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Blockbuster Stock Plummets On Revised Forecast

18 Dec, 2002 By: Holly J. Wagner

A major sellthrough Christmas, falling rentals and a holiday sellthrough release slate fatter than Santa Claus grounded Blockbuster's stock today as the chain slashed its fourth quarter earnings forecast in half, sending its stock into a more than 30 percent drop.

"Although our results will be lower than anticipated, we expect to deliver record revenues during the fourth quarter and the best same store sales performance of the year," said Blockbuster Chairman and CEO John Antioco.

Blockbuster shares lost more than $6, closing at 13.13, on the news that post-Thanksgiving rentals had slowed dramatically as DVD lured consumers to shift to buying titles as gifts rather than spending on rentals.

"The strong rental transaction growth we experienced in the early fall slowed significantly beginning Thanksgiving, causing shortfalls in both revenues and gross profit dollars,” Antioco said. “We believe this is largely due to a number of factors unique to this holiday season, including the unprecedented number of movie titles available for sale at deeply discounted prices, this year's DVD gift-giving phenomenon and a compressed holiday season which has limited consumers' leisure time. Based on our positive trends before the holiday selling season, we believe the degree of the impact on rental should be temporary although we will be in a better position to evaluate this when more normal conditions return during the first quarter of next year."

Big Blue expects full year 2002 revenues to exceed $5.5 billion and result in gross profit dollar percentage increases in the low-single digit range and earnings per share of $1.03 to $1.10. The chain also expects high single-digit same-store revenue percentage increases and low single-digit gross profit dollar percentage increases.

Blockbuster had expected that fourth quarter same-store revenue percentage increases would be in the low to mid-teen range, with gross profit dollar percentage gains in the mid- to high single digits. For the full year 2002, gross profit dollar percentage increases were expected to be in the mid-single-digit range, and earnings per share were expected to increase 30 percent to approximately $1.31 versus 2001 cash EPS, excluding charges, of $1.01.

The chain's expected ace in the hole is that the biggest two weeks of the video rental and retail season remain in the year and results could differ from present expectations. The company will update 2003 guidance early in the new year.

Blockbuster spokesman Randy Hargrove noted discounting has been particularly severe this holiday season, saying that titles with a wholesale cost of $17 to $18 can sell for $14 to $15. “We're talking about deep discounts, that's what we're talking about,” he said.

The period saw an unusual number of highly collectible titles released on DVD that had consumers opening their wallets, including Star Wars: Episode 2—Attack of the Clones,Lilo & Stitch, Spider-Man and Men in Black 2.

“When you get into the first quarter [next year], you're going to see the trend skew more to rental,” Hargrove said. “With all these collectible titles people are purchasing, it's causing rental transactions to drop.”He also said that retail sales should be up 30 percent to 40 percent in the fourth quarter.

Shortly after Blockbuster's announcement, independent industry analyst Dennis McAlpine issued a note in which he revised his estimate for the company's fourth quarter downward to 20 cents per share from a previous 40-cent estimate. He also dropped his full year estimate to $1.35 from $1.55.

The chain's aggressive push into lower profit margin retail sales may have exacerbated the situation, he wrote. Blockbuster's Hargrove said the chain does not break out gross profit margins for rentals and sales. However, McAlpine estimates that gross margins on rentals are in the mid-60 percent range and retail margins are in the 20 percent range.

He expects Blockbuster's stock price to drop further.“We expect the stock will be hurt near-term, particularly given the paucity of details so far and the apparent strength of Blockbuster's competition,” he wrote. “We are maintaining our Hold rating but expect that the stock could drop enough to move into a Buy range. At this point, we expect substantial volatility until the various issues are clarified.”

Meanwhile shares of the No. 2 and 3 chains, Hollywood Entertainment Corp. and Movie Gallery, also lost in sympathy, even though those chains reiterated their earlier guidance. Hollywood dropped more than 14 percent to close at 16.48 and Movie Gallery also fell 17 percent to 15.05.

Both chains said they would meet their previous earnings guidance, but also reported a downward trend in rentals.

"As previously announced, we continue to focus on our core business of rental, both movies and games,” Hollywood CEO Mark Wattles said. “We believe that consumer interest in rental products will continue to grow as a result of the higher quality of DVD and have merchandised our stores accordingly. Contrary to what is being assumed in the market we anticipate reporting strong sales growth in our core rental business."

Movie Gallery reported its same-store revenue since Thanksgiving trending toward the low end of its forecast, but hanging on and also pinned its hopes on the last two weeks of the year.

“The company continues to evaluate the impact of a change in its merchandise mix between DVD and VHS inventory on its amortization method of rental inventory. Any change in the company's amortization method of rental inventory would result in a significant non-cash charge in the quarter in which the change occurred.”

The statement suggests that rural market ruler Movie Gallery will soon follow suit behind its larger competitors, which have already revised the way they amortize VHS.

McAlpine said Hollywood Entertainment “does not seem to have this same problem” as Blockbuster, noting that the nation's No. 2 rentailer on Dec. 3 had raised its guidance, estimating a fourth quarter same store sales increase of 12 percent, based on strong sales through Thanksgiving week.
B“Of course, conditions may have changed for Hollywood in the last few weeks and they could have another update to make,” he said.

As for Movie Gallery, that chain has remained mum as investors have awaited the Dothan, Ala.-based rentailer's decision on switching to a more conservative accounting policy. That announcement is expected to come shortly after the New Year, McAlpine wrote in his report.

“We expect both of these stocks will also be subjected to selling pressure until they clarify their recent experience,” McAlpine wrote. “Remember that Hollywood has been pushing more into video games sales that could mask weakness in the video rental area. Obviously there is more to come and we urge caution among holders, both current ones and prospective ones, of these stocks.”

Shares of online rentailer Netflix lost 13 percent, closing at $10.99.

(Additional reporting by Joan Villa and Enrique Rivero)

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