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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 31, 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)
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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)
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(805) 397-7955
(Registrant's Telephone Number, Including Area Code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, $0.01 PAR VALUE PER SHARE
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
----- -----
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES X NO
----- -----
The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of April 20, 1998, was approximately $7,783,081.
The number of shares of common stock outstanding on April 20, 1998 was
11,589,039 shares.
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]
DOCUMENTS INCORPORATED BY REFERENCE
The registrant's definitive proxy statement for its Annual Meeting of
Stockholders which is anticipated to be filed within 120 days of January 31,
1998 is incorporated by reference in response to Part III of this Annual Report
on Form 10-K.
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PART I
Safe Harbor Statement under the Private Securities Litigation Reform Act of
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1995.
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This Annual Report contains forward-looking statements within the meaning
of the "safe harbor" provisions of the Private Securities Litigation Reform Act
of 1995, such as statements of the Company's plans, objectives, expectations and
intentions, that involve risks and uncertainties that could cause actual results
to differ materially from those discussed in such forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in the section entitled "Special Considerations" as
well as those discussed elsewhere in this Annual Report.
ITEM 1. BUSINESS
GENERAL
Video City, Inc. ("Video City" or the "Company") owns and operates several
chains of video specialty stores that rent and sell a variety of videocassettes,
game cartridges, video players, game equipment, accessories and concessions.
Throughout fiscal 1998 and as of January 31, 1998, the Company owned and
operated 18 video specialty superstores in California. Due to recent
acquisitions, as of April 20, 1998, the Company owned and operated 47 video
specialty stores in California, Colorado and Minnesota, and managed an
additional two stores owned by others operating under the "Video City" name
pursuant to management agreements. As part of its strategic plan to acquire
additional video stores and participate in the trend toward consolidation of the
fragmented retail video industry, Video City acquired 29 of its 47 video stores
through the acquisition of five companies as wholly-owned subsidiaries in March
1998. As a result of the Company's sale of its library of 47 feature films and
other film properties in March 1998, the Company's sole business is the
ownership and operation of video specialty stores. See "--Recent Developments."
Video City's predecessor, Lee Video City, Inc. ("Lee Video City"), was
formed as a California corporation on February 20, 1990 for the purpose of
developing a chain of video retail superstores primarily in secondary markets.
A video superstore is generally a retail video store that carries more than
7,500 units for rental or sale. Secondary markets are generally metropolitan
areas having a total population of less than 500,000 people.
Lee Video City opened its first two video superstores in Bakersfield,
California in 1990 and opened four additional superstores in Bakersfield by the
end of 1992. In 1993 Lee Video City acquired four existing superstores and
opened another ten. In the first half of 1994, Lee Video City opened an
additional eleven superstores, bringing its total store count to 31. In the
fall of 1994, Lee Video City sold two of its superstores in Idaho, and ended the
year with a total of 29 superstores. Lee Video City owned and operated 29
stores until June 1996 when it sold its eleven stores outside of California.
These eleven stores were sold to reduce debt and restructure Lee Video City's
operations by focusing its attention on the "core stores" in California.
On January 8, 1997, Lee Video City merged with and into Prism Entertainment
Corporation ("Prism"). Prism was a film production and distribution company
operating as a debtor in possession under Chapter 11 of the U.S. Bankruptcy
code. Prism was incorporated as a Delaware corporation on January 27, 1984.
Prism emerged from the bankruptcy upon the consummation of the merger, and the
surviving Delaware corporation changed its name to "Video City, Inc."
The Company's principal executive offices are located at 6840 District
Boulevard, Bakersfield, California 93313, and its telephone number is (805) 397-
7955.
2.
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RECENT DEVELOPMENTS
Acquisitions of Five Companies. On March 25, 1998, Video City acquired five
corporations owning and operating an aggregate of 29 retail video stores. These
acquisitions increased Video City's chain of retail video stores from 18 to 47
stores and (on a pro forma basis had the acquisitions taken place at the
beginning of the respective fiscal periods of the companies) would have
increased Video City's annual level of revenues from approximately $10 million
to approximately $21 million, based on results for the 12 months ended January
31, 1998 (in the case of Video City) or December 31, 1997 (in the case of the
five acquired companies). Each of the acquisitions was structured as a reverse
triangular merger, with a newly formed subsidiary of Video City merging into the
acquired corporation. All of these acquisitions were accounted for using
purchase accounting. The consideration consisted of a combination of Video
City's Common Stock, assumption of indebtedness (some of which was paid off by
Video City at the closings in accordance with the respective merger agreements),
and in one instance cash and in another instance cash and a short-term note.
Each of the five acquisitions was made in accordance with an Agreement of
Merger and Plan of Reorganization (referred to herein as a "Merger Agreement")
by and among Video City, a newly formed subsidiary of Video City, the acquired
corporation, and one or more of its principal shareholders. The following
summarizes the transactions:
Adventures in Video, Inc. and KDDJ Investments, Inc. Adventures in
Video, Inc. ("Adventures in Video") and KDDJ Investments, Inc. ("KDDJ")
were owned by David A. Ballstadt and members of his immediate family.
Adventures in Video owns and operates 13 stores in Minnesota in the greater
Minneapolis metropolitan area. The purchase price for Adventures in Video
was 440,000 shares of Video City Common Stock, plus an additional 426,000
shares that will become issuable if either (a) the gross revenues of such
stores during the three months of April through June 1998 exceed their
gross revenues during the corresponding three months of 1997, or (b) if
Video City fails to make certain specified upgrades of the stores. KDDJ
owns and operates three stores in San Francisco, California. The purchase
price for KDDJ was 110,000 shares of Video City Common Stock plus an
additional 106,500 shares that will become issuable if those three stores
meet targets substantially the same as the contingent share targets
described above for Adventures in Video. The two Merger Agreements provide
for an adjustment in the number of Video City shares if and to the extent
that the aggregate liabilities of the two companies as of the closing is
greater or less than $1,200,000. Pursuant to the Adventures in Video
Merger Agreement, Video City paid off existing indebtedness of
approximately $449,000 that Adventures in Video owed to Marquette Bank,
N.A. Concurrently with these two acquisitions, the Board of Directors of
Video City was expanded from eight to nine members and David A. Ballstadt
was elected to fill this vacancy. Video City also entered into a two-year
employment agreement with Mr. Ballstadt at a salary of $100,000 per year
plus a possible bonus of up to $100,000 per year based on increases, if
any, in certain dealer allowances, and certain additional benefits.
Leptis Magna, Inc. Leptis Magna, Inc. ("Leptis Magna") owns and
operates five stores under the name "Video Unlimited" in Colorado. The
purchase price in the merger consisted of $75,000 in cash, a one-year
promissory note for $75,000 payable in twelve equal monthly installments,
and an amount of Video City Common Stock to be determined within 90 days
after the closing; of this amount of Common Stock, Video City advanced
150,000 shares at the closing, with the actual number of shares to be
determined. Pursuant to the Merger Agreement, Video City paid off existing
indebtedness including $112,000 owed to Norwest Bank Colorado, N.A.
Old Republic Entertainment, Inc. Old Republic Entertainment, Inc.
("Old Republic Entertainment") owns and operates four stores in and around
Ventura, California, under the name
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"Video Tyme." The purchase price consisted of 350,000 shares of Video City
Common Stock, $150,000 in cash, and the assumption of certain debt.
Pursuant to the Merger Agreement, Video City paid off approximately
$741,000 of existing indebtedness owed to three creditors of Old Republic
Entertainment.
Sulpizio One, Inc. Sulpizio One, Inc. ("Sulpizio One") owns and
operates four stores in Lancaster, Santa Barbara, and Los Banos,
California. The purchase price consisted of 100,000 shares of Video City
Common Stock plus the assumption of all liabilities including the amounts
owing to Rentrak Corporation. See "--Recent Developments--Restructured
Agreement With Rentrak." For more than three years prior to this
acquisition, these stores were managed by Video City under a management
agreement and operated under the name "Video City."
Sale of Film Library. Concurrent with the five acquisitions, Video City
sold the rights to its library of 47 feature films and other properties and
related accounts receivable to an entity owned and controlled by Stephen C.
Lehman, a member of Video City's board of directors, for $1,350,000 in cash.
The film library is stated at the net realizable value at January 31, 1998. The
library was the principal asset of Prism, prior to the merger in January 1997 of
Lee Video City and Prism. As a result of the sale of the film library, the
Company is now engaged exclusively in the operation of its retail video sale and
rental stores. Under the agreement by which Video City sold its film rights,
Video City has a right to buy back the film library at any time through February
4, 1999 at escalating prices ranging from $1,650,000 to $1,850,000, less amounts
actually received and collected by the buyer on account of the accounts
receivable or other exploitation of the film library; Video City would not
exercise this right unless it expects to be able to resell the film library at a
profit, since management no longer intends to remain in the film production or
distribution business.
New Credit Facility. Concurrently, 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 Video City,
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 may only be
used to finance future acquisitions.
The credit facility consists of (i) a revolving loan equal to the lesser of
$500,000 or 65% of the value of eligible inventory held for sale; (ii) a five-
year loan in the initial principal amount of $3,465,000, providing for monthly
payments of interest only until maturity, provided that an annual appraisal of
eligible rental video tape and game inventory shall be made and principal must
be paid if and to the extent it exceeds 50% of the orderly liquidation value of
such inventory; (iii) a five-year loan in the initial principal amount of
$1,735,000, providing for 60 equal monthly installments of principal, together
with interest, provided that an annual appraisal of eligible rental video tape
and game inventory shall be made and principal must be paid if and to the extent
it exceeds 25% of the orderly liquidation value of such inventory; and (iv) one
or more loans to be made in the future in amounts not to exceed 75% of the value
of eligible rental video tape and game inventory acquired by the Company in
future retail store acquisitions and approved by FINOVA in its discretion,
provided that the aggregate principal amount of such loans shall not exceed the
lesser of (a) $7,000,000 less the aggregate outstanding principal balance of the
loans referred to in clauses (ii) and (iii) of this paragraph, or (b) 75% of
such rental video tape and game inventory as appraised annually, such loans to
provide for equal monthly payments of principal based on a 15-year amortization
of the original principal amount, plus interest, with the entire principal
balance due in March 2001. The interest rate on all of these loans shall be at
a per annum rate of 2.75% in excess of the prime rate of Citibank, N.A., from
time to time. In addition, the Company is obligated to pay various closing,
monthly and annual fees. As part of the new credit facility, Video City issued
to FINOVA a warrant which gives FINOVA the right either (i) to require
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Video City to repurchase the warrant for $600,000 at any time commencing March
25, 2001 and expiring March 25, 2005, or (ii) to purchase 520,720 shares of
Video City Common Stock at a price of $.01 per share but only if, prior to March
25, 2005, the ownership of the Company's outstanding Common Stock by Robert Y.
Lee, the Company's Chairman of the Board and Chief Executive Officer, decreases
to 10% or less, or the Company makes a public offering of shares of its Common
Stock, or the Company terminates the Loan and Security Agreement with FINOVA, or
the Company recapitalizes, refinances, reorganizes, or sells substantially all
of its assets.
Restructured Agreement With Rentrak. Concurrent with the acquisitions, the
Company also entered into a restructured debt agreement with Rentrak Corporation
("Rentrak"), a major lessor of videocassettes under a revenue sharing
arrangement. Prior to the acquisitions, Video City and Sulpizio One (one of the
acquired companies) were parties to such arrangements with Rentrak. With the
expanded group of stores, management expects to increase its leasing of
videocassettes from Rentrak. As part of the restructuring, Rentrak agreed to
accept 194,950 shares of Video City Common Stock in settlement of a lawsuit
Rentrak had previously filed against Adventures in Video (one of the acquired
companies), and 470,162 shares of Video City Common Stock in satisfaction of
indebtedness owed to Rentrak by Sulpizio One. As part of the restructured debt
agreement, Rentrak also agreed to a deferral of certain amounts owed to it by
Sulpizio One and Video City, and obtained a security interest in the assets of
Video City to secure such amounts. Rentrak also released Robert Y. Lee, the
Company's Chairman of the Board and Chief Executive Officer, from personal
guaranties of Video City's indebtedness that Mr. Lee had previously given.
Other Consequences of Transactions. As a result of the recent transactions
described above, Video City had a total of 11,589,039 shares of its Common Stock
outstanding as of April 20, 1998; this figure does not include any remaining
shares that may be issued in the Leptis Magna acquisition or the 532,500
contingent shares that may be issued in connection with the acquisitions of
Adventures in Video and KDDJ. The Company used the proceeds of the sale of the
film library and approximately $24,000 of additional funds to pay off all
amounts owing to Imperial Bank, which was the principal creditor of Prism prior
to the January 1997 merger. Video City used $1,500,000 of the FINOVA credit
facility to pay off a term loan owing to Ingram Entertainment Corporation and
$885,000 of such credit facility to pay off indebtedness owing to the California
Board of Equalization arising from sales tax liability incurred by Prism before
the January 1997 merger.
INDUSTRY OVERVIEW
Video Retail Industry. According to Paul Kagan Associates, Inc. ("Paul
Kagan"), a video industry analyst, the United States video rental and sales
industry grew from $9.8 billion in revenue in 1990 to approximately $15.6
billion in 1996, and is expected to reach nearly $21.1 billion by 2006. Paul
Kagan estimates that in 1997 consumers rented approximately 3 billion videos and
purchased more than 600 million videos.
The video retail industry is highly fragmented and in recent years has been
characterized by increased consolidation as larger "superstore" (video store
that carries more than 7,500 units for rental or sale) chains have continued to
increase market share by opening new stores and acquiring smaller, local
operators. According to the Video Software Dealers Association, a video
retailing industry association, the number of video specialty stores has
decreased from 31,500 in 1990 to 27,000 in 1996. The Company believes
approximately 7,200 of the remaining stores were superstores, including
approximately 3,700 stores owned by the Blockbuster Entertainment division of
Viacom, Inc. ("Blockbuster"). The Company believes this consolidation will
continue as the video retail industry evolves from "mom-and-pop" stores to
regional and national superstore chains, fueled by the competitive impact of
superstores on smaller retailers, the need for enhanced access to working
capital and efficiencies of scale offered by such superstore chains.
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Movie Studio Dependence on Video Retailing. According to Paul Kagan, the
video retail industry is the single largest source of domestic revenue to movie
studios and represented approximately $4.5 billion, or 45%, of the $9.9 billion
of estimated domestic studio revenue in 1996. Of the many movies produced and
released by the major studios each year in the United States, relatively few are
profitable for the movie studios based on box office receipts alone. The
Company believes the consumer is more likely to view "non-hit" movies on rented
videocassette than in any other medium because video retail stores provide an
inviting opportunity to browse and make an impulse choice among a very broad
selection of new releases. As a result, video retail stores, including those
operated by the Company, purchase movies on videocassette regardless of whether
the movies were successful at the box office, thus providing the major movie
studios a reliable source of revenue for almost all of the hundreds of movies
produced each year. Consequently, the Company believes movie studios are highly
motivated to protect this unique and significant source of revenue.
Rentals versus Sales. Although the video retail industry includes both
rentals and sales, the consumer market for prerecorded videocassettes has been
primarily comprised of rentals. By setting the wholesale prices, movie studios
influence the relative levels of videocassette rentals versus sales.
Videocassettes released at a relatively high price, typically $60 to $70, are
purchased by video specialty stores and are promoted primarily as rental titles.
Videocassettes released at a relatively low price, typically $5 to $24 ("sell-
through titles"), are purchased by video specialty stores and are generally
promoted as both rental and sale titles. In general, movie studios attempt to
maximize total revenue from videocassette releases by combining the release of
most titles at a high price point to encourage purchase for the rental market,
with the release of a relatively few major hits or animated children's classics
at sell-through pricing to encourage purchase directly by the consumer at
retail. Video specialty stores will purchase sell-through titles for both the
rental market and for retail sale. Titles released at a high price are re-
released at a lower price six months to one year after the initial release to
promote sales directly to consumers.
BUSINESS STRATEGY
Superstore Format. The Company focuses on acquiring, building and
operating video retail superstores. The Company believes a superstore
(generally defined as a retail video store that carries more than 7,500 units
for rental or sale) is the most commercially viable format for video stores at
most locations. The broader selection of titles and greater availability of
popular new releases of a superstore generate enough customer traffic to make it
economically viable to lease optimal locations that may demand higher lease
rates. Because many store operating expenses, including labor costs, are
substantially fixed regardless of the size of a store, operating expenses are
proportionately lower in the larger superstore format as compared to a smaller
store.
Selection, Availability and Customer Service. The Company's goal is to
offer a more complete selection and greater availability of popular new releases
in an effort to be the customers' preferred store. The Company believes that
certain of the Company's promotional strategies such as the periodic
guaranteeing of the availability of a popular new release at its stores have
been successful in attracting and retaining its customers. The Company permits
its customers to return a videocassette to any of its other store locations and
hence provides a convenience not available in other video store chains. In
addition, the Company's goal is to place great emphasis on offering its
customers excellent service to encourage repeat visits. The Company uses
demographic and historical rental data to determine the selection and quantity
of videos that will best meet the demands of customers in particular regions or
neighborhoods.
Centralized Real-Time Management. All of the stores' point-of-sale system
is directly connected to the Company's centralized management information system
through the Internet to provide real-time communication and feedback from them
to the Company's headquarters in Bakersfield, California. Such system allows
real-time monitoring of sales and inventory, and allows the Company to actively
manage its new
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videocassette purchases and monitor customer demand. The Company periodically
redistributes its inventory of videocassettes among its stores to fulfill
customer demand without making excessive purchases of popular titles.
Presence in Secondary Markets. In the secondary markets in which the
Company operates, many of the Company's competitors generally consist of single
stores having a narrower selection of titles, smaller advertising budgets and
generally offering fewer copies of new releases than the Company's superstores.
The Company's goal is to establish its superstores as the dominant retailer in
these secondary markets.
Store Location and Marketing. Most of the Company's superstores are
located in high traffic areas providing high visibility and easy access for its
customers. The Company advertises through local television, radio, newspaper
and direct mail, and promotes its products through various special programs.
GROWTH STRATEGY
Development Program. In many regions, the Company believes there are
significant opportunities to grow through internal development and the opening
of new stores. Such internal growth will be the means of expansion in
attractive market areas where there are no strong acquisition candidates and
where good locations are still available. Before the recent acquisitions
completed in March 1998, the opening of new stores has fueled most of the
Company's growth. The Company has selected suitable locations, negotiated
reasonable leases with the property owners, retained contractors to remodel the
interior of the stores into the Company's superstore format, hired and trained
store employees, advertised the stores within their trade area, and opened the
stores for business.
Acquisitions. The Company believes the highly fragmented nature of its
industry presents the opportunity to acquire strategically located chains that
are market share leaders in their trade areas. As part of the Company's
acquisition strategy the Company acquired 29 video stores through the
acquisition of five companies in March 1998. Of the 29 video stores acquired,
13 stores are located in the greater Minneapolis metropolitan area, five stores
are located in the greater Denver metropolitan area, four stores are located in
Ventura County, California, three stores are located in San Francisco,
California, and four stores are located in Lancaster, Santa Barbara, and Los
Banos, California. See "--Recent Developments" and "--Store Operations and
Locations." The Company believes that acquiring such clusters of stores can be
the most cost-effective means of entering an area, particularly where the
acquired chain already occupies desirable locations. The purchase of an
existing chain enables the Company to immediately utilize the assets of the
acquired chain and thus to have an immediate revenue stream. Also, existing
chains have an established customer base that tends to reduce the Company's
advertising expenses. Through a combination of volume purchase discounts,
larger advertising credits, more efficient inventory management and centralized
management, the Company believes it is generally able to operate these acquired
stores more profitably than their prior owners, who were typically single store
or small chain operators. The Company anticipates opening additional stores as
necessary to fill in the market areas of the acquired video chains so that
operating efficiencies can be maximized.
Future store acquisitions, if any, will be pursued as attractive
opportunities become available. Such acquisitions will be based upon location,
quality of operations and financial criteria as determined by the Company to be
consistent with its growth strategy. In future acquisitions, the Company
anticipates that some of the owners and key personnel will be employed by the
Company.
Geographic Concentration. The Company's strategy is to concentrate its
expansion, whether through new store development or acquisitions, in a
particular geographic area to maximize operating efficiencies. The Company
believes that geographic concentration allows the Company to achieve operating
efficiencies
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in inventory management, marketing and advertising, distribution, training and
store supervision. Although the Company is not currently targeting any
particular geographic area for expansion, the Company's strategy is to move into
a new geographic area if there exists an opportunity to realize certain levels
of revenues and cash flow from that particular market.
New Products. In recent years, the Company began renting video game
cartridges and discs, and selling videocassettes, thus generating additional
revenue. The Company anticipates that there will be future new products and
technological innovations, such as digital video discs, that will result in new
product lines, creating new revenue sources for the Company.
The Company's growth is dependent on a number of factors, including its
ability to hire, train and assimilate management and store-level employees, the
adequacy of the Company's financial resources, the Company's ability to
successfully compete in the new markets, to locate suitable store sites, to
negotiate acceptable lease terms, to adapt its purchasing, management
information and other systems to accommodate expanded operations and to
assimilate the new operations into the existing operations of the Company.
There is no assurance that the Company will be able to achieve continued
growth or that the Company will be profitable as a result of such growth.
Continued growth will place increasing pressure on the Company's management. A
failure to manage successfully its planned growth would adversely affect the
Company's business. There is also no assurance that the Company's newly
developed or acquired stores will achieve sales and profitability comparable to
the Company's existing stores. See "--Special Considerations--Growth Strategy."
PRODUCTS
Videocassette Rental. The Company's primary revenue source is from the
rental of videocassettes. Each of the Company's stores currently offers from
6,000 to 14,000 videocassettes consisting of from 4,000 to 8,000 different
titles. New release videocassettes (videos within one year from release date)
are displayed in the prominent "New Release" section and are organized
alphabetically by title. Other videocassettes are displayed alphabetically by
title within categories such as "Action," "Comedy" and "Drama." The Company
seeks to be known within its markets as the chain with the most new releases.
Promotional strategies that the Company believes have been highly successful
include (i) the limited time guarantee of the availability of a popular new
release, (ii) allowing customers to reserve certain video titles up to one week
in advance, and (iii) allowing customers to rent and return videocassettes at
any of the Company's stores.
Videocassette Sales. The Company offers new and previously viewed
videocassettes for sale. Previously viewed videocassettes are pulled from the
shelves several weeks after the release date depending on customer demand and
are sold to customers at a discount price.
Video Games. Each of the Company's stores offers from 300 to 1,000 video
game cartridges, consisting of 250 to 500 different titles. Revenues generated
from game cartridges were on a continuous upward trend from 1992 to 1995. A
decline in video game rentals began in 1995 and continued through 1996 due to
consumer confusion on the direction of new hardware and formats. Video game
rentals improved in 1997 based on consolidation of formats by the major
suppliers. The Company anticipates growth of its video game business and
broadening its selection of game cartridges to include successful new formats as
they become available and grow in popularity.
Other Products. In addition to videocassette rentals and sales and video
game rentals, the Company's stores also rent videocassette players, video game
players, digital video discs, laser discs and audio books in selected stores and
sell a variety of video accessories and confectionery items.
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STORE OPERATIONS AND LOCATIONS
The Company's stores range in size from 2,500 square feet to 15,000 square
feet and offer between 6,000 to 14,000 videocassettes consisting of from 4,000
to 8,000 different titles. The Company's superstores feature television
monitors showing movie previews and promotions of coming attractions and
displays posters and stand-up displays promoting movie titles. The Company's
stores are open 365 days a year from 10:00 a.m. to 11:00 p.m.
The Company's management has substantial experience in the video retail
industry, including specific expertise in the various geographical areas in
which the Company operates its stores. The Company's management actively
monitors the inventory, pricing and rental period of movie titles through its
real-time management information system. The new release inventory is actively
managed, including the redistribution of certain copies to other stores to meet
greater demand. The Company does not consider backlog meaningful to its
business.
The following table provides the number of stores in each of the
metropolitan areas in which the Company owned and operated retail video stores
as of January 31, 1998, and the number of stores in each of the metropolitan
areas and the operating names for the additional stores acquired on March 25,
1998:
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Metropolitan Area Number of Stores Operating Name
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Stores owned and operated as of January 31, 1998:
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Bakersfield, California 12 Video City
Fresno, California 3 Video City
Lancaster/Palmdale, California 1 Video City
Santa Barbara, California 1 Video City
Santa Maria, California 1 Video City
--
18
Additional stores acquired on March 25, 1998:
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Lancaster/Palmdale, California 2 Video City
Salinas, California 1 Video City
Los Banos, California 1 Video City
Minneapolis/St. Paul, Minnesota 13 Adventures in
Video
San Francisco, California 3 Movie Magic
Denver, Colorado 5 Video Unlimited
Ventura, California 4 Video Tyme
--
29
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Total 47
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The two stores operated by the Company under management agreements are
located in Clovis and Bakersfield, California.
SUPPLIERS
The Company has supply agreements with its two major suppliers, Ingram
Entertainment ("Ingram") and Rentrak Corporation. The agreement with Ingram
requires the Company to purchase, under certain conditions, approximately 80% of
its yearly requirements for the video rental, video sell-through, and video game
products. As a result of the Company's rapid expansion in 1993 and 1994, the
Company's purchases from Ingram caused the Company's accounts payable to Ingram
to reach nearly seven million dollars by August 1994. In February 1995, $7.1
million of accounts payable to Ingram were converted to a Senior Secured Note
due December 31, 2000, pursuant to an agreement with Ingram which contained
numerous restrictive covenants which, among other things, limited the Company's
ability to finance the opening of additional stores. In June 1996, in
connection with the sale by the Company of 11 stores, the Company reduced its
debt to Ingram by $3.1 million. Upon effectiveness of the merger with Prism,
Ingram converted $3.0 million of debt to Common Stock of the Company, and the
Company entered into a new loan agreement with Ingram containing substantially
less restrictive covenants for the remaining debt of approximately $1.5 million.
This remaining debt was repaid on March 25, 1998.
Pursuant to a revenue sharing agreement with Rentrak, the Company is
obligated to pay Rentrak revenue sharing and handling fee payments that are
equal to on an annual basis at least 10% of total gross rental revenues. See
"--Recent Developments--Restructured Agreement with Rentrak." The Ingram supply
agreement expires on June 30, 2001 unless terminated earlier by Ingram, and the
Rentrak revenue sharing agreement expires on May 31, 2016.
If the relationships with Ingram and Rentrak were terminated, the Company
believes that it could readily obtain its necessary inventory of videocassette
and video games from a number of other suppliers at prices and on terms
comparable to those available from Ingram or Rentrak. However, there can be no
assurance that any replacement supplier would provide service or payment terms
as favorable as those provided by Ingram or Rentrak.
INVENTORY MANAGEMENT AND MANAGEMENT INFORMATION SYSTEMS
Inventory Management. The Company maintains an extensive inventory control
system to assist management in decisions involving purchase, distribution and
disposition of videocassettes and game cartridges. Each videocassette and game
cartridge is placed in a clear protective case which is affixed with a magnetic
security device and an optical bar code. The Company conducts physical
inventories on a quarterly basis. The inventory of videocassettes is
redistributed among the various store locations based on demand at certain
locations.
Management Information Systems. It is critically important in video
retailing to have accurate and timely information relating to videocassette
rentals and sales, individual title performance, customer demographics,
shrinkage, overdue rentals and various other financial and operational data.
Video City began development of a sophisticated management information system in
early 1992 and fully implemented its system in all superstores by mid-1994.
Each superstore uses a point-of-sale system ("POS") where all rental and sales
transactions are recorded using scanned bar code information. The management
information system electronically communicates real-time data from the POS
system of all of the Company's stores and makes the daily sales, inventory and
other data immediately available to the Company's management. The Company then
uses the data to manage inventory and monitor customer demand and rental trends
to maximize each store's profitability. The data also provides individual
customer and demographic information which is used
10.
<PAGE>
for direct marketing to these customers, and is also used for audit and loss
prevention purposes. This POS system is a sophisticated and complete system
that can be quickly implemented in new stores due to standard file layouts and
thorough documented procedures for training and staff utilization. The Company
has completed the implementation of the POS system at each of the 29 stores it
acquired in March 1998 and believes that the Company's POS system can be
implemented to support 200 or more locations.
Each of the Company's stores' POS system is linked via the Internet to a
central office computer enabling all product and customer data to be shared
real-time. This sharing allows product to be rented from one store and returned
to another while tracking the product through the system. The Company believes
it is the only major chain of superstores that actively uses the real-time
sharing so customers can rent and return at any location, and has successfully
promoted it to gain market share. The "linked" capability also allows stores to
locate rental and sale items which may not be available at one location but are
available at another location.
The Company has and will continue to make certain investments in its
software systems and applications to address any problems the Company may
encounter as a result of the year 2000 on the processing of date-sensitive
information. The financial impact to the Company of addressing such problems
has not been and is not anticipated to be material to its financial position or
results of operations.
MARKETING AND ADVERTISING
The Company advertises through television, radio, newspaper and direct
mail. Suppliers and movie studios provide advertising credits and market
development funds for certain movie titles that the Company uses to purchase the
television, radio, and newspaper advertising. Although there can be no
assurance, the Company believes that its suppliers and the movie studios will
continue to provide funds for the Company's advertising expenditures through
advertising credits and market development funds. In addition, the Company
benefits from the advertising and marketing by studios and theaters in
connection with their efforts to promote specific videos and films. The
Company's advertising emphasizes signature attributes such as movie
reservations, rent and return at any location, membership good at all locations,
and guaranteed availability of certain key new releases. The Company believes
that these promotional marketing strategies have helped increase market share
and customer loyalty.
COMPETITION
The video retail industry is highly competitive. The Company competes with
other local, regional and national chains, such as Blockbuster and Hollywood
Entertainment Corporation, and with supermarkets, pharmacies, convenience
stores, bookstores, mass merchants, mail order companies and other retailers.
Some of the Company's competitors have significantly greater financial and
marketing resources and name recognition, although the Company is generally the
largest or second largest video retailer in most of its geographic markets.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of popular titles available, customer service, and, to a lesser extent,
pricing. Approximately fifty percent of the Company's stores compete directly
with stores operated by Blockbuster, many in very close proximity. As a result
of direct competition with Blockbuster and others, rental pricing of
videocassettes and greater availability of popular releases may become a more
significant competitive factor in the Company's business, which could have an
adverse impact on the results of operations of the Company. The Company
believes it generally offers more titles and more copies of popular titles than
many of its competitors.
11.
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The Company also competes with cable television, satellite and pay-per-
view, in which subscribers pay a fee to see a movie selected by the subscriber.
Existing pay-per-view services offer a limited number of channels and movies and
are only available to households with a direct broadcast satellite or a cable
converter to unscramble incoming signals. Recent technological developments
could permit cable companies, direct broadcast satellite companies, telephone
companies, and other telecommunications companies to transmit a much greater
number of movies to homes at more frequently scheduled intervals throughout the
day. Ultimately, these technologies could lead to the availability of movies to
consumers on demand. Certain cable and other telecommunications companies have
tested "video on demand" service in some markets. Video on demand service would
allow a viewer to pause, rewind and fast forward movies. Based upon publicly
available information, the Company believes these tests have been unsuccessful.
The Company also believes movie studios have a strong interest in maintaining a
viable movie rental business because the sale of videocassettes to video retail
stores represents the studio's largest source of revenue. As a result, the
Company believes movie studios will continue to make movie titles available to
cable television and other distribution channels only after the revenue has been
derived from the sale of videocassettes to video stores. Substantial
technological developments will be necessary in order for pay-per-view to match
the low price, viewing convenience and selection available through video rental.
SEASONALITY
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
SERVICE MARKS
The Company owns a United States federal registration for its service mark
"Video City." The Company considers its service mark to be important to its
continued success.
EMPLOYEES
As of January 31, 1998 the Company had approximately 216 employees of whom
approximately 194 were located at the retail stores and the remainder were at
the Company's corporate administrative office. Due to recent acquisitions, as
of April 20, 1998, the Company had approximately 466 employees of whom
approximately 439 were located at the retail stores and the remainder were at
the Company's corporate administrative office. The Company is not currently a
party to any collective bargaining agreements. The Company believes that its
relationships with its employees are generally good.
12.
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SPECIAL CONSIDERATIONS
In addition to the other information set forth in this Annual Report,
persons who may own or intend to own securities of the Company should carefully
consider the following special considerations:
GROWTH STRATEGY
The Company's long-term strategy is to grow primarily through acquisitions
of existing stores and secondarily through new store openings. The successful
acquisition of existing stores and opening of new stores depends on numerous
conditions, some of which are described below, and requires significant amounts
of capital and other resources. In the past, the Company's growth strategy has
been funded through proceeds from bank debt, seller financing, cash from
operations and use of the Company's common stock as acquisition consideration.
The Company currently intends to finance future acquisitions and new store
openings with funds from borrowings, including the credit facility recently
established with FINOVA, through assumption of liabilities by the Company and
net proceeds from the sale of debt or equity financing. There can be no
assurance that these and other sources of capital will be available to the
Company in the future in order for the Company to pursue its growth strategy.
The Company's growth is dependent on a number of factors, including its
ability to hire, train and assimilate management and store-level employees, the
adequacy of the Company's financial resources, the Company's ability to
successfully compete in the new markets, to locate suitable store sites, to
negotiate acceptable lease terms, to adapt its purchasing, management
information and other systems to accommodate expanded operations and to
assimilate the new operations into the existing operations of the Company.
There can be no assurance that the Company will be able to achieve
continued growth or that the Company will be profitable as a result of such
growth. Continued growth will place increasing pressure on the Company's
management. The failure to manage successfully its planned growth would
adversely affect the Company's business. There can be no assurance that the
Company's newly developed or acquired stores will achieve sales and
profitability comparable to the Company's existing stores.
ACQUISITIONS
The Company's ability to grow through acquisitions and operate the acquired
stores at the desired levels of sales and profitability depends on many factors,
including the Company's ability to identify new markets in which to successfully
compete, the availability of suitable acquisition candidates at prices that the
Company considers reasonable, the Company's ability to integrate the acquired
stores into the Company's existing operations and the Company's ability to
manage the expansion into the new markets. Certain of the Company's larger,
better-capitalized competitors may seek to acquire some of the same video
specialty stores that the Company seeks to acquire. Such competition for
acquisitions would be likely to increase acquisition prices and related costs
and result in fewer acquisition opportunities, which could have a material
adverse effect on the Company's growth. Moreover, there can be no assurance
that the Company will be able to fully integrate the acquired stores' systems
into the Company's existing systems and procedures, or that once integrated, the
Company's acquired stores will achieve levels of revenues or profitability
comparable to those achieved by the Company's existing operations, or otherwise
perform as expected. The inability of the Company's acquired stores to achieve
the level of revenues and cash flow desired by the Company will have a material
adverse effect on the Company's financial condition and results of operations.
NEW STORE OPENINGS
The Company's growth through new store openings depends on the Company's
ability to identify
13.
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suitable store sites, its ability to compete effectively against competitors for
such sites, its ability to negotiate satisfactory leases and implement cost-
effective development plans for such new stores and its ability to hire, train
and assimilate new store managers and other personnel. There can be no
assurance that the Company can successfully pursue its growth strategy through
new store openings or that any of the Company's future new stores will achieve
levels of revenues or profitability comparable to those achieved by the
Company's existing stores.
ABILITY TO MANAGE GROWTH
The Company is currently experiencing a period of rapid growth and
expansion. The Company acquired 29 of its 47 video stores in March 1998 and may
consummate additional acquisitions in the future. Such growth and expansion has
placed and will continue to place a significant strain on the Company's
management, services and support operations, administrative personnel and other
resources. The Company's ability to manage such growth effectively will require
the Company to continue to improve its operational, management and financial
systems and controls and to hire, train, motivate and manage its employees. In
addition, the Company may be unable to retain or hire the necessary personnel or
acquire other resources necessary to service such growth adequately. There can
be no assurance that the Company will be able to effectively manage this rapid
growth and expansion. The inability of the Company to effectively manage its
growth and expansion may have a material adverse effect on the Company's
business and results of operations.
COMPETITION AND TECHNOLOGICAL OBSOLESCENCE
The video retail industry is highly competitive. The Company competes with
other local, regional and national chains, such as Blockbuster and Hollywood
Entertainment Corporation, and with supermarkets, pharmacies, convenience
stores, bookstores, mass merchants, mail order companies and other retailers.
Some of the Company's competitors have significantly greater financial and
marketing resources and name recognition, although the Company is generally the
largest or second largest video retailer in most of its geographic markets.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of popular titles available, customer service, and, to a lesser extent,
pricing. Approximately fifty percent of the Company's stores compete directly
with stores operated by Blockbuster, many in very close proximity. As a result
of direct competition with Blockbuster and others, rental pricing of
videocassettes and greater availability of popular releases may become a more
significant competitive factor in the Company's business, which could have an
adverse impact on the results of operations of the Company. Although the
Company believes it generally offers more titles and more copies of popular
titles than many of its competitors, the Company's inability to compete
successfully will have a material adverse effect on its financial condition and
results of operations.
The Company also competes with cable television, satellite and pay-per-
view, in which subscribers pay a fee to see a movie selected by the subscriber.
Existing pay-per-view services offer a limited number of channels and movies and
are only available to households with a direct broadcast satellite or a cable
converter to unscramble incoming signals. Recent technological developments
could permit cable companies, direct broadcast satellite companies, telephone
companies, and other telecommunications companies to transmit a much greater
number of movies to homes at more frequently scheduled intervals throughout the
day. Ultimately, these technologies could lead to the availability of movies to
consumers on demand. Certain cable and other telecommunications companies have
tested "video on demand" service in some markets. Video on demand service would
allow a viewer to pause, rewind and fast forward movies. Based upon publicly
available information, the Company believes these tests have been unsuccessful.
However, technological advances or changes in the manner in which movies are
marketed, including in particular the earlier release
14.
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of movie titles to pay-per-view, including direct broadcast satellite, cable
television or other distribution channels, could make these technologies more
attractive and economical, which could have a material adverse effect on the
business of the Company. See "--Competition."
FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced in the past, and may continue to experience in
the future, fluctuations in its operating results. Future operating results may
be affected by many factors, including the performance of new or acquired
stores, the quality and number of new release titles available for rental and
sale and the expense associated with the acquisition of new release titles, one-
time charges associated with acquisitions or other events, changes in comparable
store revenue, additional and existing competition, marketing and advertising
programs, weather, special or unusual events, seasonality and other factors that
may affect retailers in general. See "--Seasonality." No assurance can be
given that the Company will have positive earnings in any quarter, or that
earnings in any particular quarter will not fall short of either a prior fiscal
quarter or investors' expectations.
RELIANCE ON CERTAIN SUPPLIERS
The Company either purchases or leases approximately 80% of its supply of
new release videos, in the aggregate, from two suppliers, Ingram and Rentrak.
If the relationships with Ingram and Rentrak were terminated, the Company
believes that it could readily obtain its necessary inventory of videocassette
and video games from a number of other suppliers at prices and on terms
comparable to those available from Ingram or Rentrak. However, there can be no
assurance that any replacement supplier would provide service or payment terms
as favorable as those provided by Ingram or Rentrak. Failure to obtain
comparable service, support or payment terms from an alternative supplier could
have a material adverse effect on the Company's financial condition and results
of operations.
DEPENDENCE ON KEY PERSONNEL
The Company's business and operations are dependent on the continued
efforts of Robert Y. Lee, its Chairman of the Board and Chief Executive Officer,
and its other executive officers. If any of these individuals become unwilling
or unable to continue their employment or association with the Company, or if
the Company is unable to attract and retain other skilled employees when needed,
the Company's business could be materially, adversely affected. The Company
maintains a $5 million key person life insurance policy on Robert Y. Lee.
LACK OF ESTABLISHED PUBLIC TRADING MARKET
Since February 1998, the Company's Common Stock has traded on a limited
basis on the NASD Electronic Bulletin Board and there can be no assurance
regarding the future development of a public trading market for the Company's
Common Stock. Lack of an established trading market for the Company's Common
Stock may have an adverse effect on its prevailing price.
STOCK PRICE VOLATILITY
In recent years, the stock market has experienced significant price and
volume fluctuations. These fluctuations, which are often unrelated to the
operating performances of specific companies, have had a substantial effect on
the market price of stocks, particularly for many small capitalization
companies. Accordingly, the factors described in this Special Considerations
section or market conditions in general may cause the market price of the
Company's Common Stock to fluctuate, perhaps substantially.
15.
<PAGE>
ITEM 2. PROPERTIES
All of the Company's stores are leased pursuant to leases with initial
terms ranging from three to ten years, with varying option renewal periods.
Most of the leases are "triple net" requiring the Company to pay all taxes,
insurance, and common area maintenance expenses associated with the properties.
See "Business -- Store Operations and Locations."
The Company leases its corporate headquarters located in Bakersfield,
California pursuant to a lease with an initial term expiring January 2000. This
facility consists of approximately 16,000 square feet of office space. The
Company considers its corporate offices and stores to be generally suitable and
adequate for their intended purposes.
ITEM 3. LEGAL PROCEEDINGS
There are no material legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company submitted no matters to a vote of stockholders during the
fourth quarter of the fiscal year ended January 31, 1998.
16.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Lee Video City was privately held until its merger with and into Prism on
January 8, 1997. Prism's common stock did not have an established public
trading market at the time of the merger. Commencing in February 1998, the
Company's Common Stock has traded on a limited basis on the NASD Electronic
Bulletin Board under the symbol "VDCT." See "Business--General."
As of April 20, 1998, there were approximately 490 record holders of the
Company's Common Stock.
The Company has not paid cash dividends on its Common Stock since its
inception and has no current plans to pay dividends on its Common Stock in the
foreseeable future. The Company intends to reinvest future earnings, if any, in
the development and expansion of its business. The Company's current credit
facility prohibits the payment of dividends. Any future determination to pay
dividends will depend upon the Company's combined results of operations,
financial condition and capital requirements and such other factors deemed
relevant by the Company's Board of Directors.
17.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended
January 31, 1998 and December 31, 1996, 1995, 1994, and 1993 have been derived
from the financial statements. The information set forth below should be read
in conjunction with the "Management's Discussion and Analysis of Financial
Condition and Results of Operation" and the Company's financial statements and
notes thereto.
<TABLE>
<CAPTION>
One month
Year ended ended
January 31, January 31, Year ended December 31,
1998 1997 1996 1995 1994 1993
------------ ------------ ------- ------- ------- -----------
(Unaudited)
(In thousands, except per share and operating data)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues............................... 10,212 940 11,441 14,151 13,164 6,662
Operating income (loss)................ (2,423) (105) (418) 285 (379) (1,126)
Net income (loss)...................... (2,976) (133) (43) (586) (1,310) (1,450)
Net income (loss) per share............ (0.30) (0.03) (0.01) (0.14) (0.32) (0.36)
Weighted average shares used
in computation........................ 9,771 4,569 4,234 4,127 4,080 4,080
OPERATING DATA:
Number of stores at end of period...... 18 18 29 29 20
Increase (decrease) in same store
revenues(1)........................... 4.4% (1.2)% (1.9)% 5.2% 5.4%
<CAPTION>
Month
Year ended ended Year ended December 31
January 31, January 31, -----------------------------------------
1998 1997 1996 1995 1994 1993
------------ ------------ ------- ------- ------- -----------
(Unaudited)
(In thousands, except per share and operating data)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.............. 28 1,247 59 418 93 457
Videocassette rental inventory......... 2,795 2,127 2,189 3,354 3,523 2,444
Total assets........................... 6,599 11,080 4,010 7,335 7,705 4,725
Long-term debt, less current portion... 2,043 3,341 5,804 7,954 9,028 5,827
Total liabilities...................... 7,298 8,844 8,167 11,449 11,458 7,168
Stockholders' equity (deficit)......... (699) 2,236 (4,157) (4,114) (3,753) (2,443)
</TABLE>
_____________
(1) The increase (decrease) in same store revenues compares revenues from
stores opened and owned by the Company for twelve full months.
(Including relocations)
18.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION
The following discussion should be read in conjunction with the Company's
financial statements and the related notes thereto and the other financial
information included elsewhere in this Annual Report. When used in the
following discussions, the words "believes", "anticipates", "intends", "expects"
and similar expressions are intended to identify forward-looking statements.
Such statements are subject to certain risks and uncertainties, which could
cause actual results to differ materially from those projected, including, but
not limited to, those set forth in "Business--Special Considerations." Readers
are cautioned not to place undue reliance on forward-looking statements, which
speak only as of the date hereof.
OVERVIEW
Corporate History. Lee Video City opened its first video superstore in
1990. The Company owned and operated 29 superstores from the end of 1994 until
June 1996 when it sold its eleven stores outside of California. The eleven
stores were sold to reduce debt and restructure Lee Video City's operations by
focusing its attention on the "core stores" in California. On January 8, 1997,
Lee Video City merged with and into Prism. Prism had been engaged in the in-
house production of theatrical and television films and other programming for
distribution to the home video, pay and basic cable, network television and
syndication, and theatrical markets worldwide. Prism also acquired from third
parties rights to such programming, primarily for distribution to the home video
market. Upon consummation of the merger, the surviving Delaware corporation
changed its name to "Video City, Inc." See "Business--General." Prior to the
merger, Lee Video City's fiscal year ended on December 31. After the merger,
the Company retained Prism's year-end of January 31.
General Business. The Company's revenue consists primarily of rental
revenue and product sales revenue. Rental revenue includes revenue from rentals
of videos, video games, video players and video game machines and extended
viewing fees. Product sales revenue are derived from sales of new and used
videocassettes, including excess rental inventory, concessions and accessory
items.
Operating costs and expenses include operating expenses, cost of product
sales, and general and administrative expenses. Operating expenses consist of
amortization of videos purchased for rental, fees and lease expenses for leased
videos and all store expenses, including occupancy, payroll, store opening
expenses and direct store advertising and promotion expenses.
Videocassette rental inventory, which includes video games, is recorded at
cost and amortized over its estimated economic life with a salvage value of $6
per videocassette. Videocassettes that 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 Rentrak Corporation. Under its agreement with Rentrak,
pursuant to which the Company leases videos for rental to its customers, the
Company pays a handling fee of $8.30 for each videocassette. During the revenue
sharing period, which is one year, the movie studio that supplies the video to
Rentrak owns the video, and Rentrak and the Company on a predetermined basis
share the rental revenues. The Company may also sell excess copies of a video
title and share the sale proceeds with Rentrak on a predetermined basis. At the
end of the revenue sharing period for a video title, the Company may purchase
remaining copies of that title
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generally for less than $5 per copy. The handling fee per video is amortized on
a straight-line basis over the revenue sharing period, and revenue sharing
payments are expensed when incurred.
Cost of sales and leased product is comprised of the cost of videos sold to
customers and the cost of concessions and other products sold in the Company's
stores. The cost of a video is measured at its amortized basis when sold, if
previously used as a rental video, or at the Company's cost if purchased for
sell-through, or at a varying basis if a leased product, depending upon when in
the revenue sharing period it is sold.
General and administrative expenses are comprised of corporate office
expenses, including office equipment and facilities costs, management salaries
and benefits, professional fees and all other items of corporate expense.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated (i) statement of
operations data expressed as a percentage of total revenues and (ii) the number
of stores open at the end of each period.
<TABLE>
<CAPTION>
Twelve Months
Ended
January 31, Twelve Months Ended December 31,
-------------- ----------------------------------
1998 1996 1995
-------------- ---------------- ---------------
<S> <C> <C> <C>
Rental revenues and product sales 100.0% 100.0% 100.0%
Operating costs and expenses:
Store operating expenses 43.7% 55.9% 48.4%
Amortization of videocassette rental
Inventory 18.9% 17.4% 14.3%
Cost of product sales 7.5% 13.6% 12.6%
Cost of leased product 4.1% 4.9% 7.7%
General and administrative 19.9% 12.0% 15.1%
Nonrecurring writedown of Film
Library" 29.7%
Total 123.7% 103.7% 98.0%
Operating income (loss) (23.7)% (3.7)% 2.0%
Non-operating expenses 5.4% 3.3% (6.2)%
Loss before income taxes (29.1)% (0.4)% (4.1)%
Number of stores open at end of period 18 18 29
</TABLE>
YEAR ENDED JANUARY 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues. Revenues for the fiscal year ended January 31, 1998 ("fiscal
1998") decreased $1,229,000 or 10.7%, to $10,212,000 compared to $11,441,000 for
the fiscal year ended December 31, 1996 ("fiscal 1996"). The decreased revenues
were primarily attributable to the inclusion in fiscal 1996 of the eleven stores
sold by the Company in June 1996. Same store revenues increased 4.4% in fiscal
1998, which was attributable to the addition of new sell-through products and
the strategic relocation of three stores.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for fiscal 1998 decreased $59,000 or 3.0%, to
$1,928,000, compared to $1,987,000 for fiscal 1996. Amortization of
videocassette rental inventory as a percentage of total revenue was 18.9% in
fiscal 1998 compared to 17.4% in fiscal 1996. The increase as a percentage of
total revenue was due to a higher proportion of purchased
20.
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videocassettes versus leased videocassettes in fiscal 1998 compared to fiscal
1996, and an increased number of "hit" videocassettes purchased for each
location, offset partially by the change in amortization method to allow for a
$6 salvage value.
Cost of Product Sales. The cost of product sales as a percentage of total
revenue decreased to 7.5% for fiscal 1998 compared to 13.6% for fiscal 1996.
This decrease was primarily due to the Company increasing its sales of new
videocassettes and accessories for fiscal 1998 as compared to fiscal 1996, which
provided an improvement in the margins, and a return to normal holding periods
for previously viewed tapes resulting in a lower net book value at time of sale.
Cost of Leased Product. Cost of leased product for fiscal 1998 decreased
$137,000, or 24.6%, to $419,000 compared to $556,000 for fiscal 1996. The
decrease was primarily attributable to the inclusion in fiscal 1996 of the
eleven stores sold by the Company in June 1996. Cost of leased product as a
percentage of total revenue was 4.1% in fiscal 1998 compared to 4.9% in fiscal
1996. The decrease as a percentage of total revenue was due to the lower
proportion of leased videocassettes versus purchased videocassettes in fiscal
1998 compared to fiscal 1996.
Store Operating Expenses. Store operating expenses for fiscal 1998
decreased $1,931,000, or 30.2%, to $4,460,000 compared to $6,391,000 for fiscal
1996. The decrease was primarily attributable to the inclusion in fiscal 1996
of the 11 stores sold by the Company in June 1996. Store operating expenses as
a percentage of total revenues were 43.7% for fiscal 1998 compared to 55.9% for
fiscal 1996 due primarily to higher personnel costs and the payment of
settlement fees of $380,000 to landlords for the termination of two occupancy
leases related to the relocation of stores in fiscal 1996.
General and Administrative. General and administrative expenses for fiscal
1998 increased $667,000, or 48.8%, to $2,035,000 compared to $1,368,000 for
fiscal 1996. General and administrative expenses as a percentage of total
revenue were 19.9% in fiscal 1998 compared to 12.0% in fiscal 1996. The
increase was attributable to the professional services associated with the
merger with Prism Entertainment Corporation and the incremental cost of hiring
two management employees of Prism Entertainment Corporation following the
merger.
Nonrecurring Writedown of Film Library. During the fourth quarter of
fiscal 1998, management decided to dispose of the film library in order to
concentrate the company's business on the ownership and operation of video
specialty stores. The film library was written down by $3,030,000 to reflect
its net realizable value at January 31, 1998.
Gain on Disposition of Assets. The gain on disposition of assets in fiscal
1996 is primarily related to the sale of eleven stores outside of California in
June 1996.
Interest Expense. Net interest expense decreased $139,000, or 20.1%, to
$552,000 for fiscal 1998 compared to $692,000 for fiscal 1996. The decrease in
interest expenses was due to the conversion of debt to equity in January 1997 of
approximately $3,850,000 and paydown of approximately $2,000,000 primarily
through collection of accounts receivable, partially offset by the assumption by
the Company of the note payable to Imperial Bank in the amount of $3,066,000 in
January 1997.
Other. Other (income) expense of $17,000 in income in fiscal 1996 was
attributable to miscellaneous non-operating royalties.
21.
<PAGE>
Income Taxes. The Company's effective income tax rate varied from the
statutory federal tax rate as a result of operating losses for which no benefit
is recognized due to the valuation allowance on the net deferred tax asset. A
full valuation allowance has been established as the Company cannot determine
that it is more likely than not that the deferred tax asset will be realized.
ONE MONTH ENDED JANUARY 31, 1997 COMPARED TO ONE MONTH ENDED JANUARY 31, 1996
Revenues. Revenue for the one month ended January 31, 1997 decreased
$145,000, or 13.4%, to $940,000 compared to $1,085,000 for the one month ended
January 31, 1996. The reason for the decrease was the sale of the eleven stores
by the Company in June 1996. Same store revenue, however, for the one month
ended January 31, 1997 was up $131,000, or 19.2%, compared to the one month
ended January 31, 1996.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for the one month ended January 31, 1997
decreased $18,000, or 14.0%, to $111,000 compared to $129,000 for the one month
ended January 31, 1996. The primary reason for the decrease was the sale of
eleven stores by the Company in June 1996.
Cost of Product Sales. Cost of product sales for the one month ended
January 31, 1997 increased $71,000 to $136,000 compared to $65,000 for the one
month ended January 31, 1996. The increase was primarily due to the Company's
expansion of its sell-through product lines in its stores.
Cost of Leased Product. Cost of leased product for the one month ended
January 31, 1997 decreased $64,000, or 63.9%, to 36,000 compared to $99,000 for
the one month ended January 31, 1996. The decrease was due to the Company
leasing a lower proportion of videocassettes versus purchasing videocassettes in
January 1997 compared to January 1996.
Store Operating Expenses. Store operating expenses for the one month ended
January 31, 1997 decreased $138,000, or 23.9%, to $439,000 compared to $577,000
for the one month ended January 31, 1996. Store operating expenses as a
percentage of total revenues was 46.7% in January 1997 compared to 53.1% in
January 1996. The decrease was primarily due to lower personnel costs and other
controllable expenses.
General and Administrative. General and Administrative expenses for the
one month ended January 31, 1997 increased $196,000 to $323,000 compared to
$127,000 for the one month ended January 31, 1996. The increase was primarily
due to costs related to the merger of Lee Video City with and into Prism.
Interest Expense. Interest expense for the one month ended January 31,
1997 decreased $31,000, or 39.6%, to $46,000 compared to $77,000 for the one
month ended January 31, 1996. The decrease in interest expense was due to the
Company having approximately $3,750,000 less in debt in January 1997 compared to
January 1996.
Net Loss. The net loss for the one month ended January 31, 1997 of
$133,000 compared to net income for the one month ended January 31, 1996 of
$28,000 was attributable to the increased general and administrative expenses
related to the merger of Lee Video City with and into Prism.
Results of Operation of Prism. Prism's operations for the period from
January 9, 1997 through January 31, 1997 includes $1,933 of sales, operating
losses of $47,822, interest expense of $23,744, which resulted in a net loss of
$71,566.
22.
<PAGE>
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
Revenues. Revenues for 1996 decreased $ 2,710,000, or 19.2%, to $
11,441,000 compared to $14,151,000 for 1995. The decreased revenues were
primarily a result of the sale of eleven stores by the Company in June 1996.
Same store revenues were basically unchanged for 1996.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for 1996 decreased $30,000, or 1.4%, to
$1,987,000, compared to $2,017,000 for 1995. Amortization of videocassette
rental inventory as a percentage of total revenue was 17.4% in 1996 compared to
14.3% in 1995. The increase as a percentage of total revenue was due to the
higher proportion of purchased videocassettes versus leased videocassettes in
1996 compared to 1995.
Cost of Product Sales. The cost of product sales as a percentage of
revenue increased to 13.6% for 1996 compared to 12.6% for 1995. This increase
was primarily due to the Company selling many previously viewed new release
movies sooner than planned resulting in a loss on the sale of these movies due
to a high net book value at the time of sale. These sales enabled the Company
to generate needed working capital for operations.
Cost of Leased Product. Cost of leased product for 1996 decreased
$530,000, or 48.8%, to $556,000 compared to $1,086,000 for 1995. The decrease
was attributable to the Company's sale of eleven stores in June 1996 and the
Company buying less leased videocassettes in 1996. Cost of leased product as a
percentage of total revenue was 4.9% in 1996 compared to 7.7% in 1995. The
decrease as a percentage of total revenue was due to the lower proportion of
leased videocassettes versus purchased videocassettes in 1996 compared to 1995.
Store Operating Expenses. Store operating expenses for fiscal 1996
decreased $459,000, or 6.7%, to $6,391,000 compared to $ 6,850,000 for 1995.
Store operating expenses as a percentage of total revenues were 55.9% for 1996
compared to 48.4% for 1995 due primarily to higher personnel costs and the
payment of settlement fees of $380,000 to landlords for the termination of two
occupancy leases related to the relocation of stores. The decrease in operating
expenses was primarily due to the sale of eleven stores by the Company in June
1996.
General and Administrative. General and administrative expenses for 1996
decreased $763,000, or 35.8%, to $1,368,000 compared to $ 2,131,000 for 1995.
General and administrative expenses as a percentage of total revenue were 12.0%
in 1996 compared to 15.1% in 1995. The decrease was attributable to the sale of
eleven stores by the Company and management's efforts to reduce personnel costs
and professional fees to help improve the profitability of the Company.
Gain on Disposition of Assets. The gain on disposition of assets in 1996
is primarily related to the sale of eleven stores in June 1996.
Interest Expense. Net interest expense decreased $240,000, or 25.8%, to
$692,000 for 1996 compared to $932,000 for 1995. The decrease in interest
expenses was primarily due to the reduction of long-term debt of the Company
which was paid down from the proceeds from the sale of the eleven stores in June
1996.
Other. Other (income) expense was $17,000 in income in 1996 compared to
$60,000 in income in 1995. The change of $43,000 was primarily attributable to
the expenses reducing other income.
23.
<PAGE>
Income Taxes. The Company had no income tax expense for 1996 or 1995 as it
had no taxable income in 1996 or 1995. The Company's effective income tax rate
varied from the statutory federal tax rate as a result of operating losses for
which no tax has been recognized due to the change in the valuation allowance on
the net deferred tax asset. A full valuation allowance has been established as
it is more likely than not that the deferred tax asset will not be realized.
LIQUIDITY AND CAPITAL RESOURCES
The Company funds its short-term working capital needs, including the
acquisition of videos and other inventory, primarily through cash from
operations. The Company expects that cash from operations will be sufficient to
fund future video and other inventory purchases and other working capital needs.
Videocassette rental inventories are accounted for as noncurrent assets under
generally accepted accounting principles because they are not assets which are
reasonably expected to be completely realized in cash or sold in the normal
business cycle. Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital. The
acquisition cost of videocassette 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, bank 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, 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 Video City, 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 may be used only to finance future
acquisitions, if any. See "Business--Recent Developments--New Credit Facility."
As of April 30, 1998, the total outstanding balance under the FINOVA credit
facility was approximately $5,400,000, consisting of outstanding amounts under
term loans of approximately $5,200,000 and outstanding amounts under a revolving
loan of approximately $200,000. There were approximately $11,000 (net of
reserves) in amounts available under the revolving loan as of April 30, 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 the sale of debt
or equity financing. The full $1,800,000 of the FINOVA credit facility is
available to finance future acquisitions, if any, subject to approval by FINOVA.
In conjunction with the sale of its film library on March 25, 1998, the
Company paid off in full the promissory note to Imperial Bank, which had a
balance at January 31, 1998 of $1,411,306.
Net cash provided by operating activities in the year ended January 31,
1998 increased by approximately $1,241,000, or 71.7% from the year ended
December 31, 1996, primarily due to a decrease in accounts receivable, partially
offset by an increase in merchandise inventories and other assets. Net cash
used in investing activities during fiscal 1998 increased by $914,000, or 50.0%
compared to 1996, mainly due to the inclusion in 1996 of proceeds received from
the sale of certain fixed assets and increased net
24.
<PAGE>
purchases of videocassette rental inventory made in fiscal 1998 versus 1996.
Net cash used in financing activities during fiscal 1998 increased $1,187,000,
or 331.3% compared to 1996, mainly due to increased principal payments made on
obligations secured by accounts receivables.
Net cash provided by operating activities in the year ended December 31,
1996 decreased by approximately $880,000 or 33.7% from the year ended December
31, 1995 primarily due to a decrease in accounts payable and accrued expenses,
partially offset by a decrease in other assets. Net cash used in investing
activities during 1996 decreased by $229,000 or 11.1% compared to 1995 mainly
due to proceeds received from the sale of certain fixed assets that offset
increased net purchases of videocassette rental inventory made in 1996 versus
1995. Net cash used in financing activities during 1996 increased $33,000 or
14.5% compared to 1995 mainly due to increased principal payments made on
obligations under capital leases.
GENERAL ECONOMIC TRENDS, QUARTERLY RESULTS AND SEASONALITY
The Company anticipates that its business will be affected by general
economic and other consumer trends. To date, the Company has not operated
during a period of high inflation. However, the Company believes that it would
generally be able to pass on increased costs relating to inflation to its
customers. Future operating results may be affected by various factors,
including variations in the number and timing of new store openings, the
performance of new or acquired stores, the expenses associated with any
acquisition of stores, the quality and number of new release titles available
for rental and sale, the expense associated with the acquisition of new release
titles, additional and existing competition, marketing programs, weather,
special or unusual events and other factors that may affect retailers in
general. Any concentration of acquisitions or new store openings and the
related costs and other expenses associated with the acquisition of stores or
opening of new stores near the end of a fiscal quarter could have an adverse
effect on the financial results for that quarter and could, in certain
circumstances, lead to fluctuations in quarterly financial results.
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
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 programs that have time-sensitive
software may recognize a date using "00" as the year 1900 rather than the year
2000, which could result in miscalculation or system failures. Based on
preliminary information, costs of addressing potential problems are currently
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 a material financial risk.
Accordingly, the Company plans to devote the necessary resources to resolve all
significant year 2000 issues in timely manner.
NEW ACCOUNTING PRONOUNCEMENTS
Statement of Financial Accounting Standards No. 129, "Disclosure of
Information about Capital Structure" (SFAS No. 129) issued by the FASB is
effective for financial statements ending after December 15, 1997. The new
standard reinstates various securities disclosure requirements previously in
effect under
25.
<PAGE>
Accounting Principles Board Opinion No. 15, which has been superseded by SFAS
No. 128. The adoption of SFAS No. 129 did not have a material effect on the
Company's financial position or results of operations.
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS No. 130) issued by the FASB is effective for
financial statements with fiscal years beginning after December 15, 1997.
Earlier application is permitted. SFAS No. 130 establishes standards for
reporting and displaying of comprehensive income and its components in a full
set of general-purpose financial statements. The Company does not expect
adoption of SFAS No. 130 to have a material effect, if any, on its financial
position or results of operations.
Statement of Financial Accounting Standards No. 131, "Disclosure about
Segments of an Enterprise and Related Information" (SFAS No. 131) issued by FASB
is effective for financial statements beginning after December 15, 1997. The
new standard requires that public business enterprises report certain
information about operating segments in complete sets of financial statements of
the enterprise and in condensed financial statements of interim periods issued
to shareholders. It also requires that public business enterprises report
certain information about their products and services, the geographic areas in
which they operate and their major customers. The Company has not determined
the effect on its financial position or results of operations, if any, from the
adoption of this statement.
Statement of Financial Accounting Standards No. 132, "Employers'
Disclosures about Pensions and Other Postretirement Benefits" is effective for
financial statements with fiscal years beginning after December 15, 1997;
earlier application is permitted. The new standard revises employers'
disclosures about pension and other postretirement benefit plans but does not
change the measurement or recognition of those plans. SFAS No. 132 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 previously required when
no longer useful. The Company does not expect the adoption of SFAS No. 132 to
have a material effect, if any, on its financial position or results of
operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 14 of this Form 10-K for the information
required by Item 8.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
Previously reported.
26.
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, and is
incorporated herein by reference.
27.
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) AND (2) FINANCIAL STATEMENTS AND SCHEDULES:
The following financial statements of Video City, Inc. (and its predecessor
Lee Video City, Inc.) are included in this Report as pages F-1 through F-26
following the signature pages:
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
Schedule II Valuation and Qualifying Accounts
(b) FORM 8-K
No Current Report on Form 8-K was filed by the Company during the fourth
quarter of the fiscal year ended January 31, 1998.
(c) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. Exhibit Description
- ------- --------------------------------------------------------------------------------------------------
<C> <S>
2.1 Amended Plan of Reorganization of Prism Entertainment Corporation, date October 25, 1996.(1)
2.2 Agreement and Plan of Reorganization and Merger, dated as of October 25, 1996, between Prism
Entertainment Corporation and Lee Video City, Inc., as amended.(1)
3.1 Certificate of Incorporation of the Company, as amended.(2)
3.2 Bylaws of the Company, as amended.(2)
4.1 Certificate of Merger of Lee Video City, Inc. into the Company.(1)
10.1 $1,500,000 Promissory Note of the Company, dated January 8, 1997, payable to Ingram
Entertainment, Inc.(3)
10.2 Amended and Restated Credit Loan and Security Agreement, dated as of January 8, 1997, between
the Company and Imperial Bank.(1)
10.3 Override Agreement, dated as of November 19, 1996, by and among Lee Video City, Inc., Robert
Y. Lee, Prism Entertainment Corporation and Ingram Entertainment, Inc.(1)
</TABLE>
28.
<PAGE>
<TABLE>
<C> <S>
10.4 Stockholders Agreement, dated as of January 8, 1997, by and among the Company, Robert Y.
Lee, Barry Collier and Ingram Entertainment, Inc.(3)
10.5 Supply Agreement, dated January 8, 1997, between the Company and Ingram Entertainment,
Inc.(3)
10.6 National Account Agreement, dated December 16, 1994, between Rentrak Corporation and Lee
Video City, Inc., as amended.(3)
10.7 Escrow and Warrant Agreement, dated as of January 8, 1997, granted by Robert Y. Lee to Ingram
Entertainment, Inc. to purchase 404,403 shares of Common Stock of the Company.(3)
10.8 Warrant, dated as of January 8, 1997, to purchase 852,750 shares of Common Stock of the
Company issued to Ingram Entertainment, Inc.(3)
10.9 Stock Purchase Warrant, dated August 24, 1995, issued by Lee Video City, Inc. to Rentrak
Corporation.(3)
10.10 Stock Purchase Warrant, dated June 19, 1996, issued by Lee Video City, Inc. to Rentrak
Corporation.(3)
10.11 Stock Purchase Warrant, dated March 14, 1995, issued by Prism Entertainment Corporation to
Imperial Bank.(3)
10.12 Employment Agreement, dated January 8, 1997, between the Company and Robert Y. Lee.(3)
10.13 Employment Agreement, dated January 8, 1997, between the Company and James Craig Kelly.(3)
10.14 Employment Agreement, dated January 8, 1997, between the Company and Barry L. Collier.(3)
10.15 1996 Stock Option Plan of Lee Video City, Inc.(3)
10.16 Stock Option Agreement, dated January 8, 1997, between the Company and Barry L. Collier.(3)
10.17 Irrevocable Proxy, dated January 8, 1997, given by Barry Collier to Robert Y. Lee.(3)
10.18 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and among
Video City, Inc., Video Adventures Corp., Adventures in Video, Inc. and David A. Ballstadt.(4)
10.19 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and among
Video City, Inc., Video Ballstadt Corp., KDDJ Investments, Inc. and David A. Ballstadt.(4)
10.20 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and among
Video City, Inc., Video Acquisition Corp., Leptis Magna, Inc. d/b/a Video Unlimited and
G. Wayne Bailey and Orawan Bailey.(4)
10.21 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and among
Video City, Inc., Video Republic Corp., Old Republic Entertainment, Inc. and C. Anthony Anderson.(4)
</TABLE>
29.
<PAGE>
<TABLE>
<C> <S>
10.22 Agreement of Merger and Plan of Reorganization, dated as of March 25, 1998, by and among
Video City, Inc., Video Sulpizio Corp., Sulpizio One, Inc., Dennis Rhoton and Edward
Rheinhardt.(4)
10.23 Film Rights Transfer Agreement, dated as of March 23, 1998, by and among Conrad Entertainment,
LLC and Video City, Inc.(4)
10.24 Loan and Security Agreement, dated as of March 24, 1998, by and among FINOVA Capital
Corporation and Video City, Inc., Adventures in Video, Inc., KDDJ Investments, Inc., Leptis
Magna, Inc., Old Republic Entertainment, Inc. and Sulpizio One, Inc.(4)
10.25 Warrant issued to FINOVA Capital Corporation.(4)
10.26 Restructured Debt Agreement, dated March 25, 1998, by and among Rentrak Corporation,
Mortco, Inc., Video City, Inc., Sulpizio One, Inc. and Adventures in Video, Inc.(4)
21.1 Subsidiaries of the Company.
27.1 Financial Data Schedule
</TABLE>
_____________________
(1) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated January 8, 1997, and incorporated herein by reference.
(2) Previously filed as exhibits to Prism Entertainment Corporation's Annual
Report on Form 10-K for the fiscal year ended January 31, 1988, and
incorporated herein by reference.
(3) Previously filed as exhibits to the Company's Annual Report on Form 10-K for
the fiscal year ended January 31, 1997, and incorporated herein by
reference.
(4) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 25, 1998, and incorporated herein by reference.
(d) FINANCIAL STATEMENT SCHEDULE
The following financial statement schedule of Video City, Inc. is filed as
part of this Report as page F-26 following the signature pages:
Schedule II Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted
30.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
VIDEO CITY, INC.
By /s/ Robert Y. Lee
---------------------
Robert Y. Lee
Chairman of the Board
and Chief Executive Officer
Date: May 14, 1998
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Annual Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- --------------------------- ---------------------------------- ------------
<C> <S> <C>
/s/ Robert Y. Lee Chairman of the Board and May 14, 1998
- --------------------------- Chief Executive Officer (Principal
Robert Y. Lee Executive Officer)
/s/ Barry L. Collier President and Director May 14, 1998
- ---------------------------
Barry L. Collier
/s/ David A. Ballstadt Senior Vice President and Director May 14, 1998
- ---------------------------
David A. Ballstadt
/s/ Timothy J. Denari Chief Financial Officer (Principal May 14, 1998
- --------------------------- Financial and Accounting Officer)
Timothy J. Denari
/s/ James Craig Kelly Secretary and Director May 14, 1998
- ---------------------------
James Craig Kelly
/s/ John T. Sheehy Director May 14, 1998
- ---------------------------
John T. Sheehy
/s/ Michael T. Anderson Director May 14, 1998
- ---------------------------
Michael T. Anderson
/s/ Gerald W.B. Weber Director May 14, 1998
- ---------------------------
Gerald W.B. Weber
/s/ Charles E. Cooke Director May 14, 1998
- ---------------------------
Charles E. Cooke
/s/ Stephen C. Lehman Director May 14, 1998
- ---------------------------
Stephen C. Lehman
</TABLE>
<PAGE>
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements and schedule are filed with this report:
Reports of Independent Certified Public Accountants
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity (Deficit)
Statements of Cash Flows
Notes to Financial Statements
Schedule II - Valuation and Qualifying accounts
F-1
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Video City, Inc.
We have audited the accompanying balance sheets of Video City, Inc. (formerly
Lee Video City, Inc.) as of January 31, 1998 and 1997 and the related statements
of operations, stockholders' equity (deficit) and cash flows for each of the
years ended January 31, 1998 and December 31, 1996. We have also audited the
schedule listed in the accompanying index. These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule 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 and schedule are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements and
schedule. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
presentation of the financial statement and schedule. 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 Video City, Inc. as of January
31, 1998 and 1997 and the results of its operations and its cash flows for each
of the years ended January 31, 1998 and December 31, 1996 in conformity with
generally accepted accounting principles.
Also, in our opinion the schedule presents fairly, in all material respects, the
information set forth therein.
BDO SEIDMAN, LLP
Los Angeles, California
March 20, 1998 except for Note 14
which is as of March 25, 1998
F-2
<PAGE>
INDEPENDENT AUDITOR'S REPORT
The Board of Directors
Lee Video City, Inc.
We have audited the accompanying statements of operations, stockholders' deficit
and cash flows of Lee Video City, Inc. for the year ended December 31, 1995.
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 the
year then ended in conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Los Angeles, California
February 9, 1996, except
for note 6, which is as of
May 28, 1996.
F-3
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
BALANCE SHEETS
<TABLE>
<CAPTION>
January 31, January 31,
1998 1997
----------- ------------
<S> <C> <C>
ASSETS (NOTE 6)
CURRENT ASSETS
Cash $ 28,127 $ 1,246,517
Accounts receivable, less allowance for doubtful accounts
of $0 and $325,422 in 1998, 1997 (Note 6) 758,101 2,168,052
Notes receivable (Note 5) 355,430 398,830
Merchandise inventories (Note 6) 339,759 58,976
Other 411,536 96,143
---------- -----------
Total current assets 1,892,953 3,968,518
VIDEOCASSETTE RENTAL INVENTORY, NET OF ACCUMULATED
AMORTIZATION 2,795,258 2,166,789
PROPERTY AND EQUIPMENT, NET (NOTE 4) 859,708 1,017,089
FILM LIBRARY (NOTE 6) 818,171 3,700,000
OTHER ASSETS 233,226 267,916
---------- -----------
TOTAL ASSETS $6,599,316 $11,080,312
========== ===========
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
BALANCE SHEETS
<TABLE>
<CAPTION>
January 31, January 31,
1998 1997
------------ -------------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable $ 2,166,027 $ 1,761,297
Accrued expenses 702,293 707,485
Current portion of long-term debt (Note 6) 1,674,457 2,258,850
----------- -----------
Total current liabilities 4,542,777 4,727,632
LONG-TERM DEBT (NOTE 6) 2,043,431 3,341,313
OTHER LIABILITIES 711,931 774,875
----------- -----------
TOTAL LIABILITIES 7,298,139 8,843,820
COMMITMENTS (NOTE 10)
STOCKHOLDERS' EQUITY (DEFICIT) (NOTE 7)
Common stock, $.01 par value per share,
authorized 20,000,000 shares; issued and
outstanding 9,773,927 shares at 1998 and
9,753,927 shares at 1997 97,739 97,539
Additional paid-in capital 7,075,735 7,035,935
Accumulated deficit (7,872,297) (4,896,982)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY (DEFICIT) (698,823) 2,236,492
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,599,316 $11,080,312
=========== ===========
</TABLE>
See accompanying notes to financial statement.
F-5
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended Year ended Year ended
January 31, December 31, December 31,
1998 1996 1995
------------- ------------- -------------
<S> <C> <C> <C>
REVENUE
Rental revenues and product sales $10,007,358 $11,271,229 $14,007,083
Management fee income 205,000 170,000 144,000
----------- ----------- -----------
TOTAL REVENUE 10,212,358 11,441,229 14,151,083
----------- ----------- -----------
OPERATING COSTS AND EXPENSES
Store operating expenses 4,460,200 6,390,574 6,850,068
Amortization of videocassette rental inventory 1,928,343 1,987,407 2,016,660
Cost of product sales 762,153 1,557,062 1,782,260
Cost of leased product 419,361 556,248 1,085,814
General and administrative 2,035,428 1,367,650 2,130,797
Non recurring write down of Film Library (Note 13) 3,029,829
----------- ----------- -----------
TOTAL OPERATING COSTS AND EXPENSES 12,635,314 11,858,941 13,865,599
INCOME (LOSS) FROM OPERATIONS (2,422,956) (417,712) 141,484
OTHER (INCOME) EXPENSE
Gain on disposition of assets, net (Note 9) - (1,049,295) -
Interest expense 552,359 691,782 931,775
Other - (17,275) (59,868)
NET LOSS $(2,975,315) $ (42,924) $ (586,423)
=========== =========== ===========
BASIC NET LOSS PER SHARE $(0.30) $(0.01) $(0.14)
BASIC WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING 9,770,594 4,234,024 4,127,097
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
One One
month ended month ended
January 31, January 31,
----------- -----------
1997 1996
(unaudited) (unaudited)
<S> <C> <C>
REVENUE
Rental revenues and product sales $ 940,141 $1,085,250
Management fee income 0 0
---------- ----------
Total Revenue 940,141 1,085,250
OPERATING COSTS AND EXPENSES
Store operating expenses 438,766 576,543
Amortization of videocassette rental inventory 111,034 129,145
Cost of product sales 135,894 65,301
Cost of leased product 35,864 99,425
---------- ----------
General and administrative expenses 323,206 126,828
---------- ----------
TOTAL OPERATING COSTS AND EXPENSES 1,044,764 997,242
INCOME (LOSS) FROM OPERATIONS (104,623) 88,008
OTHER (INCOME) EXPENSE
Interest expense 46,351 76,793
Other (18,132) (17,192)
---------- ----------
NET LOSS $ (132,842) $ 28,407
========== ==========
BASIC NET LOSS PER SHARE $(0.02) $0.01
BASIC WEIGHTED AVERAGE NUMBER OF COMMON SHARES
OUTSTANDING 8,373,951 4,234,024
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Common Stock Additional
Paid-In Accumulated
Shares Amount Capital Deficit
--------- -------- ----------- ------------
<S> <C> <C> <C> <C>
Balance at January 1, 1995 4,079,976 $40,800 $ 341,200 $(4,134,793)
Issuance of Lee Video City, Inc. Common
Stock 154,048 1,540 223,460
Net Loss (586,423)
--------- ------- ---------- -----------
Balance at December 31, 1995 4,234,024 42,340 564,660 (4,721,216)
Net Loss (42,924)
--------- ------- ---------- -----------
Balance at December 31, 1996 4,234,024 42,340 564,660 (4,764,140)
Stock issued in satisfaction of debt 1,500,000 15,000 2,985,000
Stock issued in conversion of debt 773,653 7,737 811,263
Effect of the Merger 3,246,250 32,462 2,675,012
Net Loss (one month ended) (132,842)
--------- ------- ---------- -----------
Balance at January 31, 1997 9,753,927 97,539 7,035,935 (4,896,982)
Stock issued in satisfaction of services 20,000 200 39,800
Net Loss (2,975,315)
--------- ------- ---------- -----------
Balance at January 31, 1998 9,773,927 $97,739 $7,075,735 $(7,872,297)
========= ======= ========== ===========
</TABLE>
See accompanying notes to financial statements.
F-8
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended Year ended Year ended
INCREASE (DECREASE) IN CASH, January 31, December 31, December 31,
CASH FLOWS FROM OPERATING ACTIVITIES: 1998 1996 1995
------------ ------------- -------------
<S> <C> <C> <C>
Net loss $(2,975,315) $ (42,924) $ (586,423)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 2,127,443 2,518,068 2,667,050
(Gain) loss on disposal of assets (1,049,294) 14,281
Note issued for legal settlement 379,632 -
Noncash interest - 135,000
Stock issued for legal fees 40,000 - -
Non recurring write down of film library 3,029,829
Other - 18,805
Changes in assets and liabilities:
Decrease in accounts receivable 1,409,951 - -
Decrease (increase) in notes receivable 29,954 55,295
Decrease (increase) in merchandise inventories (280,783) 21,464 62,211
Decrease (increase) in other assets (280,703) 175,792 (173,995)
(Increase) decrease in accounts payable (30,302) (214,125) 287,206
(Increase) decrease in accrued expenses (5,192) (58,817) 146,574
(Decrease) in other liabilities (62,944) (28,844) (15,235)
----------- ----------- -----------
Net cash provided by operating activities 2,971,984 1,730,906 2,610,769
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of videocassette rental inventory, net (2,596,812) (2,260,680) (1,976,677)
Purchases of fixed assets (189,719) (169,512) (81,642)
Proceeds from sale of fixed assets - 601,301 -
Repayment on notes receivable 43,400 - -
----------- ----------- -----------
Net cash used in investing activities (2,743,131) (1,828,891) (2,058,319)
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on obligations under capital leases - (299,751) (175,726)
Repayment of long-term debt (1,447,243) (1,034,939) (51,900)
Proceeds from issuance of long-term debt - 1,074,431 -
----------- ----------- -----------
Net cash used in financing activities (1,447,243) (260,259) (227,626)
NET INCREASE (DECREASE) IN CASH (1,218,390) (358,244) 324,824
Cash at beginning of year 1,246,517 417,517 92,693
----------- ----------- -----------
Cash at end of year $ 28,127 $ 59,273 $ 417,517
</TABLE>
F-9
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended Year ended Year ended
January 31, December 31, December 31.
1998 1996 1995
----------- ------------ ------------
<S> <C> <C> <C>
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE YEAR:
Interest $557,551 $ 757,259 $820,202
Income taxes 800 800 255,000
NONCASH INVESTING AND FINANCING ACTIVITIES:
Interest charges financed through issuance
of long-term debt - - 135,000
Professional services financed through
issuance of common stock 40,000 - 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 -
Accounts payable converted to a
a note payable 435,032
</TABLE>
See accompanying notes to financial statements.
F-10
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
One
month ended
January 31,
INCREASE (DECREASE) IN CASH, 1997
-----------
<S> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $ (132,842)
Adjustments to reconcile net loss to
net cash provided by operating activities:
Depreciation and amortization 142,065
Changes in assets and liabilities:
Decrease (increase) in notes receivable (5,913)
Decrease in merchandise inventories (9,379)
Decrease (increase) in other assets 68,037
Increase in accounts payable (119,740)
Increase in accrued expenses (45,540)
-----------
Total adjustments 29,530
-----------
Net cash provided by (used in) operating activities (103,312)
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of videocassette rental inventory, net (1,094,536)
Disposal of videocassette rental inventory 1,072,084
Purchases of fixed assets (13,641)
Cash received in merger 1,454,293
-----------
Net cash used in investing activities 1,418,200
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on obligations under capital leases (21,159)
Repayment of long-term debt (43,985)
Payment of dissenter's shares (62,500)
-----------
Net cash used in financing activities (127,644)
-----------
NET INCREASE (DECREASE) IN CASH 1,187,244
Cash at beginning of period 59,273
Cash at end of period $ 1,246,517
</TABLE>
F-11
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
One
month ended
January 31,
1997
-----------
<S> <C>
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION
CASH PAID DURING THE PERIOD:
Interest $ 25,333
Income taxes -
NONCASH INVESTING AND FINANCING ACTIVITIES:
Long-term debt converted to common stock 819,000
In conjunction with the merger of Lee Video City, Inc.
into Prism Entertainment Corporation, common stock
was issued and the following fair value of non cash
net assets were acquired. 1,440,535
</TABLE>
See accompanying notes to financial statements.
F-12
<PAGE>
VIDEO CITY, INC.
(FORMERLY LEE VIDEO CITY, INC.)
NOTES TO FINANCIAL STATEMENTS
1. THE COMPANY
Video City, Inc. (the "Company"), originally known as Lee Video City, Inc., was
incorporated in California on February 20, 1990. The Company owns and operates
video specialty stores located primarily in secondary markets.
On January 8, 1997, the Company merged with and into Prism Entertainment
Corporation ("Prism"). Prism was an inactive film production and distribution
company. Prism's business is limited to the sale of its existing film products
to domestic markets and the licensing of foreign rights to its existing film
library. The film library consists of 47 feature films and numerous shorter
films.
As of January 31, 1998, the Company owned and operated 18 stores and managed an
additional 6 "licensed" stores pursuant to management agreements. All of the
stores are located in California.
2. MERGER
On December 1, 1995, Prism filed a voluntary Chapter 11 petition and commenced a
case under Chapter 11 of the United States Bankruptcy Code. During the course
of the Bankruptcy Proceedings, Prism operated as a debtor in possession and
engaged in only limited business activities consisting of the sale of its
existing film products to domestic markets as well as foreign rights to its
existing film library.
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 in 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
5,007,677 of the common stock of Prism Entertainment Corporation or
approximately 51% of the Company's common stock. Upon consummation of the
merger, the name of the surviving corporation ("the Company") was changed from
Prism Entertainment Corporation to Video City, Inc.
3. 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.
F-13
<PAGE>
VIDEOCASSETTE RENTAL INVENTORY
Videocassette rental inventory, which includes video games, is recorded at cost
and amortized over its estimated economic life. The company revised the
estimate of salvage value relating to the amortization of videocassette
inventory to provide for a $6 salvage value per tape, to reflect a more accurate
salvage value as demonstrated in the industry. Videocassettes that 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 (typically average approximately $60). 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 $1,928,000, $1,987,000 and $2,017,000 for the years ended January
31, 1998, December 31, 1996 and 1995. As videocassettes are sold or retired,
the applicable cost and accumulated amortization are eliminated from the
accounts, and any gain or loss is recorded.
FILM LIBRARY
Film costs are paid to obtain film license rights and are amortized in the same
proportion that current revenues bear to estimated remaining lifetime revenues.
Estimates of total lifetime revenues and expenses are periodically reviewed by
management and revised if warranted by changing conditions. Where all or a
portion of the film costs appear not to be recoverable through estimated
remaining lifetime revenues, the non-recoverable portion is charged to expense.
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.
In the event that facts and circumstances indicate that the cost of an asset may
be impaired, an evaluation of recoverability would be performed. If an
evaluation is required, the estimated future undiscounted cash flows associated
with the asset would be compared to the carrying amount to determine if a write-
down to market value is required.
REVENUE RECOGNITION
Revenue is recognized at the time of rental or sale, or as late charges accrue,
net of valuation reserve.
Revenues from licensing agreements, which provide for the receipt by the Company
of nonrefundable guaranteed amounts, are recognized when the programming becomes
available for exhibition and all other conditions of the
F-14
<PAGE>
sale have been met. Deposits and cash advances received under such licensing
contracts are deferred until all conditions of sale have been met, and are
reflected in the accompanying financial statements as deferred income.
Revenues are recorded net of applicable rebates, returns and advertising
allowance.
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 Accounting Standards 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.
LOSS PER SHARE
The Company adopted Statement of Financial Accounting Standards No. 128 (SFAS
No. 128), "Earnings Per Share", which established new standards for calculating
and disclosing earnings per share. All prior period earnings per share data has
been restated to conform with the provisions of SFAS No. 128.
Basic loss per share computations are based on the weighted average number of
common shares outstanding. Diluted loss per share has not been presented as the
effect from the assumed exercise of stock options and warrants would be
antidilutive. Subsequent to year end, the Company issued 1,815,112 shares of
Common Stock.
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
Statements of financial accounting Standards No. 129 "Disclosure of Information
about Capital Structure" (SFAS No. 129) issued by the FASB is effective for
financial statements ending after December 15, 1997. The new standards
reinstates various securities disclosure requirements previously in effect under
Accounting Principles Board Opinion No. 15, which has been superseded by SFAS
No. 128. The adoption of SFAS No. 129 did not
F-15
<PAGE>
have a material effect, on the Company's financial position or results of
operations.
Statements of Financial Accounting Standards No. 130, Reporting Comprehensive
Income" (SFAS No. 130) issued by the FASB is effective for financial statements
with fiscal years beginning after December 15, 1997. Earlier application is
permitted. SFAS No. 130 establishes standards for reporting an display of
comprehensive income and its components in a full set of general-purpose
financial statements. The Company does not expect adoption of SFAS No. 130 to
have a material effect, if any, on its financial position or results of
operations.
Statements of Financial Accounting Standards No. 131, "Disclosure about Segments
of an Enterprise and Related Information" (SFAS No. 131) issued by FASB is
effective for financial statements beginning after December 15, 1997. The new
standard requires that public business enterprises report certain information
about operating segments in complete sets of financial statements of the
enterprise and in condensed financial statements of interim periods issued to
shareholders. It also requires that public business enterprises report certain
information about their products and services, the geographic areas in which
they operate and their major customers. The Company has not determined the
effect on its financial position or results of operations, if any, from the
adoption of this statement.
4. PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
<TABLE>
<CAPTION>
January 31, January 31,
1998 1997
<S> <C> <C>
Furniture and fixtures $ 1,192,192 $ 1,134,876
Equipment 811,911 683,330
Leasehold improvements 435,917 432,095
----------- -----------
$ 2,440,020 $ 2,250,301
Accumulated
depreciation (1,580,312) (1,233,212)
----------- -----------
$ 859,708 $ 1,017,089
=========== ===========
</TABLE>
Depreciation expense was $347,000, $531,000 and $650,000 for the years ended
January 31, 1998, December 31, 1996 and 1995.
5. NOTES RECEIVABLE
At January 31, 1998, and January 31, 1997, the Company had unsecured employee
loans aggregating approximately $86,700 and $86,700, bearing interest at 7%, and
are due on demand. Included in notes receivable is a secured note amounting to
approximately $144,200 and $158,500 as of January 31, 1998 and January 31, 1997,
bearing interest at 8%, and is due September 15, 1998. Notes receivable also
include other miscellaneous unsecured notes receivable of approximately $124,500
and $153,600 as of January 31, 1998, and January 31, 1997.
F-16
<PAGE>
6. LONG-TERM DEBT
Long-term debt is summarized as follows:
<TABLE>
<CAPTION>
January 31, January 31,
1998 1997
------------ ------------
<S> <C> <C>
Promissory note, secured by all assets, bearing interest at 10% per annum,
interest only payments monthly beginning January 31, 1997 through the
year 2000. Principal balance due and payable January 2000. $ 1,500,000 $ 1,500,000
Promissory note, secured by the film library, accounts receivable and the
store inventory. All proceeds from current and future accounts receivable
collections as well as from the sale of the film library are to be applied to
the outstanding principal until paid in full. Any principal balance
outstanding as of July 1, 1998 will be paid in twelve equal monthly
installments. The note bears interest at the bank's prime rate plus 3%.
The interest rate on the note was 11.25% on January 31, 1997. 1,411,306 3,066,388
Other loan payable to an individual for $50,000 (unsecured), payable on
January 1, 1999, bearing interest at 11%, with personal guarantee by
primary stockholder of the Company. 50,000 50,000
Other unsecured loans, payable in monthly installments until September 15,
1997, bearing interest at 8%. - 42,850
Promissory notes payable, 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
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. 203,414 310,819
Capital lease obligations, payable in monthly installments, with interest
rates of 14% to 28%, secured by the respective assets under the lease
(Note 10). 18,136 316,778
Short term advance - Sulpizio One, Inc. payable upon demand with an
interest rate of 7%. 100,000 -
Promissory note - Rentrak Fourth Addendum which was executed in
July 1997 called for the conversion of balances in accounts payable to a
note with an interest rate of 10% due and payable in January 1998. 435,032 -
----------- -----------
Total Debt 3,717,888 5,600,163
Current portion (1,674,457) (2,258,850)
----------- -----------
Total long-term debt $ 2,043,431 $ 3,341,313
</TABLE>
F-17
<PAGE>
<TABLE>
<CAPTION>
YEAR ENDING
JANUARY 31, AMOUNT
- ---------------------------
<S> <C>
1999 $1,674,457
2000 688,050
2001 884,818
2002 124,620
Thereafter 345,943
- ---------------------------
$3,717,888
</TABLE>
7. COMMON STOCK
During 1995, common stock was issued in exchange for videocassette rental
inventory and certain professional services. The videocassette rental inventory
and professional services were valued at the approximate fair value.
During 1995, in conjunction with an addendum to the Revenue Sharing Agreement
(Note 3), the Company granted to the distributor a warrant to purchase shares of
common stock of the Company, representing 2% of the fully diluted issued and
outstanding shares of common stock at an exercise price of $400,000. The number
of shares issuable under this warrant is now fixed, 132,279 shares at an
exercise price of $3.02 per share. The warrant is exercisable during the period
commencing August 24, 1995 and ending on August 23, 2005.
In 1996, in conjunction with a second addendum to the Revenue Sharing Agreement
(Note 3), the Company granted to the distributor a warrant to purchase shares of
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 number of shares issuable under this
warrant is now fixed at a maximum of 341,141 shares at a weighted average
exercise price of $0.45 per share. The warrant is exercisable during the period
commencing June 19, 1997 and ending on September 30, 2005. The vesting schedule
is as follows:
<TABLE>
<CAPTION>
Cumulative Percentage of
June 19, Total Shares Outstanding Purchase Price
- ----------- ------------------------ --------------
<S> <C> <C>
1997 1 $ 30,795
1998 2 61,590
1999 3 92,385
2000 4 123,180
2001 5 153,975
</TABLE>
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. In 1996,
the Company amended this 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. As a result of the merger,
this warrant was then exchanged for a new warrant to purchase 404,403 shares of
the Company's stock from the principal stockholder of the Company at $0.6085 per
share. The grant date of this warrant is January 8, 1997 and expires five years
from that date.
F-18
<PAGE>
As a result of the merger and effective on the merger date, the major supplier
also received a warrant to purchase up to an aggregate of 852,750 shares of the
Company's common stock. A summary of this warrant is as follows:
<TABLE>
<CAPTION>
Number of Shares Life (Years) Exercise Price
- ------------------ ------------ --------------
<S> <C> <C>
200,000 5.0 $2.00
200,000 6.0 2.25
200,000 7.0 2.50
114,240 5.0 0.51
54,360 5.0 1.03
15,000 5.0 1.00
69,150 5.0 2.00
</TABLE>
In 1997 the Company issued a stock certificate for 20,000 shares of its common
stock to a law firm in satisfaction of fees for legal services rendered to Lee
Video City, Inc. in the January 1997 merger with Prism Entertainment
Corporation. These shares were issued without registration under the Securities
Act of 1933, in reliance upon the exemption in Section 4(2) thereof.
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 and consultants. 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
options and warrants activity is as follows:
<TABLE>
<CAPTION>
1998 1996 1995
---- ---- ----
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 1,881,560 $1.18 1,355,483 $0.93 1,149,000 $0.70
period
Granted 1,187,750 1.69 526,077 1.81 1,355,483 0.93
Exercised - - -
Terminated - - 1,149,000 0.70
Outstanding at
end of period 3,069,310 1.37 1,881,560 1.18 1,355,483 0.93
Options
exercisable at 2,959,310 1.35 1,881,560 1.18 1,355,483 0.93
period end
</TABLE>
F-19
<PAGE>
Information relating to stock option and warrant at January 31, 1998 summarized
by exercise price are as follows:
<TABLE>
<CAPTION>
Outstanding Exercisable
---------------------------------- ---------------------------
Weighted Average Weighted Average
- ---------------------------------------------------------------------------------------
Exercise Price
Per Share Shares Life Exercise Price Shares Exercise Price
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.10 to $0.51 1,090,917 4.2 $0.45 1,090,917 $0.45
1.00 to 1.03 531,760 4.0 1.02 531,760 1.02
2.00 to 2.50 1,315,150 4.5 2.11 1,205,150 2.12
3.04 to 3.04 131,483 4.0 3.04 131,483 3.04
- ---------------------------------------------------------------------------------------
3,069,310 4.3 $1.37 2,959,310 $1.35
</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 and loss per share would be as follows:
<TABLE>
<CAPTION>
January 31, December 31, December 31,
1998 1996 1995
------------ ------------- -------------
<S> <C> <C> <C> <C>
Net Loss As reported $(2,975,315) $ (42,924) $(586,423)
Proforma (3,021,357) (112,020) (586,423)
Net Loss Per Share As reported $ (0.30) $ (0.01) $ (0.14)
Proforma (0.31) (0.03) (0.14)
</TABLE>
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 rates ranging from 5.38% to
5.69%, and a 0% dividend yield. The weighted average fair value of options
granted ranged from $0 to $0.42.
8. INCOME TAXES
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.
As of January 31, 1998, the Company had net operating loss carryforwards
generated by Lee
F-20
<PAGE>
Video City, Inc. of approximately $1,703,000 and $851,000 for Federal and
California income tax purposes and net operating loss carryforwards generated by
Prism Entertainment Corporation of approximately $4,675,000 for Federal income
tax purposes, which are available to offset future taxable income through 2012.
The Company's ability to utilize net operating loss carryforwards is dependent
upon the ability to generate taxable income in future periods which may be
limited due to ownership changes as defined under Section 382 of the Internal
Revenue Code of 1986. Such an ownership change occurred on January 8, 1997
which results in an annual limitation per year. Any unused annual limitation
may be carried over to future years until the net operating losses expire.
Utilization of net operating losses may also be limited in any one year by
alternative minimum tax rules. Net operating loss carryforwards of Prism would
be lost if the historical business of Prism is not continued for two years.
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.
The tax effects of temporary differences that give rise to significant portions
of the deferred tax assets at January 31, 1997 and 1998 are presented below:
<TABLE>
<CAPTION>
January January
1998 1997
------------ ------------
<S> <C> <C>
Rental inventory principally due to difference in amortization $ (48,315) $ 120,080
Fixed assets due to difference in depreciation 87,067 87,970
Section 481 adjustment 39,707 80,032
Deferred rent 73,441 74,013
Net operating loss carryforward 817,887 2,247,663
Non recurring writedown of Film Library 1,211,932
Other 13,678 16,169
Total gross deferred tax asset 2,195,397 2,625,927
Less valuation allowance (2,195,397) (2,625,927)
----------- -----------
Net deferred tax assets $ -0- $ -0-
=========== ===========
</TABLE>
9. 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.
F-21
<PAGE>
10. COMMITMENTS
The Company is obligated under various capital leases for certain fixtures and
equipment expiring at various dates through 1999. At January 31, 1998 and 1997,
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>
January 31 January 31,
1998 1997
----------- ------------
<S> <C> <C>
Furniture and fixtures $ 397,539 $ 397,539
Equipment 405,167 405,167
--------- ---------
802,706 802,706
Accumulated amortization (621,898) (514,827)
--------- ---------
$ 180,808 $ 287,879
========= =========
</TABLE>
The Company leases its facilities under noncancelable operating leases expiring
at various dates through 2005. Rent expense under operating leases was
approximately $1,502,000, $1,444,000 and $1,597,000 for the year ended January
31, 1998 and the years ended December 31, 1996 and 1995.
The future minimum lease payments under capital leases and noncancelable
operating leases with initial lease terms in excess of one year as of January
31, 1998 are as follows:
<TABLE>
<CAPTION>
Year Ending
January 31, Capital Leases Operating Leases
- ----------------------------------------------------------------------
<S> <C> <C>
1999 $18,136 $1,123,378
2000 992,908
2001 678,435
2002 510,141
Thereafter 806,809
- ----------------------------------------------------------------------
Total minimum lease payments $18,136 $4,111,671
Amount representing interest $ 468
- ----------------------------------------------------------------------
</TABLE>
Pursuant to the Revenue Sharing Agreement (Note 3), 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.
The agreement expires on June 30, 2001.
The Company's CEO, Robert Y. Lee, its President, Barry Collier and its major
supplier Ingram Entertainment, Inc. ("Ingram") entered into Override Agreement
dated November 19,1996 which provides, subject to certain exceptions, that
without the written consent of Ingram, the Company shall not enter into a merger
or a sale or
F-22
<PAGE>
transfer of all or substantially all of its assets, or make any material change
in the nature of its business as now conducted, or change the form of
organization of its business; and that without unanimous approval of the Board
of Directors, the Company shall not enter into any line of business other than
the sale and rental of video product and related goods, the completion of one
film that Prism had under way, and the exploitation of Prism's film library;
these provisions will remain in force until the later of the payment in full of
the Company's $1,500,000 debt to Ingram, or such time as Ingram's beneficial
ownership interest in the Company's common stock, on a fully diluted basis, is
4% or less.
Effective January 8, 1997, Robert Y. Lee entered into an Employment Agreement
with the Company pursuant to which he will serve for a period of three years in
the capacity as Chairman of the Board and Chief Executive Officer. Mr. Lee will
receive a base salary of $178,000 per year and an annual bonus of 3% of any
pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing in 1997; 3% of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing in 1998; and 3% of any pre-tax profit in
excess of $1,300,000 with respect to the fiscal year commencing in 1999. Mr.
Lee is also entitled to certain fringe benefits including payment of up to $500
per month for the use of one Company provided automobile.
Effective January 8, 1997, Barry Collier entered into an Employment Agreement
with the Company pursuant to which for a period of two years he will serve in
the capacity of President. He will receive a base salary of $178,000 per year.
In addition, Mr. Collier is entitled to an annual bonus equal to 12% of all
annual revenues (net of commissions and expenses related thereto) recorded in
excess of $625,000 from the licensing and/or transfer of rights to the Prism
film library; an annual bonus equal to 5% of any promotional advertising
development funds from any external source in excess of $350,000 received by or
credited to the Company; and a bonus equal to 20% of proceeds in excess of
$3,700,000 (net of commissions and expenses of sale) received by the Company
generated from the sale of the Company's film library in its entirety. Mr.
Collier is also entitled to certain fringe benefits including payment of up to
$500 per month for the use of one Company provided automobile.
Effective January 8, 1997, James Craig Kelly entered into an Employment
Agreement with the Company pursuant to which he will serve for a period of three
years in the capacity of Senior Vice President and Chief Executive Officer. Mr.
Kelly will receive a base salary of $120,000 per year and a bonus of 3% of any
pre-tax profit in excess of $1,100,000 with respect to the fiscal year
commencing in 1997; 3% of any pre-tax profit in excess of $1,200,000 with
respect to the fiscal year commencing in 1998; and 3% of any pre-tax profit in
excess of $1,300,000 with respect to the fiscal year commending in 1999. Mr.
Kelly is also entitled to certain fringe benefits including payment of up to
$500 per month for the use of one Company provided automobile.
In the event that the employment of any of the above individuals is terminated
for any reason other than "material breach" or "cause" as defined in his
Employment Agreement, the Company will pay the remainder of the base salary to
such individual for the remaining term of his employment agreement.
11. 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.
F-23
<PAGE>
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------------------------------------------
<S> <C> <C> <C> <C>
Financial Assets:
Notes Receivable $ 355,430 $ 355,430 $ 398,830 $ 399,282
Financial Liabilities:
Long-Term Debt $3,717,888 $3,717,888 5,600,163 5,633,745
</TABLE>
12. PRO FORMA CONDENSED STATEMENTS OF OPERATIONS (UNAUDITED)
The following unaudited pro forma condensed statements of operations are based
on the historical income statements of Lee Video City, Inc. and Prism
Entertainment Corporation and assumes the reorganization and merger took place
January 1, 1996 for the year ended December 31, 1996 and January 1, 1995 for the
year ended December 31, 1995.
The unaudited pro forma condensed statements of operations 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 following unaudited pro forma condensed statements of operations should be
read in connection with the historical financial statements of Lee Video City,
Inc. and Prism Entertainment Corporation.
(In thousands, except per share amount)
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1996 1995
------------- -------------
<S> <C> <C>
Revenue and product sales $13,742 $29,805
Operating costs and expenses:
Store operating expenses 6,221 6,850
Amortization of videocassette
rental inventory 1,987 2,017
Cost of product sales 7,045 18,826
Cost of leased product 556 1,086
General & administrative 2,886 7,843
Total operating costs and expenses 18,695 36,622
Income (loss) from operations (4,953) (6,817)
Other (income) expense
Interest expense, net 573 688
Gain on disposition of assets (1,049) --
Other 80 (204)
</TABLE>
F-24
<PAGE>
<TABLE>
<S> <C> <C>
Income (loss) before income taxes (4,557) (7,678)
Provision (benefit) for income taxes -- --
------- -------
Net income (loss) $(4,557) $(7,678)
Loss per share $ (0.47) $ (0.79)
Weighted average number of shares outstanding 9,754 9,754
</TABLE>
Prism Entertainment Corporation's cost of sales includes approximately
$2,600,000 of amortization for the writedown of the film library due to the
revision of the film library ultimates for the year ended December 31, 1996
respectively and $4,500,000 for the year ended December 31,1995.
13. WRITEDOWN OF FILM LIBRARY
During the fourth quarter of fiscal 1998, management decided to dispose of the
film library in order to concentrate the Company's business on the ownership and
operation of video specialty superstores. The film library was written down by
$3,030,000 to reflect it's net realizable value at January 31, 1998.
14. SUBSEQUENT EVENTS
The Company sold the rights to its Film Library and related accounts receivable
on March 25, 1998 to an entity owned and controlled by Stephen C. Lehman, a
member of the Company's Board of Directors for $1,350,000 in cash. No gain or
loss was recognized upon sale since the film library was stated at the net
realizable value at January 31, 1998. The proceeds were used to retire
indebtedness to Imperial Bank. The Company entered into a new $7.5 million
senior credit agreement with Finova Capital Corporation on March 25, 1998. The
initial advance of $5.5 million was used to refinance substantially all company
debt and fund the cash portion of acquisitions completed concurrently. The
Company acquired five video retail companies on March 25, 1998 for an aggregate
consideration of $1.9 million in cash, $1.17 million in assumption of payables,
and 1,815,112 shares of the Company's common stock, subject to subsequent
adjustment. In conjunction with these acquisitions, Rentrak Corporation agreed
to convert $210,000 of the Company's accounts payable balance to a subordinated
note. Subsequent to year end, the Company issued warrants to purchase 125,000
shares of the Company's common stock at an exercise price of $2.00 per share to
directors and consultants.
F-25
<PAGE>
SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
Balance at Additions Balance at
Beginning charged to costs Other end of
Description of period and expenses Retirements Changes period
----------- --------- ------------ ----------- --------- ------
<S> <C> <C> <C> <C> <C>
Reserves and allowances
deducted from asset accounts:
Allowance for uncollectible
accounts receivable:
Year ended January 31, 1998 $325,422 $325,422 0
Month ended January 31,
1997 0 $325,422 $325,422
Year ended December 31,
1996 0 0
</TABLE>
F-26
<PAGE>
EXHIBIT 21.1
LIST OF SUBSIDIARIES
<TABLE>
<CAPTION>
STATE OF NAME UNDER WHICH
SUBSIDIARY INCORPORATION BUSINESS IS DONE
- ---------- ------------- -------------------
<S> <C> <C>
Adventures in Video, Inc...................... Minnesota Adventures in Video
KDDJ Investments, Inc......................... Minnesota Movie Magic
Old Republic Entertainment, Inc............... California Video Tyme
Sulpizio One, Inc............................. California Video City
Leptis Magna, Inc............................. Colorado Video Unlimited
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JAN-31-1998
<PERIOD-START> FEB-01-1997
<PERIOD-END> JAN-31-1998
<CASH> 28,127
<SECURITIES> 0
<RECEIVABLES> 1,113,531
<ALLOWANCES> 0
<INVENTORY> 339,759
<CURRENT-ASSETS> 1,892,953
<PP&E> 859,708
<DEPRECIATION> (1,580,312)
<TOTAL-ASSETS> 6,599,316
<CURRENT-LIABILITIES> 4,542,777
<BONDS> 0
0
0
<COMMON> 97,739
<OTHER-SE> (796,562)
<TOTAL-LIABILITY-AND-EQUITY> 6,599,316
<SALES> 10,007,358
<TOTAL-REVENUES> 10,212,358
<CGS> 762,153
<TOTAL-COSTS> 12,635,314
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 552,359
<INCOME-PRETAX> (2,975,315)
<INCOME-TAX> 0
<INCOME-CONTINUING> (2,422,956)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (2,975,315)
<EPS-PRIMARY> (0.30)
<EPS-DILUTED> 0
</TABLE>
