-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, U9I3tE5jnYYLdrATRs49HNPJk6b8Noz7phSAAbP0jvhP3d0gkCAKxDw9sefxFYi+ DV0vq9oFS4fgOwX9hdWbfg== 0000925178-01-500006.txt : 20010409 0000925178-01-500006.hdr.sgml : 20010409 ACCESSION NUMBER: 0000925178-01-500006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20001231 FILED AS OF DATE: 20010402 FILER: COMPANY DATA: COMPANY CONFORMED NAME: MOVIE GALLERY INC CENTRAL INDEX KEY: 0000925178 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-VIDEO TAPE RENTAL [7841] IRS NUMBER: 631120122 STATE OF INCORPORATION: DE FISCAL YEAR END: 0103 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-24548 FILM NUMBER: 1589980 BUSINESS ADDRESS: STREET 1: 900 WEST MAIN STREET CITY: DOTHAN STATE: AL ZIP: 36301 BUSINESS PHONE: 3346772108 MAIL ADDRESS: STREET 1: 900 WEST MAIN STREET CITY: DOTHAN STATE: AL ZIP: 36301 10-K 1 form10-k12312000.txt ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________. Commission file number: 0-24548 MOVIE GALLERY, INC. (Exact name of registrant as specified in its charter) Delaware 63-1120122 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 900 West Main Street, Dothan, Alabama 36301 (Address of principal executive offices) (Zip Code) (334) 677-2108) (Registrant's Telephone Number, including Area Code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.001 par value (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy statement or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 12, 2001, was approximately $34,692,272. The number of shares of Common Stock outstanding on March 12, 2001, was 11,176,167 shares. Documents incorporated by reference: 1. Notice of 2001 Annual Meeting and Proxy Statement (Part III of Form 10-K). The exhibit index to this report appears at page 27. ITEM 1. BUSINESS General As of March 12, 2001, Movie Gallery, Inc. (the "Company") owned and operated 1,035 video specialty stores located in 30 states that rent and sell videocassettes, digital video discs ("DVDs"), and video games. Since the Company's initial public offering in August 1994, the Company has grown from 97 stores to its present size through acquisitions and the development of new stores. The Company is the leading video specialty retailer in rural and secondary markets and is among the three largest video specialty retailers in the United States. The Company was incorporated in Delaware in June 1994 under the name Movie Gallery, Inc. From March 1985 until the present time, substantially all of the Company's operations have been conducted through its wholly-owned subsidiary, M.G.A., Inc. The Company's executive offices are located at 900 West Main Street, Dothan, Alabama 36301, and its telephone number is (334) 677-2108. Video Industry Overview Video Retail Industry. According to Paul Kagan Associates, Inc. ("Paul Kagan"), the home video rental and sales industry has grown from $10.9 billion in revenue in 1991 to $19.9 billion in 2000 with 87% of all television households owning a videocassette recorder ("VCR") or DVD player. The industry is projected to reach $27.4 billion in revenue by 2010 with 92% VCR and DVD penetration in television households, according to Paul Kagan. The video retail industry is highly fragmented and continues to experience consolidation pressures. Trends toward consolidation have been fueled by the competitive impact of superstores on smaller retailers, the need for enhanced access to working capital and economies of scale. The Company believes that the video specialty store industry will continue to consolidate into regional and national chains. While many of the largest retail chains posted same-store revenue growth in the last three years, industry sources speculated that many independent operators struggled to maintain market share. The combination of increased product offerings and improved marketing efforts have solidified the positions of the largest retail chains versus independent operators over the past several years. The domestic video retail industry includes both rentals and sales of videocassettes and DVDs; however, the majority of revenue is generated through the rental of prerecorded videocassettes and DVDs. There are three primary pricing strategies that the movie studios use to influence the relative levels of movie rentals versus sales. First, videocassettes can be priced at relatively high levels, typically between $60 and $75 ("rental priced movies"). These movies are purchased by video specialty stores and are promoted primarily as rental titles. Second, videocassettes can be priced at relatively low levels, typically between $5 and $25 ("sell-through movies"). These movies are purchased by video specialty stores and generally promoted for both rental and new videocassette sales. Third, movie studios have developed revenue sharing and other copy depth programs. DVD pricing is currently similar to the pricing of sell-through movies. Movie studios attempt to maximize total revenue from movie releases via the combined utilization of these pricing structures. The combination of revenue sharing and other copy depth programs, as well as the pricing of sell-through movies, provides larger quantities of product available to meet initial consumer demand. The incremental product is made available to the consumer for sale once initial rental demand is met, driving continued growth in sales revenue from previously viewed product. The concept of revenue sharing and risk sharing between major retailers and the movie studios was embraced by the industry in 1998 and continued to grow during 1999 and 2000. Revenue sharing is a concept whereby retailers and movie studios share the risks associated with the rental performance of individual titles. Generally, retailers pay a small upfront fee for each copy leased under revenue sharing, typically $0 to $8. As the movies are rented by consumers, the 2 movie studio receives a percentage of the revenue generated based on a predetermined formula, which is generally less than fifty percent. After a period of time, generally six months to a year, these movies are no longer subject to revenue sharing and are either owned outright by the retailer, purchased from the movie studio for a nominal amount or returned to the studio. Revenue sharing has allowed retailers to vastly increase both copy depth and breadth for the consumers. Movie Studio Dependence on Video Rental Industry. The home video industry is the largest single source of domestic revenue to movie studios and independent suppliers of theatrical and direct-to-video movies and, according to Paul Kagan, represented approximately $8.0 billion (an 8.5% increase from 1999), or 49%, of the estimated $16.4 billion of revenue generated in 2000. The Company believes that of the many movies produced by major studios and released in the United States each year, relatively few are profitable for the studios based on box office revenue alone. In addition to purchasing box office hits, video specialty stores provide the movie studios with a reliable source of revenue for a large number of their movies by purchasing movies that were not successful at the box office. The Company believes the consumer is more likely to view movies which were not box office hits via rental than any other medium because video specialty stores provide an inviting opportunity to browse and make impulse choices among a very broad selection of movie titles. In addition, the Company believes the relatively low cost of video rentals encourages consumers to rent films they might not pay to view at a theater. Historically, new technologies have led to the creation of additional distribution channels for movie studios. Movie studios seek to maximize their revenue by releasing movies in sequential release date "windows" to various movie distribution channels. These distribution channels include, in the customary order of release date: movie theaters, airlines and hotels, video specialty stores, pay-per-view satellite and cable television systems ("Pay-Per-View"), premium cable television, basic cable television and, finally, network and syndicated television. (See "Business -- Competition and Technological Obsolescence") The Company believes that this method of sequential release has allowed movie studios to increase their total revenue with relatively little adverse effect on the revenue derived from previously established distribution channels and it is anticipated that movie studios will continue the practice of sequential release even as near video on demand ("NVOD") and, eventually, video on demand ("VOD") become more readily available to the consumer. Most movie studios release hit movie titles to the home video market from 30 days to 80 days prior to the Pay-Per-View release date. This proprietary window of release from the movie studios shows the level of commitment to the home video industry and is indicative of the importance of this channel of distribution to the overall profitability of movie studios and other independent movie suppliers. Operating Strategy Movie Gallery Stores. The Company maintains a flexible store format, tailoring the size, inventory and look of each store to local demographics. The Company's stores generally range from approximately 2,000 to 9,000 square feet (averaging approximately 4,600 square feet), with inventories ranging from approximately 4,000 to 15,000 rental movies and 200 to 1,000 video games for rental. The Company builds both freestanding stores and stores located in strip centers anchored by major grocery or discount drug store chains, focusing on easy access, good visibility and high traffic. The store fixtures, equipment and layout are designed by the Company to create a visually-appealing, up-beat ambiance using bright lighting, vibrant graphics and carpet, and coordinating signage. The inviting atmosphere is augmented by a background of television monitors displaying MGTV (Movie Gallery Television), which shows movie previews and promotions of coming attractions, and by posters and stand-up displays promoting specific movie titles. Movies are arranged in attractive display boxes organized into categories by topic, except for new releases, which are assembled alphabetically in their own section for ease of selection by customers. The Company's stores are generally open seven days a week, from 10:00 a.m. to 11:00 p.m. on weekends and from 10:00 a.m. to 10:00 p.m. on weekdays. The Company's policy is to constantly evaluate its existing store base to determine where improvements may benefit the Company's competitive position. In negotiating its leases and renewals, the Company attempts to obtain short lease terms and favorable options to extend allowing for the mobility necessary to 3 react to changing demographics and other market conditions. The current average remaining life of the Company's leases is approximately two years with approximately 300 leases considered for renewal each year. The Company actively pursues relocation opportunities to adapt to changes in customer shopping patterns and retail market shifts. To date, we have not experienced difficulty in obtaining favorable leases or renewals at or below market rates in suitable locations. Similarly, the Company may elect to expand and/or remodel certain of its stores in order to improve facilities, meet customer demand and maintain the visual appeal of each store. Employees. As of March 12, 2001, the Company employed approximately 8,000 persons, referred to by the Company as "associates," including approximately 7,700 in retail stores and the remainder in the Company's corporate offices, field staff and distribution facility ("Support Center Staff"). Of the retail associates, approximately 1,500 were full-time and 6,200 were part-time. None of the Company's associates are represented by a labor union and the Company believes that its relations with its associates are good. Each of the Company's stores typically employs five to fourteen persons, including one Store Manager and, in larger stores, one Assistant Manager. Store Managers report to District Managers who supervise the operations of 10 to 15 stores. The District Managers report to one of ten Regional Managers, who report directly to the Company's Senior Vice President - Store Operations. As the Company has grown, it has increased the number of District Managers and Regional Managers. The Support Center Staff has regular and periodic meetings with the Regional Managers and District Managers to review operations. Compliance with the Company's policies, procedures and regulations is monitored on a store-by-store basis through quarterly quality assurance audits performed by District Managers. The performance and accuracy of the quarterly District Manager audits is monitored by the Company's quality assurance function. Throughout the last year, the Company has developed internal hiring, training and retention programs designed to enhance consistent and thorough communication of Company operating policies and procedures as well as increase the rate of internal promotions. The Company has an incentive and discretionary bonus program pursuant to which retail management personnel receive quarterly bonuses when stores meet or exceed criteria established under the program. Management believes that its program rewards excellence in management, gives associates an incentive to improve operations, and results in an overall reduction in the cost of operations. In addition, District Managers, Regional Managers and certain Support Center Staff are eligible to receive bonuses, based on individual and Company performance, and options to purchase shares of the Company's common stock (exercisable at the fair market value on the date of grant), subject to service requirements. New Release Purchases. The Company actively manages its new release purchases in order to balance customer demand with the maximization of profitability. Buying decisions are made centrally which allows the Company to obtain volume discounts, market development funds and cooperative advertising credits that are generally not available to single store or small chain operators. In order to maximize profits, the Company varies the quantity of its new release inventory, the rental and sales prices for videocassettes, DVDs and video games, and the rental period from location to location to meet competition and demographic demand in the area. The Company generally has a one-day rental term for new release movies (increasing to five days once rental demand has fallen below predetermined levels), which tends to keep new releases more readily available and requires the purchase of fewer copies of new releases than a longer rental policy. Video games generally have a five-day rental term for both the most recent releases and older titles. Marketing and Advertising. The Company uses market development funds, cooperative allowances from its suppliers and movie studios, and internal funds to purchase radio advertising, direct mail, newspaper advertising, in-store visual merchandising and in-store media to promote new releases. The video specialty stores and the Company's trade name are promoted along with the appropriate suppliers' product. Creative copy is prepared by the Company and the studios, with advertising being placed by in-house media buyers. The Company also prepares a monthly consumer magazine called Video Buzz and a customized video program (MGTV), both of which feature Company programs, promotions and new releases. The Company also benefits from the advertising and marketing by studios and theaters in connection with their efforts to promote films and 4 increase box office revenue. In addition to these traditional forms of advertising, the Company has developed and implemented a customer loyalty program, Reel Players. The program is based on a point system that provides customers the opportunity to earn free rentals and other incentives. The Company has also executed strategically timed trivia games to drive customer visits and to increase awareness of the Company's internet offerings at www.moviegallery.com. Expenditures for marketing and advertising above the amount of the Company's advertising allowances from its suppliers and movie studios have been minimal. Centralized Operations. In order to increase operating efficiency, the Company centrally manages labor costs, real estate costs, accounting, cash management and collections and utilizes centralized purchasing, advertising and information systems. Company-wide operational standards help ensure a high degree of customer service and visually appealing stores. Products For the fiscal year ended December 31, 2000, over 87% of the Company's rental revenue was derived from the rental of movies on videocassettes and DVD, with the remainder being derived primarily from the rental of video games. Substantially all of the Company's revenue from product sales during this period was derived from the sale of new and previously viewed movies, confectionery items and video accessories, such as blank cassettes, cleaning equipment and movie memorabilia. The Company's stores generally offer from 4,000 to 15,000 movies and from 200 to 1,000 video games for rental, depending upon location. New release movies are displayed alphabetically and older titles are displayed alphabetically by category, such as "Action," "Comedy," "Drama" and "Children." Buying decisions are made centrally and are based on box office results, actual rental history of comparable titles within each store and industry research. During 1999 and early 2000, the Company rolled out DVD product for rental and sale to all Company stores. During December 1999, DVD revenues accounted for approximately 1% of rental revenues for the Company compared to approximately 4% for the 2000 fiscal year and over 6% for December 2000. Paul Kagan reports that DVD sales exceeded expectations for 2000 and predicts that DVD technology will penetrate approximately 78% of television households by 2010. This product area is growing rapidly and the Company intends to follow the desires of its consumers for DVD by expanding its product offerings of DVD over time. Because of the ease of use and durability of DVD, it is anticipated that eventually DVD may replace videocassettes. The acquisition costs of DVD hardware have reached levels competitive with the VCR and the Company anticipates that when recordable DVD hardware is available to the public at a reasonable price, this product area could grow at an accelerated pace. In the near term, video retailers have the opportunity to expand DVD offerings at attractive pricing comparable to that of sell-through movies. However, industry sources indicate that studios may eventually begin to shift the pricing model for DVD toward a structure similar to the current rental videocassette pricing, including revenue share programs. Videocassettes, DVDs and video games utilized as initial inventory in the Company's newly developed stores consist of excess copies of older titles and new release titles from existing stores, supplemented as necessary by purchases directly from suppliers. This inventory for developed stores is packaged at the Company's processing and distribution facility located in Dothan, Alabama. Each videocassette, DVD and video game is removed from its original packaging and an optical bar code label, used in the Company's computerized inventory system, is applied to the plastic rental case. The inventory is placed in the rental case, and a display carton is created by inserting foam or cardboard into the original packaging and shrink-wrapping the carton. The repackaged videocassettes, DVDs, video games and display cartons are then shipped to the developed store ready for use. Management believes that internal factors which most affect a typical store's revenues are its new release title selection and the number of copies of each new release available for rental as compared to the competition. The 5 Company is committed to offering as many copies and the widest variety of new releases as necessary to be competitive within a market, while at the same time keeping its costs as low as possible. New videocassettes and DVDs offered for sale are primarily "hit" titles promoted by the studios for sell-through, as well as special interest and children's titles and seasonal titles related to particular holidays. In an effort to provide more depth of copy on hit titles to better satisfy initial customer demand, the Company has continued to pursue direct relationships with major and independent studios providing product copy depth programs. These programs have lowered the average per unit cost of rental inventory and permit the Company to carry larger levels of new release inventory while making available more titles that were previously unaffordable. The Company believes that these programs continue to have a positive impact on revenues by helping to retain the existing customer base and attract new customers. There can be no assurance that studios will continue to offer such programs or that such programs will continue to have positive results. The Company rents and sells video games, which are licensed primarily by "Nintendo," "Sony" and "Sega." Game rentals as a percentage of the Company's total revenues have increased since early 1997 due to the increase in the installed base of 32-bit and 64-bit game platforms. Sega launched the 128-bit Dreamcast system in September 1999 and Sony released a backward compatible 128-bit PlayStation 2 ("PS2") system in November 2000. The release of the PS2 did not meet expectations in that hardware shipments were less than half the amount promised by Sony. 2001 will be a transitional year for the video game industry as PS2 will continue to slowly gain market share as hardware and software becomes available; Sega has decided to cease production of the Dreamcast console mid-year; and the market will be anticipating the release of both the Nintendo Gamecube and the Microsoft X-box, slated for the fall. The Company expects video game rentals and sales to be flat during the transition to the new game platforms, with the next upswing dependent upon the timing and acceptance of the release of the new platforms. Movie and Video Game Suppliers The Company obtains its videocassettes, DVDs and video games for rental and its movies held for sale through relationships with various distributors and through direct agreements with studios. Because of revenue sharing and the impact it has had on distributors, the Company believes that if one of its suppliers were unable or unwilling to continue the contractual relationship with the Company, a viable replacement could be found without materially adversely impacting the Company's business. Since a majority of the Company's rental movie inventory is obtained under contract directly from various studios, the importance of the distributor relationships has been somewhat diminished. Generally, the relationships with distributors for product directly obtained from the studios is one of fulfillment agent. The Company pays the distributor a flat fulfillment fee for the distributor to pack and ship product directly to the Company's stores. The price paid directly to studios for each title varies and depends on whether the movie is priced to encourage rental or sale to consumers as discussed earlier. The components of the cost of a title to the Company would generally be a small, upfront fee paid to the studio, revenue sharing expenses and end-of-term buyouts that transfer the ownership of the product to the Company after a pre-determined period of time, generally six months. Being one of the top three video retailers in the United States, the Company believes its relationships with the movie studios are strong. While the content providers will always have the most control in the supplier-retailer relationship, the Company believes the studios have a vested interest in the Company's success, not only because of the impact of revenue sharing but also because of the competitive landscape within the video retail industry. Having one or more viable competitors to the industry leader enables the studios to maintain a balance within the retailer and studio relationship. The Company believes that its position is a positive force in interacting with studios and forging partnerships for the future. 6 Several companies acquired by the Company had pre-existing long-term contracts with Rentrak Corporation ("Rentrak") whereby product would be provided under pay-per-transaction revenue sharing arrangements. During late 1996, the Company consolidated existing contracts with Rentrak into one national agreement. Under this agreement which expires in September 2006, the Company has a minimum gross annual purchase commitment in revenue sharing, handling fees, sell-through fees and end-of-term buyouts. The Company utilizes Rentrak on a selective title by title basis. The Company has exceeded the minimum purchase requirements in each year since 1996. Growth Strategy The Company opened a record 110 new stores during 2000, acquired 16 stores and reached a milestone level of 1,020 stores in operation at the end of the year. This follows growth of 53 new stores and 131 acquired stores in 1999, including the acquisition of 88 stores previously operated by Blowout Entertainment, Inc. The Company spent 1997 and most of 1998 absorbing the significant growth experienced in 1994 through 1996, primarily from acquisitions. The following table is a historical summary showing store openings, acquisitions and store closings by the Company since January 1, 1996.
Fiscal Year Ended ---------------------------------------------------------------------- January 1 January 5, January 4, January 3, January 2, December 31, to March 12, 1997 1998 1999 2000 2000 2001 ----------- ----------- ----------- ----------- ------------- ----------- New store openings 75 50 18 53 110 23 Stores Acquired 174(1) 2 4 131 16 -- Stores Closed 48 59 41 58 69 8 Total Stores at End of Period 863 856 837 963 1,020 1,035 - ----- (1) Includes 98 stores acquired on July 1, 1996 and accounted for as poolings-of-interests.
For 2001, the Company intends to open approximately 75 new stores and will evaluate acquisition opportunities as they arise. However, the Company anticipates that most of its store growth in 2001 will come in the form of internally-developed stores. The Company's ability to execute its stated growth strategy will be dependent upon its ability to generate cash flow from operations. The key elements of the Company's development and acquisition strategy include the following: Development. From January 1, 1994 through March 12, 2001, the Company has developed 420 stores. The Company utilizes store development to complement its existing base of stores in rural and secondary markets where it finds attractive locations and a sufficient population to support additional video specialty stores. Generally, the Company's stores are located in small towns or suburban areas surrounding mid-sized cities. In these areas, the Company's principal competition usually consists of single store or small chain operators who have less buying power, smaller advertising budgets and generally offer fewer copies of new release movies. The Company attempts to become the leading video retailer in its markets and believes that it can achieve a higher return on invested capital in these smaller markets than it could in the larger urban areas because of the reduced level of competition, lower operating costs and the Company's expertise in operating in smaller markets. The Company attempts to develop real estate in 3,000 to 4,500 square foot locations primarily in towns with populations from 3,000 to 15,000. Although developed stores generally require approximately one year for revenue to reach the level of a mature store, they typically become profitable within the first six months of operations and produce greater returns on investment than acquired stores. Future sales growth depends on the Company's ability to aggressively, steadily add stores in a profitable manner. The Company's real estate and construction departments are responsible for new store development, including site selection, market evaluation, lease negotiation and construction. The Company maintains a flexible real estate strategy with short-term leases. Thus, the Company evaluates over 300 leases each year and does not hesitate to close a unit if it is not profitable or on-strategy. The cost of closing a unit is minimal and usable inventory, signage, fixtures and equipment is transferred to existing or new locations. The Company usually leases existing or build-to-suit locations from development companies which construct properties to negotiated specifications. Full-time, professional construction managers with significant video specialty store construction experience are employed to manage the process and ensure the Company's standards and design elements are achieved. The balance of the construction necessary to build-out the interior of a new location is also contracted and supervised by the construction department. 7 The Company continues to target new markets in which to develop stores. Most of the new markets are located within states that are either contiguous to states in which the Company has stores or states that have not reached full market penetration. By concentrating its new store development in and around existing markets, the Company is able to achieve operating efficiencies, primarily consisting of cost savings relating to advertising, training and store supervision. The Company also believes that its geographic dispersion tends to offset the impact of weather fluctuations and temporary economic and competitive conditions within individual markets. The following table provides information at March 12, 2001 and March 10, 2000, regarding the number of Company stores located in each state. Number of Stores ---------------- March 12, March 10, 2001 2000 ------------ ------------ Alabama..................................... 150 144 Florida..................................... 122 119 Texas ...................................... 92 95 Georgia..................................... 91 82 Virginia.................................... 60 59 Tennessee................................... 57 49 Maine....................................... 48 44 Ohio........................................ 43 46 Mississippi ................................ 42 37 Missouri.................................... 38 32 Indiana..................................... 35 37 South Carolina ............................. 33 31 Wisconsin................................... 30 31 North Carolina.............................. 24 18 Kentucky.................................... 23 23 Illinois.................................... 21 11 Oklahoma.................................... 20 10 Kansas...................................... 16 18 Louisiana................................... 16 17 Massachusetts............................... 15 14 New Hampshire............................... 15 14 Connecticut................................. 11 3 Arkansas.................................... 10 3 Pennsylvania................................ 8 5 Iowa........................................ 6 4 California.................................. - 2 Michigan.................................... 3 2 West Virginia............................... 3 1 Colorado.................................... 1 1 New York.................................... 1 1 Vermont..................................... 1 1 ----- ----- TOTAL.............................. 1,035 954 ===== ===== 8 Acquisitions. The Company's real estate and construction departments are responsible for identifying, selecting, and implementing acquisitions. From January 1, 1994 through March 12, 2001, the Company acquired 850 stores. Acquisitions permitted the Company to quickly gain market share and experienced management in markets that the Company believed had potential for growth. Through a combination of volume purchase discounts, larger advertising credits, more efficient inventory management and lower average labor costs, the Company believes it is generally able to operate these acquired stores more profitably than their prior owners, typically single store or small chain operators. During 2001, the Company intends to evaluate acquisition opportunities that may arise, but anticipates that most of its store growth will result from internally-developed locations. E-Commerce Initiative During 1999, the Company developed and released to the general public its e-commerce business, located at www.moviegallery.com. The Company has developed a consumer-oriented, on-line business that sells new and used movies and games to consumers. The Company's main goal with MovieGallery.com is to strengthen its existing relationship with its millions of customers that frequent the Company's brick and mortar stores. The Company has gathered in excess of 250,000 e-mail addresses from Movie Gallery customers and through third party advertising and partnerships, and is actively marketing its immense product library, in excess of 75,000 titles, to these customers. Due to physical constraints within the stores, the Company can offer, at most, a few hundred movie titles for sale to its customers. However, MovieGallery.com enables consumers to find the exact movie of their choice by simply logging on to www.moviegallery.com. Customer traffic and sales have grown consistently since the inception of the business in September 1999. The Company does not intend to spend a disproportionate amount of capital on its e-commerce business. The Company lost approximately $1.1 million to run this business in 2000 and has budgeted a loss of approximately $400,000 for 2001. The Company believes that this approach to developing its on-line business will build strong customer loyalty for the Movie Gallery concept without materially diminishing the Company's future earnings. The major e-commerce initiatives for 2001 include reaching customers outside the established Movie Gallery store base to increase volume, minimizing expenses, and continuing to adjust the pricing structure to find the right balance between investment of resources and operating results. Information Systems The Company utilizes a proprietary point-of-sale ("POS") system. The POS system provides detailed information with respect to store operations (including the rental history of titles and daily operations for each store) which is telecommunicated to the corporate office on a daily basis. The POS system is installed in all developed stores prior to opening, and the Company installs the system in all acquired stores shortly after the closing of the acquisition. The Company's POS system records all rental and sale information upon customer checkout using scanned bar code information and updates the information when the videocassettes and video games are returned. This POS system is linked to a management information system ("MIS") at the corporate office. Each night the POS system transmits store data into the MIS where all data is processed, generating reports which allow management to effectively monitor store operations and inventory, as well as to review rental history by title and location to assist in making purchasing decisions with respect to new releases. The POS system also enables the Company to perform its monthly physical inventory using bar code recognition. The Company also maintains a financial reporting system, relating to the general ledger, human resources/payroll, revenue and accounts payable functions, capable of handling the Company's current needs and anticipated growth, as well as additional systems which have been developed and implemented by the Company including a Collections system, a Processing/Distribution Center system and various other database systems and auditing systems. 9 Competition and Technological Obsolescence The video retail industry is highly competitive, and the Company competes with other video specialty stores, including stores operated by other regional chains and national chains such as Blockbuster Video ("Blockbuster"), and with other businesses offering videocassettes, DVDs and video games such as supermarkets, pharmacies, convenience stores, bookstores, mass merchants, mail order operations and other retailers. Approximately 30% of the Company's stores compete with stores operated by Blockbuster. In addition, the Company competes with all forms of entertainment, such as movie theaters, network and cable television, direct broadcast satellite television, Internet-related activities, live theater, sporting events and family entertainment centers. Some of the Company's competitors have significantly greater financial and marketing resources and name recognition than the Company. The Company believes the principal competitive factors in the video retail industry are store location and visibility, title selection, the number of copies of each new release available, customer service and, to a lesser extent, pricing. With 30% of stores having been newly built, relocated or remodeled within the last three years, the Company has a relatively young store base. The Company believes it generally offers superior service, more titles and more copies of new releases than most of its competitors. The Company also competes with Pay-Per-View in which subscribers pay a fee to view a movie selected by the subscriber. Recently developed technologies, referred to as NVOD, permit certain cable companies, direct broadcast satellite companies (such as Direct TV), telephone companies and other telecommunications companies to transmit a much greater number of movies to homes throughout the United States at more frequent intervals (often as frequently as every five minutes) throughout the day. NVOD does not offer full interactivity or VCR functionality, such as allowing consumers to control the playing of the movie (i.e., starting, stopping and rewinding). Ultimately, further improvements in these technologies could lead to the availability to the consumer of a broad selection of movies on demand, referred to as VOD, at a price which may be competitive with the price of videocassette/DVD rentals and with the functionality of VCRs. Certain cable and other telecommunications companies have tested and are continuing to test limited versions of NVOD and VOD in various markets throughout the United States and Europe. The Company believes movie studios have a significant interest in maintaining a viable movie rental business because the sale of movies to video retail stores currently represents the studios' largest source of domestic revenue. Specifically, video stores provide the best medium for movie studios to market their non-box office hit titles ("B movies"), which either produce less than $5 million in box office receipts upon theatrical release or are not released theatrically. These B movies comprise a large portion of total studio revenues, and video retailers are responsible for a majority of that revenue. Consumers, while browsing the new release section, will many times choose to watch a B movie even though they did not have the specific movie in mind when they entered the store. Pay-per-view, NVOD and VOD do not currently, nor are anticipated to be able to, provide the type of impulse marketing benefits that video stores provide related to B movies. As a result, the Company anticipates that movie studios will continue to make movie titles available to Pay-Per-View, cable television or other distribution channels only after revenues have been derived from the sale of videocassettes and DVDs to video stores. In addition, the Company believes that for Pay-Per-View television to match the low price, viewing convenience and selection available through video rental, substantial capital expenditures and further technological advances will be necessary. Although the Company does not believe NVOD or VOD represent a near-term competitive threat to its business, technological advances and broad consumer availability of NVOD and VOD, or changes in the manner in which movies are marketed, including the earlier release of movie titles to Pay-Per-View, cable television or other distribution channels, could have a material adverse effect on the Company's business. 10 Cautionary Statements The "BUSINESS" and "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS" sections of this Report contain certain forward-looking statements regarding the Company. These statements are subject to certain risks and uncertainties, including those identified below, which could cause actual results to differ materially from such statements. The words "believe", "expect", "anticipate", "intend", "aim", "will", "should" and similar expressions identify forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date on which they are made. The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and in that regard is cautioning the readers of this Report that the following important factors, among others, could affect the Company's actual results of operations and may cause changes in the Company's strategy with the result that the Company's operations and results may differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Growth Strategy. The Company's long-term strategy is to grow primarily through new store openings and secondarily through acquisitions of existing stores. Successful implementation of the strategy is contingent on numerous conditions, some of which are described below, and there can be no assurance that the Company's business plan can be executed. The acquisition of existing stores and the opening of new stores require significant amounts of capital. In the past, the Company's growth strategy has been funded through proceeds primarily from public offerings of common stock, and secondarily through bank debt, seller financing, internally generated cash flow and use of the Company's common stock as acquisition consideration. These and other sources of capital, including public or private sales of debt or equity securities, may not be available to the Company in the future. New Store Openings. The Company's ability to open new stores may be adversely affected by the following factors, among others: (i) its availability of capital; (ii) its ability to identify new sites where the Company can successfully compete; (iii) its ability to negotiate acceptable leases and implement cost-effective development plans for new stores; (iv) its ability to hire, train and assimilate new store managers and other personnel; and (v) its ability to compete effectively against competitors for prime real estate locations. Acquisitions. The Company's ability to consummate acquisitions and operate acquired stores at the desired levels of sales and profitability may be adversely affected by: (i) the inability to consummate identified acquisitions, which may result from a lack of available capital; (ii) the reduction in the size of the pool of available sellers; (iii) the inability to identify acquisition candidates that fit the Company's criteria (such as size, location and profitability) and who are willing to sell at prices the Company considers reasonable; (iv) more intensive competition to acquire the same video specialty stores the Company seeks to acquire; (v) an increase in price for acquisitions; (vi) misrepresentations and breaches of contracts by sellers; (vii) the Company's limited knowledge and operating history of the acquired stores; (viii) the replacement of purchasing and marketing systems of acquired stores; and (ix) the integration of acquired stores' systems into the Company's systems and procedures. Same-Store Revenues Increases. The Company's ability to maintain or increase same-store revenues during any period will be directly impacted by the following factors, among others, which are often beyond the control of the Company: (i) increased competition from other video stores, including large national or regional chains, supermarkets, convenience stores, pharmacies, mass merchants and other retailers, which might include significant reductions in pricing to gain market share; (ii) competition from other forms of entertainment such as movie theaters, cable television, Internet-related activities and Pay-Per-View television, including direct satellite television; (iii) the development and cost-effective distribution of movie and game rentals via an in-home medium, such as the home computer, television or any other electronic device either available today or in the future, which would compete with the current video store experience; (iv) the weather conditions in the selling area; (v) the timing of the release of new hit movies by the studios for the video rental market; (vi) the extent to which the Company experiences any increase in the number of titles released from studios priced for sell-through, which may be more effectively distributed to the consumer through mass merchants rather than video specialty stores; (vii) competition from special events such as the Olympics or an ongoing major news event of significant public interest; and 11 (viii) a reduction in, or elimination of, the period of time between the release of hit movie titles to the home video market and the release of these hit movies to the Pay-Per-View markets (the "release window"), currently 30 to 80 days. Income Estimates. The Company's ability to meet its income projections for any period are dependent upon many factors, including the following, among others: (i) reductions in revenues caused by factors such as those listed under "Same-Store Revenues Increases" above; (ii) the extent to which the Company experiences an increase in the number of new competitive openings, which tends to divide market share and reduce profitability in a given trade area; (iii) the extent to which the movie studios substantially alter the current revenue sharing or copy depth programs that results in either the overall per unit cost increasing materially or the Company substantially reducing the amount of product facings that it provides its customers on a weekly basis; (iv) the extent to which the movie studios reduce the level of marketing and advertising support; (v)changes in the prices for the Company's products or a reduction in, or elimination of, the videocassette release window as compared to Pay-Per-View, NVOD or VOD, as determined by the movie studios, could result in a competitive disadvantage for the Company relative to other forms of distribution; (vi) the Company's ability to control costs and expenses, primarily rent, store payroll and general and administrative expenses; (vii) the extent to which the Company experiences any increase in the number of titles released from studios priced for sell-through, which may tend to increase the satisfaction of demand through product sales which carry lower profit margins than rental revenues; (viii) the Company's ability to react and obtain other distribution sources for its products in the event that the Company's suppliers are unable to meet the terms of their contracts with the Company; and (ix) advancements and cost reductions in various new technological delivery systems such as (a) Pay-Per-View cable television systems and digital satellite systems offering NVOD or VOD; and (b) other forms of new technology, which could affect the Company's profit margins. Directors and Executive Officers of the Company
Name Age Position(s) Held - ---- --- ---------------- Joe Thomas Malugen(1) 49 Chairman of the Board and Chief Executive Officer H. Harrison Parrish(1) 53 President and Director William B. Snow(1)(2)(3) 69 Vice Chairman of the Board J. Steven Roy 40 Executive Vice President and Chief Financial Officer Jeffrey S. Stubbs 38 Senior Vice President - Store Operations S. Page Todd 39 Senior Vice President, Secretary and General Counsel Keith A. Cousins 32 Senior Vice President - Real Estate/Development Theodore L. Innes 51 Senior Vice President - Sales and Marketing Richard R. Langford 44 Senior Vice President - Management Information Systems Mark S. Loyd 45 Senior Vice President - Purchasing and Product Management Sanford C. Sigoloff(2)(3) 70 Director Philip B. Smith(2)(3) 65 Director Joseph F. Troy (1) 62 Director - ------------------- (1) Member of Executive Committee. (2) Member of Compensation Committee. (3) Member of Audit Committee.
Mr. Malugen co-founded the Company in 1985 and has been its Chairman of the Board and Chief Executive Officer since that time. Prior to the Company's initial public offering in August 1994, Mr. Malugen had been a practicing attorney in the States of Alabama and Missouri since 1978, but spent a majority of his time managing the operations of the Company beginning in early 1992. Mr. Malugen received a B.S. degree in Business Administration from the University of Missouri-Columbia, his J.D. from Cumberland School of Law, Samford University and his LL.M. (in Taxation) from New York University School of Law. 12 Mr. Parrish co-founded the Company in 1985 and has been its President and a Director of the Company since that time. From December 1988 until January 1992, Mr. Parrish was Vice President of Deltacom, Inc., a regional long distance telephone provider. Mr. Parrish received a B.A. degree in Business Administration from the University of Alabama. Mr. Snow was elected Vice Chairman of the Board in July 1994, and he served as Chief Financial Officer from July 1994 until May 1996. Since May 1996, Mr. Snow has continued to serve as Vice Chairman of the Board and has served as a consultant to the Company. Mr. Snow was the Executive Vice President and Chief Financial Officer and a Director of Consolidated Stores Corporation, a publicly held specialty retailer, from 1985 until he retired in June 1994. Mr. Snow is a director of Homeland Stores, Inc., a publicly held company. Mr. Snow is a Certified Public Accountant, and he received his Masters in Business Administration from the Kellogg Graduate School of Management at Northwestern University and his Masters in Taxation from DePaul University. Mr. Roy was elected Senior Vice President - Finance and Principal Accounting Officer in June 1995, was elected Chief Financial Officer in May 1996 and was elected Executive Vice President in March 1998. Mr. Roy was an accountant with the firm of Ernst & Young LLP for the 11 years prior to joining the Company. Mr. Roy is a Certified Public Accountant and received a B.S. degree in Business Administration from the University of Alabama. Mr. Stubbs was elected to his current position as Senior Vice President - Store Operations in November 1997. He joined the Company in November 1995 and served as Regional Manager over Texas, Louisiana, and Mississippi. Prior to joining the Company, Mr. Stubbs served as Vice President and General Manager of A.W.C. Corporation, a video specialty and restaurant retailer in East Texas, from 1987 to 1995. He has an additional eight years experience in grocery and convenience store management. Mr. Stubbs attended Texas A & M University and graduated from Southwest Texas State University, where he received a B.B.A. degree in Business Administration and Marketing. Mr. Todd was elected Senior Vice President, Secretary and General Counsel in December 1994. For more than the previous five years, he had been an attorney practicing tax and corporate law in Dothan, Alabama. Mr. Todd received a B.S. degree in Business Administration from the University of Alabama, his J.D. from the University of Alabama School of Law and his LL.M. (in Taxation) from New York University School of Law. Mr. Cousins was elected to his current position as Senior Vice President - Real Estate/Development in March 1999. He joined the Company in August 1998 as Senior Director of Development, Planning and Analysis. Prior to joining the Company, Mr. Cousins acquired four years of management consulting experience with Computer Sciences Corporation as Program Control Manager; Management Consulting and Research, Inc. as Cost Analyst; and Tecolote Research, Inc. as Advanced Cost Estimator. He has an additional seven years of real estate and property management experience as Senior Director of Development for KinderCare Learning Centers, Inc. and Senior Accountant with Aronov Realty Management Co., Inc. Mr. Cousins received a B.S. degree in Business Administration from Auburn University at Montgomery. Mr. Innes joined the Company in May 1999 and was elected Senior Vice President - Sales and Marketing in June 1999. From October 1997 until he joined the Company, Mr. Innes was a marketing consultant with Neighborhood Marketing Institute, a neighborhood marketing and consulting firm specializing in multi-unit restaurants and retailers, most recently serving as Executive Vice President and Chief Operating Officer. From November 1989 to September 1997, Mr. Innes was employed with Blockbuster Entertainment, most recently serving as Vice President - Marketing. Prior to joining Blockbuster Entertainment, he was employed with Long John Silver's Seafood Shoppe for fifteen years, most recently serving as Controller of Retail Operations and Marketing. Mr. Innes is a Certified Public Accountant and a Certified Management Accountant and received a B.S. degree in Business Administration from the University of Kentucky. 13 Mr. Langford joined the Company in August 1995 as Vice President and was elected Senior Vice President - Management Information Systems in October 1996. From August 1993 until he joined the Company, Mr. Langford served as a Manager for Payroll, Fixed Assets and Accounts Payable for Rocky Mountain Healthcare. From February 1990 to August 1993, he was Director of Support Operations for U. I. Video Stores, Inc. ("UIV") of Denver, Colorado. UIV was one of the largest Blockbuster franchisees, operating 110 stores in seven states in July 1993 when UIV was acquired by Blockbuster. Mr. Langford received a B.A. degree in Communications from Brigham Young University. Mr. Loyd joined the Company in August 1986 and has served as the retail store coordinator as well as Vice President - Purchasing and Product Management. In October 1996, he was elected Senior Vice President - Purchasing and Product Management. Mr. Loyd attended Southeast Missouri State University, where he majored in Business Administration. Mr. Sigoloff became a director of the Company in September 1994. Since 1989, Mr. Sigoloff has been Chairman of the Board, President and Chief Executive Officer of Sigoloff & Associates, Inc., a management consulting company. In August 1989, LJ Hooker Corporation, a client of Sigoloff & Associates, Inc., appointed Mr. Sigoloff to act as its Chief Executive Officer during its reorganization under Chapter 11 of the United States Bankruptcy Code. From March 1982 until 1988, Mr. Sigoloff was Chairman of the Board, President and Chief Executive Officer of Wickes Companies, Inc., one of the largest retailers in the United States. Mr. Sigoloff is a director of Kaufman and Broad Home Corporation, a publicly held company. In addition, Mr. Sigoloff is an adjunct full professor at the John E. Anderson Graduate School of Management at the University of California at Los Angeles. Mr. Smith became a director of the Company in September 1994. Since June 1998, Mr. Smith has served as Vice Chairman of the Board of Laird & Co., LLC, a merchant bank. In addition, from 1991 until August 1998, Mr. Smith served as Vice Chairman of the Board of Spencer Trask Securities Incorporated, an investment banking firm. Mr. Smith is a founding General Partner of Lawrence Venture Associates, a venture capital limited partnership headquartered in New York City. From 1981 to 1984, he served as Executive Vice President and Group Executive of the worldwide corporations group at Irving Trust Company. Prior to joining Irving Trust Company, he was at Citibank for 15 years, where he founded Citicorp Venture Capital as President and Chief Executive Officer. Since 1988 he has also been the managing general partner of Private Equity Partnership, L.P. Mr. Smith is a director of the following publicly held companies: KLS EnviroResources, Inc., Digital Video Systems, Inc. and Careside, Inc. Mr. Smith is an adjunct professor at Columbia University Graduate School of Business. Mr. Troy became a director of the Company in September 1994. Mr. Troy is the founder and has been a member of the law firm of Troy & Gould Professional Corporation since May 1970. Directors are elected to serve until the next annual meeting of stockholders of the Company or until their successors are elected and qualified. Officers serve at the discretion of the Board of Directors, subject to any contracts of employment. Non-employee directors receive an annual fee of $16,000, a fee of $1,000 for each Board meeting attended and a fee of $500 for each committee meeting attended. The Company has granted vested options to purchase 115,000 shares of Common Stock to each of Messrs. Sigoloff and Smith, vested options to purchase 140,000 shares to Mr. Troy and vested options to purchase 150,000 shares to Mr. Snow, in each case at or above the fair market value of the Common Stock on the date of grant. ITEM 2. PROPERTIES At March 12, 2001, all but one of the Company's 1,035 stores were located on premises leased from unaffiliated persons pursuant to leases with remaining terms which generally vary from one month to six years. The Company is generally responsible for taxes, insurance and utilities under its leases. Rental rates often increase upon exercise of any renewal option, and some leases have percentage rental arrangements pursuant to which the Company is obligated to pay a base rent plus a percentage of the store's revenues in excess of a stated 14 minimum. In general, the stated minimums are set at such a high level of revenues that the Company does not pay additional rents based on reaching the required revenue levels and does not anticipate paying such additional rents in the future. The Company anticipates that future stores will also be located in leased premises. The Company owns a family entertainment center, including a video specialty store, in Meridian, Mississippi. During 2000, the Company's Support Center offices and distribution facility were consolidated from six different locations into one 90,000 square foot location purchased by the Company at 900 West Main Street, Dothan, Alabama. ITEM 3. LEGAL PROCEEDINGS The Company is subject to various legal proceedings in the course of conducting its business. However, the Company believes that these proceedings are not likely to result in judgments that will have a material adverse effect on its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's Common Stock began trading on the Nasdaq National Market on August 2, 1994 under the symbol "MOVI." The following table sets forth for the periods indicated the high and low last sale prices of the Company's Common Stock as reported on the Nasdaq National Market.
High Low 2001 First Quarter (through March 12, 2001)................... $ 6.03 $ 3.06 2000 First Quarter............................................ 4.38 2.88 Second Quarter........................................... 4.44 3.25 Third Quarter............................................ 4.50 3.50 Fourth Quarter........................................... 3.75 3.00 1999 First Quarter............................................. 7.50 3.88 Second Quarter............................................ 6.38 4.69 Third Quarter............................................. 6.19 5.19 Fourth Quarter............................................ 5.44 3.75
The last sale price of the Company's Common Stock on March 12, 2001, as reported on the Nasdaq National Market was $6.03 per share. As of March 12, 2001, there were approximately 2,100 holders of the Company's Common Stock, including 108 stockholders of record. The payment of dividends is within the discretion of the Company's Board of Directors and will depend on the earnings, capital requirements, restrictions in future credit agreements and the operating and financial condition of the Company, among other factors. The Company presently expects to retain its earnings to finance the expansion and further development of its business. There can be no assurance that the Company will ever pay a dividend in the future. 16 ITEM 6. SELECTED FINANCIAL DATA
Fiscal Year Ended ----------------------------------------------------------------- December 31, January 2, January 3, January 4, January 5, 2000 2000 1999 1998 1997(2)(3)(4) ----------------------------------------------------------------- (dollars in thousands, except per share data) Statement of Operations Data: Revenues: Rentals $ 271,457 $ 235,452 $ 222,784 $ 220,787 $ 219,002 Product sales 47,479 41,493 44,849 39,569 35,393 --------- --------- --------- --------- --------- 318,936 276,945 267,633 260,356 254,395 Cost of sales: Cost of rental revenues 81,958 69,716 113,192(1) 72,806 66,412(5) Cost of product sales 31,213 25,884 29,744 24,597 21,143 --------- --------- --------- --------- --------- Gross margin 205,765 181,345 124,697 162,953 166,840 Operating costs and expenses: Store operating expenses 153,665 137,128 130,473 130,512 121,588 Amortization of intangibles 7,465 8,452 7,068 7,206 7,160 General and administrative 24,945 21,403 17,996 17,006 20,266 Restructuring and other charges -- -- -- -- 9,595 --------- --------- --------- --------- --------- Operating income (loss) 19,690 14,362 (30,840) 8,229 8,231 Interest expense, net (3,779) (3,349) (5,325) (6,326) (5,619) --------- --------- --------- --------- --------- Income (loss) before income taxes, extraordinary item and cumulative effect of accounting change 15,911 11,013 (36,165) 1,903 2,612 Income taxes 6,425 4,615 (13,089) 998 1,006(6) --------- --------- --------- --------- --------- Income (loss) before extraordinary item and cumulative effect of accounting change 9,486 6,398 (23,076) 905 1,606 Extraordinary loss on early extinguishment of debt, net of tax -- (682) -- -- -- Cumulative effect of accounting change, net of tax -- (699) -- -- -- --------- --------- --------- --------- --------- Net income (loss) $ 9,486 $ 5,017 $ (23,076) $ 905 $ 1,606 ========= ========= ========= ========= ========= Basic and diluted earnings (loss) per share $ 0.83 $ 0.38 $ (1.72) $ 0.07 $ 0.12 ========= ========= ========= ========= ========= Shares used in computing earnings (loss) per share: Basic 11,467 13,115 13,388 13,420 13,241 ========= ========= ========= ========= ========= Diluted 11,497 13,370 13,388 13,421 13,368 ========= ========= ========= ========= ========= Operating Data: Number of stores at end of period 1,020 963 837 856 863 Adjusted EBITDA (7) $ 39,744 $ 35,494 $ 37,378 $ 26,898 $ 26,232 Cash earnings per diluted share (8) $ 1.47 $ 1.11 $ 0.87 $ 0.60 $ 1.01 Increase (decrease) in same-store revenues (9) 3.8% 0.4% 3.9% 1.1% (1.0)%
17 ITEM 6. SELECTED FINANCIAL DATA (continued)
December 31, January 2, January 3, January 4, January 5, 2000 2000 1999 1998 1997 ----------------------------------------------------------------- (dollars in thousands) Balance Sheet Data: Cash and cash equivalents $ 7,029 $ 6,970 $ 6,983 $ 4,459 $ 3,982 Rental inventory, net 61,773 52,357 44,998 92,183 89,929 Total assets 217,536 209,527 202,369 259,133 261,577 Long-term debt, less current maturities 40,600 44,377 46,212 63,479 67,883 Total liabilities 88,327 84,106 78,254 111,504 114,853 Stockholders' equity 129,209 125,421 124,115 147,629 146,724 - --------------------- (1) Effective July 6, 1998, the Company changed its method of amortizing rental inventory resulting in a non-recurring, non-cash, pre-tax charge of approximately $43.6 million. (2) On July 1, 1996, the Company adopted a fiscal year ending on the first Sunday following December 30, which periodically results in a fiscal year of 53 weeks. The 1996 fiscal year, ended on January 5, 1997, reflects a 53-week year. (3) Includes a non-recurring charge of approximately $10.4 million for store closures, corporate restructuring and merger-related expenses. (4) Includes the results of Home Vision Entertainment, Inc. ("Home Vision") and Hollywood Video, Inc. ("Hollywood Video"), which were acquired in two separate pooling-of-interests transactions on July 1, 1996. The Company's results for the fiscal year ended January 5, 1997 are combined with results of Home Vision and Hollywood Video for the period January 1, 1996 to the date of the acquisitions. (5) Effective April 1, 1996, the Company changed its method of amortizing rental inventory resulting in a one-time, non-cash, pre-tax charge of approximately $7.7 million. (6) Includes pro forma adjustments to reflect income tax expense which would have been recognized if Hollywood Video had been taxed as a C corporation for all periods presented. Historical operating results of Hollywood Video do not include any provision for income taxes prior to July 1, 1996 due to their S corporation status prior to that date. (7) Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, excluding non-recurring charges, less the Company's purchase of rental inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. (8) Cash earnings is defined as net income before extraordinary items, cumulative effect accounting changes, non-recurring non-cash charges and amortization of intangibles. Cash earnings should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. (9) Same-store revenue is defined as the aggregate revenues from stores operated by the Company for at least 13 months.
18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations The following table sets forth, for the periods indicated, statement of income data, expressed as a percentage of total revenue, and the number of stores open at the end of each period. Statement of Operations Data:
Fifty-Two Weeks Ended ---------------------------------- December 31, January 2, January 3, 2000 2000 1999 ---------------------------------- Revenues: Rentals 85.1 % 85.0 % 83.2 % Product sales 14.9 15.0 16.8 --------- --------- --------- 100.0 100.0 100.0 Cost of sales: Cost of rental revenues Recurring 25.7 25.2 26.0 Policy change -- -- 16.3 Cost of product sales 9.8 9.3 11.1 --------- --------- --------- Gross margin 64.5 65.5 46.6 Operating costs and expenses: Store operating expenses 48.2 49.5 48.7 Amortization of intangibles 2.3 3.1 2.7 General and administrative 7.8 7.7 6.7 --------- --------- --------- Operating income (loss) 6.2 5.2 (11.5) Interest expense, net (1.2) (1.2) (2.0) --------- --------- --------- Income (loss) before income taxes, extraordinary item and cumulative effect of accounting change 5.0 4.0 (13.5) Income taxes 2.0 1.7 (4.9) --------- --------- --------- Income (loss) before extraordinary item and cumulative effect of accounting change 3.0 2.3 (8.6) Extraordinary loss on early extinguishment of debt, net of tax -- (0.2) -- Cumulative effect of accounting change, net of tax -- (0.3) -- --------- --------- --------- Net income (loss) 3.0 % 1.8 % (8.6)% ========= ========= ========= Adjusted EBITDA (in thousands) $ 39,744 $ 35,494 $ 37,378 ========= ========= ========= Number of stores open at end of period 1,020 963 837 ========= ========= =========
19 Fiscal year ended December 31, 2000 ("Fiscal 2000") compared to the fiscal year ended January 2,2000 ("Fiscal 1999") Revenue. Total revenue increased 15.2% to $318.9 million for Fiscal 2000 from $276.9 million for Fiscal 1999. The increase was due primarily to an increase in same-store revenues of 3.8%, as well as a 9.7% increase in the average number of stores open during Fiscal 2000 versus Fiscal 1999. The increase in same-store revenues was primarily the result of (i) increased product availability for the customer; (ii) a strong slate of new title releases versus the prior year, especially in the fourth quarter where box office revenues on the titles released were approximately 40% higher than the fourth quarter of 1999; (iii) successful, chain-wide internal marketing programs designed to generate more consumer excitement and traffic in the Company's base of stores; (iv) an increase in the sale of previously viewed movies and previously played games; (v) the return of the Christmas and New Year's holidays to a weekday instead of a weekend day, as well as the absence of the "millennium effect" experienced in 1999; and (vi) increases in other ancillary sales. The revenue increase was partially offset by a decline in new movie sales as a result of fewer titles being released at sell-through price points and a deemphasis on the sale of older sell-through titles in certain stores. Cost of Sales. Rental revenue costs as a percentage of rental revenues for Fiscal 2000 was 30.2%, a slight increase from 29.6% in Fiscal 1999 primarily due to the significant concentration of product purchases in the fourth quarter of Fiscal 2000. The cost of rental revenues includes both the amortization of rental inventory and revenue sharing expenses incurred by the Company. Cost of product sales includes the costs of new videocassettes and DVDs, confectionery items and other goods, as well as the unamortized value of previously viewed rental inventory sold. The gross margin on product sales decreased to 34.3% in Fiscal 2000 from 37.6% in Fiscal 1999. The decrease in profitability of product sales is primarily the result of significant discounting in the fourth quarter for the holiday season and continued liquidation of older sell-through titles in certain stores. Gross Margins. As a result of slightly lower margins on both rental revenues and product sales, total gross margins declined from 65.5% in Fiscal 1999 to 64.5% in Fiscal 2000. Operating Costs and Expenses. Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, decreased to 48.2% of total revenue for Fiscal 2000 from 49.5% for Fiscal 1999. The decrease in store operating expenses as a percentage of revenue is primarily due to the same-store revenue increase in Fiscal 2000, as well as the centralization of certain functions at the general and administrative level which have resulted in store level expense savings and the continued focus on closure of underperforming stores. Amortization of intangibles decreased as a percentage of revenues to 2.3% in Fiscal 2000 versus 3.1% in Fiscal 1999. This decrease is primarily due to the increase in same-store revenue in Fiscal 2000 and a reduction in goodwill impairment write-offs during Fiscal 2000 required by Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." General and administrative expenses as a percentage of revenues was 7.8% for Fiscal 2000 compared to 7.7% for Fiscal 1999. Increases in general and administrative expenses due to increased staffing and travel costs associated with the Company's new store development which began to intensify in the latter half of 1999, as well as incremental expenses from the operation of the Company's e-commerce effort which was launched in September 1999, were offset by revenue increases in Fiscal 2000. 20 As a result of the above factors, operating income increased by 37.1% to $19.7 million in Fiscal 2000 from $14.4 million in Fiscal 1999. For Fiscal 2000 the Company's effective income tax rate was 40.4%, as compared to a 41.9% effective rate for Fiscal 1999. The decrease in the income tax rate in Fiscal 2000 is primarily due to higher pre-tax income which leverages certain permanently non-deductible items, therefore reducing the effective tax rate. Fiscal 1999 compared to the fiscal year ended January 3, 1999 ("Fiscal 1998") Revenue. Total revenue increased 3.5% to $276.9 million for Fiscal 1999 from $267.6 million for Fiscal 1998. The increase was due primarily to an increase in same-store revenues of 0.4%, as well as approximately 40 more average stores open during Fiscal 1999 versus Fiscal 1998. The increase in same-store revenues was primarily the result of (i) an increase in the number of copies of new release videocassettes available to customers as a result of copy-depth initiatives, including revenue sharing programs and other depth of copy programs available from movie studios; (ii) an increase in the sale of previously viewed movies, which is the direct result of more product available to consumers due to the copy-depth initiatives and revenue sharing programs discussed above; (iii) a double-digit increase in the video game rental business due to increasing growth in the penetration of the Nintendo 64 and Sony Playstation game platforms, the introduction of the Sega Dreamcast game platform in late Fiscal 1999 and an increase in the number of game titles available for these platforms; and (iv) successful, chain-wide internal marketing programs designed to generate more consumer excitement and traffic in the Company's base of stores. These positive aspects of revenue growth were offset, in part, by (i) a greater than 40% decrease in new tape sales during Fiscal 1999 as a result of fewer titles being released at sell-through price points; (ii) the negative comparative impact of the hit title "Titanic," which was released in the third quarter of Fiscal 1998 and was the highest grossing box office hit of all time; (iii) the combination of the new millenium celebration and the Christmas and New Year's holidays falling within weekend days during Fiscal 1999 versus week days in Fiscal 1998; and (iv) overall unfavorable weather in Fiscal 1999 as compared to Fiscal 1998. Product sales decreased as a percentage of total revenues to 15.0% for Fiscal 1999 from 16.8% for Fiscal 1998, primarily as a result of the decrease in new tape sales, offset in part by the increase in the sales of previously viewed rental inventory. Cost of Sales. Net of the impact of a rental inventory policy change in the third quarter of Fiscal 1998, the cost of rental inventory, which includes amortization of rental inventory and revenue sharing expenses, decreased as a percentage of total revenue from 26.0% in Fiscal 1998 to 25.2% in Fiscal 1999. As a percentage of rental revenue, the cost of rental inventory in Fiscal 1999 was 29.6% versus 31.2% in Fiscal 1998. The decrease in rental inventory costs as a percentage of both total revenue and rental revenue is primarily due to the Company's change in amortization policy during the third quarter of Fiscal 1998, the Company's reduced per unit costs of acquiring rental product through various copy-depth programs available from movie studios, as well as the more efficient allocation of product to the store base. Effective July 6, 1998, the Company changed its amortization policy for rental inventory. The change resulted in a nonrecurring, non-cash, pre-tax charge of approximately $43.6 million in the third quarter of Fiscal 1998. The major impetus for the change in amortization policy was the changing purchasing economics within the industry, which have resulted in a significant increase in new release videos available for rental. While revenue sharing programs and other copy-depth initiatives have increased customer satisfaction and driven increased rental revenue, the overall demand for each new release is satisfied sooner. In order to match more accurately the valuation of tape inventory with accelerated consumer demand, the Company changed its amortization policy for rental inventory as described in Note 1 of the "Notes to Consolidated Financial Statements." 21 Cost of product sales includes the costs of new videocassettes, confectionery items and other goods, as well as the unamortized value of previously viewed rental inventory sold. The gross margin on product sales increased to 37.6% in Fiscal 1999 from 33.7% in Fiscal 1998. The increase in profitability of product sales is primarily the result of an increase in previously viewed movie sales and a decrease in new movie sales throughout the year. Previously viewed movies carry gross margins that are substantially higher than the average gross margins for new movie sales. In addition, the movie "Titanic" was released in the third quarter of Fiscal 1998 and was sold by the Company at low profit margins, although it was the largest new movie sales campaign in the history of the Company. Gross Margins. As a result of the improved margins on both rental revenues and product sales, total gross margins improved from 62.9% in Fiscal 1998, net of the impact of the change in rental inventory amortization policy, to 65.5% in Fiscal 1999. Operating Costs and Expenses. Store operating expenses, which include store-level expenses such as lease payments and in-store payroll, increased to 49.5% of total revenue for Fiscal 1999 from 48.7% for Fiscal 1998. The increase in store operating expenses as a percentage of revenues was primarily due to same-store revenues of 0.4% for Fiscal 1999 falling short of Company expectations and the impact of the Blowout Entertainment, Inc. ("Blowout") stores (acquired in May 1999) on operating expenses. These stores-within-a-store operate with a higher percentage of salaries and wages to total revenue than the Company's other stores and generate less average revenue than the Company's overall average revenue level. Also, the Company incurred some incremental training and other operational expenses during the integration of the 88-store Blowout acquisition and the ramp up of new store growth in the latter half of 1999. Amortization of intangibles increased as a percentage of revenues to 3.1% in Fiscal 1999 versus 2.7% in Fiscal 1998. This increase relates solely to the inclusion of $1.6 million in goodwill impairment write-offs during Fiscal 1999 in conjunction with ongoing asset impairment analysis performed by the Company, which is required by Financial Accounting Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." General and administrative expenses increased as a percentage of revenues from 6.7% for Fiscal 1998 to 7.7% for Fiscal 1999. The increase is primarily due to increased staffing and travel costs associated with the Company's ramp up in new store development, expense increases resulting from the acquisition and integration of the Blowout acquisition and incremental expenses from the launching of the Company's e-commerce effort at www.moviegallery.com. As a result of the above factors, excluding the impact of the amortization policy change in relation to Fiscal 1998, operating income increased by 12.5% to $14.4 million in Fiscal 1999 from $12.8 million in Fiscal 1998. Net interest expense as a percentage of revenues decreased to 1.2% in Fiscal 1999 versus 2.0% in Fiscal 1998. This decrease was primarily due to reductions in average debt outstanding during Fiscal 1999 versus Fiscal 1998. For Fiscal 1999 the Company's effective income tax rate was 41.9%, as compared to a 36.2% effective rate for Fiscal 1998. The increase in the income tax rate in Fiscal 1999 is primarily due to a shortfall in pre-tax income versus expectations, which causes the non-tax-deductible goodwill amortization associated with stock acquisitions made in previous years to increase the effective tax rate of the Company. 22 During the first quarter of Fiscal 1999, the Company incurred an extraordinary loss on the early extinguishment of debt of $682,000 (net of income taxes of $359,000), or $0.05 per diluted share. The extraordinary loss was comprised primarily of the write-off of both the unamortized debt issue costs and the negative value of an interest rate swap agreement in association with the restructuring of the Company's debt obligations discussed below in "Liquidity and Capital Resources." Effective January 4, 1999, the Company adopted the provisions of the American Institute of Certified Public Accountants Statement of Position 98-5, "Reporting the Costs of Start-Up Activities." As a result, the Company recorded a charge for the cumulative effect of an accounting change of $699,000 (net of income taxes of $368,000), or $0.05 per diluted share, to expense the unamortized portion of certain start-up costs that had been capitalized prior to January 4, 1999, discussed fully in Note 1 of the "Notes to Consolidated Financial Statements." Liquidity and Capital Resources Historically, the Company's primary capital needs have been for opening and acquiring new stores and for the purchase of videocassette inventory. Other capital needs include the refurbishment, remodeling and relocation of existing stores, as well as for common stock repurchases within the past two years. The Company has funded inventory purchases, remodeling and relocation programs, new store opening costs, acquisitions and stock repurchases primarily from cash flow from operations, the proceeds of two public equity offerings, loans under revolving credit facilities and seller financing. During Fiscal 2000, the Company generated $39.7 million in Adjusted EBITDA versus $35.5 million for Fiscal 1999. The increase in Adjusted EBITDA was primarily driven by the operating earnings generated by a 15.2% increase in total revenue. Adjusted EBITDA is defined as earnings before interest, taxes, depreciation and amortization, less the Company's purchase of rental inventory which excludes rental inventory purchases specifically for new store openings. Adjusted EBITDA should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. Cash earnings for Fiscal 2000 increased 14.1% to $17.0 million, or $1.47 per diluted share, from $14.9 million, or $1.11 per diluted share for Fiscal 1999. Contributing to this increase was a 14.0% decline in weighted average shares outstanding as a result of share repurchases. Cash earnings is defined as net income before extraordinary items, cumulative effect accounting changes and amortization of intangibles. Cash earnings should be considered in addition to, but not as a substitute for or superior to, operating income, net income, cash flow and other measures of financial performance prepared in accordance with generally accepted accounting principles. Net cash provided by operating activities was $99.2 million for Fiscal 2000 as compared to $84.4 million for Fiscal 1999. The increase in net cash provided by operating activities was primarily the result of increased net income and depreciation, decreased levels of merchandise inventory due to fewer titles being released at sell-through price points and a deemphasis on the sale of new movies in certain stores, as well as increased accounts payable due to significant rental inventory purchases in the fourth quarter of 2000 versus 1999. The increase was partially offset by reductions in accrued liabilities. Net cash provided by operating activities continues to be sufficient to cover capital resource and debt service needs. Net cash used in investing activities was $89.4 million for Fiscal 2000 as compared to $78.7 million for Fiscal 1999. This increase in funds used for investing activities is primarily the result of increases in capital expenditures related to rental inventory and property, furnishings and equipment purchased to support the growth in the Company's store base and the Company's increased new store development plan. 23 Net cash used by financing activities was $9.7 million for Fiscal 2000 as compared to $5.7 million for Fiscal 1999. This increase in funds used for financing activities is due to more stock repurchases and more significant reductions in long-term debt during Fiscal 2000 versus Fiscal 1999. On January 7, 1999, the Company entered into a Credit Agreement with First Union National Bank of North Carolina with respect to a revolving credit facility (the "Facility"). The Facility provides for borrowings of up to $65 million, is unsecured and will mature in its entirety on January 7, 2002. The interest rate of the Facility is based on LIBOR plus an applicable margin percentage, which depends on the Company's cash flow generation and borrowings outstanding. The Company may repay the Facility at any time without penalty. The more restrictive covenants of the Facility restrict borrowings based upon cash flow levels. The Company is currently negotiating a replacement for the existing Facility. The Company grows its store base through internally developed and acquired stores. The Company opened 110 internally-developed stores and acquired 16 stores during Fiscal 2000. During the year 2001, the Company intends to open approximately 75 new stores and will entertain potential acquisition transactions; however, the number of acquired stores in 2001 is anticipated to be less than the number of internally developed stores. To the extent available, new stores and future acquisitions may be completed using funds available under the Facility, financing provided by sellers, alternative financing arrangements such as funds raised in public or private debt or equity offerings or shares of the Company's stock issued to sellers. However, there can be no assurance that financing will be available to the Company on terms which will be acceptable, if at all. During the first quarter of 2000, the Company completed its previously announced $5 million stock repurchase plan and announced a second $5 million stock repurchase plan which was completed in May 2000. During Fiscal 2000, the Company repurchased 1.4 million shares for $5.7 million, which was funded through cash flow from operations. At December 31, 2000, the Company had a working capital deficit of $21.1 million, due to the accounting treatment of its rental inventory. Rental inventory is treated as a noncurrent asset under generally accepted accounting principles because it is a depreciable asset and is not an asset which is reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates the major portion of the Company's revenue, the classification of this asset as noncurrent results in its exclusion from working capital. The aggregate amount payable for this inventory, however, is reported as a current liability until paid and, accordingly, is included in working capital. Consequently, the Company believes that working capital is not an appropriate measure of its liquidity and it anticipates that it will continue to operate with a working capital deficit. The Company believes its projected cash flow from operations, borrowing capacity with the Facility, cash on hand and trade credit will provide the necessary capital to fund its current plan of operations for the fiscal year 2001, including its anticipated new store openings and a modest potential acquisition program. However, to fund a major acquisition program, or to provide funds in the event that the Company's need for funds is greater than expected, or if certain of the financing sources identified above are not available to the extent anticipated or if the Company increases its growth plan, the Company will need to seek additional or alternative sources of financing. This financing may not be available on terms satisfactory to the Company. Failure to obtain financing to fund the Company's expansion plans or for other purposes could have a material adverse effect on the Company. 24 Other Matters Market Risk Sensitive Instruments. The market risk inherent in the Company's financial instruments represents the increased interest costs arising from adverse changes in interest rates (primarily LIBOR and prime bank rates). In order to manage this risk, the Company entered into an interest rate swap agreement that effectively fixes the Company's interest rate exposure on $37 million of the amount outstanding under the Facility at 5.8% plus an applicable margin percentage. Assuming a hypothetical 10% adverse change in the LIBOR interest rate and assuming debt levels outstanding as of December 31, 2000, the Company would incur an immaterial amount of additional annual interest expense on unhedged variable rate borrowings. These amounts are determined by considering the impact of the hypothetical change in interest rates on the Company's cost of borrowing. The analysis does not consider the potential negative impact on overall economic activity that could exist in such an environment. The Company believes that its exposure to adverse interest rate changes and its impact on its total cost of borrowing capital has been largely mitigated by the interest rate swap agreement that is in place. Supply Contract. In March 2001, the Company and Rentrak Corporation ("Rentrak") amended the terms of the Company's existing supply contract with Rentrak. The Company paid Rentrak $1,600,000 in connection with the amendment to the contract. Additionally, the Company prepaid approximately $900,000 to be applied over a three-year period against future amounts due under the contract. Stock Repricing. In March 2000, the FASB issued FASB Interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25." The Interpretation requires that stock options that have been modified to reduce the exercise price be accounted for as variable. The Company repriced 384,000 stock options in March 2001, and reduced the exercise price to $4 per share. Under the Interpretation, the options are accounted for as variable until the options are exercised, forfeited or expire unexercised. The Company will record compensation expense in the first quarter of fiscal 2001 that will approximate the difference between the exercise price of the repriced options and the market price at the end of the quarter. Forward Looking Statements. With respect to forward-looking statements contained in this Item 7, please review the disclosures set forth under "Cautionary Statements" in Item 1 above. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Reference is made to Part II, Item 7, "Market Risk Sensitive Instruments" of this Form 10-K for the information required by Item 7A. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Reference is made to Part IV, Item 14 of this Form 10-K for the information required by Item 8. ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 25 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item (other than the information regarding executive officers set forth at the end of Item 1 of Part I of this Form 10-K) will be contained in the Company's definitive Proxy Statement for its 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item will be contained in the Company's definitive Proxy Statement for its 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item will be contained in the Company's definitive Proxy Statement for its 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item will be contained in the Company's definitive Proxy Statement for its 2001 Annual Meeting of Stockholders, and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) Financial Statements: Report of Ernst & Young LLP, Independent Auditors. Consolidated Balance Sheets as of December 31, 2000 and January 2, 2000. Consolidated Statements of Operations for the Fiscal Years Ended December 31, 2000, January 2, 2000, and January 3, 1999. Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended December 31, 2000, January 2, 2000, and January 3, 1999. Consolidated Statements of Cash Flows for the Fiscal Years Ended December 31, 2000, January 2, 2000, and January 3, 1999. Notes to Consolidated Financial Statements. (a)(2) Schedules: None. 26 (a)(3) Exhibits: The following exhibits, which are furnished with this Annual Report or incorporated herein by reference, are filed as part of this Annual Report: Exhibit No. Exhibit Description - ------- ------------------- 3.1 - Certificate of Incorporation of the Company. (1) 3.2 - Bylaws of the Company. (1) 4.1 - Specimen Common Stock Certificate. (2) 10.1 - 1994 Stock Option Plan, as amended and form of Stock Option Agreement. (3) 10.2 - Form of Indemnity Agreement. (1) 10.3 - Employment Agreement between M.G.A., Inc. and Joe Thomas Malugen.(1) 10.4 - Employment Agreement between M.G.A., Inc. and H.Harrison Parrish.(1) 10.5 - Employment Agreement between M.G.A., Inc. and J. Steven Roy. (4) 10.6 - Employment Agreement between M.G.A., Inc. and S. Page Todd. (4) 10.7 - Employment Agreement between M.G.A., Inc. and Jeffrey S. Stubbs. (filed herewith) 10.8 - Credit Agreement between First Union National Bank of North Carolina and Movie Gallery, Inc. dated January 7, 1999. (5) 18 - Change in Accounting Principle. (6) 21 - List of Subsidiaries. (filed herewith) 23 - Consent of Independent Auditors. (filed herewith) - --------------- (1) Previously filed with the Securities and Exchange Commission on June 10, 1994, as exhibits to the Company's Registration Statement on Form S-1 (File No. 33-80120). (2) Previously filed with the Securities and Exchange Commission on August 1, 1994, as an exhibit to Amendment No. 2 to the Company's Registration Statement on Form S-1. (3) Previously filed with the Securities and Exchange Commission on April 7, 1997, as an exhibit to the Company's Form 10-K for the fiscal year ended January 5, 1997. (4) Previously filed with the Securities and Exchange Commission on April 6, 1998, as an exhibit to the Company's Form 10-K for the fiscal year ended January 4, 1998. (5) Previously filed with the Securities and Exchange Commission on April 5, 1999, as an exhibit to the Company's Form 10-K for the fiscal year ended January 3, 1999. (6) Previously filed with the Securities and Exchange Commission on November 18, 1998, as an exhibit to the Company's Form 10-Q for the quarter ended October 4, 1998. (b) Reports on Form 8-K: The Company did not file any reports on Form 8-K during the quarter ended December 31, 2000. (c) Exhibits: See (a)(3) above. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this annual report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. MOVIE GALLERY, INC. By /s/ JOE THOMAS MALUGEN ---------------------------- Joe Thomas Malugen, Chairman of the Board and Chief Executive Officer Date: April 2, 2001 Pursuant to the requirements of the Securities Exchange Act of 1934, this annual report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ JOE THOMAS MALUGEN Chairman of the Board and Chief April 2, 2001 - ----------------------- Executive Officer Joe Thomas Malugen /s/ WILLIAM B. SNOW Vice Chairman of the Board April 2, 2001 - ----------------------- William B. Snow /s/ H. HARRISON PARRISH Director and President April 2, 2001 - ----------------------- H. Harrison Parrish /s/ SANFORD C. SIGOLOFF Director April 2, 2001 - ----------------------- Sanford C. Sigoloff /s/ J. STEVEN ROY Executive Vice President and April 2, 2001 - ----------------------- Chief Financial Officer J. Steven Roy /s/ IVY M. JERNIGAN Vice President - Controller April 2, 2001 - ----------------------- Ivy M. Jernigan 28 Movie Gallery, Inc. Consolidated Financial Statements Fiscal years ended December 31, 2000, January 2,2000 and January 3, 1999 Contents Report of Independent Auditors.............................................F-1 Audited Financial Statements Consolidated Balance Sheets.................................................F-2 Consolidated Statements of Operations.......................................F-3 Consolidated Statements of Stockholders' Equity.............................F-4 Consolidated Statements of Cash Flows.......................................F-5 Notes to Consolidated Financial Statements..................................F-6 Report of Independent Auditors Board of Directors and Stockholders Movie Gallery, Inc. We have audited the accompanying consolidated balance sheets of Movie Gallery, Inc. as of December 31, 2000 and January 2, 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in period ended December 31, 2000. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Movie Gallery, Inc. at December 31, 2000 and January 2, 2000, and the consolidated results of its operations and its cash flows for each of the three years in period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. As discussed in Note 1 to the financial statements, in fiscal 1999 the Company changed its method of accounting for the costs of start-up activities and in fiscal 1998 the Company changed its method of accounting for amortization of rental inventory. /s/ Ernst & Young, LLP Birmingham, Alabama February 16, 2001, except for Note 8, as to which the date is March 30, 2001 F-1 Movie Gallery, Inc. Consolidated Balance Sheets (in thousands)
December 31, January 2, 2000 2000 --------- --------- Assets Current assets: Cash and cash equivalents $ 7,029 $ 6,970 Merchandise inventory 9,264 15,148 Prepaid expenses 1,000 814 Store supplies and other 3,852 3,395 Deferred income taxes 502 229 --------- --------- Total current assets 21,647 26,556 Rental inventory, net 61,773 52,357 Property, furnishings and equipment, net 53,124 44,320 Goodwill and other intangibles, net 77,926 83,539 Deposits and other assets 3,066 2,543 Deferred income taxes -- 212 --------- --------- Total assets $ 217,536 $ 209,527 ========= ========= Liabilities and stockholders' equity Current liabilities: Accounts payable $ 31,111 $ 26,243 Accrued liabilities 11,631 12,989 Current portion of long-term debt -- 263 --------- --------- Total current liabilities 42,742 39,495 Long-term debt 40,600 44,377 Other accrued liabilities 253 234 Deferred income taxes 4,732 -- Stockholders' equity: Preferred stock, $.10 par value; 2,000,000 shares authorized, no shares issued or outstanding -- -- Common stock, $.001 par value; 35,000,000 shares authorized, 11,136,167 and 12,549,667 shares issued and outstanding 11 13 Additional paid-in capital 121,841 127,537 Retained earnings (deficit) 7,357 (2,129) --------- --------- Total stockholders' equity 129,209 125,421 --------- --------- Total liabilities and stockholders' equity $ 217,536 $ 209,527 ========= ========= See accompanying notes.
F-2 Movie Gallery, Inc. Consolidated Statements of Operations (in thousands, except per share data)
Fiscal Year Ended ----------------------------------- December 31, January 2, January 3, 2000 2000 1999 ----------------------------------- Revenues: Rentals $ 271,457 $ 235,452 $ 222,784 Product sales 47,479 41,493 44,849 --------- --------- --------- 318,936 276,945 267,633 Cost of sales: Cost of rental revenues 81,958 69,716 113,192 Cost of product sales 31,213 25,884 29,744 --------- --------- --------- Gross margin 205,765 181,345 124,697 Operating costs and expenses: Store operating expenses 153,665 137,128 130,473 Amortization of intangibles 7,465 8,452 7,068 General and administrative 24,945 21,403 17,996 --------- --------- --------- Operating income (loss) 19,690 14,362 (30,840) Interest expense, net (3,779) (3,349) (5,325) --------- --------- --------- Income (loss) before income taxes, extraordinary item and cumulative effect of accounting change 15,911 11,013 (36,165) Income taxes 6,425 4,615 (13,089) --------- --------- --------- Income (loss) before extraordinary item and cumulative effect of accounting change 9,486 6,398 (23,076) Extraordinary loss on early extinguishment of debt, net of income taxes of $359 -- (682) -- Cumulative effect of accounting change, net of income taxes of $368 -- (699) -- --------- --------- --------- Net income (loss) $ 9,486 $ 5,017 $ (23,076) ========= ========= ========= Basic and diluted earnings (loss) per share: Income (loss) before extraordinary item and cumulative effect of accounting change $ 0.83 $ 0.48 $ (1.72) Extraordinary loss on early extinguishment of debt, net of income taxes -- (0.05) -- Cumulative effect of accounting change, net of income taxes -- (0.05) -- --------- --------- --------- Net income (loss) $ 0.83 $ 0.38 $ (1.72) ========= ========= ========= Weighted average shares outstanding: Basic 11,467 13,115 13,388 Diluted 11,497 13,370 13,388 See accompanying notes.
F-3 Movie Gallery, Inc. Consolidated Statements of Stockholders' Equity (in thousands)
Additional Retained Total Common Paid-in Earnings Stockholders' Stock Capital (Deficit) Equity ------------------------------------------------ Balance at January 4, 1998 $ 13 $ 131,686 $ 15,930 $ 147,629 Net loss -- -- (23,076) (23,076) Exercise of stock options for 12,230 shares -- 48 -- 48 Tax benefit of stock options exercised -- 9 -- 9 Repurchase and retirement of 115,200 shares -- (495) -- (495) --------- --------- --------- --------- Balance at January 3, 1999 13 131,248 (7,146) 124,115 Net income -- -- 5,017 5,017 Exercise of stock options for 12,350 shares -- 48 -- 48 Tax benefit of stock options exercised -- 7 -- 7 Repurchase and retirement of 778,598 shares -- (3,766) -- (3,766) --------- --------- --------- --------- Balance at January 2, 2000 13 127,537 (2,129) 125,421 Net income -- -- 9,486 9,486 Repurchase and retirement of 1,413,500 shares (2) (5,696) -- (5,698) --------- --------- --------- --------- Balance at December 31, 2000 $ 11 $ 121,841 $ 7,357 $ 129,209 ========= ========= ========= ========= See accompanying notes.
F-4 Movie Gallery, Inc. Consolidated Statements of Cash Flows (in thousands)
Fiscal Year Ended ----------------------------------- December 31, January 2, January 3, 2000 2000 1999 ----------------------------------- Operating activities: Net income (loss) $ 9,486 $ 5,017 $ (23,076) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary loss on early extinguishment of debt, net of taxes -- 682 -- Cumulative effect of accounting change, net of taxes -- 699 -- Depreciation and amortization 76,787 72,205 126,257 Deferred income taxes 4,671 2,744 (14,855) Changes in operating assets and liabilities: Merchandise inventory 5,884 (2,788) 1,911 Other current assets (643) 348 (649) Deposits and other assets (518) (1,104) 105 Accounts payable 4,868 2,847 1,879 Accrued liabilities (1,356) 3,740 (709) --------- --------- --------- Net cash provided by operating activities 99,179 84,390 90,863 Investing activities: Business acquisitions (3,085) (11,839) (799) Purchases of rental inventory, net (63,211) (54,259) (59,266) Purchases of property, furnishings and equipment (23,086) (12,573) (6,251) --------- --------- --------- Net cash used in investing activities (89,382) (78,671) (66,316) Financing activities: Net proceeds from issuance of common stock -- 48 48 Purchases and retirement of common stock (5,698) (3,766) (495) Payments on notes payable -- -- (200) Principal payments on long-term debt (4,040) (2,014) (21,376) --------- --------- --------- Net cash used in financing activities (9,738) (5,732) (22,023) --------- --------- --------- Increase (decrease) in cash and cash equivalents 59 (13) 2,524 Cash and cash equivalents at beginning of period 6,970 6,983 4,459 --------- --------- --------- Cash and cash equivalents at end of period $ 7,029 $ 6,970 $ 6,983 ========= ========= ========= Supplemental disclosures of cash flow information: Cash paid during the period for interest $ 3,817 $ 3,076 $ 5,066 Cash paid during the period for income taxes 1,688 2,705 478 Noncash investing and financing information: Tax benefit of stock options exercised -- 7 9 See accompanying notes.
F-5 Movie Gallery, Inc. Notes to Consolidated Financial Statements December 31, 2000, January 2, 2000 and January 3, 1999 1. Accounting Policies The accompanying financial statements present the consolidated financial position, results of operations and cash flows of Movie Gallery, Inc. and subsidiaries (the "Company"). All material intercompany accounts and transactions have been eliminated. The Company owns and operates video specialty stores in 30 states. Fiscal Year The Company's fiscal year ends on the first Sunday following December 30, which periodically results in a fiscal year of 53 weeks. Results for fiscal years ended December 31, 2000 ("Fiscal 2000"), January 2, 2000 ("Fiscal 1999") and January 3, 1999 ("Fiscal 1998") reflect 52-week years. The Company's fiscal year includes revenues and certain operating expenses, such as salaries, wages and other miscellaneous expenses, on a daily basis. All other expenses, primarily depreciation and amortization, are calculated and recorded monthly, with twelve months included in each fiscal year. Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Merchandise Inventory Merchandise inventory consists primarily of videocassette tapes, digital video discs (DVDs), video games, video accessories and concessions and is stated at the lower of cost, on a first-in first-out basis, or market. Impairment of Long-Lived Assets The Company periodically assesses the impairment of long-lived assets, including allocated goodwill, to be held for use in operations based on expectations of future undiscounted cash flows from the related operations, and when circumstances dictate, adjusts the assets to the extent carrying value exceeds the estimated fair value of the assets. These factors, along with management's plans with respect to the operations, are considered in assessing the recoverability of goodwill, other purchased intangibles, rental inventory and property and equipment. Amortization of intangibles for Fiscal 2000, 1999 and 1998 includes an impairment loss of $1,000,000, $1,600,000 and $84,000, respectively, to write-off the net book value of goodwill in excess of its estimated fair market value. The Company assesses the recoverability of enterprise level goodwill and intangible assets by determining whether the unamortized balances can be recovered through undiscounted future cash flows. Rental Inventory Effective July 6, 1998, the Company changed its method of amortizing movie and video game rental inventory. This method accelerates the rate of amortization and was adopted as a result of an industry trend towards significant increases F-6 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) in copy-depth availability from movie studios, which have resulted in earlier satisfaction of consumer demand, thereby, accelerating the rate of revenue recognition. Under this method, the cost of base stock movie inventory, consisting of two copies per title for each store, is amortized on an accelerated basis to a net book value of $8 over six months and to a $4 salvage value over the next thirty months. The cost of non-base stock movie inventory, consisting of the third and succeeding copies of each title per store, is amortized on an accelerated basis over six months to a net book value of $4 which is then amortized on a straight-line basis over the next 30 months or until the movie is sold, at which time the unamortized book value is charged to cost of sales. Video games are amortized on a straight-line basis to a $10 salvage value over eighteen months. This method of amortization was applied to all inventory held at July 6, 1998. The adoption of this method of amortization was accounted for as a change in accounting estimate effected by a change in accounting principle during the quarter ended October 4, 1998. The application of the new method of amortizing movie and video game rental inventory decreased rental inventory and increased depreciation expense for Fiscal 1998 by approximately $43.6 million and reduced net income by $27.7 million, or $2.06 per basic and diluted share. Rental inventory consists of the following (in thousands): December 31, January 2, 2000 2000 --------- ---------- Rental inventory $ 145,557 $ 183,185 Less accumulated amortization (83,784) (130,828) --------- ---------- $ 61,773 $ 52,357 ========= ========== Property, Furnishings and Equipment Property, furnishings and equipment are stated at cost and include costs incurred in the construction of new stores. Depreciation is provided on a straight-line basis over the estimated lives of the related assets, generally five to seven years. Goodwill and Other Intangibles Goodwill is being amortized on a straight-line basis over twenty years. Other intangibles consist primarily of non-compete agreements and are amortized on a straight-line basis over the lives of the respective agreements which generally range from five to ten years. Accumulated amortization of goodwill and other intangibles at December 31, 2000 and January 2, 2000 was $35,830,000 and $32,097,000, respectively. F-7 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) Income Taxes The Company accounts for income taxes under the provisions of Financial Accounting Standards Board ("FASB") Statement No. 109, "Accounting for Income Taxes." Under Statement 109, deferred tax assets and liabilities are determined based upon differences between financial reporting and tax bases of assets and liabilities and are measured at the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Rental Revenue Rental revenue is recognized when the movie or video game is rented by the customer. Extended viewing fees on rentals are recognized when received from the customer. Advertising Costs Advertising costs, exclusive of cooperative reimbursements from vendors, are expensed when incurred. Store Opening and Start-up Costs Store opening costs, which consist primarily of payroll and advertising, are expensed as incurred. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position ("SOP") 98-5, "Reporting the Costs of Start-up Activities," which requires that certain costs related to start-up activities be expensed as incurred. Prior to January 4, 1999, the Company capitalized certain costs incurred in connection with site selection for new video specialty store locations. The Company adopted the provisions of the SOP in its financial statements for the first quarter of fiscal 1999. The effect of the adoption of SOP 98-5 was to record a charge for the cumulative effect of an accounting change of $699,000 (net of income taxes of $368,000), or $0.05 per share, to expense the unamortized costs that had been capitalized prior to January 4, 1999. The impact of adoption on income from continuing operations for Fiscal 1999 was not material. Fair Value of Financial Instruments At December 31, 2000 and January 2, 2000, the carrying value of financial instruments such as cash and cash equivalents, accounts payable, notes payable and long-term debt approximated their fair values, calculated using discounted cash flow analysis at the Company's incremental borrowing rate. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant estimates and assumptions relate to the amortization methods and useful lives of rental inventory, goodwill and other intangibles. These estimates and assumptions could change and actual results could differ from these estimates. F-8 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 1. Accounting Policies (continued) Recently Issued Accounting Pronouncements The FASB has issued Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" (as amended by Statements No. 137 and 138) which is required to be adopted by the Company in fiscal year 2001. Statement 133 will require the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If a derivative is a hedge, depending on the nature of the hedge, changes in the fair value of the derivative will either offset against the change in fair value of the hedged item through earnings or be recognized in other comprehensive income until the hedged item is recognized in earnings. Management does not anticipate that the adoption of this Statement will have a significant effect on earnings or the financial position of the Company. Employee Benefits The Company has a 401(k) savings plan available to all active employees who are over 21 years of age and have completed one year of service. The Company makes discretionary and matching contributions based on employee compensation. The matching contribution for Fiscal 2000, 1999 and 1998 was immaterial to the Company's operating results. 2. Property, Furnishings and Equipment Property, furnishings and equipment consists of the following (in thousands): December 31, January 2, 2000 2000 --------------------------- Land and buildings $ 4,006 $ 1,889 Furniture and fixtures 37,291 33,383 Equipment 33,616 28,495 Leasehold improvements and signs 36,860 27,931 --------- --------- 111,773 91,698 Accumulated depreciation (58,649) (47,378) --------- --------- $ 53,124 $ 44,320 ========= ========= 3. Long-Term Debt On January 7, 1999, the Company entered into a Credit Agreement with First Union National Bank of North Carolina with respect to a revolving credit facility (the "Facility"). The Facility provides for borrowings of up to $65 million, is unsecured and will mature in its entirety on January 7, 2002. The interest rate of the Facility is based on LIBOR plus an applicable margin percentage, which depends on the Company's cash flow generation and borrowings outstanding. The Company may repay the Facility at any time without penalty. The more restrictive covenants of the Facility restrict borrowings based upon cash flow levels. At December 31, 2000, $40.6 million was outstanding, approximately $23.9 million was available for borrowing and the effective interest rate was approximately 7.4%. F-9 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 3. Long-Term Debt (continued) Concurrent with the Facility, the Company amended its then existing interest rate swap to coincide with the maturity of the Facility. The amended interest rate swap agreement effectively fixes the Company's interest rate exposure on $37 million of the amount outstanding under the Facility at 5.8% plus an applicable margin percentage. The interest rate swap reduces the risk of increases in interest rates during the life of the Facility. The Company accounts for its interest rate swap as a hedge of its debt obligation. The Company pays a fixed rate of interest and receives payment based on a variable rate of interest. The difference in amounts paid and received under the contract is accrued and recognized as an adjustment to interest expense on the debt. There are no termination penalties associated with the interest rate swap agreement; however, if the swap agreement was terminated at the Company's option, the Company would either pay or receive the present value of the remaining hedge payments at the then prevailing interest rates for the time to maturity of the swap agreement. The interest rate swap agreement terminates at the time the Facility matures. As a result of the Facility and the amended interest rate swap agreement, the Company recognized an extraordinary loss on the extinguishment of debt of approximately $682,000 (net of income taxes of $359,000), or $.05 per share, during the first quarter of Fiscal 1999. The extraordinary loss was comprised primarily of unamortized debt issue costs associated with the Company's previous credit facility and the negative value of the previous interest rate swap at January 7, 1999. 4. Income Taxes The following reflects actual income tax expense (benefit) (in thousands): Fiscal Year Ended ----------------------------------------- December 31, January 2, January 3, 2000 2000 1999 ----------------------------------------- Current payable: Federal $ 1,439 $ 1,673 $ 1,275 State 315 198 491 -------- -------- -------- Total current 1,754 1,871 1,766 Deferred: Federal 4,056 2,454 (13,423) State 615 290 (1,432) -------- -------- -------- Total deferred 4,671 2,744 (14,855) -------- -------- -------- $ 6,425 $ 4,615 $(13,089) ======== ======== ======== F-10 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 4. Income Taxes (continued) A reconciliation of income tax expense (benefit) at the federal income tax rate to the Company's effective income tax provision is as follows (in thousands): Fiscal Year Ended ------------------------------------- December 31, January 2, January 3, 2000 2000 1999 ------------------------------------- Income tax expense (benefit) at statutory rate $ 5,569 $ 3,855 $(12,658) State income tax expense (benefit) net of federal income tax benefit 604 317 (612) Other, net (primarily goodwill not deductible for tax purposes) 252 443 181 -------- -------- -------- $ 6,425 $ 4,615 $(13,089) ======== ======== ======== Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income taxes. Components of the Company's deferred tax assets and liabilities are as follows (in thousands): December 31, January 2, 2000 2000 ----------------------- Deferred tax liabilities: Furnishings and equipment $ 6,003 $ 5,473 Rental inventory 6,351 3,818 Goodwill 2,251 2,026 Other -- 461 -------- -------- Total deferred tax liabilities 14,605 11,778 Deferred tax assets: Non-compete agreements 4,979 4,970 Alternative minimum tax credit carryforward 4,163 2,827 Net operating loss carryforwards -- 2,802 Accrued liabilities 502 777 Other 731 843 -------- -------- Total deferred tax assets 10,375 12,219 -------- -------- Net deferred tax assets (liabilities) $ (4,230) $ 441 ======== ======== F-11 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 5. Stockholders' Equity Common Stock In 1995, the Company registered shares of common stock with an aggregate public offering price of $127,000,000. This common stock may be offered directly through agents, underwriters or dealers or may be offered in connection with business acquisitions. As of December 31, 2000, common stock of approximately $83,000,000 was available to be issued from this registration. Earnings Per Share Basic earnings per share and basic pro forma earnings per share are computed based on the weighted average number of shares of common stock outstanding during the periods presented. Diluted earnings per share and diluted pro forma earnings per share are computed based on the weighted average number of shares of common stock outstanding during the periods presented, increased solely by the effects of shares to be issued from the exercise of dilutive common stock options (30,000, 255,000 and none for Fiscal 2000, 1999 and 1998, respectively). No adjustments were made to net income in the computation of basic or diluted earnings per share. Stock Option Plan In July 1994, the Board of Directors adopted, and the stockholders of the Company approved, the 1994 Stock Option Plan (the "Plan"). The Plan provides for the award of incentive stock options, stock appreciation rights, bonus rights and other incentive grants to employees, independent contractors and consultants. Currently 3,000,000 shares are reserved for issuance under the Plan. Options granted under the Plan have a 10-year term and generally vest over 3 to 5 years. In accordance with the provisions of FASB Statement No. 123, "Accounting for Stock-Based Compensation," the Company applies Accounting Principles Board Opinion No. 25 and related Interpretations in accounting for its stock option plan and, accordingly, has not recognized compensation cost in connection with the Plan. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by Statement 123, net income and earnings per share would have been reduced to the pro forma amounts indicated in the table below. The effect on net income and earnings per share is not expected to be indicative of the effects on net income and earnings per share in future years. Fiscal Year Ended --------------------------------------- December 31, January 2, January 3, 2000 2000 1999 --------------------------------------- (in thousands, except per share data) Pro forma net income (loss) $ 8,496 $ 3,801 $ (24,324) Pro forma earnings (loss) per share: Basic and diluted 0.74 0.29 (1.82) F-12 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 5. Stockholders' Equity (continued) The fair value of each option grant was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions: Fiscal Year Ended -------------------------------------------- December 31, January 2, January 3, 2000 2000 1999 -------------------------------------------- Expected volatility 0.703 0.720 0.733 Risk-free interest rate 5.15% 6.39% 4.70% Expected life of option in years 5.7 6.0 6.0 Expected dividend yield 0.0% 0.0% 0.0% The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. A summary of the Company's stock option activity and related information is as follows:
Fiscal Year Ended ------------------------------------------------------------------------------------- December 31, 2000 January 2, 2000 January 3, 1999 --------------------------- --------------------------- ---------------------------- Weighted- Weighted- Weighted- Average Average Average Options Exercise Price Options Exercise Price Options Exercise Price --------- -------------- --------- -------------- --------- -------------- Outstanding-beginning of year 2,276,987 $ 9.56 2,188,899 $ 9.73 1,895,537 $ 10.62 Granted 405,000 3.20 444,000 4.36 363,000 5.13 Exercised - - 12,350 3.88 12,230 3.88 Forfeited 139,480 5.14 343,562 4.17 57,408 11.32 Outstanding-end of year 2,542,507 8.79 2,276,987 9.56 2,188,899 9.73 Exercisable at end of year 1,669,307 11.30 1,440,871 12.03 1,206,397 12.68 Weighted-average fair value of options granted during the year $ 2.10 $ 3.05 $ 3.43
F-13 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 5. Stockholders' Equity (continued) Options outstanding as of December 31, 2000 had a weighted-average remaining contractual life of 7.1 years and exercise prices ranging from $3.00 to $40.00 as follows:
Exercise price of ---------------------------------------------------------------- $3.00 to $6.00 $14.00 to $22.00 $24.00 to $40.00 ---------------------------------------------------------------- Options outstanding 1,894,507 380,000 268,000 Weighted-average exercise price $4.05 $15.16 $33.22 Weighted-average remaining contractual life 8.0 years 4.3 years 4.4 years Options exercisable 1,030,707 370,600 268,000 Weighted-average exercise price of exercisable options $4.20 $15.19 $33.22
6. Commitments and Contingencies Rent expense for Fiscal 2000, 1999 and 1998 totaled $45,132,000, $41,683,000 and $40,959,000, respectively. Future minimum payments under noncancellable operating leases which contain renewal options and escalation clauses with remaining terms in excess of one year consisted of the following at December 31, 2000 (in thousands): 2001 $ 30,430 2002 26,015 2003 17,037 2004 10,301 2005 4,283 Thereafter 2,944 -------- $ 91,010 ======== The Company has a supply contract with Rentrak Corporation ("Rentrak") which requires the Company to order videocassette rental inventory under lease sufficient to require an aggregate minimum payment of $4,000,000 per year in revenue sharing, handling fees, sell through fees and end-of-term buyout fees. The agreement expires in 2006. The Company is occasionally involved in litigation in the ordinary course of its business, none of which, individually or in the aggregate, is material to the Company's business or results of operations. F-14 Movie Gallery, Inc. Notes to Consolidated Financial Statements (continued) 7. Summary of Quarterly Results of Operations (Unaudited) The following is a summary of unaudited quarterly results of operations (in thousands, except per share data):
Thirteen Weeks Ended ---------------------------------------------- April 2, July 2, October 1, December 31, 2000 2000 2000 2000 ---------------------------------------------- Revenue $81,493 $77,345 $75,350 $84,748 Operating income $ 7,478 $ 4,237 $ 1,893 $ 6,082 Net income $ 3,900 $ 1,935 $ 561 $ 3,090 Basic and diluted earnings per share $ 0.32 $ 0.17 $ 0.05 $ 0.28
Thirteen Weeks Ended ----------------------------------------------- April 4, July 4, October 3, January 2, 1999 1999 1999 2000 ----------------------------------------------- Revenue $ 69,620 $ 65,510 $ 67,742 $ 74,073 Operating income $ 6,377 $ 2,006 $ 1,642 $ 4,337 Income before extraordinary item and cumulative effect of accounting change $ 3,362 $ 679 $ 546 $ 1,811 Extraordinary loss on early extinguishment of debt, net of income taxes of $359 (682) -- -- -- Cumulative effect of accounting change, net of income taxes of $368 (699) -- -- -- -------- -------- -------- -------- Net income $ 1,981 $ 679 $ 546 $ 1,811 ======== ======== ======== ======== Basic and diluted earnings per share: Income before extraordinary item and cumulative effect of accounting change $ 0.25 $ 0.05 $ 0.04 $ 0.14 Extraordinary loss on early extinguishment of debt, net of tax (0.05) -- -- -- Cumulative effect of accounting change, net of tax (0.05) -- -- -- -------- -------- -------- -------- Net income $ 0.15 $ 0.05 $ 0.04 $ 0.14 ======== ======== ======== ========
8. Subsequent Events In March 2001, the Company and Rentrak amended the terms of the Company's existing supply contract with Rentrak. The Company paid Rentrak $1,600,000 in connection with the amendment to the contract. Additionally, the Company prepaid approximately $900,000 to be applied over a three-year period against future amounts due under the contract. In March 2000, the FASB issued FASB Interpretation No. 44 "Accounting for Certain Transactions involving Stock Compensation, an interpretation of APB Opinion No. 25." The Interpretation requires that stock options that have been modified to reduce the exercise price be accounted for as variable. The Company repriced 384,000 stock options in March 2001, and reduced the exercise price to $4 per share. Under the Interpretation, the options are accounted for as variable until the options are exercised, forfeited or expire unexercised. The Company will record compensation expense in the first quarter of fiscal 2001 that will approximate the difference between the exercise price of the repriced options and the market price at the end of the quarter. F-15 Index to Exhibits Exhibit No. Description - ----------- ----------- 10.7 Employment agreement between M.G.A., Inc. and Jeffrey S. Stubbs 21 List of Subsidiaries 23 Consent of Independent Auditors EX-10 2 form10k12312000ex10-7.txt EMPLOYMENT AGREEMENT Exhibit 10.7 EXECUTIVE EMPLOYMENT AGREEMENT BETWEEN M.G.A., INC. AND JEFFREY S. STUBBS DATED NOVEMBER 30, 1999 1 TABLE OF CONTENTS EXECUTIVE EMPLOYMENT AGREEMENT PARAGRAPH PAGE NO. - --------- -------- 1. Background 3 2. Definitions 3 3. Employment 6 4. Responsibilities 6 5. Non-Stock Compensation and Reimbursements 7 6. [Intentionally Left Blank] 9 7. [Intentionally Left Blank] 9 8. Termination 9 9. Proprietary Information 10 10. Covenant Not To Compete 11 11. Severability 11 12. Attorneys' Fees 11 13. Headings 11 14. Notices 11 15. General Provisions 11 16. Entire Agreement 12 2 EXECUTIVE EMPLOYMENT AGREEMENT This EXECUTIVE EMPLOYMENT AGREEMENT (the "Agreement") is entered into this 30th day of November, 1999 by and between M.G.A., INC., a Delaware corporation with its principal offices at 739 West Main Street, Dothan, Alabama 36301 (the "Company") and JEFFREY S. STUBBS ("Employee"), an individual, whose address is 118 Stonegate Drive, Headland, Alabama 36345, and shall be effective on the Effective Date, as defined below. NOW, THEREFORE, in consideration of the premises and the mutual covenants and agreements of the parties hereto, the parties do hereby covenant and agree as follows: 1. Background. A. The Company is engaged in the business of owning, managing, and operating video specialty stores. B. The Company desires to secure and retain the services of Employee in the office of Senior Vice President - Store Operations, and such services are considered by the Company to be valuable with regard to the business of owning, managing and operating video specialty stores. C. Employee desires to accept full and active employment with the Company in accordance with the terms and conditions herein set forth. 2. Definitions. As used in this Agreement, the following terms shall have the meaning as set forth below, and the parties hereto agree to be bound by the provisions hereof: A. Area means the geographic area of the forty-eight (48) contiguous continental states of the United States which is the area in which operations are performed, supervised, or assisted in by Employee on behalf of the Company, both as of the date hereof and as are anticipated to be conducted throughout the Term. B. Board of Directors means the Board of Directors of the Company. C. Change of Control means the occurrence of any of the following events: (i) Merger or consolidation where the Company is not the consolidated, continuing or surviving company, and the surviving or resulting company does not expressly agree to be bound by and have the benefits of the provisions of this Agreement, Employee's corporate position is eliminated, or the scope of Employee's position or responsibilities is materially changed; (ii) Transfer of all or substantially all of the assets or stock of the Company, and the transferee of the Company's assets or stock does not expressly agree to be bound by and have the benefits of the provisions of this Agreement, Employee's corporate position is eliminated, or the scope of Employee's position or responsibilities is materially changed; 3 (iii) Change in control of Company of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Securities Exchange Act of 1934 as in effect on the date thereof, and any person or persons acting in concert (as such term is used in Section 13(d) and 14(d)(2) of the Exchange Act) is or becomes the beneficial holder directly or indirectly of securities of the Company representing fifty percent (50%) or more of the combined voting power of Company's then outstanding securities, and the Employee's corporate position is eliminated, or the scope of Employee's position or responsibilities is materially changed; or (iv) Discontinuation of the business by Company. D. Chief Executive Officer means the Chief Executive Officer of the Company from time to time. E. Company means M.G.A., Inc., its parent corporation, Movie Gallery, Inc., and successors. F. Constructive Termination means a termination of this Agreement resulting from any material failure by the Company to fulfill its obligations under this Agreement which is not cured within thirty (30) days after receipt of written notice by the Company from Employee specifying the nature of the failure, which failure shall include, but shall not be limited to, (a) removal of Employee during the Term, other than removal as a result of a Termination With Cause or a Voluntary Termination, as Senior Vice President - Store Operations of the Company or any material change by the Company in the functions, duties or responsibilities of Employee during the Term from those in which Employee was engaged as Senior Vice President - Store Operations of the Company on the Effective Date, without the consent of Employee, (b) a material, non-voluntary reduction in Employee's Base Salary and eligibility for bonus amounts, or (c) the occurrence of a Change of Control. Constructive Termination shall occur only (A) after receipt by the Company of written notice from Employee specifying Employee's reasonable belief that an event of Constructive Termination has occurred, as defined herein, and (B) if Employee provides such notice to the Company and the Board of Directors within sixty (60) days after the date of such event. G. Effective Date means October 18, 1999. H. [Intentionally Left Blank] I. Initial Term means the basic term of this Agreement, which shall be twelve (12) months, beginning on the Effective Date and ending on the date which is twelve (12) months following the Effective Date. J. Permanent Disability means a physical or mental condition which renders Employee incapable of performing his regular duties hereunder for a period of one hundred twenty (120) consecutive days. In the event of any disagreement between Employee and the Company as to whether Employee is suffering from Permanent Disability, the determination of Employee's Permanent Disability shall be made by one or more board certified licensed physicians practicing the specialty of medicine applicable to Employee's disorder in accordance with the provisions of this Subsection J. If either the Company or Employee desires to initiate the procedure provided in this Section, such party (the "Initiating Party") shall deliver written notice to the other party (the "Responding Party") in accordance with the provisions of this Agreement specifying that the Initiating Party desires to proceed with a medical examination and the procedures specified in this Section. Such notice shall include the name, address and telephone number of the physician selected by the 4 Initiating party (the "Disability Examination Notice"). If the Responding Party fails within thirty (30) days after the receipt of the Disability Examination Notice to designate a physician meeting the standards specified herein, the physician designated by the Initiating Party in the Disability Examination Notice shall make the determination of Permanent Disability as provided in this Section. If the Responding Party by written notice notifies the Initiating Party within thirty (30) days of the receipt by the Responding Party of the Disability Examination Notice by notice specifying the physician selected by the Responding Party for purposes of this Section, then each of the two physicians as so designated by the respective parties shall each examine Employee. Examinations shall be made by each such physician within thirty (30) days of such physician's respective designation. Each physician shall render a written report as to whether Employee is, in such physician's opinion, suffering Permanent Disability. If the two physicians agree on the status of Employee for purposes of this Section, such determination shall be conclusive and dispositive for all purposes of this Section. If the two physicians cannot agree, the two physicians shall jointly select a third physician meeting the standards specified in this Section within thirty (30) days after the later report of the two physicians is submitted. The third physician shall render a written report on the status of Employee within thirty (30) days of selection and such report shall be dispositive for purposes of this Section. For purposes of this Subsection J, Employee agrees that he shall promptly submit to such examinations and tests as such physicians shall reasonably request for purposes of making a determination of Permanent Disability as provided herein. Failure or refusal of the Company to designate a licensed physician to make a determination of Permanent Disability as required in accordance with this Section or of Employee to submit to the examination as required by this Section shall constitute a conclusive admission by the Company or Employee, as appropriate, that Employee is suffering from a Permanent Disability as provided herein. K. Renewal Term means the period, if any, following the Initial Term during which the Agreement is extended as set forth in Section 8B. L. [Intentionally Left Blank] M. Severance Amount shall have the meaning as set forth in Section 5C. N. Term means the Initial Term and any Renewal Term. 0. Termination Date means the following: (a) with respect to Termination With Cause, thirty (30) days after the date the Company notifies Employee in writing of the actions described in Subsection 2P(i) and the termination of this Agreement based thereon, or the date which is thirty (30) days after written notice of violation to Employee pursuant to Subsection 2P(ii) not cured by Employee; (b) with respect to the death of Employee, the date of his death; (c) with respect to Termination Without Cause, thirty (30) days after the date on which the Company gives Employee notice of Termination Without Cause; (d) with respect to Voluntary Termination, thirty (30) days after the date on which Employee unilaterally terminates his employment relationship with the Company; (e) with respect to the Permanent Disability of Employee, the date Employee is determined to be suffering from Permanent Disability, as provided in Subsection 2J; and (f) with respect to Constructive Termination, the date which is thirty (30) days after the receipt by the Company of the notice specified in Subsection 2F. P. Termination With Cause means the termination of this Agreement and the employment relationship of Employee with the Company, only for the following: (i) Theft or embezzlement with regard to material property of the Company; or 5 (ii) Continued neglect by Employee in fulfilling his duties as Senior Vice President - Store Operations of the Company as a result of alcoholism, drug addiction or nervous breakdown, intentional neglect, insubordination, or excessive unauthorized absenteeism by Employee, after written notification thereof from the Chief Executive Officer or Board of Directors, setting forth in detail the matters involved, and Employee's failure to cure the problems or matters set forth in such notice within a reasonable time. Q. Termination Without Cause means any of the following: (i) A termination by the Company of this Agreement and the employment relationship of Employee with the Company during the Term which is not a Termination With Cause, a Voluntary Termination or a Constructive Termination, including the expiration of the Term as a result of the Company electing not to renew this Agreement at the end of the Initial Term or any Renewal Term. (ii) Any relocation of Employee by the Company, not agreed to in writing by the Employee (which must reference this Agreement), to a location which is outside of a fifty (50) mile radius of Dothan, Alabama. R. Triggering Event means (i) a termination of Employee's employment by the Company during the Term due to a Termination Without Cause or (ii) a Constructive Termination of Employee's employment with the Company. S. Video Business means the business engaged in by the Company in owning, managing and operating video specialty stores, and all ancillary services relating to the ownership, management and operation of video specialty stores. T. Voluntary Termination means unilateral termination by Employee of his employment with the Company prior to the end of the Term and in the absence of a Triggering Event, or as a result of Employee electing not to renew this Agreement at the end of the Initial Term or any Renewal Term. Notice by Employee to the Company of a failure by the Company to fulfill its obligations under this Agreement pursuant to Section 2F shall not constitute a Voluntary Termination for purposes of this Agreement. 3. Employment. The Company, through its Board of Directors, agrees to employ Employee in the office of Senior Vice President - Store Operations of the Company for the Term, and Employee agrees to accept such employment and office upon the terms and conditions set forth herein. 4. Responsibilities. Pursuant to this Agreement, Employee shall assume the responsibilities, perform the duties, and exercise the powers as Senior Vice President - Store Operations of the Company, as set forth in the Bylaws of the Company or as designated, assigned or set forth by the Chief Executive Officer or Board of Directors and consistent with the responsibilities, duties and powers exercised by Employee as Senior Vice President - Store Operations of the Company as of the Effective Date and such other duties as may be assigned from time to time by the Chief Executive Officer or Board of Directors. The Employee agrees to devote his full time and efforts to the performance of his duties as Senior Vice President - Store Operations of the Company. The Employee agrees that he will not engage in any other gainful occupation during the term of this Agreement, without the prior written consent of the Company. Nothing contained herein shall be construed, however, to prevent the Employee from personal business, charitable and professional activities, from trading, for his own account and benefit, in stocks, bonds, securities, real estate, commodities, or other forms of investments. Employee agrees to comply with the Company's policies, rules and regulations as determined by the Board of Directors. 6 5. Non-Stock Compensation and Reimbursements. The Company shall pay, and Employee agrees to accept, as partial compensation for services to be rendered hereunder during the Term, the remuneration described below: A. Annual Salary. The Company shall pay Employee a base annual salary as of the Effective Date of One Hundred Twenty Five Thousand and No/100 Dollars ($125,000.00) per year ("Base Salary"), subject to such increases as the Board of Directors in its sole discretion deems appropriate in accordance with the Company's customary procedures regarding the salaries of its executive officers. The Base Salary shall be payable according to the customary payroll practices of the Company, but in no event less frequently than monthly. B. Bonuses. During the Term, Employee shall be entitled to participate in the Company's annual salaried employee bonus program, as amended from time to time by the Board of Directors. Under the current bonus program, Employee shall be eligible to receive bonuses of up to forty percent (40%) of Base Salary. Such bonuses are based on individual performance versus defined objectives and a corporate performance multiplier. During the Term, Employee shall be entitled to participate in other incentive and/or bonus, cash and equity compensation plans of the Company which provide benefits to senior officers, as determined by the Board of Directors of the Company. C. Severance Payments and Agreements. (i) Upon the occurrence of a Triggering Event, Employee shall be deemed to have earned the Severance Amount, as defined below, on the effective date of the Triggering Event. The obligation of the Company under this Subsection 5C(i) shall take the place of any other obligations of the Company under this Section 5 to pay to Employee for the balance of the Term Employee's then Base Salary pursuant to Subsection 5A. (ii) For purposes of this Agreement, the term Severance Amount shall mean the following: (a) if a Triggering Event occurs as a result of a Constructive Termination in connection with a Change of Control, the Severance Amount shall be an amount equal to one and one half (1 1/2) times Employee's Base Salary; (b) if a Triggering Event (other than a Constructive Termination in connection with a Change of Control) occurs within one hundred eighty (180) days prior or subsequent to the date of a Change of Control, or is in any way related to, results from, arises out of, or is in connection with a Change of Control, the Severance Amount shall be an amount equal to one and one half (1 1/2) times Employee's Base Salary; or (c) if a Triggering Event otherwise occurs, the Severance Amount shall be an amount equal to one (1) times Employee's Base Salary. (iii) If the Severance Amount payable pursuant to this Section is an amount equal to one and one-half (1 1/2) times Employee's Base Salary, then the Severance Amount shall be paid within thirty (30) days of the date of the Triggering Event. Otherwise, the Severance Amount payable pursuant to this Section shall be paid over the twelve (12) month period following the Triggering Event according to the Company's payroll practices and procedures in effect at the time of the Triggering Event. (iv) Upon the occurrence of a Triggering Event, any and all stock options to purchase shares of the Company's Common Stock which are held by Employee shall become one hundred percent (100%) vested and immediately exercisable as of the date of such Triggering Event, and shall be exercisable by the Employee over the balance of the remaining stated term of such stock options (which term shall be the term applicable to the Employee in the absence of termination of employment), notwithstanding any provision contained in the stock option agreement to the contrary. 7 (v) [Intentionally Left Blank] (vi) Any controversy or claim arising out of or relating to whether termination of Employee's employment is due to a Triggering Event, or is a Termination With Cause, a Termination Without Cause, a Constructive Termination or a Voluntary Termination as provided herein, shall be settled by arbitration in accordance with the Commercial Arbitration Rules ("Rules") of the American Arbitration Association ("AAA"). Arbitration shall be initiated by a party by giving notice in the manner set forth herein to the other party of its intention to arbitrate, which notice shall contain a statement setting forth the nature of the dispute, the amount claimed, if any, and the remedy sought. The initiating party shall then file a copy or copies of the notice as set forth under the Rules. Dothan, Alabama shall be the location where the arbitration is held. The parties shall agree upon and appoint three (3) arbitrators in accordance with the Rules within thirty (30) days of the effective date of notice of arbitration; however, if the parties fail to make such designation within thirty (30) days, the AAA shall make the appointment. The determinations of such arbitrators will be final and binding upon the parties to the arbitration, and judgment upon the award rendered by the arbitrators may be entered in any such court having jurisdiction, or application may be made to such court for a judicial acceptance of the award and an order of enforcement, as the case may be. The arbitrators shall apply the laws of the State of Alabama as to both substantive and procedural questions. D. Car Allowance. The Company shall pay Employee a monthly car allowance payable monthly in advance in accordance with customary practices of the Company of not less than Five Hundred and No/100 Dollars ($500.00) per month. E. Insurance and Benefits. (i) Employee shall be entitled to participate in or receive benefits under all employee and executive benefit plans or arrangements and perquisites of employment, including, without limitation, plans or arrangements providing for health and disability insurance coverage, life insurance for the benefit of Employee's beneficiaries, deferred compensation and pension benefits, and personal financial, investment, legal or tax advice, all at the highest level that is available through the Company to other senior officers of the Company subject to the same terms and conditions as apply to such other senior officers. (ii) Employee shall be entitled to all holidays recognized by the Company and vacation time for not less than three (3) weeks per year plus such additional time as is available under the vacation policy of the Company in effect for senior officers with continuing payment of all compensation as set forth herein. Employee shall be reimbursed by the Company for all expenses incurred on behalf of the Company in accordance with the then current reimbursement policies of the Company. Nothing paid to Employee under any plan, arrangement or perquisite presently in effect or made available in the future shall be deemed to be in lieu of the salary and other compensation or payments paid or payable to Employee under this Agreement. (iii) In the event of a termination of Employee's employment with the Company as a result of or in connection with a Triggering Event, and Employee elects under COBRA to continue his individual and/or family group health coverage, then for a twelve (12) month period following the Termination Date, the Company shall pay Employee (on a monthly basis) an amount equal to the actual premium cost to Employee for such continuation coverage. 8 F. [Intentionally Left Blank] 6. [Intentionally Left Blank] 7. [Intentionally Left Blank] 8. Termination. A. This Agreement will commence on the Effective Date and shall continue during the Initial Term. B. In addition to the Initial Term, this Agreement shall be renewed for additional one (1) year periods (the "Renewal"), ad infinitum, unless either party gives notice of non-renewal at least thirty (30) days prior to the expiration of the Initial Term or the then current Renewal Term. C. During the Term, the Company or Employee may terminate this Agreement, subject to the terms, conditions and obligations hereof, by any of the following events: (i) Mutual written agreement expressed in a single document signed by both the Company and Employee; (ii) Voluntary Termination by Employee; (iii) Death of Employee; (iv) Termination Without Cause; (v) Termination With Cause; (vi) Constructive Termination; or (vii) Permanent Disability. Upon termination for any of the foregoing reasons, Employee shall continue to render services and shall be paid his Base Salary and benefits up to the Termination Date. In the event of such termination, this Agreement shall be deemed terminated for all purposes, except to the extent otherwise herein provided. D. The obligations of Employee under Sections 8 and 9 shall survive termination or expiration of this Agreement. The obligations of the Company under Section 8, and those obligations under Section 5 that by their terms are to be paid or to continue after termination of this Agreement, shall also survive such termination. 9 9. Proprietary Information. A. In performance of services under this Agreement, Employee may have access to: (i) information which derives economic value, actual or potential, from not being generally known to, and not being readily ascertainable by proper means by, other persons who can obtain economic value from its disclosure or use, and is the subject of efforts that are reasonable under the circumstances to maintain its secrecy (hereinafter "Trade Secrets" or "Trade Secret"); or (ii) information which does not rise to the level of a Trade Secret, but is valuable to the Company and provided in confidence to Employee (hereinafter "Confidential Information"). B. Employee acknowledges and agrees with respect to Trade Secrets and Confidential Information provided to or obtained by Employee (hereinafter collectively the "Proprietary Information"): (i) that the Proprietary Information is and shall remain the exclusive property of the Company; (ii) to use the Proprietary Information exclusively for the purpose of fulfilling the obligations under this Agreement; (iii) to return the Proprietary Information, and any copies thereof, in his possession or under his control, to the Company upon request of the Company, or expiration or termination of this Agreement for any reason; and (iv) to hold the Proprietary Information in confidence and not to copy, publish, or disclose to others or allow any other party to copy, publish, or disclose to in any form, any Proprietary Information without the prior written approval of an authorized representative of the Company. C. The obligations and restrictions set forth in this section 9 shall survive expiration or termination of this Agreement, for any reason, and shall remain in full force and effect as follows: (i) as to Trade Secrets, for so long as such information remains subject to protection under applicable law; (ii) as to Confidential Information, for a period of five (5) years after expiration or termination of this Agreement for any reason. D. The obligations set forth in this Section 9 shall not apply or shall terminate with respect to any particular portion of the Proprietary Information which: (i) was in Employee's possession, free of any obligation of confidence, prior to his receipt of the Confidential Information from the Company; (ii) is in the public domain at the time the Company communicates it to Employee, or becomes available to the public through no breach of this Agreement by Employee; or (iii) is received by Employee independently and in good faith from a third party lawfully in possession thereof and having no obligation to keep such information confidential. 10 10. Covenant Not To Compete. Employee hereby agrees that during the term hereof, and for a period of one (1) year from the date of expiration or termination of this Agreement for any reason, and within the Area, Employee will not: A. compete with the Company in the Video Business, or engage in or carry on the Video Business, directly or indirectly, through any person or entity, or in any capacity, including, without limitation, agent, lender, trustee, consultant, shareholder, director, officer, employee, or partner; B. be employed by, or perform any services as employee, consultant, or otherwise for, any person, firm, partnership, joint venture, corporation or other entity that competes with the Company in the Video Business, or that is engaged in the Video Business within the Area; C. employ, solicit for employment, or advise or recommend to any other person or entity that such person or entity employ, or solicit for employment, any employee of the Company; or D. deal with, invest in (other than as a stockholder of less than one percent (1%) of the issued and outstanding stock of a publicly traded corporation having assets in excess of $25,000,000.00), lend money to, guarantee loans of, make gifts to, advise, or by any other means assist any other person or entity that competes with the Company, or that is engaged in the Video Business within the Area. 11. Severability. If any provision of this Agreement is held to be invalid or unenforceable by any court of competent jurisdiction, such holdings shall not affect the enforceability of any other provision of this Agreement, and all other provisions shall continue in full force and effect. 12. Attorneys' Fees. If a dispute between the parties arises in connection with this Agreement, the prevailing party as determined through arbitration or final judgment of a court of competent jurisdiction (which arbitration or judgment is not subject to further appeal due to the passage of time or otherwise) shall be entitled to reimbursement from the other party for reasonable attorneys' fees and expenses incurred by the prevailing party in connection with the resolution of the dispute. 13. Headings. The headings of the several paragraphs in this Agreement are inserted for convenience of reference only and are not intended to affect the meaning or interpretation of this Agreement. 14. Notices. All notices, consents, requests, demands and other communications hereunder shall be in writing and shall be deemed to have been duly given or delivered if (i) delivered personally; (ii) mailed by certified mail, return receipt requested, with proper postage prepaid; or (iii) delivered by recognized courier contracting for same day or next day delivery with signed receipt acknowledgment to the Company at its principal offices, or to Employee at the address last shown on the records of the Company, or at such other address as the parties hereto may have last designated by notice to the other party. Any item delivered personally or by recognized courier contracting for same day or next day delivery shall be deemed delivered on the date of delivery. Any item mailed shall be deemed to have been delivered on the date evidenced on the return receipt. 15. General Provisions. This Agreement shall be governed by and construed under the laws of the State of Alabama, without giving effect to its conflict of law principles. The terms of this Agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns. Neither party may assign his or its rights and obligations under this Agreement to any other party. 11 16. Entire Agreement. This Agreement contains the entire agreement between the parties hereto, and except as otherwise provided in this Agreement, supersedes and cancels all previous and contemporaneous written and oral agreements, including all prior employment agreements between the Company and Employee and amendments thereto. No amendment or modification of this Agreement shall be valid or binding unless in writing and signed by the party to be bound. IN WITNESS WHEREOF, the parties hereto have affixed their seals and executed this Agreement effective as of the date first above written. COMPANY: ATTEST: M.G.A., INC. /s/ S. Page Todd By: /s/ J. T. Malugen - ------------------------- ----------------------- Secretary J. T. Malugen Its: Chief Executive Officer ----------------------- Date: January 3, 2000 --------------- EMPLOYEE: /s/ S. Page Todd /s/ Jeffrey S. Stubbs - ------------------------ ------------------------------- Witness Jeffrey S. Stubbs, Individually Date: December 22, 1999 ----------------- 12 EX-21 3 form10k12312000ex21.txt LIST OF SUBSIDIARIES EXHIBIT 21 Movie Gallery, Inc. List of Subsidiaries Name of Subsidiary State of Incorporation - ------------------ ---------------------- M.G.A., Inc. Delaware MovieGallery.com, Inc. Delaware Movie Gallery Finance, Inc. Delaware EX-23 4 form10k12312000ex23.txt CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statements (Form S-8 Nos. 33-82968, 33-98896, 333-04633 and 333-82183) pertaining to the Movie Gallery, Inc. 1994 Stock Plan and in the Registration Statement (Form S-3 No. 33-95854) of Movie Gallery, Inc. and the related Prospectus, of our report dated February 16, 2001 (except for Note 8, as to which the date is March 30, 2001) with respect to the consolidated financial statements of Movie Gallery, Inc. included in the Annual Report (Form 10-K) for the fiscal year ended December 31, 2000. /s/ Ernst & Young, LLP Birmingham, Alabama March 30, 2001 -----END PRIVACY-ENHANCED MESSAGE-----