<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission file number 0-14023
VIDEO CITY, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 95-3897052
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6840 DISTRICT BOULEVARD, BAKERSFIELD, CALIFORNIA 93313
(Address of principal executive offices) (Zip Code)
(805) 397-7955
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
-------- ------
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15 (d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
-------- ------
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as of the latest practicable date.
Class Outstanding at September 10, 1998
- ----- ---------------------------------
Common Stock 11,775,914
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 31,
1998 JANUARY 31,
(UNAUDITED) 1998
------------------ ------------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 20,768 $ 28,127
Accounts receivable 1,319,573 758,101
Notes receivable 231,177 355,430
Merchandise inventories 956,677 339,759
Other 351,910 411,536
------------------ ------------------
Total current assets 2,880,105 1,892,953
Videocassette rental inventory, net of
accumulated amortization 6,411,578 2,795,258
Property and equipment, net 1,744,051 859,708
Prism film library 0 818,171
Goodwill 1,610,781 0
Deferred tax asset 1,933,699 0
Other assets 1,352,249 233,226
------------------ ------------------
TOTAL ASSETS $15,978,279 $6,599,316
================== ==================
</TABLE>
See accompanying notes to financial statements.
2
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VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JULY 31,
1998 JANUARY 31,
(UNAUDITED) 1998
----------------- -----------------
<S> <C> <C>
LIABILITIES
Current liabilities:
Accounts payable $ 3,588,734 $ 2,166,027
Accrued expenses 569,213 702,293
Current portion of long-term debt 1,395,798 1,674,457
----------------- -----------------
Total current liabilities 5,553,745 4,542,777
Long-term debt 6,445,612 2,043,431
Other liabilities 428,805 711,931
----------------- -----------------
TOTAL LIABILITIES 12,428,162 7,298,139
----------------- -----------------
Series A convertible redeemable preferred
stock; 7,000 shares issued and outstanding
at July 31, 1998 700,000 0
STOCKHOLDERS' EQUITY
Common stock, $.01 par value per share, 30,000,000
shares authorized; 11,775,883 shares issued and
outstanding at July 31, 1998 and 9,773,927 shares
issued and outstanding at January 31, 1998 117,759 97,739
Additional paid-in capital 8,659,737 7,075,735
Accumulated deficit (5,927,379) (7,872,297)
----------------- -----------------
TOTAL STOCKHOLDER'S EQUITY 2,850,117 (698,823)
----------------- -----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $15,978,279 $ 6,599,316
================= =================
</TABLE>
See accompanying notes to financial statements.
3
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VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JULY 31, JULY 31, JULY 31, JULY 31,
1998 1997 1998 1997
-------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
REVENUES
Rental revenues and product sales $ 6,009,738 $2,489,192 $ 9,401,061 $4,709,009
Management Fee Income 13,500 61,500 56,333 123,000
-------------- -------------- --------------- --------------
TOTAL REVENUES 6,023,238 2,550,692 9,457,394 4,832,009
-------------- -------------- --------------- --------------
OPERATING COSTS AND EXPENSES
Store operating expenses 2,715,555 1,074,439 4,430,824 2,156,463
Amortization of videocassette rental
inventory 710,143 347,029 1,163,380 971,928
Cost of product sales 1,070,747 211,898 1,283,696 435,819
Cost of leased product 469,794 65,936 706,885 169,046
General and administrative expenses 771,818 718,166 1,450,559 1,219,010
-------------- -------------- --------------- --------------
TOTAL OPERATING COSTS AND EXPENSES 5,738,057 2,417,468 9,035,344 4,952,266
-------------- -------------- --------------- --------------
INCOME (LOSS) FROM OPERATIONS 285,181 133,224 422,050 (120,257)
Other (Income) Expense:
Interest expense 199,957 126,316 322,101 279,148
Other (15,097) (90,256) (15,097) (160,958)
-------------- -------------- --------------- --------------
Income before taxes 100,321 97,164 115,046 (238,447)
Income tax expense (benefit) (1,829,869) 0 (1,829,869) 0
-------------- -------------- --------------- --------------
NET INCOME (LOSS) $ 1,930,190 $ 97,164 $ 1,944,915 $ (238,447)
============== ============== =============== ==============
Basic Earnings (Loss) Per Share $0.17 $0.01 $0.18 $(0.02)
Diluted Earnings (Loss) Per Share $0.16 $0.01 $0.17 $(0.02)
Weighted average number of common shares
outstanding
Basic 11,605,716 9,753,927 11,053,757 9,753,927
Diluted 12,220,067 9,753,927 11,626,322 9,753,927
</TABLE>
See accompanying notes to financial statements.
4
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VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JULY 31, JULY 31,
1998 1997
------------------- -----------------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 1,944,915 $ (238,447)
Adjustments for non-cash items:
Amortization of film cost 818,171 12,000
Depreciation and amortization 1,875,732 1,145,251
Non-cash interest 0 2,974
Issuance of common stock for services 333,444 -
(Gain) loss on disposal of assets 0 4,004
Decrease (increase) in accounts receivable (561,472) 1,337,398
Decrease (increase) in notes receivable 124,253 109,897
Decrease (increase) in merchandise inventories (616,918) (139,656)
Decrease (increase) in other assets (2,819,824) 18,938
Decrease (increase) in deferred tax assets (1,829,869) 0
Increase (decrease) in accounts payable 1,422,707 (433,372)
Increase (decrease) in accrued expenses (133,080) (206,511)
Increase (decrease) in other liabilities (283,126) (635)
------------------- -----------------
Net cash provided by (used in) operating activities 274,933 1,611,841
------------------- -----------------
Cash flows from investing activities:
Purchases of videocassette rental inventory, net (5,413,099) (966,502)
Purchases of fixed assets (963,296) (30,420)
Proceeds from sale of fixed assets 0 0
------------------- -----------------
Net cash used in investing activities (6,376,395) (996,922)
------------------- -----------------
Cash flows from financing activities:
Principal payments on obligations under
capital leases (18,136) (105,988)
Repayment of long-term debt (3,589,724) (1,569,908)
Proceeds from issuance of long-term debt 7,731,385 0
Proceeds from issuance of common stock 1,270,578 0
Proceeds from issuance of preferred stock 700,000 0
------------------- -----------------
Net cash provided by (used in) financing activities 6,094,103 (1,675,896)
------------------- -----------------
Net increase (decrease) in cash (7,359) (1,060,977)
Cash at beginning of the period 28,127 1,246,517
------------------- -----------------
Cash at end of the period $ 20,768 $ 185,540
=================== =================
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
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 Adventures in Video, Inc., KDDJ Investments, Inc., Leptis
Magna, Inc., Old Republic Entertainment, Inc., and Sulpizio One, Inc. All
material intercompany balances and transactions have been eliminated.
The consolidated balance sheet as of July 31, 1998, the consolidated statement
of operations for the three and six months ended July 31, 1998, and the
consolidated statement of cash flows for the six months ended July 31, 1998 are
unaudited and have been prepared in accordance with generally accepted
accounting principles for interim financial statements and pursuant to the rules
and regulations of the Securities and Exchange Commission. Certain information
and disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been omitted pursuant to such
rules and regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading. 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, 1998.
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, 1998, the results of operations for the
three and six months ended July 31, 1998 and 1997, and cash flows for the six
months ended July 31, 1998 and 1997. 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.
2. RECENT ACCOUNTING PRONOUNCEMENTS
6
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SFAS 132 - EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT
BENEFITS - The Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions
and Other Postretirement Benefits," ("SFAS 132") which revises employers'
disclosures about pension and other postretirement benefit plans. SFAS 132 does
not change the measurement or recognition of those plans. It standardizes the
disclosure requirements for pensions and other postretirement benefits to the
extent practicable, requires additional information on changes in the benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer as useful as
they were when FASB Statements No. 87 "Employers Accounting for Pensions," No.
88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit
Pension Plans and for Terminations Benefits" and No. 106, "Employers' Accounting
for Postretirement Benefits Other Than Pensions," were issued. SFAS 132 suggests
combined formats for presentation of pension and other postretirement benefit
disclosures.
The Company adopted SFAS 132 as of February 1, 1998. SFAS 132 is effective for
the Company for its January 31, 1999 consolidated financial statements with
comparative information for earlier years to be restated. Management has
determined that the implementation of SFAS 132 will not have a material impact
on the Company's financial condition or results of operations.
SFAS 133 - ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES -
Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, (collectively referred to as
derivatives) and for hedging activities. It requires that an entity recognizes
all derivatives as either assets or liabilities in the balance sheet and
measures those instruments at fair value. If certain conditions are met, a
derivative may be specifically designated as (a) a hedge of the exposure to
changes in the fair value of a recognized asset or liability or an unrecognized
firm commitment, (b) a hedge of the exposure to variable cash flows of a
forecasted transaction, or (c) a hedge of the foreign currency exposure of a net
investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency denominated forecasted
transaction. The accounting for changes in fair value of a derivative (that is,
gains and losses) depends on the intended use of the derivative and the
resulting designation.
SFAS 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999. Initial application of SFAS 133 must be as of the beginning of
an entity's fiscal quarter. On that date, hedging relationships must be
designated anew and documented pursuant to the provisions of SFAS 133. SFAS 133
is not to be applied retroactively to financial statements of prior periods.
Management does not believe that there will be material adverse impact on the
financial position or results of operations of the Company upon adoption of SFAS
133.
7
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3. EARNINGS PER SHARE
The Company adopted SFAS 128, "Earnings Per Share," ("SFAS No. 128") for the
fiscal year ended January 31, 1998. SFAS 128 simplifies the standards for
computing and presenting earnings per share as previously prescribed by APB
Opinion No. 15, "Earnings Per Share." SFAS 128 replaces primary EPS with basic
EPS and fully diluted EPS with diluted EPS. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Diluted EPS
reflects the potential dilution that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock or
resulted from issuance of common stock that then share in earnings. SFAS 128
also requires dual presentation of basic and diluted EPS on the face the income
statement and a reconciliation of the numerator and denominator of the basic EPS
computation to the numerator and denominator of the diluted EPS computation.
All prior earnings per share amounts have been restated to reflect the adoption
of SFAS 128. The following table summarizes the calculation of the Company's
basic and diluted earnings per share for the periods presented:
<TABLE>
<CAPTION>
For the three months ended July 31,
--------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------------------
Per-share Per-share
Income Shares amount Income Shares amount
---------- ---------- --------- ------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to common
stockholders $1,930,190 11,605,716 $0.17 $97,164 9,753,927 $0.01
Effect of dilutive securities
stock options -- 614,351 -- --
---------- ---------- ------- ---------
Diluted EPS
Income available to common
stockholders and assumed
conversions $1,930,190 12,220,067 $0.16 $97,164 9,753,927 $0.01
========== ========== ========= ======= ========= ==========
</TABLE>
<TABLE>
<CAPTION>
For the six months ended July 31,
--------------------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------------------
Per-share Per-share
Income Shares Amount Income Shares Amount
---------- ---------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Basic EPS
Income available to common
stockholders $1,944,915 11,053,757 $0.18 $(238,447) 9,753,927 $(0.02)
Effect of dilutive securities
stock options -- 572,566 -- --
---------- ---------- -------- ---------
Diluted EPS
Income available to common
stockholders and assumed
conversions $1,944,915 11,626,322 $0.17 $(238,447) 9,753,927 $(0.02)
========== ========== ========= ========= ========= ==========
</TABLE>
4. DEFERRED TAX ASSETS
Statement of Financial Accounting Standards No. 109 requires a valuation
allowance to be recorded when it is more likely than not that some or all of the
deferred tax assets of a Company will not be realized. At January 31, 1998, a
valuation allowance for the full amount of the net deferred tax asset in the
amount of $2,195,000 was recorded because of pre-fiscal 1998 losses and
uncertainties as to the amount of taxable income that would be generated in
future years. Due in a large part to the Company generating taxable income,
excluding non-recurring items, for five consecutive quarters, management has
determined that it is more likely than not that future taxable income would be
sufficient to enable the Company to realize a substantial portion of its
deferred tax assets. As a result, the Company has reduced the valuation
allowance of the deferred tax assets. As of July 31, 1998, the remaining balance
of the valuation allowance was approximately $323,000.
5. ISSUANCE OF SERIES A CONVERTIBLE REDEEMABLE PREFERRED STOCK
In June 1998, the Company sold an aggregate of 7,000 shares of its Series A
Convertible Redeemable Preferred Stock ("Series A Preferred Stock") and
detachable warrants to purchase an aggregate of 350,000 shares of the Company's
Common Stock at an exercise price of $2.00 per share to eight investors,
including certain directors of the Company and their affiliates, for a total
consideration of $700,000. Each share of Series A Preferred Stock is convertible
into 50 shares of the Company's Common Stock, subject to adjustment. The terms
of the Series A Preferred Stock require the Company to redeem the Series A
Preferred Stock in May 2003. The Series A Preferred Stock has been presented
separately outside of permanent stockholders' equity in the accompanying
financial statements.
6. RECENT EVENTS
8
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In an effort to improve the Company's operating results and improve operating
cash flow, the Company has closed three retail video stores and intends to
relocate several of the video retail stores that were acquired in March 1998.
Although the Company believes it is generally able to operate acquired stores
more profitably than their prior owners through a combination of revenue growth,
volume purchase discounts, higher advertising co-operative credits, and more
efficient inventory and centralized management, certain limitations such as the
video stores' size, location, and competitive position may restrict the Company
from achieving its targeted operating results.
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, particularly under
this Item 2, 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, 1998.
RESULTS OF OPERATIONS
Three and Six Months Ended July 31, 1998 Compared to the Three and Six Months
Ended July 31, 1997
REVENUES
Rental revenue and product sales for the three months and six months ended
July 31, 1998 totaled $6,009,000 and $9,401,000, respectively, as compared to
$2,489,000 and $4,709,000 for the three months and six months ended July 31,
1997, respectively. The increase in revenues was primarily due to the
acquisition of five corporations that owned an aggregate of 29 stores on March
25, 1998. Same store revenues for the three months and six months ended July 31,
1998 increased by approximately 6.3%, and 6.1%, respectively, compared to the
same periods of the previous year. Management fee income for the three months
and six months ended July 31, 1998 totaled $14,000 and $56,000, respectively, as
compared to $62,000 and $123,000 for the three months and six months ended July
31, 1997, respectively. The decrease resulted from the reduction in the number
of managed stores from six stores during the three and six months ended July 31,
1997 to two stores for the corresponding periods of 1998.
STORE OPERATING EXPENSES
Store operating expenses for the three months and six months ended July 31, 1998
totaled $2,716,000 and $4,431,000, respectively, as compared to $1,074,000 and
$2,156,000 for the three months and six months ended July 31, 1997,
respectively. The increase in store operating expenses was primarily due to the
acquisition of the 29 stores on March 25, 1998. Store operating expenses as a
percentage of total revenue were 45.1% and 46.9% for the three months and six
months ended July 31, 1998 compared to 42.1% and 44.6% for the corresponding
periods of 1997. The increase in store expenses as a percentage of total revenue
for the three months ended July 31, 1998 compared to the corresponding period of
1997 was due to the fixed portion of operating expenses for the 29 acquired
stores comprising a higher percentage of its operating costs than the Company's
existing 18 stores. The increase in store expenses as a percentage of total
revenue for the six months ended July 31, 1998 compared to the corresponding
period
9
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of 1997 was primarily due to initial payroll, supply, and maintenance expenses
for the 29 newly acquired stores.
AMORTIZATION OF VIDEOCASSETTE RENTAL INVENTORY
Amortization of videocassette rental inventory increased $363,000, or 105%, and
$191,000, or 20% for the three and six months ended July 31, 1998, respectively,
compared to the corresponding periods of 1997. The increase for both the three
and six months ended July 31, 1998 was primarily due to the incremental rental
inventory amortization from the 29 stores acquired on March 25, 1998.
COST OF PRODUCT SALES
Cost of product sales for the three and six months ended July 31, 1998 increased
$859,000 to $1,071,000 from $212,000 and increased $848,000 to $1,284,000 from
$436,000, respectively, compared to the comparable periods of 1997. Cost of
product sales as a percentage of total revenue were 17.8% and 13.6% for the
three and six months ended July 31, 1998 compared to 8.3% and 9.0% for the
corresponding periods of 1997. The increase in the cost of product sales for
the three and six months ended July 31, 1998 was primarily due to growth in
videocassette "sell through" revenues resulting from the addition of "sell
through" videocassettes as a new product line at the 29 acquired stores.
COST OF LEASED PRODUCT
Cost of leased product for the three and six months ended July 31, 1998
increased $404,000 to $470,000 from $66,000 and increased $538,000 to $707,000
from $169,000, respectively, compared to the corresponding periods of 1997.
Cost of leased product as a percentage of total revenue were 7.8% and 7.5% for
the three and six months ended July 31, 1998 compared to 2.6% and 3.5% for the
same periods of 1997. The increase was due to the purchase of 29 stores by the
Company on March 25, 1998 and the Company leasing additional titles to
periodically provide "guaranteed" rentals in all stores.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased to $772,000 and $1,451,000 for the
three and six months ended July 31, 1998, respectively, from $718,000 and
$1,219,000 for the comparable periods of the prior year. The increase for both
the three and six months ended July 31, 1998 was primarily due to additional
costs incurred to support the 29 stores purchased on March 25, 1998, partially
offset by legal and professional fees related to the Prism Entertainment, Inc.
merger which were incurred in the first fiscal quarter of 1997. General and
administrative expenses as a percentage of revenues were 12.8% and 15.3% for the
three and six months ended July 31, 1998 compared to 28.1% and 25.2 % for the
same periods of 1997. The percentage decrease was mainly the result of spreading
the corporate expenses over significantly higher revenues for the three and six
months ended July 31, 1998.
INTEREST EXPENSE
Interest expense increased to $200,000 and $322,000 for the three and six months
ended July 31, 1998, respectively, compared to $126,000 and $279,000 for the
same periods of the prior year. The increase in interest expense was primarily
due to a higher level of debt incurred under the FINOVA Capital Corporation line
of credit obtained on March 25, 1998, slightly offset by the reduction of long-
term debt in the first quarter of 1998 as a result of the proceeds from the sale
of the Prism Film Library. The Prism film library had been written down to net
realizable value as of January 31, 1998.
INCOME TAXES
Statement of Financial Accounting Standards No. 109 requires a valuation
allowance to be recorded when it is more likely than not that some or all of the
deferred tax assets of a Company will not be realized. At January 31, 1998, a
valuation allowance for the full amount of the net deferred tax asset in the
amount of $2,195,000 was recorded because of pre-fiscal 1998 losses and
uncertainties as to the amount of taxable income that would be generated in
future years. Due in a large part to the Company generating taxable income,
excluding non-recurring items, for five consecutive quarters,
10
<PAGE>
management has determined that it is more likely than not that future taxable
income would be sufficient to enable the Company to realize a substantial
portion of its deferred tax assets. As a result, the Company has reduced the
valuation allowance of the deferred tax assets. As of July 31, 1998, the
remaining balance of the valuation allowance was approximately $323,000.
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its short-term working capital needs, including the
acquisition of videocassettes and other inventory, primarily through cash from
operations and extended vendor terms. The Company expects that cash from
operations and extended vendor terms will be sufficient to fund future
videocassette and other inventory purchases and other working capital needs.
There can be no assurance, however, that cash from operations and extended
vendor terms will be sufficient to fund future videocassette and inventory
purchases and other working capital.
Videocassette rental inventories are accounted for as noncurrent assets under
generally accepted accounting principles because they are not assets that are
reasonably expected to be completely realized in cash or sold in the normal
business cycle. Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital. The
acquisition cost of videocassette rental inventories, however, is reported as a
current liability until paid and, accordingly, included in the computation of
working capital. Consequently, the Company believes working capital is not as
significant a measure of financial condition for companies in the video retail
industry as it is for companies in other industries. Because of the accounting
treatment of videocassette rental inventory as a noncurrent asset, the Company
anticipates that it will operate with a working capital deficit during fiscal
1999.
The Company's primary long-term capital needs are for opening and acquiring new
stores. The Company expects to fund such needs through cash flows from
operations, the net proceeds from the possible sale of debt or equity
securities, credit facilities, trade credit, and equipment leases. On March 25,
1998, the Company and its five newly acquired subsidiaries entered into a
$7,500,000 Loan and Security Agreement with FINOVA Capital Corporation
("FINOVA"), secured by all of the assets of the Company. Of these funds,
$5,700,000 has been or may be used to pay the cash portion of the acquisition
purchase prices, to repay other existing indebtedness of the Company, to repay
certain existing indebtedness of the acquired companies, and to provide
inventory financing and working capital for the expanded retail operation of the
combined companies. The remaining $1,800,000 of the credit facility has been or
may be used only to finance future acquisitions, if any.
As of July 31, 1998, the total outstanding balance under the FINOVA credit
facility was approximately $5,400,000, consisting of outstanding amounts under
term loans of approximately $5,100,000 and outstanding amounts under a revolving
loan of approximately $300,000. There was approximately $194,000 (net of
reserves) in amounts available under the revolving loan as of July 31, 1998. The
Company currently intends to finance future acquisitions with funds from
borrowings, including the credit facility established with FINOVA, through
assumption of liabilities by the Company and net proceeds from possible debt or
equity financing.
CASH FLOWS
Six Months Ended July 31, 1998 Compared to the Six Months Ended July 31, 1997
The decrease in net cash provided by operating activities of $1,337,000 for the
six months ended July 31, 1998 compared to the six months ended July 31, 1997
was primarily due to an increase in accounts receivables, other assets and
merchandise inventories, partially offset by an increase in accounts payable.
Net cash used in investing activities increased by $5,379,000 for the six months
ended July 31, 1998 compared to the six months ended July 31, 1997 primarily due
to the acquisition of 29 stores. Net cash provided by financing activities
increased $7,770,000 for the six months ended July 31, 1998 compared to the six
months ended July 31, 1997 mainly due to the proceeds received from the FINOVA
credit facility, the issuance of common
11
<PAGE>
stock in satisfaction of a portion of the acquisition purchase price on the 29
stores and the issuance of the Series A preferred stock, partially
offset by the repayment of existing debt of the Company.
YEAR 2000
The Company is currently working to resolve the potential impact of the year
2000 on the processing of date-sensitive information by the Company's
computerized information systems. The year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. Any of the Company's computer systems that uses time-sensitive
software programming may recognize a date using "00" as the year 1900 rather
than the year 2000, which could result in miscalculation or system failures.
Management has determined that the costs of addressing potential problems are
not expected to have a material adverse impact on the Company's financial
position, results of operations or cash flows in future periods. However, if
the Company, its customers, or vendors are unable to resolve such processing
issues in a timely manner, it could result in material financial risk.
Accordingly, the Company plans to devote the necessary resources to resolve all
significant year 2000 issues in a timely manner.
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In June 1998, the Company sold an aggregate of 7,000 shares of its Series A
Convertible Redeemable Preferred Stock ("Series A Preferred Stock") and
detachable warrants to purchase an aggregate of 350,000 shares of the Company's
Common Stock at an exercise price of $2.00 per share to eight investors,
including certain directors of the Company and their affiliates, for a total
consideration of $700,000. Each share of Series A Preferred Stock is convertible
into 50 shares of the Company's Common Stock, subject to adjustment. The terms
of the Series A Preferred Stock require the Company to redeem the Series A
Preferred Stock in May 2003.
On June 10, 1998, the Company issued 9,375 shares of its Common Stock to The
Value Group, LLC for professional services rendered to the Company. On June 30,
1998, the Company issued 127,305 shares of its Common Stock to Bonafide
Management Systems for services and equipment rendered to the Company and 57,111
shares of its Common Stock to Rentrak Corporation for satisfaction of accounts
payable.
The Company believes that the issuances of its securities pursuant to the
foregoing transactions were exempt from registration under the Securities Act of
1933, as amended, by virtue of Regulation D promulgated under the Securities Act
or Section 4(2) of the Securities Act as transactions not involving public
offerings.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
The shareholders of the Company approved an amendment (the "Amendment") to the
Company's Certificate of Incorporation to increase the number of authorized
shares of Common Stock to 30,000,000 shares and to authorize 2,000,000 shares of
the Company's preferred stock, which may be issued in one or more series on
terms and conditions that may be established by the Board of Directors of the
Company from time to time. The Amendment was approved and adopted by the
affirmative written consents of the holders of more than a majority of the
outstanding shares of Common Stock of the Company. The Amendment became
effective on May 27, 1998.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
--------
Numbers Description
- ------- -----------
10.1 Employment Agreement, entered into in August 1998, between Video
City, Inc. and Timothy J. Denari.
27 Financial Data Schedule.
____________________
12
<PAGE>
(b) Reports on Form 8-K:
-------------------
On April 9, 1998, the Company filed a Current Report on Form 8-K, dated
March 25, 1998, to report under Item 2 and Item 5 the acquisition of five
companies, the sale of its film library, and the entering into of a new credit
facility and a restructured debt agreement. On June 8, 1998, the Company filed
an amendment to such Current Report to report under Item 7 the financial
statements of the businesses acquired and the pro forma financial statements.
13
<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 thereunto duly authorized.
VIDEO CITY, INC.
Date: September 14, 1998 /s/ Robert Y. Lee
-----------------
Robert Y. Lee
Chief Executive Officer
(Principal Executive Officer)
Date: September 14, 1998 /s/ Timothy J. Denari
---------------------
Timothy J. Denari
Chief Financial Officer
(Principal Financial Officer)
14
<PAGE>
EXHIBIT 10.1
EMPLOYMENT AGREEMENT
THIS EMPLOYMENT AGREEMENT ("Agreement") is made and entered into as of the
1st day of January, 1998, by and between Video City, Inc., a Delaware
corporation (the "Company"), and Tim Denari ("Employee").
1. Term of Employment. The Company hereby employs Employee, and Employee
------------------
hereby agrees to serve the Company, under and subject to all of the terms,
conditions and provisions of this Agreement from the date hereof through
January 7, 2000, in the capacity of Chief Financial Officer or Director of
Finance of the Company, at the Company's option, or to serve in such other
executive capacity with the Company as the Company's board of directors (the
"Board of Directors") may from time to time designate, provided such assignment
is consistent with Employee's level of experience and expertise. In the
performance of his duties and the exercise of his discretion, Employee shall be
under the supervision and control of, and shall report only to, the Chief
Executive Officer of the Company. Employee's duties shall be designated by the
Chairman of the Board and shall be subject to such policies and directions as
may be established or given by the Board of Directors from time to time.
2. Devotion of Time to Company Business. Employee shall devote
------------------------------------
substantially all of his productive time, ability and attention to the business
of the Company during the term of this Agreement. Employee shall not, without
the prior written consent of the Board of Directors, directly or indirectly
render any services of a business, commercial or professional nature to any
other person or organization, whether for compensation or otherwise, which may
compete or conflict with the Company's business or with Employee's duties to the
Company.
3. Compensation.
------------
3.1 Base Salary. For all services rendered by Employee under this
-----------
Agreement, the Company shall pay Employee a base salary ("Base Salary"),
payable semi-monthly, at the rate of $9,791.67 per month.
3.2 Bonus. In addition to the Base Salary, the Company shall pay
-----
Employee an annual bonus ("Bonus") with respect to any pretax profit of the
Company (any such pretax profit to be determined in accordance with the usual
and customary accounting practices of the Company and consistent with generally
accepted accounting principles) as follows (provided, however, that if Employee
has not been employed by the Company for the full period
1
<PAGE>
of a fiscal year, the bonus, if any, shall be prorated in proportion to the
percentage of such fiscal year that Employee has been employed by the Company):
(a) an amount equal to 2.5% of any pretax profit of the Company in
excess of $1,100,000 with respect to the fiscal year commencing in 1997;
(b) an amount equal to 2.5% of any pretax profit of the Company in
excess of $1,200,000 with respect to the fiscal year commencing in 1998; and
(c) an amount equal to 2.5% of any pretax profit of the Company in
excess of $1,300,000 with respect to the fiscal year commencing in 1999.
4. Benefits.
--------
(a) In addition to the Base Salary and the Bonus, if any, Employee
will be entitled to participate in all benefits of employment available to other
members of the Company's management, on a commensurate basis as they may be
offered from time to time by the Board of Directors to the Company's other
management employees. Such benefits include, but are not limited to, full
medical, dental and long term disability insurance for Employee and his wife and
minor children, participation in group life insurance and retirement plans, and
term life insurance of $500,000 payable to Employee's designees. During the
period of his employment hereunder, Employee will be reimbursed for reasonable
business, travel and entertainment expenses incurred in accordance with Company
policy on behalf of the Company in connection with his employment, and will be
required to submit appropriate expense reports for approval by signature of the
Chief Executive Officer as a condition of reimbursement of such expenses.
(b) The Company will pay up to $500 per month (including all
maintenance and operating expenses) for Employee to have the use of one Company-
provided automobile (or an equivalent expense allowance for an automobile owned
by Employee).
(c) Employee shall be entitled to three weeks paid vacation for
any full fiscal year of the term of this Agreement, and a prorated portion of
three weeks vacation for any fiscal year in which Employee is not employed by
the Company for the full fiscal year.
(d) If the Company's principal office is moved from Bakersfield,
California, such that Employee must move his residence in order to continue his
employment as provided herein,
2
<PAGE>
the Company shall pay his reasonable relocation costs, including but not limited
to moving expenses.
5. Authority. So long as Employee serves as Chief Financial Officer of
---------
the Company under this Agreement, he shall have the authority and
responsibilities outlined in Exhibit A hereto and such other duties and
responsibilities as are specified in the Bylaws of the Company, except that he
shall not proceed with any matters, or permit the Company to take any actions,
which are prohibited by, or are in conflict with, resolutions or guidelines
adopted by the Board of Directors.
6. Termination. This Agreement shall terminate in advance of the time
-----------
specified in Section 1 above (and except as provided in Sections 6(c) and 6(e)
below, Employee shall have no right to receive any compensation not due and
payable to him or to his estate at the time of such termination) under any of
the following circumstances:
(a) Upon the death of Employee.
(b) In the event that Employee shall become either physically or
mentally incapacitated so as to not be capable of performing his duties as
required hereunder, and if such incapacity shall continue for a period of three
months consecutively, the Company may, at its option, terminate this Agreement
by written notice to Employee at that time or at any time thereafter while such
incapacity continues. In case of termination under this Section 6(b) or under
Section 6(a), Employee or his estate shall be entitled to receive Base Salary or
any other compensation accrued or earned as of or to the date of any termination
and for six months following such termination or until expiration of this
Agreement, whichever is earlier.
(c) By Employee, if the Company shall have materially breached any
of the provisions of this Agreement, and such termination shall have the same
effect on the payment of Employee's Base Salary and Bonus as a termination by
the Company under Section 6(e).
(d) By the Company for Cause. The term "Cause" used in this
Section 6(e) means Employee (i) after repeated notices and warnings, fails to
perform his reasonably assigned duties as reasonably determined by the Company,
(ii) materially breaches any of the terms or conditions of Sections 1 or 2 of
this Agreement, or (iii) commits or engages in a felony or any intentionally
dishonest or fraudulent act which materially damages the Company or the
Company's reputation. If the Company terminates Employee for Cause, no payments
or benefits under this Agreement shall become payable after the date of
Employee's termination. The Company may terminate Employee's employment
3
<PAGE>
under this Section 6(e)(i) or (ii) only if written notice of the facts
constituting the basis for such termination has been given to Employee and
Employee shall have been afforded 30 days opportunity to take such action as may
be reasonable under the circumstances to furnish assurance to the Board of
Directors that such basis for termination has been corrected or cured (to the
extent susceptible to cure) and will not recur.
(e) By the Company at any time, without Cause; provided, that the
Company shall pay Employee his Base Salary and any Bonus which would otherwise
have become payable under Section 3.2 above through the remaining term of this
Agreement.
7. Loyalty, Non-Competition and Confidentiality.
--------------------------------------------
(a) Non-Competition. Employee agrees and covenants that, except
---------------
for the benefit of the Company (and/or any successor, parent or subsidiary)
during the Non-Competition Period (as defined in Section 7(b)) he will not
engage, directly or indirectly (whether as an officer, director, consultant,
employee, representative, agent, partner, owner, stockholder or otherwise), in
any business engaged in by the Company in the Non-Competition Area (as defined
on Section 7(c)). It is the parties' express intention that if a court of
competent jurisdiction finds or holds the provisions of this Section 7 to be
excessively broad as to time, duration, geographical scope, activity or subject,
this Section 7 shall then be construed by limiting or reducing it so as to
comport with then applicable law.
(b) Non-Competition Period. As used herein, the "Non-Competition
----------------------
Period" means the period beginning on the date hereof and ending on a date which
is two years after the later to occur of (i) January 7, 2002 or (ii) the date on
which Employee's employment with the Company terminates; provided, however, that
-------- -------
if Employee's employment is terminated by the Company without Cause, the Non-
Competition Period shall end on the date of such termination.
(c) Non-Competition Area. As used herein, the term
--------------------
"Non-Competition Area" mean anywhere in any County in which the Company conducts
business during the term of this Agreement and anywhere within a ten-mile radius
of any store operated by the Company.
(d) Other Employees. Employee agrees that during the
---------------
Non-Competition Period he shall not, directly or indirectly, for his own account
or as agent, servant or employee of any business entity, engage, hire or offer
to hire or entice away or in any other manner persuade or attempt to persuade
any officer,
4
<PAGE>
employee or agent of the Company or any subsidiary to discontinue his or her
relationship with the Company or any subsidiary.
(e) Confidentiality. Employee acknowledges that he has learned and
---------------
will learn Confidential Information, as defined in Section 7(f), relating to the
business of the Company. Employee agrees that he will not, except in the normal
and proper course of his duties, disclose or use or enable anyone else to
disclose or use, either during the Non-Competition Period or subsequently
thereto, any such Confidential Information without prior written approval of the
Board of Directors of the Company.
(f) Confidential Information. "Confidential Information" shall
------------------------
include, but not be limited to, the following types of information regarding the
Company: corporate information, including contractual arrangements, plans,
locations, strategies, tactics, potential acquisitions or business combinations
or joint venture possibilities, policies and negotiations; marketing
information, including sales, purchasing and inventory plans, strategies,
tactics, methods, customers, advertising, promotion or market research data;
financial information, including operating results and statistics, cost and
performance data, projections, forecasts, investors, and holdings; and
operational information, including trade secrets, secret formulae, control and
inspection practices, accounting systems and controls, computer programs and
data, personnel lists, resumes, personal data, organizational structure and
performance evaluations. Confidential Information is limited to that
information which is not generally known in the industries in which the Company
or any subsidiary operates, and does not include skills, knowledge and
experience acquired by Employee during his employment with any prior employer.
(g) Corporate Documents. Employee agrees that all documents of any
-------------------
nature pertaining to activities of the Company or to any of the foregoing
matters in his possession now or at any time during the Non-Competition Period,
including, without limitation, memoranda, notebooks, notes, computer records,
disks, electronic information, data sheets, records and blueprints, are and
shall be the property of the Company and that they and all copies of them shall
be surrendered to the Company whenever requested by the Company from time to
time during the Non-Competition Period or thereafter and with or without request
upon termination of Employee's employment with the Company.
(h) Equitable Remedies. In the event of a breach by Employee of
------------------
any of the provisions of this Section 7, the Company, in addition to any other
remedies it may have, shall be entitled to an injunction restraining Employee
from doing or continuing to do any such act in violation of this Section 7.
5
<PAGE>
8. Attorney Fees. The successful party in any litigation relating to
-------------
matters covered by this Agreement shall be entitled to an award of reasonable
attorneys' fees in such action.
9. Assignment. Neither this Agreement nor any of the rights or
----------
obligations of either party hereunder shall be assignable by either Employee or
the Company, except that this Agreement shall be assignable by the Company to
and shall inure to the benefit of and be binding upon (i) any successor of the
Company by way of merger, consolidation or transfer of all or substantially all
of the assets of the Company to an entity other than any parent, subsidiary or
affiliate of the Company and (ii) any parent, subsidiary or affiliate of the
Company to which the Company may transfer its rights hereunder.
10. Binding Effect. The terms, conditions, covenants and agreements set
--------------
forth herein shall inure to the benefit of, and be binding upon, the heirs,
administrators, successors and assigns of each of the parties hereto, and upon
any corporation, entity or person with which the Company may become merged,
consolidated, combined or otherwise affiliated.
11. Amendment. This Agreement may not be altered or modified except by
---------
further written agreement between the parties.
12. Notices. Any notice required or permitted to be given under this
-------
Agreement by one party to the other shall be sufficient if given or confirmed in
writing and delivered personally or mailed by first class mail, registered or
certified, return receipt requested (if mailed from the United States), postage
prepaid, addressed to such party as respectively indicated below or as otherwise
designated by such party in writing.
If to the Company, to:
Video City, Inc.
6840 District Blvd.
Bakersfield, California 93313
Attention: Robert Y. Lee
Fax: (805) 397-5982
If to Employee, to:
Tim Denari
2704 Slender Oak Court
Bakersfield, California 93311
13. California Law. This Agreement is being executed and delivered and is
--------------
intended to be performed and shall be governed by and construed in accordance
with the laws of the State of California.
6
<PAGE>
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of
the date and year first above written.
VIDEO CITY, INC.
By: /s/ Robert Y. Lee
-----------------------------------
Robert Y. Lee
Chief Executive Officer
/s/ Tim Denari
-----------------------------------
Tim Denari
7
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<PAGE>
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<FISCAL-YEAR-END> JAN-31-1999 JAN-31-1999
<PERIOD-START> MAY-01-1998 FEB-01-1998
<PERIOD-END> JUL-31-1998 JUL-31-1998
<CASH> 20,768 20,768
<SECURITIES> 0 0
<RECEIVABLES> 1,550,750 1,550,750
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<TOTAL-ASSETS> 15,978,279 15,978,279
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<INTEREST-EXPENSE> 199,957 322,101
<INCOME-PRETAX> 100,321 115,046
<INCOME-TAX> (1,829,869) (1,829,869)
<INCOME-CONTINUING> 1,930,190 1,944,915
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