<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities and Exchange Act of 1934
January 8, 1997
...............
Date of Report (date of earliest event reported)
Video City, Inc.
...............
(Exact Name of Registrant as Specified in its Charter)
Delaware 0-14023 95-3897052
............... ............. ..........
(State or other (Commission File (IRS Employer
jurisdiction of Number) Identification
Incorporation) Number)
6840 District Boulevard, Bakersfield, California 93313
......................................................
(Address of principal executive offices)
(805) 397-7955
..............
(Registrant's telephone number, including area code)
Prism Entertainment Corporation
...............................
(Former Name)
6851 McDivitt Drive, Suite A, Bakersfield, California 93313
...........................................................
(Former Address)
<PAGE>
VIDEO CITY, INC.
The name of the Registrant was changed from "Prism Entertainment
Corporation" to "Video City, Inc." in conjunction with the merger of Lee Video
City, Inc. into Prism Entertainment Corporation on January 8, 1997.
ITEM 4. CHANGES IN REGISTRANT'S CERTIFYING ACCOUNTANT.
In conjunction with the merger of Lee Video City, Inc. into Prism
Entertainment Corporation, the registrant has engaged BDO Seidman, LLP as the
registrant's independent accountants for the fiscal year ended December 31, 1996
for Lee Video City, Inc. and for the fiscal year ended January 31, 1997 for
Video City, Inc. BDO Seidman, LLP served as Prism Entertainment Corporation's
independent accountants prior to the merger.
Lee Video City, Inc. has not consulted with BDO Seidman, LLP regarding the
application of accounting principles to a specified transaction or the type of
audit opinion that might be rendered on the financial statements during the two
most recent fiscal years through the date of the merger.
The change of auditors was approved by the Board of Directors of Video
City, Inc. in January, 1997.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL
INFORMATION AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESS ACQUIRED.
As was indicated on Form 8-K filed by Video City, Inc. (the "Company") on
January 23, 1997, the merger of Lee Video City, Inc. into Prism Entertainment
Corporation was reported. At that time, it was impracticable to provide the
financial statements of Lee Video City, Inc. for the period ended December 31,
1996. Such financial statements are now provided herein by this amendment.
(b) PRO FORMA FINANCIAL INFORMATION
As was also indicated on Form 8-K filed by the Company on January 23, 1997,
in which the merger of Lee Video City, Inc. into Prism Entertainment Corporation
was reported, at that time it was impracticable to provide the required pro
forma financial information for such acquisition. Such pro forma financial
information is now provided herein by this amendment.
ITEM 8. CHANGE IN FISCAL YEAR
In conjunction with the merger, Lee Video City, Inc. has adopted Prism
Entertainment Corporation's fiscal year end of January 31. The annual report
for the fiscal year ending January 31, 1997 will include a transition period of
one month.
<PAGE>
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 hereunto duly authorized.
VIDEO CITY, INC.
Dated: March 24, 1997 By: /s/ Robert Y. Lee
---------------------------
Robert Y. Lee
Chairman of the Board and
Chief Executive Officer
<PAGE>
VIDEO CITY, INC.
<TABLE>
<CAPTION>
<S> <C>
Reports of Independent Certified Public Accountants F-2
Financial Statements of Lee Video City, Inc.
Balance Sheets F-4
Statements of Operations F-6
Statements of Stockholders' Deficit F-7
Statements of Cash Flows F-8
Notes to Financial Statements F-10
Pro Forma Financial Information (unaudited)
Introductory Information F-21
Pro Forma Condensed Consolidated Balance Sheet (unaudited) F-22
Pro Forma Condensed Consolidated Statement of Operations (unaudited) F-24
Notes to Pro Forma Condensed Consolidated Financial Statements (unaudited) F-25
</TABLE>
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Video City, Inc.
We have audited the accompanying balance sheet of Lee Video City, Inc. as of
December 31, 1996 and the related statements of operations, stockholders'
deficit and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Lee Video City, Inc. as of
December 31, 1996 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
BDO SEIDMAN, LLP
Los Angeles, California
March 17, 1997
F-2
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Lee Video City, Inc.
We have audited the accompanying balance sheet of Lee Video City, Inc. as of
December 31, 1995 and the related statements of operations, stockholders'
deficit and cash flows for each of the years in the two-year period then ended.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Lee Video City, Inc. as of
December 31, 1995 and the results of its operations and its cash flows for each
of the years in the two-year period then ended in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
February 9, 1996, except
for note 5, which is as of
May 28, 1996.
F-3
<PAGE>
LEE VIDEO CITY, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1996 1995
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS (NOTE 5)
CURRENT ASSETS
Cash $ 59,273 $ 417,517
Notes receivable, less allowance for doubtful accounts 245,176 116,657
of $0 and $25,000 in 1996 and 1995 (Note 4)
Merchandise inventories 49,597 71,061
Other 169,130 340,312
- ------------------------------------------------------------------------------------------------------------
Total current assets 523,176 945,547
VIDEOCASSETTE RENTAL INVENTORY, NET OF ACCUMULATED 2,189,038 3,354,370
AMORTIZATION
PROPERTY AND EQUIPMENT, NET (NOTE 3) 1,034,479 2,609,030
NOTE RECEIVABLE (NOTE 4) - 158,473
OTHER ASSETS 262,966 267,576
- ------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 4,009,659 $ 7,334,996
- ------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
LEE VIDEO CITY, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, 1996 1995
- ---------------------------------------------------------------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' DEFICIT
CURRENT LIABILITIES
Accounts payable $ 1,192,156 $ 1,406,281
Accrued expenses 404,571 463,388
Current portion of long-term debt 614,916 1,445,736
(Note 5)
- ---------------------------------------------------------------------
Total current liabilities 2,211,643 3,315,405
LONG-TERM DEBT (NOTE 5) 5,804,014 7,953,821
OTHER LIABILITIES 151,142 179,986
- ---------------------------------------------------------------------
Total Liabilities 8,166,799 11,449,212
- ---------------------------------------------------------------------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' DEFICIT (Note 6)
Common stock, $.04 par value per
share, authorized
20,000,000 shares; issued and
outstanding 1,495,408 shares 59,816 59,816
Additional paid-in capital 547,184 547,184
Accumulated deficit (4,764,140) (4,721,216)
- ---------------------------------------------------------------------
Total stockholders' deficit (4,157,140) (4,114,216)
- ---------------------------------------------------------------------
Total Liabilities and Stockholders' $ 4,009,659 $ 7,334,996
deficit
=====================================================================
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
LEE VIDEO CITY, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Years ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenue
Rental revenues and merchandise sales $11,271,229 $14,007,083 $13,164,490
- ---------------------------------------------------------------------------------------------------------------------
Operating costs and expenses
Store operating expenses 5,974,826 6,850,068 6,775,516
Amortization of videocassette rental inventory 1,987,407 2,016,660 2,567,613
Cost of sales 1,557,062 1,782,260 1,294,814
Cost of leased product 556,248 1,085,814 -
Selling, general and administrative expenses 1,632,761 2,130,797 2,905,067
- ---------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses 11,708,304 13,865,599 13,543,010
- ---------------------------------------------------------------------------------------------------------------------
Income (loss) from operations (437,075) 141,484 (378,520)
Other (income) expense
Gain on disposition of assets, net (1,334,111) - -
Interest expense 691,782 931,775 826,757
Other 248,178 (203,868) 104,590
- ---------------------------------------------------------------------------------------------------------------------
Net loss $ (42,924) $ (586,423) $(1,309,867)
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
LEE VIDEO CITY, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Common Stock Additional Net
-------------------- Paid-In Accumulated Stockholders'
Shares Amount Capital Deficit Deficit
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1994 1,441,000 $57,640 $324,360 $(2,824,926) $(2,442,926)
Net Loss (1,309,867) (1,309,867)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 1,441,000 57,640 324,360 (4,134,793) (3,752,793)
Issuance of Common Stock 54,408 2,176 222,824 225,000
Net Loss (586,423) (586,423)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 1,495,408 59,816 547,184 (4,721,216) (4,114,216)
Net Loss (42,924) (42,924)
- -----------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 1,495,408 $59,816 $547,184 $(4,764,140) $(4,157,140)
- -----------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE>
LEE VIDEO CITY, INC.
STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH
<TABLE>
<CAPTION>
Years ended December 31, 1996 1995 1994
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (42,924) $ (586,423) $(1,309,867)
Adjustments to reconcile net loss to
net cash provided by operating
activities
Depreciation and amortization 2,518,069 2,667,050 3,121,693
(Gain) loss on disposal of assets (1,334,111) 14,281 109,588
Noncash interest - 135,000 305,238
Note issued for legal settlement 379,632
Other - 18,805 -
Changes in assets and liabilities:
Decrease (increase) in notes
receivable 29,954 55,295 (322,475)
Decrease in merchandise
inventories 21,464 62,211 61,337
Decrease (increase) in other
assets 175,792 (173,995) (316,832)
Increase (decrease) in accounts
payable (214,125) 287,206 451,396
Increase (decrease) in accrued
expenses (58,817) 146,574 203,505
Decrease in other liabilities (28,844) (15,235) -
- -------------------------------------------------------------------------------------
Total adjustments 1,489,014 3,197,192 3,613,450
- -------------------------------------------------------------------------------------
Net cash provided by operating
activities 1,446,090 2,610,769 2,303,583
- -------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of videocassette rental (1,814,809) (1,976,677) (1,283,764)
inventory, net
Purchases of fixed assets (169,512) (81,642) (1,485,539)
Proceeds from sale of fixed assets 601,301 - 846,398
- -------------------------------------------------------------------------------------
Net cash used in investing activities (1,383,020) (2,058,319) (1,922,905)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on obligations
under capital leases (299,752) (175,726) (225,895)
Repayment of long-term debt (1,034,939) (51,900) (579,209)
Proceeds from issuance of
long-term debt 913,377 - 60,000
- -------------------------------------------------------------------------------------
Net cash used in financing activities (421,314) (227,626) (745,104)
NET INCREASE (DECREASE) IN CASH (358,244) 324,824 (364,426)
Cash at beginning of year 417,517 92,693 457,119
Cash at end of year $ 59,273 $ 417,517 $ 92,693
- -------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to financial statements.
F-8
<PAGE>
LEE VIDEO CITY, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years ended December 31, 1996 1995 1994
- ------------------------------------------------------------------------------
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
<S> <C> <C> <C>
Cash paid during the year:
Interest $ 692,202 $820,202 $ 472,639
Income taxes 800 255,000 -
Noncash investing and financing
activities:
Videocassette rental inventory
acquired through issuance of
long-term debt - - 3,129,832
Interest charges financed through
issuance of long-term debt - 135,000 305,238
Acquisition of assets by issuance of
long-term debt - - 300,000
Furniture, fixtures and equipment
acquired under capital lease - - 585,801
Professional services financed
through issuance of common stock - 25,000 -
Videocassette rental inventory
acquired through issuance of common stock - 200,000 -
Long-term debt issued for settlement
of lawsuit 379,632 - -
Sale of stores in exchange for
assignment of debt 3,100,000 - -
</TABLE>
See accompanying notes to financial statements.
F-9
<PAGE>
LEE VIDEO CITY, INC.
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY
Lee Video City, Inc. (the "Company"), owns and operates video specialty stores
located primarily in secondary markets. The Company was incorporated in
California on February 20, 1990. As of December 31, 1996, the Company owned and
operated 18 stores, all located in California.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MERCHANDISE INVENTORIES
Merchandise inventories consisting primarily of prerecorded videocassettes and
video games held for sale are stated at the lower of cost (first-in, first-out)
or market.
VIDEOCASSETTE RENTAL INVENTORY
Videocassette rental inventory, which includes video games, is recorded at cost
and amortized over their estimated economic life with no provision for salvage
value. Videocassettes which are considered base stock are amortized over 36
months on a straight-line basis. Purchases of new release videocassettes and
video games are amortized whereby the tenth and any succeeding copies of each
title per store are amortized over 9 months on an accelerated basis; the fourth
through ninth copies of each title per store are amortized over 36 months on an
accelerated basis; and copies one through three of each title per store are
amortized as base stock.
Certain videocassettes in the rental inventory are leased under a revenue
sharing agreement with a vendor, as broker for various studios (Revenue Sharing
Agreement). During the revenue sharing period, which is generally one year, the
studios retain ownership of the videocassettes and the Company shares the rental
revenue with a vendor rather than purchasing the videocassettes for a fixed cost
per copy. Such revenue sharing amounts are included as cost of leased product in
the accompanying statements of operations. The associated handling fee per
leased videocassette is amortized on a straight-line basis over the term of the
lease and is included in amortization of videocassette rental inventory in the
accompanying statements of operations.
Amortization expense related to videocassette rental inventory totaled
approximately $1,987,000, $2,017,000 and $2,568,000 for the years ended
December 31, 1996, 1995 and 1994. As videocassettes are sold or retired, the
applicable cost and accumulated amortization are eliminated from the accounts,
and any gain or loss is recorded.
F-10
<PAGE>
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost. Furniture, fixtures and equipment
under capital leases are recorded at the lower of the present value of the
future minimum lease payments or the fair value of the asset at the inception of
the leases. Property and equipment are depreciated using the straight-line
method over estimated useful lives, ranging from five to ten years.
REVENUE RECOGNITION
Revenue is recognized at the time of rental or sale.
STORE OPENING COSTS
Store opening costs, which consist primarily of payroll, advertising and
supplies, are expensed as incurred.
STOCK-BASED COMPENSATION
In 1996, the Company adopted for footnote disclosure purposes only, Statement of
Financial Account Standard No. 123, "Accounting for Stock-Based Compensation"
(SFAS No. 123), which requires that companies measure the cost of stock-based
employee compensation at the grant date based on the value of the award and
recognize this cost over the service period. For accounting purposes, the value
of the stock based award is determined using the intrinsic value method whereby
compensation cost is the excess of the quoted market prices of the stock at
grant date or other measurement date over the amount an employee must pay to
acquire the stock.
INCOME TAXES
The Company records income taxes pursuant to Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). Under the
asset and liability method of SFAS No. 109, deferred income taxes are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
F-11
<PAGE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the year. Actual results
could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standard No. 125, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No.
125) issued by the Financial Accounting Standards Board (FASB) is effective for
transfers and servicing of financial assets and extinguishments of liabilities
occurring after December 31, 1996, and is to be applied prospectively. Earlier
or retroactive application is not permitted. The new standard provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities. The Company does not expect adoption
to have a material effect on its financial position or results of operations.
Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS
No. 128) issued by the Financial Accounting Standards Board (FASB) is effective
for financial statements issued for periods ending after December 15, 1997,
including interim periods. The statement requires restatement of all prior
period earnings per share (EPS) data presented. The new standard requires a
reconciliation of the numerator and denominator of the basic EPS computation
(EPS) to the numerator and denominator of the diluted EPS computation. The
Company has not determined the effect of adoption on its EPS computation.
3. PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
<TABLE>
<CAPTION>
December 31, 1996 1995
- --------------------------- ---------- ----------
<S> <C> <C>
Land....................... $ - $ 300,000
Furniture and fixtures..... 1,134,369 1,521,448
Equipment.................. 678,695 1,339,501
Leasehold improvements..... 423,597 936,906
- --------------------------- ---------- ----------
2,236,661 4,097,855
Accumulated depreciation... 1,202,182 1,488,825
- --------------------------- ---------- ----------
$1,034,479 $2,609,030
</TABLE>
4. NOTES RECEIVABLE
F-12
<PAGE>
At December 31, 1996 and 1995, the Company had unsecured employee loans
aggregating approximately $86,700 and $90,300, bearing interest at 7%, and are
due on demand. Also included in notes receivable is a secured note amounting to
approximately $158,500 and $184,800 as of December 31, 1996 and 1995, bearing
interest at 8%, and is due September 15, 1997, and other miscellaneous unsecured
notes receivable of approximately $26,300 as of December 31, 1995.
5. LONG-TERM DEBT
Long-term debt is summarized as follows at December 31, 1996 and 1995:
<TABLE>
<CAPTION>
December 31 1996 1995
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Promissory note, secured by all assets and personally
guaranteed by the Company's primary stockholder,
bearing interest at 9% per annum, principal and interest
payments of $62,192 per month payable
beginning July 31, 1997 through the year 2001 4,498,460 7,283,586
Convertible, subordinated, unsecured notes to various
individuals, maturing on January 31, 2001, interest
payable monthly, bearing interest at 5% to 10%.
Convertible into common stock at conversion
price of $3.64 per share 851,510 859,000
Promissory note, secured by land, and personally
guaranteed by the primary stockholder of the
Company, bearing interest at 7%, principal and
interest were paid on May 27, 1996 - 300,000
Other loans to various individuals for $160,000
(secured by property) and $50,000 (unsecured),
payable on February 29, 1996 and January 1, 1998,
respectively, bearing interest at 10% and 11%,
respectively, with personal guarantee by
primary stockholder of the Company 50,000 210,000
Other unsecured loans, payable in monthly
installments until September 15, 1997, bearing
interest at 8% 48,166 109,283
Promissory notes, personally guaranteed by the
primary stockholder for $123,595 and $189,783,
payable in monthly installments until February
1, 1997, and February 1, 2000, respectively,
bearing interest at 10.25% 313,378 -
</TABLE>
F-13
<PAGE>
<TABLE>
<CAPTION>
December 31 1996 1995
- -------------------------------------------------------------------------------------------
<S> <C> <C>
Other unsecured loans to fulfill settlement obligations
for $259,847 and $59,632, payable in monthly
installments until February 20, 2000 and December 15,
1998, respectively 319,479 -
Capital lease obligations, payable in monthly installments,
with interest rates of 14% to 28%, secured by the respective
assets under the lease (Note 9) 337,937 637,688
- --------------------------------------------------------------- ---------- -----------
Total Debt 6,418,930 9,399,557
Less current portion (614,916) (1,445,736)
- --------------------------------------------------------------- ---------- -----------
Total long-term debt $5,804,014 $ 7,953,821
===========================================================================================
</TABLE>
Subsequent to year end $3,819,000 of debt was converted to equity (Note 11).
Total maturities of remaining long-term debt for five years subsequent to
December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Year ending
December 31, Amount
- --------------------------------------------------------------
<S> <C>
1997 $ 614,915
1998 301,948
1999 159,757
2000 1,523,310
- --------------------------------------------------------------
$2,599,930
</TABLE>
6. COMMON STOCK
On July 25, 1995, the Board of Directors approved an amendment to the Company's
Articles of Incorporation increasing the number of shares of common stock
authorized from 1 million to 20 million, and reducing the par value per share of
common stock from $10.00 to $.04. The company issued 250 shares of $.04 par
value common stock for each share of $10.00 common stock. All share data
included in these financial statements have been restated to reflect the stock
split.
During 1995, common stock was issued in exchange for videocassette rental
inventory and certain professional services. The videocassette rental inventory
and professional services have been valued at the approximate fair value.
During 1995, in conjunction with an addendum to the Revenue Sharing Agreement
(Note 2), the Company granted to a distributor a warrant to purchase 29,408
shares of common stock of the Company, representing 2% of the fully diluted
issued and outstanding shares
COMMON STOCK (CONTINUED)
F-14
<PAGE>
of common stock at an exercise price of $400,000. The warrant is exercisable
during the period commencing August 24, 1995 and ending on August 23, 2005.
Additionally, during 1995 the Company issued a warrant to its major supplier to
purchase common stock at an exercise price of $30,795 for each 1% of the fully
diluted number of common shares outstanding, not to exceed 5% of the fully
diluted number of common shares outstanding. The warrant is exercisable during
the period commencing January 1, 1996 and ending on December 31, 2004. The
vesting schedule is as follows:
In 1996, the Company amended the above warrant under basically the same terms,
except the warrant shall not exceed 8.5% of the fully diluted common shares
outstanding and the warrant is fully vested as of December 31, 1996.
In 1995, the Company granted stock options to purchase the company's common
stock to key employees and consultants. The options expire five years after
date of grant and are fully vested. In 1996, the Company granted stock options
to purchase the Company's common stock to key employees. The options expire five
years after the date of grant and vest ratably over a three year period. In
1996, the Company also granted options to consultants which expire five years
after date of grant and are fully vested. A summary of stock option activity is
as follows:
<TABLE>
<CAPTION>
December 31, 1994 1995 1996
-------------------- -------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year - 727,000 1.11 802,500 1.08
Granted 727,500 1.11 802,500 1.08 162,153 5.69
Exercised -
Terminated - 727,500 1.11
Outstanding at end of year 727,500 1.11 802,500 1.08 964,653 1.85
Options exercisable at year-end 727,500 1.11 802,500 1.08 884,924 1.51
- ----------------------
</TABLE>
F-15
<PAGE>
Information relating to stock options at December 31, 1996 summarized by
exercise price are as follows:
<TABLE>
<CAPTION>
Outstanding
----------------------------------
Exercise Price Weighted Average Exercisable
------------------------------- --------------------------
Weighted Average
Per Share Shares Life (year) Exercise Price Shares Exercise Price
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.82 to $1.65 802,500 5.0 $1.08 802,500 $1.08
5.69 to 5.69 166,153 5.0 5.59 82,424 5.69
- ------------------------------------------------------------------------------------------------
964.463 5.0 $1.85 884,924 $1.51
================================================================================================
</TABLE>
All stock options issued to employees have an exercise price not less than the
fair market value of the Company's common stock on the date of grant, and in
accordance with accounting for such options utilizing the intrinsic value method
there is no related compensation expense recorded in the Company's financial
statements. Had compensation cost for stock-based compensation been determined
based on the fair value at the grant dates consistent with the methods of SFAS
123, the Company's net loss for the year ended December 31, 1996 would not be
materially different.
Due to the fact that the Company's stock option programs vest over many years
and additional awards are made each year, the above effect on net loss is not
indicative of the financial impact had the disclosure provisions of FASB 123
been applicable to all years of previous option grants. The above numbers do
not include the effect of options granted prior to 1995 that vested in 1995 and
1996.
The fair value of option grants are estimated on the date of grant utilizing a
simple option pricing model with the expected life of option ranging from 3 to 5
years, expected volatility of 0%, risk-free interest rate of 5.69% and a 0%
dividend yield.
7. INCOME TAXES
At December 16, 1994, the Company converted from an S Corporation to a C
Corporation. As a C Corporation, the Company is subject to Federal and State
income taxes at the corporate level.
Income tax expense differs from the "expected" benefit (computed by applying the
U.S. Federal corporate statutory income tax rate to loss before income taxes)
primarily due to an increase in the valuation allowance for deferred tax assets.
F-16
<PAGE>
INCOME TAXES (CONTINUED)
As of December 31, 1996, the Company had net operating loss carryforwards of
approximately $1,651,235 and $825,618 for Federal and California income tax
purposes, which are available to offset future taxable income through 2011. The
Company's ability to utilize the net operating loss carryforwards is dependent
upon the ability to generate taxable income in future periods which may be
limited due to future ownership changes as defined under Section 382 of the
Internal Revenue Code of 1986. Utilization of net operating losses may also be
limited in any one year by alternative minimum tax rules.
Deferred tax assets are initially recognized for differences between the
financial statement carrying amount and the tax bases of assets and liabilities
which will result in future deductible amounts and operating loss and tax credit
carryforwards. A valuation allowance is then established to reduce that deferred
tax asset to the level at which it is "more likely than not" that the tax
benefits will be realized. Realization of tax benefits of deductible temporary
differences and operating loss or credit carryforwards depends on having
sufficient taxable income of an appropriate character within the carryback and
carryforward periods. Sources of taxable income that may allow for the
realization of tax benefits include (I) taxable income in the current year or
prior years that is available through carryback, (ii) future taxable income that
will result from the reversal of existing taxable temporary difference, and
(iii) future taxable income generated by future operations. Based on an
evaluation of the realizability of the deferred tax asset, management has
determined that it is not more likely than not that the Company will realize
this tax benefit. Therefore, a valuation allowance has been established for the
entire deferred tax asset.
F-17
<PAGE>
INCOME TAXES (CONTINUED)
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at December 31, 1996 and 1995 are presented below:
<TABLE>
<CAPTION>
1996 1995
------------ ------------
<S> <C> <C>
Rental inventory principally due to
difference in amortization $ 119,641 $ 540,600
Fixed assets due to difference in depreciation 85,698 65,700
Section 481 adjustment 83,377 127,600
Deferred rent 73,755 74,100
Net operating loss carryforward 638,202 193,600
Other 19,205 36,800
----------- -----------
Total gross deferred tax asset 1,019,878 1,038,400
Less valuation allowance (1,019,878) (1,038,400)
----------- -----------
Net deferred tax assets $ - $ -
=========== ===========
</TABLE>
8. GAIN ON DISPOSITION OF ASSETS
During 1996, the Company sold 11 stores and the resulting gain on sale of assets
is included in the statement of operations.
9. COMMITMENTS AND CONTINGENCIES
The Company is obligated under various capital leases for certain fixtures and
equipment expiring at various dates through 1999. At December 31, 1996 and
1995, the gross amount of furniture, fixtures and equipment and related
accumulated amortization recorded under capital leases included in furniture,
fixtures and equipment was as follows:
<TABLE>
<CAPTION>
Year Ending December 31, 1996 1995
--------- ----------
<S> <C> <C>
Furniture and fixtures $ 397,539 $ 548,352
Equipment 405,167 558,873
--------- ----------
802,706 1,107,225
--------- ----------
Accumulated amortization (502,930) (474,474)
--------- ----------
$ 299,776 $ 632,751
========= ==========
COMMITMENTS AND CONTINGENCIES (CONTINUED)
</TABLE>
F-18
<PAGE>
The Company leases its facilities under noncancelable operating leases expiring
at various dates through 2005. Rent expense under operating leases was
approximately $1,444,000, $1,597,000 and $1,472,000 for the years ended December
31, 1996, 1995, and 1994.
The present value of future minimum capital lease payments and future minimum
lease payments under noncancelable operating leases with initial lease terms in
excess of one year as of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Year Ending Operating
December 31, Capital Leases Leases
- --------------------------------------------- --------------- ----------
<S> <C> <C>
1997 $317,218 $1,154,475
1998 93,060 1,123,378
1999 514 992,908
2000 0 678,435
Thereafter 0 1,316,750
- --------------------------------------------- -------- ----------
Total minimum lease payments $410,792 $5,265,946
Amount representing interest (72,855)
- --------------------------------------------- -------- ----------
Present value of net minimum capital lease
payments (included in long-term debt) $337,937
- --------------------------------------------- -------- ----------
</TABLE>
Pursuant to the Revenue Sharing Agreement (Note 2), the Company is obligated to
pay the vendor revenue sharing and handling fee payments that are equal on an
annual basis to at least 10% of the Company's gross revenues.
On November 6, 1996, the Company amended the March 13, 1996 agreement with its
major supplier to purchase, under certain conditions, 80% of its yearly
requirements for the video rental, video sell-through and video game products.
F-19
<PAGE>
10. FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Notes receivable: Estimated discounting of future cash flow using the current
rate at which similar loans would be made with similar credit risks and for the
same remaining maturities. The fair market value of employee notes cannot be
estimated due to their related party nature and terms.
Long-term debt: Estimated based upon current market borrowing rates for loans
with similar terms and maturities.
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
1996 1996 1995 1995
Carrying Fair Carrying Fair
December 31, Amount Value Amount Value
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Notes Receivable $ 245,176 $ 245,454 $ 275,130 $ 272,340
Financial Liabilities:
Long-Term Debt 6,418,930 6,456,849 9,399,557 9,491,658
</TABLE>
11. SUBSEQUENT EVENT
On January 8, 1997, the Company merged with and into Prism Entertainment
Corporation ("Prism") pursuant to Prism's plan of reorganization. The
shareholders of the Company received 5,078,750 shares of the common stock (or
approximately 51.7% of Prism's common stock on the effective date of the
merger). In conjunction with the merger, $3,819,000 of debt was converted to
equity in exchange for 2,273,653 shares of Prism's common stock. In addition,
Prism assumed the warrants and options previously issued by the Company.
F-20
<PAGE>
VIDEO CITY, INC.
PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
On January 8, 1997, Lee Video City, Inc. merged into Prism Entertainment
Corporation pursuant to an Agreement and Plan of Reorganization and Merger,
dated as of October 25, 1996 (the "Plan"). The merger was authorized by the Plan
and was a condition precedent to the effectiveness of the Plan.
The transaction was accounted for as a reverse acquisition. In a reverse
acquisition, the stock issued goes to the accounting acquirer. Accordingly,
since the reverse purchase accounting is the reverse of normal, it is the fair
market value (FMV) of the issuer's stock at date of acquisition that is valued
with a write up (write down) of the issuer's net assets depending on whether the
stock is trading is excess (less than) book value. If a FMV cannot be determined
for the stock and cost is determined based on the FMV of the issuer's net
assets, then goodwill is not recognized and the transaction is valued at the
issuer's net tangible assets. Due to the trading of Prism Entertainment
Corporation's common stock being suspended during the bankruptcy proceedings,
the FMV of the stock could not be determined. Accordingly, goodwill was not
recognized and the transaction was recorded at the fair value of the issuer's
net tangible assets. The existing shareholders of Lee Video City, Inc. received
5,078,750 shares of the common stock of Prism Entertainment Corporation or
approximately 51.7% of the Company's common stock. Under consummation of the
Merger, the name of the surviving corporation ("the Company") was changed from
Prism Entertainment Corporation to Video City, Inc.
The accompanying condensed consolidated financial statements illustrate the
effect of the reorganization and merger ("Pro Forma") on the Company's financial
position and results of operations. The pro forma condensed consolidated balance
sheet as of December 31, 1996 is based on the historical balance sheets of Lee
Video City, Inc. and Prism Entertainment Corporation as of that date and assumes
the reorganization and merger took place on that date. The pro forma condensed
consolidated statement of operations for the year ended December 31, 1996 is
based on the historical statements of Lee Video City, Inc. and Prism
Entertainment Corporation and assumes the reorganization and merger took place
on January 1, 1996. Prism Entertainment Corporation's historical balance sheet
is as of October 31, 1996. Pro forma adjustment 1a reflects the activity for the
period November 1, 1996 to December 31, 1996. Prism Entertainment Corporation's
historical statement of operations is for the nine months ended October 31,
1996. Pro forma adjustment 2a reflects the activity for the three months of
January, November and December.
The pro forma condensed consolidated financial statements may not be indicative
of the actual results of the merger and there can be no assurance that the
foregoing results will be obtained.
The accompanying pro forma condensed consolidated financial statements should be
read in connection with the historical financial statements of Lee Video City,
Inc. and Prism Entertainment Corporation.
F-21
<PAGE>
VIDEO CITY, INC.
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
Lee Video City Prism Pro Forma
Dec. 31, 1996 Oct. 31, 1996 Adjustments
ASSETS (Note 1) Pro Forma
------ -------------- ------------- ------------- ---------
<S> <C> <C> <C> <C>
Cash $ 59 $2,085 ($1,300) (a) $ 741
($103) (l)
Accounts receivable 0 2,518 (266) (a) 2,252
Notes receivable 245 0 0 245
Merchandise inventories 50 0 0 50
Other assets 169 34 (34) (a) 169
------ ------ ------- ------
Total current assets 523 4,637 (1,703) 3,457
Videocassette rental inventory 2,189 0 0 2,189
Property and equipment 1,035 190 (190) (b) 1,035
Film inventory 0 3,700 0 3,700
Notes receivable 0 0 0 0
Other assets 263 656 (109) (c) 263
(547) (d)
------ ------ ----------- ---------
Total assets $4,010 $9,183 ($2,549) $10,644
====== ====== ====== =======
</TABLE>
F-22
<PAGE>
VIDEO CITY, INC.
PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)
DECEMBER 31, 1996
(IN THOUSANDS)
<TABLE>
<CAPTION>
Prism Pro Forma
Lee Video City Oct. 31, Adjustments Pro
Dec. 31, 1996 1996 (Note 1) Forma
------------- ----------- ----------- -------
<S> <C> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Accounts payable $1,192 $ 1,249 ($1,149) (e) $ 1,292
Accrued expenses 405 876 (51) (a) 491
(622) (f)
(78) (g)
(39) (k)
Current portion of long term debt 615 2,973 (24) (a) 2,567
(1,115) (h)
118 (i)
Liabilities subject to compromise 0 11,017 (11,017) (a) 0
------- ------- ------- -------
Total Current Liabilities 2,212 16,115 (13,977) 4,350
Long term debt 5,804 0 1,115 (h) 3,100
(3,819) (k)
Other liabilities 151 47 622 (f) 773
(47) (j)
------- ------- ------- -------
Total liabilities 8,167 16,162 (16,106) 8,223
Stockholders' equity (deficit) (4,157) (6,979) 9,802 (m) 2,421
3,755 (k)
------- ------- ------- -------
Total liabilities and $4,010 $ 9,183 ($2,549) $10,644
stockholders' equity ======= ======= ======= =======
</TABLE>
See Notes to Pro Forma Condensed Consolidated Financial Statements (Unaudited)
F-23
<PAGE>
VIDEO CITY, INC
PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
YEAR ENDED DECEMBER 31, 1996
(IN THOUSANDS, EXCEPT PER SHARE AMOUNT)
<TABLE>
<CAPTION>
Lee Video
City Prism Pro Forma
Dec. 31, Oct. 31, Adjustments Pro
1996 1996 (Note 2) Forma
------- --------------------------- -------
<S> <C> <C> <C> <C>
Revenue $11,271 $1,414 $1,057 (a) $13,742
Operating costs and expenses:
Store operating expenses 5,975 0 0 5,975
Amortization of Videocassette rental 1,987 0 0 1,987
inventory
Cost of sales (Note 3) 1,557 5,216 272 (a) 7,045
Cost of leased product 556 0 0 556
General & administrative expenses 1,633 1,776 393 (a) 3,151
(131) (b)
(70) (c)
(227) (d)
(98) (e)
(125) (f)
------- ------ ------ -------
Total operating costs and expenses 11,708 6,992 14 18,714
Income (loss) from operations (437) (5,578) 1,043 (4,972)
Other (income) expenses:
Interest expense, net 692 233 (365) (h) 573
13 (i)
Gain on disposition of assets (1,334) 0 0 (1,334)
Other 248 1,031 (933) (g) 346
------ ----- ----- -----
Net income (loss) (43) (6,842) 2,320 (4,557)
====== ===== ===== =====
Loss per share (0.46)
Weighted average number of shares outstanding 9,825
</TABLE>
See Notes to Pro Forma Condensed Consolidated Financial Statements
(Unaudited)
F-24
<PAGE>
VIDEO CITY, INC.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED)
1. PRO FORMA ADJUSTMENTS: BALANCE SHEET
The adjustments to the pro forma condensed consolidated balance sheet are as
follows:
a. To reflect the activity of Prism Entertainment Corporation for the period
November 1, 1996 to December 31, 1996.
b. To eliminate property, plant and equipment that was returned to vendors and
disposed of during bankruptcy proceedings.
c. To eliminate goodwill and security deposits that were written off during
bankruptcy proceedings.
d. To eliminate unamortized debenture loan costs and officers life insurance
surrender value, as part of bankruptcy proceedings.
e. To reflect payment of administrative claims and selling, general and
administrative accounts payable.
f. To reclass portion of sales taxes payable to long term other liability.
g. To reflect reduction in sales tax liability resulting from bankruptcy
proceedings.
h. To reclass debt as long term debt pursuant to an amended and restated credit
loan and security agreement.
i. To reflect increase in debt pursuant to an amended and restated credit loan
and security agreement.
j. To eliminate liability for foreign deposits that are reclassed as unsecured
claims.
k. To reflect conversion of long term debt to equity.
l. To reflect settlement of contract dispute and effect of exercise of
dissenter's rights claim settled with cash payment.
m. To reflect the results of the above pro forma adjustments on stockholders'
equity.
F-25
<PAGE>
VIDEO CITY, INC.
NOTES TO PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (UNAUDITED) - CONCLUDED
2. PRO FORMA ADJUSTMENTS: STATEMENT OF OPERATIONS
The adjustments to the pro forma condensed statement of operations are as
follows:
a. To reflect the activity of Prism Entertainment Corporation for the three
months of January, November and December 1996..
b. To eliminate consulting fees related to expenses incurred for the fairness
opinion and consultation regarding the merger.
c. To eliminate depreciation and amortization expense to reflect the
writeoff of tangible and intangible assets related to the bankruptcy
proceedings.
d. To eliminate rent expense incurred for the calendar year by Prism
Entertainment Corporation.
e. To eliminate amortization of loan costs related to write-off of
unamortized debenture loan costs as part of bankruptcy proceedings.
f. To eliminate Lee Video City, Inc. professional fees related to the merger.
g. To eliminate professional fees related to the bankruptcy.
h. To eliminate interest expense on long term debt converted to equity.
i. To reflect increase in interest expense due to increase in debt pursuant to
an amended and restated credit loan and security agreement.
3. NON-RECURRING ITEMS:
Prism Entertainment Corporation's cost of sales include approximately
$2,600,000 of amortization for the writedown of the film library due to
revision of the film library ultimates. In addition, there are non-recurring
expenses of approximately $550,000 for residual and royalty payments related
to prior years that were expensed in the current period as part of the
bankruptcy proceedings.
F-26
