UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended July 1,September 30, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
¨ | 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
(Exact name of registrant as specified in charter)
DELAWARE 63-1120122
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
900 West Main Street, Dothan, Alabama 36301
(Address of principal executive offices) (zip code)
DELAWARE | 63-1120122 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
900 West Main Street, Dothan, Alabama | 36301 | |
(Address of principal executive offices) | (zip code) |
(334) 677-2108
(Registrant's
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a non-accelerated filer.smaller reporting company. See definition of "accelerated
filer“large accelerated filer”, “accelerated filer” and large accelerated filer"“smaller reporting company” in Rule 12b-2 of the Exchange Act. Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
(Check one):
Large accelerated filer ¨ | Accelerated filer x | |
Non-accelerated filer ¨ | Smaller reporting company ¨ | |
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ]¨ No [X]
x
The number of shares outstanding of the registrant'sregistrant’s common stock, par value $0.001 per share as of August 1, 2007May 19, 2008 (prior to the Effective Date, as defined below) was 33,096,866.
32,917,345.
On the Effective Date, the date of our emergence from Chapter 11 Bankruptcy, our old common stock and other equity interests existing immediately prior to May 20, 2008 were canceled for no consideration.
Part I -– Financial Information
Forward Looking Statements
This quarterly reportQuarterly Report on Form 10-Q for Movie Gallery, Inc. (“Movie Gallery,” “Company,” “we,” “us,” or “our”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which represent our expectations or beliefs about future events and financial performance. Forward-looking statements are identifiable by the fact that they do not relate strictly to historical information and may include words such as "believe,"
"anticipate," "expect," "intend," "plan," "will," "may," "estimate"“believe,” “anticipate,” “expect,” “intend,” “plan,” “will,” “may,” “estimate” or other similar expressions and variations thereof. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Our forward-looking statements are based on management'smanagement’s current intent, belief, expectations, estimates and projections regarding our company and our industry. Forward-
lookingForward-looking statements are subject to known and unknown risks and uncertainties, including those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.2006 and subsequent reports filed with the Securities and Exchange Commission. Forward-looking statements include statements regarding the risks and uncertainties associated with our ability to restructure our indebtedness,successfully effectuate the Second Amended Joint Plan of Reorganization of Movie Gallery, Inc. and Its Debtor Subsidiaries Under Chapter 11 of the Bankruptcy Code with Technical Modifications (the “Plan”), as confirmed by order of the United States Bankruptcy Court of the Eastern District of Virginia (the “Bankruptcy Court”) on April 10, 2008 (the “Confirmation Order”), our ability to continueoperate subject to the terms of our existing financing obligations, our ability to fund our operations, our ability to make projected capital expenditures, the impact of litigation on our business, the importance of the home video industry to movie studios, our ability to expand into the online video rental market, the receipt of our federal tax refund for the 2002 tax year, as well as general market conditions, competition and pricing. Our forward-looking statements are subject to risks and uncertaintiesFactors that could cause actual results to differ materially including,from these forward-looking statements include, but are not limited to, risks and uncertainties that:
- - revenuesregarding:
our ability to successfully implement all post-emergence aspects of the Plan;
our ability to manage liquidity needs and operate subject to the terms of our financing;
our ability to maintain contracts and leases that are less than projected;
- -critical to our operations;
our ability to execute our business plans and strategy, including our operational restructuring initially announced in 2007, and doing so in a timely fashion;
the volatility of financial results and the potential that they do not reflect historical trends;
our ability to attract, motivate, and/or retain key executives and associates;
2
unfavorable general economic or business conditions affecting the video and game rental and sale industry (which is dependent on consumer spending), either nationally or regionally;
our ability to attract and retain customers;
increased competition in the video and game rental and sale industry;
additional impairment and other charges that we could incur additional impairment charges on our long-lived assets, including rental inventory, should our future estimates of operating cash flows and our estimates of the recoverability of the values of our assets differ from our current estimates;
- - we are unable to extend our Forbearance Agreement (as amended) or
otherwise amend the financial covenants contained in our senior credit
facility;
- - we default on our second lien facility and/or our 11% Senior Notes;
- -
our real estate subleasing programdownsizing efforts and other initiatives failfailing to generate anticipated cost reductions;
- -
the availability of new movie releases priced for sale below the current market negatively impacts
consumers'impacting consumers’ desire to rent movies;
- -
unforeseen issues arisearising with the continued integration of the Hollywood Entertainment business;
- -
our actual expenses or liquidity requirements differdiffering from estimates and expectations;
- - consumer demand for movies and games is less than expected;
- -
the availability of movies and games isbeing less than expected;
- -
competitive pressures arebecoming greater than anticipated; - - we are unableor
an inability to obtain additional working capital for our business; or
- - are related to a restructuring of our indebtedness either pursuant to an
out-of-court transaction or through a chapter 11 proceeding.
business.
In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this quarterly reportQuarterly Report on Form 10-Q might not occur. In addition, actual results could differ materially from those suggested by the forward-looking statements, and therefore you should not place undue reliance on the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We desire to take advantage of the "safe harbor"“safe harbor” provisions of the Private Securities Litigation Reform Act of 1995, and, in that regard, we caution the readers of this quarterly reportQuarterly Report on Form 10-Q that the important factors described under Part II, Item 1A. Risk Factors in this quarterly reportQuarterly Report on Form 10-Q and under Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, among others, could affect our actual results of operations and may cause changes in our strategy with the result that our operations and results may differ materially from those expressed in any forward-looking statements made by us, or on our behalf.
Item 1. Financial Statements
Similarly, these and other factors, including the terms of the Plan, affected the value of our various pre-petition liabilities, pre-petition common stock and/or other equity securities. Pursuant to the Plan, on the Effective Date, our old common stock and other equity interests existing immediately prior to the Effective Date were canceled for no consideration.
3
Item 1. | Financial Statements |
Movie Gallery, Inc.
Consolidated Balance Sheets
(In
(In thousands, except per share amounts)
--------------------------
December 31, July 1,
2006 2007
------------ ------------
(Unaudited)
Assets
Current assets:
Cash and cash equivalents $ 32,953 $ 45,513
Merchandise inventory, net 140,614 175,470
Prepaid expenses 45,324 45,787
Store supplies and other 20,211 16,722
Assets held for sale - 7,613
Deferred income taxes 209 -
------------ ------------
Total current assets 239,311 291,105
Rental inventory, net 339,981 325,259
Property, furnishings and equipment, net 242,935 153,925
Goodwill 115,569 -
Other intangibles, net 181,912 82,673
Deferred income taxes, net - 3,031
Deposits and other assets 33,569 36,000
------------ ------------
Total assets $ 1,153,277 $ 891,993
============ ============
Liabilities and stockholders' deficit
Current liabilities:
Current maturities of long-term obligations $ 4,580 $ 1,197,683
Accounts payable 86,380 64,322
Accrued liabilities 80,432 72,825
Accrued payroll 47,896 34,276
Accrued interest 6,774 11,239
Deferred revenue 42,055 38,870
------------ ------------
Total current liabilities 268,117 1,419,215
Long-term obligations, less current portion 1,087,875 -
Other accrued liabilities 33,716 33,072
------------ ------------
1,389,708 1,452,287
Stockholders' deficit:
Preferred stock, $.10 par value; 2,000
shares authorized, no shares issued
or outstanding - -
Common stock, $.001 par value; 65,000
shares authorized, 31,840 and 32,275
shares issued and outstanding, respectively 32 32
Additional paid-in capital 197,961 199,130
Accumulated deficit (443,602) (768,407)
Accumulated other comprehensive income 9,178 8,951
------------ ------------
Total stockholders' deficit (236,431) (560,294)
------------ ------------
Total liabilities and stockholders' deficit $ 1,153,277 $ 891,993
============ ============
December 31, 2006 | September 30, 2007 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 32,953 | $ | 42,689 | ||||
Merchandise inventory, net | 140,614 | 159,331 | ||||||
Prepaid expenses | 45,324 | 19,155 | ||||||
Store supplies and other | 20,211 | 20,702 | ||||||
Assets held for sale | — | 26,165 | ||||||
Deferred income taxes | 209 | — | ||||||
Total current assets | 239,311 | 268,042 | ||||||
Rental inventory, net | 339,981 | 247,583 | ||||||
Property, furnishings and equipment, net | 242,935 | 133,240 | ||||||
Goodwill | 115,569 | — | ||||||
Other intangibles, net | 181,912 | 21,693 | ||||||
Deferred income taxes, net | — | 1,774 | ||||||
Deposits and other assets | 33,569 | 34,070 | ||||||
Total assets | $ | 1,153,277 | $ | 706,402 | ||||
Liabilities and stockholders’ deficit | ||||||||
Current liabilities: | ||||||||
Current maturities of long-term obligations | $ | 4,580 | $ | 1,194,601 | ||||
Accounts payable | 86,380 | 52,743 | ||||||
Accrued liabilities | 80,432 | 77,541 | ||||||
Accrued payroll | 47,896 | 31,157 | ||||||
Accrued interest | 6,774 | 22,992 | ||||||
Deferred revenue | 42,055 | 35,526 | ||||||
Total current liabilities | 268,117 | 1,414,560 | ||||||
Long-term obligations, less current portion | 1,087,875 | — | ||||||
Other accrued liabilities | 33,716 | 39,101 | ||||||
Commitments and contingencies | ||||||||
Stockholders’ deficit | ||||||||
Preferred stock, $.10 par value; 2000 shares authorized, no shares issued or outstanding | — | — | ||||||
Common stock, $.001 par value; 65,000 shares authorized, 31,840 and 32,282 shares issued and outstanding, respectively | 32 | 32 | ||||||
Additional paid-in capital | 197,961 | 199,602 | ||||||
Accumulated deficit | (443,602 | ) | (956,937 | ) | ||||
Accumulated other comprehensive income | 9,178 | 10,044 | ||||||
Total stockholders’ deficit | (236,431 | ) | (747,259 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 1,153,277 | $ | 706,402 | ||||
The accompanying notes are an integral part of thisthese consolidated financial statement.
statements.
4
Movie Gallery, Inc.
Consolidated Statements of Operations
(Unaudited,
(Unaudited, in thousands, except per share amounts)
Thirteen Weeks Ended Twenty-Six Weeks Ended
----------------------- -----------------------
July 2, July 1, July 2, July 1,
2006 2007 2006 2007
---------- ---------- ----------- -----------
Revenue:
Rentals $ 493,546 $ 433,405 $ 1,063,975 $ 944,449
Product sales 107,739 127,819 231,677 264,469
--------- ---------- ----------- -----------
Total revenue 601,285 561,224 1,295,652 1,208,918
Cost of sales:
Cost of rental revenue 154,904 140,993 328,481 296,016
Cost of product sales 77,413 96,114 171,293 199,502
-------- ---------- ----------- -----------
Gross profit 368,968 324,117 795,878 713,400
Operating costs and expenses:
Store operating expenses 305,494 303,621 617,221 611,603
General and administrative 48,523 45,930 95,464 92,895
Amortization of intangibles 708 686 1,441 1,381
Impairment of goodwill - 115,570 - 115,570
Impairment of other
intangibles - 97,879 - 97,879
Impairment of property,
furnishings, and equipment - 43,001 - 43,001
Other expenses - (325) - (303)
-------- --------- ----------- -----------
Operating income (loss) 14,243 (282,245) 81,752 (248,626)
Interest expense, net (includes
$17,538 write off of debt
issuance costs for the twenty-
six weeks ended July 1, 2007) 30,694 28,679 58,147 76,479
-------- --------- ----------- -----------
Income (loss) before income
taxes (16,451) (310,924) 23,605 (325,105)
Income taxes (benefit) (1,553) (985) (1,847) (300)
-------- --------- ----------- -----------
Net income (loss) $(14,898) $(309,939) $ 25,452 $ (324,805)
======== ========= =========== ===========
Net income (loss) per share:
Basic $ (0.47) $ (9.69) $ 0.80 $ (10.18)
Diluted $ (0.47) $ (9.69) $ 0.80 $ (10.18)
Weighted average shares outstanding:
Basic 31,828 31,986 31,759 31,917
Diluted 31,828 31,986 31,828 31,917
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
October 1, 2006 | September 30, 2007 | October 1, 2006 | September 30, 2007 | |||||||||||||
Revenue: | ||||||||||||||||
Rentals | $ | 475,779 | $ | 430,919 | $ | 1,539,754 | $ | 1,375,367 | ||||||||
Product sales | 107,210 | 148,043 | 338,888 | 412,514 | ||||||||||||
Total revenue | 582,989 | 578,962 | 1,878,642 | 1,787,881 | ||||||||||||
Cost of sales: | ||||||||||||||||
Cost of rental revenue | 141,589 | 184,229 | 470,073 | 480,246 | ||||||||||||
Cost of product sales | 78,160 | 121,449 | 249,455 | 320,953 | ||||||||||||
Gross profit | 363,240 | 273,284 | 1,159,114 | 986,682 | ||||||||||||
Operating costs and expenses: | ||||||||||||||||
Store operating expenses | 320,521 | 305,631 | 937,743 | 917,233 | ||||||||||||
General and administrative | 46,144 | 57,359 | 141,605 | 150,252 | ||||||||||||
Amortization of intangibles | 701 | 451 | 2,142 | 1,832 | ||||||||||||
Impairment of goodwill | — | — | — | 115,570 | ||||||||||||
Impairment of other intangibles | — | 60,543 | — | 158,422 | ||||||||||||
Impairment of property, furnishings and equipment | — | 5,657 | — | 48,658 | ||||||||||||
Other expenses (income) | — | (701 | ) | — | (1,005 | ) | ||||||||||
Operating income (loss) | (4,126 | ) | (155,656 | ) | 77,624 | (404,280 | ) | |||||||||
Interest expense, net (includes $17,538 write-off of debt issuance costs for the thirty-nine weeks ended September 30, 2007) | 31,185 | 35,654 | 89,331 | 112,134 | ||||||||||||
Loss before income taxes | (35,311 | ) | (191,310 | ) | (11,707 | ) | (516,414 | ) | ||||||||
Income taxes (benefit) | 800 | (2,780 | ) | (1,048 | ) | (3,079 | ) | |||||||||
Net loss | $ | (36,111 | ) | $ | (188,530 | ) | $ | (10,659 | ) | $ | (513,335 | ) | ||||
Net loss per share: | ||||||||||||||||
Basic | $ | (1.13 | ) | $ | (5.84 | ) | $ | (0.34 | ) | $ | (16.02 | ) | ||||
Diluted | $ | (1.13 | ) | $ | (5.84 | ) | $ | (0.34 | ) | $ | (16.02 | ) | ||||
Weighted average shares outstanding: | ||||||||||||||||
Basic | 31,840 | 32,280 | 31,786 | 32,038 | ||||||||||||
Diluted | 31,840 | 32,280 | 31,786 | 32,038 |
The accompanying notes are an integral part of thisthese consolidated financial statement.
statements.
5
Movie Gallery, Inc.
Consolidated Statements of Cash Flows
(Unaudited,
(Unaudited, in thousands)
Twenty-Six Weeks Ended
----------------------
July 2, July 1,
2006 2007
--------- ---------
Operating activities:
Net income (loss) $ 25,452 $(324,805)
Adjustments to reconcile net income (loss)
to net cash used in operating activities:
Rental inventory amortization 119,750 93,779
Purchases of rental inventory, net (82,236) (77,264)
Purchases of rental inventory-base stock (9,434) (524)
Depreciation and intangibles amortization 52,080 47,126
Gain on disposal of property, furnishings,
equipment, net (697) (268)
Stock-based compensation 1,057 635
Amortization of debt issuance cost 3,243 3,388
Write off of debt issuance cost - 17,538
Impairment of goodwill - 115,570
Impairment of other intangibles - 97,879
Impairment of property, furnishings, and
equipment - 43,001
Other non-cash (income) expense - (1,806)
Deferred income taxes 687 (2,851)
Changes in operating assets and liabilities,
net of business acquisitions:
Merchandise inventory 14,709 (34,486)
Other current assets (7,326) 5,223
Deposits and other assets (75) (1,460)
Accounts payable (144,096) (22,397)
Accrued interest 54 4,466
Accrued liabilities and deferred revenue (8,404) (24,932)
--------- ---------
Net cash used in operating activities (35,236) (62,188)
Investing activities:
Business acquisitions, net of cash acquired (319) (3,129)
Purchase of property, furnishings and equipment (15,091) (1,384)
Proceeds from disposal of property,
furnishings and equipment 1,320 537
--------- ---------
Net cash used in investing activities (14,090) (3,976)
Financing activities:
Repayment of capital lease obligations (328) (1,034)
Net borrowings (repayments) on credit facilities (1,395) 83,477
Debt financing fees (5,528) (23,239)
Proceeds from issuance of long-term debt - 775,000
Principal payments on long-term debt (58,840) (754,858)
--------- ---------
Net cash provided by (used in)
financing activities (66,091) 79,346
Effect of exchange rate changes on cash
and cash equivalents 1,330 (622)
--------- ---------
Increase (decrease) in cash and
cash equivalents (114,087) 12,560
Cash and cash equivalents at
beginning of period 135,238 32,953
--------- ---------
Cash and cash equivalents
at end of period $ 21,151 $ 45,513
========= =========
Supplemental non-cash investing and financing
activities:
Change in construction phase assets $ 373 $ -
Borrowings of capital lease obligations - 2,365
Thirty-Nine Weeks Ended | ||||||||
October 1, 2006 | September 30, 2007 | |||||||
Operating activities: | ||||||||
Net loss: | $ | (10,659 | ) | $ | (513,335 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities | ||||||||
Rental inventory amortization | 311,283 | 266,441 | ||||||
Purchases of rental inventory | (280,581 | ) | (244,798 | ) | ||||
Purchases of rental inventory - base stock | (10,527 | ) | (608 | ) | ||||
Change in rental amortization estimates | 11,311 | 57,007 | ||||||
Depreciation and intangibles amortization | 82,890 | 62,457 | ||||||
Stock-based compensation | 2,073 | 1,107 | ||||||
Amortization of debt issuance cost | 4,952 | 4,824 | ||||||
Write off of debt issuance cost | — | 17,538 | ||||||
Impairment of goodwill | — | 115,570 | ||||||
Impairment of other intangibles | — | 158,422 | ||||||
Impairment of property, furnishings, and equipment | — | 48,658 | ||||||
Other non-cash (income) expense | — | (1,806 | ) | |||||
Deferred income taxes | 18 | (1,547 | ) | |||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||
Merchandise inventory | 12,634 | (18,034 | ) | |||||
Other current assets | (7,075 | ) | 28,353 | |||||
Deposits and other assets | 2,567 | (1,361 | ) | |||||
Accounts payable | (157,454 | ) | (34,172 | ) | ||||
Accrued interest | 9,029 | 16,219 | ||||||
Accrued liabilities and deferred revenue | (5,487 | ) | (21,045 | ) | ||||
Net cash used in operating activities | (35,026 | ) | (60,110 | ) | ||||
Investing activities: | ||||||||
Business acquisitions, net of cash acquired | (319 | ) | (3,129 | ) | ||||
Purchases of property, furnishings and equipment | (19,145 | ) | (4,305 | ) | ||||
Proceeds from disposal of property, furnishings, and equipment | 1,320 | 537 | ||||||
Net cash used in investing activities | (18,144 | ) | (6,897 | ) | ||||
Financing activities: | ||||||||
Repayment of capital lease obligations | (412 | ) | (1,173 | ) | ||||
Net borrowings on credit facilities | 13,142 | 83,477 | ||||||
Debt financing fees | (5,528 | ) | (23,239 | ) | ||||
Proceeds from issuance of long-term debt | 1,948 | 775,000 | ||||||
Principal payments on long-term debt | (72,392 | ) | (756,358 | ) | ||||
Net cash provided by (used in) investing activities | (63,242 | ) | 77,707 | |||||
Effect of exchange rate changes on cash and cash equivalents | 808 | (964 | ) | |||||
Increase (decrease) in cash and cash equivalents | (115,604 | ) | 9,736 | |||||
Cash and cash equivalents at beginning of period | 135,238 | 32,953 | ||||||
Cash and cash equivalents at end of period | $ | 19,634 | $ | 42,689 | ||||
Supplemental non-cash investing and financing activities | ||||||||
Change in construction phase assets | 3,553 | — | ||||||
Borrowings of capital lease obligations | — | 1,096 |
The accompanying notes are an integral part of thisthese consolidated financial statement.
statements.
6
Movie Gallery, Inc.
Notes to Consolidated Financial Statements (Unaudited)
July 1,
September 30, 2007
References herein to “Movie Gallery,” the “Company,” “we,” “our,” or “us” refer to Movie Gallery, Inc. and its subsidiaries unless the context specifically indicates otherwise. References herein to “Hollywood” refer to Hollywood Entertainment Corporation.
1. Proceedings under Chapter 11 of the United States Bankruptcy Code
On October 16, 2007, referred to herein as the Commencement Date, Movie Gallery, Inc., or the Company, and each of its U.S. subsidiaries, collectively referred to herein as the Reorganized Debtors, filed voluntary petitions in the United States Bankruptcy Court for the Eastern District of Virginia, Richmond Division, referred to herein as the Bankruptcy Court, seeking reorganization relief under the provisions of Chapter 11 of the United States Bankruptcy Code, referred to herein as the Bankruptcy Code, collectively referred to herein as the Chapter 11 Cases. The Reorganized Debtors filed jointly with the following direct and indirect subsidiaries: Hollywood Entertainment Corporation, M.G. Digital, LLC, M.G.A. Realty I, LLC, MG Automation LLC and Movie Gallery US, LLC. Our Canadian subsidiary, Movie Gallery Canada, Inc., and our Mexican subsidiary, Movie Gallery Mexico, Inc., S. de R.L. de C.V., were not part of the filing and continued operating outside of the Chapter 11 Cases. In general, as debtors-in-possession, each of the former Debtor entities was authorized to continue to operate as an ongoing business, but could not engage in transactions outside the ordinary course of business without the prior approval of the Bankruptcy Court.
Subject to certain exceptions in the Bankruptcy Code, the filing of the Chapter 11 Cases automatically stayed the initiation or continuation of most actions against the Reorganized Debtors, including most actions to collect pre-petition indebtedness or to exercise control over the property of the Reorganized Debtors’ estates. As a result, absent an order of the Bankruptcy Court, creditors were precluded from collecting pre-petition debts.
Under the Bankruptcy Code, debtors generally must assume or reject pre-petition executory contracts and unexpired leases, including but not limited to real property leases, subject to the approval of the Bankruptcy Court and certain other conditions. In this context, “assumption” means that the debtors agree to perform obligations and cure all existing defaults under the executory contract or unexpired lease, and “rejection” means that the debtors are relieved from obligations to perform further under the executory contract or unexpired lease that is rejected, but, for a contract or lease that is rejected, the debtors are liable for a pre-petition claim for damages for the breach thereof, subject to certain limitations. Any damages that result from executory contracts and unexpired leases being rejected that are recoverable under Chapter 11 shall be classified as liabilities subject to compromise for fiscal reporting periods subsequent to the Commencement Date unless such claims were secured prior to the Commencement Date. Since the Commencement Date and through the filing date of this Quarterly Report on Form 10-Q, the Reorganized Debtors have received Bankruptcy Court approval to reject or terminate unexpired leases of real property related to approximately 1,330 stores and other executory contracts and unexpired leases of various types. In connection with the Plan, on the Effective Date, the Reorganized Debtors assumed certain executory contracts and unexpired leases, among others, set
7
forth in the Schedule of Executory Contracts and Unexpired Leases (Other Than Unexpired Leases of Nonresidential Real Property) Included in the “Schedule of Assumed Executory Contracts and Unexpired Leases,” Revised Schedule of Executory Contracts and Unexpired Leases (Other Than Unexpired Leases of Nonresidential Real Property) Included in the “Schedule of Assumed Executory Contracts and Unexpired Leases” and the Schedule of Unexpired Leases of Nonresidential Real Property Included in the “Schedule of Assumed Executory Contracts and Unexpired Leases.”
The Reorganized Debtors sought and obtained Bankruptcy Court approval of their “first day” motions and applications to, among other things, pay pre-petition employee wages, health benefits and other employee obligations during their restructuring under Chapter 11. Additionally, the Reorganized Debtors were given approval to continue to honor their current customer policies regarding merchandise returns and to honor outstanding gift cards and loyalty programs. Also, the Reorganized Debtors were authorized to pay ordinary course post-petition expenses without seeking Bankruptcy Court approval.
We received notification from The NASDAQ Stock Market, or NASDAQ, indicating that our common stock was delisted from NASDAQ due to our filing for protection under Chapter 11. Trading in our common stock was suspended at the opening of business on October 25, 2007. We did not appeal NASDAQ’s delisting decision, and from October 25, 2007 and through May 19, 2008, our common stock traded on the over-the-counter, or OTC, Bulletin Board or the “Pink Sheets” under the symbol MOVIQ.PK.
In connection with the Chapter 11 Cases, on November 16, 2007, the Reorganized Debtors received final approval of their motion filed with the Bankruptcy Court for a $150 million secured super-priority debtor in possession (DIP) credit agreement, referred to herein as the DIP Credit Agreement, between and among us, certain of our subsidiaries as Guarantors, Goldman Sachs Credit Partners L.P., as Lead Arranger and Syndication Agent, the Bank of New York as Administrative Agent and Collateral Agent, and the lenders that from time to time become party thereto. The DIP Credit Agreement provided for (i) a $50 million revolving loan and letter of credit facility and (ii) a $100 million term loan. The proceeds of the loans and other financial accommodations incurred under the DIP Credit Agreement (as amended) were used to refinance our pre-petition, secured revolving credit facility and provide us with additional working capital. For more information regarding the DIP Credit Agreement, see Note 8, Long Term Obligations and Item 2. Liquidity and Capital Resources in this Quarterly Report on Form 10-Q.
On October 14, 2007 the Reorganized Debtors, certain lenders under the second lien facility, certain holders of Movie Gallery’s 11% senior notes and Sopris Capital Advisors LLC, a private investment fund, or Sopris, entered into a Lock Up, Voting and Consent Agreement through which the parties to the agreement committed to support the Reorganized Debtors’ restructuring plans, including an agreement to vote to accept a Chapter 11 plan consistent with the Plan Term Sheet attached to the Lock Up Agreement.
The Reorganized Debtors negotiated the terms of the Plan with Sopris, in its capacity as the largest holder of Movie Gallery’s 11% Senior Notes and in its capacity as a substantial holder of claims under our second lien credit agreement, as well as the Reorganized Debtors’ other significant creditor constituencies. As a result of these negotiations, the Reorganized Debtors formulated the Plan with the input and support of their major constituents. The Plan is based on the Plan Term Sheet attached to the Lock Up Agreement and the plan attached to the Plan Support Agreement (described below), but there are some material modifications, including with respect to recoveries for holders of claims and equity interests.
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Additionally, while the Reorganized Debtors were negotiating the terms of the Plan, the parties were also negotiating the terms of a Plan Support Agreement, pursuant to which certain parties memorialized their agreement to support the Plan. The Plan Support Agreement was agreed to by the parties on January 18, 2008. The Plan Support Agreement was executed and on February 6, 2008, the Bankruptcy Court entered an order authorizing the Reorganized Debtors to perform under the Plan Support Agreement.
On December 22, 2007, the Reorganized Debtors filed with the Bankruptcy Court the Joint Plan of Reorganization of Movie Gallery, Inc. and Its Debtor Subsidiaries Under Chapter 11 of the Bankruptcy Code and a related Disclosure Statement. On February 4, 2008, the Reorganized Debtors filed with the Bankruptcy Court amended versions of those documents, which were titled the First Amended Joint Plan of Reorganization of Movie Gallery, Inc. and Its Debtor Subsidiaries Under Chapter 11 of the Bankruptcy Code (as amended by the Second Amended Joint Plan of Movie Gallery, Inc. and Its Debtor Subsidiaries Under Chapter 11 of the Bankruptcy Code filed with the Bankruptcy Court on February 18, 2008 and as further amended by the Second Amended Joint Plan of Movie Gallery, Inc. and Its Debtor Subsidiaries Under Chapter 11 of the Bankruptcy Code with Technical Modifications filed with the Bankruptcy Court on April 10, 2008) and a Disclosure Statement related to the Plan, referred to herein as the Disclosure Statement.
On February 5, 2008, the Bankruptcy Court approved the Disclosure Statement and authorized the Reorganized Debtors to begin soliciting votes on the Plan. On April 4, 2008, the Reorganized Debtors issued a press release announcing that each class of creditors entitled to vote on the Plan voted to support the Plan. On April 10, 2008, the Bankruptcy Court entered an order confirming the Plan as supplemented by certain plan supplements filed with the Bankruptcy Court beginning on April 2, 2008.
On May 20, 2008, the date of our emergence from Chapter 11 Bankruptcy, or the Effective Date, the Reorganized Debtors consummated the transactions contemplated by the Plan. On the Effective Date, our old common stock and other equity interests existing immediately prior to the Effective Date were canceled. Pursuant to the Plan, on or promptly after the Effective Date, we issued (i) 7,544,460 shares of common stock, par value $0.001 per share (the “New Common Stock”) to holders of 11% Senior Note Claims (as defined in the Plan), (ii) 8,251,498 shares of New Common Stock to affiliates of Sopris Capital Advisors LLC (“Sopris”), on account of the conversion of the Sopris Second Lien Claims (as defined in the Plan), (iii) 5,000,000 shares of New Common Stock to participants in the Rights Offering (as defined in the Plan), (iv) 115,000 shares of New Common Stock to affiliates of Sopris in satisfaction of its fee for providing the Backstop Commitment (as defined in the Plan), and (v) 60,000 shares of New Common Stock to Imperial Capital, LLC, on account of a claim against us for services rendered on behalf of the official committee of unsecured creditors during our chapter 11 proceedings. We will reserve 2,395,540 shares of New Common Stock for future issuance to holders of allowed claims in Classes 7A, 7B and 7E under the Plan.
In addition, we reserved 2,828,226 shares of New Common Stock for future issuance as grants of equity, restricted stock or options under a management and directors equity incentive plan, the terms of which will be determined by our Board of Directors. Under the Plan, at a minimum, 50% of the awards under such management and directors equity incentive plan must be granted within 60 days following the Effective Date.
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Pursuant to the Plan, on or promptly after the Effective Date, we issued warrants (the “$20 Warrants”) to purchase an aggregate of 1,229,815 shares of New Common Stock. We will issue 933,430 $20 Warrants to the holders of 11% Senior Note Claims and will reserve 296,385 $20 Warrants for future issuance to holders of allowed claims in Classes 7A, 7B and 7E under the Plan. In addition, pursuant to the Plan, on or promptly after the Effective Date, we will issue (i) warrants (the “$10 Warrants”) to purchase an aggregate of 86,250 shares of New Common Stock to Sopris in satisfaction of the arrangement fee payable under the Seasonal Overadvance Facility (as defined in the Plan), and (ii) warrants (the “$0.01 Warrants” and, together with the $20 Warrants and the $10 Warrants, the “New Warrants”) to purchase up to an aggregate of 2,001,289 shares of New Common Stock to lenders under the Exit Facility (as defined in the Plan).
On the Effective Date, we entered into a Registration Rights Agreement with Sopris and its affiliates. The Registration Rights Agreement provides registration rights for the shares of New Common Stock, New Warrants and the shares of New Common Stock issuable upon exercise of the New Warrants (collectively, the “Registrable Securities”).
Under the Registration Rights Agreement, and subject to certain restrictions, the holders of a majority of the Registrable Securities have the right to request that we effect the registration of the Registrable Securities held by such requesting holders, plus the Registrable Securities of any other holder giving us a timely request to join in such registration (a “Demand Registration”). Additionally, under the Registration Rights Agreement, and subject to certain restrictions, if we propose to register any of our securities (other than pursuant to a Demand Registration) then we must provide the holders of Registrable Securities with piggyback registration rights to have their Registrable Securities included in such registration.
On the Effective Date, May 20, 2008, the Reorganized Debtors entered into several new credit facilities:
We and certain of our subsidiaries entered into the Amended and Restated First Lien Credit and Guaranty Agreement with a syndicate of lenders, Wilmington Trust Company, as administrative agent, and Deutsche Bank Trust Company Americas, as collateral agent, which amended and restated the First Lien and Guaranty Agreement, dated March 8, 2007. The Amended and Restated First Lien Credit and Guaranty Agreement is a senior secured credit facility in an aggregate amount not to exceed $626,488,750 (plus accrued and capitalized interest and fees), consisting of $602,988,750 aggregate principal amount of term loans (the “First Lien Term Loan Facility”) and $23,500,000 aggregate principal amount of letters of credit (the “Letter of Credit Facility” and, together with the First Lien Term Loan Facility, the “First Lien Credit Facility”);
We and certain of our subsidiaries entered into the Amended and Restated Second Lien Credit and Guaranty Agreement with a syndicate of lenders and Wells Fargo Bank, as administrative agent and collateral agent, which amended and restated the Second Lien and Guaranty Agreement, dated March 8, 2007. The Amended and Restated Second Lien Credit and Guaranty Agreement is a senior secured credit facility which provides for term loans in an aggregate principal amount not to exceed $117,141,030 (plus accrued and capitalized interest and fees) (the “Second Lien Credit Facility”); and
We and certain of our subsidiaries entered into the Revolving Credit and Guaranty Agreement with various lenders, Sopris Partners Series A of Sopris Capital Partners, LP, as arranger, The Bank of New York, as administrative agent, and Deutsche Bank Trust Company Americas, as collateral agent. The Revolving Credit and Guaranty Agreement is a senior secured credit facility which provides for revolving loans up to an aggregate principal amount of $100,000,000 (the “Revolving Credit Facility”).
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We and certain of our subsidiaries entered into the Seasonal Overadvance Facility with various lenders, Sopris Partners Series A of Sopris Capital Partners, LP, as arranger. The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to procure up to $25 million in letters of credit during the period between September 2008 and January 2009, which is referred to as the “Commitment Period.” During the Commitment Period, we may elect to provide certain studios and game vendors with whom we conduct business letters of credit which may be drawn upon if we fail to make timely payments of certain amounts due. Additionally, in the event a vendor draws on a letter of credit, we will be obligated to pay Sopris an amount equal to the amount of the drawing, plus certain additional consideration in the form of Warrants.
Liquidity
The accompanying financial statements have been prepared on a going concern basis, which assumes that we will realize our assets and satisfy our liabilities in the normal course of business. However, we have experienced
recurring lossesThe appropriateness of continuing to use the going concern basis for our financial statements is dependent upon, among other things, our ability to comply with the terms of our credit facilities and any cash management order entered by the Bankruptcy Court in connection with the Chapter 11 Cases (through the Effective Date), our ability to maintain adequate cash on hand, our ability to generate cash from operations, which have generated an accumulated deficit
of $768.4 million through July 1, 2007. In addition, we are not in compliance
with the financial covenants contained inand our first lien facilities described
in Note 8 as of July 1, 2007 and accordingly, the obligations due under our
first lien facilities have been classified as current liabilities as of July 1,
2007. Dueability to this default under the first lien credit agreement, the
obligations due under our second lien term loan and the 11% senior notes, each
as described in Note 8, have also been classified as current liabilities as of
July 1, 2007. As of July 1, 2007, we have a working capital deficiency of $1.1
billion. At July 1, 2007, we had $45.5 million of cash and cash equivalents
and did not have any available borrowings under our March 2007 Credit Facility.achieve profitability following emergence. These events raise substantial doubt as to our ability to continue as a going concern. The accompanying financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or amounts and classification of liabilities or amounts that may result from the outcome of this uncertainty.
As a result of our non-compliance with the financial covenants contained in the
first lien facilities and our resulting default under the first lien credit
agreement, the first lien credit agreement lenders have the right to terminate
their commitments, accelerate all of our obligations and exercise their
remedies under the first lien credit agreement. We have executed a Forbearance
Agreement (as amended), effective as of July 2, 2007, with certain lenders
under the first lien credit agreement. Under the Forbearance Agreement (as
amended), the lenders will forbear until August 14, 2007 from exercising
default-related rights and remedies arising from existing defaults, absent any
new defaults under the first lien credit agreement or the Forbearance Agreement
(as amended). We have also begun discussions with the advisors representing
our first lien lenders on extending the Forbearance Agreement (as amended).
We are currently in discussions with the advisors representing our first lien
lenders and other major creditors to address our current financial situation.
In the near future, we expect to present a longer-term solution to the first
lien lender group and other major creditors that will address the operational
and financial issues currently impacting our business. This longer-term
solution includes accelerating the closure of unprofitable stores,
consolidating stores in certain markets, obtaining additional working capital,
realigning our cost structure to better reflect our reduced size and seeking a
more competitive capital structure. In connection with a solution, it is
likely that we will need the first lien lenders to waive our existing defaults
under the first lien credit agreement and to substantially modify the financial
covenants contained therein. We cannot assure you that:
- - we will reach such an agreement with our first lien lenders prior to the
expiration of the forbearance period discussed above;
- - we will be able to obtain an extension of our forbearance period if we
are not able to reach such an agreement with our first lien lenders prior
to the August 14, 2007 expiration of the forbearance period; or
- - if we do reach an agreement, what the terms of such agreement will be or
what actions we will be required to undertake in connection with such an
agreement, such as selling assets, closing stores, securing additional
financing, reducing or delaying capital expenditures or restructuring our
existing indebtedness.
If we fail to reach such an agreement, the first lien lenders could institute
foreclosure proceedings against our assets securing borrowings under the first
lien facilities.
Our liquidity is dependent upon our cash flows from store operations, access to
our existing credit facility and vendor financing. Historically, we maintained
favorable payment terms with our vendors, which has been a significant source
of liquidity for us. During the latter part of fiscal 2006, and continuing
into fiscal 2007, we have experienced significant vendor terms contraction,
which eroded our working capital capacity. Due to our non-compliance with the
covenants contained in the first lien facilities, many of our significant
vendors have discontinued extending us trade credit, requiring us to pay for
product before it is shipped, and we have experienced additional tightening of
terms with other vendors. If we continue to experience substantial
restrictions or tightening of terms with our vendors and continue to generate
operating losses similar to those experienced for the twenty-six weeks ended
July, 1, 2007, we do not believe we will have sufficient liquidity to operate
our business through the third quarter of 2007 without gaining access to
additional capital.
See Note 8 and Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Liquidity and Capital Resources" in this
Quarterly Report on Form 10-Q for additional information regarding our long
term obligations, liquidity, and ongoing discussions with our major creditors.
2. Accounting Policies
References herein to "Movie Gallery", the "Company", "we", "our", or "us" refer
to Movie Gallery, Inc. and its subsidiaries unless the context specifically
indicates otherwise. References herein to "Hollywood" refer to Hollywood
Entertainment Corporation.
2. | Accounting Policies |
Principles of Consolidation
The accompanying financial statements present the consolidated financial position, results of operations and cash flows of Movie Gallery, Inc. and its subsidiaries. All intercompany accounts and transactions have been eliminated.
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotesdisclosures required by generally accepted accounting principles for complete consolidated financial statements. The consolidated balance sheet at December 31, 2006 has been derived from the audited consolidated financial statements at that date but does not include all of the information and footnotesdisclosures required by generally accepted accounting principles for complete consolidated financial statements. In theour opinion, of management, all adjustments (consisting of normal, recurring adjustments and accruals) considered necessary for a fair presentation have been included. Operating results for the thirteen and twenty-sixthirty-nine weeks ended July 1,September 30, 2007 are not necessarily indicative of the results that may be expected for the fiscal year ending January 6, 2008. For further information, refer to the consolidated financial statements and related footnotesdisclosures included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
Reclassifications
We have not made any adjustments or reclassifications in the consolidated financial statements as of and Revisions
for the thirteen and thirty-nine weeks ended September 30, 2007 that will be required in future consolidated financial statements in accordance with AICPA Statement of Position, 90-7Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, or SOP 90-7. Under SOP 90-7 we will report pre-petition liabilities that are subject to compromise and pre-petition liabilities that are not subject to compromise and post-petition liabilities.
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Reclassifications
Certain reclassifications have been made to the prior year consolidated financial statements to conform to the current year presentation. These reclassifications had no impact on stockholders'stockholders’ deficit or net income (loss).loss. For the thirteen and twenty-sixthirty-nine weeks ended July 2,October 1, 2006, $2.3$2.1 million and $4.6$6.8 million, respectively, in depreciation expense was reclassified from Store operating expenses to General and administrative expenses related to depreciation on corporate fixedlong-lived assets. In addition, the accompanying consolidated statement of cash flows for the thirty-nine weeks ended October 1, 2006 has been revised to reclassify the book cost of previously viewed movie sales from a reduction of purchases of rental inventory to rental inventory amortization to be consistent with the presentation in the current year. Also, the accompanying consolidated statement of cash flows for the thirty-nine weeks ended October 1, 2006 has been revised to reclassify and separately present changes in rental amortization estimates from rental inventory amortization and rental purchases.
Change in Accounting Estimate for Rental Inventory
We manage our movie rental inventories as two distinct categories, new releases and catalog. New releases, which represent the majority of all movies acquired, are those movies that are primarily purchased on a weekly basis in large quantities to support demand upon their initial release by the studios and are generally held for relatively short periods of time. Catalog, or library, purchases represent an investment in a smaller quantity of those movies we intend to hold for an extended period of time and represent a historic collection of movies that are maintained on a long-term basis for rental to customers. In addition, we purchase catalog inventories to support new store openings and to build-up title selection for formats preferred by our customers.
We regularly review, evaluate and update our rental amortization accounting estimates. Historically, our purchases of new release and catalog DVD movies were amortized to an average residual value of $4.00 on an accelerated basis over six months for new releases and over twenty-four months for catalog. We define the residual value of our rental inventory as estimated disposal proceeds, less the costs to sell, at the point that the inventory is no longer useful to the Company.
For new release movies and games acquired under revenue-sharing arrangements, the studios’ share of rental revenue is charged to cost of rental as revenue is earned on the respective revenue-sharing titles. Amortization periods, carrying values and residual values of movies purchased under revenue-sharing arrangements approximate those of our non-revenue sharing purchases as outlined above.
In the third quarter of fiscal 2007, we completed liquidation sales of our new release and catalog inventory in approximately 70 stores that were closed. In addition, we began to liquidate our inventory at approximately 520 additional stores, which was our largest liquidation event to date. During these liquidation sales, the average unit sales price of our DVD catalog rental inventory realized was below our $4.00 residual value. Further, we realized lower than anticipated sales prices on sales of our new release inventory. We viewed the results of these liquidation sales as a triggering event which caused us to reexamine our estimates and assumptions with respect to our salvage values for DVD rental inventory. In order to determine the appropriate useful lives and residual values, we consider the actual historic performance trends of our rental inventory and expectations of future trends and patterns. As a result, we lowered our estimated residual value on
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new releases and catalog DVDs from $4.00 to $3.00 effective July 2, 2007. In addition, for the comparatively small percentage of new release purchases that we intend to keep for an extended period of time as catalog, we revised our accelerated amortization rate in order to remain consistent with observed rental patterns. These changes were accounted for as a change in accounting estimate in accordance with Statement of Financial Accounting Standards Board, or FASB, Statement No. 154,Accounting Changes and Error Corrections,or FASB Statement No. 154, paragraph 19. This change in accounting estimate increased cost of rental revenue and loss from continuing operations in the current-year third quarter by $57.0 million, increasing net loss by $56.2 million and $56.7 million, net of tax, or $1.74 and $1.77 per diluted share, for the thirteen and thirty-nine weeks ended September 30, 2007. As of September 30, 2007, $16.6 million in remaining liquidation inventory, net of costs to sell, is included within the “Assets held for sale” caption in our consolidated balance sheet.
Video games are amortized over twelve months on an accelerated basis to an average residual value of $5.00.
Goodwill and Other Indefinite-Lived Intangible Assets
Goodwill and other indefinite-lived intangible assets are not amortized, but are subject to impairment testing annually or whenever indicators of impairment are present. Finite-lived intangible assets are amortized on a straight-line basis over their estimated useful lives.
In accordance with FASB Statement of Financial Accounting Standards, or SFAS, No. 142, "GoodwillGoodwill and Other Intangible Assets", or SFASFASB Statement No. 142, we assess goodwill and intangible assets with indefinite lives for impairment at the reporting unit level on an annual basis and between annual tests if events occur or circumstances change that could more likely than not reduce the fair value of these assets below their carrying amount.
SFAS
FASB Statement No. 142 requires that the impairment test be performed through the application of a two-step fair value test. The first step of the test compares the book value of our reporting units to their estimated fair values at the respective test dates. The estimated fair values of the reporting units are computed using the present value of estimated future cash flows. If fair value does not exceed carrying value then the second step must be performed to quantify the amount of the impairment. The second step of the goodwill and other indefinite-lived intangible assets impairment test compares the implied fair value of these assets to their book values. In the case of goodwill, to the book value
of goodwill. The implied fair value of goodwill is calculated as the excess of the estimated fair value of the reporting unit being tested over the fair value of its tangible assets and liabilities as well as existing recorded and unrecorded identifiable intangible assets. The estimated implied fair value of goodwill and the estimated fair value of identified intangibles are compared to their respective carrying values and any excess carrying value is recorded as a charge to operating income.
See Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, and Note 6, Goodwill and Other Intangible Assets, below for a discussion of goodwill, other intangible assets and impairment charges.
Impairment of Long-Lived Assets
Long-lived assets, including rental inventory, property, furnishings and equipment and intangible assets with finite lives, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable, in accordance with SFASFASB Statement No. 144, "AccountingAccounting for the Impairment or Disposal of Long-Lived Assets", or SFASFASB Statement No. 144. We consider a continuing trend of significantly unsatisfactory operating results that are not in
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line with our expectations to be our primary indicator of potential impairment. When an indicator of impairment is noted, assets are evaluated for impairment at the lowest level for which there are identifiable cash flows (e.g., at the store level). We deem a store to be impaired if a forecast of undiscounted future operating cash flows directly related to the store, including estimated disposal value, if any, is less than the asset carrying amount. If a store is determined to be impaired, the loss is measured as the amount by which the carrying amount of the store'sstore’s assets exceeds its fair value and is recorded as a charge to operating income. We primarily use discounted cash flow methods to estimate the fair value of long-lived assets.
See Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, below for a discussion on impairment of long-lived assets.
Stock-Based Compensation
Effective January 2, 2006, we adopted SFASFASB Statement No. 123(R)123(Revised),Share-Based Payment, "Share-Based Payment,"
or SFASFASB Statement No. 123(R), which no longer permits the use of the intrinsic value method under Accounting Principles Board Opinion No. 25, "AccountingAccounting for Stock Issued to Employees", or APB No. 25. We used the modified prospective method to adopt SFASFASB Statement No. 123(R), which requires that compensation expense be recorded for all stock-based compensation granted on or after January 2, 2006, as well as the unvested portion of previously granted options.
On the Effective Date, our old common stock and other equity interests existing immediately prior to the Effective Date were canceled for no consideration.
Earnings/Loss Per Share
Basic earnings/loss per share is computed based on the weighted averageweighted-average number of shares of common stock outstanding during the periods presented. Diluted earnings per share is computed using the weighted averageweighted-average number of shares of common stock outstanding and common stock issuable upon the assumed exercise of dilutive common stock options and non-vested shares for the periods presented. For the twenty-six weeks ended July 2, 2006, dilutive common stock options
exercisable into 895,751 shares of common stock and 1,351,519 shares of non-
vested stock were included in the calculation of diluted earnings per share.
Due to our loss for the thirteen and thirty-nine weeks ended July 2,October 1, 2006, common stock options exercisable into 895,751876,188 shares of common stock and 1,351,5191,344,417 shares of non-
vestednon-vested stock were excluded from the calculation of diluted loss per share, as their inclusion would have been anti-dilutive. Due to our loss for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, common stock options exercisable into 763,703743,983 shares of common stock and 890,370769,509 shares of non-
vestednon-vested stock were excluded from the calculation of diluted loss per share, as their inclusion would have been anti-dilutive.
Lease Liability on Closed Stores
We accrue for obligations related to closed stores based upon the present value of expected payments over the remaining lease terms, net of estimated sublease income when relevant, using a discount rate based on a credit-adjusted risk-free rate. Expected payments generally include lease payments, real estate taxes, common area maintenance charges and utility costs.
Recently Issued Accounting Pronouncements
On July 13, 2006, the Financial Accounting Standards Board, or the FASB, issued
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes, an
Interpretation of FASB Statement No. 109," or FIN 48, which clarifies the way
companies account for uncertainty in income taxes. FIN 48 is effective for the
first fiscal year beginning after December 15, 2006, which for us was our
fiscal year beginning January 1, 2007. The adoption of FIN 48 did not have a
material impact on our consolidated financial statements. See Note 4 "Income
Taxes" for further discussion.
In September 2006, the FASB issued SFASFASB Statement No. 157, "FairFair Value Measurements", or SFASFASB Statement No. 157, which provides enhanced guidance for using fair value to measure assets and liabilities. SFASFASB Statement No. 157 also responds to investors'investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS
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FASB Statement No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value into any new circumstances. SFASFASB Statement No. 157 is effective for our fiscal year beginning January 7, 2008. We are in the process of evaluating the effect of SFASFASB Statement No. 157 on our consolidated financial statements.
position, results of operations, or cash flows. On February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2,Effective Date of FASB Statement No. 157, which amends FASB Statement No. 157 to defer its effective date to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in financial statements on a recurring basis. FASB Statement No. 157’s effective date for financial assets and financial liabilities, November 15, 2007, remains intact.
In February 2007, the FASB issued SFASFASB Statement No.159, "TheThe Fair Value Option for Financial Assets and Financial Liabilities", or SFASFASB Statement No. 159, which provides guidance on applying fair value measurements on financial assets and liabilities. SFASFASB Statement No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFASFASB Statement No. 159 attempts to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings, caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFASFASB Statement No. 159 is effective for us for our fiscal year beginning January 7, 2008. We are in the process of evaluating the effect of SFASFASB Statement No. 159 on our consolidated financial statements.
position, results of operations, and cash flows.
In December 2007, the FASB issued FASB Statement No. 141 (R),Business Combinations, or FASB Statement No. 141 (R), which provides guidance on changes to business combination accounting. FASB Statement No. 141 (R) includes requirements to recognize, with certain exceptions, 100 percent of the fair values of assets acquired, liabilities assumed, and noncontrolling interests in acquisitions of less than 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity, expense acquisition-related transaction costs, and recognize preacquisition loss and gain contingencies at their acquisition-date fair values. FASB Statement No. 141 (R) is effective for us for any business combination transaction for which the acquisition date is on or after our fiscal year beginning January 5, 2009.
In March 2008, the FASB issued FASB Statement No. 161,Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, or FASB Statement No. 161, which requires entities to provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. To meet those objectives, FASB Statement No. 161 requires (1) qualitative disclosures about objectives for using derivatives by primary underlying risk exposure (e.g., interest rate, credit or foreign exchange rate) and by purpose or strategy (fair value hedge, cash flow hedge, net investment hedge and non-hedges), (2) information about the volume of derivative activity in a flexible format that the preparer believes is the most relevant and practicable, (3) tabular disclosures about balance sheet location and gross fair value amounts of derivative instruments, income statement and other comprehensive income (OCI) location and amounts of gains and losses on derivative instruments by type of contract (e.g., interest rate contracts, credit contracts, or foreign exchange contracts), and (4) disclosures about credit-risk-related contingent features in derivative agreements. FASB Statement No. 161 is effective for us as of our fiscal year beginning January 5, 2009. Early application is encouraged, as are comparative disclosures for earlier periods, but neither are required. We are in the process of evaluating the effect of FASB Statement No. 161 on our consolidated financial position, results of operations, and cash flows.
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In April 2008, the FASB issued FASB Staff Position, or FSP, No. 90-7-a,An Amendment of AICPA Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code, or FSP SOP No. 90-7-a, which would apply to entities that are required to apply fresh-start reporting under SOP 90-7.This FSP amends SOP 90-7 to eliminate the requirement that changes in accounting principles required in financial statements of an entity emerging from bankruptcy reorganization within the 12 months following the adoption of fresh-start reporting are required to be adopted at the time fresh-start reporting is adopted. As a result of this FSP, an entity emerging from bankruptcy that uses fresh-start reporting would only follow the accounting standards in effect at the date of emergence. FSP SOP No. 90-7-a is effective for financial statements issued subsequent to April, 24, 2008.
3. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
----------- ----------
December 31, July 1,
2006 2007
----------- ----------
Land and buildings $ 19,716 $ 18,739
Furnishings and equipment 240,075 231,873
Leasehold improvements 279,009 276,150
Asset removal obligation 5,860 5,767
Equipment under capital lease 1,659 2,365
----------- ----------
546,319 534,894
Less accumulated depreciation,
amortization, and impairment
charges (303,384) (380,969)
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$ 242,935 $ 153,925
=========== ==========
December 31, 2006 | September 30, 2007 | |||||||
Land and buildings | $ | 19,716 | $ | 18,546 | ||||
Furnishings and equipment | 240,075 | 215,938 | ||||||
Leasehold improvements | 279,009 | 249,457 | ||||||
Asset removal obligation | 5,860 | 4,963 | ||||||
Equipment under capital lease | 1,659 | 1,096 | ||||||
546,319 | 490,000 | |||||||
Less accumulated depreciation, amortization, and impairment charges | (303,384 | ) | (356,760 | ) | ||||
$ | 242,935 | $ | 133,240 | |||||
Accumulated depreciation and amortization, as presented above, includes accumulated amortization of assets under capital leases of $0.8 million and $0.2$0.5 million at December 31, 2006 and July 1,September 30, 2007, respectively. Depreciation expense related to property, furnishings and equipment was $24.5$15.1 million and $45.6$60.7 million for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, respectively, compared to $23.8$28.2 million and $48.8$77.0 million for the corresponding periods in 2006.
During
For the second quarter of fiscalthirty-nine weeks ended September 30, 2007, we have recorded an impairment chargecharges of $43.0$48.7 million on our property, furnishings, and equipment. See Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, below for further discussion of thisthese impairment charge.
charges.
During the second quarter of fiscal 2007, we began to pursue the sale of one of our aircraft in conjunction with our review of non-core assets for disposal. As of July 1,September 30, 2007, we have determined that the plan of sale criteria as set forth in SFASFASB Statement No. 144 related to this aircraft has beenwere met. We have estimated that the fair value, less costs to sell, of this asset is $7.8$7.5 million, based on quoted market
prices from a third party. Asparty offer to purchase the aircraft. During the third quarter of July 1,fiscal 2007 the carrying amountwe recorded a charge of the
aircraft was $7.6 million. As such, no impairment charge was recorded$0.1 million to bring the asset to its estimated fair value. The carrying value of the aircraft is presented in the "Assets Held“Assets held for Sale"sale” caption in our consolidated balance sheet. Subsequent to the end of third quarter of fiscal 2007, this aircraft was sold, net of costs to sell, for $7.5 million.
16
During the third quarter of fiscal 2007, we decided to pursue the sale of the MovieBeam business and communicated this plan to our lenders and financial advisors. As of September 30, 2007, we determined that the plan of sale criteria as set forth in FASB Statement No. 144 related to MovieBeam’s assets were met. In the fourth quarter of fiscal 2007 we ceased operations associated with MovieBeam, and in the second quarter of fiscal 2008 we sold MovieBeam’s assets, including certain trademarks and intellectual property associated with its business, for cash consideration of approximately $2.3 million, which was in excess of their carrying value of $2.1 million. The carrying value of these assets is presented in the “Assets held for sale” caption in our consolidated balance sheet.
4. Income Taxes
The effective tax rate was a benefit of 0.3%1.5% and 0.1%0.6% for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, respectively, as compared to an expense of 2.3% and a benefit of 9.4% and 7.8%8.9% for the corresponding prior year periods. The projected annual effective tax rate is a provisionbenefit of 0.4%, which differs from the benefit of 0.3%1.5% for the quarter ended July 1,September 30, 2007, due to the impact of a $2.8 million benefit recognized in the third quarter of fiscal 2007 related to the release of reserves due to the receipt of tax refunds, changes in the proportion of income earned from foreign operations, and various state income tax changes.
In July 2006, the FASB issued FINFASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes, or FASB Interpretation No. 48, which addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.
We adopted the provisions of FINFASB Interpretation No. 48 on January 1, 2007. The adoption of FINFASB Interpretation No. 48 did not have a material effect on our consolidated balance sheetfinancial position, results of operations, or statement
of operations.cash flows. The amount of unrecognized benefits as of January 1, 2007 iswas $11.2 million, of which $4.8 million would impact our effective rate if realized. There were no material changes to unrecognized benefitsWe recognized approximately $2.8 million of benefit during the twenty-sixthirty-nine weeks ended July 1, 2007.
We have filed amendedSeptember 30, 2007 due to the release of reserves due to the receipt of refunds from federal and state returns that claimed refundstaxing authorities. The amount of
approximately $3.0 million for the 2002 tax year. This refund claim is
included in our unrecognized benefits as of January 1, 2007. Subsequent to the
twenty-six weeks ended July 1,September 30, 2007 we received notification from the IRS thatis $8.1 million, of which $2.0 million would impact our refund claim has been processed, and we expect to receive and record this
refund during the third quarter of fiscal 2007. Besides this 2002 tax year
refund claim, weeffective rate if realized. We cannot estimate a range of potential changes in the amount of unrecognized tax benefits during the next twelve months.
We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense in our consolidated statements of operations, which is consistent with the recognition of these items in prior reporting periods. As of January 1, 2007, we had recorded a liability of approximately $0.3 million for the payment of interest and penalties. There have been no material changes to this liability as of September 30, 2007.
All statutes of limitations related to federal income tax returns of Movie Gallery, Inc. are closed through 2001. The statutes related to federal tax returns of Hollywood Entertainment Corporation are closed through 1997. Due to net operating losses generated by Hollywood in 1998 and later years, the statute of limitations remains open for those years to the extent of the net operating losses.
State income tax returns are generally subject to examination for a period of three to five years after the filing of the respective return. The state tax impact of any federal changes remains subject to examination by various states for a period of up to one year after formal notification to the states. Also, we have generated net operating losses for state purposes in certain states, which have had the effect of extending the statute of limitations in those states.
17
5. Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangibles,Intangible Assets, and Goodwill
Impairment Indicators
SFAS
FASB Statements No. 142 and SFAS No. 144 require interim testing for impairment of other long-lived assets, other definite and indefinite-lived intangible assets and goodwill when impairment indicators are present. SFASFASB Statement No. 144 provides examples of events or changes in circumstances that might indicate that impairment exists for a particular long-lived asset or asset group. During the month of March 2007 and
most notably during the second quarter of fiscal 2007 it became apparent that our industry in general, and our business in particular, have experiencedwere experiencing a trend of unfavorable events and circumstances that required us to assess the recoverability of the carrying value of certain of our long-lived assets. These events and circumstances also carried into the third quarter of fiscal 2007. Among those events and circumstances that we believe to be impairment indicators are:
- -
substantially larger than anticipated drop in year-over-year same store sales and gross margins;
- -
a continuing trend of operating losses;
- -
projected cash flow losses for a substantial number of our stores;
- -
a significant drop in our stock price and resulting market capitalization;
- -
a significant drop in trading prices for our first and second lien debt and 11% senior notes; and
- -
recent significant adverse changes in our industry as discussed in Item
2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations".
industry.
Other Long-Lived Assets (Including Definite-Lived Intangible Assets)
Long-lived assets are reviewed for impairment in accordance with SFASFASB Statement No. 144. When an indicator of impairment is noted, assets are evaluated for impairment at the lowest level for which there are identifiable cash flows (e.g., at the store level). Due to the impairment indicators noted above, we performed impairment testing on our long-lived assets asat the end of July 1,the second and third quarters of fiscal 2007. As a result, we determined that the long-lived assets associated with certain stores were impaired. We recorded a charge of $26.2$29.1 million and $16.8$19.5 million related to the impairment of property, furnishings, and equipment under the Hollywood and Movie Gallery operating segments, respectively.
respectively, for the thirty-nine weeks ended September 30, 2007.
We also determined that our definite-lived intangible asset for the customer listlists in the Hollywood segment was impaired as a result of attrition in active customers. We therefore recorded an impairment charge of $2.5 million, which was recognized in Impairment of other intangibles.
Other intangibles, for the thirty-nine weeks ended September 30, 2007.
Indefinite-Lived Intangibles
Intangible Assets
We normally conduct our annual test of the valuation of our indefinite-lived
intangible asset, the Hollywood trademark during the fourth quarter of each fiscal year in accordance with our policy and the requirements as set forth in SFASFASB Statement No. 142.142 as it pertains to indefinite-lived intangible assets. However due to the impairment indicators noted above, we performed impairment testing on the Hollywood trademark at the end of the second quarter of fiscal 2007. Furthermore, due largely to the subsequent filing of the Chapter 11 Cases on October 16, 2007, we performed an additional testing of impairment on the Hollywood trademark as of July 1,the end of the third quarter of fiscal 2007.
18
The impairment testing of the Hollywood trademark compared the fair value of the trademark with its carrying value. The fair value was determined by the Relief from Royalty method, a specific discounted cash flow approach, to analyze cash flows attributable to the Hollywood trademark. The basic tenet of the Relief from Royalty method is that without ownership of the subject intangible asset, the user of that intangible asset would have to make a stream of payments to the owner of the asset in return for the rights to use that asset. By acquiring the intangible asset, the user avoids these payments. Assumptions regarding future revenues, a market-driven royalty rate, and a discount rate are among the most significant estimates used in this method. We determined at the end of the second quarter of fiscal 2007 that the carrying value of the Hollywood trademark was greater than its fair value and therefore was deemed to be impaired. The implied fair value of the Hollywood trademark was determined to be $75.5 million, and therefore an impairment charge was recorded for $95.4 million in Impairment of other intangibles.
intangibles for the twenty-six weeks ended July 1, 2007.
In the third quarter of fiscal 2007, we updated certain of our assumptions with respect to our use of the Relief from Royalty method, most notably our assumption regarding the Hollywood trademark royalty rate. We determined that the adjusted carrying value of $75.5 million was greater than the updated fair value of $15.0 million. Accordingly, an additional impairment charge was recorded for $60.5 million in Impairment of other intangibles for the thirteen weeks ended September 30, 2007.
Furthermore, we concluded that due to the impairment indicators experienced during the thirty-nine weeks ended September 30, 2007, and the subsequent filing of the Chapter 11 Cases on October 16, 2007, there existed substantial doubt as to whether we could continue to classify our Hollywood trademark as an indefinite-lived intangible asset. According to FASB Statement No. 142, when a company determines that the life of an intangible asset is no longer indefinite, that asset should be tested for impairment in the same manner as other indefinite-lived intangible assets. The intangible asset, after recognition of any impairment, should then be amortized over its estimated useful life and accounted for prospectively in the same manner as other intangible assets with finite lives. Therefore, after conducting our tests of impairment, we determined that our Hollywood trademark should be classified as a definite-lived intangible asset with an estimated useful life of ten years.
Goodwill
We normally conduct our annual test of the valuation of goodwill during the fourth quarter of each fiscal year in accordance with our policy and the requirements as set forth in SFASFASB Statement No. 142. However, due to the impairment indicators noted above, we performed impairment testing on our valuation of goodwill asat the end of July 1,the second quarter of fiscal 2007.
Goodwill is tested at a reporting unit level, which for this purpose consists solely of Hollywood Video, as our Movie Gallery reporting unit had an immaterial amount of goodwill and our Game Crazy reporting unit has no goodwill. Goodwill is impaired if the fair value of a reporting unit is less than the carrying value of its assets. The estimated fair value of the Hollywood Video reporting unit was computed using the present value of estimated future cash flows, which included the impact of trends in the business and industry noted in Item 2. "Management's Discussionincluding:
cannibalization of rentals by low priced movies available for sale;
19
growth of the online rental segment;
growth of DVD-dispensing kiosk machines operated by our competitors;
the standard DVD format nearing the end of its life cycle;
movie studios structuring their DVD movie release towards the later part of the year;
competing high definition DVD formats delaying content release and Analysisconsumer acceptance; and
the proliferation of Financial Conditionalternative consumer entertainment options, including movies available through video-on-demand, TIVO/DVR, digital cable, satellite TV, broadband, and Results of Operations." Internet and broadcast television.
In addition to these business and industry trends, the computation of estimated fair value considered market prices of our debt and equity securities.
When we performed our testing, the first step of the impairment test indicated that the fair value of the Hollywood Video reporting unit was lower than its carrying value, and therefore the goodwill of the Hollywood reporting unit was determined to be impaired. The second step of the impairment test indicated that the implied fair value of goodwill for the Hollywood reporting unit was zero, and therefore a goodwill impairment charge was recorded for $115.6 million.
million for the thirty-nine weeks ended September 30, 2007.
Impairment Estimates and Assumptions
The impairment charges related to our long-lived assets associated with our stores, our definite-lived intangible assets, our indefinite-lived intangible asset, and our goodwill were calculated using our best estimateestimates of future forecasted cash flows to be generated from the respective assets and a discount rate inherent within our cost of capital. The nature of this analysisthese analyses requires significant judgment by management judgment about our future operating results, including revenues, margins, operating expenses and applicable discount rate. If we had used different assumptions and estimates regarding our future operating results or discount rate, the impairment chargecharges might have been materially different. However, we believe that our assumptions and estimates are reasonable and represent our most likely future operating results based upon the current information available.
To date, we have not recorded any
For the thirty-nine weeks ended September 30, 2007, recognized impairment charges related to our rental inventory.inventory have been immaterial. In addition to our property, furnishings, and equipment impairment charges and our customer list and trademark impairment charge,charges, we could incur material impairment charges to our rental inventory. If we were to closeinventory in the future. As a result of closing a significant number of our stores, we may need to liquidate the on-hand rental inventory for amounts that are less than the carrying value of the rental inventory product. These potential future asset impairments could have a materially adverse effect on our consolidated results of operations.
We will continue to review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amountamounts may not be recoverable. In circumstances where impairment is determined to exist, we will write down the assets to their fair market value.
See Note 2., Accounting Policies, for other charges associated with our rental inventory.
20
6. Goodwill and Other Intangible Assets
The components of goodwill and other intangible assets are as follows (in thousands):
December 31, 2006 July 1, 2007
Weighted- ------------------------ ---------------------
Average Gross Gross
Amortization Carrying Accumulated Carrying Accumulated
Period Amount Amortization Amount Amortization
------------ -------- ------------ -------- ------------
Goodwill
Segments:
Movie Gallery - $ 147 $ - $ - $ -
Hollywood Video - 115,422 - - -
-------- ------------ -------- ------------
Total goodwill $115,569 $ - $ - $ -
======== ============ ======== ============
Other intangible assets:
Non-compete
agreements 8 years $ 12,263 $ (10,880) $ 12,329 $ (11,273)
Trademarks:
Hollywood Video Indefinite 170,977 - 75,543 -
Game Crazy 15 years 4,000 (444) 4,000 (578)
Customer lists 5 years 8,994 (2,998) 8,994 (6,342)
-------- ------------ -------- ------------
$196,234 $ (14,322) $100,866 $ (18,193)
======== ============ ======== ============
December 31, 2006 | September 30, 2007 | |||||||||||||||
Weighted- Average Amortization Period | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||
Goodwill | ||||||||||||||||
Segments: | ||||||||||||||||
Movie Gallery | — | $ | 147 | $ | — | $ | — | $ | — | |||||||
Hollywood Video | — | 115,422 | — | — | — | |||||||||||
Total goodwill | $ | 115,569 | $ | — | $ | — | $ | — | ||||||||
Other intangible assets: | ||||||||||||||||
Non-compete agreements | 8 years | $ | 12,263 | $ | (10,880 | ) | $ | 12,385 | $ | (11,465 | ) | |||||
Trademarks: | ||||||||||||||||
Hollywood Video | 10 years | 170,977 | — | 15,000 | — | |||||||||||
Game Crazy | 15 years | 4,000 | (444 | ) | 4,000 | (644 | ) | |||||||||
Customer lists | 5 years | 8,994 | (2,998 | ) | 8,994 | (6,577 | ) | |||||||||
$ | 196,234 | $ | (14,322 | ) | $ | 40,379 | $ | (18,686 | ) | |||||||
Estimated amortization expense for other intangible assets for the remainder of fiscal 2007 and the five succeeding fiscal years is as follows (in thousands):
2007 886
2008 1,614
2009 1,427
2010 671
2011 292
2012 269
Fiscal Year | Estimated Amortization Expense | ||
2007 | $ | 814 | |
2008 | 3,116 | ||
2009 | 2,928 | ||
2010 | 2,171 | ||
2011 | 1,792 | ||
2012 | 1,769 |
21
The changes in the carrying amounts of goodwill, indefinite-lived intangibles, and definite-lived intangibles for the fiscal year ended December 31, 2006 and the twenty-sixthirty-nine weeks ended July 1,September 30, 2007 are as follows (in thousands):
Indefinite- Definite-
Lived Lived
Goodwill Intangibles Intangibles
--------- ----------- -----------
Net balance as of January 1, 2006 $ 118,404 $ 170,959 $ 13,712
Additions and adjustments (2,835) 18 61
Amortization expense - - (2,838)
--------- ----------- -----------
Net balance as of December 31, 2006 $ 115,569 $ 170,977 $ 10,935
--------- ----------- -----------
Additions and adjustments 1 - 21
Impairment charges (115,570) (95,434) (2,445)
Amortization expense - - (1,381)
--------- ----------- -----------
Net balance as of July 1, 2007 $ - $ 75,543 $ 7,130
========= =========== ===========
Goodwill | Indefinite- Lived Intangibles | Definite- Lived Intangibles | ||||||||||
Net balance as of January 1, 2006 | $ | 118,404 | $ | 170,959 | $ | 13,712 | ||||||
Additions and adjustments | (2,835 | ) | 18 | 61 | ||||||||
Amortization expense | — | — | (2,838 | ) | ||||||||
Net balance as of December 31, 2006 | $ | 115,569 | $ | 170,977 | $ | 10,935 | ||||||
Impairment charges | (115,570 | ) | (155,977 | ) | (2,445 | ) | ||||||
Additions and adjustments | 1 | (15,000 | ) | 15,035 | ||||||||
Amortization expense | — | — | (1,832 | ) | ||||||||
Net balance as of September 30, 2007 | $ | — | $ | — | $ | 21,693 | ||||||
7. Store Closure, Merger and Restructuring Reserves
Store Closure
Closures
We continue to evaluate underperforming and unprofitable stores as part of our restructuring strategies to conserve cash and stores that have overlap
trade areas inreduce our Movie Gallery, Hollywood Video and Game Crazy segments.overall cost structure. During the twenty-sixthirty-nine weeks ended July 1,September 30, 2007, we closed 92216 underperforming stores. WeFor the thirty-nine weeks ended September 30, 2007, we have recognized $1.1$10.0 million in expenses associated with our continued lease obligations on our closed stores. We apply the “cease-use date approach” required by FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities, or FASB Statement No. 146, in accruing costs that will continue to be incurred under our store lease contracts over their remaining term without economic benefit to us. We recognize and measure these costs at their fair value when we cease using the rights conveyed by the contracts. We have not reduced the accrual for our remaining lease obligations by any sublease rental income for stores closed during the thirteen weeks ended September 30, 2007, as we subsequently received Bankruptcy Court approval to reject the leases associated with closed stores.
During the third quarter of fiscal 2007, we identified approximately 520 Movie Gallery and Hollywood Video stores, which we refer to as the Phase 1 stores, that were subsequently closed during the fourth quarter of fiscal 2007, along with approximately 20 other stores that were closed in the normal course of business. On February 4, 2008, we announced and began closing approximately 370 additional underperforming stores, referred to as the Phase 2 stores, which we closed during the first quarter of fiscal 2008. On April 2, 2008 we began our Phase 3 store closures affecting approximately 160 store locations which were completed during the second quarter of fiscal 2008.
22
Movie Gallery | Hollywood Video | Total | ||||||||||
Store closure reserve (in thousands): | ||||||||||||
Balance as of January 1, 2006 | $ | 10,112 | $ | 3,613 | $ | 13,725 | ||||||
Additions and adjustments | 3,344 | (145 | ) | 3,199 | ||||||||
Payments | (5,474 | ) | (773 | ) | (6,247 | ) | ||||||
Balance as of December 31, 2006 | $ | 7,982 | $ | 2,695 | $ | 10,677 | ||||||
Additions and adjustments | 1,951 | 8,051 | 10,002 | |||||||||
Payments | (2,171 | ) | (851 | ) | (3,022 | ) | ||||||
Balance as of September 30, 2007 | $ | 7,762 | $ | 9,895 | $ | 17,657 | ||||||
Our store closure expenses for the twenty-
six weeks ended July 1, 2007.
Movie Hollywood
Gallery Video Total
---------- --------- ---------
Store closure reserve:
Balancereserve as of January 1, 2006 $ 10,112 $ 3,613 $ 13,725
Additions andSeptember 30, 2007 does not include any adjustments 3,344 (145) 3,199
Payments (5,474) (773) (6,247)
---------- --------- ---------
Balancethat will be recorded as a result of December 31, 2006 $ 7,982 $ 2,695 $ 10,677
Additions and adjustments (846) 624 (222)
Payments (2,075) (422) (2,497)
---------- --------- ---------
Balance asthe Bankruptcy Court’s approval to reject certain store leases subsequent to the third quarter of July 1, 2007 $ 5,061 $ 2,897 $ 7,958
========== ========= =========
2007.
Restructuring
During fiscal 2005 and fiscal 2006, in accordance with EITF Issue No. 95-3, "Recognition“Recognition of Liabilities in Connection with a Purchase Business Combination,"” we established and maintained restructuring reserves in the Hollywood segment for Hollywood executives and other employees that were terminated shortly after the merger withacquisition of Hollywood in fiscal 2005, including some employees that were terminated as part of our integration efforts. During this same time, we also established and maintained restructuring reserves in the Movie Gallery segment for termination benefits associated with the relocation or elimination of positions according to our plan of integration.
During the second quarterand third quarters of fiscal 2007, we established additional restructuring reserves in both the Hollywood Video and Movie Gallery segments for termination benefits associated with the elimination of positions as part of a planned headcount reduction of corporate and field associates. This headcount reduction was instituted as part of our cost-cutting initiatives. Severance and retention incentives and outplacement services costs are recognized in Store operating expenses and General and administrative expenses.
23
A summary of our restructuring reserve activity is as follows:
Movie Hollywood
Gallery Video Total
Termination benefits: ---------- --------- --------
Balance as of January 1, 2006 $ 1,190 $ 4,116 $ 5,306
Additions and adjustments 1,135 - 1,135
Payments (1,985) (3,034) (5,019)
---------- --------- --------
Balance as of December 31, 2006 $ 340 $ 1,082 $ 1,422
Additions and adjustments 297 471 768
Payments (357) (1,118) (1,475)
---------- --------- --------
Balance as of July 1, 2007 $ 280 $ 435 $ 715
========== ========= ========
Estimated future
additions and
adjustments $ 113 $ 377 $ 490
Total termination
benefits cost $ 2,736 $ 7,503 $ 10,239
Movie Gallery | Hollywood Video | Total | ||||||||||
Termination benefits (in thousands): | ||||||||||||
Balance as of January 1, 2006 | $ | 1,190 | $ | 4,116 | $ | 5,306 | ||||||
Additions and adjustments | 1,135 | — | 1,135 | |||||||||
Payments | (1,985 | ) | (3,034 | ) | (5,019 | ) | ||||||
Balance as of December 31, 2006 | $ | 340 | $ | 1,082 | $ | 1,422 | ||||||
Additions and adjustments | 851 | 999 | 1,850 | |||||||||
Payments | (586 | ) | (1,469 | ) | (2,055 | ) | ||||||
Balance as of September 30, 2007 | $ | 605 | $ | 612 | $ | 1,217 | ||||||
Estimated future additions and adjustments | $ | — | $ | — | $ | — | ||||||
Total termination benefits cost | $ | 3,177 | $ | 7,654 | $ | 10,831 |
8. Long Term Obligations
Long term debt consistsconsisted of the following (in thousands):
December 31, July 1,
Instrument 2006 2007
- ----------------------------------- ----------- ------------
Movie Gallery Senior Notes $ 322,044 $ 322,321
April 2005 Credit Facility
Term A Loan 66,787 -
Term B Loan 688,070 -
Revolving credit facility 15,024 -
Instrument | December 31, 2006 | September 30, 2007 | ||||||
Movie Gallery Senior Notes | $ | 322,044 | $ | 322,147 | ||||
April 2005 Credit Facility | ||||||||
Term A Loan | 66,787 | — | ||||||
Term B Loan | 688,070 | — | ||||||
Revolving credit facility | 15,024 | — | ||||||
March 2007 Credit Facility | ||||||||
First lien term loan | — | 597,000 | ||||||
Second lien term loan | — | 175,000 | ||||||
Revolving credit facility | — | 100,000 | ||||||
Hollywood senior subordinated notes | 450 | 450 | ||||||
Capital leases | 80 | 4 | ||||||
Total | 1,092,455 | 1,194,601 | ||||||
Less current portion | (4,580 | ) | (1,194,601 | ) | ||||
$ | 1,087,875 | $ | — | |||||
March 2007 Credit Facility First lien term loan - 598,500
Second lien term loan - 175,000
Revolving credit facility - 100,000
Hollywood senior subordinated notes 450 450
Capital leases 80 1,412
------------ ------------
Total 1,092,455 1,197,683
Less current portion (4,580) (1,197,683)
------------ ------------
$ 1,087,875 $ -
============ ============
March 2007 Credit Facility
(Amended and Restated on May 20, 2008)
On March 8, 2007, we entered into a new $900 million senior secured credit facility, or the March 2007 Credit Facility. The March 2007 Credit Facility refinanced a previous $829.9 million senior secured credit facility, or the April 2005 Credit Facility, which we entered into in April 2005 in connection with the acquisition of Hollywood. The $325 million of 11% senior unsecured notes due 2012, or the 11% senior notes, which we also issued in connection with the Hollywood acquisition, remain outstanding.
remained outstanding at that time.
We accounted for the refinancing of the April 2005 Credit Facility as an extinguishment of debt, and in the first quarter of fiscal 2007 we recognized a debt extinguishment charge of $17.5 million to write off the unamortized deferred financing fees related to the April 2005 Credit Facility. In addition, we have deferred $23.2 million in debt financing fees related to the March 2007 Credit Facility, which will be recognized ratably over the term of the March 2007 Credit Facility.
The
Prior to the commencement of the Chapter 11 Cases, the March 2007 Credit Facility consistsconsisted of:
- -
a $100 million revolving credit facility, which we refer to as the revolver;
- - revolver, which was subsequently refinanced under the DIP Credit Agreement, as discussed below;
a $25 million first lien synthetic letter of credit facility;
- -
a $600 million first lien term loan; and
- -
a $175 million second lien term loan.
We sometimes collectively refer to the revolver, the first lien term loan and the letter of credit facility as the first lien facilities.
The first lien facilities require us to meet certain financial covenants,
including a secured leverage test, a total leverage test and an interest
coverage test. Each of these covenants is calculated based on trailing four
quarter results using specific definitions that are contained in the first lien
credit agreement. Due to current industry conditions and increasing
competition in the home video market, as discussed in Item 2. Management's
Discussion and Analysis of Financial Condition and Results of Operations, we
were not in compliance with the financial covenants contained in the first lien
facilities as of the end of the second quarter of fiscal 2007. The second lien
credit facility contains no financial covenants, but a default under the first
lien credit agreement could create a cross default under the second lien term
loan and the 11% senior notes.
As a result of our non-compliance with the financial covenants contained in the
first lien facilities and our resulting default under the first lien credit
agreement, the first lien credit agreement lenders have the right to terminate
their commitments, accelerate all of our obligations and exercise their
remedies under the first lien credit agreement. We have executed a Forbearance
Agreement (as amended), effective as of July 2, 2007, with certain lenders
under the first lien credit agreement. Under the Forbearance Agreement (as
amended), the lenders will forbear until August 14, 2007 from exercising
default-related rights and remedies arising from existing defaults, absent any
new defaults under the first lien credit agreement or the Forbearance Agreement
(as amended).
Due to our default under the first lien credit agreement, we have classified
all obligations due under the first lien facilities as current liabilities as
of July 1, 2007. Due to the uncertainty that our default under the first lien
credit agreement could trigger the cross default provisions on our second lien
term loan and 11% senior notes, we have classified our $175 million second lien
term loan and our $325 million 11% senior notes as current liabilities as of
July 1, 2007.
For further information regarding our March 2007 Credit Facility and our
default under our first lien credit agreement, see Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Liquidity and Capital Resources" in this Quarterly Report on Form 10-Q.
Interest Rate Hedges
24
Our March 2007 Credit Facility requiresrequired that no later than 90 days subsequent to entering into the March 2007 Credit Facility, 50% of our total outstanding debt was to be converted to fixed ratefixed-rate debt for a period of three years subsequent to March 8, 2007. On April 3, 2007, we executed a floating-to-fixed interest rate swap for an
amount of $225.0 million, with an effective date of April 5, 2007 and a
termination date of June 29, 2007. Under the terms of this swap agreement, we
paid fixed-rate interest on the $225.0 million at a rate of 5.348% and received
floating-rate interest based on a linear interpolation of two-month and three-
month LIBOR for the 85 days covering the term of this swap. We received $0 in
consideration upon settlement of this interest rate swap.
On April 3, 2007, we executed a forward-starting floating-to-fixed interest
rate swap for an amount of $225.0 million, with an effective date of June 29,
2007 and a termination date of June 30, 2010. Under the terms of this forward-
starting swap agreement, we paid fixed-rate interest on the $225.0 million at a
rate of 5.128% and received floating-rate interest based on three-month LIBOR.
On July 5, 2007, we settled this interest rate swap (prior to the scheduled
termination date) and received $1.3 million in consideration.
On July 31, 2007, we entered into a new 6.5% interest rate cap agreement with a notional amount of $275.0 million, for which we paid a fixed fee of $0.3 million. Under the terms of the newthis cap agreement, we willwould pay floating-rate interest up to a maximum of 6.50% and receive floating-rate interest based on three-month LIBOR through the scheduled termination date of March 8, 2010.
Under the terms of the first lien credit agreement, our filing of the Chapter 11 Cases created an event of default. Upon the filing of the Chapter 11 Cases, the lenders’ obligations to loan additional money to us terminated and the outstanding principal balance of all loans and other obligations under the first lien facilities became immediately due and payable. Accordingly, we have classified all obligations under the first lien facilities as current liabilities as of September 30, 2007.
The filing of the Chapter 11 Cases also created an event of default under our second lien credit facility. Under the terms of the second lien credit agreement, the entire principal balance of all loans and other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we have classified our $175 million second lien term loan as a current liability as of September 30, 2007.
The first and second lien facilities were amended and restated as discussed below in connection with our emergence from Chapter 11 on May 20, 2008.
11% Senior Notes due 2012
The filing of the Chapter 11 Cases also created an event of default under our 11% senior notes due 2012. Under the terms of the 11% senior notes, the outstanding principal balance of all of the 11% senior notes and other obligations became due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we have classified our $325 million 11% senior notes as a current liability as of September 30, 2007.
On the Effective date, the 11% senior notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of 11% senior notes and other general unsecured claims will receive equity in the Reorganized Debtors.
9.625% Senior Subordinated Notes due 2011
Finally, the filing of the Chapter 11 Cases created an event of default under Hollywood’s 9.625% Senior Subordinated Notes due 2011, or the Senior Subordinated Notes. Under the terms of the Senior Subordinated Notes, the outstanding principal balance of all of the Senior Subordinated Notes and other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we have classified our $0.5 million in Senior Subordinated Notes as a current liability as of September 30, 2007.
On the Effective date, the 9.625% senior subordinated notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of 9.625% senior subordinated notes and other general unsecured claims will receive equity in the Reorganized Debtors.
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Chapter 11 Financing Arrangements
DIP Credit Agreement (As Amended)
In connection with the Chapter 11 Cases, the Reorganized Debtors entered into a $150 million DIP Credit Agreement among us, certain of our subsidiaries (all of whom were Debtors) as Guarantors, Goldman Sachs Credit Partners L.P. as Lead Arranger and Syndication Agent, The Bank of New York as Administrative Agent and Collateral Agent, and the lenders that from time to time become party thereto.
The DIP Credit Agreement provides for (i) a $50 million revolving loan and letter of credit facility, or the Revolving Facility, and (ii) a $100 million term loan. The proceeds of the loans and other financial accommodations incurred under the DIP Credit Agreement were used to refinance our then-existing $100 million pre-petition, secured revolving credit facility, pay certain transactional expenses and fees incurred by us and support our working capital needs and general corporate purposes. At our option, a portion of the Revolving Facility may be made available as swing line loans or for the issuance of letters of credit. On October 16, 2007, the Reorganized Debtors received interim approval from the Bankruptcy Court to access up to $140 million of the DIP Credit Agreement. On October 17, 2007, we closed on our DIP financing facility and, in connection therewith, (i) refinanced in full the existing $100 million pre-petition, secured revolving credit facility and (ii) were granted access of up to $40 million under the Revolving Facility. Subsequently, on November 16, 2007, the Reorganized Debtors received final approval from the Bankruptcy Court granting access to the entire $150 million of the DIP Credit Agreement.
Advances under the DIP Credit Agreement bore interest, at the borrower’s option, (i) at the Base Rate, as defined in the DIP Credit Agreement, plus 2.50% per annum plus the Applicable Case Milestone Margin, as defined below, then in effect (if any) or (ii) at the Adjusted Eurodollar Rate, as defined in the DIP Credit Agreement, plus 3.50% per annum plus the Applicable Case Milestone Margin. As defined in the DIP Credit Agreement, Applicable Case Milestone Margin then in effect means: (i) 0.75%, in the event we failed to file a Chapter 11 plan of reorganization or liquidation and a related disclosure statement with the Bankruptcy Court on or prior to January 15, 2008, and/or in the event an order approving our disclosure statement was not entered by the Bankruptcy Court in the Chapter 11 Cases on or prior to March 1, 2008; (ii) 1.50% in the event an order confirming the Reorganized Debtors’ Chapter 11 plan of reorganization or liquidation was not entered by the Bankruptcy Court in the Chapter 11 Cases on or prior to April 30, 2008; and (iii) 2.25% in the event the effective date of the Reorganized Debtors’ Chapter 11 plan of reorganization or liquidation had not occurred on or prior to May 31, 2008.
Obligations under the DIP Credit Agreement were secured by (i) a lien on substantially all of the assets of the Reorganized Debtors (which lien had a first priority with respect to substantially all of the Reorganized Debtors’ assets), including a pledge of all of the equity interests of each of our domestic subsidiaries and 65% of all of the equity interests of our foreign subsidiaries, and (ii) a superpriority administrative claim in each of the Chapter 11 Cases. In addition, the DIP Credit Agreement obligated the Reorganized Debtors to pay certain fees to the agents and lenders thereunder, as described in the DIP Credit Agreement.
The DIP Credit Agreement contained various representations, warranties and covenants by the Reorganized Debtors that are customary for transactions of this nature, including (without limitation) reporting requirements and maintenance of financial covenants.
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The Reorganized Debtors’ obligations under the DIP Credit Agreement could have been accelerated following certain events of default, including (without limitation) any breach by the Reorganized Debtors of any of the representations, warranties or covenants made in the DIP Credit Agreement or the conversion of any of the Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code or the appointment of a trustee pursuant to Chapter 11 of the Bankruptcy Code.
The DIP Credit Agreement was to mature on the earliest of (i) September 30, 2008, (ii) the effective date of a Chapter 11 plan of reorganization or liquidation confirmed in the Chapter 11 Cases by the Bankruptcy Court and (iii) the date that all loans under the DIP Credit Agreement shall become due and payable in full, whether by acceleration or otherwise.
The DIP Credit Agreement was subsequently amended on November 26, 2007 (the First Amendment), and again on February 5, 2008 (the Second Amendment). The Second Amendment allowed for, among other things, relaxed financial covenants with respect to minimum consolidated adjusted EBITDA, total available liquidity and the secured leverage ratio requirements for the fiscal months of December 2007 through May 2008 and modifications to the interest rate for obligations under the DIP Credit Agreement.
On the Effective Date and pursuant to the Plan, the DIP Credit Agreement was terminated. The creditors under the DIP Credit Agreement were paid in full in cash on the Effective Date.
Post – Chapter 11 Financing Arrangements
On May 20, 2008, we emerged from Chapter 11 by consummating the transactions contemplated by the Plan. In connection therewith, the Reorganized Debtors entered into new financing agreements as described below.
Amended and Restated First Lien Senior Credit Facility
The First Lien Credit Facility is a senior secured credit facility providing for aggregate borrowings in an amount not to exceed $626,488,750 (plus accrued and capitalized interest and fees), consisting of $602,988,750 aggregate principal amount of term loans, or the First Lien Term Loan Facility, and $23,500,000 aggregate principal amount of letters of credit, or the Letter of Credit Facility. The First Lien Credit Facility amended and restated the first lien facilities that were outstanding immediately prior to the commencement of the Chapter 11 Cases.
Borrowings under the First Lien Term Loan Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the First Lien Credit Facility) plus (i) in the case of Base Rate Loans (as defined in the First Lien Credit Facility), 6.25% per annum plus the Applicable Margin Adjustment (as defined in the First Lien Credit Facility), plus interest at 2.75% per annum minus the Applicable Margin Adjustment to be added to the principal amount of such term loans (payment-in-kind, or PIK interest), and (ii) in the case of Eurodollar Rate Loans (as defined in the First Lien Credit Facility), 7.25% per annum plus the Applicable Margin Adjustment, plus interest at 2.75% per annum minus the Applicable Margin Adjustment to be added to the principal amount of such term loans (payment-in-kind, or PIK interest). Disbursements under the Letter of Credit Facility bear interest at a rate equal to (a) for the period from the date of such disbursement to the applicable reimbursement date (as defined in the First Lien Credit Facility), the rate of interest with respect to Base Rate Loans, and (b) thereafter, the rate of interest with respect to Base Rate Loans plus 2% per annum.
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The maturity date of the First Lien Term Loan Facility is the earliest of May 20, 2012, or ninety days following the date the aggregate principal amount of the Term Loans do not exceed $20,000,000, or in the event that the Term Loans become due and payable in full, whether by acceleration or otherwise.
The First Lien Term Loan Facility requires us to meet certain financial covenants, including an interest coverage test, a leverage test, and a secured leverage test. Each of these covenants is calculated on trailing four quarter results using specific definitions that are contained in the First Lien Credit Facility. In general terms,
the interest coverage test is a measurement of operating cash flow relative to cash interest expense;
the leverage test is a measurement of total leverage under the First Lien Credit Facility, including amounts drawn under letters of credit, relative to operating cash flow; and
the secured leverage test is a measurement of secured leverage, which includes indebtedness under the First Lien Term Loan Facility, the Second Lien Term Loan Facility, amounts drawn under letters of credit and any other secured indebtedness relative to operating cash flow.
The First Lien Term Loan Facility also places annual limits on the amount of our consolidated capital expenditures.
The obligations under the First Lien Credit Facility are unconditionally guaranteed each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada, Inc. (“Movie Gallery Canada”). The obligations under the First Lien Credit Facility are also secured by a first priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
Amended and Restated Second Lien Credit Facility
The Second Lien Credit Facility is a senior secured credit facility which provides for term loans in an aggregate principal amount not to exceed $117,141,030. The Second Lien Credit Facility amended and restated the second lien facility that was part of our March 2007 Credit Facility.
Borrowings under the Second Lien Term Loan Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the Second Lien Credit Facility) plus the Applicable Margin defined as (i) until the first anniversary of the Effective Date, 12.75% per annum in the case of Eurodollar Rate Loans and 11.75% in the case of Base Rate Loans and (ii) from the first anniversary of the Effective Date, 13.00% per annum in the case of Eurodollar Rate Loans and 12.00% in the case of Base Rate Loans, which shall increase by an additional 0.25% per annum each six months thereafter; provided that, notwithstanding the foregoing, upon the occurrence of an Interest Event (as defined in the Second Lien Credit Facility), then, as of the next Interest Payment Date (as defined in the Second Lien Credit Facility), the Applicable Margin shall be 8.00% per annum in the case of Eurodollar Rate Loans and 7.00% in the case of Base Rate Loans. Interest on the Second Lien Term Loan Facility will be added to the principal amount of such term loan (payment-in-kind, or PIK interest), provided that all interest shall be paid in cash on each Interest Payment Date following an Interest Event.
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The maturity date of the Second Lien Term Loan Facility is the earlier of November 20, 2012, or in the event that the Term Loans become due and payable in full, whether by acceleration or otherwise.
The Second Lien Term Loan Facility contains no financial covenants.
The obligations under the Second Lien Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada. The obligations under the Second Lien Credit Facility are also secured by a second priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
Revolving Credit Facility
The Revolving Credit Facility is a senior secured credit facility due May 20, 2011 which provides for revolving loans up to an aggregate principal amount of $100,000,000. We entered into the Revolving Credit Facility with various lenders, Sopris Partners Series A of Sopris Capital Partners, LP, as arranger, The Bank of New York, as administrative agent, and Deutsche Bank Trust Company Americas, as collateral agent.
Loans under the Revolving Credit Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the Revolving Credit Facility), plus a margin of 1.5% in the case of Base Rate Loans (as defined in the Revolving Credit Facility) or 3.0% in the case of Eurodollar Rate Loans (as defined in the Revolving Credit Facility). In addition, we must pay commitment fees equal to the average of the daily difference between the revolving commitments and the aggregate principal amount of all outstanding loans, times 0.375% per annum.
Amounts borrowed under the Revolving Credit Facility may be repaid and reborrowed, with the final payment due and payable at the earlier of (i) the third anniversary of the Closing Date (as defined in the Revolving Credit Facility) and (ii) the date that we terminate the revolving commitments. Interest is payable (a) in the case of Base Rate Loans, on the last day of each calendar month and (b) in the case of Eurodollar Rate Loans, on the last day of each applicable interest period. We may voluntarily prepay any revolving loans in whole or in part without penalty or premium. In the event that at any time the sum of the aggregate principal amount of all outstanding revolving loans exceeds the lesser of (i) the Borrowing Base (as defined in the Revolving Credit Facility) and (ii) the aggregate commitments under the Revolving Credit Facility, we will be required to make prepayments in the amount of such excess.
The obligations under the Revolving Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada. The obligations under the Revolving Credit Facility are also secured by a first priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
The Revolving Credit Facility contains customary covenants for facilities of this type, including covenants that will limit our ability, the other guarantors and other subsidiaries to incur or guarantee additional indebtedness, incur liens, make further negative pledges, pay dividends on or repurchase stock, restrict dividends or other distributions from our subsidiaries, make certain types of investments, sell assets, merge with other companies, dispose of subsidiary interests, enter into sales and lease back transactions, enter into transactions with affiliates, or change lines of business. Pursuant to the Revolving Credit Facility, we must comply with the financial covenants set forth in the First Lien Credit Facility.
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Seasonal Overadvance Facility
The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to procure up to $25 million in letters of credit during the period between September 2008 and January 2009, which is referred to as the “Commitment Period.” During the Commitment Period, we may elect to provide certain studios and game vendors with whom we conduct business letters of credit which may be drawn upon if we fail to make timely payments of certain amounts due. Additionally, in the event a vendor draws on a letter of credit, we will be obligated to pay Sopris an amount equal to the amount of the drawing, plus certain additional consideration in the form of Warrants.
Subject to certain exceptions in the Bankruptcy Code, the Chapter 11 filings automatically stayed the initiation or continuation of most actions against the Reorganized Debtors, including most actions to collect pre-petition indebtedness or to exercise control over the property of the bankruptcy estates. Moreover, the Plan and Confirmation Order discharged all pre-petition debts and liabilities not dealt with under the Plan and created an injunction against collecting such debts.
9. Stock Based Compensation
We recognize stock-based compensation expense in accordance with SFASFASB Statement No. 123(R)123 (R). Our accounting for our current stock based compensation plans was recorded in our results of operations during our bankruptcy proceedings. On the Effective Date, our old common stock and other equity interests existing immediately prior to the Effective Date were canceled for no consideration.
Stock options granted under our stock plans have a ten-year term and generally vest over four years. There was no expense recognized related to stock options in the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 or July 1,September 30, 2007, as all of our outstanding options were fully vested as of the end of fiscal 2005.
Following is a summary of our stock option activity for the twenty-sixthirty-nine weeks ended July 1,September 30, 2007:
Weighted-
Options Average Exercise
Outstanding Price Per Share
------------- ----------------
Outstanding at December 31, 2006 779,828 14.47
Granted - -
Exercised - -
Cancelled (16,125) 17.52
------------- ----------------
Outstanding at July 1, 2007 763,703 14.40
Exercisable at December 31, 2006 779,828 14.47
Exercisable at July 1, 2007 763,703 14.40
Options Outstanding | Weighted- Average Exercise Price Per Share | |||||
Outstanding at December 31, 2006 | 779,828 | $ | 14.47 | |||
Granted | — | — | ||||
Exercised | — | — | ||||
Canceled | (35,845 | ) | 16.69 | |||
Outstanding at September 30, 2007 | 743,983 | $ | 14.36 | |||
Exercisable at December 31, 2006 | 779,828 | $ | 14.47 | |||
Exercisable at September 30, 2007 | 743,983 | $ | 14.36 |
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Service-based non-vested share awards vest over periods ranging from one to four years. Compensation expense, representing the excess of the fair market value of the shares at the date of issuance over the nominal purchase price, if any, of the shares, net of assumptions regarding estimated future forfeitures, is charged to earnings over the vesting period. Compensation expense charged to operations related to these stock grants was $0.7$1.6 million and $0.6$1.1 million for the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007, respectively. The total grant date fair value of service-based share awards vested during the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007 was $1.5 million and $3.5$3.6 million, respectively.
Following is a summary of our service-based non-vested share activity for the twenty-sixthirty-nine weeks ending July 1,September 30, 2007:
Weighted-Average
Grant-Date Fair
Shares Value
---------- ------------------
Outstanding at December 31, 2006 1,331,067 $ 8.00
Granted 135,000 3.58
Vested (436,015) 8.14
Cancelled (139,682) 6.65
----------
Outstanding at July 1, 2007 890,370 7.48
==========
Shares | Weighted-Average Grant-Date Fair Value | |||||
Outstanding at December 31, 2006 | 1,331,067 | $ | 8.00 | |||
Granted | 125,000 | 3.68 | ||||
Vested | (444,516 | ) | 8.12 | |||
Canceled | (242,043 | ) | 7.09 | |||
Outstanding at September 30, 2007 | 769,508 | $ | 7.52 | |||
Performance-based non-vested share awards entitle participants to acquire shares of stock upon attainment of specified performance goals. Compensation expense, representing the excess of the fair market value of the shares at the date of issuance over the nominal purchase price, if any, net of assumptions regarding future forfeitures and the likelihood that the performance requirements will be attained, is charged to earnings over the vesting period. Compensation cost of $0.3$0.5 million and $0zero for performance-based stock grants was recognized for the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007, respectively, using the accelerated expense attribution method under SFASFASB Interpretation No. 28,Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans,or EITF 00-23.Issue No. 00-23,Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44. The total grant date fair value of performance-based share awards vested during the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007 was $1.5 million and $0.8 million, respectively.
Following is a summary of our performance-based non-vested share activity for the twenty-sixthirty-nine weeks ended July 1,September 30, 2007:
Weighted-Average
Grant-Date Fair
Shares Value
---------- ------------------
Outstanding at December
Shares | Weighted-Average Grant-Date Fair Value | |||||
Outstanding at December 31, 2006 | 25,000 | $ | 30.03 | |||
Granted | — | — | ||||
Vested | (25,000 | ) | 30.03 | |||
Canceled | — | — | ||||
Outstanding at September 30, 2007 | — | $ | — | |||
31 2006 25,000 $ 30.03
Granted - -
Vested (25,000) 30.03
Cancelled - -
----------
Outstanding at July 1, 2007 - -
==========
Total compensation cost related to all non-vested awards that is not yet recognized was $4.3$3.3 million at July 1,September 30, 2007 and is expected to be recognized over a weighted-average period of approximately two years.
10. Comprehensive Income (Loss)
Comprehensive income (loss) is as follows (in thousands):
Thirteen Weeks Ended Twenty-Six Weeks Ended
---------------------- ----------------------
July 2, July 1, July 2, July 1,
2006 2007 2006 2007
--------- --------- --------- ---------
Net income (loss) $ (14,898) $(309,939) $ 25,452 $(324,805)
Change in foreign currency
cumulative translation
adjustment, net of taxes 1,418 1,327 1,330 1,579
Change in value of interest
rate swap, net of taxes (1,148) (893) (146) (1,806)
--------- --------- --------- ---------
Comprehensive income (loss) $ (14,628) $(309,505) $ 26,636 $(325,032)
========= ========= ========= =========
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
October 1, 2006 | September 30, 2007 | October 1, 2006 | September 30, 2007 | |||||||||||||
Net income (loss) | $ | (36,111 | ) | $ | (188,530 | ) | $ | (10,659 | ) | $ | (513,335 | ) | ||||
Change in foreign currency cumulative translation adjustment, net of taxes | (523 | ) | 1,093 | 808 | 2,672 | |||||||||||
Change in value of interest rate swap, net of taxes | (135 | ) | — | (282 | ) | (1,806 | ) | |||||||||
Comprehensive income (loss) | $ | (36,769 | ) | $ | (187,437 | ) | $ | (10,133 | ) | $ | (512,469 | ) | ||||
11. Commitments and Contingencies
Hollywood and the members of its former board of directors (including Hollywood'sHollywood’s former chairman Mark Wattles) were named as defendants in several lawsuits in the Circuit Court in Clackamas County, Oregon. The lawsuits, filed between March 31, 2004 and April 14, 2004, asserted breaches of duties associated with the mergeracquisition agreement executed with a subsidiary of Leonard Green & Partners, L.P., or LGP. The Clackamas County actions were later consolidated, and the plaintiffs filed an Amended Consolidated Complaint alleging four claims for relief against Hollywood'sHollywood’s former board members arising out of the mergeracquisition of Hollywood withby Movie Gallery. The purported four claims for relief arewere breach of fiduciary duty, misappropriation of confidential information, failure to disclose material information in the proxy statement in support of the Movie Gallery merger,acquisition and a claim for attorneys'attorneys fees and costs. The Amended Consolidated Complaint also namesnamed UBS Warburg and LGP as defendants. Following the merger withacquisition by Movie Gallery, the plaintiffs filed a Second Amended Consolidated Complaint. The plaintiffs restated their causes of action and generally allegealleged that the defendants adversely impacted the value of Hollywood through the negotiations and dealings with LGP. Hollywood and the former members of its board havewere also been named as defendants in a separate lawsuit entitled JDL Partners, L.P. v. Mark J. Wattles et al. filed in Clackamas County, Oregon, Circuit Court on December 22, 2004. This lawsuit, filed before Hollywood'sHollywood’s announcement of the mergeracquisition agreement with Movie Gallery, allegesalleged breaches of fiduciary duties related to a bid by Blockbuster Inc. to acquire Hollywood, as well as breaches related to a loan to Mr. Wattles that Hollywood forgave in December 2000. On April 25, 2005, the JDL Partners action was consolidated with the other Clackamas County lawsuits. The plaintiffs seeksought damages and attorneys'attorneys’ fees and costs. The parties agreed to settle the case and entered into a Stipulation of Settlement and Release dated March 29, 2007. An order and final judgment, approving the settlement and dismissing the case with prejudice, was entered by the court on June 4, 2007. Due to our current liquidity situation, we haveHollywood did not yet performed ourperform certain obligations pursuant to the Stipulation of Settlement and Release. As a result, the plaintiffs filed a motion for contempt against certain former Debtor entities and certain of our officers. The case was stayed due to the commencement of the Chapter 11 Cases and is now subject to the injunction in the Plan. Hollywood’s remaining obligations pursuant to the Stipulation of Settlement and Release are pre-petition liabilities that are subject to compromise under the Plan.
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By letter dated August 29, 2005, Boards Video Company, LLC (as successor in interest to Boards, Inc.), or Boards, an entity controlled by Mark Wattles, the founder and former Chief Executive Officer of Hollywood, exercised a contractual right to require Hollywood to purchase all of the 20 Hollywood Video stores, including 17 Game Crazy stores, owned and operated by Boards, pursuant to a put option. The put option, and a related call option, were contained in the license agreement between Hollywood and Boards that was effective January 25, 2001. On a change of control (as defined in the license agreement), Hollywood had an option to purchase the stores within six months. Likewise, on a change of control, Boards had the option to require Hollywood to purchase the stores within six months. In both cases, the process by which the price would be determined was detailed in the license agreement and was at fair value as determined by an appraisal process. In accordance with the terms of
the license agreement, Hollywood and Boards have agreed to the retention of a
valuation expert and are proceeding with the valuation of the stores. As of July 1,September 30, 2007 the purchase price had not yet been determined. It is possible
that the transaction will close in fiscal 2007. On March 7, 2007, Boards sent to us a demand for arbitration, which we refer to as the Demand, seeking to determine the purchase price of these stores, along with accrued interest. Additionally, Boards claimsclaimed an additional $10.0 million in punitive damages, alleging that we have takentook action to deliberately diminish the value of the Boards stores in order to lower the purchase price. We believemaintain that the allegations contained in the Demand are without meritmerit. The Demand has been stayed due to the commencement of the Chapter 11 Cases. Subsequently, the Reorganized Debtors and intendBoards entered into a stipulation and agreed order that rejected the license agreement and related product and support agreement, subject to vigorously defend this
matter.
certain conditions. As part of the stipulation and agreed order, Boards agreed that the put option was terminated and released the Reorganized Debtors from all claims, except for certain ordinary course payment obligations that the Reorganized Debtors may have under the license agreement and related product and support agreement. On March 25, 2008, the Bankruptcy Court approved the stipulation and agreed order.
In addition, we have been named to various other claims, disputes, legal actions and other proceedings involving contracts, employment and various other matters.matters, most of which have been stayed due to the filing of the Chapter 11 Cases. A negative outcome in certain of the ongoing litigation could harm our business, financial condition, liquidity or results of operations. In addition, prolonged litigation, regardless of which party prevails, could be costly, divert management'smanagement’s attention or result in increased costs of doing business. We believe we have provided adequate reserves for contingencies and that the outcome of these matters will not have a material adverse effect on our consolidated results of operation, financial condition or liquidity.
At July 1,September 30, 2007 the legal contingencies reserve was $2.0 million, of which $1.0 million relates to pre-Hollywood acquisition contingencies.
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12. Segment Reporting
Our reportable segments are based on our three store brands, Movie Gallery, Hollywood Video, and Game Crazy. As of September 30, 2007, Movie Gallery represents 2,522represented 2,443 video stores serving mainly rural markets in the United States and Canada; Hollywood Video represents 2,017represented 1,972 video stores serving predominantly urban markets; and Game Crazy represents 623represented 600 in-store departments and 14 free-standing stores serving the game market in urban locations. Subsequent to September 30, 2007, these respective store count numbers have been significantly reduced as the result of our phased store closure programs. We measure segment profit as operating income (loss), which is defined as income (loss) before interest and other financing costs, equity in losses of unconsolidated entities and income taxes. Information on our reportable operating segments is as follows (in thousands):
Thirteen Weeks Ended
July 2, 2006
-------------------------------------------
Movie Hollywood Game
Gallery Video Crazy Total
---------- --------- -------- ----------
Rental revenue $ 191,351 $ 302,195 $ - $ 493,546
Product sales 17,880 25,001 64,858 107,739
Depreciation and
amortization 9,664 13,239 2,459 25,362
Rental amortization 23,883 30,495 - 54,378
Operating income (loss) (1,824) 17,400 (1,333) 14,243
Goodwill 147 117,771 - 117,918
Total assets 369,534 730,436 97,666 1,197,636
Purchases of property,
furnishings and
equipment 3,890 2,199 19 6,108
Thirteen Weeks Ended
July 1, 2007
-------------------------------------------
Movie Hollywood Game
Gallery Video Crazy Total
---------- --------- -------- ----------
Rental revenue $ 174,802 $ 258,603 $ - $ 433,405
Product sales 18,943 26,732 82,144 127,819
Depreciation and
amortization 11,069 12,201 2,014 25,284
Rental amortization 20,119 24,337 - 44,456
Impairment of goodwill 148 115,422 - 115,570
Impairment of other
intangibles - 97,879 - 97,879
Impairment of property,
furnishings, and
equipment 16,769 23,256 2,976 43,001
Operating loss (15,787) (265,912) (546) (282,245)
Goodwill - - - -
Total assets 338,773 433,868 119,352 891,993
Purchases of property,
furnishings and
equipment 531 (246) - 285
Twenty-six Weeks Ended
July 2, 2006
-------------------------------------------
Movie Hollywood Game
Gallery Video Crazy Total
---------- --------- -------- ----------
Rental revenue $ 414,032 $ 649,943 $ - $1,063,975
Product sales 39,595 54,668 137,414 231,677
Depreciation and
amortization 19,059 27,785 5,236 52,080
Rental amortization 52,670 67,080 - 119,750
Operating income (loss) 13,542 71,106 (2,896) 81,752
Goodwill 147 117,771 - 117,918
Total assets 369,534 730,436 97,666 1,197,636
Purchases of property,
furnishings and
equipment 10,709 4,289 93 15,091
Twenty-six Weeks Ended
July 1, 2007
-------------------------------------------
Movie Hollywood Game
Gallery Video Crazy Total
---------- --------- -------- ----------
Rental revenue $ 385,012 $ 559,437 $ - $ 944,449
Product sales 37,660 54,556 172,253 264,469
Depreciation and
amortization 19,063 24,017 4,046 47,126
Rental amortization 42,687 51,092 - 93,779
Impairment of goodwill 148 115,422 - 115,570
Impairment of other
intangibles - 97,879 - 97,879
Impairment of property,
furnishings, and
equipment 16,769 23,256 2,976 43,001
Operating income (loss) 4,970 (254,783) 1,187 (248,626)
Goodwill - - - -
Total assets 338,773 433,868 119,352 891,993
Purchases of property,
furnishings and
equipment 453 931 - 1,384
Thirteen Weeks Ended October 1, 2006 | ||||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | |||||||||||||
Rental revenue | $ | 186,007 | $ | 289,772 | $ | — | $ | 475,779 | ||||||||
Product sales | 16,569 | 22,498 | 68,143 | 107,210 | ||||||||||||
Depreciation and amortization | 12,934 | 15,466 | 2,408 | 30,808 | ||||||||||||
Rental amortization | 49,402 | 44,949 | — | 94,351 | ||||||||||||
Operating income (loss) | (14,799 | ) | 10,990 | (317 | ) | (4,126 | ) | |||||||||
Goodwill | 147 | 117,479 | — | 117,626 | ||||||||||||
Total assets | 353,110 | 717,262 | 95,555 | 1,165,927 | ||||||||||||
Purchases of property, furnishings and equipment | 1,455 | 2,545 | 54 | 4,054 | ||||||||||||
Thirteen Weeks Ended September 30, 2007 | ||||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | |||||||||||||
Rental revenue | $ | 176,154 | $ | 254,765 | $ | — | $ | 430,919 | ||||||||
Product sales | 19,873 | 27,152 | 101,018 | 148,043 | ||||||||||||
Depreciation and amortization | 6,972 | 7,262 | 1,363 | 15,597 | ||||||||||||
Rental amortization | 33,646 | 49,537 | — | 83,183 | ||||||||||||
Change in rental amortization estimates | 23,489 | 33,518 | — | 57,007 | ||||||||||||
Impairment of other intangibles | — | 60,543 | — | 60,543 | ||||||||||||
Impairment of property, furnishings, and equipment | 2,779 | 2,498 | 380 | 5,657 | ||||||||||||
Operating income (loss) | (40,772 | ) | (114,623 | ) | (261 | ) | (155,656 | ) | ||||||||
Goodwill | — | — | — | — | ||||||||||||
Total assets | 287,084 | 297,041 | 122,277 | 706,402 | ||||||||||||
Purchases of property, furnishings and equipment | 698 | 2,199 | 26 | 2,923 | ||||||||||||
Thirty-Nine Weeks Ended October 1, 2006 | ||||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | |||||||||||||
Rental revenue | $ | 600,041 | $ | 939,713 | $ | — | $ | 1,539,754 | ||||||||
Product sales | 56,164 | 77,168 | 205,556 | 338,888 | ||||||||||||
Depreciation and amortization | 31,993 | 43,264 | 7,633 | 82,890 | ||||||||||||
Rental amortization | 138,451 | 172,832 | — | 311,283 | ||||||||||||
Change in rental amortization estimates | 11,311 | — | — | 11,311 | ||||||||||||
Operating income (loss) | (1,256 | ) | 82,097 | (3,217 | ) | 77,624 | ||||||||||
Goodwill | 147 | 117,479 | — | 117,626 | ||||||||||||
Total assets | 353,110 | 717,262 | 95,555 | 1,165,927 | ||||||||||||
Purchases of property, furnishings and equipment | 12,164 | 6,834 | 147 | 19,145 | ||||||||||||
Thirty-nine Weeks Ended September 30, 2007 | ||||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | |||||||||||||
Rental revenue | $ | 561,165 | $ | 814,202 | $ | — | $ | 1,375,367 | ||||||||
Product sales | 57,534 | 81,709 | 273,271 | 412,514 | ||||||||||||
Depreciation and amortization | 25,768 | 31,278 | 5,411 | 62,457 | ||||||||||||
Rental amortization | 109,280 | 157,161 | — | 266,441 | ||||||||||||
Change in rental amortization estimates | 23,489 | 33,518 | — | 57,007 | ||||||||||||
Impairment of goodwill | 148 | 115,422 | — | 115,570 | ||||||||||||
Impairment of other intangibles | — | 158,422 | — | 158,422 | ||||||||||||
Impairment of property, furnishings, and equipment | 19,547 | 25,754 | 3,357 | 48,658 | ||||||||||||
Operating income (loss) | (35,803 | ) | (369,405 | ) | 928 | (404,280 | ) | |||||||||
Goodwill | — | — | — | — | ||||||||||||
Total assets | 287,084 | 297,041 | 122,277 | 706,402 | ||||||||||||
Purchases of property, furnishings and equipment | 1,159 | 3,120 | 26 | 4,305 |
34
13. Consolidating Financial Statements
The following tables present condensed consolidating financial information for: (a) Movie Gallery, Inc., or the Parent, on a stand-alone basis; (b) on a combined basis, the guarantors of our 11% Senior Notes due 2012,senior notes, or the Subsidiary Guarantors, which include Movie Gallery US, LLC; Hollywood Entertainment Corporation; M.G.A. Realty I, LLC; M.G. Digital, LLC; MG Automation, LLC and (c) on a combined basis, the non-guarantor subsidiaries, which include Movie Gallery Canada, Inc., and Movie Gallery Mexico, Inc., S. de R.L. de C.V., and MG
Automation, Inc. Each of the Subsidiary Guarantors is wholly owned by Movie Gallery, Inc. The guarantees issued by each of the Subsidiary Guarantors are full, unconditional, joint and several. Accordingly, separate financial statements of the wholly owned Subsidiary Guarantors are not presented because the Subsidiary Guarantors are jointly, severally and unconditionally liable under the guarantees, and we believe separate financial statements and other disclosures regarding the Subsidiary Guarantors are not material to investors. Furthermore, there are no significant legal restrictions on the Parent'sParent’s ability to obtain funds from its subsidiaries by dividend or loan.
The Parent is a Delaware holding company and has no independent operations other than investments in subsidiaries and affiliates.
35
Consolidating Statement of Operations
Thirteen weeks ended July 2,October 1, 2006
(unaudited,
(unaudited, in thousands)
--------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- --------- --------- --------- ---------
Revenue:
Rentals $ - $ 473,467 $ 20,079 $ - $ 493,546
Product sales - 105,449 2,290 - 107,739
--------- --------- --------- --------- ---------
Total revenue - 578,916 22,369 - 601,285
Cost of sales:
Cost of rental revenue - 145,875 9,029 - 154,904
Cost of product sales - 75,516 1,897 - 77,413
--------- --------- --------- --------- ---------
Gross profit - 357,525 11,443 - 368,968
Operating costs and expenses:
Store operating expenses - 291,566 13,928 - 305,494
General and administrative 106 47,314 1,103 - 48,523
Amortization of intangibles - 672
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Revenue: | |||||||||||||||||||
Rental | $ | — | $ | 454,002 | $ | 21,777 | $ | — | $ | 475,779 | |||||||||
Product sales | — | 104,858 | 2,352 | — | 107,210 | ||||||||||||||
Total revenue | — | 558,860 | 24,129 | — | 582,989 | ||||||||||||||
Cost of sales: | |||||||||||||||||||
Cost of rental revenue | — | 133,701 | 7,888 | — | 141,589 | ||||||||||||||
Cost of product sales | — | 76,347 | 1,813 | — | 78,160 | ||||||||||||||
Gross profit | — | 348,812 | 14,428 | — | 363,240 | ||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Store operating expenses | — | 306,981 | 13,540 | — | 320,521 | ||||||||||||||
General and administrative | 3,167 | 41,255 | 1,722 | — | 46,144 | ||||||||||||||
Amortization of intangibles | — | 665 | 36 | — | 701 | ||||||||||||||
Operating income (loss) | (3,167 | ) | (89 | ) | (870 | ) | — | (4,126 | ) | ||||||||||
Interest expense, net | 21,063 | 10,014 | 108 | — | 31,185 | ||||||||||||||
Equity in earnings (losses) of subsidiaries | (11,022 | ) | (361 | ) | — | 11,383 | — | ||||||||||||
Income (loss) before income taxes | (35,252 | ) | (10,464 | ) | (978 | ) | 11,383 | (35,311 | ) | ||||||||||
Income taxes (benefit) | 859 | 558 | (617 | ) | — | 800 | |||||||||||||
Net income (loss) | $ | (36,111 | ) | $ | (11,022 | ) | $ | (361 | ) | $ | 11,383 | $ | (36,111 | ) | |||||
36 - 708
-------- -------- -------- -------- ---------
Operating income (loss) (106) 17,973 (3,624) - 14,243
Interest expense, net 20,321 10,337 36 - 30,694
Equity in earnings (losses)
of subsidiaries 5,193 (2,526) - (2,667) -
-------- -------- -------- -------- ---------
Income (loss) before
income taxes (15,234) 5,110 (3,660) (2,667) (16,451)
Income benefit (336) (83) (1,134) - (1,553)
-------- -------- -------- -------- ---------
Net income (loss) $(14,898) $ 5,193 $ (2,526) $ (2,667) $(14,898)
======== ======== ======== ======== =========
Consolidating Statement of Operations
Thirteen weeks ended July 1,September 30, 2007
(unaudited,
(unaudited, in thousands)
--------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- ---------- --------- ------- ---------
Revenue:
Rentals $ - $ 414,571 $ 18,834 $ - $ 433,405
Product sales - 125,349 2,470 - 127,819
--------- ---------- --------- ------- ---------
Total revenue - 539,920 21,304 - 561,224
Cost of sales:
Cost of rental revenue - 135,423 5,570 - 140,993
Cost of product sales - 94,037 2,077 - 96,114
--------- ---------- --------- ------- ---------
Gross profit - 310,460 13,657 - 324,117
Operating costs and expenses:
Store operating expenses - 290,353 13,268 - 303,621
General and administrative 2,690 41,677 1,563 - 45,930
Amortization of intangibles - 650 36 - 686
Impairment of goodwill - 115,556 14 - 115,570
Impairment of other
intangibles - 97,879 - - 97,879
Impairment of property,
Furnishings, and equipment - 38,953 4,048 - 43,001
Other expenses - - (325) - (325)
--------- --------- --------- ------- ---------
Operating loss (2,690) (274,608) (4,947) - (282,245)
Interest expense, net 19,070 9,609 - - 28,679
Equity in earnings (losses)
of subsidiaries (288,592) (4,074) - 292,666 -
--------- --------- --------- ------- ---------
Income (loss) before
income taxes (310,352) (288,291) (4,947) 292,666 (310,924)
Income taxes (benefit) (413) 301 (873) - (985)
--------- --------- --------- -------- ---------
Net income (loss) $(309,939) $(288,592)$ (4,074) $292,666 $(309,939)
========= ========= ========= ======== =========
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Revenue: | |||||||||||||||||||
Rental | $ | — | $ | 409,431 | $ | 21,488 | $ | — | $ | 430,919 | |||||||||
Product sales | — | 144,729 | 3,314 | — | 148,043 | ||||||||||||||
Total revenue | — | 554,160 | 24,802 | — | 578,962 | ||||||||||||||
Cost of sales: | |||||||||||||||||||
Cost of rental revenue | — | 173,715 | 10,514 | — | 184,229 | ||||||||||||||
Cost of product sales | — | 118,566 | 2,883 | — | 121,449 | ||||||||||||||
Gross profit | — | 261,879 | 11,405 | — | 273,284 | ||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Store operating expenses | — | 292,584 | 13,047 | — | 305,631 | ||||||||||||||
General and administrative | 15,224 | 40,362 | 1,773 | — | 57,359 | ||||||||||||||
Amortization of intangibles | — | 414 | 37 | — | 451 | ||||||||||||||
Impairment of other intangibles | — | 60,543 | — | — | 60,543 | ||||||||||||||
Impairment of property, furnishings, and equipment | — | 5,046 | 611 | — | 5,657 | ||||||||||||||
Other expenses | — | — | (701 | ) | — | (701 | ) | ||||||||||||
Operating income (loss) | (15,224 | ) | (137,070 | ) | (3,362 | ) | — | (155,656 | ) | ||||||||||
Interest expense, net | 24,651 | 11,003 | — | — | 35,654 | ||||||||||||||
Equity in earnings (losses) of subsidiaries | (152,217 | ) | (4,154 | ) | — | 156,371 | — | ||||||||||||
Income (loss) before income taxes | (192,092 | ) | (152,227 | ) | (3,362 | ) | 156,371 | (191,310 | ) | ||||||||||
Income taxes (benefit) | (3,562 | ) | (10 | ) | 792 | — | (2,780 | ) | |||||||||||
Net income (loss) | $ | (188,530 | ) | $ | (152,217 | ) | $ | (4,154 | ) | $ | 156,371 | $ | (188,530 | ) | |||||
37
Consolidating Statement of Operations
Twenty-six
Thirty-nine weeks ended July 2,October 1, 2006
(unaudited,
(unaudited, in thousands)
---------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- ---------- --------- --------- ----------
Revenue:
Rentals $ - $1,021,067 $ 42,908 $ - $1,063,975
Product sales - 226,564 5,113 - 231,677
--------- ---------- --------- --------- ----------
Total revenue - 1,247,631 48,021 - 1,295,652
Cost of sales:
Cost of rental revenue - 310,738 17,743 - 328,481
Cost of product sales - 166,750 4,543 - 171,293
--------- ---------- --------- --------- ----------
Gross profit - 770,143 25,735 - 795,878
Operating costs and expenses:
Store operating expenses - 590,224 26,997 - 617,221
General and administrative 2,897 90,262 2,305 - 95,464
Amortization of intangibles - 1,369 72 - 1,441
-------- --------- -------- -------- ----------
Operating income (loss) (2,897) 88,288 (3,639) - 81,752
Interest expense, net 40,147 17,884 116 - 58,147
Equity in earnings (losses)
of subsidiaries 68,131 (2,594) - (65,537) -
-------- --------- -------- -------- ----------
Income (loss) before
income taxes 25,087 67,810 (3,755) (65,537) 23,605
Income benefit (365) (321) (1,161) - (1,847)
-------- --------- -------- -------- ----------
Net income (loss) $ 25,452 $ 68,131 $ (2,594) $(65,537)$ 25,452
======== ========= ======== ======== ==========
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Revenue: | ||||||||||||||||||||
Rental | $ | — | $ | 1,475,068 | $ | 64,686 | $ | — | $ | 1,539,754 | ||||||||||
Product sales | — | 331,422 | 7,466 | — | 338,888 | |||||||||||||||
Total revenue | — | 1,806,490 | 72,152 | — | 1,878,642 | |||||||||||||||
Cost of sales: | ||||||||||||||||||||
Cost of rental revenue | — | 444,442 | 25,631 | — | 470,073 | |||||||||||||||
Cost of product sales | — | 243,097 | 6,358 | — | 249,455 | |||||||||||||||
Gross profit | — | 1,118,951 | 40,163 | — | 1,159,114 | |||||||||||||||
Operating costs and expenses: | ||||||||||||||||||||
Store operating expenses | — | 897,204 | 40,539 | — | 937,743 | |||||||||||||||
General and administrative | 6,065 | 131,514 | 4,026 | — | 141,605 | |||||||||||||||
Amortization of intangibles | — | 2,034 | 108 | — | 2,142 | |||||||||||||||
Operating income (loss) | (6,065 | ) | 88,199 | (4,510 | ) | — | 77,624 | |||||||||||||
Interest expense, net | 61,209 | 27,898 | 224 | — | 89,331 | |||||||||||||||
Equity in earnings (losses) of subsidiaries | 57,109 | (2,956 | ) | — | (54,153 | ) | — | |||||||||||||
Income (loss) before income taxes | (10,165 | ) | 57,345 | (4,734 | ) | (54,153 | ) | (11,707 | ) | |||||||||||
Income taxes (benefit) | 494 | 236 | (1,778 | ) | — | (1,048 | ) | |||||||||||||
Net income (loss) | $ | (10,659 | ) | $ | 57,109 | $ | (2,956 | ) | $ | (54,153 | ) | $ | (10,659 | ) | ||||||
38
Consolidating Statement of Operations
Twenty-six
Thirty-nine weeks ended July 1,September 30, 2007
(unaudited,
(unaudited, in thousands)
---------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- ---------- --------- --------- ----------
Revenue:
Rentals $ - $ 904,843 $ 39,606 $ - $ 944,449
Product sales - 259,720 4,749 - 264,469
--------- ---------- --------- --------- ----------
Total revenue - 1,164,563 44,355 - 1,208,918
Cost of sales:
Cost of rental revenue - 284,402 11,614 - 296,016
Cost of product sales - 195,645 3,857 - 199,502
--------- ---------- --------- --------- ----------
Gross profit - 684,516 28,884 - 713,400
Operating costs and expenses:
Store operating expenses - 585,526 26,077 - 611,603
General and administrative 5,543 84,429 2,923 - 92,895
Amortization of intangibles - 1,311 70 - 1,381
Impairment of goodwill - 115,556 14 - 115,570
Impairment of other
intangibles - 97,879 - - 97,879
Impairment of property,
Furnishings, and equipment - 38,953 4,048 - 43,001
Other expenses - - (303) - (303)
-------- --------- -------- -------- ----------
Operating income (loss) (5,543) (239,138) (3,945) - (248,626)
Interest expense, net
(Parent includes $17,538
write off of debt issuance
costs) 56,697 19,762 20 - 76,479
Equity in earnings (losses)
of subsidiaries (262,509) (3,616) - 266,125 -
--------- --------- -------- -------- ----------
Income (loss) before
income taxes (324,749) (262,516) (3,965) 266,125 (325,105)
Income taxes (benefit) 56 (7) (349) - (300)
--------- --------- -------- -------- ----------
Net income (loss) $(324,805) $(262,509) $ (3,616) $266,125 $ (324,805)
-======== ========= ======== ======== ==========
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Revenue: | |||||||||||||||||||
Rental | $ | — | $ | 1,314,274 | $ | 61,093 | $ | — | $ | 1,375,367 | |||||||||
Product sales | — | 404,449 | 8,065 | — | 412,514 | ||||||||||||||
Total revenue | — | 1,718,723 | 69,158 | — | 1,787,881 | ||||||||||||||
Cost of sales: | |||||||||||||||||||
Cost of rental revenue | — | 458,118 | 22,128 | — | 480,246 | ||||||||||||||
Cost of product sales | — | 314,210 | 6,743 | — | 320,953 | ||||||||||||||
Gross profit | — | 946,395 | 40,287 | — | 986,682 | ||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Store operating expenses | — | 878,110 | 39,123 | — | 917,233 | ||||||||||||||
General and administrative | 20,767 | 124,789 | 4,696 | — | 150,252 | ||||||||||||||
Amortization of intangibles | — | 1,725 | 107 | — | 1,832 | ||||||||||||||
Impairment of goodwill | — | 115,556 | 14 | — | 115,570 | ||||||||||||||
Impairment of other intangibles | — | 158,422 | — | — | 158,422 | ||||||||||||||
Impairment of property, furnishings, and equipment | — | 43,999 | 4,659 | — | 48,658 | ||||||||||||||
Other expenses | — | — | (1,005 | ) | — | (1,005 | ) | ||||||||||||
Operating income (loss) | (20,767 | ) | (376,206 | ) | (7,307 | ) | — | (404,280 | ) | ||||||||||
Interest expense, net | 81,348 | 30,765 | 21 | — | 112,134 | ||||||||||||||
Equity in earnings (losses) of subsidiaries | (414,724 | ) | (7,771 | ) | — | 422,495 | — | ||||||||||||
Income (loss) before income taxes | (516,839 | ) | (414,742 | ) | (7,328 | ) | 422,495 | (516,414 | ) | ||||||||||
Income taxes (benefit) | (3,504 | ) | (18 | ) | 443 | — | (3,079 | ) | |||||||||||
Net income (loss) | $ | (513,335 | ) | $ | (414,724 | ) | $ | (7,771 | ) | $ | 422,495 | $ | (513,335 | ) | |||||
39
Condensed Consolidating Balance Sheet
December 31, 2006
(in
(in thousands)
--------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- --------- -------- --------- ----------
Assets
Current assets:
Cash and cash equivalents $ - $ 29,274 $ 3,679 $ - $ 32,953
Merchandise inventory, net - 136,887 3,727 - 140,614
Prepaid expenses - 43,683 1,641 - 45,324
Store supplies and other - 18,764 1,447 - 20,211
Deferred income taxes - - 209 - 209
--------- --------- ------ ----------- --------
Total current assets - 228,608 10,703 - 239,311
Rental inventory, net - 326,183 13,798 - 339,981
Property, furnishings and
equipment, net - 230,146 12,789 - 242,935
Goodwill - 115,556 13 - 115,569
Other intangibles, net - 181,646 266 - 181,912
Deposits and other assets 28,906 4,175 488 - 33,569
Investments in subsidiaries 878,144 16,833 - (894,977) -
--------- ---------- ------- ----------- ----------
Total assets $ 907,050 $1,103,147 $38,057 $ (894,977)$1,153,277
========= ========== ======= =========== ==========
Liabilities and stockholders' equity (deficit):
Current liabilities:
Current maturities of
long-term obligations $ 4,500 $ 80 $ - $ - $ 4,580
Accounts payable - 81,007 5,373 - 86,380
Accrued liabilities 858 79,262 312 - 80,432
Accrued payroll 534 45,568 1,794 - 47,896
Accrued interest 6,567 13 194 - 6,774
Deferred revenue - 41,362 693 - 42,055
--------- --------- ------- ---------- ----------
Total current liabilities 12,459 247,292 8,366 - 268,117
Long-term obligations, less
current portion 1,087,425 450 - - 1,087,875
Other accrued liabilities - 31,346 2,370 - 33,716
Intercompany promissory note
(receivable) (384,200) 384,200 - - -
Payable to (receivable from)
affiliate 427,797 (438,285) 10,488 - -
Stockholders' equity
(deficit) (236,431) 878,144 16,833 (894,977) (236,431)
---------- ---------- ------- ----------- ----------
Total liabilities and
stockholders' equity
(deficit) $ 907,050 $1,103,147 $38,057 $ (894,977)$1,153,277
========== ========== ======= =========== ==========
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Assets | |||||||||||||||||||
Current Assets: | |||||||||||||||||||
Cash and cash equivalents | $ | — | $ | 29,274 | $ | 3,679 | $ | — | $ | 32,953 | |||||||||
Merchandise inventory, net | — | 136,887 | 3,727 | — | 140,614 | ||||||||||||||
Prepaid expenses | — | 43,683 | 1,641 | — | 45,324 | ||||||||||||||
Store supplies and other | — | 18,764 | 1,447 | — | 20,211 | ||||||||||||||
Deferred income taxes | — | — | 209 | — | 209 | ||||||||||||||
Total current assets | — | 228,608 | 10,703 | — | 239,311 | ||||||||||||||
Rental inventory, net | — | 326,183 | 13,798 | — | 339,981 | ||||||||||||||
Property, furnishings, and equipment, net | — | 230,146 | 12,789 | — | 242,935 | ||||||||||||||
Goodwill | — | 115,556 | 13 | — | 115,569 | ||||||||||||||
Other intangibles, net | — | 181,646 | 266 | — | 181,912 | ||||||||||||||
Deposits and other assets | 28,906 | 4,175 | 488 | — | 33,569 | ||||||||||||||
Investments in subsidiaries | 878,144 | 16,833 | — | (894,977 | ) | — | |||||||||||||
Total assets | $ | 907,050 | $ | 1,103,147 | $ | 38,057 | $ | (894,977 | ) | $ | 1,153,277 | ||||||||
Liabilities and stockholders’ equity (deficit) | |||||||||||||||||||
Current liabilites: | |||||||||||||||||||
Current maturities of long-term obligations | $ | 4,500 | $ | 80 | $ | — | $ | — | $ | 4,580 | |||||||||
Accounts payable | — | 81,007 | 5,373 | — | 86,380 | ||||||||||||||
Accrued liabilities | 858 | 79,262 | 312 | — | 80,432 | ||||||||||||||
Accrued payroll | 534 | 45,568 | 1,794 | — | 47,896 | ||||||||||||||
Accrued interest | 6,567 | 13 | 194 | — | 6,774 | ||||||||||||||
Deferred revenue | — | 41,362 | 693 | — | 42,055 | ||||||||||||||
Total current liabilities | 12,459 | 247,292 | 8,366 | — | 268,117 | ||||||||||||||
Long-term obligations, less current | 1,087,425 | 450 | — | — | 1,087,875 | ||||||||||||||
Other accrued liabilities | — | 31,346 | 2,370 | — | 33,716 | ||||||||||||||
Intercompany promissory note (receivable) | (384,200 | ) | 384,200 | — | — | — | |||||||||||||
Payable to (receivable from) affiliate | 427,797 | (438,285 | ) | 10,488 | — | — | |||||||||||||
Stockholders’ equity (deficit) | (236,431 | ) | 878,144 | 16,833 | (894,977 | ) | (236,431 | ) | |||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 907,050 | $ | 1,103,147 | $ | 38,057 | $ | (894,977 | ) | $ | 1,153,277 | ||||||||
40
Condensed Consolidating Balance Sheet
July 1,
September 30, 2007
(unaudited,
(unaudited, in thousands)
--------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
--------- --------- ------- ---------- ----------
Assets
Current assets:
Cash and cash equivalents $ - $ 40,961 $ 4,552 $ - $ 45,513
Merchandise inventory, net - 171,120 4,350 - 175,470
Prepaid expenses - 43,942 1,845 - 45,787
Store supplies and other - 15,821 901 - 16,722
Assets held for sale - 7,613 - - 7,613
--------- --------- ------ ----------- --------
Total current assets - 279,457 11,648 - 291,105
Rental inventory, net - 310,305 14,954 - 325,259
Property, furnishings and
equipment, net - 146,282 7,643 - 153,925
Other intangibles, net - 82,456 217 - 82,673
Deferred income taxes, net 1,774 - 1,257 - 3,031
Deposits and other assets 34,109 1,583 308 - 36,000
Investments in subsidiaries 617,216 14,985 - (632,201) -
--------- ---------- ------- ----------- ----------
Total assets $ 653,099 $ 835,068 $36,027 $ (632,201)$ 891,993
========= ========== ======= =========== ==========
Liabilities and stockholders' equity (deficit):
Current liabilities:
Current maturities of
long-term obligations $1,195,821 $ 1,862 $ - $ - $1,197,683
Accounts payable - 61,504 2,818 - 64,322
Accrued liabilities 3,641 67,800 1,384 - 72,825
Accrued payroll - 32,724 1,552 - 34,276
Accrued interest 11,226 13 - - 11,239
Deferred revenue - 38,355 515 - 38,870
--------- --------- ------- ---------- ---------
Total current liabilities 1,210,688 202,258 6,269 - 1,419,215
Long-term obligations, less
current portion - - - - -
Other accrued liabilities - 31,025 2,047 - 33,072
Intercompany promissory note
(receivable) (384,200) 384,200 - - -
Payable to (receivable from)
affiliate 386,905 (399,631) 12,726 - -
Stockholders' equity
(deficit) (560,294) 617,216 14,985 (632,201) (560,294)
---------- ---------- ------- ---------- ----------
Total liabilities and
stockholders' equity
(deficit) $ 653,099 $ 835,068 $36,027 $ (632,201)$ 891,993
========== ========== ======= ========== ==========
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Assets | |||||||||||||||||||
Current assets: | |||||||||||||||||||
Cash and cash equivalents | $ | — | $ | 38,945 | $ | 3,744 | $ | — | $ | 42,689 | |||||||||
Merchandise inventory, net | — | 154,514 | 4,817 | — | 159,331 | ||||||||||||||
Prepaid expenses | — | 17,065 | 2,090 | — | 19,155 | ||||||||||||||
Store supplies and other | — | 19,744 | 958 | — | 20,702 | ||||||||||||||
Assets held for sale | — | 26,165 | — | — | 26,165 | ||||||||||||||
Total current assets | — | 256,433 | 11,609 | — | 268,042 | ||||||||||||||
Rental inventory, net | — | 236,389 | 11,194 | — | 247,583 | ||||||||||||||
Property, furnishings, and equipment, net | — | 126,339 | 6,901 | — | 133,240 | ||||||||||||||
Other intangibles, net | — | 21,499 | 194 | — | 21,693 | ||||||||||||||
Deferred tax assets, net | 1,774 | — | — | 1,774 | |||||||||||||||
Deposits and other assets | 31,375 | 2,376 | 319 | — | 34,070 | ||||||||||||||
Investments in subsidiaries | 466,094 | 11,921 | — | (478,015 | ) | — | |||||||||||||
Total assets | $ | 499,243 | $ | 654,957 | $ | 30,217 | $ | (478,015 | ) | $ | 706,402 | ||||||||
Liabilities and stockholders’ equity (deficit) | |||||||||||||||||||
Current liabilites: | |||||||||||||||||||
Current maturities of long-term obligations | $ | 1,194,147 | $ | 454 | $ | — | $ | — | $ | 1,194,601 | |||||||||
Accounts payable | — | 50,064 | 2,679 | — | 52,743 | ||||||||||||||
Accrued liabilities | 2,002 | 74,079 | 1,460 | — | 77,541 | ||||||||||||||
Accrued payroll | — | 30,078 | 1,079 | — | 31,157 | ||||||||||||||
Accrued interest | 22,968 | 24 | — | — | 22,992 | ||||||||||||||
Deferred revenue | — | 34,900 | 626 | — | 35,526 | ||||||||||||||
Total current liabilities | 1,219,117 | 189,599 | 5,844 | — | 1,414,560 | ||||||||||||||
Other accrued liabilities | — | 36,802 | 2,299 | — | 39,101 | ||||||||||||||
Intercompany promissory note (receivable) | (384,200 | ) | 384,200 | — | — | — | |||||||||||||
Payable to (receivable from) affiliate | 411,585 | (421,738 | ) | 10,153 | — | — | |||||||||||||
Stockholders’ equity (deficit) | (747,259 | ) | 466,094 | 11,921 | (478,015 | ) | (747,259 | ) | |||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 499,243 | $ | 654,957 | $ | 30,217 | $ | (478,015 | ) | $ | 706,402 | ||||||||
41
Condensed Consolidating Statement of Cash Flow
Twenty-six
Thirty-nine weeks ended July 2,October 1, 2006
(unaudited,
(unaudited, in thousands)
-------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
-------- --------- -------- -------- ---------
Operating Activities:
Net income (loss) $ 25,452 $ 68,131 $ (2,594) $(65,537) $ 25,452
Equity in earnings (losses)
of subsidiaries (68,131) 2,594 - 65,537 -
Adjustments to reconcile
net income (loss) to cash
provided by (used in)
operating activities:
Rental inventory
amortization - 110,903 8,847 - 119,750
Purchases of rental
inventory - (75,986) (6,250) - (82,236)
Purchase of rental
inventory-base stock - (9,160) (274) - (9,434)
Depreciation and
intangibles amortization - 49,774 2,306 - 52,080
Gain on disposal of property,
furnishings, and equipment - (697) - - (697)
Stock based compensation 1,253 (196) - - 1,057
Amortization of debt
issuance cost 3,243 - - - 3,243
Deferred income taxes 669 - 18 - 687
Changes in operating
assets and liabilities, net
of business acquisitions:
Merchandise inventory - 13,974 735 - 14,709
Other current assets 19 (7,384) 39 - (7,326)
Deposits and other assets (1,434) 1,405 (46) - (75)
Accounts payable - (142,056) (2,040) - (144,096)
Accrued interest
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Operating Activities: | ||||||||||||||||||||
Net income (loss) | $ | (10,659 | ) | $ | 57,109 | $ | (2,956 | ) | $ | (54,153 | ) | $ | (10,659 | ) | ||||||
Equity earnings in subsidiaries | (57,109 | ) | 2,956 | 54,153 | — | |||||||||||||||
Adjustments to reconcile net income to cash provided by (used in) operating activities | ||||||||||||||||||||
Rental inventory amortization | — | 291,869 | 19,414 | — | 311,283 | |||||||||||||||
Purchases of rental inventory | — | (263,964 | ) | (16,617 | ) | — | (280,581 | ) | ||||||||||||
Purchases of rental inventory - base stock | — | (10,252 | ) | (275 | ) | — | (10,527 | ) | ||||||||||||
Change in rental amortization estimates | 10,623 | 688 | 11,311 | |||||||||||||||||
Depreciation and intangibles amortization | — | 79,441 | 3,449 | — | 82,890 | |||||||||||||||
Stock based compensation | 1,977 | 96 | — | — | 2,073 | |||||||||||||||
Amortization of debt issuance cost | 4,952 | — | — | — | 4,952 | |||||||||||||||
Deferred income taxes | (4 | ) | 4 | 18 | — | 18 | ||||||||||||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||||||||||||||
Merchandise inventory | — | 12,413 | 221 | — | 12,634 | |||||||||||||||
Other current assets | 19 | (7,846 | ) | 752 | — | (7,075 | ) | |||||||||||||
Deposits and other assets | — | 2,540 | 27 | — | 2,567 | |||||||||||||||
Accounts payable | — | (155,884 | ) | (1,570 | ) | — | (157,454 | ) | ||||||||||||
Accrued interest | 9,015 | (6 | ) | 20 | — | 9,029 | ||||||||||||||
Accrued liabilties and deferred revenue | 2,577 | (7,327 | ) | (737 | ) | — | (5,487 | ) | ||||||||||||
Net cash provided by (used in) operating activities | (49,232 | ) | 11,772 | 2,434 | — | (35,026 | ) | |||||||||||||
Investing Activities: | ||||||||||||||||||||
Business acquisitions, net of cash acquired | — | (300 | ) | (19 | ) | — | (319 | ) | ||||||||||||
Purchases of property, furnishings and equipment | — | (17,502 | ) | (1,643 | ) | — | (19,145 | ) | ||||||||||||
Proceeds from disposal of property, furnishings and equipment | — | 1,320 | — | — | 1,320 | |||||||||||||||
Investment in subsidiaries | 88,576 | (1,276 | ) | — | (87,300 | ) | — | |||||||||||||
Net cash provided by (used in) investing activities | 88,576 | (17,758 | ) | (1,662 | ) | (87,300 | ) | (18,144 | ) | |||||||||||
Financing Activities: | ||||||||||||||||||||
Repayment of capital lease obligations | — | (412 | ) | — | — | (412 | ) | |||||||||||||
Intercompany payable/ (receivable) | 16,567 | (20,285 | ) | 3,718 | — | — | ||||||||||||||
Net borrowings (repayments) on credit facilities | 20,004 | — | (6,862 | ) | — | 13,142 | ||||||||||||||
Debt financing fees | (5,528 | ) | — | — | — | (5,528 | ) | |||||||||||||
Proceeds from issuance of long-term debt | 1,948 | — | — | — | 1,948 | |||||||||||||||
Principal payments on debt | (72,335 | ) | — | (57 | ) | — | (72,392 | ) | ||||||||||||
Capital contribution from parent | — | (88,576 | ) | 1,276 | 87,300 | — | ||||||||||||||
Net cash provided by (used in) financing activities | (39,344 | ) | (109,273 | ) | (1,925 | ) | 87,300 | (63,242 | ) | |||||||||||
Effect of exchange rate changes on cash and cash equivalents | — | 808 | — | — | 808 | |||||||||||||||
Decrease in cash and cash equivalents | — | (114,451 | ) | (1,153 | ) | — | (115,604 | ) | ||||||||||||
Cash and cash equivalents at beginning of period | — | 133,901 | 1,337 | — | 135,238 | |||||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | 19,450 | $ | 184 | $ | — | $ | 19,634 | ||||||||||
42 3 9 - 54
Accrued liabilities and
deferred revenue 302 (8,458) (248) - (8,404)
-------- --------- -------- -------- ---------
Net cash provided
by (used in) operating
activities (38,585) 2,847 502 - (35,236)
Investing Activities:
Business acquisitions,
net of cash acquired - (300) (19) - (319)
Purchase of property,
furnishings and equipment - (13,577) (1,514) - (15,091)
Proceeds from disposal of
property, furnishings and
equipment - 1,320 - - 1,320
Investment in subsidiaries 88,576 (1,748) - (86,828) -
-------- --------- -------- -------- ---------
Net cash provided by
(used in) investing
activities 88,576 (14,305) (1,533) (86,828) (14,090)
Financing Activities:
Repayment of capital
lease obligations - (328) - - (328)
Intercompany payable/
receivable 8,855 (14,360) 5,505 - -
Net borrowings on credit
facilities 5,464 - (6,859) - (1,395)
Debt financing fees (5,528) - - - (5,528)
Principal payments on
debt (58,782) - (58) - (58,840)
Capital contribution
from parent - (88,576) 1,748 86,828 -
-------- --------- -------- -------- ---------
Net cash provided by
(used in) financing
activities (49,991) (103,264) 336 86,828 (66,091)
Effect of exchange rate
changes on cash and
cash equivalents - 1,330 - - 1,330
-------- --------- -------- -------- ---------
Decrease in cash and
cash equivalents - (113,392) (695) - (114,087)
Cash and cash equivalents at
beginning of period - 133,901 1,337 - 135,238
-------- --------- -------- -------- ---------
Cash and cash equivalents
at end of period $ - $ 20,509 $ 642 $ - $ 21,151
======== ========= ======== ======== =========
Condensed Consolidating Statement of Cash Flow
Twenty-six
Thirty-nine weeks ended July 1,September 30, 2007
(unaudited,
(unaudited, in thousands)
--------------------------------------------------
Non-
Guarantor Guarantor
Subsid- Subsid- Elimin- Consol-
Parent iaries iaries ations idated
-------- --------- --------- -------- ---------
Operating Activities:
Net income (loss) $(324,805)$(262,509) $ (3,616) $266,125 $(324,805)
Equity in earnings (losses)
of subsidiaries 262,509 3,616 - (266,125) -
Adjustments to reconcile
net income (loss) to cash
used in operating
activities:
Rental inventory
amortization - 88,602 5,177 - 93,779
Purchases of rental
inventory, net - (72,200) (5,064) - (77,264)
Purchases of rental
inventory base stock - (524) - - (524)
Depreciation and
intangibles amortization - 44,842 2,284 - 47,126
Gain on disposal of property,
furnishings, and equipment (228) (40) - (268)
Stock based compensation 538 97 - - 635
Amortization of debt
issuance cost 3,388 - - - 3,388
Write off of debt issuance
costs 17,538 - - - 17,538
Impairment of goodwill - 115,556 14 - 115,570
Impairment of other
intangibles - 97,879 - - 97,879
Impairment of property,
furnishings, and equipment - 38,953 4,048 - 43,001
Other non-cash (income)
expense (1,806) - - - (1,806)
Deferred income taxes (1,774) - (1,077) - (2,851)
Changes in operating
assets and liabilities, net
of business acquisitions:
Merchandise inventory - (34,233) (253) - (34,486)
Other current assets - 4,660 563 - 5,223
Deposits and other assets (2,613) 943 210 - (1,460)
Accounts payable - (19,503) (2,894) - (22,397)
Accrued interest 4,659 - (193) - 4,466
Accrued liabilities and
deferred revenue 2,783 (27,632) (83) - (24,932)
--------- --------- -------- -------- ---------
Net cash used in operating
activities (39,583) (21,681) (924) - (62,188)
Investing Activities:
Business acquisitions,
net of cash acquired - (3,129) - - (3,129)
Purchases of property,
furnishings and equipment - (1,291) (93) - (1,384)
Proceeds from disposal of
property, furnishings, and - 450 87 537
equipment
Investment in subsidiaries - (179) 179 - -
--------- --------- -------- -------- ---------
Net cash provided by
(used in) investing
activities - (4,149) 173 - (3,976)
Financing Activities:
Repayments of capital lease
obligations - (1,034) - - (1,034)
Intercompany payable/
receivable (40,797) 38,551 2,246 - -
Net borrowings (repayments)
on credit facilities 83,477 - - - 83,477
Debt financing fees (23,239) - - - (23,239)
Proceeds from the issuance
of debt 775,000 - - - 775,000
Principal payments on
long-term debt (754,858) - - - (754,858)
-------- -------- -------- -------- ---------
Net cash provided by
financing activities 39,583 37,517 2,246 - 79,346
Effect of exchange rate
changes on cash and
cash equivalents - - (622) - (622)
-------- -------- -------- -------- ---------
Increase in cash and cash
equivalents - 11,687 873 - 12,560
Cash and cash equivalents at
beginning of period - 29,274 3,679 - 32,953
-------- --------- -------- -------- ---------
Cash and cash equivalents
at end of period $ - $ 40,961 $ 4,552 $ - $ 45,513
======== ========= ======== ======== =========
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Operating Activities: | ||||||||||||||||||||
Net income (loss) | $ | (513,335 | ) | $ | (414,724 | ) | $ | (7,771 | ) | $ | 422,495 | $ | (513,335 | ) | ||||||
Equity earnings in subsidiaries | 414,724 | 7,771 | (422,495 | ) | — | |||||||||||||||
Adjustments to reconcile net income to cash provided by (used in) operating activities | ||||||||||||||||||||
Rental inventory amortization | — | 252,919 | 13,522 | — | 266,441 | |||||||||||||||
Purchases of rental inventory | — | (231,605 | ) | (13,193 | ) | — | (244,798 | ) | ||||||||||||
Purchases of rental inventory - base stock | — | (608 | ) | — | — | (608 | ) | |||||||||||||
Change in rental amortization estimates | — | 52,530 | 4,477 | — | 57,007 | |||||||||||||||
Depreciation and intangibles amortization | — | 59,510 | 2,947 | — | 62,457 | |||||||||||||||
Stock based compensation | 883 | 224 | — | — | 1,107 | |||||||||||||||
Amortization of debt issuance cost | 4,824 | — | — | — | 4,824 | |||||||||||||||
Write off of debt issuance costs | 17,538 | — | — | — | 17,538 | |||||||||||||||
Impairment of goodwill | — | 115,556 | 14 | — | 115,570 | |||||||||||||||
Impairment of other intangibles | — | 158,422 | — | — | 158,422 | |||||||||||||||
Impairment of property, furnishings, and equipment | — | 43,998 | 4,660 | — | 48,658 | |||||||||||||||
Other non-cash (income) expense | (1,806 | ) | — | — | — | (1,806 | ) | |||||||||||||
Deferred income taxes | (1,774 | ) | — | 227 | — | (1,547 | ) | |||||||||||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||||||||||||||
Merchandise inventory | — | (17,627 | ) | (407 | ) | — | (18,034 | ) | ||||||||||||
Other current assets | 289 | 27,616 | 448 | — | 28,353 | |||||||||||||||
Deposits and other assets | (1,778 | ) | 197 | 220 | — | (1,361 | ) | |||||||||||||
Accounts payable | — | (30,942 | ) | (3,230 | ) | — | (34,172 | ) | ||||||||||||
Accrued interest | 16,401 | 11 | (193 | ) | — | 16,219 | ||||||||||||||
Accrued liabilties and deferred revenue | 1,147 | (21,684 | ) | (508 | ) | — | (21,045 | ) | ||||||||||||
Net cash provided by (used in) operating activities | (62,887 | ) | 1,564 | 1,213 | — | (60,110 | ) | |||||||||||||
Investing Activities: | ||||||||||||||||||||
Business acquisitions, net of cash acquired | — | (3,129 | ) | — | — | (3,129 | ) | |||||||||||||
Purchases of property, furnishings and equipment | — | (4,184 | ) | (121 | ) | — | (4,305 | ) | ||||||||||||
Proceeds from disposal of property, furnishings and equipment | — | 450 | 87 | — | 537 | |||||||||||||||
Investment in subsidiaries | — | (181 | ) | 181 | — | — | ||||||||||||||
Net cash provided by (used in) investing activities | — | (7,044 | ) | 147 | — | (6,897 | ) | |||||||||||||
Financing Activities: | ||||||||||||||||||||
Repayment of capital lease obligations | — | (1,173 | ) | — | — | (1,173 | ) | |||||||||||||
Intercompany payable/(receivable) | (15,993 | ) | 16,324 | (331 | ) | — | — | |||||||||||||
Net borrowings (repayments) on credit facilities | 83,477 | — | — | — | 83,477 | |||||||||||||||
Debt financing fees | (23,239 | ) | — | — | — | (23,239 | ) | |||||||||||||
Proceeds from issuance of long-term debt | 775,000 | — | — | — | 775,000 | |||||||||||||||
Principal payments on debt | (756,358 | ) | — | — | — | (756,358 | ) | |||||||||||||
Capital contribution from parent | — | — | — | — | — | |||||||||||||||
Net cash provided by (used in) financing activities | 62,887 | 15,151 | (331 | ) | — | 77,707 | ||||||||||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | (964 | ) | — | (964 | ) | |||||||||||||
Increase in cash and cash equivalents | — | 9,671 | 65 | — | 9,736 | |||||||||||||||
Cash and cash equivalents at beginning of period | — | 29,274 | 3,679 | — | 32,953 | |||||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | 38,945 | $ | 3,744 | $ | — | $ | 42,689 | ||||||||||
43
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Overview
Summary of Financial Condition
During the thirteen weeks ended July 1,
Chapter 11 Reorganization
On October 16, 2007, we incurred significant losses
from operations as a result of current industry conditions and increased
competition in the home video market. Our operating results caused us to fail
the financial covenants contained in our first lien credit facilities as of the
end of the second quarter of fiscal 2007, which in turn creates uncertainty
that the associated default under the first lien credit agreement could trigger
cross default provisions on our second lien term loan and 11% senior notes. As
a result of these recent losses, we updated our future projections of operating
cash flows, which caused us to recognize substantial impairment charges on certain of our long-lived assets. Subsequentsubsidiaries, whom we refer to collectively as the Reorganized Debtors, filed voluntary petitions for relief, which we refer to as the Chapter 11 Cases, under Chapter 11 of the United States Bankruptcy Code, or the Bankruptcy Code. For further information regarding these petitions, see Note 1. Proceedings under Chapter 11 of the United States Bankruptcy Code, to our Notes to the endConsolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q. The Reorganized Debtors emerged from Chapter 11 Bankruptcy on May 20, 2008. For further information on our current financing arrangements see the second quarter
of fiscal 2007, many of our significant vendors have discontinued extending us
trade credit, and we have experienced additional tightening of terms with other
vendors. Consequently, our liquidity has been adversely affected and there is
now substantial doubt as to our ability to continue as a going concern.
For additional information regarding our long term obligations, liquidity and
ongoing discussions with our major creditors, see "LiquidityLiquidity and Capital Resources" further below in this Item 2. "Management's Discussion and Analysis
of Financial Condition and Results of Operations."
Resources discussion below.
Current Industry Conditions
Our Movie Gallery and Hollywood Video retail store locations compete in the home video retail industry. The home video retail industry includes the sale and rental of movies by traditional video store retailers, online retailers, subscription rental retailers, mass merchants and other retailers. A number of industry-wide factors have combined to negatively impact the rental market, which include but are not limited to:
- - weak movie title lineup;
- - (without limitation):
cannibalization of rentals by low-pricedlow priced movies available for sale;
- -
growth of the online rental segment;
- -
growth of DVD-dispensing kiosk machines operated by our competitors;
the standard DVD format nearing the end of its life cycle;
- -
movie studios structuring their DVD movie releases towards the later part of the year;
- -
competing high definition DVD formats delaying content release and consumer acceptance; and
- -
the proliferation of alternative consumer entertainment options, including movies available through video-on-demand, TIVO/DVR, digital cable, satellite TV, broadband, and Internet and broadcast television.
While these trends have been apparent for some time, they have beenwere more prevalent overduring the past four months.second quarter of 2007. In addition, while the movie rental market was expected to be soft during the first half of 2007, we experienced significantly sharper than anticipated declines in revenue also over the past
four months.seven month period of March 2007 to September 2007. These declines were primarily the result of competitive pricing between Blockbuster and Netflix over their subscription services and greater than expected customer acceptance of Blockbuster'sBlockbuster’s Total Access program, which mixes elements of instorein-store and online movie rentals. These factors, along with the trends discussed above have had a negative impact on our business over the twenty-sixthirty-nine weeks ended July 1,September 30, 2007. We expect that these factors and trends will continue to have a negative impact on the rental market for at least the next six months, if not longer.
foreseeable future.
44
Our Business
As of July 1,September 30, 2007, we operated approximately 4,5504,429 home video retail stores that rent and sell movies and video games in urban, rural and suburban markets. We currently plan to open fewer than 10opened three new stores forduring the full fiscal year
2007, subject to market and industry conditions.thirty-nine weeks ended September 30, 2007. We operate three distinct brands: Movie Gallery, Hollywood Video and Game Crazy. Movie Gallery'sGallery’s eastern-focused rural and secondary market presence and Hollywood's western-
focusedHollywood’s western-focused prime urban and suburban superstore locations combine to form a nationwide geographical store footprint.
We believe the most significant dynamic in our industry is the relationship our industry maintains with the movie studios. The studios have historically maintained an exclusive window for home video distribution (available for rental and sale), which provides the home video industry with an approximately 45- to 60- day period during which we can rent and sell new releases before they are made available on pay-per-view or through other distribution channels. According to Adams Media Research, the domestic home video industry accounted for approximately 60% of domestic studio movie revenue in 2006. For this reason, we believe movie studios have a significant interest in maintaining a viable home video business.
Our strategies are focused on developing and maintaining a sustainable business model. We strive to minimize the operating and overhead costs associated with our business. It is our belief that the brick-and-mortar stores will continue to retain their relevance, and that relevance can be augmented with certain enhancements, such as:
- -
store size optimization;
- -
geographical placement and branding of stores within our fleet;
- -
expansion of thea movie kiosk program;
- -
integration of complementary in-store technology;
- -
integration of online video rentalrental; and video on demand; and
- -
balanced marketing and promotions that provide a meaningful return on investment.
To that end, we
We have continued to explore the economic viability of various alternative delivery channels,channels. For example, we may develop and we are taking steps to develop our own
online video rental and video-on-demand delivery systems. We anticipate
offeringoffer online video rental to the broader marketplace in earlythe future subject to the availability of funds for development. However, we were unable to achieve our previously anticipated revenue and customer acquisition levels for MovieBeam, our video-on-demand program which we acquired earlier in fiscal 2007, and in the fourth quarter of fiscal 2007 we ceased operations associated with MovieBeam. Subsequently, in the second quarter of fiscal 2008 we sold MovieBeam’s assets, including certain trademarks and we recently acquired MovieBeam, Inc., or MovieBeam, an on-demand movie
service.
intellectual property associated with its business, for cash consideration of approximately $2.3 million, which was in excess of their carrying value.
We do not see a cost-benefit advantage in the adoption of a first-mover strategy that ignores underlying economic fundamentals. Rather, it is our intent to deliver complementary offerings to our customers when these offerings can provide not only compelling value propositions, but also tangible contributions to our operating performance.
In addition to the relationship between our industry and the movie studios, our operating results are driven by revenue, inventory, rent and payroll. Given those key factors, we believe that monitoring our five operating performance indicators described below will contribute to the execution of our operating plans and strategy.
- - Revenues. Our business is a cash business with initial rental fees paid
upfront by the customer. Our management team continuously reviews inventory
levels, marketing and sales promotions, real estate strategies, and staffing
requirements in order to maximize revenues at each location. Additionally,
our team monitors revenue performance on a daily basis to quickly identify
trends or issues in our store base or in the industry as a whole. Our
management closely monitors same-store revenues, which we define as revenues
at stores that we have operated for at least 12 full months, excluding
stores that have been downsized or remodeled, to assess the performance of
our business.
- - Product purchasing economics. In order to maintain the desired profit
margin in our business, we carefully manage purchases of inventory for both
rental and sale. Our purchasing models are designed to analyze the impact
of the economic factors inherent in the various pricing strategies employed
by the studios. We believe that our models enable us to achieve purchasing
levels tailored for the customer demographics of each of our markets and to
maximize the return on investment of our inventory purchase dollars.
- - Store level cost control. The most significant store expenses are payroll
and rent, followed by other supply and service expenditures. We attempt to
control these expenses primarily through budgeting systems and
centralization of purchases in our corporate support centers. This enables
us to measure performance against expectations and to leverage our
purchasing power. We also benefit from the reduced labor and real estate
costs the Movie Gallery brand stores enjoy by being located in rural markets
versus the higher costs associated with the larger urban markets. We are
also able to adjust store hours and staffing levels to specific market
conditions, as well as leverage best practices from both Movie Gallery and
Hollywood to reduce expense and increase operating efficiency.
- - Leverage of overhead expenses. We apply the same principles of budgeting,
accountability and conservatism in our overhead spending that we employ in
managing our store operating costs. Our general and administrative expenses
include the costs to maintain our corporate support centers as well as the
overhead costs of our field management teams. Our integration strategy is
focused on eliminating duplication, leveraging best practices and reaping
the financial benefits of economies of scale to reduce costs.
- - Operating cash flows. In prior years, our stores generated significant
levels of cash flow. These cash flows were able to fund the majority of our
store growth and acquisitions, as well as ongoing inventory purchases. An
exception to this was the acquisition of Hollywood, which we funded through
a combination of cash on hand and significant long-term debt. Currently our
inventory purchases are being funded through a combination of store cash
flows and cash on hand, as a result of our having fully drawn the remaining
availability under the revolving portion of our March 2007 Credit Facility.
During the second quarter of fiscal 2007, Bill Kosturos, a Managing Director at
restructuring and corporate advisory firm Alvarez & Marsal, resumed his role as
our Chief Restructuring Officer. Alvarez & Marsal was retained by us in 2006
to bolster our accounting and finance functions and assist in improving our
overall operating performance. Alvarez & Marsal's responsibilities have now
expanded to include helping us evaluate available strategic and restructuring
alternatives. In addition to Alvarez & Marsal, we have hired Lazard Freres &
Co. LLC to serve as an independent financial advisor.
45
• | Revenues. Our business is a cash business with initial rental fees paid upfront by the customer. Our management team continuously reviews inventory levels, marketing and sales promotions, real estate strategies, and staffing requirements in order to maximize revenues at each location. Additionally, we monitor revenue performance on a daily basis to quickly identify trends or issues in our store base or in the industry as a whole. Our management closely monitors same-store revenues, which we define as revenues at stores that we have operated for at least 12 full months, excluding stores that have been downsized or remodeled, to assess the performance of our business. |
• | Product purchasing economics. In order to maintain the desired profit margin in our business, we carefully manage purchases of inventory for both rental and sale. Our purchasing models are designed to analyze the impact of the economic factors inherent in the various pricing strategies employed by the movie studios. We believe that our models enable us to achieve purchasing levels tailored for the customer demographics of each of our markets and to maximize the return on investment of our inventory purchase dollars. |
• | Store level cost control. The most significant store expenses are payroll and rent, followed by other supply and service expenditures. We attempt to control expenses primarily through budgeting systems and centralization of purchases in our corporate support centers. This enables us to measure performance against expectations and to leverage our purchasing power. We also benefit from the reduced labor and real estate costs that the Movie Gallery brand stores enjoy by being located in rural markets versus the higher costs associated with the larger urban markets. We are also able to adjust store hours and staffing levels to specific market conditions, as well as leverage best practices from both Movie Gallery and Hollywood to reduce expenses and increase operating efficiency. |
• | Leverage of overhead expenses. We apply the same principles of budgeting, accountability and conservatism in our overhead spending that we employ in managing our store operating costs. Our general and administrative expenses include the costs to maintain our corporate support centers as well as the overhead costs of our field management teams. Our integration strategy is focused on eliminating duplication, leveraging best practices and reaping the financial benefits of economies of scale to reduce costs. |
• | Operating cash flows. In prior years, our stores generated significant levels of cash flow. These cash flows were able to fund the majority of our store growth and acquisitions, as well as ongoing inventory purchases. An exception to this was the acquisition of Hollywood, which we funded through a combination of cash on hand and significant long-term debt. Subsequent to the Effective Date, May 20, 2008, the date of our emergence from Chapter 11 Bankruptcy, our inventory purchases are being funded through a combination of store cash flows, our new Revolving Credit Facility and cash on hand. |
46
Seasonality
There is a distinct seasonal pattern to the home video and game retail business. Compared to other months during the year, we typically experience peak revenues during the months of November, December, January, and February due to the holidays in these months, inclement weather conditions and frequently the home video release of the preceding summer'ssummer’s hit titles. September is typically the lowest revenue period with schools back in session and the premiere of new fall broadcast television programs. Seasonal patterns for our Game Crazy operating segment are similar to traditional retail revenue peaks, which are significantly weighted towards holiday periods and when schools are out of session.
Pending Acquisition
By letter dated August 29, 2005, Boards, Inc., or Boards, an entity controlled
by Mark Wattles, the founder and former Chief Executive Officer of Hollywood,
exercised a contractual right to require Hollywood to purchase all of the 20
Hollywood Video stores, including 17 Game Crazy stores, owned and operated by
Boards, pursuant to a put option. The put option, and a related call option,
were contained in the license agreement between Hollywood and Boards that was
effective January 25, 2001. On a change of control (as defined in the license
agreement), Hollywood had an option to purchase the stores within six months.
Likewise, on a change of control, Boards had the option to require Hollywood to
purchase the stores within six months. In both cases, the process by which the
price would be determined was detailed in the license agreement and was at fair
value as determined by an appraisal process. In accordance with the terms of
the license agreement, Hollywood and Boards have agreed to the retention of a
valuation expert and are proceeding with the valuation of the stores. As of
July 1, 2007, the purchase price had not yet been determined. It is possible
that the transaction will close in fiscal 2007. On March 7, 2007, Boards sent
to us a demand for arbitration, which we refer to as the Demand, seeking to
determine the purchase price of these stores, along with accrued interest.
Additionally, Boards claims an additional $10.0 million in punitive damages,
alleging that we have taken action to deliberately diminish the value of the
Boards stores in order to lower the purchase price. We believe the allegations
contained in the Demand are without merit and intend to vigorously defend this
matter.
Results of Operations
The following discussion of our results of operations, liquidity and capital resources is intended to provide further insight into our performance for the thirteen weeks and twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007.
47
Selected Financial Statement and Operational Data:
Thirteen Weeks Ended Twenty-Six Weeks Ended
-------------------- ----------------------
July
Thirteen Weeks Ended | Thirty-Nine Weeks Ended | |||||||||||||||
October 1, 2006 | September 30, 2007 | October 1, 2006 | September 30, 2007 | |||||||||||||
($ in thousands, except per share and store data) | ||||||||||||||||
Rental revenue | $ | 475,779 | $ | 430,919 | $ | 1,539,754 | $ | 1,375,367 | ||||||||
Product sales | 107,210 | 148,043 | 338,888 | 412,514 | ||||||||||||
Total revenue | 582,989 | 578,962 | 1,878,642 | 1,787,881 | ||||||||||||
Cost of rental revenue | 141,589 | 184,229 | 470,073 | 480,246 | ||||||||||||
Cost of product sales | 78,160 | 121,449 | 249,455 | 320,953 | ||||||||||||
Total gross profit | 363,240 | 273,284 | 1,159,114 | 986,682 | ||||||||||||
Store operating expenses | 320,521 | 305,631 | 937,743 | 917,233 | ||||||||||||
General and administrative expenses | 46,144 | 57,359 | 141,605 | 150,252 | ||||||||||||
Impairment of goodwill | — | — | — | 115,570 | ||||||||||||
Impairment of other intangibles | — | 60,543 | — | 158,422 | ||||||||||||
Impairment of property, furnishings, and equipment | — | 5,657 | — | 48,658 | ||||||||||||
Operating income (loss) | (4,126 | ) | (155,656 | ) | 77,624 | (404,280 | ) | |||||||||
Interest expense, net (includes $17,538 write off of debt issuance costs for the thirty-nine weeks ended September 30, 2007) | 31,185 | 35,654 | 89,331 | 112,134 | ||||||||||||
Net loss | (36,111 | ) | (188,530 | ) | (10,659 | ) | (513,335 | ) | ||||||||
Net loss per diluted share | $ | (1.13 | ) | $ | (5.84 | ) | $ | (0.34 | ) | $ | (16.02 | ) | ||||
Rental margin | 70.2 | % | 57.2 | % | 69.5 | % | 65.1 | % | ||||||||
Product sales margin | 27.1 | % | 18.0 | % | 26.4 | % | 22.2 | % | ||||||||
Total gross margin | 62.3 | % | 47.2 | % | 61.7 | % | 55.2 | % | ||||||||
Percent of total revenue: | ||||||||||||||||
Rental revenue | 81.6 | % | 74.4 | % | 82.0 | % | 76.9 | % | ||||||||
Product sales | 18.4 | % | 25.6 | % | 18.0 | % | 23.1 | % | ||||||||
Store operating expenses | 55.0 | % | 52.8 | % | 49.9 | % | 51.3 | % | ||||||||
General and administrative expenses | 7.9 | % | 9.9 | % | 7.5 | % | 8.4 | % | ||||||||
Impairment of goodwill | 0.0 | % | 0.0 | % | 0.0 | % | 6.5 | % | ||||||||
Impairment of other intangibles | 0.0 | % | 10.5 | % | 0.0 | % | 8.9 | % | ||||||||
Impairment of property, furnishings, and equipment | 0.0 | % | 1.0 | % | 0.0 | % | 2.7 | % | ||||||||
Operating income (loss) | -0.7 | % | -26.9 | % | 4.1 | % | -22.6 | % | ||||||||
Interest expense, net | 5.3 | % | 6.2 | % | 4.8 | % | 6.3 | % | ||||||||
Net income (loss) | -6.2 | % | -32.6 | % | -0.6 | % | -28.7 | % | ||||||||
Total same-store revenues | -0.4 | % | 1.3 | % | -4.0 | % | -3.3 | % | ||||||||
Movie Gallery same-store revenues | 3.0 | % | 0.6 | % | 0.0 | % | -2.4 | % | ||||||||
Hollywood same-store revenues | -1.9 | % | 1.6 | % | -5.9 | % | -3.8 | % | ||||||||
Total same-store rental revenues | -1.9 | % | -8.1 | % | -5.2 | % | -9.5 | % | ||||||||
Movie Gallery same-store revenues | 3.1 | % | -1.7 | % | -0.8 | % | -3.3 | % | ||||||||
Hollywood same-store revenues | -4.6 | % | -12.2 | % | -7.5 | % | -13.3 | % | ||||||||
Total same-store product sales | 6.5 | % | 41.6 | % | 1.1 | % | 23.8 | % | ||||||||
Movie Gallery same-store sales | 1.0 | % | 26.1 | % | 8.8 | % | 6.7 | % | ||||||||
Hollywood same-store sales | 7.5 | % | 44.3 | % | -0.2 | % | 27.1 | % | ||||||||
Store count: | ||||||||||||||||
Beginning of period | 4,763 | 4,553 | 4,749 | 4,642 | ||||||||||||
New store builds | 13 | — | 115 | 3 | ||||||||||||
Stores acquired | — | — | — | — | ||||||||||||
Stores closed | (101 | ) | (124 | ) | (189 | ) | (216 | ) | ||||||||
End of period | 4,675 | 4,429 | 4,675 | 4,429 | ||||||||||||
48
Store Closures
We continue to evaluate underperforming and unprofitable stores as part of our restructuring strategies to conserve cash and reduce our overall cost structure. During the thirty-nine weeks ended September 30, 2007, we closed 216 underperforming stores. During the third quarter of fiscal 2007, we identified approximately 520 Movie Gallery and Hollywood Video stores, which we refer to as the Phase 1 stores, that were subsequently closed during the fourth quarter of fiscal 2007, along with approximately 20 other stores that were closed in the normal course of business. On February 4, 2008, we announced and began closing approximately 370 additional underperforming stores, referred to as the Phase 2 July 1, Julystores, which we closed during the first quarter of fiscal 2008. On April 2, July 1,
20062008 we began our Phase 3 store closures affecting approximately 160 store locations which were completed during the second quarter of fiscal 2008.
Revenue
For the thirteen weeks ended September 30, 2007, 2006consolidated total revenues decreased 0.7% from the comparable period in 2006. The decrease for the thirteen weeks ended September 30, 2007 --------- --------- ---------- ---------
($was primarily due to a decrease in thousands, except per share and store data)
Rental revenue $ 493,546 $ 433,405 $1,063,975 $ 944,449
Productthe number of weighted-average stores operated, partially offset by an increase in consolidated same-store revenue. For the thirteen weeks ended September 30, 2007, the number of weighted-average stores operated declined 4.6%, while consolidated same-store sales 107,739 127,819 231,677 264,469
--------- --------- ---------- ----------
Total revenue 601,285 561,224 1,295,652 1,208,918
Costincreased 1.3%. Consolidated same-store sales for the thirteen-week period consisted of an 8.1% decline in same-store rental revenue, 154,904 140,993 328,481 296,016
Costoffset by a 41.6% increase in same-store product revenue.
For the thirty-nine weeks ended September 30, 2007, consolidated total revenues decreased 4.8% from the comparable period in 2006. The decrease in the thirty-nine weeks ended September 30, 2007 was due to a decrease in the number of productweighted-average stores operated and a decrease in consolidated same-store sales. For the thirty-nine weeks September 30, 2007, consolidated same-store sales 77,413 96,114 171,293 199,502
--------- --------- ---------- ----------
Total gross profit $ 368,968 $ 324,117 $ 795,878 $ 713,400
Store operating expenses $ 305,494 $ 303,621 $ 617,221 $ 611,603
Generaldeclined 3.3% and administrative
expenses $ 48,523 $ 45,930 $ 95,464 $ 92,895
Impairmentthe number of goodwill $ - $ 115,570 $ - $ 115,570
Impairment of other
intangibles $ - $ 97,879 $ - $ 97,879
Impairment of property,
furnishings, and equipment $ - $ 43,001 $ - $ 43,001
Operating income (loss) $ 14,243 $(282,245) $ 81,752 $ (248,626)
Interest expense, net
(includes $17,538 write off
of debt issuance costsweighted-average stores operated declined 4.1%. Consolidated same-store sales for the twenty-six weeks ended
July 1, 2007) $ 30,694 $ 28,679 $ 58,147 $ 76,479
Net income (loss) $ (14,898) $(309,939) $ 25,452 $ (324,805)
Net income (loss) per
diluted share $ (0.47) $ (9.69) $ 0.80 $ (10.18)
Rental margin 68.6% 67.5% 69.1% 68.7%
Product sales margin 28.1% 24.8% 26.1% 24.6%
Total gross margin 61.4% 57.8% 61.4% 59.0%
Percentthirty-nine week period consisted of total revenue:
Rental revenue 82.1% 77.2% 82.1% 78.1%
Product sales 17.9% 22.8% 17.9% 21.9%
Store operating expenses 50.8% 54.1% 47.6% 50.6%
General and administrative
expenses 8.1% 8.2% 7.4% 7.7%
Impairment of goodwill - 20.6% - 9.6%
Impairment of other
intangibles - 17.4% - 8.1%
Impairment of property,
furnishings, and equipment - 7.7% - 3.6%
Operating income (loss) 2.4% (50.3%) 6.3% (20.6%)
Interest expense, net 5.1% 5.1% 4.5% 6.3%
Net income (loss) (2.5%) (55.2%) 2.0% (26.9%)
Total same-store revenues (4.6%) (4.7%) (5.6%) (5.3%)
Movie Gallery same-store
revenues 1.6% (3.5%) (1.3%) (3.7%)
Hollywood same-store revenues (7.3%) (5.3%) (7.5%) (6.2%)
Totala 9.5% decline in same-store rental revenues (5.3%) (10.4%) (6.6%) (10.1%)
Movie Gallery same-store
revenues 1.1% (4.8%) (2.5%) (4.0%)
Hollywood same-store revenues (8.5%) (13.9%) (8.7%) (13.8%)
Totalrevenue, partially offset by a 23.8% increase in same-store product sales (1.5%) 21.0% (1.2%) 15.9%
Movie Gallery same-store sales 6.1% 10.4% 12.3% (1.4%)
Hollywood same-store sales (2.9%) 23.0% (3.4%) 19.2%
Store count:
Beginning of period 4,773 4,589 4,749 4,642
New store builds 32 2 102 3
Stores acquired - - - -
Stores closed (42) (38) (88) (92)
--------- --------- ---------- ---------
End of period 4,763 4,553 4,763 4,553
========= ========= ========== =========
Revenue
revenue.
For the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, consolidatedthe Movie Gallery operating segment’s total revenues decreased 6.7%3.2% and 5.7% from the comparable periods in 2006, primarily due to a decline in consolidated same-store sales and a decrease in the number of weighted averageweighted-average stores operated. For the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, consolidated same-store sales declined 4.7% and 5.3%,
respectively, and the Movie Gallery operating segment’s number of weighted average stores operated declined 4.1%
and 4.4%6.2%, respectively, compared to the prior year periods. Consolidated same-
storePartially offsetting the decrease in the Movie Gallery operating segment’s revenue for the thirteen weeks ended September 30, 2007, was a 0.6% increase in same-store sales. The same-store sales for the thirteen-week period consisted of a 10.4%1.7% decline in same-
storesame-store rental revenue partially offset by a 21.0%26.1% increase in same-store product revenue.
For the thirteen weeks and twenty-six weeks ended July 1, 2007, the Movie
Gallery operating segment's total revenues decreased 7.4% and 6.8% from the
comparable periods in 2006, primarily due to a decline in same-store sales and
a decrease in the number of weighted average stores operated. For the thirteen
weeks and twenty-six weeks ended July 1, 2007, the Movie Gallery operating
segment's same-store sales declined 3.5% and 3.7%, respectively, and the number
of weighted average stores operated declined 6.1% and 6.7%, respectively,
compared to the prior year periods. Same-store sales for the thirteen-week
period consisted of a 4.8% decline in same-store rental revenue, partially
offset by a 10.4% increase in same-store product revenue.
Total revenue for the Hollywood and Game Crazy operating segments for the thirteen weeks and twenty-sixended September 30, 2007 increased 0.7% while total revenue for the thirty-nine weeks ended July 1, 2007 decreased 6.3% and 6.6%,
respectively,4.4 %, from the comparable periods in 2006,2006. The increase in revenue for the thirteen week period was primarily due to a decline1.6% increase in same-store sales of 5.3% and 6.2%, respectively.while the thirty-nine week period decrease in revenue was primarily due to a 3.8% decline in same store sales. Same-store sales for the thirteen-week period consisted of a 13.9%12.2% decline in same-store rental revenue, partially offset by a 23.0% increase in same-store product revenue. The44.3% increase in same-store product revenue, which was driven by a 32.0% and 29.1%54.7% increase in Game Crazy same-store/department sales for the thirteen weeks and twenty-six
weeks ended July 1, 2007, respectively.
sales.
49
We believe the following factors contributed to the decline in our same-store rental revenues:
- -
aggressive pricing and promotion tactics recently implemented by our competition;
- -
the overabundance of DVD titles available for sale in the marketplace;
- -
the growth of online rental;
- -
the growth of DVD-dispensing kiosk machines operated by our competitors;
the maturation of the standard definition DVD life cycle; and
- -
the widespread availability of content through other audio/video media such as recorded television, pay-per-view movies and the Internet.
Cost of Sales
The cost of rental revenues includes the amortization of rental inventory, revenue-sharing expenses incurred and the cost of previously viewed rental inventory sold. The gross margins on rental revenue for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007 were 67.5%57.2% and 68.7%65.1%, respectively, compared to 68.6%70.2% and 69.1%69.5% for the comparable periods in 2006. Gross margins for the thirteen weeks and thirty-nine weeks ended September 30, 2007 were negatively impacted by changes in rental amortization estimates that increased cost of rental revenue by $57.0 million as discussed in Note 2., Accounting Policies, to our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q. Similarly, gross margins for 2006 were negatively impacted by $4.5 million for the thirteen-week period
and $11.3 million for the twenty-sixduring thirty-nine week period ended October 1, 2006 for charges that were recorded to reflectrecognize changes in rental amortization estimates. The decrease in rental
gross margins is primarily due to a declineYear-over-year declines in the average sales price of previously viewed movies and an increase incontinue to negatively impact the cost of product acquired under
revenue sharing arrangements.
gross margins on rental revenue.
Cost of product sales includes the costs of new video game merchandise and used video game merchandise taken in on trade within the Game Crazy operating segment, new movies, concessions and other goods sold. New movies and new game merchandise typically have a much lower margin than used game merchandise and concessions. The gross margin on product sales is subject to fluctuations in the relative mix of the products that are sold. The gross margins on product sales for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007 were 24.8%18.0% and 24.6%22.2%, respectively, compared to 28.1%27.1% and 26.1%26.4% for the comparable periods in 2006. The decrease in product gross margins was primarily due to a shift in the sales mix towards lower-margin products such as DVD movies, game hardware and game software and away from higher-margin products such as concessions. Also contributing to the decrease was a $3.2 million lower-of-cost-or-market write down of inventory that was being liquidated in store closures and $2.9 million of write downs on defective Game Crazy inventory.
Operating Costs and Expenses
Store operating costs and expenses include store-level operational expense, store labor, depreciation, advertising, and other store expenses. Operational expense includes store lease payments, utilities, banking fees, repairs and maintenance, and store supplies expense. Store labor expense includes salaries and wages, employment taxes, benefits, and bonuses for our store employees. Store operating expenses as a percentage of total revenue was 54.1%52.8% and 50.6%51.3% for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, respectively, compared to 50.8%55.0% and 47.6%49.9% for the comparable periods of fiscal 2006.
50
The following table sets forth the changes in store operating costs and expenses as a percent of total revenue for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, compared to the comparable periods in fiscal 2006:
Thirteen Weeks Ended
----------------------------------
July 2, July 1, Net
2006 2007 Change
--------- --------- ---------
Operational expenses 26.0% 27.4% 1.4%
Store labor expense 19.3% 20.3% 1.0%
Depreciation expense 3.4% 3.8% 0.4%
Advertising expense 0.8% 1.4% 0.6%
Other store expense 1.3% 1.2% (0.1%)
--------- --------- ---------
50.8% 54.1% 3.3%
Twenty-Six Weeks Ended
---------------------------------
July 2, July 1, Net
2006 2007 Change
--------- --------- ---------
Operational expenses 24.2% 25.5% 1.3%
Store labor expense 18.3% 19.4% 1.1%
Depreciation expense 3.3% 3.2% (0.1%)
Advertising expense 0.6% 1.2% 0.6%
Other store expense 1.2% 1.3% 0.1%
--------- ---------- --------
47.6% 50.6% 3.0%
The increases in store operating costs and expenses as a percentage of total
revenue for the thirteen weeks and twenty-six weeks ended July 1, 2007 was due
to the proportion of fixed costs affected by the decrease in sales of 6.7% for
both the thirteen weeks and twenty-six weeks ended July 1, 2007.
Thirteen Weeks Ended | |||||||||
October 1, 2006 | September 30, 2007 | Net Change | |||||||
Operational expenses | 26.9 | % | 27.8 | % | 0.9 | % | |||
Store labor expense | 19.7 | % | 20.2 | % | 0.5 | % | |||
Depreciation expense | 4.3 | % | 2.1 | % | -2.2 | % | |||
Advertising expense | 0.9 | % | 1.5 | % | 0.6 | % | |||
Other store expense | 3.2 | % | 1.2 | % | -2.0 | % | |||
Thirty-Nine Weeks Ended | |||||||||
October 1, 2006 | September 30, 2007 | Net Change | |||||||
Operational expenses | 25.0 | % | 26.2 | % | 1.2 | % | |||
Store labor expense | 18.7 | % | 19.7 | % | 1.0 | % | |||
Depreciation expense | 3.6 | % | 2.9 | % | -0.7 | % | |||
Advertising expense | 0.7 | % | 1.3 | % | 0.6 | % | |||
Other store expense | 1.9 | % | 1.2 | % | -0.7 | % |
General and Administrative Expenses
General and administrative expenses as a percentage of revenue for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007 were 8.2%9.9% and 7.7%8.4%, respectively, compared to 8.1%7.9% and 7.4%7.5% for the corresponding periods of 2006.
The increase in General and administrative expenses as a percentage of revenue for the thirteen-weeksthirteen weeks ended July 1,September 30, 2007 was primarily due to a decreasean increase in year over year sales of 6.7%.professional fees. For the thirteen-weeksthirteen weeks ended July 1,September 30, 2007 payroll and related expenses decreased by $7.5$6.5 million, or 1.0%1.1% of revenue, from the corresponding period of 2006, which was partially offset by expenses of MovieBeam of $3.0$2.8 million, or 0.5% of revenue, and an increase in professional fees of $2.0 million.$14.8 million, or 2.6% of revenue. In absolute dollar terms, including MovieBeam expenses, General and administrative expenses decreased $2.6increased $11.2 million compared to the comparable period of fiscal 2006. ForIn addition, for the thirteen weeks ended July 2,October 1, 2006, $2.3$2.1 million in depreciation expense was reclassified from Store operating expenses to General and administrative expenses related to depreciation on corporate fixed assets.
General and administrative expenses as a percentage of revenue for the twenty-
sixthirty-nine weeks ended July 1,September 30, 2007 was relatively flat, increasing 0.3%increased 0.9% when compared to the corresponding period of the prior year. For the twenty-sixthirty-nine weeks ended July 1,September 30, 2007, payroll and related expenses were reduced by $8.7$15.2 million, or 0.7%0.6% of revenue. This decrease was partially offset by MovieBeam expenses of $5.3$8.1 million, or 0.4%0.5% of revenue, and an increase in professional services of $17.3 million, or 1.0% of revenue. In absolute dollar terms, including MovieBeam expenses, Generalgeneral and administrative expenses decreased $2.6increased by $8.7 million compared to the comparable period of fiscal 2006. For the twenty-sixthirty-nine weeks ended July 2,October 1, 2006, $4.6$6.7 million in depreciation expense was reclassified from Store operating expenses to Generalgeneral and administrative expenses related to depreciation on corporate fixed assets.
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Stock compensation expense primarily represents non-cash charges associated with non-vested stock grants. Beginning in fiscal 2006, we adopted Statement of
Financial Accounting Standards Board, or SFAS,FASB, Statement No. 123(R)123(Revised),Accounting for Stock-Based Compensation, "Accounting for Stock-
Based Compensation," or SFASFASB Statement No. 123(R). We used the modified prospective method to adopt SFASFASB Statement No. 123(R), which requires that compensation expense be recorded for all stock-based compensation granted on or after January 2, 2006, as well as the unvested portion of previously granted options.
For the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 and July 1,September 30, 2007, we recognized $0.7$1.6 million and $0.6$1.1 million, respectively, in compensation expenses related to service-based stock grants, and $0.3$0.5 million and $0,zero, respectively, in expenses related to performance-based stock grants. Total compensation cost related to all non-vested awards that is not yet recognized was $4.3$3.3 million at July 1,September 30, 2007 and is expected to be recognized over a weighted-average period of approximately two years.
We may, from time to time, decide to issue stock-based compensation in the form of stock grants and stock options, which under SFASFASB Statement No. 123(R) requires a fair value recognition approach and will be expensed in income from continuing operations. As a result, the amount of compensation expense we recognize over the vesting period will generally not be affected by subsequent changes in the trading value of our common stock. Furthermore, projections as to the number of stock awards that will ultimately vest requires making estimates, and to the extent that actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised. Actual results and future changes in estimates may differ substantially from the current estimates.
Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangibles, and Goodwill
Other Long-Lived Assets (Including Definite-Lived Intangible Assets)
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable, in accordance with SFASFASB Statement No. 144, "AccountingAccounting for the Impairment or Disposal of Long Lived Assets", or SFASFASB Statement No. 144. When an indicator of impairment is noted, assets are evaluated for impairment at the lowest level for which there are identifiable cash flows (e.g., at the store level). Due to the impairment indicators noted in Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, to our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q, we performed impairment testing on our long-lived assets asat the end of July 1,the second and third quarters of fiscal 2007. As a result, we determined that the long-lived assets associated with certain stores were impaired. We recorded a charge of $26.2$29.1 million and $16.8$19.5 million related to the impairment of property, furnishings, and equipment under the Hollywood and Movie Gallery operating segments, respectively.
respectively, for the thirty-nine weeks ended September 30, 2007.
We also determined that our definite-lived intangible asset for the customer list in the Hollywood segment was impaired as a result of attrition in active customers. We therefore recorded an impairment charge of $2.5 million, which was recognized in Impairment of other intangibles.
intangibles, for the thirty-nine weeks ended September 30, 2007.
Other Indefinite-Lived Intangibles
Intangible Assets
We normally conduct our annual test of the valuation of our indefinite-lived
intangible asset, the Hollywood trademark during the fourth quarter of each fiscal year in accordance with our policy and the requirements as set forth in SFASFASB Statement No. 142 "Goodwill and Other Intangible Assets," or SFAS No. 142.as it pertains to indefinite-lived intangible assets. However due to the
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impairment indicators noted in Note 5 to our Notes to Consolidated
Financial Statements,above we performed impairment testing on the Hollywood trademark at the end of the second quarter of fiscal 2007. Furthermore, due to the subsequent filing of the Chapter 11 Cases on October 16, 2007, we performed an additional testing of impairment on the Hollywood trademark as of July 1,the end of third quarter of fiscal 2007.
The impairment testing of the Hollywood trademark compared the fair value of the trademark with its carrying value. The fair value was determined by the Relief from Royalty method, a specific discounted cash flow approach, to analyze cash flows attributable to the Hollywood trademark. The basic tenet of the Relief from Royalty method is that without ownership of the subject intangible asset, the user of that intangible asset would have to make a stream of payments to the owner of the asset in return for the rights to use that asset. By acquiring the intangible asset, the user avoids these payments. Assumptions regarding future revenues, a market-driven royalty rate, and a discount rate are among the most significant estimates used in this method. We determined at the end of the second quarter of fiscal 2007 that the carrying value of the Hollywood trademark was greater than its fair value and therefore was deemed to be impaired. The implied fair value of the Hollywood trademark was determined to be $75.5 million, and therefore an impairment charge was recorded for $95.4 million in Impairment of other intangibles.
intangibles for the twenty-six weeks ended July 1, 2007.
In the third quarter of fiscal 2007, we updated certain of our assumptions with respect to our use of the Relief from Royalty method, most notably our assumption regarding the Hollywood trademark royalty rate. We determined that the adjusted carrying value of $75.5 million was greater than the updated fair value of $15.0 million. Accordingly, an additional impairment charge was recorded for $60.5 million in Impairment of other intangibles for the thirteen weeks ended September 30, 2007.
Furthermore, we concluded that due to the impairment indicators experienced during the thirty-nine weeks ended September 30, 2007, and our subsequent filing of the Chapter 11 Cases on October 16, 2007, there exists substantial doubt as to whether we could continue to classify our Hollywood trademark as an indefinite-lived intangible asset. According to FASB Statement No. 142, when a company determines that the life of an intangible asset is no longer indefinite, that asset should be tested for impairment in the same manner as other indefinite-lived intangible assets. The intangible asset, after recognition of any impairment, should then be amortized over its estimated useful life and accounted for prospectively in the same manner as other intangible assets with finite lives. Therefore, after conducting our tests of impairment, we determined that our Hollywood trademark should be classified as a definite-lived intangible asset, and we have assigned to it an estimated useful life of ten years.
Goodwill
We normally conduct our annual test of the valuation of goodwill during the fourth quarter of each fiscal year in accordance with our policy and the requirements as set forth in SFASFASB Statement No. 142. However, due to the impairment indicators noted in Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, to our Notes to Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q, we performed impairment testing on our valuation of goodwill asat the end of July 1,the second quarter of fiscal 2007.
Goodwill is tested at a reporting unit level, which for this purpose consists solely of Hollywood Video, as our Movie Gallery reporting unit had an immaterial amount of goodwill and our Game Crazy reporting unit has no goodwill. Goodwill is impaired if the fair value of a reporting unit is less than the carrying value of its assets. The estimated fair value of the Hollywood Video reporting unit was computed using the present value of estimated future cash flows, which included the impact of trends in the business and industry noted in the Overview section above. In addition to these business and industry trends, the computation of estimated fair value also considered market prices of our debt and equity securities.
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When we performed our testing, the first step of the impairment test indicated that the fair value of the Hollywood Video reporting unit was lower than its carrying value, and therefore the goodwill of the Hollywood reporting unit was determined to be impaired. The second step of the impairment test indicated that the implied fair value of goodwill for the Hollywood reporting unit was zero, and therefore a goodwill impairment charge was recorded for $115.6 million.
million for the thirty-nine weeks ended September 30, 2007.
Interest Expense, net
Interest expense, net decreased $2.0increased $4.5 million from $30.7$31.2 million for the thirteen weeks ended July 2,October 1, 2006 to $28.7$35.7 million for the thirteen weeks ended July 1,September 30, 2007. The decreaseincrease is primarily attributed to lowerhigher interest rates during the third quarter of fiscal 2007 on our March 2007 Credit Facility.Facility due to our covenant violations. Interest expense, net increased $18.3$22.8 million from $58.1$89.3 million for the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 to $76.4$112.1 million for the twenty-sixthirty-nine weeks ended July 1,September 30, 2007. The increase is primarily attributed to a debt extinguishment charge of $17.5 million to write off the unamortized deferred financing fees related to our previous senior credit facility when it was refinanced in the first quarter of fiscal 2007.
2007, an increase in the amount of debt outstanding during fiscal 2007, and higher interest rates during the third quarter of fiscal 2007 due to our covenant violations.
Income Taxes
In the ordinary course of business, there may be many transactions and calculations where the ultimate tax outcome is uncertain. The calculation of tax liabilities involves dealing with uncertainties in the application of complex tax laws. No assurance can be given that the final outcome of these matters will not be different than the estimated outcomes reflected in the current and historical income tax provisions and accruals.
In July 2006, the Financial Accounting Standards Board, or FASB issued Interpretation No. 48, "AccountingAccounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109, Accounting for Income Taxes," or FIN
48. FINFASB Interpretation No. 48.FASB Interpretation No. 48 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FINFASB Interpretation No. 48, we may recognize a benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FINFASB Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requirements for increased disclosures.
We adopted the provisions of FINFASB Interpretation No. 48 on January 1, 2007. The adoption of FINFASB Interpretation No. 48 did not have a material effect on our consolidated balance sheet or statement of operations. The amount of unrecognized benefits as of January 1, 2007 iswas $11.2 million, of which $4.8 million would impact our effective rate if recognized. There were no material changesWe recognized approximately $2.8 million of benefit during the thirty-nine weeks ended September 30, 2007 due to the release of reserves due to the receipt of refunds from federal and state taxing authorities. The amount of unrecognized benefits during the
twenty-six weeks ended July 1, 2007.
as of September 30, 2007 is $8.1 million of which $2.0 million would impact our effective rate if realized.
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The effective tax rate was a benefit of 0.3%1.5% and 0.1%0.6% for the thirteen weeks and twenty-sixthirty-nine weeks ended July 1,September 30, 2007, respectively, as compared to an expense of 2.3% and a benefit of 9.4% and 7.8%8.9% for the corresponding prior year periods. The projected annual effective tax rate is a provisionbenefit of 0.4%, which differs from the benefit of 0.3%1.5% for the quarter ended July 1,September 30, 2007, due to the impact of a $2.8 million benefit recognized in the third quarter of fiscal 2007 related to tax refunds, changes in the proportion of income earned from foreign operations, and various state income tax changes.
Liquidity and Capital Resources
Summary
Our primary capital needs are for seasonal working capital, debt service, remodeling and relocating existing stores, new technology initiatives, such as online video rental, MovieBeam, kiosks and e-commerce, and to a much lesser extent, new store investment. As discussed above, we currently plan to open
fewer than 10opened three new stores forduring the full fiscal yearthirty-nine weeks ended September 30, 2007. We have historically funded our capital needs primarily by cash flow from operations and borrowings under the revolving portion of our then-existing senior secured credit facility, or our March
2007 Credit Facility.facility. For the twenty-sixthirty-nine weeks ended July 1,September 30, 2007, net cash used in operating activities was $62.2$60.1 million, resulting in an increased use of borrowings under our March 2007 Credit Facilitythen-existing senior credit facility to fund our operating and capital needs. At July 1,September 30, 2007, we had cash and cash equivalents of $45.5$42.7 million and $0zero in available borrowings under the revolving portion of our then-existing senior credit facility.
Post -Chapter 11 Financing Arrangements
On May 20, 2008, we emerged from Chapter 11 by consummating the transactions contemplated by the Plan. In connection therewith, the Reorganized Debtors entered into several new financing agreements as described below.
Amended and Restated First Lien Senior Credit Facility
The First Lien Credit Facility is a senior secured credit facility providing for aggregate borrowings in an amount not to exceed $626,488,750 (plus accrued and capitalized interest and fees), consisting of $602,988,750 aggregate principal amount of term loans (the “First Lien Term Loan Facility”) and $23,500,000 aggregate principal amount of letters of credit (the “Letter of Credit Facility”). The First Lien Credit Facility amended and restated the first lien facilities that were outstanding immediately prior to the commencement of the Chapter 11 Cases, which we refer to herein as the “March 2007 Credit Facility.”
Borrowings under the First Lien Term Loan Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the First Lien Credit Facility) plus (i) in the case of Base Rate Loans (as defined in the First Lien Credit Facility), 6.25% per annum plus the Applicable Margin Adjustment (as defined in the First Lien Credit Facility), plus interest at 2.75% per annum minus the Applicable Margin Adjustment to be added to the principal amount of such term loans (payment-in-kind, or PIK interest), and (ii) in the case of Eurodollar Rate Loans (as defined in the First Lien Credit Facility), 7.25% per annum plus the Applicable Margin Adjustment, plus interest at 2.75% per annum minus the Applicable Margin Adjustment to be added to the principal amount of such term loans (payment-in-kind, or PIK interest). Disbursements under the Letter of Credit Facility bear interest at a rate equal to (a) for the period from the date of such disbursement to the applicable reimbursement date (as defined in the First Lien Credit Facility), the rate of interest with respect to Base Rate Loans, and (b) thereafter, the rate of interest with respect to Base Rate Loans plus 2% per annum.
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The maturity date of the First Lien Term Loan Facility is the earliest of May 20, 2012, or ninety days following the date the aggregate principal amount of the Term Loans do not exceed $20,000,000, or in the event that the Term Loans become due and payable in full, whether by acceleration or otherwise.
The First Lien Term Loan Facility requires us to meet certain financial covenants, including an interest coverage test, a leverage test, and a secured leverage test. Each of these covenants is calculated on trailing four quarter results using specific definitions that are contained in the First Lien Credit Facility. In general terms,
the interest coverage test is a measurement of operating cash flow relative to cash interest expense;
the leverage test is a measurement of total leverage under the First Lien Credit Facility, including amounts drawn under letters of credit, relative to operating cash flow; and
the secured leverage test is a measurement of secured leverage, which includes indebtedness under the First Lien Term Loan Facility, the Second Lien Term Loan Facility, amounts drawn under letters of credit and any other secured indebtedness relative to operating cash flow.
The First Lien Term Loan Facility also places annual limits on the amount of our consolidated capital expenditures.
The obligations under the First Lien Credit Facility are unconditionally guaranteed by each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada, Inc. (“Movie Gallery Canada”). The obligations under the First Lien Credit Facility are also secured by a first priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
Amended and Restated Second Lien Credit Facility
The Second Lien Credit Facility is a senior secured credit facility which provides for term loans in an aggregate principal amount not to exceed $117,141,030. The Second Lien Credit Facility amended and restated the second lien facility that was part of our March 2007 Credit Facility.
Borrowings under the Second Lien Term Loan Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the Second Lien Credit Facility) plus the Applicable Margin defined as (i) until the first anniversary of the Effective Date, 12.75% per annum in the case of Eurodollar Rate Loans and 11.75% in the case of Base Rate Loans and (ii) from the first anniversary of the Effective Date, 13.00% per annum in the case of Eurodollar Rate Loans and 12.00% in the case of Base Rate Loans, which shall increase by an additional 0.25% per annum each six months thereafter; provided that, notwithstanding the foregoing, upon the occurrence of an Interest Event (as defined in the Second Lien Credit Facility), then, as of the next Interest Payment Date (as defined in the Second Lien Credit Facility), the Applicable Margin shall be 8.00% per annum in the case of Eurodollar Rate Loans and 7.00% in the case of Base Rate Loans. Interest on the Second Lien Term Loan Facility will be added to the principal amount of such term loan (payment-in-kind, or PIK interest), provided that all interest shall be paid in cash on each Interest Payment Date following an Interest Event.
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The $325 millionmaturity date of 11% senior unsecured notes duethe Second Lien Term Loan Facility is the earlier of November 20, 2012, or 11%in the event that the Term Loans become due and payable in full, whether by acceleration or otherwise.
The Second Lien Term Loan Facility contains no financial covenants.
The obligations under the Second Lien Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada. The obligations under the Second Lien Credit Facility are also secured by a second priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
Revolving Credit Facility
The Revolving Credit Facility is a senior notes,secured credit facility due May 20, 2011 which provides for revolving loans up to an aggregate principal amount of $100,000,000. We entered into the Revolving Credit Facility with various lenders, Sopris Partners Series A of Sopris Capital Partners, LP, as arranger, The Bank of New York, as administrative agent, and Deutsche Bank Trust Company Americas, as collateral agent.
Loans under the Revolving Credit Facility bear interest at a floating rate based on, at our option, the Base Rate or Adjusted Eurodollar Rate (each as defined in the Revolving Credit Facility), plus a margin of 1.5% in the case of Base Rate Loans (as defined in the Revolving Credit Facility) or 3.0% in the case of Eurodollar Rate Loans (as defined in the Revolving Credit Facility). In addition, we issuedmust pay commitment fees equal to the average of the daily difference between the revolving commitments and the aggregate principal amount of all outstanding loans, times 0.375% per annum.
Amounts borrowed under the Revolving Credit Facility may be repaid and reborrowed, with the final payment due and payable at the earlier of (i) the third anniversary of the Closing Date (as defined in the Revolving Credit Facility) and (ii) the date that we terminate the revolving commitments. Interest is payable (a) in the case of Base Rate Loans, on the last day of each calendar month and (b) in the case of Eurodollar Rate Loans, on the last day of each applicable interest period. We may voluntarily prepay any revolving loans in whole or in part without penalty or premium. In the event that at any time the sum of the aggregate principal amount of all outstanding revolving loans exceeds the lesser of (i) the Borrowing Base (as defined in the Revolving Credit Facility) and (ii) the aggregate commitments under the Revolving Credit Facility, we will be required to make prepayments in the amount of such excess.
The obligations under the Revolving Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and, at our election and upon compliance with certain requirements, Movie Gallery Canada. The obligations under the Revolving Credit Facility are also secured by a first priority lien on substantially all of our assets and the other guarantors, including a pledge of all the equity interests of each of their respective domestic subsidiaries and 65% of all the equity interests of each of their respective foreign subsidiaries.
The Revolving Credit Facility contains customary covenants for facilities of this type, including covenants that will limit our ability, the other guarantors and other subsidiaries to incur or guarantee additional indebtedness, incur liens, make further negative pledges, pay dividends on or repurchase stock, restrict dividends or other distributions from our subsidiaries, make certain types of investments, sell assets, merge with other companies, dispose of subsidiary interests, enter into sales and lease back transactions, enter into transactions with affiliates, or change lines of business. Pursuant to the Revolving Credit Facility, we must comply with the financial covenants set forth in the First Lien Credit Facility.
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We will use borrowings under the Revolving Credit Facility (i) to fund the transactions contemplated by the Plan and the payment of administrative fees and other fees and expenses relating to our implementation of the Plan, (ii) to pay certain other fees and expenses relating to the Revolving Credit Facility, and (iii) for general working capital and other corporate purposes.
Each of the First Lien Term Loan Facility, the Second Lien Term Loan Facility, the Revolving Credit Facility, were filed as exhibits to our Current Report on Form 8-K filed on May 28, 2008.
Seasonal Overadvance Facility
The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to procure up to $25 million in letters of credit during the period between September 2008 and January 2009, which is referred to as the “Commitment Period.” During the Commitment Period, we may elect to provide certain studios and game vendors with whom we conduct business letters of credit which may be drawn upon if we fail to make timely payments of certain amounts due. Additionally, in the event a vendor draws on a letter of credit, we will be obligated to pay Sopris an amount equal to the amount of the drawing, plus certain additional consideration in the form of Warrants.
Subject to certain exceptions in the Bankruptcy Code, the Chapter 11 filings automatically stayed the initiation or continuation of most actions against the Reorganized Debtors, including most actions to collect pre-petition indebtedness or to exercise control over the property of the bankruptcy estates. Moreover, the Plan and Confirmation Order discharged all pre-petition debts and liabilities not dealt with under the Plan and created an injunction against collecting such debts.
Chapter 11 Financing Arrangements
DIP Credit Agreement (As Amended)
In connection with the Hollywood
acquisition, remain outstanding.Chapter 11 Cases, the Reorganized Debtors entered into a $150 million DIP Credit Agreement among us, certain of our subsidiaries (all of whom were Debtors) as Guarantors, Goldman Sachs Credit Partners L.P., as Lead Arranger and Syndication Agent, The Bank of New York as Administrative Agent and Collateral Agent, and the lenders that from time to time become party thereto.
The DIP Credit Agreement provided for (i) a $50 million revolving loan and letter of credit facility, or the Revolving Facility, and (ii) a $100 million term loan. The proceeds of the loans and other financial accommodations incurred under the DIP Credit Agreement were used to refinance our existing $100 million pre-petition, secured revolving credit facility, pay certain transactional expenses and fees incurred by us and support our working capital needs and general corporate purposes. At our option, a portion of the Revolving Facility could be made available as swing line loans or for the issuance of letters of credit. On October 16, 2007, the Reorganized Debtors received interim approval from the Bankruptcy Court to access up to $140 million of the DIP Credit Agreement. On October 17, 2007, we closed on our DIP financing facility and, in connection therewith, (i) refinanced in full the existing $100 million pre-petition, secured revolving credit facility and (ii) were granted access of up to $40 million under the Revolving Facility. Subsequently, on November 16, 2007, the Reorganized Debtors received final approval from the Bankruptcy Court granting access to the entire $150 million of the DIP Credit Agreement.
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Advances under the DIP Credit Agreement bore interest, at the borrower’s option, (i) at the Base Rate, as defined in the DIP Credit Agreement, plus 2.50% per annum plus the Applicable Case Milestone Margin, as defined below, then in effect (if any) or (ii) at the Adjusted Eurodollar Rate, as defined in the DIP Credit Agreement, plus 3.50% per annum plus the Applicable Case Milestone Margin. As defined in the DIP Credit Agreement, Applicable Case Milestone Margin then in effect means: (i) 0.75%, in the event the Reorganized Debtors failed to file a Chapter 11 plan of reorganization or liquidation and a related disclosure statement with the Bankruptcy Court on or prior to January 15, 2008, and/or in the event an order approving the Reorganized Debtors’ disclosure statement was not entered by the Bankruptcy Court in the Chapter 11 Cases on or prior to March 1, 2008; (ii) 1.50% in the event an order confirming the Reorganized Debtors’ Chapter 11 plan of reorganization or liquidation was not entered by the Bankruptcy Court in the Chapter 11 Cases on or prior to April 30, 2008; and (iii) 2.25% in the event the effective date of the Reorganized Debtors’ Chapter 11 plan of reorganization or liquidation had not occurred on or prior to May 31, 2008.
Obligations under the DIP Credit Agreement were secured by (i) a lien on all of the assets of the Reorganized Debtors (which lien had a first priority with respect to substantially all of the Reorganized Debtors’ assets), including a pledge of all of the equity interests of each of our domestic subsidiaries and 65% of all of the equity interests of our foreign subsidiaries, and (ii) a superpriority administrative claim in each of the Chapter 11 Cases. In addition, the DIP Credit Agreement obligated the Reorganized Debtors to pay certain fees to the agents and lenders thereunder, as described in the DIP Credit Agreement.
The DIP Credit Agreement contained various representations, warranties and covenants by the Reorganized Debtors that are customary for transactions of this nature, including (without limitation) reporting requirements and maintenance of financial covenants.
The Reorganized Debtors’ obligations under the DIP Credit Agreement could be accelerated following certain events of default, including (without limitation) any breach by the Reorganized Debtors of any of the representations, warranties or covenants made in the DIP Credit Agreement or the conversion of any of the Chapter 11 Cases to a case under Chapter 7 of the Bankruptcy Code or the appointment of a trustee pursuant to Chapter 11 of the Bankruptcy Code.
The DIP Credit Agreement was to mature on the earlier of (i) September 30, 2008, (ii) the effective date of a Chapter 11 plan of reorganization or liquidation confirmed in the Chapter 11 Cases by the Bankruptcy Court and (iii) the date that all loans under the DIP Credit Agreement shall become due and payable in full, whether by acceleration or otherwise.
The DIP Credit Agreement was subsequently amended on November 26, 2007 (the “First Amendment”), and again on February 5, 2008 (the “Second Amendment”). The Second Amendment allowed for, among other things, relaxed financial covenants for the fiscal months of December 2007 through May 2008 and modifications to the interest rate for obligations under the DIP Credit Agreement.
On the Effective Date, the DIP Credit Agreement was terminated. The creditors under the DIP Credit Agreement were paid in full in cash on the Effective Date. The preceding description of the DIP Credit Agreement is qualified in its entirety by reference to the text of the DIP Credit Agreement, which was previously filed as an exhibit to our Current Report on Form 8-K filed on October 16, 2007 and is incorporated herein by reference.
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Impact of Chapter 11 Filing and Effectiveness of the Plan
Prior to the commencement of the Chapter 11 Case, our principal financing arrangements consisted of our March 2007 Credit Facility and long-term debt securities. Our March 2007 Credit Facility consistsconsisted of:
- -
a $100 million revolving credit facility, which we refer to as the revolver;
- - revolver, which was subsequently refinanced under the DIP Credit Agreement, as discussed below;
a $25 million first lien synthetic letter of credit facility;
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a $600 million first lien term loan; and
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a $175 million second lien term loan.
We sometimes collectively refer to the revolver, the first lien term loan and the letter of credit facility as the first“first lien facilities.
The first lien facilities require us”
Our March 2007 Credit Facility required that no later than 90 days subsequent to meet certain financial covenants,
includingentering into the March 2007 Credit Facility, 50% of our total outstanding debt was to be converted to fixed-rate debt for a secured leverage test,period of three years subsequent to March 8, 2007. On July 31, 2007, we entered into a total leverage test6.5% interest rate cap agreement with a notional amount of $275.0 million, for which we paid a fixed fee of $0.3 million. Under the terms of the new cap agreement, we would pay floating-rate interest up to a maximum of 6.50% and anreceive floating-rate interest
coverage test. Each of these covenants is calculated based on trailing four
quarter results using specific definitions that are contained inthree-month LIBOR through the first lien
credit agreement. Due to current industry conditions and increasing
competition in the home video market, as discussed in the Overview section
above, we were not in compliance with the financial covenants contained in the
first lien facilities asscheduled termination date of end of the second quarter of fiscal 2007. The
second lien credit facility contains no financial covenants, but a default
under the first lien credit agreement could create a cross default under the
second lien term loan and 11% senior notes.
As a result of our non-compliance with the financial covenants contained in the
first lien facilities and our resulting default under the first lien credit
agreement, the first lien credit agreement lenders have the right to terminate
their commitments, accelerate all of our obligations and exercise their
remedies under the first lien credit agreement. We have executed a Forbearance
Agreement (as amended), effective as of July 2, 2007, with certain lenders
under the first lien credit agreement. March 8, 2010.
Under the Forbearance Agreement (as
amended), the lenders will forbear until August 14, 2007 from exercising
default-related rights and remedies arising from existing defaults, absent any
new defaults under the first lien credit agreement or the Forbearance Agreement
(as amended). We have also begun discussions with the advisors representing
our first lien lenders on extending the Forbearance Agreement (as amended).
The Forbearance Agreement (as amended) further provides for the amendmentterms of the first lien credit agreement, our filing of the Chapter 11 Cases created an event of default. Upon the filing of the Chapter 11 Cases, the lenders’ obligations to increaseloan additional money to us under the interest rate margin applicable
to revolving borrowings by 1.0% per yearMarch 2007 Credit Facility terminated and the interest rate margin
applicable to term loan borrowings and synthetic letteroutstanding principal balance of credit obligations
by 2.0% per year. The Forbearance Agreement (as amended) also provides for
additional information delivery requirements by us, increases the Applicable
Loan to Value Ratio to 3.5 to 1.0 from 3.0 to 1.0, and modifies to make more
restrictive the use and application of proceeds of certain assets sales.
We are currently in discussions with the advisors representing our first lien
lendersall loans and other major creditors to address our current financial situation.
In the near future, we expect to present a longer-term solution to the first
lien lender group and other major creditors that will address the operational
and financial issues currently impacting our business. This longer-term
solution includes accelerating the closure of unprofitable stores,
consolidating stores in certain markets, obtaining additional working capital,
realigning our cost structure to better reflect our reduced size and seeking a
more competitive capital structure. In connection with a solution, it is
likely that we will need the first lien lenders to waive our existing defaultsobligations under the first lien credit agreementfacilities became immediately due and to substantially modify the financial
covenants contained therein. We cannot assure you that:
- - we will reach such an agreement with our first lien lenders prior to the
expiration of the forbearance period discussed above;
- - we will be able to obtain an extension of our forbearance period if we
are not able to reach such an agreement with our first lien lenders prior
to the August 14, 2007 expiration of the forbearance period; or
- - if we do reach an agreement, what the terms of such agreement will be or
what actions we will be required to undertake in connection with such an
agreement, such as selling assets, closing stores, securing additional
financing, reducing or delaying capital expenditures or restructuring our
existing indebtedness.
If we fail to reach such an agreement, the first lien lenders could institute
foreclosure proceedings against our assets securing borrowings under the first
lien facilities.
Due to our default under the first lien credit agreement,payable. Accordingly, we have classified all obligations due under the first lien facilities as current liabilities as of July 1,September 30, 2007. Due to
The filing of the uncertainty that ourChapter 11 Cases also created an event of default under the first lien
credit agreement could trigger cross default provisions on our second lien term
loancredit facility. Under the terms of the second lien credit facility, the entire principal balance of all loans and 11% senior notes,other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we have classified our $175 million second lien term loan as a current liability as of September 30, 2007.
The first and second lien were amended and restated as discussed above in connection with our emergence from Chapter 11 on May 20, 2008.
For additional information regarding the terms of our March 2007 Credit Facility, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in our Annual Report on Form 10-K for the year ended December 31, 2006.
11% Senior Notes due 2012
The filing of the Chapter 11 Cases also created an event of default under our 11% senior notes. Under the terms of the 11% senior notes, the outstanding principal balance of all of the 11% senior notes and other obligations became due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we classified our $325 million 11% senior notes as a current liabilitiesliability as of July 1,September 30, 2007.
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On the Effective Date, the 11% senior notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of 11% senior notes and other general unsecured claims will receive equity in the Reorganized Debtors.
9.625% Senior Subordinated Notes due 2011
The filing of the Chapter 11 Cases created an event of default under Hollywood’s 9.625% senior subordinated notes due 2011. Under the terms of the senior subordinated notes, the outstanding principal balance of all of the senior subordinated notes and other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. Accordingly, we have classified our $0.5 million in senior subordinated notes as a current liability as of September 30, 2007.
On the Effective Date, the 9.625% senior subordinated notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of 9.625% senior subordinated notes and other general unsecured claims will receive equity in the Reorganized Debtors.
Other
Subject to certain exceptions in the Bankruptcy Code, the Chapter 11 filings automatically stayed the initiation or continuation of most actions against the Reorganized Debtors, including most actions to collect pre-petition indebtedness or to exercise control over the property of the bankruptcy estates. Moreover, the Plan and Confirmation Order discharged all pre-petition debts and liabilities not dealt with under the Plan and created an injunction against collecting such debts.
Current Liquidity Position
Our liquidity is dependent upon our cash flows from store operations, access to our existing credit facilitythe Revolving Credit Facility and vendor financing. Historically, we maintained favorable payment terms with our vendors, which hashad been a significant source of liquidity for us. During the latter part of fiscal 2006, and continuing into fiscal 2007, we have experienced significant vendor terms contraction, which eroded our working capital capacity. Due to our non-compliance with the covenants contained in the first lien facilities,March 2007 Credit Facilities earlier in fiscal 2007 and the filing of the Chapter 11 Cases, many of our significant vendors have discontinued extending us trade credit, requiring us to pay for product before it iswas shipped, and we have experienced additional tightening of terms with other vendors.
We believe that the Revolving Credit Facility and the Seasonal Overadvance Facility provide sufficient funds to meet our short-term liquidity needs. Significant assumptions underlie this belief, including, among other things, our business strategy, especially our operational restructuring activities, and there being no further material adverse developments in our business, liquidity or capital requirements. If we continuecannot generate sufficient cash flow from operations to experience substantial
restrictionsservice our indebtedness and to meet our working capital needs and other obligations and commitments, we
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will be required to further refinance or tighteningrestructure our debt or to dispose of assets to obtain funds for such purposes. There is no assurance that such a refinancing or restructuring or asset dispositions could be effectuated on a timely basis or on satisfactory terms, if at all, or would be permitted by the terms of our existing debt instruments.
Other Liquidity
During the second quarter of fiscal 2007, we began to pursue the sale of one of our aircraft in conjunction with our vendors and continuereview of non-core assets for disposal. Subsequent to generate
operating losses similar to those experienced for the twenty-six weeks ended
July, 1, 2007, we do not believe we will have sufficient liquidity to operate
our business throughend of the third quarter of fiscal 2007, without gaining accessthis aircraft was sold, net of costs to additional capital.
sell, for $7.5 million.
Due to our significant operating losses for the twenty sixthirty-nine weeks ended July 1,September 30, 2007 and our present liquidity position, we have reduced planned capital and maintenance expenditures for, among other things, projects related to our management information systems infrastructure, which include but are not
limited to:
- - (without limitation):
replacing old and outdated hardware technology in our stores and in our two store support centers;
- -
either replacing, or updating and integrating our multiple point-of-
sale,point-of-sale, or POS, systems;
- -
additional integration of systems between our two store support centers; and
- -
upgrading our present versions of certain operating and applications systems platforms, including our Oracle database environment, without which we may incur additional cost for ongoing maintenance and support.
We cannot make assurances that our business will not be adversely affected should this reduction in capital and maintenance expenditures contribute to a failure of our management information systems to perform as expected.
In response to the challenging market conditions facing our business, we will
continue to take actions to conserve cash and improve profitability. These
actions include accelerating the closure of unprofitable stores, consolidating
stores in certain markets, realigning our cost structure to better reflect our
reduced size, and seeking a more competitive capital structure. We also intend
to consider a number of alternatives, including asset divestitures,
recapitalizations, restructurings, alliances with strategic partners, and a
sale to or merger with a third party, as well as whether a restructuring needs
to be completed under chapter 11 of the Bankruptcy Code. We cannot make
assurances that such actions or alternatives will be successful or that, even
if such actions or alternatives are successful, that we will be able to
continue to service our existing indebtedness.
Our March 2007 Credit Facility is fully and unconditionally guaranteed on a
joint and several basis by all of our domestic subsidiaries. It is also
secured by (i) in the case of the first lien credit facility, first priority
security interests in, and liens on, substantially all of our direct and
indirect domestic subsidiaries' tangible and intangible assets (other than
leasehold mortgages on stores), first priority pledges of all the equity
interests owned by us in our existing and future direct and indirect wholly
owned domestic subsidiaries, and 65% of the equity interests owned by us in our
existing and future wholly owned non-domestic subsidiaries, and (ii) in the
case of the second lien credit facility, second priority security interests in,
and liens on, substantially all of our direct and indirect domestic
subsidiaries' tangible and intangible assets (other than leasehold mortgages on
stores), second priority pledges of all the equity interests owned by us in our
existing and future direct and indirect wholly owned domestic subsidiaries, and
65% of the equity interests owned by us in our existing and future wholly owned
non-domestic subsidiaries.
For additional information regarding our March 2007 Credit Facility, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources" in our Annual Report on Form 10-K
for the year ended December 31, 2006.
Interest Rate Hedges
Our March 2007 Credit Facility requires that no later than 90 days subsequent
to entering into the March 2007 Credit Facility, 50% of our total outstanding
debt was to be converted to fixed rate debt for a period of three years
subsequent to March 8, 2007.
On April 3, 2007, we executed a floating-to-fixed interest rate swap for an
amount of $225.0 million, with an effective date of April 5, 2007 and a
termination date of June 29, 2007. Under the terms of this swap agreement, we
paid fixed-rate interest on the $225.0 million at a rate of 5.348% and received
floating-rate interest based on a linear interpolation of two-month and three-
month LIBOR for the 85 days covering the term of this swap. We received $0 in
consideration upon settlement of this interest rate swap.
On April 3, 2007, we executed a forward-starting floating-to-fixed interest
rate swap for an amount of $225.0 million, with an effective date of June 29,
2007 and a termination date of June 30, 2010. Under the terms of this forward-
starting swap agreement, we paid fixed-rate interest on the $225.0 million at a
rate of 5.128% and received floating-rate interest based on three-month LIBOR.
On July 5, 2007, we settled this interest rate swap (prior to the scheduled
termination date) and received $1.3 million in consideration.
On July 31, 2007, we entered into a new 6.5% interest rate cap agreement with a
notional amount of $275.0 million, for which we paid a fixed fee of $0.3
million. Under the terms of the new cap agreement, we will pay floating-rate
interest up to a maximum of 6.50% and receive floating-rate interest based on
three-month LIBOR through the scheduled termination date of March 8, 2010.
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Contractual Obligations.
The following table discloses our contractual obligations and commercial commitments as of July 1,September 30, 2007, with the exception of the operating lease information which is presented as of January 6, 2008.
Contractual | Total | 1 Year | 2 - 3 Years | 4 - 5 Years | More than 5 Years | ||||||||||
Principal Payments | |||||||||||||||
March 2007 Credit Facility (1) | |||||||||||||||
First lien term loan | $ | 597,000 | $ | 597,000 | $ | — | $ | — | $ | — | |||||
Second lien term loan | 175,000 | 175,000 | — | — | — | ||||||||||
2007 Revolver | 100,000 | 100,000 | — | — | — | ||||||||||
Senior notes (1) | 325,450 | 325,450 | — | — | — | ||||||||||
Capital leases | 4 | 4 | — | — | — | ||||||||||
Interest | |||||||||||||||
First lien term loan (2) | 42,663 | 42,663 | — | — | — | ||||||||||
Second lien term loan (2) | 17,594 | 17,594 | — | — | — | ||||||||||
Senior notes (2) | 22,223 | 22,223 | — | — | — | ||||||||||
Capital leases | — | — | — | — | — | ||||||||||
Operating leases | 953,604 | 282,386 | 375,324 | 212,256 | 83,638 | ||||||||||
Total | $ | 2,233,538 | $ | 1,562,320 | $ | 375,324 | $ | 212,256 | $ | 83,638 | |||||
(1) | Due to our default under the first lien credit agreement and the filing of the Chapter 11 Cases, we have classified all obligations due under our March 2007 Credit Facility as well as our 11% senior notes and Senior Subordinated Notes as current liabilities as of September 30, 2007. |
(2) | Interest was calculated through the Effective Date, May 20, 2008, and was based on actual interest rates and calculations. |
(3) | Unrecognized tax benefits of $8.1 million as of September 30, 2007 are not included as we are unable to reasonably estimate the amounts that will be settled within each year in the table as presented above. |
The following supplemental pro-forma table is provided to show our contractual obligations and commercial commitments for the succeeding five years from the Effective Date, May 20, 2008, taking into consideration our amended first lien and second lien term loans, as well as our new Revolver Credit Facility. The operating lease information is presented is as of December 31, 2006; however, these amounts approximate the obligations as
of July 1, 2007.
Contractual 2-3 4-5 More than
Obligations Total 1 Year Years Years 5 Years
- --------------- ---------- ---------- -------- --------- ----------
Principal Payments
March 2007 Credit Facility (1)
First lien term loan $ 598,500 $ 598,500 $ - $ - $ -
Second lien term loan 175,000 175,000 - - -
2007 Revolver 100,000 100,000 - - -
Senior Notes (1) 325,450 325,450 - - -
Capital leases 1,412 1,412 - - -
Interest
First lien term loan (2) 64,753 64,753 - - -
Second lien term loan (2) 20,781 20,781 - - -
Senior Notes 35,793 35,793 - - -
Capital leases 37 37 - - -
Operating leases 1,478,182 376,012 557,087 329,453 215,630
Estimatable
unrecognized tax
benefits (3) (3,000) (3,000) - - -
---------- ---------- -------- --------- ----------
Total (3) $2,796,908 $1,694,738 $557,087 $ 329,453 $ 215,630
---------- ---------- -------- --------- ----------
(1) Due to our default under the first lien credit agreement, we have
classified all obligations due under our March 2007 Credit Facility as well as
our 11% senior notes as current liabilities as of July 1, 2007.
(2) Interest rates based on current LIBOR rates plus margin. As of July 1,
2007, the first lien term loan and second lien term loan rates are 10.86% and
11.88%, respectively. The first lien term loan rate of 10.86% is quoted
inclusive of the 2% interest rate margin increase effective July 2, 2007 in
accordance with the Forbearance Agreement (as amended). We have assumed these
interest rates will stay the same for the remaining terms of the loans for
purposes of presenting future interest payments.
(3) Unrecognized tax benefits of $8.4 million as of July 1, 2007 are not
included as we are unable to reasonably estimate the amounts that will be
settled within each year in the table as presented above.
January 6, 2008.
Contractual | Total | 1 Year | 2 - 3 Years | 4 - 5 Years | More than 5 Years | ||||||||||
Principal Payments | |||||||||||||||
First Lien Credit Facility (1) | $ | 671,818 | $ | 6,030 | $ | 12,060 | $ | 653,728 | $ | — | |||||
Second Lien Credit Facility (1) | 231,672 | — | — | 231,672 | — | ||||||||||
Revolver Credit Facility (4) | 65,000 | — | 65,000 | — | — | ||||||||||
Interest | |||||||||||||||
First Lien Credit Facility (2) | 246,442 | 52,561 | 120,849 | 73,032 | — | ||||||||||
Second Lien Credit Facility (3) | — | — | — | — | — | ||||||||||
Operating leases | 953,604 | 282,386 | 375,324 | 212,256 | 83,638 | ||||||||||
Total | $ | 2,168,536 | $ | 340,977 | $ | 573,233 | $ | 1,170,688 | $ | 83,638 | |||||
(1) | Includes payment-in-kind interest that is added to the outstanding principal balance on the scheduled interest payment date. See the Liquidity and Capital Resources section above for further discussion on payment-in-kind interest for our First Lien Credit Facility and Second Lien Credit Facility. |
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(2) | As of May 20, 2008, the First Lien Credit Facility interest rate was 9.65%. We have assumed this interest rate will stay the same for the remaining terms of the loans for purposes of presenting future interest payments. |
(3) | All interest on the Second Lien Credit Facility is to be treated as payment-in-kind interest and added to the outstanding principal balance on the scheduled interest payment date. As such, there are no contractually obligated interest payments on our Second Lien Credit Facility. |
(4) | Amount equals the balance on the Revolving Credit Facility at May 20, 2008. |
Statement of Cash Flow Data
Twenty-Six Weeks Ended
------------------------
July 2, July 1,
2006 2007
---------- ----------
($ in thousands)
Statements of Cash Flow Data:
Net cash used in operating activities $ (35,236) $ (62,188)
Net cash used in investing activities (14,090) (3,976)
Net cash provided by (used in) financing
activities (66,091) 79,346
Thirty-Nine Weeks Ended | ||||||
October 1, 2006 | September 30, 2007 | |||||
($ in thousands) | ||||||
Statements of Cash Flow Data: | ||||||
Net cash used in operating activities | (35,026 | ) | (60,110 | ) | ||
Net cash used in investing activities | (18,144 | ) | (6,897 | ) | ||
Net cash provided by (used in) financing activities | (63,242 | ) | 77,707 |
Operating Activities
The decrease in net cash provided by operating activities for the twenty-sixthirty-nine weeks ended July 1,September 30, 2007 compared to the same period of fiscal 2006 was primarily due to a decrease in operating income, an increase in interest expense and an increase in Game Crazy inventory purchases, partially offset by a decrease in the use of cash for accounts payable.
Investing Activities
Net cash used in investing activities includes the cost of business acquisitions, new store builds and other capital expenditures. For the twenty-
sixthirty-nine weeks ended July 1,September 30, 2007, net cash used for investing activities was $4.0$6.9 million, which included $3.1 million in acquisitions and $1.4$4.3 million for improvements to our existing store base, offset by proceeds from asset disposals. For the twenty-sixthirty-nine weeks ended July 2,October 1, 2006, net cash used for investing activities was $14.1$18.1 million, which included the addition of 102115 stores.
Capital expenditure requirements for fiscal 2007 are estimated at $25$10 million to fund a limited number of store openings, maintenance on our existing store base and strategic investments. This estimate also does not include capital
required to fund our acquisition of the Boards stores pursuant to a contractual
put provision. The Boards stores acquisition may occur in fiscal 2007; however,
a purchase price has yet to be negotiated.
Financing Activities
Net cash flow related to financing activities for the twenty-sixthirty-nine weeks ended July 1,September 30, 2007 was a source of cash of $79.3$77.7 million, which included $83.5 million of net borrowings on our March 2007 Credit Facility. Net cash flow related to financing activities for the twenty-sixthirty-nine weeks ended July 2,October 1, 2006 was a use of cash of $66.1$63.2 million, primarily due to an excess cash flow payment of $56.9 million under the terms of our previous senior credit facility and lender fees of $5.5 million related to the amendment of that facility.
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At July 1,September 30, 2007, we had a working capital deficit of $1.1 billion. This is primarily due to the reclassification of our long-term debt as a current liability and, to a much lesser extent, the accounting treatment of rental inventory. Rental inventory is treated as a non-current asset under accounting principles generally accepted in the United States because it is a depreciable asset. Although the rental of this inventory generates a majority of our revenue, the classification of this asset as non-current results in its exclusion from working capital. However, accounts payable incurred in connection with purchases of this inventory are reported as a current liability until paid and accordingly, is reflectedrecognized as a reduction in working capital.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Critical Accounting Policies and Estimates
Our critical accounting policies are described in our Annual Report on Form 10-
K10-K for the fiscal year ended December 31, 2006. NoApart from a change in estimate for rental inventory, discussed below, there have been no other significant changes have occurred to our critical accounting policies during the twenty-sixthirty-nine weeks ended September 30, 2007.
Change in Accounting Estimate for Rental Inventory
We manage our movie rental inventories as two distinct categories, new releases and catalog. New releases, which represent the majority of all movies acquired, are those movies that are primarily purchased on a weekly basis in large quantities to support demand upon their initial release by the studios and are generally held for relatively short periods of time. Catalog, or library, purchases represent an investment in a smaller quantity of those movies we intend to hold for an extended period of time and represent a historic collection of movies that are maintained on a long-term basis for rental to customers. In addition, we purchase catalog inventories to support new store openings and to build-up title selection for formats preferred by our customers.
We regularly review, evaluate and update our rental amortization accounting estimates. Historically, our purchases of new release and catalog DVD movies were amortized to an average residual value of $4.00 on an accelerated basis over six months for new releases and over twenty-four months for catalog. We define the residual value of our rental inventory as estimated disposal proceeds, less the costs to sell, at the point that the inventory is no longer useful to the Company.
For new release movies and games acquired under revenue-sharing arrangements, the studios’ share of rental revenue is charged to cost of rental as revenue is earned on the respective revenue-sharing titles. Amortization periods, carrying values and residual values of movies purchased under revenue-sharing arrangements approximate those of our non-revenue sharing purchases as outlined above.
In the third quarter of fiscal 2007, we completed liquidation sales of our new release and catalog inventory in approximately 70 stores that were closed. In addition, we began to liquidate our inventory at approximately 520 additional stores, which was our largest liquidation event to date. During these liquidation sales, the average unit sales price of our DVD catalog rental inventory realized was below our $4.00 residual value. Further, we realized lower than anticipated sales prices on sales of our new release inventory. We viewed the results of these liquidation sales as a triggering event which caused us to reexamine our estimates and assumptions with respect to our salvage values for DVD rental inventory. In order to determine the appropriate useful lives and residual values, we consider the actual historic performance trends of our rental inventory and
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expectations of future trends and patterns. As a result, we lowered our estimated residual value on new releases and catalog DVDs from $4.00 to $3.00 effective July 1,2, 2007. In addition, for the comparatively small percentage of new release purchases that we intend to keep for an extended period of time as catalog, we revised our accelerated amortization rate in order to remain consistent with observed rental patterns. These changes were accounted for as a change in accounting estimate in accordance with Statement of Financial Accounting Standards Board, or FASB, Statement No. 154,Accounting Changes and Error Corrections,or FASB Statement No. 154, paragraph 19. This change in accounting estimate increased cost of rental revenue and loss from continuing operations in the current-year third quarter by $57.0 million, increasing net loss by $56.2 million and $56.7 million, net of tax, or $1.74 and $1.77 per diluted share, for the thirteen and thirty-nine weeks ended September 30, 2007. As of September 30, 2007, $16.6 million in remaining liquidation inventory, net of costs to sell, is included within the “Assets held for sale” caption in our consolidated balance sheet.
Video games are amortized over twelve months on an accelerated basis to an average residual value of $5.00.
Recently Issued Accounting Pronouncements
On July 13, 2006, the FASB issued FIN 48, which clarifies the way companies
account for uncertainty in income taxes. FIN 48 is effective for the first
fiscal year beginning after December 15, 2006, which for us was our fiscal year
beginning January 1, 2007. The adoption of FIN 48 did not have a material
impact on our consolidated financial statements. See Note 4 for further
discussion of income taxes.
In September 2006, the FASB issued SFASFASB Statement No. 157, "FairFair Value Measurements", or SFASFASB Statement No. 157, which provides enhanced guidance for using fair value to measure assets and liabilities. SFASFASB Statement No. 157 also responds to investors'investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFASFASB Statement No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value into any new circumstances. SFASFASB Statement No. 157 is effective for our fiscal year beginning January 7, 2008. We are in the process of evaluating the effect of SFASFASB Statement No. 157 on our consolidated financial statements.
position, results of operations, or cash flows. On February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2,Effective Date of FASB Statement No. 157, which amends FASB Statement No. 157 to defer its effective date to fiscal years beginning after November 15, 2008 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in financial statements on a recurring basis. FASB Statement No. 157’s effective date for financial assets and financial liabilities, November 15, 2007, remains intact.
In February 2007, the FASB issued SFAS No. 159, "TheFASB Statement No.159,The Fair Value Option for Financial Assets and Financial Liabilities", or SFASFASB Statement No. 159, which provides guidance on applying fair value measurements on financial assets and liabilities. SFASFASB Statement No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFASFASB Statement No. 159 attempts to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings, caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFASFASB Statement No. 159 is effective for us for our fiscal year beginning January 7, 2008. We are in the process of evaluating the effect of SFASFASB Statement No. 159 on our consolidated financial statements.
Item 3. Quantitativeposition, results of operations, and Qualitative cash flows.
In December 2007, the FASB issued FASB Statement No. 141 (R),Business Combinations, or FASB Statement No. 141 (R), which provides guidance on changes to business combination accounting. FASB Statement No. 141 (R) includes requirements to recognize, with certain exceptions, 100 percent of the fair values of assets acquired, liabilities assumed, and noncontrolling interests in acquisitions of less than 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity, expense acquisition-related transaction costs, and recognize preacquisition loss and gain contingencies at their acquisition-date fair values. FASB Statement No. 141 (R) is effective for us for any business combination transaction for which the acquisition date is on or after our fiscal year beginning January 5, 2009.
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In March 2008, the FASB issued FASB Statement No. 161,Disclosures About Market Risk
about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133, or FASB Statement No. 161, which requires entities to provide greater transparency about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FASB Statement No. 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. To meet those objectives, FASB Statement No.161 requires (1) qualitative disclosures about objectives for using derivatives by primary underlying risk exposure (e.g., interest rate, credit or foreign exchange rate) and by purpose or strategy (fair value hedge, cash flow hedge, net investment hedge and non-hedges), (2) information about the volume of derivative activity in a flexible format that the preparer believes is the most relevant and practicable, (3) tabular disclosures about balance sheet location and gross fair value amounts of derivative instruments, income statement and other comprehensive income (OCI) location and amounts of gains and losses on derivative instruments by type of contract (e.g., interest rate contracts, credit contracts, or foreign exchange contracts), and (4) disclosures about credit-risk-related contingent features in derivative agreements. FASB Statement No. 161 is effective for us as of our fiscal year beginning January 5, 2009. Early application is encouraged, as are comparative disclosures for earlier periods, but neither are required. We are in the process of evaluating the effect of FASB Statement No. 161 on our consolidated financial position, results of operations, and cash flows.
In April 2008, the FASB issued FASB Staff Position No. 90-7-a,An Amendment of AICPA Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code, or FSP SOP No. 90-7-a, which would apply to entities that are required to apply fresh-start reporting under SOP 90-7. This FSP amends SOP 90-7 to eliminate the requirement that changes in accounting principles required in financial statements of an entity emerging from bankruptcy reorganization within the 12 months following the adoption of fresh-start reporting are required to be adopted at the time fresh-start reporting is adopted. As a result of this FSP, an entity emerging from bankruptcy that uses fresh-start reporting would only follow the accounting standards in effect at the date of emergence. FSP SOP No. 90-7-a is effective for financial statements issued subsequent to April 24, 2008.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk represents the risk of loss that may impact our financial position, operating results, or cash flows due to adverse changes in financial and commodity market prices and rates. We have entered into certain market-risk-
sensitivemarket-risk-sensitive financial instruments for other than trading purposes, principally to hedge against fluctuations in variable interest rates on our debt.
Interest payable on our March 2007 Credit Facility isand DIP Credit Agreement are based on variable interest rates equal to a specified Eurodollar rate or base rate and is therefore affected by changes in market interest rates. If variable base rates were to increasehad increased 1% from the three-month LIBOR at July 1,September 30, 2007, our interest expense on an annual basis would increasehave increased by approximately $7.7$7.4 million on the principal, based on both the outstanding balance on our March 2007 Credit Facility as of July 1,September 30, 2007 and its mandatory principal payment schedule.
Item 4. Controlsschedules. As discussed above, on the Effective Date, the first lien facilities were amended and Procedures
restated when we entered into the First Lien Credit Facility and, also in connection with our emergence from Chapter 11, we entered into the new Revolving Credit Facility.
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Item 4. | Controls and Procedures |
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC'sSEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including theour Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Securities and Exchange Act Rule 13a-15. Based upon this evaluation as of July 1,September 30, 2007, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were not effective for the reasons more fully described below, related to the unremediated material weakness in our internal control over financial reporting identified during our evaluation pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 as of the fiscal year ended December 31, 2006. To address this control weakness, we performed additional analysis and other procedures in order to prepare this Quarterly Report on Form 10-Q, including the unaudited quarterly consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States contained herein. Accordingly, management believes that the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.
Management's
Management’s assessment identified one material weakness in our internal control over financial reporting as of December 31, 2006 that is in the process of being remediated as of July 1,September 30, 2007, as described further below. This section of Item 4. "Controls“Controls and Procedures,"” should be read in conjunction with Item 9A. "Controls“Controls and Procedures,"” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 for additional information on Management'sManagement’s Report on Internal Controls Over Financial Reporting.
As of July 1,September 30, 2007, the unremediated material weakness was:
Ineffective controls over lease accounting. Our process related to identifying, understanding, and properly accounting for lease terms that have an accounting impact did not function to reduce to remote the likelihood that material misstatements would not be prevented or detected in a timely manner. The material weakness stems from the aggregation of control deficiencies related to the identification of non-standard lease terms, insufficient knowledge of accounting for leases under generally accepted accounting principles in the United States, and an inadequate process in place to review and identify all terms included in leases that impact the accounting for leases. The material weakness resulted in adjustments to property, furnishings, and equipment, asset retirement obligations, deferred rent, depreciation and amortization expense, rent expense, and store closure reserve accounts in both the annual and interim financial statements for the fiscal year ended December 31, 2006.
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Remediation
Remediation efforts surrounding
We plan to take the following steps, among others, with respect to our planned remediation of our material weakness over lease accounting:
provide additional lease accounting training for staff involved in the review of new and modified lease contracts,
improve communication between our Asset Management departments and our Accounting department so as to identify all leases subject to review,
improve our secondary review procedures for lease calculations, and
develop a database that will ultimately replace spreadsheets for a portion of our lease accounting calculations.
Due to the filing of the Chapter 11 Cases, among other things, we expect that the remediation of the ineffective controls overrelated to lease accounting will occurtake place during fiscal 2009. However, we cannot make any assurances that we will successfully remediate this material weakness within the anticipated timeframe and thus reduce to remote the likelihood that material misstatements concerning lease accounting will not be prevented or detected in future quartersa timely manner.
Chapter 11 Reorganization
As discussed above, on October 16, 2007, we and substantially all of fiscal 2007.
our subsidiaries filed voluntary petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. The Chapter 11 Cases have had a significant impact on our business processes and related internal control over financial reporting to ensure proper separation and payment of pre-petition and post-petition obligations, and to prepare consolidated financial statements reflecting the changes brought about as a result of the Chapter 11 Cases.
Other Changes in Internal Control over Financial Reporting
In April 2007, Richard Langford,
As previously noted in our Chief Information Officer, resigned. John
Rossman from Alvarez & Marsal Business Consulting, LLCCurrent Report on Form 8-K filed on May 28, 2008 and effective May 20, 2008, Clarence J. Gabriel, Jr. was appointed Interim
Chief Information Officer and Tracy Sennett, also from Alvarez & Marsal
Business Consulting, LLC, was appointed Interim Assistant Chief Information
Officer until we appoint a new Chief Information Officer.
In May 2007, Jeff Stubbs, Chief Operating Officer of the Movie Gallery
division, was appointed President of Retail Operations for the company. In his
new position, Mr. Stubbs is responsible for all aspects of retail operations of
our three brands: Movie Gallery, Hollywood Video, and Game Crazy.
In June 2007, Timothy A. Winner, Executive Viceas President and Chief OperatingExecutive Officer of Movie Gallery. Additionally, on the Hollywood division, resigned.
DuringEffective Date individuals were appointed to serve as the second quarteraudit committee of fiscal 2007, Jon Goulding from the firmboard of Alvarez
& Marsal assumeddirectors, which now consists of Mark E. Holliday (Chairman), Robert Fiorella, and Steven Scheiwe.
Other than the position of interim Treasurer, replacing Ryan McCarthy,
also from Alvarez & Marsal, who we have reassigned to assist us with the
management of certain of our technology initiatives.
In June 2007, Michelle Lewis, our Senior Vice President - Finance, resigned.
We currently have no plans to fill this position.
Thereaforementioned, there have been no other changes in our internal control over financial reporting during the most recently completed fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II - Other Information
Item 1. Legal Proceedings
Item 1. | Legal Proceedings |
Hollywood and the members of its former board of directors (including Hollywood'sHollywood’s former chairman Mark Wattles) were named as defendants in several lawsuits in the Circuit Court in Clackamas County, Oregon. The lawsuits, filed between March 31, 2004 and April 14, 2004, asserted breaches of duties associated with the mergeracquisition agreement executed with a subsidiary of Leonard Green & Partners, L.P., or LGP. The Clackamas County actions were later consolidated, and the plaintiffs filed an Amended Consolidated Complaint alleging four claims for relief against Hollywood'sHollywood’s former board members arising out of the mergeracquisition of Hollywood withby Movie Gallery.
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The purported four claims for relief arewere breach of fiduciary duty, misappropriation of confidential information, failure to disclose material information in the proxy statement in support of the Movie Gallery merger,acquisition and a claim for attorneys'attorneys fees and costs. The Amended Consolidated Complaint also namesnamed UBS Warburg and LGP as defendants. Following the merger withacquisition by Movie Gallery, the plaintiffs filed a Second Amended Consolidated Complaint. The plaintiffs restated their causes of action and generally allegealleged that the defendants adversely impacted the value of Hollywood through the negotiations and dealings with LGP. Hollywood and the former members of its board havewere also been named as defendants in a separate lawsuit entitled JDL Partners, L.P. v. Mark J. Wattles et al. filed in Clackamas County, Oregon, Circuit Court on December 22, 2004. This lawsuit, filed before Hollywood'sHollywood’s announcement of the mergeracquisition agreement with Movie Gallery, allegesalleged breaches of fiduciary duties related to a bid by Blockbuster Inc. to acquire Hollywood, as well as breaches related to a loan to Mr. Wattles that Hollywood forgave in December 2000. On April 25, 2005, the JDL Partners action was consolidated with the other Clackamas County lawsuits. The plaintiffs seeksought damages and attorneys'attorneys’ fees and costs. The parties agreed to settle the case and entered into a Stipulation of Settlement and Release dated March 29, 2007. An order and final judgment, approving the settlement and dismissing the case with prejudice, was entered by the court on June 4, 2007. Due to our current liquidity situation, we haveHollywood did not yet performed ourperform certain obligations pursuant to the Stipulation of Settlement and Release. As a result, the plaintiffs filed a motion for contempt against certain former Debtor entities and certain of our officers. The case was stayed due to the commencement of the Chapter 11 Cases and is now subject to the injunction in the Plan. Hollywood’s remaining obligations pursuant to the Stipulation of Settlement and Release are pre-petition liabilities that are subject to compromise under the Plan.
In addition, we have been named to various other claims, disputes, legal actions and other proceedings involving contracts, employment and various other matters.matters, most of which have been stayed due to the filing of the Chapter 11 Cases. A negative outcome in certain of the ongoing litigation could harm our business, financial condition, liquidity or results of operations. In addition, prolonged litigation, regardless of which party prevails, could be costly, divert management'smanagement’s attention or result in increased costs of doing business. We believe we have provided adequate reserves for contingencies and that the outcome of these matters will not have a material adverse effect on our consolidated results of operation, financial condition or liquidity.
At July 1,September 30, 2007, the legal contingencies reserve was $2.0 million, of which $1.0 million relates to pre-Hollywood acquisition contingencies.
Item 1A. Risk Factors
Item 1A. | Risk Factors |
Our Annual Report on Form 10-K for the year ended December 31, 2006 includes a detailed discussion of our risk factors, which could materially affect our business, financial condition or future results. The information presented below amends, updates and should be read in conjunction with the risk factors and information disclosed in our Annual Report on Form 10-K for the year ended December 31, 2006. The risks described in our Annual Report on Form 10-K for the year ended December 31, 2006 and the information presented below are not the only risks facing our Company.company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and operating results.
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We have a significant amount of indebtedness, which may limit our operating flexibility.
As of May 20, 2008 we had approximately $785.1 million of indebtedness, consisting of indebtedness under our First Lien Credit Facility of approximately $603.0 million, indebtedness under our Second Lien Credit Facility of approximately $117.1 million and indebtedness under the Revolving Credit Facility of $65.0 million.
Our high level of indebtedness could have important consequences, including the following:
it may be difficult for us to satisfy our obligations with respect to our indebtedness;
our ability to obtain additional financing for working capital, capital expenditures, or general corporate or other purposes may be impaired;
a substantial portion of our cash flow from operations must be dedicated to the payment of principal and interest on our indebtedness, reducing the funds available to us for other purposes;
it may cause our trade creditors to change their terms for payment on goods and services provided to us, thereby negatively impacting our ability to receive products and services on acceptable terms;
it may place us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged; and
we may be more vulnerable to economic downturns, may be limited in our ability to respond to competitive pressures and may have reduced flexibility in responding to changing business, regulatory and economic conditions.
Our ability to pay interest on and to satisfy our other debt obligations will depend upon, among other things, our future operating performance and our ability to refinance indebtedness when necessary. Each of these factors is, to a large extent, dependent upon economic, financial, competitive and other factors beyond our control. If, in the future, we cannot generate sufficient cash from operations to meet our debt obligations, we will need to refinance our existing debt, obtain additional financing or sell assets. We cannot assure you that our business will generate sufficient cash flows to satisfy our existing indebtedness or that funding sufficient to satisfy our debt service requirements will be available on satisfactory terms, if at all.
Our business could continue to be adversely affected by increased competition, including new business initiatives by our competitors.
We compete with:
- -
local, regional and national video retail stores, including stores operated by Blockbuster, Inc., the largest video retailer in the United States;
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Internet-based, mail-delivery home video rental subscription services, such as Netflix, Blockbuster Online, and Blockbuster Total Access, a subscription service incorporating both mail-delivery and video retail stores;
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competitors who operate Internet-based rental services that provide online delivery, such as Apple’s iTunes Store;
competitors who operate DVD-dispensing kiosk machines, such as Redbox Kiosk;
mass merchants;
- -
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specialty retailers, including GameStop and Suncoast;
- -
supermarkets, pharmacies, convenience stores, bookstores and other retailers that rent or sell similar products as a component, rather than the focus, of their overall business;
- -
mail order operations and online stores, including Amazon.com; and
- -
noncommercial sources, such as libraries.
Pricing strategies for movies and video games, including Blockbuster's "NoBlockbuster’s “No Late Fees"Fees” and "Total Access"“Total Access” programs, are major competitive factors in the video retail industry, and we have fewer financial and marketing resources, lower market share and less name recognition than Blockbuster. In recent months, we experienced significant declines in revenue as a result of competitive pricing between Blockbuster and Netflix over their subscription services and greater customer acceptance of Blockbuster'sBlockbuster’s Total Access program.
Other types of entertainment, such as theaters, television, personal video recorders, Internet-related activities, sporting events, and family entertainment centers, also compete with our movie and video game businesses. Some of our competitors, such as online stores, mass merchants and warehouse clubs may operate at margins lower than we do and may be able to distribute and sell movies at lower price points than we can. These competitors may even be willing to sell movies below cost due to their broad inventory mix.
If any of our competitors were to substantially increase their presence in the markets we serve, our revenues and profitability could decline, our financial condition, liquidity, and results of operations could be harmed and the continued success of our business could be challenged.
We may be unable to successfully implement all post-emergence aspects of the Plan.
The financial projections and certain other business information contained in the Plan and the Disclosure Statement rely on the successful implementation of our business plan after emergence from bankruptcy. The success of our business plan depends in part on economic conditions beyond our control. If we are unable to meet the projected targets under the business plan, we may not achieve the anticipated results set forth in our financial projections.
Our debt instruments include restrictive and financial covenants that limit our operating flexibility.
The Revolving Credit Facility requires us to maintain certain financial ratios and covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in the Company’s best interest. These include, among other things, restrictions on our ability to:
incur or guarantee additional indebtedness;
create liens;
make further negative pledges;
pay dividends on or repurchase stock;
restrict dividends or other distributions from subsidiaries;
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make or own certain investments;
enter into transactions with affiliates;
engage in new lines of business;
consolidate, merge or sell all or substantially all of our assets;
enter into sales and lease-back transactions.
Any failure to comply with the financial covenants in our first lien facilities
couldrestrictions of the Revolving Credit Facility may result in an event of default. Such default may allow our creditors to accelerate the related debt and may result in the acceleration of all of our outstanding indebtedness.
The first lien facilities requireany other debt to which cross-acceleration or cross-default provisions apply. In addition, these creditors may be able to terminate commitments they had made to provide us to meet certain financial covenants,
including a secured leverage test, a total leverage test and an interest
coverage test. Each of these covenants is calculated based on trailing four
quarter results using specific definitions that are contained in the first lien
credit agreement. Due to current industry conditions and increasing
competition in the home video market, as discussed inwith further funds. See Item 2. Management's“Management’s Discussion and Analysis of Financial Condition and Results of Operations,
we were not in compliance with theOperations—Liquidity and Capital Resources,” for more information on our restrictive and financial covenants containedcovenants.
Limitations in the first
lien facilities asRevolving Credit Facility on making capital expenditures and incurring secured debt may prevent us from pursuing new business initiatives, which may place us at a competitive disadvantage.
The Revolving Credit Facility limits the amount of endmoney that we may spend on capital expenditures. We believe that successful execution of our business plan will require us to dedicate a significant portion of our capital expenditures to the continuing integration of Hollywood and Movie Gallery and required maintenance capital. Accordingly, we could be unable to make capital expenditures to open or acquire a significant number of new stores or pursue new business initiatives, including investing in an online rental program or other alternative delivery vehicles. Our inability to pursue new business initiatives may place us at a disadvantage to our competitors who are not subject to these restrictions. If our competitors successfully pursue new business initiatives, these restrictions may limit our ability to react effectively, and our results of operations or financial condition could be adversely affected.
Our business could be negatively impacted by changes to the traditional exclusive movie windows.
Following a movie’s theatrical release, most studios distribute movies in a specific sequence in order to maximize studio revenues on each title they release. The order of distribution of movies is typically: (1) movie theaters; (2) home video retailers; (3) pay-per-view; and (4) all other sources, including cable and syndicated television. The length of the second quarter of fiscal 2007.movie rental window varies, but is typically 45 days prior to the pay-per-view release date and during this window, home video retailers have historically enjoyed exclusive rights to market movies. However, the movie studios are not contractually obligated to continue to observe these window periods. As a result, we cannot be certain that movie studios will maintain this exclusive window in the future. Indeed, certain movie studios have experimented with modifying or eliminating the exclusive window provided to the home video industry. Most recently, on April 30, 2008, Time Warner, in contrast to the other studios, announced that it will begin aggressively moving toward releasing essentially all of its titles to video on demand (“VOD”) at the same time as they are released to DVD in 2008.
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We could be adversely affected as a result of this move by Warner, or if additional movie studios decided to shorten or eliminate the exclusive window period or if the home rental retailers were no longer first following the theatrical release. As a result, consumers would no longer need to wait until after the home video distribution window to view these movies through other distribution channels. Certain other studios presently offer concurrent theatrical and home video releases on a limited basis for certain lower box office titles in selected genres, which could lead to further compression of the window period that home video retailers generally enjoy. Changes to the distribution scheme could cause our profitability to decline, which in turn, could have an adverse effect on our business, financial condition, liquidity, and results of operations.
Our business may be negatively impacted by new and existing technologies.
Advances in technologies that benefit our competitors may adversely affect our business. For example, advances in cable and direct broadcast satellite technologies, including high definition digital television transmissions offered through those systems and the increasing ease of downloading video content on the Internet, may adversely affect public demand for video store rentals. Expanded content available through these media, including movies and video games, specialty programming and sporting events, could result in fewer movies and video games being rented and sold at video stores. In addition, higher quality resolution and sound offered through these services and technologies could require us to increase capital expenditures, for example, to upgrade our DVD inventories to provide movies in high definition.
Cable and direct broadcast satellite technologies offer movie channels, for which subscribers pay a subscription fee to access movies selected by the provider at times selected by the provider, as well as pay-per-view services, for which subscribers pay a discrete fee to view a particular movie selected by the subscriber. Historically, pay-per-view services have offered a limited number of channels and movies and have offered movies only at scheduled intervals. Over the past five years, however, advances in digital compression and other developing technologies have enabled cable and satellite companies, and may enable Internet service providers and others, to transmit a significantly greater number of movies to homes at more frequently scheduled intervals. Certain cable companies, Internet service providers and others are also testing or offering VOD services. VOD provides a subscriber with the ability to view any movie included in a catalog of titles maintained by the provider at any time.
If pay-per-view, VOD or any other alternative movie delivery systems enable consumers to conveniently view and control the movies they want to see and when they want to see them, such alternative movie delivery systems could achieve a competitive advantage over the traditional home video rental industry. This risk would be exacerbated if these competitors receive the movies from the studios at the same time as video stores, for example, see the discussion above regarding Warner’s recent video-on-demand and Internet rental day-and-date release announcement. It could be further exacerbated by the increasing popularity and availability of personal digital recording systems (such as TiVo), which allow viewers to record, pause, rewind, and fast forward live broadcasts and create their own personal library of movies.
In addition, we may compete in the future with other distribution or entertainment technologies that are either in their developmental or testing phases now or that may be developed in the future. For example, some retailers have begun to rent or sell DVDs through kiosks or vending machines. Additionally, the technology exists to offer disposable DVDs, which would allow a consumer to view a DVD an unlimited number of times during a specified period of time, at the end of which the DVD becomes unplayable. We cannot predict the impact that future technologies will have on our business. If any of the technologies described above creates a competitive advantage for our competitors, our business, financial condition, liquidity, and results of operations could be adversely affected.
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Our business could be adversely affected if the trend of consumers purchasing movies rather than renting movies continues.
Historically, studios offered for sale the movies they distribute at prices too high to generate significant consumer demand to purchase these movies. A limited number of titles were released at a lower price point when consumers were believed more likely to have a desire to purchase a certain title. The penetration of DVDs into the market at a significantly lower price point has resulted in a significant increase in the quantity of newly released movies available for purchase by the consumer. These movies are purchased to rent by home video specialty retailers and to sell by both home video specialty retailers and mass merchants, among others. We believe that these changes in pricing have led to an increasing number of consumers who decide to purchase, rather than rent, movies. Further changes in studio pricing or sustained or further depressed pricing by competitors could further accelerate this trend and could result in increased competition. If we are not able to derive most of our non-compliancerevenues from our higher margin rental business, our profit levels would be adversely impacted and we may not be able to compete with our competitors for the consumer’s sell-through dollar, which in turn could have an adverse effect on our business, financial covenants containedcondition, liquidity, and results of operations.
Our business could be adversely impacted if movie studios negatively altered revenue sharing agreements.
Prior to studio revenue sharing agreements and the advent of DVD, we would typically pay between $35 and $65 per videocassette for major theatrical releases not priced as sell-through titles. Under studio revenue sharing agreements, we are able to pay a minimal up-front cost per unit and thereafter pay a percentage of each revenue dollar earned for a specified period of time to the studios. We currently utilize these types of agreements for a significant number of movie releases. These agreements have enabled us to increase significantly the number of copies carried for each title to better meet consumer demand. After a specified period of time, we offer the copies for sale to our customers as “previously viewed movies” at lower prices than new copies of the movie. We could be adversely affected if these agreements are changed to give the movie studios a greater percentage of each revenue dollar or if such agreements are discontinued. Additionally, studio revenue sharing agreements permit the studios, in the first lien facilities andordinary course of business, to audit our resulting default under the first lien credit
agreement, the lendersrecords to determine whether we have the right to terminate their commitments,
accelerate all of our obligations and, subject tocomplied with the terms of these agreements. We may be required to pay additional amounts as a result of these audits. Further, some of our revenue sharing agreements may be terminated on short notice. If we are unable to purchase movies through revenue sharing agreements, our business, financial condition, liquidity and results of operations could be adversely affected.
We could be adversely affected by conditions impacting the Forbearance
Agreement (as amended) described below, exercise their remedies undermotion picture industry.
The availability of new movies produced by the first
lien credit agreement. Wemovie studios is vital to us. The quality and quantity of new movies available in our stores could be adversely affected by factors that negatively impact the motion picture industry, such as financial difficulties, regulatory requirements and work disruptions involving key personnel, such as writers or actors. For example, on November 5, 2007, two labor unions that represent film, television and radio writers working in the United States decided to go on strike. Over 12,000 writers were affected by the strike. Labor strikes, such as this, cost the entertainment industry millions of dollars (for example, the last such strike in 1988, which lasted 22 weeks, cost the American entertainment industry an estimated $500 million). These costs to the entertainment industry, in turn, negatively affect the home video retail industry and could have executedunintended consequences to our business.
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Additionally, we depend on the movie studios to produce new movies that appeal to consumer tastes. A decrease in the quality and quantity of new movies available in our stores could result in reduced consumer demand, and we cannot assure you that future releases of movies and video games will appeal to consumers and, as a Forbearance Agreement (as amended),
effective asresult of July 2, 2007, with certain lenders underthese uncertainties, our business, financial condition, liquidity and results of operations could be adversely affected.
Our business could be adversely affected if video game software and hardware manufacturers do not introduce new products in a timely manner.
The video game industry is characterized by the first lien credit
agreement. Undersignificant impact on consumer spending that accompanies the Forbearance Agreement (as amended),introduction of new video game software and hardware platforms. Retail spending in the lenders will
forbear until August 14, 2007 from exercising default-related rights and
remedies arising from existing defaults, absent any new defaults under the
first lien credit agreement or the Forbearance Agreement (as amended). We have
also begun discussionsvideo game industry typically grows rapidly with the advisors representingintroduction of new platforms and then declines considerably prior to the release of new platforms. In 2005, Microsoft introduced the XBOX 360 platform and, in late 2006, Sony and Nintendo released their newest platforms. Consumer demand for video games available in our first lien lenders on
extending the Forbearance Agreement (as amended).
If the obligations under the first lien credit agreementstores could be adversely affected if manufacturers fail to introduce new video games for these new gaming platforms in a timely manner or are accelerated or 60
days have passed since the dateunable to make new video games and gaming systems available in sufficient quantities. A decline in consumer demand for video games available in our stores could negatively affect our revenues and, as a result, our business, financial condition, liquidity and results of operations could be adversely affected.
An increased piracy of products we offer may adversely affect our results of operations.
The development of the default underInternet and related technologies increases the first lien credit
agreement, a cross default will exist under our second lien credit facility.
If a cross default werethreat of piracy by making it easier to occur,duplicate and subject to the terms of the intercreditor
agreement between the parties to the first lien credit agreement and second
lien credit agreement, the lenders under the second lien credit agreement may
accelerate our obligations and exercise their remedies. If the obligations
under the first lien credit agreement or the second lien credit agreement are
accelerated, a cross default under the 11% senior note indenture will result.
Our assets and cash flow will not be sufficient to fully repay our outstanding
indebtedness if such indebtedness were accelerated.
We are currently in discussions with the advisors representing our first lien
lenders and other major creditors to address our current financial situation.
In the near future, we expect to present a longer-term solution to the first
lien lender group and other major creditors that will address the operational
and financial issues currently impacting our business. This longer-term
solution includes accelerating the closure of unprofitable stores,
consolidating stores in certain markets, obtaining additional working capital,
realigning our cost structure to better reflect our reduced size and seeking a
more competitive capital structure. In connection with a solution, it is
likely that we will need the first lien lenders to waive our existing defaults
under the first lien credit agreement and to substantially modify the financial
covenants contained therein.widely distribute pirated content. We cannot assure you that:
- -that movie studios and others with rights in movies and video games and related product will take steps to enforce their rights against Internet piracy or that they will be successful in preventing the distribution of pirated content. Technological developments and advances of products (such as at-home DVD burners) also may increase piracy of movies and video games, and, as a result, our business, financial condition, liquidity and results of operations could be adversely affected.
Our financial results could be adversely impacted if we will reach such an agreementare unable to effectively manage our merchandise inventory.
Our merchandise carries risks associated with inventory management, obsolescence and theft. While most of our first lien lenders priorretail movie product is returnable to the expirationmovie studios, our investment in inventory increases our exposure to excess inventories in the event anticipated sales fail to materialize. In addition, customer returns of video games, which video games are prone to obsolescence because of the forbearance period discussed above;
- -nature of the video game industry, are subject to negotiation with video game vendors. The prevalence of multiple gaming platforms may make it more difficult to predict accurately consumer demand with respect to video games.
The nature of and market for our products, particularly movies and video games makes us particularly prone to risk of theft and loss. Our operating results could suffer if we are unable to:
maintain the appropriate levels of inventory to support customer demand without building excess inventories;
obtain or maintain favorable terms from the movie studios and video game vendors with respect to payment and product returns;
control shrinkage resulting from theft, loss or obsolescence; and
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avoid significant inventory excesses that could force us to sell products at a discount or loss.
If we are unable to manage effectively our merchandise inventory such that we increase our exposure to excess inventories in the event anticipated sales fail to materialize, our profitability could decline, which could have an adverse effect on our business, financial condition, liquidity and results of operations.
Our gross margins may be adversely affected if we fail to meet or exceed the expected average price for previously viewed movie titles or video games.
We earn revenues from the sale of previously viewed movies and video games. We need to sell previously viewed movies and video games at an expected price to achieve certain gross margin targets. Our gross margins may be adversely affected if the average sales price for previously viewed movies and video games is not at or above our target price.
A consumer’s desire to own a particular movie or video game and the number of previously viewed movies or video games available for sale to the public by our competitors are both factors that affect our ability to sell previously viewed movies and video games at our target price. Additionally, sales of previously viewed movies and video games also compete with newly released movies and video games priced for sell-through. As a result, there are no assurances that we will be able to obtain an extension of our forbearance period ifsell previously viewed movies and video games at or above the expected price. If selling prices for previously viewed movies and video games decline, we are not able to reach such an agreement with our first lien lenders prior
to the August 14, 2007 expiration of the forbearance period; or
- - if we do reach an agreement, what the terms of such agreement will be or
what actions we willmay be required to undertakewrite down the carrying value of our rental inventory and, as a result, our business, financial condition, liquidity and results of operations could be adversely affected.
Our quarterly operating results fluctuate for reasons unrelated to our long-term performance.
Historically, our quarterly operating results have varied, and we anticipate that they will continue to vary in connection with such an
agreement,the future. Factors that may cause quarterly operating results to vary, many of which we cannot control, include, without limitation: (a) decreased consumer demand for our products; (b) decreased prices at which we can rent or sell our products; (c) the timing, cost and availability of newly-released movies and video games; (d) increased competition from providers of similar products, other forms of entertainment, and special events, such as selling assets, closing stores, securing additional
financing, reducingthe Olympics or delayingongoing major news events of significant public interest; and (e) acts of God or public authorities, war, civil unrest, hurricanes, fire, floods, earthquakes, acts of terrorism and other matters beyond our control.
Further, our revenues and operating results fluctuate on a seasonal basis, because seasonality and weather patterns can either significantly increase business (inclement conditions that prohibit outdoor activities) or significantly decrease business (mild temperatures and dry conditions that reduce the consumer’s desire to relax indoors). The home video retail industry generally experiences relative revenue declines in April and May, due in part to the change in Daylight Savings Time and improved weather, and in September and October, due in part to the start of the traditional school year and the introduction of new television programs. The industry typically experiences peak revenues during the months of November, December and January due to the holidays in these months, inclement weather conditions and, frequently the home video release of the preceding summer’s hit titles. The video game sales business is traditionally strongest in November and December, as title releases are often clustered around the holiday shopping season.
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In light of these seasonal variations in our revenues and operating results and the impact on our revenues and operating results of the strength of the home video title slate, comparisons of our revenues and operating results for any period with those of the immediately preceding period or the same period of the preceding fiscal year may be of limited relevance in evaluating historical financial performance and predicting future financial performance. Our working capital, expenditures or restructuring our
existing indebtedness.cash and short-term borrowings also fluctuate during the year as a result of numerous factors.
Our operating results may suffer if revenues during peak seasons do not meet expectations. If we fail to reach such an agreement, the first lien lenders could institute
foreclosure proceedings against our assets securing borrowings under the first
lien facilities.
We mayrevenues during these periods do not be able to generate sufficient cash flows to meet our liquidity
needs.
Our businessexpectations, we may not generate sufficient cash flow from operations, or future
borrowings underrevenue to offset increased costs incurred in preparation for peak seasons and our March 2007 Credit Facility, or from other sources; and
cash flowsoperating results may notsuffer. Finally, the operational risks described elsewhere in these risk factors may be availableexacerbated if the events described therein were to us in an amount sufficient to enable us to
meet our capital needs, which include funding for seasonal working capital,
debt service, remodeling and relocating existing stores and, tooccur during a lesser
extent, new store investment. peak season.
Our ability to generate cash from operations is,
to a significant extent,business could be adversely affected by litigation.
From time-to-time, we are subject to general conditions withinclaims or litigation incident to our business. As of this date, we are not currently involved in any legal proceedings that, individually or in the video rental
market. In recent months,aggregate, are expected to harm our business, financial condition, liquidity and results of operations.
Our business could be adversely affected by exposure to laws in a number of industry-wide factorsjurisdictions.
In operating more than 3,300 stores located throughout all 50 states and Canada, we are exposed to federal, state and local legal issues in a significant number of jurisdictions. Additionally, we are party to various contracts and business relationships that require us to adhere to certain contractual obligations. Any changes or modifications to our obligations under our contracts and business relationships, as well as any changes in local, state and/or federal laws, could adversely affect our business, financial condition, liquidity and operations.
We may have combinedhigher purchasing costs related to negatively impact the rental market. These factors include: weak movie title
lineup; cannibalizationrelease of rentals by low-priced movies available for sale;
growth offilms on the online rental segment;Blu-ray format.
As the standard DVD format nearing the end of
its life cycle; movie studios structuring their DVD movie releases towardsrelease more films on the later part of the year; competingnew high definition DVD formats delaying content
release and consumer acceptance; andformat—Blu-ray—we will need to purchase greater volumes of such films. Films released on the proliferation of alternative consumer
entertainment options including movies available through video-on-demand,
TIVO/DVR, digital cable, satellite TV, broadband, Internet and broadcast
television. We expect thatBlu-ray format may be more expensive to acquire than in DVD format. And these factors will continuenew high definition format DVDs appear to have a negative
impacthigher damage rates than regular DVDs. The rate of customer acceptance and adoption of the new format is uncertain and we may be unable to charge higher prices for either the rental or sale of movies on the rental market for at least the next six months, if not longer.
Our ability to generate cash from operations has been negatively impacted by
current market conditions. For the twenty-six weeks ended July 1, 2007,Blu-ray format. Thus, our operating activities used $62.2 million of cash, which was funded through
additional borrowings under our March 2007 Credit Facility. At July 1, 2007,
we had $45.5 million of cashexpenditures on DVDs could increase and cash equivalents and did not have any
available borrowings under our March 2007 Credit Facility. Due to our
substantial indebtedness, we have significant debt service obligations. For
the remainder of fiscal 2007 we have scheduled interest payments aggregating
approximately $60.7 million. If we cannot meet our capital needs, including
servicing our indebtedness, we may have to take actions such as selling assets,
seeking additional equity, reducing or delaying capital expenditures and
restructuring our indebtedness.
Historically, we maintained favorable payment terms with our vendors, which has
been a significant source of liquidity for us. During the latter part of fiscal
2006, and continuing into fiscal 2007, we have experienced significant vendor
term contraction, which eroded our working capital capacity. Due to our non-
compliance with the covenants contained in the first lien facilities, many of
our significant vendors have discontinued extending us trade credit, requiring
us to pay for product before it is shipped, and we have experienced additional
tightening of terms with other vendors. If we continue to experience
substantial restrictions or tightening of terms with our vendors and continue
to generate operating losses similar to those experienced for the twenty-six
weeks ended July 1, 2007, we do not believe we will have sufficient liquidity
to operate our business, through the third quarterfinancial condition, liquidity and results of 2007 without gaining
access to additional capital.
Our stock mayoperations could be delisted from the Nasdaq Stock Market.
Since July 2, 2007, our common stock has failed to maintain a minimum per share
bid price of one dollar. If our common stock does not maintain a minimum per
share bid price of one dollar over a period of 30 consecutive trading days, we
will be in non-compliance with the requirements for continued listing on the
Nasdaq Stock Market and will be subject to possible delisting proceedings by
the Nasdaq Stock Market. A common course of action for companies attempting to
maintain their listing by ensuring a bid price in excess of one dollar per
share is the institution of a reverse stock split. At present, we have made no
decision with respect to this course of action but will continue to evaluate
this alternative in light of all other options, including accepting a delisting
determination. A reverse stock split could negatively impact the value of our
stock by allowing additional downward pressure on the stock price as its
relative value becomes greater following the reverse split. That is to say,
the stock at its new higher price has farther to fall and therefore more room
for investors to short or otherwise trade the value of the stock downward.
Similarly, a delisting may negatively impact the value of the stock, as stocks
trading on the over-the-counter market are typically less liquid and trade with
larger variations between the bid and ask price, and we could lose support from
institutional investors, brokerage firms and market makers, if any, that
currently buy and sell our stock and provide information to investors about us.
adversely affected.
We may be required to recognize additional asset impairment and other asset-related charges.
We have incurred in the past, and continue to incur, impairment charges with respect to our indefinite-lived intangible assets such as goodwill and the Hollywood trademark, our definite-lived intangible assets such as customer lists, and our definite-lived tangible assets such as property, furnishings, and equipment.equipment, and to an immaterial extent rental inventory. In accordance with the applicable accounting literature, we test for impairment when impairment indicators arise, which include but are
not limited to:
- - (without limitation):
significant adverse changes in the business climate;
- -
current period operating or cash flow losses combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with long-lived assets;
- -
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a current expectation that more-likely-than-not (e.g., a likelihood that is more than 50%) long-lived assets will be sold or otherwise disposed of significantly before the end of their previously estimated useful life; and
- -
a significant drop in our stock price.
Due to the impairment indicators noted in Note 5, Impairment of Other Long-Lived Assets, Other Indefinite-Lived Intangible Assets, and Goodwill, to our Notes to Consolidated Financial Statements, we performed impairment testing on our indefinite-lived and definite-lived intangible assets and our definite-lived tangible assets as
of July 1, 2007.assets. As a result, we determined that each were impaired and recorded charges of $115.6 million, $97.9$158.4 million, and $43.0$48.7 million related to the impairment of goodwill, impairment of other intangibles, and the impairment of property, furnishings, and equipment, respectively, for the thirteenthirty-nine weeks ended July 1,September 30, 2007.
Our impairment calculations are based upon our best estimates at the time of preparation of the recoverability of the assets'assets’ values using primarily discounted cash flow methods. Future industry trends and our future performance relative to our competition may require us to revise our cash flow estimates and other assumptions when determining fair value and thus compel us to recognize additional long-lived asset and rental inventory impairment charges.
To date, we have not recorded any
For the thirty-nine weeks ended September 30, 2007, recognized impairment charges related to our rental inventory.inventory have been immaterial. In addition to our property, furnishings, and equipment impairment charges and our customer list impairment charge, we could incur material impairment charges to our rental inventory. If we were to closeinventory in the future. As a result of closing a significant number of our stores, we may need to liquidate the on-hand rental inventory for amounts that are less than the carrying valuesvalue of the rental inventory product. These potential future asset impairments could have a materially adverse effect on our consolidated statementresults of operations.
Furthermore, in the thirty-nine weeks ended September 30, 2007, we have recognized a material charge associated with changing our estimates of the salvage values of our rental inventory. We may be required to recognize additional charges in the future with respect to these estimates of salvage values for reasons including (without limitation) the following:
the overabundance of DVD titles available for sale in the marketplace;
the maturation of the standard definition DVD life cycle culminating in the anticipated consumer acceptance of the Blu-ray DVD next generation high definition format; and
aggressive pricing and promotion tactics recently implemented by our competition.
Our business could be adversely affected by the failure of our management information systems to perform as expected, or by additional loss of key management information systems personnel.
Due to our significant operating losses for the twenty sixthirty-nine weeks ended July 1,September 30, 2007 and our present liquidity position, we have reduced planned capital and maintenance expenditures for, among other things, projects related to our management information systems infrastructure, which include but are not
limited to:
- - (without limitation):
replacing old and outdated hardware technology in our stores and in our two store support centers;
- -
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either replacing, or updating and integrating our multiple point-of-
sale,point-of-sale, or POS, systems;
- -
additional integration of systems between our two store support centers; and
- -
upgrading our present versions of certain operating and applications systems platforms, including our Oracle database environment, without which we may incur additional costcosts for ongoing maintenance and support.
We depend on our management information systems for the efficient operation of our business. Our merchandise operations use our inventory utilization system to track rental activity by format for each individual movie and video game title so that we may determine appropriate buying, distribution and disposition of our inventory. We also rely on a scalable client-server system to maintain and update information relating to revenue, rental and sales activity, movie and video game rental patterns, store membership demographics, and individual customer history. These systems, together with our POS and in-store systems, allow us to control our cash flow, keep our in-store inventories at optimum levels, move our inventory more efficiently and track and record our performance. We rely on our management information systems personnel to operate and maintain these systems, however we have experienced attrition in key positions within this area. If our management information systems failed to perform as expected, or if we were to continue to lose personnel in this area, our ability to manage our inventory and monitor our performance could be adversely affected, which, in turn, could harm our business, financial condition, liquidity and financial
condition.
Item 2. Unregistered Salesresults of operations.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
Pursuant to the Plan, we issued (i) 7,544,460 shares of New Common Stock to holders of 11% Senior Note Claims, (ii) 8,251,498 shares of New Common Stock to affiliates of Sopris, on account of the conversion of the Sopris Second Lien Claims, (iii) 5,000,000 shares of New Common Stock to participants in the Rights Offering, (iv) 115,000 shares of New Common Stock to affiliates of Sopris in satisfaction of its fee for providing the Backstop Commitment, and Use(v) 60,000 shares of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. SubmissionNew Common Stock to Imperial Capital, LLC, on account of Mattersa claim against us for services rendered on behalf of the official committee of unsecured creditors during our chapter 11 proceedings. We reserved (a) 2,395,540 shares of New Common Stock for future issuance to a Voteholders of Security Holders
Our Annual Meeting of Stockholders was held on June 7, 2007. The following
action was taken at the Annual Meeting, for which proxies were solicited
pursuant to Regulation 14Aallowed claims in Classes 7A, 7B and 7E under the Securities Exchange ActPlan, and (b) 2,828,226 shares of 1934,New Common Stock for future issuance as amended:
1. The five individuals nominated bygrants of equity, restricted stock or options under a management and directors equity incentive plan.
In addition, we issued (i) the Board$20 Warrants to purchase 933,430 shares of Directors for election as
directors were elected by the following votes:
Name For Withheld
-------------------- ---------- --------
Joe T. Malugen 23,643,923 973,122
H. Harrison Parrish 23,642,117 974,928
John J. Jump 23,702,602 914,443
James C. Lockwood 23,702,902 914,143
William B. Snow 23,658,668 958,377
2. A proposal to approve an amendmentNew Common Stock to the Company's Certificateholders of Incorporation11% Senior Note Claims and will reserve $20 Warrants to increase the number of authorizedpurchase 296,385 shares of common stock from
65,000,000New Common Stock for future issuance to 250,000,000holders of allowed claims in Classes 7A, 7B and 7E under the number of authorizedPlan, (ii) the $10 Warrants to purchase 86,250 shares of preferred
stock from 2,000,000New Common Stock to 10,000,000 required the affirmative vote of a majoritySopris in satisfaction of the Company's outstandingarrangement fee payable under the Seasonal Overadvance Facility, and (iii) the $0.01 Warrants to purchase 2,001,289 shares and was not approved by a vote of 12,510,336 for versus 3,764,546 against. There were 28,788 abstentions and
8,313,375 broker non-votes.
3. A proposalNew Common Stock to ratifylenders under the appointment of Ernst & Young LLP asExit Facility.
Based on the Company's
independent registered public accounting firm for the 2007 fiscal year was
approved by a vote of 24,418,228 for versus 173,915 against. There were 24,902
abstentions.
Item 5. Other Information
None.
Item 6. Exhibits
a) Exhibits
3.2 Amended and Restated Bylaws dated April 12, 2007, previously
filed as exhibitConfirmation Order, we relied on Section 1145(a)(1) of the same numberBankruptcy Code to exempt from the Company's Current
Report on Form 8-K filed on April 18, 2007, and incorporated
herein by reference.
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-
14(a)/Rule 15d-14(a)registration requirements of the Securities Exchange Act of 1934.
31.2 Certification1933, as amended (the “Securities Act”), the issuance of Chief Financial Officer pursuantthe New Common Stock and the New Warrants to Rule 13a-
14(a)/Rule 15d-14(a)holders of claims as outlined above. Section 1145(a)(1) of the Bankruptcy Code exempts the offer and sale of securities under a plan of reorganization from registration under Section 5 of the Securities Exchange Act and state laws if three principal requirements are satisfied:
the securities must be offered and sold under a plan of 1934.
32.1 Certificationreorganization and must be securities of Chief Executive Officer pursuantthe debtor, of an affiliate participating in a joint plan of reorganization with the debtor, or of a successor to Rule 13a-
14(b)/15d-14(b)the debtor under the plan of reorganization;
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the recipients of the securities must hold claims against or interests in the debtor; and
the securities must be issued in exchange, or principally in exchange, for the recipient’s claim against or interest in the debtor.
We relied upon Section 4(2) of the Securities Exchange Act of 1934 and 18
U.S.C Section 1350.
32.2 Certification of Chief Financial Officer pursuant to Rule 13a-
14(b)/15d-14(b)in connection with the issuance of the Securities Exchange ActNew Common Stock and New Warrants to Sopris to the extent that Section 1145(a)(1) was not available.
Item 3. | Defaults Upon Senior Securities |
Under the terms of 1934the first lien credit agreement, our filing of the Chapter 11 Cases created an event of default. Upon the filing of the Chapter 11 Cases, the lenders’ obligations to loan additional money to us terminated and 18
U.S.C Section 1350.
the outstanding principal balance of all loans and other obligations under the first lien facilities became immediately due and payable. On the Effective Date, the first lien facilities were amended and restated when we entered into the First Lien Credit Facility, a senior secured credit facility in an aggregate amount not to exceed $626,488,750 (plus accrued and capitalized interest and fees), consisting of $602,988,750 aggregate principal amount of term loans and $23,500,000 aggregate principal amount of letters of credit.
The filing of the Chapter 11 Cases also created an event of default under our second lien credit facility. Under the terms of the second lien credit agreement, the entire principal balance of all loans and other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. On the Effective Date, the second lien credit facility was amended and restated when we entered into the Second Lien Credit Facility, a senior secured credit facility which provides for term loans in an aggregate principal amount not to exceed $117,141,030.
The filing of the Chapter 11 Cases also created an event of default under our 11% senior notes. Under the terms of the 11% senior notes, the outstanding principal balance of all of the 11% senior notes and other obligations became due and payable as a result of the filing of the Chapter 11 Cases. On the Effective date, the 11% senior notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of 11% senior notes and other general unsecured claims will receive equity in the Reorganized Debtors.
Finally, the filing of the Chapter 11 Cases created an event of default under Hollywood’s 9.625% Senior Subordinated Notes due 2011, or the Senior Subordinated Notes. Under the terms of the Senior Subordinated Notes, the outstanding principal balance of all of the Senior Subordinated Notes and other obligations became immediately due and payable as a result of the filing of the Chapter 11 Cases. On the Effective date, the Senior Subordinated Notes were canceled and the indentures governing such securities were terminated (except that the indentures continue in effect solely for the purposes of allowing holders of the notes to receive distributions under the Plan and allowing the trustees to exercise certain rights). Holders of the Senior Subordinated Notes and other general unsecured claims will receive equity in the Reorganized Debtors.
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Item 4. | Submission of Matters to a Vote of Security Holders |
None.
Item 5. | Other Information |
None.
Item 6. | Exhibits |
a) Exhibits
2 | Second Amended Joint Plan of Reorganization with Technical Modifications dated April 10, 2008, previously filed as exhibit 99.2 to the Company’s Current Report on Form 8-K filed on April 16, 2008, and incorporated herein by reference. | |
3.2 | Amended and Restated Bylaws dated April 12, 2007, previously filed as exhibit of the same number to the Company’s Current Report on Form 8-K filed on April 18, 2007, and incorporated herein by reference. | |
10.1 | Second Amendment to Employment Contract between Movie Gallery US, LLC and J.T. Malugen, dated September 14, 2007. | |
10.2 | Executive Employment Contract between Movie Gallery US, LLC and Jeffrey S. Stubbs, dated August 1, 2007, previously filed as exhibit 99.1 to the Company’s Current Report on Form 8-K filed on August 3, 2007, and incorporated herein by reference. | |
10.3 | First Amendment to Employment Contract between Movie Gallery US, LLC and Jeffrey S. Stubbs, dated September 14, 2007. | |
10.4 | Form of First Amendment to Executive Employment Agreement with S. Page Todd and Mark S. Loyd, dated September 14, 2007. | |
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934. | |
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a)/Rule 15d-14(a) of the Securities Exchange Act of 1934. | |
32.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C Section 1350. | |
32.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C Section 1350. |
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Movie Gallery, Inc.
-------------------
(Registrant)
Date: August 10, 2007 /s/ Thomas D. Johnson, Jr.
------------------------------
Thomas D. Johnson, Jr.
Executive Vice President and
Chief Financial Officer
Date: June 27, 2008 | ||
/s/ Thomas D. Johnson, Jr. | ||
Thomas D. Johnson, Jr. Executive Vice President and Chief Financial Officer |
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