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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 September 30, 2004
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 October 19, 2004 there were 60,906,808 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 Nine Months Ended
September 30, September 30,
------------------ ---------------------
2004 2003 2004 2003
-------- -------- ---------- ----------
REVENUE:
Rental product revenue $325,379 $337,306 $1,028,905 $1,031,784
Merchandise sales 85,175 64,652 247,568 177,208
-------- -------- ---------- ----------
410,554 401,958 1,276,473 1,208,992
COST OF REVENUE:
Cost of rental product 93,253 104,641 307,952 327,408
Cost of merchandise 60,509 46,672 182,984 128,222
-------- -------- ---------- ----------
153,762 151,313 490,936 455,630
-------- -------- ---------- ----------
GROSS MARGIN 256,792 250,645 785,537 753,362
Operating costs and expenses:
Operating and selling 194,580 181,791 576,321 531,328
General and administrative 27,347 25,650 86,706 81,200
Store opening expenses 460 1,219 1,497 3,942
Restructuring charges
for store closures - - (190) -
------- -------- ---------- ----------
222,387 208,660 664,334 616,470
------- -------- ---------- ----------
INCOME FROM OPERATIONS 34,405 41,985 121,203 136,892
Non-operating expense:
Interest expense, net (7,772) (7,879) (23,031) (25,715)
Early debt retirement - - - (12,467)
-------- -------- ---------- ----------
Income before income taxes 26,633 34,106 98,172 98,710
Provision for income taxes (10,653) (13,636) (39,269) (39,484)
-------- -------- ---------- ----------
NET INCOME $ 15,980 $ 20,470 $ 58,903 $ 59,226
======== ======== ========== ==========
- -----------------------------------------------------------------------------
Net income per share:
Basic $ 0.26 $ 0.34 $ 0.98 $ 0.98
Diluted $ 0.25 $ 0.32 $ 0.94 $ 0.92
- -----------------------------------------------------------------------------
Weighted average shares outstanding:
Basic 60,788 60,942 60,349 60,482
Diluted 62,846 64,624 62,657 64,414
- -----------------------------------------------------------------------------
The accompanying notes are an integral part of this financial statement
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
--------------------------
September 30, December 31,
2004 2003
------------ -----------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 145,929 $ 74,133
Receivables, net 29,287 33,987
Merchandise inventories 136,422 129,864
Prepaid expenses and other current
assets 13,351 13,233
------------ -----------
Total current assets 324,989 251,217
Rental inventory, net 267,029 268,748
Property and equipment, net 275,918 288,857
Goodwill 67,737 66,678
Deferred income tax asset, net 73,508 104,302
Other assets 15,519 17,655
------------ -----------
$ 1,024,700 $ 997,457
============ ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term
obligations $ 547 $ 647
Accounts payable 142,821 159,586
Accrued expenses 122,061 117,867
Accrued interest 992 6,467
Income taxes payable 2,926 284
----------- -----------
Total current liabilities 269,347 284,851
Long-term obligations, less current
portion 350,862 370,669
Other liabilities 15,349 16,108
----------- -----------
635,558 671,628
Shareholders' equity:
Preferred stock, 25,000,000 shares
authorized; no shares issued and
outstanding - -
Common stock, 100,000,000 shares
authorized; 60,853,693 and
59,666,347 shares issued and
outstanding, respectively 493,524 489,247
Unearned compensation - (133)
Accumulated deficit (104,382) (163,285)
----------- -----------
Total shareholders' equity 389,142 325,829
----------- -----------
$ 1,024,700 $ 997,457
=========== ===========
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
Nine Months Ended
September 30,
--------------------
2004 2003
--------- ---------
Operating activities:
Net income $ 58,903 $ 59,226
Adjustments to reconcile net income to cash
provided by operating activities:
Write-off deferred financing costs - 5,827
Amortization of rental product 143,120 158,552
Depreciation 47,232 45,675
Amortization of deferred financing costs 2,507 1,910
Tax benefit from exercise of stock options 5,754 7,485
Change in deferred rent (759) (1,146)
Change in deferred taxes 30,793 27,694
Non-cash stock compensation 133 432
Net change in operating assets and liabilities:
Receivables 4,700 10,457
Merchandise inventories (6,559) (31,014)
Accounts payable (16,765) (21,361)
Accrued interest (5,475) (10,113)
Other current assets and liabilities 6,562 (7,353)
--------- ---------
Cash provided by operating activities 270,146 246,271
--------- ---------
Investing activities:
Purchases of rental inventory, net (141,401) (152,388)
Purchase of property and equipment, net (34,293) (70,798)
Increase in intangibles and other assets (1,271) (1,088)
Proceeds from indenture trustee - 218,531
--------- ---------
Cash used in investing activities (176,965) (5,743)
--------- ---------
Financing activities:
Extinguishment of subordinated debt - (250,000)
Borrowings under new term loan - 200,000
Repayment of prior revolving loan - (107,500)
Decrease in credit facilities (20,000) (55,000)
Debt financing costs - (7,454)
Repayments of capital lease obligations (437) (7,818)
Repurchase of common stock (3,665) (9,412)
Proceeds from capital lease obligation 529 -
Proceeds from exercise of stock options 2,188 3,452
--------- ---------
Cash used in financing activities (21,385) (233,732)
--------- ---------
Increase in cash and
cash equivalents 71,796 6,796
Cash and cash equivalents at
beginning of year 74,133 33,145
--------- ---------
Cash and cash equivalents
at end of third quarter $ 145,929 $ 39,941
========= =========
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 Hollywood Entertainment Corporation (the "Company") believes that the
disclosures made are adequate to make the information presented not misleading.
The information furnished reflects all adjustments (consisting of normal
recurring adjustments) that are, in the opinion of management, necessary to
provide a fair statement of the results for the interim periods presented.
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 fiscal year ended December 31, 2003 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 audited
Consolidated Financial Statements included in the Company's Annual Report on
Form 10-K for the fiscal year ended December 31, 2003. 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 profit, net income or shareholders' equity.
The Company accounts for its stock option plans under the recognition and
measurement principles of Accounting Principles Board opinion No. 25,
"Accounting for Stock Issued to Employees, and Related Interpretations."
Pursuant to the disclosure requirements of Statement of Financial Accounting
Standards No. 123 (SFAS 123), "Accounting for Stock-Based Compensation" and
Statement of Financial Accounting Standards No. 148, "Accounting for Stock-
Based Compensation - Transition and Disclosure - an Amendment of SFAS 123," 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.
(in thousands, except per share amounts)
Three Months Nine Months
Ended September 30, Ended September 30,
-------- -------- -------- --------
2004 2003 2004 2003
-------- -------- -------- --------
Net income, as reported $ 15,980 $ 20,470 $ 58,903 $ 59,226
Add: Stock-based compensation
expense included in reported
net income, net of tax 0 80 80 259
Deduct: Total stock-based employee
compensation expense under
fair value based method for
all awards, net of tax (1,038) (1,723) (3,731) (6,206)
-------- -------- -------- --------
Pro forma net income $ 14,942 $ 18,827 $ 55,252 $ 53,279
======== ======== ======== ========
Earnings per Share:
Basic--as reported $ 0.26 $ 0.34 $ 0.98 $ 0.98
Basic--pro forma 0.25 0.31 0.92 0.88
Diluted--as reported 0.25 0.32 0.94 0.92
Diluted--pro forma $ 0.24 $ 0.30 $ 0.90 $ 0.85
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" (FIN 46). FIN 46 requires the consolidation of
variable interest entities in which an enterprise absorbs a majority of the
entity's expected losses, receives a majority of the entity's expected residual
returns, or both, as a result of ownership, contractual or other financial
interests in the entity. Application of this interpretation is required in
financial statements of public entities that have interests in variable
interest entities or potential variable interest entities commonly referred to
as special-purpose entities for periods ending after December 15, 2003.
Application by public entities for all other types of entities is required in
financial statements for periods ending after March 15, 2004. The adoption of
this interpretation did not have a material impact on the Company's financial
position or results of operations.
(2) Merger Agreement
On March 28, 2004 the Company signed a definitive merger agreement with Carso
Holdings Corporation ("Carso") and its wholly owned subsidiary, Hollywood
Merger Corporation ("Merger Corp"), both affiliates of Leonard Green &
Partners, L.P. ("LGP"), which provided for the merger of Merger Corp into the
Company with the Company surviving as a wholly owned subsidiary of Carso. On
October 14, 2004, the Company filed a current report on Form 8-K announcing
that the Company had executed an amended and restated merger agreement with
Carso and Merger Corp, dated as of October 13, 2004. The amended and restated
merger agreement reduces the merger consideration from $14.00 to $10.25 per
share and includes other modifications, including the elimination of the
termination fee previously payable to LGP and restrictions on the Company's
ability to solicit offers from other interested acquirors. If the merger is
completed as contemplated by the amended and restated merger agreement,
Hollywood Entertainment shareholders, except for Mark Wattles, the Company's
founder, Chairman and Chief Executive Officer, and other members of senior
management who will acquire Carso common stock, will receive $10.25 per share
in cash. Mr. Wattles will continue in his current capacities following the
merger and will own 50% of the common stock and 50% of the junior preferred
stock of Carso on a fully diluted basis. Green Equity Investors IV, LP will
own 50% of the common stock of Carso, 50% of the junior preferred stock of
Carso, and all of the senior preferred stock of Carso on a fully dilutive
basis. The Company entered into the amended and restated merger agreement
following the unanimous recommendation of a special committee comprised of the
independent directors of the Company's Board of Directors (the "Special
Committee"). The Special Committee and the Board of Directors received a
fairness opinion from Lazard Freres & Company, LLC as to the consideration to
be received by the Company's shareholders pursuant to the amended and restated
merger agreement.
The closing of the merger is subject to terms and conditions customary for
transactions of its type, including shareholder approval and the completion of
financing. The parties to the amended and restated merger agreement anticipate
completing the merger in January 2005.
(3) Rental Inventory 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 that 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
newer 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.
(4) PROPERTY AND EQUIPMENT
Property and equipment as of September 30, 2004 and December 31, 2003 consists
of (in thousands):
---------------------
2004 2003
--------- ----------
Fixtures and equipment $ 242,115 $ 229,183
Leasehold improvements 497,685 469,070
Equipment under capital lease 1,950 4,644
Leasehold improvements under
capital lease - 6,725
--------- ----------
741,750 709,622
Less accumulated depreciation
and amortization (465,832) (420,765)
--------- ----------
$ 275,918 $ 288,857
========= ==========
Depreciation expense related to property, plant and equipment was $15.4 million
and $15.7 million for the three months ended September 30, 2004 and 2003,
respectively, and $47.2 million and $45.7 million for the nine months ended
September 30, 2004 and 2003, respectively.
(5) Statements of Changes in Shareholders' Equity
A summary of changes to shareholders' equity amounts for the nine months ended
September 30, 2004 is as follows (in thousands, except share numbers):
Common Stock Unearned
------------------- Compen- Accumulated
Shares Amount sation Deficit Total
---------- -------- -------- --------- --------
Balance at 12/31/2003 59,666,347 $489,247 $ (133) $(163,285) $325,829
---------- -------- -------- --------- --------
Issuance of common stock:
Stock options exercised 1,482,485 2,188 2,188
Stock options tax benefit 5,754 5,754
Stock compensation - 133 133
Repurchase of common stock (295,139) (3,665) (3,665)
Net income 58,903 58,903
---------- -------- -------- --------- --------
Balance at 09/30/2004 60,853,693 $493,524 $ - $(104,382) $389,142
========== ======== ======== ========= ========
(6) Off Balance Sheet Arrangements
The Company leases all of its stores, corporate offices, distribution centers
and zone offices under non-cancelable operating leases. The Company's stores
generally 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 $60.6 million and $179.5 million for the three months and the nine
months ended September 30, 2004, respectively, compared to $56.7 million and
$167.5 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 $12.4 million and $37.0 million for the three months and the nine
months ended September 30, 2004, respectively, compared to $11.3 million and
$34.4 million for the corresponding periods of the prior year.
At December 31, 2003, the last fiscal year-end date, the future minimum annual
rental commitments under non-cancelable operating leases were as follows (in
thousands):
------------------------------
Year Ending Operating
December 31, Leases
------------------------------
2004 $237,821
2005 228,986
2006 209,071
2007 178,674
2008 139,845
Thereafter 361,134
(7) LONG-TERM OBLIGATIONS AND LIQUIDITY
The Company had the following long-term obligations as of September 30, 2004
and December 31, 2003 (in thousands):
September 30, December 31,
------------ -----------
2004 2003
------------ -----------
Borrowings under credit facilities $ 125,000 $ 145,000
Senior subordinated notes due 2011 (1) 225,000 225,000
Obligations under capital leases 1,409 1,316
------------ -----------
351,409 371,316
Current portion:
Capital leases 547 647
Total long-term obligations ------------ -----------
net of current portion $ 350,862 $ 370,669
============ ===========
(1) Coupon payments at 9.625% are due semi-annually in March and September.
If the merger described in Note 2 is completed, the Company's capital structure
is expected to change significantly. In connection with the proposed merger,
the Company anticipates the senior subordinated notes due 2011 and the current
term loan credit facility will be retired and replaced with new financing
arrangements. The new arrangements would substantially increase the long-term
obligations of the Company.
The senior subordinated notes due 2011 are redeemable, at the option of the
Company, beginning March 15, 2007, at rates starting at 104.8% of principal
amount reduced annually through March 15, 2009, at which time they become
redeemable at 100% of the principal amount. The terms of the indenture
governing the notes may restrict, among other things, payment of dividends and
other distributions, investments, the repurchase of capital stock or
subordinated indebtedness, the making of certain other restricted payments, the
incurrence of additional indebtedness or liens by the Company or any of its
subsidiaries, and certain mergers, consolidations and disposition of assets.
Additionally, if a change of control occurs, as defined, each holder of the
notes will have the right to require the Company to repurchase the holder's
notes at 101% of principal amount thereof. At September 30, 2004, the Company
was in compliance with the restrictions, covenants, and other terms of the
indenture. Hollywood Management Company, and any future subsidiaries of
Hollywood Entertainment Corporation, are guarantors under the credit agreement.
On January 16, 2003, the Company completed the closing of the senior secured
credit facilities from a syndicate of lenders led by UBS Warburg LLC. The
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
prior credit facilities that were due in 2004, redeem the remaining $46.1
million outstanding principal amount of the Company's 10.625% senior
subordinated notes due 2004 and for general corporate purposes. The Company
completed the redemption of the 10.625% senior subordinated notes on February
18, 2003. The Company has prepaid $75 million of the term loan facility
principal payments due through 2006, including a $20 million payment made on
January 5, 2004.
Revolving credit loans under the new facility bear interest, at the Company's
option, at an applicable margin over the bank's base rate loan or the LIBOR
rate. The initial margin over LIBOR was 3.5% for the term loan facility and
will step down if specified performance targets are met. The credit facility
contains financial covenants (determined in each case on the basis of the
definitions and other provisions set forth in such credit agreement), some of
which may become more restrictive over time, that include a (1) maximum debt to
adjusted EBITDA test, (2) minimum interest coverage test, and (3) minimum fixed
charge coverage test. Amounts outstanding under the credit agreement are
collateralized by substantially all of the assets of the Company. Hollywood
Management Company, and any future subsidiaries of Hollywood Entertainment
Corporation, are guarantors under the credit agreement. At September 30 2004,
the Company was in compliance with all covenants contained in the agreement.
Maturities on long-term obligations at September 30, 2004 for the next five
years are as follows (in thousands):
Capital
Year Ending Subordinated Credit Leases
December, 31 Notes Facility & Other Total
- ------------ ---------- ---------- --------- ---------
2004 $ - $ - $ 153 $ 153
2005 - - 594 594
2006 - - 578 578
2007 - 20,000 84 20,084
2008 - 105,000 - 105,000
Thereafter 225,000 - - 225,000
---------- ---------- --------- ---------
$ 225,000 $ 125,000 $ 1,409 $ 351,409
---------- ---------- --------- ---------
(8) Earnings per Share
Earnings per basic share are calculated based on income available to common
shareholders and the weighted-average number of common shares outstanding
during the reported period. Earnings per diluted share include 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 earnings per basic and diluted
share computations (in thousands, except per share amounts):
Three Months Ended September 30,
----------------------------------------------------------
2004 2003
--------------------------- -----------------------------
Net Per Share Net Per Share
Income Shares(1) Amounts Income Shares(1) Amounts
------- --------- ------- -------- --------- --------
Income per
basic share: $ 15,980 60,788 $ 0.26 $ 20,470 60,942 $ 0.34
Effect of dilutive ======= =======
securities:
Stock options - 2,058 - 3,682
------- --------- -------- ---------
Income per
diluted share: $ 15,980 62,846 $ 0.25 $ 20,470 64,624 $ 0.32
======= ========= ======= ======== ========= ========
(1) Represents weighted average shares outstanding.
Antidilutive stock options excluded from the calculation of income per diluted
share were 4.0 million shares and 1.1 million shares for the three months ended
September 30, 2004 and 2003, respectively.
Nine Months Ended September 30,
-----------------------------------------------------------
2004 2003
---------------------------- -----------------------------
Net Per Share Net Per Share
Income Shares(1) Amounts Income Shares(1) Amounts
------- --------- -------- -------- ------- ----------
Income per
basic share: $58,903 60,349 $ 0.98 $ 59,226 60,482 $ 0.98
Effect of dilutive ======= =========
securities:
Stock options - 2,308 - 3,932
------- --------- -------- -------
Income per
diluted share: $58,903 62,657 $ 0.94 $ 59,226 64,414 $ 0.92
======= ========= ======== ======== ======= =========
(1) Represents weighted average shares outstanding.
Antidilutive stock options excluded from the calculation of income per diluted
share were 4.1 million shares and 1.2 million shares in the nine months ended
September 30, 2004 and 2003, respectively.
(9) Store Closure Restructuring
At September 30, 2004, there were no remaining stores to be closed pursuant to
the Company's store closure plan adopted in December of 2000 and amended in
December of 2001, 2002 and 2003. As a result, the remaining balance of $0.2
million was reversed in the second quarter of 2004.
(10) Commitments and Contingencies
The Company has been named in several purported class action lawsuits alleging
various causes of action, including claims regarding its membership application
and additional rental period charges. The Company has vigorously defended these
actions and maintains that the terms of its additional rental charge policy are
fair and legal. The Company has been successful in obtaining dismissal of three
of the actions filed against it. A statewide class action entitled George
Curtis v. Hollywood Entertainment Corp., dba Hollywood Video, Defendant, No.
01-2-36007-8 SEA was certified on June 14, 2002 in the Superior Court of King
County, Washington. On May 20, 2003, a nationwide class action entitled George
DeFrates v. Hollywood Entertainment Corporation, No. 02 L 707 was certified in
the Circuit Court of St. Clair County, Twentieth Judicial Circuit, State of
Illinois. The Company received preliminary approval on August 10, 2004 of an
agreement to settle these claims and expects final approval in June 2005.
Notice to class members began on October 10, 2004 and will last for six months.
The Company believes it has provided adequate reserves in connection with these
lawsuits.
The Company is aware of eight lawsuits filed in the circuit courts of Oregon
for the counties of Clackamas and Multnomah related to the proposed merger of
the Company with an affiliate of Leonard Green & Partners, L.P. (LGP) pursuant
to the initial Agreement and Plan of Merger, dated as of March 28, 2004, among
the Company and affiliates of LGP (the "March 28 Merger Agreement"). These
purported class action and derivative suits each seek a court order enjoining
completion of the Merger, and costs and attorneys' fees to the plaintiffs'
lawyers. Some of the suits additionally request damages in an unstated amount
allegedly suffered by the Company's shareholders by reason of the March 28
Merger Agreement. The Clackamas County suits were consolidated and, on July 28,
2004, the parties to the Clackamas and Multnomah County suits entered into a
memorandum of understanding regarding a potential settlement of claims. The
Company described, in a current report on Form 8-K filed July 8, 2004, the
terms of the proposed settlement, which included additional disclosure in the
Company's proxy statement regarding the merger, modifications to the
termination fee and shareholder approval requirements in the March 28 Merger
Agreement, covenants from an affiliate of LGP regarding the future sale of the
Company, and payment of $995,000 of the plaintiff's attorney fees. The Company
provided a reserve for this litigation that it believed was adequate. An
amended and restated merger agreement was entered into on October 13, 2004.
Plaintiffs in the consolidated cases have informed the Company of their intent
to file a consolidated complaint that includes allegations regarding the
amended and restated merger agreement. It is not clear how the reduction in
the per share consideration and other changes in the amended and restated
merger agreement will affect the settlement negotiations and there is no
assurance that a settlement will be effected or that current reserves for this
litigation will be adequate.
In 2003, the Company was named as a defendant in two complaints regarding wage
and hour claims in California. In 2004, an additional lawsuit was filed with
substantially similar claims. The plaintiffs are seeking to certify a class
action alleging that certain California employees were denied meal and rest
periods. There are several additional related wage and hours claims for unpaid
overtime, late payment of wages and off the clock work. A mediation took place
on September 9, 2004 and the parties reached a settlement of all claims alleged
in each of the actions. The parties will jointly move for preliminary approval
of the settlement in November 2004. Following preliminary approval, notice of
the settlement will be provided to class members. The Company believes it has
provided adequate reserves in connection with these lawsuits.
In addition, the Company has been named to various other claims, disputes,
legal actions and other proceedings involving contracts, employment and various
other matters. The Company believes it has provided adequate reserves for
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. At September 30, 2004, the commitments and contingencies reserve
was $9.3 million. At December 31, 2003, the commitments and contingencies
reserve was $6.8 million.
(11) Related Party Transactions
In July 2001, Boards, Inc. (Boards) began to open Hollywood Video stores as a
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 1,973 stores operated by the Company. Mark Wattles, the
Company's founder and Chief Executive Officer, 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 2.0% of revenue and also purchases products
and services from the Company at the Company's cost. Boards is in compliance
with the 30 day payment terms under the arrangement. The outstanding balance of
$0.5 million due the Company is related to current activity. As of September
30, 2004, Boards operated 20 stores.
The following table reconciles the net receivable balance due from Boards, Inc.
(in thousands):
--------------------- ---------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
2004 2003 2004 2003
-------- -------- -------- --------
Beginning Receivable
Balance $ 985 $ 468 $ 1,509 $ 631
-------- -------- -------- --------
License fee - 50 25 225
(2%)Royalty Fees 135 101 398 233
Products & Services 2,249 2,173 7,303 6,549
-------- -------- -------- --------
Expenses 2,384 2,324 7,726 7,007
Payments (2,826) (2,135) (8,692) (6,981)
-------- -------- -------- --------
Ending Balance
September 30 $ 543 $ 657 $ 543 $ 657
======== ======== ======== ========
(12) Segment Reporting
In 2003, in an effort to ensure the creation of a "gamer" culture within its
game departments, the Company began managing its business as two separate
segments, Hollywood Video and Game Crazy. The Hollywood Video segment
represents the Hollywood Video stores and the Game Crazy segment represents the
in-store game departments. Beginning with the 2003 annual report on Form 10-K,
the Company chose to present its financial results pursuant to the guidelines
for segment reporting under FAS 131, including the presentation of operating
income by segment. When calculating operating income by segment, in addition
to any direct costs incurred as a result of operating the game departments, the
Company also allocated a portion of the Company's total corporate overhead
based on needed resources to support game departments. Assigned costs included
costs associated with information technology support, treasury and accounting
functions and other general and administrative services.
Three Months Ended Three Months Ended
September 30, 2004 September 30, 2003
------------------------------ ------------------------------
Hollywood Game Hollywood Game
Video Crazy Total Video Crazy Total
---------- -------- ---------- ---------- -------- ----------
Revenues $ 349,197 $ 61,357 $ 410,554 $ 363,030 $ 38,928 $ 401,958
Depreciation 13,605 1,745 15,350 14,360 1,308 15,668
Overhead
Allocation (572) 572 - (389) 389 -
Income (loss)
from operations 38,775 (4,370) 34,405 46,360 (4,375) 41,985
Total assets 913,285 111,415 1,024,700 856,779 88,332 945,111
Purchases of
property and
equipment, net 7,312 3,194 10,506 18,328 7,085 25,413
Nine Months Ended Nine Months Ended
September 30, 2004 September 30, 2003
------------------------------ ------------------------------
Hollywood Game Hollywood Game
Video Crazy Total Video Crazy Total
---------- -------- ---------- ---------- -------- ----------
Revenues $1,104,788 $171,685 $1,276,473 $1,114,771 $ 94,221 $1,208,992
Depreciation 42,486 4,746 47,232 42,718 2,957 45,675
Overhead
Allocation (1,665) 1,665 - (942) 942 -
Income (loss)
from operations 136,093 (14,890) 121,203 149,493 (12,601) 136,892
Total assets 913,285 111,415 1,024,700 856,779 88,332 945,111
Purchases of
property and
equipment, net 28,428 5,865 34,293 45,675 25,123 70,798
(13) Consolidating Financial Statements
Hollywood Entertainment Corporation (HEC) had one subsidiary, Hollywood
Management Company (HMC), during the three months ended September 30, 2004. 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 September 30, 2004
(unaudited, in thousands)
---------- ---------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- --------- ----------
REVENUE $ 411,272 $ 38,326 $ (39,044)$ 410,554
COST OF REVENUE 153,762 - - 153,762
GROSS MARGIN 257,510 38,326 (39,044) 256,792
OPERATING COSTS & EXPENSES:
Operating and selling 188,802 5,778 - 194,580
General & administrative 50,526 15,865 (39,044) 27,347
Store Opening Expenses 460 - - 460
Restructuring charge for
Store closure - - - -
INCOME FROM OPERATIONS 17,722 16,683 - 34,405
Interest income - 8,287 (7,854) 433
Interest expense (16,059) - 7,854 (8,205)
Early debt retirement - - - -
Equity Earnings in Subsidiary 14,982 - (14,982) -
Income before income
taxes 16,645 24,970 (14,982) 26,633
Benefit from (provision for)
income taxes (665) (9,988) - (10,653)
NET INCOME $ 15,980 $ 14,982 $(14,982) $ 15,980
Consolidating Condensed Statement of Operations
Three months ended September 30, 2003
(unaudited, in thousands)
---------- ---------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- --------- ----------
REVENUE $ 402,675 $ 31,857 $ (32,574)$ 401,958
COST OF REVENUE 151,313 - - 151,313
GROSS MARGIN 251,362 31,857 (32,574) 250,645
OPERATING COSTS & EXPENSES:
Operating and selling 176,323 5,468 - 181,791
General & administrative 51,148 7,076 (32,574) 25,650
Store Opening Expenses 1,219 - - 1,219
Restructuring charge for
Store closure - - - -
INCOME FROM OPERATIONS 22,672 19,313 - 41,985
Interest income - 9,863 (9,680) 183
Interest expense (17,742) - 9,680 (8,062)
Early debt retirement - - - -
Equity Earnings in Subsidiary 17,512 - (17,512) -
Income before income
taxes 22,442 29,176 (17,512) 34,106
Benefit from (provision for)
income taxes (1,972) (11,664) - (13,636)
NET INCOME $ 20,470 $ 17,512 $(17,512) $ 20,470
Consolidating Condensed Statement of Operations
Nine months ended September 30, 2004
(unaudited, in thousands)
---------- ---------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- --------- ----------
REVENUE $1,278,629 $ 113,208 $(115,364)$1,276,473
COST OF REVENUE 490,936 - - 490,936
GROSS MARGIN 787,693 113,208 (115,364) 785,537
OPERATING COSTS & EXPENSES:
Operating and selling 558,737 17,584 - 576,321
General & administrative 158,896 43,174 (115,364) 86,706
Store Opening Expenses 1,497 - - 1,497
Restructuring charge for
Store closure (190) - - (190)
INCOME FROM OPERATIONS 68,753 52,450 - 121,203
Interest income - 26,244 (25,511) 733
Interest expense (49,275) - 25,511 (23,764)
Early debt retirement - - - -
Equity Earnings in Subsidiary 47,409 - (47,409) -
Income before income
taxes 66,887 78,694 (47,409) 98,172
Benefit from (provision for)
income taxes (7,984) (31,285) - (39,269)
NET INCOME $ 58,903 $ 47,409 $ (47,409)$ 58,903
Consolidating Condensed Statement of Operations
Nine months ended September 30, 2003
(unaudited, in thousands)
---------- ---------- --------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- --------- ----------
REVENUE $ 1,211,149 $ 109,590 $(111,747)$1,208,992
COST OF REVENUE 455,630 - - 455,630
GROSS MARGIN 755,519 109,590 (111,747) 753,362
OPERATING COSTS & EXPENSES:
Operating and selling 517,794 13,534 - 531,328
General & administrative 161,079 31,868 (111,747) 81,200
Store Opening Expenses 3,942 - - 3,942
Restructuring charge for
Store closure - - - -
INCOME FROM OPERATIONS 72,704 64,188 - 136,892
Interest income - 26,915 (26,185) 730
Interest expense (52,630) - 26,185 (26,445)
Equity in Earnings
Of Subsidiary 54,323 - (54,323) -
Early debt retirement (12,467) - - (12,467)
Income before income
taxes 61,930 91,103 (54,323) 98,710
Benefit from (provision for)
income taxes (2,704) (36,780) - (39,484)
NET INCOME $ 59,226 $ 54,323 $ (54,323)$ 59,226
Consolidating Condensed Balance Sheet
September 30, 2004
(unaudited, in thousands)
---------- ---------- ---------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- ---------- ----------
ASSETS
Cash and cash equivalents $ 2,372 $ 143,557 $ - $ 145,929
Receivables 21,982 417,312 (410,007) 29,287
Merchandise inventories 136,422 - - 136,422
Prepaid expenses and other 9,414 3,937 - 13,351
current assets
Total current assets 170,190 564,806 (410,007) 324,989
Rental inventory, net 267,029 - - 267,029
Property & equipment, net 250,242 25,676 - 275,918
Goodwill, net 67,737 - - 67,737
Deferred tax assets, net 73,508 - - 73,508
Other assets, net 360,967 7,772 (353,220) 15,519
Total Assets $1,189,673 $ 598,254 $ (763,227)$1,024,700
LIABILITIES & SHAREHOLDERS'
EQUITY (DEFICIT)
Current maturities of
long-term obligations $ 547 $ - $ - $ 547
Accounts payable 410,007 142,821 (410,007) 142,821
Accrued expenses 23,766 98,295 - 122,061
Accrued interest - 992 - 992
Income taxes payable - 2,926 - 2,926
Total current liabilities 434,320 245,034 (410,007) 269,347
Long-term obligations, less
current portion 350,862 - - 350,862
Other liabilities 15,349 - - 15,349
Total liabilities 800,531 245,034 (410,007) 635,558
Common stock 493,524 4,008 (4,008) 493,524
Unearned compensation - - - -
Retained earnings
(accumulated deficit) (104,382) 349,212 (349,212) (104,382)
Total shareholders'
equity (deficit) 389,142 353,220 (353,220) 389,142
Total liabilities and
shareholders' equity
(deficit) $1,189,673 $ 598,254 $(763,227) $1,024,700
Consolidating Condensed Balance Sheet
December 31, 2003
(in thousands)
---------- ---------- ---------- ----------
HEC HMC Elimin- Consol-
ations idated
---------- ---------- ---------- ----------
ASSETS
Cash and cash equivalents $ 2,259 $ 71,874 $ - $ 74,133
Cash held by trustee for
Refinancing - - - -
Accounts receivable, net 24,796 461,250 (452,059) 33,987
Merchandise inventories 129,864 - - 129,864
Prepaid expenses and other
current assets 10,041 3,192 - 13,233
Total current assets 166,960 536,316 (452,059) 251,217
Rental inventory, net 268,748 - - 268,748
Property & equipment, net 265,257 23,600 - 288,857
Goodwill, net 66,678 - - 66,678
Deferred income tax asset 104,302 - - 104,302
Other assets, net 10,461 7,194 - 17,655
Investment in Subsidiary 305,813 - (305,813) -
Total assets $1,188,219 $ 567,110 $ (757,872) $ 997,457
LIABILITIES & SHAREHOLDERS'
EQUITY (DEFICIT)
Current maturities of
long-term obligations $ 647 $ - $ - $ 647
Subordinated notes to be
Retired with cash held by
Trustee (including accrued
Interest of $8.1 million) - - - -
Accounts payable 452,059 159,586 (452,059) 159,586
Accrued expenses 22,907 94,960 - 117,867
Accrued interest - 6,467 - 6,467
Income taxes payable - 284 - 284
Total current liabilities 475,613 261,297 (452,059) 284,851
Long-term obligations, less
current portion 370,669 - - 370,669
Other liabilities 16,108 - - 16,108
Total liabilities 862,390 261,297 (452,059) 671,628
Common stock 489,247 4,008 (4,008) 489,247
Unearned compensation (133) - - (133)
Retained earnings
(accumulated deficit) (163,285) 301,805 (301,805) (163,285)
Total shareholders'
equity (deficit) 325,829 305,813 (305,813) 325,829
Total liabilities and
shareholders equity
(deficit) $1,188,219 $ 567,110 $ (757,872) $ 997,457
Consolidating Condensed Statement of Cash Flows
Nine months ended September 30, 2004
(unaudited, in thousands)
---------- ---------- ---------- ----------
HEC HMC Elimin- Consol-
ation idated
---------- ---------- ---------- ----------
OPERATING ACTIVITIES:
Net income $ 58,903 $ 47,409 $ (47,409)$ 58,903
Equity Earnings in
subsidiary (47,409) - 47,409 -
Adjustments to reconcile
net income to
cash provided by
operating activities:
Write-off of deferred
financing costs - - - -
Depreciation &
amortization 188,699 4,160 - 192,859
Tax benefit from exercise
of stock options 5,754 - - 5,754
Change in deferred tax
asset 30,793 - - 30,793
Change in deferred rent (759) - - (759)
Non cash stock compensation 133 - - 133
Net change in operating
assets & liabilities (44,308) 26,771 - (17,537)
Cash provided by (used in)
Operating activities 191,806 78,340 - 270,146
INVESTING ACTIVITIES:
Purchases of rental
inventory, net (141,401) - - (141,401)
Purchase of property &
equipment, net (28,056) (6,237) - (34,293)
Increase in intangibles
& other assets (851) (420) - (1,271)
Refinancing Proceeds - - - -
Cash used in investing
activities (170,308) (6,657) - (176,965)
FINANCING ACTIVITIES:
Proceeds from the sale of
common stock, net - - - -
Repayments of capital lease
obligations (437) - - (437)
Repurchase of Common Stock (3,665) - - (3,665)
Proceeds from exercise
of stock options 2,188 - - 2,188
Decrease in Credit Facility (20,000) - - (20,000)
Debt financing costs - - - -
Proceeds from Capital lease
Obligations 529 - - 529
Cash used in financing
activities (21,385) - - (21,385)
Increase in cash
and cash equivalents 113 71,683 - 71,796
Cash and cash equivalents
at beginning of year 2,259 71,874 - 74,133
Cash and cash equivalents at
the end of the third
quarter $ 2,372 $ 143,557 $ - $ 145,929
Consolidating Condensed Statement of Cash Flows
Nine months ended September 30, 2003
(unaudited, in thousands)
---------- ---------- ---------- ----------
HEC HMC Elimin- Consol-
ation idated
---------- ---------- ---------- ----------
OPERATING ACTIVITIES:
Net income $ 59,226 $ 54,323 $ (54,323)$ 59,226
Equity Earnings in
subsidiary (54,323) - 54,323 -
Adjustments to reconcile
net income to
cash provided by
operating activities:
Write-off of deferred
financing costs 5,827 - - 5,827
Depreciation &
amortization 199,948 6,189 - 206,137
Tax benefit from exercise
of stock options 7,485 - - 7,485
Change in deferred tax
asset 27,694 - - 27,694
Change in deferred rent (1,146) - - (1,146)
Non cash stock compensation 432 - - 432
Net change in operating
assets & liabilities 204,721 (264,105) - (59,384)
Cash provided by (used in)
Operating activities 449,864 (203,593) - 246,271
INVESTING ACTIVITIES:
Purchases of rental
inventory, net (152,388) - - (152,388)
Purchase of property &
equipment, net (63,186) (7,612) - (70,798)
Increase in intangibles
& other assets (380) (708) - (1,088)
Net Proceeds from indenture
trustee - 218,531 - 218,531
Cash used in investing
activities (215,954) 210,211 - (5,743)
FINANCING ACTIVITIES:
Repayment of subordinated
debt (250,000) - - (250,000)
Borrowings under new
term loan 200,000 - - 200,000
Repayment of prior revolving
loan (107,500) - - (107,500)
Decrease in credit
facilities (55,000) - - (55,000)
Debt financing costs (7,454) - - (7,454)
Repayments of capital lease
obligations (7,818) - - (7,818)
Repurchase of common stock (9,412) - - (9,412)
Proceeds from exercise
of stock options 3,452 - - 3,452
Cash used in financing
activities (233,732) - - (233,732)
Increase in cash
and cash equivalents 178 6,618 - 6,796
Cash and cash equivalents
at beginning of year 2,045 31,100 - 33,145
Cash and cash equivalents at
the end of the third
quarter $ 2,223 $ 37,718 $ - $ 39,941
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
ABOUT HOLLYWOOD ENTERTAINMENT
We are the second largest rental retailer of movies and video games in the
United States. We opened our first Hollywood Video store in October 1988 and,
as of September 30, 2004, we operated 1973 Hollywood Video stores in 47 states
and the District of Columbia, of which 678 included an in-store game
department("Game Crazy"), where game enthusiasts can buy, sell and trade new
and used video game hardware, software and accessories. A typical Game Crazy
department carries over 2,500 video game titles and occupies an area of
approximately 700 to 900 square feet within the store.
For the nine months ended September 30, 2004, we derived 80.6% of our revenue
from movie and game rental products, 13.4% from the sale of new and used game
hardware, software and accessories in our game departments, and 6.0% from the
sale of new movies, concessions and video accessories.
Although domestic rental spending has remained fairly flat over the past five
years and appears to be declining in 2004, we have increased our total revenue
through opening new stores, taking market share and selling more used movies.
We estimate approximately half of the rental industry's market share remains
divided among a relatively large number of smaller independent and regional
operators. The studios' current movie distribution practice provides an
exclusive window for DVD and VHS retail channels before the movies are
available to pay-per view, video-on-demand and other distribution channels.
Changes in the studio distribution practice or changes in pricing of movies
could negatively impact our business. For a discussion of risks inherent to our
industry in general and Hollywood video in particular, please see "Cautionary
Statements".
The video game industry, an approximately $10 billion market in the United
States in 2003 according to NPD Group, Inc., has historically experienced peaks
and valleys in consumer spending attributable to the release of new technology
platforms for game play. In 2000 and 2001, Sony's PlayStation 2, Nintendo's
GameCube and Microsoft's Xbox, three new-generation hardware technology
products, were introduced. These platforms have substantially increased the
installed base of video game hardware units and have driven significant growth
in video game software. As with the introduction of previous new platforms,
consumers have increased both their purchase and rental of games. In addition,
the emergence and acceptance of buying, selling and trading used games has
caused used game sales to grow rapidly for certain retailers who sell used
games, including us.
Our strategy is to make Hollywood Video stores a total home entertainment
destination. The Hollywood Video retail model, including the types of real
estate sites we pursue, the store design, employee hiring and training
practices, and inventory and merchandising standards, is designed to maximize
the number of customers per store, as well as the frequency of customer visits
and the amount that consumers spend per visit. Our stores are typically located
in high-traffic, high-visibility locations with convenient access and parking.
Inside the store, we focus on providing a superior selection of movies and
games for rent as well as new and used movies and games for sale, in a friendly
and inviting atmosphere that encourages browsing. We believe that consumers
view movie and game rentals in general, and our pricing structure and rental
terms in particular, as a convenient form of entertainment and an excellent
value. As it relates to movie sales, our focus is primarily on used movies
which we believe offer a better value to those consumers who choose to purchase
instead of rent. As it relates to game sales, our approach is to build
dedicated departments within the store. This approach, combined with the core
concept of buy, sell and trade, along with our employee hiring and training,
and inventory selection and merchandising presentation, is designed to appeal
to both "hard-core" and casual game consumers.
Remerchandising a Hollywood Video to include a game department allows us to
leverage our real estate investment and customer traffic, and even though we
reduce the area dedicated to movie merchandising in order to make room for a
game department, increases rental membership, customer traffic and movie-
related revenue and total transactions. Moreover, we believe that there is
significant customer overlap, and that our integrated approach provides a
competitive advantage by enabling us to offer consumers a total home
entertainment destination.
Key indicators used in running our business include total revenue growth, same
store sales, gross margin rates, inventory levels, and operating expenses in
dollars and as percentage of revenue. We also use key indicators that are non-
GAAP including EBITDA, Adjusted EBITDA, free cash flow and return on
investment. Our operating results are subject to the application of critical
accounting policies as discussed in "Critical Accounting Policies and
Estimates." These policies require management to make significant estimates,
judgments and assumptions that are subject to uncertainties that may change as
additional information becomes known.
Merger Agreement
On March 28, 2004 we signed a definitive merger agreement with Carso Holdings
Corporation ("Carso") and its wholly owned subsidiary Hollywood Merger
Corporation ("Merger Corp"), both affiliates of Leonard Green & Partners, L.P.,
which provided for the merger of Merger Corp into Hollywood Entertainment with
Hollywood Entertainment surviving as a wholly owned subsidiary of Carso. On
October 14, 2004, we filed a current report on Form 8-K announcing that we had
executed an amended and restated merger agreement with Carso and Merger Corp,
dated as of October 13, 2004. The amended and restated merger agreement
reduces the merger consideration from $14.00 to $10.25 per share and includes
other modifications, including the elimination of the termination fee
previously payable to LGP and restrictions on our ability to solicit offers
from other interested acquirors. If the merger is completed as contemplated by
the amended and restated merger agreement, our shareholders, except for Mark
Wattles, our founder, Chairman and Chief Executive Officer, and other members
of senior management who will acquire Carso common stock, will receive $10.25
per share in cash. Mr. Wattles will continue in his current capacities
following the merger and will own 50% of the common stock and 50% of the junior
preferred stock of Carso on a fully diluted basis. Green Equity Investors IV,
LP will own 50% of the common stock of Carso, 50% of the junior preferred stock
of Carso on a fully diluted basis, and all of the senior preferred stock of
Carso. We entered into the amended and restated merger agreement following the
unanimous recommendation of a special committee comprised of the independent
directors of the Company's Board of Directors (the "Special Committee"). The
Special Committee and the Board of Directors received a fairness opinion from
Lazard Freres & Company, LLC as to the consideration to be received by our
shareholders pursuant to the amended and restated merger agreement.
The closing of the merger is subject to terms and conditions customary for
transactions of its type, including shareholder approval and the completion of
financing. The parties to the amended and restated merger agreement anticipate
completing the merger in January 2005.
RESULTS OF OPERATIONS
Summary Results of Operations
Total revenue for the three months and nine months ended September 30, 2004 was
$410.6 million and $1,276.5 million, respectively, compared to $402.0 million
and $1,209.0 million for the corresponding periods of the prior year. The
increase was primarily attributable to the increased number of Hollywood Video
stores open, as well as the impact of more game departments and positive same
store sales per game department, which more than offset the negative same store
revenue from rental products.
Our income from operations for the three months ended September 30, 2004 was
$34.4 million compared to $42.0 million for the three months ended September
30, 2003. The decrease was attributable to increased operating and selling
expenses of $12.8 million, and increased general and administrative expenses of
$1.6 million, partially offset by increased gross profit of $6.1 million and a
reduction in store opening expenses of $0.8 million. The increase in operating
and selling expenses was driven by increased store occupancy costs and repair
and maintenance costs of $6.7 million, increased Game Crazy operating expenses
of $4.1 million, and increased labor and advertising associated with new video
merchandising initiatives of $1.4 million. The increase in general and
administrative expenses was attributable to $1.7 million in merger-related
expenses.
Income from operations for the nine months ended September 30, 2004 was $121.2
million compared to $136.9 million for the nine months ended September 30,
2003. The decrease was attributable to increased operating and selling
expenses of $45.0 million and increased general and administrative expenses of
$5.5 million, partially offset by increased gross margin of $32.2 million and a
reduction in store opening expenses of $2.4 million. The increase in operating
and selling expenses was driven by increased store occupancy costs of $16.6
million, increased Game Crazy operating expenses of $17.1 million, increased
labor of $4.9 million due to a higher video store count, and increased video
advertising of $3.9 million. The increase in general and administrative
expenses was attributable to $5.3 million in merger-related expenses.
Net income for the three months ended September 30, 2004 was $16.0 million
compared to net income of $20.5 million for the three months ended September
30, 2003. The decrease was attributable to the $12.8 million increase in
operating and selling expenses and $1.7 million in merger-related expenses,
partially offset by increased gross profit of $6.1 million.
Net income for the nine months ended September 30, 2004 was $58.9 million
compared to net income of $59.2 million for the nine months ended September 30,
2003. The decrease was attributable to increased gross profit of $32.2
million, as well as a $12.5 million expense for early debt retirement in the
first quarter of 2003, which causes net income to increase year-over-year by
the same amount, offset by the $45.0 million increase in operating and selling
expenses and $5.3 million of merger-related expenses for the nine months ended
September 30, 2004.
Results of Operation Expressed as a Percentage of Revenue
The following table sets forth (i) results of operations data expressed as a
percentage of total revenue and (ii) gross margin data.
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -------------------
2004 2003 2004 2003
-------- -------- -------- --------
Revenue:
Rental product revenue 79.3% 83.9% 80.6% 85.3%
Merchandise sales 20.7% 16.1% 19.4% 14.7%
-------- -------- -------- --------
100.0% 100.0% 100.0% 100.0%
-------- -------- -------- --------
Gross margin 62.5% 62.4% 61.5% 62.3%
Operating costs and expenses:
Operating and selling 47.4% 45.2% 45.1% 43.9%
General and administrative 6.7% 6.4% 6.8% 6.7%
Store opening expense 0.1% 0.3% 0.1% 0.3%
Restructuring Charges for Store
Closure 0.0% 0.0% 0.0% 0.0%
-------- -------- -------- --------
54.2% 51.9% 52.0% 50.9%
-------- -------- -------- --------
Income from operations 8.3% 10.5% 9.5% 11.4%
Interest expense, net (1.8%) (2.0%) (1.8%) (2.1%)
Early debt retirement 0.0% 0.0% 0.0% (1.1%)
-------- -------- -------- --------
Income before income taxes 6.5% 8.5% 7.7% 8.2%
Provision for income taxes (2.6%) (3.4%) (3.1%) (3.3%)
-------- -------- -------- --------
Net income 3.9% 5.1% 4.6% 4.9%
======== ======== ======== ========
Other data:
Rental product gross margin (1) 71.3% 69.0% 70.1% 68.3%
Merchandise sales gross margin (2) 29.0% 27.8% 26.1% 27.6%
- --------------------------
(1) Rental product gross margin as a percentage of rental product revenue.
(2) Merchandise sales gross margin as a percentage of merchandise sales.
REVENUE
Revenue increased by $8.6 million, or 2.1%, and $67.5 million, or 5.6%, for the
three months and nine months ended September 30, 2004, respectively, compared
to the three months and nine months ended September 30, 2003. The increases
were primarily due to opening new Hollywood Video stores and additional game
departments. We operated an additional 109 and 100 weighted-average Hollywood
Video stores and 131 and 201 additional weighted-average game departments for
the three months and nine months ended September 30, 2004, respectively. Same
store sales decreased 2% in the three months ended September 30, 2004 and
increased 1% in the nine months ended September 30, 2004. Decreases in same
store sales from rental product of 8% and 5% for the three months and nine
months ended September 30, 2004 were offset by same store increases for our
game departments of 32% and 29%.
The following is a summary of revenue by product category (in thousands):
Three Months Ended Nine months Ended
September 30, September 30,
-------------------- ----------------------
2004 2003 2004 2003
--------- --------- ---------- ----------
DVD rental product revenue $ 229,966 $ 193,208 $ 704,039 $ 550,759
VHS rental product revenue 68,223 117,357 239,648 394,612
Game rental product revenue 27,190 26,741 85,218 86,413
--------- --------- ---------- ----------
Total rental product revenue 325,379 337,306 1,028,905 1,031,784
--------- --------- ---------- ----------
Game Crazy departments 61,357 38,928 171,685 94,221
New movies, concessions
and accessories 23,818 25,724 75,883 82,987
--------- --------- ---------- ----------
Total merchandise sales 85,175 64,652 247,568 177,208
--------- --------- ---------- ----------
--------- --------- ---------- ----------
Total revenue $ 410,554 $ 401,958 $1,276,473 $1,208,992
========= ========= ========== ==========
Rental product revenue is generated from the rental of movies and games and
from the sale of used movies and games no longer needed as rental inventory. We
currently offer a 5-day rental term on all products in the majority of our
stores. All DVDs and new release VHS movies typically rent for $3.79. Catalog
VHS movies typically rent for $1.99. Since the fourth quarter of 1999, we have
not increased prices on DVDs, new release VHS or catalog VHS. Video games
typically rent for $4.99 and $5.99, with games designed for the newer platforms
renting for the higher amount. Customers who choose not to return movies within
the applicable rental period are deemed to have commenced a new rental period
of equal length at the same price. Revenue recorded for extended rental periods
is net of amounts that we do not anticipate collecting. The percentage of
rental product revenues generated from extended rental periods has not changed
significantly in several years.
In the third quarter of 2004 we began to offer nationally the Movie Value Pass
(MVP), an in-store movie rental subscription service that allows customers to
rent an unlimited number of most new release movies and all catalog movies
during the term of the pass, subject to a limit on the number of movies that
can be out at one time. Subscription fees are paid up-front and recognized as
revenue on a straight-line basis over the applicable term of the pass.
Merchandise sales are generated from the sale of new and used game hardware,
software and accessories, new movies, concessions and miscellaneous video
accessory items. Revenue from our game departments increased 57.6% and 82.2% in
the three months and nine months ended September 30, 2004, respectively,
compared to the three months and nine months ended September 30, 2003. The
increase was primarily due to the addition of 98 new departments and favorable
year-over-year increases for existing departments.
GROSS MARGIN
Rental Product Margin
Rental product gross profit as a percentage of rental product revenue ("gross
margin") increased to 71.3% and 70.1% for the three months and the nine months
ended September 30, 2004, respectively, from 69.0% and 68.3% for the three
months and the nine months ended September 30, 2003. The increase was primarily
due to a shift in revenue from VHS product to DVD product resulting in an
increase in the percentage of new release movies acquired under DVD revenue
sharing arrangements, which typically have a higher gross margin than VHS
revenue sharing arrangements. Improved inventory management on titles not
purchased under revenue sharing arrangements also contributed to the increase
in gross margin.
Merchandise Sales Margins
Merchandise sales gross margin increased to 29.0% for the three months ended
September 30, 2004 from 27.8% for the three months ended September 30, 2003.
The increase was partially attributable to a decrease in discounts on
concession sales related to promotional programs.
Merchandise sales gross margin decreased to 26.1% for the nine months ended
September 30, 2004 from 27.6% for the nine months ended September 30, 2003. The
decrease was primarily the result of an increase in the percentage of revenue
from new game sales, which typically have lower gross margins than other
product categories, such as used games, accessories and concessions.
OPERATING COSTS AND EXPENSES
Operating and Selling Expenses
Total operating and selling expenses for the three months ended September 30,
2004 increased as a percentage of revenue to 47.4% from 45.2% for the three
months ended September,30 2003. Total operating and selling expenses for the
three months ended September 30, 2004 increased $12.8 million to $194.6 million
from $181.8 million for 2003. The increase was primarily the result of
increased variable costs associated with increased total revenue, an increase
of 109 weighted-average stores and an increase in operating and selling
expenses associated with the expansion of our Game Crazy initiative, including
operating an additional 131 weighted-average game departments. Payroll and
related expenses increased by $3.6 million, rent and related expenses increased
by $5.0 million, utilities increased by $1.4 million, and other operating and
selling expenses increased by $2.8 million for the three months ended September
30, 2004 compared to the corresponding period of the prior year.
Total operating and selling expenses for the nine months ended September 30,
2004 increased as a percentage of revenue to 45.1% from 43.9% for the nine
months ended September 30, 2003. Total operating and selling expense for the
nine months ended September 30, 2004 increased $45.0 million to $576.3 million
from $531.3 million for 2003. The increase was primarily the result of
increased variable costs associated with increased total revenue, an increase
of 100 weighted-average stores and an increase in operating and selling
expenses associated with the expansion of our Game Crazy initiative, including
operating an additional 201 weighted-average game departments. Payroll and
related expenses increased by $17.4 million, rent and related expenses
increased by $14.5 million, advertising increased by $6.0 million, and other
operating and selling expenses increased by $7.1 million for the nine months
ended September 30, 2004 compared to the corresponding period of the prior
year.
General and Administrative Expenses
General and administrative expenses for the three months ended September 30,
2004 increased $1.6 million to $27.3 million, or 6.7% of total revenue, from
$25.7 million, or 6.4% of total revenue for the three months ended September
30, 2003. Included in the general and administrative expenses for three months
ended September 30, 2004 was $1.7 million in merger-related expenses.
General and administrative expenses for the nine months ended September 30,
2004 increased $5.5 million to $86.7 million, or 6.8% of total revenue, from
$81.2 million, or 6.7% of total revenue for the nine months ended September 30,
2003. Included in the general and administrative expenses for nine months ended
September 30, 2004 was $5.3 million in merger-related expenses.
NON-OPERATING INCOME (EXPENSE), NET
Interest Expense
Interest expense, net of interest income, was $7.8 million and $23.0 million
for the three months and nine months ended September 30, 2004, respectively
compared to $7.9 million and $25.7 million for the corresponding periods of the
prior year. The reduction was primarily due to decreased borrowing levels and
lower interest rates (see Note 7 to see a detailed table of long-term
obligations).
Early Debt Retirement
In the first quarter of 2003, we redeemed the outstanding $250 million 10.625%
senior subordinated notes due 2004 and retired our prior credit facility due
2004. As a result, we recorded a charge of $12.5 million that included an early
redemption premium of $6.6 million and the non-cash write-off of deferred
financing costs.
INCOME TAXES
Our effective tax rate was 40% for the three months and nine months ended
September 30, 2004 compared to 40% for the three months and nine months ended
September 30, 2003. Our effective tax rate varies from the federal statutory
rate as a result of nondeductible officer's compensation, other permanent items
and minimum state income taxes. In the fourth quarter of 2003 we applied for a
change in accounting method with the Internal Revenue Service (IRS) to
accelerate the deduction of store pre-opening supplies and the amortization of
DVD and VHS movies and video games. The application is under review by the
IRS. Based on internal forecasts and utilization of our net operating loss
carryforwards, but excluding any impact of the proposed merger, we do not
anticipate significant cash tax payments until 2005.
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
dollar amount of new releases held as rental inventory on our consolidated
balance sheet. Under revenue sharing, in exchange for acquiring agreed-upon
quantities of DVDs or videocassettes at reduced or no up-front costs, we share
with the studio agreed-upon portions of the revenue that we derive from those
DVDs or videocassettes. The studio's share of the revenue is expensed, net of
an estimated residual value, as revenue is earned on revenue sharing titles.
The resulting revenue sharing expense is considered a direct cost of revenue
rather than an investment in rental inventory. Under sell-through pricing, we
purchase movies from the studios with no further obligation to make payments to
the studios for those movies. Sell-through purchases are recognized as an
investment in rental inventory, which is then amortized to cost of rental
product over its estimated useful life to an estimated residual value.
Therefore, 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
$12.0 million and $45.9 million for the three months and nine months ended
September 30, 2004 compared to $18.8 million and $70.4 million for the three
months and nine months ended September 30, 2003. The decline in revenue sharing
expense is primarily the result of an increase in the percentage of movies
acquired on DVD compared to VHS, as DVD revenue sharing arrangements typically
result in lower net revenue sharing expense than VHS revenue sharing
arrangements.
MERCHANDISE INVENTORY
Merchandise inventory consists of new and used game software, hardware and
accessories, new movies for sale, concessions and accessory items for sale, and
the residual book value of movies and games that are transferred from rental
inventory to merchandise inventory to be sold as used.
Consolidated merchandise inventory increased $6.5 million to $136.4 million as
of September 30, 2004, from $129.9 million as of December 31, 2003. The
increase was primarily related to the addition of 83 game departments and game
inventory increases in existing game departments to support a 29% increase in
same store sales in the nine months ended September 30, 2004.
LIQUIDITY AND CAPITAL RESOURCES
Overview
Our primary source of operating cash flow is generated from the rental and
sales of movies on DVD and VHS, video game hardware and software, video game
and movie accessories, and concessions. The amount of cash generated from
operations in nine months ended September 30, 2004 funded our debt service
requirements, maintenance capital expenditures, and provided the capital
required to open 64 Hollywood Video stores and add 83 game departments. At
September 30, 2004, we had $145.9 million of cash and cash equivalents on hand.
We believe cash flow from operations, flexibility under our credit facilities,
cash on hand and trade credit will provide adequate liquidity and capital
resources to execute our business plan for the foreseeable future, including
our expansion plans discussed below in "Cash Used in Investing Activities." If
the merger disclosed above under the heading "Merger Agreement" is completed,
our capital structure will change significantly. The financing required to
complete the merger transaction will substantially increase our long-term
obligations, which will increase our debt service requirements. Information
regarding the merger agreement and related financing can be found in the
Company's preliminary proxy statement filed on July 8, 2004, as updated by the
Company's current report on Form 8-K filed October 14, 2004. The Company will
amend its preliminary proxy statement to reflect the amended and restated terms
of the merger agreement with affiliates of LGP.
Cash Provided by Operating Activities
Net cash provided by operating activities increased by $23.9 million, or 9.7%,
to $270.1 million for the nine months ended September 30, 2004 compared to
$246.3 million for the corresponding period of the prior year. The increase was
primarily attributable to favorable changes in working capital accounts
including $24.5 million for merchandise inventory driven by a reduction in the
number of new game departments opened in the current year period.
Cash Used in Investing Activities
Net cash used in investing activities was $177.0 million for the nine months
ended September 30, 2004 compared to $5.7 million for the corresponding period
of the prior year. We opened 64 Hollywood Video stores and added 83 game
departments in the nine months ended September 30, 2004 compared to opening 42
Hollywood Video stores and adding 304 game departments in the nine months ended
September 30, 2003. Cash used in investing activities for the nine months ended
September 30, 2003 includes $218.5 million of proceeds delivered to
subordinated note holders on our behalf by the indenture trustee. The delivery
of the proceeds to the indenture trustee in the fourth quarter of 2002 and the
subsequent use of the proceeds to redeem the notes in the first quarter of 2003
were classified as investing activities.
We anticipate investing approximately $85 million in 2004 to open approximately
100 Hollywood Video stores and to add approximately 120 game departments
(including the investment in inventory and opening expenses) and for
maintenance capital expenditures. In addition, we regularly consider new
business initiatives that would enhance, expand, or complement our position in
the entertainment industry. Some of those under consideration, such as movie
trading and mail delivery rental services, are closely related to our existing
business. Any initiative undertaken could require significant capital
investment, could be unsuccessful, or, even if successful, could have a short-
term adverse impact on our financial condition, liquidity and operating
results.
Cash Used in Financing Activities
Net cash flow from financing activities was a $21.4 million use of cash for the
nine months ended September 30, 2004 that included a $20 million prepayment on
our term loan facility, which is now prepaid through 2006, as well as the
repurchase of 295,139 shares of common stock for $3.7 million. Net cash flow
from financing activities was a $233.7 million use of cash for the nine months
ended September 30, 2003. The use of cash reflected the redemption of $250.0
million of senior subordinated notes and the retirement of our prior credit
facility of $107.5 million with $218.5 million in proceeds from the indenture
trustee and $200.0 million of initial borrowings under our new credit facility.
Instruments governing our indebtedness contain various covenants, including
covenants requiring us to meet specified financial ratios and tests and
covenants that restrict our business, including our ability to pay dividends
and repurchase common stock. At September 30, 2004, we were in compliance with
all covenants contained within our debt agreements.
At September 30, 2004, 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
- ------------ ---------- ---------- --------- ---------
2004 $ - $ - $ 153 $ 153
2005 - - 594 594
2006 - - 578 578
2007 - 20,000 84 20,084
2008 - 105,000 - 105,000
Thereafter 225,000 - - 225,000
---------- ---------- --------- ---------
$ 225,000 $ 125,000 $ 1,409 $ 351,409
---------- ---------- --------- ---------
Contractual Obligations
Our contractual obligations consist of long-term debt, operating leases
(primarily store leases) and capital leases. We lease all of our stores,
corporate offices, distribution centers and zone offices under non-cancelable
operating leases. Our stores generally have an initial operating lease term of
five to 15 years and most have options to renew for between five and 15
additional years. Contractual obligations as of December 31, 2003, the last
fiscal year-end date, are as follows (in thousands):
Contractual 2-3 4-5 More than
Obligations Total 1 Year Years Years 5 Years
- --------------- ---------- -------- -------- -------- ---------
Long-term Debt $ 370,000 $ - $ 20,000 $125,000 $ 225,000
Capital Leases 1,316 647 669 - -
Operating Leases 1,355,531 237,821 438,057 318,519 361,134
---------- -------- -------- -------- ---------
Total $1,726,847 $238,468 $458,726 $443,519 $ 586,134
---------- -------- -------- -------- ---------
Other Financial Measurements: Working Capital
At September 30, 2004, we had cash and cash equivalents of $145.9 million and a
positive working capital balance of $55.6 million. Prior to the second quarter
of 2004 we had operated with a working capital deficit. The current period
positive working capital balance was primarily due to the discontinuation of
prepayments on our term facility and the cessation of all activity related to
our share repurchase program in connection with the proposed merger with an
affiliate of LGP. Prior to the second quarter of 2004 the working capital
deficits were 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 that 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 useful 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 may be 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 existence of a working capital deficit does not affect
our ability to operate our business and meet our obligations as they come due.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
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, 2003 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,
net; 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, 2003 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE 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 September 30, 2004, 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 September 30, 2004 our interest
expense would have increased by approximately $1.3 million based on our
outstanding balance on the facility as of September 30, 2004.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
We evaluated, under the supervision and with the participation of our
management, including our Chief Executive Officer and our Chief Financial
Officer, the effectiveness of our disclosure controls and procedures as of the
end of the period covered by this report pursuant to Rule 13a-15(b) under the
Securities Exchange Act of 1934. Based on the evaluation, our Chief Executive
Officer and the Chief Financial Officer have concluded that our disclosure
controls and procedures are effective in ensuring that information required to
be disclosed is recorded, processed, summarized and reported in a timely
manner.
Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that
occurred during our last fiscal quarter that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
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, and Section 21E of
the Securities Exchange Act of 1934, 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
filed with 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 materialize, our business, financial condition,
liquidity and results of operations could be harmed, and the value of our
securities could fall.
Failure to complete our proposed merger could negatively impact the market
price of our common stock. If the merger is terminated and our board of
directors seeks another merger or business combination, shareholders cannot be
certain that we will be able to find a partner willing to pay an equivalent or
better price than the price to be paid in the merger.
Completion of the merger contemplated by the amended and restated merger
agreement is subject to a number of contingencies, including approval by a
majority of our shareholders (with shares held by Mark J. Wattles counted
toward determining the number of shares outstanding, but not counted toward
reaching majority approval), the completion of the financing, and other
customary closing conditions. Prior to execution of the amended and restated
merger agreement, Leonard Green & Partners, L.P. had informed us that, due to
industry and market conditions, Leonard Green & Partners, L.P. believed the
financing condition to the completion of the merger (on the terms set forth in
the original merger agreement dated March 28, 2004) would not be satisfied.
Notwithstanding our execution of the amended and restated merger agreement, we
do not assure you that a merger with Carso will be completed, or if completed,
that it would be completed on terms that do not differ materially from those in
the amended and restated merger agreement. In addition, eight class action
lawsuits have been filed naming us, the members of our board of directors, one
of our executive officers and Leonard Green & Partners. The lawsuits seek to
enjoin the completion of the merger.
Uncertainties associated with the proposed merger may cause Hollywood to lose
key personnel.
If the merger is not completed for any reason, Hollywood will be subject to a
number of risks, including:
- - the market price of Hollywood common stock may decline to the extent
the current market price reflects an assumption that the merger will be
completed; and
- - costs related to the merger, such as legal and accounting fees and a
portion of the investment banking fees and, in certain circumstances,
termination and expense reimbursement fees, must be paid even if the
merger is not completed and will be expensed in the fiscal period in
which termination occurs.
We face intense competition in the rental and sale of our products.
The home video and video game industries are fragmented and highly competitive.
We compete for the rental and sale of our products with:
- - local, regional and national video retail stores, including those
operated by Blockbuster, Inc., the largest video retailer in the United
States, and Movie Gallery;
- - mass merchants, including Wal-Mart;
- - specialty retailers, including GameStop, Electronics Boutique and
Suncoast;
- - supermarkets, pharmacies, convenience stores, bookstores and other
retailers that rent or sell our products as a component, rather than the
focus, of their overall business;
- - Internet-based mail-delivery home video rental subscription services,
such as Netflix;
- - mail order operations and online stores, including Amazon.com; and
- - noncommercial sources, such as libraries.
In particular, substantially all of our stores compete with stores operated by
Blockbuster, most in very close proximity. Some of our competitors, including
Blockbuster, have significantly greater financial and marketing resources,
market share and name recognition than Hollywood. In addition, some retailers
sell DVDs and videocassettes at lower prices in order to increase overall
traffic to their stores or businesses, and mass merchants may be more willing
to sell at lower, or even below wholesale, prices because of the variety of
their inventory. As a result of direct competition with Blockbuster and
others, pricing strategies for movies and video games is a significant
competitive factor in our business.
If we do not compete effectively with competitors in the home video industry or
the video game industry, our revenues and/or our profit margins could decline
and our business, financial condition, liquidity and results of operations
could be harmed.
New technologies could create competitive advantages for our competitors.
Advances in technologies that benefit our competitors may materially adversely
effect our business. For example, advances in cable and direct broadcast
satellite technologies, including high definition digital television
transmissions offered through those systems, may adversely affect public demand
for video store rentals. Expanded content available through these media,
including movies, specialty programming and sporting events could result in
fewer movies being rented. In addition, higher quality resolution and sound
offered through these services and technologies could require us to increase
capital expenditures: for example, to upgrade our DVD inventory to provide
movies in high definition.
Cable and direct broadcast satellite technologies 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. Certain cable companies, Internet service providers and
others are also 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 pay-per-view, video-on-demand or other alternative movie delivery systems
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
home video rental industry. This risk would be exacerbated if these
competitors receive the movies from the studios at the same time video stores
do and by the increased popularity and availability of personal digital
recording systems (such as TiVo) that allow viewers to record, pause, rewind
and fast forward live broadcasts and create their own personal library of
movies.
In addition, we may compete in the future with other distribution or
entertainment technologies that are either in their developmental or testing
phases now or that may be developed in the future. For example, some retailers
have begun to rent or sell DVDs through kiosks or vending machines.
Additionally, the technology exists to offer disposable DVDs which would allow
a consumer to view a DVD an unlimited number of times during a specified period
of time, at the end of which the DVD becomes unplayable. We cannot predict the
impact that future technologies will have on our business.
If any of the technologies described above create a competitive advantage for
our competitors, our business, financial condition, liquidity and results of
operations could be harmed.
Changes in the way that movie studios price DVDs and/or videocassettes could
adversely affect our revenues and profit margins.
Movie studios use various pricing models to maximize the revenues they receive
from the home video industry. Historically, these pricing models have enabled
a profitable home video rental market to exist and compete effectively with
mass merchant retailers and other sellers of home movies. If the studios were
to significantly change their pricing policies in a manner that increases our
cost of obtaining movies under revenue sharing or other arrangements, or
decreases wholesale prices leading consumers to purchase movies instead of
renting movies, our revenues and/or profit margins could decrease, and our
business, financial condition, liquidity and results of operations could 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. 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 margins could decrease, and our
business, financial condition, liquidity and results of operations could be
harmed.
We could lose a significant competitive advantage if the movie studios were to
adversely change their current distribution practices.
Currently, Hollywood Video stores and other retail outlets 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 and other retail
outlets 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 home video 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 Hollywood Video
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
customers.
We are dependent on the introduction of new and enhanced video games and video
game systems to attract and retain video game customers. We currently
anticipate that hardware manufactures will release new products with enhanced
features some time within the next few years. If manufacturers fail to
introduce or delay the introduction of new video games and systems, the demand
for video games available to us could decline, negatively impacting our
revenues, and our business, financial condition, liquidity and results of
operations could be harmed. In addition, although past introductions of new
hardware platforms have expanded sales and rentals, we cannot be certain that
the next generation will provide similar benefits to our business.
Expansion of our store base and new business initiatives have placed and may
continue to 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 the second half of 2002 we resumed
opening Hollywood Video stores and began a significant remerchandising
initiative to add Game Crazy departments to existing Hollywood Video stores,
opening 41 new Hollywood Video stores and adding 207 Game Crazy departments.
In 2003, we opened 102 Hollywood Video stores and added 319 Game Crazy
departments. In 2004, we anticipate opening approximately 100 new Hollywood
Video stores and adding approximately 120 new Game Crazy departments. This
expansion has placed, and may continue to place, increased pressure on our
operating and management controls. To manage a larger store base and a growing
video game buy, sell and trade business, 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 profitably 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, these
newly opened stores could adversely affect the revenues and profitability of
other stores in the same market.
We also regularly consider new business initiatives that would enhance, expand,
or complement our position in the entertainment industry. Some of those under
consideration, such as in-store subscription services and mail delivery rental
services, are closely related to our existing business. Any initiative
undertaken could require significant capital investment and senior management
involvement, could be unsuccessful, or, even if successful, could have a short-
term adverse impact on our financial condition and operating results.
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, including Mark J. Wattles, our founder, chairman and
chief executive officer. These key management personnel may not be able to
continue 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 DVD, videocassette and video game to determine
appropriate buying, distribution and disposition of movies and video games. In
addition, our Game Crazy point-of-sale system is used to determine appropriate
used game trade-in values and used game prices. 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 DVD, videocassette 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.
If we experience delays in implementing and testing our internal control over
financial reporting, our independent auditors may be unable to attest to our
report on its effectiveness, and our stock price could suffer.
On October 6, 2004 we received from PricewaterhouseCoopers, our independent
auditors, a letter noting that, if our implementation of systems necessary for
the auditors' attestation of management's report on internal control over
financial reporting is delayed due to remediative or other requirements, our
auditors may not have the resources available to timely complete their
assessment and report on internal control over financial reporting. Some
slippage in our implementation schedule has already occurred due to remediative
action on some of our information systems, which has reduced the margin for
implementing any additional remediative action. Although we believe our
internal control over financial reporting is effective, if management or our
independent auditors are unable to report on its effectiveness when we file our
annual report for the fiscal year ending December 31, 2004, our stock price may
suffer.
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 September 30, 2004, we had total consolidated long-term debt, including
capital leases, of approximately $351.4 million. We and our subsidiary could
incur substantial additional indebtedness in the future, including the
financing required to complete the merger, which will substantially increase
our indebtedness. An increase in our indebtedness could intensify the related
risks that we now face. 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 September 30, 2004, 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;
- - repurchase shares of our common stock;
- - 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;
- - pay dividends;
- - 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 home video rental records and
access and use of Hollywood 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 and game 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 movies, games and game
hardware;
- - 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;
- - initial investments in and 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 and video game 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 these factors, 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. We
are aware of eight putative class action lawsuits related to the merger
agreement. We may incur substantial costs related to our defense and we may
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. These 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.
We are party to various legal proceedings with respect to which a negative
outcome could have a material adverse effect on our operations.
In addition to the merger-related litigation described above, we have been
named in several purported class action lawsuits alleging various causes of
action, including claims regarding our membership application and additional
rental period charges. We have been successful in obtaining dismissal of three
of the actions filed against us. A statewide class action entitled George
Curtis v. Hollywood Entertainment Corp., dba Hollywood Video, Defendant, No.
01-2-36007-8 SEA was certified on June 14, 2002 in the Superior Court of King
County, Washington. On May 20, 2003, a nationwide class action entitled George
DeFrates v. Hollywood Entertainment Corporation, No. 02 L 707 was certified in
the Circuit Court of St. Clair County, Twentieth Judicial Circuit, State of
Illinois.
In 2003, we were named as a defendant in two complaints regarding wage and hour
claims in California. In 2004, an additional suit was filed with substantially
similar claims. The plaintiffs are seeking to certify a class action alleging
that certain California employees were denied meal and rest periods. There are
several additional related wage and hours claims for unpaid overtime, late
payment of wages and off the clock work.
In addition, we have been named to various other claims, disputes, legal
actions and other proceedings involving contracts, employment and various other
matters.
A negative outcome in any of the foregoing actions could harm our business,
financial condition, liquidity or results of operations and could cause us to
vary aspects of our operations. In addition, prolonged litigation, regardless
of which party prevails, could be costly, divert management attention or result
in increased costs of doing business.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We have been named in several purported class action lawsuits alleging various
causes of action, including claims regarding its membership application and
additional rental period charges. We have vigorously defended these actions and
maintain that the terms of our additional rental charge policy are fair and
legal. We have been successful in obtaining dismissal of three of the actions
filed against us. A statewide class action entitled George Curtis v. Hollywood
Entertainment Corp., dba Hollywood Video, Defendant, No. 01-2-36007-8 SEA was
certified on June 14, 2002 in the Superior Court of King County, Washington. On
May 20, 2003, a nationwide class action entitled George DeFrates v. Hollywood
Entertainment Corporation, No. 02 L 707 was certified in the Circuit Court of
St. Clair County, Twentieth Judicial Circuit, State of Illinois. We received
preliminary approval on August 10, 2004 of an agreement to settle these claims
and expect final approval in June 2005. Notice to class members began on
October 10, 2004 and will last for six months. We believe we have provided
adequate reserves in connection with these lawsuits.
We are aware of eight lawsuits filed in the circuit courts of Oregon for the
counties of Clackamas and Multnomah related to the proposed merger of the
Company with an affiliate of Leonard Green & Partners, L.P. (LGP) pursuant to
the initial Agreement and Plan of Merger, dated as of March 28, 2004, among
Hollywood Entertainment and affiliates of LGP (the "March 28 Merger
Agreement"). These purported class action and derivative suits each seek a
court order enjoining completion of the Merger, and costs and attorneys' fees
to the plaintiffs' lawyers. Some of the suits additionally request damages in
an unstated amount allegedly suffered by our shareholders by reason of the
March 28 Merger Agreement. The Clackamas County suits were consolidated and, on
July 28, 2004, the parties to the Clackamas and Multnomah County suits entered
into a memorandum of understanding regarding a potential settlement of claims.
We described, in a current report on Form 8-K filed July 8, 2004, the terms of
the proposed settlement, which included additional disclosure in our proxy
statement regarding the merger, modifications to the termination fee and
shareholder approval requirements in the March 28 Merger Agreement, covenants
from an affiliate of LGP regarding the future sale of Hollywood Entertainment,
and payment of $995,000 of the plaintiff's attorney fees. We provided a
reserve for this litigation that we believe was adequate. An amended and
restated merger agreement was entered into on October 13, 2004. Plaintiffs in
the consolidated cases have informed us of their intent to file a consolidated
complaint that includes allegations regarding the amended and restated merger
agreement. It is not clear how the reduction in the per share consideration
and other changes in the amended and restated merger agreement will affect the
settlement negotiations and there is no assurance that a settlement will be
effected or that current reserves for this litigation will be adequate.
In 2003, we were named as a defendant in two complaints regarding wage and hour
claims in California. In 2004, an additional lawsuit was filed with
substantially similar claims. The plaintiffs are seeking to certify a class
action alleging that certain California employees were denied meal and rest
periods. There are several additional related wage and hours claims for unpaid
overtime, late payment of wages and off the clock work. A mediation took place
on September 9, 2004 and the parties reached a settlement of all claims alleged
in each of the actions. The parties will jointly move for preliminary approval
of the settlement in November 2004. Following preliminary approval, notice of
the settlement will be provided to class members. We believe we have provided
adequate reserves in connection with these lawsuits.
In addition, we have been named to various other claims, disputes, legal
actions and other proceedings involving contracts, employment and various other
matters. We believe we have provided adequate reserves for contingencies and
that the outcome of these matters should not have a material adverse effect on
our consolidated results of operation, financial condition or liquidity. At
September 30, 2004, the commitments and contingencies reserve was $9.3 million.
At December 31, 2003, the commitments and contingencies reserve was $6.8
million.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
A summary of our purchases of shares of our common stock for the three months
ended September 30, 2004 is as follows (in thousands , except share amounts):
ISSUER PURCHASES OF EQUITY SECURITIES
------------------------------------------------------------
Period Total Average Total Maximum
Number of Price Paid Number of Number(or
Shares per Share Shares Approximate
Purchased Purchased as Dollar
Part of Value)
Publicly of Share
Announced that May
Plans or Yet Be
Programs Purchased
Under the
Plans or
Programs(1)
--------- --------- --------- ---------
July 1-31 - $ - - $ 20,690
August 1-5 - - - $ 20,690
August 6-31 - - - $ 40,951
Sept. 1-30 - - - $ 40,951
--------- --------- ---------
Total - $ - -
========= ========= =========
(1) Hollywood's ability to purchase shares under its publicly announced plan
is limited by its bank credit facility. The calculation is outlined in our
amended credit facility as exhibit 10.1 in our quarterly report on Form 10-Q
for the period ended September 30, 2003. We do not intend to make further
purchases under the plan while our proposed merger transaction is pending.
ITEM 6. EXHIBITS
2.1 Amended and Restated Agreement and Plan of Merger dated October 13, 2004
by and among the Registrant, Carso Holdings Corporation and Hollywood Merger
Corporation (incorporated by reference to Exhibit 2.1 to the Registrant's
current report on Form 8-K filed October 14, 2004).
2.1(a) Agreement and Plan of Merger dated March 28, 2004 by and among the
Registrant, Carso Holdings Corporation and Cosar Corporation (incorporated by
reference to Exhibit 2.1 to the Registrant's current report on Form 8-K filed
March 29, 2004). (This agreement has been superseded by the agreement listed as
Exhibit 2.1).
2.1(b) First Amendment to Agreement and Plan of Merger by and among the
Registrant, Carso Holdings Corporation and Cosar Corporation dated June 4, 2004
(incorporated by reference to Exhibit 2.1 to the Registrant's current report on
Form 8-K filed June 8, 2004). (This amendment has been superseded by the
agreement listed as Exhibit 2.1.)
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).
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).
10.1 Resolutions adopted by the Board of Directors of the Registrant October
13, 2004 regarding Indemnification of Specified Officers.
31.1 Certification of Chief Executive Officer of Registrant Pursuant to SEC
Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
31.2 Certification of Chief Financial Officer of Registrant Pursuant to SEC
Rule 13a-14(a)/15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-
Oxley Act of 2002.
32.1 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.
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)
October 21, 2004 /S/Timothy R. Price
- ------------------ -------------------------------------------------
(Date) Timothy R. Price
Chief Financial Officer
(Authorized Officer and Principal Financial and
Accounting Officer of the Registrant)