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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________.
Commission File Number: 0-14023
VIDEO CITY, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-3897052
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9998 Global Road, 2/nd/ Floor, Philadelphia, Pennsylvania 19115
(Address of principal executive offices) (Zip Code)
(215) 856-2560
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of each class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO _________
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Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. YES X NO _________
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The aggregate market value of the registrant's common stock held by non-
affiliates of the registrant as of May 10, 2000, was approximately $2,882,573.
The number of shares of common stock outstanding as May 10, 2000 was 16,107,998
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. X
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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,
1999 is incorporated by reference in response to Part III of this Annual Report
on Form 10-K.
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Safe Harbor Statement under the Private Securities Litigation Reform Act of
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1995.
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This Annual Report contains forward-looking statements within the meaning
of the "safe harbor" provisions of the Private Securities Litigation Reform Act
of 1995, such as statements of the Company's plans, objectives, expectations and
intentions, that involve risks and uncertainties that could cause actual results
to differ materially from those discussed in such forward-looking statements.
Factors that could cause or contribute to such differences include, but are not
limited to, those discussed in the section entitled "Special Considerations" as
well as those discussed elsewhere in this Annual Report.
PART I
ITEM 1. BUSINESS
General
Video City, Inc. ("Video City" or the "Company") owns and operates several
chains of retail video specialty stores and, measured in growth rates, was one
of the fastest growing publicly-held retail video specialty store companys in
the United States in 1998. As part of its strategic plan of acquisition, during
the period from March 1998 through March 1999 the Company grew through ten
separate acquisitions from 18 stores in California to more than 130 video stores
located in 12 states. In July and August 1999, the Company sold 49 stores in
Oregon and Washington to Blockbuster, Inc. Currently, the Company owns and
operates 74 strategically located stores. The Company is planning to acquire,
through a merger, West Coast Entertainment Corporation ("West Coast"), which
owns and operates 233 video stores and franchises 80 video stores, primarily in
the Atlantic corridor between Philadelphia and Boston. See "Recent
Developments."
On March 3, 2000, Video City and West Coast entered into a Management
Agreement, pursuant to which Video City manages and operates West Coast's
business until the closing of the proposed merger between Video City and West
Coast. See "Recent Developments."
Video City's predecessor was founded in 1990 by Chairman and Chief
Executive Officer, Robert Y. Lee, for the purpose of developing a chain of
retail video specialty stores. In January 1997, this predecessor company merged
into Prism Entertainment Corporation, a publicly traded company incorporated in
Delaware, which concurrently changed its name to Video City, Inc.
The Company's predecessor, Lee Video City, Inc. ("Lee Video City"), was
formed as a California corporation in February 1990 for the purpose of
developing a chain of retail video specialty stores. In January 1997, Lee Video
City, Inc. merged with and into Prism Entertainment Corporation, a Delaware
corporation incorporated in January 1984 ("Prism"), and the surviving Delaware
corporation changed its name to "Video City, Inc." As a result of the Company's
sale of its library of 47 feature films and other film properties in March 1998,
the Company's sole business is the ownership and operation of video specialty
stores. The Company's principal executive offices were located at 370 Amapola
Avenue, Suite 208, Torrance, California 90501. In March 2000, concurrent with
the execution of the Management Agreement, the Company relocated its corporate
offices to 9998 Global Road, 2/nd/ Floor, Philadelphia, Pennsylvania, 19115 and
its new telephone number is (215) 856-2560.
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Developments During Fiscal 2000
During fiscal 2000, the Company acquired Video Galaxy, Inc. ("Video
Galaxy") from the shareholders of Video Galaxy, in a transaction structured as a
reverse triangular merger, with a newly formed subsidiary of Video City merging
into Video Galaxy. Video Galaxy owned and operated 15 retail video stores in
Connecticut and Massachusetts. The purchase price consisted of (i) 344,000
shares of Video City Common Stock and (ii) assumption and payment of
indebtedness of Video Galaxy by the Company in the amount of $4,833,000 (of
which approximately $1,757,000 was paid off by the Company at closing and
$2,000,000 was converted into 2,000 shares of the Company's Series D Convertible
Redeemable Preferred Stock and 500,000 warrants with an exercise price of $3.00
per share). The payoff of indebtedness at closing was provided by proceeds
obtained from a note payable to an existing creditor of the Company.
On July 26, 1999, the Company sold the assets of 49 of its Videoland retail
video stores located in the states of Washington and Oregon to Blockbuster, Inc
("Blockbuster"). The aggregate purchase price for the sale of the 49 stores
was approximately $14 million in cash, and approximately $2 million in notes
receivable which were subject to the transfer of assets of the four additional
Videoland stores and to certain post closing adjustments. The Company
recognized the gain on the sale of approximately $1.4 million on July 26, 1999,
which includes the four additional Videoland stores, which were transferred on
August 30, 1999.
Recent Developments
Pending merger - On August 1, 1999, the Company and West Coast
Entertainment Corporation, entered into an Agreement and Plan of Merger
("Pending Merger") (Refer to the bank term sheet and capital reorganization in
the Agreement and Plan of Merger filed as exhibit 10.12). West Coast owns and
operates 233 video stores and franchises 80 video stores, primarily in the
Atlantic corridor between Philadelphia and Boston. Under the terms of the Merger
Agreement, upon consummation of the merger, each share of West Coast common
stock will be converted for no less than 0.25 and no more than .333 share of
Video City common stock. In addition, each share of West Coast common stock will
receive .05 share of Video City Series F convertible redeemable preferred stock.
The merger will be accounted for as a purchase. The consummation of the merger,
is subject to certain terms and conditions set forth in the Merger Agreement,
including the approval of the transactions by the shareholders of Video City and
West Coast and approval by creditors and other third parties.
Management agreement - On March 3, 2000, Video City and West Coast
Entertainment Corporation ("West Coast") entered into a Management Agreement,
pursuant to which Video City will manage and operate West Coast's business until
the closing of the proposed merger between Video City and West Coast. The
Management Agreement provides that West Coast shall pay management fees for
Video City's management services in an amount equal to certain percentages of
gross revenues actually collected from the West Coast business less all costs
and expenses of West Coast incurred and paid in the ordinary course of business.
Under the Management Agreement, the management fee paid to Video City, in no
event shall be less than $400,000 per calendar month. West Coast may terminate
the Management Agreement on or after August 31, 2000. Concurrent with the
execution of the Management Agreement, the directors and executive officers of
West Coast resigned and Video City moved its principal executive offices from
Torrance, California to Philadelphia, Pennsylvania.
Restructuring - In March 2000, after entering into the Management Agreement
with West Coast and in anticipation of the proposed merger between the Company
and West Coast, the Company's management, in an effort to improve the
performance of its operations, decided to move its corporate facility and
streamline its corporate expenses. As a result of restructuring its operations,
the Company will recognize a charge of approximately $1.5 million in the first
quarter of fiscal 2001. The restructuring charge will mainly consist of
severance obligations to employees, lease liability for the executive offices in
Torrance, California, and a non-cash write down of leasehold improvements for
the Torrance facility.
Divestiture of stores - The Company is negotiating the sale of a
significant number of its stores and is entertaining several offers. The stores
for sale were strategically selected, to concentrate the Company's operations in
efficient geographic areas. The anticipated proceeds from the divestiture will
be used to eliminate the Company's indebtedness to its credit facility and to
improve its liquidity and working capital. In addition, under the Pending Merger
and Management
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Agreement with West Coast, the Company is currently negotiating to divest a
number of West Coast's video stores, with the anticipated proceeds being used to
pay the cash portion necessary to complete the restructuring of West Coast's
indebtedness and the merger. The Company believes that the successful
implementation of these plans will permit the merger to proceed and will result
in a stronger combined company. There can be no assurance that these objectives
can be successfully completed or that the resultant company will be profitable.
Industry Overview
Video Retail Industry. According to Paul Kagan Associates, the U.S.
videocassette and DVD rental and sales industry grew from $17.1 billion in
revenue in 1998 to a projected $18.5 billion in 1999 and is projected to reach
$22.8 billion in 2005. Paul Kagan Associates estimates that, in 1999, 85.9
million, or 85.9%, of the 100 million total U.S. television households owned a
VCR. The number of VCRs that were sold in the United States in 1999 was
estimated by Paul Kagan Associates to be 20.5 million, which represents the
largest number of VCRs sold in any single year. In addition, the Consumer
Electronics Manufacturers Association estimates that about 4.1 million DVD
players were sold to dealers in the United States during 1999. According to Paul
Kagan Associates, the VCR and DVD markets will continue to grow as the number of
multi-VCR households is expected to increase from 39.7 million in 1999 to 51.4
million by 2005 and the number of DVD households is projected to reach 31.0
million in 2005.
As part of its Annual Report on the Home Video Market 1998, the Video
Software Dealers Association revealed that each week some 50 million consumers
make a trip to a video store, and almost 60% of the U.S. households owning at
least one VCR rent videos at least a couple of times each month. We believe that
the following factors, among others, make video rental a preferred medium of
entertainment for millions of customers:
. the opportunity to browse among a very broad selection of movies;
. the control over viewing, such as the ability to control start, stop, pause,
fast-forward and rewind; and
. the opportunity to entertain one or more people at home for a reasonable
price.
In addition, a significant competitive advantage that our industry
currently enjoys over most other movie distribution channels except theatrical
release is the early timing of our distribution "window." After the initial
theatrical release, studios make their movies available to video stores for a
specified period of time. This window is exclusive against most other forms of
non-theatrical movie distribution, such as pay-per-view, premium television,
basic cable and network and syndicated television. The current length of the
window for video stores varies, typically ranging from 30 to 90 days for
domestic video stores and from 120 to 180 days for international video stores.
Thereafter, movies are made sequentially available to television distribution
channels.
The home video industry is highly fragmented. However, the home video
industry has experienced consolidation in recent years, as video store chains
have gained significant market share from single store operators. In the past
two years, there has been about a 14% reduction in the total number of video
stores operating in the United States. We believe that small stores and chains
in the home video industry will continue to consolidate with national and
regional chains and that such consolidation will offer us numerous acquisition
opportunities. We believe that there are several competitive advantages in being
a growing home video chain, including marketing efficiencies, access to more
copies of each videocassette through direct revenue-sharing agreements,
sophisticated information systems, and competitive pricing. Even if there is
significant consolidation, however, we expect that the home video industry will
remain fragmented.
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Movie Studio Dependence on Video Retailing. According to Paul Kagan, total
U.S. movie studio and independent supplier revenue in the United States grew at
a compound annual rate of 6.2% per year from $11.3 billion in 1995 to $15.2
billion in 1999. Paul Kagan Associates also indicate that the video retail
industry is the single largest source of domestic revenue to movie studios and
represented approximately $7.4 billion, or 48.5%, of the $15.2 billion of
estimated domestic studio revenue in 1999. 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 retail video stores provide an
inviting opportunity to browse and make an impulse choice among a very broad
selection of new releases. As a result, retail video 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 and DVDs
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. According to Paul Kagan, video rental
revenue has increased from $7.4 billion in 1997 to $8.1 billion in 1998 and is
expected to increase to $9.7 billion in 2002.
Revenue Sharing. Historically, the major studios or their licensees
released movies to video stores at wholesale prices generally between $60 and
$70 per videocassette for major theatrical releases that were priced for rental
in the United States. The studios still release movies at relatively high
wholesale prices unless the movie is subject to a revenue-sharing agreement or a
quantity discount program or is designated by the studios as a sell-through
movie. The studios attempt to maximize total revenue from newly released video
titles by maintaining the high wholesale price during the first four months to
one year after a movie is released. Thereafter, in order to promote sales to
consumers, the major studios release the movies at a substantially lower price,
generally at retail for about $10 to $20 per videocassette.
Since the late 1980s, revenue-sharing agreements have been available to
home video chains and independent video dealers through deals brokered by
distributors such as Rentrak Corporation and SuperComm, Inc. More recently, the
major studios have entered into revenue-sharing agreements directly with several
large video chains. For titles purchased under these agreements, video stores
share with the studios an agreed-upon percentage of the video stores' rental
revenue for a limited period of time in exchange for minimal fixed payments for
the videocassettes by the video stores. This percentage generally declines over
a period of weeks following the initial release of the movie. The video stores
also agree to take a minimum number of copies of each movie that is released by
a studio in any U.S. movie theater. The video stores may also agree to take a
minimum number of movies that are not released by a studio in any U.S. movie
theater. The revenue-sharing agreements, subject to limitations and exceptions,
allow the video stores to sell previously viewed videotapes to their customers.
Since 1998 a number of studios and video retailers adopted revenue sharing
as an alternative to the
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historical rental pricing structure. Studios began offering retailers more
videocassettes for an individual title at substantially lower initial cost in
exchange for a share of the rental revenue that those copies generate over their
initial release window. This has led to higher rental revenues for the video
industry as well as for the studios. In addition, revenue sharing provides the
studios an incentive to market these titles which improve revenue generated by
increased transactions for both the video industry and the studios.
We believe revenue-sharing agreements have the following significant
benefits to participating video stores:
. they provide these stores with the opportunity to substantially increase the
quantity and selection of newly released video titles that they stock;
. they increase revenues as a result of the increase in total number of
transactions per store and number of videocassettes rented per transaction;
and
. they align the studios' economic interests more closely with the interests of
the video stores.
In addition, we believe that revenue-sharing has increased the revenues
received on an annual basis by the studios through increased rental activity on
new releases as well as greater distribution and revenues on non-hit movies
through minimum output provisions.
Business Strategy
Superstore Format. The Company focuses on acquiring, building and
operating retail video superstores. The Company believes a superstore 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 in many markets 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. The majority of the stores' point-of-
sale systems are directly connected to the Company's centralized management
information systems which allows real-time communication and the ability for
customers to rent at one location and return at another. In addition the systems
infrastructure allows close monitoring of sales and inventory enabling the
Company to actively manage its new videocassette 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.
Store Location and Marketing. Most of the Company's superstores are
located in high traffic areas providing high visibility and easy access for its
customers. The Company believes excellent customer service, a
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bright, clean and friendly shopping environment and convenient store locations
are important to its success. The Company advertises through local television,
radio, newspaper and direct mail, and promotes its products through various
special programs.
Growth Strategy
Development Program. In many regions, the Company believes there are
significant opportunities for growth. Following the pending merger with West
Coast, the Company's strategy is to grow through a combination of owned and
operated growth in selected regional markets, acquisitions and the development
and rollout of a proprietary licensing program in other markets. Such 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. The
licensing program being developed will leverage off the existing infrastructure
already in place and is viewed by management as a means to rapidly expand into
new markets. Before the completion of the acquisitions in fiscal 1999, the
opening of new stores had fueled most of the Company's growth. The Company
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 is planning to merge with a company that owns
and operates 233 video stores and franchises 80 video stores See "--Recent
Developments" 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 not only enables the Company to leverage its existing infrastructure and
achieve economies of scale, but also 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.
Future store acquisitions, if any, will be pursued selectively, should
attractive opportunities become available. Such acquisitions will be based upon
location, quality of operations and financial criteria as determined by the
Company to be consistent with its growth strategy.
Geographic Concentration. The Company's strategy is to concentrate its
owned and operated expansion, whether through new store development or
acquisitions, in particular geographic areas to maximize operating efficiencies.
The Company believes that geographic concentration allows the Company to achieve
operating efficiencies in inventory management, marketing and advertising,
distribution, training and store supervision.
The Company's growth is dependent on a number of factors, including its
ability to hire, train and assimilate management and store-level employees, the
adequacy of the Company's financial resources, the Company's ability to
successfully compete in the new markets, to locate suitable store sites, to
negotiate acceptable lease terms, to adapt its purchasing, management
information and other systems to accommodate expanded operations and to
assimilate the new operations into the existing operations of the Company.
There is no assurance that the Company will be able to achieve 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
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and profitability comparable to the Company's existing stores.
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 17,000 videocassettes consisting of from 4,000 to 10,000 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 is
committed to offering as many copies of new releases as necessary to be
competitive within its markets. Promotional strategies that the Company
believes have been highly successful include (i) the 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 600 different titles. Revenues generated
from game cartridges were on a continuous upward trend from 1992 to 1995. A
decline in video game rentals began in 1995 and continued through 1996 due to
consumer confusion on the direction of new hardware and formats. Video game
rentals improved in 1997 and 1998 based on consolidation of formats by the major
suppliers, but showed a decline in 1999 as a result of maturity of the existing
platforms. 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.
Digital Video Discs. DVDs are an alternative format to VHS tapes that
offer consumers digital picture and sound and additional features such as
enhanced content and interactivity. The DVD format was introduced in late 1997,
and since then more than 6 million DVD players have reportedly been sold. The
Company began its rollout of the DVD format in its stores in December 1997 and
now carries the format in all of its stores. DVDs have shown to be the fastest
growing sell through and rental category introduced by the Company due to high
consumer demand and the Company's aggressive merchandising strategy to position
the stores to satisfy consumer demand.
Other Products. In addition to videocassette, videogame and DVD rentals
and sales the Company also rents videocassette players and video game players
in selected stores and sells a variety of video accessories and confectionery
items.
Store Operations and Locations
The Company's stores range in size from 2,125 square feet to 13,690 square
feet and offer between 6,000 to 17,000 videocassettes consisting of from 4,000
to 10,000 different titles. The Company's superstores feature television
monitors showing movie previews and promotions of coming attractions and
displays posters and stand-up displays promoting movie titles. The Company's
stores are open 365 days a year from 10:00 a.m. to 11:00 p.m.
The Company's management has substantial experience in the 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
comprehensive management information systems. The new release inventory is
actively managed, including the redistribution of certain copies to other stores
to meet greater demand.
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The following table provides the number of stores in each of the states in
which the Company owned and operated retail video stores as of May 10, 2000:
<TABLE>
<CAPTION>
Number of
State Stores
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<S> <C>
California 27
Connecticut 10
Idaho 7
Minnesota 8
Nevada 5
Iowa 6
Colorado 3
Maine 6
South Dakota 1
Massachusetts 1
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Total 74
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</TABLE>
The Company is negotiating the sale of a significant number of its stores
and is entertaining several offers. The stores for sale were strategically
selected, to concentrate the Company's operations in efficient geographic
areas. The anticipated proceeds from the divestiture will be used to eliminate
the Company's indebtedness to its credit facility and to improve its liquidity
and working capital.
Suppliers
The Company has supply agreements with its two major suppliers, Ingram
Entertainment Inc. ("Ingram") and Rentrak Corporation ("Rentrak"). 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. The Ingram supply agreement expires
on June 30, 2001 unless terminated earlier by Ingram. Pursuant to the 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. The Rentrak revenue sharing agreement
expires on May 31, 2016. In October 1999, the Company temporarily ceased
leasing or purchasing product with Rentrak, and is limiting its purchasing with
Ingram as a result of leasing product directly from film studios. The Company is
in the process of renegotiating terms with both Rentrak and Ingram, which the
Company believes will result in a favorable outcome.
Revenue Sharing
In the fourth quarter of fiscal 2000 and in the first quarter of fiscal
2001, the Company entered into revenue sharing agreements directly with major
studios. Under these agreements, studios will supply quantities of specified
videocassettes and DVDs, and the video stores share with the studios an agreed
upon percentage of the video stores' rental revenue from these products for a
limited period of time, usually up to 26 weeks following the initial release of
the movie. The revenue sharing agreements, in many cases, also allow the video
stores to sell the previously viewed tapes to their customers.
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These revenue sharing agreements provide a major competitive advantage for the
Company and have the following significant benefits;
. They provide the opportunity to substantially increase the quantity and
selection of newly released video titles in stock and decrease the in-store
copy depth problems that have plagued the industry for years;
. They increase revenues as a result of the increase in total number of
transactions per store and number of videocassettes and DVDs rented per
transaction;
. They allow for significantly increased availability of new release movies;
and
. They align the studios' economic interest more closely with the interest of
the video stores.
Revenue sharing allows Video City to purchase rental product at a lower
product cost than the traditional buying arrangements, and reduces the shelf
life of each rental product. As the new business model results in a greater
proportion of rental revenue over a shorter period of time, Video City has
changed its method of amortizing the rental library in order to more closely
match expenses in proportion with the anticipation revenues to be generated
therefrom.
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. The
Company has expended significant resources and time over the past decade to
insure a comprehensive management information system to support its future
growth initiatives and meet revenue-sharing demands. Each superstore uses a
point-of-sale system ("POS") where all rental and sales transactions are
recorded using scanned bar code information. The management information system
electronically communicates real-time data from the POS system of most of the
Company's stores and makes the daily sales, inventory and other data immediately
available to the Company's management. The Company then uses the data to manage
inventory and monitor customer demand and rental trends to maximize each store's
profitability. The data also provides individual customer and demographic
information which is used for direct marketing to these customers, and is also
used for audit and loss prevention purposes. This POS system is a sophisticated
and complete system that can be quickly implemented in new stores due to
standard file layouts and thorough documented procedures for training and staff
utilization.
Most of the Company's stores' POS systems are linked on a real-time basis,
enabling product and customer data to be shared. This sharing allows product to
be rented from one store and returned to another while tracking the product
through the system. The Company believes it is the only major chain of
superstores that
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actively uses the real-time sharing so customers can rent and return at
different locations, and has successfully promoted it to gain market share. The
"linked" capability also allows stores to locate rental and sale items which may
not be available at one location but are available at another location.
Marketing and Advertising
The Company 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 Inc. and
Hollywood Entertainment Corporation ("Hollywood Entertainment"), and with
supermarkets, 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 one of the
largest video retailers in most of its geographic markets.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of popular titles available, customer service, and, to a lesser extent,
pricing. Most of the Company's stores compete directly with stores operated by
Blockbuster and/or Hollywood Entertainment. As a result of direct competition
with Blockbuster, Hollywood Entertainment and others, rental pricing of
videocassettes and greater availability of new releases may become a more
significant competitive factor in the Company's business, which could have an
adverse impact on the results of operations of the Company.
The Company also competes with cable television, satellite and pay-per-
view, in which subscribers pay a fee to see a movie selected by the subscriber.
Existing pay-per-view services offer a limited number of channels and movies and
are only available to households with a direct broadcast satellite or a cable
converter to unscramble incoming signals. Recent technological developments
could permit cable companies, direct broadcast satellite companies, telephone
companies, and other telecommunications companies to transmit a much greater
number of movies to homes at more frequently scheduled intervals throughout the
day. Ultimately, these technologies could lead to the availability of movies to
consumers on demand. Certain cable and other telecommunications companies have
tested "video on demand" service in some markets. Video on demand service would
allow a viewer to pause, rewind and fast forward movies. Based upon publicly
available information, the Company believes these tests have been unsuccessful.
The Company also believes movie studios have a strong interest in maintaining a
viable movie rental business because the sale of videocassettes to video retail
stores represents the studio's largest source of revenue. As a result, the
Company believes movie studios will continue to make movie titles available to
cable television and other distribution channels only after the revenue has been
derived from the sale of videocassettes to video stores. Substantial
technological developments will be necessary in order for pay-per-view to match
the low price, viewing convenience and selection available through video rental.
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Seasonality
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes these
seasonality trends will continue.
Service Marks
The Company owns a United States federal registration for its service mark
"Video City." The Company considers its service mark to be important to its
continued success.
Employees
As of May 10, 2000 the Company had approximately 750 employees of whom
approximately 700 were located at the retail stores and the remainder were at
the Company's corporate administrative office. The Company is not currently a
party to any collective bargaining agreements. The Company believes that its
relationships with its employees are generally good.
ITEM 2. PROPERTIES
All of the Company's stores are leased pursuant to leases with initial
terms ranging from three to ten years, with varying option renewal periods.
Most of the leases are "triple net" requiring the Company to pay all taxes,
insurance, and common area maintenance expenses associated with the properties.
See "Business -- Store Operations and Locations."
The Company moved its corporate headquarter from Torrance, California to
Philadelphia, Pennsylvania. The facility consists of approximately 6,500 square
feet of office space and 10,000 square feet of warehouse 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, 2000.
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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 the NASD Electronic Bulletin Board under
the symbol "VDCT.OB" See "Business--General."
The following sets forth for the periods indicated the high and low sales
prices of the Company's Common Stock as reported on the NASD Electronic Bulletin
Board:
<TABLE>
<CAPTION>
<S> <C> <C>
High Low
---- ---
Fiscal Year Ended January 31, 1999:
First Fiscal Quarter $1.500 $0.250
Second Fiscal Quarter $1.500 $0.656
Third Fiscal Quarter $1.000 $0.200
Fourth Fiscal Quarter $1.937 $0.375
Fiscal Year Ended January 31, 2000:
First Fiscal Quarter $2.312 $0.812
Second Fiscal Quarter $2.687 $1.781
Third Fiscal Quarter $1.781 $0.750
Fourth Fiscal Quarter $0.960 $0.375
</TABLE>
Such over-the-counter market quotations reflect inter-dealer prices,
without retail mark-up, mark-down or commission and may not necessarily
represent actual transactions.
As of May 10, 2000, there were approximately 533 record holders of the
Company's Common Stock.
The Company has not paid cash dividends on its Common Stock since its
inception and has no current plans to pay cash dividends on its Common Stock in
the foreseeable future. The Company intends to reinvest future earnings, if
any, in the development and expansion of its business. The Company's current
credit facility prohibits the payment of cash dividends on the Company's Common
Stock. Any future determination to pay
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cash dividends will depend upon the Company's combined results of operations,
financial condition and capital requirements and such other factors deemed
relevant by the Company's Board of Directors.
The Company issued 454,720 shares of the Company's Common Stock to various
shareholders of the Company's Series B Convertible Redeemable Preferred Stock as
stock dividends with respect to the Series B Convertible Redeemable Preferred
Stock ("Series B Preferred Stock"). The stock dividends were issued on monthly
basis commencing in June 1999.
The Company issued 60,289 shares of the Company's Common Stock to various
shareholders as stock dividends with respect to the Company's Series AA
Convertible Redeemable Preferred Stock ("Series AA Preferred Stock"). The stock
dividends are issued semi-annually in June and November.
The Company will continue to issue stock dividends to shareholders of
Series B Preferred Stock and Series AA Preferred Stock, as specified by the
certificates of designation.
Recent Sales of Unregistered Securities
The Company did not sell unregistered securities in the fourth quarter of
fiscal 2000.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected historical financial data for the years ended
January 31, 2000, 1999, 1998 and December 31, 1996 and 1995, have been derived
from the financial statements. As a result of the reverse acquisition of Prism,
the Company changed its fiscal year from December 31 to January 31 effective
February 1, 1997. 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>
Month
Year ended January 31, Ended Year ended December 31,
January 31,
2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................... $ 44,785 $24,436 $10,212 $ 940 $11,441 $14,151
Operating income (loss).................... (30,001) (1,263) (2,423) (105) (418) 285
Net income (loss).......................... (32,766) 11 (2,976) (133) (43) (586)
Net income (loss) per share................ (2.29) 0.00 (0.30) (0.03) (0.01) (0.14)
Weighted average shares used
in computation............................ 14,510 12,091 9,771 4,569 4,234 4,127
OPERATING DATA:
Number of stores at end of period.......... 77 128 18 - 18 29
Increase (decrease) in same store
Revenues(1)............................... 6.8% 1.6% 4.4% - (1.2)% (1.9)%
</TABLE>
<TABLE>
<CAPTION>
Month
Year ended January 31, Ended Year ended December 31,
January 31,
2000 1999 1998 1997 1996 1995
---- ---- ---- ---- ---- ----
(In thousands of dollars, except per share and operating data)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents.................. $ 24 $ 172 $ 28 $ 1,247 $ 59 $ 418
Rental library(2).......................... 6,223 21,120 2,795 2,127 2,189 3,354
Total assets............................... 21,294 38,253 6,599 11,080 4,010 7,335
Credit facility 9,770 16,045 - - - -
Long-term debt, less current portion....... 1,232 1,637 2,043 3,341 5,804 7,954
Total liabilities.......................... 42,770 32,985 7,298 8,844 8,167 11,449
Stockholders' equity (deficit)............. (21,476) 5,267 (699) 2,236 (4,157) (4,114)
</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)
(2) The decrease in rental library is partially attributable to the adoption of
an accelerated method of amortizing videocassettes, DVDs and game inventory
in the fourth quarter of fiscal 2000.
(3) The Company used the proceeds from the divestiture on 49 stores during
fiscal 2000 to reduce the bad debt.
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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, DVDs, video games, video players and video game machines and extended
viewing fees. Product sales revenue are derived from sales of new and used
videocassettes and DVDs, including excess rental inventory, concessions and
accessory items.
Operating costs and expenses include operating expenses, cost of product
sales, and general and administrative expenses. Operating expenses consist of
amortization of videos purchased for rental, fees and lease expenses for leased
videos and all store expenses, including occupancy, payroll, store opening
expenses and direct store advertising and promotion expenses.
Rental library, which includes videocassettes, DVDs and video games, is
recorded at cost and amortized over its estimated economic life. Effective
January 31, 2000, Video City adopted an accelerated method of amortizing its
videocassette, DVD and game rental library. Video City has adopted this new
method of amortization because it has implemented a new business model,
including revenue sharing agreements with film studios, which has dramatically
increased the number of videocassettes and DVDs in the stores and is satisfying
consumer demand over a shorter period of time. Revenue sharing allows Video City
to purchase videocassettes and DVDs at a lower product cost than the traditional
buying arrangements, with a percentage of net rental revenues shared with the
studios over a contractually determined period of time. As the new business
model results in a greater proportion of rental revenue over a shorter period of
time, Video City has changed its method of amortizing the rental library in
order to more closely match expenses in proportion with the anticipation
revenues generated therefrom.
Pursuant to the new method, the Company records base stock (generally 3
copies per title for each store) at cost and amortizes a portion of these costs
on an accelerated basis over three months, generally to $8 per unit, with the
remaining base stock cost amortized on a straight line basis over 33 months to
an estimated $3 salvage value. The cost of non base stock ( generally greater
than 3 copies per title for each store) are
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<PAGE>
amortized on an accelerated basis over three months to an estimated $3 salvage
value. Video games are amortized on an accelerated basis over a 12 month period
to an estimated $10 salvage value. Revenue-sharing payments are expensed when
revenues are earned pursuant to the applicable contractual arrangements.
The adoption of the new method of amortization was accounted for as a
change in accounting estimate effected by a change in accounting principle and,
accordingly, the Company recorded a non-cash pre-tax charge of approximately
$7.1 million to cost of rental revenues in the forth quarter of the fiscal year
ended January 31, 2000. The charge represents an adjustment to the carrying
value of the rental library due to the new method of amortization.
Certain videocassettes in the rental inventory are obtained through
revenue-sharing agreements with and the film studios. Any handling fees per
video are amortized on a straight-line basis over the revenue sharing period,
and revenue sharing payments are expensed when incurred.
Cost of sales and revenue-sharing product are comprised of the cost of
videos sold to customers and the cost of concessions and other products sold in
the Company's stores. The cost of a video is measured at its amortized basis
when sold, if previously used as a rental video, or at the Company's cost if
purchased for sell-through, or at a varying basis if a revenue sharing product,
depending upon when in the revenue-sharing period it is sold.
General and administrative expenses are comprised of corporate office
expenses, including office equipment and facilities costs, management salaries
and benefits, professional fees, merger and acquisition fees, bank and financing
fees and all other items of corporate expense.
Year Ended January 31, 2000 Compared to Year Ended January 31, 1999
Revenues. Revenues for the fiscal year ended January 31, 2000 (fiscal
"2000") increased $20,349,000 or 83.3%, to $44,785,000 compared to $24,436,000
for the fiscal year ended January 31, 1999 ("fiscal 1999"). The increase in
revenues was primarily attributable to the acquisition of 15 stores on March 31,
1999, the acquisition of 76 stores acquired on December 28, 1998, partially
offset by the divestiture of 49 stores to Blockbuster on July 26, 1999 and the
closure of 15 under-performing stores during the third and forth quarters of
fiscal 2000. Even though the Company concluded fiscal 2000 with 77 stores as
compared to 128 stores for fiscal 1999, revenues increased due the fact that the
weighted average number of stores for fiscal 2000 was 109 stores as compared to
51 stores for fiscal 1999. Same store revenues for fiscal 2000 increased by
approximately 6.8% compared to fiscal 1999. The Company has no management fee
income for fiscal 2000 compared to $607,733 for fiscal 1999. The decrease
resulted due to the Company acquiring all stores that it previously managed.
Store Operating Expenses. Store operating expenses for fiscal 2000
increased $16,275,000, or 119.0%, to $29,950,000 compared to $13,675,000 for
fiscal 1999. The increase was primarily attributable to acquisition of 15
stores on March 31, 1999 and the acquisition of 76 stores on December 28, 1998,
partially offset by the divestiture of 49 stores to Blockbuster on July 26,
1999, and the closure of 15 under-performing stores in the third and fourth
quarter of fiscal 2000. Store operating expenses as a percentage of total
revenues were 66.8% for fiscal 2000 compared to 56.0% for fiscal 1999. The
increase in store expenses as a percentage of total revenue for fiscal 1999 was
primarily due to assimilation, payroll, training, and inventory expenses related
to the acquired stores.
Amortization of Rental Library. Amortization of videocassette rental
inventory for fiscal 2000 increased $11,149,000 or 438.6%, to $13,691,000
compared to $2,542,000 for fiscal 1999. The increase was primarily
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<PAGE>
attributable to an increase in rental inventory from the acquisition of 15
stores on March 31, 1999 and the acquisition of 76 stores on December 28, 1998,
partially offset by a decrease in rental inventory from the divestiture of 49
stores to Blockbuster on July 26, 1999, and the closure of 15 under-performing
stores in the third and fourth quarter of fiscal 2000. In addition, the Company
adopted an accelerated method of amortizing its rental inventory in fiscal 2000.
Pursuant to the adoption of the new method of amortization, the Company recorded
a pre-tax charge of approximately $7.1 million, in the fourth quarter of fiscal
2000. Based on the new amortization method, the Company amortizes base stock
(copies 1-3) on an accelerated basis over three months, to $8, with the
remaining base stock cost amortized on a straight line basis over 33 months to a
salvage value of $3. In fiscal 1999 the Company amortized base on a straight
line basis over 60 months to a salvage value of $3. Amortization of
videocassette rental inventory as a percentage of total revenue was 30.6% in
fiscal 2000 compared to 10.4% in fiscal 1999. The increase was primarily due to
the adoption of the accelerated method of amortizing rental inventory, partially
offset by a lower proportion of purchased rental inventory versus leased rental
inventory in fiscal 2000 compared to fiscal 1999.
Cost of Product Sales. The cost of product sales for fiscal 2000 increased
$5,612,000 or 170.0%, to $8,913,000 compared to $3,301,000 for fiscal 1999.
This increase was directly attributable to aggregate growth in videocassette,
DVD, concession and accessory sale of 126% in fiscal 2000 compared to fiscal
1999.
Cost of Leased Product. Cost of leased product for fiscal 2000 increased
$2,887,000 or 207.1%, to $4,281,000 compared to $1,394,000 for fiscal 1999. The
increase was primarily attributable to the acquisition of 15 stores on March 31,
1999 and the acquisition of 76 stores on December 28, 1998, partially offset by
the divestiture of 49 stores to Blockbuster on July 26, 1999, and the closure of
15 under-performing stores in the third and fourth quarter of fiscal 2000. Cost
of leased product as a percentage of total revenue was 9.6% in fiscal 2000
compared to 5.7% in fiscal 1999. The increase as a percentage of total revenue
was due to the higher proportion of leased rental inventory versus purchased
rental inventory in fiscal 2000 compared to fiscal 1999. In fiscal 2000 the
Company entered into direct revenue sharing agreements with film studios,
whereby the Company and the film studios will share in the revenue generated
from the leased product based on the contractual arrangement. Thus, in fiscal
2000, the Company leased product from both a supplier and film studios, while in
fiscal 1999 the Company solely leased product from a supplier.
General and Administrative. General and administrative expenses for fiscal
2000 increased $9,952,000, or 207.9%, to $14,738,000 compared to $4,786,000 for
fiscal 1999. General and administrative expenses as a percentage of total
revenues increased to 32.9% in fiscal 2000 compared to 19.6% in fiscal 1999. The
increase in general and administrative expenses was attributable to the
Company's preparation for the pending merger with West Coast Entertainment
Corporation, and the additional resources that will be required to complete the
acquisition. The Company incurred significant legal, accounting, financing and
other acquisition related costs during fiscal 2000 in order to satisfy the
demands of the pending merger, which included restructuring of bank debt,
revision of the corporate structure and satisfaction of regulatory requirements.
In addition, the Company incurred additional costs for payroll, professional
services, and travel to support the addition stores acquired in fiscal 2000 and
the stores acquired at the end of the fourth quarter in fiscal 1999.
Store Closure Expenses. Between September and December of 1999, the
Company closed 15 under-performing stores and incurred $3,211,000 of store
closure expenses.
Gain on Sale of Assets. Gain on sale of assets in fiscal 2000, resulted
from the sale of 49 stores sold to Blockbuster, Inc. on July 26, 1999. The
Company reported a $1.4 million gain.
Interest Expense. Net interest expense increased $2,144,000, or 137.1%, to
$3,707,000 compared to $1,563,000 for fiscal 2000. The increase in interest
expense was primarily due to the increased level of borrowing under the
Company's credit facility, BankBoston Retail Finance Inc. ("BankBoston"). In
addition,
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<PAGE>
the Company wrote off the unamortized loan fees related to the BankBoston credit
facility when the $30 million revolving credit facility with BankBoston was
terminated and replaced with a Forbearance Agreement that limited the credit
facility to $10.75 million.
Other. Other (income) expense increased $(28,000), or 12.6% to $(249,000)
for fiscal 2000 compared to $(221,000) for fiscal 1999. In fiscal 1999 other
income was due to the receipt of a break-up fee in connection with the
acquisition agreement entered into with Planet Video, Inc, while in fiscal 2000,
other income was primarily attributable to vending machine sales.
Income Taxes. Statement of Financial Accounting Standards No. 109
requires a valuation allowance to be recorded when it is more likely than not
that some or all of the deferred tax assets of a Company will not be realized.
At January 31, 1999, due to significant acquisitions consummated during the
year, the Company determined from its projections, that it is more likely than
not that future taxable income would be sufficient to enable the Company to
realize its deferred tax assets and had accordingly, reversed the full amount of
the valuation allowance. However, at January 31, 2000, due to the pending
acquisition with West Coast Entertainment, the losses incurred during fiscal
2000, and the Company's short-term divestiture strategy, management cannot
determine it is more likely than not that future taxable income will be
sufficient to realize the deferred tax asset. Accordingly, a full valuation
allowance has been established against the deferred tax asset at January 31,
2000.
Year Ended January 31, 1999 Compared to Year Ended January 31, 1998
Revenues. Revenues for the fiscal year ended January 31, 1999 increased
$14,224,000 or 139%, to $24,436,000 compared to $10,212,000 for the fiscal year
ended January 31, 1998 ("fiscal 1998"). The increased revenues were primarily
attributable to the acquisition of 114 stores during fiscal 1999. Same store
revenues for fiscal 1999 increased by approximately 1.6% compared to fiscal
1998. The Company ended fiscal 1999 with 128 stores operating in 9 states
compared to 18 stores operating in California at the end of fiscal 1998.
Management fee income for fiscal 1999 totaled $607,733 compared to $205,000 for
fiscal 1998. The increase was mainly due to the management fees earned from
managing Videoland's stores for the 10 weeks prior to its acquisition.
Store Operating Expenses. Store operating expenses for fiscal 1999
increased $9,215,000, or 207%, to $13,675,000 compared to $4,460,000 for fiscal
1998. The increase was primarily attributable to acquisition of 114 stores
during fiscal 1999. Store operating expenses as a percentage of total revenues
were 56.0% for fiscal 1999 compared to 43.7% for fiscal 1998. The increase in
store expenses as a percentage of total revenue for fiscal 1999 was primarily
due to assimilation, payroll, training, and inventory expenses related to the
acquired stores.
Amortization of Videocassette Rental Inventory. Amortization of
videocassette rental inventory for fiscal 1999 increased $614,000 or 31.8%, to
$2,542,000 compared to $1,928,000 for fiscal 1998. The primary reason for the
increase was the addition of 114 stores acquired during fiscal 1999, partially
offset by the effect of a change in the amortization period for base inventory
(copies 1-3) from 36 months to 60 months. Amortization of videocassette rental
inventory as a percentage of total revenue was 10.4% in fiscal 1999 compared to
18.9% in fiscal 1998. The decrease was primarily due to the Company purchasing a
lower proportion of purchased videocassettes versus leased videocassettes in
fiscal 1999 compared to fiscal 1998.
Cost of Product Sales. The cost of product sales for fiscal 1999 increased
$2,539,000 or 333%, to $3,301,000 compared to $762,000 for fiscal 1998. This
increase was directly attributable to aggregate growth in product sales of 262%
in fiscal 1999 compared to fiscal 1998.
Cost of Leased Product. Cost of leased product for fiscal 1999 increased
$975,000 or 233%, to $1,394,000 compared to $419,000 for fiscal 1998. The
increase was primarily attributable to the Company
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acquiring 114 stores during fiscal 1999. Cost of leased product as a percentage
of total revenue was 5.7% in fiscal 1999 compared to 4.1% in fiscal 1998. The
increase as a percentage of total revenue was due to the higher proportion of
leased videocassettes versus purchased videocassettes in fiscal 1999 compared to
fiscal 1998, in part due to the company's increased leasing of additional titles
to periodically provide "guaranteed" rentals of popular films in all stores.
General and Administrative. General and administrative expenses for fiscal
1999 increased $2,751,000, or 135%, to $4,786,000 compared to $2,035,000 for
fiscal 1998. The increase was primarily attributable to incurring additional
costs for payroll, professional services, and travel to support the addition of
114 new stores during fiscal 1999. General and administrative expenses as a
percentage of total revenues decreased to 19.6% in fiscal 1999 compared to 19.9%
in fiscal 1998. The decrease was mainly the result of spreading the corporate
expenses over significantly higher revenues for that period.
Write-down 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. On March 25, 1998, the Company 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 the Company's board of directors, for $1,350,000 in cash. The film
library was 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 with and into Prism. Under the agreement by which the Company sold
its film rights, the Company had 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. The
Company did not exercise this right.
Interest Expense. Net interest expense increased $1,011,000, or 183%, to
$1,563,000 for fiscal 1999 compared to $552,000 for fiscal 1998. The increase
in interest expense was primarily due to the increase in borrowings related to
the addition of the credit facility entered into with FINOVA Capital Corporation
("FINOVA") in March of 1998. The facility was used primarily to fund the cash
portion of the March 25, 1998 and September 30, 1998 acquisitions and to pay off
other short term debt. In addition, the Company incurred a write off of the
unamortized loan fees related to the FINOVA credit facility when it was paid off
on December 28, 1998 with proceeds from the new $30 million revolving credit
facility with BankBoston Retail Finance Inc. ("BankBoston").
Other. Other (income) expense was $(221,000) for fiscal 1999 compared to
$0 for fiscal 1998 mainly due to the receipt by the Company of a break-up fee in
June 1998 in connection with the acquisition agreement entered into with Planet
Video, Inc.
Income Taxes. Statement of Financial Accounting Standards No. 109
requires a valuation allowance to be recorded when it is more likely than not
that some or all of the deferred tax assets of a Company will not be realized.
At January 31, 1998, a valuation allowance for the full amount of the net
deferred tax asset in the amount of $2,195,397 was recorded because of pre-
fiscal 1998 losses and uncertainties as to the amount of taxable income that
would be generated in future years. Due to significant acquisitions consummated
during the year, the Company determined from its projections that it was more
likely than not that future taxable income would be sufficient to enable the
Company to realize its deferred tax assets and accordingly, reversed the full
amount of the valuation allowance as of January 31, 1999.
20
<PAGE>
Liquidity and Capital Resources
The Company funds its short-term working capital needs, including the
purchase of videocassettes and other inventory, primarily through cash from
operations. The Company expects that cash from operations and extended vendor
terms will be sufficient to fund future videocassette and other inventory
purchases for its existing stores. There can be no assurance, however, that
cash from operations and extended vendor terms will be sufficient to fund future
videocassette and inventory purchases.
Videocassette rental inventory is accounted for as a non-current asset
under generally accepted accounting principles because it is not an asset that
is reasonably expected to be completely realized in cash or sold in the normal
business cycle. Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of this asset as non-
current excludes it from the computation of working capital. The acquisition
cost of videocassette rental inventory, however, is reported as a current
liability until paid and, accordingly, included in the computation of working
capital. Consequently, the Company believes working capital is not as
significant a measure of financial condition for companies in the video retail
industry as it is for companies in other industries. Because of the accounting
treatment of videocassette rental inventory as a non-current asset, the Company
anticipates that it will operate with a working capital deficit during the
fiscal year ending January 31, 2001.
The Company has suffered recurring operating losses and has a working
capital deficit and a stockholders' deficit at January 31, 2000. The Company is
also in default under its debt agreements. These factors raise substantial doubt
about the Company's ability to continue as a going concern. The report of our
Independent Certified Public Accountants contains an explanatory paragraph
regarding the uncertainty of the Company's ability to continue as a going
concern.
On December 28, 1998, the Company and its subsidiaries entered into a Loan
and Security agreement with BankBoston providing for a $30 million revolving
credit facility secured by all of the assets of Video City and its subsidiaries.
The BankBoston credit facility replaced the Company's previous loan facility.
The loan agreement provided for a maturity date of December 29, 2001 and a per
annum interest rate equal to either (a) the base rate announced from time to
time by BankBoston, N.A. plus 0.5 percent or (b) LIBOR plus 3.0 percent, at
Video City's election. In addition, the Company is obligated to pay various
fees in connection with the credit facility. The amount available for borrowing
under the line of credit is determined by deducting the Company's principal
balance of the line of credit from its borrowing base. The borrowing base is
determined by multiplying the applicable inventory advance rate by the number of
units of the acceptable inventory, net of reserves. The agreement provides for
various financial reporting and financial performance covenants that require the
Company to meet or exceed certain financial ratios on a monthly basis. Due to
the Company not meeting some of the financial covenants as required, the Company
requested and was granted waivers by BankBoston for the quarters ended April 30,
1999 and July 31, 1999. On September 23, 1999, the Company entered into a
forbearance agreement with BankBoston that amended the terms of the Loan
Agreement and revised the financial performance covenants of the Loan Agreement
and contained weekly covenant requirements. From November 17, 1999 through
November 30, 1999, the Company did not meet the financial performance covenants
as set forth in the forbearance agreement. As a result of not meeting the
financial covenants, the interest rate on the loan was increased from .5% plus
prime to the default rate of interest of 3% plus prime. The forbearance
agreement also provides that the aggregate balance of the loan shall be
temporarily limited to $10,500,000. On March 9, 2000, the Company entered into
a second Forbearance Agreement with the BankBoston, after the September 10, 1999
Forbearance Agreement expired. Subject to the terms of the second Forbearance
Agreement, the Credit Facility was limited to $10,750,000, and the financial
performance covenants were revised. As of May 10, 2000, the Company is in
compliance with the financial performance covenants described in the Forbearance
Agreement dated March 9, 2000. The Company has reclassified the senior secured
revolving credit facility to current liability. BankBoston, at its discretion,
is continuing to make advances in accordance with the Loan Agreement. There
can be no assurance, however, that BankBoston will continue to make advances in
the future under the terms of the Loan Agreement.
On March 3, 2000, Video City and West Coast Entertainment Corporation
("West Coast") entered into a Management Agreement, pursuant to which Video City
will manage and operate West Coast's business until the closing of the proposed
merger between Video City and West Coast. The Management Agreement provides
that West Coast shall pay management fees for Video City's management services
in amount equal to certain percentages of gross revenues actually collected from
the West Coast business less all costs and expenses of West Coast incurred and
paid in the ordinary course of business (in no event should the management fee
paid by West Coast to Video City be less than $400,000 per calender month).
West Coast may terminate the Management Agreement on or after August 31, 2000.
The Company is negotiating the sale of a significant number of its stores
and is entertaining several offers. The stores for sale were strategically
21
<PAGE>
selected, to concentrate the Company's operations in efficient geographic areas.
The proceeds from the divestiture will be used to eliminate the Company's
indebtedness to its credit facility and to improve its liquidity and working
capital. In addition, under the Pending Merger and Management Agreement with
West Coast, the Company is currently negotiating to divest a number of West
Coast's video stores, with the proceeds being used to pay the cash portion
necessary to complete the restructuring of West Coast's indebtedness and the
merger. The Company believes that the successful implementation of these plans
will permit the merger to proceed and will result in a stronger combined
company. There can be no assurance that these objectives can be successfully
completed or that the resultant company will be profitable.
As of January 31, 2000, the total outstanding balance under the BankBoston
credit facility was $9,770,000 and the availability on the credit facility was
approximately $270,000. As of May 8, 2000, the total outstanding balance under
the BankBoston credit facility was $10,416,000 and the availability on the
credit facility was approximately $83,000.
The Company has outstanding indebtedness in the aggregate amount of
$4,862,000 with certain of the Company's key suppliers that reached maturity and
are now overdue. The debt agreements with the key suppliers provide for
increased interest rates ranging between 12% and 18% and penalty payment of up
to 8% during the periods of default. Although there can be no assurances, the
Company anticipates that it will be able to extend the maturity dates of such
indebtedness.
On June 14, 1999, the Company issued an aggregate of 2,000 shares of the
Company's Series E Convertible Preferred Stock, $1,000 stated value per share,
to a supplier, and common stock purchase warrants to purchase 50,000 shares of
the Company's Common Stock at an exercise price of $2.00 per share. The
suppliers agreed to cancel outstanding trade payables in the amount of
$2,000,000 owed by the Company to the supplier.
On July 19, 1999, the Company issued an aggregate of 625 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share to various shareholders for $625,000 cash in the form of a private
placement. Each share of Series C Convertible Redeemable Preferred Stock is
convertible into 500 shares of the Company's Common Stock at a conversion price
of $2.00 per share.
On July 26, 1999, the Company sold the assets of 49 of its Videoland retail
video stores located in the states of Washington and Oregon to Blockbuster, Inc.
The aggregate purchase price for the sale of the 49 stores is approximately $16
million in cash, of which $15.3 million was received as of August 30, 1999 and
$800,000 was received in December 1999. The net proceeds from the sale of
assets were utilized to pay down the Company's Senior Credit Facility.
On August 1, 1999, the Company and West Coast Entertainment Corporation
("West Coast") entered into an Agreement and Plan of Merger (the "Merger
Agreement"), pursuant to which a wholly-owned subsidiary of the Company will
merge with and into West Coast such that West Coast will become a wholly-owned
subsidiary of the Company (the "Merger"). Pursuant to the Merger Agreement,
upon the effectiveness of the Merger, each outstanding share of Common Stock of
West Coast will be converted into the right to receive (i) a number of shares of
Common Stock of the Company, as is calculated pursuant to the Common Stock
Exchange Ratio (as defined in the Merger Agreement), subject to a maximum of
.333 shares and a minimum of .250 shares, and (ii) 0.05 shares of the Company's
Series F Convertible Redeemable Preferred Stock, having a liquidation preference
of $25.00 per share.
The consummation of the Merger is subject to certain terms and conditions
set forth in the Merger Agreement, including the obtaining or arranging of
financing, the approval by the stockholders of the
22
<PAGE>
Company and West Coast, certain regulatory approvals and the approval by
creditors and other third parties. There can be no assurance that the Merger
with West Coast will be consummated.
Cash Flows
Net cash used in operating activities for fiscal 2000 increased by
approximately $1,183,000 or 58% compared to fiscal 1999, primarily due to an
increase in merchandise inventory and accrued expenses, partially offset by an
increase in accounts payable. Net cash provided by investing activities during
fiscal 2000 increased by $14,057,000 or 207% compared to fiscal 1999, mainly due
to proceeds from sale of assets, partially offset by an increased inventory and
fixed assets purchases. Net cash used in financing activities during fiscal
2000 increased by $13,166,000, or 194% compared to fiscal 1999, due to
repayments on the BankBoston credit facility, partially offset by the proceeds
from the issuance of long term debt and preferred stock.
Net cash provided by operating activities for fiscal 1999 decreased by
approximately $5,002,000 or 168% from fiscal 1998, primarily due to an increase
in accounts receivable, merchandise inventory, other assets, and accrued
expenses, partially offset by a decrease in notes receivable. Net cash used in
investing activities during fiscal 1999 increased by $4,034,000 or 147% compared
to fiscal 1998, mainly due to increased inventory and fixed assets purchases to
operate a larger number of stores. Net cash provided by financing activities
during fiscal 1999 was $8,952,000 compared to net cash used of $1,447,000 during
fiscal 1998. The change was mainly due to proceeds received from the BankBoston
credit facility, issuance of debt, and issuance of preferred stock, partially
offset by repayment of the FINOVA credit facility loan balance.
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 Readiness Disclosure
Before the rollover of the year from 1999 to 2000, many installed computer
systems and software products were coded to accept only two digit date entries
and were unable to accept four digit date entries to distinguish 21st century
dates from the 20th century dates. As a result, computers systems and software
used by many companies prior to the rollover date required upgrading or
replacement to comply with such "Year 2000" requirements. The failure of the
Company, its vendors, suppliers or other critical third parties with whom the
Company conducts business to achieve Year 2000 compliance on a timely basis
could materially adversely affect the Company's business, operating results, and
financial condition.
As of May 10, 2000, the Company has not experienced and does not anticipate
any material adverse effects on its production equipment, systems or operations
as a result of Year 2000 issues. Business is continuing as usual, and internal
equipment and systems will continue to be monitored for any likely disruptions.
Further, as of May 10, 2000, the Company has not experienced any operational
difficulties as a result of Year 2000 issues with its vendors, suppliers or
other critical third parties with whom the Company conducts business. However,
Year 2000 compliance has many elements and potential consequences, some of which
may not be foreseeable or may be realized in future periods. Consequently, there
can be no assurance that unforeseen circumstances may not arise, or that the
Company will not in the future identify equipment or systems which are not Year
2000 compliant.
Although the transition to the Year 2000 did not have any significant
impact on the Company or its equipment, systems and operations, the Company will
continue to monitor the impact of the Year 2000 on its equipment and systems and
those of its vendors, suppliers and other critical third parties. The
contingency plans that were developed for use in the event of Year 2000-related
failures will be maintained and generalized for ongoing business use.
In the aggregate, the Company has spent approximately $25,000 to address
Year 2000 issues and does not anticipate spending any additional material
amounts relating to Year 2000 issues.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
The Company's market risk sensitive instruments do not subject it to
material market risk exposures, except for such risks related to interest rate
fluctuations. The carrying value of the Company's bank debt approximates fair
value at January 31, 2000 and 1999 since the note related thereto substantially
bears interest at a floating rate based upon the lenders' "prime" rate.
23
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 14 of this Form 10-K for the
information required by Item 8.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
Not applicable.
24
<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 2000 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 2000 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 2000 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 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
25
<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-30
following the signature pages:
Balance Sheets
Statements of Operations
Statements of Stockholders' Equity
Statements of Cash Flows
Notes to Financial Statements
(b) Form 8-K
None in the quarter ended January 31, 2000.
(c) Exhibits
Numbers Description
- ------- -----------
3.1 Certificate of Designations for the Company's Series C Convertible
Redeemable Preferred Stock.(1)
3.2 Certificate of Designations for the Company's Series D Convertible
Redeemable Preferred Stock.(1)
3.3 Certificate of Designations for the Company's Series E Convertible
Preferred Stock.(1)
10.1 Asset Purchase Agreement dated as of April 22, 1999, by and among, the
Company, Videoland, Inc. and Blockbuster Inc.(1)
10.2 Agreement of Merger and Plan of Reorganization, dated as of March 30,
1999, by and among the Company, Video Galaxy, Inc., James G. Howard,
George M. Peloso and Kurt Peterson (previously filed).(1)
10.3 Debt Conversion Agreement dated as of March 30, 1999, by and among the
Company, Rentrak Corporation, Mortco, Inc. and Video Galaxy, Inc.(1)
10.4 Warrant to purchase 500,000 shares of Common Stock, dated as of March
31, 1999, between the Company and Mortco, Inc.(1)
10.5 Form of Option Agreement for directors and executive officers of the
Company.(1)
10.6 Form of Indemnity Agreement for directors and officers of the
Company.(1)
26
<PAGE>
10.7 Second Modification Agreement, dated as of March 31, 1999, to Loan and
Security Agreement by and among the Company, its subsidiaries and
BankBoston Retail Finance Inc.(1)
10.8 Stock Purchase Agreement, dated June 2, 1999, by and between the
Company and The Value Group, LLC.(2)
10.9 Common Stock Purchase Warrant, dated May 11, 1999, by and between the
Company and The Value Group, LLC.(2)
10.10 Stock Purchase Agreement, dated June 11, 1999, by and between the
Company and International Video Distributors, LLC.(2)
10.11 Common Stock Purchase Warrant, dated June 11, 1999, by and between the
Company and International Video Distributors, LLC.(2)
10.12 Agreement and Plan of Merger, dated August 1, 1999, by and among the
Company, Key Stone Merger Corp. and West Coast Entertainment
Corporation (previously filed).(2)
10.13 Employment Agreement, dated June 16, 1999, between the Company and
Richard T. Gibson(2)
10.14 Amendment to Loan Documents, dated as of December 31, 1998, by and
among the Company, Ingram Entertainment Inc. and the debtors named
therein.(2)
10.15 Warrant to Purchase Common Stock, dated December 31, 1998, executed by
the Company for Ingram Entertainment Inc.(2)
10.16 Forbearance Agreement dated September 10, 1999, by and between the
Company and BankBoston Retail Finance, Inc.(3)
10.17 Management Agreement, dated as of March 3, 2000, by and between Video
City, Inc. and West Coast Entertainment Corporation. (4)
10.18 First Amendment to Merger Agreement, dated as of March 3, 2000, by and
among Video City, Inc., Keystone Merger Corp. and West Coast
Entertainment Corporation. (4)
10.19 Forbearance Agreement, dated March 9, 2000, between Video City, Inc.
and Fleet Retail Finance Inc. f/k/a BankBoston Retail Finance Inc. (5)
21.1 List of Subsidiaries of Video City, Inc. (5)
23.1 Consent of BDO Seidman, LLP (5)
27 Financial Data Schedule (5)
_____________________
(1) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended April 30, 1999, and incorporated herein by
reference.
(2) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended July 31, 1999, and incorporated herein by
reference.
27
<PAGE>
(3) Previously filed as exhibits to the Company's Quarterly Report on Form 10-Q
for the fiscal quarter ended October 31, 1999, and incorporated herein by
reference.
(4) Previously filed as exhibits to the Company's Current Report on Form 8-K,
dated March 30, 1998, and incorporated herein by reference.
(5) Filed herewith
(d) Financial Statement Schedule
Schedules for which provision is made in the applicable accounting
regulation of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted
28
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED JANUARY 31, 2000, 1999 AND 1998
<PAGE>
ITEM 8. Consolidated Financial Statements and Supplementary Data
The following consolidated financial statements are filed with this report:
Report of Independent Certified Public Accountants F-3
Consolidated Balance Sheets F-4
Consolidated Statements of Operations F-5
Consolidated Statements of Stockholders' Equity (Deficit) F-6
Consolidated Statements of Cash Flows F-7
Notes to Consolidated Financial Statements F-9
F-2
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors
Video City, Inc.
We have audited the accompanying consolidated balance sheets of Video City, Inc.
as of January 31, 2000 and 1999 and the related consolidated statements of
operations, stockholders' equity (deficit), and cash flows for each of the three
years in the period ended January 31, 2000. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Video City, Inc. as
of January 31, 2000 and 1999, and the results of its operations and its cash
flows for each of the three years in the period ended January 31, 2000, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring operating
losses, has a working capital deficit and a stockholders' deficit at January 31,
2000. The Company is also in default under its debt agreements. These conditions
raise substantial doubt about its ability to continue as a going concern.
Management's plans in regard to these matters are also described in Note 1. The
consolidated financial statements do not include any adjustments that might
result from the outcome of this uncertainty.
BDO Seidman, LLP
Los Angeles, California
May 12, 2000
F-3
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
January 31, January 31,
2000 1999
--------------- ---------------
<S> <C> <C>
Assets (Notes 1, 6, 7 and 8)
Current assets
Cash $ 24,316 $ 172,043
Customer receivables (Note 1) 1,003,578 2,932,807
Notes receivable (Note 6) 9,078 86,703
Merchandise inventories (Note 1) 3,767,919 2,026,628
Prepaid expenses 75,000 52,870
--------------- ---------------
Total current assets 4,879,891 5,271,051
Rental library, net (Note 1) 6,223,364 21,119,897
Property and equipment, net (Note 7) 4,266,665 4,525,986
Goodwill, net (Note 1) 4,920,303 5,176,850
Deferred taxes, net (Note 10) - 883,249
Other assets 1,003,564 1,275,847
--------------- ---------------
Total assets $ 21,293,787 $ 38,252,880
=============== ===============
Liabilities and Stockholders' Equity (Deficit)
Current liabilities
Accounts payable $ 23,033,955 $ 9,328,556
Accrued expenses 3,069,765 3,422,724
Senior secured revolving credit facility (Note 8) 9,769,574 -
Current portion of long-term debt (Note 9) 5,565,078 2,125,187
--------------- ---------------
Total current liabilities 41,438,372 14,876,467
Senior secured revolving credit facility (Note 8) - 16,044,502
Long-term debt, less current portion (Note 9) 1,231,907 1,636,646
Other liabilities 99,456 427,791
--------------- ---------------
Total liabilities 42,769,735 32,985,406
Commitments and contingencies (Note 11)
Stockholders' equity (deficit) (Note 12)
Preferred stock 6,217,135 3,763,963
Common stock, $.01 par value per share, authorized 30,000,000 shares;
issued and outstanding 15,767,959 shares at 2000 and
13,498,715 shares at 1999 157,679 134,987
Additional paid-in capital 13,268,548 9,229,687
Accumulated deficit (41,119,310) (7,861,163)
--------------- ---------------
Total stockholders' equity (deficit) (21,475,948) 5,267,474
--------------- ---------------
Total liabilities and stockholders' equity (deficit) $ 21,293,787 $ 38,252,880
=============== ===============
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
January 31, January 31, January 31,
2000 1999 1998
----------------- ----------------- -----------------
<S> <C> <C> <C>
Revenue
Rental revenues and product sales $ 44,784,703 $ 23,828,501 $ 10,007,358
Management fee income - 607,733 205,000
----------------- ----------------- -----------------
Total revenue 44,784,703 24,436,234 10,212,358
----------------- ----------------- -----------------
Operating costs and expenses
Store operating expenses 29,950,293 13,675,372 4,460,200
Amortization of rental library 13,691,184 2,541,934 1,928,343
Cost of product sales 8,913,401 3,301,185 762,153
Cost of leased product 4,281,313 1,394,409 419,361
General and administrative 14,738,358 4,785,890 2,035,428
Non-recurring write-down of Film Library
(Note 15) - 3,029,829
Store closure expenses 3,210,830 - -
----------------- ----------------- -----------------
Total operating costs and expenses 74,785,379 25,698,790 12,635,314
Loss from operations (30,000,676) (1,262,556) (2,422,956)
Other (income) expense
Gain on sale of assets (Note 3) (1,400,021) - -
Interest expense, net 3,706,749 1,563,348 552,359
Other (249,078) (221,081) -
----------------- ----------------- -----------------
Loss before income taxes (32,058,326) (2,604,823) (2,975,315)
----------------- ----------------- -----------------
Income tax expense (benefit) (Note 10) 707,299 (2,615,957) -
----------------- ----------------- -----------------
Net income (loss) before dividends $ (32,765,625) $ 11,134 $ (2,975,315)
================= ================== =================
Dividends (492,522) - -
----------------- ----------------- -----------------
Net income (loss) available to common
shareholders $ (33,258,147) $ 11,134 $ (2,975,315)
================= ================== =================
Earnings (loss) per share (Note 13):
Basic earnings (loss) per share $ (2.29) $ 0.00 $ (0.30)
Diluted earnings (loss) per share $ (2.29) $ 0.00 $ (0.30)
================= ================== =================
Weighted average number of common shares
outstanding:
Basic 14,509,555 12,091,467 9,770,594
Diluted 14,509,555 13,428,378 9,770,594
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
Preferred Stock (Note 12)
--------------------------------------------------------------------------------
Series AA Series B Series C
----------------------- ---------------------- ----------------------
Shares Amount Shares Amount Shares Amount
------- -------- -------- ------- ------ ------
<S> <C> <C> <C> <C> <C> <C>
Balance, at January 31, 1998 - $ - - $ - - $ -
Stock issued in satisfaction of 750 75,000 - - - -
payables
Stock issued for acquisition of - - 76,000 3,065,190 - -
stores
Stock issued for private placement 7,000 623,773 - - - -
Net income - - - - - -
--------- -------- -------- ---------- -------- --------
Balance at January 31, 1999 7,750 698,773 76,000 3,065,190 - -
Stock issued in satisfaction of - - - - - -
payables
Stock issued for services rendered - - - - 403 403,000
Stock issued for acquisitions - - - - 112 63,840
Stock issued for private placement - - - - 625 625,000
Stock option and warrants - - - - - -
exercised
Preferred stock converted into (3,750) (334,162) - - (740) (691,840)
common
Stock dividends issued - - - - - -
Issuance of options and warrants - - - - - -
Net loss - - - - - -
--------- -------- -------- ---------- -------- --------
Balance at January 31, 2000 4000 $364,611 76,000 $3,065,190 400 $400,000
========= ======== ======== ========== ======== ========
<CAPTION>
Preferred Stock (Note 12)
------------------------------------------
Series D Series E Common Stock Additional
----------------- ------------------- -------------------- Paid-In
Shares Amount Shares Amount Shares Amount Capital
------ ------- ------ ------ ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, at January 31, 1998 - $ - - $ - 9,773,927 $ 97,739 $ 7,075,735
Stock issued in satisfaction of - - - - 243,288 2,433 192,803
payables
Stock issued for acquisition of - - - - 3,481,500 34,815 1,961,149
stores
Stock issued for private placement - - - - - - -
Net income - - - - - - -
------- ---------- ------- ---------- ---------- --------- ------------
Balance at January 31, 1999 - - - - 13,498,715 134,987 9,229,687
Stock issued in satisfaction of - - 2,056 2,056,000 203,300 2,033 379,667
payables
Stock issued for services rendered - - - - 26,000 260 33,852
Stock issued for acquisitions 2,000 1,187,334 - - 344,000 3,440 609,224
Stock issued for private placement - - - - - - -
Stock option and warrants
exercised - - - - 123,077 1,231 66,459
Preferred stock converted into
common - - (856) (856,000) 1,057,858 10,578 1,657,734
Stock dividends issued - - - - 515,009 5,150 487,373
Issuance of options and warrants - - - - - - 804,552
Net loss - - - - - -
------- ---------- ------- ---------- ---------- --------- ------------
Balance at January 31, 2000 2,000 $1,187,334 1,200 $1,200,000 15,767,959 $ 157,679 $ 13,268,548
======= ========== ======= ========== ========== ========= ============
<CAPTION>
Accumulated
Deficit
------------
<S> <C>
Balance, at January 31, 1998 $ (7,872,297)
Stock issued in satisfaction of -
payables
Stock issued for acquisition of -
stores
Stock issued for private placement -
Net income 11,134
--------------
Balance at January 31, 1999 (7,861,163)
Stock issued in satisfaction of
payables -
Stock issued for services rendered -
Stock issued for acquisitions -
Stock issued for private placement -
Stock option and warrants -
exercised
Preferred stock converted into
common -
Stock dividends issued (492,522)
Issuance of options and warrants -
Net loss (32,765,625)
--------------
Balance at January 31, 2000 $ (41,119,310)
==============
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended Year ended Year ended
January 31, January 31, January 31,
2000 1999 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Increase (Decrease) in cash and cash equivalents
Cash flows from operating activities:
Net income (loss) before dividends $ (32,765,625) $ 11,134 $ (2,975,315)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization 16,253,259 3,692,329 2,127,443
Gain on sale of assets (1,400,021) - -
Issuance of stock for services and inventory 2,846,082 195,236 40,000
Non-recurring writedown of film library - - 3,029,829
Store closures 1,604,297 - -
Issuance of stock options and warrants 804,552 - -
Decrease (increase) in deferred tax asset 688,536 (883,249) -
Changes in assets and liabilities, net of effects from
acquisitions:
Decrease (increase) in accounts receivable 1,160,962 (1,378,087) 1,409,951
Decrease (increase) in notes receivable 82,234 268,727 (280,783)
Increase in merchandise inventory (2,205,613) (853,142) -
Decrease (increase) in other assets 240,026 (925,751) (280,703)
Increase (decrease) in accounts payable 12,128,385 (134,616) (30,302)
Decrease in accrued expenses (2,321,764) (1,738,833) (5,192)
Decrease in other liabilities (328,335) (284,140) (62,944)
-------------- ------------- -------------
Net cash provided by (used in) operating activities (3,213,025) (2,030,392) 2,971,984
Cash flows from investing activities
Purchases of videocassette rental inventory, net (6,425,632) (4,213,040) (2,596,812)
Purchases of fixed assets (2,043,954) (756,398) (189,719)
Store acquisitions (167,036) (2,626,185) -
Proceeds from sale of fixed assets 13,863,000 - -
Proceeds from sale of film library - 818,171 -
Repayment on notes receivable 2,053,391 - 43,400
-------------- ------------- -------------
Net cash provided by (used in) investing activities 7,279,769 (6,777,452) (2,743,131)
Cash flows from financing activities
Proceeds from the issuance of preferred stock 625,000 623,773 -
Principal payments on obligations under capital leases - (18,136) -
Repayment of long-term debt (434,533) (13,221,880) (1,447,243)
Proceeds from issuance of long-term debt 2,015,979 5,523,501 -
Proceeds from borrowings (repayments) under revolving (6,274,919) 16,044,502 -
credit facility, net
Cash payment made in conversion of preferred stock (213,690) - -
Proceeds from exercising stock options 67,692 - -
-------------- ------------- -------------
Net cash provided by (used in) financing activities (4,214,471) 8,951,760 (1,447,243)
Net increase (decrease) in cash (147,727) 143,916 (1,218,390)
Cash at beginning of year 172,043 28,127 1,246,517
-------------- ------------- -------------
Cash at end of year $ 24,316 $ 172,043 $ 28,127
============== ============= ==============
</TABLE>
See accompanying notes to financial statements.
F-7
<PAGE>
VIDEO CITY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS CONTINUED
<TABLE>
<CAPTION>
Year ended Year ended Year ended
January 31, January 31, January 31,
2000 1999 1998
-------------- -------------- --------------
<S> <C> <C> <C>
Supplementary disclosures of cash flow information
Cash paid during the year:
Interest $ 1,437,112 $ 1,071,506 $ 557,551
Income taxes 17,924 800 800
Noncash investing and financing activities:
Professional services financed through issuance of common
stock 2,846,082 195,236 40,000
Liabilities converted to preferred stock 1,187,334 - -
Preferred stock dividends 492,522 - -
Conversion of accounts payable to short term debt 1,453,706 - -
Accounts payable converted to long term debt - 494,935 435,032
Professional services financed through issuance of
preferred stock - 75,000 -
For acquisitions consummated during fiscal 2000 and fiscal 1999, the Company paid $167,036 and $2,626,185 , net of
cash acquired. In conjunction with the acquisitions, liabilities were assumed as follows:
Fair value of assets acquired $ 1,614,929 $ 22,018,218 $ -
Cash paid (167,036) (2,626,185) -
Common stock issued (641,394) (1,995,964) -
Preferred stock issued (1,251,174) (3,065,190) -
Goodwill 4,172,469 5,260,990 -
------------- ------------- -------------
Liabilities assumed $ 3,727,794 $ 19,591,869 $ -
============= ============= =============
</TABLE>
See accompanying notes to consolidated financial statements
F-8
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--Business Operations and Significant Accounting Policies
Video City, Inc. (the "Company"), a Delaware Corporation, was formed on January
27, 1984. The Company owns and operates retail video specialty stores. As of
January 31, 2000 ("Fiscal 2000"), the Company owned and operated 77 stores. The
stores are located in California, Oregon, Nevada, Idaho, Iowa, South Dakota,
Colorado, Minnesota, Maine, Connecticut and Massachusetts.
The Company's predecessor, Lee Video City, Inc. ("Lee Video City"), was formed
as a California corporation in February 1990 for the purpose of developing a
chain of retail video specialty stores. In January 1997, Lee Video City, Inc.
merged with and into Prism Entertainment Corporation, a Delaware Corporation
incorporated in January 1984 ("Prism"), pursuant to an Agreement and Plan of
Reorganization and Merger, dated as of October 25, 1996 (the "Plan"), and the
surviving corporation changed its name to "Video City, Inc." Prism had operated
as a debtor in possession under Chapter 11 of the United States Bankruptcy Code
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.
The accompanying consolidated financial statements include the accounts of Video
City, Inc. and its wholly owned subsidiaries. These subsidiaries include Old
Republic Entertainment, Inc., Sulpizio One, Inc., Video Tyme, Inc., Videoland,
Inc and Video Galaxy, Inc. All material intercompany transactions have been
eliminated. The financial statements include the operations of companies
acquired from the dates of acquisition (Note 2).
Going Concern Uncertainty
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern which contemplates the
realization of assets and the satisfaction of liabilities in the ordinary course
of business. The carrying amounts of assets and liabilities presented in the
financial statements do not purport to represent realizable or settlement
values. However, the Company has suffered recurring operating losses and has a
working capital deficit and stockholders' deficit at January 31, 2000. The
Company is also in default of its debt agreements. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
The Company has entered into a management agreement (Note 17) with West Coast
Entertainment Corporation, until the closing of the proposed merger between the
Company and West Coast (Note 16), which provides a management fee for the
Company's management services. Under the Management agreement, the management
fee, in no event shall be less than $400,000 per month.
Concurrent with the execution of the management agreement, and in anticipation
of the proposed merger, the Company combined the operations and substantially
reduced corporate expenses of both Video City and West Coast Entertainment, thus
utilizing the benefits of economies of scale.
The Company is negotiating the sale of a significant number of its stores and is
entertaining several offers. The stores for sale were strategically selected, to
concentrate the Company's operations in efficient geographic areas. The
proceeds from the divestiture will be used to eliminate the Company's
indebtedness to its credit facility and to improve its liquidity and working
capital. In addition, under the Pending Merger and Management Agreement with
West Coast, the Company is currently negotiating to divest a number of West
Coast's video stores, with the proceeds being used to pay the cash portion
necessary to complete the restructuring of West Coast's indebtedness and the
merger.
The Company believes that the successful implementation of these plans will
permit the merger to proceed and that the combined company after the merger will
have the potential for greater financial strength, operational efficiencies,
earning power and growth potential than either Video City or West Coast would
have on its own. There can be no assurance, however, that these objectives can
be successfully completed or that the resultant company will be profitable and
have higher operating cash flows.
Customer Receivables
Customer receivables primarily consist of late fees on the film and game rental
library, and fees for unreturned items. In the fourth quarter of fiscal 2000,
the Company reviewed the collectibility of outstanding late fees and wrote-off
approximately $1.1 million of customer receivable from late fees based on its
collection results during fiscal 2000.
F-9
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--Business Operations and Significant Accounting Policies
(Continued)
Merchandise Inventories
Merchandise inventories, consist primarily of prerecorded videocassette retail
inventory, DVDs, video games, concessions, and accessories held for resale and
are stated at the lower of cost or market. Merchandise inventory cost of sales
are determined on a first-in, first-out basis.
Rental Library
During the fourth quarter of fiscal 2000, the Company adopted an accelerated
method of amortizing its film and game rental library in order to more closely
match expenses in proportion with anticipated revenues from the revenue-sharing
business model (see Note 5).
Rental amortization expense approximated $13,691,372 (including a $7.1 million
adjustment recorded in the fourth quarter fiscal 2000), $2,541,934 and
$1,928,343 for the years ended January 31, 2000, 1999 and 1998.
As videocassettes are sold or retired, the applicable cost and accumulated
amortization are eliminated from the accounts, and any gain or loss is recorded.
Property and Equipment
Property and equipment are recorded at cost and are depreciated using the
straight-line method over estimated useful lives, ranging from five to ten
years. Leasehold improvements are recorded at cost and amortized using the
straight-line method over the estimated economic life of the lease term.
Impairment of Long-Lived Assets
In the event that facts and circumstances indicate that the cost of an asset may
be impaired, an evaluation of recoverability would be performed. If an
evaluation were required, the estimated future undiscounted cash flows
associated with the asset would be compared to the carrying amount to determine
if a writedown to market value is required
Goodwill
Goodwill represents the excess of the cost of the companies acquired over the
fair value of their net assets at the dates of acquisition and is amortized on
the straight-line method over 20 years. Periodically, the Company reviews the
recoverability of goodwill. The measurement of possible impairment is based
primarily on the ability to recover the balance of the goodwill from the
expected future operating cash flows on an undiscounted basis. In management's
opinion, no material impairment exists at January 31, 2000. Amortization
expense charged to operations for the year ended January 31, 2000 was $312,561.
F-10
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Revenue Recognition
Revenue is recognized at the time of rental or sale, or as late charges accrue.
Store Opening Costs
Store opening costs, which consist primarily of payroll, advertising and
supplies, are expensed as incurred.
Store Closures
Reserves for store closures are established by calculating the remaining lease
obligation, adjusted for estimated subtenant agreements or lease buyouts, if
any, and are expensed along with any leasehold improvements, and unamortized
goodwill. Store furniture and equipment are either transferred at historical
cost to another location or written down to their net realizable value. In
fiscal 2000, the Company incurred approximately $3.2 million in store closure
expenses, of which approximately $1.8 million was incurred in the fourth quarter
of fiscal 2000.
Stock-Based Compensation
The Company adopted for footnote disclosure purposes only, Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS No. 123). SFAS No. 123 requires that companies recognize
the fair value of all stock-based awards on the date of grant as compensation
expense over the vesting period. Alternatively, SFAS 123 also allows entities
to continue to apply the provisions of APB Opinion No. 25 and provide pro forma
net income and pro forma earnings per share disclosures for employee stock
option grants made in 1995 and future years as if the fair-value method defined
in SFAS 123 had been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma disclosure provision
of SFAS 123.
F-11
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Income Taxes
The Company records income taxes pursuant to Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS No. 109). Under the
asset and liability method of SFAS No. 109, deferred income taxes are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled.
Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date.
Earnings (Loss) per Share
Earning (loss) per share is presented according to Statement of Financial
Accounting Standards No. 128 (SFAS No. 128), "Earnings Per Share." Basic EPS
excludes dilution and is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period. Diluted EPS reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or converted
into common stock or resulted from issuance of common stock that then share in
earnings. SFAS No. 128 also requires dual presentation of basic and diluted EPS
on the face of the income statement and a reconciliation of the numerator and
denominator of the basic EPS computation to the numerator and denominator of the
diluted EPS computation.
Comprehensive Income
Comprehensive income (loss) is the change in equity of a business enterprise
during a period from transactions and all other events and circumstances from
non-owner sources. Other comprehensive income (loss) includes foreign currency
items and minimum pension liability adjustments. The Company did not have
components of other comprehensive income (loss) during the periods presented.
As a result, comprehensive income (loss) is the same as the net income (loss)
for the periods presented.
Use of Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the year.
Actual results could differ from those estimates.
F-12
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
Reclassification
Certain reclassifications have been made to the prior year financial statements
to conform with the 2000 presentation.
NOTE 2--ACQUISITIONS
On March 31, 1999, the Company acquired Video Galaxy, Inc. ("Video Galaxy") from
the shareholders of Video Galaxy, in a transaction structured as a reverse
triangular merger, with a newly formed subsidiary of Video City merging into
Video Galaxy. Video Galaxy owned and operated 15 retail video stores in
Connecticut and Massachusetts. The purchase price consisted of (i) 344,000
shares of Video City Common Stock and (ii) assumption and payment of
indebtedness of Video Galaxy by the Company in the amount of $4,833,000 (of
which approximately $1,757,000 was paid off by the Company at closing and
$2,000,000 was converted into 2,000 shares of the Company's Series D Convertible
Redeemable Preferred Stock and 500,000 warrants with an exercise price of $3.00
per share). The payoff of indebtedness at closing was provided by proceeds
obtained from a note payable to an existing creditor of the Company.
On March 26, 1999, the Company issued 112 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to Box
Office, LLC as part of the consideration for the purchase of the assets of a
video store acquired from Box Office, LLC. The Series C Convertible Redeemable
Preferred Stock is convertible into shares of the Company's Common Stock at a
conversion price of $2.00 per share.
On December 28, 1998, the Company acquired Cianci's Videoland, Inc.
("Videoland). Videoland owned and operated 76 stores in Oregon, Washington,
Iowa, Idaho, South Dakota and California. The consideration consisted of 76,000
shares of the Company's Series B voting Convertible Redeemable Preferred Stock
with a stated value of $100 per share, $1,900,000 in cash and the assumption of
approximately $11,500,000 of liabilities.
On September 30, 1998, the Company acquired an aggregate of nine retail video
stores through the acquisition of all of the outstanding shares of capital stock
of Video Tyme, Inc. ("Video Tyme") and substantially all of the assets of Far
West Entertainment, Inc. ("Far West") and Game City, Inc. ("Game City). The
following sets forth a description of the transactions:
F-13
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2--ACQUISITIONS (Continued)
(a) Video Tyme, Inc. - Video Tyme owned and operated seven retail video stores
in Las Vegas, Nevada, of which six were acquired. The purchase price of
Video Tyme consisted of 1,050,000 shares of the Company's common stock and
cash in the amount of $1,000,000. The Company also entered into a
management agreement with the selling shareholders to manage an additional
store in Las Vegas currently owned by the selling shareholders.
(b) Far West Entertainment, Inc. - Far West owned and operated two retail video
stores located in Clovis, California and Pocatello, Idaho. The purchase
price of the assets of Far West consisted of 32,000 shares of the Company's
common stock, cash in the amount of $20,000, the assumption of certain
indebtedness to third parties and to the Company in the total amount of
$495,000 and a promissory note in the principal amount of $100,000. For
more than 21 months prior to this acquisition, the store located in Clovis,
California was managed by the Company pursuant to a management agreement,
and operated under the name "Video City."
(c) Game City, Inc. -Game City owned and operated a retail video store in
Bakersfield, California. The purchase price of the assets consisted of cash
in the amount of $7,500, the assumption of certain indebtedness to third
parties and to the Company in the total amount of $117,500, and a
promissory note in the principal amount of $150,000. For more than 26
months prior to this acquisition, this acquired store was managed by the
Company pursuant to a management agreement, and operated under the name
"Video City." The prior owners of Game City are related to Robert Y. Lee,
the Company's Chief Executive Officer and Chairman of the Board.
On March 25, 1998, Video City acquired five corporations owning and operating an
aggregate of 29 retail video stores. The following sets forth a description of
the transactions:
(a) Adventures in Video, Inc. ("Adventures") and KDDJ Investments, Inc.
("KDDJ") - Adventures owned and operated thirteen stores in Minnesota in
the greater Minneapolis metropolitan area. The purchase price for
Adventures was 866,000 shares of the Company's common stock. KDDJ owned
and operated three stores in San Francisco, California. The purchase price
for KDDJ was 216,500 shares of the Company's common stock. Pursuant to the
merger agreement, the Company paid off existing indebtedness of
approximately $449,000 that Adventures owed to Marquette Bank, N.A. As
part of the restructuring (see Note 3), Rentrak accepted 194,950 shares of
Video City common stock in settlement of $389,900 owed by Adventures. The
Company also entered into a two-year employment agreement with the prior
owner 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.
(b) Leptis Magna, Inc. - This company owned and operated five stores under the
name "Video Unlimited" in Colorado. The purchase price in this merger
consisted of $75,000 in cash, a one-year promissory note for $75,000
payable in twelve equal monthly installments, and 150,000 shares of the
Company's common stock. Pursuant to the Merger Agreement, the Company also
paid off existing indebtedness including $131,000 owed to Norwest Bank
Colorado, N.A. and $372,000 of indebtedness owed to a major vendor.
F-14
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2--ACQUISITIONS (Continued)
(c) Old Republic Entertainment, Inc. - This company owned and operated four
stores in and around Ventura, California, under the name "Video Tyme." The
purchase price consisted of 350,000 shares of the Company's common stock,
$150,000 in cash, and the assumption of certain debt. Pursuant to the
Merger Agreement, the Company paid off approximately $741,000 of existing
indebtedness owed to three creditors of the acquired company.
(d) Sulpizio One, Inc. - This company owned and operated four stores in
Lancaster, Santa Barbara, and Los Banos, California. The purchase price
consisted of 100,000 shares of the Company's common stock plus the
assumption of all liabilities including the amounts owing to Rentrak (See
Note 3). For more than three years prior to this acquisition, these stores
were managed by the Company under a management agreement and operated under
the name "Video City."
NOTE 3--DIVESTITURE OF STORES
On July 26, 1999, the Company sold the assets of 49 of its Videoland retail
video stores located in the states of Washington and Oregon to Blockbuster, Inc
("Blockbuster"). The aggregate purchase price for the sale of the 49 stores
was approximately $14 million in cash, and approximately $2 million in notes
receivable which were subject to the transfer of assets of the four additional
Videoland stores and to certain post closing adjustments. The Company
recognized the gain on the sale of approximately $1.4 million on July 26, 1999,
which includes the four additional Videoland stores, which were transferred on
August 30, 1999.
NOTE 4--PRO FORMA CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
The following unaudited pro forma condensed consolidated statements of
operations are based on the historical income statements of Video City, Inc.,
Far West Entertainment, Inc., Game City, Inc., Video Tyme, Inc., Videoland,
Inc., Video Galaxy, Inc., and the 49 stores divested, and assumes all
acquisitions and divestitures occurred at the beginning of each period
presented. The unaudited pro forma condensed consolidated statements of
operations may not be indicative of the actual results of the transactions and
there can be no assurance that the foregoing results will be obtained.
<TABLE>
<CAPTION>
Year ended Year ended
January 31, January 31,
2000 1999
---------------- ----------------
<S> <C> <C>
Revenue and product sales $ 36,327,830 $ 58,362,793
Loss before income taxes $ (33,741,255) $ (1,650,680)
Net loss before dividends $ (34,448,554) $ (1,023,422)
Net loss available to common shareholders $ (35,131,039) $ (1,530,089)
Basic loss per share $ (2.40) $ (0.11)
Basic weighted average number of shares outstanding 14,621,688 13,643,335
</TABLE>
F-15
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--CHANGE IN AMORTIZATION METHOD OF RENTAL LIBRARY
During the fourth quarter of fiscal 2000, the Company adopted an accelerated
method of amortizing its videocassette, DVD and game rental library. The
Company has adopted this new method of amortization because it has implemented a
new business model, including revenue sharing agreements with film studios,
which has increased the number of videocassettes and DVDs in the stores and is
satisfying consumer demand over a shorter period of time. Revenue sharing
allows the Company to purchase videocassettes and DVDs at a lower initial
product cost than the traditional buying arrangements, with a percentage of net
rental revenues shared with the studios over a contractually determined period
of time. As the new business model results in a greater proportion of rental
revenue over a shorter period of time, the Company has changed its method of
amortizing the rental library in order to more closely match expenses in
proportion with the anticipated revenues to be generated therefrom.
Pursuant to the new amortization method, the Company records base stock
(generally 3 copies per title for each store) at cost and amortizes a portion of
these costs on an accelerated basis over three months, generally to $8 per unit,
with the remaining base stock cost amortized on a straight line basis over 33
months to an estimated $3 salvage value. The cost of non base stock (generally
greater than 3 copies per title for each store) are amortized on an accelerated
basis over three months to an estimated $3 salvage value. Video games are
amortized on an accelerated basis over a 12 month period to an estimated $10
salvage value. Revenue-sharing payments are expensed when revenues are earned
pursuant to the applicable contractual arrangements.
The adoption of the new method of amortization was accounted for as a change in
accounting estimate and, accordingly, the Company recorded a pre-tax adjustment
of approximately $7.1 million to cost of rental revenues in the fourth quarter
of the fiscal year ended January 31, 2000. The charge represents an adjustment
to the carrying value of the rental library due to the new method of
amortization.
F-16
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5--CHANGE IN AMORTIZATION METHOD OF RENTAL LIBRARY (Continued)
Under the previous amortization method, the rental library was recorded at cost
and amortized over its estimated economic life. Base stock was amortized over a
60 month period on a straight-line basis with a salvage value of $6 per tape.
The fourth through ninth copies of each title per store were amortized over a 36
month period on an accelerated basis with a salvage value of $6 per tape. The
tenth and any succeeding copies of each title per store were amortized over 9
months on a straight-line basis with a salvage value of $6 per tape.
During the fourth quarter of fiscal 1999, the Company adopted a new method for
amortizing its base stock (copies one through three of each title per store) of
its rental library. The new method of amortization was adopted because the
Company believed that decelerating expense recognition for its base stock more
accurately matched its revenue stream and useful economic life as demonstrated
in the industry. Prior to the change, base stock was amortized over a 60 month
period on a straight-line basis with a salvage value of $6 per tape. The effect
of the change on base stock amortization for the year ended January 31, 1999 was
a reduction in the amortization of rental library of approximately $570,000.
During fiscal 1998, the Company revised the estimate of salvage value relating
to the amortization of its rental library to provide for a $6 salvage value per
tape in order to reflect a more accurate salvage value as demonstrated in the
industry.
Certain videocassettes are leased under revenue sharing arrangements. During
the revenue sharing period, which is generally one year, the studios retain
ownership of the videocassettes and the Company shares the rental rather than
purchasing the videocassettes for a fixed cost per copy. Such revenue sharing
amounts are included as cost of leased product in the accompanying statements of
operations. The associated fee per leased videocassette is amortized over the
term of the lease and is included in amortization of rental library in the
accompanying statements of operations.
NOTE 6--RELATED PARTY TRANSACTIONS
In March 1999, Video City acquired Video Galaxy, Inc. for 360,667 shares of
Video City's common stock and the assumption of $4,833,000 of indebtedness. In
connection with this acquisition, Video City borrowed $1,700,000 from Ingram
Entertainment, Inc. (a shareholder) to pay off certain amounts owed to Video
Galaxy's creditors and other parties. The interest rate on the $1,700,000 loan
was prime plus 1.5 percent, but increased to 14% in July 1999. Video City also
agreed to pay Ingram a management information system fee in the amount of
$85,000. Also in connection with this acquisition, Video City paid $1,117,000
to Mortco, Inc. (a wholly owned subsidiary of Rentrak, a shareholder) in partial
payment of indebtedness owed by Video Galaxy to Mortco. In addition, Video City
issued to Mortco 2,000 shares of Series D convertible redeemable preferred
stock, $1,000 stated value per share, convertible into 666,667 shares of Video
City common stock, and warrants to purchase 500,000 shares of Video City common
stock at $3.00 per share, in consideration for the cancellation by Mortco, Inc.
and Rentrak of $2,000,000 owed to them by Video Galaxy. Rentrak and its wholly-
owned subsidiary, Mortco, Inc., were the supplier and creditor of Video Galaxy
before the acquisition.
In November 1999, the Company issued warrants to purchase 2,000,000 shares of
the Company's common stock, at an exercise price of $.875 per share (1,000,000
shares to Ingram Entertainment and 1,000,000 shares to an officer of the
Company). Ingram Entertainment agreed to provide an additional $2 million trade
credit to the Company of which up to $1 million was guaranteed by an officer of
the Company.
F-17
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6--RELATED PARTY TRANSACTIONS (Continued)
From February 1999 through January 31, 2000, Video City had consulting
agreements with two principal shareholders of Video City pursuant to which they
provided retail video rental and sales consulting services to Video City. The
consulting agreements provide for the payment by Video City of $25,333 per month
to each of them, and the consultants granted a waiver of a like amount of
dividends payable on the Series B Preferred Stock.
During the fiscal years ended January 31, 2000 and 1999, Video City retained a
law firm to render legal services to it on real estate, litigation and other
matters. A partner at the law firm serves as a director of Video City. Total
fees for the years ended January 31, 2000 and 1999 were $360,000 and $75,000.
In July 1999, Video City issued 625 shares of its Series C Convertible
Redeemable Preferred Stock, $1,000 stated value per share, to eight accredited
investors for cash in the amount of $625,000 in a private placement transaction.
An officer and a director of the Company participated in the private placement
financing by investing $50,000 and $75,000, respectively.
In connection with the purchase of Game City, Inc. on September 30, 1998, the
Company had a note payable balance due to the former owners at January 31, 2000
and 1999 of $0 and $113,797, which is included as part of the long term debt
balance. For more than 26 months prior to this acquisition, this acquired store
was managed by the Company pursuant to a management agreement, and operated
under the name "Video City." Young C. Lee and Kay L. Lee are relatives of
Robert Y. Lee, the Company's Chief Executive Officer and Chairman of the Board.
On September 30, 1998, in connection with the purchase of Far West
Entertainment, Inc., the Company issued 32,000 shares of the Company's common
stock and a note payable in the amount of $100,000 to the seller, Brad Maples.
The note requires monthly principal and interest payments of $1,028 beginning in
October 1998 for a period of twelve years and bears an annual interest rate of
7%. The balance of the note at January 31, 2000 and 1999 was $92,559 and
$98,204 and is included as part of the long term debt balance.
In May 1998, the Company commenced a $700,000 private placement financing of the
Company's securities in which Ridgewood Capital Funding, Inc. ("Ridgewood")
agreed to serve as the placement agent. John T. Sheehy, a member of the Board
of Directors of the Company, assisted Ridgewood in conducting the offering,
acting as a registered broker under Ridgewood's broker-dealership. In addition,
certain directors of the Company and The Value Group, LLC participated in the
private placement financing by investing in the Company's securities.
Ingram Entertainment Inc. has been the principal supplier of videocassettes and
related equipment to the Company, and has been a secured creditor of the Company
since August 1991. On January 8, 1997, concurrent with the merger of Lee Video
City, Inc. into Prism Entertainment Corporation, Ingram accepted 1,500,000
shares of common stock of the Company in consideration of $3,000,000 of the
Company's indebtedness to Ingram.
F-18
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6--RELATED PARTY TRANSACTIONS (Continued)
At the same time, Ingram also received warrants to purchase 852,750 shares of
common stock from the Company and 404,403 shares of common stock from Robert Y.
Lee. In March 1998, the Company used funds in the amount of $1,500,000 from a
credit facility to pay off the term loan owing to Ingram. As of January 31, 2000
and 1999, the Company owed Ingram approximately $11.1 million and $6.8 million.
In addition, the Company entered into a new long-term supply agreement with
Ingram for videocassettes and related products (Note 11); Ingram released Mr.
Lee from his personal guarantee of the Company's indebtedness; and the parties
entered into the Stockholders Agreement and the Override Agreement, which among
other things prohibit certain corporate actions without the approval of Ingram
or Ingram's designees on the Board of Directors. All of these transactions and
arrangements were entered into either simultaneously with or prior to Ingram's
receipt of common stock of the Company.
On March 25, 1998, the Company entered into a restructured debt agreement with
Rentrak Corporation ("Rentrak"), a major lessor of videocassettes under a
revenue sharing arrangement (Note 11). Prior to the acquisition of the five
companies on March 25, 1998, the Company and Sulpizio One, Inc. (one of the
acquired companies) were parties to such arrangements with Rentrak. As part of
the restructuring, Rentrak agreed to accept 194,950 shares of the Company's
common stock in settlement of a lawsuit Rentrak had previously filed against
Adventures in Video, Inc. (one of the acquired companies), and 470,162 shares of
the Company's common stock in satisfaction of indebtedness owed to Rentrak by
Sulpizio One, Inc. As part of the restructured debt agreement, Rentrak also
agreed to a deferral of certain amounts owed to it by Sulpizio One, Inc. and the
Company, and obtained a security interest in the assets of the Company to secure
such amounts. Rentrak also released Robert Y. Lee, the Company's Chairman of
the Board and Chief Executive Officer, from personal guaranties of the Company's
indebtedness that Mr. Lee had previously given. Rentrak's wholly-owned
subsidiary, Mortco, Inc., is a principal stockholder of the Company. As of
January 31, 2000 and 1999, the Company owed Rentrak approximately $8.8 million
and $6.7 million.
The Company had either purchased or leased approximately 80% of its supply of
new release videos, in the aggregate, from two suppliers, Ingram and Rentrak.
During fiscal 2000, the Company purchased approximately $5,789,000 of product
from Ingram Entertainment and approximately $3,414,000 of product from Rentrak.
In October 1999, Video City temporarily discontinued making purchases from
Rentrak and began leasing product directly from film studios (Note 5). If the
relationships with Ingram, Rentrak and the film studios 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 comparable
terms and prices. However, there can be no assurance that any replacement
supplier would provide service or payment terms as favorable as those provided
by Ingram, Rentrak or the film studios. 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.
On March 25, 1998, the Company 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 the Company's board of
directors, for $1,350,000 in cash. During the fourth quarter of fiscal 1998,
the film library was written down by $3,030,000 to reflect its 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 with and into Prism.
F-19
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6--RELATED PARTY TRANSACTIONS (Continued)
The Company has entered into employment and consulting agreements with certain
shareholders (See Note 11).
At January 31, 2000 and 1999, the Company had unsecured employee and director
loans aggregating approximately $9,078 and $86,703, respectively, bearing
interest at 7%, and due on demand.
At January 31, 2000, the Company determined that certain unsecured employee and
director loans aggregating approximately $86,700 were uncollectible and were
consequently written off, in the fourth quarter of fiscal 2000.
NOTE 7--PROPERTY AND EQUIPMENT
Property and equipment are comprised of the following:
<TABLE>
<CAPTION>
January 31, January 31,
2000 1999
------------------ ----------------
<S> <C> <C>
Furniture and fixtures $ 3,147,307 $ 2,188,217
Equipment 2,956,876 2,457,431
Leasehold Improvements 2,052,684 2,058,056
------------------ ----------------
Total Property and Equipment 8,156,867 6,703,704
Accumulated depreciation and amortization (3,890,202) (2,177,718)
------------------ ----------------
Total Property and Equipment, net $ 4,266,665 $ 4,525,986
================== ================
</TABLE>
Depreciation and amortization expense was $1,879,370, $601,000 and $347,000 for
the years ended January 31, 2000, 1999 and 1998.
NOTE 8--SENIOR SECURED REVOLVING CREDIT FACILITY
On December 29, 1998, the Company entered into a Senior Secured Revolving Credit
Facility agreement (the "Credit Facility") with BankBoston to be used for
working capital purposes and capital expenditures. The Credit Facility bears
interest at the bank's prime rate plus 1/2 percent and is secured by
substantially all assets of the Company. The amount available for borrowing
under the Credit Facility is determined by deducting the Company's principal
balance of the Credit Facility from its borrowing base. The borrowing base is
determined by multiplying the applicable inventory advance rate and the number
of units of the acceptable inventory, net of reserves. The maximum amount
available to borrow is the lesser of the borrowing base or $30,000,000. The
Credit Facility matures on December 29, 2001. The Credit Facility contains
various financial covenants of which the Company was in compliance at January
31, 1999.
F-20
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8--SENIOR SECURED REVOLVING CREDIT FACILITY (Continued)
During the fiscal year ended January 31, 2000, the Company did not meet certain
of the financial covenants as required by the credit facility. The Company
requested and was granted waivers by BankBoston for the quarters ended April 30,
1999 and July 31, 1999. On September 23, 1999, the Company entered into a
forbearance agreement with BankBoston that amended the terms of the Loan
Agreement, revised the financial performance covenants of the Loan Agreement and
contained weekly covenant requirements. In November 1999, the Company did not
meet the financial performance covenants as set forth in the forbearance
agreement. As a result of not meeting the financial covenants, the interest rate
on the loan was increased from .5% plus prime to the default rate of interest of
3% plus prime (12.5% at January 31, 2000). The forbearance agreement also
provides that the aggregate balance of the loan shall be temporarily limited to
$10,500,000. The Company has reclassified the senior secured revolving credit
facility to a current liability. BankBoston, at its discretion, is continuing to
make advances in accordance with the Loan Agreement despite the default of the
aforementioned forbearance agreement. There can be no assurance, however, that
BankBoston will continue to make advances in the future under the terms of the
Loan Agreement.
On March 9, 2000, the Company entered into a second forbearance agreement (See
Note 17).
The loan fees related to the credit facility were capitalized and amortized over
the term of the loan agreement. The balance of deferred loan charges, net of
related amortization, at January 31, 1999 was $675,695 and was included in other
assets. In the fourth quarter of fiscal 2000, the deferred loan charges were
written off when the original loan agreement was terminated and replaced with a
forbearance agreement.
F-21
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9--LONG-TERM DEBT
Long-term debt is summarized in the following table:
<TABLE>
<CAPTION>
January 31, January 31,
2000 1999
--------------- --------------
<S> <C> <C>
Promissory note, secured by certain assets, subordinate to the credit
facility, executed in April 1999, payable in April 2000 and bearing
interest at a prime plus 1.5%. The Company has defaulted on the
payment terms of this note. Interest rate increased to 14% in July 1999. $ 1,700,000 $ -
Unsecured note to fulfill outstanding trade payables, executed in
February 1999, bearing interest of 10%, payable in January 2000. The
Company has defaulted on the payment terms of this note. Interest rate
increased to 14% in January 2000. 1,453,706 -
Promissory notes, secured by certain assets subordinate to the credit
facility (Note 8), payable in monthly installments of $34,403 and
$5,952, interest imputed at 9% per annum, due June 2003. 1,660,653 1,782,484
Promissory notes, secured by certain assets subordinate to the credit
facility (Note 8), at interest rates varying from 9% to 10% per annum,
due July 1999. The Company has defaulted on the payment terms of this
note. Interest rate increased to 12% in July 1999. 1,405,141 1,405,141
Other unsecured loan to fulfill settlement obligation for $259,847,
payable in monthly installments of $8,000, including interest at 8.5%
per annum until February 20, 2000. 8,059 92,033
Unsecured notes to fulfill outstanding trade payables, executed in July
through September of 1999, bearing interest of 10% due and payable in
December 1999. The Company has defaulted on the payment terms of this
note. Interest increased to 18% in December 1999. 303,539 -
Other unsecured obligations, including interest from 7% to 15% per
annum, due from January 2000 to September 2010. The Company has
defaulted on the payment terms of this note. 265,887 482,175
--------------- --------------
Total debt 6,796,985 3,761,833
Less current portion (5,565,078) (2,125,187)
--------------- --------------
Total long-term debt $ 1,231,907 $ 1,636,646
=============== ==============
</TABLE>
Total maturities of remaining long-term debt for five years subsequent to
January 31, 2000 are presented in the following table:
<TABLE>
<CAPTION>
Years ending Amount
January 31,
-------------- --------------
<S> <C>
2001 $ 5,565,078
2002 509,487
2003 451,454
2004 204,732
2005 7,956
Thereafter 58,278
--------------
$ 6,796,985
==============
</TABLE>
The Company has outstanding indebtedness in the aggregate amount of $4,862,238
with certain of the Company's key suppliers that reached maturity and are now
overdue. The debt agreements with the key suppliers provide for increased
interest rates ranging from 12% to 18% and penalty payments of up to 8%
F-22
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
during the periods of default. Although there can be no assurance, the Company
anticipates that it will be able to extend the maturity dates of such
indebtedness. The note holders have extended the Maturity date of the debt
agreements to comply with the terms of the Company's forbearance agreement (Note
8).
NOTE 10--INCOME TAXES
As of January 31, 2000, net operating loss carryforwards generated by the
Company of approximately $32,235,719 and $14,917,963 for Federal and California
income tax purposes are available to offset future taxable income through 2019.
The Company's ability to utilize net operating loss carryforwards is dependent
upon its ability to generate taxable income in future periods. Approximately
$650,000 of Federal and $305,000 of State net operating losses are limited due
to ownership changes (as defined under Section 382 of the Internal Revenue Code
of 1986) which occurred on January 8, 1997 and resulted in an annual limitation
per year. Unused annual limitations may be carried over to future years until
the net operating losses expire. Utilization of net operating losses may also be
limited in any one year by alternative minimum tax rules.
The income tax provision (benefit) is comprised of the following current and
deferred amounts:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
January 31, January 31, December 31,
2000 1999 1998
--------------- --------------- ----------------
<S> <C> <C> <C>
Current
Federal $ - $ - $ -
State 16,765 5,000 -
--------------- --------------- ----------------
16,765 5,000 -
--------------- --------------- ----------------
Deferred
- --------
Federal 712,425 (2,384,229) -
State (21,891) (236,728) -
--------------- --------------- ----------------
690,534 (2,620,957) -
--------------- --------------- ----------------
$ 707,299 $$ (2,615,957 $ -
=============== =============== ================
</TABLE>
Deferred tax assets are initially recognized for differences between the
financial statement carrying amount and the tax bases of assets and liabilities
which will result in future deductible amounts and operating loss and tax credit
carryforwards. A valuation allowance is then established to reduce that
deferred tax asset to the level at which it is "more likely than not" that the
tax benefits will be realized. Realization of tax benefits of deductible
temporary differences and operating loss or credit carryforwards depends on
having sufficient taxable income of an appropriate character within the
carryback and carryforward periods. Sources of taxable income that may allow
for the realization of tax benefits include (i) taxable income in the current
year or prior years that is available through carryback, (ii) future taxable
income that will result from the reversal of existing taxable temporary
difference, and (iii) future taxable income generated by future operations. At
January 31, 1999, due to significant acquisitions consummated during the year,
the Company determined from its projections, that it is more likely than not
that future taxable income would be sufficient to enable the Company to realize
its deferred tax asset and had accordingly, reversed the full amount of the
valuation allowance. At January 31, 2000, due to the pending acquisition with
West Coast Entertainment, the losses incurred during fiscal 2000, and the
Company's short-term divestiture strategy, management cannot determine it is
more likely than not that future taxable income will be sufficient to realize
the deferred tax asset. Accordingly, a full valuation allowance has been
established against the deferred tax asset at January 31, 2000.
F-23
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10--INCOME TAXES (Continued)
The assets acquired from the Videoland merger were recorded at fair market value
for financial statement purposes. The difference between that value and the tax
basis of the assets result in a deferred tax liability of approximately
$1,732,708 as of January 31, 1999. In April 1999, the Company sold 49 of its 76
stores acquired from Videoland. The remaining deferred tax liability equaled
$190,221 as of January 31, 2000. In connection with the acquisition of Video
Galaxy, a net deferred tax liability of $194,713 was recorded. The following
table presents the primary components of the Company's net long-term deferred
tax asset:
<TABLE>
<CAPTION>
January 31, January 31,
2000 1999
--------------- ---------------
<S> <C> <C>
Components of long-term deferred tax assets:
Federal and State NOL carryforward $ 11,829,861 $ 2,227,462
Videoland fixed asset basis difference 867,986 1,043,903
Fixed assets due to difference in depreciation and
amortization 205,554 202,219
Deferred rent - 170,389
Store closure reserve 270,844 -
Other 17,342 15,887
--------------- ---------------
Total gross deferred tax asset 13,191,587 3,659,860
Valuation allowance (12,133,380) -
--------------- ---------------
Total deferred tax asset, net of valuation allowance 1,058,207 3,659,860
--------------- ---------------
Components of long-term deferred tax liability:
Videoland and Video Galaxy inventory basis difference (1,058,207) (2,776,611)
--------------- ---------------
Net long-term deferred tax asset $ - $ 883,249
=============== ===============
</TABLE>
The total income tax provision differs from the amount computed by applying the
statutory Federal income tax rate for the following reasons:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
January 31, 2000 January 31, 1999 December 31, 1998
---------------- ---------------- ------------------
% of % of % of
Pretax Pretax Pretax
income Income income
---------- ---------- ----------
<S> <C> <C> <C>
Income tax at Federal statutory rate (34.0)% (34.0)% (34.0)%
State taxes, net of Federal tax benefit -% 2.4% (5.8)%
Valuation allowance 37.8% (84.3)% 39.5%
Expiration of net operating losses -% 14.9% -%
Other (1.6)% 0.6% 0.3%
---------- ---------- ----------
Total 2.2% (100.4)% 0.0%
========== ========== ==========
</TABLE>
F-24
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--COMMITMENTS AND CONTINGENCIES
Operating Leases - The Company leases its facilities under noncancelable
operating leases expiring at various dates through 2013. Rent expense under
operating leases was approximately $7,857,682, $3,601,986 and $1,502,000 for the
years ended January 31, 2000, 1999 and 1998.
The future minimum lease payments under noncancelable operating leases with
initial lease terms in excess of one year as of January 31, 2000 are as follows:
<TABLE>
<CAPTION>
Years ending Operating
January 31, Leases
--------------- ---------------
<S> <C>
2001 $ 4,854,423
2002 4,143,929
2003 3,310,107
2004 2,705,593
2005 1,867,627
Thereafter 1,791,172
---------------
Total $ 18,672,851
===============
</TABLE>
Revenue Sharing Agreement - Pursuant to the Revenue Sharing Agreement (Note 5),
the Company is obligated to pay revenue sharing and fee payments that are based
on a percentage of the Company's gross rental revenues.
Vendor Supply Agreement - On November 6, 1996, the Company amended the March 13,
1996 agreement with a 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. During fiscal 2000, the
Company purchased approximately $5,789,354 of product from this supplier. Since
the Company is leasing the majority of its new release rental titles, the
Company and the supplier are in the process of renegotiating the terms of the
agreement.
The Company's CEO and the same supplier entered into an Override Agreement dated
November 19, 1996 which provides, subject to certain exceptions, that without
the written consent of the supplier, the Company shall not enter into a merger
or a sale or 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 the supplier, or such time as the supplier's
beneficial ownership interest in the Company's common stock, on a fully diluted
basis, is 4% or less. The $1,500,000 debt was paid in March 1998, but, the
supplier's beneficial ownership interest in the Company's common stock, on a
fully diluted basis remains greater than 4%.
F-25
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--COMMITMENTS AND CONTINGENCIES (Continued)
Employment Agreements - The Company has entered into employment agreements with
various of its key officers. In general, these agreements cover a period of
three years or less. The annual salary amounts for these agreements range from
$117,500 to $250,000. In the event that the employment of any of the these
officers 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.
Other Agreements - On March 25, 1998, the Company acquired Adventures in Video,
Inc. ("Adventures in Video") and KDDJ Investments, Inc. ("KDDJ") from David A.
Ballstadt and members of his immediate family pursuant to two Agreements of
Merger and Plan of Reorganization (each a "Merger Agreement"). Adventures in
Video owns and operates 13 stores in the greater Minneapolis metropolitan area
and KDDJ owns and operates three stores in San Francisco, California. The
purchase price for Adventures in Video was 866,000 shares of the Company's
common stock. The purchase price for KDDJ was 216,500 shares of the Company's
Common. Pursuant to the Adventures in Video Merger Agreement, the Company 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 the Company was expanded from eight to nine members and
David A. Ballstadt was elected to fill this vacancy. Mr. Ballstadt has served
as a director of the Company since the consummation of the two acquisitions.
The Company 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.
On April 16, 1997, the Company entered into three year consulting agreements
with Gerald W. B. Weber and Stephen C. Lehman pursuant to which Messrs. Weber
and Lehman shall provide finance, acquisitions and corporate development
consulting services to the Company. The consulting agreements of Messrs. Weber
and Lehman provide for compensation in the form of options to purchase an
aggregate of 75,000 and 90,000 shares, respectively, of the Company's common
stock at $2.00 per share. Options to purchase one-third of such shares of
common stock vest each year commencing on April 16, 1997 and any unexercise
portions terminate on April 15, 2002. Each consulting agreement also provides
that the Company shall reimburse the consultant for reasonable out-of-pocket
expenses incurred in performing his consulting services, that the Company shall
indemnify the consultant with respect to any claims made against the consultant
arising in connection with the consulting service, and that either party may
terminate the consulting agreement by providing 30 days notice to the other
party. On March 24, 1998, Mr. Lehman's consulting agreement was amended to
provide Mr. Lehman additional compensation in the form of warrants to purchase
100,000 shares of the Company's common stock at $2.00 per share. Mr. Weber is a
director of the Company and Mr. Lehman was a director of the Company until
December 1999.
F-26
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11--COMMITMENTS AND CONTINGENCIES (Continued)
In April 1997, the Company entered into an engagement agreement with Sphere
Capital Partners ("Sphere Capital") pursuant to which Sphere Capital shall act
as the exclusive financial advisor to the Company providing financial
management, acquisition and financing advisory services for a period of one year
commencing April 1997 and for such additional one year terms as may be mutually
agreed to by Sphere Capital and the Company. The agreement provided that during
the term of the engagement, Sphere Capital shall limit its financial advisory
services within the video retail industry solely to the Company. The engagement
agreement provided for a base fee of $5,000 per month which shall be credited
against any transaction fees to which Sphere Capital may be entitled upon
consummation of any acquisition or financing transaction. The engagement
agreement also provided that the Company would reimburse Sphere Capital for
reasonable out-of-pocket expenses incurred in performing its financial advisory
services and that either party may terminate the engagement by providing 45 days
notice to the other party. In May 1997, Sphere Capital assigned the agreement
to The Value Group, LLC. During the fiscal year ended January 31, 1998, the
Company paid Sphere Capital fees in the amount of approximately $28,000.
Effective April 1998, a new engagement agreement was entered into by the Company
and The Value Group, LLC, the successor entity to Sphere Capital, which provides
for a base fee of $2,500 per month which shall be credited against any
transaction fees to which The Value Group, LLC, may be entitled upon
consummation of any acquisition or financing transaction, John T. Sheehy serves
as a director of the Company and is a Managing Director of The Value Group, LLC
and its predecessor, Sphere Capital.
Litigation - The Company is subject to certain legal proceedings and claims
arising in connection with its business. In the opinion of management, there
are currently no claims that will have a material adverse effect on the
Company's consolidated financial position, results of operations or cash flows.
NOTE 12--STOCKHOLDERS' EQUITY (DEFICIT)
Redeemable Preferred Stock - The Company has 2,000,000 shares of authorized
preferred stock, $.01 par value per share which consists of the following;
Series AA Convertible Redeemable Preferred Stock, 5,750 shares issued and
outstanding, stated value $100 per share; Series B Voting Convertible Redeemable
Preferred Stock, 76,000 shares issued and outstanding, stated value $100 per
share; Series C Convertible Redeemable Preferred Stock, 1,028 shares issued and
outstanding, stated value $1000 per share; Series D Convertible Redeemable
Preferred Stock, 2,000 shares issued and outstanding, stated value $1000 per
share; Series E Convertible Preferred Stock, 1,256 shares issued and
outstanding, stated value $1000 per share;
On January 21, 2000, an investor of the Company, converted 1,250 shares of the
Company's Series AA Convertible Redeemable Preferred Stock, $100 stated value
per share, to Common Stock at a conversion rate of 50 shares of Common Stock for
one share of Series AA Preferred Stock.
On January 21, 2000, investors of the Company converted 478 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On January 5, 2000, a vendor of the Company converted 38 shares of the Company's
Series E Convertible Redeemable Preferred Stock, $1,000 stated value per share,
to Common Stock at a conversion rate of 625 shares of Common stock for 1 Share
of Series E Preferred Stock.
F-27
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
On December 1, 1999, a vendor of the Company converted 100 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On November 24, 1999, an investor of the Company converted 50 shares of the
Company's Series C Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 500 shares of Common stock
for 1 Share of Series C Preferred Stock.
On November 22, 1999 a vendor of the Company, converted 18 shares of the
Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to Common Stock at a conversion rate of 625 shares of Common stock
for one Share of Series E Preferred Stock.
On September 17, 1999 International Video Distributors, LLC, converted 200
shares of the Company's Series E Convertible Redeemable Preferred Stock, $1,000
stated value per share, to Common Stock at a conversion rate of 625 shares of
Common Stock for one share of Series E Preferred Stock. International Video
Distributor converted an additional 200 shares of the Company's Series E
Convertible Redeemable Preferred Stock on July 17, 1999.
On September 9, 1999, the Company issued 56 shares of the Company's Series E
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
Interstate Personnel, Inc., in consideration for cancellation of trade payables
owed by the Company to Interstate Personnel, Inc., in the amount of $56,000.
Each share of Series E Preferred Stock is convertible into a number of shares of
Common Stock determined by dividing $1,000 by the conversion price in effect on
the conversion date. During certain periods, the conversion price is equal to
the market price of the Company's Common Stock and ranges between $1.60 and
$3.00; after such period, the conversion price is equal to $3.00.
On August 8, 1999, International Video Distributors, LLC, converted 400 shares
of the Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated
value per share, to Common Stock at a conversion rate of 625 shares of Common
Stock for one share of Series E Preferred Stock.
On August 3, 1999, three of the Company's investors converted 2,500 shares of
the Company's Series AA Convertible Redeemable Preferred Stock, $100 stated
value per share, to Common Stock at a conversion rate of 50 shares of Common
Stock for one share of Series AA Preferred Stock.
On July 19, 1999, the Company issued an aggregate of 625 shares of the Company's
Series C Convertible Redeemable Preferred Stock, $1,000 stated value per share,
to eight accredited investors including an executive officer of the Company, for
cash in the amount of $625,000 in a private placement transaction. The shares
of Series C Preferred Stock are convertible into the Company's Common Stock at a
conversion price of $2.00 per share.
On July 19, 1999, International Video Distributors, LLC, converted shares of the
Company's Series E Convertible Redeemable Preferred Stock, $1,000 stated value
per share, to common stock at a conversion rate of 625 shares of common stock
for one share of Series E Preferred Stock.
On June 11, 1999, the Company issued 2,000 shares of the Company's Series E
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
International Video Distributors, LLC ("IVD") and Common Stock Purchase Warrants
to purchase 50,000 shares of the Company's Common Stock at an exercise price of
$2.00 per share. IVD cancelled outstanding trade payables in the amount of
$2,000,000
F-28
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
owed by the Company to IVD. Each share of Series E Preferred Stock is
convertible into a number of shares of Common Stock determined by dividing
$1,000 by the conversion price in effect on the conversion date. During certain
periods, the conversion price is equal to the market price of the Company's
Common Stock and ranges between $1.60 and $3.00; after such period, the
conversion price is equal to $3.00.
On June 2, 1999, the Company issued 303 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to The
Value Group, LLC in consideration for cancellation of trade payables owed by the
Company to The Value Group, LLC in the amount of $303,000. On July 13, 1999, the
Company issued 100 shares of the Company's Series C Convertible Redeemable
Preferred Stock, $1,000 stated value per share, to DAZ Systems, Inc. in
consideration for the cancellation of trade payables owed by the Company to DAZ
Systems, Inc. in the amount of $100,000. The shares of Series C Preferred Stock
are convertible into the Company's Common Stock at a conversion price of $2.00
per share.
On March 31, 1999, the Company issued 2,000 shares of the Company's Series D
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to
Mortco, Inc. (a subsidiary of Rentrak Corporation) in consideration for the
cancellation of indebtedness from Video Galaxy, Inc., to such parties in the
amount of $2,000,000. Each share of Series D Convertible Redeemable Preferred
Stock is convertible into 333.3 shares of the Company's Common Stock at a
conversion price of $3.00 per share.
On March 26, 1999, the Company issued 112 shares of the Company's Series C
Convertible Redeemable Preferred Stock, $1,000 stated value per share, to Box
Office, LLC, as part of the consideration for the purchase of the assets of a
video store acquired from Box Office, LLC. Each share of Series C Convertible
Redeemable Preferred Stock is convertible into 500 shares of the Company's
Common Stock at a conversion price of $2.00 per share. The Series C Preferred
Stock was converted based on the market value of the Company's Common Stock on
the date of issuance. On June 30, 1999, Box Office LLC converted 112 shares of
the Company's Series C Convertible Redeemable Preferred Stock to 56,000 of the
Company's Common Stock.
In June 1998, the Company sold an aggregate of 7,000 shares of its Series A
Convertible Redeemable Preferred Stock ("Series A Preferred Stock") with a
stated value of $100 per share and detachable warrants to purchase an aggregate
of 350,000 shares of the Company's common stock at an exercise price of $2.00
per share to eight investors, including certain directors of the Company and
their affiliates, for a total consideration of $700,000 less related expenses of
$76,227. Each share of Series A Preferred Stock is convertible into 50 shares
of the Company's common stock, subject to adjustment. The Company authorized
20,000 shares and the terms of the Series A Preferred Stock require the Company
to redeem the Series A Preferred Stock in May 2003. In the fourth quarter of
fiscal 1999, these shares were exchanged for an equivalent number of shares of
Series AA Convertible Redeemable Preferred Stock ("Series AA Preferred Stock").
The terms of the Series AA Preferred Stock are identical to those of the Series
A Preferred Stock except that the Series AA Preferred Stock does not provide for
mandatory redemption and provides for the issuance of common stock dividends.
In December 1998, the Company granted 750 shares of Series AA Preferred Stock to
a supplier for satisfaction of accounts payable.
On December 28, 1998, in connection with the Videoland acquisition, the Company
issued 76,000 shares of the Company's Series B Voting Convertible Redeemable
Preferred Stock with a stated value of $100 per share (200,000 shares
authorized). A portion of the 76,000 shares of the Company's Series B Preferred
F-29
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
Stock issued to the former owners as part of the consideration for the
acquisition has been pledged to the Company in order to secure Videoland's
existing shareholder receivable in the amount of $1,370,673. In the event the
trading price of the Company's common stock for any period of 20 consecutive
trading days during the five year period commencing December 28, 1998 is equal
to or exceeds $3.1667, then the Company may, at its option, receive the number
of outstanding shares of the Series B Preferred Stock then held by the former
owners determined by dividing (i) the total amount of the outstanding receivable
by (ii) $100, or any lesser number of outstanding shares of Series B Preferred
Stock then held by the former owners, in exchange for full or partial
satisfaction of the applicable amount then owed. Not withstanding the
foregoing, in the event such trading price for any period of 20 consecutive
trading days during the five year period commencing December 28, 1998 does not
equal or exceed $3.1667, then at the end of such five year period, the Company
shall forgive the $1,370,673 receivable balance outstanding. This receivable has
been recorded as a reduction against the carrying value of the Company's Series
B Convertible Redeemable Preferred Stock.
The holders of these shares shall have the right to convert all or any shares
into duly authorized, validly issued, fully paid and nonassessable shares of
common stock of the Company. Each share of Series B Preferred Stock shall be
converted into a number of shares of common stock determined by dividing (i)
$100 by (ii) the conversion price initially set at $3.1667. The outstanding
shares of Series B Preferred Stock may be redeemed, in whole or in part, at any
time at the option of the Company for cash at $100 per share, plus, in each
case, all declared and unpaid dividends thereon, if any, to the redemption date.
The holders of the outstanding shares shall be entitled to receive when, as and
if declared by the Board of Directors, cumulative dividends at an annual rate of
8.0% of the stated value per share. In the event the Company is unable to pay
such dividends in cash, the Company may pay such dividends in shares of common
stock of the Company. The holders of these shares agreed to waive and discharge
the Company of its obligation to pay such dividends during the period January
1999 to June 1999 in exchange for a monthly consultant fee of $50,667 per month.
Common Stock - In September 1998, the Company issued 1,050,000 shares of its
common stock as part of the purchase price for all of the outstanding shares of
capital stock of Video Tyme Inc. Video Tyme owned and operated seven retail
video stores in Las Vegas, Nevada, of which six were acquired. In September
1998, the Company issued 32,000 shares of its common stock as part of the
purchase price for the two video stores acquired from Far West Entertainment,
Inc. Also in September 1998, the Company issued 38,500 shares of common stock
for the asset purchase of one video store. In December 1998, the Company issued
49,497 shares of common stock to various vendors for satisfaction of accounts
payable.
In June 1998, the Company issued 9,375 shares of its common stock to a
consultant for professional services rendered to the Company. Also in June
1998, the Company issued 127,305 shares of its common stock to a vendor for
services and equipment rendered to the Company and 57,111 shares of its common
stock to a supplier for satisfaction of accounts payable.
In March 1998, the Company issued 1,682,500 shares of its common stock to
acquire five corporations owning and operating an aggregate of 29 retail video
stores (Note 2).
F-30
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
Preferred Stock Dividends - The Company issued 454,720 shares of the Company's
Common Stock to two holders of the Company's Series B Convertible Redeemable
Preferred Stock as stock dividends with respect to the Series B Preferred Stock.
The stock dividends are issued on monthly basis commencing in June 1999 through
June 2018, unless the two holders convert the preferred stock to common stock.
The Company issued 60,289 shares of the Company's Common Stock to various
shareholders as stock dividends with respect to the Company's Series AA
Convertible Redeemable Preferred Stock. The stock dividends are issued semi-
annually in June and November.
Common Stock Warrants - In December 1999, the Company issued warrants to
purchase 2,000,000 shares of the Company's Common Stock, at an exercise price of
$.875 per share (1,000,000 shares to Ingram Entertainment and 1,000,000 shares
to an officer of the Company). Ingram Entertainment agreed to provide an
additional $2 million trade credit to the Company of which up to $1 million was
guaranteed by an officer of the Company.
In May through November 1999, the Company issued warrants to purchase an
aggregate of 339,812 shares of the Company's Common Stock, at an exercise price
of $2, to several vendors and consultants, for services provided to the Company.
In June 1999, the Company, in conjunction with the issuance of 2000 shares of
the Company Series E Convertible Redeemable Preferred Stock, issued warrants to
purchase 50,000 share of the Company's Common Stock, at an exercise price of $2,
to a supplier. The preferred stock and the detachable warrants were issued in
consideration of outstanding trade payable in the amount of $2 million.
In April 1999, the Company, in conjunction with a $1.7 million note assumed
during the Video Galaxy acquisition, issued warrants to purchase 474,000 shares
of the Company's Common Stock at an exercise price of $2.00 per share, to a
major supplier.
In March 1999, the Company, in conjunction with the Video Galaxy acquisition,
issued warrants to purchase 500,000 shares of the Company's Common Stock, at an
exercise price of $2,00 per share, to a major supplier.
In March 1999, the Company, in conjunction with a $3.6 million note assumed by
the Company during the acquisitions of Sulpizio One, Old Republic Entertainment,
Video Tyme and Videoland, issued warrants to purchase 561,725 shares of the
Company's Common Stock at an exercise price of $2.00 per share, to a major
supplier. The warrants were issued provided that the supplier extend the terms
of a demand note, assumed by the Company, through June 30, 1999. The number of
warrants increased on July 1, 1999 to 1,048,451 since the demand note remained
outstanding.
F-31
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
In June 1998, the Company, in conjunction with the sale of an aggregate of 7,000
shares of its Series A Convertible Redeemable Preferred Stock ("Series A
Preferred Stock"), issued detachable warrants to purchase an aggregate of
350,000 shares of the Company's common stock at an exercise price of $2.00 per
share to eight investors, including certain directors of the Company and their
affiliates, for a total consideration of $700,000. In the fourth quarter of
1998, the Company issued warrants to purchase an aggregate of 105,000 shares of
the Company's common stock at an exercise price of $2.00 per share to various
consultants as payment for services provided to the Company by such consultants.
Stock Option Plan - The stock option plans adopted by the Company allow the
Company to grant up to 5,364,000 stock options to qualified employees,
directors, and affiliates. A summary of the Company's warrant and stock option
activity and related information is presented in the following table:
<TABLE>
<CAPTION>
Year Ended January 31, Year Ended January 31, Year Ended January 31,
2000 1999 1998
-------------------------- ----------------------- -------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
----------- --------- ------------ ------- ------ -------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 5,183,651 $ 1.63 3,947,435 $ 1.47 3,549,997 $ 1.45
Granted 6,985,017 1.85 1,756,936 1.41 397,438 1.65
Exercised (123,077) .33 - - - -
Cancelled (466,443) 2.00 (520,720) 0.01 - -
=========== ======= ========= ======= ========= =======
Outstanding at end of year 11,579,148 $ 1.73 5,183,651 $ 1.59 3,947,435 $ 1.47
=========== ======= ========= ======= ========= =======
Options exercisable at year end 8,960,138 $ 1.75 4,142,265 $ 1.49 3,320,881 $ 1.36
=========== ======= ========= ======= ========= =======
</TABLE>
Information relating to warrants and stock options at January 31, 2000
summarized by exercise price is presented in the following table:
<TABLE>
<CAPTION>
Outstanding Exercisable
- ---------------------------------------------------------------------------------- -------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Price Contractual Exercise Exercise
Per Share Shares Life Price Shares Price
- -------------------- --------------- ----------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
$0.10 to $0.87 3,050,840 5.5 years $ 0.73 2,050,840 $ .65
1.00 to 1.03 531,760 1.9 years 1.02 531,760 1.02
2.00 to 2.00 5,828,279 5.0 years 2.00 4,734,269 2.00
2.25 to 3.00 2,036,786 4.8 years 2.54 1,511,786 2.60
3.04 to 3.04 131,483 .33 years 3.04 131,483 3.04
- -------------------- --------------- ----------------- --------------- --------------- ---------------
11,579,148 4.9 years $ 1.73 8,960,138 $ 1.75
=============== ================= =============== =============== ===============
</TABLE>
F-32
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12--STOCKHOLDERS' EQUITY (Continued)
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 income (loss) and earnings (loss) per share would be as
follows:
<TABLE>
<CAPTION>
Year Ended Year Ended Year Ended
January 31, 2000 January 31, 1999 January 31, 1998
------------------ ------------------ -------------------
<S> <C> <C> <C> <C>
Net income (loss) As reported $ (32,765,625) $ 11,134 $ (2,975,315)
Pro forma (33,494,742) (184,277) (2,988,270)
Basic earnings (loss) per share As reported $ (2.29) 0.00 $ (0.30)
Pro forma (2.31) (0.01) (0.30)
</TABLE>
The fair value of options granted during the years ended January 31, 2000 are
estimated on the date of grant utilizing a Black-Scholes pricing model over the
expected life of the options ranging from 1 to 5 years, expected volatility of
70%, risk-free interest rate of 5.14%, and a 0% dividend yield. The weighted
average fair value of options granted was $0.47.
The fair value of options granted during the year ended January 31, 1999 is
estimated on the date of grant utilizing a Black-Scholes pricing model over the
expected life of the options ranging from 3 to 5 years, expected volatility of
70%, risk-free interest rates ranging from 4.45% to 5.61%, and a 0% dividend
yield. The weighted average fair value of options granted was $0.54.
The fair value of options granted during the year ended January 31, 1998 is
estimated on the date of grant utilizing a Black-Scholes pricing model over the
expected life of the options 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 was $0.42.
NOTE 13--EARNINGS PER SHARE
The following table summarizes the calculation of the Company's basic and
diluted earnings per share for the periods presented:
<TABLE>
<CAPTION>
Year Ended January 31, 2000 Year Ended January 31, 1999 Year Ended January 31, 1998
-------------------------------- ------------------------------ ------------------------------
Per Per- Per
Income Share Income Share Income Share
(Loss) Shares Amount (Loss) Shares Amount (Loss) Shares Amount
--------- ---------- --------- --------- --------- -------- ----------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Basic EPS
- ---------
Income (loss) available to
common stockholders:
Net income (loss) $(33,258,147) 14,509,555 $ (2.29) $ 11,134 12,091,467 $ 0.00 $(2,975,315) 9,770,594 $(0.30)
Effect of Dilutive Securities:
Incremental shares from
common stock options,
warrants, and preferred
stock outstanding - - - - 1,336,911 - - - -
------------ ----------- -------- --------- ---------- ------ ----------- ---------- ------
Diluted EPS
- ------------------------------
Income (loss) available to - - - - - - - - -
common stockholders
Net income (loss) $(33,258,147) 14,509,555 $ (2.29) $ 11,134 13,428,378 $ 0.00 $(2,975,315) 9,770,594 $(0.30)
------------ ----------- -------- --------- ---------- ------ ----------- ---------- ------
</TABLE>
F-33
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13 - EARNINGS PER SHARE (Continued)
In fiscal 1998 and 2000, all outstanding common stock options, warrants and
preferred stock were not included in the computation of diluted earnings per
share because the effect of the exercise and/or conversion would have an
antidilutive effect on earning per share.
In fiscal 1999, warrants to purchase 15,000 shares at $1.00, 54,360 shares at
$1.03, 724,150 shares at $2.00, 200,000 shares at $2.25, 200,000 shares at
$2.50, and 131,483 shares at $3.04 were outstanding, but were not included in
the computations of diluted earnings per share because the effect of exercise
and/or conversion would have an antidilutive effect on earnings per share.
NOTE 14--FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate that
value:
Long-term debt: Estimated based upon current market borrowing rates for loans
with similar terms and maturities.
Revolving credit facility: Estimated based upon variable interest rates for
facilities with similar terms and maturities.
The estimated fair values of the Company's financial instruments are as follows:
<TABLE>
<CAPTION>
January 31, 2000 January 31, 1999
-------------------------------- --------------------------------
Carrying Carrying
Amount Fair Value Amount Fair Value
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Financial Liabilities:
Long-Term Debt $ 6,796,985 6,796,985 $ 3,761,833 $ 3,761,833
Senior Secured Revolving
Credit Facility $ 9,769,574 9,769,574 $ 16,044,502 $ 16,044,502
</TABLE>
NOTE 15--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. On March
25, 1998, the Company 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 the Company's board of directors,
for $1,350,000 in cash. The film library was 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 with and into Prism.
NOTE 16--PENDING MERGER
On August 1, 1999, the Company and West Coast Entertainment Corporation, entered
into an Agreement and Plan of Merger ("Pending Merger"). Under the terms of the
Merger Agreement, upon consummation of the merger, each share of West Coast
common stock will be converted for not less than 0.25 and no more than 0.333
shares of Video City common stock. In addition, each share West Coast common
stock will receive .05 shares of Video City Series F convertible redeemable
preferred stock. The merger will be accounted for as a purchase.
F-34
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16--PENDING MERGER (Continued)
On March 3, 2000, Video City and West Coast entered into a Management Agreement
(Note 17) and amended the Agreement and Plan of merger entered into in August
1999, to provide that the "Outside Date," as defined in the Merger Agreement,
shall be August 31, 2000. The consummation of the previously reported merger is
subject to certain terms and conditions set forth in the Merger Agreement,
including the approval of the transactions by the stockholders of Video City and
West Coast and the approval by creditors and other third parties.
NOTE 17--SUBSEQUENT EVENTS
Management agreement - On March 3, 2000, Video City and West Coast Entertainment
Corporation ("West Coast") entered into a Management Agreement, pursuant to
which Video City will manage and operate West Coast's business until the closing
of the proposed merger between Video City and West Coast. The Management
Agreement provides that West Coast shall pay management fees for Video City's
management services in amount equal to certain percentages of gross revenues
actually collected from the West Coast business less all costs and expenses of
West Coast incurred and paid in the ordinary course of business (in no event
should the management fee paid by West Coast to Video City be less than $400,000
per calendar month). West Coast may terminate the Management Agreement on or
after August 31, 2000. Concurrent with the execution of the Management
Agreement, the directors and executive officers of West Coast resigned and Video
City moved its principle executive offices from Torrance, California to
Philadelphia, Pennsylvania. The Company entered into non-compete agreements with
former members of West Coast's management that require annual payments of
approximately $800,000 over 3 years.
F-35
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17--SUBSEQUENT EVENTS (Continued)
Restructuring - In March 2000, after entering into the Management Agreement with
West Coast and in anticipation of the proposed merger between the Company and
West Coast, the Company's management, in an effort to improve the performance of
its operations, decided to move its corporate facility and streamline its
corporate expenses. As a result of restructuring its operations, the Company
will recognize a charge of approximately $1.5 million in the first quarter of
fiscal 2001. The restructuring charge will mainly consist of severance
obligations to employees, lease liability for the executive offices in Torrance,
California, and a non-cash write down of leasehold improvements for the Torrance
facility.
Forbearance Agreement - On March 9, 2000, the Company entered into a second
Forbearance Agreement with BankBoston related to the Senior Secured Revolving
Credit Facility, after the September 10, 1999 Forbearance Agreement expired
(Note 8). Subject to the terms of the new Forbearance Agreement, the Credit
Facility is limited to $10,750,000, and the financial performance covenants have
been revised. As of May 10, 2000, the Company is in compliance with the
financial covenants set forth in the Forbearance Agreement. The Forbearance
Agreement expires July 31, 2000 but may be extended by August 15, 2000, if the
lender is satisfied, in its sole discretion, that the closing of any sale of
stores (see "Divestiture of Stores") which will result in the payment of the
outstanding bank debt.
Divestiture of stores - The Company is negotiating the sale of a significant
number of its stores and is entertaining several offers. The stores for sale
were strategically selected, to concentrate the Company's operations in an
efficient geographic area. The anticipated proceeds from the divestiture will be
used to eliminate the Company's indebtedness to its credit facility and to
improve its liquidity and working capital. In addition, under the Pending Merger
and Management Agreement with West Coast, the Company is currently negotiating
to divest a number of West Coast's video stores, with the proceeds being used to
pay the cash portion necessary to complete the restructuring of West Coast's
indebtedness and the merger. The Company believes that the successful
implementation of these plans will permit the merger to proceed and will result
in a stronger combined company. There can be no assurance that these objectives
can be successfully completed or that the resultant company will be profitable.
F-36
<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 10, 2000
<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
--------- ----- ----
<S> <C> <C>
/s/ Robert Y. Lee
- --------------------------------------- Chairman of the Board and May 10, 2000
Robert Y. Lee Chief Executive Officer (Principal
Executive Officer)
/s/ Robert Y. Lee
- --------------------------------------- Acting Chief Financial Officer May 10, 2000
Robert Y. Lee (Principal Financial and Accounting
Officer)
/s/ James Craig Kelly
- --------------------------------------- Director May 10, 2000
James Craig Kelly
/s/ David A. Ballstadt
- --------------------------------------- Director May 10, 2000
David A. Ballstadt
/s/ Michael T. Anderson
- --------------------------------------- Director May 10, 2000
Michael T. Anderson
/s/ Barry L. Collier
- --------------------------------------- Director May 10, 2000
Barry L. Collier
/s/ Charles E. Cooke
- --------------------------------------- Director May 10, 2000
Charles E. Cooke
/s/ John T. Sheehy
- --------------------------------------- Director May 10, 2000
John T. Sheehy
/s/ Gerald W.B. Weber
- --------------------------------------- Director May 10, 2000
Gerald W.B. Weber
</TABLE>
<PAGE>
EXHIBIT 10.19
FORBEARANCE AGREEMENT
THIS FORBEARANCE AGREEMENT ("Agreement") is dated as of March 9, 2000 between
Video City, Inc., a Delaware corporation with its principal executive offices at
370 Amapola Avenue, Suite 208, Torrance, California, 90501, (as a "Borrower" and
"Agent Borrower") and its wholly owned subsidiaries listed as "a Borrower" below
("Subsidiaries", and together with Video City, Inc., the "Borrowers") and Fleet
Retail Finance Inc. f/k/a BankBoston Retail Finance Inc., a Delaware corporation
with an address of 40 Broad Street, Boston 02109 (the "Lender").
RECITALS
A. Lender and Borrowers are parties to the Loan and Security Agreement
(the "Loan Agreement") dated as of December 29, 1999, as amended from time to
time. Terms defined in the Loan Agreement are used herein as therein defined.
B. The Borrowers defaulted under the terms of the Loan Agreement and the
parties entered into a Forbearance Agreement dated as September 10, 1999. The
Forbearance Agreement has expired.
C. The Borrowers have requested that Lender forbear from exercising its
Rights and Remedies under the Loan Documents regarding such defaults and to
consent to the Borrowers entering into certain agreements with West Coast
Entertainment Corporation, a Delaware company ("West Coast"), and Marshall
Morgan, LLC (the "Consultants"), which will provide, inter alia, for the
Borrowers to provide interim management services to West Coast and assist West
Coast, in conjunction with the Consultants to sell certain of the stores owned
by West Coast, along with certain of the stores owned by the Borrowers. As an
accommodation to the Borrowers, Lender has agreed to the foregoing request,
subject in all respects, however, to the terms and conditions set forth in this
Agreement.
NOW, THEREFORE, the parties agree as follows:
1. Accuracy of Recitals. The parties hereto acknowledge and agree that
--------------------
the foregoing Recitals are true and accurate.
2. Effective Date. This Agreement shall be effective upon receipt by the
--------------
Lender of each of the following items: (i) a fully executed copy of this
Agreement, in form and substance satisfactory to the Lender in its sole
discretion; (ii) a fully executed copy of the Management Agreement (defined
below); (iii) an executed copy of the Engagement Letter (defined below); and
(iv) an executed copy of the Merger Agreement (defined below).
3. Acknowledgment of Indebtedness. The Borrowers acknowledge and agree
------------------------------
they are indebted to Lender under the Loan Documents in the following amounts
(plus accrued and unpaid legal fees and expenses):
(a) an aggregate principal amount of $10,247,077.35 (as of March 2, 2000);
1
<PAGE>
(b) interest of $3,486.85 (as of March 2, 2000);
(c) costs and expenses of Lender of $7,226.96 (as of March 2, 2000);
(d) a remaining unpaid facility fee of $73,500.00;
(e) a line (unused) fee of $274.33 (as of March 2, 2000);
(f) a termination fee of $300,000.00; and
4. Default Rate. The Lender has exercised its right to charge and
------------
collect the default rate of interest applicable to the Liabilities under the
Loan Agreement commencing as of the date of this Agreement. The lender shall not
charge the default rate retroactive prior to the date of which the default rate
was imposed.
5. Limitation on Borrowings. Without in any way modifying the amount of
------------------------
the Loan Ceiling, which, subject to change by the Lender pursuant to the terms
of the Loan Agreement, remains Thirty Million Dollars ($30,000,000.00), the
aggregate of the balance of the Loan Account and the Stated Amount of all L/C's
shall be temporarily limited to Ten Million Seven Hundred and Fifty Thousand
Dollars ($10,750,000.00), or such lesser amount as the Lender may establish
following the occurrence of a New Default, defined in Section 10, below.
6. Availability Reserve. Lender agrees that the Availability Reserve
--------------------
established to address discrepancies in inventory reporting by the Borrowers
shall be reduced from five Hundred Thousand Dollars ($500,000.000) to Three
Hundred and Fifty Thousand Dollars ($350,000.000).
7. Financial Performance Covenants. The Borrowers' compliance with the
-------------------------------
financial performance covenants set forth in Exhibit 5-12(a) of the Loan
Agreement shall be suspended during the term of this Agreement. During the term
of this Agreement, the Borrowers shall observe and comply with the following
financial performance covenants. The financial performance covenants are based
upon the cash flow projections dated February 25, 2000 submitted to the Lender
by the Borrowers, a true copy of which is attached hereto as EXHIBIT "A".
Pursuant to Section 5.11(e) of the Loan Agreement, the Lender hereby signs-off
on such projections, which, shall hereinafter be considered the Business Plan
under the Loan Agreement.
a. The Borrowers shall not permit or suffer to exist their revenues to be
less than 85% of the projected revenues, as calculable from the
Business Plan. This revenue covenant shall be tested commencing March
20, 2000 for the two week period ending March 17, 2000, on March 24,
2000 for the three week period ending March 27, 2000, and on each week
thereafter for the trailing four week period.
b. The Borrowers shall not permit or suffer to exist purchases (delineated
as "Costs of Goods Sold" in its Business Plan) to be less than 85% of
projected purchases, as calculable from the Business Plan. This
purchases covenant shall be tested commencing March 20, 2000 for the
two week period ending March 17, 2000, on March 24, 2000 for the three
week period ending March 27, 2000, and on each week thereafter for the
trailing four week period.
2
<PAGE>
C. The Borrowers shall not permit or suffer to exist purchases from
Ingraru Entertainment, Inc. or other reputable vendor/studio
acceptable to the Lender in its reasonable discretion for prerecorded
video cassettes, DVDs, video games, tapes, discs, and other products
supplied by Ingram Entertainment, Inc. to the Borrowers in the
ordinary course of the Borrowers' businesses to be less than
$100,000.00 per week (tested on a rolling four week basis),
commencing as of March 13, 2000 for the week ending March 10, 2000.
d. The Borrowers shall not permit or suffer to exist EBITDA, tested as
of Monday of each fiscal week (tested on a rolling four week basis)
ending the previous Friday, commencing as of March 27, 2000, to be
less than 85% of a projected positive or more than 115% of a
projected negative EBITDA, as calculable from the Business Plan.
8. Additional Financial Reporting. In addition to any other weekly
------------------------------
financial reports the Borrowers are required to provide to the Lender pursuant
to the terms of the Loan Agreement, weekly, on the Tuesday of each week (as of
the then immediately preceding Saturday) the Borrowers shall provide the Lender
with an inventory roll forward report, with computer inventory control system
generated back-up documentation and actual weekly cash flow reports compared to
the projections attached hereto as Exhibit "A", in each case certified by the
Borrowers' President or Chief Financial Officer as to the accuracy thereof.
Additionally, the Borrowers shall provide the Lender with weekly certifications
as to the Borrowers' compliance or noncompliance with the financial covenants,
signed by the Borrowers' President or Chief Financial Officer. Such reports and
supporting documentation shall be in form and substance acceptable to Lender in
its sole discretion. Such report may be sent to the Lender by facsimile
transmission, provided that the original is forwarded to the Lender on the date
of such transmission. In addition to the foregoing financial reports regarding
the Borrowers, the Borrowers shall provide the Lender with copies of all
financial reports to be provided to West Coast under the terms of the Management
Agreement, when such reports are provided to West Coast.
9. Conditions Precedent. It shall be a condition precedent to the
--------------------
effectiveness of this Agreement that the following events occur:
a. The Borrower shall have delivered to Lender an executed copy of that
certain Management Agreement by and between West Coast and the Video City Inc.
dated on or about March 3, 2000 (the "Management Agreement"), which Management
Agreement shall provide, among other things, that (i) the Borrowers will be paid
by West Coast a management fee of not less than $100,000.00 per week (or
$400,000.00) per month for the term of the Management Agreement, which fee shall
be paid before any SG&A expenses of West Coast and shall be deposited by
Borrower directly into the Concentration Account and (ii) the Borrowers will not
be obligated to provide any working capital funding, directly or indirectly, to
West Coast.
b. The Borrower shall have delivered to Lender an executed copy of that
certain engagement letter dated on or about March 3, 2000 by and between the
Consultant and Video
3
<PAGE>
City, Inc. (the "Engagement Letter"), which provides for the retention of the
Consultant to assist the Borrowers with the marketing and selling of the
Borrowers' stores in a manner and for an amount that will be sufficient to
satisfy the Borrowers' obligations under Section 3 hereof.
C. The Borrowers shall have delivered to the Lender an executed copy of
that certain merger agreement dated on or about March 3, 2000 by and between
Video City, Inc. and West Coast (the "Merger Agreement").
10. Sale of Stores. Simultaneously upon the execution of this Agreement
--------------
the Borrower shall engage the services of the Consultant for the purpose of
selling Stores in a number sufficient to generate proceeds sufficient to satisfy
all of the Borrowers' Liabilities to the Lender. To that end, on or before May
15, 2000, the Borrowers shall have delivered an executed purchase and sale
agreement, which (i) reflects a sale price (after payment of all transaction
costs) in an amount sufficient to satisfy all of the Borrowers' Liabilities to
the Lender and (ii) a closing to occur such that the Borrowers' Liabilities to
the Lender are paid in full, in cash, on or before July 31, 2000.
11. Past Due Rents and Sales Taxes. The Borrower represents that
------------------------------
through February 28, 2000 it owes $498,963.00 in past due rent and $727,374.00
in past due sales taxes. The Borrowers shall make sufficient provision in its
weekly cash flow expenditures to reduce these outstanding obligations by at
least $50,000.00 per week.
12. Forbearance Fee. In consideration of the Lender's willingness to
---------------
enter into this Agreement, the Borrowers agree to pay the Lender a Forbearance
Fee, so referred to herein, in the amount of $250,000.00. The Borrowers hereby
authorize the Lender to charge the Loan Account with the Forbearance Fee upon
execution of this Agreement by the Borrowers and the Lender.
13. Acknowledgment Regarding Liabilities: Acknowledgment of Default
--------------------------------------------------------------------
Under the Loan Documents. Borrowers acknowledge and agree that the amounts set
- ------------------------
forth in Section 2 above are due and owing to Lender without offset, claim or
defense in connection therewith, all of which Borrowers hereby waive. The
Borrowers acknowledge and agree that (i) the existing defaults under the Loan
Documents constitute material defaults under the Loan Documents, (ii) any
notices which must be given and any grace periods or cure periods which must
expire, prior to Lender exercising any of its rights and remedies in connection
with the Loan Documents, have been given, complied with and expired and, in any
event, are hereby waived by Borrowers, and (iii) as a consequence, Lender is now
entitled to immediately exercise all of its rights and remedies under the Loan
Documents, at law or in equity, including, without limitation, its rights to
declare all "Liabilities" (as defined in the Loan Agreement) to be immediately
due, payable and performable, except to the extent that Lender agrees to forbear
from existing those rights and remedies in this Agreement.
14. Forbearance: New Default. All rights and remedies of Lender in
------------------------
connection with the existing defaults under the Loan Documents are hereby
reserved, but, except as otherwise specifically provided herein, Lender agrees
to forbear from exercising its rights and remedies in connection with the
existing defaults under the Loan Documents until the earlier to occur of the
<PAGE>
following (a "Termination Event"): (i) July 31, 2000, provided however, this
date may be extended to August 25, 2000, if the Lender is satisfied, in its sole
discretion, that the closing of any sale of stores which will result in the
payment of the Liabilities will occur prior to August 15, 2000 or (ii) the
occurrence of a "New Default" (as defined below). For purposes of this
Agreement, the term "New Default" shall mean any failure of the Borrowers in the
performance of any of the terms or conditions of, or any breach of any
representation or warranty under, or any other default under this Agreement, the
Loan Documents, any other agreements, instruments or documents entered into in
connection therewith, except that "New Default" shall not include any of the
foregoing which have occurred prior to the date hereof, and of which Lender has
actual knowledge, prior to the date hereof. A "New Default" shall also include
any material payment defaults under the Management Agreement, the Consulting
Agreement, or the Merger Agreement. "New Default" shall also not include the
failure of Borrowers to make rental payments when due under Leases as
contemplated in the Business Plan; provided, however, that none of Borrowers'
lessors has made a written demand (whether by letter, the commencement of legal
proceedings or otherwise) for payment of the overdue rent, which demand is not
cured within ten (10) days, provided further, that the lessor has not taken any
step to distrain rent. Upon a Termination Event, Lender's agreement thereunder
to forbear from exercising its rights or remedies shall immediately terminate,
without the requirement of any demand, presentment, protest or notice of any
kind, all of which Borrowers hereby waive, and Lender may at any time thereafter
proceed to exercise any and all of its rights and remedies, including without
limitation, its rights and remedies in connection with the existing defaults
under the Loan Documents, all of which are hereby reserved.
15. Enforceability of Liabilities: Waiver and Consents. Borrowers agree
--------------------------------------------------
that (i) the Liabilities are secured by the Collateral described in the Loan
Documents, (ii) the Loan Documents are in full force and effect, and enforceable
against Borrowers in accordance with their respective terms, (iii) the Borrowers
have no offsets, claims or defenses to or in connection with the Liabilities, or
the terms of the Loan Documents, all of which offsets, claims or defenses are
hereby waived. Borrowers hereby waive and affirmatively agree not to challenge
or otherwise pursue any and all defenses, affirmative defenses, counterclaims,
claims, cause of actions, setoffs or other rights that it may have as of the
date hereof relating to the Liabilities, the Loan Documents, or the Collateral
therefor, including, but not limited to, any right to contest the existing
defaults under the Loan Documents, the liens and security interests in favor of
Lender, or the conduct of Lender in administering any such indebtedness or
agreements.
16. Covenants, Representations and Warranties. The Borrowers hereby make
-----------------------------------------
the following covenants, representations and warranties:
16.1 Authority. The Borrowers are duly authorized to enter into,
---------
and perform its obligations under, this Agreement and the agreements,
instruments and documents contemplated hereby. The execution, delivery and
performance by Borrowers of this Agreement will not violate any law or any
provision of, nor are there any grounds for acceleration under, any agreement,
note, or instrument which is binding upon Borrowers.
<PAGE>
16.2 No Misrepresentations. Without limiting any rights or
---------------------
remedies Lender may have under law or in equity, Borrowers agree that all
written statements and information provided by Borrowers to Lender pursuant to,
or in connection with, this Agreement or the negotiations leading to this
Agreement, have been true, complete and correct in all material respects, and
none of the same contain any material omissions of any fact or matter necessary
to keep the statements and information therein from being misleading.
16.3 Indemnity. The Borrowers agree to indemnify and hold Lender
---------
harmless from and against any and all losses, debts, damages, liabilities,
claims, demands, actions, causes of action, lawsuits, penalties, judgments,
costs and expenses (including, without limitation, attorneys' fees of counsel of
Lender's choice), of every nature and description, which Lender may sustain or
incur, based upon, arising out of, or in any way relating to any represenations
or warranties of Borrowers being untrue or misleading, or this Agreement.
17. Entitlement to Relief from Stay. Borrowers hereby acknowledge and
-------------------------------
agree, in further consideration for the Lender entering into this Forbearance
Agreement, that, in the event that Borrowers shall make application for or seek
relief or protection under any of the sections of chapters of the Bankruptcy
Code, 11 U.S.C. (S) 101 et seq. (the "Code"), or in the event that any
involuntary petition is filed against the Borrowers under the Code and an order
for relief is entered as a result thereof, then the Lender shall thereupon be
entitled to immediate relief from any automatic stay imposed by Section 362 of
the Code, or otherwise, on or against the exercise of any and all of its rights
and remedies under this Agreement, the Loan Documents or under applicable law
based upon defaults which have occurred as of the date of this Agreement. This
entitlement shall be irrespective of any of the requirements of Section 362 of
the Code and the Lender will not be obliged to satisfy those requirements in
order to obtain relief from stay. Notwithstanding the foregoing, the Borrowers
specifically acknowledge that "cause" now exists and will continue to exist for
such relief within the meaning of Section 362(d) of the Code. Borrowers now
consent and will hereafter consent to any motion for relief from stay the Lender
may file and the Borrowers irrevocably waive and release any right to object to
such relief or to impede any of the Lender's remedies, including without
limitation any rights under Sections 362 and 105 of the Code. This provision is
a material inducement to the Lender in entering into the Forbearance Agreement.
The Lender, in turn, acknowledges that this paragraph shall not be construed as
a restriction or prohibition on the Borrowers' right to make application for or
seek relief or protection under the Code.
18. Release. In consideration for Lender entering into this Agreement,
-------
Borrowers hereby release and forever discharge Lender, and its successors,
assigns, agents, shareholders, directors, officers, employees, agents,
attorneys, parent corporations, subsidiary corporations, affiliated
corporations, affiliates, and each of them, (and in the case of individuals, in
their individual capacity and as they have acted as agents of the Lender) from
any and all claims, debts, liabilities, demands, obligations, costs, expenses,
actions and causes of action, of every nature and description, known and
unknown, whether or not related to the subject matter of this Agreement, which
Borrowers now have or at any time may hold, by reason of any matter, cause or
thing occurred, done, omitted or suffered to be done prior to the date of this
Agreement. Borrowers waive the benefits of any law, which may provide in
substance: "A general release
6
<PAGE>
does not extend to claims which the creditor does not know or suspect to exist
in his favor at the time of executing the release, which if known by him must
have materially affected his settlement with the debtor." Borrowers understand
that the facts which they believe to be true at the time of making the release
provided for herein may later turn out to be different than they now believe,
and that information which is not now known or suspected may later be
discovered. Borrowers accept this possibility, and Borrowers assume the risk of
the facts turning out to be different and new information being discovered; and
Borrowers further agree that the release provided for herein shall in all
respects continue to be effective and not subject to termination or rescission
because of any difference in such facts or any new information. This release is
fully effective on the date hereof. Lender is not releasing Borrowers from any
claims, debts, liabilities, demands, obligations, costs, expenses, actions or
causes of action.
19. General Provisions.
------------------
19.1 Integration: Amendment: Waivers. This Agreement, and the
------------------------------
Loan Documents set forth in full and terms of agreement between the parties
and are intended as the full, complete and exclusive contract governing the
relationship between the parties, superseding all other discussions,
promises, representations, warranties, agreements and the understandings between
the parties with respect thereto. No term of the Loan Documents may be modified
or amended, nor may any rights thereunder be waived, except in a writing signed
by the party against whom enforcement of the modification, amendment or waiver
is sought. Any waiver of any condition in, or breach of, any of the foregoing in
a particular instance shall not operate as a waiver of other or subsequent
conditions or breaches of the same or a different kind. Lender's exercise or
failure to exercise any rights under any of the foregoing in a particular
instance shall not operate as a waiver of its right to exercise the same or
different rights in subsequent instances. Except as expressly provided to the
contrary in this Agreement, or in another written agreement, all the terms,
conditions, and provisions of the Loan Documents shall continue in full force
and effect. If in this Agreement's description of an agreement between the
parties, rights and remedies of Lender or obligations of the borrower are
described which also exist under the terms of the other Loan Documents, the fact
that this Agreement may omit or contain a briefer description of any rights,
remedies and obligations shall not be deemed to limit any of such rights,
remedies and obligations contained in the other Loan Documents.
19.2 Payment of Expenses. Without limiting the terms of the Loan
-------------------
Documents, Borrowers shall pay all costs and expenses incurred by or on behalf
of Lender (including attorneys' fees) arising under or in connection with the
Loan Documents, including without limitation, in connection with (i) the
negotiation, preparation, execution and delivery of this Agreement and the Loan
Documents, and any and all consents, waivers or other documents or instruments
relating thereto, (ii) the filing and recording of any Loan Documents and any
other documents or instruments or further assurances filed or recorded in
connection with any Loan Document, (iii) any other action reasonably required in
the course of administration hereof, including, but not limited to, all
reasonable out-of-pocket expenses incurred in connection with audits and
inspections, and (iv) the defense or enforcement of the Loan Documents, whether
or not there is any litigation between the parties. All costs and expenses shall
be added to the
7
<PAGE>
Liabilities and the Borrowers authorize the Lender to charge the Loan Account
for such expenses.
19.3 No Third Party Beneficiaries. Except as may be otherwise
----------------------------
expressly provided for herein, this Agreement does not create, and shall not be
construed as creating, any rights enforceable by any person not a party to this
Agreement.
19.4 Separability. If any provision of this Agreement is
------------
held by a court of competent jurisdiction to be invalid, illegal or
unenforceable, the remaining provisions of this Agreement shall nevertheless
remain in full force and effect.
19.5 Counterparts. This Agreement may be executed in any number
------------
of counterparts, which together shall constitute one and the same agreement.
19.6 Time of Essence. Time is of the essence in each of the
---------------
Liabilities of the Borrowers and with respect to all conditions to be satisfied
by the Borrowers.
19.7 Statute of Limitations. The Borrowers waive the benefit of
----------------------
all statute(s) of limitations in any action or proceeding based upon or arising
out of this Agreement or the other Loan Documents.
19.8 Construction: Voluntary Agreement: Representation by
----------------------------------------------------
Counsel. This Agreement has been prepared through the joint efforts of all the
- -------
parties. Neither its provisions nor any alleged ambiguity shall be interpreted
or resolved against any party on the ground that such party's counsel was the
draftsman of this Agreement. Each of the parties declares that such party has
carefully read this Agreement and the agreements, documents and instruments
being entered into in connection herewith and that such party knows the contents
thereof and sign the same freely and voluntarily. The parties hereto acknowledge
that they have been represented in negotiations for and preparation of this
Agreement and the agreements, documents and instrument being entered into in
connection herewith by legal counsel of their own choosing, and that each of
them has read the same and had their contents fully explained by such counsel
and is fully aware of their contents and legal effect.
19.9 Governing law: Forum Selection. This Agreement has been
------------------------------
entered into and shall be governed by the laws of, the Commonwealth of
Massachusetts. As a material part of the consideration to the parties for
entering into this Agreement, each party (i) agrees that, at the option of the
Lender, all actions and proceedings based upon, arising out of or relating in
any way directly or indirectly to, this Agreement, or the Loan Documents, shall
be litigated exclusively in courts located in Suffolk County, Massachusetts;
(ii) consents to the jurisdiction of any such court and consent to the service
of process in any such action or proceeding (whether or not litigated in courts
located in Suffolk County, Massachusetts) by personal delivery or any other
method permitted by law; and (iii) waives any and all such rights to transfer or
to change the venue of any such action or proceeding to any court located
outside Suffolk County.
8
<PAGE>
19.10 Further Assurances. Borrowers agree to take all further actions
------------------
and execute all further documents as Lender may from time to time reasonably
request to carry out the transactions contemplated by this Agreement.
19.11 Notices. All notices, requests and demands to or upon the
-------
respective parties hereto shall be given in accordance with the Loan Agreement.
19.12 Mutual Waiver of Right to Jury Trial. LENDER AND EACH
------------------------------------
BORROWER EACH HEREBY WAIVE THE RIGHT TO TRIAL BY JURY IN ANY ACTION OR
PROCEEDING BASED UPON, ARISING OUT OF, OR IN ANY WAY RELATING TO:
(I) THIS AGREEMENT, OR ANY OF THE AGREEMENTS, INSTRUMENTS OR DOCUMENTS REFERRED
TO HEREIN; OR (II) ANY OTHER PRESENT OR FUTURE INSTRUMENT OR AGREEMENT BETWEEN
OR AMONG THEM; OR (III) ANY CONDUCT, ACTS OR OMISSIONS OF LENDER OR ANY BORROWER
OR ANY OF THEIR DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, ATTORNEYS OR ANY OTHER
PERSONS AFFILIATED WITH THEM; IN EACH OF THE FOREGOING CASES, WHETHER SOUNDING
IN CONTRACT OR TORT OR OTHERWISE.
[THE REMAINDER OF THIS PAGE IS INTENTIONALLY BLANK]
9
<PAGE>
Executed under seal as of the date written above.
Video City, Inc. ("Borrower" and "Agent Old Republic Entertainment, Inc.
Borrower") ("Borrower")
/s/ Robert Y. Lee /s/ Robert Y. Lee
- --------------------------------------- -----------------------------------
By: Robert Y. Lee By: Robert Y. Lee
----------------------------------- -------------------------------
Title: CEO Title: CEO
-------------------------------- ----------------------------
Sulpizio One, Inc. ("Borrower") Video Tyne, Inc. ("Borrower")
/s/ Robert Y. Lee /s/ Robert Y. Lee
- --------------------------------------- -----------------------------------
By: Robert Y. Lee By: Robert Y. Lee
----------------------------------- -------------------------------
Title: CEO Title: CEO
-------------------------------- ----------------------------
Videoland, Inc. ("Borrower") Video Galaxy, Inc. ("Borrower")
/s/ Robert Y. Lee /s/ Robert Y. Lee
- --------------------------------------- -----------------------------------
By: Robert Y. Lee By: Robert Y. Lee
----------------------------------- -------------------------------
Title: CEO Title: CEO
-------------------------------- ----------------------------
BANKBOSTON RETAIL FINANCE INC.
("Lender")
- ---------------------------------------
By:
-----------------------------------
Title:
--------------------------------
GUARANTOR ACKNOWLEDGEMENT
For good and valuable consideration, the receipt and sufficiency of which
are hereby acknowledged, the undersigned guarantor hereby irrevocably and
unconditionally acknowledges and confirms to the Lender that his guaranty of the
liabilities pursuant to the Limited Guaranty of Collection, dated as of
December 29, 1998 of the Borrowers continues in full force and effect and is a
valid and binding obligation of the undersigned guarantor in accordance with its
terms, that no defenses, offsets, claims, counterclaims exist with respect to
the guaranty, and that such guaranty is enforceable in accordance with its
terms, and guarantees and shall continue to guarantee in accordance with its
terms the performance of all amounts guaranteed thereby.
Executed under seal as of the date written above,
Guarantor:
/s/ Robert Y. Lee
-----------------------------------
Robert Y. Lee
Signature Page to Forbearance Agreement dated as of September 1999.
10
<PAGE>
EXHIBIT 21.1
Subsidiaries of the Company
<TABLE>
<CAPTION>
STATE OF NAME UNDER WHICH
SUBSIDIARY INCORPORATION BUSINESS IS DONE
- ---------- ------------- ----------------
<S> <C> <C>
Old Republic Entertainment, Inc.....California............. Video Tyme, Movie Magic,
........................................................... Adventures in Video,
........................................................... Video Unlimited
Sulpizio One, Inc...................California............. Video City
Video Tyme, Inc.....................Nevada................. Video Tyme
Videoland, Inc......................Oregon................. Videoland
Video Galaxy, Inc...................Delaware............... Video Galaxy
</TABLE>
<PAGE>
EXHIBIT 23.1
Consent of Independent Certified Public Accountants
Video City, Inc.
9998 Global Road, 2nd Floor
Philadephia, Pennsylvania 19115
We hereby consent to the incorporation by reference in the registration
statement of Video City, Inc. on Form S-3 (File Nos. 333-91037 and 333-81607)
and on Form S-8 (File No. 333-85273) of our report dated May 12, 2000 on our
audit of the consolidated financial statements of Video City, Inc. as of January
31, 2000 and for the year then ended, which report is included in this Annual
Report on Form 10-K.
/s/ BDO Seidman, LLP
Los Angeles, California
May 12, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C> <C>
<PERIOD-TYPE> YEAR YEAR
<FISCAL-YEAR-END> JAN-31-2000 JAN-31-1999
<PERIOD-START> FEB-01-1999 FEB-01-1998
<PERIOD-END> JAN-31-2000 JAN-31-1999
<CASH> 24,316 172,043
<SECURITIES> 0 0
<RECEIVABLES> 1,012,656 3,019,510
<ALLOWANCES> 0 0
<INVENTORY> 9,991,283 23,146,525
<CURRENT-ASSETS> 4,879,891 5,271,051
<PP&E> 8,156,867 6,703,704
<DEPRECIATION> 3,890,202 2,177,718
<TOTAL-ASSETS> 21,293,787 38,252,880
<CURRENT-LIABILITIES> 41,438,372 14,876,467
<BONDS> 1,231,907 17,681,148
0 0
6,217,135 3,763,963
<COMMON> 157,679 134,987
<OTHER-SE> (27,850,762) 1,368,524
<TOTAL-LIABILITY-AND-EQUITY> 21,293,787 38,252,880
<SALES> 44,784,703 24,436,234
<TOTAL-REVENUES> 44,784,703 24,436,234
<CGS> 56,836,191 20,912,900
<TOTAL-COSTS> 56,836,191 20,912,900
<OTHER-EXPENSES> 17,949,188 4,785,890
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> 3,706,749 1,563,348
<INCOME-PRETAX> (32,058,326) (2,604,823)
<INCOME-TAX> 707,299 (2,615,957)
<INCOME-CONTINUING> (33,258,147) 11,134
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (33,258,147) 11,134
<EPS-BASIC> (2.29) 0.00
<EPS-DILUTED> (2.29) 0.00
</TABLE>
