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Little Upside for Hollywood's Third Quarter

16 Oct, 2003 By: Erik Gruenwedel

Citing a dearth of major title releases that resulted in an emphasis on unit margins at the expense of same-store revenue, Hollywood Entertainment Corp. posted an $11.5 million decrease in net income for the quarter ended Sept. 30.

Net income, which was $20.4 million, or 32 cents per diluted share, compared to $31.9 million, or 50 cents per share, during the same period last year, surpassed the chain's previous guidance of 30 cents per diluted share.

“We knew the quarter didn't have much upside because there weren't a lot of strong titles for rent,” said Mark Wattles, chairman and CEO, in a conference call with analysts last week.

Only 7 percent of the quarter's revenue came from increases in same-store sales, which were buoyed by an 8 percent same-store rise in video game merchandise sales.

Hollywood added 94 Game Crazy video game departments and opened 21 new franchises during the period for a total of 1,864 stores. It plans to open 24 new video game units in the fourth quarter and be operational in 1,100 video stores by 2005.

With the growth of Game Crazy, Wattles said game inventories for the quarter were down 20 percent compared to last year and resulted in a $1 million earnings reduction. He cited a lack of used product, which typically represents up to 50 percent of a Game Crazy inventory, for the decline.

“The only supply of used games for our new stores has been from existing stores, which has not be sufficient,” said Wattles, who added that limited purchases of new games in the past has put Hollywood “at a significant disadvantage” with game publishers.

“Game publishers tightly control the distribution to create a buzz,” he said.

Hollywood reduced unit purchases of several movie releases, including select non-revenue sharing titles from an unnamed studio, which had two of the quarter's biggest releases.

“We made this decision with the belief that those titles (in reduced numbers) would provide a larger return on investment, even with the offset of reduced revenue,” Wattles said.

The effect was that DVD/VHS sales sales dropped 1 percent, while rental revenue fell about 2 percent below expectations to $254 million.

The decision to reduce the number of unit purchases on select DVD titles appeared motivated as much by Wattles' frustration at obtaining revenue-sharing agreements with one particular studio as by economic theory.

He said the strong sellthrough and lower purchase price of DVD (compared to VHS) has eliminated the “motivation” by some studios to make revenue-sharing agreements and has turned some negotiations into drawn out affairs that become mired in “finer points” that would otherwise be ignored.

Wattles said changes in buying strategies with the studio in question will depend on “what their action is” and whether “we are able to negotiate the deal we want.”

“Our preference is to always grow profits through revenues,” he added.

Hollywood has DVD revenue sharing deals with MGM Home Entertainment, Warner Home Video, and Columbia TriStar Home Entertainment.

Wattles remains upbeat for the fourth quarter, considering 14 new releases that each exceeded $100 million at the box office that, he said, will result in the “strongest traffic-driving slate of titles” ever released in a quarter.

“Rental comps [between stores] for the last four weeks have increased an average of 4 percent as a result of the traffic driven by [such films as] Anger Management, Daddy Day Care, 2 Fast 2 Furious, and The Italian Job,” Wattles said.

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