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, 2000
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXHANGE 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
of incorporation or organization) Identification No.)
9275 S.W. Peyton Lane, 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 short period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
As of November 9, 2000 there were 46,246,086 shares of the registrant's
Common Stock outstanding.
HOLLYWOOD ENTERTAINMENT CORPORATION
September 30, 2000
Page
PART I. FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Consolidated Statements of Operations 3
Consolidated Balance Sheets 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial 12
Condition and Results of Operations
PART II. OTHER INFORMATION 19
Item 6. Exhibits and Reports on Form 8-K 19
Signatures 20
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share amounts)
Three Mondths Ended Nine Months Ended
September 30, September 30,
--------------------- --------------------
2000 1999 2000 1999
<S> --------- -------- -------- --------
REVENUE: <C> <C> <C> <C>
Rental revenue $262,077 $221,292 $796,429 $648,235
Product sales 44,455 45,027 168,061 134,981
--------- -------- -------- --------
306,532 266,319 964,490 783,216
COST OF SALES:
Cost of rental 82,695 67,440 253,556 199,186
Cost of product 31,754 33,702 148,074 97,022
--------- -------- -------- --------
114,449 101,142 401,630 296,208
--------- -------- -------- --------
GROSS MARGIN 192,083 165,177 562,860 487,008
OPERATING COSTS AND EXPENSES:
Operating and selling 155,998 132,813 480,685 373,971
General and administrative 15,832 16,960 54,430 50,220
Restructuring charge for closure
of internet Business - - 48,548 -
Amortization of intangibles 1,814 14,388 28,097 42,704
--------- -------- -------- --------
173,644 164,161 611,760 466,895
--------- -------- -------- --------
INCOME (LOSS) FROM OPERATIONS 18,439 1,016 (48,900) 20,113
Non-operating income (expense):
Interest income 40 4 142 77
Interest expense (17,275) (11,999) (46,892) (33,109)
--------- --------- --------- --------
Income (loss) before income taxes 1,204 (10,979) (95,650) (12,919)
Benefit (provision) for income taxes (488) (643) 21,159 (9,809)
Income (loss) before cumulative effect of a
change in accounting principle 716 (11,622) (74,491) (22,728)
Cumulative effect of a change in accounting
principle (net of income tax benefit
of $983) - - - (1,444)
--------- --------- --------- ---------
NET INCOME (LOSS) $ 716 $(11,622) $(74,491) $(24,172)
========= ========= ========= =========
Net income (loss) per share before cumulative
effect of a change in accounting principle
Basic $0.02 $(0.25) $(1.62) $(0.50)
Diluted $0.02 $(0.25) $(1.62) $(0.50)
Net income (loss) per share:
Basic $0.02 $(0.25) $(1.62) $(0.53)
Diluted $0.02 $(0.25) $(1.62) $(0.53)
Weighted average shares outstanding:
Basic 46,207 45,743 46,119 45,522
Diluted 46,483 45,743 46,119 45,522
</TABLE>
The accompanying notes are an integral part of this financial statement
<TABLE>
<CAPTION>
HOLLYWOOD ENTERTAINMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
<C> <C>
September 30, December 31,
2000 1999
------------ -----------
ASSETS (unaudited)
Current assets:
Cash and cash equivalents $ 10,089 $ 6,941
Receivables 41,329 42,679
Merchandise inventories 74,198 84,373
Income tax receivable 3,033 1,797
Prepaid expenses and other current assets 11,393 10,377
----------- -----------
Total current assets 140,042 146,167
Rental inventory, net 374,184 339,912
Property and equipment, net 398,712 382,345
Goodwill, net 102,852 145,504
Deferred income tax 79,551 52,691
Other assets, net 24,495 13,558
----------- -----------
$ 1,119,836 $ 1,080,177
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term obligations $ 166,460 $ 14,493
Accounts payable 148,099 111,578
Accrued expenses 66,114 64,566
Accrued revenue sharing 20,736 9,402
Accrued interest 5,650 11,865
----------- -----------
Total current liabilities 407,059 211,904
Long-term obligations, less current portion 428,851 519,413
Other liabilities 50,755 44,331
----------- -----------
886,665 775,648
Shareholders' equity: =========== ===========
Preferred stock, 19,500,000 shares authorized; no shares
issued and outstanding - -
Common stock, 100,000,000 shares authorized; 46,243,526
and 45,821,537 shares issued and outstanding, respectively 365,440 362,307
Retained deficit (132,269) (57,778)
----------- -----------
Total shareholders' equity 233,171 304,529
----------- -----------
$ 1,119,836 $ 1,080,177
=========== ============
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,
--------------------------
2000 1999
---------- -----------
OPERATING ACTIVITIES:
Net loss $ (74,491) $ (24,172)
Adjustments to reconcile net loss to cash
provided by operating activities:
Cumulative effect of a change in accounting principle - 1,444
Depreciation and amortization 168,727 162,683
Amortization of deferred financing costs 1,934 1,383
Change in deferred rent 1,791 2,286
Change in deferred income taxes (22,227) (557)
Net asset write down for closure of internet business 40,087 -
Net change in operating assets and liabilities:
Receivables 1,181 269
Merchandise inventories (3,279) (3,292)
Accounts payable 36,522 (23,331)
Accrued interest (6,215) (5,382)
Accrued revenue sharing 11,334 (2,888)
Other current assets and liabilities 516 2,242
---------- ----------
Cash provided by operating activities 155,880 110,685
---------- ----------
INVESTING ACTIVITIES:
Purchases of rental inventory, net (130,331) (125,855)
Purchases of property and equipment, net (71,464) (71,273)
Investment in businesses acquired - (15,976)
Increase in intangibles and other assets (13,187) (4,259)
---------- ----------
Cash used in investing activities (214,982) (217,363)
---------- ----------
FINANCING ACTIVITIES:
Issuance of long-term obligations 12,511 50,000
Repayments of long-term obligations (11,106) (7,555)
Tax benefit from exercise of stock options 63 5,151
Proceeds from exercise of stock options 782 4,056
Increase in revolving loan, net 60,000 55,000
---------- ----------
Cash provided by financing activities 62,250 106,652
---------- ----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 3,148 (26)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 6,941 3,975
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF THE THIRD QUARTER $ 10,089 $ 3,949
========== ==========
NON-CASH FINANCING ACTIVITIES
Issuance of common stock as part of a legal settlement agreement $ 2,288 $ -
</TABLE>
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 for
the year ended December 31, 1999, filed with the Securities and Exchange
Commission.
(1) Accounting Policies
The consolidated financial statements included herein have been prepared
in accordance with the accounting policies described in Note 1 to the
December 31, 1999 audited consolidated financial statements included in
the Company's annual report on Form 10-K. Certain prior year amounts
have been reclassified to conform to the presentation used for the
current year. These reclassifications had no impact to previously
reported net loss or shareholders' equity.
(2) Statements of Changes in Shareholders' Equity
An analysis of the shareholders' equity amounts for the three quarters
ended September 30, 2000 is as follows:
<TABLE>
<C> Common Stock <C>
----------------------- Retained
(In thousands, except share amounts) Shares Amount Deficit Total
---------- --------- ----------- ---------
Balance at December 31, 1999 45,821,537 $ 362,307 $ (57,778) $ 304,529
Issuance of common stock under option
plan 221,989 782 782
Tax benefit from exercise of stock options 63 63
Issuance of common stock as part of a
legal settlement agreement 200,000 2,288 2,288
Net loss (74,491) (74,491)
---------- --------- ----------- ---------
Balance at September 30, 2000 46,243,526 $ 365,440 $ (132,269) $ 233,171
========== ========= =========== =========
</TABLE>
(3) Operating Leases
The Company leases all of its stores, corporate offices, distribution
centers and zone offices under non-cancelable operating leases. All of
the Company's stores have an initial operating lease term of five to
fifteen years and most have options to renew for between five and fifteen
additional years. Most operating leases require payment of property
taxes, utilities, common area maintenance and insurance. Total rent
expense, including related lease-required cost was $62.0 million and
$181.3 million for the current year third quarter and three quarters,
respectively, compared with $51.0 million and $146.8 million for the
corresponding periods of the prior year.
(4) Long-term Obligations
The Company had the following long-term obligations as of September 30,
2000 and as of December 31, 1999 (in thousands).
<TABLE>
<C> <C>
<S> September 30, December 31,
2000 1999
------------- ------------
Senior subordinated notes (1) $ 250,000 $ 250,000
Borrowings under revolving credit facility 300,000 240,000
Obligations under capital leases 45,302 43,886
Other 9 20
------------ ------------
595,311 533,906
Current portions:
Credit facility 150,000 -
Capital leases 16,460 14,493
------------ ------------
166,460 14,493
Total long-term obligations ------------ ------------
net of current portion $ 428,851 $ 519,413
============ ============
</TABLE>
(1) 10.625% coupon payments are due semi-annually in February and August
of each year
At September 30, 2000, maturities on long-term obligations for the next
five years were as follows (in thousands):
<TABLE>
<C> <C> <C> <C> <C>
Capital
Year Ending Subordinated Credit Leases
December, 31 Notes Facility & Other Total
------------- ------------ ---------- --------- ---------
2000 $ - $ 37,500 $ 6,086 $ 43,586
2001 - 150,000 14,721 164,721
2002 - 112,500 18,415 130,915
2003 - - 6,089 6,089
2004 250,000 - - 250,000
Thereafter - - - -
------------ ---------- --------- ---------
$ 250,000 $ 300,000 $ 45,311 $ 595,311
------------ ---------- --------- ---------
</TABLE>
(5) Earnings per Share
Basic earnings per share are calculated based on income available to
common shareholders and the weighted-average number of common shares
outstanding during the reported period. Diluted earnings per share
includes additional dilution from the effect of potential issuances of
common stock, such as stock issuable pursuant to the exercise of stock
options, warrants outstanding and the conversion of debt.
The following tables are a reconciliation of the basic and diluted
earnings per share computations:
<TABLE>
<CAPTION>
Three Months Ended
September 30,
(In thousands, except per share amounts)
-----------------------------------------------------------------
2000 1999
------------------------------ ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Per Per
Share Share
Net Income Shares Amounts Loss Shares Amounts
--------- ------- -------- -------- ------- -------
Basic loss per share: $ 716 46,207 $ 0.02 $(11,622) 45,743 $ (0.25)
Effect of dilutive
securities:
Stock options - 276 - -
--------- ------- -------- -------
Diluted loss per share: $ 716 46,483 $ 0.02 $(11,622) 45,743 $ (0.25)
========= ======= ======== ========= ======= ========
</TABLE>
Due to the Company's net loss in 1999, stock options accounted for using the
treasury stock method would be antidilutive. Accordingly, 1.5 million shares
have been excluded from the diluted net loss per share calculation.
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
(In thousands, except per share amounts)
----------------------------------------------------------------
2000 1999
----------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Per Per
Share Share
Loss Shares Amounts Loss Share Amounts
--------- ------- -------- -------- ------- -------
Basic loss per share: $(74,491) 46,119 $ (1.62) $(24,172) 45,522 $ (0.53)
Effect of dilutive
securities:
Stock options - - - -
--------- ------- -------- -------
Diluted loss per share: $(74,491) 46,119 $ (1.62) $(24,172) 45,522 $ (0.53)
========= ======= ======== ========= ======= ========
</TABLE>
Due to the Company's net loss, stock options accounted for using the treasury
Stock method would be antidilutive. Accordingly, .3 million shares and 2.3
million shares have been excluded from the diluted net loss per share
calculation for the nine months ended September 30, 2000 and 1999,
respectively.
(6) Store Preopening Cost
In April 1998, SOP 98-5, "Reporting on the Cost of Start-up Activities,"
was finalized, which required that cost 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 was
to increase net loss in the first quarter of 1999 by $1.4 million, net of
tax benefit.
(7) Segment Reporting
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 Hollywood Video segment, which consists of the Company's 1,796 retail
stores located in 47 states was the only segment operated by the Company
in the current year third quarter. The Company operated two segments
during the first six months of the current year, the Hollywood Video
segment and the Reel.com segment, primarily an e-commerce company
specializing in movies. During the current year second quarter, the
Company announced the discontinuation of e-commerce operations at
Reel.com. This resulted in a restructuring charge detailed below in Note
8. All assets of Reel.com were transferred to the Hollywood Video segment
on June 12, 2000. The Company measures segment profit as operating
profit, which is defined as income (loss) before interest expense and
income taxes. Information on segments and a reconciliation to operating
income (loss) are as follows (in thousands):
<TABLE>
<CAPTION>
Three Months Ended September 30,
-------------------------------------------------------------------
2000 1999
-------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C> <C>
Hollywood Hollywood
Video Reel.com Total Video Reel.com Total
-------- -------- -------- -------- -------- ---------
Revenue $306,532 $306,532 $256,201 $ 10,118 $266,319
Tape amortization 30,733 30,733 22,231 118 22,349
Other depreciation and
Amortization 20,187 20,187 17,408 13,446 30,854
Gross Margin 192,083 192,083 164,606 571 165,177
Operating income (loss) * 18,439 18,439 23,703 (22,687) 1,016
Interest expense, net 17,235 17,235 10,733 1,262 11,995
Total assets 1,119,836 1,119,836 933,316 64,609 997,925
Purchases of property and
Equipment, net 15,727 15,727 23,741 2,060 25,801
</TABLE>
*Reel.com's operating loss for the three months ended September 30, 1999
includes $12.5 million in goodwill amortization. Excluding goodwill
amortization, Reel.com's operating loss would have been $10.2 million.
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------------------------------------------
2000 1999
-------------------------------- --------------------------------
<S> <C> <C> <C> <C> <C> <C>
Hollywood Hollywood
Video Reel.com Total Video Reel.com Total
--------- -------- -------- -------- -------- ---------
Revenue $ 938,210 $ 26,280 $964,490 $ 758,352 $ 24,864 $ 783,216
Tape amortization 88,621 110 88,731 76,668 354 77,022
Other depreciation and
Amortization 58,438 23,492 81,930 48,277 38,767 87,044
Gross Margin 581,834 (18,974) 562,860 484,995 2,013 487,008
Operating income (loss) * 73,869 (122,769) (48,900) 84,027 (63,914) 20,113
Interest expense, net 42,484 4,266 46,750 30,314 2,720 33,034
Total assets 1,119,836 - 1,119,836 933,316 64,609 997,925
Purchases of property and
Equipment, net 69,946 1,518 71,464 67,124 4,149 71,273
</TABLE>
*Reel.com's operating loss includes a restructuring charge of $69.3 million
for discontinued e-commerce operations. The loss also includes $22.7 million
in goodwill amortization. Excluding the restructuring charge and goodwill
amortization, Reel.com's operating loss would have been $30.8 million for
the six months ended June 30, 2000. The Company did not operate Reel.com as
a segment in the current year third quarter. The operating loss for the nine
months ended September 30, 1999 would have been $26.3 million excluding
$37.6 million in goodwill amortization.
(8) Reel.com Discontinued E-commerce Operations
On June 12, 2000, the Company announced that it would close down the e-
commerce business at Reel.com. The Company developed a leading web-site over
the seven quarters since Reel.com was purchased in October of 1998, but its
business model of rapid customer acquisition led to large operating losses
and required significant cash funding. Due to market conditions, the
Company was unable to obtain outside financing for Reel.com, and could not
justify continued funding from its video store cash flow. On June 13, 2000,
the Company terminated employment of approximately 200 of Reel.com's 240
employees, and paid $1.9 million in involuntary termination benefits. The
remaining employees have since been terminated or integrated into Hollywood
Entertainment.
The Company plans to maintain the web-site as a content-only site to
minimize any negative effect the Reel.com shutdown may have on existing
Hollywood Video store customers for a period of time not expected to exceed
twelve months from the e-commerce shutdown. During this time, point of
purchase materials promoting Reel.com as an e-commerce destination will need
to be removed from the stores. To offset the costs of maintaining the web-
site during this period, the Company has entered into an agreement with
Buy.com to direct Reel.com visitors to Buy.com to make purchases. Revenues
associated with the Buy.com agreement and the expenses of maintaining the
web-site will be recognized as earned and incurred, respectively.
As a result of the discontinuation of e-commerce operations, the Company
recorded a total charge of $69.3 million in the current year second quarter,
of which $48.5 million was classified as a restructuring charge on the
consolidated statement of operations and $20.8 million was included in cost
of product sales.
The restructuring charge line item includes $1.9 million of severance and
benefits paid on June 13, 2000, $19.3 million of asset write downs, and
$27.3 million of accrued liabilities. The assets written down include the
remaining $14.9 million of goodwill associated with the acquisition of
Reel.com, and $4.4 million to write down equipment, leasehold improvements,
prepaid expenses and accounts receivable to their net realizable values.
Amounts accrued include $21.5 million for contractual obligations, including
lease commitments and anticipated legal claims against the Company, and $5.8
million for legal, financial, and other professional services incurred as a
direct result of the closure of Reel.com.
The Company used some of the equipment from Reel.com at the new distribution
center in Nashville, Tennessee, and at the corporate offices in Wilsonville,
Oregon. Equipment not utilized by the Company was sold. Proceeds of $250,000
were received in the current year third quarter.
Most of Reel.com's business agreements have been terminated under the
provisions of each agreement. Many of these agreements contain minimum
guarantee provisions, some of which cannot be waived by terminating the
agreement. The Company paid $0.5 million of the $21.5 million total accrual
in the current year third quarter and anticipates paying between $0.5
million and $2.0 million in the current year fourth quarter with the
remaining amount paid some time in 2001.
Charged to cost of goods sold was the write down of Reel.com inventory,
primarily DVD's, to net realizable value. This represents excess product for
the Hollywood Video segment because the stores are currently fully stocked
for both rental and sell through. The Company plans to liquidate this
inventory by the fourth quarter of 2001 through special tent sales or
sidewalk sales at select stores, vendor returns, grand opening promotions,
and outlet centers.
(9) Related Party Transactions
On May 8, 2000, the Board of Directors approved a long-term compensation
package for the Company's Chief Executive Officer, which included a $15
million loan. The five year loan bears interest at an annual rate equal to
the greater of ten percent or the minimum rate required under the Internal
Revenue Code and regulations for loans to affiliated persons, and is due in
five annual installments of $3 million beginning on June 1, 2001.
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
Summary Results of Operations
The Company's net income for the current year third quarter was $.7 million
compared with a net loss of $11.6 million in the third quarter of 1999. The
improvement in net income was the result of closing down e-commerce
operations at Reel.com. The Company's net loss for the current year three
quarters was $74.5 million compared with a net loss before cumulative effect
of a change in accounting principle of $22.7 million in the corresponding
period of the prior year. The increase in net loss was primarily due to a
restructuring charge for discontinued e-commerce operations of Reel.com
recorded in the current year second quarter.
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.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -----------------------
<S> <C> <C> <C> <C>
2000 1999 2000 1999
----------- ---------- --------- ----------
(Unaudited) (Unaudited)
REVENUE:
Rental revenue 85.5 % 83.1 % 82.6% 82.8 %
Product sales 14.5 16.9 17.4 17.2
---------- ---------- --------- ----------
100.0 100.0 100.0 100.0
---------- ---------- --------- ----------
GROSS MARGIN 62.7 62.0 58.4 62.2
OPERATING COSTS AND EXPENSES:
Operating and selling 50.9 49.9 49.8 47.7
General and administrative 5.2 6.4 5.7 6.4
Restructuring charge for closure
of internet business - - 5.0 -
Amortization of intangibles 0.6 5.3 2.9 5.5
--------- ---------- --------- ----------
56.7 61.6 63.4 59.6
--------- ---------- --------- ----------
INCOME (LOSS) FROM OPERATIONS 6.0 0.4 (5.0) 2.6
Non-operating income (expense), net (5.6) (4.5) (4.9) (4.2)
--------- ---------- --------- ----------
Income (loss) before income taxes 0.4 (4.1) (9.9) (1.6)
Benefit (provision) for income
taxes (0.2) (0.3) 2.2 (1.3)
Income (loss) before cumulative effect
of a change in accounting principle 0.2 (4.4) (7.7) (2.9)
Cumulative effect of a change in
accounting principle - - - (0.2)
--------- ---------- --------- ----------
NET INCOME (LOSS) 0.2 % (4.4) % (7.7) % (3.1) %
--------- ---------- --------- ----------
OTHER FINANCIAL DATA:
Rental gross margin (1) 68.4% 69.5% 68.2% 69.3%
Product gross margin (2) 28.6% 25.2% 11.9% 28.1%
EBITDA (3) (In thousands)
Hollywood Video segment EBITDA $ 68,681 $ 62,806 $218,991 $ 206,174
Reconciliation to Adjusted EBITDA (4)
Add special charges (5) - 2,335 - 3,779
Add non-cash expenses (6) 15,924 14,143 51,020 37,821
Less existing store investment in
new release inventory (7) (44,591) (32,615) (127,527) (96,229)
--------- ---------- --------- ----------
ADJUSTED EBITDA HOLLYWOOD VIDEO 40,014 46,669 142,484 151,545
Reel.com segment EBITDA (8) (9,124) (29,834) (24,792)
CONSOLIDATED ADJUSTED EBITDA $ 40,014 $ 37,545 $ 112,650 $126,753
CASH FLOW FROM: (In thousands)
Operating activities $ 54,890 $ 49,814 $ 155,880 $ 110,685
Investing activities (56,093) (71,282) (214,982) (217,363)
Financing activities 6,921 19,269 62,250 106,652
OPERATING DATA:
Number of stores at quarter end 1,796 1,474 1,796 1,474
Weighted average stores open during
the period 1,786 1,431 1,729 1,360
Comparable store revenue increase (9) 1% 11% 4% 16%
</TABLE>
(1) Rental gross margin as a percentage of rental revenue.
(2) Product gross margin as a percentage of product revenue.
(3) EBITDA consists of operating income before interest, tax, 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. This calculation of EBITDA is not necessarily comparable to
reported EBITDA of other companies due to the lack of a uniform definition
of EBITDA.
(4) Adjusted EBITDA represents income from operations before depreciation
and amortization plus non-cash expenses that reduce EBITDA, less the cost
of acquiring new release rental inventory which is capitalized. 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 amounts reported by other companies due to the lack of a
uniform definition of EBITDA.
(5) The special charge for the prior year third quarter relates to the
settlement between the Company and Twentieth Century Fox Home Entertainment
("Fox"). The prior year three quarters included the settlement with Fox
and a cumulative effect of a change in accounting principle resulting
from the adoption of SOP 98-5.
(6) Expenses which were non-cash in nature including tape loss and the
book cost of previously viewed movies sold.
(7) This represents existing store purchases of new release tapes, games
and DVD's that are considered investing activities on the statement of
cash flows. This is in addition to the cost of product represented by
revenue sharing expense already included in the statement of operations.
(8) Excludes the restructuring charge of $69.3 million for the discontinuation
of e-commerce operations.
(9) 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 $40.2 million, or 15%, in the current year third
quarter and $181.3 million, or 23%, in the current year three quarters
compared with the corresponding periods of the prior year. The increase was
primarily due to the addition of 360 new superstores in the twelve months
ended September 30, 2000. An increase in comparable store revenue of 1% and
4% in the current year third quarter and three quarters, respectively, also
favorably impacted revenue.
GROSS MARGIN
Rental margin as a percentage of rental revenue was 68.4% and 68.2% in the
current year third quarter and three quarters compared to 69.5% and 69.3% in
the corresponding periods of the prior year. The decrease in margin
primarily relates to a decrease in new release videocassettes purchased at
sell through pricing. Prior to revenue sharing, studios had two primary
options for pricing new release titles. The first, rental pricing, was to
price each cassette at approximately $65 and focus sales to video rental
outlets. The second, sell through pricing, was to price each cassette under
$20 and sell to all distributors of videocassette movies. The biggest hits
each year were priced for sell through and generally came with a substantial
marketing push from the studio. The low unit price, and studio advertising,
made these types of purchases the Company's best performers in terms of
margin, including revenue sharing purchases. Over the last two years, as
revenue sharing has gained acceptance, the percentage of titles released at
sell through pricing has substantially decreased.
Product margin as a percentage of product sales was 28.6% and 11.9% in the
current year third quarter and three quarters compared to 25.2% and 28.1% in
the corresponding periods of the prior year. The increase in margin in the
current year third quarter is primarily due to Reel.com's discontinuation of
e-commerce sales, which were at a significantly lower margin than the
Hollywood Video stores. The decrease in margin in the current year three
quarters is primarily due to a $20.8 million write down of inventory
associated with the restructuring of Reel.com in the current year second
quarter.
OPERATING COSTS AND EXPENSES
Operating and Selling
Total operating expenses for the current year third quarter and three
quarters increased by $23 million and $107 million, respectively, when
compared to the prior year corresponding periods. Operating and selling
expenses increased as a percentage of total revenue to 50.9% and 49.8% in
the current year third quarter and three quarters ended, respectively,
compared to 49.9% and 47.7% in the corresponding periods of the prior year
primarily due to an increase in advertising expenses. For the current year
third quarter, the increase in total operating expenses resulted from an
increase in store labor cost of $10 million, occupancy costs of $11 million,
other store operating expenses of $11 million, offset by the closure of
Reel.com which had operating expenses for the prior year third quarter of $9
million. For the current year three quarters, the increase in total
operating expenses resulted from an increase in store labor cost of $36
million, occupancy costs of $34 million, other store operating expenses of
$30 million and an increase in Reel.com operating costs of $6 million.
With the exception of Reel.com, operating expenses increased due to the
growth in the number of superstores operated by the Company.
General and Administrative
General and administrative expenses in the current year third quarter
decreased $1.1 million to $15.8 million due to the closure of the e-commerce
business at Reel.com. The general and administrative expenses for the
current year three quarters increased $4.2 million to $54.4 million. The
increase was primarily due to higher payroll and related costs partially off
set by the closure of the e-commerce business at Reel.com.
Restructuring Charge for Closure of Internet Business
On June 12, 2000, the Company announced that it would close down the e-
commerce business at Reel.com. The Company developed a leading web-site over
the seven quarters since Reel.com was purchased in October of 1998, but its
business model of rapid customer acquisition led to large operating losses
and required significant cash funding. Due to market conditions, the
Company was unable to obtain outside financing for Reel.com, and could not
justify continued funding from its video store cash flow.
The Company plans to maintain the web-site as a content-only site to
minimize any negative effect the Reel.com shutdown may have on existing
Hollywood Video store customers for a period of time not expected to exceed
twelve months from the e-commerce shutdown. During this time, point of
purchase materials promoting Reel.com as an e-commerce destination will need
to be removed from the stores. To offset the costs of maintaining the web-
site during this period, the Company has entered into an agreement with
Buy.com to direct Reel.com visitors to Buy.com to make purchases. Revenues
associated with the Buy.com agreement and the expenses of maintaining the
web-site will be recognized as earned and incurred, respectively.
The restructuring charge of $48.5 million includes $1.9 million of severance
and benefits paid on June 13, 2000, $19.3 million of asset write downs, and
$27.3 million of accrued liabilities. The assets written down include the
remaining $14.9 million of goodwill associated with the acquisition of
Reel.com, and $4.4 million to write down equipment, leasehold improvements,
prepaid expenses and accounts receivable to their net realizable values.
Amounts accrued include $21.5 million for contractual obligations, including
lease commitments and anticipated legal claims against the Company, and $5.8
million for legal, financial, and other professional services incurred as a
direct result of the closure of Reel.com.
The Company used some of the equipment from Reel.com at the new distribution
center in Nashville, Tennessee, and at the corporate offices in Wilsonville,
Oregon. Equipment not utilized by the Company was sold. Proceeds of $250,000
were received in the current year third quarter.
Most of Reel.com's business agreements have been terminated under the
provisions of each agreement. Many of these agreements contain minimum
guarantee provisions, some of which cannot be waived by terminating the
agreement. The Company paid $0.5 million of the $21.5 million total accrual
in the current year third quarter and anticipates paying between $0.5
million and $2.0 million in the current year fourth quarter with the
remaining amount paid some time in 2001.
Amortization of Intangibles
Amortization of intangibles decreased to $1.8 million and $28 million in the
current year third quarter and three quarters from $14 million and $43
million in the corresponding periods of the prior year. The decrease was
caused by a write down of Reel.com's goodwill as e-commerce operations
discontinued in the current year second quarter. The goodwill write down of
$14.9 million was included in the restructuring charge for closure of
Internet business line item on the Company's consolidated statement of
operations.
NONOPERATING INCOME (EXPENSE), NET
Interest expense, net of interest income increased by $5.2 million and $13.7
million in the 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 provision (benefit) for income taxes for the third quarter and first
nine months of 2000 results in effective tax rates of 40.5% and (22.12)% of
pretax income, as compared to 5.9% and 75.9% for the same calendar periods
of 1999, respectively. The tax provision for the first nine months of 2000
decreased compared to the prior year due to a decrease in taxable income.
The increase in the effective tax rate for the third quarter compared to the
prior year is due to a reduction in net operating loss associated with
Reel.com.
LIQUIDITY AND CAPITAL RESOURCES
The amount of cash generated from operations in the nine months ending
September 30 exceeded the Company's current debt service requirements. The
capital expenditures (including purchases of rental inventory) of the
Company are primarily funded by the excess operating cash flow and through
loans under a revolving line of credit.
At September 30, 2000, the Company had cash and cash equivalents of $10.1
million and a working capital deficit of $267 million. 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 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 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 increased by $45.2 million in the
current year three quarters compared with the corresponding period of the
prior year. This increase was primarily due to an increase in accounts
payable and accrued liabilities, which are sources of operating cash. A
significant part of the increase was related to Reel.com.
Cash Used in Investing Activities
Net cash used in investing activities decreased by $2.4 million in the
current year three quarters compared with the corresponding period of the
prior year. The decrease is primarily due to fewer new store openings offset
by a higher reinvestment of revenue in new release movies and an increase in
other assets.
Cash Provided by Financing Activities
Net cash provided by financing activities decreased by $44.4 million in the
current year three quarters compared with the corresponding period of the
prior year. The decrease was primarily due to a decrease in the issuance of
long-term obligations as the Company begins to open fewer stores and fund
them through operating cash flow instead of debt financing. 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. The total
commitment under this facility will begin its scheduled reduction of $37.5
million per quarter beginning on December 5, 2000 which continues until the
revolving credit facility's maturity in September 2002. The Company expects
to meet scheduled commitment reductions through debt pay-down from
internally generated cash flow from operations and a slowdown in capital
expenditures and investing activities. The Company may seek additional
financing as a source of incremental liquidity as necessary. As of September
30, 2000, $300 million was outstanding under the revolving credit agreement
with $10.1 million in cash and cash equivalents on hand.
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, warehouse 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 based on opening
215 stores to be approximately $110 million in 2000, of which $95 million is
anticipated to relate to new, relocated, remodeled stores and game
departments. The remaining balance relates to corporate capital
expenditures. We expect the total investment per new store to approximate
$420,000 this year, 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 by operations, supplemented by the
availability of the revolving line of credit or other forms of equipment
financing and/or leasing if necessary. The Company expects to open between
50 and 80 stores in 2001, based upon the availability of capital resources
coupled with the Company's desire to reduce outstanding indebtness.
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit 10.1 Amended Revolving Credit Agreement
(b) Exhibit 10.2 Change of Control Plan for Senior Management
(c) Exhibit 27.1 Financial data schedule (electronic filing only)
(d) Reports on Form 8-K
None filed during the period.
HOLLYWOOD ENTERTAINMENT CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HOLLYWOOD ENTERTAINMENT CORPORATION
(Registrant)
/S/David G. Martin
---------------- ---------------------------------------------------
(Date) David G. Martin
Executive Vice President and Chief Financial Officer
(Authorized Officer and Principal Financial and
Accounting Officer of the Registrant)
