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DOTHAN, AL-Mediocre theater, good weather and an added pinch of daylight were among the incongruous ingredients conspiring against Movie Gallery Inc. in the first quarter of FY 2007, as North America’s second largest video rental company saw revenues fall 6.7%, from $694 million to $648 million, primarily on dour same-store sales. Despite the difficult beginning, management remained upbeat during a Friday conference call, with CEO Joseph Malugen insisting that “we are on the right track to deliver renewed growth” in the evolving visual entertainment sector.

A good portion of the future is based on delivery of movies and their ilk in direct contrast to the industry’s bricks-and-mortar legacy, Malugen acceded, and Movie Gallery officials made it clear they will succeed “no matter what method the consumer chooses.” Trailing only Blockbuster in the video rental business, the company has more than 4,500 retail units in the US and Canada through the Movie Gallery, Hollywood Video and Game Crazy brands, but emerging technology is requiring participants to stay nimble. “We are implementing long-term strategies that we believe are important for the business,” Malugen said.

That pledge was underscored by the first quarter acquisition of MovieBeam, a former rival that gives Movie Gallery proprietary technology allowing movies to be downloaded directly to one’s home via a special box. Monikered as the “True Choice” program, the concept is being rolled out in four markets this month on a test basis. Customers will be able to receive up to 10 new movies each week, many in high-definition, and 100 movies can be stored on the box. Consumers can also buy movies and DVD’s, with Movie Gallery using the mail once the item is ordered via the box or on the Internet.

“The soft launch will be an important learning tool that will help mold our future efforts,” said Malugen, dictating what packages are most popular and how to best structure the program. True Choice is expected to be in place nationally by 2008. Movie Gallery has already secured commitments from many major studios to participate in the distribution network, said Malugen, and hopes to have most on board in the near term.

Movie Gallery shuttered 184 stores during the first quarter, and shook up leadership of retail operations by putting Jeffery Stubbs in charge of all brands, including the struggling Hollywood Video division, which has underperformed Movie Gallery in recent quarters. That brand’s outcome “is totally and completely unacceptable to us,” said Malugen, who passed on the opportunity to blame an aggressive marketing program by Blockbuster and the advent of sales at major department stores for stunting activity at either Hollywood Video or its other brands.

Despite the interest in Internet, mail delivery and other changes afoot, the company still seems convinced the retail element will survive. The 184 stores closed in the first quarter were largely the result of overlap, said CFO Thomas Johnson, and the company is also planning to ramp up its Game Crazy platform by opening 500 in-house locations in Hollywood Video and Movie Gallery stores during the second half of 2007. In another approach, the group plans to roll out a test “kiosk” concept that will provide entertainment to consumers at supermarkets and other high traffic areas. Some 200 kiosks will be installed during the second half of the year.

While concurring that the retail operation needs improvement, Movie Gallery cited diverse factors for the first-quarter malaise, including a slate of lower-grade releases compared to the first quarter of 2006. According to Johnson, just 30 titles reaping more than $20 million at the box office were released to video in the first three months compared to 34 meeting such criteria in the comparable period of 2006. The top four titles last year were Happy Feet, Casino Royale, Pursuit of Happyness and Open Season, versus Harry Potter, Wedding Crashers, Chicken Little and Walk The Line in 2006, “definitely a stronger title slate,” according to Johnson.

Movie Gallery performed to plan in January, had a soft February, and then was hit by the implementation of daylight savings time three weeks earlier than last year. According to Johnson, the video rental business traditionally registers a seasonal revenue shift when daylight savings time occurs. Coupled with unusually warm weather “created additional top-line pressure on a year-over-year comp basis,” said Johnson, whose firm attributed 75% of the revenue drop from 2006 to the decline in same-store sales, which were down 5.9% from 2006.

Although Malugen said the video rental market is in the midst of a price war, and acknowledges the constantly shifting sands of the industry, the firm’s leader insisted the company is in a strong position. “Though market conditions have been far more challenging than we anticipated, we have continued to move forward with our strategy to create value for our shareholders,” he said. “I’ve always been confident we would manage through the headwinds that we have faced, and now that our plans are moving forward, I am more confident than ever.”

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