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U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-KSB
(Mark One)
| X | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
--- EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996
| | 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 0-17001
Choices Entertainment Corporation
(Name of small business issuer in its charter)
Delaware 52-1529536
(State or other jurisdiction of (I.R.S. employer identification no.)
incorporation or organization)
836 W. Trenton Avenue, Morrisville, Pennsylvania 19067
- - - ----------------------------------------------------- ----------------
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code (215) 428-1000
Securities registered under Section 12(b) of the Exchange Act: None
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, par value $.01 per share.
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(Title of class)
Check whether the issuer (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
Check if there is no disclosure of delinquent filers in response to Item
405 of Regulation S-B contained in this form, and no disclosure will 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-
KSB or any amendment to this Form 10-KSB. [ ]
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Issuer's revenues for the year ended December 31, 1996: $5,173,000.
Aggregate market value of the voting stock held by non-affiliates of the
registrant based upon a price of $0.05 per share, the average of the inside bid
and ask prices of the registrant's Common Stock at March 17, 1997: $995,730. For
purposes of this calculation, all directors and officers of the registrant have
been considered affiliates.
Number of outstanding shares of the registrant's Common Stock at March 17,
1997: 22,004,395 shares.
Transitional Small Business Disclosure Format (check one):
Yes No x
DOCUMENTS INCORPORATED BY REFERENCE
The information called for by Items 9, 10, 11 and 12 of Part III hereof is
incorporated by reference from registrant's definitive Proxy Statement,
involving the election of directors, to be filed pursuant to Regulation 14A.
(ii)
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PART I
ITEM 1. Description of Business
The Company currently operates a chain of nine retail video home
entertainment stores, principally under the trade name CHOICES(R) - MOVIES AND
GAMES, which rent and sell videocassette tapes, video games and other video home
entertainment products. The Company's home entertainment stores, all of which
are superstores, are located in Delaware, New Jersey and Pennsylvania.
The West Coast Transaction
As previously reported, the Company has entered into an asset purchase
agreement with West Coast Entertainment Corporation ("West Coast"), dated
December 16, 1996, as amended (the "Purchase Agreement"), providing for the
sale, transfer and assignment of substantially all of the Company's assets and
business to West Coast (the "West Coast Transaction").
Under the terms of the Purchase Agreement, the Company is to be paid a
purchase price in cash of $2,430,000, subject to possible downward adjustment,
based upon net operating cash flow for 1996, as defined in the Purchase
Agreement. The purchase price was determined through arm's-length negotiation
between the Company and West Coast.
The Purchase Agreement provides that $243,000 of the purchase price shall
be held by West Coast as escrow agent in an interest-bearing escrow account for
a period of two years, to be used to satisfy certain indemnity obligations of
the Company, if any, to West Coast.
Consummation of the West Coast Transaction is contingent upon a number of
conditions, the satisfaction of which cannot be assured, including, among
others, obtaining of all necessary consents, West Coast obtaining financing in
an amount sufficient to enable it to consummate the West Coast Transaction and
certain additional acquisitions, and approval of the West Coast Transaction by
the Company's stockholders. The West Coast Transaction was approved by the
Company's stockholders on March 12, 1997.
The Company also agreed to pay to West Coast a break-up fee of $100,000:
(i) if the Company's directors or stockholders had failed to approve the West
Coast Transaction; or (ii) if prior to the closing of the West Coast Transaction
the directors of the Company, whether or not in the exercise of their fiduciary
or other legal duties, shall withdraw or adversely modify or take a public
position materially inconsistent with their prior approval of, the Purchase
Agreement.
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If an event occurs which entitles West Coast to receive the break-up fee,
West Coast has been granted an option in the Purchase Agreement to purchase all
of the Company's assets relating to the Company's retail video store located in
Newtown, Pennsylvania (the "Newtown Store") for the purchase price of $250,000
payable in cash.
In connection with the Purchase Agreement, West Coast also loaned the
Company $150,000 on December 16, 1996, $20,000 on March 3, 1997, and $29,000 on
March 19, 1997, all of which loans are evidenced by 12% promissory notes, which
provide for repayment of the loans at the closing of the West Coast Transaction
or, if applicable, at the closing of the sale of the assets of the Newtown Store
or, in any event, on demand at any time from and after April 30, 1997. The notes
are secured by a security interest in all of the assets of the Newtown Store.
The proceeds of the notes were used to pay certain costs previously incurred.
General Description
The Company was incorporated in Maryland in July, 1985, under the name PPV
Enterprises, Inc. and was reincorporated in Delaware under the name DataVend,
Inc. in August, 1987. In March, 1990, the Company changed its name to "Choices
Entertainment Corporation." The Company's executive offices are located at 836
W. Trenton Avenue, Morrisville, Pennsylvania 19067; its telephone number is
(215) 428-1000.
The Home Video Industry
General. The Company believes that the retail video store industry is
consolidating into regional and national chains. The Company believes that the
principal competitive factors in the video retail industry are store location
and visibility, title selection, the number of copies of each new release
available, customer service and, to a lesser extent, pricing.
Studio Dependence on Video Rental Industry. Of the many movies produced by
major studios and released in the United States each year, relatively few are
profitable for the studios based on box office revenue alone. In addition to
purchasing box office hits, retail video stores, including those operated by the
Company, purchase movies on videocassette that were not successful at the box
office, thus providing the movie studios with a reliable source of revenue for
almost all of their movies.
Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenues by releasing movies in sequential release date "windows" to various
movie distribution channels. These distribution channels include, in usual
release date order, movie theaters, retail video stores, pay-per-view, pay
television,
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network and syndicated television and, finally, basic cable television. The
Company believes that this method of sequential release has allowed movie
studios to increase their total revenue with relatively little adverse effect on
the revenue derived from previously established channels, and that movie studios
will continue the practice of sequential release as new distribution channels
become available.
Home Entertainment Store Operations
Products. Approximately 80% of the Company's revenues are derived from the
rental of videocassettes and video games, with the balance of revenues being
derived from the sale of videocassettes and video games, the rental of video
recorders, the sale of video accessories, such as blank cassettes and cleaning
equipment, and the sale of confectionery items. Each of the Company's
superstores offers from 8,000 to 12,000 videocassettes (from 5,000 to 10,000
titles) and from 500 to 2,000 video games (from 400 to 1,500 titles) for rental
and sale, depending upon each store's location.
Management believes that a typical store's revenues are most affected by
its new release title selection and the number of copies of each new release
available for rental as compared to the competition. Although the Company is
committed to offering as many copies of new releases as necessary to be
competitive, its ability to do so is dependent on its ability to continue to
finance its short-term working capital needs. Videocassettes offered for sale
are both previously-viewed movies as well as major box office hit titles that
are promoted by the studios at a reduced price to encourage direct consumer
purchases. The Company also rents and sells video games, which are licensed
primarily by Nintendo(R) and Sega Genesis(R).
Customers; Nature of Business. The business of the Company is not dependent
upon a single, or a few customers, the loss of which would have a material
adverse effect.
Inventory Management. The Company's inventory (videocassettes and games)
consists of its catalog titles (those in release for more than one year) and new
release titles. All of the Company's videocassette and video game rental
inventory is purchased from suppliers. In each of its stores, the Company
maintains a selection of new releases that balances customer demand and rental
trends with maximization of store profitability. Buying decisions are made
centrally based on box office results, industry newsletters, management's
knowledge of the popularity of certain types of movies in its markets and input
from store managers.
Suppliers. The Company purchases substantially all of its videocassettes
and video games for rental and sale from a single supplier, Star Entertainment
LP. ("Star"). Star has a security interest in the Company's inventory (except
with respect to the
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Company's Newtown Store), which secures the Company's ongoing account payable to
Star. The Company also currently seeks marketing funds from Star based upon a
percentage of purchases. The Company also has a pay-per-transaction arrangement
with a different supplier. In the event that the Company's relationship with
Star was terminated, the Company believes that it could obtain its required
inventory of videocassettes and video games from alternative suppliers at prices
and on terms comparable to those available from Star. However, the Company's
results of operations could be adversely affected until its debt with Star is
fully satisfied and a suitable replacement is found. At December 31, 1996, the
Company owed Star approximately $325,000.
Marketing and Advertising. With advertising credits and market development
funds that it receives from its primary video supplier, the Company uses
in-store advertising, discount coupons and promotional materials to promote new
releases, its video specialty stores and its trade name. Expenditures for
advertising above the amount of the Company's advertising credits from its
primary supplier have been minimal. The Company also benefits from the
advertising and marketing by studios and theaters in connection with their
efforts to promote films and increase box office revenues.
Employees. The Company currently has 91 employees, of which 29 are full
time. Besides store personnel, the Company has two employees in operations,
three employees in accounting and one employee in administration.
Trade Name. The Company currently operates under the trade name Choices(R)
- - - - Movies and Games, for which it has obtained federal and state trade name
protection.
Competition and Technological Obsolescence
The video retail industry is highly competitive. The Company competes with
other retail video stores, including stores operated by regional and national
chains, as well as other businesses offering videocassettes and video games such
as supermarkets, convenience stores, bookstores, mass merchants, mail order
operations and other retailers. In addition, the Company competes with movie
theaters, network and cable television, live theater, sporting events and family
entertainment centers. Several of the Company's stores compete with
Blockbuster(R) stores, the dominant video specialty retailer in the United
States. Many of the Company's competitors have significantly greater financial
and marketing resources, market share and name recognition than the Company.
Additionally, while advances in technology such as video-on-demand have proven
expensive and have not adversely affected the retail video market to date, such
technologies could in the future have a materially adverse impact on the
Company's operations.
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The Company also competes with Pay-Per-View cable television systems, 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
generally available only to households with a converter to unscramble incoming
signals. Recently developed technologies, however, permit certain cable
companies, direct broadcast satellite companies, telephone companies and other
telecommunications companies to transmit a much greater number of movies to
homes throughout the United States at more frequent intervals (often as
frequently as every five minutes) throughout the day, referred to as
"Near-Video-on-Demand ("NVOD"). NVOD does not offer full interactivity or VCR
functionality such as allowing consumers to control the playing of the movies,
starting, stopping and rewinding. Ultimately, further improvements in these
technologies could lead to the availability of a broad selection of movies to
the consumer on demand referred as Video-on-Demand ("VOD"), at a price which may
be competitive with the price of videocassette rentals and with the
functionality of VCRs. Certain cable and other telecommunications companies have
tested and are continuing to test limited versions of NVOD and VOD in various
markets throughout the United States and Europe.
ITEM 2. Description of Property
The Company currently leases its corporate offices, located at 836 W.
Trenton Avenue, Morrisville, Pennsylvania, from a non-affiliated party. The
lease provides for monthly rental payments of $875, and expires July, 1997.
Thereafter, the lease will continue on a month-to-month basis.
Each of the Company's nine home entertainment stores is in good condition
and is leased from a non-affiliated party. The lease agreements covering six of
the stores were entered into directly between the Company and the respective
landlord, while the lease agreements covering the remaining three stores were
assigned to the Company in connection with a prior acquisition. As of January
1997, the total monthly rent relating to the Company's nine stores was
approximately $76,000.
ITEM 3. Legal Proceedings
The Company has recently been involved in certain legal proceedings
concerning control of the Company's Board of Directors. The following is a
description of these proceedings and certain other material legal proceedings,
which are pending:
Shareholder Committee Litigation. On July 26, 1996, the Company filed a
lawsuit in the United States District Court for the District of Columbia (the
"Washington Proceedings"), entitled Choices Entertainment Corporation v. Carl
Shaifer et al., Civil Action No. 1:96-CV-01753, seeking declaratory and
injunctive relief
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against the following group of stockholders: Carl Shaifer, Joseph DeSaye, Max
Scheuerer, Maureen and Lawrence Feeney, William and Evelyn Goatley, P.L.
Anderson, Jr., Harold E. Hamburg, David F. Beckman, Mark and Barbara Raifman and
Frank Harvey (collectively, the "Shareholder Committee") for alleged violations
of the federal securities laws. The Shareholder Committee had previously filed a
Solicitation Statement (the "Solicitation Statement") with the Securities and
Exchange Commission on June 28, 1996, in connection with the Shareholder
Committee's solicitation of written consents from other stockholders for the
purpose of removing and replacing the Board of Directors of the Company without
the holding of a meeting. The Company believes that the Solicitation Statement
contained material misleading statements and omissions of material facts,
including the failure to disclose serious conflicts of interests of the
Shareholder Committee and of certain of its director nominees to the Board, that
the Shareholder Committee had failed to file a Schedule 13D in accordance with
the requirements of the Securities Exchange Act of 1934, and that any consents
obtained by the Shareholder Committee had been obtained in violation of the
federal securities laws and were invalid.
On July 29, 1996, the Shareholder Committee delivered written consents to
the Company, which the Shareholder Committee asserted were sufficient to remove
and replace the Company's then Board of Directors with the nominees of the
Shareholder Committee without the holding of a meeting, and such nominees
attempted to assert control and to terminate the employment of then existing
management. The Company did not recognize the action purported to have been
taken by the Shareholder Committee, having concluded that the Shareholder
Committee had not delivered sufficient consents to remove and replace the
Company's Board and, in any event, that such consents were otherwise invalid as
having been obtained in violation of the federal securities laws.
On August 2, 1996, a lawsuit was filed in the Court of Common Pleas of
Bucks County, Pennsylvania, against the then existing Directors of the Company
by the director nominees to the Board of the Shareholder Committee, Carl
Shaifer, Joseph DeSaye and Max Scheuerer, as well as on behalf of the Company,
entitled Choices Entertainment Corporation et al. v. Ronald W. Martignoni et
al., No. 96005737-18-5. The lawsuit requested that the Court grant a preliminary
injunction requiring that the defendants cease acting as corporate officers or
directors and otherwise relinquish control of the Company. On August 9, 1996,
the lawsuit was discontinued by plaintiffs.
On August 16, 1996, the Shareholder Committee's nominees, Carl Shaifer,
Joseph DeSaye and Max Scheuerer, filed a lawsuit in the Delaware Court of
Chancery for New Castle County (the "Delaware Proceedings"), C.A. No. 15170,
entitled Carl Shaifer, et al. v. Ronald W. Martignoni, et al., against the
Company and the then existing Board of Directors, seeking: (i) a declaration
that the
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Board had been duly and validly removed and that plaintiffs were validly elected
as the Company's Board, (ii) an order directing the holding of an annual meeting
of stockholders on a date, to be fixed by the Court, not more than 30 days from
August 16, 1996 (the date of the filing of the complaint), (iii) costs and
expenses, including attorneys fees, and (iv) such other relief as the Court
deemed just and proper.
On September 4, 1996, after two summary hearings, and prior to the filing
of an answer by defendants in the Delaware Proceedings, the Delaware Court of
Chancery, without ruling on the merits, ordered, inter alia: (i) that the annual
meeting of stockholders be held on December 20, 1996, as previously announced by
the Company, (ii) that the then present Board, consisting of Ronald W.
Martignoni, John A. Boylan and Fred E. Portner, constituted the Company's board
of directors, until the earlier of the election of directors at the annual
meeting or the resolution of plaintiffs' claims in the lawsuit, and that Joseph
DeSaye, except with respect to certain matters, be permitted to attend Board
meetings, and (iii) that, until the earlier of the election of directors at the
annual meeting or the resolution of plaintiffs' claims in the lawsuit, the
Company could not issue any voting securities in certain specified transactions
except upon Court order and that the Company could not, except upon five
business days notice, take any "action out of the ordinary course," as defined
in the order. The order also provided that the restrictions contained therein
could be waived by written agreement of the parties and that the order could be
modified by the Court. On September 6, 1996, defendants filed an answer to the
complaint in the Delaware Proceedings, denying plaintiffs' allegations with
regard to all claims.
On September 12, 1996, counsel for the Company and the Shareholder
Committee notified the Court in the Washington Proceedings that they were
engaged in settlement discussions and requested postponement of the hearing
previously scheduled for September 13, 1996, which postponement was granted.
The annual meeting was held, in accordance with the Chancery Court order,
on December 20, 1996, at which a new Board of Directors was elected consisting
of: Joseph DeSaye, Ronald W. Martignoni, and Fred E. Portner. Mr. Portner was
nominated at the annual meeting upon the withdrawal, without prior notice, on
the day of the meeting, of Ralph V. Esposito, one of the Company's nominees.
On February 6, 1997, counsel for the Company and the Shareholder Committee
agreed to a stipulation of dismissal without prejudice as to both the Washington
and Delaware Proceedings.
Scheuerer Litigation. On September 18, 1996, a lawsuit was filed against
the Company in the Court of Common Pleas of Bucks County, Pennsylvania,
captioned Max Scheuerer v. Choices
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Entertainment Corporation, Civil Action No. 96006871, in which plaintiff, Max
Scheuerer, a member of the Shareholder Committee, is seeking a judgment in the
amount of $146,298 (plus future interest, costs and any other appropriate
damages), which amount allegedly represents $120,000 of principal and $26,298 of
interest owed by the Company to Mr. Scheuerer under two 10% promissory notes.
The Company has entered into a settlement agreement with Mr. Scheuerer,
providing for $3,000 monthly payments to Mr. Scheuerer with the unpaid balance
to be paid at closing of the West Coast Transaction. Notwithstanding the
settlement agreement, Mr. Scheuerer is proceeding with the litigation. For
further information, see ITEM 6. Management's Discussion and Analysis or Plan of
Operation.
Gibbs Litigation. On April 9, 1996, a lawsuit was filed against the Company
in the Superior Court of California, entitled Gary N. Gibbs et al. v. Choices
Entertainment Corporation et al., No. BC147815, by certain individuals who
allegedly purchased or purchased and sold securities of the Company. Also named
as defendants in the lawsuit were the members of the Board of Directors, a
former director and certain others. It is alleged that the Company made false
and misleading statements and omitted to state certain material facts in public
communications and in reports filed with the Securities and Exchange Commission
with regard to a possible merger with JD Store Equipment, Inc. ("JD Store"),
which was terminated by JD Store in September 1995, and the Company's related
acquisition program. On July 12, 1996, Demurrers to the Complaint filed on
behalf of the Company and the other defendants were sustained. On July 29, 1996,
a Second Amended Complaint was filed, in which plaintiffs seek monetary damages
against the Company and the other defendants in the amount of $303,470, plus
attorney's fees, costs of suit and such other relief as the Court deems just.
The plaintiffs are principally the same individuals who filed the prior
Complaint, which contains substantially the same allegations as now set forth in
the Second Amended Complaint. On August 28, 1996, the Company filed an answer to
the Second Amended Complaint, denying plaintiffs' allegations with regard to all
claims. On October 22, 1996, the Company filed a Motion for Summary Judgment,
which was denied on November 26, 1996. Discovery is proceeding. The Company
intends to contest the lawsuit vigorously.
ITEM 4. Submission of Matters to a Vote of Security Holders
An Annual Meeting of Stockholders was held on December 20, 1996, at which
the following matters were voted upon by the holders of the Company's Common and
Series C Preferred Stock ("Preferred Stock"), voting together as a class:
Election of Board of Directors. A board of three directors was elected at
the meeting consisting of Messrs. Joseph DeSaye, Ronald W. Martignoni and Fred
E. Portner. Mr. Portner was
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nominated at the annual meeting upon the withdrawal, without prior notice, on
the day of the meeting, of Ralph V. Esposito, one of the Company's nominees.
Messrs. DeSaye, Martignoni and Portner received the following combined vote of
the Company's Common and Preferred Stock:
For Withhold
--- --------
Joseph DeSaye 18,041,358 408,909
Ronald W. Martignoni 11,462,771 6,987,496
Fred E. Portner 18,041,358 408,909
Subsequent to the Annual Meeting, on February 13, 1997, the Board was
expanded to four directors, and James D. Sink, M.D. was appointed to the Board.
On February 21, 1997, Joseph DeSaye resigned as a director.
Ratification of Appointment of KPMG Peat Marwick LLP. The appointment of
KPMG Peat Marwick LLP as the Company's independent auditors for 1996 was
ratified by the following combined vote of the Company's Common and Preferred
Stock:
For Against Abstain
--- ------- -------
18,394,352 50,690 5,225
Amendment of Company's Certificate of Incorporation. An amendment to
the Company's Certificate of Incorporation was approved to permit the conversion
of the Company's Series C Preferred Stock without any further increase in the
authorized shares of Common Stock and any reduction in the number of presently
authorized shares of Preferred Stock by the following combined vote of the
Company's Common and Preferred Stock:
For Against Abstain
--- ------- -------
13,476,315 239,822 320,799(1)
- - - ----------
(1) Does not include 4,413,331 broker non-votes.
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PART II
ITEM 5. Market for Common Equity Stock and Related Stockholder
Matters
The Company's Common Stock is currently traded in the over-the-counter
market on the OTC-Bulletin Board. The following table sets forth the high and
low inside bid prices as reported by the OTC-Bulletin Board.
Common Stock
(CECSC)
1995 High Low
- - - ---- ---- ---
First quarter .................................. 1.84 1.25
Second quarter ................................. 1.28 .91
Third quarter .................................. 1.22 .13
Fourth quarter ................................. .22 .16
1996
- - - ----
First quarter .................................. .20 .09
Second quarter ................................. .14 .04
Third quarter .................................. .28 .10
Fourth quarter ................................. .16 .05
On March 17, 1997, the high and low inside bid prices for the Company's
Common Stock were both $0.04, as reported by the OTC-Bulletin Board.
The quotations set forth above reflect inter-dealer prices, without retail
markup, markdown or commission and may not necessarily represent actual
transactions.
Holders. As of March 17, 1997, the outstanding shares of the Company's
Common Stock were held by approximately 555 holders of record.
Dividends. The Company has neither declared nor paid any dividends on its
Common Stock since its inception, and the Board of Directors does not
contemplate the payment of dividends in the foreseeable future, given the lack
of earnings to date and the current policy of the Board of Directors which is to
retain future earnings, if any, to fund the growth of the Company. Any decision
as to the future payment of dividends will depend on the earnings, if any, and
financial position of the Company and such other factors as the Board of
Directors deems relevant.
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ITEM 6. Management's Discussion and Analysis or Plan of
Operation
The following is management's discussion and analysis of certain
significant factors which have affected the Company's financial condition,
changes in financial condition and results of operations. It also includes a
discussion of the Company's liquidity and capital resources at December 31,
1996, and later dated information, where practicable. This discussion should be
read together with the Company's Financial Statements and the Notes thereto
beginning on page F-1.
Financial Condition, Liquidity and Capital Resources
The Company is currently operating in a severely distressed financial
condition. As of December 31, 1996, the Company had a net working capital
deficiency of approximately $2,388,000. The Company is currently funding its
business on a day-to-day basis from revenues generated from its nine store
operations. Because of the timing of the payment of certain obligations and an
increase in the amount of credit extended by its primary supplier of
videocassettes, the Company has reported positive cash flow from operations for
the year ended December 31, 1996. However, as the revenues from the Company's
existing nine stores are insufficient to ensure timely payment of its
obligations, the Company continues to be in immediate need of financing to fund
its short-term working capital needs.
As a result of its severely distressed financial condition, the Company
elected to issue 3.4 shares of its Series C Preferred Stock to the holders of
its 5% unsecured promissory notes, in payment of $34,000 of accrued interest due
such noteholders in September, 1996, in accordance with the terms of such notes.
In addition, such 5% promissory notes, in the principal amount of $680,000,
provide, by their terms, that the sole remedy of the holders thereof upon
default is to convert the principal and all accrued interest owing thereon into
shares of Series C Preferred Stock (valued at $.25 per share of Common Stock).
The notes are not presently in default in the payment of principal or interest.
However, the Board of Directors does not presently intend to make any payment on
such notes upon their maturity in August 1997, leaving the holders thereof with
the sole remedy of converting such notes into Series C Preferred Stock. The
notes are not presently convertible.
The Company is in default under the terms of three 10% promissory notes in
the aggregate principal amount of $150,000 plus accrued interest. These notes
are held by Carl Shaifer and Max Scheuerer, two members of the Shareholder
Committee (See ITEM 3. Legal Proceedings). The aggregate principal amount owing
by the Company on said promissory notes was reduced to $150,000 from $180,000 as
a result of a $30,000 payment made by the Company
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during 1995 to Mr. Scheuerer, the holder of two such notes in the then total
principal amount of $150,000. This payment was made following the filing of a
lawsuit against the Company by Mr. Scheuerer in which a judgment was sought in
the principal amount of $150,000 plus accrued interest of $15,548. The lawsuit
was withdrawn following said $30,000 payment without prejudice to its being
reinstated if the balance owing on said notes was not paid in full prior to
March 15, 1996. No further payments were made on such notes and Mr. Scheuerer
filed a new lawsuit on September 18, 1996 (See ITEM 3. Legal Proceedings),
seeking a judgment in the amount of $146,298, representing principal and
interest owing to Mr. Scheuerer by the Company on said notes (plus future
interest, costs and any other appropriate damages). Since that time, the Company
has made payments to Mr. Scheuerer totaling $6,989. The Company has entered into
a settlement agreement with Mr. Scheuerer, providing for $3,000 monthly payments
to him with the unpaid balance to be paid at closing of the West Coast
Transaction. Notwithstanding the settlement agreement, Mr. Scheuerer is
proceeding with the litigation. If the West Coast Transaction is not
consummated, the Company would be unable to satisfy the balance owing.
Additionally, the Company is in default under the terms of a 10% promissory
note in the principal amount of $30,000, which note is held by Harold E.
Hamburg, a member of the Shareholder Committee. The Company has paid all
interest due to date on said note.
The Company is also delinquent and presently unable to satisfy various
other liabilities, including amounts owing to vendors and landlords, as well as
substantial professional fees owing in connection with, among other things, its
now discontinued acquisition program and with respect to ongoing litigation (See
ITEM 3. Legal Proceedings).
In connection with its now discontinued acquisition program, the Company
incurred substantial professional fees. Of the amount billed, approximately
$353,000 remains unpaid to a law firm retained in that connection. Previously,
in 1994, JD Store Equipment, Inc. ("JD Equipment") agreed that, in the event its
merger with the Company (the "JD Merger") was not consummated, JD Store
Equipment would pay to the Company legal fees billed to the Company by the above
law firm. That law firm resigned as counsel to the Company shortly after JD
Store Equipment notified the Company that it was terminating the JD Merger.
Subsequently, the Company has made a demand for payment upon JD Store Equipment
for all fees and disbursements in the amount of $793,281 billed to it by the law
firm, of which $439,482 has to date been paid by the Company. To avoid the
uncertainties associated with litigation and with collecting any judgment that
may be obtained, the Company is attempting to reach a settlement with JD Store
Equipment, pursuant to which, among other things, JD Store Equipment will assume
any obligation of the Company for the
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above professional fees which have been billed but not paid to such firm, and
the Company will release JD Store Equipment from any obligation to pay the
$793,281 of legal fees billed to the Company. As part of such settlement, the
Company would be released by the law firm. There is no assurance that any such
settlement will be concluded.
On April 9, 1996, a lawsuit was filed against the Company and certain
others, including the members of the then Board of Directors, in the Superior
Court of California, by certain individuals who allegedly purchased or purchased
and sold securities of the Company, entitled Gary N. Gibbs et al. v. Choices
Entertainment Corporation et al., in which plaintiffs seek monetary damages
against the Company and other defendants in the amount of $303,470, plus
attorney's fees, costs of suit and such other relief as the Court deems just.
(See ITEM 3. Legal Proceedings). The Company intends to contest the lawsuit
vigorously. However, if the Company is unsuccessful in defending the lawsuit,
the Company would not be able to satisfy an award of damages in the amount
claimed. Furthermore, even if the Company is successful in defending this
lawsuit, the cost alone in professional fees will be substantial.
If the West Coast Transaction is successfully consummated, as to which no
assurance can be given, the Company intends to use a substantial portion of the
proceeds to reduce a portion of its debt, including all amounts owing on the 10%
promissory notes discussed above, held by Messrs. Shaifer, Scheuerer and
Hamburg, but exclusive of $680,000 (plus accrued interest) owing on its 5%
promissory notes (discussed above) and exclusive of $353,000 of professional
fees billed in connection with its now discontinued acquisition program (also
discussed above). Thereafter, assuming that sufficient cash proceeds remain, as
to which no assurance can be given, the Company's Board of Directors will
consider various alternatives including (without limitation) seeking and
considering other business opportunities that may be presented to the Company or
making a partial distribution of the net cash proceeds to the Company's
stockholders. However, as noted above, following a closing of the West Coast
Transaction, certain liabilities will remain which, if paid, and, in addition,
certain claims against the Company will exist which, if successfully asserted,
could result in there being no cash proceeds with which to seek further business
opportunities or to make any cash distribution to stockholders. Furthermore,
available proceeds following a closing will also be reduced by related
transaction expenses and taxes, and by certain continuing costs, as well as by
the $243,000 required to be escrowed pursuant to the terms of the Purchase
Agreement with West Coast. See ITEM 1. Description of Business, The West Coast
Transaction.
Absent consummation of the West Coast Transaction, the Company's future
viability is doubtful, given its inability to secure needed capital, to extend
further the due dates of liabilities, or to otherwise conclude or settle
existing
14
<PAGE>
liabilities and claims on a satisfactory basis, and, possibly, to conclude
successfully existing litigation. Furthermore, in such event, the Company would
be required to repay all amounts loaned to it by West Coast, which loans are
secured by the assets of the Company's Newtown Store, the Company's most
profitable and valuable store. See ITEM 1. Description of Business, The West
Coast Transaction. In the event the Company is not successful in consummating
the West Coast Transaction, as to which no assurance can be given, the Company's
Board of Directors believes, due to the Company's severely distressed financial
condition and the expectation that its financial condition will continue to
deteriorate, that the Company will be ultimately forced to seek protection under
the bankruptcy laws. Because the decision to file for bankruptcy is likely to be
based upon the actions of third parties, primarily the landlords for the
Company's stores and certain major creditors of the Company, it is not possible
to predict at what point the Company would be forced to do so. In the event the
Company is forced to file for bankruptcy, the Company's ability to conduct its
business would likely be severely hampered and it is unlikely that the
stockholders would receive any value.
---------------------------
This Annual Report on Form 10-KSB contains forward looking statements with
respect to, among other things, plans, future events or future performance of
the Company, the occurrence of which involve certain risks and uncertainties
that could cause actual results or future events to differ materially from those
expressed in any forward looking statement, including but not limited to the
inability to consummate the West Coast Transaction, the risk of adverse
litigation, the effect of competition, the inability to make timely payment to
vendors, landlords and other creditors, the risk of being unable to finance
videocassette inventory acquisitions due to the Company's severely distressed
financial condition, and uncertainties detailed in the Company's filings with
the Securities and Exchange Commission. Where any forward looking statement
includes a statement of the assumptions or bases underlying such forward looking
statement, the Company cautions that, while such assumptions or bases are
believed to be reasonable and are made in good faith, assumed facts or bases
almost always vary from actual results, and the differences between assumed
facts or bases and actual results can be material, depending upon the
circumstances. Where, in any forward looking statement, the Company expresses an
expectation or belief as to plans or future results or events, such expectation
or belief is expressed in good faith and believed to have a reasonable basis,
but there can be no assurance that the statement of expectation or belief will
result or be achieved or accomplished. The words "believe," "expect" and
"anticipate" and similar expressions identify forward looking statements.
15
<PAGE>
Capital Expenditures
The Company's capital expenditures were approximately $1,617,000 during the
year ended December 31, 1996, compared to $1,455,000 during 1995. This increase
was primarily due to an increase in videocassette rental film purchases of
approximately $223,000, which more than offset a decrease in purchases of
fixtures for use in the Company's video stores of approximately $61,000. During
1996, the Company closed two stores, opened one new store and expanded one of
its existing stores.
Material Changes in Financial Condition
The following material changes in financial condition reflect changes
occurring during the two-year period from December 31, 1994, through December
31, 1996.
As of December 31, 1996 and 1995:
Assets:
Current assets increased by approximately $69,000 between December 31, 1995
and December 31, 1996, due primarily to the increase in merchandise inventories
of $43,000, to the reclassification of approximately $30,000 of other deferred
costs from long-term to current assets, and to the decrease in cash used to fund
operations of the Company's stores. The increase in merchandise inventories is
primarily related to the addition of music products in one of the Company's
stores during October 1996.
In the event that the West Coast Transaction is not consummated and a
change to a liquidation basis of accounting becomes appropriate, the most likely
effect on the recorded value of the Company's assets would be to reduce
materially the valuation of the videocassette rental inventory to an amount that
approximates liquidation value. In addition, the Company would not be able to
recover from future cash flows the recorded value of goodwill listed under the
caption "Intangible Assets," and would, therefore, write off this amount of
approximately $173,000. The Company would also be likely to incur certain other
costs, including, without limitation, appraisal and related costs.
Equipment and videocassette rental inventory decreased by approximately
$151,000, due primarily to the excess of depreciation over purchases of fixed
assets in the normal course of business.
The decrease in intangible assets of approximately $17,000 was due to the
amortization of goodwill. The decrease in other deferred costs of approximately
$70,000 was due primarily to the expensing of those costs that were associated
with the Company's expansion plans implemented during 1994 and to the
reclassification of deferred costs to a current asset as noted above.
16
<PAGE>
Liabilities:
Current liabilities increased by approximately $1,151,000 between December
31, 1995 and December 31, 1996. Accounts payable increased approximately
$277,000 primarily as a result of obtaining a higher credit line with the
Company's major videocassette supplier and to the delaying of payment of certain
obligations. Notes payable increased by approximately $819,000 due to both the
reclassification of $680,000 of notes payable to current liabilities at December
31, 1996, such notes becoming due September 11, 1997, and to a $150,000 note
payable to West Coast Entertainment Corporation in connection with the West
Coast Transaction (See ITEM 1. Description of Business, The West Coast
Transaction). Accrued merger and acquisition costs decreased approximately
$139,000 primarily due to the write-off of certain costs relating to the
Company's previously reported discontinued acquisition program. Accrued
professional fees increased approximately $82,000 due primarily to the costs
associated with certain litigation (See ITEM 3. Legal Proceedings) and to the
timing of payments of these obligations. Accrued expenses increased
approximately $92,000 due primarily to costs associated with a consulting
agreement with an ex-officer of the Company and to timing differences with
respect to payment of these obligations.
Notes payable due after one year decreased $680,000 primarily due to the
reclassification of these notes to current liabilities at December 31, 1996. The
notes are due September 11, 1997.
Stockholders' Deficit:
Between December 31, 1995 and December 31, 1996, the net increase in
stockholders' deficit of approximately $633,000 is due primarily to the net
effect of the loss of approximately $667,000 and to the issuance of 3.4 shares
of the Company's Series C Preferred Stock to the holders of its 5% unsecured
promissory notes, in payment of $34,000 of accrued interest due such noteholders
in August 1996, in accordance with the terms of such notes. (See Note 7 to the
Financial Statements).
As of December 31, 1995 and 1994:
Assets:
Current assets decreased by approximately $316,000 between December 31,
1994 and December 31, 1995, due primarily to both the decrease in merchandise
inventories of $287,000 and to the decrease in cash used to fund operations of
the Company's stores. The decrease in merchandise inventories resulted from the
sale and return of music inventories following the discontinuance of the sale of
music product in the Company's stores.
17
<PAGE>
Equipment and videocassette rental inventory decreased by approximately
$223,000, due primarily to the excess of depreciation over purchases of fixed
assets in the normal course of business.
The decrease in intangible assets of approximately $17,000 was due to the
amortization of goodwill. The decrease in other deferred costs of approximately
$169,000 was due primarily to the expensing of those costs which were associated
with the Company's acquisition program implemented during 1994, which program
has been discontinued.
Liabilities:
Current liabilities decreased by approximately $814,000 between December
31, 1994 and December 31, 1995. Accounts payable decreased approximately
$357,000 primarily as a result of the discounted cash settlement of
approximately $235,000 of debt and to the payment of accounts payable in the
normal course of business. Notes payable decreased by approximately $295,000 due
to the conversion of approximately $148,000 of notes payable to equity and to
repayment of notes payable. Accrued merger and acquisition costs increased
approximately $469,000 primarily due to the Company's discontinued acquisition
program. Accrued professional fees decreased approximately $583,000 due
primarily to the conversion of approximately $283,000 of debt to equity and to
the payment of these obligations in the normal course of business. Accrued
expenses increased approximately $48,000 due primarily to timing differences
with respect to payment of these obligations. The accrual for lease cancellation
and litigation reserves decreased approximately $90,000 due primarily to both
payment of these costs and to the utilization of reserves established for the
closing of two of the companies stores.
Notes payable due after one year increased $680,000 primarily due to
issuance of promissory notes payable in conjunction with the private issuance of
preferred stock. Other accrued expenses decreased approximately $139,000
primarily due to expending the costs associated with the issuance of common
stock to a consulting firm. Other liabilities decreased $200,000 due primarily
to the recognition of a non-refundable deposit received in conjunction with the
Company's previously discontinued acquisition program.
Stockholders' Deficit:
Between December 31, 1994 and December 31, 1995, there was a net increase
in stockholders' deficit of approximately $252,000, which was due primarily to
the net effect of the loss of approximately $2,139,000, to the issuance of
approximately 2,449,461 shares of the Company's Common Stock from the exercise
of stock options, warrants and the conversion of debt, the issuance of 34 shares
of Preferred Stock in connection with a private offering of Preferred Stock, and
to the issuance of approximately 900,000
18
<PAGE>
shares of the Company's Common Stock in connection with a private offering of
Common Stock.
Material Changes in Results of Operations
The following material changes in results of operations occurred during the
three-year period from January 1, 1994 through December 31, 1996.
Years Ended December 31, 1996 and 1995:
Revenues increased approximately $412,000 during 1996 when compared to 1995
primarily due to the increase in movie rentals of approximately $233,000 and the
increase in merchandise sales of approximately $179,000. The increase in movie
rental revenue is primarily related to higher availability of rental product,
due to increased purchases of videocassette rental films and the utilization of
a pay per transaction arrangement with a supplier of videocassettes, and to more
favorable rental-weather conditions during 1996. The increase in merchandise
sales is primarily related to increased purchases of merchandise movies for
sale, increased sales of previously viewed movies and other items. Also included
in merchandise sales for the 1996 period is approximately $38,000 of customer
membership revenue. Additionally, approximately $20,000 of the increase in
merchandise sales related to the re-introduction of music into the product line
in one of its stores during October of 1996.
Costs of goods sold increased approximately $72,000, but decreased
approximately 9% as a percentage of merchandise sales during 1996 as compared to
1995. The percentage decrease is primarily related to higher margins on rental
films sold during 1996 compared to 1995 and to approximately $38,000 of customer
membership revenue which had no corresponding cost of sales.
Cost of movie rentals increased approximately $143,000 during 1996 when
compared to 1995, primarily due to the increased usage of a pay per transaction
arrangement with a supplier of videocassette rental films. The Company had
previously used the same arrangement with the same supplier in 1994, but
discontinued this practice in 1995 under the direction of the Company's then new
management team. The Company reinstituted this practice in 1996 to provide more
rental product to its stores than it could have provided had the same rental
product been purchased. This practice also creates a higher rental expense since
the Company shares a higher percentage of the related revenue stream with the
pay per transaction supplier through rental expense than it would through
depreciation expense and loss on disposal related to purchased product. The
Company intends to rent selected pay per transaction titles where it believes it
can be used to help satisfy customer demands and improve competitiveness.
19
<PAGE>
Store payroll expenses decreased approximately $71,000, or 7%, primarily as
a result of continuing efforts to reduce operating costs and to the net effect
of closing two and opening one new store during 1996. Rents and other store
operating expenses remained relatively constant when compared to 1995.
Selling and administrative expenses decreased approximately $255,000, or
31% during 1996, primarily due to the Company's continuing efforts to reduce
overhead costs.
Professional and consulting fee expenses increased approximately $107,000
during 1996 primarily due to costs associated with certain litigation.
Merger and acquisition expenses decreased approximately $1,630,000 during
1996 due primarily to the termination of the Company's previously reported
acquisition program in September 1995.
Loss on disposal of videocassette rental inventory increased approximately
$64,000, or approximately 1% of revenue during 1996 primarily due to the
increase in the number of videocassette rental films sold at less than carrying
value during 1996 to provide additional cash flow for operations.
Depreciation and amortization expense increased approximately $69,000 but
remained relatively constant as a percentage of movie rental revenue during
1996.
Interest expense increased approximately $27,000 during 1996 primarily due
to the length of time these notes payable were outstanding at December 31, 1996.
As a result of the foregoing, the Company incurred a net loss of
approximately $667,000 during the year ended December 31, 1996.
Years Ended December 31, 1995 and 1994:
During 1995 the Company incurred a net loss of approximately $2,139,000
primarily due to merger and acquisition expenses associated with contemplated
mergers of the Company with other organizations, selling and administrative
expenses and operating expenses associated with operating the Company's retail
stores.
Revenues decreased by approximately $1,132,000 during 1995 when compared to
1994 primarily due to the decrease in merchandise sales of approximately
$861,000 as a result of the elimination of the sale of music products in the
Company's stores. The remaining decrease was primarily due to the closing of one
of the Company's stores in March 1994, weather factors, increased industry
competition and fewer highly-rented titles released during 1995 when compared to
1994.
20
<PAGE>
Costs of goods sold decreased approximately $771,000, but increased
approximately 4% as a percentage of merchandise sales during 1995 primarily due
to the sale of previously viewed rental films at less than carrying value to
provide additional cash flow for operations. Cost of movie rentals decreased
approximately $106,000, or 93%, during 1995 primarily due to the elimination of
a pay per transaction arrangement with a supplier of videocassette rental films.
Store payroll expenses decreased approximately $75,000 or 7%, primarily as
a result of closing one store in March of 1994 and to continuing efforts to
reduce operating costs. Rents and other store operating expenses remained
relatively constant when compared to 1994.
Selling and administrative expenses increased approximately $84,000 or 11%
during 1995, primarily due to the write-off of certain obligations in
conjunction with discounted cash settlements during 1994.
Professional fee and consulting expenses decreased approximately $128,000
or 36% during 1995, primarily due to adjustments to accruals.
Merger and acquisition expenses increased approximately $1,535,000 during
1995, primarily due to professional, consulting, and employee expenses directly
related to the Company's discontinued acquisition program.
Loss on disposal of videocassette rental inventory increased approximately
$34,000 during 1995, primarily due to re-merchandising the Company's stores and
to the sale of rental inventory at less than carrying value to provide
additional cash flow for operations.
Videocassette and inventory reserves decreased approximately $158,000
during 1995, due to the elimination of reserves taken in 1994. These reserves
were established for music inventories that were to be sold off, based on a
decision to discontinue the sale of music product in the Company's stores.
Store opening, closing and lease termination provisions increased
approximately $7,000 or 25% during 1995 when compared to 1994, primarily due to
the opening of one and the closing of two stores during 1995.
Depreciation and amortization expenses decreased approximately $173,000 or
14% during 1995, primarily due to most of the stores' assets only requiring
one-half year of depreciation during 1995, as those assets reached full
depreciation during 1995.
21
<PAGE>
Net interest expense decreased approximately $12,000 or 33% during 1995,
primarily due to interest income in connection with funds held in escrow from a
private offering of Preferred Stock.
ITEM 7. Financial Statements
The Company's Financial Statements and Notes thereto are filed together
with this report commencing at Page F-1.
ITEM 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure
None.
22
<PAGE>
PART III
ITEMS 9, 10, 11 and 12 are incorporated in this report by reference to the
Company's definitive Proxy Statement to be filed pursuant to Regulation 14A
within 120 days of the close of the Company's fiscal year.
ITEM 13. Exhibits, List and Reports on Form 8-K
(a) Exhibits: The exhibits listed in the Index to Exhibits appearing on
Page E-1.
(b) Reports on Form 8-K:
During the quarter ended December 31, 1996, the Company filed two
reports on Form 8-K, dated October 4, 1996, and December 17, 1996,
both with respect to Item 5. thereof.
23
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
CHOICES ENTERTAINMENT CORPORATION
By: /s/ Ronald W. Martignoni
----------------------------------------
Ronald W. Martignoni
Chief Executive Officer
March 21, 1997
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the registrant and in the capacities and on
the dates indicated.
/s/ Ronald W. Martignoni March 21, 1997
- - - ----------------------------------
Ronald W. Martignoni
Chairman of the Board of Directors,
Chief Executive Officer and President
/s/ Fred E. Portner March 21, 1997
- - - ----------------------------------
Fred E. Portner
Director
- - - ----------------------------------
James D. Sink
Director
/s/ Lorraine E. Cannon March 21, 1997
- - - ----------------------------------
Lorraine E. Cannon
Chief Financial Officer
(Principal Accounting Officer)
24
<PAGE>
INDEX TO EXHIBITS
Exhibit
No. Description of Exhibit
- - - ------- ----------------------
3(a) Certificate of Incorporation, as amended (1)
(b) Certificate of Designations of Series C Preferred
Stock, as amended (10)
(c) By-Laws, as amended (2)
4(a) Form of certificate evidencing shares of
Common Stock (3)
(b) Form of 5% Promissory Note (4)
10(a) Stock Option and Appreciation Rights
Plan of 1987(3)
(b) Form of Long-Term Management Incentive
Stock Option Agreement (5)
(c) Form of 1991 Management Option Agreement (5)
(d) Severance Benefits Agreement, as amended,
between Registrant and Ronald W. Martignoni (6)
(e) Severance Benefits Agreement, as amended,
between Registrant and Lorraine E. Cannon (6)
(f) Form of 1994 Management Option Agreement (6)
(g) Finder's Fee Agreement dated December 19, 1994, between
Registrant, JD Store Equipment, Inc. and John E.
Maioriello (7)
(h) Non-Employee Director Stock Option Agreement
between Registrant and Fred E. Portner (8)
(i) Asset Purchase Agreement, dated December 16, 1996, as
amended, between West Coast Entertainment Corporation
and Registrant (9)
(j) Form of Escrow Agreement under Asset Purchase Agreement,
dated December 16, 1996, as amended, between West Coast
Entertainment Corporation and Registrant (9)
(k) Secured Promissory Note of Registrant, dated December 16,
1996, in principal amount of $150,000, payable to West Coast
Entertainment Corporation (9)
(l) Security Agreement, dated December 16, 1996, between West
Coast Entertainment Corporation and Registrant (9)
11 Computation of loss per share (10)
21 List of Subsidiaries (10)
23 Consent of KPMG Peat Marwick LLP (10)
27 Financial Data Schedule (10)
- - - ----------
(1) Filed as an Exhibit to Registrant's Registration Statement on Form S-8
(File No. 33-87016) and incorporated herein by reference.
(2) Filed as an Exhibit to Registrant's 1992 Annual Report on Form 10-K and
incorporated herein by reference.
(3) Filed as an Exhibit to Registrant's Registration Statement on Form S-1,
inclusive of Post-Effective Amendment No. 1 thereto (File No.: 33-198983)
and incorporated herein by reference.
(4) Filed as an Exhibit to Registrant's Quarterly Report on Form 10-QSB, for
the quarter ended September 30, 1995, and incorporated herein by reference.
E-1
<PAGE>
(5) Filed as an Exhibit to Registrant's Post-Effective Amendment No. 1 to Form
S-1 Registration Statement (File No.: 33-32396) and incorporated herein by
reference.
(6) Filed as an Exhibit to Registrant's 1993 Annual Report on Form 10-K and
incorporated herein by reference.
(7) Filed as an Exhibit to Registrant's 1994 Annual Report on Form 10-K and
incorporated herein by reference.
(8) Filed as an Exhibit to Registrant's Quarterly Report on Form 10-QSB, for
the quarter ended March 31, 1996, and incorporated herein by reference.
(9) Filed as an Exhibit to Registrant's definitive Proxy Statement, dated
February 11, 1997, with regard to a special meeting of stockholders held on
March 12, 1997, and incorporated herein by reference.
(10) Filed herewith.
E-2
<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-KSB
ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 1996
CHOICES ENTERTAINMENT CORPORATION
FINANCIAL STATEMENTS
F-1
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent auditors' report...................................... F-3
Balance sheets as of December 31, 1996 and 1995................... F-4
Statements of loss for the years ended December 31,
1996, 1995 and 1994............................................... F-5
Statements of stockholders' deficit for the years ended
December 31, 1996, 1995 and 1994.................................. F-6
Statements of cash flows for the years ended December 31,
1996, 1995 and 1994............................................... F-7 - F-8
Notes to financial statements..................................... F-9 - F-20
F-2
<PAGE>
Independent Auditors' Report
The Board of Directors and Stockholders
Choices Entertainment Corporation:
We have audited the financial statements of Choices Entertainment Corporation as
listed in the accompanying index. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Choices Entertainment
Corporation as of December 31, 1996 and 1995, and the results of operations and
its cash flows for each of the years in the three-year period ended December 31,
1996, in conformity with generally accepted accounting principles.
The accompanying financial statements have been prepared assuming that Choices
Entertainment Corporation will continue as a going concern. As discussed in Note
3 to the financial statements, the Company has suffered recurring losses from
operations, is in default on certain obligations and has a net working capital
deficiency. These factors raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters are
described in Note 3. The financial statements do not include any adjustments
that might result from the outcome of these uncertainties.
/S/ KPMG PEAT MARWICK LLP
Philadelphia, Pennsylvania
March 7, 1997, except for the second and third paragraphs of note 14, as to
which the dates are March 19, 1997, and March 12, 1997, respectively.
F-3
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash $ 66,739 $ 86,391
Accounts receivable 12,790 11,098
Merchandise inventories 181,280 138,149
Other deferred costs (Note 6) 30,453
Prepaid expenses 41,683 28,236
------------ ------------
Total current assets 332,945 263,874
Videocassette rental inventory (Note 4) 704,616 778,728
Equipment, net (Note 4) 110,403 186,990
Intangible assets, net of amortization of $113,665 in
1996 and $96,826 in 1995 172,603 189,443
Other deferred costs (Note 6) 69,621
Other assets 74,203 68,254
------------ ------------
$ 1,394,770 $ 1,556,910
============ ============
LIABILITIES AND STOCKHOLDERS' DEFICIT Current liabilities:
Notes payable $ 1,004,000 $ 184,691
Accounts payable 699,838 422,582
Accrued merger and acquisition expenses 425,299 563,901
Accrued professional fees 268,199 186,243
Deferred revenue 27,797
Accrual for lease cancellation and litigation reserves 1,250 13,750
Accrued salaries 55,734 52,603
Accrued expenses 239,200 147,007
------------ ------------
Total current liabilities 2,721,317 1,570,077
Notes payable (Notes 5 and 7) 680,000
------------ ------------
Total liabilities 2,721,317 2,250,777
------------ ------------
Commitments and Contingencies (Notes 3 and 13)
Stockholders' deficit (Notes 7,8,9,10 and 11)
Preferred stock, par value $ .01 per share:
authorized 5,000 shares; 37.4 shares issued and outstanding
in 1996 and 34 shares issued and outstanding in 1995
Common stock, par value $ .01 per share: authorized
50,000,000 shares; issued and outstanding 22,004,395
shares in 1996 and 1995 220,044 220,044
Additional paid-in capital 20,519,203 20,485,203
Accumulated deficit (22,065,794) (21,399,114)
------------ ------------
Total stockholders' deficit (1,326,547) (693,867)
------------ ------------
$ 1,394,770 $ 1,556,910
============ ============
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
STATEMENTS OF LOSS
<TABLE>
<CAPTION>
Year ended December 31,
-----------------------
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Revenues:
Movie rentals $ 4,115,891 $ 3,882,969 $ 4,154,693
Merchandise sales 1,056,613 877,715 1,738,181
----------- ----------- -----------
5,172,504 4,760,684 5,892,874
----------- ----------- -----------
Operating costs and expenses:
Costs of goods sold 936,400 864,226 1,634,983
Cost of movie rentals 151,726 8,476 114,265
Store payroll 984,084 1,054,643 1,129,516
Store rents 941,468 944,260 925,903
Other store operating expenses 453,733 452,235 451,520
Selling and administrative expenses 564,120 819,169 734,954
Merger and acquisition expenses 1,630,192 95,319
Professional and consulting expenses 332,322 225,694 353,361
Loss on disposal of videocassette
rental inventory 229,446 165,877 131,908
Store opening, closing, lease
termination and litigation provisions 51,615 33,060 26,424
Depreciation and amortization 1,142,440 1,073,116 1,246,237
----------- ----------- -----------
5,787,354 7,270,948 6,844,390
----------- ----------- -----------
Other income (expenses):
Gain on settlement of debt 395,640
Interest expense, net (51,830) (24,703) (36,623)
----------- ----------- -----------
(51,830) 370,937 (36,623)
----------- ----------- -----------
Net loss $ (666,680) $(2,139,327) $ (988,139)
=========== =========== ===========
Net loss per share of common stock
(Note 11) $ (.03) $ (.10) $ (.05)
=========== =========== ===========
</TABLE>
See accompanying notes to financial statements.
F-5
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
STATEMENTS OF STOCKHOLDERS' DEFICIT
For the Years Ended December 31, 1996, 1995 and 1994
<TABLE>
<CAPTION>
Preferred Common Stock Additional
Stock ----------------------------- Paid-in Accumulated
Shares Shares Amount Capital Deficit Total
------------ ------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1993 18,478,934 $ 184,789 $ 18,420,976 $(18,271,648) $ 334,117
Issuance of common stock to
satisfy debt obligations 166,000 1,660 63,687 65,347
Issuance of common stock for
cash from employee exercise
of stock options 10,000 100 2,200 2,300
Reversal of costs associated
with previous warrant 144,578 144,578
exercises
Net loss for the year ended
December 31, 1994 (988,139) (988,139)
------------ ------------ ------------ ------------ ------------
Balance at December 31, 1994 18,654,934 186,549 18,631,441 (19,259,787) (441,797)
Issuance of common stock for
cash from exercise of stock
options and warrants 2,186,000 21,860 883,895 905,755
Issuance of common stock for
cash to two private foreign
investors, net of related 900,000 9,000 387,000 396,000
costs
Issuance of common stock to
satisfy debt obligations 113,461 1,135 146,417 147,552
Issuance of common stock in
conjunction with consulting
services 150,000 1,500 137,250 138,750
Issuance of preferred stock to
private investors, net of
related costs (Note7) 34 299,200 299,200
Net loss for the year ended
December 31, 1995 (2,139,327) (2,139,327)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 34 22,004,395 220,044 20,485,203 (21,399,114) (693,867)
Issuance of preferred stock
in
lieu of cash to investors 3.4 34,000 34,000
(Note 7)
Net loss for the year ended
December 31, 1996 (666,680) (666,680)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 37.4 22,004,395 $ 220,044 $ 20,519,203 $(22,065,794) $ (1,326,547)
============ ============ ============ ============ ============ ============
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
1996 1995 1994
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss $ (666,680) $(2,139,327) $ (988,139)
----------- ----------- -----------
Adjustments to reconcile not loss to net cash
used in operating activities:
Depreciation and amortization 1,086,433 1,073,116 1,246,237
Gain on settlement of debt (395,640)
Loss on disposal of videocassette rental
inventory 238,874 165,877 131,908
Videocassette and inventory reserves 22,686 45,169 203,378
Cost of rental film sales 410,399 335,230 243,961
Amortize goodwill and deferred costs 56,007 (49,271)
Change in assets and liabilities:
(Increase) decrease in accounts receivable (1,692) (9,659) 14,786
(Increase) decrease in merchandise inventories (43,131) 287,208 73,112
(Increase) decrease in prepaid expenses (13,447) (4,124) 9,708
(Increase) decrease in other assets (5,949) (27) 23,286
Increase in accounts payable 277,256 25,999 11,544
Increase (decrease) in accrued merger and
acquisition expenses (138,602) 468,582
Increase in deferred revenue 27,797
Increase (decrease) in accrued professional fees 81,956 (582,866) 265,399
Increase (decrease) in accrued salaries 3,131 (6,067) (25,338)
Increase (decrease) in other accrued expenses 126,194 60,696 (11,984)
Decrease in accrual for lease cancellation and
other litigation reserves (12,500) (13,750) (253,770)
----------- ----------- -----------
Total adjustments 2,115,412 1,400,473 1,932,227
----------- ----------- -----------
Net cash provided by (used in) operating activities 1,448,732 (738,854) 944,088
----------- ----------- -----------
Cash flows from investing activities:
(Increase) decrease in deferred acquisition costs 100,000 (100,000)
Purchases of videocassette rental inventory, net (1,573,140) (1,349,871) (1,240,594)
Purchases of equipment, net (43,982) (105,457)
Proceeds from sale of fixed assets 9,429
----------- ----------- -----------
Net cash used in investing activities (1,607,693) (1,355,328) (1,340,594)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from notes payable 150,000 710,000 180,000
Proceeds from private offering of common stock 396,000
Proceeds from issuance of preferred stock net 217,600
Proceeds from other liabilities 200,000
Repayment of notes payable (10,691) (178,171) (41,530)
Proceeds from issuance of common stock, net 905,755 2,300
----------- ----------- -----------
Net cash provided by financing activities 139,309 2,051,184 340,770
----------- ----------- -----------
Net decrease in cash (19,652) (42,998) (55,736)
Cash at beginning of year 86,391 129,389 185,125
----------- ----------- -----------
Cash at end of year $ 66,739 $ 86,391 $ 129,389
=========== =========== ===========
Supplementary disclosure of cash flow information
Cash paid during the year for interest $ 14,556 $ 1,316 $ -0-
=========== =========== ===========
</TABLE>
F-7
<PAGE>
Statements of Cash Flow (Continued)
During 1996, the Company issued 3.4 shares of Series C Preferred stock to
the holders of its 5% unsecured promissory notes, in payment of $34,000 of
accrued interest due such noteholders in August 1996, in accordance with the
terms of such notes.
During 1995, the Company converted approximately $148,000 of notes payable
into 113,461 shares of the Company's common stock. Additionally, during 1995 the
Company negotiated discounted cash settlements to certain vendors which
eliminated approximately $859,000 of accounts payable for cash of $463,000 and
resulted in a net gain to the Company of approximately $396,000.
During 1994, the Company converted approximately $180,000 of accounts
payable into a note payable and approximately $65,000 of accounts payable in
166,000 shares of the Company's common stock. Additionally approximately
$144,000 of previously accrued warrant exercise costs were reversed.
F-8
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
Notes to Financial Statements
(1) Incorporation and Other Matters
The Company was incorporated under the laws of the State of Maryland on
July 11, 1985, as "PPV Enterprises, Inc." On August 18, 1987, the Company
changed its name to "DataVend, Inc." and reincorporated under the laws of the
State of Delaware.
On March 14, 1990, the Company changed its name to Choices Entertainment
Corporation.
(2) Summary of Significant Accounting Policies
Accounting Estimates: The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Merchandise Inventories: Merchandise inventories are stated at the lower of
cost or market. Cost is determined by the average cost method, which
approximates the first-in first-out method.
Videocassette Rental Inventory: Videocassettes are recorded at cost and
amortized over their estimated economic life to a $4 residual value.
Videocassettes are amortized over two years on an accelerated basis.
Equipment: Equipment is stated at cost. Depreciation of equipment is
provided under the straight-line method over the estimated useful lives of the
respective assets.
Intangible Assets: Intangible assets, consisting solely of goodwill, have a
net book value of approximately $172,600. Goodwill, which represents the excess
of purchase price over fair value of net assets acquired, is amortized on a
straight-line basis over the expected periods to be benefited, approximately 17
years. The Company assesses the recoverability of this asset by determining
whether the goodwill can be recovered through undiscounted future operating cash
flows.
Income Taxes: Effective January 1, 1993, the Company adopted Statement 109.
The change in the method of accounting for income taxes had no effect on the
1994, 1995 and 1996 Financial Statements.
Revenue Recognition: The Company recognizes revenue when products are
rented or sold with the exception of certain promotional membership fees, which
are amortized over 12 months.
Recently Issued Accounting Pronouncements: The Company adopted the
provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to Be Disposed Of, on January 1, 1996. This Statement
requires that long-lived assets and certain identifiable intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Adoption of this Statement
did not have a material impact on the Company's financial position, results of
operations, or liquidity.
The Company has adopted the provisions of SFAS No. 123, Accounting for
Stock-Based Compensation on January 1, 1996. SFAS 123 defines a fair value based
method of accounting for stock based compensation plans, however it allows the
continued use of the intrinsic value method under Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees. The Company has
elected to continue to use the intrinsic value method with pro forma disclosures
of net income as if the fair value method had been applied. Pro forma
compensation costs ( and related pro forma net loss) for the Company's stock
based compensation plan determined in accordance with SFAS 123 have not been
separately presented since such amounts are not materially different from the
basic financial statements.
F-9
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(2) Summary of Significant Accounting Policies (Continued)
Reclassification: Reclassification of the 1994 Financial Statements has
been made to conform with the presentation of the 1995 Financial Statements.
(3) Liquidity
The financial statements have been presented on the basis that the Company
is a going concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred net losses in each year of its existence, aggregating $22,065,794 from
inception through December 31, 1996, including a net loss of $666,680 for the
year ended December 31, 1996.
The Company is currently operating in a severely distressed financial
condition. As of December 31, 1996, the Company had a net working capital
deficiency of approximately $2,388,000. The Company is currently funding its
business on a day-to-day basis from revenues generated from its nine store
operations. Because of the timing of the payment of certain obligations and an
increase in the amount of credit extended by its primary supplier of
videocassettes, the Company has reported positive cash flow from operations for
the year ended December 31, 1996. However, as the revenues from the Company's
existing nine stores are insufficient to insure timely payment of its
obligations, the Company continues to be in immediate need of financing to fund
its short-term working capital needs.
As a result of its severely distressed financial condition, the Company
elected to issue 3.4 shares of its Series C Preferred Stock to the holders of
its 5% unsecured promissory notes, in payment of $34,000 of accrued interest due
such noteholders in August 1996, in accordance with the terms of such notes. In
addition, such 5% promissory notes, in the principal amount of $680,000,
provide, by their terms, that the sole remedy of the holders thereof upon
default is to convert the principal and all accrued interest owing thereon, into
shares of Series C Preferred Stock (valued at $.25 per share of Common Stock).
The notes are not presently in default in the payment of principal or interest.
However, the Board of Directors does not presently intend to make any payment on
such notes upon their maturity in September 1997, leaving the holders thereof
with the sole remedy of converting such notes into Series C Preferred Stock. The
notes are not presently convertible.
The Company is in default under the terms of three 10% promissory notes in
the aggregate principal amount of $150,000 plus accrued interest. These notes
are held by Carl Shaifer and Max Scheuerer, two members of the Shareholder
Committee. The aggregate principal amount owing by the Company on said
promissory notes was reduced to $150,000 from $180,000 as a result of a $30,000
payment made by the Company during 1995, to Mr. Scheuerer, the holder of two
such notes in the then total principal amount of $150,000. This payment was made
following the filing of a lawsuit against the Company by Mr. Scheuerer in which
a judgment was sought in the principal amount of $150,000 plus accrued interest
of $15,548. The lawsuit was withdrawn following said $30,000 payment without
prejudice to its being reinstated if the balance owing on said notes was not
paid in full prior to March 15, 1996. No further payments were made on such
notes and Mr. Scheuerer filed a new lawsuit on September 18, seeking a judgment
in the amount of $146,298, representing principal and interest owing to Mr.
Scheuerer by the Company on said notes (plus future interest, costs and any
other appropriate damages). Since that time, the Company has made payments to
Mr. Scheuerer totaling $6,989. The Company has entered into a settlement
agreement with Mr. Scheuerer, providing for $3,000 monthly payments to him with
the unpaid balance to be paid at closing of the West Coast Transaction.
Notwithstanding the settlement agreement, Mr. Scheuerer is proceeding with the
litigation. If the West Coast Transaction is not consummated, the Company would
be unable to satisfy the balance owing.
Additionally, the Company is in default under the terms of a 10% promissory
note in the principal amount of $30,000, which note is held by Harold E.
Hamburg, a member of the Shareholder Committee. The Company has paid all
interest due to date on said note.
F-10
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(3) Liquidity (Continued)
The Company is also delinquent and presently unable to satisfy various
other liabilities, including amounts owing to vendors and landlords, as well as
substantial professional fees owing in connection with, among other things, its
now discontinued acquisition program and with respect to ongoing litigation.
In connection with its now discontinued acquisition program, the Company
incurred substantial professional fees. Of the amount billed, $353,799 remains
unpaid to law firm retained in that connection. Previously, in 1994, JD Store
Equipment, Inc. ("JD Store Equipment") agreed that, in the event its merger with
the Company (the "JD Merger") was not consummated, JD Store Equipment would pay
to the Company legal fees billed to the Company by the above law firm. That law
firm resigned as counsel to the Company shortly after JD Store Equipment
notified the Company that it was terminating the JD Merger. Subsequently, the
Company has made a demand for payment upon JD Store Equipment for all fees and
disbursements in the amount of $793,281 billed to it by the law firm, of which
$439,482 has to date been paid by the Company. To avoid the uncertainties
associated with litigation and with collecting any judgment that may be
obtained, the Company is attempting to reach a settlement with JD Store
Equipment, pursuant to which, among other things, JD Store Equipment will assume
any obligation of the Company for the above professional fees which have been
billed but not paid to such firm, and the Company will release JD Store
Equipment from any obligation to pay the $793,281 of legal fees billed to the
Company. As part of such settlement, the Company would be released by the law
firm. There is no assurance that any such settlement will be concluded.
On April 9, 1996, a lawsuit was filed against the Company and certain
others, including the members of the then Board of Directors, in the Superior
Court of California, by certain individuals who allegedly purchased or purchased
and sold securities of the Company, entitled Gary N. Gibbs et al. v. Choices
Entertainment Corporation et al.,. in which plaintiffs seek monetary damages
against the Company and other defendants in the amount of $303,470, plus
attorney's fees, costs of suit and such other relief as the Court deems just.
Discovery is proceeding and the Company intends to contest the lawsuit
vigorously. However, if the Company is unsuccessful in defending the lawsuit,
the Company would not be able to satisfy an award of damages in the amount
claimed. Furthermore, even if the Company is successful in defending this
lawsuit, the cost alone in professional fees will be substantial.
The Company has entered into an Asset Purchase Agreement (the "Agreement")
with West Coast Entertainment Corporation, a Delaware corporation ("West
Coast"), dated December 16, 1996, as amended, providing for the sale of
substantially all of the Company's assets to West Coast. At the time of the
signing of the Agreement, and in anticipation of the sale of assets, West Coast
loaned the Company $150,000, which loan is secured by a pledge of assets of a
selected Company store. (See Note 13).
Should the sale not be approved by the Company's stockholders, or if its
board of directors withdraws its approval, the Company will be required to pay a
breakup fee to West Coast, which shall also, under such circumstances, have the
option to purchase a selected Company store. West Coast may also be entitled to
liquidated damages under certain circumstances. (See Note 13).
If the West Coast Transaction is successfully consummated, as to which no
assurances can be given, the Company intends to use a substantial portion of the
proceeds to reduce a portion of its debt, including all amounts owing on the10%
promissory notes discussed above, held by Messrs. Shaifer, Scheuerer and
Hamburg, but exclusive of $680,000 (plus accrued interest) owing on its 5%
promissory notes (discussed above) and exclusive of $353,000 of professional
fees billed in connection with its discontinued acquisition program (also
discussed above). Thereafter, assuming that sufficient cash proceeds remain, as
to which no assurance can be given, the Company's Board of Directors will
consider various alternatives including (without limitation) seeking and
considering other business opportunities that may be presented to the Company or
making a partial distribution of the net cash proceeds to the Company's
stockholders. However, as noted above, following a closing of the West Coast
Transaction, certain liabilities will remain
F-11
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(3) Liquidity (Continued)
which, if paid, and, in addition, certain claims against the Company will exist
which, if successfully asserted, could result in there being no cash proceeds
with which to seek further business opportunities or to make any cash
distribution to stockholders. Furthermore, available proceeds following a
closing will also be reduced by related transaction expenses and taxes, and by
certain continuing costs, as well as by the $243,000 required to be escrowed
pursuant to the terms of the Purchase Agreement with West Coast. (See Note 13).
Absent consummation of the West Coast Transaction, the Company's future
viability is doubtful, given its inability to secure needed capital, to extend
further the due dates of liabilities, or to otherwise conclude or settle
existing liabilities and claims on a satisfactory basis, and, possibly, to
conclude successfully existing litigation. Furthermore in such event, the
Company would be required to repay all amounts loaned to it by West Coast, which
loans are secured by the assets of the Company's Newtown Store, the Company's
most profitable and valuable store. In the event the Company is not successful
in consummating the West Coast Transaction, as to which no assurance can be
given, the Company's Board of Directors believes, due to the Company's severely
distressed financial condition, and the expectation that its financial condition
will continue to deteriorate, that the Company will be ultimately forced to seek
protection under the bankruptcy laws. Because the decision to file for
bankruptcy is likely to be based upon the actions of third parties, primarily
the landlords for the Company's stores and certain major creditors of the
Company, it is not possible to predict at what point the Company would be forced
to do so. In the event the Company is forced to file for bankruptcy, the
Company's ability to conduct its business would likely be severely hampered and
it is unlikely that the stockholders would receive any value.
(4) Equipment and Videocassette Rental Inventory
December 31,
------------ Estimated
1996 1995 Useful Lives
----------- ----------- ------------
Equipment $ 231,956 $ 366,313 5 years
Furniture and fixtures 356,176 380,986 5 years
Leasehold improvements 936,611 1,013,471 Life of Lease
Computers and peripherals 353,818 428,345 5 years
----------- -----------
1,878,561 2,189,115
Less: Accumulated depreciation
and amortization (1,768,158) (2,002,125)
=========== ===========
$ 110,403 $ 186,990
=========== ===========
Videocassette rental inventory $ 2,936,230 $ 2,936,280 2 years
Less: Accumulated depreciation (2,231,614) (2,157,552)
----------- -----------
$ 704,616 $ 778,728
=========== ===========
F-12
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(5) Notes Payable, Capital Lease Obligations, and Other Liabilities
The following table sets forth the Company's Notes Payable and Capital
Lease Obligations:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
----------- -----------
<S> <C> <C>
5 % Unsecured Promissory Notes due September 1997
(See Note 7) $ 680,000 $ 680,000
12% Note Payable to West Coast (See Note 3 and 14) 150,000
Capital lease obligation payable monthly through
August 1, 1995 (interest rate 14.5%) 4,691
10% Promissory Note Payable to investor in 8 equal
monthly installments due April 1995, extended to
March 15, 1996 14,000 20,000
10% Promissory Note Payable to investor in 8 equal
monthly installments due August 1, 1995, extended
to March 15, 1996 100,000 100,000
10% Promissory Note Payable to investor in 8 equal
monthly installments due May 1995 30,000 30,000
10% Promissory Note Payable to investor due October 1, 1996 30,000 30,000
----------- -----------
1,004,000 864,691
Less portion of notes payable due within one year (1,004,000) (184,691)
----------- -----------
Notes payable due after one year $ -0- $ 680,000
=========== ===========
</TABLE>
(6) Other Deferred Costs
In December 1994, the Company entered into a letter of intent to purchase a
chain of 12 video stores. In conjunction with signing the letter of intent and
as a representation of its good faith and in consideration of a no shopping
agreement, the Company paid the chain a $100,000 non-refundable deposit. In
connection with the termination of the letter of intent, the Company recorded
the non-refundable deposit as an expense in 1995.
In December 1994, the Company entered into a consulting agreement with a
firm that was to provide consulting services to the Company. In conjunction with
the agreement, the Company issued 150,000 shares of its common stock to the firm
in March 1995. The deferred costs of stock awarded to the consulting firm, was
expensed during 1995 in connection with the termination of the Company's
acquisition program.
As of December 31, 1996 deferred costs of $30,453 consist of certain debt
placement fees net of amortization. (See Note 7.)
F-13
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(7) Preferred Stock and Private Placement Transaction
The Company is authorized to issue 5,000 shares of preferred stock, par
value $.01 per share. The Board of Directors of the Company has the authority,
without further action by the stockholders, to issue the preferred stock in one
or more series, and to fix, for any series the dividend rate, redemption price,
liquidation or dissolution preferences, conversion rights, voting rights and
other preferences and privileges.
The Company, in connection with a private offering of units of preferred
stock, promissory notes and warrants to purchase preferred stock, which
terminated in September 1995, issued a total of : (i) 34 shares of the Company's
Series C Convertible Preferred Stock ("Preferred Stock"), convertible below into
1,360,000 shares of common stock, (ii) 5% unsecured promissory notes in the
aggregate principal amount of $680,000 due in September 1997, with interest
payable annually in cash or, at the election of the Company, in shares of
Preferred Stock (valued at $.25 per share of Common Stock), and with principal
and any accrued but unpaid interest convertible into Preferred Stock (valued at
$.25 per share of Common Stock) as the sole remedy of the holder in the event
the Company defaults in the payment of principal or is otherwise in default, and
(iii) three-year warrants to purchase 10.2 shares of Preferred Stock at an
exercise price of $10,000 per share, convertible into a total of 408,000 shares
of common stock.
As a result of its severely distressed financial condition, the Company
elected to issue 3.4 shares of its Series C Preferred Stock to the holders of
its 5% unsecured promissory notes, in payment of $34,000 of accrued interest due
such noteholders in August 1996, in accordance with the terms of such notes.
Additionally, the Company paid a placement fee consisting of $122,400 and
five-year warrants to purchase 5.1 shares of Preferred Stock at an exercise
price of $10,000 per share and a finder's fee consisting of five-year warrants
to purchase 8.5 shares of Preferred Stock at an exercise price of $37,500 per
share, all of which Preferred Stock being convertible into an aggregate of
544,000 shares of common stock. A portion of these issuance costs was
capitalized as a debt placement fee and is being amortized over the term of the
related debt.
Each share of Preferred Stock is convertible, at the option of the holder
thereof, into 40,000 shares of the Company's common stock, subject to
adjustment. Holders of the Preferred Stock are entitled to vote on any matter
submitted to a vote of the Company's stockholders, with each share of Preferred
Stock entitled to 40,000 votes. Holders of Preferred Stock have no liquidation
or other preferences upon the liquidation, dissolution, or winding up of the
Company, and are entitled to certain piggyback and demand registration rights
for the shares of common stock into which the Preferred Stock may be converted.
(8) Common Stock
During 1994, the Company reversed approximately $144,000 of accrued costs
relating to prior year warrant exercises upon determining that it no longer has
an obligation to pay such costs. Such costs representing underwriting
commissions, were initially recorded as a charge to additional paid in capital.
Also during 1994, the Company issued 5,000 shares of its common stock to an
employee upon exercise of a stock option at $.23 per share and a then related
party accepted 166,000 shares of the Company's Common stock in full settlement
of approximately $65,000 of debt.
In January 1995, the Company completed a private placement of stock for
900,000 shares of its common stock to two private foreign investors.
Additionally during 1995, the Company issued 113,461 shares of its common stock
to a vendor in settlement of a debt, and 150,000 shares of common stock to a
firm in connection with a consulting agreement. Additionally during 1995, former
employees of the Company exercised stock options to purchase 1,990,000 shares, a
warrant holder exercised its option to purchase 150,000 shares, and certain
employees of the Company exercised stock options to purchase 46,000 shares of
common stock.
F-14
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(9) Non-Employee Stock Options
Options
The following table sets forth certain information regarding non-employee
and non-management stock options granted by the Company, which were outstanding
at December 31, 1996:
<TABLE>
<CAPTION>
Shares of Common Exercise
Number of Stock Subject Price Registration
Date of Grant Holders to Option Per Share Expiration Date Rights
- - - ----------------- --------- ---------------- --------- ----------------- ------------
<S> <C> <C> <C> <C> <C>
December 13, 1988 2 12,500 $ 1.00 October 18,1999 None
November 14, 1989 2 65,000 $ 1.30 November 14, 1999 None
December 14, 1989 1 25,000 $ 2.00 December 14, 1999 None
January 11, 1990 2 16,875 $ 2.00 January 10, 1999 None
June 1, 1990 1 291,667 $ 1.25 June 1, 1999 None
January 31, 1991 2 510,000 $ 0.43 January 31, 2001 Registered
August 22, 1991 1 100,000 $ 0.63 August 21, 1999 Piggyback
November 3, 1994 2 400,000 $ 0.69 November 3,1999 Piggyback
December 1, 1994 1 1,000,000 $ 0.91 December 1, 1999 Piggyback
---------
Total 2,421,042
=========
</TABLE>
(10) Employee and Management Stock Options
Stock Option and Appreciation Rights Plan
The Company has reserved an aggregate of 1,694,000 shares of its common
stock for purchase under its 1987 Stock Option and Appreciation Rights Plan (the
"1987 Plan"). Pursuant to the 1987 Plan, the Company may grant either incentive
stock options, intended to comply with the requirements of Section 422A of the
Internal Revenue Code of 1986, as amended (the "Code"), or non-qualified stock
options, as well as stock appreciation rights.
All matters relating to the 1987 Plan are administered by a committee
selected by the Company's Board of Directors, including selection of
participants, allotment of shares, determination of price and other conditions
of purchase. The exercise price of incentive stock options granted under the
1987 Plan may not be less than the fair market value of the common stock on the
date of grant and the term of the option may not exceed ten years from the date
of grant. In the case of incentive options granted to individuals who own more
than 10% of the outstanding common stock of the Company, the exercise price may
not be less than 110% of the fair market value of the common stock on the date
of the 1987 Plan grant and the term of the option may not exceed five years from
the date of grant. All options and stock appreciation rights granted under the
1987 Plan are non-transferable other than by will or by the laws of descent and
distribution.
F-15
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(10) Employee and Management Stock Options (Continued)
Stock Option and Appreciation Rights Plan (Continued)
The following table sets forth information with respect to incentive stock
options under the Plan for the three years ended December 31, 1996:
<TABLE>
<CAPTION>
Number of Shares
Under Option (1) Price Per Share
---------------- ---------------
<S> <C> <C>
Outstanding at January 1, 1994 345,000 $.59 - $.75
(279,000 shares under exercisable options)
Cancelled (44,000) .23
Exercised (10,000) .23
--------
Outstanding at December 31, 1994 291,000
(291,000 shares under exercisable options)
Granted 657,000 .19
Cancelled (338,500) .23
Exercised (46,000) .23
--------
Outstanding at December 31, 1995 563,500 .19 - .23
(119,000 shares under exercisable options)
Cancelled (28,000) .19 - .23
--------
Outstanding at December 31, 1996 535,500 .19 - .23
========
(252,500 shares under exercisable options)
</TABLE>
- - - --------------------------------------
(1) Gives effect to the expiration of options due to termination of employment
All incentive options issued are exercisable in installments of one-third
of the total award on each of the first three anniversary dates and ending ten
years from the initial date of grant. All grants of options are conditioned on
the continued employment of the optionee. No stock appreciation rights have been
granted.
Non-Qualified Management Incentive Stock Options
In connection with the employment agreements entered into by the Company's
executive officers in May 1989, the Company granted Long-term Management
Incentive Options to four executive officers to purchase up to 4,275,000 shares
of Common Stock, all at an exercise price of $1.25 per share, which was the bid
price for the Common Stock on the date of grant as reported by NASDAQ. The
Long-Term Management Incentive Options expire on June 1, 1999. Options to
purchase 708,333 shares were forfeited upon the resignation of one of the
officers in June 1990. In August of 1990, the Company awarded additional
Long-Term Management Incentive Options to the three officers originally
receiving the options and one other officer in an amount equal to 558,333 shares
of the forfeited options, all at an exercise price of $2.97 per share. In
December of 1991, all of the August 1990 Long-Term Management Options and
2,616,666 of the 1989 Long-Term Management Incentive Options held by Company
officers were surrendered and cancelled. In 1996, two officers of the Company
surrendered the then remaining outstanding Long-term
F-16
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(10) Employee and Management Stock Options (Continued)
Non-Qualified Management Incentive Stock Options (Continued)
Management Incentive Options. Only 291,667 of the 1989 Long-Term Management
Incentive Options remain outstanding.
On January 31, 1991, the Board of Directors approved the grant of 4,750,000
1991 Management Options to four executive officers of the Company. One officer
has subsequently retired and two other officers have left the Company. One
ex-officer exercised his options in full, one ex-officer exercised 540,000
options leaving 510,000 options outstanding, and 1,000,000 options held by the
second officer who has left the Company remain outstanding. All of the 1991
Management Options were issued at an exercise price of $.4325 per share, which
represented the bid price for the Company's common stock on the date of the
grant of such options. The 1991 Management Options vested fully as of August 2,
1991, and expire January 31, 2001.
On February 9, 1994, the Board of Directors approved the grant of 915,000
1994 Management Options to three officers and one director of the Company at an
exercise price of $.23 per share, which represented the bid price for the
Company's common stock on the date of grant of such options. The 1994 Management
Options vested fully as of April 7, 1994, and expire on January 31, 2001.
Registration statements under the 1933 Act have been filed by the Company
with respect to the 8,425,001 shares underlying the 1987 Stock Option and
Appreciation Rights Plan ( the "1987 Plan"), the outstanding Long-Term
Management Incentive Options, the 1991 Management Options, and the 1994
Management Options, and an option held by a director. Of these options,
3,056,001 have either been cancelled, exercised or have expired, and 1,158,500
options remain unissued, and 283,000 have yet to vest under the 1987 SOP.
Generally, such registration permits the immediate sale of the 3,927,500 vested
shares upon exercise, subject to the volume limitations imposed by Rule 144.
Holders of these options are afforded certain anti-dilution and piggy-back
rights under the 1933 Act with respect to the shares of common stock issuable
upon exercise of said options.
On September 27, 1995, the Company granted a five-year non-qualified stock
option to purchase 100,000 shares of the Company's common stock to a director of
the Company at an exercise price of $.19 per share, the average fair market
value on that date.
(11) Net Loss Per Share of Common Stock
Net loss per share of common stock for each period is based on the net loss
divided by the weighted average number of common shares outstanding during the
period. No effect was given to common stock equivalents or the conversion of
preferred shares as the effect would be anti-dilutive.
The approximate number of shares used in the computation of loss per share
amounts are as follows:
Year ended December 31, Number of shares used in calculation
----------------------- ------------------------------------
1996 22,004,000
1995 21,652,000
1994 18,491,000
F-17
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(12) Income Taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. SFAS
No. 109 requires the liability method of accounting for deferred income taxes.
Deferred tax assets and liabilities are determined based on differences between
financial reporting and tax bases of assets and liabilities, and are measured by
applying enacted tax rates for the taxable years in which those differences are
expected to reverse. Recognition of deferred tax assets is subject to a
valuation allowance if it is more likely than not that some or all of a deferred
tax asset will not be realized.
The tax effects of temporary differences that give rise to deferred tax
assets and deferred tax liabilities at December 31, 1996 consist primarily of
net operating loss carry-forwards as well as differences related to fixed asset
depreciation, videocassette amortization, and certain accruals for book and tax
purposes. The Company is in a net deferred tax asset position at December 31,
1996 (before consideration of a valuation allowance) due to the significant net
operating loss carry-forwards described below. However, due to the uncertainty
of the Company realizing this carry-forward benefit through future taxable
income, the net deferred tax asset is fully reserved and no benefit has been
recognized in the statements of loss.
Under the Tax Reform Act of 1986, the utilization a corporation's net
operating loss carry-forwards is limited following a greater than 50 percent
change is ownership. As a result of various capital transactions, the Company
appears to have experienced such an ownership change. Accordingly, its
utilization of loss carry-forwards incurred may be subject to an annual
limitation generally determined by multiplying the market value of the Company
on the date of the ownership change by the federal long-term tax-exempt rate.
As of December 31, 1996, the Company had approximately $16,879,000 of net
operating loss carry-forwards for tax purposes which may be available to offset
future federal income, if any, through 2010. The amount ultimately available, if
any in future years, is dependent on the limitation discussed above. Should the
Company operate profitably in 1997 or future years, it may be subject to current
tax expense in certain states for which no net operating loss carry-forwards are
available.
(13) Commitments
The Company leases certain retail store facilities under non-cancelable
long-term operating leases which expire periodically through 2002. The Company's
commitments under these leases (excluding increases to base maintenance and
repairs, insurance an real estate taxes, which also are payable by the Company)
are as follows:
Year Ending December 31, Total Annual Rentals
------------------------ --------------------
1997 $ 996,026
1998 947,159
1999 826,681
2000 - 2002 2,061,950
-----------
$ 4,831,816
===========
Rent expense for 1996, 1995, and 1994 was $965,616, $980,510 and $962,824,
respectively.
In April, 1992, the Company entered into severance agreements with three
officers, which provide, under certain circumstances, that the Company will pay
these individuals upon their severance an amount equal to one full year's base
salary in the event that their affiliation with the Company ceases within either
one or two years (depending upon the circumstances) following a "change in
control" of the Corporation, as that term is defined in the Company's
F-18
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(13) Commitments (Continued)
Stock Option and Appreciation Rights Plan of 1987, as amended. In November 1993,
the Board of Directors adopted amendments to the severance agreements for two of
these officers, who are also directors of the Company and one of which who has
resigned (as mentioned above) after considering a possible conflict of interest
should they be required to vote on a business merger or combination that may
result in their removal as officers and directors of the Company. The amendments
principally increase the amount to be paid on severance from one full year's
base salary to two full year's base salary.
On August 15, 1996, the Company entered into an agreement with one of the
officers, pursuant to which he resigned from employment and from all positions
with the Company, while remaining a director and Chairman of the Board until
December 20, 1996, released the Company from all obligations and liabilities,
including any obligations under the severance agreement between him and the
Company referred to above, and agreed to the cancellation of certain
fully-vested options to purchase 291,667 shares of the Company's common stock,
and the Company entered into an eleven-month consulting agreement with said
officer, under which he receives $3,500 on a bi-weekly basis, and certain other
benefits for a period of one year.
As previously reported, during September 1995, a merger agreement between
the Company and JD Store Equipment Inc. was terminated. However, in connection
with a letter of intent entered into with regard to said then proposed merger,
the Company and JD also reached an agreement in the event a merger was not
consummated, for the payment of finder's fees with respect to any completed
merger or acquisition which the Company's then Chairman was responsible for
having introduced to the Company from the date of the letter of intent (November
4, 1994) until such time as it was publicly announced that the JD Merger was not
consummated (September 11, 1995). Such finder's fees are to consist of warrants
for the purchase of shares of the Company's common stock in an amount based upon
10% of the consideration issued or paid by the Company in said merger or
acquisition. The exercise price of the warrants is to be at a 20% discount to
the bid price of the Company's common stock, generally calculated on the date of
the letter of intent for said merger or acquisition. The warrants are to have a
five-year term and are to include certain piggy-back rights. JD also agreed, in
the event the merger was not consummated, to pay legal fees billed to the
Company by its then principal outside law firm.
As previously reported, the Company has entered into an asset Purchase
Agreement with West Coast, as amended, dated December 16, 1996, providing for
the sale, transfer and assignment of substantially all of the Company's assets
and business to West Coast.
Under the terms of the Purchase Agreement, the Company is to be paid a
purchase price in cash of $2,430,000, subject to possible downward adjustment,
based upon net operating cash flow for 1996, as defined in the Purchase
Agreement. The purchase price was determined through arm's-length negotiation
between the Company and West Coast.
The Purchase Agreement provides that $243,000 of the purchase price shall
be held by West Coast as escrow agent in an interest-bearing escrow account for
a period of two years, to be used to satisfy certain indemnity obligations of
the Company, if any, to West Coast.
Consummation of the West Coast Transaction is contingent upon a number of
conditions, the satisfaction of which cannot be assured, including, among
others, obtaining of all necessary consents, West Coast obtaining financing in
an amount sufficient to enable it to consummate the West Coast Transaction and
certain additional acquisitions, and approval of the West Coast Transaction by
the Company's stockholders. (See Note 14).
The Company also agreed to pay to West Coast a break-up fee of $100,000 if
the Company's directors or stockholders had failed to approve the West Coast
Transaction, or if prior to the closing of the West Coast Transaction
F-19
<PAGE>
CHOICES ENTERTAINMENT CORPORATION
NOTES TO FINANCIAL STATEMENTS - (Continued)
(13) Commitments (Continued)
the directors of the Company, whether or not in the exercise of their fiduciary
or other legal duties, shall withdraw or adversely modify or take a public
position materially inconsistent with their prior approval of, the Purchase
Agreement.
If an event occurs which entitles West Coast to receive the break-up fee,
West Coast has been granted an option in the Purchase Agreement to purchase all
of the Company's assets relating to the Company's retail video store located in
Newton, Pennsylvania ( the "Newtown Store") for the purchase price of $250,000
payable in cash.
In connection with the Purchase Agreement, West Coast also loaned the
Company $150,000 on December 16, 1996, which loan is evidenced by a 12%
promissory note, which is required to be paid at the closing of the West Coast
Transaction or, if applicable, at the closing of the sale of the assets of the
Newtown Store or, in any event, on demand at any time from and after April 30,
1997. The note is secured by a security interest in all of the assets of the
Newtown Store. The proceeds of the note were used to pay certain costs
previously incurred.
(14) Subsequent Events
On February 13, 1997, the Board of Directors of the Company authorized the
grant of non-qualified stock options to purchase 450,000 shares of the Company's
common stock at $.05 per share, the fair market value of the common stock on
that date, to three directors of the Company. The options become fully vested
after six months from the date of grant.
In connection with the Purchase Agreement, West Coast also loaned the
Company $20,000 on March 3, 1997 and $29,000 on March 19, 1997, both of which
loans are evidenced by 12% promissory notes, which are required to be paid at
the closing of the West Coast Transaction or, if applicable, at the closing of
the sale of the assets of the Newtown Store or, in any event, on demand at any
time from and after April 30, 1997. The notes are secured by a security interest
in all of the assets of the Newtown Store. The proceeds of the notes were used
to pay certain costs previously incurred.
On March 12, 1997, at a Special Meeting of Shareholders, the shareholders
of the Company voted to approve the sale of substantially all of the Company's
assets to West Coast Entertainment Corporation (See Note 13).
F-20
<PAGE>
EXHIBIT 3(b)
AMENDMENT NO. 2
TO
CERTIFICATE OF DESIGNATIONS OF
SERIES C PREFERRED STOCK/CERTIFICATE OF
AMENDMENT OF CERTIFICATE OF INCORPORATION
OF
CHOICES ENTERTAINMENT CORPORATION
CHOICES ENTERTAINMENT CORPORATION, a corporation organized and existing
under the General Corporation Law of the State of Delaware (the "Corporation"),
hereby certifies that:
A. "Amendment No. 1 to Certificate of Designations of Series C Preferred
Stock of the Corporation" (the "Amended Certificate of Designations") was filed
with the Office of the Secretary of State of the State of Delaware and became
effective on August 11, 1995.
B. The amendment to the Corporation's Certificate of Incorporation (as
heretofore amended and/or supplemented, the "Certificate of Incorporation") set
forth below was duly adopted in accordance with Section 242 of the General
Corporation Law of the State of Delaware (the "GCL"):
The Certificate of Incorporation is hereby amended by striking the text of
the Amended Certificate of Designations in its entirety, and inserting in lieu
thereof the following:
RESOLVED, that pursuant to the authority
vested in the Board of Directors of the
Corporation by the Certificate of Incorporation,
the Board of Directors does hereby approve the
issuance up to 500 shares of Preferred Stock, par
value $.01 per share, of the Corporation, to be
designated "Series C Preferred Stock" of the
presently authorized shares of Preferred Stock.
The voting powers, designations, preferences, and
other rights of the Series C Preferred Stock
authorized hereunder and the qualifications,
limitations and restrictions of such preferences
and rights are as follows:
1. Cash Dividends. Cash dividends shall be
paid with respect to the shares of Series C
Preferred Stock on the same basis as dividends are
paid to holders of common stock of the Corporation
(the "Common Stock"), and shall be distributed
ratably to holders of the Series C
<PAGE>
Preferred Stock and holders of Common Stock on the
basis that each 1/40,000 share of Series C
Preferred Stock shall be pro rata with each whole
share of Common Stock.
2. Voting. The holders of Series C Preferred
Stock shall be entitled to vote on any matter
required to be or otherwise submitted to a vote of
stockholders of the Corporation together with the
Common Stock and not as a separate class, unless
otherwise required by law. Each share of Series C
Preferred Stock shall be entitled to 40,000 votes.
3. Conversion. The Series C Preferred Stock
is convertible into shares of Common Stock at the
rate of 40,000 shares of Common Stock for every
one share of Series C Preferred Stock (the
"Conversion Rate"). The following provisions shall
apply with respect to conversion:
(a) Any holder of shares of Series C
Preferred Stock electing to convert such shares
into Common Stock shall surrender the certificate
or certificates for such shares at the office of
the Corporation (or at such other place as the
Corporation may designate by notice to the holders
of shares of Series C Preferred Stock) during
regular business hours, duly endorsed to the
Corporation or in blank, or accompanied by
instruments of transfer to the Corporation in
blank, in form satisfactory to the Corporation and
shall give written notice to the Corporation at
such office that such holder elects to convert
such shares of Series C Preferred Stock. The
Corporation shall, as soon as practicable after
such deposit of certificates for shares of Series
C Preferred Stock, accompanied by the written
notice above prescribed, issue and deliver at such
office to the holder for whose account such shares
were surrendered, or to his nominee, certificates
representing the number of shares of Common Stock
to which such holder is entitled upon such
conversion.
(b) Conversion shall be deemed to have
been made as of the date of surrender of
certificates for the shares of Series C Preferred
Stock to be converted and the delivery of written
notice as hereinabove provided; and the person
entitled to receive
<PAGE>
the Common Stock issuable upon such conversion
shall be treated for all purposes as the record
holder of such Common Stock on such date.
(c) The Conversion Rate shall be
adjusted from time to time as follows:
i) In case the Corporation shall
(A) subdivide its outstanding shares of Common
Stock, (B) combine its outstanding shares of
Common Stock into a smaller number of shares or,
(C) issue by reclassification of its shares of
Common Stock any shares of capital stock of the
Corporation, the conversion right and each
Conversion Rate in effect immediately prior to
such action shall be adjusted so that the holder
of any shares of the Series C Preferred Stock
thereafter surrendered for conversion shall be
entitled to receive the number of shares of
capital stock of the Corporation which such holder
would have owned immediately following such action
had such shares of the Series C Preferred Stock
been converted immediately prior thereto. An
adjustment made pursuant to this subparagraph
shall become effective retroactively immediately
after the record date in the case of a dividend or
distribution and shall become effective
immediately after the effective date in the case
of a subdivision, combination or reclassification.
If, as a result of an adjustment made pursuant to
this subparagraph, the holder of any shares of the
Series C Preferred Stock thereafter surrendered
for conversion shall become entitled to receive
shares of two or more classes of capital stock of
the Corporation, the Board of Directors (whose
determination shall be conclusive) shall determine
the allocation of the adjusted Conversion Rate
between or among shares of such classes of capital
stock.
ii) Notwithstanding the foregoing,
the Corporation shall not be required to make any
adjustment of the Conversion Rate unless such
adjustment would require an increase or decrease
of at least 5% in such rate. Any lesser adjustment
shall be carried forward and shall be made at the
time of and together with the next subsequent
adjustment which, together with any adjustment or
adjustments so carried forward, shall
<PAGE>
amount to an increase or decrease of at least 5%
in such rate.
iii) Whenever an adjustment in the
Conversion Rate is required, the Corporation shall
forthwith place on file with its Secretary a
statement signed by its Chairman of the Board,
President or a Vice President and by its Secretary
or Treasurer or one of its Assistant Secretaries
or Assistant Treasurers, stating the adjusted
Conversion Rate determined as provided herein.
Such statement shall set forth in reasonable
detail such facts as shall be necessary to show
the reason and the manner of computing such
adjustment. Promptly after the adjustment of the
Conversion Rate, the Corporation shall mail a
notice thereof to each holder of shares of Series
C Preferred Stock.
iv) In case of either (A) any
consolidation or merger to which the Corporation
is a party, other than a merger or consolidation
in which the Corporation is the surviving or
continuing corporation and which does not result
in any reclassification of, or change (other than
a change in par value or from par value to no par
value or from no par value to par value, or as a
result of a subdivision or combination) in,
outstanding shares of Common Stock, or (B) any
sale or conveyance to another corporation of all
or substantially all of the assets of the
Corporation, then the Corporation, or such
successor corporation, as the case may be, shall
make appropriate provision so that the holder of
each share of Series C Preferred Stock then
outstanding shall have the right to convert such
shares of Series C Preferred Stock into the kind
and amount of shares or other securities and
property receivable upon such consolidation,
merger, sale or conveyance by a holder of the
number of shares of Common Stock into which such
shares of Series C Preferred Stock might have been
converted immediately prior to such consolidation,
merger, sale or conveyance, subject to adjustments
which shall be as nearly equivalent as may be
practicable to the adjustments provided for
hereunder. The provisions of this subparagraph
shall apply similarly to successive
consolidations, mergers, sales or conveyances.
<PAGE>
v) The Corporation shall take all
necessary action to cause any shares of Series C
Preferred Stock which shall at any time have been
converted to resume the status of authorized but
unissued shares of Preferred Stock, without
designation as to series, until such shares are
once more designated as part of a particular
series by the Board of Directors. The Corporation
shall at all times reserve and keep available out
of its authorized but unissued stock, for the
purpose of effecting the conversion of the shares
of the Series C Preferred Stock, such number of
its duly authorized shares of Common Stock as
shall from time to time be sufficient to effect
the conversion of all outstanding shares of the
Series C Preferred Stock; provided, however, that
nothing contained herein shall preclude the
Corporation from satisfying its obligations in
respect of the conversion of the shares by
delivery of purchased shares of Common Stock which
are held in the treasury of the Corporation.
vi) The Corporation shall pay any
and all issue or transfer taxes that may be
payable in respect of any issuance or delivery of
shares of Common Stock on conversion of shares of
Series C Preferred Stock pursuant hereto. The
Corporation shall not, however, be required to pay
any tax which is payable in respect of any
transfer involved in the issue or delivery of
Common Stock in a name other than that in which
the shares of Series C Preferred Stock so
converted were registered, and no such issue or
delivery shall be made unless and until the person
requesting such issue has paid to the Corporation
the amount of such tax, or has established, to the
satisfaction of the Corporation, that such tax has
been paid.
vii) Before taking any action that
would result in the effective price of the shares
of Common Stock issuable upon conversion of Series
C Preferred Stock being less than the then par
value of the Common Stock, the Corporation shall
take any corporate action which may, in the
opinion of its counsel, be necessary in order that
the Corporation may validly and legally issue
fully paid and nonassessable shares of Common
Stock.
<PAGE>
4. Fractional Shares. The Series C Preferred
Stock may be issued as fractional shares in
increments of 1/40,000 of a share. Each fractional
share of Series C Preferred Stock shall be
entitled to the same rights and powers on a pro
rata basis as a whole share of Series C Preferred
Stock.
5. Liquidation, Dissolution, Winding Up. The
Series C Preferred Stock shall have no liquidation
or other preference over the Corporation's Common
Stock. Upon the voluntary or involuntary
liquidation, dissolution or winding up of the
Corporation, its net assets shall be distributed
ratably to holders of the Series C Preferred Stock
and holders of Common Stock on the basis that each
1/40,000 share of Series C Preferred Stock shall
be pro rata with each whole share of Common Stock.
IN WITNESS WHEREOF, CHOICES ENTERTAINMENT CORPORATION, has caused this
Certificate to be signed by Ronald W. Martignoni, its President, and attested by
Lorraine E. Cannon, its Secretary, this 20th day of December, 1996.
CHOICES ENTERTAINMENT CORPORATION
By: /s/ Ronald W. Martignoni
----------------------------------------
Ronald W. Martignoni, President
ATTEST: [CORPORATE SEAL]
By: /s/ Lorraine E. Cannon
----------------------------------------
Lorraine E. Cannon, Secretary
<PAGE>
EXHIBIT 11
CHOICES ENTERTAINMENT CORPORATION
Loss Per Share
1996 1995 1994
---- ---- ----
Net loss $ (666,680) $ (2,139,327) $ (988,139)
============ ============ ============
Weighted Average
Number of Shares
Outstanding 22,004,395 21,652,000 18,491,000
============ ============ ============
Net loss per share $ (0.03) $ (0.10) $ (0.05)
============ ============ ============
<PAGE>
EXHIBIT 21
List of Subsidiaries
The Company has the following two wholly-owned subsidiaries, which were
incorporated for purposes of proposed acquisitions in 1995 in connection with
the Company's now discontinued acquisition program. Both of these subsidiaries
are inactive and neither has conducted any business nor holds any assets.
Subsidiary State of Incorporation
- - - ---------- ----------------------
VJ Merger Corp. Delaware
JD Merger Corp. California
<PAGE>
EXHIBIT 23
Consent of Independent Auditors
The Board of Directors
Choices Entertainment Corporation:
We consent to incorporation by reference in the Registration Statements (Nos.
33-44343 and 33-87016) on Form S-8, of Choices Entertainment Corporation of our
report dated March 7, 1997 (except for the second and third paragraphs of note
14, as to which the dates are March 19, 1997, and March 12, 1997, respectively),
relating to the balance sheets of Choices Entertainment Corporation as of
December 31, 1996 and 1995, and the related statements of loss, stockholders'
deficit and cash flows for each of the years in the three-year period ended
December 31, 1996, which report appears in the December 31, 1996 annual report
on Form 10-KSB of Choices Entertainment Corporation.
Our report contains an explanatory paragraph that states that the Company has
suffered recurring losses from operations, is in default on certain obligations
and has a net working capital deficiency, which factors raise substantial doubt
about its ability to continue as a going concern. The financial statements do
not include any adjustments that might result from the outcome of these
uncertainties.
/S/ KPMG Peat Marwick LLP
Philadelphia, Pennsylvania
March 21, 1997
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
financial statements of Choices Entertainment Corporation and is qualified in
its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 66,739
<SECURITIES> 0
<RECEIVABLES> 12,790
<ALLOWANCES> 0
<INVENTORY> 181,280
<CURRENT-ASSETS> 332,945
<PP&E> 4,814,791
<DEPRECIATION> 3,999,772
<TOTAL-ASSETS> 1,394,770
<CURRENT-LIABILITIES> 2,721,317
<BONDS> 0
0
0
<COMMON> 220,044
<OTHER-SE> (1,546,591)
<TOTAL-LIABILITY-AND-EQUITY> 1,394,770
<SALES> 5,172,504
<TOTAL-REVENUES> 5,172,504
<CGS> 1,088,126
<TOTAL-COSTS> 1,088,126
<OTHER-EXPENSES> 4,699,228
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 51,830
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (666,680)
<EPS-PRIMARY> (0.03)
<EPS-DILUTED> (0.03)
</TABLE>
