UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended October 4, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For The Transition Period From___________ to__________
Commission file number 0-24548
Movie Gallery, Inc.
(Exact name of registrant as specified in its charter)
Delaware 63-1120122
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
739 West Main Street, Dothan, Alabama 36301
(Address of principal executive offices) (Zip Code)
(334) 677-2108
(Registrant's telephone number, including area code)
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 number of shares outstanding of the registrant's common stock as of November
12, 1998 was 13,427,980.
<PAGE>
Movie Gallery, Inc.
Index
Part I. Financial Information
Item 1. Consolidated Financial Statements (Unaudited)
Consolidated Balance Sheets - October 4, 1998 and January 4, 1998.............1
Consolidated Statements of Operations - Thirteen weeks and
thirty-nine weeks ended October 4, 1998 and October 5, 1997...................2
Consolidated Statements of Cash Flows - Thirty-nine weeks
ended October 4, 1998 and October 5, 1997.....................................3
Notes to Consolidated Financial Statements - October 4, 1998..................4
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition.........................................6
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K....................................11
<PAGE>
Movie Gallery, Inc.
Consolidated Balance Sheets
(in thousands)
<TABLE>
<CAPTION>
October 4, January 4,
1998 1998
--------- ---------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 1,201 $ 4,459
Merchandise inventory 11,010 13,512
Prepaid expenses 1,267 1,341
Store supplies and other 3,438 2,561
Deferred income taxes 273 531
--------- ---------
Total current assets 17,189 22,404
Videocassette rental inventory, net 44,423 92,183
Property, furnishings and equipment, net 44,973 50,321
Goodwill and other intangibles, net 87,086 92,321
Deposits and other assets 1,917 1,904
Deferred income taxes 2,735 --
--------- ---------
Total assets $ 198,323 $ 259,133
========= =========
Liabilities and stockholders' equity
Current liabilities:
Accounts payable $ 18,894 $ 21,517
Accrued liabilities 6,402 7,014
Current portion of long-term debt 6,074 4,751
--------- ---------
Total current liabilities 31,370 33,282
Long-term debt 45,631 63,479
Other accrued liabilities 881 1,899
Deferred income taxes -- 12,844
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, 13,425,530 and 13,418,885
shares issued and outstanding, respectively 13 13
Additional paid-in capital 131,712 131,686
Retained earnings (deficit) (10,789) 15,930
Treasury stock (115,200 shares) (495) --
--------- ---------
Total stockholders' equity 120,441 147,629
--------- ---------
Total liabilities and stockholders' equity $ 198,323 $ 259,133
========= =========
See accompanying notes.
</TABLE>
1
<PAGE>
Movie Gallery, Inc.
Consolidated Statements of Operations
(Unaudited)
(in thousands, except per share data)
<TABLE>
<CAPTION>
Thirteen weeks ended Thirty-nine weeks ended
October 4, October 5, October 4, October 5,
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenues:
Rentals $ 53,104 $ 53,776 $ 166,127 $ 161,404
Product sales 11,293 8,784 32,423 28,162
--------- --------- --------- ---------
64,397 62,560 198,550 189,566
Operating costs and expenses:
Store operating expenses 35,190 33,939 103,581 99,953
Amortization of videocassette
rental inventory 58,066 17,593 92,462 51,169
Amortization of intangibles 1,741 1,739 5,235 5,275
Cost of product sales 7,790 5,762 21,987 17,028
General and administrative 4,579 4,428 13,146 12,559
--------- --------- --------- ---------
Operating income (loss) (42,969) (901) (37,861) 3,582
Interest expense, net (1,211) (1,590) (4,179) (4,632)
--------- --------- --------- ---------
Loss before income taxes (44,180) (2,491) (42,040) (1,050)
Income taxes (16,134) (822) (15,321) (174)
--------- --------- --------- ---------
Net loss $ (28,046) $ (1,669) $ (26,719) $ (876)
========= ========= ========= =========
Basic and diluted loss per share $ (2.09) $ (.12) $ (1.99) $ (.07)
========= ========= ========= =========
Weighted average shares outstanding -
basic and diluted 13,424 13,419 13,421 13,420
========= ========= ========= =========
See accompanying notes.
</TABLE>
2
<PAGE>
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)
<TABLE>
<CAPTION>
Thirty-nine weeks ended
October 4, October 5,
1998 1997
--------- ---------
<S> <C> <C>
Operating activities
Net loss $ (26,719) $ (876)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation and amortization 107,207 64,601
Deferred income taxes (15,321) (174)
Changes in operating assets and liabilities:
Merchandise inventory 2,502 (3,091)
Other current assets (803) (404)
Deposits and other assets (13) 497
Accounts payable (2,623) (1,987)
Accrued liabilities (1,630) (610)
--------- ---------
Net cash provided by operating activities 62,600 57,956
Investing activities
Business acquisitions -- (262)
Purchases of videocassette rental inventory, net (44,702) (55,071)
Purchases of property, furnishings and equipment (4,162) (10,688)
--------- ---------
Net cash used in investing activities (48,864) (66,021)
Financing activities
Net proceeds from issuance of common stock 26 --
Purchases of treasury stock (495) --
Payments on notes payable (200) --
Proceeds from issuance of long-term debt -- 5,400
Principal payments on long-term debt (16,325) (180)
--------- ---------
Net cash (used in) provided by financing activities (16,994) 5,220
--------- ---------
Decrease in cash and cash equivalents (3,258) (2,845)
Cash and cash equivalents at beginning of period 4,459 3,982
--------- ---------
Cash and cash equivalents at end of period $ 1,201 $ 1,137
========= =========
See accompanying notes.
</TABLE>
3
<PAGE>
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (Unaudited)
October 4, 1998
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, the financial statements do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the thirty-nine week
period ended October 4, 1998 are not necessarily indicative of the results that
may be expected for the fiscal year ended January 3, 1999. For further
information, refer to the consolidated financial statements and footnotes
thereto included in Movie Gallery, Inc.'s annual report on Form 10-K for the
fiscal year ended January 4, 1998.
2. Videocassette Rental Inventory
Effective July 6, 1998, the Company changed its method of amortizing
videocassette and video game rental inventory. This new method accelerates the
rate of amortization and has been adopted as a result of an industry trend
towards significant increases in copy-depth availability from Hollywood studios,
which have resulted in earlier satisfaction of consumer demand, thereby,
accelerating the rate of revenue recognition. Under the new method, the cost of
base stock videocassettes, consisting of two copies per title for each store, is
amortized on an accelerated basis to a net book value of $8 over six months and
to a $4 salvage value over the next thirty months. The cost of non-base stock
videocassettes, consisting of the third and succeeding copies of each title per
store, is amortized on an accelerated basis over six months to a net book value
of $4 which is then amortized on a straight-line basis over the next 30 months
or until the videocassette is sold, at which time the unamortized book value is
charged to cost of sales. Video games are amortized on a straight-line basis to
a $10 salvage value over eighteen months. The Company will continue to expense
revenue sharing payments as revenues are earned pursuant to contractual
arrangements.
The new method of amortization has been applied to all inventory held at July 6,
1998. 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 and video game rental
inventory decreased rental inventory and increased depreciation expense for the
quarter ended October 4, 1998 by approximately $43.6 million and increased the
net loss and the loss per diluted share by $27.7 million and $2.06,
respectively.
Prior to July 6, 1998, videocassette rental inventory (including video games)
was recorded at cost and amortized over its economic useful life. Videocassettes
considered to be base stock were amortized over thirty-six months on a
straight-line basis to a $5 salvage value. New release videocassettes were
amortized as follows: (i) the fourth and any succeeding copies of each title per
store were amortized on a straight-line basis over six months to an average net
book value of $5 which was then amortized on a straight-line basis over the next
thirty months or until the videocassette was sold, at which time the unamortized
book value was charged to cost of sales and (ii) copies one through three of
each title per store were amortized as base stock.
4
<PAGE>
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (Unaudited)(continued)
3. Financing Obligations
The Company has a Credit Agreement with First Union National Bank of North
Carolina with respect to a reducing revolving credit facility (the "Facility").
At October 4, 1998, $51.0 million was outstanding and $18.8 million was
available for borrowing under the Facility. The available amount of the Facility
reduces quarterly with a final maturity 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 more restrictive
covenants of the Facility restrict borrowings based upon cash flow levels.
Currently, the Company is in default of a minimum net worth covenant in the
Facility as a result of the $27.7 million after-tax charge associated with the
change in amortization policy. The Company has obtained a temporary waiver of
this covenant and is currently in negotiations to refinance the existing
Facility.
4. 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 period presented.
Basic earnings per share is computed based on the weighted average number of
shares of common stock outstanding during the periods presented. Diluted
earnings per share is 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 (none for the thirteen weeks and thirty-nine weeks ended October 4, 1998
and October 5, 1997). No adjustments were made to net loss in the computation of
basic or diluted earnings per share.
5. Recently Issued Accounting Standard
In April 1998, the AICPA issued Statement of Position (SOP) 98-5, "Reporting the
Costs of Start-up Activities". The SOP is effective for the Company beginning on
January 4, 1999, and requires that start-up costs capitalized prior to January
4, 1999 be written-off and any future start-up costs to be expensed as incurred.
The unamortized balance of start-up costs as of January 3, 1998 will be written
off as a cumulative effect of an accounting change as of January 4, 1999. The
impact of adopting this SOP has not yet been determined.
5
<PAGE>
Movie Gallery, Inc.
Management's Discussion and Analysis of Results of Operations
and Financial Condition
The following table sets forth, for the periods indicated, statement of
operations data expressed as a percentage of total revenue, the percentage
increase or decrease from the comparable period and the number of stores open at
the end of each period.
<TABLE>
<CAPTION>
Thirteen weeks ended Thirty-nine weeks ended
------------------------------------ -----------------------------------
October 4, October 5, Increase October 4, October 5, Increase
1998 1997 (Decrease) 1998 1997 (Decrease)
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Rentals 82.5% 86.0% (3.5)% 83.7% 85.1% (1.4)%
Product sales 17.5 14.0 3.5 16.3 14.9 1.4
-------- -------- -------- -------- -------- --------
100.0 100.0 -- 100.0 100.0 --
Operating costs and expenses:
Store operating expenses 54.6 54.2 0.4 52.2 52.7 (0.5)
Amortization of rental inventory:
Recurring 22.5 28.1 (5.6) 24.6 27.0 (2.4)
Policy change 67.7 -- 67.7 22.0 -- 22.0
Amortization of intangibles 2.7 2.8 (0.1) 2.6 2.8 (0.2)
Cost of product sales 12.1 9.2 2.9 11.1 9.0 2.1
General and administrative 7.1 7.1 -- 6.6 6.6 --
-------- -------- -------- -------- -------- --------
Total 166.7 101.4 65.3 119.1 98.1 21.0
-------- -------- -------- -------- -------- --------
Operating income (loss) (66.7) (1.4) (65.3) (19.1) 1.9 (21.0)
Interest expense, net (1.9) (2.6) 0.7 (2.1) (2.5) 0.4
-------- -------- -------- -------- -------- --------
Loss before income taxes (68.6) (4.0) (64.6) (21.2) (0.6) (20.6)
Income taxes (25.0) (1.3) (23.7) (7.7) (0.1) (7.6)
-------- -------- -------- -------- -------- --------
Net loss (43.6)% (2.7)% (40.9)% (13.5)% (0.5)% (13.0)%
======== ======== ======== ======== ======== ========
Adjusted EBITDA 5,979 3,624 2,355 25,376 14,250 11,126
======== ======== ======== ======== ======== ========
Number of stores open at end of period 834 856 (22) 834 856 (22)
======== ======== ======== ======== ======== ========
</TABLE>
For the thirteen weeks and thirty-nine weeks ended October 4, 1998, revenues
were $64.4 million and $198.6 million, respectively, increases of 2.9% and 4.7%
over the comparable periods in 1997. The increase was due to an increase in
same-store sales of 4.6% and 5.5% for the thirteen week and thirty-nine week
periods, respectively, partially offset by fewer stores in operation during 1998
versus 1997. The increase in same-store sales for the third quarter and
year-to-date period of 1998 was the result of (i) an increase in the number of
copies of new release videocassettes available to customers as a result of
copy-depth initiatives, including revenue sharing programs and other depth of
copy programs available from Hollywood studios; (ii) an increase in the game
rental business due to both increasing consumer acceptance of the Nintendo 64
and Sony Playstation game platforms and an increase in the number of game titles
available for these platforms; (iii) the release of "Titanic", the largest box
office movie of all time; and (iv) successful, chain-wide internal marketing
programs designed to generate more consumer excitement and traffic in the
Company's base of stores.
6
<PAGE>
Movie Gallery, Inc.
Management's Discussion and Analysis of Results of Operations
and Financial Condition (continued)
Product sales as a percentage of total revenue for the thirteen weeks and
thirty-nine weeks ended October 4, 1998 were 17.5% and 16.3%, respectively,
compared to 14.0% and 14.9% for the comparable periods in 1997, respectively.
This increase for the thirty-nine weeks ended October 4, 1998 was primarily the
result of (i) the Company's increasing sale of previously viewed rental
inventory due, in part, to greater quantities of rental product available to
consumers; and (ii) the impact of the release of "Titanic", for which the
Company sold more quantities of than any other sell-through priced title in its
history.
Store operating expenses, which reflect direct store expenses such as lease
payments and in-store payroll, increased as a percentage of revenues to 54.6%
from 54.2% for the thirteen weeks ended October 4, 1998 and October 5, 1997,
respectively, and decreased as a percentage of revenues to 52.2% from 52.7% for
the thirty-nine weeks ended October 4, 1998 and October 5, 1997, respectively.
The changes in store operating expenses as a percentage of revenues for the
third quarter and year-to-date period of 1998 versus 1997 were primarily due to
(i) an increase in revenue sharing expense of approximately $1.2 million and
$2.9 million for the quarter and year-to-date period ended October 4, 1998,
respectively, versus the comparable periods in fiscal year 1997; (ii) increases
in store level costs of approximately $400,000 and $800,000 for the third
quarter and year-to-date period in 1998, respectively, due to the implementation
of the Company's Operation: Excellence program, a program designed to elevate
the standards of customer service and store presentation throughout the
Company's store base; and (iii) same-store sales increases.
Effective July 6, 1998, the Company changed its amortization policy for rental
inventory, which was accounted for as a change in accounting estimate effected
by a change in accounting principle. The change resulted in a non-recurring,
non-cash, pre-tax charge of $43.6 million. The major impetus for the change in
amortization policy is the changing purchasing economics within the industry,
which have resulted in a significant increase in new release videos available
for rental. While revenue sharing agreements and other copy-depth initiatives
have increased customer satisfaction and driven increased rental revenue, the
overall demand for each new release is satisfied sooner. In order to match more
accurately the valuation of tape inventory with accelerated consumer demand, the
Company has changed its amortization policy for rental inventory.
Amortization of videocassette rental inventory for the third quarter and the
year-to-date period ended October 4, 1998 was 22.5% and 24.6% of revenue,
excluding the non-recurring charge related to the change in amortization policy.
Both percentages declined from the comparable periods in 1997. Amortization of
videocassette rental inventory for all periods ending prior to July 6, 1998, was
calculated under the previous policy described in Note 2 of the "Notes to
Consolidated Financial Statements." Significantly reduced tape purchase dollars
in 1998 versus 1997, an increased use of revenue sharing, as well as the
same-store sales increases in the current year, are the main reasons that the
amortization of inventory as a percentage of revenue in 1998 has declined versus
1997.
Cost of product sales includes the costs of new videocassettes, confectionery
items and other goods, as well as the unamortized value of previously viewed
rental inventory sold in the Company's stores. Cost of product sales increased
with the increased revenue from product sales and increased as a percentage of
revenues from product sales from 65.6% and 60.5% for the third quarter and
year-to-date period of 1997, respectively, to 69.0% and 67.8% for the third
quarter and year-to-date period of 1998, respectively. The decrease in product
sales gross margins resulted primarily from (i) an intense effort by the Company
to reduce inventory levels through discounts on selected inventory during the
first half of 1998; and (ii) the negative impact of "Titanic", which the Company
sold at a below average profit margin and for which the Company sold more units
of than any sell-through priced title in its history.
7
<PAGE>
Movie Gallery, Inc.
Management's Discussion and Analysis of Results of Operations
and Financial Condition (continued)
Net interest expense as a percentage of revenues decreased to 1.9% and 2.1% for
the third quarter and year-to-date period of 1998 from 2.6% and 2.5% for the
third quarter and year-to-date period of 1997, respectively. These decreases
were due primarily to lower total debt outstanding in 1998 versus 1997.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's primary capital needs have been for opening and
acquiring new stores and for the purchase of videocassette inventory. Other
capital needs include the remodeling of existing stores, the relocation of
existing stores and the continued maintenance and upgrading of the Company's
management information systems. The Company has funded inventory purchases,
remodeling and relocation programs, new store opening costs and acquisitions
primarily from cash flow from operations, the proceeds of two public equity
offerings, loans under revolving credit facilities and seller financing.
During the thirty-nine weeks ended October 4, 1998, the Company generated $25.4
million in Adjusted EBITDA versus $14.3 million for the comparable period in
1997, an increase of approximately 78.0%. The increase in Adjusted EBITDA is
attributable primarily to the same-store sales increase of 5.5% and the
Company's leveraging of rental inventory purchases in the first three quarters
of 1998 versus the comparable periods in 1997. "Adjusted EBITDA" is earnings
before interest, taxes, depreciation and amortization, less the Company's
purchase of videocassette rental inventory which excludes 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 growth.
Net cash provided by operating activities was $62.6 million for the thirty-nine
weeks ended October 4, 1998 as compared to $58.0 million for the comparable
period in 1997. The increase was primarily due to (i) an increase in net income
before the $27.7 million non-cash, after-tax charge for the change in
amortization policy; and (ii) a decrease in merchandise inventory, offset in
part by a decrease in accounts payable and other accrued liabilities. Over the
past three quarters, the Company's merchandise inventory and accounts payable
have been reduced by 18.5% and 12.2%, respectively. Some of these decreases are
associated with seasonal changes; however, much of the merchandise inventory
reduction is attributable to the Company attempting to reduce and refine its
sell-through inventory presentation by selling older, less-attractive titles to
consumers at a discount and replacing this merchandise with fewer, more
attractive product offerings. The accounts payable decrease is due both to
seasonality as well as the fact that the Company has lowered its overall tape
purchases versus a year ago through copy depth initiatives and revenue sharing,
which has lowered its outstanding payables amount at quarter end.
Net cash used in investing activities was $48.9 million for the thirty-nine
weeks ended October 4, 1998 as compared to $66.0 million for the comparable
period in 1997, primarily as a result of a decrease in the expenditures of
capital for both videocassette rental inventory and property, furnishings and
equipment.
8
<PAGE>
Movie Gallery, Inc.
Management's Discussion and Analysis of Results of Operations
and Financial Condition (continued)
Net cash used in financing activities was $17.0 million for the thirty-nine
weeks ended October 4, 1998 as compared to net cash provided by financing
activities of $5.2 million for the comparable period in 1997. This change
resulted directly from the Company's improved Adjusted EBITDA performance that
allowed the Company to decrease its debt outstanding during the first three
quarters of 1998 versus an increase in debt in the comparable period of the
prior year.
The Company has a Credit Agreement with First Union National Bank of North
Carolina ("First Union") with respect to a reducing revolving credit facility
(the "Facility"). At October 4, 1998, $51.0 million was outstanding and $18.8
million was available for borrowing under the Facility. The available amount of
the Facility reduces quarterly with a final maturity 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
more restrictive covenants of the Facility restrict borrowings based upon cash
flow levels.
The Company was in default of a minimum net worth covenant in the Facility as a
result of the $27.7 million after-tax charge associated with the change in
amortization policy. The Company has obtained a temporary waiver of this
covenant. In addition, the Company is currently working with First Union to
refinance its existing facility. The contemplated new credit facility would be
an $85 million senior credit facility with a three-year maturity and which would
have covenants similar in type to the Company's existing facility. There can be
no assurance that the Company will be able to refinance its existing Facility,
or that the minimum net worth covenant, as currently in place, will be revised.
The failure to accomplish either of the foregoing would have a material adverse
effect on the Company.
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 that will be acceptable, if at all.
At October 4, 1998, the Company had a working capital deficit of $14.2 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 that 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.
During the latter half of 1998, the Company has accelerated its new store
opening program and currently intends to develop up to 100 new stores in 1999.
The Company believes its projected cash flow from operations, borrowing capacity
with the Facility, cash on hand and trade credit will provide the necessary
capital to fund its current plan of operations for the remainder of Fiscal 1998
and the fiscal year 1999, 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
9
<PAGE>
Movie Gallery, Inc.
Management's Discussion and Analysis of Results of Operations
and Financial Condition (continued)
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.
This report contains 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 a number of important risk factors
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. These risk factors include competitive
factors and weather conditions within the Company's geographic markets, adequate
product availability from Hollywood, the ability of the Company to restructure
the current Facility and obtain refinancing on terms acceptable to the Company,
the Company's ability to successfully execute its new store opening program and
the risk factors that are discussed from time-to-time in the Company's SEC
reports, including, but not limited to, the report on Form 10-K for the fiscal
year ended January 4, 1998.
10
<PAGE>
Part II - Other Information
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
18 Change in Accounting Principle
27 Financial Data Schedule
27.1 Financial Data Schedule - Restated for October 5, 1997
b) Reports on Form 8-K
None.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Movie Gallery, Inc.
----------------------------------------
Date: November 18, 1998 /s/ J. Steven Roy
----------------------------------------
J. Steven Roy, Executive Vice President
and Chief Financial Officer
11
EXHIBIT 18
November 13, 1998
The Board of Directors and Stockholders
Movie Gallery, Inc.
739 West Main Street
Dothan, Alabama 36301
Dear Sirs:
Note 2 of Notes to Condensed Consolidated Financial Statements of Movie Gallery,
Inc. included in its Form 10-Q for the nine months ended October 4, 1998
describes a change in the method of accounting for amortizing the cost of
videocassette and video game rental inventory from the straight-line method to
an accelerated method. You have advised us that you believe that the change is
to a preferable method in your circumstances because (1) it will result in a
better match of the cost of videocassettes and video games with their revenues
in the Company's current operating environment and (2) it is consistent with
trends in industry practice.
There are no authoritative criteria for determining a preferable accounting
method for amortization of videocassette and video game inventory based on the
particular circumstances; however, we conclude that the change in the method of
accounting for amortization is to an acceptable alternative method which, based
on your business judgment to make this change for the reasons cited above, is
preferable in your circumstances. We have not conducted an audit in accordance
with generally accepted auditing standards of any financial statements of the
Company as of any date or for any period subsequent to January 4, 1998; and
therefore, we do not express any opinion on any financial statements of Movie
Gallery, Inc. subsequent to that date.
Very truly yours,
/s/ Ernst & Young LLP
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000925178
<NAME> MOVIE GALLERY, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-03-1999
<PERIOD-START> JAN-05-1998
<PERIOD-END> OCT-04-1998
<CASH> 1,201
<SECURITIES> 0
<RECEIVABLES> 616
<ALLOWANCES> 0
<INVENTORY> 11,010
<CURRENT-ASSETS> 17,189
<PP&E> 296,734<F1>
<DEPRECIATION> 207,338<F2>
<TOTAL-ASSETS> 198,323
<CURRENT-LIABILITIES> 31,370
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 120,428
<TOTAL-LIABILITY-AND-EQUITY> 198,323
<SALES> 32,423
<TOTAL-REVENUES> 198,550
<CGS> 21,987
<TOTAL-COSTS> 236,411
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,179
<INCOME-PRETAX> (42,040)
<INCOME-TAX> (15,321)
<INCOME-CONTINUING> (26,719)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (26,719)
<EPS-PRIMARY> (1.99)
<EPS-DILUTED> (1.99)
<FN>
<F1> INCLUDES $217,450 OF VIDEOCASSETTE RENTAL INVENTORY.
<F2> INCLUDES $173,027 OF ACCUMULATED AMORTIZATION ON VIDEOCASSETTE RENTAL
INVENTORY.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM FORM 10-Q
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000925178
<NAME> MOVIE GALLERY, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> JAN-04-1998
<PERIOD-START> JAN-06-1997
<PERIOD-END> OCT-05-1997
<CASH> 1,137
<SECURITIES> 0
<RECEIVABLES> 1,067
<ALLOWANCES> 0
<INVENTORY> 13,409
<CURRENT-ASSETS> 19,853
<PP&E> 275,611<F1>
<DEPRECIATION> 128,634<F2>
<TOTAL-ASSETS> 263,031
<CURRENT-LIABILITIES> 30,244
<BONDS> 0
0
0
<COMMON> 13
<OTHER-SE> 145,835
<TOTAL-LIABILITY-AND-EQUITY> 263,031
<SALES> 28,162
<TOTAL-REVENUES> 189,566
<CGS> 17,028
<TOTAL-COSTS> 185,984
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 4,632
<INCOME-PRETAX> (1,050)
<INCOME-TAX> (174)
<INCOME-CONTINUING> (876)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (876)
<EPS-PRIMARY> (0.07)
<EPS-DILUTED> (0.07)
<FN>
<F1> INCLUDES $198,656 OF VIDEOCASSETTE RENTAL INVENTORY.
<F2> INCLUDES $104,406 OF ACCUMULATED AMORTIZATION ON VIDEOCASSETTE RENTAL
INVENTORY.
</FN>
</TABLE>
