Movie Gallery continues to struggle with industry conditions, says cash will last through end of year

By Jennifer Lanning Drey

Eugene, Ore., Aug. 10 - Movie Gallery Inc. continued to suffer from the troubles of the video rental industry in the second quarter, leading to less improvement than the company had hoped.

But it has enough cash and other liquidity to last the remainder of 2006 while it looks at changes to its capital structure and makes its operations more efficient.

"During the second quarter of 2006, challenging industry conditions continued to impact our business. We did see some improvement during the early part of the second quarter, but it was not as substantial as we had hoped," said Joe Malugen, chairman, president and chief executive officer of Movie Gallery, in a company conference call.

"As expected, and as is typical due to the seasonality in our industry, it turned out to be a somewhat slow quarter."

But executives of the home video rental chain said that as of Aug. 9, Movie Gallery had no borrowings on its revolving credit facility apart from open letter of credit commitments.

The company believes that its cash on hand, cash from operations, cash from non-core asset sales and available borrowings under its revolving credit facility will be sufficient to operate the business through the end of 2006, according to Thomas Johnson, interim chief financial officer of Movie Gallery.

The amount is also expected to satisfy working capital and capital expenditure requirements and meet the company's foreseeable liquidity requirements, including remaining in compliance with the financial covenants contained in the credit facility and debt service, through the end of the year, he said.

Movie Gallery had cash and cash equivalents of $21.2 million and $39.3 million in available borrowings under its revolving credit facility at July 2.

Working on capital structure

The company continues to pursue modifications to its capital structure as part of an overall strategy to meet more stringent credit facility financial covenants that go into effect in the first quarter of 2007, Johnson said.

He also said Movie Gallery is confident in its ability to execute projects toward the capital restructuring or obtaining amendments to the credit facility.

During the second quarter, the company hired Merrill Lynch & Co. to explore ways to improve its capital structure, and Alvarez & Marsal Inc. to assist in streamlining its operations.

"We aren't going to comment on what types of transactions or restructurings we might consider, but we are encouraged by the range of possibilities now under review," Johnson said.

Closing stores, cutting space

Movie Gallery did say that it has plans to restructure 70% of its real estate portfolio in an effort to generate additional cash.

The real estate restructurings include returning under-utilized portions of retail stores to landlords and negotiating sub-leases. The company also plans to close 175 stores in 2006.

But the executives cautioned that the projects are long term in nature.

"Most of the financial benefits associated with these projects are expected to begin ramping up in 2007 with the bulk of the financial benefits to be realized in 2008 and beyond," said Malugen.

The company also continues to review its overall asset portfolio, and said net proceeds from any divestitures will be used for debt reduction, working capital and other general corporate purposes.

Expect Q4 improvements

Looking toward the fourth quarter, Movie Gallery expects to see improvements following a slow summer for home video rentals, Malugen said.

Movie Gallery reported a net loss of $14.9 million, or $0.47 per diluted share, for the second quarter, compared to a net loss of $12.2 million, or $0.39 per diluted share, in the second quarter of 2005.

The company remains "cautiously optimistic" about the rest of the year, he said.

With September historically being its slowest month, Movie Gallery hopes the releases of several box office hits will bring customers back in October, Malugen said.

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