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Movie Gallery Lenders Extend Default Deadline

16 Aug, 2007 By: Erik Gruenwedel

Facing default proceedings with creditors and possible insolvency, Movie Gallery Inc. didn't blink and instead extended its forbearance agreement with lenders to Aug. 27.

The No. 2 domestic video rental chain recently warned it had incurred significant losses in the second quarter (ended July 1), raising doubts it could meet its debt requirements and continue operations.

Gallery lost $325 million in the second quarter, compared to $25 million during the same period last year, according to a filing with the Securities and Exchange Commission. Revenue fell 6% to $561 million, from $601 million last year.

In the filing, the company said non-compliance with its debt requirements resulted in vendors, including studios, restricting credit terms in favor of up-front payment or cash-on-delivery.

Gallery had originally extended until Aug. 14 a forbearance agreement with senior lenders after disclosing poor quarterly sales and less than $50 million in liquidity. The company's financial disclosure made it likely it wouldn't meet those obligations, and analysts warned creditors could begin foreclosure proceedings.

Separately, the company Aug. 1 sold an empty warehouse originally built as a distribution center to an investment group in Dothan, Ala., for an undisclosed amount.“They are not quite dead yet, but they are definitely passed out,” said Michael Pachter, analyst with Wedbush Morgan Securities in Los Angeles.

He said Gallery was beyond the point financially where current management could save it.

Joe Malugen, chairman, president and CEO of Movie Gallery, said the forbearance extension allows the company to continue operations without interruption.

“Despite the challenging market conditions for Movie Gallery and the entire rental industry, we are continuing to work with our lenders and our outside advisors to help address the company's current financial situation,” Malugen said in a statement.

Dothan-based Gallery, which operates more than 4,500 stores, has been struggling since it outbid No. 1 Blockbuster Inc. in 2005 and paid $1.1 billion to acquire then No. 2 Hollywood Video.

Subsequent flat years in the DVD movie rental business, coupled with Blockbuster and Netflix Inc.'s successful establishment of an online DVD rental market, crippled Gallery, which had no online component.

“They cut their wrists when they bought Hollywood,” Pachter said. “They didn't cut the [major] arteries and have been slowly bleeding to death ever since.”

Pachter said he envisions Gallery resurfacing, after the dust settles, as a rural DVD rental chain with Hollywood Video locations severely reduced.

He wondered who would bail out the company, considering the current credit crunch among private equity firms, which he said often step in when conventional forms of capital are unavailable.

“I don't see the same landscape for a private equity firm buying even the Movie Gallery-branded stores, which are probably well performing stores,” Pachter said. “I don't know who would buy them.”

He said the upside to Gallery's woes means fewer movie rental locations, resulting in a net benefit to Blockbuster, Netflix and independent video stores.

“Everybody who stays in business, including the mom-and-pop operations, will pick up business,” Pachter said.

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