| MOVIE GALLERY INC Item 1A RISK FACTORS We have a significant amount of indebtedness, which may limit our operating flexibility |
| As of January 1, 2006, we had approximately dlra1cmam161dtta2 million of indebtedness, consisting primarily of borrowings under our senior credit facility and our 11prca Senior Notes due 2012, or the senior notes |
| Our high level of indebtedness could have important consequences to you, including the following: - - it may be difficult for us to satisfy our obligations with respect to our indebtedness; - - our ability to obtain additional financing for working capital, capital expenditures, or general corporate or other purposes may be impaired; - - a substantial portion of our cash flow from operations must be dedicated to the payment of principal and interest on our indebtedness, reducing the funds available to us for other purposes; - - cause our trade creditors to change their terms for payment on goods and services provided to us, thereby negatively impacting our ability to receive products and services on acceptable terms; - - it may place us at a competitive disadvantage compared to our competitors that have less debt or are less leveraged; and - - we may be more vulnerable to economic downturns, may be limited in our ability to respond to competitive pressures and may have reduced flexibility in responding to changing business, regulatory and economic conditions |
| Our ability to pay interest on and to satisfy our other debt obligations will depend upon, among other things, our future operating performance and our ability to refinance indebtedness when necessary |
| Each of these factors is, to a large extent, dependent upon economic, financial, competitive and other factors beyond our control |
| If, in the future, we cannot generate sufficient cash from operations to meet our debt obligations, we will need to refinance our existing debt, obtain additional financing or sell assets |
| We cannot assure you that our business will generate sufficient cash flows to satisfy our existing indebtedness obligations or that funding sufficient to satisfy our debt service requirements will be available on satisfactory terms, if at all |
| We may be unsuccessful in executing our plan to reduce our level of indebtedness and return to profitability |
| Our plan to reduce our level of indebtedness and return to profitability includes, among other things, taking advantage of synergies arising out of the Hollywood acquisition, closing overlapping stores and reducing store sizes |
| Our plan also involves our disposal of certain non-core assets in order to generate proceeds to repay indebtedness |
| We may be unable to identify buyers for these assets or negotiate for their sale on terms that are satisfactory, if at all |
| If we are unable to successfully execute our plan to reduce our level of indebtedness, the interest expense associated with this indebtedness will adversely affect our results of operations |
| We require a significant amount of cash, which may not be available to us |
| Our ability to make payments on, repay or refinance our debt, to fund planned capital expenditures and to generate sufficient working capital to operate our business will depend largely upon our future operating performance |
| Our future performance is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control |
| In addition, our ability to borrow funds depends on the satisfaction of the covenants in our senior credit facility and our other debt agreements, including the indenture governing the senior notes, and other agreements we may enter into in the future |
| Specifically, our senior credit facility requires us to maintain certain financial ratios |
| Additionally, our working capital needs may increase to the extent that our suppliers are unwilling to extend credit to us on satisfactory terms |
| We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our senior credit facility or from other sources in an amount sufficient to enable us to pay our debt, fund capital expenditures or to fund our working capital or other liquidity needs |
| Our debt instruments include restrictive and financial covenants that limit our operating flexibility |
| Our senior credit facility requires us to maintain certain financial ratios and our senior credit facility and the indenture governing the senior notes contain covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in our best interest |
| These include, among other things, restrictions on our ability to: - - incur indebtedness or issue preferred stock; - - pay dividends or make other distributions or repurchase or redeem our stock or subordinated indebtedness or make investments; - - sell assets and issue capital stock of our subsidiaries; - - use the proceeds of permitted sales of assets; - - create liens; - - enter into agreements restricting our subsidiaries &apos ability to pay dividends; - - enter into transactions with affiliates; - - engage in new lines of business; - - consolidate, merge or sell all or substantially all of our assets; and - - issue guarantees of debt |
| While we were in compliance at the end of the fourth quarter 2005 with the financial covenants contained in our senior credit facility, we obtained an amendment to the senior credit facility on March 15, 2006 in order to remain in compliance with those covenants in the near term |
| This amendment provides covenant relief for the period ending on December 31, 2006 |
| For the first quarter of 2007, absent further amendment, the more restrictive financial covenants contained in the original senior credit facility will apply to us |
| Because the most restrictive covenants are computed on a trailing four quarter basis, we do not expect that we will be in compliance with the first quarter 2007 covenants unless the covenants are further amended or we obtain additional equity financing by that time |
| We are exploring several alternative strategies to remain in compliance with the terms of our senior credit facility, including, among other things, operational improvements through capitalizing on merger integration synergy opportunities, raising additional equity, divesting certain non-core assets and sale/leaseback transactions |
| We also may be required to seek further amendments to our senior credit facility |
| We cannot assure you that any of these actions will be successful, or that any sales of assets, additional debt or equity financings or further debt amendments can be obtained |
| Any failure to comply with the restrictions of our senior credit facility, the indenture governing the senior notes or any subsequent financing agreements may result in an event of default |
| Such default may allow our creditors to accelerate the related debt and may result in the acceleration of any other debt to which cross-acceleration or cross-default provisions apply |
| In addition, these creditors may be able to terminate any commitments they had made to provide us with further funds |
| See Managementapstas Discussion and Analysis of Financial Condition and Results of Operations, "e Liquidity and Capital Resources, "e for more information on our restrictive and financial covenants |
| Limitations in our senior credit facility on making capital expenditures may prevent us from pursuing new business initiatives, which may place us at a competitive disadvantage |
| Our senior credit facility limits the amount of money that we may spend on capital expenditures to dlra35dtta0 million in 2006 and, subject to certain exceptions, dlra17dtta5 million in subsequent years |
| We believe that successful execution of our plan will require us to dedicate substantially all of these amounts to capital expenditures associated with the continuing integration of Hollywood and Movie Gallery and required maintenance capital |
| Accordingly, we will be unable to make capital expenditures in order to open or acquire a significant number of new stores or pursue new business initiatives, including investing in an online rental program or other alternative delivery vehicles |
| Our inability to pursue new business initiatives may place us at a disadvantage to our competitors who are not subject to these restrictions |
| If our competitors successfully pursue new business initiatives, these restrictions may limit our ability to react effectively, and our results of operations or financial condition could be adversely affected |
| Uncertainty surrounding our ability to meet our financial obligations has adversely impacted and could continue to adversely impact our ability to obtain sufficient product on favorable terms |
| Since our acquisition of Hollywood in April 2005, we have entered into two amendments of our senior credit facility pursuant to which certain covenants in our senior credit facility were amended or waived |
| This, coupled with the continued declines and uncertainty in the rental industry, has caused negative publicity surrounding our business |
| As a result, our flexibility with our suppliers has been affected |
| We cannot assure you that our trade creditors will not further change their terms for payment on goods and services provided to us or that we will continue to be able to receive products and services on acceptable terms |
| The continuing integration of Hollywood and Movie Gallery may strain our resources and prove to be difficult and may subject us to liabilities |
| On April 27, 2005, we completed our acquisition of Hollywood, which was substantially larger than any of our previous acquisitions |
| The expansion of our business and operations resulting from the acquisition of Hollywood, including the differences in the cultures, strategies and infrastructures of our operating segments, may strain our administrative, operational and financial resources |
| The continuing integration of Movie Gallery and Hollywood will require substantial time, effort, attention and dedication of management resources and may distract management in unpredictable ways from their other responsibilities |
| The integration process could create a number of potential challenges and adverse consequences, including the possible unexpected loss of key employees or suppliers, a possible loss of sales, an increase in operating and other costs, possible difficulties in integrating the information management systems, including point-of-sale, inventory control systems previously maintained by Hollywood and Movie Gallery and the need to modify operating accounting controls and procedures to comply with the Sarbanes-Oxley Act of 2002 |
| These types of challenges and uncertainties could have a material adverse effect on our business, financial condition, liquidity and results of operations |
| Our business could be adversely affected by increased competition, including new business initiatives by our competitors |
| We compete with: - - local, regional and national video retail stores, including stores operated by Blockbuster, Inc, the largest video retailer in the United States; - - internet-based, mail-delivery home video rental subscription services, such as Netflix and, recently, Blockbuster Online; - - mass merchants; - - specialty retailers, including GameStop and Suncoast; - - supermarkets, pharmacies, convenience stores, bookstores and other retailers that rent or sell similar products as a component, rather than the focus, of their overall business; - - mail order operations and online stores, including Amazon |
| com; and - - noncommercial sources, such as libraries |
| Pricing strategies, including Blockbusterapstas "e No Late Fees "e program, for movies and video games are a major competitive factor in the video retail industry and we have fewer financial and marketing resources, lower market share and less name recognition than Blockbuster |
| Other types of entertainment, such as theaters, television, personal video recorders, internet related activities, sporting events, and family entertainment centers, also compete with our movie and video game businesses |
| Some of our competitors, such as online stores, mass merchants and warehouse clubs may operate at margins lower than we do and may be able to distribute and sell movies at lower price points than we can |
| These competitors may even be willing to sell movies below cost due to their broad inventory mix |
| If any of our competitors were to substantially increase their presence in the markets we serve, our revenues and/or profitability could decline, our financial condition, liquidity, and results of operations could be harmed and the continued success of our business could be challenged |
| Our business could be adversely affected if we lost key members of our executive management team |
| We are highly dependent on the efforts and performance of our executive management team |
| If we were to lose any key members of this team, our business could be adversely affected |
| You should read the information under "e Directors and Executive Officers "e for a detailed description of our executive management team |
| Our business could be adversely affected by the failure of our management information systems to perform as expected |
| We depend on our management information systems for the efficient operation of our business |
| Our merchandise operations use our inventory utilization system to track rental activity by format for each individual movie and video game title to determine appropriate buying, distribution and disposition of our inventory |
| We also rely on a scalable client-server system to maintain and update information relating to revenue, rental and sales activity, movie and video game rental patterns, store membership demographics, and individual customer history |
| These systems, together with our point-of-sale and in-store systems, allow us to control our cash flow, keep our in-store inventories at optimum levels, move our inventory more efficiently and track and record our performance |
| If our management information systems failed to perform as expected, our ability to manage our inventory and monitor our performance could be adversely affected, which, in turn, could harm our business and financial condition |
| Our financial results could be adversely affected if we are unable to manage our merchandise inventory effectively |
| Our merchandise inventory introduces risks associated with inventory management, obsolescence and theft |
| While most of our retail movie product is returnable to vendors, our investment in inventory necessary to operate our business increases our exposure to excess inventories in the event anticipated sales fail to materialize |
| In addition, returns of video game inventory, which is prone to obsolescence because of the nature of the industry, are subject to negotiation with vendors |
| The prevalence of multiple game platforms may make it more difficult to accurately predict consumer demand with respect to video games |
| The nature of and market for our products, particularly games and DVDs, also makes them prone to risk of theft and loss |
| Specifically, our operating results could suffer if we are unable to: - - maintain the appropriate levels of inventory to support customer demand without building excess inventories; - - obtain or maintain favorable terms from our vendors with respect to payment and product returns; - - control shrinkage resulting from theft, loss or obsolescence; and - - avoid significant inventory excesses that could force us to sell products at a discount or loss |
| Our business could be negatively impacted if movie studios significantly alter the movie distribution windows |
| Studios distribute movies in a specific sequence in order to maximize studio revenues on each title they release |
| The order of distribution of movies is typically: (1) movie theaters; (2) home video retailers; (3) pay-per-view; and (4) all other sources, including cable and syndicated television |
| The length of the movie rental window varies, but is typically 45 days prior to the pay- per-view release date |
| The movie studios are not contractually obligated to continue to observe these window periods |
| We could be adversely affected if the movie studios shorten or eliminate these exclusive windows, or if the movie rental windows were no longer among the first windows following the theatrical release, because newly released movies would be made available earlier through other forms of non-theatrical movie distribution |
| As a result, consumers would no longer need to wait until after the home video distribution window to view these movies through other distribution channels |
| Some studios have tested concurrent theatrical and home video releases on an experimental basis for certain "e B "e titles in selected genres which could in turn lead to further compression of the window period that home video retailers currently enjoy |
| Changes like these could negatively impact the demand for our products and reduce our revenues and could harm our business, financial condition, liquidity, and results of operations |
| Our business may be negatively impacted by new and existing technologies |
| Advances in technologies that benefit our competitors may materially and adversely affect our business |
| For example, advances in cable and direct broadcast satellite technologies, including high definition digital television transmissions offered through those systems, and the increasing ease of downloading video content on the internet may adversely affect public demand for video store rentals |
| Expanded content available through these media, including movies, specialty programming and sporting events, could result in fewer movies being rented |
| In addition, higher quality resolution and sound offered through these services and technologies could require us to increase capital expenditures, for example, to upgrade our DVD inventories to provide movies in high definition |
| Cable and direct broadcast satellite technologies offer both movie channels, for which subscribers pay a subscription fee for access to movies selected by the provider at times selected by the provider, and pay-per-view services, for which subscribers pay a discrete fee to view a particular movie selected by the subscriber |
| Historically, pay-per-view services have offered a limited number of channels and movies and have offered movies only at scheduled intervals |
| Over the past five years, however, advances in digital compression and other developing technologies have enabled cable and satellite companies, and may enable internet service providers and others, to transmit a significantly greater number of movies to homes at more frequently scheduled intervals throughout the day |
| Certain cable companies, internet service providers and others are also testing or offering video-on-demand, (VOD) services |
| As a concept, VOD provides a subscriber with the ability to view any movie included in a catalog of titles maintained by the provider at any time of the day |
| If pay-per-view, VOD or any other alternative movie delivery systems achieve the ability to enable consumers to conveniently view and control the movies they want to see, when they want to see them, such alternative movie delivery systems could achieve a competitive advantage over the traditional home video rental industry |
| This risk would be exacerbated if these competitors receive the movies from the studios at the same time video stores do and by the increased popularity and availability of personal digital recording systems (such as TiVo) that allow viewers to record, pause, rewind, and fast forward live broadcasts and create their own personal library of movies |
| In addition, we may compete in the future with other distribution or entertainment technologies that are either in their developmental or testing phases now or that may be developed in the future |
| For example, some retailers have begun to rent or sell DVDs through kiosks or vending machines |
| Additionally, the technology exists to offer disposable DVDs, which would allow a consumer to view a DVD an unlimited number of times during a specified period of time, at the end of which the DVD becomes unplayable |
| We cannot predict the impact that future technologies will have on our business |
| If any of the technologies described above creates a competitive advantage for our competitors, our business, financial condition, liquidity, and results of operations could be harmed |
| Our business could be adversely affected if the trend of consumers deciding to purchase rather than rent movies continues |
| Historically, studios priced a number of movies they distributed at pricing which was typically too high to generate significant consumer demand to purchase these movies |
| A limited number of titles were released at a lower price point when consumers were believed to be more likely to have a desire to purchase a certain title |
| The penetration of DVD into the market has resulted in a significant increase in the quantity of newly released movies available for purchase by the consumer |
| These movies are purchased to rent by home video specialty retailers, and to sell by both home video specialty retailers and mass merchants, among others |
| We believe that these changes in pricing have led to an increasing number of consumers who decide to purchase, rather than rent movies |
| Further changes in studio pricing and/or sustained or further depressed pricing by competitors could further accelerate this trend and could result in increased competition |
| If we are not able to derive most of our revenues from our higher margin rental business, our profit levels would be adversely impacted and we may not be able to compete with our competitors for the consumerapstas sell-through dollar |
| Our business could be adversely impacted if movie studios negatively altered revenue sharing programs |
| Prior to studio revenue sharing programs and the advent of DVD, we would typically pay between dlra35 and dlra65 per videocassette for major theatrical releases not priced as sell-through titles |
| Under studio revenue sharing programs, we are able to pay a minimal up-front cost per unit and thereafter pay a percentage of each revenue dollar earned for a specified period of time to the studios |
| We currently utilize these types of programs for a significant number of DVD and VHS movie releases |
| These programs have enabled us to significantly increase the number of copies carried for each title, thereby enabling us to better meet consumer demand |
| After a specified period of time, we offer them for sale to our customers as "e previously viewed movies "e at lower prices than new copies of the movie |
| We could be adversely affected if these programs are changed to give the movie studios a greater percentage of each revenue dollar or if they are discontinued |
| Further, some of our agreements may be terminated on short notice |
| Our gross margins may be adversely affected if the average sales price for our previously viewed product is not at or above an expected price |
| We earn rental revenues from video rentals and from the sale of previously viewed movies to the public |
| We need to sell previously viewed movies at an expected price in order to achieve our gross margin targets |
| Our gross margins may be adversely affected if the number of rentals we expect to generate does not materialize or if the average sales price for previously viewed movies is not at or above our target price |
| A consumerapstas desire to own a particular movie and the number of previously viewed movies available for sale to the public by our competitors are factors that affect our ability to sell previously viewed movies at our target price |
| Additionally, sales of previously viewed movies also compete with newly released movies that are priced for sell-through |
| As a result, there are no assurances that we will be able to sell an appropriate quantity of previously viewed movies at or above the expected price |
| If selling prices for previously viewed movies or previously played games decline, we may be required to write- down the carrying value of our rental inventory |
| The video store industry could be adversely affected by conditions impacting the motion picture industry |
| The availability of new movies produced by the movie studios is vital to our industry |
| The quality and quantity of new movies available in our stores could be negatively impacted by factors that adversely affect the motion picture industry, such as financial difficulties, regulatory requirements and work disruptions involving key personnel such as writers or actors |
| Additionally, we depend on the movie studios to produce new movies that appeal to consumer tastes |
| A decrease in the quality and quantity of new movies available in our stores could result in reduced consumer demand, which could negatively impact our revenues and harm our business and financial position |
| Our revenues could be adversely affected due to the variability in consumer appeal of the movie titles and game software released for rental and sale |
| The quality of movie titles and game software released for rental and sale is not within our control, and our results of operations have from time to time reflected the variability in consumer appeal for such items |
| We cannot assure you that future releases of movie titles and game software will appeal to consumers and, as a result, our revenues and profitability may be adversely affected |
| Our business could be adversely affected if video game software and hardware manufacturers do not introduce new products in a timely manner |
| The video game industry is characterized by the significant impact on consumer spending that accompanies the introduction of new game software and hardware platforms |
| Retail spending in the video game industry typically grows rapidly with the introduction of new platforms but declines considerably prior to the release of new platforms |
| In 2005, Microsoft introduced the XBOX-360 platform and in 2006, we expect new platforms from Sony and Nintendo |
| Consumer demand for video games available in our stores could be adversely affected if manufacturers fail to introduce new games and systems in a timely manner or are unable to make new games and systems available in sufficient quantities |
| A decline in consumer demand for video games available in our stores could negatively affect our revenues and harm our business and financial position |
| Piracy of the products we offer may adversely affect our results of operations |
| The development of the internet and related technologies increases the threat of piracy by making it easier to duplicate and widely distribute pirated content |
| We cannot assure you that movie studios and others with rights in the product will take steps to enforce their rights against internet piracy or that they will be successful in preventing the distribution of pirated content |
| Technological developments and advances of products such as at-home DVD burners also may increase piracy of movies and games |
| Increased piracy could negatively affect our revenues and results of operations |
| The value of our securities may be affected by variances in our quarterly operating results that are unrelated to our long-term performance |
| Historically, our quarterly operating results have varied, and we anticipate that they will vary in the future |
| Factors that may cause our quarterly operating results to vary, many of which we cannot control, include: - - consumer demand for our products; - - prices at which we can rent or sell our products; - - timing, cost and availability of newly-released movies, new video games and new video game systems; - - competition from providers of similar products, other forms of entertainment, and special events, such as the Olympics or ongoing major news events of significant public interest; - - seasonality; - - weather patterns that can significantly increase business (inclement conditions that prohibit outdoor activities) or decrease business (mild temperatures and dry conditions that reduce the consumerapstas desire to relax indoors); and - - acts of God, or public authorities, war, civil unrest, hurricanes, fire, floods, earthquakes, acts of terrorism, and other matters beyond our control |
| Our revenues and operating results fluctuate on a seasonal basis and may suffer if revenues during peak seasons do not meet expectations |
| The home video retail industry generally experiences relative revenue declines in April and May, due in part to the change in Daylight Savings Time and due to improved weather, and in September and October, due in part to the start of the traditional school year and the introduction of new television programs |
| The industry typically experiences peak revenues during the months of November, December and January due to the holidays in these months as well as inclement weather conditions |
| Additionally, revenues generally rise in the months of June, July and August when most schools are out of session, providing people with additional discretionary time to spend on entertainment |
| The game sales business is traditionally strongest in November and December, as title releases are often clustered around the holiday shopping season |
| In view of seasonal variations in our revenues and operating results, comparisons of our revenues and operating results for any period with those of the immediately preceding period or the same period of the preceding fiscal year may be of limited relevance in evaluating historical financial performance and predicting future financial performance |
| Our working capital, cash and short-term borrowings also fluctuate during the year as a result of the factors set forth above |
| Our operating results may suffer if revenues during peak seasons do not meet expectations |
| If revenues during these periods do not meet expectations, we may not generate sufficient revenue to offset increased costs incurred in preparation for peak seasons and operating results may suffer |
| The market price for our common stock may fluctuate substantially |
| We have experienced, and continue to expect, periodic fluctuations in our stock price due to technological advancements, developments concerning our business, our competitors or the home video specialty retail industry, including fluctuations in our operating results, the introduction of new products, the performance of other similar companies, changes in financial estimates by financial analysts or our failure to meet these estimates and other factors |
| In addition, in recent years the stock market has experienced a high level of price and volume volatility, and market prices for the stock of many companies have experienced wide fluctuations that have not necessarily been related to the operating performance of these companies |
| These broad market fluctuations could have a material adverse effect on the market price of our common stock, business, and results of operations or financial condition |
| We cannot assure you that our stock price will not experience significant fluctuations in the future |
| Historically, companies that have experienced market price volatility have been the target of securities class action litigation |
| We could incur significant costs and our managementapstas time and resources could be diverted from the operation of our business if we were the target of securities class action litigation |
| Terrorism, war or other acts of violence could have a negative impact on our stock price or our business |
| Terrorist attacks, as well as the on-going events in Iraq or other acts of violence and civil unrest in the nation and throughout the world, could influence the financial markets and the economy |
| Consumers &apos television viewing habits may be altered as a result of these events such that the demand for home video entertainment is reduced |
| These factors could have a negative impact on our results of operations or our stock price |
| Investor confidence may be adversely impacted as a result of the material weaknesses in our internal controls |
| We are required, pursuant to rules adopted by the SEC under Section 404 of the Sarbanes-Oxley Act of 2002, to include a report of our managementapstas assessment of the effectiveness of our internal control over financial reporting in our Annual Reports on Form 10-K Our management assessed the effectiveness of our internal control over financial reporting as of January 1, 2006, and this assessment identified four material weaknesses in our internal controls |
| A material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| These material weaknesses related to: - - Ineffective management review of account analyses and reconciliations; - - Ineffective communication of accounting policy for capitalizing costs and lack of effective review process; - - Inaccurate or lack of timely updating of accounting inputs for key estimates and assumptions |
| - - Ineffective procurement and receiving processes |
| These material weaknesses could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact market prices for our securities |