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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-21824
HOLLYWOOD ENTERTAINMENT CORPORATION
(Exact name of registrant as specified in charter)
OREGON 93-0981138
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
9275 S.W. Peyton Lane, Wilsonville, Oregon 97070
(Address of principal executive offices) (zip code)
(503) 570-1600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such short period that 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 [ ]
As of July 31, 2002 there were 58,882,405 shares of the registrant's Common
Stock outstanding.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2002 2001 2002 2001
-------- -------- -------- --------
REVENUE:
Rental product revenue $313,228 $302,150 $643,667 $619,355
Merchandise sales 32,033 22,922 65,242 47,962
-------- -------- -------- --------
345,261 325,072 708,909 667,317
COST OF REVENUE:
Cost of rental product 103,711 109,758 219,462 235,817
Cost of merchandise 24,740 18,075 49,628 36,457
-------- -------- -------- --------
128,451 127,833 269,090 272,274
-------- -------- -------- --------
GROSS MARGIN 216,810 197,239 439,819 395,043
OPERATING COSTS AND EXPENSES:
Operating and selling 155,005 153,042 313,050 306,197
General and administrative 22,417 22,500 46,446 47,468
Restructuring charge for closure
of internet business (12,430) - (12,430) -
Amortization of intangibles - 1,256 - 2,505
-------- -------- -------- --------
164,992 176,798 347,066 356,170
-------- -------- -------- --------
INCOME FROM OPERATIONS 51,818 20,441 92,753 38,873
Interest expense, net (9,944) (13,511) (21,920) (28,341)
-------- -------- -------- --------
Income before income taxes
and extraordinary item 41,874 6,930 70,833 10,532
Provision for income taxes (418) (145) (708) (221)
-------- -------- -------- --------
Net income before extraordinary item 41,456 6,785 70,125 10,311
Extraordinary loss on retirement of debt
(net of income tax benefit of $1,308) - - (2,226) -
-------- -------- -------- --------
NET INCOME $ 41,456 $ 6,785 $ 67,899 $ 10,311
======== ======== ======== ========
Net income per share before
extraordinary item:
Basic $ 0.71 $ 0.14 $ 1.27 $ 0.21
Diluted $ 0.64 $ 0.13 $ 1.15 $ 0.21
Net income per share:
Basic $ 0.71 $ 0.14 $ 1.23 $ 0.21
Diluted $ 0.64 $ 0.13 $ 1.12 $ 0.21
Weighted average shares outstanding:
Basic 58,722 49,249 55,186 48,834
Diluted 64,365 53,093 60,811 49,994
The accompanying notes are an integral part of this financial statement
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
June 30, December 31,
------------ -----------
2002 2001
------------ -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 17,384 $ 38,810
Receivables 28,813 29,056
Merchandise inventories 84,872 61,585
Prepaid expenses and other current assets 14,116 10,863
----------- -----------
Total current assets 145,185 140,314
Rental inventory, net 223,908 191,016
Property and equipment, net 247,233 270,586
Goodwill 64,934 64,934
Deferred tax asset, net 38,396 38,396
Other assets, net 13,921 13,298
----------- -----------
$ 733,577 $ 718,544
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current maturities of long-term obligations $ 32,703 $ 111,914
Accounts payable 150,199 167,479
Accrued expenses 85,659 112,799
Accrued interest 10,357 13,712
Income taxes payable 3,859 5,266
----------- -----------
Total current liabilities 282,777 411,170
Long-term obligations, less current portion 359,979 402,088
Other liabilities 18,185 18,840
----------- -----------
660,941 832,098
----------- -----------
Shareholders' equity (deficit):
Preferred stock, 25,000,000 shares
authorized; no shares issued and
outstanding - -
Common stock, 100,000,000 shares authorized;
58,843,071 and 49,428,763 shares issued
and outstanding, respectively 493,169 375,503
Unearned compensation (1,030) (1,655)
Accumulated deficit (419,503) (487,402)
----------- -----------
Total shareholders' equity (deficit) 72,636 (113,554)
----------- -----------
$ 733,577 $ 718,544
=========== ===========
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Six Months Ended
June 30,
------------------------
2002 2001
---------- ----------
OPERATING ACTIVITIES:
Net income $ 67,899 $ 10,311
Adjustments to reconcile net income
to cash provided by operating activities:
Extraordinary loss on retirement of debt 2,226 -
Amortization of rental product 102,739 94,098
Depreciation and amortization 30,061 33,273
Amortization of deferred financing costs 2,012 1,653
Change in deferred rent (656) (184)
Non-cash stock compensation 2,713 4,580
Net change in operating assets and liabilities:
Receivables 243 (2,421)
Merchandise inventories (23,287) (196)
Accounts payable (17,280) (31,481)
Accrued interest (3,355) 2,096
Other current assets and liabilities (30,522) (10,395)
--------- ---------
Cash provided by operating activities 132,793 101,334
--------- ---------
INVESTING ACTIVITIES:
Purchases of rental inventory, net (135,631) (74,123)
Purchases of property and equipment, net (6,709) (3,202)
Increase in intangibles and other assets (491) (453)
--------- ---------
Cash used in investing activities (142,831) (77,778)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock 120,750 -
Equity financing costs (7,651) -
Borrowings under new term loan facility 150,000 -
Repayment of prior revolving loan (240,000) -
Increase (decrease) in credit agreements (25,000) 5,000
Debt financing costs (5,647) (4,034)
Repayments of capital lease obligations (6,319) (8,024)
Proceeds from exercise of stock options 2,479 1
--------- ---------
Cash used in financing activities (11,388) (7,057)
-------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENT (21,426) 16,499
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 38,810 3,268
-------- --------
CASH AND CASH EQUIVALENTS AT END OF THE SECOND
QUARTER $ 17,384 $ 19,767
======== ========
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unaudited Consolidated Financial Statements have been prepared pursuant to
the rules and regulations of the Securities and Exchange Commission.
Certain information and note disclosures normally included in annual financial
statements prepared in accordance with Generally Accepted Accounting Principles
(GAAP) have been condensed or omitted pursuant to those rules and regulations,
although, the Company believes that the disclosures made are adequate to make
the information presented not misleading. The information furnished reflects
all adjustments which are, in the opinion of management, necessary for a fair
statement of the results for the interim periods presented, and which are of a
normal, recurring nature. These financial statements should be read in
conjunction with the financial statements and the notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001 filed
with the Securities and Exchange Commission. Results of operations for interim
periods may not necessarily be indicative of the results that may be expected
for the full year or any other period.
(1) Accounting Policies
The Consolidated Financial Statements included herein have been prepared in
accordance with the accounting policies described in Note 1 to the December 31,
2001 audited Consolidated Financial Statements included in the Company's Annual
Report on Form 10-K. Certain prior year amounts have been reclassified to
conform to the presentation used for the current year. These reclassifications
had no impact on previously reported gross margin, net income or shareholders'
equity (deficit).
Effective January 1, 2002, the Company began reporting sales and related costs
of previously viewed rental inventory as rental product revenue and cost of
rental product, respectively. Prior to January 1, 2002, the Company included
sales and related costs of sales of previously viewed rental inventory in
merchandise sales and cost of merchandise sales, respectively. For comparative
purposes, sales and related costs of sales of previously viewed rental
inventory for the three months ended June 30, 2001, and the six months ended
June 30, 2001, have been reclassified to conform to the presentation for the
current year.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) Nos. 141 and 142, "Business
Combinations" and "Goodwill and Other Intangible Assets," respectively. SFAS
141 supersedes Accounting Principles Board (APB) Opinion No. 16 and eliminates
pooling-of-interests accounting. It also provides guidance on purchase
accounting related to the recognition of intangible assets and accounting for
negative goodwill. SFAS 142 changes the accounting for goodwill from an
amortization method to an impairment only approach. Under SFAS 142, goodwill
and non-amortizing intangible assets shall be adjusted whenever events or
circumstances occur indicating that goodwill has been impaired. The Company
has completed its impairment testing of the valuation of its goodwill and has
determined that there is no impairment. SFAS 141 and 142 are effective for all
business combinations completed after June 30, 2001. Upon adoption of SFAS 142,
amortization of goodwill recorded for business combinations consummated prior
to July 1, 2001 ceased, and intangible assets acquired prior to July 1, 2001
that did not meet criteria for recognition under SFAS 141 were reclassified to
goodwill. The Company adopted SFAS 142 on January 1, 2002, the beginning of
fiscal 2002. Application of the non-amortization provisions of SFAS 142 to
goodwill, which had previously been amortized over 20 years, and to the
Company's trade-name right, which had previously been amortized over 15 years,
resulted in an increase in net income of $1.3 million and $2.5 million, net of
tax, for the three and six months ended June 30, 2002, respectively.
The components of intangible assets, are as follows (in thousands):
December 31, June 30,
2001 Additions 2002
------------ --------- ------------
Goodwill $ 64,934 $ - $ 64,934
Trade-name rights 4,612 327 4,939
------------ --------- ------------
$ 69,546 $ 327 $ 69,873
============ ========= ============
The following table summarizes the pro forma impact of excluding amortization
of intangible assets for the three months ended June 30, 2001 and for the six
months ended June 30, 2001 (in thousands, except per share amounts):
Three Months Six Months
Ended Ended
June 30, June 30,
2001 2001
------------ ------------
Net income as reported $ 6,785 $ 10,311
Add back: Amortization of
intangible assets, net of tax 1,230 2,452
------------ ------------
Pro forma net income $ 8,015 $ 12,763
============ ============
Basic net income per share:
As reported $ 0.14 $ 0.21
Pro forma net income per share $ 0.16 $ 0.26
Diluted net income per share:
As reported $ 0.13 $ 0.21
Pro forma net income per share $ 0.15 $ 0.26
On October 3, 2001, the FASB issued SFAS 144 "Accounting for the Impairment or
Disposal of Long-lived Assets." SFAS 144 supersedes SFAS 121 "Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed
of." SFAS 144 applies to long-lived assets to be held and used, or to be
disposed of, except for goodwill and non-amortizing intangible assets to be
held and used, as well as goodwill associated with a reporting unit. SFAS 144
supersedes accounting and reporting provisions of APB 30, "Reporting the
Results of Operations, Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions." SFAS 144 develops one accounting model for long-lived assets
that are to be disposed of by sale. SFAS 144 requires that long-lived assets
that are to be disposed of by sale be measured at the lower of book value or
fair value less cost to sell. Additionally, SFAS 144 expands the scope of
discontinued operations to include all components of an entity with operations
and cash flows that (1) can be distinguished from the rest of the entity and
(2) will be eliminated from the ongoing operations of the entity in a disposal
transaction. SFAS 144 is effective for the Company for all financial statements
issued beginning January 1, 2002. Currently, the Company does not anticipate
disposing of any long-lived assets in 2002, other than the assets intended to
be disposed of pursuant to the 2001 amended store closure plan (see note 7).
Therefore, the adoption of SFAS 144 is not expected to have a material impact
on its results of operations, financial position or liquidity.
In May 2002, the FASB issued SFAS 145, "Rescission of FAS Nos. 4, 44 and 64,
Amendment of FAS 13, and Technical Corrections." Among other things, SFAS 145
rescinds various pronouncements regarding the treatment of early extinguishment
of debt as extraordinary unless the provisions of APB Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effect of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" are met. SFAS 145 provisions regarding early
extinguishment of debt are generally effective for fiscal years beginning after
May 15, 2002. The Company expects to adopt SFAS 145 in January 2003 and has
not yet completed an analysis of the impact on its results of operation,
financial position or liquidity.
In July 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal". SFAS 146 supersedes EITF 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit and Activity
(Including Certain Costs Incurred in a Restructuring)". This statements
applies to costs that are associated with exit activities that are not covered
by SFAS 144, "Accounting for the Impairment of Disposal of Long-Lived Assets,"
or entities that are newly acquired in a business combination. The costs that
are covered are one-time termination benefits paid to employees who were
involuntarily terminated, costs to terminate contracts that are not capital
leases and costs to consolidate facilities and relocate employees. The Company
expects to adopt SFAS 146 in January 2003 and has not yet completed an analysis
of the impact on its results of operation, financial position or liquidity.
(2) Statements of Changes in Shareholders' Equity (Deficit)
An analysis of the shareholders' equity (deficit) amounts for the six months
ended June 30, 2002 is as follows (in thousands, except share amounts):
Common Stock Unearned
------------------- Compen- Accumulated
Shares Amount sation Deficit Total
---------- -------- -------- --------- ---------
Balance at 12/31/2001 49,428,763 $375,503 $(1,655) $(487,402) $(113,554)
---------- -------- -------- --------- ---------
Issuance of common stock:
Stock issuance 8,050,000 120,750 120,750
Equity offering costs (7,651) (7,651)
Stock options exercised 1,364,308 2,479 2,479
Stock compensation 2,088 625 2,713
Net income 67,899 67,899
---------- -------- -------- --------- ---------
Balance at 6/30/2002 58,843,071 $493,169 $(1,030) $(419,503) $ 72,636
========== ======== ======== ========= =========
(3) Operating Leases
The Company leases all of its stores, corporate offices, distribution centers
and zone offices under non-cancelable operating leases. All of the Company's
stores have an initial operating lease term of five to fifteen years and most
have options to renew for between five and fifteen additional years. Rent
expense was $53.0 million and $106.0 million for the three months and the six
months ended June 30, 2002, respectively, compared to $52.6 million and $106.1
million for the corresponding periods of the prior year. Most operating leases
require payment of additional occupancy costs, including property taxes,
utilities, common area maintenance and insurance. These additional occupancy
costs were $10.7 million and $20.8 million for the three months and the six
months ended June 30, 2002, respectively, compared to $10.6 million and $20.4
million for the corresponding periods of the prior year.
(4) Long-term Obligations
The Company had the following long-term obligations as of June 30, 2002 and
December 31, 2001 (in thousands):
June 30, December 31,
----------- ----------
2002 2001
----------- ----------
Senior subordinated notes $ 250,000 $ 250,000
Borrowings under credit agreements 125,000 240,000
Obligations under capital leases 17,682 24,002
----------- ----------
392,682 514,002
Current portions:
Credit agreements 17,500 98,500
Capital leases & other 15,203 13,414
----------- ----------
32,703 111,914
Total long-term obligations ----------- ----------
net of current portion $ 359,979 $ 402,088
=========== ==========
On December 7, 2001, the Company filed with the Securities and Exchange
Commission a shelf registration statement covering up to $426.5 million of
securities, consisting of $126.5 million of equity securities and $300.0
million of debt securities. The registration statement became effective on
February 14, 2002.
On March 11, 2002, the Company completed a public offering of 8,050,000 shares
of its common stock under its shelf registration statement, resulting in
proceeds of $120.8 million before fees and expenses, of which $114 million was
applied to the repayment of borrowings under the Company's prior revolving
credit facility. The shelf registration statement, as amended on May 20, 2002,
for the common stock offering, covers the possible issuance of up to an
aggregate of $305.8 million in debt and/or equity securities.
On March 18, 2002, the Company obtained new senior bank credit facilities from
a syndicate of lenders led by UBS Warburg LLC and applied a portion of the
initial borrowings thereunder to repay all remaining borrowings under the
Company's prior revolving credit facility, which was then terminated. The new
bank credit facilities consist of a $150.0 million senior secured term facility
maturing in 2004 and a $25.0 million senior secured revolving credit facility
maturing in 2004. The maturity of the new facilities will automatically be
extended to 2006 if the Company's existing $250 million 10.625% senior
subordinated notes due in 2004 (the "Subordinated Notes") are refinanced prior
to February 2004 with a maturity date beyond 2006.
On April 19, 2002, the Company filed a preliminary prospectus supplement under
the shelf registration statement contemplating the sale of $275.0 million
senior subordinated notes due 2010. The Company planned to use the proceeds
from the issuance of the notes to redeem the existing Subordinated Notes and
pay related transaction costs and expenses. The Company decided to postpone
this financing transaction until such time as it believes it can complete the
transaction at terms advantageous to the Company at that time. The redemption
premium applicable to the existing Subordinated Notes declines from 5.313%
currently to 2.656% on August 15, 2002 and declines to zero on August 15, 2003.
At June 30, 2002, maturities on long-term obligations for the next five years
are as follows (in thousands):
Capital
Year Ending Subordinated Credit Leases
December 31, Notes Agreements & Other Total
- ------------ ---------- ---------- --------- ---------
2002 $ - $ - 7,094 $ 7,094
2003 - 35,000 10,588 45,588
2004 250,000 90,000(1) - 340,000
2005 - - - -
2006 - - - -
Thereafter - - - -
---------- ---------- --------- ---------
$ 250,000 $ 125,000 $ 17,682 $ 392,682
---------- ---------- --------- ---------
(1) The maturity of the credit facilities will automatically be extended, such
that $35 million will be due in 2004 and 2005 and $20 million will be due in
2006, if the Subordinated Notes are refinanced prior to February 2004 with a
maturity date beyond 2006.
(5) Earnings per Share
Basic earnings per share are calculated based on income available to common
shareholders and the weighted-average number of common shares outstanding
during the reported period. Diluted earnings per share includes additional
dilution from the effect of potential issuances of common stock, such as stock
issuable pursuant to the exercise of stock options, warrants outstanding and
the conversion of debt.
The following tables are reconciliations of the basic and diluted earnings per
share computations (in thousands, except per share amounts):
Three Months Ended June 30,
----------------------------------------------------------
2002 2001
--------------------------- -----------------------------
Net Per Share Net Per Share
Income Shares(1) Amounts Income Shares(1) Amounts
------- --------- ------- -------- --------- --------
Basic income
per share: $41,456 58,722 $ 0.71 $ 6,785 49,249 $ 0.14
Effect of dilutive
securities:
Stock options - 5,643 - 3,844
------- --------- -------- ---------
Diluted income
per share: $41,456 64,365 $ 0.64 $ 6,785 53,093 $ 0.13
======= ========= ======= ======== ========= ========
(1) Represents weighted average shares outstanding.
Antidilutive stock options excluded from the calculation of diluted income per
share were 0.1 million shares and 4.7 million shares in the three months ended
June 30, 2002 and 2001, respectively.
Six Months Ended June 30,
-----------------------------------------------------------
2002 2001
---------------------------- -----------------------------
Net Per Share Net Per Share
Income Shares(1) Amounts Income Shares(1) Amounts
------- --------- -------- -------- ------- ----------
Basic income
per share: $67,899 55,186 $ 1.23 $ 10,311 48,834 $ 0.21
Effect of dilutive
securities:
Stock options - 5,625 - 1,160
------- --------- -------- -------
Diluted income
per share: $67,899 60,811 $ 1.12 $ 10,311 49,994 $ 0.21
======= ========= ======== ======== ======= =========
(1) Represents weighted average shares outstanding.
Antidilutive stock options excluded from the calculation of diluted income per
share were 0.6 million shares and 4.9 million shares in the six months ended
June 30, 2002 and 2001, respectively.
(6) Reel.com Discontinued E-commerce Operations
On June 12, 2000, the Company announced that it would discontinue the e-
commerce business of Reel.com, Inc. (Reel.com). Although we believe the Company
had developed a leading website over the seven quarters after Reel.com was
purchased in October of 1998, Reel.com's 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 retail
stores' cash flow. As a result of the discontinuation of Reel.com's e-commerce
operations, the Company recorded a restructuring charge of $69.3 million in the
second quarter of 2000 that included $22.4 million of accrued liabilities (net
of $4.9 million of reductions). Amounts accrued included $17.3 million for
contractual obligations, lease commitments and anticipated legal claims against
the Company and $5.1 million for legal, financial, and other professional
services incurred as a direct result of the closure of Reel.com. Since June
2000, the Company has paid $10.0 million of the $22.4 million of accrued
liabilities, inclusive of legal and legal related costs in settlement of all
claims with 3PF. As a result, the remaining accrual balance for such claims
has been reversed to a zero balance at June 30, 2002.
(7) Store Closure Restructuring
In December of 2001, the Company amended its store closure restructuring plan
and currently anticipates closing the remaining 15 stores in 2002. In
accordance with the amended plan and revised estimates on closing costs, the
Company has a $3.7 million accrual balance as of June 30, 2002 for store
closing costs. The Company did not close any of the 15 stores in the first six
months of 2002.
(8) Legal Proceedings
During 1999, the Company was named as a defendant in three complaints which
have been coordinated into a single 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 were seeking to certify a class made
up of certain exempt employees, who they claim are owed overtime payments for
work performed in certain stores in California. The parties have since entered
into a settlement agreement, which was given preliminary approval by the court
on August 5, 2002. The class consists of only those individuals employed by
Hollywood Entertainment within the Sate of California as salaried store
managers in Hollywood Video stores during the period from January 25, 1995 to
March 31, 2002, and only those employed by Hollywood Entertainment within the
Sate of California as salaried assistant managers in Hollywood Video stores
during the period from January 25, 1995 to December 31, 1999, who do not opt-
out of the settlement. The Company believes that based upon the agreement, it
has provided adequate reserves in connection with the settlement agreement.
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 Hollywood and Reel.com. 3PF and Reel.com entered into a
Warehousing and Distribution Agreement (Agreement) on February 7, 2000. 3PF
alleged that, as a result of the discontinuation of Reel.com operations,
Reel.com was in default under the Agreement, failed to perform material
obligations under the Agreement, and failed to pay amounts due 3PF. On May 15,
2002, the Company, 3PF and Rentrak Corporation entered into a settlement
agreement encompassing all claims between the two parties including
counterclaims and causes of action that were asserted or could have been
asserted and agreed to the dismissal of the arbitration case.
The Company has been named to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters,
including suits related to amounts charged to customers in connection with
extended rental periods. The Company believes it has provided adequate
reserves for these various contingencies and that the outcome of these matters
should not have a material adverse effect on the Company's consolidated results
of operation, financial condition or liquidity.
(9) Related Party Transactions
In the second quarter of 2002, Boards, Inc. (Boards) opened a Hollywood Video
store as licensee of the Company pursuant to rights granted by the Company and
approved by the Board of Directors in January 2001. Boards now operates three
stores, which are not included in the 1,800 stores operated by the Company.
Mark Wattles, the Company's founder, Chief Executive Officer and President, is
the majority owner of Boards. Under the license arrangement, Boards will pay
the Company $25,000 per store as a license fee, royalty payments of 2% of
revenue and may purchase product and services from the Company. At June 30,
2002, Boards owed the Company approximately $317 thousand for fees, services
and product.
(10) Consolidating Financial Statements
Hollywood Entertainment Corporation (HEC) had one wholly owned subsidiary,
Hollywood Management Company (HMC), during the six months ended June 30, 2002.
HMC is a guarantor of the subordinated notes of HEC. The consolidating
condensed financial statements below present the results of operations,
financial position and liquidity of HEC and HMC.
Consolidating Condensed Statement of Operations
Six months ended June 30, 2002
(in thousands)
---------- -------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- -------- --------- ----------
REVENUE $ 710,347 $ 74,931 $ (76,369) $ 708,909
COST OF REVENUE 269,090 -- -- 269,090
GROSS MARGIN 441,257 74,931 (76,369) 439,819
OPERATING COSTS & EXPENSES:
Operating and selling 308,508 4,542 -- 313,050
General & administrative 101,650 21,165 (76,369) 46,446
Restructuring charge for
closure of internet
business (12,430) -- -- (12,430)
INCOME FROM OPERATIONS 43,529 49,224 -- 92,753
Interest income -- 14,441 (14,238) 203
Interest expense (36,361) -- 14,238 (22,123)
Income before income
taxes and extraordinary
item 7,168 63,665 -- 70,833
Benefit from (provision for)
income taxes 23,822 (24,530) -- (708)
Net income before
extraordinary item 30,990 39,135 -- 70,125
Extraordinary loss on
retirement of debt (net
of income tax benefit of
$1,308) (2,226) -- -- (2,226)
NET INCOME $ 28,764 $ 39,135 $ -- $ 67,899
Consolidating Condensed Balance Sheet
June 30, 2002
(in thousands)
---------- -------- --------- ---------
HEC HMC Elimin- Consol-
ations idated
---------- -------- --------- ---------
ASSETS
Cash and cash equivalents $ 1,930 $ 15,454 $ -- $ 17,384
Receivables 19,433 390,183 (380,803) 28,813
Merchandise inventories 84,872 -- -- 84,872
Prepaid expenses and other
current assets 10,064 4,052 -- 14,116
Total current assets 116,299 409,689 (380,803) 145,185
Rental inventory, net 223,908 -- -- 223,908
Property & equipment, net 229,284 17,949 -- 247,233
Goodwill, net 64,934 -- -- 64,934
Deferred tax assets, net 38,396 -- -- 38,396
Other assets, net 12,889 5,040 (4,008) 13,921
Total Assets $ 685,710 $432,678 $(384,811) $ 733,577
LIABILITIES & SHAREHOLDERS'
EQUITY (DEFICIT)
Current maturities of
long-term obligations $ 32,703 $ -- $ -- $ 32,703
Accounts payable 380,803 150,199 (380,803) 150,199
Accrued expenses 11,716 73,943 -- 85,659
Accrued interest -- 10,357 -- 10,357
Income taxes payable -- 3,859 -- 3,859
Total current liabilities 425,222 238,358 (380,803) 282,777
Long-term obligations, less
current portion 359,979 -- -- 359,979
Other liabilities 18,185 -- -- 18,185
Total liabilities 803,386 238,358 (380,803) 660,941
Common stock 493,169 4,008 (4,008) 493,169
Unearned compensation (1,030) -- -- (1,030)
Retained earnings
(accumulated deficit) (609,815) 190,312 -- (419,503)
Total shareholders'
equity (deficit) (117,676) 194,320 (4,008) 72,636
Total liabilities and
shareholders' equity
(deficit) $ 685,710 $432,678 $(384,811) $ 733,577
Consolidating Condensed Statement of Cash Flows
Six months ended June 30, 2002
(in thousands)
---------- -------- ----------
HEC HMC Consol-
idated
---------- -------- ----------
OPERATING ACTIVITIES:
Net income $ 28,764 $ 39,135 $ 67,899
Adjustments to reconcile
net income to
cash provided by
operating activities:
Extraordinary item 2,226 -- 2,226
Depreciation &
amortization 131,849 2,963 134,812
Change in deferred rent (656) -- (656)
Non cash stock compensation 2,713 -- 2,713
Net change in operating
assets & liabilities (13,852) (60,349) (74,201)
Cash provided by (used in)
Operating activities 151,044 (18,251) 132,793
INVESTING ACTIVITIES:
Purchases of rental
inventory, net (135,631) -- (135,631)
Purchase of property &
equipment, net (3,931) (2,778) (6,709)
Increase in intangibles
& other assets (163) (328) (491)
Cash used in investing
activities (139,725) (3,106) (142,831)
FINANCING ACTIVITIES:
Proceeds from the sale of
common stock, net 113,099 -- 113,099
Repayments of capital lease
obligations (6,319) -- (6,319)
Proceeds from exercise
of stock options 2,479 -- 2,479
Increase in revolving
loans, net (120,647) -- (120,647)
Cash used in financing
activities (11,388) -- (11,388)
Decrease in cash
and cash equivalents (69) (21,357) (21,426)
Cash and cash equivalents
at beginning of year 1,999 36,811 38,810
Cash and cash equivalents at
the end of the second quarter $ 1,930 $ 15,454 $ 17,384
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
CRITICAL ACCOUNTING POLICIES
The preparation of financial statements and related disclosures in conformity
with Generally Accepted Accounting Principles (GAAP) requires us to make
judgments, assumptions and estimates that affect the amounts reported in the
Consolidated Financial Statements and accompanying notes. Note 1 to the audited
Consolidated Financial Statements included in our Annual Report on Form 10-K
for the year ended December 31, 2001 describes the significant accounting
policies and methods used in the preparation of the Consolidated Financial
Statements. Our judgments, assumptions and estimates affect, among other
things, the amounts of: receivables; rental and merchandise inventories;
property and equipment, net; goodwill; deferred income tax assets; other
liabilities; revenue; cost of revenue; and operating costs and expenses. We
base our judgments, assumptions and estimates on historical experience and on
various other factors that we believe to be reasonable under the circumstances.
Actual results could differ significantly from amounts based on our judgments,
assumptions and estimates. Certain critical accounting policies that involve
significant judgments, assumptions and estimates which affect amounts recorded
in the Consolidated Financial Statements are discussed in our Annual Report on
Form 10-K for the year ended December 31, 2001 in Management's Discussion and
Analysis of Results of Operations and Financial Condition under the heading
"Critical Accounting Policies."
For a discussion of new accounting pronouncements, refer to Footnote 1,
"Accounting Policies," to the Consolidated Financial Statements.
RESULTS OF OPERATIONS
Summary Results of Operations
The Company's net income for the three months and the six months ended June 30,
2002 was $41.5 million and $67.9 million, respectively, compared with net
income of $6.8 million and $10.3 million for the three months and six months
ended June 30, 2001, respectively. The improvement in net income was primarily
the result of improved operating performance in the Company's existing store
base, in which comparable store sales rose 7% for both the three months and six
months ended June 30, 2002. Net income also improved due to the reversal of an
accrual associated with the resolution of certain claims associated with the
closure of Reel.com Inc (Reel.com) and the change in accounting policy
regarding the amortization of rental inventories and goodwill.
The following table sets forth (i) selected results of operations data,
expressed as a percentage of total revenue; (ii) other financial data; and
(iii) selected operating data.
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(Unaudited)
REVENUE:
Rental product revenue 90.7% 92.9% 90.8% 92.8%
Merchandise sales 9.3 7.1 9.2 7.2
---------- ---------- ---------- ----------
100.0 100.0 100.0 100.0
---------- ---------- ---------- ----------
GROSS MARGIN 62.8 60.7 62.0 59.2
OPERATING COSTS AND EXPENSES:
Operating and selling 44.9 47.1 44.2 45.9
General and administrative 6.5 6.9 6.5 7.1
Restructuring charge for
closure of internet business (3.6) 0.0 (1.8) 0.0
Amortization of intangibles 0.0 0.4 0.0 0.4
---------- ---------- ---------- ----------
47.8 54.4 48.9 53.4
---------- ---------- ---------- ----------
INCOME FROM OPERATIONS 15.0 6.3 13.1 5.8
Interest expense, net (2.9) (4.2) (3.1) (4.2)
---------- ---------- ---------- ----------
Income before income taxes
and extraordinary item 12.1 2.1 10.0 1.6
Provision for income taxes (0.1) (0.0) (0.1) (0.0)
---------- --------- ---------- ----------
Net income before
extraordinary item 12.0 2.1 9.9 1.6
---------- --------- ---------- ----------
Extraordinary loss on
retirement of debt, net 0.0 0.0 (0.3) 0.0
---------- --------- ---------- ----------
NET INCOME 12.0% 2.1% 9.6% 1.6%
---------- --------- ---------- ----------
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
OTHER FINANCIAL DATA:
Rental product gross margin (1) 66.9% 63.7% 65.9% 61.9%
Merchandise gross margin (2) 22.8% 21.1% 23.9% 24.0%
ADJUSTED EBITDA
(in thousands)(3)(4) $ 44,325 $ 41,121 $108,573 $ 94,262
CASH FLOW FROM:(in thousands)
Operating activities $ 62,391 $ 54,900 $132,793 $101,334
Investing activities (71,159) (43,591) (142,831) (77,778)
Financing activities (24,545) (10,569) (11,388) (7,057)
OPERATING DATA:
Number of stores at quarter end 1,800 1,815 1,800 1,815
Weighted average stores open
during the period 1,799 1,816 1,800 1,817
Comparable store revenue
increase (5) 7% 1% 7% 0%
- ---------------------------------
(1) Rental product gross margin as a percentage of rental revenue.
(2) Merchandise sales gross margin as a percentage of merchandise sales.
(3) Adjusted EBITDA, as reported in this table, represents income from
operations, before depreciation and amortization and certain other adjustments
such as special charges, plus non-cash expenses minus the cost of replenishing
new release rental inventory for existing stores which is capitalized.
Adjusted EBITDA should not be viewed as a measure of financial performance
under GAAP or as a substitute for GAAP measurements such as net income or cash
flow from operations.
(4) The calculation of Adjusted EBITDA is not necessarily comparable to
reported EBITDA or Adjusted EBITDA of other companies (including our most
significant competitor), due to the lack of uniform definition of EBITDA and
Adjusted EBITDA. In order to eliminate confusion and to provide investors with
more meaningful comparative data of EBITDA as compared to our most significant
competitor, effective with the third quarter results and the quarterly report
on From 10-Q, we will adopt the methodology of our most significant competitor
to calculate EBITDA. Under the new method, EBITDA for the three month and six
months ended June 30, 2002 would have been $55.6 million and $113.1 million,
respectively, compared to $43.1 million and $92.8 million for the three month
and six months ended June 30, 2001, respectively. For a detailed discussion of
Adjusted EBITDA and the change in methodology, see "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Liquidity and
Capital Resources - Other Financial Measurements: Adjusted EBITDA and Free Cash
Flow."
(5) A store is comparable after it has been open and owned by the Company for
12 full months.
REVENUE
Revenue increased by $20.2 million, or 6.2%, in the three months ended June 30,
2002 compared to the three months ended June 30, 2001, due to a 7% increase in
comparable store revenue, offset by a net reduction of 17 weighted average
superstores. Revenue increased by $41.6 million,or 6.2%, in the six months
ended June 30, 2002 compared to the six months ended June 30, 2001, due to a 7%
increase in comparable store revenue, offset by a net reduction of 17 weighted
average superstores. At June 30, 2002, we had 1,800 superstores operating in
47 states compared to 1,815 stores operating in 47 states at June 30, 2001. We
currently offer a 5-day rental program on all products in the majority of our
stores. In most of our stores, new release videos and DVDs rent for $3.79 and
catalog videos rent for $1.99. Since the fourth quarter of 1999, other than
test pricing, we have not increased prices on new release videos, DVDs and
catalog videos. Video games rent for $4.99 and $5.99, with the newer platforms
renting for the higher amount. Customers who choose not to return movies and
games within the applicable rental period are deemed to have commenced a new
rental period of equal length at the same price (extended rental periods).
Rental revenue from extended rental periods for the three months and for the
six months ended June 30, 2002 were $37.6 million and $78.3 million,
respectively, compared to $35.8 million and $74.0 million in the corresponding
periods of the prior year.
Effective January 1, 2002, we began reporting sales and related costs of
previously viewed rental inventory as rental product revenue and cost of rental
product, respectively. Prior to January 1, 2002, we included sales and related
costs of sales of previously viewed rental inventory in merchandise sales and
cost of merchandise sales, respectively. For comparative purposes, sales and
related costs of sales of previously viewed rental inventory for the three
months ended June 30, 2001 and the six months ended June 30, 2001 have been
reclassified to conform to the presentation for the current year.
GROSS MARGIN
Rental Product Margins
Rental product gross margin as a percentage of rental product revenue increased
to 66.9% and 65.9% in the three months and six months ended June 30, 2002,
respectively, from 63.7% and 61.9% in the three months and six months ended
June 30, 2001, respectively. Rental product margins in the three months and six
months ended June 30, 2001 were negatively impacted by $5 million and $16
million, respectively, in incremental depreciation expense associated with
changes in estimated rental inventory lives and residual values that were
adopted on a prospective basis on October 1, 2000. As a result of the growing
demand for DVDs, the estimated residual value of catalog VHS cassettes was
reduced from $6.00 to $2.00 and the estimated useful life was reduced from five
years to one year. Excluding the incremental depreciation expense, margins
increased to 66.9% and 65.9% in the three months and six months ended June 30,
2002, respectively, from 65.3% and 64.5% in the three months and six months,
ended June 30, 2001, respectively. The increases were primarily due to a shift
in revenue from VHS product to DVD product, which typically has higher margins.
Merchandise Sales Margins
Merchandise sales gross margin as a percentage of merchandise sales increased
to 22.8% in the three months ended June 30, 2002 from 21.1% in the three months
ended June 30, 2001. The increase was primarily the result of an increase in
the percentage of merchandise sales from our Game Crazy units, which typically
have higher margins than merchandise sales in our video stores.
Merchandise sales gross margin as a percentage of merchandise sales decreased
to 23.9% in the six months ended June 30, 2002 from 24.0% in the six months
ended June 30, 2001. The decrease was primarily the result of an increase in
the percentage of merchandise sales from new movies, which typically have lower
margins than other components of merchandise sales, such as concessions. The
margin impact of the increase in sales from new movies was mostly offset by an
increase in the percentage of merchandise sales from our Game Crazy units,
which typically have higher margins than merchandise sales in our video stores.
OPERATING COSTS AND EXPENSES
Operating and Selling
Total operating and selling expense in the three months ended June 30, 2002
decreased as a percentage of revenue to 44.9% compared to 47.1% in the
corresponding period of the prior year. The percentage decrease is primarily
the result of leverage on increased revenue. Total operating and selling
expense in the three months ended June 30, 2002 increased $2.0 million to
$155.0 million from $153.0 million in the three months ended June 30, 2001. The
increase was primarily the result of increased variable costs associated with
increased store sales volume. Payroll and related expenses increased by $3.4
million and other operating and selling expenses decreased by $1.4 million.
Total operating and selling expense in the six months ended June 30, 2002
decreased as a percentage of revenue to 44.2% compared to 45.9% in the
corresponding period of the prior year. The percentage decrease is primarily
the result of leverage on increased revenue. Total operating and selling
expense in the six months ended June 30, 2002 increased $6.9 million to $313.1
million from $306.2 million in the six months ended June 30, 2001. The increase
was primarily the result of increased variable costs associated with increased
store sales volume. Payroll and related expenses increased by $5.8 million and
other operating and selling expenses increased by $1.1 million.
General and Administrative
General and administrative expenses in the three months ended June 30, 2002
decreased $0.1 million to $22.4 million from $22.5 million in the three months
ended June 30, 2001. General and administrative expenses decreased as a
percentage of total revenue to 6.5%, compared to 6.9% in the corresponding
period of the prior year. General and administrative expenses in the six months
ended June 30, 2002 decreased $1.0 million to $46.4 from $47.5 million in the
six months ended June 30, 2001. Included in general and administrative expenses
in the six months ended June 30, 2001 was $5.6 million in compensation expense
related to a stock grant to our Chief Executive Officer. Excluding
compensation expense related to the stock grant, general and administrative
expenses increased as a percentage of revenue to 6.6% for the six months ended
June 30, 2002, compared to 6.3% for the prior year. The increase is the result
of our investment in certain elements of our business such as the store field
supervision structure, the loss prevention function and human resources. We
believe these investments have had, and will continue to have, a direct impact
on our business by improving our level of execution.
Restructuring charge for closure of internet business
On June 12, 2000, we announced that we would discontinue the e-commerce
business of Reel.com. Although we believe that we had developed a leading
website over the seven quarters after Reel.com was purchased in October of
1998, Reel.com's business model of rapid customer acquisition led to large
operating losses and required significant cash funding. Due to market
conditions, we were unable to obtain outside financing for Reel.com, and could
not justify continued funding from our retail stores' cash flow. As a result of
the discontinuation of Reel.com's e-commerce operations, we recorded a
restructuring charge of $69.3 million in the second quarter of 2000 that
included $22.4 million of accrued liabilities (net of $4.9 million of
reductions). Amounts accrued included $17.3 million for contractual
obligations, lease commitments and anticipated legal claims against us and $5.1
million for legal, financial, and other professional services incurred as a
direct result of the closure of Reel.com. Since June 2000, we have paid $10.0
million of the $22.4 million of accrued liabilities including legal and legal
related costs in settlement of all claims with 3PF. As a result, the remaining
accrual balance for such claims has been reversed to a zero balance at June 30,
2002.
Amortization of Intangibles
We adopted SFAS 142 as of January 1, 2002, and as a result, we had no
amortization expense in the three months or the six months ended June 30, 2002,
respectively, compared to $1.3 million and $2.5 of amortization expense for the
three months and the six months ended June 30, 2001, respectively. Had we not
adopted SFAS 142, we would have had $1.3 million and $2.6 million of
amortization expense in the three months ended and six months ended June 30,
2002, respectively.
INTEREST EXPENSE, NET
Interest expense, net of interest income, decreased by $3.6 million and $6.4
million in the three months and six months ended June 30, 2002, respectively,
compared to the corresponding periods of the prior year. The decrease is due
to decreased borrowings under our revolving credit facilities and lower
interest rates.
INCOME TAXES
Our effective tax rate was a provision of 1.00% for the three months and six
months ended June 30, 2002, compared to a provision of 2.10% in the
corresponding periods in the prior year. The rate varies from the federal
statutory rate as a result of minimum state taxes in excess of statutory state
income taxes and a change in the deferred tax valuation allowance as a result
of the utilization of net deferred tax assets, primarily net operation loss
carryforwards. Valuation allowances reduce deferred income tax balances to the
approximate amount of recoverable income taxes based on assessments of taxable
income within the carryback and carryforward periods for each year.
As of December 31, 2000, we had recorded a $211.2 million valuation allowance
on our $211.2 million net deferred tax asset, consisting of temporary timing
differences and net operating loss carry forwards. As of June 30, 2002, this
valuation allowance was $124.0 million on our $162.4 million net deferred tax
asset. Excluding this allowance, as of June 30, 2002 shareholders' equity would
have been $196.6 million.
EXTRAORDINARY CHARGE ON RETIREMENT OF DEBT
As a result of the early retirement of our prior revolving credit facility, we
recorded an extraordinary charge of $2.2 million in the three months ended
March 31, 2002 (net of an income tax benefit of $1.3 million) to write-off
deferred financing costs.
LIQUIDITY AND CAPITAL RESOURCES
Overview
We generate substantial operating cash flow from the rental and sales of
videocassettes, DVDs and games. The amount of cash generated from operations in
the six months ended June 30, 2002 funded our debt service requirements and
maintenance capital expenditures with sufficient cash left over to invest over
$25 million in an expansion of our DVD catalog selection in certain stores. At
June 30, 2002, we had $17.4 million of cash and cash equivalents on hand.
On December 7, 2001, we filed with the Securities and Exchange Commission a
shelf registration statement covering up to $426.5 million of securities,
consisting of $126.5 million of equity securities and $300.0 million of debt
securities. The registration statement became effective on February 14, 2002.
On March 11, 2002, we completed a public offering of 8,050,000 shares of our
common stock under our shelf registration statement, resulting in proceeds of
$120.8 million before fees and expenses, of which $114 million was applied to
the repayment of borrowings under our prior revolving credit facility. On May
20, 2002, we amended our shelf registration statement to reflect the sale of
$120.8 million of equity securities and to allow the issuance of up to an
aggregate of $305.8 million of debt and equity securities.
On March 18, 2002, we obtained new senior bank credit facilities from a
syndicate of lenders led by UBS Warburg LLC and applied a portion of initial
borrowings thereunder to repay all remaining borrowings under our prior
revolving credit facility, which was then terminated. The new bank credit
facilities consist of a $150.0 million senior secured term facility maturing in
2004 and a $25.0 million senior secured revolving credit facility maturing in
2004. The maturity of the new facilities will automatically be extended to 2006
if our existing $250 million 10.625% senior subordinated notes due in 2004 (the
"Subordinated Notes") are refinanced prior to February 2004 with a maturity
date beyond 2006.
We believe that cash flow from operations, increased flexibility under our new
credit facilities, cash on hand and trade credit will provide adequate
liquidity and capital resources to execute our business plan for the next
twelve months. With respect to our longer term cash requirements and desire for
increased financial and operating flexibility, taking into account the maturity
of our credit facilities and our outstanding subordinated notes due in 2004, we
will likely need to effect additional capital and/or financing transactions.
Accordingly, we continue to analyze our capital structure and from time to time
may consider additional capital and/or financing transactions as a source of
incremental liquidity. Although we believe that we will be able to timely
affect additional capital and/or financing transactions on acceptable terms,
any failure to do so could impair our ability to execute our business plan
and/or satisfy our other cash requirements over the longer term.
Cash Provided by Operating Activities
Net cash provided by operating activities increased by $31.5 million or 31.0%
in the six months ended June 30, 2002 compared to the six months ended June 30,
2001. The increase was primarily due to improved operating performance in our
existing store base.
Cash Used in Investing Activities
Net cash used in investing activities increased by $65.1 million, or 83.6%, to
$142.8 million in the six months ended June 30, 2002 from $77.8 million in the
six months ended June 30, 2001. The increase was primarily a result of the
shift in product mix from VHS to DVD, as DVD is mainly purchased directly
through distributors or from the studios rather than through revenue sharing
arrangements. Also, we increased our investment in DVD product to expand our
non-new release catalog selection in certain stores. Following is a table
summarizing our cash used in investing activities (in thousands):
Six Months Ended
June 30,
--------------------
2002 2001
--------- ---------
Rental Inventory:
New release replenishment $ 147,438 $ 111,157
New store and other investments 30,518 639
Book value of transfers to merchandise
inventory and tape loss (42,325) (37,673)
--------- ---------
Purchases of rental inventory, net $ 135,631 $ 74,123
--------- ---------
Purchase of property and equipment, net 6,709 3,202
Increase in intangibles and other
assets 491 453
--------- ---------
Total cash used in investing $ 142,831 $ 77,778
========= =========
New release replenishment includes the cost of purchases of new release video
tapes, DVDs and games for existing stores and the estimated interim residual
value of video tapes and DVDs acquired under revenue sharing arrangements. It
does not include net revenue sharing expense included in cost of rental product
on the statement of operations. Net revenue sharing expense was $72.0 million
and $104.1 million for the six months ended June 30, 2002 and 2001,
respectively. New store and other investments in rental product include all
purchases of rental inventories for new store openings, major catalog inventory
enhancement projects, such as an expansion of DVD catalog, and other long-term
investments not considered new release replenishment.
As of June 30, 2002, net rental inventory was $223.9 million compared to $191.0
million as of December 31, 2001, an increase of $32.9 million. The increase was
primarily the result of an investment in DVD product to expand our non-new
release catalog selections in certain stores and initial investments in our new
video store expansion strategy.
Cash Used in Financing Activities
Net cash used in financing activities increased $4.3 million to $11.4 million
in the six months ended June 30, 2002, compared to $7.1 million in the
corresponding period of the prior year. In the first quarter of 2002, we sold
8,050,000 shares of our common stock resulting in proceeds of $120.8 million
before underwriting fees and expenses. We also obtained new senior bank credit
facilities consisting of a $150.0 million senior secured term facility and a
$25.0 million senior secured revolving credit facility. Net proceeds from the
sale of common stock and initial borrowings under the bank credit facility were
used to repay all amounts outstanding under our prior revolving credit
facility. During the first quarter of 2002, we made our first scheduled payment
of $2.5 million on our senior secured term facility. As a result of our
ability to generate positive free cash flow in the second quarter of 2002, we
decided to make our remaining 2002 scheduled term loan amortization payments of
$22.5 million in the second quarter. As a result we have no mandatory
amortization requirements for our term loan remaining in 2002. At June 30,
2002 the balance owed under our new senior secured term facility was $125
million and we had $25.0 million of borrowings available under our new
revolving credit facility.
At June 30, 2002, 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
- ------------ ---------- ---------- --------- ---------
2002 $ - $ - $ 7,094 $ 7,094
2003 - 35,000 10,588 45,588
2004 250,000 90,000(1) - 340,000
2005 - - - -
2006 - - - -
Thereafter - - - -
---------- ---------- --------- ---------
$ 250,000 $ 125,000 $ 17,682 $ 392,682
---------- ---------- --------- ---------
(1) The maturity of the credit facilities will automatically be extended, such
that $35 million will be due in 2004 and 2005, and $20 million will be due in
2006, if the Subordinated Notes are refinanced prior to February 2004 with a
maturity date beyond 2006.
Other Financial Measurements: Working Capital
At June 30, 2002, we had cash and cash equivalents of $17.4 million and a
working capital deficit of $137.6 million. The working capital deficit is
primarily the result of the accounting treatment of rental inventory. Rental
inventories are accounted for as non-current assets under GAAP 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 our 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, we believe 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, we will, more likely than not, operate
with a working capital deficit. We believe the current existence of a working
capital deficit does not affect our ability to operate our business and meet
obligations as they come due.
Other Financial Measurements: Adjusted EBITDA and Free Cash Flow
We believe other financial measurements, such as Adjusted EBITDA and Free Cash
Flow, as defined below, are additional measurements that are useful in
understanding our operating results, including our ability to meet our growth
plans and debt service requirements. These measurements should not be viewed as
a measure of financial performance under GAAP or as substitute for GAAP
measurements, such as net income or cash flow from operations. Our calculation
of these measurements is not necessarily comparable to those reported by other
companies due to the lack of uniform definitions.
Adjusted EBITDA represents income (loss) from operations before depreciation
and amortization and certain special charges, plus non-cash expenses, minus the
cost of replenishing new release rental inventory for existing stores, which is
capitalized. Following is a table calculating Adjusted EBITDA (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Income from operations $ 51,818 $ 20,441 $ 92,753 $ 38,873
Depreciation and
amortization (1) 63,371 61,510 132,800 127,366
Non-cash expenses (2) 20,003 17,215 42,888 39,180
Reversal of restructuring
charge for closure of
internet business (12,430) - (12,430) -
New release replenishment (3) (78,437) (58,045) (147,438) (111,157)
---------- ---------- ---------- ----------
Adjusted EBITDA $ 44,325 $ 41,121 $ 108,573 $ 94,262
========== ========== ========== ==========
(1) Includes depreciation and amortization of property and equipment and
intangible assets and amortization of rental product.
(2) Expenses that are non-cash in nature represent tape loss, the book value of
previously viewed product sold and stock compensation. The non-cash tape loss
and the book value of previously viewed product sold for the three months ended
and the six months ended June 30, 2002 were $18.8 million and $40.2 million,
respectively, compared to $15.9 million and $34.6 in the corresponding periods
of the prior year. The non-cash stock compensation for the three months and
the six months ended June 30, 2002 was $1.2 million and $2.7 million,
respectively, compared to $1.3 million and $4.6 million in the corresponding
periods of the prior year.
(3) This represents existing store purchases that are considered replenishment
of new release tapes, games and DVDs, which are included in the amounts
presented as 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.
Our calculation of Adjusted EBITDA, as presented above, is not comparable to
the methodology for calculating EBITDA by our most significant competitor. The
following table provides an EBITDA calculation for Hollywood consistent with
their methodology.
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Income from operations $ 51,818 $ 20,441 $ 92,753 $ 38,873
Depreciation and amortization(1) 14,979 16,377 30,061 33,273
Non-cash expenses(2) 1,208 1,299 2,713 4,580
Special charges(3) (12,430) 5,000 (12,430) 16,000
---------- ---------- ---------- ----------
EBITDA $ 55,575 $ 43,117 $ 113,097 $ 92,726
========== ========== ========== ==========
(1) Represents depreciation and amortization of property and equipment, and
amortization of intangibles. It does not include amortization of rental
product.
(2) Expenses that are non-cash in nature including compensation associated with
certain stock option grants.
(3) The special charge for the three months and six months ended June 30, 2002
is $12.4 million for an accrual reversal of restructuring charges related to
the closure of Reel.com. Special charges were $5.0 million and $16.0 million
for the three months and six months ended June 30, 2001. These charges
represent incremental depreciation expense associated with changes in estimated
rental inventory lives and residual values that were adopted on a prospective
basis October 1, 2000.
While the methodologies used in calculating Adjusted EBITDA differ, we believe
that any differences in the methodologies are immaterial in the long term.
EBITDA for the year 2001 under this method would have been $204.6 million
compared to Adjusted EBITDA of $194.7 million as reported. While both
methodologies have benefits, we believe that the methodology employed by our
most significant competitor more accurately takes into account any timing
effects of new release titles that may positively or negatively impact EBITDA
for any specific quarter and thus provides a more reflective view of our cash
earnings power on a quarter to quarter basis. In order to eliminate confusion
and to provide investors with more meaningful comparative data of EBITDA as
compared to our most significant competitor, effective with the third quarter
results and the quarterly report on Form 10-Q, we will adopt the methodology of
our most significant competitor to calculate EBITDA.
Free Cash Flow represents EBITDA, less cash paid for interest and taxes,
maintenance capital expenditures and discretionary investment capital
expenditures (e.g. investment in new store openings and new product platform
rollouts). Discretionary Free Cash Flow represents Free Cash Flow before
discretionary investments in capital expenditures that are not required to
maintain existing stores. We believe Discretionary Free Cash Flow and Free Cash
Flow are useful measurements in determining our ability to meet our growth
plans, satisfy working capital demands and meet our debt service requirements.
Following is a table calculating Discretionary Free Cash Flow and Free Cash
Flow (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
2002 2001 2002 2001
-------- -------- -------- --------
EBITDA $ 55,575 $ 43,117 $113,097 $ 92,726
Less: Cash interest paid (2,586) (4,885) (23,465) (26,432)
Cash taxes paid (626) (791) (861) (603)
Maintenance capital
expenditures (2,746) (387) (4,797) (1,019)
-------- -------- -------- --------
Discretionary Free Cash Flow 49,617 37,054 83,974 64,672
Less: discretionary investment
capital expenditures (10,180) (866) (32,429) (2,823)
-------- -------- -------- --------
Free Cash Flow (1) 39,437 36,188 51,545 61,849
======== ======== ======== ========
(1) Free Cash Flow as historically reported using Adjusted EBITDA would have
been $28.2 million and $47.0 million for the three months and six months ended
June 30, 2002, respectively, compared to $34.2 million and $63.4 million in the
corresponding periods of the prior year.
Maintenance capital expenditures represents expenditures that we believe are
necessary to maintain the existing store operations, including equipment,
fixtures, leasehold improvements, remodeling projects, and implementing and
upgrading office and store technology. We anticipate that maintenance capital
expenditures will be approximately $20 million in 2002. Discretionary
investment capital expenditures in the six months ended June 30, 2002 were for
an expansion of our DVD non-new release catalog selections in certain stores
and initial investments in our expansion strategies for Game Crazy and new
video stores. In the six months ended June 30, 2001, discretionary investment
capital expenditures were primarily related to new stores. We anticipate that
discretionary investment capital expenditures will be approximately $62.0
million in 2002, which includes at least 100 new Game Crazy units and 50 new
video stores and our DVD non-new release catalog expansion.
During the first quarter of 2002, we made our first scheduled payment of $2.5
million on our senior secured term facility. As a result of our ability to
generate positive free cash flow in the second quarter of 2002, we decided to
make our remaining 2002 scheduled term loan amortization payments of $22.5
million in the second quarter. As a result we have no mandatory amortization
requirements for our senior secured term facility remaining in 2002.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Market risk represents the risk of loss that may impact our financial position,
operating results, or cash flows due to adverse changes in financial and
commodity market prices and rates. We have entered into certain market-risk-
sensitive financial instruments for other than trading purposes, principally
short-term and long-term debt. Historically, and as of June 30, 2002, we have
not held derivative instruments for the purpose of addressing market risks,
including market risks associated with variable rate indebtedness.
The interest payable on our senior credit facilities is based on variable
interest rates (IBOR or the prime bank rate at our option), and therefore,
affected by changes in market interest rates. Hypothetically, if variable base
rates were to increase 1% in 2002 as compared to the rates at June 30, 2002,
our interest rate expense would increase by approximately $1.3 million based on
our outstanding balance on the facilities as of June 30, 2002.
GENERAL ECONOMIC TRENDS, QUARTERLY RESULTS AND SEASONALITY
Our business may be affected by general economic and other consumer trends.
Future operating results may be affected by various factors, including (i)
variations in the number and timing of new store openings, (ii) the performance
of new or acquired stores, (iii) the quality and number of new release titles
available for rental and sale, (iv) additional and existing competition, (v)
marketing programs, (vi) the level of demand for movie and video game rentals
and purchases, (vii) the effects of changing and/or new technology and intense
competition, (viii) the prices for which we are able to rent or sell our
products, (ix) the costs and availability to us of newly-released movies and
video games, (x) changes in other significant operating costs and expenses,
(xi) the effects of our substantial indebtedness and the limitations imposed by
restrictive covenants contained in our debt instruments, and (xii) our ability
to manage store expansions and growth, (xiii) acts of God or public
authorities, war, civil unrest, fire, floods, earthquakes, acts of terrorism,
the weather and other matters beyond our control.
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. We believe these
seasonality trends will continue.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended, under the
headings "Management's Discussion and Analysis of Results of Operations and
Financial Condition ("MD&A") - Operating Costs and Expenses - General and
Administrative," "MD&A - Liquidity and Capital Resources - Overview," "MD&A -
Liquidity and Capital Resources - Other Financial Measurements: Working
Capital," "MD&A - Liquidity and Capital Resources - Other Financial
Measurements: Adjusted EBITDA and Free Cash Flow," "General Economic Trends,
Quarterly Results and Seasonality" and "Cautionary Statements" that involve
substantial risks and uncertainties and which are intended to be covered by the
safe harbors created thereby. These statements can be identified by the fact
that they do not relate strictly to historical information and include the
words "expects", "believes", "anticipates", "plans", "may", "will", "intends",
"estimates", "continue" or other similar expressions. These forward-looking
statements are subject to various risks and uncertainties that could cause
actual results to differ materially from those currently anticipated. These
risks and uncertainties include, but are not limited to, items discussed in the
Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2001 under the heading "Cautionary Statements" and under the heading "General
Economic Trends, Quarterly Results and Seasonality". 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.
CAUTIONARY STATEMENTS
We are subject to a number of risks that are particular to our business and
that may or may not affect our competitors. We describe some of these risks
below. If any of these risks materializes, our business, financial condition,
liquidity and results of operations could be harmed, and the value of our
securities could fall.
We face intense competition and risks associated with technological
obsolescence, and we may be unable to compete effectively.
The home video and home video game industries are highly competitive. We
compete with local, regional and national video retail stores, including those
operated by Blockbuster, Inc., the largest video retailer in the United States,
and with mass merchants, specialty retailers, supermarkets, pharmacies,
convenience stores, bookstores, mail order operations, online stores and other
retailers, as well as with noncommercial sources, such as libraries.
Substantially all of our stores compete with stores operated by Blockbuster,
most in very close proximity. Some of our competitors have significantly
greater financial and marketing resources, market share and name recognition
than Hollywood. As a result of direct competition with Blockbuster and others,
pricing strategies for videos and video games is a significant competitive
factor in our business. Our home video and home video game businesses also
compete with other forms of entertainment, including cinema, television,
sporting events and family entertainment centers. If we do not compete
effectively with competitors in the home video industry or the home video game
industry or with providers of other forms of entertainment, our revenues and/or
our profit margin could decline and our business, financial condition,
liquidity and results of operations could be harmed.
We also compete with cable and direct broadcast satellite television systems.
These systems offer both movie channels, for which subscribers pay a
subscription fee for access to movies selected by the provider at times
selected by the provider, and pay-per-view services, for which subscribers pay
a discrete fee to view a particular movie selected by the subscriber.
Historically pay-per-view services have offered a limited number of channels
and movies, and have offered movies only at scheduled intervals. Today,
however, advances in digital compression and other developing technologies are
enabling cable and satellite companies, and may enable internet service
providers and others, to transmit a significantly greater number of movies to
homes more frequently scheduled intervals throughout the day. In addition,
certain cable companies, internet service providers and others have tested and
are continuing to test video-on-demand services in some markets. As a concept,
video on demand would provide a subscriber with the ability to view any movie
included in a catalog of titles maintained by the provider at any time of the
day. If video on demand or other alternative movie delivery systems, whether
alone or in conjunction with sophisticated digital recording systems (which
allow viewers to record, pause, rewind and fast forward live broadcasts),
achieve the ability to enable consumers to conveniently view and control the
movies they want to see when they want to see them, such alternative movie
delivery systems could achieve a competitive advantage over the traditional
video rental industry. While we believe that there presently exist substantial
technological, economic and other impediments to alternative movie delivery
systems achieving such a competitive advantage, technological advances and
other developments could enable them to do so, which in turn could harm our
profitability and otherwise harm our business, financial condition, liquidity
and results of operations.
Changes in the way that movie studios price videocassettes and/or DVDs could
adversely affect our revenues and profit margins.
Movie studios use various pricing models to maximize the revenues they receive
for movies released to the home video industry. Historically, these pricing
models have enabled a profitable video rental market to exist and compete
effectively with mass retailers and other sellers of home videos. Initially,
the movie studios adopted a "rental pricing" model under which high initial
wholesale prices are established in order for the studios to maximize revenues
from rental retailers prior to setting prices at levels to create demand from
mass merchants. More recently, movie studios have entered into revenue sharing
arrangements (usually on a title-by-title basis) under which studios provide
movies to video rental retailers at reduced prices in exchange for a share of
rental revenues. Movie studios have also utilized "sell-through" pricing under
which lower wholesale prices generate more consumer demand for home video
purchases, but also result in an increase in profit margins on video rentals.
If the studios were to significantly change their pricing policies in a manner
that increases our cost of obtaining movies under revenue sharing arrangements
or other arrangements, our revenues and/or profit margin could decrease, and
our business, financial condition, liquidity and results of operations would be
harmed. We can neither control nor predict with certainty whether the studios'
pricing policies will continue to enable us to operate our business as
profitably as we can under current pricing arrangements.
We could lose a significant competitive advantage if the movie studios were to
adversely change their current distribution practices.
Currently, video stores receive movie titles approximately 30 to 90 days
earlier than pay-per-view, cable and satellite distribution companies. If
movie studios were to change the current distribution schedule for movie titles
such that video stores were no longer the first major distribution channel to
receive a movie title after its theatrical or direct-to-video release or to
provide for the earlier release of movie titles to competing distribution
channels, we could be deprived of a significant competitive advantage, which
could negatively impact the demand for our products and reduce our revenues and
could harm our business, financial condition, liquidity and results of
operations.
The video store industry could be adversely impacted by conditions affecting
the motion picture industry.
The video store industry is dependent on the continued production and
availability of motion pictures produced by movie studios. Any conditions that
adversely affect the motion picture industry, including constraints on capital,
financial difficulties, regulatory requirements and strikes, work stoppages or
other disruptions involving writers, actors or other essential personnel, could
reduce the number and quality of the new release titles in our stores. This in
turn could reduce consumer demand and negatively impact our revenues, which
would harm our business, financial condition, liquidity and results of
operations.
The failure of video game software and hardware manufacturers to timely
introduce new products could hurt our ability to attract and retain video game
rental customers.
We are dependent on the introduction of new and enhanced video games and game
systems to attract and retain video game rental customers. If manufacturers
fail to introduce or delay the introduction of new games and systems, the
demand for games available to us could decline, negatively impacting our
revenues, and our business, financial condition, liquidity and results of
operations could be harmed.
Expansion of our store base has placed and may place pressure on our operations
and management controls.
We have expanded the size of our store base and the geographic scope of
operations significantly since our inception. Between 1996 and 2000 we opened
an average of 306 stores per year. Although we have currently curtailed new
store openings, we intend to open new stores in the future. This expansion has
placed, and may continue to place, increased pressure on our operating and
management controls. To manage a larger store base, we will need to continue
to evaluate and improve 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. In addition,
our ability to open and operate new stores in a profitable manner depends upon
numerous contingencies, many of which are beyond our control. These
contingencies include but not limited to:
- - our ability under the terms of the instruments governing our existing and
future indebtedness to make capital expenditures associated with new store
openings;
- - our ability to locate suitable store sites, negotiate acceptable lease
terms, and build out or refurbish sites on a timely and cost-effective
basis;
- - our ability to hire, train and retain skilled associates; and
- - our ability to integrate new stores into our existing operations.
We may also open stores in markets where we already have significant operations
in order to maximize our market share within these markets. If we do so, we
cannot assure you that these newly opened stores will not adversely affect the
revenues and profitability of those pre-existing stores in any given market.
We depend on key personnel whom we may not be able to retain; recent management
changes are unproven.
Our future performance depends on the continued contributions of certain key
management personnel. From late 2000 through mid-2001, we made significant
changes to our management personnel, including adding two new outside directors
to the board of directors, reinstating Mark J. Wattles, Hollywood's founder and
Chief Executive Officer, full-time as President, hiring Scott R. Schultze, who
subsequently became Executive Vice President and Chief Operating Officer,
hiring James A. Marcum as Executive Vice President and Chief Financial Officer
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. A loss of one or more of these key
management personnel, our inability to attract and retain additional key
management personnel, including qualified store managers, or the inability of
management to successfully manage our operations could prevent us from
implementing our business strategy and harm our business, financial condition,
liquidity or results of operations.
The failure of our management information systems to perform as we anticipate
could harm our business.
The efficient operation of our business is dependent on our management
information systems. In particular, we rely on an inventory utilization system
used by our merchandise organization and in our distribution centers to track
rental activity by individual videocassette, DVD and video game to determine
appropriate buying, distribution and disposition of videocassettes, DVDs and
video games. We use a scalable client-server system to 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. We rely on these systems as
well as our proprietary point-of-sale and in-store systems to keep our in-store
inventories at optimum levels, to move inventory efficiently and to track and
record our performance. The failure of our management information systems to
perform as we anticipate could impair our ability to manage our inventory and
monitor our performance and harm our business, financial condition, liquidity
and results of operations.
Instruments governing our existing and future indebtedness contain or may
contain covenants that restrict our business.
Instruments governing our bank credit facility and our 10.625% senior
subordinated notes due 2004 contain, and our future indebtedness may contain a
number of covenants that, among other things, significantly restrict our
ability to:
- - open new stores;
- - incur additional indebtedness;
- - guarantee third-party obligations;
- - enter into capital leases;
- - create liens on assets;
- - dispose of assets;
- - repay indebtedness or amend indebtedness instruments;
- - make capital expenditures;
- - make investments, loans or advances;
- - make acquisitions or engage in mergers or consolidations; and
- - engage in certain transactions with our subsidiaries and affiliates.
We have a substantial amount of indebtedness and debt service obligations,
which could adversely affect our financial and operational flexibility and
increase our vulnerability to adverse conditions.
As of June 30, 2002, we had total consolidated long-term debt, including
capital leases, of approximately $392.7 million. We and our subsidiaries may
incur substantial additional indebtedness in the future, including indebtedness
that would be secured by our assets or those of our subsidiaries. If new
indebtedness is added to our and our subsidiaries' current indebtedness levels,
the related risks that we and they now face could intensify. For example, it
could:
- - require us to dedicate a substantial portion of our cash flow to payments
on our indebtedness;
- - limit our ability to borrow additional funds;
- - increase our vulnerability to general adverse economic and industry
conditions;
- - limit our ability to fund future working capital, capital expenditures and
other general corporate requirements;
- - limit our flexibility in planning for, or reacting to, changes in our
business and the industry in which we operate or taking advantage of
potential business opportunities;
- - limit our ability to execute our business strategy successfully; and
- - place us at a competitive disadvantage in our industry.
We and our subsidiaries may incur substantial additional indebtedness in the
future, including indebtedness that would be secured by our assets or those of
our subsidiaries. If new indebtedness is added to our and our subsidiaries'
current indebtedness levels, the related risks that we and they now face could
intensify.
Our ability to satisfy our indebtedness obligations will depend on our
financial and operating performance, which may fluctuate significantly from
quarter to quarter and is subject to economic, industry and market conditions
and to risks related to our business and other factors beyond our control.
We cannot assure you that our business will generate sufficient cash flow from
operations or that future borrowings will be available to us in amounts
sufficient to enable us to pay our indebtedness or to fund our other liquidity
needs. We may need to refinance all or a portion of our indebtedness, on or
before maturity. We cannot assure you that we will be able to refinance any of
our indebtedness, including the debt securities, on commercially reasonable
terms or at all.
Instruments governing our existing and future indebtedness contain or may
contain various covenants, including covenants requiring us to meet specified
financial ratios and tests. Our failure to comply with all applicable
covenants could result in our indebtedness being immediately due and payable.
The instruments governing our existing indebtedness contain various covenants
which, among other things, limit our ability to make capital expenditures and
require us to meet specified financial ratios, which generally become more
stringent over time, including a maximum leverage ratio and a minimum interest
and rent coverage ratio. The instruments governing our future indebtedness may
impose similar or other restrictions and may require us to meet similar or
other financial ratios and tests. Our ability to comply with covenants
contained in the instruments governing our existing and future indebtedness may
be affected by events and circumstances beyond our control. If we breach any
of these covenants, one or more events of default, including cross-defaults
between multiple components of our indebtedness, could result. These events of
default could permit our creditors to declare all amounts owing to be
immediately due and payable, and terminate any commitments to make further
extensions of credit. If we were unable to repay indebtedness owed to our
secured creditors, they could proceed against the collateral securing the
indebtedness owed to them.
We are subject to governmental regulations that impose obligations and
restrictions and may increase our costs.
We are subject to various U.S. federal and state laws that govern, among other
things, the disclosure and retention of our video rental records and access and
use of our video stores by disabled persons, and are subject to various state
and local licensing, zoning, land use, construction and environment
regulations. Furthermore, changes in existing laws, including environmental
and employment laws, new laws or increases in the minimum wage may increase our
costs.
Terrorist attacks, such as the attacks that occurred in New York and
Washington, D.C. on September 11, 2001, and other acts of violence or war may
affect the markets on which our common stock trades, the markets in which we
operate, our operations and our profitability.
Terrorist attacks and other acts of violence or war may negatively affect our
operations and your investment. There can be no assurance that there will not
be further terrorist attacks or other acts of violence or war against the
United States or United States businesses. Also, as a result of terrorism, the
United States has entered into armed conflict. These attacks or armed
conflicts may directly impact our physical facilities or those of our
suppliers. Furthermore, these attacks or armed conflicts may make travel and
the transportation of our supplies and products more difficult and more
expensive and ultimately affect our revenues.
More generally, any of these events could cause consumer confidence and
spending to decrease further or result in increased volatility in the United
States and worldwide financial markets and economy. They also could result in
economic recession in the United States or abroad. Any of these occurrences
could harm our business, financial condition or results of operations, and may
result in the volatility of the market price for our securities and on the
future price of our securities.
Our quarterly operating results will vary, which may affect the value of our
securities in a manner unrelated to our long-term performance.
Our quarterly operating results have varied in the past and we expect that they
will continue to vary in the future depending on a number of factors, many of
which are outside of our control. Factors that may cause our quarterly
operating results to vary include:
- - the level of demand for movie rentals and purchases;
- - existing and future competition from providers of similar products and
alternative forms of entertainment;
- - the prices for which we are able to rent or sell our products;
- - the availability and cost to us of newly-released movies;
- - changes in other significant operating costs and expenses;
- - weather;
- - seasonality;
- - variations in the number and timing of store openings;
- - the performance of newer stores;
- - acquisitions by us of existing video stores;
- - the success of new business initiatives;
- - other factors that may affect retailers in general;
- - changes in movie rental habits resulting from domestic and world events;
- - actual events, circumstances, outcomes and amounts differing from judgments,
assumptions and estimates used in determining the amount of certain assets
(including the amounts of related valuation allowances), liabilities and
other items reflected in our Consolidated Financial Statements; and
- - acts of God or public authorities, war, civil unrest, fire, floods,
earthquakes, acts of terrorism and other matters beyond our control.
Future sales of shares of our common stock may negatively affect our stock
price.
If we or our shareholders sell substantial amounts of our common stock in the
public market, the market price of our common stock could fall. In addition,
sales of substantial amounts of our common stock might make it more difficult
for us to sell equity or equity-related securities in the future.
We do not expect to pay dividends in the foreseeable future.
We have never declared or paid any cash dividends on our common stock and we do
not expect to declare dividends on our common stock in the foreseeable future.
The instruments governing our existing and future indebtedness contain or may
contain provisions prohibiting or limiting the payment of dividends on our
common stock.
Provisions of Oregon law and our articles of incorporation may make it more
difficult to acquire us, even though an acquisition may be beneficial to our
shareholders.
Provisions of Oregon law condition the voting rights that would otherwise be
associated with any shares of our common stock that may be acquired in
specified transactions deemed to constitute a "control share acquisitions" upon
approval by our shareholders (excluding, among other things, the acquiror in
any such transaction). Provisions or Oregon law also restrict, subject to
specified exceptions, the ability of a person owning 15% or more of our common
stock to enter into any "business combination transaction" with us. In
addition, under our articles of incorporation, our Board of Directors has the
authority to issue up to 25.0 million 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 foregoing provisions of Oregon
law and our articles of incorporation have the effect of delaying, deferring or
preventing a change in control of Hollywood, may discourage bids for our common
stock at a premium over the market price of our common stock and may adversely
affect the market price of, and the voting and other rights of the holders of,
our common stock and the occurrence of a control share acquisition may
constitute an event of default under, or otherwise require us to repurchase or
repay, our indebtedness.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
During 1999, the Company was named as a defendant in three complaints which
have been coordinated into a single 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, who they claim are owed overtime payments for
work performed in certain stores in California. The parties have since entered
into a settlement agreement, which has been given preliminary approval by the
court. The class consists of only those individuals employed by Hollywood
Entertainment within the Sate of California as salaried store managers in
Hollywood Video stores during the period from January 25, 1995 to March 31,
2002, and only those employed by Hollywood Entertainment within the Sate of
California as salaried assistant managers in Hollywood Video stores during the
period from January 25, 1995 to December 31, 1999, who do not opt-out of the
settlement. The Company believes it has provided adequate reserves in
connection with the settlement agreement.
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 Hollywood and Reel.com. 3PF and Reel.com entered into a
Warehousing and Distribution Agreement (Agreement) on February 7, 2000. 3PF
alleged that, as a result of the discontinuation of Reel.com operations,
Reel.com was in default under the Agreement, failed to perform material
obligations under the Agreement, and failed to pay amounts due 3PF. On May 15,
2002, the Company, 3PF and Rentrak Corporation entered into a settlement
agreement encompassing all claims between the two parties including
counterclaims and causes of action that were asserted or could have been
asserted and agreed to the dismissal of the arbitration case.
The Company has been named to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters,
including suits related to amounts charged to customers in connection with
extended rental periods. The Company believes it has provided adequate
reserves for these various contingencies and that the outcome of these matters
should not have a material adverse effect on the Company's consolidated results
of operation, financial condition or liquidity.
ITEM 5. OTHER INFORMATION
On August 12, 2002, we filed a current report on Form 8-K under "Item 9.
Regulation FD Disclosure" reporting that each of the principal executive
officer and principal financial officer of the Company submitted to the
Securities and Exchange Commission the statements under oath in according with
the Commission's Order No 4-460 requiring the filing of sworn statements
pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
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")).
4.1 Indenture, dated August 13, 1997, between the Registrant and BNY Western
Trust Company, as successor in interest to 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 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), the
Second Supplemental Indenture, dated as of January 20, 2000, between the
Registrant and the Trustee (incorporated by reference to Exhibit 10.1 to the
Registrant's Annual Report on Form 10-K for the year ended December 31, 1999)
and the Third Supplemental Indenture, dated as of February 12, 2002, between
Registrant, as Issuer, Hollywood Management Company, as Subsidiary Guarantor,
and Trustee (incorporated by reference to Exhibit 4.1 to the Registrant's
Quarterly Report on Form 10-Q/A for the quarter ended September 30, 2001).
99.1 Certification of Chief Executive Officer and Chief Financial Officer of
Registrant Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
None filed during the period.
HOLLYWOOD ENTERTAINMENT CORPORATION
SIGNATURES
Pursuant to the requirements 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.
HOLLYWOOD ENTERTAINMENT CORPORATION
(Registrant)
August 14, 2002 /S/James A. Marcum
- ------------------ -------------------------------------------------
(Date) James A. Marcum
Executive Vice President and Chief Financial Officer
(Authorized Officer and Principal Financial and
Accounting Officer of the Registrant)
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