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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2000
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OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 0-21824
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HOLLYWOOD ENTERTAINMENT CORPORATION
(Exact name of registrant as specified in its charter)
Oregon 93-0981138
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(State or other jurisdiction of (IRS Employer
incorporation or organization) identification No.)
9275 SW Peyton Lane, Wilsonville, OR 97070
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(Address of principal executive offices) (Zip Code)
(503) 570-1600
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Title of Each Class Name of Each Exchange on
- ----------------------- Which Registered
--------------------------
Common Stock Nasdaq National Market
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period than the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of the Form 10-K or any
amendment to this Form 10-K. [ ]
On March 20, 2001, the registrant had 49,247,599 shares of Common Stock
outstanding, and on such date, the aggregate market value of the shares of
Common Stock held by non-affiliates of the Registrant was $91,851,167 based
upon the last sale price reported for such date on the Nasdaq National Market.
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DOCUMENTS INCORPORATED BY REFERENCE
Part III - Portions of registrant's Proxy Statement which is anticipated to be
filed within 120 days after the end of the registrant's fiscal year ended
December 31, 2000.
HOLLYWOOD ENTERTAINMENT CORPORATION
ANNUAL REPORT ON FORM 10-K
YEAR ENDED DECEMBER 31, 2000
Item Page
PART I
1. Business 3
2. Properties 13
3. Legal Proceedings 13
4. Submission of Matters to a Vote of Security Holders 14
4A. Executive Officers and Key Employees of the Registrant 15
PART II
5. Market for Registrant's Common Stock and Related
Shareholder Matters 17
6. Selected Financial Data 17
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 20
7A. Quantitative and Qualitative Disclosure About Market Risk 33
8. Financial Statements and Supplementary Data 34
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 34
PART III
10. Directors and Executive Officers of the Registrant 35
11. Executive Compensation 35
12. Security Ownership of Certain Beneficial Owners and
Management 35
13. Certain Relationships and Related Transactions 35
PART IV
14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 36
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PART I
ITEM 1. BUSINESS
GENERAL
Hollywood Entertainment owns and operates 1,818 Hollywood Video retail
superstores in 47 states and the District of Columbia as of December 31, 2000
and is the second largest retailer of rentable home videocassettes, DVDs and
video games in the United States. Based on 2000 industry estimates from Adams
Media Research, we estimate that our video stores attained a U.S. market share
of approximately 10%. In 2000 our average store generated approximately
$710,000 in annual revenue. Our customer transaction database contains
information on about 30 million U.S. member accounts. Hollywood Video total
revenue has increased from $302 million in 1996 to nearly $1.3 billion in 2000.
In 2000 we changed our business strategy from one of high growth in revenue
through new store openings to one of revenue growth and cash generation from
existing stores. Over recent months, we have made significant changes to our
management, including reinstating Mark Wattles, the Company's founder, full
time as President, hiring Scott Schultze as Chief Administration Officer and
Sam Ellis as Chief Information Officer and promoting Roger Osborne to Executive
Vice President of Store Operations. With these changes, we have consolidated
our field operations, reorganized our management reporting relationships and
moved toward a more structured and financially disciplined operation. After
opening stores at the rate of nearly one per day for four years through June
2000, we plan to open fewer than 10 stores in 2001. During 2001, we intend to
focus primarily on a disciplined approach to the quality of our store
operations, increasing same store revenue and store-level profitability, and
generating free cash flow.
INDUSTRY OVERVIEW
Video Retail Industry
According to Adams Media Research, the videocassette and DVD rental industry in
2000 hit an all-time high of $10.28 billion in revenue, up 1.7% from the prior
year. We believe growth will continue in 2001 and possibly beyond, driven in
part by increasing penetration of DVD as well as greater availability of new
release videocassettes as a result of revenue sharing arrangements. According
to Adams Media Research, the total U.S. video industry (comprised of both
rental and sales) grew from $19.3 billion in revenue in 1999 to $21.1 billion
in 2000, and is expected to grow significantly over the next five years to over
$30 billion. According to the Consumer Electronics Association ("CEA"), 28
million VCRs were sold in the U.S. in 2000, which represents the largest number
of VCRs sold in any single year. According to Adams Media Research, VCR
penetration now stands at 93.6% of the 101.4 million television households. In
addition, the CEA estimates that sales of DVD players rose by almost 109
percent in 2000 to total sales of 8.5 million units. In just four years of
sales, DVD players have already reached 14 million units. This growth has
outpaced that of CD players by 3 to 1 and VCRs by 7 to 1 in those technologies'
first four years of existence. The DVD Entertainment Group predicts DVD
shipments will reach 13 million units in 2001, bringing the total to 27 million
or nearly 27% penetration of television households by the end of the year.
The home video industry is highly fragmented but has experienced consolidation
in recent years as video store chains have gained significant market share from
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independent store operators. Based upon information disclosed by Video Store
Magazine, the five largest video store chains had a 44% market share of all
U.S. consumer video rentals in 2000. The National Association of Video
Distributors and the Video Software Dealers Association, estimated that at the
end of 1999 there were about 27,882 independent video stores in the United
States. Over 70% of all locations that rent video titles are currently
operated by independent store owners whose average store revenue tends to be
significantly less than a Hollywood Video store. We believe that there are
several competitive advantages in being a large home video chain, including
marketing efficiencies, brand recognition, access to more copies of each
videocassette through direct revenue sharing agreements, sophisticated
information systems, greater access to prime real estate locations, greater
access to capital, and competitive pricing made possible by size and operating
efficiencies. Even if there is significant additional consolidation, however,
we expect that the home video industry will remain fragmented.
Movie Studio Dependence on Video Retail Industry
According to Adams Media Research, the video retail industry is the single
largest source of revenue to movie studios and represented approximately $9.5
billion, or 54.8%, of the $17.4 billion of estimated domestic studio revenue in
2000.
Of the hundreds of movies produced by the major studios each year in the U.S.,
relatively few are profitable for the movie studios based on box office revenue
alone. According to the Motion Picture Association of America (the "MPAA"), in
2000, the average movie generated approximately $30 million in worldwide
theater revenue for studios. Over the past few years, the average total cost to
make and market a movie has increased significantly to over $82 million.
Therefore, the average movie loses approximately $50 million at the box office
and relies on other sources of revenue to become profitable - most importantly
home video. Home video is often the only significant source of revenue on the
non-hit movies. Due to the unique browsing characteristics of the retail
environment, a Hollywood Video store's average customer rents slightly over 2.0
movies per transaction - frequently one hit and one non-hit movie. Because of
this, we acquire movies on videocassette and DVD regardless of whether the
movies were successful at the box office, thus providing movie studios a
reliable source of revenue for almost all of the hundreds of movies produced
each year. Consequently, movie studios are highly motivated to protect this
unique and significant source of revenue.
Historically, movie studios have sought to generate incremental sources of
revenue through the addition of new distribution channels. To maximize revenue,
the studios have implemented a strategy of sequential release "windows," giving
each distribution channel the rights to its movies for a limited time before
making them available to the next sequential channel. The studios have
determined the sequential order in which they release movies to each
distribution channel based upon the order they believe will maximize their
total revenue from all distribution channels combined. These distribution
channels generally include the following, in release date order:
- Movie theaters
- Video retail stores
- Pay-per-view television (including DBS)
- Premium channels (HBO, Showtime, etc.)
- Basic cable television
- Network television
- Syndicated television
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Trends in Video Rental and Sales
Studios have historically sold videocassettes to video retailers under two
pricing structures, "rental" and "sell-through." Rental titles are initially
sold at relatively high prices (typically $60 to $65 wholesale) and promoted
primarily for rental, and then later re-released for sale to consumers at a
lower price (typically $10 to $15 wholesale). Certain high-grossing box office
films, generally with box office revenue in excess of $100 million, are
targeted at the sell-through market. These titles are released on
videocassette at a relatively low initial price (approximately $12 to $17
wholesale) and are both promoted as a rental title by video stores and sold
directly to consumers through a broad array of retailers including video
stores. Studios elect to release a title either as rental or sell-through
based on which would optimize their income from the title. Due to the high up-
front costs, it was difficult for retailers to buy enough copies under rental
pricing to satisfy customer demand in the first few weeks of a title's release.
Customer satisfaction was not maximized.
In 1998, the major studios and several large video retailers began entering
into revenue sharing agreements as an alternative to the historical rental
pricing structures. Studios began offering retailers more videocassettes for
an individual title at a substantially lower initial cost in exchange for a
share of the rental revenue that those copies generate over their initial
release window. The additional copies have contributed to improved consumer
satisfaction early in a title's release because the supply of titles better
matches demand. This has led to higher rental revenues for the video store
industry as well as for studios. Revenue sharing also gives the studios an
incentive to market these titles because they share in the revenue generated by
increased transactions.
DVDs are an alternative format to VHS tapes that offer consumers digital
picture and sound and additional features such as enhanced content and
interactivity. The Company introduced DVDs in all its stores in November 1998,
resulting in the most successful introduction of a new format in the Company's
history. DVDs are the fastest growing new category introduced by the Company
due to increased interest in older movie titles as a result of the substantial
improvement in picture and sound quality over VHS. Currently, all DVDs are
priced by the studios for sell through. Today, revenue sharing on DVDs would
not maximize profit because of the low cost for us to purchase these outright
and retain 100% of the revenue.
Home Video Game Industry
The home video game industry has historically been affected by changing
technology, limited hardware platform life cycles and hit-or-miss software
titles. In addition, video games typically generate most of their rental
revenue during the first twelve months after their release. Hollywood believes
that during this time period, the differential between the retail price and the
rental price of a new video game is typically high enough to make rentals an
attractive alternative to the customer. According to The NPD Group, the total
domestic home video game market declined by 1.7% in 2000 to $4.1 billion in
sales. The softness in the industry in 2000 was caused by a number of factors,
including the lack of success of the Sega Dreamcast platform and subsequent
cancellation of Dreamcast machine production, the weakness in PlayStation
titles as well as the delayed rollout of Sony's Playstation 2.
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The weakness in the game industry is expected to continue for the first three
quarters of 2001. Based upon estimates by Gerard Klauer Mattison &
Co., Inc. ("GKM"), the demand for Playstation and Nintendo 64 will show
significant year-over-year declines. However, growth is expected to return to
the industry in the fourth quarter of 2001. The industry should benefit from
the increase in the installed base of Playstation 2, and should continue to
grow with the anticipated U.S. introduction of Nintendo's GameCube system and
Microsoft's Xbox in the next 12 months. Overall, according to GKM, the game
industry is expected to grow by 5% in 2001. GKM believes that most of the
growth will occur in 2002 and beyond, with growth rates in excess of 20%
predicted in 2002 and 2003. Furthermore, GKM predicts that this next
generation cycle is expected to be larger in terms of units and dollars than
any previous cycle.
BUSINESS STRATEGY
Since our inception in 1988, Hollywood Entertainment has built a strong base of
over 1,800 superstores diversified around the country. We have developed a
leading brand and an effective superstore format that distinguishes us from
competitors. As we slow our new unit growth going forward, we will be more
focused on generating same-store revenue increases at existing units and will
execute a business strategy which includes the following key elements:
- - Broad Selection and Superior Availability: We strive to provide our
customers with the broadest selection of movies and video games. Our
superstores typically carry approximately 8,000 titles and 15,000
videocassettes, DVDs and video games. Our goal is to offer more copies of
popular new video releases and more titles than our competitors. In part
because of our revenue sharing arrangements with studios, we have increased the
availability of most new releases and typically acquire 100 to 300 copies of
"hit" movies for each Hollywood Video store.
- - Exciting, Enjoyable and Convenient Shopping Experience: Our superstores are
designed to capture the bright lights, energy and excitement of the motion
picture industry. We focus on creating an inviting atmosphere that encourages
browsing and generates repeat customers. Our superstores are typically located
in high traffic, high-visibility locations. We believe excellent customer
service, a bright, clean and friendly shopping environment and convenient store
locations are important to our success.
- - Excellent Entertainment Value: We offer consumers the opportunity to rent
new releases, video games and any of our catalog movie titles for five days in
most of our stores. New release movies typically rent for $3.79 and catalog
movies typically rent for $1.99. We believe movie rental in general, and our
pricing structure and rental terms in particular, provide consumers convenient
entertainment and excellent value.
- - Expanding Product Opportunities: We regularly explore opportunities to
enhance entertainment experiences of our customers. We are exploring a new
business initiative that sells, buys and trades new and used video games, as an
expansion of our traditional video game rental business. This initiative,
called "Game Crazy", is designed as a store-within-a-store concept, leveraging
a portion of our existing superstore real estate. As of December 31, 2000, the
Company had 69 of these departments. While the initial capital required to add
a Game Crazy department to an existing video store is approximately $80,000,
the outlay yields an estimated $400,000 in incremental revenue per store.
Another significant product opportunity is DVD. We believe DVD is a format
that complements our existing VHS business and is well suited to rental or
sale. We introduced DVD for rental in the majority of our stores in the fourth
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quarter of 1998, generating the highest revenues of any new format in our
history. By the end of 2000, DVD represented over 10% of our total rental
revenue. We expect the percentage mix of DVD rentals to be approximately
proportional to total DVD player penetration. It should therefore exceed 20%
of our total rental revenue by the end of 2001.
- - Focus on Cash Generation and Return on Investment: The Company has
increased its focus on maximizing cash generation and return on invested
capital. After being a net user of cash since our inception as a result of
rapid store growth, we became a net generator of cash in the fourth quarter of
2000. Because of our large base of stores, our cash from operations is
expected to be large enough in 2001 and beyond to pay interest, cash taxes and
all growth and maintenance capital expenditures, and have significant cash
remaining to reduce our debt balance. We believe that by closing Reel.com's e-
commerce operation (which was losing money at an annual run rate of
approximately $60 million in early 2000), and by almost stopping our new store
growth (where we were investing at an annual run rate of approximately $140
million in early 2000), we have now substantially reduced our ongoing uses of
cash from that of early 2000 and before.
REEL.COM
On October 1, 1998, the Company acquired Reel.com, the premier online
destination for film-related content and commerce, for approximately $96.9
million. Prior to June, 2000, Reel.com was a leader in e-commerce as a site
which offered an extensive selection of approximately 50,000 titles on
videocassette and DVDs for sale. The website also offered proprietary
information about movies including descriptions, ratings, critics' reviews,
recommendations and links to star filmographies that entertain consumers and
help them select and purchase movies online. Consumers could search through
Reel.com's proprietary, hyperlinked database and preview selected videos.
Reel.com was rated one of the top 10 most recognized Internet commerce brands
by Opinion Research Corporation International in August 1999, and was named
"the best place to buy movies" by Yahoo! Internet Life. According to Media
Metrix, the number of unique visitors to Reel.com was approximately 1.7 million
in January 2000.
By June 2000, Reel.com was built to a run rate of approximately $80 million in
annual revenue but was generating significant cash losses. During 1999 and
2000, we attempted to finance Reel.com with outside capital, including filing a
registration statement for an initial public offering in December of 1999. By
June of 2000, we recognized that Reel.com would not find third-party financing.
Since we were unable to fund its continued losses, we closed down the money-
losing e-commerce business on June 12, 2000. We laid off substantially all of
Reel.com's employees and closed its corporate office and warehouse in
Emeryville, California. Today, we operate Reel.com as a content-only web-site
with expert information about movies. It is funded through the sale of
advertising on its site. The large cash usage related to Reel.com has now been
stopped, and it currently operates at breakeven. We do not expect Reel.com to
be a material part of our business in the future.
STORES AND STORE OPERATIONS
Video Store Openings
We opened our first video superstore in October 1988 and grew to 25 stores in
Oregon and Washington by the end of 1993. In 1994 we significantly accelerated
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our store expansion program, adding 88 stores and expanding into California,
Texas, Nevada, New Mexico, Virginia and Utah. In 1995 we added 192 stores and
entered major new markets in the midwest, southwest, east and southeast regions
of the United States. We added 246 stores in 1996, 356 stores in 1997, 353
stores in 1998, 355 stores in 1999 and 203 stores in 2000. Following is a table
showing our store growth since 1994:
1994 1995 1996 1997 1998 1999 2000
----- ----- ----- ----- ------ ------ ------
Beginning 25 113 305 551 907 1,260 1,615
----- ----- ----- ----- ------ ------ ------
Opened 33 122 250 356 312 319 208
Acquired 55 70 41 43
Closed 4 7 5
----- ----- ----- ----- ------ ------ ------
Ending 113 305 551 907 1,260 1,615 1,818
===== ===== ===== ===== ====== ====== ======
Unlike many video retailers who have grown through acquisitions, Hollywood has
focused on organic growth. Of Hollywood's 1,500 video superstores opened since
1995, nearly 95% of these stores have been opened as new stores where Hollywood
chose the site through a rigorous selection process. We believe that this
control over site selection and discipline in the real estate process have been
among Hollywood's key competitive advantages. We have achieved significant
geographic diversification in our store base, which helps insulate us from
potentially detrimental economic, competitive or weather-related effects in
isolated areas of the country. We believe this diversification helps us
deliver more predictable and stable revenue.
Store Format
Hollywood Video superstores average approximately 6,800 square feet and are
substantially larger than the stores of most of our competitors. The store
exteriors generally feature large Hollywood Video signs, which make our stores
easily visible to and recognizable by consumers. The interior of each store is
clean and brightly lit. Our superstores are decorated with colorful murals
depicting popular screen stars and walls of video monitors with hi-fi audio
accompaniment to create an exciting Hollywood environment. Movies are organized
into 28 categories, and videocassettes are arranged alphabetically by title
within each category to assist customers in locating the movies. New releases
are prominently displayed in easily recognizable locations within the store. We
use wall-mounted and free-standing shelves arranged in wide aisles to provide
access to products and to encourage the movement of customers throughout the
store.
During 2000, we rolled out a smaller superstore format that reduced the target
size of new stores from 7,500 square feet to 5,000 square feet, which lowered
our per-store annual rent and initial build-out costs. These smaller stores
are able to carry the same amount of video and video game inventory as larger
stores due to a new store design, and we believe they retain a "superstore"
look to consumers. This efficient design also allows us greater flexibility in
locating new stores. We believe that these smaller, less expensive stores can
generate similar revenue volumes as larger units in comparable locations, thus
increasing our financial return on new stores.
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Site Selection
We believe the selection of locations for our stores is critical to the success
of our operations. We assembled a new store development team with broad and
significant experience in retail tenant development. The majority of our new
store development personnel were located in the geographic area for which they
were responsible, but all final site approval took place at the corporate
office, where new sites are approved by a committee of senior management
personnel. Final approval of all new sites is the responsibility of the
Chairman of the Real Estate Committee of the Board of Directors. Important
criteria for the location of a Hollywood Video superstore include density of
local residential population, traffic count on roads immediately adjacent to
the store location, visibility and accessibility of the store and availability
of ample parking. We generally seek what we consider the most desirable
locations, typically locating our stores in high-visibility stand-alone
structures or in prominent locations in multi-tenant shopping developments. All
of our stores are in leased premises; we do not own any real estate. As part
of our decision to substantially reduce our new store growth, in December 2000,
we downsized our store development team and eliminated 46 positions.
PRODUCTS
Rental of Products: The rental of products represented 83% of our total revenue
in 2000. Our primary source of revenue is the rental of videocassettes, DVDs
and video games. For the convenience of our customers, we also rent VCRs, DVD
players and game players. Our superstores typically carry approximately 8,000
movie titles and 15,000 videocassettes, DVDs and video games. Excluding new
releases, movie titles are classified into 28 categories, such as "Action,"
"Drama," "Family" and "Children," and are displayed alphabetically within those
categories. We do not rent or sell adult movies in our superstores. In addition
to video rentals, we rent video games licensed by Nintendo, Sega and Sony. Each
mature Hollywood Video store offers between 1,200 and 4,000 video games.
Sales of Products: The sales of products represented 17% of our total revenue
in 2000. We offer new and previously viewed videos and games for sale and sell
blank videocassettes, video cleaning equipment, confectionery and other items.
Our sales business has shifted more toward the sales of previously viewed
movies due to the significant number of extra copies available for sale due to
copy-depth rental programs such as revenue sharing. We believe we have an
advantage over mass merchant retailers when it comes to being able to sell
previously view movies at lower prices than new movies.
REVENUE SHARING
In the fourth quarter of 1998, we entered into revenue sharing agreements
directly with major studios. Under these agreements, we share with the studios
an agreed upon percentage of our rental revenue for a limited period of time,
usually 26 weeks. The revenue sharing agreements allow us to sell previously
viewed tapes to our customers.
We believe that we are one of the few retailers who have revenue sharing
agreements with all the major studios. These revenue sharing agreements
provide a major competitive advantage for us and have the following significant
benefits:
They provide the opportunity to substantially increase the quantity and
selection of newly released video titles in stock and decrease the in-store
copy depth problems that have plagued the industry for years;
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They allow for significantly increased availability of new release
movies; and
They align the studios' economic interest more closely with our interests.
In addition, the Company believes that revenue sharing has increased the
revenues received on an annual basis by the studios through increased rental
activity of new releases as well as greater distribution and revenues on non-
hit movies that we might not otherwise purchase.
ADVERTISING AND MARKETING
Our primary goal in advertising is to increase transactions in our stores,
either from new members or existing members. In 2000, we advertised primarily
using television and radio. We also use cooperative movie advertising funds
made available by studios and suppliers to promote certain videos. Going
forward, we intend to focus our advertising expenditures primarily in the area
of direct mailings in the markets where our stores are currently located. We
believe this is the most productive and cost effective manner to increase
customer visits.
PRICING
Revenue sharing arrangements significantly increased the number of new release
videocassettes acquired by the Company, thereby allowing the Company to
introduce a 5-day rental program on all product in the majority of the stores.
In exchange for this added convenience to our customers, the Company increased
its prices in the majority of the stores in the fourth quarter of 1998 from
$1.49 to $1.99 for catalog titles and from $2.99 to $3.49 for new releases. In
the fourth quarter of 1999, the Company increased its pricing on new releases
from $3.49 to $3.79 in the majority of its stores. DVDs are priced at $3.79
for five days. We did not raise prices in 2000. We believe that our pricing
structure and rental terms provide consumers convenient entertainment and
excellent value.
INVENTORY AND INFORMATION MANAGEMENT
Inventory Management: We maintain detailed information on inventory
utilization. We track rental activity by individual videocassette, DVD and
video game to determine appropriate buying, distribution and disposition of
videocassettes and video games. The system provides information allowing us to
determine when to sell excess videocassettes, DVDs and video games, and when to
redistribute to new stores. Our inventory of videocassettes, DVDs and video
games for rental is prepared according to uniform standards. Each new
videocassette, DVD and video game is removed from its original carton and
placed in a rental case with a magnetic security device and bar coding is
affixed to each videocassette, DVD and video game.
Information Management: We use a scalable client-server system and maintain two
distinct system areas: a point-of-sale ("POS") system and a corporate
information system. We maintain information, updated daily, regarding revenue,
current and historical rental and sales activity, demographics of store
membership, individual customer history, and videocassette, DVD and video game
rental patterns. This system allows us to compare current performance against
historical performance and the current year's budget, manage inventory, make
purchasing decisions on new releases and manage labor costs. We believe our
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system has the ability to continue to improve customer service, operational
efficiency, and management's ability to monitor critical performance factors.
COMPETITION
The video retail industry is highly competitive. We compete with local,
regional and national video retail stores, including Blockbuster, and with
supermarkets, pharmacies, convenience stores, bookstores, mass merchants, mail
order operations and other retailers, as well as with noncommercial sources
such as libraries. Some of our competitors have significantly greater financial
and marketing resources, market share and name recognition than we have.
We believe the principal competitive factors in the video retail industry are
title selection, rental period, the number of copies of popular titles
available, store location and visibility, customer service and employee
friendliness and convenience of store access and parking. Substantially all of
our stores compete with stores operated by Blockbuster, most in very close
proximity. In addition to competing with other video retailers, we compete
with all leisure-time activities, especially entertainment activities such as
movies, sporting events and network and cable television programs.
We compete with cable, satellite and pay-per-view television systems, in which
subscribers pay a fee to see a movie selected by the subscriber. Existing pay-
per-view services offer a limited number of channels and movies and are only
available to households with a direct broadcast satellite receiver or a cable
converter to unscramble incoming signals. Digital compression technology and
other developing technologies are enabling cable companies, direct broadcast
satellite companies, telephone companies and other telecommunications companies
to transmit a much greater number of movies to homes at more frequently
scheduled intervals throughout the day. Certain cable and other
telecommunications companies have tested Video on Demand (V.O.D) service in
some markets. V.O.D service would allow a viewer to pause, rewind and fast
forward movies. Based on publicly available information, we believe these tests
have shown that the V.O.D. technology and service is still some years away from
being able to deploy on a large scale in a profitable manner.
We also believe movie studios have a significant interest in maintaining a
viable movie rental business because their sale of videocassettes to stores
represents the largest source of their revenue. According to Adams Media
Research, in 2000 video stores represented approximately 55% of the studios
domestic revenue, while pay-per-view represented only 2%. In addition, home
video provides the only reliable source of revenue on "non-hit" or "B-title"
movies which make up the majority of movies distributed by the major studios
each year. As a result, we believe movie studios will continue to make movie
titles available to cable television, satellite services or other distribution
channels only after revenues have been derived from the rentals and sales of
videos. Currently, video stores receive product approximately two months
earlier than pay per view, cable and satellite distribution companies. The
window provided to video stores by the studios has been in place since the
inception of our industry.
In addition, we believe substantial technological developments will be
necessary to allow pay-per-view television to match the viewing convenience and
selection available through video rental, and substantial capital expenditures
will be necessary to implement these systems. In contrast, according to Adams
Media Research, 94.9 million, or 86.8%, of all U.S. television households own a
VCR and more VCR's were sold in 2000 than in any previous year. Although we do
not believe cable television, V.O.D or other distribution channels represent a
near-term competitive threat to our business, technological advances or changes
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in the manner in which movies are marketed, including in particular the earlier
release of movie titles to pay-per-view, including DBS, cable television or
other distribution channels, could make these technologies more attractive and
economical, which could have a material adverse effect on our business.
SEASONALITY
The video retail industry generally experiences relative revenue declines in
April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. We believe these
seasonality trends will continue.
EMPLOYEES
As of December 31, 2000, we had approximately 21,695 employees, of which 20,811
were in the retail stores and zone offices and the remainder in our corporate
administrative, and warehousing operations.
Store managers report to district managers who supervise the operations of the
stores. The district managers report to regional managers, who report directly
to the Vice President of Operations for each zone office. The corporate
support staff periodically has meetings with zone personnel, regional managers,
district managers and store managers to review operations. None of our
employees are covered by collective bargaining agreements and employee
relations are considered to be excellent.
SERVICE MARK
We own United States federal registrations for the service marks "Hollywood
Video", "Hollywood Video Superstores" and "Reel.com". We consider our service
marks important to our continued success.
12
ITEM 2. PROPERTIES
Store Locations
As of December 31, 2000, the Company's stores by location are as follows:
HOLLYWOOD ENTERTAINMENT
NUMBER OF VIDEO STORES BY STATE
Alabama 13 Nebraska 14
Arizona 56 Nevada 27
Arkansas 9 New Hampshire 1
California 311 New Jersey 31
Colorado 30 New Mexico 10
Connecticut 14 New York 71
Delaware 1 North Carolina 28
Florida 79 North Dakota 3
Georgia 38 Ohio 79
Idaho 12 Oklahoma 21
Illinois 92 Oregon 67
Indiana 39 Pennsylvania 74
Iowa 10 Rhode Island 7
Kansas 14 South Carolina 13
Kentucky 17 South Dakota 3
Louisiana 15 Tennessee 35
Maine 2 Texas 178
Maryland 29 Utah 33
Massachusetts 39 Virginia 40
Michigan 61 Washington 86
Minnesota 38 Washington, D.C. 2
Mississippi 8 West Virginia 1
Missouri 33 Wisconsin 32
Montana 1 Wyoming 1
Total Stores 1818
Total States (excluding District of Columbia) 47
All of the Company's stores are located in leased premises with an initial
lease term of five to 15 years and most have options to renew for between five
and 15 additional years. Most of the store leases are "triple net," requiring
the Company to pay all taxes, insurance and common area maintenance expenses
associated with the properties.
The Company's corporate headquarters are located at 9275 Southwest Peyton Lane,
Wilsonville, Oregon, and consists of approximately 123,000 square feet of
leased space. The lease expires in November 2008. The Company has two
warehouse facilities. The first is located at 25600 Southwest Parkway Center
Drive, Wilsonville, Oregon and consists of approximately 175,000 square feet of
leased space. The second is located at 501 Mason Road, LaVergne, Tennesse, and
consists of approximately 98,000 square feet of leased space. These facilities
are leased pursuant to agreements that expire in November 2005 and June 2010,
respectively.
ITEM 3. LEGAL PROCEEDINGS
During 1999, the Company was named as a defendant in three complaints which
have been coordinated into a single class action entitled California Exemption
Cases, Case No. CV779511, in the Superior Court of the State of California in
13
and for the County of Santa Clara. The plaintiffs are seeking to certify a
class made up of certain exempt employees, which they claim are owed overtime
payments in certain stores in California. The case is in the early stages of
discovery. A class has not been certified. The Company believes it has
provided adequate reserves in connection with this claim and intends to
vigorously defend the action.
On November 15, 2000, 3PF, a subsidiary of Rentrak Corporation filed a demand
for arbitration with the American Arbitration Association, Case No. 75 181
00413 00 GLO against the Company and Reel.com, Inc. ("Reel"). 3PF and Reel
entered into a Warehousing and Distribution Agreement on February 7, 2000. 3PF
has alleged that Reel is in default under the Agreement, has failed to perform
material obligations under the Agreement, and has failed to pay amounts due
3PF. 3PF seeks to recover approximately $4.8 million and consequential damages.
The case is in the early stages of discovery. The Company believes it has
provided adequate reserves in connection with this claim and intends to
vigorously defend the action.
On January 24, 2000, the Company settled the case filed in April 1998 entitled
RENTRAK CORPORATION V. HOLLYWOOD ENTERTAINMENT, ET AL, Case No. 98-04-02811,
Circuit Court for the County of Multnomah, Portland, Oregon. The plaintiff,
Rentrak, had alleged that the Company was contractually obligated until
December 31, 2011 to deal exclusively with Rentrak whenever it obtained
videocassettes on a revenue sharing basis. Rentrak had claimed the Company
violated its obligations by obtaining videocassettes on a revenue sharing basis
directly from the movie studios. Rentrak also claimed that the Company
violated alleged audit and reporting obligations under contractual
arrangements. The complaint was seeking injunctive relief and monetary damages
in the amount of approximately $200.0 million. Under the terms of the
settlement, the Company paid Rentrak approximately $14.0 million, which
included Rentrak's attorney fees. The Company also issued to Rentrak 200,000
shares of the Company's Common Stock as part of the settlement. All claims
between the parties were settled, including the release of the Company from any
exclusivity claim. In the settlement, the Company specifically disclaimed and
denied any liability or wrongdoing.
The Company is party to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters. In the
opinion of management, the outcome of these matters should not have a material
adverse effect on the consolidated financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
A special meeting of the Company's shareholders was held on March 29, 2001. No
directors were elected at the meeting. The meeting was called to vote upon the
adoption of the Company's 2001 Stock Incentive Plan (the "Plan"), which was
approved by the Board of Directors effective January 25, 2001, and included the
reservation of 9 million shares of Common Stock for issuance under the Plan.
The proposal was approved by the shareholders.
14
ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth information with respect to the Company's
executive officers as of March 31, 2001.
Name Age Positions with the Company
Mark J. Wattles 40 Chairman of the Board, Chief Executive Officer and
President
David G. Martin 35 Executive Vice President and Chief Financial Officer
Scott R. Schultze 46 Executive Vice President and Chief Administration
Officer
Donald J. Ekman 48 Executive Vice President of Legal Affairs, Secretary
and Director
F. Bruce Giesbrecht 41 Executive Vice President of Business Development
Roger J. Osborne 48 Executive Vice President of Operations
MARK J. WATTLES founded the Company in June 1988 and has served as Chairman of
the Board and Chief Executive Officer since that time. Mr. Wattles served as
President of the Company from June 1988 to September 1997 and resumed the
position in October 2000. Mr. Wattles has been an owner and operator in the
video rental industry since 1985. He has been a participant and key speaker in
several entertainment industry panels and conferences and currently serves as a
member of the Video Software Dealers Association (VSDA) Board of Directors.
DAVID G. MARTIN was appointed Executive Vice President and Chief Financial
Officer in February 1999. From 1996 until he joined the Company, Mr. Martin
worked for NationsBanc Montgomery Securities LLC, most recently as a Managing
Director of high yield finance specializing in retail and consumer products.
From 1991 to 1996, he was a Vice President of high yield finance and merchant
banking at Nomura Securities International, Inc. Prior to 1991, Mr. Martin was
an investment banker with Salomon Brothers, Inc, specializing in mergers and
acquisitions.
SCOTT SCHULTZE became Chief Administrative Officer of the Company in July 2000.
From 1988 until Mr. Schultze joined the Company, he served as Executive Vice
President and Chief Financial Officer for The Limited Stores, a division of the
Limited Inc. From 1986 to 1988, Mr. Schultze held the position of Vice
President/Controller for The May Company California and from 1977 to 1986, he
held numerous positions at Meier and Frank, a division of May Company, his last
assignment being Vice President of Finance.
DONALD J. EKMAN became a director of the Company in June 1993, was named Vice
President and General Counsel in March 1994, became Senior Vice President in
1995 and Executive Vice President of Legal Affairs in July 2000. Mr. Ekman was
a partner in Ekman & Bowersox from January 1992 until March 1994, and from
August 1990 until December 1991 he practiced law with Foster Pepper &
Shefelman.
F. BRUCE GIESBRECHT was named Senior Vice President of Product Management in
January 1996, became Senior Vice President of Strategic Planning in January
1998, and Executive Vice President of Business Development in March 2000. He
joined the Company in May 1993 as Vice President of Corporate Information
Systems and Chief Information Officer. Mr. Giesbrecht was a founder of RamSoft,
Inc., a software development company specializing in management systems for the
video industry, and served as its President.
15
ROGER J. OSBORNE was named Senior Vice President of Operations in January 1999
and became Executive Vice President of Operations in October 2000. Prior to
being named Senior Vice President of Operations, he was the Executive Vice
President of J. Baker, Corporation, an apparel and footwear retailer, and
President of its Work `N Gear Division since June 1997. Before joining J.
Baker Corporation, Mr. Osborne was Senior Vice President and Zone Director for
Mid-West and East coast markets for the Company from November 1996 until May of
1997. From January 1995 to November 1996, he served as the Senior Vice
President of J. Baker, Inc. and Director of its licensed shoe department
business. From 1988 until January 1995, Mr. Osborne was employed as Senior
Vice President and Director of Store Operations for Pic `n Pay Stores, Inc., a
chain of discount footwear stores. Prior to his employment as Senior Vice
President for Pic 'n Pay Stores Mr. Osborne spent 14 years with May Company's
Payless Shoesource Division in a number of different capacities throughout the
United States with his last position being, Division Operating Manager for
their 600 store Chicago Office.
16
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
The Company has not paid any cash dividends on its common stock since its
initial public offering in July 1993 and anticipates that future earnings will
be retained for the development of its business. The payment of any future
dividends will be at the discretion of the Company's Board of Directors. Loan
covenants contained in its senior subordinated notes limit the amount of
dividends the Company may pay and the amount of stock it may repurchase. As of
December 31, 2000, these covenants effectively prohibit any dividends or stock
repurchases. The Company's common stock is traded on the Nasdaq National
Market ("Nasdaq") under the symbol "HLYW". The following table sets forth the
quarterly high and low last sale prices per share, as reported on Nasdaq.
2000 1999
----------------------------------------
Quarter High Low High Low
------- ------- ------ -------- -------
First $14.88 $6.69 $34.50 $18.38
Second 8.00 6.38 27.50 17.69
Third 9.31 6.56 19.50 12.00
Fourth 7.38 1.00 17.44 13.38
As of December 31, 2000, there were 219 holders of record of the Company's
common stock.
ITEM 6. SELECTED FINANCIAL DATA
Year Ended December 31,
------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- --------- --------- --------
OPERATING RESULTS:
Revenue $1,296,237 $1,096,841 $763,908 $500,501 $302,342
---------- ---------- --------- --------- --------
Income (loss) from
operations (436,321) (2,513) (36,451) 23,303 38,418
---------- ---------- --------- --------- --------
Interest expense 62,302 45,691 33,355 14,302 4,339
---------- ---------- --------- --------- --------
Income (loss) before
extraordinary
item and cumulative
effect of a change
in accounting
principle (530,040) (49,858) (50,464) 5,559 20,630
---------- ---------- --------- --------- --------
Net income (loss) (530,040) (51,302) (50,464) 4,996 20,630
---------- ---------- --------- --------- --------
17
- ---------------------------------------------------------------------------
Net Income (Loss)
Per Share Before
Extraordinary Item
and Cumulative
Effect of a Change
in Accounting
Principle:
Basic $(11.48) $(1.09) $(1.30) $0.15 $0.60
Diluted $(11.48) (1.09) (1.30) 0.15 0.59
---------- ---------- --------- --------- --------
Net Income (Loss)
Per Share:
Basic $(11.48) $(1.13) $(1.30) $0.14 $0.60
Diluted $(11.48) (1.13) (1.30) 0.13 0.59
---------- ---------- --------- --------- --------
BALANCE SHEET DATA:
Rental inventory,
net $168,462 $339,912 $259,255 $226,051 $144,264
Property and
equipment, net 323,666 382,345 328,182 234,497 115,812
Total assets 665,114 1,053,291 936,330 691,165 453,605
Long-term
obligations(1) 536,401 533,906 392,145 233,496 82,361
Shareholders' equity
(deficit) (222,377) 304,529 347,591 291,938 277,013
OPERATING DATA:
Number of stores at
year end 1,818 1,615 1,260 907 551
Weighted average stores
open during the year 1,751 1,405 1,074 694 398
Comparable store
revenue increase (2) 2% 12% 8% 3% 7%
- --------------------------------------------------------------------------
OTHER DATA
Hollywood superstores
EBITDA (3) 176,942 265,787 168,158 162,445 125,534
Reconciliation to
Adjusted EBITDA (4)
-Add special
charges (5) - 26,885 99,910 26,320 -
-Add non-cash
expenses (6) 126,260 49,627 51,143 18,022 7,994
-Less existing
Store investment
in new release
inventory (7) (173,787) (137,794) (189,814) (125,301) (75,788)
--------- --------- -------- -------- --------
Adjusted EBITDA
Superstores 129,415 204,505 129,397 81,486 57,740
Reel.com EBITDA(8) (29,834) (46,902) (7,322) - -
--------- --------- -------- -------- --------
Consolidated Adjusted
EBITDA 99,581 157,603 122,075 81,486 57,740
========= ========= ======== ======== ========
18
Cash flows generated
from (used in):
Operating activities 248,871 177,151 246,641 176,478 116,271
Investing activities (255,822) (320,338) (438,411) (338,120) (189,085)
Financing activities 3,278 146,153 191,836 152,702 55,683
- ---------------------------------------------------------------------------
(1) Includes the current portion of long-term obligations.
(2) A store is comparable after it has been open and owned by the Company
for 12 full months. An acquired store converted to the Hollywood Video
name store design is removed from the comparable store base when the
conversion process is initiated and returned 12 full months after
reopening.
(3) EBITDA consists of operating income before interest, tax, depreciation and
amortization. EBITDA should not be viewed as a measure of financial
performance under Generally Accepted Accounting Principles (GAAP) or as a
substitute for GAAP measurements such as net income or cash flow from
operations. This calculation of EBITDA is not necessarily comparable to
reported EBITDA of other companies due to the lack of a uniform definition
of EBITDA.
(4) Adjusted EBITDA represents income from operations before depreciation and
amortization plus non-cash expenses that reduce EBITDA, less the cost of
acquiring new release rental inventory which is capitalized. Adjusted
EBITDA should not be viewed as a measure of financial performance under
GAAP and should not be considered as an alternative to cash flows from
operating activities (as determined in accordance with GAAP) as a measure
of liquidity. Our calculation of adjusted EBITDA is not necessarily
comparable to amounts reported by other companies due to the lack of a
uniform definition of EBITDA.
(5) These special charges include:
-1999: Litigation settlement charges of $25.4 million related to the
settlement of the Fox and Rentrak lawsuits (see Item 3. Legal
Proceedings) and a $1.4 million charge for the cumulative effect of a
change in accounting principle (see Note 1 to the Consolidated
Financial Statements);
-1998: an inventory write-down of $99.9 million (see Note 5 to the
Consolidated Financial Statements);
-1997: a litigation settlement of $18.9 million, an inventory write-down
of $2.3 million, $4.6 million related to a failed self-tender offer, and
$.6 million from a loss on early extinguishment of debt.
(6) Expenses which were non-cash in nature including tape loss, the book
cost of previously viewed movies sold, accounts receivable reserves, net
loss on long-term asset disposals and write downs of merchandise inventory
to net realizable value.
(7) This represents existing store purchases of new release tapes, games and
DVD's that are considered investing activities on the statement of cash
flows. This is in addition to the cost of product represented by revenue
sharing expense already included in the statement of operations.
(8) The year 2000 excludes the restructuring charge of $67.7 million for the
discontinuation of e-commerce operations (Note 11).
19
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Summary Results of Operations
The Company's net loss for 2000 was $530.0 million, compared to $51.3 million
in 1999 and $50.5 million in 1998. The increase in loss was primarily the
result of special charges as summarized in Note 21 to the Consolidated
Financial Statements.
The following table sets forth (i) results of operations data expressed as a
percentage of total revenue and (ii) gross margin data.
Year Ended December 31,
----------------------------
2000 1999 1998
-------- ------- -------
Revenue:
Rental revenue 82.6% 81.5% 82.9%
Product sales 17.4% 18.5% 17.1%
-------- ------- -------
100.0% 100.0% 100.0%
-------- ------- -------
Cost of revenue:
Cost of rental 44.8% 25.4% 35.6%
Cost of product 15.8% 14.1% 11.5%
-------- ------- -------
60.6% 39.5% 47.1%
-------- ------- -------
Gross margin 39.4% 60.5% 52.9%
Operating costs and expenses:
Operating and selling 55.0% 47.7% 50.1%
General and administrative 8.5% 7.8% 4.9%
Restructuring charge for closure
of internet business 3.6% - -
Restructuring charge for store
closures 1.3% - -
Amortization of intangibles 4.6% 5.2% 2.4%
Purchased in-process research
and development - - 0.3%
-------- ------- -------
73.0% 60.7% 57.7%
-------- ------- -------
Loss from operations (33.6%) (0.2%) (4.8%)
Nonoperating expense (4.8%) (4.2%) (4.3%)
-------- ------- -------
Loss before income taxes and
cumulative effect adjustment (38.4%) (4.4%) (9.1%)
(Provision for) benefit from income
taxes (2.4%) (0.2%) 2.5%
-------- -------- ------
Loss before cumulative effect
adjustment (40.8%) (4.6%) (6.6%)
Cumulative effect of a change in
accounting principle - (0.1%) -
20
-------- ------- ------
Net loss (40.8%) (4.7%) (6.6%)
======== ======= ======
- ----------------------------------------------------------------------
Other data:
Rental gross margin (1) 45.8% 68.8% 57.1%
Product gross margin (2) 9.2% 23.8% 32.9%
- ----------------------------------------------------------------------
(1) Rental gross margin as a percentage of rental revenues.
(2) Product gross margin as a percentage of product revenues.
REVENUE
Revenue increased by $199.4 million, or 18.2%, in 2000 compared to 1999,
primarily due to the addition of 203 new superstores in 2000. Revenue was also
favorably impacted by an increase of 2% in comparable store revenue in the
current year. The discontinuation of e-commerce operations in June 2000 by
Reel.com unfavorably impacted revenue. Revenue increased by $332.9 million, or
44%, in 1999 compared to 1998, due to the addition of 355 new superstores in
1999 combined with an increase of 12% in comparable store revenue and the full
year impact of Reel.com, acquired in October 1998. The Company ended 2000 with
1,818 superstores operating in 47 states, compared to 1,615 stores operating in
44 states at the end of 1999 and 1,260 stores operating in 42 states at the end
of 1998. The Company increased its prices at most stores in the fourth quarter
of 1998 from $1.49 to $1.99 for catalog titles and from $2.99 to $3.49 for new
releases. In the fourth quarter of 1999, the Company increased prices at most
stores from $3.49 to $3.79 for all new rental releases. The Company did not
increase price in 2000.
GROSS MARGIN
Rental Margins
Rental gross margin as a percentage of rental revenue decreased to 45.8% in
2000 from 68.8% in 1999. In the fourth quarter of 2000, the Company changed
several estimates with respect to the useful lives and salvage values of
various types of rental product. As a result, the Company recorded a charge of
$164.3 million (see Note 4 to the Consolidated Financial Statements). Excluding
the charge, margins decreased to 61.1% in 2000 from 68.8% in 1999. The decrease
is primarily the result of increased rental inventory amortization in the
fourth quarter of 2000 using the new amortization estimates.
Rental gross margin as a percentage of rental revenue increased to 68.8% in
1999 from 57.1% in 1998. In the fourth quarter of 1998, the Company
significantly changed its business model. In order to increase the quantity
and selection of newly released video titles and satisfy the customer's demand
while trying to mitigate the Company's risk, we entered into revenue sharing
agreements with major studios. Prior to these revenue sharing agreements, the
Company paid approximately $60 to $65 per videocassette for major theatrical
releases that were priced for rental in the United States. The Company was
seldom able to fully satisfy its customer's demand for new releases under this
fixed price model. The Company expected that the revenue sharing model would
have a significant impact on the Company's cost of rental as it changed its
business model from a primarily fixed to a primarily variable cost approach.
Starting in the fourth quarter of 1998, revenue sharing payments became a
significant component of the Company's cost of rental. The revenue sharing
agreements made it necessary for the Company to make adjustments to its
inventory valuation as of October 1, 1998 in order to account for the shorter
21
rental lives that videocassettes have in the revenue sharing business model
because initial customer demand is satisfied significantly sooner. As a result
of this change, the Company recorded a $99.9 million charge to reflect a
reduction in the carrying value of rental inventory in the fourth quarter of
1998(See Note 5). Excluding this charge, rental margins decreased as a
percentage of rental revenues from 72.9% in 1998 to 68.8% in 1999. This
decrease was primarily due to increased revenue sharing payments to studios and
increased rental revenues.
Product Margins
Product gross margin as a percentage of product sales decreased to 9.2% in 2000
from 23.8% in 1999. Product margins in 2000 were impacted by a $20.8 million
charge for the discontinuation of e-commerce operations at Reel.com and a $8.6
million charge to value the inventory on hand at December 31, 2000 at the lower
of cost or net realizable value. Excluding the $8.6 million charge, product
margins for the Hollywood Video Stores decreased to 24.4% in 2000 from 31.8% in
1999, primarily due to a decrease in the average sales price of previously
viewed movies for sale. Excluding the $20.8 million charge, product margins for
Reel.com increased to 5.8% from a negative 8.9% in 1999.
Product margin, as a percentage of product revenue, including Reel.com, was
23.8% in 1999, compared to 32.9% in 1998. Excluding Reel.com, product margin as
a percentage of product revenue decreased from 34.8% in 1998 to 31.8% in 1999.
The decline in product margin in 1999 was primarily due to pricing pressure on
sell-through video merchandise from mass merchant retailers, which use video
sales as a loss leader to drive customer traffic and due to the impact of on-
line sales where both VHS and DVD titles can be purchased at or below their
wholesale cost in many cases.
Operating Costs and Expenses
Operating and Selling
Total operating and selling expenses of $713.4 million in 2000 increased $190.8
million from $522.7 million in 1999. Total operating expenses as a percentage
of total revenues increased to 55.0% in 2000 from 47.7% in 1999. The increase
in total operating expenses was due to increases in depreciation expense of
$57.0 million, store wages of $44.9 million, occupancy costs of $42.3 million,
advertising expenses of $24.4 million, and other store operating expenses of
$33.6 million, offset by an $11.4 million decrease in expenses incurred by
Reel.com. The decrease in Reel.com expense was primarily due to operating
Reel.com for six months in 2000 compared to the entire year in 1999. The
increases in store wages, occupancy costs, and other store operating expenses
were due to the increase in the number of superstores operated by the Company.
The Company operated 1,818 superstores at December 31, 2000 compared with 1,615
superstores at the end of 1999. The increase in depreciation expense was due to
a charge for impairment of property and equipment of $44.3 million (See Note 8
to Consolidated Financial Statements). Advertising expense was higher due to an
increase in national television campaigns when compared to prior years.
Operating and selling expense, excluding the impairment of long-lived assets,
increased as a percentage of total revenue in 2000 primarily due to higher
advertising expenses in 2000 compared to 1999.
Total operating and selling expenses of $522.7 million in 1999 increased $140.0
million from $382.7 million in 1998. Total operating expenses as a percentage
of total revenues decreased to 47.7% in 1999 from 50.1% in 1998. The increase
in total operating expenses was due to increases in depreciation expense of
$15.7 million, store wages of $35.1 million, occupancy costs of $45.9 million
22
and other store operating expenses of $10.2 million. Additionally, the Company
incurred $38.9 million in operating and selling expenses in 1999, an increase
of $33.0 million over the prior year, due to Reel.com. The increase in
Reel.com expenses was primarily due to operating Reel.com, for the entire year
in 1999 compared to only the fourth quarter in 1998. All of the above
increases, with the exception of Reel.com were due to the increase in the
number of superstores operated by the Company. The Company operated 1,615
superstores at December 31, 1999 compared with 1,260 superstores at the end of
1998. Operating and selling expense decreased as a percentage of total revenue
in 1999 primarily due to higher average revenue per store in 1999 compared to
1998.
Restructuring for Closure of Internet Business
On June 12, 2000, the Company announced that it would close down the e-commerce
business at Reel.com. The Company developed a leading web-site over the seven
quarters since Reel.com was purchased in October of 1998, but its business
model of rapid customer acquisition led to large operating losses and required
significant cash funding. Due to market conditions, the Company was unable to
obtain outside financing for Reel.com, and could not justify continued funding
from its video store cash flow. On June 13, 2000, the Company terminated
employment of approximately 200 of Reel.com's 240 employees, and paid $1.9
million in involuntary termination benefits. The remaining employees have since
been terminated or integrated into Hollywood Entertainment.
The Company plans to maintain the web-site as a content-only site to minimize
any negative effect the Reel.com shutdown may have on existing Hollywood Video
store customers for a period of time not expected to exceed twelve months from
the e-commerce shutdown. During this time, point of purchase materials
promoting Reel.com as an e-commerce destination will be removed from the
stores. To offset the costs of maintaining the web-site during this period, the
Company entered into a short-term agreement with Buy.com to direct Reel.com
visitors to Buy.com to make purchases. Revenues associated with the Buy.com
agreement and the expenses of maintaining the web-site have been recognized as
earned and incurred, respectively.
As a result of the discontinuation of e-commerce operations, the Company
recorded a total charge of $69.3 million in the current year second quarter, of
which $48.5 million was classified as a restructuring charge on the
consolidated statement of operations and $20.8 million was included in cost of
product sales. In the fourth quarter of the current year, the charge was
reduced by $1.6 million to $46.9 million because the Company was able to
negotiate termination of certain obligations and lease commitments more
favorably than originally anticipated.
The restructuring charge line item includes $1.9 million of severance and
benefits paid on June 13, 2000, $19.3 million of asset write downs, and $25.7
million of accrued liabilities. The assets written down include the remaining
$14.9 million of goodwill associated with the acquisition of Reel.com, and $4.4
million to write down equipment, leasehold improvements, prepaid expenses and
accounts receivable to their net realizable values. Amounts accrued include
$19.9 million for contractual obligations, lease commitments and anticipated
legal claims against the Company and $5.8 million for legal, financial, and
other professional services incurred as a direct result of the closure of
Reel.com. As of December 31, 2000, the Company had paid $3.9 million of the
accrued amounts and anticipates paying the remaining $21.8 million in 2001.
The Company used some of the equipment from Reel.com at the new distribution
center in Nashville, Tennessee, and at the corporate offices in Wilsonville,
23
Oregon. Equipment not utilized by the Company was sold. Proceeds of $250,000
were received in the current year third quarter.
Charged to cost of goods sold was the write down of Reel.com inventory,
primarily DVD's, to net realizable value. This represented excess product for
the Hollywood Video segment. The Company liquidated over 85% of this inventory
as of the end of the current year and plans to liquidate the remaining amount
by the end of the second quarter of 2001.
Restructuring charge for store closures
In December 2000, the Company approved a restructuring plan involving the
closure and disposition of 43 stores that were not operating to management's
expectations (the "Restructuring Plan"). In accordance with the Restructuring
Plan, these stores will be closed in 2001. The Company has recognized a charge
of $16.9 million, including an $8.0 million write down of property and
equipment, a $1.5 million write down of goodwill and an accrual for store
closing costs of $7.4 million. The established reserve for cash expenditures
is for lease termination fees and other store closure costs. The Company
anticipates paying all accrued store closure costs in 2001.
The Company plans to liquidate all inventories through store closing sales; any
remaining product will be used in other stores. The Company anticipates
inventory liquidations and asset disposals will be completed in 2001.
Revenue during the years ended December 31, 2000, 1999 and 1998 for the stores
included in the Restructuring Plan was approximately $15.5 million, $13.4
million and $9.1 million, respectively. Operating results (defined as income
or loss before interest expense and income taxes) during the years ended
December 31, 2000, 1999 and 1998 for the stores included in the Restructuring
Plan were approximately $1.8 million loss, $0.5 million loss and $15,684
income, respectively.
General and Administrative
Total general administrative expenses of $110.2 million increased $24.3 million
from $85.9 million in 1999. Total general and administrative expenses as a
percentage of total revenue increased to 8.5% in 2000 compared to 7.8% in 1999.
Included in general and administrative expenses in 1999 is a special charge of
$25.4 million for legal and settlement charges associated with the settlement
of the Fox and Rentrak lawsuits (see Part 1, Item 3 "Legal Proceedings").
Excluding this charge, general and administrative expenses increased by $49.7
million in 2000, primarily due to employee loans written off or fully reserved
for as doubtful, other payroll and related costs, and establishing reserves for
pending litigation, offset by a $2.1 million decrease in overhead costs
associated with Reel.com. The decrease in Reel.com expenses was primarily due
to operating Reel.com six months in 2000 compared to the entire year in 1999.
Total general administrative expenses of $85.9 million increased $48.4 million
from $37.5 million in 1998. Total general and administrative expenses as a
percentage of total revenue increased to 7.8% in 1999 compared to 4.9% in 1998.
Included in general and administrative expenses in 1999 is a special charge of
$25.4 million for legal and settlement charges associated with the settlement
of the Fox and Rentrak lawsuits (see Part 1, Item 3 "Legal Proceedings").
Excluding this charge, general and administrative expenses increased by $23.0
million in 1999, primarily due to an increase in payroll and related costs,
higher legal costs, due to the Fox and Rentrak lawsuits, and increased overhead
costs of $5.3 million associated with Reel.com. The increase in Reel.com
expenses was primarily due to the full year impact of operating Reel.com in
1999 compared to only the fourth quarter of 1998.
24
Amortization of Intangibles
Amortization of intangibles increased by $3.0 million in 2000 compared to 1999,
primarily due to an impairment charge of $30 million related to goodwill on
several acquired stores as discussed in Note 8 to the consolidated financial
statements, offset by a decrease in amortization of goodwill associated with
the Reel.com acquisition. See Note 11 to the Consolidated Financial Statements
for a discussion of the discontinuation of e-commerce operations and the
resulting charges.
Amortization of intangibles increased by $38.3 million in 1999 compared to
1998, primarily due to the full year impact of amortizing goodwill associated
with the Reel.com acquisition, (as discussed in Note 10 to the Consolidated
Financial Statements).
Other Operating Charges
The Company incurred a non-cash charge of $1.9 million in 1998 to write-off the
value of purchased in-process research and development costs in connection with
the acquisition of Reel.com (see Note 10 to the Consolidated Financial
Statements).
Non-operating Income (Expense), Net
Interest expense, net of interest income, increased in 2000 compared to 1999
and 1998 primarily due to increased levels of borrowings under the revolving
credit facility combined with increased interest rates and the issuance of $50
million in senior subordinated notes in June 1999.
INCOME TAXES
The Company's effective tax rate was a provision of 6.3% in 2000 compared to a
provision of 3.9% in 1999 and a benefit of 27.6% in 1998 which varies from the
federal statutory rate as a result of non-deductible goodwill amortization
associated with the Reel.com acquisition, state income taxes and deferred tax
valuation allowances. Valuation allowances reduce deferred income tax balances
to the approximate amount of recoverable income taxes based on assessments of
taxable income within the carryback or carryforward periods for each year.
CHANGE IN EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE
In April 1998, SOP 98-5, "Reporting on the Cost of Start-up Activities" was
finalized, which requires that cost incurred for start-up activities, such as
store openings, be expensed as incurred. The Company adopted SOP 98-5
effective January 1, 1999. The cumulative effect of the change in accounting
principle was to increase net loss by $1.4 million, net of tax benefit.
LIQUIDITY AND CAPITAL RESOURCES
Overview
During 2000, the Company experienced a number of significant events with
respect to its liquidity and capital situation. The Company began the year
growing at the average rate of one store per day, as well as funding
significant cash losses at Reel.com. In order to meet the funding needs to
continue at this growth rate, the Company's then-existing $300 million credit
facility needed to be expanded or refinanced. During early 2000, the Company
25
attempted to refinance this facility. In March 2000 the Company received an
underwritten commitment from a group of banks for a new $375 million credit
facility. However, syndication of this new facility failed in May 2000
primarily due to lenders' concerns with losses at Reel.com and the significant
capital needed to fund our aggressive growth. Without the availability of new
funding, the Company was faced with the need to begin reducing the outstanding
principal amount of its $300 million credit facility starting with $37.5
million on December 5, 2000 and continuing to reduce by $37.5 million each
quarter thereafter. In order to meet this obligation, the Company needed to
make significant changes to its growth plans.
As part of these changes, in June of 2000, the Company closed the e-commerce
business at Reel.com, thereby stopping its cash losses. Furthermore, the
Company made the decision to stop its new store growth and not sign new leases
for the remainder of the year. At that time, the Company had 141 signed leases
for stores yet to open in 2000 and 2001. The Company has since worked to
either open the remaining stores or terminate their leases. As of December 31,
2000, the Company had opened 47 of those stores and terminated 51 leases, with
an additional 43 remaining. In 2001, the Company intends to terminate the
remaining leases and anticipates opening fewer than 10 stores. Stopping new
store growth allows more of the cash flow from the Company's over 1,800
existing video stores to pay down debt or vendor balances. In the fourth
quarter of 2000, the Company turned free cash flow positive for the first time
as a public company. After being a net user of cash since inception, the
Company became a net generator of free cash.
Cash Provided by Operating Activities
Net cash flow provided by operating activities increased by $71.7 million, or
40%, from $177.2 million in 1999 to $248.9 million in 2000. This increase was
primarily due to an increase in accounts payable and accrued revenue sharing,
which are sources of operating cash. In order to fund the Company's investing
activities for 2000, including opening 208 new stores and purchasing new
releases for existing stores, and meet its debt service requirements for 2000
(including $37.5 million of amortization requirements under the credit facility
and $15.0 million of maturities of capital lease obligations), the Company
generated funds through increases in working capital. We estimate that
accounts payable will decrease by approximately $40 million in 2001 as we bring
down vendor balances.
Cash Used in Investing Activities
Net cash used in investing activities decreased by $64.5 million, or 20%, from
$320.3 million in 1999 to $255.8 million in 2000. The decrease is primarily due
to fewer new store openings in 2000 and no store acquisitions. The Company
opened 355 new stores in 1999 and only 208 stores in 2000. The Company
anticipates that the number of new store openings in 2001 will be fewer than
10.
Following is a table summarizing our cash used in investing activities for the
last three years:
2000 1999 1998
--------- --------- ---------
Purchases of rental inventory, net $ 176,753 $ 185,877 $ 265,158
Purchase of property and
equipment, net 77,639 112,258 132,122
Investment in businesses acquired - 17,434 40,804
Increase in intangibles and other
assets 1,430 4,769 327
--------- --------- ---------
Total cash used in investing $ 255,822 $ 320,338 $ 438,411
--------- --------- ---------
26
Purchases of video rental inventory include buying the initial rental inventory
for new stores, as well as a portion of the cash costs for video product for
existing stores (such as revenue share up-front fees, and purchases of games,
DVDs and non-revenue sharing movies).
Capital expenditures other than product include equipment, fixtures, and
leasehold improvements for new and existing stores, remodeling projects, and
implementing and upgrading office and store technology. We anticipate that
capital expenditures, other than purchases of rental inventory, will be
approximately $20 million in 2001, of which $9.6 million is anticipated to
relate to new, relocated and remodeled stores. The remaining balance relates
to corporate capital expenditures.
Cash Provided by Financing Activities
Net cash provided by financing activities decreased by $142.9 million, or 98%,
from $146.2 million in 1999 to $3.3 million in 2000. The decrease was primarily
due to an increase of cash provided by operations, coupled with a decrease in
cash used by investing activities due to slower store growth. In the first
quarter of 2000, the Company borrowed an additional $12.5 million through
capital lease financing, and over the course of the year has repaid $15.0
million of principal on capital leases. The balance on the revolving credit
facility began the year at $240 million, reached a maximum of $300 million at
September 30, and was reduced to a balance of $245 million at December 31, 2000
leaving the Company $17.5 million under the maximum availability of $262.5
million. Because it is doubtful the Company will be able to meet the scheduled
2001 facility amortization of $150 million, the Company has been negotiating a
restructured amortization with its lenders. On March 6, 2001, the Company made
a $6 million amortization payment and its lenders agreed to defer $31.5 million
of the $37.5 million total due on that date and work toward a permanent change
in the amortization schedule to better match debt pay-down with the current
business plan. This change is scheduled to be completed by May 5, 2001.
However, this change requires the affirmative vote of 100% of the approximately
20 lenders involved with the credit facility. There can be no assurances that
the Company will be successful in its negotiations. As a result of this, in
addition to the fact that the Company has had net losses in 2000, 1999, and
1998 and at December 31, 2000 has a shareholders deficit of $222.4 million, the
Company's independent accountants have included a going concern paragraph in
their report dated March 21, 2001, except as to Note 25 which is dated March
29, 2001, on our consolidated financial statements. The Company believes that,
if it negotiates a new amortization schedule which better matches debt pay-down
with the current business plan, it is possible that our independent accountants
would rescind this going concern paragraph. Adjustments relating to the
realization of assets and classification of the liabilities that might be
necessary if the Company is unable to continue as a going concern have not been
made.
As of December 31, 2000, the Company was in violation of covenants contained
within the credit facility. The Company was able to obtain the appropriate
waiver for the violations. However, this waiver expires May 5, 2001. Because it
is probable the Company will incur covenant violations after May 5, 2001
without a restructured agreement, in accordance with FAS 78, Classification of
Obligations That Are Callable by the Creditor, the Company has reclassified
$112.5 million of the credit facility that matures in 2002 to current
liabilities on the consolidated balance sheet as of December 31, 2000.
27
Other Financial Measurements: Working Capital
At December 31, 2000, we had cash and cash equivalents of $3.3 million and a
working capital deficit of $501.4 million. Rental inventories are accounted for
as non-current assets under generally accepted accounting principles because
they are not assets which are reasonably expected to be completely realized in
cash or sold in the normal business cycle. Although the rental of this
inventory generates a substantial portion of the Company's revenue, the
classification of these assets as non-current excludes them from the
computation of working capital. The acquisition cost of rental inventories,
however, is reported as a current liability until paid and, accordingly,
included in the computation of working capital. Consequently, the Company
believes working capital is not as significant a measure of financial condition
for companies in the video retail industry as it is for companies in other
industries. Because of the accounting treatment of rental inventory as a non-
current asset, the Company will, more likely than not, operate with a working
capital deficit.
RECENTLY ISSUED ACCOUNTING STANDARDS
See Note 1 to the consolidated financial statements for a discussion of
recently issued accounting standards and the impact they may have on the
financial condition or results of operation of the Company.
GENERAL ECONOMIC TRENDS, QUARTERLY RESULTS AND SEASONALITY
The Company anticipates that its business will be affected by general economic
and other consumer trends. Future operating results may be affected by various
factors, including variations in the number and timing of new store openings,
the performance of new or acquired stores, the quality and number of new
release titles available for rental and sale, the expense associated with the
acquisition of new release titles, additional and existing competition,
marketing programs, weather, special or unusual events and other factors that
may affect retailers in general.
The video retail industry generally experiences relative revenue declines in
April and May, due in part to the change in Daylight Savings Time and due to
improved weather, and in September and October, due in part to the start of
school and the introduction of new television programs. The Company believes
these seasonality trends will continue.
FORWARD-LOOKING STATEMENTS
The information set forth in this report, including without limitation, in Item
1, Business, under the caption "Industry Overview" with respect to industry
consolidation, "Business Strategy" with respect to future relationships,
expanding product opportunities and generation and use of cash, "Advertising
and Marketing" with respect to future advertising expenditures, "Competition"
with respect to the future viability of the video industry and in Item 7,
Management's Discussion and Analysis of Financial Condition and Results of
Operations, under the caption "Liquidity and Capital Resources" with respect to
the sufficiency of financial resources and the restructuring of debt
amortization includes "forward-looking statements" within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934 and is subject to the safe harbors created by those
sections. Certain factors that could cause results to differ materially from
those projected in the forward-looking statements are set forth in Item 1,
28
Business, under the captions "Competition", in Item 7, Management's Discussion
and Analysis of Financial Conditions and Results of Operations, under the
caption "General Economic Trends, Quarterly Results and Seasonality" and in
Item 3, Legal Proceedings. Forward-looking statements speak only as of the
date made. We undertake no obligation to publicly release or update forward-
looking statements, whether as a result of new information, future events or
otherwise. You are, however, advised to consult any further disclosures we
make on related subjects in our quarterly reports on Form 10-Q and any reports
made on Form 8-K to the Securities and Exchange Commission.
CAUTIONARY STATEMENTS
In making an investment or possible investment in our securities and in
assessing the forward-looking statements referred to above, you should
carefully consider the following risk factors and other information in or
incorporated in this report.
The Company may make other forward-looking statements from time to time. The
risks and uncertainties described below are not the only ones we face.
Additional risks and uncertainties not known to us or that we now think are
immaterial may also impair our business operations or could otherwise cause
actual results to differ materially from the forward-looking statements.
If any of the following risks actually occur, our business, financial condition
and results of operations could be materially and adversely affected. If that
occurs, the trading price of our securities could decline.
Past expansion places pressure on our operations and management controls.
We have expanded the size of our store base and the geographic scope of
operations significantly over the last several years. This expansion has
placed, and we expect it to continue to place, increasing pressure on our
operating and management controls. To manage our larger store base, we will
need to continue to evaluate our financial controls, management information
systems and distribution facilities. We may not adequately anticipate or
respond to all of the changing demands of expansion on our infrastructure.
We depend on key personnel; recent management changes are unproven.
Our future performance depends on the continued contributions of certain key
management personnel. In late 2000 and early 2001, the Company made significant
changes to management personnel of the Company, including adding two new
outside directors to the board of directors, reinstating Mark J. Wattles, the
Company's founder and Chief Executive Officer, full time as President, hiring
Scott Schultze as Chief Administrative Officer and Sam Ellis as Chief
Information Officer, promoting Roger Osborne to Executive Vice President of
Store Operations and restructuring other executive and senior management
positions. These new members of management may not be able to successfully
manage our existing operations and they may not remain with us. Our future
profitability also depends on our ability to attract and retain other
management personnel, including qualified store managers.
We face intense competition and risks associated with technological
obsolescence.
The video retail industry is highly competitive. We compete with local,
regional and national video retail stores, including those operated by
Blockbuster, Inc., the largest video retailer in the U.S., and with
supermarkets, pharmacies, convenience stores, bookstores, mass merchants, mail
29
order operations, online stores and other retailers, as well as with
noncommercial sources such as libraries. According to information disclosed by
Video Store Magazine, the five largest video store chains had a 44% market
share of all U.S. consumer rentals in 2000. The Video Software Dealers
Association and the National Association of Video Distributors estimated that
at the end of 1999 there were 27,882 independent video stores in the U.S. We
believe that over 70% of all locations that rent video titles are currently
operated by independent store owners whose average store revenue tends to be
significantly less than a Hollywood Video Store. On the other hand, some of
our competitors have significantly greater financial and marketing resources,
market share and name recognition than the Company. Substantially all of our
stores compete with stores operated by Blockbuster, most in very close
proximity. As a result of direct competition with Blockbuster, rental pricing
of videos is a significant competitive factor in our business and, from time to
time, in certain markets, Blockbuster has cut prices below those offered in our
stores. If price cutting occurs on a more sustained and widespread basis, it
could have an adverse impact on our results of operations.
We also compete with cable, satellite and pay-per-view television systems, in
which subscribers pay a fee to see a movie selected by the subscriber.
Existing pay-per-view services offer a limited number of channels and movies
and are available only to households with a direct broadcast satellite receiver
or a cable converter to unscramble incoming signals. Digital compression and
other developing technologies, however, are expected eventually to permit cable
companies, direct broadcast satellite companies, telephone companies and other
telecommunications companies to transmit a much greater number of movies to
homes at more frequently scheduled intervals throughout the day. Certain cable
and other telecommunications companies have tested and are continuing to test
movie-on-demand services in some markets. Technological advances or changes in
the manner in which movies are marketed, including in particular the earlier
release of movie titles to pay-per-view providers, such as direct broadcast
satellite, cable television or other distribution channels, could make these
technologies more attractive and economical, which could have a material
adverse effect on our business.
Our business would be adversely affected if revenue sharing arrangements were
reduced or eliminated.
We believe our operating results have been and will continue to be positively
affected by revenue sharing arrangements with movie studios. See "Item 1.
Business - Revenue Sharing" and "- Pricing." If the scope of these
arrangements were reduced, or if some studios were to stop using these
arrangements, our business would be adversely affected. Movie studios might
reduce their use of revenue sharing if they found it to be less profitable than
alternative distribution methods, in response to technological developments, as
the result of new government regulation, or for other reasons.
We would lose a significant competitive advantage if the movie studios were to
adversely change their current distribution practices.
Currently, video stores receive movie titles approximately two months earlier
than pay-per-view, cable and satellite distribution companies. Due to the
large, reliable market that home video provides for studios for both hit and
non-hit movies when compared to the alternative pay-per-view sources, it is
likely that movie studios will continue to make movie titles available
exclusively to video stores before they are made available to additional
distribution channels. See "Item 1. Business - Industry Overview - Movie
Studio Dependence on Video Retail Industry" and "Item 1. Business -
30
Competition." If movie studios change this distribution schedule such that
video stores were no longer the first distribution channel to receive a movie
title after a movie studio's theatrical release or to provide for the earlier
release of movie titles to pay-per-view providers, such as direct broadcast
satellite, cable television or other distribution channels, however, this could
make these alternative technologies more attractive and economical than video
rental, which could have a material adverse effect on our business.
Our future operating results may fluctuate.
Various factors may affect future operating results, including
- variations in the number and timing of store openings;
- the performance of newer stores;
- the quality and number of new release titles available for rental and
sale;
- the expense associated with the acquisition of new release titles;
- acquisitions by us of existing video stores;
- changes in comparable store revenue;
- additional and existing competition;
- marketing programs;
- labor conditions in the movie industry that affect the production of new
movies;
- weather;
- special or unusual events;
- seasonality;
- the success of new business initiatives; and
- other factors that may affect retailers in general.
If operating results fall below the expectations of securities analysts or
investors in some future period, the trading price of our securities would
likely decline, perhaps significantly.
We have substantial amounts of outstanding indebtedness.
At December 31, 2000, there was $245 million outstanding under our $300 million
senior revolving credit facility, and we had outstanding $250 million principal
amount of 10.625% Senior Subordinated Notes due 2004 (the "Notes"). Our
indebtedness presents risks to investors, including the possibility that we may
be unable to generate sufficient cash to pay the principal of and interest on
the indebtedness. Our ability to make principal and interest payments on our
indebtedness will be dependent on our future operating performance, which is
dependent on a number of factors many of which are beyond our control. These
factors include prevailing economic conditions and financial, competitive,
regulatory and other elements affecting our business and operations, and may be
dependent on the availability of borrowings. If we do not have sufficient
available resources to repay any
31
indebtedness when it becomes due and payable, we may find it necessary to
refinance indebtedness, and such refinancing may not be available, or available
on reasonable terms. Additionally, our indebtedness could have a material
adverse effect on our future operating performance, including, but not limited
to, the following:
- a significant portion of our cash flow from operations will be dedicated
to debt service payments, thereby reducing the funds available for other
purposes;
- our ability to obtain additional financing in the future for working
capital, capital expenditures, acquisitions or general corporate purposes
or other purposes may be impaired;
- our leverage may place us at a competitive disadvantage;
- our leverage will limit our ability to expand; and
- our leverage may hinder our ability to adjust rapidly to changing market
conditions and could make us more vulnerable in the event of a downturn in
general economic conditions or our business.
If a change of control of the Company occurs, we may be required to purchase
all or a portion of the Notes then outstanding at a purchase price equal to
101% of the principal amount, plus accrued and unpaid interest, if any, to the
date of purchase. Prior to commencing such an offer to purchase, we may be
required to (i) repay in full all of our indebtedness that would prohibit the
repurchase of the Notes or (ii) obtain any consent required to make the
repurchase.
We may be unable to make timely amortization payments under our credit
agreement and we may be unable to renegotiate a revised amortization schedule
with our lenders.
Under the terms of the senior revolving credit agreement, the Company began
reducing the outstanding principal amount of its $300 million credit facility
starting with a $37.5 million amortization payment on December 5, 2000. We are
required to continue making $37.5 million payments each quarter. Because it is
doubtful the Company will be able to meet the scheduled 2001 facility
amortization of $150 million, the Company has been negotiating a restructured
amortization with its lenders. On March 6, 2001, the Company made a $6 million
amortization payment and its lenders agreed to defer $31.5 million of the $37.5
million total due on that date until May 5, 2001 in order to work toward a
formal amendment to the credit agreement, which will include a revised
amortization schedule to better match debt pay-down with the Company's current
business plan. We have presented our lenders with a business plan which
provides for sufficient capital for competitive levels of product in our
Hollywood Video stores and timely payment for vendors while also giving the
lenders meaningful debt reduction over the next 24 to 36 months. The Company
is targeting to have the amended amortization schedule approved by the lenders
by May 5, 2001. However, this change requires the affirmative vote of 100% of
the approximately 20 lenders involved with the credit facility and there is no
assurance that we will be successful in our negotiations. If we are unable to
successfully renegotiate the terms of the revolving credit facility, we may be
unable to meet the required quarterly payments. Because amounts outstanding
under the credit agreement are collateralized by substantially all of the
assets of the Company, a failure to make the amortization payments could be
harmful to the operations of the Company and adversely affect the trading price
of our securities.
32
We have incurred nonrecurring expenses in the recent past.
In 1997, we had special charges for a litigation settlement of $18.9 million,
an inventory write-down of $2.3 million, $4.6 million related to a failed self-
tender offer, and $.6 million from a loss on early extinguishment of debt. In
1998, the Company accounted for an inventory write-down of $99.9 million. In
1999, we took special charges of $25.4 million related to the settlement of
lawsuits and a $1.4 million charge for the cumulative effect of a change in
accounting principle. In the fourth quarter of fiscal 2000, we experienced a
loss of approximately $456 million and a negative adjusted EBITDA of
approximately $13 million primarily due to the following special charges: (i)
write-downs associated with modifications to rental product depreciation
estimates, (ii) write-downs of excess and obsolete inventory primarily due to
the stoppage of new store growth, (iii) impairments of goodwill and fixed
assets, (iv) reserves against receivables, (v) reserves against deferred tax
assets, (vi) employee severance costs, (vii) litigation and other settlement
costs, (viii) costs associated with terminating existing leases, and (ix) a
restructuring charge for the planned closure of 43 stores in 2001. If we incur
special charges in the future, they could adversely affect our results and
cause the trading price of our securities to decline.
Our stock price may be volatile.
The market price of our common stock has fluctuated substantially since our
initial public offering in July 1993. The common stock is traded on the Nasdaq
National Market, which market has experienced and is likely to continue to
experience significant price and volume fluctuations that could adversely
affect the market price of the common stock without regard to our operating
performance. We also believe factors such as fluctuations in financial
results, variances from financial market expectations, changes in earnings
estimates by analysts, announcements of new technologies in movie distribution
or announcements by us or competitors may cause the market price of our common
stock to fluctuate, perhaps substantially. These factors, as well as general
economic conditions such as recessions or high interest rates, may adversely
affect the market price of the common stock.
Certain provisions of our articles of incorporation and Oregon law may have
anti-takeover effects.
Our Board of Directors has authority to issue up to 19,500,000 shares of
preferred stock and to fix the rights, preferences, privileges and restrictions
of those shares without any further vote or action by the shareholders. The
potential issuance of preferred stock may have the effect of delaying,
deferring or preventing a change in control of the Company, may discourage bids
for the common stock at a premium over the market price of the common stock and
may adversely affect the market price of, and the voting and other rights of
the holders of, our common stock. In addition, provisions of Oregon law could
make it more difficult for a party to gain control of the Company.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market risk represents the risk of loss that may impact the Company's financial
position, operating results, or cash flows due to adverse changes in financial
and commodity market prices and rates. The Company has entered into certain
market-risk-sensitive financial instruments for other than trading purposes,
principally short-term and long-term debt. Historically, and as of December 31,
2000 the Company has not used derivative instruments or engaged in hedging
activities.
33
The interest payable on the Company's credit facility is based on variable
interest rates (IBOR or the prime bank rate at the Company's option) and
therefore affected by changes in market interest rates. Hypothetically, if
variable base rates were to increase 1% in 2000 as compared to the end of 1999,
the Company's interest rate expense would increase by approximately $2.5
million based on the Company's outstanding debt as of December 31, 2000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Incorporated by reference to Item 14 of this report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
34
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information with respect to directors of the Company is incorporated by
reference from the Company's definitive proxy statement, under the caption
"Nomination and Election of Board of Directors," for its 2001 annual meeting of
shareholders (the "2001 Proxy Statement") to be filed pursuant to Regulation
14A promulgated by the Securities and Exchange Commission under the Securities
Exchange Act of 1934, which proxy statement is anticipated to be filed no later
than 120 days after the end of the Company's fiscal year ended December 31,
2000. Information with respect to executive officers of the Company is
included under Item 4A of Part I of this report.
ITEM 11. EXECUTIVE COMPENSATION
Information required by this Item 11 is hereby incorporated by reference from
the 2001 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this Item 12 is hereby incorporated by reference from
the 2001 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item 13 is hereby incorporated by reference from
the 2001 Proxy Statement.
35
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Listed below are all financial statements, notes, schedules and exhibits filed
as part of this Annual Report on Form 10-K:
(a)(1), (2) FINANCIAL STATEMENTS
The following financial statements of the Registrant, together with the Report
of Independent Accountants dated March 21, 2001, on pages F-1 to F-21 of this
report on Form 10-K are filed herewith:
(i) FINANCIAL STATEMENTS
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 2000 and 1999
Consolidated Statements of Operations for the years ended December 31, 2000,
1999 and 1998
Consolidated Statements of Changes in Shareholders' Equity for the years ended
December 31, 2000, 1999 and 1998
Consolidated Statements of Cash Flows for the years ended December 31, 2000,
1999 and 1998
Notes to Consolidated Financial Statements
(ii) FINANCIAL SCHEDULES
All financial schedules are omitted as the required information is inapplicable
or the information is presented in the respective consolidated financial
statements or related notes.
(a) (3) Exhibits
The following exhibits are filed with or incorporated by reference into
this Annual Report:
EXHIBIT
NUMBER DESCRIPTION
3.1 1993B Restated Articles of Incorporation, as amended (incorporated
by reference to the Registrant's Registration Statement on Form S-1
(File No. 33-63042)(the "Form S-1"), by reference to Exhibit 4 to the
Registrant's Registration Statement on Form S-3 (File No. 33-96140),
and by reference to Exhibit 3.1 to the Registrant's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1998.
3.2 1999 Restated Bylaws (incorporated by reference to Exhibit 3.2 to the
Registrant's Registration Statement on Form S-4 (File No. 333-82937)
(the "1999 S-4")).
10.1 Indenture, dated August 13, 1997, between the Registrant and U.S.
Trust Company of California, N.A., as Trustee (incorporated by
reference to Exhibit 4.1 to the Registration Statement on Form S-4
(No.333-35351) (the "1997 S-4")), as supplemented by the First
36
Supplemental Indenture, dated as of June 24, 1999, between the
Registrant and the Trustee (incorporated by reference to Exhibit 4.2
of the 1999 S-4) and the Second Supplemental Indenture, dated as of
January 20, 2000, between the Registrant and the Trustee.
10.2 1993 Stock Incentive Plan, as amended (incorporated by reference
to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997).
10.3 Form of Incentive Stock Option Agreement (incorporated by
reference to Exhibit 10.1 of the Form S-1).
10.4 Form of Nonqualified Stock Option Agreement (incorporated by
reference to Exhibit 10.3 of the Form S-1).
10.5 Revolving Credit Agreement, as amended as of August 4, 2000, among the
Registrant, as Borrower, and Societe Generale, Goldman Sachs Credit
Partners L.P. and certain other financial institutions, as Lenders,
and Societe Generale, as Agent for the Lenders, Goldman Sachs Credit
Partners, L.P., as Documentation Agent, and Credit Lyonnais Los
Angeles Branch, Deutsche Bank AG, New York Branch, U.S. Bank National
Association and KeyBank National Association, as Co-Agents
(incorporated by reference to Exhibit 10.1 of the Registrant's
Quarterly Report on Form 10-Q/A for the quarter ended September 30,
2000).
10.6 Separation and Severance Agreement effective as of October 24, 2000
between the Registrant and Jeffrey B. Yapp.
10.7 Offer of Employment Term Sheet effective as of January 25, 2001 from
the Registrant to Mark J. Wattles
10.8 Change of Control Plan for Senior Management dated as of February 3,
2001
10.9 Consent to partial principal deferral dated as of March 5, 2001
between the Registrant and Societe Generale, as agent, the Co-Agents
as defined, and the Lenders as defined.
21.1 List of Subsidiaries.
23.1 Consent of PricewaterhouseCoopers LLP.
(b) REPORTS ON FORM 8-K:
None filed during the fourth quarter of 2000.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Hollywood Entertainment
Corporation
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in shareholders' equity
(deficit) and of cash flows present fairly, in all material respects, the
financial position of Hollywood Entertainment Corporation and its subsidiaries
at December 31, 2000 and 1999, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2000 in
conformity with accounting principles generally accepted in the United States
of America. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audits. We conducted our audits of these statements in
accordance with auditing standards generally accepted in the United States of
America, which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 16 to the
financial statements, the Company believes they may not be able to make the
payments on their line of credit as they come due. This in addition to the
fact that the Company has had net losses in 2000, 1999 and 1998 and at December
31, 2000 has a shareholders' deficit of $222.4 million raises substantial doubt
about its ability to continue as a going concern. Management's plans in regard
to these matters are also described in Note 16. The financial statements do
not include any adjustments that might result from the outcome of this
uncertainty.
As discussed in Note 5 of the consolidated financial statements, the Company
changed its amortization method for videocassette rental inventory in 1998.
PRICEWATERHOUSECOOPERS LLP
Portland, Oregon
March 21, 2001, except as to Note 25 which is as of March 29, 2001
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
-------------------------
December 31, December 31,
2000 1999
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $ 3,268 $ 6,941
Accounts receivable 23,830 42,679
Merchandise inventories 54,201 84,373
Income taxes receivable - 1,797
Prepaid expenses and other current
assets 10,099 10,377
----------- -----------
Total current assets 91,398 146,167
Rental inventory, net 168,462 339,912
Property and equipment, net 323,666 382,345
Goodwill, net 69,616 145,504
Deferred income tax asset - 25,805
Other assets, net 11,972 13,558
----------- -----------
$ 665,114 $ 1,053,291
=========== ===========
LIABILITIES AND SHAREHOLDERS'
EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term
obligations $ 261,164 $ 14,493
Accounts payable 169,503 111,578
Accrued expenses 114,633 64,566
Accrued revenue sharing 30,855 9,402
Accrued interest 11,817 11,865
Income taxes payable 4,844 -
----------- ----------
Total current liabilities 592,816 211,904
Long-term obligations, less current
portion 275,237 519,413
Other liabilities 19,438 17,445
----------- ----------
887,491 748,762
Commitments and contingencies (Note 22) - -
Shareholders' equity (deficit):
Preferred stock, 19,500,000 shares
authorized; no shares issued and
outstanding - -
Common stock, no par value, 100,000,000
shares authorized; and 46,247,599
and 45,821,537 shares issued and
outstanding, respectively 365,441 362,307
Accumulated deficit (587,818) (57,778)
----------- ----------
Total shareholders' equity (deficit) (222,377) 304,529
----------- ----------
$ 665,114 $ 1,053,291
=========== ===========
See notes to consolidated financial statements.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
Twelve Months Ended
December 31,
-------------------------------------
2000 1999 1998
----------- ---------- ----------
Rental revenue $ 1,071,024 $ 893,491 $ 633,140
Product sales 225,213 203,350 130,768
----------- ---------- ----------
1,296,237 1,096,841 763,908
----------- ---------- ----------
Cost of Revenue:
Cost of rental 580,849 278,890 271,778
Cost of product 204,401 154,990 87,799
----------- ---------- ----------
785,250 433,880 359,577
----------- ---------- ----------
Gross Profit 510,987 662,961 404,331
Operating costs and expenses:
Operating and selling 713,431 522,682 382,728
General and administrative 110,242 85,873 37,543
Restructuring charge for closure
of Internet business 46,862 - -
Restructuring charge for store
closures 16,859 - -
Amortization of intangibles 59,914 56,919 18,611
Purchased in-process research
and development - 1,900
----------- ---------- ----------
947,308 665,474 440,782
----------- ---------- ----------
Loss from operations (436,321) (2,513) (36,451)
Non-operating income (expense):
Interest income 175 214 141
Interest expense (62,302) (45,691) (33,355)
----------- ---------- ----------
Loss before income taxes and
cumulative effect adjustment (498,448) (47,990) (69,665)
(Provision for) benefit from
income taxes (31,592) (1,868) 19,201
----------- ---------- ----------
Loss before cumulative effect of
a change in accounting principle (530,040) (49,858) (50,464)
Cumulative effect of a change in
accounting principle (net of
income tax benefit of $983) (1,444) -
----------- ---------- ----------
Net loss $ (530,040) $ (51,302) $ (50,464)
=========== ========== ==========
- ------------------------------------------------------------------------
Net loss per share before
cumulative effect of a change
in accounting principle:
Basic $ (11.48) $ (1.09) $ (1.30)
Diluted (11.48) (1.09) (1.30)
- -------------------------------------------------------------------------
Net loss per share:
Basic $ (11.48) $ (1.13) $ (1.30)
Diluted (11.48) (1.13) (1.30)
- -------------------------------------------------------------------------
Weighted average shares
outstanding:
Basic 46,151 45,592 38,844
Diluted 46,151 45,592 38,844
- -------------------------------------------------------------------------
See notes to consolidated financial statements.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
(In thousands, except share amounts)
Retained
Common Stock Earnings
--------------------- (Accumulated
Shares Amount Deficit) Total
---------- -------- -------- ---------
Balance at December 31, 1997 36,786,396 $247,950 $ 43,988 $ 291,938
---------- -------- -------- ---------
Issuance of common stock:
Stock options exercised 633,859 4,376 - 4,376
Tax benefit from stock options - 2,563 - 2,563
Reel.com acquisition 4,000,000 42,760 - 42,760
Sold to Reel.com affiliates 1,982,537 26,764 - 26,764
Conversion of preferred stock
to common stock 2,380,263 29,324 - 29,324
Stock options issued for
Reel.com acquisition - 10,840 - 10,840
Common stock repurchases (850,000) (10,510) - (10,510)
Net loss - - (50,464) (50,464)
---------- -------- -------- ---------
Balance at December 31, 1998 44,933,055 354,067 (6,476) 347,591
---------- -------- -------- ---------
Issuance of common stock:
Stock options exercised 888,482 4,392 - 4,392
Tax benefit from stock options - 3,848 - 3,848
Net loss - - (51,302) (51,302)
---------- -------- -------- ---------
Balance at December 31, 1999 45,821,537 362,307 (57,778) 304,529
---------- -------- -------- ---------
Issuance of common stock:
Legal settlement 200,000 2,288 2,288
Stock options exercised 226,062 783 783
Tax benefit from stock options - 63 63
Net loss - - (530,040) (530,040)
---------- -------- -------- ---------
Balance at December 31, 2000 46,247,599 $365,441 $(587,818) $(222,377)
========== ======== ======== =========
See notes to consolidated financial statements.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
-------------------------------
2000 1999 1998
--------- --------- --------
Operating activities:
Net loss $(530,040) $ (51,302) $(50,464)
Adjustments to reconcile net
loss to cash provided by
operating activities:
Cumulative effect of a change
in accounting principle - 1,444 -
Depreciation and amortization 277,163 222,842 195,387
Amortization charge for change in
estimate on rental inventory 164,306 - -
Impairment of long-lived assets 74,305 - -
Amortization of deferred financing
costs 2,665 1,936 1,462
Inventory valuation charge - - 99,910
Write-off of purchased in-process
research and development - - 1,900
Net asset write down for closure of
Internet business 40,087 - -
Net asset write down for store closures 9,516 - -
Loss on other asset dispositions 10,292
Tax benefit from exercise of
stock options 63 3,848 2,563
Change in deferred rent 1,993 3,565 3,961
Change in deferred income taxes 25,805 (1,545) (27,236)
Net change in operating assets
and liabilities:
Accounts receivable 18,680 (1,817) (1,071)
Merchandise inventories 16,718 (26,290) 3,749
Accounts payable 57,925 3,713 10,194
Accrued interest (48) 2,172 1,437
Accrued revenue sharing 21,453 (4,098) 13,500
Other current assets and
liabilities 57,988 22,683 (8,651)
--------- -------- --------
Cash provided by operating
activities 248,871 177,151 246,641
--------- -------- --------
Investing activities:
Purchases of rental inventory, net (176,753) (185,877) (265,158)
Purchase of property and
equipment, net (77,639) (112,258) (132,122)
Investment in businesses acquired - (17,434) (40,804)
Increase in intangibles and other
assets (1,430) (4,769) (327)
--------- -------- --------
Cash used in investing
activities (255,822) (320,338) (438,411)
--------- -------- --------
Financing activities:
Proceeds from the sale of
common stock, net - - 45,398
Issuance of long-term obligations 12,511 90,162 -
Repayments of long-term obligations (15,016) (8,401) (2,429)
Repurchase of common stock - - (10,510)
Proceeds from exercise of stock
options 783 4,392 4,376
Increase in revolving loan, net 5,000 60,000 155,001
--------- --------- --------
Cash provided by financing
activities 3,278 146,153 191,836
--------- --------- --------
Increase (decrease) in cash and
cash equivalents (3,673) 2,966 66
Cash and cash equivalents at
beginning of year 6,941 3,975 3,909
--------- --------- --------
Cash and cash equivalents at end
of year $ 3,268 $ 6,941 $ 3,975
========= ========= ========
Other Cash Flow Information:
Interest expense paid $ 60,702 $ 42,896 $ 31,562
Income taxes paid (refunded), net (915) 5,741 (706)
Non-cash financing activities
Issuance of common stock as part of
a legal settlement agreement 2,288
See notes to consolidated financial statements.
HOLLYWOOD ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2000, 1999, 1998
1. SIGNIFICANT ACCOUNTING POLICIES
Corporate Organization and Consolidation
The accompanying financial statements include the accounts of Hollywood
Entertainment Corporation and its wholly owned subsidiaries (the "Company").
The Company's subsidiaries include Hollywood Management Company and Reel.com,
Inc. All significant inter-company transactions have been eliminated.
Nature of the Business
The Company operates a chain of video superstores ("Hollywood Video")
throughout the United States. The Company also operated an Internet retailer of
video only products ("Reel.com") from October 1998 to June 2000 (see Note 10
for a discussion of the acquisition, and Note 11 for a discussion of the
discontinuation of e-commerce operations). The Company was incorporated in
Oregon on June 2, 1988 and opened its first store in October 1988. As of
December 31, 2000 and 1999, the Company operated 1,818 stores in 47 states and
1,615 stores in 44 states, respectively.
Use of Estimates in the Preparation of Financial Statements
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities as of the date of the financial statements
and the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. Significant estimates
relative to the Company include depreciation and amortization policies.
Reclassification of Prior Year Amounts
Certain prior year amounts have been reclassified to conform to the
presentation used for the current year. These reclassifications had no impact
to previously reported net loss or shareholders' equity.
Recently Issued Accounting Standards
The adoption of SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" issued by the Financial Accounting Standards Board
(FASB) on June 15, 1998, is not expected to have an effect on the Company's
results of operations or its financial position
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements", as amended by SAB 101A and SAB 101B, which was required
to be adopted by the Company by the fourth quarter of the year ended December
31, 2000. SAB No. 101 codifies the SEC's views regarding the recognition of
revenues. The Company adopted SAB No. 101, effective January 1, 2000 and the
impact on the Company's consolidated financial position and consolidated
results of operations was immaterial.
In April 2000, Financial Accounting Standards Board Interpretation No. 44
(FIN 44), Accounting for Certain Transactions Involving Stock Compensation, an
interpretation of APB Opinion No. 25, was issued. FIN 44 clarifies and
modifies APB Opinion No. 25, Accounting for Stock Issued to employees. The
Company adopted FIN 44 in fiscal year 2000. Accordingly 850,000 options to
purchase common stock that were effectively re-priced will be accounted for as
variable plan options. Such accounting could result in future charges to
earnings (Note 19).
Revenue Recognition
The Company recognizes rental and product revenue related to the Hollywood
Video segment at the point of rental or sale to the customer. Additional fees
on rentals are recognized when earned, net of allowances for doubtful amounts
based on historical experience. The Company accrues for revenue sharing
expenses at contractual rates at the point videocassettes are rented. Such
expenses are included as cost of rental in the accompanying statement of
operations. Revenue from the Reel.com segment for product sales, net of
allowances and estimated returns, is recognized when the product is shipped to
the customer.
Cost of Rental
Cost of rental includes revenue sharing expense and amortization of
videocassettes.
Cash and Cash Equivalents
The Company considers highly liquid investment instruments, with an original
maturity of three months or less, to be cash equivalents.
Inventories
Merchandise inventories, consisting primarily of prerecorded videocassettes,
concessions, and other accessories held for resale, are stated at the lower of
cost or market. Cost of sales is determined using an average costing method.
Rental inventory, which includes VHS videocassettes, DVDs and video games is
stated at cost and amortized over its estimated useful life to a specified
salvage value. See Notes 4 and 5 for a discussion of the amortization policy
applied to rental inventory.
Property, Equipment, Depreciation and Amortization
Property is stated at cost and is depreciated on the straight-line method for
financial reporting purposes over the estimated useful life of the assets,
which range from approximately five to ten years. Leasehold improvements are
amortized primarily over ten years, which generally approximates the term of
the lease.
Additions to property and equipment are capitalized and include acquisitions of
property and equipment, costs incurred in the development and construction of
new stores, major improvements to existing property and major improvements in
management information systems. As property and equipment is sold or retired,
the applicable cost and accumulated depreciation and amortization are
eliminated from the accounts and any gain or loss thereon is recorded.
In 1998, the Company adopted Statement of Position 98-1 ("SOP 98-1"), which
defines the types of costs that may be capitalized for internally developed
computer software. Accordingly, the Company capitalized $.3 million and $1.5
million in 1999 and 1998, respectively. The Company did not incur costs in 2000
that meet the capitalization requirements.
Long-lived Assets
In accordance with FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("Statement
121"), the Company reviews for impairment of long-lived assets, and goodwill
related to those assets, to be held and used in the business whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The Company periodically reviews and monitors its internal
management reports for indicators of impairment of individual stores. The
Company considers a trend of unsatisfactory operating results that are not in
line with management's expectations to be its primary indicator of potential
impairment. For purposes of Statement 121, assets are evaluated for impairment
at the store level, which management believes is the lowest level for which
there are identifiable cash flows. The Company deems a store to be impaired if
a forecast of undiscounted future operating cash flows directly related to the
store, including estimated disposal value if any, is less than the asset
carrying amount. If a store is determined to be impaired, the loss is measured
as the amount by which the carrying amount of the store exceeds its fair value.
Fair value is estimated using a discounted future cash flow valuation technique
similar to that used by management in making a new investment decision.
Considerable management judgment is necessary to estimate discounted future
cash flows. Accordingly, actual results could vary significantly from such
estimates. See Note 8 for estimated impairments at December 31, 2000.
Treasury Stock
In accordance with Oregon law, shares are automatically retired and classified
as available for issuance upon the repurchase of common stock.
Income Taxes
The Company calculates income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes", which requires recognition of deferred tax
liabilities and assets for the expected future tax consequences of events that
have been included in the financial statements and tax returns. Valuation
allowances are established when necessary to reduce deferred tax assets to the
amount expected to be realized.
Deferred Rent
Many of the Company's operating leases contain predetermined fixed increases of
the minimum rental rate during the initial lease term. For these leases, the
Company recognizes the related rental expense on a straight-line basis and
records the difference between the amount charged to expense and the rent paid
as deferred rent.
Fair Value of Financial Instruments
In accordance with SFAS No. 107, "Disclosure about Fair Value of Financial
Instruments", the Company has disclosed the fair value, related carrying value
and method for determining the fair value for the following financial
instruments in the accompanying notes as referenced: cash and cash equivalents
(see Note 1), accounts receivable (see Note 2), and long-term obligations (see
Note 16).
Comprehensive Income
Comprehensive income (loss) is equal to net income (loss) for all periods
presented.
Advertising
The Company receives cooperative reimbursements from vendors as eligible
expenditures occur relative to the promotion of rental and sales product.
Advertising costs, net of these reimbursements, are expensed as incurred.
Advertising expense was $25.6 million, $1.2 million and $6.7 for 2000, 1999 and
1998, respectively.
Store Pre-opening Costs
Store pre-opening costs, including store employee labor costs and advertising,
incurred prior to the opening of a new store had been expensed during the first
full month of a store's operation. In April 1998, Statement of Position 98-5
(SOP 98-5), "Reporting on the Costs of Start-up Activities" was finalized,
which requires that costs incurred for start-up activities, such as store
openings, be expensed as incurred. The Company adopted SOP 98-5 effective
January 1, 1999. The cumulative effect of the change was to increase net loss
by $1.4 million, net of tax.
2. ACCOUNTS RECEIVABLE
Accounts receivable as of December 31, 2000 and 1999 consists of:
----------------------
2000 1999
---------- ---------
(in thousands)
Construction receivables $ 1,266 $ 8,274
Additional rental fees 17,425 15,218
Marketing allowances 4,365 8,863
Other 774 10,324
---------- ---------
$ 23,830 $ 42,679
========== =========
The carrying amount of accounts receivable approximates fair value because of
the short maturity of those receivables.
3. RENTAL INVENTORY
Rental inventory as of December 31, 2000 and 1999 consists of (in thousands):
-------------------------
2000 1999
---------- ----------
Rental inventory $ 604,715 $ 571,460
Less accumulated amortization (436,253) (231,548)
---------- ----------
$ 168,462 $ 339,912
========== ==========
Amortization expense related to rental inventory was $341 million, $107.6
million and $135.2 million in 2000, 1999 and 1998, respectively, and is
included in cost of rental. Amortization in the current year includes a $164.3
million charge for changes in estimated useful lives and salvage values of
various types of rental product (see Note 4). As rental inventory is
transferred to merchandise inventory and sold (previously viewed product), the
applicable cost and accumulated amortization are eliminated from the accounts,
determined on a first-in-first-out ("FIFO") basis applied in the aggregate to
monthly purchases.
4. AMORTIZATION POLICY AND CHANGES IN ESTIMATE
During the fourth quarter of 2000, the Company made the following key
observations leading management to change estimates regarding rental inventory
lives and residual values.
- - Growth in DVD rental revenue exceeded the Company's original estimates and
has negatively impacted revenue from VHS product.
- - In December 2000, rental revenue from DVD product surpassed rental revenue
from catalog VHS product.
- - The average sales price of previously viewed VHS movies in fourth quarter of
2000 declined by 24% compared to the third quarter of 2000.
- - The decline in new store openings has caused a build-up of VHS and game
inventory in the Company's warehouse.
Based on the observations noted above, and revised internal estimates on the
growth of DVD rental revenue, the Company's amortization policy with revised
estimates compared to previous estimates is as follows:
- - All catalog VHS product, regardless of the method of acquisition, is
amortized straight-line with an estimated useful life of one year compared to
the previous estimate of five years, and an estimated residual value of $2
compared to the previous estimate of $6.
- - For new release tapes acquired under revenue sharing, the studios share of
rental revenue is expensed net of an average value established in rental
inventory, prior to amortization, of $3 compared to the previous estimate of
$4. Tapes that remain in the Company's catalog selection are amortized to $2 in
one year.
- - New release VHS tapes acquired under methods other than revenue sharing are
amortized to an average value of approximately $4 in the first four months
compared to the previous estimate of $8. Tapes that remain in the Company's
catalog selection are amortized to $2 in one year.
- - DVD rental inventory is amortized on an accelerated basis to an average
value of approximately $7 in the first four months. DVDs that remain in the
Company's catalog selection are amortized to $6 in 60 months. Prior to the
change in estimate, all purchases of DVD rental inventory were amortized
straight-line to a residual value of $6 in 60 months.
- - Game rental inventory is amortized on an accelerated basis to an average
value of approximately $14 in the first four months. Games that remain in the
Company's catalog selection are amortized to $5 in 24 months. Prior to the
change in estimate, Game rental inventory was amortized on an accelerated basis
to an average value of approximately $14.50 in the first twelve months and the
catalog residual value was $8.
The Company adopted these changes in estimate prospectively on October 1, 2000.
The change resulted in a $164.3 million increase to amortization expense in the
fourth quarter of 2000 and is classified as cost of rental on the consolidated
statement of operations.
5. CHANGE IN AMORTIZATION METHOD FOR RENTAL INVENTORY
Effective October 1, 1998, Hollywood Video adopted a new method of amortizing
videocassette rental inventory. During the fourth quarter of 1998, Hollywood
Video acquired a majority of new video releases under revenue sharing
arrangements with major studios. Revenue sharing allows the Company to acquire
videocassettes at a lower product cost than the traditional buying
arrangements, with a percentage of the net rental revenues shared with the
studios over a contractually determined period of time. The increased copy
depth under revenue sharing arrangements satisfies the initial consumer demand
for new releases over a shorter period of time. As the new business model
results in a significantly greater proportion of rental revenue received over a
shorter period of time, the Company changed its method of amortizing rental
inventory in order to better match expenses with the related revenues.
The policy prior to October 1, 1998 was a follows:
- - Non-revenue sharing new release videocassettes were amortized on an
accelerated basis over 4 months to an average net book value of $15 and then on
a straight-line basis to their estimated salvage value of $6 over the next 32
months.
- - Base stock videocassettes and video games were amortized on a straight-line
basis to an estimated salvage value of $6 over 36 months.
The new method of amortization was applied to rental inventory held as of
October 1, 1998. The adoption of the new method of amortization was accounted
for as a change in accounting estimate effected by a change in accounting
principle, and accordingly the Company recorded a pre-tax charge of $99.9
million, or $1.53 per diluted share, in the fourth quarter of 1998. The
calculation of the change in operating expense attributable to videocassettes
for periods prior to October 1, 1998 would not be meaningful because the new
business model involving revenue sharing arrangements had not been implemented.
The change in estimate, effective October 1, 1998 decreased net loss by $1.0
million, or $.03 per diluted share net of tax in the fourth quarter of 1998.
6. PROPERTY AND EQUIPMENT
Property and equipment as of December 31, 2000 and 1999 consists of:
---------------------
2000 1999
--------- ----------
(in thousands)
Fixtures and equipment $ 156,960 $ 146,318
Leasehold improvements 352,245 327,838
Equipment under capital lease 19,578 16,058
Leasehold improvements under
capital lease 44,279 35,258
--------- ----------
573,062 525,472
Less accumulated depreciation
and amortization (249,396) (143,127)
--------- ----------
$ 323,666 $ 382,345
========= ==========
Accumulated depreciation and amortization, as presented above, includes
accumulated amortization of assets under capital leases of $16.4 million and
$8.0 million at December 31, 2000 and 1999, respectively.
7. STORE CLOSURE RESTRUCTURING
In December 2000, the Company approved a restructuring plan involving the
closure and disposition of 43 stores that were not operating to management's
expectations (the "Restructuring Plan"). In accordance with the Restructuring
Plan, these stores will be closed in the year 2001. The Company has recognized
a charge of $16.9 million, including an $8.0 million write down of property and
equipment, a $1.5 million write down of goodwill and an accrual for store
closing costs of $7.4 million. The established reserve for cash expenditures
is for lease termination fees and other store closure costs. The Company
anticipates paying all accrued store closure costs in 2001.
The Company plans to liquidate all inventories through store closing sales; any
remaining product will be used in other stores. The Company anticipates
inventory liquidations and asset disposals will be completed in 2001.
Revenue during the years ended December 31, 2000, 1999 and 1998 for the stores
included in the Restructuring Plan was approximately $15.5 million, $13.4
million and $9.1 million, respectively. Operating results (defined as income
or loss before interest expense and income taxes) during the years ended
December 31, 2000, 1999 and 1998 for the stores included in the Restructuring
Plan were approximately $1.8 million loss, $0.5 million loss and $15,684
income, respectively.
8. IMPAIRMENT OF LONG-LIVED ASSETS
In the fourth quarter of 2000, the Company experienced negative same store
sales for the first time in 21 quarters while major competitors experienced
positive same store sales. With a strong slate of new release titles, the
decline in same store sales was unexpected and triggered an impairment analysis
in accordance with the Company's policy outlined in Note 1. The company
identified a number of impaired stores and recorded a charge of $74.3 million.
The non-cash charge included $44.3 million classified as operating and selling
in the consolidated statement of operations that reduced the net carrying
amount of property and equipment, and $30 million classified as amortization of
intangibles that reduced the net carrying amount of goodwill. Property and
equipment primarily consisted of leasehold improvements and fixtures that could
not be used in other locations.
9. GOODWILL
Goodwill as of December 31, 2000 and 1999 consists of:
--------------------
2000 1999
--------- ---------
(in thousands)
Goodwill $ 134,309 $ 236,445
Less accumulated
amortization (64,693) (90,941)
--------- ---------
$ 69,616 $ 145,504
========= =========
Goodwill represents the excess of cost over fair value of net assets purchased
and is being amortized on a straight-line basis over two or 20 years. Goodwill
in connection with store acquisitions is amortized over 20 years. Goodwill from
the Reel.com acquisition was amortized over two years prior to the
discontinuation of e-commerce operations in June 2000. In the second quarter
of 2000, the Company recorded a $69.3 million charge in connection with the
restructuring of Reel.com, including $14.9 million of Goodwill (see Note 11).
The Company assesses the recoverability of store acquisition intangibles by
determining whether the amortization of the goodwill over the remaining lives
can be recovered through projected future operating results on an undiscounted
basis. During the fourth quarter of 2000, a plan was developed to close 43
stores, of which, 5 were acquired stores. The Company recorded a restructuring
charge of $16.9 million, including $1.5 million of goodwill associated with the
acquired stores (see Note 7). The Company also determined estimated future cash
flows on several additional acquired stores were less than the net carrying
amount of assets associated with each store (see Note 8). As required by FAS
121, the Company recorded an impairment charge of $74.3 million, including $30
million of goodwill.
10. ACQUISITIONS
Reel.com
See Note 11 for a discussion of the discontinuation of Reel.com e-commerce
operations on June 12, 2000.
On October 1, 1998, the Company completed the merger of Reel.com with and into
Hollywood Entertainment Corporation. At the closing, the Company acquired all
the outstanding shares of Reel.com for $32.7 million in cash and 4,000,000
shares of Common Stock and 1,000,000 shares of Series A Redeemable Preferred
Stock. Both common and preferred shares were valued at $10.69 per share,
representing a 10% discount from the October 1, 1998 closing price. In
addition, the Company assumed Reel.com's incentive stock option plan and
converted all outstanding Reel.com stock options into options to acquire the
Company's Common Stock. Options for a total of 958,568 shares were assumed in
connection with the acquisition (the options granted were valued at $11.31 per
share using the Black-Scholes option valuation model).
Concurrent with the acquisition of Reel.com, the Company sold 1,982,537 shares
of Common Stock and 1,380,263 shares of Series A Redeemable Preferred Stock at
a price of $13.50 per share to certain shareholders and affiliates of Reel.com.
The Series A Redeemable Preferred Stock was converted into Common Stock on a
one for one basis upon shareholder approval on December 30, 1998.
The acquisition of Reel.com for approximately $96.9 million was accounted for
under the purchase method of accounting. The financial statements reflect the
allocation of the purchase price and assumption of Reel.com's liabilities and
include the operating results from the date of acquisition.
The following sets forth the reconciliation of the cash paid (in thousands) for
Reel.com, Inc.:
Fair value of assets acquired $ 3,634
Goodwill 100,349
Purchased research and development 1,900
Value of stock issued (53,450)
Value of stock options issued (10,840)
Liabilities assumed (8,934)
---------
Cash paid, including transaction
costs, net of cash received $ 32,659
=========
The value of stock options issued was determined using the Black-Scholes stock
option pricing model. Goodwill began amortizing in the fourth quarter of 1998
over the estimate useful life of 2 years.
The following unaudited pro forma information presents the results of the
Company's operations assuming the Reel.com acquisition occurred at the
beginning of each period presented (in thousands, except per share data):
Year Ended
December 31,
-----------
1998
-----------
Total revenue $ 773,812
Net loss (97,306)
Net loss per share:
Basic (2.16)
Diluted (2.16)
The pro forma financial information is not necessarily indicative of the
operating results that would have occurred had the Reel.com acquisition been
consummated as of the beginning of each period, nor is it necessarily
indicative of future operating results.
Store Acquisitions
Store growth in 2000 did not include any acquired stores.
During 1999, the Company acquired the operations and assets of 49 video
superstores for an aggregate purchase price of $17.4 million. The acquisitions
were accounted for under the purchase method of accounting. Approximately $14.6
million was allocated to Goodwill and is being amortized over the estimated
useful life of 20 years. The results of operations for these acquisitions do
not have a material effect on the consolidated operating results and therefore
are not included in the pro forma data presented.
During 1998, the Company acquired the operations and assets of 41 video
superstores located in New York (11) and Florida (30) for an aggregate purchase
price of $14.1 million. $6.0 million of the purchase price was paid with a
note payable bearing interest at 10.0% per annum due April 1, 1999, and the
remainder was paid in cash. The acquisitions were accounted for under the
purchase method of accounting. Approximately $9.8 million was allocated to
Goodwill and is being amortized over the estimated useful life of 20 years.
The results of operations for these acquisitions do not have a material effect
on the consolidated operating results and therefore are not included in the pro
forma data presented above.
11. REEL.COM DISCONTINUED E-COMMERCE OPERATIONS
On June 12, 2000, the Company announced that it would close down the e-commerce
business at Reel.com. The Company developed a leading web-site over the seven
quarters since Reel.com was purchased in October of 1998, but its business
model of rapid customer acquisition led to large operating losses and required
significant cash funding. Due to market conditions, the Company was unable to
obtain outside financing for Reel.com, and could not justify continued funding
from its video store cash flow. On June 13, 2000, the Company terminated
employment of approximately 200 of Reel.com's 240 employees, and paid $1.9
million in involuntary termination benefits. The remaining employees have since
been terminated or integrated into Hollywood Entertainment.
The Company plans to maintain the web-site as a content-only site to minimize
any negative effect the Reel.com shutdown may have on existing Hollywood Video
store customers for a period of time not expected to exceed twelve months from
the e-commerce shutdown. During this time, point of purchase materials
promoting Reel.com as an e-commerce destination will need to be removed from
the stores. To offset the costs of maintaining the web-site during this period,
the Company entered into a short-term agreement with Buy.com to direct Reel.com
visitors to Buy.com to make purchases. Revenues associated with the Buy.com
agreement and the expenses of maintaining the web-site have been recognized as
earned and incurred, respectively.
As a result of the discontinuation of e-commerce operations, the Company
recorded a total charge of $69.3 million in the second quarter of 2000, of
which $48.5 million was classified as a restructuring charge on the
consolidated statement of operations and $20.8 million was included in cost of
product sales. In the fourth quarter of 2000, the charge was reduced by $1.6
million to $46.9 million because the Company was able to negotiate termination
of certain obligations and lease commitments more favorably than originally
anticipated.
The restructuring charge line item includes $1.9 million of severance and
benefits paid on June 13, 2000, $19.3 million of asset write downs, and $25.7
million of accrued liabilities. The assets written down include the remaining
$14.9 million of goodwill associated with the acquisition of Reel.com and $4.4
million to write down equipment, leasehold improvements, prepaid expenses and
accounts receivable to their net realizable values. Amounts accrued include
$19.9 million for contractual obligations, lease commitments and anticipated
legal claims against the Company and $5.8 million for legal, financial, and
other professional services incurred as a direct result of the closure of
Reel.com. As of December 31, 2000, the Company had paid $3.9 million of the
accrued amounts and anticipates paying the remaining $21.8 million in 2001.
The Company used some of the equipment from Reel.com at the new distribution
center in Nashville, Tennessee, and at its corporate offices in Wilsonville,
Oregon. Equipment not utilized by the Company was sold. Proceeds of $250,000
were received in the third quarter of 2000.
Charged to cost of goods sold was the write down of Reel.com inventory,
primarily DVD's, to net realizable value. This represents excess product for
the Hollywood Video segment. The Company liquidated over 85% of this inventory
as of the end of 2000 and plans to liquidate the remaining amount by the end of
the second quarter of 2001.
12. OPERATING LEASES
The Company leases all of its stores, corporate offices, distribution center
and zone offices under non-cancelable operating leases. All of the Company's
stores have an initial operating lease term of five to 15 years and most have
options to renew for between five and 15 additional years. Most operating
leases require payment of property taxes, utilities, common area maintenance
and insurance. Total rent expense, including related lease-required costs,
incurred during 2000, 1999, and 1998 was $243.9 million, $201.6 million and
$154.8 million, respectively.
At December 31, 2000, the future minimum annual rental commitments under non-
cancelable operating leases were as follows:
------------------------------
Operating
Year Ending Leases
December 31, (in thousands)
------------------------------
2001 $214,985
2002 211,392
2003 209,235
2004 203,973
2005 194,017
Thereafter 706,341
13. ACCRUED LIABILITIES
Accrued liabilities as of December 31, 2000 and 1999 consist of:
----------------------
2000 1999
---------- ---------
(in thousands)
Payroll and benefits 19,431 13,071
Property taxes and common
area maintenance 16,340 12,476
Gift certificates and coupons 6,226 2,256
Marketing 14,409 451
Rentrak litigation settlement - 21,429
Store closures and lease
terminations 17,071 -
Reel.com restructuring 21,455 -
Other operating and general
administration 19,701 14,883
---------- ---------
$ 114,633 $ 64,566
========== =========
14. EMPLOYEE BENEFIT PLANS
The Company is self-insured for employee medical benefits under the Company's
group health plan. The Company maintains stop loss coverage for individual
claims in excess of $100,000 and for annual Company claims which exceed
approximately $3.0 million in the aggregate. While the ultimate amount of
claims incurred is dependent on future developments, in management's opinion,
recorded reserves are adequate to cover the future payment of claims.
Adjustments, if any, to recorded estimates resulting from ultimate payments
will be reflected in operations in the period in which such adjustments are
known.
Beginning January 1, 1998, the Company added a 401(k) plan in which eligible
employees may elect to contribute up to 15% of their earnings. Eligible
employees are at least 21 years of age, have completed at least one year of
service and work at least 1,000 hours in a year. The Company increased the
maximum contribution to 20% in July 1999 and began matching 25% of the
employees first 6% of contributions in January 2000. There were no matching
contributions in 1999 or 1998.
Beginning in April 2000, the Company offered a deferred compensation plan to
certain key employees designated by the Company. The plan allows for the
deferral and investment of current compensation on a pre-tax basis.
15. RELATED PARTY TRANSACTIONS
On May 8, 2000, the Board of Directors approved a long-term compensation
package for the Company's Chief Executive Officer, which included a $15 million
loan. The five year loan bears interest at an annual rate equal to the greater
of ten percent or the minimum rate required under the Internal Revenue Code and
regulations for loans to affiliated persons, and is due in five annual
installments of $3 million beginning on June 1, 2001. In December 2000, the
Board of Directors determined that the loan was not collectible and directed
the Company to write off the loan.
16. LONG-TERM OBLIGATIONS AND LIQUIDITY
The Company had the following long-term obligations as of December 31, 2000 and
1999 (in thousands).
December 31,
----------- ----------
2000 1999
----------- ----------
Senior subordinated notes (1) $250,000 $ 250,000
Borrowings under revolving credit facility 245,000 240,000
Obligations under capital leases 41,396 43,886
Other 5 20
----------- ----------
536,401 533,906
Current portions:
Credit facility (2) 245,000 -
Capital leases 16,164 14,493
----------- ----------
261,164 14,493
Total long-term obligations ----------- ----------
net of current portion $ 275,237 $ 519,413
=========== ==========
(1) Coupon payments at 10.625% are due semi-annually in February and August
of each year
(2) Includes $112.5 million that matures in 2002 reclassified as current
portion due to covenant violations that have not been waived beyond May 5, 2001
as discussed below.
At December 31, 2000, maturities on long-term obligations for the next
five years were as follows (in thousands):
Capital
Year Ending Subordinated Credit Leases
December, 31 Notes Facility & Other Total
- ------------ ---------- ---------- --------- ---------
2001 $ - $ 132,500(3) $ 16,164 $ 148,664
2002 - 112,500 14,648 127,148
2003 - - 10,589 10,589
2004 250,000 - - 250,000
2005 - - - -
Thereafter - - - -
----------- ---------- --------- ---------
$ 250,000 $ 245,000 $ 41,401 $ 536,401
----------- ---------- --------- ---------
(3) Does not include $112.5 million that matures in 2002 reclassified as
current portion due to covenant violations that have not been waived beyond May
5, 2001 as noted above and discussed below.
In August 1997, the Company issued $200 million principal amount of 10.625%
senior subordinated notes (the "Notes") due August 15, 2004. The proceeds
received from the sale of the Notes, net of offering costs of $6.8 million,
were used to repay the entire outstanding indebtedness under the then existing
bank revolving loan.
In June 1999, the Company issued an additional $50 million principal amount of
10.625% senior subordinated notes under substantially the same terms as the
original $200 million. Proceeds were used to repay a portion of its
indebtedness outstanding under its senior revolving credit agreement.
The Notes are redeemable, at the option of the Company, after August 14, 2001
at rates starting at 105.313% of principal amount reduced annually through
August 15, 2004, at which time they become redeemable at 100% of the principal
amount. The terms of the Notes may restrict, among other things, the payment of
dividends and other distributions, investments, the repurchase of capital stock
and the making of certain other restricted payments by the Company, the
incurrence of additional indebtedness by the Company or any of its
subsidiaries, and certain mergers, consolidations and disposition of assets.
Additionally, if a change of control occurs, as defined, each holder of the
Notes will have the right to require the Company to repurchase such holder's
Notes at 101% of principal amount thereof.
The Company is limited in the amount of cash dividends that it can pay and the
amount of common stock and subordinated indebtedness that it may repurchase by
applicable covenants contained in the Notes.
In September 1997, the Company entered into a senior revolving credit agreement
that provided the availability of up to $300 million in aggregate extension of
credit. Revolving credit loans under the credit agreement bear interest, at the
Company's option, at an applicable margin over the bank's base rate loan of the
IBOR rate. The applicable margin is based upon the ratio of consolidated
indebtedness to consolidated adjusted EBITDA, as defined below. The credit
agreement also provides for a commitment fee of 1/2% of any unused portion of
the credit agreement. Among other restrictions, the credit agreement contains
financial covenants relating to specified levels of indebtedness to adjusted
net cash EBITDA. Adjusted net cash EBITDA is defined as income from operations
before depreciation and amortization plus non-cash expenses that reduced
EBITDA, less the cost of acquiring new release videocassettes, game inventory
and new store rental inventory which is capitalized. Other ratios and
restrictions include: adjusted net cash EBITDA less cash taxes paid compared to
interest expense; adjusted net cash EBITDA less cash taxes paid plus rent
expense compared to interest expense plus rent expense; maintenance of average
store contribution levels; and the maintenance of minimum tangible net worth.
Amounts outstanding under the credit agreement are collateralized by
substantially all of the assets of the Company.
The Company began the year growing at the average rate of one store per day, as
well as funding significant cash losses at Reel.com. In order to meet the
funding needs to continue at this growth rate, the Company's $300 million
credit facility needed to be expanded or refinanced. During early 2000, the
Company attempted to refinance this facility. In March 2000 the Company
received an underwritten commitment from a group of banks for a new $375
million credit facility but syndication of this new facility failed in May
2000. Without the availability of new funding, the Company was faced with the
need to begin reducing the outstanding principal amount of its $300 million
credit facility starting with $37.5 million on December 5, 2000 and continuing
to reduce by $37.5 million each quarter thereafter.
The Company has increased its focus on maximizing cash generation and return on
invested capital. After being a net user of cash since inception as a result
of rapid store growth, the Company became a net generator of cash in the fourth
quarter of 2000. The Company believes that by closing Reel.com's e-commerce
operation, and almost stopping new store growth, it has substantially reduced
the ongoing uses of cash from that of early 2000. Because of the large base of
stores, cash from operations is expected to be large enough in 2001 and beyond
to pay interest, cash taxes and all growth and maintenance capital
expenditures, and have significant cash remaining to reduce the debt balance.
The balance on the revolving credit facility began the year at $240 million,
reached a maximum of $300 million at September 30, and was reduced to a balance
of $245 million at December 31, 2000 leaving the Company $17.5 million under
the maximum availability of $262.5 million. Because it is doubtful the Company
will be able to meet the scheduled 2001 facility amortization of $150 million,
the Company has been negotiating a restructured amortization with its lenders.
On March 6, 2001, the Company made a $6 million amortization payment and its
lenders agreed to defer $31.5 million of the $37.5 million total due on that
date and work toward a permanent change in the amortization schedule to better
match debt pay-down with the current business plan. This change is scheduled
to be completed by May 5, 2001. However, this change requires the affirmative
vote of 100% of the approximately 20 lenders involved with the credit facility.
There can be no assurances that the Company will be successful in its
negotiations. As a result of this, in addition to the fact that the Company has
had net losses in 2000, 1999, and 1998 and at December 31, 2000 has a
shareholders deficit of $222.4 million, the Company's independent accountants
have included a going concern paragraph in their report dated March 21, 2001,
except as to Note 25 which is dated March 29, 2001, on these consolidated
financial statements. Adjustments relating to the realization of assets and
classification of the liabilities that might be necessary if the Company is
unable to continue as a going concern have not been made.
As of December 31, 2000, the Company was in violation of covenants contained
within the credit facility. The Company was able to obtain the appropriate
waiver for the violations. However, this waiver expires May 5, 2001. Because
the waiver does not extend beyond May 5, 2001, in accordance with FAS 78,
Classification of Obligations That Are Callable by the Creditor, the Company
has reclassified $112.5 million of the credit facility that matures in 2002 to
current liabilities on the consolidated balance sheet as of December 31, 2000.
As of December 31, 2000, the fair value of the Notes was $101.3 million. The
fair value of the Notes was based on quoted market prices as of December 31,
2000. The revolving credit facility is a variable rate loan, and thus, the
fair value approximates the carrying amount as of December 31, 2000.
As of December 31, 2000, the Company had $2.3 million of outstanding letters of
credit.
17. INCOME TAXES
The provision for (benefit from) income taxes for the years ended December
31, 2000, 1999 and 1998 consists of:
------------------------------
2000 1999 1998
---------- -------- --------
(in thousands)
Current:
Federal $ 3,396 2,802 $ -
State 2,391 1,064 983
--------- -------- --------
Total current provision 5,787 3,866 983
Deferred:
Federal 22,523 (2,450) (17,281)
State 3,282 452 (2,903)
--------- -------- --------
Total deferred liability
(benefit) 25,805 (1,998) (20,184)
--------- -------- --------
Total provision (benefit) $ 31,592 $ 1,868 $(19,201)
========= ======== ========
The Company is subject to minimum state taxes in excess of statutory state
income taxes in many of the states in which it operates. These taxes are
included in the current provision for state and local income taxes. Certain
acquisitions in 1995 and the Reel.com acquisition in 1998 yielded non-
deductible goodwill which is reflected in the tax rate reconciliation below.
The tax impact of purchase accounting adjustments is reflected in deferred
taxes. A reconciliation of the statutory federal income tax rate with the
Company's effective tax rate is as follows:
--------------------------
2000 1999 1998
-------- ------- -------
Statutory federal rate
(benefit) (34.0%) (34.0%) (34.0%)
State income taxes, net of
federal income tax benefit (3.5) 2.1 (1.8)
Amortization of non-deductible
goodwill 2.6 35.7 6.9
Increase in valuation allowance 41.3 - -
Other, net (0.1) 0.1 1.3
------- ------- -------
6.3% 3.9% (27.6%)
======= ======= =======
Deferred income taxes reflect the impact of "temporary differences" between
amounts of assets and liabilities for financial reporting purposes and such
amounts as measured by tax laws. The tax effects of temporary differences that
give rise to significant portions of deferred tax assets and liabilities at
December 31 are as follows:
---------------------
2000 1999
---------- --------
Deferred tax assets:
Tax loss carryforward $ 122,702 $ 29,428
Deferred rent 7,775 7,037
Financial leases 8,161 5,903
Accrued liabilities and reserves 18,790 2,537
Tax credit carryforward 3,456 4,031
Restructure charge 13,735 -
Accrued legal settlement 522 9,835
Inventory valuation 59,358 -
Amortization deductible for financial
statement purposes 14,237 -
Other - 25
---------- --------
Total deferred tax assets 248,736 58,796
Valuation allowance (211,247) (6,105)
---------- --------
Net deferred tax assets 37,489 52,691
---------- --------
Deferred tax liabilities:
Depreciation and amortization (32,843) (22,894)
Capitalized leases (4,646) (3,745)
Deferred expenses - (247)
---------- --------
Total deferred tax liabilities (37,489) (26,886)
---------- --------
Net deferred tax asset (liability) $ - $ 25,805
========== ========
The valuation allowance of $211.2 million as of December 31, 2000 represents a
provision for the uncertainty as to the realization of deferred tax assets,
including temporary differences and net operating loss carryforwards.
Management believes that based on the losses incurred for the years ended
December 31, 2000 and 1999, and other factors, the weight of available evidence
indicates that it is more likely than not that the Company will not be able to
realize its deferred tax assets, and thus a full valuation allowance has been
recorded at December 31, 2000. As of December 31, 2000, the Company had
approximately $336.4 million of net operating loss carryforwards available to
reduce future income taxes. The carryforward periods expire in years 2010
through 2020. The Company has federal Alternative Minimum Tax ("AMT") credit
carryforwards of $3.0 million which are available to reduce future regular
taxes in excess of AMT. These credits have no expiration date.
The Company may realize tax benefits as a result of the exercise of certain
employee stock options. For financial reporting purposes, any reduction in
income tax obligations as a result of these tax benefits is credited to
shareholder equity.
18. SHAREHOLDERS' EQUITY
Preferred Stock
At December 31, 2000 the Company is authorized to issue 19,500,000 shares of
preferred stock in one or more series. The Board of Directors has authority
over the designations, preferences, special rights, limitations or restrictions
thereof as it may determine. The Company issued and sold a total of 2,380,263
shares of Series A Redeemable Preferred Stock in connection with the Reel.com
acquisition. These shares were converted into Common Stock on a one for one
basis upon shareholder approval on December 30, 1998.
Common Stock
On January 24, 2000, the Company issued to Rentrak Corporation 200,000 shares
of common stock as part of a litigation settlement.
During 1998, the Company repurchased 850,000 Common Shares on the open market
for $10.5 million.
In October 1998, the Company exchanged and sold a total of 8,362,800 shares of
its Common Stock in connection with the acquisition of Reel.com as discussed in
Note 10. This amount includes the Preferred Shares converted to Common Stock
discussed above.
19. STOCK OPTION PLANS
In general, the Company's stock option plans provide for the granting of
options to purchase Company shares at the market price of such shares as of the
option grant date. The options generally have a nine year term and become
exercisable on a pro rata basis over five years. The Company adopted stock
option plans in 1993 and 1997 providing for the granting of non-qualified stock
options, stock appreciation rights, bonus rights and other incentive grants to
employees up to an aggregate of 10,000,000 shares of common stock. The 1997
plan provides for the granting of nonqualified stock options to employees up to
an aggregate of 2,000,000 shares of common stock. The Company granted non-
qualified stock options pursuant to the 1993 and the 1997 Plans totaling
2,512,650, 2,804,925 and 5,347,269 in 2000, 1999 and 1998, respectively.
The Company has elected to follow APB No. 25; "Accounting for Stock Issued to
Employees" ("APB 25"), and related interpretations in accounting for its
employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying
stock on the date of the grant, no compensation expense is recognized. Pro
forma information regarding net income per share is required by SFAS No. 123,
"Accounting for Stock-Based Compensation", and has been determined as if the
Company had accounted for its employee stock options under the fair value
method of that statement. The fair value of these options was estimated at the
date of grant using Black-Scholes option pricing model with the following
weighted-average assumptions for 2000, 1999 and 1998:
-----------------------------
2000 1999 1998
-----------------------------
Risk free interest rate 4.87% 6.33% 4.5%
Expected dividend yield 0% 0% 0%
Expected lives 5 years 5 years 5 years
Expected volatility 98% 85% 75%
The Black-Scholes option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. Because the Company's employee stock options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in the Company's opinion the existing available models do
not necessarily provide a reliable single measure of the fair value of the
Company's employee stock options.
Using the Black-Scholes option valuation model, the weighted average grant date
value of options granted during 2000, 1999 and 1998 (excluding the options
assumed in connection with the Reel.com acquisition) was $5.32, $9.95, and
$6.77 per option, respectively. Options issued in connection with the
Reel.com acquisition totaled 958,568 and had an aggregate fair market value of
$10.8 million at the closing date using the Black-Scholes option valuation
model.
For the purpose of pro forma disclosures, the estimated fair value of the
options is amortized over the option's vesting period. The value of options
issued in connection with the Reel.com acquisition are excluded from the pro
forma disclosure as the value of these options was part of the acquisition
purchase price.
The Company's pro forma information is as follows:
December 31,
------------------------------------------------------------
2000 1999 1998
-------------------- -------------------- ------------------
Pro Pro Pro
Reported Forma Reported Forma Reported Forma
--------- --------- --------- --------- -------- --------
Net income
(loss) $(530,040) $(538,886) $(51,302) $(57,665) $(50,464)$(53,583)
Earnings (loss)
per Share:
Basic (11.48) (11.68) (1.13) (1.26) (1.30) (1.38)
Diluted (11.48) (11.68) (1.13) (1.26) (1.30) (1.38)
Due to the Company's loss in 2000, 1999 and 1998, a calculation of earnings per
share assuming dilution is not required. In 2000, 1999 and 1998 dilutive
securities consisting of options convertible into 5.4 million, 8.2 million and
7.5 million shares of common stock, respectively, were excluded from the form
the reported and pro forma calculations due to the net loss in each year.
A summary of the Company's stock option activity and related information for
2000, 1999 and 1998 is as follows (in thousands, except per share amounts):
Weighted
Average
Exercise
Shares Price
-------- --------
Outstanding at December 31, 1997 5,138 12.09
Granted (1) 5,347 8.55
Exercised (633) 7.39
Cancelled (2,392) 13.79
-------- --------
Outstanding at December 31, 1998 7,460 9.40
Granted 2,805 14.05
Exercised (889) 5.24
Cancelled (1,189) 9.13
-------- --------
Outstanding as December 31, 1999 8,187 11.49
Granted 2,511 7.01
Exercised (226) 3.52
Cancelled (5,050) 11.81
-------- --------
Outstanding as December 31, 2000 5,422 9.45
======== ========
(1) Includes 958,568 stock options issued in connection with the Reel.com
acquisition. See Note 10.
A summary of options outstanding and exercisable at December 31, 2000 is as
follows (in thousands, except per share amounts):
------------------------------ -------------------
Options Outstanding Options Exercisable
------------------------------ -------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Life Exercise Exercise
Exercise Prices Options (in years) Price Options Price
- --------------- ------- --------- -------- ------- --------
$ 0.56 - $6.50 565 4.67 $ 4.55 350 $ 5.12
6.84 - 9.25 2,524 7.29 7.41 491 8.07
9.50 - 10.44 851 6.71 9.97 336 9.97
10.50 - 15.00 961 6.68 12.32 371 12.23
15.06 - 28.625 521 5.01 18.52 315 18.53
------ --------- -------- ------- --------
5,422 6.60 $ 9.45 1,863 $ 10.46
====== ========= ======== ======= ========
In the first quarter of 2000, the Company granted stock options to
approximately fifty key employees. The grants were for the same number of
shares issued to these employees prior to January 1, 2000. In the third quarter
of 2000, the Company canceled the stock options that were issued prior to
January 1, 2000 for the fifty employees. The grant and cancellation of the same
number of options for these employees resulted in variable accounting treatment
for the related options for 850,000 shares of the Company's common stock.
Variable accounting treatment will result in unpredictable stock-based
compensation dependent on fluctuations in quoted prices for the Company's
common stock.
20. EARNINGS PER SHARE
A reconciliation of the basic and diluted per share computations for 2000,
1999 and 1998 is as follows (in thousands, except per share data):
----------------------------------
2000
----------------------------------
Weighted Per
Income Average Share
(Loss) Shares Amount
---------- --------- ---------
Loss per common share $ (530,040) 46,151 $ (11.48)
Effect of dilutive securities:
Stock options - - -
---------- --------- ---------
Loss per share assuming dilution $ (530,040) 46,151 $ (11.48)
========== ========= =========
----------------------------------
1999
----------------------------------
Weighted Per
Income Average Share
(Loss) Shares Amount
---------- --------- ---------
Loss before cumulative effect
adjustment $ (49,858) 45,592 $ (1.09)
Cumulative effect of a change in
accounting principle, net of tax (1,444) - (0.04)
---------- --------- ---------
Loss per common share $ (51,302) 45,592 $ (1.13)
Effect of dilutive securities:
Stock options - - -
---------- --------- ---------
Loss per share assuming dilution $ (51,302) 45,592 $ (1.13)
========== ========= =========
----------------------------------
1998
----------------------------------
Weighted Per
Income Average Share
(Loss) Shares Amount
---------- --------- ---------
Loss per common share $ (50,464) 38,844 $ (1.30)
Effect of dilutive securities:
Stock options - - -
---------- --------- ---------
Loss per share assuming dilution $ (50,464) 38,844 $ (1.30)
========== ========= =========
Due to the Company's loss in 2000, 1999 and 1998, a calculation of earnings per
share assuming dilution is not required. In 2000, 1999 and 1998 dilutive
securities consisting of options convertible into 5.4 million, 8.2 million and
7.5 million shares of common stock, respectively, were excluded from the
calculation due to the net loss in each year.
21. SPECIAL AND/OR UNUSUAL ITEMS
The Company incurred the following special and/or unusual charges in 2000, 1999
and 1998.
2000
On June 12, 2000, the Company announced that it would close down the e-commerce
business at Reel.com. As a result, the Company recorded a total charge of $67.7
million, of which $46.9 million was classified as a restructuring charge on the
consolidated statement of operations and $20.8 million was included in cost of
product sales (Note 11).
Effective October 1, 2000, the Company changed several estimates regarding
useful lives and salvage values on various types of rental inventory. As a
result, the Company recorded a charge of $164.3 million to cost of rental on
the consolidated statement of operations (Note 4).
In the fourth quarter of 2000, the Company developed a plan to close a group of
stores by the end of 2001. The assets associated with each identified store
were removed from the books and estimated closing costs were accrued resulting
in a $16.9 million charge (Note 7).
In accordance with FASB Statement No. 121, the Company recorded a $74.3 million
charge to properly value long-lived assets at several stores (Note 8). The
charge included $30 million of goodwill, classified as amortization of
intangibles on the consolidated statement of operations, and $44.3 million of
property and equipment, classified as operating and selling.
1999
The Company recorded at 23.1 million charge in connection with a legal
settlement with Rentrak Corporation. On January 24, 2000, the Company and
Rentrak Corporation reached a settlement of their dispute concerning revenue
sharing videocassettes Rentrak had provided to the Company. The settlement
agreement resolves all disputes between the companies and dismisses all claims
against the Company. The settlement included $8.0 million in cash to cover
outstanding invoices and consideration for business disruption to Rentrak; $6.0
million to cover Rentrak's legal fees and costs; and finally, the Company
issued 200,000 shares of its common stock to Rentrak. Additionally, the Company
also incurred $5.8 million in legal fees related to the lawsuit.
On November 1, 1999, the Company and Twentieth Century Fox Home Entertainment
reached a settlement of their dispute. Fox had filed suit alleging fraud and
interference with Fox's contract with Rentrak. The Company incurred $2.3
million in settlement and related legal costs.
1998
The Company recorded a $99.9 million charge related to the valuation of its
rental inventory (Note 5). In addition, the Company wrote off $1.9 million
related to purchased research and development costs associated with the
Reel.com acquisition (Note 10).
22. COMMITMENTS AND CONTINGENCIES
During 1999, the Company was named as a defendant in three complaints which
have been coordinated into a single class action entitled California Exemption
Cases, Case No. CV779511, in the Superior Court of the State of California in
and for the County of Santa Clara. The plaintiffs are seeking to certify a
class made up of certain exempt employees, which they claim are owed overtime
payments in certain stores in California. The case is in the early stages of
discovery. A class has not been certified. The Company believes it has
provided adequate reserves in connection with this claim and intends to
vigorously defend the action.
On November 15, 2000, 3PF, a subsidiary of Rentrak Corporation filed a demand
for arbitration with the American Arbitration Association, Case No. 75 181
00413 00 GLO against the Company and Reel.com, Inc. ("Reel"). 3PF and Reel
entered into a Warehousing and Distribution Agreement on February 7, 2000. 3PF
has alleged that Reel is in default under the Agreement, has failed to perform
material obligations under the Agreement, and has failed to pay amounts due
3PF. 3PF seeks to recover approximately $4.8 million and consequential damages.
The case is in the early stages of discovery. The Company believes it has
provided adequate reserves in connection with this claim and intends to
vigorously defend the action.
The Company is party to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters. The
Company has provided reserves for these matters in an amount such that, in the
opinion of management, the outcome of these matters should not have a material
adverse effect on the consolidated financial condition of the Company.
23. SEGMENT REPORTING
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
effective for fiscal years beginning after December 15, 1997. The Company
adopted Statement No. 131 in 1998.
The Company identifies its segments based on management responsibility. The
Company operated two segments during the first six months of the current year,
the Hollywood Video segment, consisting of the Company's 1,818 retail stores
located in 47 states, and the Reel.com segment, primarily an e-commerce company
specializing in movies. During the current year second quarter, the Company
announced the discontinuation of e-commerce operations at Reel.com. This
resulted in a restructuring charge detailed in (Note 11). All assets of
Reel.com were transferred to the Hollywood Video segment on June 12, 2000. The
Company measures segment profit as operating profit, which is defined as income
(loss) before interest expense and income taxes. Information on segments and a
reconciliation to operating income (loss) are as follows (in thousands):
Year Ended December 31, 2000
-----------------------------------
Hollywood
Video Reel.com Total
---------- ----------- ----------
Revenues $1,269,957 $ 26,280 $1,296,237
Tape amortization (1) 176,459 110 176,569
Other depreciation and
Amortization (2) 77,102 23,492 100,594
Gross profit 529,961 (18,974) 510,987
Operating income (loss) (315,238) (121,083) (436,321)
Interest expense, net 57,861 4,266 62,127
Total assets 665,114 - 665,114
Purchase of property and
equipment, net 76,121 1,518 77,639
Year Ended December 31, 1999
-----------------------------------
Hollywood
Video Reel.com Total
---------- ----------- ----------
Revenues $1,054,879 $ 41,962 $1,096,841
Tape amortization 107,127 450 107,577
Other depreciation and
amortization 64,078 51,187 115,265
Gross profit 665,348 (2,387) 662,961
Operating income (loss) 96,025 (98,538) (2,513)
Interest expense, net 41,042 4,435 45,477
Total assets 983,887 69,404 1,053,291
Purchase of property and
equipment, net 108,804 3,454 112,258
Year Ended December 31, 1998
-----------------------------------
Hollywood
Video Reel.com Total
---------- ----------- ----------
Revenues $ 756,658 $ 7,250 $ 763,908
Tape amortization 135,093 191 135,284
Other depreciation and
amortization 47,592 12,511 60,103
Gross profit 404,210 121 404,331
Operating income (loss) (14,527) (21,924) (36,451)
Interest expense, net 33,048 166 33,214
Total assets 842,212 94,118 936,330
Purchase of property and
equipment, net 131,364 758 132,122
(1) Excludes the $164.3 million charge for amortization policy change in
estimate (Note 4).
(2) Excludes the $74.3 million charge for the impairment of long-lived assets
(Note 8).
24. QUARTERLY FINANCIAL DATA (UNAUDITED)
Selected quarterly financial data is as follows (in thousands, except per share
data):
Quarter Ended
------------------------------------------
March June September December
--------- --------- --------- ---------
2000
-------------------------
Total revenue $ 335,322 $ 322,636 $ 306,532 $ 331,747
Gross profit 196,754 174,023 192,083 (51,873)
Income (loss) from
operations 2,735 (70,074) 18,439 (387,421)
Net income (loss) (12,163) (63,044) 716 (455,549)
Net income (loss)
per share:
Basic (0.26) (1.37) 0.02 (9.85)
Diluted (0.26) (1.37) 0.02 (9.85)
1999
------------------------
Total revenue
As previously reported $ 266,529 $ 250,368 $ 266,319
Adjustments (1) (404) (905) (652)
--------- --------- ---------
As adjusted $ 266,125 $ 249,463 $ 265,667 $ 315,586
========= ========= ========= =========
Gross profit:
As previously reported $ 166,581 $ 155,382 $ 165,177
Adjustments (1) (371) (1,002) (873)
--------- --------- ---------
As adjusted $ 166,210 $ 154,380 $ 164,304 $ 178,067
========= ========= ========= =========
Income from operations
As previously reported $ 13,390 $ 5,707 $ 1,016
Adjustments (1) 204 (1,106) (1,375)
--------- --------- ---------
As adjusted $ 13,594 $ 4,601 $ (359) $ (20,349)
========= ========= ========= =========
Net income (loss)
As previously reported $ (4,221) $ (8,329) $ (11,622)
Adjustments (1) 204 (1,106) (1,375)
--------- --------- ---------
As adjusted $ (4,017) $ (9,435) $ (12,997) $ (24,853)
========= ========= ========= =========
Net income (loss) per
share:
Basic
As previously reported $ (0.09) $ (0.18) $ (0.25)
Adjustments (1) 0.00 (0.03) (0.03)
--------- --------- ---------
As adjusted $ (0.09) $ (0.21) $ (0.28) $ (0.54)
========= ========= ========= =========
Net income (loss) per
share:
Diluted
As previously reported $ (0.09) $ (0.18) $ (0.25)
Adjustments (1) 0.00 (0.03) (0.03)
--------- --------- ---------
As adjusted $ (0.09) $ (0.21) $ (0.28) $ (0.54)
========= ========= ========= =========
1998
-------------------------
Total revenue $ 169,952 $166,731 $ 184,072 $ 243,153
Gross profit 115,210 109,727 123,396 55,998
Income (loss) from
operations 19,797 17,403 18,982 (92,633)
Net income (loss) 7,663 5,654 6,082 (69,863)
Net income (loss)
per share:
Basic 0.21 0.15 0.16 (1.56)
Diluted 0.21 0.15 0.16 (1.56)
(1) During the fourth quarter of 1999, the Reel.com segment of the Company
recorded adjustments primarily related to advertising revenue and product
development costs. The impact of these changes, including related income
tax effects, was to increase previously reported net income by $204,000 for
the quarter ended March 31, 1999 and to decrease net income by $1,106,000
and $1,375,000 for the quarters ended June 30, 1999 and September 30, 1999,
respectively.
25. SUBSEQUENT EVENTS
On January 25, 2001, the Compensation Committee of the Board of Directors of
the Company unanimously approved an employment agreement between the Company
and Mark J. Wattles as President and Chief Executive Officer. Pursuant to the
terms of the agreement, Mr. Wattles received a grant of 3 million shares of
common stock on January 25, 2001. On the date of the grant, the shares had a
market value of $3.27 million.
A special meeting of the Company's shareholders was held on March 29, 2001. The
meeting was called to vote upon the adoption of the Company's 2001 Stock
Incentive Plan (the "Plan"), which was approved by the Board of Directors
effective January 25, 2001, and included the reservation of 9 million shares of
Common Stock for issuance under the Plan. The proposal was approved by the
shareholders. Pursuant to the Plan, options to purchase approximately 7.5
million shares of the Company's stock were granted to existing officers.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized, as of March 30,
2001.
Hollywood Entertainment Corporation
By: /S/ DAVID G. MARTIN
---------------------------
David G. Martin
Executive Vice President
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities indicated as of March 30, 2001.
Signatures Title
MARK J. WATTLES
- ----------------
Mark J. Wattles Chairman of the Board of Directors,
and Chief Executive Officer
(Principal Executive Officer)
DAVID G. MARTIN
- ---------------
David G. Martin Executive Vice President
and Chief Financial Officer
(Principal Financial and Accounting Officer)
DONALD J. EKMAN
- ---------------
Donald J. Ekman Director
WILLIAM P. ZEBE
- ---------------
William P. Zebe Director
JAMES N. CUTLER JR.
- -------------------
James N. Cutler Jr. Director
DOUGLAS GLENDENNING
- -------------------
Douglas Glendenning Director
1
17