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Gallery Annual Report Shows Chains Won't Go Online Rental Route

24 Mar, 2006 By: Jessica Wolf

As Movie Gallery treads the troubled waters of improving its bottom line, online rentals aren't likely to be part of the solution for the No. 2 rental chain.

Movie Gallery President and CEO Joe Malugen said March 23 in the company's fourth-quarter and year-end earnings call that he estimates the online business to only be about 8 million or 9 million subscribers strong, without much growth beyond that number.

“The studios agree that's about the size of it,” he said. “We believe to fight over 8 million or 9 million subs is a business that no one is going to make any money at.”

Meanwhile, sales of previously viewed product give the company a “competitive advantage” over mass-market retailers, according to a comprehensive year-end report Movie Gallery filed with the Securities and Exchange Commission March 24.

Previously viewed sales of VHS, DVD and game-rental stock made up 14% of the chain's revenue in 2005, the same as 2004 and up a bit from 2003's 12%

DVD rentals made up 54% of revenue in 2005, down a bit from 2004, when DVDs generated 58% of revenue. VHS revenue percentage took a big dive for the second year, dropping from 12% of Movie Gallery's revenue mix in 2004, to 7% in 2005. In 2003, VHS rentals were 32% of the chain's revenue and DVD made up 38%.

New movie product sales made up the smallest portion of revenue for the chain in 2005, at 3%.

Game rental revenue's part of the pie fell a bit too, from 8% in 2004 to %7 last year.

With the company's acquisition of Hollywood Video's Game Crazy stores, sales of new and used game increased its chunk of Movie Gallery revenue by more than tenfold to 11% last year from 1% in 2004.

The fate of the Game Crazy store concept is still up in the air for the beleaguered Movie Gallery. The company isn't ruling out selling off the segment, but isn't aggressively pursuing a buyer either.

“I don't think we would generate as much value disposing of it today over holding on to it and doing some kind of an IPO in 2007,” said Tom Johnson, SVP of corporate finance and business development at Movie Gallery. “But if the right offer were to present itself we would act on it accordingly.”

The game segment of the video market has life in it, the company said in its filing. Major manufacturers such as Sony and Nintendo are releasing new gaming platforms this year.

Pricing on new game software hasn't eroded like the DVD market, and this has kept the value of legacy games for older systems high as well, for trading and used sell off.

Company executives said Movie Gallery plans to limit new store openings in 2006 to the 140 already scheduled. March 24's report adds that Movie Gallery expects to also purchase 20 Hollywood Video stores and 17 Game Crazy stores currently owned by Boards Video Company LLC.

Movie Gallery also reported it is carrying nearly $1.2 billion in debt. While the company has secured some leeway with its senior credit facility thanks to a covenant amendment announced March 15, this relief stops at the end of the year and Movie Gallery reported it will likely not be able to comply with its first quarter covenants unless the company procures more amendments or gathers some equity financing before then.

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