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Movie Gallery Stays Hopeful

18 Aug, 2005 By: Holly J. Wagner

Movie Gallery executives remain optimistic about the rental business despite its recent knocks and a weak slate of theatricals. But chief Joe Malugen used the chain's second-quarter financial call to rail against the subscription model, which many see as the salvation of rental.

“While some may take our disappointing results this quarter as an indication that we are under attack from mass merchants and new technologies, I want to tell you again today that this is simply not the case,” said Malugen, the chain's chairman, president and CEO.

He told analysts that in markets where the chain has tested $1-a-night rentals, “our rental transactions increased over 70 percent. Our active customers went up 24 percent. This simply proves my point: People are happy to come to the video store, and they will buy more if you give the product away.”

Movie Gallery and Hollywood Video stores competing head-to-head against Blockbuster Video stores have felt little impact from that chain's “no late fees” policy, he added, saying that depleted stock at Blockbuster stores sends customers back to his chain.

The stock market punished Movie Gallery after executives Aug. 12 announced an 8.4 percent decline in same-store rentals and that the chain lost $12.2 million, mainly because of one-time charges related to the Hollywood Entertainment Corp. acquisition, in the second quarter ended July 3.

Executives blamed the weak release slate, Hollywood's lower margins from deeper stocking, and bigger-than-expected drops in same-store movie rental revenue and previously viewed product prices.

Second-quarter results include 10 weeks of Hollywood's results and 13 weeks of Movie Gallery's results as a result of the merger that in late April created the second-largest rental chain.

Same-store total revenue was down 5.5 percent for the second quarter and 0.3 percent year-to-date; same-store rental revenue dropped 8.4 percent in the quarter and 2.7 percent year-to-date.

“We believe that this softness is temporary and expect rental demand to rebound in the fourth quarter,” Malugen said, pinning his hopes on titles like Batman Begins, Star Wars: Episode III — Revenge of the Sith, War of the Worlds, Mr. & Mrs. Smith and Fantastic Four.

Total quarterly revenue for the combined company was $504.7 million, compared to Movie Gallery's stand-alone revenue of $189.6 million in the second quarter of 2004. Net loss for the 2005 second quarter was $12.2 million, including $6.6 million in late fees after conforming Hollywood's revenue-recognition method to Movie Gallery's method.

The company had noted in earlier filings with the Securities and Exchange Commission (SEC) that Hollywood was booking late-fee revenue when it was incurred, and Gallery books them when they are collected.

The company also took a $5.9 million charge related to a change in accounting estimate for VHS residual value and a one-time cash charge of $2.5 million related to the writeoff of merger-related bridge financing fees. In addition, net loss for the second quarter includes $10 million after-tax in interest expenses related to the new credit agreement to fund the acquisitions of Hollywood and smaller businesses.

Analysts are still disappointed that the rental chains are not providing guidance for the rest of the year.

“We believe that the precipitous decline in value for Movie Gallery shares is directly attributable to management's decision not to provide such a signal,” said Wedbush Morgan Securities analyst Michael Pachter. Without help from the management, Pachter anticipated a year-on-year 7 percent decline in rental comps for the third quarter and a 4 percent decline in the fourth quarter.

Blockbuster executives had earlier revoked their prior guidance for the rest of the year and declined to offer a revised outlook.

Movie Gallery plans to maintain the Hollywood store format and brand separately from the Movie Gallery business. Gallery closed 50 unprofitable Game Crazy stores and is beginning to re-brand Movie Gallery's 23 Game Zone stores under the Game Crazy brand.

The chain also is testing DVD vending machines with a 1,000-disc capacity to extend store hours and reduce overhead.

Hollywood total same-store revenue was down 4.4 percent for the quarter and up 0.9 percent year-to-date; same-store rental revenue dropped 8.2 percent for the quarter and 2.7 percent year-to-date. Same-store product sales increased 12.9 percent in the quarter and increased 16.6 percent for the year-to-date period in 2005. The growth in Hollywood same-store product sales was attributed to the strength of the in-store Game Crazy departments. The same-store revenue percentage changes given for Hollywood are for the full 13 weeks and 26 weeks ended July 3.

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