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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 March 31, 2003
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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No [ ]
As of May 12, 2003 there were 60,733,373 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
March 31,
------------------
2003 2002
-------- --------
REVENUE:
Rental product revenue $364,547 $330,439
Merchandise sales 53,045 33,209
-------- --------
417,592 363,648
COST OF REVENUE:
Cost of rental product 116,610 115,751
Cost of merchandise 39,082 24,888
-------- --------
155,692 140,639
-------- --------
GROSS MARGIN 261,900 223,009
OPERATING COSTS AND EXPENSES:
Operating and selling 175,086 158,045
General and administrative 30,393 24,029
Store opening expense 1,385 -
-------- --------
206,864 182,074
-------- --------
INCOME FROM OPERATIONS 55,036 40,935
Interest expense, net (9,664) (11,976)
Early debt retirement (12,467) (3,534)
-------- --------
Income before income taxes 32,905 25,425
Benefit (provision) for income taxes (13,327) 1,018
-------- --------
NET INCOME $ 19,578 $ 26,443
======== ========
- ----------------------------------------------------------------
Net income per share:
Basic $0.33 $0.51
Diluted $0.31 $0.46
- ----------------------------------------------------------------
Weighted average shares outstanding:
Basic 59,867 51,610
Diluted 63,898 57,163
- ----------------------------------------------------------------
The accompanying notes are an integral part of this financial statement
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
March 31, December 31,
------------ -----------
2003 2002
------------ -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 65,168 $ 33,145
Cash held by trustee for refinancing - 218,531
Receivables, net 33,512 34,996
Merchandise inventories 105,459 97,307
Prepaid expenses and other current assets 12,913 14,772
----------- -----------
Total current assets 217,052 398,751
Rental inventory, net 259,219 260,190
Property and equipment, net 259,094 255,497
Goodwill 64,934 64,934
Deferred tax asset, net 138,450 147,813
Other assets, net 19,800 19,191
----------- -----------
$ 958,549 $ 1,146,376
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 9,827 $ 27,678
Subordinated notes to be retired with
cash held by trustee (including accrued
interest of $8.1 million) - 212,080
Accounts payable 139,765 158,423
Accrued expenses 101,470 108,432
Accrued interest 2,848 2,923
Income taxes payable 3,636 1,151
----------- -----------
Total current liabilities 257,546 510,687
Long-term obligations, less current portion 405,000 361,068
Other liabilities 17,117 17,472
----------- -----------
679,663 889,227
----------- -----------
Shareholders' equity:
Preferred stock, 25,000,000 shares
authorized; no shares issued and
outstanding - -
Common stock, 100,000,000 shares authorized;
60,101,168 and 59,796,573 shares issued
and outstanding, respectively 505,395 503,403
Unearned compensation (530) (697)
Accumulated deficit (225,979) (245,557)
----------- -----------
Total shareholders' equity 278,886 257,149
----------- -----------
$ 958,549 $ 1,146,376
=========== ===========
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Three Months Ended
March 31,
-----------------------
2003 2002
--------- ---------
OPERATING ACTIVITIES:
Net income $ 19,578 $ 26,443
Adjustments to reconcile net income
to cash provided by operating activities:
Write-off of deferred financing costs 5,827 3,534
Amortization of rental product 58,536 54,347
Depreciation 14,969 15,082
Amortization of deferred financing costs 698 1,087
Tax benefit from exercise of stock options 1,219 -
Change in deferred rent (355) (312)
Change in deferred taxes 9,363 -
Non-cash stock compensation 167 1,505
Net change in operating assets and liabilities:
Receivables 1,484 (1,928)
Merchandise inventories (8,152) (4,518)
Accounts payable (18,658) (13,096)
Accrued interest (8,215) (9,888)
Other current assets and liabilities (2,626) (1,854)
--------- ---------
Cash provided by operating activities 73,835 70,402
--------- ---------
INVESTING ACTIVITIES:
Purchases of rental inventory, net (57,565) (69,259)
Purchases of property and equipment, net (18,566) (2,082)
Increase in intangibles and other assets (211) (331)
Proceeds from indenture trustee 218,531 -
--------- ---------
Cash provided by (used in)
investing activities 142,189 (71,672)
--------- ---------
FINANCING ACTIVITIES:
Proceeds from issuance of common stock - 120,750
Equity financing costs - (7,234)
Extinguishment of subordinated debt (250,000)
Borrowings under new term loan facility 200,000 150,000
Repayment of prior revolving loan (107,500) (240,000)
Decrease in credit agreements (15,000) (2,500)
Debt financing costs (6,915) (5,250)
Repayments of capital lease obligations (5,359) (3,547)
Proceeds from exercise of stock options 773 938
--------- ---------
Cash provided by (used in) financing
activities (184,001) 13,157
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 32,023 11,887
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 33,145 38,810
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF FIRST
QUARTER $ 65,168 $ 50,697
========= =========
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, 2002 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,
2002 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.
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 143 (SFAS 143), "Accounting For Asset
Retirement Obligations." SFAS 143 requires entities to record the fair value of
a liability for an asset retirement obligation in the period in which it is
incurred. When the liability is initially recorded, the entity is required to
capitalize the cost by increasing the carrying amount of the related long-lived
asset. Over time, the liability is accreted to its present value each period,
and the capitalized cost is depreciated over the useful life of the related
asset. SFAS 143 is effective for fiscal years beginning after June 15, 2002 and
was adopted by the Company on January 1, 2003. Adoption of the standard did not
impact the Company's results of operations, financial position or liquidity in
the three months ended March 31, 2003.
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148 (SFAS 148), "Accounting for Stock-Based Compensation - Transition and
Disclosure - An Amendment of FASB Statement No. 123." SFAS 148 amends
Statement of Financial Accounting Standards No. 123 (SFAS 123), "Accounting for
Stock-Based Compensation," to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. SFAS 148 amends the disclosure requirements of SFAS 123
to require prominent disclosures both in annual and interim financial
statements about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results.
The Company accounts for its stock option plans under the recognition and
measurement principles of APB Opinion No. 25, "Accounting for Stock Issued to
Employees, and related Interpretations." The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of SFAS 123, "Accounting for Stock-Based
Compensation."
Three Months Ended March 31,
-------------------------------------
2003 2002
---------------- -------------------
Net income (loss)
as reported $ 19,578 $ 26,443
Add: Stock-based
compensation expense
included in reported
net income, net of
tax related tax
effects 103 285
Deduct: Total stock-
based employee
compensation expense
under fair value
based method for all
awards, net of
related tax effects (2,117) (2,121)
-------- --------
Pro forma net income $ 17,564 $ 24,607
======== ========
Earnings (loss)
per Share:
Basic--as reported $ 0.33 $ 0.51
Basic--pro forma 0.29 0.48
Diluted--as reported 0.31 0.46
Diluted--pro forma $ 0.29 $ 0.44
In May 2002, the FASB issued Statement of Financial Accounting Standards No.
145 (SFAS 145), "Rescission of SFAS Nos. 4, 44 and 64, Amendment of SFAS 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. In
the first quarter of 2003, the Company redeemed its $250 million 10.625% senior
subordinated notes due 2004 and retired its prior credit facility due 2004,
resulting in a charge of $12.5 million that was not considered an extraordinary
item. Additionally, in the first quarter of 2002, the Company retired its
credit facility in place at that time resulting in a $3.5 million charge that
was considered an extraordinary item in the Company's Consolidated Statement of
Operation in its Quarterly Report on Form 10-Q for the period ended March 31,
2002. In accordance with SFAS 145, this charge has been reclassified to conform
to the presentation of the current period.
In July 2002, the FASB issued Statement of Financial Accounting Standards No.
146 (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 an Activity (Including Certain
Costs Incurred in a Restructuring)." This statement 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 adopted SFAS 146 on
January 1, 2003. Adoption of the standard did not have a material impact on the
Company's results of operations, financial position or liquidity.
In November 2002, the FASB's Emerging Issues Task Force (EITF) reached a
consensus on Issue 02-16, addressing the accounting of cash consideration
received by a customer from a vendor, including vendor rebates and refunds.
The consensus reached states that consideration received should be presumed to
be a reduction of the prices of the vendor's products or services and should
therefore be shown as a reduction of cost of sales in the income statement of
the customer. The presumption could be overcome if the vendor receives an
identifiable benefit in exchange for the consideration or the consideration
represents a reimbursement of a specific incremental identifiable cost incurred
by the customer in selling the vendor's product or service. If one of these
conditions is met, the cash consideration should be characterized as a
reduction of those costs in the income statement of the customer. The
consensus reached also concludes that if rebates or refunds can be reasonably
estimated, such rebates or refunds should be recognized as a reduction of the
cost of sales based on a systematic and rational allocation of the
consideration to be received relative to the transactions that mark the
progress of the customer toward earning the rebate or refund. The provisions
of this consensus will be applied prospectively. The Company evaluated its
agreements with vendors and determined that its current presentation of certain
considerations, primarily cooperative advertising, is consistent with the
consensus.
In November 2002, the FASB issued Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees." FIN 45
requires a guarantor to recognize, at the inception of a guarantee, a liability
for the fair value of the obligation it has undertaken in issuing the
guarantee. The Company will apply FIN 45 to guarantees, if any, issued after
December 31, 2002. In addition, FIN 45 also requires guarantors to disclose
certain information for guarantees, including product warranties, outstanding
at December 31, 2002. The Company does not have significant guarantees that
require liability recognition or disclosure.
(2) Rental Amortization Policy
The Company manages its rental inventories of movies as two distinct
categories, new releases and catalog. New releases, which represent the
majority of all movies acquired, are those movies which are primarily purchased
on a weekly basis in large quantities to support demand upon their initial
release by the studios and are generally held for relatively short periods of
time. Catalog, or library, represents an investment in those movies the Company
intends to hold for an indefinite period of time and represents a historic
collection of movies which are maintained on a long-term basis for rental to
customers. In addition, the Company acquires catalog inventories to support new
store openings and to build-up its title selection, primarily as it relates to
new formats such as DVD.
Purchases of new release movies are amortized over four months to current
estimated average residual values of approximately $2.00 for VHS and $4.00 for
DVD (net of estimated allowances for losses). Purchases of VHS and DVD catalog
are currently amortized on a straight-line basis over twelve months and sixty
months, respectively, to estimated residual values of $2.00 for VHS and $4.00
for DVD.
For new release movies acquired under revenue sharing arrangements, the
studios' share of rental revenue is charged to cost of rental net of average
estimated residual values which are approximately equal to the residual values
of purchased inventory, as outlined above. The expense is recorded as revenue
is earned on the respective revenue sharing titles.
The majority of games purchased are amortized over four months to an average
residual value below $5.00. Games that the Company expects to keep in rental
inventory for an indefinite period of time are amortized on a straight-line
basis over two years to a current estimated residual value of $5.00.
(3) Statements of Changes in Shareholders' Equity
A summary of changes to shareholders' equity amounts for the three months ended
March 31, 2003 is as follows (in thousands, except share amounts):
Common Stock Unearned
------------------- Compen- Accumulated
Shares Amount sation Deficit Total
---------- -------- -------- --------- --------
Balance at 12/31/2002 59,796,573 $503,403 $ (697) $(245,557) $257,149
---------- -------- -------- --------- --------
Issuance of common stock:
Stock options exercised 304,595 773 773
Stock options tax benefit 1,219 1,219
Stock compensation - 167 167
Net income 19,578 19,578
---------- -------- -------- --------- --------
Balance at 03/31/2003 60,101,168 $505,395 $ (530) $(225,979) $278,886
========== ======== ======== ========= ========
(4) 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 $55.0 million for the three months ended March 31, 2003, compared
to $53.0 million for the corresponding period 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 $11.6 million for the three months ended March
31, 2003 compared to $10.1 million for the corresponding period of the prior
year.
(5) Long-term Obligations
The Company had the following long-term obligations as of March 31, 2003 and
December 31, 2002 (in thousands):
March 31, December 31,
--------- ---------
2003 2002
--------- ---------
Borrowings under credit facilities $ 185,000 $ 107,500
Senior subordinated notes due 2011 (1) 225,000 225,000
Senior subordinated notes due 2004 (2) - 250,000
Obligations under capital leases 4,827 10,178
--------- ---------
414,827 592,678
Current portions:
Credit facilities 5,000 17,500
Capital leases 4,827 10,178
--------- ---------
9,827 27,678
Subordinated notes to be retired
with cash held by trustee 203,932
Total long-term obligations
net of current portion and notes to --------- ---------
be retired with cash held by trustee $ 405,000 $ 361,068
========= =========
(1) Coupon payments at 9.625% are due semi-annually in March and September.
(2) On December 18, 2002, the Company called $203.9 million of the notes, which
were redeemed on January 17, 2003. The remaining $46.1 million was called on
January 17, 2003 and redeemed on February 18, 2003.
On December 18, 2002, the Company completed the sale of $225 million 9.625%
senior subordinated notes due 2011. The Company delivered the net proceeds to
an indenture trustee to redeem $203.9 million of the $250 million 10.625%
senior subordinated notes due 2004 including accrued interest and the required
call premium. At December 31, 2002, the trustee was holding $218.5 million and
the Company continued to carry the $250 million 10.625% senior subordinated
notes on its balance sheet. On January 17, 2003, the redemption of $203.9
million of the notes was completed.
On January 16, 2003, the Company completed the closing of new senior secured
credit facilities from a syndicate of lenders led by UBS Warburg LLC. The new
facilities consist of a $200.0 million term loan facility and a $50.0 million
revolving credit facility, each maturing in 2008. The Company used the net
proceeds from the transaction to repay amounts outstanding under the Company's
existing credit facilities which were due in 2004, redeem the remaining $46.1
million outstanding principal amount of the Company's 10.625% senior
subordinated notes due 2004 on February 18, 2003 and for general corporate
purposes.
At March 31, 2003, maturities on long-term obligations for the next five years
are as follows (in thousands):
Capital
Year Ending Subordinated Credit Leases
December, 31 Notes Facility & Other Total
- ------------ ---------- ---------- --------- ---------
2003 - - 4,827 4,827
2004 - 20,000 - 20,000
2005 - 20,000 - 20,000
2006 - 20,000 - 20,000
2007 - 20,000 - 20,000
Thereafter 225,000 105,000 - 330,000
----------- ---------- --------- ---------
$ 225,000 $ 185,000 $ 4,827 $ 414,827
----------- ---------- --------- ---------
(6) 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.
The following tables are reconciliations of the basic and diluted earnings per
share computations (in thousands, except per share amounts):
Three Months Ended March 31,
----------------------------------------------------------
2003 2002
--------------------------- -----------------------------
Net Per Share Net Per Share
Income Shares(1) Amounts Income Shares(1) Amounts
------- --------- ------- -------- --------- --------
Basic income
per share: $ 19,578 59,867 $ 0.33 $ 26,443 51,610 $ 0.51
Effect of dilutive ======= =======
securities:
Stock options - 4,031 - 5,553
------- --------- -------- ---------
Diluted income
per share: $ 19,578 63,898 $ 0.31 $ 26,443 57,163 $ 0.46
======= ========= ======= ======== ========= ========
(1) Represents weighted average shares outstanding.
Antidilutive stock options excluded from the calculation of diluted income per
share were 1.4 million shares and 0.6 million shares for the three months ended
March 31, 2003 and 2002, respectively.
(7) Store Closure Restructuring
At March 31, 2003, twelve stores remained to be closed pursuant to the
Company's store closure plan adopted in December of 2000 and amended in
December of 2001 and 2002. In accordance with the plan and the updated
estimates of closing costs, at March 31, 2003, the Company had an accrual of
$2.8 million related to the closures.
(8) Legal Proceedings
In 1999, Hollywood Entertainment Corporation was named as a defendant in three
complaints that have been consolidated 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
sought to certify a class of former and current California salaried Store
Managers and Assistant Managers alleging that Hollywood engaged in unlawful
conduct by improperly designating its salaried Store Managers and Assistant
Store Managers as "exempt" from California's overtime compensation requirements
in violation of the California Labor Code. Hollywood maintains that its
California Store Managers and Assistant Store Managers were properly designated
as exempt from overtime and therefore disputes all claims for damages and other
relief made in the lawsuit. The parties have since entered into a settlement
agreement, which was given final approval by the court on January 28, 2003.
The class consists of only those individuals employed by Hollywood
Entertainment within the State 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 State of
California as salaried assistant managers in Hollywood Video stores during the
period from January 25, 1995 to December 31, 1999, who did not opt-out of the
settlement. Our established reserves at March 31, 2003 are adequate to cover
amounts in the settlement agreement.
Hollywood Entertainment Corporation has been named in several purported class
action lawsuits alleging various causes of action, including claims regarding
its membership application and extended rental period charges. Hollywood has
vigorously defended these actions and maintains that the terms of its extended
rental charge policy are fair and legal. Hollywood has been successful in
obtaining dismissal of three of the actions filed against it. Two of the
lawsuits have been consolidated in a nationwide class action entitled, George
Curtis and Karl G. Anuta, on behalf of themselves and the class of similarly
situated customers of Hollywood Video, Plaintiffs, and Michael DeLong,
Intervenor-Plaintiff v. Hollywood Entertainment Corp., dba Hollywood Video,
Defendant, No. 01-2-36007-8 SEA, in the Superior Court of King County,
Washington. Hollywood and the plaintiffs in this nationwide class action have
entered into a settlement agreement and are seeking preliminary approval from
the King County Superior Court. Final approval of this settlement would fully
and finally resolve all class actions with regard to Hollywood's membership
application and extended rental period charges. (An individual plaintiff can
opt out of the class and bring an action in his or her own name but could not
bring a class action.) The Company believes, based upon the settlement
agreement, it has provided adequate reserves in connection with these lawsuits.
In addition, the Company does not believe the pending settlement will have any
material effect on its methods of operating or on its future results of
operations or liquidity.
The Company has been under examination by the Internal Revenue Service (IRS)
for the tax years 1994 through 1997. In connection with those examinations,
the IRS proposed adjustments for tax years 1994 through 1997, which the Company
did not agree with at the exam or appeals level. In April 2001, the IRS issued
a Notice of Deficiency (the Notice) for tax years 1994 through 1997 with
respect to various issues. In July 2001, the Company filed a petition in
United States Tax Court requesting a re-determination of the proposed
deficiency. In April 2003, the IRS and the Company reached a settlement
agreement related to the various issues and the Company established a deferred
tax asset in the amount of $3.1 million.
The Company has been named to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters. 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 its consolidated results of operation, financial condition or
liquidity.
(9) Related Party Transactions
In July 2001, Boards, Inc. (Boards) began to open Hollywood Video stores as
licensee of the Company pursuant to rights granted by the Company and approved
by the Board of Directors in connection with Mark J. Wattles employment
agreement in January 2001. These stores are operated by Boards and are not
included in the 1,837 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 pays the Company an initial
license fee of $25,000 per store, a royalty of 2% of revenue and also purchases
products and services from the Company at the Company's cost. As of March 31,
2003, Boards operated 12 stores. Under the arrangement, Boards has 30 day
payment terms. From July 2001 through March 31, 2003, Boards has incurred
license fees and royalties, and purchased products and services from the
Company totaling $7.2 million, of which, $6.8 has been paid in full as of March
31, 2003, leaving an outstanding balance due to the Company of $0.4 million. In
the three months ended March 31, 2003, Boards incurred charges of $2.3 million
and made $2.5 million in payments.
(10) Consolidating Financial Statements
Hollywood Entertainment Corporation (HEC) had one subsidiary, Hollywood
Management Company (HMC), during the three months ended March 31, 2003. HMC is
wholly owned and a guarantor of the senior 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
Three months ended March 31, 2003
(unaudited, in thousands)
---------- ---------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- --------- ----------
REVENUE $ 418,311 $ 43,030 $(43,749) $ 417,592
COST OF REVENUE 155,692 - - 155,692
GROSS MARGIN 262,619 43,030 (43,749) 261,900
OPERATING COSTS & EXPENSES:
Operating and selling 170,437 4,649 - 175,086
General & administrative 58,937 15,205 (43,749) 30,393
Store Opening Expenses 1,385 - - 1,385
Restructuring charge for
closure of internet
business - - - -
INCOME FROM OPERATIONS 31,860 23,176 - 55,036
Interest income - 8,196 (7,875) 321
Interest expense (17,860) - 7,875 (9,985)
Early debt retirement (12,467) - - (12,467)
Income before income
taxes 1,533 31,372 - 32,905
Benefit from (provision for)
income taxes (1,562) (11,765) - (13,327)
NET INCOME $ (29) $ 19,607 $ - $ 19,578
Consolidating Condensed Balance Sheet
March 31, 2003
(unaudited, in thousands)
---------- ---------- ---------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- ---------- ----------
ASSETS
Cash and cash equivalents $ 2,109 $ 63,059 $ - $ 65,168
Receivables 22,287 399,636 (388,411) 33,512
Merchandise inventories 105,459 - - 105,459
Prepaid expenses and other 11,608 1,305 - 12,913
current assets
Total current assets 141,463 464,000 (388,411) 217,052
Rental inventory, net 259,219 - - 259,219
Property & equipment, net 239,982 19,112 - 259,094
Goodwill, net 64,934 - - 64,934
Deferred tax assets, net 138,450 - - 138,450
Other assets, net 17,702 6,106 (4,008) 19,800
Total Assets $ 861,750 $ 489,218 $(392,419) $ 958,549
LIABILITIES & SHAREHOLDERS'
EQUITY (DEFICIT)
Current maturities of
long-term obligations $ 9,827 $ - $ - $ 9,827
Accounts payable 388,411 110,025 (388,411) 110,025
Accrued expenses 13,187 118,023 - 131,210
Accrued interest - 2,848 - 2,848
Income taxes payable - 3,636 - 3,636
Total current liabilities 411,425 234,532 (388,411) 257,546
Long-term obligations, less
current portion 405,000 - - 405,000
Other liabilities 17,117 - - 17,117
Total liabilities 833,542 234,532 (388,411) 679,663
Common stock 505,396 4,008 (4,008) 505,396
Unearned compensation (531) - - (531)
Retained earnings
(accumulated deficit) (476,657) 250,678 - (225,979)
Total shareholders'
equity (deficit) 28,208 254,686 (4,008) 278,886
Total liabilities and
shareholders' equity
(deficit) $ 861,750 $ 489,218 $(392,419) $ 958,549
Consolidating Condensed Statement of Cash Flows
Three months ended March 31, 2003
(unaudited, in thousands)
---------- ---------- ----------
HEC HMC Consol-
idated
---------- ---------- ----------
OPERATING ACTIVITIES:
Net income $ (29) $ 19,607 $ 19,578
Adjustments to reconcile
net income to
cash provided by
operating activities:
Write-off of deferred
financing costs 5,827 - 5,827
Depreciation &
amortization 72,450 1,753 74,203
Tax benefit from exercise
of stock options 1,219 - 1,219
Change in deferred tax asset 9,363 - 9,363
Change in deferred rent (355) - (355)
Non cash stock compensation 167 - 167
Net change in operating
assets & liabilities 170,490 (206,657) (36,167)
Cash provided by (used in)
Operating activities 259,132 (185,297) 73,835
INVESTING ACTIVITIES:
Purchases of rental
inventory, net (57,565) - (57,565)
Purchase of property &
equipment, net (17,559) (1,007) (18,566)
Increase in intangibles
& other assets 57 218,263 218,320
Cash used in investing
activities (75,067) 217,256 142,189
FINANCING ACTIVITIES:
Proceeds from the sale of
common stock, net - - -
Repayments of capital lease
obligations (5,359) - (5,359)
Proceeds from exercise
of stock options 773 - 773
Increase in revolving
loans, net (179,415) - (179,415)
Cash used in financing
activities (184,001) - (184,001)
Increase in cash
and cash equivalents 64 31,959 32,023
Cash and cash equivalents
at beginning of year 2,045 31,100 33,145
Cash and cash equivalents at
the end of the first quarter $ 2,109 $ 63,059 $ 65,168
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, 2002 and Note 1 to the Consolidated Financial
Statements contained in this Quarterly Report on Form 10-Q describe 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, 2002 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 Note 1, "Accounting
Policies," to the Consolidated Financial Statements.
RESULTS OF OPERATIONS
Summary Results of Operations
Our net income for the three months ended March 31, 2003 was $19.6 million,
compared with net income of $26.4 million for the three months ended March 31,
2002. Net income for the three months ended March 31, 2002 benefited from a
reduction in our valuation allowance on our deferred income tax assets,
resulting in an effective tax rate of 1.0% (excluding a $1.3 million income tax
benefit due to a charge of $3.5 million for early debt retirement). The Company
believes that its effective tax rate when the valuation allowance reduction is
excluded of 40.5% is more representative of a normalized provision for income
taxes. The effective tax rate for the three months ended March 31, 2003 was
40.5%. Income before income taxes was $32.9 million and $25.4 million for the
three months ended March 31, 2003 and 2002, respectively. Net income was
adversely impacted by charges associated with early debt retirement of $12.5
million and $3.5 million for the three months ended March 31, 2003 and 2002,
respectively.
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
March 31,
----------------------
2003 2002
---------- ----------
REVENUE:
Rental product revenue 87.3% 90.9%
Merchandise sales 12.7 9.1
---------- ----------
100.0 100.0
---------- ----------
GROSS MARGIN 62.7 61.3
OPERATING COSTS AND EXPENSES:
Operating and selling 41.9 43.4
General and administrative 7.3 6.6
Store opening expense 0.3 0.0
---------- ----------
49.5 50.0
---------- ----------
INCOME FROM OPERATIONS 13.2 11.3
Interest expense, net (2.3) (3.3)
Early debt retirement (3.0) (1.0)
---------- ----------
Income before income taxes 7.9 7.0
Provision for income taxes (3.2) 0.3
---------- ---------
NET INCOME 4.7% 7.3%
---------- ---------
Three Months Ended
March 31,
----------------------
2003 2002
---------- ----------
OTHER FINANCIAL DATA:
Rental product gross margin (1) 68.0% 65.0%
Merchandise gross margin (2) 26.3% 25.1%
OPERATING DATA:
Number of stores at quarter end 1,837 1,800
Weighted average stores open
during the period 1,831 1,801
Same store revenue increase (3) 13% 7%
- ---------------------------------
(1) Rental product gross margin as a percentage of rental revenue.
(2) Merchandise sales gross margin as a percentage of merchandise sales.
(3) A store is comparable (same store) after it has been open and owned by the
Company for 12 full months.
REVENUE
Revenue increased by $53.9 million, or 14.8%, for the three months ended March
31, 2003 compared to the three months ended March 31, 2002, due to a 13.0%
increase in comparable store revenue and a net increase of 30 weighted average
stores. At March 31, 2003, we had 1837 stores operating in 47 states compared
to 1800 stores operating in 47 states at March 31, 2002. In most of our stores,
we currently offer 5-day rentals on all products with new release videos and
all DVDs renting for $3.79 and catalog videos renting for $1.99. Since the
fourth quarter of 1999, other than test pricing, we have not increased prices
on new release or catalog videos and DVDs. 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 initial rental period are
deemed to have commenced a new rental period equal in length and price to the
initial rental period, an extended rental period. Rental revenue from extended
rental periods for the three months ended March 31, 2003 was $ 45.9 million,
compared to $40.7 million in the corresponding period of the prior year.
GROSS MARGIN
Rental Product Margins
Rental product gross margin as a percentage of rental product revenue increased
to 68.0% for the three months ended March 31, 2003, from 65% for the three
months ended March 31, 2002. The increase was primarily due to a shift in
revenue from VHS product to DVD product, which typically has higher margins,
and the strength in our same store sales in the first quarter.
Merchandise Sales Margins
Merchandise sales gross margin as a percentage of merchandise sales increased
to 26.3% for the three months ended March 31, 2003 from 25.1% for the three
months ended March 31, 2002. The increase was primarily the result of an
increase in the percentage of merchandise sales from our Game Crazy
departments, which typically have higher margins than merchandise sales in our
video stores. The favorable impact of an increase in sales mix attributable to
Game Crazy was offset by a decline in margins on new movies for sale.
OPERATING COSTS AND EXPENSES
Operating and Selling
Total operating and selling expenses for the three months ended March 31, 2003
decreased as a percentage of revenue to 41.9% from 43.4% in the corresponding
period of the prior year. The percentage decrease is primarily the result of
leverage on increased revenue. Total operating and selling expenses for the
three months ended March 31, 2003 increased $17.1 million to $175.1 million
from $158.0 million for the three months ended March 31, 2002. The increase was
primarily the result of increased variable costs associated with increased
store revenue, an increase of 30 weighted-average stores compared to the
corresponding period of the prior year as well as an increase in operating and
selling expenses associated with the expansion of our Game Crazy departments.
For the three months ended March 31, 2003, payroll and related expenses
increased by $10.6 million, rent and related expenses increased by $3.4
million, and other operating and selling expenses increased by $3.1 million,
respectively, compared to the corresponding period of the prior year.
General and Administrative
General and administrative expenses for the three months ended March 31, 2003
increased $6.4 million to $30.4 million from $24.0 million for the three months
ended March 31, 2002. General and administrative expenses increased as a
percentage of total revenue to 7.3% for the three months ended March 31, 2003
compared to 6.6% for the corresponding period of the prior year. General and
administrative expenses increased primarily due to an incremental bonus accrual
of approximately $3 million resulting from the better than expected performance
in the current quarter and a charge of $1.7 million to adjust the legal
settlement reserve for the class action case regarding extended rental period
charges (see Note 8 to the Consolidated Financial Statements). Also included in
general and administrative expenses was non-cash stock compensation of $0.2
million for the three months ended March 31, 2003 compared to $1.5 million for
the three months ended March 31, 2002.
Store opening expenses
Store opening expenses were $1.4 million for the three months ended March 31,
2003 compared to no store opening expenses in the corresponding period of the
prior year. Store opening expenses are primarily expenses related to
relocating, recruiting and training new field employees and grand-opening
advertising expenses.
INTEREST EXPENSE, NET
Interest expense, net of interest income, decreased by $2.3 million to $9.7
million for the three months ended March 31, 2003 from $12.0 million for the
corresponding period of the prior year. The decrease is due to decreased
interest rates, partially offset by an increase in total borrowings.
EARLY DEBT RETIREMENT
In the first quarter of 2003, we redeemed the outstanding $250 million 10.625%
senior subordinated notes due 2004 and our prior credit facility due 2004. As a
result, we recorded a charge of $12.5 million that included the early
redemption premium of $6.6 million and the write-off of deferred financing
costs. In the first quarter of 2002, we paid all amounts outstanding and
retired our credit facility in place at that time, resulting in a $3.5 million
charge to write-off deferred financing costs.
INCOME TAXES
Our effective tax rate was a provision of 40.5% for the three months ended
March 31, 2003. For the three months ended March 31, 2002 we had a net tax
benefit of $1.0 million that included a benefit of $1.3 million due to charges
associated with early debt retirement. Our effective tax rate varies from the
federal statutory rate as a result of minimum state taxes in excess of
statutory state income taxes and a reduction in the deferred tax valuation
allowance. The allowance was reduced as a result of the utilization of net
deferred tax assets, primarily net operating loss carryforwards, based upon
taxable income earned during the period.
RENTAL INVENTORY
Analysis of rental inventory and investment in rental product
When analyzing our rental inventory purchase activity, it is important to
consider that we acquire new releases of movies under two different pricing
structures, "revenue sharing" and "sell-through." These methods impact the
amount of new releases held as rental inventory on our consolidated balance
sheet. Under revenue sharing, in exchange for acquiring agreed-upon quantities
of tapes or DVDs at reduced or no up-front costs, we share agreed-upon portions
of the revenue that we derive from the tapes or DVDs with the applicable
studio. The studio's share of rental revenue is expensed, net of an estimated
residual value, as revenue is earned on the revenue sharing titles. The
resulting revenue sharing expense is considered a direct cost of sales rather
than an investment in rental inventory. Under sell-through pricing, we purchase
movies from the studios with no obligation for future payments to the studios.
Sell-through purchases are recognized as an investment in rental inventory,
which is then amortized to cost of sales over its estimated useful life.
Purchases of rental inventories, as shown on our consolidated statement of cash
flows, are not reflective of the total costs of acquiring movies for rental and
are impacted by the mix of movies acquired under these pricing structures. Cost
of rental product included revenue sharing expense of $28.9 million and $37.4
million for the three months ended March 31, 2003 and 2002, respectively.
MERCHANDISE INVENTORY
Merchandise inventory includes new VHS and DVD movies for sale, concessions and
accessory items for sale, Game Crazy merchandise inventory and the residual
book value of movies and games that are transferred from rental inventory to
merchandise inventory to be sold as previously viewed product. Merchandise
inventory increased $8.2 million to $105.5 million as of March 31, 2003, from
$97.3 million as of December 31, 2002 primarily due to the expansion of our
Game Crazy departments.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary source of operating cash flow is generated from the rental and
sales of videocassettes, DVDs and games. The amount of cash generated from
operations in the three months ended March 31, 2003 funded our debt service
requirements and maintenance capital expenditures and provided the majority of
the capital required to remodel and remerchandise 84 stores to include Game
Crazy departments and open 11 new video stores. At March 31, 2003, we had $65.2
million of cash and cash equivalents on hand.
During 2002 and early 2003, we completed several refinancing transactions that
lengthened maturities on our long-term debt, lowered our effective interest
rate and increased working capital availability (see cash "Cash Flow From
Financing Activities" below). 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 foreseeable future. However, we continue to analyze our
capital structure and our business plan and from time to time may consider
additional capital and/or financing transactions as a source of incremental
liquidity.
Cash Provided by Operating Activities
Net cash provided by operating activities was $73.8 million and $70.4 million
for the three months ended March 31, 2003 and 2002, respectively. The increase
of $3.4 million or 5% was primarily due to improved operating performance in
our existing store base.
Cash Provided by and Used in Investing Activities
In the three months ended March 31, 2003, investing activities resulted in a
$142.2 million source of cash. The source of cash was primarily the result of
proceeds delivered to subordinated note holders on our behalf by the indenture
trustee. On December 18, 2002, we completed the sale of $225 million 9.625%
senior subordinated notes due 2011 and delivered net proceeds of $218.5 million
to the indenture trustee to redeem $203.9 million of the $250 million 10.625%
senior subordinated notes due 2004. The delivery of the proceeds to the
indenture trustee and the subsequent use of the proceeds to redeem the notes in
the first quarter of 2003 were classified as investing activities. In the three
months ended March 31, 2003, we opened 11 video stores and remerchandised 84
stores to include a Game Crazy department compared to no video stores and no
Game Crazy departments in the three months ended March 31, 2002. We currently
anticipate investing approximately $125 million in new video openings, Game
Crazy expansion and maintenance capital expenditures in property and equipment.
Cash Provided by and Used in Financing Activities
Net cash flow from financing activities was a $184.0 million use of cash for
the three months ended March 31, 2003 compared to a $13.2 million source of
cash in the corresponding period of the prior year. The $184.0 million use of
cash reflects the redemption of $250.0 million senior subordinated notes and
the retirement of our prior credit facility of $107.5 million with proceeds
from the indenture trustee and initial borrowings under our new credit
facility. At December 31, 2002, we had $218.5 million of cash held by the
indenture trustee that was used to redeem $203.9 million of the $250.0 million
10.625% senior subordinated notes on January 17, 2003.
On March 11, 2002, we completed a public offering of 8,050,000 shares of our
common stock, 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 March 18, 2002, we obtained 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 bank credit facilities consisted 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.
On December 18, 2002, we completed the sale of $225 million 9.625% senior
subordinated notes due 2011. We delivered the net proceeds from the transaction
to the indenture trustee to redeem $203.9 million of the $250 million 10.625%
senior subordinated notes due 2004, including accrued interest and the required
call premium. At December 31, 2002, the trustee was holding $218.5 million and
we continued to carry the $250 million 10.625% senior subordinated notes on our
balance sheet, $203.9 million of which was classified as a current liability
titled "Subordinated notes to be retired by trustee." On January 17, 2003, the
redemption of $203.9 million of the notes was completed.
On January 16, 2003, we obtained new senior secured credit facilities from a
syndicate of lenders led by UBS Warburg LLC. The new facilities consist of a
$200.0 million term loan facility and a $50.0 million revolving credit
facility, each maturing in 2008. We used the borrowings under the term loan
facility to repay amounts outstanding under our existing credit facilities
which were due in 2004, redeem the remaining $46.1 million principal amount of
our 10.625% senior subordinated notes due 2004 on February 18, 2003 and for
general corporate purposes. On February 28, 2003, we prepaid the required 2003
term loan facility principle payments of $15.0 million.
Instruments governing our indebtedness contain various covenants, including
covenants requiring us to meet specified financial ratios and tests and
covenants that restrict our business. At March 31, 2003, we were in compliance
with all covenants contained within our debt agreements.
At March 31, 2003, maturities on long-term obligations for the next five years
are as follows (in thousands):
Capital
Year Ending Subordinated Credit Leases
December, 31 Notes Facility & Other Total
- ------------ ---------- ---------- --------- ---------
2003 - - 4,827 4,827
2004 - 20,000 - 20,000
2005 - 20,000 - 20,000
2006 - 20,000 - 20,000
2007 - 20,000 - 20,000
Thereafter 225,000 105,000 - 330,000
----------- ---------- --------- ---------
$ 225,000 $ 185,000 $ 4,827 $ 414,827
----------- ---------- --------- ---------
Other Financial Measurements: Working Capital
At March 31, 2003, we had cash and cash equivalents of $65.2 million and a
working capital deficit of $40.5 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 and the majority of this
inventory has a relatively short life, as evidenced by our amortization
policies, 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 rental 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.
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 March 31, 2003, we have
not held derivative instruments or engaged in hedging activities. However, we
may in the future enter into such instruments for the purpose of addressing
market risks, including market risks associated with variable-rate
indebtedness.
The interest payable on our bank credit facility is based on variable interest
rates equal to a specified Eurodollar rate or base rate and is therefore
affected by changes in market interest rates. If variable base rates had
increased 1% during the twelve months ended March 31, 2003 our interest expense
would have increased by approximately $1.9 million based on our outstanding
balance on the facility as of March 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Within the 90 days prior to the date of this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and our Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934.
Based on the evaluation of our disclosure controls and procedures, our Chief
Executive Officer and the Chief Financial Officer have concluded that our
disclosure controls and procedures are effective in alerting them, in timely
manner, to material information relating to the Company that is required to be
included in our periodic SEC filings.
Internal Controls and Procedures
There have been no significant changes in our internal controls or in other
factors that could significantly affect internal controls subsequent to the
date we carried out our evaluation.
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, 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", "intend",
"estimate", "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 below
under the heading "Cautionary Statements." Forward-looking statements speak
only as of the date made. We undertake no obligation to publicly release or
update forward-looking statements, whether as a result of new information,
future events or otherwise. You are, however, advised to consult any further
disclosures we make on related subjects in our quarterly reports on Form 10-Q
and any reports made on Form 8-K to the Securities and Exchange Commission.
CAUTIONARY STATEMENTS
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. Over the past
five years, however, advances in digital compression and other developing
technologies have enabled cable and satellite companies, and may enable
internet service providers and others, to transmit a significantly greater
number of movies to homes at more frequently scheduled intervals throughout the
day. In addition, certain cable companies, internet service providers and
others are testing or offering video-on-demand services. As a concept, video-
on-demand provides 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 that 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 and they receive the movies from the studios at the
same time video stores do, 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, if they did, our business and financial condition could
suffer materially.
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. 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 60 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. In 2002 we began an accelerated rollout of
our Game Crazy departments, departments within our video stores that specialize
in selling and trading video games, opening 207 new departments. We intend to
open at least 300 additional Game Crazy departments and grow our video store
base by up to 10% in 2003. This expansion has placed, and may continue to
place, increased pressure on our operating and management controls. To manage
a larger store base and additional Game Crazy departments, 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 are 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.
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 reinstatement of Mark J.
Wattles, Hollywood's founder and Chief Executive Officer, full-time as
President, and hiring or restructuring other executive and senior management
positions. 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.
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 March 31, 2003, we had total consolidated long-term debt, including
capital leases, of approximately $414.8 million. We and our subsidiaries could
incur substantial additional indebtedness in the future, including indebtedness
that would be secured by our assets or those of our subsidiaries. If we
increase our indebtedness, the related risks that we 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 potential competitive disadvantage in our industry.
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.
Instruments governing our existing and future indebtedness contain or may
contain various covenants, including covenants requiring us to meet specified
financial ratios and tests and covenants that restrict our business. 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. At March 31, 2003, we were in compliance with all
covenants contained within our debt agreements.
Instruments governing our bank credit facilities and our senior subordinated
notes contain, and our future indebtedness may contain, 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 debt 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 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.
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 could also impact consumer television
viewing habits and may reduce the amount of time available for watching rented
movies, which could adversely impact our revenue. They also could result in an
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.
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.
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 new release movie titles;
- - 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 and related acquisitions;
- - 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.
Our securities may experience extreme price and volume fluctuations.
The market price of our securities has been and can be expected to be
significantly affected by a variety of factors, including:
- - public announcements concerning us, our competitors or the home video rental
industry;
- - fluctuations in our operating results;
- - introductions of new products or services by us or our competitors;
- - the operating and stock price performance of other comparable companies; and
- - changes in analysts' revenue or earnings estimates.
In addition to the foregoing, the market price of our debt securities may be
significantly affected by change in market rates of interest, yields obtainable
from investments in comparable securities, credit ratings assigned to our debt
securities by third parties and perceptions regarding our ability to pay our
obligations on our debt securities.
In the past, companies that have experienced volatility in the market price of
their securities have been the target of securities class action litigation.
If we were sued in a securities class action, we could incur substantial costs
and suffer from a diversion of our management's attention and resources.
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 acquirer 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
In 1999, Hollywood Entertainment Corporation was named as a defendant in three
complaints that have been consolidated 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
sought to certify a class of former and current California salaried Store
Managers and Assistant Managers alleging that Hollywood engaged in unlawful
conduct by improperly designating its salaried Store Managers and Assistant
Store Managers as "exempt" from California's overtime compensation requirements
in violation of the California Labor Code. Hollywood maintains that its
California Store Managers and Assistant Store Managers were properly designated
as exempt from overtime and therefore disputes all claims for damages and other
relief made in the lawsuit. The parties have since entered into a settlement
agreement, which was given final approval by the court on January 28, 2003.
The class consists of only those individuals employed by Hollywood
Entertainment within the State 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 State of
California as salaried assistant managers in Hollywood Video stores during the
period from January 25, 1995 to December 31, 1999, who did not opt-out of the
settlement. Our established reserves at March 31, 2003 are adequate to cover
amounts in the settlement agreement.
Hollywood Entertainment Corporation has been named in several purported class
action lawsuits alleging various causes of action, including claims regarding
its membership application and extended rental period charges. Hollywood has
vigorously defended these actions and maintains that the terms of its extended
rental charge policy are fair and legal. (Some of Hollywood's major
competitors have settled similar litigation by agreeing, in addition to other
remedies, to modify their extended rental policies to conform very closely to
Hollywood's existing policy.) Hollywood has been successful in obtaining
dismissal of three of the actions filed against it. Two of the lawsuits have
been consolidated in a nationwide class action entitled, George Curtis and Karl
G. Anuta, on behalf of themselves and the class of similarly situated customers
of Hollywood Video, Plaintiffs, and Michael DeLong, Intervenor-Plaintiff v.
Hollywood Entertainment Corp., dba Hollywood Video, Defendant, No. 01-2-36007-8
SEA, in the Superior Court of King County, Washington. Hollywood and the
plaintiffs in this nationwide class action have entered into a settlement
agreement and are seeking preliminary approval from the King County Superior
Court. Final approval of this settlement would fully and finally resolve all
class actions with regard to Hollywood's membership application and extended
rental period charges. (An individual plaintiff can opt out of the class and
bring an action in his or her own name but could not bring a class action.)
The Company believes, based upon the settlement agreement, it has provided
adequate reserves in connection with these lawsuits. In addition, the Company
does not believe the pending settlement will have any material effect on its
methods of operating or on its future results of operations or liquidity.
The Company has been under examination by the Internal Revenue Service (IRS)
for the tax years 1994 through 1997. In connection with those examinations,
the IRS proposed adjustments for tax years 1994 through 1997, which the Company
did not agree with at the exam or appeals level. In April 2001, the IRS issued
a Notice of Deficiency (the Notice) for tax years 1994 through 1997 with
respect to various issues. In July 2001, the Company filed a petition in
United States Tax Court requesting a re-determination of the proposed
deficiency. In April 2003, the IRS and the Company reached a settlement
agreement related to the various issues and the Company established deferred
tax assets in the amount of $3.1 million.
The Company has been named to various claims, disputes, legal actions and other
proceedings involving contracts, employment and various other matters. 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 its consolidated results of operation, financial condition or
liquidity.
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), 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 January 25, 2002 among the Registrant, Hollywood
Management Company, as potential guarantor, and BNY Western Trust Company as
trustee (incorporated by reference to Exhibit 4.1 to our Registration Statement
on Form S-3 (File No. 333-14802)) as supplemented by the First Supplemental
Indenture dated as of December 18, 2002 among the Registrant and Hollywood
Management Company and BNY Western Trust Company as Trustee (incorporated by
reference to Exhibit 4.3 to our Annual Report on Form 10-K for the year ended
December 31, 2002).
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
No current reports on Form 8-K were filed during the period.
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)
May 14, 2003 /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)
CERTIFICATIONS
I, Mark J. Wattles, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hollywood
Entertainment Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ Mark J. Wattles
---------------------------
Mark J. Wattles
Chief Executive Officer
I, James A. Marcum, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hollywood
Entertainment Corp.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities, particularly
during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness
of the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls;
and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 14, 2003
/s/ James A. Marcum
---------------------------
James A. Marcum
Chief Financial Officer