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Index to Financial Statements

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

For the fiscal year ended January 31, 2003

OR

For the transition period from              to             .

Commission File Number:    0-14023

VIDEO CITY, INC.

(Exact name of registrant as specified in its charter)

(661) 634-9171

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.01 par value per share

(Title of each class)

Securities registered pursuant to Section 12(b) of the Act:    None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)    YES  ¨    NO  x

The aggregate market value of the voting stock held by non-affiliates of the registrant (based on the closing sale price of such stock as reported on July 31, 2002 on the Pink Sheets) was approximately $1,978,366, assuming solely for purposes of this calculation that all directors and executive officers of the registrant and all stockholders beneficially owning more than 10% of the registrant’s common stock are “affiliates.” This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of May 31, 2003, 10,042,720 shares of the registrant’s Common Stock were outstanding.

Documents Incorporated by Reference:    NONE

Index to Financial Statements

Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995.

This Annual Report contains forward-looking statements within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, such as statements of the Company’s plans, 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 in this Annual Report.

PART I

General

Video City, Inc. (“Video City” or the “Company”) owns and operates video specialty stores located in the United States that rent and sell videocassettes, digital video discs (“DVDs”), and video games.

The Company’s predecessor, Lee Video City, Inc. (“Lee Video City”), was formed as a California corporation in February 1990 for the purpose of developing a chain of retail video specialty stores. In January 1997, Lee Video City, Inc. merged with and into Prism Entertainment Corporation, a publicly traded film company incorporated in Delaware in January 1984 (“Prism”), and the surviving Delaware corporation changed its name to “Video City, Inc.”

The Company’s principal executive offices are located at 4800 Easton Drive Suite 108, Bakersfield, California 93309 and its telephone number is (661) 634-9171. The Company does not have an Internet website, but can be reached at rudyp@videocity.com.

Recent Events

In November 2002, the Company completed the disposition of 19 of its 40 retail video stores to M.G. Midwest, Inc., a Delaware corporation and an affiliate of Movie Gallery, Inc. (“Movie Gallery”). The 19 Stores represented all stores owned by the Company outside of California and included 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 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. The remaining $50,000 is payable by September 10, 2003, and is contingent upon the level of gross revenues attained by one of the 19 Stores, located in Nampa, Idaho. The sale of the stores has been accounted

Index to Financial Statements

for as “Discontinued Operations”. The statements of operations for the last fiscal year have been stated to show the net effect of the discontinuance of the 19 stores sold.

In May 2003, the Company sold two of its retail video stores to Movie Gallery to raise cash in order to satisfy the Company’s immediate need for liquidity. The sale of the two stores were made pursuant to an Asset Purchase 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. Of the $900,000 purchase price, Movie Gallery has paid the Company $550,000 as of the date of this report. The remaining $350,000 is payable upon the Company obtaining a certain lease assignment satisfactory to Movie Gallery. Although the Company is exercising its best efforts to obtain such lease assignment, there can be no assurance that such lease assignment will be obtained.

During the months of November and December of 2002, the Company closed four unprofitable retail stores located in Bakersfield, California. The costs related to the closing during the last fiscal year are shown under store closure costs in the statements of operations. The Company had 17 stores remaining in the State of California as of the fiscal year ended January 31, 2003.

The Company has entered into a non-binding letter of intent 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 sale would be subject to a number of contingencies including, without limitation, the negotiation and execution of a definitive agreement for such transaction, Movie Gallery’s satisfactory completion of financial and real estate due diligence, successful assignment of store leases to be assumed by Movie Gallery, the approval of the Company’s shareholders, and the Company’s satisfaction of any other approvals and regulatory requirements. 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 may also 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 is currently exploring all possibilities regarding future plans for its business and continued existence 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.

PROCEEDINGS UNDER CHAPTER 11

On August 24, 2000, the Company and its subsidiaries filed voluntary petitions seeking reorganization under Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”) in the United States Bankruptcy Court of the Central District of California (the “Bankruptcy Court”). These petitions were jointly administered under Case Number LA00-34254TD, pursuant to Rule 1015b of the Federal Rules of Bankruptcy Procedure. The Company was in possession of its properties and assets and continued to operate with its existing directors and officers as debtors-in-possession. The Company was authorized to operate its business, but could not engage in transactions outside the normal course of business without approval, after notice and hearing, of the Bankruptcy Court.

Pursuant to the provisions of the Bankruptcy Code, as of the petition date actions to collect pre-petition indebtedness owed by the Company were stayed and other pre-petition contractual obligations could not be enforced against the Company. In addition, as debtors-in-possession, the Company had the right, subject to the Bankruptcy Court’s approval and certain other conditions, to assume or reject any pre-petition executory contracts and unexpired leases. Parties affected by these rejections could file claims with the Bankruptcy Court in accordance with the reorganization process. The Bankruptcy Court approved payment of certain pre-petition liabilities such as employee wages and benefits. Furthermore, the Bankruptcy Court allowed for the retention of legal and financial professionals.

The Company presented a plan of reorganization to the Bankruptcy Court on July 10, 2001 to reorganize the Company’s businesses and to restructure the Company’s obligations. On July 30, 2001 the Bankruptcy Court approved the company’s plan of reorganization with an effective date of August 29, 2001.

Index to Financial Statements

The holders of existing voting shares immediately before the confirmation received more than 50% of the total voting shares of the emerged entity and therefore did not adopt fresh-start reporting upon its emergence from Chapter 11. Liabilities compromised by the confirmed plan were stated at the present value of the amounts to be paid, and the forgiveness of debt has been reported as an extraordinary item.

Effective May 7, 2003, a hearing was held before the United States Bankruptcy Court in which an order was granted to approve The Company’s motion for a final decree and the closing of the Chapter 11 bankruptcy case.

Industry Overview

Home Entertainment Retail Industry. According to Adams Media Research (“Adams”), the domestic home video specialty retail industry grew from an estimated $15.3 billion in revenue in 1996 to $22.2 billion in 2002, representing a 6.4% compound annual growth rate, outpacing the 2.3% growth rate of the Consumer Price Index during the same period. Adams Media predicts that this industry will reach $30.1 billion in revenue by 2007, with growth driven primarily by the growth of DVD penetration. At the end of 2002, approximately 90% of all television households owned a videocassette recorder (“VCR”) and approximately 36% owned a DVD Player. According to Adams Media, the number of households owning DVD players is expected to increase from approximately 38.8 million at the end of 2002 to over 75 million by 2007.

According to the Video Software Dealers Association, DVD generated 53 percent of the total market revenue in 2002, or $10.9 billion. DVD retail sale’s of $8 billion in 2002 represented 65 percent of the total home video retail sales market. Meanwhile, in rental VidTrac showed DVD had a 35 percent share of the rental market in 2002, for some $2.9 billion in revenue, a leap of 106 percent from 2001.

As mentioned above, 90% of the U.S. households own at least one VCR or DVD Player, and, on average, rent videos at least a couple of times each month. We believe that the following factors, among others, make video and DVD rental a preferred medium of entertainment for millions of customers:

In addition, a significant competitive advantage that the video industry enjoys over most other movie distribution channels except theatrical release, is the early timing of distribution “window.” After the initial theatrical release, studios make their movies available for rental over to video and DVD stores for a specified period of time. This window is exclusive against most other forms of non-theatrical movie distribution, such as pay-per-view, premium television, basic cable and network and syndicated television.

The home entertainment industry is highly fragmented and continues to experience consolidation pressures. Trends toward consolidation have been fueled by the competitive impact of superstores on smaller retailers and the need for enhanced access to working capital and economies of scale. However, the home entertainment industry has experienced consolidation in recent years, as home entertainment store chains have gained significant market share from single store operators. We believe that small stores and smaller chains in the home entertainment industry will continue to consolidate with national and larger regional chains. We believe that there are several competitive advantages in being national or larger regional home entertainment chain, including access to working capital, economies of scale, marketing efficiencies, access to sophisticated information systems, and competitive pricing. Even if there is significant consolidation, however, we expect that the home entertainment industry will remain fragmented.

Movie Studio Dependence on Video Retailing. According to Paul Kagan, the home entertainment industry is the largest single source of domestic revenue to movie studios and independent suppliers of theatrical and direct-to-video movies. The Company believes that of the many movies produced by major studios and released in the United States each year, relatively few are profitable for the studios based on the box office revenue alone. The Company believes the consumer is more likely to view “non hit” movies on rented videocassette and DVD than in any other medium because retail home entertainment stores

Index to Financial Statements

provide an inviting opportunity to browse and make an impulse choice among a very broad selection of new releases. As a result, retail home entertainment stores, including those operated by the Company, purchase movies on videocassette and DVD regardless of whether the movies were successful at the box office, thus providing the major movie studios a reliable source of revenue for almost all of the hundreds of movies produced each year. Consequently, the Company believes movie studios are highly motivated to protect this unique and significant source of revenue.

Rentals versus Sales. Although the home entertainment retail industry includes both rentals and sales, the consumer market for prerecorded videocassettes and DVDs has been primarily comprised of rentals. By setting the wholesale prices, movie studios influence the relative levels of videocassette and DVD rentals versus sales. Videocassettes released at a relatively high price, typically $35 to $65 for video, are purchased by home entertainment specialty stores and are promoted primarily as rental titles. Videocassettes released at a relatively low price, typically less than $20 per copy (“sell-through titles”), are purchased by video specialty stores and are generally promoted as both rental and sale titles. DVDs are released and sold for both rental and sale at a relatively low price, typically $16 to $17. Home entertainment specialty stores utilize this format mainly for rental, with only a small percentage of DVDs used for sell-through. In general, movie studios attempt to maximize total revenue from videocassette and DVD releases by combining the release of most titles at a high price point to encourage purchase for the rental market, with the release of a relatively few major hits or animated children’s classics at sell-through pricing to encourage purchase directly by the consumer at retail. Home entertainment specialty stores will purchase sell-through titles for both the rental market and for retail sale. Titles released at a high price are re-released at a lower price six months to one year after the initial release to promote sales directly to consumers. According to Adams Media Research figures released, video and DVD rental revenue was approximately $9.0 billion in 2002.

Video Game Industry. According to industry reports, domestic sales of video software increased to approximately $6.0 billion in 2002 from approximately $4.6 billion in 2001. Domestic sales of video game hardware were estimated at $4.2 billion for 2002 versus $3.7 billion in 2001. These increases were primarily attributable to sales of Microsoft Xbox and Nintendo GAMECUBE hardware and software which were released in the fourth quarter of 2001, as well as continued sales of Sony PlayStation 2 hardware and software which were released in the fourth quarter of 2000.

Growth in this industry is driven by increases in the installed base of video game hardware systems, the introduction of new hardware platforms and continued improvement in systems technology leading to the development of new game titles. We expect the video game industry to continue to grow as a result of significant technological advancements in the last few years. These advancements allow for more flexibility and creativity in software development, as well as the introduction of hardware with the potential to offer capabilities beyond gaming, such as DVD and compact disc play and backward compatibility of game software.

Business Strategy

Superstore Format. The Company focuses on operating retail home entertainment superstores. The Company believes a superstore is the most commercially viable format for home entertainment stores at most locations. The broader selection of titles and greater availability of popular new releases of a superstore generate enough customer traffic to make it economically viable to lease optimal locations that may demand higher lease rates. Because many store operating expenses, including labor costs, are substantially fixed regardless of the size of a store, operating expenses are proportionately lower in the larger superstore format as compared to a smaller store.

Selection, Availability and Customer Service. The Company’s goal is to offer a more complete selection and greater availability of popular new releases in an effort to be the customers’ preferred store. The Company believes that certain of the Company’s promotional strategies such as the periodic guaranteeing of the availability of a popular new release at its stores have been successful in attracting and retaining its customers. The Company permits its customers in many markets to return a rental item to any of its other store locations and hence provides a convenience not available in other home entertainment store chains. In addition, the Company’s goal is to place greater emphasis on offering its customers excellent service to encourage repeat visits. The Company uses demographic and historical rental data to determine the selection and quantity of videos and DVDs that will best meet the demands of customers in particular regions or neighborhoods.

Index to Financial Statements

Centralized Real-Time Management. The majority of the stores’ point-of-sale systems are directly connected to the Company’s centralized management information systems which allows real-time communication and the ability for customers to rent at one location and return at another. In addition, the systems infrastructure allows close monitoring of sales and inventory, enabling the Company to actively manage its new videocassette and DVD purchases and monitor customer demand. The Company periodically redistributes its inventory of videocassettes and DVDs among its stores to fulfill customer demand without making excessive purchases of popular titles.

Store Location and Marketing. Most of the Company’s superstores are located in high traffic areas providing high visibility and easy access for its customers. The Company believes excellent customer service, a bright, clean and friendly shopping environment and convenient store locations are important to its success. The Company advertises through local television, radio, newspaper and direct mail, and promotes its products through various special programs.

Products

Videocassette and DVD Rental. The Company’s primary revenue source has been from the rental of videocassettes. DVDs are an alternative format to VHS tapes that offer consumers digital picture and sound and additional features such as enhanced content and interactivity. Each of the Company’s stores currently offers from 7,000 to 11,000 videocassettes and DVDs consisting of from 4,000 to 8,000 different titles. New release titles (titles within one year from release date) are displayed in the prominent “New Release” section and are organized alphabetically by title. Other titles are displayed alphabetically within categories such as “Action,” “Comedy” and “Drama.” The Company is committed to offering as many copies of new releases as necessary to be competitive within its markets. Promotional strategies that the Company believes have been highly successful include (i) the guarantee for a limited time of the availability of a popular new release, (ii) allowing customers to reserve certain titles up to one week in advance, and (iii) allowing customers to rent and return videocassettes and DVDs at any of the Company’s stores. DVDs have shown to be the fastest growing sell through and rental category introduced by the Company due to high consumer demand and the Company’s aggressive merchandising strategy to position the stores to satisfy consumer demand.

Videocassette and DVD Sales. The Company offers new and previously viewed videocassettes and DVD for sale. Previously viewed videocassettes and DVD are pulled from the shelves several weeks after the release date depending on customer demand and are sold to customers at a discount price.

Video Games. Each of the Company’s stores offers from 300 to 1,000 video game cartridges, consisting of 250 to 600 different titles. With the introduction of the Nintendo GameCube and the Microsoft Xbox in November 2001 and PlayStation 2 was released in the fourth quarter of 2000, early performance and consumer acceptance of these new platforms have been strong while the establised 32-bit and 64-bit platforms (Sony PlayStation and Nintendo 64) continue to maintain a solid market share. The Company anticipates growth of its video game business and broadening its selection of game cartridges to include successful new formats as they become available and grow in popularity.

Other Products. In addition to videocassette, DVD and Videogame rentals and sales, the Company also sells a variety of video accessories and confectionery items.

Store Operations and Locations

The 14 stores currently owned and operated by the Company are located at the following cities in the state of California:

The Company’s stores range in size from 3,560 square feet to 9,500 square

Index to Financial Statements

feet and offer between 7,000 to 11,000 videocassettes and DVDs consisting of from 4,000 to 8,000 different titles. The Company’s superstores feature television monitors showing movie previews and promotions of coming attractions and displays posters and stand-up displays promoting movie titles. The Company’s stores are open 365 days a year from 10:00 a.m. to 11:00 p.m.

The Company’s management has substantial experience in the home entertainment retail industry, including specific expertise in the various geographical areas in which the Company operates its stores. The Company’s management actively monitors the inventory, pricing and rental period of movie titles through its comprehensive management information systems. The new release inventory is actively managed, including the redistribution of certain copies to other stores to meet greater demand.

Supplier Agreements

In July 2001 the Company entered into an agreement with Video Products Distributors (“VPD”) under which VPD agreed to become the exclusive video distributor for all of Video City’s home entertainment retail chain. VPD will provide all videocassettes, DVDs and accessories for rental and sale with the exception of Warner Brothers Home Video product in all locations. As part of this agreement, Video City is receiving a line of trade credit and 90 day terms for repayment to VPD.

Effective in November 2002, with the sale of the 19 stores located outside of California to Movie Gallery, Video Products Distributors has modified their agreement with Video City 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 June of 2001, the Company also 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 the Company’s stores through a third party distributor.

Inventory Management and Management Information Systems

Inventory Management. The Company maintains an extensive inventory control system to assist management in decisions involving purchase, distribution and disposition of videocassettes, DVDs and game cartridges. Each videocassette, DVD and game cartridge is placed in a clear protective case which is affixed with a magnetic security device and an optical bar code. The Company conducts physical inventories on a quarterly basis. The inventory is redistributed among the various store locations based on demand at certain locations.

Management Information Systems. It is critically important in home entertainment retailing to have accurate and timely information relating to videocassette and DVD rentals and sales, individual title performance, customer demographics, shrinkage, overdue rentals and various other financial and operational data. Video City began development of a sophisticated management information system in early 1992 and fully implemented its system in all superstores by mid-1994. The Company has expended significant resources and time over the past decade to ensure a comprehensive management information system. Each superstore uses a point-of-sale system (“POS”) where all rental and sales transactions are recorded using scanned bar code information. The management information system electronically communicates real-time data from the POS system of most of the Company’s stores and makes the daily sales, inventory and other data immediately available to the Company’s management. The Company then uses the data to manage inventory and monitor customer demand and rental trends to maximize each store’s profitability. The data also provides individual customer and demographic information which is used for direct marketing to these customers, and is also used for audit and loss prevention purposes.

Most of the Company’s stores’ POS systems are linked on a real-time basis, enabling product and customer data to be shared. This sharing allows product to be rented from one store and returned to another while tracking the product through the system. The Company believes it is the only major chain of superstores that actively uses the real-time sharing so customers can rent and return at different locations, and has successfully promoted it to gain market share. The “linked” capability also allows stores to locate rental and sale items which may not be available at one location but are available at another location.

Index to Financial Statements

Marketing and Advertising

The Company has advertised through radio, newspaper and direct mail. Suppliers and movie studios provided advertising credits and market development funds for certain movie titles that the Company used to purchase the television, radio, and newspaper advertising. Although there can be no assurance, the Company believes that its suppliers and the movie studios will continue to provide funds for the Company’s advertising expenditures through advertising credits and market development funds. In addition, the Company benefited from the advertising and marketing by studios and theaters in connection with their efforts to promote specific videos and films. The Company’s advertising emphasizes signature attributes such as movie reservations, rent and return at any location, membership good at all locations, and guaranteed availability of certain key new releases. The Company believes that these promotional marketing strategies have helped increase market share and customer loyalty.

Competition

The home entertainment retail industry is highly competitive. The Company competes with other local, regional and national chains, such as Blockbuster Inc. and Hollywood Entertainment Corporation (“Hollywood Entertainment”), and with supermarkets, mass merchants, mail order companies and other retailers. Many of the Company’s competitors have significantly greater financial and marketing resources and name recognition.

The Company believes the principal competitive factors in the video retail industry are store location and visibility, title selection, the number of copies of popular titles available, customer service, and, to a lesser extent, pricing. Most of the Company’s stores compete directly with stores operated by Blockbuster and/or Hollywood Entertainment. As a result of direct competition with Blockbuster, Hollywood Entertainment and others, rental pricing of videocassettes and DVDs and greater availability of new releases may become a more significant competitive factor in the Company’s business, which could have an adverse impact on the results of operations of the Company.

The Company also competes with cable television, satellite and pay-per- view, in which subscribers pay a fee to see a movie selected by the subscriber. Existing pay-per-view services offer a limited number of channels and movies and are only available to households with a direct broadcast satellite or a cable converter to unscramble incoming signals. Recent technological developments could permit cable companies, direct broadcast satellite companies, telephone companies, and other telecommunications companies to transmit a much greater number of movies to homes at more frequently scheduled intervals throughout the day. Ultimately, these technologies could lead to the availability of movies to consumers on demand. Certain cable and other telecommunications companies have tested “video on demand” service in some markets. Video on demand service would allow a viewer to pause, rewind and fast forward movies. Based upon publicly available information, the Company believes these tests have been unsuccessful. The Company also believes movie studios have a strong interest in maintaining a viable movie rental business because the sale of videocassettes to video retail stores represents the studio’s largest source of revenue. As a result, the Company believes movie studios will continue to make movie titles available to cable television and other distribution channels only after the revenue has been derived from the sale of videocassettes to video stores. Substantial technological developments will be necessary in order for pay-per-view to match the low price, viewing convenience and selection available through video rental.

Seasonality

The video retail industry generally experiences relative revenue declines in April and May, due in part to the change to Daylight Savings Time and improved weather, and in September and October, due in part to the start of school and introduction of new television programs. The Company believes these seasonality trends will continue.

Service Marks

The Company owns a United States federal registration for its service mark

Index to Financial Statements

“Video City.” The Company considers its service mark to be important to its continued success.

Employees

As of May 31, 2003 the Company had approximately 132 employees of whom approximately 124 were located at the retail stores and the remainder were at the Company’s corporate administrative office. The Company is not currently a party to any collective bargaining agreements. The Company believes that its relationships with its employees are generally good.

The 14 stores currently owned and operated by the Company are located at the following cities in the state of California:

The Company’s stores range in size from 3,560 square feet to 9,500 square feet. All of the Company’s stores are leased pursuant to leases with initial terms ranging from three to ten years, with varying option renewal periods. Most of the leases are “triple net” requiring the Company to pay all taxes, insurance, and common area maintenance expenses associated with the properties.

The corporate office facility consists of approximately 4,692 square feet of leased office space. The Company considers its corporate offices and stores to be generally suitable and adequate for their intended purposes.

Effective May 7, 2003, a hearing was held before the Bankruptcy Court for the Central District of California in which an order was granted to approve the Company’s motion for a final decree and the closing of the Chapter 11 bankruptcy case.

The Company is involved in litigation from time to time, in the ordinary course of business, in connection with its closure of unprofitable video stores. As of May 31, 2003, the Company is a party to three lawsuits pending in civil courts located in Bakersfield California in connection with the Company’s closure of three stores located at Bakersfield, California. The Company is being sued by landlords regarding three retail store leases, the outcome which can not be readily determined. The Company intends to vigorously defend these claims.

The Company submitted no matters to a vote of stockholders during the the fiscal year ended January 31, 2003.

PART II

The Company’s Common Stock trades on the NASD Electronic Bulletin Board under the symbol “VDCY”. The following sets forth for the periods indicated, the high and low sales prices of the Company’s Common Stock as reported on the NASD Electronic Bulletin Board:

Index to Financial Statements

The figures for the first three quarters of fiscal year 2002 are actual reported market prices for the more than 16 million shares that were outstanding prior to completion of the Chapter 11 Plan of Reorganization and the issuance of the new shares of the reorganized debtor.

Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.

As of May 31, 2003, there were approximately 649 record holders of the Company’s Common Stock.

The Company has not paid cash dividends on its Common Stock since its inception and has no current plans to pay cash dividends on its Common Stock in the foreseeable future. The Company intends to reinvest future earnings, if any, in the operation of its business. Any future determination to pay cash dividends will depend upon the Company’s combined results of operations, financial condition and capital requirements and such other factors deemed relevant by the Company’s Board of Directors.

On July 30, 2001, the Bankruptcy Court entered an Order confirming Video City’s First Amended Chapter 11 Plan of Reorganization (the “Plan”). The Plan became effective on August 29, 2001. Pursuant to the Plan, the existing common shareholders of Video City are to receive 700,000 shares of common stock of Reorganized Video City in cancellation of all shares of common stock outstanding prior to such distribution, for pro rata distribution; 700,000 shares of common stock are to be issued to preferred shareholders in cancellation of all shares of preferred stock outstanding prior to such distribution; and 5,600,000 shares are to be issued to Video City’s creditors. Substantially all liabilities subject to compromise will receive, in full satisfaction of their claims, shares of common stock of Video City based on the Plan of Reorganization. In addition, certain liabilities subject to compromise consist of tax obligations of approximately $1.3 million that are to be paid in cash over five years from date of assessment.

As of May 31, 2003, the Company has issued approximately 6,136,000 shares of common stock of the Reorganized Video City. The balance of approximately 864,000 shares have been issued.

Recent Sales of Unregistered Securities

On November 8, 2002, the Company sold thirteen Series A Units for an aggregate amount of $13,000 to an individual in exchange for forgiveness of debt on commissions owed, which included the issuance of $13,000 10% Senior Subordinated Convertible Notes due

Index to Financial Statements

November 1, 2003, and warrants to purchase 26,000 shares of common stock at an exercise price of $0.01 per share to November 1, 2003. The warrants hold registration rights for the underlying shares of the Company’s common stock.

On November 19, 2002, the Company sold thirty Series A Units for an aggregate amount of $30,000 to an individual in exchange for full settlement of a lease liability on a closed store, which included the issuance of $30,000 10% Senior Subordinated Convertible Notes due November 1, 2003, and warrants to purchase 60,000 shares of common stock at an exercise price of $0.01 per share to November 1, 2003. The warrants hold registration rights for the underlying shares of the Company’s common stock.

On January 29, 2003, the Company sold fifty Series A Units for an aggregate amount of $50,000 to an individual in exchange for full settlement of a lease liability on a closed store, which included the issuance of $50,000 10% Senior Subordinated Convertible Notes due November 1, 2003, and warrants to purchase 100,000 shares of common stock at an exercise price of $0.01 per share to November 1, 2003. The warrants hold registration rights for the underlying shares of the Company’s common stock.

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 2,638,164 shares of its common stock. The aggregate exercise price in the amount of $26,381.64 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 it’s 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.

The following selected historical financial data for the years ended January 31, 2003, 2002, 2001, 2000 and 1999, have been derived from the financial statements. The information set forth below should be read in conjunction with the “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and the Company’s financial statements and notes thereto.

Index to Financial Statements

The following discussion should be read in conjunction with the Company’s financial statements and the related notes thereto and the other financial information included elsewhere in this Annual Report. When used in the following discussions, the words “believes”, “anticipates”, “intends”, “expects” and similar expressions are intended to identify forward-looking statements. Such statements are subject to certain risks and uncertainties, which could cause actual results to differ materially from those projected. Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our amortization of inventory and valuation of customer receivables. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ materially from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements:

Overview

General Business. The Company’s revenue consists primarily of rental revenue and product sales revenue. Rental revenue includes revenue from rentals of videos, DVDs, video games, players and game machines and extended viewing fees. Product sales revenue are derived from sales of new and used videocassettes and DVDs, including excess rental inventory, concessions and accessory items.