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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, 2001
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.)
4800 Easton Drive, Suite 108 Bakersfield, California 93309
(Address of principal executive offices) (Zip Code)
(661) 634-9171
(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 [_] NO [_]
The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of January 7, 2002, was approximately $70,000.
The number of shares of common stock outstanding as January 20, 2002 was
16,442,662 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. [X]
Documents Incorporated by Reference
NONE
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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 elsewhere in this Annual Report.
PART I
ITEM 1. BUSINESS
General
Video City, Inc. ("Video City" or the "Company") owns and operates video
specialty stores located in the United States that rent and sell videocassettes,
digital video discs ("DVDs"), and video games.
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 publicly
traded film company incorporated in Delaware 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 were located at 9998 Global Road,
Second Floor, Philadelphia, Pennsylvania, 19115. In February 2001, concurrent
with the termination of the Management Agreement with West Coast Entertainment,
the Company relocated its corporate offices to 4800 Easton Drive Suite 108,
Bakersfield, California 93309 and its new telephone number is (661) 634-9171.
PROCEEDINGS UNDER CHAPTER 11
On August 24, 2000, the Company and its subsidiaries filed voluntary petitions
seeking reorganization under Chapter 11 of the United States Bankruptcy Code
(the "Bankruptcy Code") in the United States Bankruptcy Court of the Central
District of California (the "Bankruptcy Court"). These petitions were jointly
administered under Case Number LA00-34254TD, pursuant to Rule 1015b of the
Federal Rules of Bankruptcy Procedure. The Company was in possession of its
properties and assets and continued to operate with its existing directors and
officers as debtors-in-possession. The Company was authorized to operate its
business, but could not engage in transactions outside the normal course of
business without approval, after notice and hearing, of the Bankruptcy Court.
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Pursuant to the provisions of the Bankruptcy Code, as of the petition date
actions to collect pre-petition indebtedness owed by the Company were stayed and
other pre-petition contractual obligations could not be enforced against the
Company. In addition, as debtors-in-possession, the Company had the right,
subject to the Bankruptcy Court's approval and certain other conditions, to
assume or reject any pre-petition executory contracts and unexpired leases.
Parties affected by these rejections could file claims with the Bankruptcy Court
in accordance with the reorganization process. The Bankruptcy Court approved
payment of certain pre-petition liabilities such as employee wages and benefits.
Furthermore, the Bankruptcy Court allowed for the retention of legal and
financial professionals.
The Company presented a plan of reorganization to the Bankruptcy Court on July
10, 2001 to reorganize the Company's businesses and to restructure the Company's
obligations. On July 30, 2001 the Bankruptcy Court approved the company's plan
of reorganization with an effective date of August 29, 2001.
Industry Overview
Home Entertainment Retail Industry. According to Paul Kagan Associates,
Inc. ("Paul Kagan"), the U.S. videocassette and DVD rental and sales industry
has grown from $10.9 billion in revenue in 1991 to $19.9 billion in 2000 with
87% of all television households owning a videocassette recorder ("VCR") or DVD
Player. The industry is projected to reach $27.4 billion in revenue by 2010 with
92% VCR and DVD penetration in television households, according to Paul Kagan.
According to Adams Media Research, DVD consoles were expected to reach 25
million U.S. homes by the end of 2001. It has been a breakout year for DVD and
in 2002 the pace is expected to continue as DVD console households are expected
to reach 36 million penetration.
Cambridge Associates consultant Mr. Richard Kelly reports that despite
escalating DVD growth, tape duplication hasn't shrunk as quickly as some
analysts had predicted. In his lastest IRMA report, Kelly estimated VHS output
at 980 million cassettes in 2000, 922 million prerecorded cassettes in 2001 and
projections for 840 million in 2002, still a significant market force. DVD
replication is expected to soar from 284 million discs to 700 million in the
same three-year period.
As mentioned above, 87% of the U.S. households own at least one VCR or DVD
Player, and on the average rent videos at least a couple of times each month. We
believe that the following factors, among others, make video and DVD rental a
preferred medium of entertainment for millions of customers:
. the opportunity to browse among a very broad selection of movies;
. the control over viewing, such as the ability to control start, stop, pause,
fast-forward, rewind and screen select; and
. the opportunity to entertain one or more people at home for a reasonable
price.
In addition, a significant competitive advantage that our industry
currently enjoys over most other movie distribution channels except theatrical
release, is the early timing of our distribution "window." After the initial
theatrical release, studios make their movies available for rental over to video
and DVD stores for a specified period of time. This window is exclusive against
most other forms of non-theatrical movie distribution, such as pay-per-view,
premium television, basic cable and network and syndicated television.
The home entertainment industry is highly fragmented and continues to
experience consolidation pressures. Trends toward consolidation have been fueled
by the competitive impact of superstores on smaller retailers and the need for
enhanced access to working capital and economies of scale. However, the home
entertainment industry has experienced consolidation in recent years, as home
entertainment store chains have gained significant market share from single
store operators. We believe that small stores and chains in the home
entertainment industry will continue to consolidate with national and regional
chains and that such consolidation will offer
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us selective acquisition opportunities. We believe that there are several
competitive advantages in being a regional home entertainment chain, including
marketing efficiencies, access to sophisticated information systems, and
competitive pricing. Even if there is significant consolidation, however, we
expect that the home entertainment industry will remain fragmented.
Movie Studio Dependence on Video Retailing. According to Paul Kagan, the
home entertainment industry is the largest single source of domestic revenue to
movie studios and independent suppliers of theatrical and direct-to-video movies
and represent approximately $8.0 billion (an 8.5% increase from 1999), or 49%,
of the estimated $16.4 billion of revenue generated in 2000. The Company
believes that of the many movies produced by major studios and released in the
United States each year, relatively few are profitable for the studios based on
the box office revenue alone. The Company believes the consumer is more likely
to view "non hit" movies on rented videocassettee and DVD than in any other
medium because retail home entertainment stores provide an inviting opportunity
to browse and make an impulse choice among a very broad selection of new
releases. As a result, retail home entertainment stores, including those
operated by the Company, purchase movies on videocassette and DVD 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 home entertainment retail industry
includes both rentals and sales, the consumer market for prerecorded
videocassettes and DVDs has been primarily comprised of rentals. By setting the
wholesale prices, movie studios influence the relative levels of videocassette
and DVD rentals versus sales. Videocassettes released at a relatively high
price, typically $60 to $70 for video, are purchased by home entertainment
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. DVDs are released and sold for both rental and sale at a
relatively low price, typically $16 to $17. Home entertainment specialty stores
utilize this format mainly for rental, with only a small percentage of DVDs used
for sell-through. In general, movie studios attempt to maximize total revenue
from videocassette and DVD 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. Home
entertainment 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 and DVD
rental revenue was approximately $8.0 billion in 2000 and is expected to
increase to approximately $9.7 billion in 2002.
Business Strategy
Superstore Format. The Company focuses on operating retail home
entertainment superstores. The Company believes a superstore is the most
commercially viable format for home entertainment 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 in many markets to return a rental item to any of its other
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store locations and hence provides a convenience not available in other home
entertainment store chains. In addition, the Company's goal is to place greater
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 and DVDs that will best meet the demands of
customers in particular regions or neighborhoods.
Centralized Real-Time Management. The majority of the stores' point-of-
sale systems are directly connected to the Company's centralized management
information systems which allows real-time communication and the ability for
customers to rent at one location and return at another. In addition, the
systems infrastructure allows close monitoring of sales and inventory, enabling
the Company to actively manage its new videocassette and DVD purchases and
monitor customer demand. The Company periodically redistributes its inventory of
videocassettes and DVDs 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
its success. The Company advertises through local television, radio, newspaper
and direct mail, and promotes its products through various special programs.
Growth Strategy
The following discussion of the Company's growth strategy applied prior to the
Chapter 11 filing in August 2000. Since that filing, this growth strategy has
been suspended.
Development Program. In many regions, the Company believes there are
opportunities for growth. Such growth if any 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. Future store acquisitions, if any, will be pursued
selectively, should 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.
Geographic Concentration. The Company's strategy is to concentrate its
owned and operated expansion, whether through new store development or
acquisitions, in particular geographic areas 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.
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 such growth would adversely affect the Company's business.
There is also no assurance that any newly developed or acquired stores will
achieve sales and profitability comparable to the Company's existing stores.
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Products
Videocassette and DVD Rental. The Company's primary revenue source has been
from the rental of videocassettes. DVDs are an alternative format to VHS tapes
that offer consumers digital picture and sound and additional features such as
enhanced content and interactivity. Each of the Company's stores currently
offers from 6,000 to 15,000 videocassettes and DVDs consisting of from 4,000 to
10,000 different titles. New release titles (titles within one year from release
date) are displayed in the prominent "New Release" section and are organized
alphabetically by title. Other titles are displayed alphabetically 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 guarantee for a limited time of the availability of a
popular new release, (ii) allowing customers to reserve certain titles up to one
week in advance, and (iii) allowing customers to rent and return videocassettes
and DVDs at any of the Company's stores. DVDs have shown to be the fastest
growing sell through and rental category introduced by the Company due to high
consumer demand and the Company's aggressive merchandising strategy to position
the stores to satisfy consumer demand.
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.
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, but showed a decline in 1999 as a result of maturity of the existing
platforms. Based on the game console industry's growth in 2000 and anticipated
additional growth in 2001 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.
Other Products. In addition to videocassette, DVD and Videogame rentals and
sales, the Company also rents videocassette players and video game players in
selected stores and sells 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 17,000 videocassettes and DVDs 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 home
entertainment 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 comprehensive management information systems. The new release
inventory is actively managed, including the redistribution of certain copies to
other stores to meet greater demand.
The following table provides the number of stores in each of the states in
which the Company owned and operated retail home entertainment stores as of
January 7, 2002:
5
Number of
State Stores
- ---------------- ----------
California 20
Idaho 6
Minnesota 5
Nevada 2
Iowa 5
Colorado 2
South Dakota 1
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Total 41
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Supplier Agreements
The Company has had a supply agreement with Rentrak Corporation
("Rentrak"). The Revenue sharing agreement with Rentrak stated that the Company
is obligated to pay Rentrak revenue sharing and handling fee payments that are
equal to on an annual basis of at least 10% of total gross rental revenues. In
October 1999, the Company temporarily ceased leasing or purchasing product with
Rentrak. The Company rejected this agreement as part of its reorganization plan
during its bankruptcy proceeding.
In July 2001 the Company entered into an agreement with Video Products
Distributors ("VPD") under which VPD agreed to become the exclusive video
distributor for all of Video City's home entertainment retail chain. VPD will
provide all videocassettes, DVDs and accessories for rental and sale with the
exception of Warner Brothers Home Video product in all locations. As part of
this agreement, Video City is receiving a line of trade credit and 90 day terms
for repayment to VPD.
In June of 2001, the Company also entered into a purchase money security
agreement directly with Warner Brothers Home Video. The agreement provides the
company with a line of trade credit and 60 day terms for repayment. The company
purchases all Warner Brothers product directly from Warner Brothers Home Video,
which is then distributed to all Video City's home entertainment retail chain
through a third party distributor.
Revenue Sharing
In the fourth quarter of fiscal 2000 and in the first quarter of fiscal
2001, the Company entered into revenue sharing agreements directly with major
studios. Under these agreements, studios supply quantities of specified
videocassettes and DVDs, and the Company shares with the studios an agreed
upon percentage of the rental revenue from these products for a limited period
of time, usually up to 26 weeks following the initial release of the movie. The
revenue sharing agreements, in many cases, also allow the stores to sell the
previously viewed videocassettes and DVDs to their customers.
Revenue sharing allowed Video City to obtain rental product at a lower
product cost than the traditional buying arrangements, and reduces the shelf
life of each rental product. This business model results in a greater proportion
of rental revenue over a shorter period of time. The Company rejected these
revenue sharing agreements as part of its reorganization plan during its
bankruptcy proceeding.
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, DVDs and game cartridges. Each videocassette, DVD
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
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physicalinventories on a quarterly basis. The inventory is redistributed among
the various store locations based on demand at certain locations.
Management Information Systems. It is critically important in home
entertainment retailing to have accurate and timely information relating to
videocassette and DVD 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. The Company has expended significant resources and time
over the past decade to insure a comprehensive management information system.
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 most 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.
Most of the Company's stores' POS systems are linked on a real-time basis,
enabling product and customer data to be shared. This sharing allows product to
be rented from one store and returned to another while tracking the product
through the system. The Company believes it is the only major chain of
superstores that actively uses the real-time sharing so customers can rent and
return at different locations, 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 has advertised through radio, newspaper and direct mail.
Suppliers and movie studios provided advertising credits and market development
funds for certain movie titles that the Company used 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 benefited 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. During the Chapter 11 proceedings which began in August
2000, the Company's advertising activities were limited by budgets that were
subject to Bankruptcy Court review.
Competition
The home entertainment 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.
Many of the Company's competitors have significantly greater financial and
marketing resources and name recognition, although the Company is generally one
of the largest home entertainment retailers 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,
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pricing. Most of the Company's stores compete directly with stores operated by
Blockbuster and/or Hollywood Entertainment. As a result of direct competition
with Blockbuster, Hollywood Entertainment and others, rental pricing of
videocassettes and DVDs 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.
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
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 7, 2002 the Company had approximately 387 employees of whom
approximately 371 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.
ITEM 2. PROPERTIES
All of the Company's stores are leased pursuant to leases with initial
terms ranging from three to ten years, with varying option renewal periods. Most
of the leases are "triple net" requiring the Company to pay all taxes,
insurance, and common area maintenance expenses associated with the properties.
The Company moved its corporate headquarter in February 2001 from
Philadelphia, Pennsylvania to Bakersfield, California. The corporate facility
consists of approximately 4,457 square feet of office space. The Company
considers its corporate offices and stores to be generally suitable and adequate
for their intended purposes.
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ITEM 3. LEGAL PROCEEDINGS
On August 17, 2000, Fleet Retail Finance ("Fleet") purported to accelerate
the outstanding indebtedness under the Company's secured credit facility with
Fleet. Fleet also initiated an action in the Massachusetts State Court to
recover the sums allegedly due under the credit facility and obtained a
temporary order requiring that the Company deposit its cash receipts into
designated Fleet accounts. Additionally, the Company filed a complaint against
Fleet and certain other defendants seeking damages in excess of $25,000,000. The
Complaint alleges fraud, breach of contract, breach of the covenant of good
faith and fair dealing, intentional interference with contractual relations,
intentional interference with advantageous relations, violation of the Racketeer
Influenced and Corrupt Organizations Act and violation of applicable provisions
of Massachusetts state law.
The Company also filed a motion to vacate the temporary order obtained by Fleet
and to restrain Fleet from sweeping the cash from the Company's depository
accounts, which are used to fund operations and payroll. On August 22, 2000 the
Massachusetts court directed Fleet to release enough funds to cover payroll.
On August 24, 2000, as a result of Fleet Retail Finance Retail action to
accelerate payment of the outstanding indebtedness under the Company's secured
credit facility, the Company and its subsidiaries filed voluntary petitions for
reorganization under Chapter 11 of the United States Bankruptcy Code. The
Company is in possession of its properties and assets and continues to operate
with its existing directors and officers as a Debtor-in-Possession. As
debtors-in-possession, the Company is authorized to operate its business, but
may not engage in transactions outside of the normal course of business without
approval, after notice and hearing, of the Bankruptcy Court.
Subsequent to January 31, 2001 the Company and Fleet Retail Finance entered into
an agreement ("the Fleet Compromise"), which was approved by the Court on March
28, 2001. The salient terms of the agreement granted Fleet Retail Finance an
allowed claim in the amount of $10.0 million. In full satisfaction of the claim,
the Company paid Fleet a total of $1.5 million, $1.0 million of which was paid
on March 28, 2001 and $0.5 million on June 29, 2001. In addition, both parties
jointly dismissed the pending actions with prejudice and Fleet Retail Finance
and the Company simultaneously executed a mutual release of any and all claims
against the directors, officers, employees and other representatives of each
company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company submitted no matters to a vote of stockholders during the the
fiscal year ended January 31, 2001.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has traded on the NASD Electronic Bulletin Board
under the symbol "VDCT.OB" The following sets forth for the periods indicated,
the high and low sales prices of the Company's Common Stock as reported on the
NASD Electronic Bulletin Board:
High Low
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Fiscal Year Ended January 31, 2000:
First Fiscal Quarter $2.312 $0.812
Second Fiscal Quarter $2.687 $1.781
Third Fiscal Quarter $1.781 $0.750
Fourth Fiscal Quarter $0.960 $0.375
Fiscal Year Ended January 31, 2001:
First Fiscal Quarter $0.290 $0.850
Second Fiscal Quarter $0.135 $0.320
Third Fiscal Quarter $0.005 $0.180
Fourth Fiscal Quarter $0.006 $0.050
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 January 7, 2002, there were approximately 533 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 cash 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 Chapter 11
Bankruptcy proceeding prohibited the payment of cash dividends on the Company's
Common Stock. Any future determination to pay cash 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.
The Company issued 455,142 shares of the Company's Common Stock to two
shareholders of the Company's Series B Convertible Redeemable Preferred Stock as
stock dividends with respect to the Series B Convertible Redeemable Preferred
Stock ("Series B Preferred Stock"). The stock dividends were issued on a monthly
basis between February 15, 2000 and July 31, 2000.
10
On February 15, 2000 the Company issued 150,000 shares of the Company's
Common Stock to a vendor in satisfaction of certain outstanding payables.
On February 15, 2000 the Company issued 50 shares of the Company's Series C
Convertible Redeemable Preferred Stock , $1,000 stated value per share to a
professional firm in consideration for certain professional services previously
provided to the Company by such firm. Each Share of Series C Convertible
Redeemable Preferred Stock is convertible into 500 shares of the Company's
Common Stock at a conversion price of $2.00 per share.
On February 15, 2000 the Company issued 25 shares of the Company's Series C
Convertible Redeemable Preferred Stock , $1,000 stated value per share to a
financial advisor in consideration for certain financial advisory services
previously provided to the Company. Each Share of Series C Convertible
Redeemable Preferred Stock is convertible into 500 shares of the Company's
Common Stock at a conversion price of $2.00 per share.
On July 30, 2001, the Bankruptcy Court entered an Order confirming Video
City's First Amended Chapter 11 Plan of Reorganization (the "Plan"). The Plan
became effective on August 29, 2001. Pursuant to the Plan, the existing common
shareholders of Video City are to receive 700,000 shares of common stock of
Reorganized Video City in cancellation of all shares of common stock outstanding
prior to such distribution, for pro rata distribution; 700,000 shares of common
stock are to be issued to preferred shareholders in cancellation of all shares
of preferred stock outstanding prior to such distribution; and 5,600,000 shares
are to be issued to Video City's creditors. The Company anticipates that
approximately all liabilities subject to compromise will receive in full
satisfaction of their claims through shares of common stock of Video City based
on the Plan of Reorganization. As part of the plan certain class 4A creditors
had the option to receive 20% of their claim in cash if their claim was under
$1,000 or if they choose to reduce their claim to that amount. The total amount
for all class 4A creditors who opted for the cash payout was less than $22,000.
In addition, certain liabilities subject to compromise consist of tax
obligations of approximately $1.3 million that are to be paid in cash over five
years from date of assessment.
Recent Sales of Unregistered Securities
The Company did not sell unregistered securities in the fourth quarter of
fiscal 2001.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended
January 31, 2001, 2000, 1999, 1998 and December 31, 1997, 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.
Year Ended January 31, Month Year
------------------------------------------------- Ended Ended
Jan 31, Dec 31,
2001 2000 1999 1998 1997 1996
---- ---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
STATEMENT OF OPERATIONS DATA:
Revenues $ 31,615 $ 44,785 $ 24,436 $ 10,212 $ 940 $ 11,441
Operating income (loss) (10,755) (30,001) (1,263) (2,423) (105) (418)
Net income (loss) (12,103) (32,766) 11 (2,976) (133) (43)
Net income (loss) per share (1.01) (2.29) 0.00 (0.30) (0.03) (0.01)
Weighted average shares used in
computation 16,302 14,510 12,091 9,771 4,569 4,234
OPERATING DATA:
Number of stores at end of period 44 77 128 18 - 18
Increase (decrease) in same store
Revenues(1) (14.1)% 6.8% 1.6% 4.4% - (1.2)%
11
Month Year
Year Ended January 31, Ended Ended
Jan 31, Dec 31,
2001 2000 1999 1998 1997 1996
---- ---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
BALANCE SHEET DATA:
Cash and cash equivalents ................. $ 1,046 $ 24 $ 172 $ 28 $ 1,247 $ 59
Rental library(2) ......................... 3,012 6,223 21,120 2,795 2,127 2,189
Total assets .............................. 10,097 21,294 38,253 6,599 11,080 4,010
Credit facility ........................... - 9,770 16,045 - - -
Long-term debt, less current portion ...... - 1,232 1,637 2,043 3,341 5,804
Total liabilities ......................... 47,621 42,770 32,985 7,298 8,844 8,167
Stockholders' equity (deficit) ............ (37,524) (21,476) 5,267 (699) 2,236 (4,157)
- -------------
(1) The increase (decrease) in same store revenues compares revenues from stores
opened and owned by the Company for twelve full months. (Including
relocations)
(2) The decrease in rental library is mainly attributable to the reduction in
the number of stores between fiscal years 1999, 2000 and 2001.
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. Readers are cautioned
not to place undue reliance on forward-looking statements, which speak only as
of the date hereof.
Overview
General Business. The Company's revenue consists primarily of rental
revenue and product sales revenue. Rental revenue includes revenue from rentals
of videos, DVDs, video games, players and game machines and extended viewing
fees. Product sales revenue are derived from sales of new and used
videocassettes and DVDs, 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.
Rental library, which includes videocassettes, DVDs and video games, is
recorded at cost and amortized over its estimated economic life. Effective
January 31, 2000, Video City adopted an accelerated method of amortizing its
videocassette, DVD and game rental library. Video City has adopted this method
of amortization because it has implemented a new business model, including
revenue sharing arrangements, which has dramatically increased the number of
videocassettes and DVDs in the stores and is satisfying consumer demand over a
shorter period of time. As the new business model results in a greater
proportion of rental revenue over a shorter period of time, Video City has
changed its method of amortizing the rental library in order to more closely
match expenses in proportion with the anticipation revenues generated therefrom.
12
The Company records base stock (generally 3 copies per title for each
store) at cost and amortizes a portion of these costs on an accelerated basis
over three months, generally to $8 per unit, with the remaining base stock cost
amortized on a straight line basis over 33 months to an estimated $3 salvage
value. The cost of non-base stock (generally greater than 3 copies per title for
each store) are amortized on an accelerated basis over three months to an
estimated $3 salvage value. Video games are amortized on an accelerated basis
over a 12 month period to an estimated $10 salvage value. Revenue-sharing
payments are expensed when revenues are earned pursuant to the applicable
contractual arrangements.
The adoption of the new method of amortization was accounted for as a
change in accounting estimate effected by a change in accounting principle and,
accordingly, the Company recorded a non-cash pre-tax charge of approximately
$7.1 million to cost of rental revenues in the forth quarter of the fiscal year
ended January 31, 2000. The charge represents an adjustment to the carrying
value of the rental library due to the new method of amortization.
Certain videocassettes in the rental inventory are obtained through
revenue-sharing arrangements. Any handling fees per video are amortized on a
straight-line basis over the revenue sharing period, and revenue sharing
payments are expensed when incurred.
Cost of sales and revenue-sharing product are 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 revenue sharing 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, merger and acquisition fees, bank and financing
fees and all other items of corporate expense.
Year Ended January 31, 2001 Compared to Year Ended January 31, 2000
Revenues. Revenues for the fiscal year ended January 31, 2001 (fiscal
"2001") decreased $13,170,000 or 29.4%, to $31,615,000 compared to $44,785,000
for the fiscal year ended January 31, 2000 ("fiscal 2000"). The decrease in
revenues was primarily attributable to the liquidation and divestiture of 19
stores during the second and third quarters of fiscal 2001 and the divestiture
and sale of 11 stores during the fourth quarter of fiscal 2001. In addition, the
Company had reduced funds available for advertising or purchasing sales
inventory. Same store revenues for fiscal 2001 decreased by approximately 14.1%
compared to fiscal 2000.The Company had management fee income of $4,386,000 for
fiscal 2001 compared to no management fee income in fiscal 2000. The management
fee income attributed to 2001 was the result of the "Management Agreement"
entered into with West Coast Entertainment Corporation on March 3, 2000 and
terminated on February 13, 2001.
Store Operating Expenses. Store operating expenses for fiscal 2001
decreased $10,133,000, or 33.8%, to $19,817,000 compared to $29,950,000 for
fiscal 2000. The decrease in store operating expenses was primarily attributable
to the divestiture of 19 stores during the second and third quarters of fiscal
2001 and the divestiture and sale of 11 stores during the fourth quarter of
fiscal 2001. Store operating expenses as a percentage of total revenues were
62.7% for fiscal 2001 compared to 66.9% for fiscal 2000. The decrease in store
expenses as a percentage of total revenue for fiscal 2001 was primarily due to
operating in Chapter 11 for six months of the fiscal year which reduced expenses
to minimum levels to preserve working capital.
Amortization of Rental Library. Amortization of videocassette rental
inventory for fiscal 2001 decreased $6,400,000 or 46.7%, to $7,291,000 compared
to $13,691,000 for fiscal 2000. The decrease was primarily attributable to a
decrease in rental inventory from the divestiture of 19 stores during the second
and third quarters of fiscal 2001 and the divestiture and sale of 11 stores
during
13
the fourth quarter of fiscal 2001. In January 2000 the Company adopted an
accelerated method of amortizing its rental inventory. Based on the new
amortization method, the Company amortizes base stock (copies 1-3) on an
accelerated basis over three months to $8, with the remaining base stock cost
amortized on a straight line basis over 33 months to a salvage value of $3. The
cost of non base stock (generally greater than 3 copies per title per store) are
amortized on an accelerated basis over three months to an estimated $3 salvage
value. Amortization of videocassette rental inventory as a percentage of rental
revenues and product sales was 27% for the fiscal 2001 compared to 31% for the
corresponding period of 2000. In addition, the decrease was partially due to the
Company not leasing product under studio revenue sharing agreements due to the
Chapter 11 filing. This was partially offset by the liquidation and closing of
33 stores.
Cost of Product Sales. The cost of product sales for fiscal 2001 decreased
$4,839,000 or 54.3%, to $4,074,000 compared to $8,913,000 for fiscal 2000. The
decrease in the cost of product sales was primarily due to the liquidation and
closing of 33 stores during the second, third and fourth quarters of fiscal
2001. In addition, the decrease was attributable to reduced inventory levels of
videocassette, DVD, concession and accessory available during fiscal 2001
compared to fiscal 2000 due to the Company being in Chapter 11 Bankruptcy and
reduced working capital available for purchases of sale inventory.
Cost of Leased Product. Cost of leased product for fiscal 2001 decreased
$2,919,000 or 68.2%, to $1,362,000 compared to $4,281,000 for fiscal 2000. The
decrease was primarily attributable to the divestiture of 19 stores during the
second and third quarters of fiscal 2001 and the divestiture and sale of 11
stores during the fourth quarter of fiscal 2001. Cost of leased product as a
percentage of total revenue was 4.3% in fiscal 2001 compared to 9.6% in fiscal
2000. The decrease as a percentage of total revenue was due to the lower
proportion of leased rental inventory versus purchased rental inventory in
fiscal 2001 compared to fiscal 2000. The Company ceased revenue sharing with the
Studios as of August 24, 2000, upon filing of the Chapter 11 Bankruptcy and did
not lease products from a former supplier during the fiscal year 2001.
Restructuring Costs. The Company incurred $1.6 million in restructuring
costs during the fiscal year ending 2001, consisting of severance obligations to
employees of approximately $950,000, lease liability for the former executive
offices in Torrance, California of approximately $100,000, moving expenses of
the corporate office of approximately $80,000 and non-cash write down of the
related leasehold improvements of approximately $430,000. These costs were
related to the Company's effort to improve the performance of its operations and
streamline its corporate expenses after entering into the Management Agreement
and in anticipation of the proposed merger between the Company and West Coast
Entertainment Corporation. During fiscal 2001 the company paid $703,472 in cash
for restructuring expenses.
General and Administrative. General and administrative expenses for fiscal
2001 decreased $6,676,000, or 45.0%, to $8,062,000 compared to $14,738,000 for
fiscal 2000. General and administrative expenses as a percentage of total
revenues decreased to 24.0% in fiscal 2001 compared to 32.9% in fiscal 2000. The
decrease in general and administrative expenses was primarily attributable to
the company's reduction in employee salaries and related cost savings that
resulted from the moving of the Company's corporate headquarters from Torrance,
California to Philadelphia, Pennsylvania in March 2000. Also the Company
incurred significant legal, accounting, financing and other acquisition related
costs during fiscal 2000 in order to satisfy the demands of the pending merger,
which included restructuring of bank debt, revision of the corporate structure
and satisfaction of regulatory requirements that were not required in fiscal
2001. In addition, the Company did not incur the additional costs for payroll,
professional services and travel required in fiscal 2000 related to the
additional stores acquired in fiscal 2000 and the fourth quarter of fiscal 1999,
since the company did not acquire any stores during fiscal 2001.
Gain(Loss) on Sale of Assets. Gain on sale of assets in fiscal 2000
resulted from the sale of 49 stores sold to Blockbuster, Inc. on July 26, 1999.
The Company reported a $1.4 million gain. The loss on sale of assets in 2001
resulted from the disposal of 2 stores prior to the bankruptcy filing.
14
Store Closure Expenses during fiscal 2000 were $3,211,000 and were related
to the Company closing 15 under-performing stores between September and December
of 1999.
Interest Expense. Net interest expense for fiscal 2001 decreased
$2,359,000, or 63.6%, to $1,348,000 compared to $3,707,000 for fiscal 2000. The
decrease in interest expense is reflective of a decreased average balance of
borrowings as well as the discontinuance of recording interest expense on
secured and unsecured prepetition debt pursuant to American Institute of
Certified Accountants Statement of Position 90-7.
Other. The income for fiscal 2000 was primarily due to the receipt of a
break-up fee in connection with the acquisition agreement entered into with
Planet Video, Inc.
Reorganization Items. Professional fees in fiscal 2001 resulted from the
retention of legal and financial professionals during the bankruptcy period, as
approved by the Bankruptcy Court. Loss on sale of assets in fiscal 2001 resulted
from the sale and liquidation of 30 stores during the fiscal year. The Company
reported a $3.5 million loss. The liquidation and sale of stores was approved by
the Bankruptcy Court during the bankruptcy proceedings subsequent to the August
24, 2000 bankruptcy date.
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, 2001, due to the losses incurred during fiscal 2000 and fiscal 2001,
management cannot determine it is more likely than not that future taxable
income will be sufficient to realize the deferred tax asset. Accordingly, a full
valuation allowance has been established against the deferred tax asset at
January 31, 2001.
Year Ended January 31, 2000 Compared to Year Ended January 31, 1999
Revenues. Revenues for the fiscal year ended January 31, 2000 (fiscal
"2000") increased $20,956,000 or 87.9%, to $44,785,000 compared to $23,829,000
for the fiscal year ended January 31, 1999 ("fiscal 1999"). The increase in
revenues was primarily attributable to the acquisition of 15 stores on March 31,
1999, the acquisition of 76 stores acquired on December 28, 1998, partially
offset by the divestiture of 49 stores to Blockbuster on July 26, 1999 and the
closure of 15 under-performing stores during the third and forth quarters of
fiscal 2000. Even though the Company concluded fiscal 2000 with 77 stores as
compared to 128 stores for fiscal 1999, revenues increased due the fact that the
weighted average number of stores for fiscal 2000 was 109 stores as compared to
51 stores for fiscal 1999. Same store revenues for fiscal 2000 increased by
approximately 6.8% compared to fiscal 1999. The Company has no management fee
income for fiscal 2000 compared to $607,733 for fiscal 1999. The decrease
resulted due to the Company acquiring all stores that it previously managed.
Store Operating Expenses. Store operating expenses for fiscal 2000
increased $16,275,000, or 119.0%, to $29,950,000 compared to $13,675,000 for
fiscal 1999. The increase was primarily attributable to acquisition of 15 stores
on March 31, 1999 and the acquisition of 76 stores on December 28, 1998,
partially offset by the divestiture of 49 stores to Blockbuster on July 26,
1999, and the closure of 15 under-performing stores in the third and fourth
quarter of fiscal 2000. Store operating expenses as a percentage of total
revenues were 66.8% for fiscal 2000 compared to 56.0% for fiscal 1999. 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 Rental Library. Amortization of videocassette rental
inventory for fiscal 2000 increased $11,149,000 or 438.6%, to $13,691,000
compared to $2,542,000 for fiscal 1999. The increase was primarily attributable
to an increase in rental inventory from the acquisition of 15 stores on March
31, 1999 and the acquisition of 76 stores on December 28, 1998, partially offset
by a decrease in rental inventory from the divestiture of 49 stores to
Blockbuster on July 26, 1999, and the closure of 15 under-performing
15
stores in the third and fourth quarter of fiscal 2000. In addition, the Company
adopted an accelerated method of amortizing its rental inventory in fiscal 2000.
Pursuant to the adoption of the new method of amortization, the Company recorded
a pre-tax charge of approximately $7.1 million, in the fourth quarter of fiscal
2000. Based on the new amortization method, the Company amortizes base stock
(copies 1-3) on an accelerated basis over three months, to $8, with the
remaining base stock cost amortized on a straight line basis over 33 months to a
salvage value of $3. In fiscal 1999 the Company amortized base on a straight
line basis over 60 months to a salvage value of $3. Amortization of
videocassette rental inventory as a percentage of total revenue was 30.6% in
fiscal 2000 compared to 10.4% in fiscal 1999. The increase was primarily due to
the adoption of the accelerated method of amortizing rental inventory, partially
offset by a lower proportion of purchased rental inventory versus leased rental
inventory in fiscal 2000 compared to fiscal 1999.
Cost of Product Sales. The cost of product sales for fiscal 2000 increased
$5,612,000 or 170.0%, to $8,913,000 compared to $3,301,000 for fiscal 1999. This
increase was directly attributable to aggregate growth in videocassette, DVD,
concession and accessory sale of 126% in fiscal 2000 compared to fiscal 1999.
Cost of Leased Product. Cost of leased product for fiscal 2000 increased
$2,887,000 or 207.1%, to $4,281,000 compared to $1,394,000 for fiscal 1999. The
increase was primarily attributable to the acquisition of 15 stores on March 31,
1999 and the acquisition of 76 stores on December 28, 1998, partially offset by
the divestiture of 49 stores to Blockbuster on July 26, 1999, and the closure of
15 under-performing stores in the third and fourth quarter of fiscal 2000. Cost
of leased product as a percentage of total revenue was 9.6% in fiscal 2000
compared to 5.7% in fiscal 1999. The increase as a percentage of total revenue
was due to the higher proportion of leased rental inventory versus purchased
rental inventory in fiscal 2000 compared to fiscal 1999. In fiscal 2000 the
Company entered into direct revenue sharing agreements with film studios,
whereby the Company and the film studios will share in the revenue generated
from the leased product based on the contractual arrangement. Thus, in fiscal
2000, the Company leased product from both a supplier and film studios, while in
fiscal 1999 the Company solely leased product from a supplier.
General and Administrative. General and administrative expenses for fiscal
2000 increased $9,952,000, or 207.9%, to $14,738,000 compared to $4,786,000 for
fiscal 1999. General and administrative expenses as a percentage of total
revenues increased to 32.9% in fiscal 2000 compared to 19.6% in fiscal 1999. The
increase in general and administrative expenses was attributable to the
Company's preparation for the pending merger with West Coast Entertainment
Corporation, and the additional resources that will be required to complete the
acquisition. The Company incurred significant legal, accounting, financing and
other acquisition related costs during fiscal 2000 in order to satisfy the
demands of the pending merger, which included restructuring of bank debt,
revision of the corporate structure and satisfaction of regulatory requirements.
In addition, the Company incurred additional costs for payroll, professional
services, and travel to support the addition stores acquired in fiscal 2000 and
the stores acquired at the end of the fourth quarter in fiscal 1999.
Gain on Sale of Assets. Gain on sale of assets in fiscal 2000, resulted
from the sale of 49 stores sold to Blockbuster, Inc. on July 26, 1999. The
Company reported a $1.4 million gain.
Store Closure Expenses. Between September and December of 1999, the Company
closed 15 under-performing stores and incurred $3,211,000 of store closure
expenses.
Interest Expense. Net interest expense increased $2,144,000, or 137.1%, to
$3,707,000 compared to $1,563,000 for fiscal 2000. The increase in interest
expense was primarily due to the increased level of borrowing under the
Company's credit facility, BankBoston Retail Finance Inc. ("BankBoston"). In
addition, the Company wrote off the unamortized loan fees related to the
BankBoston credit facility when the $30 million revolving credit facility with
BankBoston was terminated and replaced with a Forbearance Agreement that limited
the credit facility to $10.75 million.
Other. Other (income) expense increased $(28,000), or 12.6% to $(249,000)
for fiscal 2000 compared to $(221,000) for fiscal 1999. In fiscal 1999 other
income was due to the receipt of a break-up fee in connection with the
acquisition agreement entered into with Planet Video, Inc, while in fiscal 2000,
16
other income was primarily attributable to vending machine sales.
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, 1999, due to significant acquisitions consummated during the year, the
Company 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 had accordingly, reversed the full amount of the
valuation allowance. However, at January 31, 2000, due to the pending
acquisition with West Coast Entertainment, the losses incurred during fiscal
2000, and the Company's short-term divestiture strategy, management cannot
determine it is more likely than not that future taxable income will be
sufficient to realize the deferred tax asset. Accordingly, a full valuation
allowance has been established against the deferred tax asset at January 31,
2000.
Liquidity and Capital Resources
The Company funds its short-term working capital needs, including the
purchase of videocassettes, DVD 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, DVD and other inventory
purchases for its existing stores. There can be no assurance, however, that cash
from operations and extended vendor terms will be sufficient to fund future
videocassette, DVD and inventory purchases.
Videocassette and DVD rental inventory is accounted for as a non-current
asset under generally accepted accounting principles because it is not an asset
that is 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 this asset
as non- current excludes it from the computation of working capital. The
acquisition cost of videocassette and DVD rental inventory, 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 and DVD rental inventory as a non-current asset, the
Companyanticipates that it will operate with a working capital deficit during
the fiscal year ending January 31, 2002.
On December 29, 1998, the Company entered into a Senior Secured Revolving Credit
Facility agreement (the "Credit Facility") with BankBoston/Fleet Retail Finance
to be used for working capital purposes and capital expenditures. The Credit
Facility was scheduled to mature on December 29, 2001. On September 23, 1999,
the Company entered into a forbearance agreement with BankBoston/Fleet Retail
Finance that amended the terms of the Loan Agreement, revised the financial
performance covenants of the Loan Agreement and contained weekly covenant
requirements. In November 1999, the Company did not meet the financial
performance covenants as set forth in the forbearance agreement. During the
fiscal year ended January 31, 2000, the Company did not meet certain of the
financial covenants as required by the credit facility. On March 9, 2000, the
Company entered into a second forbearance agreement that limited the Credit
Facility to $10,750,000 and revised the financial covenant requirements.
On August 24, 2000, as a result of the Fleet Retail Finance action to accelerate
payment of the outstanding indebtedness under the Company's secured credit
facility, the Company filed a voluntary petition in the United States Bankruptcy
Court seeking to reorganize under Chapter 11 of the U.S. Bankruptcy Code.
The Company and Fleet Retail Finance entered into a compromise agreement which
was approved by the Bankruptcy Court on March 28, 2001 under which the
outstanding debt to Fleet Retail Finance was settled in full satisfaction by the
payment of $1,500,000.
Inherent in a successful plan of reorganization is a capital structure which
permits the Company to generate sufficient cash flow after reorganization to
meet its restructured obligations and fund the current obligations of the
reorganized Company. Under the Bankruptcy Code, the rights of and ultimate
payment to prepetition creditors may be substantially altered and, as to some
classes, eliminated. The Company believes that the sources of capital described
above and internally generated funds will be adequate to meet the Company's
anticipated needs through fiscal 2002; however, no assurance can be given with
respect to the Company's liquidity.
During the Debtor-in-Possession period the Company's supply vendors require all
purchases of inventory be made only by cash in advance. There can be no
assurance, however, that
17
future cash from operations will be sufficient to fund future videocassette, DVD
and inventory purchases.
In June of 2001, the Company also entered into a purchase money security
agreement directly with Warner Brothers Home Video. The agreement provides the
company with a line of trade credit and 60 day terms for repayment. The company
purchases all Warner Brothers product directly from Warner Brothers Home Video,
which is then distributed to all Video City's home entertainment retail chain
through a third party distributor.
In July 2001 the Company entered into an agreement with Video Products
Distributors ("VPD") under which VPD agreed to become the exclusive video
distributor for all of Video City's home entertainment retail chain. VPD will
provide all videocassettes, DVDs and accessories for rental and sale with the
exception of Warner Brothers Home Video product in all locations. As part of
this agreement, Video City is receiving a line of trade credit and 90 day terms
for payment to VPD.
On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's
First Amended Chapter 11 Plan of Reorganization (the "Plan"). The Plan became
effective on August 29, 2001. Pursuant to the Plan, the existing common
shareholders of Video City are to receive 700,000 shares of common stock of
Reorganized Video City in cancellation of all shares of common stock outstanding
prior to such distribution, for pro rata distribution; 700,000 shares of common
stock are to be issued to preferred shareholders in cancellation of all shares
of preferred stock outstanding prior to such distribution; and 5,600,000 shares
are to be issued to Video City's creditors. The Company anticipates that
approximately all liabilities subject to compromise will receive in full
satisfaction of their claims through shares of common stock of Video City based
on the Plan of Reorganization. As part of the plan certain class 4A creditor's
had the option to receive 20% of their claim in cash if their claim was under
$1,000 or if they choose to reduce their claim to that amount. The total amount
for all class 4A creditors who opted for the cash payout was less than $22,000.
In addition, certain liabilities subject to compromise consist of tax
obligations of approximately $1.3 million that are to be paid in cash over five
years from date of assessment.
Cash Flows
Cash Provided by Operating Activities
Net cash provided by operating activities for fiscal 2001 increased by
approximately $11,264,000, or 350%, compared to fiscal 2000. This increase was
primarily due to a decrease in accounts receivable and merchandise inventory as
a result of the divestiture of 19 stores in the second and third quarter of
fiscal 2001 and the divestiture and sale of 11 stores in the fourth quarter of
fiscal 2001. The increase was also due to an increase in accounts payable and
accrued expenses as a result of the non-payment of vendor balances from August
24, 2000, as a result of the bankruptcy filing, partially offset by a decrease
in accrued expenses.
Cash Used in Investing Activities
Net cash used in investing activities during fiscal 2001 increased by
approximately $14,985,000 or 206%, compared to fiscal 2000. The change was
mainly attributable to the decrease in the proceeds from the sale of assets from
fiscal 2000, offset partially by an increase in the purchase of merchandise
inventory.
Cash Provided by Financing Activities
Net cash provided by financing activities during fiscal 2001 increased by
approximately $4,890,000 or 116%, compared to fiscal 2000. The change was mainly
attributable to the decrease in the repayment of borrowings from the revolving
credit facility. Repayments on the revolving credit facility with Fleet
(formerly BankBoston), were halted as a result of the bankruptcy filing on
August 24, 2000.
General Economic Trends, Quarterly Results and Seasonality
18
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.
QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended January 31, 2001 and 2000 are
reflected below:
- -------------------------------------------------------------------------------------------------
FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------
2001
- -------------------------------------------------------------------------------------------------
Revenue $ 6,419,679 $ 6,807,108 $ 8,885,774 $ 9,502,084
- -------------------------------------------------------------------------------------------------
Operating loss $ (2,705,567) $ (2,628,562) $ (2,613,486) $ (2,807,221)
- -------------------------------------------------------------------------------------------------
Net loss $ (4,487,606) $ (4,812,694) $ (3,599,140) $ (3,538,628)
- -------------------------------------------------------------------------------------------------
Basic and diluted
loss per share $ (0.28) $ (0.29) $ (0.22) $ (0.22)
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------
2000
- -------------------------------------------------------------------------------------------------
Revenue $ 8,543,634 $ 8,723,038 $ 14,212,961 $ 13,305,070
- -------------------------------------------------------------------------------------------------
Operating loss $ (17,771,645) $ (5,826,083) $ (4,091,030) $ (911,897)
- -------------------------------------------------------------------------------------------------
Net loss $ (22,571,067) $ (6,801,871) $ (2,954,506) $ (930,703)
- -------------------------------------------------------------------------------------------------
Basic and diluted
loss per share $ (1.55) $ (0.46) $ (0.21) $ (0.07)
- -------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------
Quarterly and year-to-date computations of per share amounts are made
independently. Therefore, the sum of per share amounts for the quarters may not
agree with the per share amounts for the year.
Item 7A. 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.
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.
19
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Management of the Company
The following sets forth certain information with respect to the directors
and executive officers of Video City, Inc. (the "Company"):
Name Age Positions with the Company Director
---- --- -------------------------- Since
-----
Robert Y. Lee (1) 38 Chairman of the Board 1997
Timothy Ford (2) 43 Chief Executive Officer --
Richard Gibson (3) 38 President and Chief Operating Officer --
Rudolph R. Patino 53 Chief Financial Officer and Director --
James Craig Kelly (4) 42 Executive Vice President and Director 1997
Secretary --
David A. Ballstadt 61 Director 1998
Barry L. Collier 58 Director 1997
Gerald W. B. Weber 50 Director 1997
______________________
(1) Mr. Lee resigned as Chief Executive Officer in July 2001.
(2) Mr. Ford was appointed Chief Executive Officer in July 2001.
(3) Mr. Gibson resigned as President and Chief Operating Officer in March 2001.
(4) Mr. Kelly resigned as Executive Vice President and Director in April 2001.
Robert Y. Lee has served as the Company's chairman of the board and chief
executive officer since the merger of the Company's predecessor, Lee Video City,
Inc. ("Lee Video City"), with and into Prism Entertainment Corporation ("Prism")
in January 1997. Mr. Lee founded Lee Video City, Inc. and served as its chairman
of the board and chief executive officer since its inception in February 1990.
Mr. Lee purchased his first video store in 1983, and during the 1980s opened and
acquired more than 20 video stores in Southern California.
Tim Ford has served as Chief Executive Officer since July 2001 and as
President and Chief Operating Officer since the corporate office relocated to
Bakersfield, California in March 2001. In 1993, Mr. Ford served as Vice
President of Product and Merchandising as well as Regional Vice President of
Operations. In 1989 Mr. Ford began pursuing a career in entertainment retail as
a District Manager for Wherehouse Entertainment where he was responsible for 32
million dollars in revenue with an operating cash flow of 3.8 million. In 1989
Mr. Ford sold his interest in his companies to his partners. His businesses,
which began in 1982, consisted of two restaurants, three nightclubs, five
fitness facilities and one racquetball club.
Richard Gibson has served as the Company's president and chief operating
officer since June 1999. Prior to joining the Company, Mr. Gibson served as
global controller for Nike Retail, an $800 million division of Nike, Inc., where
he was head of financial operations and strategic planning. These included
director of finance for the U.K. Film Distribution Division, European Director
of Finance and Operations of Warner Brothers European Studio Stores, and finally
four years as Vice President of Warner Brothers Studio Stores International
Division.
Mr. Patino has served as Chief Financial Officer of Video City since June
2000, and director since July 2001. He practiced public accounting for the
accounting firm of Ernst & Young for four years and has been in private industry
for the last 19 years. He has extensive experience in the entertainment industry
and started his career in private industry with a controllership at Universal
Studios Tour in 1982. Beginning in 1986, he continued his career as the Vice
President and Chief Financial Officer of Avalon Attractions, the largest live
concert promoter in Southern California. Since leaving Avalon Attractions in
1995, he has worked for Prism Entertainment Corporation, an independent film
production and distribution company and J2 Communications, parent company of the
National Lampoon franchise, both publicly held entertainment companies, as their
Chief Financial Officer.
20
James Craig Kelly has served as a senior vice president and as a director
of Video City since the Prism merger in January 1997, and as its secretary from
January 1997 to April 16, 1997 and from November 20, 1997 to March 25, 1999.
Since July 1999 Mr. Kelly has served as an executive vice president of Video
City. Mr. Kelly served as the chief operating officer of Lee Video City from
1992 until the Prism merger, and as chief operating officer of Video City from
the Prism merger to July 1999. For fifteen years, Mr. Kelly held various
positions with Wherehouse Entertainment, a $500 million revenue retailer of
music and video products, including director of loss prevention from 1982 to
1984, and vice president and regional manager from 1984 to 1991.
David A. Ballstadt has served and as a director of the Company since the
acquisition by the Company of its subsidiaries, Adventures in Video, Inc. and
KDDJ Investments, Inc., in March 1998. Mr. Ballstadt served as president of the
Company from January 1997 to January 1999. Mr. Ballstadt founded and served as
the president and chief executive officer of Adventures in Video, Inc. and KDDJ
Investments, Inc. until their sale to the Company.
Barry L. Collier has served as a director of the Company since the Prism
merger in January 1997. Mr. Collier served as the president, chief operating
officer and as a director of Prism since its inception in 1984 until the Prism
merger, and as president of Video City from January 1997 to July 1999. He served
as the secretary of Prism from 1984 to 1985 and was appointed as the chief
executive officer of Prism from 1985 until the Prism merger. Mr. Collier served
as the chairman of the board of Prism from 1990 until 1994. Prism filed a
voluntary petition under Chapter 11 of the Bankruptcy Code in December 1995 and
emerged from Chapter 11 upon the consummation of the Prism merger.
Gerald W. B. Weber has served as a director of the Company since the Prism
merger in January 1997. Since October 1998, Mr. Weber has served as a chief
operating officer of CarSpa, Inc. Mr. Weber was the Senior Vice President of
Retail Operations of AutoNation USA, where he was responsible for all AutoNation
USA retail operations, including sales, training, planning, hiring and loss
prevention. Prior to joining AutoNation USA, Mr. Weber held various management
positions with Blockbuster Entertainment, including Zone Vice President of the
East and Southeast Regions, vice president of operations, and senior vice
president of domestic retail for the video retail division and president of
Blockbuster Music.
Video City, Robert Y. Lee, Barry L. Collier and Ingram Entertainment, Inc.
("Ingram") entered into a Stockholders Agreement, dated as of January 8, 1997,
which provides that the Company's Board of Directors shall consist of eight
members and that Ingram, Mr. Lee and Mr. Collier shall collectively vote their
shares in favor of two designees of Ingram, four designees of Mr. Lee and two
designees of Mr. Collier The same parties also entered into an Override
Agreement, dated November 19, 1996 (the "Override Agreement"), which provides,
subject to certain exceptions, that without the written consent of Ingram, the
Company shall not enter into a merger or a sale or transfer of all or
substantially all of its assets, or make any material change in the nature of
its business as now conducted, or change the form of organization of its
business; and that without unanimous approval of the Board of Directors, the
Company shall not enter into any line of business other than the sale and rental
of video product and related goods, the completion of one film that the
Company's predecessor, Prism Entertainment Corporation, had under way, and the
exploitation of Prism's film library. The Company rejected these agreements with
Ingram as part of its reorganization plan during its bankruptcy proceedings.
Directors serve until the next annual meeting of the Company's stockholders
or until their successors are elected or appointed. Officers are elected by and
serve at the discretion of the Board of Directors.
Meetings; Attendance; Committees
During the fiscal year ended January 31, 2001, the Board of Directors of
the Company met five times. No incumbent member who was a director during the
past fiscal year attended fewer than 75% of the aggregate of all meetings of the
Board of Directors and all meetings of the committees of the Board of Directors
on which he served.
The Company's compensation committee was formed to make recommendations to
21
the Board concerning salaries and incentive compensation for officers and
employees of the Company, including the grant of stock options to the Company's
executive officers under the Company's stock option plans. The compensation
committee currently consists of Gerald Weber and Barry Collier of its Board of
Directors. The audit committee reviews the scope of the audit and other
accounting related matters. The Company's audit committee currently consists of
Robert Y. Lee and Barry Collier of its Board of Directors.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 (the "Exchange Act")
requires the Company's directors and executive officers, and persons who own
more than 10 percent of a registered class of the Company's equity securities,
to file reports of ownership and changes in ownership with the Securities and
Exchange Commission (the "Commission"). Directors, executive officers and
greater than 10 percent stockholders are required by the Commission's
regulations to furnish the Company with copies of all Section 16(a) forms they
file. Based solely on a review of the copies of the forms furnished to the
Company and the representations made by the reporting persons to the Company,
the Company believes that during the fiscal year ended January 31, 2001, its
directors, executive officers and 10 percent stockholders complied with all
filing requirements under Section 16(a) of the Exchange Act.
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation for the fiscal years ended
January 31, 2001, January 31, 2000 and January 31, 1999 paid by the Company to
its chief executive officer and the other executive officers of the Company who
earned in excess of $100,000 (collectively, the "Named Executive Officers")
based on salary and bonus for the fiscal year ended January 31, 2001:
Name and Long-Term
Principal Position Annual Compensation(1) Compensation
- --------------------------- ------------------------------------------------- ----------------
Securities
Period Underlying
Ended Salary($) Bonus Options (#)
-------------------- ------------- ------------ ----------------
Robert Y. Lee January 31, 2001 $ 350,000 -- --
Chief Executive Officer January 31, 2000 231,000 $ -- --
January 31, 1999 178,000 30,000 --
Richard Gibson January 31, 2001 250,000 -- 600,000
President January 31, 2000 145,000 -- --
Chief Operating Officer
James Craig Kelly (2) January 31, 2001 210,000 -- --
Executive Vice President January 31, 2000 168,000 -- --
January 31, 1999 120,000 20,000 --
(1) The compensation described in this table does not include medical
insurance, retirement benefits and other benefits received by the foregoing
executive officers which are available generally to all employees of the
Company and certain perquisites and other personal benefits received by the
foregoing executive officers of the Company, the value of which did not
exceed the lesser of $50,000 or 10% of the executive officer's cash
compensation in the table.
(2) Mr. Kelly served as executive vice president since July 1999.
Option Grants
The Company granted no options to officers during the fiscal year ended January
31, 2001.
______________________
Option Exercises and Fiscal Year-End Values
No stock options were exercised by any of the Named Executive Officers
during the fiscal year ended January 31, 2001. The following table sets forth
certain information regarding stock options held by the Named Executive Officers
22
as of January 31, 2001:
Fiscal Year-End Options
Number of Securities
Underlying Unexercised Value of Unexercised
Options at Fiscal In-the-Money Options at
Name Year-End (#) Fiscal Year End ($)(1)
---- ----------------------------------- ---------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Robert Y. Lee ............. 750,000 -- -- --
James Craig Kelly ......... 761,600 -- -- --
Richard Gibson 300,000 300,000 -- --
- -------------------
(1) Amounts are shown as the positive spread between the exercise price and the
last sale price of the Company's Common Stock as reported on the OTC
Bulletin Board on January 31, 2001 ($0.03).
Director Compensation
Directors, other than directors who are employees of Video City, receive
cash compensation in the amount of $12,000 per year for serving on the Video
City board and are also entitled to participate in Video City's stock option
plans and from time to time to receive grants of options thereunder to purchase
shares of Video City's common stock.
Stock Option Plan
1996 Stock Option Plan. In November 1996, the Video City board and
shareholders of Video City's predecessor, Lee Video City, adopted its 1996 Stock
Option Plan. The 1996 Stock Option Plan, which was assumed by Video City,
provides for the grant of options to directors, officers, other employees and
consultants of Video City to purchase up to an aggregate of 1,000,000 shares of
its common stock. The purpose of the 1996 Stock Option Plan is to provide
participants with incentives which will encourage them to acquire a proprietary
interest in, and continue to provide services to, Video City. The 1996 Stock
Option Plan is administered by the Video City board or a committee of the board,
which has discretion to select optionees and to establish the terms and
conditions of each option, subject to the provisions of the 1996 Stock Option
Plan. Options granted under the 1996 Stock Option Plan may be "incentive stock
options" as defined in Section 422 of the Internal Revenue Code of 1986, as
amended (the Code"), or nonqualified options.
The exercise price of incentive stock options may not be less than the fair
market value of Video City common stock as of the date of grant (110% of the
fair market value if the grant is to an employee who owns more than 10 percent
of the total combined voting power of all classes of capital stock of Video
City). The Code currently limits to $100,000 the aggregate value of Video City
common stock that may become exercisable in any one year pursuant to incentive
stock options under the 1996 Stock Option Plan or any other option plan adopted
by Video City.
Nonqualified options may be granted under the 1996 Stock Option Plan at an
exercise price of not less than 85% of the fair market value of Video City
common stock on the date of grant. Nonqualified options may be granted without
regard to any restriction on the amount of Video City common stock that may
become exercisable pursuant to such options in any one year. Options may not be
exercised more than ten years after the date of grant (five years after the date
of grant if the grant is an incentive stock option to an employee who owns more
than 10 percent of the total combined voting power of all classes of capital
stock of Video City), or such lesser period of time as is set forth in the
applicable stock option agreement. Options granted under the 1996 Stock Option
Plan generally are nontransferable except by will or by the laws of descent and
distribution. Shares subject to options that expire unexercised under the 1996
Stock Option Plan are available for future grant under the 1996 Stock Option
Plan. The number of options outstanding and the exercise price thereof are
subject to adjustment in the case of certain transactions such as
recapitalizations, stock splits or stock dividends. The 1996 Stock Option Plan
is effective for ten years, unless sooner terminated or suspended.
In general, upon termination of employment of an optionee, all options
23
granted to such person which were not exercisable on the date of such
termination will immediately terminate, and any options that are exercisable
will terminate not less than three months (six months in the case of termination
by reason of death or disability) following termination of employment, or such
other period of not less than 30 days after the date of termination as is
specified in the applicable stock option agreement.
1998 Stock Option Plan. In June 1998, Video City's board unanimously
approved Video City's 1998 Stock Option Plan. In August 1998 Video City's
shareholders approved the 1998 Stock Option Plan. The purpose of the 1998 Stock
Option Plan is to enable Video City to attract and retain top-quality employees,
officers, directors and consultants and to provide them with an incentive to
enhance shareholder return. The 1998 Stock Option Plan originally provided for
the grant of options to officers, directors, other employees and consultants of
Video City to purchase up to an aggregate of 1,200,000 shares of Video City
common stock. In March 1999, the Video City board increased the number of shares
covered under the 1998 Stock Option Plan to 2,700,000, subject to obtaining
shareholder approval; such approval was not solicited, and the proposed increase
in the number of shares was abandoned. The 1998 Stock Option Plan is
administered by the Video City board or a committee of the Board, and is
currently administered by the compensation committee of the Video City board,
which has complete discretion to select the optionees and to establish the terms
and conditions of each option, subject to the provisions of the 1998 Stock
Option Plan. Options granted under the 1998 Stock Option Plan may be "incentive
stock options" as defined in Section 422 of the Code, or nonqualified options,
and will be designated as such.
The exercise price of incentive stock options may not be less than the fair
market value of Video City's common stock as of the date of grant (110% of the
fair market value if the grant is to an employee who owns more than 10% of the
total combined voting power of all classes of capital stock of Video City). The
Code currently limits to $100,000 the aggregate value of Video City common stock
that may become exercisable for the first time in any one year pursuant to
incentive stock options under the 1998 Stock Option Plan or any other option
plan adopted by Video City. Nonqualified options may be granted under the 1998
Stock Option Plan at an exercise price less than the fair market value of Video
City common stock on the date of grant. Nonqualified options also may be granted
without regard to any restriction on the amount of Video City common stock that
may become exercisable pursuant to such options in any one year.
In general, upon termination of employment of an optionee, all options
granted to such person which were not exercisable on the date of such
termination would immediately terminate, and any options that are exercisable
would terminate 90 days (six months in the case of termination by reason of
death or disability) following termination of employment.
Options may not be exercised more than ten years after the grant (five
years after the grant if the grant is an incentive stock option to an employee
who owns more than 10% of the total combined voting power of all classes of
capital stock of Video City). Options granted under the 1998 Stock Option Plan
are not transferable and may be exercised only by the respective grantees during
their lifetime or by their heirs, executors or administrators in the event of
death. Under the 1998 Stock Option Plan, shares subject to cancelled or
terminated options are available for subsequently granted options. The number of
options outstanding and the exercise price thereof are subject to adjustment in
the case of certain transactions such as recapitalizations, stock splits or
stock dividends. The 1998 Stock Option Plan is effective for ten years, unless
sooner terminated or suspended. The 1998 Stock Option Plan provides that options
covering no more than 600,000 shares of Video City common stock may be granted
to any one employee in any twelve month period. In accordance with Rule
260.140.45 of the California Commissioner of Corporations, the 1998 Stock Option
Plan provides that at no time shall the total number of shares issuable upon
exercise of all outstanding options and the total number of shares provided for
under any stock bonus or similar plan of Video City exceed 30% of the then
outstanding shares of Video City (with convertible preferred shares being
counted on an as if converted basis) as calculated in accordance with this rule,
based on the shares of Video City which are outstanding at the time the
calculation is made.
Compensation Committee
Video City's compensation committee was formed to make recommendations to
the Video City board concerning salaries and incentive compensation for officers
of Video City, including the grant of stock options to Video City's executive
24
officers under Video City's stock option plans.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of Video City's common stock as of August 23, 2000 the day prior to
the commencement of the Chapter 11 bankruptcy proceeding, by (i) each person who
is known by Video City to own beneficially more than 5% of Video City's
outstanding Video City common stock, (ii) each of the directors of Video City,
(iii) each of the Named Executive Officers, and (iv) all officers and directors
of Video City as a group.
Number of Shares Percentage of
Name and Address(1) Beneficially Owned(2) Ownership
------------------ --------------------- ---------
Robert Y. Lee 3,376,524(3)(4)(5) 20.0%
Richard Gibson 1,225,000(4)(6)(10) 7.1%
Barry L. Collier 955,577(4) 5.9%
James Craig Kelly 761,600(4) 4.5%
David A. Ballstadt 660,325 4.1%
Gerald W.B. Weber 322,023(4)(7) 2.0%
Ingram Entertainment Inc.(9) 5,262,864(11) 27.0%
Mortco, Inc.(10) 2,500,133(12) 14.2%
Victor J. Cianci 1,200,000(13) 6.9%
Evvy R. Cianci 1,200,000(13) 6.9%
Andrew T. Baruffi 1,050,000 6.5%
All Directors and Executive
Officers as a group (10
persons) 7,011,302 36.2%
- --------------------
* Less than one percent.
(1) Except as otherwise indicated, the address of each principal shareholder of
Video City is c/o Video City, Inc., whose current address is 4800 Easton
Drive, Suite 108, Bakersfield, California 93309.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to the securities. Shares of Video City
common stock subject to options or warrants that are currently exercisable
or are exercisable within 60 days of August 23, 2001 are deemed outstanding
for computing the percentage of the person holding such options or warrants
but are not deemed outstanding for computing the percentage of any other
person. Except as indicated by footnote and subject to community property
laws where applicable, the persons named in the table have sole voting and
investment power with respect to all shares of Video City common stock
shown as beneficially owned by them.
(3) Includes a proxy to vote 610,000 shares owned by Mr. Collier.
(4) Includes the following currently exercisable stock options to purchase
shares from Video City: Mr. Lee 750,000; Mr. Collier, 175,000 shares; Mr.
Kelly, 761,600 shares; Mr. Weber, 120,000 shares and Mr. Gibson 200,000.
(5) Includes 1,357,282 shares of Video City common stock pledged by Mr. Lee to
certain persons who served as former management of West Coast
Entertainment, Inc. The shares were pledged by Mr. Lee to guarantee that
the Company will make payments to the former management of West Coast
Entertainment under the terms of the Consulting Agreement and the Non-
Compete Agreement. Mr. Lee retains voting rights of the pledged shares of
common stock.
(6) Includes 1,000,000 shares of Video City common stock issuable upon exercise
of warrants.
(7) Includes 100,000 shares of Video City common stock issuable upon exercise
of warrants.
(8) Includes 12,500 shares of Video City common stock issuable upon conversion
of outstanding shares of Video City's Series AA preferred stock and 12,500
shares of Video City common stock issuable upon exercise of warrants.
(9) Does not include shares of Video City common stock beneficially owned by
the Value Group. Mr. Sheehy is a Managing Director of the Value Group.
25
(10) Consists of 25,000 shares of Video City common stock issuable upon
conversion of outstanding shares of our Series C preferred stock held by
Mr. Gibson's spouse
(11) Consists of 1,500,000 shares of Video City common stock owned outright; a
warrant to purchase 404,403 shares from Mr. Lee; and warrants to purchase
3,358,461 shares from Video City. Ingram Entertainment Inc.'s address is
Two Ingram Boulevard, La Vergne, Tennessee 37089.
(12) Consists of 1,061,906 shares Video City common stock owned outright; 37,500
shares issuable upon conversion of outstanding shares of the Series AA
preferred stock; 666,667 shares issuable upon conversion of outstanding
shares of the Series D convertible redeemable preferred stock; and 734,060
shares issuable by Video City upon exercise of warrants. Mortco, Inc.
beneficially owns 750 shares of Series AA preferred stock. Mortco, Inc.'s
address is One Airport Center, 7700 N.E. Ambassador Place, Portland, Oregon
97220. Mortco, Inc. is a wholly-owned subsidiary of Rentrak Corporation.
(13) Consists of shares of Video City common stock issuable upon conversion of
outstanding shares of Video City's Series B convertible redeemable
preferred stock.
The following table sets forth the beneficial owners of all outstanding shares
of Video City's Series B convertible redeemable preferred stock as of January
31, 2001:
Number of Shares
Percentage of
Name and Address(1) Beneficially Owned(2)
Ownership
------------------ -------------------
- ---------
Victor J. Cianci.................................... 38,000
50.0%
Evvy R. Cianci...................................... 38,000
50.0%
___________________
(1) Except as otherwise indicated, the address of each principal shareholder of
Video City is c/o Video City, Inc., whose address is 4800 Easton Drive,
Suite 108, Bakersfield, California 93309.
(2) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission and generally includes voting or
investment power with respect to the securities. Except as indicated by
footnote and subject to community property laws where applicable, the
persons named in the table have sole voting and investment power with
respect to all shares of Video City's Series B preferred stock shown as
beneficially owned by them.
Video City does not know of any arrangements that may at a subsequent date
result in a change of control of Video City.
On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's
First Amended Chapter 11 Plan of Reorganization ("the Plan"). The Plan became
effective on August 29, 2001. Pursuant to the Plan, all outstanding Video City
options and warrants were deemed cancelled.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the fiscal years ended January 31, 2001 and 2000, Video City
retained a law firm to render legal services to it on real estate, litigation
and other matters. A partner at the law firm serves as a director of Video City.
Total fees for the years ended January 31, 2001 and 2000 were $235,000 and
$360,000.
26
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. 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.
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 11); 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.
As of January 31, 2001 and 2000, the Company owed Ingram approximately
$11.2 million and $11.1 million.
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 11). 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. As of
January 31, 2000 and 1999 the Company owed Rentrak approximately $8.9 million
and $8.8 million.
The Company had either purchased or leased approximately 80% of its
supply of new release videos, in the aggregate, from two suppliers, Ingram and
Rentrak. During fiscal 2001, the Company purchased approximately $3.5 million of
product from Ingram Entertainment and approximately $0 of product from Rentrak.
In October 1999, Video City temporarily discontinued making purchases from
Rentrak and began leasing product directly from film studios (Note 5). If the
relationships with Ingram, Rentrak and the film studios 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 comparable
terms and prices. However, there can be no assurance that any replacement
supplier would provide service or payment terms as favorable as those provided
by Ingram, Rentrak or the film studios. 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.
The Company has entered into employment and consulting agreements with
certain shareholders.
At January 31, 2001 and 2000, the Company had unsecured employee and
director loans aggregating approximately $0 and $9,078, respectively, bearing
interest at 7%, and due on demand.
At January 31, 2000, the Company determined that certain unsecured
employee and director loans aggregating approximately $86,700 were uncollectible
and were consequently written off, in the fourth quarter of fiscal 2000.
On March 3, 2000, Robert Y. Lee entered into a Security Agreement with
Ralph W. Standley, III, and T. Kyle Standley, whereby Mr. Lee pledges, assigns
and transfers 1,357,282 shares of Video City common stock ("Security Interest")
to Mr. Ralph and Kyle Standley. The Security Interest shall secure the due and
punctual payment and performance of any an all present and future obligations
and liabilities of Video City arising under or in connection with the Consulting
and Non-Compete agreements. As long as there is no default of this agreement,
Mr. Lee shall continue to be entitled to exercise the sole and exclusive voting
rights with respect to the pledged common stock.
27
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-37:
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
(b) Form 8-K
None in the quarter ended January 31, 2001.
(c) Exhibits
Numbers Description
- ------- -----------
3.1 Certificate of Designations for the Company's Series C Convertible
Redeemable Preferred Stock.(1)
3.2 Certificate of Designations for the Company's Series D Convertible
Redeemable Preferred Stock.(1)
3.3 Certificate of Designations for the Company's Series E Convertible
Preferred Stock.(1)
10.1 Asset Purchase Agreement dated as of April 22, 1999, by and among, the
Company, Videoland, Inc. and Blockbuster Inc.(1)
10.2 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 (previously filed).(1)
10.3 Debt Conversion Agreement dated as of March 30, 1999, by and among the
Company, Rentrak Corporation, Mortco, Inc. and Video Galaxy, Inc.(1)
10.4 Warrant to purchase 500,000 shares of Common Stock, dated as of March
31, 1999, between the Company and Mortco, Inc.(1)
10.5 Form of Option Agreement for directors and executive officers of the
Company.(1)
10.6 Form of Indemnity Agreement for directors and officers of the
Company.(1)
10.7 Second Modification Agreement, dated as of March 31, 1999, to Loan and
Security Agreement by and among the Company, its subsidiaries and
BankBoston Retail Finance Inc.(1)
10.8 Stock Purchase Agreement, dated June 2, 1999, by and between the
Company and The Value Group, LLC.(2)
10.9 Common Stock Purchase Warrant, dated May 11, 1999, by and between the
Company and The Value Group, LLC.(2)
10.10 Stock Purchase Agreement, dated June 11, 1999, by and between the
Company and International Video Distributors, LLC.(2)
10.11 Common Stock Purchase Warrant, dated June 11, 1999, by and between the
28
Company and International Video Distributors, LLC.(2)
10.12 Agreement and Plan of Merger, dated August 1, 1999, by and among the
Company, Key Stone Merger Corp. and West Coast Entertainment
Corporation (previously filed).(2)
10.13 Employment Agreement, dated June 16, 1999, between the Company and
Richard T. Gibson(2)
10.14 Amendment to Loan Documents, dated as of December 31, 1998, by and
among the Company, Ingram Entertainment Inc. and the debtors named
therein.(2)
10.15 Warrant to Purchase Common Stock, dated December 31, 1998, executed by
the Company for Ingram Entertainment Inc.(2)
10.16 Forbearance Agreement dated September 10, 1999, by and between the
Company and BankBoston Retail Finance, Inc.(3)
10.17 Management Agreement, dated as of March 3, 2000, by and between Video
City, Inc. and West Coast Entertainment Corporation. (4)
10.18 First Amendment to Merger Agreement, dated as of March 3, 2000, by and
among Video City, Inc., Keystone Merger Corp. and West Coast
Entertainment Corporation. (4)
10.19 Forbearance Agreement, dated March 9, 2000, between Video City, Inc.
and Fleet Retail Finance Inc. f/k/a BankBoston Retail Finance Inc. (5)
21.1 List of Subsidiaries of Video City, Inc. (5)
(1) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended April 30, 1999, and incorporated herein by
reference.
(2) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 1999, and incorporated herein by
reference.
(3) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended October 31, 1999, and incorporated herein by
reference.
(4) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 30, 1998, and incorporated herein by reference.
29
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 31, 2001, 2000 AND 1999
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-2
Consolidated Balance Sheets F-3
Consolidated Statements of Operations F-4
Consolidated Statements of Stockholders' Deficit F-5
Consolidated Statements of Cash Flows F-6
Notes to Consolidated Financial Statements F-8
F-1
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.
(Debtor-In-Possession) as of January 31, 2001 and 2000 and the related
consolidated statements of operations, stockholders' deficit, and cash flows for
each of the three years ended January 31, 2001. 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 auditing standards generally accepted
in the United States of America. 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.
(debtor-in-possession) as of January 31, 2001 and 2000, and the results of its
operations and its cash flows for each of the three years ended January 31,
2001, in conformity with accounting principles generally accepted in the United
States of America.
As discussed in Note 1, the Company has filed for reorganization under Chapter
11 of the United States Bankruptcy Code. The accompanying consolidated financial
statements do no purport to reflect or provide for the consequences of the
bankruptcy proceedings. In particular, such consolidated financial statements do
not purport to show (a) as to assets, their realizable value on a liquidation
basis or their availability to satisfy liabilities; (b) as to liabilities, the
amounts that may be allowed for claims or contingencies, or the status and
priority thereof; (c) as to stockholder accounts, the effect of any changes that
may be made in the capitalization of the Company; and (d) as to operations, the
effect of any changes that may be made in its business.
BDO Seidman, LLP
Los Angeles, California
September 7, 2001
F-2
Years ended January 31,
----------------------------
2001 2000
------------ ------------
Assets
Current assets:
Cash $ 1,046,164 $ 24,316
Customer receivables 433,024 1,003,578
Other receivables (Note 3) 946,655 -
Notes receivables from employees and directors (Note 5) - 9,078
Merchandise inventories 965,025 3,767,919
Prepaid expenses - 75,000
------------ ------------
Total current assets 3,390,868 4,879,891
Rental library, net 3,012,387 6,223,364
Property and equipment, net (Note 6) 1,525,409 4,266,665
Goodwill, net 1,912,713 4,920,303
Other assets 256,011 1,003,564
------------ ------------
Total assets $ 10,097,388 $ 21,293,787
============ ============
Liabilities and Stockholders' Deficit
Liabilities not subject to compromise:
Current liabilities:
Accounts payable (including $0 and $13,680,500 due to related parties) (Note 5) $ 215,724 $ 23,033,955
Accrued expenses (including $0 and $527,925 due to related parties) (Note 5) 1,041,134 3,069,765
Senior secured revolving credit facility (Note 7) - 9,769,574
Current portion of long-term debt (including $0 and $5,043,107 due to related
parties) (Note 8) - 5,565,078
------------ ------------
Total current liabilities 1,256,858 41,438,372
Long-term debt, less current portion (including $0 and $1,176,393 due to related
parties) (Note 8) - 1,231,907
Other liabilities 45,526 99,456
------------ ------------
Total liabilities not subject to compromise 1,302,384 42,769,735
Liabilities subject to compromise:
Accounts payable (including $13,880,500 and $0 due to related parties) (Note 5) 26,443,937 -
Senior secured revolving credit facility (Note 7) 10,451,429 -
Long-term debt (including $6,219,500 and $0 due to related parties) (Note 8) 6,790,454 -
Accrued interest (including $956,260 and $0 due to related parties) (Note 5) 1,004,342 -
Other liabilities 1,628,690 -
------------ ------------
Total liabilities subject to compromise 46,318,852 -
------------ ------------
Total liabilities 47,621,236 42,769,735
------------ ------------
Commitments and contingencies (Note 11)
Stockholders' deficit (Note 12):
Preferred stock 6,292,135 6,217,135
Common stock, $.01 par value per share, authorized 30,000,000 shares; issued and
outstanding 16,442,662 shares at 2001 and 15,767,959 shares at 2000 164,427 157,679
Additional paid-in capital 13,576,968 13,268,548
Accumulated deficit (57,557,378 (41,119,310
------------ ------------
Total stockholders' deficit (37,523,848 (21,475,948
------------ ------------
Total liabilities and stockholders' deficit $ 10,097,388 $ 21,293,787
============ ===============
See accompanying notes to consolidated financial statements
F-3
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended January 31,
------------------------------------------------
2001 2000 1999
------------- ------------- ------------
Revenue
Rental revenues and product sales $ 27,228,759 $ 44,784,703 $ 23,828,501
Management fee income (Note 13) 4,385,886 - 607,733
------------- ------------- ------------
Total revenue 31,614,645 44,784,703 24,436,234
------------- ------------- ------------
Operating costs and expenses
Store operating costs 19,816,623 29,950,293 13,675,372
Amortization of rental library 7,291,355 13,691,184 2,541,934
Cost of product sales 4,073,617 8,913,401 3,301,185
Cost of leased product 1,362,251 4,281,313 1,394,409
Restructuring (Note 10) 1,564,000 - -
General and administrative 8,062,262 14,738,358 4,785,890
(Gain) loss on sale of assets 199,373 (1,400,021) -
Store closure costs - 3,210,830 -
------------- ------------- ------------
Total operating costs and expenses 42,369,481 73,385,358 25,698,790
------------- ------------- ------------
Loss from operations (10,754,836) (28,600,655) (1,262,556)
Other (income) expense
Interest expense, net (contractual interest $1,980,104,
$3,706,749 and $1,563,348) 1,347,699 3,706,749 1,563,348
Other - (249,078) (221,081)
------------- ------------- ------------
Loss before reorganization items and income taxes (12,102,535) (32,058,326) (2,604,823)
Reorganization items
Professional fees 504,777 - -
Loss on sale of assets (Note 3) 3,508,614 - -
------------- ------------- ------------
Loss before income taxes (16,115,926) (32,058,326) (2,604,823)
Income tax expense (benefit) (Note 9) - 707,299 (2,615,957)
------------- ------------- ------------
Net income (loss) before dividends $ (16,115,926) $ (32,765,625) $ 11,134
------------- ------------- ------------
Dividends on preferred stock (322,142) (492,522) -
Net income (loss) available to common shareholders $ (16,438,068) (33,258,147) $ 11,134
============= ============= ============
Earnings (loss) per share (Note 15)
Basic and diluted earnings (loss) per share $ (1.01) $ (2.29) $ 0.00
============= ============= ============
Weighted average number of common shares outstanding
Basic 16,301,969 14,509,555 12,091,467
Diluted 16,301,969 14,509,555 13,428,378
See accompanying notes to financial statements.
F-4
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
Preferred Stock (Note 12)
----------------------------------------------------------------------------------------
Series AA Series B Series C Series D
------------------- -------------------- -------------------- --------------------
Shares Amount Shares Amount Shares Amount Shares Amount
-------- --------- -------- ---------- -------- --------- -------- ----------
Balance at January 31, 1998 - $ - - $ - - $ - - $ -
Stock issued in satisfaction
of debt - - - - - - - -
Stock issued in satisfaction
of services 750 75,000 - - - - - -
Stock issued for
acquisition of stores - - 76,000 3,065,190 - - - -
Stock issued for private
placement 7,000 623,773 - - - - - -
Net income - - - - - - - -
-------- --------- -------- ---------- -------- --------- -------- ----------
Balance at January 31, 1999 7,750 698,773 76,000 3,065,190 - - - -
Stock issued in satisfaction
of payables - - - - - - - -
Stock issued for services
rendered - - - - 403 403,000 - -
Stock issued for acquisitions - - - - 112 63,840 2,000 1,187,334
Stock issued for private
placement - - - - 625 625,000 - -
Stock option and warrants
exercised - - - - - - - -
Preferred stock converted
into common (3,750) (334,162) - - (740) (691,840) - -
Preferred stock dividends
($492,522 in common stock) - - - - - - - -
Issuance of options and
warrants - - - - - - - -
Net loss - - - - - - - -
-------- --------- -------- ---------- -------- --------- -------- ----------
Balance at January 31, 2000 4000 364,611 76,000 3,065,190 400 400,000 2,000 1,187,334
Stock issued in satisfaction
of payables - - - - - - - -
Stock issued for services
rendered - - - - 75 75,000 - -
Preferred stock dividends
($202,668 in common stock) - - - - - - - -
Net loss - - - - - - - -
-------- --------- -------- ---------- -------- --------- -------- ----------
Balance at January 31, 2001 4000 $ 364,611 76,000 $3,065,190 475 $ 475,000 2,000 $1,187,334
======== ========= ======== ========== ======== ========= ======== ==========
Preferred Stock (Note 12) Additional
-------------------------
Series E Common Stock Paid-In Accumulated
------------------------- ---------------------
Shares Amount Shares Amount Capital Deficit
--------- ---------- ---------- --------- ------------ -------------
Balance at January 31, 1998 - $ - 9,773,927 $ 97,739 $ 7,075,735 $ (7,872,297)
Stock issued in satisfaction
of debt - - 106,608 1,066 91,660 -
Stock issued in satisfaction
of services - - 136,680 1,367 101,143 -
Stock issued for
acquisition of stores - - 3,481,500 34,815 1,961,149 -
Stock issued for private
placement - - - - - -
Net income - - - - - 11,134
-------- ---------- ---------- --------- ------------ -------------
Balance at January 31, 1999 - - 13,498,715 134,987 9,229,687 (7,861,163)
Stock issued in satisfaction
of payables 2,056 2,056,000 203,300 2,033 379,667 -
Stock issued for services
rendered - - 26,000 260 33,852 -
Stock issued for acquisitions - - 344,000 3,440 609,224 -
Stock issued for private
placement - - - - - -
Stock option and warrants
exercised - - 123,077 1,231 66,459 -
Preferred stock converted
into common (856) (856,000) 1,057,858 10,578 1,657,734 -
Preferred stock dividends
($492,522 in common stock) - - 515,009 5,150 487,373 (492,522)
Issuance of options and
warrants - - - - 804,552 -
Net loss - - - - (32,765,625)
-------- ---------- ---------- --------- ------------ -------------
Balance at January 31, 2000 1,200 1,200,000 15,767,959 157,679 13,268,548 (41,119,310)
Stock issued in satisfaction
of payables - - 150,000 1,500 111,000 -
Stock issued for services
rendered - - - - - -
Preferred stock dividends
($202,668 in common stock) - - 524,703 5,248 197,420 (322,142)
Net loss - - - - - (16,115,926)
-------- ---------- ---------- --------- ------------ -------------
Balance at January 31, 2001 1,200 $1,200,000 16,442,662 $ 164,427 $ 13,576,968 $ (57,557,378)
======== ========== ========== ========= ============ =============
See accompanying notes to consolidated financial statements.
F-5
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in cash and cash equivalents
Years ended January 31,
--------------------------------------------------
2001 2000 1999
--------------- --------------- --------------
Cash flows from operating activities:
Net income (loss) $ (16,115,926) $ (32,765,625) $ 11,134
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization 12,946,560 16,253,259 3,692,329
(Gain) loss on sale of assets 3,969,510 (1,400,021) -
Issuance of stock for services and inventory 187,500 2,846,082 195,236
Store closures - 1,604,297 -
Issuance of stock options and warrants - 804,552 -
Decrease (increase) in deferred tax asset - 688,536 (883,249)
Changes in assets and liabilities, net of effects from acquisitions:
Decrease (increase) in accounts receivable 570,555 1,160,962 (1,378,087)
Increase in other receivables (946,655) - -
Decrease in notes receivable 9,078 82,234 268,727
Decrease (increase) in merchandise inventory 2,802,894 (2,205,613) (853,142)
Decrease (increase) in other assets 571,113 240,026 (925,751)
Increase (decrease) in accounts payable and liabilities subject
to compromise 3,506,231 12,128,385 (134,616)
Decrease in accrued expenses and liabilities subject to compromise (1,024,290) (2,321,764) (1,738,833)
Increase (decrease) in other liabilities and liabilities subject
to compromise 1,574,760 (328,335) (284,140)
-------------- -------------- -------------
Net cash provided by (used in) operating activities 8,051,330 (3,213,025) (2,030,392)
-------------- -------------- -------------
Cash flows from investing activities
Purchases of videocassette rental inventory, net (9,146,740) (6,425,632) (4,213,040)
Purchases of fixed assets (162,391) (2,043,954) (756,398)
Store acquisitions - (167,036) (2,626,185)
Proceeds from sale of fixed assets 28,434 13,863,000 -
Proceeds from sale of fixed assets after bankruptcy filing 1,575,893 - -
Proceeds from sale of film library - - 818,171
Repayment on notes receivable - 2,053,391 -
-------------- -------------- -------------
Net cash provided by (used in) investing activities (7,704,804) 7,279,769 (6,777,452)
-------------- -------------- -------------
Cash flows from financing activities
Proceeds from the issuance of preferred stock - 625,000 623,773
Principal payments on obligations under capital leases - - (18,136)
Repayment of pre-petition long-term debt (6,531) (434,533) (13,221,880)
Proceeds from issuance of long-term debt - 2,015,979 5,523,501
Proceeds from borrowings (repayments) under pre-petition
revolving credit facility, net 681,855 (6,274,919) 16,044,502
Cash payment made in conversion of preferred stock - (213,690) -
Proceeds from exercise of stock options - 67,692 -
-------------- -------------- -------------
Net cash provided by (used in) financing activities 675,324 (4,214,471) 8,951,760
-------------- -------------- -------------
Net increase (decrease) in cash 1,021,850 (147,727) 143,916
Cash at beginning of year 24,316 172,043 28,127
-------------- -------------- -------------
Cash at end of year $ 1,046,166 24,316 $ 172,043
============== ============== =============
See accompanying notes to financial statements.
F-6
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
cONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years ended January 31,
---------------------------------------------
2001 2000 1999
----------- ------------- ------------
Supplementary disclosures of cash flow information
Cash paid during the year:
Interest $ 1,347,669 $ 1,437,112 $ 1,071,506
Income taxes - 17,924 800
Reorganization items 104,000 - -
Noncash investing and financing activities:
Professional services financed through issuance of common stock - 2,846,082 195,236
Liabilities converted to preferred stock - 1,187,334 -
Common stock issued in satisfaction of payables 112,500 - -
Professional services financed through issuance of preferred stock 75,000 - 75,000
Preferred stock dividends 322,142 492,522 -
Conversion of accounts payable to short term debt - 1,453,706 -
Accounts payable converted to long term debt - - 494,935
For acquisitions consummated during fiscal 2000 and fiscal 1999, the Company
paid $167,036 and $2,626,185, net of cash acquired. In conjunction with the
acquisitions, liabilities were assumed as follows:
Fair value of assets acquired $ 1,614,929 $ 22,018,218
Cash paid (167,036) (2,626,185)
Common stock issued (641,394) (1,995,964)
Preferred stock issued (1,251,174) (3,065,190)
Goodwill 4,172,469 5,260,990
------------- ------------
Liabilities assumed $ 3,727,794 $ 19,591,869
============= ============
See accompanying notes to consolidated financial statements
F-7
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 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 located
throughout the United States that rent and sell videocassettes, digital video
discs ("DVD"), and video games.
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"), 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". As a result of the
Company's sale of its library of feature films and other film properties in
1998, the Company's sole business is the ownership and operations of video
specialty stores.
As a result of the merger with and into Prism, the Company changed its fiscal
year end to January 31.
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., Videoland,
Inc and Video Galaxy, Inc. All material intercompany transactions have been
eliminated. The financial statements include the operations of companies
acquired from the dates of acquisition (Note 2).
Bankruptcy
On August 17, 2000, Fleet Retail Finance purported to accelerate the outstanding
indebtedness under the Company's secured credit facility. Fleet Retail Finance
also initiated an action in the Massachusetts State Court to recover the sums
allegedly due under the credit facility and obtained a temporary order requiring
that the Company deposit its cash receipts into designated Fleet Retail Finance
accounts. The Company filed a complaint against Fleet Retail Finance and certain
other defendants seeking damages in excess of $25.0 million. The Complaint
alleges fraud, breach of contract, breach of the covenant of good faith and fair
dealing, intentional interference with contractual relations, intentional
interference with advantageous relations, violation of the Racketeer Influenced
and Corrupt Organizations Act and violation of applicable provisions of
Massachusetts state law. The Company also filed a motion to vacate the temporary
order obtained by Fleet Retail Finance and to restrain Fleet Retail Finance from
sweeping the cash from the Company's depository accounts, which are used to fund
operations and payroll. On August 22, 2000, the Massachusetts court directed
Fleet Retail Finance to release enough funds to cover payroll.
On August 24, 2000 as a result of the Fleet Retail Finance action to accelerate
payment of the outstanding indebtedness under the Company's secured credit
facility, the Company and its subsidiaries filed a voluntary petition in the
United States Bankruptcy Court for the Central District of California (the
"Bankruptcy Court") seeking to reorganize under Chapter 11 of the U.S.
Bankruptcy Code. Under Chapter 11, certain claims against the Company in
existence prior to the filing of the petition for relief under federal
bankruptcy law, are stayed while the Company continues business operations as
Debtor-In-Possession (DIP). These claims are reflected in the accompanying
Consolidated Balance Sheets as "Liabilities subject to compromise".
F-8
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
The Bankruptcy Court approved payment of certain pre-petition liabilities such
as employee expenses and benefits. The Bankruptcy Court also allowed for the
retention of legal and financial professionals. These items are recorded as
accounts payable and accrued expenses not subject to compromise.
The Court established January 16, 2001 (the "Bar Date") as the deadline for
filing proofs of claim in the bankruptcy proceedings. The Company notified all
known claimants for the purposes of identifying all pre-petition claims against
the Company.
Liabilities subject to compromise were subject to further adjustment depending
on Bankruptcy Court action, further developments with respect to disputed
claims, determination as to the value of any collateral securing claims, or
other events.
There were approximately 390 scheduled liabilities and filed proofs of claim
against the Company. The aggregate amount of those claims, which specified
amounts was approximately $79,600,000. Included in the claims filed, were claims
of unspecified amounts. The Company considered the amount to be highly inflated
and a totally unreliable estimate of its liabilities. The Company requested the
Bankruptcy Court to approve reductions of, or to expunge, overstated, duplicate
or amended claims. The ultimate amount of and settlement terms for such
liabilities were subject to the approved plan of reorganization. No provision
was made for the differences between the amounts filed with the Bankruptcy Court
and the balances reflected in the accompanying Consolidated Financial
Statements.
The plan of reorganization, as finally approved by the Bankruptcy Court, will
materially change the currently recorded amounts of assets and liabilities.
These financial statements do not reflect further adjustments to the carrying
value of assets and the amounts and classifications of liabilities or
shareholders' deficit as a consequence of the bankruptcy proceedings.
Under the Bankruptcy Code, the Company could elect to assume or reject real
estate leases, employment contracts, personal property leases, service contracts
and other unexpired executory pre-petition contracts, subject to Bankruptcy
Court approval. Certain leases and contracts were rejected in connection with
the bankruptcy proceedings. Obligations related to these rejected items have
been included in liabilities subject to compromise in amounts pursuant to the
Bankruptcy Code. The ultimate amount of such claims was subject to adjustment
based on the finalization of a reorganization plan.
Since the commencement of the bankruptcy filing, the Company filed a plan of
reorganization which was confirmed on July 30, 2001, effective on August 29,
2001.
F-9
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
During the bankruptcy period, the Company obtained approval from the Bankruptcy
Court to liquidate the assets of 17 stores, thereby recognizing a loss of $2.2
million (Note 3). The Company also entered into a compromise agreement with
Fleet Retail Finance with the approval of the Bankruptcy Court, under which the
outstanding debt was settled in full satisfaction by the payment of $1,500,000.
Financial Reporting for Bankruptcy Proceedings
The American Institute of Certified Public Accountants Statement of Position
90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code" ("SOP 90-7"), provides guidance for financial reporting by entities that
have filed petitions with the Bankruptcy Court and expect to reorganize under
Chapter 11 of the Bankruptcy Code.
Under SOP 90-7, the financial statements of an entity in a Chapter 11
reorganization proceeding should distinguish transactions and events that are
directly associated with the reorganization from those of the operations of the
ongoing business as it evolves. Accordingly, SOP 90-7 requires the following
financial reporting/accounting treatments in respect to each of the financial
statements:
The balance sheet separately classifies pre-petition and post-petition
liabilities. A further distinction is made between pre-petition liabilities
subject to compromise (generally unsecured and undersecured claims) and those
not subject to compromise (fully secured claims). Pre-petition liabilities are
reported on the basis of the expected amount of such allowed claims, as opposed
to the amounts for which those allowed claims may be settled. Under an approved
final plan of reorganization, those claims may be settled at amounts
substantially less than their allowed amounts.
When a liability subject to compromise becomes an allowed claim and that claim
differs from the net carrying amount of the liability, the net carrying amount
is adjusted to the amount of the allowed claim. The resulting gain or loss is
classified as a reorganization item in the Consolidated Statements of
Operations.
Revenues and expenses, realized gains and losses, and provisions for losses
resulting from the reorganization of the business are reported in the
Consolidated Statement of Operations separately as reorganization items.
Professional fees are expensed as incurred. Interest expense is reported only to
the extent that it will be paid during the proceeding or that it is probable
that it will be an allowed claim.
F-10
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Customer Receivables
Customer receivables primarily consist of extended rental fees. In the fourth
quarter of fiscal 2000, the Company wrote-off approximately $1.1 million of
customer receivables from extended rental fees based on its collection results
during fiscal 2000.
Merchandise Inventories
Merchandise inventories consist primarily of prerecorded videocassettes, DVDs,
video games, concessions, and accessories held for resale and are stated at the
lower of cost or market. Merchandise inventory cost of sales are determined on a
first-in, first-out basis.
Rental Library
During the fourth quarter of fiscal 2000, the Company adopted an accelerated
method of amortizing its videocassette, DVD and game rental library. The Company
has adopted this new method of amortization because it has implemented a new
business model, including revenue sharing agreements, which has increased the
number of videocassettes and DVDs in the stores and is satisfying consumer
demand over a shorter period of time. Revenue sharing allows the Company to
purchase videocassettes and DVDs at a lower initial product cost than the
traditional buying arrangements, with a percentage of net rental revenues shared
over a contractually determined period of time. As the new business model
results in a greater proportion of rental revenue over a shorter period of time,
the Company has changed its method of amortizing the rental library in order to
more closely match expenses in proportion with the anticipated revenues to be
generated there from.
Pursuant to the new amortization method, the Company records base stock
(generally 3 copies per title for each store) at cost and amortizes a portion of
these costs on an accelerated basis over three months, generally to $8 per unit,
with the remaining base stock cost amortized on a straight line basis over 33
months to an estimated $3 salvage value. The cost of non base stock (generally
greater than 3 copies per title for each store) are amortized on an accelerated
basis over three months to an estimated $3 salvage value. Video games are
amortized on an accelerated basis over a 12 month period to an estimated $10
salvage value. Revenue-sharing payments are expensed when revenues are earned
pursuant to the applicable contractual arrangements.
The new method of amortization was applied to the rental library that was held
at February 1, 1999. The adoption of the new method of amortization was
accounted for as a change in accounting estimate and, accordingly, the Company
recorded a pre-tax adjustment of approximately $7.1 million to cost of rental
revenues in the fourth quarter of the fiscal year ended January 31, 2000. The
charge represents an adjustment to the carrying value of the rental library due
to the new method of amortization.
F-11
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Prior to February 1, 1999, the rental library was recorded at cost and amortized
over its estimated economic life. Base stock was 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 were 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 were amortized over 9 months
on a straight-line basis with a salvage value of $6 per tape.
Rental amortization expense approximated $7.2 million and $13.7 million
(including a $7.1 million adjustment recorded in the fourth quarter fiscal
2000), and $2.5 million for the years ended January 31, 2001, 2000 and 1999.
As videocassettes, DVD's and games 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. Leasehold improvements are
recorded at cost and amortized using the straight-line method over the estimated
economic life of the lease term.
Furniture and fixtures 5 years
Computer equipment and software 3 years
Equipment 3 years
Leasehold improvements 5-10 years
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 fair value is required.
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, 2001. Amortization expense
charged to operations for the year ended January 31, 2001 was $0.2 million.
F-12
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition
Revenue is recognized at the time of rental or sale, or as extended rental fees
accrue, net of allowances for doubtful amounts, based on historical experience.
Store Opening Costs
Store opening costs, which consist primarily of payroll, advertising and
supplies, are expensed as incurred.
Store Closures
Reserves for store closures are established by calculating the remaining lease
obligation, adjusted for estimated subtenant agreements or lease buyouts, if
any, and are expensed along with any leasehold improvements, and unamortized
goodwill. Store furniture and equipment are either transferred at historical
cost to another location or written down to their net realizable value.
Advertising
Advertising costs are expensed as incurred. Advertising expense was $210,258,
$1,191,891 and $485,681 for the years ended January 31, 2001, 2000 and 1999,
respectively.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (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 allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
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 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.
F-13
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings (Loss) per Share
Earning (loss) per share is presented according to Statement of Financial
Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share". 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.
Comprehensive Income
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 other
components of 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.
Fair Value of Financial Instruments
In accordance with SFAS No. 107, "Disclosure about Fair Value of Financial
Instruments", the Company has disclosed the fair value, related carrying value
and method for determining the fair value of its financial instruments. (See
Note 15.)
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 substantially differ from those estimates.
New Accounting Pronouncements
Statement of Financial Accounting Standards No. 133, "Accounting for Certain
Derivative Instruments and Certain Hedging Activities" (SFAS 133), establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. Statement of Financial Accounting
Standards No. 137, Accounting for Derivative Instruments and Hedging Activities
- - Deferral of the effective date of FASB Statement No. 133 - an amendment of
FASB Statement No. 133 ("SFAS 133"), defers the effective date of SFAS 133 to be
effective for financial statements ending after June 15, 2000. Statement of
Financial Accounting Standards No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities, an amendment of FASB Statement No.
133, amended certain of the accounting and reporting standards of SFAS 133. The
adoption of SFAS No. 133 did not have a material effect on the financial
position or results of operations.
F-14
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--Business Operations and Significant Accounting Policies (Continued)
In December 1999, the SEC staff released Staff Accounting Bulletin SAB No. 101,
"Revenue Recognition in Financial Statements". SAB 101 provides interpretive
guidance on the recognition, presentation and disclosure or revenue in the
financial statements. SAB 101 must be applied to the financial statements no
later than the quarter ending September 30, 2000. The adoption of SAB 101 had no
material affect on the Company's financial results.
In March 2000, the Financial Accounting Standards Board issued Interpretation
No. 44 ("FIN 44") Accounting for Certain Transactions Involving Stock
Compensation, an Interpretation of APB Opinion No. 25. FIN 44 clarifies the
application of Opinion No. 25 for (a) the definition of employee for purposes of
applying Opinion No. 25, (b) the criteria for determining whether a plan
qualifies as a non-compensatory plan, (c) the accounting consequences of various
modifications to the terms of a previously fixed stock option or award, and (d)
the accounting for an exchange of stock compensation awards in a business
combination. FIN 44 is effective July 2, 2000, but certain conclusions cover
specific events that occur after either December 15, 1998, or January 12, 2000.
The implementation of FIN 44 did not have a material effect on the Company's
financial position.
NOTE 2--ACQUISITIONS
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 owned and operated 15 retail video stores in
Connecticut and Massachusetts. The purchase price consisted of (i) 344,000
shares of Video City 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 2,000 shares of the
Company's Series D Convertible Redeemable Preferred Stock and 500,000 warrants
with an exercise price of $3.00 per share). The payoff of indebtedness at
closing was provided by proceeds obtained from a note payable to an existing
creditor of the Company.
On March 26, 1999, the Company issued 112 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to Box
Office, LLC as part of the consideration for the purchase of the assets of a
video store acquired from Box Office, LLC. The Series C Convertible Redeemable
Preferred Stock is convertible into shares of the Company's Common Stock at a
conversion price of $2.00 per share.
NOTE 3--DIVESTITURE OF STORES
During the fourth quarter of fiscal 2001, the Company sold an additional 14
stores and recorded a loss of approximately $1.3 million, which included
approximately $1.25 million of unamortized goodwill. At January 31, 2001, the
proceeds from the sale of the stores were held in a trust account by a legal
firm.
On September 27, 2000, the Company obtained approval from the Bankruptcy Court
to reject the leases on 17 under performing store locations and liquidate the
assets. The assets were sold to Video One Liquidators at the aggregate net
liquidation price of $508,760. The Company recognized a loss on the sale of
approximately $2.2 million during the third quarter of fiscal 2001 including
approximately $1.5 million of unamortized goodwill, which is included in the
reorganization items.
In July 2000, the Company sold 2 stores and recorded a loss of approximately
$199,000.
F-15
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
On July 26, 1999, the Company sold the assets of 49 of its Videoland retail
video stores located in the states of Washington and Oregon to Blockbuster, Inc
("Blockbuster"). The aggregate purchase price for the sale of the 49 stores was
approximately $14 million in cash, and approximately $2 million in notes
receivable which were subject to the transfer of assets of the four additional
Videoland stores and to certain post closing adjustments. The Company recognized
the gain on the sale of approximately $1.4 million on July 26, 1999, which
includes the four additional Videoland stores, which were transferred on August
30, 1999.
The following unaudited pro forma condensed consolidated statements of
operations assumes all acquisitions and divestitures 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
transactions and there can be no assurance that the foregoing results will be
obtained.
Years ended January 31,
---------------------------------
2001 2000
-------------- ---------------
Revenue and product sales $ 19,664,069 $ 36,327,830
Loss before income taxes $ (12,222,475) $ (33,741,255)
Net loss before dividends $ (12,222,475) $ (34,448,554)
Net loss available to common shareholders $ (12,554,617) $ (35,131,039)
Basic loss per share $ (0.77) $ (2.40)
Basic weighted average number of shares outstanding 16,301,969 $ 14,621,688
NOTE 5--RELATED PARTY TRANSACTIONS
Ingram Entertainment Inc.
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. 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.
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 long-term supply agreement with Ingram
for videocassettes and related products (Note 11); 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 prohibited 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.
F-16
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--RELATED PARTY TRANSACTIONS (Continued)
In March 1999, Video City acquired Video Galaxy, Inc. for 360,667 shares of
Video City's common stock and the assumption of $4,833,000 of indebtedness. In
connection with this acquisition, Video City borrowed $1,700,000 from Ingram
Entertainment, Inc. (a shareholder) to pay off certain amounts owed to Video
Galaxy's creditors and other parties. The interest rate on the $1,700,000 loan
was prime plus 1.5 percent, but increased to 14% in July 1999. Video City also
agreed to pay Ingram a management information system fee in the amount of
$85,000.
In November 1999, the Company issued warrants to purchase 2,000,000 shares of
the Company's common stock, at an exercise price of $.875 per share (1,000,000
shares to Ingram Entertainment and 1,000,000 shares to an officer of the
Company). Ingram Entertainment agreed to provide an additional $2 million trade
credit to the Company of which up to $1 million was guaranteed by an officer of
the Company.
As of January 31, 2001 and 2000, the Company owed Ingram approximately $11.2
million and $11.1 million. As a result of the bankruptcy, the amount owing has
been included in liabilities subject to compromise.
Rentrak Corporation
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 11). 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.
In March 1999, Video City acquired Video Galaxy, Inc. for 360,667 shares of
Video City's common stock, and the assumption of $4,833,000 of indebtedness. In
connection with this acquisition, Video City paid $1,117,000 to Mortco, Inc. (a
wholly owned subsidiary of Rentrak, a shareholder) in partial payment of
indebtedness owed by Video Galaxy to Mortco. In addition, Video City issued to
Mortco 2,000 shares of Series D convertible redeemable preferred stock, $1,000
stated value per share, convertible into 666,667 shares of Video City common
stock, and warrants to purchase 500,000 shares of Video City common stock at
$3.00 per share, in consideration for the cancellation by Mortco, Inc. and
Rentrak of $2,000,000 owed to them by Video Galaxy. Rentrak and its wholly-owned
subsidiary, Mortco, Inc., were the supplier and creditor of Video Galaxy before
the acquisition. Mortco, Inc. is a principal shareholder of Video City.
As of January 31, 2001 and 2000, the Company owed Rentrak approximately $8.9
million and $8.8 million. As a result of the bankruptcy, the amount owing has
been included in liabilities subject to compromise.
F-17
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--RELATED PARTY TRANSACTIONS (Continued)
The Company had either purchased or leased approximately 80% of its supply of
new release videos, in the aggregate, from two suppliers, Ingram and Rentrak.
During fiscal 2001, the Company purchased approximately $3.5 million of product
from Ingram Entertainment and approximately $0 of product from Rentrak. In
October 1999, Video City temporarily discontinued making purchases from Rentrak
and began leasing product directly from film studios. The relationships with
these vendors were replaced with the new agreements entered into as a result of
the bankruptcy filings. (Notes 11 and 16.)
Other Related Parties
From February 1999 through January 31, 2000, Video City had consulting
agreements with two principal shareholders of Video City pursuant to which they
provided retail video rental and sales consulting services to Video City. The
consulting agreements provide for the payment by Video City of $25,333 per month
to each of them, and the consultants granted a waiver of a like amount of
dividends payable on the Series B Preferred Stock.
During the fiscal years ended January 31, 2001 and 2000, Video City retained a
law firm to render legal services to it on real estate, litigation and other
matters. A partner at the law firm serves as a director of Video City. Total
fees for the years ended January 31, 2001 and 2000 were $235,000 and $360,000.
The Company has entered into employment and consulting agreements with certain
shareholders (See Note 11).
The Company made loans to employees and directors during the years ended January
31, 2001, 2000 and 1999, respectively. The Company determined that certain
unsecured employee and director loans aggregating approximately $86,700 were
uncollectible and were consequently written off, in the fourth quarter of fiscal
2000. At January 31, 2001 and 2000, the Company had unsecured employee and
director loans aggregating approximately $0 and $9,078, respectively, bearing
interest at 7%, and due on demand.
F-18
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6--PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
January 31,
------------------------------
2001 2000
------------- -------------
Furniture and fixtures $ 1,883,969 $ 3,147,307
Equipment 2,650,198 2,956,876
Leasehold Improvements 1,064,784 2,052,684
------------ ------------
Total Property and Equipment 5,598,951 8,156,867
Accumulated depreciation and amortization (4,073,542) (3,890,202)
------------ ------------
Total Property and Equipment, net $ 1,525,409 $ 4,266,665
============ ============
Depreciation and amortization expense was $1,680,478, $1,879,370 and $601,000
for the years ended January 31, 2001, 2000 and 1999, respectively.
NOTE 7--SENIOR SECURED REVOLVING CREDIT FACILITY
On December 29, 1998, the Company entered into a Senior Secured Revolving Credit
Facility agreement (the "Credit Facility") with BankBoston/Fleet Retail Finance
to be used for working capital purposes and capital expenditures. The Credit
Facility was scheduled to mature on December 29, 2001. The loan fees related to
the credit facility were capitalized and amortized over the term of the loan
agreement.
During the fiscal year ended January 31, 2000, the Company did not meet certain
of the financial covenants as required by the credit facility. On September 23,
1999, the Company entered into a forbearance agreement with BankBoston/Fleet
Retail Finance that amended the terms of the Loan Agreement, revised the
financial performance covenants of the Loan Agreement and contained weekly
covenant requirements. In the fourth quarter of fiscal 2000, the deferred loan
fees were written off when the original loan agreement was terminated and
replaced with the forbearance agreements. In November 1999, the Company did not
meet the financial performance covenants as set forth in the forbearance
agreement. On March 9, 2000, the Company entered into a second forbearance
agreement that limited the Credit Facility to $10,750,000 and revised the
financial covenant requirements.
On August 24, 2000, as a result of the Fleet Retail Finance action to accelerate
payment of the outstanding indebtedness under the Company's secured credit
facility, the Company filed a voluntary petition in the United States Bankruptcy
Court seeking to reorganize under Chapter 11 of the U.S. Bankruptcy Code (see
Note 1). As a result of the bankruptcy, the outstanding indebtedness was
classified as liabilities subject to compromise and the Company stopped accruing
interest on the outstanding balance of the credit facility.
The Company and Fleet Retail Finance entered into a compromise agreement which
was approved by the Bankruptcy Court on March 28, 2001 under which the
outstanding debt to Fleet Retail Finance was settled in full satisfaction by the
payment of $1,500,000 (see Note 16).
F-19
Video City, Inc.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8--LONG-TERM DEBT
Long-term debt consists of the following:
January 31,
----------------------------
2001 2000
------------ ------------
Promissory note, secured by certain assets, subordinate to the credit facility,
executed in April 1999, payable in April 2000 and bearing interest at a prime
plus 1.5%. The Company has defaulted on the payment terms of this note.
Interest rate increased to 14% in July 1999. $ 1,700,000 $ 1,700,000
Unsecured note to fulfill outstanding trade payables, executed in February 1999,
bearing interest of 10%, payable in January 2000. The Company has defaulted
on the payment terms of this note. Interest rate increased to 14% in January
2000. 1,453,706 1,453,706
Promissory notes, secured by certain assets subordinate to the credit facility
(Note 8), payable in monthly installments of $34,403 and $5,952, interest
imputed at 9% per annum, due June 2003. 1,660,653 1,660,653
Promissory notes, secured by certain assets subordinate to the credit facility
(Note 8), at interest rates varying from 9% to 10% per annum, due July 1999.
The Company has defaulted on the payment terms of this note. Interest rate
increased to 12% in July 1999. 1,405,141 1,405,141
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. 8,059 8,059
Unsecured notes to fulfill outstanding trade payables, executed in July through
September of 1999, bearing interest of 10% due and payable in December 1999.
The Company has defaulted on the payment terms of this note. Interest
increased to 18% in December 1999. 303,539 303,539
Other unsecured obligations, including interest from 7% to 15% per annum, due
from January 2000 to September 2010. The Company has defaulted on the payment
terms of this note. 259,356 265,887
----------- -----------
Total long-term debt 6,790,454 6,796,985
Current portion - (5,565,078)
----------- -----------
Long-term debt, less current portion $ 6,790,454 $ 1,231,907
----------- -----------
All long-term debt outstanding has been classified as liabilities subject to
compromise on August 24, 2000. No interest was accrued on the long-term debt
subsequent to the bankruptcy filing. No principal or interest payments on
pre-petition debt were made during the bankruptcy proceedings.
The Company has outstanding indebtedness in the aggregate amount of $4,862,238
with certain of the Company's key suppliers that reached maturity and are now
overdue. The debt agreements with the key suppliers provided for increased
interest rates ranging from 12% to 18% and penalty payments of up to 8% during
the periods of default. As a result of the bankruptcy filing, the outstanding
indebtedness to these key suppliers has been included in liabilities subject to
compromise.
F-20
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9--INCOME TAXES
As of January 31, 2001, net operating loss carryforwards generated by the
Company of approximately $45,653,000 and $21,626,000 for Federal and California
income tax purposes are available to offset future taxable income through 2020.
The Company's ability to utilize net operating loss carryforwards is 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. The Company anticipates that a portion of the Federal and
State net operating losses may be limited due to ownership changes as a result
of the bankruptcy filing. The ownership changes are as defined under Section 382
of the Internal Revenue Code of 1986. 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:
Years Ended January 31,
----------------------------------------------
2001 2000 1999
----------- ------------ -------------
Current
- -------
Federal $ - $ - $ -
State - 16,765 5,000
----------- ------------ -------------
- 16,765 5,000
----------- ------------ -------------
Deferred
- --------
Federal - 712,425 (2,384,229)
State - (21,891) (236,728)
----------- ------------ -------------
- 690,534 (2,620,957)
----------- ------------ -------------
$ - $ 707,299 $ (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. At January 31, 1999,
as a result of the significant acquisitions consumated during the year, the
Company 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 asset and had accordingly, reversed the full amount of the
valuation allowance. At January 31, 2001 and 2000, due to the losses incurred
during fiscal 2001 and 2000, and the Company's short-term divestiture strategy,
management cannot determine it is more likely than not that future taxable
income will be sufficient to realize the deferred tax asset. Accordingly, a full
valuation allowance has been established against the deferred tax asset at
January 31, 2001 and 2000.
F-21
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9--INCOME TAXES (Continued)
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. In April 1999, the Company sold 49 of its 76
stores acquired from Videoland. The remaining deferred tax liability equaled
$190,221 as of January 31, 2001 and 2000. In connection with the acquisition of
Video Galaxy, a net deferred tax liability of $194,713 was recorded. The
following table presents the primary components of the Company's net long-term
deferred tax asset:
January 31,
----------------------------------
2001 2000
------------- --------------
Components of long-term deferred tax assets:
Federal and State NOL carryforward $ 16,782,957 $ 11,829,861
Videoland fixed asset basis difference 867,986 867,986
Fixed assets due to difference in depreciation and amortization 213,520 205,554
Store closure reserve 138,819 270,844
Other 11,144 17,342
------------- -------------
Total gross deferred tax asset 18,014,426 13,191,587
Valuation allowance (16,956,219) (12,133,380)
------------- -------------
Total deferred tax asset, net of valuation allowance 1,058,207 1,058,207
------------- -------------
Components of long-term deferred tax liability:
Videoland and Video Galaxy inventory basis difference (1,058,207) (1,058,207)
------------- -------------
Net long-term deferred tax asset $ - $ -
------------- -------------
The total income tax provision differs from the amount computed by applying the
statutory Federal income tax rate for the following reasons:
Year Ended January 31,
--------------------------------------------------------
2001 2000 1999
----------------- ----------------- ------------------
% 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 %
Valuation allowance 29.9% 37.8 % (84.3)%
Expiration of net operating losses -% - % 14.9 %
Other 4.1% (1.6)% 0.6 %
------- ------- -------
Total -% 2.2 % (100.4)%
------- ------- -------
F-22
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10--RESTRUCTURING
Restructuring Expense
The Company incurred $1.6 million in restructuring costs during the period
ending October 31, 2000, consisting of severance obligations to employees of
approximately $950,000, lease liability for the former executive offices in
Torrance, California of approximately $100,000, moving expenses of the corporate
office of approximately $80,000, and a non-cash write down of the related
leasehold improvements of approximately $430,000. These costs are related to the
Company's effort to improve the performance of its operations and streamline its
corporate expenses. During the year ended January 31, 2001, the Company paid
$703,472 in cash for the restructuring expenses.
NOTE 11--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 $5,032,859, $7,857,682 and $3,601,986 for the
years ended January 31, 2001, 2000 and 1999, respectively.
The future minimum lease payments under noncancelable operating leases with
initial lease terms in excess of one year as of January 31, 2001 are as follows:
Years ending Operating
January 31, Leases
- ------------------ ------------
2002 $ 2,821,842
2003 2,230,397
2004 1,880,922
2005 1,456,476
2006 790,093
Thereafter 742,478
------------
Total $ 9,922,208
============
Revenue Sharing Agreement - Pursuant to the Revenue Sharing Agreement (Note 1),
the Company was obligated to pay revenue sharing and fee payments that are based
on a percentage of the Company's gross rental revenues. As a result of the
bankruptcy filing, the agreements were rejected.
Vendor Supply Agreement - On November 6, 1996, the Company amended the March 13,
1996 agreement with a major supplier to purchase, under certain conditions, 80%
of its annual requirements for the video rental, video sell-through and video
game products. The agreement expired on June 30, 2001. During fiscal 2001, the
Company purchased approximately $3.5 million of product from this supplier. As a
result of the bankruptcy filing, the agreements were rejected.
F-23
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--COMMITMENTS AND CONTINGENCIES (Continued)
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, but, 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 had entered into employment agreements with
various of its key officers. In general, these agreements cover a period of
three years or less. As a result of the bankruptcy filing, the agreements were
rejected.
Other Agreements - In June of 2001, the Company entered into a purchase money
security agreement directly with Warner Brothers Home Video. The agreement
provides the company with a credit line and 60 day terms for repayment. The
company purchases all Warner Brothers product directly from Warner Brothers Home
Video, which is then distributed to all Video City's home entertainment retail
chain through a third party distributor.
In July 2001 the Company entered into an agreement with Video Products
Distributors ("VPD") under which VPD agreed to become the exclusive video
distributor for all of Video City's home entertainment retail chain. VPD will
provide all videocassettes, DVDs and accessories for rental and sale with the
exception of Warner Brothers Home Video product in all locations. As part of
this agreement, Video City is receiving a credit line and 60 day terms for
payment to VPD.
F-24
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--COMMITMENTS AND CONTINGENCIES (Continued)
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 unexercised options
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. Mr. Weber is a director of the
Company and Mr. Lehman was a director of the Company until December 1999.
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.
F-25
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT
Video City's authorized capital consists of 30,000,000 shares of common stock,
$.01 par value per share, and 2,000,000 shares of preferred stock, $.01 par
value per share.
Common Stock
The Company's common stockholders are entitled to one vote for each share held
of record on all matters submitted to a vote of the stockholders and are
entitled to receive ratably any dividends declared by its board of directors out
of legally available funds, after payment of any dividends required on its
outstanding preferred stock. Upon liquidation, dissolution or winding up, its
common stockholders are entitled to share ratably in all assets that are legally
available for distribution, after payment of or provision for all debts and
liabilities and any payments with respect to the preferred stock.
Preferred Stock
The Company's board is authorized to issue up to 2,000,000 shares of Series AA,
B, C, D, E, F and G Convertible Redeemable Preferred Stock. The following sets
forth the material terms of the Preferred Stock outstanding:
- Series AA Convertible Redeemable Preferred Stock.
Holders are entitled to receive, when, as and if declared by the Company's
board, out of funds legally available therefore, dividends at the annual rate of
9.0% of the stated value per share. These dividends are cumulative from the date
of original issue and are payable semi-annually on November 30 and May 31 of
each year. In the event the Company does not pay such dividends in cash, the
Company may elect to pay such dividends in shares of Company Common Stock,
valued at the average of the trading price for the 20 consecutive trading days
immediately preceding the dividend payment date.
The holders are not entitled to vote upon any matter except as otherwise
required by law, and each share of Series AA Preferred Stock is convertible at
any time into a number of shares of Company common stock determined by dividing
$100 by the conversion price of $2.00.
Commencing on June 1, 2000, the Series AA Preferred Stock may be redeemed in
whole or in part by the Company for cash at $100 per share, plus all declared
and unpaid dividends thereon. However, the Company may not redeem the Series AA
Preferred Stock unless the common stock has had a trading price of not less than
175 percent of the conversion price for 20 consecutive trading days ending not
more than two trading days prior to the date of the redemption notice.
With respect to dividend rights and rights upon liquidation, dissolution or
winding up, the Series AA Preferred Stock ranks:
. senior to the common stock, and to all equity securities ranking junior to
the Series AA Preferred Stock; and
. pari passu with all currently outstanding preferred stock of the Company
and with shares of any other series of preferred stock to be issued that may
be designated to rank pari passu with the Series AA Preferred Stock.
F-26
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
- Series B Voting Convertible Redeemable Preferred Stock.
Holders are entitled to receive, when, as and if declared by the Company's
board, out of funds legally available therefore, dividends at the annual rate of
8.0% of the stated value per share. These dividends are cumulative from the date
of original issue and are payable monthly on the last day of each calendar
month. In the event the Company is unable to pay such dividends in cash, the
Company may pay such dividends in shares of Company common stock, valued at the
average of the trading price for the ten consecutive trading days immediately
preceding the dividend payment date.
Holders are entitled to vote together with the common stock holders as a single
class upon all matters presented to the Company stockholders, with each share
being entitled to a number of votes equal to the number of shares of common
stock a Series B Preferred Stock holder would be holding on the record date for
the relevant stockholders meeting if the Series B Preferred Stock holder had
converted such share of Series B Preferred Stock into shares of Company common
stock.
Each share of Series B Preferred Stock is convertible at any time into a number
of shares of Company common stock determined by dividing $100 by the conversion
price of $3.1667. In addition in the event the trading price of the Company
common stock is $4.00 or higher for any period of 20 consecutive trading days,
then all of the Series B Preferred Stock shall be automatically converted into
Company common stock at such conversion price.
The Series B Preferred Stock may be redeemed at any time in whole or in part by
Company for cash at $100 per share, plus all declared and unpaid dividends
thereon.
With respect to dividend rights and rights upon liquidation, dissolution or
winding up, the Series B Preferred Stock ranks:
. senior to the common stock, and to all equity securities ranking junior to
the Series B Preferred Stock; and
. pari passu with all currently outstanding preferred stock and with shares
of any other series of preferred stock to be issued by the Company that may
be designated to rank pari passu with the Series B Preferred Stock.
- - Series C Convertible Redeemable Preferred Stock.
Holders are not entitled to any dividends unless declared by the Company board
at its sole discretion, and the holders are not entitled to vote upon any matter
except as otherwise required by law.
Each share of Series C Preferred Stock is convertible at any time into a number
of shares of Company common stock determined by dividing $1,000 by the
conversion price of $2.00.
The Series C Preferred Stock may be redeemed in whole or in part at any time by
the Company for cash at $1,000 per share, plus all declared and unpaid dividends
thereon.
F-27
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
With respect to dividend rights and rights upon liquidation, dissolution or
winding up, the Series C Preferred Stock ranks:
. senior to the common stock, and to all equity securities ranking junior to
the Series C Preferred Stock; and
. pari passu with all currently outstanding preferred stock and with shares
of any other series of preferred stock to be issued by the Company that may
be designated to rank pari passu with the Series C Preferred Stock.
- - Series D Convertible Redeemable Preferred Stock.
Holders are not entitled to any dividends unless declared by the Company's board
at its sole discretion and holders of are not entitled to vote upon any matter
except as otherwise required by law.
Each share is convertible at any time into a number of shares of Company common
stock determined by dividing $1,000 by the conversion price of $3.00.
The Series D Preferred Stock may be redeemed in whole or in part at any time by
Company for cash at $1,000 per share, plus all declared and unpaid dividends
thereon.
With respect to dividend rights and rights upon liquidation, dissolution or
winding up, the Series D Preferred Stock ranks:
. senior to the common stock, and to all equity securities ranking junior to
the Series D Preferred Stock; and
. pari passu with all currently outstanding preferred stock and with shares
of any other series of preferred stock to be issued by the Company that
may be designated to rank pari passu with the Series D Preferred Stock.
- - Series E Convertible Preferred Stock.
Holders are not entitled to any dividends unless declared by the Company board
at its sole discretion and holders are not entitled to vote upon any matter
except as otherwise required by law.
Each share is convertible at any time into a number of shares of Company common
stock determined by dividing $1,000 by the conversion price of $3.00.
The Series E Preferred Stock is not redeemable, except as otherwise required by
law.
With respect to dividend rights and rights upon liquidation, dissolution or
winding up, the Series E Preferred Stock ranks:
. senior to the common stock, and to all equity securities ranking junior to
the Series E Preferred Stock; and
. pari passu with all currently outstanding preferred stock and with shares
of any other series of preferred stock to be issued by the Company that
may be designated to rank pari passu with the Series E Preferred Stock.
F-28
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued
Redeemable Preferred Stock - The Company at January 31, 2001 and 2000,
respectively, has 2,000,000 shares of authorized preferred stock, $.01 par value
per share which consists of the following; Series AA Convertible Redeemable
Preferred Stock, 4,000 and 5,750 shares issued and outstanding, stated value
$100 per share; Series B Voting Convertible Redeemable Preferred Stock, 76,000
shares issued and outstanding, stated value $100 per share; Series C Convertible
Redeemable Preferred Stock, 475 and 1,028 shares issued and outstanding, stated
value $1000 per share; Series D Convertible Redeemable Preferred Stock, 2,000
shares issued and outstanding, stated value $1000 per share; Series E
Convertible Preferred Stock, 1,200 and 1,256 shares issued and outstanding,
stated value $1000 per share;
The following summarizes the Company's preferred stock transactions for the
three years ended January 31, 2001:
On February 15, 2000, the Company issued 75 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, for
services rendered.
On January 21, 2000, an investor of the Company, converted 1,250 shares of the
Company's Series AA Convertible Redeemable Preferred Stock, $100 stated value
per share, to Common Stock at a conversion rate of 50 shares of Common Stock for
one share of Series AA Preferred Stock.
On January 21, 2000, investors of the Company converted 478 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On January 5, 2000, a vendor of the Company converted 38 shares of the Company's
Series E Convertible Redeemable Preferred Stock, $1,000 stated value per share,
to Common Stock at a conversion rate of 625 shares of Common stock for 1 Share
of Series E Preferred Stock.
On December 1, 1999, a vendor of the Company converted 100 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On November 24, 1999, an investor of the Company converted 50 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On November 22, 1999 a vendor of the Company, converted 18 shares of the
Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 625 shares of Common stock
for one Share of Series E Preferred Stock.
On September 17, 1999 International Video Distributors, LLC, converted 200
shares of the Company's Series E Convertible Redeemable Preferred Stock, $1,000
stated value per share, to Common Stock at a conversion rate of 625 shares of
Common Stock for one share of Series E Preferred Stock. International Video
Distributor converted an additional 200 shares of the Company's Series E
Convertible Redeemable Preferred Stock on July 17, 1999.
F-29
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
On September 9, 1999, the Company issued 56 shares of the Company's Series E
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
Interstate Personnel, Inc., in consideration for cancellation of trade payables
owed by the Company to Interstate Personnel, Inc., in the amount of $56,000.
On August 8, 1999, International Video Distributors, LLC, converted 400 shares
of the Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated
value per share, to Common Stock at a conversion rate of 625 shares of Common
Stock for one share of Series E Preferred Stock.
On August 3, 1999, three of the Company's investors converted 2,500 shares of
the Company's Series AA Convertible Redeemable Preferred Stock, $100 stated
value per share, to Common Stock at a conversion rate of 50 shares of Common
Stock for one share of Series AA Preferred Stock.
On July 19, 1999, the Company issued an aggregate of 625 shares of the Company's
Series C Convertible Redeemable Preferred Stock, $1,000 stated value per share,
to eight accredited investors including an executive officer of the Company, for
cash in the amount of $625,000 in a private placement transaction.
On July 19, 1999, International Video Distributors, LLC, converted shares of the
Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to common stock at a conversion rate of 625 shares of common stock
for one share of Series E Preferred Stock.
On June 11, 1999, the Company issued 2,000 shares of the Company's Series E
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
International Video Distributors, LLC ("IVD") and Common Stock Purchase Warrants
to purchase 50,000 shares of the Company's Common Stock at an exercise price of
$2.00 per share. IVD cancelled outstanding trade payables in the amount of
$2,000,000 owed by the Company to IVD.
On June 2, 1999, the Company issued 303 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to The
Value Group, LLC in consideration for cancellation of trade payables owed by the
Company to The Value Group, LLC in the amount of $303,000. On July 13, 1999, the
Company issued 100 shares of the Company's Series C Convertible Redeemable
Preferred Stock, $1,000 stated value per share, to DAZ Systems, Inc. in
consideration for the cancellation of trade payables owed by the Company to DAZ
Systems, Inc. in the amount of $100,000.
On March 31, 1999, the Company issued 2,000 shares of the Company's Series D
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
Mortco, Inc. (a subsidiary of Rentrak Corporation) in consideration for the
cancellation of indebtedness from Video Galaxy, Inc., to such parties in the
amount of $2,000,000.
On March 26, 1999, the Company issued 112 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to Box
Office, LLC, as part of the consideration for the purchase of the assets of a
video store acquired from Box Office, LLC. The Series C Preferred Stock was
converted based on the market value of the Company's Common Stock on the date of
issuance. On June 30, 1999, Box Office LLC converted 112 shares of the Company's
Series C Convertible Redeemable Preferred Stock to 56,000 of the Company's
Common Stock.
F-30
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
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 of fiscal
1999, 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 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 outstanding. 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 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.
F-31
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
Preferred Stock Dividends - The Company issued 524,703 shares of the Company's
Common Stock to two holders of the Company's Series B Convertible Redeemable
Preferred Stock as stock dividends with respect to the Series B Preferred Stock.
The stock dividends are issued on a monthly basis commencing in June 1999
through June 2018, unless the two holders convert the preferred stock to common
stock. As a result of the bankruptcy filing on August 24, 2000, the accrual of
stock dividends stopped.
During fiscal 2000, the Company issued 60,289 shares of the Company's Common
Stock to various shareholders as stock dividends with respect to the Company's
Series AA Convertible Redeemable Preferred Stock. The stock dividends are issued
semi-annually in June and November. No stock dividends were declared during
fiscal 2001 with respect to the Series AA Convertible Redeemable Preferred
Stock.
Common Stock Warrants - The fair value of the common stock warrants granted
during the year ended January 31, 2000 was estimated on the date of the grant
utilizing a Black-Scholes pricing model over the expected life of the warrants
of 1 year, expected volatility of 70%, risk-free interest rates ranging from
4.45% to 6.19% and a 0% dividend yield.
In December 1999, the Company issued warrants to purchase 2,000,000 shares of
the Company's Common Stock, at an exercise price of $.875 per share (1,000,000
shares to Ingram Entertainment and 1,000,000 shares to an officer of the
Company). Ingram Entertainment agreed to provide an additional $2 million trade
credit to the Company of which up to $1 million was guaranteed by an officer of
the Company. Interest expense of $81,772 was recorded as a result of issuance of
the warrants.
In May through November 1999, the Company issued warrants to purchase an
aggregate of 339,812 shares of the Company's Common Stock, at an exercise price
of $2, to several vendors and consultants, for services provided to the Company.
Interest expense of $30,105, rent expense of $4,800, labor costs of $1,221,
professional expenses of $6,461 and advertising expenses of $100,025 were
recorded as a result of issuance of the warrants.
In June 1999, the Company, in conjunction with the issuance of 2000 shares of
the Company Series E Convertible Redeemable Preferred Stock, issued warrants to
purchase 50,000 share of the Company's Common Stock, at an exercise price of $2,
to a supplier. The preferred stock and the detachable warrants were issued in
consideration of outstanding trade payable in the amount of $2 million. Interest
expense of $45,262 was recorded as a result of the issuance of the warrants.
In April 1999, the Company, in conjunction with a $1.7 million note assumed
during the Video Galaxy acquisition, issued warrants to purchase 474,000 shares
of the Company's Common Stock at an exercise price of $2.00 per share, to a
major supplier. Interest expense of $130,264 was recorded as a result of the
issuance of the warrants.
F-32
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
In March 1999, the Company, in conjunction with the Video Galaxy acquisition,
issued warrants to purchase 500,000 shares of the Company's Common Stock, at an
exercise price of $2,00 per share, to a major supplier. Interest expense of
$115,941 was recorded as a result of the issuance of the warrants.
In March 1999, the Company, in conjunction with a $3.6 million note assumed by
the Company during the acquisitions of Sulpizio One, Old Republic Entertainment,
Video Tyme and Videoland, issued warrants to purchase 561,725 shares of the
Company's Common Stock at an exercise price of $2.00 per share, to a major
supplier. The warrants were issued provided that the supplier extend the terms
of a demand note, assumed by the Company, through June 30, 1999. The number of
warrants increased on July 1, 1999 to 1,048,451 since the demand note remained
outstanding. Interest expense of $288,701 was recorded as a result of the
issuance of the warrants.
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.
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.
The warrant and option activity of the Company is summarized as follows:
At January 31, 1998, there were 3,947,435 warrants and options outstanding at a
weighted average exercise price of $1.47 per share. During the year ended
January 31, 1999, 1,756,936 warrants and options were granted and 520,720 were
cancelled.
At January 31, 1999, there were 5,183,651 warrants and options outstanding at a
weighted average exercise price of $1.59, of which 4,142,265 were exercisable at
an average exercise price of $1.36. During the year ended January 31, 2000,
6,985,017 warrants and options were granted, 123,077 were exercised and 466,443
were cancelled.
At January 31, 2000, there were 11,579,148 warrants and options outstanding at a
weighted average exercise price of $1.73, of which 8,960,138 were exercisable at
an average exercise price of $1.75.
During the year ended January 31, 2001, there was no warrants or options granted
and as a result of the bankruptcy filing on August 24, 2000, all warrants and
options outstanding will be deemed cancelled.
F-33
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' DEFICIT (Continued)
All stock options issued to employees had 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 was 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 have
been as follows:
---------------------------------
Years Ended January 31,
---------------------------------
2000 1999
------------- ------------
Net income (loss) As reported $ (32,765,625) $ 11,134
Pro forma (33,494,742) (184,277)
Basic earnings (loss) per share As reported $ (2.29) $ 0.00
Pro forma (2.31) (0.01)
There were no options granted during the year ended January 31, 2001.
The fair value of options granted during the year ended January 31, 2000 are
estimated on the date of grant utilizing a Black-Scholes pricing model over the
expected life of the options ranging from 1 to 5 years, expected volatility of
70%, risk-free interest rate of 5.14%, and a 0% dividend yield. The weighted
average fair value of options granted was $0.47.
The fair value of options granted during the year ended January 31, 1999 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
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.
NOTE 13--MANAGEMENT FEE INCOME
On March 3, 2000, Video City and West Coast Entertainment Corporation ("West
Coast") entered into a Management Agreement, pursuant to which Video City would
manage and operate West Coast's business until the closing of the proposed
merger between Video City and West Coast.
Subsequent to the year end the agreement was terminated (see Note 16).
F-34
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 14--EARNINGS PER SHARE
In fiscal 1999, 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, but were not included in
the computations of diluted earnings per share because the effect of exercise
and/or conversion would have an antidilutive effect on earnings per share.
The following table summarizes the calculation of the Company's basic and
diluted earnings per share for 1999:
Year ended January 31, 1999
-------------------------------------------
Income Per Share
(Loss) Shares Amount
----------- ------------ -----------
Basic EPS
- ---------
Income available to common stockholders:
Net income $ 11,134 12,091,467 $ 0.00
Effect of Dilutive Securities:
Incremental shares from common stock options, warrants,
and preferred stock outstanding - 1,336,911 -
----------- ------------ ----------
Diluted EPS
- -----------
Income (loss) available to common stockholders - - -
----------- ------------ ----------
Net income $ 11,134 13,428,378 $ 0.00
=========== ============ ==========
In fiscal 2001 and 2000, all outstanding common stock options, warrants and
preferred stock were not included in the computation of diluted earnings per
share because the effect of the exercise and/or conversion would have an
antidilutive effect on earning per share.
F-35
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15--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:
Long-term debt: Estimated based upon current market borrowing rates for loans
with similar terms and maturities.
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,
------------------------------------------------------------
2001 2000
---------------------------- ----------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
Financial Liabilities:
Long-Term Debt $ 6,790,454 $ 6,790,454 $ 6,796,985 6,796,985
Senior Secured Revolving
Credit Facility $10,451,429 1,500,000 $ 9,769,574 9,769,574
NOTE 16--SUBSEQUENT EVENTS
Merger: Effective February 13, 2001, West Coast Entertainment director's
informed the Company that they were terminating the "Management Agreement"
effective immediately, due to the sale of substantially all West Coast
Entertainment's remaining 56 Stores and various other assets to Video One
Liquidators.
Corporate Office: In February 2001, the Company relocated its corporate offices
from 9998 Global Road, 2nd Floor, Philadelphia, Pennsylvania, 19115 to 4800
Easton Drive, Suite 108, Bakersfield, California.
Bankruptcy Filing: The Company and Fleet Retail Finance entered into an
agreement ("the Fleet Compromise"), which was approved by the Bankruptcy Court
on March 28, 2001. The salient terms of the agreement granted Fleet Retail
Finance an allowed claim in the amount of $10,000,000. In full satisfaction of
the claim, the Company agreed to make two payments consisting of $1,500,000. The
first payment of $1,000,000 was paid on March 28, 2001, and the second payment
of $500,000 was made on June 29, 2001 resulting in the full satisfaction of the
Allowed Fleet Claim. As a result, the Company will record an extraordinary gain
from troubled debt restructuring of $8,951,429 during the second quarter of
fiscal 2002. In addition, both parties jointly dismissed the State Court Action
with prejudice and Fleet Retail Finance and the Company simultaneously executed
a mutual release of any and all claims against the directors, officers,
employees and other representatives of each company.
F-36
VIDEO CITY, INC.
DEBTOR-IN-POSSESSION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16--SUBSEQUENT EVENTS (Continued)
In June of 2001, the Company entered into a purchase money security agreement
directly with Warner Brothers Home Video. The agreement provides the company
with a line of trade credit and 60 day terms for repayment. The company
purchases all Warner Brothers product directly from Warner Brothers Home Video,
which is then distributed to all Video City's home entertainment retail chain
through a third party distributor.
In July 2001 the Company entered into an agreement with Video Products
Distributors ("VPD") under which VPD agreed to become the exclusive video
distributor for all of Video City's home entertainment retail chain. VPD will
provide all videocassettes, DVDs and accessories for rental and sale with the
exception of Warner Brothers Home Video product in all locations. As part of
this agreement, Video City is receiving a line of trade credit and 90 day terms
for payment to VPD.
On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's
First Amended Chapter 11 Plan of Reorganization (the "Plan"). The Plan became
effective on August 29, 2001. Pursuant to the Plan, the existing common stock
shareholders of Video City are to receive 700,000 shares of common stock of
Reorganized Video City in cancellation of all shares of common stock outstanding
prior to such distribution, for pro rata distribution; 700,000 shares of common
stock are to be issued to preferred shareholders in cancellation of shares of
preferred stock outstanding prior to such distribution; and 5,600,000 common
shares are to be issued to Video City's creditors. The Company anticipates that
approximately all liabilities subject to compromise will receive, in full
satisfaction of their claims, shares of common stock of Video City based on the
Plan of Reorganization. As part of the Plan, certain Class 4A creditor's had the
option to receive 20% of their claim in cash if their claim was under $1,000 or
if they choose to reduce their claim to that amount. The total amount for all
Class 4A creditors who opted for the cash payout was less than $22,000. In
addition, certain liabilities subject to compromise consist of tax obligations
of approximately $1.3 million that are to be paid in cash over five years from
the date of assessment.
The Company will issue 7,000,000 shares of new common stock of Reorganized Video
City upon completion of the Company's past SEC filings on forms 10Q and 10K and
completion of the audit and reviews of the Company's financial statements by
it's independent certified public accountants.
F-37
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 on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
VIDEO CITY, INC.
By /s/ Timothy L. Ford
_________________________________________
Chief Executive Officer
Date: February 15, 2002
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Amendment No. 1 to the Annual Report on Form 10-K has been signed below by the
following persons on behalf of the Registrant and in the capacities and on the
dates indicated.
Date Signature Title
- ---- --------- -----
/s/ Robert Y. Lee Chairman of the Board
- -------------------------------
February 15, 2002
Robert Y. Lee
/s/ Timothy L. Ford Chief Executive Officer
- ------------------------------- (Principal Executive Officer)
February 15, 2002
Timothy L. Ford
/s/ Rudolph R. Patino Chief Financial Officer
- ------------------------------- (Principal Financial and Accounting
February 15, 2002 Officer)
Rudolph R. Patino
/s/ David A. Ballstadt Director
- -------------------------------
February 15, 2002
David A. Ballstadt
/s/ Barry L. Collier Director
- -------------------------------
February 15, 2002
Barry L. Collier
/s/ Gerald W.B. Weber Director
- --------------------------------
February 15, 2002
Gerald W.B. Weber
F-38