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 April 2, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For The Transition Period From___________ to__________ Commission file number 0-24548 Movie Gallery, Inc. (Exact name of registrant as specified in its charter) Delaware 63-1120122 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 739 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 May 11, 2000 was 11,286,167. Movie Gallery, Inc. Index Part I. Financial Information Item 1. Consolidated Financial Statements (Unaudited) Consolidated Balance Sheets - April 2, 2000 and January 2, 2000................1 Consolidated Statements of Income - Thirteen weeks ended April 2, 2000 and April 4, 1999..............................................................2 Consolidated Statements of Cash Flows - Thirteen weeks ended April 2, 2000 and April 4, 1999..............................................................3 Notes to Consolidated Financial Statements - April 2, 2000.....................4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..........................................................6 Item 3. Quantitative and Qualitative Disclosures About Market Risk...........11 Part II. Other Information Item 6. Exhibits and Reports on Form 8-K.....................................11 Movie Gallery, Inc. Consolidated Balance Sheets (in thousands) April 2, January 2, 2000 2000 --------- --------- (Unaudited) Assets Current assets: Cash and cash equivalents $ 6,109 $ 6,970 Merchandise inventory 13,019 15,148 Prepaid expenses 883 814 Store supplies and other 3,601 3,395 Deferred income taxes 274 229 --------- --------- Total current assets 23,886 26,556 Rental inventory, net 53,909 52,357 Property, furnishings and equipment, net 45,960 44,320 Goodwill and other intangibles, net 82,357 83,539 Deposits and other assets 3,862 2,543 Deferred income taxes -- 212 --------- --------- Total assets $ 209,974 $ 209,527 ========= ========= Liabilities and stockholders' equity Current liabilities: Accounts payable $ 23,338 $ 26,243 Accrued liabilities 9,543 12,989 Current portion of long-term debt 174 263 --------- --------- Total current liabilities 33,055 39,495 Long-term debt 47,760 44,377 Other accrued liabilities 177 234 Deferred income taxes 1,768 -- Stockholders' equity: Preferred stock, $.10 par value; 2,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, $.001 par value; 35,000,000 shares authorized, 11,992,167 and 12,549,667 shares issued and outstanding 12 13 Additional paid-in capital 125,431 127,537 Retained earnings (deficit) 1,771 (2,129) --------- --------- Total stockholders' equity 127,214 125,421 --------- --------- Total liabilities and stockholders' equity $ 209,974 $ 209,527 ========= ========= See accompanying notes. 1 Movie Gallery, Inc. Consolidated Statements of Income (Unaudited) (in thousands, except per share data) Thirteen weeks ended April 2, April 4, 2000 1999 -------------------- Revenues: Rentals $ 69,777 $ 59,326 Product sales 11,716 10,294 -------- -------- 81,493 69,620 Cost of sales: Cost of rental revenues 20,591 16,626 Cost of product sales 7,190 6,884 -------- -------- Gross margin 53,712 46,110 Operating costs and expenses: Store operating expenses 38,113 32,978 Amortization of intangibles 1,805 1,838 General and administrative 6,316 4,917 -------- -------- Operating income 7,478 6,377 Interest expense, net (868) (866) -------- -------- Income before income taxes, extraordinary item and cumulative effect of accounting change 6,610 5,511 Income taxes 2,710 2,149 -------- -------- Income before extraordinary item and cumulative effect of accounting change 3,900 3,362 Extraordinary loss on early extinguishment of debt, net of tax -- (682) Cumulative effect of accounting change, net of tax -- (699) -------- -------- Net income $ 3,900 $ 1,981 ======== ======== Basic and diluted earnings per share: Income before extraordinary item and cumulative effect of accounting change $ 0.32 $ 0.25 Extraordinary loss on early extinguishment of debt, net of tax -- (0.05) Cumulative effect of accounting change, net of tax -- (0.05) -------- -------- Net income $ 0.32 $ 0.15 ======== ======== Weighted average shares outstanding: Basic 12,275 13,279 Diluted 12,300 13,614 See accompanying notes. 2 Movie Gallery, Inc. Consolidated Statements of Cash Flows (Unaudited) (in thousands) Thirteen weeks ended April 2, April 4, 2000 1999 -------------------- Operating activities Net income $ 3,900 $ 1,981 Adjustments to reconcile net income to net cash provided by operating activities: Extraordinary loss on early extinguishment of debt, net of tax -- 682 Cumulative effect of accounting change, net of tax -- 699 Depreciation and amortization 18,443 18,757 Deferred income taxes 1,935 1,813 Changes in operating assets and liabilities: Merchandise inventory 2,129 1,064 Other current assets (275) 78 Deposits and other assets (1,319) (755) Accounts payable (2,905) (3,491) Accrued liabilities (3,503) (1,844) -------- -------- Net cash provided by operating activities 18,405 18,984 Investing activities Business acquisitions (628) (65) Purchases of rental inventory, net (14,642) (13,812) Purchases of property, furnishings and equipment (5,183) (1,569) -------- -------- Net cash used in investing activities (20,453) (15,446) Financing activities Purchases and retirement of common stock (2,107) (402) Proceeds from issuance of long-term debt 3,383 -- Principal payments on long-term debt (89) (5,768) -------- -------- Net cash provided by (used in) financing activities 1,187 (6,170) -------- -------- Decrease in cash and cash equivalents (861) (2,632) Cash and cash equivalents at beginning of period 6,970 6,983 -------- -------- Cash and cash equivalents at end of period $ 6,109 $ 4,351 ======== ======== See accompanying notes. 3 Movie Gallery, Inc. Notes to Consolidated Financial Statements (Unaudited) April 2, 2000 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 thirteen week period ended April 2, 2000 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2000. 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 2, 2000. Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation. These reclassifications had no impact on stockholders' equity or net income. Amortization of rental inventory and revenue sharing expenses have been combined and are presented as cost of rental revenues on the statement of operations. 2. Financing Obligations On January 7, 1999, the Company entered into a Credit Agreement with First Union National Bank of North Carolina with respect to a revolving credit facility (the "Facility"). The Facility provides for borrowings of up to $65 million, is unsecured and will mature in its entirety on January 7, 2002. The Company may increase the amount of the Facility to $85 million if existing banks increase their commitments or if any new banks enter the Credit Agreement. The interest rate of the Facility is based on LIBOR plus an applicable margin percentage, which depends on the Company's cash flow generation and borrowings outstanding. The Company may repay the Facility at any time without penalty. The more restrictive covenants of the Facility restrict borrowings based upon cash flow levels. Concurrent with the Facility, the Company amended its then existing interest rate swap to coincide with the maturity of the Facility. The amended interest rate swap agreement effectively fixes the Company's interest rate exposure on $37 million of the amount outstanding under the Facility at 5.8% plus an applicable margin percentage. The interest rate swap reduces the risk of increases in interest rates during the life of the Facility. The Company accounts for its interest rate swap as a hedge of its debt obligation. The Company pays a fixed rate of interest and receives payment based on a variable rate of interest. The difference in amounts paid and received under the contract is accrued and recognized as an adjustment to interest expense on the debt. There are no termination penalties associated with the interest rate swap agreement; however, if the swap agreement was terminated at the Company's option, the Company would either pay or receive the present value of the remaining hedge payments at the then prevailing interest rates for the time to maturity of the swap agreement. The interest rate swap agreement terminates at the time the Facility matures. As a result of the Facility and the amended interest rate swap agreement, the Company recognized an extraordinary loss on the early extinguishment of debt of $682,000 (net of taxes of $359,000), or $0.05 per share, during the first quarter of 1999. The extraordinary loss was comprised primarily of unamortized debt issue costs associated with the Company's previous credit facility and the negative value of the previous interest rate swap at January 7, 1999. 4 Movie Gallery, Inc. Notes to Consolidated Financial Statements (Unaudited)(continued) 3. Earnings Per Share 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 (25,000 and 335,000 for the thirteen weeks ended April 2, 2000 and April 4, 1999, respectively). No adjustments were made to net income in the computation of basic or diluted earnings per share. 4. Cumulative Effect of a Change in Accounting Principle In April 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-Up Activities," which requires that certain costs related to start-up activities be expensed as incurred. Prior to January 4, 1999, the Company capitalized certain costs incurred in connection with site selection for new video specialty store locations. The Company adopted the provisions of the SOP in its financial statements for the first quarter of 1999. The effect of the adoption of SOP 98-5 was to record a charge for the cumulative effect of an accounting change of $699,000 (net of taxes of $368,000), or $0.05 per share, to expense the unamortized costs that had been capitalized prior to January 4, 1999. The impact of adoption on income from continuing operations for the thirteen weeks ended April 4, 1999 was not material. 5 Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations The following table sets forth, for the periods indicated, statements 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. Thirteen weeks ended ---------------------------------- April 2, April 4, Increase 2000 1999 (Decrease) -------- -------- -------- Revenues: Rentals 85.6% 85.2% 0.4% Product sales 14.4 14.8 (0.4) -------- -------- -------- 100.0 100.0 -- Cost of sales: Cost of rental revenues 25.2 23.9 1.3 Cost of product sales 8.8 9.9 (1.1) -------- -------- -------- Gross margin 66.0 66.2 (0.2) Operating costs and expenses: Store operating expenses 46.8 47.4 (0.6) Amortization of intangibles 2.2 2.6 (0.4) General and administrative 7.8 7.1 0.7 -------- -------- -------- Operating income 9.2 9.1 0.1 Interest expense, net (1.1) (1.2) 0.1 -------- -------- -------- Income before income taxes, extraordinary item and cumulative effect of accounting change 8.1 7.9 0.2 Income taxes 3.3 3.1 0.2 -------- -------- -------- Income before extraordinary item and cumulative effect of accounting change 4.8 4.8 -- Extraordinary loss on early extinguishment of debt, net of tax -- (1.0) 1.0 Cumulative effect of accounting change, net of tax -- (1.0) 1.0 -------- -------- -------- Net income 4.8% 2.8% 2.0% ======== ======== ======== Adjusted EBITDA (in thousands) $ 12,664 $ 11,509 $ 1,155 ======== ======== ======== Cash earnings (in thousands) $ 5,705 $ 5,200 $ 505 ======== ======== ======== Number of stores open at end of period 960 826 134 ======== ======== ======== 6 Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Revenue. For the thirteen weeks ended April 2, 2000, total revenues were $81.5 million, a 17.1% increase from $69.6 million in the first quarter of 1999. The increase was due primarily to an increase in same-store revenues of 3.1%, as well as a 15.5% increase in the average number of stores open during the first quarter of 2000 versus 1999. The increase in same-store revenues for the first quarter of 2000 was the result of (i) an increase in the number of copies of new release videocassettes available to customers as a result of the Company's continuing focus on the use of copy-depth initiatives, including revenue sharing programs and other depth of copy programs available from movie studios; (ii) an increase in the sales of previously viewed movies, which is the direct result of more product available to consumers due to the copy-depth initiatives and revenue sharing programs discussed above; (iii) marginally favorable weather conditions; and (iv) successful, chain-wide internal marketing programs designed to generate more consumer excitement and traffic in the Company's base of stores. The revenue increase was partially offset by a decline in new movie sales as a result of fewer titles being released at sell-through price points. Cost of Sales. The cost of rental revenues as a percentage of total rental revenues for the thirteen week period ended April 2, 2000 was 29.5%, an increase from 28.0% in the prior year quarter. The cost of rental revenues includes both the amortization of rental inventory and revenue sharing expenses incurred by the Company. The slight increase is primarily due to continued expansion of the Company's participation in various revenue sharing and other copy depth programs and costs associated with the chain-wide roll-out of DVD in the last half of 1999 and early 2000. Cost of product sales includes the costs of new videocassettes, confectionery items and other goods, as well as the unamortized value of previously viewed rental inventory sold. The gross margin on product sales increased to 38.6% in the first quarter of 2000 from 33.1% in the first quarter of 1999. The increase in profitability of product sales is primarily the result of an increase in previously viewed movie sales and a decrease in new movie sales throughout 1999 and continuing in 2000, driven by the Company's increased focus on the sale of previously viewed movies. Previously viewed movies carry gross margins that are substantially higher than the average gross margins for new movie sales and increasing participation in copy depth programs provides significant resources to support a larger previously viewed movie inventory. Gross Margins. The significant improvement in profit margins on product sales was partially offset by the slight increase in the cost margin on rental revenues resulting in a total gross margin increase to 34.0% for the first quarter of 2000 from 33.8% in the first quarter of 1999. Operating Costs and Expenses. Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, decreased to 46.8% of total revenue for the first quarter of 2000 from 47.4% in the first quarter of 1999. The decrease in store operating expenses is primarily due to the same-store revenue increase of 3.1% during the first quarter of 2000 and overall cost containment at the store level. Amortization of intangibles as a percentage of total revenue for the thirteen weeks ended April 2, 2000 was 2.2%, a decrease from 2.6% for the comparable period in the prior year. This decrease is primarily due to the 17.1% increase in revenue. General and administrative expenses as a percentage of revenue increased to 7.8% in the first quarter of 2000 from 7.1% for the first quarter of 1999. The increase is primarily due to increased staffing and travel costs associated with the Company's increased new store development which began in the latter half of 1999, as well as incremental expenses from the operation of the Company's e-commerce effort which was launched in September 1999. 7 Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Extraordinary Loss. During the first quarter of 1999, the Company incurred an extraordinary loss on the early extinguishment of debt of $682,000 (net of taxes of $359,000), or $0.05 per share. The extraordinary loss was comprised primarily of the write off of both the unamortized debt issue costs and the negative value of an interest rate swap agreement in association with the restructuring of the Company's debt obligations discussed below in "Liquidity and Capital Resources." Cumulative Effect Accounting Change. Effective January 4, 1999, the Company adopted the provisions of the American Institute of Certified Public Accountants Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-up Activities." As a result, the Company recorded a charge for the cumulative effect of an accounting change of $699,000 (net of taxes of $368,000), or $0.05 per share, to expense the unamortized portion of certain start-up costs that had been capitalized prior to January 4, 1999, discussed fully in Note 4 of the "Notes to Consolidated Financial Statements." Liquidity and Capital Resources Historically, the Company's primary capital needs have been for opening and acquiring new stores and for the purchase of videocassette inventory. Other capital needs include the refurbishment, remodeling and relocation of existing stores, as well as common stock repurchases within the past year. The Company has funded inventory purchases, remodeling and relocation programs, new store opening costs, acquisitions and stock repurchases primarily from cash flow from operations, the proceeds of two public equity offerings, loans under revolving credit facilities and seller financing. During the thirteen weeks ended April 2, 2000 the Company generated approximately $12.7 million in Adjusted EBITDA, a 10.0% increase over $11.5 million for the comparable period in 1999. The increase was primarily driven by the 17.1% increase in total revenue. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, less the Company's purchase of rental inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. Cash earnings per diluted share for the first quarter of 2000 increased 21.1% to $0.46 from $0.38 in the first quarter of 1999. Contributing to this increase was a 9.7% decline in weighted average shares outstanding as a result of share repurchases. Cash earnings is defined as net income before extraordinary items, cumulative effect accounting changes and amortization of intangibles. Cash earnings should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. Net cash provided by operating activities was $18.4 million for the thirteen weeks ended April 2, 2000 as compared to $19.0 million for the thirteen weeks ended April 4, 1999. The decrease in net cash provided by operating activities was primarily the result of a continued reduction in rental product costs that are capitalized and amortized versus an increase in variable rental product costs which are expensed as incurred. The remaining decrease is due to increases in various other assets and offsetting decreases of inventory, accounts payable and accrued liabilities. Net cash provided by operating activities continues to be sufficient to cover capital resource and debt service needs. 8 Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Net cash used in investing activities was $20.5 million for the first quarter of 2000 as compared to $15.4 million for the comparable period of 1999. This increase in funds used for investing activities is primarily the result of increases in capital expenditures related to rental inventory and property, furnishings and equipment purchased to support the Company's increased new store development plan. Net cash provided by financing activities was $1.2 million for the first quarter of 2000 as compared to net cash used in financing activities of $6.2 million for the comparable period of 1999. The changes from the first quarter of 1999 are due primarily to significant reductions in long-term debt repayments during the first quarter of 2000 to fund increased capital needs for stock repurchases and new store development. On January 7, 1999, the Company entered into a new Credit Agreement with First Union National Bank of North Carolina with respect to a revolving credit facility (the "Facility"). The Facility provides for borrowings of up to $65 million, is unsecured and will mature in its entirety on January 7, 2002. The Company may increase the amount of the Facility to $85 million if existing banks increase their commitments or if any new banks enter the Credit Agreement. The interest rate of the Facility is based on LIBOR plus an applicable margin percentage, which depends on the Company's cash flow generation and borrowings outstanding. The Company may repay the Facility at any time without penalty. The more restrictive covenants of the Facility restrict borrowings based upon cash flow levels. The Company grows its store base through internally developed and acquired stores and may require capital in excess of internally generated cash flow to achieve its desired growth. The Company opened 24 internally-developed stores during the first quarter of 2000 and remains on target to open approximately 100 new stores during the year. The Company will entertain potential acquisition transactions; however, the number of acquired stores in 2000 is expected to be less than the number of internally developed stores. 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. During the first quarter of 2000, the Company completed its previously announced $5 million stock repurchase plan and announced another $5 million stock repurchase plan. Through May 11, 2000, the Company has repurchased 1,063,500 shares under the new repurchase plan which, combined with the previous repurchase plan, represents approximately 16% of the Company's outstanding shares since September 1998. It is anticipated the majority of the $5 million under the new repurchase plan will be utilized during the first half of fiscal year 2000. At April 2, 2000, the Company had a working capital deficit of $9.2 million, due to the accounting treatment of its rental inventory. Rental inventory is treated as a noncurrent asset under generally accepted accounting principles because it is a depreciable asset and is not an asset which is reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates the major portion of the Company's revenue, the classification of this asset as noncurrent results in its exclusion from working capital. The aggregate amount payable for this inventory, however, is reported as a current liability until paid and, accordingly, is included in working capital. Consequently, the Company believes that working capital is not an appropriate measure of its liquidity and it anticipates that it will continue to operate with a working capital deficit. The Company believes its projected cash flow from operations, borrowing capacity with the Facility, cash on hand and trade credit will provide the necessary capital to fund its current plan of operations for the remainder of fiscal year 2000, including its anticipated new store openings, a modest potential acquisition program and stock repurchases. However, to fund a major acquisition program, or to provide funds in the event that the Company's need for funds is 9 Movie Gallery, Inc. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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. Forward Looking Statements 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, but are not limited to, competitive factors and weather conditions within the Company's geographic markets, adequate product availability from movie studios, the Company's ability to successfully execute its new store opening program, the Company's ability to repurchase common stock under its share repurchase authorization 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 2, 2000. 10 Item 3. Quantitative and Qualitative Disclosures About Market Risks There have been no material changes in the Company's inherent market risks since the disclosures made as of January 2, 2000 in the Company's annual report on Form 10-K. Part II - Other Information Item 6. Exhibits and Reports on Form 8-K a) Exhibits 10.1 Amended and Restated Supply Agreement dated February 28, 2000 between M. G. A., Inc. and Ingram Entertainment, Inc. (portions were omitted pursuant to a request for confidential treatment) 10.2 First Amendment to Employment Contract between M.G.A., Inc. and J. T. Malugen dated April 3, 2000. 10.3 First Amendment to Employment Contract between M.G.A., Inc. and H. Harrison Parrish dated April 3, 2000. 27 Financial Data Schedule. 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. ------------------------------------- (Registrant) Date: May 17, 2000 /s/ J. Steven Roy -------------------------------------- J. Steven Roy, Executive Vice President and Chief Financial Officer 11