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UPDATE: Movie Gallery Posts Strong Sales

26 Oct, 2001 By: Joan Villa

While much of the retail economy languishes, Movie Gallery presented a bullish outlook on the video industry, reporting a nearly 15% increase in quarterly revenues to $86.5 million, a 5.6% boost in same-store sales and plans to open at least 125 new stores next year.

Adjusted earnings before interest, taxes, depreciation, amortization and non-recurring items (EBITDA) climbed 25.6% to $9.57 million for the quarter ended Sept. 30, on an 11% higher store base of 1,082 locations. Pro forma net income, excluding a $2.4 million non-cash charge for compensation resulting from variable stock options, jumped 392% to $2.76 million from $561,000 in the year-ago quarter.

“The adjusted EBITDA we generated through the first nine months of the year is more than our debt, net of cash, at the end of the third quarter,” chairman and c.e.o. Joe Malugen said.

In a conference call with analysts, Malugen credited the expansion of DVD — now at 14% of rental revenue — for stimulating same-store sales and providing higher-margin product. DVD is expected to reach 20% of rental revenue by year-end, he added.

“We are increasing DVD as well as maintaining appropriate levels of VHS” to meet consumer demand in the chain's primarily rural and secondary market locations, he said.

However, Malugen also acknowledged that this year's third-quarter video titles totaled 35% higher theatrical box-office receipts than last year and also lacked competition from 2000's Summer Olympics. Malugen says the Sept. 11 attacks had virtually no effect on sales, but he anticipated a growing “sense of family togetherness” combined with the current economic slowdown could stimulate video rental results in coming months.

“We were fortunate to see little or no impact on sales from this tragic event except on the 11th,” he explained. “Since the attack we have seen generally higher traffic in our stores.”

In the fourth quarter, the Dothan, Ala.-based chain is projecting same-store sales in “low single digits,” based on strong releases such as Shrek, The Grinch, Rush Hour 2 and Pearl Harbor, that have virtually the same box-office clout as last year's titles. In addition, the quarter will contain 14 weeks instead of the usual 13, expected to add “approximately 5 cents of earnings to fourth quarter results given the high level of revenue that is generated” during that final week of the year, he noted.

As a result, Movie Gallery raised earnings projections for the fourth quarter to the range of 26 cents to 31 cents per share versus 18 cents in the year-ago quarter, and pro forma earnings per diluted share for the year in the range of 87 cents to 92 cents compared to 55 cents for fiscal 2000. In 2002's first quarter, the chain will adopt accounting standards that eliminate the amortization of goodwill, expected to boost net income by $3.5 million per year.

Analyst Bob DeLean with Morgan Keegan says the results contained “no surprises” and even delivered pro forma earnings about 4 cents per share higher than he expected primarily due to higher margins on DVD product and previously-viewed movie sales.

“Those trends should continue,” DeLean says. “The big question overhanging this industry is how do the studios fight back with DVD pricing and rev-share? The studios are in a box, they came out with one pricing structure for DVD and now they're leaving money on the table and how do they fix that?”

If the DVD format shifts to rental pricing and a revenue-sharing model, DeLean believes Movie Gallery's earnings won't be heavily impacted, depending on which pricing structure the studios propose. “That's a risk,” he adds. “There's only so much revenue to go around, so if the studios are going to demand more, somebody's going to get less.”

So far, Movie Gallery hasn't said when it will add accretive earnings from the anticipated acquisition of 300-store Video Update, slated to become a fully-owned subsidiary of Movie Gallery when it emerges from bankruptcy. But the confirmation hearing, slated for Oct. 31, will likely be continued, according to c.f.o. J. Steven Roy.

Roy said a report by the unsecured creditors committee, investigating previous Video Update officers for possible fraud before and during bankruptcy, is delaying Movie Gallery's access to the financials it needs to audit the company and complete the acquisition.

Michael A. Bloom, of Morgan, Lewis & Bockius and counsel for the creditors committee, declined to elaborate on the nature or progress of the investigation. However, he believes the hearing to confirm the reorganization plan will be pushed back about 30 days at the request of Movie Gallery and Video Update.

“To my knowledge, the request had nothing to do with the committee's special investigation,” Bloom says. “From the creditors' standpoint, we are hoping for as short a delay as possible.”

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