Movie Gallery to Declare Bankruptcy

DOTHAN, Ala. – Movie Gallery, Inc., the second-largest movie rental chain in the United States, and long a target of religious pro-censorship groups, has announced that it will declare bankruptcy under Chapter 11, possibly as early as this week.

The move would be part of a pre-negotiated arrangement with several key creditors that would involve, according to informed sources, the conversion of company bonds, as well as a portion of its second-lien debt, into a stock offering. It will also reportedly close 520 under-performing Movie Gallery and Hollywood Video branches – 13% of its approximately 4,600 outlets in the U.S., Canada and Mexico – in such diverse locations as Springettsbury Township, Pa., Grove Hill, Ala., and Little Falls, Herkimer and Vernon, N.Y.

"Closing these stores was a difficult but necessary decision to help protect the future of the company," said Movie Gallery Chairman, President and CEO Joe Malugen in a press release. "These stores are being closed after evaluating a number of factors, including store profits and the terms of the leases at each location. This action will allow us to focus our resources on the approximate 4,000 stores that have a stronger operating performance and prospects for future growth."

As of July, the company carried $1.2 billion in debt, including $322 million in bonds, $175 million in second-lien debt, and $600 million in first-lien debt, according to the Wall Street Journal. In that month, the company failed to meet scheduled payments on its senior loan from Goldman Sachs Credit Partners; a failure which the company attributed to lower-than-expected second-quarter earnings. The company had posted a net loss of $14.9 million, or 47 cents per share, for the first quarter of 2007, compared to a net income of $40.3 million, or $1.27 per share, in 2006.

In addition, Chief Development Officer Keith A. Cousins resigned effective Sept. 14 at the company's request, reportedly as part of the company's restructuring program. However, on Sept. 20, Standards & Poor’s Ratings Services cut the company's corporate credit rating from "CC" to "D" – "junk bond" status – as a result of the company failing to make the interest payment on its second-lien term loan.

Analysts trace Movie Gallery's troubles to its cutthroat bidding war with larger competitor Blockbuster Video to acquire the Hollywood Video retail chain in 2005, for which it wound up paying $1 billion. At the time, Blockbuster was beginning to expand its operations into "movies-by-mail" to compete with the successful online service Netflix Inc. – a situation that left many Hollywood Video locations unprofitable.

"The acquisition of Hollywood sunk Movie Gallery," said Michael Pachter, a Wedbush Morgan Securities analyst. "But Hollywood didn't bring Movie Gallery down. It was the price they paid and the way they managed the integration that brought them down."

Referring to Movie Gallery's failure to join in the "movies-by-mail" competition, Pachter concluded, "They were the victims, and they did nothing about it."

It is also rumored that Movie Gallery may try to sell either its Hollywood Video or Game Crazy stores, but with the unprofitability of the Hollywood chain, such a sale may be difficult – and with its locations closing, the chief beneficiaries of those lost Hollywood revenues will be Blockbuster and Netflix.