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United States
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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Form 10-Q
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[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2002
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[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________ to ________.
Commission File No. 0-14023
VIDEO CITY, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-3897052
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
4800 Easton Drive, Suite 108, Bakersfield, California 93309
(Address of principal executive offices) (Zip Code)
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Registrant's telephone number, including area code: (661) 634-9171
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ___
Indicate by check mark whether the registrant has filed all documents
and reports required to be filed by Section 12, 13, or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes ___ No ___
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
The number of shares of Common Stock outstanding as of September 13, 2002
was 6,256,724.
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Table of Contents
10-Q
PART I .............................................................. 3
Item 1 .............................................................. 3
Balance Sheet Assets ................................................ 3
Balance Sheet Liabilities ........................................... 4
Income Statement .................................................... 5
Cash Flow Statement ................................................. 6
Table 5 ............................................................. 7
Table 6 ............................................................. 13
Item 2 .............................................................. 14
PART II ............................................................. 22
Item 2 .............................................................. 22
Item 6 .............................................................. 22
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
July 31, January 31,
2002 2002
------------- ------------
(Unaudited) (Audited)
ASSETS
Current assets:
Cash......................................... $ -- $ --
Customer receivables......................... 309,461 377,033
Other receivable ............................ 5,981 --
Merchandise inventory........................ 470,946 529,334
Other........................................ 83,555 74,270
------------ ------------
Total current assets...................... 869,943 980,637
Rental library, net............................ 2,426,162 2,261,331
Property and equipment, net.................... 973,015 1,215,146
Goodwill....................................... 1,787,361 1,787,361
Other assets................................... 333,208 346,645
------------ ------------
Total assets.............................. $ 6,389,689 $ 6,591,120
============ ============
See accompanying notes to consolidated financial statements
Page 3
VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
July 31, January 31,
2002 2002
-------------- -------------
Unaudited (Audited)
LIABILITIES NOT SUBJECT TO COMPROMISE
Current liabilities:
Bank overdraft........................................................................... $ 50,566 $ 103,582
Accounts payable......................................................................... 2,076,330 1,666,978
Accrued Expenses ........................................................................ 872,463 1,052,653
Note payable............................................................................. 42,531 48,262
Current portion of tax liability. ....................................................... 178,581 149,880
Other liabilities........................................................................ 139,489 332,829
-------------- -------------
Total current liabilities............................................................. 3,359,960 3,354,184
Senior Subordinated Convertible Notes Payable (net of unamortized discount of $420,559).. 321,861 --
Shares issuable under plan of reorganization ............................................ 216,176 1,750,000
Deferred tax liability .................................................................. 136,000 136,000
Tax liability less current portion ...................................................... 459,207 431,759
-------------- -------------
Total liabilities Not Subject to Compromise ............................................... 4,493,204 5,671,943
-------------- -------------
LIABILITIES SUBJECT TO COMPROMISE
Accounts payable .......................................................................... 317,120 956,347
-------------- -------------
Total Liabilities Subject to Compromise .............................................. 317,120 956,347
-------------- -------------
Total Liabilities ......................................................................... 4,810,324 6,628,290
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock, $.01 par value per share, 30,000,000 shares authorized; 6,256,724
shares issued and outstanding at July 31, 2002 and 0 shares issued and outstanding
at January 31, 2002 .................................................................... 62,567 --
Additional paid-in capital .............................................................. 21,623,725 19,683,530
Accumulated deficit ..................................................................... (20,106,927) (19,720,700)
-------------- -------------
Total stockholders' equity (deficit).................................................. 1,579,365 (37,170)
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Total liabilities and stockholders' equity (deficit) ...................................... $ 6,389,689 $ 6,591,120
============== =============
See accompanying notes to consolidated financial statements
Page 4
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
July 31, July 31, July 31, July 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
REVENUES:
Rental revenues and product sales .................................. $ 3,960,894 $ 4,448,342 $ 7,892,972 $ 9,118,461
Management fee income .............................................. -- -- -- 7,143
------------ ------------ ------------ ------------
TOTAL REVENUES ....................................................... 3,960,894 4,448,342 7,892,972 9,125,604
------------ ------------ ------------ ------------
OPERATING COSTS AND EXPENSES:
Store operating expenses ........................................... 2,355,855 2,729,954 4,746,784 5,281,305
Amortization of rental library ..................................... 1,003,035 1,366,253 1,938,874 2,793,734
Cost of product sales .............................................. 507,646 516,287 911,792 1,008,703
Cost of leased product ............................................. -- 18,022 -- 41,442
General and administrative expenses ................................ 532,793 723,924 1,129,285 1,510,227
------------ ------------ ------------ ------------
TOTAL OPERATING COSTS AND EXPENSES ................................... 4,399,329 5,354,440 8,726,735 10,635,411
Loss from operations before reorganization items ..................... (438,435) (906,098) (833,763) (1,509,807)
Other (Income) expense
Interest expense, net .............................................. 76,775 12,500 88,475 12,500
Other .............................................................. -- 22,484 -- (109,896)
------------ ------------ ------------ ------------
Loss before reorganization items .................................... (515,210) (941,082) (922,238) (1,412,411)
Reorganization items .................................................
Professional fees .................................................. -- 178,566 -- 417,577
(Gain) Loss on sale of assets ...................................... -- (34,600) -- (34,600)
Relocation of Corporate Office ..................................... -- 5,329 -- 57,925
------------ ------------ ------------ ------------
Net loss before extraordinary item ................................... (515,210) (1,090,377) (922,238) (1,853,313)
Extraordinary item ................................................... 536,011 8,951,429 536,011 8,951,429
------------ ------------ ------------ ------------
Net income (loss) .................................................... $ 20,801 $ 7,861,052 $ (386,227) $ 7,098,116
============ ============ ============ ============
Basic and diluted loss per common share before extraordinary item .... $ (0.10) $ (0.07) $ (0.23) $ (0.11)
Basic and diluted income per common share from extraordinary item .... $ 0.11 $ 0.54 $ 0.13 $ 0.54
Basic and diluted net income (loss) per common share ................. $ 0.00 $ 0.48 $ (0.10) $ 0.43
Weighted average number of common shares outstanding basic and
diluted ............................................................ 5,087,458 16,442,662 4,039,575 16,442,662
See accompanying notes to consolidated financial statements
Page 5
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
July 31, July 31,
2002 2001
Increase (Decrease) in cash
Cash flows from operating activities:
Net Income (loss) ............................................................ ($ 386,227) $ 7,098,116
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Depreciation and amortization .............................................. 2,264,429 3,088,274
Forgiveness of bank debt ................................................... -- (8,951,429)
Satisfaction of debt through sale of store ................................. -- (104,371)
Settlement of liabilities subject to compromise ............................ (536,011) --
Amortization of beneficial conversion ...................................... 47,166 --
(Gain) Loss on sale of asset ............................................... -- (34,600)
Changes in assets and liabilities:
Decrease in customer receivables ........................................... 67,572 5,465
Decrease (increase) in other receivables ................................... (5,981) 946,655
Decrease in merchandise inventories ........................................ 58,388 265,164
Increase in other assets ................................................... (2,848) (55,202)
Increase in accounts payable and liabilities subject to compromise.......... 409,116 588,373
Increase in accrued expenses and liabilities subject to compromise ......... 189,903 370,999
Decrease in other liabilities and liabilities subject to compromise......... (226,413) (13,841)
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Net cash provided by operating activities .................................... 1,879,094 3,203,603
---------- -----------
Cash flows from investing activities:
Purchases of videocassette rental library .................................. (2,103,704) (2,506,636)
Purchases of fixed assets .................................................. (76,425) (67,777)
Proceeds from sale of assets ............................................... -- 134,370
---------- -----------
Net cash used in investing activities ........................................ (2,180,129) (2,440,043)
---------- -----------
Cash flows from financing activities:
Decrease in bank overdraft ................................................. (53,016) --
Proceeds from the issuance of common stock ................................. 1,214 --
Proceeds from notes payable ................................................ 352,837 --
Repayment of notes payable liability subject to compromise ................. -- (1,598,292)
---------- -----------
Net cash provided by (used in) financing activities .......................... 301,035 (1,598,292)
---------- -----------
Net increase (decrease) in cash .............................................. 0 (834,732)
Cash at beginning of period ................................................. 0 1,046,164
---------- -----------
Cash at end of period ........................................................ $ 0 $ 211,432
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See accompanying notes to consolidated financial statements
Page 6
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
July 31, July 31,
2002 2001
------------ ------------
Supplementary disclosures of cash flow information
Cash Paid For:
Interest.................................................................. $ 41,300 $ 12,500
Reorganization items ..................................................... -- 228,061
Non-cash investing and financing activities:
Troubled debt restructuring .............................................. -- 8,951,429
Satisfaction of debt through sale of store ............................... -- 104,371
Value of warrants and Beneficial Conversion related to issuance of
$742,420 Senior Subordinated Convertible Notes ......................... 467,725 --
Accrued expenses relieved in exchange for $389,583 in Senior
Subordinated Convertible Notes ......................................... 389,583 --
Par value of common stock issued according to the Plan of
Reorganization ......................................................... 61,353 --
Excess over the par value of common stock issued according to the
Plan of Reorganization ................................................. 1,472,471 --
See accompanying notes to consolidated financial statements.
Page 7
VIDEO CITY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Financial Statement Presentation
The accompanying consolidated financial statements include the accounts of Video
City, Inc. ("the Company") and all of 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.
The consolidated statement of operations for the three and six months ended July
31, 2001, and the consolidated statement of cash flows for the six months ended
July 31, 2001 are unaudited and have been prepared in accordance with the
American Institute of Certified Public Accountants Statement of Position 90-7,
Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. The
financial statements have been prepared using accounting principles applicable
to a going concern, which assumes realization of assets and settlement of
liabilities in the normal course of business. The appropriateness of using the
going concern basis is dependent upon, among other things, the ability to comply
with debtor-in-possession financing agreements, confirmation of a plan of
reorganization, the ability to achieve profitable operations, and the ability to
generate sufficient cash flow from operations to meet its obligations.
The accompanying interim consolidated financial statements reflect all
adjustments that are, in the opinion of management, necessary to present fairly
the financial position as of July 31, 2002, the results of operations for the
three and six months ended July 31, 2002 and 2001, and cash flows for the six
months ended July 31, 2002 and 2001. All such adjustments are of a normal and
recurring nature. The results of operations for the interim periods presented
are not necessarily indicative of the results to be expected for the full year.
Certain reclassifications have been made to the prior year financial statements
to conform with the current year presentation. It is recommended that these
financial statements be read in conjunction with the consolidated financial
statements and notes thereto included in the Company's annual report on Form
10-K for the fiscal year ended January 31, 2002.
Page 8
The accompanying consolidated balance sheets as of January 31, 2002 and July 31,
2002 segregates liabilities subject to compromise, which represents claims still
in dispute, from liabilities not subject to compromise, such as liabilities
arising subsequent to filing bankruptcy.
Reorganization items represent expenses incurred by the Company as a result of
the bankruptcy filing and proceedings, which are required to be expensed as
incurred.
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. 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 then existing common
shareholders of Video City were 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 were 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 were to be issued to Video City's creditors. The Company
anticipated that all liabilities subject to compromise would 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 are to be paid
in cash over five years from the date of assessment, of which approximately $1.1
million has been reclassified out of liabilities subject to compromise. The
remaining balance is still in dispute.
The Company was required to issue 7,000,000 shares of new common stock of
reorganized Video City. 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.
Page 9
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.
On August 29, 2001, the effective date of the Plan, liabilities subject to
compromise totaling $34,169,523 were discharged. At July 31, 2002, the balance
sheet reflects a liability in the amount of $216,176 for 864,705 shares of
common stock still to be issued according to the terms of the Plan of
Reorganization. The estimated fair value of the common stock of $0.25 was
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.
3. Senior Subordinated Convertible Notes Payable
On May 10, 2002 the Company initiated a Private Placement Offering to accredited
investors. The Offering was to purchase Series A Units with each unit consisting
of a $10,000 10% Senior Subordinated Convertible Note Due November 1, 2003 and a
Series A Warrant to purchase 20,000 Shares of Common Stock. The Company is
offering a minimum of 50 units and a maximum of 100 units. The Units, Notes,
Warrants and underlying Common Stock have not been registered under the
Securities Act of 1933, as amended (the "Securities Act"), or with any
securities regulatory authority of any jurisdiction. As of July 31, 2002 the
Company has closed the first round with 74 units sold. The aggregate principal
amount of the Convertible Notes is $742,420 at an interest rate of 10% per
annum. Principal on these Notes shall be payable in one installment plus accrued
but unpaid interest on November 1, 2003. Interest shall be payable semi-annually
in arrears on the first day of November and May of each year, commencing
November 1, 2002. The Notes shall be convertible at the election of the payee to
common stock of the Company at a conversion price of $1.00 per share. The market
price of the stock and the relative fair value of the notes in relation to the
conversion price of these convertible debentures created a beneficial conversion
amount of $66,818, and is recorded as a note discount that is amortized over the
life of the notes.
In connection with issuance of the Notes, the Company issued one-year warrants
to purchase 1,484,840 shares of the Company's common stock at an exercise price
of $0.01 per share. The Company recorded the fair value of the warrants issued
of $400,907 using the Black-Scholes model, as a note discount and is being
amortized over the life of the notes as interest expense.
Page 10
4. 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.
11,579,148 common stock options and warrants were not included in the
computations of diluted earnings per share for the three months ended July 31,
2001 because the effect of exercise and/or conversion would have an antidilutive
effect on earnings per share.1,240,000 common stock options and 1,484,840
warrants to purchase common stock were not included in the computations of
diluted earnings per share for the three months ended July 31, 2002 because the
effect of exercise and/or conversion would have an antidilutive effect on
earnings per share.
5. Use of Estimates
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Actual results could differ materially from
those estimates.
6. New Accounting Pronouncements
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 these 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,
Page 11
2001 and, generally, are to be applied prospectively. The adoption of this
statement did not have a material impact on the financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
This statement eliminates the current requirement that gains and losses on debt
extinguishment must be classified as extraordinary items in the income
statement. Instead, such gains and losses will be classified as extraordinary
items only if they are deemed to be unusual and infrequent, in accordance with
the current GAAP criteria for extraordinary classification. In addition, SFAS
145 eliminates an inconsistency in lease accounting by requiring that
modifications of capital leases that result in reclassification as operating
leases be accounted for consistent with sale-leaseback accounting rules. The
statement also contains other nonsubstantive corrections to authoritative
accounting literature. The changes related to debt extinguishment will be
effective for fiscal years beginning after May 15, 2002, and the changes related
to lease accounting will be effective for transactions occurring after May 15,
2002. The Company has previously reported in its' consolidated financial
statements, extraordinary income that arose as a result of the bankruptcy and
the approval of the Plan of Reorganization. Consequently, the Company is
considering the reclassification of this extraordinary income in accordance with
SFAS 145 in the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities, which addresses accounting for restructuring and
similar costs. SFAS No. 146 supersedes previous accounting guidance, principally
Emerging Issues Task Force (EITF) Issue No. 94-3. The Company will adopt the
provisions of SFAS No. 146 for restructuring activities initiated after December
31, 2002. SFAS No. 146 requires that the liability for costs associated with an
exit or disposal activity be recognized when the liability is incurred. Under
EITF No. 94-3, a liability for an exit cost was recognized at the date of a
company's commitment to an exit plan. SFAS No. 146 also establishes that the
liability should initially be measured and recorded at fair value. Accordingly,
SFAS No. 146 may affect the timing of recognizing future restructuring costs as
well as the amount recognized.
Page 12
7. Adoption of SFAS No. 142, "Goodwill and Other Intangible Assets"
The Company adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142") on February 1, 2002. In
accordance with the requirements of SFAS 142, during the six months ended July
31, 2002, the Company:
. Evaluated the balance of goodwill and other intangible assets recorded
on the consolidated balance sheet as of February 1, 2002. No
reclassifications were required to be made in order to conform to the
new criteria for recognition.
. Determined that there were no intangible assets (other than goodwill)
with indefinite useful lives.
. Determined that the Company only has one reporting unit that is Video
City, Inc. to be used to test for goodwill impairment in accordance
with SFAS 142.
. As required by SFAS 142, the Company determined the fair value of the
reporting unit and compared it to the carrying value of goodwill
effective February 1, 2002. No impairment of the carrying value of
goodwill has been recorded upon adoption of SFAS 142.
As required under SFAS No. 142, with effect from February 1, 2002, we eliminated
the amortization of goodwill. The following table represents a reconciliation of
net income (loss) and per share data that would have been reported had the new
rules been in effect during the three months and six months ended July 31, 2002
(in thousands, except per share data):
Three Months Three Months Six Months Six Months
Ended July 31, Ended July 31, Ended July 31, Ended July 31,
2002 2001 2002 2001
Reported net income (loss) $20,801 $ 7,861,052 $(386,227) $ 7,098,116
Add back goodwill amortization, net of tax -- 31,338 -- 62,676
------------ --------------- -------------- --------------
Adjusted net income (loss) $20,801 $ 7,892,390 $(386,227) $ 7,160,792
------------ --------------- -------------- --------------
Basic and diluted net income (loss) per common share
Reported net income (loss) $ 0.00 $ 0.48 $ 0.10 $ 0.43
Goodwill amortization, net of tax -- $ 0.00 -- $ 0.01
-------------- --------------- -------------- --------------
Adjusted net income (loss) $ 0.00 $ 0.48 $ 0.10 $ 0.44
-------------- --------------- -------------- --------------
Page 13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Special Note Regarding Forward Looking Statements
Certain statements in this Quarterly Report on Form 10-Q, may constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking
statements involve known and unknown risks, uncertainties, and other factors
which may cause the actual results, performance or achievements of the Company
to be materially different from any future results, performance or achievements,
expressed or implied by such forward-looking statements. Factors that could
cause or contribute to such differences include, but are not limited to, those
discussed herein and in the Company's Annual Report on Form 10-K for the fiscal
year ended January 31, 2002.
As described in Note 1 to the unaudited consolidated financial statements, the
Company filed voluntary petitions for reorganization under Chapter 11 of the
United States Bankruptcy Code on August 24, 2000.
Estimates and Critical Accounting Policies
Estimates and Critical Accounting Policies Estimates and judgments made by
Management are an integral part of financial statements prepared in accordance
with accounting principles generally accepted in the United States of America
("GAAP"). Actual results may be different from estimated amounts included in the
financial statements. Management believes that the following critical accounting
policies address the significant estimates required of Management when preparing
the consolidated financial statements in accordance with GAAP:
. 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.
Page 14
. Customer receivable balances represent extended viewing fees charged
on rentals and are evaluated on a continual basis. Allowances are
provided for against 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 previously
acquired over the fair value of their net assets at the dates of
acquisition. 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 accordance
with SFAS No. 142, Goodwill has been evaluated for impairment and
management has determined that no impairment of goodwill exists at
July 31, 2002.
New Accounting Pronouncements
See note 6 and 7 to the Consolidating Financial Statements.
Results of Operations
Three months and six months ended July 31, 2002 compared to the three months and
six months ended July 31, 2001.
Revenues
Rental revenue and product sales for the three months and six months ended July
31, 2002 totaled $4.0 million and $7.9 million compared to $4.5 million and $9.1
million for the three and six months ended July 31, 2001. Revenue decreased by
$0.5 million or 12% and $1.2 million or 43% for the three months and six months
ended July 31, 2002 as compared to the corresponding periods of the previous
year. The decrease in revenues was primarily attributable to the reduced number
of stores operating during the three and six month periods ending July 31, 2002
as compared to the prior year periods. During the three and six months ended
July 31, 2002, the Company was operating 40 stores in 7 states compared to 44
stores in 7 states during most of the fiscal period ended July 31, 2001. This
reduction is stores accounted for approximately $900,000 of the decrease in
revenues in the six months ended July 31, 2002. The Company had no management
fee income in either the three months or six months ended July 31, 2002 compared
to the $7,000 for the three months ended April 30, 2001, related to the
"Management Agreement" entered into with West Coast Entertainment Corporation on
March 3, 2000 and terminated on February 13, 2001.
Page 15
Store Operating Expenses
Store operating expenses for the three months and six months ended July 31, 2002
totaled $2.4 million and $4.7 million, as compared to $2.7 million and $5.3
million for the three months and six months ended July 31, 2001. Store operating
expenses decreased by $0.3 million or 12% and $0.6 million or 12% for the three
months and six months ended July 31, 2002 as compared to the corresponding
periods of the previous year. The decrease in store operating expenses was
primarily attributable to the reduced number of stores operating during the
three and six month periods ending July 31, 2002 as compared to the prior year
periods. During the three and six months ended July 31, 2002, the Company was
operating 40 stores in 7 states compared to 44 stores in 7 states during most of
the fiscal year ended July 31, 2001. Store operating expenses as a percentage of
rental revenues and product sales were 60% and 61% for the three months and six
months ended July 31, 2002 compared to 62% and 58% for the corresponding periods
of 2001.
Amortization of Videocassette Rental Inventory
Amortization of videocassette rental inventory for the three months and six
months ended July 31, 2002 totaled $1.0 million and $1.9 million, compared to
$1.4 million and $2.8 million for the three months and six months ended July 31,
2001. Amortization decreased by $0.4 million or 29% and $0.9 million or 33% for
the three months and six months ended July 31, 2002 as compared to the
corresponding periods of the previous year. The decrease in amortization was
primarily due to the reduced number of stores operating during the three and six
month periods ending July 31, 2002 as compared to the prior year periods. In
addition, the rental inventory has been reduced from the prior year due to the
sale of excess non active rental inventory and the reduction in pricing of VHS
tapes by selected studios. Amortization of videocassette rental inventory as a
percentage of rental revenues and product sales were 26% and 25% for the three
months and six months ended July 31, 2002 compared to 31% and 31% for the
corresponding period, of 2001.
Cost of Product Sales
Cost of product sales for the three months and six months ended July 31, 2002
totaled $0.5 million and $0.9 million, compared to $0.5 million and $1.0 million
for the three months and six months ended July 31, 2001. Cost of product sales
was the same for the three months and increased $0.1 million or 10% for the six
months ended July 31, 2002 as compared to the corresponding periods of the
previous year. Cost of product sales as a percentage of rental revenues
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and product sales, was 13% and 12% for the three months and six months ended
July 31, 2002, compared to 12% and 11% for the same period of 2001.
Cost of Leased Product
The Company had no leased product for the three and six months ended July 31,
2002 compared to $18,022 and $41,442 for the three months and six months ended
July 31, 2001. The Company terminated leasing product under studio revenue
sharing agreements beginning August 24, 2000 due the Chapter 11 Bankruptcy
filing. The leased product reported for the prior year represented residual
payments due to the studios subsequent to the Bankruptcy filing.
General and Administrative Expenses
General and administrative expenses for the three months and six months ended
July 31, 2002 totaled $0.5 million and $1.1 million, compared to $0.7 million
and $1.5 million for the three months and six months ended July 31, 2001.
General and administrative expenses decreased $0.2 million or 29% and $0.4
million or 20% for the six months ended July 31, 2002 as compared to the
corresponding periods of the previous year. The decrease in general and
administrative expenses was primarily attributable to a reduction in employee
salaries, consulting expense and travel and entertainment expense, partially
offset by increased insurance expense. General and administrative expense as a
percentage of total revenues were 14% and 15% for the three months and six
months ended July 31, 2002, compared to 17% and 17% for the same period in 2001.
Interest Expense
Interest Expense for the three months and six months ended July 31, 2002 totaled
$76,775 and $88,475, compared to $12,500 and $12,500 for the three and six
months ended July 31, 2001. The increase in interest expense is primarily
attributable to the payment of interest on lease cure payment arrangements and
interest payments on priority tax payments payable in terms of the Plan of
Reorganization. In addition, the company began paying interest related to the
Notes Payable issued in connection with the Private Placement that were executed
on May 22, 2002, which included 10% interest on the Notes Payable balance as
well as the amoritization of the discount attached to the warrants granted with
notes payable and the beneficial conversion. The $12,500 interest expense for
the three and six months ended July 31, 2001 was interest charged on the balance
of the $500,000 payable to Fleet Retail
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Finance on June 29, 2001, per the ("the Fleet Compromise") agreement, which was
approved by the Bankruptcy Court on March 28, 2001.
Other (income) expense
The Company had no other income or expense for the three months and six months
ended July 31, 2002, compared to $22,484 of other expense and $109,896 of other
income for the corresponding periods of the previous year. Other income and
expense of the previous year consisted of miscellaneous expense and
miscellaneous income from vendor royalty payments and collection of previous
period late fees
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. Accordingly, a full
valuation allowance has been established against the deferred tax asset at July
31, 2001.
Reorganization Items
The Company had no reorganization expense for the three months and six months
ended July 31, 2002, compared to $149,295 and $440,902 for the three and six
months ended July 31, 2001. The prior period expenses consisted of professional
fees, corporate relocation expenses and a gain on the sale of assets directly
related the Company's Chapter 11 reorganization plan.
Extraordinary Gain on Withdrawal of Priority Tax Claims and Trouble Debt
Restructuring
The Company reported an extraordinary gain of $536,011 and $536,011 for the
three months and six months ended July 31, 2002, compared to $8,951,429 and
$8,951,429 for the corresponding periods of the previous year. During the
quarter ended July 31, 2002 the Company recorded an extraordinary gain relating
to the withdrawal of priority tax claims from various taxing authorities. During
the Quarter ended July 31, 2001 the Company recorded a gain on troubled debt
restructuring of $8,951,429 relating to the loan agreement with Fleet Retail
Finance.
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Liquidity and Capital Resource
The Company funds its short-term working capital needs, including the purchase
of videocassettes and other inventory, primarily through cash from operations.
The Company expects that cash from operations will be sufficient to fund future
videocassette, DVD and other inventory purchases and other working capital needs
for its existing stores.
Videocassette and DVD rental inventories are accounted for as noncurrent assets
under accounting principles generally accepted in the United States of America
because they are not assets which are reasonably expected to be completely
realized in cash or sold in the normal business cycle. Although the rental of
this inventory generates a substantial portion of the Company's revenue, the
classification of these assets as noncurrent excludes them from the computation
of working capital. The acquisition cost of videocassette and DVD rental
inventories, however, is reported as a current liability until paid and,
accordingly, included in the computation of working capital. Consequently, the
Company believes working capital is not as significant a measure of financial
condition for companies in the video retail industry as it is for companies in
other industries. Because of the accounting treatment of videocassette and DVD
rental inventory as a noncurrent asset, the Company anticipates that it will
operate with a working capital deficit during the fiscal year ended January 31,
2003.
In June of 2001, the Company also entered into a purchase money security
agreement directly with Warner Brothers Home Video. The agreement provides the
company with a line of trade credit and 60 day terms for repayment. The company
purchases all Warner Brothers product directly from Warner Brothers Home Video,
which is then distributed to all Video City's home entertainment retail chain
through a third party distributor.
In July 2001 the Company entered into an agreement with Video Products
Distributors ("VPD") under which VPD agreed to become the exclusive video
distributor for all of Video City's home entertainment retail chain. VPD will
provide all videocassettes, DVDs and accessories for rental and sale with the
exception of Warner Brothers Home Video product in all locations. As part of
this agreement, Video City is receiving a line of trade credit and 90 day terms
for repayment to VPD.
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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. Various pre-petition liabilities are still in
dispute and as a result are still classified as "Liabilities subject to
compromise".
Inherent in a successful plan of reorganization is a capital structure which
permits the Company to generate sufficient cash flow after reorganization to
meet its restructured obligations and fund the current obligations of the
reorganized Company. Under the Bankruptcy Code, the rights of and ultimate
payment to prepetition creditors may be subsequently altered and, as to some
classes, eliminated. The Company believes that the sources of capital available
to the Company and internally generated funds will be adequate to meet the
Company's anticipated needs through fiscal 2003; however, no assurance can be
given with respect to the Company's liquidity.
On May 10, 2002 the Company initiated a Private Placement Offering to accredited
investors. The Offering was to purchase Series A Units with each unit consisting
of a $10,000 10% Senior Subordinated Convertible Note Due November 1, 2003 and a
Series A Warrant to purchase 20,000 Shares of Common Stock. The Company is
offering a minimum of 50 units and a maximum of 100 units. The Units, Notes,
Warrants and underlying Common Stock have not been registered under the
Securities Act of 1933, as amended (the "Securities Act"), or with any
securities regulatory authority of any jurisdiction. As of July 31, 2002 the
Company has closed the first round with 74 units sold. The aggregate principal
amount of the Convertible Notes is $742,420 at an interest rate of 10% per
annum. Principal on these Notes shall be payable in one installment plus accrued
but unpaid interest on November 1, 2003. Interest shall be payable semi-annually
in arrears on the first day of November and May of each year, commencing
November 1, 2002. The Notes shall be convertible at the election of the payee to
common stock of the Company at a conversion price of $1.00 per share. The market
price of the stock and the relative fair value of the notes in relation to the
conversion price of these convertible debentures created a beneficial conversion
amount of $66,818, and is recorded as a note discount that is amortized over the
life of the notes.
In connection with issuance of the Notes, the Company issued one-year warrants
to purchase 1,484,840 shares of the Company's common stock at an exercise price
of $0.01 per share. The Company recorded the fair value of the warrants issued
of $400,907 using the Black-Scholes model, as a note discount and is being
amortized over the life of the notes as interest expense.
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The Company is seeking to improve its working capital position by seeking
increased trade credit, extended terms from its vendors and continuing to seek
additional investments through the private placement offering. However, no
assurance can be given that the Company will be successful in its efforts to
obtain additional short-term capital to improve its working capital position.
Cash Flows
Six months Ended July 31, 2002 Compared to the Six months Ended July 31, 2001
Cash Provided by Operating Activities
Net cash provided by operating activities for the six months ended July 31,
2002, decreased by approximately $1,325,000 or 42%, compared to the six months
ended July 31, 2001. This change was caused by the decrease in net income of
$7.4 million over the comparable prior year period, offset by the non-cash gain
of $8,851,429 recorded as a result of the forgiveness of debt by Fleet. The
decrease was also attributable to a decrease in depreciation and amortization as
a result of the reduction of 4 stores in the second quarter of fiscal 2001. The
decrease was also due to a decrease in accounts payable, accrued expenses and
other liabilities subject to compromise over the comparable prior year period.
Cash Used in Investing Activities
Net cash used in investing activities during the six months ended July 31, 2002
decreased by approximately $260,000 or 11%, compared to the six months ended
July 31, 2001. The change was mainly attributable to the decrease in the
purchase of videocassettes for the rental library due to the Company having less
stores, during the six months ended July 31, 2002.
Cash Provided by (Used in) Financing Activities
Net cash provided by (used) in financing activities during the six months ended
July 31, 2002, increased by approximately $1.9 million or 119%, compared to the
six months ended July 31, 2001. The change was mainly
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attributable to the receipt of the proceeds from the private placement and that
the fact there was no repayment of notes payable liability subject to compromise
for the six month period ended July 31, 2002.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
The Company's market risk sensitive instruments do not subject it to material
market risk exposures, except for such risks related to interest rate
fluctuations. The Company discontinued recording interest expense on unsecured
and partially secured prepetition debt subject to compromise.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
None
Item 2. Changes in Securities and Use of Proceeds
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
None
(b) Reports on Form 8-K
None
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Video City, Inc
---------------
(Registrant)
September 16, 2002 /s/ Timothy L. Ford
-------------------
Timothy L. Ford
Chief Executive Officer
(Principal Executive Officer)
-----------------------------
September 16, 2002
/s/ Rudolph R. Patino
---------------------
Rudolph R. Patino
Chief Financial Officer
(Principal Financial Officer)
-----------------------------
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