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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, 2002
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 _____
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Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES X NO ______
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The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of May 2, 2002, was approximately $746,000. The
number of shares of common stock outstanding as May 2, 2002 was 7,121,000
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.
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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 are located at 4800 Easton Drive Suite
108, Bakersfield, California 93309 and its 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.
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.
The holders of existing voting shares immediately before the confirmation
received more than 50% of the voting shares of the emerging entity and therefore
did not adopt fresh-start reporting upon its emergence from Chapter 11.
Liabilities compromised by the confirmed plan were stated at the present value
of the amounts to be paid, and the forgiveness of debt has been reported as an
extraordinary item.
Industry Overview
Home Entertainment Retail Industry. According to Adams Media Research
("Adams"), the domestic home video specialty retail industry grew from an
estimated $15.3 billion in revenue in 1996 to $20.6 billion in 2001,
representing a 6.1% compound annual growth rate, outpacing the 2.5% growth rate
of the Consumer Price Index during the same period. Adams predicts that this
industry will reach $31.2 billion in revenue by 2010, with growth driven
primarily by the growth of DVD penetration. Currently, 90% of all television
households own a videocassette recorder ("VCR") or DVD Player. Additionally,
households owning DVD players reached 24.8 million at the end of 2001 and are
projected to grow to 90.4 million households by 2010 according to Adams.
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, 90% 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.
According to the Video Software Dealers Association, more consumers rented
videos in 2001 than went to the movie theatres. Industry rental revenue was
$8.42 billion compared to box office revenues estimated at $8.38 billion.
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 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 videocassette 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.
Video Game Industry. 2001 was a transitional year for the video game
industry with Sony PlayStation 2 gaining market share as hardware and software
became available. Additionally, the game market was soft throughout the year in
anticipation of the release of both the Nintendo GameCube and the Microsoft Xbox
in November 2001. Early performance and consumer acceptance of these new
platforms have been strong while the established 32-bit and 64-bit platforms
(Sony PlayStation and Nintendo 64) continue to maintain a solid market share.
According to industry estimates, domestic sales of video game software
approached $4.6 billion in 2001, an increase from just over $4.1 billion in
2000. Growth in domestic sales of video game hardware units has also been
reported in 2001, estimated at $3.7 billion versus $1.6 billion in 2000. These
increases were primarily attributable to sales of Sony PlayStation 2 hardware
and software, which was released in the fourth quarter of 2001. Increases in
sales were also driven by the introduction of two new video game platforms in
the fourth quarter of 2001: Microsoft Xbox and Nintendo GameCube.
Growth in this industry is driven by increases in the installed base of
video game hardware systems, the introduction of new hardware platforms and
continued improvement in systems technology leading to the development of new
game titles. At the end of 2001, the installed base of video game hardware
systems in the United States has been estimated at approximately 29.5 million
Sony PlayStation units, 16.5 million Nintendo 64 units, 8.2 million PlayStation
2 units, 1.4 million Microsoft Xbox units and 1.2 million Nintendo GameCube
units. We expect the video game industry to continue to grow as a result of
significant technological advancements in the last few years. These advancements
allow for more flexibility and creativity in software development, as well as
the introduction of hardware with the potential to offer capabilities beyond
gaming, such as DVD and compact disc play and backward compatibility of game
software.
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 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
Growth Strategy. The current strategy for the Company is to increase market
share and cost savings in our existing markets by driving same store revenues
and profit growth through:
. Capitalizing on continued strong industry growth (driven by strong DVD
and video game trends)
. Adopting merchandising and pricing initiatives
. Adopting special promotional and customer initiatives
. Achieving targeted cost savings in all areas of store operations
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 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.
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 and DVD Sales. The Company offers new and previously viewed
videocassettes and DVD for sale. Previously viewed videocassettes and DVD 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. With the introduction of the Nintendo GameCube and the Microsoft Xbox
in November 2001, early performance and consumer acceptance of these new
platforms have been strong while the extablised 32-bit and 64-bit platforms
(Sony PlayStation and Nentendo 64) continue to maintain a solid market share.
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 May
2, 2002:
Number of
State Stores
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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
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.
The Company did not operate under any studio revenue sharing agreements
during the entire fiscal year 2002.
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 physical
inventories 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.
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,
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 May 2, 2002 the Company had approximately 336 employees of whom
approximately 320 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 headquarters in February 2001 from
Philadelphia, Pennsylvania to Bakersfield, California. The corporate facility
consists of approximately 5,527 square feet of office space. The Company
considers its corporate offices and stores to be generally suitable and adequate
for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's
First Amended Chapter 11 Plan of Reorganization (the "Plan"). On August 29,
2001, the Reorganization Plan became effective and the Company emerged from
bankruptcy reorganization proceedings.
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, 2002.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the NASD Electronic Bulletin Board
under the symbol "VDCY". 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:
The figures for fiscal 2001 are actual reported market prices for the more than
16 million shares that were outstanding prior to completion of the Chapter 11
Plan of Reorganization.
High Low
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Fiscal Year Ended January 31, 2001:
First Fiscal Quarter $0.850 $0.290
Second Fiscal Quarter $0.320 $0.135
Third Fiscal Quarter $0.180 $0.005
Fourth Fiscal Quarter $0.050 $0.006
Fiscal Year Ended January 31, 2002:
First Fiscal Quarter $0.009 $0.009
Second Fiscal Quarter $0.010 $0.010
Third Fiscal Quarter $0.010 $0.010
Fourth Fiscal Quarter $0.100 $0.100
Such over-the-counter market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
As of May 2, 2002, there were approximately 619 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. 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.
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. Substantially 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. 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.
As of May 2, 2002, the Company has issued approximately 5,000,000 shares of
common stock of the Reorganized Video City. The balance of the 2,000,000 shares
will be issued by June 30, 2002, upon final determination between the Company
and certain unsecured creditors whose claims have not been finally resolved.
Recent Sales of Unregistered Securities
The Company did not sell unregistered securities in the fourth quarter of
fiscal 2002.
ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended
January 31, 2002, 2001, 2000, 1999 and 1998, have been derived from the
financial statements. 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,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
STATEMENT OF OPERATIONS DATA:
Revenues................................... $17,451 $ 31,615 $ 44,785 $ 24,436 $ 10,212
Operating income (loss).................... (3,330) (10,297) (28,601) (1,263) (2,423)
Net Income (loss) before reorganizational
Item (3,131) (12,103) (32,058) 11 (2,976)
Loss before extraordinary item ............ (3,748) (16,116) (32,766) 11 (2,976)
Net Income (Loss) available to common
shareholders 37,837 (16,116) (32,766) 11 (2,976)
Net income (loss) per share................ 3.07 (1.01) (2.29) 0.00 (0.30)
Weighted average shares used
in computation............................ 12,323 16,302 14,510 12,091 9,771
OPERATING DATA:
Number of stores at end of period.......... 41 44 77 128 18
Increase (decrease) in same store
Revenues(1)............................... (4.8)* (14.1)% 6.8% 1.6% 4.4%
Year Ended January 31,
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
BALANCE SHEET DATA:
Cash and cash equivalents.................. $ 0 $ 1,046 $ 24 $ 172 $ 28
Rental library(2).......................... 2,261 3,012 6,223 21,120 2,795
Total assets............................... 6,591 10,097 21,294 38,253 6,599
Credit facility - - 9,770 16,045 -
Long-term debt, less current portion....... - - 1,232 1,637 2,043
Total liabilities.......................... 6,628 47,621 42,770 32,985 7,298
Stockholders' equity (deficit)............. (37) (37,524) (21,476) 5,267 (699)
- -------------
(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 1998, 1999, 2000, 2001 and 2002.
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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. On an on-going basis, we evaluate our estimates, including those
related to our amortization of inventory and valuation of customer receivables.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ materially from these estimates under different assumptions or
conditions. We believe the following critical accounting policies affect our
more significant judgments and estimates used in the preparation of our
consolidated financial statements:
... The amortization method of 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) is 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.
... Customer receivable balances are evaluated on a continual basis and allowances
are provided for potentially uncollectable accounts based on management's
estimate of the collectability of customer accounts. Allowance adjustments are
charged to operations in the period in which the facts that give rise to the
adjustments become known.
... 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, 2002.
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 anticipated revenues generated therefrom.
As of August 24, 2000, Video City terminated its studio revenue share agreements
due to the filing of Chapter 11 Bankruptcy. The Company is currently continuing
to use the accelerated method of amortization to insure that its rental
inventory value remains conservative. The Company will continue to review the
current method of amortization of its rental library as it reviews the carrying
value of its library in the future.
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 were obtained through
revenue-sharing arrangements, prior to cancellation of such agreements in the
fiscal year ended January 31, 2001. 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, 2002 Compared to Year Ended January 31, 2001
Revenues. Revenues for the fiscal year ended January 31, 2002 (fiscal
"2002") decreased $14,164,000 or 44.8%, to $17,451,000 compared to $31,615,000
for the fiscal year ended January 31, 2001 ("fiscal 2001"). The decrease in
revenues was primarily attributable to the reduced number of stores operating
during the year ended January 31, 2002 as compared to the prior year. The
Company divested 30 stores during fiscal year 2001, as part of the Company's
bankruptcy reorganization plan. The weighted average number of stores for fiscal
2002 was 42 compared to the prior fiscal year total of 71 stores. Same store
revenues for fiscal 2002 decreased by approximately 4.8% compared to fiscal
2001.The Company had management fee income of $7,000 for fiscal 2002 compared to
$4,386,000 management fee income in fiscal 2001. 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 2002
decreased $9,171,000, or 46.0%, to $10,646,000 compared to $19,817,000 for
fiscal 2001. The decrease in store expenses was primarily attributable to the
reduced number of stores operating during the year ended January 31, 2002 as
compared to the prior year. The Company divested 30 stores during fiscal year
2001, as part of the Company's bankruptcy reorganization plan. The weighted
average number of stores for fiscal 2002 was 42 compared to the prior fiscal
year total of 71 stores. Store operating expenses as a percentage of total
revenues were 60.2% for fiscal 2002 compared to 62.7% for fiscal 2001.
Amortization of Rental Library. Amortization of videocassette rental
inventory for fiscal 2002 decreased $1,951,000 or 26.8%, to $5,340,000
compared to $7,291,000 for fiscal 2000. The decrease in amortization was
primarily attributable to the reduced number of stores operating during the year
ended January 31, 2002 as compared to the prior year. The Company divested 30
stores during fiscal year 2001 as part of the Company's bankruptcy
reorganization plan. Amortization of videocassette rental inventory as a
percentage of rental revenues and product sales was 30.6% for the fiscal 2002
compared to 26.8% for the corresponding period of 2001. The increase in
percentage of amortization this fiscal year over last fiscal year was mainly due
to the Company not leasing product under studio revenue sharing agreements
during the entire fiscal year 2002 versus the Company being on revenue sharing
for seven months of the prior fiscal year 2001.
Cost of Product Sales. The cost of product sales for fiscal 2002 decreased
$2,374,000 or 58.3%, to $1,700,000 compared to $4,074,000 for fiscal 2001. The
decrease in the cost of product sales was primarily due to the reduced number of
stores operating during the year ended January 31, 2002 as compared to the prior
year. The Company divested
30 stores during fiscal year 2001, as part of the Company's bankruptcy
reorganization plan. The weighted average number of stores for fiscal 2002 was
42 compared to the prior fiscal year total of 71 stores. Cost of product sales
as a percentage of rental revenue and product sales, was 9.8% for the fiscal
year ended 2002 versus 15.0% for the fiscal year ended 2001.
Cost of Leased Product. Cost of leased product for fiscal 2002 decreased
$1,320,558 or 97%, to $41,443 compared to $1,362,000 for fiscal 2001. The
decrease was primarily attributable to the Company ceased revenue sharing with
the Studios as of August 24, 2000, upon filing of the Chapter 11 Bankruptcy and
was not on revenue sharing during fiscal 2002. The $41,443 expense recorded for
fiscal 2002 was the balance of expenses related to the end of term revenue
sharing costs on various studio titles.
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 $703,000 in cash
for restructuring expenses. No restructuring expenses were paid in fiscal 2002.
General and Administrative. General and administrative expenses for fiscal
2002 decreased $4,550,000, or 59.8%, to $3,055,000 compared to $7,605,000 for
fiscal 2001. General and administrative expenses as a percentage of total
revenues decreased to 17.5% in fiscal 2002 compared to 24.0% in fiscal 2001. The
decrease in general and administrative expenses was primarily attributable to
the company's reduction in number of employees, employee salaries and related
cost savings that resulted from the moving of the Company's corporate
headquarters from Philadelphia, Pennsylvania to Bakersfield, California in March
2001.
Gain(Loss) on Sale of Assets. The loss on sale of assets in 2001 resulted
from the disposal of 2 stores prior to the bankruptcy filing.
Interest Expense. Net interest expense for fiscal 2002 decreased
$1,331,000, or 99%, to $17,000 compared to $1,348,000 for fiscal 2001. The
decrease in interest expense is reflective of a discontinuance of recording
interest expense on secured and unsecured prepetition debt pursuant to American
Institute of Certified Accountants Statement of Position 90-7. Interest expense
recorded in fiscal 2002 primarily represents payment of interest charged of
$12,500 on the balance of the $500,000 payable to Fleet Retail Finance on June
29, 2001, per the agreement ("the Fleet Compromise"), which was approved by the
Bankruptcy Court on March 28, 2001.
Other. "Other" for fiscal 2002 was income of $217,000 compared to expenses
of $458,000 for the fiscal year ended 2001. The income for 2002 was primarily
attributable to advertising credits from prior periods and various other
miscellaneous revenues. The expense for fiscal 2001 was primarily attributable
to merger costs written off due to the termination of the West Coast
Entertainment and Video City, Inc. management agreement and merger agreement
which was terminated as of February 13, 2001.
Reorganization Items. Professional fees in fiscal 2002 resulted from the
retention of legal and financial professionals during the bankruptcy period, as
approved by the Bankruptcy Court. Relocation expenses were related to the cost
of moving the corporate offices from Philadelphia, Pennsylvania to Bakersfield,
California in March 2001. Loss on sale of assets in fiscal 2002 resulted from
the sale and liquidation of two stores during the fiscal year. 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, 2002, due to the losses incurred during fiscal 2001 and fiscal
2002, 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, 2002.
Extraordinary Items. During the year ended January 31, 2002, the Company
reported an extraordinary gain from the discharge of $32,769,523 of allowed
claims that will be issued common stock pursuant to the Company's approved Plan
of Reorganization, net of a deferred
tax liability of $136,000. The net deferred tax liability arose as a result of
the forgiveness of indebtedness income related to the confirmation of the Plan
of Reorganization. In addition, the Company reported an extraordinary gain on
troubled debt restructuring of $8,951,429, which represents a settlement of the
loan agreement with Fleet Retail Finance as part of the Fleet Compromise.
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 revenues was primarily attributable to the reduced
number of stores operating during the year ended January 31, 2002 as compared to
the prior year. The Company divested 17 stores during the period August 1, 2000
to September 30, 2000 as part of the Company's bankruptcy reorganization plan.
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 the fourth quarter of fiscal 2001. In January 2000 the Company adopted an
accelerated 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 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 $7,133,000, or 48.0%, to $7,605,000 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.
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. "Other" for fiscal 2001 was an expense of $458,000 compared to
income of $249,000 for the fiscal year ended 2000. The expense for fiscal 2001
was primarily attributable to merger costs written off due to the termination of
the West Coast Entertainment and Video City, Inc. management agreement and
merger agreement which was terminated as of February 13, 2001. 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.
Liquidity and Capital Resources
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
Company anticipates that it will operate with a working capital deficit during
the fiscal year ending January 31, 2002.
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 this
will be the case.
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.
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
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.
Subsequent to the year end the Company issued approximately 5,000,000 shares in
terms of the approved Plan of Reorganization. Approximately 2,000,000 shares
still remain to be issued upon final determination between the Company and
certain unsecured creditors, whose claims have not been finally resolved.
The Company is currently seeking to improve its working capital position by
seeking increased trade credit and extended terms from its vendors. In addition,
the Company may seek to acquire other short term financing through a private
placement. However, no assurance can be given that the Company will be
successful in its efforts to obtain either method of short term capital to
improve its working capital position.
Cash Flows
Cash Provided by Operating Activities
Net cash provided by operating activities for fiscal 2002 decreased by
approximately $2,694,000, or 34%, compared to fiscal 2001. This decrease was
primarily due to a smaller decrease in merchandise inventory in fiscal 2002 as a
result of the divestiture of 30 stores in fiscal 2001 as part of the company's
bankruptcy reorganization plan, offset by a decrease in other receivables. The
decrease was also due to a smaller increase in accounts payable and liabilities
subject to compromise in fiscal 2002 as a result of the bankruptcy filing in
fiscal 2001.
Cash Used in Investing Activities
Net cash used in investing activities during fiscal 2002 decreased by
approximately $2,698,000 or 35%, compared to fiscal 2001. The change was mainly
attributable to the decrease in purchases of videocassette rental inventory as a
result of the divestiture of stores in fiscal 2001. In addition, there were less
proceeds from sale of fixed assets during fiscal 2002 versus 2001.
Cash Provided by Financing Activities
Net cash used by financing activities during fiscal 2002 decreased by
approximately $2,072,000 or 307%, compared to fiscal 2001. The change was mainly
attributable to the repayment of $1,500,000 under the pre-petition revolving
credit facility with Fleet (formerly BankBoston) related to the Fleet Compromise
Settlement approved by the Bankruptcy court on March 28, 2001.
New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board finalized FASB
Statements No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and
Other Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase
method of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test nine months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
Currently, the Company is assessing but has not yet determined how the
adoption of SFAS 141 and SFAS 142 will impact its financial position and results
of operations.
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 requires the fair value of a liability for
an asset retirement obligation to be recognized in the period in which it is
incurred if a reasonable estimate of fair value can be made. The associated
asset retirement costs are capitalized as part of the carrying amount of the
long-lived asset. SFAS No. 143 is effective for fiscal years beginning after
June 15, 2002. The Company believes the adoption of this Statement will have no
material impact on its financial statements.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS 144 requires that those
long-lived assets be measured
at the lower of carrying amount or fair value less cost to sell, whether
reported in continuing operations or in discontinued operations. Therefore,
discontinued operations will no longer be measured at net realizable value or
include amounts for operating losses that have not yet occurred. SFAS 144 is
effective for financial statements issued for fiscal years beginning after
December 15, 2001 and, generally, are to be applied prospectively. The Company
believes the adoption of this Statement will have no material impact on its
financial statements.
General Economic Trends, Quarterly Results and Seasonality
The Company anticipates that its business will be affected by general
economic and other consumer trends. To date, the Company has not operated during
a period of high inflation. However, the Company believes that it would
generally be able to pass on increased costs relating to inflation to its
customers. Future operating results may be affected by various factors,
including variations in the number and timing of new store openings, the
performance of new or acquired stores, the expenses associated with any
acquisition of stores, the quality and number of new release titles available
for rental and sale, the expense associated with the acquisition of new release
titles, additional and existing competition, marketing programs, weather,
special or unusual events and other factors that may affect retailers in
general. Any concentration of acquisitions or new store openings and the related
costs and other expenses associated with the acquisition of stores or opening of
new stores near the end of a fiscal quarter could have an adverse effect on the
financial results for that quarter and could, in certain circumstances, lead to
fluctuations in quarterly financial results.
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
QUARTERLY RESULTS (UNAUDITED)
Quarterly results for the years ended January 31, 2002 and 2001 are
reflected below:
- -------------------------------------------------------------------------------------------------------------------------
FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------------------------------
2002
- ----
- -------------------------------------------------------------------------------------------------------------------------
Revenue $ 4,463,509 $ 3,862,364 $ 4,448,342 $4,677,262
- -------------------------------------------------------------------------------------------------------------------------
Operating income (loss) $ (629,556) $ (1,191,691) $ (906,098) (603,709)
- -------------------------------------------------------------------------------------------------------------------------
Net loss before extraordinary items $ (777,377) $ (1,117,584) $ (1,090,377) (762,936)
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (913,377) $ 31,651,939 $ 7,861,052 (762,936)
- -------------------------------------------------------------------------------------------------------------------------
Extraordinary items $ (136,000) $ 32,769,523 $ 8,951,429 -
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted loss per share before
extraordinary items $ (0.45) $ (0.07) $ (0.07) (0.05)
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per share
from extraordinary item $ (0.08) $ 1.99 $ 0.54 -
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted earnings (loss) per share
$ (0.53) $ 1.92 $ 0.48 (0.05)
- -------------------------------------------------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------------------------------
FOURTH THIRD SECOND FIRST
- -------------------------------------------------------------------------------------------------------------------------
2001
- ----
- -------------------------------------------------------------------------------------------------------------------------
Revenue $ 6,419,679 $ 6,807,108 $ 8,885,774 $ 9,502,084
- -------------------------------------------------------------------------------------------------------------------------
Operating income (loss) $ (2,248,067) $ (2,628,562) $ (2,613,486) (2,807,221)
- -------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (4,487,606) $ (4,812,694) $ (3,599,140) (3,538,628)
- -------------------------------------------------------------------------------------------------------------------------
Basic earnings per share $ (0.28) $ (0.29) $ (0.22) $ (0.22)
- -------------------------------------------------------------------------------------------------------------------------
Diluted earnings per share $ (0.28) $ (0.29) $ (0.22) (0.22)
- -------------------------------------------------------------------------------------------------------------------------
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
None
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.
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) 39 Chairman of the Board 1997
Timothy Ford (2) 45 Chief Executive Officer --
Rudolph R. Patino 54 Chief Financial Officer, Secretary and Director 2001
David A. Ballstadt 62 Director 1998
Barry L. Collier 59 Director 1997
Gerald W. B. Weber 51 Director 1997
________________________
(1) Mr. Lee resigned as Chief Executive Officer in July 2001.
(2) Mr. Ford was appointed Chief Executive Officer in July 2001.
Robert Y. Lee served until July 31, 2001 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.
Timothy L. 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.
Rudolph R. 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.
David A. Ballstadt has served 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.
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, 2002, 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
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. Because the Company was in Chapter 11 proceedings and because the final
figures for stock to be issued to existing shareholders and creditors had not
been finally determined, the Company's directors and executive officers have not
been able to file revised section 16(a) reports; it is anticipated that such
reports will be filed in the near future
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth the compensation for the fiscal years ended
January 31, 2002, January 31, 2001 and January 31, 2000 paid by the Company to
its chief executive officer and the other executive officers of the Company who
earned in excess of $100,000 (collectively, the "Named Executive Officers")
based on salary and bonus for the fiscal year ended January 31, 2002:
Name and Long-Term
Principal Position Annual Compensation(1) Compensation
- --------------------------- ------------------------------------------------- ----------------
Securities
Period Underlying
Ended Salary($) Bonus Options (#)
-------------------- ------------- ------------ ----------------
Robert Y. Lee (2) January 31, 2002 94,000 -- 150,000
Chief Executive Officer January 31, 2001 350,000 -- --
January 31, 2000 231,000 -- --
Timothy L. Ford (3) January 31, 2002 145,000 -- 250,000
Chief Executive Officer January 31, 2001 113,000 -- --
Rudolph Patino January 31, 2002 175,000 -- 250,000
Chief Financial Officer January 31, 2001 99,500 -- --
(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) Robert Y. Lee resigned as Chief Executive Officer July 2001.
(3) Timothy Ford was appointed Chief Executive Officer in July 2001.
Effective October 1, 2001, Robert Y. Lee entered into an Non-compete/advisory
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity as an advisor with no responsibility for the day-to-day
operations of the Company. Mr. Lee will receive a Noncompete/advisory payment of
$60,000 per year and participate in all benefits available to members of the
Company's management. Mr. Lee is also entitled to certain fringe benefits
including a monthly auto allowance.
Effective September 1, 2001, Timothy L. Ford entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity as Chief Executive Officer. Mr. Ford will receive a base
salary of $160,000, including annual percentage increases per year and an annual
bonus of 3% of adjusted EBITDA cash flow "as defined by Industry standards"
provided the Company hits its budgeted EBITDA goals for each fiscal year. Mr.
Ford is also entitled to certain fringe benefits including a monthly auto
allowance.
Effective September 1, 2001, Rudolph R. Patino entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity as Chief Financial Officer. Mr. Patino will receive a base
salary of $175,000, including annual percentage increases per year and an annual
bonus of 3% of adjusted EBITDA cash flow "as defined by Industry standards"
provided the Company hits its budgeted EBITDA goals for each fiscal year. Mr.
Patino is also entitled to certain fringe benefits including a monthly auto
allowance.
Option Grants
The Company granted 500,000 options to two officers during the fiscal year
ended January 31, 2002, pursuant to their officers employment agreements. The
options have an exercise price of $.25 and vested 50% on September 1, 2001 and
will vest 50% on September 1, 2002.
Option Exercises and Fiscal Year-End Values
No stock options were exercised by any of the Named Executive Officers
during the fiscal year ended January 31, 2002. The following table sets forth
certain information regarding stock options held by the Named Executive Officers
as of January 31, 2002:
Fiscal Year-End Options
Number of Securities
Underlying Unexercised Value of Unexercised
Options at Fiscal In-the-Money Options at
Name Year-End (#) Fiscal Year End ($)(1)
---- ---------------------------------- --------------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Robert Y. Lee ............... 150,000 150,000 -- --
Timothy L. Ford ............. 125,000 125,000 -- --
Rudolph R. Patino ........... 125,000 125,000 -- --
(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, 2002 ($0.10).
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. The Company granted 75,000 stock options to
each of the three outside directors during the fiscal year ended 2002.
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
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 voted to increase 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
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 May 2, 2002 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 ............................................ 377,318(3) 4.1%
Timothy Ford ............................................. 125,000(3) 1.4%
Rudolph R. Patino ........................................ 167,637(3) 1.8%
Barry Collier ............................................ 127,255(3) 1.4%
David A. Ballstadt ....................................... 98,394(3) 1.1%
Gerald W.B. Weber ........................................ 75,000(3) 0.1%
Ingram Entertainment Inc ................................. 1,815,935 19.8%
Mortco, Inc .............................................. 169,542 1.9%
Rentrak Corporation ...................................... 1,177,304 12.8%
All Directors and Executive Officers as a group (7
persons) ................................................ 970,604 11.0%
_________________
* 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 May 2, 2002 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 the following currently exercisable stock options to purchase
shares from Video City: Mr. Ford 125,000 shares; Mr. Patino 125,000 shares;
Mr. Lee 150,000 shares; Mr. Collier, 75,000 shares; Mr.Ballstadt, 75,000
shares; Mr. Weber, 75,000 shares.
Video City does not know of any arrangements that may at a subsequent date
result in a change of control of Video City.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During the fiscal year ended January 31, 2001, 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 served as a director of Video City during
fiscal year 2001. Total fees for the years ended January 31, 2001 were $235,000.
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, during 1998 the Company entered into a new long-term supply
agreement with Ingram for videocassettes and related products; Ingram released
Mr. Lee from his personal guarantee of the Company's indebtedness; and the
parties entered into the Stockholders Agreement and the Override Agreement,
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, 2002 and 2001, the Company owed Ingram approximately $0
million and $11.2 million, respectively.
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, 2002 and 2001 the Company owed Rentrak approximately $0 million and
$8.9 million, respectively.
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 2002, the Company purchased approximately $2.3 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 relationship
with Rentrak and Ingram were replaced with the new agreements entered into as a
result of the bankruptcy filings (Note 11).
The Company has entered into employment and consulting agreements with
certain shareholders.
The Company has entered into employment and non-compete/advisory
agreements with certain executives and a director of the company. These basic
terms of these agreements are summarized under Item 11.
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-27:
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, 2002.
(c) Exhibits
Numbers Description
- ------- -----------
3.1 Certificate of Incorporation of the Company including amendments
thereto (1)(2)
3.2 Bylaws of the Company (1)
3.3 Certificate of Designations for the Company's Series C Convertible
Redeemable Preferred Stock.(3)
3.4 Certificate of Designations for the Company's Series D Convertible
Redeemable Preferred Stock.(3)
3.5 Certificate of Designations for the Company's Series E Convertible
Preferred Stock.(3)
10.1 Asset Purchase Agreement dated as of April 22, 1999, by and among, the
Company, Videoland, Inc. and Blockbuster Inc.(3)
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).(3)
10.3 Debt Conversion Agreement dated as of March 30, 1999, by and among the
Company, Rentrak Corporation, Mortco, Inc. and Video Galaxy, Inc.(3)
10.4 Warrant to purchase 500,000 shares of Common Stock, dated as of March
31, 1999, between the Company and Mortco, Inc.(3)
10.5 Form of Option Agreement for directors and executive officers of the
Company.(3)
10.6 Form of Indemnity Agreement for directors and officers of the
Company.(3)
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.(3)
10.8 Stock Purchase Agreement, dated June 2, 1999, by and between the
Company and The Value Group, LLC.(4)
10.9 Common Stock Purchase Warrant, dated May 11, 1999, by and between the
Company and The Value Group, LLC.(4)
10.10 Stock Purchase Agreement, dated June 11, 1999, by and between the
Company and International Video Distributors, LLC.(4)
10.11 Common Stock Purchase Warrant, dated June 11, 1999, by and between the
Company and International Video Distributors, LLC.(4)
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).(4)
10.13 Employment Agreement, dated June 16, 1999, between the Company and
Richard T. Gibson(4)
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.(4)
10.15 Warrant to Purchase Common Stock, dated December 31, 1998, executed by
the Company for Ingram Entertainment Inc.(4)
10.16 Forbearance Agreement dated September 10, 1999, by and between the
Company and BankBoston Retail Finance, Inc.(5)
10.17 Management Agreement, dated as of March 3, 2000, by and between Video
City, Inc. and West Coast Entertainment Corporation. (6)
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. (6)
10.19 Forbearance Agreement, dated March 9, 2000, between Video City, Inc.
and Fleet Retail Finance Inc. f/k/a BankBoston Retail Finance Inc. (6)
23.1 Consent of Certified Public Accountants (7)
(1) Previously filed as exhibit to Prism Entertainment Corporation's Annual
Report on Form 10K for the fiscal year ended January 31, 1998, and
incorporated herein by reference.
(2) Previously filed as Exhibit 3.1 to the Company's Quarterly Report on Form
10-Q for the fiscal quarter ended April 30, 1998, 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 April 30, 1999, and incorporated herein by
reference.
(4) 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.
(5) 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.
(6) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 30, 1998, and incorporated herein by reference.
(7) Filed herewith
(d) Financial Statement Schedule
Schedules for which provision is made in the applicable accounting
regulation Of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted.
VIDEO CITY, INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 31, 2002, 2001 AND 2000
ITEM 8. Consolidated Financial Statements and Supplementary Data
The following consolidated financial statements are filed with this report:
Report of Independent Certified Public Accountants F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Deficit F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
F-2
Report of Independent Certified Public Accountants
The Board of Directors
Video City, Inc.
We have audited the accompanying consolidated balance sheets of Video City, Inc.
as of January 31, 2002 and 2001 and the related consolidated statements of
operations, stockholders' deficit, and cash flows for each of the three years
ended January 31, 2002. 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. as
of January 31, 2002 and 2001, and the results of its operations and its cash
flows for each of the three years ended January 31, 2002, in conformity with
accounting principles generally accepted in the United States of America.
BDO SEIDMAN, LLP
Los Angeles, California
April 19, 2002
F-3
VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
Years ended January 31,
--------------------------------
2002 2001
-------------- --------------
Assets
Current assets:
Cash $ - $ 1,046,164
Customer receivables 377,033 433,024
Other receivables (Note 3) - 946,655
Merchandise inventories 529,334 965,025
Prepaid expenses and other assets 74,270 -
-------------- --------------
Total current assets 980,637 3,390,868
Rental library, net 2,261,331 3,012,387
Property and equipment, net (Note 5) 1,215,146 1,525,409
Goodwill, net 1,787,361 1,912,713
Other assets 346,645 256,011
-------------- --------------
Total assets $ 6,591,120 $ 10,097,388
-------------- --------------
Liabilities and Stockholders' Equity (Deficit)
Liabilities not subject to compromise:
Current liabilities:
Bank overdraft $ 103,582 $ -
Accounts payable (Note 4) 1,666,978 215,724
Accrued expenses (Note 4) 1,052,653 1,041,134
Note payable 48,262 -
Current portion of tax liability 149,880 -
Other liabilities 332,829 -
-------------- --------------
Total current liabilities 3,354,184 1,256,858
Other liabilities - 45,526
Shares issuable under plan of reorganization (Note 11) 1,750,000 -
Deferred tax liability (Note 8) 136,000 -
Tax liability less current portion 431,759 -
-------------- --------------
Total liabilities not subject to compromise 5,671,943 1,302,384
Liabilities subject to compromise:
Accounts payable (including $0 and $13,880,500 due to related parties) (Note 4) 956,347 26,443,937
Senior secured revolving credit facility (Note 6) - 10,451,429
Long-term debt (including $0 and $6,219,500 due to related parties) (Note 7) - 6,790,454
Accrued interest (including $0 and $956,260 due to related parties) (Note 4) - 1,004,342
Other liabilities - 1,628,690
-------------- --------------
Total liabilities subject to compromise 956,347 46,318,852
-------------- --------------
Total liabilities 6,628,290 47,621,236
-------------- --------------
Commitments and contingencies (Note 10)
Stockholders' deficit (Note 11):
Preferred stock - 6,292,135
Common stock, $.01 par value per share, authorized 30,000,000 shares; issued and
outstanding 16,442,662 shares at 2001 - 164,427
Additional paid-in capital 19,683,530 13,576,968
Accumulated deficit (19,720,700) (57,557,378)
-------------- --------------
Total stockholders' deficit (37,170) (37,523,848)
-------------- --------------
Total liabilities and stockholders' deficit $ 6,591,120 $ 10,097,388
============== ==============
See accompanying notes to consolidated financial statements.
F-4
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended January 31,
----------------------------------------------
2002 2001 2000
------------ ------------- -------------
Revenue
Rental revenues and product sales $ 17,444,177 $ 27,228,759 $ 44,784,703
Management fee income (Note 12) 7,300 4,385,886 -
------------ ------------- -------------
Total revenue 17,451,477 31,614,645 44,784,703
------------ ------------- -------------
Operating costs and expenses
Store operating costs 10,646,248 19,816,623 29,950,293
Amortization of rental library 5,339,991 7,291,355 13,691,184
Cost of product sales 1,699,690 4,073,617 8,913,401
Cost of leased product 41,443 1,362,251 4,281,313
Restructuring (Note 9) - 1,564,000 -
General and administrative 3,054,529 7,604,762 14,738,358
(Gain) loss on sale of assets - 199,373 (1,400,021)
Store closure costs - - 3,210,830
------------ ------------- -------------
Total operating costs and expenses 20,781,901 41,911,981 73,385,358
------------ ------------- -------------
Loss from operations (3,330,424) (10,297,336) (28,600,655)
Other (income) expense
Interest expense, net (contractual interest $1,758,000, $1,980,104
and $3,706) 16,945 1,347,699 3,706,749
Other (216,816) 457,500 (249,078)
------------ ------------- -------------
Loss before reorganization items and income taxes (3,130,553) (12,102,535) (32,058,326)
Reorganization items
Professional fees 587,865 504,777 -
(Gain) Loss on sale of assets (Note 3) (34,600) 3,508,614 -
Relocation of corporate office 58,417 - -
------------ ------------- -------------
Loss before income taxes and extraordinary items (3,742,235) (16,115,926) (32,058,326)
Income tax expense (Note 8) 6,039 - 707,299
------------ ------------- -------------
Loss before extraordinary items (3,748,274) (16,115,926) (32,765,625)
Extraordinary items
Troubled debt restructuring gain, net of tax (Note 6) 8,951,429 - -
Discharge of liabilities subject to compromise, net of deferred tax
liability of $136,000 (Notes 1 and 8) 32,633,523 - -
------------ ------------- -------------
Total extraordinary items 41,584,952 - -
------------ ------------- -------------
Income (loss) before dividends 37,836,678 (16,115,926) (32,765,625)
============ ============= =============
Dividends on preferred stock - (322,142) (492,522)
Net income (loss) available to common shareholders $ 37,836,678 $ (16,438,068) $ (33,258,147)
============ ============= =============
Earnings (loss) per share (Note 13)
Basic and diluted loss per common share before extraordinary items $ (0.30) $ (1.01) $ (2.29)
Basic and diluted income per common share from extraordinary items $ 3.37 $ - $ -
Basic and diluted net income (loss) per common share $ 3.07 $ (1.01) $ (2.29)
Weighted average number of common shares outstanding - basic and
diluted 12,323,490 16,301,969 14,509,555
See accompanying notes to consolidated financial statements.
F-5
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' 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, 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 4,000 364,611 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 4,000 364,611 76,000 3,065,190 475 475,000 2,000 1,187,334
Stock cancelled upon effective date
of plan of reorganization (4,000) (364,611) (76,000) (3,065,190) (475) (475,000) (2,000) (1,187,334)
Net income - - - - - - - -
------ --------- ------- ----------- -------- --------- -------- -----------
- $ - - $ - - $ - - $ -
====== ========= ======= =========== ======== ========= ======== ===========
Additional
--------------------
Series E Common Stock Paid-in Accumulated
-------------------- ------------------------
Shares Amount Shares Amount Capital Deficit
------- ---------- ----------- ---------- ----------- ------------
------- ---------- ----------- ---------- ----------- ------------
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 - - - - (32,765,62)
------- ----------- ------------ --------- ----------- ------------
Balance at January 31, 2000 1,200 1,200,000 15,767,959 157,679 13,268,548 (41,119,31)
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 - - - - - (16,115,92)
------- ----------- ------------ --------- ----------- ------------
Balance at January 31, 2001 1,200 1,200,000 16,442,662 164,427 13,576,968 (57,557,37)
Stock cancelled upon effective date
of plan of reorganization (1,200) (1,200,000) (16,442,662) (164,427) 6,106,562 -
Net income - - - - - 37,836,678
------- ----------- ------------ --------- ----------- ------------
- $ - - $ - $19,683,530 $(19,720,700)
======= =========== ============ ========= =========== ============
See accompanying notes to consolidated financial statements.
F-6
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Increase (Decrease) in cash and cash equivalents
Years ended January 31,
------------------------------------------------
2002 2001 2000
------------- ------------- -------------
Cash flows from operating activities:
Net income (loss) $ 37,836,678 $(16,115,926) $(32,765,625)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 6,137,639 12,946,560 16,253,259
(Gain) loss on sale of assets (34,600) 3,969,510 (1,400,021)
Extraordinary item - troubled debt restructuring (8,951,429) - -
Extraordinary item - discharged liabilities subject to compromise (32,769,523) - -
Deferred tax liability 136,000 - -
Issuance of stock for services and inventory - 187,500 2,846,082
Store closures - - 1,604,297
Issuance of stock options and warrants - - 804,552
Decrease (increase) in deferred tax asset - - 688,536
Changes in assets and liabilities, net of effects from acquisitions:
Decrease in accounts receivable 55,991 570,555 1,160,962
Decrease (increase) in other receivables 946,655 (946,655) -
Decrease in notes receivable - 9,078 82,234
Decrease (increase) in merchandise inventory 435,691 2,802,894 (2,205,613)
Decrease (increase) in prepaid express and other assets (178,904) 571,113 240,026
Increase in accounts payable and liabilities subject to compromise 962,326 3,506,231 12,128,385
Increase (decrease) in accrued expenses and liabilities subject
to compromise 444,903 (1,024,290) (2,321,764)
Increase (decrease) in other liabilities and liabilities subject
to compromise 287,303 1,574,760 (328,335)
Increase in deferred revenue 48,262 - -
------------ ------------ ------------
Net cash provided by (used in) operating activities 5,356,992 8,051,330 (3,213,025)
------------ ------------ ------------
Cash flows from investing activities
Purchases of videocassette rental inventory, net (4,790,099) (9,146,740) (6,425,632)
Purchases of fixed assets (351,009) (162,391) (2,043,954)
Store acquisitions - - (167,036)
Proceeds from sale of fixed assets 134,370 28,434 13,863,000
Proceeds from sale of fixed assets after bankruptcy filing - 1,575,893 -
Repayment on notes receivable - - 2,053,391
------------ ------------ ------------
Net cash provided by (used in) investing activities (5,006,738) (7,704,804) 7,279,769
------------ ------------ ------------
Cash flows from financing activities
Increase in bank overdraft 103,580 - -
Proceeds from the issuance of preferred stock - - 625,000
Repayment of pre-petition long-term debt - (6,531) (434,533)
Proceeds from issuance of long-term debt - - 2,015,979
Proceeds from borrowings (repayments) under pre-petition revolving
credit facility, net (1,500,000) 681,855 (6,274,919)
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 (1,396,420) 675,324 (4,214,471)
------------ ------------ ------------
Net increase (decrease) in cash (1,046,166) 1,021,850 (147,727)
Cash at beginning of year 1,046,166 24,316 172,043
------------ ------------ ------------
Cash at end of year $ - $ 1,046,166 $ 24,316
============ ============ ============
See accompanying notes to consolidated financial statements.
F-7
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
Years ended January 31,
----------------------------------------------
2002 2001 2000
------------ -------------- -------------
Supplementary disclosures of cash flow information
Cash paid during the year:
Interest $ 12,500 $ 1,347,669 $ 1,437,112
Income taxes 6,039 - 17,924
Reorganization items 1,047,000 104,000 -
Noncash investing and financing activities:
Cancellation of preferred stock 6,292,135 - -
Cancellation of common stock 13,741,395 - -
Liability for shares issuable under plan of reorganization 1,750,000 - -
Professional services financed through issuance of common stock - - 2,846,082
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 -
Preferred stock dividends - 322,142 492,522
Conversion of accounts payable to short term debt - - 1,453,706
For acquisitions consummated during fiscal 2000, the Company paid $167,036, net of cash acquired. In conjunction with the
acquisitions, liabilities were assumed as follows:
Fair value of assets acquired $ 1,614,929
Cash paid (167,036)
Common stock issued (641,394)
Preferred stock issued ( 1,251,174)
Goodwill 4,172,469
-------------
Liabilities assumed $ 3,727,794
=============
See accompanying notes to consolidated financial statements
F-8
VIDEO CITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
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 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 retail
specialty stores.
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 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. The proceedings began on August 17, 2000, when
Fleet Retail Finance ("Fleet") purported to accelerate the outstanding
indebtedness under the Company's secured credit facility (Note 7). On August 24,
2000 as a result of the Fleet action, 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. 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 in cancellation of all shares of
preferred stock outstanding prior to such distribution to preferred
shareholders; and 5,600,000 shares of common stock are to be issued to Video
City's creditors. The Company anticipates that all liabilities subject to
compromise will receive shares of common stock of Video City in full
satisfaction of their claims 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 tax obligations of
approximately $1.3 million that are to be paid in cash over five years from the
date of assessment, of which approximately $600,000 have been reclassified out
of liabilities subject to compromise. The remaining balance is still in dispute.
The Company will issue 7,000,000 shares of new common stock of reorganized Video
City (Note 16). The holders of existing voting shares immediately before the
confirmation received more than 50% of the voting shares of the emerging entity
and therefore the Company did not adopt fresh-start reporting upon its emergence
from Chapter 11. Liabilities compromised by the confirmed plan were stated at
the present value of the amounts to be paid, and the forgiveness of debt has
been reported as an extraordinary item.
F-9
VIDEO CITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
On August 29, 2001, the effective date of the Plan, liabilities subject to
compromise totaling $34,169,523 were discharged. All of the preferred and common
stock of the Company was deemed canceled. The Company recorded an extraordinary
gain of $32,769,523, net of $1,400,000 fair value of 5,600,000 share of common
stock to be issued to creditors, to discharge liabilities subject to compromise.
At January 31, 2002, the balance sheet reflects a liability in the amount of
$1,750,000 for 7,000,000 shares of common stock issuable under the Plan of
Reorganization. The estimated fair value of the common stock was $0.25
determined by the board of directors based on pre-petition trading prices
converted at the ratio of common stock issued to the existing common
shareholders in the plan of reorganization.
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.
Reorganization items are reported separately within the operating, investing and
financing categories of the Consolidated Statement of Cash Flows.
F-10
VIDEO CITY, INC.
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 changed its method of amortizing the rental library in order to more
closely match expenses in proportion with the anticipated revenues to be
generated therefrom.
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) is 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.
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 $5.5 million, $7.2 million and $13.7
million (including a $7.1 million adjustment recorded in the fourth quarter
fiscal 2000), for the years ended January 31, 2002, 2001 and 2000.
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, 2002. Amortization expense
charged to operations for the year ended January 31, 2002 and 2001 was $0.13
million and $0.2 million, respectively.
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.
F-12
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 $20,666,
$210,258 and $1,191,891 for the years ended January 31, 2002, 2001 and 2000,
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.
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
F-13
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation.
F-14
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 14.)
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
In June 2001, the Financial Accounting Standards Board finalized FASB Statements
No. 141, Business Combinations (SFAS 141), and No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 141 requires the use of the purchase method
of accounting and prohibits the use of the pooling-of-interests method of
accounting for business combinations initiated after June 30, 2001. SFAS 141
also requires that the Company recognize acquired intangible assets apart from
goodwill if the acquired intangible assets meet certain criteria. SFAS 141
applies to all business combinations initiated after June 30, 2001 and for
purchase business combinations completed on or after July 1, 2001. It also
requires, upon adoption of SFAS 142, that the Company reclassify the carrying
amounts of intangible assets and goodwill based on the criteria in SFAS 141.
SFAS 142 requires, among other things, that companies no longer amortize
goodwill, but instead test goodwill for impairment at least annually. In
addition, SFAS 142 requires that the Company identify reporting units for the
purposes of assessing potential future impairments of goodwill, reassess the
useful lives of other existing recognized intangible assets, and cease
amortization of intangible assets with an indefinite useful life. An intangible
asset with an indefinite useful life should be tested for impairment in
accordance with the guidance in SFAS 142. SFAS 142 is required to be applied in
fiscal years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized at that date, regardless of when those assets were
initially recognized. SFAS 142 requires the Company to complete a transitional
goodwill impairment test nine months from the date of adoption. The Company is
also required to reassess the useful lives of other intangible assets within the
first interim quarter after adoption of SFAS 142.
Currently, the Company is assessing but has not yet determined how the adoption
of SFAS 141 and SFAS 142 will impact its financial position and results of
operations.
F-15
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations. SFAS No. 143 requires the fair value of a liability for an asset
retirement obligation to be recognized in the period in which it is incurred if
a reasonable estimate of fair value can be made. The associated asset retirement
costs are capitalized as part of the carrying amount of the long-lived asset.
SFAS No. 143 is effective for fiscal years beginning after June 15, 2002. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets. SFAS 144 requires that those long-lived assets be
measured at the lower of carrying amount or fair value less cost to sell,
whether reported in continuing operations or in discontinued operations.
Therefore, discontinued operations will no longer be measured at net realizable
value or include amounts for operating losses that have not yet occurred. SFAS
144 is effective for financial statements issued for fiscal years beginning
after December 15, 2001 and, generally, are to be applied prospectively. The
Company believes the adoption of this Statement will have no material impact on
its financial statements.
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 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 year ended January 31, 2002, the Company closed two stores and
rejected the leases in terms of the Plan of Reorganization. A third store was
sold in exchange for cancellation of a note payable and receipt of cash. The
Company realized a gain on sale of $34,600.
During the fourth quarter of fiscal 2001, the Company sold 14 stores and
recorded a loss of approximately $1.4 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.
In July 2000, the Company sold 2 stores and recorded a loss of approximately
$199,000.
F-16
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3--DIVESTITURE OF STORES (Continued)
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.
NOTE 4--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; 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.
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 $0.875 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, 2002 and 2001, the Company owed Ingram approximately $0 and
$11.2 million. As a result of the bankruptcy, the amount owing at August 24,
2000 was included in liabilities subject to compromise.
F-17
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--RELATED PARTY TRANSACTIONS (Continued)
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, 2002 and 2001, the Company owed Rentrak approximately $0 and
$8.9 million. As a result of the bankruptcy, the amount owing at August 24, 2000
was included in liabilities subject to compromise.
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 2002, the Company purchased approximately $2.3 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. (Note 10.)
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 provided 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, 2002 and 2001, 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 previously served as a director of Video
City. Total fees for the years ended January 31, 2002 and 2001 were $0 and
$235,000.
F-18
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4--RELATED PARTY TRANSACTIONS (Continued)
The Company has entered into employment and consulting agreements with certain
shareholders and officers (See Note 10).
The Company made loans to employees and directors during the years ended January
31, 2002 and 2001, respectively. At January 31, 2002 and 2001, the Company had
no unsecured employee and director loans.
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
January 31,
----------------------------
2002 2001
------------ ------------
Furniture and fixtures $ 1,393,239 $ 1,883,969
Equipment 847,297 2,650,198
Leasehold improvements 848,111 1,064,784
------------ ------------
Total property and equipment 3,088,647 5,598,951
Accumulated depreciation and amortization (1,873,501) (4,073,542)
------------ ------------
Total property and equipment, net $ 1,215,146 $ 1,525,409
============ ============
Depreciation and amortization expense was $658,296, $1,680,478 and $1,879,370
for the years ended January 31, 2002, 2001 and 2000, respectively.
NOTE 6--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.
F-19
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6--SENIOR SECURED REVOLVING CREDIT FACILITY (Continued)
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 $10,000,000. 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 has recorded an extraordinary gain from troubled debt restructuring
during the year ended January 31, 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.
NOTE 7--LONG-TERM DEBT
Long-term debt consists of the following:
January 31,
----------------------
2002 2001
-------- ----------
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
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
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
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
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
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
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
-------- -----------
Total long-term debt - 6,790,454
Current portion - -
-------- -----------
Long-term debt, less current portion $ - $ 6,790,454
======== ===========
All long-term debt outstanding on August 24, 2000 was classified as liabilities
subject to compromise and settled pursuant to the Plan. 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.
As of August 24, 2000, the Company had outstanding indebtedness in the aggregate
amount of $4,862,238 with certain of the Company's key suppliers that reached
maturity and were 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 those key suppliers was included in liabilities
subject to compromise and settled pursuant to the Plan.
F-20
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8--INCOME TAXES
As of January 31, 2002, net operating loss carryforwards generated by the
Company of approximately $6,900,000 and $0 for Federal and California income tax
purposes are available to offset future taxable income through 2021. The
Company's ability to utilize net operating loss carryforwards is dependent upon
its ability to generate taxable income in future periods. The Company believes
that a portion of the Federal net operating losses may be limited due to
ownership changes as a result of the plan of reorganization (Note 1). 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,
--------------------------------------------
2002 2001 2000
----------- ------------ -----------
Current
- -------
Federal $ - $ - $ -
State 6,039 - 16,765
----------- ------------ -----------
6,039 - 16,765
----------- ------------ -----------
Deferred
- --------
Federal - - 712,425
State 136,000 - (21,891)
----------- ------------ -----------
136,000 - 690,534
----------- ------------ -----------
$ 142,039 $ - $ 707,299
=========== ============ ===========
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, 2002
and 2001, due to the losses incurred during fiscal 2002 and 2001, 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, 2002 and 2001.
F-21
VIDEO CITY INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8--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 resulted in a net 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 asset equaled $89,000
as of January 31, 2002. In connection with the acquisition of Video Galaxy, a
net deferred tax liability of $194,713 was recorded. In accordance with Internal
Revenue Code Section 108, the Federal and California net operating loss
carryovers were reduced by the amount of the discharge of indebtedness income
totaling $41,720,952 and $24,243,038, respectively. In addition, the tax bases
for California tax purposes were written down for fixed assets and the rental
library in the amount of $1,062,000 and $2,261,000, respectively. The following
table presents the primary components of the Company's net long-term deferred
tax asset and net long-term deferred tax liabilities:
January 31,
--------------------------------
2002 2001
------------ -------------
Components of long-term deferred tax assets:
Federal and State NOL carryforward $ 2,347,000 $ 16,782,957
Videoland fixed asset basis difference 89,000 867,986
Fixed assets due to difference in depreciation and amortization 189,000 213,520
Store closure reserve - 138,819
Other 52,000 11,144
------------ -------------
Total gross deferred tax asset 2,677,000 18,014,426
Valuation allowance (2,677,000) (16,956,219)
------------ -------------
Total deferred tax asset, net of valuation allowance - 1,058,207
------------ -------------
Components of long-term deferred tax liability:
Fixed assets due to difference in depreciation and amortization (43,000) -
Rental library due to writedown in connection with discharge of
indebtedness income (93,000) -
Videoland and Video Galaxy inventory basis difference - (1,058,207)
------------ -------------
Net long-term deferred tax liability $ (136,000) $ -
============ =============
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,
-------------------------------------
2002 2001 2000
-------- -------- --------
% 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 0.4 % - % - %
Valuation allowance - 29.9 % 37.8 %
Deferred tax asset writedown due to discharge of
indebtedness income, net of valuation allowance change 3.5 % - % - %
Non taxable income from discharge of indebtedness (37.6)% - % - %
Other 0.1 % 4.1 % (1.6)%
------- ------ -----
Total 0.4 % - % 2.2 %
======= ====== =====
F-22
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9--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 years ended January 31, 2002 and 2001, the
Company paid $0 and $703,472, respectively, in cash for the restructuring
expenses.
NOTE 10--COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company leases its facilities under noncancelable
operating leases expiring at various dates through 2013. Rent expense under
operating leases was approximately $3,227,913, $5,032,859 and $7,857,682 for the
years ended January 31, 2002, 2001 and 2000, respectively.
The future minimum lease payments under noncancelable operating leases with
initial lease terms in excess of one year as of January 31, 2002 are as follows:
Years ending Operating
January 31, Leases
- ------------------ ------------
2003 $ 2,804,872
2004 2,509,625
2005 2,261,974
2006 1,539,718
2007 979,160
Thereafter 854,313
------------
Total $ 10,949,662
============
Vendor Supply Agreement - 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 90 day
terms for payment to VPD. On October 31, 2001 the Company granted 100,000
options to the supplier in order to obtain a larger line of trade credit. During
fiscal 2002, the Company purchased approximately $2.5 million of product from
this supplier.
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.
Employment Agreements - Effective September 1, 2001, the Company entered into an
employment agreement with each of the Chief Executive Officer and the Chief
Financial Officer. The agreements are for a term of 3 years each and provide for
an annual salary, a minimum annual increase, an annual bonus, certain fringe
benefits and granted each of the officers options to purchase up to 250,000
shares of the Company common stock, each.
F-23
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--STOCKHOLDERS' EQUITY (DEFICIT)
Video City's authorized capital consists of 30,000,000 shares of common stock,
$.01 par value per share. The Company only has one class of stock available for
issuance. The Company has not yet issued 7,000,000 shares of common stock
required to be issued under the Plan of Reorganization. At January 31, 2002, the
balance sheet reflects a liability in the amount of $1,750,000 for 7,000,000
shares of common stock issuable under the Plan of Reorganization. The estimated
fair value of the common stock was $0.25 determined by the board of directors
based on pre-petition trading prices converted at the ratio of common stock
issued to the existing common shareholders in the plan of reorganization.
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. 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.
Stock Option Plans
As a result of the Plan of Reorganization, all options issued prior to August
24, 2000 were cancelled.
Under the 1996 Stock Option Plan, the Company could still grant options to
officers, other employees and consultants to Video City to purchase up to an
aggregate of 1,000,000 shares of its common stock.
Under the 1998 Stock Option Plan, the Company could still grant options to
officers, other employees and consultants to Video City to purchase up to an
aggregate of 1,200,000 shares of its common stock.
Options Issued
During the year ended January 31, 2002, the Company granted 121,429 options,
exercisable for 5 years, to various attorneys, on July 30, 2001. The options
have an exercise price of $0.01 per share and vested immediately.
During the year ended January 31, 2002, the Company granted 250,000 options
exercisable for 5 years, to each of the Chief Executive Officer and Chief
Financial Officer pursuant to the terms of their employment agreements. The
options have an exercise price of $0.25 per share and vested 50% on September 1,
2001, and will vest 50% on September 1, 2002.
During the year ended January 31, 2002, the Company granted a total of 375,000
options, exercisable for 5 years, to the remaining four directors on October 1,
2001. The options have an exercise price of $0.25 per share and vested on the
grant date.
During the year ended January 31, 2002, the Company granted 100,000 options,
exercisable for 5 years, to VPD, a major supplier of the Company, on October 31,
2001. The options have an exercise price of $0.25 per share and vest
immediately.
F-24
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--STOCKHOLDERS' EQUITY (DEFICIT) (Continued)
During the year ended January 31, 2002, the Company granted a total of 838,000
options, exercisable for 5 years, to various employees on January 1, 2002. The
options have an exercise price of $0.25 per share and vest over two years.
Information relating to stock options at January 31, 2002, summarized by
exercise price is presented in the following table:
Outstanding Exercisable
- ------------------------------------------------------------------ -----------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Price Contractual Exercise Exercise
Per Share Shares Life Price Shares Price
- ------------------ ------------- --------------- ------------ ------------- -------------
$0.01 121,429 4.4 years $ 0.01 121,429 $ 0.01
0.25 1,813,000 4.76 years 0.25 250,000 0.25
- ------------------ ------------- --------------- -------------
1,934,429 4.74 years $ 0.24 371,429 $ 0.17
============= =============== ============ ============= =============
All stock options issued to employees had an exercise price of 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,
---------------------------------------------
2002 2001 2000
------------ --------------- ------------
Net income (loss) As reported $ 37,836,678 $ (32,765,625) $ 11,134
Pro forma 37,791,387 (33,494,742) (184,277)
Basic and diluted earnings (loss)
per share As reported $ 3.07 $ (2.29) $ -
Pro forma 3.07 (2.31) (0.01)
The fair value of options granted during the year ended January 31, 2002 is
estimated on the date of the grant utilizing a Black Scholes pricing model over
the expected life of the options ranging from 1 to 5 years, expected volatility
of 50%, a risk-free interest rate of 4.5% and a 0% dividend yield. The weighted
average fair value of options granted was $0.24.
NOTE 12--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.
The merger agreement and management agreement was terminated on February 13,
2001 due to the sale of substantially all West Coast Entertainment's remaining
56 stores and various other assets.
F-25
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13--EARNINGS PER SHARE
The following table summarizes the calculation of the Company's basic and
diluted earnings per share for 2002:
Year Ended January 31, 2002
---------------------------------------
Income Per Share
(Loss) Shares Amount
------------ ------------ ---------
Basic and diluted EPS
- ---------------------
Net loss before extraordinary items $ (3,748,274) 12,323,490 $ (0.30)
Income from extraordinary item 41,584,952 12,323,490 $ 3.37
Income available to common stockholders 37,836,678 12,323,490 $ 3.07
In fiscal 2002, 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.
NOTE 14--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.
During the year ended January 31, 2002, the Company granted 250,000 options,
exercisable for 5 years, to each of the Chief Executive Officer and Chief
Financial Officer pursuant to the terms of their employment agreements. The
options have an exercise price of $0.25 and vested 50% on September 2001 and
will vest 50% on September 1, 2002.
The Company also granted 75,000 options, exercisable for 5 years, to each of the
remaining three directors, at an exercise price of $0.25, immediately vested.
NOTE 14--FINANCIAL INSTRUMENTS (Continued)
The estimated fair values of the Company's financial instruments are as follows:
January 31,
----------------------------------------------------
2002 2001
------------------------ -------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
---------- ----------- ----------- -----------
Financial Liabilities:
Long-Term Debt $ - $ - $ 6,790,454 $ 6,790,454
Senior Secured Revolving Credit Facility $ - $ - $10,451,429 1,500,000
F-26
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15 -- QUARTERLY RESULTS (Unaudited)
Quarterly results for the years ended January 31, 2002 and 2001 are reflected
below:
Fourth Third Second First
- -----------------------------------------------------------------------------------------------------------------------
2002
- ----
Revenue $ 4,463,509 $ 3,862,364 $ 4,448,342 $ 4,677,262
Operating loss $ (629,556) $ (1,191,691) $ (906,098) $ (603,079)
Net loss before extraordinary items $ (777,377) $ (1,117,584 $ (1,090,377) $ (762,936)
Net income (loss) $ (913,377) $ 31,651,939 $ 7,861,052 $ (762,936)
Extraordinary items $ (136,000) $ 32,769,523 $ 8,951,429 $ -
Basic and diluted earnings (loss) per share
before extraordinary items $ (0.45) $ (0.07) $ (0.07) $ (0.05)
Basic and diluted earnings (loss) per share
from extraordinary item $ (0.08) $ 1.99 $ 0.54 $ -
Basic and diluted earnings (loss) per share $ (0.53) $ 1.92 $ 0.48 $ (0.05)
2001
- ----
Revenue $ 6,419,679 $ 6,807,108 $ 8,885,774 $ 9,502,084
Operating income (loss) $ (2,248,067) $ (2,628,562) $ (2,613,486) $ (2,807,221)
Net income (loss) $ (4,487,606) $ (4,812,694) $ (3,599,140) $ (3,538,628)
Basic earnings per share $ (0.28) $ (0.29) $ (0.22) $ (0.22)
Diluted earnings per share $ (0.28) $ (0.29) $ (0.22) $ (0.22)
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.
NOTE 16 -- SUBSEQUENT EVENTS
Issuance of Common Stock:
Subsequent to the year end the Company issued approximately 5,000,000 shares in
terms of the approved Plan of Reorganization. Approximately 2,000,000 shares
still remain to be issued upon final determination between the Company and
certain unsecured creditors, whose claims have not been finally resolved.
F-27
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: May 31, 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
- ---- --------- -----
May 31, 2002 /s/ Robert Y. Lee Chairman of the Board
--------------------------
Robert Y. Lee
May 31, 2002 /s/ Timothy L. Ford Chief Executive Officer
-------------------------- (Principal Executive Officer)
Timothy L. Ford
May 31, 2002 /s/ Rudolph R. Patino Chief Financial Officer
-------------------------- (Principal Financial and
Rudolph R. Patino Accounting Officer)
May 31, 2002 /s/ David A. Ballstadt Director
--------------------------
David A. Ballstadt
May 31, 2002 /s/ Barry L. Collier Director
--------------------------
Barry L. Collier
May 31, 2002 /s/ Gerald W.B. Weber Director
--------------------------
Gerald W.B. Weber
S-1