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United States

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



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Form 10-QSB



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|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



For the quarterly period ended July 31, 2003



| ̈ |  | 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



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VIDEO CITY, INC.

(Exact name of registrant as specified in its charter)



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|Delaware                                                       |  | 95-3897052                             
|-------------------------------------------------------------- |  | ---------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification Number)



|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



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Check whether the registrant filed all documents and reports required to be filed by Section 12, 13, or 15 (d) of the
Securities Exchange Act of 1934 after the distribution of securities under a plan confirmed by a court.    Yes  x    No ̈



State the number of shares outstanding of each of the issuers classes of common equity as of the latest practicable date.



The number of shares of Common Stock outstanding as of September 12, 2003 was 10,102,520



Transitional Small Business Disclosure Format (Circle One):    Yes ̈No  x



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
act).    Yes ̈No  x



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PART I. FINANCIAL INFORMATION



Item 1. Financial Statements



VIDEO CITY, INC.

CONSOLIDATED
BALANCE SHEETS



|                               |  | July 31, 2003 |           | January 31, 2003
|------------------------------ |  | ------------- | --------- | ----------------
|                               |  | (Unaudited)   |           | (Audited)       
|ASSETS                         |  |               |           |                 
|Current assets:                |  |               |           |                 
|Customer receivables           |  |               |          |                 
|Merchandise inventory.         |  |               |          |                 
|Receivable from sale of stores |  |               | 224,000   |                 
|Assets held for sale           |  |               | 2,288,708 |                 
|Other                          |  |               | 218,729   |                 
|                               |  |               |           |                 
|Total current assets           |  |               | 2,731,437 |                 
|                               |  |              
|Rental library, net            |  |               |          |                 
|Property and equipment, net    |  |               | 106,362   |                 
|Goodwill                       |  |               |          |                 
|Other assets                   |  |               | 114,477   |                 
|                               |  |               |           |                 
|Total assets                   |  | $             | 2,952,276 |                 
|                               |  |               |           |                 



See accompanying notes
to consolidated financial statements



2



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VIDEO CITY, INC.

CONSOLIDATED BALANCE SHEETS



|                                                                                                                                                                                                |  | July 31, 2003 |             |   | January 31, 2003 |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ----------- | - | ---------------- | -
|                                                                                                                                                                                                |  | (Unaudited)   |             |   | (Audited)        |  
|LIABILITIES NOT SUBJECT TO COMPROMISE                                                                                                                                                           |  |               |             |   |                  |  
|Current liabilities:                                                                                                                                                                            |  |               |             |   |                  |  
|Bank overdraft.                                                                                                                                                                                 |  | $             | 68,881      |   |                  | $
|Accounts payable.                                                                                                                                                                               |  |               | 1,284,049   |   |                  |  
|Accrued Expenses                                                                                                                                                                                |  |               | 1,122,689   |   |                  |  
|Note payable.                                                                                                                                                                                   |  |               | 494,127     |   |                  |  
|Senior subordinated convertible notes payable, including $187,562 and $134,452 payable to related parties (net of unamortized
discount of $57,890 and $180,467)                                 |  |               | 495,112     |   |                  |  
|Current portion of tax liability.                                                                                                                                                               |  |               | 178,197     |   |                  |  
|Liabilities related to assets held for sale                                                                                                                                                     |  |               | 109,706     |   |                  |  
|Other liabilities.                                                                                                                                                                              |  |               | 92,555      |   |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total current liabilities.                                                                                                                                                                      |  |               | 3,845,316   |   |                  |  
|Shares issuable under plan of reorganization                                                                                                                                                    |  |               |            |   |                  |  
|Deferred tax liability                                                                                                                                                                          |  |               | 136,000     |   |                  |  
|Tax liability less current portion                                                                                                                                                              |  |               | 415,792     |   |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total liabilities Not Subject to Compromise                                                                                                                                                     |  |               | 4,397,108   |   |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|LIABILITIES SUBJECT TO COMPROMISE                                                                                                                                                               |  |               |             |   |                  |  
|Accounts payable                                                                                                                                                                                |  |               | 182,097     |   |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total Liabilities Subject to Compromise                                                                                                                                                         |  |               | 182,097     |   |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total Liabilities                                                                                                                                                                               |  |               | 4,579,205   |   |                  |  
|STOCK HOLDERS DEFICIT                                                                                                                                                                          |  |               |             |   |                  |  
|Common stock, $.01 par value per share, 30,000,000 shares authorized; 10,102,520 shares issued and outstanding at July 31, 2003
and 6,299,798 shares issued and outstanding at January 31, 2003 |  |               | 101,016     |   |                  |  
|Additional paid-in capital                                                                                                                                                                      |  |               | 22,035,017  |   |                  |  
|Accumulated deficit                                                                                                                                                                             |  |               | (23,762,962 | ) |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total stockholders deficit                                                                                                                                                                     |  |               | (1,626,929  | ) |                  |  
|                                                                                                                                                                                                |  |               |             |   |                  |  
|Total liabilities and stockholders deficit                                                                                                                                                     |  | $             | 2,952,276   |   |                  | $
|                                                                                                                                                                                                |  |               |             |   |                  |  



See accompanying notes
to consolidated financial statements



3



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VIDEO CITY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)



|                                                                       |  | Three Months Ended |           |   | Six Months Ended |  
|---------------------------------------------------------------------- |  | ------------------ | --------- | - | ---------------- | -
|                                                                       |  | July 31, 2003      |           |   | July 31, 2002    |  
|OPERATING COSTS AND EXPENSES:                                          |  |                    |           |   |                  |  
|General and administrative expenses                                    |  | $                  | 584,403   |   |                  | $
|                                                                       |  |                    |           |   |                  |  
|TOTAL OPERATING COSTS AND EXPENSES                                     |  |                    | 584,403   |   |                  |  
|Loss from operations                                                   |  |                    | (584,403  | ) |                  |  
|Other expense.                                                         |  |                    |           |   |                  |  
|Interest expense, net                                                  |  |                    | 264,734   |   |                  |  
|                                                                       |  |                    |           |   |                  |  
|Net loss from continuing operations                                    |  |                    | (849,137  | ) |                  |  
|Discontinued Operations:                                               |  |                    |           |   |                  |  
|Income (loss) from operations ofdiscontinued operations                |  |                    | (109,159  | ) |                  |  
|Gain on disposal of discontinued operations                            |  |                    | 472,096   |   |                  |  
|                                                                       |  |                    |           |   |                  |  
|Net income (loss) from discontinued operations                         |  |                    | 362,937   |   |                  |  
|Net loss before extraordinary item                                     |  |                    | (486,200  | ) |                  |  
|Extraordinary item                                                     |  |                    |          |   |                  |  
|                                                                       |  |                    |           |   |                  |  
|Net income (loss)                                                      |  | $                  | (486,200  | ) |                  | $
|                                                                       |  |                    |           |   |                  |  
|Loss per common share data:                                            |  |                    |           |   |                  |  
|Basic and diluted loss per common share from continuing operations     |  | $                  | (0.12     | ) |                  | $
|Basic and diluted income per common share from discontinued operations |  | $                  | 0.05      |   |                  | $
|Basic and diluted loss per common share before extraordinary item      |  | $                  | (0.07     | ) |                  | $
|Basic and diluted income per common share from extraordinary item      |  | $                  | 0.00      |   |                  | $
|Basic and diluted net income (loss) per common share                   |  | $                  | (0.07     | ) |                  | $
|Weighted average number of common shares outstanding basic and diluted |  |                    | 6,923,340 |   |                  |  



See accompanying notes
to consolidated financial statements



4



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VIDEO CITY, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                            |  | Six Months Ended |           
|--------------------------------------------------------------------------- |  | ---------------- | ----------
|                                                                            |  | July 31, 2003    |           
|Increase (Decrease) in cash                                                 |  |                  |           
|Cash flows from operating activities:                                       |  |                  |           
|Net loss from continuing operations                                         |  | $                | (1,433,748
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                  |           
|Depreciation and amortization                                               |  |                  | 40,489    
|Settlement of liabilities subject to compromise                             |  |                  |          
|Amortization of discount on senior subordinated notes payable               |  |                  | 153,490   
|Changes in assets and liabilities:                                          |  |                  |           
|Customer receivables                                                        |  |                  | 3,695     
|Other receivables                                                           |  |                  | (118,842  
|Receivable from sale of stores                                              |  |                  | (150,000  
|Other assets                                                                |  |                  | 99,440    
|Accounts payable and liabilities subject to compromise                      |  |                  | (235,472  
|Accrued expenses and liabilities subject to compromise                      |  |                  | 236,592   
|Liabilities related to assets held for sale                                 |  |                  | 109,706   
|Other liabilities and liabilities subject to compromise                     |  |                  | (43,855   
|                                                                            |  |                  |           
|Net cash used in operating activities                                       |  |                  | (1,338,505
|                                                                            |  |                  |           
|Cash flows from discontinued operations                                     |  |                  | 802,532   
|                                                                            |  |                  |           
|Cash flows from investing activities:                                       |  |                  |           
|Purchases of fixed assets                                                   |  |                  | (951      
|                                                                            |  |                  |           
|Net cash used in investing activities                                       |  |                  | (951      
|                                                                            |  |                  |           
|Cash flows from financing activities:                                       |  |                  |           
|Decrease in bank overdraft                                                  |  |                  | (13,748   
|Proceeds from the issuance of common stock                                  |  |                  | 29,667    
|Proceeds from notes payable                                                 |  |                  | 449,255   
|Proceeds from senior subordinated notes payable                             |  |                  | 205,000   
|Repayment of senior subordinated notes payable                              |  |                  | (133,250  
|                                                                            |  |                  |           
|Net cash provided by financing activities                                   |  |                  | 536,924   
|                                                                            |  |                  |           
|Net increase (decrease) in cash                                             |  |                  |          
|Cash at beginning of period                                                 |  |                  |          
|                                                                            |  |                  |           
|Cash at end of period                                                       |  | $                |          
|                                                                            |  |                  |           



See accompanying notes
to consolidated financial statements



5



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VIDEO CITY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)



|                                                                                            |  | Six Months Ended
|------------------------------------------------------------------------------------------- |  | ----------------
|                                                                                            |  | July 31,2003    
|Supplementary disclosures of cash flow information                                          |  |                 
|Cash Paid For:                                                                              |  |                 
|Interest.                                                                                   |  | $               
|Non-cash investing and financing activities:                                                |  |                 
|Beneficial Conversion related to issuance of $742,420 Senior Subordinated Convertible Notes |  |                 
|Accrued expenses relieved in exchange for $389,583 in Senior Subordinated Convertible Notes |  |                 
|Par value of common stock issued according to the Plan of Reorganization                    |  |                 
|Excess over the par value of common stock issued according to the Plan of Reorganization    |  |                 
|Par value of common stock issued to settle accrued expenses                                 |  |                 
|Excess of the par value of common stock issued to settle accrued expenses                   |  |                 



See accompanying notes
to consolidated financial statements.



6



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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 subsidiaries have been inactive since
emerging from bankruptcy.



The accompanying interim
consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary to present fairly the financial position as of July 31, 2003, the results of operations for the three and six months ended July 31, 2003 and
2002, and cash flows for the six months ended July 31, 2003 and 2002. 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 amended annual report on Form 10-K/A for the fiscal year ended January 31, 2003.



The Company has experienced recurring net losses and has negative working capital as of July 31, 2003. The Company also signed a definitive agreement to
sell the majority of the Companys stores. These conditions give rise to substantial doubt about the Companys ability to continue as a going concern. The accompanying financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the
amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern. The Companys continuation as a going concern is dependent upon the Companys ability to generate sufficient cash flows
to meet the Companys obligations on a timely basis.



The
Company is currently exploring all possibilities regarding future plans for its business in the event of the sale of substantially all of its assets. The Company is uncertain whether its business will continue to be in the retail video industry or
in any specific industry related to the retail video industry. In any case, the Company plans to reduce its work force and expenses to a minimum level in the event of such sale.



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The accompanying consolidated balance sheets as of January 31, 2003 and July 31, 2003 segregate
liabilities subject to compromise, which represents pre-bankruptcy claims still in dispute, from liabilities not subject to compromise.



2. 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. 1,240,000 common stock options and 1,484,840 warrants to purchase common stock were not included in the computations of diluted earnings per share for the three months and six months ended July 31, 2002 because the effect of exercise
and/or conversion would have an antidilutive effect on earnings per share. 928,336 common stock options and 51,428 warrants to purchase common stock were not included in the computations of diluted earnings per share for the three months and six
months ended July 31, 2003 because the effect of exercise and/or conversion would have an antidilutive effect on earnings per share.



3. Accounting for Stock Options



The Company has adopted the intrinsic value method of accounting for employee stock options under the principles of APB Opinion No. 25, Accounting
for Stock Issued to Employees (APB 25) and discloses the pro forma effect on net income (loss) and income (loss) per share as if the fair value based method had been applied. For equity instruments, including stock options, issued to
non-employees, the fair value of the equity instruments or the fair value of the consideration received, whichever is more readily determinable, is used to determine the value of services or goods received and the corresponding charge to operations.



The following table illustrates the effect on net income
(loss) and income (loss) per share as if the Company had applied the fair value recognition provision of SFAS No. 123 to stock-based employee compensation.



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|                                                                                                       |  | Three MonthsEnded July 31, 2003 |          |   | Three MonthsEnded July 31, 2002 |   |          | Six Months Ended July 31, 2003 |  |   | Six Months Ended July 31, 2002 |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------------- | -------- | - | ------------------------------- | - | -------- | ------------------------------ |  | - | ------------------------------ | -
|Net loss from continuing operations: as reported                                                       |  | $                               | (849,137 | ) |                                 | $ | (629,568 | )                              |  | $ | (1,433,748                     | )
|Add: total stock based employee compensation expense determined under fair value method for all awards |  |                                 | (8,613   | ) |                                 |   | (21,317  | )                              |  |   | (17,226                        | )
|                                                                                                       |  |                                 |          |   |                                 |   |          |                                |  |   |                                |  
|Pro forma net loss                                                                                     |  | $                               | (857,750 | ) |                                 | $ | (650,885 | )                              |  | $ | (1,450,974                     | )
|                                                                                                       |  |                                 |          |   |                                 |   |          |                                |  |   |                                |  
|Loss per sharebasic and diluted:                                                                      |  |                                 |          |   |                                 |   |          |                                |  |   |                                |  
|As reported                                                                                            |  | $                               | (0.12    | ) |                                 | $ | (0.12    | )                              |  | $ | (0.19                          | )
|Pro forma                                                                                              |  | $                               | (0.12    | ) |                                 | $ | (0.13    | )                              |  | $ | (0.19                          | )



As required by SFAS
123, the Company provides the following disclosure of estimated values for these awards. The weighted-average grant-date fair value of options granted during 2002 was estimated to be $0.24. There were no options granted in 2003.



The fair value of each option grant during the three months and six months
ended July 31, 2002 was estimated on the date of grant using a Black-Scholes option-pricing model with the following weighted average assumptions for 2002 risk free interest rates of 4.5%, expected lives of 1 to 5 years; volatility of 50% and no
assumed dividends. There were no options granted during three months and six months ended July 31, 2003.



4. Use of Estimates



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 materially from those estimates.



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5. Commitments and Contingencies



Contingent Liability for Assigned Operating Leases - The Company remains contingently liable for four of the store location operating
leases that have been assigned to Movie Gallery in connection with the sale of such four stores to Movie Gallery in November 2002. Unlike the other lease assignments entered into by the Company, the landlords did not agree to release the Company
from any and all obligation or liability under the operating leases accruing and/or attributable to the period on or after the effective date of the assignment. In the event Movie Gallery defaults on its obligations on the four operating leases, the
Company may be liable to the landlord for such obligations. The Company remains contingently liable in the total amount of approximately $559,400 as of July 31, 2003 for the four operating leases. Although there can be no assurances, the Company
does not anticipate that it will be contingently liable for store location leases to be assigned to Movie Gallery as part of the pending sale of the 12 stores because the proposed form of lease assignment being submitted to the landlords for the
stores to be sold contain the release provisions, releasing the Company from any and all obligation or liability under the operating leases. In the event the landlord refuses to release the Company, the Company will remain contingently liable for
such operating leases.



Guarantees and Indemnifications - The
Companys Certificate of Incorporation provides that the Company shall be empowered to indemnity to the full extent of its power to do so, all directors and officers, pursuant to the applicable provisions of the Delaware General
Corporation Law. The Company will indemnify its officers and directors to the full extent permitted under Section 145 of the Delaware General Corporation Law.



Litgation - Colonial Shopping Center v. 32ndStreet Inc., Lee Video City, Inc, Video City, Inc. et alOn March 13, 2003, Colonial Shopping Center filed suit in Superior Court of California Kern County, against
the Company for damages from breach of the lease regarding the property at 2333 Brundage Lane, Bakersfield, California. Colonial is seeking damages of approximately $34,000 for unpaid rent, and an unknown amount from rent and other amounts,
including operating expenses from December 1, 2002 through March 31, 2007, less any sums plaintiff receives from re-letting the property. In August 2003, the court granted the application of Colonial Shopping Center for a right to attach order and
order for issuance of writ of attachment, allowing Colonial Shopping Center a right to attach property of the Company in the amount of $248,628.



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Laurelglen-Bakersfield v. 32ndStreet Inc., Lee Video City, Inc, Video City, Inc. et alAlso on March 13, 2003,
Laurelglen-Bakersfield filed suit against the Company in Superior Court of California Kern County, alleging breach of a lease for the property at 6615 Ming Avenue, Bakersfield, California. Laurelglen is seeking damages of approximately $43,000 in
unpaid rent, and an unknown amount of rent from December 1, 2002 through May 31, 2004, less any sums plaintiff receives from re-letting the property. In August 2003, the court granted the application of Laurelglen-Bakersfield for a right to attach
order and order for issuance of writ of attachment, allowing Laurelglen-Bakersfield a right to attach property of the Company in the amount of $224,308.



6. Notes Payable



On June 23, 2003, the Company completed the issuance of a Secured Promissory Note to an unaffiliated accredited investor in the principal amount of
$460,000. The Secured Promissory Note was sold at a discount of 37.5 percent from the face value of such note due to the financial condition of, and perceived risks of investing in, the Company. The Secured Promissory Note had an original maturity
date of August 29, 2003 and bears interest at rate of nine percent per annum. The Secured Promissory Note is secured by the assets of the Company. After the discount from face value and the commission payable to the Companys investment banking
firm in connection with such financing, the Company received net proceeds in the amount of $258,150. The Company used such net proceeds to satisfy its immediate need for liquidity and to pay the costs and expenses in connection with the proposed
sale of its 12 stores. On August 28, 2003, the investor agreed to extend the maturity date of the Secured Promissory Note through October 16, 2003 in consideration for the Company agreeing to pay a late fee of $9,200 on such maturity date. The
discount of $ 172,500 is recorded as deferred financing charges and is being amortized over the period of the note.



7. Senior Subordinated Convertible Notes Payable



During the quarter ended July 31, 2003, the Company issued an additional 2 Series A Units for cash proceeds of $20,000 with each unit consisting of a
$10,000 10% Senior Subordinated Convertible Note due



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November 1, 2003 and a Series A warrant to purchase 20,000 shares of Common Stock. The Series A warrants had a term of one year and an exercise price of
$0.01 per share.



8. Discontinued Operations



On October 24, 2002 the Board of Directors approved the disposition of 19
retail video stores (the 19 Stores) to M.G. Midwest, Inc., a Delaware corporation (Movie Gallery). The 19 Stores represent all stores owned by the Company outside of California and includes certain assets and liabilities
related to the 19 Stores. The disposition was effected pursuant to an Asset Purchase Agreement between the Company and Movie Gallery, dated October 24, 2002. The 19 Stores represented approximately 38% of the Companys total assets at the date
of disposal.



The aggregate cash purchase price for the 19
Stores was $2,080,500, which was determined as a result of arms-length negotiations between the Company and Movie Gallery. Of the $2,080,500 purchase price, Movie Gallery paid the Company $2,030,500 at the closing of the transaction on November 6,
2002, and $40,000 on June 17, 2003. The balance of the $10,000 will not be paid based on the uncertainties of whether one of the 19 sold stores will achieve certain levels of gross revenue for the six months ending August 31, 2003.



The sale of the stores has been accounted for as Discontinued
Operations in accordance with Statement of Financial Accounting Standards No. 144.



In May 2003, the Company sold two of its retail video stores to M.G. Midwest, Inc., an affiliate of Movie Gallery, Inc. (Movie Gallery), to
raise cash in order to satisfy the Companys immediate need for liquidity. The sales of the two stores was made pursuant to an Asset Purchace Agreement, dated as of May 12, 2003, by and between the Company and Movie Gallery. The two sold stores
were located in Salinas and San Francisco, California. The aggregate purchase price for the two sold stores consisted of cash in the amount of $900,000, and was determined as a result of arms-length negotiations between the Company and Movie
Gallery.



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In July 2003, the Company and Movie Gallery amended the May 2003 agreement for the sale of the two stores
located in Salinas and San Francisco California to modify the disposition of the amount of $350,000 held back by Movie Gallery pending the assignment of the San Francisco store lease. Pursuant to such amendment, Movie Gallery released $96,000 to the
Company to pay the rent payments owed to landlords for its video stores, and $54,000 was retained by Movie Gallery. The remaining $200,000 is held back by Movie Gallery and is to be released to the Company contingent upon the closing on or before
December 31, 2003 of the sale of the 12 California stores to Movie Gallery and obtaining the lease assignment for the San Francisco store that is satisfactory to Movie Gallery. In the event the sale of the 12 California stores to Movie Gallery does
not close on or before December 31, 2003, Movie Gallery shall retain $40,000 of the $200,000 held back and up to an additional $120,000 to the extent that Movie Gallery is required to pay VPD, Inc. for movie inventory that the Company has purchased
from VPD, Inc. The Company obtained an additional line of trade credit in the amount of $120,000 from VPD, Inc. which additional line of trade credit was guaranteed by Movie Gallery. The remaining amount held back will be either released to the
Company or retained by Movie Gallery depending on when the lease assignment for the San Francisco store is obtained. In the event the sale of the 12 California stores to Movie Gallery does not close on or before December 31, 2003 and either the
lease assignment for the San Francisco store is not obtained or Movie Gallery is not able to manage the San Francisco store, the Company will forfeit the amount held back and shall additionally pay Movie Gallery $95,000. In the event the sale of the
12 California stores to Movie Gallery closes on or before December 31, 2003, but the lease assignment for the San Francisco store is not obtained, five percent of the $200,000 held back will be released over time commencing in September 2004 for
each month that Movie Gallery was able to manage the San Francisco store.



In June 2003, the Companys Board of Directors unanimously approved the proposal, subject to stockholder approval, to sell substantially all of the assets of the Company. Pursuant to such proposal, the Company
entered into a definitive purchase agreement on June 20, 2003 with M.G. Midwest, Inc., an affiliate of Movie Gallery, Inc., for the sale of 12 of the 14 retail video stores which the Company currently owns and operates, for a purchase prices of
$3,250,000. Management also plans to sell or close the remaining 2 video stores.



In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the stores have been reported in the accompanying balance sheet as



13



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Assets Held for Sale and the results of operations of the 14 stores has been accounted for as Discontinued Operations in the
accompanying consolidated statements of operations.



The
statements of operations have been restated to show the net effect of the discontinuance of all the Companys stores sold and closed.



|                                                         |  | Three Months Ended July 31, |           |   | Three Months Ended July 31, |   | Six Months Ended July 31, |  |   | Six Months Ended July 31,
|-------------------------------------------------------- |  | --------------------------- | --------- | - | --------------------------- | - | ------------------------- |  | - | -------------------------
|                                                         |  | 2003                        |           |   | 2002                        |   | 2003                      |  |   | 2002                     
|REVENUES:                                                |  |                             |           |   |                             |   |                           |  |   |                          
|Rental revenues and product sales                        |  | $                           | 1,601,756 |   |                             | $ | 3,960,894                 |  | $ | 3,446,191                
|                                                         |  |                             |           |   |                             |   |                           |  |   |                          
|TOTAL REVENUES                                           |  |                             | 1,601,756 |   |                             |   | 3,960,894                 |  |   | 3,446,191                
|                                                         |  |                             |           |   |                             |   |                           |  |   |                          
|OPERATING COSTS AND EXPENSES:                            |  |                             |           |   |                             |   |                           |  |   |                          
|Store operating expenses                                 |  |                             | 994,906   |   |                             |   | 2,335,855                 |  |   | 2,076,382                
|Amortization of rental library                           |  |                             | 275,117   |   |                             |   | 1,003,035                 |  |   | 669,719                  
|Cost of product sales                                    |  |                             | 138,156   |   |                             |   | 507,646                   |  |   | 343,567                  
|Closed store expense                                     |  |                             | 93,073    |   |                             |   |                          |  |   | 181,955                  
|General and administrative expenses                      |  |                             | 209,663   |   |                             |   |                          |  |   | 209,663                  
|                                                         |  |                             |           |   |                             |   |                           |  |   |                          
|TOTAL OPERATING COSTS AND EXPENSES                       |  |                             | 1,710,915 |   |                             |   | 3,846,536                 |  |   | 3,481,286                
|                                                         |  |                             |           |   |                             |   |                           |  |   |                          
|Income (loss) from operations of discontinued operations |  |                             | (109,159  | ) |                             |   | 114,358                   |  |   | (35,095                  
|Gain on sale of assets                                   |  |                             | 472,096   |   |                             |   |                          |  |   | 472,096                  
|                                                         |  |                             |           |   |                             |   |                           |  |   |                          
|Net income (loss) from discontinued operations           |  | $                           | 362,937   |   |                             | $ | 114,358                   |  | $ | 437,001                  



No general corporate overhead and
interest expense has been allocated to these stores.



9. Assets held for
Sale



The following table represents a detailed listing of
the assets held for sale as of July 31, 2003.



|Customer receivables  |  | $ | 92,178 
|--------------------- |  | - | -------
|Merchandise inventory |  |   | 122,175



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|Rental library, net         |  |   | 914,060  
|--------------------------- |  | - | ---------
|Property and equipment, net |  |   | 184,220  
|Goodwill, net               |  |   | 864,368  
|Other assets                |  |   | 111,707  
|                            |  |   |          
|Total assets held for sale  |  | $ | 2,288,708



10. Equity Transactions



In May 2003, certain investors that previously invested
in the Companys private placement offering of its Series A Units exercised their warrants to purchase the Companys common stock. The investors had previously received warrants to purchase the Companys common stock at a purchase
price of $0.01 per share as part of the private placement offering. As a result of such investors exercise, the Company issued a total of 2,698,164 shares of its common stock. The aggregate exercise price in the amount of $26,982 received by
the Company was used for general working capital purposes.



On
May 28, 2003, the Company issued 240,000 shares of common stock to its three outside directors in lieu of cash compensation of $60,00 for director fees due for the year 2002.



The Company believes that the issuance of securities in each of the foregoing transactions were exempt from registration in
reliance on Section 4(2) of the Securities Act of 1933, as amended, as a transaction not involving a public offering.



In addition, on May 30, 2003, the Company issued 863,578 shares of the Companys common stock as a final distribution pursuant to the Companys
Plan of Reorganization in connection with the Companys prior bankruptcy proceedings. The issuance of such shares of common stock were exempt from registration under 11 U.S.C. Section 1145(a).



11. Recent Accounting Pronouncements



15



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In April 2003, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 149,
Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other
contracts and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement is effective for contracts entered into or modified after June 30, 2003. The adoption of this statement
is not expected to have a significant effect on the results of operations, financial condition or cash flows of the Company.



In May 2003, the Financial Accounting Standards Board (FASB) issued SFAS No. 150, Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities
and equity. SFAS No. 150 represents a significant change in practice in the accounting for a number of financial instruments, including mandatorily redeemable equity instruments. The adoption of this statement is not expected to have a significant
effect on the results of operations, financial condition or cash flows of the Company.



In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46), which requires variable interest entities to be consolidated by the primary
beneficiary of the entity if certain criteria are met. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003,
the provisions of FIN 46 will become effective for the Company during the third quarter of 2003. The adoption of FIN 46 is not expected to have a significant effect on the results of operations, financial condition or cash flows of the Company.



In November 2002, the Emerging Issues Task Force reached a consensus on EITF
No. 00-21, Revenue arrangements with Multiple Deliverables (EITF 00-21). EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to
use assets. The provisions of EITF 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15,



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2003. The adoption of EITF 00-21 is not expected to have a significant effect on the results of operations, financial condition or cash flows of the Company.



Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations



Special Note Regarding Forward Looking
Statements



This quarterly report contains forward-looking
statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, such as statements of the Companys plans, activities, expectations and intentions, that involve risks and
uncertainties that could cause actual results to differ materially from those discussed in such forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to: the Companys liquidity and
financial condition; the Companys liabilities and potential contingent liabilities of the Company; the ability to complete certain anticipated transactions including the satisfaction of certain contingencies necessary for such completion; the
ability to obtain assignments of store leases to be assumed by the acquirer; the approval of the sale by the Companys shareholders; availability of financing and capital resources; the performance and operations of the Companys retail
video stores; the demand for video tapes, both rental and sales, which may be affected by seasonal factors, weather, and the level of home viewing; competition from other retailers; the Companys ability to manage its operations and financial
obligations; and other factors discussed herein and in the Companys Amended Annual Report on Form 10-K/A for the fiscal year ended January 31, 2003.



Estimates and Critical Accounting Policies



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Estimates and Critical Accounting Policies Estimates and judgments made by Management are an integral
part of financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Actual results may be different from estimated amounts included in the financial statements.
Management believes that the following critical accounting policies address the significant estimates required of Management when preparing the consolidated financial statements in accordance with GAAP:



| |  |  | The amortization method of the Company records base stock (generally 3 copies per title for each store) at cost and amortizes a portion of these costs on an accelerated basis over
three months, generally to $8 per unit, with the remaining base stock cost amortized on a straight line basis over 33 months to an estimated $3 salvage value. The cost of non base stock (generally greater than 3 copies per title for each store) is
amortized on an accelerated basis over three months to an estimated $3 salvage value. Video games are amortized on an accelerated basis over a 12 month period to an estimated $10 salvage value.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Customer receivable balances represent extended viewing fees charged on rentals and are evaluated on a continual basis. Allowances are provided for potentially uncollectable
accounts based on managements estimate of the collectability of customer accounts. Allowance adjustments are charged to operations in the period in which the facts that give rise to the adjustments become known.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Goodwill represents the excess of the cost of the companies acquired over the fair value of their net assets at the dates of acquisition. Upon the adoption of Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, the Company tested its goodwill for impairment. Based on the fair market value of the reporting unit, no goodwill impairment adjustment was required. The
Company no longer records amortization of goodwill and performs an annual impairment test in the fourth quarter. Management also reviews each quarter for other factors that may indicate impairment.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On January 1, 2002, we adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which requires that the assets and liabilities and the
results of operations of any properties that have been sold since the adoption of SFAS No. 144, or otherwise qualify as held for sale as of July 31, 2003, be presented as discontinued operations in our consolidated financial statements in both
current and prior periods presented. The assets classified as held for sale is stated at the lower of its carrying amount or estimated fair value less disposal costs. Depreciation is not recorded on assets classified as held for sale.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | In accordance with SFAS No. 144, our assets, including fixed assets are carried at cost and are periodically evaluated for indicators of impairment. The evaluation of impairment and
the determination of values are based on several factors, and future events could occur which would cause management to conclude that indicators of impairment exist and a reduction in carrying value to estimated fair value is warranted.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We classify assets as held for sale when it is probable, in the opinion of management, that a property will be disposed of within one year.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------



Results of Operations



Three months and six months ended July 31, 2003 compared to the three months and six months ended July 31, 2002.



General and Administrative Expenses



General and administrative expenses for the three months and six months
ended July 31, 2003 totaled $565,000 and $1,029,000, respectively, compared to $533,000 and $1,129,000 for the three months and six months ended July 31, 2002. General and administrative expenses increased $32,000 or 6% and decreased $100,000 or 8%
for the three and six months ended July 31, 2003, respectively, as compared to the corresponding periods of the previous year. The increase in general and administrative expenses for the three months ended July 31, 2003 versus the prior year period
was primarily attributable to an increase in consulting expense and amortization expense, partially offset by a reduction in employee salaries and utilities expenses. The decrease in general and administrative expenses for the six months ended July
31, 2003 versus the prior year period was primarily attributable to the companys reduction in employee salaries, travel and entertainment expenses, insurance and professional fees.



Interest Expense



Interest expense for the three months and six months ended July 31, 2003 totaled $264,734 and $365,287, respectively, compared to $76,775 and $88,475 for
the three and six months ended July 31, 2002, respectively. Interest Expense increased $187,959 or 245% and $276,812 or 313%, respectively during such comparable periods.



19



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The increase in interest expense is primarily attributable to the interest paid by the company, related to the
convertible notes issued in connection with the private placement offering by the Company in on May 2002, which included 10% interest on the notes balance as well as the amortization of the discount attached to the warrants granted with the notes
and the beneficial conversion. In addition, the Company recorded additional interest in the three months ended July 31, 2003 related to the amortization of the discount of 37.5% from the face value of the $460,000 note entered into on June 23, 2003
between the Company and an unaffiliated accredited investor, and the 9% interest payable on that note.



Discontinued Operations



Net income (loss) from discontinued operations for the three and six months ended July 31, 2003 totaled $362,937 and $437,001 compared to $114,358 and $335,522 for the three and six months ended July 31, 2002, respectively. Income (loss)
from operations of discontinued operations represents the results of operations of the stores in operation for the periods presented. The weighted average number of stores in operation was fifteen and forty during the periods ended July 31, 2003 and
2002, respectively. In, addition, the Company recorded a gain on sale of assets of $470,096 for the three months and six months ended July 31, 2003, which represented the sale of two stores which were located in San Francisco and Salinas California.
General and administrative expenses represent direct expenses incurred related to the sale and disposition of the stores.



Extraordinary Gain



The Company reported an extraordinary gain of $536,011 and $536,011 for the three months and six months ended July 31, 2002. During the quarter ended July
31, 2002 the Company recorded an extraordinary gain relating to the withdrawal of priority tax claims from various taxing authorities. The Company had no extraordinary gain during the three or six months ended July 31, 2003.



Liquidity and Capital Resources



At July 31, 2003 the Company had a stockholders deficit, recurring
losses and negative working capital. These conditions raise substantial doubt about the ability of the Company to continue as a going concern. The consolidated financial statements do not include any adjustments that might result should the Company
be unable to continue as a going concern. In May 2003, the Company sold two of its retail video stores to M.G. Midwest, Inc., an affiliate of Movie Gallery, Inc. (Movie Gallery), to raise cash in order to satisfy the Companys
immediate need for liquidity. The Company has entered into a definitive agreement to sell 12 of its retail video stores, which constitute all of its remaining stores, except for two stores located in Ventura, California, to Movie Gallery. Such



20



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sale would be subject to a number of contingencies including, without limitation, Movie Gallerys satisfactory completion of financial and real estate
due diligence, successful assignment of store leases to be assumed by Movie Gallery, and the approval of the Companys shareholders. There can be no assurances that such a transaction with Movie Gallery will be completed.



The Company is also seeking to sell the two stores located in Ventura
California, depending on whether the Company is able to negotiate an attractive purchase price for such two stores from any purchaser.



The Company has received two indications of interest from third parties in entering into a transaction for the sale of these two stores; these potential
buyers are being actively pursued. Movie Gallery was not interested in purchasing the two Ventura, California stores because one operated at a loss and the other operated at a modest level of profit considered to be inadequate by Movie Gallery.
There can be no assurance that the Company will be able to sell such two stores, or that any such sales will be on terms and conditions that are satisfactory to the Company. The Company believes it is likely that a purchaser for the two stores will
be found. In the unlikely event the Company is unable to obtain a purchaser for the stores, the Company would do the following:



| | 1) |  | The 2723 E. Main Street Ventura store, which is currently trending at a $45,000 positive annual store cash flow would remain open until the current lease expires on June 30, 2004.
The remaining assets would then be sold upon expiration of the lease.
| | -- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2) |  | The 5944 Telegraph Road Ventura store, which is currently unprofitable would be closed immediately and the assets sold and the proceeds would be used to settle with the landlord on
the remaining lease liability. The store is located in a highly desirable shopping center location and the Company believes that the Company could sublease the location at its current rent or at a slight discount until the end of the lease term of
September 20, 2006.
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Company is currently
exploring all possibilities regarding future plans for its business in the event of the sale of substantially all of its assets. The Company is uncertain whether its business will continue to be in the retail video industry or in any specific
industry related to the retail video industry. In either case, the Company plans to reduce its work force and expenses to a minimum level in the event of such sale.



During the months of November and December of 2002, the Company closed four unprofitable retail stores located in
Bakersfield, California. The Company closed an additional unprofitable store in June 2003. The costs



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related to the closing during the last fiscal year are shown under store closure costs in the discontinued operations. The Company had 14 stores remaining in
the State of California as of July 31, 2003.



The Company funds
its short-term working capital needs, including the purchase of videocassettes, DVDs and other inventory, primarily through cash from operations. The Company expects that cash from operations will be insufficient to fund future videocassette, DVD
and other inventory purchases and other working capital needs for its existing stores. The Company sold two of its stores located in San Francisco and Salinas California in May 2003, for a total price of $900,000 to Movie Gallery. The proceeds from
the two stores were used to pay down a portion of the senior debt and the balance was used for working capital. As of the closing of such transaction, there was a balance of $350,000 that was being held back until satisfactory completion of the
lease assignment for the San Francisco store to Movie Gallery.



In July 2003, the Company and Movie Gallery amended the May 2003 agreement for the sale of the two stores located in Salinas and San Francisco California to modify the disposition of the amount of $350,000 held back by Movie Gallery pending
the assignment of the San Francisco store lease. Pursuant to such amendment, Movie Gallery released $96,000 to the Company to pay the rent payments owed to landlords for its video stores, and $54,000 was retained by Movie Gallery. The remaining
$200,000 is held back by Movie Gallery and is to be released to the Company contingent upon the closing on or before December 31, 2003 of the sale of the 12 California stores to Movie Gallery and obtaining the lease assignment for the San Francisco
store that is satisfactory to Movie Gallery. In the event the sale of the 12 California stores to Movie Gallery does not close on or before December 31, 2003, Movie Gallery shall retain $40,000 of the $200,000 held back and up to an additional
$120,000 to the extent that Movie Gallery is required to pay VPD, Inc. for movie inventory that the Company has purchased from VPD, Inc. The Company obtained an additional line of trade credit in the amount of $120,000 from VPD, Inc. which
additional line of trade credit was guaranteed by Movie Gallery. The remaining amount held back will be either released to the Company or retained by Movie Gallery depending on when the lease assignment for the San Francisco store is obtained. In
the event the sale of the 12 California stores to Movie Gallery does not close on or before December 31, 2003 and either the lease assignment for the San Francisco store is not obtained or Movie Gallery is not able to manage the San Francisco store,
the Company will forfeit the amount held back and shall additionally pay Movie Gallery $95,000. In the event the sale of the 12 California stores to Movie Gallery closes on



22



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or before December 31, 2003, but the lease assignment for the San Francisco store is not obtained, five percent of the $200,000 held back will be released
over time commencing in September 2004 for each month that Movie Gallery was able to manage the San Francisco store.



It is managements opinion that it is more likely than not that all conditions related to the San Francisco lease holdback will be met and the
Company will receive the entire $200,000 balance as per the agreement.



Videocassette and DVD rental inventories are accounted for as noncurrent assets under accounting principles generally accepted in the United States of America 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 and DVD rental inventories, however, is reported as a current liability until paid and, accordingly, included in the computation of working capital.



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 of the Companys video stores 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 the Companys video stores. VPD
provides all videocassettes, DVDs and accessories for rental and sale with the exception of Warner Brothers Home Video product in all of the Companys store locations. As part of this agreement, the Company is receiving a line of trade credit
and 90 day terms for repayment to VPD.



Effective in November
2002, with the sale of the 19 stores located outside of California to Movie Gallery, VPD modified its agreement with the Company by reducing the line of trade credit that it previously was operating with and reducing its terms for repayment from 90
days to 60 days. In July 2003, the Company obtained an



23



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additional line of trade credit in the amount of $120,000 from VPD, which additional line of trade credit was guaranteed by Movie Gallery.



In May 2002 the Company initiated a private placement offering to accredited
investors of the Companys Series A Units, with each unit consisting of a $10,000 10% Senior Subordinated Convertible Note due November 1, 2003 and a Series A Warrant to purchase 20,000 shares of common stock.. The Company offered a minimum of
50 units and a maximum of 100 units. As of July 2002 the Company closed the first round with 74 units sold. The aggregate principal amount of the convertible notes was $742,420 at an interest rate of 10% per annum. Principal on these convertible
notes shall be payable in one installment plus accrued but unpaid interest on November 1, 2003. Interest shall be payable semi-annually in arrears on the first day of November and May of each year, commencing November 1, 2002. The convertible notes
shall be convertible at the election of the payee to common stock of the Company at a conversion price of $1.00 per share. The market price of the stock and the relative fair value of the convertible notes in relation to the conversion price of
these convertible debentures created a beneficial conversion amount of $66,818, and is recorded as a note discount that is amortized over the life of the convertible notes.



In connection with issuance of the convertible notes, the Company issued one-year warrants to purchase 1,484,840 shares of
the Companys common stock at an exercise price of $0.01 per share. The Company recorded the fair value of the warrants issued of $400,907 using the Black-Scholes model, as a note discount and is being amortized over the life of the notes as
interest expense.



The Company sold an additional 14 Series A
Units for an aggregate amount of $140,000 and issued additional one-year warrants to purchase 280,000 shares of the Companys common stock at an exercise price of $0.01 per share during the quarter ended October 31, 2002.



In November 2002, in conjunction with the sale of the 19 stores to Movie
Gallery, the Company presented to holders of Series A units in the private placement an option to be paid in full on the balance of their Series A Units including interest due or to roll up to 65% of their investment back into the private placement.
In consideration the Company offered each Series A unit holder an additional warrant for each dollar rolled over into the private



24



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placement. The conditions and terms would remain the same as the initial terms of the private placement offering. The total principal of convertible notes
remaining outstanding after the completion of the rollover was $387,752.



The Company sold an additional 9 Series A Units for an aggregate amount of $93,500 and issued additional one-year warrants to purchase 187,000 shares of the Companys common stock at an exercise price of $0.01
per share during the fourth quarter ended January 31, 2003.



To
help improve the Companys working capital needs, the Company sold an additional 18 Series A Units for an aggregate amount of $185,000 and issued additional one-year warrants to purchase 370,000 shares of the Companys common stock at an
exercise price of $0.01 per share during February and March 2003. Of the six investors that invested in such units, five were unaffiliated accredited investors. One of the investors that invested $100,000 of the total $185,000 is a trust in which
the Companys board member, Robert Y. Lee, is the trustee. The total principal of senior subordinated convertible notes payable outstanding at April 30, 2003 was $666,252.



The Company sold an additional 2 Series A Units for an aggregate amount of $20,000 and issued additional one year warrants
to purchase 40,000 shares of the Companys common stock at an exercise price of $0.01 per share during the three months ended July 31, 2003. The total principal of convertible notes remaining outstanding as of July 31, 2003 was $553,002.



On June 23, 2003, the Company completed the issuance of a
Secured Promissory Note to an unaffiliated accredited investor in the principal amount of $460,000. The Secured Promissory Note was sold at a discount of 37.5 percent from the face value of such note due to the financial condition of, and perceived
risks of investing in, the Company. The Secured Promissory Note had an original maturity date of August 29, 2003 and bears interest at rate of nine percent per annum. The Secured Promissory Note is secured by the assets of the Company. After the
discount from face value and the commission payable to the Companys investment banking firm in connection with such financing, the Company received net proceeds in the amount of $258,150. The Company used such net proceeds to satisfy its
immediate need for liquidity and to pay the costs and expenses in connection with the proposed sale of its 12 stores. On August 28, 2003, the investor agreed to extend the maturity date of the Secured



25



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Promissory Note through October 16, 2003 in consideration for the Company agreeing to pay a late fee of $9,200 on such maturity date.



Although the Company has tried to raise additional funds, there has been very
little further interest by potential investors in the Companys private placement of its notes and warrants. In addition, the Company believes that lenders and large companies are increasingly reluctant to finance retail operations of the sort
conducted by the Company. In the past, the Company was able to use its stock, valued in the public market, as consideration in connection with its acquisition strategy. However, because of the very low market price of the Companys common stock
and the very low volume of trading since the Companys reorganization under Chapter 11 of the United States Bankruptcy Code, the Company believes that there will be limited prospects of raising additional capital or pursuing acquisitions though
the issuance of the Companys capital stock. Management and the Board believe that it will be extremely difficult for the Company to access any additional capital, or capital on terms and conditions that are satisfactory to the Company.



On June 20, 2003, the Company entered into an Asset Purchase
Agreement with Movie Gallery, for the sale of 12 video stores which constitute all of the Companys stores other than the two stores located in Ventura, California. The purchase price of cash in the aggregate amount of $3,250,000, was
determined as a result of arms length negotiations between the Company and Movie Gallery, and is payable to the Company at the closing of the sale. Such sale would be subject to a number of contingencies including, without limitation, the
approval of the Companys shareholders, Movie Gallerys satisfactory completion of financial and real estate due diligence, and the successful assignments of store leases to be assumed by Movie Gallery. There can be no assurances that such
a transaction with Movie Gallery will be completed.



The
Company closed an additional unprofitable store in June 2003. The Company is seeking to sell the two stores located in Ventura California, depending on whether the Company is able to negotiate an attractive purchase price for such two stores from
any purchaser.



In the event of the sale of substantially all
of the assets of the Company, the Company will receive the consideration for such sale and will have no operating revenue.



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The Company is currently exploring all possibilities regarding future plans for its business in the event
of the sale of substantially all of its assets. The Company is uncertain whether its business will continue to be in the retail video industry or in any specific industry related to the retail video industry. In any case, the Company plans to reduce
its work force and expenses to a minimum level in the event of such sale. The Company estimates such minimum level of expenses to be approximately $10,000 per month to maintain a small office with a part time employee to oversee the general
administration of the Company. The Company believes that part of the proceeds from the sale of its assets will be sufficient to sustain such minimum level of expenses.



The Company remains contingently liable for four of the store location operating leases that have been assigned to Movie
Gallery in connection with the sale of such four stores to Movie Gallery in November 2002. Unlike the other lease assignments entered into by the Company, the landlords did not agree to release the Company from any and all obligation or liability
under the operating leases accruing and/or attributable to the period on or after the effective date of the assignment. In the event Movie Gallery defaults on its obligations on the four operating leases, the Company may be liable to the landlord
for such obligations. The Company remains contingently liable in the total amount of approximately $559,400 as of July 31, 2003 for the four operating leases. Although there can be no assurances, the Company does not anticipate that it will be
contingently liable for store location leases to be assigned to Movie Gallery as part of the pending sale of the 12 stores because the proposed form of lease assignment being submitted to the landlords for the stores to be sold contain the release
provisions, releasing the Company from any and all obligation or liability under the operating leases. In the event the landlord refuses to release the Company, the Company will remain contingently liable for such operating leases.



Cash Flows



Six months Ended July 31, 2003 Compared to the Six months Ended July 31, 2002



Cash Used In Operating Activities



Net cash used in operating activities for the six months ended July 31,
2003, decreased by approximately $552,000 or 70%, compared to the six months ended July 31, 2002. This change was mainly attributable to an



27



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increase in net loss from continuing operations of $712,000 over the comparable prior year period, offset by an increase in accrued expenses and liabilities
subject to compromise, amortization of discount on senior subordinated notes payable and liabilities related to assets held for sale.



Cash Flow from Discontinued Operations



Cash flows from discontinued operations was $802,532 for the six months ended July 31, 2003 versus $485,282 for the six months ended July 31, 2002. These
figures represented the store cash flows based on the number of stores operating during the periods presented.



Cash Used in Investing Activities



Net cash used in investing activities during the six months ended July 31, 2003 was $951 compared to $0 for the six months ended July 31, 2002. The Company reduced all investing activity due to its cash shortage
position.



Cash Provided by Financing Activities



Net cash provided by in financing activities during the six months ended July 31, 2003,
increased by approximately $236,000 or 78%, compared to the six months ended July 31, 2002. The change was mainly attributable to the net receipt of the proceeds from the private placement and proceeds from notes payable.



Item 4. Controls and Procedures



Within 90 days prior to the filing date of this quarterly report, the
Company carried out an evaluation, under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation
of the Companys disclosure controls and procedures pursuant to the Exchange Act Rule 13a-14. Based upon that evaluation, the Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure
controls and procedures effectively ensure that material information required to be in this quarterly report is made known to them by others in a timely manner. The Company have not made any significant changes to its internal controls, and no other
factors have come to our attention that could significantly affect its internal controls, subsequent to the date of this most recent evaluation.



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PART II. OTHER INFORMATION



Item 1. Legal Proceedings



Colonial Shopping Center v. 32ndStreet Inc., Lee Video City, Inc, Video City, Inc. et alOn March 13, 2003, Colonial Shopping Center filed suit in Superior Court of California Kern County, against
the Company for damages from breach of the lease regarding the property at 2333 Brundage Lane, Bakersfield, California. Colonial is seeking damages of approximately $34,000 for unpaid rent, and an unknown amount from rent and other amounts,
including operating expenses from December 1, 2002 through March 31, 2007, less any sums plaintiff receives from re-letting the property. In August 2003, the court granted the application of Colonial Shopping Center for a right to attach order and
order for issuance of writ of attachment, allowing Colonial Shopping Center a right to attach property of the Company in the amount of $248,628.



Laurelglen-Bakersfield v. 32ndStreet Inc., Lee Video City, Inc, Video City, Inc. et alAlso on March 13, 2003, Laurelglen-Bakersfield filed suit against the Company in Superior Court of California
Kern County, alleging breach of a lease for the property at 6615 Ming Avenue, Bakersfield, California. Laurelglen is seeking damages of approximately $43,000 in unpaid rent, and an unknown amount of rent from December 1, 2002 through May 31, 2004,
less any sums plaintiff receives from re-letting the property. In August 2003, the court granted the application of Laurelglen-Bakersfield for a right to attach order and order for issuance of writ of attachment, allowing Laurelglen-Bakersfield a
right to attach property of the Company in the amount of $224,308.



Item 2. Changes in Securities and Use of Proceeds



Recent
Sales of Unregistered Securities



In May 2003, certain
investors that previously invested in the Companys private placement offering of its Series A Units exercised their warrants to purchase the Companys common stock. The investors had previously received warrants to purchase the
Companys common stock at a purchase price of $0.01 per share as part of the private placement offering. As a result of such investors exercise, the Company issued a total of 2,698,164 shares of its common stock. The aggregate exercise
price in the amount of $26,982 received by the Company was used for general working capital purposes.



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On May 28, 2003, the Company issued 240,000 shares of common stock to its three outside directors in lieu
of cash compensation for director fees due for the year 2002.



The Company believes that the issuance of securities in each of the foregoing transactions were exempt from registration in reliance on Section 4(2) of the Securities Act of 1933, as amended, as a transaction not involving a public
offering.



In addition, on May 30, 2003, the Company issued
863,578 shares of the Companys common stock as a final distribution pursuant to the Companys Plan of Reorganization in connection with the Companys prior bankruptcy proceedings. The issuance of such shares of common stock were
exempt from registration under 11 U.S.C. Section 1145(a).



Item 6. Exhibits
and Reports on Form 8-K.



|(a) |  | Exhibits
|--- |  | --------



|Exhibits |  | Description                                                                                                          
|-------- |  | ---------------------------------------------------------------------------------------------------------------------
|2.1      |  | Asset Purchase Agreement, dated as of May 12, 2003, by and between the Company and M.G. Midwest, Inc.(1)             
|         | 
|2.2      |  | Asset Purchase Agreement, dated as of June 20, 2003, by and between the Company and M.G. Midwest, Inc.(2)            
|         | 
|2.3      |  | Amendment to Asset Purchase Agreement, dated as of July 24, 2003, by and between the Company and M.G. Midwest,
Inc.  
|         | 
|10.1     |  | Amendment to Non-Compete Advisory Agreement, dated as of July 10, 2003, by and between the Company and Robert Y.
Lee.
|         | 
|10.2     |  | Amendment to Employment Agreement, dated as of July 10, 2003, by and between the Company and Timothy L.
Ford.        
|         | 
|10.3     |  | Amendment to Employment Agreement, dated as of July 10, 2003, by and between the Company and Rudolph R.
Patino.      
|         | 
|10.4     |  | Form of Secured Promissory Note for private placement investment.(2)                                                 



30



---

|     | 
|---- | 
|10.5 | 
|     | 
|31.1 | 
|     | 
|31.2 | 
|     | 
|32.1 | 
|     | 
|32.2 | 

---

|(1) |  | Previously filed as an exhibit to the Companys Current Report on Form 8-K dated May 14, 2003, and incorporated herein by reference.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Previously filed as an exhibit to the Companys Quarterly Report on Form 10-QSB for the quarter ended April 30, 2003, and incorporated herein by reference.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------



|(b) |  | Reports on Form 8-K
|--- |  | -------------------



On May 9, 2003, the Company filed an amendment to the current report on Form 8-K, dated November 6, 2002, to report under Item 7, certain financial
information in connection with the sale of 19 of its retail video stores to M.G. Midwest, Inc. in November 2002.



On June 11, 2003, the Company filed a current report on Form 8-K, dated May 14, 2003, to report under Item 2, Item 5 and Item 7, the disposition of two of
its retail video stores to M.G. Midwest, Inc. and the current status of certain matters.



31



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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)         
|                   |  |  | 
|September 19, 2003 |  |  |  |  |  | /s/ Timothy L. Ford  
|                   |  |  |  |  |  |                      
|                   |  |  | 
|September 19, 2003 |  |  |  |  |  | /s/ Rudolph R. Patino
|                   |  |  |  |  |  |                      



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