10-Q/A 1 r10qa-06.txt QUARTERLY REPORT ON FORM 10-Q/A 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 June 30, 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 offices) (zip code) (503) 570-1600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such short period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No As of July 31, 2001 there were 49,288,165 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 Six Months Ended June 30, June 30, ------------------ ------------------ 2001 2000 2001 2000 -------- -------- -------- -------- REVENUE: Rental revenue $273,091 $261,902 $563,771 $534,352 Product sales 51,981 60,734 103,546 123,606 -------- -------- -------- -------- 325,072 322,636 667,317 657,958 COST OF REVENUE: Cost of rental 91,842 79,700 200,986 170,861 Cost of product 35,991 68,913 71,288 116,320 -------- -------- -------- -------- 127,833 148,613 272,274 287,181 -------- -------- -------- -------- GROSS MARGIN 197,239 174,023 395,043 370,777 OPERATING COSTS AND EXPENSES: Operating and selling 153,042 161,804 306,197 324,687 General and administrative 22,500 21,781 47,468 38,598 Restructuring charge for closure of internet business - 48,548 - 48,548 Amortization of intangibles 1,256 11,964 2,505 26,283 -------- -------- -------- -------- 176,798 244,097 356,170 438,116 -------- -------- -------- -------- INCOME (LOSS) FROM OPERATIONS 20,441 (70,074) 38,873 (67,339) Non-operating income (expense): Interest income 164 102 187 102 Interest expense (13,675) (15,547) (28,528) (29,617) -------- -------- -------- -------- Income (loss) before income taxes 6,930 (85,519) 10,532 (96,854) Benefit (provision) for income taxes (145) 22,475 (221) 21,647 -------- --------- ------- --------- NET INCOME (LOSS) $ 6,785 $(63,044) $ 10,311 $(75,207) ======== ========= ======= ========= Net income (loss) per share: Basic $0.14 $(1.37) $ 0.21 $(1.63) Diluted $0.13 $(1.37) $ 0.21 $(1.63) Weighted average shares outstanding: Basic 49,249 46,141 48,834 46,074 Diluted 53,093 46,141 49,994 46,074 The accompanying notes are an integral part of this financial statement HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) June 30, December 31, ------------ ----------- 2001 2000 ------------ ----------- (Unaudited) ASSETS Current assets: Cash and cash equivalents $ 19,767 $ 3,268 Receivables 26,251 23,830 Merchandise inventories 54,397 54,201 Prepaid expenses and other current assets 11,432 10,099 ----------- ----------- Total current assets 111,847 91,398 Rental inventory, net 148,486 168,462 Property and equipment, net 296,103 323,666 Goodwill, net 67,294 69,616 Other assets, net 14,651 11,972 ----------- ----------- $ 638,381 $ 665,114 =========== =========== LIABILITIES AND SHAREHOLDERS' DEFICIT Current liabilities: Current maturities of long-term obligations $ 64,210 $ 261,164 Accounts payable 142,744 169,503 Accrued expenses 105,982 114,633 Accrued revenue sharing 26,133 30,855 Accrued interest 13,913 11,817 Income taxes payable 4,463 4,844 ----------- ----------- Total current liabilities 357,445 592,816 Long-term obligations, less current portion 469,167 275,237 Other liabilities 19,254 19,438 ----------- ----------- 845,866 887,491 ----------- ----------- Shareholders' deficit: Preferred stock, 25,000,000 shares authorized; no shares issued and outstanding - - Common stock, 100,000,000 shares authorized; 49,249,565 and 46,247,599 shares issued and outstanding, respectively 372,594 365,441 Unearned compensation (2,572) - Accumulated deficit (577,507) (587,818) ----------- ----------- Total shareholders' deficit (207,485) (222,377) ----------- ----------- $ 638,381 $ 665,114 =========== =========== The accompanying notes are an integral part of this financial statement. HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) Six Months Ended June 30, ------------------------ 2001 2000 ---------- ---------- OPERATING ACTIVITIES: Net income (loss) $ 10,311 $ (75,207) Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation and amortization 127,371 118,485 Amortization of deferred financing costs 1,653 1,256 Tax benefit from exercise of stock options - 54 Change in deferred rent (184) 1,349 Change in deferred income taxes - (22,988) Net asset write down for closure of internet business - 40,087 Non-cash stock compensation 4,580 - Net change in operating assets and liabilities: Receivables (2,421) 3,725 Merchandise inventories (196) 1,261 Accounts payable (26,759) 4,125 Accrued interest 2,096 (1,703) Accrued revenue sharing (4,722) 16,406 Other current assets and liabilities (10,395) 14,194 --------- --------- Cash provided by operating activities 101,334 101,044 --------- --------- INVESTING ACTIVITIES: Purchases of rental inventory, net (74,123) (89,176) Purchases of property and equipment, net (3,202) (55,737) Increase in intangibles and other assets (4,487) (13,976) --------- --------- Cash used in investing activities (81,812) (158,889) --------- --------- FINANCING ACTIVITIES: Issuance of long-term obligations - 12,511 Repayments of long-term obligations (8,024) (6,854) Proceeds from exercise of stock options 1 618 Increase in revolving loan, net 5,000 49,000 --------- --------- Cash (used in) provided by financing activities (3,023) 55,275 --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 16,499 (2,570) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 3,268 6,941 --------- --------- CASH AND CASH EQUIVALENTS AT END OF THE SECOND QUARTER $ 19,767 $ 4,371 ========= ========= 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' deficit. 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. In July 2001, the Financial Accounting Standards Board (FASB) issued FASB Statements Nos. 141 and 142 (SFAS 141 and SFAS 142), "Business Combinations" and "Goodwill and Other Intangible Assets." SFAS 141 replaces APB 16 and eliminates pooling-of-interests accounting prospectively. It also provides guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. SFAS 142 changes the accounting for goodwill from an amortization method to an impairment only approach. Under SFAS 142, goodwill will be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. SFAS 141 and 142 are effective for all business combinations completed after June 30, 2001. Upon adoption of SFAS 142, amortization of goodwill recorded for business combinations consummated prior to July 1, 2001 will cease, and intangible assets acquired prior to July 1, 2001 that do not meet criteria for recognition under SFAS 141 will be reclassified to goodwill. Companies are required to adopt SFAS 142 for fiscal years beginning after December 15, 2001. The Company will adopt SFAS 142 on January 1, 2002, the beginning of fiscal 2002. In connection with the adoption of SFAS 142, the Company will be required to perform a transitional goodwill impairment assessment. The Company has not yet determined the impact these standards will have on its results of operations and financial position. (2) Statements of Changes in Shareholders' Deficit An analysis of the shareholders' deficit amounts for the six months ended June 30, 2001 is as follows (in thousands, except share amounts): Common Stock Unearned ------------------- Compen- Accumulated 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 1,966 1 1 Stock option tax benefit - - Stock compensation 3,871 (2,572) 1,299 Net income 10,311 10,311 ---------- -------- -------- --------- --------- Balance at 6/30/2001 49,249,565 $372,594 (2,572) $(577,507) $(207,485) ========== ======== ======== ========= ========= (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 $63.2 million and $126.5 million for the current year second quarter and six months, respectively, compared with $60.7 million, and $119.3 for the corresponding periods of the prior year. (4) Long-term Obligations On June 5, 2001, the Company amended its revolving credit facility. The amendment extends the maturity of the facility from September 5, 2002 to December 23, 2003, and creates a new amortization payment schedule. The new amortization payment schedule on the $250 million outstanding on June 30, 2001 is as follows (in thousands): After Prior to Amendment Amendment --------- --------- Second Quarter 2002 62,500 Third Quarter 2002 37,500 Fourth Quarter 2002 8,500 37,500 First Quarter 2002 20,000 37,500 Second Quarter 2002 20,000 37,500 Third Quarter 2002 20,000 37,500 Fourth Quarter 2002 40,000 First Quarter 2003 25,000 Second Quarter 2003 25,000 Third Quarter 2003 25,000 Fourth Quarter 2003 66,500 --------- --------- 250,000 250,000 --------- --------- Consideration paid to the lenders to complete the amendment was an up-front fee of 1.5% of the outstanding principal balance on June 5, 2001. The interest rate is set at LIBOR plus 5.0% and will step down if certain performance targets are met. The Company had the following long-term obligations as of June 30, 2001 and as of December 31, 2000 (in thousands): June 30, December 31, ----------- ---------- 2001 2000 ----------- ---------- Senior subordinated notes (1) $250,000 $ 250,000 Borrowings under revolving credit facility 250,000 245,000 Obligations under capital leases 33,377 41,396 Other - 5 ----------- ---------- 533,377 536,401 Current portions: Credit facility 48,500 245,000 Capital leases 15,710 16,164 ----------- ---------- 64,210 261,164 Total long-term obligations ----------- ---------- net of current portion $ 469,167 $ 275,237 =========== ========== (1) Coupon payments at 10.625% are due semi-annually in February and August of each year. The principal amount is due in August 2004. (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 June 30, (In thousands, except per share amounts) ------------------------------------------------------- 2001 2000 ------------------------- -------------------------- Net Per Share Per Share Income Shares Amounts Loss Shares Amounts ------- ------- ------- -------- ------- ------- Basic income (loss) per share: $ 6,785 49,249 $ 0.14 $(63,044) 46,141 $ (1.37) Effect of dilutive securities: Stock options 3,844 - - ------- ------- -------- ------- Diluted income (loss) per share: $ 6,785 53,093 $ 0.13 $(63,044) 46,141 $ (1.37) ======= ======= ======= ======== ======= ======= Antidilutive stock options excluded from the calculation of diluted income (loss) per share were 4.7 million shares and 6.7 million shares in the second quarter of 2001 and 2000, respectively. Six Months Ended June 30, (In thousands, except per share amounts) ------------------------------------------------------- 2001 2000 ------------------------- -------------------------- Net Per Share Per Share Income Shares Amounts Loss Shares Amounts ------- ------- ------- -------- ------- ------- Basic income (loss) per share: $10,311 48,834 $ 0.21 $(75,207) 46,074 $ (1.63) Effect of dilutive securities: Stock options 1,160 - - ------- ------- -------- ------- Diluted income (loss) per share: $10,311 49,994 $ 0.21 $(75,207) 46,074 $ (1.63) ======= ======= ======= ======== ======= ======= Antidilutive stock options excluded from the calculation of diluted income (loss) per share were 4.9 million shares and 6.0 million shares in the first six months 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 1,815 retail stores located in 47 states, was the only segment operated by the Company in the current year second quarter and six months ended June 30, 2001. The Company operated two segments during corresponding periods of the prior year, the Hollywood Video segment and the Reel.com segment. The Reel.com segment was 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 June 30, ----------------------------------------------------------- 2001 2000 -------------------------- -------------------------------- Hollywood Hollywood Video Reel.com Total Video Reel.com Total -------- -------- -------- ---------- -------- --------- Revenue $325,072 $325,072 $ 310,657 $ 11,979 $ 322,636 Tape depreciation 45,138 45,138 28,841 - 28,841 Other depreciation and amortization 16,377 16,377 20,034 10,489 30,523 Gross margin 197,239 197,239 194,147 (20,124) 174,023 Operating income (loss) * 20,441 20,441 24,266 (94,340) (70,074) Interest expense, net 13,511 13,511 13,342 2,103 15,445 Total assets 638,381 638,381 1,098,867 - 1,098,867 Purchases of property and equipment, net 821 821 25,065 207 25,272 * Reel.com's operating loss includes a restructuring charge of $69.3 million for discontinued e-commerce operations. The loss also includes $10.2 million in goodwill amortization. Excluding the restructuring charge and goodwill amortization, Reel.com's operating loss would have been $14.9 million for the three months ended June 30, 2000. Six Months Ended March 31, ----------------------------------------------------------- 2001 2000 -------------------------- -------------------------------- Hollywood Hollywood Video Reel.com Total Video Reel.com Total -------- -------- -------- ---------- -------- --------- Revenue $667,317 $667,317 $ 631,678 $ 26,280 $ 657,958 Tape depreciation 94,099 94,099 57,888 110 57,998 Other depreciation and amortization 33,272 33,272 38,251 23,492 61,743 Gross margin 395,043 395,043 389,751 (18,974) 370,777 Operating income (loss) * 38,873 38,873 55,430 (122,769) (67,339) Interest expense, net 28,341 28,341 25,249 4,266 29,515 Total assets 638,831 638,831 1,098,867 - 1,098,867 Purchases of property and equipment, net 3,202 3,202 54,219 1,518 55,737 * 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. (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. 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 June 30, 2001, the Company had paid $6 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 are expected to close 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 June 30, 2001, the Company has closed 7 of the 43 scheduled stores that are included in the Restructuring Plan. The Company incurred $154,725 in expenses during the current year six months related to these closures. (9) Consolidating Financial Statements Hollywood Entertainment Corporation (HEC) had one wholly owned subsidiary during the six months ended June 30, 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 Six months ended June 30, 2001 (in thousands) ---------- -------- --------- ---------- HEC HMC Elimin- Consol- ations idated ---------- -------- --------- ---------- Revenue $ 668,755 $ 73,240 $ (74,678) $ 667,317 Cost of revenue 272,274 -- -- 272,274 Gross profit 396,481 73,240 (74,678) 395,043 Operating costs & expenses: Operating and selling 299,890 6,307 -- 306,197 General & administrative 99,081 23,065 (74,648) 47,468 Amortization of intangibles 2,321 184 -- 2,505 Income (loss) from operations (4,811) 43,684 -- 38,873 Interest income -- 18,316 (18,129) 187 Interest expense (46,657) -- 18,129 (28,528) Income(loss)before income taxes (51,468) 62,000 -- 10,532 (Provision for) benefit from income taxes 22,719 (22,940) -- (221) Net income (loss) $ (28,749)$ 39,060 $ -- $ 10,311 Consolidating Condensed Balance Sheet June 30, 2001 (in thousands) ---------- -------- --------- --------- HEC HMC Elimin- Consol- ations idated ---------- -------- --------- --------- ASSETS Cash and cash equivalents $ 1,918 $ 17,849 $ -- $ 19,767 Accounts receivable 18,407 364,700 (356,856) 26,251 Merchandise inventories 54,397 -- -- 54,397 Prepaid expenses and other current assets 7,958 3,474 -- 11,432 Total current assets 82,680 386,023 (356,856) 111,847 Rental inventory, net 148,486 -- -- 148,486 Property & equipment, net 286,915 9,188 -- 296,103 Goodwill, net 67,294 -- -- 67,294 Other assets, net 13,914 4,745 (4,008) 14,651 Total Assets $ 599,289 $399,956 $(360,864) $ 638,381 LIABILITIES & SHAREHOLDERS' EQUITY (DEFICIT) Current maturities of long-term obligations $ 64,210 $ -- $ -- $ 64,210 Accounts payable 356,856 142,744 (356,856) 142,744 Accrued expenses 6,065 99,917 -- 105,982 Accrued revenue sharing -- 26,133 -- 26,133 Accrued interest -- 13,913 -- 13,913 Income taxes payable -- 4,463 -- 4,463 Total current liabilities 427,131 287,170 (356,856) 357,445 Long-term obligations, less current portion 469,167 -- -- 469,167 Other liabilities 19,254 -- -- 19,254 Total liabilities 915,552 287,170 (356,856) 845,466 Preferred stock -- -- -- -- Common stock 372,594 4,008 (4,008) 372,594 Unearned compensation (2,572) -- -- (2,572) Accumulated deficit (686,285) 108,778 -- (577,507) Total shareholders' equity equity (deficit) (316,263) 112,786 (4,008) (207,485) Total liabilities and shareholders equity (deficit) $ 599,289 $399,956 $(360,864) $ 638,381 Consolidating Condensed Statement of Cash Flows Six months ended June 30, 2001 (in thousands) ---------- -------- -------- ---------- HEC HMC Elimin- Consol- ations idated ---------- -------- -------- ---------- Operating activities: Net income (loss) $ (28,749)$ 39,060 $ -- $ 10,311 Adjustments to reconcile net income (loss) to cash provided by operating activities: Depreciation & amortization 125,873 3,151 -- 129,024 Change in deferred rent (184) -- -- (184) Change in deferred income taxes -- -- -- -- Non cash stock compen- sation 4,580 -- -- 4,580 Net change in operating assets & liabilities (17,385)(25,012) -- (42,397) Cash provided by operating activities 84,135 17,199 -- 101,334 Investing activities: Purchases of rental inventory, net (74,123) -- -- (74,123) Purchase of property & equipment, net (2,901) (301) -- (3,202) Increase in intangibles & other assets (4,085) (402) -- (4,487) Cash used in investing activities (81,109) (703) -- (81,812) Financing activities: Proceeds from the sale of common stock, net -- -- -- -- Issuance of long-term obligations -- -- -- -- Repayments of long-term obligations (8,024) -- -- (8,024) Proceeds from exercise of stock options 1 -- -- 1 Increase in revolving loan, net 5,000 -- -- 5,000 Cash provided by financing activities (3,023) -- -- (3,023) Increase (decrease) in cash and cash equivalents 3 16,496 -- 16,499 Cash and cash equivalents at beginning of year 1,915 1,353 -- 3,268 Cash and cash equivalents at end of year $ 1,918 $17,849 $ -- $ 19,767 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 second quarter and six months was $6.8 million and $10.3 million, respectively, compared with a net loss of $63.0 million and $75.2 million for the corresponding periods of the prior year. 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 Six Months Ended June 30, June 30, ---------------------- ---------------------- 2001 2000 2001 2000 ---------- ---------- ---------- ---------- (Unaudited) REVENUE: Rental revenue 84.0% 81.2% 84.5% 81.2% Product sales 16.0 18.8 15.5 18.8 ---------- ---------- ---------- ---------- 100.0 100.0 100.0 100.0 ---------- ---------- ---------- ---------- GROSS MARGIN 60.7 53.9 59.2 56.4 OPERATING COSTS AND EXPENSES: Operating and selling 47.1 50.1 45.9 49.3 General and administrative 6.9 6.8 7.1 5.9 Restructuring charge for closure of internet business - 15.0 - 7.4 Amortization of intangibles 0.4 3.7 0.4 4.0 ---------- ---------- ---------- ---------- 54.4 75.6 53.4 66.6 ---------- ---------- ---------- ---------- INCOME (LOSS) FROM OPERATIONS 6.3 (21.7) 5.8 (10.2) Non-operating expense, net (4.2) (4.8) (4.2) (4.5) ---------- ---------- ---------- ---------- Income (loss) before income taxes 2.1 (26.5) 1.6 (14.7) Provision for income taxes - 7.0 - 3.3 ---------- ---------- ---------- ---------- NET INCOME (LOSS) 2.1% (19.5)% 1.6% (11.4) ---------- ---------- ---------- ---------- Three Months Ended Six Months Ended June 30, June 30, ---------------------- ---------------------- 2001 2000 2001 2000 ---------- ---------- ---------- ---------- OTHER FINANCIAL DATA: Rental gross margin (1) 66.4% 69.6% 64.3% 68.0% Product gross margin (2) 30.8% (13.5)% 31.2% 5.9% EBITDA (3) (In thousands) Hollywood Video segment EBITDA $ 81,951 $ 72,470 $166,239 $150,310 Reconciliation to Adjusted EBITDA (4) Add non-cash expenses(5) 17,215 17,618 39,180 35,095 Less existing store investment in new release inventory (6) (58,045) (46,614) (111,157) (82,936) ---------- ---------- ---------- ---------- ADJUSTED EBITDA HOLLYWOOD VIDEO 41,121 43,474 94,262 102,469 Reel.com segment EBITDA - (14,518) - (29,834) ---------- ---------- ---------- ---------- CONSOLIDATED ADJUSTED EBITDA $ 41,121 $ 28,956 $ 94,262 $ 72,635 CASH FLOW FROM:(In thousands) Operating activities $ 54,900 $ 80,928 $101,334 $101,044 Investing activities (43,591) (89,599) (81,812) (158,889) Financing activities (10,569) 8,639 (3,023) 55,275 OPERATING DATA: Number of stores at quarter end 1,815 1,772 1,815 1,772 Weighted average stores open during the period 1,816 1,736 1,817 1,700 Comparable store revenue increase (7) 1% 7% 0% 5% (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 for the current year and prior year include tape loss and the book cost of previously viewed movies sold. Additionally, in the current year second quarter and six months ended non-cash items included $1.3 million and $4.6 million of stock compensation. (6) This represents existing store purchases that are considered replenishment of new release tapes, games and DVDs which are included in the amounts presented as 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 $2.4 million, or 1%, in the current year second quarter and $9.3 million, or 1% in the current year six months compared with the corresponding periods of the prior year. Excluding Reel.com revenue increased by $14.4 million, or 5%, in the current year second quarter and $35.6 million, or 6%, in the current year six months compared with the corresponding periods of the prior year. The increase was primarily due to the addition of 43 new superstores in the twelve months ended June 30, 2001. An increase in comparable store revenue of 1% and 0% in the current year second quarter and six months, respectively, also favorably impacted revenue. Rental revenue from initial rental periods was $237 million in the current year second quarter and $490 million in the six months ended June 30, 2001 compared to $231 million and $470 million in the corresponding periods of the prior year. Rental revenue from extended rental periods was $36 million in the current year second quarter and $74 million in the six months ended June 30, 2001 compared to $31 million and $65 million in the corresponding periods of the prior year. GROSS MARGIN Rental margin as a percentage of rental revenue decreased to 66.4% in the current year second quarter from 69.6% in the corresponding period of the prior year. Rental margins for the six month period ended June 30, 2001 decreased to 64.3% from 68% in the corresponding period of the prior year. The decrease in margin primarily relates to an increase in rental product 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 increased to 30.8% in the current year second quarter from a negative 13.5% in the corresponding period of the prior year. Cost of product sales in the prior year second quarter included a $20.8 million dollar charge for the discontinuation of e-commerce sales at Reel.com (see Note 7 to Consolidated Financial Statements). Excluding Reel.com, product margins increased to 30.8% from 24.5% primarily due to improved margins on previously viewed movie sales. Compared to the prior year, margins on previously viewed product have increased due to the depreciation change in estimate, which results in lower residual values that are charged to cost of product sales. Product margins for the six month period ended June 30, 2001 increased to 31.2% from 5.9% 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 31.2% from 27.2% primarily due to improved margins on previously viewed movie sales caused by the deprecation change in estimate. OPERATING COSTS AND EXPENSES Operating and Selling Total operating and selling expense for the current year second quarter and the six months ended June 30, 2001 decreased by $9 million and $18 million, respectively, when compared to the corresponding periods of the prior year. Operating and selling expense decreased as a percentage of total revenue to 47.1% and 45.9% in the current year second quarter and the six months ended June 30, 2001, respectively, compared to 50.2% and 49.3% in the corresponding periods of the prior year. The decrease in total operating expense for the second quarter was the result of the discontinuation of e-commerce operations at Reel.com, which had operating expenses for the prior year second quarter of $12 million. Due to the addition of new stores, labor costs increased by $2 million and occupancy costs increased by $2 million. These increases were partially offset by other store operating expenses that were reduced by $1 million. The decrease in total operating expense for the six months ended June 30, 2001 was the result of the discontinuation of e-commerce operations at Reel.com, which had operating expenses for the prior year period of $27 million. Due to the addition of new stores, labor costs increased by $5 million and occupancy costs increased by $7 million. These increases were partially offset by other store operating expenses that were reduced by $3 million. Excluding Reel.com, operating and selling expense as a percentage of Hollywood Video revenue decreased to 47.1% and 45.9% in the current year second quarter and six months ended June 30, 2001, respectively, compared to 48.2% and 47.1% in the corresponding periods of the prior year. The Company has a high degree of focus on operating and selling expenses and this focus is expected to increase so the Company can continue to see leverage in this area when revenue increases. General and Administrative General and administrative expenses in the current year second quarter and six months increased $0.7 million and $8.9 million, respectively, to $22.5 million and $47.5 million. The increase for the current year second quarter was primarily due to $1.3 million of non-cash stock compensation and other payroll and related costs. This was partially offset by the discontinuation of Reel.com in the second quarter prior year, which had general and administrative expenses of $3.4 million. The increase for the current year six months was primarily due to $5.6 million in compensation expense related to a stock grant to the Company's Chief Executive Officer, $1.3 million of non-cash stock compensation and other payroll and related costs. The Company made the decision to invest in certain elements of the business such as the store field supervision structure, the loss prevention function and human resources. The Company believes these investments will have a direct impact on the business by improving the level of execution. The increase was partially offset by the discontinuation of Reel.com, which had general and administrative expenses of $5.1 million in the prior year period. 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. 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. As a result of the discontinuation of e-commerce operations, the Company recorded a total charge of $69.3 million in the second quarter of 2000, 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. In the fourth quarter of 2000, the charge was reduced by $1.6 million to $46.9 million because the Company was able to negotiate termination of certain obligations and lease commitments more favorably than originally anticipated. 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 June 30, 2001, the Company had paid $6 million of the accrued amounts. 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 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. Amortization of Intangibles Amortization of intangibles decreased to $1.3 million and $2.5 million in the current year second quarter and six months, respectively. 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, decreased by $1.9 million and $1.2 million in the current year second quarter and six months, respectively, compared to the corresponding periods of the prior year. The decrease is due to decreased borrowings under the Company's revolving credit facility and lower interest rates. INCOME TAXES The Company's income tax rate is 2.10% for both the second quarter and the first six months of fiscal 2001, compared with a benefit of 26.3% and 22.4% for the corresponding periods in the prior year. The increase is a result of minimum state taxes in excess of statutory state income taxes, nondeductible executive compensation and a full valuation allowance placed against the net deferred tax assets. LIQUIDITY AND CAPITAL RESOURCES Overview The Company generates substantial operating cash flow because most of its revenue is received in cash from rental and sales of videocassettes, DVDs and games. The amount of cash generated from operations in the six months ended June 30, 2001 funded the Company's debt service requirements and all capital expenditures with enough cash left over to reduce accounts payable and accrued liabilities by $40 million. At June 30, 2001 the Company had $19.8 million of cash and cash equivalents on hand. The Company believes cash flow from operations, increased flexibility under the amended credit facility, cash on hand and trade credit will provide adequate liquidity and capital resources to execute its business plan for the next twelve months. The Company continues to analyze its capital structure and related flexibility and as such, from time to time, may consider additional capital and/or financing transactions as a source of incremental liquidity. Cash Provided by Operating Activities Although net cash flow provided by operating activities remained flat at $101 million in the six months ended June 30, 2001 and the corresponding period of the prior year, the components were dramatically different. The Company's net income/loss plus adjustments to reconcile net income/loss to cash provided by operating activities increased by $81 million or 128% in the six months ended June 30, 2001 compared to the corresponding period of the prior year. The increase was due to the discontinuation of e-commerce operations at Reel.com and improved operating performance in the existing store base. The increase was offset by pay-downs of accounts payable and accrued liabilities of $40 million compared to a net increase in accounts payable and accrued liabilities of $33 million in the prior year period. Cash Used in Investing Activities Net cash used in investing activities decreased by $77.1 million, or 49%, to $81.8 million in the six months ended June 30, 2001 from $158.9 million in the corresponding period of the prior year. The decrease was primarily due to fewer new store openings. The Company opened only 5 new stores in the first six months of 2001 compared to 160 in the first six months 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 less than $20 million in 2001, of which approximately half is anticipated to relate to new, relocated and remodeled stores and related store maintenance. The remaining balance relates to corporate capital expenditures. Cash Provided by Financing Activities In the six months ended June 30, 2001 the Company's cash flow from financing activities was a net use of $3 million compared to $55.3 million of cash provided by financing activities in the six months ended June 30, 2000. The slowing of store growth coupled with an increase of cash provided by operations is allowing the Company to operate with internally generated cash flow instead of outside financing. On June 5, 2001, the Company amended its revolving credit facility. The amendment extends the maturity of the facility from September 5, 2002 to December 23, 2003, and creates a new amortization payment schedule. (See Note 4 to the Consolidated Financial Statements for a table of amortization payments.) Consideration paid to the lenders to complete the amendment was an up-front fee of 1.5% of the outstanding principal balance on June 5, 2001. The interest rate is set at LIBOR plus 5.0% and will step down if certain performance targets are met. As of June 30, 2001 the balance on the revolving credit facility was $250 million. Other Financial Measurements: Working Capital At June 30, 2001, the Company had cash and cash equivalents of $19.8 million and a working capital deficit of $246 million. The working capital deficit is primarily the result of the accounting treatment of rental inventory as discussed below. Other factors contributing to the deficit are the current amounts due under the revolving credit facility and significant accrued expenditures. 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 will, more likely than not, operate with a working capital deficit. The Company believes the current existence of a working capital deficit does not effect its ability to operate its business and meet obligations as they come due. Disclosure Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby. These statements can be identified by the fact that they do not relate strictly to historical information and include the words expects, believes, anticipates, plans or other similar expressions. These forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those currently anticipated. These risks and uncertainties include, but are not limited to, items discussed in the Company's Annual Report on Form 10K for the fiscal year ended December 31, 2000 under the heading Cautionary Statements. 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)