Movie Gallery's Horrific Earnings

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You know you're in for a fun ride when the lead-in on a company's earnings press release touts adjusted EBITDA (earnings before interest taxes and depreciation) -- and nothing else. Welcome to the horrorshow that is Movie Gallery (Nasdaq: MOVI).

Investors seem somewhat surprised that the company reported a stinker of a quarter this morning; the stock is down 45% today. On a pro forma basis, sales and same-store sales declined, and the company reported a net loss of $0.47 per share. To make things worse, this isn't a situation where one-time items obscure cash profitability; the company's operating cash flow was also negative.

I don't think there's much cause for investors to be surprised. The company did report a pretty good first quarter three months ago, which got Wall Street excited. But the company remained overleveraged, still operating a declining business that Comcast (Nasdaq: CMCSA) and Motley Fool Stock Advisor selection Netflix (Nasdaq: NFLX) continue to erode. Even industry leader Blockbuster (NYSE: BBI) is having a tough go of it, and today, investors were reminded that Movie Gallery is no different.

Investors who might consider Movie Gallery a turnaround play should remember the more than $1 billion in debt on its books, and the company's inability to cover its interest expense in three of the last four quarters.

To help right the ship, the company has brought on Merrill Lynch (NYSE: ML) in hopes of improving its capital structure (i.e., its balance sheet). I think it's unlikely that debtholders will accept lower interest payments, but it's possible that Movie Gallery could use its assets to raise cash. There's little in the way of land and buildings on the company's balance sheet, but there are a fair number of leases that may be below market value. As the company reduces its store count in markets where it has overlap between its Hollywood Video and Movie Gallery chains, it can probably get something for the furnishings and rental inventory.

That's not a lot to work with, and for the rest of the year, the company still plans to open 30 new stores. That will require cash for inventory, equipment, and furnishings as well. I don't see much that will allow the company make a great deal of headway on its $1 billion in debt. These moves seem destined to keep the company operating a little bit longer, in hopes that the decline in sales and same-store sales will abate.

I think it's very likely that the only people to get anything out of Movie Gallery will be Merrill Lynch (fees) and the debtholders, who will look to recoup their principal. I just can't envision a scenario where shareholders end up with much of anything at all.

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At the time of publication, Nathan Parmelee had no interest in any of the companies mentioned. The Motley Fool has an ironclad disclosure policy.