia). 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 an additional location in Woodland Hills, California. We also have international offices in London, England and Sydney, Australia.

We are a premium digital channel company serving distinct audiences through our proprietary subscription-based digital channels (or Digital Channels segment), Acorn TV and UMC or Urban Movie Channel. Acorn TV features high-quality British and International mysteries and dramas. UMC showcases quality urban programming including feature films, documentaries, original series, stand-up comedy and other exclusive content for African-American and urban audiences.  

We also exclusively control, co-produce, and own a large library of content primarily consisting of British mysteries and dramas, independent feature films and Urban content. In addition to supporting our Digital Channels, we monetize our library through intellectual property (or IP) rights that we own, produce, and then exploit worldwide (our IP Licensing segment) and distribution operations across all available wholesale windows of exploitation (our Wholesale Distribution segment). Our IP Licensing segment consists of content that we own and includes our investment in Agatha Christie Ltd. (or ACL), while our Wholesale Distribution segment consists of worldwide exploitation of exclusive content in various formats through our wholesale partners, including broadcasters, digital outlets and major retailers in the United States of America (or U.S.), Canada, U.K. and Australia. 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.

On June 24, 2016, we entered into a licensing agreement with Universal Screen Arts (or USA) whereby USA took over our Acorn U.S. catalog/ecommerce business becoming the official, exclusive, direct-to-consumer seller of Acorn product in the U.S. During the quarter ended June 30, 2016, we also electronically distributed our last Acacia catalogs. As a result of these actions, we classified the U.S. catalog/ecommerce business as discontinued operations.

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Revenue Sources

Revenues by reporting segment as a percentage of total revenues for the periods presented are as follows:

 

 

Revenues by geographical area as a percent of the total revenues are as follows:

 

 

Digital Channels Segment

Our Digital Channels segment predominately operates in the U.S. and comprises 31.5% of our overall revenue base. The Digital Channels segment revenues are derived from our online, proprietary, SVOD channels, Acorn TV and UMC. During 2017, revenues from our Digital Channels totaled $27.2 million, which represents an increase of $10.9 million when compared to 2016.

IP Licensing Segment

Our television drama productions are generally financed by the pre-sale of the initial broadcast license rights. Revenues reported in this segment include the initial broadcast license revenues, generally from the U.K. territory, and sublicense revenues for other territories outside the U.S., U.K. and Australia.

Wholesale Distribution Segment

DVD and Blu-ray

Our primary source of revenues within the Wholesale Distribution segment continues to be from the exploitation of exclusive content on DVD and Blu-ray through third-party retailers such as Amazon and Walmart.

Digital, VOD and Broadcast

Revenues derived from digital and broadcast exploitation of our content continue to grow as a percentage of revenues. Net revenues derived from digital, VOD, third-party SVOD and broadcast exploitation account for approximately 41.5% of the segment’s revenues in 2017 versus 34.9% in 2016. This is consistent with consumer adoption trends. As retailers continue to offer consumer-friendly devices that make access to these on-demand services easier, including allowing consumption on portable devices such as smartphones and tablets, we believe we are well-positioned to capture business in this growing distribution channel. Some of our digital retailers include Amazon, Hulu, iTunes, Netflix and a variety of cable television providers.

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Other Licensing

We continue our efforts to acquire more programming with international rights. Our key sublicensing partners, that cover territories outside the U.S., the U.K. and Australia, are Universal Music Group International, Universal Pictures Australia and Warner Music Australia. To date, most of the feature films we have acquired do not include rights outside of North America. However, given our presence in the United Kingdom and Australia, we are focusing our efforts to acquire more programming in all English-language markets. When appropriate, we now seek the greatest variety of distribution rights regarding acquired content in the greatest variety of formats. We believe that this will allow us to further diversify revenue streams.

Cost Structure

Our most significant costs and cash expenditures relate to acquiring or producing content for exclusive exploitation. We generally acquire programming through exclusive license or distribution agreements, under which we either (1) pay royalties or (2) receive distribution fees and pay net profits after recoupment of our upfront costs. Upon entering into a typical license (royalty) agreement, we pay an advance based on the estimated expected future net profits. Once the advance payment has been recouped, we pay royalties to the content suppliers quarterly based on the net revenues collected from the previous quarter. Under a typical exclusive distribution agreement, we may pay upfront fees, which are expressed as advances against future net profits. Once the advance and any other costs incurred are recouped, we pay the content supplier their share of net cash-profits, which is after our distribution fee, from the prior quarter’s exploitation.

In addition to advances, upfront fees and production costs, the other significant expenditures we incur are DVD/Blu-ray replication and digitalization of program masters, shipping costs from self-distribution of exclusive content, content hosting and delivery costs associate with our Digital Channels segment, advertising, personnel compensation costs and interest.

We strive to achieve long-term, sustainable growth and profitability exceeding our internal return on investment target on new content acquisitions. This financial target is based on all up-front expenses associated with the acquisition and release of a title, including advances and development costs, and is calculated after allocating overhead costs.

We also seek to maximize our operational cash flow and profitability by closely managing our marketing and discretionary expenses, and by actively negotiating and managing collection and payment terms.

Highlights

Highlights for the year ended December 31, 2017 and other significant events are as follows:

The highlights above and the discussion below are intended to identify some of our more significant results and transactions during 2017 and should be read in conjunction with our consolidated financial statements and related discussions within this Annual Report.

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Results of Operations

A summary of our results of operations is presented below for the years ended December 31, 2017 and 2016, as disclosed in our consolidated financial statements in Item 8, Financial Statements and Supplementary Data, herein referred to as our “consolidated financial statements.” Our consolidated financial statements have been prepared in accordance US GAAP.

 

 

Revenues

A summary of revenues by segment for the years ended December 31, 2017 and 2016 is as follows:

 

 

Revenues for the year ended December 31, 2017 increased $6.1 million when compared to the year ended December 31, 2016. The increase in revenues is primarily driven by our Digital Channels segment, which increased by $10.9 million, offset by revenues from our Wholesale Distribution segment, which decreased by $4.8 million. The increase in revenues from our Digital Channels segment was driven by 50.6% growth in paying subscribers. We increased our marketing efforts during the year to support subscriber growth. In addition, we are continually featuring new content on our digital channels, which we believe is a key factor in attracting new subscribers for all of our channels. Revenues from our Digital Channels segment continues to represent a growing and more meaningful portion of our consolidated revenues.  Revenues from these channels for the year ended December 31, 2017, account for 31.5% of our total revenues as compared to 20.3% for the same period in 2016.

Our Wholesale Distribution segment’s revenue decline is attributable to decreases in the U.S. revenues of $5.6 million and an increase in international revenues of $0.9 million. The Wholesale Distribution segment’s U.S. revenue decrease is primarily attributable to less content being released in the first half of 2017 compared to the same period last year as well as a decline in demand for DVDs and Blu-ray product as more digital programming becomes available. In 2017, one of our major wholesale partners substantially discontinued the sale of DVDs which contributed to the decrease in U.S. revenues. International Wholesale Distribution revenues increased due to the strong performance of two new releases during the year.

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Cost of Sales (“COS”) and Gross Margins

A summary of COS by segment and overall gross margins for the years ended December 31, 2017 and 2016 is as follows:

 

 

COS decreased by $4.7 million to $49.2 million for 2017 compared to the same period in 2016. The decrease in COS is attributed to lower sales of physical content, lower impairment charges and lower step-up amortization in our Wholesale Distribution segment. Impairment charges recorded for content investments and inventories total $3.0 million and $4.6 million for the years ended December 31, 2017 and 2016, respectively. Impairment charges decreased due to improved performance of our released content relative to our estimation of future revenues. Our step-up amortization was $2.6 million and $3.6 million for the years ended December 31, 2017 and 2016, respectively. The decrease in step-up amortization is attributable to lower revenues from titles that were acquired prior to our Business Combination. As time passes, we expect that step-up amortization will decrease.

As a percentage of revenues, our gross margin improved to 43.0% for 2017 compared to 32.9% for 2016. The improvement is primarily attributable to lower impairments and step-up amortization, as well as, revenue growth of our proprietary digital channels. Revenues from this segment account for 31.5% of our total revenues during 2017 as compared to 20.3% of total revenues during 2016. This business segment generates a higher gross margin than our other business segments. The Wholesale Distribution segment margins also increased due to the positive impact of a few one-time sales and licensing renewal transactions representing revenues of $1.1 million during 2017, which had very little associated costs.

Operating Expenses (“SG&A”)

The following table includes a summary of the components of SG&A:

 

 

SG&A increased by $6.2 million for the year ended December 31, 2017, compared to the same period in 2016. The increase is primarily attributable to targeted marketing expenses that increased $3.6 million for year ended December 31, 2017, primarily due to increased marketing related to our Digital Channels segment. General and administrative expenses increased $1.9 million primarily due to increased incentive compensation costs including increased expenses associated with stock-based compensation for executives and employees. Depreciation and amortization expense increased $0.8 million primarily due to investments in our websites to support the growth of the Digital Channels segment.

Equity Earnings of Affiliate

Equity earnings of affiliate (which is ACL) increased $2.9 million for the year ended December 31, 2017 to $6.0 million when compared to 2016. During 2017, ACL’s gross profit margin and its income from operations are higher when compared to 2016 due to higher publishing and licensing revenues, as a percent of its total revenues, which generate higher margins when compared to its other operations. In addition, ACL’s results were impacted by the strong performance of film and television programming released in 2017, as well as the receipt of additional licensing revenues from one title.

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Interest Expense

Interest expense increased $0.2 million for the year ended December 31, 2017, as compared to 2016. The increase is primarily a result of higher average outstanding debt balances partially offset by reduced interest rates on our senior debt.

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. Changes in fair value are primarily driven by changes in our common stock price and its volatility. During 2017, we recognized expense of $3.9 million due to changes in the fair value of our stock warrants and other derivative liabilities. During 2016, we recognized expense of $4.6 million due to changes in the fair value of our stock warrants and other derivative liabilities.

Gain (Loss) on Extinguishment of Debt

In 2016, upon repaying our previous credit facility and entering into the senior secured credit agreement with AMC, we recognized a $3.6 million loss from the early extinguishment of debt, which is reported separately within our statement of operations. This loss primarily represents the unamortized debt discount and deferred financing costs at the time of repayment and a prepayment penalty of $0.8 million. In 2017, we amended our credit agreement with AMC (see Liquidity and Capital Resources below) and recorded a gain of $0.3 million. The gain was a result of us recording the new amended debt at an amount that was slightly less than its current carrying amount.

Other Income (Expense)

Other expense mostly 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 recognized other income; and as the Pound weakens relative to the Dollar, we recognize other expense. During 2017, the Pound strengthened relative to the dollar, and we recognized a foreign currency gain of $0.6 million. During 2016, the Pound weakened relative to the dollar, and we recognized foreign currency loss of $1.5 million.

Income Taxes

We have fully reserved our net U.S. deferred tax assets, and such tax assets 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 losses (or NOL) carryforwards, the ability to use our NOL carryforwards against future earnings will be subject to applicable carryforward periods and limitations subsequent to a change in ownership. As of December 31, 2017, we had NOL carryforwards for federal and state income tax purposes of approximately $113.6 million and $61.0 million, respectively.

We recorded income tax expense of $1.2 million and $0.2 million for the years ended December 31, 2017 and 2016, respectively. Our tax provision consists primarily of a deferred tax provision for certain deferred tax liabilities and a current tax provision for our U.K. operations. We are recording a deferred tax provision and liability for our equity earnings of affiliate (ACL). These earnings will be taxable in the U.K., when and if we dispose of our investment. We are providing current income tax expense on pre-tax income from our consolidated U.K. subsidiaries at an effective tax rate of approximately 19%. We are not providing a current tax provision (benefit) on our U.S. operations, other than for certain state minimum taxes, which are not material.

Loss from Discontinued Operations, Net of Income Taxes

Our loss from discontinued operations is attributable to us transitioning our U.S. catalog/ecommerce business to USA, which was completed during 2016. For the year ended December 31, 2016, our loss from discontinued operations was $3.3 million. Revenues from discontinued operations were $7.8 million for the year ended December 31, 2016.

Adjusted EBITDA

Management defines Adjusted EBITDA as earnings before income tax, depreciation and amortization, non-cash royalty expense, interest expense, non-cash exchange gains and losses on intercompany accounts, goodwill impairments, restructuring costs, change in fair value of stock warrants and other derivatives, stock-based compensation, basis-difference amortization in equity earnings of affiliate and dividends received from affiliate in excess of equity earnings of affiliate.

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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 non-cash items that allows investors to analyze the operating performance of the business using the same metric management uses. The exclusion of non-cash 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. Management uses this measure to assess operating results and performance of our business, perform analytical comparisons, identify strategies to improve performance and allocate resources to our business segments. While management considers Adjusted EBITDA to be an important measure 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 US 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.

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

 

 

Adjusted EBITDA increased by $3.5 million for the year ended December 31, 2017 compared to the same period in the prior year. The increase reflects our improved operating results from continuing operations after adjusting for the above non-cash expenses. The improved performance primarily results from the growth of our Digital Channels segment, which is becoming a larger portion of our business and is contributing a higher profit margin. Adjusted EBITDA also improved due to the improved performance of our investment in ACL during the fiscal year ended December 31, 2017 as compared to the same period in December 31, 2016. The 2017 restructuring adjustment primarily includes our net gain on extinguishment of debt, certain non-recurring transaction costs totaling $0.3 million, a legal settlement of $0.2 million and severance payments totaling $0.2 million. The 2016 restructuring adjustment includes our loss on extinguishment of debt and related transaction costs. The adjustment also includes severance payments and related expenses totaling $2.1 million, which consist entirely of personnel costs that have been eliminated as a result of our restructuring activities.

 

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BALANCE SHEET ANALYSIS

Assets

Total assets at December 31, 2017 and 2016, were $147.6 million and $136.0 million, respectively. The increase of $11.6 million in assets is primarily attributed to increases in investments in content of $9.8 million, equity investment in ACL of $5.1 million and increase in accounts receivable of $1.2 million offset by decreases in other intangible assets of $1.6 million, cash of $1.6 million and inventories of $1.3 million. The decrease in cash is primarily due to increased investments in content and increased royalty payments offset by the expansion of our debt, which generated about $9.3 million of cash, and cash dividends received from ACL of $2.5 million. Our equity investment in ACL primarily increased due to improved operating performance. Our accounts receivable increased largely due to the growth of revenues from our Digital Channels segment.

A summary of assets by segment is as follows:

 

 

Liabilities and Equity

The increase of liabilities and equity of $11.6 million to $147.6 million is primarily due to an $10.6 million increase in our debt balance.

Liquidity and Capital Resources

Liquidity

A summary of our cash flow activities is as follows:

 

 

At December 31, 2017 and 2016, our cash balances were approximately $6.2 million and $7.8 million, respectively.

 

The aggregate cash used in operating and investing activities during the year ended December 31, 2017 was provided by cash from our operation and our financing activities. During the year ended December 31, 2017, our cash position was impacted by the following:

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Our past due vendor payables are currently $7.7 million, a reduction of $4.4 million from last year. These past-due payables are largely a result of significant past-due vendor payables acquired in 2012 when purchasing Image. As we work to catch up on the acquired past-due payables, we have fallen behind on other payables. We continue to work with our vendors to make payment arrangements that are agreeable with them and that give us flexibility in terms of when payments will be made. Additionally, we must maintain a certain level of expenditures for marketing to support subscriber growth and for the acquisition of new content that allows us to generate revenues and margins sufficient to meet our obligations.

Growth of our Digital Channels segment has the potential impact of improving our liquidity. We continue to realize significant growth in our Digital Channels segment. Our Digital Channels segment revenues increased 67.2% to $27.2 million during 2017. After cost of sales and operating expenses, our Digital Channels segment contributed $8.8 million of income from continuing operations for 2017 compared to $6.3 million last year. Our expectation is that our Digital Channels will continue to grow, however there is no assurance that this will occur.

In October 2016, we refinanced our senior debt. In January 2017, to repay our subordinated notes payable, we amended our senior debt and borrowed an additional $8.0 million. In June 2017, we expanded our senior debt and borrowed an additional $10.0 million. The proceeds received are available for working capital purposes, including the acquisition of content In addition to providing us liquidity, the amended senior loan facility helps us address our liquidity constraints going forward in three ways: (1) it eliminates cash interest payments, which were 12% prior to October 14, 2016 and 4% through March 31, 2017, (2) there are no required principal payments until 2020, and (3) the financial covenants have been reset to less restrictive levels that provide us the necessary flexibility to invest in our operations.

During the year ended December 31, 2017, we had capital expenditures of $1.9 million which includes $0.3 million that was accrued for in accounts payable. The capital expenditures by segment during 2017 were $1.3 million $0.6 million for the Digital Channels and Corporate segments, respectively. During the year ended December 31, 2016, we had capital expenditures of $1.7 million, which includes $0.3 million that was accrued for in accounts payable. The capital expenditures by segment during 2016 were $1.4 million and $0.3 million for the Digital Channels and Corporate segments, respectively.

We believe that our current cash at December 31, 2017, will be sufficient to meet our forecasted requirements for operating liquidity and capital expenditures for at least one year from the date of issuance of this report. We have no required debt repayments until 2020. However, there can be no assurances that we will be successful in realizing improved results from operations including improved Adjusted EBITDA, generating sufficient cash flows from operations or agreeing with vendors on revised payment terms.

Capital Resources

Cash

As of December 31, 2017, we had cash of $6.2 million, as compared to $7.8 million as of December 31, 2016.

Senior Term Notes

On October 14, 2016, we entered into a $65.0 million Credit and Guaranty Agreement (the AMC Credit Agreement) with Digital Entertainment Holdings LLC, a wholly owned subsidiary of AMC Networks Inc. (or AMC). Concurrent with entering into the AMC Credit Agreement, we also issued AMC three warrants (the AMC Warrants) to acquire a total of 20.0 million shares of our common stock at $3.00 per share. The entering of the AMC Credit Agreement, the issuance of the AMC Warrants and the associated transactions are referred to as the AMC Transaction.

The proceeds received from the AMC Credit Agreement were used to repay our prior senior secured term notes of $55.1 million, including accrued interest, and transaction expenses of approximately $1.7 million, which includes a prepayment penalty of $0.8 million. Initially, the AMC Credit Agreement consisted of (i) a term loan tranche in the principal amount of

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$5.0 million (or Tranche A Loan), which was due on October 14, 2017, and (ii) a term loan tranche in the principal amount of $60.0 million (or Tranche B Loan) of which 25% is due after five years, 50% is due after six years and the remaining 25% is due after seven years. The Tranche A Loan bears interest at a rate of 7.0% per annum and the Tranche B Loan bears interest at a rate of 6.0% per annum. Interest was payable quarterly whereby 4.0% was payable in cash and the balance was payable in shares of common stock determined using a per-share value of $3.00. The loan is secured by a lien on substantially all of our consolidated assets.

On January 30, 2017, to repay prior debt obligations under the subordinated notes payable we amended the AMC Credit Agreement and borrowed an additional $8.0 million, thereby increasing our Tranche A Loan from $5.0 million to $13.0 million. We also extended the maturity date for our Tranche A Loan from October 14, 2017 to June 30, 2019.

On June 16, 2017, to fuel the growth of our business we expanded the AMC Credit Agreement and borrowed an additional $10.0 million, thereby increasing our Tranche A Loan from $13.0 million to $23.0 million. Further, we extended the maturity date for our Tranche A Loan from June 30, 2019 to beginning on June 30, 2020. We also amended the payment provisions regarding interest whereby all interest is now settled with shares of common stock at $3.00 per share beginning as of April 1, 2017. The additional $10.0 million borrowed was used for working capital purposes, including the acquisition of content. This amendment also changed certain debt covenant ratios to reflect the extended maturity date and the increase of the Tranche A Loan balance.

On October 2, 2017, we issued AMC 427,347 shares of common stock in payment of $1.3 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement.

Concurrent with the June amendment, RLJ SPAC Acquisition, LLC converted all of its preferred stock holdings into shares of common stock and AMC exercised a portion of its warrants, which resulted in the Tranche B Loan principal reduction of $5.0 million. This reduction in principal did not result in a prepayment penalty.

Subject to certain customary exceptions, the AMC Credit Agreement requires mandatory prepayments if we were to receive proceeds from asset sales, insurance, debt issuance or the exercise of the warrants. We may also make voluntary prepayments. Prepayments of the Tranche B Loan (either voluntary or mandatory) are subject to a prepayment premium of 3.0% if principal is repaid on or before October 14, 2018, and 1.5% if principal is repaid after October 14, 2018 but on or before October 14, 2019. No prepayment premium is due for amounts prepaid after October 14, 2019, and for mandatory prepayments made from proceeds received from the exercise of warrants. The Tranche A Loan is not subject to prepayment penalties.

The AMC Credit Agreement contains certain financial and non-financial covenants. Financial covenants are assessed annually and are based on Consolidated Adjusted EBITDA, as defined in the AMC Credit Agreement. Financial covenants vary by fiscal year and generally become more restrictive over time.

Financial covenants include the following:

 

 

The AMC 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 AMC Credit Agreement.

The AMC Credit Agreement imposes restrictions on such items as encumbrances and liens, payments of dividends to common stockholders, 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 AMC Credit Agreement, we must maintain at all times a cash balance of $2.0 million in cash for 2017 and $3.5 million in cash for all years thereafter. As of December 31, 2017, we were in compliance with all covenants as stipulated in the amended AMC Credit Agreement.

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Subordinated Notes Payable

On January 31, 2017, we repaid the outstanding principal and interest on our unsecured subordinated promissory notes. When doing so, we did not incur a prepayment penalty. The subordinated notes were issued in 2012 in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image (or Subordinated Note Holders). In 2015, and 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 warrants to acquire approximately 855,000 shares of common stock.

Preferred Stock

On May 20, 2015, we closed a transaction in which we sold 31,046 shares of preferred stock and warrants to acquire 3.1 million shares of common stock (the 2015 Warrants) 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 1.7 million 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 senior notes payable 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 was used for content investment and working capital purposes. Of the fees incurred, $0.9 million was recorded against the proceeds received, $0.5 million was recorded as additional debt discounts, $0.2 million was included as interest expense and the balance was included in other expense.

On October 14, 2016 and concurrent with the close of the AMC Credit Agreement, we amended our preferred stock such that we were able to classify our preferred stock and its embedded conversion feature within our shareholders’ equity. Prior to the amendment, our preferred stock and its embedded conversion feature were recorded on our consolidated balance sheet outside of shareholders’ equity. The amended terms are disclosed below.

The preferred stock has the following rights and preferences:

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We are adjusting the carrying balance of our preferred stock to its Redemption Value using the effective interest-rate method over a period of time beginning from the issuance of May 20, 2015 to the required redemption date of May 20, 2020. During the years ended December 31, 2017 and 2016, we recognized accretion of $1.2 million and $4.3 million, respectively. Accretion includes cumulative preferred dividends. As of December 31, 2017, the accumulated unpaid dividends on preferred stock were $2.8 million. During the years ended December 31, 2017 and 2016, accumulated unpaid dividends increased by $0.7 million (or $46.16 per share of preferred stock) and $2.7 million (or $88.60 per share of preferred stock), respectively.

During 2016, two preferred shareholders converted a total of 849 shares of preferred stock and $0.1 million of accumulated dividends into 0.3 million shares of common stock. During June 2017, the largest preferred shareholder (RLJ SPAC Acquisition, LLC) converted a total of 15,000 shares of preferred stock and $2.7 million of accumulated dividends into 5.9 million shares of common stock.

In 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 2015 Warrants. The registration statement was declared effective in July 2015 and amended in 2016. 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 will use our best efforts to keep the registration statement effective.

RELATED PARTY TRANSACTIONS

In the ordinary course of business we enter into transactions with related parties, primarily our equity method investee and entities owned and controlled by the Chairman of our Board of Directors. Information regarding transactions and amounts with related parties is discussed in Note 22, Related Party Transactions of our consolidated financial statements and Item 13 of this report.

NEW ACCOUNTING AND REPORTING PRONOUNCEMENTS

A summary of the accounting pronouncement issued but, not required to be adopted for the preparation of our current financial statements is as follows:

In May 2014, the FASB Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, as a new Topic, (ASC) Topic 606. Subsequent to the issuance of the May 2014 guidance, several clarifications and updates have been issued by the FASB on this topic, the most recent of which was issued in December 2016. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Based on the current guidance, the new framework will become effective for us on January 1, 2018. We will be electing the modified retrospective method; and as such, we will not be restating our revenues for 2017 or prior periods. Upon adoption, we will also be applying the new standard to all customer contracts. We have completed our analysis and identified certain areas that will be impacted as follows:

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The new revenue standards also contain expanded disclosure requirements for which we are currently analyzing. We will conclude on our expanded revenue disclosures before issuing our first quarter financial statements in May 2018.

In February 2016, the FASB issued ASU No. 2016-02, Leases. This ASU establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of the pending adoption of this new standard on our financial statements and we have yet to determine the overall impact this ASU is expected to have. The likely impact will be one of presentation only on our consolidated balance sheet.  Our leases currently consist of operating leases with varying expiration dates through 2022 and our future minimum lease commitments before sub-lease income total $3.8 million.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our consolidated financial statements are prepared in accordance with US GAAP, which requires management to make estimates, judgments and assumptions that affect the amounts reported in our consolidated financial statements. Management considers an accounting policy to be critical if it is important to our financial condition and results of operations, and if it requires significant judgment and estimates on the part of management in its application. The development and selection of these critical accounting policies have been determined by management and the related disclosures have been reviewed with the Audit Committee of our Board of Directors. We consider the following accounting policies to be critical in the preparation of our consolidated financial statements:

Revenue Recognition

Revenue Recognition

Revenues from our digital channels are recognized on a straight-line basis over the subscription period once the subscription has been activated.

Revenues from home video exploitation, which includes IP Licensing and Wholesale Distribution revenues, are recognized upon meeting the recognition requirements of the Financial Accounting Standards Board Accounting Standards Codification (or ASC) 926, Entertainment—Films and ASC 605, Revenue Recognition. We generate our IP Licensing and Wholesale Distribution revenues primarily from the exploitation of acquired or produced content rights through various distribution channels. The content is monetized in DVD format to wholesalers, licensed to broadcasters including cable companies and digital platforms like Amazon and Netflix, and exploited through other windows such as VOD. Revenues are presented net of sales returns, rebates, unit price adjustments, sales return reserves, sales discounts and market development fund reserves. Revenues from our U.K. catalog sales are recognized, net of an allowance for estimated returns, once payment has been received from the customer and the items ordered have been shipped.

Revenues from home video exploitation are recognized net of an allowance for estimated returns, as well as related costs, in the period in which the product is available for sale by our wholesale partners (at the point that title and risk of loss transfer to the customer, which is generally upon receipt by the customer and in the case of new releases, after “street date” restrictions lapse). Rental revenues under revenue sharing arrangements are recognized when we are entitled to receipts and such receipts are determinable. Revenues from domestic and international broadcast licensing and home video sublicensing, as well as associated costs, are recognized when the programming is available to the licensee and all other recognition requirements are met such as the broadcaster is free to air the programming. Fees received in advance of availability, usually in the case of advances received from international home video sub-licensees and for broadcast programming, are deferred until earned and all revenue recognition requirements have been satisfied. Provisions for sales returns and uncollectible accounts receivable are provided at the time of sale.

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Allowances for Sales Returns

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

Investments in Content

Investments in content include the unamortized costs of completed and uncompleted films and television programs that were acquired or produced. Within the carrying balance of investments in content are development and production costs for films and television programs which are acquired or produced.

Acquired Distribution Rights and Produced Content

Royalty and Distribution Fee Advances – When acquiring titles, we often make a royalty and distribution fee advances that represent a fixed minimum payment made to program suppliers for exclusive content distribution rights. A program supplier’s share of exclusive program distribution revenues is retained by us until the share equals the advance(s) paid to the program supplier plus recoupable costs. Thereafter, any excess is paid to the program supplier. In the event of an excess, we also record, as content amortization and royalties – a component of cost of sales, an amount equal to the program supplier’s share of the net distribution revenues.

Original Production Costs – For films and television programs produced by RLJE, original production costs include all direct production and financing costs, as well as production overhead.

Unamortized content investments for our Digital Channels are charged to content amortization and royalties using the straight-line method over the license term for which the content is available to the Digital Channels.

For IP Licensing and Wholesale Distribution, unamortized content investments are charged to content amortization and royalties as revenues are earned in the same ratio that current period revenue for a title or group of titles bears to the estimated remaining unrecognized ultimate revenue for that title.

Ultimate revenue includes estimates over a period not to exceed ten years following the date of initial release, or for episodic television series a period not to exceed 10 years from the date of delivery of the first episode or, if still in production, five years from the date of delivery of the most recent episode, if later.

Investments in content are stated at the lower of amortized 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 a film or television program is less than its unamortized cost. Additional amortization is recorded in the amount by which the unamortized costs exceed the estimated fair value of the film or television program. Estimates of future revenues involve measurement uncertainty and it is therefore possible that reductions in the carrying value of investment in films and television programs may be required as a consequence of changes in management’s future revenue estimates.

Content programs in progress include the accumulated costs of productions, which have not yet been completed, and advances on content not yet received from program suppliers. We begin to amortize these investments once the content has been released.

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Production Development Costs

The costs to produce licensed content for domestic and international exploitation include the cost of converting film prints or tapes into the optical disc format. Depending on the platform for which the content is being exploited, costs may include menu design, authoring, compression, subtitling, closed captioning, service charges related to disc manufacturing, ancillary material production, product packaging design and related services. These costs are capitalized as incurred. A percentage of the capitalized production costs are amortized to expense based upon: (i) a projected revenue stream resulting from distribution of new and previously released content related to such production costs; and (ii) management’s estimate of the ultimate net realizable value of the production costs. Estimates of future revenues are reviewed periodically and amortization of production costs is adjusted accordingly. If estimated future revenues are not sufficient to recover the unamortized balance of production costs, such costs are reduced to their estimated fair value.

Inventories

For each reporting period, we review the value of inventories on hand to estimate the recoverability through future sales. Values in excess of anticipated future sales are recorded as obsolescence reserve. Inventories consist primarily of packaged goods for sale, which are stated at average cost, as well as componentry.

Goodwill and Other Intangible Assets

Goodwill

Goodwill represents the excess of acquisition costs over the tangible and identifiable intangible assets acquired and liabilities assumed in a business acquisition. Goodwill is recorded at our reporting units, which are consolidated into our reporting segments. Goodwill is not amortized but is reviewed for impairment annually on October 1^st of each year or between the annual tests if an event occurs or circumstances change that indicates it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value. Goodwill is considered potentially impaired if there are subjective characteristics that suggest that goodwill is impaired or quantitatively when the fair value of the reporting unit is less than the reporting unit’s carry amount, including goodwill. An impairment loss is then measured as the excess of recorded goodwill over the value of the goodwill. The calculated value of goodwill is determined as the difference between the reporting unit’s current fair value and its book value, without goodwill. The determination of a reporting unit’s fair value requires various assumptions and estimates, which include consideration of the future, projected operating results and cash flows. Such projections could be different than actual results. Should actual results be significantly less than estimates, the value of our goodwill could be impaired in future periods.

Other Intangible Assets

Other intangible assets are reported at their estimated fair value, when acquired, less accumulated amortization. The majority of our intangible assets were recognized as a result of the Business Combination. As such, the fair values of our intangibles were recorded in 2012 when applying purchase accounting. Additions since the 2012 Business Combination are limited to software expenditures related to our websites and various digital platforms such as Roku and AppleTV. Similar to how we account for internal-use software development, costs incurred to develop and implement our websites and digital platforms are capitalized in accordance with ASC 350-50, Website Development Costs. Website operating costs are expensed as incurred. Costs incurred for upgrades and enhancements that provide additional functionality are capitalized.

Amortization expense of our other intangible assets is generally computed by applying the straight-line method, or based on estimated forecasted future revenues as stated below, over the estimated useful lives of trade names (11 to 15 years), websites and digital platforms (three years), supplier contracts (seven years), customer relationships (five years), options on future content (seven years) and leases (two years). The recorded value of our customer relationships is amortized on an accelerated basis over five years, with approximately 60% being amortized over the first two years (through 2014), 20% during the third year and the balance ratably over the remaining useful life. The recorded value of our options on future content is amortized based on forecasted future revenues, whereby approximately 50% is being amortized over the first two years (through 2014), 25% during the third year and the balance in decreasing amounts over the remaining four years.

Additional amortization expense is provided on an accelerated basis when the useful life of an intangible asset is determined to be less than originally expected. Other intangible assets are reviewed for impairment when an event or circumstance indicates the fair value is lower than the current carrying value.

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Warrant and Other Derivative Liabilities

We have warrants outstanding to purchase 21.3 million shares of our common stock. In October 2016, we issued three separate warrants to our senior lender to acquire a total of 20.0 million shares of our common stock. For one of these warrants issued to acquire 5.0 million shares of common stock, we are accounting for the warrant as a derivative liability because the warrant contains a provision that may increase the number of shares acquirable for no additional consideration. This increase is contingent upon the number of shares of common stock outstanding at the time of exercise. Derivative liability warrants are carried on our consolidated balance sheet at their fair value with changes in fair value being included in the consolidated statement of operations as a separate component of other income (expense).

In May 2015, we issued additional warrants to acquire 3.1 million shares of our common stock. We were accounting for these warrants as a derivative liability because, among other provisions, the warrants contained a provision that allows the warrant holders to sell their warrants back to us, at their discretion, at a cash purchase price equal to the warrants’ then fair value, upon the consummation of certain fundamental transactions, such as a business combination or other change-in-control transactions. In October 2016, the 2015 warrants were amended and they are now being accounted for within shareholders’ equity.

Warrants issued in 2012 to acquire 7.0 million shares of common stock contain a provision whereby the exercise price would be reduced if RLJE is reorganized as a private company. Because of this provision, we accounted for those warrants as a derivative liability in accordance with ASC 815-40, Contracts in Entity’s Own Equity. The 2012 Warrants expired on October 3, 2017.

Our preferred stock is convertible into shares of common stock at an exchange rate equal to 333.3 shares of common stock for each share of preferred stock, subject to adjustment for any unpaid dividends. The conversion rate is subject to certain anti-dilution protections. Those protections did include an adjustment for offerings consummated at a per-share price of less than $3.00 per common share. Because of this potential adjustment to the conversion rate, we had bifurcated the conversion feature from its host instrument (a preferred share) and we were accounting for the conversion feature as a derivative liability. In October 2016, we amended the conversion feature to avoid liability accounting and as such we now account for the conversion feature as part of the host instrument.

Income Taxes

We account for income taxes pursuant to the provisions of ASC 740, Income Taxes, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and the future tax benefits derived from operating loss and tax credit carryforwards. We provide a valuation allowance on our deferred tax assets when it is more likely than not that such deferred tax assets will not be realized.

ASC 740 requires that we recognize in the consolidated financial statements the effect of a tax position that is more likely than not to be sustained upon examination based on the technical merits of the position. The first step is to determine whether or not a tax benefit should be recognized. A tax benefit will be recognized if the weight of available evidence indicates that the tax position is more likely than not to be sustained upon examination by the relevant tax authorities. The recognition and measurement of benefits related to our tax positions requires significant judgment as uncertainties often exist with respect to new laws, new interpretations of existing laws, and rulings by taxing authorities. Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known. For tax liabilities, we recognize accrued interest related to uncertain tax positions as a component of income tax expense, and penalties, if incurred, are recognized as a component of operating expense.

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Off-Balance Sheet Arrangements

We typically acquire content via separately executed licensing or distribution agreements with content suppliers. These contracts generally require that we make advance payments before the content is available for exploitation. Advance payments are generally due prior to and upon delivery of the related content. To the extent payment is not due until delivery has occurred, we do not recognize our payment obligations under our licensing and distribution agreements prior to the content being delivered. As of December 31, 2017, we had entered into licensing and distribution agreement for which we are obligated to pay $7.2 million once the related content has been delivered.

CONTRACTUAL COMMITMENTS

A table with our contractual commitments is not required for smaller reporting companies within our MD&A. For information regarding our contractual commitments refer to Note 10, Debt and Note 21, Commitment and Contingencies to our consolidated financial statements.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk is not required for smaller reporting companies.

 

 

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RLJ ENTERTAINMENT, INC. AND SUBSIDIARIES

Report of Independent Registered Public Accounting Firm

Shareholders and Board of Directors

RLJ Entertainment, Inc.

Silver Spring, Maryland

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of RLJ Entertainment, Inc. (the “Company”) and subsidiaries as of December 31, 2017 and 2016, the related consolidated statements of operations, comprehensive loss, changes in shareholders’ (deficit) equity, and cash flows for the years then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2017 and 2016, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ BDO USA, LLP

We have served as the Company's auditor since 2015.

Los Angeles, California

March 16, 2018

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

As of December 31, 2017 and 2016

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended December 31, 2017 and 2016

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

Years Ended December 31, 2017 and 2016

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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RLJ ENTERTAINMENT, INC.

 

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ (DEFICIT) EQUITY

 

Years Ended December 31, 2017 and 2016

 

 

See accompanying notes to consolidated financial statements.

 

 

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RLJ ENTERTAINMENT, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2017 and 2016

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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RLJ ENTERTAINMENT, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Description of Business

RLJ Entertainment, Inc. (RLJE or the Company) 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 United Kingdom (or U.K.) subsidiaries RLJ Entertainment Ltd (or RLJE Ltd.), Acorn Media Enterprises Limited (or AME), and RLJE International Ltd (collectively, RLJE UK), as well as RLJ Entertainment Australia Pty Ltd (or RLJE Australia). 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 an additional location in Woodland Hills, California. We also have international offices in London, England and Sydney, Australia.

We are a premium digital channel company serving distinct audiences through our proprietary subscription-based video on demand (or SVOD) digital channels (or Digital Channels segment), Acorn TV and UMC or Urban Movie Channel. Acorn TV features high-quality British and International mysteries and dramas. UMC showcases quality urban programming including feature films, documentaries, original series, stand-up comedy and other exclusive content for African-American and urban audiences.  

We also exclusively control, co-produce, and own a large library of content primarily consisting of British mysteries and dramas, independent feature films and Urban content. In addition to supporting our Digital Channels, we monetize our library through distribution operations across all available wholesale windows of exploitation (our Wholesale Distribution segment) and intellectual property (or IP) rights that we own, produce, and then exploit worldwide (our IP Licensing segment). Our IP Licensing segment consists of content that we own and includes our investment in Agatha Christie Ltd. (or ACL), while our Wholesale Distribution segment consists of content we license from others that we exploit through our wholesale partners, including broadcasters, digital outlets and major retailers in the United States of American (or U.S.), Canada, U.K. and Australia. 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.

Basis of Presentation

The accompanying audited consolidated financial statements and related footnotes have been prepared in accordance with accounting principles generally accepted in the United States of America (or US GAAP) and with the Securities and Exchange Commission’s (or SEC) instructions for the Form 10-K. The preparation of financial statements in conformity with US GAAP requires estimates and assumptions that affect the reported amounts within our consolidated financial statements. Although we believe that these estimates to be reasonably accurate, actual amounts may differ.  

Principles of Consolidation

The operations of ACL are subject to oversight by ACL’s Board of Directors. 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. 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 our 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 as “Equity earnings of affiliate” in our consolidated statements of operations.  All intercompany transactions and balances have been eliminated.

Discontinued Operations

During December 2015, we committed to a plan to stop circulating our Acacia catalogs and to liquidate the catalog’s inventory. The last Acacia print catalogs were circulated in January 2016 and electronic email distribution continued through May 2016. On June 24, 2016, we entered into a licensing agreement to outsource our U.S. Acorn catalog and ecommerce business to Universal Screen Arts (or USA) whereby USA took over our Acorn U.S. catalog/ecommerce business becoming the official, exclusive, direct-to-consumer seller of Acorn product in the U.S. through catalogs and ecommerce. As such, USA received the rights to the Acorn catalog

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and related website for an 18-month period. In May 2017, we amended the agreement and extended the licensing term through March 31, 2020. To facilitate the transfer of the catalog to USA, we granted USA access to the catalog’s customer list and the Acorn brand. Going forward, we will also endeavor to provide USA with an exclusivity period for new Acorn releases. USA is responsible for all costs associated with their efforts. On an annual basis, USA will purchase from us a minimum of $1.2 million of inventory (Acorn video content) at pricing that is consistent with wholesale pricing. We also agreed to a one-time transfer of certain existing inventory to USA at cost. Further, we have been given meaningful consultation rights regarding sales prices of Acorn content listed in the catalog.

In addition to purchasing inventory from us, USA makes royalty payments to us for the various rights we have licensed. Further, all customer and marketing data obtained during the license period is jointly owned by both companies. During the years ended December 31, 2017 and 2016, our Wholesale Distribution segment recognized revenues of $2.2 million and $0.8 million, respectively, from its sale of inventory to USA.

We consider the outsourcing of the U.S. Acorn catalog to be a major strategic shift in our business. Future revenues and gross margins from our outsourced operations will decrease. However, operating profits will increase as we have historically incurred significant selling expenses that will be eliminated. Upon circulating the last Acacia catalog and entering into the licensing agreement with USA during the quarter ended June 30, 2016, we classified the U.S. catalog/ecommerce business (Acacia and U.S. Acorn catalogs) as discontinued operations.

Major classes of line items constituting loss from discontinued operations, net of income taxes are:

 

 

There are no income taxes allocable to the discontinued operations as the discontinued operations reside in the U.S. for which there is no tax provision as a result of the overall U.S. operating loss for tax purposes.

During 2016, we assessed the remaining useful lives of property, equipment and improvements and other intangible assets held by the discontinued operations. As a result, we recorded accelerated depreciation and amortization of $0.3 million during 2016. Because USA is licensing our customer list, for which we retained a shared ownership, we made no changes as to how we are amortizing our other intangible assets.

During 2016, we provided lay-off notices to our U.S. catalog/ecommerce business employees and recorded severance charges of $0.3 million.

In September 2016, we vacated our office space in Minnesota. Our lease in Minnesota requires us to make average monthly payments of $12,500 through June 2022. We subleased our office space effective October 1, 2016. As a result, we incurred a loss on this sublease of $0.2 million primarily pertaining to leasehold improvements and other fixed assets that we provided to the subtenant for no additional consideration.

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Operating and investing cash flows of the discontinued operations are as follows:

 

 

Liquidity

At December 31, 2017, our cash balance was $6.2 million. For the year ended December 31, 2017, we recognized a net loss of $6.1 million and we used $8.9 million of cash for operating activities. At December 31, 2017, we had $52.6 million of term debt outstanding (see Note 10, Debt). We continue to experience liquidity constraints as we have several competing demands on our available cash and cash that may be generated from operations. We continue to have significant past-due vendor payables that are currently $7.7 million, which is $4.4 million less than last year’s balance. These past-due payables are largely a result of significant past-due vendor payables acquired in 2012 when purchasing Image. As we work to catch up on the acquired past-due payables, we have fallen behind on other payables. We continue to work with our vendors to make payment arrangements that are agreeable with them and that give us flexibility in terms of when payments will be made. Additionally, we must maintain a certain level of expenditures for marketing to support subscriber growth and for the acquisition of new content that allows us to generate revenues and margins sufficient to meet our obligations.

Growth of our Digital Channels segment has the potential impact of improving our liquidity. We continue to realize significant growth in our Digital Channels segment. Our channel revenues increased 67.2% to $27.2 million during 2017 (see Note 3, Segment Information). By way of comparison, our channel revenues increased 116% during 2016. After cost of sales and operating expenses, our Digital Channels segment contributed $8.8 million of income from continuing operations for 2017 compared to $6.3 million last year. Our expectation is that our digital channels will continue to grow, however there is no assurance that this will occur.

On October 14, 2016, we refinanced our senior debt (see Note 10, Debt). In January 2017, to repay our subordinated notes payable, we amended our senior debt and borrowed an additional $8.0 million. In June 2017, we expanded our senior debt and borrowed an additional $10.0 million. The proceeds received are available for working capital purposes, including the acquisition of content. In addition to providing us liquidity, the amended senior loan facility helps us address our liquidity constraints going forward in three ways: (1) it eliminates cash interest payments, which were 12% prior to October 14, 2016 and 4% through March 31, 2017, (2) there are no required principal payments until 2020, and (3) the financial covenants have been reset to less restrictive levels that provide us the necessary flexibility to invest in our operations.

We believe that our current cash at December 31, 2017 will be sufficient to meet our forecasted requirements for operating liquidity, capital expenditure and debt repayments for at least one year from the date of issuance of these consolidated financial statements. However, there can be no assurances that we will be successful in realizing improved results from operations including improved Adjusted EBITDA, generating sufficient cash flows from operations or agreeing with vendors on revised payment terms.

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Use of Estimates

The preparation of our consolidated financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. The significant areas requiring the use of management estimates are related to provisions for lower-of-cost or market inventory write-downs, accounts receivable allowances and provision for doubtful accounts and sales returns reserves, valuation of deferred taxes, valuation of warrants, goodwill impairments, and ultimate projected revenues of our film library, which impact amortization of investments in content and related impairment assessments. Although these estimates are based on management’s knowledge of current events and actions management may undertake in the future, actual results may ultimately differ materially from those estimates.

Revenues and Receivables

Revenue Recognition

Revenues from our SVOD services through our Digital Channels segment are recognized on a straight-line basis over the subscription period once the subscription has been activated.

Revenues from home video exploitation, which includes the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, AME, and our majority-owned equity method investee, ACL (IP Licensing segment) and Wholesale Distribution segment revenues, are recognized upon meeting the recognition requirements of the Financial Accounting Standards Board Accounting Standards Codification (or ASC) 926, Entertainment—Films and ASC 605, Revenue Recognition. We generate our IP Licensing and Wholesale Distribution segment revenues primarily from the exploitation of acquired or produced content rights through various distribution channels. The content is monetized in DVD format to wholesalers, licensed to broadcasters including cable companies and digital platforms like Amazon and Netflix, and exploited through other windows such as video-on-demand (or VOD). Revenue is presented net of sales returns, rebates, unit price adjustments, sales return reserves, sales discounts and market development fund reserves. Revenues from our U.K. catalog sales are recognized, net of an allowance for estimated returns, once payment has been received from the customer and the items ordered have been shipped.

Revenues from home video exploitation are recognized net of an allowance for estimated returns, as well as related costs, in the period in which the product is available for sale by our wholesale partners (at the point that title and risk of loss transfer to the customer, which is generally upon receipt by the customer and in the case of new releases, after “street date” restrictions lapse). Rental revenues under revenue sharing arrangements are recognized when we are entitled to receipts and such receipts are determinable. Revenues from domestic and international broadcast licensing and home video sublicensing, as well as associated costs, are recognized when the programming is available to the licensee and all other recognition requirements are met such as the broadcaster is free to air the programming. Fees received in advance of availability, usually in the case of advances received from international home video sub-licensees and for broadcast programming, are deferred until earned and all revenue recognition requirements have been satisfied. Provisions for sales returns and uncollectible accounts receivable are provided at the time of sale.

Allowances for Sales Returns

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

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Allowances Received from Vendors

In accordance with ASC 605-50, Revenue Recognition—Customer Payments and Incentives, we classify consideration received as a reduction in cost of sales in the accompanying statements of operations unless the consideration represents reimbursement of a specific, identifiable cost incurred by us in selling the vendor’s product.

Shipping Revenues and Expenses

In accordance with ASC 605-45, Revenue Recognition—Principal Agent Considerations, we classify amounts billed to customers for shipping fees as revenues, and classify costs related to shipping as cost of sales in the accompanying consolidated statements of operations.

Market Development Funds

In accordance with ASC 605-50, Revenue Recognition—Customer Payment and Incentives, market development funds, including funds for specific product positioning, taken as a deduction from payment for purchases by customers are classified as a reduction to revenues.

Investments in Content

Investments in content include the unamortized costs of completed and uncompleted films and television programs that were acquired or produced. Within the carrying balance of investments in content are development and production costs for films and television programs which are acquired or produced.

Acquired Distribution Rights and Produced Content

Royalty and Distribution Fee Advances – When acquiring titles, we often make royalty and distribution fee advances that represent fixed minimum payments made to program suppliers for exclusive content distribution rights. A program supplier’s share of exclusive program distribution revenues is retained by us until the share equals the advance(s) paid to the program supplier plus recoupable costs. Thereafter, any excess is paid to the program supplier. In the event of an excess, we also record, as content amortization and royalties – a component of cost of sales, an amount equal to the program supplier’s share of the net distribution revenues.

Original Production Costs – For films and television programs we produce, original production costs include all direct production and financing costs, as well as production overhead.

Unamortized content investments for our digital channels are charged to content amortization and royalties using the straight-line method over the license term for which the content is available to the digital channels.

For IP Licensing and Wholesale Distribution, unamortized content investments are charged to content amortization and royalties as revenues are earned in the same ratio that current period revenue for a title or group of titles bears to the estimated remaining unrecognized ultimate revenue for that title.

Ultimate revenue includes estimates over a period not to exceed ten years following the date of initial release, or for episodic television series a period not to exceed 10 years from the date of delivery of the first episode or, if still in production, five years from the date of delivery of the most recent episode, if later.

Investments in content are stated at the lower of amortized 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 a film or television program is less than its unamortized cost. Additional amortization is recorded in the amount by which the unamortized costs exceed the estimated fair value of the film or television program. Estimates of future revenue involve measurement uncertainty and it is therefore possible that reductions in the carrying value of investment in films and television programs may be required as a consequence of changes in management’s future revenue estimates.

Content programs in progress include the accumulated costs of productions, which have not yet been completed, and advances on content not yet received from program suppliers. We begin to amortize these investments once the content has been released.

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Production Development Costs

The costs to produce licensed content for domestic and international exploitation include the cost of converting film prints or tapes into the optical disc format. Depending on the platform for which the content is being exploited, costs may include menu design, authoring, compression, subtitling, closed captioning, service charges related to disc manufacturing, ancillary material production, product packaging design and related services. These costs are capitalized as incurred. A percentage of the capitalized production costs are amortized to expense based upon: (i) a projected revenue stream resulting from distribution of new and previously released content related to such production costs; and (ii) management’s estimate of the ultimate net realizable value of the production costs. Estimates of future revenues are reviewed periodically and amortization of production costs is adjusted accordingly. If estimated future revenues are not sufficient to recover the unamortized balance of production costs, such costs are reduced to their estimated fair value.

Inventories

For each reporting period, we review the value of inventories on hand to estimate the recoverability through future sales. Values in excess of anticipated future sales are recorded as obsolescence reserve. Inventories consist primarily of packaged goods for sale, which are stated at average cost, as well as componentry.

Goodwill and Other Intangible Assets

Goodwill

Goodwill represents the excess of acquisition costs over the tangible and identifiable intangible assets acquired and liabilities assumed in a business acquisition. Goodwill is recorded at our reporting units, which are consolidated into our reporting segments. Goodwill is not amortized but is reviewed for impairment annually on October 1^st of each year or between the annual tests if an event occurs or circumstances change that indicates it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value. Goodwill is considered potentially impaired if there are subjective characteristics that suggest that goodwill is impaired or quantitatively when the fair value of the reporting unit is less than the reporting unit’s carry amount, including goodwill. An impairment loss is then measured as the excess of recorded goodwill over the value of the goodwill. The calculated value of goodwill is determined as the difference between the reporting unit’s current fair value and its book value, without goodwill. The determination of a reporting unit’s fair value requires various assumptions and estimates, which include consideration of the future, projected operating results and cash flows. Such projections could be different than actual results. Should actual results be significantly less than estimates, the value of our goodwill could be impaired in future periods.

During 2017 and 2016, we did not recognize goodwill impairments.

Other Intangible Assets

Other intangible assets are reported at their estimated fair value, when acquired, less accumulated amortization. The majority of our intangible assets were recognized as a result of the Business Combination. As such, the fair values of our intangibles were recorded in 2012 when applying purchase accounting. Additions since the 2012 Business Combination are limited to software expenditures related to our websites and various digital platforms such as Roku and AppleTV. Similar to how we account for internal-use software development, costs incurred to develop and implement our websites and digital platforms are capitalized in accordance with ASC 350-50, Website Development Costs. Website operating costs are expensed as incurred. Costs incurred for upgrades and enhancements that provide additional functionality are capitalized.

Amortization expense of our other intangible assets is generally computed by applying the straight-line method, or based on estimated forecasted future revenues as stated below, over the estimated useful lives of trade names (11 to 15 years), websites and digital platforms (three years), supplier contracts (seven years), customer relationships (five years), options on future content (seven years) and leases (two years). The recorded value of our customer relationships is amortized on an accelerated basis over five years, with approximately 60% being amortized over the first two years (through 2014), 20% during the third year and the balance ratably over the remaining useful life. The recorded value of our options on future content is amortized based on forecasted future revenues, whereby approximately 50% is being amortized over the first two years (through 2014), 25% during the third year and the balance in decreasing amounts over the remaining four years.

Additional amortization expense is provided on an accelerated basis when the useful life of an intangible asset is determined to be less than originally expected. Other intangible assets are reviewed for impairment when an event or circumstance indicates the fair value is lower than the current carrying value.

During 2017 and 2016, we did not recognize any impairment on our other intangible assets.

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Warrant and Other Derivative Liabilities

We have warrants outstanding to purchase 21.3 million shares of our common stock (see Note 12, Stock Warrants). In October 2016, we issued three separate warrants to our senior lender to acquire a total of 20.0 million shares of our common stock. For one of these warrants issued to acquire 5.0 million shares of common stock, we are accounting for the warrant as a derivative liability because the warrant contains a provision that may increase the number of shares acquirable for no additional consideration. This increase is contingent upon the number of shares of common stock outstanding at the time of exercise. Derivative liability warrants are carried on our consolidated balance sheet at their fair value with changes in fair value being included in the consolidated statement of operations as a separate component of other income (expense).

In May 2015, we issued additional warrants to acquire 3.1 million shares of our common stock. We were accounting for these warrants as a derivative liability because, among other provisions, the warrants contained a provision that allows the warrant holders to sell their warrants back to us, at their discretion, at a cash purchase price equal to the warrants’ then fair value, upon the consummation of certain fundamental transactions, such as a business combination or other change-in-control transactions. In October 2016, the 2015 warrants were amended, and they are now accounted for within shareholders’ equity.

Warrants issued in 2012 to acquire 7.0 million shares of common stock contained a provision whereby the exercise price would be reduced if RLJE was reorganized as a private company. Because of this provision, we accounted for those warrants as a derivative liability in accordance with ASC 815-40, Contracts in Entity’s Own Equity. The 2012 Warrants expired on October 3, 2017.

Our preferred stock is convertible into shares of common stock at an exchange rate equal to 333.3 shares of common stock for each share of preferred stock, subject to adjustment for any unpaid dividends. The conversion rate is subject to certain anti-dilution protections. Those protections did include an adjustment for offerings consummated at a per-share price of less than $3.00 per common share. Because of this potential adjustment to the conversion rate, we had bifurcated the conversion feature from its host instrument (a preferred share) and we were accounting for the conversion feature as a derivative liability. In October 2016, we amended the conversion feature to avoid liability accounting and as such we now account for the conversion feature as part of the host instrument.

Income Taxes

We account for income taxes pursuant to the provisions of ASC 740, Income Taxes, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and the future tax benefits derived from operating loss and tax credit carryforwards. We provide a valuation allowance on our deferred tax assets when it is more likely than not that such deferred tax assets will not be realized. We have a valuation allowance against 100% of our net deferred tax assets.

ASC 740 requires that we recognize in the consolidated financial statements the effect of a tax position that is more likely than not to be sustained upon examination based on the technical merits of the position. The first step is to determine whether or not a tax benefit should be recognized. A tax benefit will be recognized if the weight of available evidence indicates that the tax position is more likely than not to be sustained upon examination by the relevant tax authorities. The recognition and measurement of benefits related to our tax positions requires significant judgment as uncertainties often exist with respect to new laws, new interpretations of existing laws, and rulings by taxing authorities. Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known. For tax liabilities, we recognize accrued interest related to uncertain tax positions as a component of income tax expense, and penalties, if incurred, are recognized as a component of operating expense.

In December 2017, Staff Accounting Bulletin No. 118 (or SAB 118) was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Cuts and Jobs Act (the Act). In accordance with SAB 118, we determined that the deferred tax expense recorded in connection with the remeasurement of certain deferred tax assets and liabilities was a provisional amount and a reasonable estimate at December 31, 2017. Additional work is necessary to do a more detailed analysis and any subsequent adjustment to these amounts will be recorded in 2018 when the analysis is complete.

Our foreign subsidiaries are subject to income taxes in their respective countries, as well as U.S. Federal and state income taxes. The income tax payments they make outside the U.S. may give rise to foreign tax credits that we may use to offset taxable income in the U.S.

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Foreign Currency Translation

The consolidated financial statements are presented in our reporting currency, which is the U.S. dollar. For the foreign subsidiaries whose functional currency is other than the U.S. dollar (the British Pound Sterling or GBP for RLJE UK and AME; and Australian dollar for RLJE Australia), balance sheet accounts, other than equity accounts, are translated into U.S. dollars at exchange rates in effect at the end of the period and income statement accounts are translated at average monthly exchange rates. Equity accounts are translated at historical rates. Translation gains and losses are included as a separate component of equity. Gains and losses from foreign currency denominated transactions are included in our consolidated statement of operations as a component of other income (expense).

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 its fair value as it bears interest at market rates of interest after taking into consideration the debt discounts.

ASC 820 defines fair value, establishes a framework for measuring fair value under US GAAP and enhances disclosures about fair value measurements. Fair value is defined under ASC 820 as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value under ASC 820 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair-value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities.

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

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

Our recurring fair value measurements of stock warrants and other derivative liabilities and our non-recurring fair value measurements of investments in content are disclosed in Note 15, Fair Value Measurements. Any non-recurring fair value measurement of goodwill is disclosed in Note 9, Goodwill and Other Intangible Assets.

Concentrations of Credit Risk

Financial instruments, which potentially subject us to concentrations of credit risk, consist primarily of deposit accounts and trade accounts receivable. We maintain bank accounts at financial institutions, which at times may exceed amounts insured by the Federal Deposit Insurance Corporation (or FDIC) and Securities Investor Protection Corporation (or SIPC). We place our cash with several financial institutions which are reputable and therefore bear minimal credit risk. We have never experienced any losses related to these balances.

With respect to trade receivables, we perform ongoing credit evaluations of our customers’ financial conditions and limit the amount of credit extended when deemed necessary but generally require no collateral.

Major Customers and Distribution Facilitators

We have a high concentration of net revenues from relatively few customers, the loss of which may adversely affect our liquidity, business, results of operations, and financial condition. During 2017, sales reported within our Wholesale Distribution segment to one customer accounted for 24.6% of our net revenues. Our top five customers accounted for 55.0% of our Wholesale Distribution segment revenues during the same period. During 2016, sales reported within our Wholesale Distribution segment to one customer accounted for 15.3%, of our net revenues. Our top five customers accounted for approximately 47.8% of our Wholesale Distribution segment revenues for the same period.

During 2017, one customer accounted for 37.5% of revenues reported within our Digitals Channels segment. Our Digital Channels segment includes the sale of video directly to consumers through our digital channels, such as Acorn TV and UMC or Urban Movie Channel.

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We may be unable to maintain favorable relationships with our retailers and distribution facilitators such as, Sony Pictures Home Entertainment (or SPHE) and Sony DADC UK Limited. Further, our retailers and distribution facilitators may be adversely affected by economic conditions. If we lose any of our top customers, or if any of these customers reduces or cancels a significant order, it could have a material adverse effect on our liquidity, business, results of operations, and financial condition.

Our high concentration of sales to relatively few customers (and use of a third-party to manage collection of substantially all packaged goods receivables) may result in significant uncollectible accounts receivable exposure, which may adversely affect our liquidity, business, results of operations and financial condition. As of December 31, 2017, Amazon, SPHE, Hulu and Netflix accounted for approximately 25.0%, 22.2%, 15.2% and 13.9%, respectively, of our gross accounts receivable. At December 31, 2016, Netflix, SPHE and Amazon accounted for approximately 29.3%, 25.4% and 16.7%, respectively, of our gross accounts receivable.

Property, Equipment and Improvements

Property, equipment and improvements are stated at cost less accumulated depreciation and amortization. Major renewals and improvements are capitalized; minor replacements, maintenance and repairs are expensed as incurred. Internal-use software development costs are capitalized if the costs were incurred while in the application development stage, or if the costs were for upgrades and enhancements that provide additional functionality. Training and data-conversion costs are expensed as incurred. We cease capitalizing software costs and start depreciating the software once the project is substantially complete and ready for its intended use.

Depreciation and amortization are computed by applying the straight-line method over the estimated useful lives of the furniture, fixtures and equipment (3 to 5 years), and software (3 to 5 years). Leasehold improvements are amortized over the shorter of the useful life of the improvement or the life of the related leases (7 years).

Impairment of Long-Lived Assets

We review long-lived and specific, definite-lived, identifiable intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. An impairment loss of the excess of the carrying value over fair value would be recognized when estimated undiscounted future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. We have no intangible assets with indefinite useful lives.

Leases

We lease all of the office space utilized for our operations. All of our leases are operating leases in nature. A majority of our leases have fixed incremental increases over the lease terms, which are recognized on a straight-line basis over the term of the lease.

Equity Method Investments

We use the equity method of accounting for investments in companies in which we do not have voting control but where we do have the ability to exert significant influence over operating decisions of the companies. Our equity method investments are periodically reviewed to determine whether there has been a loss in value that is other than a temporary decline.

Debt Discounts

The difference between the principal amount of our debt and the amount recorded as the liability represents a debt discount. The carrying amount of the liability is accreted up to the principal amount through the amortization of the discount, using the effective interest method, to interest expense over the expected term of the debt.

Advertising Costs

Our advertising expense consists of expenditures related to advertising in trade and consumer publications, product brochures and catalogs, booklets for sales promotion, radio advertising and other promotional costs. In accordance with ASC 720-35, Other Expenses—Advertising Costs, and ASC 340-20, Other Assets and Deferred Costs—Capitalized Advertising Costs, we expense advertising costs in the period in which the advertisement first takes place. Product brochures and catalogs and various other promotional costs are capitalized and amortized over the expected period of future benefit, but generally not exceeding six months. Advertising and promotion expense are included as a component of selling expenses. For the years ended December 31, 2017 and 2016, advertising expense was $8.0 million and $4.1 million, respectively.

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Stock Options and Restricted Stock Awards

We expense our stock-based awards in accordance with ASC 718, Compensation—Stock Compensation. ASC 718 establishes standards with respect to the accounting for transactions in which an entity exchanges its equity instruments for goods or services, or incurs liabilities in exchange for goods or services, that are based on the fair value of the entity’s equity instruments, focusing primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. ASC 718 requires entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions) and recognize the cost over the period during which an employee is required to provide service in exchange for the award. Expense recognized is not reduced by estimated forfeitures as forfeitures have been immaterial.

Earnings/Loss per Common Share

Basic earnings/loss per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings per share are computed using the combination of dilutive common share equivalents and the weighted-average shares outstanding during the period. For the periods reporting a net loss, diluted loss per share is equivalent to basic loss per share, as inclusion of common share equivalents would be anti-dilutive.

Recently Issued Accounting Standards

In May 2014, the FASB Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, as a new Topic, (ASC) Topic 606. Subsequent to the issuance of the May 2014 guidance, several clarifications and updates have been issued by the FASB on this topic, the most recent of which was issued in December 2016. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. Based on the current guidance, the new framework will become effective for us on January 1, 2018. We will be electing the modified retrospective method; and as such, we will not be restating our revenues for 2017 or prior periods. Upon adoption, we will also be applying the new standard to all customer contracts. We have completed our analysis and identified certain areas that will be impacted as follows:

The new revenue standards also contain expanded disclosure requirements for which we are currently analyzing. We will conclude on our expanded revenue disclosures before issuing our first quarter financial statements in May 2018.

In February 2016, the FASB issued ASU No. 2016-02, Leases. This ASU establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be

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classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. We are currently evaluating the impact of the pending adoption of this new standard on our financial statements and we have yet to determine the overall impact this ASU is expected to have. The likely impact will be one of presentation only on our consolidated balance sheet.  Our leases currently consist of operating leases with varying expiration dates through 2022 and our future minimum lease commitments before sub-lease income total $3.8 million (see Note 21, Commitments and Contingencies).

 

 

In accordance with the requirements of the ASC 280 “Segment Reporting,” selected financial information regarding our reportable business segments, Digital Channels, IP Licensing and Wholesale Distribution, 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 business model (subscription based vs. transactional) or acquires content differently. Our Digital Channels includes the subscription-based sale of video content directly and through third-party distribution to consumers through our digital channels, such as Acorn TV and UMC. 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 Distribution segment consists of the acquisition and worldwide exploitation through our wholesale partners of exclusive content in various formats, including DVD, Blu-ray, digital, broadcast (including cable and satellite), VOD, SVOD, downloading and sublicensing. Our wholesale partners are broadcasters, digital outlets and major retailers in the U.S. Our Wholesale Distribution segment also includes our U.K. mail-order catalog and ecommerce businesses.

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 our 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.

Operating costs and expenses exclude costs related to depreciation and amortization which are separately presented in the tables below. The segment results also exclude our discontinued operations.

The following tables summarize the segment contribution for the years ended December 31, 2017 and 2016:

 

 

 

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A reconciliation of total segment contribution income (loss) to loss from continuing operations before provision for income taxes is as follows:

 

 

Total revenues by geographical location is as follows:

 

 

Revenues are attributed to geographical locations based on where our customers reside.

Total assets for each segment primarily include accounts receivable, inventory and investments in content. The Corporate segment primarily includes assets not fully allocated to a segment including consolidated cash accounts, certain prepaid assets and fixed assets used across all segments.

Total assets by segment, excluding assets of discontinued operations, are as follows:

 

 

During the year ended December 31, 2017, we had capital expenditures of $1.9 million which included $0.3 million that was accrued for in accounts payable. The capital expenditures by segment during 2017 were $1.3 million and $0.6 million for the Digital Channels and Corporate segments, respectively. During the year ended December 31, 2016, we had capital expenditures of $1.7 million, which included $0.3 million that was accrued for in accounts payable. The capital expenditures by segment during 2016 were $1.4 million and $0.3 million for the Digital Channels and Corporate segments, respectively.

Long-lived assets by geographical location are as follows:

 

 

Long-lived assets include website, digital platform software assets and property, equipment and improvements.

 

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In February 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.

A summary of the ACL investment account is as follows:

 

 

The following summarized financial information is derived from financial statements of ACL as of December 31, 2017 and 2016 (balance sheets), and for the years ended December 31, 2017 and 2016 (income statements):

 

 

 

Balance sheet amounts have been translated from the GBP to U.S. dollar using the December 31, 2017 and 2016 exchange rates. Income statement amounts have been translated from the GBP to U.S. dollar using the average exchange rate for each of the years presented.

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Accounts receivable for our Digital Channels segment are primarily derived from subscription revenues, which are processed by merchant banks or our channel partners such as Amazon, that have not cleared our bank as of period end. Accounts receivable for our Wholesale Distribution segment are primarily derived from (1) video content we license to broadcast, cable/satellite providers and digital subscription platforms like Netflix, and (2) the sale of physical content to retailers and wholesale distributors and U.K. ecommerce and catalog sales. Our accounts receivable typically trends with retail seasonality.

 

 

Wholesale Distribution receivables are partially billed and collected by our U.S. distribution facilitation partner, SPHE. Each quarter, SPHE preliminarily settles their portion of 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 SPHE. Amounts vary and tend to be seasonal following our sales activity. As of December 31, 2017, we owed SPHE $4.1 million for receivables settled as of year-end. As of December 31, 2016, we owed SPHE $5.6 million for receivables settled as of year-end. The Wholesale Distribution receivables are reported net of amounts owed to SPHE as these amounts are offset against each other when settling.

As of December 31, 2017 and 2016, the net Wholesale Distribution receivables with SPHE were $4.3 million and $4.3 million, respectively, which is included in accounts receivable.

 

 

Inventories are summarized as follows:

 

 

For each reporting period, we review the value of inventories on hand to estimate the recoverability through future sales. Values in excess of anticipated future sales are booked as obsolescence reserve. Our obsolescence reserve was $10.2 million and $10.0 million as of December 31, 2017 and 2016, respectively. We reduce our inventories with adjustments for lower of cost or market valuation, shrinkage, excess quantities and obsolescence. During the years ended December 31, 2017 and 2016, we recorded impairment charges of $1.4 million and $1.8 million, respectively. These charges are included in cost of sales as manufacturing and fulfillment cost.

 

 

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Property, equipment and improvements are summarized as follows:

 

 

During the years ended December 31, 2017 and 2016, we recorded no impairment to property, equipment and improvements. Depreciation expense was $0.8 million for the year ended December 31, 2017 and $0.7 million for the year ended December 31, 2016.

 

 

Investments in content are as follows:

 

 

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. Impairment charges for the years ended December 31, 2017 and 2016 were $1.6 million and $2.8 million, respectively. Impairments charges are included in cost of sales as part of content amortization and royalties.

In determining the fair value of content for impairments (Note 15, Fair Value Measurements), we employ a discounted cash flow (or 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.

Our estimated future amortization for investments in content is as follows:

 

 

 

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Goodwill

Goodwill by segment is as follows:

 

 

Of the goodwill initially recognized, approximately $22.3 million is being amortized over 15 years for tax purposes giving rise to a future tax deduction.

Goodwill was tested for impairment for the periods presented and we did not impair our goodwill during 2017 and 2016.

Other Intangibles

A summary of our intangibles and accumulated amortization are as follows:

 

 

 

Amortization expense for the years ended December 31, 2017 and 2016 was $2.9 million and $2.3 million, respectively. Costs incurred to develop, upgrade or enhance functionality of websites and digital platform software are capitalized while maintenance and operating costs are expensed as incurred. During the years ended December 31, 2017 and 2016, we capitalized $1.2 million and $1.4 million of costs related to our websites and digital platform software, respectively.

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As of December 31, 2017, the remaining amortization by year for intangible assets is as follows:

 

 

 

Debt consists of the following:

 

 

Future minimum principal payments as of December 31, 2017 are as follows:

 

Senior Term Notes

On October 14, 2016, we entered into a $65.0 million Credit and Guaranty Agreement (the AMC Credit Agreement) with Digital Entertainment Holdings LLC, a wholly owned subsidiary of AMC Networks Inc. (or AMC). Concurrent with entering into the AMC Credit Agreement, we also issued AMC three warrants (the AMC Warrants) to acquire a total of 20.0 million shares of our common stock at $3.00 per share. The entering of the AMC Credit Agreement, the issuance of the AMC Warrants and the associated transactions are referred to as the AMC Transaction.

The proceeds received from the AMC Credit Agreement were used to repay our prior senior secured term notes of $55.1 million, including accrued interest, and transaction expenses of approximately $1.7 million, which includes a prepayment penalty of $0.8 million. Initially, the AMC Credit Agreement consisted of (i) a term loan tranche in the principal amount of $5.0 million (or Tranche A Loan), which was due on October 14, 2017, and (ii) a term loan tranche in the principal amount of $60.0 million (or Tranche B Loan) of which 25% is due after five years, 50% is due after six years and the remaining 25% is due after seven years. The Tranche A Loan bears interest at a rate of 7.0% per annum and the Tranche B Loan bears interest at a rate of 6.0% per annum. Interest was payable quarterly whereby 4.0% was payable in cash and the balance was payable in shares of common stock determined using a per-share value of $3.00. The loan is secured by a lien on substantially all of our consolidated assets.

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When repaying the previous credit facility on October 14, 2016, we recognized a $3.5 million loss from the early extinguishment of debt, which is reported separately within our statement of operations. This loss primarily represents the unamortized debt discount and deferred financing costs at the time of repayment of our prior credit facility and prepayment penalty of $0.8 million.

On January 30, 2017, to repay prior debt obligations under the subordinated notes payable we amended the AMC Credit Agreement and borrowed an additional $8.0 million, thereby increasing our Tranche A Loan from $5.0 million to $13.0 million. We also extended the maturity date for our Tranche A Loan from October 14, 2017 to June 30, 2019. When doing so, we did not incur a prepayment penalty.

On June 16, 2017, to fuel the growth of our business, we expanded the AMC Credit Agreement and borrowed an additional $10.0 million, thereby increasing our Tranche A Loan from $13.0 million to $23.0 million. Further, we extended the maturity date for our Tranche A Loan from June 30, 2019 to beginning on June 30, 2020. We also amended the payment provisions regarding interest whereby all interest is now settled with shares of common stock at $3.00 per share beginning as of April 1, 2017. The additional $10.0 million borrowed is available for working capital purposes, including the acquisition of content. This amendment also changed certain debt covenant ratios to reflect the extended maturity date and the increase of the Tranche A Loan balance.

On October 2, 2017, we issued AMC 427,347 shares of common stock in payment of $1.3 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement.

During 2017, we recognized a $0.4 million net gain on extinguishment of debt resulting from the amendments of our AMC Credit Agreement and the repayment of our subordinated notes payable.

Concurrent with the June amendment, RLJ SPAC Acquisition, LLC converted all of its preferred stock holdings into shares of common stock (see Note 11, Redeemable Convertible Preferred Stock) and AMC exercised a portion of their warrants (see Note 12, Stock Warrants) that resulted in the Tranche B Loan principal reduction of $5.0 million.

Subject to certain customary exceptions, the AMC Credit Agreement requires mandatory prepayments if we were to receive proceeds from asset sales, insurance, debt issuance or the exercise of the warrants (see Note 12, Stock Warrants). We may also make voluntary prepayments. Prepayments of the Tranche B Loan (either voluntary or mandatory) are subject to a prepayment premium of 3.0% if principal is repaid on or before October 14, 2018, and 1.5% if principal is repaid after October 14, 2018 but on or before October 14, 2019. No prepayment premium is due for amounts prepaid after October 14, 2019, and for mandatory prepayments made from proceeds received from the exercise of warrants. The Tranche A Loan is not subject to prepayment penalties.

The AMC Credit Agreement contains certain financial and non-financial covenants. Financial covenants are assessed annually and are based on Consolidated Adjusted EBITDA, as defined in the AMC Credit Agreement. Financial covenants vary by fiscal year and generally become more restrictive over time.

Financial covenants include the following:

 

 

The AMC 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 AMC Credit Agreement.

The AMC Credit Agreement imposes restrictions on such items as encumbrances and liens, payments of dividends to common stockholders, 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 AMC Credit Agreement, we must maintain at all times a cash balance of $1.0 million for 2016, $2.0 million in cash for 2017 and $3.5 million in cash for all years thereafter. As of December 31, 2017, we were in compliance with all covenants as stipulated in the amended AMC Credit Agreement.

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Concurrent with entering into the AMC Transaction, we issued the AMC Warrants to acquire shares of our common stock. The first warrant is for 5.0 million shares of common stock, of which 1.7 million shares were exercised in June 2017, and expires on October 14, 2021. The second warrant is for 10.0 million shares of common stock and expires on October 14, 2022. The third warrant is for 5.0 million shares of common stock, subject to adjustment, and expires on October 14, 2023. The AMC Warrants are subject to certain standard anti-dilution provisions and may be exercised on a non-cash basis at AMC’s discretion.

The third warrant (the AMC Tranche C Warrant) contains a provision that may increase the number of shares acquirable upon exercising, for no additional consideration payable by AMC, such that the number of shares acquirable upon exercise is equal to the sum of (i) at least 50.1% of our then outstanding shares of common stock, determined on a fully diluted basis, less (ii) the sum of 15.0 million shares and the equity interest shares issued in connection with the AMC Credit Agreement. This provision provides AMC the ability to acquire at least 50.1% of our common stock for $60.0 million, provided that all warrants are exercised and AMC elects not to exercise on a non-cash basis. The third warrant with this guarantee provision is being accounted for as a derivative liability.

Subordinated Notes Payable

On January 31, 2017, we repaid the outstanding principal and interest on our unsecured subordinated promissory notes. This reduction in principal did not result in a prepayment penalty. The subordinated notes were issued in 2012 in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image (or Subordinated Note Holders). In 2015, and 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 warrants to acquire approximately 855,000 shares of common stock (see Note 12, Stock Warrants).

 

 

On May 20, 2015, we closed a transaction in which we sold 31,046 shares of preferred stock and warrants to acquire 3.1 million shares of common stock (the 2015 Warrants) 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 1.7 million 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 senior notes payable 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 was used for content investment and working capital purposes. Of the fees incurred, $0.9 million was recorded against the proceeds received, $0.5 million was recorded as additional debt discounts, $0.2 million was included as interest expense and the balance was included in other expense.

On October 14, 2016 and concurrent with the close of our AMC Credit Agreement, we amended our preferred stock such that we were able to classify our preferred stock and its embedded conversion feature within our shareholders’ equity. Prior to the amendment, our preferred stock and its embedded conversion feature were recorded on our consolidated balance sheet outside of shareholders’ equity. The amended terms are disclosed below.

The preferred stock has the following rights and preferences:

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We are adjusting the carrying balance of our preferred stock to its Redemption Value using the effective interest-rate method over a period of time beginning from the issuance date of May 20, 2015 to the required redemption date of May 20, 2020. During the years ended December 31, 2017 and 2016, we recognized accretion of $1.2 million and $4.3 million, respectively. Accretion includes cumulative preferred dividends. As of December 31, 2017, the accumulated unpaid dividends on preferred stock were $2.8 million. During the years ended December 31, 2017 and 2016, accumulated dividends increased by $0.7 million (or $46.16 per share of preferred stock) and $2.7 million (or $88.60 per share of preferred stock), respectively. During 2017, we made cash dividend payments of $0.7 million.

During 2016, two preferred shareholders converted a total of 849 shares of preferred stock and $0.1 million of accumulated dividends into 0.3 million shares of common stock. During June 2017, the largest preferred shareholder (RLJ SPAC Acquisition, LLC) converted a total of 15,000 shares of preferred stock and $2.7 million of accumulated dividends into 5.9 million shares of common stock.

In 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 2015 Warrants (see Note 12, Stock Warrants). The registration statement was declared effective in July 2015 and amended in 2016. 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 will use our best efforts to keep the registration statement effective

 

 

We have the following unregistered warrants outstanding:

 

 

Concurrent with entering into the AMC Credit Agreement, we issued AMC three warrants (the AMC Warrants) to acquire shares of our common stock at $3.00 per share. The first warrant is for 5.0 million shares of common stock, of which 1.7 million shares were exercised in June 2017, and expires on October 14, 2021. The second warrant is for 10.0 million shares of common stock and expires on October 14, 2022. The third warrant is for 5.0 million shares of common stock, subject to adjustment, and expires on October 14, 2023. The AMC Warrants are subject to certain standard anti-dilution provisions and may be exercised on a non-cash basis at AMC’s discretion.

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The third warrant (the AMC Tranche C Warrant) contains a provision that may increase the number of shares acquirable upon exercising, for no additional consideration payable by AMC, such that the number of shares acquirable upon exercise is equal to the sum of (i) at least 50.1% of our then outstanding shares of common stock, determined on a fully diluted basis, less (ii) the sum of 15.0 million shares and the equity interest shares issued in connection with the AMC Credit Agreement. This provision provides AMC the ability to acquire at least 50.1% of our common stock for $60.0 million, provided that all warrants are exercised and AMC elects not to exercise on a non-cash basis. The third warrant with this guarantee provision is being accounted for as a derivative liability.

On May 20, 2015 and concurrent with our preferred stock placement, we issued warrants to our preferred stock holders to acquire 3.1 million shares of our common stock (the 2015 Warrants). The warrants have term of five years. On October 14, 2016 and in connection with the AMC Credit Agreement, we amended the anti-dilution and redemption provisions of the warrants to conform to the terms of the amended preferred stock. Because of the AMC transaction and the then-existing terms of the 2015 Warrants, the warrant exercise price was reduced from $4.50 to $3.00; however, the exercise price was further reduced down to $1.50 for warrants to acquire 1.5 million shares of common stock, and down to $2.37 for warrants to acquire 150,000 shares of common stock. Because of the October 14, 2016 amendment, we began accounting for the 2015 Warrants as equity awards and reclassified the carrying balance of the warrants to shareholders’ equity.

During the year ended December 31, 2017, warrant holders exercised warrants for approximately 106,000 shares with an exercise price of $1.50. We received cash proceeds of $0.2 million.

On October 3, 2012, we issued warrants with a term of five years that provide the warrant holder the right to acquire one share of our common stock for $36.00 per share (the 2012 Warrants). The warrants expired on October 3, 2017.

 

 

Our articles of incorporation authorize us to issue up to 250 million shares of common stock and one million shares of preferred stock, par value $0.001 per share. As of December 31, 2017, there were 14,071,423 shares of common stock issued and outstanding. As of December 31, 2016, there were 5,240,085 shares issued and outstanding.

As shares of common stock are forfeited, they become treasury shares. Forfeiture of shares occurs when directors or employees, who hold compensatory restricted stock, resign or stop working for us prior to achieving required vesting conditions, or when performance conditions are not met regardless of continued employment or service. Treasury shares are available to RLJE for future grants or issuances of shares at our discretion. At December 31, 2017 and 2016, we did not hold any treasury shares.

 

 

Equity Compensation Plan

As of December 31, 2017 and 2016, we had one equity compensation plan. The 2012 Incentive Compensation Plan of RLJ Entertainment, Inc. (the Incentive Plan) was approved by the shareholders of RLJ Acquisition, Image and Acorn Media on September 20, 2012. The Incentive Plan is administered by the compensation committee of our Board of Directors. On August 4, 2017, our stockholders approved an amendment to the Incentive Plan adding 3.0 million shares, such that the compensation committee may grant awards totaling a maximum of 5,081,385 shares, and amendments to the limitations on the size of the awards. The compensation committee may award options, stock appreciation rights, restricted stock awards, restricted stock unit awards, bonus stock and awards in lieu of obligations, dividend equivalents, performance awards and other stock-based awards (as those terms are defined in the Incentive Plan). Under the Incentive Plan as amended, no person may be granted (i) options or stock appreciation rights with respect to more than 1,400,000 shares or (ii) restricted stock, restricted stock units, performance shares and/or other stock-based awards with respect to more than 1,300,000 shares. In addition, no person may be granted awards worth more than $1.2 million of grant date fair value with respect to any 12-month Performance Period (as that term is defined in the Incentive Plan) or $2.4 million with respect to any Performance Period that is more than 12 months. The maximum term allowed for an option is 10 years and a stock award shall either vest or be forfeited not more than 10 years from the date of grant.

At December 31, 2017 and 2016, there were 1,581,429 and 1,109,046 shares, respectively, available for future grants under the Incentive Plan.

Restricted Stock-Based Compensation

Our share-based compensation consists of awards of restricted stock, restricted stock units, performance stock units and stock options. During the year ended December 31, 2017, 1.1 million shares of restricted stock-based awards were granted, 1.4 million options were granted to an executive officer, 0.3 million shares vested and 6,170 shares were forfeited due to employee terminations.

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Of the shares granted, we issued 0.9 million shares of restricted stock-based awards to executive officers and directors and 0.2 million shares of restricted stock units to employees. The restricted stock-based awards were fair valued on the date of grant using the closing price of the common stock on the grant date. The restricted stock-based awards generally vest over a three- to four-year period for executive officers and a one-year period for directors. The restricted stock units generally vest over a three-year period for employees. The vesting of restricted stock awards and restricted stock units is subject to certain service criteria. The awards may be subject to further forfeitures if the employee or director terminates his or her service during the vesting period. All shares of restricted stock participate in dividends, if declared prior to their vesting date.

The option grants in 2017 include an option to purchase 0.7 million shares of common stock with an exercise price of $2.66 per share cliff vesting in two years and an option to purchase 0.7 million shares of common stock with an exercise price of $3.00 per share cliff vesting in four years. The options were fair valued at $1.90 per share using the Black Scholes model. Inputs into the model included the stock price of $2.66 at the time of grant, the exercise price, the risk-free interest rate of 1.97%, expected volatility of 75% and the expected terms, which were 7.0 years and 8.4 years. The expected term for the option with an exercise price of $2.66 was estimated as the average of its vesting term of two years and its contractual term of 10 years. The expected term of the option with an exercise price of $3.00 was estimated by using a lattice model that took into consideration the vesting term, the contractual term of 10 years, post-vesting exercise behavior and the award’s exercise price relative to the current fair value of a share of common stock.

Compensation expense relating to our share-based grants for the years ended December 31, 2017 and 2016 was $1.8 million and $1.0 million, respectively. Compensation expense related to share-based grants is included in general and administrative expenses. As of December 31, 2017, unrecognized share-based compensation expense relating to restricted stock-based service awards of $1.8 million is expected to be expensed ratably over the remaining weighted-average vesting period of 1.3 years. Unrecognized compensation expense relating to restricted stock-based performance awards of $1.2 million is expected to be expensed ratably over the remaining weighted-average vesting period of 2.0 years. Unrecognized compensation expense relating to unvested stock options of $2.0 million is expected to be expensed ratably over the remaining weighted-average vesting period of 1.2 years. Expense associated with our performance award is contingent upon achieving specified financial criteria and upon certification by the Compensation Committee of the satisfaction of such performance criteria based upon our audited financial statements for 2017, 2018, 2019 and 2020. The above unrecognized stock-based compensation expense assumes that the performance awards will vest at 130% (or 0.7 million shares). However, the possible range of vesting is between zero and 1.0 million shares.

Assuming 100% vesting for all service awards and 130% vesting of all performance awards, we expect to recognize $5.0 million of compensation expense over the next 12 months.

Restricted stock award activity under the Incentive Plan for the year ended December 31, 2017, and changes during the year then ended are presented below:

 

 

During the year ended December 31, 2016, 0.4 million shares of restricted stock-based awards were granted. Of the awards granted, 0.2 million restricted stock awards were granted to executive officers and directors and 0.2 million restricted stock units were granted to employees. The shares were fair valued using our closing stock price of $1.92 per share on the grant date, for a total value of approximately $0.8 million, which will be expensed over the vesting period as a component of general and administrative expenses.

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Restricted stock award activity under the Incentive Plan for the year ended December 31, 2016, and changes during the year then ended are presented below:

 

 

 

Warrant Liability

Stock Warrant and Other Derivative Liabilities

Certain warrants are accounted for as derivative liabilities, which require us to carry them on our consolidated balance sheet at their fair value. Our derivative liability warrants consist of the AMC Tranche C Warrant to acquire 5.0 million shares of common stock and our 2012 Warrants to acquire 7.0 million shares of common stock. Prior to the amendment on October 14, 2016, our 2015 Warrants to purchase 3.1 million shares of our common stock and the preferred stock’s embedded conversion feature were being accounted for as derivative liabilities as well.

We determined the fair value of the AMC Tranche C warrant using a lattice model, which is classified as Level 3 within in the fair-value hierarchy. Inputs to the model include our publicly-traded stock price, our stock volatility, the risk-free interest rate and contractual terms of the warrant (which are remaining life of the warrant, exercise price and assumptions pertaining to increasing the number of acquirable shares of common stock to achieve 50.1% ownership). We use the closing stock price of our common stock to compute stock volatility. To quantify and value the possibility of increasing the number of acquirable shares, management took into consideration its current capital structure, the impact of the 20% penalty if we were to fail to meet certain equity issuance conditions, and management’s best estimates of the likelihood of being subject to the 20% penalty. The AMC Tranche C warrant was valued at $13.7 million as of December 31, 2017, and $9.8 million as of December 31, 2016. During 2017, the AMC Tranche C warrant increased in value as a result of an increase in our common stock price

We determined the fair value of our 2012 Warrants using a Monte Carlo simulation model. Because the warrants are so far out-of-the-money (exercise price is $36.00 per share) as they approach their expiration date, their fair value was effectively zero as of December 31, 2016. The warrants expired on October 3, 2017.

Prior to the October 14, 2016 amendment, we were using a lattice model to value the 2015 Warrants, which was classified as Level 3 within the fair-value hierarchy. Inputs to the model were stock volatility, contractual warrant terms (which were remaining life of the warrant and the exercise price), the risk-free interest rate and management’s assessment of the likelihood of doing a down-round transaction.

Prior to the October 14, 2016 amendment, we were using the lattice model to value the preferred stock’s embedded conversion feature, which was classified as Level 3 within the fair-value hierarchy. Inputs to the model were stock volatility, contractual terms (which were remaining life of the conversion option and the conversion rate), the risk-free interest rate and management’s assessment of the likelihood of doing a down-round transaction.

 

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The following tables represent the valuation of our warrant and other derivative liabilities within Level 3 of the fair-value hierarchy:

 

 

 

 

The following tables include a roll-forward of activity for our warrant and other derivative liabilities classified within Level 3 of the fair-value hierarchy:

 

  

 

 

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. The following fair value hierarchy tables present information about our assets and liabilities measured at fair value on a non-recurring basis.:

 

 

 

During the years ended December 31, 2017 and 2016, the investments in content were impaired by $1.6 million and $2.8 million, respectively. In determining the fair value of our investments in content, 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.

 

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The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per common share for the years ended December 31, 2017 and 2016:

 

 

We have outstanding warrants to acquire 21.3 million and 30.1 million shares of common stock as of December 31, 2017 and 2016, respectively, which are not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.

During periods of reported net losses from continuing operations after adjusting for accretion on preferred stock, all reported net losses are allocated to our unrestricted common stock. This has the effect of excluding our outstanding restricted common stock from the computation of our net loss per common share. For the years ended December 31, 2017 and 2016 we have weighted average unvested shares of 2.6 million and 0.4 million, respectively of compensatory stock options and restricted share-based awards, that were not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.

When dilutive, we include in our computation of diluted loss per share the number of shares of common stock that is acquirable upon conversion of the preferred stock by applying the as-converted method per ASC 260, Earnings per Share. For the years ended December 31, 2017 and 2016, we excluded 5.9 million and 11.5 million shares of common stock that are acquirable upon conversion of the preferred stock as they were anti-dilutive.

 

RLJE files income tax returns in the U.S. Federal jurisdiction and various state jurisdictions. Our subsidiaries in the United Kingdom and Australia continue to file income tax returns in their foreign jurisdictions.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We must assess the likelihood that our deferred tax assets will be recovered from future taxable income and, to the extent that it is more likely than not that such deferred tax assets will not be realized, we must establish a valuation allowance.

As of December 31, 2017, we have a valuation allowance against 100% of our deferred tax assets, which are composed primarily of net operating loss (or NOL) carryforwards that were either acquired in the Business Combination or generated in the years following. Even though we have reserved all of these net deferred tax assets for book purposes, we would still be able to utilize them to reduce future income taxes payable should we have future taxable earnings. To the extent our deferred tax assets relate to NOL carryforwards, the ability to use such NOLs against future earnings will be subject to applicable carryforward periods. As of December 31, 2017, we had NOL carryforwards for Federal and state tax purposes of approximately $113.6 million and approximately $61.0 million, respectively, which are available to offset taxable income through 2037. Our NOL carryforwards began to expire in 2017. NOL carryforwards that were acquired in the Business Combination reflect our assessment of an annual limitation on the utilization of these carryforwards due to ownership change limitations as required by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), as well as similar state limitations.

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Income tax expense is summarized below:

 

 

Loss from continuing operations before provision for income taxes is as follows:

 

 

The tax effects of temporary differences that give rise to a significant portion of the net deferred tax assets and liabilities are presented below:

 

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A reconciliation of income tax benefit based on the federal statutory rate to actual income tax expense (benefit) is as follows:

 

 

Our significant tax returns are filed in the following jurisdictions: United States, United Kingdom and in the following states: Maryland and California. The tax years for 2009 through 2017 remain open to examination. We are not currently under examination by any of the jurisdictions where we file significant tax returns. We believe that our tax filing positions and deductions will be sustained if audited, and we do not anticipate any adjustments that would result in a material adverse effect on our financial condition, results of operations, or cash flow. Therefore, no reserves or related interest and penalties for uncertain tax positions have been recorded.

 

 

Supplemental Disclosures

 

 

 

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During the year ended December 31, 2017, we recognized severance charges of $25,000. During the year ended December 31, 2016, we recognized severance charges of $0.5 million of which $0.3 million is included in discontinued operations. Severance charges that are not part of discontinued operations are recorded as a component of general and administrative expense.

 

 

Effective October 3, 2012, we established the RLJ Entertainment 401(k) Plan, a defined contribution 401(k) plan for the benefit of employees meeting certain eligibility requirements. Under the plan, participants may contribute a portion of their earnings on a pre-tax basis. Employee contributions are forwarded to the plan administrator and invested in various funds at the discretion of the employee. We match a portion of those contributions based upon the employee’s compensation status in accordance with the U.S. Internal Revenue Code. Our U.S. sponsor plan contributes up to four percent depending on the employee’s contribution beginning one month after the date of hire. Our U.K. subsidiary sponsor plan contributes between three to seven percent to employees beginning after a probationary period of three months. Our Australia subsidiary sponsor plan contributes 9.5 percent to employees beginning at the date of hire.

During the years ended December 31, 2017 and 2016, we incurred compensation expenses related to these plans of $0.5 million and $0.4 million, respectively.

 

 

Operating Leases

Our principal executive office is located in Silver Spring, Maryland. We also maintain offices in Woodland Hills, California; London, England and Sydney, Australia with varying terms and expiration dates. All locations are leased. In addition, we have subleased our Stillwater, Minnesota, location associated with our discontinued operations. A summary of our principal locations is as follows:

 

 

Future minimum annual rental payments include amounts we are obligated to pay under the leases described above and on space associated with discontinued operations that we began subleasing in 2016. The sublease is in effect through the end of the lease term in July 2022. Beginning in March 2017, our obligations for the subleased space are entirely offset by sublease income. We received sublease income of $0.1 million during 2017. We received no sublease income in 2016. Future minimum annual rental payments by year under noncancelable operating leases at December 31, 2017, are as follows:

 

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Rent expense was $1.3 million and $1.7 million, for the years ended December 31, 2017 and 2016, respectively.

Employment Agreements

At December 31, 2017, our future contractual obligations under three employment agreements are summarized below. Included in the amounts below are any minimum bonus or agreed-upon amounts to be paid within the employment contracts over the next five years as long as the employee continues to be an employee in good standing and meets the performance criteria within the individual employment agreements. One of the three employment agreements does not have an expiration date and is included in each of the five years presented below.

 

 

Future Royalty Obligations

At December 31, 2017, our future obligations for royalty advances, minimum royalty guarantees and exclusive distribution fee guarantees under the terms of our existing licenses and exclusive distribution agreements that have an off-balance sheet commitment totaling $7.2 million. To the extent payment is not due until delivery has occurred, these commitments will be recognized in 2018 upon the earlier of payment or upon delivery of content by the content supplier.

Legal Proceedings

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

 

 

Equity Investments in Affiliate

During 2017 and 2016, we paid ACL $0.1 million and $0.7 million, respectively, for the distribution rights to three titles, two of which have been released as of December 31, 2016 and one which was released in 2017. As we recognize revenues from these titles, and all other titles, we amortize our content advances resulting in the recognition of content amortization and royalty expense. During 2017 and 2016, we recognized content amortization and royalty expense of $0.3 million and $0.5 million, respectively. This amortization is included in our cost of sales as content amortization and royalties. As of December 31, 2017 and 2016, our remaining unamortized content advance is $1.5 million and $1.7 million, respectively.

ACL paid dividends to RLJE Ltd. of $2.5 million and $3.3 million during the years ended December 31, 2017 and 2016, respectively. Dividends received were recorded as a reduction to the ACL investment account.

Foreign Currency

We recognize foreign currency gains and losses, as a component of other expense, on amounts lent by Acorn Media to AME and RLJE Australia. As of December 31, 2017, Acorn Media had lent its U.K. subsidiaries approximately $2.4 million and its Australian subsidiary approximately $3.3 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 year ended December 31, 2017, we recognized foreign currency gains of $0.6 million. During the year ended December 31, 2016, we recognized foreign currency losses of $1.5 million.

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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, are included in accrued royalties and distribution fees in the accompanying consolidated balance sheets. During the year ended December 31, 2017, we made payments totaling $1.0 million to The RLJ Companies, which reduced our remaining obligation to $2.5 million.

Debt, Preferred Stock and Warrants

In May 2015, certain present and former board members and their affiliate companies, including RLJ SPAC Acquisition, LLC which is owned by the chairman of our board of directors, purchased 16,500 shares of preferred stock and warrants to acquire 1.7 million shares of common stock from us for $16.5 million.

In June 2017, RLJ SPAC Acquisition, LLC converted its 15,000 shares of preferred stock and accumulated dividends and received 5.9 million shares of common stock.

During 2017, we made cash dividend payments totaling $0.7 million to preferred stockholders.

Since AMC held shares of common stock during 2017, they are considered a related party. During 2017, AMC expanded their debt facility with us (see Note 10, Debt) and partially exercised 1.7 million shares of AMC Tranche A Warrants.

 

On January 2, 2018, we made a dividend payment of $0.4 million to our preferred shareholders.

On January 2, 2018, we issued AMC 418,255 shares of common stock in payment of $1.3 million of interest on $78.0 million of principal outstanding under the AMC Credit Agreement. At December 31, 2017, this accrued interest was included in accounts payable and accrued liabilities.

AMC Networks Acquisition Proposal

On February 27, 2018, we announced the formation of the Special Committee of the Board of Directors to consider the February 26, 2018 proposal from AMC to acquire all of our outstanding common stock and outstanding rights to acquire our common stock not owned by AMC or entities affiliated with Robert L. Johnson, Chairman of our Board of Directors.

 

 

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None.

Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended (or Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. We periodically review the design and effectiveness of our disclosure controls and internal control over financial reporting. We make modifications to improve the design and effectiveness of our disclosure controls and internal control structure, and may take other corrective action, if our reviews identify a need for such modifications or actions.  

As of the end of the period covered by this Annual Report on Form 10-K for the year ended December 31, 2017 (or Annual Report), we evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our disclosure controls and procedures. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Annual Report.  

Internal Control Over Financial Reporting

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for our Company. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with United States generally accepted accounting principles. Internal control over financial reporting includes policies and procedures that:

A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations, internal controls over financial reporting may not prevent or detect misstatements. Projections of any evaluation of the effectiveness of internal control over financial reporting to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  

Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting at December 31, 2017. In conducting this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework– 2013. Based on that evaluation under those criteria, management concluded that, at December 31, 2017, our internal control over financial reporting was effective.

This Annual Report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules that permit us to provide only management's report in this Annual Report.

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Changes in Internal Control over Financial Reporting

Management determined that, at December 31, 2017, there has been no change in our internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rules 13a-15(d) and 15d-15 that occurred during the fourth quarter period covered by this annual report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

None.

 

 

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PART III

Board Composition

As of March 9, 2018, our board of directors (or Board) was comprised of nine members as set forth in the table below.  Each director elected holds office for a three-year term, until a successor is duly elected and qualified or until his earlier death, resignation or removal from office.

 

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Pursuant to the terms of the outstanding Preferred Stock, Wolverine, the holder of Series C-1 Preferred Stock, designated John Ziegelman as a director, and Sudbury, the holder of Series C-2 Preferred Stock, designated Dayton Judd as a director.  Pursuant to the terms of the Investment Agreement with AMC Networks, Inc. (or AMC), AMC is entitled to designate two director nominees, and in connection with the closing under the AMC Transaction, AMC designated John Hsu and Arlene Manos, and the Board appointed them to be members of the Board. Pursuant to a voting agreement between AMC and RLJ SPAC Acquisition LLC, Miguel Penella, Tyrone Brown, Dayton Judd, JH Evergreen Management, LLC, Sudbury Capital Fund, LP, Peter Edwards, Morris Goldfarb and certain other stockholders, who in the aggregate then held approximately 47% of the outstanding common stock, the stockholders party to this agreement agreed to vote their shares to elect AMC’s nominees to the Board until the earlier of the termination of the Investment Agreement or AMC is no longer a stockholder of the Company.

Executive Officers

The following table sets forth the name, age and position of each of our executive officers as of March 9, 2018.

 

 

 

Biographical information for Mr. Penella is set forth above under “Board Composition.”

Mr. Rostom was appointed as the Company’s Chief Financial Officer in May 2016.  From January 2014 to May 2016, Mr. Rostom served in senior and executive positions with GetWellNetwork, Inc. (or GWN), a healthcare solutions provider. He was GWN’s Vice President, Financial Planning and Analysis from January 2014 to February 2015, Acting Chief Financial Officer from March 2015 to September 2015 and was Vice President, Finance from October 2015 to May 2016. During his tenure, Mr. Rostom led various strategic financing, M&A activities, and financial planning and analysis at GWN. Prior to GWN, he was Director of Finance and Assistant Treasurer for GTT Communications, Inc. (or GTT, formerly Global Telecom and Technology, Inc.), from September 2011 to January 2014. Previous to GTT, Mr. Rostom led various structured financing deals in the capital markets at National Rural Utilities Electric Cooperative Finance Corporation and CapitalSource, Inc. Mr. Rostom began his career in investment banking at PriceWaterhouseCoopers, Securities LLC. Mr. Rostom is a Certified Public Accountant and a CFA Charterholder. He holds a MBA from Duke University and a Bachelor of Science in Business Administration from Georgetown University.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act requires RLJE’s directors, executive officers and the beneficial holders of more than 10% of a registered class of RLJE’s equity securities to file initial reports of ownership and changes in ownership of common stock and other equity securities of RLJE with the Securities and Exchange Commission (or SEC).  Based solely on a review of copies of reports filed with the SEC and written representations by certain officers and directors, we believe that all of our officers, directors and stockholders subject to the reporting requirements of Section 16(a) filed all of their reports related to non-exempt transactions on a timely basis during the fiscal year ended December 31, 2017, except for one Form 4 for Mr. Sinclair, reporting one transaction.  We also believe these persons filed all of their reports related to exempt transactions on a timely basis with respect to the fiscal year ended December 31, 2017.

Code of Ethics and Governance Guidelines

We have a Code of Ethics and Business Conduct Policy that applies to all of our employees, including our principal executive officer and principal financial and accounting officer, and to our directors.  We have posted the Code of Ethics and Business Conduct Policy under the menu “Investors – Corporate Governance” on our website at www.rljentertainment.com.  If we waive any material portion of our Code of Ethics and Business Conduct Policy that applies to our principal executive officer or principal financial and accounting officer or amend the Code of Ethics and Business Conduct Policy (other than technical, administrative or other non-substantive amendments), we will disclose that fact on our website at www.rljentertainment.com within four business days.

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Board Independence.

A discussion regarding Board independence is included in Item 13 below.

Committees of the Board

Audit Committee. The Company has an Audit Committee comprised of Messrs. Judd, Royster, and Laszlo (Chairman).  The Board has determined that Messrs. Judd, Royster, and Laszlo are independent as that term is used in NASDAQ Marketplace Rule 5605 and in Rule 10A-3(b)(1) under the Securities Exchange Act of 1934 and that Mr. Royster is an “audit committee financial expert,” as that term is defined in Item 407(d)(5)(ii) of Regulation S-K.

Compensation Committee. The Company has a Compensation Committee comprised of Ms. Manos and Messrs. Hsu, Laszlo, Ziegelman and Sinclair (Chairman), with Mr. Sinclair appointed effective April 5, 2017 to replace Mr. Brown as Chairman.  The Board has determined that Ms. Manos and Messrs. Hsu, Laszlo, Sinclair and Ziegelman are independent as that term is used in NASDAQ Marketplace Rule 5605.

Nominations and Governance Committee.  The Company has a Nominations and Governance Committee comprised of Ms. Manos and Messrs. Hsu, Judd, Laszlo, Sinclair, Ziegelman, and Royster (Chairman).  Mr. Sinclair was appointed effective May 2, 2017 to replace Mr. Brown.  The Board has determined that Ms. Manos and Messrs. Hsu, Judd, Laszlo, Sinclair, Ziegelman, and Royster are independent as that term is used in NASDAQ Marketplace Rule 5605.

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Summary Compensation Table for Fiscal Year 2017

The following table sets forth the compensation of those persons who served as our principal executive officer, principal financial officer and our other executive officers (collectively, the Named Executive Officers) for the fiscal year ended on December 31, 2017.

 

 

 

Fiscal year 2016 includes restricted stock awards of 91,824 shares for Mr. Penella and 33,334 shares for Mr. Rostom, each vesting in three equal installments on March 31, 2017, 2018 and 2019. The amounts shown represent the total grant date fair value of the grant computed in accordance with FASB ASC Topic 718.

Employment Agreements

We have entered into employment agreements with Messrs. Penella and Rostom.

Agreement with Mr. Penella

The agreement with Mr. Penella was effective as of July 18, 2013.  Certain terms of the agreement are summarized below.

Term.  Mr. Penella’s agreement provides that he will serve the Company as an employee under the terms of the agreement until terminated.

Base Compensation.  The agreement provides for minimum annual base salary of $500,000, subject to any increase as determined by the Board.

Cash Bonus Opportunity.  Mr. Penella has an opportunity to earn an annual bonus, based on achieving certain corporate performance levels to be established by the Board. The annual bonus is set by the Board annually by March 31, and the annual bonus amount, subject to achieving the applicable performance levels, will not be less than $250,000. The annual bonus is subject to the Company achieving 97% of the earnings before income tax, depreciation, amortization, cash investment in content, interest expense, transaction and severance costs, warrants and stock-based compensation (or Adjusted EBITDA) or revenue targets proposed by management and approved and adopted by the Board, in its sole discretion.

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Stock Grant.  Mr. Penella was awarded 128,756 shares of restricted stock, with 64,378 shares vesting on March 1, 2014, 32,189 shares vesting on January 1, 2015 and 32,189 shares vesting on January 1, 2016. One-half of the shares subject to vesting on each of these dates were subject to an additional condition of the Company achieving 97% of the Adjusted EBITDA or revenue targets proposed by management and approved and adopted by the Board, in its sole discretion, for 2013, 2014 and 2015. These targets were not satisfied and the performance-based shares for each of the above vest dates were forfeited.

Benefits.  Mr. Penella is entitled to certain insurance, fringe and leave benefits generally available to senior executives of the Company. The agreement requires Mr. Penella to protect the confidentiality of the Company’s confidential information.  It further provides that for one year after termination he will not engage in any business which is substantially similar to the Company’s business and that for two years after termination he will not seek to solicit or hire the Company’s employees.

Severance Benefits.  The Company may terminate Mr. Penella’s employment for cause, without cause or upon death or disability, and Mr. Penella may terminate his employment for good reason or without cause.  If Mr. Penella’s employment is terminated by the Company without cause (other than upon death or disability) or Mr. Penella terminate his employment for good reason, he would be entitled to receive, for 12 months following termination (the severance period), his base salary as in effect immediately prior to termination and a pro rata annual bonus based upon the Company’s performance for the year in which termination occurs, if 97% of the performance target levels are met.  In addition, his benefits would continue for the severance period. Under the agreement, “cause” includes (a) material dishonesty, theft, misrepresentation, deceit or fraud, (b) negligence or insubordination (subject to certain rights of cure), (c) conviction for, or plea of nolo contendere to, a charge or commission of a felony or (d) material breach of the confidentiality, non-competition or non-solicitation provisions of the agreement (subject to certain rights of cure) and “good reason” includes (a) material diminution of Mr. Penella’s duties or responsibilities, (subject in either case to certain rights of cure), (b) a material breach by the Company of the agreement (subject to certain rights of cure) and (c) requiring Mr. Penella to relocate to an office on a regular basis that is more than 50 miles from the Company’s current principal executive offices.

Agreement with Mr. Rostom

The agreement with Mr. Rostom was effective as of May 18, 2016.  Certain terms of the agreement are summarized below.

Term.  Mr. Rostom’s agreement provides that he will serve the Company as an employee under the terms of the agreement until terminated.

Base Compensation.  The agreement provides for minimum annual base salary of $275,000, subject to any increase as determined by the Board.

Cash Bonus Opportunity.  Mr. Rostom has an opportunity to earn an annual bonus, based on achieving certain corporate performance levels to be established by the Board. The annual bonus is set by the Board annually by March 31, and the annual bonus amount, subject to achieving the applicable performance levels, will not be less than $68,750. The annual bonus is subject to the Company achieving 97% of the earnings before income tax, depreciation, amortization, cash investment in content, interest expense, transaction and severance costs, warrants and stock-based compensation (or Adjusted EBITDA) or revenue targets proposed by management and approved and adopted by the Board, in its sole discretion.

Stock Grant.  Mr. Rostom was awarded 33,334 shares of restricted stock, with 11,111 shares vesting on March 31, 2017, 11,111 shares vesting on March 31, 2018 and 11,112 shares vesting on March 31, 2019.

Benefits.  Mr. Rostom is entitled to certain insurance, fringe and leave benefits generally available to senior executives of the Company. The agreement requires Mr. Rostom to protect the confidentiality of the Company’s confidential information.  It further provides that for one year after termination he will not engage in any business which is substantially similar to the Company’s business and that for two years after termination he will not seek to solicit or hire the Company’s employees.

Severance Benefits.  The Company may terminate Mr. Rostom’s employment for cause, without cause or upon death or disability, and Mr. Rostom may terminate his employment for good reason or without cause.  If Mr. Rostom’s employment is terminated by the Company without cause (other than upon death or disability) or Mr. Rostom terminate his employment for good reason, he would be entitled to receive, for 12 months following termination (the severance period), his base salary as in effect immediately prior to termination and a pro rata annual bonus based upon the Company’s performance for the year in which termination occurs, if 97% of the performance target levels are met.  In addition, his benefits would continue for the severance period. Under the agreement, “cause” includes (a) material dishonesty, theft, misrepresentation, deceit or fraud, (b) negligence or insubordination (subject to certain rights of cure), (c) conviction for, or plea of nolo contendere to, a charge or commission of a felony or (d) material breach of the confidentiality, non-competition or non-solicitation provisions of the agreement (subject to certain rights of cure) and “good reason” includes (a) material diminution of Mr. Rostom’s duties or responsibilities, (subject in either case to certain rights of cure), (b) a material breach by the Company of the agreement (subject to certain rights of cure) and (c) requiring Mr. Rostom to relocate to an office on a regular basis that is more than 50 miles from the Company’s current principal executive offices.

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Outstanding Equity Awards at Fiscal Year End 2017

The following table includes all outstanding equity awards at December 31, 2017.

 

 

 

Director Compensation

The following non-employee members of our Board, Dayton Judd, Andor (Andy) M. Laszlo, Scott R. Royster, and H. Van Sinclair receive an annual retainer of $50,000, paid quarterly, and an annual restricted stock award valued at $50,000. Effective October 1, 2017, the value of the annual retainer and annual restricted stock award were increased to $75,000 each.  The other non-employee members of the Board, Arlene Manos, John Hsu and John Ziegelman have waived this compensation.  In addition, all non-employee directors are reimbursed for reasonable travel expenses to attend Board or committee meetings.  Employee directors receive no additional compensation for their service as directors.

For fiscal year 2017, each of our non-employee directors was each granted a restricted stock award, valued at $50,000, for 11,664 shares of common stock, based upon the five-day volume weighted average stock price of $4.2868 per share.  The restricted stock awards were granted under our 2012 Incentive Compensation Plan on July 31, 2017 and vest 100% on July 31, 2018, provided the recipient continues to serve as a director.  

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Director Compensation Table for Fiscal Year 2017

The following table sets forth information regarding the compensation earned by our non-employee directors in fiscal year 2017:

 

 

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The following table sets forth certain information as of March 9, 2018, with respect to the beneficial ownership of shares of our common stock owned by (i) each person, who, to our knowledge based on Schedules 13D or 13G or other reports filed with the SEC, is the beneficial owner of more than 5% of our outstanding common stock, (ii) each person who is a director, (iii) each Named Executive Officer, and (iv) all of our directors and executive officers as a group.

 

 

Notes to Beneficial Ownership Table:

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Equity Compensation Plan Information

The following table sets forth certain information as of December 31, 2017 with respect to our equity compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance, aggregated by (i) all compensation plans previously approved by our security holders, and (ii) all compensation plans not previously approved by our security holders:

 

 

Our policy on related-person transactions is included in our revised Code of Ethics and Business Conduct Policy, which has been reviewed and approved by the Board.  Our policy states that each executive officer, director or nominee for director will disclose to the Audit Committee of the Board the following information regarding a related-person transaction for review, approval or ratification by the Audit Committee:  (i) the name of the related-person (as defined by Item 404(a) of Regulation S-K under the Securities Exchange Act), and if he or she is an immediate family member of an executive officer, director or nominee for director, the nature of such relationship; (ii) the related-person’s interest in the transaction; (iii) the approximate dollar value of the amount involved in the transaction; (iv) the approximate dollar value of the amount of the related-person’s interest in the transaction; and (v) in the case of indebtedness, the largest total amount of principal outstanding since the beginning of our last fiscal year, the amount of principal outstanding as of the latest practicable date, the amount of principal paid since the beginning of our last fiscal year, and the rate or amount of interest payable on the indebtedness.

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The Audit Committee’s decision whether or not to approve or ratify the related-person transaction is made in light of its determination as to whether consummation of the transaction is believed by the Audit Committee to not be or have been contrary to our best interests.  The Audit Committee may take into account the effect of a director’s related-person transaction on such person’s status as an independent member of our Board and eligibility to serve on Board committees under SEC and stock exchange rules, as applicable.

Credit Agreement Amendment

On October 14, 2016, we entered into the AMC Credit Agreement. See the description of the AMC Credit Agreement above at Management’s Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources – Capital Resources – Senior Term Notes.  

On January 30, 2017, we entered into a First Amendment to the AMC Credit Agreement (or First Amendment) with certain subsidiaries of the Company in their capacity as guarantors and AMC as administrative agent and lender under the AMC Credit Agreement.

The First Amendment amended the AMC Credit Agreement by adding an incremental $8 million to the Tranche A Term Loan under the AMC Credit Agreement thereby increasing the aggregate principal amount of the Tranche A Term Loan from $5 million to $13 million. The First Amendment also (i) extended the Tranche A Term Loan Maturity Date from October 14, 2017 to June 30, 2019; (ii) amended the definition of Consolidated Fixed Charges to reflect the extended maturity date of the Tranche A Term Loan and the repayment of the Company’s subordinated debt with the proceeds; (iii) increased the maximum Senior Leverage Ratio as of December 31, 2018 from 2.75:1.00 to 3.50:1.00; and (iv) amended the definition of Consolidated Adjusted EBITDA.

The proceeds were used to prepay our obligations under the unsecured subordinated promissory notes we issued in October 2012 (or Subordinated Notes). As of December 31, 2016, the Subordinated Notes had an aggregate outstanding principal balance of $8.6 million, which was scheduled to amortize quarterly starting September 30, 2017, with final payment due July 31, 2018. The interest rate under the Subordinated Notes increased after January 1, 2017 from 1.5% to 12% per annum.

On June 16, 2017, the Company and AMC entered into a second amendment to the credit agreement (the Second Amendment). On June 20, 2017, upon the closing pursuant to the Second Amendment, the Company added a tranche of term loan debt in the principal amount of $10 million dollars with a maturity date of June 30, 2021. Upon the closing, the Second Amendment also (i) extended the maturity date of the Tranche A Term Loan to June 30, 2020, (ii) provided that, commencing with the interest payment to be made on June 30, 2017, all interest under the credit agreement will be paid in shares of common stock valued at $3.00 per share (subject to adjustment for stock splits and similar adjustments) and (iii) increased the maximum Senior Leverage Ratio as of December 31, 2018 to 4.0:1, as of December 31, 2019 to 3.75:1, as of December 31, 2020 to 2.75:1, and as of December 31, 2021 and thereafter to 2.5:1.

In connection with the Second Amendment, on June 20, 2017, AMC exercised a portion of its Class A warrant at $3.00 per share to acquire 1,667,000 shares of common stock in exchange for the cancellation of $5,001,000 of the Tranche B Loan. Following the cancellation, the balance of the Tranche B Loan is $54,999,000.

Preferred Stock and 2015 Warrants

On October 14, 2016, the Company closed on the exchange of 30,197.53 shares of preferred stock, convertible into 11,259,537 shares of common stock, and warrants to purchase 3,104,628 shares of common stock, in accordance with the terms described below.  As part of this transaction, the Company exchanged (a) 4,000 shares of Series A-1 Convertible Preferred Stock for 4,000 shares of C-1 Convertible Preferred Stock with Wolverine Flagship Fund Trading Limited, (b) 2,000 shares of Series A-2 Convertible Preferred Stock for 2,000 shares of Series C-2 Convertible Preferred Stock with Sudbury Capital Fund, L.P., (c) 7,491.086 shares of Series B-1 Convertible Preferred Stock for 7,491.086 shares of Series D-1 Convertible Preferred Stock with JH Evergreen Management, LLC and its affiliates, (d) 183.506 shares of Series B-1 Preferred Stock for 183.506 shares of Series D-1 Preferred Stock with Sudbury Capital Fund, L.P., (e) 15,000 shares of Series B-2 Convertible Preferred Stock for 15,000 shares of Series D-2 Convertible Preferred Stock with RLJ SPAC Acquisition, LLC, an affiliate of Robert L. Johnson, (f) 500 shares of Series B-2 Convertible Preferred Stock for 500 shares of Series D-2 Convertible Preferred Stock with Peter Edwards and (g) 1,000 shares of Series B-2 Convertible Preferred Stock for 1,000 shares of Series D-2 Convertible Preferred Stock with Morris Goldfarb. In addition, the Company exchanged on a share-for-share basis with each of these investors warrants to purchase a number of shares of common stock equal to 30% of the shares of common stock initially issuable upon conversion of such investor’s shares of preferred stock (or 2015 Warrants). The AMC Transaction triggered the exercise price adjustment provision in the 2015 Warrants, and upon the closing of the AMC Transaction the exercise price per share of the 2015 Warrants was reduced from $4.50 to $3.00.

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The amendments to the preferred stock are as follows:

As a condition to the closing of the Second Amendment, on June 20, 2017, RLJ SPAC Acquisition LLC converted 15,000 shares of the Company’s Class D-2 preferred stock, constituting its entire holdings of preferred stock, plus its accrued preferred dividends, into common stock at $3.00 per share, resulting in the issuance of 5,905,634 shares of common stock.

The 2015 Warrants issued with the preferred stock have a term of five years and initially had an exercise price of $4.50 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 the exercise price. Additionally, if we were to consummate certain fundamental transactions, such as a business combination or other change-in-control transactions, the warrant holders were entitled to 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. In connection with the amendments to the preferred stock described above, we amended the anti-dilution and redemption provisions of the 2015 Warrants to conform to the terms of the new preferred stock.

As a result of the AMC Transaction and the existing anti-dilution provisions of the 2015 Warrants, the exercise price of the 2015 Warrants was reduced to $3.00 per share.  In exchange for the holders’ consent to the amendments to the preferred stock and the 2015 Warrants and the AMC Transaction, the exercise price of the 2015 Warrants held by the holders of the Series A-1, A-2 and B-1 Preferred Stock was further reduced to $1.50 per share and the 2015 Warrants held by Mr. Goldfarb and Mr. Edwards in connection with their shares of Series B-2 Preferred Stock was further reduced to $2.37 per share (due to an existing floor on the reduction of the exercise price of their warrants).  RLJ SPAC Acquisition, LLC waived further reduction of the warrant exercise price in connection with its shares of Series B-2 Preferred Stock such that the exercise price of its 2015 Warrants was set at $3.00 per share.  

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.

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Subordinated Notes

Upon consummation of the Business Combination, we issued the Subordinated Notes in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image, which included JH Evergreen Management, LLC and its affiliates.  The Subordinated Notes bore interest at 12% per annum, of which 5.4% was payable in cash annually, and at our discretion the balance was either paid through the issuance of shares of our common stock valued at their then-current market price, or accrued and added to principal, which was payable upon maturity. Effective on May 20, 2015, in connection with the issuance of the preferred stock, the holder of the Subordinated Notes (a) converted 50% of the outstanding balance of the Subordinated Notes into Series B-1 preferred stock, (b) amended the interest rate payable from 12% to 1.5% per annum for the 24-month period commencing on January 1, 2015, and then returning to 12% per annum thereafter, (c) agreed that 45% of the interest due would be payable in cash and the remainder of the accrued interest would be payable in the form of additional Subordinated Notes and (d) waived any existing defaults and events of default. The Subordinated Notes were scheduled to mature on October 3, 2018 or six months after the latest stated maturity of the senior debt issued pursuant to our senior credit facility.

On October 14, 2016, the holders of the Subordinated Notes, including JH Evergreen Management, LLC and its affiliates, holding $7,553,745.23 principal amount of Subordinated Notes, and Sudbury Capital Fund, L.P., holding $1,040,852.28 principal amount of Subordinated Notes, consented to the AMC Transaction and waived any existing events of default or any right to exercise remedies upon a change in control of the Company in connection with the issuance or subsequent exercise of the AMC Warrants.  The payment terms of the Subordinated Notes were amended such that 25% of the principal amount outstanding on October 14, 2016 was due at the end of the quarters ending September 2017, December 2017 and March 2018, with the remaining outstanding principal due on the maturity date of the Subordinated Notes, which was July 31, 2018, instead of the entire principal amount being due upon maturity of the Subordinated Notes.  

We prepaid the Subordinated Notes in full on January 31, 2017 in connection with the First Amendment to the AMC Credit Agreement.

Executive Waiver Agreement

In connection with the AMC Transaction, Miguel Penella, the Chief Executive Officer of the Company, Nazir Rostom, the Chief Financial Officer of the Company, the Company’s directors and certain other officers of the Company each entered into a waiver agreement with the Company acknowledging that the closing of the AMC Transaction, the execution of the underlying transaction documents and the issuance and any subsequent exercise of the AMC Warrants do not constitute a change of control for the purposes of any benefit or compensation plan, program, policy, agreement or other arrangement or obligation of the Company to such officer.

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, are included in accrued royalties and distribution fees in the accompanying consolidated balance sheets. During the year ended December 31, 2017, we made payments totaling $1.0 million to The RLJ Companies, which reduced our remaining obligation to $2.5 million.  

Director Independence

Our Board reviewed the NASDAQ independence standards with regard to our directors, including whether specified transactions or relationships existed during the past three years, between our directors, or certain family members or affiliates of our directors, and RLJE, any of its subsidiaries, certain other affiliates, or our independent registered public accounting firm.  As a result of the review, our Board determined that Ms. Manos and Messrs. Hsu, Judd, Laszlo, Royster, Sinclair and Ziegelman are “independent” as that term is used in NASDAQ Marketplace Rule 5605.  We do not know of any family relationships among or between any of our directors, executive officers, or key employees.  With regard to the independence of our directors regarding committee independence, see Directors, Executive Officers and Corporate Governance – Committees of the Board above.

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The following table summarizes the aggregate fees billed for professional services provided by BDO USA, LLP related to the fiscal years ended December 31, 2017 and 2016.

 

 

Audit Fees.  Audit fees consisted of fees billed for professional services rendered for: (i) the audit of our consolidated financial statements; (ii) the review of interim consolidated financial statements for our quarterly filings; and (iii) any services that are normally provided by our principal accountant in connection with statutory and regulatory filings or engagements.

Audit-Related Fees.  There were no audit-related fees during the fiscal years ended December 31, 2017 and 2016.

Tax Fees.  BDO USA, LLP provided tax advice and compliance services during fiscal years ended December 31, 2017 and 2016.

All Other Fees. There were no other fees during the fiscal years ended December 31, 2017 and 2016.

Policy on Audit Committee Pre-Approval of Audit and Permissible Non-Audit Services of Independent Registered Public Accounting Firm

Our Audit Committee’s policy is to pre-approve the audit and non-audit services provided by the independent registered public accounting firm, in order to assure that the provision of such services does not impair the auditor’s independence.  As provided in our Audit Committee Charter, our Audit Committee believes that the combination of general pre-approval of certain types of audit services (e.g., quarterly reviews, annual audit and review of certain other documents filed with the SEC) and specific pre-approval of other services results in an effective and efficient procedure to pre-approve services performed by the independent registered public accounting firm.  Unless a type of service to be provided by the independent registered public accounting firm has received general pre-approval, it will require specific pre-approval by the Audit Committee.  In determining whether to grant general or specific pre-approval, our Audit Committee will consider whether such services are consistent with the applicable rules and regulations on auditor independence.  The term of any pre-approval is 12 months from the date of pre-approval, unless the Audit Committee specifically provides for a different period. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to the particular service or category of services and is generally subject to a specific budget. With respect to each proposed pre-approved service, the independent registered public accounting firm is required to provide to the Audit Committee detailed back-up documentation regarding the specific services to be provided.

All of the fees paid to BDO USA, LLP in fiscal 2017 and 2016 were pre-approved by the Audit Committee.  Our Audit Committee also considered whether the provision of services other than those described above under the heading of “Audit Fees” were compatible with maintaining the independence of BDO USA, LLP.

 

 

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PART IV

 

 

 

 

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Not applicable.

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SIGNATURES

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

 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

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