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 |
For the quarterly period ended April 6, 2008
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission File Number 0-24548
Movie Gallery, Inc.
(Exact name of registrant as specified in charter)
Delaware | 63-1120122 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
9275 S. W. Peyton Lane, Wilsonville, Oregon | 97070 | |
(Address of principal executive offices) | (zip code) |
(503) 570-1600
(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 ¨ No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ | Accelerated filer ¨ | |
Non-accelerated filer ¨ | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares outstanding of the registrant’s New Common Stock (as defined) as of December 29, 2008 (subsequent to the Effective Date, as defined) was 37,433,487.
Part I – Financial Information
Forward Looking Statements
This Quarterly 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” 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’s current intent, belief, expectations, estimates and projections regarding our Company and our industry. Forward-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 January 6, 2008, filed with the United States Securities and Exchange Commission on December 18, 2008, which may cause the actual results of our Company to be materially different from any future results expressed or implied by such forward-looking statements. Forward-looking statements in this Quarterly Report on Form 10-Q include statements regarding the risks and uncertainties associated with our ability to 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 on April 10, 2008, our ability to operate subject to the terms of our existing financing obligations, our ability to fund our operations, our ability to make projected capital expenditures, the importance of the home video industry to movie studios, as well as general market conditions, competition and pricing. Factors that could cause actual results to differ materially from these forward-looking statements include, but are not limited to, those described under Part II, Item 1A. Risk Factors in this Quarterly Report on Form 10-Q and under Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008, as well as risks and uncertainties regarding:
• | our ability to successfully implement all post-emergence aspects of the Plan; |
• | our ability to manage our liquidity needs and operate subject to the terms of our financing, including limitations on making capital expenditures and incurring secured debt; |
• | the volatility of financial results and the potential that they do not reflect our historical trends; |
• | our ability to attract and retain customers; |
• | the availability of new movie releases priced for sale below the current market negatively impacting consumers’ desire to rent movies; |
• | our actual expenses or liquidity requirements differing from our estimates and our expectations; |
• | lower-than-expected availability of new movies and games; |
• | changes in the traditional exclusive movie windows from which we currently benefit or changes in our revenue sharing agreements with movie studios; |
• | our ability to effectively manage our merchandise inventory; |
• | our ability to meet or exceed the expected average price for previously viewed movie titles or video games; |
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• | our ability to maintain our management information systems to perform as expected and to prevent additional loss of key management information systems personnel; |
• | higher purchasing and damage rate costs related to release of films on the Blu-ray format; |
• | our inability to obtain additional working capital for our business; |
• | our ability to maintain contracts and leases that are critical to our operations; |
• | our ability to execute our business plans and strategy, including our operational restructuring initially announced in 2007; |
• | our ability to attract, motivate and/or retain key executives and associates; |
• | 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; |
• | additional impairment and other charges that we could incur on our long-lived assets, including rental inventory; and |
• | increased competition in the video and game rental and sale industry and advances in new and existing technologies that benefit our competitors. |
In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Quarterly 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.
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Item 1. | Financial Statements |
Movie Gallery, Inc.
(Debtors-in-Possession as of October 16, 2007)
Condensed Consolidated Balance Sheets
(In thousands, except per share amounts)
January 6, 2008 | April 6, 2008 | |||||||
(Unaudited) | ||||||||
Assets | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 61,312 | $ | 82,170 | ||||
Merchandise inventory | 149,908 | 161,172 | ||||||
Prepaid expenses | 42,273 | 37,214 | ||||||
Store supplies and other | 16,358 | 26,954 | ||||||
Assets held for sale | 2,085 | 2,085 | ||||||
Total current assets | 271,936 | 309,595 | ||||||
Rental inventory, net | 237,433 | 216,289 | ||||||
Property, furnishings and equipment, net | 106,753 | 96,824 | ||||||
Other intangibles, net | 20,874 | 20,069 | ||||||
Deferred income tax asset, net | 1,153 | 1,153 | ||||||
Deposits and other assets | 25,176 | 24,815 | ||||||
Total assets | $ | 663,325 | $ | 668,745 | ||||
Liabilities and stockholders’ deficit | ||||||||
Current liabilities: | ||||||||
Current maturities of long-term obligations | $ | 883,366 | $ | 887,225 | ||||
Accounts payable | 24,737 | 39,762 | ||||||
Accrued liabilities | 56,105 | 55,708 | ||||||
Accrued payroll | 22,113 | 23,016 | ||||||
Accrued interest | 9,327 | 7,479 | ||||||
Deferred revenue | 42,726 | 39,573 | ||||||
Total current liabilities | 1,038,374 | 1,052,763 | ||||||
Other accrued liabilities | 20,856 | 16,596 | ||||||
Total liabilities not subject to compromise | 1,059,230 | 1,069,359 | ||||||
Total liabilities subject to compromise | 460,116 | 494,059 | ||||||
1,519,346 | 1,563,418 | |||||||
Commitments and contingencies (Note 11) | ||||||||
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, 32,282 and 32,282 shares issued and outstanding, respectively | 32 | 32 | ||||||
Additional paid-in capital | 200,069 | 200,477 | ||||||
Accumulated deficit | (1,066,000 | ) | (1,104,927 | ) | ||||
Accumulated other comprehensive income | 9,878 | 9,745 | ||||||
Total stockholders’ deficit | (856,021 | ) | (894,673 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 663,325 | $ | 668,745 | ||||
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Movie Gallery, Inc.
(Debtors-in-Possession as of October 16, 2007)
Condensed Consolidated Statements of Operations
(Unaudited, in thousands, except per share amounts)
For the Thirteen Weeks Ended | ||||||||
April 1, 2007 | April 6, 2008 | |||||||
Revenue: | ||||||||
Rentals | $ | 510,990 | $ | 414,642 | ||||
Product sales | 136,650 | 141,097 | ||||||
Total revenue | 647,640 | 555,739 | ||||||
Cost of sales: | ||||||||
Cost of rental revenue | 154,825 | 133,213 | ||||||
Cost of product sales | 103,388 | 106,793 | ||||||
Gross profit | 389,427 | 315,733 | ||||||
Operating costs and expenses: | ||||||||
Store operating expenses | 307,984 | 336,063 | ||||||
General and administrative | 44,712 | 39,985 | ||||||
Amortization of intangibles | 695 | 805 | ||||||
Other expenses | 22 | 89 | ||||||
Operating income (loss) | 36,014 | (61,209 | ) | |||||
Interest expense, net (includes $17,538 write-off of debt issuance costs for the thirteen week period ended April 1, 2007) | 47,800 | 26,872 | ||||||
Loss before reorganization items and income tax expense | (11,786 | ) | (88,081 | ) | ||||
Reorganization items, net | — | (50,159 | ) | |||||
Loss before income tax expense | (11,786 | ) | (37,922 | ) | ||||
Income tax expense | 685 | 469 | ||||||
Net loss from continuing operations | (12,471 | ) | (38,391 | ) | ||||
Discontinued operations: | ||||||||
Loss from discontinued operations, net of tax ($0 income tax expense for the thirteen week periods ended April 1, 2007 and April 6, 2008) | 2,395 | 536 | ||||||
Net loss | $ | (14,866 | ) | $ | (38,927 | ) | ||
Net loss per common share - Basic and Diluted: | ||||||||
Continuing operations | $ | (0.39 | ) | $ | (1.19 | ) | ||
Discontinued operations | $ | (0.08 | ) | $ | (0.02 | ) | ||
Net loss | $ | (0.47 | ) | $ | (1.21 | ) | ||
Weighted average shares outstanding: | ||||||||
Basic and Diluted | 31,848 | 32,282 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Movie Gallery, Inc.
(Debtors-in-Possession as of October 16, 2007)
Condensed Consolidated Statements of Cash Flows
(Unaudited, in thousands)
For the Thirteen Weeks Ended | ||||||||
April 1, 2007 | April 6, 2008 | |||||||
Operating activities: | ||||||||
Net loss | $ | (14,866 | ) | $ | (38,927 | ) | ||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||
Rental inventory amortization | 95,951 | 92,326 | ||||||
Purchases of rental inventory | (89,602 | ) | (71,144 | ) | ||||
Purchases of rental inventory - base stock | (184 | ) | (110 | ) | ||||
Non-cash reorganization items, net | — | (66,705 | ) | |||||
Depreciation and intangibles amortization | 21,842 | 12,081 | ||||||
Amortization of debt issuance cost | 1,640 | 1,978 | ||||||
Write-off of debt issuance cost | 17,538 | — | ||||||
Stock based compensation | 709 | 408 | ||||||
Deferred income taxes | 161 | — | ||||||
Other non-cash income | (913 | ) | — | |||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||
Merchandise inventory | (8,356 | ) | (11,289 | ) | ||||
Other current assets | 2,615 | 6,927 | ||||||
Deposits and other assets | 279 | (1,282 | ) | |||||
Accounts payable | (8,659 | ) | 15,545 | |||||
Accrued interest | 13,567 | 4,687 | ||||||
Lease liability on closed stores | 1,094 | 105,065 | ||||||
Other accrued liabilities and deferred revenue | (16,033 | ) | (11,798 | ) | ||||
Net cash provided by operating activities | 16,783 | 37,762 | ||||||
Investing activities: | ||||||||
Business acquisitions | (3,129 | ) | — | |||||
Capital expenditures | (1,099 | ) | (1,614 | ) | ||||
Net cash used in investing activities | (4,228 | ) | (1,614 | ) | ||||
Financing activities: | ||||||||
Repayment of capital lease obligations | (51 | ) | — | |||||
Net repayments on credit facilities | (15,024 | ) | — | |||||
Debt financing fees | (23,239 | ) | (338 | ) | ||||
Proceeds from the issuance of long term debt | 775,000 | — | ||||||
Principal payments on long term debt | (754,858 | ) | — | |||||
Principal payments on DIP credit facility | — | (14,921 | ) | |||||
Net cash used in financing activities | (18,172 | ) | (15,259 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (1 | ) | (31 | ) | ||||
Increase (decrease) in cash and cash equivalents | (5,618 | ) | 20,858 | |||||
Cash and cash equivalents at beginning of period | 32,953 | 61,312 | ||||||
Cash and cash equivalents at end of period | $ | 27,335 | $ | 82,170 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Net cash paid for reorganization items included in operating activities | — | $ | 12,604 | |||||
Net cash paid for reorganization items included in financing activities | — | $ | 338 | |||||
Supplemental non-cash investing and financing activities: | ||||||||
Payment-in-kind interest | — | $ | 6,536 |
The accompanying notes are an integral part of these condensed consolidated financial statements.
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Movie Gallery, Inc.
(Debtors-in-Possession as of October 16, 2007)
Notes to Consolidated Financial Statements (Unaudited)
April 6, 2008
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 (the “Commencement Date”), Movie Gallery, Inc. and each of its U.S. subsidiaries (the “Reorganized Debtors”), filed voluntary petitions (the “Chapter 11 Cases”), in the United States Bankruptcy Court for the Eastern District of Virginia, Richmond Division (the “Bankruptcy Court”), seeking reorganization relief under the provisions of Chapter 11 of the United States Bankruptcy Code (the “Bankruptcy Code”). The Reorganized Debtors who filed jointly are the Company and the following direct and indirect subsidiaries of the Company: 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. (“Movie Gallery Canada”), and our Mexican subsidiary, Movie Gallery Mexico, Inc., S. de R.L. de C.V. (“Movie Gallery Mexico”), were not part of the filing and continued operating outside of the Chapter 11 Cases, and are collectively referred to herein as “Non-Debtor parties”. 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 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.
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 Chapter 11 Cases. 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. The Reorganized Debtors were authorized to pay ordinary course post-petition expenses without seeking Bankruptcy Court approval.
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 (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 from time to time 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 repay our pre-petition, secured revolving credit facility and provide us with additional working capital. For more information regarding the DIP Credit Agreement, see Note 9. Long Term Obligations.
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On August 17, 2007, the Company received a NASDAQ Staff Determination indicating that it was not in compliance with Marketplace Rule 4450(a)(5), which requires a minimum bid price of $1.00 per share for the Company’s common stock, and was not in compliance with NASDAQ Marketplace Rule 4450(b)(3), which requires Movie Gallery to maintain a minimum market value of publicly held shares of $15 million. On October 16, 2007, we received notification from the NASDAQ Stock Market that our old common stock under the symbol MOVI would be 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 the NASDAQ’s delisting decision, and from October 25, 2007 through May 20, 2008, the date of our emergence from Chapter 11 protection (the “Effective Date”), our old common stock traded on the over-the-counter (“OTC”) market commonly known as the “Pink Sheets” under the symbol MOVIQ.PK. Subsequent to the Effective Date and through the filing date of this Quarterly Report on Form 10-Q, our new common stock trades on the Pink Sheets under the symbol MVGR.PK.
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 the rejection of executory contracts and unexpired leases that are recoverable under the Bankruptcy Code are classified as liabilities subject to compromise for fiscal reporting periods subsequent to the Commencement Date unless such claims were secured. During the Chapter 11 Cases, the Reorganized Debtors 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 forth in the 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” filed with the Bankruptcy Court.
Developing a Plan of Reorganization
Prior to the Commencement Date, on October 14, 2007, the Reorganized Debtors, certain lenders under the second lien facility, certain holders of Movie Gallery’s 11% senior notes due 2011 (the “11% Senior Notes”) and Sopris Capital Advisors LLC, a private investment fund (“Sopris”), entered into a Lock Up, Voting and Consent Agreement through which the parties 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, Voting and Consent 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, Voting and Consent Agreement and the plan attached to the Plan Support Agreement (described below), with 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, 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 (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 had 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.
The Reorganized Debtors’ Emergence From Chapter 11
On 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:
• | 7,544,460 shares of common stock, par value $0.001 per share (the “New Common Stock”), to holders of 11% Senior Note Claims; |
• | 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; |
• | 5,000,000 shares of New Common Stock to participants in the Rights Offering; |
• | 115,000 shares of New Common Stock to affiliates of Sopris in satisfaction of its fee for providing the Backstop Commitment; |
• | 60,000 shares of New Common Stock to Imperial Capital, LLC, for services rendered on behalf of the official committee of unsecured creditors during the Chapter 11 proceedings; |
• | warrants to purchase 933,430 shares of New Common Stock at a purchase price of $20 per share (the “$20 Warrants”), to the holders of the 11% Senior Note Claims; |
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• | warrants to purchase an aggregate of 86,250 shares of New Common Stock at a purchase price of $10 per share (the “$10 Warrants”), to Sopris in satisfaction of the arrangement fee payable under the Seasonal Overadvance Facility; and |
• | warrants to purchase up to an aggregate of 2,001,289 shares of New Common Stock at a purchase price of $0.01 per share (the “$0.01 Warrants”, which we refer to together with the $20 Warrants and $10 Warrants, as the “New Warrants”), to lenders under the Exit Facility. |
Pursuant to the Plan, on or promptly after the Effective Date, we reserved:
• | 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; |
• | 296,385 $20 Warrants for future issuance to holders of allowed claims in Classes 7A, 7B and 7E under the Plan; |
• | 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 were determined by our Board of Directors upon their adoption of the Movie Gallery, Inc. 2008 Omnibus Equity Incentive Plan (the “Equity Incentive Plan”). In accordance with the Plan, a minimum of 50% of the awards under the Equity Incentive Plan were granted within 60 days following the Effective Date. |
On the Effective Date, we entered into a Registration Rights Agreement with Sopris and its affiliates. The Registration Rights Agreement provides certain demand and piggyback 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, the Reorganized Debtors entered into several 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 $626.5 million (plus accrued and capitalized interest and fees), consisting of $603.0 million aggregate principal amount of term loans (the “First Lien Term Loan Facility”), and $23.5 million 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”); |
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• | 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 $117.1 million (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 $100.0 million (the “Revolving Credit Facility”). |
• | We and certain of our subsidiaries entered into the Seasonal Overadvance Facility with various lenders and Sopris Partners Series A of Sopris Capital Partners, LP, as arranger. The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to support up to $25.0 million in letters of credit during the period between September 2008 and January 2009 (the “Commitment Period”). During the Commitment Period, we could elect to provide certain studios and game vendors with whom we conduct business with letters of credit which could 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. |
Claims Resolution
Bankruptcy Rule 3003(c)(3) requires the Bankruptcy Court to set the time within which proofs of claim or interest may be filed in a Chapter 11 case. In the Chapter 11 Cases, the Bankruptcy Court established January 25, 2008 as the last date for each person or entity with a claim against the Reorganized Debtors to file a proof of claim (except for claims of governmental units and certain claims arising from the rejection of unexpired leases and executory contracts). The bar date for governmental units to file proofs of claim against the Reorganized Debtors was April 14, 2008. Claims that are objected to by the Reorganized Debtors or the Plan Administrator are determined through the claims resolution process administered by the Bankruptcy Court. Pursuant to the claims objections filed by the Reorganized Debtors, the Bankruptcy Court reduced, reclassified and/or disallowed a significant number of claims for varying reasons, including because such claims were duplicative, without merit, improperly classified or overstated. Additionally, the Reorganized Debtors or the Plan Administrator may resolve their objections to claims through a settlement. Prior to the Effective Date, many claims were resolved through settlement or a Bankruptcy Court order.
Once a claim has been allowed under the Plan (either through a Bankruptcy Court order, a settlement, or otherwise), the claimant may be entitled to a distribution as provided for by the Plan. Unsecured creditors with allowed claims in certain Plan classes were entitled to a distribution of shares of New Common Stock and $20 Warrants, with the number of shares ultimately distributed to each creditor dependent on the amount of the allowed claim in proportion with the amount of total allowed claims in that creditor’s Plan class. Pursuant to the Plan, we have set aside and reserved 2,395,540 shares of New Common Stock and 296,385 $20 Warrants for future issuance to holders of allowed claims in classes 7A, 7B, and 7E under the Plan. As of January 1, 2009, no shares from this reserve have been distributed to unsecured creditors and the claims resolution process is still ongoing.
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Under the Plan, secured claims in classes 3 and 4 were satisfied by the Reorganized Debtors’ obligations under the Amended and Restated First Lien Credit and Guaranty Agreement and Amended and Restated Second Lien Credit and Guaranty Agreement, respectively, as discussed above. The claims resolution process with respect to certain other secured claims remains ongoing.
Except as specifically provided in the Plan, the distributions under the Plan, including the distribution of New Common Stock and New Warrants, as noted above, were in exchange for, and in complete satisfaction, discharge and release of, all claims against the Reorganized Debtors arising on or before the Effective Date, including any interest accrued on such claims from and after the Commencement Date.
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. The appropriateness of continuing to use the going concern basis for our financial statements is dependent upon, among other things, our ability to generate sufficient cash from operations, our ability to comply with the terms of our credit facilities, and our ability to have access to other liquidity.
We believe that the Revolving Credit Facility and the Seasonal Overadvance Facility, together with improved cash operating results, will provide sufficient funds to meet our short-term liquidity needs through at least the end of the first quarter of fiscal 2009. Significant assumptions underlie this belief, including the execution of our business strategy, especially our operational restructuring activities, and no further material adverse developments in our business, liquidity or capital requirements. If we cannot generate sufficient cash flow from operations to service our indebtedness and to meet our working capital needs and other obligations and commitments, we will be required to further refinance or restructure our debt, obtain new funding sources or dispose of assets to obtain funds for such purposes.
2. Accounting Policies
Principles of Consolidation
The accompanying condensed consolidated financial statements present the consolidated financial position, results of operations and cash flows of Movie Gallery, Inc. and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the unaudited condensed consolidated financial statements do not include all of the information and disclosures required by generally accepted accounting principles for complete consolidated financial statements. The consolidated balance sheet at January 6, 2008 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and disclosures required by generally accepted accounting principles for complete consolidated financial statements. In our opinion, all adjustments (consisting of normal, recurring adjustments
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and accruals) considered necessary for a fair presentation have been included. Operating results for the thirteen week period ended April 6, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending January 4, 2009. For further information, refer to the consolidated financial statements and related disclosures included in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant estimates and assumptions and those possessing the most subjectivity relate to our accounting while in Chapter 11 of the Bankruptcy Code, the residual values and useful lives of rental inventory, useful lives of fixed assets and other intangibles, estimated accruals related to revenue-sharing titles subject to performance guarantees, revenues generated by customer programs and incentives, valuation allowances for deferred tax assets, estimated cash flows used to test goodwill and long-lived assets for impairment, the allocation of the purchase price to the fair value of net assets of acquired businesses, share-based compensation, and contingencies. Actual results could differ materially from the results using these estimates and assumptions.
Accounting in Chapter 11 of the Bankruptcy Code
Our accompanying consolidated financial statements have been prepared in accordance with AICPA Statement of Position (“SOP”) 90-7,Financial Reporting of Entities in Reorganization Under the Bankruptcy Code (“SOP 90-7”).
In accordance with SOP 90-7, we are required to segregate and disclose all pre-petition liabilities that are subject to compromise. Liabilities subject to compromise are reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. Accordingly, unsecured liabilities of the Reorganized Debtors, other than those specifically approved for payment by the Court, have been classified as liabilities subject to compromise. The amounts of such liabilities as of the filing of the Chapter 11 Cases were based on balances on the Commencement Date, adjusted in some cases for pro-rated activity from October 1, 2007 to the Commencement Date. Liabilities subject to compromise are adjusted for changes in estimates and settlement of pre-petition obligations. See Note 7. Liabilities Subject to Compromise, below for additional information regarding liabilities subject to compromise.
Expenses, realized gains and losses, and provisions for losses that result from reorganization are reported separately as Reorganization items, net in the Consolidated Statements of Operations. Net cash used for reorganization items is disclosed separately in the Consolidated Statements of Cash Flows. See Note 6. Reorganized Debtors’ Condensed Combined Financial Statements, below for additional information regarding reorganization items.
Fresh-Start Reporting
The amounts and classification of certain items reported in our consolidated financial statements will materially change in reporting periods subsequent to the Effective Date as a result of the consummation by the Reorganized Debtors of the transactions contemplated by the Plan. We will be required to adopt the “fresh start” provisions of SOP 90-7, which require, among other things, that liabilities and assets be restated to their fair values as of the Effective Date. Certain of these
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fair values will be materially different from the values recorded on our Consolidated Balance Sheet as of April 6, 2008. Additionally, we may decide to make other changes in accounting practices and policies as of the Effective Date. For these reasons, our consolidated financial statements for Successor Periods will not be comparable with those of Predecessor Periods. See Note 14. Fresh-Start Reporting, below for further information.
Reclassifications
Certain reclassifications have been made to the prior year condensed consolidated financial statements to conform to the current year presentation. These reclassifications had no impact on stockholders’ deficit or net loss.
The accompanying Condensed Consolidated Statement of Cash Flows for the thirteen week period ended April 1, 2007 has been revised to reclassify $46.6 million of cost of previously viewed movie sales from purchases of rental inventory to rental inventory amortization to be consistent with the presentation in the current year.
Stock-Based Compensation
Effective January 2, 2006, we adopted Financial Accounting Standards Board (“FASB”) Statement No. 123 (Revised 2004),Share-Based Payment, (“FASB Statement No. 123(R)”), which no longer permits the use of the intrinsic value method under Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (“APB Opinion No. 25”). We used the modified prospective method to adopt FASB 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. Our accounting for our stock-based compensation plans in place prior to the Effective Date will continue to be recorded in our results of operations for financial periods 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.
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed based on the weighted-average number of shares of common stock outstanding during the periods presented. Diluted earnings (loss) per share is computed using the weighted-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. Due to our loss for the thirteen week period ended April 1, 2007, common stock options exercisable into 772,078 shares of common stock and 1,276,562 shares of non-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 week period ended April 6, 2008, common stock options exercisable into 657,872 shares of common stock and 638,428 shares of non-vested stock were excluded from the calculation of diluted loss per share, as their inclusion would have been anti-dilutive.
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Recently Issued Accounting Pronouncements
In September 2006, the FASB issued FASB Statement No. 157,Fair Value Measurements (“FASB Statement No. 157”), which provides enhanced guidance for using fair value to measure assets and liabilities. FASB Statement No. 157 also responds to 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. 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 to any new circumstances. FASB Statement No. 157 is effective for our fiscal year beginning January 7, 2008. The adoption of FASB Statement No. 157 did not have a material impact on our consolidated financial position, results of operations, and cash flows. On February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2,Effective Date of FASB Statement No. 157 (“FASB Staff Position No. 157-2”), 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. We are in the process of evaluating the effect of FASB Statement No. 157 as it relates to nonfinancial assets and nonfinancial liabilities on our consolidated financial position, results of operations, and cash flows.
In February 2007, the FASB issued FASB Statement No. 159,The Fair Value Option for Financial Assets and Financial Liabilities (“FASB Statement No. 159”), which provides guidance on applying fair value measurements on financial assets and liabilities. FASB Statement No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. FASB 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. FASB Statement No. 159 is effective for us for our fiscal year beginning January 7, 2008. The adoption of FASB Statement No. 159 did not have a material impact on our consolidated financial position, results of operations, and cash flows.
In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007),Business Combinations(“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 non-controlling interests in acquisitions of less than 100 percent controlling interest when the acquisition constitutes a change in control of the acquired entity, to expense acquisition-related transaction costs, and recognize pre-acquisition 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(“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
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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 Staff Position (“FSP”) No. FAS 142-3,Determination of Useful Life of Intangible Assets (“FSP FAS 142-3”). FSP FAS 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142,Goodwill and Other Intangible Assets. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 and is effective for us for our fiscal year beginning January 5, 2009. Earlier adoption is prohibited. We have not yet commenced evaluating the potential impact, if any, of the adoption of FSP FAS 142-3 on our consolidated financial position, results of operations and cash flows.
In April 2008, the FASB issued FSP No. 90-7-a,An Amendment of AICPA Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“FSP SOP No. 90-7-a”), which applies 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 FSP SOP No. 90-7-a, 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. We do not believe that the adoption of FSP SOP No. 90-7-a will have a material impact on our consolidated financial position, results of operations, or cash flows in the second quarter of 2008.
3. Property, Furnishings and Equipment
Property, furnishings and equipment consists of the following (in thousands):
January 6, 2008 | April 6, 2008 | |||||||
Land and buildings | $ | 15,986 | $ | 15,986 | ||||
Furnishings and equipment | 172,732 | 172,533 | ||||||
Leasehold improvements | 171,204 | 169,205 | ||||||
Asset removal obligation | 3,718 | 3,534 | ||||||
363,640 | 361,258 | |||||||
Less accumulated depreciation and amortization | (256,887 | ) | (264,434 | ) | ||||
$ | 106,753 | $ | 96,824 | |||||
Depreciation expense related to property, furnishings and equipment was $20.9 million and $11.3 million for the thirteen week periods ended April 1, 2007 and April 6, 2008, respectively.
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4. Income Taxes
The effective tax rate was a provision of 4.8% and 1.2% for the thirteen week periods ended April 1, 2007 and April 6, 2008, respectively. The projected annual effective tax rate for fiscal year 2008 is a provision of 1.8%, which differs from the provision of 1.2% for the quarter ended April 6, 2008, due to various state income tax changes. The effective tax rate differs from the statutory rate due primarily to a valuation allowance the Company has established against deferred tax assets.
In July 2006, the FASB issued FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes –an interpretation of FASB Statement No. 109(“FIN 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 FIN No. 48 on January 1, 2007. The adoption of FIN No. 48 did not have a material effect on our consolidated financial position, results of operations, or cash flows.
The amount of unrecognized benefits as of April 6, 2008 was $10.0 million, of which $2.4 million would impact our effective rate if realized. There has not been a material change in the amount of unrecognized benefits in the first quarter of 2008. Due to our emergence from bankruptcy, there could be material changes in our unrecognized state tax liabilities during the next 12 months. However, due to the uncertainties involved, we cannot estimate the range of these potential changes.
We recognize accrued interest and penalties related to unrecognized tax benefits in income tax expense in our Condensed Consolidated Statements of Operations, which is consistent with the recognition of these items in prior reporting periods. As of April 6, 2008, we had recorded a liability of approximately $0.3 million for the payment of interest and penalties.
All statutes of limitations related to federal income tax returns of Movie Gallery, Inc. are closed through 2001. The statutes of limitations 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.
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5. Other Intangible Assets
The components of other intangible assets are as follows (in thousands):
January 6, 2008 | April 6, 2008 | |||||||||||||||
Weighted- | Gross Carrying Amount | Accumulated Amortization | Gross Carrying Amount | Accumulated Amortization | ||||||||||||
Other intangible assets: | ||||||||||||||||
Non-compete agreements | 2 years | $ | 12,376 | $ | (11,600 | ) | $ | 12,376 | $ | (11,729 | ) | |||||
Trademarks: | ||||||||||||||||
Hollywood Video | 9 years | 15,000 | (375 | ) | 15,000 | (750 | ) | |||||||||
Game Crazy | 12 years | 4,000 | (711 | ) | 4,000 | (778 | ) | |||||||||
Customer lists | 2 years | 2,844 | (660 | ) | 2,844 | (894 | ) | |||||||||
9 years | $ | 34,220 | $ | (13,346 | ) | $ | 34,220 | $ | (14,151 | ) | ||||||
The weighted-average remaining amortization period of the intangible assets yet to be fully amortized as of April 6, 2008 is nine years. The changes in the carrying amounts of goodwill, indefinite-lived intangibles, and definite-lived intangibles for the fiscal year ended January 6, 2008 and the thirteen week period ended April 6, 2008 are as follows (in thousands):
Goodwill | Indefinite-Lived Intangibles | Definite-Lived Intangibles | ||||||||||
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 | ) | 15,033 | ||||||||
Amortization expense | — | (2,649 | ) | |||||||||
Net balance as of January 6, 2008 | $ | — | $ | — | $ | 20,874 | ||||||
Additions and adjustments | — | — | — | |||||||||
Amortization expense | — | — | (805 | ) | ||||||||
Net balance as of April 6, 2008 | $ | — | $ | — | $ | 20,069 | ||||||
6. Reorganized Debtors’ Condensed Combined Financial Statements
Basis of Presentation
As required by SOP 90-7, the Reorganized Debtors’ Condensed Combined Financial Statements exclude the financial statements of the Non-Debtor parties. Intercompany receivables and payables between the Reorganized Debtors are eliminated in consolidation. However, the Reorganized Debtors’ Condensed Combined Balance Sheet includes intercompany receivables from related Non-Debtor parties.
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Condensed combined financial statements of the Reorganized Debtors are set forth below.
Condensed Combined Balance Sheets
Reorganized Debtors | ||||||||
January 6, 2008 | April 6, 2008 | |||||||
(in thousands) | ||||||||
Assets: | ||||||||
Current assets | $ | 257,066 | $ | 288,825 | ||||
Rental inventory, net | 225,627 | 204,820 | ||||||
Property, furnishing and equipment, net | 101,641 | 92,112 | ||||||
Intercompany receivable, net | 9,805 | 11,742 | ||||||
Other assets | 63,329 | 63,895 | ||||||
Total assets | $ | 657,468 | $ | 661,394 | ||||
Liabilities not subject to compromise | ||||||||
Current liabilities | $ | 151,080 | $ | 160,006 | ||||
Current maturities of long-term obligations | 883,366 | 887,225 | ||||||
Other liabilities | 18,926 | 14,779 | ||||||
Liabilities not subject to compromise | 1,053,372 | 1,062,010 | ||||||
Liabilities subject to compromise | 460,116 | 494,059 | ||||||
Total liabilities | 1,513,488 | 1,556,069 | ||||||
Stockholders’ deficit | (856,020 | ) | (894,675 | ) | ||||
Total liabilities and stockholders’ deficit | $ | 657,468 | $ | 661,394 | ||||
Condensed Combined Statement of Operations
For the Thirteen Weeks Ended | ||||
April 6, 2008 | ||||
Reorganized Debtors | ||||
(in thousands) | ||||
Total revenue | $ | 528,657 | ||
Total cost of revenue | 229,905 | |||
Operating expenses | 361,739 | |||
Operating loss | (62,987 | ) | ||
Interest expense | 26,930 | |||
Reorganization items, net | (50,159 | ) | ||
Income tax expense | 469 | |||
Loss from continuing operations | (40,227 | ) | ||
Net loss from discontinued operations, net of tax | 536 | |||
Net loss | $ | (40,763 | ) | |
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Condensed Combined Statement of Cash Flows
For the Thirteen Weeks Ended | ||||
April 6, 2008 | ||||
Reorganized Debtors | ||||
(in thousands) | ||||
Net cash provided by (used in): | ||||
Operating activities | $ | 33,600 | ||
Investing activities | (1,516 | ) | ||
Financing activities | (17,168 | ) | ||
Increase in cash and cash equivalents | 14,916 | |||
Cash and cash equivalents at beginning of period | 54,432 | |||
Cash and cash equivalents at end of period | $ | 69,348 | ||
Net cash paid for reorganization items included in operating activities | $ | 12,604 | ||
Net cash paid for reorganization items included in financing activities | $ | 338 | ||
Reorganization Items, net
Reorganization items, net in our Condensed Consolidated Statements of Operations, represents amounts incurred since the Commencement Date as a direct result of the Chapter 11 Cases and was comprised of the following:
For the Thirteen Weeks Ended | ||||
April 6, 2008 | ||||
Reorganized Debtors | ||||
(in thousands) | ||||
Lease rejections, net | $ | (66,705 | ) | |
Professional fees | 17,238 | |||
Restructuring cash gains | (692 | ) | ||
Reorganization items, net | $ | (50,159 | ) | |
Professional fees include financial and legal services directly associated with the reorganization process. Lease rejections, net represents the reduction of lease liabilities due to Bankruptcy Court rejections, partially offset by an accrual for claims for damages due to lease rejections, as limited by Section 502(b)(6) of the Bankruptcy Code. We received Bankruptcy Court approval to reject a total of 1,330 store leases during the Chapter 11 proceedings. From the Commencement Date through January 6, 2008, we rejected 668 store leases. For the thirteen week period ended April 6, 2008, we rejected an additional 435 store leases. The rejection of these additional 435 store leases resulted in the recognition of non-cash gains of $66.7 million for the thirteen week period ended April 6, 2008.
See Note 8. Store Closure, Merger and Restructuring reserves, below for further information on lease rejections.
7. Liabilities Subject to Compromise
Liabilities subject to compromise include unsecured and undersecured liabilities incurred by the Reorganized Debtors prior to the Commencement Date and exclude liabilities that are fully secured, liabilities of the Non-Debtor parties, and other payments such as taxes and payroll that are entitled to priority treatment under the Bankruptcy Code. Set forth below are the amounts of our known liabilities that are subject to compromise. These amounts represent our best estimates of known or potential pre-petition liabilities that may result in an allowed claim against us under the Plan and are recorded at the estimated or reserved amount of the claim, which may differ from the amount at which the claim ultimately will be allowed. Accordingly, such claims remain subject to future adjustments, including adjustments from negotiations, orders of the Bankruptcy Court, or other events.
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The components of liabilities subject to compromise consisted of the following at January 6, 2008 and April 6, 2008 (in thousands):
January 6, 2008 | April 6, 2008 | |||||
Accounts payable | $ | 38,026 | $ | 38,532 | ||
Accrued liabilities | 22,219 | 17,311 | ||||
Accrued utilities | 4,285 | 4,234 | ||||
Accrued interest | 16,410 | 16,410 | ||||
Long term obligations | 313,784 | 313,784 | ||||
Lease liability on closed stores | 65,392 | 103,788 | ||||
Total liabilities subject to compromise | $ | 460,116 | $ | 494,059 | ||
The increase in the lease liability on closed stores is a result of the accrual for the Company’s liability under Section 502(b)(6) of the Bankruptcy Code. See Note 8. Store Closure, Merger and Restructuring Reserves, below for further information on lease rejections.
Certain of these claims were resolved and satisfied on or before our emergence from bankruptcy protection on the Effective Date or are still pending resolution. See Note 1. Proceedings under Chapter 11 of the United States Bankruptcy Code, for further information on distributions made under the Plan.
See Note 14. Fresh-Start Reporting, below for further information on liabilities subject to compromise.
8. Store Closure, Merger and Restructuring Reserves
Store Closures
We continue to evaluate underperforming and unprofitable stores to conserve cash and reduce our overall cost structure as part of our restructuring strategies. During the thirteen week period ended April 6, 2008, we closed 404 underperforming stores, of which 370 were underperforming stores that we announced as part of our Phase 2 store closures on February 4, 2008. On April 2, 2008, we began our Phase 3 store closures affecting approximately 160 additional store locations, which were completed during the second quarter of fiscal 2008.
For the thirteen week period ended April 6, 2008, we recognized $105.2 million in expenses associated with our continued lease obligations on closed stores, offset by $105.6 million of corresponding non-cash gains associated with lease rejections approved by the Bankruptcy Court. We apply the “cease-use date approach” required by FASB Statement No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“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 week period ended April 6, 2008, as we received Bankruptcy Court approval to reject the leases associated with closed stores.
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The lease liability on closed stores is based upon the present value of expected payments over the remaining lease terms, net of estimated sublease income, if applicable, and is included in our liabilities subject to compromise balance.
Movie Gallery | Hollywood Video | Total | ||||||||||
Store Closure Reserve (in thousands): | ||||||||||||
Balance as of January 6, 2008 | $ | 128 | $ | 627 | $ | 755 | ||||||
Additions and Adjustments | 20,500 | 84,748 | 105,248 | |||||||||
Payments | (21 | ) | — | (21 | ) | |||||||
Adjustments due to lease rejections | (20,230 | ) | (85,301 | ) | (105,531 | ) | ||||||
Balance as of April 6, 2008 | $ | 377 | $ | 74 | $ | 451 | ||||||
During the pendency of the Chapter 11 Cases, we reviewed all of our executory contracts, including our real property leases on both open and closed stores, to determine which contracts would be rejected as allowed under the Bankruptcy Code. Since the Commencement Date and through the filing date of this Quarterly Report on Form 10-Q, we have received approval from the Court to reject leases related to approximately 1,330 stores. As of January 6, 2008, we had rejected 668 store leases. For the thirteen week period ended April 6, 2008, we rejected an additional 435 store leases. Approval of further lease rejections and/or closure of additional stores will result in revisions of the lease liability on closed stores and recognition of additional gains or losses subsequent to April 6, 2008.
Upon Bankruptcy Court approval of the rejection of a real property lease, the previously recorded liability is reversed as an adjustment due to lease rejections. The reduction of these liabilities due to lease rejections is partially offset by an accrual for claims for damages due to lease rejections, as limited by Section 502(b)(6) of the Bankruptcy Code, which is also included in our liabilities subject to compromise balance. The net effect of the lease rejection adjustment and the lease rejection claims accrual is included in the Statement of Operations as a component of Reorganization items, net. As of April 6, 2008, we had a $103.6 million liability for damage claims related to lease rejection claims.
Restructuring
During the first quarter of 2008, we established additional restructuring reserves in the Hollywood Video segment 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 are recognized in store operating expenses and general and administrative expenses.
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A summary of our restructuring reserve activity for the thirteen week period ended April 6, 2008 is as follows:
Movie Gallery | Hollywood Video | Total | |||||||||
Termination benefits (in thousands): | |||||||||||
Balance as of January 6, 2008 | $ | 531 | $ | 513 | $ | 1,044 | |||||
Additions and Adjustments | — | 52 | 52 | ||||||||
Payments | — | (23 | ) | (23 | ) | ||||||
Balance as of April 6, 2008 | $ | 531 | $ | 542 | $ | 1,073 | |||||
Estimated future additions and adjustment | — | — | — | ||||||||
Total termination benefits cost | $ | 3,173 | $ | 7,680 | $ | 10,853 |
9. Long Term Obligations
Long term debt consisted of the following (in thousands):
Instrument | January 6, 2008 | April 6, 2008 | ||||||
Movie Gallery Senior Notes | $ | 313,334 | $ | 313,334 | ||||
First lien term loan | 598,502 | 610,987 | ||||||
Second lien term loan | 183,653 | 190,189 | ||||||
DIP credit facility | 100,000 | 85,077 | ||||||
Hollywood senior subordinated notes | 450 | 450 | ||||||
Other | 1,211 | 971 | ||||||
Total | 1,197,150 | 1,201,009 | ||||||
Less current portion | (883,366 | ) | (887,225 | ) | ||||
Less liabilities subject to compromise | (313,784 | ) | (313,784 | ) | ||||
$ | — | $ | — | |||||
March 2007 Credit Facility (Amended and Restated on May 20, 2008)
On March 8, 2007, we entered into a $900 million senior secured credit facility (the “March 2007 Credit Facility”). The March 2007 Credit Facility refinanced a previous $829.9 million senior secured credit facility (the “April 2005 Credit Facility”), which we entered into in April 2005 in connection with the acquisition of Hollywood. We deferred $23.2 million in debt financing fees related to the March 2007 Credit Facility, which we have since been recognizing ratably over the term of the March 2007 Credit Facility.
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.
Prior to the commencement of the Chapter 11 Cases, the March 2007 Credit Facility consisted of:
• | a $100 million revolving credit facility, which we refer to as the revolver, which was subsequently refinanced under the DIP Credit Agreement, as discussed below; |
• | a $600 million first lien term loan; |
• | a $25 million first lien synthetic letter of credit facility; 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 first lien letter of credit facility as the first lien facilities.
We had $14.0 million in issued and undrawn letters of credit under our first lien synthetic letter of credit facility at April 6, 2008.
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 the outstanding balance of $611.0 million under the first lien facilities as a current liability at April 6, 2008.
The filing of the Chapter 11 Cases also created an event of default under our second lien term loan. 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 the outstanding balance of $190.2 million under the second lien term loan as a current liability at April 6, 2008.
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.
Interest Rate Cap
Our March 2007 Credit Facility required 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 following March 8, 2007.
On July 31, 2007, we entered into a 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 this cap agreement, we pay floating-rate interest up to a maximum of 6.5% and receive floating-rate interest based on three-month LIBOR through the scheduled termination date of March 8, 2010. This derivative instrument did not qualify as a hedging instrument under the requirements set forth in FASB Statement No. 133,Accounting for Derivative Instruments and Hedging Activities, as amended. Therefore, changes in the fair value of this derivative, as well as gains and losses on settlement, are recognized in Interest expense in the Condensed Consolidated Statement of Operations, and as a component of Net loss in the Condensed Consolidated Statement of Cash Flows.
11% Senior Notes due 2012
The filing of the Chapter 11 Cases also created an event of default under the 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. The 11% Senior Notes were treated as an unsecured liability of the Reorganized Debtors, and accordingly, we classified our $325 million 11% Senior Notes as a liability subject to compromise, in accordance with SOP 90-7, as of April 6, 2008.
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On the Effective Date, the 11% Senior Notes were canceled and the indentures governing such securities were terminated. Under the Plan, holders of 11% Senior Notes received 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 (“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. The Senior Subordinated Notes were treated as an unsecured liability of the Reorganized Debtors, and accordingly, we classified our $0.5 million in Senior Subordinated Notes as a liability subject to compromise, in accordance with SOP 90-7, as of April 6, 2008.
On the Effective Date, the 9.625% Senior Subordinated Notes were canceled and the indentures governing such securities were terminated. Under the Plan, holders of the Senior Subordinated Notes received equity in the Reorganized Debtors.
Chapter 11 Financing Arrangements
DIP Credit Agreement (As Amended)
In connection with the Chapter 11 Cases, we entered into a $150.0 million DIP Credit Agreement with certain of our subsidiaries (all of whom were Reorganized Debtors) as Guarantors and the lenders and agents from time to time party thereto.
The DIP Credit Agreement provided for (i) a $50 million revolving loan and letter of credit facility (“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 revolver under the March 2007 Credit Facility, pay certain transactional expenses and fees incurred by us and support our working capital needs, including general corporate purposes.
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 or (ii) at the Adjusted Eurodollar Rate (as defined in the DIP Credit Agreement) plus 3.50% per annum.
At April 6, 2008, we had $85.1 million outstanding under the DIP Credit Agreement.
On the Effective Date and pursuant to the Plan, the creditors under the DIP Credit Agreement were paid in full in cash and the DIP Credit Agreement was terminated.
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.
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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 $626.5 million (plus accrued and capitalized interest and fees), consisting of $603.0 million aggregate principal amount of term loans under the First Lien Term Loan Facility and $23.5 million aggregate principal amount of letters of credit. The First Lien Credit Facility amended and restated the first lien facilities under our March 2007 Credit Facility.
Borrowings under the First Lien Term Loan Facility bear interest at floating interest rates, plus applicable margins that are computed in accordance with the First Lien Term Loan Facility. The applicable margin generally increases over time and is also subject to increase to the extent we elect for payment-in-kind interest by adding the amount of such interest to the principal amount of the term loans.
The maturity date of the First Lien Term Loan Facility is the earliest of May 20, 2012 or 90 days following the date the aggregate principal amount of the term loans does not exceed $20.0 million.
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 Consolidated Adjusted EBITDA (as defined below) relative to cash interest expense; |
• | the leverage test is a measurement of total leverage, which includes indebtedness under the First Lien Credit Facility, including amounts drawn under letters of credit, and the Revolving Credit Facility described below, relative to Consolidated Adjusted EBITDA; and |
• | the secured leverage test is a measurement of secured leverage, which includes indebtedness under the First Lien Credit Facility, the Second Lien Credit Facility described below, the Revolving Credit Facility, amounts drawn under letters of credit, and any other secured indebtedness relative to Consolidated Adjusted EBITDA. |
For purposes of the First Lien Credit Facility, Consolidated Adjusted EBITDA means our consolidated net income plus interest expense, income tax expense, depreciation expense and amortization expense after giving effect to certain other adjustments described more specifically in the First Lien Credit Facility.
Additionally, the First Lien Term Loan Facility 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 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 those of the other guarantors.
On October 6 and 7, 2008, we entered into conversion agreements with certain holders of term loans under our First Lien Credit Facility, pursuant to which such holders assigned approximately $159.0 million aggregate principal amount of term loans (including accrued and unpaid interest thereon) to us. As a result of the assignment, the assigned term loans converted into approximately 15.9 million shares of our New Common Stock at a price of $10 per share. In connection with the conversion, our Audit Committee, with the assistance of a third-party advisory firm, evaluated the fairness of the conversion price from a financial point of view.
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Between December 26, 2008 and January 7, 2009, we have repurchased, or are under contract to repurchase, approximately $45.4 million in outstanding principal amount of term loans under our First Lien Credit Facility from an unaffiliated third party. After retirement of these term loans repurchased by us, the principal amount of term loans outstanding under the First Lien Credit Facility is approximately $402.5 million.
Amended and Restated Second Lien Credit Facility
The Second Lien Credit Facility is a senior secured credit facility that provides for term loans in an aggregate principal amount not to exceed $117.1 million. 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 Credit Facility bear interest at floating interest rates plus applicable margins that are computed in accordance with the Second Lien Credit Facility. The applicable margin generally increases over time and is also subject to increase to the extent we elect to pay interest by adding the amount of such interest to the principal amount of the term loans (payment-in-kind interest).
The maturity date of the Second Lien Credit Facility is the earlier of November 20, 2012 or the date that the term loans under the First Lien Credit Facility become due and payable in full, whether by acceleration or otherwise.
The Second Lien Credit 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 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 those of the other guarantors.
Revolving Credit Facility
The Revolving Credit Facility with various lenders (including affiliates of Sopris) and agents is a senior secured credit facility due May 20, 2011, which provides for revolving loans up to an aggregate principal amount of $100.0 million.
Loans under the Revolving Credit Facility bear interest at floating interest rates plus applicable margins that are computed in accordance with the Revolving Credit Facility. In addition, we must pay annual commitment fees equal to the average of the daily difference between the revolving commitments and the aggregate principal amount of all outstanding revolving loans, multiplied by 0.375%.
Amounts borrowed under the Revolving Credit Facility may be repaid and reborrowed, with the final payment due and payable at the earlier of May 20, 2011 or the date that we terminate the revolving commitments. 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 the Borrowing Base or the aggregate commitments under the Revolving Credit Facility, we will be required to make prepayments in the amount of such excess. The amount of the Borrowing Base is calculated using
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a definition contained in the Revolving Credit Facility by reference to the amount of eligible accounts receivable and the liquidation value of our inventory, in each case after certain adjustments described in the Revolving Credit Facility, including the establishment of certain reserves.
The obligations under the Revolving Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and 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 those of the other guarantors. The Revolving Credit Facility constitutes a “first-out” revolving facility, under which the distribution of the proceeds of the collateral will be applied to the repayment of the Revolving Credit Facility prior to the repayment of the borrowings under the First Lien Credit Facility and the Second Lien Credit Facility.
The Revolving Credit Facility contains customary operational covenants for revolving facilities of this type, including covenants that will limit the ability of us, 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 sale 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 Term Loan Facility.
Seasonal Overadvance Facility
The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to support up to $25.0 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 with 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.
As of January 4, 2009, there are $24.0 million in letters of credit outstanding under the Seasonal Overadvance Facility, of which none have been drawn upon. In consideration for supporting these letters of credit, we have issued warrants to purchase 82,800 shares of New Common Stock at a purchase price of $10.00 per share to Sopris.
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Classification of Debt
At April 6, 2008, all of our pre-petition debt was in default, and a portion of it was subject to compromise. The following table classifies our pre-petition debt in terms of whether it was subject to compromise:
April 6, 2008 | |||
(in millions) | |||
Short-term debt and long-term debt not subject to compromise: | |||
First lien credit facility | $ | 611.0 | |
Second lien credit facility | 190.2 | ||
DIP term loan | 85.1 | ||
Other | 1.0 | ||
Total debt not subject to compromise | 887.2 | ||
Long-term debt subject to compromise: | |||
11% Senior Notes due 2012 (net of deferred financing fees and discount) | 313.3 | ||
Hollywood 9.625% Senior Subordinated Notes due 2011 | 0.5 | ||
Total long-term debt subject to compromise | 313.8 | ||
Total outstanding debt | $ | 1,201.0 | |
Pursuant to the requirements of SOP 90-7, as of the filing of the Chapter 11 Cases, deferred financing fees of $8.8 million related to pre-petition debt determined to be subject to compromise are no longer being amortized and have been included as an adjustment to the net carrying value of the related pre-petition debt at April 6, 2008. The carrying value of the pre-petition debt will be adjusted in future reporting periods as of the point that it becomes an allowed claim under the Plan to the extent the carrying value differs from the amount of the allowed claim.
10. Comprehensive Loss
Comprehensive loss is as follows (in thousands):
For the Thirteen Weeks Ended | ||||||||
April 1, 2007 | April 6, 2008 | |||||||
Net loss | (14,866 | ) | (38,927 | ) | ||||
Change in foreign currency cumulative translation adjustment, net of taxes | 252 | (133 | ) | |||||
Change in value of interest rate swap, net of taxes | (913 | ) | — | |||||
Comprehensive loss | $ | (15,527 | ) | $ | (39,060 | ) | ||
11. Commitments and Contingencies
Litigation
We have been named to various claims, disputes, legal actions and other proceedings involving contracts, employment, our bankruptcy filing and various other matters. If such claims, disputes, actions or other proceedings were subject to the release, discharge or exculpation provisions in the Plan, they are subject to a permanent injunction against the collection of such debts as set forth in the Plan and the Confirmation Order. For those claims that are not subject to the injunction, a negative outcome in certain of the ongoing matters 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’s attention or result in increased costs of doing business.
At April 6, 2008, the legal contingencies reserve was $2.1 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 April 6, 2008, Movie Gallery represented 2,047 video stores serving mainly rural markets in the United States and Canada; Hollywood Video represented 1,425 video stores serving predominantly urban markets. Beginning in fiscal 2007, we established dedicated retail space within certain of our Hollywood Video and Movie Gallery stores to operate as scaled-down versions of our standard Game Crazy departments. For purposes of financial reporting, the games hardware and software transactions realized from these dedicated spaces are included within either the Hollywood Video segment or the Movie Gallery segment depending upon their location because, among other reasons, they share a common point of sale system and common management with the host store. Game Crazy represented 572 in-store departments and 13 free-standing stores serving the game market in urban locations. 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 tax expense. Information on our reportable operating segments is as follows (in thousands):
Thirteen weeks ended April 1, 2007 | |||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | ||||||||||||
Rental revenue | $ | 210,156 | $ | 300,834 | $ | — | $ | 510,990 | |||||||
Product sales | 18,717 | 27,824 | 90,109 | 136,650 | |||||||||||
Depreciation and amortization | 7,994 | 11,814 | 2,034 | 21,842 | |||||||||||
Operating income | 23,151 | 11,130 | 1,733 | 36,014 | |||||||||||
Loss from discontinued operations, net of tax | (2,395 | ) | — | — | (2,395 | ) | |||||||||
Capital expenditures | (78 | ) | 1,177 | — | 1,099 | ||||||||||
As of April 1, 2007 | |||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | ||||||||||||
Goodwill, net | 147 | 115,422 | — | 115,569 | |||||||||||
Total assets | 341,220 | 686,555 | 108,284 | 1,136,059 | |||||||||||
Thirteen weeks ended April 6, 2008 | |||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | ||||||||||||
Rental revenue | $ | 185,018 | $ | 229,621 | $ | 3 | $ | 414,642 | |||||||
Product sales | 20,795 | 26,594 | 93,708 | 141,097 | |||||||||||
Depreciation and amortization | 4,411 | 6,698 | 971 | 12,081 | |||||||||||
Operating income (loss) | 5,825 | (71,533 | ) | 4,499 | (61,209 | ) | |||||||||
Loss from discontinued operations, net of tax | (536 | ) | — | — | (536 | ) | |||||||||
Capital expenditures | 247 | 1,040 | 327 | 1,614 | |||||||||||
As of April 6, 2008 | |||||||||||||||
Movie Gallery | Hollywood Video | Game Crazy | Total | ||||||||||||
Assets held for sale | 2,085 | — | — | 2,085 | |||||||||||
Total assets | 307,311 | 258,694 | 102,740 | 668,745 |
All intercompany transactions are accounted for at historical cost basis.
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13. Discontinued Operations, net
On March 5, 2007, we acquired substantially all of the assets, technology, network operations, and customers of MovieBeam, an on-demand movie service, for cash consideration of $3.1 million. However, we were unable to achieve our previously anticipated revenue and customer acquisition levels for MovieBeam and 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. In the fourth quarter of fiscal 2007, we ceased operations associated with MovieBeam. 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. We have adjusted our financial statements and related notes for the thirteen week period ended April 1, 2007 to classify the $2.4 million net operating loss of this entity as a loss from discontinued operations. There is no tax benefit associated with this loss due to the valuation allowance on our deferred tax benefits (see Note 4. Income Taxes).
14. Fresh-Start Reporting
In accordance with SOP 90-7, fresh-start reporting was required upon emergence from Chapter 11 because holders of existing voting shares immediately before confirmation of the Plan received less than 50% of the emerging entity and the reorganization value of our assets was less than its post-petition liabilities and allowed claims.
All conditions required for the adoption of fresh-start reporting were met on May 20, 2008, the Effective Date. However, in light of the proximity of the Effective Date to our accounting period close immediately preceding May 20, 2008, which was May 11, 2008, we elected to adopt a convenience date of May 11, 2008 for recording adjustments needed to account for fresh-start reporting and the Plan of Reorganization, including the cancellation of the old common stock of the Predecessor and the issuance of the New Common Stock of the Successor. These entries were reported for accounting purposes as if they occurred on May 11, 2008. We evaluated the activity between May 11, 2008 and May 20, 2008 and, based upon the immateriality of such activity, concluded that the use of an accounting convenience date of May 11, 2008 was appropriate for financial reporting purposes. The use of the May 11, 2008 convenience date is for financial reporting purposes only and does not affect the legality of or the effective date of the Plan.
Fresh-start reporting requires resetting the historical net book value of assets and liabilities to fair value by allocating the entity’s reorganization value to its assets and liabilities pursuant to FASB Statement No. 141,Business Combinations(“FASB Statement No. 141”). Under fresh-start reporting, a new reporting entity is deemed created, and all assets and liabilities are revalued to their fair values. Accordingly, our financial statements prior to May 11, 2008 are not comparable to our financial statements for periods on or after May 11, 2008. References to “Successor” refer to Movie Gallery on or after May 11, 2008, after application of fresh-start reporting. References to “Predecessor” refer to Movie Gallery prior to May 11, 2008. “Successor Periods” refer to accounting periods of the Successor from May 12, 2008 and later and “Predecessor Periods” refer to accounting periods of the Predecessor that ended May 11, 2008 and earlier.
As part of our fresh-start reporting we applied various valuation methods to calculate the reorganization value of the Successor. These methods included (i) a comparison of the Company and our projected performance to the market values of comparable companies; (ii) review and
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analysis of several recent transactions of companies determined to be similar to the Company; (iii) a calculation of the present value of the future cash flows based on our projections; and (iv) a calculation of the fair value of our total debt, our New Common Stock, and our New Warrants issued as part of the Plan. Based upon an evaluation of relevant factors used in determining the range of reorganization values and updated expected cash flow projections, we concluded that $1.0 billion should be used for fresh-start reporting purposes as it most closely approximated the fair value of the Company. This value was determined using projections and assumptions, which are inherently subject to significant uncertainties and the resolution of contingencies which are beyond the control of the Company. Accordingly, there can be no assurance that the estimates, assumptions and amounts reflected in the valuation will be realized.
Fresh-start reporting required us to allocate our reorganization value to our assets and liabilities in accordance with FASB Statement No. 141. Assets were revalued to fair value, generally as determined by independent appraisals and valuations. Liabilities were revalued at present values using appropriate current interest rates. Deferred taxes were recorded to recognize differences between book and tax basis of assets and liabilities. In addition to revaluing existing assets and liabilities, we recorded certain previously unrecognized assets and liabilities, including favorable and unfavorable leases and other intangibles. The reorganization value exceeded the sum of the amounts assigned to assets and liabilities by approximately $439.4 million. Per FASB Statement No. 141, the excess amount of the reorganization value over the amounts allocated to assets and liabilities should be allocated to goodwill. Accordingly, $439.4 million was recorded as goodwill as of May 11, 2008.
Adjustments to reflect the revaluation of assets and liabilities resulted in a net gain of $336.4 million. The restructuring of our capital structure and resulting discharge of pre-petition debt resulted in a gain of $251.2 million. Both of these gains were recorded as Plan of Reorganization adjustments in the Predecessor’s condensed consolidated balance sheet.
Estimates of fair value represent our best estimates, which are based on industry data and trends and by reference to relevant market rates and transactions, and discounted cash flow valuation methods, among other factors. The foregoing estimates and assumptions are inherently subject to significant uncertainties and contingencies beyond our reasonable control. Accordingly, there can be no assurance that the estimates, assumptions, and amounts reflected in the valuations will be realized, and actual results could vary materially. In accordance with FASB Statement No. 141, the allocation of the reorganization value to individual assets and liabilities is subject to adjustment as additional or improved information becomes available, which may result in revisions to the fresh-start valuation adjustments presented below.
The following table presents the effects of transactions outlined in the Plan and adoption of fresh-start reporting on our Condensed Consolidated Balance Sheet as of May 11, 2008. The table reflects settlement of various liabilities, cancellation of existing stock and issuance of new stock, and other transactions as well as the fresh-start adjustments, such as revaluation of assets and liabilities to fair value and the recording of certain intangible assets.
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Balance Sheet | |||||||||||||||
May 11, 2008 | Plan of Reorganization Adjustments | Fresh-start Valuation Adjustments | May 11, 2008 | ||||||||||||
Assets | |||||||||||||||
Current assets: | |||||||||||||||
Cash and cash equivalents | $ | 62,830 | $ | 14,528 | a | $ | — | $ | 77,358 | ||||||
Merchandise inventory | 168,684 | — | (11,742 | )b | 156,942 | ||||||||||
Prepaid expenses | 34,002 | (646 | )c | — | 33,356 | ||||||||||
Store supplies and other | 27,125 | (12,484 | )d | (6,562 | )b | 8,079 | |||||||||
Assets held for sale | — | — | 1,890 | b | 1,890 | ||||||||||
Total current assets | 292,641 | 1,398 | (16,414 | ) | 277,625 | ||||||||||
Rental inventory, net | 212,640 | — | (2,040 | )b | 210,600 | ||||||||||
Property, furnishings and equipment, net | 93,971 | — | 27,833 | b | 121,804 | ||||||||||
Goodwill, net | — | — | 439,357 | b | 439,357 | ||||||||||
Other intangible assets | 19,804 | — | 94,096 | b | 113,900 | ||||||||||
Deferred income tax asset, net | 1,153 | — | — | 1,153 | |||||||||||
Deposits and other assets | 24,340 | 8,630 | e | 23,859 | b | 56,829 | |||||||||
Total assets | $ | 644,549 | $ | 10,028 | $ | 566,691 | $ | 1,221,268 | |||||||
Liabilities and stockholders’ equity (deficit) | |||||||||||||||
Current liabilities: | |||||||||||||||
Current maturities of long-term obligations | $ | 883,226 | $ | (876,305 | )f | $ | — | $ | 6,921 | ||||||
Accounts payable | 51,770 | — | — | 51,770 | |||||||||||
Accrued liabilities | 61,836 | 13,241 | g | — | 75,077 | ||||||||||
Accrued payroll | 24,616 | — | — | 24,616 | |||||||||||
Accrued interest | 13,415 | (13,415 | )f | — | — | ||||||||||
Deferred revenue | 38,374 | — | (1,245 | )b | 37,129 | ||||||||||
Total current liabilities | 1,073,237 | (876,479 | ) | (1,245 | ) | 195,513 | |||||||||
Long-term obligations, less current portion | — | 779,100 | f | — | 779,100 | ||||||||||
Other accrued liabilities | 19,406 | (1,385 | )h | (2,697 | )b | 15,324 | |||||||||
Total liabilities not subject to compromise | 1,092,643 | (98,764 | ) | (3,942 | ) | 989,937 | |||||||||
Total liabilities subject to compromise | 482,555 | (482,555 | )g | — | — | ||||||||||
Total liabilities | 1,575,198 | (581,319 | ) | (3,942 | ) | 989,937 | |||||||||
Commitments and contingencies | |||||||||||||||
Stockholders’ equity (deficit): | |||||||||||||||
Common stock | 32 | (11 | )i | — | 21 | ||||||||||
Additional paid-in capital | 200,624 | 30,686 | i | — | 231,310 | ||||||||||
Accumulated deficit | (1,141,028 | ) | 570,508 | i | 570,520 | j | — | ||||||||
Accumulated other comprehensive income | 9,723 | (9,836 | )j | 113 | j | — | |||||||||
Total stockholders’ equity (deficit) | (930,649 | ) | 591,347 | 570,633 | 231,331 | ||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 644,549 | $ | 10,028 | $ | 566,691 | $ | 1,221,268 | |||||||
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a. | Primarily reflects the proceeds received from the New Common Stock Rights Offering, offset by the repayment of borrowings under the DIP Credit Agreement and related accrued interest and expenditures for professional services related to the consummation of the Plan and the Amended and Restated March 2007 Credit Facility. |
b. | Reflects revaluation of assets and liabilities to fair values, including recognition of certain intangible assets, leases and the resulting amount of goodwill. |
c. | Reflects write-off of prepaid expenses associated with March 2007 Credit Facility. |
d. | Reflects collection of receivable associated with outstanding letters of credit under the March 2007 Credit Facility. |
e. | Reflects capitalization of debt issuance costs associated the Amended and Restated March 2007 Credit Facility, net of the write-off of unamortized debt issuance costs of the March 2007 Credit Facility and DIP Credit Agreement. |
f. | Reflects borrowings under the Amended and Restated March 2007 Credit Facility and related interest accruals. |
g. | Reflects the discharge of most of the Predecessor’s liabilities subject to compromise in accordance with the Plan, accrual for maximum aggregate payment to unsecured creditors under the Plan and the accrual of debt issuance costs associated with the Amended and Restated March 2007 Credit Facility. |
h. | Reflects the write-down of liabilities for uncertain tax positions. |
i. | Reflects the issuance of the Successor’s New Common Stock and New Warrants, the cancellation of the Predecessor’s common stock, the gain on the discharge of liabilities subject to compromise, the gain on the discharge of the Predecessors pre-petition debt, and professional fees associated with the consummation of the Plan, the Amended and Restated March 2007 Credit Facility and the issuance of the New Warrants. |
j. | Reflects the elimination of the Predecessor’s historical accumulated deficit and other equity accounts. |
15. Consolidating Financial Statements
The following tables present condensed consolidating financial information for: (a) Movie Gallery, Inc. (the “Parent”) on a stand-alone basis; (b) on a combined basis, the guarantors of our 11% Senior Notes, (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. 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’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.
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Consolidating Statement of Operations
Thirteen week period ended April 1, 2007
(unaudited, in thousands)
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Revenue: | |||||||||||||||||||
Rental | $ | — | $ | 490,217 | $ | 20,773 | $ | — | $ | 510,990 | |||||||||
Product sales | — | 134,370 | 2,280 | — | 136,650 | ||||||||||||||
Total revenue | — | 624,587 | 23,053 | — | 647,640 | ||||||||||||||
Cost of sales: | |||||||||||||||||||
Cost of rental revenue | — | 148,782 | 6,043 | — | 154,825 | ||||||||||||||
Cost of product sales | — | 101,607 | 1,781 | — | 103,388 | ||||||||||||||
Gross profit | — | 374,198 | 15,229 | — | 389,427 | ||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Store operating expenses | — | 295,175 | 12,809 | — | 307,984 | ||||||||||||||
General and administrative | 2,854 | 40,499 | 1,359 | — | 44,712 | ||||||||||||||
Amortization of intangibles | — | 661 | 34 | — | 695 | ||||||||||||||
Other expenses | — | — | 22 | — | 22 | ||||||||||||||
Operating income (loss) | (2,854 | ) | 37,863 | 1,005 | — | 36,014 | |||||||||||||
Interest expense, net | 37,628 | 10,152 | 20 | — | 47,800 | ||||||||||||||
Equity in earnings (losses) of subsidiaries | 26,085 | 461 | — | (26,546 | ) | — | |||||||||||||
Income (loss) before reorganization items and income tax expense (benefit) | (14,397 | ) | 28,172 | 985 | (26,546 | ) | (11,786 | ) | |||||||||||
Reorganization items, net | — | — | — | — | — | ||||||||||||||
Income (loss) before income tax expense (benefit) | (14,397 | ) | 28,172 | 985 | (26,546 | ) | (11,786 | ) | |||||||||||
Income tax expense (benefit) | 469 | (308 | ) | 524 | — | 685 | |||||||||||||
Net income (loss) from continuing operations | (14,866 | ) | 28,480 | 461 | (26,546 | ) | (12,471 | ) | |||||||||||
Loss from discontinued operations, net of tax | — | 2,395 | — | — | 2,395 | ||||||||||||||
Net income (loss) | $ | (14,866 | ) | $ | 26,085 | $ | 461 | $ | (26,546 | ) | $ | (14,866 | ) | ||||||
35
Consolidating Statement of Operations
Thirteen week period ended April 6, 2008
(unaudited, in thousands)
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Revenue: | |||||||||||||||||||
Rental | $ | — | $ | 391,518 | $ | 23,124 | $ | — | $ | 414,642 | |||||||||
Product sales | — | 137,140 | 3,957 | — | 141,097 | ||||||||||||||
Total revenue | — | 528,658 | 27,081 | — | 555,739 | ||||||||||||||
Cost of sales: | |||||||||||||||||||
Cost of rental revenue | — | 126,241 | 6,972 | — | 133,213 | ||||||||||||||
Cost of product sales | — | 103,664 | 3,129 | — | 106,793 | ||||||||||||||
Gross profit | — | 298,753 | 16,980 | — | 315,733 | ||||||||||||||
Operating costs and expenses: | |||||||||||||||||||
Store operating expenses | — | 323,412 | 12,651 | — | 336,063 | ||||||||||||||
General and administrative | 1,500 | 36,800 | 1,685 | — | 39,985 | ||||||||||||||
Amortization of intangibles | — | 771 | 34 | — | 805 | ||||||||||||||
Other expenses | — | (744 | ) | 833 | — | 89 | |||||||||||||
Operating income (loss) | (1,500 | ) | (61,486 | ) | 1,777 | — | (61,209 | ) | |||||||||||
Interest expense, net | 16,166 | 10,762 | (56 | ) | — | 26,872 | |||||||||||||
Equity in earnings (losses) of subsidiaries | (3,872 | ) | 1,833 | — | 2,039 | — | |||||||||||||
Income (loss) before reorganization items and income tax expense (benefit) | (21,538 | ) | (70,415 | ) | 1,833 | 2,039 | (88,081 | ) | |||||||||||
Reorganization items, net | 17,239 | (67,398 | ) | — | — | (50,159 | ) | ||||||||||||
Income (loss) before income tax expense (benefit) | (38,777 | ) | (3,017 | ) | 1,833 | 2,039 | (37,922 | ) | |||||||||||
Income tax expense | 150 | 319 | — | — | 469 | ||||||||||||||
Net income (loss) from continuing operations | (38,927 | ) | (3,336 | ) | 1,833 | 2,039 | (38,391 | ) | |||||||||||
Loss from discontinued operations, net of tax | — | 536 | — | — | 536 | ||||||||||||||
Net income (loss) | $ | (38,927 | ) | $ | (3,872 | ) | $ | 1,833 | $ | 2,039 | $ | (38,927 | ) | ||||||
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Condensed Consolidating Balance Sheet
January 6, 2008
(audited, in thousands)
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Assets | ||||||||||||||||||||
Current Assets: | ||||||||||||||||||||
Cash and cash equivalents | $ | — | $ | 54,432 | $ | 6,880 | $ | — | $ | 61,312 | ||||||||||
Merchandise inventory, net | — | 144,456 | 5,452 | — | 149,908 | |||||||||||||||
Prepaid expenses | — | 40,440 | 1,833 | — | 42,273 | |||||||||||||||
Store supplies and other | — | 15,654 | 704 | — | 16,358 | |||||||||||||||
Assets held for sale | — | 2,085 | — | — | 2,085 | |||||||||||||||
Total current assets | — | 257,067 | 14,869 | — | 271,936 | |||||||||||||||
Rental inventory, net | — | 225,626 | 11,807 | — | 237,433 | |||||||||||||||
Property, furnishings, and equipment, net | — | 101,641 | 5,112 | — | 106,753 | |||||||||||||||
Goodwill | — | — | — | — | — | |||||||||||||||
Other intangibles, net | — | 20,720 | 154 | — | 20,874 | |||||||||||||||
Deferred tax assets, net | 41 | 1,112 | — | 1,153 | ||||||||||||||||
Deposits and other assets | 20,474 | 4,386 | 316 | — | 25,176 | |||||||||||||||
Investments in subsidiaries | 399,285 | 16,597 | — | (415,882 | ) | — | ||||||||||||||
Total assets | $ | 419,800 | $ | 627,149 | $ | 32,258 | $ | (415,882 | ) | $ | 663,325 | |||||||||
Liabilities and stockholders’ equity (deficit) | ||||||||||||||||||||
Current liabilities: | ||||||||||||||||||||
Current maturities of long-term obligations | $ | 883,366 | $ | — | $ | — | $ | — | $ | 883,366 | ||||||||||
Accounts payable | — | 25,135 | (398 | ) | — | 24,737 | ||||||||||||||
Accrued liabilities | 4,354 | 49,847 | 1,904 | — | 56,105 | |||||||||||||||
Accrued payroll | — | 20,841 | 1,272 | — | 22,113 | |||||||||||||||
Accrued interest | 9,326 | 1 | — | — | 9,327 | |||||||||||||||
Deferred revenue | — | 41,586 | 1,140 | — | 42,726 | |||||||||||||||
Total current liabilities | 897,046 | 137,410 | 3,918 | — | 1,038,374 | |||||||||||||||
Other accrued liabilities | 1,806 | 17,120 | 1,930 | — | 20,856 | |||||||||||||||
Intercompany promissory note (receivable) | (384,200 | ) | 384,200 | — | — | — | ||||||||||||||
Payable to (receivable from) affiliate | 431,451 | (441,264 | ) | 9,813 | — | — | ||||||||||||||
Total liabilities not subject to compromise | 946,103 | 97,466 | 15,661 | — | 1,059,230 | |||||||||||||||
Liabilities subject to compromise | 329,718 | 130,398 | — | — | 460,116 | |||||||||||||||
Total liabilities | 1,275,821 | 227,864 | 15,661 | — | 1,519,346 | |||||||||||||||
Stockholders’ equity (deficit) | (856,021 | ) | 399,285 | 16,597 | (415,882 | ) | (856,021 | ) | ||||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 419,800 | $ | 627,149 | $ | 32,258 | $ | (415,882 | ) | $ | 663,325 | |||||||||
37
Condensed Consolidating Balance Sheet
April 6, 2008
(unaudited, in thousands)
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | |||||||||||||||
Assets | |||||||||||||||||||
Current Assets: | |||||||||||||||||||
Cash and cash equivalents | $ | — | $ | 69,350 | $ | 12,820 | $ | — | $ | 82,170 | |||||||||
Merchandise inventory, net | — | 155,452 | 5,720 | — | 161,172 | ||||||||||||||
Prepaid expenses | 54 | 35,542 | 1,618 | — | 37,214 | ||||||||||||||
Store supplies and other | — | 26,345 | 609 | — | 26,954 | ||||||||||||||
Assets held for sale | — | 2,085 | — | — | 2,085 | ||||||||||||||
Total current assets | 54 | 288,774 | 20,767 | — | 309,595 | ||||||||||||||
Rental inventory, net | — | 204,820 | 11,469 | — | 216,289 | ||||||||||||||
Property, furnishings, and equipment, net | — | 92,111 | 4,713 | — | 96,824 | ||||||||||||||
Other intangibles, net | — | 19,947 | 122 | — | 20,069 | ||||||||||||||
Deferred tax assets, net | 41 | 1,112 | 1,153 | ||||||||||||||||
Deposits and other assets | 18,781 | 5,716 | 318 | — | 24,815 | ||||||||||||||
Investments in subsidiaries | 395,277 | 18,294 | — | (413,571 | ) | — | |||||||||||||
Total assets | $ | 414,153 | $ | 630,774 | $ | 37,389 | $ | (413,571 | ) | $ | 668,745 | ||||||||
Liabilities and stockholders’ equity (deficit) | |||||||||||||||||||
Current liabilities: | |||||||||||||||||||
Current maturities of long-term obligations | $ | 887,225 | $ | — | $ | — | $ | — | $ | 887,225 | |||||||||
Accounts payable | — | 38,638 | 1,124 | — | 39,762 | ||||||||||||||
Accrued liabilities | 9,492 | 44,621 | 1,595 | — | 55,708 | ||||||||||||||
Accrued payroll | 815 | 20,564 | 1,637 | — | 23,016 | ||||||||||||||
Accrued interest | 7,479 | — | — | 7,479 | |||||||||||||||
Deferred revenue | — | 38,396 | 1,177 | — | 39,573 | ||||||||||||||
Total current liabilities | 905,011 | 142,219 | 5,533 | — | 1,052,763 | ||||||||||||||
Other accrued liabilities | 1,806 | 12,973 | 1,817 | — | 16,596 | ||||||||||||||
Intercompany promissory note (receivable) | (384,200 | ) | 384,200 | — | — | — | |||||||||||||
Payable to (receivable from) affiliate | 456,490 | (468,231 | ) | 11,741 | — | — | |||||||||||||
Total liabilities not subject to compromise | 979,107 | 71,161 | 19,091 | — | 1,069,359 | ||||||||||||||
Liabilities subject to compromise | 329,720 | 164,339 | — | — | 494,059 | ||||||||||||||
Total liabilities | 1,308,827 | 235,500 | 19,091 | — | 1,563,418 | ||||||||||||||
Stockholders’ equity (deficit) | (894,674 | ) | 395,277 | 18,295 | (413,571 | ) | (894,673 | ) | |||||||||||
Total liabilities and stockholders’ equity (deficit) | $ | 414,153 | $ | 630,777 | $ | 37,386 | $ | (413,571 | ) | $ | 668,745 | ||||||||
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Condensed Consolidating Statement of Cash Flow
Thirteen week period ended April 1, 2007
(unaudited, in thousands)
Parent Guarantor | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Operating Activities: | ||||||||||||||||||||
Net income (loss) | $ | (14,866 | ) | $ | 26,085 | $ | 461 | $ | (26,546 | ) | $ | (14,866 | ) | |||||||
Equity in earnings (losses) of subsidiaries | (26,085 | ) | (461 | ) | — | 26,546 | — | |||||||||||||
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities: | ||||||||||||||||||||
Rental inventory amortization | — | 91,490 | 4,461 | — | 95,951 | |||||||||||||||
Purchases of rental inventory, net | — | (85,706 | ) | (3,896 | ) | — | (89,602 | ) | ||||||||||||
Purchases of rental inventory - base stock | — | (184 | ) | — | — | (184 | ) | |||||||||||||
Depreciation and intangibles amortization | — | 20,796 | 1,046 | — | 21,842 | |||||||||||||||
Stock-based compensation | 511 | 198 | — | — | 709 | |||||||||||||||
Amortization of debt issuance cost | 1,640 | — | — | — | 1,640 | |||||||||||||||
Write-off of debt issuance cost | 17,538 | — | — | — | 17,538 | |||||||||||||||
Other non-cash income | (913 | ) | — | — | — | (913 | ) | |||||||||||||
Deferred income taxes | (363 | ) | — | 524 | — | 161 | ||||||||||||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||||||||||||||
Merchandise inventory | — | (8,343 | ) | (13 | ) | — | (8,356 | ) | ||||||||||||
Other current assets | — | 2,033 | 582 | — | 2,615 | |||||||||||||||
Deposits and other non-current assets | — | 110 | 169 | — | 279 | |||||||||||||||
Accounts payable | — | (7,424 | ) | (1,235 | ) | — | (8,659 | ) | ||||||||||||
Accrued interest | 13,771 | (11 | ) | (193 | ) | — | 13,567 | |||||||||||||
Lease liability on closed stores | — | 1,005 | 89 | — | 1,094 | |||||||||||||||
Accrued liabilities and deferred revenue | 1,357 | (16,387 | ) | (1,003 | ) | — | (16,033 | ) | ||||||||||||
Net cash provided by (used in) operating activities | (7,410 | ) | 23,201 | 992 | — | 16,783 | ||||||||||||||
Investing Activities: | ||||||||||||||||||||
Business acquisitions, net of cash acquired | — | (3,129 | ) | — | — | (3,129 | ) | |||||||||||||
Capital expenditures | — | (1,118 | ) | 19 | — | (1,099 | ) | |||||||||||||
Investment in subsidiaries | — | (174 | ) | 174 | — | — | ||||||||||||||
Net cash provided by (used in) investing activities | — | (4,421 | ) | 193 | — | (4,228 | ) | |||||||||||||
Financing Activities: | ||||||||||||||||||||
Repayments of capital lease obligations | — | (51 | ) | — | — | (51 | ) | |||||||||||||
Intercompany payable/receivable | 25,531 | (25,598 | ) | 67 | — | — | ||||||||||||||
Net borrowings repayments on credit facilities | (15,024 | ) | — | — | — | (15,024 | ) | |||||||||||||
Debt financing fees | (23,239 | ) | — | — | — | (23,239 | ) | |||||||||||||
Proceeds from issuance of debt | 775,000 | — | — | — | 775,000 | |||||||||||||||
Principal payments on long-term debt | (754,858 | ) | — | — | — | (754,858 | ) | |||||||||||||
Net cash provided by (used in) financing activities | 7,410 | (25,649 | ) | 67 | — | (18,172 | ) | |||||||||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | (1 | ) | — | (1 | ) | |||||||||||||
Increase (decrease) in cash and cash equivalents | — | (6,869 | ) | 1,251 | — | (5,618 | ) | |||||||||||||
Cash and cash equivalents at beginning of period | — | 29,274 | 3,679 | — | 32,953 | |||||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | 22,405 | $ | 4,930 | $ | — | $ | 27,335 | ||||||||||
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Condensed Consolidating Statement of Cash Flow
Thirteen week period ended April 6, 2008
(unaudited, in thousands)
Parent | Guarantor Subsidiaries | Non- Guarantor Subsidiaries | Eliminations | Consolidated | ||||||||||||||||
Operating Activities: | ||||||||||||||||||||
Net income (loss) | $ | (38,927 | ) | $ | (3,872 | ) | $ | 1,833 | $ | 2,039 | $ | (38,927 | ) | |||||||
Equity earnings in subsidiaries | 3,872 | (1,833 | ) | (2,039 | ) | — | ||||||||||||||
Adjustments to reconcile net income to cash provided by (used in) operating activities | ||||||||||||||||||||
Rental inventory amortization | — | 87,230 | 5,096 | — | 92,326 | |||||||||||||||
Purchases of rental inventory | — | (66,313 | ) | (4,831 | ) | — | (71,144 | ) | ||||||||||||
Purchases of rental inventory - base stock | — | (110 | ) | — | (110 | ) | ||||||||||||||
Depreciation and intangibles amortization | — | 11,579 | 502 | — | 12,081 | |||||||||||||||
Stock-based compensation | 296 | 112 | — | — | 408 | |||||||||||||||
Non-cash reorganization items, net | — | (66,705 | ) | — | — | (66,705 | ) | |||||||||||||
Amortization of debt issuance cost | 1,978 | — | — | — | 1,978 | |||||||||||||||
Changes in operating assets and liabilities, net of business acquisitions: | ||||||||||||||||||||
Merchandise inventory | — | (10,995 | ) | (294 | ) | — | (11,289 | ) | ||||||||||||
Other current assets | (54 | ) | 6,693 | 288 | — | 6,927 | ||||||||||||||
Deposits and other assets | 53 | (1,331 | ) | (4 | ) | — | (1,282 | ) | ||||||||||||
Accounts payable | — | 14,006 | 1,539 | — | 15,545 | |||||||||||||||
Accrued interest | 4,687 | — | — | — | 4,687 | |||||||||||||||
Lease liability on closed stores | — | 105,119 | (54 | ) | — | 105,065 | ||||||||||||||
Accrued liabilities and deferred revenue | 5,955 | (17,838 | ) | 85 | — | (11,798 | ) | |||||||||||||
Net cash provided by (used in) operating activities | (22,140 | ) | 55,742 | 4,160 | — | 37,762 | ||||||||||||||
Investing Activities: | ||||||||||||||||||||
Capital expenditures | — | (1,516 | ) | (98 | ) | — | (1,614 | ) | ||||||||||||
Net cash used in investing activities | — | (1,516 | ) | (98 | ) | — | (1,614 | ) | ||||||||||||
Financing Activities: | ||||||||||||||||||||
Intercompany payable/ receivable) | 37,399 | (39,308 | ) | 1,909 | — | — | ||||||||||||||
Debt financing fees | (338 | ) | — | — | — | (338 | ) | |||||||||||||
Principal payments on debt | (14,921 | ) | — | — | — | (14,921 | ) | |||||||||||||
Net cash provided by (used in) financing activities | 22,140 | (39,308 | ) | 1,909 | — | (15,259 | ) | |||||||||||||
Effect of exchange rate changes on cash and cash equivalents | — | — | (31 | ) | — | (31 | ) | |||||||||||||
Decrease in cash and cash equivalents | — | 14,918 | 5,940 | — | 20,858 | |||||||||||||||
Cash and cash equivalents at beginning of period | — | 54,432 | 6,880 | — | 61,312 | |||||||||||||||
Cash and cash equivalents at end of period | $ | — | $ | 69,350 | $ | 12,820 | $ | — | $ | 82,170 | ||||||||||
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Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Emergence from Chapter 11
On the Effective Date, the Reorganized Debtors consummated the transactions contemplated by the Plan. As provided in the Plan, our common stock and other equity interests existing immediately prior to the Effective Date were canceled for no consideration. Pursuant to the Plan, on or promptly after the Effective Date, we issued:
• | 7,544,460 shares of common stock, par value $0.001 per share to holders of 11% Senior Note Claims; |
• | 8,251,498 shares of New Common Stock to affiliates of Sopris, on account of the conversion of the Sopris Second Lien Claims; |
• | 5,000,000 shares of New Common Stock to participants in the Rights Offering; |
• | 115,000 shares of New Common Stock to affiliates of Sopris in satisfaction of its fee for providing the Backstop Commitment for the Rights Offering; |
• | 60,000 shares of New Common Stock to Imperial Capital, LLC, for services rendered on behalf of the official committee of unsecured creditors during the Chapter 11 proceedings; |
• | $20 Warrants to purchase 933,430 shares of New Common Stock to the holders of 11% Senior Note Claims; |
• | $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; and |
• | $0.01 Warrants to purchase up to an aggregate of 2,001,289 shares of New Common Stock to lenders under the Exit Facility. |
Pursuant to the Plan, on or promptly after the Effective Date, we reserved:
• | 2,395,540 shares of New Common Stock for future issuance to holders of certain allowed unsecured claims; |
• | 296,385 $20 Warrants for future issuance to holders of certain allowed unsecured claims; and |
• | 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 were determined by our Board of Directors upon their adoption of the Movie Gallery, Inc. 2008 Omnibus Equity Incentive Plan. In accordance with the Plan, a minimum of 50% of the awards under such the Equity Incentive Plan were granted within 60 days following the Effective Date. |
On the Effective Date, the Reorganized Debtors also entered into several credit facilities, as discussed below in Liquidity and Capital Resources.
41
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 store-based rental market in recent years, including:
• | cannibalization of rentals by low-priced movies available for sale; |
• | the growth of the online rental segment; |
• | the standard DVD format nearing the end of its life cycle; |
• | competing high definition DVD formats delaying content release and consumer acceptance until early 2008 when Sony’s Blu-ray format emerged as the industry choice; |
• | the growth of DVD-dispensing kiosk machines operated by our competitors; |
• | 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; and |
• | the proliferation of the release of television shows on DVD. |
The above factors, together with competitive pricing between Blockbuster and Netflix over their subscription services and greater than expected customer acceptance of Blockbuster’s Total Access program, which mixes elements of in-store and online movie rentals, had a negative impact on our business over the thirteen week period ended April 6, 2008. We expect that these factors and trends will continue to have a negative impact on the video rental market for the foreseeable future.
Our Business
As of April 6, 2008, we operated 3,485 home video retail stores that rent and sell movies and video games in urban, rural and suburban markets. We operate three distinct brands: Movie Gallery, Hollywood Video and Game Crazy. Movie Gallery’s eastern-focused rural and secondary market presence and Hollywood’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. Most of the studios have historically observed an exclusive window for home video distribution (most Blu-ray discs, DVDs and, in prior years, videocassettes, available for rental and sale), which provides the home video industry with an approximately 45-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 SNL Kagan, a division of SNL Financial, LC, a provider of sector-specific financial data, news and analytics, the domestic home video industry accounted for approximately 51% of domestic studio movie revenue in 2007. For this reason, we believe movie studios have a significant interest in maintaining a viable home video business.
42
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 in the home entertainment business, and that relevance can be augmented with certain enhancements to the extent that our capital structure allows, such as:
• | store size optimization; |
• | strategic geographical placement and branding of stores; |
• | increasing our inventories of Blu-ray discs; |
• | increasing our video game hardware and software inventories; |
• | integration of complementary in-store technology; and |
• | balanced marketing and promotions that provide a meaningful return on investment. |
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 to customers, but also tangible contributions to our operating performance. For the near term, we do not intend to make additional significant investments in either a movie kiosk program or the integration of an online video rental channel. We are presently focusing our operational efforts to improve customer support and enhance the customer experience within our stores.
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 the 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, 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 |
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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 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. |
• | Operating cash flows. In prior years, our stores generated significant levels of cash flows. 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, our inventory purchases are being funded through a combination of store cash flows, our new Revolving Credit Facility and cash on hand. |
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 week period ended April 6, 2008 as compared to the thirteen week period ended April 1, 2007.
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Selected Financial Statement and Operational Data:
For the Thirteen Weeks Ended | ||||||||
April 1, 2007 | April 6, 2008 | |||||||
($ in thousands, except per share and store data) | ||||||||
Rental revenue | $ | 510,990 | $ | 414,642 | ||||
Product sales | 136,650 | 141,097 | ||||||
Total revenues | 647,640 | 555,739 | ||||||
Cost of rental revenues | 154,825 | 133,213 | ||||||
Cost of product sales | 103,388 | 106,793 | ||||||
Total gross profit | 389,427 | 315,733 | ||||||
Store operating expenses | $ | 307,984 | $ | 336,063 | ||||
General and administrative | 44,712 | 39,985 | ||||||
Operating income (loss) | 36,014 | (61,209 | ) | |||||
Interest expense, net | 47,800 | 26,872 | ||||||
Loss before reorganization items and income tax expense | (11,786 | ) | (88,081 | ) | ||||
Reorganization items, net | — | (50,159 | ) | |||||
Loss before income tax expense | (11,786 | ) | (37,922 | ) | ||||
Net loss from continuing operations | (12,471 | ) | (38,391 | ) | ||||
Loss from discontinued operations, net of tax | (2,395 | ) | (536 | ) | ||||
Net loss | $ | (14,866 | ) | $ | (38,927 | ) | ||
Net loss per basic and diluted share | $ | (0.47 | ) | $ | (1.21 | ) | ||
Rental margin | 69.7 | % | 67.9 | % | ||||
Product sales margin | 24.3 | % | 24.3 | % | ||||
Total gross margin | 60.1 | % | 56.8 | % | ||||
Percent of total revenues: | ||||||||
Rental revenues | 78.9 | % | 74.6 | % | ||||
Product sales | 21.1 | % | 25.4 | % | ||||
Store operating expenses | 47.6 | % | 60.5 | % | ||||
General and administrative expenses | 6.9 | % | 7.2 | % | ||||
Operating income (loss) | 5.6 | % | -11.0 | % | ||||
Interest expense, net | 7.4 | % | 4.8 | % | ||||
Net loss | -2.3 | % | -7.0 | % | ||||
Total same-store revenues | -5.9 | % | -3.8 | % | ||||
Movie Gallery total same-store revenues | -4.0 | % | -1.9 | % | ||||
Hollywood total same-store revenues | -6.8 | % | -4.8 | % | ||||
Total same-store rental revenues | -9.7 | % | -8.6 | % | ||||
Movie Gallery same-store rental revenues | -3.3 | % | -4.4 | % | ||||
Hollywood same-store rental revenues | -13.7 | % | -11.8 | % | ||||
Total same-store product sales | 11.4 | % | 13.4 | % | ||||
Movie Gallery same-store product sales | -11.0 | % | 26.0 | % | ||||
Hollywood same-store product sales | 16.0 | % | 11.4 | % | ||||
Store Count: | ||||||||
Beginning of period | 4,642 | 3,889 | ||||||
New store builds | 1 | — | ||||||
Stores acquired | — | — | ||||||
Stores closed | (54 | ) | (404 | ) | ||||
End of period | 4,589 | 3,485 | ||||||
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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 thirteen week period ended April 6, 2008, we closed 404 underperforming stores, of which 370 were part of our Phase 2 store closures that we announced on February 4, 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. As a result of the Chapter 11 Cases, we were able to reject the lease agreements related to these closed facilities. As of April 6, 2008, we operated 3,485 home video retail stores.
Revenue
For the thirteen week period ended April 6, 2008, consolidated total revenue decreased 14.2% from the comparable period in 2007. The decrease for the thirteen week period ended April 6, 2008 was primarily due to a decrease in the number of weighted-average stores operated and a decrease in consolidated same-store revenue. For the thirteen week period ended April 6, 2008, the number of weighted-average stores operated decreased 18.5%, and consolidated same-store sales decreased 3.8% as compared to the comparable period in 2007. Consolidated same-store sales for the thirteen-week period consisted of an 8.6% decrease in same-store rental revenue, partially offset by a 13.4% increase in same-store product revenue.
Total revenue for the Movie Gallery operating segment for the thirteen week period ended April 6, 2008 decreased 10.1% from the comparable period in 2007. The decrease in revenue for the thirteen week period ended April 6, 2008 was primarily due to a decrease in the number of weighted-average stores operated and a decrease in same-store revenue. For the thirteen week period ended April 6, 2008, the number of weighted-average stores operated decreased 16.0% and same-store sales decreased 1.9% compared to the corresponding period in 2007. Same-store sales for the thirteen-week period consisted of a 4.4% decrease in same-store rental revenue, partially offset by a 26.0% increase in same-store product revenue.
Total revenue for the combined Hollywood and Game Crazy operating segments for the thirteen week period ended April 6, 2008 decreased 16.4% from the comparable period in 2007. The decrease in revenue for the thirteen week period ended April 6, 2008 was primarily due to a decrease in the number of weighted-average stores operated and a decrease in same-store revenue. For the thirteen week period ended April 6, 2008, the number of weighted-average stores operated decreased 21.8% and same-store sales decreased 4.8% compared to the corresponding period in 2007. Same-store sales for the thirteen-week period consisted of an 11.8% decrease in same-store rental revenue, partially offset by an 11.4% increase in same-store product revenue, which included an 11.5% increase in Game Crazy same-store department sales.
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We believe the following factors contributed to the decline in our same-store rental revenues:
• | the overabundance of DVD titles available for sale in the marketplace; |
• | the growth of online rental and bundled subscription plans, caused in part by aggressive pricing and promotion employed by our competition; |
• | the growth of rental DVD-dispensing kiosk machines; |
• | the maturation of the DVD life cycle; |
• | the slow adoption of Blu-ray discs; 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. |
Cost of Sales
The cost of rental revenues includes the amortization of rental inventory, revenue-sharing expenses and the cost of previously viewed rental inventory sold. The gross margins on rental revenue for the thirteen week period ended April 6, 2008 were 67.9% compared to 69.7% for the comparable period in 2007. The primary factors contributing to the decrease in gross margins include a relative increase in rental product amortization resulting from a change in residual values on DVD movies from $4.00 to $3.00, as discussed in Note 2. Accounting Policies in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008, and a decrease in the percentage of new release movies acquired through revenue-sharing arrangements.
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 margins on product sales are subject to fluctuations in the relative mix of the products that are sold. The gross margins on product sales for the thirteen week period ended April 6, 2008 were 24.3%, which was flat to the comparable period in 2007.
Operating Costs and Expenses
Store operating costs and expenses include store-level operational expense, store labor, closed store expenses, 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 increased $28.1 million, or 9.1%, for the thirteen week period ended April 6, 2008 as compared to the comparable period in 2007. As a percentage of total revenues, store operating expenses were 60.5% for the thirteen week period ended April 6, 2008 as compared to 47.6% for the comparable period in 2007.
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The following table sets forth store operating costs and expenses as a percent of total revenue:
For the thirteen weeks ended | |||||||||
April 1, 2007 | April 6, 2008 | Net Change | |||||||
Operational expenses | 23.7 | % | 20.9 | % | -2.8 | % | |||
Store labor expense | 18.7 | % | 17.5 | % | -1.2 | % | |||
Lease liability on closed stores | 0.2 | % | 19.0 | % | 18.8 | % | |||
Depreciation expense | 2.8 | % | 1.6 | % | -1.2 | % | |||
Advertising expense | 1.0 | % | 0.7 | % | -0.3 | % | |||
Other store expense | 1.3 | % | 0.8 | % | -0.5 | % |
Store operating costs increased primarily due to an increase in closed store rent accruals of $104.3 million for the thirteen weeks ended April 6 2008 compared to the corresponding prior year period, as a result of closure of the 404 stores in the thirteen week period ended April 6, 2008, which was partially offset by a reduction in store operating costs of approximately $57 million as a result of the 18.5% decrease in weighted-average store count and approximately $19 million of decreased expenses as a result of lower year over year per store costs. The $19 million decrease in expenses is comprised of approximately $1 million in reduced labor costs, $6 million in lower depreciation expenses, $9 million in reduced operating store expenses (primarily rent expenses) and $3 million in reduced advertising and other store expenses.
General and Administrative Expenses
General and administrative expenses decreased $4.7 million in the thirteen week period ended April 6, 2008 as compared to the corresponding period in 2007. As a percentage of total revenue, general and administrative expenses were 7.2% for the thirteen week period ended April 6, 2008 compared to 6.9% for the corresponding period in 2007.
The increase in general and administrative expenses as a percentage of total revenue for the thirteen week period ended April 6, 2008 was primarily due to payroll and related expenses. For the thirteen week period ended April 6, 2008, payroll and related expenses decreased by $1.9 million but increased 0.3% as a percentage of revenue compared to the corresponding period in 2007 due to higher health care and bonus costs. As a percentage of revenue, travel and meeting expenses, professional fees and other expenses decreased while other general and administrative expenses remained flat compared to the corresponding period in 2007.
Stock compensation expense primarily represents non-cash charges associated with non-vested stock grants in accordance with Financial Accounting Standards Board (“FASB”) Statement No. 123(R),Accounting for Stock-Based Compensation, (“FASB Statement No. 123(R)”).
For the thirteen week periods ended April 1, 2007 and April 6, 2008, we recognized $0.7 million and $0.4 million, respectively, in compensation expenses related to service-based stock grants. No compensation expenses were recorded for performance-based stock grants in the thirteen week periods ended April 1, 2007 and April 6, 2008. Total compensation cost related to all non-vested awards that is not yet recognized was $2.1 million at April 6, 2008, with weighted-average remaining service 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 FASB 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
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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.
Interest Expense, Net
Interest expense, net decreased $20.9 million from $47.8 million for the thirteen week period ended April 1, 2007 to $26.9 million for the thirteen week period ended April 6, 2008. The decrease is primarily attributable to a charge of $17.5 million recognized in the thirteen week period ended April 1, 2007 to write off the unamortized deferred financing costs related to our previous senior credit facility when it was refinanced in the first quarter of 2007.
Reorganization Items, Net
Reorganization items, net in our Condensed Consolidated Statements of Operations represents reorganization charges incurred as a direct result of the Chapter 11 filings. For the thirteen week period ended April 6, 2008, reorganization items, net was a gain of $50.2 million and was comprised of professional fees, non-cash gains and losses resulting from lease rejections and amounts received for the sale of leases on closed stores to new tenants. Professional fees included financial and legal services directly associated with the reorganization process and totaled $17.2 million for the thirteen week period ended April 6, 2008. In the thirteen week period ended April 6, 2008, we received Bankruptcy Court approval to reject 435 leases, resulting in non-cash gains and losses resulting from lease rejections that totaled $66.7 million, which represents the reduction of lease liabilities due to Bankruptcy Court rejections, partially offset by an accrual for claims for damages due to lease rejections, as limited by Section 502(b)(6) of the Bankruptcy Code. We recorded a $0.7 million gain in the thirteen week period ended April 6, 2008 for cash payments received on leases that were sold to new tenants and interest income.
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 FASB issued FASB 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 FASB 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. FASB Interpretation No. 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requirements for increased disclosures.
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We adopted the provisions of FASB Interpretation No. 48 on January 1, 2007. The adoption of FASB Interpretation No. 48 did not have a material effect on our Condensed Consolidated Balance Sheet or statement of operations. The amount of unrecognized benefits as of April 6, 2008 was $10.0 million, of which $2.4 million would impact our effective rate if recognized. There has not been a material change in the amount of unrecognized benefits in the first quarter of 2008.
The effective tax rate was a provision of 4.8% and 1.2% for the thirteen week periods ended April 1, 2007 and April 6, 2008, respectively. The projected annual effective tax rate is a provision of 1.8%, which differs from the provision of 1.2% for the quarter ended April 6, 2008, due to various state income tax changes. The effective tax rate differs from the statutory rate due primarily to a valuation allowance the Company has established against its deferred tax assets.
Discontinued Operations, Net
On March 5, 2007, we acquired substantially all of the assets, technology, network operations, and customers of MovieBeam, an on-demand movie service, for cash consideration of $3.1 million. However, we were unable to achieve our previously anticipated revenue and customer acquisition levels for MovieBeam and 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. In the fourth quarter of fiscal 2007, we ceased operations associated with MovieBeam. 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. We have adjusted our financial statements and related notes for the thirteen week period ended April 1, 2007 to classify the $2.4 million net operating loss of this entity as a loss from discontinued operations.
Liquidity and Capital Resources
Summary
Our primary capital needs are for seasonal working capital, debt service, remodeling and relocating existing stores, new technology initiatives, and new store investment. We have historically funded our capital needs primarily by cash flow from operations and borrowings under the revolving portion of our senior credit facilities.
For the thirteen week period ended April 6, 2008, net cash provided by operating activities was $37.8 million as compared to $16.8 million provided by operating activities in the corresponding period in 2007. At April 6, 2008, we had cash and cash equivalents of $82.2 million and $14.9 million in available borrowings under our DIP Credit Agreement.
At January 4, 2009, we had cash and cash equivalents in excess of $30.0 million and $40.0 million in available borrowings under our Revolving 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 financing agreements as described below.
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Amended and Restated First Lien Senior Credit Facility
The First Lien Credit Facility is a senior secured credit facility providing for aggregate borrowings of up to $626.5 million (plus accrued and capitalized interest and fees), consisting of $603.0 million aggregate principal amount of term loans (“First Lien Term Loan Facility”), and $23.5 million aggregate principal amount of letters of credit (“Letter of Credit Facility”). The First Lien Credit Facility amended and restated the first lien term loan and letter of credit facility under our March 2007 Credit Facility.
Borrowings under the First Lien Term Loan Facility bear interest at floating interest rates, plus applicable margins that are computed in accordance with the First Lien Term Loan Facility. The applicable margin generally increases over time and is also subject to increase to the extent we elect to pay interest by adding the amount of such interest to the principal amount of the term loans (payment-in-kind interest).
The maturity date of the First Lien Term Loan Facility is the earliest of May 20, 2012 or 90 days following the date the aggregate principal amount of the term loans does not exceed $20.0 million.
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 Consolidated Adjusted EBITDA (as defined below) relative to cash interest expense; |
• | the leverage test is a measurement of total leverage, which includes indebtedness under the First Lien Credit Facility, including amounts drawn under letters of credit, and the Revolving Credit Facility described below, relative to Consolidated Adjusted EBITDA; and |
• | the secured leverage test is a measurement of secured leverage, which includes indebtedness under the First Lien Credit Facility, the Second Lien Credit Facility described below, the Revolving Credit Facility, amounts drawn under letters of credit, and any other secured indebtedness relative to Consolidated Adjusted EBITDA. |
For purposes of the First Lien Credit Facility, Consolidated Adjusted EBITDA means our consolidated net income plus interest expense, income taxes, depreciation expense and amortization expense and after giving effect to certain other adjustments described more specifically in the First Lien Credit Facility.
Additionally, the First Lien Term Loan Facility 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 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 those of the other guarantors.
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On October 6 and 7, 2008, we entered into conversion agreements with certain holders of term loans under our First Lien Credit Facility, pursuant to which such holders assigned approximately $159.0 million aggregate principal amount of term loans (including accrued and unpaid interest thereon) to us. As a result of the assignment, the assigned term loans converted into approximately 15.9 million shares of our New Common Stock at a price of $10 per share. In connection with the conversion, our Audit Committee, with the assistance of a third-party advisory firm, evaluated the fairness of the conversion price from a financial point of view.
Between December 26, 2008 and January 7, 2009, we have repurchased, or are under contract to repurchase, approximately $45.4 million in outstanding principal amount of term loans under our First Lien Credit Facility from an unaffiliated third party. After retirement of these term loans repurchased by us, the principal amount of term loans outstanding under the First Lien Credit Facility is approximately $402.5 million.
Amended and Restated Second Lien Credit Facility
The Second Lien Credit Facility is a senior secured credit facility that provides for term loans in an aggregate principal amount not to exceed $117.1 million. 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 Credit Facility bear interest at floating interest rates, plus applicable margins that are computed in accordance with the Second Lien Credit Facility. The applicable margin generally increases over time and is also subject to increase to the extent we elect to pay interest by adding the amount of such interest to the principal amount of the term loans (payment-in-kind interest).
The maturity date of the Second Lien Credit Facility is the earlier of November 20, 2012 or the date that the term loans under the First Lien Credit Facility become due and payable in full, whether by acceleration or otherwise.
The Second Lien Credit 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 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 those of the other guarantors.
Revolving Credit Facility
The Revolving Credit Facility with various lenders (including affiliates of Sopris) and agents is a senior secured credit facility due May 20, 2011, which provides for revolving loans up to an aggregate principal amount of $100.0 million.
Loans under the Revolving Credit Facility bear interest at floating interest rates plus applicable margins that are computed in accordance with the Revolving Credit Facility. In addition, we must pay annual commitment fees equal to the average of the daily difference between the revolving commitments and the aggregate principal amount of all outstanding revolving loans, multiplied by 0.375%.
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Amounts borrowed under the Revolving Credit Facility may be repaid and reborrowed, with the final payment due and payable at the earlier of May 20, 2011 or the date that we terminate the revolving commitments. 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 the Borrowing Base or the aggregate commitments under the Revolving Credit Facility, we will be required to make prepayments in the amount of such excess. The amount of the Borrowing Base is calculated using a definition contained in the Revolving Credit Facility by reference to the amount of eligible accounts receivable and the liquidation value of our inventory, in each case after certain adjustments described in the Revolving Credit Facility, including the establishment of certain reserves.
The obligations under the Revolving Credit Facility are unconditionally guaranteed by us and each of our domestic subsidiaries and 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 those of the other guarantors. The Revolving Credit Facility constitutes a “first-out” revolving facility, under which the distribution of the proceeds of the collateral will be applied to the repayment of the Revolving Credit Facility prior to the repayment of the borrowings under the First Lien Credit Facility and the Second Lien Credit Facility.
The Revolving Credit Facility contains customary operational covenants for revolving facilities of this type and also requires us to meet the financial covenants contained in the First Lien Term Loan Facility. Please refer to the Item 1A. Risk Factors in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008 for a further description of these operational covenants.
Seasonal Overadvance Facility
The Seasonal Overadvance Facility is a facility pursuant to which Sopris agreed to support up to $25.0 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 with 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.
As of January 4, 2009, there are $24.0 million in letters of credit outstanding under the Seasonal Overadvance Facility, of which none have been drawn upon. In consideration for supporting these letters of credit, we have issued warrants to purchase 82,800 shares of New Common Stock at a purchase price of $10.00 per share to Sopris.
Chapter 11 Financing Arrangements
DIP Credit Agreement (As Amended)
In connection with the Chapter 11 Cases, we entered into a $150.0 million DIP Credit Agreement with certain of our subsidiaries (all of whom were debtors) as Guarantors, and lenders and agents from time to time party thereto.
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The DIP Credit Agreement provided for (i) a $50 million revolving loan and letter of credit facility (“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 revolver under our March 2007 Credit Facility, pay certain transactional expenses and fees incurred by us and support our working capital needs, including for general corporate purposes.
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 or (ii) at the Adjusted Eurodollar Rate (as defined in the DIP Credit Agreement) plus 3.50% per annum.
At April 6, 2008, we had $85.1 million outstanding under the DIP Credit Agreement.
On the Effective Date and pursuant to the Plan, the creditors under the DIP Credit Agreement were paid in full in cash and the DIP Credit Agreement was terminated.
Impact of Chapter 11 Filing and Effectiveness of the Plan
Prior to the commencement of the Chapter 11 Cases, our principal financing arrangements consisted of our March 2007 Credit Facility and long-term debt securities. Our March 2007 Credit Facility consisted of:
• | a $100 million revolving credit facility, which we refer to as the revolver, which was subsequently refinanced under the DIP Credit Agreement, as discussed above; |
• | 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 first lien letter of credit facility as the first lien facilities.
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 under the March 2007 Credit Facility 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 the outstanding balance of $611.0 million under the first lien facilities as a current liability at April 6, 2008.
The filing of the Chapter 11 Cases also created an event of default under our second lien term loan. Under the terms of the second lien credit facility, 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 classified the outstanding balance of $190.2 million under the second lien term loan as a current liability at April 6, 2008.
The first lien term loan and letter of credit facility and second lien term loan 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 fiscal year ended January 6, 2008.
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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 (“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. The 11% Senior Notes were treated as an unsecured liability of the Reorganized Debtors, and accordingly, we classified our $325 million 11% Senior Notes as a liability subject to compromise as of April 6, 2008.
On the Effective Date, the 11% Senior Notes were canceled and the indentures governing such securities were terminated. Under the Plan, holders of 11% Senior Notes received 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 (“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. The Senior Subordinated Notes were treated as an unsecured liability of the Reorganized Debtors, and accordingly, we classified our $0.5 million in Senior Subordinated Notes as a liability subject to compromise as of April 6, 2008.
On the Effective Date, the 9.625% Senior Subordinated Notes were canceled and the indentures governing such securities were terminated. Under the Plan, holders of the Senior Subordinated Notes received 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 estate. 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.
Liquidity
Our liquidity is dependent upon our cash flows from store operations, access to the Revolving Credit Facility, Seasonal Overadvance Facility and vendor financing. Historically, we maintained favorable payment terms with our vendors, which had been a significant source of liquidity for us. During fiscal 2006 and 2007, and continuing into the first quarter of 2008, we experienced significant vendor terms contraction, which eroded our working capital capacity. Due to our non-compliance with the covenants contained in the March 2007 Credit Facility and the filing of the Chapter 11 Cases, many of our significant vendors discontinued extending us trade credit, requiring us to pay for product before it was shipped, and we experienced additional tightening of terms with other vendors. Subsequent to the Effective Date, we have negotiated substantially improved terms with most of our vendors. Based on our year to date results of operations for fiscal 2008, we will likely be required to reduce our purchases of inventory and other uses of working capital that we fund with borrowings under the Revolving Credit Facility and the Seasonal Overadvance Facility in order to remain in compliance with our financial covenants.
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The credit and capital markets have recently experienced adverse conditions. Continuing volatility in the credit and capital markets may increase costs associated with the incurrence of debt or affect our ability to access the credit or capital markets. Notwithstanding these adverse market conditions and assuming we are able to adjust our working capital needs to remain in compliance with our financial covenants, we believe that the Revolving Credit Facility and the Seasonal Overadvance Facility, together with improved cash operating results, will 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 no further material adverse developments in our business, liquidity or capital requirements. If we cannot generate sufficient cash flow from operations to service our indebtedness and to meet our working capital needs and other obligations and commitments, we will be required to further refinance or restructure our debt, obtain new funding sources 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
We have made cash payments during the course of fiscal 2008 of approximately $14 million for employee retention and severance programs related to changes in our management team and consolidation of certain corporate functions, and for professional services associated with our various business and operational improvement activities.
Due to our significant operating losses for fiscal year 2007 and the first quarter of fiscal 2008, as well as our liquidity position, we reduced planned capital and maintenance expenditures for, among other things, projects related to our management information systems infrastructure. 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.
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Classification of Debt
At April 6, 2008, all of our pre-petition debt was in default, and a portion of it subject to compromise. The following table classifies our pre-petition debt in terms of whether it was subject to compromise:
April 6, 2008 | |||
(in millions) | |||
Short-term debt and long-term debt not subject to compromise: | |||
First lien credit facility | $ | 611.0 | |
Second lien credit facility | 190.2 | ||
DIP term loan | 85.1 | ||
Other | 1.0 | ||
Total debt not subject to compromise | 887.2 | ||
Long-term debt subject to compromise: | |||
11% Senior Notes due 2012 (net of deferred financing fees and discount) | 313.3 | ||
Hollywood 9.625% Senior Subordinated Notes due 2011 | 0.5 | ||
Total long-term debt subject to compromise | 313.8 | ||
Total outstanding debt | $ | 1,201.0 | |
Pursuant to the requirements of AICPA Statement of Position 90-7,Financial Reporting of Entities in Reorganization Under the Bankruptcy Code, as of the filing of the Chapter 11 Cases, deferred financing fees of $8.8 million related to pre-petition debt determined to be subject to compromise are no longer being amortized and have been included as an adjustment to the net carrying value of the related pre-petition debt at April 6, 2008. The carrying value of the pre-petition debt will be adjusted in future reporting periods at the point that it becomes an allowed claim under the Plan to the extent the carrying value differs from the amount of the allowed claim.
Statement of Cash Flow Data
For the Thirteen Weeks Ended | ||||||||
April 1, 2007 | April 6, 2008 | |||||||
($ in thousands) | ||||||||
Statements of Cash Flow Data: | ||||||||
Net cash provided by operating activities | $ | 16,783 | $ | 37,762 | ||||
Net cash used in investing activities | (4,228 | ) | (1,614 | ) | ||||
Net cash used in financing activities | (18,172 | ) | (15,259 | ) |
Operating Activities
The increase in net cash provided by operating activities for the thirteen week period ended April 6, 2008 compared to the corresponding period in 2007 was primarily due to favorable trends in the use of cash for accounts payable and reduced rental inventory purchases, which were partially offset by changes in operating income. Operating income was lower for the thirteen week period ended April 6, 2008 corresponding to the same period in 2007 primarily due to non-cash costs related to our store closure activities, as well as reorganization costs paid to professionals related to our reorganization efforts. This was partially offset by store-level cost savings attributable to the reduction in the number of our stores.
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Investing Activities
Net cash used in investing activities includes the cost of business acquisitions, new store builds and other capital expenditures. For the thirteen week period ended April 6, 2008, net cash used for investing activities was $1.6 million for improvements to our existing store base as compared to $4.2 million in the corresponding period in 2007 of which $3.1 million was used for business acquisitions and $1.1 million for miscellaneous capital expenditures.
Capital expenditure requirements for the 2008 fiscal year are estimated at $15.0 million mainly for improvements to our existing store base.
Financing Activities
Net cash flow used in financing activities for the thirteen week period ended April 6, 2008 was $15.3 million, which included $14.9 million of principal payments on our DIP credit facility. Net cash flow used in financing activities for the thirteen week period ended April 1, 2007 was $18.2 million, consisting primarily of $775.0 million in proceeds from the issuance of long term debt, offset by $754.9 million of payments on long term debt, $23.2 million incurred for debt financing costs and $15.0 million for repayments on credit facilities.
At April 6, 2008, we had a working capital deficit of $0.7 billion. This is primarily due to the reclassification of most 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 recognized as a reduction in working capital.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Recently Issued Accounting Pronouncements
In September 2006, the FASB issued FASB Statement No. 157,Fair Value Measurements (“FASB Statement No. 157”), which provides enhanced guidance for using fair value to measure assets and liabilities. FASB Statement No. 157 also responds to 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. 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 to any new circumstances. FASB Statement No. 157 is effective for our fiscal year beginning January 7, 2008. The adoption of FASB Statement No. 157 did not have a material impact on our consolidated financial position, results of operations, and cash flows. On February 12, 2008, the FASB issued FASB Staff Position No. FAS 157-2,Effective Date of FASB Statement No. 157 (“FASB Staff Position No. 157-2”), 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. We are in the process of evaluating the effect of FASB Statement No. 157 as it relates to nonfinancial assets and nonfinancial liabilities on our consolidated financial position, results of operations, and cash flows.
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In February 2007, the FASB issued FASB Statement No.159,The Fair Value Option for Financial Assets and Financial Liabilities (“FASB Statement No. 159”), which provides guidance on applying fair value measurements on financial assets and liabilities. FASB Statement No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. FASB 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. FASB Statement No. 159 is effective for us for our fiscal year beginning January 7, 2008. The adoption of FASB Statement No. 159 did not have a material impact on our consolidated financial position, results of operations, and cash flows.
In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007),Business Combinations, 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 non-controlling 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 pre-acquisition 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, 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 Staff Position (“FSP”) No. FASB 142-3,Determination of Useful Life of Intangible Assets.FSP FAS 142-3 amends the factors that should be considered in developing the renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142,Goodwill and Other Intangible Assets. FSP FAS 142-3 also requires expanded disclosure related to the determination of intangible asset useful lives. FSP FAS 142-3 is effective for fiscal years beginning after December 15, 2008 and is effective for us for our fiscal year beginning January 5, 2009. Earlier adoption is prohibited. We have not yet commenced evaluating the potential impact, if any, of the adoption of FSP FAS 142-3 on our consolidated financial position, results of operations and cash flows.
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In April 2008, the FASB issued FSP No. 90-7-a,An Amendment of AICPA Statement of Position 90-7, Financial Reporting by Entities in Reorganization under the Bankruptcy Code (“FSP SOP No. 90-7-a”), which applies 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 FSP SOP No. 90-7-a, 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. We do not believe that the adoption of FSP SOP No. 90-7-a will have a material impact on our consolidated financial position, results of operations, or cash flows in the second quarter of 2008.
Critical Accounting Policies and Estimates
Our critical accounting policies are described in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008. There have been no significant changes to our critical accounting policies during the thirteen week period ended April 6, 2008.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. The most significant estimates and assumptions and those possessing the most subjectivity relate to our accounting while in Chapter 11 of the Bankruptcy Code, the residual values and useful lives of rental inventory, useful lives of fixed assets and other intangibles, estimated accruals related to revenue-sharing titles subject to performance guarantees, revenues generated by customer programs and incentives, valuation allowances for deferred tax assets, estimated cash flows used to test goodwill and long-lived assets for impairment, the allocation of the purchase price to the fair value of net assets of acquired businesses, share-based compensation and contingencies. Actual results could differ materially from these estimates and assumptions.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Not applicable to a smaller reporting company.
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’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.
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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 our 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, 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 weaknesses 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 January 6, 2008. To address these control weaknesses, we performed additional analysis and other procedures in order to prepare this Quarterly Report on Form 10-Q, including the unaudited quarterly condensed 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 assessment identified two material weaknesses in our internal control over financial reporting as of January 6, 2008 that are in the process of being remediated as of April 6, 2008, as described further below. This section of Item 4. “Controls and Procedures,” should be read in conjunction with Item 9A(T). “Controls and Procedures,” included in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008 for additional information on Management’s Report on Internal Controls Over Financial Reporting.
Plan for Remediation of Material Weaknesses
Ineffective Controls Over Lease Accounting
As previously reported, there was a material weakness in our internal control over financial reporting related to controls over lease accounting as of December 31, 2006. This material weakness was not remediated during fiscal 2007 or in the thirteen week period ended April 6, 2008.
Due to the filing of the Chapter 11 Cases, among other things, we expect that the remediation of the ineffective controls related to lease accounting will take 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 a timely manner.
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 significant portion of our lease accounting calculations. |
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Ineffective Controls Over Accurately Reporting Accrued Liabilities
We are in the process of remediating the material weakness in accounting for and reporting of accrued liabilities. In connection with our remediation process we are implementing the following measures:
• | Enhancing procedures and documentation supporting our accrued liabilities. |
• | Incorporating more robust management review of our accrued liabilities. |
• | Establishing periodic meetings to improve communication and coordination surrounding the recording of our accrued liabilities. |
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that has occurred since the changes disclosed in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Part II - Other Information
Item 1. | Legal Proceedings |
We have been named to various claims, disputes, legal actions and other proceedings involving contracts, employment, our bankruptcy filing and various other matters. If such claims, disputes, actions or other proceedings were subject to the release, discharge or exculpation provisions in the Plan, they are subject to a permanent injunction against the collection of such debts as set forth in the Plan and the Confirmation Order. For those claims that are not subject to the injunction, a negative outcome in certain of the ongoing matters 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’s attention or result in increased costs of doing business.
At April 6, 2008 the legal contingencies reserve was $2.1 million, of which $1.0 million relates to pre-Hollywood acquisition contingencies.
Item 1A. | Risk Factors |
Our Annual Report on Form 10-K for the fiscal year ended January 6, 2008 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 fiscal year ended January 6, 2008. The risks described in our Annual Report on Form 10-K for the fiscal year ended January 6, 2008 and the information presented below are not the only risks facing our 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/or operating results.
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We are no longer required to file periodic reports with the Securities and Exchange Commission under the Exchange Act and have taken steps to de-register our stock under Section 12(g) of the Exchange Act, which may adversely affect the market for shares of the New Common Stock.
Because we have fewer than 300 stockholders, we are not obligated to file periodic reports (Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q or Current Reports on Form 8-K) with the SEC. However, because we are not obligated to make these filings with the SEC, under the terms of the Plan, we are required to make available to stockholders reports that are the same or substantially similar in content to those SEC reports. We also have made the necessary SEC filing to cause the de-registration of our New Common Stock under Section 12(g) of the Exchange Act. When the de-registration is effective, we will no longer be required to comply with other substantive requirements of the Exchange Act, including those relating to proxy solicitations and tender offers. Although our stockholders will continue to have access to information regarding the company and our financial performance, the discontinuance of our SEC filings and the de-registration may inhibit the ability of our stockholders to trade shares of our New Common Stock in the open market, as potential investors may not be willing to own shares in a company that is not subject to the reporting and other requirements of the Exchange Act.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
None.
Item 3. | Defaults Upon Senior Securities |
None.
Item 4. | Submission of Matters to a Vote of Security Holders |
None.
Item 5. | Other Information |
None.
Item 6. | Exhibits |
a) Exhibits
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: January 8, 2009 | /s/ Lucinda M. Baier | |||
Lucinda M. Baier | ||||
Executive Vice President and | ||||
Chief Financial Officer |
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