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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 31, 1999
OR
[ ] 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
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
370 Amapola Avenue, Suite 208, Torrance, California 90501
(Address of principal executive offices) (Zip Code)
(310) 533-3900
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of each 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 that 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
----- -----
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
----- -----
The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of May 10, 1999, was approximately $14,051,000.
The number of shares of common stock outstanding as May 10, 1999 was 13,846,936
shares.
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 or any amendment to this
Form 10-K. __________
Documents Incorporated by Reference
The registrant's definitive proxy statement for its Annual Meeting of
Stockholders which is anticipated to be filed within 120 days of January 31,
1999 is incorporated by reference in response to Part III of this Annual Report
on Form 10-K.
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Safe Harbor Statement under the Private Securities Litigation Reform Act of
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1995.
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This Annual Report contains forward-looking statements within the meaning of
the "safe harbor" provisions of the Private Securities Litigation Reform Act of
1995, such as statements of the Company's plans, objectives, expectations and
intentions, that involve risks and uncertainties that could cause actual results
to differ materially from those discussed in such forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in the section entitled "Special Considerations" as
well as those discussed elsewhere in this Annual Report.
PART I
ITEM 1. BUSINESS
General
Video City, Inc. ("Video City" or the "Company") owns and operates several
chains of retail video specialty stores and, measured in growth rates, was the
fastest growing publicly-held retail video specialty store company in the United
States in 1998. As part of its strategic plan of acquisition, during its fiscal
year ended January 31, 1999 ("fiscal 1999"), Video City grew from 18 stores in
California to a total of 128 video stores located in nine states. As of May 10,
1999, the Company owned and operated 137 video specialty stores in eleven
states. The Company has recently entered into an agreement to sell 50 of its
video stores located in the states of Washington and Oregon. See "--Recent
Developments."
The Company's predecessor, Lee Video City, Inc. ("Lee Video City"), was formed
as a California corporation in February 1990 for the purpose of developing a
chain of retail video specialty stores. In January 1997, Lee Video City, Inc.
merged with and into Prism Entertainment Corporation, a Delaware corporation
incorporated in January 1984 ("Prism"), and the surviving Delaware corporation
changed its name to "Video City, Inc." As a result of the Company's sale of its
library of 47 feature films and other film properties in March 1998, the
Company's sole business is the ownership and operation of video specialty
stores. The Company's principal executive offices are located at 370 Amapola
Avenue, Suite 208, Torrance, California 90501 and its telephone number is (310)
533-3900.
Developments During Fiscal 1999
During fiscal 1999, the Company acquired nine companies that owned and
operated an aggregate of 114 retail video stores. The consideration for the
acquisitions consisted of a combination of cash, capital stock of the Company,
promissory notes and the assumption by the Company of certain indebtedness and
liabilities of the companies being acquired, some of which were paid off by the
Company at the closings. Except for the acquisition of Video Tyme, Inc., Far
West Entertainment, Inc. and Game City, Inc., each of the acquisitions described
below was structured as a reverse triangular merger, with a newly formed
subsidiary of Video City merging into the acquired company. Video City acquired
all of the outstanding capital stock of Video Tyme, Inc. and substantially all
of the assets of Far West Entertainment, Inc. and Game City, Inc. The following
summarizes
2.
the acquisitions completed by the Company during fiscal 1999:
Acquired Companies Number of Stores States
- ------------------ ---------------- ------
Cianci's Videoland, Inc. 76 California, Idaho, Iowa, Oregon
South Dakota and Washington
Adventures in Video, Inc. 13 Minnesota
Video Tyme Inc. 6 Nevada
Leptis Magna, Inc. 5 Colorado
Sulpizio One, Inc. 4 California
Old Republic Entertainment, Inc. 4 California
KDDJ Investments, Inc. 3 California
Far West Entertainment, Inc. 2 California and Idaho
Game City, Inc. 1 California
The Company has recently entered into an agreement to sell 50 of its video
stores located in the states of Washington and Oregon. See "--Recent
Developments."
Recent Developments
Acquisition of Video Galaxy. On March 31, 1999, the Company acquired Video
Galaxy, Inc. ("Video Galaxy") from the shareholders of Video Galaxy, in a
transaction structured as a reverse triangular merger, with a newly formed
subsidiary of Video City merging into Video Galaxy. Video Galaxy owns and
operates 15 retail video stores in Connecticut and Massachusetts and had
aggregate revenues of approximately $5,800,000 during the year ended December
31, 1998. The purchase price consisted of (i) 360,667 shares of Video City
common stock (subject to post-closing adjustments, if any) and (ii) assumption
and payment of indebtedness of Video Galaxy by Video City in the amount of
$4,833,000 (of which approximately $1,757,000 was paid off by Video City at
closing and $2,000,000 was converted into shares of Video City preferred stock
and warrants). The payoff of indebtedness at closing was provided by cash
obtained from an existing creditor of the Company.
Sale of Certain Assets. On April 22, 1999 the Company entered into an Asset
Purchase Agreement with Blockbuster Inc. pursuant to which the Company has
agreed to sell to Blockbuster Inc. substantially all of the assets of 50 of the
Company's retail video stores located in the states of Washington and Oregon for
approximately $16 million in cash. The consummation of the sale is subject to
certain conditions, including satisfactory due diligence investigations by
Blockbuster Inc. and the receipt of certain governmental and other third-party
consents. The company anticipates using the net proceeds from the sale of the
assets to pay off certain of the Company's indebtedness and to finance future
acquisitions. There can be no assurances that the contemplated asset sale will
be consummated.
Industry Overview
Video Retail Industry. According to the Video Software Dealers Association
("VSDA"), a video
3.
retailing industry association, the videocassette rental industry grew
approximately 10% in 1998, reaching $8.1 billion in revenue, in sharp contrast
to recent years in which rental revenue was generally flat and industry growth
was driven by increases in product sales revenue. According to Paul Kagan
Associates, Inc. ("Paul Kagan"), a video industry analyst, the United States
video rental and sales industry grew from $9.8 billion in revenue in 1990 to
approximately $16.9 billion in 1998, and is expected to reach nearly $20.8
billion by 2002.
The video retail industry is highly fragmented and in recent years has been
characterized by increased consolidation as larger regional and national
"superstore" (video store that carries more than 7,500 units for rental or sale)
chains have continued to increase market share by opening new stores and
acquiring smaller, local operators. According to the VSDA, there were between
25,000 to 30,000 video specialty stores in operation during 1998. The Company
believes approximately 8,500 of these stores are "superstores." The Company
believes this consolidation will continue as the video retail industry evolves
from independent stores to regional and national superstore chains, fueled by
the competitive impact of superstores on smaller retailers, the need for
enhanced access to working capital and efficiencies of scale offered by such
superstore chains, the favorable revenue sharing and other copy depth
opportunities afforded to the regional and national chains, and the increased
marketing efforts of such regional and national chains.
Movie Studio Dependence on Video Retailing. According to Paul Kagan, the
video retail industry is the single largest source of domestic revenue to movie
studios and represented approximately $6.7 billion, or 48.5%, of the $13.8
billion of estimated domestic studio revenue in 1998. Of the many movies
produced and released by the major studios each year in the United States,
relatively few are profitable for the movie studios based on box office receipts
alone. The Company believes the consumer is more likely to view "non-hit"
movies on rented videocassette than in any other medium because retail video
stores provide an inviting opportunity to browse and make an impulse choice
among a very broad selection of new releases. As a result, retail video stores,
including those operated by the Company, purchase movies on videocassette
regardless of whether the movies were successful at the box office, thus
providing the major movie studios a reliable source of revenue for almost all of
the hundreds of movies produced each year. Consequently, the Company believes
movie studios are highly motivated to protect this unique and significant source
of revenue.
Rentals versus Sales. Although the video retail industry includes both
rentals and sales, the consumer market for prerecorded videocassettes 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 $24 ("sell-
through titles"), are purchased by video specialty stores and are generally
promoted as both rental and sale titles. In general, movie studios attempt to
maximize total revenue from videocassette releases by combining the release of
most titles at a high price point to encourage purchase for the rental market,
with the release of a relatively few major hits or animated children's classics
at sell-through pricing to encourage purchase directly by the consumer at
retail. Video specialty stores will purchase sell-through titles for both the
rental market and for retail sale. Titles released at a high price are re-
released at a lower price six months to one year after the initial release to
promote sales directly to consumers. According to Paul Kagan, video rental
revenue has increased from $7.4 billion in 1997 to $8.1 billion in 1998 and is
expected to increase to $9.7 billion in 2002.
Revenue Sharing. In 1998 a number of studios and video retailers adopted
revenue sharing as an alternative to the historical rental pricing structure.
Studios began offering retailers more videocassettes for an individual title at
substantially lower initial cost in exchange for a share of the rental revenue
that those copies generate over their initial release window. This has led to
higher rental revenues for the video industry as well as for the studios. In
addition, revenue sharing provides the studios an incentive to market these
titles which improve revenue generated by increased transactions for both the
video industry and the studios.
4.
Business Strategy
Superstore Format. The Company focuses on acquiring, building and operating
retail video superstores. The Company believes a superstore is the most
commercially viable format for video stores at most locations. The broader
selection of titles and greater availability of popular new releases of a
superstore generate enough customer traffic to make it economically viable to
lease optimal locations that may demand higher lease rates. Because many store
operating expenses, including labor costs, are substantially fixed regardless of
the size of a store, operating expenses are proportionately lower in the larger
superstore format as compared to a smaller store.
Selection, Availability and Customer Service. The Company's goal is to offer
a more complete selection and greater availability of popular new releases in an
effort to be the customers' preferred store. The Company believes that certain
of the Company's promotional strategies such as the periodic guaranteeing of the
availability of a popular new release at its stores have been successful in
attracting and retaining its customers. The Company permits its customers to
return a videocassette to any of its other store locations and hence provides a
convenience not available in other video store chains. In addition, the
Company's goal is to place great emphasis on offering its customers excellent
service to encourage repeat visits. The Company uses demographic and historical
rental data to determine the selection and quantity of videos that will best
meet the demands of customers in particular regions or neighborhoods.
Centralized Real-Time Management. All of the stores' point-of-sale system is
directly connected to the Company's centralized management information system
through Internet technology to provide real-time communication and feedback from
them to the Company's headquarters in Torrance, California. Such system allows
real-time monitoring of sales and inventory, and allows the Company to actively
manage its new videocassette purchases and monitor customer demand. The Company
periodically redistributes its inventory of videocassettes among its stores to
fulfill customer demand without making excessive purchases of popular titles.
Store Location and Marketing. Most of the Company's superstores are located
in high traffic areas providing high visibility and easy access for its
customers. The Company believes excellent customer service, a bright, clean and
friendly shopping environment and convenient store locations are important to
it's success. The Company advertises through local television, radio, newspaper
and direct mail, and promotes its products through various special programs.
Growth Strategy
Development Program. In many regions, the Company believes there are
significant opportunities to grow through internal development and the opening
of new stores. Such internal growth will be the means of expansion in
attractive market areas where there are no strong acquisition candidates and
where good locations are still available. Before the completion of the
acquisitions in fiscal 1999, the opening of new stores had fueled most of the
Company's growth. The Company 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
industry presents the opportunity to acquire strategically located chains that
are market share leaders in their trade areas. As part of the Company's
acquisition strategy the Company acquired 114 video stores in fiscal 1999 and 15
video stores in March 1999. See "--Developments During Fiscal 1999," "--Recent
Developments" and "--Store Operations and Locations." The Company believes that
acquiring such clusters of stores can be the most cost-effective means of
entering an area, particularly where the acquired chain already occupies
desirable locations. The purchase of an existing chain enables the Company to
immediately utilize the assets of the acquired chain and thus to have an
immediate revenue stream. Also, existing chains have an established customer
base that tend to reduce the Company's
5.
advertising expenses. Through a combination of volume purchase discounts, larger
advertising credits, more efficient inventory management and centralized
management, the Company believes it is generally able to operate these acquired
stores more profitably than their prior owners, who were typically single store
or small chain operators. 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.
Future store acquisitions, if any, will be pursued as attractive opportunities
become available. Such acquisitions will be based upon location, quality of
operations and financial criteria as determined by the Company to be consistent
with its growth strategy. In future acquisitions, the Company anticipates that
some of the key employees of the acquired companies will be employed by the
Company.
Geographic Concentration. The Company's strategy is to concentrate its
expansion, whether through new store development or acquisitions, in a
particular geographic area to maximize operating efficiencies. The Company
believes that geographic concentration allows the Company to achieve operating
efficiencies in inventory management, marketing and advertising, distribution,
training and store supervision. Although the Company is not currently targeting
any particular geographic area for expansion, the Company's strategy is to move
into a new geographic area if there exists an opportunity to realize certain
levels of revenues and cash flow from that particular market.
New Products. The Company continues to offer new products to achieve
competitive results and generate additional revenue in each of its stores. In
December 1997, the Company introduced digital video discs ("DVDs") at its
stores.
The Company's growth is dependent on a number of factors, including its
ability to hire, train and assimilate management and store-level employees, the
adequacy of the Company's financial resources, the Company's ability to
successfully compete in the new markets, to locate suitable store sites, to
negotiate acceptable lease terms, to adapt its purchasing, management
information and other systems to accommodate expanded operations and to
assimilate the new operations into the existing operations of the Company.
There is no assurance that the Company will be able to achieve continued
growth or that the Company will be profitable as a result of such growth.
Continued growth will place increasing pressure on the Company's management. A
failure to manage successfully its planned growth would adversely affect the
Company's business. There is also no assurance that the Company's newly
developed or acquired stores will achieve sales and profitability comparable to
the Company's existing stores. See "--Special Considerations--Growth Strategy."
Products
Videocassette Rental. The Company's primary revenue source is from the rental
of videocassettes. Each of the Company's stores currently offers from 6,000 to
17,000 videocassettes consisting of from 4,000 to 10,000 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. Other videocassettes are displayed alphabetically by title within
categories such as "Action," "Comedy" and "Drama." The Company is committed to
offering as many copies of new releases as necessary to be competitive within
its markets. Promotional strategies that the Company believes have been highly
successful include (i) the limited time guarantee of the availability of a
popular new release, (ii) allowing customers to reserve certain video titles up
to one week in advance, and (iii) allowing customers to rent and return
videocassettes at any of the Company's stores.
Videocassette Sales. The Company 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.
6.
Video Games. Each of the Company's stores offers from 300 to 1,000 video game
cartridges, consisting of 250 to 600 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. Video game rentals
improved in 1997 and 1998 based on consolidation of formats by the major
suppliers. The Company anticipates growth of its video game business and
broadening its selection of game cartridges to include successful new formats as
they become available and grow in popularity.
Digital Video Discs. DVDs are an alternative format to VHS tapes that offer
consumers digital picture and sound and additional features such as enhanced
content and interactivity. The DVD format was introduced in late 1997, and since
then more than 1.3 million DVD players have reportedly been sold. The Company
began its rollout of the DVD format in its stores in December 1997 and currently
carries the format in approximately 47 percent of its stores. The company
anticipates the format will be available chain wide by January 31, 2000. DVDs
have shown to be the fastest growing new category introduced by the Company due
to increased interest in older movie titles as a result of the substantial
improvement in picture and sound quality over VHS.
Other Products. In addition to videocassette rentals and sales, video game
rentals and DVDs, the Company's stores also rent videocassette players, video
game players, digital video discs, laser discs and audio books in selected
stores and sell a variety of video accessories and confectionery items.
Store Operations and Locations
The Company's stores range in size from 2,125 square feet to 13,690 square
feet and offer between 6,000 to 14,000 videocassettes consisting of from 4,000
to 10,000 different titles. The Company's superstores feature television
monitors showing movie previews and promotions of coming attractions and
displays posters and stand-up displays promoting movie titles. The Company's
stores are open 365 days a year from 10:00 a.m. to 11:00 p.m.
The Company's management has substantial experience in the video retail
industry, including specific expertise in the various geographical areas in
which the Company operates its stores. The Company's management actively
monitors the inventory, pricing and rental period of movie titles through its
real-time management information system. The new release inventory is actively
managed, including the redistribution of certain copies to other stores to meet
greater demand. The Company does not consider backlog meaningful to its
business.
The following table provides the number of stores in each of the states in
which the Company owned and operated retail video stores as of May 10, 1999:
Number of
State Stores
------------- ---------
Oregon 32
California 30
Washington 22
Connecticut 14
Idaho 9
Minnesota 9
Nevada 7
Iowa 6
Colorado 4
7.
Maine 2
South Dakota 1
Massachusetts 1
---------
Total 137
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The Company has recently entered into an agreement to sell 50 of its video
stores located in the states of Washington and Oregon. See "--Recent
Developments."
Suppliers
The Company has supply agreements with its two major suppliers, Ingram
Entertainment, Inc. ("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. The Ingram supply agreement expires
on June 30, 2001 unless terminated earlier by Ingram. 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
10% of total gross rental revenues. The Rentrak revenue sharing agreement
expires on 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.
Inventory Management and Management Information Systems
Inventory Management. The Company maintains an extensive inventory control
system to assist management in decisions involving purchase, distribution and
disposition of videocassettes and game cartridges. Each videocassette and game
cartridge is placed in a clear protective case which is affixed with a magnetic
security device and an optical bar code. The Company conducts physical
inventories on a quarterly basis. The inventory of videocassettes is
redistributed among the various store locations based on demand at certain
locations.
Management Information Systems. It is critically important in video retailing
to have accurate and timely information relating to videocassette rentals and
sales, individual title performance, customer demographics, shrinkage, overdue
rentals and various other financial and operational data. Video City began
development of a sophisticated management information system in early 1992 and
fully 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. The management information system
electronically communicates real-time data from the POS system of all of the
Company's stores and makes the daily sales, inventory and other data immediately
available to the Company's management. The Company then uses the data to manage
inventory and monitor customer demand and rental trends to maximize each store's
profitability. The data also provides individual customer and demographic
information which is used for direct marketing to these customers, and is also
used for audit and loss prevention purposes. This POS system 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.
Each of the Company's stores' POS system is linked via the Internet to a
central office computer enabling all product and customer data to be shared
real-time. This sharing allows product to be rented from one store and
8.
returned to another while tracking the product through the system. The Company
believes it is the only major chain of superstores that 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.
Marketing and Advertising
The Company advertises through television, radio, newspaper and direct mail.
Suppliers and movie studios provide advertising credits and market development
funds for certain movie titles that the Company uses to purchase the television,
radio, and newspaper advertising. Although there can be no assurance, the
Company believes that its suppliers and the movie studios will continue to
provide funds for the Company's advertising expenditures through advertising
credits 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 specific 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. The Company believes that these promotional marketing
strategies have helped increase market share and customer loyalty.
Competition
The video retail industry is highly competitive. The Company competes with
other local, regional and national chains, such as Blockbuster Inc. and
Hollywood Entertainment Corporation ("Hollywood Entertainment"), and with
supermarkets, mass merchants, mail order companies and other retailers. Some of
the Company's competitors have significantly greater financial and marketing
resources and name recognition, although the Company is generally the largest or
second largest video retailer in most of its geographic markets.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of popular titles available, customer service, and, to a lesser extent,
pricing. Approximately 35 percent of the Company's stores compete directly with
stores operated by Blockbuster and/or Hollywood Entertainment, many in very
close proximity. As a result of direct competition with Blockbuster, Hollywood
Entertainment and others, rental pricing of videocassettes and greater
availability of new releases may become a more significant competitive factor in
the Company's business, which could have an adverse impact on the results of
operations of the Company.
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.
Existing pay-per-view services offer a limited number of channels and movies and
are only available to households with a direct broadcast satellite or a cable
converter to unscramble incoming signals. 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. Certain cable and other telecommunications companies have
tested "video on demand" service in some markets. Video on demand service would
allow a viewer to pause, rewind and fast forward movies. Based upon publicly
available information, the Company believes these tests have been unsuccessful.
The Company also believes movie studios have a strong interest in maintaining a
viable movie rental business because the sale of videocassettes to video retail
stores 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.
9.
Seasonality
The video retail industry generally experiences relative revenue declines in
April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
Service Marks
The Company owns a United States federal registration for its service mark
"Video City." The Company considers its service mark to be important to its
continued success.
Employees
As of January 31, 1999 the Company had approximately 1,096 employees of whom
approximately 1,055 were located at the retail stores and the remainder were at
the Company's corporate administrative office. Due to recent acquisitions, as
of March 31, 1999, the Company had approximately 1,560 employees of whom
approximately 1,516 were located at the retail stores and the remainder were at
the Company's corporate administrative office. The Company is not currently a
party to any collective bargaining agreements. The Company believes that its
relationships with its employees are generally good.
SPECIAL CONSIDERATIONS
In addition to the other information set forth in this Annual Report, persons
who may own or intend to own securities of the Company should carefully consider
the following special considerations:
Growth Strategy
The Company's long-term strategy is to grow primarily through acquisitions of
existing stores and secondarily through new store openings. The successful
acquisition of existing stores and opening of new stores depends on numerous
conditions, some of which are described below, and requires significant amounts
of capital and other resources. In the past, the Company's growth strategy has
been funded through proceeds from bank debt, seller financing, cash from
operations and use of the Company's common stock as acquisition consideration.
The Company currently intends to finance future acquisitions and new store
openings with funds from borrowings, including the Company's credit facility
through assumption of liabilities by the Company and net proceeds from the sale
of debt or equity financing. There can be no assurance that these and other
sources of capital will be available to the Company in the future in order for
the Company to pursue its growth strategy.
The Company's growth is dependent on a number of factors, including its
ability to hire, train and assimilate management and store-level employees, the
adequacy of the Company's financial resources, the Company's ability to
successfully compete in the new markets, to locate suitable store sites, to
negotiate acceptable lease terms, to adapt its purchasing, management
information and other systems to accommodate expanded operations and to
assimilate the new operations into the existing operations of the Company.
There can be no assurance that the Company will be able to achieve continued
growth or that the Company will be profitable as a result of such growth.
Continued growth will place increasing pressure on the Company's management.
The failure to manage successfully its planned growth would adversely affect the
Company's business. There can be no assurance that the Company's newly
developed or acquired stores will
10.
achieve sales and profitability comparable to the Company's existing stores.
Acquisitions
The Company's ability to grow through acquisitions and operate the acquired
stores at the desired levels of sales and profitability depends on many factors,
including the Company's ability to identify new markets in which to successfully
compete, the availability of suitable acquisition candidates at prices that the
Company considers reasonable, the Company's ability to integrate the acquired
stores into the Company's existing operations and the Company's ability to
manage the expansion into the new markets. Certain of the Company's larger,
better-capitalized competitors may seek to acquire some of the same video
specialty stores that the Company seeks to acquire. Such competition for
acquisitions would be likely to increase acquisition prices and related costs
and result in fewer acquisition opportunities, which could have a material
adverse effect on the Company's growth. Moreover, there can be no assurance
that the Company will be able to fully integrate the acquired stores' systems
into the Company's existing systems and procedures, or that once integrated, the
Company's acquired stores will achieve levels of revenues or profitability
comparable to those achieved by the Company's existing operations, or otherwise
perform as expected. The inability of the Company's acquired stores to achieve
the level of revenues and cash flow desired by the Company will have a material
adverse effect on the Company's financial condition and results of operations.
New Store Openings
The Company's growth through new store openings depends on the Company's
ability to identify suitable store sites, its ability to compete effectively
against competitors for such sites, its ability to negotiate satisfactory leases
and implement cost-effective development plans for such new stores and its
ability to hire, train and assimilate new store managers and other personnel.
There can be no assurance that the Company can successfully pursue its growth
strategy through new store openings or that any of the Company's future new
stores will achieve levels of revenues or profitability comparable to those
achieved by the Company's existing stores.
Ability to Manage Growth
The Company is currently experiencing a period of rapid growth and expansion.
The Company acquired 114 video stores during the fiscal year ended January 31,
1999 and may consummate additional acquisitions in the future. Such growth and
expansion has placed and will continue to place a significant strain on the
Company's management, services and support operations, administrative personnel
and other resources. The Company's ability to manage such growth effectively
will require the Company to continue to improve its operational, management and
financial systems and controls and to hire, train, motivate and manage its
employees. In addition, the Company may be unable to retain or hire the
necessary personnel or acquire other resources necessary to service such growth
adequately. There can be no assurance that the Company will be able to
effectively manage this rapid growth and expansion. In the event the Company is
unable to effectively manage its growth and expansion, there may be a material
adverse effect on the Company's business and results of operations.
Competition and Technological Obsolescence
The video retail industry is highly competitive. The Company competes with
other local, regional and national chains, such as Blockbuster and Hollywood
Entertainment, and with mass merchants, mail order companies and other
retailers. Some of the Company's competitors have significantly greater
financial and marketing resources and name recognition, although the Company is
generally the largest or second largest video retailer in most of its geographic
markets.
11.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of popular titles available, customer service, and, to a lesser extent,
pricing. Approximately 35 percent of the Company's stores compete directly with
stores operated by Blockbuster and/or Hollywood Entertainment, many in very
close proximity. As a result of direct competition with Blockbuster, Hollywood
Entertainment and others, rental pricing of videocassettes and greater
availability of popular releases may become a more significant competitive
factor in the Company's business, which could have an adverse impact on the
results of operations of the Company.
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.
Existing pay-per-view services offer a limited number of channels and movies and
are only available to households with a direct broadcast satellite or a cable
converter to unscramble incoming signals. 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. Certain cable and other telecommunications companies have
tested "video on demand" service in some markets. Video on demand service would
allow a viewer to pause, rewind and fast forward movies. Based upon publicly
available information, the Company believes these tests have been unsuccessful.
However, technological advances or changes in the manner in which movies are
marketed, including in particular the earlier release of movie titles to pay-
per-view, including direct broadcast satellite, cable television or other
distribution channels, could make these technologies more attractive and
economical, which could have a material adverse effect on the business of the
Company. See "--Competition."
Fluctuations in Operating Results
The Company has experienced in the past, and may continue to experience in the
future, fluctuations in its operating results. Future operating results may be
affected by many factors, including the performance of new or acquired stores,
the quality and number of new release titles available for rental and sale and
the expense associated with the acquisition of new release titles, one-time
charges associated with acquisitions or other events, changes in comparable
store revenue, additional and existing competition, marketing and advertising
programs, weather, special or unusual events, seasonality and other factors that
may affect retailers in general. See "--Seasonality." No assurance can be
given that the Company will have positive earnings in any quarter, or that
earnings in any particular quarter will not fall short of either a prior fiscal
quarter or investors' expectations.
Reliance on Certain Suppliers
The Company either purchases or leases approximately 80% of its supply of new
release videos, in the aggregate, from two suppliers, Ingram and Rentrak. 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. Failure to obtain comparable service,
support or payment terms from an alternative supplier could have a material
adverse effect on the Company's financial condition and results of operations.
Dependence on Key Personnel
The Company's business and operations are dependent on the continued efforts
of Robert Y. Lee, its Chairman of the Board and Chief Executive Officer, and its
other executive officers. If any of these individuals become unwilling or unable
to continue their employment or association with the Company, or if the Company
is
12.
unable to attract and retain other skilled employees when needed, the Company's
business could be materially, adversely affected. The Company maintains a key
person life insurance policy on Robert Y. Lee.
Stock Price Volatility
In recent years, the stock market has experienced significant price and volume
fluctuations. These fluctuations, which are often unrelated to the operating
performances of specific companies, have had a substantial effect on the market
price of stocks, particularly for many small capitalization companies.
Accordingly, the factors described in this Special Considerations section or
market conditions in general may cause the market price of the Company's Common
Stock to fluctuate, perhaps substantially.
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. See
"Business -- Store Operations and Locations."
The Company leases its corporate headquarters located in Torrance, California
pursuant to a lease with an initial term expiring September 2002. This facility
consists of approximately 9,300 square feet of office space. The Company
considers its corporate offices and stores to be generally suitable and adequate
for their intended purposes.
The Company's corporate headquarters were relocated from Bakersfield,
California to Torrance, California during November 1998. The Company will
continue to lease the Bakersfield facility as a regional office primarily for
various support staff and storage until the expiration of the lease in January
2000.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company submitted no matters to a vote of stockholders during the fourth
quarter of the fiscal year ended January 31, 1999.
13.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Lee Video City was privately held until its merger with and into Prism on
January 8, 1997. Prism's common stock did not have an established public
trading market at the time of the merger. Commencing in February 1998, the
Company's Common Stock has traded on the NASD Electronic Bulletin Board under
the symbol "VDCT." See "Business--General."
The following sets forth for the periods indicated the high and low last sale
prices of the Company's Common Stock as reported on the NASD Electronic Bulletin
Board:
High Low
Fiscal Year Ended January 31, 1999:
First Fiscal Quarter $1.500 $.250
Second Fiscal Quarter $1.500 $.656
Third Fiscal Quarter $1.000 $.200
Fourth Fiscal Quarter $1.937 $.375
Such over-the-counter market quotations reflect inter-dealer prices, without
retail mark-up, mark-down or commission and may not necessarily represent actual
transactions.
As of May 10, 1999, there were approximately 540 record holders of the
Company's Common Stock.
The Company has not paid cash dividends on its Common Stock since its
inception and has no current plans to pay dividends on its Common Stock in the
foreseeable future. The Company intends to reinvest future earnings, if any, in
the development and expansion of its business. The Company's current credit
facility prohibits the payment of dividends on the Company's Common Stock. Any
future determination to pay dividends will depend upon the Company's combined
results of operations, financial condition and capital requirements and such
other factors deemed relevant by the Company's Board of Directors.
Recent Sales of Unregistered Securities
On December 1, 1998, the Company issued warrants to purchase an aggregate of
105,000 shares of the Company's Common Stock to three consultants as
consideration for certain consulting services provided to the Company. All of
the warrants were exercisable at $2.00 per share.
On December 28, 1998, the Company issued a total of 76,000 shares of the
Company's Series B Convertible Redeemable Preferred Stock ("Series B Preferred
Stock") to Victor J. Cianci and Evvy R. Cianci as part of the consideration for
the acquisition of Cianci's Videoland, Inc ("Videoland"). The shares of Series B
Preferred Stock are convertible at a conversion price of $3.1667 per share. On
December 28, 1998, the Company also issued 25,000 shares its Common Stock to the
Company's financial advisor as part of the compensation for financial advice
rendered in connection with the acquisition.
14.
On January 31, 1999, the Company issued a total of 24,497 shares of its Common
Stock to two of the Company's vendors in satisfaction of approximately $49,000
owed to such vendors by the Company.
The Company believes that the issuance of securities in each of the foregoing
transactions were exempt from registration in reliance on Section 4(2) of the
Securities Act of 1933, as amended, as a transaction not involving a public
offering.
Effective as of January 31, 1999, the Company issued 7,000 shares of its
Series AA Convertible Redeemable Preferred Stock to the holders of the Series A
Convertible Redeemable Preferred Stock in exchange for an equivalent number of
previously outstanding shares of the Company's Series A Convertible Redeemable
Preferred Stock. The Company believes that the exchange was exempt pursuant to
Section 3(a)(9) of the Securities Act of 1933, as amended.
15.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended January
31, 1999 and 1998 and December 31, 1996, 1995, and 1994 have been derived from
the financial statements. As a result of the reverse acquisition of Prism, the
Company changed its fiscal year from December 31 to January 31 effective
February 1, 1997. The information set forth below should be read in conjunction
with the "Management's Discussion and Analysis of Financial Condition and
Results of Operation" and the Company's financial statements and notes thereto.
Month
ended
Year ended January 31, January 31, Year ended December 31,
1999 1998 1997 1996 1995 1994
----------- ----------- ----------- ------- ------- -------
STATEMENT OF OPERATIONS DATA: (In thousands of dollars, except per share and operating data)
Revenues............................... $24,436 $10,212 $ 940 $11,441 $14,151 $13,164
Operating income (loss)................ (1,263) (2,423) (105) (418) 285 (379)
Net income (loss)...................... 11 (2,976) (133) (43) (586) (1,310)
Net income (loss) per share............ 0.00 (0.30) (0.03) (0.01) (0.14) (0.32)
Weighted average shares used
in computation........................ 12,091 9,771 4,569 4,234 4,127 4,080
OPERATING DATA:
Number of stores at end of period...... 128 18 18 18 29 20
Increase (decrease) in same store
revenues(1)........................... 1.6% 4.4% (1.2)% (1.9)% 5.2%
January
January 31, 31, December 31,
1999 1998 1997 1996 1995 1994
----------- ----------- ----------- ------- ------- -------
BALANCE SHEET DATA: (In thousands of dollars, except per share and operating data)
Cash and cash equivalents.............. $ 172 $ 28 $ 1,247 $ 59 $ 418 $ 93
Videocassette rental inventory......... 21,120 2,795 2,127 2,189 3,354 3,529
Total assets........................... 38,253 6,599 11,080 4,010 7,335 7,705
Credit facility........................ 16,045 - - - - -
Long-term debt, less current portion... 1,637 2,043 3,341 5,804 7,954 9,028
Total liabilities...................... 32,985 7,298 8,844 8,167 11,449 11,458
Stockholders' equity (deficit)......... 5,267 (699) 2,236 (4,157) (4,114) (3,753)
_____________
(1) The increase (decrease) in same store revenues compares revenues from
stores opened and owned by the Company for twelve full months. (Including
relocations)
16.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with the Company's
financial statements and the related notes thereto and the other financial
information included elsewhere in this Annual Report. When used in the
following discussions, the words "believes", "anticipates", "intends", "expects"
and similar expressions are intended to identify forward-looking statements.
Such statements are subject to certain risks and uncertainties, which could
cause actual results to differ materially from those projected, including, but
not limited to, those set forth in "Business--SpecialConsiderations." Readers
are cautioned not to place undue reliance on forward-looking statements, which
speak only as of the date hereof.
Overview
Corporate History. Lee Video City opened its first video superstore in
1990. The Company owned and operated 29 superstores from the end of 1994 until
June 1996 when it sold its eleven stores outside of California. The eleven
stores were sold to reduce debt and restructure Lee Video City's operations by
focusing its attention on the "core stores" in California. On January 8, 1997,
Lee Video City merged with and into Prism. Prism had 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. Upon consummation of the merger, the surviving Delaware corporation
changed its name to "Video City, Inc." See "Business--General." Prior to the
merger, Lee Video City's fiscal year ended on December 31. After the merger,
the Company retained Prism's year-end of January 31.
General Business. The Company's revenue consists primarily of rental
revenue and product sales revenue. Rental revenue includes revenue from rentals
of videos, video games, video players and video game machines and extended
viewing fees. Product sales revenue are derived from sales of new and used
videocassettes, 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. Effective February 1,
1998, the Company adopted a new method for amortizing its base stock (copies one
through three of each title per store) of rental videocassettes. Base stock is
now amortized over a 60 month period on a straight-line basis to a salvage value
of $6 per tape, whereas prior to the change, base stock was amortized over a 36
month period on a straight-line basis to a salvage value of $6 per tape. The
new method of amortization was adopted because the Company believes that
decelerating expense recognition for its base stock more accurately matches its
revenue stream and useful economic life. The fourth through ninth copies of
each title per store are amortized over a 36 month period on an accelerated
basis to a salvage value of $6 per tape. The tenth and any succeeding copies of
each title per store are amortized over 9 months on a straight-line basis to a
salvage value of $6 per tape. The method for amortizing copies four and any
succeeding copies of each title per store has remained the same. The effect of
the change on base stock amortization for the year ended January 31, 1999 was a
reduction of amortization of videocassette rental inventory of approximately
$570,000.
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 videocassette. During the revenue
sharing
17.
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.
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.
Year Ended Year Ended Year Ended
January 31, January 31, December 31,
1999 1998 1996
----------- ----------- ------------
Revenue 100.0% 100.0% 100.0%
Operating costs and expenses:
Store operating expenses 56.0% 43.7% 55.9%
Amortization of videocassette rental
Inventory 10.4% 18.9% 17.4%
Cost of product sales 13.5% 7.5% 13.6%
Cost of leased product 5.7% 4.1% 4.9%
General and administrative 19.6% 19.9% 12.0%
Nonrecurring writedown of Film Library 29.7%
Total Operating costs and expenses: 105.2% 123.7% 103.7%
Operating income (loss) (5.2)% (23.7)% (3.7)%
Non-operating expenses 5.5% 5.4% 3.3%
Loss before income taxes (10.7)% (29.1)% (0.4)%
Number of stores open at end of period 128 18 18
Weighted average number of stores 51 18 22
18.
Year Ended January 31, 1999 Compared to Year Ended January 31, 1998
Revenues. Revenues for the fiscal year ended January 31, 1999 increased
$14,224,000 or 139%, to $24,436,000 compared to $10,212,000 for the fiscal year
ended January 31, 1998 ("fiscal 1998"). The increased revenues were primarily
attributable to the acquisition of 114 stores during fiscal 1999. Same store
revenues for fiscal 1999 increased by approximately 1.6% compared to fiscal
1998. The Company ended fiscal 1999 with 128 stores operating in 9 states
compared to 18 stores operating in California at the end of fiscal 1998.
Management fee income for fiscal 1999 totaled $607,733 compared to $205,000 for
fiscal 1998. The increase was mainly due to the management fees earned from
managing Videoland's stores for the 10 weeks prior to its acquisition.
Store Operating Expenses. Store operating expenses for fiscal 1999
increased $9,215,000, or 207%, to $13,675,000 compared to $4,460,000 for fiscal
1998. The increase was primarily attributable to acquisition of 114 stores
during fiscal 1999. Store operating expenses as a percentage of total revenues
were 56.0% for fiscal 1999 compared to 43.7% for fiscal 1998. The increase in
store expenses as a percentage of total revenue for fiscal 1999 was primarily
due to assimilation, payroll, training, and inventory expenses related to the
acquired stores.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for fiscal 1999 increased $614,000 or 31.8%, to
$2,542,000 compared to $1,928,000 for fiscal 1998. The primary reason for the
increase was the addition of 114 stores acquired during fiscal 1999, partially
offset by the effect of a change in the amortization period for base inventory
(copies 1-3) from 36 months to 60 months. Amortization of videocassette rental
inventory as a percentage of total revenue was 10.4% in fiscal 1999 compared to
18.9% in fiscal 1998. The decrease was primarily due to the Company purchasing a
lower proportion of purchased videocassettes versus leased videocassettes in
fiscal 1999 compared to fiscal 1998.
Cost of Product Sales. The cost of product sales for fiscal 1999 increased
$2,539,000 or 333%, to $3,301,000 compared to $762,000 for fiscal 1998. This
increase was directly attributable to aggregate growth in product sales of 262%
in fiscal 1999 compared to fiscal 1998.
Cost of Leased Product. Cost of leased product for fiscal 1999 increased
$975,000 or 233%, to $1,394,000 compared to $419,000 for fiscal 1998. The
increase was primarily attributable to the Company acquiring 114 stores during
fiscal 1999. Cost of leased product as a percentage of total revenue was 5.7%
in fiscal 1999 compared to 4.1% in fiscal 1998. The increase as a percentage of
total revenue was due to the higher proportion of leased videocassettes versus
purchased videocassettes in fiscal 1999 compared to fiscal 1998, in part due to
the company's increased leasing of additional titles to periodically provide
"guaranteed" rentals of popular films in all stores.
General and Administrative. General and administrative expenses for fiscal
1999 increased $2,750,000, or 135%, to $4,786,000 compared to $2,035,000 for
fiscal 1998. The increase was primarily attributable to incurring additional
costs for payroll, professional services, and travel to support the addition of
114 new stores during fiscal 1999. General and administrative expenses as a
percentage of total revenues decreased to 19.6% in fiscal 1999 compared to 19.9%
in fiscal 1998. The decrease was mainly the result of spreading the corporate
expenses over significantly higher revenues for that period.
Write-down of Film Library. During the fourth quarter of fiscal 1998,
management decided to dispose of the film library in order to concentrate the
Company's business on the ownership and operation of video specialty
superstores. The film library was written down by $3,030,000 to reflect it's net
realizable value at January 31, 1998. On March 25, 1998, the Company sold the
rights to its library of 47 feature films and other properties and related
accounts receivable to an entity owned and controlled by Stephen C. Lehman, a
member of the Company's board of
19.
directors, for $1,350,000 in cash. The film library was stated at the net
realizable value at January 31, 1998. The library was the principal asset of
Prism prior to the merger in January 1997 of Lee Video City with and into Prism.
Under the agreement by which the Company sold its film rights, the Company had a
right to buy back the film library at any time through February 4, 1999 at
escalating prices ranging from $1,650,000 to $1,850,000, less amounts actually
received and collected by the buyer. The Company did not exercise this right.
Interest Expense. Net interest expense increased $1,011,000, or 183.2%, to
$1,563,000 for fiscal 1999 compared to $552,000 for fiscal 1998. The increase
in interest expense was primarily due to the increase in borrowings related to
the addition of the credit facility entered into with FINOVA Capital Corporation
("FINOVA") in March of 1998. The facility was used primarily to fund the cash
portion of the March 25, 1998 and September 30, 1998 acquisitions and to pay off
other short term debt. In addition, the Company incurred a write off of the
unamortized loan fees related to the FINOVA credit facility when it was paid off
on December 28, 1998 with proceeds from the new $30 million revolving credit
facility with BankBoston Retail Finance Inc. ("BankBoston").
Other. Other (income) expense was $(221,000) for fiscal 1999 compared to
$0 for fiscal 1998 mainly due to the receipt by the Company of a break-up fee in
June 1998 in connection with the acquisition agreement entered into with Planet
Video, Inc.
Income Taxes. Statement of Financial Accounting Standards No. 109
requires a valuation allowance to be recorded when it is more likely than not
that some or all of the deferred tax assets of a Company will not be realized.
At January 31, 1998, a valuation allowance for the full amount of the net
deferred tax asset in the amount of $2,195,397 was recorded because of pre-
fiscal 1998 losses and uncertainties as to the amount of taxable income that
would be generated in future years. Due to significant acquisitions consummated
during the year, the Company has determined from its projections that it is more
likely than not that future taxable income would be sufficient to enable the
Company to realize its deferred tax assets and has accordingly, reversed the
full amount of the valuation allowance as of January 31, 1999.
Year Ended January 31, 1998 Compared to Year Ended December 31, 1996
Revenues. Revenues for the fiscal year ended January 31, 1998 ("fiscal
1998") decreased $1,229,000 or 10.7%, to $10,212,000 compared to $11,441,000 for
the fiscal year ended December 31, 1996 ("fiscal 1996"). The decreased revenues
were primarily attributable to the inclusion in fiscal 1996 of the eleven stores
sold by the Company in June 1996. Same store revenues increased 4.4% in fiscal
1998, which was attributable to the addition of new sell-through products and
the strategic relocation of three stores.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for fiscal 1998 decreased $59,000 or 3.0%, to
$1,928,000, compared to $1,987,000 for fiscal 1996. Amortization of
videocassette rental inventory as a percentage of total revenue was 18.9% in
fiscal 1998 compared to 17.4% in fiscal 1996. The increase as a percentage of
total revenue was due to a higher proportion of purchased videocassettes versus
leased videocassettes in fiscal 1998 compared to fiscal 1996, and an increased
number of "hit" videocassettes purchased for each location, offset partially by
the change in amortization method to allow for a $6 salvage value.
Cost of Product Sales. The cost of product sales as a percentage of total
revenue decreased to 7.5% for fiscal 1998 compared to 13.6% for fiscal 1996.
This decrease was primarily due to the Company increasing its sales of new
videocassettes and accessories for fiscal 1998 as compared to fiscal 1996, which
provided an improvement in the margins, and a return to normal holding periods
for previously viewed tapes resulting in a
20.
lower net book value at time of sale.
Cost of Leased Product. Cost of leased product for fiscal 1998 decreased
$137,000, or 24.6%, to $419,000 compared to $556,000 for fiscal 1996. The
decrease was primarily attributable to the inclusion in fiscal 1996 of the
eleven stores sold by the Company in June 1996. Cost of leased product as a
percentage of total revenue was 4.1% in fiscal 1998 compared to 4.9% in fiscal
1996. The decrease as a percentage of total revenue was due to the lower
proportion of leased videocassettes versus purchased videocassettes in fiscal
1998 compared to fiscal 1996.
Store Operating Expenses. Store operating expenses for fiscal 1998
decreased $1,931,000, or 30.2%, to $4,460,000 compared to $6,391,000 for fiscal
1996. The decrease was primarily attributable to the inclusion in fiscal 1996
of the 11 stores sold by the Company in June 1996. Store operating expenses as
a percentage of total revenues were 43.7% for fiscal 1998 compared to 55.9% for
fiscal 1996 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 in fiscal 1996.
General and Administrative. General and administrative expenses for fiscal
1998 increased $667,000, or 48.8%, to $2,035,000 compared to $1,368,000 for
fiscal 1996. General and administrative expenses as a percentage of total
revenue were 19.9% in fiscal 1998 compared to 12.0% in fiscal 1996. The
increase was attributable to the professional services associated with the
merger with Prism Entertainment Corporation and the incremental cost of hiring
two management employees of Prism Entertainment Corporation following the
merger.
Nonrecurring Writedown of Film Library. During the fourth quarter of
fiscal 1998, management decided to dispose of the film library in order to
concentrate the company's business on the ownership and operation of video
specialty stores. The film library was written down by $3,030,000 to reflect
its net realizable value at January 31, 1998.
Gain on Disposition of Assets. The gain on disposition of assets in fiscal
1996 is primarily related to the sale of eleven stores outside of California in
June 1996.
Interest Expense. Net interest expense decreased $140,000, or 20.2%, to
$552,000 for fiscal 1998 compared to $692,000 for fiscal 1996. The decrease in
interest expenses was due to the conversion of debt to equity in January 1997 of
approximately $3,850,000 and paydown of approximately $2,000,000 primarily
through collection of accounts receivable, partially offset by the assumption by
the Company of the note payable to Imperial Bank in the amount of $3,066,000 in
January 1997.
Other. Other (income) expense of $(17,000) in fiscal 1996 was attributable
to miscellaneous non-operating royalties.
Income Taxes. The Company's effective income tax rate varied from the
statutory federal tax rate as a result of operating losses for which no benefit
is recognized due to the valuation allowance on the net deferred tax asset. A
full valuation allowance has been established as the Company cannot determine
that it is more likely than not that the deferred tax asset will 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.
21.
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 63.6%, 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 23.8%, 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 of Lee Video City with and into Prism.
Interest Expense. Interest expense for the one month ended January 31,
1997 decreased $31,000, or 40.2%, to $46,000 compared to $77,000 for the one
month ended January 31, 1996. The decrease in interest expense 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 of Lee Video City with and into Prism.
Results of Operation of Prism. Prism's operations for the period from
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.
Liquidity and Capital Resources
The Company funds its short-term working capital needs, including the
purchase of videocassettes and other inventory, primarily through cash from
operations. The Company expects that cash from operations and extended vendor
terms will be sufficient to fund future videocassette and other inventory
purchases and other working capital needs for its existing stores. As part of
its aggressive growth strategy, the Company requires greater working capital to
sustain its current level of growth. There can be no assurance, however, that
cash from operations and extended vendor terms will be sufficient to fund future
videocassette and inventory purchases and other working capital to sustain the
continued aggressive growth of the Company. In the event the Company is unable
to obtain the equity financing, debt financing or the contemplated strategic
divestiture, the Company may not have the liquidity to sustain its current rate
of growth.
Videocassette rental inventories are accounted for as noncurrent assets
under generally accepted
22.
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 2000.
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. On
December 28, 1998, the Company and its subsidiaries entered into a Loan and
Security agreement with BankBoston providing for a $30 million revolving credit
facility secured by all of the assets of Video City and its subsidiaries. The
BankBoston credit facility replaced the Company's previous $7.5 million loan
facility with FINOVA Capital Corporation. The new loan agreement provides for a
maturity date of December 29, 2001 and a per annum interest rate equal to either
(a) the base rate announced from time to time by BankBoston, N.A. plus 0.5
percent or (b) LIBOR plus 3.0 percent, at Video City's election. In addition,
Video City is obligated to pay various fees in connection with the credit
facility. The amount available for borrowing under the Line of Credit is
determined by deducting the Company's principal balance of the Line of Credit
from its borrowing base. The borrowing base is determined by multiplying the
applicable inventory advance rate and the number of units of the acceptable
inventory, net of reserves. As of December 30, 1998, Video City borrowed
$13,400,000 of which (a) $6,400,000 was used to pay off all amounts due to
FINOVA Capital Corporation, (b) $1,900,000 was used as the cash component of the
purchase price of Videoland, and (c) $3,700,000 was used to pay off certain
indebtedness and trade payables of Videoland, and (d) $800,000 was used to pay
off certain amounts owed by Video City. As of January 31, 1999, the outstanding
amount under the BankBoston credit facility was $16,045,000. As of May 14,
1999, the outstanding amount under the BankBoston credit facility was
$23,692,000, the unused portion was $6,308,000 and the availability was $70,000.
On April 22, 1999 the Company entered into an Asset Purchase Agreement with
Blockbuster Inc. pursuant to which the Company has agreed to sell to Blockbuster
Inc. substantially all of the assets of 50 of the Company's retail video stores
located in the states of Washington and Oregon for approximately $16 million in
cash. The consummation of the sale is subject to certain conditions, including
satisfactory due diligence investigations by Blockbuster Inc. and the receipt of
certain governmental and other third-party consents. The company anticipates
using the net proceeds from the sale of the assets to pay off certain of the
Company's indebtedness and to finance future acquisitions. There can be no
assurances that the contemplated asset sale will be consummated.
In conjunction with the sale of its film library on March 25, 1998, the
Company paid off in full the promissory note to Imperial Bank, which had a
balance at January 31, 1998 of $1,411,306.
Net cash provided by operating activities for fiscal 1999 decreased by
approximately $5,002,000 or 168% from fiscal 1998, primarily due to an increase
in accounts payable and accrued expenses, partially offset by an increase in
goodwill and accounts receivable. Net cash used in investing activities during
fiscal 1999 increased by $23,914,000 or 872% compared to fiscal 1998, mainly due
the inventory and fixed assets purchased through acquisitions and increased
inventory purchases to operate a larger number of stores. Net cash provided by
financing activities during fiscal 1999 was $21,866,000 compared to net cash
used of $1,447,243 during fiscal 1998. The change was mainly due to proceeds
received from the BankBoston credit facility, issuance of debt, and issuance of
preferred and common stock, partially offset by repayment of the FINOVA credit
facility loan balance.
23.
Net cash provided by operating activities in the year ended January 31,
1998 increased by approximately $1,241,000 or 71.7% from the year ended December
31, 1996, primarily due to a decrease in accounts receivable, partially offset
by an increase in merchandise inventories and other assets. Net cash used in
investing activities during fiscal 1998 increased by $914,000, or 50.0% compared
to 1996, mainly due to the inclusion in 1996 of proceeds received from the sale
of certain fixed assets and increased net purchases of videocassette rental
inventory made in fiscal 1998 versus 1996. Net cash used in financing activities
during fiscal 1998 increased $1,187,000, or 331.3% compared to 1996, mainly due
to increased principal payments made on obligations secured by accounts
receivables.
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. However, the Company 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 expenses associated with any
acquisition of 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 acquisitions or new store openings and the
related costs and other expenses associated with the acquisition of stores or
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 to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
Year 2000
The year 2000 problem is the result of computer programs written using two
digits rather than four to define the applicable year. Any of the Company's
computer systems that uses time-sensitive software programming may recognize a
date using "00" as the year 1900 rather than the year 2000, which could result
in miscalculation or system failures.
The Company has completed its assessment of all its information technology
systems, related computer applications, and any embedded systems contained in
the Company's buildings, equipment, and other infrastructure and has determined
that it is ready for the year 2000. Substantially all of the Company's hardware
and software systems have been verified as being Year 2000 compliant.
The Company has important and material relationships with a number of its
vendors and suppliers and has obtained written verification from these third
parties that they expect to be Year 2000 compliant in time. However, if the
Company's vendors and suppliers are unable to resolve such processing issues in
a timely manner, it could result in material financial risk to the Company.
Management has determined that the costs of addressing potential problems
are not expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in the future periods. The
estimated total costs to address the Company's Year 2000 issues is approximately
$25,000 which includes the cost of upgrading software and hardware systems.
24.
The reasonably most likely worst case scenario for the Company would be
the failure of its video stores' point of sale system. The Company is in the
process of developing back-up systems that do not rely on computers in response
to this unlikely event.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities" (SFAS 133") which
requires companies to recognize all derivatives contracts as either assets or
liabilities in the balance sheet and to measure them at fair value. The
provisions of this statement are effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. Historically, the Company has not entered
into derivatives contracts either to hedge existing risks or for speculative
purposes. Accordingly, the Company does not expect adoption of the new standard
on January 31, 2001 to affect its financial statements.
Quantitative and Qualitative Disclosure About Market Risk
The Company's market risk sensitive instruments do not subject it to
material market risk exposures, except for such risks related to interest rate
fluctuations. The carrying value of the Company's bank debt approximates fair
value at January 31, 1999 and 1998 since the note related thereto substantially
bears interest at a floating rate based upon the lenders' "prime" rate.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 14 of this Form 10-K for the
information required by Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
25.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1999 Annual Meeting of Stockholders, and is
incorporated herein by reference.
26.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) and (2) Financial Statements and Schedules:
The following financial statements of Video City, Inc. (and its predecessor
Lee Video City, Inc.) are included in this Report as pages F-1 through F-30
following the signature pages:
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
(b) Form 8-K
A Current Report on Form 8-K, dated December 28, 1998, was filed by the
Company on January 12, 1999 to report under Item 2 and Item 5 the acquisition of
Cianci's Videoland, Inc. and obtaining of a credit facility. An amendment to
the Form 8-K was filed by the Company on March 15, 1999 to report under Item 7
the financial statements and pro forma financial information relating to the
acquisition of Cianci's Videoland, Inc.
(c) Exhibits
Exhibit
No. Exhibit Description
- -------- ----------------------------------------------------------------------------------------
2.1 Amended Plan of Reorganization of Prism Entertainment Corporation, date October 25,
1996.(1)
2.2 Agreement and Plan of Reorganization and Merger, dated as of October 25, 1996, between
Prism Entertainment Corporation and Lee Video City, Inc., as amended.(1)
3.1 Certificate of Incorporation of the Company, as amended.(2)(5)
3.2 Bylaws of the Company, as amended.(2)
3.3 Certificate of Designations for the Company's Series A Convertible Redeemable Preferred
Stock.(5)
3.4 Certificate of Designations for the Company's Series AA Convertible Redeemable
Preferred Stock
3.5 Certificate of Designations for the Company's Series B Convertible Redeemable Preferred
Stock.(9)
4.1 Certificate of Merger of Lee Video City, Inc. into the Company.(1)
27.
10.1 Override Agreement, dated as of November 19, 1996, by and among Lee Video City, Inc.,
Robert Y. Lee, Prism Entertainment Corporation and Ingram Entertainment, Inc.(1)
10.2 Stockholders Agreement, dated as of January 8, 1997, by and among the Company, Robert
Y. Lee, Barry Collier and Ingram Entertainment, Inc.(3)
10.3 Supply Agreement, dated January 8, 1997, between the Company and Ingram Entertainment,
Inc.(3)
10.4 Escrow and Warrant Agreement, dated as of January 8, 1997, granted by Robert Y. Lee to
Ingram Entertainment, Inc. to purchase 404,403 shares of Common Stock of the Company.(3)
10.5 Warrant, dated as of January 8, 1997, to purchase 852,750 shares of Common Stock of the
Company issued to Ingram Entertainment, Inc.(3)
10.6 Stock Purchase Warrant, dated August 24, 1995, issued by Lee Video City, Inc. to
Rentrak Corporation.(3)
10.7 Stock Purchase Warrant, dated June 19, 1996, issued by Lee Video City, Inc. to Rentrak
Corporation.(3)
10.8 Employment Agreement, dated January 8, 1997, between the Company and Robert Y. Lee.(3)
10.9 Employment Agreement, dated January 8, 1997, between the Company and James Craig
Kelly.(3)
10.10 Employment Agreement, entered into in August 1998, between the Company and Timothy J.
Denari.(6)
10.11 1996 Stock Option Plan of Lee Video City, Inc.(3)
10.12 1998 Stock Option Plan.(11)
10.13 Stock Option Agreement, dated January 8, 1997, between the Company and Barry L.
Collier.(3)
10.14 Irrevocable Proxy, dated January 8, 1997, given by Barry Collier to Robert Y. Lee.(3)
10.15 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and
among Video City, Inc., Video Adventures Corp., Adventures in Video, Inc. and David A.
Ballstadt.(4)
10.16 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and
among Video City, Inc., Video Ballstadt Corp., KDDJ Investments, Inc. and David A.
Ballstadt.(4)
10.17 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and
among Video City, Inc., Video Acquisition Corp., Leptis Magna, Inc. d/b/a Video
Unlimited and G. Wayne Bailey and Orawan Bailey.(4)
10.18 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and
among Video City, Inc., Video Republic Corp., Old Republic Entertainment, Inc. and C.
Anthony Anderson.(4)
10.19 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and
among Video City, Inc., Video Sulpizio Corp., Sulpizio One, Inc., Dennis Rhoton and
Edward Rheinhardt.(4)
10.20 Film Rights Transfer Agreement, dated as of March 23, 1998, by and among Conrad
Entertainment, LLC and Video City, Inc.(4)
28.
10.21 Loan and Security Agreement, dated as of March 24, 1998, by and among FINOVA Capital
Corporation and Video City, Inc., Adventures in Video, Inc., KDDJ Investments, Inc.,
Leptis Magna, Inc., Old Republic Entertainment, Inc. and Sulpizio One, Inc.(4)
10.22 Warrant issued to FINOVA Capital Corporation.(4)
10.23 Restructured Debt Agreement, dated March 25, 1998, by and among Rentrak Corporation,
Mortco, Inc., Video City, Inc., Sulpizio One, Inc. and Adventures in Video, Inc.(4)
10.24 Stock Purchase Agreement, dated as of July 3, 1998, by and among the Company, Andrew T.
Baruffi, The Baruffi Family Trust, and The Baruffi Family Partnership, as amended by
that certain Addendum, dated as of September 30, 1998.(8)
10.25 Asset Purchase Agreement, dated as of September 30, 1998, by and among the Company, Far
West Entertainment, Inc. and Bradley K. Maples.(8)
10.26 Asset Purchase Agreement, dated as of September 30, 1998, by and among the Company,
Game City, Inc., Young C. Lee and Kay L. Lee.(8)
10.27 Management Agreement, dated as of October 16, 1998, by and between the Company and
Cianci's Videoland, Inc.(7)
10.28 Agreement of Merger and Plan of Reorganization, dated as of October 9, 1998, by and
among the Company, Cianci's Videoland, Inc., Victor J. Cianci and Evvy Cianci.(7)
10.29 Agreement of Merger and Plan of Reorganization, dated as of March 30, 1999, by and
among the Company, Video Galaxy, Inc. James G. Howard, George M. Peloso and Kurt
Peterson.(10)
10.30 Loan and Security Agreement, dated as of December 29, 1998, by and among the Company
and its subsidiaries and BankBoston Retail Finance Inc.
21.1 Subsidiaries of the Company.
27.1 Financial Data Schedule
_____________________
(1) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated January 8, 1997, and incorporated herein by reference.
(2) Previously filed as exhibits to Prism Entertainment Corporation's Annual
Report on Form 10-K for the fiscal year ended January 31, 1988, and
incorporated herein by reference.
(3) Previously filed as exhibits to the Company's Annual Report on Form 10-K for
the fiscal year ended January 31, 1997, and incorporated herein by
reference.
(4) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 25, 1998, and incorporated herein by reference.
(5) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended April 30, 1998, and incorporated herein by
reference.
(6) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 1998, and incorporated herein by
reference.
(7) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended
29.
October 31, 1998, and incorporated herein by reference.
(8) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated September 30, 1998, and incorporated herein by reference.
(9) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated December 28, 1998, and incorporated herein by reference.
(10) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 31, 1999, and incorporated herein by reference.
(11) Previously filed as exhibits to the Company's Definitive Proxy Statement
for its 1998 Annual Meeting of Stockholders, and incorporated herein by
reference.
(d) Financial Statement Schedule
Schedules for which provision is made in the applicable accounting regulation of
the Securities and Exchange Commission are not required under the related
instructions or are inapplicable and therefore have been omitted
30.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Annual Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
VIDEO CITY, INC.
By /s/ Robert Y. Lee
-------------------------------
Robert Y. Lee
Chairman of the Board
and Chief Executive Officer
Date: May 14, 1999
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Robert Y. Lee Chairman of the Board and May 14, 1999
- --------------------------------------- Chief Executive Officer (Principal
Robert Y. Lee Executive Officer)
/s/ Timothy J. Denari Chief Financial Officer (Principal May 14, 1999
- --------------------------------------- Financial and Accounting Officer)
Timothy J. Denari
/s/ James Craig Kelly Director May 14, 1999
- ---------------------------------------
James Craig Kelly
/s/ David A. Ballstadt Director May 14, 1999
- ---------------------------------------
David A. Ballstadt
/s/ Michael T. Anderson Director May 14, 1999
- ---------------------------------------
Michael T. Anderson
/s/ Barry L. Collier
- --------------------------------------- Director May 14, 1999
Barry L. Collier
/s/ Charles E. Cooke Director May 14, 1999
- ---------------------------------------
Charles E. Cooke
Director May 14, 1999
/s/ Stephen C. Lehman
- ---------------------------------------
Stephen C. Lehman
/s/ John T. Sheehy Director May 14, 1999
- ---------------------------------------
John T. Sheehy
/s/ Gerald W.B. Weber Director May 14, 1999
- ---------------------------------------
Gerald W.B. Weber
Video City, Inc.
Consolidated Financial Statements
For the Years Ended January 31, 1999 and 1998,
the Year Ended December 31, 1996,
and
the Months Ended January 31, 1997 and 1996 (unaudited)
ITEM 8. Consolidated Financial Statements and Supplementary Data
The following consolidated financial statements are filed with this report:
Report of Independent Certified Public Accountants F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Equity (Deficit) F-7
Consolidated Statements of Cash Flows F-8
Notes to Consolidated Financial Statements F-11
F-2
Report of Independent Certified Public Accountants
The Board of Directors
Video City, Inc.
We have audited the accompanying consolidated balance sheets of Video City, Inc.
(formerly "Lee Video City") as of January 31, 1999 and 1998 and the related
consolidated statements of operations, stockholders' equity (deficit), and cash
flows for each of the years ended January 31, 1999 and 1998 and December 31,
1996. These consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Video City, Inc. as
of January 31, 1999 and 1998 and the results of its operations and its cash
flows for each of the years ended January 31, 1999 and 1998 and December 31,
1996 in conformity with generally accepted accounting principles.
BDO Seidman, LLP
Los Angeles, California
May 14, 1999
F-3
Video City, Inc
(Formerly Lee Video City, Inc.)
Consolidated Balance Sheets
January 31, January 31,
1999 1998
--------------- ---------------
Assets (Notes 1, 6, and 7)
Current assets
Cash $ 172,043 $ 28,127
Customer receivables (Note 1) 2,932,807 758,101
Notes receivable (Note 4) 86,703 355,430
Merchandise inventories (Note 1) 2,026,628 339,759
Other 52,870 411,536
--------------- ---------------
Total current assets 5,271,051 1,892,953
Videocassette rental inventory, net (Note 1) 21,119,897 2,795,258
Property and equipment, net (Note 5) 4,525,986 859,708
Goodwill, net (Note 1) 5,176,850 -
Deferred taxes, net (Note 8) 883,249 -
Film Library (Note 14) - 818,171
Other assets (Note 6) 1,275,847 233,226
--------------- ---------------
Total assets $ 38,252,880 $ 6,599,316
=============== ===============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities
Accounts payable $ 9,328,556 $ 2,166,027
Accrued expenses 3,422,724 702,293
Current portion of long-term debt (Note 7) 2,125,187 1,674,457
--------------- ---------------
Total current liabilities 14,876,467 4,542,777
Senior secured revolving credit facility (Note 6) 16,044,502 -
Long-term debt, less current portion (Note 7) 1,636,646 2,043,431
Other liabilities 427,791 711,931
--------------- ---------------
Total liabilities 32,985,406 7,298,139
Commitments and contingencies (Note 9)
Stockholders' equity (deficit) (Note 10)
Preferred stock 3,763,963 -
Common stock, $.01 par value per share, authorized 30,000,000
shares at 1999 and 20,000,000 shares at 1998; issued and
outstanding 13,498,715 shares at 1999 and 9,773,927 shares
at 1998 134,987 97,739
Additional paid-in capital 9,229,687 7,075,735
Accumulated deficit (7,861,163) (7,872,297)
--------------- ---------------
Total stockholders' equity (deficit) 5,267,474 (698,823)
--------------- ---------------
Total liabilities and stockholders' equity (deficit) $ 38,252,880 $ 6,599,316
=============== ===============
See accompanying notes to consolidated financial statements
F-4
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Operations
Year Ended Year Ended Year Ended
January 31, January 31, December 31,
1999 1998 1996
----------------- ----------------- -----------------
Revenue
Rental revenues and product sales $ 23,828,501 $ 10,007,358 $ 11,271,229
Management fee income 607,733 205,000 170,000
----------------- ----------------- -----------------
Total revenue 24,436,234 10,212,358 11,441,229
----------------- ----------------- -----------------
Operating costs and expenses
Store operating expenses 13,675,372 4,460,200 6,390,574
Amortization of videocassette rental inventory 2,541,934 1,928,343 1,987,407
Cost of product sales 3,301,185 762,153 1,557,062
Cost of leased product 1,394,409 419,361 556,248
General and administrative 4,785,890 2,035,428 1,367,650
Non-recurring write-down of Film Library
(Note 14) - 3,029,829 -
----------------- ----------------- -----------------
Total operating costs and expenses 25,698,790 12,635,314 11,858,941
Loss from operations (1,262,556) (2,422,956) (417,712)
Other (income) expense
Gain on disposition of assets, net (Note 12) - - (1,049,295)
Interest expense, net 1,563,348 552,359 691,782
Other (221,081) - (17,275)
----------------- ----------------- -----------------
Loss before income taxes (2,604,823) (2,975,315) (42,924)
Income tax benefit (Note 8) 2,615,957 - -
----------------- ----------------- -----------------
Net income (loss) $ 11,134 $ (2,975,315) $ (42,924)
----------------- ----------------- -----------------
Earnings (loss) per share (Note 11):
Basic earnings (loss) per share $ 0.00 $ (0.30) $ (0.01)
Diluted earnings (loss) per share $ 0.00 $ (0.30) $ (0.01)
See accompanying notes to consolidated financial statements
F-5
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Operations
(continued)
One One
Month Ended Month Ended
January 31, January 31,
1997 1996
(Unaudited) (Unaudited)
----------------- -----------------
Revenue
Rental revenues and product sales $ 940,141 $ 1,085,250
Operating costs and expenses
Store operating expenses 438,766 576,543
Amortization of videocassette rental inventory 111,034 129,145
Cost of product sales 135,894 65,301
Cost of leased product 35,864 99,425
General and administrative 323,206 126,828
----------------- -----------------
Total operating costs and expenses 1,044,764 997,242
Income (loss) from operations (104,623) 88,008
Other (income) expense
Interest expense, net 46,351 76,793
Other (18,132) (17,192)
----------------- -----------------
Income (loss) before income taxes (132,842) 28,407
Income tax benefit - -
----------------- -----------------
Net income (loss) $ (132,842) $ 28,407
================= =================
Earnings (loss) per share:
Basic earnings (loss) per share $ (0.02) $ 0.01
Diluted earnings (loss) per share $ (0.02) $ 0.01
See accompanying notes to consolidated financial statements
F-6
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Stockholders' Equity (Deficit)
Preferred Stock
------------------------------------------
Series AA (Note 10) Series B (Note 10) Common Stock Additional
------------------- -------------------- ---------------------- Paid-In Accumulated
Shares Amount Shares Amount Shares Amount Capital Deficit
-------- -------- ------ ---------- ---------- -------- ---------- -----------
Balance at January 1, 1996 - $ - - $ - 4,234,024 $ 42,340 $ 564,660 $(4,721,216)
Net loss (42,924)
----- -------- ------ ---------- ---------- -------- ---------- -----------
Balance, at December 31, 1996 - - - - 4,234,024 42,340 564,660 (4,764,140)
Stock issued in satisfaction
of debt - - - - 1,500,000 15,000 2,985,000 -
Stock issued in conversion of
debt - - - - 773,653 7,737 811,263 -
Effect of the Merger - - - - 3,246,250 32,462 2,675,012 -
Net loss (one month ended) - - - - - - - (132,842)
----- -------- ------ ---------- ---------- -------- ---------- -----------
Balance, at January 31, 1997 - - - - 9,753,927 97,539 7,035,935 (4,896,982)
Stock issued in satisfaction - - - - 20,000 200 39,800
of debt
Net loss - - - - - - - (2,975,315)
----- -------- ------ ---------- ---------- -------- ---------- -----------
Balance, at January 31, 1998 - - - - 9,773,927 97,739 7,075,735 (7,872,297)
Stock issued in satisfaction
of services 750 75,000 - - 243,288 2,433 192,803 -
Stock issued for acquisition
of stores - - 76,000 3,065,190 3,481,500 34,815 1,961,149 -
Stock issued for private
placement 7,000 623,773 - - - - - -
Net income - - - - - - - 11,134
----- -------- ------ ---------- ---------- -------- ---------- -----------
Balance at January 31, 1999 7,750 $698,773 76,000 $3,065,190 13,498,715 $134,987 $9,229,687 $(7,861,163)
----- -------- ------ ---------- ---------- -------- ---------- -----------
See accompanying notes to consolidated financial statements
F-7
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Cash Flows
Year ended Year ended Year ended
January 31, January 31, December 31,
1999 1998 1996
-------------- -------------- ---------------
Increase (Decrease) in cash and cash equivalents
Cash flows from operating activities:
Net income (loss) $ 11,134 $ (2,975,315) $ (42,924)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 3,692,329 2,127,443 2,518,068
(Gain) loss on disposal of assets - - (1,049,294)
Note issued for legal settlement - - 379,632
Stock issued for professional services 195,236 40,000 -
Non-recurring writedown of film library - 3,029,829 -
Changes in assets and liabilities net of effects from acquisitions:
Decrease (increase) in accounts receivable (1,378,087) 1,409,951 -
Decrease (increase) in notes receivable 268,727 (280,783) 29,954
Decrease (increase) in merchandise inventories (853,142) 21,464
Decrease (increase) in other assets (925,751) (280,703) 175,792
Increase in deferred tax asset (883,249) - -
Decrease in accounts payable (134,616) (30,302) (214,125)
Decrease in accrued expenses (1,738,833) (5,192) (58,817)
Decrease in other liabilities (284,140) (62,944) (28,814)
-------------- -------------- ---------------
Net cash provided by (used in) operating activities (2,030,392) 2,971,984 1,730,906
Cash flows from investing activities
Purchases of videocassette rental inventory, net (4,213,040) (2,596,812) (2,260,680)
Purchases of fixed assets (756,398) (189,719) (169,512)
Payment for acquisitions, net of cash acquired (2,626,185) - -
Proceeds from sale of fixed assets - - 601,301
Proceeds from sale of film library 818,171 - -
Repayment on notes receivable - 43,400 -
-------------- -------------- ---------------
Net cash used in investing activities (6,777,452) (2,743,131) (1,828,891)
Cash flows from financing activities
Issuance of preferred stock 623,773 - -
Principal payments on obligations under capital leases (18,136) - (299,751)
Repayment of long-term debt (13,221,880) (1,447,243) (1,034,939)
Proceeds from issuance of long-term debt 5,523,501 - 1,074,431
Proceeds from borrowing under lines of credit 16,044,502 - -
-------------- -------------- ---------------
Net cash used in financing activities 8,951,760 (1,447,243) (260,259)
Net increase (decrease) in cash 143,916 (1,218,390) (358,244)
Cash at beginning of year 28,127 1,246,517 417,517
-------------- -------------- ---------------
Cash at end of year $ 172,043 $ 28,127 $ 59,273
============== ============== ===============
F-8
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Cash Flows
(continued)
Year ended Year ended Year ended
January 31, January 31, December 31,
1999 1998 1996
-------------- -------------- ---------------
Supplementary disclosures of cash flow information
Cash paid during the year:
Interest $ 1,071,506 $ 557,551 $ 757,259
Income taxes 800 800 800
Noncash investing and financing activities:
Professional services financed through issuance of common stock 195,236 40,000 -
Videocassette rental inventory acquired through issuance
of common stock - - 379,632
Long-term debt issued for settlement of lawsuit - - -
Sale of stores in exchange for assignment of debt - - 3,100,000
Accounts payable converted to long term debt 494,935 435,032 -
Professional services financed through issuance
of preferred stock 75,000 - -
For acquisitions consummated during the year, the Company paid
$2,626,185, net of cash acquired. In conjunction with the acquisitions,
liabilities were assumed as follows:
Fair value of assets acquired $22,018,218
Cash paid (2,626,185)
Common stock issued (1,995,964)
Preferred stock issued (3,065,190)
Goodwill 5,260,990
-----------
Liabilities assumed $19,591,869
See accompanying notes to consolidated financial statements
F-9
Video City, Inc.
(Formerly Lee Video City, Inc.)
Consolidated Statements of Cash Flows
(continued)
One
Month Ended
January 31,
1997
(Unaudited)
-------------------
Increase (Decrease) in cash and cash equivalents
Cash flows from operating activities:
Net loss $ (132,842)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 142,065
Changes in assets and liabilities:
Decrease (increase) in accounts receivable (5,913)
Decrease in merchandise inventories (9,379)
Decrease (increase) in other assets 68,037
Increase (decrease) in accounts payable (119,740)
Increase in accrued expenses (45,540)
-------------------
Net cash used in operating activities (103,312)
Cash flows from investing activities
Purchases of videocassette rental inventory, net (1,094,536)
Disposal of videocassette rental inventory 1,072,084
Purchases of fixed assets (13,641)
Proceeds from sale of fixed assets 1,454,293
-------------------
Net cash provided by investing activities 1,418,200
Cash flows from financing activities
Principal payments on obligations under capital leases (21,159)
Repayment of long-term debt (43,985)
Payment of dissenter's shares (62,500)
-------------------
Net cash used in financing activities (127,644)
Net increase in cash 1,187,244
Cash at beginning of period 59,273
-------------------
Cash at end of period $ 1,246,517
-------------------
Supplementary disclosures of cash flow information
Cash paid during the year: $ 25,333
Interest
Noncash investing and financing activities:
Long-term debt converted to common stock 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 1,440,535
See accompanying notes to consolidated financial statements.
F-10
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
1. Business Operations and Significant Accounting Policies
Video City, Inc. (the "Company"), a Delaware Corporation, was formed on January
27, 1984. The Company owns and operates retail video specialty stores. As of
January 31, 1999, the Company owned and operated 128 stores and managed one
"licensed" store. The stores are located in California, Oregon, Washington,
Nevada, Idaho, Iowa, South Dakota, Colorado and Minnesota.
The Company's predecessor, Lee Video City, Inc. ("Lee Video City"), was formed
as a California corporation in February 1990 for the purpose of developing a
chain of retail video specialty stores. In January 1997, Lee Video City, Inc.
merged with and into Prism Entertainment Corporation ("Prism") pursuant to an
Agreement and Plan of Reorganization and Merger, dated as of October 25, 1996
(the "Plan"), and the surviving corporation changed its name to "Video City,
Inc." (Note 2). Prism had operated as a debtor in possession under Chapter 11 of
the United States Bankruptcy Code 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.
The existing shareholders of Lee Video City, Inc. received 5,007,677 of the
common stock of Prism Entertainment Corporation or approximately 51% of the
Company's common stock. 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. As a result of the reverse
acquisition of Prism, the Company changed its fiscal year from December 31 to
January 31 effective February 1, 1997.
The accompanying consolidated financial statements include the accounts of Video
City, Inc. and its wholly owned subsidiaries. These subsidiaries include Old
Republic Entertainment, Inc., Sulpizio One, Inc., Video Tyme, Inc., and
Videoland, Inc. All material intercompany transactions have been eliminated.
The financial statements include the operations of companies acquired from the
dates of acquisition (Note 2).
The financial statements also include the accounts of Prism for the period
January 9, 1997 through January 31, 1997. Prism'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.
Customer Receivables
Customer receivables primarily consist of late fees on rental videocassettes and
games and fees for unreturned items.
F-11
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
Merchandise Inventories
Merchandise inventories, consisting primarily of videocassettes, video games,
concessions, and accessories held for resale, are stated at the lower of cost or
market. Cost of sales are determined on a first-in, first-out basis.
Videocassette Rental Inventory
Videocassette rental inventory, which includes video games, is recorded at cost
and amortized over its estimated economic life. Base stock is amortized over a
60 month period on a straight-line basis with a salvage value of $6 per tape.
The fourth through ninth copies of each title per store are amortized over a 36
month period on an accelerated basis with a salvage value of $6 per tape. The
tenth and any succeeding copies of each title per store are amortized over 9
months on a straight-line basis with a salvage value of $6 per tape.
During the fourth quarter of fiscal 1999, the Company adopted a new method for
amortizing its base stock (copies one through three of each title per store) of
rental videocassettes. The new method of amortization was adopted because the
Company believes that decelerating expense recognition for its base stock more
accurately matches its revenue stream and useful economic life as demonstrated
in the industry. Prior to the change, base stock was amortized over a 36 month
period on a straight-line basis with a salvage value of $6 per tape. The effect
of the change on base stock amortization for the year ended January 31, 1999 was
approximately $570,000.
During fiscal 1998, the Company revised the estimate of salvage value relating
to the amortization of videocassette inventory to provide for a $6 salvage value
per tape in order to reflect a more accurate salvage value as demonstrated in
the industry.
Certain videocassettes 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
(average cost per tape approximately $70). 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 $2,541,934, $1,928,343 and $1,987,407 for the years ended January
31, 1999 and 1998 and December 31, 1996. As videocassettes are sold or retired,
the applicable cost and accumulated amortization are eliminated from the
accounts, and any gain or loss is recorded.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the
straight-line method over estimated useful lives, ranging from five to ten
years. Leasehold improvements are recorded at cost and amortized using the
straight-line method over the estimated economic life of the lease term.
Impairment of Long-Lived Assets
In the event that facts and circumstances indicate that the cost of an asset may
be impaired, an evaluation of recoverability would be performed. If an
evaluation were required, the estimated future undiscounted cash flows
associated with the asset would be compared to the carrying amount to determine
if a writedown to market value is required.
F-12
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
Goodwill
Goodwill represents the excess of the cost of the companies acquired over the
fair value of their net assets at the dates of acquisition and is amortized on
the straight-line method over 20 years. Periodically, the Company reviews the
recoverability of goodwill. The measurement of possible impairment is based
primarily on the ability to recover the balance of the goodwill from the
expected future operating cash flows on an undiscounted basis. In management's
opinion, no material impairment exists at January 31, 1999. Amortization
expense charged to operations for the year ended January 31, 1999 was $84,139.
Film Library
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 be recoverable through estimated remaining
lifetime revenues, the non-recoverable portion is charge to expense.
Revenue Recognition
Revenue is recognized at the time of rental or sale, or as late charges accrue.
Store Opening Costs
Store opening costs, which consist primarily of payroll, advertising and
supplies, are expensed as incurred.
Stock-Based Compensation
Prior to January 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of APB Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. As such, compensation expense
would be recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. On January 1, 1996, the Company
adopted for footnote disclosure purposes only, Statement of Financial Accounting
Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS No. 123).
SFAS No. 123 requires that companies recognize the fair value of all stock-based
awards on the date of grant as compensation expense over the vesting period.
Alternatively, SFAS 123 also allows entities to continue to apply the provisions
of APB Opinion No. 25 and provide pro forma net income and pro froma earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value method defined in SFAS 123 had been applied. The
Company has elected to continue to apply the provisions of APB Opinion No. 25
and provide the pro forma disclosure provision of SFAS 123.
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
F-13
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
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.
Earnings (Loss) per Share
The Company adopted Statement of Financial Accounting Standards No. 128 (SFAS
No. 128), "Earnings Per Share," which simplifies the standards for computing and
presenting earnings per share as previously prescribed by APB Opinion No. 15,
"Earnings per Share." SFAS No. 128 replaces primary EPS with basic EPS and
fully diluted EPS with diluted EPS. Basic EPS excludes dilution and is computed
by dividing income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted EPS reflects the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised or converted into common stock or resulted from
issuance of common stock that then share in earnings. SFAS No. 128 also
requires dual presentation of basic and diluted EPS on the face of the income
statement and a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
All prior earnings per share amounts have been restated to reflect the adoption
of SFAS No. 128.
Comprehensive Income
The Company adopted SFAS 130 in January 1998. Comprehensive income (loss) is
the change in equity of a business enterprise during a period from transactions
and all other events and circumstances from non-owner sources. Other
comprehensive income (loss) includes foreign currency items and minimum pension
liability adjustments. The Company did not have components of other
comprehensive income (loss) during the periods presented. As a result,
comprehensive income (loss) is the same as the net income (loss) for the periods
presented.
Use of Estimates
The preparation of consolidated 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.
Reclassification
Certain reclassifications have been made to the prior year financial statements
to conform with the 1999 presentation.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued SFAS 133,
"Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133")
which requires companies to recognize all derivatives contracts as either assets
or liabilities in the balance sheet and to measure them at fair value. The
provisions of this statement are effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. Historically, the Company has not entered
into derivatives contracts either to hedge existing risks or for speculative
purposes. Accordingly, the Company does not expect adoption of the new standard
on January 31, 2001 to affect its financial statements.
F-14
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
2. Acquisitions
On March 25, 1998, Video City acquired five corporations owning and operating an
aggregate of 29 retail video stores. The following sets forth a description of
the transactions:
(a) Adventures in Video, Inc. ("Adventures") and KDDJ Investments, Inc.
("KDDJ") - Adventures owned and operated thirteen stores in Minnesota in
the greater Minneapolis metropolitan area. The purchase price for
Adventures was 866,000 shares of the Company's common stock. KDDJ owned and
operated three stores in San Francisco, California. The purchase price for
KDDJ was 216,500 shares of the Company's common stock. Pursuant to the
merger agreement, the Company paid off existing indebtedness of
approximately $449,000 that Adventures owed to Marquette Bank, N.A. As part
of the restructuring (see Note 3), Rentrak accepted 194,950 shares of Video
City common stock in settlement of $389,900 owed by Adventures. The Company
also entered into a two-year employment agreement with the prior owner at a
salary of $100,000 per year plus a possible bonus of up to $100,000 per
year based on increases, if any, in certain dealer allowances, and certain
additional benefits.
(b) Leptis Magna, Inc. - This company owned and operated five stores under the
name "Video Unlimited" in Colorado. The purchase price in this merger
consisted of $75,000 in cash, a one-year promissory note for $75,000
payable in twelve equal monthly installments, and 150,000 shares of the
Company's common stock. Pursuant to the Merger Agreement, the Company also
paid off existing indebtedness including $131,000 owed to Norwest Bank
Colorado, N.A. and $372,000 of indebtedness owed to a major vendor.
(c) Old Republic Entertainment, Inc. - This company owned and operated four
stores in and around Ventura, California, under the name "Video Tyme." The
purchase price consisted of 350,000 shares of the Company's common stock,
$150,000 in cash, and the assumption of certain debt. Pursuant to the
Merger Agreement, the Company paid off approximately $741,000 of existing
indebtedness owed to three creditors of the acquired company.
(d) Sulpizio One, Inc. - This company owned and operated four stores in
Lancaster, Santa Barbara, and Los Banos, California. The purchase price
consisted of 100,000 shares of the Company's common stock plus the
assumption of all liabilities including the amounts owing to Rentrak
Corporation (see Note 3). For more than three years prior to this
acquisition, these stores were managed by the Company under a management
agreement and operated under the name "Video City."
On September 30, 1998, the Company acquired an aggregate of nine retail video
stores through the acquisition of all of the outstanding shares of capital stock
of Video Tyme, Inc. ("Video Tyme") and substantially all of the assets of Far
West Entertainment, Inc. ("Far West") and Game City, Inc. ("Game City). The
following sets forth a description of the transactions:
(a) Video Tyme, Inc. - Video Tyme owned and operated seven retail video stores
in Las Vegas, Nevada, of which six were acquired. The purchase price of
Video Tyme consisted of 1,050,000 shares of the Company's common stock and
cash in the amount of $1,000,000. The Company also entered into a
management agreement with the selling shareholders to manage an additional
store in Las Vegas currently owned by the selling shareholders. Pursuant to
the management agreement, the Company has the option to acquire such store
from the selling shareholders at a cash purchase price of (a) $400,000 if
such option to purchase is exercised on or before March 31, 1999 or (b)
$440,000 if such option to purchase
F-15
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
is exercised between April 1, 1999 and September 30, 1999. The Company has
not exercised any of the above options as of May 14, 1999.
(b) Far West Entertainment, Inc. - Far West owned and operated two retail video
stores located in Clovis, California and Pocatello, Idaho. The purchase
price of the assets of Far West consisted of 32,000 shares of the Company's
common stock, cash in the amount of $20,000, the assumption of certain
indebtedness to third parties and to the Company in the total amount of
$495,000 and a promissory note in the principal amount of $100,000. For
more than 21 months prior to this acquisition, the store located in Clovis,
California was managed by the Company pursuant to a management agreement,
and operated under the name "Video City."
(c) Game City, Inc. -Game City owned and operated a retail video store in
Bakersfield, California. The purchase price of the assets consisted of cash
in the amount of $7,500, the assumption of certain indebtedness to third
parties and to the Company in the total amount of $117,500, and a
promissory note in the principal amount of $150,000. For more than 26
months prior to this acquisition, this acquired store was managed by the
Company pursuant to a management agreement, and operated under the name
"Video City." The prior owners of Game City are related to Robert Y. Lee,
the Company's Chief Executive Officer and Chairman of the Board.
On December 28, 1998, the Company acquired Cianci's Videoland, Inc.
("Videoland). Videoland owned and operated 76 stores in Oregon, Washington,
Iowa, Idaho, South Dakota and California. The consideration consisted of 76,000
shares of the Company's Series B voting Convertible Redeemable Preferred Stock
with a stated value of $100 per share, $1,900,000 in cash and the assumption of
approximately $11,500,000 of liabilities.
Pro Forma Condensed Consolidated Statements of Operations (unaudited)
The following unaudited pro forma condensed consolidated statements of
operations are based on the historical income statements of Video City, Inc.,
Far West Entertainment, Inc., Game City, Inc., Video Tyme, Inc., and Videoland,
Inc. and assumes all acquisitions had occurred at the beginning of each period
presented. The unaudited pro forma condensed consolidated 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.
Year ended Year ended
January 31, January 31,
1999 1998
----------- -----------
Revenue and product sales 58,785,961 53,470,065
Income (loss) before income taxes 73,881 4,716,421
Net income (loss) 44,328 2,829,853
Basic earnings (loss) per share $ 0.00 $ 0.17
Basic weighted average number of shares outstanding 13,179,316 13,200,206
3. Related Party Transactions
In connection with the purchase of Game City, Inc. on September 30, 1998, the
Company had a note payable balance due to the former owners at January 31, 1999
of $113,797, which is included as part of the long term debt balance. For more
than 26 months prior to this acquisition, this acquired store was managed by the
Company pursuant to a management agreement, and operated under the name "Video
F-16
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
City." Young C. and Kay L. Lee are relatives of Robert Y. Lee, the Company's
Chief Executive Officer and Chairman of the Board.
On September 30, 1998, in connection with the purchase of Far West
Entertainment, Inc., the Company issued 32,000 shares of the Company's common
stock and a note payable in the amount of $100,000 to the seller, Brad Maples.
The note requires monthly principal and interest payments of $1,028 beginning in
October 1998 for a period of twelve years and bears an annual interest rate of
7%. The balance of the note at January 31, 1999 was $98,204 and is included as
part of the long term debt balance.
In May 1998, the Company commenced a $700,000 private placement financing of the
Company's securities in which Ridgewood Capital Funding, Inc. ("Ridgewood")
agreed to serve as the placement agent. John T. Sheehy, a member of the Board
of Directors of the Company, assisted Ridgewood in conducting the offering,
acting as a registered broker under Ridgewood's broker-dealership. In addition,
certain directors of the Company and The Value Group, LLC participated in the
private placement financing by investing in the Company's securities.
Ingram Entertainment Inc. has been the principal supplier of videocassettes and
related equipment to the Company, 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 Entertainment
Corporation, Ingram accepted 1,500,000 shares of common stock of the Company in
consideration of $3,000,000 of the Company's indebtedness to Ingram, reducing
the Company's remaining long-term indebtedness to Ingram to $1,500,000. 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.
In March 1998, the Company used funds in the amount of $1,500,000 from a credit
facility to pay off the term loan owing to Ingram.
In addition, the Company entered into a new long-term supply agreement with
Ingram for videocassettes and related products (Note 9); 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, 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 common stock of the Company.
On March 25, 1998, the Company entered into a restructured debt agreement with
Rentrak Corporation ("Rentrak"), a major lessor of videocassettes under a
revenue sharing arrangement (Note 9). Prior to the acquisition of the five
companies on March 25, 1998, the Company and Sulpizio One, Inc. (one of the
acquired companies) were parties to such arrangements with Rentrak. As part of
the restructuring, Rentrak agreed to accept 194,950 shares of the Company's
Common Stock in settlement of a lawsuit Rentrak had previously filed against
Adventures in Video, Inc. (one of the acquired companies), and 470,162 shares of
the Company's Common Stock in satisfaction of indebtedness owed to Rentrak by
Sulpizio One, Inc. As part of the restructured debt agreement, Rentrak also
agreed to a deferral of certain amounts owed to it by Sulpizio One, Inc. and the
Company, and obtained a security interest in the assets of the Company to secure
such amounts. Rentrak also released Robert Y. Lee, the Company's Chairman of the
Board and Chief Executive Officer, from personal guaranties of the Company's
indebtedness that Mr. Lee had previously given. Rentrak's wholly-owned
subsidiary, Mortco, Inc., is a principal stockholder of the Company.
The Company either purchases or leases approximately 80% of its supply of new
release videos, in the aggregate, from two suppliers, Ingram and Rentrak. During
fiscal 1999, the Company purchased approximately $4,660,000 of product from
Ingram Entertainment and approximately $1,035,000 of product from Rentrak. 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. Failure to obtain comparable service,
support or payment terms from an alternative supplier could have a material
adverse effect on the Company's financial condition and results of operations.
F-17
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
On March 25, 1998, the Company sold the rights to its library of 47 feature
films and other properties and related accounts receivable to an entity owned
and controlled by Stephen C. Lehman, a member of the Company's board of
directors, for $1,350,000 in cash. During the fourth quarter of fiscal 1998,
the film library was written down by $3,030,000 to reflect its net realizable
value at January 31, 1998. The library was the principal asset of Prism prior
to the merger in January 1997 of Lee Video City with and into Prism. Under the
agreement by which the Company sold its film rights, the Company has a right to
buy back the film library at any time through February 4, 1999 at escalating
prices ranging from $1,650,000 to $1,850,000, less amounts actually received and
collected by the buyer. The Company did not exercise this right.
In January 1997, the Company entered into a seven year Non-Competition Agreement
with Barry Collier, former president of Prism. Pursuant to the agreement, the
Company is obligated to pay Mr. Collier $147,500 over a period of 15 months
commencing on November 15, 1997.
The Company has entered into employment and consulting agreements with certain
shareholders (Note 9).
4. Notes Receivable
At January 31, 1999 and 1998, the Company had unsecured employee and director
loans aggregating approximately $86,703 and $86,700, respectively, bearing
interest at 7%, and due on demand. Included in notes receivable was a secured
note amounting to approximately $144,200 as of January 31, 1998, bearing
interest at 8%. The balance of the note was satisfied on September 30, 1998 as
part of the consideration received by the former owner of Far West
Entertainment, Inc. for the purchase of the assets of its two video stores.
Notes receivable also includes other miscellaneous unsecured notes receivable of
approximately $124,500 as of January 31, 1998.
5. Property and Equipment
Property and equipment are comprised of the following:
January 31, January 31,
1999 1998
----------- -----------
Furniture and fixtures $ 2,188,217 $ 1,192,192
Equipment 2,457,431 811,911
Leasehold Improvements 2,058,056 435,917
----------- -----------
Total Property and Equipment 6,703,704 2,440,020
Accumulated depreciation and amortization (2,177,718) (1,580,312)
----------- -----------
Total Property and Equipment, net $ 4,525,986 $ 859,708
=========== ===========
Depreciation and amortization expense was $601,000, $347,000 and $531,000 for
the years ended January 31, 1999 and 1998 and December 31, 1996.
6. Senior Secured Revolving Credit Facility
On March 25, 1998, the Company entered into a $7,500,000 Loan and Security
Agreement with FINOVA Capital Corporation, secured by all of the assets of the
Company and its subsidiaries.
F-18
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
The interest rate on this loan was at a per annum rate of 2.75% plus the prime
rate of Citibank, N.A. This credit facility was paid off on December 29, 1998 at
the time of the Videoland purchase.
On December 29, 1998, the Company entered into a Senior Secured Revolving Credit
Facility agreement (the "Credit Facility") with BankBoston to be used for
working capital purposes and capital expenditures. The Credit Facility bears
interest at the bank's prime rate plus 1/2 percent (8.25% at January 31, 1999)
and is secured by substantially all assets of the Company. The amount available
for borrowing under the Credit Facility is determined by deducting the Company's
principal balance of the Credit Facility from its borrowing base. The borrowing
base is determined by multiplying the applicable inventory advance rate and the
number of units of the acceptable inventory, net of reserves. The maximum amount
available to borrow is the lesser of the borrowing base or $30,000,000. The
Credit Facility matures on December 29, 2001. The Credit Facility contains
various financial covenants of which the Company is in compliance at January 31,
1999. The loan fees related to the loan are capitalized and amortized over the
three-year term of the loan. The balance of deferred loan charges, net of
related amortization, at January 31, 1999 is $675,695 and is included in other
assets.
F-19
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
7. Long-Term Debt
Long-term debt is summarized in the following table:
January 31, January 31,
1999 1998
---------- -----------
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 and interest paid in March 1998. $ - $ 1,500,000
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 - 1,411,306
rate plus 3%.
Other loan payable to individual for $50,000 (unsecured), bearing
interest at 11%, with personal guarantee by primary stockholder of the - 50,000
Company.
Other unsecured loan to fulfill settlement obligation for $259,847,
payable in monthly installments of $8,000, including interest at 8.5%
per annum until February 20, 2000. 92,033 203,414
Promissory note - Rentrak Fourth Addendum which was executed in July
1997 called for the conversion of balances in accounts payable to a
note with an interest rate of 10% due and payable in January 1998. - 435,032
Promissory notes, secured by certain assets subordinate to the credit
facility (note 6), payable in monthly installments of $34,403 and
$5,952, interest imputed at 9% per annum, due June 2003. 1,782,484 -
Promissory notes, secured by certain assets subordinate to the credit
facility (note 6), at interest rates varying from 9% to 10% per annum, 1,405,141 -
due from April 1999 to July 1999
Other unsecured obligations, including interest from 7% to 15% per
annum, due from March 1999 to September 2010. 482,175 118,136
----------- -----------
Total debt 3,761,833 3,717,888
Less current portion (2,125,187) (1,674,457)
----------- -----------
Total long-term debt $ 1,636,646 $ 2,043,431
----------- -----------
Total maturities of remaining long-term debt for five years subsequent to
January 31, 1999 are presented in the following table:
Year ending Amount
January 31,
----------- ------
2000 $ 2,271,913
2001 589,450
2002 490,751
2003 491,120
2004 209,238
Thereafter 65,592
--------------
$ 4,118,064
Less: imputed interest 356,231
--------------
Total $ 3,761,833
==============
8. Income Taxes
As of January 31, 1999, net operating loss carryforwards generated by the
Company of approximately $6,037,000 and $2,999,000 for Federal and California
income tax purposes are available to offset future taxable income through 2019.
The Company's ability to utilize net operating loss carryforwards is
F-20
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
dependent upon its ability to generate taxable income in future periods.
Approximately $650,000 of Federal and $305,000 of State net operating losses may
be limited due to ownership changes (as defined under Section 382 of the
Internal Revenue Code of 1986) which occurred on January 8, 1997 and resulted in
an annual limitation per year. Unused annual limitations 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.
The income tax provision (benefit) is comprised of the following current and
deferred amounts:
Year Ended Year Ended Year Ended
January 31, January 31, December 31,
1999 1998 1996
----------- ----------- -----------
Current
- -------
Federal $ - $ - $ -
State 5,000 - -
----------- ----------- -----------
5,000 - -
----------- ----------- -----------
Deferred
- --------
Federal (2,384,229) - -
State (236,728) - -
----------- ----------- -----------
(2,620,957) - -
----------- ----------- -----------
$(2,615,957) $ - $ -
=========== =========== ===========
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 more likely than not that the Company will
realize this tax benefit. Therefore, the valuation allowance that had been
established for a portion of the deferred tax asset has been reversed for the
year ended January 31, 1999.
The assets acquired from the Videoland merger were recorded at fair market value
for financial statement purposes. The difference between that value and the tax
basis of the assets result in a deferred tax liability of approximately
$1,732,708 as of January 31, 1999. The following table presents the primary
components of the Company's net long-term deferred tax asset:
January 31, January 31,
1999 1998
--------------- ---------------
Components of long-term deferred tax assets:
Rental inventory principally due to difference in
amortization $ - $ (48,315)
Federal and State NOL carryforward 2,227,462 817,887
Videoland fixed asset basis difference 1,043,903 -
Fixed assets due to difference in depreciation and
amortization 202,219 87,067
Section 481 adjustment - 39,707
Deferred rent 170,389 73,441
Non-recurring writedown of Film Library - 1,211,932
F-21
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
Other 15,887 13,678
--------------- ---------------
Total gross deferred tax asset 3,659,860 2,195,397
Valuation allowance - (2,195,397)
--------------- ---------------
Total deferred tax asset, net of valuation allowance 3,659,860 -
--------------- ---------------
Components of long-term deferred tax liability:
Videoland inventory basis difference (2,776,611) -
--------------- ---------------
Net long-term deferred tax asset $ 883,249 $ -
=============== ===============
The total income tax provision differs from the amount computed by applying the
statutory Federal income tax rate for the following reasons:
Year Ended Year Ended Year Ended
January 31, 1999 January 31, 1998 December 31, 1996
---------------- ---------------- -----------------
% of % of % of
Pretax Pretax Pretax
income income income
------ ------ ------
Income tax at Federal statutory rate (34.0)% (34.0)% (34.0)%
State taxes, net of Federal tax benefit 2.4 % (5.8)% (5.8)%
Valuation allowance (84.3)% 39.5 % 39.8 %
Expiration of net operating losses 14.9 % - % - %
Other 0.6 % 0.3 % - %
------ ------ ------
Total (100.4)% 0.0 % 0.0 %
====== ====== ======
9. Commitments and Contingencies
Operating Leases - The Company leases its facilities under noncancelable
operating leases expiring at various dates through 2013. Rent expense under
operating leases was approximately $3,601,986, $1,502,000 and $1,444,000 for the
years ended January 31, 1999, 1998 and the year ended December 31, 1996.
The future minimum lease payments under noncancelable operating leases with
initial lease terms in excess of one year as of January 31, 1999 are as follows:
Years ending Operating
January 31, Leases
------------ -----------
2000 $ 7,682,374
2001 6,117,381
2002 4,852,814
2003 3,751,184
2004 2,546,154
Thereafter 6,762,362
-----------
Total $31,712,269
-----------
Revenue Sharing Agreement - Pursuant to the Revenue Sharing Agreement (Note 3),
the Company is obligated to pay a major vendor revenue sharing and handling fee
payments that are equal on an annual basis to at least 10% of the Company's
gross revenues. During fiscal 1999, the Company purchased approximately
$1,035,000 of product from this vendor.
Vendor Supply Agreement - 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
F-22
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
for the video rental, video sell-through and video game products. The agreement
expires on June 30, 2001. During fiscal 1999, the Company purchased
approximately $4,660,000 of product from this supplier. The Company's CEO and
the same supplier entered into an Override Agreement dated November 19, 1996
which provides, subject to certain exceptions, that without the written consent
of the supplier, 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 the supplier, or such time as the supplier's beneficial
ownership interest in the Company's common stock, on a fully diluted basis, is
4% or less. The $1,500,000 debt was paid in March 1998, however, the supplier's
beneficial ownership interest in the Company's common stock, on a fully diluted
basis remains greater than 4%.
Employment Agreements - The Company has entered into employment agreements with
various of its key officers. In general, these agreements cover a period of
three years or less. The annual salary amounts for these agreements range from
$117,500 to $178,000. In the event that the employment of any of the these
officers 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.
Other Agreements - On March 25, 1998, the Company acquired Adventures in Video,
Inc. ("Adventures in Video") and KDDJ Investments, Inc. ("KDDJ") from David A.
Ballstadt and members of his immediate family pursuant to two Agreements of
Merger and Plan of Reorganization (each a "Merger Agreement"). Adventures in
Video owns and operates 13 stores in the greater Minneapolis metropolitan area
and KDDJ owns and operates three stores in San Francisco, California. The
purchase price for Adventures in Video was 866,000 shares of the Company's
Common Stock. The purchase price for KDDJ was 216,500 shares of the Company's
Common. Pursuant to the Adventures in Video Merger Agreement, the Company paid
off existing indebtedness of approximately $449,000 that Adventures in Video
owed to Marquette Bank, N.A. Concurrently with these two acquisitions, the
Board of Directors of the Company was expanded from eight to nine members and
David A. Ballstadt was elected to fill this vacancy. Mr. Ballstadt has served
as a director of the Company since the consummation of the two acquisitions.
The Company also entered into a two-year employment agreement with Mr. Ballstadt
at a salary of $100,000 per year plus a possible bonus of up to $100,000 per
year based on increases, if any, in certain dealer allowances, and certain
additional benefits.
On April 16, 1997, the Company entered into three year consulting agreements
with Gerald W. B. Weber and Stephen C. Lehman pursuant to which Messrs. Weber
and Lehman shall provide finance, acquisitions and corporate development
consulting services to the Company. The consulting agreements of Messrs. Weber
and Lehman provide for compensation in the form of options to purchase an
aggregate of 75,000 and 90,000 shares, respectively, of the Company's Common
Stock at $2.00 per share. Options to purchase one-third of such shares of
Common Stock vest each year commencing on April 16, 1997 and any unexercise
portions terminate on April 15, 2002. Each consulting agreement also provides
that the Company shall reimburse the consultant for reasonable out-of-pocket
expenses incurred in performing his consulting services, that the Company shall
indemnify the consultant with respect to any claims made against the consultant
arising in connection with the consulting service, and that either party may
terminate the consulting agreement by providing 30 days notice to the other
party. On March 24, 1998, Mr. Lehman's consulting agreement was amended to
provide Mr. Lehman additional compensation in the form of warrants to purchase
100,000 shares of the Company's Common Stock at $2.00 per share. Messrs. Weber
and Lehman are directors of the Company.
F-23
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
In April 1997, the Company entered into an engagement agreement with Sphere
Capital Partners ("Sphere Capital") pursuant to which Sphere Capital shall act
as the exclusive financial advisor to the Company providing financial
management, acquisition and financing advisory services for a period of one year
commencing April 1997 and for such additional one year terms as may be mutually
agreed to by Sphere Capital and the Company. The agreement provided that during
the term of the engagement, Sphere Capital shall limit its financial advisory
services within the video retail industry solely to the Company. The engagement
agreement provided for a base fee of $5,000 per month which shall be credited
against any transaction fees to which Sphere Capital may be entitled upon
consummation of any acquisition or financing transaction. The engagement
agreement also provided that the Company would reimburse Sphere Capital for
reasonable out-of-pocket expenses incurred in performing its financial advisory
services and that either party may terminate the engagement by providing 45 days
notice to the other party. In May 1997, Sphere Capital assigned the agreement
to The Value Group, LLC. During the fiscal year ended January 31, 1998, the
Company paid Sphere Capital fees in the amount of approximately $28,000.
Effective April 1998, a new engagement agreement was entered into by the Company
and The Value Group, LLC, the successor entity to Sphere Capital, which provides
for a base fee of $2,500 per month which shall be credited against any
transaction fees to which The Value Group, LLC, may be entitled upon
consummation of any acquisition or financing transaction, John T. Sheehy serves
as a director of the Company and is a Managing Director of The Value Group, LLC
and its predecessor, Sphere Capital.
Litigation
The Company is subject to certain legal proceedings and claims arising in
connection with its business. In the opinion of management, there are currently
no claims that will have a material adverse effect on the Company's consolidated
financial position, results of operations or cash flows.
10. Stockholders' Equity
Redeemable Preferred Stock - In June 1998, the Company sold an aggregate of
7,000 shares of its Series A Convertible Redeemable Preferred Stock ("Series A
Preferred Stock") with a stated value of $100 per share and detachable warrants
to purchase an aggregate of 350,000 shares of the Company's Common Stock at an
exercise price of $2.00 per share to eight investors, including certain
directors of the Company and their affiliates, for a total consideration of
$700,000, less related expenses of $76,227. Each share of Series A Preferred
Stock is convertible into 50 shares of the Company's Common Stock, subject to
adjustment. The Company authorized 20,000 shares and the terms of the Series A
Preferred Stock require the Company to redeem the Series A Preferred Stock in
May 2003. In the fourth quarter, these shares were exchanged for an equivalent
number of shares of Series AA Convertible Redeemable Preferred Stock ("Series AA
Preferred Stock"). The terms of the Series AA Preferred Stock are identical to
those of the Series A Preferred Stock except that the Series AA Preferred Stock
does not provide for mandatory redemption and provides for the issuance of
common stock dividends. In December 1998, the Company granted 750 shares of
Series AA Preferred Stock to a supplier for satisfaction of accounts payable.
On December 28, 1998, in connection with the Videoland acquisition, the Company
issued 76,000 shares of the Company's Series B Voting Convertible Redeemable
Preferred Stock with a stated value of $100 per share (200,000 shares
authorized). A portion of the 76,000 shares of the Company's Series B Preferred
Stock issued to the former owners as part of the consideration for the
acquisition has been pledged to the Company in order to secure Videoland's
existing shareholder receivable in the amount of $1,370,673. In the event the
trading price of the Company's Common Stock for any period of 20 consecutive
trading days during the five year period commencing December 28, 1998 is equal
to or exceeds $3.1667, then the Company may, at its option, receive the number
of outstanding shares of the Series B Preferred Stock then held by the former
owners
F-24
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
determined by dividing (i) the total amount of the outstanding receivable by
(ii) $100, or any lesser number of outstanding shares of Series B Preferred
Stock then held by the former owners, in exchange for full or partial
satisfaction of the applicable amount then owed. Not withstanding the foregoing,
in the event such trading price for any period of 20 consecutive trading days
during the five year period commencing December 28, 1998 does not equal or
exceed $3.1667, then at the end of such five year period, the Company shall
forgive the $1,370,673 receivable balance oustanding. This receivable has been
recorded as a reduction against the carrying value of the Company's Series B
Convertible Redeemable Preferred Stock.
The holders of these shares shall have the right to convert all or any shares
into duly authorized, validly issued, fully paid and nonassessable shares of
Common Stock of the Company. Each share of Series B Preferred Stock shall be
converted into a number of shares of common stock determined by dividing (i)
$100 by (ii) the conversion price initially set at $3.1667. The outstanding
shares of Series B Preferred Stock may be redeemed, in whole or in part, at any
time at the option of the Company for cash at $100 per share, plus, in each
case, all declared and unpaid dividends thereon, if any, to the redemption date.
The holders of the outstanding shares shall be entitled to receive when, as and
if declared by the Board of Directors, cumulative dividends at an annual rate of
8.0% of the stated value per share. In the event the Company is unable to pay
such dividends in cash, the Company may pay such dividends in shares of common
stock of the Company. The holders of these shares have agreed to waive and
discharge the Company of its obligation to pay such dividends during the period
January 1999 to June 1999 in exchange for a monthly consultant fee of $50,667
per month.
Common Stock - In September 1998, the Company issued 1,050,000 shares of its
common stock as part of the purchase price for all of the outstanding shares of
capital stock of Video Tyme Inc. Video Tyme owned and operated seven retail
video stores in Las Vegas, Nevada, of which six were acquired. In September
1998, the Company issued 32,000 shares of its common stock as part of the
purchase price for the two video stores acquired from Far West Entertainment,
Inc. Also in September 1998, the Company issued 38,500 shares of common stock
for the asset purchase of one video store. In December 1998, the Company issued
49,497 shares of common stock to various vendors for satisfaction of accounts
payable.
In June 1998, the Company issued 9,375 shares of its common stock to a
consultant for professional services rendered to the Company. Also in June
1998, the Company issued 127,305 shares of its common stock to a vendor for
services and equipment rendered to the Company and 57,111 shares of its common
stock to a supplier for satisfaction of accounts payable.
In March 1998, the Company issued 1,682,500 shares of its common stock to
acquire five corporations owning and operating an aggregate of 29 retail video
stores (Note 2).
Common Stock Warrants - 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 was fixed
at 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 was fixed at a maximum of 341,141 shares at a weighted average exercise
price of $0.45 per share. The
F-25
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
warrant was exercisable during the period commencing June 19, 1997 and ending on
September 30, 2005.
In 1997, the Company cancelled the above described warrants granted to the
distributor and reissued 131,483 and 65,077 warrants effective June 1, 1995 and
June 1, 1996, respectively. These warrants vested immediately, are exercisable
at $3.04 and $0.47, respectively, and expire five years from the date of grant.
During 1995, the Company issued a warrant to its major supplier (Note 9) 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 common stock from a 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.
As a result of the Prism Entertainment merger and effective on the merger date,
the major supplier also received warrants to purchase up to an aggregate of
852,750 shares of the Company's common stock. A summary of these warrants is
presented below:
Number Life Exercise
of Shares (Years) 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
-------
852,750
In June 1998, the Company, in conjunction with the sale of an aggregate of 7,000
shares of its Series A Convertible Redeemable Preferred Stock ("Series A
Preferred Stock"), issued detachable warrants to purchase an aggregate of
350,000 shares of the Company's common stock at an exercise price of $2.00 per
share to eight investors, including certain directors of the Company and their
affiliates, for a total consideration of $700,000. In the fourth quarter of
1998, the Company issued warrants to purchase an aggregate of 105,000 shares of
the Company's common stock at an exercise price of $2.00 per share to various
consultants as payment for services provided to the Company by such consultants.
F-26
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
Stock Option Plan - The stock option plans adopted by the Company allow the
Company to grant up to 5,364,000 stock options to qualified employees,
directors, and affiliates. A summary of the Company's warrant and stock option
activity and related information is presented in the following table:
Year Ended January 31, Year Ended January 31, Year Ended December 31,
1999 1998 1996
---------------------- ---------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at beginning of year 3,947,435 $1.47 3,549,997 $1.45 1,355,483 $0.93
Granted 1,756,936 1.41 397,438 1.65 2,194,514 1.76
Exercised - - - - - -
Cancelled (520,720) 0.01 - - - -
--------- ----- --------- ----- --------- -----
Outstanding at end of year 5,183,651 $1.59 3,947,435 $1.47 3,549,997 $1.45
========= ===== ========= ===== ========= =====
Options exercisable at year end 4,142,265 $1.49 3,320,881 $1.36 2,827,310 $1.30
========= ===== ========= ===== ========= =====
Information relating to warrants and stock options at January 31, 1999
summarized by exercise price is presented in the following table:
Outstanding Exercisable
-------------------------------------------------------------- ----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Price Contractual Exercise Exercise
Per Share Shares Life Price Shares Price
-------------- --------- ----------- -------- --------- --------
$0.10 to $0.51 1,195,917 1.8 years $0.43 1,195,917 $0.43
1.00 to 1.03 531,760 1.4 years 1.02 531,760 1.02
2.00 to 2.00 2,924,491 6.0 years 2.00 1,883,105 2.00
2.25 to 3.04 531,483 2.5 years 2.54 531,483 2.54
-------------- --------- ----------- -------- --------- --------
5,183,651 4.2 years $1.59 4,142,265 $1.49
========= =========== ======== ========= ========
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 income (loss) and earnings (loss) per share would be as
follows:
Year Ended Year Ended Year Ended
January 31, January 31, December 31,
1999 1998 1996
--------- ----------- -------
Net income (loss) As reported $ 11,134 $(2,975,315) (42,924)
Proforma (184,277) (2,988,270) (42,924)
Diluted earnings (loss) per share As reported $ 0.00 $ (0.30) (0.01)
Proforma (0.01) (0.30) (0.01)
The fair value of options granted during the year ended January 31, 1999 is
estimated on the date of grant utilizing a Black-Scholes pricing model over the
expected life of the options ranging from 3 to 5 years, expected volatility of
70%, risk-free interest rates ranging from 4.45% to 5.61%, and a 0% dividend
yield. The weighted average fair value of options granted was $0.54.
F-27
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
The fair value of options granted during the years ended January 31, 1998 and
December 31, 1996 are estimated on the date of grant utilizing a Black-Scholes
pricing model over the expected life of the options 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.
11. Earnings Per Share
The following table summarizes the calculation of the Company's basic and
diluted earnings per share for the periods presented:
Year Ended January 31, 1999 Year Ended January 31, 1998 Year Ended December 31, 1996
--------------------------- -------------------------------- ----------------------------
Per- Per- Per-
Income share share Income share
(loss) Shares amount Income (loss) Shares amount (loss) Shares amount
------ ------ ------ ------------- ------ ------ ------ ------ ------
Basic EPS
Income (loss) available
to common stockholders:
Net income (loss) $11,134 12,091,467 $0.00 $(2,975,315) 9,770,594 $(0.30) $(42,924) 4,234,024 $(0.01)
Effect of Dilutive Securities:
Incremental shares from
outstanding common stock
options, warrants, and
preferred stock 1,336,911 - -
------- ---------- ----- ----------- --------- ------ --------- --------- ------
Diluted EPS
Income (loss) available to
common stockholders
Net income (loss) $11,134 13,428,378 $0.00 $(2,975,315) 9,770,594 $(0.30) $(42,924) 4,234,024 $(0.01)
------- ---------- ----- ----------- --------- ------ --------- --------- ------
Warrants to purchase 15,000 shares at $1.00, 54,360 shares at $1.03, 724,150
shares at $2.00, 200,000 shares at $2.25, 200,000 shares at $2.50, and 131,483
shares at $3.04 were outstanding for the year ended January 31, 1999, but were
not included in the computations of diluted earnings per share because the
effect of exercise would have an antidilutive effect on earnings per share.
Warrants to purchase 114,240 at $0.51, 65,077 at $0.47, 15,000 shares at $1.00,
54,360 shares at $1.03, 269,150 shares at $2.00, 200,000 shares at $2.25,
200,000 shares at $2.50, and 131,483 shares at $3.04 were outstanding for the
year ended January 31, 1998, but were not included in the computations of
diluted earnings per share because the effect of exercise would have an
antidilutive effect on earnings per share.
Warrants to purchase 65,077 at $0.47 and 131,483 shares at $3.04 were
outstanding for the year ended December 31, 1996, but were not included in the
computations of diluted earnings per share because the effect of exercise would
have an antidilutive effect on earnings per share.
12. Gain on Disposition of Assets
During 1996, the Company sold 11 stores and the resulting gain on sale of assets
is included in the statement of operations.
13. 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:
F-28
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
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.
Senior Secured Revolving Credit Facility: Estimated based upon variable
interest rates for facilities with similar terms and maturities.
The estimated fair values of the Company's financial instruments are as follows:
January 31, 1999 January 31, 1998
---------------------------- --------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
----------- ----------- ---------- ----------
Financial Assets:
Notes Receivable $ - $ - $ 355,430 $ 355,830
Financial Liabilities:
Long-Term Debt $ 5,143,004 $ 5,143,004 $3,717,888 $3,717,888
Senior Secured Revolving
Credit Facility $16,044,502 $16,044,502 $ - $ -
14. Writedown of Film Library
During the fourth quarter of fiscal 1998, management decided to dispose of the
film library in order to concentrate the Company's business on the ownership and
operation of video specialty superstores. The film library was written down by
$3,030,000 to reflect it's net realizable value at January 31, 1998. On March
25, 1998, the Company sold the rights to its library of 47 feature films and
other properties and related accounts receivable to an entity owned and
controlled by Stephen C. Lehman, a member of the Company's board of directors,
for $1,350,000 in cash. The film library was stated at the net realizable value
at January 31, 1998. The library was the principal asset of Prism prior to the
merger in January 1997 of Lee Video City with and into Prism. Under the
agreement by which the Company sold its film rights, the Company had a right to
buy back the film library at any time through February 4, 1999 at escalating
prices ranging from $1,650,000 to $1,850,000, less amounts actually received and
collected by the buyer. The Company did not exercise this right.
15. Employee Benefit Plans
The Company maintains a 401(k) profit sharing plan, which allows eligible
employees to defer part of their income on a pre-tax basis through contributions
to the plan. The Company also provides a 15% matching contribution of up to 20%
of an employee's salary.
16. Subsequent Events
Acquisition of Video Galaxy, Inc. - On March 31, 1999, the Company acquired
Video Galaxy, Inc. (Video Galaxy") from the shareholders of Video Galaxy, in a
transaction structured as a reverse triangular merger, with a newly formed
subsidiary of Video City merging into Video Galaxy. Video Galaxy owns and
operates 15 retail video stores, fourteen of which are located in Connecticut
and one in Massachusetts and had aggregate revenues of approximately $5,800,000
during the year ended December 31, 1998. The acquisition increased Video City's
chain of retail video stores from 128 to 143.
F-29
Video City, Inc.
(Formerly Lee Video City, Inc.)
Notes to Consolidated Financial Statements
The purchase price consisted of (i) 360,667 shares of the Company's common stock
(subject to post-closing adjustments, if any) and (ii) assumption and payment of
indebtedness of Video Galaxy by the Company in the amount of $4,833,000 (of
which approximately $1,757,000 was paid off by the Company at closing and
$2,000,000 was converted into shares of the Company's preferred stock and
warrants). The payoff of indebtedness at closing was provided by cash obtained
from an existing creditor of the Company.
Pending Sale of Assets - On April 22, 1999, the Company entered into a
definitive asset purchase agreement with a third party for the purpose of
selling substantially all of the assets of 50 of the Company's video retail
stores located in the states of Washington and Oregon.
The consideration received by the Company for the sale is expected to be
$16,200,000, subject to the following post-closing adjustment, if any: if the
actual number of videocassettes held for rental and for sale and the actual
number of new retail videocassettes which are included as part of the purchased
inventory is less than the minimum number of tapes as defined in the agreement,
the purchase price shall be reduced by an amount equal to the result of
multiplying the difference between the minimum inventory and the actual
inventory by the predetermined value defined in the agreement for each item.
There is no assurance that the sale will ultimately be consummated.
F-30