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Tough Times for Movie Gallery

12 Aug, 2005 By: Holly J. Wagner

Movie Gallery stock took a pounding Friday after executives announced an 8.4 percent decline in same-store rentals and that the chain lost $12.2 million in the second quarter ended July 3.

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

The stock plummeted $1.89, or nearly 10 percent, to $19.47 in early trading, even as executives addressed analysts on the company's quarterly call.

The second-quarter results include 10 weeks of Hollywood Video's results and 13 weeks of Movie Gallery's results because of the merger that created the second-largest rental chain in late April.

"During the quarter we were delighted to complete our acquisitions of both Hollywood Entertainment and VHQ," said chairman, president and CEO Joe Malugen. "Having said that, we were disappointed to see that our same-store revenues in both the rural and urban markets were adversely impacted by what many experts are now characterizing as the worst box-office slump in more than two decades. Coming into the quarter, we were expecting our same-store revenues to be down slightly. However, with the month of June down considerably more than anticipated, we experienced a 5.5 percent decrease in same-store revenues for the second quarter of 2005.

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, War of the Worlds, Mr. and Mrs. Smith and Fantastic Four.

Total quarterly revenues for the combined company were $504.7 million, compared to Movie Gallery's stand-alone revenues 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 write-off 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.

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.

"We have already made significant progress in integrating the two companies and we remain committed to moving quickly to realize the benefits of this winning combination. While it is premature to give specific guidance at this time, we continue to believe in our ability to generate sustainable growth while producing consistent profitability now that the acquisition is complete," Malugen said.

Thomas Johnson, Movie Gallery's SVP of Corporate Finance and Business Development who is managing the integration, for which efforts to date have focused primarily on selecting a leadership team for and consolidating the support functions in all three operating segments. This top-level consolidation is complete for the Human Resources, Real Estate, Legal, Lease Administration, Finance, Information Systems, Loss Prevention and Distribution, and resulted in the elimination of almost 60 positions.

Movie Gallery same-store revenue decreased 8.1 percent for the quarter and 3.2 percent; year-to-date. Same-store rental revenue declined 8.7 percent in the quarter and 2.9 percent year-to-date; same-store product sales declined 1.2 percent in the second quarter and declined 5.6 percent for the first half.

The addition of Hollywood operating segment revenue for the thirteen weeks and twenty-six weeks ended July 3, 2005 accounted for 97.0 percent and 88.4 percent, respectively, of the total revenue increases.

Hollywood total same- store revenues were 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 provided for Hollywood are for the full 13 weeks and 26 weeks ended July 3.

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