Blue, Gallery cut staff to reduce costs

Blockbuster-Universal stalemate develops

By Paul Sweeting -- Video Business, 10/28/2005

OCT. 28 | With the long slump in the rental market deepening, the nation’s two largest video rental chains are cutting staff, scrambling for debt relief and taking other cost-saving measures to position themselves for potential turnaround.

Blockbuster said this week it had approached its banks for the third time this year about modifying the terms of its loan agreement to give the retailer greater financial flexibility.

The company previously announced it would be in compliance with covenants in its loan agreement for the third quarter that require the retailer to report at least $45 million in operating cash flow for the period. But the new talks with its banks suggest the retailer does not expect to hit its cash flow target of $205 million for the fourth quarter.

Also this week, No. 2 retailer Movie Gallery said it was laying off about 100 headquarters staffers as part of a cost-cutting drive in the face of flagging rentals. The retailer had previously said same-store rental revenue for the third quarter fell 10% from the same period a year earlier.

The respective announcements sent the shares of both companies plunging, though both stabilized by week’s end.

Meanwhile, the apparent cash squeeze at Blockbuster has put the retailer at odds with studios concerned about the company’s ability to make payments on a timely basis. Most studios have worked out new payment schedules with Blockbuster to allow the chain to continue buying new releases at competitive studio levels. But one supplier, Universal Home Entertainment, has refused to relax its terms.

As a result, Blockbuster has passed on some recent Universal titles, such as Carlito’s Way: Rise to Power and Land of the Dead, and has bought light on others, such as The Interpreter and Unleashed.

“It’s very hard to put our money into Universal titles when other studios are more willing to work with us,” said Nick Shepherd, Blockbuster president, North America.

The cutbacks at Blockbuster and Hollywood come as the rental market is contracting faster than many expected.

“Our industry continues to face significant challenges, including the worst box office slump in more than two decades,” Movie Gallery chairman-CEO Joe Malugen said in announcing the staff cuts. “While we are hopeful that the fourth quarter will begin to show some improvement due to the release to video of several box office hits, the profound softness in our market requires us to take a hard look at our cost structure.”

The company said it will consolidate all corporate finance, accounting, treasury, logistics and other headquarters functions in the Portland, Ore., headquarters of its Hollywood Video operation. As a result, staffers in those departments in Movie Gallery’s Dothan, Ala., offices will be pinkslipped.

“This decision was a difficult one, but we believe that it will enable us to reduce expenses, leverage the company’s purchasing power and streamline the organization to drive top-line results,” Malugen said.

Blockbuster has not announced a formal plan for layoffs, but the chain has instituted sharp cutbacks in staffing hours in its stores. The chain also has said it will seek to raise additional capital to fund ongoing operations and pay down debt.

The company did not announce how much capital it hopes to raise. But a Standard & Poor’s publication last week, citing lender source, reported that Blockbuster hopes to raise $150 million in the form of convertible, subordinated notes.

“I think it’s really a guns or butter situation for Blockbuster,” independent equity analyst Dennis McAlpine said. “They can use their cash to continue to invest in what they’re doing to try to turn their business around, or they can use it to keep the banks happy, but they can’t do both.”

Part of that investment in turning things around involves heavily promoting its Blockbuster Online subscription service. The company recently began pushing store employees to sell online subs to keep pace with online rival Netflix.

“The company has embraced this like a religion, and the pressure to sell [online subscriptions] at the store level is enormous,” a Blockbuster store manager said.

Shepherd acknowledges employee complaints but maintains the company has no choice.

“There’s a certain amount of self-selection going on,” he said. “You have [Blockbuster] customers who have made a decision to switch to online or are inclined to do it, and I’d rather they go to Blockbuster Online than to Netflix.”

The worst outcome for Blockbuster, according to Shepherd, is for customers to use its stores to rent new releases but to rely on Netflix for everything else.

“Our economics, our margins, are much better on catalog than on new releases, so I’m not willing to concede that business to Netflix,” he said.

Another challenge for Blockbuster has been maintaining competitive levels of new release inventory, as cash remains tight and the retailer’s elimination of late fees has added strain on store stocks.

Earlier this year, indications of a severe cash squeeze at the retailer led studios to tighten up on payment terms for Blockbuster and put a lid on its credit limits. Since then, the chain has worked out accommodations with most studios, but Universal has taken a tougher line.

A source said the studio has refused to extend the retailer additional credit to purchase new releases until it pays down a proportional amount of its outstanding receivable. That has effectively put Blockbuster on a pay-as-you-go basis with Universal.

But Shepherd said the issue is Universal’s policy of not extending either revenue-sharing terms or copy-depth programs to retailers.

“They’re the only one that doesn’t have any program in place for any retailer,” Shepherd said. “We think they’re leaving a lot of money on the table, because we’re spending our money with studios that don’t have the same attitude toward the rental market.”

Universal officials declined to comment.