Movie Gallery gets extension on loan

UPDATE: Retailer admits 'substantial doubt' it can continue

By Cindy Spielvogel and Marcy Magiera -- Video Business, 8/17/2007

AUG. 17 | Teetering on the verge of bankruptcy, Movie Gallery received an extension until Aug. 27 on its forbearance agreement with its lenders, even after reporting a $310 million net loss for the second quarter. The forbearance agreement, which the company obtained after defaulting on its loan requirements, had been set to expire Aug. 14.

Gallery’s lenders are “letting them exhaust all the possibilities,” said Michael Pachter, research analyst with Wedbush Morgan Securities. Although he was somewhat surprised by the extension, he said the few extra days wouldn’t be much of a problem for the lenders.

According to an Aug. 16 filing with the Securities and Exchanges Commission, Gallery must now meet a tight schedule of providing its lenders with information on how the company plans to solve its financial difficulties. Due Aug. 17 were estimates of the costs and savings to Gallery for “in-court and out-of-court restructuring alternatives,” according to the filing.

An in-court solution—bankruptcy—is probably more likely, according to Pachter, because of Gallery’s weak financial position and current uncertainty in the credit markets. In an Aug. 13 report, Pachter and associate Edward Woo stated that “Gallery’s assets could fetch as much as $600 million, below its total debt of $1.1 billion.”

Although Gallery has been given another temporary reprieve to allow management more time to come up with a solution before having to face bankruptcy, the company admitted in its 10-Q filing with the SEC for the quarter ended July 1 that there is “substantial doubt” whether it can continue as a going concern. Filed Aug. 10, the 10-Q indicated that if Gallery doesn’t come up with a viable solution soon, its lenders could start foreclosure proceedings.

The filing also discussed “significant vendor terms contraction,” including discontinued credit with many suppliers, which has eroded the company’s working capital. Without access to additional capital, it said, Gallery does not have the resources to operate its business through the third quarter.

The No. 2 U.S. rental chain reported revenue of $561 million for the quarter, a drop of 6.7% from the same period a year earlier. The net loss of $310 million widened from a $25 million loss a year earlier.

Rental revenue—which accounts for 82% of Gallery’s overall revenue—fell 12.2% in the quarter.

For the first half of the year, revenue fell 6.7% to $1.21 billion, and Gallery’s loss was $325 million. In first-half 2006, Gallery posted income of $25 million.

The retailer also admitted in its 10-Q filing that its stock is in danger of being delisted because it has fallen below $1. 

The 10-Q outlined various other problems the company is facing because of its financial crisis. For example, in regard to settlement of a merger-related lawsuit against former Hollywood Entertainment officials that Gallery inherited as a result of the merger, a suit that also involved a loan to former Hollywood chairman Mark Wattles that was forgiven by his company in 2000, Gallery said it can’t meet its settlement obligations yet “due to our current liquidity situation.”

The longer-term solution the chain is pitching to lenders includes accelerating the closure of unprofitable stores, consolidating stores in certain markets, obtaining additional capital and realigning its cost structure.

The company also plans to step up to compete with Blockbuster and Netflix in online mail-order and video-on-demand through Gallery’s Moviebeam service, although it indicated in the 10-Q that it is delaying a national rollout of its mail-order service from late this year until early next year.

According to the Wedbush Morgan report, whether Gallery is sold off completely or merely reduced in store count, the main company to benefit will be Blockbuster, along with Netflix.

Those two companies, particularly Blockbuster with its Total Access service, have greatly impacted Gallery’s Hollywood Video stores, according to the report. The report estimated that about 1,000 Hollywood stores are unprofitable and would be difficult to sell, although Blockbuster might be interested in buying as many as 500 of them at book value if they would help Blockbuster with its own consolidation plans “by closing those stores with customers that it is best positioned to capture after closing.”

In the event of a bankruptcy, the Gallery-branded stores, most of which are profitable, would probably continue to operate to generate income for creditors before possibly being sold to a private equity buyer, according to the report. Some Hollywood stores, mainly those with Game Crazy departments, are profitable as well, the report said, which might also interest a private equity buyer.