RLJ ENTERTAINMENT, INC. - FORM 10-Q - November 7, 2014

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

FORM 10-Q

(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2014.
 
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from ________ to ________.
 
Commission File Number 001-35675
 
 
RLJ ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
 
 
Nevada
  
45-4950432
(State or other jurisdiction of incorporation)
  
(IRS Employer Identification Number)
     
8515 Georgia Avenue, Suite 650
Silver Spring, Maryland
  
20910
(Address of principal executive offices)
  
(Zip Code)

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

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

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

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 þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o
Accelerated filer  o
Non- accelerated filer  o
Smaller reporting company  þ
(Do not check if a smaller reporting company)

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

Number of shares outstanding of the issuer’s common stock on October 27, 2014:  13,359,086

RLJ ENTERTAINMENT, INC.
INDEX TO FORM 10-Q
 
PART I.
FINANCIAL INFORMATION
  
     
Item 1.
Financial Statements
  
     
 
(a)
 4
 
 
(b)
 5
       
 
(c)
 6
       
 
(d)
 7
       
 
(e)
 8
       
 
(f)
 9
       
Item 2.
 24
     
Item 3.
 36
     
Item 4.
 36
     
PART II.
OTHER INFORMATION
  
     
Item 1.
 37
     
Item 1A.
 37
     
Item 2.
 37
     
Item 6.
 38
     
39

 
FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2014 (or Quarterly Report), includes forward-looking statements that involve risks and uncertainties within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Other than statements of historical fact, all statements made in this Quarterly Report are forward-looking, including, but not limited to, statements regarding industry prospects, future results of operations or financial position, and statements of our intent, belief and current expectations about our strategic direction, prospective and future results and condition.  In some cases, forward-looking statements may be identified by words such as “will,” “should,” “could,” “may,” “might,” “expect,” “plan,” “possible,” “potential,” “predict,” “anticipate,” “believe,” “estimate,” “continue,” “future,” “intend,” “project” or similar words.

Forward-looking statements involve risks and uncertainties that are inherently difficult to predict, which could cause actual outcomes and results to differ materially from our expectations, forecasts and assumptions.  Factors that might cause such differences include, but are not limited to:

§ Our financial performance, including our ability to achieve revenue growth, gross margins, realize synergies, and earnings before income tax, depreciation, amortization, cash investment in content, interest expense, transaction and severance costs, warrants and stock-based compensation (or Adjusted EBITDA);
§ The effects of limited cash liquidity on operational growth;
§ Our ability to satisfy financial ratios;
§ Our ability to fund planned capital expenditures and development efforts;
§ Our inability to gauge and predict the commercial success of our programming;
§ Our ability to estimate sales returns;
§ The ability of our officers and directors to generate a number of potential investment opportunities;
§ Our ability to maintain relationships with customers, employees, suppliers and lessors;
§ Delays in the release of new titles or other content;
§ The effects of disruptions in our supply chain;
§ The loss of key personnel;
§ Our public securities’ limited liquidity and trading; or
§ Our ability to continue to meet the NASDAQ Capital Market continuing listing standards.
 
All forward-looking statements should be evaluated with the understanding of inherent uncertainty. The inclusion of such forward-looking statements should not be regarded as a representation that contemplated future events, plans or expectations will be achieved.  Unless otherwise required by law, we undertake no obligation to release publicly any updates or revisions to any such forward-looking statements that may reflect events or circumstances occurring after the date of this Quarterly Report.  Important factors that could cause or contribute to such material differences include those discussed in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K filed on March 19, 2014.  You are cautioned not to place undue reliance on such forward-looking statements.
 
3
PART I - FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS
 
RLJ ENTERTAINMENT, INC.

CONSOLIDATED BALANCE SHEETS

September 30, 2014 (unaudited) and December 31, 2013
 
(In thousands, except share data)
  
September 30,
    
December 31,
  
   
2014
    
2013
  
ASSETS
        
Cash
  
$
8,174
    
$
7,674
  
Accounts receivable, net
    
13,354
      
20,324
  
Inventories
     12,512      
15,589
  
Investments in content, net
    
67,556
      
81,641
  
Prepaid expenses and other assets
    
4,701
      
2,527
  
Property, equipment and improvements, net
    
2,568
      
1,759
  
Equity investment in affiliates
    
24,289
      
25,233
  
Other intangible assets
    
16,154
      
19,651
  
Goodwill
    
47,066
      
47,066
  
Total assets
  
$
196,374
    
$
221,464
  
LIABILITIES AND EQUITY
                
Accounts payable and accrued liabilities
  
$
26,752
    
$
32,331
  
Accrued royalties and distribution fees
    
36,548
      
43,309
  
Deferred revenue
    
4,966
      
4,402
  
Debt, net of discount
    
81,210
      
76,264
  
Production loan
    
565
      
1,294
  
Deferred tax liability
    
1,814
      
1,814
  
Stock warrant liability
    
6,400
      
4,123
  
Total liabilities
    
158,255
      
163,537
  
Equity:
                
Common stock, $0.001 par value, 250 million shares authorized,13,724,756 shares issued and 13,359,086 shares outstanding at September 30, 2014 and 13,700,862  shares issued and outstanding at December 31, 2013
    
13
      
13
  
Additional paid-in capital
    
87,621
      
86,938
  
Accumulated deficit
    
(49,482
)
    
(29,334
)
Accumulated other comprehensive income (loss)
    
(33
)
    
310
  
Treasury shares, at cost, 365,670 shares at September 30, 2014 and zero at December 31, 2013
    
—
      
—
  
Total equity
    
38,119
      
57,927
  
Total liabilities and equity
  
$
196,374
    
$
221,464
  
 
 
See accompanying notes to consolidated financial statements.
 
4
RLJ ENTERTAINMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS

For the Three and Nine Months Ended September 30, 2014 and 2013
 
   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands, except per share data)
  
2014
    
2013
    
2014
    
2013
  
                 
Revenues
  
$
37,123
    
$
32,741
    
$
99,478
    
$
107,333
  
Cost of sales
    
28,149
      
24,747
      
74,521
      
88,627
  
Gross profit
    
8,974
      
7,994
      
24,957
      
18,706
  
                                 
Selling expenses
    
5,411
      
6,397
      
17,448
      
18,046
  
General and administrative expenses
    
4,710
      
4,560
      
14,553
      
16,827
  
Depreciation and amortization
    
1,301
      
1,388
      
4,258
      
4,308
  
Total selling, general and administrative expenses
    
11,422
      
12,345
      
36,259
      
39,181
  
LOSS FROM OPERATIONS
    
(2,448
)
    
(4,351
)
    
(11,302
)
    
(20,475
)
                                 
Equity earnings of affiliates
    
1,190
      
1,364
      
2,540
      
2,924
  
Interest expense, net
    
(2,508
)
    
(2,019
)
    
(6,473
)
    
(6,027
)
Change in fair value of stock warrants
    
(1,599
)
    
(3,884
)
    
(2,277
)
    
(3,082
)
Loss on extinguishment of debt
    
(1,457
)
    
—
      
(1,457
)
    
—
  
Other income (expense)
    
(1,141
)
    
1,052
      
(655
)
    
(669
)
LOSS BEFORE PROVISION FOR INCOME TAXES
    
(7,963
)
    
(7,838
)
    
(19,624
)
    
(27,329
)
Benefit (provision) for income taxes
    
164
      
(670
)
    
(524
)
    
(1,681
)
NET LOSS
  
$
(7,799
)
  
$
(8,508
)
  
$
(20,148
)
  
$
(29,010
)
Net loss per common share:
                                
Basic and diluted
  
$
(0.62
)
  
$
(0.68
)
  
$
(1.61
)
  
$
(2.33
)
                                 
Weighted average shares outstanding:
                                
Basic and diluted
    
12,557
      
12,442
      
12,502
      
12,442
  
 
 
See accompanying notes to consolidated financial statements.
 
5
RLJ ENTERTAINMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

For the Three and Nine Months Ended September 30, 2014 and 2013
 
   
For The Three Months Ended
September 30,
    
For The Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
Net loss
  
$
(7,799
)
  
$
(8,508
)
  
$
(20,148
)
  
$
(29,010
)
Other comprehensive income (loss):
                                
Foreign currency translation gain (loss)
    
(852
)
    
803
      
(343
)
    
228
  
Total comprehensive loss
  
$
(8,651
)
  
$
(7,705
)
  
$
(20,491
)
  
$
(28,782
)

 
See accompanying notes to consolidated financial statements.
 
6
RLJ ENTERTAINMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF EQUITY

For the Nine Months Ended September 30, 2014 and 2013

   
Common Stock
            
Accumulated
   
Treasury Stock
      
(In thousands)
  
Shares
    
Par
Value
    
Additional
Paid-in
Capital
    
Accumulated
Deficit
    
Other
Comprehensive
Income (Loss)
    
Shares
    
At
Cost
    
Total
Equity
  
Balance at January 1, 2014
    
13,701
    
$
13
    
$
86,938
    
$
(29,334
)
  
$
310
      
—
    
$
—
    
$
57,927
  
Issuance of restricted common stock for services
    
190
      
—
      
—
      
—
      
—
      
(166
)
    
—
      
—
  
Forfeiture of restricted common stock
    
(83
)
    
—
      
—
      
—
      
—
      
83
      
—
      
—
  
Forfeiture of founder shares
    
(449
)
    
—
      
—
      
—
      
—
      
449
      
—
      
—
  
Stock-based compensation
    
—
      
—
      
683
      
—
      
—
      
—
      
—
      
683
  
Foreign currency translation
    
—
      
—
      
—
      
—
      
(343
)
    
—
      
—
      
(343
)
Net loss
    
—
      
—
      
—
      
(20,148
)
    
—
      
—
      
—
      
(20,148
)
Balance at September 30, 2014
    
13,359
    
$
13
    
$
87,621
    
$
(49,482
)
  
$
(33
)
    
366
    
$
—
    
$
38,119
  
 
   
Common Stock
             Accumulated    
Treasury Stock
      
(In thousands)
  
Shares
    
Par
Value
    
Additional
Paid-in
Capital
    
Accumulated
Deficit
    
Other
Comprehensive
Income (Loss)
    
Shares
    
At
Cost
    
Total
Equity
  
Balance at January 1, 2013
    
13,378
    
$
13
    
$
86,133
    
$
1,743
    
$
155
      
—
    
$
—
    
$
88,044
  
Issuance of restricted common stock for services
    
323
      
—
      
—
      
—
      
—
      
—
      
—
      
—
  
Stock-based compensation
    
—
      
—
      
463
      
—
      
—
      
—
      
—
      
463
  
Foreign currency translation
    
—
      
—
      
—
      
—
      
228
      
—
      
—
      
228
  
Net loss
    
—
      
—
      
—
      
(29,010
)
    
—
      
—
      
—
      
(29,010
)
Balance at September 30, 2013
     13,701     $ 13     $ 86,596     $ (27,267 )     383     $
—
     $
—
     $ 59,725  

 
See accompanying notes to consolidated financial statements.
 
7
RLJ ENTERTAINMENT, INC.

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2014 and 2013
 
(In thousands)
  
Nine Months Ended
September 30,
  
   
2014
    
2013
  
CASH FLOWS FROM OPERATING ACTIVITIES:
        
Net loss
  
$
(20,148
)
  
$
(29,010
)
Adjustments to reconcile net loss to net cash:
                
Equity earnings in affiliates
    
(2,540
)
    
(2,924
)
Amortization of content, including impairments
    
44,979
      
50,535
  
Depreciation and amortization
    
4,258
      
4,308
  
Foreign currency exchange loss
    
405
      
706
  
Fair value adjustment of stock warrant liability
    
2,277
      
3,082
  
Non-cash interest expense
    
1,925
      
750
  
Loss on extinguishment of debt
    
1,457
      
—
  
Stock-based compensation expense
    
683
      
463
  
Changes in assets and liabilities:
                
Accounts receivable, net
    
6,930
      
9,151
  
Inventories
    
3,061
      
6,308
  
Investments in content, net
    
(37,618
)
    
(38,276
)
Prepaid expenses and other assets
    
(1,156
)
    
(361
)
Accounts payable and accrued liabilities
    
(5,519
)
    
(7,617
)
Deferred revenue
    
606
      
1,403
  
Net cash used in operating activities
    
(400
)
    
(1,482
)
CASH FLOWS FROM INVESTING ACTIVITIES:
                
Capital expenditures
    
(1,580
)
    
(350
)
Dividends received from affiliate
    
2,947
      
4,005
  
Net cash provided by investing activities
    
1,367
      
3,655
  
CASH FLOWS FROM FINANCING ACTIVITIES:
                
Borrowings under revolving credit facility
    
—
      
10,398
  
Repayments of borrowings under revolving credit facility
    
(14,949
)
    
(3,000
)
Proceeds from production loan
    
9,865
      
191
  
Repayment of production loan
    
(10,602
)
    
—
  
Proceeds from senior debt, net of discount and deferred financing costs
    
63,801
      
—
  
Repayment of senior debt
    
(48,280
)
    
(11,452
)
Cash paid to extinguish debt
    
(30
)
    
—
  
Net cash used in financing activities
    
(195
)
    
(3,863
)
Effect of exchange rate changes on cash
    
(272
)
    
(419
)
NET INCREASE (DECREASE) IN CASH:
    
500
      
(2,109
)
Cash at beginning of period
    
7,674
      
4,739
  
Cash at end of period
  
$
8,174
    
$
2,630
  
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
                
Cash paid during the period for:
                
Interest
  
$
4,830
    
$
4,183
  
Income taxes
  
$
180
    
$
539
  
 
 
See accompanying notes to consolidated financial statements.
 
8
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1.
DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

Description of Business

RLJ Entertainment, Inc. (or RLJE) is a company with a direct presence in North America, the United Kingdom and Australia and sublicense and distribution relationships covering Europe, Asia and Latin America.  RLJE was incorporated in Nevada in April 2012.  On October 3, 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media), which is referred to herein as the “Business Combination.”  Acorn Media includes its subsidiaries RLJE International Ltd (or RLJE U.K.), RLJ Entertainment Australia Pty Ltd. (or RLJE Australia) and RLJ Entertainment Ltd  (or RLJE Ltd).  In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL). References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC. “We,” “our” or “us” refers to RLJE and its consolidated subsidiaries, unless otherwise noted. Our principal executive offices are located in Silver Spring, Maryland, with additional U.S. locations in Woodland Hills, California, and Stillwater, Minnesota, and international locations in London, England and Sydney, Australia.

We acquire content rights in various categories including: British episodic mystery and drama, urban programming, and full-length independent motion pictures.  Through long-term exclusive agreements, we license rights to third-party programs.  We also develop, produce, and own original programming through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, in addition to the development and production of fitness titles through our Acacia brand.  Our owned content includes Foyle’s War made-for-TV films, multiple fitness/wellness titles, and through our 64% ownership of ACL, the works of Agatha Christie.

We exploit our products through a multi-channel strategy encompassing (1) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, (IP Licensing segment) as well as our fitness offerings; (2) wholesale exploitation through partners covering broadcast/cable, digital, online, and brick and mortar outlets (Wholesale segment); and (3)  direct relations with consumers via proprietary e-commerce, catalog, and subscription-based video on demand (or SVOD) channels (Direct-to-Consumer segment).

Our wholesale partners are broadcasters, digital outlets and major retailers in the U.S., Canada, United Kingdom (or U.K.) and Australia, including, among others:  DirecTV, Showtime, BET, PBS, Netflix, Amazon, Hulu, Walmart, Target, Costco, Barnes & Noble, HMV and iTunes.

Our Direct-to-Consumer segment includes the sale of video content and complementary merchandise directly to consumers through proprietary e-commerce websites and catalogs and our proprietary SVOD channels, AcornTV and Acacia TV, which was launched in January 2014.  We will be launching our urban content SVOD channel in November 2014.  We also plan to develop other audience-based, premium SVOD channels based on our existing library.
 
9
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Our management views the operations of RLJE based on these three distinctive reporting segments: (1) IP Licensing; (2) Wholesale; and (3) Direct-to-Consumer.  Operations and net assets that are not associated with any of these stated segments are reported as “Corporate” when disclosing and discussing segment information.  The IP Licensing segment includes intellectual property (or IP) rights that we own or create and then sublicense for exploitation worldwide.  Our Wholesale and Direct-to-Consumer segments consist of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including broadcast (including cable and satellite), DVD, Blu-ray, digital, video-on-demand (or VOD), SVOD, downloading and sublicensing.  The Wholesale segment exploits content through third-party vendors such as DirecTV, Showtime, BET, Netflix, Amazon, Walmart, Best Buy, Target and Costco, while the Direct-to-Consumer segment exploits the same content and complementary merchandise directly to consumers through our proprietary e-commerce websites, mail-order catalogs and digital streaming channels.

During the first quarter of 2014, we changed the names of a few of our subsidiaries.  A summary of the name changes are as follows:

Former Subsidiary Name
New Subsidiary Name
Acorn Productions Limited (or APL)
RLJ Entertainment Ltd  (or RLJE Ltd)
Acorn Productions (UK) Limited
Acorn Productions Ltd
Acorn Media UK Limited (or Acorn UK)
RLJE International Ltd (or RLJE U.K.)
 
 
Basis of Presentation

Unaudited Interim Financial Statements

The financial information presented in the accompanying unaudited interim consolidated financial statements as of September 30, 2014 and for the three and nine months ended September 30, 2014 and 2013 has been prepared in accordance with accounting principles generally accepted in the United States (or U.S. GAAP) and with the Securities and Exchange Commission’s (or SEC) instructions for interim financial reporting instructions for the Form 10-Q (or Form 10-Q) and Article 10 of Regulation S-X of the SEC. Accordingly, they do not include all the information and footnotes required by U.S. GAAP for complete audited financial statements.

In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included in the accompanying unaudited interim consolidated financial statements.  Due to the seasonal nature of our business in which a disproportionate amount of sales occur in the fourth quarter, and other factors, including our content release schedule, interim results are not necessarily indicative of the results that may be expected for the entire fiscal year.  The accompanying unaudited financial information should, therefore, be read in conjunction with the consolidated financial statements and the notes thereto in our Annual Report on Form 10-K filed on March 19, 2014 (or the 2013 Form 10-K).  Our significant accounting policies are included in our 2013 Form 10-K within Note 2, Summary of Significant Accounting Policies.  As of September 30, 2014, no material changes to our significant accounting policies disclosed in our 2013 Form 10-K have been made.
 
10
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Accounting and Reporting Pronouncements Adopted

Since the filing of our 2013 Form 10-K, there were no new accounting pronouncements adopted.  A summary of the accounting pronouncement issued but, not required to be adopted for the preparation of our current financial statements is as follows:

On May 28, 2014, the Financial Accounting Standards Board issued accounting standard update (or ASU) No. 2014-09, Revenue from Contracts with Customers (or ASU 2014-09), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for RLJE on January 1, 2017. Early application is not permitted. The standard permits the use of one of three transition methods. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We are also assessing the transition methods available to implement this new accounting standard.  This update could impact the timing and amounts of revenue recognized within our consolidated financial statements.

Earnings Per Share Presentation

During the first quarter of 2014, we changed our presentation of our earnings per share (or EPS) by excluding our restricted common stock from the calculation, and as a result, we removed our two-class method presentation of EPS per Accounting Standards Codification (or ASC) 260, Earnings Per Share.  This change was determined because our restricted common stock is not obligated to fund our reported net losses.  We also removed 898,438 founder shares from unrestricted common stock for the periods ended September 30, 2013, as these shares could be forfeited in future periods (see Note 8, Equity).  For the three and nine month periods ended September 30, 2013, the unrestricted weighted average shares outstanding was reduced by 898,438 founder shares and the loss per share for unrestricted common stock increased to $(0.68) per share from $(0.62) per share for the three months ended September 30, 2013 and $(2.33) per share from $(2.15) per share for the nine months ended September 30, 2013.  We have assessed this change in presentation for materiality and determined this change is not material to our consolidated financial statements.

Reclassifications

Some balances within our consolidated financial statements have been reclassified to conform to the current presentation.  We reclassified certain expenses which had been reported in previous periods within our Wholesale segment to Corporate.  Also, beginning in 2014, we began reporting depreciation and amortization as a separate line item within our segment tables; and in the third quarter of 2014, we began reporting the change in fair value of our stock warrants as a separate line item within our statement of operations.

NOTE 2.
SEGMENT INFORMATION
 
In accordance with the requirements of the ASC 280, Segment Reporting, selected financial information regarding our reportable business segments - IP Licensing, Wholesale, and Direct-to-Consumer - are presented below.  Our reportable segments are determined based on the distinct nature of their operations, and each segment is a strategic business unit that is managed separately and either exploits our content over a different customer base or acquires content differently.  Our IP Licensing segment includes intellectual property (or content) owned or created by us, other than certain fitness related content, that is licensed for exploitation worldwide. The IP Licensing segment also includes our investment in ACL.  Our Wholesale segment consists of the acquisition, content enhancement and worldwide exploitation of exclusive content in various formats, including DVD, Blu-ray, digital, broadcast (including cable and satellite), VOD, downloading and sublicensing. Our Direct-to-Consumer segment consists of our mail-order catalog and e-commerce businesses and our proprietary digital streaming channels.

Management currently evaluates segment performance based primarily on revenue, and operating income (loss), including earnings from ACL. Operating costs and expenses allocated below to Corporate include only those expenses incurred by us at the parent corporate level, which are not allocated to our reporting segments, and include costs associated with RLJE’s corporate functions such as finance and accounting, human resources, legal and information technology departments.  Interest expense, other income (expense) and benefit (provision) for income tax are evaluated by management on a consolidated basis and are not allocated to our reportable segments.
 
11
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The following tables summarize the segments for the three month periods ended September 30, 2014 and 2013:

(In thousands)
  
Three Months Ended September 30, 2014
  
   
IP
Licensing
    
Wholesale
    
Direct-to-
Consumer
    
Corporate
    
Total
  
                     
Revenue
  
$
8,674
    
$
22,003
    
$
6,446
    
$
—
    
$
37,123
  
Operating costs and expenses
    
(6,373
)
    
(22,491
)
    
(6,935
)
    
(2,471
)
    
(38,270
)
Depreciation and amortization
    
(30
)
    
(334
)
    
(864
)
    
(73
)
    
(1,301
)
Share in ACL earnings
    
1,190
      
—
      
—
      
—
      
1,190
  
Segment contribution
  
$
3,461
    
$
(822
)
  
$
(1,353
)
  
$
(2,544
)
  
$
(1,258
)
 
 
(In thousands)
  
Three Months Ended September 30, 2013
  
   
IP
Licensing
    
Wholesale
    
Direct-to-
Consumer
    
Corporate
    
Total
  
                     
Revenue
  
$
16
    
$
25,026
    
$
7,699
    
$
—
    
$
32,741
  
Operating costs and expenses
    
(52
)
    
(24,770
)
    
(8,028
)
    
(2,854
)
    
(35,704
)
Depreciation and amortization
    
(22
)
    
(444
)
    
(921
)
    
(1
)
    
(1,388
)
Share in ACL earnings
    
1,364
      
—
      
—
      
—
      
1,364
  
Segment contribution
  
$
1,306
    
$
(188
)
  
$
(1,250
)
  
$
(2,855
)
  
$
(2,987
)
 
 
In July of 2014, our IP Licensing segment released the current season of Foyle’s War. Our IP Licensing segment released last year’s season of Foyle’s War in the first quarter of 2013.

The following tables summarize the segments for the nine month periods ended September 30, 2014 and 2013:
 
(In thousands)
  
Nine Months Ended September 30, 2014
  
   
IP
Licensing
    
Wholesale
    
Direct-to-
Consumer
    
Corporate
    
Total
  
                     
Revenue
  
$
8,687
    
$
66,777
    
$
24,014
    
$
—
    
$
99,478
  
Operating costs and expenses
    
(6,883
)
    
(63,952
)
    
(26,800
)
    
(8,887
)
    
(106,522
)
Depreciation and amortization
    
(85
)
    
(1,125
)
    
(2,648
)
    
(400
)
    
(4,258
)
Share in ACL earnings
    
2,540
      
—
      
—
      
—
      
2,540
  
Segment contribution
  
$
4,259
    
$
1,700
    
$
(5,434
)
  
$
(9,287
)
  
$
(8,762
)
 
 
(In thousands)
  
Nine Months Ended September 30, 2013
  
   
IP
Licensing
    
Wholesale
    
Direct-to-
Consumer
    
Corporate
    
Total
  
                     
Revenue
  
$
8,040
    
$
75,750
    
$
23,543
    
$
—
    
$
107,333
  
Operating costs and expenses
    
(7,201
)
    
(82,195
)
    
(25,223
)
    
(8,881
)
    
(123,500
)
Depreciation and amortization
    
(65
)
    
(1,411
)
    
(2,820
)
    
(12
)
    
(4,308
)
Share in ACL earnings
    
2,924
      
—
      
—
      
—
      
2,924
  
Segment contribution
  
$
3,698
    
$
(7,856
)
  
$
(4,500
)
  
$
(8,893
)
  
$
(17,551
)
 
 
Included in our Wholesale segment contribution for the nine months ended September 30, 2014 is a loss of $3.1 million incurred during the sell-off period under a terminated feature film content output deal that was recognized in the first quarter of 2014.
 
12
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
During the nine months ended September 30, 2013, we recognized additional operating costs and expenses of approximately $11.5 million, which was primarily recognized within our Wholesale segment as follows:  $4.6 million when management entered into an early termination of a feature film content output deal, increased reserves for inventory and content impairments in the aggregate of approximately $3.4 million, primarily attributable to costs associated with transitioning of the Madacy product line, increased integration costs from a distributor when we combined our Image and Acorn operations of $1.1 million, and $2.4 million associated with entering into certain severance agreements.

A reconciliation of total segment contribution to loss before provision for income taxes is as follows:

(In thousands)
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2014
    
2013
    
2014
    
2013
  
                 
Total segment contribution (loss)
  
$
(1,258
)
  
$
(2,987
)
  
$
(8,762
)
  
$
(17,551
)
Interest expense
    
(2,508
)
    
(2,019
)
    
(6,473
)
    
(6,027
)
Change in fair value of stock warrants
    
(1,599
)
    
(3,884
)
    
(2,277
)
    
(3,082
)
Loss on extinguishment of debt
    
(1,457
)
    
—
      
(1,457
)
    
—
  
Other income (expense)
    
(1,141
)
    
1,052
      
(655
)
    
(669
)
Loss before provision for income taxes
  
$
(7,963
)
  
$
(7,838
)
  
$
(19,624
)
  
$
(27,329
)
 
 
Total assets for each segment primarily include accounts receivable, inventory, investments in content, goodwill, other intangible assets and equity investment in affiliate.  The Corporate segment primarily includes assets not fully allocated to a segment including consolidated cash accounts, prepaid assets and fixed assets used across all segments.

Total assets by segment are as follows:

(In thousands)
  
September 30,
    
December 31,
  
   
2014
    
2013
  
         
IP Licensing
  
$
29,149
    
$
36,127
  
Wholesale
    
142,094
      
162,162
  
Direct-to-Consumer
    
14,630
      
15,964
  
Corporate
    
10,501
      
7,211
  
   
$
196,374
    
$
221,464
  
 
 
Goodwill by segment is as follows:

(In thousands)
  
September 30,
    
December 31,
  
   
2014
    
2013
  
         
Wholesale
  
$
44,230
    
$
44,230
  
Direct-to-Consumer
    
2,836
      
2,836
  
   
$
47,066
    
$
47,066
  
 
 
13
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 3.
EQUITY EARNINGS IN AFFILIATE
 
In February 2012, we acquired 64% of ACL’s outstanding stock.  We account for the investment in ACL using the equity method of accounting because (1) we are 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.

The following summarized financial information is derived from the unaudited financial statements of ACL:

(In thousands)
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2014
    
2013
    
2014
    
2013
  
                 
Revenues
  
$
4,634
    
$
11,326
    
$
11,385
    
$
28,165
  
Film cost amortization
    
(932
)
    
(7,731
)
    
(2,833
)
    
(19,156
)
General, administrative and other expenses
    
(1,075
)
    
(789
)
    
(2,699
)
    
(2,266
)
Income from operations
    
2,627
      
2,806
      
5,853
      
6,743
  
Net income
  
$
2,101
    
$
2,349
    
$
4,665
    
$
5,218
  
 
 
ACL’s functional currency is the British Pound Sterling.  Amounts have been translated from British Pound to U.S. Dollar using the average exchange rate for the periods presented.  The above operating results of ACL do not include step-up basis amortization resulting from the Business Combination.

NOTE 4.
ACCOUNTS RECEIVABLE
 
Accounts receivable are primarily derived from (1)  the sales of physical content (DVDs) to retailers and certain resellers, (2) direct-to-consumer, e-commerce, catalog and download-to-own sales of content and other merchandise, or both, and (3) the licensing of content to broadcast, cable/satellite providers and digital subscription platforms including AcornTV, Netflix and Amazon.  Our accounts receivable typically trends with retail seasonality.

(In thousands)
  
September 30,
2014
    
December 31,
2013
  
         
Wholesale
  
$
16,104
    
$
30,966
  
IP Licensing
    
764
      
—
  
Direct-to-Consumer
    
494
      
67
  
Accounts receivable before allowances and reserves
    
17,362
      
31,033
  
Less:  reserve for returns
    
(3,853
)
    
(10,690
)
Less:  allowance for doubtful accounts
    
(155
)
    
(19
)
Accounts receivable, net
  
$
13,354
    
$
20,324
  
 
 
14
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Wholesale receivables are primarily billed and collected by our U.S. and U.K. distribution partners and include certain adjustments for receivables previously settled.  Each quarter, our distribution partners preliminarily settle our wholesale receivables assuming a timing lag on collections and an average return rate.  When actual returns differ from the amounts previously assumed, adjustments are made that give rise to payables and receivables between us and our distribution partners.  Amounts vary and tend to be seasonal following our sales activity.  As of September 30, 2014, our advances and accrued obligations due to our distribution partner were $10.5 million, which exceeded our accounts receivable of $6.1 million. The net over advance of $4.4 million has been recorded in accounts payable and accrued liabilities as of September 30, 2014.  As of December 31, 2013, our advances and accrued obligations due to our distribution partner were $2.6 million and our accounts receivable was $14.3 million.  As of December 31, 2013, our distribution partners owed us $700,000 for receivables settled as of year-end.

NOTE 5.
INVENTORIES
 
Inventories are summarized as follows:

(In thousands)
  
September 30,
2014
    
December 31,
2013
  
         
Packaged discs
  
$
9,608
    
$
11,340
  
Packaging materials
    
1,215
      
1,873
  
Other merchandise (1)
    
1,689
      
2,376
  
Inventories
  
$
12,512
    
$
15,589
  

 
(1) Other merchandise primarily consists of gifts, jewelry, and home accents purchased from third-parties.

We incur impairment charges associated with our inventories due to adjustments for lower of cost or market valuation, shrinkage, and excess and obsolescence.  Inventory impairment charges are included in the cost of sales.  Impairment charges for the three months ended September 30, 2014 and 2013 were $712,000 and $1.2 million, respectively, and for the nine months ended September 30, 2014 and 2013, they were $1.9 million and $6.2 million, respectively.

During the first quarter of 2014 and during the second quarter of 2013, we recorded impairment charges of $263,000 and $3.4 million, respectively, resulting from the early termination of an output agreement with a content supplier and the transition of the Madacy product line.

NOTE 6.
INVESTMENTS IN CONTENT
 
(In thousands)
  
September 30,
2014
    
December 31,
2013
  
         
Released
  
$
61,895
    
$
66,527
  
Completed, not released
    
4,952
      
10,387
  
In-production
    
709
      
4,727
  
Investments in content, net
  
$
67,556
    
$
81,641
  
 
 
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 three months ended September 30, 2014 and 2013 were $1.4 million and $1.9 million, respectively, and for the nine months ended September 30, 2014 and 2013, they were $2.7 million and $5.2 million, respectively.  Impairments are included in cost of sales.
 
15
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
In determining the fair value of content (Note 10, 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.

NOTE 7. DEBT
 
Debt consists of the following:
 
(In thousands)  
Maturity
Date
    
Interest
Rate
    
September 30,
2014
    
December 31,
2013
  
                 
Revolving credit facility
          
$
—
    
$
14,949
  
                                 
Senior term notes
  
September
11, 2019
    
LIBOR + 9.9% -
10.64%
      
70,000
      
48,280
  
Less: debt discount
                    
(4,825
)
    
(2,007
)
Total senior-term notes
                    
65,175
      
46,273
  
                                 
Secured debt, net of discount
                    
65,175
      
61,222
  
                                 
Subordinated notes payable to prior Image shareholders
  
October 3,
2018
      
12%
    
16,035
      
15,042
  
Debt, net of discount
                    
81,210
      
76,264
  
                                 
Subordinated production loan - Foyle's War
  
November
8, 2014
    
LIBOR + 2.15%
      
565
      
1,294
  
Debt
                  
$
81,775
    
$
77,558
  
 
 
On September 11, 2014, we refinanced our secured debt into a new credit facility with new lenders.  Maturity dates and interest rates disclosed above are for debt obligations that are outstanding as of September 30, 2014.  At September 30, 2014 and December 30, 2013, the carrying value of our debt approximates its fair value due to the relative short-term maturities of the debt, the associated interest rates approximate market rates, or both.

Future minimum principal payments as of September 30, 2014 are as follows:
 
(In thousands)
      
Subordinated
    
Production
      
   
Senior Notes
    
Notes
    
Loan
    
Total
  
                 
2014
  
$
613
    
$
—
    
$
565
    
$
1,178
  
2015
    
2,450
      
—
      
—
      
2,450
  
2016
    
2,975
      
—
      
—
      
2,975
  
2017
    
4,375
      
—
      
—
      
4,375
  
2018
    
59,587
    
$
16,035
      
—
      
75,622
  
   
$
70,000
    
$
16,035
    
$
565
    
$
86,600
  
 
 
Currently, the subordinated notes mature in 2018 and the new senior notes mature in 2019, however, if we do not subsequently extend the subordinated debt maturity beyond 2019, then the new senior note’s maturity would accelerate in conjunction with the subordinated notes in 2018.  The above table reflects the assumption that no extension of the subordinated notes occurs.  The senior note’s debt service would be $5.3 million if the maturity remains in 2019.
 
16
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
New Credit Facility
 
On September 11, 2014, we entered into a $70.0 million Credit and Guaranty Agreement (the “Credit Facility”) with a syndicate of lenders lead by McLarty Capital Partners, as lead administrative agent. The Credit Facility consists of a term loan totaling $70.0 million with a final maturity of five years, at an interest rate equal to (a) LIBOR plus 10.64% for so long as the unpaid principal amount of the Credit Facility is greater than $65.0 million, and (b) LIBOR plus 9.9% thereafter with a floor of 0.25% for LIBOR.  The quarterly principal amortization is 3.5% for the first two years, 5.0% for the third year and 7.5% for the remaining term with any unpaid principal balance due at maturity.  The obligations under the Credit Facility are secured by a lien on substantially all of our consolidated assets pursuant to the Pledge and Security Agreement, dated as of September 11, 2014.  Initial debt service begins on December 31, 2014.

Under the new Credit Facility, interest and principal is payable quarterly with principal payments beginning on December 31, 2014.  Initial quarterly principal payments are $613,000 through June 2016, then increase to $875,000 through June 2017, and thereafter are $1.3 million.  Beginning in 2016, we are obligated to make certain accelerated principal payments annually which are contingent upon:  (1) the occurrence of consolidated excess cash flows, as defined in the Credit Facility, and (2) only to the extent at which such excess cash flows are above our minimum cash threshold of $12.0 million.  We are permitted to make additional voluntary principal payments under the Credit Facility, yet prepayments are subject to an applicable prepayment premium of:  (a) 5% if prepaid during the first year, (b) 3% if prepaid during the second year, and (c) 1.5% if prepaid during the third year.  The first $5.0 million of voluntary prepayment is not subject to any prepayment premium.

We incurred $4.9 million in original issuance discounts and other related fees paid to lenders under the new Credit Facility.  We also incurred $1.3 million in fees for legal and other professional services.  Repayment of our previous credit facility included principal and accrued interest of $56.1 million ($15.0 million revolving credit facility and $41.1 million of term loans and accrued interest).

The new Credit Facility contains certain financial and non-financial covenants beginning on December 31, 2014.  Financial covenants are assessed quarterly and are based on an Adjusted EBITDA, as defined in the Credit Facility.  Financial covenants vary each quarter and generally become more restrictive over time.  Financial covenants include the following:

   
December 31,
2014
    
 
2015
    
 
2016
    
 
Thereafter
  
Leverage Ratios:
                
Senior debt-to-
Adjusted EBITDA
  
4.64 : 1.00
    
Ranges from
4.87 : 1.00 to
 4.03 : 1.00
    
Ranges from
3.86 : 1:00 to
2:67 : 1.00
    
2.67 : 1.00
  
Total debt-to-Adjusted
EBITDA
  
5.71 : 1.00
    
Ranges from
6.09 : 1.00 to
5.06 : 1.00
    
Ranges from
4.82 : 1:00 to
3.44 : 1.00
    
3.44 : 1.00
  
Fixed charge coverage
ratio
  
1.10 : 1.00
    
Ranges from
1.07 : 1.00 to
1.20 : 1.00
    
Ranges from
1.24 : 1.00 to
1.59 : 1.00
    
1.59 : 1.00
  
 
 
Beginning in 2016, we are also obligated to maintain a minimum valuation ratio computed on the outstanding principal balance of our senior debt compared to the sum of our valuations of our content library and our investment in ACL.  To the extent the valuation ratio exceeds the allowed threshold, we are obligated to make an additional principal payment such that the threshold would not be exceeded after giving effect of this payment.  The valuation threshold is 83% as long as the unpaid principal balance exceeds $65.0 million and 75% thereafter.
 
17
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
The Credit Facility 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 Sony Pictures Home Entertainment 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 will increase the applicable rate of interest and could result in the acceleration of our obligations under the Credit Facility.

The Credit Facility imposes restrictions on such items as encumbrances and liens, payments of dividends, other indebtedness, stock repurchases, capital expenditures and entering into new lease obligations.  The Credit Facility also requires us to comply with minimum financial and operating covenants as disclosed above.  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 new Credit Facility, we must maintain at all times a cash balance of $3.5 million.  When repaying the previous credit facility, we recognized a $1.5 million loss from the early extinguishment of debt, which is reported as a separate line item within our statement of operations.  This loss primarily represented the unamortized debt discount and deferred financing costs at the time of repayment of our prior credit facility.

Subordinated Notes Payable and Other Debt

Upon consummation of the Business Combination in October 2012, we issued unsecured subordinated promissory notes in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image.  The subordinated notes mature on the earlier of October 3, 2018 or six months after the latest stated maturity of the senior debt issued pursuant to the Credit Facility.  The unsecured subordinated notes bear an interest rate of 12% per an annum, of which 5.4% is payable in cash annually and at our discretion the balance is either paid through the issuance of shares of our common stock valued at their then-current market price, or accrues and is added to the principal, which is payable upon maturity.  During the second quarter of 2014, interest was due of $992,000 and added to the principal balance of these notes.  At September 30, 2014, our principal balance due pursuant to these notes was $16.0 million.

In October 2013, we began our production of the next season of the franchise series of Foyle’s War.  Acorn Productions Limited, and Acorn Global Enterprises Limited, both wholly-owned subsidiaries of RLJE Ltd, entered into a cash advance facility (the FW9 Facility) with Coutts and Co., a U.K. based lender, for purposes of producing three ninety-minute television programs entitled “Foyle’s War Series 9.” The facility carries interest at a rate of LIBOR plus 2.15%.  Interest and repayment of advances received are due on or before November 8, 2014.  This facility is substantially secured by (i) executed license agreements whereby we have pre-sold certain broadcast and distribution rights and (ii) U.K. tax credits based on anticipated qualifying production expenditures.  The assets and intellectual property will become secured collateral of the Credit Facility once the production loan is fully paid and settled.  At September 30, 2014, our principal balance due pursuant to these notes was $565,000.

NOTE 8.
EQUITY
 
Founder and Treasury Shares

As of September 30, 2014, included in our common shares outstanding are 449,218 shares held by certain founding shareholders as part of the initial public offering of RLJE.  These shares will be returned to the Company after October 2014, as certain stock price targets were not achieved.  During the three and nine months ended September 30, 2014, shares forfeited were 7,187 and 449,218, respectively.

During the three and nine months ended September 30, 2014, there were 4,368 and 82,838 shares, of restricted common stock, respectively, that were forfeited due to the failure to achieve required performance conditions or due to resignation of the holder.  During the three and nine months ended September 30, 2013, there were no forfeiture of shares.

As shares are forfeited, they are held as treasury stock.  Treasury shares are available to RLJE for future grants or issuances as the Company may elect.
 
18
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
Stock Based Compensation

Compensation expense relating to the restricted stock awards for the three months ended September 30, 2014 and 2013 was $227,000 and $311,000, respectively, and for the nine months ended September 30, 2014 and 2013 stock based compensation was $683,000 and $463,000, respectively.  Compensation expense related to restricted stock awards is included in general and administrative expenses.

During the nine months ended September 30, 2014, 190,280 shares of restricted stock were granted, 182,206 shares were vested and 82,838 shares were forfeited.  Of the 190,280 shares granted in 2014, 105,780 shares were granted to directors, 59,000 shares were granted to executive officers, and 25,500 shares were granted to other members of management.  Of the 82,838 shares forfeited, 66,244 shares of restricted stock were forfeited based upon the failure to achieve the required performance conditions and the remainder of the forfeitures were due to employee resignations.  The shares granted during 2014, were fair valued on the date of grant with a range of $3.49 - $5.00 per share, for a total value of approximately $766,000.

A summary of the activity since January 1, 2014 is as follows:

(In thousands, except per share data)
                
   
Service Shares
    
Performance Shares
  
Restricted Stock-Based Compensation
Award Activity
  
Shares
    
Weighted-
Average Grant
Date Fair Value
    
Shares
    
Weighted-
Average Grant
Date Fair Value
  
                 
Nonvested shares at January 1, 2014
    
188
    
$
5.38
      
135
    
$
5.15
  
Granted
    
129
      
3.76
      
61
      
4.60
  
Vested
    
(126
)
    
3.89
      
(56
)
    
4.60
  
Forfeited
    
(6
)
    
5.21
      
(77
)
    
5.26
  
Nonvested shares at September 30, 2014
    
185
    
$
5.28
      
63
    
$
4.96
  
 
 
The restricted shares granted during the nine months ended September 30, 2014 will vest and be expensed over a 13 month period for employees and a nine month period for directors from the date of grant.  The vesting of restricted shares is subject to the achievement of certain service criteria, performance criteria, or both.  As of September 30, 2014, there is $548,000 of unamortized compensation that will vest solely on completion of future services over the next 21 months.  As of September 30, 2014, there is $296,000 of unamortized compensation that will vest based on achieving certain performance criteria through July 2016.

A summary of the activity for the period of January 1 through September 30, 2013 is as follows:

(In thousands, except per share data)
                
   
Service Shares
    
Performance Shares
  
Restricted Stock-Based Compensation
Award Activity
  
Shares
    
Weighted-
Average Grant
Date Fair Value
    
Shares
    
Weighted-
Average Grant
Date Fair Value
  
                 
Nonvested shares at January 1, 2013
    
38
    
$
7.98
      
—
    
$
—
  
Granted
    
188
      
5.38
      
135
      
5.15
  
Vested
    
—
      
—
      
—
      
—
  
Forfeited
    
—
      
—
      
—
      
—
  
Nonvested shares at September 30, 2013
    
226
    
$
5.81
      
135
    
$
5.15
  
 
 
19
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
During the nine months ended September 30, 2013, 323,316 shares of restricted stock were granted, and no shares were vested or forfeited.  Of the 323,316 shares granted in 2013, 181,387 shares were granted to executive officers, 52,320 shares were granted to directors, and 89,609 shares were granted to other members of management.  The shares granted during 2013, were fair valued on the date of grant with a range of $3.72 - $5.97 per share, for a total value of approximately $1.7 million.  The shares granted during 2013 will vest over a period for up to three years from the date of grant.

NOTE 9. 
STOCK WARRANTS
 
RLJE had the following warrants outstanding:

   
September 30, 2014
(In thousands, except per share data)
  
Shares
    
Exercise
Price
  
Remaining
Life
Registered warrants
    
12,525
    
$
12.00
  
3.00 years
Sponsor warrants
    
6,667
    
$
12.00
  
3.00 years
Unregistered warrants
    
1,850
    
$
12.00
  
3.00 years
     
21,042
             

We have warrants outstanding to purchase 21,041,667 shares of our common stock, which are recorded at fair value on the consolidated balance sheet.  The warrants have a term of five years beginning October 3, 2012, and provide the warrant holder the right to acquire a share of our common stock for $12.00 per share. The warrants are redeemable by us for $0.01 per warrant share if our common stock trades at $17.50 or more per share for 20 out of 30 trading days. The warrants contain standard anti-dilution provisions.

The warrants contain a provision whereby the exercise price will be reduced if RLJE reorganized as a private company.  The reduction in exercise price depends upon the amount of other consideration, if any, received by the warrant holders in the reorganization and how many years after the Business Combination a reorganization is consummated.  Generally, the reduction in exercise price would be between $6.00 and $9.00 assuming no additional consideration was received.  Because of this provision, all warrants are being accounted for as a derivative liability in accordance with ASC 815-40, Contracts in Entity’s Own Equity.

The fair value of the warrants as of September 30, 2014 was $6.4 million.  The valuation of the warrants is a Level 3 measurement.  The registered warrants had been traded on the over-the-counter market and previously were reported as a Level 1 measurement but, due to the lack of trade activity since the first quarter of 2014, the warrant valuation for registered warrants was transferred to Level 3 and valued in the same manner of the Sponsor and unregistered warrants.  Because RLJE has agreed not to exercise its redemption right pertaining to certain warrants held by RLJ SPAC Acquisition LLC (or the Sponsor) and because the unregistered warrants generally have a discounted fair value as compared to the registered warrants, the valuation of the non-registered warrants has always been a Level 3 measurement.  The increase in the fair value of the warrants for the three months ended September 30, 2014 and 2013 was $1.6 million and $3.9 million, respectively.  The increase in the fair value of the warrants for the nine months ended September 30, 2014 and 2013 was $2.3 million and $3.1 million, respectively.
 
20
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 10.
FAIR VALUE MEASUREMENTS
 
The following tables represent RLJE’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis:

(In thousands)
  
September 30, 2014
  
   
Level 1
    
Level 2
    
Level 3
    
Total
  
                 
Warrant liability
  
$
—
    
$
—
    
$
6,400
    
$
6,400
  
 
 
(In thousands)
  
December 31, 2013
  
   
Level 1
    
Level 2
    
Level 3
    
Total
  
                 
Warrant liability
  
$
2,630
    
$
—
    
$
1,493
    
$
4,123
  

 
The following tables include a roll-forward of liabilities classified within Level 1 and Level 3:

(In thousands)
  
Nine Months Ended September 30, 2014
  
   
Level 1
    
Level 2
    
Level 3
    
Total
  
                 
Warrant liability at December 31, 2013
  
$
2,630
    
$
—
    
$
1,493
    
$
4,123
  
Change in fair value hierarchy
    
(2,755
)
    
—
      
2,755
      
—
  
Change in fair value of warrant liability
    
125
      
—
      
2,152
      
2,277
  
Warrant liability
  
$
—
    
$
—
    
$
6,400
    
$
6,400
  

 
(In thousands)
  
Nine Months Ended September 30, 2013
  
   
Level 1
    
Level 2
    
Level 3
    
Total
  
                 
Warrant liability at December 31, 2012
  
$
2,755
    
$
—
    
$
1,569
    
$
4,324
  
Change in fair value of warrant liability
    
1,879
      
—
      
1,203
      
3,082
  
Warrant liability
  
$
4,634
    
$
—
    
$
2,772
    
$
7,406
  

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

(In thousands)
  
Nine Months Ended September 30, 2014
  
   
Level 1
    
Level 2
    
Level 3
    
Total
    
Loss
  
                     
Investments in content
  
$
—
    
$
—
    
$
11,223
    
$
11,223
    
$
2,743
  
 
 
21
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(In thousands)
  
Nine Months Ended September 30, 2013
  
   
Level 1
    
Level 2
    
Level 3
    
Total
    
Loss
  
                     
Investments in content
  
$
—
    
$
—
    
$
8,361
    
$
8,361
    
$
5,159
  
 
 
During the nine months ended September 30, 2014 and 2013, the investments in content were written down by $2.7 million and $5.2 million, respectively, as a result of a change in fair value.  In determining the fair value, we employ a DCF methodology.  Key inputs employed in the DCF methodology include estimates of a film's ultimate revenue and costs as well as a discount rate.  The discount rate utilized in the DCF analysis is based on a market participant’s weighted average cost of capital plus a risk premium representing the risk associated with producing a particular film or television program.  As the primary determination of fair value is determined using a DCF model, the resulting fair value is considered a Level 3 measurement.
 
NOTE 11.
NET LOSS PER COMMON SHARE DATA
 
The following is a reconciliation of the numerators and denominators used in computing basic and diluted net loss per common share for the three and nine months ended September 30, 2014 and 2013:

(In thousands, except per share data)
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
   
2014
    
2013
    
2014
    
2013
  
Basic and diluted:
                
                 
Net loss
  
$
(7,799
)
  
$
(8,508
)
  
$
(20,148
)
  
$
(29,010
)
                                 
Denominator - basic and diluted:
                                
Weighted-average common shares outstanding – basic
    
12,557
      
12,442
      
12,502
      
12,442
  
Effect of dilutive securities
    
—
      
—
      
—
      
—
  
Weighted-average common shares outstanding – diluted
    
12,557
      
12,442
      
12,502
      
12,442
  
                                 
Net loss per common share:
                                
Basic and diluted
  
$
(0.62
)
  
$
(0.68
)
  
$
(1.61
)
  
$
(2.33
)

 
We have outstanding warrants to acquire 21,041,667 shares of common stock that are not included in the computation of diluted net loss per common share as the effect would be anti-dilutive.  For the three and nine months ended September 30, 2014, we have weighted average outstanding shares of approximately 758,000 and 991,000, respectively, of restricted common stock, which includes certain forfeitable shares held by the founding shareholders (See Note 8, Equity), that are not included in the computation of basic or diluted net loss per share as the effect would be anti-dilutive.  For the three and nine months ended September 30, 2013, we have weighted average outstanding shares of approximately 1,190,000 and 1,026,000 shares, respectively of restricted common stock, that are not included in the computation of basic and diluted net loss per share as the effect would be anti-dilutive.
 
22
RLJ ENTERTAINMENT, INC.

UNAUDITED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 12.
COMMITMENTS AND CONTINGENCIES
 
In the normal course of business, we are subject to proceedings, lawsuits and other claims, including proceedings under government laws and regulations relating to employment and tax matters. While it is not possible to predict the outcome of these matters, the opinion of management is, based on consultations with internal and external legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on our financial condition, results of operations or liquidity. Accordingly, we record a charge to earnings based on the probability of settlement and determination of an estimated amount. These charges were not material to our results.
 
NOTE 13.
RELATED PARTY TRANSACTIONS
 
Equity Investments in Affiliates

All of ACL’s staff is employed by RLJE Ltd.  ACL was charged overhead and personnel costs for the three months ended September 30, 2014 and 2013, of approximately $578,000 and $443,000, respectively, and for the nine months ended September 30, 2014 and 2013, of approximately $1.6 million and $1.4 million, respectively.  Amounts were recorded as a reduction in general and administrative expenses in the accompanying consolidated statements of operations.

ACL paid dividends to RLJE Ltd of $2.9 million and $4.0 million during the nine months ended September 30, September 30, 2014 and 2013, respectively.  Dividends received were recorded as a reduction to the ACL investment account.  There were no dividends received during the three month periods ended September 30, 2014 and 2013.

Foreign Currency

We recognize foreign currency gains and losses as a component of other expense on amounts related to monies lent, including intercompany balances, by Acorn Media to RLJE Ltd and RLJE Australia.  As of September 30, 2014, Acorn Media had lent its U.K. subsidiaries approximately $16.1 million and its Australian subsidiary approximately $3.6 million.   Amounts lent will be repaid in U.S. dollars based on available cash. Movement in exchange rates between the U.S. dollar and the functional currencies (which are the British Pound Sterling and the Australian Dollar) of those subsidiaries that were lent the monies will result in foreign currency gains and losses. During the three months ended September 30, 2014 and 2013, we recognized loss a of $928,000 and a gain of $1.1 million, respectively, and during the nine months ended September 30, 2014 and 2013, we recognized a loss of $405,000 and a loss of $706,000, respectively.

The RLJ Companies, LLC

On June 27, 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 obligations were payable by us to the vendor through September 5, 2013.  Pursuant to the purchase, The RLJ Companies, LLC became the account creditor with respect to these accounts, but the accounts have not been otherwise modified, and the vendor continued to be the account creditor with respect to other outstanding accounts payable by us after September 5, 2013.  These purchased liabilities are included in accrued royalties and distribution fees in the accompanying consolidated balance sheets.

RLJ SPAC Acquisition, LLC

Mr. Robert L. Johnson through his company, RLJ SPAC Acquisition, LLC announced his intention to purchase up to $2.0 million of our outstanding common stock from time to time over a 24-month period beginning June 19, 2013. Any purchases will be made in the open market or in privately negotiated transactions in compliance with applicable laws and regulations.

All $2.0 million of Common Stock may or may not be purchased during such period.  The repurchases by RLJ SPAC Acquisition LLC during the quarter is reported in Part II, Other Information, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds of this Form 10-Q.
 
23
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions.  As described at the beginning of this Quarterly Report under the heading “Forward-Looking Statements,” our actual results could differ materially from those anticipated in these forward-looking statements. Factors that could contribute to such differences include those discussed elsewhere in this Quarterly Report under the heading “Forward-Looking Statements.” You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report. Except as may be required under federal law, we undertake no obligation to update publicly any forward-looking statements for any reason, even if new information becomes available or other events occur.

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

OVERVIEW

RLJ Entertainment, Inc. (or RLJE) is a global entertainment company with a direct presence in North America, the United Kingdom (or U.K.) and Australia and strategic sublicense and distribution relationships covering Europe, Asia and Latin America.  RLJE was incorporated in Nevada in April 2012.  On October 3, 2012, we completed the business combination of RLJE, Image Entertainment, Inc. (or Image) and Acorn Media Group, Inc. (or Acorn Media or Acorn), which is referred to herein as the “Business Combination.”  Acorn Media includes its subsidiaries RLJE International Ltd (or RLJE U.K.), RLJ Entertainment Australia Pty Ltd. (or RLJE Australia) and RLJ Entertainment Ltd  (or RLJE Ltd).  In February 2012, Acorn Media acquired a 64% ownership of Agatha Christie Limited (or ACL).  References to Image include its wholly-owned subsidiary Image/Madacy Home Entertainment, LLC.  “We,” “our” or “us” refers to RLJE and its subsidiaries, unless otherwise noted.  Our principal executive offices are located in Silver Spring, Maryland, with additional U.S. locations in Woodland Hills, California, and Stillwater, Minnesota, and international locations in London, England and Sydney, Australia.

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

We acquire content rights in various categories, with particular focus on British episodic mystery and drama, urban programming, and full-length independent motion pictures.  Through long-term exclusive agreements, we license a wide set of rights to third-party vendors.  We also develop, produce, and own original programming through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, in addition to the development and production of fitness titles through our Acacia brand.  We have a library of titles segmented into genre-based brands such as Acorn (British drama and mystery television), Image (action, thriller and horror feature films and stand-up comedy), One Village (urban), Acacia (fitness), Athena (life-long learning documentaries) and Madacy (uniquely packaged collections of historical footage and films).  Our owned content includes 28 Foyle’s War made-for-TV films, multiple fitness/wellness titles, and through our 64% ownership of ACL, the vast majority of the works of Agatha Christie.  We exploit this content across multiple platforms, including broadcast and cable; and digital distribution formats such as download-to-own, download-to-rent, subscription video on demand (or SVOD), and free video on demand (or FVOD); DVD and Blu-ray retail and online e-commerce; and international licensing and sales.

We exploit our products through a multi-channel strategy encompassing (1) the licensing of original drama and mystery content managed and developed through our wholly-owned subsidiary, RLJE Ltd, and our majority-owned subsidiary, ACL, (IP Licensing segment); (2) wholesale exploitation through partners covering broadcast and cable, digital, online, and brick and mortar outlets (Wholesale segment); and (3) direct relations with consumers via proprietary e-commerce, catalog, and SVOD channels (Direct-to-Consumer segment).
 
24
RLJE Ltd manages our British drama co-productions, including Foyle’s War, one of our most successful Acorn television series, and the intellectual property rights owned by ACL including all the TV/film and publishing revenues associated with those rights.  ACL is home to some of the world’s greatest works of mystery fiction, including Murder on the Orient Express and Death on the Nile and includes all development rights to iconic sleuths such as Hercule Poirot and Miss Marple.  The Agatha Christie library includes approximately 80 novels and short story collections, 19 plays and a film library of nearly 40 made-for-television films.  In 2013, ACL commissioned a new writer to expand the Agatha Christie library content and in the third quarter of 2014, ACL published its first book, Monogram Murders since the death of Agatha Christie.

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

Our Direct-to-Consumer segment includes the sale of video content and complementary merchandise directly to consumers through proprietary e-commerce websites and catalogs and our proprietary SVOD channels, AcornTV and Acacia TV, which was launched in January 2014.  As of September 30, 2014, AcornTV had over 112,000 paying subscribers.  We will be launching our urban content SVOD channel in November 2014, in conjunction with our planned strategic investment in SVOD during 2014.  In response to the strategic opportunity brought by the convergence of television and the internet, we will continue to invest in more exclusive and appealing content programming, greater marketing support and an expanded IT infra-structure for AcornTV.  We also plan to develop other audience-based, premium SVOD channels based on our existing library.

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

FINANCIAL HIGHLIGHTS

Highlights and significant events for the three and nine months ended September 30, 2014 and 2013 are as follows:
 
§ Revenue was up by $4.4 million or 13.4% for the quarter to date periods and down by $7.9 million or 7.3% for year-to-date periods.  Excluding the effects of the terminated feature-film output deal, revenue was up $7.9 million or 26.9% for the quarter to date periods and up by $7.5 million or 8.1% for the year-to-date periods.
 
§ Adjusted EBITDA is up 76.8% or $2.9 million for the quarter ended September 30, 2014 compared to the prior year quarter.  Adjusted EBITDA is up 144.7% or $1.7 million year-to-date period compared the same period in the prior year.
 
§ On September 11, 2014, we entered into a $70.0 million Credit and Guaranty Agreement (the “Credit Facility”).  This new Credit Facility is expected to improve our liquidity and future cash flows by approximately $15.0 million through December 2015 from the reduced future debt service requirements.
 
§ Gross margin was flat for the quarter compared to the prior year and up 7.7 basis points or $6.3 million for the year-to-date period compared to prior year.
 
25
§ Selling, general and administrative expenses (or SG&A) continue to be managed closely.  SG&A decreased when comparing the three and nine months ended September 30, 2014 to the same periods in 2013.  The decline in SG&A is mostly attributed to the synergistic savings from integrating the combination of the two companies, over the last year.  As a percentage of revenue, SG&A was 30.8% versus 37.7% for the three month periods ended September 30, 2014 and 2013, respectively.  For the year-to-date periods, SG&A as a percentage of revenue was flat at 36.4% and 36.5% when comparing 2014 to 2013, respectively.

RESULTS OF OPERATIONS

Our unaudited consolidated financial information for the three and nine months ended September 30, 2014 and 2013, should be read in conjunction with our consolidated financial statements and the notes thereto and the section entitled “Management's Discussion and Analysis of Financial Condition and Results of Operations” in our 2013 Annual Report on Form 10-K filed on March 19, 2014 (or 2013 Form 10-K).

A summary of our results of operations for the three and nine months ended September 30, 2014 and 2013, as disclosed in our consolidated financial statements in Item 1, Financial Statements, herein referred to as our “consolidated financial statements” are as follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
Revenues
  
$
37,123
    
$
32,741
    
$
99,478
    
$
107,333
  
Costs of sales
    
28,149
      
24,747
      
74,521
      
88,627
  
Gross profit
    
8,974
      
7,994
      
24,957
      
18,706
  
Selling, general and administrative expenses
    
11,422
      
12,345
      
36,259
      
39,181
  
Loss from operations
    
(2,448
)
    
(4,351
)
    
(11,302
)
    
(20,475
)
Equity earnings of affiliates
    
1,190
      
1,364
      
2,540
      
2,924
  
Interest expense, net
    
(2,508
)
    
(2,019
)
    
(6,473
)
    
(6,027
)
Change in fair value of stock warrants
    
(1,599
)
    
(3,884
)
    
(2,277
)
    
(3,082
)
Loss on extinguishment of debt
    
(1,457
)
    
––
      
(1,457
)
    
––
  
Other income (expense)
    
(1,141
)
    
1,052
      
(655
)
    
(669
)
Benefit (provision) for income taxes
    
164
      
(670
)
    
(524
)
    
(1,681
)
Net loss
  
$
(7,799
)
  
$
(8,508
)
  
$
(20,148
)
  
$
(29,010
)
 
 
26
Revenues

The comparability of our revenue between years is affected by the termination of a feature-film output deal, which we terminated in 2013 and completed an inventory sell-off period during the first quarter of 2014. A summary of net revenue by segment with and without the terminated output deal revenue for the three and nine months ended September 30, 2014 and 2013 is as follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
Wholesale Revenue:
                
U.S.
  
$
19,749
    
$
22,085
    
$
57,306
    
$
66,481
  
Terminated Image output deal
    
––
      
(3,492
)
    
1,059
      
(14,287
)
U.S. excluding output deal
    
19,749
      
18,593
      
58,365
      
52,194
  
International
    
2,254
      
2,941
      
9,471
      
9,269
  
Total Wholesale
    
22,003
      
21,534
      
67,836
      
61,463
  
                                 
Direct-to-Consumer
                                
Ecommerce Catalog U.S.
    
4,806
      
7,113
      
19,665
      
21,242
  
Proprietary Digital Channels
    
1,162
      
107
      
2,769
      
485
  
International Ecommerce
    
478
      
479
      
1,580
      
1,816
  
Total Direct-to-Consumer
    
6,446
      
7,699
      
24,014
      
23,543
  
                                 
Intellectual Property
    
8,674
      
16
      
8,687
      
8,040
  
                                 
Total revenues by segment excluding terminated output deal revenues
    
37,123
      
29,249
      
100,537
      
93,046
  
                                 
Terminated output deal revenues
    
––
      
3,492
      
(1,059
)
    
14,287
  
Total Revenues
  
$
37,123
    
$
32,741
    
$
99,478
    
$
107,333
  

 
Revenue for the three months ended September 30, 2014 increased $4.4 million or 13.4% compared to the three months ended September 30, 2013, driven by increased revenue related to the release of the current season of Foyle’s War franchise, offset by a decrease in revenue in the Wholesale segment.  Excluding the impact of the terminated output deal, revenue increased by $7.9 million or 26.9% for the three months ended September 30, 2014 versus the same three month period in 2013.  The Wholesale segment’s revenue decreased by $3.0 million for the quarter when comparing it to the same quarter last year and was primarily attributable to the feature-film output deal that was terminated during 2013.  Excluding the impact of the terminated output deal, the revenues increased $469,000 or 2.2% for the Wholesale segment during the third quarter of 2014 when compared to the same period in 2013.  This increase is primarily attributed to the release of two feature films, Rage and Cabin Fever and three key British TV dramas, including franchises Miss Marple, Midsummer Murder and Case Histories.

Revenue from our Direct-to-Consumer segment decreased $1.3 million when comparing the three-month period ended September 30, 2014 to 2013.  The decrease in revenue in the Direct-to-Consumer segment was due to lower catalog sales of $2.3 million from increased backorders that did not ship during the quarter due to limited availability of cash to replenish inventory levels, offset by revenue growth from the proprietary SVOD channels, primarily AcornTV, which generated increased revenue of $1.1 million.  AcornTV's paying subscribers have increased from 89,000 at June 30, 2014 to 112,000 as of September 30, 2014.
 
27
Revenue decreased $7.9 million for the nine months ended September 30, 2014 compared to 2013.  The decrease in revenue was primarily due to a decrease in our Wholesale revenue of $9.0 million which is primarily attributed to the revenues related to the terminated output deal which were negative revenues of $1.1 million for the year-to-date period of 2014 compared to $14.3 million during the same period in 2013.  Excluding the impact of the terminated output deal, Wholesale revenue increased $6.4 million or 10.4% year-over-year, driven by a 19.6% increase in the feature film content and a 0.5% increase in the British mystery drama content.

For the nine months ended September 30, 2014, Direct-to-Consumer revenue increased $471,000 when compared to the same period in 2013.  This increase in revenue is attributed to the growth in our proprietary digital networks with revenue of $2.8 million for the nine months ended September 30, 2014 compared to $485,000 for the nine months ended September 30, 2013.  As of September 30, 2014, the paying subscribers for AcornTV have grown by 99.5% to approximately 112,000 subscribers since December 31, 2013.

Our IP licensing segment revenue for the nine months ended September 30, 2014 increased by $647,000 when compared to the same period in 2013.  This increase is attributable to increased broadcast revenue for the Foyle’s War current season released as compared to the prior season.

Cost of Sales (“COS”) and Gross Margins

A summary of COS by segment and overall gross margins for the three and nine months ended September 30, 2014 and 2013 is as follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
IP Licensing
  
$
6,278
    
$
––
    
$
6,557
    
$
6,449
  
Wholesale
    
18,230
      
19,949
      
54,517
      
67,902
  
Direct-to-Consumer
    
3,641
      
4,798
      
13,447
      
14,276
  
COS by segment
  
$
28,149
    
$
24,747
    
$
74,521
    
$
88,627
  
                                 
Gross Margin
  
$
8,974
    
$
7,994
    
$
24,957
    
$
18,706
  
Gross Margin %
    
24.2
%
    
24.4
%
    
25.1
%
    
17.4
%

 
COS increased by $3.4 million to $28.1 million for the three months ended September 30, 2014, compared to the same period in 2013.  The increase in COS is primarily attributed to increased content expense amortization of $6.3 million within our IP Licensing segment related to the release of the current season of Foyle’s War during the quarter, offset in part by a decrease of $1.7 million in our Wholesale segment.  The decrease in our Wholesale’s COS corresponds to the decrease in revenue related to the termination of the aforementioned feature-film output deal whereby we recorded COS under the terminated output deal of zero and $3.1 million for the three months ended September 30, 2014 and 2013, respectively.

In addition, COS decreased by $1.2 million in our Direct-to-Consumer segment when comparing the three months ended September 30, 2014 to 2013.  The decrease in COS for the Direct-to-Consumer segment is due to reduced inventory attributable to limited cash flow as discussed above, in the Direct-to-Consumer revenue discussion.

Included in our COS is amortization from the step-up of investments in content resulting from our Business Combination on October 3, 2012.  During the three months ended September 30, 2014 and 2013, we recognized step-up amortization on our investments in content of $1.3 million and $2.0 million, respectively.  Excluding this step-up amortization and also excluding the gross margins related to the terminated feature-film output deal, our gross margins would have been 27.7% and 32.9% for the three months ended September 30, 2014 and 2013, respectively.
 
28
COS for the nine months ended September 30, 2014 was $74.5 million, a decrease of $14.1 million when comparing COS for the same period in 2013.  This decrease is primarily a result of a decrease in COS in our Wholesale segment of $13.4 million.  The COS in our Wholesale segment deceased primarily due to the elimination of COS incurred pursuant to a feature-film output deal that we terminated in 2013.  For the nine months ended September 30, 2014 and 2013, we incurred COS under this terminated output deal of $2.0 million and $16.4 million, respectively.

COS within our Wholesale segment for the nine months ended September 30, 2013 also includes impairment and other charges recognized during the second quarter of 2013 that aggregate to approximately $3.4 million and are primarily related to the transition of the Madacy content line and the consolidation of distributors.  These costs did not repeat in 2014; however, during 2014 we incurred other COS that largely offset this cost savings.  These offsetting COS are attributable to increased revenue recognized for all of our reporting segments, after making adjustments for the terminated feature-film output deal.

Our gross margin increased to 25.1% from 17.4% for the nine months ended September 30, 2014 and 2013, respectively.  The increase in margin was the result of (i) changes implemented in management’s investment criteria for content acquisitions, which requires an estimated return on investment threshold of at least 20%, (ii) the termination of the feature-film output deal, and (iii) the impact of certain aforementioned charges and impairments that were incurred in 2013, which did not repeat in 2014.  Excluding the impact of these 2013 charges and the margins recognized from the terminated feature-film output deal, we realized gross margins of 27.9% and 26.1% for the nine months ended September 30, 2014 and 2013, respectively.  Our year-over-year gains are a result of a greater mix of revenue from higher margin intangible formats such as broadcast, VOD, and digital, including revenue from our digital streaming channels.

Included in our COS is amortization from the step-up of investments in content resulting from our Business Combination on October 3, 2012. During the nine months ended September 30, 2014 and 2013, we recognized step-up amortization on our investments in content of $5.3 million and $6.6 million, respectively.  Excluding this step-up amortization and after taking into consideration the above adjustments to remove (i) the gross margins related to the terminated feature-film output deal, and (ii) the impacts of the increased charges and impairments in 2013, our gross margins would have been 33.2% and 25.8% for the nine months ended September 30, 2014 and 2013, respectively.

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

A summary of SG&A expenses for the three and nine months ended September 30, 2014 and 2013 is as follows:

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
Selling expenses
  
$
5,411
    
$
6,397
    
$
17,448
    
$
18,046
  
General and administrative expenses
    
4,710
      
4,560
      
14,553
      
16,827
  
Depreciation and amortization
    
1,301
      
1,388
      
4,258
      
4,308
  
Total selling, general and administrative expenses
  
$
11,422
    
$
12,345
    
$
36,259
    
$
39,181
  

 
SG&A decreased by $923,000 for the three-month period ended September 30, 2014, compared to the same period in 2013 and $2.9 million for the nine-month period ended September 30, 2014, compared to the same period in 2013.  The decrease in SG&A is primarily related to the synergistic savings related to the combining of Acorn and Image legacy companies after the Business Combination and the delay and reduced circulation of our Direct-to-Consumer segment’s catalog drops due to limited cash to support the segment when compared to the same periods in 2013.  During the three and nine months ended September 30, 2013, $351,000 and $2.4 million, respectively, of severance charges were incurred as part of the synergistic savings while no severance costs were incurred during the three and nine months ended September 30, 2014.
 
29
Equity Earnings in Affiliates

Equity earnings in affiliates for the three and nine months ended September 30, 2014 were $1.2 million and $2.5 million, respectively, as compared to $1.4 million and $2.9 million for the three and nine month periods ended September 30, 2013, respectively.  The decrease in equity earnings in affiliates (which is ACL) is mostly attributed to the release of the last Poirot television series and the Miss Marple television series in 2013 with no similar releases during the 2014 period.

Interest Expense, net

Interest expense for the three months ended September 30, 2014 was $2.5 million compared to $2.0 million for the same period in 2013.  Interest expense for the nine months ended September 30, 2014 was $6.5 million compared to $6.0 million for the same period in 2013.  Interest expense increased during the current period due to the increased balance of the new Credit Facility at September 30, 2014 of $70.0 million versus the Credit Facility balance at September 30, 2013 of $65.9 million.

Change in Fair Value of Stock Warrants

The change in the fair value of our warrant liability impacts the statement of operations whereby a decrease in the warrant liability results in the recognition of income, while an increase in the warrant liability results in the recognition of expense.  For the three months ended September 30, 2014 and 2013, the fair value of our warrant liability increased by $1.6 million and $3.9 million, respectively.  For the nine months ended September 30, 2014 and 2013, the fair value of our warrants increased by $2.3 million and $3.1 million, respectively.  Changes in our warrants’ fair value are primarily driven by changes in our stock price and changes in the volatility of our stock.

Loss on Extinguishment of Debt

When entering into the new Credit Facility, we recognized a loss on extinguishment of debt of $1.5 million in the current quarter of 2014.  The loss primarily represents the expensing of unamortized debt discounts and deferred financing costs associated with the prior credit facility.

Other Expense

Other income (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 impact 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.  From January through July of 2014, the Pound was strengthening relative to the Dollar, yet these gains were entirely reversed in August and September of 2014.  In 2013, we experienced the opposite with the Pound generally weakening against the Dollar from January through July of 2013, and then partially recovered in August and September.  As a result, for the three and nine months ended September 30, 2014 we recognized foreign currency losses of approximately $928,000 and $405,000 respectively, and for the three and nine months ended September 30, 2013 we recognized a foreign currency gain of $1.1 million and a loss of $706,000, respectively.

Income Taxes

We recorded income tax benefit of $164,000 and an income tax provision of $670,000 for the three-month periods ended September 30, 2014 and 2013, respectively and we recorded income tax provisions of $524,000 and $1.7 million for the nine-month periods ended September 30, 2014 and 2013, respectively.  We incur income tax expense on pre-tax income from our consolidated U.K. subsidiaries at an effective tax rate of approximately 22%.  Tax provision (benefit) on our U.S. and Australian operations are minimal as we have provided a full valuation allowance on their net operating losses, which are sufficient to offset any tax obligations in the near term.
 
30
Net Loss

We recorded a net loss of $7.8 million and $8.5 million for the three-month periods ended September 30, 2014 and 2013, respectively and we recorded a net loss of $20.1 million and $29.0 million for the nine-month periods ended September 30, 2014 and 2013, respectively.

ADJUSTED EBITDA

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

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

   
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
(In thousands)
  
2014
    
2013
    
2014
    
2013
  
                 
Net loss
  
$
(7,799
)
  
$
(8,508
)
  
$
(20,148
)
  
$
(29,010
)
                                 
Amortization of content
    
18,911
      
13,947
      
44,979
      
50,535
  
Cash investment in content
    
(11,467
)
    
(10,346
)
    
(37,618
)
    
(38,276
)
Depreciation and amortization
    
1,301
      
1,388
      
4,258
      
4,308
  
Interest expense
    
2,508
      
2,019
      
6,473
      
6,027
  
Loss on extinguishment of debt
    
1,457
      
—
      
1,457
      
—
  
Provision (benefit) for income tax
    
(164
)
    
670
      
524
      
1,681
  
Severance
    
—
      
351
      
—
      
2,369
  
Warrant liability fair value adjustment
    
1,599
      
3,884
      
2,277
      
3,082
  
Stock-based compensation
    
227
      
312
      
683
      
463
  
Adjusted EBITDA
  
$
6,573
    
$
3,717
    
$
2,885
    
$
1,179
  
 
 
Adjusted EBITDA increased by $2.9 million or 76.8% for the three months ended September 30, 2014 compared to the same period in 2013 and increased by $1.7 million for the nine months ended September 30, 2014.  The increase in the three-month period ended September 30, 2014 is primarily driven by a decline in the net operating loss as a result of improved operational activities consisting of increased revenue and gross margin, partly due to the release of Foyle’s War 9, and reduced operating expenses.  Our ability to continue to improve our Adjusted EBITDA is contingent on our ability to generate sufficient cash flow to invest in content to grow the business.  These increases were partially offset by a decline resulting from the loss of Adjusted EBITDA realized in the third quarter of 2013 from content sold pursuant to the terminated feature-film output deal.

The increase of $1.7 million or 144.7% in our Adjusted EBITDA for the nine-month period ended September 30, 2014 compared to the same period last year was primarily due to our improved operational activities.
 
31
BALANCE SHEET ANALYSIS

Assets

Total assets at September 30, 2014 and December 31, 2013, were $196.4 million and $221.5 million, respectively.  The decline of $25.1 million in assets is mostly attributed to a decline in investments in content of $14.1 million and accounts receivable of $7.0 million.  The decline in investments in content is attributable to (1) increased content amortization in the current quarter related to the release of Foyle’s War 9, and (2) an overall reduction in non-Foyle’s War content investment during the current year versus the prior year resulting from the termination of the feature-film output deal.  The decline in accounts receivable is primarily due to the seasonality of our business with a significant portion of our revenue being generated in the fourth quarter of each year.

A summary of assets by segment is as follows:

(In thousands)
  
September 30,
    
December 31,
  
   
2014
    
2013
  
         
IP Licensing
  
$
29,149
    
$
36,127
  
Wholesale
    
142,094
      
162,162
  
Direct-to-Consumer
    
14,630
      
15,964
  
Corporate
    
10,501
      
7,211
  
   
$
196,374
    
$
221,464
  
 
 
Liabilities and Equity

Our total liabilities as of September 30, 2014, decreased by $5.3 million to $158.3 million when compared to December 31, 2013, which is mostly attributable to the decline in accrued royalties and distribution fees of $6.8 million which is in line with the decline in investment in content as discussed, above. Additionally, our accounts payable and accrued liabilities declined by $5.6 million largely due to the seasonality of our business. Included in our accounts payable and accrued liabilities is $4.4 million due to our distribution partner at September 30, 2014. These declines were offset by an increase in debt of approximately $4.9 million related to the increased borrowings under the new Credit Facility compared to the previous unpaid principal balance due under the prior credit facility.

The decrease in equity of $19.8 million since December 31, 2013 is mostly attributed to the year-to-date net loss of $20.1 million.
 
32
LIQUIDITY AND CAPITAL RESOURCES 

Liquidity

A summary of our cash flow activities is as follows:

(In thousands)
  
Nine Months Ended
September 30,
  
   
2014
    
2013
  
         
Net cash used in operating activities
  
$
(400
)
  
$
(1,482
)
Net cash provided by investing activities
    
1,367
      
3,655
  
Net cash used in financing activities
    
(195
)
    
(3,863
)
Effect of exchange rate changes on cash
    
(272
)
    
(419
)
Net increase (decrease) in cash
    
500
      
(2,109
)
Cash at beginning of period
    
7,674
      
4,739
  
Cash at end of period
  
$
8,174
    
$
2,630
  
 
 
At September 30, 2014 and December 31, 2013, our cash position was approximately $8.2 million and $7.7 million, respectively.  During the nine-months ended September 30, 2014, our cash position was impacted by the following:
§ Principal repayments totaling $63.2 million pursuant to our prior credit facility, offset by borrowings, net of discount and deferred financing costs of $63.8 million from our new Credit Facility.
§ We incurred a net use of cash of $400,000 resulting from our operating activities.  The net use of cash was largely attributable to management’s use of cash to pay off vendor trade payables and invest in content during a period of relative lower revenue and content amortization, offset by cash provided by increased collection on our account receivable.  During the nine months ended September 30, 2014, we paid approximately $5.5 million of vendor trade payables.  The legacy Image business had significant short-term vendor debts, which were past due, that we are in the process of paying off by making increased cash payments or modifying payment terms in the short term.  Bringing our vendor trade payables current continues to constrain our liquidity.
§ The quarterly results are typically affected by:  (a) the timing and release dates of key productions, (b) the seasonality of our Wholesale and Direct-to-Consumer business which are 32 – 35% weighted to the 4th quarter and (c) the company generally invests more cash on content during the first half of the year.

The aggregate cash used in operating activities during the nine months ended September 30, 2014 was provided by our cash reserves as of December 31, 2013 and cash provided by our investing and financing activities.  During the nine months ended September 30, 2014, significant factors affecting cash provided by investing and financing activities were:

§ Dividends received from ACL ($2.9 million);
§ Debt borrowing to finance the production of Foyle’s War 9 ($9.9 million), less repayments under the production facility ($10.6 million);
§ Repayment of senior debt ($63.2 million), offset by borrowings under the new Credit Facility ($63.8 million); and
§ Capital expenditures of $1.6 million.
 
With the new Credit Facility entered into on September 11, 2014, we expect to have additional liquidity and future cash flows of approximately $15.0 million through December 31, 2015 from the reduced future debt service requirements.  The expected cash flow improvement will assist the company in addressing legacy past due payables and other operating investments that have been deferred.
 
33
We believe that our current financial position combined with our forecasted operational cash flow will be sufficient to meet our operational commitments.  Prior to entering into the new Credit Facility, we had curtailed our non-Foyle’s War content spending in 2014 to make our principal payments on the prior credit facility.  Now that our new Credit Facility is in place, it will provide increased liquidity primarily through the reduction of near-term future principal payments. As a result, we anticipate increasing over time our cash expenditures on investments in content and expenditures on the launching of additional digital channels.
 
Capital Resources

Cash

As of September 30, 2014, we had cash of $8.2 million, as compared to $7.7 million as of December 31, 2013.

New Credit Facility

On September 11, 2014, we entered into a $70.0 million Credit and Guaranty Agreement (the “Credit Facility”) with a syndicate of lenders lead by McLarty Capital Partners, as lead administrative agent. The Credit Facility consists of a term loan totaling $70.0 million with a final maturity of five years, at an interest rate equal to (a) LIBOR plus 10.64% for so long as the unpaid principal amount of the Credit Facility is greater than $65.0 million, and (b) LIBOR plus 9.9% thereafter with a floor of 0.25% for LIBOR.  The quarterly principal amortization is 3.5% for the first two years, 5.0% for the third year and 7.5% for the remaining term with any unpaid principal balance due at maturity.  The obligations under the Credit Facility are secured by a lien on substantially all of our consolidated assets pursuant to the Pledge and Security Agreement, dated as of September 11, 2014.  Initial debt service begins on December 31, 2014.

Under the new Credit Facility, interest and principal is payable quarterly with principal payments beginning on December 31, 2014.  Initial quarterly principal payments are $613,000 through June 2016, then increase to $875,000 through June 2017, and thereafter are $1.3 million.  Beginning in 2016, we are obligated to make certain accelerated principal payments annually which are contingent upon:  (1) the occurrence of consolidated excess cash flows, as defined in the Credit Facility, and (2) only to the extent at which such excess cash flows are above our minimum cash threshold of $12.0 million.  We are permitted to make additional voluntary principal payments under the Credit Facility, yet prepayments are subject to an applicable prepayment premium of:  (a) 5% if prepaid during the first year, (b) 3% if prepaid during the second year, and (c) 1.5% if prepaid during the third year.  The first $5.0 million of voluntary prepayment is not subject to any prepayment premium.

We incurred $4.9 million in original issuance discounts and other related fees paid to lenders under the new Credit Facility.  We also incurred $1.3 million in fees for legal and other professional services.  Repayment of our previous credit facility included principal and accrued interest of $56.1 million ($15.0 million revolving credit facility and $41.1 million of term loans and accrued interest).

The new Credit Facility contains certain financial and non-financial covenants beginning on December 31, 2014.  Financial covenants are assessed quarterly and are based on an Adjusted EBITDA, as defined in the Credit Facility.  Financial covenants vary each quarter and generally become more restrictive over time.  The principal financial covenants are:  (1) Senior Debt Leverage Ratio that initially is 4.64 : 1.00 and declines to 2.67 : 1.00 by end of 2016 and for remainder term, (2) Total Debt Leverage Ratio that initially is 5.71 : 1.00 and declines to 3.44 : 1.00 by end of 2016 and for remainder term and (3) Fixed Charges Coverage Ratio that initially is 1.10: 1.00 and increases to 1.59 : 1.00 by end of 2016 and for remainder term.

Beginning in 2016, we are also obligated to maintain a minimum valuation ratio computed on the outstanding principal balance of our senior debt compared to the sum of our valuations of our content library and our investment in ACL.  To the extent the valuation ratio exceeds the allowed threshold, we are obligated to make an additional principal payment such that the threshold would not be exceeded after giving effect of this payment.  The valuation threshold is 83% as long as the unpaid principal balance exceeds $65.0 million and 75% thereafter.
 
34
The Credit Facility 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 Sony Pictures Home Entertainment 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 will increase the applicable rate of interest and could result in the acceleration of our obligations under the Credit Facility.

The Credit Facility imposes restrictions on such items as encumbrances and liens, payments of dividends, other indebtedness, stock repurchases, capital expenditures and entering into new lease obligations.  The Credit Facility also requires us to comply with minimum financial and operating covenants as disclosed above.  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 new Credit Facility, we must maintain at all times a cash balance of $3.5 million.  When repaying the previous credit facility, we recognized a $1.5 million loss from the early extinguishment of debt, which is reported as a separate line item within our statement of operations.  This loss primarily represented the unamortized debt discount and deferred financing costs at the time of repayment of our prior credit facility.

Subordinated Notes Payable and Other Debt

Upon consummation of the Business Combination, we issued unsecured subordinated promissory notes in the aggregate principal amount of $14.8 million to the selling preferred stockholders of Image.  The subordinated notes mature on the earlier of October 3, 2018 or six months after the latest stated maturity of the senior debt issued pursuant to the Credit Facility.  The unsecured subordinated notes bear an interest rate of 12% per an annum, of which 5.4% is payable in cash annually and at our discretion the balance is either paid through the issuance of shares of our common stock valued at their then-current market price, or accrues and is added to the principal, which is payable upon maturity.  During the second quarter of 2014, interest was due of $992,000 and added to the principal balance of these notes.  At September 30, 2014, our principal balance due pursuant to these notes was $16.0 million.

In October 2013, we began our pre-production of the next series of Foyle’s War.  Acorn Productions Ltd, and Acorn Global Enterprises Limited., both wholly-owned subsidiaries of RLJE Ltd, entered into a cash advance facility (the FW9 Facility) with Coutts and Co., a U.K. based lender, for purposes of producing three ninety-minute television programs entitled “Foyle’s War Series 9.” The facility carries interest at a rate of LIBOR plus 2.15%.  Interest and repayment of advances received are due on or before November 8, 2014.  This facility is substantially secured by (i) executed license agreements whereby we have pre-sold certain broadcast and distribution and (ii) U.K. tax credits based on anticipated qualifying production expenditures.  The assets and intellectual property will become secured collateral of the Credit Facility once the Coutts loan is fully paid and settled.  At September 30, 2014, our principal balance due pursuant to these notes was $565,000.

OTHER ITEMS

Off-Balance Sheet Arrangements

We currently do not have any off-balance sheet arrangements.
 
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Critical Accounting Policies and Procedures

Since the filing of our 2013 Form 10-K, there were no new accounting pronouncements adopted.  A summary of the accounting pronouncement issued but, not required to be adopted for the preparation of our current financial statements is as follows:

On May 28, 2014, the Financial Accounting Standards Board issued an accounting standard update (or ASU) No. 2014-09, Revenue from Contracts with Customers (or ASU 2014-09), which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for RLJE on January 1, 2017. Early application is not permitted. The standard permits the use of three transition methods. We are evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures. We are also assessing the transition methods available to implement this new accounting standard.  This update could impact the timing and amounts of revenue recognized within our consolidated financial statements.

ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.
 
ITEM 4.
CONTROLS AND PROCEDURES

a) Evaluation of Disclosure Controls and Procedures

The term “disclosure controls and procedures” is defined in Rules 13(a)-15(e) and 15(d)-15(e) of the Exchange Act.  Disclosure controls and procedures refer to the controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company's management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

We have evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, the effectiveness of our system of disclosure controls and procedures as of the end of the period covered by this Quarterly Report.  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.

b) Changes in Internal Control over Financial Reporting

As required by Rule 13a-15(d) of the Exchange Act, we have evaluated, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, whether any changes occurred to our internal control over financial reporting during the period covered by this Quarterly Report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there have been no such changes during the period covered by this Quarterly Report.
 
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PART II - OTHER INFORMATION
 
ITEM 1. 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 employment and tax matters.  While it is not possible to predict the outcome of these matters, it is the opinion of management, based on consultations with legal counsel, that the ultimate disposition of known proceedings will not have a material adverse impact on our financial position, results of operations or liquidity.
 
ITEM 1A. RISK FACTORS 
 
Our results of operations and financial condition are subject to numerous risks and uncertainties described in our Annual Report on Form 10-K filed on March 19, 2014.  You should carefully consider these risk factors in conjunction with the other information contained in this Quarterly Report.  Should any of these risks materialize, our business, financial condition and future prospects could be negatively impacted.  As of September 30, 2014, there have been no material changes to the risk factors set forth in that Form 10-K.
 
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
RLJ SPAC Acquisition LLC, an affiliate of the Company, has purchased shares of our common stock in the open market and through block purchases pursuant to a 10b5-1 plan.  Robert L. Johnson, the Chairman of the Board of the Company, is the sole manager and sole voting member of RLJ SPAC Acquisition LLC. The table below sets forth information regarding purchases of our common stock by RLJ SPAC Acquisition LLC during the quarter ended September 30, 2014:

Period
  
Total
Number of
Shares
Purchased
    
Average
Price Paid
Per Share
    
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
    
Approximate Dollar
Value of Shares that
May Yet be
Purchased Under
Publicly Announced
Plans or Programs
  
                 
July 1, 2014 to
July 31, 2014
    
11,570
    
$
3.71
      
314,193
    
$
521,201
  
                                 
August 1, 2014 to
August 31, 2014
    
—
    
$
—
      
314,193
    
$
521,201
  
                                 
September 1, 2014 to
September 30, 2014
    
22,067
    
$
3.46
      
336,260
    
$
444,764
  
                                 
     
33,637
    
$
3.55
                  
 
 
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ITEM 6. EXHIBITS
 
10.1* Credit and Guaranty Agreement, dated as of September 11, 2014, by and among RLJ Entertainment, Inc., as Parent Borrower, and Subsidiaries of Parent Borrower, as Guarantors, the Lenders party hereto from time to time, McLarty Capital Partners SBIC, L.P., as Administrative Agent, Collateral Agent, Arranger, Bookmanager, and Syndication Agent, and Crystal Financial LLC as Documentation Agent.

31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

32.1* Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

101.INS XBRL Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

101.LAB XBRL Taxonomy Extension Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

* Filed herewith.
 
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SIGNATURES

Pursuant to the requirements 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.

   
RLJ ENTERTAINMENT, INC.
       
Date:
November 7, 2014
By:
/S/ MIGUEL PENELLA
     
Miguel Penella
     
Chief Executive Officer
     
(Principal Executive Officer)
       
Date:
November 7, 2014
By:
/S/ ANDREW S. WILSON
     
Andrew S. Wilson
     
Chief Financial Officer
     
(Principal Financial and Accounting Officer)
       
 
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EXHIBIT INDEX

10.1* Credit and Guaranty Agreement, dated as of September 11, 2014, by and among RLJ Entertainment, Inc., as Parent Borrower, and Subsidiaries of Parent Borrower, as Guarantors, the Lenders party hereto from time to time, McLarty Capital Partners SBIC, L.P., as Administrative Agent, Collateral Agent, Arranger, Bookmanager, and Syndication Agent, and Crystal Financial LLC as Documentation Agent.

31.1* Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.

31.2* Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.

32.1* Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.

101.INS XBRL Instance Document

101.SCH XBRL Taxonomy Extension Schema Document

101.CAL XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF XBRL Taxonomy Extension Definition Linkbase Document

101.LAB XBRL Taxonomy Extension Label Linkbase Document

101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

  * Filed herewith.
† Management contract or compensatory plan or arrangement.
 
 
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RLJ ENTERTAINMENT, INC. Reports