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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended January 2, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________.
Commission file number: 0-24548
MOVIE GALLERY, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-1120122
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
739 W. Main Street, Dothan, Alabama 36301
(Address of principal executive offices) (Zip Code)
(334) 677-2108
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES X NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy statement or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 10, 2000, was approximately $24,922,631. The number
of shares of Common Stock outstanding on March 10, 2000, was 12,119,667 shares.
Documents incorporated by reference:
1.Notice of 2000 Annual Meeting and Proxy Statement (Part III of Form 10-K).
- --------------------------------------------------------------------------------
The exhibit index to this report appears at page 28.
ITEM 1. BUSINESS
General
As of March 10, 2000, Movie Gallery, Inc. (the "Company") owned and
operated 954 video specialty stores located in 31 states that rent and sell
videocassettes and video games. Since the Company's initial public offering in
August 1994, the Company has grown from 97 stores to its present size through
acquisitions and the development of new stores. The Company is among the three
largest video specialty retailers in the United States.
The Company was incorporated in Delaware in June 1994 under the name Movie
Gallery, Inc. From March 1985 until the present time, substantially all of the
Company's operations have been conducted through its wholly-owned subsidiary,
M.G.A., Inc. The Company's executive offices are located at 739 W. Main Street,
Dothan, Alabama 36301, and its telephone number is (334) 677-2108.
Video Industry Overview
Video Retail Industry. According to Paul Kagan Associates, Inc. ("Paul
Kagan"), the home video rental and sales industry has grown from $0.7 billion in
revenue in 1982 to a projected $18.5 billion in 1999 and is projected to reach
$23.3 billion by 2009. Paul Kagan estimates that in 1999 consumers rented
approximately 3.4 billion videos, a 6% increase over 1998, and purchased more
than 750 million videos. Growth in videos sold has exceeded 15% per year over
the past decade, according to Paul Kagan. In fact, at the end of 1999 over 85%
of all television households owned a videocassette recorder ("VCR") and total
VCR penetration is expected to reach 90% by 2003, according to Paul Kagan. In
addition, total VCR sales in the U.S. have increased in each year during the
decade of the 1990s and are estimated to have reached 20.5 million units in
1999, the highest level ever, according to Paul Kagan. The growth in VCR sales
has been fueled by the low retail price for VCRs, which averaged approximately
$185 in 1999.
The video retail industry is highly fragmented and continues to experience
consolidation pressures. Trends toward consolidation have been fueled by the
competitive impact of superstores on smaller retailers, the need for enhanced
access to working capital and efficiencies of scale. The Company believes that
the video specialty store industry will continue to consolidate into regional
and national chains. While many of the largest retail chains posted same-store
revenue growth in both 1998 and 1999, industry sources speculated that many
independent operators struggled to maintain market share. The combination of
revenue sharing and other copy depth opportunities and increased marketing
efforts have solidified the positions of the largest retail chains versus
independent operators over the past couple of years.
The domestic video retail industry includes both rentals and sales of
videocassettes; however, the majority of revenue is generated through the rental
of prerecorded videocassettes. There are three primary pricing strategies that
the movie studios use to influence the relative levels of videocassette rentals
versus sales. First, videocassettes can be priced at relatively high levels,
typically between $60 and $75 ("rental priced movies"). These movies are
purchased by video specialty stores and are promoted primarily as rental titles.
Second, videocassettes can be priced at relatively low levels, typically between
$5 and $25 ("sell-through movies"). These movies are purchased by video
specialty stores and generally promoted for both rental and new videocassette
sales. Third, movie studios have developed revenue sharing and other copy depth
programs. Movies purchased under revenue sharing and other copy depth programs
result in larger quantities available to meet consumer demand. Movie studios
attempt to maximize total revenue from videocassette releases via the combined
utilization of all three pricing structures.
2
The concept of revenue sharing and risk sharing between major retailers and
the movie studios was embraced by the industry in 1998 and continued to grow
during 1999. Revenue sharing is a concept whereby retailers and movie studios
share the risks associated with the rental performance of individual titles.
Generally, retailers pay a small upfront fee for each copy leased under revenue
sharing, typically $0 to $10. As the movies are rented by consumers, the movie
studio receives a percentage of the revenue generated based on a predetermined
formula, which is generally less than fifty percent. After a period of time,
generally six months to a year, these movies are no longer subject to revenue
sharing and are either owned outright by the retailer, purchased from the movie
studio for a nominal amount or returned to the studio. Revenue sharing allows
retailers to vastly increase both copy depth and breadth for the consumers.
According to Paul Kagan, retail revenue generated via revenue sharing deals
increased from just $211 million in 1997 to approximately $3.7 billion in 1999,
and is expected to reach $4.5 billion during 2000.
The increase in sell-through priced movies and revenue sharing programs has
greatly increased the availability of previously viewed movies. These movies are
made available to the consumer for sale once initial rental demand is met.
Movie Studio Dependence on Video Rental Industry. The videocassette rental
and sales industry is the largest single source of domestic revenue to movie
studios and independent suppliers of theatrical and direct-to-video movies and,
according to Paul Kagan, represented approximately $7.4 billion, or 49%, of the
$15.2 billion of revenue generated in 1999. The Company believes that of the
many movies produced by major studios and released in the United States each
year, relatively few are profitable for the studios based on box office revenue
alone. In addition to purchasing box office hits, video specialty stores provide
the movie studios with a reliable source of revenue for a large number of their
movies by purchasing movies on videocassette that were not successful at the box
office. The Company believes the consumer is more likely to view movies which
were not box office hits on a rental videocassette than on any other medium
because video specialty stores provide an inviting opportunity to browse and
make impulse choices among a very broad selection of movie titles. In addition,
the Company believes the relatively low cost of video rentals encourages
consumers to rent films they might not pay to view at a theater.
Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenue by releasing movies in sequential release date "windows" to various
movie distribution channels. These distribution channels include, in the
customary order of release date, movie theaters, airlines and hotels, video
specialty stores, pay-per-view satellite and cable television systems
("Pay-Per-View"), premium cable television, basic cable television and, finally,
network and syndicated television. (See "Business -- Competition and
Technological Obsolescence") The Company believes that this method of sequential
release has allowed movie studios to increase their total revenue with
relatively little adverse effect on the revenue derived from previously
established distribution channels and it is anticipated that movie studios will
continue the practice of sequential release even as near video on demand
("NVOD") and, eventually, video on demand ("VOD") become more readily available
to the consumer. Most movie studios release hit movie videocassettes to the home
video market from 30 days to 80 days (extending up to 120 days for certain
titles priced for sale rather than rental) prior to the Pay-Per-View release
date. This proprietary window of release from the movie studios shows the level
of commitment to the home video industry and is indicative of the importance of
this channel of distribution to the overall profitability of movie studios and
other independent movie suppliers.
3
Growth Strategy
During the fiscal years 1994 through 1996, approximately 78% of the
Company's growth in total number of stores occurred through the acquisition of
stores and the balance occurred through the development of new stores. The
Company spent all of 1997 and much of 1998 absorbing the large increase in the
number of stores which began in 1994. During 1999, the Company began to ramp up
its new store development efforts and closed the year having opened 53
internally-developed stores. In addition, during 1999 the Company acquired 131
stores, including 88 stores previously operated by Blowout Entertainment, Inc.
("Blowout"). For 2000, the Company intends to open approximately 100 new stores
and will evaluate acquisition opportunities that arise. However, the Company
anticipates that most of its store growth in 2000 will come in the form of
internally-developed stores. The Company's ability to execute its stated growth
strategy will be dependent upon its ability to generate cash flow from
operations. The key elements of the Company's development and acquisition
strategy include the following:
Development. From January 1, 1994 through March 10, 2000, the Company has
developed 301 stores. The Company utilizes store development to complement its
existing base of stores in rural and secondary markets where it finds attractive
locations and a sufficient population to support additional video specialty
stores. The Company attempts to develop real estate in 3,000 to 5,000 square
foot locations primarily in towns with populations from 3,000 to 60,000.
Although developed stores generally require approximately one year for revenue
to reach the level of a mature store, they typically become profitable within
the first six months of operations and produce greater returns on investment
than acquired stores.
The Company's real estate and construction departments are responsible for
new store development, including site selection, market evaluation, lease
negotiation and construction. The Company usually acts as the general contractor
with respect to the construction of its new stores and, in that regard, employs
full-time construction managers who have significant video specialty store
construction experience.
Set forth below is a historical summary showing store openings,
acquisitions and store closings by the Company since January 1, 1994.
Fiscal Year Ended
Year Ended ------------------------------------------------
December 31, January 3
-------------- January 5, January 4, January 3, January 2, to March 10,
1994 1995 1997 1998 1999 2000 2000
---- ---- --------- --------- --------- --------- -----------
New store openings 25 66 75 50 18 53 14
Stores Acquired 196 327 174(1) 2 4 131 --
Stores Closed 2 23 48 59 41 58 23
Total Stores at End
of Period 292 662 863 856 837 963 954
- -------------------
(1) Includes 98 stores acquired on July 1, 1996 and accounted for as
poolings-of-interests. Store counts, prior to the fiscal year ended January
5, 1997, have not been restated for purposes of this table.
Acquisitions. From January 1, 1994 through March 10, 2000, the Company
acquired 834 stores. Acquisitions permitted the Company to quickly gain market
share and experienced management in markets that the Company believed had
potential for growth. Through a combination of volume purchase discounts, larger
advertising credits, more efficient inventory management and lower average labor
costs, the Company believes it is generally able to operate these acquired
stores more profitably than their prior owners, typically single store or small
chain operators. During 2000, the Company intends to evaluate acquisition
opportunities that may arise, but anticipates that most of its store growth will
result from internally-developed stores.
If future store acquisitions occur, target stores will be selected based
upon location, quality of operations and financial criteria as determined by the
Company to be consistent with its growth strategy. In connection with future
acquisitions, the Company anticipates that some of the owners and most of the
key personnel will be employed by the Company. Historically, the owners of the
stores acquired by the Company have entered into noncompetition agreements with
the Company which are generally for a five- to ten-year term.
4
During May 1999, the Company purchased the assets and assumed the leases of
88 Blowout stores for an aggregate purchase price of approximately $2.4 million.
The majority of Blowout stores operate within Wal-Mart Supercenters. The Company
anticipates that other acquisition opportunities may arise in the future.
However, there can be no assurance that future acquisition opportunities will be
available or that the integration of future acquisitions will not materially and
adversely affect the Company.
Operating Strategy
Focus on Smaller Markets. Generally, the Company's stores are located in
small towns or suburban areas surrounding mid-sized cities. In these areas, the
Company's principal competition usually consists of single store or small chain
operators who have less buying power, smaller advertising budgets and generally
offer fewer copies of new release videocassettes. The Company attempts to become
the leading video retailer in its markets and believes that it can achieve a
higher return on invested capital in these smaller markets than it could in the
larger urban areas because of the reduced level of competition and lower
operating costs.
Market Concentration. By concentrating its new store development in and
around existing markets, the Company is able to achieve operating efficiencies,
primarily consisting of cost savings relating to advertising, training and store
supervision.
New Market Development. The Company has begun to target new markets in
which to develop stores. Most of the new markets are located within states that
are either contiguous to states in which the Company has stores or states that
have not reached full market penetration.
New Release Purchases. The Company actively manages its new videocassette
purchases in order to balance customer demand with the maximization of
profitability. Buying decisions are made centrally which allows the Company to
obtain volume discounts, market development funds and cooperative advertising
credits that are generally not available to single store or small chain
operators.
Centralized Operations. In order to increase operating efficiency, the
Company centrally manages labor costs, real estate costs, accounting, cash
management and collections and utilizes centralized purchasing, advertising and
information systems. Company-wide operational standards help ensure a high
degree of customer service and visually appealing stores.
Store Location and Format. The Company maintains a flexible store format,
tailoring the size, inventory and look of each store to local demographics. The
Company's stores, with the exception of its store-within-a-store units,
generally range from approximately 2,000 to 9,000 square feet (averaging
approximately 4,700 square feet), with inventories ranging from approximately
4,000 to 15,000 videocassettes. Most of the Company's stores are located in
strip centers, anchored by major grocery or discount drug store chains, which
provide easy access, good visibility and high traffic.
5
Movie Gallery Stores
At March 10, 2000, the Company owned and operated 954 stores, all but one
of which were located in leased premises. The following table provides
information at March 10, 2000, regarding the number of Company stores located in
each state.
Number
Of
Stores
------
Alabama............................. 144
Florida............................. 119
Texas .............................. 95
Georgia............................. 82
Virginia............................ 59
Tennessee........................... 49
Ohio................................ 46
Maine............................... 44
Indiana............................. 37
Mississippi ........................ 37
Missouri............................ 32
Wisconsin........................... 31
South Carolina ..................... 31
Kentucky............................ 23
Kansas.............................. 18
North Carolina...................... 18
Louisiana........................... 17
New Hampshire....................... 14
Massachusetts....................... 14
Illinois............................ 11
Oklahoma............................ 10
Pennsylvania........................ 5
Iowa................................ 4
Arkansas............................ 3
Connecticut......................... 3
California.......................... 2
Michigan............................ 2
New York............................ 1
Colorado............................ 1
W. Virginia......................... 1
Vermont............................. 1
-----
TOTAL........................ 954
=====
The Company's stores are generally open seven days a week, from 10:00 a.m.
to 11:00 p.m. on weekends and from 10:00 a.m. to 10:00 p.m. on weekdays. The
store fixtures, equipment and layout are designed by the Company to create a
visually-appealing, up-beat ambiance, which is augmented by a background of
television monitors displaying MGTV (Movie Gallery Television), which shows
movie previews and promotions of coming attractions, and by posters and stand-up
displays promoting specific movie titles. Movies are arranged in attractive
display boxes organized into categories by topic, except for new releases, which
are assembled alphabetically in their own section for ease of selection by
customers.
6
The Company's policy is to constantly evaluate its existing store base to
determine where improvements may benefit the Company's competitive position. In
negotiating its leases and renewals, the Company attempts to obtain short lease
terms to allow for the mobility necessary to react to changing demographics and
other market conditions. The current average remaining life of the Company's
leases is approximately two years with approximately 300 leases considered for
renewal each year. The Company actively pursues relocation opportunities to
adapt to market shifts. Similarly, the Company may elect to expand and/or
remodel certain of its stores in order to improve facilities, meet customer
demand and maintain the visual appeal of each store. In order to maximize
profits, the Company varies the quantity of its new release inventory, the
rental and sales prices for videocassettes and video games and the rental period
for catalog titles from location to location to meet competition and demographic
demand in the area. The Company generally has a one-day rental term for new
release movies less than 90 days old (five days for titles greater than 90 days
old), which tends to keep new releases more readily available and requires the
purchase of fewer copies of new releases than a two-day rental policy. Video
games generally have a five-day rental term for both the most recent new
releases and older titles.
Products
For the fiscal year ended January 2, 2000, over 85% of the Company's rental
revenue was derived from the rental of movies on videocassettes and digital
video discs (DVDs), with the remainder being derived primarily from the rental
of video games. Substantially all of the Company's revenue from product sales
during this period was derived from the sale of new and previously viewed
videocassettes, confectionery items and video accessories, such as blank
cassettes, cleaning equipment and movie memorabilia.
The Company's stores generally offer from 4,000 to 15,000 movies and from
200 to 1,000 video games for rental and sale, depending upon location. New
release movies are displayed alphabetically and older titles are displayed
alphabetically by category, such as "Action," "Comedy," "Drama" and "Children."
Buying decisions are made centrally and are based on box office results, actual
rental history of comparable titles within each store and industry research.
During 1999 and early 2000, the Company rolled out DVD product for rental
and sale to all Company stores. During December 1999, DVD revenues accounted for
approximately 2% of total revenues for the Company. This product area is growing
rapidly and the Company intends to follow the desires of its consumers for DVD
by expanding its product offerings of DVD over time. Because of the ease of use
and durability of DVD, it is anticipated that eventually DVD may replace
videocassettes. The Company anticipates that when recordable DVD hardware is
available to the public at a reasonable price, this product area could grow at
an accelerated pace.
Videocassettes, DVDs and video games utilized as initial inventory in the
Company's developed stores consist of excess copies of older titles and new
release titles from existing stores, supplemented as necessary by purchases
directly from suppliers. This inventory for developed stores is packaged at the
Company's processing and distribution facility located in Dothan, Alabama. Each
videocassette and video game is removed from its original packaging, and an
optical bar code label, used in the Company's computerized inventory system, is
applied to the plastic rental case. The cassette is placed in the rental case,
and a display carton is created by inserting foam or cardboard into the original
packaging and shrink-wrapping the carton. The repackaged videocassettes, video
games and display cartons are then shipped to the developed store ready for use.
Management believes that internal factors which most affect a typical
store's revenues are its new release title selection and the number of copies of
each new release available for rental as compared to the competition. The
Company is committed to offering as many copies and the widest variety of new
releases as necessary to be competitive within a market, while at the same time
keeping its costs as low as possible. New videocassettes offered for sale are
primarily "hit" titles promoted by the studios for sell-through, as well as
special interest and children's titles and seasonal titles related to particular
holidays.
7
In an effort to provide more depth of copy on hit titles to better satisfy
initial customer demand, the Company has continued to pursue direct
relationships with major and independent studios providing product copy depth
programs. These programs have lowered the average per unit cost of rental
inventory and permit the Company to carry larger levels of new release inventory
while making available more titles that were previously unaffordable. Thus, the
Company has pursued such opportunities and believes that during late 1998 and
1999, these programs had a positive impact on revenues by helping to retain the
existing customer base and attract new customers. There can be no assurance that
studios will continue to offer such programs or that such programs will continue
to have positive results.
The Company rents and sells video games, which are licensed primarily by
"Nintendo," "Sony" and "Sega." Game rentals as a percentage of the Company's
total revenues have increased since early 1997 due to the increase in the
installed base of 32-bit and 64-bit game platforms. Sega launched the 128-bit
Dreamcast system in September 1999. Sony is expected to release a backward
compatible 128-bit PlayStation 2 system in September 2000. The Company expects
the video game rental portion of the business to be flat during the transition
to the 128-bit platform, while the sales portion of its business will continue
to grow during 2000.
Videocassette and Video Game Suppliers
During 1999, the Company purchased its videocassettes/DVDs and video games
for rental and its movies held for sale from three primary vendors, Major Video
Concepts, Inc. ("MVC"), Ingram Entertainment, Inc. ("Ingram") and Valley Media,
Inc. ("Valley"), respectively. During early 2000, the Company consolidated its
vendor relationships through changing its primary videocassette/DVD movie rental
distributor from MVC to Ingram. During 1999, the Company spent approximately 60%
of its purchasing budget with its three primary suppliers and the balance
directly with studios and secondary vendors. Because of revenue sharing and the
impact it has had on distributors, the Company believes that if one of its
primary distributors were unable or unwilling to continue the contractual
relationship with the Company a viable replacement can be found without
materially adversely impacting the Company's business.
Since a majority of the Company's rental movie inventory is purchased under
contract directly from various studios, the importance of the distributor
relationships has been somewhat diminished. Generally, the relationships with
distributors for product directly purchased from the studios is one of
fulfillment agent. The Company pays the distributor a flat fulfillment fee for
the distributors to pack and ship product directly to the Company's stores. The
price paid directly to studios for each title varies and depends on whether the
movie is priced to encourage rental or sale to consumers as discussed earlier.
The components of the cost of a title to the Company would generally be a small,
upfront fee paid to the studio, revenue sharing expenses and end-of-term buyouts
that transfer the ownership of the product to the Company after a pre-determined
period of time, generally six months.
Being one of the top three video retailers in the United States, the
Company believes its relationships with the movie studios are strong. While the
content providers will always have the most control in the supplier-retailer
relationship, the Company believes the studios have a vested interest in the
Company's success, not only because of the impact of revenue sharing but also
because of the competitive landscape within the video retail industry. Having
one or more viable competitors to the industry leader enables the studios to
maintain a balance within the retailer and studio relationship. The Company
believes that its position is a positive force in interacting with studios and
forging partnerships for the future.
8
Several companies acquired by the Company had pre-existing long-term
contracts with Rentrak Corporation ("Rentrak") whereby product would be provided
under pay-per-transaction revenue sharing arrangements. During late 1996, the
Company consolidated existing contracts with Rentrak into one national
agreement. Under this ten-year agreement, the Company has a minimum gross annual
purchase commitment in revenue sharing, handling fees, sell-through fees and
end-of-term buyouts. The Company utilizes Rentrak on a selective title by title
basis. The Company has exceeded the minimum purchase requirements in each year
since 1996.
Marketing and Advertising
The Company uses market development funds and cooperative allowances from
its suppliers and movie studios to purchase radio advertising, direct mail,
newspaper advertising, in-store visual merchandising and in-store media to
promote new releases. The video specialty stores and the Company's trade name
are promoted along with the appropriate suppliers' product. Creative copy is
prepared by the Company and the studios, with advertising being placed by
in-house media buyers. Expenditures for marketing and advertising above the
amount of the Company's advertising allowances from its suppliers and movie
studios have been minimal. The Company anticipates that it will continue to make
substantial marketing and advertising expenditures, and that movie studios will
continue to support such expenditures. The Company also benefits from the
advertising and marketing by studios and theaters in connection with their
efforts to promote films and increase box office revenue. The Company prepares a
monthly consumer magazine called Video Buzz and a customized video program
(MGTV), both of which feature Company programs, promotions and new releases.
Information Systems
The Company utilizes a proprietary point-of-sale ("POS") system. The POS
system provides detailed information with respect to store operations (including
the rental history of titles and daily operations for each store) which is
telecommunicated to the corporate office on a daily basis. The POS system is
installed in all developed stores prior to opening, and the Company installs the
system in all acquired stores shortly after the closing of the acquisition.
The Company's POS system records all rental and sale information upon
customer checkout using scanned bar code information and updates the information
when the videocassettes and video games are returned. This POS system is linked
to a management information system ("MIS") at the corporate office. Each night
the POS system transmits store data into the MIS where all data is processed,
generating reports which allow management to effectively monitor store
operations and inventory, as well as to review rental history by title and
location to assist in making purchasing decisions with respect to new releases.
The POS system also enables the Company to perform its monthly physical
inventory using bar code recognition.
In addition, during the last three years the Company has installed a
financial reporting system, relating to the general ledger, human
resources/payroll, revenue and accounts payable functions, capable of handling
the Company's current needs and anticipated growth. Additional systems which
have been developed and implemented by the Company include a Collections system
and a Processing/Distribution Center system.
E-Commerce Initiative
During 1999 the Company developed and released to the general public its
e-commerce business, located at www.moviegallery.com. The Company has developed
a consumer-oriented, on-line business that sells new and used movies and games
to consumers. The Company's main goal with MovieGallery.com is to strengthen its
existing relationship with its millions of customers that frequent the Company's
brick and mortar stores. The Company has gathered in excess of 100,000 e-mail
addresses from Movie Gallery customers and is actively marketing its immense
product library, in excess of 100,000 titles, to these customers. Due to
physical constraints within the stores, the Company can offer, at most, a few
hundred movie titles for sale to its customers. However, MovieGallery.com
enables consumers to find the exact movie of their choice by simply logging on
to www.moviegallery.com. Customer traffic and sales have grown consistently
since the inception of the business in September 1999.
9
The Company is currently testing special kiosk locations within a few
stores that encourage customers to shop online at MovieGallery.com within a
Movie Gallery store. If successful, the Company believes that, not only will
customers have a greater incentive to shop with the Company, but the Company can
develop partnerships with other vendors to market their e-commerce businesses
within the Company's brick and mortar stores.
The Company does not intend to spend a disproportionate amount of capital
on its e-commerce business. The Company currently has budgeted approximately $1
million in expenditures to run this business during the year 2000. The Company
believes that this more moderate approach to developing its on-line business
will build strong customer loyalty for the Movie Gallery concept without
materially diminishing the Company's future earnings.
Competition and Technological Obsolescence
The video retail industry is highly competitive, and the Company competes
with other video specialty stores, including stores operated by other regional
chains and national chains such as Blockbuster Video ("Blockbuster"), and with
other businesses offering videocassettes and video games such as supermarkets,
pharmacies, convenience stores, bookstores, mass merchants, mail order
operations and other retailers. Approximately 30% of the Company's stores
compete with stores operated by Blockbuster. In addition, the Company competes
with all forms of entertainment, such as movie theaters, network and cable
television, direct broadcast satellite television, Internet-related activities,
live theater, sporting events and family entertainment centers. Some of the
Company's competitors have significantly greater financial and marketing
resources and name recognition than the Company.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of each new release available, customer service and, to a lesser extent,
pricing. The Company believes it generally offers superior service, more titles
and more copies of new releases than most of its competitors.
The Company also competes with Pay-Per-View in which subscribers pay a fee
to view a movie selected by the subscriber. Recently developed technologies,
referred to as NVOD, permit certain cable companies, direct broadcast satellite
companies (such as Direct TV), telephone companies and other telecommunications
companies to transmit a much greater number of movies to homes throughout the
United States at more frequent intervals (often as frequently as every five
minutes) throughout the day. NVOD does not offer full interactivity or VCR
functionality, such as allowing consumers to control the playing of the movie
(i.e., starting, stopping and rewinding). Ultimately, further improvements in
these technologies could lead to the availability to the consumer of a broad
selection of movies on demand, referred to as VOD, at a price which may be
competitive with the price of videocassette rentals and with the functionality
of VCRs. Certain cable and other telecommunications companies have tested and
are continuing to test limited versions of NVOD and VOD in various markets
throughout the United States and Europe.
10
The advent of DVD may result in consumers purchasing more films than in the
past, which could have a material adverse effect on the Company's rental volume
and, as a result, on its profit margins. While DVD may in the future supplant
VHS videocassettes as the preferred rental and purchase medium, there are a few
hardware and content issues that will probably lengthen the time horizon for
full DVD acceptance. In the near term, hardware costs for non-recordable DVD
technologies are expected to remain higher than VCRs. Although recordable DVD
players should be introduced in late 2000 or 2001, the estimated cost of these
players is significantly higher than current VCRs. Finally, while DVD title
releases continue to grow, hit titles are released to the VHS videocassette
format on average before they are released to the DVD format and in no instance
has a title been released to DVD before being released on the VHS videocassette.
Whether or not DVD replaces VHS is not an overriding concern to the Company. The
Company anticipates that it will react to changing consumer format demands and
intends to provide its customers with the rental medium demanded over time.
The Company believes movie studios have a significant interest in
maintaining a viable movie rental business because the sale of videocassettes to
video retail stores currently represents the studios' largest source of domestic
revenue. Specifically, video stores provide the best medium for movie studios to
market their non-box office hit titles ("B movies"), which either produce less
than $5 million in box office receipts upon theatrical release or are not
released theatrically. These B movies comprise a large portion of total studio
revenues, and video retailers are responsible for a majority of that revenue.
Consumers, while browsing the new release section, will many times choose to
watch a B movie even though they did not have the specific movie in mind when
they entered the store. Pay-per-view, NVOD and VOD do not currently nor are
anticipated to be able to provide the type of impulse marketing benefits that
video stores provide related to B movies. As a result, the Company anticipates
that movie studios will continue to make movie titles available to Pay-Per-View,
cable television or other distribution channels only after revenues have been
derived from the sale of videocassettes, and perhaps digital disks, to video
stores. In addition, the Company believes that for Pay-Per-View television to
match the low price, viewing convenience and selection available through video
rental, substantial capital expenditures and further technological advances will
be necessary. Although the Company does not believe NVOD or VOD represent a
near-term competitive threat to its business, technological advances and broad
consumer availability of NVOD and VOD or changes in the manner in which movies
are marketed, including the earlier release of movie titles to Pay-Per-View,
cable television or other distribution channels, could have a material adverse
effect on the Company's business.
Employees
As of March 10, 2000, the Company employed approximately 7,300 persons
referred to by the Company as "associates," including approximately 7,000 in
retail stores and the remainder in the Company's corporate offices, field staff
and distribution facility ("Support Center Staff"). Of the retail associates,
approximately 1,500 were full-time and 5,500 were part-time. One recently
acquired store is represented by a labor union, however, none of the Company's
other associates are represented by a labor union, and the Company believes that
its relations with its associates are good.
Each of the Company's stores typically employs five to fifteen persons,
including one Store Manager and, in larger stores, one Assistant Manager. Store
Managers report to District Managers who supervise the operations of 10 to 15
stores. The District Managers report to one of ten Regional Managers, who report
directly to the Company's Senior Vice President - Store Operations. As the
Company has grown, it has increased the number of District Managers and Regional
Managers. The Support Center Staff has regular and periodic meetings with the
Regional Managers and District Managers to review operations. Compliance with
the Company's policies, procedures and regulations is monitored on a
store-by-store basis through quarterly quality assurance audits performed by
District Managers. The performance and accuracy of the quarterly District
Manager audits is monitored by the Company's quality assurance function.
The Company has an incentive and discretionary bonus program pursuant to
which retail management personnel receive quarterly bonuses when stores meet or
exceed criteria established under the program. Management believes that its
program rewards excellence in management, gives associates an incentive to
improve operations and results in an overall reduction in the cost of
operations. In addition, District Managers, Regional Managers and certain
Support Center Staff are eligible to receive discretionary bonuses, based on
individual and Company performance, and options to purchase shares of the
Company's common stock (exercisable at the fair market value on the date of
grant), subject to service requirements.
11
Cautionary Statements
The "BUSINESS" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS" sections of this Report contain certain
forward-looking statements regarding the Company. These statements are subject
to certain risks and uncertainties, including those identified below, which
could cause actual results to differ materially from such statements. The words
"believe", "expect", "anticipate", "intend", "aim", "will", "should" and similar
expressions identify forward-looking statements. Readers are cautioned not to
place undue reliance on these forward-looking statements, which speak only as of
the date on which they are made. The Company desires to take advantage of the
"safe harbor" provisions of the Private Securities Litigation Reform Act of 1995
and in that regard is cautioning the readers of this Report that the following
important factors, among others, could affect the Company's actual results of
operations and may cause changes in the Company's strategy with the result that
the Company's operations and results may differ materially from those expressed
in any forward-looking statements made by, or on behalf of, the Company.
Growth Strategy. The Company's long-term strategy is to grow primarily
through new store openings and secondarily through acquisitions of existing
stores. Successful implementation of the strategy is contingent on numerous
conditions, some of which are described below, and there can be no assurance
that the Company's business plan can be executed. The acquisition of existing
stores and the opening of new stores require significant amounts of capital. In
the past, the Company's growth strategy has been funded through proceeds
primarily from public offerings of common stock, and secondarily through bank
debt, seller financing, internally generated cash flow and use of the Company's
common stock as acquisition consideration. These and other sources of capital,
including public or private sales of debt or equity securities, may not be
available to the Company in the future.
New Store Openings. The Company's ability to open new stores may be
adversely affected by the following factors, among others: (i) its availability
of capital; (ii) its ability to identify new sites where the Company can
successfully compete; (iii) its ability to negotiate acceptable leases and
implement cost-effective development plans for new stores; (iv) its ability to
hire, train and assimilate new store managers and other personnel; and (v) its
ability to compete effectively against competitors for prime real estate
locations.
Acquisitions. The Company's ability to consummate acquisitions and operate
acquired stores at the desired levels of sales and profitability may be
adversely affected by: (i) the inability to consummate identified acquisitions,
which may result from a lack of available capital; (ii) the reduction in the
size of the pool of available sellers; (iii) the inability to identify
acquisition candidates that fit the Company's criteria (such as size, location
and profitability) and who are willing to sell at prices the Company considers
reasonable; (iv) more intensive competition to acquire the same video specialty
stores the Company seeks to acquire; (v) an increase in price for acquisitions;
(vi) misrepresentations and breaches of contracts by sellers; (vii) the
Company's limited knowledge and operating history of the acquired stores; (viii)
the replacement of purchasing and marketing systems of acquired stores; and (ix)
the integration of acquired stores' systems into the Company's systems and
procedures.
12
Same-Store Revenues Increases. The Company's ability to maintain or
increase same-store revenues during any period will be directly impacted by the
following factors, among others, which are often beyond the control of the
Company: (i) increased competition from other video stores, including large
national or regional chains, supermarkets, convenience stores, pharmacies, mass
merchants and other retailers, which might include significant reductions in
pricing to gain market share; (ii) competition from other forms of entertainment
such as movie theaters, cable television, Internet-related activities and
Pay-Per-View television, including direct satellite television; (iii) the
development and cost-effective distribution of movie and game rentals via an
in-home medium, such as the home computer, television or any other electronic
device either available today or in the future, which would compete with the
current video store experience; (iv) the weather conditions in the selling area;
(v) the timing of the release of new hit movies by the studios for the video
rental market; (vi) competition from special events such as the Olympics or an
ongoing major news event of significant public interest; and (vii) a reduction
in, or elimination of, the period of time between the release of hit movie
videocassettes to the home video market and the release of these hit movies to
the Pay-Per-View markets (the "release window"), currently 30 to 80 days.
Income Estimates. The Company's ability to meet its income projections for
any period are dependent upon many factors, including the following, among
others: (i) reductions in revenues caused by factors such as those listed under
"Same-Store Revenues Increases" above; (ii) the extent to which the Company
experiences an increase in the number of new competitive openings, which tends
to divide market share and reduce profitability in a given trade area; (iii) the
extent to which the movie studios substantially alter the current revenue
sharing or copy depth programs that results in either the overall per unit cost
increasing materially or the Company substantially reducing the amount of
product facings that it provides its customers on a weekly basis; (iv) changes
in the prices for the Company's products or a reduction in, or elimination of,
the videocassette release window as compared to Pay-Per-View, NVOD or VOD, as
determined by the movie studios, could result in a competitive disadvantage for
the Company relative to other forms of distribution; (v) the Company's ability
to control costs and expenses, primarily rent, store payroll and general and
administrative expenses; (vi) the extent to which the Company experiences any
increase in the number of titles released from studios priced for sell-through,
which may tend to increase the satisfaction of demand through product sales
which carry lower profit margins than rental revenues; (vii) the Company's
ability to react and obtain other distribution sources for its products in the
event that the Company's primary suppliers are unable to meet the terms of their
contracts with the Company; and (viii) advancements and cost reductions in
various new technological delivery systems such as (a) Pay-Per-View cable
television systems and digital satellite systems offering NVOD or VOD; (b)
universal acceptance of DVD technology which might result in lower profit
margins and increased costs associated with higher inventory requirements; and
(c) other forms of new technology, which could affect the Company's profit
margins.
Directors and Executive Officers of the Company
Name Age Position(s) Held
- ---- --- ----------------
Joe Thomas Malugen(1) 48 Chairman of the Board and Chief Executive Officer
H. Harrison Parrish(1) 52 President and Director
William B. Snow(1)(2) 68 Vice Chairman of the Board
J. Steven Roy 39 Executive Vice President and Chief Financial Officer
S. Page Todd 38 Senior Vice President, Secretary and General Counsel
Keith A. Cousins 31 Senior Vice President - Real Estate/Development
William G. Guerrette, Jr. 40 Senior Vice President - E-Commerce
Steven M. Hamil 31 Senior Vice President - Finance and Chief Accounting Officer
Theodore L. Innes 50 Senior Vice President - Sales and Marketing
Richard R. Langford 43 Senior Vice President - Management Information Systems
Mark S. Loyd 44 Senior Vice President - Purchasing and Product Management
Jeffrey S. Stubbs 37 Senior Vice President - Store Operations
Sanford C. Sigoloff(2)(3) 69 Director
Philip B. Smith(2)(3) 64 Director
Joseph F. Troy (1)(3) 61 Director
- -------------------
(1) Member of Executive Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.
13
Mr. Malugen co-founded the Company in 1985 and has been its Chairman of the
Board and Chief Executive Officer since that time. Prior to the Company's
initial public offering in August 1994, Mr. Malugen had been a practicing
attorney in the States of Alabama and Missouri since 1978, but spent a majority
of his time managing the operations of the Company beginning in early 1992. Mr.
Malugen received a B.S. degree in Business Administration from the University of
Missouri-Columbia, his J.D. from Cumberland School of Law, Samford University
and his LL.M. (in Taxation) from New York University School of Law.
Mr. Parrish co-founded the Company in 1985 and has been its President and a
Director of the Company since that time. From December 1988 until January 1992,
Mr. Parrish was Vice President of Deltacom, Inc., a regional long distance
telephone provider. Mr. Parrish received a B.A. degree in Business
Administration from the University of Alabama.
Mr. Snow was elected Vice Chairman of the Board in July 1994, and he served
as Chief Financial Officer from July 1994 until May 1996. Since May 1996, Mr.
Snow has continued to serve as Vice Chairman of the Board and has served as a
consultant to the Company. Mr. Snow was the Executive Vice President and Chief
Financial Officer and a Director of Consolidated Stores Corporation, a publicly
held specialty retailer, from 1985 until he retired in June 1994. Mr. Snow is a
director of Homeland Stores, Inc., a publicly held company. Mr. Snow is a
Certified Public Accountant, and he received his Masters in Business
Administration from the Kellogg Graduate School of Management at Northwestern
University and his Masters in Taxation from DePaul University.
Mr. Roy was elected Senior Vice President - Finance and Principal
Accounting Officer in June 1995, was elected Chief Financial Officer in May 1996
and was elected Executive Vice President in March 1998. Mr. Roy was an
accountant with the firm of Ernst & Young LLP for the 11 years prior to joining
the Company. Mr. Roy is a Certified Public Accountant and received a B.S. degree
in Business Administration from the University of Alabama.
Mr. Todd was elected Senior Vice President, Secretary and General Counsel
in December 1994. For more than the previous five years, he had been an attorney
practicing tax and corporate law in Dothan, Alabama. Mr. Todd received a B.S.
degree in Business Administration from the University of Alabama, his J.D. from
the University of Alabama School of Law and his LL.M. (in Taxation) from New
York University School of Law.
Mr. Cousins joined the Company in August 1998 and served as Senior Director
of Development, Planning and Analysis until March 1999 when he was elected
Senior Vice President - Real Estate/Development. Prior to joining the Company,
Mr. Cousins acquired four years of management consulting experience with
Computer Sciences Corporation as Program Control Manager; Management Consulting
and Research, Inc. as Cost Analyst; and Tecolote Research, Inc. as Advanced Cost
Estimator. He has seven years of real estate and property management experience
as Senior Director of Development for KinderCare Learning Centers, Inc. and
Senior Accountant with Aronov Realty Management Co., Inc. Mr. Cousins received a
B.S. degree in Business Administration from Auburn University at Montgomery.
Mr. Guerrette joined the Company in April 1997, serving as Vice President -
Retail Sales, was elected Senior Vice President - Sales in December 1997 and was
elected Senior Vice President - E-Commerce in June 1999. Mr. Guerrette was
President of Sounds Easy Video when it was acquired by Home Vision
Entertainment, Inc. ("Home Vision") in September 1994 and served as Executive
Vice President and Chief Operating Officer of Home Vision until it was acquired
by the Company in July 1996. He was elected to the Maine House of
Representatives, where he served from November 1994 to 1996. Mr. Guerrette
attended Brigham Young University and majored in Accounting.
14
Mr. Hamil was elected Vice President and Controller in June 1996, was
elected Chief Accounting Officer in October 1996, Senior Vice President in March
1998 and Senior Vice President - Finance in October 1999. From July 1994, after
receiving a Masters in Business Administration from Duke University's Fuqua
School of Business, until he joined the Company, Mr. Hamil was an Investment
Banking Associate with NationsBanc Capital Markets, Inc. He has also served as a
Staff Auditor with Ernst & Young LLP. Mr. Hamil is a Certified Public Accountant
and received a B.S. degree in Business Administration from the University of
Alabama.
Mr. Innes joined the Company in May 1999 and was elected Senior Vice
President - Sales and Marketing in June 1999. From October 1997 until he joined
the Company, Mr. Innes was a marketing consultant with Neighborhood Marketing
Institute, a neighborhood marketing and consulting firm specializing in
multi-unit restaurants and retailers, most recently serving as Executive Vice
President and Chief Operating Officer. From November 1989 to September 1997, Mr.
Innes was employed with Blockbuster Entertainment, most recently serving as Vice
President - Marketing. Prior to joining Blockbuster Entertainment, he was
employed with Long John Silver's Seafood Shoppe for fifteen years, most recently
serving as Controller of Retail Operations and Marketing. Mr. Innes is a
Certified Public Accountant and a Certified Management Accountant and received a
B.S. degree in Business Administration from the University of Kentucky.
Mr. Langford joined the Company in August 1995 as Vice President and was
elected Senior Vice President - Management Information Systems in October 1996.
From August 1993 until he joined the Company, Mr. Langford served as a Manager
for Payroll, Fixed Assets and Accounts Payable for Rocky Mountain Healthcare.
From February 1990 to August 1993, he was Director of Support Operations for U.
I. Video Stores, Inc. ("UIV") of Denver, Colorado. UIV was one of the largest
Blockbuster franchisees, operating 110 stores in seven states in July 1993 when
UIV was acquired by Blockbuster. Mr. Langford received a B.A. degree in
Communications from Brigham Young University.
Mr. Loyd joined the Company in August 1986 and has served as the retail
store coordinator as well as Vice President - Purchasing and Product Management.
In October 1996, he was elected Senior Vice President - Purchasing and Product
Management. Mr. Loyd attended Southeast Missouri State University, where he
majored in Business Administration.
Mr. Stubbs was elected Senior Vice President - Store Operations in November
1997. He joined the Company in November 1995 as a District Manager and served as
a Regional Manager prior to his current position. Mr. Stubbs attended Texas A &
M University and Southwest Texas State University, where he received his B.B.A.
degree in Business Administration and Marketing.
Mr. Sigoloff became a director of the Company in September 1994. Since
1989, Mr. Sigoloff has been Chairman of the Board, President and Chief Executive
Officer of Sigoloff & Associates, Inc., a management consulting company. In
August 1989, LJ Hooker Corporation, a client of Sigoloff & Associates, Inc.,
appointed Mr. Sigoloff to act as its Chief Executive Officer during its
reorganization under Chapter 11 of the United States Bankruptcy Code. From March
1982 until 1988, Mr. Sigoloff was Chairman of the Board, President and Chief
Executive Officer of Wickes Companies, Inc., one of the largest retailers in the
United States. Mr. Sigoloff is a director of Kaufman and Broad Home Corporation,
a publicly held company. In addition, Mr. Sigoloff is an adjunct full professor
at the John E. Anderson Graduate School of Management at the University of
California at Los Angeles.
15
Mr. Smith became a director of the Company in September 1994. Since June
1998, Mr. Smith has served as Vice Chairman of the Board of Laird & Co., LLC, a
merchant bank. In addition, from 1991 until August 1998, Mr. Smith served as
Vice Chairman of the Board of Spencer Trask Securities Incorporated, an
investment banking firm. Mr. Smith is a founding General Partner of Lawrence
Venture Associates, a venture capital limited partnership headquartered in New
York City. From 1981 to 1984, he served as Executive Vice President and Group
Executive of the worldwide corporations group at Irving Trust Company. Prior to
joining Irving Trust Company, he was at Citibank for 15 years, where he founded
Citicorp Venture Capital as President and Chief Executive Officer. Since 1988 he
has also been the managing general partner of Private Equity Partnership, L.P.
Mr. Smith is a director of the following publicly held companies: KLS
EnviroResources, Inc., Digital Video Systems, Inc. and Careside, Inc. Mr. Smith
is an adjunct professor at Columbia University Graduate School of Business.
Mr. Troy became a director of the Company in September 1994. Mr. Troy is
the founder and has been a member of the law firm of Troy & Gould Professional
Corporation since May 1970. Mr. Troy is also a director of Argoquest, Inc., an
Internet holding company.
Directors are elected to serve until the next annual meeting of
stockholders of the Company or until their successors are elected and qualified.
Officers serve at the discretion of the Board of Directors, subject to any
contracts of employment. Non-employee directors receive an annual fee of
$16,000, a fee of $1,000 for each Board meeting attended and a fee of $500 for
each committee meeting attended. The Company has granted vested options to
purchase 110,000 shares of Common Stock to each of Messrs. Sigoloff and Smith,
vested options to purchase 135,000 shares to Mr. Troy and vested options to
purchase 145,000 shares to Mr. Snow, in each case at or above the fair market
value of the Common Stock on the date of grant.
ITEM 2. PROPERTIES
At March 10, 2000, all but one of the Company's 954 stores were located on
premises leased from unaffiliated persons pursuant to leases with remaining
terms which generally vary from one month to six years. The Company is generally
responsible for taxes, insurance and utilities under its leases. Rental rates
often increase upon exercise of any renewal option, and some leases have
percentage rental arrangements pursuant to which the Company is obligated to pay
a base rent plus a percentage of the store's revenues in excess of a stated
minimum. In general, the stated minimums are set at such a high level of
revenues that the Company does not pay additional rents based on reaching the
required revenue levels and does not anticipate paying such additional rents in
the future. The Company anticipates that future stores will also be located in
leased premises. The Company owns a family entertainment center, including a
video specialty store, in Meridian, Mississippi.
The Company's support center offices are located in four buildings at 739
W. Main Street, Dothan, Alabama, consisting of an aggregate of approximately
13,000 square feet of space, and a portion of an office building located at 2323
W. Main Street, Dothan, Alabama, consisting of approximately 10,000 square feet
of space. Two of these buildings with an aggregate of approximately 6,500 square
feet of space are owned by the Company. Two of these buildings which are used
primarily for executive and general corporate offices have an aggregate of
approximately 6,500 square feet of space and are leased from Messrs. Malugen and
Parrish. In Fiscal 1999, lease payments to Messrs. Malugen and Parrish totaled
$43,800. The remaining office building space is used for general corporate
offices and is leased from an unaffiliated third party for a one-year term with
multiple one-year renewal options. The Company also leases a 60,000 square foot
videocassette processing, distribution and warehouse facility in Dothan,
Alabama, from an unaffiliated third party pursuant to a three-year lease with
three, three-year renewal options. In March 2000, the Company purchased
approximately 90,000 square feet of space where the Company expects to
consolidate all of its office and distribution personnel during the summer of
2000.
ITEM 3. LEGAL PROCEEDINGS
The Company is occasionally involved in litigation in the ordinary course
of its business, none of which, individually or in the aggregate, is material to
the Company's business or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock began trading on the Nasdaq National Market on
August 2, 1994 under the symbol "MOVI." The following table sets forth for the
periods indicated the high and low last sale prices of the Company's Common
Stock as reported on the Nasdaq National Market.
High Low
------- ------
2000
First Quarter (through March 10, 2000) $ 4.38 $ 2.88
1999
First Quarter 7.50 3.88
Second Quarter 6.38 4.69
Third Quarter 6.19 5.19
Fourth Quarter 5.44 3.75
1998
First Quarter 8.13 2.88
Second Quarter 8.06 5.50
Third Quarter 7.63 3.63
Fourth Quarter 8.00 2.81
The last sale price of the Company's Common Stock on March 10, 2000, as
reported on the Nasdaq National Market was $3.75 per share. As of March 10,
2000, there were approximately 2,500 holders of the Company's Common Stock,
including 125 stockholders of record.
The payment of dividends is within the discretion of the Company's Board of
Directors and will depend on the earnings, capital requirements, restrictions in
future credit agreements and the operating and financial condition of the
Company, among other factors. The Company presently expects to retain its
earnings to finance the expansion and further development of its business. There
can be no assurance that the Company will ever pay a dividend in the future.
17
ITEM 6. SELECTED FINANCIAL DATA
Fiscal Year Ended Year Ended
---------------------------------------------------------------------
January 2, January 3, January 4, January 5, December 31,
2000 1999 1998 1997(3)(4) 1995
---------------------------------------------------------------------
(dollars in thousands, except per share data)
Statement of Income Data (1):
Revenues:
Rentals $ 235,452 $ 222,784 $ 220,787 $ 219,002 $ 130,353
Product sales 41,493 44,849 39,569 35,393 18,848
--------- --------- --------- --------- ---------
276,945 267,633 260,356 254,395 149,201
Cost of sales:
Cost of rental revenues 69,716 113,192(2) 72,806 66,412(5) 29,815
Cost of product sales 25,884 29,744 24,597 21,143 12,600
--------- --------- --------- --------- ---------
Gross margin 181,345 124,697 162,953 166,840 106,786
Operating costs and expenses:
Store operating expenses 137,128 130,473 130,512 121,588 67,045
Amortization of intangibles 8,452 7,068 7,206 7,160 3,380
General and administrative 21,403 17,996 17,006 20,266 13,525
Restructuring and other charges -- -- -- 9,595 --
--------- --------- --------- --------- ---------
Operating income (loss) 14,362 (30,840) 8,229 8,231 22,836
Interest expense, net (3,349) (5,325) (6,326) (5,619) (1,528)
--------- --------- --------- --------- ---------
Income (loss) before income taxes, extraordinary
item and cumulative effect of accounting change 11,013 (36,165) 1,903 2,612 21,308
Income taxes(6) 4,615 (13,089) 998 1,006 7,871
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 6,398 (23,076) 905 1,606 13,437
Extraordinary loss on early extinguishment of debt,
net of tax (682) -- -- -- --
Cumulative effect of accounting change, net of tax (699) -- -- -- --
--------- --------- --------- --------- ---------
Net income (loss) $ 5,017 $ (23,076) $ 905 $ 1,606 $ 13,437
========= ========= ========= ========= =========
Basic earnings (loss) per share $ 0.38 $ (1.72) $ 0.07 $ 0.12 $ 1.14
========= ========= ========= ========= =========
Diluted earnings (loss) per share $ 0.38 $ (1.72) $ 0.07 $ 0.12 $ 1.11
========= ========= ========= ========= =========
Shares used in computing earnings (loss) per share:
Basic 13,115 13,388 13,420 13,241 11,795
========= ========= ========= ========= =========
Diluted 13,370 13,388 13,421 13,368 12,153
========= ========= ========= ========= =========
Operating Data:
Number of stores at end of period (1) 963 837 856 863 750
Adjusted EBITDA (7) $ 35,494 $ 37,378 $ 26,898 $ 26,232 $ 8,766
Cash earnings per diluted share (8) $ 1.11 $ 0.87 $ 0.60 $ 1.01 $ 1.38
Increase (decrease) in same-store revenues (9) 0.4% 3.9% 1.1% (1.0)% 0.0%
January 2, January 3, January 4, January 5, December 31,
2000 1999 1998 1997 1995
---------------------------------------------------------------------
Balance Sheet Data (1):
Cash and cash equivalents $ 6,970 $ 6,983 $ 4,459 $ 3,982 $ 6,255
Rental inventory, net 52,357 44,998 92,183 89,929 72,979
Total assets 209,527 202,369 259,133 261,577 233,479
Long-term debt, less current maturities 44,377 46,212 63,479 67,883 19,622
Total liabilities 84,106 78,254 111,504 114,853 97,340
Stockholders' equity 125,421 124,115 147,629 146,724 136,139
18
- ---------------
(1) Statement of income data for all periods presented has been restated to
include the results of Home Vision Entertainment, Inc. ("Home Vision") and
Hollywood Video, Inc. ("Hollywood Video"), which were acquired in two
separate pooling-of-interests transactions on July 1, 1996. Home Vision
reported on a fiscal year ending September 30 and Hollywood Video reported
on a calendar year basis. The Company's results for the fiscal year ended
January 5, 1997 are combined with results of Home Vision and Hollywood
Video for the period January 1, 1996 to the date of the acquisitions. The
results of the Company and Hollywood Video for the year ending December 31,
1995 are combined with Home Vision's results for the year ending September
30, 1995. Balance sheet data has also been restated consistent with the
statement of income data except the December 31, 1995 balance sheet data
includes that of Home Vision at December 31, 1995 instead of September 30,
1995. In order to conform with the fiscal year end of the Company, Home
Vision's net loss of $2,082,000 for the quarter ended December 31, 1995 is
not reflected in the statement of income data but is reflected in
stockholders' equity at December 31, 1995. The ending number of stores for
each period presented has been restated to include the store counts of Home
Vision and Hollywood Video.
(2) Effective July 6, 1998, the Company changed its method of amortizing rental
inventory resulting in a non-recurring, non-cash, pre-tax charge of
approximately $43.6 million.
(3) On July 1, 1996, the Company adopted a fiscal year ending on the first
Sunday following December 30, which periodically results in a fiscal year
of 53 weeks. The 1996 fiscal year, ended on January 5, 1997, reflects a
53-week year.
(4) Includes a non-recurring charge of approximately $10.4 million for store
closures, corporate restructuring and merger-related expenses.
(5) Effective April 1, 1996, the Company changed its method of amortizing
rental inventory resulting in a one-time, non-cash, pre-tax charge of
approximately $7.7 million.
(6) Includes pro forma adjustments to reflect income tax expense which would
have been recognized if Hollywood Video had been taxed as a C corporation
for all periods presented. Historical operating results of Hollywood Video
do not include any provision for income taxes prior to July 1, 1996 due to
their S corporation status prior to that date.
(7) Adjusted EBITDA is defined as earnings before interest, taxes, depreciation
and amortization, excluding non-recurring charges, less the Company's
purchase of videocassette rental inventory which excludes rental inventory
purchases specifically for new store openings. New store inventory
purchases were $3.2 million, $1.2 million, $1.3 million and $5.7 million
for the fiscal years ended January 2, 2000, January 3, 1999, January 4,
1998 and January 5, 1997, respectively. For the fiscal year ended December
31, 1995, new store inventory purchases are not separately identified and,
thus, have not been excluded from Adjusted EBITDA. Adjusted EBITDA should
be considered in addition to, but not as a substitute for or superior to,
operating income, net income, cash flow and other measures of financial
performance prepared in accordance with generally accepted accounting
principles.
(8) Cash earnings is defined as net income before extraordinary items,
cumulative effect accounting changes, non-recurring non-cash charges and
amortization of intangibles. Cash earnings should be considered in addition
to, but not as a substitute for or superior to, operating income, net
income, cash flow and other measures of financial performance prepared in
accordance with generally accepted accounting principles.
(9) Same-store revenue is defined as the aggregate revenues from stores
operated by the Company for at least 13 months. Same-store revenues for the
Company have not been restated to include the same-store revenues of Home
Vision and Hollywood Video.
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
The following table sets forth, for the periods indicated, statement of income
data, expressed as a percentage of total revenue, and the number of stores open
at the end of each period.
Statement of Operations Data:
Fifty-Two Weeks Ended
-------------------------------------
January 2, January 3, January 4,
2000 1999 1998
-------------------------------------
Revenues:
Rentals 85.0% 83.2% 84.8%
Product sales 15.0 16.8 15.2
--------- -------- --------
100.0 100.0 100.0
Cost of sales:
Cost of rental revenues
Recurring 25.2 26.0 28.0
Policy change -- 16.3 --
Cost of product sales 9.3 11.1 9.4
--------- -------- --------
Gross margin 65.5 46.6 62.6
Operating costs and expenses:
Store operating expenses 49.5 48.7 50.1
Amortization of intangibles 3.1 2.7 2.8
General and administrative 7.7 6.7 6.5
--------- -------- --------
Operating income (loss) 5.2 (11.5) 3.2
Interest expense, net (1.2) (2.0) (2.5)
--------- -------- --------
Income (loss) before income taxes, extraordinary item
and cumulative effect of accounting change 4.0 (13.5) 0.7
Income taxes 1.7 (4.9) 0.4
--------- -------- --------
Income (loss) before extraordinary item and
cumulative effect of accounting change 2.3 (8.6) 0.3
Extraordinary loss on early extinguishment
of debt, net of tax (0.2) -- --
Cumulative effect of accounting change, net of tax (0.3) -- --
--------- -------- --------
Net income (loss) 1.8% (8.6)% 0.3%
========= ======== ========
Adjusted EBITDA (in thousands) $ 35,494 $ 37,378 $ 26,898
========= ======== ========
Number of stores open at end of period 963 837 856
========= ======== ========
20
Fiscal year ended January 2, 2000 ("Fiscal 1999") compared to the fiscal year
ended January 3, 1999 ("Fiscal 1998")
Revenue. Total revenue increased 3.5% to $276.9 million for Fiscal 1999 from
$267.6 million for Fiscal 1998. The increase was due primarily to an increase in
same-store revenues of 0.4%, as well as approximately 40 more average stores
open during Fiscal 1999 versus Fiscal 1998. The increase in same-store revenues
was primarily the result of (i) an increase in the number of copies of new
release videocassettes available to customers as a result of copy-depth
initiatives, including revenue sharing programs and other depth of copy programs
available from movie studios; (ii) an increase in the sale of previously viewed
movies, which is the direct result of more product available to consumers due to
the copy-depth initiatives and revenue sharing programs discussed above; (iii) a
double-digit increase in the video game rental business due to increasing growth
in the penetration of the Nintendo 64 and Sony Playstation game platforms, the
introduction of the Sega Dreamcast game platform in late Fiscal 1999 and an
increase in the number of game titles available for these platforms; and (iv)
successful, chain-wide internal marketing programs designed to generate more
consumer excitement and traffic in the Company's base of stores. These positive
aspects of revenue growth were offset, in part, by (i) a greater than 40%
decrease in new tape sales during Fiscal 1999 as a result of fewer titles being
released at sell-through price points; (ii) the negative comparative impact of
the hit title "Titanic," which was released in the third quarter of Fiscal 1998
and was the highest grossing box office hit of all time; (iii) the combination
of the new millenium celebration and the Christmas and New Year's holidays
falling within weekend days during Fiscal 1999 versus week days in Fiscal 1998;
and (iv) overall unfavorable weather in Fiscal 1999 as compared to Fiscal 1998.
Product sales decreased as a percentage of total revenues to 15.0% for Fiscal
1999 from 16.8% for Fiscal 1998, primarily as a result of the decrease in new
tape sales, offset in part by the increase in the sales of previously viewed
rental inventory.
Cost of Sales. Net of the impact of a rental inventory policy change in the
third quarter of Fiscal 1998, the cost of rental inventory, which includes
amortization of rental inventory and revenue sharing expenses, decreased as a
percentage of total revenue from 26.0% in Fiscal 1998 to 25.2% in Fiscal 1999.
As a percentage of rental revenue, the cost of rental inventory in Fiscal 1999
was 29.6% versus 31.2% in Fiscal 1998. The decrease in rental inventory costs as
a percentage of both total revenue and rental revenue is primarily due to the
Company's change in amortization policy during the third quarter of Fiscal 1998,
the Company's reduced per unit costs of acquiring rental product through various
copy-depth programs available from movie studios, as well as the more efficient
allocation of product to the store base.
Effective July 6, 1998, the Company changed its amortization policy for rental
inventory. The change resulted in a nonrecurring, non-cash, pre-tax charge of
approximately $43.6 million in the third quarter of Fiscal 1998. The major
impetus for the change in amortization policy was the changing purchasing
economics within the industry, which have resulted in a significant increase in
new release videos available for rental. While revenue sharing programs and
other copy-depth initiatives have increased customer satisfaction and driven
increased rental revenue, the overall demand for each new release is satisfied
sooner. In order to match more accurately the valuation of tape inventory with
accelerated consumer demand, the Company changed its amortization policy for
rental inventory as described in Note 1 of the "Notes to Consolidated Financial
Statements."
Cost of product sales includes the costs of new videocassettes, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold. The gross margin on product sales increased to 37.6% in
Fiscal 1999 from 33.7% in Fiscal 1998. The increase in profitability of product
sales is primarily the result of an increase in previously viewed movie sales
and a decrease in new movie sales throughout the year. Previously viewed movies
carry gross margins that are substantially higher than the average gross margins
for new movie sales. In addition, the movie "Titanic" was released in the third
quarter of Fiscal 1998 and was sold by the Company at low profit margins,
although it was the largest new movie sales campaign in the history of the
Company.
21
Gross Margins. As a result of the improved margins on both rental revenues and
product sales, total gross margins improved from 62.9% in Fiscal 1998, net of
the impact of the change in rental inventory amortization policy, to 65.5% in
Fiscal 1999.
Operating Costs and Expenses. Store operating expenses, which include
store-level expenses such as lease payments and in-store payroll, increased to
49.5% of total revenue for Fiscal 1999 from 48.7% for Fiscal 1998. The increase
in store operating expenses as a percentage of revenues was primarily due to
same-store revenues of 0.4% for Fiscal 1999 falling short of Company
expectations and the impact of the Blowout stores on operating expenses. These
stores-within-a-store operate with a higher percentage of salaries and wages to
total revenue than the Company's other stores and generate less average revenue
than the Company's overall average revenue level. Also, the Company incurred
some incremental training and other operational expenses during the integration
of the 88-store Blowout acquisition and the ramp up of new store growth in the
latter half of 1999.
General and administrative expenses increased as a percentage of revenues from
6.7% for Fiscal 1998 to 7.7% for Fiscal 1999. The increase is primarily due to
increased staffing and travel costs associated with the Company's ramp up in new
store development, expense increases resulting from the acquisition and
integration of the Blowout acquisition and incremental expenses from the
launching of the Company's e-commerce effort at www.moviegallery.com.
Amortization of intangibles increased as a percentage of revenues to 3.1% in
Fiscal 1999 versus 2.7% in Fiscal 1998. This increase relates solely to the
inclusion of $1.6 million in goodwill write-offs during Fiscal 1999 in
conjunction with ongoing asset impairment analysis performed by the Company,
which is required by Financial Accounting Standards Board Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of."
As a result of the above factors, excluding the impact of the amortization
policy change in relation to Fiscal 1998, operating income increased by 12.5% to
$14.4 million in Fiscal 1999 from $12.8 million in Fiscal 1998.
Net interest expense as a percentage of revenues decreased to 1.2% in Fiscal
1999 versus 2.0% in Fiscal 1998. This decrease was primarily due to reductions
in average debt outstanding during Fiscal 1999 versus Fiscal 1998.
For Fiscal 1999 the Company's effective income tax rate was 41.9%, as compared
to a 36.2% effective rate for Fiscal 1998. The increase in the income tax rate
in Fiscal 1999 is primarily due to a shortfall in pre-tax income versus
expectations, which causes the non-tax-deductible goodwill amortization
associated with stock acquisitions made in previous years to increase the
effective tax rate of the Company. The Company currently has a net deferred tax
asset of $441,000. The Company anticipates the generation of sufficient future
taxable income, based on its current operations, to utilize these deferred tax
assets.
During the first quarter of Fiscal 1999, the Company incurred an extraordinary
loss on the early extinguishment of debt of $682,000 (net of income taxes of
$359,000), or $0.05 per diluted share. The extraordinary loss was comprised
primarily of the write-off of both the unamortized debt issue costs and the
negative value of an interest rate swap agreement in association with the
restructuring of the Company's debt obligations discussed below in "Liquidity
and Capital Resources."
22
Effective January 4, 1999, the Company adopted the provisions of the American
Institute of Certified Public Accountants Statement of Position 98-5, "Reporting
the Costs of Start-Up Activities." As a result, the Company recorded a charge
for the cumulative effect of an accounting change of $699,000 (net of income
taxes of $368,000), or $0.05 per diluted share, to expense the unamortized
portion of certain start-up costs that had been capitalized prior to January 4,
1999, discussed fully in Note 1 of the "Notes to Consolidated Financial
Statements."
Fiscal year ended January 3, 1999 compared to the fiscal year ended January 4,
1998 ("Fiscal 1997")
Revenue. Total revenue increased 2.8% to $267.6 million for Fiscal 1998 from
$260.4 million for Fiscal 1997. The increase was due primarily to an increase in
same-store revenues of 3.9%, offset in part due to fewer average stores open
during Fiscal 1998 versus Fiscal 1997. The increase in same-store revenues was
primarily the result of (i) an increase in the number of copies of new release
videocassettes available to customers as a result of copy-depth initiatives,
including revenue sharing programs and other depth of copy programs available
from movie studios; (ii) an increase in the video game rental business due to
both increasing consumer acceptance of the Nintendo 64 and Sony Playstation game
platforms and an increase in the number of game titles available for these
platforms; and (iii) successful, chain-wide internal marketing programs designed
to generate more consumer excitement and traffic in the Company's base of
stores. Product sales increased as a percentage of total revenues to 16.8% for
Fiscal 1998 from 15.2% for Fiscal 1997, primarily as a result of an increase in
the sales of previously viewed rental inventory.
Cost of Sales. Net of the impact of the rental inventory policy change in the
third quarter of Fiscal 1998, the cost of rental revenues, which includes
amortization of rental inventory and revenue sharing expenses, decreased as a
percentage of total revenue from 28.0% in Fiscal 1997 to 26.0% in Fiscal 1998.
As a percentage of rental revenue, the cost of rental revenues in Fiscal 1998
was 31.2% versus 33.0% in Fiscal 1997. Significantly reduced tape purchase
dollars in Fiscal 1998 versus Fiscal 1997, an increased use of revenue sharing,
as well as the same-store revenue increases in Fiscal 1998, are the main reasons
that the cost of rental revenues as a percentage of both total revenue and
rental revenue in Fiscal 1998 has declined versus Fiscal 1997.
Cost of product sales includes the costs of new videocassettes, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold in the Company's stores. The gross margin on product sales
decreased from 37.8% in Fiscal 1997 to 33.7% in Fiscal 1998. The decrease in
product sales gross margins is primarily the result of: (i) a concentrated
effort by the Company to reduce inventory levels through discounts on selected
inventory during the first half of 1998; and (ii) the impact of "Titanic," which
the Company sold at a below average profit margin and for which the Company sold
more units than any sell-through priced title in its history.
Gross Margins. Although the Company experienced improved margins on rental
revenues, the positive impact of rental gross margins were offset by a decrease
in product sales margins. As a result, total gross margins improved slightly
from 62.6% in Fiscal 1997 to 62.9% in Fiscal 1998, net of the impact of the
change in rental inventory amortization policy.
Operating Costs and Expenses. Store operating expenses, which include
store-level expenses such as lease payments and in-store payroll, decreased to
48.7% of total revenue for Fiscal 1998 from 50.1% for Fiscal 1997. The decrease
in store operating expenses as a percentage of revenues was primarily due to
same-store revenue increases during Fiscal 1998.
General and administrative expenses increased as a percentage of revenues from
6.5% for Fiscal 1997 to 6.7% for Fiscal 1998. The increase is primarily due to
Fiscal 1998 increases in fixed asset depreciation, marketing expenses, salaries
and wages and other personnel costs, in part associated with the increase in
personnel in the Company's real estate department in anticipation of its planned
new store development during Fiscal 1999.
23
As a result of the above factors, excluding the impact of the amortization
policy change, operating income increased by 55.4% to $12.8 million in Fiscal
1998 from $8.2 million in Fiscal 1997.
Liquidity and Capital Resources
Historically, the Company's primary capital needs have been for opening and
acquiring new stores and for the purchase of videocassette inventory. Other
capital needs include the refurbishment, remodeling and relocation of existing
stores, as well as for common stock repurchases within the past year. The
Company has funded inventory purchases, remodeling and relocation programs, new
store opening costs, acquisitions and stock repurchases primarily from cash flow
from operations, the proceeds of two public equity offerings, loans under
revolving credit facilities and seller financing.
During Fiscal 1999, the Company generated $35.5 million in Adjusted EBITDA
versus $37.4 million for Fiscal 1998. The decrease in Adjusted EBITDA is
attributable primarily to expense increases associated with acquisitions and new
store development, as well as same-store revenues that, though increasing 0.4%
for Fiscal 1999, fell short of the Company's goals. Adjusted EBITDA is defined
as earnings before interest, taxes, depreciation and amortization, less the
Company's purchase of rental inventory which excludes rental inventory purchases
specifically for new store openings. Adjusted EBITDA should be considered in
addition to, but not as a substitute for or superior to, operating income, net
income, cash flow and other measures of financial performance prepared in
accordance with generally accepted accounting principles.
Cash earnings for Fiscal 1999 increased to $14.9 million, or $1.11 per diluted
share, from $11.7 million, or $0.87 per diluted share for Fiscal 1998. On a
diluted per share basis, cash earnings increased 27.6% year-over-year. Cash
earnings is defined as net income before extraordinary items, cumulative effect
accounting changes, non-recurring non-cash charges and amortization of
intangibles. Cash earnings should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, cash flow and other
measures of financial performance prepared in accordance with generally accepted
accounting principles.
Net cash provided by operating activities was $84.4 million for Fiscal 1999 as
compared to $90.9 million for Fiscal 1998. Net income was higher in Fiscal 1999
versus Fiscal 1998 because of the impact of the change in amortization policy.
However, cash provided by operating activities decreased primarily due to an
increase in merchandise inventory and an increase in deposits and other assets,
as well as lower depreciation and amortization, net of the impact of the change
in videocassette amortization policy, in Fiscal 1999 versus Fiscal 1998. These
items were offset, in part, by an increase in accounts payable and accrued
liabilities in Fiscal 1999 versus Fiscal 1998.
Net cash used in investing activities was $78.7 million for Fiscal 1999 as
compared to $66.3 million for Fiscal 1998. This increase in funds used for
investing activities is primarily the result of an increase in the expenditures
of capital for both acquisitions and property, furnishings and equipment during
Fiscal 1999 versus Fiscal 1998. This increase was offset, in part, by less
capital used in the net purchases of rental inventory.
Net cash used by financing activities was $5.7 million for Fiscal 1999 as
compared to $22.0 million for Fiscal 1998. This decrease in funds used for
financing activities is a direct result of more store openings and acquisitions
during Fiscal 1999, which resulted in less debt paydowns during Fiscal 1999
versus Fiscal 1998. A partial offset to the decrease in debt paydowns was an
increase in funds used to repurchase the Company's common stock during Fiscal
1999 versus Fiscal 1998.
24
On January 7, 1999, the Company entered into a Credit Agreement with First Union
National Bank of North Carolina with respect to a revolving credit facility (the
"Facility"). The Facility provides for borrowings of up to $65 million, is
unsecured and will mature in its entirety on January 7, 2002. The Company may
increase the amount of the Facility to $85 million if existing banks increase
their commitments or if any new banks enter the Credit Agreement. The interest
rate of the Facility is based on LIBOR plus an applicable margin percentage,
which depends on the Company's cash flow generation and borrowings outstanding.
The Company may repay the Facility at any time without penalty. The more
restrictive covenants of the Facility restrict borrowings based upon cash flow
levels. At January 2, 2000, $44.4 million was outstanding, approximately $20
million was available for borrowing and the effective interest rate was
approximately 7.1%.
The Company grows its store base through internally developed and acquired
stores and may require capital in excess of internally generated cash flow to
achieve its desired growth. The Company opened 53 internally-developed stores
and acquired 131 stores during Fiscal 1999. During the year 2000, the Company
intends to open approximately 100 new stores and will entertain potential
acquisition transactions; however, the number of acquired stores in 2000 is
anticipated to be less than the number of internally developed stores. To the
extent available, new stores and future acquisitions may be completed using
funds available under the Facility, financing provided by sellers, alternative
financing arrangements such as funds raised in public or private debt or equity
offerings or shares of the Company's stock issued to sellers. However, there can
be no assurance that financing will be available to the Company on terms which
will be acceptable, if at all.
During Fiscal 1999, the Company repurchased $3.8 million of its common stock. In
early 2000, the Company completed its previously announced $5 million stock
repurchase plan and announced another $5 million stock repurchase plan. It is
anticipated that the majority of the $5 million under the second repurchase plan
will be utilized during the fiscal year 2000.
At January 2, 2000, the Company had a working capital deficit of $12.9 million,
due to the accounting treatment of its rental inventory. Rental inventory is
treated as a noncurrent asset under generally accepted accounting principles
because it is a depreciable asset and is not an asset which is reasonably
expected to be completely realized in cash or sold in the normal business cycle.
Although the rental of this inventory generates the major portion of the
Company's revenue, the classification of this asset as noncurrent results in its
exclusion from working capital. The aggregate amount payable for this inventory,
however, is reported as a current liability until paid and, accordingly, is
included in working capital. Consequently, the Company believes that working
capital is not an appropriate measure of its liquidity and it anticipates that
it will continue to operate with a working capital deficit.
The Company believes its projected cash flow from operations, borrowing capacity
with the Facility, cash on hand and trade credit will provide the necessary
capital to fund its current plan of operations for the fiscal year 2000,
including its anticipated new store openings, a modest potential acquisition
program and stock repurchases. However, to fund a major acquisition program, or
to provide funds in the event that the Company's need for funds is greater than
expected, or if certain of the financing sources identified above are not
available to the extent anticipated or if the Company increases its growth plan,
the Company will need to seek additional or alternative sources of financing.
This financing may not be available on terms satisfactory to the Company.
Failure to obtain financing to fund the Company's expansion plans or for other
purposes could have a material adverse effect on the Company.
25
Other Matters
Impact of Year 2000
In prior years, the Company discussed the nature and progress of its plans to
become Year 2000 compliant related to its operating systems. In late 1999, the
Company completed its review, remediation and testing of systems to ensure Year
2000 readiness. The Company experienced no significant disruptions in mission
critical information technology and non-information technology systems and
believes those systems successfully responded to the Year 2000 date change. The
costs associated with the remediation of the Company's systems in preparation
for the Year 2000 were not material. The Company is not aware of any material
problems resulting from Year 2000 issues, either with its products, its internal
systems or the products and services of third parties. The Company will continue
to monitor its mission critical computer applications and those of its suppliers
and vendors throughout the year 2000 to ensure that any latent Year 2000 matters
that may arise are addressed promptly.
Market Risk Sensitive Instruments
The market risk inherent in the Company's financial instruments represents the
increased interest costs arising from adverse changes in interest rates
(primarily LIBOR and prime bank rates). In order to manage this risk, the
Company entered into an interest rate swap agreement that effectively fixes the
Company's interest rate exposure on $37 million of the amount outstanding under
the New Facility at 5.8% plus an applicable margin percentage. Assuming a
hypothetical 10% adverse change in the LIBOR interest rate and assuming debt
levels outstanding as of January 2, 2000, the Company would incur an immaterial
amount of additional annual interest expense on unhedged variable rate
borrowings. These amounts are determined by considering the impact of the
hypothetical change in interest rates on the Company's cost of borrowing. The
analysis does not consider the potential negative impact on overall economic
activity that could exist in such an environment. The Company believes that its
exposure to adverse interest rate changes and its impact on its total cost of
borrowing capital has been largely mitigated by the interest rate swap agreement
that is in place.
Forward Looking Statements
With respect to forward-looking statements contained in this Item 7, please
review the disclosures set forth under "Cautionary Statements" in Item 1 above.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Reference is made to Part II, Item 7, "Market Risk Sensitive Instruments"
of this Form 10-K for the information required by Item 7A.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Reference is made to Part IV, Item 14 of this Form 10-K for the information
required by Item 8.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
26
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item (other than the information regarding
executive officers set forth at the end of Item 1 of Part I of this Form 10-K)
will be contained in the Company's definitive Proxy Statement for its 2000
Annual Meeting of Stockholders, and is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 2000 Annual Meeting of Stockholders, and is
incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
Report of Ernst & Young LLP, Independent Auditors.
Consolidated Balance Sheets as of January 2, 2000 and January 3, 1999.
Consolidated Statements of Operations for the Fiscal Years Ended
January 2, 2000, January 3, 1999, and January 4, 1998.
Consolidated Statements of Stockholders' Equity for the Fiscal Years
Ended January 2, 2000, January 3, 1999, and January 4, 1998.
Consolidated Statements of Cash Flows for the Fiscal Years Ended
January 2, 2000, January 3, 1999, and January 4, 1998.
Notes to Consolidated Financial Statements.
(a)(2) Schedules:
None.
27
(a)(3) Exhibits:
The following exhibits, which are furnished with this Annual Report or
incorporated herein by reference, are filed as part of this Annual Report:
Exhibit
No. Exhibit Description
- ------- -------------------
3.1 - Certificate of Incorporation of the Company.(1)
3.2 - Bylaws of the Company.(1)
4.1 - Specimen Common Stock Certificate.(2)
10.1 - 1994 Stock Option Plan, as amended and form of Stock Option
Agreement.(3)
10.2 - Form of Indemnity Agreement.(1)
10.3 - Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen.(1)
10.4 - Employment Agreement between M.G.A., Inc. and H. Harrison Parrish.(1)
10.5 - Consulting Agreement between M.G.A., Inc. and William B. Snow dated
December 21, 1998.(4)
10.6 - Employment Agreement between M.G.A., Inc. and J. Steven Roy.(5)
10.7 - Employment Agreement between M.G.A., Inc. and S. Page Todd.(5)
10.8 - Employment Agreement between M.G.A., Inc. and Steven M. Hamil. (5)
10.9 - Employment Agreement between M.G.A., Inc. and Robert L. Sirkis dated
September 12, 1997.(4)
10.10- Agreement dated August 15, 1997 between Major Video Concepts, Inc. and
Movie Gallery, Inc.(6) (portions were omitted pursuant to a request for
confidential treatment)
10.11- Real estate lease dated June 1, 1994 between J. T. Malugen, H. Harrison
Parrish and M.G.A., Inc.(1)
10.12- Real estate lease dated June 1, 1994 between H. Harrison Parrish and
M.G.A., Inc.(1)
10.13- Credit Agreement between First Union National Bank of North Carolina and
Movie Gallery, Inc. dated January 7, 1999.(4)
10.14- Asset Purchase Agreement between Blowout Entertainment, Inc. and M.G.A.,
Inc. dated March 22, 1999.(4)
18 - Change in Accounting Principle.(7)
21 - List of Subsidiaries.(filed herewith)
23 - Consent of Ernst & Young LLP, Independent Auditors.(filed herewith)
27 - Financial Data Schedule. (filed herewith)
- ---------------
(1) Previously filed with the Securities and Exchange Commission on June 10,
1994, as exhibits to the Company's Registration Statement on Form S-1
(File No. 33-80120).
(2) Previously filed with the Securities and Exchange Commission on August 1,
1994, as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1.
(3) Previously filed with the Securities and Exchange Commission on April 7,
1997, as an exhibit to the Company's Form 10-K for the fiscal year ended
January 5, 1997.
(4) Previously filed with the Securities and Exchange Commission on April 5,
1999, as an exhibit to the Company's Form 10-K for the fiscal year ended
January 3, 1999.
(5) Previously filed with the Securities and Exchange Commission on April 6,
1998, as an exhibit to the Company's Form 10-K for the fiscal year ended
January 4, 1998.
(6) Previously filed with the Securities and Exchange Commission on November
19, 1997 as an exhibit to the Company's Form 10-Q for the quarter ended
October 5, 1997.
(7) Previously filed with the Securities and Exchange Commission on November
18, 1998, as an exhibit to the Company's Form 10-Q for the quarter ended
October 4, 1998.
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the quarter ended
January 2, 2000.
(c) Exhibits:
See (a)(3) above.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this annual report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
MOVIE GALLERY, INC.
By /s/ JOE THOMAS MALUGEN
-------------------------------
Joe Thomas Malugen,
Chairman of the Board
and Chief Executive Officer
Date: April 3, 2000
Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ JOE THOMAS MALUGEN Chairman of the Board and April 3, 2000
- ----------------------- Chief Executive Officer
Joe Thomas Malugen
/s/ WILLIAM B. SNOW Vice Chairman of the Board April 3, 2000
- -----------------------
William B. Snow
/s/ H. HARRISON PARRISH Director and President April 3, 2000
- -----------------------
H. Harrison Parrish
/s/ PHILIP B. SMITH Director April 3, 2000
- -----------------------
Philip B. Smith
/s/ J. STEVEN ROY Executive Vice President and April 3, 2000
- ----------------------- Chief Financial Officer
J. Steven Roy
/s/ STEVEN M. HAMIL Senior Vice President - Finance April 3, 2000
- ----------------------- and Chief Accounting Officer
Steven M. Hamil
29
Movie Gallery, Inc.
Consolidated Financial Statements
Fiscal years ended January 2, 2000, January 3, 1999 and January 4, 1998
Contents
Report of Ernst & Young LLP, Independent Auditors............................F-1
Audited Financial Statements
Consolidated Balance Sheets..................................................F-2
Consolidated Statements of Operations........................................F-3
Consolidated Statements of Stockholders' Equity..............................F-4
Consolidated Statements of Cash Flows........................................F-5
Notes to Consolidated Financial Statements...................................F-6
Report of Ernst & Young LLP, Independent Auditors
Board of Directors and Stockholders
Movie Gallery, Inc.
We have audited the accompanying consolidated balance sheets of Movie Gallery,
Inc. as of January 2, 2000 and January 3, 1999, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in period ended January 2, 2000. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Movie Gallery,
Inc. at January 2, 2000 and January 3, 1999, and the consolidated results of its
operations and its cash flows for each of the three years in period ended
January 2, 2000, in conformity with accounting principles generally accepted in
the United States.
As discussed in Note 1 to the financial statements, in 1999 the Company changed
its method of accounting for the costs of start-up activities and in 1998 the
Company changed its method of accounting for amortization of rental inventory.
/s/ Ernst & Young, LLP
Birmingham, Alabama
February 11, 2000
F-1
Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)
January 2, January 3,
2000 1999
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 6,970 $ 6,983
Merchandise inventory 15,148 11,824
Prepaid expenses 814 779
Store supplies and other 3,395 3,772
Deferred income taxes 229 312
--------- ---------
Total current assets 26,556 23,670
Rental inventory, net 52,357 44,998
Property, furnishing and equipment, net 44,320 43,920
Goodwill and other intangibles, net 83,539 85,743
Deposits and other assets 2,543 1,799
Deferred income taxes 212 2,239
--------- ---------
Total assets $ 209,527 $ 202,369
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 26,243 $ 23,396
Accrued liabilities 12,989 7,426
Current portion of long-term debt 263 442
--------- ---------
Total current liabilities 39,495 31,264
Long-term debt 44,377 46,212
Other accrued liabilities 234 778
Stockholders' equity:
Preferred stock, $.10 par value; 2,000,000 shares
authorized, no shares issued or outstanding -- --
Common stock, $.001 par value; 35,000,000
shares authorized, 12,549,667 and 13,315,915
shares issued and outstanding 13 13
Additional paid-in capital 127,537 131,248
Retained earnings (deficit) (2,129) (7,146)
--------- ---------
Total stockholders' equity 125,421 124,115
--------- ---------
Total liabilities and stockholders' equity $ 209,527 $ 202,369
========= =========
See accompanying notes.
F-2
Movie Gallery, Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
Fiscal Year Ended
-----------------------------------
January 2, January 3, January 4,
2000 1999 1998
-----------------------------------
Revenues:
Rentals $ 235,452 $ 222,784 $ 220,787
Product sales 41,493 44,849 39,569
--------- --------- ---------
276,945 267,633 260,356
Cost of sales:
Cost of rental revenues 69,716 113,192 72,806
Cost of product sales 25,884 29,744 24,597
--------- --------- ---------
Gross margin 181,345 124,697 162,953
Operating costs and expenses:
Store operating expenses 137,128 130,473 130,512
Amortization of intangibles 8,452 7,068 7,206
General and administrative 21,403 17,996 17,006
--------- --------- ---------
Operating income (loss) 14,362 (30,840) 8,229
Interest income 26 44 45
Interest expense (3,375) (5,369) (6,371)
--------- --------- ---------
Income (loss) before income taxes, extraordinary item
and cumulative effect of accounting change 11,013 (36,165) 1,903
Income taxes 4,615 (13,089) 998
--------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 6,398 (23,076) 905
Extraordinary loss on early extinguishment of debt, (682) -- --
net of income taxes of $359
Cumulative effect of accounting change, net of
income taxes of $368 (699) -- --
--------- --------- ---------
Net income (loss) $ 5,017 $ (23,076) $ 905
========= ========= =========
Basic and diluted earnings (loss) per share:
Income (loss) before extraordinary item and
cumulative effect of accounting change $ 0.48 $ (1.72) $ 0.07
Extraordinary loss on early extinguishment of debt, (0.05) -- --
net of income taxes
Cumulative effect of accounting change, net of income taxes (0.05) -- --
--------- --------- ---------
Net income (loss) $ 0.38 $ (1.72) $ 0.07
========= ========= =========
Weighted average shares outstanding:
Basic 13,115 13,388 13,420
Diluted 13,370 13,388 13,421
See accompanying notes.
F-3
Movie Gallery, Inc.
Consolidated Statements of Stockholders' Equity
(in thousands)
Additional Retained Total
Common Paid-in Earnings Stockholders'
Stock Capital (Deficit) Equity
-----------------------------------------------
Balance at January 5, 1997 $ 13 $ 131,686 $ 15,025 $ 146,724
Net income -- -- 905 905
--------- --------- --------- ---------
Balance at January 4, 1998 13 131,686 15,930 147,629
Net loss -- -- (23,076) (23,076)
Exercise of stock options for 12,230 shares -- 48 -- 48
Tax benefit of stock options exercised -- 9 -- 9
Repurchase and retirement of 115,200 shares -- (495) -- (495)
--------- --------- --------- ---------
Balance at January 3, 1999 13 131,248 (7,146) 124,115
Net income -- -- 5,017 5,017
Exercise of stock options for 12,350 shares -- 48 -- 48
Tax benefit of stock options exercised -- 7 -- 7
Repurchase and retirement of 778,598 shares -- (3,766) -- (3,766)
--------- --------- --------- ---------
Balance at January 2, 2000 $ 13 $ 127,537 $ (2,129) $ 125,421
========= ========= ========= =========
See accompanying notes.
F-4
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Year Ended
-----------------------------------
January 2, January 3, January 4,
2000 1999 1998
-----------------------------------
Operating activities
Net income (loss) $ 5,017 $ (23,076) $ 905
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Extraordinary loss on early extinguishment of debt, net of taxes 682 -- --
Cumulative effect of accounting change, net of taxes 699 -- --
Depreciation and amortization 72,205 126,257 88,140
Deferred income taxes 2,744 (14,855) 998
Changes in operating assets and liabilities:
Merchandise inventory (2,788) 1,911 (3,493)
Other current assets 348 (649) 435
Deposits and other assets (1,104) 105 834
Accounts payable 2,847 1,879 (2,804)
Accrued liabilities 3,740 (709) (1,134)
--------- --------- ---------
Net cash provided by operating activities 84,390 90,863 83,881
Investing activities
Business acquisitions (11,839) (799) (474)
Purchases of rental inventory, net (54,259) (59,266) (70,801)
Purchases of property, furnishings and equipment (12,573) (6,251) (13,072)
Proceeds from disposal of equipment -- -- 1,170
--------- --------- ---------
Net cash used in investing activities (78,671) (66,316) (83,177)
Financing activities
Net proceeds from issuance of common stock 48 48 --
Purchases and retirement of common stock (3,766) (495) --
Payments on notes payable -- (200) --
Principal payments on long-term debt (2,014) (21,376) (227)
--------- --------- ---------
Net cash used in financing activities (5,732) (22,023) (227)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents (13) 2,524 477
Cash and cash equivalents at beginning of period 6,983 4,459 3,982
--------- --------- ---------
Cash and cash equivalents at end of period $ 6,970 $ 6,983 $ 4,459
========= ========= =========
Supplemental disclosures of cash flow information
Cash paid during the period for interest $ 3,076 $ 5,066 $ 5,777
Cash paid during the period for income taxes 2,705 478 --
Noncash investing and financing information:
Assets acquired by issuance of notes payable -- -- 200
Tax benefit of stock options exercised 7 9 --
See accompanying notes.
F-5
Movie Gallery, Inc.
Notes to Consolidated Financial Statements
January 2, 2000, January 3, 1999 and January 4, 1998
1. Accounting Policies
The accompanying financial statements present the consolidated financial
position, results of operations and cash flows of Movie Gallery, Inc. and
subsidiaries (the "Company"). All material intercompany accounts and
transactions have been eliminated.
The Company owns and operates video specialty stores in 31 states.
Fiscal Year
The Company's fiscal year ends on the first Sunday following December 30, which
periodically results in a fiscal year of 53 weeks. Results for fiscal years
1999, 1998 and 1997 reflect 52-week years. The Company's fiscal year includes
revenues and certain operating expenses, such as salaries, wages and other
miscellaneous expenses, on a daily basis. All other expenses, primarily
depreciation and amortization, are calculated and recorded monthly, with twelve
months included in each fiscal year.
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to conform to the current year presentation. These reclassifications had no
impact on stockholders' equity or net income. Amortization of rental inventory
and revenue sharing expenses have been combined and are presented as cost of
rental revenue on the statement of operations.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Merchandise Inventory
Merchandise inventory consists primarily of videocassette tapes, video
accessories and concessions and is stated at the lower of cost, on a first-in
first-out basis, or market.
Impairment of Long-Lived Assets
The Company periodically assesses the impairment of long-lived assets, including
allocated goodwill, to be held for use in operations based on expectations of
future undiscounted cash flows from the related operations, and when
circumstances dictate, adjusts the assets to the extent carrying value exceeds
the fair value of the assets. These factors, along with management's plans with
respect to the operations, are considered in assessing the recoverability of
goodwill, other purchased intangibles, rental inventory and property and
equipment. For the fiscal year ended January 2, 2000, amortization of
intangibles includes an impairment loss of $1,600,000 to write-off the net book
value of goodwill in excess of its estimated fair market value.
F-6
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
The Company assesses the recoverability of enterprise level goodwill and
intangible assets by determining whether the unamortized balances can be
recovered through undiscounted future cash flows.
Rental Inventory
Effective July 6, 1998, the Company changed its method of amortizing
videocassette and video game rental inventory. The new method accelerates the
rate of amortization and was adopted as a result of an industry trend towards
significant increases in copy-depth availability from movie studios, which have
resulted in earlier satisfaction of consumer demand, thereby, accelerating the
rate of revenue recognition. Under this method, the cost of base stock
videocassettes, consisting of two copies per title for each store, is amortized
on an accelerated basis to a net book value of $8 over six months and to a $4
salvage value over the next thirty months. The cost of non-base stock
videocassettes, consisting of the third and succeeding copies of each title per
store, is amortized on an accelerated basis over six months to a net book value
of $4 which is then amortized on a straight-line basis over the next 30 months
or until the videocassette is sold, at which time the unamortized book value is
charged to cost of sales. Video games are amortized on a straight-line basis to
a $10 salvage value over eighteen months.
The new method of amortization was applied to all inventory held at July 6,
1998. The adoption of the new method of amortization was accounted for as a
change in accounting estimate effected by a change in accounting principle
during the quarter ended October 4, 1998. The application of the new method of
amortizing videocassette and video game rental inventory decreased rental
inventory and increased depreciation expense for the fiscal year ended January
3, 1999 by approximately $43.6 million and reduced net income by $27.7 million,
or $2.06 per basic and diluted share.
Prior to July 6, 1998, videocassettes and video games considered to be base
stock were amortized over thirty-six months on a straight-line basis to a $5
salvage value. New release videocassettes and video games were amortized as
follows: (i) the fourth and any succeeding copies of each title per store were
amortized on a straight-line basis over six months to an average net book value
of $5 which was then amortized on a straight-line basis over the next thirty
months or until the videocassette or video game was sold, at which time the
unamortized book value was charged to cost of sales and (ii) copies one through
three of each title per store were amortized as base stock.
Rental inventory consists of the following (in thousands):
January 2, January 3,
2000 1999
--------- ---------
Rental inventory $ 85,978 $ 180,858
Less accumulated amortization (33,621) (135,860)
--------- ---------
$ 52,357 $ 44,998
========= =========
F-7
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Property, Furnishings and Equipment
Property, furnishings and equipment are stated at cost and include costs
incurred in the construction of new stores. Depreciation is provided on a
straight-line basis over the estimated lives of the related assets, generally
five to seven years.
Goodwill and Other Intangibles
Goodwill is being amortized on a straight-line basis over twenty years. Other
intangibles consist primarily of non-compete agreements and are amortized on a
straight-line basis over the lives of the respective agreements which generally
range from five to ten years. Accumulated amortization of goodwill and other
intangibles at January 2, 2000 and January 3, 1999 was $32,097,000 and
$25,245,000, respectively.
Income Taxes
The Company accounts for income taxes under the provisions of Financial
Accounting Standards Board ("FASB") Statement No. 109, "Accounting for Income
Taxes." Under Statement 109, deferred tax assets and liabilities are determined
based upon differences between financial reporting and tax bases of assets and
liabilities and are measured at the enacted tax rates and laws that will be in
effect when the differences are expected to reverse.
Rental Revenue
Rental revenue is recognized when the videocassette or video game is rented by
the customer. Extended viewing fees on rentals are recognized when received from
the customer.
Advertising Costs
Advertising costs, exclusive of cooperative reimbursements from vendors, are
expensed when incurred.
Store Opening and Start-up Costs
Store opening costs, which consist primarily of payroll and advertising, are
expensed as incurred.
In April 1998, the American Institute of Certified Public Accountants issued
Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-up
Activities," which requires that certain costs related to start-up activities be
expensed as incurred. Prior to January 4, 1999, the Company capitalized certain
costs incurred in connection with site selection for new video specialty store
locations. The Company adopted the provisions of the SOP in its financial
statements for the first quarter of fiscal 1999. The effect of the adoption of
SOP 98-5 was to record a charge for the cumulative effect of an accounting
change of $699,000 (net of income taxes of $368,000), or $0.05 per share, to
expense the unamortized costs that had been capitalized prior to January 4,
1999. The impact of adoption on income from continuing operations for the fiscal
year ended January 2, 2000 was not material.
F-8
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Fair Value of Financial Instruments
At January 2, 2000 and January 3, 1999, the carrying value of financial
instruments such as cash and cash equivalents, accounts payable, notes payable
and long-term debt approximated their fair values, calculated using discounted
cash flow analysis at the Company's incremental borrowing rate.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. The most significant estimates and assumptions relate to the
amortization methods and useful lives of rental inventory, goodwill and other
intangibles. These estimates and assumptions could change and actual results
could differ from these estimates.
Recently Issued Accounting Pronouncements
The FASB has issued Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (as amended by Statement No. 137, "Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133"), which is required to be adopted by the Company in
fiscal year 2001. Management does not anticipate that the adoption of this
Statement will have a significant effect on earnings or the financial position
of the Company.
Employee Benefits
The Company has a 401(k) savings plan available to all active employees who are
over 21 years of age and have completed one year of service. The Company makes
discretionary and matching contributions based on employee compensation. The
matching contribution for the fiscal years ended January 2, 2000 and January 3,
1999 was immaterial to the Company.
2. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
January 2, January 3,
2000 1999
----------------------
Land and buildings $ 1,889 $ 1,889
Furniture and fixtures 33,383 29,688
Equipment 28,495 24,755
Leasehold improvements and signs 27,931 24,661
-------- --------
91,698 80,993
Accumulated depreciation (47,378) (37,073)
-------- --------
$ 44,320 $ 43,920
======== ========
F-9
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
3. Long-Term Debt
On January 7, 1999, the Company entered into a Credit Agreement with First Union
National Bank of North Carolina with respect to a revolving credit facility (the
"Facility"). The Facility provides for borrowings of up to $65 million, is
unsecured and will mature in its entirety on January 7, 2002. The Company may
increase the amount of the Facility to $85 million if existing banks increase
their commitments or if any new banks enter the Credit Agreement. The interest
rate of the Facility is based on LIBOR plus an applicable margin percentage,
which depends on the Company's cash flow generation and borrowings outstanding.
The Company may repay the Facility at any time without penalty. The more
restrictive covenants of the Facility restrict borrowings based upon cash flow
levels. At January 2, 2000, $44.4 million was outstanding, approximately $20
million was available for borrowing and the effective interest rate was
approximately 7.1%.
Concurrent with the Facility, the Company amended its then existing interest
rate swap to coincide with the maturity of the Facility. The amended interest
rate swap agreement effectively fixes the Company's interest rate exposure on
$37 million of the amount outstanding under the Facility at 5.8% plus an
applicable margin percentage. The interest rate swap reduces the risk of
increases in interest rates during the life of the Facility. The Company
accounts for its interest rate swap as a hedge of its debt obligation. The
Company pays a fixed rate of interest and receives payment based on a variable
rate of interest. The difference in amounts paid and received under the contract
is accrued and recognized as an adjustment to interest expense on the debt.
There are no termination penalties associated with the interest rate swap
agreement; however, if the swap agreement was terminated at the Company's
option, the Company would either pay or receive the present value of the
remaining hedge payments at the then prevailing interest rates for the time to
maturity of the swap agreement. The interest rate swap agreement terminates at
the time the Facility matures.
As a result of the Facility and the amended interest rate swap agreement, the
Company recognized an extraordinary loss on the extinguishment of debt of
approximately $682,000 (net of income taxes of $359,000), or $.05 per share,
during the first quarter of fiscal 1999. The extraordinary loss was comprised
primarily of unamortized debt issue costs associated with the Company's previous
credit facility and the negative value of the previous interest rate swap at
January 7, 1999.
Scheduled maturities of long-term debt are as follows:$263,000 in 2000 and
$44,377,000 in 2002.
F-10
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
4. Income Taxes
The following reflects actual income tax expense (benefit) for the fiscal years
ended January 2, 2000, January 3, 1999 and January 4, 1998 (in thousands):
Fiscal Year Ended
---------------------------------
January 2, January 3, January 4,
2000 1999 1998
---------------------------------
Current payable:
Federal $ 1,673 $ 1,275 $ --
State 198 491 --
-------- -------- --------
Total current 1,871 1,766 --
Deferred:
Federal 2,454 (13,423) 903
State 290 (1,432) 95
-------- -------- --------
Total deferred 2,744 (14,855) 998
-------- -------- --------
$ 4,615 $(13,089) $ 998
======== ======== ========
A reconciliation of income tax expense (benefit) at the federal income tax rate
to the Company's effective income tax provision is as follows (in thousands):
Fiscal Year Ended
----------------------------------
January 2, January 3, January 4,
2000 1999 1998
----------------------------------
Income tax expense (benefit)
at statutory rate $ 3,855 $(12,658) $ 647
State income tax expense (benefit)
net of federal income tax benefit 317 (612) 63
Other, net (primarily goodwill not
deductible for tax purposes) 443 181 288
-------- -------- --------
$ 4,615 $(13,089) $ 998
======== ======== ========
At January 2, 2000, the Company had net operating loss carryforwards of
approximately $7.4 million for income taxes that expire in years 2010 through
2012. The Company has not recorded a valuation allowance related to its deferred
tax assets as management considers it more likely than not that available tax
strategies and future taxable income will allow the deferred tax assets to be
realized.
F-11
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
4. Income Taxes (continued)
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income taxes. Components of the Company's
deferred tax assets and liabilities are as follows (in thousands):
January 2, January 3,
2000 1999
------------------------
Deferred tax liabilities:
Furnishings and equipment $ 5,473 $ 5,740
Rental inventory 3,818 788
Goodwill 2,026 2,295
Other 461 997
------- -------
Total deferred tax liabilities 11,778 9,820
Deferred tax assets:
Non-compete agreements 4,970 4,839
Alternative minimum tax credit carryforward 2,827 1,460
Net operating loss carryforwards 2,802 4,806
Accrued liabilities 777 828
Other 843 438
------- -------
Total deferred tax assets 12,219 12,371
------- -------
Net deferred tax assets $ 441 $ 2,551
======= =======
5. Stockholders' Equity
Common Stock
In 1995, the Company registered shares of common stock with an aggregate public
offering price of $127,000,000. This common stock may be offered directly
through agents, underwriters or dealers or may be offered in connection with
business acquisitions. As of January 2, 2000, common stock of approximately
$83,000,000 was available to be issued from this registration.
Since January 2, 2000, the Company has repurchased 200,000 shares of common
stock for retirement at an average purchase price of $3.63.
Earnings Per Share
Basic earnings per share and basic pro forma earnings per share are computed
based on the weighted average number of shares of common stock outstanding
during the periods presented. Diluted earnings per share and diluted pro forma
earnings per share are computed based on the weighted average number of shares
of common stock outstanding during the periods presented, increased solely by
the effects of shares to be issued from the exercise of dilutive common stock
options (255,000, none and 1,000 for the fiscal years ended January 2, 2000,
January 3, 1999 and January 4, 1998, respectively). No adjustments were made to
net income in the computation of basic or diluted earnings per share.
F-12
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders Equity (continued)
Stock Option Plan
In July 1994, the Board of Directors adopted, and the stockholders of the
Company approved, the 1994 Stock Option Plan (the "Plan"). The Plan provides for
the award of incentive stock options, stock appreciation rights, bonus rights
and other incentive grants to employees, independent contractors and
consultants. Currently 2,600,000 shares are reserved for issuance under the
Plan. Options granted under the Plan have a 10-year term and generally vest over
3 to 5 years.
In October 1995, the FASB issued Statement No. 123, "Accounting for Stock-Based
Compensation." In accordance with the provisions of Statement 123, the Company
applies Accounting Principles Board Opinion No. 25 and related Interpretations
in accounting for its stock option plan and, accordingly, has not recognized
compensation cost in connection with the Plan. If the Company had elected to
recognize compensation cost based on the fair value of the options granted at
grant date as prescribed by Statement 123, net income and earnings per share
would have been reduced to the pro forma amounts indicated in the table below.
The effect on net income and earnings per share is not expected to be indicative
of the effects on net income and earnings per share in future years.
Fiscal Year Ended
-----------------------------------
January 2, January 3, January 4,
2000 1999 1998
-----------------------------------
(in thousands, except per share data)
Pro forma net income (loss) $ 3,801 $ (24,324) $ (890)
Pro forma earnings (loss) per share:
Basic and diluted 0.29 (1.82) (0.07)
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
Fiscal Year Ended
---------------------------------
January 2, January 3, January 4,
2000 1999 1998
---------------------------------
Expected volatility 0.720 0.733 0.649
Risk-free interest rate 6.39% 4.70% 6.28%
Expected life of option in years 6.0 6.0 6.0
Expected dividend yield 0.0% 0.0% 0.0%
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
F-13
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
A summary of the Company's stock option activity and related information is
detailed below. During 1997, the Company modified 505,100 stock options with
exercise prices ranging from $6.00 to $42.63 by cancelling the stock options and
issuing 378,827 new stock options at an exercise price of $3.88. This
modification excluded directors and certain senior management.
Fiscal Year Ended
------------------------------------------------------------------------------------
January 2, 2000 January 3, 1999 January 4, 1998
------------------------------------------------------------------------------------
Weighted- Weighted- Weighted-
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
--------- -------------- --------- -------------- --------- --------------
Outstanding-beginning
of year 2,188,899 $ 9.73 1,895,537 $ 10.62 1,318,650 $ 21.98
Granted 444,000 4.36 363,000 5.13 1,256,087 4.04
Exercised 12,350 3.88 12,230 3.88 -- --
Forfeited 343,562 4.17 57,408 11.32 679,200 20.50
Outstanding-end of year 2,276,987 9.56 2,188,899 9.73 1,895,537 10.62
Exercisable at end of year 1,440,871 12.03 1,206,397 12.68 916,908 14.43
Weighted-average fair value
of options granted during
the year $ 3.05 $ 3.43 $ 2.62
Options outstanding as of January 2, 2000 had a weighted-average remaining
contractual life of 7.6 years and exercise prices ranging from $3.00 to $40.00
as follows:
Exercise price of
----------------------------------------------------------
$3.00 to $6.00 $14.00 to $22.00 $24.00 to $40.00
----------------------------------------------------------
Options outstanding 1,618,487 390,500 268,000
Weighted-average exercise price $4.29 $15.13 $33.22
Weighted-average remaining contractual life 8.5 years 5.4 years 5.4 years
Options exercisable 824,171 361,700 255,000
Weighted-average exercise price of
exercisable options $4.16 $15.22 $32.93
F-14
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
6. Commitments and Contingencies
Rent expense for the fiscal years ended January 2, 2000, January 3, 1999 and
January 4, 1998 totaled $41,683,000, $40,959,000 and $40,788,000, respectively.
Future minimum payments under noncancellable operating leases which contain
renewal options and escalation clauses with remaining terms in excess of one
year consisted of the following at January 2, 2000 (in thousands):
2000 $ 26,950
2001 21,678
2002 13,399
2003 8,032
2004 4,288
Thereafter 3,830
--------
$ 78,177
========
The Company has an agreement with Rentrak Corporation which requires the Company
to order videocassette rental inventory under lease sufficient to require an
aggregate minimum payment of $4,000,000 per year in revenue sharing, handling
fees, sell through fees and end-of-term buyout fees. The agreement expires in
2006.
The Company is occasionally involved in litigation in the ordinary course of its
business, none of which, individually or in the aggregate, is material to the
Company's business or results of operations.
F-15
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. Summary of Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations (in
thousands, except per share data):
Thirteen Weeks Ended
-----------------------------------------------------
April 4, July 4, October 3, January 2,
1999 1999 1999 2000
------------------------------------------------------
Revenue $ 69,620 $ 65,510 $ 67,742 $ 74,073
Operating income 6,377 2,006 1,642 4,337
Income before extraordinary item
and cumulative effect of
accounting change 3,362 679 546 1,811
Extraordinary loss on early extinguishment
of debt, net of income taxes of $359 (682) -- -- --
Cumulative effect of accounting change,
net of income taxes of $368 (699) -- -- --
-------- -------- -------- ----------
Net income $ 1,981 $ 679 $ 546 $ 1,811
======== ======== ======== ==========
Basic and diluted earnings per share:
Income before extraordinary item
and cumulative effect of
accounting change $ 0.25 $ 0.05 $ 0.04 $ 0.14
Extraordinary loss on early extinguishment
of debt, net of tax (0.05) -- -- --
Cumulative effect of accounting change,
net of tax (0.05) -- -- --
-------- -------- -------- ----------
Net income $ 0.15 $ 0.05 $ 0.04 $ 0.14
======== ======== ======== ==========
Thirteen Weeks Ended
--------------------------------------------------------
April 5, July 5, October 4, January 3,
1998 1998 1998 1999
--------------------------------------------------------
Revenue $ 70,491 $ 63,662 $ 64,397 $ 69,083
Operating income (loss) 4,613 495 (42,969) 7,021
Net income (loss) 1,882 (555) (28,046) 3,643
Basic and diluted earnings (loss)
per share 0.14 (0.04) (2.09) 0.27
F-16
Index to Exhibits
Exhibit No. Description
21 List of Subsidiaries
23 Consent of Ernst & Young LLP, Independent Auditors
27 Financial Data Schedule