10-Q 1 d10q.txt QUARTERLY REPORT ENDED 10/31/2001 ================================================================================ United States SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- Form 10-Q --------------- [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended October 31, 2001 ---------------- [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to ________. Commission File No. 0-14023 VIDEO CITY, INC. (Exact name of registrant as specified in its charter) Delaware 95-3897052 (State or other jurisdiction of (I.R.S. Employer Identification Number) incorporation or organization) 4800 Easton Drive, Suite 108, Bakersfield, California 93309 (Address of principal executive offices) (Zip Code) --------------- Registrant's telephone number, including area code:(661) 634-9171 Page 1 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15 (d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes --- No ---- Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date. The number of shares of Common Stock outstanding as of January 20, 2002 was 16,442,662. Page 2 PART I. FINANCIAL INFORMATION Item 1. Financial Statements VIDEO CITY, INC. CONSOLIDATED BALANCE SHEETS

~~July~~October 31, January 31, ~~2000~~2001 ~~2000~~2001 ------------- ------------ (Unaudited) (Audited) ASSETS Current assets: Cash. ........................................~~...............................~~ $ ~~880~~25,~~981~~176 $ 241,~~316~~046,164 Customer receivables .........................~~..............................~~ ~~637~~395,~~762~~226 1433,~~003,578~~024 ~~Notes~~Other ~~receivable~~Receivables ............................~~...............................~~ ~~9,078~~-- 9946,~~078~~655 Merchandise inventory. .......................~~...............................~~ 3570,~~173,114~~685 3965,~~767,919~~025 Other ........................................~~..............................~~ 152,~~423,199~~416 ~~75,000~~ -- ----------- ------------ Total current assets ........................~~..............................~~ 61,~~124~~043,~~134~~503 43,~~879~~390,~~891~~868 Rental library, (net ~~of accumulated amortization)~~ ............................ 52,~~536~~607,~~428~~383 63,~~223~~012,~~364~~387 Property and equipment, net ....................~~..............................~~ 31,~~361~~290,~~858~~350 41,~~266~~525,~~665~~409 Goodwill .......................................~~..............................~~ 41,~~787~~818,~~378~~699 41,~~920~~912,~~303~~713 Other assets ...................................~~..............................~~ ~~834~~295,~~001~~008 1256,~~003,564~~011 ------------- ------------ Total assets .................................~~...........................~~ $207,~~643~~054,~~799~~943 $2110,~~293~~097,~~787~~388 ============= ============

See accompanying notes to consolidated financial statements Page 3 VIDEO CITY, INC. CONSOLIDATED BALANCE SHEETS

~~July~~October 31, January 31, ~~2000~~2001 ~~2000~~2001 -------------- ------------- (Unaudited) (Audited) LIABILITIES ~~AND~~NOT ~~STOCKHOLDERS'~~SUBJECT ~~DEFICIT~~TO COMPROMISE Current liabilities: Accounts payable .................................................... $ 1,648,942 $ 215,724 Accrued Expenses ................................................... $811,797 251,~~610~~041,~~985~~134 $Current ~~23,033,955~~portion ~~Accrued~~of ~~expenses~~tax liability ................................... 147,643 -- Shares issuable under plan of reorganization .......................~~...~~ 41,~~509~~750,~~603~~000 ~~3,069,765~~-- ~~Senior~~------------ ~~secured~~------------- ~~revolving~~Total ~~credit~~current ~~facility~~liabilities ........................................ 114,~~856~~358,~~849~~382 91,~~769~~256,~~574~~858 ~~Current~~Tax liability less current portion of................................... ~~long~~456,400 -~~term~~- ~~debt~~Other liabilities .................................................. 628,~~790,454~~694 545,~~565,078~~526 ------------ ------------- Total liabilities Not Subject to Compromise .......................... 4,843,476 1,302,384 ------------ ------------- ~~Total~~LIABILITIES ~~current~~SUBJECT ~~liabilities~~TO COMPROMISE Accounts payable ..................................................... 481,~~767~~324,~~891~~031 4126,~~438~~443,~~372~~937 ~~Long-term~~Senior ~~debt,~~secured ~~less~~revolving ~~current~~credit ~~portion~~facility ............................. -- 10,451,429 Notes payable .............. ~~-- 1,231,907 Other liabilities~~ .......................................... -- 6,790,454 Accrued interest .................... ~~99,456 99,456 -------------- ------------- Total liabilities~~ ................................. -- 1,004,342 Other liabilities .................................................... 4811,~~867,347~~230 421,~~769~~628,~~735~~690 ------------ ------------- Total Liabilities Subject to Compromise 1,335,261 46,318,852 ------------ ------------- ~~Stockholders'~~Total ~~deficit~~Liabilities 6,178,737 47,621,236 STOCKHOLDERS EQUITY (DEFICIT): Preferred stock ....................................................~~..........~~ -- 6,292,135 ~~6,217,135~~ Common stock, $.01 par value per share, 30,000,000 shares authorized;: 16,442,662 shares issued and outstanding at ~~July~~October 31, ~~2000~~2001 and 1516,~~767~~442,~~959~~662 shares issued and outstanding at January 31, ~~2000~~2001 .................................................. -- 164,427 ~~157,679~~ Additional paid-in capital .........................................~~..........~~ 1319,~~576~~683,~~968~~529 13,~~268~~576,~~548~~968 Accumulated deficit ................................................~~..........~~ (4818,~~257~~807,~~078~~323) (4157,~~119~~557,~~310~~378) -------------- ------------- Total stockholders' ~~deficit~~equity (deficit)...............................~~................~~ ~~(28~~876,~~223,548)~~206 (2137,~~475~~523,~~948~~848) -------------- ------------- Total liabilities and stockholders' equity (deficit) .................~~...................~~ $ 207,~~643~~054,~~799~~943 $ 2110,~~293~~097,~~787~~388 ============== =============

See accompanying notes to consolidated financial statements Page 4 VIDEO CITY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

Three Months Ended ~~Six~~Nine Months Ended ~~July~~October 31, ~~July~~October 31, ~~July~~October 31, ~~July~~October 31, 2001 2000 ~~1999~~2001 2000 ~~1999~~ ------------- ------------- ------------- ------------ REVENUES: Rental revenues and product sales ............................ $ 73,~~677~~862,~~944~~364 $ 145,~~212~~808,~~961~~282 $ 1512,~~864~~980,~~025~~825 $27 21,~~518~~672,~~031~~312 Management fee income ........................................ ~~1,207,830~~ -- 2998,~~523~~826 7,~~830~~143 --3,522,656 ------------- ------------- ------------- ------------ TOTAL REVENUES ................................................. 83,~~885~~862,~~774~~364 146,~~212~~807,~~961~~108 1812,~~387~~987,~~855~~968 2725,~~518~~194,~~031~~968 ------------- ------------- ------------- ------------ OPERATING COSTS AND EXPENSES: Store operating expenses ..................................... 42,~~638~~491,~~515~~990 93,~~151~~855,~~708~~825 97,~~156~~773,~~946~~295 1713,~~055~~012,~~535~~773 Amortization of rental library ............................... 31,~~039~~347,~~823~~583 1,~~733~~872,~~543~~009 54,~~031~~141,~~947~~317 36,~~506~~903,~~033~~956 Cost of product sales ........................................ 1399,~~171,130~~308 2816,~~395,466~~509 21,~~695~~408,~~506~~011 43,~~355~~512,~~781~~018 Cost of leased product ....................................... ~~384,351~~-- 1343,~~651,808~~540 ~~848~~41,~~528~~442 21,~~151~~192,~~592~~068 Restructuring ................................................ -- -- -- 1,564,000 -- General and administrative expenses .......................... 2815,~~265,441~~174 32,~~371~~547,~~466~~787 42,~~511~~325,~~635~~401 57,~~452~~059,~~017~~423 ------------- ------------- ------------- ------------ TOTAL OPERATING COSTS AND EXPENSES ............................. 115,~~499~~054,~~260~~055 189,~~303~~435,~~991~~670 2315,~~808~~689,~~562~~466 3233,~~520~~244,~~958~~238 ~~LOSS~~Loss ~~FROM~~from ~~OPERATIONS~~operations before reorganization items ...............~~......................~~ (21,~~613~~191,~~486~~691) (42,~~091~~628,~~030~~562) (52,~~420~~701,~~707~~498) (58,~~002~~049,~~927~~270) Other (~~income~~Income) expense. ~~(Gain)~~Interest ~~loss~~expense, onnet ~~sale~~(contractual ofinterest ~~assets~~$552,000 and $1,758,000) .......................... ~~199,373 (1,913,178) 199,373 (1,913,178) Interest expense, net~~ ......................~~............~~ ~~626,710~~-- ~~694~~141,~~035~~137 112,~~206,117~~500 1,~~282~~347,~~762~~254 Other ........................................................ (1074,~~571~~107) (3115,~~418~~586) (10184,~~571~~003) (5426,~~736~~157) ------------- ------------- ------------- ------------ Loss before ~~taxes~~reorganization items ...............................~~.........~~ (31,~~428~~117,~~998~~584) (2,~~840~~754,~~469~~113) (62,~~815~~529,~~626~~995) (49,~~317~~370,~~775~~367) ~~Income~~Reorganization ~~tax~~items ~~benefit~~........................................... Professional fees ............................................ -- --104,000 417,577 104,000 (Gain) Loss on sale of assets ................................ -- 1,954,581 (~~546~~34,~~603~~600) 2,153,954 Relocation of Corporate Office ............................... -- -- 57,925 -- ------- ----- -------- ---- ------------ ------------ Net Loss before ~~Dividends~~extraordinary items ............................~~....~~ (31,~~428~~117,~~998~~584) (24,~~840~~812,~~469~~694) (62,~~815~~970,~~626~~897) (311,~~771~~628,~~172~~321) ~~=============~~Extraordinary ~~=============~~items: ~~=============~~Troubled ~~============~~debt ~~Dividends~~restructuring gain, net of tax of $0 (Note 6) ....................................................... ~~170,142~~-- ~~114~~-- 8,~~037~~951,429 ~~322~~-- Discharge of liabilities subject to compromise (Note 3) ...... 32,~~142~~769,523 ~~114~~-- 32,~~037~~769,523 -- ------------ ------------ ------------ ------------ Total extraordinary items ...................................... 32,769,523 -- 41,720,952 -- ------------ ------------ ------------ ------------ Net ~~Loss~~income to(loss) ~~Common~~before ~~Shareholders~~dividends ............................. $31,651,939 (34,~~599~~812,~~140~~694) $38,750,055 (211,~~954~~628,~~506~~321) Dividends on preferred stock ................................... -- -- -- (322,142) ------------ ------------ ------------ ------------ Net Income (loss) attributable to common shareholders .......... $ 31,651,939 $ (74,~~137~~812,~~768~~694) $ 38,750,055 $(311,~~885~~950,~~209~~463) ============= ============= ============= ============ ~~Loss~~Basic and diluted loss per common share ~~data:~~before ~~Basic~~extraordinary ~~Loss~~items ~~Per Share~~ ............................................ $ (0.2207) $ (0.2129) $ (0.4418) $ (0.2873) ~~Diluted~~Basic ~~Loss~~and ~~Per~~diluted ~~Share~~income per common share from extraordinary items ............................................ $ (01.~~22)~~99 $ ~~(0.21)~~-- $ (02.~~44)~~53 $ ~~(0.28)~~-- ~~Weighted~~Basic ~~average~~and ~~number~~diluted ofnet ~~common~~income ~~shares~~(loss) ~~outstanding~~per ~~Basic~~common share ........... $ 1.92 $ (0.29) $ 2.36 $ (0.~~..................................~~73) ~~16,378,259~~Weighted ~~13,978,010~~average ~~16,159,038~~number ~~13,811,603~~of ~~Diluted~~common shares outstanding basic and diluted ............................................... 16,~~378~~442,~~259~~662 1316,~~978~~442,~~010~~662 16,~~159~~442,~~038~~662 1316,~~811~~268,~~603 ============= ============= ============= ============~~843

See accompanying notes to consolidated financial statements Page 5 VIDEO CITY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

~~Six~~Nine Months Ended ~~July~~October 31, ~~July~~October 31, 2001 2000 ~~1999 ------------- -------------~~ Increase (Decrease) in cash Cash flows from operating activities: Net ~~Loss~~income (loss) before dividends .............................................~~....~~ $ (638,~~815~~750,~~626)~~055 $ (311,~~771~~628,~~172~~321) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Depreciation and amortization ................................................ 64,~~141~~770,~~861~~735 48,~~602~~508,~~772~~961 ~~Increase~~Extraordinary initem ~~net~~- ~~deferred~~troubled ~~tax~~debt ~~asset~~restructuring ............................. (8,951,429) -- Extraordinary item - discharge of liabilities subject to compromise .......... -- (~~546~~32,~~603~~769,523) -- Issuance of stock for services and inventory ................................. -- 187,500 ~~2,681,682~~ (Gain) Loss on sale of asset ................................................. ~~199~~(34,~~373~~600) (12,~~913~~153,~~179)~~954 Changes in assets and liabilities, net of effects of acquisitions: Decrease (increase) in customer receivables .................................. ~~365~~37,~~819~~798 (1491,~~333,347)~~264 Decrease ~~(increase)~~ in ~~merchandise~~other ~~inventories~~receivables ................................................ ~~594~~946,~~805~~655 ~~(2,552,530)~~-- ~~Increase~~Decrease in ~~other~~notes ~~assets~~receivable ................................................. ~~(1,241,859)~~-- ~~(420~~9,~~777)~~078 ~~Increase~~Decrease in ~~accounts~~merchandise ~~payable~~inventories ............................................ 2394,~~577,029~~340 3848,~~321,290~~879 Increase ~~(decrease)~~ in ~~accrued~~other ~~expenses~~assets ..................................................... 1(101,~~320,363~~913) (1426,~~961,342~~417) ~~Decrease~~Increase in ~~other~~accounts payable and liabilities subject to compromise ........... 1,334,377 3,923,008 Increase in accrued expenses ................................................. --225,647 1,148,444 Decrease in other liabilities and liabilities subject to compromise .......... (~~128~~27,~~565~~202) -- ------------ ------------- Net cash provided by ~~(used in)~~ operating activities ...................................... 34,~~329~~574,~~265~~940 (25,~~021~~216,~~771)~~350 ------------- ------------- Cash flows from investing activities: Purchases of videocassette rental library, ................................... (43,~~423~~937,~~265~~478) (5,~~591~~705,~~490~~372) Purchases of fixed assets .................................................... (~~158~~292,~~513~~820) (2162,~~071,508~~391) ~~Store~~Proceeds ~~acquisitions~~from sale of assets .................................................~~.....~~ 134,370 -- ~~(167,036)~~ Proceeds from sale of assets after Chapter 11 filing .........................~~...................~~ ~~28,434~~-- 13508,~~863,000~~760 ------------- ------------- Net cash ~~provided by~~ (used) in) investing activities ........................................ (4,~~553~~095,~~344~~928) 6(5,~~032~~359,~~966~~003) ------------- ------------- Cash flows from financing activities: ~~Repayment~~Proceeds offrom ~~long-term debt .............................................~~ (~~6,531~~repayment) ~~(285,592) Proceeds from issuance~~ of long- term debt ................................ ~~-- 1,700,000 Proceeds from issuance of preferred stock~~ ..~~.............................~~ -- ~~625~~(6,~~000~~531) Proceeds from borrowings (repayments) under credit facility .................. ~~2,087,275~~ (61,~~095~~500,~~439~~000) 751,813 ------------- ------------- Net cash provided by (used in) financing activities ............................ ~~2,080,744~~ (41,~~056~~500,~~031~~000) 745,282 ------------- ------------- Net increase (decrease) in cash ................................................ ~~856,665~~ (441,~~836~~020,988) 602,629 Cash at beginning of period ................................................... 1,046,164 24,316 ~~172,043~~ ------------- ------------- Cash at end of period .......................................................... $ ~~880~~25,~~981~~176 $ ~~127~~626,~~207~~945 ~~-------------~~============ ~~-------------~~============

See accompanying notes to consolidated financial statements Page 6 VIDEO CITY, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

~~Six~~Nine Months Ended ~~July~~October 31, ~~July~~October 31, 2001 2000 ~~1999~~ ------------ ------------ Supplementary disclosures of cash flow information Cash Paid For: Interest ............................................................ $ ~~651~~12,~~225~~500 $ ~~890~~651,~~304~~225 ~~Income~~Reorganization ~~taxes~~items ................................................~~....~~ --228,061 17104,~~924~~000 Non-cash investing and financing activities: ~~Common~~Troubled ~~Stock~~debt ~~issued~~restructuring ~~for professional services~~ ................... ~~112,500 278,682 Preferred stock issued in satisfaction of liabilities~~ ........... ~~75,000 4,000,000 Note receivable from sale of assets~~ ...........~~..................~~ 8,951,429 -- ~~2,058,000~~Discharge ~~Preferred~~of ~~stock~~liabilities ~~dividends~~subject to compromise ......................~~.................~~ ~~322~~34,~~142 114~~169,~~037~~523 ~~For~~-- ~~acquisitions~~Cancellation ~~consummated during the six months ended July 31, 1999, the Company paid $167,036, net~~ of ~~cash~~preferred ~~acquired.~~stock ~~In conjunction with the 1999 acquisitions, liabilities were assumed as follows: Fair value of assets acquired~~ ....................................... ~~$ 2~~6,~~156~~292,~~998~~135 ~~Cash~~-- ~~paid~~Cancellation of common stock ........................................ 13,741,395 -- Liability for shares issuable under plan of reorganization ..........~~.........~~ ~~(167~~1,~~036)~~750,000 Common ~~stock~~Stock issued for professional services .......................~~..........................~~ ~~(641~~-- 112,~~394)~~500 Preferred stock issued ~~..............................................~~in ~~(1,251,230)~~satisfaction ~~Goodwill~~of liabilities ...............~~.............................................~~ ~~3,630,456~~ --~~---------~~ ~~Liabilities~~75,000 ~~assumed~~Preferred stock dividends ........................................... $-- 3322,~~727,794 ===========~~142

See accompanying notes to consolidated financial statements. Page 7 VIDEO CITY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Financial Statement Presentation The accompanying consolidated financial statements include the accounts of Video City, Inc. ("the Company") and all of its wholly owned subsidiaries. These subsidiaries include Old Republic Entertainment, Inc., Sulpizio One, Inc., Video Tyme, Inc., Videoland, Inc., and Video Galaxy, Inc. All material intercompany transactions have been eliminated. The financial statements include the operations of companies acquired from the dates of acquisition. The consolidated balance sheet as of October 31, 2001, the consolidated statement of operations for the three and nine months ended October 31, 2001 and 2000, and the consolidated statement of cash flows for the nine months ended October 31, 2001 are unaudited and have been prepared in accordance with the American Institute of Certified Public Accountants Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code. The financial statements have been prepared using accounting principles applicable to a going concern, which assumes realization of assets and settlement of liabilities in the normal course of business. The appropriateness of using the going concern basis is dependent upon, among other things, the ability to comply with debtor-in-possession financing agreements, confirmation of a plan of reorganization, the ability to achieve profitable operations, and the ability to generate sufficient cash flow from operations to meet its obligations. The accompanying interim consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to present fairly the financial position as of October 31, 2001, the results of operations for the three and nine months ended October 31, 2001 and 2000, and cash flows for the nine months ended October 31, 2001 and 2000. All such adjustments are of a normal and recurring nature. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year. Certain reclassifications have been made to the prior year financial statements to conform with the current year presentation. It is recommended that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year ended January 31, 2001. Page 8 The accompanying consolidated balance sheets as of January 31, 2001 and October 31, 2001 segregates liabilities subject to compromise, such as unsecured claims, from liabilities not subject to compromise, such as fully secured liabilities and liabilities arising subsequent to filing bankruptcy. A plan of reorganization could materially change the amounts currently recorded in the consolidated financial statements. The consolidated statements that might result from the outcome of this uncertainty may be materially different that those presented herein. Reorganization items represent expenses incurred by the Company as a result of the bankruptcy filing and proceedings, which are required to be expensed as incurred. The reorganization value of the assets immediately before the date of confirmation was more than the total of all postpetition liabilities and allowed claims. Consequently, fresh-start reporting does not apply and the emergence from Chapter 11 has been accounted for as a quasi-reorganization. 2. Restructuring Costs The Company incurred $1.6 million in restructuring costs during the period ending October 31, 2000, consisting of severance obligations to employees of approximately $950,000, lease liability for the former executive offices in Torrance, California of approximately $100,000, moving expenses of the corporate office of approximately $80,000 and non-cash write down of the related leasehold improvements of approximately $430,000. These costs are related to the Company's effort to improve the performance of its operations and streamline its corporate expenses after entering into the Management Agreement and in anticipation of the proposed merger between the Company and West Coast Entertainment Corporation. The merger agreement was subsequently terminated and the merger did not occur. 3. Bankruptcy Page 9 On August 17, 2000, Fleet Retail Finance purported to accelerate the outstanding indebtedness under the Company's secured credit facility with Fleet Retail Finance. Fleet Retail Finance also initiated an action in the Massachusetts State Court to recover the sums allegedly due under the credit facility and obtained a temporary order requiring that the Company deposit its cash receipts into designated Fleet Retail Finance accounts. Additionally, the Company filed a complaint against Fleet Retail Finance and certain other defendants seeking damages in excess of $25.0 million. The Complaint alleges fraud, breach of contract, breach of the covenant of good faith and fair dealing, intentional interference with contractual relations, intentional interference with advantageous relations, violation of the Racketeer Influenced and Corrupt Organizations Act and violation of applicable provisions of Massachusetts state law. The Company also filed a motion to vacate the temporary order obtained by Fleet Retail Finance and to restrain Fleet Retail Finance from sweeping the cash from the Company's depository accounts, which are used to fund operations and payroll. On August 22, 2000, the Massachusetts court directed Fleet Retail Finance to release enough funds to cover payroll. On August 24, 2000, as a result of Fleet Retail Finance action to accelerate payment of the outstanding indebtedness under the Company's secured credit facility, the Company and its subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The company retained possession of its properties and assets and continued to operate with its existing directors and officers as a Debtor-in-Possession ("DIP"). As Debtors-in-Possession, the Company is authorized to operate its business, but may not engage in transactions outside of the normal course of business without approval, after notice and hearing, of the Bankruptcy Court. Pursuant to the provisions of the Bankruptcy Code, as of the petition date actions to collect pre-petition indebtedness owed by the Company are stayed and other pre-petition contractual obligations may not be enforced against the Company. In addition, as debtors-in-possession, the Company has the right, subject to the Bankruptcy Court's approval and certain other conditions, to assume or reject any pre-petition executory contracts and unexpired leases. Page 10 Parties affected by these rejections may file claims with the Bankruptcy Court in accordance with the reorganization process. Accordingly, these obligations have been included as liabilities subject to compromise. The Bankruptcy Court approved payment of certain pre-petition liabilities such as employee expenses and benefits. The Bankruptcy Court also allowed for the retention of legal and financial professionals. The items are recorded as accounts payable and accrued expenses not subject to compromise. On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's First Amended Chapter 11 Plan of Reorganization (the "Plan"). The Plan became effective on August 29, 2001. Pursuant to the Plan, the existing common shareholders of Video City are to receive 700,000 shares of common stock of Reorganized Video City in cancellation of all shares of common stock outstanding prior to such distribution, for pro rata distribution; 700,000 shares of common stock are to be issued in cancellation of all shares of preferred stock outstanding prior to such distribution to preferred shareholders; and 5,600,000 shares of common stock are to be issued to Video City's creditors. The Company anticipates that all liabilities subject to compromise will receive shares of common stock of Video City in full satisfaction of their claims based on the Plan of Reorganization. As part of the plan certain class 4A creditors had the option to receive 20% of their claim in cash if their claim was under $1,000 or if they choose to reduce their claim to that amount. The total amount for all class 4A creditors who opted for the cash payout was less than $22,000. In addition, certain tax obligations of approximately $1.3 million that are to be paid in cash over five years from the date of assessment, of which approximately $600,000 have been reclassified out of liabilities subject to compromise. The remaining balance is still in dispute. The Company will issue 7,000,000 shares of new common stock of reorganized Video City upon completion of the Company's past SEC filings on forms 10Q and 10K and completion of the audit and reviews of the Company's financial statements by its independent certified public accountants. On August 29, 2001, the effective date of the Plan, liabilities subject to compromise totaling $34,169,523 were discharged. All of the preferred and common stock of the Company was deemed canceled. The Company recorded an extraordinary gain of $32,769,523, net of $1,400,00 fair value of 5,600,000 share of common stock to be issued Page 11 to creditors, to discharge liabilities subject to compromise. At October 31, 2001 the balance sheet reflects a liability in the amount of $1,750,000 for 7,000,000 shares of common stock issuable under the Plan of Reorganization. The estimated fair value of the common stock was $0.25 determined by the board of directors based on pre-petition trading prices converted at the ratio of common stock issued to the existing common shareholders in the plan of reorganization. 4. Earnings Per Share Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted from issuance of common stock that then share in earnings. Common stock options, warrants, and preferred stock were not included in the computations of diluted earnings per share because they have been cancelled as a result of the bankruptcy filing on August 24, 2000 and the subsequent Plan of Reorganization. 5. Use of Estimates In addition to the uncertainties related to the Chapter 11 proceedings, the preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 6. Significant Developments In July 2000, the Company sold 2 stores and recorded a loss of approximately $199,000. On September 27, 2000, the Company obtained approval from the United States Bankruptcy Court to reject the leases on 17 under- Page 12 performing store locations and liquidate the assets. The assets were sold to Video One Liquidators at the aggregate net liquidation price of $508,760. As a result, the Company recognized a loss on sale of approximately $2.2 million during the third quarter ended October 31, 2000. During the fourth quarter of fiscal 2001, the Company sold an additional 11 stores and recorded a loss of approximately $1.3 million, which included approximately $1.25 million of unamortized goodwill. Effective February 13, 2001 West Coast Entertainment directors informed the Company that they were terminating the "Management Agreement" effective immediately, due to the sale of substantially all of West Coast Entertainment's remaining 56 stores and various other assets to Video One Liquidators. In February 2001, the Company relocated its corporate offices from 9998 Global Road, 2nd Floor, Philadelphia, Pennsylvania, 19115 to 4800 Easton Drive, Suite 108, Bakersfield, California, 93309. The Company and Fleet Retail Finance entered into an agreement ("the Fleet Compromise"), which was approved by the Court on March 28, 2001. The salient terms of the agreement granted Fleet Retail Finance an allowed claim in the amount of $10,000,000. In full satisfaction of the claim, the Company agreed to make two payments consisting of $1,500,000. The first payment of $1,000,000 was paid on March 28,2001 and the second payment of $500,000 was made on June 29, 2001 resulting in the full satisfaction of the Allowed Fleet Claim. As a result, the Company has recorded an extraordinary gain from troubled debt restructuring during the nine months ended October 31, 2001. In addition, both parties jointly dismissed the State Court Action with prejudice and Fleet Retail Finance and the Company simultaneously executed a mutual release of any and all claims against the directors, officers, employees, and other representatives of each company. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Special Note Regarding Forward Looking Statements Page 13 Certain statements in this Quarterly Report on Form 10-Q, may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Such forward-looking statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements, expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed herein and in the Company's Annual Report on Form 10-K for the fiscal year ended January 31, 2001. As described in Note 1 to the unaudited consolidated financial statements, the Company filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code on August 24, 2000. Results of Operations Three months and nine months ended October 31, 2001 compared to the three months and nine months ended October 31, 2000: Revenues Rental revenue and product sales for the three months and nine months ended October 31, 2001 totaled $3.9 million and $13.0 million compared to $5.8 million and $21.7 million for the three and nine months ended October 31, 2000. Revenue decreased by $1.9 million or 33% and $8.7 million or 40% for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. The decreased revenues were primarily attributable to the reduced number of stores operating during the three and nine month periods ending October 31, 2001 as compared to the prior year periods. The Company divested 17 stores during the period August 1, 2000 to September 30, 2000 as part of the Company's bankruptcy reorganization plan. The Company had no management fee income for the three months and $7,143 for the nine months ended October 31, 2001 compared to $1.0 million and $3.5 million of income in the corresponding periods of the previous year. The Company entered Page 14 into a "Management Agreement" with West Coast Entertainment Corporation on March 3, 2000 and West Coast Entertainment terminated the agreement on February 13, 2001. Store Operating Expenses Store operating expenses for the three months and nine months ended October 31, 2001 totaled $2.5 million and $7.8 million, as compared to $3.9 million and $13.0 million for the three months and nine months ended October 31, 2000. Store operating expenses decreased by $1.4 million or 36% and $5.2 million or 40% for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. The decrease in store expenses was primarily attributable to the reduced number of stores operating during the three and nine month periods ending October 31, 2001 as compared to the prior year periods. The Company divested 17 stores during the period August 1, 2000 to September 30, 2000 as part of the Company's bankruptcy reorganization plan. Store operating expenses as a percentage of rental revenues and product sales were 65% and 60% for the three months and nine months ended October 31, 2001 compared to 67% and 60% for the corresponding periods of 2000. Amortization of Videocassette Rental Inventory Amortization of videocassette rental inventory for the three months and nine months ended October 31, 2001 totaled $1.4 million and $4.1 million, compared to $1.9 million and $6.9 million for the three months and nine months ended October 31, 2000. Amortization decreased by $0.5 million or 26% and $2.7 million or 39% for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. The decrease in amortization expense was primarily attributable to the reduced number of stores operating during the three and nine month periods ending October 31, 2001 which resulted in lower levels of rental inventory as compared to the prior year periods. The Company divested 17 stores during the period August 1, 2000 to September 30, 2000 as part of the Company's bankruptcy reorganization plan. Amortization of videocassette rental inventory as a percentage of rental revenues and product sales were 35% and 32% for the three months and nine months ended October 31, 2001 compared to 33% and 32% for the corresponding period of 2000. Page 15 Cost of Product Sales Cost of product sales for the three months and nine months ended October 31, 2001 totaled $0.4 million and $1.4 million, compared to $0.8 million and $3.5 million for the three months and nine months ended October 31, 2000. Cost of product sales decreased by $0.4 million or 50% and $2.1 million or 60% for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. The decrease in cost of product sales was primarily attributable to the reduced number of stores operating during the three and nine month periods ending October 31, 2001 as compared to the prior year periods. The Company divested 17 stores during the period August 1, 2000 to September 30, 2000 as part of the Company's bankruptcy reorganization plan. In addition, the Company lacked sufficient working capital during the fiscal year to purchase adequate sell thru products. Cost of product sales as a percentage of rental revenues and product sales, was 10% and 11% for the three months and nine months ended October 31, 2001, compared to 14% and 16% for the corresponding period of the previous year. Cost of Leased Product Cost of leased product for the three months and nine months ended October 31, 2001 totaled $0 and $41,442, compared to $0.3 million and $1.2 million for the three months and nine months ended October 31, 2000. Cost of leased product decreased by $0.3 million and $1.2 million for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. Cost of leased product as a percentage of rental revenues and product sales, was 0% and 0% for the three months and nine months ended October 31, 2001, compared to 6% and 6% for the same period of 2000. The decrease was primarily due to the Company not leasing product under studio revenue sharing agreements beginning August 24, 2000 due the Chapter 11 Bankruptcy filing. Restructuring Costs The Company incurred $1.6 million in restructuring costs during the fiscal year ending 2001, consisting of severance obligations to employees of approximately $950,000, lease liability for the former executive offices in Torrance, California of approximately $100,000, moving expenses of the corporate office of approximately $80,000 Page 16 and non-cash write down of the related leasehold improvements of approximately $430,000. These costs were related to the Company's effort to improve the performance of its operations and streamline its corporate expenses after entering into the Management Agreement and in anticipation of the proposed merger between the Company and West Coast Entertainment Corporation. During fiscal 2001 the Company paid $703,472 in cash for restructuring expenses. General and Administrative Expenses General and administrative expenses for the three months and nine months ended October 31, 2001 totaled $0.8 million and $2.3 million, compared to $2.5 million and $7.1 million for the three months and nine months ended October 31, 2000. General and administrative expenses decreased by $1.7 million or 68% and $4.8 million or 68% for the three months and nine months ended October 31, 2001 as compared to the corresponding periods of the previous year. The decrease in general and administrative expenses was primarily attributable to the reduction in executive and staff employee salaries, professional fees, travel and entertainment, utilities and related cost savings that resulted from the moving of the Company's corporate headquarters from Philadelphia, Pennsylvania to Bakersfield, California in February 2001 and the monitoring of costs during the bankruptcy period. In addition, the Company incurred additional costs for professional services and travel expenses in connection with the "Management Agreement" during the three and nine months ended October 31, 2000, that were not incurred in the current periods. General and administrative expenses as a percentage of total revenues were 21% and 18% for the three months and nine months ended October 31, 2001, compared to 43% and 33% for the same period in 2000. Interest Expense Interest Expense for the three months and nine months ended October 31, 2001 totaled $0 and $12,500, compared to $141,137 and $1.3 million for the three and nine months ended October 31, 2000. The decrease in interest expense is reflective of the discontinuance of recording interest expense on unsecured and partially secured prepetition debt subject to compromise. The $12,500 interest expense during the three and nine months ended Page 17 October 31, 2001 was interest charged on the balance of the $500,000 payable to Fleet Retail Finance on June 29, 2001, per the agreement ("the Fleet Compromise"), which was approved by the Bankruptcy Court on March 28, 2001. Other (Income) Expense The Company had other income of $74,107 and $184,003 for the period ending October 31, 2001 compared to $15,586 and $26,157 in other income in the prior period ending October 31, 2000. Reorganization Items Reorganization items expense was $0 and $382,977 for the three months and nine months ended October 31, 2001. It consisted of professional fees, corporate relocation expenses and a gain on the sale of assets directly related the Company's Chapter 11 reorganization plan. The Company had $2,058,581 reorganization items expense in the prior year consisting of professional fees and loss on sale of assets. Income Taxes Statement of Financial Accounting Standards No. 109 requires a valuation allowance to be recorded when it is more likely than not that some or all of the deferred tax assets of a Company will not be realized. Accordingly, a full valuation allowance has been established against the deferred tax asset at October 31, 2001. Extraordinary Items During the three months ended October 31, 2001 the Company reported an extraordinary gain from the discharge of $32,769,523 of allowed claims that will be issued common stock pursuant to the Company's approved Plan of Reorganization. During the nine months ended October 31, 2001 the Company reported an extraordinary gain on troubled debt restructuring of $8,951,429, which represents a settlement of the loan agreement with Fleet Retail Finance as part of the Fleet Compromise. Page 18 Liquidity and Capital Resource The Company funds its short-term working capital needs, including the purchase of videocassettes and other inventory, primarily through cash from operations. The Company expects that cash from operations will be sufficient to fund future videocassette and other inventory purchases and other working capital needs for its existing stores. Videocassette rental inventories are accounted for as noncurrent assets under generally accepted accounting principles because they are not assets which are reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates a substantial portion of the Company's revenue, the classification of these assets as noncurrent excludes them from the computation of working capital. The acquisition cost of videocassette rental inventories, however, is reported as a current liability until paid and, accordingly, included in the computation of working capital. Consequently, the Company believes working capital is not as significant a measure of financial condition for companies in the video retail industry as it is for companies in other industries. Because of the accounting treatment of videocassette rental inventory as a noncurrent asset, the Company anticipates that it will operate with a working capital deficit during the fiscal year ended January 31, 2002. On December 29, 1998, the Company entered into a Senior Secured Revolving Credit Facility agreement (the "Credit Facility") with BankBoston/Fleet Retail Finance to be used for working capital purposes and capital expenditures. The Credit Facility was scheduled to mature on December 29, 2001. On September 23, 1999, the Company entered into a forbearance agreement with BankBoston/Fleet Retail Finance that amended the terms of the Loan Agreement, revised the financial performance covenants of the Loan Agreement and contained weekly covenant requirements. In November 1999, the Company did not meet the financial performance covenants as set forth in the forbearance agreement. During the fiscal year ended January 31, 2000, the Company did not meet certain of the financial covenants as required by the credit facility. On March 9, 2000, the Company entered into a second forbearance agreement that limited the Credit Facility to $10,750,000 and revised the financial covenant requirements. Page 19 On August 24, 2000, as a result of the Fleet Retail Finance action to accelerate payment of the outstanding indebtedness under the Company's secured credit facility, the Company filed a voluntary petition in the United States Bankruptcy Court seeking to reorganize under Chapter 11 of the U.S. Bankruptcy Code. The Company and Fleet Retail Finance entered into a compromise agreement which was approved by the Bankruptcy Court on March 28, 2001 under which the outstanding debt to Fleet Retail Finance was settled in full satisfaction by the payment of $1,500,000. Inherent in a successful plan of reorganization is a capital structure which permits the Company to generate sufficient cash flow after reorganization to meet its restructured obligations and fund the current obligations of the reorganized Company. Under the Bankruptcy Code, the rights of and ultimate payment to prepetition creditors may be substantially altered and, as to some classes, eliminated. The Company believes that the sources of capital described above and internally generated funds will be adequate to meet the Company's anticipated needs through fiscal 2002; however, no assurance can be given with respect to the Company's liquidity. During the Debtor-in-Possession period the Company's supply vendors required all purchases of inventory be made only by cash in advance. There can be no assurance, however, that future cash from operations will be sufficient to fund future videocassette, DVD and inventory purchases. In June 2001, the Company entered into a purchase money security agreement directly with Warner Brothers Home Video. The agreement provides the company with a line of trade credit and 60 day terms for repayment. The company purchases all Warner Brothers product directly from Warner Brothers Home Video, which is then distributed to all Video City's home entertainment retail chain through a third party distributor. In July 2001 the Company entered into an agreement with Video Products Distributors ("VPD") under which VPD agreed to become the exclusive video distributor for all of Video City's home entertainment retail chain. VPD will provide all videocassettes, DVDs and accessories for rental and sale with the exception of Warner Brothers Home Video product in all locations. As part of this agreement, Video City is receiving a line of trade credit and 90 day terms for repayment to VPD. Page 20 On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's First Amended Chapter 11 Plan of Reorganization (the "Plan"). The Plan became effective on August 29, 2001. Pursuant to the Plan, the existing common shareholders of Video City are to receive 700,000 shares of common stock of Reorganized Video City in cancellation of all shares of common stock outstanding prior to such distribution, for pro rata distribution; 700,000 shares of common stock are to be issued in cancellation of all shares of preferred stock outstanding prior to such distribution to preferred shareholders; and 5,600,000 shares of common stock are to be issued to Video City's creditors. The Company anticipates that all liabilities subject to compromise will receive shares of common stock of Video City in full satisfaction of their claims based on the Plan of Reorganization. As part of the plan certain class 4A creditors had the option to receive 20% of their claim in cash if their claim was under $1,000 or if they choose to reduce their claim to that amount. The total amount for all class 4A creditors who opted for the cash payout was less than $22,000. In addition, certain tax obligations of approximately 1.3 million are to be paid in cash over five years from date of assessment, of which approximately $600,000 have been reclassified out of liability subject to compromise. The remaining balance is still in dispute. Cash Flows Nine months Ended October 31, 2001 Compared to the Nine months Ended October 31, 2000 Cash Provided by Operating Activities Net cash provided by operating activities for the nine months ended October 31, 2001, decreased by approximately $641,000, or 12%, compared to the nine months ended October 31, 2000. This change was caused by an increase in net income of approximately $50 million over the comparable prior year period, offset by the non-cash gain of approximately $41.7 million recorded upon completion of the troubled debt restructuring and discharge of liabilities as a result of the confirmation of the Plan of Reorganization. The change was also attributable to a decrease in depreciation and amortization as a result of the divestiture of stores during the bankruptcy period. All of these stores were closed for the nine months ended October 31, 2001 and this has also caused a decrease in merchandise Page 21 inventories. The change was also due to a smaller increase in accounts payable and accrued expenses as a result of the bankruptcy filing. Cash Used in Investing Activities Net cash used in investing activities during the nine months ended October 31, 2001 decreased by approximately $1.3 million or 24%, compared to the nine months ended October 31, 2000. The change was mainly attributable to the decrease in the purchase of videocassettes for the rental library as a result of the bankruptcy and the conserving of cash during this period, offset by the proceeds received from the sale of assets. Cash Provided by (Used in) Financing Activities Net cash used in financing activities during the nine months ended October 31, 2001, increased by approximately $2.2 million or 301%, compared to the nine months ended October 31, 2000. The change was mainly attributable to the repayment of $1.5 million, approved by the Bankruptcy Court, for the revolving credit facility with Fleet (formerly BankBoston). As a result of these payments, the debt to Fleet was forgiven and the Company recorded a non-cash item of $8,951,429. Item 3. Quantitative and Qualitative Disclosure About Market Risk The Company's market risk sensitive instruments do not subject it to material market risk exposures, except for such risks related to interest rate fluctuations. The Company discontinued recording interest expense on unsecured and partially secured prepetition debt subject to compromise. PART II. OTHER INFORMATION Item 1. Legal Proceedings Page 22 On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City's First Amended Chapter 11 Plan of Reorganization (the "Plan"). On August 29, 2001, the Reorganization Plan became effective and the Company emerged from bankruptcy reorganization proceedings. Item 2. Changes in Securities and Use of Proceeds None Item 3. Defaults Upon Senior Securities. Pursuant to the provisions of the Bankruptcy Code, as of the petition date actions to collect pre-petition indebtedness owed by the Company were stayed and other pre-petition contractual obligations could not be enforced against the Company. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits None (b) Reports on Form 8-K None SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Video City, Inc --------------- (Registrant) Page 23 February 15, 2002 /S/ Timothy L. Ford ------------------- Timothy L. Ford Chief Executive Officer (Principal Executive Officer) --------------------------- February 15, 2002 /S/ Rudolph R. Patino --------------------- Rudolph R. Patino Chief Financial Officer (Principal Financial Officer) page 24

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