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 April 30, 2005 [ ] 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.) 1762A 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 June 15, 2005 - --------------------------- ----------------------------------- Common Stock, 20,086,585 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...................... 17 Item 3. Controls and Procedures........................................................ 21 PART II Item 1. Legal Proceedings.............................................................. 21 Item 2. Changes in Securities and Use of Proceeds...................................... 22 Item 3. Defaults Upon Senior Securities................................................ 23 Item 4. Submissions of Matters to a Vote of Security Holders........................... 23 Item 5. Other Information.............................................................. 23 Item 6. Exhibits and Reports on Form 8-K............................................... 23 Signatures..................................................................... 24 Videolocity International Inc. and Subsidiaries (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED BALANCE SHEET April 30, 2005 ASSETS CURRENT ASSETS Cash $ 18,871 Accounts receivable 22,423 Other assets 51,122 ------------ Total current assets 92,416 Property and equipment, at cost, net 668,390 Other assets 124,909 ------------ $ 885,715 ============ LIABILITIES AND STOCKHOLDERS' DEFICIT CURRENT LIABILITIES Accounts payable $ 274,189 Accrued liabilities 598,196 Accrued interest payable 363,441 Notes payable - related parties 125,000 Notes payable 2,239,800 Current portion of long term obligations 235,930 ------------ Total current liabilities 3,836,556 Long term obligations less current portion 615,104 Compensation debenture 370,000 MINORITY INTERESTS 4,866 COMMITMENTS AND CONTINGENCIES -- STOCKHOLDERS' DEFICIT Common stock, $0.001 par value; 100,000,000 shares authorized, 19,829,783 issued and outstanding 19,830 Preferred stock, $0.001 par value; 5,000,000 shares authorized none outstanding -- Additional paid-in capital 6,766,083 Deficit accumulated during the development stage (10,726,724) ------------ Total stockholders' deficit (3,940,811) ------------ $ 885,715 ============ 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 From Three months ended Six months ended May 26, 2000 April 30, April 30, through ---------------------------- ---------------------------- April 30 2005 2004 2005 2004 2005 ------------ ------------ ------------ ------------ ------------ Revenues $ 32,298 $ -- $ 61,043 $ -- $ 71,268 Cost of Goods Sold 23,088 -- 40,320 -- 49,049 ------------ ------------ ------------ ------------ ------------ Gross Profit 9,210 -- 20,723 -- 22,219 Operating expenses Salaries, payroll taxes, and employee benefits 357,863 193,727 582,886 464,689 4,104,340 Professional fees and consultants 17,875 28,316 34,765 33,164 1,289,939 Technology development consulting 45,070 29,594 83,785 52,937 696,942 Directors compensation through stock plan -- -- -- -- 95,000 Rent 12,000 8,000 24,000 24,000 280,305 Provision for bad debts -- -- -- -- 600,000 Travel , conventions, meals and entertainment 9,040 6,108 19,007 6,943 226,293 Depreciation and amortization 35,797 6,323 72,064 12,647 217,705 Utilities 5,161 8,216 8,489 10,659 100,104 Gain on transfer of license agreements -- -- -- -- (114,509) Write off of goodwill -- -- -- -- 958,628 Other 14,045 18,581 35,746 20,657 598,943 ------------ ------------ ------------ ------------ ------------ 496,851 298,865 860,742 625,696 9,053,690 ------------ ------------ ------------ ------------ ------------ Operating loss (487,641) (298,865) (840,019) (625,696) (9,031,471) ------------ ------------ ------------ ------------ ------------ Interest income -- -- -- -- 5,578 Legal Settlement -- (97,400) -- (97,400) (97,400) Gain on sale of stock, net -- -- -- -- 338,049 Interest and beneficial conversion expense (30,896) (141,810) (124,459) (197,111) (1,847,968) Expense for stock options on guarantee, services, debt (5,555) (69,120) (19,526) (69,120) (88,646) Minority interests -- -- -- -- (4,866) ------------ ------------ ------------ ------------ ------------ Loss before income taxes (524,092) (607,195) (984,004) (989,327) (10,726,724) ------------ ------------ ------------ ------------ ------------ Income taxes -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ NET LOSS $ (524,092) $ (607,195) $ (984,004) $ (989,327) $(10,726,724) ============ ============ ============ ============ ============ Loss per common share Basic and Diluted $ (0.03) $ (0.06) $ (0.06) $ (0.13) Weighted-average common and dilutive common equivalent shares outstanding Basic and Diluted 18,682,520 9,559,225 17,495,709 7,943,015 The accompanying notes are an integral part of these financial statements. -3- Videolocity International Inc. and Subsidiaries (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT April 30, 2005 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) ----------- ----------- ----------- ----------- ----------- ----------- 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) (continued) -4- Videolocity International Inc. and Subsidiaries (A Development Stage Company) UNAUDITED CONSOLIDATED CONDENSED STATEMENT OF STOCKHOLDERS' DEFICIT April 30, 2005 Deficit Accumulated Preferred stock Common stock Additional during the -------------------------- -------------------------- paid-in Development Shares Amount Shares Amount capital Stage ----------- ----------- ----------- ----------- ----------- ----------- Balance at October 31, 2003 $ -- $ -- 6,346,996 $ 6,347 $ 4,083,060 $ (7,585,101) Fees related to Equity Distribution Agreement -- -- -- -- (390,000) -- Issuance of stock options for: Guarantee -- -- -- -- 69,120 -- Services -- -- -- -- 46,316 -- Loan -- -- -- -- 140,432 -- Issuance of common stock for: Bonus interest and extensions on debt -- -- 736,500 736 215,464 -- Services -- -- 500,000 500 87,500 -- Cash -- -- 500,000 500 224,500 -- Cash under Equity Line -- -- 140,746 141 37,859 -- Conversion of debt -- -- 6,429,056 6,429 1,580,851 -- Stock incentive plans -- -- 770,000 770 144,081 -- Legal settlement -- -- 80,000 80 22,320 -- Net loss for the year -- -- -- -- -- (2,157,619) ----------- ----------- ----------- ----------- ----------- ----------- Balance at October 31, 2004 -- -- 15,503,298 15,503 6,261,503 (9,742,720) Issuance of common stock for: Conversion of debt -- -- 745,432 745 181,353 -- Stock incentive plans -- -- 23,000 23 17,177 -- Issuance of stock under Equity Line -- -- 1,494,722 1,495 158,505 -- Issuance of stock options on loans -- -- -- -- 13,971 -- Net loss for the period -- -- -- -- -- (459,912) ----------- ----------- ----------- ----------- ----------- ----------- Balance at January 31, 2005 -- -- 17,766,452 17,766 6,632,509 (10,202,632) Issuance of common stock for: Stock incentive plans -- -- 22,900 23 17,027 -- Issuance of stock under Equity Line -- -- 1,493,764 1,494 88,506 -- Payment on compensatin debenture -- -- 500,000 500 19,500 -- Legal settlement -- -- 30,000 30 1,170 -- Bonus interest and extensions of debt -- -- 16,667 17 1,816 -- Issuance of stock options on loans -- -- -- -- 5,555 -- Net loss for the period -- -- -- -- -- (524,092) ----------- ----------- ----------- ----------- ----------- ----------- Balance at April 30, 2005 $ -- $ -- 19,829,783 $ 19,830 $ 6,766,083 $(10,726,724) =========== =========== =========== =========== =========== ============= 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 six months ended May 26, 2000 April 30, (inception) -------------------------------- Through 2005 2004 April 30, 2005 --------------- --------------- ------------------- Increase (decrease) in cash Cash flows from operating activities Net loss $ (984,004) $ (989,327) $ (10,726,724) Adjustments to reconcile net loss to net cash used in operating activities Minority interests - - 4,866 Provision for bad debts - - 600,000 Write off of goodwill - - 958,628 Gain on sale of investment stock - - (338,049) Gain on transfer of license - - (114,509) Depreciation and amortization 72,064 12,647 217,710 Interest expense recognized on beneficial conversion - - 423,900 Issuance of common stock under stock plans 34,250 117,150 808,208 Issuance of common stock for services - 60,000 553,832 Issuance of common stock for interest 1,833 128,701 508,925 Options issued on guarantee, services, and loans 19,526 69,120 275,394 Issuance of common stock for legal settlement - 22,400 22,400 Changes in assets and liabilities Accounts receivable (13,385) - (22,423) Other assets 20,962 (104,128) (176,031) Accounts payable and accrued liabilities 282,481 138,086 873,585 Accrued interest 96,578 44,667 582,819 --------------- --------------- ------------------- Total adjustments 514,309 488,643 5,179,255 --------------- --------------- ------------------- Net cash used in operating activities (469,695) (500,684) (5,547,469) --------------- --------------- ------------------- Net cash flows from investing activities Investment stock and licenses, net - - 555,791 Increase in notes receivable - - (600,000) Purchase of property and equipment - - (164,977) --------------- --------------- ------------------- Net cash flows used in investing activities - - (209,186) --------------- --------------- ------------------- Cash flows from financing activities Increase in notes payable 325,000 200,000 4,519,800 Proceeds from lease - 357,000 357,000 Cash received on equity distribution agreement - - 38,000 Payments on lease (22,130) (50,890) (163,580) Proceeds from issuance of common stock - 225,000 1,024,306 --------------- --------------- ------------------- Net cash provided by financing activities 302,870 731,110 5,775,526 --------------- --------------- ------------------- Net increase (decrease) in cash (166,825) 230,426 18,871 Cash at beginning of period 185,696 10,385 - --------------- --------------- ------------------- Cash at end of period $ 18,871 $ 240,811 $ 18,871 =============== =============== =================== Supplemental disclosures of cash flow information - ------------------------------------------------- Cash paid during the period for Interest $ -- $ -- $ -- Income taxes -- -- -- Noncash investing and financing activities - ------------------------------------------ During the nine months ended April 30, 2005 the Company retired $250,000 of notes payable using cash from its standby equity distribution agreement and converted $20,000 of its compensation debenture into common stock. Additionally, the Company converted $180,000 of notes payable and $2,098 of accrued interest payable into common stock. The accompanying notes are an integral part of these statements. -6- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - ACCOUNTING POLICIES The information for Videolocity International Inc. (the Company) as of April 30, 2005 and for the three and six months ended April 30, 2005 and 2004 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 and six months ended April 30, 2005 should be read in conjunction with the Company's annual report on Form 10-KSB for the fiscal year ended October 31, 2004. The results of operations for the three months and six months ended April 30, 2005 may not be indicative of the results that may be expected for the year ending October 31, 2005. NOTE C - ORGANIZATION AND BUSINESS ACTIVITY The Company is 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, residences, and condominiums. At April 30, 2005, 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 has recorded minimal revenue from its planned principal operations. On December 1, 2000, the Company completed a reverse stock split of its 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. As of September 16, 2004, the Company received written consent from shareholders representing approximately 55 percent of the outstanding shares, at that time, to increase the number of authorized shares of common stock from 50,000,000 to 100,000,000 and the number of authorized shares of preferred stock from 1,000,000 to 5,000,000. On March 3, 2005, the increase in authorized shares was recorded by the State of Nevada based on the written consent of the shareholders. There are currently no preferred shares outstanding. Preferred shares may be issued from time to time in one or more distinctly designated series. The Board of Directors has the authority to designate the powers, preferences, qualifications, powers, limitations, and the rate and timing of dividends prior to the issuance of any series of preferred stock. 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. -7- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED 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 I, J, K, L, and N 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 - 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 approximately $9,000 on April 30, 2005. 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 attorney's fees to collect (Note M). As of April 30, 2005, the Company has recorded an allowance for bad debt totaling $600,000 against the note receivable. NOTE G - OTHER ASSETS At April 30, 2005, other assets consisted of the following: Short term Long term Non trade receivables $ 1,317 $ -- Deposits 267 24,909 Prepaid expenses 49,538 -- Promissory loan fee (Note L) -- 100,000 --------------------------- $ 51,122 $ 124,909 =========================== NOTE H - PROPERTY AND EQUIPMENT At January 31, 2005, property and equipment and estimated useful lives consist of the following: Amount Years ---------- --------- Equipment $ 164,978 3-5 Equipment under capital lease 657,613 3-5 ---------- 822,591 Less accumulated depreciation and amortization 154,201 ---------- $ 668,390 ========== NOTE I - NOTES PAYABLE The Company originated approximately $80,000 in notes payable during the three months ended April 30, 2005, of which $40,000 had been received by April 30, 2005. The remaining $40,000 due to the Company under the note is scheduled to be remitted on a monthly basis of $10,000 per month until the total amount of the note payable is received. The total is convertible at $0.04 per share and the holder was granted an option to purchase 400,000 shares of Videolocity common stock at $0.04 per share through the second anniversary of the agreement. The note payable is due on demand no earlier than during September 2005. The value of the options granted is based on the fair value at the date of grant calculated using the Black-Scholes option-pricing model. Expense was recognized at the time the options become exercisable. -8- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At April 30, 2005 the Company has notes payable totaling $2,364,800 due to various individuals and companies including $125,000 to current related parties including Board of Directors and Management. Of the total, $150,000 is written at 12%, $1,154,800 is written at 8 percent, $250,000 is variable between 10 percent and 25 percent depending on repayment date and $810,000 has no stated interest rate. Interest has been imputed from the origination date on all non-interest bearing notes payable. Of the total notes payable $627,800 is convertible at the option of the debt holder in the following amounts: $167,800 is convertible at $1.00 per share, $60,000 is convertible at $0.72 per share, $15,000 is convertible at $0.30 per share, $80,000 is convertible at $0.25 per share, $65,000 is convertible at $0.22 per share, $125,000 is convertible at $0.20 per share, $60,000 is convertible at $0.15 per share, $15,000 is convertible at $0.12 per share and $40,000 received during the quarter ended April 30, 2005 is convertible at $0.04 per share. The notes payable have maturities as follows: $20,000 matured during October 2002, $335,000 matured during November 2002, $30,000 matured during January 2003, $719,800 matured during August 2003, $25,000 matured during November 2003, $15,000 matured during September 04, $605,000 is callable on demand when the Company has secured between $1 million and $5 million in new debt or equity funding, $75,000 is due June 2005, $250,000 is due during July 2005, $40,000 is due on demand no earlier than September 2005, $100,000 has no set maturity and is payable until paid in full and $150,000 is due on a set schedule of $10,000 per week beginning in during July 2005 until paid in full using advances under the Company's Standby Equity Line for repayment. (Note N). Approximately $1,104,800 of the total notes payable is past due as of April 30, 2005. During the quarter ended April 30, 2005, the Company received demand notices on two notes payable totaling $295,000. Of that total, the Company is currently reviewing anticipated cash inflows to determine a time-frame for repayment on one note payable totaling $80,000. The other demand notification regarding a note payable for $215,000 is noted below in the UCC-1 description. The Company has granted options to purchase Company stock under certain of the notes payable originated in the following amounts: 400,000 shares at $0.77, 120,000 shares at $0.72, 20,000 shares at $0.50, 200,000 shares at $0.14, 60,000 shares at $0.12 and 400,000 shares at $0.04. All options granted in conjunction with new notes payable were granted at or above the fair market value on the date the notes payable were originated. Where necessary, the value of the options granted is based on the fair value at the date of grant calculated using the Black-Scholes option-pricing model. Expense has been recognized at the time the options become exercisable. 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 $100,000 to current related parties. During the year ended October 31, 2004, the Company converted a total of $535,000 of notes payable under the UCC-1 into common stock of the Company including $135,000 to current related parties. During the quarter ended January 31, 2005, the Company converted a total of $100,000 of notes payable under the UCC-1 into common stock of the company. As of April 30, 2005 there remains a total of $865,000 of notes payable under the UCC-1. The notes payable under the UCC-1 have maturities as follows: $20,000 matured during October 2002, $335,000 matured during November 2002, $30,000 matured during January 2003 and $480,000 matured during August 2003. On February 6th, 2003 the Company received a formal notice of default from ISOZ, LC regarding the $215,000 in notes payable under the UCC-1 to ISOZ, LC and on March 29, 2005 the Company received a demand letter regarding -9- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS the $215,000 in notes payable to ISOZ, LC. The Company has forwarded certain documentation over to federal authorities toward their examination and investigation regarding the origination of the $215,000 in notes payable to the Company and certain other transactions including the origination of the borrowed funds. The Company will work with the federal authorities and rely on their examination and investigation in determining the actions the Company will take in response to this demand notice. NOTE J - LONG TERM OBLIGATIONS The Company has a capital lease agreement that includes approximately $658,000 in equipment and approximately $357,000 in operating capital. The lease terms require approximately $25,000 in monthly payments over a 48 month 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. Expense recognized for the period ended October 31, 2004 related to these options totaled $69,120. The equipment was recorded as equipment under capital leases. The following is a schedule by year of future minimum payments under long term obligations, together with the present value of the net payments as of April 30, 2005: Cash proceeds from Equipment Lease Total ---------- ---------- ---------- Through April 30, 2006 $ 197,098 $ 106,033 $ 303,131 Through April 30, 2007 197,098 106,033 303,131 Through April 30, 2008 197,098 106,033 303,131 Through April 30, 2009 49,274 26,508 75,782 Thereafter -- -- -- ---------- ---------- ---------- Total minimum payments 640,568 344,607 985,175 Less amount representing interest 88,688 45,453 134,141 ---------- ---------- ---------- Present value of net minimum payments 551,880 299,154 851,034 Less current portion 152,702 83,228 235,930 ---------- ---------- ---------- Long-term portion $ 399,178 $ 215,926 $ 615,104 ========== ========== ========== NOTE K - STOCK INCENTIVE PLANS On October 1, 2000 the Company established a stock incentive plan to attract and retain qualified key employees. The Company reserved 1,000,000 common shares that can be issued under the plan. Awards made under the plan are issued in units with each unit being convertible into one share of common stock at the option of the holder. The plan units vest, generally, over three years as specified in each individual grant. The individual units are issued with a -10- strike price of $0.00. Accordingly, compensation expense is incurred by the Company over the vesting periods and is calculated using the stock price on the grant date times the number of shares vesting. During the quarter ended April 30, 2005, the Company recognized approximately $17,000 of compensation expense with the issuance of 22,900 shares of stock under vesting schedules. Through April 30, 2005, the Company has granted 998,384 plan units of which 976,984 units have been exercised under the plan and 21,400 plan units remain subject to vesting requirements. 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. During the first quarter of 2004, the Board of Directors approved 30,000 shares for issuance to consultants of the Company under the plan but to date have not issued the shares. Through April 30, 2005, 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 vested at various times through FY 2004. Additionally, during the quarter ended April 30, 2005, as an incentive, and to retain current key individuals, the Board of Directors approved a total of 2,000,000 options to purchase stock outside of the plans to employees that vest at various times through FY 2006. The above noted 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, 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. As permitted under accounting principles generally accepted in the United States of America, grants to employees under the Plan and other grants to employees of options are accounted for following APB Opinion No. 25 and related Interpretations. Had compensation cost for the Plan been determined based on the grant date fair values of awards using the Black-Scholes option pricing model, reported net earnings (loss) and earnings (loss) per common share would have been changed to the pro forma amounts shown below. -11- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Three months Three months Six months Six months ended ended ended ended April 30, April 30, April 30, April 30, 2005 2004 2004 2004 ------------- ------------ ------------- ------------ Net earnings (loss): As reported $(524,092) $(607,195) $(984,004) $ (989,327) Proforma $(524,092) $(942,762) $(984,004) $(1,420,055) Basic earnings (loss) per share: As reported $(0.03) $(0.06) $(0.06) $(0.13) Pro forma $(0.03) $(0.10) $(0.06) $(0.18) Diluted earnings (loss) per share: As reported $(0.03) $(0.06) $(0.06) $(0.13) Pro forma $(0.03) $(0.10) $(0.06) $(0.18) 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 $0.10 for the shares granted during the quarter ended April 30, 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 quarter ended ---------------------- April 30, April 30, 2005 2004 ---------- ---------- Risk-free interest rate 3.5% 2.5% Dividend yield 0% 0% Volatility factor .59 .59 Expected option term life in years 2.0 2.5 -12- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table summarizes stock option activity for the period May 26, 2000 (inception) through April 30, 2005: Shares subject Weighted-average to options exercise price - --------------------------------------- ----------------- ----------------- Outstanding at May 26, 2000 (inception) -- $ -- Granted -- $ -- Exercised -- $ -- Forfeited -- $ -- ----------------- ----------------- Outstanding at October 31, 2000 -- $ - Granted 490,833 $ 1.13 Exercised (5,000) $ 1.00 Forfeited -- $ - ----------------- ----------------- Outstanding at October 31, 2001 485,833 $ 1.14 Granted 185,400 $ 1.08 Exercised (36,684) $ 1.35 Forfeited (416,249) $ 1.01 ----------------- ----------------- Outstanding at October 31, 2002 218,300 $ 1.30 ----------------- ----------------- Granted -- $ - Exercised (119,400) $ 1.45 Forfeited (4,200) $ 1.40 ----------------- ----------------- Outstanding at October 31, 2003 94,700 $ 1.04 Granted 9,955,000 $ 0.13 Exercised (770,000) $ 0.19 Forfeited (2,400) $ 1.50 ----------------- ----------------- Outstanding at October 31, 2004 9,277,300 $ 0.14 Granted 20,000 0.27 Exercised (23,000) 0.75 Forfeited -- -- ----------------- ----------------- Outstanding at January 31, 2005 9,274,300 $ 0.13 Granted 2,000,000 0.10 Exercised (22,900) 0.75 Forfeited -- --- ----------------- ----------------- Outstanding at April 30, 2005 11,251,400 $ 0.13 Exercisable at January 31, 2005 9,230,000 $ 0.13 ----------------- ----------------- The plan units vest at various dates ranging through November 2005. A further summary of information related to options outstanding at April 30, 2005 is as follows: Weighted Average Weighted Average Range of Exercise Number Remaining Contractual Exercise Price Prices Outstanding / Exercisable Life (Years) Outstanding / Exercisable - ------------------- ------------------------- ------------ ------------------------- $0.00 to 0.50 11,230,000 / 9,230,000 8.82 $0.13 / $0.13 0.51 to 1.00 21,000 / - 0.51 0.70 / - 1.01 to 1.50 400 / - 0.01 1.22 / - ------ ---- ---- ---- ---- 11,251,400 / 9,230,000 8.81 $0.13 / $0.13 -13- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE L - 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 $359,000 for the six months ended April 30, 2005. As of April 30, 2005, the Company had net operating loss carryforwards for tax reporting purposes of approximately $9,000,000 expiring through 2025. NOTE M - COMMITMENTS AND CONTINGENCIES The Company is engaged in various 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 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 F). 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 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. On March 15, 2004, the Company reached a settlement agreement on the redeemable preferred stock. The settlement agreement included the Company issuing 80,000 shares of common stock and 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. As of April 30, 2005, the Company has completed the payments required under the settlement agreement. -14- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 other assets at April 31, 2005 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. 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. NOTE N - STANDBY EQUITY DISTRIBUTION AGREEMENT AND COMPENSATION DEBENTURE During May 2004, the Company entered into a Standby Equity Distribution Agreement with Cornell Capital Partners, LP, a New Jersey-based domestic investment fund. Pursuant to the terms of the funding agreement with Cornell Capital, Videolocity has the right, but not the obligation, to require Cornell Capital to purchase shares of the company's common stock in amounts up to $350,000 per drawdown and up to $1 million per month to a maximum of $20 million over the 24 months following the effective date. The equity drawdowns are entirely at Videolocity's discretion and the agreement does not require minimum drawdowns. The effective date of the agreement is the date that the Securities and Exchange Commission first declared a registration statement effective registering the resale of the securities. The drawdowns are subject to an effective registration statement with the United States Securities and Exchange Commission covering the resale of the shares. The Company filed a SB-2 on July 9, 2004 to register 19,314,099 shares of common stock and the SB-2 was declared effective by the Securities and Exchange Commission on July 22, 2004. As of April 30, 2005, the Company had issued 140,746 shares to Cornell and received $38,000 under the agreement. The Company placed 10,000,000 of the registered shares into escrow to facilitate drawdowns and the repayment of a $400,000 loan due to Cornell Capital Partners LP (Notes I and R). and has issued 2,988,486 shares under the Standby Equity Distribution Agreement using the proceeds to repay $250,000 of the loan. The balance of the loan at April 30, 2005 totals $150,000. Those shares not issued under drawdowns or as repayment on the loan will be returned to the Company. The Company has 7,011,514 shares (10,000,000 less 2,988,486 shares issued) that remain in escrow. The shares held in escrow are not included in the Company's outstanding shares. -15- Videolocity International Inc. and Subsidiaries (A Development Stage Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS As consideration for Cornell to enter into the agreement, the Company issued a $390,000, 5% convertible debenture. The principal and interest are due during May 2007. At the Company's option, the principal and interest due can be repaid or converted to common stock at a rate of 250% of the current closing bid price of the common stock as listed on a principal market as quoted by Bloomberg L.P. or 100% of the lowest closing bid price of the Company's common stock for the three trading days immediately preceding the conversion date. At the holder's option, they may convert to the Company's stock until paid in full. The Company may redeem all or a portion of the outstanding principal at a redemption price of 120% multiplied by the portion of the principal sum being redeemed plus any accrued and unpaid interest. Through April 30, 2005, the holder has converted $20,000 of the debenture balance into 500,000 shares of the Company's common stock. The balance of the compensation debenture as of April 30, 2005 totals $370,000. NOTE O - SIGNIFICANT TRANSACTIONS WITH RELATED PARTIES As of April 30, 2005, current officers and directors have made 8.0 percent loans to the Company totaling approximately $125,000. Additionally, the Company has accounts payable totaling approximately $58,000 due to a director. As of April 30, 2005, Directors and Executive Officers of the Company hold approximately 11 percent of the outstanding shares. NOTE P - 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 Q - 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 R - SUBSEQUENT EVENTS Notes Payable As of June 15, 2005 approximately $1,104,800 of notes payable are past due. Management is currently in discussions with certain note holders pursuing extensions and/or conversions. Standby Equity Distribution Agreement (NOTES I and N) Subsequent to April 30, 2005, the Company placed an additional 5,000,000 shares into escrow to facilitate drawdowns on the Standby Equity Distribution Agreement. Subsequent to April 30, 2005, the Company issued 243,902 shares in repayment of $10,000 of its compensation debenture. Any shares held in escrow toward drawdowns under the Standby Equity Distribution Agreement are not included in outstanding shares. -16- 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 technology company that is committed to continued development and marketing of innovative, high quality, cost effective systems to build future ongoing revenue streams. We are currently, and intend to remain a technology company. We have developed proprietary technologies that reduce bandwidth requirements for numerous applications of digital content. We are currently using advanced proprietary technologies to transmit streaming video at speeds of 1Mbps or less. We have the technological capacity to enter into a variety of markets that include hospitality, healthcare, residential, security and corporate training with currently developed technologies. To date we have been focused on the acquisition and development of our proprietary technologies. Our current business strategy is to continue with development of additional technologies as well as enhancements to our current proprietary technologies to further enable their use in other markets. We also intend to actively market our first product, the Videolocity Digital Entertainment System(TM) (DES(TM)) in the hospitality, healthcare, residential, and other similar markets in both wired and wireless applications. 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, Mexico and the Caribbean. However, as we expand operations we fully intend to operate and market our products wherever prudent, including internationally. We operate our business through five subsidiaries that perform various functions strategic to their market place or core competency. -17- We have started to actively market our DES(TM). DES(TM) is a complete digital entertainment system using our proprietary technologies to deliver video on demand streaming at 1Mbps or less, full screen, in like DVD quality. In addition to video content viewing, DES(TM) provides high-speed Internet access, digital music on demand, games, full Web surfing and a variety of e-commerce applications as well as customer specific informational and educational content. The Videolocity DES(TM) can be deployed in closed network environments such as hotels, timeshare condominiums, hospitals, and assisted living facilities, or over wide area networks serving intelligent communities, residences and personal digital assistants (PDAs). The Videolocity DES(TM) is currently available using Wireless 802.11 WAN/LAN, Fiber, Satellite, Ethernet or DSL network architectures. We tailor the user interface 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(TM) is available on either a Microsoft or Linux operating system in a stand-alone set top box. The flexible, highly customizable and fully scalable delivery platforms combined with advanced embedded software applications allow for full remote system upgrades and easy updates of content and/or system enhancements. Our DES(TM) 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. Content is owned by third parties, such as movie studios, and is paid for on a revenue share basis when the content is viewed on the DES(TM). 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 have started deploying our DES(TM) into signed contracts. We intend to use our existing capital, together with proceeds from prospective future financings, to continue marketing and deployment of our DES(TM) and to fund development of new technologies and enhancements of existing proprietary technologies. Management estimates that minimum expenses to carry out our business plan 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. We will also incur substantial additional costs in connection with the manufacture and deployment of the DES(TM). 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(TM) 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. -18- 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(TM). 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 $ 12.95 for each 1- to 24-hour period Video on demand $ 3.95 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. 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(TM). As of the date hereof, we have not formalized any new funding except for a Standby Equity Distribution Agreement 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. During May 2004 we entered into a Standby Equity Distribution Agreement with Cornell Capital Partners, LP, a New Jersey-based domestic investment fund. We anticipate that this agreement will provide us with adequate working capital for at least the next 24 months. Under the equity distribution agreement, 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 million over a 24-month period. There is no minimum draw down although we may draw-down up to four times per month at a maximum $350,000 per draw and a maximum of $1 million per month. The draw-downs are subject to an effective registration statement with the United States Securities and Exchange Commission covering the resale of the shares. The registration statement was declared effective by the Securities and Exchange Commission on July 22, 2004. The 24-month term commences on the effective date of the registration statement. The purchase price of the shares will be 98% 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. We have placed 15,000,000 shares of common stock in escrow to facilitate drawdowns on the Standby Equity Distribution Agreement. To date, 3,232,388 shares of those have been issued. Any shares held in escrow toward drawdowns are not included in outstanding shares. Those shares not issued under drawdowns will be returned to the Company. Without drawing against the standby equity distribution agreement 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 operations 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 April 30, 2005, our total current assets decreased approximately $121,000 and total assets decreased approximately $157,000 from approximately $1,042,000 to approximately $886,000. The decrease in current assets is primarily due to use of cash for operational expenses during the quarter. The decrease in the remaining assets is due to depreciation taken on property and equipment. During the three months ended April 30, 2005, total current liabilities increased from approximately $3,582,000 to approximately $3,837,000. This net increase totaling approximately $255,000 to our current liabilities is attributed primarily to an increase to accounts payable of approximately $22,000, and an increase to accrued liabilities of approximately $254,000, offset by a decrease to notes payable of approximately $50,000. The increase in -19- accounts payable is from everyday operational expenses. The decrease in notes payable is from an increase in notes payable originated during the quarter totaling $40,000 offset by the repayment of $90,000 on a note payable using the proceeds from our Standby Equity Distribution Agreement. The increase in accrued expenses primarily is from the accrual of a Board of Director approved bonus to employees and certain consultants to be issued in restricted stock as well as the operational accruals for payroll and related payroll taxes. A total of $80,000 in notes payable were originated during the three months ended April 30, 2005, of which, $40,000 had been received by April 30, 2005. The remaining $40,000 is scheduled to be received on a monthly basis of $10,000 by the Company . The total amount borrowed is being used for general operational expenses. The $80,000 in notes payable originated during the three months ended April 30, 2005 is convertible at $0.04 per share which was the market value of our common stock on the date of origination. Results of Operations To date, we have been a development stage company and are just beginning to realize revenue from our planned operations. During the three months ended April 30, 2005 we realized approximately $32,000 in revenue generated through our DES(TM) with hotel guests purchasing Internet access, video content, and games. We began to install our DES(TM) into a signed contract during the fourth quarter of our fiscal year ended October 31, 2004 and finished installation during November 2004. Cost of goods sold for the three months ended April 30, 2005 totaled approximately $23,000 resulting in gross profit for the three months of approximately $9,000. Cost of goods sold consists primarily of the variable content cost for each usage and the fixed costs of interest on an equipment lease. The Hotel is currently undergoing a major renovation. As we continue to add content to the system and the hotel completes its renovation we anticipate that revenue will increase and the resulting gross profit and gross profit percentage will increase. For the three months ended April 30, 2005, operational expenses increased approximately $198,000, or approximately 66 percent, as compared to the three months ended April 30, 2004. This is attributed primarily to an increase in salaries, payroll taxes, and employee benefits as well as technology development expenses of approximately $180,000, due to the Board of Directors approving a bonus to employees and certain consultants. The bonus was accrued during the three months ended April 30, 2005 and will be issued in restricted stock when administratively possible. Also contributing to the increase in expenses was an increase in depreciation and amortization of approximately $29,000. During the three months ended April 30, 2005, non operating expenses decreased approximately $285,000 as compared to the three months ended April 30, 2004 primarily from a the decrease of interest and beneficial conversion expense of approximately $111,000 a decrease of approximately $64,000 in expenses for stock options for services and acquiring debt and the decrease of approximately $97,000 from a legal settlement during the three months ended April 30, 2004. We also had an increase in our non operating expenses of approximately $52,000, which included additional expenses recorded for the issuance of options with notes payable combined with interest from a capital lease and interest expense from a compensation debenture that the Company did not have in the prior year. In the prior year the company granted bonus interest on extensions of debt which increased interest expense. -20- Management anticipates that as we scale up the installation of our DES(TM), 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 Net Operating Loss As of April 30, 2005, we have, together with our subsidiaries, accumulated a net operating loss carryforward of approximately $9,000,000, with an operating loss tax benefit of approximately $3,356,000. 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 2025. 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. 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 included our issuing 80,000 shares of common stock and payments totaling $70,000 as follows: $10,000 at execution of the agreement and $5,000 per month beginning May 1, 2004 and continuing until paid in full. During the quarter ended April 30, 2005 we forwarded the balance of the necessary payments. -21- 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 sought $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. On June 2, 2003, we 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 we filed a multi count civil complaint against the privately held company. The $100,000 fee is included in other assets at April 30, 2005 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. 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. 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 April 30, 2005, we issued an aggregate of 2,040,431 shares of common stock. Of the total 46,667 shares were unregistered. We issued 16,667 shares under an agreement negotiated under a note payable. We also issued 30,000 shares under a legal settlement completed in a prior year which had been accrued but the shares had not been issued. The aforementioned shares were issued without registration under the Securities Act of 1933 in reliance on the exemption from such registration requirements provided by Section 4(2) of that Act. The shares were issued without general advertising or solicitation and purchasers acknowledged that they were acquiring restricted securities which had not been registered under the Securities Act. Certificates representing the shares bear the usual and customary restricted stock legend. -22- 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 13, 2004 we are in default on notes payable due to ISOZ, LC. totaling $215,000 and related accrued interest. On March 29, 2005 the Company received a demand letter regarding the $215,000 in notes payable to ISOZ, LC. The Company has forwarded certain documentation over to federal authorities toward their examination and investigation regarding the origination of the $215,000 in notes payable to the Company and certain other transactions including the origination of the borrowed funds. The Company will work with the federal authorities and rely on their examination and investigation in determining the actions the Company will take in response to this demand notice. Also during the quarter ended April 30, 2005, the Company received a demand notice for collection of a note payable totaling $80,000. The Company is currently reviewing anticipated cash inflows to determine a time-frame for repayment of the note payable. The notes payable have maturities as follows: $20,000 matured during October 2002, $335,000 matured during November 2002, $30,000 matured during January 2003, $719,800 matured during August 2003, $25,000 matured during November 2003, $15,000 matured during September 04, $605,000 is callable on demand when the Company has secured between $1 million and $5 million in new debt or equity funding, $75,000 is due June 2005, $250,000 is due during July 2005, $40,000 is due on demand no earlier than September 2005, $100,000 has no set maturity and is payable until paid in full and $150,000 is due on a set schedule of $10,000 per week beginning in during July 2005 until paid in full using advances under the Company's Standby Equity Line for repayment. 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 This Item is not applicable. -23- 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: June 20, 2005 BY: /S/ CORTNEY TAYLOR ------------------------------------ CORTNEY TAYLOR Chief Financial Officer (Principal accounting Officer) Date: June 20, 2005 -24-