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Previous: HOLLYWOOD ENTERTAINMENT CORP, 10-Q/A, 2000-03-03 |
Next: JANUS ASPEN SERIES, 24F-2NT, 2000-03-03 |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q/A
Amendment No. 1
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999 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)
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25600 Southwest 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. [X] Yes [ ] No
As of November 8, 1999 there were 45,795,234 shares of the registrant's Common Stock outstanding.
HOLLYWOOD ENTERTAINMENT CORPORATION
September 30, 1999
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Statements of Operations
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
Liquidity and Capital Resources
Item 3: Quantitative and Qualitative Disclosures about Market Risks
PART II. OTHER INFORMATION
Item 6: Exhibits and Reports on Form 8-K
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
Revenue: (Note 7)
Rental revenue................... $221,292 $156,008 $648,235 $438,944
Product sales.................... 45,027 28,064 134,981 81,810
---------- ---------- ---------- ----------
266,319 184,072 783,216 520,754
---------- ---------- ---------- ----------
Cost of sales:
Cost of rental revenue........... 67,440 42,573 199,186 119,644
Cost of product.................. 33,702 18,103 97,022 52,777
---------- ---------- ---------- ----------
101,142 60,676 296,208 172,421
---------- ---------- ---------- ----------
Gross margin....................... 165,177 123,396 487,008 348,333
---------- ---------- ---------- ----------
Operating expenses:
Operating and selling............ 132,813 94,454 373,971 263,288
General and administrative....... 16,960 8,438 50,220 24,404
Amortization of intangibles...... 14,388 1,522 42,704 4,459
---------- ---------- ---------- ----------
164,161 104,414 466,895 292,151
---------- ---------- ---------- ----------
Income from operations (Note 7).... 1,016 18,982 20,113 56,182
Nonoperating income (expense):
Interest income.................. 4 - 77 89
Interest expense................. (11,999) (8,760) (33,109) (23,668)
---------- ---------- ---------- ----------
Income (loss) before
income taxes (Note7).............. (10,979) 10,222 (12,919) 32,603
Provision for income taxes......... (643) (4,140) (9,809) (13,204)
---------- ---------- ---------- ----------
Income (loss) before cumulative
effect of a change in
accounting principle.............. (11,622) 6,082 (22,728) 19,399
Cumulative effect of a change
in accounting principle (net
of income tax benefit
of $983).......................... - - (1,444) -
---------- ---------- ---------- ----------
Net income (loss).................. ($11,622) $6,082 ($24,172) $19,399
========== ========== ========== ==========
Net income (loss) per share
before cumulative effect of
a change in accounting
principle
Basic............................ ($0.25) $0.16 ($0.50) $0.53
Diluted.......................... ($0.25) $0.16 ($0.50) $0.52
Net income (loss) per share:
Basic............................ ($0.25) $0.16 ($0.53) $0.53
Diluted.......................... ($0.25) $0.16 ($0.53) $0.52
Weighted average shares
outstanding:
Basic............................ 45,743 36,943 45,522 36,904
Diluted.......................... 45,743 37,907 45,522 37,622
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(unaudited)
September 30, December 31,
1999 1998
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents......................... $3,949 $3,975
Accounts receivable............................... 40,593 40,862
Merchandise inventories........................... 61,375 58,083
Prepaid expenses and other current assets......... 10,857 12,138
------------ ------------
Total current assets.............................. 116,774 115,058
Videocassettes rental inventory, net............... 310,048 259,255
Property and equipment, net........................ 356,697 328,182
Goodwill, net...................................... 158,992 187,607
Deferred income tax................................ 42,094 35,513
Other assets, net.................................. 13,320 10,715
------------ ------------
$997,925 $936,330
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations....... $2,418 $8,418
Accounts payable.................................. 84,534 107,865
Accrued expenses.................................. 32,509 34,664
Accrued revenue sharing........................... 16,388 13,500
Accrued interest.................................. 4,311 9,693
Income taxes payable.............................. 4,524 5,739
------------ ------------
Total current liabilities........................ 144,684 179,879
Long-term obligations, less current portion........ 487,172 383,727
Other liabilities.................................. 33,443 25,133
------------ ------------
665,299 588,739
Shareholders' equity:
Preferred stock, 19,500,000 shares authorized;
no shares issued and outstanding................. - -
Common stock, 100,000,000 shares authorized;
and 45,776,722 and 44,933,055 shares issued
and outstanding, respectively.................... 363,274 354,067
Retained deficit (30,648) (6,476)
------------ ------------
Total shareholders' equity....................... 332,626 347,591
------------ ------------
$997,925 $936,330
============ ============
The accompanying notes are an integral part of this financial statement.
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
Nine Months Ended
September 30,
----------------------
1999 1998
---------- ----------
Operating activities:
Net income (loss)....................................... ($24,172) $19,399
Adjustments to reconcile net income (loss)
to cash provided by operating activities:
Cumulative effect of a change in
accounting principle................................. 1,444 -
Depreciation and amortization.......................... 164,066 149,684
Change in deferred rent................................ 2,286 3,171
Change in deferred income taxes........................ (557) 249
Net change in operating assets and liabilities:
Accounts receivable.................................. 269 (5,035)
Merchandise inventories.............................. (3,292) 8,193
Accounts payable..................................... (23,331) (1,652)
Accrued interest..................................... (5,382) (4,894)
Other current assets and liabilities................. (646) 2,541
---------- ----------
Cash provided by operating activities.................... 110,685 171,656
---------- ----------
Investing activities:
Purchases of videocassette rental inventory, net........ (125,855) (189,561)
Purchase of property and equipment, net................. (71,273) (94,309)
Investment in businesses acquired....................... (15,976) -
Increase in intangibles and other assets................ (4,259) (6,915)
---------- ----------
Cash used in investing activities........................ (217,363) (290,785)
---------- ----------
Financing activities:
Issuance of long-term obligations....................... 50,000 -
Repayments of long-term obligations..................... (7,555) (1,779)
Repurchase of common stock.............................. - (6,185)
Tax benefit from exercise of stock options.............. 5,151 1,173
Proceeds from exercise of stock options................. 4,056 2,140
Increase in revolving loan, net......................... 55,000 122,001
---------- ----------
Cash provided by financing activities.................... 106,652 117,350
---------- ----------
Decrease in cash and cash equivalents.................... (26) (1,779)
Cash and cash equivalents at beginning of year........... 3,975 3,909
---------- ----------
Cash and cash equivalents at end of third quarter........ $3,949 $2,130
========== ==========
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 have been condensed or omitted pursuant to those rules and regulations, although the Company believes that the disclosures made are adequate to make the information presented not misleading. The information furnished reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the interim periods presented, and which are of a normal, recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's annual report on Form 10-K/A Amendment No. 1 for the current year ended December 31, 1998, filed with the Securities and Exchange Commission.
The consolidated financial statements included herein have been prepared in accordance with the accounting policies described in Note 1 to the December 31, 1998 audited consolidated financial statements included in the Company's Form 10-K/A Amendment No. 1. Certain prior year amounts have been reclassified to conform to the presentation used for the current year.
An analysis of the shareholders' equity amounts for the three quarters ended September 30, 1999 is as follows:
(In thousands, except share amounts)
Common Stock
--------------------- Retained
Shares Amount Deficit Total
----------- --------- --------- ---------
Balance at December 31, 1998 .. 44,933,055 $354,067 ($6,476) $347,591
Issuance of common stock
under option plan.......... 843,667 4,056 - 4,056
Tax benefit from exercise
of stock options........... - 5,151 - 5,151
Net loss..................... - - (24,172) (24,172)
----------- --------- --------- ---------
Balance at September 30, 1999.. 45,776,722 $363,274 ($30,648) $332,626
=========== ========= ========= =========
In June 1999, the Company issued an additional $50 million principal amount senior subordinated notes (the "1999 Notes") due August 15, 2004. The 1999 Notes are substantially identical to the $200 million 10.625 % senior subordinated notes due August 15, 2004. The proceeds from the 1999 Notes, net of offering costs of approximately $1.7 million, were used to repay a portion of the amounts outstanding under the Company's revolving credit facility.
The Company leases all of its stores, corporate offices, distribution center and zone offices under non-cancelable operating leases. All of the Company's stores have an initial operating lease term of five to fifteen years and most have options to renew for between five and fifteen additional years. Most operating leases require payment of property taxes, utilities, common area maintenance and insurance. Total rent expense, including related lease-required cost was $51,013 and $146,757 for the third quarter and current year three quarters, respectively, compared with $40,293 and $111,060 for the corresponding periods of the prior year.
Basic earnings per share is calculated based on income available to common shareholders and the weighted-average number of common shares outstanding during the reported period. Diluted earnings per share includes additional dilution from the effect of potential issuances of common stock, such as stock issuable pursuant to the exercise of stock options, warrants outstanding and the conversion of debt.
The following table is a reconciliation of the basic and diluted earnings per share computations:
Nine Months Ended
September 30,
(In thousands, except per share amounts)
---------------------------------------------------------
1999 1998
---------------------------- ----------------------------
Per Per
Share Share
Income Shares Amounts Income Shares Amounts
--------- --------- -------- --------- --------- --------
Basic income
(loss) per share .. ($24,172) 45,522 ($0.53) $19,399 36,904 $0.53
Effect of dilutive
securities:
Stock options .... - - - 718
--------- --------- --------- ---------
Diluted income
(loss) per share .. ($24,172) 45,522 ($0.53) $19,399 37,622 $0.52
========= ========= ======== ========= ========= ========
Due to the Company's loss in the first three quarters of 1999, stock options accounted for using treasury stock method would be antidilutive. Accordingly, 2.3 million shares have been excluded from the dilutive net loss per share calculation.
In April 1998, SOP 98-5, "Reporting on the Cost of Start-up Activities" was finalized, which requires that costs incurred for start-up activities, such as store openings, be expensed as incurred. The Company adopted SOP 98-5 effective January 1, 1999. The cumulative effect of the change in accounting principle was to increase net loss by $1.4 million, net of tax benefit.
In June 1997, the Financial Accounting Standards Board (FASB) issued Statement No. 131, "Disclosures about Segments of an Enterprise and Related Information" effective for fiscal years beginning after December 15, 1997. The Company adopted Statement No. 131 in 1998.
The Company identifies its segments based on management responsibility. The Company has two segments, the Hollywood Video segment, which consists of the Company's 1,474 retail stores located in 44 states and the District of Columbia, and the Reel.com segment, which is the leading website for film related content and commerce. The Company measures segment profit as operating profit, which is defined as income before interest expense and income taxes. Information on segments and a reconciliation to income before income taxes are as follows (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- -----------------------------
Hollywood Hollywood
Video Real.com Total Video Real.com Total
--------- --------- --------- --------- --------- ---------
Revenues............. $256,201 $10,118 $266,319 $758,352 $24,864 $783,216
Depreciation and
amortization........ 39,639 13,564 53,203 124,945 39,121 164,066
Operating income
(loss)(1)........... 23,703 (22,687) 1,016 84,027 (63,914) 20,113
Interest
expense, net........ 10,737 1,262 11,999 30,389 2,720 33,109
Total assets......... 933,316 64,609 997,925 933,316 64,609 997,925
Purchase of
property and
equipment, net...... 23,741 2,060 25,801 67,124 4,149 71,273
(1) Reel.com's operating loss includes $12.5 million and $37.6 million in goodwill amortization for the third quarter and current year three quarters, respectively. Excluding the goodwill amortization, Reel.com's operating loss would have been $10.1 million and $26.3 million for the third quarter and current year three quarters, respectively.
There was only one segment, Hollywood Video, in the prior year three quarters ended September 30, 1998.
On November 1, 1999, the Company and Twentieth Century Fox Home Entertainment ("Fox") reached a settlement of their dispute. Fox had filed suit in Santa Monica Superior Court alleging fraud and interference with Fox's contract with Rentrak. The Company incurred $2.3 million in settlement and related legal costs.
On January 24, 2000, the Company and Rentrak Corporation reached a settlement of their dispute concerning revenue sharing videocassettes Rentrak had provided to the Company. The settlement agreement resolves all disputes between Rentrak and the Company and dismisses all claims against the Company. The Company incurred $23.1 million in settlement and legal costs, which includes $8.0 million in cash to cover outstanding invoices and consideration for business disruption payable to Rentrak, $6.0 million to cover Rentrak's legal fees and costs, and the issuance of 200,000 shares of the Company's common stock to Rentrak. The Company also incurred $5.8 million in legal fees related to the lawsuit.
Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations
Results of Operations
Summary Results of Operations
The Company's loss before cumulative effect of a change in accounting principle was $11.6 million and $22.7 million for the third quarter and current year three quarters, respectively, compared with net income of $6.1 million and $19.4 million for the corresponding periods of the prior year. The decrease in earnings was primarily due to Reel.com goodwill amortization of $12.5 million and $37.6 million for the third quarter and current year three quarters, respectively, and a $2.3 million charge for the settlement of the Fox lawsuit in the current year third quarter (see Note 8).
The following table sets forth, (i) selected results of operations data expressed as a percentage of total revenue; (ii) other financial data; and (iii) selected operating data .
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ---------------------
1999 1998 1999 1998
---------- ---------- ---------- ----------
(unaudited) (unaudited)
Revenue:
Rental revenue................... 83.1 84.8 82.8 84.3
Product sales.................... 16.9 15.2 17.2 15.7
---------- ---------- ---------- ----------
100.0 100.0 100.0 100.0
---------- ---------- ---------- ----------
Gross margin....................... 62.0 67.0 62.2 66.9
Operating expenses:
Operating and selling............ 49.9 51.3 47.7 50.6
General and administrative....... 6.4 4.6 6.4 4.7
Amortization of intangibles...... 5.3 0.8 5.5 0.8
---------- ---------- ---------- ----------
61.6 56.7 59.6 56.1
---------- ---------- ---------- ----------
Income from operations............. 0.4 10.3 2.6 10.8
Nonoperating income (expense),
net............................... (4.5) (4.7) (4.2) (4.5)
---------- ---------- ---------- ----------
Income (loss) before
income taxes ..................... (4.1) 5.6 (1.6) 6.3
Provision for income taxes......... (0.3) (2.3) (1.3) (2.6)
---------- ---------- ---------- ----------
Income (loss) before cumulative
effect of a change in
accounting principle.............. (4.4) 3.3 (2.9) 3.7
Cumulative effect of a change
in accounting principle........... - - (0.2) -
---------- ---------- ---------- ----------
Net income (loss).................. (4.4) 3.3 (3.1) 3.7
========== ========== ========== ==========
________________________________________________________________________________
Other Data:
Rental margin...................... 69.5% 72.7% 69.3% 72.7%
Product margin..................... 25.2% 35.5% 28.1% 35.5%
________________________________________________________________________________
EBITDA (3):
Hollywood Superstores............. $62,807 $72,217 $205,926 $204,769
Reel.com.......................... (9,124) - (24,573) -
---------- ---------- ---------- ----------
Consolidated EBITDA............... 53,683 72,217 181,353 204,769
Add special charges (4)............ - - 1,444 -
Add non-cash expenses.............. 14,142 5,115 37,820 14,649
Less existing store investment
for new release rental inventory.. (32,615) (46,802) (96,229) (131,683)
---------- ---------- ---------- ----------
Adjusted EBITDA (5)................ $35,210 $30,530 $124,388 $87,735
========== ========== ========== ==========
Cash flows from:
Operating activities............ 49,814 68,120 110,685 171,656
Investing activities............ (71,282) (114,797) (217,363) (290,785)
Financing activities............ 19,269 44,839 106,652 117,350
________________________________________________________________________________
Operating Data:
Number of stores at quarter end.... 1,474 1,134 1,474 1,134
Comparable store revenue
increase (6)...................... 11% 7% 16% 4%
________________________________________________________________________________
(1) Rental gross margin as a percentage of rental revenue.
(2) Product gross margin as a percentage of rental revenue.
(3) EBITDA consists of operating income before interest, taxes, depreciation and amortization. EBITDA should not be viewed as a measure of financial performance under Generally Accepted Accounting Principles (GAAP) or as a substitute for GAAP measurements such as net income or cash flow from operations. EBITDA is not necessarily comparable to other companies due to the lack of uniform definition of EBITDA by all companies.
(4) The special charge relates to the cumulative effect of a change in accounting principle resulting from the adoption of SOP 98-5. See Note 6 to the consolidated financial statements.
(5) Adjusted EBITDA represents income from operations before depreciation and amortization plus non-cash expenses that reduce EBITDA, less the cost of acquiring new release videocassettes and game inventory which are capitalized. Adjusted EBITDA is consistent with the calculation specified in the Company's debt convenants related to the line of credit facility. Adjusted EBITDA should not be viewed as a measure of financial performance under GAAP and should not be considered as an alternative to cash flows from operating activities (as determined in accordance with GAAP) as a measure of liquidity. Our calculation of adjusted EBITDA is not necessarily comparable to other companies due to the lack of uniform definitions of EBITDA by all companies.
(6) A store is comparable after it has been open and owned by the Company for 12 full months. An acquired store converted to the Hollywood Video name and store design is removed from the comparable store base when the conversion process is initiated and returned 12 full months after reopening.
Revenue
Revenue increased by $82.2 million, or 45%, in the third quarter and $262.5 million, or 50%, in the current year three quarters compared with the corresponding periods of the prior year, respectively, primarily due to the addition of 346 superstores in the twelve months ended September 30, 1999. Revenue was also favorably impacted by an increase of 11% and 16% in comparable store revenue in the third quarter and current year three quarters, respectively, and the purchase of Reel.com in October 1998, which added $10.1 million and $24.9 million in revenue in the third quarter and current year three quarters, respectively, (of which $9.7 million and $23.6 million was on-line revenue, respectively).
Gross Margin
Rental margin as a percentage of rental revenue decreased to 69.5% and 69.3% in the current year third quarter and three quarters, compared to 72.7% in the corresponding periods of the prior year. The decrease in rental margins in both the current year third quarter and three quarters primarily relates to increased revenue sharing payments to studios and increased rental revenues. Pursuant to the change in accounting method adopted on October 1, 1998, revenue sharing payments are expensed net of $4 salvage value per tape and rental tape amortization was accelerated. During the current year third quarter and three quarters, payments made pursuant to the revenue sharing agreements increased by $43.5 million and $118.0 million, respectively, as compared to the corresponding periods of the prior year. The increase was partially offset by a decrease in rental tape amortization in the current year third quarter and three quarters of $18.5 million and $37.8 million, respectively, as compared to the corresponding periods of the prior year. The Company was not operating under the revenue sharing models during the first three quarters of 1998.
Product margin as a percentage of product sales, excluding Reel.com, decreased from 35.5% for both the prior year third quarter and prior year three quarters to 31.2% in the current year third quarter and 33.0% in the current year three quarters. The Company's gross margin on product sales has been affected by pricing pressure on previously viewed sell-through video merchandise. Product margins as a percentage of product revenue, including Reel.com, was 25.2% and 28.1% in the third quarter and current year three quarters, respectively.
Operating and Selling
Total operating and selling expenses of $132.8 million and $374.0 million for the current year third quarter and three quarters, respectively, increased $38.4 million and $110.7 million from $94.5 million and $263.3 million from the prior year third quarter and three quarters, respectively. Operating and selling expenses decreased as a percentage of total revenue to 49.9% and 47.7% in the current year third quarter and three quarters, respectively, compared to 51.3% and 50.6% in the corresponding periods of the prior year primarily due to an increase in the average revenue generated per store in 1999. The increase in total operating and selling expenses in both the current year third quarter and three quarters resulted from the following:
An increase in store labor costs of $9.9 million in the third quarter and $28.3 million in the current year three quarters.
An increase in depreciation costs of $4.0 million in the current year third quarter and $12.2 million in the current year three quarters.
An increase in occupancy costs of $10.7 million in the current year third quarter and $35.1 million in the current year three quarters.
An increase in other store operating and selling expenses of $4.7 million in the current year third quarter and $14.0 million in the current year three quarters.
An increase in Reel.com store operating expenses of $9.1 million in the current year third quarter and $21.1 million in the current year three quarters.
With the exception of Reel.com, store operating and selling expenses increased due to the growth in the number of superstores operated by the Company.
General Administrative
General and administrative expenses of $17.0 million and $50.2 million in the current year third quarter and three quarters, respectively, increased by $8.5 million and $25.8 million from $8.4 million and $24.4 million from the prior year third quarter and three quarters, respectively. The increases were due to higher payroll and related expenses and an increase in legal costs. In addition, the Company incurred $2.3 million in settlement charges and related legal costs associated with the settlement of the Fox lawsuit (see Note 8). Finally, Reel.com incurred $1.6 million and $7.2 million in general and administrative costs in the current year and three quarters, respectively.
Amortization of Intangibles
Amortization of intangibles increased by $12.9 million and $38.2 million in the current year third quarter and current year three quarters respectively, compared with the corresponding periods of the prior year, primarily due to the amortization of the costs associated with the Reel.com acquisition.
Nonoperating Income (Expense), Net
Interest expense, net of interest income, increased in the current year third quarter and current year three quarters compared to the corresponding periods of the prior year due to increased levels of borrowings under the Company's revolving credit facility.
Income Taxes
The Company's effective tax rate was a provision of 5.9% and 75.9% in the current year third quarter and current year three quarters, respectively, compared to a provision of 40.5% for both of the corresponding periods in the prior year. The change is due to the Company's net loss for financial reporting purposes versus net income for tax reporting purposes in the current year third quarter and three quarters. This is caused by the non-deductibility of goodwill amortization associated with the Reel.com acquisition.
Liquidity and Capital Resources
The amount of cash generated from operations in the current year three quarters significantly exceeded the current debt service requirements of the Company's long-term obligations. The capital expenditures (including purchases of videocassette inventory) of the Company are primarily funded by the excess operating cash flow and through loans under a revolving line of credit. The Company has a $300 million revolving line of credit available to address the timing of certain working capital and capital expenditure disbursements. As of September 30, 1999, $235 million was outstanding under the revolving credit agreement.
At September 30, 1999, the Company had cash and cash equivalents of $3.9 million and a working capital deficit of $27.9 million. Videocassette rental inventories are accounted for as non-current assets under generally accepted accounting principles because they are not assets which are reasonably expected to be completely realized in cash or sold in the normal business cycle. Although the rental of this inventory generates a substantial portion of the Company's revenue, the classification of these assets as non- current excludes them from the computation of working capital. The acquisition cost of 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 non-current asset, the Company may, from time to time, operate with a working capital deficit.
Cash Provided by Operating Activities
Net cash provided by operating activities decreased by $61.0 million in the current year three quarters compared with the corresponding period of the prior year, primarily due to lower results of operations, net of the non-cash charge for the change in accounting principle (see "Results of Operations"), combined with a net unfavorable change in certain working capital accounts, partly offset by an increase in depreciation and amortization expenses.
Cash Used in Investing Activities
Net cash used in investing activities decreased by $73.4 million in the current year three quarters compared with the corresponding period of the prior year, primarily due to reduced purchases of videocassette rental inventory (excluding revenue sharing titles), including DVD's and video game inventory.
Cash Provided by Financing Activities
Net cash provided by financing activities decreased by $10.7 million in the current year three quarters compared with the corresponding period of the prior year resulting from a decrease in the Company's borrowing under the revolving credit facility combined with increased proceeds from the exercise of the Company's stock options, partially offset by the issuance of an additional $50.0 million of senior subordinated notes. The Company has the availability of up to $300 million in revolving credit loans. The Company may utilize the revolving credit facility as needed for working capital, capital expenditures and general corporate purposes. As of September 30, 1999, $235 million was outstanding under the revolving credit agreement.
Capital Expenditures
The Company's capital expenditures include product for stores, store equipment and fixtures, remodeling a certain number of existing stores, implementing and upgrading office and store technology and opening for new store locations. Each new store opening requires initial capital expenditures, including leasehold improvements, inventory, equipment and costs related to site location, lease negotiations and construction permits. We currently anticipate that capital expenditures of approximately $164.3 million will be incurred in 1999, of which $153.7 million is anticipated to relate to new, relocated and remodeled stores and the conversion of acquired stores. The remaining balance relates to corporate capital expenditures. We expect the total investment per new store to approximate $450,000 which includes rental and merchandise inventory, leasehold improvement, signage, furniture, fixtures and equipment. However, the cost of opening a new store can vary based on size, construction costs in a particular market, and other factors. These capital expenditures will be funded primarily by cash generated from operations, supplemented by the availability of senior revolving line of credit or other forms of equipment financing and/or leasing if necessary.
Year 2000 Compliance
The year 2000 issue is the result of computer programs that were written using two digits rather than four to define the applicable year. For example, computer programs that have time-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. To the extent that the Company's software applications contain source code that is unable to interpret appropriately the upcoming calendar year 2000 and beyond, some level of modification or replacement of such applications will be necessary to avoid system failures and the temporary inability to process transactions or engage in other normal business activities.
The Company's year 2000 project group has been coordinating the Company's year 2000 compliance efforts and has identified all computer-based systems and applications (including embedded systems) the Company uses in its operations that might not be year 2000 compliant. The Company is determining what modifications or replacements will be necessary to achieve compliance. The Company has substantially completed any necessary modifications and replacements; has conducted tests necessary to verify that the modified systems are operational; and has transitioned the compliant systems into the regular operations of the Company. All critical systems and applications are now year 2000 compliant. Noncritical systems and applications are approximately 95% complete and the remaining remediation work will be complete by November 30, 1999. The Company will continue to monitor and re-test systems and applications through the century rollover.
The year 2000 project group has also completed review of the Company's relationship with certain key outside vendors and others with whom the Company has significant business relationships to determine, to the extent practical, the degree of such outside parties' year 2000 compliance. While the regional or national failure of a utilities or communications supplier could have a significant impact if not restored, the Company has evaluated the Y2K readiness of utility and communication links and believes that they are prepared. The Company believes that, if it, or any third party with whom the Company has a significant business relationship, has a year 2000 related systems failure, the most significant impact would likely be the inability, with respect to a group of stores, to conduct operations due to a power failure, to deliver inventory in timely fashion, to receive certain products from vendors or to process electronically customer sales at store level. The Company does not anticipate that any such impact would be material to the Company's liquidity or results of operations.
The year 2000 project group has established contingency plans to provide for viable alternatives to ensure that the Company's core business operations are able to continue in the event of a year 2000 related systems failure. The plans address both operational and technical alternatives. This phase will continue through the end of 1999. In addition, the Company has established its century rollover management procedure and command center which will monitor and address any operational developments that may arise during the transition into the year 2000.
Through September 30, 1999, the Company has expended approximately $0.9 million to address year 2000 compliance issues. The Company estimates that it will incur an additional $0.2 million, for a total of approximately $1.1 million, to address year 2000 compliance issues, which includes the estimated costs of all modifications, testing and consultant fees.
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
None filed during the quarter
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) |
| By: | /S/ DAVID G. MARTIN |
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| David G. Martin | |
| Executive Vice President and Chief Financial Officer | |
| (Authorized Officer and Principal Financial and Accounting Officer of the Registrant) |
| Date: March 2, 2000 |
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