Q4 2004 Movie Gallery Inc Earnings Conference Call - Final.

Original Source: FD (FAIR DISCLOSURE) WIRE

OPERATOR: Excuse me, ladies and gentlemen. We now have Movie Gallery's management team in conference. Please be aware that each your lines is in a listen-only mode. At the conclusion of management's presentation, we will open the floor for questions. At that time, instructions will be given to the procedure to follow if you would like to ask a question. I would now like to turn the conference over to Mr. Thomas Johnson. Mr. Johnson, you may begin.

THOMAS JOHNSON, SR. VICE PRESIDENT CORPORATE FINANCE AND BUSINESS DEVELOPMENT, MOVIE GALLERY, INC.: Thank you, David. And good morning, everyone.

This is Thomas Johnson, Senior Vice President of Corporate Finance and Business Development for Movie Gallery. I would like to welcome everyone to the Company's 2004 fourth quarter conference call.

This morning, we have a few remarks from Ivy Jernigan, our Chief Financial Officer, and Joe Malugen, our Chairman, President, and Chief Executive Officer. After these remarks, we will be happy to take your questions.

Before we begin, I would like to remind you that this conference call may contain forward-looking statements, including statements relating to our financial estimates for the 2005 first quarter and fiscal 2005 year, growth opportunities in the home entertainment industry, anticipated new store openings, and our proposed acquisition of Hollywood Entertainment, as well as anticipated benefits to both Hollywood's and Movie Gallery's shareholders.

For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, discussions of forecast, estimates, targets, plans, beliefs, expectations, and the like, are intended to identify forward-looking statements. We would like to caution you that these statements may be affected by various risks and uncertainties which could cause actual results to differ materially from those stated or implied by such statements.

We refer you to our SEC filings which may contain a more detailed description of our forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events, or otherwise.

I would also like to take just a second and point out that we are on track to file our 10-K today, which is our due date. I know a lot of people in the industry have missed their filing dates, and I am pleased to report that Ivy and her group have done an outstanding job and we're on track to get our 10-K filed.

With that, I would like to turn the call over to Ivy.

IVY JERNIGAN, CFO, MOVIE GALLERY, INC.: Thank you, Thomas. And good morning, everyone.

Before I go through the results, I want to briefly address the lease accounting matter detailed in the press release we issued earlier this morning, and explain the $6.3 million pretax non-cash charge included in our fourth quarter. I will then discuss our quarterly and full-year results before turning the call over to Joe for an update on the business, including our pending acquisitions and 2005 guidance.

As many of you already know, on February 7, 2005, the SEC clarified certain lease accounting matters and their application under GAAP. The SEC specifically addressed the depreciable life of leasehold improvements, rent holidays, and landlord-tenant incentives.

Like many other companies, Movie Gallery, together with our external auditor, reviewed our accounting practices with respect to leasehold improvements and determined to take a one-time pretax non-cash charge of 6.3 million, or $0.12 per diluted share to conform the Company's accounting to the treatment outlined in the SEC clarifications. This represents the total cumulative impact of the adjustment and has been recorded in the fourth quarter of fiscal 2004.

The charge was comprised of $3.4 million pretax, or $0.07 per share for the current year, and $2.9 million pretax, or $0.05 per share for prior years. This is a non-cash charge, and there will be no impact on future cash flows. However, during 2005, as the result of this correction, we do expect to recognize about $0.06 per share in accelerated depreciation expense. With that matter aside, now let's turn to the quarterly results.

Total revenue in the fourth quarter was 208.4 million, an increase of 12.9 million, or 6.6 percent from 195.5 million in the same period a year ago. The increase in total revenue was primarily driven by a 15.6 percent increase in the average number of stores operated during the period, and partially offset by the anticipated overall 6 percent decrease in same store sales versus the fourth quarter of 2003.

We attribute the decline in same store sales to a number of factors, including both Christmas and New Year's Day occurring on weekend days in 2004, a significantly weaker home video release schedule in the fourth quarter as a result of a 33 percent decrease in the number of movie titles released in the quarter that grossed over $100 million at the box office, a decrease in product sales revenue of 21.4 percent due to reduction in new release movie inventory for sell-through, and warm and dry weather patterns in the fourth quarter which adversely affected our business.

Looking at our revenue mix for the quarter, rental revenue was 191.1 million, or 91.7 percent of total revenues versus 173.5 million, or 88.7 percent of total revenues in the comparable period last year.

Our overall movie rental comps were down about 2.5 percent during the fourth quarter. DVD revenue comprised over 85 percent of movie rental revenues for the fourth quarter of 2004 versus approximately 65 percent for the fourth quarter of 2003.

Our game business was down 12.5 percent in the fourth quarter, reflecting the overall weakness of the new game titles currently being released. This is consistent with industry softness than occurs in anticipation of the introduction of new game platforms.

Product sales for the 2004 fourth quarter were 17.3 million, or 8.3 percent of total revenues versus 22 million, or 11.3 percent of total revenues in the year-ago quarter. This decrease in sell through revenue was driven by our decision in the early part of 2004 to reduce our levels of new release movie inventory available for sale in the stores.

Moving on down the P&L, total gross profit for the 2004 fourth quarter increased to 140.8 million from 128.3 million in the 2003 fourth quarter. Excluding the charge associated with the rental inventory amortization change in estimate from 2002, total gross profit in the 2003 fourth quarter would have been 129.2 million, or a 66.1 percent gross margin. Overall, this year's fourth quarter gross margins improved 200 basis points to a 67.6 percent versus the fourth quarter of last year.

Our store operating expenses for the fourth quarter were 107.6 million, or 51.6 percent of total revenues. Excluding the lease accounting charges, store operating expenses for the 2004 fourth quarter would have been 101.3 million, or 48.6 percent of total revenues versus 86.4 million, or 44.2 percent of total revenues in the comparable period last year.

The increase in store operating expenses as a percentage of total revenue was primarily driven by the 6 percent decrease in same store revenues for the 2004 fourth quarter versus the year-ago quarter as certain operating expenses are fixed.

To a lesser extent, the increase in store operating expenses was also driven by the 30.3 percent increase in the number of new store openings since last year, …