DOTHAN, AL-Movie Gallery Inc., the nation’s second largest video rental chain, has filed for Chapter 11 bankruptcy protection. Prior to filing, it negotiated an agreement with Sopris Capital Advisors LLC, a private investment fund, to finance a plan for reorganization. The company’s Canadian subsidiary was not a part of the filing.

The terms of the reorganization agreement must be approved by the bankruptcy court. The plan calls for conversion of $325 million of Movie Gallery’s 11% senior notes into new equity and another $175 million of second-lien debt, now held by Sopris, to also be converted into new equity. In addition, Sopris has committed to backstop a $50-million equity rights offering available to all eligible holders of the 11% senior notes.

Movie Gallery estimates that holders of its common equity would get a 2%-share of the total equity interest of the newly organized company. Existing shares of common stock, which traded under MOVI on the Nasdaq, will be canceled. This year alone, the stock fell from a 52-week high of $5.29 a share to $0.21 a share.

Under the plan, the company’s indebtedness of approximately $1 billion would be reduced by about $400 million, according to a printed statement from the locally based Movie Gallery. The savings, according to the statement, would significantly reduce interest expense and improve cash flow. The $600 million of first-lien debt would remain in place, but be restructured under agreement with Sopris and the lenders.

The chain is also seeking a $150-million debtor-in-possession financing agreement arranged by Goldman Sachs Credit Partners. It would include a new revolving loan of up to $50 million, a letter of credit, and a $100-million term loan. This would refinance an existing credit facility at a lower interest rate.

In addition, the Movie Gallery statement says the company is “in advanced negotiations with a number of the major motion picture studios,” and it is asking the bankruptcy court to allow it to restore normal credit terms with them. It has also asked the court to authorize the payment of wages and benefits to its employees.

In the statement, Joe Malugen, chairman, president and CEO, lists steps the company has taken to reduce debt and adds, “these actions were not sufficient to offset the significant shift in our business and the cost of our substantial indebtedness.” He called Chapter 11, “the best way to obtain financing necessary to maintain regular operations and allow for a successful restructuring.” The release also says Movie Gallery hopes to exit Chapter 11 “as expeditiously as possible,” but provides no timeline.

Movie Gallery, along with its chief rival, Blockbuster, has been hard-hit by competition from Netflix and other on-line rental services and by video-on-demand. A month ago, it said it would close 520 under performing stores operating under both the Movie Gallery and Hollywood Video names. Wall Street analysts have suggested it will close even more retail units. It currently operates approximately 4,430 stores in the US and Canada.

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