10QSB 1 video-10qsb013104.txt VIDEO 10QSB 013104 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-QSB (Mark One) [X] Quarterly Report Under Section 13 or 15(d) of The Securities Exchange Act of 1934 For the Quarterly Period ended January 31, 2004 [ ] Transition Report Under Section 13 or 15(d) of the Exchange Act Commission File Number 33-2310-D VIDEOLOCITY INTERNATIONAL, INC. ----------------------------------------------------------------- (Exact name of small business issuer as specified in its charter) Nevada 87-0429154 ------------------------------- ----------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1762-A Prospector Avenue, Park City, Utah 84060 ----------------------------------------------- (Address of principal executive officers) Issuer's telephone number: (435) 615-8338 Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 [ ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuers classes of common equity, as of the latest practicable date: Class Outstanding as of March 31, 2004 -------------------------- ------------------------------------ Common Stock, 10,359,881 Par Value $0.001 par value Transitional Small Business Disclosure Format (check one): Yes [ ] No [X]
VIDEOLOCITY INTERNATIONAL, INC. TABLE OF CONTENTS Page ----- PART I Item 1. Financial Statements.............................................................. 2 Item 2. Management's Discussion and Analysis or Plan of Operation.........................16 Item 3. Controls and Procedures...........................................................19 PART II Item 1. Legal Proceedings.................................................................20 Item 2. Changes in Securities and Use of Proceeds.........................................20 Item 3. Defaults Upon Senior Securities...................................................20 Item 4. Submissions of Matters to a Vote of Security Holders..............................21 Item 5. Other Information.................................................................21 Item 6. Exhibits and Reports on Form 8-K..................................................21 Signatures........................................................................22
Videolocity International Inc. and Subsidiaries ----------------------------------------------- (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEET January 31, 2004 ASSETS CURRENT ASSETS Cash $ 19,117 Accounts receivable, net of allowance for bad debts of $590,000 10,000 Other assets-advance deposits 107,441 ----------- Total current assets 136,558 PROPERTY AND Equipment, at cost, net 58,471 ----------- $ 195,029 =========== LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES Accounts payable $ 263,395 Accrued liabilities 447,297 Accrued interest payable 431,797 Notes payable - related parties 260,000 Notes payable 2,559,800 ----------- Total current liabilities 3,962,289 MINORITY INTERESTS 4,866 COMMITMENTS AND CONTINGENCIES -- STOCKHOLDERS' DEFICIT Common stock, $0.001 par value; 50,000,000 shares authorized, 7,082,196 issued and outstanding $ 7,082 Preferred stock, $0.001 par value; 1,000,000 shares authorized none outstanding -- Additional paid-in capital 4,188,025 Deficit accumulated during the development stage (7,967,233) ----------- Total stockholders' deficit (3,772,126) ----------- $ 195,029 =========== The accompanying notes are an integral part of these statements. 2
Videolocity International Inc. and Subsidiaries (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS Cumulative From May 26 Three Three 2000(inception) m months ended months ended Through January 31, January 31, January 31, 2004 2003 2004 ----------- ----------- -------------- Revenue $ -- $ -- $ -- ----------- ----------- -----------
Operating expenses
Salaries, payroll taxes and employee benefits 270,962 191,317 2,971,147 Professional fees and consultants 4,848 120,144 1,068,968 Directors compensation through stock incentive plan -- -- 95,000 Rent 16,000 13,000 224,305 Other 2,076 35,117 489,878 Technology development consulting 23,343 -- 398,817 Bad debts -- 149,000 590,000 Write off of goodwill -- -- 958,628 Utilities 2,443 10,608 71,720 Travel and conventions 835 10,404 166,844 Gain on transfer of license agreement -- -- (114,509) Depreciation and amortization 6,324 6,163 125,028 ----------- ----------- ----------- Total operating expenses 326,831 535,753 7,045,826 ----------- ----------- ----------- Operating loss (326,831) (535,753) (7,045,826) Interest and beneficial conversion (55,301) (170,652) (1,260,168) Gain on sale of investment stock, net -- -- 338,049 Interest income -- -- 5,578 Minority interests -- -- (4,866) ----------- ----------- ----------- Loss before income taxes (382,132) (706,405) (7,967,233) Income taxes -- -- -- ----------- ----------- ----------- NET LOSS $ (382,132) $ (706,405) $(7,967,233) =========== =========== =========== Loss per common share Basic and Diluted $ (0.06) $ (0.12) Weighted-average shares outstanding Basic and Diluted 6,371,785 5,908,822
The accompanying notes are an integral part of these statements 3
Videolocity International Inc. and Subsidiaries ----------------------------------------------- (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT For the period May 26, 2000 (inception) through October 31, 2000, the years ended October 31, 2001, 2002 and 2003 and for the three months ended January 31, 2004 Deficit Accumulated Preferred stock Common stock Additional during the -------------------------- -------------------------- paid-in Development Shares Amount Shares Amount capital Stage ----------- ----------- ----------- ----------- ----------- ----------- Balance at May 26, 2000 (inception) -- $ -- -- $ -- $ -- $ -- Issuance of common stock -- -- 640,610 641 85,685 -- Net loss for the period -- -- -- -- -- (129,778) ----------- ----------- ----------- ----------- ----------- ----------- Balance at October 31, 2000 -- -- 640,610 641 85,685 (129,778) Issuance of Series A preferred stock 950,000 950 -- -- 949,050 -- Issuance of common stock for acquisition of Videolocity, Inc. -- -- 3,028,076 3,028 386,092 -- Provision for redemption value of preferred stock -- -- -- -- (3,957,380) -- Issuance of common stock for: Services -- -- 20,000 20 19,980 -- Cash -- -- 610,000 610 499,390 -- Stock incentive plans -- -- 5,000 5 4,995 -- Bonus interest and extensions of debt -- -- 15,000 15 74,985 -- Net loss for the year -- -- -- -- -- (2,379,623) ----------- ----------- ----------- ----------- ----------- ----------- Balance at October 31, 2001 950,000 950 4,318,686 4,319 (1,937,203) (2,509,401) Redemption and cancellation of preferred (950,000) (950) 180,000 180 3,957,380 -- stock Cancellation of common stock -- -- (50,000) (50) 50 -- Interest expense recognized on beneficial conversion feature on notes payable -- -- -- -- 303,900 -- Issuance of common stock for: Bonus interest and extensions on debt -- -- 148,500 149 132,493 -- Conversion of debt -- -- 355,000 355 354,645 -- Services -- -- 419,871 419 444,453 -- Stock incentive plans -- -- 504,539 505 453,637 -- Net loss for the year -- -- -- -- -- (3,086,210) ----------- ----------- ----------- ----------- ----------- -----------
(continued) 4
Videolocity International Inc. and Subsidiaries ----------------------------------------------- (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT For the period May 26, 2000 (inception) through October 31, 2000, the years ended October 31, 2001,2002 and 2003 and for the three months ended January 31, 2004 Deficit Accumulated Preferred stock Common stock Additional during the --------------------- -------------------------- paid-in Development Shares Amount Shares Amount capital Stage --------- --------- ----------- ----------- ----------- ----------- Balance at October 31, 2002 -- -- 5,876,596 5,877 3,709,355 (5,595,611) Issuance of common stock for: Bonus interest and extensions on debt -- -- 335,000 335 82,914 -- Services -- -- 16,000 16 944 -- Stock incentive plans -- -- 119,400 119 169,847 -- Interest expense recognized on beneficial conversion feature on -- -- -- -- 120,000 -- notes payable Net loss for the period -- -- -- -- -- (1,989,490) --------- --------- ----------- ----------- ----------- ----------- Balance at October 31, 2003 $ -- $ -- 6,346,996 $ 6,347 $ 4,083,060 $ 7,585,101) Balance at October 31, 2003 $ -- $ -- 6,346,996 $ 6,347 $ 4,083,060 $(7,585,101) Issuance of common stock for: Stock incentive plans -- -- 735,200 735 104,965 -- Net loss for the period -- -- -- -- -- (382,132) --------- --------- ----------- ----------- ----------- ----------- Balance at January 31, 2004 $ -- $ -- 7,082,196 $ 7,082 $ 4,188,025 $(7,967,233) ========= ========= =========== =========== =========== ===========
The accompanying notes are an integral part of this statement. 5
Videolocity International Inc. and Subsidiaries ----------------------------------------------- (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS From For the three months ended May 26, 2000 January 31, (inception) ------------------------- Through 2004 2003 July 31, 2004 ----------- ----------- ----------- Increase (decrease) in cash Cash flows from operating activities Net loss $ (382,132) $ (706,405) $(7,967,233) Adjustments to reconcile net loss to net cash used in operating activities Minority interests -- -- 4,866 Provision for bad debts -- 149,000 590,000 Write off of goodwill -- -- 958,628 Gain on sale of investment stock -- -- (338,049) Gain on transfer of license -- -- (114,509) Depreciation and amortization 6,324 6,163 125,033 Interest expense recognized on beneficial conversion -- 120,000 423,900 Issuance of common stock under stock plans 105,700 11,614 734,808 Issuance of common stock for services -- -- 465,832 Issuance of common stock for interest -- 8,400 290,891 Changes in assets and liabilities Other assets (3,222) (14,452) (107,441) Accounts payable and accrued liabilities 206,760 (9,996) 710,692 Accrued interest 55,302 41,002 431,797 ----------- ----------- ----------- Total adjustments 370,864 311,731 4,176,448 ----------- ----------- ----------- Net cash used in operating activities (11,268) (394,674) (3,790,785) ----------- ----------- ----------- Net cash flows from investing activities - Investment stock and licenses, net -- -- 555,791 Increase in notes receivable -- -- (600,000) Purchase of property and equipment -- (1,931) (119,995) ----------- ----------- ----------- Net cash flows used in investing activities -- (1,931) (164,204) ----------- ----------- ----------- Cash flows from financing activities Increase in notes payable 20,000 400,000 3,174,800 Proceeds from issuance of common stock -- -- 799,306 ----------- ----------- ----------- Net cash provided by financing activities 20,000 400,000 3,974,106 ----------- ----------- ----------- Net increase in cash 8,732 3,395 19,117 Cash at beginning of period 10,385 31,297 -- ----------- ----------- ----------- Cash at end of period $ 19,117 $ 34,692 $ 19,117 =========== =========== ===========
The accompanying notes are an integral part of these statements 6
Videolocity International Inc. and Subsidiaries ----------------------------------------------- (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS From For the three months ended May 26, 2000 January 31, (inception) ------------------------- Through 2004 2003 July 31, 2004 ----------- ----------- ----------- Supplemental disclosures of cash flow information Cash paid during the period for Interest $ -- $ -- $ -- Income taxes -- -- --
The accompanying notes are an integral part of these statements 7 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE A - ACCOUNTING POLICIES The information for Videolocity International Inc. as of January 31, 2004 and for the three months ended January 31, 2004 and 2003 is unaudited, but includes all adjustments (consisting only of normal recurring adjustments) which in the opinion of management, are necessary to state fairly the financial information set forth therein in accordance with accounting principles generally accepted in the United States of America. NOTE B - UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited condensed consolidated financial statements have been prepared by the Company in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-QSB and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared under accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such regulations. This report on Form 10-QSB for the three months ended January 31, 2004 should be read in conjunction with the Company's annual report on Form 10-KSB for the fiscal year ended October 31, 2003. The results of operations for the three months ended January 31, 2004 may not be indicative of the results that may be expected for the year ending October 31, 2004. NOTE C - ORGANIZATION AND BUSINESS ACTIVITY We are a Nevada corporation organized on November 5, 1985 under the name Pine View Technologies. On November 27, 2000 the Company's name was changed to Videolocity International Inc. On December 4, 2000, the Company acquired Videolocity Inc. in a transaction recorded as a recapitalization with the Company being the legal survivor and Videolocity Inc. being the accounting survivor and the operating entity. Videolocity Inc., the accounting survivor, was founded on May 26, 2000. The Company and its subsidiaries were established to develop and market systems and other products for the delivery of on demand video, high speed internet access, and other digital content to end users such as hotels, hospitals, and condominiums. At January 31, 2004, the Company was considered a development stage company as its activities had principally been related to market analysis, capital raising, development and other business planning activities and as such the Company had no revenue from its planned principal operations. On December 1, 2000, the Company completed a reverse stock split of our issued and outstanding shares on a 0.61 share for one share basis. On March 1, 2002 the Company completed a reverse common stock split of one share for ten outstanding shares. This report has been completed showing after stock split shares from inception. NOTE D - PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts and operations of the Company and its wholly owned subsidiaries, Videolocity Inc., Videolocity Technologies Inc., Hospitality Concierge Inc., Videolocity Direct Inc., Fifth Digit Technologies LLC and the Company's 94 percent owned subsidiary Healthcare Concierge Inc. All material intercompany accounts and transactions have been eliminated in consolidation. 8 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE E - NET EARNINGS (LOSS) PER SHARE Basic Earnings (Loss) Per Share (EPS) are calculated by dividing net earnings (loss) available to common shareholders by the weighted-average number of common shares outstanding during each period. Diluted EPS are similarly calculated, except that the weighted-average number of common shares outstanding includes common shares that may be issued subject to existing rights with dilutive potential. All common shares with dilutive potential described in Notes H and I are not included in the computation of diluted loss per share for periods of net loss because to do so would be anti-dilutive. NOTE F - INCOME TAXES The Company has sustained net operating losses in all periods presented. There were no deferred tax assets or income tax benefits recorded in the financial statements for net deductible temporary differences or net operating loss carryforwards because the likelihood of realization of the related tax benefits cannot be established. Accordingly, a valuation allowance has been recorded to reduce the net deferred tax asset to zero. The increase in the valuation allowance was approximately $130,000 for the Quarter ended January 31, 2004. As of July 31, 2003, the Company had net operating loss carryforwards for tax reporting purposes of approximately $7,020,000 expiring through 2024. NOTE G - NOTE RECEIVABLE The Company has a $600,000 non-interest bearing note receivable that was due on or before February 28, 2002. The Company holds 1,000,000 shares of Merit Studios, Inc. common stock as collateral valued at $15,000 at January 31, 2004. As of January 31, 2004, the Company has recorded an allowance for bad debt totaling $590,000 against the note receivable. The Company started a legal action against Merit Studios, Inc. toward collection of the note receivable. On May 29, 2003, the Company was awarded a summary judgment against Merit Studios, Inc. totaling approximately $673,000 plus reasonable costs and attorneys fees to collect. (Note J) NOTE H - NOTES PAYABLE The Company originated approximately $20,000 in convertible non-interest bearing notes payable during the three months ended January 31, 2004. The $20,000 is convertible at $0.10 which was the fair market value at the date of origination. At January 31, 2004, the Company has notes payable totaling $2,819,800 due to various individuals and companies including $260,000 to current related parties including Board of Directors and Management. Of the total, $1,849,800 is written at 8 percent simple interest and $970,000 has no stated interest rate. Interest has been imputed from the date of issuance on all non-interest bearing notes payable. Of the total notes payable $1,097,800 is convertible at the option of the debt holder at the following amounts: $177,800 is convertible at $1.00 per share, $100,000 is convertible at $0.25 per share, $65,000 is convertible at $0.22 per share, $675,000 is convertible at $0.20 per share, $60,000 is convertible at $0.15 per share, and $20,000 is convertible at $0.10 per share. The notes payable have maturities or have been extended as follows: $20,000 matured during October 2002, $435,000 matured during November 2002, $30,000 matured during January 2003, $100,000 matured during July 2003, $1,264,800 matured during August 2003, $75,000 matured during November 2003, $75,000 matures during April 2004, $175,000 matures during June 2005, $375,000 is callable on demand when the Company has secured five million in new debt or equity funding and $270,000 has no set maturity and is payable until paid in full (Note O). 9 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS The Company has granted options to purchase Company stock under certain of the notes originated during 2003 in the following amounts: 20,000 shares at $0.50, 100,000 shares at $0.25, 302,000 shares at $0.20, and 40,000 shares at $0.15. All options granted in conjunction with new notes payable were granted at or above fair market value on the date the notes payable were originated. On April 30, 2002 the Company filed a UCC-1 financing statement, with the state of Nevada, on six Provisional Patent applications held in the name of Videolocity Technologies, Inc. in favor of certain promissory note holders totaling $1,500,000 including $235,000 to current related parties. The notes payable under the UCC-1 have maturities or have been extended under the UCC-1 as follows: $20,000 matured during October 2002, $435,000 matured during November 2002, $30,000 matured during January 2003 and $1,015,000 matured during August 2003. (Note O) On February 6th, 2003 the Company received a formal notice of default from ISOZ, LC regarding the $215,000 in notes payable to ISOZ, LC. NOTE I - STOCK INCENTIVE PLANS On October 1, 2000 the Company established a stock incentive plan to attract and retain qualified people to serve as key employees. Awards made under the plan shall be in plan units and each unit can be convertible, at the option of the participant, into one share of the Company's common stock after the vesting requirement has been satisfied. The Company reserved 1,000,000 common shares that can be issued under the plan. As of January 31, 2004, the Company has 980,784 plan units that have been awarded under the plan. Of the total awarded, 896,284 plan units have met the vesting requirement and have been converted to common stock and 84,500 plan units are subject to additional vesting requirements. During the three months ended January 31, 2004 the Company issued 735,200 shares of common stock in exchange for vested plan units resulting in compensation expense of approximately $104,965. On March 26, 2002 the Company filed an additional stock option and stock award plan, which had been approved by the shareholders of Pine View Technologies in November 2001. The purpose of the plan is to enable the Company to attract and retain qualified persons to serve as officers, directors, key employees and consultants of the Company, and to align the financial interests of these persons with those of its shareholders by providing those officers, directors, key employees and consultants with a proprietary interest in the Company's performance and progress through the award of stock options, appreciation rights or stock awards from time to time. The plan shall remain in effect for a period of five years or until amended or terminated by action of the Board. The termination of the Plan shall not affect any outstanding awards made under the Plan. The maximum number of shares of Common Stock, which may be issued pursuant to the Plan is 500,000. The Board of Directors approved 30,000 shares for issuance to consultants of the Company under the plan during the three months ended January 31, 2004 but to date have not issued the shares. The Company has issued a total of 467,855 shares under the Plan. Additionally, during December 2003, as an incentive and to retain current key individuals, the Board of Directors approved a total of 9,200,000 options to purchase stock outside of the plans to employees and directors that vest at various times through FY 2004. The options were issued pursuant to the Restated Articles of Incorporation approved by a majority of the stockholders on November 15, 2000. The Restated Articles of Incorporation authorizes the Board of Directors to issue, from time to time, without any vote or other action by the stockholders, of any or all shares of the Corporation of any class at any time authorized, and any securities convertible into or exchangeable for such shares, 10 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE I - STOCK INCENTIVE PLANS (continued) in each case to such persons and for such consideration and on such terms as the Board of Directors from time to time in its discretion lawfully may determine, provided that the consideration for the issuance of shares of stock of the corporation having par value shall not be less than such par value. Stock-based compensation costs- SFAS No. 123, "Accounting for Stock-Based Compensation," establishes accounting and reporting standards for stock-based employee compensation plans. As permitted by SFAS No. 123, the Company accounts for such arrangements under Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. Accordingly, no compensation expense is recognized for stock option grants because the exercise price of the stock options equals the market price of the underlying stock on the date of grant for employees and directors. SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure," requires disclosure in interim statements of the proforma effect on net income (loss) and earnings (loss) per share as if the Company had applied the fair value recognition provision of SFAS No. 123 to stock-based compensation. This disclosure is presented in the accompanying table.
Three months Three months ended ended January 31, January 31, 2004 2003 ------------- ------------ Net earnings (loss): As reported $( 382,132) $( 706,405) Proforma $( 477,293) $( 706,405) Basic earnings (loss) per share: As reported $(0.06) $(0.12) Pro forma $(0.08) $(0.12) Diluted earnings (loss) per share: As reported $(0.06) $(0.12) Pro forma $(0.08) $(0.12)
For purposes of pro forma disclosures, the estimated fair value of the stock option is amortized to expense over the option's vesting period. The weighted-average fair value of stock options granted was $0.13 for the three months ended January 31, 2004. The fair value of these stock options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions: For the three months ended -------------------------- January 31, January 31, 2004 2003 ----------- ----------- Risk-free interest rate 2.5% 3.6% Dividend yield 0% 0% Volatility factor .59 .59 Expected option term life in years 2.5 2.1 11 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE I - STOCK INCENTIVE PLANS (continued) The following table summarizes stock option activity for the three months ended January 31, 2004: Shares subject Weighted-average (In thousands, except per share amounts) to options exercise price -------------- ---------------- OMITTED] Outstanding at October 31, 2003 94,700 $ 1.04 Granted 9,955,000 $ 0.13 Exercised (735,200) $ 0.14 Forfeited (-) $ - -------------- ---------------- Outstanding at January 31, 2004 9,314,500 $ 0.14 -------------- ---------------- Exercisable at October 31, 2003 - $ - Exercisable at January 31, 2004 1,900,000 $ 0.13 -------------- ---------------- Options outstanding at January 31, 2004 had a weighted-average remaining contractual life of 4.9 years and exercise prices ranging from $0.13 to $1.50 per share. NOTE J - COMMITMENTS AND CONTINGENCIES Note Receivable On August 26, 2002 the Company's subsidiary, Healthcare Concierge Inc. filed an action in the Third District Court of Salt Lake County, Utah against Merit Studios, Inc. The action seeks $600,000 that is owed by Merit Studios to Healthcare Concierge pursuant to a promissory note executed in consideration for the reconveyance to Merit Studios of two license agreements (Note G). During June 2003 the Company received notification of a summary judgment from the Third District Court of Salt Lake County. The Court ordered that judgment be entered in the Company's favor totaling approximately $673,000 which includes the original note receivable plus accrued interest to date and some other small amounts. It was further ordered that the judgment shall be augmented in the amount of reasonable costs and attorney's fees in collecting the judgment Redeemable Preferred Stock During December 2000, the Company issued 950,000 shares of series A preferred stock for the purchase of 5th Digit Technologies, LLC. During 2002, the Company exchanged 600,000 of the outstanding series A preferred shares for 180,000 common shares of the Company. A legal action was filed against the holder of the remaining 350,000 preferred shares outstanding, alleging misrepresentation of the technology acquired as part of the purchase of 5th Digit Technologies, LLC. On January 24, 2002 the outstanding 350,000 preferred shares were tendered for liquidation at $5.00 per share and were subsequently deposited with the court pending the outcome of the legal action. On April 11, 2002 the Third Judicial District Court, Salt Lake County, signed a Default Judgment against the holder of the outstanding 350,000 preferred shares ordering cancellation of the shares. It was further determined that any and all redemption or other rights vested in and related to the shares be voided. The 350,000 preferred shares were cancelled on April 12, 2002. Subsequently, the decision of the Third Judicial District Court was set aside (Note O). 12 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE J - COMMITMENTS AND CONTINGENCIES (continued) Promissory Loan Agreement On June 2, 2003, the Company signed a ten percent simple interest promissory note with an unrelated privately held Company where the privately held Company was to provide $5,000,000 in operating funds to the Company. The terms of the note provided that the Company pay a two percent fee totaling $100,000 for arranging the loan. Terms of repayment included interest on a quarterly basis and the balance of the note at the end of thirty-six months. Additionally, the privately held Company would receive one seat on the Board of Directors until such time as the promissory note was paid in full. After weeks of delays and promises regarding funding, the privately held Company signed an addendum to the original note promising funding of the note by September 19, 2003. When the funding was not met according to the addendum, the privately held Company signed a second addendum promising funding of the note by November 10, 2003. After months of delays, and the privately held Company not fulfilling the terms of the original agreement and/or the signed addendums the Company filed a multi count civil complaint against the privately held company. The $100,000 fee is included in advance deposits at January 31, 2004 pending outcome of the complaint. Management, based on the advice of legal counsel, believes that at a minimum the $100,000 is recoverable in its action against the privately held company (Note O). We are engaged in various other lawsuits and claims, either as plaintiff or defendant, in the normal course of business. In the opinion of management, based upon advice of counsel, the ultimate outcome of these lawsuits will not have a material impact on the Company's financial position or results of operations. NOTE K - EQUITY LINE OF CREDIT AGREEMENT On May 28, 2002 the Company finalized an Equity Line of Credit Agreement, with Cornell Capital Partners, LP, a New Jersey-based domestic investment fund. Under the Equity Line, Videolocity has the right, but not the obligation, to require Cornell Capital to purchase shares of Videolocity common stock up to a maximum amount of $20,000,000 over a 24-month period. There is no minimum draw down although the Company may make draws, as provided below, during the term of the Equity Line. Pursuant to terms of the Equity Line, we are required to file with the SEC a registration statement covering the shares to be acquired by Cornell Capital Partners. The 24-month term commences on the effective date of the registration statement. We are currently working toward completion of the registration. The purchase price of the shares will be 95% of the lowest closing bid price of the Company's common stock during the five consecutive trading days immediately following receipt of the Company's notice of its intent to make a draw. The Company may make up to four draws per month at a maximum $250,000 per draw. In addition to the shares to be issued under the Equity Line, the Company will include in its registration statement an additional 300,000 shares issued to Cornell Partners and the Placement Agent in connection with the execution of the Equity Line. NOTE L - SIGNIFICANT TRANSACTIONS WITH RELATED PARTIES Current officers and directors have made 8.0 percent loans to the Company totaling approximately $260,000. Additionally, the Company has accounts payable totaling approximately $73,000 due to directors. As of January 31, 2004, Directors and Executive Officers of the Company hold approximately 18 percent of the outstanding shares. 13 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE M - RECENT ACCOUNTING PRONOUNCEMENTS The Company does not expect that the adoption of other recent accounting pronouncements will have a material impact on its financial statements NOTE N - GOING CONCERN The accompanying financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern. However, the Company has incurred losses since its inception and has not yet been successful in establishing profitable operations. These factors raise substantial doubt about the ability of the Company to continue as a going concern. The Company's product is ready for immediate deployment, although the Company needs to obtain capital, either long-term debt or equity to continue the implementation of its overall business plan. In this regard, management is proposing to raise necessary additional funds not provided by its planned operations through loans and/or through additional sales of its common stock. The financial statements do not include any adjustments that might result from the outcome of these uncertainties. NOTE O - SUBSEQUENT EVENTS Notes Payable As of March 31, 2004 approximately $1,924,800 of notes payable are past due. Management is currently in discussions with certain note holders pursuing extensions and/or conversions. During March 2004, $1,050,000 of notes payable were converted to approximately 4,701,000 shares of common stock. Operating lease During February 2004, the Company signed an operating lease agreement totaling approximately $989,000 which includes approximately $632,000 in equipment and approximately $357,000 in operating capital. The lease terms require approximately $25,000 in monthly payments over a four year term. The lease was guaranteed by an unrelated privately held Company. The privately held Company was granted 1,000,000 options to purchase common stock at $0.20 per share that expire February 4, 2006. Additionally, if the Company's outstanding shares surpass 20,000,000 prior to February 4, 2006, the privately held Company will be granted additional options at the then current market price to purchase shares equal to 2.5 percent of the then outstanding shares of the Company. 14 Videolocity International Inc. and Subsidiaries (A development Stage Company) NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS NOTE O - SUBSEQUENT EVENTS (continued) Reedemable Preferred Shares On March 15, 2004, we reached a settlement agreement on the redeemable preferred stock referred to in Note J. The settlement agreement includes the Company issuing 80,000 shares of common stock and a total payments of $70,000 payable as follows: $10,000 at execution of the agreement and $5,000 per month beginning May 1, 2004 and continuing until paid in full. Promissory Loan Agreement (Note J) The privately held company filed a motion with the Court to dismiss the complaints filed by the Company. This motion to dismiss was denied by the Court on March 12, 2004. 15 Item 2. Management's Discussion and Analysis or Plan of Operation The following information should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this Form 10-QSB. Forward-Looking Information This report on Form 10-QSB includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may relate to such matters as anticipated financial performance, future revenues or earnings, business prospects, projected ventures, new products and services, anticipated market performance and similar matters. When used in this report, the words "may," "will," expect," anticipate," "continue," "estimate," "project," "intend," and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 regarding events, conditions, and financial trends that may affect our future plans of operations, business strategy, operating results, and financial position. We caution readers that a variety of factors could cause our actual results to differ materially from the anticipated results or other matters expressed in forward-looking statements. These risks and uncertainties, many of which are beyond our control, include (i) the sufficiency of existing capital resources and our ability to raise additional capital to fund cash requirements for future operations; (ii) uncertainties involved in the rate of growth of our business and acceptance of our products and services; (iii) volatility of the stock market, particularly within the technology sector; and (iv) general economic conditions. Although we believe the expectations reflected in these forward-looking statements are reasonable, such expectations may prove to be incorrect. Plan of Operation General We are a development stage company engaged in the business of engineering, marketing and deployment of the Videolocity Digital Entertainment System (DES), and other digital information and entertainment systems. DES delivers video-on-demand in near DVD quality. It also delivers application specific information, games, music, educational material, and wireless high-speed internet access to individuals, residents, hotel guests, and patients/attendants in the healthcare industry. To date we have focused on the acquisition and development of our technology and preliminary marketing activities. We are now positioned to actively market our DES and related technologies and begin deploying our DES into our first signed contracts. Our current business strategy is to drive demand and the usage of our DES in the hospitality, healthcare, residential and other markets in both wired and wireless applications. We are presently commencing the initial marketing of DES into various marketplaces. Although we use the word international in our name, we are not currently operating outside the U.S., except for limited marketing activities in Canada and Mexico. However, as we expand operations and as our business warrants, we fully intend to operate and market our products wherever prudent, including internationally. We operate our business through five subsidiaries which perform various functions strategic to their market place or core competency. To date, our activities have been limited to our DES and other related digital technologies. We are also committed to the continual development of additional innovative, high quality, cost effective technologies. We are currently, and intend to remain, a technology company. 16 Our DES permits viewers to select from an extensive library of movie titles, informational/educational content and view their selections on their television screens, lap top computers or PDAs (personal digital assistants). Content is owned by third parties, such as movie studios, and will be paid for on a revenue share basis when DES is deployed commercially. All content is protected through our proprietary encryption and encoding process, which limits viewing to the person, or persons, authorized to access the movie or other content and prevents unauthorized digital reproduction or rebroadcast. We can tailor the user interfaces and content offering specifically to each market segment and to each customer within that market segment. Our overall delivery system design, hardware components and software applications remain identical, or only slightly modified to accommodate larger user bases and/or infrastructures. This gives us the ability to customize the feature settings and tailor the local content offering to the specific audiences for each market segment. We are capable of providing a wireless system and also offer a parallel system over wire using fiber architectures. Our DES is available on either a Microsoft or Linux operating system in a stand-alone set top box. We intend to use our existing capital, together with proceeds from prospective future financings, to continue marketing and deployment of our DES. Management estimates that minimum expenses during the next twelve months will be approximately $2.6 million, consisting of $1.45 million in payroll, payroll taxes, employee health insurance and other related employee costs including the hiring of additional personnel, $160,000 for office rent, utilities, and related costs, and $310,000 for marketing and related expenses, and $330,000 for general and administrative expenses including legal and accounting fees. Research and development expenses are estimated to be a minimum of approximately $350,000 during the next twelve months. These expenses will be directed at further development of the DES integration into television sets, other monitors and usage of our intellectual property into new products. We will also incur substantial additional costs in connection with the manufacture and deployment of DES. Management further estimates that such costs will be a minimum of $10 million, but we are optimistic that we will be able to cover most of those costs from future long-term lease financing. Currently, we do not intend to sell any hardware or software. Our business plan is to manufacture or purchase hardware and software and deploy our DES at no initial cost to the customer. It is anticipated that we will finance the system equipment and realize the majority of the revenue stream created by the end users. We do not presently anticipate any significant purchase or sale of plant or equipment. Additionally, we do not anticipate the addition of large numbers of employees because our business model calls for outsourcing any and all functions that would be directly related to the number of deployments. We anticipate generating future revenues from the delivery of video and other content as well as high-speed Internet access to the end users of our DES. Management believes that we will begin to realize revenues during our third quarter of 2004 from our first installations started during the second quarter of 2004, from contracts currently in place and contracts currently being negotiated with hotel and healthcare properties. We will charge a fee for each movie or other item of content viewed through our system and/or high-speed Internet access and we will remit a portion of each fee to the studio or other content provider. Although we have not finalized our structure for content fees, the following is an estimate of content fees that we will charge end users: Internet access $ 6.95 to $ 11.95 each 12- or 24-hour period Video on demand $ 5.95 to $ 12.95 per viewing Games $ 2.95 to $ 6.95 each 1- to 4-hour period All prices are subject to change and may vary depending upon property location, usage volume and response to competition. 17 During the next twelve months, we plan to seek additional debt funding in the form of credit lines and capital leases for up to approximately $15 million. This would permit us to cover our minimum expenses described above and accelerate deployment of our DES. As of the date hereof, we have not formalized any new funding except for a line of credit with Cornell Capital, L.P. We can not give any assurance that we will be able to secure such additional funding on favorable terms to us, or otherwise. We have entered into a $20 million equity line of credit agreement with Cornell Capital Partners, LP, a New Jersey-based domestic investment fund which, we anticipate, will provide us with adequate working capital for at least the next 24 months. Under the Equity Line, Videolocity has the right, but not the obligation, to require Cornell Capital to purchase shares of Videolocity common stock up to a maximum amount of $20,000,000 over a 24-month period. There is no minimum draw down although we may make up to four draws per month at a maximum $250,000 per draw. We are required to file a registration statement with the SEC covering the shares to be acquired by Cornell Partners. The 24-month term commences on the effective date of the registration statement. We are currently working toward completion of the registration. The purchase price of the shares will be 95% of the lowest closing bid price of our common stock during the five consecutive trading days immediately following receipt of notice of our intent to make a draw. In addition to the shares to be issued under the Equity Line, we will include in our registration statement an additional 300,000 shares issued to Cornell Partners and the Placement Agent in connection with the execution of the Equity Line. Without drawing against the line of credit and based on current costs of operation, contract commitments, and availability of credit, management estimates that our current assets will be sufficient to fund our cost of operation for approximately the next month and that we must obtain additional financing during that time in order to continue operations. Liquidity and Capital Resources During the three months ended January 31, 2004, our total current assets increased approximately $12,000 and total assets increased from approximately $189,000 to approximately $195,000. The increase is primarily due to borrowing funds during the quarter. During the three months ended January 31, 2004, our total current liabilities increased from approximately $3,680,000 to approximately $3,962,000. The increase is attributed to the increase in notes payable of $20,000, an increase in accrued interest of approximately $55,000 and an increase in accounts payable and accrued liabilities of approximately $207,000. During the three months ended January 31, 2004 our notes payable increased by $20,000. These funds were borrowed from an individual and are being used for general operational expenses. The $20,000 note is convertible at $0.10 per share which was the market value of our common stock on the day of issuance. The note has no set maturity date and is payable until paid in full. To date, we have not realized revenues from our operations. For the three months ended January 31, 2004, total expenses decreased approximately $324,000 or approximately 46% as compared to the three months ended January 31, 2003. This is attributed primarily to a $149,000 decrease in provision for bad debts, and a decrease in interest expense and beneficial conversion of approximately $115,000. Interest expense for the period ended January 31, 2003 included a beneficial conversion feature totaling approximately $120,000. Management anticipates that as we scale up the installation of our DES, our expenses will increase proportionately. Our plan of operation will depend on our ability to raise substantial additional capital, of which there can be no assurance. 18 Net Operating Loss As of January 31, 2004, we have, together with our subsidiaries, accumulated a net operating loss carryforward of approximately $7,020,000, with an operating loss tax benefit of approximately $2,457,000. No tax benefit has been recorded in the financial statements because the tax benefit has been fully offset by a valuation reserve as the realization of the future tax benefit cannot be established. The net operating loss will expire through 2024. Inflation In the opinion of management, inflation has not and will not have a material effect on our operations in the immediate future. Item 3. Controls and Procedures As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Based upon that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are effective to cause the material information required to be disclosed by us in the reports that we file or submit under the Exchange Act to be recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There have been no significant changes in our internal controls or in other factors which could significantly affect internal controls subsequent to the date we carried out our evaluation. 19 PART II Item 1. Legal Proceedings During December 2000 we issued 950,000 shares of preferred stock for the purchase of 5th Digit Technologies, LLC. During 2002, we exchanged 180,000 shares of our common stock for 600,000 shares of the preferred stock. A legal action was filed against the holder of the remaining 350,000 preferred shares outstanding, alleging misrepresentation of the technology acquired as part of the purchase of 5th Digit Technologies, LLC. On January 24, 2002 the outstanding 350,000 preferred shares were tendered for liquidation at $5.00 per share and were subsequently deposited with the court pending the outcome of the legal action. On April 11, 2002 the Third Judicial District Court, Salt Lake County, signed a Default Judgment against the holder of the outstanding 350,000 preferred shares ordering cancellation of the shares. It was further determined that any and all redemption or other rights vested in and related to the shares be voided. The 350,000 preferred shares were cancelled on April 12, 2002. Subsequently, the decision of the Third Judicial District Court was set aside. On March 15, 2004, we reached a settlement agreement which includes our issuing 80,000 shares of common stock and payments totaling $70,000 payable as follows: $10,000 at execution of the agreement and $5,000 per month beginning May 1, 2004 and continuing until paid in full. On August 26, 2002 our subsidiary, Healthcare Concierge Inc. filed an action in the Third District Court of Salt Lake County, Utah against Merit Studios, Inc. The action seeks $600,000 that is owed by Merit Studios to Healthcare Concierge pursuant to a promissory note executed in consideration for the reconveyance to Merit Studios of two license agreements. During June 2003 we received notification of a summary judgment from the Third District Court of Salt Lake County. The Court ordered that judgment be entered in our favor totaling approximately $673,000 which includes the original note receivable plus accrued interest to date and some other small amounts. It was further ordered that the judgment shall be augmented in the amount of reasonable costs and attorney's fees in collecting the judgment. We are engaged in various other lawsuits and claims, either as plaintiff or defendant, in the normal course of business. In the opinion of management, based upon advice of counsel, the ultimate outcome of these lawsuits will not have a material impact on our financial position or results of operations. Item 2. Changes in Securities and Use of Proceeds Recent Sales of Unregistered Securities During the three months ended January 31, 2004, we issued an aggregate of 735,200 shares of common stock to employees and consultants under the Videolocity, Inc. 2000 Stock Incentive Plan. These shares were subject to a registration statement filed with the SEC on July 31, 2001. Item 3. Defaults Upon Senior Securities On February 6, 2003 we received a formal notice of default from ISOZ, LC regarding our $215,000 in notes payable to ISOZ, LC. As of September 9, 2003 we are in default on notes payable due to ISOZ, LC. totaling $215,000 and accrued interest of approximately $43,000. The notes payable have maturities or have been extended as follows: $20,000 matured during October 2002, $435,000 matured during November 2002, $30,000 matured during January 2003, $100,000 matured during July 2003, $1,264,800 matured during August 2003, $75,000 matured during November 2003, $75,000 matures during April 2004, $175,000 matures during June 2005, $375,000 is callable on demand when we have secured five million in new debt or equity funding and $270,000 has no set maturity and is payable until paid in full. 20 As of March 31, 2004, we had a total of $1,924,800 in notes payable that are past due and related accrued interest of approximately $343,000. We are actively pursuing extensions and/or conversions on the notes payable. Item 4. Submissions of Matters to a Vote of Security Holders This Item is not applicable. Item 5. Other Information This Item is not applicable Item 6. Exhibits and Reports on Form 8-K (a) Exhibits. The following documents are included attached as exhibits to this report. Exhibit 31.1 Certification of CEO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 31.2 Certification of CFO Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 Certification of CEO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 Certification of CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (b) Reports on Form 8-K On March 5, 2004, our Board of Directors met and unanimously approved a resolution to dismiss Andersen Andersen & Strong, L.C. from its position as our independent certifying accountants. The audit report of Andersen Andersen & Strong, L.C. for the year ended October 31, 2002, contained a modification expressing substantial doubt as our ability to continue as a going concern. The audit report contained no other adverse opinion, disclaimer of opinion or modification as to uncertainty, audit scope or accounting principle. In connection with its audits for the past two fiscal years and review of unaudited financial statements through July 31, 2003, and through the date of dismissal on March 5, 2004, there have been no disagreements with Andersen Andersen & Strong L.C. on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which if not resolved to the satisfaction of Andersen Anderson & Strong L.C., would have caused them to make reference thereto on the financial statements. Also on March 5, 2004, our Board of Directors unanimously approved a resolution to engage Madsen & Associates, CPAs, Inc. to audit our financial statements for the year ended October 31, 2003. During the two most recent fiscal years and through March 5, 2004, we have not consulted with Madsen & Associates regarding (i) the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on the our financial statements, and no written report or oral advice was provided to us by concluding there was an important factor to be considered by us in reaching a decision as to an accounting, auditing or financial reporting issue; or (ii) any matter was either the subject of a disagreement, as that term is defined in Item 304(a)(1)(iv) of Regulation S-B and the related instructions thereto, or a reportable event, as set forth in Item 304(a)(1)(iv) of Regulation S-B. 21 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VIDEOLOCITY INTERNATIONAL, INC. BY: /S/ ROBERT E. HOLT ------------------------------------ ROBERT E. HOLT President and Director Date: April 9, 2004 BY: /S/ CORTNEY TAYLOR ------------------------------------ CORTNEY TAYLOR Chief Financial Officer (Principal accounting Officer) Date: April 9, 2004 22