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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 [FEE REQUIRED]
For the fiscal year ended January 5, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ____________ to _______________.
Commission File Number: 0-24548
MOVIE GALLERY, INC.
(Exact name of registrant as specified in its charter)
Delaware 63-1120122
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
739 W. Main Street, Dothan, Alabama 36301
(Address of principal executive offices) (Zip Code)
(334) 677-2108
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of each 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
filing requirements for the past 90 days. YES X NO
The aggregate market value of the voting stock held by non-affiliates of
the registrant as of April 1, 1997, was approximately $60,078,322.50. The number
of shares of Common Stock outstanding on April 1, 1997 was 13,420,791 shares.
Documents incorporated by reference:
1. Notice of 1997 Annual Meeting and Proxy Statement (Part III of Form
10-K).
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
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
ITEM 1. BUSINESS
General
As of March 14, 1997, Movie Gallery, Inc. (the "Company") owned and
operated 855 video specialty stores and had 106 franchisees and licensees
located in 22 states, primarily in the eastern half of the United States, that
rent and sell videocassettes and video games. Since the Company's initial public
offering in August 1994, the Company has grown from 97 stores to its present
size through acquisitions and the development of new stores. The Company
believes it is the second largest video retailer in the United States in terms
of locations and is among the three largest in terms of revenue.
The Company was incorporated in Delaware in June 1994 under the name
Movie Gallery, Inc. From March 1985 until the present time, substantially all of
the Company's operations have been conducted through its wholly-owned
subsidiary, M.G.A., Inc. The Company's executive offices are located at 739 W.
Main Street, Dothan, Alabama 36301, and its telephone number is (334) 677-2108.
Video Industry Overview
Video Retail Industry. According to Paul Kagan Associates, Inc. ("Paul
Kagan"), the videocassette rental and sales industry has grown from $0.7 billion
in revenue in 1982 to a projected $15.8 billion in 1996 and is projected to
reach $20.5 billion by 2005. Paul Kagan estimates that in 1996 consumers made
more than 3.3 billion visits to video stores, rented approximately 3 billion
videos and purchased more than 580 million videos. In fact, Adams Media Research
estimates that 85.0% of America's 96 million television households have
videocassette recorders, a percentage which is expected to exceed 90% by 2002.
Reports from industry analysts, including Paul Kagan, demonstrate that
the video retail industry is highly fragmented with approximately 27,000 video
specialty stores, nearly 70% of which operate independently or as part of a
small chain of 10 or fewer stores. According to these sources, recent trends
toward consolidation have been fueled by the impact of superstores on smaller
retailers, the need for enhanced access to working capital and efficiencies of
scale. The Company believes that the video specialty store industry is
continuing to consolidate into regional and national chains.
Although the domestic video retail industry includes both rentals and
sales, the consumer market for prerecorded videocassettes has been primarily
comprised of rentals. By setting the wholesale prices, movie studios influence
the relative levels of videocassette rentals versus sales. Videocassettes
released at a relatively high price, typically $60 to $75, are purchased by
video specialty stores and are promoted primarily as rental titles.
Videocassettes released at a relatively low price, typically $5 to $25
("sell-through titles"), are purchased by video specialty stores and are
generally promoted as both rental and sales titles. In general, movie studios
attempt to maximize total revenue from videocassette releases by combining the
release of most titles at a high price point to encourage purchase for the
rental market, with the release of a relatively few major hits or animated
children's classics at sell-through pricing to encourage purchase directly by
the consumer at retail. Video specialty stores will purchase sell-through titles
for both the rental market and for retail sale.
1
Movie Studio Dependence on Video Rental Industry. The videocassette
rental and sales industry is the largest single source of domestic revenue to
movie studios and, according to Paul Kagan, represented approximately $4.3
billion, or 47%, of the $9.3 billion of studio revenue in 1996. The Company
believes that of the many movies produced by major studios and released in the
United States each year, relatively few are profitable for the studios based on
box office revenue alone. In addition to purchasing box office hits, video
specialty stores provide the movie studios with a reliable source of revenue for
a large number of their movies by purchasing movies on videocassette that were
not successful at the box office. The Company believes the consumer is more
likely to view movies which were not box office hits on a rented videocassette
than on any other medium because video specialty stores provide an inviting
opportunity to browse and make impulse choices among a very broad selection of
movie titles. In addition, the Company believes the relatively low cost of video
rentals encourages consumers to rent films they might not pay to view at a
theater.
Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenue by releasing movies in sequential release date "windows" to various
movie distribution channels. These distribution channels include, in the
customary order of release date, movie theaters, airlines and hotels, video
specialty stores, pay-per-view satellite and cable television systems
("Pay-Per-View"), premium cable television, basic cable television and, finally,
network and syndicated television. See "Business -- Competition and
Technological Obsolescence." The Company believes that this method of sequential
release has allowed movie studios to increase their total revenue with
relatively little adverse effect on the revenue derived from previously
established distribution channels and it is anticipated that movie studios will
continue the practice of sequential release even as near video on demand
("NVOD") and, eventually, video on demand ("VOD") become more readily available
to the consumer. According to Paul Kagan, most movie studios release hit movie
videocassettes to the home video market from 30 days to 80 days (extending up to
120 days for certain titles priced for sale rather than rental) prior to the
Pay-Per-View release date.
Growth Strategy
During the fiscal years 1994 through 1996, approximately 78% of the
Company's growth in the total number of stores has occurred through the
acquisition of stores and the balance has occurred through the development of
new stores. It is expected that, in the future, development of new stores will
account for at least half of the Company's growth. The Company's ability to
continue this growth strategy will be dependent upon its ability to raise
additional funds. The key elements of the Company's development and acquisition
strategy include the following:
Development. From January 1, 1994 through March 14, 1997, the Company
has developed 166 stores and intends to develop approximately 30 additional
stores during the first half of fiscal 1997. The Company utilizes store
development to complement its existing base of stores in markets where it finds
attractive locations and a sufficient population to support additional video
specialty stores. 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.
2
The Company's real estate and construction departments are responsible
for new store development, including site selection, market evaluation, lease
negotiation and construction. The Company usually acts as the general contractor
with respect to the construction of its new stores and, in that regard, employs
full-time construction managers who have significant video specialty store
construction experience.
Set forth below is a historical summary showing store openings,
acquisitions and store closings by the Company since inception.
Nine Months Year Ended
Year Ended March 31 Ended December 31 Year Ended January 5
------------------- December 31 -------------- January 5 to March 14
1985-1992 1993 1993 1994 1995 1997 1997
--------- ---- ------------- ----- ------ ---------- -----------
New Store Openings 13 11 10 25 66 75 5
Stores Acquired 26 15 1 196 327 174(1) 0
Stores Closed 2 0 1 2 23 48 13
Total Stores at End
of Period 37 63 73 292 662 863 855
(1) Includes 98 stores acquired on July 1, 1996 and accounted for as
poolings-of-interests. Store counts, prior to the fiscal year ended January 5,
1997, have not been restated for purposes of this table. For total store counts
at the end of the fiscal years 1993 through 1996, see "Overview" in Item 7.
Acquisitions. From January 1, 1994 through March 14, 1997, the Company
has acquired 697 stores. Acquisitions have permitted the Company to quickly gain
market share and experienced management in markets that the Company believes
have 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 the last six months of 1996, the Company
suspended its acquisition program, primarily in order to concentrate on
improving operations at the stores it had acquired and developed from August
1994 through July 1996. Subject to the availability of funds, the Company
expects to resume an acquisition program in the second half of 1997.
Future store acquisitions will be selected based upon location, quality
of operations and financial criteria as determined by the Company to be
consistent with its growth strategy. In connection with future acquisitions, the
Company anticipates that some of the owners and most of the key personnel will
be employed by the Company. Historically, the owners of the stores acquired by
the Company have entered into noncompetition agreements with the Company which
are generally for a five to ten-year term.
3
The Company continues to have preliminary discussions with the owners
of video retail businesses. While the Company has no present understandings,
commitments or agreements with respect to any future acquisition, it anticipates
that acquisition opportunities will arise in the future. However, there can be
no assurance that future acquisition opportunities will be available and that
the integration of future acquisitions will not materially and adversely affect
the Company.
Operating Strategy
Focus on Smaller Markets. Generally, the Company's stores are located
in small towns or suburban areas surrounding mid-sized cities. In these areas,
the Company's principal competition usually consists of single store or small
chain operators, who have less buying power, smaller advertising budgets and
generally offer fewer copies of new videocassette releases. The Company attempts
to become the leading video retailer in its markets and believes that it can
achieve a higher return on invested capital in these smaller markets than it
could in the larger urban areas because of the reduced level of competition and
lower operating costs.
Market Concentration. By concentrating its new store development in
existing markets, the Company is able to achieve operating efficiencies,
primarily consisting of cost savings relating to advertising, training and store
supervision.
New Release Purchases. The Company actively manages its new
videocassette purchases in order to balance customer demand with the
maximization of profitability. Buying decisions are made centrally with input
from store, district and regional managers. Centralized purchasing allows the
Company to obtain volume discounts, market development funds and cooperative
advertising credits that are generally not available to single store or small
chain operators.
Centralized Operations. In order to increase operating efficiency, the
Company centrally manages labor costs, real estate costs, accounting and cash
management and utilizes centralized purchasing, advertising and information
systems. A Company-wide quality assurance program insures a high degree of
customer service and a visually appealing store. The Company believes this
program increases customer satisfaction and loyalty.
Store Location and Format. The Company maintains a flexible store
format, tailoring the size, inventory and look of each store to local
demographics. The Company's stores generally range from approximately 2,000 to
9,000 square feet (averaging 4,750 square feet), with inventories ranging from
approximately 3,000 to 15,000 videocassettes. Substantially all of the Company's
stores are located in strip centers, anchored by major grocery or discount drug
store chains, which provide easy access, good visibility, and high traffic.
4
Movie Gallery Stores
At March 14, 1997, the Company owned and operated 855 stores, all but
one of which were located in leased premises. The following table provides
information at March 14, 1997 regarding the number of Company stores located in
each state.
Number
of
Stores
------
Alabama..................................... 147
Florida..................................... 112
Texas....................................... 91
Georgia..................................... 67
Virginia.................................... 54
Ohio........................................ 50
Tennessee................................... 46
Maine....................................... 41
South Carolina.............................. 33
Wisconsin................................... 32
Indiana..................................... 31
Mississippi................................. 29
North Carolina.............................. 22
Missouri.................................... 21
Kentucky.................................... 19
Kansas...................................... 16
Louisiana................................... 15
New Hampshire............................... 11
Illinois.................................... 10
Iowa........................................ 4
Massachusetts............................... 3
Michigan.................................... 1
---
TOTAL.............................. 855
===
The Company's stores are generally open seven days a week, from 10:00
a.m. to 11:00 p.m. on weekends and from 10:00 a.m. to 10:00 p.m. on weekdays.
The store fixtures, equipment and layout are designed by the Company to create a
visually-appealing, up-beat ambiance, which is augmented by a background of
popular music, television monitors displaying movies and promotions of coming
attractions, and 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 has implemented a quality assurance program to ensure
compliance with the Company's customer service and store operating policies. A
team of seven employees located in different store regions make periodic visits
to monitor compliance and report results to the Company's Vice President -
Administration. District managers and regional managers are expected to quickly
address and resolve any compliance problems.
It is the Company's policy to constantly evaluate its existing store
base to determine where improvements may benefit the Company's competitive
position. In negotiating its leases and renewals, the Company attempts to obtain
short lease terms to allow for the mobility necessary to react to changing
demographics and other market conditions. The Company actively pursues
relocation opportunities to adapt to market shifts. Similarly, the Company may
elect to expand and/or remodel certain of its stores in order to improve
facilities, meet customer demand and maintain the visual appeal of each store.
During the fiscal year ended January 5, 1997, the Company relocated, expanded or
fully remodeled 53 stores.
5
In order to maximize profits, the Company varies the quantity of its
new release inventory, the rental and sales prices for videocassettes and video
games, and the rental period for catalog titles from location to location to
meet competition and demographic demand in the area. The Company generally has a
one-day rental term for most recent new releases (two days for catalog titles),
which tends to keep new releases more readily available and requires the
purchase of fewer copies of new releases than a two-day rental policy.
Stores generally offer multiple checkout counters, each with a computer
terminal. Rental payment is required upon checkout in substantially all of the
Company's stores, with the remainder requiring payment on return. To generate
goodwill with its customers, the Company's stores will, upon customer request,
temporarily reserve in-stock titles.
Franchises and Licenses
In connection with certain of its acquisitions, the Company assumed
obligations under franchise agreements and license agreements. The Company has
entered into additional license agreements with certain former owners of
acquired stores and with existing licensees. As of March 14, 1997, the Company
had 106 franchisees and licensees operating under such agreements pursuant to
which the Company receives various royalty and license payments and has certain
non-monetary obligations to the franchisees and licensees. The Company does not
presently intend to offer franchises or licenses for sale and, whenever
possible, will purchase stores operated by franchisees or licensees if they
become available at reasonable prices. For the fiscal year ended January 5,
1997, revenues from franchisees and licensees were not material to the Company.
Products
For the fiscal year ended January 5, 1997, substantially all of the
Company's rental revenue was derived from the rental of videocassettes, with the
remainder being derived from the rental of video games. Substantially all of the
Company's revenue from product sales during these periods was derived from the
sale of new and previously viewed videocassettes and video games. The balance of
product sale revenue was derived from video accessories, such as blank cassettes
and cleaning equipment, confectionery items and movie memorabilia. The Company
also sells audio products in a few of its stores.
The Company's stores generally offer from 3,000 to 15,000
videocassettes (from 2,500 to 8,000 titles) and from 200 to 1,000 video games
(from 150 to 750 titles) for rental and sale, depending upon location. New
release movies are displayed alphabetically and catalog titles are displayed
alphabetically by category, such as "Action," "Comedy," "Children" and
"Classics." A typical store's inventory consists of 4,000 catalog selections
(chosen from a core selection of about 6,000 titles), plus new release titles
and older titles which continue to be in strong demand. Each store has a few
special interest titles, covering such subjects as hunting, golf and education,
selected by management to appeal to the customer base in the store's market
area. Buying decisions are made centrally with input from store, district and
regional managers and are based on box office results, industry newsletters and
management's knowledge of the popularity of certain types of movies in its
markets.
Management believes that internal factors which most affect a typical
store's revenues are its new release title selection and the number of copies of
each new release available for rental as compared to the competition. The
Company is committed to offering as many copies of new releases as necessary to
be competitive within a market, while at the same time keeping its costs as low
as possible. New videocassettes offered for sale are primarily "hit" titles
promoted by the studios for sell through, as well as special interest and
children's titles and seasonal titles connected to particular holidays.
6
The Company rents and sells video games, which are licensed primarily
by "Nintendo," "Sega Genesis" and "Sony." Game rentals as a percentage of the
Company's total revenues have decreased since 1994 due to the decrease in
consumer demand pending the release and consumer acceptance of the new 32-bit
and 64-bit game platforms. Sega Genesis and Sony released new platforms in late
1995, while Nintendo released its N64 platform in the fall of 1996. The Company
anticipates that one or more of the platforms will become dominant as more
households in its markets acquire video game hardware. At that time, the Company
expects that the video game rental and sales portion of its business may grow.
Videocassette and Video Game Suppliers
During the fiscal year ended Janaury 5, 1997, the Company purchased over
80% of its videocassettes and video games from Sight & Sound Distributors, Inc.
("Sight & Sound") pursuant to a contract with Sight & Sound which has been
renewed through March 30, 1998. Two other distributors were the primary
suppliers of the balance.
The Company's contract with Sight & Sound provides for the direct purchase
of videocassettes and video games at varying prices. These prices are a function
of the wholesale prices set by the movie studios, which depend upon whether a
videocassette is initially priced to encourage rental or sale. The Company
currently receives marketing funds and an advertising allowance from Sight &
Sound based upon a percentage of videocassette and video game purchases.
If the relationship with Sight & Sound were terminated, the Company
believes that it could readily obtain its required inventory of videocassettes
and video games from alternative suppliers at prices and on terms comparable to
those available from Sight & Sound. However, the number of alternative suppliers
has diminished in recent years and the termination of the Company's present
relationship with Sight & Sound could adversely affect the Company's results of
operations until a suitable replacement was found. There can be no assurance
that the replacement would provide service, support or payment terms as
favorable as those provided by Sight & Sound.
Several companies acquired by the Company had pre-existing long-term
contracts with Rentrak Corporation ("Rentrak") whereby product would be provided
under pay-per-transaction revenue sharing arrangements. During late 1996, the
Company consolidated existing contracts with Rentrak into one national
agreement. Under this ten-year agreement, the Company has a minimum annual
purchase commitment in revenue share, handling fees, sell-through fees and
end-of-term buyout fees. The Company intends to utilize Rentrak in specific
marketing campaigns or in very competitive markets.
Marketing and Advertising
With advertising credits and market development funds that it receives
from its video suppliers and the movie studios, the Company uses radio and
television advertising, direct mail, newspaper advertising, discount coupons and
promotional materials to promote new releases, its video specialty stores and
its trade name. Using copy prepared by the Company and the studios, advertising
is placed by an advertising subsidiary of Sight & Sound as well as by in-house
media buyers. Expenditures for marketing and advertising above the amount of the
Company's advertising credits from its suppliers and movie studios have been
minimal. The Company anticipates that it will continue to make substantial
marketing and advertising expenditures, but that its primary supplier and movie
studios will continue to pay most of such cost. The Company also benefits from
the advertising and marketing by studios and theaters in connection with their
efforts to promote films and increase box office revenue. The Company prepares a
monthly marketing magazine and videotape, which it sends to all of its stores,
featuring promotions and new releases.
7
Inventory
The videocassette and video game inventory in each store consists of
its catalog titles (those in release for more than one year) and new release
titles. New releases of videocassettes and video games purchased from suppliers
for existing stores are prepackaged by suppliers, rental-ready (except for the
bar codes, which are applied at the store) to the Company's specifications and
drop-shipped to the stores to avoid time delays in making videocassettes and
video games available for rental.
Videocassettes and video games utilized as initial inventory in the
Company's developed stores consist of excess copies of catalog titles and new
release titles from existing stores, supplemented as necessary by purchases
directly from suppliers. This inventory for developed stores is packaged at the
Company's processing and distribution facility located in Dothan, Alabama. Each
videocassette and video game is removed from its original packaging, and an
optical bar code label, used in the Company's computerized inventory system, is
applied to both the packaging and the plastic rental case. The cassette, along
with a brief description of the movie or game, is placed in the rental case, and
a display carton is created by inserting foam or cardboard into the original
packing and shrink-wrapping the carton. The repackaged videocassettes, video
games and display cartons are then shipped to the developed store ready for use.
Management Information System
In November 1995, the Company began development of its proprietary
Point of Sale ("POS") system. On January 10, 1996, the first Beta test store was
installed with the new system. Additional Beta test sites were rolled out until
March 31, 1996, at which time the Company had 17 Beta test stores. On April 1,
1996, the Company began the rapid deployment of the POS system in its stores. As
of March 14, 1997, there were 609 Company stores operating on the POS system. By
July 1997, the Company expects to have all of its stores on the new POS system.
The new 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 as soon after the closing of the
acquisition as practicable.
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
offices. 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, which is more efficient, more
accurate and less costly than a manual count.
In addition, during the last two years, the Company has installed a
financial reporting system relating to the general ledger, revenue, accounts
payable and payroll functions capable of handling the Company's anticipated
growth.
8
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, and with other
businesses offering videocassettes and video games such as supermarkets,
pharmacies, convenience stores, bookstores, mass merchants, mail order
operations and other retailers. Approximately 35% of the Company's stores
compete with stores operated by Blockbuster. In addition, the Company competes
with all forms of entertainment, such as movie theaters, network and cable
television, direct broadcast satellite television, Internet-related activities,
live theater, sporting events and family entertainment centers. Some of the
Company's competitors have significantly greater financial and marketing
resources and name recognition than the Company.
The Company believes the principal competitive factors in the video
retail industry are store location and visibility, title selection, the number
of copies of each new release available, customer service and, to a lesser
extent, pricing. The Company believes it generally offers superior service, more
titles and more copies of new releases than most of its competitors.
The Company also competes with Pay-Per-View, in which subscribers pay a
fee to view a movie selected by the subscriber. Recently developed technologies
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, referred to as NVOD. NVOD does not offer full interactivity
or VCR functionality, such as allowing consumers to control the playing of the
movie (starting, stopping and rewinding). Ultimately, further improvements in
these technologies could lead to the availability of a broad selection of movies
to the consumer on demand, referred to as VOD, at a price which may be
competitive with the price of videocassette rentals and with the functionality
of VCRs. Certain cable and other telecommunications companies have tested and
are continuing to test limited versions of NVOD and VOD in various markets
throughout the United States and Europe.
The Company anticipates that movies recorded on digital video discs
("DVD"), the same size as audio discs, will be introduced during 1997. At that
time, playback machines which play both audio discs and DVD will be introduced.
Because of the ease of use and durability of DVD, it is anticipated that
eventually DVD may begin to replace videocassettes. During the transition
period, the Company's cost to maintain its inventory may increase. The Company
expects to offer DVD for rental and sale once they are introduced commercially.
In addition, the advent of DVD may result in consumers purchasing more films
than in the past, which could have a material adverse effect on the Company's
rental volume and, as a result, on its profit margins.
9
The Company believes movie studios have a significant interest in
maintaining a viable movie rental business because the sale of videocassettes to
video retail stores currently represents the studios' largest source of domestic
revenue. 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 to video stores. In addition, the Company believes that for
Pay-Per-View television to match the low price, viewing convenience and
selection available through video rental, substantial capital expenditures and
further technological advances will be necessary. Although the Company does not
believe NVOD or VOD represent a near-term competitive threat to its business,
technological advances and broad consumer availability of NVOD and VOD or
changes in the manner in which movies are marketed, including the earlier
release of movie titles to Pay-Per-View, cable television or other distribution
channels, could have a material adverse effect on the Company's business.
Employees
As of March 14, 1997, the Company employed approximately 6,300 persons,
referred to by the Company as "associates," including approximately 6,000 in
retail stores and the remainder in the Company's corporate offices and
distribution facility. Of the retail associates, approximately 1,400 were
full-time and 4,600 were part-time. None of the Company's associates is
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 four to fifteen persons,
including one manager and one assistant manager. Store managers report to
district managers who supervise the operations of 12 to 15 stores. The district
managers report to one of eight 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, often by
employing owners or key employees of acquired stores. The corporate support
staff has periodic meetings with the regional managers, district managers and
store managers to review operations. Compliance with the Company's policies,
procedures and regulations is regularly monitored on a store-to-store basis by
members of the Company's quality assurance department.
The Company has an incentive bonus program pursuant to which retail
management personnel receive quarterly bonuses when store results equal or
exceed established goals and quality assurance standards are met. Management
believes that its program rewards excellence in management, gives retail
management an incentive to improve operations and results in an overall
reduction in the cost of operations. In addition, store managers, district
managers, regional managers and other corporate personnel are eligible to
receive discretionary bonuses 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.
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. 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.
10
Growth Strategy. The Company's strategy is to grow through a
combination of new store openings and 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 requires significant amounts of capital. In the past,
the Company's growth strategy has been funded primarily through proceeds from
public offerings, 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 in the future to the Company.
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 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; (iii) more intensive competition to acquire the same video
specialty stores the Company seeks to acquire; (iv) an increase in price for
acquisitions; (v) misrepresentations and breaches of contracts by sellers; (vi)
the Company's limited knowledge of and operating history of the acquired stores;
(vii) the replacement of purchasing and marketing systems of acquired stores;
and (viii) the integration of acquired stores' systems into the Company's
systems and procedures.
Same-Store Revenue 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) the timing of the release of new hit movies by the studios for the
video rental market; (ii) competition from special events such as the Olympics
or a televised trial of significant public interest; (iii) the weather
conditions in the selling area; (iv) competition from other forms of
entertainment such as movie theaters, cable television, Internet-related
activities and Pay-Per-View television, including direct satellite television;
(v) 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; and (vi) a reduction in, or elimination of, the period of
time (the "release window") between the release of hit movie videocassettes to
the home video market and the release of these hit movies to the Pay-Per-View
markets (currently 30 days 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
"Growth Strategy" above; (ii) 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 reduce levels of rental activity which carry higher profit
margins than product sales; (iii) changes in the prices for the Company's
products or a reduction in, or elimination of, the videocassette release window
11
as compared to Pay-Per-View, as determined by the movie studios, could result in
a competitive disadvantage for the Company relative to other forms of
distribution; (iv) the Company's ability to implement its new point-of-sale
management information system and financial management systems; (v) the
Company's ability to control costs and expenses, primarily rent, store payroll
and general and administrative expenses; (vi) the Company's ability to react and
obtain other distribution sources for its products in the event that Sight &
Sound Distributors, Inc., which supplies over 80% of the Company's product, is
unable to meet the terms of its contract with the Company; and (vii)
advancements and cost reductions in various new technological delivery systems
such as (A) pay-per-view cable television systems and digital satellite systems
offering NVOD or VOD; (B) DVD technology and its anticipated introduction during
1997, which might result in lower profit margins and increased costs associated
with higher inventory requirements; and, (C) other forms of new technology,
which could affect the Company's profit margins.
Directors and Executive Officers of the Company
Name Age Position(s) Held
Joe Thomas Malugen(1) 45 Chairman of the Board and Chief Executive
Officer
H. Harrison Parrish(1) 49 President and Director
William B. Snow(1) 65 Vice Chairman of the Board
J. Steven Roy 36 Senior Vice President and Chief Financial
Officer
S. Page Todd 35 Senior Vice President, Secretary and
General Counsel
Richard R. Langford 40 Senior Vice President-Management Information
Systems
Mark S. Loyd 41 Senior Vice President-Purchasing and
Product Management
Craig D. Steeves 38 Senior Vice President-Store Operations
Curry M. Herring 52 Senior Vice President
Steven M. Hamil 28 Vice President-Chief Accounting Officer
and Controller
Sanford C. Sigoloff(2)(3) 66 Director
Philip B. Smith(2)(3) 61 Director
Joseph F. Troy (1)(2)(3) 58 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.
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 from the University of
Alabama in Business Administration.
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. Mr. Snow entered into
a two-year consulting agreement with the Company commencing January 1, 1997. 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 member of the Board of
Directors of Action Industries, 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 of Taxation from DePaul University.
12
Mr. Roy was elected Senior Vice President-Finance and Principal Accounting
Officer in June 1995 and was elected Chief Financial Officer in May 1996. Mr.
Roy was an accountant with the firm of Ernst & Young LLP for the 11 years prior
to joining the Company, most recently as a Senior Manager in the Audit
Department. Mr. Roy is a Certified Public Accountant and received a B.S. degree
in Business Administration from the University of Alabama.
Mr. Todd was elected Senior Vice President, Secretary and General Counsel
in December 1994. For more than the previous five years, he had been an attorney
practicing tax and corporate law in Dothan, Alabama. Mr. Todd received a B.S.
degree in Business Administration from the University of Alabama, his J.D. from
the University of Alabama School of Law and his L.L.M. (in Taxation) from New
York University School of Law.
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. 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.
Mr. Steeves joined the Company in March 1995, became Senior Vice
President-Support Services in June 1995 and became Senior Vice President - Store
Operations in October 1995. From August 1993 until he joined the Company, Mr.
Steeves was a consultant specializing in lease review and leasehold expense
reduction. From September 1989 until July 1993, Mr. Steeves was a regional
manager, director-support operations and then Vice President-Support Services
for UIV.
Mr. Herring joined the Company in August 1986 and served as Controller
until May 1994 when he was elected Vice President - Administration. In December
1996, he was elected Senior Vice President. Prior to his employment with the
Company, Mr. Herring was a major in the United States Army, where he completed
numerous command and staff-level courses for military officers. Mr. Herring
received a B.S. degree from Troy State University in Accounting and Business
Administration.
Mr. Hamil was elected Vice President and Controller in June 1996. In
October 1996, he was elected Chief Accounting Officer. From July 1994, after
receiving a Masters in Business Administration from Duke University's Fuqua
School of Business, until he joined the Company, Mr. Hamil was an Investment
Banking Associate with NationsBanc Capital Markets, Inc. He has also served as a
Staff Auditor with Ernst & Young LLP. Mr. Hamil is a Certified Public Accountant
and received a B.S. degree in Business Administration from the University of
Alabama.
Mr. Sigoloff became a director of the Company in September 1994. Mr.
Sigoloff has been Chairman of the Board, President and Chief Executive Officer
of Sigoloff & Associates, Inc., a management consulting company since 1989. 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 the following publicly-held
corporations: ChatCom, Inc.; Digital Video Systems, Inc.; Kaufman and Broad Home
Corporation; SunAmerica, Inc. and Wickes plc-London, England. 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.
13
Mr. Smith became a director of the Company in September 1994. Mr. Smith has
been Vice Chairman of the Board of Spencer Trask Securities Incorporated since
1991. He was formerly a Managing Director of Prudential Securities in its
merchant bank. 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 DenAmerica Corp.; Digital Video Systems, Inc.;
ChatCom, Inc. and KLS EnviroResources, Inc., publicly-held companies.
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. He is a director of Digital Video Systems, Inc., a
publicly-held company.
Directors are elected to serve until the next annual meeting of
stockholders of the Company or until their successors are elected and qualified.
Officers serve at the discretion of the Board of Directors, subject to any
contracts of employment. Non-employee directors receive an annual fee of
$12,000, 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 85,000 shares of Common Stock to each of Messrs. Sigoloff and Smith and
options to purchase 110,000 shares to Mr. Troy in each case at or above the fair
market value of the Common Stock on the date of grant.
ITEM 2. PROPERTIES
At March 14, 1997, all but one of the Company's 855 stores were
located on premises leased from unaffiliated persons pursuant to leases with
remaining terms which vary from month-to-month to ten years. The Company is
generally responsible for taxes, insurance and utilities under its leases.
Rental rates often increase upon exercise of any renewal option, and some leases
have percentage rental arrangements pursuant to which the Company is obligated
to pay a base rent plus a percentage of the store's revenues in excess of a
stated minimum. In general, the stated minimums are set at such a high level of
revenues that the Company is not obligated to pay additional rents based on
reaching the stated revenue levels, and it anticipates that any future payments
would be rare and would be minimal amounts not material to the Company's
business or results of operations. The Company anticipates that future stores
will also be located in leased premises. The Company owns a family entertainment
center, including a video specialty store, in Meridian, Mississippi.
The Company's corporate campus is located in four buildings at 739 W.
Main Street, Dothan, Alabama, consisting of an aggregate of approximately 13,000
square feet of space, and a portion of an office building located at 2323 W.
Main Street, Dothan Alabama, consisting of approximately 10,000 square feet of
space. Two of these buildings with an aggregate of approximately 6,500 square
feet of space are owned by the Company and are used for general corporate
offices. Two of these buildings which are used primarily for executive and
general corporate offices have an aggregate of approximately 6,500 square feet
of space and are leased from Messrs. Malugen and Parrish pursuant to a
three-year lease with two, two-year options at an initial annual rental rate of
$32,700, subject to increases based upon increases in the consumer price index.
The office building space is used for general corporate offices and is leased
from an unaffiliated third party for a one-year term. The Company is
consolidating its videocassette processing, distribution and warehouse
facilities into a 26,730 square foot facility in Dothan, Alabama, pursuant to a
three-year lease with three, three-year options. The consolidation is expected
to be completed in May 1997. The primary processing and distribution facility
being vacated is subleased by the Company from Mr. Parrish pursuant to a $1,120
a month sublease, which expires on November 8, 1997.
14
ITEM 3. LEGAL PROCEEDINGS
The Company is not currently involved in legal proceedings that
management believes could have a material adverse effect on the Company's
financial condition or results of operations. The legal proceeding disclosed in
the Form 10-K for the fiscal year ended December 31, 1995, was settled in May
1996 for a nominal amount which was not material to the Company's business or
results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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
1995
First Quarter ........................ $ 27 1/2 $ 21
Second Quarter........................ 36 26
Third Quarter......................... 50 34 7/8
Fourth Quarter........................ 42 23
1996
First Quarter......................... 30 1/2 19 1/4
Second Quarter........................ 36 1/8 19 5/8
Third Quarter......................... 24 1/2 10 3/4
Fourth Quarter........................ 15 1/2 12 1/2
1997
First Quarter (through April 1, 1997). 13 3/4 7 1/2
The last sale price of the Company's Common Stock on April 1, 1997 as
reported on the Nasdaq National Market was $7.50 per share. As of April 1, 1997,
there were 109 holders of record of the Company's Common Stock.
In March 1993, December 1993, August 1994 and April 1995, the Company
paid cash dividends (in the form of S corporation distributions) of $239,864,
$186,561, $2.5 million and $188,000, respectively, to the existing stockholders
prior to the Company's initial public offering (Messrs. Malugen and Parrish).
The Company presently expects to retain its earnings to finance the expansion
and further development of its business. 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. There can be no
assurance that the Company will ever pay a dividend in the future.
15
Item 6. Selected Financial Data
Nine Months
Year Ended Year Ended Year Ended Ended Year Ended
January 5 December 31 December 31 December 31 March 31
1997(5)(6) 1995 1994(3) 1993(3)(4) 1993(3)
---------- ----------- ----------- ----------- ---------
Statement of Income Data (1):
Revenues:
Rentals $ 219,002 $ 130,353 $ 47,782 $ 21,133 $ 19,509
Product sales 35,393 18,848 5,441 1,908 1,582
--------- --------- -------- -------- --------
254,395 149,201 53,223 23,041 21,091
Operating costs and expenses:
Store operating expenses 124,456 67,758 24,119 11,891 11,376
Amortization of videocassette rental inventory 63,544(7) 29,102 10,263 4,541 4,900
Amortization of intangibles 7,160 3,380 606 133 --
Cost of sales 21,143 12,600 4,018 1,462 1,120
Special management bonus -- -- -- 560 200
General and administrative 20,266 13,525 5,647 2,024 2,437
Restructuring and other charges 9,595 -- -- -- --
--------- --------- -------- -------- --------
Operating income 8,231 22,836 8,570 2,430 1,058
Non-operating income (expense):
Interest expense, net (5,619) (1,528) (486) (458) (427)
Other, net -- -- 58 49 66
--------- --------- -------- -------- --------
Income before income taxes 2,612 21,308 8,142 2,021 697
Income taxes (2) 1,006 7,871 2,991 757 263
--------- --------- -------- -------- --------
Net income $ 1,606 $ 13,437 $ 5,151 $ 1,264 $ 434
========= ========= ======== ======== ========
Net income per share $ .12 $ 1.11 $ .63 $ .19 $ .06
========= ========= ======== ======== ========
Cash dividends declared per share $ 0.0 $ 0.0 $ .39 $ .04 $ .04
========= ========= ======== ======== ========
Shares used in computing net income
per share 13,368 12,153 8,152 6,716 6,716
========= ========= ======== ======== ========
Operating Data:
Number of stores at end of period(1) 863 750 352 108 93
Adjusted EBITDA(8) $ 20,542 $ 8,766 $ 3,902 $ 757 $ 1,298
Increase (decrease) in same-store revenues (9) (1.0%) 0.0% 14.3% 13.7% 22.3%
December 31
January 5 -------------------------------- March 31
1997 1995 1994 1993 1993(3)
---------------------------------------------------------------
Balance Sheet Data(1):
Cash and cash equivalents $ 3,982 $ 6,255 $ 3,723 $ 408 $ 586
Videocassette rental inventory, net 89,929 72,979 27,138 7,455 5,054
Total assets 261,577 233,479 76,647 13,446 9,552
Long-term debt, less current maturities 67,883 19,622 6,681 4,104 4,581
Total liabilities 114,853 97,340 29,652 10,988 8,655
Stockholders' equity 146,724 136,139 46,995 2,458 897
16
- ----------------------------
(1) Statement of income data for all periods presented has been
restated to include the results of Home Vision Entertainment, Inc., ("Home
Vision") and Hollywood Video, Inc. ("Hollywood Video"), which were acquired
in two separate pooling-of-interests transactions on July 1, 1996. Home
Vision reported on a fiscal year ending September 30 and Hollywood Video
reported on a calendar year basis. The Company's results for the fiscal
year ended January 5, 1997 are combined with results of Home Vision and
Hollywood Video for the period January 1, 1996 to the date of the
acquisitions. The results of the Company and Hollywood Video for the years
ending December 31, 1995 and 1994 are combined with Home Vision's results
for the years ending September 30, 1995 and 1994, respectively. The
Company's results for the nine months ended December 31, 1993 are combined
with Home Vision's results for the year ended September 30, 1993 and
Hollywood Video's results for the year ended December 31, 1993. Results of
the Company for the year ended March 31, 1993 are combined with Home
Vision's results for the year ended September 30, 1992 (the effects of
recasting financial results within 93 days of the fiscal year end of the
Company are not material) and Hollywood Video's results for the year ended
December 31, 1992. Balance sheet data has also been restated consistent
with the statement of income data except the December 31, 1995 balance
sheet data includes that of Home Vision at December 31, 1995 instead of
September 30, 1995. In order to conform with the fiscal year end of the
Company, Home Vision's net loss of $2,082,000 for the quarter ended
December 31, 1995 is not reflected in the statement of income data but is
reflected in stockholders' equity at December 31, 1995. The ending number
of stores for each period presented has been restated to include the store
counts of Home Vision and Hollywood Video.
(2) The provision for income tax includes pro forma adjustments to reflect
income tax expense which would have been recognized if the Company, Home
Vision and Hollywood Video had been taxed as C corporations for all periods
presented. Historical operating results of the Company, Home Vision and
Hollywood Video do not include any provision for income taxes prior to
August 2, 1994, October 1, 1994, and July 1, 1996, respectively, due to
their S corporation status prior to those dates.
(3) General and administrative expenses and income taxes include pro forma
adjustments for the change in compensation levels arising from employment
contracts with two stockholders who are executive officers of the Company.
(4) Effective April 1, 1993, the Company changed its fiscal year end from March
31 to December 31 and adopted a change in accounting relating to the
amortization of new release inventory. The change in accounting relating to
amortization increased operating income by $1.4 million for the nine months
ended December 31, 1993.
(5) 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.
(6) Includes a non-recurring charge of approximately $10.4 million for store
closures, corporate restructuring and merger-related expenses.
(7) Effective April 1, 1996, the Company changed its method of amortizing
videocassette rental inventory resulting in a one-time, non-cash charge of
approximately $7.7 million.
(8) "Adjusted EBITDA" is earnings before interest, taxes, depreciation and
amortization, excluding non-recurring charges, less the Company's purchase
of videocassette rental inventory. Included in the Company's videocassette
rental inventory purchases for the fiscal year ended January 5, 1997 is
$5.7 million associated with inventory purchases specifically for new store
openings. Adjusted EBITDA does not take into account capital expenditures,
other than purchases of videocassette rental inventory, and does not
represent cash generated from operating activities in accordance with
generally accepted accounting principles ("GAAP"), is not to be considered
as an alternative to net income or any other GAAP measurements as a measure
of operating performance and is not indicative of cash available to fund
all cash needs. The Company's definition of Adjusted EBITDA may not be
identical to similarly titled measures of other companies. The Company
believes that in addition to cash flows and net income, Adjusted EBITDA is
a useful financial performance measurement for assessing the operating
performance of the Company because, together with net income and cash
flows, Adjusted EBITDA is widely used in the videocassette specialty
retailing industry to provide investors with an additional basis to
evaluate the ability of the Company to incur and service its debt and to
fund acquisitions. To evaluate Adjusted EBITDA and the trends it depicts,
the components of Adjusted EBITDA, such as net revenues, cost of services,
and sales, general and administrative expenses, should be considered. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(9) For periods prior to 1994, same-store revenue was defined as the aggregate
revenues from stores operated by the Company for the entirety of the
periods being compared. Beginning in 1994, stores were included in the
calculation once they had been operated by the Company for at least 13
months. Same-store revenues for the Company have not been restated to
include the same-store revenues of Home Vision and Hollywood Video.
17
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The Company has experienced rapid growth in revenue and operating income
primarily as a result of acquiring stores and opening new stores. The number of
stores operated by the Company at the end of each of the following periods
increased as follows:
December 31, 1993 108
December 31, 1994 352
December 31, 1995 750
January 5, 1997 863
The results of operations for all periods presented include the combined results
of the Company, Home Vision Entertainment, Inc. ("Home Vision") and Hollywood
Video, Inc. ("Hollywood Video"). The combined 98-store acquisitions of Home
Vision and Hollywood Video were consummated on July 1, 1996 and accounted for as
poolings-of-interests. The above store count totals reflect the combined totals
of Movie Gallery, Inc., Home Vision and Hollywood Video for all periods
presented.
During the fiscal year ended January 5, 1997 ("Fiscal 1996"), 174 stores were
acquired (including the 98 stores acquired in the Home Vision and Hollywood
Video transactions), 85 stores were developed by the Company (75 of which were
developed by Movie Gallery, Inc.) and 48 stores were closed.
As a result of the 697 store acquisitions during the periods January 1, 1994
through July 1, 1996, the Company recorded $95.6 million in goodwill and
acquisition-related costs, which are being amortized over twenty years from the
effective date of each acquisition. The Company also recorded an additional
$15.4 million in deferred charges related to noncompetition agreements, which
are being amortized over periods varying from two to ten years.
On July 1, 1996, the Company adopted a fiscal year which will end on the first
Sunday following December 30. This change will result in the Company having a 52
or 53-week year. Fiscal 1996 was a 53-week year.
Effective April 1, 1996, the Company changed its method of amortizing
videocassette rental inventory (which includes video games and audio books).
Under the new method, new release videocassettes are amortized as follows: (i)
copies one through three of each title per store are considered base stock and
are amortized over thirty-six months on a straight-line basis to a $5 salvage
value; and (ii) the fourth and any succeeding copies of each title per store are
amortized on a straight-line basis over six months to an average net book value
of $5, which is then amortized on a straight-line basis over the next thirty
months or until the videocassette is sold, at which time the unamortized book
value is charged to cost of sales. Management believes that the new method
results in a better matching of expenses with revenues in the Company's current
operating environment and that it is compatible with changes made by other
companies in the industry.
During Fiscal 1996, the Company adopted a business restructuring plan to close
approximately 50 of its stores and reduce the corporate organizational staff by
approximately 15%. The restructuring plan resulted in a $9.6 million pretax
restructuring charge recorded in the third quarter of Fiscal 1996. The
components of the restructuring charge included approximately $5.4 million in
reserves for future cash outlays for lease terminations, miscellaneous closing
costs and legal and accounting costs, as well as approximately $4.2 million in
asset write downs. Approximately $807,000 of costs were paid and charged against
the liability during Fiscal 1996. Additionally, during the third quarter the
Company incurred merger-related costs of approximately $757,000 related to the
acquisition of Home Vision and Hollywood Video.
18
The provision for income taxes includes pro forma adjustments to reflect income
tax expense which would have been recognized if the Company, Home Vision and
Hollywood Video had been taxed as C corporations for all periods presented.
Historical operating results of the Company, Home Vision and Hollywood Video do
not include any provision for income taxes prior to August 2, 1994, October 1,
1994, and July 1, 1996, respectively, due to their S corporation status prior to
those dates.
With respect to forward-looking statements contained in this Item 7, please
review the disclosures set forth under "Cautionary Statements" in Item 1 above.
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. The store count and the operating results reflect the
combined operations of Movie Gallery, Inc., Home Vision and Hollywood Video for
all periods.
6. Statement of Income Data
Year Ended
------------------------------------
January 5 December 31 December 31
1997 1995 1994(1)
------------------------------------
Revenues:
Rentals 86.1% 87.4% 89.8%
Product sales 13.9 12.6 10.2
------ ------ ------
Total 100.0 100.0 100.0
Operating Costs and Expenses:
Store operating expenses 48.9 45.4 45.3
Amortization of videocassette rental inventory(2) 25.0 19.5 19.3
Amortization of intangibles 2.8 2.3 1.1
Cost of sales 8.3 8.4 7.6
General and administrative 8.0 9.1 10.6
Restructuring and other charges 3.8 -- --
------ ------ ------
Total 96.8 84.7 83.9
------ ------ ------
Operating income 3.2 15.3 16.1
Non-operating expense, net (2.2) (1.0) (0.8)
------ ------ ------
Income before income taxes 1.0 14.3 15.3
Income taxes(3) 0.4 5.3 5.6
------ ------ ------
Net income 0.6% 9.0% 9.7%
====== ====== ======
Number of stores at end of period 863 750 352
====== ====== ======
- ---------------------------
(1) General and administrative expenses and income taxes include pro forma
adjustments for the change in compensation levels arising from employment
contracts with two stockholders who are executive officers of the Company.
(2) Effective April 1, 1996, the Company changed its method of amortizing
videocassette rental inventory resulting in a one-time, non-cash charge of
approximately $7.7 million.
(3) The provision for income taxes includes pro forma adjustments to reflect
income tax expense which would have been recognized if the Company, Home
Vision and Hollywood Video had been taxed as C corporations for all periods
presented. Historical operating results of the Company, Home Vision and
Hollywood Video do not include any provision for income taxes prior to
August 2, 1994, October 1, 1994, and July 1, 1996, respectively, due to
their S corporation status prior to those dates.
19
Year ended January 5, 1997 compared to the year ended December 31, 1995 ("Fiscal
1995")
Revenue. Total revenue increased 70.5% to $254.4 million for Fiscal 1996 from
$149.2 million for Fiscal 1995. The increase was due to an increase in the
number of stores in operation from 352 at January 1, 1995 to 863 at January 5,
1997, and the maturation of the developed store base throughout Fiscal 1996,
partially offset by a decrease in same-store revenues of 1%. The decrease in
same-store revenues was primarily a result of unusually dry weather during the
second quarter, the negative impact of the Summer Olympics and the negative
impact of a reduction in rental inventory purchases as a percentage of revenues
during the first three quarters of Fiscal 1996 versus Fiscal 1995. Product sales
increased as a percentage of total revenues to 13.9% for Fiscal 1996 from 12.6%
for Fiscal 1995, as a result of (i) an increase in the availability and number
of major hits (e.g., "Independence Day", "Mission Impossible" and "The Nutty
Professor") and other new release titles priced by the movie studios for
"sell-through" merchandising, (ii) the Company's continued and increased
emphasis on the sale of previously viewed rental inventory, and (iii) an
increase in the variety of other products sold in stores, such as video
accessories and confectionery items.
Operating Costs and Expenses. Store operating expenses, which reflect direct
store expenses such as lease payments and in-store payroll, increased to 48.9%
of total revenue for Fiscal 1996 from 45.4% for Fiscal 1995. The increase in
store operating expenses was primarily due to (i) higher rental payments and
other expenses in many of the recently acquired stores, (ii) higher operating
expenses as a percentage of revenues in the Company's immature, internally
developed stores, and (iii) the decrease in same-store revenues for the year.
Amortization of videocassette rental inventory increased as a percentage of
revenue to 25.0% for Fiscal 1996 from 19.5% for Fiscal 1995 due primarily to the
change in amortization policy as of April 1, 1996 (described in "Overview"
above). The application of the new method of amortizing videocassette rental
inventory also resulted in a one-time, non-recurring increase in amortization of
$7.7 million during Fiscal 1996. Had the new amortization policy been in effect
prior to January 1, 1995, amortization of videocassette rental inventory as a
percentage of revenue would have been 23.2% for Fiscal 1995.
Amortization of intangibles as a percentage of revenue increased to 2.8% for
Fiscal 1996 from 2.3% for Fiscal 1995 due to an increase in goodwill recorded as
a result of the acquisition activity of the Company accounted for under the
purchase method of accounting during 1995 and 1996.
Cost of sales includes the costs of new videocassettes, confectionery items and
other goods, as well as the unamortized value of previously viewed rental
inventory sold in the Company's stores. Cost of sales increased with the
increased revenue from product sales and decreased as percentage of revenues
from product sales from 66.9% for Fiscal 1995 to 59.7% for Fiscal 1996. The
increase in product sales gross margins resulted primarily from (i) an increase
in the sale of previously viewed rental inventory, which generally generates
higher margins than other product categories, and (ii) an increase in margins on
sell-through products.
20
General and administrative expenses decreased as a percentage of revenues from
9.1% for Fiscal 1995 to 8.0% for Fiscal 1996. Excluding $757,000 in merger
related expenses associated with the acquisitions of Home Vision and Hollywood
Video, general and administrative expenses would have been 7.7% of revenues for
Fiscal 1996. The decrease is primarily due to operating efficiencies attained
through a larger revenue base.
As a result of the above, operating income decreased to $8.2 million in Fiscal
1996 from $22.8 million in Fiscal 1995. Excluding the effects of the business
restructuring plan, the one-time non-recurring increase in amortization of
videocassette rental inventory due to the change in amortization policy and the
merger-related expenses from the Home Vision and Hollywood Video acquisitions,
operating income would have been $26.2 million.
Year ended December 31, 1995 compared to the year ended December 31, 1994
("Fiscal 1994")
Revenue. Revenue increased 180.3% to $149.2 million for Fiscal 1995 from $53.2
million for Fiscal 1994. The increase was due to an increase in the number of
stores in operation from 108 at January 1, 1994 to 750 at December 31, 1995.
Product sales increased as a percentage of total revenues to 12.6% for Fiscal
1995 from 10.2% for Fiscal 1994 as a result of (i) an increased emphasis on the
sale of previously viewed rental inventory, (ii) increased availability of
"sell-through" titles, primarily due to an increase of available major hit
titles (including "The Lion King") priced by the movie studios for
"sell-through" merchandising, and (iii) an increase in the variety of products
sold in stores, such as movie memorabilia and confectionery items.
Operating Costs and Expenses. Store operating expenses, which reflect direct
store expenses such as lease payments and in-store payroll, increased slightly
as a percentage of revenue from 45.3% for Fiscal 1994 to 45.4% for Fiscal 1995.
The net percentage change in these expenses was primarily the result of the
positive impact of reduced in-store payroll costs resulting from more efficient
scheduling of store employees, counterbalanced by the negative impact of
increased rent expense due to the integration of developed and acquired stores
into the Company's base.
Amortization of videocassette rental inventory increased as a percentage of
revenue to 19.5% for Fiscal 1995 from 19.3% for Fiscal 1994 due to an increase
in purchasing levels as a percentage of revenues.
Amortization of intangibles increased as a percentage of revenues to 2.3% for
Fiscal 1995 from 1.1% for Fiscal 1994 due to the substantial number of
acquisitions which occurred subsequent to August 1994 and which were accounted
for by the purchase method of accounting.
Cost of sales decreased as a percentage of product sales from 73.8% for Fiscal
1994 to 66.9% for Fiscal 1995. The increase in gross margins from product sales
resulted from an increase in margins on hit titles priced for sell-through and
from an increase in the sale of previously viewed rental inventory, the
unamortized value of which is expensed to cost of sales and generally generates
higher margins than other product categories.
General and administrative expenses decreased as a percentage of revenues from
10.6% for Fiscal 1994 to 9.1% for Fiscal 1995 due to operating efficiencies
attained through a larger revenue base.
21
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 remodeling of existing stores, the relocation of
existing stores and the continued upgrading and installation of the Company's
POS system and management information systems. The Company has funded inventory
purchases, remodeling and relocation programs, new store opening costs and
acquisitions primarily from cash flow from operations, the proceeds of two
public equity offerings, loans under revolving credit facilities and seller
financing.
During Fiscal 1996, the Company generated $20.5 million in Adjusted EBITDA
versus $8.8 million for Fiscal 1995. "Adjusted EBITDA" is earnings before
interest, taxes, depreciation and amortization, excluding non-recurring charges
and less the Company's purchase of videocassette rental inventory. Included in
the Company's videocassette rental inventory purchases for Fiscal 1996 is $5.7
million associated with inventory purchases specifically for new store openings.
Adjusted EBITDA does not take into account capital expenditures, other than
purchases of videocassette rental inventory, and does not represent cash
generated from operating activities in accordance with generally accepted
accounting principles ("GAAP"), is not to be considered as an alternative to net
income or any other GAAP measurements as a measure of operating performance and
is not indicative of cash available to fund cash needs. The Company's definition
of Adjusted EBITDA may not be identical to similarly titled measures of other
companies. The Company believes that in addition to cash flows and net income,
Adjusted EBITDA is a useful financial performance measurement for assessing the
operating performance of the Company because, together with net income and cash
flows, Adjusted EBITDA is widely used in the videocassette specialty retailing
industry to provide investors with an additional basis to evaluate the ability
of the Company to incur and service its debt and to fund acquisitions.
Net cash provided by operating activities was $91.8 million for Fiscal 1996 as
compared to $61.3 million for Fiscal 1995. The increase was primarily due to
higher net income before depreciation and amortization and the non-cash
restructuring charge discussed above.
Net cash used in investing activities was $104.8 million for Fiscal 1996 as
compared to $154.8 million for Fiscal 1995. This decrease in funds used for
investing activities is primarily the result of a decrease in the total cash
expended for stores acquired during Fiscal 1996 versus Fiscal 1995, partially
offset by a net increase in the purchase of videocassette rental inventory
resulting from the Company's growth.
Net cash provided by financing activities decreased from $96.3 million for
Fiscal 1995 to $10.7 million for Fiscal 1996. This decrease was primarily the
result of a common stock public offering during Fiscal 1995, as well as a net
increase in total debt of $33.8 million in Fiscal 1995 versus a $10.2 million
net increase in debt for Fiscal 1996.
During Fiscal 1996, the Company replaced its existing $60 million revolving
credit facility with a $125 million reducing revolving credit facility (the
"Facility"). The Facility has a maturity date of June 30, 2000. The interest
rate of the Facility is LIBOR-based and the Company may repay the Facility at
any time without penalty. The Facility has covenants that restrict borrowing
based upon cash flow levels. At January 5, 1997, $67 million was outstanding
under the Facility with additional availability of approximately $11.3 million.
The Company grows its store base through internally developed and acquired
stores and requires capital in excess of internally generated cash flow to
achieve its desired growth. To the extent available, 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. However, there can be no assurance that
financing will be available to the Company on terms which will be acceptable, if
at all. During Fiscal 1996, the Company issued an aggregate of 1,273,467 shares
of its common stock in connection with the acquisition of 154 additional stores,
which includes the acquisitions of Home Vision and Hollywood Video.
22
At January 5, 1997, the Company had a working capital deficit of $12.6 million,
due to the accounting treatment of its videocassette rental inventory.
Videocassette rental inventory is treated as a noncurrent asset under generally
accepted accounting principles because it 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 Fiscal 1997, including its
anticipated new store openings. However, to fund a resumption of the Company's
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.
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.
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
1997 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 1997 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 1997 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 1997 Annual Meeting of
Stockholders, and is incorporated herein by reference.
23
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
Report of Independent Auditors
Consolidated Balance Sheets as of Janaury 5, 1997 and December 31,
1995.
Consolidated Statements of Income for the Fiscal Years Ended
January 5, 1997 and December 31, 1995 and 1994.
Consolidated Statements of Stockholders' Equity for the Fiscal
Years Ended Janaury 5, 1997 and December 31, 1995 and 1994.
Consolidated Statements of Cash Flows for the Fiscal Years Ended
January 5, 1997 and December 31, 1995 and 1994.
Notes to Consolidated Financial Statements
(a)(2) Schedules:
None.
(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 Exhibit Description
No.
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.
(filed herewith)
10.2 - Form of Indemnity Agreement.(1)
10.3 - Stock Purchase Agreement dated June 30, 1995 between The Movie Shop and
M.G.A., Inc.(3)
10.4 - Asset Purchase Agreement dated August 3, 1995 between Indiana Video
Limited Liability Company and FGS Enterprises, Inc. d/b/a Box Office
Video and M.G.A., Inc.(4)
10.5 - Asset Purchase Agreement dated August 15, 1995 between John Day and Jane
Day, d/b/a The Video Connection, J & J Enterprises and The Video
Connection, Inc. and M.G.A., Inc.(4)
10.6 - Agreement of Merger dated November 29, 1995 between TSC, Inc. of Virginia
and Video World of Virginia, Inc., a subsidiary of Movie Gallery, Inc.(5)
10.7 - Agreement of Merger dated November 29, 1995 between TSC, Inc. of Richmond
and Video World of Virginia, Inc., a subsidiary of Movie Gallery, Inc.(5)
10.8 - Agreement of Merger dated June 5, 1996 between Home Vision Entertainment,
Inc. and Movie Gallery, Inc. and Amendment to Agreement of Merger dated
June 28, 1996. (6)
24
10.9 - Agreement dated March 13, 1997 between Sight & Sound Distributors, Inc.
and Movie Gallery, Inc.(filed herewith)(portions have been omitted
pursuant to a request for confidential treatment)
10.10- Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen.(1)
10.11- Employment Agreement between M.G.A., Inc. and H. Harrison Parrish. (1)
10.12- Consulting Agreement between William B. Snow and M.G.A., Inc. dated
December 12, 1996. (filed herewith)
10.13- Real estate lease dated June 1, 1994 between J.T. Malugen, H. Harrison
Parrish and M.G.A., Inc.(1)
10.14- Real estate lease dated June 1, 1994 between H. Harrison Parrish and
M.G.A., Inc.(1)
10.15- Tax Agreement between M.G.A., Inc. and Joe T. Malugen and Harrison
Parrish.(1)
10.16- Certificate of Title dated October 6, 1992 and United States Patent and
Trademark Office Notice of Recordation of Assignment Document dated
January 27, 1993 (relating to the Company's acquisition of the "Movie
Gallery" service mark, trade name and goodwill associated therewith).(7)
10.17- Credit Agreement between First Union National Bank of North Carolina and
Movie Gallery, Inc. dated July 10, 1996. (6)
11 - Computation of Earnings Per Share. (filed herewith)
18 - Change in Accounting Principle. (8)
21 - List of Subsidiaries. (filed herewith)
23 - Consent of Ernst & Young LLP. (filed herewith)
27 - Financial Data Schedule. (filed herewith)
- ---------------
(1) Previously filed with the Securities and Exchange Commission on June 10,
1994, as exhibits to the Company's Registration Statement on Form S-1
(File No. 33-80120).
(2) Previously filed with the Securities and Exchange Commission on August 1,
1994, as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1.
(3) Previously filed with the Securities and Exchange Commission on July 14,
1995, as an exhibit to the Company's Current Report on Form 8-K.
(4) Previously filed with the Securities and Exchange Commission on August
18, 1995, as an exhibit to the Company's Current Report on Form 8-K.
(5) Previously filed with the Securities and Exchange Commission on December 13,
1995, as an exhibit to the Company's Current Report on Form 8-K.
(6) Previously filed with the Securities and Exchange Commission on July 15,
1996, as an exhibit to the Company's Current Report on Form 8-K.
(7) Previously filed with the Securities and Exchange Commission on July 14,
1994, as exhibits to Amendment No. 1 to the Company's Registration
Statement on Form S-1.
(8) Previously filed with the Securities and Exchange Commission on August 14,
1996, as an exhibit to the Company's Form 10-Q for the quarter ended
September 29, 1996.
(b) Reports on Form 8-K:
The Company did not file any reports on Form 8-K during the quarter
ended Janaury 5, 1997.
(c) Exhibits:
See (a)(3) above.
25
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this amendment to its
annual report 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 7, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
amendment to report 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 7, 1997
- -----------------------------------------Executive Officer
Joe Thomas Malugen
/s/ WILLIAM B. SNOW
- -----------------------------------------Vice Chairman of the Board April 7, 1997
William B. Snow
/s/ J. STEVEN ROY Senior Vice President and Chief April 7, 1997
- -----------------------------------------Financial Officer
J. Steven Roy
/s/ STEVEN M. HAMIL Vice President and Chief Accounting April 7, 1997
- -----------------------------------------Officer
Steven M. Hamil
/s/ H. HARRISON PARRISH
- -----------------------------------------Director and President April 7, 1997
H. Harrison Parrish
/s/ JOSEPH F. TROY
- -----------------------------------------Director April 7, 1997
Joseph F. Troy
26
Movie Gallery, Inc.
Index to Financial Statements
Page
Report of Independent Auditors......................... F-1
Consolidated Balance Sheets............................ F-2
Consolidated Statements of Income...................... 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 January 5, 1997 and December 31, 1995, and the related consolidated
statements of income, stockholders' equity and cash flows for the fiscal years
ended January 5, 1997, December 31, 1995 and 1994. 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 did not
audit the financial statements of Home Vision Entertainment, Inc., an entity
acquired and accounted for as a pooling-of-interest on July 1, 1996, which
statements reflect total assets constituting 8.6% in 1995 and total revenues
constituting 12% in 1995 and 17% in 1994 of the related consolidated totals.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to data included for Home Vision
Entertainment, Inc. for 1995 and 1994, is based solely on the report of the
other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. 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.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and, for 1995 and 1994, the report of other
auditors, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Movie Gallery, Inc. at
Janaury 5, 1997 and December 31, 1995, and the consolidated results of its
operations and its cash flows for the fiscal years ended January 5, 1997,
December 31, 1995 and 1994, in conformity with generally accepted accounting
principles.
As discussed in Note 1 to the financial statements, in 1996 the Company changed
its method of accounting for amortization of videocassette rental inventory.
/s/Ernst & Young LLP
Birmingham, Alabama
February 12, 1997
F-1
Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)
January 5 December 31
1997 1995
----------------------
Assets
Current assets:
Cash and cash equivalents $ 3,982 $ 6,255
Recoverable income tax 224 1,278
Merchandise inventory 11,181 10,989
Accounts receivable 494 1,933
Store supplies and other 2,947 2,113
Deferred income taxes 913 --
-------- --------
Total current assets 19,741 22,568
Videocassette rental inventory, net 89,929 72,979
Property, furnishings and equipment, net 50,196 41,437
Deferred charges, net 11,151 11,567
Excess of cost over net assets acquired, net 87,822 82,963
Deposits and other assets 2,738 1,965
-------- --------
Total assets $261,577 $233,479
======== ========
Liabilities and stockholders' equity
Current liabilities:
Notes payable $ -- $ 32,052
Accounts payable 24,321 24,332
Accrued liabilities 7,622 4,751
Current portion of long-term debt 374 6,390
-------- --------
Total current liabilities 32,317 67,525
Long-term debt 67,883 19,622
Other accrued liabilities 2,425 --
Deferred income taxes 12,228 10,193
Stockholders' equity:
Preferred stock, $.10 par value; 2,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $.001 par value; 30,000,000
shares authorized, 13,420,791 and 12,877,236
shares issued and outstanding 13 13
Additional paid-in capital 131,686 122,582
Retained earnings 15,025 13,544
-------- --------
Total stockholders' equity 146,724 136,139
-------- --------
Total liabilities and stockholders' equity $261,577 $233,479
======== ========
See accompanying notes.
F-2
Movie Gallery, Inc.
Consolidated Statements of Income
(in thousands, except per share data)
Year Ended
-------------------------------------
January 5 December 31 December 31
1997 1995 1994
------------------------------------
Revenues:
Rentals $ 219,002 $ 130,353 $ 47,782
Product sales 35,393 18,848 5,441
--------- --------- --------
254,395 149,201 53,223
Operating costs and expenses:
Store operating expenses 124,456 67,758 24,119
Amortization of videocassette rental inventory 63,544 29,102 10,263
Amortization of intangibles 7,160 3,380 606
Cost of sales 21,143 12,600 4,018
General and administrative 20,266 13,525 5,420
Restructuring and other charges 9,595 -- --
--------- --------- --------
Operating income 8,231 22,836 8,797
Non-operating income (expense):
Interest income 99 539 211
Interest expense (5,718) (2,067) (697)
Other, net -- -- 58
--------- --------- --------
Income before income taxes 2,612 21,308 8,369
Income taxes 1,131 8,893 3,348
--------- --------- --------
Net income $ 1,481 $ 12,415 $ 5,021
========= ========= ========
Pro forma net income per share (unaudited):
Income before income taxes $ 2,612 $ 21,308 $ 8,369
Pro forma increase in compensation expense -- -- (227)
--------- --------- --------
Pro forma income before income taxes 2,612 21,308 8,142
Pro forma income taxes 1,006 7,871 2,991
--------- --------- --------
Pro forma net income $ 1,606 $ 13,437 $ 5,151
========= ========= ========
Pro forma net income per share $ .12 $ 1.11 $ .63
========= ========= ========
Shares used in computing pro forma
net income per share (in thousands) 13,368 12,153 8,152
========= ========= ========
See accompanying notes.
F-3
Movie Gallery, Inc.
Consolidated Statements of Stockholders' Equity
(in thousands)
Additional Total
Common Paid-in Retained Stockholders'
Stock Capital Earnings Equity
--------------------------------------------------
Balance at December 31, 1993 $ 7 $ 191 $ 2,308 $ 2,506
Net income -- -- 5,021 5,021
Dividends -- -- (2,688) (2,688)
Sale of 3,450,000 shares of common stock,
net of issuance costs of $1,567 3 43,348 -- 43,351
Transactions by pooled companies:
Issuance of 115,513 shares of common stock
as compensation expense -- 235 -- 235
Stock repurchase -- -- (930) (930)
Dividends -- -- (500) (500)
---- -------- ------ --------
Balance at December 31, 1994 10 43,774 3,211 46,995
Net income -- -- 12,415 12,415
Sale of 2,500,000 shares of common stock,
net of issuance costs of $936 3 61,389 -- 61,392
Issuance of 279,863 shares of common stock
for acquisitions, net of issuance costs of $62 -- 9,688 -- 9,688
Exercise of stock options for 129,000 shares -- 1,833 -- 1,833
Tax benefit of stock options exercised -- 1,120 -- 1,120
Transactions by pooled companies:
Issuance of 301,442 shares of common stock
for acquisitions -- 3,921 -- 3,921
Issuance of warrants -- 857 -- 857
Adjustment for change in fiscal year end of
pooled company -- -- (2,082) (2,082)
---- -------- ------- --------
Balance at December 31, 1995 13 122,582 13,544 136,139
Net income -- -- 1,481 1,481
Issuance of 508,455 shares of common stock for
acquisitions, net of issuance costs of $322 -- 8,386 -- 8,386
Exercise of stock options for 35,100 shares -- 524 -- 524
Tax benefit of stock options exercised -- 218 -- 218
Transactions by pooled companies:
Other -- (24) -- (24)
---- -------- ------- --------
Balance at January 5, 1997 $ 13 $131,686 $15,025 $146,724
==== ======== ======= ========
See accompanying notes.
F-4
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Year Ended
--------------------------------------
January 5 December 31 December 31
1997 1995 1994
--------------------------------------
Operating activities
Net income $ 1,481 $ 12,415 $ 5,021
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 79,625 36,991 12,391
Deferred income taxes 822 7,428 3,034
Restructuring and other charges 9,595 -- --
Other adjustments -- -- 255
Changes in operating assets and liabilities:
Recoverable income tax 1,272 654 (811)
Merchandise inventory (43) (5,185) (3,270)
Other current assets 339 (2,077) (562)
Deposits and other assets (978) (1,567) (50)
Accounts payable (1,649) 9,609 6,815
Accrued liabilities 1,336 3,003 622
-------- -------- --------
Net cash provided by operating activities 91,800 61,271 23,445
Investing activities
Business acquisitions (8,662) (83,403) (36,627)
Purchases of videocassette rental inventory (77,666) (51,061) (17,117)
Purchases of property, furnishings and equipment (18,438) (20,355) (7,627)
-------- -------- --------
Net cash used in investing activities (104,766) (154,819) (61,371)
Financing activities
Net proceeds from issuance of common stock 524 63,482 43,431
Net proceeds from (payments on) notes payable (32,052) 28,293 3,310
Proceeds from issuance of long-term debt 72,938 10,070 2,964
Principal payments on long-term debt (30,717) (4,584) (6,000)
Dividends paid -- (996) (2,464)
-------- -------- --------
Net cash provided by financing activities 10,693 96,265 41,241
-------- -------- --------
(Decrease) increase in cash and cash equivalents (2,273) 2,717 3,315
Decrease in cash and cash equivalents to conform
fiscal year end of pooled companies -- (185) --
Cash and cash equivalents at beginning of period 6,255 3,723 408
-------- -------- --------
Cash and cash equivalents at end of period $ 3,982 $ 6,255 $ 3,723
======== ======== ========
Supplemental disclosures of cash flow
information
Cash paid during the period for interest $ 5,377 $ 1,834 $ 649
Cash paid during the period for income taxes 203 764 1,156
Noncash investing and financing information:
Assets acquired by issuance of notes payable -- 10,012 5,375
Assets acquired by issuance of common stock 8,708 13,671 --
Tax benefit of stock options exercised 218 1,120 --
See accompanying notes.
F-5
Movie Gallery, Inc.
Notes to Consolidated Financial Statements
January 5, 1997
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's historical financial statements for all periods presented have
been restated to include the financial position, results of operations and cash
flows of Home Vision Entertainment, Inc. ("Home Vision") and Hollywood Video,
Inc. ("Hollywood Video"), merger transactions accounted for as
poolings-of-interests (see note 2).
The Company owns and operates video specialty stores in 23 states, generally
located in the eastern half of the United States.
Fiscal Year
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.
Results for 1996 reflect a 53 week year ended on January 5, 1997. The Company's
fiscal year includes revenues and certain operating expenses, such as salaries,
wages and other miscellaneous expenses, on a daily basis through January 5,
1997. All other expenses, primarily depreciation and amortization, are
calculated and recorded monthly, with twelve months included in each fiscal
year.
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to conform to the current year presentation. These reclassifications had no
impact on stockholders' equity or net income.
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 and video games
purchased for resale and concessions and is stated at the lower of cost, on a
first-in first-out basis, or market.
Long-Lived Assets
During the first quarter of 1996, the Company adopted the provisions of FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," which requires impairment losses to be
recorded on long-lived assets used in operations and deferred charges and
goodwill when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
F-6
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
carrying amounts. Statement 121 also addresses the accounting for long-lived
assets that are expected to be disposed of. The effect of adoption of Statement
121 was not material.
Videocassette Rental Inventory
Videocassette rental inventory is recorded at cost and amortized over its
economic useful life. Effective April 1, 1996, the Company changed its method of
amortizing videocassette rental inventory (which includes video games and audio
books). Under the new method, videocassettes considered to be base stock are
amortized over thirty-six months on a straight-line basis to a $5 salvage value.
New release videocassettes are amortized as follows: (i) the fourth and any
succeeding copies of each title per store are amortized on a straight-line basis
over six months to an average net book value of $5 which is then amortized on a
straight-line basis over the next thirty months or until the videocassette is
sold, at which time the unamortized book value is charged to cost of sales; and
(ii) copies one through three of each title per store are amortized as base
stock. Management believes the new method will result in a better matching of
expenses with revenues in the Company's current operating environment and that
it is compatible with changes made by its primary competitors.
The new method of amortization has been applied to all inventory held at April
1, 1996. The adoption of the new method of amortization has been accounted for
as a change in accounting estimate effected by a change in accounting principle.
The application of the new method of amortizing videocassette rental inventory
increased depreciation expense and cost of sales for the quarter ended June 30,
1996 by approximately $7.7 million. For the fiscal year ended January 5, 1997,
the adoption of the new method of amortization had the effect of decreasing net
income by approximately $4.9 million or $0.37 per share.
Videocassette rental inventory consists of the following (in thousands):
January 5 December 31
1997 1995
--------- ---------
Videocassette rental inventory $ 183,264 $ 113,016
Less accumulated amortization (93,335) (40,037)
--------- ---------
$ 89,929 $ 72,979
========= =========
Property, Furnishings and Equipment
Property, furnishings and equipment are stated at cost and include costs
incurred in the development and 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.
F-7
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Deferred Charges
Deferred charges consist primarily of non-compete agreements and are amortized
on a straight-line basis over the lives of the respective agreements which range
from two to ten years. Accumulated amortization of deferred charges at January
5, 1997 and December 31, 1995 was $4,128,000 and $1,868,000, respectively.
Excess of Cost Over Net Assets Acquired
The excess of cost over net assets acquired at January 5, 1997 and December 31,
1995 is net of accumulated amortization of $7,111,000 and $2,544,000,
respectively, and is being amortized on a straight-line basis over twenty years.
Videocassette Rental Revenue
Rental revenue is recognized when the videocassette or video game is rented or
when returned by the customer, depending upon the market in which a store
operates.
Advertising Costs
Advertising costs, exclusive of cooperative reimbursements from vendors, are
expensed when incurred.
Store Opening Costs
Store opening costs, which consist primarily of payroll and advertising, are
expensed as incurred.
Pro Forma Earnings Per Share
Pro forma net income per share is based on the weighted average number of shares
of common stock and common stock equivalents outstanding during the periods
presented. Common stock equivalents include the effects of shares to be issued
upon the exercise of dilutive common stock options.
Fair Value of Financial Instruments
At January 5, 1997 and December 31, 1995, the carrying value of financial
instruments such as cash and cash equivalents, accounts payable, notes payable
and long-term debt approximated their fair values, calculated using discounted
cash flow analysis at the Company's incremental borrowing rate.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. The most significant estimates and assumptions relate to the
provision for business restructuring (see note 3) and the amortization methods
F-8
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
and useful lives of videocassette rental inventory, deferred charges and excess
of cost over net assets acquired. These estimates and assumptions could change
and actual results could differ from these estimates.
Unaudited Pro Forma Information
Income before income taxes for the year ended December 31, 1994 reflects an
adjustment for the change in compensation levels arising from the employment
agreements with certain stockholders which became effective as of the completion
of the Company's initial public offering of common stock on August 2, 1994.
Pro forma income taxes reflect income tax expense which would have been
recognized if the Company, Home Vision and Hollywood Video had been C
corporations for all periods presented. Historical operating results of the
Company, Home Vision and Hollywood Video do not include any provision for income
taxes prior to August 2, 1994, October 1, 1994, and July 1, 1996, respectively,
due to their S corporation status prior to those dates.
Weighted average shares through August 1, 1994 include the assumed issuance of
196,603 shares at the initial public offering price of $14 to fund the
distribution of undistributed S corporation earnings subsequent to the public
offering.
2. Acquisitions
During 1996, the Company acquired 76 video specialty stores in 20 transactions
with unrelated sellers for $21,447,000, including the issuance of 505,094 shares
of common stock. The excess of the cost over estimated fair value of the assets
acquired was $9,726,000.
During 1995, the Company acquired 327 video specialty stores in 55 transactions
with unrelated sellers for $99,383,000, including the issuance of $9,323,000 in
notes payable and 279,863 shares of common stock. The excess of the cost over
estimated fair value of the assets acquired was $60,380,000.
During 1994, the Company acquired 196 video specialty stores in 27 transactions
with unrelated sellers for $42,004,000, including the issuance of $5,375,000 in
notes payable and options to purchase 210,000 shares of common stock under the
1994 Stock Option Plan (see note 7) at a price equal to the fair market value at
the date of issuance. The excess of the cost over the estimated fair value of
the assets acquired was $19,361,000.
Businesses acquired during the periods discussed above were accounted for under
the purchase method of accounting and are included in the Company's consolidated
financial statements from the dates of acquisition.
On July 1, 1996, the Company acquired Home Vision in a merger transaction
accounted for as a pooling-of-interests, pursuant to which the Company issued
approximately 731,000 shares of its common stock to Home Vision shareholders and
assumed approximately $12.5 million in liabilities. At the time of the merger,
Home Vision operated 55 video specialty stores in Maine, New Hampshire and
Massachusetts. During 1994 and 1995, Home Vision acquired various video
specialty store chains with an aggregate net purchase price of $7,234,000,
F-9
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
2. Acquisitions (continued)
including the issuance of $689,000 in notes payable and 301,442 shares of common
stock. The excess of the cost over estimated fair value of the assets acquired
was $6,120,000.
On July 1, 1996, the Company acquired Hollywood Video in a merger transaction
accounted for as a pooling-of-interests, pursuant to which the Company issued
approximately 38,000 shares of its common stock to Hollywood Video shareholders
and assumed approximately $11.5 million in liabilities. At the time of the
merger, Hollywood Video operated 43 video specialty stores in Iowa, Wisconsin
and Illinois.
Prior to the merger, Home Vision reported on a fiscal year ending on September
30 and Hollywood Video reported on a calendar year basis. The Home Vision
statements of operations for the years ended September 30, 1995 and 1994 are
combined with the statements of operations for the Company and Hollywood Video
for the years ended December 31, 1995 and 1994. The combined balance sheet
includes the December 31, 1995 balance sheet for the Company, Home Vision and
Hollywood Video. In order to conform with the Company's fiscal year end, Home
Vision's results of operations for the quarter ended December 31, 1995 which
reflected revenues of $6,506,000, operating expenses of $9,374,000 (including
$1,974,000 of costs associated with a failed initial public offering) and net
loss of $2,082,000, are included in the Company's retained earnings balance at
December 31, 1995.
Separate results of operations of the merged entities for the periods prior to
the merger date are as follows (in thousands) (unaudited):
Six Months Ended Year Ended
June 30 December 31 December 31
1996 1995 1994
---------------- ------------ -----------
Revenues:
Movie Gallery $ 106,307 $ 123,143 $ 38,643
Home Vision 11,191 18,024 9,298
Hollywood Video 5,307 8,034 5,282
--------- --------- --------
Combined $ 122,805 $ 149,201 $ 53,223
========= ========= ========
Net income (loss):
Movie Gallery $ 3,106 $ 14,486 $ 4,965
Home Vision (97) (366) 545
Hollywood Video (986) (1,705) (489)
--------- --------- --------
Combined $ 2,023 $ 12,415 $ 5,021
========= ========= ========
F-10
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
2. Acquisitions (continued)
Costs of approximately $757,000 incurred by the Company in connection with the
Home Vision and Hollywood Video mergers have been included in general and
administrative expenses in the consolidated statement of income for the fiscal
year ended January 5, 1997.
The following unaudited pro forma information presents the consolidated results
of operations of the Company as though the aforementioned acquisitions, which
were accounted for as purchases and have occurred since January 1, 1995, had
occurred as of the beginning of the year in which the acquisition occurred and
the beginning of the immediately preceding year (in thousands, except per share
data):
Year Ended
-----------------------------------
January 5 December 31 December 31
1997 1995 1994
-----------------------------------
Revenues $ 261,223 $ 241,815 $ 205,351
Net income 2,521 20,796 16,454
Net income per share 0.19 1.61 1.65
3. Provision for Business Restructuring
During the third quarter of 1996 the Company began and completed an extensive
analysis of both its store base performance and organizational structure and
adopted a business restructuring plan to close approximately 50 of its stores
and reduce the corporate organizational staff by approximately 15 percent.
Management concluded that certain stores were underperforming and it was not
prudent to continue to operate these locations. These store closings are not
concentrated in a particular geographic area. The principal factors considered
in identifying stores for closure included: (i) whether a store generated
sufficient cash flow at the store level to provide an acceptable return on
current investment; (ii) whether the latest sales trends indicated a likely
improvement in the historical store results; (iii) whether the current or future
competitive climate had made sales improvements less likely; and (iv) whether a
store's performance warranted lease renewal where the lease was scheduled to
expire within the next year.
This analysis has resulted in the Company recording a $9.6 million pretax
restructuring charge in the third quarter of 1996. The components of the
restructuring charge include approximately $5.4 million in reserves for future
cash outlays for lease terminations, miscellaneous closing costs and legal and
accounting costs, as well as approximately $4.2 million in asset write downs
(see below). In some situations, the timing of store closures will depend on the
Company's ability to negotiate reasonable lease termination agreements. The
lease commitments associated with the closing stores will be retired entirely or
materially diminished by one of three methods: (i) through the normal expiration
of the lease within the next year; (ii) through the subletting of the property
to another entity; or (iii) through a negotiated lease buyout with the
individual landlord. The store closures are expected to be completed by the end
of fiscal year 1997. Approximately $807,000 of lease termination costs,
miscellaneous closing costs and legal costs were paid and charged against the
liability for the fiscal year ended January 5, 1997. The stores identified for
closure had revenues and operating losses of approximately $4.5 million and $0.2
million, respectively, for the year ended December 31, 1995 and $6.2 million and
$1.6 million, respectively, for the fiscal year ended January 5, 1997. Operating
F-11
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
3. Provision for Business Restructuring (continued)
results for the year ended December 31, 1994 are not comparable as most stores
identified for closure were opened or acquired in late 1994 or 1995.
In conjunction with the business restructuring, an estimated $4.2 million
impairment loss was incurred for those stores identified to close where
projected operating performance indicated an impairment. This impairment loss
related primarily to the write-off of leasehold improvements, fixtures and
intangibles and a valuation allowance for videocassette rental inventory
associated with the stores to be closed.
4. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
January 5 December 31
1997 1995
-----------------------
Land and buildings $ 1,879 $ 1,879
Furniture and fixtures 26,932 20,592
Equipment 18,963 14,747
Leasehold improvements and signs 18,766 12,386
-------- --------
66,540 49,604
Accumulated depreciation (16,344) (8,167)
-------- --------
$ 50,196 $ 41,437
======== ========
5. Long-Term Debt
On July 10, 1996, the Company entered into a Credit Agreement with First Union
National Bank of North Carolina with respect to a reducing revolving credit
facility (the "Facility"). The Facility is unsecured, provides borrowings for up
to $125 million and replaced the Company's previously existing line of credit
agreement.
The available amount of the Facility will reduce quarterly beginning on March
31, 1998 with a final maturity of June 30, 2000. The interest rate of the
Facility is LIBOR-based (7.5% at January 5, 1997) and the Company may repay the
Facility at any time without penalty. The more restrictive covenants of the
Facility restrict borrowings based upon cash flow levels. At January 5, 1997,
$67 million was outstanding and approximately $11.3 million of the $125 million
commitment was available for borrowing under the Facility. Based on the amount
currently outstanding, scheduled maturities of the facility are $35,750,000 in
fiscal year 1999 and $31,250,000 in fiscal year 2000.
In connection with certain acquisitions, the Company issued or assumed notes
payable which had outstanding balances of $1,257,000 and $10,781,000 at January
5, 1997 and December 31, 1995, respectively. Generally, these notes are
unsecured, require monthly or annual payments and have fixed or variable
interest rates ranging from 6% to 9%. At December 31, 1995, long-term debt also
included balances totaling $15,231,000 related to Home Vision and Hollywood
F-12
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Long-Term Debt (continued)
Video. Substantially all of these notes were paid subsequent to consummation of
the merger transactions with proceeds from the Facility. Scheduled maturities of
long-term debt are as follows: $374,000 in 1997, $395,000 in 1998, $253,000 in
1999, and $235,000 in 2000.
6. Income Taxes
The Company's earnings for the period April 1, 1992 through August 1, 1994 were
taxed directly to the Company's stockholders due to the Company's election to be
taxed as an S corporation under the Internal Revenue Code. The Company's S
corporation status terminated immediately prior to its initial public offering
of common stock on August 2, 1994. Accordingly, the Company was required to
provide for deferred taxes, arising from cumulative temporary differences
between financial and tax reporting, by recognizing a provision for income taxes
of $1,300,000 in the third quarter of fiscal 1994. Additionally, during portions
of the periods presented, Home Vision and Hollywood Video were taxed as S
corporations rather than C corporations (see note 1).
The following reflects unaudited pro forma income tax expense that the Company
would have incurred had it, Home Vision and Hollywood Video (see note 1) been
subject to federal and state income taxes for the entire fiscal years ended as
follows (in thousands):
Year Ended
-------------------------------------
January 5 December 31 December 31
1997 1995 1994
-------------------------------------
(unaudited pro forma information)
Current payable:
Federal $ 90 $1,328 $ 444
State -- 136 47
------ ------ ------
Total current 90 1,464 491
Deferred:
Federal 831 5,692 2,260
State 85 715 240
------ ------ ------
Total deferred 916 6,407 2,500
------ ------ ------
$1,006 $7,871 $2,991
====== ====== ======
F-13
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
6. Income Taxes (continued)
A reconciliation of income tax at the federal income tax rate to the Company's
pro forma effective income tax provision is as follows (in thousands):
Year Ended
-------------------------------------------
Janaury 5 December 31 December 31
1997 1995 1994
-------------------------------------------
(unaudited pro forma information)
Income tax at statutory rate $ 888 $7,245 $2,845
State income taxes, net of federal
income tax benefit 85 615 146
Other, net 33 11 --
-------- ------ ------
$1,006 $7,871 $2,991
======== ====== ======
At January 5, 1997, the Company had net operating loss carryforwards of
$9,531,000 for income taxes that expire in years 2010 through 2011. $5,564,000
of these carryforwards resulted from the Company's acquisition of Home Vision
(see note 2). Utilization of the net operating loss carryforwards related to the
Home Vision acquisition may be subject to a substantial annual limitation due to
the statutory provisions of the Internal Revenue Code.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income taxes. Components of the Company's
deferred tax assets and liabilities are as follows (in thousands):
January 5 December 31
1997 1995
------------------------
Deferred tax liabilities:
Videocassette rental inventory $ 14,847 $ 12,993
Furnishings and equipment 4,286 2,236
Excess of cost over fair value of assets acquired 1,519 710
Other 694 142
------- -------
Total deferred tax liabilities 21,346 16,081
Deferred tax assets:
Non-compete agreements 4,318 3,559
Net operating loss carryforwards 3,527 2,225
Alternative minimum tax credit carryforward 275 --
Accrued liabilities 1,911 104
------- -------
Total deferred tax assets 10,031 5,888
------- -------
Net deferred tax liabilities $11,315 $10,193
======= =======
F-14
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity
Common Stock
In 1995, the Company registered shares of common stock with an aggregate public
offering price of $127,000,000. This common stock may be offered directly
through agents, underwriters or dealers or may be offered in connection with
business acquisitions. As of January 5, 1997, common stock of approximately
$83,000,000 was available to be issued from this registration.
As of January 5, 1997, the Company had warrants outstanding to purchase
approximately 100,000 shares of the Company's common stock, exercisable through
June 30, 2000 at an exercise price of $30.11.
Stock Repurchase
On September 30, 1994, Home Vision reacquired 153,494 shares of its no par
common stock from its stockholders for an estimated fair value of $930,000,
which included Home Vision forgiving $80,000 outstanding on a note receivable,
paying $450,000 in cash subsequent to year end, and issuing a five year, 8%,
related party note payable for $400,000.
Stock Option Plan
On 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. During 1996 the Company increased the shares reserved for issuance
under the Plan from 1,250,000 to 1,750,000. Options granted under the Plan have
a 10-year term and generally vest over 5 years.
In October 1995, the Financial Accounting Standards Board issued Statement of
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS
123"). In accordance with the provisions of SFAS 123, the Company applies APB
Opinion No. 25 and related Interpretations in accounting for its stock option
and purchase plans and, accordingly, has not recognized compensation cost in
connection with such plans. If the Company had elected to recognize compensation
cost based on the fair value of the options granted at grant date as prescribed
by SFAS 123, net income and net income 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.
Year Ended
------------------------------
January 5 December 31
1997 1995
------------------------------
(in thousands, except per share data)
Pro forma net income $ 218 $ 11,220
Pro forma net income per share .02 .92
F-15
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. 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:
Year Ended
---------------------------
January 5 December 31
1997 1995
---------------------------
Expected volatility 0.607 0.607
Risk-free interest rate 6.34% 6.50%
Expected life of options in years 6.0 6.0
Expected dividend yield 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:
Year Ended
-----------------------------------------------------------------------------------
January 5, 1997 December 31, 1995 December 31, 1994
--------------------------- ------------------------ -------------------------
Weighted Average Weighted-Average Weighted-Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- ---------------- ------- ---------------- -------- -----------------
Outstanding-beginning
of year 1,107,450 $ 24.63 699,000 $ 14.88 -- $ --
Granted 379,500 14.15 578,000 34.19 716,000 14.87
Exercised 35,100 14.92 129,000 14.21 -- --
Forfeited 133,200 23.58 40,550 25.94 17,000 14.39
Outstanding-end of year 1,318,650 21.98 1,107,450 24.63 699,000 14.88
Exercisable at end of year 622,125 21.28 424,150 20.41 210,500 14.49
Weighted-average fair value
of options granted during
the year $ 8.84 $ 21.39
F-16
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
Options outstanding as of January 5, 1997 had a weighted-average remaining
contractual life of 8.6 years and exercise prices ranging from $14.00 to $42.63
as follows:
Exercise price of
$14.00 to $21.25 $21.26 to $42.63
---------------------------------------
Options outstanding 833,950 484,700
Weighted-average exercise price $14.65 $34.58
Weighted-average remaining contractual life 8.6 years 8.5 years
Options exercisable 401,475 220,650
Weighted-average exercise price of
exercisable options $15.00 $32.71
8. Commitments and Contingencies
Rent expense for the fiscal years ended January 5, 1997 and December 31, 1995
and 1994 totaled $37,266,000, $19,960,000 and $6,425,000, respectively. Future
minimum payments under noncancellable operating leases which contain renewal
options and escalation clauses (primarily for videocassette rental stores) with
remaining terms in excess of one year consisted of the following at January 5,
1997 (in thousands):
1997 $ 28,547
1998 25,924
1999 19,420
2000 11,710
2001 6,126
Thereafter 11,989
---------
$ 103,716
=========
The Company has entered into a ten year agreement with Rentrak Corporation which
requires the Company to order videocassette rental inventory under lease
sufficient to require an aggregate minimum payment of $3,000,000 per year
(beginning in 1997) in revenue share, handling fees, sell through fees and
end-of-term buyout fees.
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.
9. Related Party Transactions
During the years ended December 31, 1995 and 1994, the Company purchased signs
totaling $1,683,000 and $491,000, respectively, from a company in which two
officers who are also stockholders of the Company held a majority interest prior
to January 1, 1996.
The Company paid $260,000, $650,000 and$598,000 in legal fees for the fiscal
years ended January 5, 1997 and December 31, 1995 and 1994, respectively, to a
law firm of which one of the Company's directors is a member.
F-17
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
10. Summary of Quarterly Results of Operations (Unaudited)
The following is a summary of unaudited quarterly results of operations (in
thousands, except per share data):
Fourteen Weeks
Thirteen Weeks Ended Ended
-----------------------------------------------
March 31 June 30 September 29 January 5
1996 1996 1996 1997
-----------------------------------------------
Revenue $ 62,500 $ 60,305 $ 61,728 $ 69,862
Operating income (loss) 9,475 (3,100) (5,804) 7,660
Pro forma net income (loss) 5,160 (2,762) (4,487) 3,695
Pro forma net income per share .39 (.21) (.33) .28
Quarter Ended
------------------------------------------------
March 31 June 30 September 30 December 31
1995 1995 1995 1995
------------------------------------------------
Revenue $ 28,270 $ 30,494 $ 40,373 $ 50,064
Operating income 4,883 4,596 6,253 7,104
Pro forma net income 2,842 2,980 3,681 3,934
Pro forma net income per share .28 .24 .28 .30
F-18
Index to Exhibits
Exhibit No. Description
10.1 1994 Stock Option Plan, as amended and
forms of Stock Option Agreement
10.9 Agreement dated March 13, 1997 between
Sight & Sound Distributors, Inc. and Movie Gallery, Inc.
(portions have been omitted purusant to a request for confidential
treatment)
10.12 Consulting Agreement between William B. Snow
and M.G.A., Inc. dated December 12, 1996
11 Computation of Earnings Per Share
21 List of Subsidiaries
23 Consent of Ernst & Young LLP
27 Financial Data Schedule