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Movie Gallery to Bow Online Rental Service

19 Mar, 2007 By: Erik Gruenwedel

Pressed by internal research that found increasing numbers of its customers were using online movie rental services, executives at No. 2 movie rental chain Movie Gallery Inc. said the company would launch an online service by this summer.

Details for the so-called Friends & Family service were sketchy as Joe Malugen, chairman, president and CEO of Gallery told investors, in a conference call, that the online service would part of several digital initiatives, including retail kiosks and the recent acquisition of VOD service Moviebeam.

“Our plans for [Friends & Family] are to provide a low-cost model that will provide additional customer convenience and satisfaction,” said Malugen.

He said the Gallery would not spend “outrageous” advertising dollars announcing this service nor would it spend significant dollars to acquire customers in the online environment.

The move was prompted in part by an internal survey that found that 10% of Hollywood's frequent customers (2% for Gallery customers) used an online service, which resulted in an 18% drop for the fiscal year in catalog rentals (older than 12 months).

Malugen said deep discounts by rival online rental services (Blockbuster and Netflix) had had both an impact on Gallery's business and served as a catalyst to enter the online fray.

“There is certainly some success in deep discounting to get customer shares ,but the concern is that the customer you acquire through giving away things for free is always the worst customer to acquire because they are always disloyal,” said Malugen.

Media analyst Michael Pachter with Wedbush Morgan Securities in Los Angeles said Gallery had provided too few details on the online service to determine its viability.

“I am skeptical that it will have much impact,” said Pachter.

The video rental chain continues to find ways to stay alive following its ill-fated $1.2 billion acquisition of Hollywood Video two years ago.

Since that deal, the company's stock has plummeted more than 80%, from around $30 per share to less than $5. Last summer, an industry tip sheet named Gallery as one of 12 companies likely to default on its bond debt.

In addition to store closures, Gallery acquired video-on-demand (VOD) service Moviebeam and two weeks ago entered into a new, five-year, $900 million senior secured credit facility, which includes $100 million in revolving credit and more favorable interest terms.

Thomas Johnson, Gallery EVP and CFO cautioned that the “liquidity” from the revamped credit facility, which helped underwrite the $10 million Moviebeam deal, would be used prudently.

“We want to make it perfectly clear that we will be extremely disciplined in deploying capital on behalf of our stakeholders,” said Johnson.

Gallery chairman, president and CEO Joe Malugen said the company doesn't expect to spend much more than the purchase price on Moviebeam in 2007.

The set-top box enabled service features about 100 movies, including about 10 new titles per week.

Malugen said Internet-based download services that offer movies to the PC represent a “niche” business that would be difficult to deliver high-definition content compared to Moviebeam, which he said could better accommodate HD.

He said the service's VOD option would be updated to include other commerce options.

“Essentially, this service creates the ability for consumers to have their own individual movie store in their living room,” said Malugen.

He said the company plans to expand the current 74 Hollywood Video-branded movie rental kiosks in operation at super markets by more than 200 kiosks this year.

He said Gallery continues — through third-party subleases — to downsize average Hollywood Video store space from 6,600 square feet to 4,000 square feet and Gallery stores from 4,200 square feet to 3,000 square feet.

The CEO said implementation of store footprint had been slower than expected in 2006 due to fiscal restraints and the seasonality of the video market.

“With the negative press that was overhanging the company, many landlords took a ‘wait-and-see' approach to see whether we would be able to refinance our credit facility,” Malugen said.

For the fourth quarter (ended Dec. 31), Dothan, Ala.-based Gallery posted a $15.1 million loss, compared to negative income of more than $546 million during the same period in 2005.

Same-store revenues (open at least a year) for the quarter fell 2.9% due in part to a 4.1% drop in comp sales at subsidiary Hollywood Video stores. Overall revenue fell 1.9% to $663.3 million.

For the fiscal year 2006, same-store revenue dropped 3.7%, which included a 5.4% decline at Hollywood stores.

Fiscal year revenue increased 25% to $2.5 billion from $2 billion last year. Hollywood stores contributed $1.35 billion followed by Gallery with $871 million and in-store Game Crazy segment with $325 million.

Gallery incurred fiscal year 2006 charges of $11.1 million due to shuttering 230 total stores including its Mexican operations.

The chain operated about 2.3% fewer stores (4,642) in 2006 than it did the previous year (4,729).

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