10-Q/A 1 r10qa-03.txt QUARTERLY REPORT ON FORM 10-Q/A UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q/A [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 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 Identification No.) of incorporation or organization) 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 April 27, 2001 there were 49,249,290 shares of the registrant's Common Stock outstanding. PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts) Three Months Ended March 31, ------------------ 2001 2000 -------- -------- REVENUE: Rental revenue $290,680 $272,450 Product sales 51,565 62,872 -------- -------- 342,245 335,322 COST OF REVENUE: Cost of rental 109,144 91,161 Cost of product 35,297 47,407 -------- -------- 144,441 138,568 -------- -------- GROSS MARGIN 197,804 196,754 OPERATING COSTS AND EXPENSES: Operating and selling 153,155 162,883 General and administrative 24,968 16,817 Amortization of intangibles 1,249 14,319 -------- -------- 179,372 194,019 -------- -------- INCOME FROM OPERATIONS 18,432 2,735 Non-operating income (expense): Interest income 23 - Interest expense (14,853) (14,070) -------- -------- Income (loss) before income taxes 3,602 (11,335) Provision for income taxes (76) (828) -------- -------- NET INCOME (LOSS) $ 3,526 $(12,163) ======== ======== Net income (loss) per share: Basic $0.07 $(0.26) Diluted $0.07 $(0.26) Weighted average shares outstanding: Basic 48,414 46,006 Diluted 48,480 46,006 The accompanying notes are an integral part of this financial statement HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) March 31, December 31, ------------ ----------- 2001 2000 ------------ ----------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 19,027 $ 3,268 Receivables 23,412 23,830 Merchandise inventories 51,017 54,201 Prepaid expenses and other current assets 9,748 10,099 ----------- ----------- Total current assets 103,204 91,398 Rental inventory, net 154,994 168,462 Property and equipment, net 310,400 323,666 Goodwill, net 68,462 69,616 Other assets, net 11,548 11,972 ----------- ----------- $ 648,608 $ 665,114 =========== =========== LIABILITIES AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term obligations $ 272,380 $ 261,164 Accounts payable 157,510 169,503 Accrued expenses 104,449 114,633 Accrued revenue sharing 28,637 30,855 Accrued interest 5,123 11,817 Income taxes payable 5,108 4,844 ----------- ----------- Total current liabilities 573,207 592,816 Long-term obligations, less current portion 271,567 275,237 Other liabilities 19,404 19,438 ----------- ----------- 864,178 887,491 ----------- ----------- Shareholders' deficit: Preferred stock, 25,000,000 shares authorized; no shares issued and outstanding - - Common stock, 100,000,000 shares authorized; 49,247,599 and 46,247,599 shares issued and outstanding, respectively 371,987 365,441 Unearned compensation (3,265) Retained deficit (584,292) (587,818) ----------- ----------- Total shareholders' deficit (215,570) (222,377) ----------- ----------- $ 648,608 $ 665,114 =========== =========== The accompanying notes are an integral part of this financial statement. HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Three Months Ended March 31, ------------------------ 2001 2000 ---------- ---------- OPERATING ACTIVITIES: Net income (loss) $ 3,526 $ (12,163) Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 65,856 59,789 Amortization of deferred financing costs 692 588 Tax benefit from exercise of stock options - 42 Change in deferred rent (34) 610 Change in deferred income taxes - 125 Non-cash stock compensation 3,281 - Net change in operating assets and liabilities: Receivables 418 (2,019) Merchandise inventories 3,184 3,429 Accounts payable (11,993) (26,662) Accrued interest (6,694) (6,763) Accrued revenue sharing (2,218) 22,832 Other current assets and liabilities (9,584) (19,692) --------- --------- Cash provided by operating activities 46,434 20,116 --------- --------- INVESTING ACTIVITIES: Purchases of rental inventory, net (35,493) (38,308) Purchases of property and equipment, net (2,381) (30,465) Increase in intangibles and other assets (347) (517) --------- --------- Cash used in investing activities (38,221) (69,290) --------- --------- FINANCING ACTIVITIES: Issuance of long-term obligations - 12,511 Repayments of long-term obligations (3,954) (3,419) Proceeds from exercise of stock options - 544 Increase in revolving loan, net 11,500 37,000 --------- --------- Cash provided by financing activities 7,546 46,636 -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 15,759 (2,538) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,268 6,941 -------- -------- CASH AND CASH EQUIVALENTS AT END OF THE FIRST QUARTER $ 19,027 $ 4,403 ======== ======== NON-CASH FINANCING ACTIVITIES Issuance of common stock as part of a legal settlement agreement - $ 2,288 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 for the year ended December 31, 2000, 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, 2000 audited consolidated financial statements included in the Company's annual report on Form 10-K/A. Certain prior year amounts have been reclassified to conform to the presentation used for the current year. These reclassifications had no impact on previously reported net loss or shareholders' equity. In the first quarter of 2001 the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" issued by the Financial Accounting Standards Board(FASB) on June 15, 1998. The adoption of SFAS No. 133 did not have an effect on the Company's results of operations or its financial position. (2) Statements of Changes in Shareholders' Equity An analysis of the shareholders' equity amounts for the first quarter ended March 31, 2001 is as follows (in thousands, except share amounts): Common Stock Unearned ------------------- Compen- Retained Shares Amount sation Deficit Total ---------- -------- -------- --------- --------- Balance at 12/31/2000 46,247,599 $365,441 - $(587,818) $(222,377) ---------- -------- -------- --------- --------- Issuance of common stock: Compensation grant 3,000,000 $ 3,281 $ 3,281 Stock options exercised - - - Stock option tax benefit - - Unearned compensation 3,265 (3,265) - Net income 3,526 3,526 ---------- -------- -------- --------- --------- Balance at 3/31/2001 49,247,599 $371,987 (3,265) $(584,292) $(215,570) ========== ======== ======== ========= ========= (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 $63.3 million for the current year first quarter, compared with $58.6 million for the corresponding period of the prior year. (4) Long-term Obligations The Company had the following long-term obligations as of March 31, 2001 and as of December 31, 2000 (in thousands). March 31, December 31, ----------- ---------- 2001 2000 ----------- ---------- Senior subordinated notes (1) $250,000 $ 250,000 Borrowings under revolving credit facility 256,500 245,000 Obligations under capital leases 37,446 41,396 Other 1 5 ----------- ---------- 543,947 536,401 Current portions: Credit facility 256,500(2) 245,000 Capital leases 15,880 16,164 ----------- ---------- 272,380 261,164 Total long-term obligations ----------- ---------- net of current portion $ 271,567 $ 275,237 =========== ========== (1) Coupon payments at 10.625% are due semi-annually in February and August of each year (2) Includes $37.5 million that matures in June 2002 and $37.5 million that matures in September 2002 reclassified as current portion due to covenant violations that have not been waived beyond June 5, 2001, as discussed below. At March 31, 2001, maturities on long-term obligations for the next five years were as follows (in thousands): Capital Year Ending Subordinated Credit Leases December, 31 Notes Facility & Other Total ------------ ---------- ---------- --------- --------- 2001 - 144,000 12,214 156,214 2002 - 112,500 14,644 127,144 2003 - - 10,589 10,589 2004 250,000 - - 250,000 2005 - - - - Thereafter - - - - ----------- ---------- --------- --------- $ 250,000 $ 256,500 $ 37,447 $ 543,947 ----------- ---------- --------- --------- Because it is doubtful that the Company will be able to meet the scheduled 2001 revolving credit facility amortization of $150 million, the Company has been negotiating a restructured amortization with its lenders. On March 6, 2001, the Company made a $6 million amortization payment and its lenders agreed to defer $31.5 million of the $37.5 million total due on that date until May 5, 2001. During the deferral period, the Company and its lenders worked toward a permanent change in the amortization schedule to better match debt pay-down with the current business plan. On May 5, 2001, the Company made a $1 million amortization payment and its lenders agreed to defer $30.5 until June 5, 2001. The Company continues to work toward a permanent change in the amortization schedule. This change requires the affirmative vote of 100% of the approximately 20 lenders involved with the credit facility. There is no assurance that the Company will be successful in its negotiations. As of March 31, 2001, the Company was in violation of covenants contained within the credit facility. The Company was able to obtain the appropriate waiver for the violations. However, this waiver expires June 5, 2001. Because the waiver does not extend beyond June 5, 2001, in accordance with FAS 78, Classification of Obligations That Are Callable by the Creditor, the Company has reclassified $37.5 million that matures in June 2002 and $37.5 million that matures in September 2002 to current liabilities on the consolidated balance sheet as of March 31, 2001. (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: Three Months Ended March 31, (In thousands, except per share amounts) ------------------------------------------------------- 2001 2000 ------------------------- -------------------------- Per Per Net Share Share Income Shares Amounts Loss Shares Amounts ------- ------- ------- -------- ------- ------- Basic income (loss) per share: $ 3,526 48,414 $ 0.07 $(12,163) 46,006 $ (0.26) Effect of dilutive securities: Stock options 66 - - ------- ------- -------- ------- Diluted income (loss) per share: $ 3,526 48,480 $ 0.07 $(12,163) 46,006 $ (0.26) ======= ======= ======= ======== ======= ======= Antidultive stock options excluded from the calculation of diluted income (loss) per share were 5.2 million and 5.7 million in the first quarter of 2001 and 2000, respectively. (6) Segment Reporting The Company identifies its segments based on management responsibility. The Hollywood Video segment, which consists of the Company's 1,816 retail stores located in 47 states, was the only segment operated by the Company in the current year first quarter. The Company operated two segments during the first quarter of the prior year, the Hollywood Video segment and the Reel.com segment, primarily an e-commerce company specializing in movies. During the second quarter of 2000, the Company announced the discontinuation of e-commerce operations at Reel.com (see Note 7). 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): Three Months Ended March 31, ----------------------------------------------------------- 2001 2000 -------------------------- -------------------------------- Hollywood Hollywood Video Reel.com Total Video Reel.com Total -------- -------- -------- ---------- -------- --------- Revenue $342,245 $342,245 $ 321,021 $ 14,301 $ 335,322 Tape depreciation 48,961 48,961 29,047 110 29,157 Other depreciation and amortization 16,895 16,895 17,629 13,003 30,632 Gross Margin 197,804 197,804 195,604 1,150 196,754 Operating income (loss) * 18,432 18,432 31,164 (28,429) 2,735 Interest expense, net 14,830 14,830 11,907 2,163 14,070 Total assets 648,608 648,608 1,020,175 72,782 1,092,957 Purchases of property and equipment, net 2,381 2,381 29,154 1,311 30,465 *Reel.com's operating loss for the three months ended March 31, 2000 includes $12.5 million in goodwill amortization. Excluding goodwill amortization, Reel.com's operating loss would have been $15.9 million. (7) 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 maintains 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. To offset the costs of maintaining the web-site the Company entered into a short-term agreement with Buy.com to direct Reel.com visitors to Buy.com to make purchases. This agreement expired in the current year first quarter. The Company believes it can enter into another strategic partnership that would enable Reel.com to continue as a content-only site. Revenues associated with the Buy.com agreement and the expenses of maintaining the web- site have been recognized as earned and incurred, respectively. As a result of the discontinuation of e-commerce operations, the Company recorded a total charge of $67.7 million in 2000, of which $46.9 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 included $1.9 million of severance and benefits paid on June 13, 2000, $19.3 million of asset write downs, and $25.7 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 $19.9 million for contractual obligations, 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. As of March 31, 2001, the Company had paid $5.3 million of the accrued amounts. The Company used some of the equipment from Reel.com at the 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 third quarter of 2000. Charged to cost of goods sold was the write down of Reel.com inventory, primarily DVD's, to net realizable value. This represented excess product for the Hollywood Video segment. The Company liquidated over 85% of this inventory in 2000. The remaining amount will be liquidated or integrated into Hollywood Video inventory in 2001. (8) Restructuring charge for store closures In December 2000, the Company approved a restructuring plan involving the closure and disposition of 43 stores that were not operating to management's expectations (the "Restructuring Plan"). In accordance with the Restructuring Plan, these stores will be closed in 2001. The Company has recognized a charge of $16.9 million, including an $8.0 million write down of property and equipment, a $1.5 million write down of goodwill and an accrual for store closing costs of $7.4 million. The established reserve for cash expenditures is for lease termination fees and other store closure costs. The Company anticipates paying all accrued store closure costs in 2001. The Company plans to liquidate all inventories through store closing sales; any remaining product will be used in other stores. The Company anticipates inventory liquidations and asset disposals will be completed in 2001. Revenue during the years ended December 31, 2000, 1999 and 1998 for the stores included in the Restructuring Plan was approximately $15.5 million, $13.4 million and $9.1 million, respectively. Operating results (defined as income or loss before interest expense and income taxes) during the years ended December 31, 2000, 1999 and 1998 for the stores included in the Restructuring Plan were approximately $1.8 million loss, $0.5 million loss and $15,684 income, respectively. As of March 31, 2001, the Company has closed 6 of the 43 scheduled stores that are included in the Restructuring Plan. The Company incurred $120,000 in expenses during the current year first quarter related to these closures. Also during the current year first quarter, the Company received a payment from the landlord for the closure of a store in the amount of $450,000. These proceeds were used to offset the closure costs of that store. (9) Consolidating Financial Statements Hollywood Entertainment Corporation (HEC) had one wholly owned subsidiary during the three months ended March 31, 2001, Hollywood Management Company (HMC). HMC may become a guarantor of certain indebtedness of HEC. The consolidating condensed financial statements below present the results of operations and financial position of HEC and HMC. Consolidating Condensed Statement of Operations Three months ended March 31, 2001 (in thousands) ---------- -------- --------- ---------- HEC HMC Elimin- Consol- ations idated ---------- -------- --------- ---------- Revenue $ 342,964 $ 38,862 $ (39,581) $ 342,245 Cost of revenue 144,441 -- -- 144,441 Gross profit 198,523 38,862 (39,581) 197,804 Operating costs & expenses: Operating and selling 149,971 3,184 -- 153,155 General & administrative 52,699 11,850 (39,581) 24,968 Amortization of intangibles 1,155 94 -- 1,249 Income (loss)from operations (5,302) 23,734 -- 18,432 Interest income -- 9,175 (9,152) 23 Interest expense (24,005) -- 9,152 (14,853) Income (loss) before income taxes (29,307) 32,909 -- 3,602 (Provision for) benefit from income taxes 12,100 (12,176) -- (76) Net income (loss) $ (17,207)$ 20,733 $ -- $ 3,526 Consolidating Condensed Balance Sheet March 31, 2001 (in thousands) ---------- -------- --------- --------- HEC HMC Elimin- Consol- ations idated ---------- -------- --------- --------- ASSETS Cash and cash equivalents $ 1,916 $ 17,111 $ -- $ 19,027 Accounts receivable 18,654 355,621 (350,863) 23,412 Merchandise inventories 51,017 -- -- 51,017 Prepaid expenses and other current assets 7,976 1,772 -- 9,748 Total current assets 79,563 374,504 (350,863) 103,204 Rental inventory, net 154,994 -- -- 154,994 Property & equipment, net 299,863 10,537 -- 310,400 Goodwill, net 68,462 -- -- 68,462 Other assets, net 10,810 4,746 (4,008) 11,548 Total Assets $ 613,692 $389,787 $(354,871) $ 648,608 LIABILITIES & SHAREHOLDERS' EQUITY (DEFICIT) Current maturities of long-term obligations $ 272,380 $ -- $ -- $ 272,380 Accounts payable 350,863 157,510 (350,863) 157,510 Accrued expenses 5,499 98,950 -- 104,449 Accrued revenue sharing -- 28,637 -- 28,637 Accrued interest -- 5,123 -- 5,123 Income taxes payable -- 5,108 -- 5,108 Total current liabilities 628,742 295,328 (350,863) 573,207 Long-term obligations, less current portion 271,567 -- -- 271,567 Other liabilities 19,404 -- -- 19,404 Total liabilities 919,713 295,328 (350,863) 864,178 Preferred stock Common stock 371,987 4,008 (4,008) 371,987 Unearned compensation (3,265) -- -- (3,265) Accumulated deficit (674,743) 90,451 -- (584,292) Total shareholders' equity equity (deficit) (306,021) 94,459 (4,008) (215,570) Total liabilities and shareholders equity (deficit) $ 613,692 $389,787 $(354,871) $ 648,608 Consolidating Condensed Statement of Cash Flows Three months ended March 31, 2001 (in thousands) ---------- -------- ---------- HEC HMC Consol- idated ---------- -------- ---------- Operating activities: Net income (loss) $ (17,207)$ 20,733 $ 3,526 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation & amortization 64,981 1,567 66,548 Tax benefit from exercise of stock options -- -- -- Change in deferred rent (34) -- (34) Change in deferred income taxes -- -- -- Non cash stock compensation 3,281 -- 3,281 Net change in operating assets & liabilities (20,814) (6,073) (26,887) Cash provided by operating activities 30,207 16,227 46,434 Investing activities: Purchases of rental inventory, net (35,493) -- (35,493) Purchase of property & equipment, net (2,225) (156) (2,381) Increase in intangibles & other assets (34) (313) (347) Cash used in investing activities (37,752) (469) (38,221) Financing activities: Proceeds from the sale of common stock, net -- -- -- Issuance of long-term obligations -- -- -- Repayments of long-term obligations (3,954) -- (3,954) Proceeds from exercise of stock options -- -- -- Increase in revolving loan, net 11,500 -- 11,500 Cash provided by financing activities 7,546 -- 7,546 Increase (decrease) in cash and cash equivalents 1 15,758 15,759 Cash and cash equivalents at beginning of year 1,915 1,353 3,268 Cash and cash equivalents at end of year $ 1,916 $ 17,111 $ 19,027 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 first quarter was $3.5 million compared with a net loss of $12.2 million in the first quarter of 2000. The improvement in net income was the result of closing down e-commerce operations at Reel.com. The following table sets forth (i) selected results of operations data, expressed as a percentage of total revenue; (ii) other financial data; and (iii) selected operating data. Three Months Ended March 31, ---------------------- 2001 2000 ---------- ---------- (Unaudited) REVENUE: Rental revenue 84.9% 81.3% Product sales 15.1 18.7 ---------- ---------- 100.0 100.0 ---------- ---------- GROSS MARGIN 57.8 58.7 OPERATING COSTS AND EXPENSES: Operating and selling 44.8 48.6 General and administrative 7.3 5.0 Amortization of intangibles 0.4 4.3 ---------- ---------- 52.5 57.9 ---------- ---------- INCOME FROM OPERATIONS 5.3 0.8 Non-operating expense, net (4.3) (4.2) ---------- ---------- Income (loss) before income taxes 1.0 (3.4) Provision for income taxes - (0.2) ---------- ---------- NET INCOME (LOSS) 1.0% (3.6)% ---------- ---------- OTHER FINANCIAL DATA: Rental gross margin (1) 62.5% 66.5% Product gross margin (2) 31.5% 24.6% EBITDA (3) (In thousands) Hollywood Video segment EBITDA $ 84,288 $ 77,840 Reconciliation to Adjusted EBITDA (4) Add non-cash expenses(5) 21,966 17,478 Less existing store investment in new release inventory (6) (53,112) (36,322) ---------- ---------- ADJUSTED EBITDA HOLLYWOOD VIDEO 53,142 58,996 Reel.com segment EBITDA - (15,316) ---------- ---------- CONSOLIDATED ADJUSTED EBITDA $ 53,142 $ 43,680 CASH FLOW FROM:(In thousands) Operating activities $ 46,434 $ 20,116 Investing activities (38,221) (69,290) Financing activities 7,546 46,636 OPERATING DATA: Number of stores at quarter end 1,816 1,701 Weighted average stores open during the period 1,817 1,665 Comparable store revenue increase (7) 0% 2% (1) Rental gross margin as a percentage of rental revenue. (2) Product gross margin as a percentage of product revenue. (3) EBITDA represents income (loss) from operations 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 EBTIDA represents income (loss) from operations, before interest, tax, depreciation and amortization ("EBITDA"), plus certain special charges, plus non-cash expenses minus the cost of replenishing new release rental inventory for existing stores which is capitalized. Adjusted EBITDA should not be viewed as measures of financial performance under GAAP or as substitute for GAAP measurements such as net income or cash flow from operations. Our calculation of Adjusted EBITDA is not necessarily comparable to reported Adjusted EBITDA of other companies due to the lack of uniform definition of EBITDA and Adjusted EBITDA. (5) Expenses which were non-cash in nature including tape loss, the book cost of previously viewed movies sold and, for the fist quarter of 2000 only, $3.3 million of compensation related to a stock grant. (6) This represents existing store purchases of new release tapes, games and DVDs 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. (7) A store is comparable after it has been open and owned by the Company for 12 full months. REVENUE Revenue increased by $6.9 million, or 2%, in the current year first quarter compared with the corresponding period of the prior year. The increase was primarily due to the addition of 115 new superstores in the twelve months ended March 31, 2001 partially offset by the discontinuation of e-commerce revenue from Reel.com. Rental revenue from initial rental periods was $253 million in the current year first quarter compared to $239 million in the prior year first quarter. Rental revenue from extended rental periods was $38 million for the current year first quarter compared to $33 million for the prior year first quarter. GROSS MARGIN Rental margin as a percentage of rental revenue was 62.5% in the current year first quarter compared to 66.5% in the corresponding period of the prior year. The decrease in margin primarily relates to an increase in depreciation expense. During the fourth quarter of 2000, the Company made several key observations that led management to change estimates regarding rental inventory lives and residual values. The Company adopted the changes in estimate prospectively on October 1, 2000. Product margin as a percentage of product sales was 31.5% in the current year first quarter compared to 24.6% in the corresponding period of the prior year. The increase in margin is primarily due to the discontinuation of e-commerce sales at Reel.com in June 2000. Excluding Reel.com, product margins improved to 31.5% from 29.9%. OPERATING COSTS AND EXPENSES Operating and Selling Total operating and selling expense for the current year first quarter decreased by $10 million compared to the prior year first quarter. Operating and selling expense decreased as a percentage of total revenue to 44.8% in the current year first quarter compared to 48.6% in the prior year period. The decrease in total operating expense was the result of a reduction in advertising expense and the discontinuation of Reel.com, which had operating expenses for the prior year first quarter of $15 million. Due to the addition of new stores, labor costs increased by $3 million and occupancy costs increased by $6 million. Other store operating expenses were reduced by $4 million. Excluding Reel.com, operating and selling expense as a percentage of Hollywood Video revenue decreased to 44.8% in the current year first quarter from 46% in the prior year period. General and Administrative General and administrative expenses in the current year first quarter increased $8.2 million to $25.0 million. The increase was primarily due to $5.6 million in compensation expense related to a stock grant to the Company's Chief Executive Officer. Amortization of Intangibles Amortization of intangibles decreased to $1.2 million in the current year first quarter compared to $14.3 million in the first quarter of the prior year. The decrease was caused by a write down of Reel.com's goodwill as e-commerce operations discontinued in the prior year second quarter. NONOPERATING INCOME (EXPENSE), NET Interest expense, net of interest income, increased by $0.8 million in the current year first quarter compared to the corresponding period of the prior year due an increase in the interest rate under the Company's revolving credit facility. INCOME TAXES The Company's effective tax rate was a provision of 2.1% in the current year first quarter compared to a provision of 7.3% in the prior first quarter, which varies from the federal statutory rate as a result of minimum state taxes in excess of statutory state income taxes, nondeductible executive compensation, deferred tax valuation allowances and non-deductible goodwill amortization associated with the Reel.com acquisition. LIQUIDITY AND CAPITAL RESOURCES Overview During 2000, the Company experienced a number of significant events with respect to its liquidity and capital situation. The Company began the year growing at the average rate of one store per day, as well as funding significant cash losses at Reel.com. In order to meet the funding needs to continue at this growth rate, the Company's then-existing $300 million credit facility needed to be expanded or refinanced. During early 2000, the Company attempted to refinance this facility. In March 2000, the Company received an underwritten commitment from a group of banks for a new $375 million credit facility. However, syndication of this new facility failed in May 2000, primarily due to lenders' concerns with losses at Reel.com and the significant capital needed to fund our aggressive growth. Without the availability of new funding, the Company was faced with the need to begin reducing the outstanding principal amount of its $300 million credit facility starting with $37.5 million on December 5, 2000 and continuing to reduce by $37.5 million each quarter thereafter. In order to meet this obligation, the Company needed to make significant changes to its growth plans. As part of these changes, in June of 2000, the Company closed the e-commerce business at Reel.com, thereby stopping its cash losses. Furthermore, the Company made the decision to stop its new store growth and not to sign new leases for the remainder of the year. At that time, the Company had 141 signed leases for stores yet to open in 2000 and 2001. The Company has since worked to either open the remaining stores or terminate their leases. As of March 31, 2001, the Company had opened 51 of those stores and terminated 51 leases, with an additional 39 remaining. The Company intends to terminate the remaining leases and anticipates opening fewer than 10 stores in 2001. Stopping new store growth allows more of the cash flows from the Company's over 1,800 existing video stores to pay down debt or vendor balances. In the fourth quarter of 2000, the Company turned free cash flow positive for the first time as a public company. After being a net user of cash since inception, the Company became a net generator of free cash. Cash Provided by Operating Activities Net cash flow provided by operating activities increased by $26.3 million, or 131%, to $46.4 million in the current year first quarter from $20.1 million in the corresponding period of the prior year. This increase was primarily due to improved operating income because the Company no longer operates an e-commerce business. Amounts accrued in connection with the discontinuation of e-commerce operations at Reel.com include $19.9 million for contractual obligations, 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. As of March 31, 2001, the Company had paid $5.3 million of the accrued amounts. Cash Used in Investing Activities Net cash used in investing activities decreased by $31.1 million, or 45%, to $38.2 million in the current year first quarter from $69.3 million in the corresponding period of the prior year. The decrease was primarily due to fewer new store openings. The Company opened only 4 new stores in the first quarter of 2001 compared to 89 in the first quarter of 2000. The Company anticipates that the number of new store openings in 2001 will be fewer than 10. Capital expenditures other than rental inventory include equipment, fixtures, and leasehold improvements for new and existing stores, remodeling projects, and implementing and upgrading office and store technology. We anticipate that capital expenditures, other than purchases of rental inventory, will be approximately $20 million in 2001, of which $9.6 million is anticipated to relate to new, relocated and remodeled stores. The remaining balance relates to corporate capital expenditures. Cash Provided by Financing Activities Net cash needed from financing activities decreased by $39.1 million, or 84%, to $7.5 million in the first quarter of the current year from $46.6 million in the corresponding period of the prior year. The decrease was primarily due to an increase of cash provided by operations, coupled with a decrease in cash used by investing activities due to slower store growth. Additionally, the Company's cash balance at March 31, 2000 was $19 million. The balance on the revolving credit facility was at $256.5 million as of March 31, 2001. Because it is doubtful the Company will be able to meet the scheduled 2001 facility amortization of $150 million, the Company has been negotiating a restructured amortization with its lenders. On March 6, 2001, the Company made a $6 million amortization payment and its lenders agreed to defer $31.5 million of the $37.5 million total due on that date until May 5, 2001. During the deferral period the Company and its lenders worked toward a permanent change in the amortization schedule to better match debt pay-down with the current business plan. On May 5, 2001, the Company made a $1 million amortization payment and its lenders agreed to defer $30.5 until June 5, 2001. The Company continues to work toward a permanent change in the amortization schedule. This change requires the affirmative vote of 100% of the approximately 20 lenders involved with the credit facility. There is no assurance that the Company will be successful in its negotiations. If the Company is not successful, it could have a negative effect on our business and operations. As of March 31, 2001, the Company was in violation of covenants contained within the credit facility. The Company was able to obtain the appropriate waiver for the violations. However, this waiver expires June 5, 2001. Because the waiver does not extend beyond June 5, 2001, in accordance with FAS 78, Classification of Obligations That Are Callable by the Creditor, the Company has reclassified $37.5 million that matures in June 2002 and $37.5 million that matures in September 2002 to current liabilities on the consolidated balance sheet as of March 31, 2001. Other Financial Measurements: Working Capital At March 31, 2001, the Company had cash and cash equivalents of $19 million and a working capital deficit of $470 million. The classification of the $256.5 million outstanding under the Company's revolving credit facility as current debt was a significant factor contributing to the working capital deficit. Other factors contributing to the working capital deficit were the accounting treatment of rental inventory as discussed below and an increase in certain accrued liabilities. 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. In particular, the Company does not believe that the classification of rental inventory as non-current assets and the classification of rental inventory acquisition costs as current liabilities significantly affects its ability to operate its business or pay its obligations as they become due. However, the other factors contributing to the Company's working capital deficit, unless timely resolved, could significantly impair the Company's ability to operate its business and pay its obligations when they become due. 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) February 12, 2002 /S/JAMES MARCUM ------------------ ------------------------------------------------- (Date) James Marcum Executive Vice President and Chief Financial Officer (Authorized Officer and Principal Financial and Accounting Officer of the Registrant)