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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 December 31, 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.)
900 West 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. [ ]
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 12, 2001, was approximately $34,692,272. The number
of shares of Common Stock outstanding on March 12, 2001, was 11,176,167 shares.
Documents incorporated by reference:
1. Notice of 2001 Annual Meeting and Proxy Statement (Part III of
Form 10-K).
The exhibit index to this report appears at page 27.
ITEM 1. BUSINESS
General
As of March 12, 2001, Movie Gallery, Inc. (the "Company") owned and
operated 1,035 video specialty stores located in 30 states that rent and sell
videocassettes, digital video discs ("DVDs"), 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 the leading video specialty retailer in rural and
secondary markets and 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 900 West 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 $10.9 billion
in revenue in 1991 to $19.9 billion in 2000 with 87% of all television
households owning a videocassette recorder ("VCR") or DVD player. The industry
is projected to reach $27.4 billion in revenue by 2010 with 92% VCR and DVD
penetration in television households, according to Paul Kagan.
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 economies 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 the last three years, industry sources speculated that many
independent operators struggled to maintain market share. The combination of
increased product offerings and improved marketing efforts have solidified the
positions of the largest retail chains versus independent operators over the
past several years.
The domestic video retail industry includes both rentals and sales of
videocassettes and DVDs; however, the majority of revenue is generated through
the rental of prerecorded videocassettes and DVDs. There are three primary
pricing strategies that the movie studios use to influence the relative levels
of movie 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. DVD pricing is currently similar to the pricing of
sell-through movies. Movie studios attempt to maximize total revenue from movie
releases via the combined utilization of these pricing structures. The
combination of revenue sharing and other copy depth programs, as well as the
pricing of sell-through movies, provides larger quantities of product available
to meet initial consumer demand. The incremental product is made available to
the consumer for sale once initial rental demand is met, driving continued
growth in sales revenue from previously viewed product.
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 and 2000. 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 $8. As the movies are rented by consumers, the
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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 has allowed retailers to vastly increase both copy depth and
breadth for the consumers.
Movie Studio Dependence on Video Rental Industry. The home video 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 $8.0 billion (an 8.5% increase from 1999),
or 49%, of the estimated $16.4 billion of revenue generated in 2000. 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 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 via rental than 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 titles to the home video
market from 30 days to 80 days 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.
Operating Strategy
Movie Gallery Stores. The Company maintains a flexible store format,
tailoring the size, inventory and look of each store to local demographics. The
Company's stores generally range from approximately 2,000 to 9,000 square feet
(averaging approximately 4,600 square feet), with inventories ranging from
approximately 4,000 to 15,000 rental movies and 200 to 1,000 video games for
rental. The Company builds both freestanding stores and stores located in strip
centers anchored by major grocery or discount drug store chains, focusing on
easy access, good visibility and high traffic. The store fixtures, equipment and
layout are designed by the Company to create a visually-appealing, up-beat
ambiance using bright lighting, vibrant graphics and carpet, and coordinating
signage. The inviting atmosphere 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. 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 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 and favorable options to extend allowing for the mobility necessary to
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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 changes in customer shopping
patterns and retail market shifts. To date, we have not experienced difficulty
in obtaining favorable leases or renewals at or below market rates in suitable
locations. 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.
Employees. As of March 12, 2001, the Company employed approximately 8,000
persons, referred to by the Company as "associates," including approximately
7,700 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 6,200 were part-time. None of
the Company's 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 fourteen 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.
Throughout the last year, the Company has developed internal hiring, training
and retention programs designed to enhance consistent and thorough communication
of Company operating policies and procedures as well as increase the rate of
internal promotions.
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 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.
New Release Purchases. The Company actively manages its new release
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. In order to maximize profits, the Company varies the quantity of its
new release inventory, the rental and sales prices for videocassettes, DVDs and
video games, and the rental period 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 (increasing to five days once rental demand has
fallen below predetermined levels), which tends to keep new releases more
readily available and requires the purchase of fewer copies of new releases than
a longer rental policy. Video games generally have a five-day rental term for
both the most recent releases and older titles.
Marketing and Advertising. The Company uses market development funds,
cooperative allowances from its suppliers and movie studios, and internal funds
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. The Company
also prepares a monthly consumer magazine called Video Buzz and a customized
video program (MGTV), both of which feature Company programs, promotions and new
releases. The Company also benefits from the advertising and marketing by
studios and theaters in connection with their efforts to promote films and
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increase box office revenue. In addition to these traditional forms of
advertising, the Company has developed and implemented a customer loyalty
program, Reel Players. The program is based on a point system that provides
customers the opportunity to earn free rentals and other incentives. The Company
has also executed strategically timed trivia games to drive customer visits and
to increase awareness of the Company's internet offerings at
www.moviegallery.com. Expenditures for marketing and advertising above the
amount of the Company's advertising allowances from its suppliers and movie
studios have been minimal.
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.
Products
For the fiscal year ended December 31, 2000, over 87% of the Company's
rental revenue was derived from the rental of movies on videocassettes and DVD,
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 movies, 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, 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 1% of rental revenues for the Company compared to approximately 4%
for the 2000 fiscal year and over 6% for December 2000. Paul Kagan reports that
DVD sales exceeded expectations for 2000 and predicts that DVD technology will
penetrate approximately 78% of television households by 2010. 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 acquisition costs of DVD hardware have reached
levels competitive with the VCR and 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. In the near term, video retailers have the
opportunity to expand DVD offerings at attractive pricing comparable to that of
sell-through movies. However, industry sources indicate that studios may
eventually begin to shift the pricing model for DVD toward a structure similar
to the current rental videocassette pricing, including revenue share programs.
Videocassettes, DVDs and video games utilized as initial inventory in the
Company's newly 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, DVD 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 inventory 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, DVDs,
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
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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 and DVDs 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.
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. The
Company believes that these programs continue to have 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 and Sony released a backward compatible
128-bit PlayStation 2 ("PS2") system in November 2000. The release of the PS2
did not meet expectations in that hardware shipments were less than half the
amount promised by Sony. 2001 will be a transitional year for the video game
industry as PS2 will continue to slowly gain market share as hardware and
software becomes available; Sega has decided to cease production of the
Dreamcast console mid-year; and the market will be anticipating the release of
both the Nintendo Gamecube and the Microsoft X-box, slated for the fall. The
Company expects video game rentals and sales to be flat during the transition to
the new game platforms, with the next upswing dependent upon the timing and
acceptance of the release of the new platforms.
Movie and Video Game Suppliers
The Company obtains its videocassettes, DVDs and video games for rental and
its movies held for sale through relationships with various distributors and
through direct agreements with studios. Because of revenue sharing and the
impact it has had on distributors, the Company believes that if one of its
suppliers were unable or unwilling to continue the contractual relationship with
the Company, a viable replacement could be found without materially adversely
impacting the Company's business.
Since a majority of the Company's rental movie inventory is obtained under
contract directly from various studios, the importance of the distributor
relationships has been somewhat diminished. Generally, the relationships with
distributors for product directly obtained from the studios is one of
fulfillment agent. The Company pays the distributor a flat fulfillment fee for
the distributor 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.
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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 agreement which expires in September 2006, 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.
Growth Strategy
The Company opened a record 110 new stores during 2000, acquired 16 stores
and reached a milestone level of 1,020 stores in operation at the end of the
year. This follows growth of 53 new stores and 131 acquired stores in 1999,
including the acquisition of 88 stores previously operated by Blowout
Entertainment, Inc. The Company spent 1997 and most of 1998 absorbing the
significant growth experienced in 1994 through 1996, primarily from
acquisitions. The following table is a historical summary showing store
openings, acquisitions and store closings by the Company since January 1, 1996.
Fiscal Year Ended
----------------------------------------------------------------------
January 1
January 5, January 4, January 3, January 2, December 31, to March 12,
1997 1998 1999 2000 2000 2001
----------- ----------- ----------- ----------- ------------- -----------
New store openings 75 50 18 53 110 23
Stores Acquired 174(1) 2 4 131 16 --
Stores Closed 48 59 41 58 69 8
Total Stores at End
of Period 863 856 837 963 1,020 1,035
- -----
(1) Includes 98 stores acquired on July 1, 1996 and accounted for as
poolings-of-interests.
For 2001, the Company intends to open approximately 75 new stores and will
evaluate acquisition opportunities as they arise. However, the Company
anticipates that most of its store growth in 2001 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 12, 2001, the Company has
developed 420 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. 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 movies. 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, lower operating costs and the Company's
expertise in operating in smaller markets. The Company attempts to develop real
estate in 3,000 to 4,500 square foot locations primarily in towns with
populations from 3,000 to 15,000. 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. Future sales growth
depends on the Company's ability to aggressively, steadily add stores in a
profitable manner.
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 maintains a flexible real estate
strategy with short-term leases. Thus, the Company evaluates over 300 leases
each year and does not hesitate to close a unit if it is not profitable or
on-strategy. The cost of closing a unit is minimal and usable inventory,
signage, fixtures and equipment is transferred to existing or new locations. The
Company usually leases existing or build-to-suit locations from development
companies which construct properties to negotiated specifications. Full-time,
professional construction managers with significant video specialty store
construction experience are employed to manage the process and ensure the
Company's standards and design elements are achieved. The balance of the
construction necessary to build-out the interior of a new location is also
contracted and supervised by the construction department.
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The Company continues 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. 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. The Company also believes that its geographic dispersion tends to
offset the impact of weather fluctuations and temporary economic and competitive
conditions within individual markets. The following table provides information
at March 12, 2001 and March 10, 2000, regarding the number of Company stores
located in each state.
Number of Stores
----------------
March 12, March 10,
2001 2000
------------ ------------
Alabama..................................... 150 144
Florida..................................... 122 119
Texas ...................................... 92 95
Georgia..................................... 91 82
Virginia.................................... 60 59
Tennessee................................... 57 49
Maine....................................... 48 44
Ohio........................................ 43 46
Mississippi ................................ 42 37
Missouri.................................... 38 32
Indiana..................................... 35 37
South Carolina ............................. 33 31
Wisconsin................................... 30 31
North Carolina.............................. 24 18
Kentucky.................................... 23 23
Illinois.................................... 21 11
Oklahoma.................................... 20 10
Kansas...................................... 16 18
Louisiana................................... 16 17
Massachusetts............................... 15 14
New Hampshire............................... 15 14
Connecticut................................. 11 3
Arkansas.................................... 10 3
Pennsylvania................................ 8 5
Iowa........................................ 6 4
California.................................. - 2
Michigan.................................... 3 2
West Virginia............................... 3 1
Colorado.................................... 1 1
New York.................................... 1 1
Vermont..................................... 1 1
----- -----
TOTAL.............................. 1,035 954
===== =====
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Acquisitions. The Company's real estate and construction departments are
responsible for identifying, selecting, and implementing acquisitions. From
January 1, 1994 through March 12, 2001, the Company acquired 850 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
2001, the Company intends to evaluate acquisition opportunities that may arise,
but anticipates that most of its store growth will result from
internally-developed locations.
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 250,000 e-mail
addresses from Movie Gallery customers and through third party advertising and
partnerships, and is actively marketing its immense product library, in excess
of 75,000 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.
The Company does not intend to spend a disproportionate amount of capital
on its e-commerce business. The Company lost approximately $1.1 million to run
this business in 2000 and has budgeted a loss of approximately $400,000 for
2001. The Company believes that this 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. The major e-commerce
initiatives for 2001 include reaching customers outside the established Movie
Gallery store base to increase volume, minimizing expenses, and continuing to
adjust the pricing structure to find the right balance between investment of
resources and operating results.
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.
The Company also maintains 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, as well
as additional systems which have been developed and implemented by the Company
including a Collections system, a Processing/Distribution Center system and
various other database systems and auditing systems.
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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, DVDs 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. With 30% of stores having been newly built, relocated or remodeled
within the last three years, the Company has a relatively young store base. 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/DVD 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.
The Company believes movie studios have a significant interest in
maintaining a viable movie rental business because the sale of movies 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 DVDs 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.
10
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.
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) the extent to which the Company experiences any increase in
the number of titles released from studios priced for sell-through, which may be
more effectively distributed to the consumer through mass merchants rather than
video specialty stores; (vii) competition from special events such as the
Olympics or an ongoing major news event of significant public interest; and
11
(viii) a reduction in, or elimination of, the period of time between the release
of hit movie titles 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) the
extent to which the movie studios reduce the level of marketing and advertising
support; (v)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; (vi) the
Company's ability to control costs and expenses, primarily rent, store payroll
and general and administrative expenses; (vii) 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; (viii) the
Company's ability to react and obtain other distribution sources for its
products in the event that the Company's suppliers are unable to meet the terms
of their contracts with the Company; and (ix) 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; and (b)
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) 49 Chairman of the Board and Chief Executive Officer
H. Harrison Parrish(1) 53 President and Director
William B. Snow(1)(2)(3) 69 Vice Chairman of the Board
J. Steven Roy 40 Executive Vice President and Chief Financial Officer
Jeffrey S. Stubbs 38 Senior Vice President - Store Operations
S. Page Todd 39 Senior Vice President, Secretary and General Counsel
Keith A. Cousins 32 Senior Vice President - Real Estate/Development
Theodore L. Innes 51 Senior Vice President - Sales and Marketing
Richard R. Langford 44 Senior Vice President - Management Information Systems
Mark S. Loyd 45 Senior Vice President - Purchasing and Product Management
Sanford C. Sigoloff(2)(3) 70 Director
Philip B. Smith(2)(3) 65 Director
Joseph F. Troy (1) 62 Director
- -------------------
(1) Member of Executive Committee.
(2) Member of Compensation Committee.
(3) Member of Audit Committee.
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.
12
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. Stubbs was elected to his current position as Senior Vice President -
Store Operations in November 1997. He joined the Company in November 1995 and
served as Regional Manager over Texas, Louisiana, and Mississippi. Prior to
joining the Company, Mr. Stubbs served as Vice President and General Manager of
A.W.C. Corporation, a video specialty and restaurant retailer in East Texas,
from 1987 to 1995. He has an additional eight years experience in grocery and
convenience store management. Mr. Stubbs attended Texas A & M University and
graduated from Southwest Texas State University, where he received a B.B.A.
degree in Business Administration and Marketing.
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 was elected to his current position as Senior Vice President -
Real Estate/Development in March 1999. He joined the Company in August 1998 as
Senior Director of Development, Planning and Analysis. 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 an additional 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. 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.
13
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. 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.
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.
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 115,000 shares of Common Stock to each of Messrs. Sigoloff and Smith,
vested options to purchase 140,000 shares to Mr. Troy and vested options to
purchase 150,000 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 12, 2001, all but one of the Company's 1,035 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
14
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.
During 2000, the Company's Support Center offices and distribution facility
were consolidated from six different locations into one 90,000 square foot
location purchased by the Company at 900 West Main Street, Dothan, Alabama.
ITEM 3. LEGAL PROCEEDINGS
The Company is subject to various legal proceedings in the course of
conducting its business. However, the Company believes that these proceedings
are not likely to result in judgments that will have a material adverse effect
on its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
15
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
2001
First Quarter (through March 12, 2001)................... $ 6.03 $ 3.06
2000
First Quarter............................................ 4.38 2.88
Second Quarter........................................... 4.44 3.25
Third Quarter............................................ 4.50 3.50
Fourth Quarter........................................... 3.75 3.00
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
The last sale price of the Company's Common Stock on March 12, 2001, as
reported on the Nasdaq National Market was $6.03 per share. As of March 12,
2001, there were approximately 2,100 holders of the Company's Common Stock,
including 108 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.
16
ITEM 6. SELECTED FINANCIAL DATA
Fiscal Year Ended
-----------------------------------------------------------------
December 31, January 2, January 3, January 4, January 5,
2000 2000 1999 1998 1997(2)(3)(4)
-----------------------------------------------------------------
(dollars in thousands, except per share data)
Statement of Operations Data:
Revenues:
Rentals $ 271,457 $ 235,452 $ 222,784 $ 220,787 $ 219,002
Product sales 47,479 41,493 44,849 39,569 35,393
--------- --------- --------- --------- ---------
318,936 276,945 267,633 260,356 254,395
Cost of sales:
Cost of rental revenues 81,958 69,716 113,192(1) 72,806 66,412(5)
Cost of product sales 31,213 25,884 29,744 24,597 21,143
--------- --------- --------- --------- ---------
Gross margin 205,765 181,345 124,697 162,953 166,840
Operating costs and expenses:
Store operating expenses 153,665 137,128 130,473 130,512 121,588
Amortization of intangibles 7,465 8,452 7,068 7,206 7,160
General and administrative 24,945 21,403 17,996 17,006 20,266
Restructuring and other charges -- -- -- -- 9,595
--------- --------- --------- --------- ---------
Operating income (loss) 19,690 14,362 (30,840) 8,229 8,231
Interest expense, net (3,779) (3,349) (5,325) (6,326) (5,619)
--------- --------- --------- --------- ---------
Income (loss) before income taxes, extraordinary
item and cumulative effect of accounting change 15,911 11,013 (36,165) 1,903 2,612
Income taxes 6,425 4,615 (13,089) 998 1,006(6)
--------- --------- --------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 9,486 6,398 (23,076) 905 1,606
Extraordinary loss on early extinguishment of debt,
net of tax -- (682) -- -- --
Cumulative effect of accounting change, net of tax -- (699) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) $ 9,486 $ 5,017 $ (23,076) $ 905 $ 1,606
========= ========= ========= ========= =========
Basic and diluted earnings (loss) per share $ 0.83 $ 0.38 $ (1.72) $ 0.07 $ 0.12
========= ========= ========= ========= =========
Shares used in computing earnings (loss) per share:
Basic 11,467 13,115 13,388 13,420 13,241
========= ========= ========= ========= =========
Diluted 11,497 13,370 13,388 13,421 13,368
========= ========= ========= ========= =========
Operating Data:
Number of stores at end of period 1,020 963 837 856 863
Adjusted EBITDA (7) $ 39,744 $ 35,494 $ 37,378 $ 26,898 $ 26,232
Cash earnings per diluted share (8) $ 1.47 $ 1.11 $ 0.87 $ 0.60 $ 1.01
Increase (decrease) in same-store revenues (9) 3.8% 0.4% 3.9% 1.1% (1.0)%
17
ITEM 6. SELECTED FINANCIAL DATA (continued)
December 31, January 2, January 3, January 4, January 5,
2000 2000 1999 1998 1997
-----------------------------------------------------------------
(dollars in thousands)
Balance Sheet Data:
Cash and cash equivalents $ 7,029 $ 6,970 $ 6,983 $ 4,459 $ 3,982
Rental inventory, net 61,773 52,357 44,998 92,183 89,929
Total assets 217,536 209,527 202,369 259,133 261,577
Long-term debt, less current maturities 40,600 44,377 46,212 63,479 67,883
Total liabilities 88,327 84,106 78,254 111,504 114,853
Stockholders' equity 129,209 125,421 124,115 147,629 146,724
- ---------------------
(1) 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.
(2) 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.
(3) Includes a non-recurring charge of approximately $10.4 million for store
closures, corporate restructuring and merger-related expenses.
(4) Includes 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. 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.
(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 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.
(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.
18
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
----------------------------------
December 31, January 2, January 3,
2000 2000 1999
----------------------------------
Revenues:
Rentals 85.1 % 85.0 % 83.2 %
Product sales 14.9 15.0 16.8
--------- --------- ---------
100.0 100.0 100.0
Cost of sales:
Cost of rental revenues
Recurring 25.7 25.2 26.0
Policy change -- -- 16.3
Cost of product sales 9.8 9.3 11.1
--------- --------- ---------
Gross margin 64.5 65.5 46.6
Operating costs and expenses:
Store operating expenses 48.2 49.5 48.7
Amortization of intangibles 2.3 3.1 2.7
General and administrative 7.8 7.7 6.7
--------- --------- ---------
Operating income (loss) 6.2 5.2 (11.5)
Interest expense, net (1.2) (1.2) (2.0)
--------- --------- ---------
Income (loss) before income taxes, extraordinary item
and cumulative effect of accounting change 5.0 4.0 (13.5)
Income taxes 2.0 1.7 (4.9)
--------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 3.0 2.3 (8.6)
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) 3.0 % 1.8 % (8.6)%
========= ========= =========
Adjusted EBITDA (in thousands) $ 39,744 $ 35,494 $ 37,378
========= ========= =========
Number of stores open at end of period 1,020 963 837
========= ========= =========
19
Fiscal year ended December 31, 2000 ("Fiscal 2000") compared to the fiscal year
ended January 2,2000 ("Fiscal 1999")
Revenue. Total revenue increased 15.2% to $318.9 million for Fiscal 2000 from
$276.9 million for Fiscal 1999. The increase was due primarily to an increase in
same-store revenues of 3.8%, as well as a 9.7% increase in the average number of
stores open during Fiscal 2000 versus Fiscal 1999. The increase in same-store
revenues was primarily the result of (i) increased product availability for the
customer; (ii) a strong slate of new title releases versus the prior year,
especially in the fourth quarter where box office revenues on the titles
released were approximately 40% higher than the fourth quarter of 1999; (iii)
successful, chain-wide internal marketing programs designed to generate more
consumer excitement and traffic in the Company's base of stores; (iv) an
increase in the sale of previously viewed movies and previously played games;
(v) the return of the Christmas and New Year's holidays to a weekday instead of
a weekend day, as well as the absence of the "millennium effect" experienced in
1999; and (vi) increases in other ancillary sales. The revenue increase was
partially offset by a decline in new movie sales as a result of fewer titles
being released at sell-through price points and a deemphasis on the sale of
older sell-through titles in certain stores.
Cost of Sales. Rental revenue costs as a percentage of rental revenues for
Fiscal 2000 was 30.2%, a slight increase from 29.6% in Fiscal 1999 primarily due
to the significant concentration of product purchases in the fourth quarter of
Fiscal 2000. The cost of rental revenues includes both the amortization of
rental inventory and revenue sharing expenses incurred by the Company.
Cost of product sales includes the costs of new videocassettes and DVDs,
confectionery items and other goods, as well as the unamortized value of
previously viewed rental inventory sold. The gross margin on product sales
decreased to 34.3% in Fiscal 2000 from 37.6% in Fiscal 1999. The decrease in
profitability of product sales is primarily the result of significant
discounting in the fourth quarter for the holiday season and continued
liquidation of older sell-through titles in certain stores.
Gross Margins. As a result of slightly lower margins on both rental revenues and
product sales, total gross margins declined from 65.5% in Fiscal 1999 to 64.5%
in Fiscal 2000.
Operating Costs and Expenses. Store operating expenses, which include
store-level expenses such as lease payments and in-store payroll, decreased to
48.2% of total revenue for Fiscal 2000 from 49.5% for Fiscal 1999. The decrease
in store operating expenses as a percentage of revenue is primarily due to the
same-store revenue increase in Fiscal 2000, as well as the centralization of
certain functions at the general and administrative level which have resulted in
store level expense savings and the continued focus on closure of
underperforming stores.
Amortization of intangibles decreased as a percentage of revenues to 2.3% in
Fiscal 2000 versus 3.1% in Fiscal 1999. This decrease is primarily due to the
increase in same-store revenue in Fiscal 2000 and a reduction in goodwill
impairment write-offs during Fiscal 2000 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."
General and administrative expenses as a percentage of revenues was 7.8% for
Fiscal 2000 compared to 7.7% for Fiscal 1999. Increases in general and
administrative expenses due to increased staffing and travel costs associated
with the Company's new store development which began to intensify in the latter
half of 1999, as well as incremental expenses from the operation of the
Company's e-commerce effort which was launched in September 1999, were offset by
revenue increases in Fiscal 2000.
20
As a result of the above factors, operating income increased by 37.1% to $19.7
million in Fiscal 2000 from $14.4 million in Fiscal 1999.
For Fiscal 2000 the Company's effective income tax rate was 40.4%, as compared
to a 41.9% effective rate for Fiscal 1999. The decrease in the income tax rate
in Fiscal 2000 is primarily due to higher pre-tax income which leverages certain
permanently non-deductible items, therefore reducing the effective tax rate.
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."
21
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.
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 Entertainment, Inc. ("Blowout")
stores (acquired in May 1999) 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.
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 impairment 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."
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.
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.
22
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."
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."
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 two years. 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 2000, the Company generated $39.7 million in Adjusted EBITDA
versus $35.5 million for Fiscal 1999. The increase in Adjusted EBITDA was
primarily driven by the operating earnings generated by a 15.2% increase in
total revenue. 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 2000 increased 14.1% to $17.0 million, or $1.47 per
diluted share, from $14.9 million, or $1.11 per diluted share for Fiscal 1999.
Contributing to this increase was a 14.0% decline in weighted average shares
outstanding as a result of share repurchases. Cash earnings is defined as net
income before extraordinary items, cumulative effect accounting changes 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 $99.2 million for Fiscal 2000 as
compared to $84.4 million for Fiscal 1999. The increase in net cash provided by
operating activities was primarily the result of increased net income and
depreciation, decreased levels of merchandise inventory due to fewer titles
being released at sell-through price points and a deemphasis on the sale of new
movies in certain stores, as well as increased accounts payable due to
significant rental inventory purchases in the fourth quarter of 2000 versus
1999. The increase was partially offset by reductions in accrued liabilities.
Net cash provided by operating activities continues to be sufficient to cover
capital resource and debt service needs.
Net cash used in investing activities was $89.4 million for Fiscal 2000 as
compared to $78.7 million for Fiscal 1999. This increase in funds used for
investing activities is primarily the result of increases in capital
expenditures related to rental inventory and property, furnishings and equipment
purchased to support the growth in the Company's store base and the Company's
increased new store development plan.
23
Net cash used by financing activities was $9.7 million for Fiscal 2000 as
compared to $5.7 million for Fiscal 1999. This increase in funds used for
financing activities is due to more stock repurchases and more significant
reductions in long-term debt during Fiscal 2000 versus Fiscal 1999.
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 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. The
Company is currently negotiating a replacement for the existing Facility.
The Company grows its store base through internally developed and acquired
stores. The Company opened 110 internally-developed stores and acquired 16
stores during Fiscal 2000. During the year 2001, the Company intends to open
approximately 75 new stores and will entertain potential acquisition
transactions; however, the number of acquired stores in 2001 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 the first quarter of 2000, the Company completed its previously announced
$5 million stock repurchase plan and announced a second $5 million stock
repurchase plan which was completed in May 2000. During Fiscal 2000, the Company
repurchased 1.4 million shares for $5.7 million, which was funded through cash
flow from operations.
At December 31, 2000, the Company had a working capital deficit of $21.1
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 2001,
including its anticipated new store openings and a modest potential acquisition
program. 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.
24
Other Matters
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 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 December 31, 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.
Supply Contract. In March 2001, the Company and Rentrak Corporation ("Rentrak")
amended the terms of the Company's existing supply contract with Rentrak. The
Company paid Rentrak $1,600,000 in connection with the amendment to the
contract. Additionally, the Company prepaid approximately $900,000 to be applied
over a three-year period against future amounts due under the contract.
Stock Repricing. In March 2000, the FASB issued FASB Interpretation No. 44
"Accounting for Certain Transactions involving Stock Compensation, an
interpretation of APB Opinion No. 25." The Interpretation requires that stock
options that have been modified to reduce the exercise price be accounted for as
variable. The Company repriced 384,000 stock options in March 2001, and reduced
the exercise price to $4 per share. Under the Interpretation, the options are
accounted for as variable until the options are exercised, forfeited or expire
unexercised. The Company will record compensation expense in the first quarter
of fiscal 2001 that will approximate the difference between the exercise price
of the repriced options and the market price at the end of the quarter.
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.
25
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 2001
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 2001 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 2001 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 2001 Annual Meeting of Stockholders, and is
incorporated herein by reference.
PART IV
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 December 31, 2000 and January 2,
2000.
Consolidated Statements of Operations for the Fiscal Years Ended
December 31, 2000, January 2, 2000, and January 3, 1999.
Consolidated Statements of Stockholders' Equity for the Fiscal Years
Ended December 31, 2000, January 2, 2000, and January 3, 1999.
Consolidated Statements of Cash Flows for the Fiscal Years Ended
December 31, 2000, January 2, 2000, and January 3, 1999.
Notes to Consolidated Financial Statements.
(a)(2) Schedules:
None.
26
(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 - Employment Agreement between M.G.A., Inc. and J. Steven Roy. (4)
10.6 - Employment Agreement between M.G.A., Inc. and S. Page Todd. (4)
10.7 - Employment Agreement between M.G.A., Inc. and Jeffrey S. Stubbs.
(filed herewith)
10.8 - Credit Agreement between First Union National Bank of North
Carolina and Movie Gallery, Inc. dated January 7, 1999. (5)
18 - Change in Accounting Principle. (6)
21 - List of Subsidiaries. (filed herewith)
23 - Consent of Independent Auditors. (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 6,
1998, as an exhibit to the Company's Form 10-K for the fiscal year ended
January 4, 1998.
(5) 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.
(6) 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
December 31, 2000.
(c) Exhibits:
See (a)(3) above.
27
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 2, 2001
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 Chief April 2, 2001
- ----------------------- Executive Officer
Joe Thomas Malugen
/s/ WILLIAM B. SNOW Vice Chairman of the Board April 2, 2001
- -----------------------
William B. Snow
/s/ H. HARRISON PARRISH Director and President April 2, 2001
- -----------------------
H. Harrison Parrish
/s/ SANFORD C. SIGOLOFF Director April 2, 2001
- -----------------------
Sanford C. Sigoloff
/s/ J. STEVEN ROY Executive Vice President and April 2, 2001
- ----------------------- Chief Financial Officer
J. Steven Roy
/s/ IVY M. JERNIGAN Vice President - Controller April 2, 2001
- -----------------------
Ivy M. Jernigan
28
Movie Gallery, Inc.
Consolidated Financial Statements
Fiscal years ended December 31, 2000, January 2,2000 and January 3, 1999
Contents
Report of 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 Independent Auditors
Board of Directors and Stockholders
Movie Gallery, Inc.
We have audited the accompanying consolidated balance sheets of Movie Gallery,
Inc. as of December 31, 2000 and January 2, 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in period ended December 31, 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Movie
Gallery, Inc. at December 31, 2000 and January 2, 2000, and the consolidated
results of its operations and its cash flows for each of the three years in
period ended December 31, 2000, in conformity with accounting principles
generally accepted in the United States.
As discussed in Note 1 to the financial statements, in fiscal 1999 the Company
changed its method of accounting for the costs of start-up activities and in
fiscal 1998 the Company changed its method of accounting for amortization of
rental inventory.
/s/ Ernst & Young, LLP
Birmingham, Alabama
February 16, 2001, except
for Note 8, as to which the
date is March 30, 2001
F-1
Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)
December 31, January 2,
2000 2000
--------- ---------
Assets
Current assets:
Cash and cash equivalents $ 7,029 $ 6,970
Merchandise inventory 9,264 15,148
Prepaid expenses 1,000 814
Store supplies and other 3,852 3,395
Deferred income taxes 502 229
--------- ---------
Total current assets 21,647 26,556
Rental inventory, net 61,773 52,357
Property, furnishings and equipment, net 53,124 44,320
Goodwill and other intangibles, net 77,926 83,539
Deposits and other assets 3,066 2,543
Deferred income taxes -- 212
--------- ---------
Total assets $ 217,536 $ 209,527
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 31,111 $ 26,243
Accrued liabilities 11,631 12,989
Current portion of long-term debt -- 263
--------- ---------
Total current liabilities 42,742 39,495
Long-term debt 40,600 44,377
Other accrued liabilities 253 234
Deferred income taxes 4,732 --
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, 11,136,167 and 12,549,667
shares issued and outstanding 11 13
Additional paid-in capital 121,841 127,537
Retained earnings (deficit) 7,357 (2,129)
--------- ---------
Total stockholders' equity 129,209 125,421
--------- ---------
Total liabilities and stockholders' equity $ 217,536 $ 209,527
========= =========
See accompanying notes.
F-2
Movie Gallery, Inc.
Consolidated Statements of Operations
(in thousands, except per share data)
Fiscal Year Ended
-----------------------------------
December 31, January 2, January 3,
2000 2000 1999
-----------------------------------
Revenues:
Rentals $ 271,457 $ 235,452 $ 222,784
Product sales 47,479 41,493 44,849
--------- --------- ---------
318,936 276,945 267,633
Cost of sales:
Cost of rental revenues 81,958 69,716 113,192
Cost of product sales 31,213 25,884 29,744
--------- --------- ---------
Gross margin 205,765 181,345 124,697
Operating costs and expenses:
Store operating expenses 153,665 137,128 130,473
Amortization of intangibles 7,465 8,452 7,068
General and administrative 24,945 21,403 17,996
--------- --------- ---------
Operating income (loss) 19,690 14,362 (30,840)
Interest expense, net (3,779) (3,349) (5,325)
--------- --------- ---------
Income (loss) before income taxes, extraordinary item
and cumulative effect of accounting change 15,911 11,013 (36,165)
Income taxes 6,425 4,615 (13,089)
--------- --------- ---------
Income (loss) before extraordinary item and
cumulative effect of accounting change 9,486 6,398 (23,076)
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 (loss) $ 9,486 $ 5,017 $ (23,076)
========= ========= =========
Basic and diluted earnings (loss) per share:
Income (loss) before extraordinary item and
cumulative effect of accounting change $ 0.83 $ 0.48 $ (1.72)
Extraordinary loss on early extinguishment of debt,
net of income taxes -- (0.05) --
Cumulative effect of accounting change, net of income taxes -- (0.05) --
--------- --------- ---------
Net income (loss) $ 0.83 $ 0.38 $ (1.72)
========= ========= =========
Weighted average shares outstanding:
Basic 11,467 13,115 13,388
Diluted 11,497 13,370 13,388
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 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
Net income -- -- 9,486 9,486
Repurchase and retirement of 1,413,500 shares (2) (5,696) -- (5,698)
--------- --------- --------- ---------
Balance at December 31, 2000 $ 11 $ 121,841 $ 7,357 $ 129,209
========= ========= ========= =========
See accompanying notes.
F-4
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Year Ended
-----------------------------------
December 31, January 2, January 3,
2000 2000 1999
-----------------------------------
Operating activities:
Net income (loss) $ 9,486 $ 5,017 $ (23,076)
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 76,787 72,205 126,257
Deferred income taxes 4,671 2,744 (14,855)
Changes in operating assets and liabilities:
Merchandise inventory 5,884 (2,788) 1,911
Other current assets (643) 348 (649)
Deposits and other assets (518) (1,104) 105
Accounts payable 4,868 2,847 1,879
Accrued liabilities (1,356) 3,740 (709)
--------- --------- ---------
Net cash provided by operating activities 99,179 84,390 90,863
Investing activities:
Business acquisitions (3,085) (11,839) (799)
Purchases of rental inventory, net (63,211) (54,259) (59,266)
Purchases of property, furnishings and equipment (23,086) (12,573) (6,251)
--------- --------- ---------
Net cash used in investing activities (89,382) (78,671) (66,316)
Financing activities:
Net proceeds from issuance of common stock -- 48 48
Purchases and retirement of common stock (5,698) (3,766) (495)
Payments on notes payable -- -- (200)
Principal payments on long-term debt (4,040) (2,014) (21,376)
--------- --------- ---------
Net cash used in financing activities (9,738) (5,732) (22,023)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 59 (13) 2,524
Cash and cash equivalents at beginning of period 6,970 6,983 4,459
--------- --------- ---------
Cash and cash equivalents at end of period $ 7,029 $ 6,970 $ 6,983
========= ========= =========
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 3,817 $ 3,076 $ 5,066
Cash paid during the period for income taxes 1,688 2,705 478
Noncash investing and financing information:
Tax benefit of stock options exercised -- 7 9
See accompanying notes.
F-5
Movie Gallery, Inc.
Notes to Consolidated Financial Statements
December 31, 2000, January 2, 2000 and January 3, 1999
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 30 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
ended December 31, 2000 ("Fiscal 2000"), January 2, 2000 ("Fiscal 1999") and
January 3, 1999 ("Fiscal 1998") 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.
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, digital video
discs (DVDs), video games, 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 estimated 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. Amortization of intangibles for Fiscal 2000, 1999 and
1998 includes an impairment loss of $1,000,000, $1,600,000 and $84,000,
respectively, to write-off the net book value of goodwill in excess of its
estimated fair market value.
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 movie and
video game rental inventory. This method accelerates the rate of amortization
and was adopted as a result of an industry trend towards significant increases
F-6
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
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 movie inventory,
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 movie inventory,
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 movie 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.
This method of amortization was applied to all inventory held at July 6, 1998.
The adoption of this 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
movie and video game rental inventory decreased rental inventory and increased
depreciation expense for Fiscal 1998 by approximately $43.6 million and reduced
net income by $27.7 million, or $2.06 per basic and diluted share.
Rental inventory consists of the following (in thousands):
December 31, January 2,
2000 2000
--------- ----------
Rental inventory $ 145,557 $ 183,185
Less accumulated amortization (83,784) (130,828)
--------- ----------
$ 61,773 $ 52,357
========= ==========
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 December 31, 2000 and January 2, 2000 was $35,830,000 and
$32,097,000, respectively.
F-7
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
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 movie 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 Fiscal
1999 was not material.
Fair Value of Financial Instruments
At December 31, 2000 and January 2, 2000, 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 accounting principles
generally accepted in the United States 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.
F-8
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Recently Issued Accounting Pronouncements
The FASB has issued Statement No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (as amended by Statements No. 137 and 138) which is
required to be adopted by the Company in fiscal year 2001. Statement 133 will
require the Company to recognize all derivatives on the balance sheet at fair
value. Derivatives that are not hedges must be adjusted to fair value through
income. If a derivative is a hedge, depending on the nature of the hedge,
changes in the fair value of the derivative will either offset against the
change in fair value of the hedged item through earnings or be recognized in
other comprehensive income until the hedged item is recognized in earnings.
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 Fiscal 2000, 1999 and 1998 was immaterial to the
Company's operating results.
2. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
December 31, January 2,
2000 2000
---------------------------
Land and buildings $ 4,006 $ 1,889
Furniture and fixtures 37,291 33,383
Equipment 33,616 28,495
Leasehold improvements and signs 36,860 27,931
--------- ---------
111,773 91,698
Accumulated depreciation (58,649) (47,378)
--------- ---------
$ 53,124 $ 44,320
========= =========
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 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
December 31, 2000, $40.6 million was outstanding, approximately $23.9 million
was available for borrowing and the effective interest rate was approximately
7.4%.
F-9
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
3. Long-Term Debt (continued)
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.
4. Income Taxes
The following reflects actual income tax expense (benefit) (in thousands):
Fiscal Year Ended
-----------------------------------------
December 31, January 2, January 3,
2000 2000 1999
-----------------------------------------
Current payable:
Federal $ 1,439 $ 1,673 $ 1,275
State 315 198 491
-------- -------- --------
Total current 1,754 1,871 1,766
Deferred:
Federal 4,056 2,454 (13,423)
State 615 290 (1,432)
-------- -------- --------
Total deferred 4,671 2,744 (14,855)
-------- -------- --------
$ 6,425 $ 4,615 $(13,089)
======== ======== ========
F-10
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
4. Income Taxes (continued)
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
-------------------------------------
December 31, January 2, January 3,
2000 2000 1999
-------------------------------------
Income tax expense (benefit)
at statutory rate $ 5,569 $ 3,855 $(12,658)
State income tax expense (benefit)
net of federal income tax benefit 604 317 (612)
Other, net (primarily goodwill not
deductible for tax purposes) 252 443 181
-------- -------- --------
$ 6,425 $ 4,615 $(13,089)
======== ======== ========
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):
December 31, January 2,
2000 2000
-----------------------
Deferred tax liabilities:
Furnishings and equipment $ 6,003 $ 5,473
Rental inventory 6,351 3,818
Goodwill 2,251 2,026
Other -- 461
-------- --------
Total deferred tax liabilities 14,605 11,778
Deferred tax assets:
Non-compete agreements 4,979 4,970
Alternative minimum tax credit carryforward 4,163 2,827
Net operating loss carryforwards -- 2,802
Accrued liabilities 502 777
Other 731 843
-------- --------
Total deferred tax assets 10,375 12,219
-------- --------
Net deferred tax assets (liabilities) $ (4,230) $ 441
======== ========
F-11
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
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 December 31, 2000, common stock of approximately
$83,000,000 was available to be issued from this registration.
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 (30,000, 255,000 and none for Fiscal 2000, 1999 and 1998, respectively).
No adjustments were made to net income in the computation of basic or diluted
earnings per share.
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 3,000,000 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 accordance with the provisions of FASB Statement No. 123, "Accounting for
Stock-Based Compensation," 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
---------------------------------------
December 31, January 2, January 3,
2000 2000 1999
---------------------------------------
(in thousands, except per share data)
Pro forma net income (loss) $ 8,496 $ 3,801 $ (24,324)
Pro forma earnings (loss) per share:
Basic and diluted 0.74 0.29 (1.82)
F-12
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
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
--------------------------------------------
December 31, January 2, January 3,
2000 2000 1999
--------------------------------------------
Expected volatility 0.703 0.720 0.733
Risk-free interest rate 5.15% 6.39% 4.70%
Expected life of option in years 5.7 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.
A summary of the Company's stock option activity and related information is as
follows:
Fiscal Year Ended
-------------------------------------------------------------------------------------
December 31, 2000 January 2, 2000 January 3, 1999
--------------------------- --------------------------- ----------------------------
Weighted- Weighted- Weighted-
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
--------- -------------- --------- -------------- --------- --------------
Outstanding-beginning
of year 2,276,987 $ 9.56 2,188,899 $ 9.73 1,895,537 $ 10.62
Granted 405,000 3.20 444,000 4.36 363,000 5.13
Exercised - - 12,350 3.88 12,230 3.88
Forfeited 139,480 5.14 343,562 4.17 57,408 11.32
Outstanding-end of year 2,542,507 8.79 2,276,987 9.56 2,188,899 9.73
Exercisable at end of year 1,669,307 11.30 1,440,871 12.03 1,206,397 12.68
Weighted-average fair value
of options granted during
the year $ 2.10 $ 3.05 $ 3.43
F-13
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Stockholders' Equity (continued)
Options outstanding as of December 31, 2000 had a weighted-average remaining
contractual life of 7.1 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 1,894,507 380,000 268,000
Weighted-average exercise price $4.05 $15.16 $33.22
Weighted-average remaining contractual life 8.0 years 4.3 years 4.4 years
Options exercisable 1,030,707 370,600 268,000
Weighted-average exercise price of
exercisable options $4.20 $15.19 $33.22
6. Commitments and Contingencies
Rent expense for Fiscal 2000, 1999 and 1998 totaled $45,132,000, $41,683,000 and
$40,959,000, 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 December 31,
2000 (in thousands):
2001 $ 30,430
2002 26,015
2003 17,037
2004 10,301
2005 4,283
Thereafter 2,944
--------
$ 91,010
========
The Company has a supply contract with Rentrak Corporation ("Rentrak") 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-14
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 2, July 2, October 1, December 31,
2000 2000 2000 2000
----------------------------------------------
Revenue $81,493 $77,345 $75,350 $84,748
Operating income $ 7,478 $ 4,237 $ 1,893 $ 6,082
Net income $ 3,900 $ 1,935 $ 561 $ 3,090
Basic and diluted earnings per share $ 0.32 $ 0.17 $ 0.05 $ 0.28
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
======== ======== ======== ========
8. Subsequent Events
In March 2001, the Company and Rentrak amended the terms of the Company's
existing supply contract with Rentrak. The Company paid Rentrak $1,600,000 in
connection with the amendment to the contract. Additionally, the Company prepaid
approximately $900,000 to be applied over a three-year period against future
amounts due under the contract.
In March 2000, the FASB issued FASB Interpretation No. 44 "Accounting for
Certain Transactions involving Stock Compensation, an interpretation of APB
Opinion No. 25." The Interpretation requires that stock options that have been
modified to reduce the exercise price be accounted for as variable. The Company
repriced 384,000 stock options in March 2001, and reduced the exercise price to
$4 per share. Under the Interpretation, the options are accounted for as
variable until the options are exercised, forfeited or expire unexercised. The
Company will record compensation expense in the first quarter of fiscal 2001
that will approximate the difference between the exercise price of the repriced
options and the market price at the end of the quarter.
F-15
Index to Exhibits
Exhibit No. Description
- ----------- -----------
10.7 Employment agreement between M.G.A., Inc. and Jeffrey S. Stubbs
21 List of Subsidiaries
23 Consent of Independent Auditors