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UPDATE: Hollywood Video High on Revenue-Sharing

25 Jul, 2002 By: Joan Villa

Hollywood Entertainment Corp. has agreed to DVD revenue-sharing with MGM and Columbia TriStar and may soon expand the model to other studios and even games, CEO and president Mark Wattles said on a second quarter earnings call.

“I continue to believe the majority, if not all, of the studios will end up rev-sharing DVD based on current discussions we're having with them,” Wattles said. “That's not something I'm counting on nor is it necessary to have the growth we're experiencing to date.”

While DVD's current sellthrough pricing means Hollywood pays about $17 wholesale, Wattles noted “there could be bigger benefit under revenue-sharing to have increasing availability of DVD for opening weekends.” However, he doesn't anticipate studios will adopt rental pricing in the near future.

“They'd love to see the price point go up to get more dollars per copy out of us, but the problem with them raising that price point is it has an offsetting decrease in the quantity of product that's bought by mass merchants and sold directly to consumers,” he explained. “That's what's holding that price point down, which is benefiting those of us in the rental business.”

DVD grew to 36 percent of rental revenues by the end of the second quarter, up from 30 percent at the end of 2001, Wattles said.

The games category is also expanding rapidly, with quarterly game rentals chainwide up 20 percent and same-store sales at Hollywood's 66 Game Crazy locations climbing 50 percent for the quarter over the year-ago period. Games represent about 10 percent of revenue and are expected to grow to 14 percent of revenue by year-end, he added.

Limited revenue-sharing tests on games concluded the model is “a little more problematic, but not impossible,” Wattles said. With a record number of game titles lined up for fourth-quarter release, manufacturers “are recognizing that they need the rental business in order to provide revenue on all of their product,” he explained.

“If you asked me this question three months ago I would have said it was very unlikely that we would have revenue-sharing on games anytime in the near future,” he noted. “However, based on some of our recent discussions that's looking like a greater possibility.”

The chain will roll out another 100 Game Crazy locations by year-end, each carved out of about 1,000 square feet within existing stores, selling used and new hardware and software. Then the performance of those 166 store-within-stores will be evaluated to determine a rollout rate for the balance of the chain over 2003 and 2004, he added. More “event-oriented” game titles expected in the fall will be marketed in store windows and advertising, he said.

The 1,800-store chain boosted revenues 6 percent to $345.3 million in the second quarter on 7 percent higher same-store sales than the year-ago period. Second quarter net income of $41.5 million, up from $6.8 million a year ago, includes a $12.4 million accrual resulting from a favorable legal ruling regarding costs associated with closing Hollywood's Internet division, Reel.com.

Total revenues for the six months ended June 30 also climbed just over 6 percent to $709 million, and diluted earnings per share soared to $1.12 compared to 21 cents in the first half of 2001, the company reported.

“The growth in our revenues and profits continues to be driven by basically three factors: improving operations and execution, DVD and games,” Wattles said.

The stronger-than-expected first half results prompted Hollywood to raise its full-year projections for adjusted diluted earnings per share to a range of $1.14 to $1.16 from the previous range of $1.10 to $1.14. Same-store sales are expected to grow 3 percent in the third quarter and 4 percent in the fourth quarter.

However, Hollywood's stock fell last week with the rest of the market, shedding more than 7 percent to $14.35 on the earnings news. Analyst Dennis McAlpine of McAlpine Associates said the company's conservative projections for 2003 of 15 percent earnings growth and 2 percent to 3 percent same-store sales may have hurt the valuation.

“They're being conservative and in this market it's kind of backfiring,” McAlpine said. “My immediate reaction was probably what everyone's was: 3 percent same-store sales [projections] are pretty low.”

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