Studios eye troubled retailers with caution

Majors trim shipments to Kmart, keep eye on Toys R Us.

By Paul Sweeting and Scott Hettrick -- Video Business, 8/16/2002

AUG. 16 | An unprecedented confluence of circumstances have suppliers grappling with how much product to ship to several financially struggling giant retailers as they head into what is expected to be the industry's biggest fourth-quarter sell-through season in history.

Sources say that multiple studios are threatening to not ship any product to Kmart Stores unless the dealer pays cash upfront. That might be difficult for the mass merchant, which not too long ago represented 7% of the video retail market, and could hasten the dealer's demise.

"I think they're dead," said one studio president. "I don't think they're coming back."

Kmart Corp., which has been operating in Chapter 11 since January, last week filed a motion with a federal bankruptcy court in Chicago for permission to change its loan agreement with creditors and increase the size of the loss it is permitted to report under those loan agreements from $100 million to $400 million.

The company is also seeking an additional $500 million on top of its $2 billion debtor-in-possession line of credit secured after filing for bankruptcy. In a statement relative to the request for a bigger loan, Kmart CFO Al Koch said the company did not project needing to use the additional credit, but wanted to give its vendors greater security that they will be paid.

News of Kmart's request to the bankruptcy court came on the same day that Ames Department Stores, another bankrupt discounter, said it is shuttering all 327 remaining locations and going out of business. Several studios said Ames represents less than 1% of their business, while Kmart has declined to about 3%.

Another struggling retailer, Toys R Us, has also recently become the subject of speculation about a possible slide into bankruptcy. The chain is in the third year of a three-year store-remodeling program meant to address slowing sales and intense competition in the toy business.

Although Toys R Us also represents only about 1% or less for most studios, the retailer represents a significantly larger percentage of business for several suppliers, including Buena Vista Home Entertainment, which sells most of its product to Toys R Us on a direct basis. Other studios funnel most product through Alliance Entertainment and are largely shielded from the Toys R Us credit risk.

Although the company reported positive same-store sales growth in the first quarter of 2002, Standard & Poor's lowered its rating for Toys R Us' long-term debt, raising the prospect that the chain could violate covenants in its credit agreements.

Toys R Us is scheduled to announce its second quarter results on Aug. 19.

In his statement, Kmart's Koch said, "In order to ensure that we are optimally positioned to succeed during the critical holiday season, we are asking our lenders to approve a potential increase in the DIP. Our latest projections show that during the peak seasonal inventory build, we will have more than several hundred million dollars available in liquidity under our DIP facility as currently sized."

Studio sources aren't too worried about making up the loss of a Kmart, which would likely shift to other retailers, but they are not excited about Wal-Mart Stores picking up several additional points of market share if Kmart were to collapse.

"We would like to have seen things look a lot better [at Kmart] by now, and we're disappointed that they don't, but we're working very hard to try to continue doing business with them," one senior studio executive said. "We still plan to ship them this fourth quarter, but we're looking very closely at their orders, in some cases cutting the number back to what we think is appropriate."

Buena Vista and Universal Studios Home Video are two studios said to be considering bypassing Kmart with their biggest upcoming releases without an upfront payment. Others say nearly all suppliers are considering the same thing. However, some believe the threats are little more than that at this time.

"I believe there is always some lost business when you don't ship them product," one studio executive said. "The guy who goes to Kmart to buy a Ping-Pong table and also picks up [a movie] because it's there, that's an impulse buy, and he's not going to drive to Wal-Mart to buy it because he didn't see it at Kmart."

Another studio executive said if consumers don't go to Kmart they will go to a Wal-Mart store, which he said are within five miles of almost every Kmart. And they will make their impulse purchase there.

"We market to consumers, not to Kmart," the executive said.

Meanwhile, the studios are keeping a close eye on early sales of such expected blockbusters as Warner Home Video's Harry Potter and the Sorcerer's Stone and New Line Home Entertainment's The Lord of the Rings: The Fellowship of the Ring.

With sales of those titles starting more slowly than many in the industry expected, other studios are giving second thoughts to how many copies they need of their own big titles.

Neither Harry Potter nor Lord of the Rings set first-week sales or rental records even though they were the biggest theatrical movies of last year with more than $310 million each. Competitors estimate Harry Potter will top out on video with sales of 16 million to 18 million units, while Lord of the Rings will top out at 14 million to 15 million units, considerably below the all-time best-selling titles. Warner and New Line declined to comment on their sales figures or the estimates of others.

"At one time, it looked like there were so many big titles that there wouldn't be enough [replicating] capacity to build them all, but now we're starting to cut our order back a little bit, and by that I mean all the studios," one executive said. "It's still going to be a great fourth quarter, but maybe not quite as great as it looked at one time."