- - --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
/ X / QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1996
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 its charter)
Oregon 93-0981138
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
25600 S.W. Parkway Center Drive, Wilsonville, Oregon 97070
(Address of principal executive office, including 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 shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
------- ------
As of May 14, 1996, there were 33,879,738 shares of the registrant's Common
Stock outstanding.
- - --------------------------------------------------------------------------------
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
INDEX
PART I. FINANCIAL INFORMATION Page No.
--------
Item 1. Consolidated Financial Statements: 3
Consolidated Statements of Operations 3
Three months ended March 31, 1996 and 1995
Consolidated Balance Sheets 4
March 31, 1996 and December 31, 1995
Consolidated Statements of Cash Flows 5
Three months ended March 31, 1996 and 1995
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 12
Signatures 13
2
<PAGE>
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share and other operating data)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
1996 1995
-------------- ------------
(Unaudited)
<S> <C> <C>
Revenue:
Rental revenue $ 54,749 $ 22,961
Product sales 10,324 4,127
-------------- ------------
65,073 27,088
Operating costs and expenses:
Cost of product sales 6,245 2,688
Operating and selling 46,217 18,634
General and administrative 4,456 1,410
Amortization of intangibles 1,524 581
-------------- ------------
Operating income 6,631 3,775
Nonoperating income (expense):
Interest income 97 303
Interest expense (618) (115)
-------------- ------------
Income before income taxes 6,110 3,963
Income taxes 2,383 1,460
-------------- ------------
Net income $ 3,727 $ 2,503
============== ============
Net income per share $ 0.11 $ 0.08
============== ============
Weighted average shares outstanding 35,127 30,312
Number of stores at end of period 330 129(1)
- - ------------------
<FN>
(1) Excludes stores acquired from Title Wave, Inc. on March 29, 1995.
</FN>
</TABLE>
3
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<TABLE>
<CAPTION>
March 31, December 31,
1996 1995
---------------- ----------------
ASSETS (Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 3,889 $ 29,980
Construction and other receivables 12,022 16,154
Merchandise inventories 27,226 26,701
Prepaid expenses and other current assets 682 845
---------------- ----------------
Total current assets 43,819 73,680
Videocassette rental inventory, net 92,642 86,889
Property and equipment, net 74,819 65,958
Excess of cost over net assets acquired, net 103,349 104,679
Deferred income taxes 1,220 1,345
Other assets 2,137 2,109
---------------- ----------------
Total assets $ 317,986 $ 334,660
================ ================
LIABILITIES, MANDATORILY REDEEMABLE COMMON STOCK AND
SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 616 $ 7,616
Accounts payable 30,890 42,778
Accrued liabilities 5,436 5,553
Income taxes payable 943 ---
---------------- ----------------
Total current liabilities 37,885 55,947
Long-term debt, less current portion 198 355
Line of credit 51,000 ---
Deferred rent and other liabilities 3,874 3,369
Deferred income taxes 3,475 2,956
---------------- ----------------
96,432 62,627
Commitments and contingencies --- ---
---------------- ----------------
Mandatorily redeemable common stock (Note 2) --- 54,250
---------------- ----------------
Shareholders' equity:
Preferred stock, 25,000.000 shares authorized;
no shares issued and outstanding --- ---
Common stock, no par value, 100,000,000 shares
authorized; 33,879,190 and 36,007,190 shares
issued and outstanding, respectively 201,975 202,005
Retained earnings 22,089 18,362
Intangible assets, net (2,510) (2,584)
---------------- ----------------
Total shareholders' equity 221,554 217,783
---------------- ----------------
Total liabilities and shareholders' equity $ 317,986 $ 334,660
================ ================
</TABLE>
4
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months
Ended March 31,
---------------------------
1996 1995
----------- -----------
(Unaudited)
<S> <C> <C>
Operating activities:
Net income $ 3,727 $ 2,503
Adjustments to reconcile net income to cash
provided by operating activities:
Depreciation and amortization 19,587 8,452
Deferred rent and other liabilities 505 263
Deferred income taxes 644 656
Changes in operating assets and liabilities:
Merchandise inventories (525) (1,399)
Prepaid expenses and other current assets 163 157
Accounts payable (11,888) (7,919)
Accrued liabilities (117) (226)
Income taxes payable 913 209
----------- -----------
Cash provided by operating activities 13,009 2,696
----------- -----------
Investing activities:
Construction and other receivables 4,132 (1,681)
Purchases of videocassette rental inventory, net (20,946) (14,179)
Purchases of property and equipment, net (11,731) (6,108)
Investment in businesses acquired --- (6,995)
Other (148) (161)
----------- -----------
Cash used in investing activities (28,693) (29,124)
----------- -----------
Financing activities:
Proceeds from the issuance of common stock, net --- 140
Proceeds from long-term debt --- 11,000
Repayments of long-term debt (7,157) (1,992)
Repurchase of mandatorily redeemable stock (54,250) ---
Borrowings under line of credit 51,000 ---
----------- -----------
Cash (used) provided by financing (10,407) 9,148
activities
----------- -----------
Decrease in cash and cash equivalents (26,091) (17,280)
Cash and cash equivalents:
Beginning of period 29,980 39,017
----------- -----------
End of period $ 3,889 $ 21,737
=========== ===========
</TABLE>
5
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Financial Statement Presentation:
The consolidated financial statements as of March 31, 1996 and for the
periods ended March 31, 1996 and March 31, 1995 are unaudited and have
been prepared by Hollywood Entertainment Corporation ("the Company")
pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and disclosures normally included in
financial statements prepared in accordance with generally accepted
accounting principles have been omitted pursuant to such rules and
regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading. It is
recommended that these financial statements be read in conjunction
with the consolidated financial statements and notes thereto included
in the Company's annual report on Form 10-K for the year ended
December 31, 1995.
The accompanying interim consolidated financial statements reflect all
adjustments which are, in the opinion of management, necessary to
present fairly the financial position as of March 31, 1996 and the
results of operations and cash flows for the three months ended March
31, 1996 and March 31, 1995. All such adjustments are of a normal and
recurring nature. Certain amounts as of December 31, 1995 and March
31, 1995 have been reclassified to conform with the presentation used
as of March 31, 1996. The results of operations for the interim
periods presented are not necessarily indicative of the results to be
expected for the full year.
2. Acquisition of Video Watch
In August 1995, the Company acquired, in two separate transactions,
the assets of 42 video retail superstores operating under the name of
Video Watch. The aggregate purchase price was approximately $60.3
million, including 2,127,452 shares of the Company's common stock. The
Company granted the sellers an option to sell any of the shares issued
in connection with the Video Watch acquisition to the Company on
January 27, 1996 at the original issuance price of $25.50 per share,
for a maximum repurchase obligation of $54.3 million. Consequently,
the common shares issued in connection with the Video Watch
acquisitions are classified as "Mandatorily Redeemable Common Stock"
at December 31, 1995.
Pursuant to the option described above, in January 1996 the Company
repurchased all of the shares issued in connection with the Video
Watch acquisition. Of the aggregate purchase price of $54.3 million,
$50.0 million was provided by borrowings under the Company's revolving
credit line, and the remainder was provided by then-existing cash
balances.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Results of Operations
The following table sets forth, for the periods indicated, (i) selected
income statement data expressed as a percentage of total revenue and (ii)
the number of stores open at the end of each period:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
------------------------
1996 1995
---------- ---------
(Unaudited)
<S> <C> <C>
Revenue:
Rental revenue 84.1 % 84.8 %
Product sales 15.9 15.2
---------- ---------
100.0 100.0
Operating costs and expenses:
Cost of product sales 9.6 9.9
Operating and selling 71.0 68.8
General and administrative 6.9 5.2
Amortization of intangibles 2.3 2.2
---------- ---------
89.8 86.1
Operating income 10.2 13.9
Nonoperating income (expense), net (0.8) 0.7
---------- ---------
Income before income taxes 9.4 14.6
Income taxes 3.7 5.4
---------- ---------
Net income 5.7 % 9.2 %
========== =========
Number of stores 330 129 (1)
------------------
<FN>
(1) Excludes stores acquired from Title Wave, Inc. on March 29, 1995.
</FN>
</TABLE>
Three Months Ended March 31, 1996 Compared to Three Months Ended March 31, 1995
Revenue
Revenue increased $38.0 million, or 140%, to $65.1 million for the three
months ended March 31, 1996, compared to $27.1 million in the first quarter
of the prior year. Comparable store revenue increased 6%. During the three
months ended March 31, 1996, the Company added 25 superstores, ending the
period with 330 superstores compared to 129 superstores at the end of the
corresponding period in 1995.
7
<PAGE>
Product sales as a percentage of total revenue increased to 15.9% for the
first quarter of 1996 compared to 15.2% for the first quarter of 1995. The
slight increase in product sales as a percentage of revenue reflects the
Company's continued improvements in merchandising techniques.
The Company's pricing of videocassette rentals and merchandise for sale has
not changed significantly compared to the first quarter of 1995.
Operating Costs and Expenses:
Cost of Product Sales
The cost of product sales decreased slightly to 9.6% of total revenue for
the first quarter of 1996 compared to 9.9% for the first quarter of 1995
due to higher gross margins partially offset by increased sales of product
as a percentage of total revenue. The cost of product sales as a percentage
of product sales decreased from 65.1% to 60.5% for the three months ended
March 31, 1995 and 1996, respectively. The gross margin on product sales
has increased due to expanded merchandise offerings with higher gross
margins in 1996 compared to 1995.
Operating and Selling
Operating expenses, which principally consist of all store expenses
including payroll, occupancy, advertising, depreciation and rental revenue
sharing, increased as a percentage of total revenue to 71.0% for the first
quarter of 1996, compared to 68.8% for the same period last year. The
increase was primarily due to higher store payroll and occupancy expenses
as a percentage of total revenue, primarily due to lower average revenue
per store, resulting primarily from the addition during the last nine
months of 1995 and the first three months of 1996 a large number of new and
acquired stores which have lower revenue per store than mature Hollywood
Video stores.
Depreciation expense combined with rental revenue sharing costs was 28.1%
of total revenue for the first quarter of 1996 compared to 30.7% for the
same period in 1995. The combined decrease was primarily due to lower
revenue sharing expense and the implementation of tighter budget
procedures in the purchase of new releases. All other operating and selling
expenses accounted for the remaining change in costs as a percentage of
total revenue in the first quarter of 1996 compared to the same period last
year.
General and Administrative
General and administrative expenses increased from $1.4 million or 5.2% of
total revenue for the three months ended March 31, 1995 to $4.5 million, or
6.9% of total revenue for the three months ended March 31, 1996. The dollar
increase was primarily due to the cost of managing additional stores.
8
<PAGE>
Amortization of Intangibles
Amortization of intangibles increased from $0.6 million, or 2.2% of total
revenue, for the three months ended March 31, 1995 to $1.5 million, or 2.3%
of total revenue, for the three months ended March 31, 1996. The dollar
increase was primarily attributable to the amortization of intangible
assets arising from the Title Wave and Video Watch acquisitions in 1995.
Nonoperating Income (Expense), Net
Net nonoperating income (expense) decreased from $0.2 million for the three
months ended March 31, 1995 to ($0.5) million for the three months ended
March 31, 1996. This change was primarily attributable to the Company's
higher level of borrowing under its revolving line of credit for the first
three months of 1996 compared to the first three months of 1995.
Income Taxes
The Company's effective tax rate increased from 36.8% of income before
income taxes for the three months ended March 31, 1995 to 39.0% for the
three months ended March 31, 1996 due to higher state tax rates in 1996
compared to 1995.
Liquidity and Capital Resources
The Company's principal capital requirements are for opening new stores,
the purchase of rental inventory and the possible acquisition of existing
stores. The Company has funded its operations primarily through cash
generated from operations, the proceeds of four public equity offerings,
loans under the Company's revolving bank line of credit, trade credit and
equipment leases.
The Company ended the period with $3.9 million in cash and cash
equivalents. Working capital as of March 31, 1996 totaled $5.9 million
compared to $17.7 million at December 31, 1995. Videocassette rental
inventories are accounted for as noncurrent assets under generally accepted
accounting principles because they are not assets which are reasonably
expected to be completely realized in cash or sold in the normal business
cycle. Although the rental of this inventory generates a substantial
portion of the Company's revenue, the classification of these assets as
noncurrent excludes them from the computation of working capital. The
acquisition cost of videocassette rental inventories, however, is reported
as a current liability until paid and, accordingly, included in the
computation of working capital. Consequently, the Company believes working
capital is not as significant a measure of financial condition for
companies in the video retail industry as it is for companies in other
industries. Because of the accounting treatment of videocassette rental
inventory as a noncurrent asset, the Company may, from time to time,
operate with a working capital deficit.
9
<PAGE>
Net cash provided by operating activities was $13.0 million during the
three months ended March 31, 1996 compared to $2.7 million for the same
period last year. The increase in cash provided by operations was primarily
due to higher income from operations and higher depreciation and
amortization expenses partially offset by a an increase in accounts
payable.
Cash used in investing activities was $28.7 million for the three months
ended March 31, 1996 compared to $29.1 million for the same period last
year. During the three months ended March 31, 1996, cash used in investing
activities consisted primarily of purchases of videocassette rental
inventory for new and existing stores totaling $20.9 million, capital
expenditures totaling $11.7 million offset by a reduction in construction
and other receivables totaling $4.1 million. Capital expenditures included
the costs to open new stores, remodel certain existing stores and enhance
information systems.
Cash provided by financing activities for the three months ended March 31,
1996 totaled ($10.4) million and included the repurchase of all of the
shares issued in connection with the Video Watch acquisition for aggregate
consideration of $54.3 million. In addition, the Company repaid $7.2
million of long-term debt. Borrowings under the Company's revolving credit
line were $51.0 million at the end the period.
Future capital requirements, other than normal operating expenses, consist
primarily of financing the addition of new retail stores and converting
certain acquired stores to the Hollywood Video name and store design. The
Company anticipates opening at least 185 additional new stores during the
final nine months of 1996 and at least 200 new stores in 1997. Total
capital requirements to open 185 additional stores, including rental
inventory for new stores, are estimated to aggregate approximately $85
million for the last nine months of 1996.
In December 1995, the Company entered into a new revolving credit agreement
with its principal bank and a syndicate of banks to provide for a working
capital line of $75 million. The credit agreement allows the Company to
designate an additional lender to commit up to $25 million on the same
terms and conditions as the new revolving credit agreement. The Company has
not yet identified a lender to provide the additional $25 million of
lending capacity, and there is no assurance an additional lender will make
that commitment. The agreement provides that funds borrowed will bear
interest, at the Company's option, at either LIBOR or the bank's base rate
plus approximately 1.25%, depending on the amount of borrowings. The
Company must also pay a fee of 1/5% per annum on the available and unused
portion of the credit facility. Amounts outstanding under the credit line
are collaterized by substantially all the assets of the Company. The credit
facility expires on December 28, 1998. As of March 31, 1996, $51.0 million
was outstanding under the line, which amount was borrowed to partially fund
the share repurchase described above. The availability of borrowings under
the revolving credit agreement is based on the level of eligible inventory,
the Company's financial performance and compliance with certain covenants
and financial ratios. While the Company believes the maximum amount of
borrowings under the credit line will be available to it in 1996 to
partially fund the Company's expansion program and for other needs, there
may be periods during which the maximum amount will not be available for
borrowing.
Forward-Looking Statements
Certain of the information set forth above under the caption "Liquidity and
Capital Resources" includes "forward-looking statements" within the meaning
of Section 27A of the Securities Act of 1933 and is subject to the safe
harbor created by that section. Certain factors that could cause results to
differ materially from those projected in the forward-looking statements
are set forth under that caption, below and in the following locations in
the Company's Annual Report on Form 10-K for the year ended December 31,
1995: in Item 1 - Business under the captions "Expansion Strategy,"
"Competition," and "Legal Proceedings" and in Item 7 - "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
under the captions "Liquidity and Capital Resources" and "General Economic
Trends, Quarterly Results and Seasonality."
The level of planned new store expansion represents a substantial increase
over prior periods, and the Company does not yet have signed leases for
most of these anticipated new stores. The Company's expansion is dependent
on a number of factors, including its ability to hire, train and assimilate
management and store-level employees, the adequacy of the Company's
financial resources and the Company's ability to identify new markets in
which it can successfully compete, to locate suitable store sites and
negotiate acceptable lease terms and to adapt its purchasing, management
information and other systems to accommodate expanded operations. The
Company's expansion is also dependent on the timely fulfillment by
landlords and others of their contractual obligations to the Company, the
maintenance of construction schedules and the speed at which local zoning
and construction permits can be obtained.
The Company continually reviews its financing options and, although it
currently anticipates funding 1996 expansion through cash on hand, funds
generated from operations, funds borrowed under the Company's revolving
credit facility, equipment leases and trade credit, alternative financing
will be considered if market conditions make it financially attractive, if
the Company's need for funds is greater than expected, if certain of the
sources identified above are unavailable or not available to the extent
anticipated or if 1996 new store expansion exceeds 210 new stores. Failure
to obtain financing to fund the Company's expansion plans or for other
purposes could have a material adverse effect on the Company's results of
operations.
General Economic Trends, Quarterly Results and Seasonality
The Company anticipates that its business will be affected by general
economic conditions and other consumer trends. Future operating results may
be affected by various factors, including variations in the number and
timing of new store openings, the quality and number of new release titles
available for rental and sale, the expense associated with the acquisition
of new release titles, additional and existing competition, marketing
programs,
10
<PAGE>
weather, special or unusual events and other factors that may affect
retailers in general. Any concentration of new store openings and the
related new store pre-opening costs near the end of a fiscal quarter could
have an adverse effect on the financial results for that quarter and could,
in certain circumstances, lead to fluctuations in quarterly financial
results.
The video retail industry generally experiences relative revenue declines
in April and May, due in part to the change to Daylight Savings Time and to
improved weather, and in September and October, due in part to the start of
school and introduction of new television programs. The Company believes
these seasonality trends will continue.
11
<PAGE>
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
In January 1995 Viacom, Inc. filed a lawsuit against the Company in the
U.S. District Court for the District of Oregon alleging unfair competition,
misappropriation of trade secrets and intentional interference with
contracts in connection with the hiring by the Company in 1994 of five
former employees of the Blockbuster Entertainment division of Viacom, Inc.,
three of whom are officers of the Company. In addition, Viacom filed a
separate lawsuit against two of the employees, both of whom are officers of
the Company, in a Florida state court alleging breach of employment
agreements and misappropriation of trade secrets. Viacom sought an
injunction prohibiting the employees from working for the Company in their
current capacities and the payment of money damages by the employees.
In April 1996, the Company and its affected employees settled the
litigation described above. Although the settlement requires the Company
and Blockbuster to keep the terms confidential, the Company believes the
settlement will not adversely affect its operations and will not have a
material adverse effect on its financial condition or results of
operations.
In December 1995, three complaints were filed against the Company, certain
of the Company's directors and officers and certain other parties were
consolidated in a single action entitled Murphy v. Hollywood Entertainment
et al., case no. C95-1926-MA, United States District Court for the District
of Oregon. The consolidated complaint purports to be class action
encompassing persons who purchased common stock of the Company between June
20 and December 6, 1995. The complaint alleges violation of certain federal
securities laws with respect to statements made to the public and losses
allegedly suffered by plaintiffs resulting from the decline in the trading
price of the Company's stock. In May 1996, the court certified the class
but dismissed the claims of plaintiffs based on violations of sections 11,
12(2), and 15 of the Securities Act of 1933. The remaining claims deal with
alleged violations of the Securities Exchange Act of 1934. The Company
believes this suit is without merit and will vigorously defend the
litigation. The Company does not believe that the ultimate outcome of the
litigation will have a material adverse effect on the Company's financial
condition, cash flows or results of operations.
12
<PAGE>
HOLLYWOOD ENTERTAINMENT CORPORATION
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOLLYWOOD ENTERTAINMENT CORPORATION
-----------------------------------
(Registrant)
May 15, 1996 MARK J. WATTLES
- - -------------------------- -----------------------------------
(Date) Mark J. Wattles
Chairman of the Board, President
and Chief Executive Officer
(Principal executive officer
of the registrant)
May 15, 1996 DOUGLAS A. GORDON
- - -------------------------- ------------------------------------
(Date) Douglas A. Gordon
Senior Vice President-Finance
(Principal financial and
accounting officer
of the registrant)
13
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1996
<CASH> 3,889
<SECURITIES> 0
<RECEIVABLES> 12,022
<ALLOWANCES> 0
<INVENTORY> 27,226
<CURRENT-ASSETS> 43,819
<PP&E> 74,819
<DEPRECIATION> 19,587
<TOTAL-ASSETS> 317,986
<CURRENT-LIABILITIES> 37,885
<BONDS> 0
0
0
<COMMON> 201,975
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 317,986
<SALES> 10,324
<TOTAL-REVENUES> 65,073
<CGS> 6,245
<TOTAL-COSTS> 58,442
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 618
<INCOME-PRETAX> 6,110
<INCOME-TAX> 2,383
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,727
<EPS-PRIMARY> 0.11
<EPS-DILUTED> 0.11
</TABLE>