Note 7.

Stock Warrant Liability and Purchase Rights Liability.

The fair values of our outstanding stock warrant, purchase rights and embedded derivatives are adjusted to their fair values at the end of each reporting period, with liability increases and decreases recorded as other income or expense during the reporting period. The fair value of the stock warrant is estimated by using the Black-Scholes pricing model where the inputs are consistently applied and reflect the contractual terms of the warrant, including the period to maturity, and market-based parameters such as interest rates, and volatility. This model does not contain a high level of subjectivity as the valuation techniques used do not require significant judgment, and inputs thereto are readily observable from actively quoted markets. The fair value of the embedded derivatives are estimated by using pricing models, where some of the inputs to those models are based on readily observable market parameters and some inputs require valuation techniques using subjectivity and judgment.

We currently do not use hedging contracts to manage the risk of our overall exposure to interest rate and foreign currency changes. The derivative liabilities described below are not hedging instruments.

Purchase Rights

In connection with the January 8, 2010 sale of preferred stock to JH Partners (or Transaction Date), purchase rights (or Purchase Rights) were granted to purchase additional 7,400 shares of Series B Preferred and 66,163.4 shares of Series C Preferred for an aggregate purchase price of $7.4 million divided in two equal tranches, exercisable by 120 days or May 8, 2010 and 360 days or January 3, 2011. These Purchase Rights were classified as liabilities due to the existence of events outside of Image's control that gave rise to the possibility for ultimate settlement by a transfer of assets or cash. We performed a valuation to determine the fair value of the Series B Preferred and Series C Preferred price per share and exercise price at March 31, 2010 using an option pricing model. At March 31, 2010, the combined fair value of both tranches of Purchase Rights was $1,538,000. During the fiscal year ended March 31, 2011, both tranches of the Purchase Rights expired with respect to 7,400 shares of Series B Preferred and 66,163.4 shares of Series C Preferred. None of the purchase rights were exercised prior to expiration; therefore, at March 31, 2011 there was no remaining fair value of the Purchase Rights. The decrease in fair value of $1,538,000 was recorded as a component of other income during the fiscal year ended March 31, 2011.

The fair value of the Purchase Rights liability at March 31, 2010 was determined by using the Black-Scholes option pricing model based on the following inputs:

Series B Preferred price per share	$	313.89
Series C Preferred price per share	$	59.15
Series B Preferred exercise price per share	$	372.47
Series C Preferred exercise price per share	$	70.19
Risk-free interest rate		0.2%-0.4	%
Expected term (in years)	0.75-0.80 years
Expected volatility for purchase rights		120%-150	%
Expected dividend yield		0%-12	%

Stock Warrant Liability

On August 30, 2006, we issued a $17,000,000 senior secured note (or Note) and a related warrant to purchase 1,000,000 shares of our common stock to Portside Growth and Opportunity Fund. The Note was paid off in January 2010. The related warrant was recorded as a component of long-term liabilities.

The warrant had a term of five years and an exercise price of $4.25 per share. In the event of a change of control, the warrant must be settled in cash using the Black-Scholes model in accordance with the underlying terms contained in the warrant agreement. The transaction with JH Partners triggered the antidilution provisions contained in the warrant and as a result became exercisable for 8,018,868 shares of our common stock at an exercise price of $0.53 per share. The initial fair value of the warrant liability was determined by using the Black-Scholes valuation method as of August 30, 2006 and this model has historically been used to determine fair value as of the end of each subsequent reporting period. The assumptions used included the closing price of our common stock on the valuation date, the strike price of the warrant, the risk-free rate equivalent to the U.S. Treasury maturities, the historical volatility of our common stock and the remaining term of the warrant. The assumptions used as of March 31, 2011 are as follows:

	March 31, 2011

Risk-free interest rate		0.14	%
Expected term (in years)	0.42 years
Expected volatility		121.89	%

The following table reflects outstanding and exercisable warrants at March 31, 2011:

		Warrants Outstanding and Exercisable
Exercise Price		Shares (In thousands)		Weighted-Average Remaining Life (Years)		Weighted-Average Exercise Price
$	0.53		8,019		0.42	$	0.53

As the stock warrant expired in August 2011, there was no remaining balance at March 31, 2012. The balance at March 31, 2011 was $72,000. The decrease in the fair value of the stock warrant of $72,000 and $832,000 was included as a component of other income during the fiscal years ended March 31, 2012 and 2011, respectively.