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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 4, 1998
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 March 13, 1998, was approximately $55,146,581. The number
of shares of Common Stock outstanding on March 13, 1998, was 13,420,685 shares.
Documents incorporated by reference:
1. Notice of 1998 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. [X]
1
ITEM 1. BUSINESS
General
As of March 13, 1998, Movie Gallery, Inc. (the "Company") owned and
operated 852 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 is
among the four largest video retailers in the United States.
The Company was incorporated in Delaware in June 1994 under the name Movie
Gallery, Inc. From March 1985 until the present time, substantially all of the
Company's operations have been conducted through its wholly-owned subsidiary,
M.G.A., Inc. The Company's executive offices are located at 739 W. Main Street,
Dothan, Alabama 36301, and its telephone number is (334) 677-2108.
Video Industry Overview
Video Retail Industry. According to Paul Kagan Associates, Inc. ("Paul
Kagan"), the home video rental and sales industry has grown from $0.7 billion in
revenue in 1982 to a projected $16.3 billion in 1997 and is projected to reach
$21.1 billion by 2006. Paul Kagan estimates that in 1997 consumers rented
approximately 3 billion videos and purchased more than 600 million videos. In
fact, Adams Media Research estimates that 85.0% of America's 96.6 million
television households have videocassette recorders, a percentage which is
expected to exceed 90% by 2002.
The video retail industry is highly fragmented and is experiencing
increased consolidation. Recent trends toward consolidation have been fueled by
the competitive impact of superstores on smaller retailers, the need for
enhanced access to working capital and efficiencies of scale. The Company
believes that the video specialty store industry 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.
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.
2
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 total number of stores occurred through the acquisition of
stores and the balance occurred through the development of new stores. The
Company spent all of 1997 and expects to spend much of 1998 absorbing the large
increase in the number of stores which began in 1994. The Company expects to
begin gradually accelerating its growth rate in late 1998. It is expected that,
in the future, development of new stores will account for a substantial portion
of the Company's growth. The Company's ability to resume this growth strategy
will be dependent upon its ability to generate cash flow from operations and 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 13, 1998, the Company has
developed 219 stores. The Company utilizes store development to complement its
existing base of stores in rural and secondary markets where it finds attractive
locations and a sufficient population to support additional video specialty
stores. The Company attempts to locate stores primarily in towns with
populations from 3,000 to 60,000. Although developed stores generally require
approximately one year for revenue to reach the level of a mature store, they
typically become profitable within the first six months of operations and
produce greater returns on investment than acquired stores.
The Company's real estate and construction departments are responsible for
new store development, including site selection, market evaluation, lease
negotiation and construction. The Company usually acts as the general contractor
with respect to the construction of its new stores and, in that regard, employs
full-time construction managers who have significant video specialty store
construction experience.
Set forth below is a historical summary showing store openings,
acquisitions and store closings by the Company since January 1, 1994.
Fiscal Fiscal
Year Ended Year Ended Year Ended January 5
December 31 January 5 January 4 to March 13
1994 1995 1997 1998 1998
---- ---- ---- ---- ----
New Store Openings 25 66 75 50 3
Stores Acquired 196 327 174(1) 2 0
Stores Closed 2 23 48 59 7
Total Stores at End
of Period 292 662 863 856 852
___________________________
(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.
3
Acquisitions. From January 1, 1994 through March 13, 1998, the Company
acquired 699 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 latter portion of the third quarter 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 late 1998, although the
Company does not anticipate acquiring stores at its 1994-1996 levels.
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.
The Company continues to have preliminary discussions with the owners of
video retail businesses. While the Company currently has no formal 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 or that the
integration of future acquisitions will not materially and adversely affect the
Company.
Operating Strategy
Focus on Smaller Markets. Generally, the Company's stores are located in
small towns or suburban areas surrounding mid-sized cities. In these areas, the
Company's principal competition usually consists of single store or small chain
operators who have less buying power, smaller advertising budgets and generally
offer fewer copies of new release videocassettes. The Company attempts to become
the leading video retailer in its markets and believes that it can achieve a
higher return on invested capital in these smaller markets than it could in the
larger urban areas because of the reduced level of competition and lower
operating costs.
Market Concentration. By concentrating its new store development in and
around existing markets, the Company is able to achieve operating efficiencies,
primarily consisting of cost savings relating to advertising, training and store
supervision.
New 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 local store
and district 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 visually appealing stores. 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 4,000
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 13, 1998, the Company owned and operated 852 stores, all but one
of which were located in leased premises. The following table provides
information at March 13, 1998 regarding the number of Company stores located in
each state.
Number
of
Stores
======
Alabama 144
Florida 110
Texas 88
Georgia 65
Virginia 56
Ohio 49
Maine 44
Tennessee 44
Wisconsin 33
Indiana 32
South Carolina 31
Mississippi 28
North Carolina 23
Missouri 22
Kentucky 19
Kansas 18
Louisiana 15
New Hampshire 12
Illinois 10
Massachusetts 4
Iowa 3
Michigan 2
---
TOTAL 852
===
The Company's stores are generally open seven days a week, from 10:00 a.m.
to 11:00 p.m. on weekends and from 10:00 a.m. to 10:00 p.m. on weekdays. The
store fixtures, equipment and layout are designed by the Company to create a
visually-appealing, up-beat ambiance, which is augmented by a background of
television monitors displaying MGTV (Movie Gallery Television), which shows
movie previews and promotions of coming attractions, and by posters and stand-up
displays promoting specific movie titles. Movies are arranged in attractive
display boxes organized into categories by topic, except for new releases, which
are assembled alphabetically in their own section for ease of selection by
customers.
The Company has implemented a quality assurance program to ensure
compliance with the Company's customer service and store operating policies. A
team of Quality Assurance Auditors located in different geographic regions make
periodic visits to monitor compliance and report results to the Company's Vice
President - Support Services. District Managers and Regional Managers are
expected to quickly address and resolve any compliance problems.
The Company's policy is to constantly evaluate its existing store base to
determine where improvements may benefit the Company's competitive position. In
negotiating its leases and renewals, the Company attempts to obtain short lease
terms to allow for the mobility necessary to react to changing demographics and
other market conditions. The 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 4, 1998, the Company relocated, expanded or fully remodeled 31
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.
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 13, 1998, 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. For the fiscal year
ended January 4, 1998, revenues from franchisees and licensees were not material
to the Company.
Products
For the fiscal year ended January 4, 1998, 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 this period was derived from the
sale of new and previously viewed videocassettes, confectionery items and video
accessories, such as blank cassettes, cleaning equipment and movie memorabilia.
The Company's stores generally offer from 4,000 to 15,000 videocassettes
(from 3,000 to 10,000 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," "Drama" and "Children." 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 managers and are based on box office results, actual
rental history of comparable titles within each store and industry research.
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 related to particular holidays.
In an effort to provide more depth of copy on hit titles to better satisfy
initial customer demand, certain movie studios in late 1997 began offering
incentives and expanded revenue sharing plans which have lowered the average per
unit cost of rental inventory. These programs permit the Company to carry larger
levels of new release inventory. Thus, the Company has pursued such
opportunities and believes that during late 1997 and early 1998 these programs
had a positive impact on revenues. There can be no assurance that studios will
continue to offer such programs or that such programs will continue to have
positive results.
The Company rents and sells video games, which are licensed primarily by
"Nintendo," "Sony" and "Sega." Game rentals as a percentage of the Company's
total revenues have increased since early 1997 due to the increase in the
installed base of 32-bit and 64-bit game platforms. Sony and Sega released new
platforms in late 1995, while Nintendo released its N64 platform in the fall of
1996. The Company anticipates that the Sony and Nintendo platforms will continue
to grow as more households in its markets acquire video game hardware. The
Company expects that the video game rental and sales portion of its business
will grow through 1998 and early 1999.
6
Videocassette and Video Game Suppliers
In August 1997, the Company executed a contract with Major Video Concepts,
Inc. ("MVC") by which MVC became the Company's primary supplier of video
inventory requirements. The contract is effective through March 31, 1999. Until
August 1997, Sight and Sound Distributors, Inc. had served as the Company's
primary supplier. During Fiscal 1997, the Company purchased over 80% of its
video inventory from its primary suppliers. Remaining inventory was provided by
three other distributors.
The Company's contract with MVC 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 MVC based
in part upon a percentage of videocassette and video game purchases.
If the relationship with MVC 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 MVC. However, the number of alternative suppliers has diminished in recent
years and the termination of the Company's present relationship with MVC 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 MVC.
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 MVC 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 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 consumer magazine called "Video Buzz" and a
customized video program (MGTV), both of which feature Company programs,
promotions and new releases.
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 drop-shipped to the stores.
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
7
directly from suppliers. This inventory for developed stores is packaged at the
Company's processing and distribution facility located in Dothan, Alabama. Each
videocassette and video game is removed from its original packaging, and an
optical bar code label, used in the Company's computerized inventory system, is
applied to the plastic rental case. The cassette is placed in the rental case,
and a display carton is created by inserting foam or cardboard into the original
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 tested through
March 31, 1996. On April 1, 1996, the Company began the rapid deployment of the
POS system in its Company stores. By July 1997, the Company had converted all of
its stores to 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 office. Each night
the POS system transmits store data into the MIS where all data is processed,
generating reports which allow management to effectively monitor store
operations and inventory, as well as to review rental history by title and
location to assist in making purchasing decisions with respect to new releases.
The POS system also enables the Company to perform its monthly physical
inventory using bar code recognition.
In addition, during the last three years the Company has installed a
financial reporting system relating to the general ledger, revenue, accounts
payable and payroll functions capable of handling the Company's anticipated
growth. Additional development and implementation of systems during the past
year includes an internal Accounts Receivable Collections system and
Processing/Distribution Center system.
Competition and Technological Obsolescence
The video retail industry is highly competitive, and the Company competes
with other video specialty stores, including stores operated by other regional
chains and national chains such as Blockbuster Video ("Blockbuster"), and with
other businesses offering videocassettes and video games such as supermarkets,
pharmacies, convenience stores, bookstores, mass merchants, mail order
operations and other retailers. Approximately 33% of the Company's stores
compete with stores operated by Blockbuster. In addition, the Company competes
with all forms of entertainment, such as movie theaters, network and cable
television, direct broadcast satellite television, Internet-related activities,
live theater, sporting events and family entertainment centers. Some of the
Company's competitors have significantly greater financial and marketing
resources and name recognition than the Company.
The Company believes the principal competitive factors in the video retail
industry are store location and visibility, title selection, the number of
copies of each new release available, customer service and, to a lesser extent,
pricing. The Company believes it generally offers superior service, more titles
and more copies of new releases than most of its competitors.
The Company also competes with Pay-Per-View in which subscribers pay a fee
to view a movie selected by the subscriber. Recently developed technologies,
referred to as NOVD, permit certain cable companies, direct broadcast satellite
companies (such as Direct TV), telephone companies and other telecommunications
companies to transmit a much greater number of movies to homes throughout the
United States at more frequent intervals (often as frequently as every five
minutes) throughout the day. NVOD does not offer full intractivity or VCR
8
functionality, such as allowing consumers to control the playing of the movie
(i.e., starting, stopping and rewinding). Ultimately, further improvements in
these technologies could lead to the availability to the consumer of a broad
selection of movies on demand, referred to as VOD, at a price which may be
competitive with the price of videocassette rentals and with the functionality
of VCRs. Certain cable and other telecommunications companies have tested and
are continuing to test limited versions of NVOD and VOD in various markets
throughout the United States and Europe.
Movies recorded on digital video discs ("DVD"), the same size as audio
discs, were introduced during the summer of 1997. Playback machines which play
both audio discs and DVD have also been 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. Currently, the Company offers DVD for
rental and sale in limited, primarily metropolitan, markets. The Company expects
to expand its DVD software availability to other markets once the installed base
will support such an investment. Technology is currently being developed to
offer an alternative digital disk platform called Digital Video Express
("Divx"). Divx disks permit 48 hours of viewing from the time playback begins.
Subsequent viewings would be available at an additional charge with access and
payment handled via modem. The advent of DVD and Divx 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.
For the near-term, however, hardware costs for digital disk technologies are
expected to remain high, recordability is likely several years away and products
on digital disks remain available on VHS, typically at an earlier date. Neither
DVD nor Divx have yet attained universal support from movie studios.
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, and perhaps digital disks, to video stores. In addition, the
Company believes that for Pay-Per-View television to match the low price,
viewing convenience and selection available through video rental, substantial
capital expenditures and further technological advances will be necessary.
Although the Company does not believe NVOD or VOD represent a near-term
competitive threat to its business, technological advances and broad consumer
availability of NVOD and VOD or changes in the manner in which movies are
marketed, including the earlier release of movie titles to Pay-Per-View, cable
television or other distribution channels, could have a material adverse effect
on the Company's business.
Employees
As of March 13, 1998, the Company employed approximately 5,800 persons,
referred to by the Company as "associates," including approximately 5,500 in
retail stores and the remainder in the Company's corporate offices and
distribution facility ("Support Center Staff"). Of the retail associates,
approximately 1,000 were full-time and 4,500 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 five to fifteen persons,
including one Store Manager and, in larger stores, one Assistant Manager. Store
Managers report to District Managers who supervise the operations of 10 to 15
stores. The District Managers report to one of nine 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 Support Center Staff has regular and periodic meetings with the
Regional Managers and District Managers to review operations. Compliance with
the Company's policies, procedures and regulations is regularly monitored on a
store-to-store basis by members of the Company's Quality Assurance department.
9
The Company has an incentive bonus program pursuant to which retail
management personnel receive quarterly bonuses when stores meet or exceed
criteria established under the program. Management believes that its program
rewards excellence in management, gives associates an incentive to improve
operations and results in an overall reduction in the cost of operations. In
addition, District Managers, Regional Managers and certain Support Center Staff
are eligible to receive discretionary bonuses, based on individual and Company
performance, and options to purchase shares of the Company's Common Stock
(exercisable at the fair market value on the date of grant), subject to service
requirements.
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.
Growth Strategy. The Company's long-term strategy is to grow primarily
through new store openings and secondarily through acquisitions of existing
stores. Successful implementation of the strategy is contingent on numerous
conditions, some of which are described below, and there can be no assurance
that the Company's business plan can be executed. The acquisition of existing
stores and the opening of new stores requires significant amounts of capital. In
the past, the Company's growth strategy has been funded through proceeds
primarily from public offerings of common stock, and secondarily through bank
debt, seller financing, internally generated cash flow and use of the Company's
common stock as acquisition consideration. These and other sources of capital,
including public or private sales of debt or equity securities, may not be
available to the Company in the future.
New Store Openings. The Company's ability to open new stores may be
adversely affected by the following factors, among others: (i) its availability
of capital; (ii) its ability to identify new sites where the Company can
successfully compete; (iii) its ability to negotiate acceptable leases and
implement cost-effective development plans for new stores; (iv) its ability to
hire, train and assimilate new store managers and other personnel; and (v) its
ability to compete effectively against competitors for prime real estate
locations.
Acquisitions. The Company's ability to consummate acquisitions and operate
acquired stores at the desired levels of sales and profitability may be
adversely affected by: (i) the inability to consummate identified acquisitions,
which may result from a lack of available capital; (ii)the reduction in the size
of the pool of available sellers; (iii) the inability to identify acquisition
candidates that fit the Company's criteria (such as size, location and
profitability) and who are willing to sell at prices the Company considers
reasonable; (iv) more intensive competition to acquire the same video specialty
stores the Company seeks to acquire; (v) an increase in price for acquisitions;
(vi) misrepresentations and breaches of contracts by sellers; (vii) the
Company's limited knowledge and operating history of the acquired stores; (viii)
the replacement of purchasing and marketing systems of acquired stores; and (ix)
the integration of acquired stores' systems into the Company's systems and
procedures.
Same-Store Revenues Increases. The Company's ability to maintain or
increase same-store revenues during any period will be directly impacted by the
following factors, among others, which are often beyond the control of the
Company: (i) increased competition from other video stores, including large
national or regional chains, supermarkets, convenience stores, pharmacies, mass
merchants and other retailers, which might include significant reductions in
pricing to gain market share; (ii) the weather conditions in the selling area;
(iii) the timing of the release of new hit movies by the studios for the video
rental market; (iv) competition from special events such as the Olympics or an
ongoing major news event of significant public interest; (v) competition from
other forms of entertainment such as movie theaters, cable television,
Internet-related activities and Pay-Per-View television, including direct
satellite television; 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).
10
Income Estimates. The Company's ability to meet its income projections for
any period are dependent upon many factors, including the following, among
others: (i) reductions in revenues caused by factors such as those listed under
"Same-Store Revenues Increases" above; (ii) the extent to which the Company
experiences an increase in the number of new competitive openings, which tends
to divide market share and reduce profitability in a given trade area; (iii) the
extent to which the Company experiences any increase in the number of titles
released from studios priced for sell-through, which may tend to increase the
satisfaction of demand through product sales which carry lower profit margins
than rental revenues; (iv) changes in the prices for the Company's products or a
reduction in, or elimination of, the videocassette release window as compared to
Pay-Per-View, as determined by the movie studios, could result in a competitive
disadvantage for the Company relative to other forms of distribution; (v) the
Company's ability to control costs and expenses, primarily rent, store payroll
and general and administrative expenses; (vi) the Company's ability to react and
obtain other distribution sources for its products in the event that MVC 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) development and implementation of DVD and Divx
technology which might result in lower profit margins and increased costs
associated with higher inventory requirements; and (c) other forms of new
technology, which could affect the Company's profit margins.
Directors and Executive Officers of the Company
Name Age Position(s) Held
- ---- --- ----------------
Joe Thomas Malugen(1) 46 Chairman of the Board and Chief Executive
Officer
H. Harrison Parrish(1) 50 President and Director
William B. Snow(1) 66 Vice Chairman of the Board
Robert L. Sirkis 46 Executive Vice President and Chief Operating
Officer
J. Steven Roy 37 Executive Vice President and Chief Financial
Officer
S. Page Todd 36 Senior Vice President, Secretary and General
Counsel
William G. Guerrette, Jr. 38 Senior Vice President-Sales
Steven M. Hamil 29 Senior Vice President, Chief Accounting
Officer and Controller
Richard R. Langford 41 Senior Vice President-Management Information
Systems
Mark S. Loyd 42 Senior Vice President-Purchasing and Product
Management
Jeffrey S. Stubbs 35 Senior Vice President-Store Operations
Sanford C. Sigoloff(2)(3) 67 Director
Philip B. Smith(2)(3) 62 Director
Joseph F. Troy (1)(2)(3) 59 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 L.L.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.
11
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.
Mr. Sirkis was elected Executive Vice President and Chief Operating Officer
in September 1997. From 1994 until he joined the Company, Mr. Sirkis founded and
served as President and Chief Executive Officer of Finest Foodservice, L.L.C.,
which developed and operated Boston Market stores in seven states. Prior to
1994, he served as President and Chief Executive Officer of Silo, Inc., a
nationwide retailer of consumer electronics and subsidiary of London-based
Dixons Group, plc. Mr. Sirkis received a B.A. degree from Johns Hopkins
University and his Masters in Business Administration from Harvard Business
School.
Mr. Roy was elected Senior Vice President-Finance and Principal Accounting
Officer in June 1995, was elected Chief Financial Officer in May 1996 and was
elected Executive Vice President in March 1998. Mr. Roy was an accountant with
the firm of Ernst & Young LLP for the 11 years prior to joining the Company,
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. Guerrette joined the Company in April 1997 and, after serving as Vice
President - Retail Sales, was elected Senior Vice President - Sales in December
1997. Mr. Guerrette was President of Sounds Easy Video when it was acquired by
Home Vision Entertainment, Inc. ("Home Vision") in September 1994 and served as
Executive Vice President and Chief Operating Officer of Home Vision until it was
acquired by the Company. He was elected to the Maine House of Representatives,
where he served from November 1994 to 1996. Mr. Guerrette attended Brigham Young
University and majored in Accounting.
Mr. Hamil was elected Vice President and Controller in June 1996, was
elected Chief Accounting Officer in October 1996 and was elected Senior Vice
President in March 1998. 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. Langford joined the Company in August 1995 as Vice President and was
elected Senior Vice President - Management Information Systems in October 1996.
From August 1993 until he joined the Company, Mr. Langford served as a Manager
for Payroll, Fixed Assets and Accounts Payable for Rocky Mountain Healthcare.
From February 1990 to August 1993, he was Director of Support Operations for U.
I. Video Stores, Inc. ("UIV") of Denver, Colorado. UIV was one of the largest
Blockbuster franchisees, operating 110 stores in seven states in July 1993 when
UIV was acquired by Blockbuster. Mr. Langford received a B.A. degree in
Communications from Brigham Young University.
Mr. Loyd joined the Company in August 1986 and has served as the retail
store coordinator as well as Vice President - Purchasing and Product Management.
In October 1996, he was elected Senior Vice President - Purchasing and Product
Management. Mr. Loyd attended Southeast Missouri State University, where he
majored in Business Administration.
12
Mr. Stubbs was elected Senior Vice President - Store Operations in November
1997. He joined the Company in November 1995 as a District Manager and served as
a Regional Manager prior to his current position. Mr.Stubbs attended Texas A & M
University and Southwest Texas State University, where he received his B.B.A.
degree in Business Administration and Marketing.
Mr. Sigoloff became a director of the Company in September 1994. 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.
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 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
$16,000, a fee of $1,000 for each Board meeting attended and a fee of $500 for
each committee meeting attended. The Company has granted vested options to
purchase 100,000 shares of Common Stock to each of Messrs. Sigoloff and Smith,
vested options to purchase 125,000 shares to Mr. Troy and vested options to
purchase 135,000 shares to Mr. Snow, in each case at or above the fair market
value of the Common Stock on the date of grant.
ITEM 2. PROPERTIES
At March 13, 1998, all but one of the Company's 852 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 does not pay additional rents based on reaching the
required revenue levels and does not anticipate paying such additional rents in
the future. The Company anticipates that future stores will also be located in
leased premises. The Company owns a family entertainment center, including a
video specialty store, in Meridian, Mississippi.
13
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. In Fiscal 1997, these payments
totaled $43,800. The remaining office building space is used for general
corporate offices and is leased from an unaffiliated third party for a one-year
term with multiple one-year options. In May 1997, the Company consolidated 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.
ITEM 3. LEGAL PROCEEDINGS
In June 1997, certain former shareholders of Home Vision (the "Home Vision
Shareholders") filed a complaint against the Company in the U. S. District Court
for the District of Maine. According to the complaint, the Home Vision
Shareholders asserted a claim for breach of contract in connection with the
merger of the Company and Home Vision in July 1996. These shareholders
ultimately sought damages in excess of $10 million plus costs. On March 19,
1998, the Company received a jury verdict in its favor with respect to all
claims brought against it and does not expect to pay any monetary damages
associated with this case.
The Company continues to pursue its claims against the Home Vision
Shareholders. The case, which was filed in June 1997, is pending in the Circuit
Court of Houston County, Alabama. However, the Company does not believe that
this proceeding is material to its business or financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
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
------- -------
1998
First Quarter (through March 13, 1998) $ 7-1/8 $ 2-7/8
1997
First Quarter 13-3/4 7-1/2
Second Quarter 8 5
Third Quarter 6-7/8 3-1/2
Fourth Quarter 4-1/8 2-1/2
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
The last sale price of the Company's Common Stock on March 13, 1998, as
reported on the Nasdaq National Market was $7.00 per share. As of March 13,
1998, there were 126 holders of record of the Company's Common Stock.
In December 1993, August 1994 and April 1995, the Company paid cash
dividends (in the form of S corporation distributions) of $186,561, $2,500,000
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
Fiscal Year Ended Year Ended Ended
-------------------------- ------------------------- -------------
January 4 January 5 December 31 December 31 December 31
1998 1997(2)(3) 1995 1994(5) 1993(5)(6)
--------------------------------------------------------------------
(dollars in thousands, except per share data)
Statement of Income Data (1):
Revenues:
Rentals $ 220,787 $ 219,002 $ 130,353 $ 47,782 $ 21,133
Product sales 39,569 35,393 18,848 5,441 1,908
--------- --------- --------- --------- ---------
260,356 254,395 149,201 53,223 23,041
Operating costs and expenses:
Store operating expenses 134,141 124,456 67,758 24,119 11,891
Amortization of videocassette rental inventory 69,177 63,544 29,102 10,263 4,541
Amortization of intangibles 7,206 7,160 3,380 606 133
Cost of product sales 24,597 21,143 12,600 4,018 1,462
Special management bonus -- -- -- -- 560
General and administrative 17,006 20,266 13,525 5,647 2,024
Restructuring and other charges -- 9,595 -- -- --
--------- --------- --------- --------- ---------
Operating income 8,229 8,231 22,836 8,570 2,430
Non-operating income (expense):
Interest expense, net (6,326) (5,619) (1,528) (486) (458)
Other, net -- -- -- 58 49
--------- --------- --------- --------- ---------
Income before income taxes 1,903 2,612 21,308 8,142 2,021
Income taxes (7) 998 1,006 7,871 2,991 757
--------- --------- --------- --------- ---------
Net income $ 905 $ 1,606 $ 13,437 $ 5,151 $ 1,264
========= ========= ========= ========= =========
Basic earnings per share $ .07 $ .12 $ 1.14 $ .64 $ .19
========= ========= ========= ========= =========
Diluted earnings per share $ .07 $ .12 $ 1.11 $ .63 $ .19
========= ========= ========= ========= =========
Cash dividends declared per share $ -- $ -- $ -- $ .39 $ .04
========= =========
Shares used in computing earnings per share:
Basic 13,420 13,241 11,795 8,083 6,716
========= ========= ========= ========= ======
Diluted 13,421 13,368 12,153 8,152 6,716
========= ========= ========= ========= ======
Operating Data:
Number of stores at end of period (1) 856 863 750 352 108
Adjusted EBITDA (8) $ 25,568 $ 20,542 $ 8,766 $ 3,902 $ 757
Increase (decrease) in same-store revenues (9) 1.1% (1.0)% 0.0% 14.3% 13.7%
December 31
January 4 January 5 --------------------------------------
1998 1997 1995 1994 1993
-------------------------------------------------------------------
Balance Sheet Data(1):
Cash and cash equivalents $ 4,459 $ 3,982 $ 6,255 $ 3,723 $ 408
Videocassette rental inventory, net 92,183 89,929 72,979 27,138 7,455
Total assets 259,133 261,577 233,479 76,647 13,446
Long-term debt, less current maturities 63,479 67,883 19,622 6,681 4,104
Total liabilities 111,504 114,853 97,340 29,652 10,988
Stockholders' equity 147,629 146,724 136,139 46,995 2,458
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. 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) On July 1, 1996, the Company adopted a fiscal year ending on the first
Sunday following December 30, which periodically results in a fiscal year
of 53 weeks. The 1996 fiscal year, ended on January 5, 1997, reflects a 53-
week year.
(3) Includes a non-recurring charge of approximately $10.4 million for store
closures, corporate restructuring and merger-related expenses.
(4) 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.
(5) 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.
(6) 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.
(7) 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.
(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 years ended January 4, 1998 and
January 5, 1997 is $1.3 million and $5.7 million, respectively, 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
From August 1994 through July 1, 1996, the Company experienced rapid growth in
revenue and operating income primarily as a result of acquiring stores and
opening new stores. Since the fall of 1996, the Company has focused its efforts
on internally developed stores and on improving the operations of its existing
store base. The number of stores owned and operated by the Company at the end of
each of the following periods is as follows:
December 31, 1993 108
December 31, 1994 352
December 31, 1995 750
January 5, 1997 863
January 4, 1998 856
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 acquisitions of Home Vision and Hollywood
Video were consummated on July 1, 1996 and were 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 4, 1998 ("Fiscal 1997"), 50
stores were developed by the Company, two stores were acquired and 59 were
closed.
As a result of the 503 store acquisitions during the periods January 1, 1995
through January 4, 1998, the Company recorded $74.6 million in goodwill, which
is being amortized over twenty years from the effective date of each
acquisition. The Company also recorded an additional $9.8 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 that ends on the first Sunday
following December 30. This change results in the Company having a 52- or
53-week year. The year ended January 5, 1997 ("Fiscal 1996") was a 53-week year,
while Fiscal 1997 was a 52-week year.
Effective April 1, 1996, the Company changed its method of amortizing
videocassette rental inventory (which includes video games and audio books).
Under this 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 this 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 $2.3 million of costs were paid and charged
against the liability as of January 4, 1998. The store closures were
substantially completed by the end of Fiscal 1997. Additionally, during the
third quarter of Fiscal 1996 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 Hollywood Video had been taxed
as a C corporation for all periods presented. Historical operating results of
Hollywood Video do not include any provision for income taxes prior to July 1,
1996 due to their S corporation status prior to this date.
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.
Statement of Income Data:
52 Weeks 53 Weeks Year
Ended Ended Ended
-----------------------------------
January 4 January 5 December 31
1998 1997 1995
-----------------------------------
Revenues:
Rentals 84.8% 86.1% 87.4%
Product sales 15.2 13.9 12.6
----- ----- -----
100.0 100.0 100.0
Operating costs and expenses:
Store operating expenses 51.5 48.9 45.4
Amortization of videocassette rental inventory (1) 26.6 25.0 19.5
Amortization of intangibles 2.8 2.8 2.3
Cost of product sales 9.4 8.3 8.4
General and administrative 6.5 8.0 9.1
Restructuring and other charges -- 3.8 --
----- ----- -----
96.8 96.8 84.7
----- ----- -----
Operating income 3.2 3.2 15.3
Interest expense, net (2.5) (2.2) (1.0)
----- ----- -----
Income before income taxes 0.7 1.0 14.3
Income taxes (2) 0.4 0.4 5.3
----- ----- -----
Net income 0.3% 0.6% 9.0%
===== ===== =====
Number of stores at end of period 856 863 750
===== ===== =====
_________________________
(1) 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.
(2) The provision for income taxes includes pro forma adjustments to reflect
income tax expense which would have been recognized if Hollywood Video had
been taxed as a C corporation for all periods presented. Historical
operating results of Hollywood Video do not include any provision for
income taxes prior to July 1, 1996 due to its S corporation status prior to
this date.
19
Fiscal year ended January 4, 1998 compared to the fiscal year ended January 5,
1997
Revenue. Total revenue increased 2.3% to $260.4 million for Fiscal 1997
from $254.4 million for Fiscal 1996. The increase was due primarily to an
increase in same-store revenues of 1.1%, as well as the net positive effect of
closing lower volume stores while internally developing stores that have
generated revenue results greater than the closed stores. The increase in
same-store revenues was primarily a result of (i) the Company's emphasis in the
last half of Fiscal 1997 to increase the depth of copies of "hit titles" within
its store base, (ii) an increase in the game rental business due to the advent
and consumer acceptance of the Nintendo 64 and Sony Playstation game platforms
and (iii) a decrease in the number of competitive store openings, particularly
in the last half of Fiscal 1997. Product sales increased as a percentage of
total revenues to 15.2% for Fiscal 1997 from 13.9% for Fiscal 1996, as a result
of (i) the Company's continued and increased emphasis on the sale of previously
viewed rental inventory and (ii) 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
51.5% of total revenue for Fiscal 1997 from 48.9% for Fiscal 1996. The increase
in store operating expenses was primarily due to (i) strategic responses in the
Company's most competitive markets, which affected certain expenses, such as
labor hours used and advertising costs, (ii) the national minimum wage increases
that were implemented on September 1, 1996 and September 1, 1997, and (iii)
increases in rent in connection with the normal renewal of leases in existing
stores.
Amortization of videocassette rental inventory increased as a percentage of
revenue to 26.6% for Fiscal 1997 from 25.0% for Fiscal 1996 due primarily to (i)
a decision by the Company to increase its level of expenditures on rental
inventory during the fourth quarter of 1996 and the first half of 1997 in
response to industry-wide competitive issues, (ii) an increase in the depth of
hit new release titles purchased during the year, which results in more tapes
being substantially amortized over six months versus three years and (iii) a
marked increase in the quantity of new game release purchases, which is due to
the buildup of inventory related to the consumer acceptance of new game
platforms (i.e., Nintendo 64 and Sony Playstation).
Cost of product sales includes the costs of new videocassettes, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold in the Company's stores. Cost of product sales increased
with the increased revenue from product sales and increased as a percentage of
revenues from product sales from 59.7% for Fiscal 1996 to 62.2% for Fiscal 1997.
The decrease in product sales gross margins resulted primarily from (i) an
increase in new tape sales which carry lower margins than other sales items and
(ii) an effort by the Company to market more aggressively its new tape
inventory. These factors were offset, in part, by an increase in the sale of
previously viewed rental inventory, the unamortized value of which is expensed
to cost of product sales and generally generates higher margins than other
product categories.
General and administrative expenses decreased as a percentage of revenues from
8.0% for Fiscal 1996 to 6.5% for Fiscal 1997. 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 the efficiencies
gained from the leveraging of overhead associated with acquisition activity in
1996 and a reduction in corporate overhead over the past year.
As a result of the above, operating income was essentially flat at $8.2 million
in both Fiscal 1997 and Fiscal 1996. However, 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 in Fiscal 1996.
20
Fiscal 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 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 product sales includes the costs of new videocassettes, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold in the Company's stores. Cost of product sales increased
with the increased revenue from product sales and decreased as a 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.
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 in Fiscal 1996.
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 refurbishment, remodeling and relocation of existing
stores. 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 1997, the Company generated $25.6 million in Adjusted EBITDA
versus $20.5 million for Fiscal 1996. "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 1997 and
Fiscal 1996 are $1.3 million and $5.7 million, respectively, 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 $83.9 million for Fiscal 1997 as
compared to $91.8 million for Fiscal 1996. The decrease was primarily due to
lower net income, an increase in merchandise inventory during Fiscal 1997, a
decrease in accounts payable and other accrued liabilities during the same
period, as well as the Fiscal 1996 restructuring charge discussed above. These
factors are offset, in part, by higher depreciation and amortization in Fiscal
1997 versus Fiscal 1996.
Net cash used in investing activities was $83.2 million for Fiscal 1997 as
compared to $104.8 million for Fiscal 1996. This decrease in funds used for
investing activities is primarily the result of a decrease in the total cash
expended for acquired stores, rental inventory and property, furnishings and
equipment during Fiscal 1997 versus Fiscal 1996.
Net cash provided by financing activities was $10.7 million for Fiscal 1996 as
compared to net cash used by financing activities of $0.2 million for Fiscal
1997. This decrease was primarily the result of net borrowings remaining
unchanged during Fiscal 1997.
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 based on LIBOR plus an applicable margin percentage,
which depends on the Company's cash flow generation and borrowings outstanding.
The Company may repay the Facility at any time without penalty. The Facility has
covenants that restrict borrowing based upon cash flow levels. During 1997, the
Company voluntarily reduced the commitment to $90 million. At January 4, 1998,
$67 million was outstanding under the Facility and approximately $23 million of
the $90 million commitment was available for borrowing under the Facility.
The Company grows its store base through internally developed and acquired
stores and may require capital in excess of internally generated cash flow to
achieve its desired growth. 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 or shares of the Company's stock issued to
sellers. However, there can be no assurance that financing will be available to
the Company on terms which will be acceptable, if at all.
22
At January 4, 1998, the Company had a working capital deficit of $10.9 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 1998, 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.
Other Matters
The Company has performed an analysis of its operating systems to determine
systems' compatibility with the upcoming year 2000. Substantially all of the
Company's operating systems are year 2000 compliant, and the Company does not
believe that there will be any material exposure related to year 2000
compatibility.
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 1998
Annual Meeting of Stockholders, and is incorporated herein by reference.
23
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item will be contained in the Company's
definitive Proxy Statement for its 1998 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 1998 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 1998 Annual Meeting of Stockholders, and is
incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
Report of Ernst & Young LLP, Independent Auditors.
Consolidated Balance Sheets as of January 4, 1998 and January 5, 1997.
Consolidated Statements of Income for the Fiscal Years Ended January 4,
1998, January 5, 1997 and December 31, 1995.
Consolidated Statements of Stockholders' Equity for the Fiscal Years
Ended January 4, 1998, January 5, 1997 and December 31, 1995.
Consolidated Statements of Cash Flows for the Fiscal Years Ended January
4, 1998, January 5, 1997 and December 31, 1995.
Notes to Consolidated Financial Statements.
(a)(2) Schedules:
None.
24
(a)(3) Exhibits:
The following exhibits, which are furnished with this Annual Report or
incorporated herein by reference, are filed as part of this Annual Report:
Exhibit
No. Exhibit Description
- ------- -------------------
3.1 - Certificate of Incorporation of the Company. (1)
3.2 - Bylaws of the Company. (1)
4.1 - Specimen Common Stock Certificate. (2)
10.1 - 1994 Stock Option Plan, as amended and form of Stock Option
Agreement. (3)
10.2 - Form of Indemnity Agreement. (1)
10.3 - Employment Agreement between M.G.A., Inc. and Joe Thomas
Malugen. (1)
10.4 - Employment Agreement between M.G.A., Inc. and H. Harrison
Parrish. (1)
10.5 - Consulting Agreement between William B. Snow and M.G.A., Inc.
dated December 12, 1996. (3)
10.6 - Employment Agreement between M.G. A., Inc. and J. Steven Roy.
(filed herewith)
10.7 - Employment Agreement between M.G.A., Inc. and S. Page Todd.
(filed herewith)
10.8 - Employment Agreement between M.G.A., Inc. and Steven M. Hamil.
(filed herewith)
10.9 - 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. (4)
10.10 - Agreement dated March 13, 1997 between Sight & Sound
Distributors, Inc. and Movie Gallery, Inc. (3) (portions were
omitted pursuant to a request for confidential treatment)
10.11 - Agreement dated August 15, 1997 between Major Video Concepts, Inc.
and Movie Gallery, Inc. (5) (portions were omitted pursuant to a
request for confidential treatment)
10.12 - Real estate lease dated June 1, 1994 between J. T. Malugen, H.
Harrison Parrish and M.G.A., Inc. (1)
10.13 - Real estate lease dated June 1, 1994 between H. Harrison
Parrish and M.G.A., Inc. (1)
10.14 - Tax Agreement between M.G.A., Inc. and Joe T. Malugen and
Harrison Parrish. (1)
10.15 - 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). (6)
10.16 - Credit Agreement between First Union National Bank of North
Carolina and Movie Gallery, Inc. dated July 10, 1996. (4)
18 - Change in Accounting Principle. (7)
21 - List of Subsidiaries. (filed herewith)
23 - Consent of Ernst & Young LLP. (filed herewith)
27 - Financial Data Schedule (filed herewith)
27.1 - Financial Data Schedule - Restated for January 5, 1997
(filed herewith)
25
- --------------
(1) Previously filed with the Securities and Exchange Commission on June 10,
1994, as exhibits to the Company's Registration Statement on Form S-1 (File
No. 33-80120).
(2) Previously filed with the Securities and Exchange Commission on August 1,
1994, as an exhibit to Amendment No. 2 to the Company's Registration
Statement on Form S-1.
(3) Previously filed with the Securities and Exchange Commission on April 7,
1997, as an exhibit to the Company's Form 10-K for the fiscal year ended
January 5, 1997.
(4) Previously filed with the Securities and Exchange Commission on July 15,
1996, as an exhibit to the Company's Current Report on Form 8-K.
(5) Previously filed with the Securities and Exchange Commission on November
19, 1997 as an exhibit to the Company's Form 10-Q for the quarter ended
October 5, 1997.
(6) 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.
(7) 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 January 4, 1998.
(c) Exhibits:
See (a)(3) above.
26
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this annual report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
MOVIE GALLERY, INC.
By /s/JOE THOMAS MALUGEN
------------------------
Joe Thomas Malugen,
Chairman of the Board
and Chief Executive Officer
Date: April 6, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
annual report on Form 10-K has been signed below by the following persons on
behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date
- --------- ----- ----
/s/ JOE THOMAS MALUGEN Chairman of the Board and Chief April 6, 1998
- ------------------------ Executive Officer
Joe Thomas Malugen
/s/ WILLIAM B. SNOW Vice Chairman of the Board April 6, 1998
- ------------------------
William B. Snow
/s/ J. STEVEN ROY Executive Vice President and April 6, 1998
- ------------------------ Chief Financial Officer
J. Steven Roy
/s/ STEVEN M. HAMIL Senior Vice President and April 6, 1998
- ------------------------ Chief Accounting Officer
Steven M. Hamil
/s/ H. HARRISON PARRISH Director and President April 6, 1998
- ------------------------
H. Harrison Parrish
/s/ JOSEPH F. TROY Director April 6, 1998
- ------------------------
Joseph F. Troy
27
Movie Gallery, Inc.
Financial Statements
Fiscal years ended January 4, 1998, January 5, 1997 and December 31, 1995
Contents
Report of Ernst & Young LLP, Independent Auditors...........................F-1
Audited Financial Statements
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 Ernst & Young LLP, Independent Auditors
Board of Directors and Stockholders
Movie Gallery, Inc.
We have audited the accompanying consolidated balance sheets of Movie Gallery,
Inc. as of January 4, 1998 and January 5, 1997, and the related consolidated
statements of income, stockholders' equity and cash flows for the fiscal years
ended January 4, 1998, January 5, 1997 and December 31, 1995. 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 revenues
constituting 12% of the consolidated total in 1995. 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, 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, 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 January
4, 1998 and January 5, 1997, and the consolidated results of its operations and
its cash flows for the fiscal years ended January 4, 1998, January 5, 1997 and
December 31, 1995, 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, 1998, except for
Note 11 as to which the date
is March 19, 1998
F-1
Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)
January 4 January 5
1998 1997
--------------------
Assets
Current assets:
Cash and cash equivalents $ 4,459 $ 3,982
Merchandise inventory 13,512 10,737
Prepaid expenses 1,341 1,059
Store supplies and other 2,561 3,050
Deferred income taxes 531 913
-------- --------
Total current assets 22,404 19,741
Videocassette rental inventory, net 92,183 89,929
Property, furnishings and equipment, net 50,321 50,196
Deferred charges, net 8,940 11,151
Excess of cost over net assets acquired, net 83,381 87,822
Deposits and other assets 1,904 2,738
-------- --------
Total assets $259,133 $261,577
======== ========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 21,517 $ 24,321
Accrued liabilities 7,014 7,622
Current portion of long-term debt 4,751 374
-------- --------
Total current liabilities 33,282 32,317
Long-term debt 63,479 67,883
Other accrued liabilities 1,899 2,425
Deferred income taxes 12,844 12,228
Stockholders' equity:
Preferred stock, $.10 par value; 2,000,000 shares
authorized, no shares issued and outstanding -- --
Common stock, $.001 par value; 60,000,000 shares
authorized, 13,418,885 and 13,420,791 shares
issued and outstanding, respectively 13 13
Additional paid-in capital 131,686 131,686
Retained earnings 15,930 15,025
-------- --------
Total stockholders' equity 147,629 146,724
-------- --------
Total liabilities and stockholders' equity $259,133 $261,577
======== ========
See accompanying notes.
F-2
Movie Gallery, Inc.
Consolidated Statements of Income
(in thousands, except per share data)
Fiscal Year Ended
-------------------------------------
January 4 January 5 December 31
1998 1997 1995
-------------------------------------
Revenues:
Rentals $ 220,787 $ 219,002 $ 130,353
Product sales 39,569 35,393 18,848
--------- --------- ---------
260,356 254,395 149,201
Operating costs and expenses:
Store operating expenses 134,141 124,456 67,758
Amortization of videocassette rental inventory 69,177 63,544 29,102
Amortization of intangibles 7,206 7,160 3,380
Cost of product sales 24,597 21,143 12,600
General and administrative 17,006 20,266 13,525
Restructuring and other charges -- 9,595 --
--------- --------- ---------
Operating income 8,229 8,231 22,836
Interest income 45 99 539
Interest expense (6,371) (5,718) (2,067)
--------- --------- ---------
Income before income taxes 1,903 2,612 21,308
Income taxes 998 1,131 8,893
--------- --------- ---------
Net income $ 905 $ 1,481 $ 12,415
========= ========= =========
Basic and diluted earnings per share $ .07
=========
Pro forma earnings per share (unaudited):
Income before income taxes $ 2,612 $ 21,308
Pro forma income taxes 1,006 7,871
--------- ---------
Pro forma net income $ 1,606 $ 13,437
========= =========
Basic pro forma earnings per share $ .12 $ 1.14
========= =========
Diluted pro forma earnings per share $ .12 $ 1.11
========= =========
Weighted average shares outstanding (in thousands):
Basic 13,420 13,241 11,795
Diluted 13,421 13,368 12,153
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, 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
Other transactions by pooled companies -- (24) -- (24)
------ --------- --------- ---------
Balance at January 5, 1997 13 131,686 15,025 146,724
Net income -- -- 905 905
------ --------- --------- ---------
Balance at January 4, 1998 $ 13 $ 131,686 $ 15,930 $ 147,629
====== ========= ========= =========
See accompanying notes.
F-4
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(in thousands)
Fiscal Year Ended
-------------------------------------
January 4 January 5 December 31
1998 1997 1995
-------------------------------------
Operating activities
Net income $ 905 $ 1,481 $ 12,415
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 88,140 79,625 36,991
Deferred income taxes 998 822 7,428
Restructuring and other charges -- 9,595 --
Changes in operating assets and liabilities:
Merchandise inventory (3,493) 203 (4,987)
Other current assets 435 1,365 (1,621)
Deposits and other assets 834 (978) (1,567)
Accounts payable (2,804) (1,649) 9,609
Accrued liabilities (1,134) 1,336 3,003
--------- --------- ---------
Net cash provided by operating activities 83,881 91,800 61,271
Investing activities
Business acquisitions (474) (8,662) (83,403)
Purchases of videocassette rental inventory, net (70,801) (77,666) (51,061)
Purchases of property, furnishings and equipment (13,072) (18,438) (20,355)
Proceeds from disposal of equipment 1,170 -- --
--------- --------- ---------
Net cash used in investing activities (83,177) (104,766) (154,819)
Financing activities
Net proceeds from issuance of common stock -- 524 63,482
Net (payments on) proceeds from notes payable -- (32,052) 28,293
Proceeds from issuance of long-term debt -- 72,938 10,070
Principal payments on long-term debt (227) (30,717) (4,584)
Dividends paid -- -- (996)
--------- --------- ---------
Net cash (used in) provided by financing activities (227) 10,693 96,265
--------- --------- ---------
Increase (decrease) in cash and cash equivalents 477 (2,273) 2,717
Decrease in cash and cash equivalents to conform
fiscal year end of pooled companies -- -- (185)
Cash and cash equivalents at beginning of fiscal year 3,982 6,255 3,723
--------- --------- ---------
Cash and cash equivalents at end of fiscal year $ 4,459 $ 3,982 $ 6,255
========= ========= =========
Supplemental disclosures of cash flow
information
Cash paid during the period for interest $ 5,777 $ 5,377 $ 1,834
Cash paid during the period for income taxes -- 203 764
Noncash investing and financing information:
Assets acquired by issuance of notes payable 200 -- 10,012
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 4, 1998
1. Accounting Policies
The accompanying financial statements present the consolidated financial
position, results of operations and cash flows of Movie Gallery, Inc. and
subsidiaries (the "Company"). All material intercompany accounts and
transactions have been eliminated.
The Company'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 22 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. The Company's fiscal year includes
revenues and certain operating expenses, such as salaries, wages and other
miscellaneous expenses, on a daily basis. All other expenses, primarily
depreciation and amortization, are calculated and recorded monthly, with twelve
months included in each fiscal year.
Reclassifications
Certain reclassifications have been made to the prior year financial statements
to conform to the current year presentation. These reclassifications had no
impact on stockholders' equity or net income.
Cash Equivalents
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Merchandise Inventory
Merchandise inventory consists primarily of videocassette tapes, video
accessories and concessions and is stated at the lower of cost, on a first-in
first-out basis, or market.
Long-Lived Assets
During the first quarter of 1996, the Company adopted the provisions of
Financial Accounting Standards Board (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 intangible assets when indicators of impairment are present and
the undiscounted cash flows estimated to be generated by those assets are less
than the assets' 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.
F-6
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
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 this 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 its primary competitors.
The new method of amortization was 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 basic and diluted share.
Videocassette rental inventory consists of the following (in thousands):
January 4 January 5
1998 1997
--------- ---------
Videocassette rental inventory $ 175,922 $ 183,264
Less accumulated amortization (83,739) (93,335)
--------- ---------
$ 92,183 $ 89,929
========= =========
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.
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
4, 1998 and January 5, 1997 was $6,397,000 and $4,128,000, respectively.
Excess of Cost Over Net Assets Acquired
The excess of cost over net assets acquired at January 4, 1998 and January 5,
1997 is net of accumulated amortization of $11,864,000 and $7,111,000,
respectively, and is being amortized on a straight-line basis over twenty years.
F-7
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Income Taxes
The Company accounts for income taxes under the provisions of FASB Statement No.
109, "Accounting for Income Taxes." Under Statement 109, deferred tax assets and
liabilities are determined based upon differences between financial reporting
and tax bases of assets and liabilities and are measured at the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse.
Videocassette Rental Revenue
Rental revenue is recognized when the videocassette or video game is rented by
the customer.
Advertising Costs
Advertising costs, exclusive of cooperative reimbursements from vendors, are
expensed when incurred. Advertising costs were $728,000, $1,512,000 and $756,000
for the fiscal years ended January 4, 1998, January 5, 1997 and December 31,
1995, respectively.
Store Opening Costs
Store opening costs, which consist primarily of payroll and advertising, are
expensed as incurred.
Earnings Per Share
Effective January 4, 1998, the Company adopted Statement of Financial Accounting
Standards No. 128, "Earnings per Share." This statement is effective for fiscal
periods ending after December 15, 1997 and requires restatement of prior
periods' earnings per share data. Under this Statement the calculation of
primary and fully diluted earnings per share is replaced with basic and diluted
earnings per share and requires presentation of both amounts on the income
statement. Unlike primary earnings per share, basic earnings per share excludes
any dilutive effects of common stock equivalents. Diluted earnings per share is
similar to the previously reported fully diluted earnings per share. Adoption of
this Statement had no significant impact on earnings per share calculations for
any year presented.
Fair Value of Financial Instruments
At January 4, 1998 and January 5, 1997, 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
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.
F-8
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
1. Accounting Policies (continued)
Unaudited Pro Forma Information
Pro forma income taxes reflect income tax expense which would have been
recognized by the Company as a C corporation if the 1996 acquisition of
Hollywood Video had been consummated prior to January 1, 1995. Hollywood Video's
historical operating results do not include any provision for income taxes as
Hollywood Video was taxed as an S corporation for all periods prior to the
merger.
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.
The acquisitions 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 1995, Home Vision acquired various video specialty store
chains with an aggregate net purchase price of $5,509,000, including the
issuance of $689,000 in notes payable and 120,577 shares of common stock. The
excess of the cost over estimated fair value of the assets acquired was
$4,020,000.
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
statement of operations for the year ended September 30, 1995 is combined with
the statements of operations for the Company and Hollywood Video for the year
ended December 31, 1995. 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.
F-9
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
2. Acquisitions (continued)
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
1996 1995
---------------------------------
Revenues:
Movie Gallery $ 106,307 $ 123,143
Home Vision 11,191 18,024
Hollywood Video 5,307 8,034
--------- ---------
Combined $ 122,805 $ 149,201
========= =========
Net income (loss):
Movie Gallery $ 3,106 $ 14,486
Home Vision (97) (366)
Hollywood Video (986) (1,705)
--------- ---------
Combined $ 2,023 $ 12,415
========= =========
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, had occurred as of the beginning of the fiscal
year in which the acquisition occurred and the beginning of the immediately
preceding year (in thousands, except per share data):
Fiscal Year Ended
-------------------------
January 5 December 31
1997 1995
-------------------------
Revenues $261,223 $241,815
Net income 2,521 20,796
Earnings per share 0.19 1.61
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.
This analysis resulted in the Company recording a $9.6 million pretax
restructuring charge in the third quarter of 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.
The store closures were substantially completed by the end of fiscal year 1997.
Approximately $2.3 million of restructuring costs were paid and charged against
the liability as of January 4, 1998. The stores identified for closure had
revenues and operating losses of approximately $0.8 million and $0.4 million,
F-10
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
3. Provision for Business Restructuring (continued)
respectively, for the fiscal year ended January 4, 1998; $6.2 million and $1.6
million, respectively, for the fiscal year ended January 5, 1997; and
approximately $4.5 million and $0.2 million, respectively, for the fiscal year
ended December 31, 1995. Results for 1996 and 1995 include all stores identified
for closure under the restructuring plan while results for 1997 include only
those stores under the plan which had not been closed as of the beginning of the
fiscal year 1997.
4. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
January 4 January 5
1998 1997
------------------------
Land and buildings $ 1,879 $ 1,879
Furniture and fixtures 29,030 26,932
Equipment 23,516 18,963
Leasehold improvements and signs 22,339 18,766
-------- --------
76,764 66,540
Accumulated depreciation (26,443) (16,344)
-------- --------
$ 50,321 $ 50,196
======== ========
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, originally provided
borrowings for up to $125 million and replaced the Company's previously existing
line of credit agreement. During 1997, the Company voluntarily reduced the
commitment to $90 million. In addition, during the fourth quarter of 1997 the
Company amended the Facility, primarily by increasing certain debt covenants, to
allow greater borrowing flexibility for the Company.
The available amount of the Facility will reduce quarterly beginning March 31,
1998, with a final maturity of June 30, 2000. The interest rate of the Facility
(8.4% at January 4, 1998) is based on LIBOR plus an applicable margin
percentage, which depends on the Company's cash flow generation and borrowings
outstanding. The Company may repay the Facility at any time without penalty. The
more restrictive covenants of the Facility restrict borrowings based upon cash
flow levels. At January 4, 1998, $67 million was outstanding and approximately
$23 million was available for borrowing under the Facility. Based on the amount
outstanding at January 4, 1998, scheduled maturities of the Facility are $4
million in 1998, $40.5 million in 1999 and $22.5 million in 2000.
The Company has entered into an interest rate swap agreement with a commercial
bank which effectively fixes the Company's interest rate exposure on $37 million
of the amount outstanding under the Facility at 6.22% plus an applicable margin
percentage. The interest rate swap reduces the risk of increases in interest
rates during the remaining life of the Facility. The Company accounts for its
interest rate swap as a hedge of its debt obligation. The Company pays a fixed
rate of interest and receives payment based on a variable rate of interest. The
difference in amounts paid and received under the contract is accrued and
recognized as an adjustment to interest expense on the debt. There are no
termination penalties associated with the interest rate swap agreement; however,
if the swap agreement was terminated at the Company's option, the Company would
either pay or receive the present value of the remaining hedge payments at the
F-11
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
5. Long Term Debt (continued)
then prevailing interest rates for the time to maturity of the swap agreement.
The interest rate swap agreement terminates at the time the Facility matures.
In connection with certain acquisitions, the Company issued or assumed notes
payable which had outstanding balances of $1,230,000 and $1,257,000 at Janaury
4, 1998 and January 5, 1997, respectively. Generally, these notes are unsecured,
require monthly or annual payments and have fixed or variable interest rates
ranging from 6% to 9%. Scheduled maturities of long-term debt are as follows:
$751,000 in 1998, $248,000 in 1999 and $231,000 in 2000.
6. Income Taxes
The following reflects actual income tax expense incurred for the fiscal year
ended January 4, 1998 and unaudited pro forma income tax expense that the
Company would have incurred had Hollywood Video (see Note 1) been subject to
federal and state income taxes for the entire fiscal years ended Janaury 5, 1997
and December 31, 1995 (in thousands):
Fiscal Year Ended
-----------------------------------------------
January 4 January 5 December 31
1998 1997 1995
-----------------------------------------------
(unaudited pro forma information)
Current payable:
Federal $ -- $ 90 $1,328
State -- -- 136
------ ------ ------
Total current -- 90 1,464
Deferred:
Federal 903 831 5,692
State 95 85 715
------ ------ ------
Total deferred 998 916 6,407
------ ------ ------
$ 998 $1,006 $7,871
====== ====== ======
A reconciliation of income tax at the federal income tax rate to the Company's
effective income tax provision is as follows (in thousands):
Fiscal Year Ended
-------------------------------------------
January 4 January 5 December 31
1998 1997 1995
-------------------------------------------
(unaudited pro forma information)
Income tax at statutory rate $ 647 $ 888 $7,245
State income taxes, net of federal
income tax benefit 63 85 615
Other, net (primarily goodwill not
deductible for tax purposes) 288 33 11
------ ------ ------
$ 998 $1,006 $7,871
====== ====== ======
F-12
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
6. Income Taxes (continued)
At January 5, 1997, the Company had net operating loss carryforwards of
$21,116,000 for income taxes that expire in years 2010 through 2012. $5,410,000
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. The Company has not
recorded a valuation allowance related to its deferred tax assets as management
considers it more likely than not that available tax strategies and future
taxable income will allow the deferred tax assets to be realized.
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 4 January 5
1998 1997
-----------------------
Deferred tax liabilities:
Videocassette rental inventory $17,800 $14,847
Furnishings and equipment 5,340 4,286
Excess of cost over fair value of assets acquired 1,864 1,519
Other 1,214 694
------- -------
Total deferred tax liabilities 26,218 21,346
Deferred tax assets:
Non-compete agreements 4,522 4,318
Net operating loss carryforwards 7,870 3,527
Accrued liabilities 1,493 1,911
Alternative minimum tax credit carryforward 20 275
------- -------
Total deferred tax assets 13,905 10,031
------- -------
Net deferred tax liabilities $12,313 $11,315
======= =======
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 4, 1998, common stock of approximately
$83,000,000 was available to be issued from this registration.
As of January 4, 1998 and 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.
F-13
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
Earnings Per Share
Basic earnings per share and basic pro forma earnings per share are computed
based on the weighted average number of shares of common stock outstanding
during the periods presented. Diluted earnings per share and diluted pro forma
earnings per share are computed based on the weighted average number of shares
of common stock outstanding during the periods presented, increased solely by
the effects of shares to be issued from the exercise of dilutive common stock
options (1,000, 127,000 and 358,000 for the fiscal years ended January 4, 1998,
January 5, 1997 and December 31, 1995, respectively). No adjustments were made
to net income or pro forma net income in the computation of basic or diluted
earnings per share.
Stock Option Plan
In July 1994, the Board of Directors adopted, and the stockholders of the
Company approved, the 1994 Stock Option Plan (the "Plan"). The Plan provides for
the award of incentive stock options, stock appreciation rights, bonus rights
and other incentive grants to employees, independent contractors and
consultants. During 1997, the Company increased the shares reserved for issuance
under the Plan from 1,750,000 to 2,250,000. Options granted under the Plan have
a 10-year term and generally vest over 3 to 5 years.
In October 1995, the FASB issued Statement of Accounting Standards No. 123,
"Accounting for Stock-Based Compensation." In accordance with the provisions of
Statement 123, the Company applies Accounting Principles Board Opinion No. 25
and related Interpretations in accounting for its stock option plan and,
accordingly, has not recognized compensation cost in connection with the Plan.
If the Company had elected to recognize compensation cost based on the fair
value of the options granted at grant date as prescribed by Statement 123, net
income and earnings per share (pro forma amounts for fiscal years 1996 and 1995)
would have been reduced to the pro forma amounts indicated in the table below.
The effect on net income and earnings per share is not expected to be indicative
of the effects on net income and earnings per share in future years.
Fiscal Year Ended
-------------------------------------
January 4 January 5 December 31
1998 1997 1995
-------------------------------------
(in thousands, except per share data)
Pro forma net income (loss) $ (890) $ 218 $ 11,220
Pro forma earnings (loss) per share:
Basic (.07) .02 .95
Diluted (.07) .02 .92
The fair value of each option grant was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted-average
assumptions:
Fiscal Year Ended
-----------------------------------
January 4 January 5 December 31
1998 1997 1995
-----------------------------------
Expected volatility 0.649 0.607 0.607
Risk-free interest rate 6.28% 6.34% 6.50%
Expected life of option in years 6.0 6.0 6.0
Expected dividend yield 0.0% 0.0% 0.0%
F-14
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
7. Stockholders' Equity (continued)
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
detailed below. During 1997, the Company modified 505,100 stock options with
exercise prices ranging from $6.00 to $42.63 by cancelling the stock options and
issuing 378,827 new stock options at an exercise price of $3.88. This
modification excluded directors and certain executive senior management.
Fiscal Year Ended
--------------------------------------------------------------------------------------------------
January 4, 1998 January 5, 1997 December 31, 1995
--------------------------------------------------------------------------------------------------
Weighted-Average Weighted-Average Weighted-Average
Options Exercise Price Options Exercise Price Options Exercise Price
------- ---------------- ------- --------------- ------- ----------------
Outstanding-beginning
of year 1,318,650 $ 21.98 1,107,450 $ 24.63 699,000 $ 14.88
Granted 1,256,087 4.04 379,500 14.15 578,000 34.19
Exercised -- -- 35,100 14.92 129,000 14.21
Forfeited 679,200 20.50 133,200 23.58 40,550 25.94
Outstanding-end of year 1,895,537 10.62 1,318,650 21.98 1,107,450 24.63
Exercisable at end of year 916,908 14.43 622,125 21.28 424,150 20.41
Weighted-average fair value
of options granted during
the year $ 2.62 $ 8.84 $ 21.39
Options outstanding as of January 4, 1998 had a weighted-average remaining
contractual life of 8.9 years and exercise prices ranging from $3.00 to $42.63
as follows:
Exercise price of
$3.00 to $6.00 $14.00 to $22.00 $24.00 to $43.00
----------------------------------------------------
Options outstanding 1,208,587 411,350 275,600
Weighted-average exercise price $3.97 $15.08 $33.17
Weighted-average remaining contractual life 9.7 years 7.3 years 7.4 years
Options exercisable 374,858 342,550 199,500
Weighted-average exercise price of
exercisable options $4.25 $15.09 $32.41
F-15
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (continued)
8. Commitments and Contingencies
Rent expense for the fiscal years ended January 4, 1998, January 5, 1997 and
December 31, 1995 totaled $40,788,000, $37,266,000 and $19,960,000,
respectively. Future minimum payments under noncancellable operating leases
which contain renewal options and escalation clauses with remaining terms in
excess of one year consisted of the following at January 4, 1998 (in thousands):
1998 $ 28,418
1999 24,851
2000 15,926
2001 8,503
2002 5,841
Thereafter 10,223
--------
$ 93,762
========
The Company has an agreement with Rentrak Corporation which requires the Company
to order videocassette rental inventory under lease sufficient to require an
aggregate minimum payment of $4,000,000 per year in revenue share, handling
fees, sell through fees and end-of-term buyout fees. The agreement expires in
2006. The Company met its minimum purchase requirement in 1997.
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 year ended December 31, 1995, the Company purchased signs totaling
$1,683,000 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 $78,000, $260,000 and $650,000 in legal fees for the fiscal
years ended January 4, 1998, January 5, 1997 and December 31, 1995,
respectively, to a law firm of which one of the Company's directors is a member.
F-16
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). Earnings per share amounts for 1996 and the
first three quarters of 1997 have been restated to comply with Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (see Note 1).
Thirteen Weeks Ended
---------------------------------------------------
April 6 July 6 October 5 January 4
1997 1997 1997 1998
----------------------------------------------------
Revenue $65,678 $61,328 $62,560 $70,790
Operating income (loss) 4,716 (233) (901) 4,647
Net income (loss) 1,996 (1,203) (1,669) 1,781
Basic and diluted earnings (loss)
per share .15 (.09) (.12) .13
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
Basic and diluted pro forma
earnings (loss) per share .39 (.21) (.33) .28
11. Subsequent Events
The Company was engaged in litigation proceedings with certain former
shareholders of Home Vision in connection with the merger of the Company and
Home Vision in July 1996. These shareholders ultimately sought damages in excess
of $10 million plus costs. On March 19, 1998, the Company received a jury
verdict in its favor with respect to all claims brought against it and does not
expect to pay any monetary damages associated with this case.
F-17
Index to Exhibits
Exhibit No. Description
10.6 Employment Agreement between M.G.A., Inc. and J. Steven Roy.
10.7 Employment Agreement between M.G.A., Inc. and S. Page Todd.
10.8 Employment Agreement between M.G.A., Inc. and Steven M. Hamil.
21 List of Subsidiaries.
23 Consent of Ernst & Young LLP.
27 Financial Data Schedule.
27.1 Financial Data Schedule - Restated for January 5, 1997.