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Movie Gallery Posts Loss, May Miss Debt Payments

22 Jan, 2007 By: Jessica Wolf

Movie Gallery's third-quarter results are bleak, as net losses mount and the chain's $1.1 billion in debt looms.

The No. 2 rental chain has finally fully accounted for its third quarter, and reported a net loss of $36.1 million for the period ended Oct. 1, 2006. That's compared to a $12.5 million loss in third-quarter 2005.

Still, revenue for the quarter was $583 million, up 1.8% over the prior year's $572 million.

Movie Gallery was in arrears in its financial reporting for the quarter due to an accounting audit relating to how the chain assigns costs associated with store closures and end-of-lease agreements. Part of the quarter's net loss — $18.3 million — is pre-tax, mostly non-cash charges attributed to that accounting change in store closures as well as restructuring efforts and stock compensation expenses.

Overall same-store sales were flat, drooping 0.4% over third-quarter 2005, thanks to increases at Movie Gallery-branded locations that helped mitigate Hollywood Video stores declines.

Same-store sales at Movie Gallery branded locations increased 3%, compared to a 1.9% decrease for the Hollywood stores.

The company closed 101 stores in the 13 weeks ended Oct. 2, according to the quarterly report.

Movie Gallery's stock squeaked up a bit last week after the filing, ending up 0.8% at $3.54 Jan. 25, after weeks of wild fluctuation and a recent drop to near de-listing levels.It's the chain's $1.1 billion in debt, which the company already has restructured twice, that hangs over it like the Sword of Damocles, analysts say.

In a note Wedbush Morgan sent to investors shortly after Movie Gallery's filing, analyst Michael Pachter ranked the chain at a “hold” rating, warning investors that the company's cost-cutting efforts aren't keeping up with revenue declines and that Gallery will easily fall behind in its debt payments this year.

“We expect the company to satisfy its debt covenants for the remainder of 2006, but believe it will be in violation beginning in the first quarter of 2007,” Pachter wrote.

According to Gallery's filing, it will be in breach of its debt covenants by April 1, unless the chain can negotiate another amendment to its credit structure or come up with some added capital from other sources such as store subleases.

Store subleasing and space reductions will help, Pachter wrote, but won't contribute significantly until the end of 2007, and by then, the chain will be behind on its debt payments.

Movie Gallery has promised to announce in mid-February more capital restructuring plans along with fourth-quarter and fiscal 2006 results.

As long as Movie Gallery can make its interest payments, it may stay out of bankruptcy, J.P. Morgan analyst Barton Crockett told Reuters news service last week.

The subject even came up in Netflix's earnings call last week.

Netflix CEO Reed Hastings said a Movie Gallery bankruptcy would have little effect on the leading online rentailer.

“I don't know if Movie Gallery will file Chapter 11 or not, but it doesn't matter. They'll keep operating the stores, even if they do,” Hastings said. “We don't think there will be much commercial effect.”

It is likely, however, Pachter told investors, that both Netflix and Blockbuster Inc.'s high profile and largely successful efforts to boost online rental subscriber bases will migrate consumers away from Movie Gallery.

“We believe that recent significant increases in overall online movies subscriber growth at Blockbuster and Netflix have largely come at the expense of brick-and-mortar stores,” Pachter wrote. “Without an online service of its own, we believe that Movie Gallery will continue to lose market share, resulting in weak rental comps going forward.”

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