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Gallery Displays Improvement, Open to Blockbuster Combo

11 May, 2006 By: Jessica Wolf

Movie Gallery's belt-tightening resulted in a better-than-expected first quarter for the company, and after successfully swallowing No. 2 domestic rental chain Hollywood Entertainment Corp., executives said they weren't averse to combining with No. 1, Blockbuster Inc.

Earnings were $40.3 million for the quarter, up from $18.4 million in the prior-year period. This includes a $6.8 million charge related to rental-amortization estimates and $2.7 million in credit adjustment fees.

Revenue hit $694.4 million, up nearly three times the prior year's $233.8 million. However, overall same-store revenue fell 6.5%, a drop executives attributed to a lack of strong $100 million titles in the video pipeline.

It will be September before the industry sees any big titles, said Joe Malugen, Movie Gallery chairman, president and CEO, though upcoming releases such as Cheaper by the Dozen 2 and Failure to Launch should give the third quarter a boost.

Movie Gallery stock was up nearly 60%, to $5.03, on announcement of its first-quarter results.

Movie Gallery executives, having borne out what seems like the worst of the growing pains from the company's Hollywood acquisition, said they would consider a merger or acquisition with their only remaining major competition in the rental market — Blockbuster.

“We have certainly have always been a leader in the consolidation of this industry,” Malugen said. “We certainly believe that further consolidation is desirable.”

It's something everyone has speculated on, added Thomas Johnson, SVP of corporate finance and business development.

“It makes a lot of sense if you were to put the two companies together,” he said. “I think we would be very receptive. We are going to do what makes sense to create value for our shareholders.”

A Blockbuster spokesperson said the company doesn't comment on rumor or speculation.

It's likely antitrust issues would crop up should a merger between the two chains become more than speculation, Malugen said. Antitrust concerns were raised when both Movie Gallery and Blockbuster originally made bids for Hollywood Entertainment Corp., and that merger went through, he pointed out.

A Blockbuster/Movie Gallery merger likely won't pose any antirust problem given the evolving and increasingly diverse movie delivery options.

“The market is even more different now than it was a year and a half ago,” Malugen said.

Same-store sales at Movie Gallery locations (minus Hollywood) were up 18% for the quarter, compared to a 9.3% decline in 2005, largely due to the company's increased commitment to new sellthrough product, Johnson said.

The chain places a special focus on stocking new “re-release” DVDs at $6.99, $7.99 and $8.99, and expects to be able to sustain same-store sales, Johnson said.

Rentals made up 82% of revenue for the first quarter, down from 92.7% the prior year.

Meanwhile, product sales made up 17.8% of the revenue mix, up from just 7.3% in the first quarter of 2005.

The company is firm on its previously announced plans to lower overhead by eliminating about 300 staff positions, shut down redundant store locations, restructure lease agreements and cut down square footage of existing stores.

The chain opened 70 previously planned new locations in the first quarter and will open 70 more throughout the year.

The company's March deal with Excess Space to lease out portions of stores is starting to bear fruit, Malugen said.

“We have received a higher-than anticipated level of inquiries from retailers, restaurants and business service providers,” he said.

Discussions are underway regarding 1,500 specific store locations, and Movie Gallery already has 22 approved sublease deals and 399 letters of intent, of which 294 are for individual locations.

And the company has more than 50 “nationally branded users” that are interested in deals for multiple locations, Malugen said.

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