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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 1997.
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[_] 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 0-14023
VIDEO CITY, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 95-3897052
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(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
6840 DISTRICT BOULEVARD, BAKERSFIELD, CALIFORNIA 93313
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(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(805) 397-7955
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(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
- - - - ------------------- -----------------------------------------
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $ .01 PAR VALUE PER SHARE
----------------------------------------
(TITLE OF CLASS)
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 THAN THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
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INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM
405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE
BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS
INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K IN ANY AMENDMENT TO THIS
FORM 10-K. [_]
AS OF APRIL 24,1997, 9,753,927 SHARES OF THE REGISTRANT'S COMMON STOCK
WERE OUTSTANDING. NON-AFFILIATES OF THE REGISTRANT (I.E., EXCLUDING SHARES HELD
BY EXECUTIVE OFFICERS, DIRECTORS, AND CONTROL PERSONS AS DEFINED IN RULE 405)
HELD 4,676,853 SHARES OF COMMON STOCK ON THAT DATE. BECAUSE OF THE ABSENCE OF
AN ESTABLISHED TRADING MARKET, THE MARKET VALUE OF SUCH SHARES COULD NOT BE
DETERMINED; SEE ITEM 5 OF THIS FORM 10-K.
INDICATE BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND
REPORTS REQUIRED TO BE FILED BY SECTION 12, 13, OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN
CONFIRMED BY A COURT.
YES X NO
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1
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements in the Annual Report on Form 10-K, particularly under
Items 1 through 8, constitute "forward-looking statements" within the meaning of
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks, uncertainties, and
other factors which may cause the actual results, performance or achievements of
the Company to be materially different from any future results, performance or
achievements, expressed or implied by such forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
As the result of a merger on January 8, 1997, discussed below, the business
of Video City, Inc. (the "Company") now consists of the ownership and operation
of a chain of 18 video specialty stores in California plus an additional six
stores owned by others which the Company manages under the Video City name, and
the exploitation of a film library consisting of 47 feature motion pictures and
numerous shorter film products.
The Company (originally known as Lee Video City. Inc.) was incorporated in
California on February 20, 1990. The Company opened its first two video
superstores in Bakersfield, California in 1990 and opened four additional
superstores in Bakersfield by the end of 1992. In 1993 the Company acquired
four existing superstores and opened another ten. In the first half of 1994,
the Company opened an additional eleven superstores, bringing its total store
count to thirty-one. In the fall of 1994, the Company sold two of its
superstores in Idaho, and ended the year with a total of twenty-nine
superstores. The Company owned and operated twenty-nine stores until June 1996
when it sold its eleven stores outside of California. These eleven stores were
sold to reduce debt and restructure the Company's operations by focusing all of
its attention on the "core stores" in California. On January 8, 1997, the
Company merged with and into Prism Entertainment Corporation ("Prism").
Prism, a Delaware Corporation, was incorporated on January 27, 1984. Prism
has been engaged in the in-house production of theatrical and television films
and other programming for distribution to the home video, pay and basic cable,
network television and syndication, and theatrical markets worldwide. Prism
also acquired from third parties rights to such programming, primarily for
distribution to the home video market. Prism concentrated on developing and
obtaining rights to programming which had not received as wide a theatrical
distribution, if any, as first-run theatrical products. Through subsidiaries,
Prism entered into development arrangements with film producers and others,
licensed certain of its films into the foreign marketplace, and acquired foreign
rights to films from independent producers supplementing Prism's own
productions.
In 1994, Prism experienced a substantial decline in sales of its
videocassettes to the domestic rental market. This trend continued into 1995
causing a material reduction in available cash and receivables from the sale of
product. The reduction in receivables decreased the borrowing base under its
credit line that prevented the production of new product. Prism lacked the
necessary cash to operate its business and pay its creditors. On December 1,
1995, Prism filed a voluntary Chapter 11 petition and commenced a case under
Chapter 11 of the United States Bankruptcy Code. During the course of the
Bankruptcy Proceedings, Prism operated as a debtor in possession and engaged in
only limited business activities consisting of the sale of its existing film
products to domestic markets as well as foreign rights to its existing film
library.
Lee Video City, Inc. determined that a merger with Prism would be
advantageous for the following reasons. First, the merger would afford an
opportunity to restructure a significant portion of its debt held by Ingram
Entertainment Incorporated ("Ingram") pursuant to which Ingram would convert
three million dollars of such debt to Common Stock of the Company and terminate
various restrictive covenants contained in a related loan agreement in favor of
a new loan agreement (see "Major Suppliers"). Second, the merger would enable
Lee Video City, Inc. to become a public company and to establish a trading
market for its shares. Third, the merger would result in gaining ownership of
the Prism film library and related accounts receivable and cash subject to the
assumption of Prism's bank indebtedness. Fourth, the
2
merger would bring about the consent of other creditors of Lee Video City, Inc.
to convert approximately $819,000 of debt into Common Stock of the Company.
As a consequence, the Company joined with Prism in submitting a Plan of
Reorganization to the United States Bankruptcy Court-Los Angeles District. In
December 1996, the Bankruptcy Court entered an order confirming the Plan of
Reorganization of Prism, which provided for the merger with Lee Video City,
Inc., the issuance of Common Stock of the Company to unsecured creditors of
Prism in satisfaction of their creditor claims, the modification of Prism's
existing bank loan agreement, and other matters. Pursuant to the Plan of
Reorganization, Prism emerged from Chapter 11 at the time of its merger with Lee
Video City, Inc. on January 8, 1997.
The name of the Company and the Registrant was changed to Video City, Inc.
in conjunction with the merger of Lee Video City, Inc. into Prism Entertainment
Corporation.
FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS
The Company primarily operates in one industry segment, the video industry. Lee
Video City, Inc. has had no export sales. Prism has licensed and sold films in
foreign territories and Video City may continue to exploit the existing film
library in the foreign marketplace. Prism had foreign sales aggregating $
279,000, $ 2,699,000, and $ 4,353,000 during fiscal years ending January 31,
1997, 1996 and 1995. However, no foreign sales are included in revenues for the
thirteen months ended January 31, 1997 and the twelve months ended December 31,
1996 and 1995 as Prism had no foreign sales from January 9, 1997 through January
31, 1997.
NARRATIVE DESCRIPTION OF BUSINESS
GENERAL
The Company was formed in 1990 by Robbie Lee for the purpose of developing
a chain of video retail superstores that would serve secondary markets. A video
superstore generally has at least 4,500 square feet of floor area and over 7,500
units for rental or sale. Secondary markets are those metropolitan areas with a
total population of less than 500,000 people.
As a result of the merger on January 8, 1997, the business of Video City,
Inc. now consists of the ownership and operation of a chain of video specialty
stores in California and the exploitation of a film library consisting of 47
feature films and numerous shorter films.
As of January 8, 1997, the Company owned and operated 18 video specialty
superstores and operated an additional 6 "licensed" stores pursuant to
management agreements. All of the stores are located in California. The
Company's stores rent and sell a variety of videocassettes, game cartridges,
video players, game equipment, accessories and concessions.
The Company will continue to distribute the film library into domestic and
foreign markets. Management has no plans to resume the production of feature
films, but may consider licensing and selling some or all of the non-video store
assets. The primary focus of the Company will be the business of owning and
operating video superstores.
VIDEO RETAILING
Video Retailing: According to Paul Kagan Associates, Inc. ("Paul Kagan"),
a well known video industry analyst, the home video retail industry grew from
$0.7 billion in 1982 to $15.8 billion in 1996 and is expected to reach nearly
$22 billion by 2005. An estimated 82.5% of American households own VCR's,
providing a huge installed base. Currently, more than 65 million Americans
visit a video store every week.
Management believes that the video industry's economics favor larger chains
with larger stores. The video industry is highly fragmented with approximately
28,000 stores in the United States. Only six video specialty chains have over
100 stores, and only one chain has a market share in excess of two percent. As
the industry has matured, however, it has begun consolidating. The industry's
consolidation is in its early stages with few well-established chains, and only
one national chain. The Company believes there is an excellent opportunity for
a well-managed, well-capitalized company to become a major "regional" player.
3
Movie Studio Dependence on Video Retailing: Sales to videocassette
retailers has become the single largest source of revenues for the movie
studios. According to Paul Kagan, the video retail industry is the single
largest source of domestic revenue to movie studios, representing approximately
$4.6 billion, or fifty-three percent of the $9.4 billion studio revenue in 1994.
Of the many movies produced by major studios and released in the United States
each year, relatively few are profitable for the studios based on box office
receipts alone. Video retailers purchase not only the hits, but also those
movies that did not do well at the box office, thus providing a source of
revenue for almost all their movies. Revenues from "B" titles (titles that do
not make the top 120 movies of the year) account for approximately 25% of the
studio revenue and are derived principally from movie rentals, not box office
revenues.
Rentals versus Sales: Although the industry includes both rentals and
sales, the consumer market has been primarily comprised of rentals. By setting
the wholesale prices, movie studios influence the relative levels of
videocassette rentals versus sales. Videocassettes released at a relatively
high price, typically $60 to $70, are purchased by video specialty stores and
are promoted primarily as rental titles. Videocassettes released at a
relatively low price, typically $5 to $18, are purchased by video specialty
stores and are promoted as both rental and sale titles. In general, movie
studios attempt to maximize total revenue from videocassette releases by
maintaining prices at a relatively high level during the first six months to one
year after release. During this time, sales are made primarily to video
specialty stores for rental. Subsequently, the movie studios re-release the
tapes at a lower price to promote sales.
FILM PRODUCTION AND DISTRIBUTION
Feature Film Licensing: Feature films are licensed and sold into the
foreign market place and to the domestic ancillary market, including pay-per-
view, pay and basic cable, free television and laser disc. The home video
distribution business involves the promotion and the sale of videocassettes and
video discs to local, regional, and national video retailers (e.g., video
specialty stores, convenience stores, record stores and other outlets), which
then rent or sell the videocassettes and video discs to consumers primarily for
private viewing.
Major feature films are usually scheduled for release in the home video
market within four to six months after theatrical release to capitalize on the
theatrical advertising and publicity for the film. Promotion of new releases is
generally undertaken during the nine to twelve weeks before the release date.
Videocassettes of feature films are generally sold to domestic wholesalers at
approximately $50 to $60 per unit and generally are rented by consumers for fees
ranging from $1 to $4 per day. Selected titles, including certain made-for-
video programs, can be priced significantly lower to encourage direct purchase
by consumers.
The Company will continue to distribute the film library into domestic and
foreign markets. Management has no plans to resume the production of feature
films, but may consider licensing and selling some or all of the non-video store
assets.
BUSINESS AND EXPANSION STRATEGY
Business Strategy The Company focuses on operating, building and acquiring
superstores. The Company believes superstores, stores generally in excess of
4,500 square feet, are the most commercially viable format for most locations.
The size generates enough traffic to permit leasing optimal locations. The
majority of the store operating expenses are substantially fixed and hence,
disproportionately lower in the larger format. As most video rental customers
use two to three stores, a superstore offers a more complete selection and
greater availability of new releases; therefore, they are better able to become
a customer's preferred store. In addition to selecting superior locations and
offering superior inventory selections, the Company places much emphasis on
offering its customers excellent service.
Expansion Strategy The Company has a three-pronged growth strategy, as
follows:
Development Program. In many regions, the Company believes there are
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significant opportunities to grow through internal development and smaller
acquisitions. Such internal growth will be the means of expansion in attractive
market areas where there are no strong acquisition candidates, good locations
are still available, the competition consists of small stores vulnerable to the
superstore approach, or stores with
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less experienced or under-capitalized operators. Historically, the opening of
new stores has fueled most of the Company's growth. The Company has selected
suitable locations, negotiated reasonable leases with the property owners,
retained contractors to remodel the interior of the stores into the Company's
superstore format, hired and trained store employees, advertised the stores
within their trade area, and opened the stores for business.
Acquisitions. The Company believes the highly fragmented nature of its
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industry presents the opportunity to acquire strategically located chains that
are market share leaders in their trade areas. Management believes that
acquiring such chains can be the most cost-effective means of entering an area,
particularly where the chain already occupies the most desirable locations. The
purchase of an existing chain enables the Company to immediately utilize the
assets of the acquired chain. Also, existing chains have established a customer
base that can substantially reduce the Company's advertising expenses. The
Company anticipates opening additional stores as necessary to fill in the market
areas of the acquired video chains so that operating efficiencies can be
maximized.
New Products In recent years, the Company began renting video game
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cartridges and discs, and selling videocassettes, thus generating additional
revenue. The Company anticipates that there will be future new products and
technological innovations, such as digital video discs, that will result in new
product lines, creating new revenue sources for the Company.
MERCHANDISING
Videocassette Rental. The Company's stores primary revenue source is the
rental of videocassettes. Each store currently offers from 8,000 to 14,000
videocassettes consisting of approximately 6,000 different titles. New release
videocassettes (videos within one year from release date) are displayed in the
prominent "New Release" section and are organized alphabetically by title.
Catalog videocassettes are displayed alphabetically by title within categories
such as "Action", "Comedy", "Drama", etc. The Company seeks to be known within
its markets as the chain with the most new releases. One promotional strategy
that management deems to be highly successful is to periodically guarantee the
availability of a popular new release.
Videocassette Sales. Video City offers new and previously viewed
videocassettes for sale. Previously viewed videocassettes are pulled from the
shelves several weeks after the release date depending on customer demand and
are sold to customers at a discount price.
Video Games. The Company's stores offer from 300 to 1,000 video game
cartridges, consisting of 250 to 500 different titles. Revenues generated from
game cartridges were on a continuous upward trend from 1992 to 1995. A decline
in video game rentals began in 1995 and continued through 1996 due to consumer
confusion on the direction of new hardware and formats. The Company anticipates
broadening its selection of game cartridges to include successful new formats as
they become available and grow in popularity.
Other Products. In addition to videocassette rentals and sales and video
game rentals, Video City stores also rent videocassette players, video game
players, and audio books in selected stores and sell a variety of video
accessories and confectionery items.
STORE LOCATIONS
All of the 18 stores currently owned and operated by the Company and the
six stores operated by the Company under management agreements are located in
California. Of the owned stores, nine are located in Bakersfield, three in
Fresno, and one store each in Delano, Palmdale, Taft, Tehachapi, Salinas, and
Santa Maria.
5
MAJOR SUPPLIERS
The Company has supply agreements with its two major suppliers, Ingram
Entertainment ("Ingram") and Rentrak Corporation ("Rentrak"). The agreement
with Ingram requires the Company to purchase, under certain conditions,
approximately 80% of its yearly requirements for the video rental, video sell-
through, and video game products. As a result of the Company's rapid expansion
in 1993 and 1994, the Company's purchases from Ingram caused the Company's
accounts payable to Ingram to reach nearly seven million dollars by August 1994.
In February 1995, $7.1 million of accounts payable due to Ingram were converted
to a Senior Secured Note due December 31, 2000, pursuant to an agreement with
Ingram which contained numerous restrictive covenants which, among other things,
limited the Company's ability to finance the opening of additional stores. In
June 1996, in connection of the sale by the Company of 11 stores, the Company
reduced its debt to Ingram by $3.1 million. Upon effectiveness of the merger
with Prism, Ingram converted $3.0 million of debt to Common Stock of the
Company, and the Company entered into a new loan agreement with Ingram
containing substantially less restrictive covenants for the remaining debt of
approximately $1.5 million.
Pursuant to the Revenue Sharing Agreement with Rentrak, the Company is
obligated to pay Rentrak revenue sharing and handling fee payments that are
equal to on an annual basis at least 8% of total gross rental revenues; this
amount prior to the January 8, 1997 merger with Prism was 10% of the Company's
total gross rental revenues. The Ingram supply agreement expires June 30, 2001
unless terminated earlier by Ingram, and the Rentrak Revenue Sharing Agreement
expires May 31, 2016.
If the relationships with Ingram and Rentrak were terminated, the Company
believes that it could readily obtain its necessary inventory of videocassette
and video games from a number of other suppliers at prices and on terms
comparable to those available from Ingram or Rentrak. However, there can be no
assurance that any replacement supplier would provide service or payment terms
as favorable as those provided by Ingram or Rentrak.
MARKETING AND ADVERTISING
The Company primarily uses television, radio, newspaper and direct mail as
a means to advertise. Suppliers and movie studios provide advertising and market
development funds for certain movie titles that the Company uses to purchase the
television, radio, and newspaper advertising. Although there is no guarantee,
the Company believes its suppliers and the movie studios will continue to
provide these advertising and market development funds. In addition, the Company
benefits from the advertising and marketing by studios and theaters in
connection with their efforts to promote videos and films. The Company's
advertising emphasizes signature attributes such as movie reservations, rent and
return at any location, membership good at all locations, and guaranteed
availability of certain key new releases.
INVENTORY MANAGEMENT
Each videocassette and game cartridge is placed in a clear protective case
and has a magnetic security device and a unique optical bar code affixed to it
before being placed on the floor for rental. The unique bar code is used for
inventory management. For the most part, inventory is received and maintained
at the store level; whereas, inventory for new stores is processed by the
Company before it is placed on the shelves. The Company conducts physical
inventories on a quarterly basis. Inventory may be, and is, transferred between
locations based on demand or lack of demand to obtain maximum return on
investment.
MANAGEMENT INFORMATION SYSTEMS
It is critically important in video retailing to have accurate and timely
information relating to inventory management, sales, customer demographics, and
various other financial and operational data. Video City began development of a
sophisticated management information system in early 1992 and fully
6
implemented its system in all superstores by mid-1994. Each superstore uses a
point-of-sale system ("POS") where all rental and sales transactions are
recorded using scanned bar code information. Nightly, the corporate system
electronically uploads data from each POS so data is available for management
review each morning. This data also provides customer information which is used
for direct marketing to these customers. This data is further used for audit
purposes and loss prevention. This POS is a sophisticated and complete system
that can be quickly implemented in new stores due to standard file layouts and
thorough documented procedures for training and staff utilization.
In each of the Company's multi-store markets, the stores' POS is linked to
a central computer enabling all product and customer data to be shared real
time. This sharing allows product to be rented from one store and returned to
another while tracking the product through the system. The Company believes it
is the only major chain of superstores that not only actively uses the real time
sharing so customers can rent and return at any location, and has successfully
promoted it to gain market share. The "linked" capability also allows stores to
locate rental and sale items which may not be available at one location but are
available at another location.
COMPETITION
The video retail industry is highly competitive. The Company competes with
other local and regional chains, such as Blockbuster Entertainment, a division
of Viacom, Inc. ("Blockbuster"), and with supermarkets, pharmacies, convenience
stores, bookstores, mass merchants, mail order companies and other retailers.
Some of the Company's competitors have significantly greater financial
resources, although the Company is generally the largest or second largest video
retailer in most of its markets. The Company believes success in competing with
other operators is principally a function of store location, number of copies of
popular titles, and customer service.
Approximately fifty percent of the Company's stores compete directly with
Blockbuster. One of Blockbuster's strengths, and also one of its weaknesses, is
its standardization of design, layout, look and business practices of each of
its stores regardless of location. This approach is easy to roll out and can be
cost efficient in many respects, but does not address many market-specific
issues. The Company believes regional flexibility is an important competitive
requirement in its industry and therefore is organized along geographic lines
with each region having significant autonomy.
The Company also competes with cable television, satellite and pay-per-
view, in which subscribers pay a fee to see a movie selected by the subscriber.
Pay-per-view at this time offers a limited number of channels only available to
households with a converter to unscramble an incoming signal. Recent
technological developments could permit cable companies, direct broadcast
satellite companies, telephone companies, and other telecommunications companies
to transmit a much greater number of movies to homes at more frequently
scheduled intervals throughout the day. Ultimately, these technologies could
lead to the availability of movies to consumers on demand. The Company believes
movie studios have a strong interest in maintaining a viable movie rental
business as the sale of videocassettes represents the studio's largest source of
revenue. As a result, the Company believes movie studios will continue to make
movie titles available to cable television and other distribution channels only
after the revenue has been derived from the sale of videocassettes to video
stores. Substantial technological developments will be necessary in order for
pay-per-view to match the low price, viewing convenience and selection available
through video rental.
The Company does not believe that Video on Demand ("VOD") represents a near
term threat to the video retailing industry. VOD has been the topic of much
publicity and at some point will probably become a factor in the distribution of
video entertainment, but the Company does not perceive it as a significant
threat over the next five years. Studios have indicated their intent, should
VOD technology prove feasible, of giving VOD a release slot after video
retailing but before cable. Also, VOD technology is evolutionary not
revolutionary. Management believes VOD is essentially a refinement of existing
products and will take years to gain broad-base acceptance. Finally, the costs
of current VOD pilot systems are prohibitive, and although they are projected to
decline substantially, the lower costs are expected to exceed the costs of
renting a video.
The Company's competitors related to licensing and sale of feature films
include major studios and their affiliates, such as Universal, Walt Disney,
Paramount, Warner Bros., CBS/Fox Video, Turner Broadcasting systems/New Line
Home Video and independent companies such as Trimark Entertainment.
7
In addition, The Company faces competition from a number of privately held
production companies which target the home video market including Full Moon
Productions, Cinetel Films, Arrow Films Int'l., Vision Entertainment and Saban
Productions. Many of these private companies have distribution arrangements with
major studios. The Company's competitors have available for distribution "A"
quality films which have increasingly attracted the "buy" decisions of video
retailers thus limiting the market available to the Company.
In the international distribution market, the competition includes a wide
range of companies from small independent production companies to sales agents
acting as producers' representatives such as Atlas Int'l, and Betafilm
(Germany), Capitol Films (Britain), DB Media (Italy), and UCG Int'l. (France).
EMPLOYEES
As of January 31, 1997, the Company had approximately 207 employees, of
whom 190 are located in the retail stores and the remainder in the Company's
corporate administrative office. None of the Company's employees are
represented by a labor union, and the Company prides itself on its exemplary
relations with its employees.
SERVICE MARK
The Company owns a United States federal registration for its service mark
"Video City." The Company considers its service mark important to its continued
success.
ITEM 2. PROPERTIES
All of the Company's stores are leased pursuant to leases with initial
terms ranging from three to ten years with varying option renewal periods. Most
of the leases are "triple net" requiring the Company to pay all taxes,
insurance, and common area maintenance expenses associated with the properties.
The Company's corporate headquarters is located in Bakersfield, California
and consists of approximately 16,000 square feet of leased space.
Management considers the Company's corporate offices and stores to be
generally suitable and adequate for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in legal proceedings that management
believes could have a material adverse effect on the Company's financial
condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters requiring disclosure.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Lee Video City, Inc. was a privately held company until its merger with
Prism on January 8, 1997. Until November 30, 1995, Prism's common stock was
traded on the American Stock Exchange under the symbol "PRZ". In response to
the anticipated filing of the Bankruptcy Petition, the American Stock Exchange
suspended trading of Prism's common stock pending review of the Company's Plan
of Reorganization and its then eligibility for continued trading. Thereafter,
the Common Stock has traded on a very limited basis on the NASD Electronic
Bulletin Board. As of January 31, 1997 there was no established trading market
as the Company was delisted from the American Stock Exchange.
As of April 30, 1997, there were approximately 150 record holders of the
Registrant's common stock.
The Company has never paid any cash dividends, and the Board of Directors
intends to retain any earnings for use of the expansion of the Company's
business in the foreseeable future.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended
December 31, 1992, 1993, 1994, 1995, and 1996 have been derived from the
consolidated financial statements of Lee Video City, Inc. The selected
historical financial data for the year ended January 31, 1997 was derived from
the consolidated financial statements of the Company. The information set forth
below should be read in conjunction with the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
consolidated financial statements and notes thereto.
Thirteen
Months
Ended
January 31, Year ended December 31,
1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- ----------- -----------
(in thousands, except per share and operating data)
STATEMENT OF OPERATIONS
DATA(1):
Revenues 12,211 11,271 14,007 13,164 6,662 2,446
Operating income (loss) (522) (418) 141 (379) (1,126) 254
Income (loss) before income taxes (176) (43) (586) (1,310) (1,450) 248
Net income (loss) (176) (43) (586) (1,310) (1,450) 248
Net income (loss) per share (0.04) (0.01) (0.14) (0.32) (0.36) 0.06
Weighted average shares
Used in computation 4,569 4,234 4,127 4,080 4,080 4,080
OPERATING DATA:
Number of stores at end of period 18 18 29 29 20 6
Increase (decrease) in same 0.3% (1.2)% (1.9)% 5.2% 5.4% 11.3%
store revenues (2)
BALANCE SHEET DATA (3):
Cash and cash equivalents 1,247 59 418 93 457 56
Videocassette rental inventory 2,127 2,189 3,354 3,523 2,444 823
Total assets 11,080 4,010 7,335 7,705 4,725 1,709
Long-term debt, less current portion 3,341 5,804 7,954 9,028 5,827 210
Total liabilities 8,844 8,167 11,449 11,458 7,168 2,702
Stockholders' equity (deficit) 2,236 (4,157) (4,114) (3,753) (2,443) (993)
(1) The Statement of Operations Data reflects the results of operations of Lee
Video City, Inc. for the twelve months ended December 31 1992, 1993, 1994,
1995, and 1996 and for 1997 reflects the results of operations of Lee Video
City, Inc. for the thirteen months ended January 31, 1997 and Prism
Entertainment Corporation for 23 days, January 8, 1997 through January 31,
1997. The twelve months ended December 31, 1992 and 1993 are unaudited.
(2) The increase (decrease) in same store revenues compares revenues from
stores opened and owned by the Company for twelve full months.
(3) The Balance Sheet Data for 1997 reflects the post merger combined accounts.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements in the Annual Report on Form 10-K, particularly under
Items 1 through 8, constitute "forward-looking statements" within the meaning of
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such
forward-looking statements involve known and unknown risks,
9
uncertainties, and other factors which may cause the actual results, performance
or achievements of the Company to be materially different from any future
results, performance or achievements, expressed or implied by such forward-
looking statements.
OVERVIEW
Lee Video City, Inc. opened its first video superstore in 1990. The
Company grew to as many as 31 superstores in 1994 and owned and operated 29
stores until June 1996 when it sold eleven stores outside of California. The
eleven stores were sold to reduce debt and restructure the Company's operations
by focusing all of its attention on the "core stores" in California. On January
8, 1997, Lee Video City, Inc. merged with and into Prism Entertainment
Corporation. Upon consummation of the merger, the name of the surviving
corporation ("the Company") was changed from Prism Entertainment Corporation to
Video City, Inc. The Company retained Prism's year-end of January 31 resulting
in the presentation of thirteen months for its statement of operations ended
January 31, 1997, including the accounts of Prism Entertainment Corporation for
the period January 9, 1997 through January 31, 1997.
As of January 31, 1997, the Company owned and operated 18 video
superstores in the State of California under the Video City name and logo. The
Company's revenues consist primarily of rental revenues and product sales
revenues. Rental revenues include revenue from rentals of videos, video games,
video players and video game machines and extended viewing fees. Product sales
revenues are derived from sales of new and used videos, including excess rental
inventory, concessions and accessory items.
Operating costs and expenses include operating expenses, cost of product
sales and general and administrative expenses. Operating expenses consist of
amortization of videos purchased for rental, fees and lease expenses for leased
videos and all store expenses, including occupancy, payroll, store opening
expenses and direct store advertising and promotion expenses.
Videocassette rental inventory, which includes video games, is recorded at
cost and amortized over its estimated economic life with no provision for
salvage value. Videocassettes that are considered base stock are amortized over
36 months on a straight-line basis. Purchases of new release videocassettes and
video games are amortized whereby the tenth and any succeeding copies of each
title per store are amortized over 9 months on an accelerated basis; the fourth
through ninth copies of each title per store are amortized over 36 months on an
accelerated basis; and copies one through three of each title per store are
amortized as base stock.
Certain videocassettes in the rental inventory are leased under a Revenue
Sharing Agreement with Rentrak Corporation. Under its agreement with Rentrak,
pursuant to which the Company leases videos for rental to its customers, the
Company pays a handling fee of $8.30 for each video. During the revenue sharing
period, which is one year, the movie studio that supplies the video to Rentrak
owns the video, and Rentrak and the Company on a predetermined basis share the
rental revenues. The Company may also sell excess copies of a video title and
share the sale proceeds with Rentrak on a predetermined basis. At the end of
the revenue sharing period for a video title, the Company may purchase remaining
copies of that title generally for less than $5 per copy. The handling fee per
video is amortized on a straight-line basis over the revenue sharing period, and
revenue sharing payments are expensed when incurred.
Cost of sales and leased product is comprised of the cost of videos sold to
customers and the cost of concessions and other products sold in the Company's
stores. The cost of a video is measured at its amortized basis when sold, if
previously used as a rental video, or at the Company's cost if purchased for
sell-through, or at a varying basis if a leased product, depending upon when in
the revenue sharing period it is sold.
General and administrative expenses are comprised of corporate office
expenses, including office equipment and facilities costs, management salaries
and benefits, professional fees and all other items of corporate expense.
10
Prism Entertainment Corporation's operations for the period January 9, 1997
through January 31, 1997 includes $1,933 of sales, operating losses of $47,822,
interest expense of $23,744, which resulted in a net loss of $71,566.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated (i) statement of
operations data expressed as a percentage of total revenues and (ii) the number
of stores open at the end of each period.
Thirteen
Months
Ended Twelve Months Ended December 31,
January 31, --------------------------------
1997 1996 1995 1994
----------- --------------------------------
Rental revenues and product sales 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Store operating expenses 54.5% 55.2% 48.9% 51.5%
Amortization of videocassette rental
inventory 17.2% 17.6% 14.4% 19.5%
Cost of product sales 13.9% 13.8% 12.7% 9.8%
Cost of leased product 4.8% 4.9% 7.8% -
General and administrative 13.8% 12.1% 15.2% 22.1%
----------- --------------------------------
Total 104.3% 103.7% 99.0% 102.9%
----------- --------------------------------
Operating income (loss) (4.3)% (3.7)% 1.0% (2.9)%
Non-operating expense 2.9% 3.3% (5.2)% (7.1)%
----------- --------------------------------
Loss before income taxes (1.4)% (0.4)% (4.2)% (10.0)%
Number of stores open at end of period 18 18 29 29
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues
Revenues for 1996 decreased $ 2,736,000, or 19.5%, to $ 11,271,000 compared
to $14,007,000 for 1995. The decreased revenues were primarily a result of the
sale of 11 stores by the Company in June 1996. Same store revenues were
basically unchanged for 1996.
Amortization of Videocassette Rental Inventory
Amortization of videocassette rental inventory for 1996 decreased $29,000
or 1.5%, to $1,988,000, compared to $2,017,000 for 1995. Amortization of
videocassette rental inventory as a percentage of total revenue was 17.6% in
1996 compared to 14.4% in 1995. The increase as a percentage of total revenue
was due to the higher proportion of purchased videocassettes versus leased
videocassettes in 1996 compared to 1995.
Cost of Product Sales
The cost of product sales as a percentage of revenue increased to 13.8% for
1996 compared to 12.7% for 1995. This increase was primarily due to the Company
selling many previously viewed new
11
release movies sooner than planned resulting in a loss on the sale of these
movies due to a high net book value at the time of sale. These sales enabled the
Company to generate needed working capital for operations.
Cost of Leased Product
Cost of leased product for 1996 decreased $530,000, or 48.8%, to $556,000
compared to $1,086,000 for 1995. The decrease was attributable to the Company's
sale of eleven stores in June 1996 and the Company buying less leased
videocassettes in 1996. Cost of leased product as a percentage of total revenue
was 4.9% in 1996 compared to 7.8% in 1995. The decrease as a percentage of
total revenue was due to the lower proportion of leased videocassettes versus
purchased videocassettes in 1996 compared to 1995.
Store Operating Expenses
Store operating expenses for fiscal 1996 decreased $ 629,000, or 9.2%, to
$6,221,000 compared to $ 6,850,000 for 1995. Store operating expenses as a
percentage of total revenues were 55.2% for 1996 compared to 48.9% for 1995 due
primarily to higher personnel costs and the payment of settlement fees of
$380,000 to landlords for the termination of two occupancy leases related to the
relocation of stores. The decrease in operating expenses was primarily due to
the sale of eleven stores by the Company in June 1996.
General and Administrative
General and administrative expenses for 1996 decreased $763,000, or 35.8%,
to $1,368,000 compared to $ 2,131,000 for 1995. General and administrative
expenses as a percentage of total revenue were 11.7% in 1996 compared to 15.2%
in 1995. The decrease was attributable to the sale of eleven stores by the
Company and management's efforts to reduce personnel costs and professional fees
to help improve the profitability of the Company.
Gain on Disposition of Assets
The gain on disposition of assets in 1996 is primarily related to the sale
of eleven out of state stores in June 1996. These stores were sold to eliminate
the added expense of operating stores outside of California, so that the Company
could streamline operations, reduce debt, and increase profitability
Interest Expense
Net interest expense decreased $240,000, or 25.8%, to $692,000 for 1996
compared to $932,000 for 1995. The decrease in interest expenses was primarily
due to the reduction of long-term debt of the Company which was paid down from
the proceeds from the sale of the 11 stores in June 1996.
Other
Other (income) expense was $17,000 in income in 1996 compared to $204,000
in income in 1995. The change of $187,000 was primarily attributable to the
expenses reducing other income.
Income Taxes
The Company had no income tax expense for 1996 or 1995 as it had no taxable
income in 1996 or 1995. The Company's effective income tax rate varied from the
statutory federal tax rate as a result of operating losses for which no tax has
been recognized due to the change in the valuation allowance on the net deferred
tax asset. A full valuation allowance has been established as it is more likely
than not that the deferred tax asset will not be realized.
12
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Revenues
Revenue for 1995 increased $843,000, or 6.4%, to $14,007,000 compared to
$13,164,000 for 1994. The increase in revenue was primarily due to new stores
maturing and being open for a full year during 1995. Same store revenues were
down slightly, 1.9% for 1995.
Amortization of Videocassette Rental Inventory
Amortization of videocassette rental inventory for 1995 decreased $551,000
or 21.5%, to $2,017,000, compared to $2,568,000 for 1994. The decrease was
attributed to the Company entering into a Revenue Sharing Agreement in December
1994 and thus leasing a portion of its videocassettes, resulting in less
amortization expense of owned videocassettes.
Cost of Product Sales
The cost of product sales as a percentage of revenue increased to 12.7% for
1995 compared to 9.8% for 1994. This increase was primarily due to the Company
selling many previously viewed new release movies sooner than planned resulting
in a loss on the sale of these movies due to a high net book value at the time
of sale. These sales enabled the Company to generate needed working capital for
operations.
Cost of Leased Product
Cost of leased product for 1995 was $1,086,000 compared to $0 for 1994.
This was due entirely to the fact that the Company did not have a Revenue
Sharing Agreement until December 1994 and therefore had no cost of leased
product expense for 1994. Cost of leased product as a percentage of total
revenue for 1995 was 7.8%.
Store Operating Expenses
Store operating expenses increased $74,000 to $6,850,000 for 1995 compared
to $6,776,000 for 1994. Operating expenses as a percentage of total revenues
were 48.9% for 1995 compared to 51.5% for 1994. Store operating expenses
decreased as a percentage of total revenue primarily due to better efficiencies
of operating the stores.
General and Administrative
General and administrative expenses decreased $774,000, or 26.7%, to
$2,130,000 in 1995 compared to $2,904,000 in 1994. General and administrative
expenses as a percentage of total revenue was 15.2% in 1995 compared to 22.1% in
1994. The decrease was the result of the Company not adding any new stores in
1995 and the decision of management to reduce general and administrative expense
to increase efficiencies and profitability of the Company.
Interest Expense
Net interest expenses increased $105,000 to $932,000 for 1995 compared to
$827,000 for 1994. This increase was primarily due to the Company incurring
interest on long-term debt for a full year in 1995 compared to a partial year in
1994. The Company's effective income tax rate varied from the statutory federal
tax rate as a result of operating losses for which no tax has been recognized
due to the change in the valuation allowance on the net deferred tax asset. A
full valuation allowance has been established as it is more likely than not that
the deferred tax asset will not be realized.
13
Income Taxes
The Company had no income tax expense for 1995 or 1994 because it had no
taxable income in 1995 or 1994. Additionally, in 1995 the Company changed its
status from an S corporation to a C corporation. The Company's effective income
tax rate varied from the statutory federal tax rate as a result of operating
losses for which no tax has been recognized due to the change in the valuation
allowance on the net deferred tax asset. A full valuation allowance has been
established as it is more likely than not that the deferred tax asset will not
be realized.
ONE MONTH ENDED JANUARY 31, 1997 COMPARED TO ONE MONTH ENDED JANUARY 31, 1996
Revenues
Revenue for the one month ended January 31, 1997 decreased $145,000, or
13.4%, to $940,000 compared to $1,085,000 for the one month ended January 31,
1996. The reason for the decrease was the sale of the eleven stores by the
Company in June 1996. Same store revenue, however, for the one month ended
January 31, 1997 was up $131,000, or 19.2%, compared to the one month ended
January 31, 1996.
Amortization of Videocassette Rental Inventory
Amortization of videocassette rental inventory for the one month ended
January 31, 1997 decreased $18,000, or 14.0%, to $111,000 compared to $129,000
for the one month ended January 31, 1996. The primary reason for the decrease
was the sale of eleven stores by the Company in June 1996.
Cost of Product Sales
Cost of product sales for the one month ended January 31, 1997 increased
$71,000 to $136,000 compared to $65,000 for the one month ended January 31,
1996. The increase was primarily due to the Company's expansion of its sell
through product lines in its stores.
Cost of Leased Product
Cost of leased product for the one month ended January 31, 1997 decreased
$64,000, or 63.9%, to 36,000 compared to $99,000 for the one month ended January
31, 1996. The decrease was due to the Company leasing a lower proportion of
videocassettes versus purchasing videocassettes in January 1997 compared to
January 1996.
Store Operating Expenses
Store operating expenses for the one month ended January 31, 1997 decreased
$138,000, or 23.9%, to $439,000 compared to $577,000 for the one month ended
January 31, 1996. Store operating expenses as a percentage of total revenues
was 46.7% in January 1997 compared to 53.1% in January 1996. The decrease was
primarily due to lower personnel costs and other controllable expenses.
General and Administrative
General and Administrative expenses for the one month ended January 31,
1997 increased $196,000 to $323,000 compared to $127,000 for the one month ended
January 31, 1996. The increase was primarily due to costs related to the merger
between Lee Video City, Inc. and Prism Entertainment Corporation.
Interest Expense
Interest expense for the one month ended January 31, 1997 decreased
$31,000, or 39.6%, to $46,000 compared to $77,000 for the one month ended
January 31, 1996. The decrease in interest expense
14
was due to the Company having approximately $3,750,000 less in debt in January
1997 compared to January 1996.
Net Loss
The net loss for the one month ended January 31, 1997 of $133,000 compared
to net income for the one month ended January 31, 1996 of $28,000 was
attributable to the increased general and administrative expenses related to the
merger.
Liquidity and Capital Resources
The Company's primary long-term capital needs are for opening and acquiring
new stores. The Company expects to fund such needs through cash flows from
operations, the net proceeds from the possible sale of debt or equity
securities, bank credit facilities, trade credit, and equipment leases.
The Company funds its short-term working capital needs, including the
acquisition of videos and other inventory, primarily through cash from
operations. The Company expects that cash from operations will be sufficient to
fund future video and other inventory purchases and other working capital needs.
Videocassette rental inventories are accounted for as noncurrent assets under
generally accepted accounting principles because they are not assets which are
reasonably expected to be completely realized in cash or sold in the normal
business cycle. Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital. The
acquisition cost of videocassette rental inventories, however, is reported as a
current liability until paid and , accordingly, included in the computation of
working capital. Consequently, the Company believes working capital is not as
significant a measure of financial condition for companies in the video retail
industry as it is for companies in other industries. Because of the accounting
treatment of videocassette rental inventory as a noncurrent asset, the Company
anticipates that it will operate with a working capital deficit during fiscal
1998.
On January 8, 1997, in conjunction with the Company's merger with Prism
Entertainment Corporation, the Company entered into an amended and restated
credit and security agreement (the "Agreement") with Imperial Bank, covering
$3,066,000 of indebtedness that was owed by Prism. The Agreement calls for the
Company to pay all net collections received from accounts receivable and a
certain note receivable as well as additional accounts receivable generated from
licensing of the Company's film library, directly against the principal balance
of the loan. All principal outstanding as of July 1, 1998 shall be payable over
twelve equal monthly installments for the balance of the term. The outstanding
loan balance as of January 31, 1997 was $3,066,000. The Company's accounts
receivable and a certain note receivable available for payment on the above debt
at January 31, 1997 was $2,162,000.
The Company also received $785,000 in cash upon consummation of the merger
to be utilized for working capital purposes.
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Net cash provided by operating activities decreased by approximately
$880,000 or 33.7% primarily due to a decrease in accounts payable and accrued
expenses, partially offset by a decrease in other assets. Net cash used in
investing activities decreased by $229,000 or 11.1% mainly due to proceeds
received from the sale of certain fixed assets that offset increased net
purchases of videocassette rental inventory made in 1996 versus 1995. Net cash
used in financing activities increased $33,000 or 14.5% mainly due to increased
principal payments made on obligations under capital leases.
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
Net cash provided by operating activities increased by approximately
$307,000 or 13.3% primarily due to a decrease in notes receivable. Cash used in
investing activities increased by approximately $135,000 or 7.0% primarily due
to increased purchases of net videocassette rental inventory.
15
Cash used in financing activities decreased by approximately $517,000 or 69.4%
primarily due to the decreased repayment of long-term debt.
GENERAL ECONOMIC TRENDS, QUARTERLY RESULTS AND SEASONALITY
The Company anticipates that its business will be affected by general
economic and other consumer trends. To date, the Company has not operated
during a period of high inflation but believes that it would generally be able
to pass on increased costs relating to inflation to its customers. Future
operating results may be affected by various factors, including variations in
the number and timing of new store openings, the performance of new or acquired
stores, the quality and number of new release titles available for rental and
sale, the expense associated with the acquisition of new release titles,
additional and existing competition, marketing programs, weather, special or
unusual events and other factors that may affect retailers in general. Any
concentration of new store openings and the related new store pre-opening costs
and other expenses associated with the opening of new stores near the end of a
fiscal quarter could have an adverse effect on the financial results for that
quarter and could, in certain circumstances, lead to fluctuations in quarterly
financial results.
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and the
improved weather, and in September and October, due in part to the start of
school, the football season and the introduction of new television programs.
The Company believes these seasonality trends will continue.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 128 "Earnings per Share"
("SFAS No. 128) issued by the Financial Accounting Standards Board ("FASB") is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods. The statement requires restatement of all
prior period earnings per share (EPS) data presented. The new standard requires
a reconciliation of the numerator and denominator of the basic EPS computation
to the numerator and denominator of the diluted EPS computation. The Company
does not expect adoption to have a material effect on its EPS computation.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are filed with this report:
Reports of Independent Certified Public Accountants
Balance Sheets
Statements of Operations
Statements of Stockholders' Deficit
Statements of Cash Flows
Notes to Financial Statements
16
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Video City, Inc.
We have audited the accompanying balance sheets of Video City, Inc. (formerly
Lee Video City, Inc.) as of January 31, 1997 and December 31, 1996 and the
related statements of operations, stockholders' deficit and cash flows for the
thirteen months and one month ended January 31, 1997 and the year ended December
31, 1996. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Video City, Inc. as of January
31, 1997 and December 31, 1996 and the results of its operations and its cash
flows for each of the thirteen months and one month ended January 31, 1997
and the year ended December 31, 1996 then ended in conformity with generally
accepted accounting principles.
BDO SEIDMAN, LLP
Los Angeles, California
April 11, 1997
17
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
Lee Video City, Inc.
We have audited the accompanying balance sheet of Lee Video City, Inc. as of
December 31, 1995 and the related statements of operations, stockholders'
deficit and cash flows for the years ended December 31, 1995 and 1994. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Lee Video City, Inc. as of
December 31, 1995 and 1994 and the results of its operations and its cash flows
for the years then ended in conformity with generally accepted accounting
principles.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 9, 1996, except
for note 6, which is as of
May 28, 1996.
18
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
BALANCE SHEETS
January 31, December 31, December 31,
1997 1996 1995
----------- ---------- ----------
ASSETS (NOTE 6)
CURRENT ASSETS
Cash $ 1,246,517 $ 59,273 $ 417,517
Accounts receivable, less allowance
for doubtful accounts of $325,422,
$0 and $0 in 1997, 1996 and 1995 (Note 6) 2,168,052 - -
Notes receivable, less allowance for
doubtful accounts of $0, $0 and
$25,000 in 1997, 1996 and 1995
(Note 5) 398,830 245,176 116,657
Merchandise inventories 58,976 49,597 71,061
Other 96,143 169,130 340,312
----------- ---------- ----------
Total current assets 3,968,518 523,176 945,547
VIDEOCASSETTE RENTAL INVENTORY, NET OF
ACCUMULATED AMORTIZATION 2,126,789 2,189,038 3,354,370
PROPERTY AND EQUIPMENT, NET (NOTE 4) 1,017,089 1,034,479 2,609,030
FILM INVENTORY (NOTE 6) 3,700,000 - -
NOTE RECEIVABLE (NOTE 5) - - 158,473
OTHER ASSETS 267,916 262,966 267,576
----------- ---------- ----------
TOTAL ASSETS $11,080,312 $4,009,659 $7,334,996
=========== ========== ==========
See accompanying notes to financial statements.
19
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
BALANCE SHEETS
January 31, December 31, December 31,
1997 1996 1995
----------- ---------- ----------
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable $ 1,761,297 $ 1,192,156 $ 1,406,281
Accrued expenses 707,485 404,571 463,388
Current portion of long-term debt (Note 6) 2,258,850 614,916 1,445,736
----------- ----------- -----------
Total current liabilities 4,727,632 2,211,643 3,315,405
LONG-TERM DEBT (NOTE 6) 3,341,313 5,804,014 7,953,821
OTHER LIABILITIES 774,875 151,142 179,986
----------- ----------- -----------
TOTAL LIABILITIES 8,843,820 8,166,799 11,449,212
COMMITMENTS AND CONTINGENCIES (NOTE 10)
STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 7)
Common stock, $.01 par value per share,
authorized 20,000,000 shares; issued and
outstanding 9,753,927 shares at 1997 and
4,234,024 shares at 1996 and 1995 97,539 42,340 42,340
Additional paid-in capital 7,035,935 564,660 564,660
Accumulated deficit (4,896,982) (4,764,140) (4,721,216)
----------- ----------- -----------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) 2,236,492 (4,157,140) (4,114,216)
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $11,080,312 $ 4,009,659 $ 7,334,996
=========== =========== ===========
See accompanying notes to financial statement.
20
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF OPERATIONS
Year ended Year ended Year ended
December 31, December 31, December 31,
1996 1995 1994
----------- ----------- -----------
REVENUE
Rental revenues and product sales $11,271,229 $14,007,083 $13,164,490
----------- ----------- -----------
OPERATING COSTS AND EXPENSES
Store operating expenses 6,220,574 6,850,068 6,775,516
Amortization of videocassette rental inventory 1,987,407 2,016,660 2,567,613
Cost of product sales 1,557,062 1,782,260 1,294,814
Cost of leased product 556,248 1,085,814 -
General and administrative expenses 1,367,650 2,130,797 2,905,067
----------- ----------- -----------
TOTAL OPERATING COSTS AND EXPENSES 11,688,941 13,865,599 13,543,010
INCOME (LOSS) FROM OPERATIONS (417,712) 141,484 (378,520)
OTHER (INCOME) EXPENSE
Gain on disposition of assets, net(Note 9) (1,049,295) - -
Interest expense 691,782 931,775 826,757
Other (17,275) (203,868) 104,590
----------- ----------- -----------
NET LOSS $ (42,924) $ (586,423) $(1,309,867)
=========== =========== ===========
NET LOSS PER SHARE $ (0.01) $ (0.14) $ (0.32)
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 4,234,024 4,127,097 4,079,976
See accompanying notes to financial statements.
21
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF OPERATIONS
Thirteen One One
Months ended month ended month ended
January 31, January 31, January 31,
1997 1997 1996
----------- ---------- ----------
(unaudited)
REVENUE
Rental revenues and product sales $12,211,369 $ 940,141 $1,085,250
----------- ---------- ----------
OPERATING COSTS AND EXPENSES
Store operating expenses 6,659,340 438,766 576,543
Amortization of videocassette rental inventory 2,098,441 111,034 129,145
Cost of product sales 1,692,955 135,894 65,301
Cost of leased product 592,112 35,864 99,425
General and administrative expenses 1,690,857 323,206 126,828
----------- ---------- ----------
TOTAL OPERATING COSTS AND EXPENSES 12,733,705 1,044,764 997,242
INCOME (LOSS) FROM OPERATIONS (522,336) (104,623) 88,008
OTHER (INCOME) EXPENSE
Gain on disposition of assets, net (Note 9) (1,049,295) - -
Interest expense 738,133 46,351 76,793
Other (35,408) (18,132) (17,192)
----------- ---------- ----------
NET INCOME (LOSS) $ (175,766) $ (132,842) $ 28,407
=========== ========== ==========
NET INCOME (LOSS) PER SHARE $ (0.04) $ (0.02) $ 0.01
WEIGHTED AVERAGE NUMBER OF COMMON
SHARES OUTSTANDING 4,568,563 8,507,497 4,234,024
See accompanying notes to financial statements.
22
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF STOCKHOLDERS' EQUITY
Additional Net
Common Stock Paid-In Accumulated Stockholders'
Shares Amount Capital Deficit Deficit
--------- ------- ---------- ----------- -----------
Balance at January 1, 1994 4,079,976 $40,800 $ 341,200 $(2,824,926) $(2,442,926)
Net Loss (1,309,867) (1,309,867)
--------- ------- ---------- ----------- -----------
Balance at December 31, 1994 4,079,976 40,800 341,200 (4,134,793) (3,752,793)
Issuance of Lee Video City,
Inc. Common Stock 154,048 1,540 223,460 225,000
Net Loss (586,423) (586,423)
--------- ------- ---------- ----------- -----------
Balance at December 31, 1995 4,234,024 42,340 564,660 (4,721,216) (4,114,216)
Net Loss (42,924) (42,924)
--------- ------- ---------- ----------- -----------
Balance at December 31, 1996 4,234,024 42,340 564,660 (4,764,140) (4,157,140)
Stock issued in satisfaction of debt 1,500,000 15,000 2,985,000 3,000,000
Stock issued in conversion of debt and
Capital Contribution 773,653 7,737 811,263 819,000
Effect of the Merger 3,246,250 32,462 2,675,012 2,707,474
Net Loss (one month ended) (132,842) (132,842)
--------- ------- ---------- ----------- -----------
Balance at January 31, 1997 9,753,927 $97,539 $7,035,935 $(4,896,982) $ 2,236,492
========= ======= ========== =========== ===========
See accompanying notes to financial statements.
23
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
Year ended Year ended Year ended
December 31, December 31, December 31,
INCREASE (DECREASE) IN CASH, 1996 1995 1994
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (42,924) $ (586,423) $(1,309,867)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 2,518,068 2,667,050 3,121,693
(Gain) loss on disposal of assets (1,049,294) 14,281 109,588
Note issued for legal settlement 379,632 - -
Noncash interest - 135,000 305,238
Other - 18,805 -
Changes in assets and liabilities:
Decrease (increase) in notes receivable 29,954 55,295 (322,475)
Decrease in merchandise inventories 21,464 62,211 61,337
Increase in film library - - -
Decrease (increase) in other assets 175,792 (173,995) (316,832)
Increase in accounts payable (214,125) 287,206 451,396
Increase in accrued expenses (58,817) 146,574 203,505
Increase (decrease) in other liabilities (28,844) (15,235) -
----------- ----------- -----------
Total adjustments 1,773,830 3,197,192 3,613,450
----------- ----------- -----------
Net cash provided by operating activities 1,730,906 2,610,769 2,303,583
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of videocassette rental inventory, net (2,260,680) (1,976,677) (1,283,764)
Purchases of fixed assets (169,512) (81,642) (1,485,539)
Proceeds from sale of fixed assets 601,301 - 846,398
----------- ----------- -----------
Net cash used in investing activities (1,828,891) (2,058,319) (1,922,905)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on obligations under capital leases (299,751) (175,726) (225,895)
Repayment of long-term debt (1,034,939) (51,900) (579,209)
Proceeds from issuance of long-term debt 1,074,431 - 60,000
----------- ----------- -----------
Net cash used in financing activities (260,259) (227,626) (745,104)
NET INCREASE (DECREASE) IN CASH (358,244) 324,824 (364,426)
Cash at beginning of year 417,517 92,693 457,119
----------- ----------- -----------
Cash at end of year $ 59,273 $ 417,517 $ 92,693
=========== =========== ===========
24
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
Year ended Year ended Year ended
December 31, December 31. December 31,
1996 1995 1994
------------ ------------ ------------
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR:
Interest $ 757,259 $ 820,202 $ 472,639
Income taxes 800 255,000 -
NONCASH INVESTING AND FINANCING ACTIVITIES:
Videocassette rental inventory acquired
through issuance of long-term debt - - 3,129,832
Interest charges financed through issuance
of long-term debt - 135,000 305,238
Acquisition of assets by issuance of
long-term debt - - 300,000
Furniture, fixtures and equipment acquired
under capital lease - - 585,801
Professional services financed through
issuance of common stock - 25,000 -
Videocassette rental inventory acquired
through issuance of common stock - 200,000 -
Long-term debt issued for settlement
of lawsuit 379,632 - -
Sale of stores in exchange for
assignment of debt 3,100,000 - -
See accompanying notes to financial statements.
25
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
Thirteen One
months ended month ended
January 31, January 31,
INCREASE (DECREASE) IN CASH, 1997 1997
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (175,766) $ (132,842)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 2,660,134 142,065
(Gain) loss on disposal of assets (1,049,294) -
Noncash interest - -
Note issued for legal settlement 379,632 -
Other - -
Changes in assets and liabilities:
Increase in accounts receivable - -
Decrease (increase) in notes receivable (128,519) (5,913)
Decrease in merchandise inventories 12,085 (9,379)
Increase in film library - -
Decrease (increase) in other assets 244,169 68,037
Increase in accounts payable (333,865) (119,740)
Increase in accrued expenses (104,358) (45,540)
Increase (decrease) in other liabilities (28,844) -
------------ ------------
Total adjustments 1,651,140 29,530
------------ ------------
Net cash provided by (used in)
operating activities 1,475,374 (103,312)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of videocassette rental
inventory, net (3,355,216) (1,094,536)
Disposal of videocassette rental
inventory 1,224,304 1,072,084
Purchases of fixed assets (183,153) (13,641)
Cash received in merger 1,454,293 1,454,293
Proceeds from sale of fixed assets 601,301 -
------------ ------------
Net cash used in investing activities (258,471) 1,418,200
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on obligations
under capital leases (320,910) (21,159)
Repayment of long-term debt (1,078,924) (43,985)
Proceeds from issuance of
long-term debt 1,074,431 -
Payment of dissenter's shares (62,500) (62,500)
------------ ------------
Net cash used in financing activities (387,903) (127,644)
------------ ------------
NET INCREASE (DECREASE) IN CASH 829,000 1,187,244
Cash at beginning of year 417,517 59,273
------------ ------------
Cash at end of year $ 1,246,517 $ 1,246,517
============ ============
26
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
Thirteen One
months ended month ended
January 31, January 31,
1997 1997
------------ -----------
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR:
Interest $ 692,202 $ 25,333
Income taxes 800 -
NONCASH INVESTING AND FINANCING ACTIVITIES:
Videocassette rental inventory acquired
through issuance of long-term debt - -
Interest charges financed through issuance
of long-term debt - -
Acquisition of assets by issuance of
long-term debt - -
Furniture, fixtures and equipment acquired
under capital lease - -
Professional services financed through
issuance of common stock - -
Videocassette rental inventory acquired
through issuance of common stock - -
Long-term debt issued for settlement
of lawsuit 379,632 -
Long-term debt converted to common stock 3,819,000 3,819,000
In conjunction with the merger of Lee Video
City, Inc. into Prism Entertainment
Corporation common stock was issued and
the following fair value of non cash
net assets were acquired:
Assets acquired 5,868,705 5,868,705
Liabilities assumed (3,161,231) (3,161,231)
---------- ----------
Net assets acquired 2,707,474 2,707,474
Cash received (1,454,293) (1,454,293)
---------- ----------
Non-cash net assets 1,253,181 1,253,181
Sale of stores in exchange for
assignment of debt 3,100,000 -
See accompanying notes to financial statements.
27
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY
Video City, Inc. (the "Company"), originally known as Lee Video City, Inc., was
incorporated in California on February 20, 1990. The Company owns and operates
video specialty stores located primarily in secondary markets.
On January 8, 1997, the Company merged with and into Prism Entertainment
Corporation ("Prism"). Prism is an inactive film production and distribution
company. Prism's business is limited to the sale of its existing film products
to domestic markets and the licensing of foreign rights to its existing film
library. The film library consists of 47 feature films and numerous shorter
films.
As of January 31, 1997, the Company owned and operated 18 stores and managed an
additional 6 "licensed" stores pursuant to management agreements. All of the
stores are located in California.
2. MERGER
On December 1, 1995, Prism filed a voluntary Chapter 11 petition and commenced a
case under Chapter 11 of the United States Bankruptcy Code. During the course
of the Bankruptcy Proceedings, Prism operated as a debtor in possession and
engaged in only limited business activities consisting of the sale of its
existing film products to domestic markets as well as foreign rights to its
existing film library.
On January 8, 1997, Lee Video City, Inc. merged into Prism Entertainment
Corporation pursuant to an Agreement and Plan of Reorganization and Merger,
dated as of October 25, 1996 (the "Plan"). The merger was authorized by the
Plan and was a condition precedent to the effectiveness of the Plan.
The transaction was accounted for as a reverse acquisition. In a reverse
acquisition, the stock issued goes to the accounting acquirer. Accordingly,
since the reverse purchase accounting is the reverse of normal, it is the fair
market value (FMV) of the issuer's stock at date of acquisition that is valued
with a write up (write down) of the issuer's net assets depending on whether the
stock is trading in excess (less than) book value. If a FMV cannot be
determined for the stock and cost is determined based on the FMV of the issuer's
net assets, then goodwill is not recognized and the transaction is valued at the
issuer's net tangible assets. Due to the trading of Prism Entertainment
Corporation's common stock being suspended during the bankruptcy proceedings,
the FMV of the stock could not be determined. Accordingly, goodwill was not
recognized and the transaction was recorded at the fair value of the issuer's
net tangible assets. The existing shareholders of Lee Video City, Inc. received
4,234,024 of the common stock of Prism Entertainment Corporation or
approximately 43.4% of the Company's common stock. Upon consummation of the
merger, the name of the surviving corporation ("the Company") was changed from
Prism Entertainment Corporation to Video City, Inc.
The financial statements include the accounts of Lee Video City, Inc. for all
periods presented and the accounts of Prism Entertainment Corporation for the
period January 9, 1997 through January 31, 1997.
Prism Entertainment Corporation's operations for the period January 9, 1997
through January 31, 1997 includes $1,933 of sales, operating losses of $47,822,
interest expense of $23,744, which resulted in a net loss of $71,566.
28
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MERCHANDISE INVENTORIES
Merchandise inventories consisting primarily of prerecorded videocassettes and
video games held for sale are stated at the lower of cost (first-in, first-out)
or market.
VIDEOCASSETTE RENTAL INVENTORY
Videocassette rental inventory, which includes video games, is recorded at cost
and amortized over its estimated economic life with no provision for salvage
value. Videocassettes that are considered base stock are amortized over 36
months on a straight-line basis. Purchases of new release videocassettes and
video games are amortized whereby the tenth and any succeeding copies of each
title per store are amortized over 9 months on an accelerated basis; the fourth
through ninth copies of each title per store are amortized over 36 months on an
accelerated basis; and copies one through three of each title per store are
amortized as base stock.
Certain videocassettes in the rental inventory are leased under a revenue
sharing agreement with a vendor, as broker for various studios (Revenue Sharing
Agreement). During the revenue sharing period, which is generally one year, the
studios retain ownership of the videocassettes and the Company shares the rental
revenue with a vendor rather than purchasing the videocassettes for a fixed cost
per copy (typically approximately $60). Such revenue sharing amounts are
included as cost of leased product in the accompanying statements of operations.
The associated handling fee per leased videocassette is amortized on a straight-
line basis over the term of the lease and is included in amortization of
videocassette rental inventory in the accompanying statements of operations.
Amortization expense related to videocassette rental inventory totaled
approximately $2,098,000 for the thirteen months ended January 31, 1997 and
$1,987,000, $2,017,000 and $2,568,000 for the years ended December 31, 1996,
1995 and 1994. As videocassettes are sold or retired, the applicable cost and
accumulated amortization are eliminated from the accounts, and any gain or loss
is recorded.
FILM COSTS
Film costs are paid to obtain film license rights and are amortized in the same
proportion that current revenues bear to estimated remaining lifetime revenues.
Estimates of total lifetime revenues and expenses are periodically reviewed by
management and revised if warranted by changing conditions. Where all or a
portion of the film costs appear not to be recoverable through estimated
remaining lifetime revenues, the non-recoverable portion is charged to expense.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Furniture, fixtures and equipment
under capital leases are recorded at the lower of the present value of the
future minimum lease payments or the fair value of the asset at the inception of
the leases. Property and equipment are depreciated using the straight-line
method over estimated useful lives, ranging from five to ten years.
REVENUE RECOGNITION
Revenue is recognized at the time of rental or sale.
Revenues from licensing agreements, which provide for the receipt by the Company
of nonrefundable guaranteed amounts, are recognized when the programming becomes
available for exhibition and all other conditions of the sale have been met.
Deposits and cash advances received under such licensing contracts are deferred
until all conditions of sale have been met, and are reflected in the
accompanying financial statements as deferred income. Revenues are recorded
net of applicable rebates, returns and advertising allowance.
29
STORE OPENING COSTS
Store opening costs, which consist primarily of payroll, advertising and
supplies, are expensed as incurred.
STOCK-BASED COMPENSATION
In 1996, the Company adopted for footnote disclosure purposes only, Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123), which requires that companies measure the cost of
stock-based employee compensation at the grant date based on the value of the
award and recognize this cost over the service period. For accounting purposes,
the value of the stock based award is determined using the intrinsic value
method whereby compensation cost is the excess of the quoted market prices of
the stock at grant date or other measurement date over the amount an employee
must pay to acquire the stock.
INCOME TAXES
The Company records income taxes pursuant to Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). Under the
asset and liability method of SFAS No. 109, deferred income taxes are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
LOSS PER SHARE
Loss per share computations are based on the weighted average number of common
and common equivalent shares outstanding. Loss per share computations do not
include any effect from the assumed exercise of stock options and warrants
because they are antidilutive.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the year. Actual results
could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS
No. 128) issued by the Financial Accounting Standards Board (FASB) is effective
for financial statements issued for periods ending after December 15, 1997,
including interim periods. The statement requires restatement of all prior
period earnings per share (EPS) data presented. The new standard requires a
reconciliation of the numerator and denominator of the basic EPS computation
(EPS) to the numerator and denominator of the diluted EPS computation. The
Company does not expect adoption to have a material effect on its EPS
computation.
30
4. PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
January 31, December 31, December 31,
1997 1996 1995
----------- ----------- ------------
Land $ - $ - $ 300,000
Furniture and fixtures 1,134,876 1,134,369 1,521,448
Equipment 683,330 678,695 1,339,501
Leasehold improvements 432,095 423,597 936,906
----------- ----------- ------------
$ 2,250,301 $ 2,236,661 $ 4,097,855
Accumulated depreciation (1,233,212) (1,202,182) (1,488,825)
----------- ----------- ------------
$ 1,017,089 $ 1,034,479 $ 2,609,030
=========== =========== ============
Depreciation expense was $562,000, $531,000, $650,000, and $544,000 for the
thirteen months ended January 31, 1997 and the years ended December 31, 1996,
1995, and 1994.
5. NOTES RECEIVABLE
At January 31, 1997, December 31, 1996 and December 31, 1995, the Company had
unsecured employee loans aggregating approximately $86,700, $86,700 and $90,300,
bearing interest at 7%, and are due on demand. Also included in notes
receivable is a secured note amounting to approximately $158,500, $158,500 and
$184,800 as of January 31, 1997, December 31, 1996 and December 31, 1995,
bearing interest at 8%, and is due September 15, 1997, and other miscellaneous
unsecured notes receivable of approximately $26,300 as of December 31, 1995.
Prism Entertainment Corporation had a note receivable that was assumed by the
Company in the merger. This note bears interest at 10% and had a balance of
approximately $154,000 as of January 31, 1997.
6. LONG-TERM DEBT
Long-term debt is summarized as follows:
January 31, December 31, December 31,
1997 1996 1995
----------- ------------ ------------
Promissory note, secured by all assets, bearing
interest at 10% per annum, interest only
payments monthly beginning January 31, 1997
through the year 2000. Principal balance due and
payable January 2000. 1,500,000 4,498,460 7,283,586
Promissory note, secured by the film library, accounts
receivable and the store inventory. All proceeds from
current and future accounts receivable collections as
well as from the sale of the film library are to be
applied to the outstanding principal until paid in full.
Any principal balance outstanding as of July 1, 1998
will be paid in twelve equal monthly installments.
The note bears interest at the bank's prime rate plus
3%. The interest rate on the note was 11.25% on
January 31, 1997. 3,066,338 - -
31
January 31, December 31, December 31,
1997 1996 1995
----------- ------------ ------------
Convertible, subordinated, unsecured notes to various
Individuals, maturing on January 31, 2001, interest
payable monthly, bearing interest at 5% to 10%.
converted on January 8, 1997 into common stock. - 851,510 859,000
Promissory note, secured by land, and personally
guaranteed by the primary stockholder of the
Company, bearing interest at 7%, principal and
interest were paid on May 27, 1996. - - 300,000
Other loans payable to various individuals for $160,000
(secured by property) and $50,000 (unsecured),
payable on February 29, 1996 and January 1, 1998,
respectively, bearing interest at 10% and 11%,
respectively, with personal guarantee by
primary stockholder of the Company 50,000 50,000 210,000
Other unsecured loans, payable in monthly
installments until September 15, 1997, bearing
interest at 8%. 42,850 48,166 109,283
Promissory notes payable, personally guaranteed by
the primary stockholder for $123,595 and $189,783,
payable in monthly installments until February
1, 1997, and February 1, 2000, respectively,
bearing interest at 10.25% 313,378 313,378 -
Other unsecured loans to fulfill settlement obligations
for $259,847 and $59,632, payable in monthly
installments until February 20, 2000 and December 15,
1998, respectively. 310,819 319,479 -
Capital lease obligations, payable in monthly installments,
with interest rates of 14% to 28%, secured by the respective
assets under the lease (Note 10) 316,778 337,937 637,688
- - - - ---------------------------------------------------------------------------------------------------------------------------
Total Debt 5,600,163 6,418,930 9,399,557
Less current portion (2,258,850) (614,916) (1,445,736)
- - - - ---------------------------------------------------------------------------------------------------------------------------
Total long-term debt $ 3,341,313 $ 5,804,014 $ 7,953,821
Total maturities of remaining long-term debt for five years subsequent to
January 31, 1997 are as follows:
Year ending
January 31, Amount
- - - - -----------------------------------------------------
1998 $2,258,850
1999 1,240,584
2000 590,163
2001 1,510,566
------------------------------------------------
$5,600,163
32
7. COMMON STOCK
During 1995, common stock was issued in exchange for videocassette rental
inventory and certain professional services. The videocassette rental inventory
and professional services have been valued at the approximate fair value.
During 1995, in conjunction with an addendum to the Revenue Sharing Agreement
(Note 3), the Company granted to the distributor a warrant to purchase shares of
common stock of the Company, representing 2% of the fully diluted issued and
outstanding shares of common stock at an exercise price of $400,000. The number
of shares issuable under this warrant is now fixed, 132,279 shares at an
exercise price of $3.02 per share. The warrant is exercisable during the period
commencing August 24, 1995 and ending on August 23, 2005.
In 1996, in conjunction with a second addendum to the Revenue Sharing Agreement
(Note 3), the Company granted to the distributor a warrant to purchase shares of
common stock at an exercise price of $30,795 for each 1% of the fully diluted
number of common shares outstanding, not to exceed 5% of the fully diluted
number of common shares outstanding. The number of shares issuable under this
warrant is now fixed at a maximum of 341,141 shares at a weighted average
exercise price of $0.45 per share. The warrant is exercisable during the period
commencing June 19, 1997 and ending on September 30, 2005. The vesting schedule
is as follows:
Cumulative Percentage of
June 19, Total Shares Outstanding Purchase Price
-------------------------------------------------------------
1997 1 $ 30,795
1998 2 61,590
1999 3 92,385
2000 4 123,180
2001 5 153,975
Additionally, during 1995 the Company issued a warrant to its major supplier to
purchase common stock at an exercise price of $30,795 for each 1% of the fully
diluted number of common shares outstanding, not to exceed 5% of the fully
diluted number of common shares outstanding. The warrant is exercisable during
the period commencing January 1, 1996 and ending on December 31, 2004. In 1996,
the Company amended this warrant under basically the same terms, except the
warrant shall not exceed 8.5% of the fully diluted common shares outstanding and
the warrant is fully vested as of December 31, 1996. As a result of the merger,
this warrant was then exchanged for a new warrant to purchase 404,403 shares of
the Company's stock from the principal stockholder of the Company at $0.6085 per
share. The grant date of this warrant is January 8, 1997 and expires five years
from that date.
In 1996, in conjunction with a second addendum to the Revenue Sharing Agreement
(Note 3), the Company granted to the distributor a warrant to purchase shares of
common stock at an exercise price of $30,795 for each 1% of the fully diluted
number of common shares outstanding, not to exceed 5% of the fully diluted
number of common shares outstanding. The warrant is exercisable during the
period commencing June 19, 1997 and ending on September 30, 2005. The vesting
schedule is as follows:
Cumulative Percentage of
June 19, Total Shares Outstanding Purchase Price
-------------------------------------------------------------
1997 1 $ 30,795
1998 2 61,590
1999 3 92,385
2000 4 123,180
2001 5 153,975
33
As a result of the merger and effective on the merger date, the major supplier
also received a warrant to purchase up to an aggregate of 852,750 shares of the
Company's common stock. A summary of this warrant is as follows:
Number of Shares Life (Years) Exercise Price
---------------------------------------------------
200,000 5.0 $2.00
200,000 6.0 2.25
200,000 7.0 2.50
114,240 5.0 0.51
54,360 5.0 1.03
15,000 5.0 1.00
69,150 5.0 2.00
In 1995, the Company granted stock options to purchase the company's common
stock to key employees and consultants. The options expire five years after
date of grant and are fully vested. In 1996, the Company granted stock options
to purchase the Company's common stock to key employees and consultants. The
options expire five years after the date of grant and vest ratably over a three
year period. In 1996, the Company also granted options to consultants which
expire five years after date of grant and are fully vested. A summary of stock
options and warrants activity is as follows:
January 31, 1997 1996 1995 1994
---------------- ---- ---- ----
Weighted Weighted Weighted Weighted
Average Average Average Average
Exercise Exercise Exercise Exercise
Shares Price Shares Price Shares Price Shares Price
- - - - -----------------------------------------------------------------------------------------------------------------------------------
Outstanding at
beginning of period 1,685,000 0.91 1,224,000 0.70 1,149,000 0.70 -
Granted 1,432,453 1.31 461,000 2.00 1,224,000 0.70 1,149,000 0.70
Exercised - - - - -
Terminated - 1,149,000 0.70 -
Outstanding at end
of period 3,117,153 1.18 1,685,000 1.06 1,224,000 0.70 1,149,000 0.70
Options exercisable
at period end 2,890,486 1.11 1,458,333 0.91 1,224,000 0.70 1,149,000 0.70
Information relating to stock option and warrant at January 31, 1997 summarized
by exercise price are as follows:
Outstanding Exercisable
--------------------------------------------- ------------------------------------------------------
Weighted Average Weighted Average
---------------- ----------------
Exercise Price
Per Share Shares Life Exercise Price Shares Exercise Price
- - - - -----------------------------------------------------------------------------------------------------------------------
$0.10 to $0.61 1,455,243 5.2 $0.49 1,455,243 $0.49
1.00 to 1.03 531,760 5.0 1.02 531,760 1.02
2.00 to 2.50 1,130,150 5.5 2.13 903,483 2.17
- - - - -----------------------------------------------------------------------------------------------------------------------
3,117,153 5.3 $1.18 2,890,486 $1.11
34
All stock options issued to employees have an exercise price not less than the
fair market value of the Company's common stock on the date of grant, and in
accordance with accounting for such options utilizing the intrinsic value method
there is no related compensation expense recorded in the Company's financial
statements. Had compensation cost for stock-based compensation been determined
based on the fair value at the grant dates consistent with the methods of SFAS
123, the Company's net loss and loss per share would not be materially
different.
The fair value of option grants are estimated on the date of grant utilizing a
simple option pricing model with the expected life of option ranging from 3 to 5
years, expected volatility of 0%, risk-free interest rates ranging from 5.38% to
5.69%, and a 0% dividend yield. The weighted average fair value of options
granted ranged from $0 to $0.42.
8. INCOME TAXES
At December 16, 1994, the Company converted from an S Corporation to a C
Corporation. As a C Corporation, the Company is subject to Federal and State
income taxes at the corporate level.
Income tax expense differs from the "expected" benefit (computed by applying the
U.S. Federal corporate statutory income tax rate to loss before income taxes)
primarily due to an increase in the valuation allowance for deferred tax assets.
As of January 31, 1997, the Company had net operating loss carryforwards
generated by Lee Video City, Inc. of approximately $1,703,000 and $851,000 for
Federal and California income tax purposes and net operating loss carryforwards
generated by Prism Entertainment Corporation of approximately $4,675,000 for
Federal income tax purposes, which are available to offset future taxable income
through 2012. The Company's ability to utilize the net operating loss
carryforwards is dependent upon the ability to generate taxable income in future
periods which may be limited due to future ownership changes as defined under
Section 382 of the Internal Revenue Code of 1986. Such an ownership change
occurred on January 8, 1997 which results in an annual limitation per year. Any
unused annual limitation may be carried over to future years until the net
operating losses expire. Utilization of net operating losses may also be
limited in any one year by alternative minimum tax rules. Net operating loss
carryforwards of Prism would be lost if the historical business of Prism is not
continued for two years.
Deferred tax assets are initially recognized for differences between the
financial statement carrying amount and the tax bases of assets and liabilities
which will result in future deductible amounts and operating loss and tax credit
carryforwards. A valuation allowance is then established to reduce that
deferred tax asset to the level at which it is "more likely than not" that the
tax benefits will be realized. Realization of tax benefits of deductible
temporary differences and operating loss or credit carryforwards depends on
having sufficient taxable income of an appropriate character within the
carryback and carryforward periods. Sources of taxable income that may allow
for the realization of tax benefits include (i) taxable income in the current
year or prior years that is available through carryback, (ii) future taxable
income that will result from the reversal of existing taxable temporary
difference, and (iii) future taxable income generated by future operations.
Based on an evaluation of the realizability of the deferred tax asset,
management has determined that it is not more likely than not that the Company
will realize this tax benefit. Therefore, a valuation allowance has been
established for the entire deferred tax asset.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at December 31, 1996 and 1995 are presented below:
35
January December December
1997 1996 1995
- - - - -------------------------------------------------------------------------------------------------------------------
Rental inventory principally due to difference
in amortization $ 120,080 $ 119,641 $ 540,600
Fixed assets due to difference in depreciation 87,970 85,698 65,700
Section 481 adjustment 80,032 83,377 127,600
Deferred rent 74,013 73,755 74,100
Net operating loss carryforward 2,247,663 638,202 193,600
Other 16,169 19,205 36,800
- - - - -------------------------------------------------------------------------------------------------------------------
Total gross deferred tax asset 2,625,927 1,019,878 1,038,400
Less valuation allowance (2,625,927) (1,019,878) (1,038,400)
- - - - -------------------------------------------------------------------------------------------------------------------
Net deferred tax assets $ - $ - $ -
9. GAIN ON DISPOSITION OF ASSETS
During 1996, the Company sold 11 stores for cash and assignment of debt. The
resulting gain on sale of assets is included in the statement of operations.
10. COMMITMENTS AND CONTINGENCIES
The Company is obligated under various capital leases for certain fixtures and
equipment expiring at various dates through 1999. At December 31, 1996 and
1995, the gross amount of furniture, fixtures and equipment and related
accumulated amortization recorded under capital leases included in furniture,
fixtures and equipment was as follows:
January 31, December 31, December 31,
1997 1996 1995
- - - - -------------------------------------------------------------------------
Furniture and fixtures $ 397,539 $ 397,539 $ 548,352
Equipment 405,167 405,167 558,873
- - - - -------------------------------------------------------------------------
802,706 802,706 1,107,225
Accumulated amortization (514,827) (502,930) (474,474)
- - - - -------------------------------------------------------------------------
$ 287,879 $ 299,776 $ 632,751
The Company leases its facilities under noncancelable operating leases expiring
at various dates through 2005. Rent expense under operating leases was
approximately $1,471,000, $1,444,000, $1,597,000 and $1,472,000 for the thirteen
months ended January 31, 1997 and the years ended December 31, 1996, 1995 and
1994.
The present value of future minimum capital lease payments and future minimum
lease payments under noncancelable operating leases with initial lease terms in
excess of one year as of January 31, 1997 are as follows:
36
Year Ending Operating
January 31, Capital Leases Leases
- - - - --------------------------------------------- -------------- -----------
1998 $ 312,978 $1,154,475
1999 69,206 1,123,378
2000 257 992,908
2001 -- 678,435
Thereafter -- 1,316,750
- - - - --------------------------------------------- -------------- -----------
Total minimum lease payments $ 382,441 $5,265,946
Amount representing interest 65,663
- - - - --------------------------------------------- --------------
Present value of net minimum capital lease
payments (included in long-term debt) $ 316,778
- - - - --------------------------------------------- --------------
Pursuant to the Revenue Sharing Agreement (Note 3), the Company is obligated to
pay the vendor revenue sharing and handling fee payments that are equal on an
annual basis to at least 8% of the Company's gross revenues.
On November 6, 1996, the Company amended the March 13, 1996 agreement with its
major supplier to purchase, under certain conditions, 80% of its yearly
requirements for the video rental, video sell-through and video game products.
The agreement expires on June 30, 2001.
If the relationships with Ingram and Rentrak were terminated, the Company
believes that it could readily obtain its necessary inventory of videocassette
and video games from a number of other suppliers at prices and on terms
comparable to those available from Ingram or Rentrak. However, there can be no
assurance that any replacement supplier would provide service or payment terms
as favorable as those provided by Ingram or Rentrak.
The Company, Robert Y. Lee, Barry Collier and Ingram entered into Override
Agreement dated November 19,1996 which provides, subject to certain exceptions,
that without the written consent of Ingram, the Company shall not enter into a
merger or a sale or transfer of all or substantially all of its assets, or make
any material change in the nature of its business as now conducted, or change
the form of organization of its business; and that without unanimous approval of
the Board of Directors, the Company shall not enter into any line of business
other than the sale and rental of video product and related goods, the
completion of one film that Prism had under way, and the exploitation of Prism's
film library; these provisions will remain in force until the later of the
payment in full of the Company's $1,500,000 debt to Ingram, or such time as
Ingram's beneficial ownership interest in the Company's common stock, on a fully
diluted basis, is 4% or less.
Effective January 8, 1997, Robert Y. Lee entered into an Employment Agreement
with the Company pursuant to which he will serve for a period of three years in
the capacity as Chairman of the Board and Chief Executive Officer. Mr. Lee will
receive a base salary of $178,000 per year and an annual bonus of 3% of any
pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing in 1997; 3% of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing in 1998; and 3% of any pre-tax profit in
excess of $1,300,000 with respect to the fiscal year commencing in 1999. Mr.
Lee is also entitled to certain fringe benefits including payment of up to $500
per month for the use of one Company provided automobile.
Effective January 8, 1997, Barry Collier entered into an Employment Agreement
with the Company pursuant to which for a period of two years he will serve in
the capacity of President. He will receive a base salary of $178,000 per year.
In addition, Mr. Collier is entitled to an annual bonus equal to 12% of all
annual revenues (net of commissions and expenses related thereto) recorded in
excess of $625,000 from the licensing and/or transfer of rights to the Prism
film library; an annual bonus equal to 5% of any promotional advertising
development funds from any external source in excess of $350,000 received by or
37
credited to the Company; and a bonus equal to 20% of proceeds in excess of
$3,700,000 (net of commissions and expenses of sale) received by the Company
generated from the sale of the Company's film library in its entirety. Mr.
Collier is also entitled to certain fringe benefits including payment of up to
$500 per month for the use of one Company provided automobile.
Effective January 8, 1997, James Craig Kelly entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity of Senior Vice President and Chief Executive Officer. Mr.
Kelly will receive a base salary of $120,000 per year and a bonus of 3% of any
pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing in 1997; 3% of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing in 1998; and 3% of any pre-tax profit in
excess of $1,300,000 with respect to the fiscal year commending in 1999. Mr.
Kelly is also entitled to certain fringe benefits including payment of up to
$500 per month for the use of one Company provided automobile.
In the event that the employment of any of the above individuals is terminated
for any reason other than "material breach" or "cause" as defined in his
Employment Agreement, the Company will pay the remainder of the base salary to
such individual for the remaining term of his employment agreement.
11. FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Notes receivable: Estimated discounting of future cash flow using the current
- - - - ----------------
rate at which similar loans would be made with similar credit risks and for the
same remaining maturities. The fair market value of employee notes cannot be
estimated due to their related party nature and terms.
Long-term debt: Estimated based upon current market borrowing rates for loans
- - - - --------------
with similar terms and maturities.
The estimated fair values of the Company's financial instruments are as follows:
1997 1996 1995
---------------------------- ---------------------------- ----------------------------
Carrying Amount Fair Value Carrying Amount Fair Value Carrying Amount Fair Value
Financial Assets:
Notes Receivable $ 398,830 $ 399,282 $ 245,176 $ 245,454 $ 116,657 $ 113,867
Financial Liabilities:
Long-Term Debt 5,600,163 5,633,745 6,418,930 6,456,849 9,399,557 9,491,658
12. PRO FORMA CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
The following unaudited pro forma condensed statements of operations are based
on the historical income statements of Lee Video City, Inc. and Prism
Entertainment Corporation and assumes the reorganization and merger took place
January 1, 1996 for the thirteen months ended January 31, 1997, January 1, 1996
for the year ended December 31, 1996 and January 1, 1995 for the year ended
December 31, 1995.
The unaudited pro forma condensed statements of operations may not be indicative
of the actual results of the merger and there can be no assurance that the
foregoing results will be obtained.
The following unaudited pro forma condensed statements of operations should be
read in connection with the historical financial statements of Lee Video City,
Inc. and Prism Entertainment Corporation.
38
(In thousands, except per share amount)
Thirteen Months Year Ended Year Ended
Ended December 31, December 31,
January 31, 1997 1996 1995
------------------ ---------------- ----------------
Revenue and product sales $ 13,582 $ 13,742 $ 29,805
Operating costs and expenses:
Store operating expenses 6,659 6,221 6,850
Amortization of videocassette
rental inventory 2,098 1,987 2,017
Cost of product sales 6,713 7,045 18,826
Cost of leased product 592 556 1,086
General & administrative 3,210 2,886 7,843
------------------ ---------------- ----------------
Total operating costs and expenses 19,272 18,695 36,622
Loss from operations (5,690) (4,953) (6,817)
Other (income) expense
Interest expense, net 665 573 688
Gain on disposition of assets (1,049) (1,049) -
Other (202) 80 (204)
------------------ ---------------- ----------------
Net loss $ (5,104) $ (4,557) $ (7,301)
================== ================ ================
Loss per share $ (0.52) $ (0.47) $ (0.75)
Weighted average number of shares 9,754 9,754 9,754
outstanding
Prism Entertainment Corporation's cost of sales includes approximately
$2,600,000 of amortization for the writedown of the film library due to the
revision of the film library ultimates for the thirteen months ended January 31,
1997, and for the year ended December 31, 1996 respectively and $4,500,000 for
the year ended December 31,1995.
39
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
In conjunction with the merger of Lee Video City, Inc. into Prism Entertainment
Corporation, the registrant's name was changed from Prism Entertainment
Corporation to Video City, Inc. BDO Seidman, LLP has been selected as the
independent certified public accountants for Lee Video City, Inc. for its fiscal
year ended December 31, 1996 and for Video City, Inc. for the fiscal year ended
January 31, 1997. BDO Seidman, LLP served as Prism Entertainment Corporation's
independent certified public accountants prior to the merger. KPMG Peat
Marwick, LLP served as Lee Video City, Inc.'s independent certified public
accountants for the fiscal years ending December 31, 1995 and 1994.
There were no disagreements with KPMG Peat Marwick, LLP and Lee Video City, Inc.
within the meaning of Item 304 of Regulation S-K on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedure in connection with the audit of Lee Video City, Inc.'s financial
statements for the fiscal years ended December 31, 1995 and 1994, or for the
subsequent interim period through January 1997, which disagreements if not
resolved to their satisfaction would have caused KPMG Peat Marwick, LLP to issue
an adverse opinion or disclaimer of opinion, or was modified as to uncertainty,
audit scope or accounting principles.
During the two most recent fiscal years, there have been no reportable events
(as defined in Item 304 or Regulation S-K) with KPMG Peat Marwick, LLP. Lee
Video City, Inc. has not consulted with BDO Seidman, LLP regarding the
application of accounting principles to a specified transaction or the type of
audit opinion that might be rendered on the financial statements during the two
most recent fiscal years through the date of the merger.
A letter of KPMG Peat Marwick, LLP addressed to the Securities and Exchange
Commission was included as Exhibit 11.0 to the form 8-K.
The change in auditors was approved by the Board of Directors of Video City,
Inc. in January 1997.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Directors are elected by the stockholders at the annual meeting and executive
officers are appointed by the Board of Directors.
DIRECTORS
---------
Director of Other Positions
Name Age Registrant Since with Company
- - - - ---- --- ---------------- ---------------
Robert Y. Lee 34 January 8, 1997 (1) Chief Executive Officer
Barry Collier 54 January 8, 1997 (1) President
James Craig Kelly 38 January 8, 1997 Chief Operating Officer
Steven E. Antongiovanni 39 January 8, 1997 Chief Financial Officer
and Secretary
Stephen C. Lehman 44 January 8, 1997 None
Gerald Weber 43 January 8, 1997 None
Charles Cooke 35 January 8, 1997 None
Michael Anderson 33 January 8, 1997 None
40
(1) See biographical summary below for prior service by Mr. Lee on the Board of
Lee Video City, Inc. and by Mr. Collier for prior service on the Board of Prism
Entertainment Corporation.
ROBERT Y. LEE purchased his first video store in 1983, and during the 1980's
opened and acquired more than 20 video stores in Southern California. In 1990,
Mr. Lee moved to Bakersfield, California and founded Lee Video City, Inc. to
exploit his secondary market growth strategy. He has been the Chairman of the
Board and Chief Executive Officer since Lee Video City, Inc. was founded. Mr.
Lee was elected Chairman of the Board of Video City, Inc. when Prism
Entertainment Inc. and Lee Video City, Inc. merged on January 8, 1997.
BARRY COLLIER was a director, President and Chief Operating Officer of Prism
Entertainment Corporation. from its inception. He served as Secretary from
Prism's inception until June 12, 1985, when he became Chief Executive Officer.
Mr. Collier served as Chairman of the Board from 1990-1994. As of the merger
between Prism and Lee Video City, Inc., Mr. Collier resigned as Chairman of the
Board and Chief Executive Officer and was elected President of Video City, Inc.
JAMES CRAIG KELLY joined Lee Video City in 1992 after 15 years with Wherehouse
Entertainment, a $500 million revenue retailer of music and video products.
From 1982 to 1984, Mr. Kelly was Director of Loss Prevention, and from 1984 to
1991, Mr. Kelly was Vice President and Regional Manager for Wherehouse.
STEVEN E. ANTONGIOVANNI is Chief Financial Officer of Video City. From 1980 to
1994, he was employed by Sun World International, Inc., an agribusiness with
annual revenues in excess of $225 million, where he rose from staff accountant
to Vice President and Assistant Controller. Mr. Antongiovanni joined the
Company as Chief Financial Officer in 1994. Mr. Antongiovanni was elected
Secretary on January 8, 1997.
STEPHEN LEHMAN has been President, Chief Executive Officer and Chairman of the
Board of Premiere Radio Networks, Inc., a producer of radio programming, since
its inception in January 1987. Prior to this, Mr. Lehman was President of
Stephen Lehman Productions, a syndicated radio program company while also
serving as on-air personality at KIIS AM and FM/Los Angeles. From 1982 to 1984,
he specialized in building radio networks for independent radio syndication.
GERALD WEBER is Senior Vice President of Retail Operations of AutoNation USA
where he is responsible for all AutoNation USA retail operations, including
sales, training, planning, hiring and loss prevention. Prior to joining
AutoNation USA, he was with Blockbuster Entertainment serving as President of
Blockbuster Music. During his employment with Blockbuster Entertainment, he
served in a number of management roles in the video retail division including
Zone Vice President of the East and Southeast Regions, Vice President of
Operations, and Senior Vice President of Domestic Retail.
CHARLES COOKE is a principal of Cooke & Grace Properties that owns, manages,
sells and leases commercial real property. From 1985 to 1994, Mr. Cooke was
affiliated with Dobson & Johnson, Inc. as a commercial real estate broker.
MICHAEL ANDERSON is a principal in the law firm of Troop, Meisinger, Steuber, &
Pasich, LLP, Los Angeles, California, where he specializes in commercial
litigation. Prior to joining this firm, Mr. Anderson was associated with the
law firm of DeCastro, West, Chodorow & Burns, and was also an associate at the
Boston Consulting Group, a management consulting firm.
41
EXECUTIVE OFFICERS
Officer
Name Age Office Since
- - - - ---- --- ------ -------
Robert Y. Lee 34 Chairman of the Board and
Chief Executive Officer January 8, 1997
Barry Collier 54 President January 8, 1997
James Craig Kelly 38 Senior Vice President and
Chief Operating Officer January 8, 1997
Steven E. Antongiovanni 39 Chief Financial Officer and
Secretary January 8, 1997
Rudy R. Patino 49 Chief Accounting Officer January 8, 1997
The Company, Robert Y. Lee, Barry Collier, and Ingram have entered into a
Stockholders Agreement dated as of January 8, 1997 which provides, among other
things, that the Company's Board of Directors shall consist of eight members,
and that Ingram, Mr. Lee and Mr. Collier shall vote their shares in favor of two
designees of Ingram, four designees of Mr. Lee and two designees of Mr. Collier.
Of the present Board of Directors, Messrs. Cooke and Anderson are the designees
of Ingram; Messrs. Lee, Kelly, Antongiovanni and Lehman are the designees of Mr.
Lee; and Messrs. Collier and Weber are the designees of Mr. Collier. The same
parties also entered into an Override Agreement dated November 19,1996 which
provides, subject to certain exceptions, that without the written consent of
Ingram, the Company shall not enter into a merger or a sale or transfer of all
or substantially all of its assets, or make any material change in the nature of
its business as now conducted, or change the form of organization of its
business; and that without unanimous approval of the Board of Directors, the
Company shall not enter into any line of business other than the sale and rental
of video product and related goods, the completion of one film that Prism had
under way, and the exploitation of Prism's film library; these provisions will
remain in force until the later of the payment in full of the Company's
$1,500,000 debt to Ingram, or such time as Ingram's beneficial ownership
interest in the Company's common stock, on a fully diluted basis, is 4% or less.
ITEM 11. EXECUTIVE COMPENSATION The following table sets forth information
concerning compensation paid (or earned by the named individuals) by the Company
for the thirteen months ended January 31, 1997 and the twelve months ended
December 31, 1995 and 1994 to individuals who were the chief executive officer
and the other executive officers of the Company during fiscal 1997 who earned
more than $100,000 (the "Named Executive Officers") for the last fiscal year:
42
SUMMARY COMPENSATION TABLE
Long Term
Compensation
Awards
Shares
Fiscal Salary ($) Bonus Underlying
Name and Principal Position Year Ended ($) Options
- - - - --------------------------------------------------------------------------------
Robert Y. Lee 1/31/97 186,891 - -
Chairman of the 12/31/95 203,935 - -
Board; Chief 12/31/94 153,958 - -
Executive Officer
Barry Collier (1) 1/31/97 315,432 - 175,000
President 12/31/95 436,645 - -
12/31/94 447,319 - -
James Craig Kelly 1/31/97 109,615 - 761,600
Senior Vice President; Chief 12/31/95 100,000 - -
Operating Officer 12/31/94 100,000 - -
Steven E. Antongiovanni 1/31/97 97,500 25,000 181,200
Chief Financial Officer; 12/31/95 90,000 - -
Secretary 12/31/94 N/A - -
(1) Barry Collier received his compensation for all three periods as an employee
of Prism Entertainment Corporation
COMPENSATION OF DIRECTORS
During the fiscal year ended January 31, 1997, directors of the Company who
were also officers did not receive any compensation for their services as
directors. For the fiscal year ending January 31, 1998, each director of the
Company other than those who are officers of the Company will be entitled to
receive $ 5,000 in cash and stock options to purchase 5,000 shares of Common
Stock of the Company at an exercise price of $2.00 per share.
EMPLOYMENT AGREEMENTS
Effective January 8, 1997, Robert Y. Lee entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity as Chairman of the Board and Chief Executive Officer. Mr.
Lee will receive a base salary of $178,000 per year and an annual bonus of 3% of
any pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing in 1997; 3% of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing in 1998; and 3% of any pre-tax profit in
excess of $1,300,000 with respect to the fiscal year commencing in 1999. Mr. Lee
is also entitled to certain fringe benefits including payment of up to $500 per
month for the use of one Company provided automobile.
Effective January 8, 1997, Barry Collier entered into an Employment
Agreement with the Company pursuant to which for a period of two years he will
serve in the capacity of President. He will receive a base salary of $178,000
per year. In addition, Mr. Collier is entitled to an annual bonus equal to 12%
of all annual revenues (net of commissions and expenses related thereto)
recorded in excess of $625,000 from the licensing and/or transfer of rights to
the Prism film library; an annual bonus equal to 5% of any promotional
advertising development funds from any external source in excess of $350,000
received by or credited to the Company; and a bonus equal to 20% of proceeds in
excess of $3,700,000 (net of commissions and expenses of sale) received by the
Company generated from the sale of the Company's film library in its entirety.
Mr. Collier is also entitled to certain fringe benefits including payment of up
to $500 per month for the use of one Company provided automobile.
Effective January 8, 1997, James Craig Kelly entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity of Senior Vice
43
President and Chief Executive Officer. Mr. Kelly will receive a base salary of
$120,000 per year and a bonus of 3% of any pre-tax profit in excess of
$1,100,000 with respect to the fiscal year commencing in 1997; 3% of any pre-tax
profit in excess of $1,200,000 with respect to the fiscal year commencing in
1998; and 3% of any pre-tax profit in excess of $1,300,000 with respect to the
fiscal year commencing in 1999. Mr. Kelly is also entitled to certain fringe
benefits including payment of up to $500 per month for the use of one Company
provided automobile.
In the event that the employment of any of the above individuals is
terminated for any reason other than "material breach" or "cause" as defined in
his Employment Agreement, the Company will pay the remainder of the base salary
to such individual for the remaining term of his employment agreement.
OPTION GRANTS IN FISCAL YEAR ENDED JANUARY 31, 1997
The following table sets forth all options to acquire shares of the
Company's common stock granted to the Named Executive Officers during fiscal
year ended January 31, 1997:
Percentage of Total
Options Granted to
Employees in Fiscal Exercise Price Expiration Date
Name Granted Year ($/share)
- - - - ---------------------------------------------------------------------------------------------------------------
Barry Collier 175,000 11.1% $0.10 1/7/07
James Craig Kelly 761,600 48.2% $0.51 1/7/02
Steven E. Antongiovanni 181,200 11.5% $1.03 1/7/02
All of the above options are nonqualified stock options and are exercisable in
full. None of these options have been exercised and their value at fiscal year
end, if any, cannot be estimated. Since there is currently no established
trading market for the Company's common stock, it is not possible to calculate
the potential realizable value of these options at assumed annual rates of 5%
and 10% stock appreciation over the current market value.
AGGREGATED OPTIONS/SAR EXERCISED IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTIONS/SAR VALUES
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SARs at Options/SARs
FY-End (#) at FY-End ($)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable Unexercisable
- - - - --------------------------------------------------------------------------------------------------------------------
Robert Y. Lee 0 0 0 0
Barry Collier 0 0 175,000 / 0 (1)
James Craig Kelly 0 0 761,600 / 0 (1)
Steven E. Antongiovanni 0 0 181,200 / 0 (1)
(1) Since there currently is no established trading market for the Company's
common stock, it is not possible to calculate the value of the unexercised
options.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Set forth below is information as of April 15, 1997, concerning the
ownership of the Company's common stock by (i) all persons or entities known to
the Company to be beneficial owners of more than 5% of the outstanding common
stock, (ii) each director of the Company, (iii) each of the Named Executive
44
Officers, and (iv) all executive officers and directors of the Company as a
group. Except as otherwise indicated and subject to applicable community
property and similar laws, each of the persons or entities named have sole
voting and investment power with respect to the securities owned.
Percentage of
Beneficial Owners (1) Number of Shares Class
- - - - -------------------------------------------------------- -------------
Robert Y. Lee 3,319,024 (2) 34.0%
Barry Collier 993,050 (3) 10.0%
James Craig Kelly 761,600 (4) 7.2%
Steven E. Antongiovanni 181,200 (5) 1.8%
Stephen C. Lehman - *
Gerald Weber - *
Charles Cooke - *
Michael Anderson - *
Ingram Entertainment Inc. 2,757,153 (6) 26.0%
Rentrak Corporation 522,750 (7) 5.3%
Young C. Lee and Kay L. Lee 500,000 (8) 5.1%
All officers and directors as a group 4,694,874 43.2%
(8 persons)
* Less than 1%.
(1) The address for each person listed in this table, except as otherwise
noted, is c/o Video City, Inc., 6840 District Boulevard, Bakersfield, California
93313. Mr. Lehman's address is c/o Premiere Radio Networks, Inc., 15260 Ventura
Boulevard, 5th Floor, Sherman Oaks, California 91403. Mr. Weber's address is
c/o AutoNation U.S.A., One Financial Plaza, Ft. Lauderdale, Florida 33394. Mr.
Cooke's address is c/o Cooke & Grace, 3309 Fairmont Drive, Nashville, Tennessee
37203. Mr. Anderson's address is c/o Troop Meisinger Steuber & Pasich, LLP,
10940 Wilshire Boulevard, Los Angeles, California 90024. Ingram Entertainment
Inc.'s address is Two Ingram Boulevard, La Vergne, Tennessee 37089. Rentrak
Corporation's address is P.O. Box 18888, Portland, Oregon 97218.
(2) Consists of 2,054,621 shares owned outright, of which 721,983 shares are
subject to restrictions on transfer pursuant to a lock-up agreement with Ingram;
404,403 shares which are held in escrow for a possible delivery to Ingram upon
exercise of a five-year warrant entitling Ingram to purchase such shares from
Mr. Lee; 250,000 shares which are held in an escrow subject to possible
cancellation of such shares if and as shares of the Company are issued upon
exercise of outstanding employee stock options; and 610,000 shares owned by
Barry Collier, as to which Mr. Collier has given Mr. Lee a ten-year irrevocable
proxy to vote such shares on all matters.
(3) Includes 818,050 shares owned outright by Mr. Collier, as to which he has
granted Robert Y. Lee a ten-year irrevocable proxy to vote 610,000 shares on all
matters; and a ten-year stock option to purchase 175,000 shares from the
Company.
(4) Consists of a currently exercisable stock option to purchase 761,600 shares
from the Company.
(5) Consists of a currently exercisable stock option to purchase 181,200 shares
of common stock from the Company.
(6) Consists of 1,500,000 shares owned outright by Ingram; a warrant to
purchase 404,403 shares from Robert Y. Lee; and a warrant to purchase 852,750
shares from the Company.
(7) Consists of a currently exercisable warrant to purchase 132,279 shares from
the Company; another warrant to purchase up to 341,141 shares from the Company,
of which Rentrak currently has the right to purchase 65,471 shares; and 325,000
shares owned by Mortco, Inc., a wholly owned subsidiary of Rentrak.
(8) Rev. and Mrs. Lee are the parents of Robert Y. Lee, the founder, Chairman
of the Board and Chief Executive Officer of the Company.
45
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Ingram Entertainment Inc. has been the principal supplier of videocassettes
and related equipment to the Company for a number of years, and has been a
secured creditor of the Company since August 1991. As of December 31, 1995, the
Company owed Ingram $7.3 million. This amount was paid down to $4.5 million in
June 1996 with proceeds derived from the Company's sale of eleven stores. On
January 8, 1997, concurrent with the merger of Lee Video City, Inc. into Prism,
Ingram accepted 1,500,000 shares of common stock of the Company in cancellation
of $3 million of the Company's indebtedness to Ingram, reducing the Company's
remaining long- term indebtedness to Ingram to $1.5 million. At the same time,
Ingram also received warrants to purchase 852,750 shares of common stock from
the Company and 404,403 shares of common stock from Robert Y. Lee. See Note 7 of
Notes to Financial Statements of the Company contained in this Form 10-K Report.
In addition, the Company entered into a new long-term supply agreement with
Ingram for videocassettes and related products; Ingram released Mr. Lee from his
personal guarantee of the Company's indebtedness; and the parties entered into
the Stockholders Agreement and the Override Agreement referred to in Item 10 of
this Form 10-K Report, which among other things prohibit certain corporate
actions without the approval of Ingram or Ingram's designees on the Board of
Directors. All of these transactions and arrangements were entered into either
simultaneously with or prior to Ingram's receipt of stock of the Company.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following financial statements required to be filed by Item 8 of this
form are contained herein as follows:
Reports of Independent Certified Public Accountants
Balance sheets
Statements of Operations
Statements of Stockholders' Deficit
Statements of Cash Flows
Notes to Financial Statements
(b) The following reports on Form 8-K and Forms 8-K/A have been filed during
the last quarter of the period ending January 31, 1997:
Merger of Lee Video City, Inc. into Prism Entertainment Corporation
Changes in registrant's certifying accountant
Financial statements of Lee Video City, Inc.
Pro forma financial information
Change in fiscal year
(c) See Exhibit Index located on pages 44 through 45.
Exhibit Page
Number Title Number
- - - - --------------------------------------------------------------------------------
2.1 Amended Plan of Reorganization of Prism
Entertainment Corporation ("Prism") dated
October 25, 1996 (1)
2.2 Agreement and Plan of Reorganization and Merger
dated as of October 25, 1996 with amendments,
between Prism and Lee Video City, Inc. (1)
46
3.1 Certificate of Incorporation of Registrant, as amended through
December 31, 1986 (2)
3.2 By-laws of Registrant, as amended to date (2)
4.1 Certificate of Merger of Lee Video City, Inc. into Registrant (1)
10.1 $1,500,000 Promissory Note of Registrant dated January 8, 1997,
payable to Ingram Entertainment, Inc. ("Ingram")
10.2 Amended and Restated Credit Loan and Security Agreement dated as of
January 8, 1997, between Registrant and Imperial Bank (1)
10.3 Override Agreement dated as of November 19, 1996 among Lee Video City,
Inc., Robert Y. Lee, Prism and Ingram (1)
10.4 Stockholders Agreement dated as of January 8, 1997 by and among the
Registrant, Robert Y. Lee, Barry Collier and Ingram
10.5 Supply Agreement dated January 8, 1997 between Ingram and Registrant
10.6 National Account Agreement dated December 16, 1994, as amended to
date, between Rentrak Corporation ("Rentrak") and Lee Video City,
Inc.
10.7 Escrow and Warrant Agreement dated as of January 8, 1997, granted by
Robert Y. Lee to Ingram to purchase 404,403 shares of common stock of
Registrant
10.8 Warrant dated as of January 8, 1997, to purchase 852,750 shares of
common stock, by Registrant to Ingram
10.9 Stock Purchase Warrant dated August 24, 1995 issued by Lee Video City,
Inc. to Rentrak
10.10 Stock Purchase Warrant dated June 19, 1996 issued by Lee Video City,
Inc. to Rentrak
10.11 Stock Purchase Warrant dated March 14, 1995 issued by Prism to
Imperial Bank
10.12 Employment Agreement dated January 8, 1997 between Registrant and
Robert Y. Lee
10.13 Employment Agreement dated January 8, 1997 between Registrant and
James Craig Kelly
10.14 Employment Agreement dated January 8, 1997 between Registrant and
Barry Collier
10.15 1996 Stock Option Plan of Lee Video City, Inc.
10.16 Stock Option Agreement dated January 8, 1997 between Registrant and
Barry Collier
10.17 Irrevocable Proxy dated January 8, 1997 given by Barry Collier to
Robert Y. Lee
27 Financial Data Schedule
47
(1) Exhibits 2.1, 2.2, 4.1, 10.2, and 10.3 were filed as Exhibits to
Registrant's Form 8-K Report dated January 8, 1997 and are each
incorporated herein by this reference.
(2) Exhibits 3.1 and 3.2 were filed as exhibits to Prism Entertainment
Corporation's Annual Report on Form 10-K for the fiscal year ended January
31, 1988 and are each incorporated herein by this reference.
(d) All financial statement schedules required by Form 10-K Annual Report have
been omitted because they were not applicable, were included in the notes to the
financial statements, or were otherwise not required under the instructions
contained in Regulation S-X.
48
SIGNATURE
---------
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.
Video City Inc.
--------------------
(Registrant)
By: /s/ Robert Y. Lee
-----------------------
Robert Y. Lee
Chief Executive Officer
By: /s/ Steven E. Antongiovanni
---------------------------
Steven E. Antongiovanni
Chief Financial Officer
Date: May 16, 1997
49