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UPDATE: Hollywood Financial Turnaround on Track

10 May, 2001 By: Joan Villa

Hollywood Entertainment Corp. posted flat same-store sales for the first quarter ended March 31, but also reported a profit versus a loss for the year-ago period in what it says indicates “major strides” toward a financial turnaround.

Hollywood has also corrected previous shortages of new release DVD product on store shelves that began during the fourth quarter, Hollywoodpresident and c.e.o. Mark Wattles says. He admits the company erred in the past by poorly forecasting demand and failing to budget and purchasecorrectly. While DVD is in the “double digits” as a percentage of revenue, Wattles expects the chain to achieve “in the neighborhood of 20%” DVD sales by the end of the year.

“As of the end of February, we have been purchasing DVD on the new release side correctly and since that time we have seen prettymeaningful growth in the DVD business,” Wattles explains. He acknowledges that prior to March consumers “were as likely to not find” new DVD titles in stores for a full eight weeks following release.

Today, he says, “walking into Hollywood Video looking for a Miss Congeniality (which hit the street May 1), you’d have an 80 to 90% chance of finding it in stock on the opening weekend.”

As a result, “we don’t have customers who are converting from VHS to DVD, leaving our store and going to our competition,” Wattles continues.

“We know we are gaining new customers particularly from the smaller competitors as a result of the availability of DVD in our stores.”

The Portland, Ore.-based chain extended its $37.5 million loan paymentdeadline to June 5, paying $6 million March 5 and $1 million May 5, it reported. Lenders agreed to the extensions to give Hollywood more time to finalize new credit facility and a new amortization schedule, whichrequire approval from each bank within the 20-member group.

“Over the past month we believe we’ve gotten over major hurdles,” Wattles says, including persuading the lenders that both the industryand Hollywood’s business are solid and the outlook is favorable. He insists that the chain is capable of generating $185 million annually in EBITDA (earnings before interest, taxes, depreciation and amortization)cash flow and can pay off the remaining $256 million debt on a less aggressive schedule of two and a half years.

However, issues such as fees and compensation to the banks remain, Wattles notes.

“We are willing to give generous compensation to get this done but we are not willing to overpay,” he says. “This is a business that generates a lot of cash and has the opportunity to generate a lot more cash whenwe are in no-growth mode.” The company will open virtually no new stores in 2001 and is eyeing 43 for closure by the end of the year if those stores don’t reach profitability, Wattles has said.

Hollywood’s revenue for the quarter increased 7% to $342.2million, excluding Internet site Reel.com. While overall revenue for stores open longer than one year was flat, the chain says same-store rental revenue, taken alone, climbed 2%. The revenue growth was mostly attributed to the net addition of 152 new stores compared to last year’s first quarter.

Net income climbed to $3.5 million, or 7 cents per share, versus a year-earlier loss of $12.2 million.

In addition to generating positive cash flow for the second quarter in a row, Hollywood reduced its debt by $8 million and paid $14 million toward accounts payable. That fiscal belt-tightening was touted asputting the company “well on our way to achieving a more conservative balance sheet” by c.f.o. David Martin.

“Last year in this quarter we needed to borrow $46.6 million to finance our business,” he explains. “This year we generated over $8 million and made progress on payables. This is a meaningful turnaround.”

Like other public rental chains, Hollywood predicts a tough year-over-year comparison in the second quarter, due to last year’sstrong release slate that included titles such as The Sixth Sense, StarWars, Episode 1: The Phantom Menace and American Beauty. As a result,the retailer is expecting same-store sales to decline by 4% to 5% in the second quarter, compared to a 7% increase in the year-ago period.

Same-store revenues are expected to turn positive in the second half, with expectations of a 1% increase in the third quarter and a 2% boost by the end of the year.

Wattles believes studios will ultimately raise the wholesale price of DVD so they can participate in revenue-sharing, but despite “some testing” on individual titles, he doesn’t expect higher prices thisyear.

“The issue isn’t will wholesale prices go up, because I think they will and we’ll end up in revenue-share agreements on DVD just like VHS. The real question is what is the time difference between the day in whichit’s released on revenue-share and the date it’s available at Wal-Mart,”he says.

Although that time frame is about four to six months, Wattles predicts the studios will adopt a 90-day window between rental and sellthroughpricing, which would “still be able to take advantage of the momentum around rental advertising and rental promotion.”

As of March 31, Hollywood operated 1,816 stores in 47 states, after opening four locations and closing six in the first quarter.

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