Tax Blooper for Movie Gallery in Rival Buy

The company’s auditor mulls treatment of valuation allowance after its purchase of Hollywood Entertainment in 2005.
Stephen TaubOctober 18, 2007

Movie Gallery said its auditor has raised tax accounting issues related to its 2005 acquisition of Hollywood Video that could lead to a restatement of financials.

Ernst & Young questioned how the company had calculated and recorded its valuation allowance against its deferred tax assets at the end of fiscal 2005 in connection with the purchase, according to Movie Gallery, the country’s second-largest movie rental company, which filed for bankruptcy earlier this week.

Movie Gallery added in a regulatory filing that in fiscal 2005 it may have inappropriately netted the deferred tax liability related to the Hollywood Video trade name against the company’s deferred tax assets.

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If it is determined that errors did occur, the company said it will “evaluate the materiality of the matter” in determining whether a restatement of its prior financials is necessary. But even if it is, Movie Gallery said, this is solely a noncash financial statement matter and, therefore, would have no impact on the company’s financial covenants and ratios, cash flows, tax returns, or tax attributes, such as net operating losses.

Movie Gallery filed for Chapter 11 protection on Oct. 15 and agreed to a restructuring plan with private investment fund Sopris Capital Advisors, which will invest $50 million of new capital and convert more than $70 million of second lien debt. Movie Gallery also is seeking approval for $150 million in debtor-in-possession financing from Goldman Sachs Credit Partners. The DIP financing will consist of a $50 million revolving loan and a $100 million term loan.

The company’s problems are traced to a huge amount of debt incurred when it bought Hollywood Entertainment for $1 billion in 2005.