-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QelTkNSoO/0TqlLZktu6IatgmWLESSeYtxxk+8RQHOcMUTf1W2P64GInKiI4/p6x XwaRRGaYaM7ccQgXfX2RSQ== 0000893877-97-000199.txt : 19970401 0000893877-97-000199.hdr.sgml : 19970401 ACCESSION NUMBER: 0000893877-97-000199 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: HOLLYWOOD ENTERTAINMENT CORP CENTRAL INDEX KEY: 0000905895 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-VIDEO TAPE RENTAL [7841] IRS NUMBER: 930981138 STATE OF INCORPORATION: OR FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-21824 FILM NUMBER: 97571785 BUSINESS ADDRESS: STREET 1: 25600 SW PARKWAY CENTER DRIVE CITY: WILSON STATE: OR ZIP: 97070 BUSINESS PHONE: 5035701600 MAIL ADDRESS: STREET 1: 25600 SW PARKWAY CENTER DRIVE CITY: WILSONVILLE STATE: OR ZIP: 97070 10-K 1 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON DC 20549 FORM 10-K / X / ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 ----------------------------- OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OR THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ___________________ Commission file number 0-21824 -------------------- HOLLYWOOD ENTERTAINMENT CORPORATION (Exact name of registrant as specified in its charter) Oregon 93-0981138 - -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer incorporation or organization) identification No.) 25600 SW Parkway Center Drive Wilsonville, OR 97070 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) (503) 570-1600 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: Name of Each Exchange Title of Each Class on Which Registered ------------------- ------------------- Common Stock Nasdaq National Market SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period than 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 --- --- Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. [ ] On March 14, 1997, the registrant had 36,560,596 outstanding shares of Common Stock, and on such date, the aggregate market value of the shares of Common Stock held was $927,725,123 based upon the last sale price reported for such date on the Nasdaq National Market. DOCUMENTS INCORPORATED BY REFERENCE Part III - Portions of registrant's Proxy Statement which is anticipated to be filed within 120 days after the end of the registrant's fiscal year ended December 31, 1996 Hollywood Entertainment Corporation Annual Report on Form 10-K Year Ended December 31, 1996 Item Page - ---- ---- PART I 1. Business................................................................. 1 2. Properties............................................................... 9 3. Legal Proceedings........................................................10 4. Submission of Matters to a Vote of Security Holders......................11 4(a) Executive Officers of the Registrant.....................................11 PART II 5. Market for Registrant's Common Stock and Related Stockholder Matters................................. 14 6. Selected Financial Data..................................................15 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................17 8. Financial Statements and Supplementary Data..............................24 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................................................24 PART III 10. Directors and Executive Officers of the Registrant.......................25 11. Executive Compensation...................................................25 12. Security Ownership of Certain Beneficial Owners and Management...........25 13. Certain Relationships and Related Transactions...........................25 PART IV 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K..........26 PART I Item 1. Business General Hollywood Entertainment owns and operates 551 video retail superstores in 29 states as of December 31, 1996 and is the second largest video retailer in the United States. According to video industry analyst Paul Kagan Associates, Inc., the Company operates the highest volume video stores in the country. Hollywood Entertainment's goal is to be a dominant national video retailer and to build a strong national brand which consumers will identify with the entertainment industry. As part of its strategy to achieve this goal, the Company has developed a store format and design that captures the bright lights, excitement and energy of the motion picture industry and enables the public to easily identify and recognize Hollywood Video superstores. Hollywood Video superstores average approximately 7,500 square feet and typically carry approximately 10,000 titles and 16,000 videocassettes, consisting of many copies of popular new releases and an extensive selection of older or "catalog" movies. Hollywood Entertainment's goal is to be the category killer in its industry, offering more copies of popular new videocassette releases and more titles than its competitors to achieve greater customer satisfaction and encourage repeat visits. Hollywood Video stores are primarily located in high traffic locations, in stand-alone buildings, at the end of shopping strips or in other highly visible locations. The Company opened its first video superstore in October 1988 and had grown to 25 stores in two states at the end of 1993, 113 stores in eight states at the end of 1994, 305 stores in 23 states at the end of 1995, and 551 stores in 29 states at the end of 1996. As a result, the Company's revenue increased from $17.3 million in 1993 to $302.3 million in 1996, and its pro forma net income increased from $1.5 million to $20.6 million over the same period. The Company opened 250 new stores in 1996 and intends to open at least 300 new stores in 1997. Decentralization and Creation Of Zone Offices To support its larger store base and continued expansion, the Company has opened four zone offices, in Chicago, Illinois; Dallas, Texas; Portland, Oregon; and Boston, Massachusetts. Each zone now includes approximately 100 to 250 stores, and the Company believes each zone will be capable of opening 75 to 100 stores annually and of supporting the operations of 400 to 500 stores. Each zone is headed by a senior vice president of operations, who has responsibility for new store development and store operations in the zone, including recruiting, training, marketing and budgeting, and is accountable for the profitability of all stores in the zone. The Company recently hired four senior vice presidents with significant experience managing large, national chains to fill these positions. When fully implemented, the senior vice presidents will be supported by a complete team that will include a vice president of new store development, a vice president of store operations, directors of construction, recruiting and training, product and marketing, and a controller. As part of the Company's decentralization strategy, the 1 corporate office and warehouse will provide central support to the zones, including systems, product purchasing, distribution, accounting and national marketing programs. In addition, the corporate office will continue to give final approval for all new store sites and store design and oversee quality standards and other critical elements of the Hollywood concept. The Company believes the creation of geographic zones managed from zone offices that are accountable for the profitability of the stores will allow the Company to more effectively manage its business, thereby enhancing its ability to achieve its expansion plans without compromising operating standards. Industry Overview Video Retail Industry. According to Paul Kagan, total U.S. consumer spending on movies has increased from less than $3.0 billion in 1980 to approximately $27.0 billion in 1995. The U.S. videocassette rental and sales industry has grown at a compound annual growth rate of approximately 8.6%, from $9.8 billion in revenue in 1990 to $14.8 billion in 1995, and is expected to reach $18.2 billion in 2000. The video retail industry is highly fragmented and in recent years has been characterized by increased consolidation as larger "superstore" chains, video stores with at least 7,500 videocassettes, have continued to increase market share by opening new stores and acquiring smaller, local operators. According to the Video Software Dealers Association, the number of video specialty stores has decreased from 31,500 in 1990 to 27,000 in 1995, approximately 6,500 of which were "superstores," including approximately 3,180 Blockbuster stores. The Company believes this consolidation will continue as the video retail industry evolves from "mom-and-pop" stores to regional and national superstore chains. Movie Studio Dependence on Video Retail Industry. According to Paul Kagan, the video retail industry is the single largest source of revenue to movie studios and represented approximately $4.3 billion, or 47%, of the $9.3 billion of estimated domestic studio revenue in 1995. Of the hundreds of movies produced by the major studios each year in the U.S., relatively few are profitable for the movie studio based on box office revenue alone. The Company believes the consumer is more likely to view "non-hit" movies on rented videocassette than through any other form of distribution because video retail stores provide an inviting opportunity to browse and make an impulse choice among a very broad selection of new releases, which includes hits (movies that are successful at the box office) and non-hits. As a result, video retail stores, including those operated by the Company, purchase on videocassette almost all new release movies produced theatrically (approximately 400 per year) regardless of whether the movies were successful at the box office, thus providing the major movie studios a reliable source of revenue for almost all of the hundreds of movies produced each year. Consequently, the Company believes movie studios are highly motivated to protect this unique and significant source of revenue. Historically, movie studios have sought to generate incremental sources of revenue through the addition of new distribution channels. To maximize revenue, the studios have implemented a strategy of sequential release "windows," giving each distribution channel the rights to its movies for a limited time before making them available to the next sequential channel. The studios have determined the sequential order in which they release movies to each 2 distribution channel based upon the order they believe will maximize their total revenue from all distribution channels combined. These distribution channels are set forth below. Order of Sequential Release Windows to Primary Channels of Distribution o Movie theaters o Video retail stores o Pay-per-view television (including direct broadcast satellite) o Pay cable (HBO, Showtime, etc.) o Basic cable television o Network television o Syndicated television Trends in Video Rentals and Sales. The domestic video retail industry includes both rentals and sales. According to Paul Kagan, video rental revenue has increased from $6.6 billion in 1990 to $7.5 billion in 1995 and is expected to increase to $8.3 billion in 2000, video sales have increased from $3.2 billion in 1990 to $7.3 billion in 1995 and are expected to increase to $9.9 billion in 2000. Videocassettes released at a relatively high price, typically $60 to $65 wholesale, are generally purchased by video retail stores and promoted primarily as a rental title and then later re-released by the studios at a lower price, typically $10 to $20 wholesale, to promote sales directly to consumers. Certain high grossing box office films, generally with box office revenue in excess of $100 million, are released on videocassette at a relatively low initial price, typically $10 to $15 wholesale, and are generally purchased by video retailers, mass merchants, grocery stores and other retailers and promoted both as a rental title and for sale directly to customers. Because these videocassettes are initially priced much lower, video retailers can stock more copies of these movies for rental at a substantially lower aggregate cost. The best selling sell-through titles are usually among the leading rental titles because of the substantial advertising and awareness of these titles, and the return on investment in rental inventory for those titles is typically much higher than for comparable titles initially priced and promoted for rental. Expansion Strategy The Company opened its first video superstore in October 1988 and had grown to 25 stores in Oregon and Washington by the end of 1993. In 1994 the Company significantly accelerated its store expansion program, adding 88 new stores (55 of which were acquired) and expanding into California, Texas, Nevada, New Mexico, Virginia and Utah. In 1995 the Company opened 122 new stores, acquired 70 stores and entered major new markets in the midwest, southwest, east and southeast regions of the United States. In 1996 the Company opened 250 new stores (no acquired units) and entered into 6 new states. The Company's expansion strategy is to continue to open or, to a lesser extent, acquire stores in regions where it has existing operations and to expand into new geographic regions where it believes it can become one of the dominant video retailers. 3 The Company plans to open at least 300 new stores in 1997. The Company has signed leases for approximately one-half of these anticipated new stores. The Company's expansion is dependent on a number of factors, including its ability to hire, train and assimilate management and store-level employees, the adequacy of the Company's financial resources and the Company's ability to identify and successfully compete in new markets, to locate suitable store sites and negotiate acceptable lease terms and to adapt its purchasing, management information and other systems to accommodate expanded operations. See "Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources." The Company's expansion is also dependent on the timely fulfillment by landlords and others of their contractual obligations to the Company, the maintenance of construction schedules and the speed at which local zoning and construction permits can be obtained. There is no assurance that the Company will be able to achieve its planned expansion or that expansion will be profitable. The Company's planned expansion, including possible growth through acquisitions, will place increasing pressure on the Company's management controls. A failure to manage successfully its planned expansion would adversely affect the Company's business. There is also no assurance that the Company's new stores will achieve sales and profitability comparable to the Company's existing stores. Business Strategy The Company's goal is to create a strong national brand which consumers will identify with the entertainment industry. The Company plans to build the brand by becoming a dominant national videoretailer. The Company's business strategy includes the following key elements: Broad Selection and Superior Availability. The Company strives to provide its customers with the broadest selection of videocassette movies and video games. Hollywood Video superstores typically carry approximately 10,000 titles and 16,000 videocassettes and video games. The Company's goal is to be the category killer in its industry, offering more copies of popular new videocassette releases and more titles than its competitors. The Company typically purchases 35 to 95 copies of "hit" movies for each Hollywood Video store and may purchase as many as 200 copies for high volume stores. 4 Exciting, Enjoyable and Convenient Shopping Experience. The Company's superstores are designed to capture the bright lights, excitement and energy of the motion picture industry. The Company focuses on creating an atmosphere that invites consumers into the store, encourages browsing and generates repeat customers. Hollywood Video stores are typically located in high traffic, high-visibility locations. The Company believes excellent customer service, a bright, clean and friendly shopping environment and convenient store locations are important to its success. Excellent Entertainment Value. The Company offers consumers the opportunity to rent any of its approximately 10,000 catalog movie titles for five days for only $1.50. All new release movies and video games can be rented for approximately $3.00. The Company believes movie rental in general, and its pricing structure and rental terms in particular, provide consumers convenient entertainment and excellent value. The Company is testing increased prices and may increase prices in the future. Products Videocassette Rental. The Company's primary source of revenue is the rental of videocassettes. Each mature Hollywood Video superstore carries approximately 10,000 movie titles and 16,000 videocassettes. Excluding new releases, movie titles are classified into 28 categories, such as "Action," "Drama," "Family" and "Children, and are displayed alphabetically within those categories. The Company does not rent or sell adult movies in Hollywood Video superstores. The Company is committed to offering more copies of popular new releases than its competitors. Videocassette Sales. Hollywood Entertainment also offers new and previously viewed videocassettes for sale. The Company believes it can profit from either the rental or sale of videocassettes. Video Games. In addition to video rentals and sales, Hollywood Video also rents video games licensed by NintendoTM, SegaTM and SonyTM. Each mature Hollywood Video store offers between 1,200 and 4,000 video games. Other Products. The Company rents audio books, including abridged fiction classics and religious, self-improvement and education materials such as foreign language instruction. The Company also rents videocassette and video game players for the convenience of its customers and sells blank videocassettes, video cleaning equipment and confectionery and other items. Hollywood Video Store Design Hollywood Video superstores average approximately 7,500 square feet and are substantially larger than the stores of most its competitors. The store exteriors generally feature large Hollywood Video signs and colors, which make the Company's stores easily visible to and recognizable by consumers. The interior of each store is clean and brightly lit. Hollywood video superstores are decorated with colorful neon, murals depicting popular screen stars and walls of video monitors with hi-fi audio accompaniment to create an exciting Hollywood environment. Movies in all of the Company's superstores are organized into 28 categories, and 5 videocassettes are arranged alphabetically by title within each category to assist customers in locating the movies. New releases are prominently displayed in easily recognizable locations within the store. Videocassettes are displayed with the box cover facing the customer for ease of selection and visual impact. The Company uses wall-mounted and free-standing shelves arranged in wide aisles to provide access to products and to encourage the movement of customers throughout the store. Site Selection The Company believes the selection of locations for its superstores is critical to the success of its operations. Important criteria for the location of a Hollywood Video superstore include density of local residential population, traffic count on roads immediately adjacent to the store location, visibility and accessibility of the store and availability of ample parking. The Company typically attempts to locate its stores in either stand-alone structures or at the end of a shopping strip. Within a shopping center or other retail development or area, the Company's strategy is to seek the most desirable site with respect to its selection factors. The Company typically competes for these prime sites with other retailers, including other video retailers, banks, restaurants and fast food operators. The Company maintains its own architectural staff and also uses outsourced architectural services. The ability of the Company to use its staff to customize its standard store design increases the Company's flexibility with respect to the type of sites that are acceptable to it, and the Company believes this flexibility gives it an advantage in competing for retail sites. All of the Company's stores are in leased premises; the Company does not own any real estate. Marketing and Advertising The Company primarily has used radio and direct mail advertising. The Company frequently uses cooperative movie advertising funds made available by studios and suppliers to promote certain videocassettes. The Company intends to increase its advertising expenditures in the future. Inventory and Information Management Inventory Management. Generally, inventory for existing stores is received by and maintained in each individual store. Inventory for new stores is processed and stored in the Company's warehouse in Oregon. The Company's inventory of videocassettes for rental is prepared according to uniform standards. Each new videocassette is removed from its original carton and placed in a rental case with a magnetic security device and bar coding is affixed to each videocassette. Management Information Systems. Hollywood Video stores use software modified and periodically updated by the Company's information systems department for use in the Company's operations. The Company maintains information, updated daily, regarding revenue, current and historical 6 sales and rental activity, demographics of store membership and videocassette rental patterns. The Company upgraded its management information systems by the addition of a scalable Oracle-based client-server system. The Company maintains two distinct system areas: A point-of-sale ("POS") system and a corporate information system. All rental and sales transactions are recorded by the POS system when scanned at the time of customer checkout. Nightly, the POS system transmits each store's data into the corporate information system. The systems track products using scanned bar code information and also maintain rental history of each customer and title. This information is used to produce the reports used by the Company, including reports used in making purchasing decisions on new releases. All of the Company's stores, including all of the acquired stores, use the Company's POS system. Competition The video retail industry is highly competitive. The Company competes with other local, regional and national video retail stores, including the Blockbuster Entertainment Division of Viacom, Inc. ("Blockbuster"), and with supermarkets, pharmacies, convenience stores, bookstores, mass merchants, mail order operations and other retailers, as well as with noncommercial sources such as libraries. According to the Video Software Dealers Association, in 1995 there were approximately 27,000 video specialty stores in the U.S., of which approximately 6,500 were video retail superstores. Some of the Company's competitors have significantly greater financial and marketing resources, market share and name recognition than the Company. The Company believes the principal competitive factors in the video retail industry are title selection, the number of copies of popular titles available, store location and visibility, convenience of store access and parking and, to a lesser extent, pricing. The Company's stores compete with stores operated by Blockbuster, many in very close proximity. As a result of direct competition with Blockbuster, rental pricing of videocassettes may become a more significant competitive factor in the Company's business, which could have an adverse impact on the results of operations of the Company. The Company believes it generally offers more titles and more copies of popular titles than the majority of its competitors. In addition to competing with other video retailers, the Company competes with all leisure-time activities, especially entertainment activities such as movies, sporting events, the Internet and network and cable television programs. The Company competes with cable, satellite and pay-per-view cable television systems, in which subscribers pay a fee to see a movie selected by the subscriber. Existing pay-per-view services offer a limited number of channels and movies and are only available to households with a direct broadcast satellite receiver or a cable converter to unscramble incoming signals. Digital compression technology and other developing technologies are expected eventually to permit cable companies, direct broadcast satellite companies, telephone companies and other telecommunications companies to transmit a much greater number of movies to homes at more frequently scheduled intervals throughout the day on demand. Certain cable and other 7 telecommunications companies have tested and are continuing to test movie on demand services in some markets. The Company believes movie studios have a significant interest in maintaining a viable movie rental business because the sale of videocassettes to video retail stores represents the studios' largest source of revenue. In addition, home video provides the only viable source of revenue on "non-hit" or "B-title" movies which make up the majority of movies produced by the major studios each year. As a result, the Company believes movie studios will continue to make movie titles available to cable television or other distribution channels only after revenues have been derived from the sale of videocassettes to video stores. In addition, the Company believes substantial technological developments will be necessary to allow pay-per-view television to match the viewing convenience and selection available through video rental, and substantial capital expenditures will be necessary to implement these systems. Although the Company does not believe cable television or other distribution channels represent a near-term competitive threat to its business, technological advances or changes in the manner in which movies are marketed, including in particular the earlier release of movie titles to pay-per-view, including direct broadcast satellite (DBS), cable television or other distribution channels, could make these technologies more attractive and economical, which could have a material adverse effect on the business of the Company. Seasonality The video retail industry generally experiences relative revenue declines in April and May, due in part to the change to Daylight Savings Time and to improved weather, and in September and October, due in part to the start of school and introduction of new television programs. The Company believes these seasonality trends will continue. Employees As of December 31, 1996, the Company had approximately 10,150 employees, of which 9,500 were in the retail stores and the remainder in the Company's corporate administrative, zone office and warehousing operations. None of the Company's employees are covered by collective bargaining agreements and employee relations are considered to be excellent. Service Mark The Company owns United States federal registrations for its service marks "Hollywood Video" and "Hollywood Video Superstores". The Company considers its service mark important to its continued success. 8 Item 2. Properties Store Locations As of December 31, 1996, the Company's stores by location are as follows: California.......................................... 120 Texas............................................... 78 Michigan............................................ 41 Washington.......................................... 30 Oregon.............................................. 28 Ohio................................................ 28 Minnesota........................................... 22 Arizona............................................. 22 Illinois............................................ 22 Virginia............................................ 14 Indiana............................................. 14 Georgia............................................. 14 Utah................................................ 13 Wisconsin........................................... 12 Tennessee........................................... 12 Pennsylvania........................................ 12 Missouri............................................ 10 Oklahoma............................................ 9 Colorado............................................ 8 Maryland............................................ 8 Nevada.............................................. 6 Kansas.............................................. 6 North Carolina...................................... 6 Nebraska............................................ 4 New Mexico.......................................... 3 Iowa................................................ 3 Kentucky............................................ 3 Arkansas............................................ 1 Louisiana........................................... 1 District of Columbia................................ 1 --- 551 === All of the Company's stores are located in leased premises with an initial lease term of five to 15 years and options to renew for between five and 15 additional years. Most of the store leases are "triple net," requiring the Company to pay all taxes, insurance and common area maintenance expenses associated with the properties. The Company's corporate headquarters and warehouse facility is located in Wilsonville, Oregon and consists of approximately 170,000 square feet of leased space. 9 Item 3. Legal Proceedings In December 1995 three complaints were filed against the Company, certain of the Company's directors and officers and certain other parties and consolidated in a single action entitled Murphy v. Hollywood Entertainment Corporation et al., case no. C95-1926-MA, U.S. District Court for the District of Oregon. The consolidated case is a class action encompassing persons who purchased common stock of the Company between June 20 through December 6, 1995. The plaintiffs alleged violation of certain federal securities laws with respect to statements made to the public and losses allegedly suffered by plaintiffs as a result of the decline in the trading price of the Company's stock. In May 1996 the court certified the class but dismissed claims based on violations of sections 11, 12(2) and 15 of the Securities Act of 1933. The remaining claims dealt with alleged violations of the Securities Exchange Act of 1934. Prior to trial, the parties reached a settlement, which is subject to court approval. The settlement consists of warrants valued at $9 million to purchase Hollywood common stock and $6 million in cash. It is anticipated that the warrants will be issued on or about August 31, 1997, will expire on August 31, 1998, and will have an exercise price of approximately $5 per share in excess of the Company's Common Stock price at the time of issuance. The Company may, however, at its option reduce the spread between the stock price and the exercise price and/or lengthen the exercise period so long as the value of the warrants remains at $9 million on the date of issuance. The Company agreed to the settlement to avoid further litigation expense and inconvenience and to put an end to all controversy and claims related to the subject of litigation. In the proposed settlement, the Company has specifically disclaimed and denied any liability or wrongdoing and that any person has suffered any harm or damage as a result of any of the matters alleged in the litigation. 10 Item 4. Submission of Matters to a Vote of Security Holders. Not Applicable. Item 4(a) Executive Officers Of The Registrant. The following table sets forth information with respect to the Company's executive officers as of the date of this document.
Name Age Positions with the Company - ---- --- -------------------------- Mark J. Wattles 36 Chairman of the Board, President and Chief Executive Officer F. Mark Wolfinger 41 Chief Financial Officer Donald J. Ekman 44 Senior Vice President, General Counsel, Secretary and Director Max G. Fratto 53 Executive Vice President of Store Operations James O. George 49 Executive Vice President of Product and Marketing F. Bruce Giesbrecht 36 Senior Vice President of Product Management Douglas A. Gordon 29 Senior Vice President of Finance Glen E. Hahn 44 Senior Vice President of Operations John R. Hnanicek 32 Senior Vice President of Information Systems Dale A. Naftzger 51 Senior Vice President of Operations (Western Zone) Roger J. Osbourne 44 Senior Vice President of Operations (Northeast Zone) William M. Spae 44 Senior Vice President of Operations (Southern Zone) William P. Zebe 38 Senior Vice President of Development
Mark J. Wattles founded the Company in June 1988 and has served as Chairman of the Board, President and Chief Executive Officer since that time. In May 1986 Mr. Wattles founded Convenience Video Movies, Inc., a videocassette distributor that operated video rental centers in approximately 300 convenience stores throughout the country, and served as its Chief Executive Officer until November 1987. Mr. Wattles founded Downtown Video, a two-store video rental company, in 1985 and served as its general manager until 1986. F. Mark Wolfinger became Chief Financial Officer of the Company in January 1997. Mr. Wolfinger joined the Company from Metromedia Restaurant Group, which owns, operates and franchises multiple nationwide restaurant chains. Prior to joining Metromedia as Chief Financial Officer, Mr. Wolfinger was with Grand Metropolitan, PLC where he served in various capacities, including Chief Financial Officer of Pearle Vision, Vice President and Group Controller of Grand Met and Vice President for Burger King. 11 Donald J. Ekman became a director of the Company in July 1993 and became Vice President and General Counsel in March 1994. Mr. Ekman was a partner in Ekman & Bowersox from January 1992 until March 1994, and from August 1990 until December 1991 he practiced law with Foster Pepper & Shefelman. Max G. Fratto joined the Company as Executive Vice President of Store Operations in May 1994. From 1991 to 1994 Mr. Fratto was a partner in Wallpaper Warehouse of Idaho, a small retail chain. From 1986 to 1991 he served as Vice President of W.N.S., Inc., a retail holding company, where he was responsible for the Wallpapers to Go division. Prior to his employment with W.N.S., Mr. Fratto was Vice President of Store Operations for several General Mills, Inc. specialty retailing companies. James O. George joined the Company in October 1995 as Executive Vice President of Product and Marketing. Previously, Mr. George was employed by Blockbuster Entertainment for eight years. Most recently, Mr. George served as Zone Vice President, where he managed the operations of over 450 Blockbuster stores. F. Bruce Giesbrecht was named Senior Vice President - Product Management in January 1996 and joined the Company in May 1993 as Vice President of Corporate Information Systems and Chief Information Officer. Mr. Giesbrecht was a founder of RamSoft, Inc., a software development company specializing in management systems for the video industry, and served as its President. Douglas A. Gordon was named Senior Vice President - Finance in November 1995 and joined the Company as Vice President of Strategic Analysis and Forecasting in May 1995. From September 1991 to May 1995, Mr. Gordon worked for Montgomery Securities as a Vice President and senior analyst covering the entertainment and retail industries. Glen E. Hahn joined the Company in April 1996 as Senior Vice President of Operations (Central Zone). From 1993 to 1996 Mr. Hahn was Senior Vice President - - Director of Stores for Fayva/Parade of Shoes (a specialty retail footwear division of J. Baker), overseeing approximately 400 stores. From 1979 to 1993 Mr. Hahn worked for Payless Shoesource (a division of May Department Stores) in various capacities. From 1987 to 1993 Mr. Hahn worked as Division Operations Manager for Payless Shoesource, overseeing the development of nearly 200 new stores during this period and the overall operations of approximately 580 specialty retail footwear stores at the time of his departure. John R. Hnanicek joined the Company in October 1996 as Senior Vice President of Information Systems. From March 1996 to October 1996 Mr. Hnanicek was Chief Information Officer for HomePlace, a privately owned home furnishings speciality retailer, operating 37 stores at the time of his departure. From July 1995 to February 1996 Mr. Hnanicek was Chief Information Officer for Communicate! Powerstores, Inc., a start-up communications superstore. From 1990 to 1995, Mr. Hnanicek worked for OfficeMax, Inc., in various capacities, including most recently as Senior Vice President - Information Systems and Logistics. 12 Dale A. Naftzger joined the Company in April 1996 as Senior Vice President of Operations (Western Zone). From May 1995 to November 1995, Mr. Naftzger was Chief Operating Officer of Caribou Coffee Company, a privately owned speciality coffee retailer with approximately 40 company-owned units. From 1994 to 1995 Mr. Naftzger was President and Chief Executive Officer of Chop Chop Chinese to You, a venture capital financed Chinese food delivery business, operating 40 units and three distribution centers at the time of his departure. From 1992 to 1994 Mr. Naftzger was Senior Vice President - Operations for Checkers Drive-In Restaurants, overseeing all 248 company-owned and 200 franchised units. From 1987 to 1992 Mr. Naftzger worked for Taco Bell Corporation as Zone Vice President, overseeing the development of approximately 100 new units and the overall operations of approximately 350 units. From 1980 to 1987 Mr. Naftzger worked for Wendy's International, Inc. in various capacities, including as Zone Vice President-Operations, overseeing more than 500 company-owned and 400 franchised units at the time of his departure. Roger J. Osbourne joined the Company in December 1996 as Senior Vice President of Operations (Northeast Zone). From January 1995 to December 1996, Mr. Osbourne was Senior Vice President/Director of Stores for J. Baker, Inc., overseeing approximately 1,100 stores. From October 1988 to January 1995, Mr. Osbourne was Senior Vice President/Director of Stores for Pic 'n Pay Stores, Inc., a subsidiary of Bata Shoe Company, where he was responsible for approximately 1,000 stores. William M. Spae joined the Company in July 1996 as Senior Vice President of Operations (Southern Zone). From 1991 to June 1996 Mr. Spae worked for Wendy's International as Divisional Vice President, overseeing the development of approximately 130 new units during this period and the overall operations of more than 100 company-owned and 150 franchised units at the time of his departure. From 1987 to 1991 Mr. Spae was a Zone Vice President for Taco Bell Corporation, overseeing more than 160 company-owned and approximately 100 franchised units. William P. Zebe was named Senior Vice President - Development in January 1996 and joined the Company as National Vice President of Real Estate in May 1994. Mr. Zebe previously worked from June 1993 to April 1994 as the Real Estate Manager for the Western Zone for Blockbuster Video, Blockbuster Music and Blockbuster franchisee-owned Discovery Zone. From 1992 to May 1993 Mr. Zebe was a Real Estate Representative for Blockbuster. 13 PART II Item 5. Market for Registrant's Common Stock and Related Stockholder Matters The Company's common stock is traded on the Nasdaq National Market under the symbol "HLYW". The following table sets forth the quarterly high and low last sale prices per share, as reported on the Nasdaq National Market, adjusted for two stock splits through December 31, 1996.
1996 1995 ---- ---- High Low High Low ------ ------ ------ ------ First Quarter $13.88 $ 6.50 $18.25 $11.25 Second Quarter 18.13 13.31 23.13 15.00 Third Quarter 21.75 11.88 35.00 19.00 Fourth Quarter 22.44 17.88 28.63 7.38
As of December 31, 1996, there were 195 holders of record of the Company's common stock. The Company has not paid any cash dividends on its common stock since its initial public offering in July 1993 and anticipates that all future earnings will be retained for development of its business. The payment of any future dividends will be at the discretion of the Company's Board of Directors. 14 Item 6. Selected Financial Data The following selected financial data have been derived from the consolidated financial statements of the Company. The data set forth below should be read in conjunction with Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and notes thereto.
Year Ended December 31, --------------------------------------------------------------------- 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Statement of Operations Data: (In thousands, except per share and other operating data) Revenue: Rental $ 252,625 $ 123,894 $ 61,941 $ 15,267 $ 9,762 Product sales 49,717 25,536 11,347 2,072 1,282 ----------- ----------- ----------- ---------- ---------- $ 302,342 $ 149,430 $ 73,288 $ 17,339 $ 11,044 =========== =========== =========== ========== ========== Operating income $ 38,418 $ 17,537 $ 12,610 $ 3,643 $ 2,270 =========== =========== =========== ========== ========== Income before cumulative effect of a change in accounting principle (1) $ 20,630 $ 11,786 $ 8,143 $ 2,146 $ 1,177 Cumulative effect of a change in accounting principle (2) -- (2,560) -- -- -- ----------- ----------- ----------- ---------- ---------- Net income (1) $ 20,630 $ 9,226 $ 8,143 $ 2,146 $ 1,177 =========== =========== =========== ========== ========== Earnings per common and common equivalent share (3): Earnings before cumulative effect of a change in accounting principle $ 0.59 $ 0.36 $ 0.32 $ 0.14 $ 0.09 Cumulative effect of a change in accounting principle -- (0.08) -- -- -- ----------- ----------- ----------- ---------- ---------- Net income $ 0.59 $ 0.28 $ 0.32 $ 0.14 $ 0.09 =========== =========== =========== ========== ========== Pro forma amounts assuming the new accounting principle were applied retroactively (2): Net income $ 20,630 $ 11,786 $ 6,277 $ 1,507 $ 892 Net income per share $ 0.59 $ 0.36 $ 0.25 $ 0.10 $ 0.07 Operating Data: Number of stores at end of period 551 305 113 25 15 Comparable store revenue increase (4) 7% 1% 7% 16% 27% Balance Sheet Data: Working capital $ 6,393 $ 17,733 $ 27,738 $ 5,025 ($ 1,179) Total assets 449,783 334,660 142,861 22,791 7,475 Long-term debt (including current portion) 82,361 7,971 3,505 2,399 1,873 Mandatorily redeemable common stock -- 54,250 -- -- -- Shareholders' equity 274,703 217,783 110,765 13,303 2,282 - ------------ (1) Income before cumulative effect of a change in accounting principle and net income for 1993 and 1992 include pro forma income tax adjustments to reflect taxation of the Company as a C corporation rather than an S corporation. (2) Effective January 1, 1995, the Company changed its method of amortizing the cost of videocassette rental inventory as discussed in Note 2 of Notes to Consolidated Financial Statements. The change in 15 amortization method resulted in a charge to earnings in 1995 totaling $2.6 million representing the cumulative effect as of January 1, 1995 if the new method had been applied retroactively to all videocassettes in service as of such date. The pro forma amounts shown herein reflect the impact to net income had the new amortization method been in effect as of the beginning of each of the periods presented. (3) Earnings per share are based on the weighted average shares outstanding during the period after giving effect to all stock splits through December 31, 1996. (4) A store becomes comparable after it has been open and owned by the Company for 12 full months. An acquired store converted to the Hollywood Video name and store design is removed from the comparable store base when the conversion process is initiated and returned 12 full months after the retrofit is completed.
16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations General Hollywood Entertainment opened its first video superstore in October 1988 and had expanded to 551 superstores in 29 states as of the end of 1996. The Company's revenue growth has been accomplished through a combination of new store openings, strategic acquisitions and, to a lesser extent, comparable store revenue increases Store activity for the last three years is summarized as follows:
Video Superstores Open Beginning Open End of Period Opened Closed Acquired of Period --------- ------ ------ -------- --------- 1994 25 33 0 55 113 1995 113 122 0 70 305 1996 305 250 4 0 551
The Company plans to open at least 300 stores during 1997. The Company's results are impacted by the timing of and costs incurred in connection with new store openings. New Hollywood Video stores typically experience lower sales volume in the first year of operation than do mature stores. Because a portion of store-level operating expenses is fixed, new stores generally have lower operating margins in their first year of operation. In addition, pre-opening expenses are charged to earnings in the first full month of a store's operation. Therefore, the addition of a significant number of new stores to the Company's existing store base has had and is expected to continue to have an adverse impact on the Company's operating margins. Forward-Looking Statements The information set forth in this report in Item 1- Business under the captions "Expansion Strategy" and in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" includes "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and is subject to the safe harbor created by that section. Certain factors that could cause results to differ materially from those projected in the forward-looking statements are set forth in Item 1 - Business under the captions "Expansion Strategy," "Competition," and "Legal Proceedings" and in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the captions "Liquidity and Capital Resources" and "General Economic Trends, Quarterly Results and Seasonality". 17 Results of Operations The following table sets forth, for the periods indicated, (i) selected statement of operations data expressed as a percentage of total revenue; (ii) the percentage change from the same period of the prior year in such selected statement of operations data, and (iii) the number of stores open at the end of each such period.
Percentage Change in Dollar Year Ended December 31, Amounts From --------------------------------------- ----------------------------- 1996 1995 1994 1995 to 1996 1994 to 1995 ------------ ----------- ----------- ------------- ------------- Revenue Rental income 83.6% 82.9% 84.5% 104% 100% Product sales 16.4 17.1 15.5 95 125 ------------ ----------- ----------- 100.0 100.0 100.0 102 104 ------------ ----------- ----------- Operating costs and expenses: Cost of product sales 10.2 9.9 9.9 108 104 Operating and selling 69.1 70.6 64.6 98 123 General and administrative 6.0 5.3 6.0 131 79 Amortization of intangibles 2.0 2.5 2.3 60 123 ------------ ----------- ----------- 87.3 88.3 82.8 ------------ ----------- ----------- Operating income 12.7 11.7 17.2 119 39 Interest (expense) income, net (1.4) 0.8 (0.2) N/A N/A ------------ ----------- ----------- Income before income taxes and cumulative effect of a change in accounting principle 11.3 12.5 17.0 84 49 Income taxes 4.5 4.6 5.9 99 58 ------------ ----------- ----------- Income before cumulative effect of a change in accounting principle 6.8 7.9 11.1 75 45 Cumulative effect of a change in accounting principle (1) -- (1.7) -- N/A N/A ------------ ----------- ----------- Net income 6.8% 6.2% 11.1% 124 13 ============ =========== =========== Pro forma net income assuming new accounting principle is applied retroactively (1) 6.8% 7.9% 8.6% 75 88 ============ =========== =========== Number of stores at end of period 551 305 113 - ----------- (1) Effective January 1, 1995, the Company changed its method of amortizing the cost of videocassette rental inventory as discussed in Note 2 of Notes to Consolidated Financial Statements. The change in amortization method resulted in a charge to earnings in 1995 totaling $2.6 million, representing the cumulative effect as of January 1, 1995 as if the new method had been applied retroactively to all videocassettes in service as of that date. The pro forma amounts shown herein reflect the impact to net income had the new amortization method been in effect as of the beginning of each of the periods presented. As a result, pro forma results for 1995 do not include the charge of $2.6 million.
18 1996 Compared to 1995 Revenue Revenue for 1996 increased $152.9 million, or 102%, to $302.3 million compared to $149.4 million for 1995. The increase in revenue was primarily the result of new store expansion. During 1996, the Company increased the number of superstores operated by 246, ending the period with 551 superstores, compared to 305 superstores at the end of 1995. Comparable store revenue increased 7% for 1996. Product sales as a percentage of total revenue decreased to 16.4% for 1996 from 17.1% for 1995. Product sales have decreased as the Company has de-emphasized the sale of certain movie accessories. Operating Costs and Expenses Cost of Product Sales The cost of product sales as a percentage of product sales increased from 57.8% for 1995 to 61.8% for 1996. The gross margin on product sales has decreased as the Company has de-emphasized the sale of certain high gross margin movie accessories. The Company believes the operating costs associated with maintaining those products offset the higher gross margins that they generated. Operating and Selling Operating expenses, which principally consist of all store expenses, including payroll, occupancy, advertising, depreciation and rental revenue sharing, decreased as a percentage of total revenue to 69.1% for 1996, compared to 70.6% for 1995. Depreciation expense combined with rental revenue sharing costs was 27.0% of total revenue for 1996, compared to 29.6% for 1995. The decrease was due to lower revenue sharing expense and the implementation of improved budgeting procedures in the purchase of new releases for existing stores. Other operating and selling expenses increased as a percentage of total revenue primarily due to lower average revenue per store, resulting from the addition during 1995 and 1996 of a large number of new stores, which have lower revenue per store than mature Hollywood Video stores. General and Administrative General and administrative expenses increased from $7.9 million, or 5.3% of total revenue, for 1995 to $18.3 million, or 6.0% of total revenue, for 1996. The percentage increase is primarily attributable to the cost associated with establishing and staffing the Company's new regional zone offices. 19 Amortization of Intangibles Amortization of intangibles increased from $3.8 million, or 2.5% of total revenue, for 1995 to $6.0 million, or 2.0% of total revenue, for 1996. The dollar increase in 1996 was attributable to the inclusion of the amortization of intangible assets arising from the Title Wave and Video Watch acquisitions for the year, while only partially included in 1995. Interest (Expense) Income, Net Net interest (expense) income decreased from $1.1 million for 1995 to ($4.1 million) for 1996. This change was primarily attributable to the Company's higher level of borrowing under its revolving line of credit and a decrease in interest earned on cash investments for 1996 compared to 1995. Income Taxes The Company's effective tax rate increased from 36.8% of income before income taxes for 1995 to 39.8% for 1996 due to increased operations in states with higher income tax rates in 1996 compared to 1995 and a decrease in tax exempt interest income. 20 1995 Compared to 1994 Revenue Revenue for 1995 increased $76.1 million, or 104%, to $149.4 million from $73.3 million for 1994. Comparable store revenue increased 1%. During the year, the Company opened 122 new stores and acquired 70 stores, including 42 stores purchased in August 1995 operating under the name "Video Watch" and 12 stores purchased during March 1995 from Title Wave Stores, Inc. The Company believes comparable store revenue was negatively impacted by lower revenues from the rental and sale of video games, lower revenues at stores acquired during 1994 prior to conversion to the Hollywood Video name and store design and an uneven and therefore less favorable distribution of new release "hit" movies during 1995 compared to 1994. Product sales as a percentage of total revenue increased to 17.1% for 1995 compared to 15.5% during 1994. The increase in product sales as a percentage of revenue was due to improved merchandising techniques and higher per store product inventory levels. The Company's pricing of video cassettes for rental and for sale merchandise did not change significantly compared to 1994. Operating Costs and Expenses: Cost of Product Sales The cost of product sales decreased as a percentage of product sales from 63.9% in 1994 to 57.8% for 1995. The gross margin on product sales increased in 1995 compared to 1994 due to expanded offerings of merchandise with higher gross margins. Operating and Selling Operating and selling expenses, which consist of all store expenses including payroll, occupancy, advertising, depreciation and rental revenue sharing expense, increased as a percentage of total revenue to 70.6% in 1995 compared to 64.6% in 1994. Operating and selling expenses increased as a percentage of total revenue primarily due to lower average revenue per store, resulting primarily from the addition during 1995 of a large number of new and acquired stores which have lower revenue per store than mature Hollywood Video stores. Depreciation expense combined with rental revenue sharing expense was 29.6% of total revenue in 1995 compared to 27.9% in 1994. The increase was primarily due to a change in the Company's method of depreciating videocassette rental inventory effective January 1, 1995. 21 General and Administrative General and administrative expenses, which principally consist of corporate overhead, decreased from 6.0% of total revenue for 1994 to 5.3% for 1995. The decrease in expenses as a percentage of revenue was due to the Company's ability to increase revenue without proportionally increasing corporate overhead expenses. Amortization of Intangibles Amortization of intangibles increased from $1.7 million, or 2.3% of total revenue, during 1994 to $3.8 million, or 2.5% of total revenue, during 1995. The dollar increase was primarily attributable to the amortization of intangible assets arising from the Title Wave, Video Watch and other store acquisitions in 1995. Interest (Expense) Income, Net Net interest expense was $0.1 million, or 0.2% of total revenue, in 1994 while net interest income was $1.1 million, or 0.8% of total revenue, in 1995. The change in net interest was primarily due to the receipt of the net proceeds of the Company's public stock offering completed in July 1995, resulting in a decrease in average debt outstanding and an increase in interest earned on cash investments. Income Taxes The Company's effective tax rate for 1995 was 36.8%, compared to 34.9% in 1994. The increase in 1995 was due to a higher federal statutory rate and a higher aggregate state tax rate, partially offset by higher tax exempt interest income. Liquidity and Capital Resources The Company's principal capital requirements are for opening new stores, the purchase of rental inventory and the possible acquisition of existing stores. The Company has funded its operations primarily through cash from operations, the proceeds of five public offerings, loans under the Company's revolving bank line of credit, trade credit and equipment leases. At December 31, 1996, the Company had cash and cash equivalents of approximately $12.8 million and working capital of $6.4 million. Videocassette rental inventories are accounted for as noncurrent 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 noncurrent excludes them from the computation of working capital. The acquisition cost of videocassette 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 videocassette rental inventory as a noncurrent asset, the Company may, from time to time, operate with a working capital deficit. 22 Net cash provided by operating activities was $125.4 million for 1996 compared to $68.7 million for 1995. The increase in cash provided by operations was primarily due to higher net income from operations and higher depreciation and amortization expenses, partially offset by an increase in merchandise inventories. Cash used in investing activities was $198.7 million for 1996 compared to $168.9 million for 1995. For 1996, cash used in investing activities consisted primarily of net purchases of videocassette rental inventory for new and existing stores totaling $124.3 million and capital expenditures and related increase in landlord receivables totaling $73.7 million. Capital expenditures included the costs to open new stores, remodel certain existing stores and enhance information systems. Cash provided by financing activities for 1996 totaled $56.2 million and included a cash reduction due to the repurchase of all of the shares issued in connection with the Video Watch acquisition for aggregate consideration of $54.3 million, the repayment of $7.6 million of long-term debt, borrowings on the line of credit of $82.0 million, and net proceeds from the Company's fifth equity offering of $34.7 million. Future capital requirements consist primarily of financing the addition of new retail stores and converting certain acquired stores to the Hollywood Video name and store design, together with the possible acquisition of existing stores. The Company anticipates opening at least 300 new stores in 1997. Each video store opening requires initial capital expenditures, including leasehold improvements, inventory, equipment and costs related to site location, lease negotiations, construction supervision and permits, of approximately $500,000, excluding leasehold improvements that are customarily paid for by the property developer. At December 31, 1996, the Company had a $100 million revolving credit agreement with a syndicate of banks. In January 1997 the Company replaced its existing revolving credit agreement with a new $150 million revolving credit agreement. Under the new agreement funds borrowed bear interest, at the Company's option, at IBOR or the bank's base rate, plus approximately 1.25%, depending on the amount of borrowings. The Company must also pay a fee of 0.3% per annum on the available and unused portion of the credit facility. Amounts outstanding under the credit line are collateralized by substantially all the assets of the Company. The availability of borrowings under the revolving credit agreement is based on the level of eligible inventory, the Company's financial performance and compliance with certain covenants and financial ratios. The credit line expires on December 28, 1998. As of December 31, 1996, $82.0 million was outstanding under the revolving credit agreement that was in place at that time. Of this amount, approximately $50.0 million was borrowed to fund the share repurchase. (See Note 3). The Company believes the net proceeds from its December 1996 public offering, its recently increased borrowing capacity, projected cash flow from operations, cash on hand and equipment leases and trade credit will provide the necessary capital to fund the opening of approximately 300 new video retail superstores in 1997. 23 General Economic Trends, Quarterly Results and Seasonality The Company anticipates that its business will be affected by general economic and other consumer trends. Future operating results may be affected by various factors, including variations in the number and timing of new store openings, the performance of new or acquired stores, the quality and number of new release titles available for rental and sale, the expense associated with the acquisition of new release titles, additional and existing competition, marketing programs, weather, special or unusual events and other factors that may affect retailers in general. In addition, any concentration of new store openings and the related new store pre-opening costs and other expenses associated with the opening of new stores near the end of a fiscal quarter could have an adverse effect on the financial results for that quarter and could, in certain circumstances, lead to fluctuations in quarterly financial results. The video retail industry generally experiences relative revenue declines in April and May, due in part to the change in Daylight Savings Time and due to improved weather, and in September and October, due in part to the start of school and the introduction of new television programs. The Company believes these seasonality trends will continue. Item 8. Financial Statements and Supplementary Data Incorporated by reference to Item 14 of this report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Information with respect to this item has been previously reported in the Company's Current Report on Form 8-K dated December 13, 1995 (and Amendment No. 1 thereto on Form 8-K/A). 24 PART III Item 10. Directors and Executive Officers of the Registrant Information with respect to directors of the Company is hereby incorporated by reference from the Company's definitive proxy statement, under the caption "Nomination and Election of Board of Directors," for its 1997 annual meeting of shareholders (the "1997 Proxy Statement") to be filed pursuant to Regulation 14A promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, which proxy statement is anticipated to be filed no later than 120 days after the end of the Company's fiscal year ended December 31, 1996. Information with respect to executive officers of the Company is included under Item 4(a) of Part I of this report. Item 11. Executive Compensation Information required by this Item 11 is hereby incorporated by reference from the 1997 Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management Information required by this Item 12 is hereby incorporated by reference from the 1997 Proxy Statement. Item 13. Certain Relationships and Related Transactions Information required by this Item 13 is hereby incorporated by reference from the 1997 Proxy Statement. 25 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K Listed below are all financial statements, notes, schedules and exhibits filed as part of this Annual Report on Form 10-K: (a)(1), (2) Financial Statements The following financial statements of the Registrant, together with the Independent Auditors' Report dated February 20, 1997, except as to Note 11, which is as of March 15, 1997, on pages F-1 to F-23 of this report on Form 10-K are filed herewith: (i) Financial Statements Independent Accountants' Reports Consolidated Balance Sheets as of December 31, 1996 and 1995 Consolidated Statements of Operations for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Changes in Shareholders' Equity for the years ended December 31, 1996, 1995 and 1994 Consolidated Statements of Cash Flows for the years ended December 31, 1996, 1995 and 1994 Notes to Consolidated Financial Statements (ii) Financial Schedules All financial schedules are omitted as the required information is inapplicable or the information is presented in the respective consolidated financial statements or related notes. 26 (a)(3) Exhibits The following exhibits are filed with or incorporated by reference into this Annual Report: Exhibit Number Description ------ ----------- 3.1 1993 Restated Articles of Incorporation. (1) 3.2 Bylaws. (1) 4.1 Rights of Security Holders - See Article II of Exhibit 3.1 and Articles I and V of Exhibit 3.2. 10.1 1993 Stock Incentive Plan, as amended. (2) 10.2 Employment Agreement of Mark J. Wattles, dated February 1, 1994. (3) 10.3 Tax Indemnification Agreement dated as of February 3, 1994 between the Registrant and Mark J. Wattles and Scott D. South. (2) 10.4 Amended and Restated Revolving Credit Agreement, dated February 12, 1997, among the Registrant and a syndicate of banks led by Bank of America National Trust & Savings Association. (5) 10.5 Purchase and Sale Agreement, dated July 27, 1995, among the Registrant, Video Watch Inc., Ray Sumon and Mahmood Sohrabi. (4) 23.1 Consent of Price Waterhouse LLP (5) 23.2 Consent of Coopers & Lybrand L.L.P. (5) - ------------- (1) Incorporated by reference to the Registration Statement on Form S-1 of the Company (File No. 33-63042). (2) Incorporated by reference to the Annual Report on Form 10-K of the Company for the year ended December 31, 1995. (3) Incorporated by reference to the Registration Statement on Form S-1 of the Company (File No. 33-73966). (4) Incorporated by reference to the Company's Current Report on Form 8-K dated August 23, 1995. (5) Filed herewith. (b) Reports on Form 8-K: No reports on Form 8-K were filed by the Company in the three months ended December 31, 1996. 27 Report of Independent Accountants To the Board of Directors and Shareholders of Hollywood Entertainment Corporation In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of changes in shareholders' equity and of cash flows present fairly, in all material respects, the financial position of Hollywood Entertainment Corporation and its subsidiaries at December 31, 1996 and 1995, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 2 of the consolidated financial statements, the Company changed its amortization method for videocassette rental inventory. PRICE WATERHOUSE LLP Portland, Oregon February 20, 1997, except as to Note 11, which is dated as of March 15, 1997 F-1 Report of Independent Accountants To the Board of Directors and Shareholders Hollywood Entertainment Corporation We have audited the accompanying statements of income, changes in shareholders' equity and cash flows of Hollywood Entertainment Corporation for the year ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the statements of income, changes in shareholders' equity and cash flows are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the statements of income, changes in shareholders' equity, and cash flows. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the statements of income, changes in shareholders' equity and cash flows. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Hollywood Entertainment Corporation for the year ended December 31, 1994 in conformity with generally accepted accounting principles. COOPERS & LYBRAND L.L.P. Portland, Oregon February 14, 1995 except for Note 3 as to which the date is March 29, 1995 F-2
HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED BALANCE SHEETS (In thousands, except share amounts) December 31, -------------------------------------- 1996 1995 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $12,849 $29,980 Construction and other receivables 25,785 16,154 Merchandise inventories 45,255 25,991 Prepaid expenses and other current assets 3,232 1,555 ------------- ------------- Total current assets 87,121 73,680 Videocassette rental inventory, net 144,264 86,889 Property and equipment, net 115,812 65,958 Excess of cost over net assets acquired, net 99,229 104,679 Deferred income taxes 783 1,345 Other assets 2,574 2,109 ------------- ------------- Total assets $449,783 $334,660 ============= ============= LIABILITIES, MANDATORILY REDEEMABLE COMMON STOCK AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $205 $7,616 Accounts payable 67,207 42,778 Accrued expenses 10,402 5,553 Income taxes payable 2,914 -- ------------- ------------- Total current liabilities 80,728 55,947 Long-term debt, excluding current maturities 156 355 Line of credit 82,000 -- Deferred rent and other liabilities 6,452 3,369 Deferred income taxes 5,744 2,956 ------------- ------------- 175,080 62,627 ------------- ------------- Commitments and contingencies (notes 9 and 11) -- -- Mandatorily redeemable common stock -- 54,250 ------------- ------------- Shareholders' equity: Preferred stock, 25,000,000 shares authorized; no shares issued and outstanding -- -- Common stock 100,000,000 shares authorized; 36,006,201 and 33,879,738 shares issued and outstanding, respectively 238,021 202,005 Retained earnings 38,992 18,362 Intangible assets, net (2,310) (2,584) ------------- ------------- Total shareholders' equity 274,703 217,783 ------------- ------------- Total liabilities and shareholders' equity $449,783 $334,660 ============= ============= See notes to consolidated financial statements.
F-3
HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except share amounts) Year Ended December 31, ----------------------------------------- 1996 1995 1994 ------------ ---------- ----------- Revenue: Rental revenue $ 252,625 $ 123,894 $ 61,941 Product sales 49,717 25,536 11,347 ------------ ---------- ----------- 302,342 149,430 73,288 ------------ ---------- ----------- Operating costs and expenses: Cost of product sales 30,707 14,769 7,251 Operating and selling 208,895 105,433 47,312 General and administrative 18,302 7,916 4,419 Amortization of intangibles 6,020 3,775 1,696 ------------ ---------- ----------- 263,924 131,893 60,678 ------------ ---------- ----------- Operating income 38,418 17,537 12,610 ------------ ---------- ----------- Nonoperating income (expense): Interest income 203 1,614 687 Interest expense (4,339) (490) (795) ------------ ---------- ----------- (4,136) 1,124 (108) ------------ ---------- ----------- Income before income taxes and cumulative effect of a change in accounting principle 34,282 18,661 12,502 Income taxes 13,652 6,875 4,359 ------------ ---------- ----------- Income before cumulative effect of a change in accounting principle 20,630 11,786 8,143 Cumulative effect of a change in accounting principle (note 2) -- (2,560) -- ------------ ---------- ----------- Net income $ 20,630 $ 9,226 $ 8,143 ============ ========== =========== Earnings per common and common equivalent share: Income before cumulative effect of a change in accounting principle $ 0.59 $ 0.36 $ 0.32 Cumulative effect of a change in accounting principle -- (0.08) -- ------------ ---------- ----------- Net income $ 0.59 $ 0.28 $ 0.32 ============ ========== =========== See notes to consolidated financial statements.
F-4
HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (In thousands, except share amounts) Common Stock -------------------------- Intangible Retained Shares Amount Assets Earnings Total ------------- ----------- ---------- ----------- ---------- Balance at December 31, 1993 18,150,244 $ 12,890 $ (580) $ 993 $ 13,303 Public offerings of common stock, net 10,152,750 87,164 -- -- 87,164 Issuance of common stock under option plan 230,600 45 -- -- 45 Warrants exercised 450,000 1,260 -- -- 1,260 Tax benefit from exercise of stock options and warrants -- 567 -- -- 567 Issuance of stock options in connection with acquisitions -- 2,598 (2,598) -- -- Amortization of intangible assets -- -- 283 -- 283 Net income -- -- -- 8,143 8,143 ------------- ----------- ---------- ----------- ---------- Balance at December 31, 1994 28,983,594 104,524 (2,895) 9,136 110,765 Public offering of common stock, net 4,600,000 95,436 -- -- 95,436 Issuance of common stock under option plan 296,144 1,341 -- -- 1,341 Tax benefit from exercise of stock options -- 704 -- -- 704 Amortization of intangible assets -- -- 311 -- 311 Net income -- -- -- 9,226 9,226 ------------- ----------- ---------- ----------- ---------- Balance at December 31, 1995 33,879,738 202,005 (2,584) 18,362 217,783 Public offering of common stock, net 2,000,000 34,705 -- -- 34,705 Issuance of common stock under option plan 126,463 838 -- -- 838 Tax benefit from exercise of stock options -- 473 -- -- 473 Amortization of intangible assets -- -- 274 -- 274 Net income -- -- -- 20,630 20,630 ------------- ----------- ---------- ----------- ---------- Balance at December 31, 1996 36,006,201 $ 238,021 $ (2,310) $ 38,992 $ 274,703 ============= =========== ========== =========== ========== See notes to consolidated financial statements.
F-5
HOLLYWOOD ENTERTAINMENT CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands, except share amounts) Year Ended December 31, ------------------------------------------ 1996 1995 1994 ------------- ------------- ------------ Operating activities: Net income $20,630 $9,226 $8,143 Adjustments to reconcile net income to cash provided by operating activities: Cumulative effect of a change in accounting principle -- 2,560 -- Depreciation and amortization 87,115 47,292 19,826 Deferred rent and other liabilities 3,083 1,288 640 Deferred income taxes 3,350 5,045 1,270 Changes in assets and liabilities: Merchandise inventories (19,264) (13,571) (6,532) Prepaid expenses and other current assets (1,677) (1,251) (125) Accounts payable 24,429 19,053 16,867 Accrued expenses 4,849 (154) 1,942 Income taxes payable 2,914 (749) 668 ------------- ------------- ------------ Net cash provided by operating activities 125,429 68,739 42,699 ------------- ------------- ------------ Investing activities: Construction and other receivables (9,631) (11,332) (3,963) Purchases of videocassette rental inventory, net (124,253) (85,634) (34,251) Purchases of property and equipment (64,038) (54,337) (10,401) Investment in businesses acquired -- (16,988) (53,750) Other (794) (570) 26 ------------- ------------- ------------ Net cash used in investing activities (198,716) (168,861) (102,339) ------------- ------------- ------------ Financing activities: Proceeds from the issuance of common stock, net 34,705 95,436 88,424 Proceeds from long-term debt -- 23,500 18,979 Repayments of long-term debt (7,610) (29,896) (18,465) Proceeds from exercise of stock options 838 1,341 45 Tax benefit from exercise of stock options 473 704 69 Repurchase of common stock (54,250) -- -- Borrowings on line of credit 82,000 -- -- ------------- ------------- ------------ Net cash provided by financing activities 56,156 91,085 89,052 ------------- ------------- ------------ Increase (decrease) in cash and cash equivalents (17,131) (9,037) 29,412 ------------- ------------- ------------ Cash and cash equivalents: Beginning of year 29,980 39,017 9,605 ------------- ------------- ------------ End of year $12,849 $29,980 $39,017 ============= ============= ============ Other Cash Flow Information: Interest expense paid $4,339 $455 $796 Income taxes paid, net of refunds 6,130 1,953 2,421 See notes to consolidated financial statements.
F-6 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (1) Nature of the Business and Summary of Significant Accounting Policies Nature of the Business Hollywood Entertainment Corporation and subsidiaries (the "Company") operates a chain of video superstores throughout the United States. The Company was incorporated in Oregon on June 2, 1988 and opened its first store in October 1988. As of December 31, 1996 and 1995, the Company operated 551 stores in 29 states and 305 stores in 23 states, respectively. Basis of Presentation The consolidated financial statements include the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain amounts in the 1995 and 1994 consolidated financial statements have been reclassified to be consistent with the 1996 presentation. The reclassifications had no effect on previously reported net income or shareholders' equity. Certain Risks and Uncertainties The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers highly liquid investment instruments, with an original maturity of three months or less, to be cash equivalents. Construction and Other Receivables Construction and other receivables consist primarily of leasehold improvements paid by the Company, which will be reimbursed by the lessor. Merchandise Inventories Merchandise inventories, consisting primarily of prerecorded video cassettes, concessions, and other accessories held for resale, are stated at the lower of cost or market value. Cost is determined on a first-in, first-out basis. F-7 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) Videocassette Rental Inventory Videocassette rental inventory, which includes video games and audio books, is stated at cost and amortized over its estimated useful life to a $6 per videocassette salvage value. See note 2 for a discussion of the amortization policy applied to videocassette rental inventory and a discussion of the change in amortization method effective January 1, 1995. Videocassette rental inventory and related accumulated amortization at December 31 for each of the last two years are as follows (in thousands):
1996 1995 -------------- --------------- Videocassette rental inventory $ 201,444 $ 119,135 Less: accumulated amortization (57,180) (32,246) -------------- --------------- $ 144,264 $ 86,889 ============== ===============
Amortization expense related to videocassette rental inventory was $67.1 million, $37.6 million and $16.1 million in 1996, 1995 and 1994, respectively, and is included in operating and selling expenses. As videocassette rental inventory is sold, the applicable cost and accumulated amortization are eliminated from the accounts, determined on a first-in, first-out basis applied in the aggregate based on monthly purchases. Any gain or loss thereon is recorded in the Company's consolidated statement of operations. Property and Equipment Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from approximately five to ten years. Leasehold improvements are amortized over the lesser of the lease term or the estimated useful life of the improvement. Property and equipment at December 31 consist of the following (in thousands):
1996 1995 ----------- ----------- Fixtures and equipment $43,428 $24,059 Leasehold improvements 91,648 46,978 Equipment under capital leases 3,525 3,525 ----------- ----------- 138,601 74,562 Less: accumulated depreciation and amortization (22,789) (8,604) ----------- $115,812 $65,958 =========== ===========
F-8 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) Depreciation and amortization expense related to property and equipment was $14.2 million, $5.9 million and $2.0 million in 1996, 1995 and 1994, respectively. Accumulated amortization of equipment under capital leases was $3.0 million and $2.3 million at December 31, 1996 and 1995, respectively. Additions to property and equipment are capitalized and include acquisitions of property and equipment, costs incurred in the development and construction of new stores, major improvements to existing property and major improvements in management information systems. As property and equipment is sold or retired, the applicable cost and accumulated depreciation and amortization are eliminated from the accounts and any gain or loss thereon is recorded. Intangible Assets Intangible assets primarily consist of the cost of acquired businesses in excess of the market value of net identifiable assets acquired (goodwill). Goodwill is amortized on a straight-line basis over 20 years. The Company annually reviews the realizability of recorded goodwill based upon expectations of nondiscounted cash flows and operating income. As of December 31, 1996, the Company believes that there are no materially impaired intangible assets. Accumulated amortization of intangible assets at December 31, 1996 and 1995 was $11.6 million and $5.6 million, respectively. In March 1995, the Financial Accounting Standards Board issued Statement No. 121, "Accounting for the Impairment of Long-Lived Assets". This pronouncement requires long-lived assets to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. This new standard is required for fiscal years beginning after December 15, 1995. The Company adopted the new standard and it had no impact on the Company's consolidated financial position or results of operations. Deferred Rent Many of the Company's operating leases contain predetermined fixed increases of the minimum rental rate during the initial lease term. For these leases, the Company recognizes the related rental expense on a straight-line basis and records the difference between the amount charged to expense and the rent paid as deferred rent. Advertising Advertising costs, net of cooperative reimbursements from vendors, are expenses when incurred. F-9 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) Store Pre-opening Costs Store pre-opening costs, including store employee labor costs and advertising, incurred prior to the opening of a new store are expenses during the first full month of a store's operation. Incremental costs incurred by existing stores to prepare and train new employees are expenses as incurred. Income Taxes The Company accounts for income taxes under the provisions of Statement of Financial Accounting Standard No. 109. Accordingly, deferred income taxes are provided at the current statutory rates for the difference between the financial statement and tax basis of assets and liabilities and are classified in the consolidated balance sheet as current or long-term, consistent with the classification of the related asset or liability giving rise to the deferred income taxes. Net Income per Common Share Net income per share of common stock is computed using the weighted average number of common and common equivalent shares (if dilutive) outstanding during each period, as adjusted for stock splits through December 31, 1996 (35,158,846 shares in 1996, 32,961,806 shares in 1995 and 25,578,240 shares in 1994). Fair Value of Financial Instruments The carrying amount of cash and cash equivalents, construction and other receivables, accounts payable, accrued liabilities, debt and mandatorily redeemable common stock approximate fair value at December 31, 1996 and 1995 because these financial instruments bear interest at competitive rates or have a short maturity. Stock-based Compensation The Company adopted Statement of Financial Accounting Standards Number 123 (SFAS 123) "Accounting for Stock-Based Compensation", in 1996. SFAS 123 was issued by the Financial Accounting Standards Board in October 1995 and allows companies to choose whether to account for stock-based compensation under the current method as prescribed in accounting Principles Board Opinion Number 25 (APB 25) or use the fair value method described in SFAS 123. The Company continues to follow the measurement provisions of APB 25. F-10 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) (2) Change in Amortization Method for Videocassette Rental Inventory Effective January 1, 1995, the Company adopted an accelerated method of amortizing its videocassette rental inventory. Under this new method, videocassette rental inventory, which includes video games and audio books, is stated at cost, including the related costs to prepare such video cassettes for rent, and amortized, beginning on the date video cassettes are placed into service, to its salvage value ($6 per videocassette during 1995 and 1996) over an estimated useful life of 36 months. All copies of new release video cassettes are amortized on an accelerated basis during their first four months to an average net book value of $15 and then on a straight-line basis to their salvage value of $6 over the next 32 months. The method for calculating amortization of videocassette rental inventory in 1994 and prior years was as follows: base stock video cassettes, together with the related costs to prepare such video cassettes for rent, were amortized over 36 months on a straight-line basis. New release video cassettes were amortized as follows: the tenth and succeeding copies of each title per store were amortized over nine months on a straight-line basis; the fourth through ninth copies of each title per store were amortized 40% in the first year and 30% in each of the second and third years; and copies one through three of each title per store were amortized as base stock. Under the old method, no provision for salvage value was established. The new method of amortization was adopted because the Company believes accelerating expense recognition for new release video cassettes during the first four months more closely matches the typically higher revenue generated following a title's release, and believes $15 represents a reasonable average carrying value for tapes to be rented or sold after four months and $6 represents a reasonable salvage value for all tapes after 36 months. The new method of amortization has been applied to videocassette rental inventory that was held at January 1, 1995. The cumulative effect of the change as of January 1, 1995 was to reduce net income by $2.6 million after income taxes of $1.6 million. The application of the new method of amortizing videocassette rental inventory increased 1995 amortization expense by $2.6 million and reduced net income by $1.6 million and earnings per share by $0.05. F-11 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) (3) Acquisitions The Company made no acquisitions in 1996. The following acquisitions were made in 1995: Title Wave In March 1995, the Company purchased all of the outstanding capital stock of Title Wave Stores, Inc. ("Title Wave"), an operator of 14 music and video retail superstores located in Minneapolis, Minnesota. The aggregate purchase price, including the assumption of Title Wave's liabilities, was $15.7 million. The Company closed two Title Wave stores immediately following the acquisition. Video Watch In August 1995, the Company acquired, in two separate transactions, the assets of 42 video retail superstores operating under the name of "Video Watch". The aggregate purchase price was approximately $60.3 million, including 2,127,452 shares of the Company's common stock. The Company granted the sellers an option to sell any of the shares issued in connection with the Video Watch acquisition to the Company on January 27, 1996 at the original issuance price of $25.50 per share, for a maximum repurchase obligation of $54.3 million. Consequently, the common shares issued in connection with the Video Watch acquisitions are classified as "Mandatorily Redeemable Common Stock" at December 31, 1995. Pursuant to the option described above, in January 1996 the Company repurchased all of the shares issued in the Video Watch acquisition. Of the aggregate purchase price of $54.3 million, $50.0 million was provided by borrowings under the Company's revolving credit line, and the remainder was provided by then existing cash balances. Other Acquisitions In addition to the acquisitions discussed above in 1995, the Company acquired six video retail superstores operated under the name "Video Watch" for $7.0 million and acquired 10 other video retail superstores in eight separate transactions for an aggregate purchase price of $4.8 million. The purchase price for the Video Watch stores was paid in the form of a note bearing interest at 5.75% per annum and paid January 4, 1996. All of the acquisitions consummated by the Company during 1995 were accounted for as purchases. Accordingly, the results of operations of the acquired stores subsequent to the date acquired are included in the results of operations of the Company. F-12 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) The excess of cost over net identifiable assets acquired for the above acquisitions totaling $72.1 million is being amortized over 20 years. The Company's consolidated results of operations for the years ended December 31 on an unaudited pro forma basis assuming the acquisitions of Title Wave and Video Watch had occurred as of January 1, 1995 and assuming the new method of amortizing videocassette rental inventory was in effect during each period are as follows (in thousands, except per share amounts): 1995 1994 -------------- ------------ Total revenue $ 166,028 $ 136,848 Net income $ 12,275 $ 6,443 Net income per share $ 0.36 $ 0.23 The unaudited pro forma results of operations are not necessarily indicative of actual results that would have occurred had the acquisitions been completed as of January 1, 1995 or of the results which may occur in the future. (4) Leases The Company leases all of its stores, corporate office and distribution center under noncancelable operating leases and leases certain fixtures and equipment under capital leases. All of the Company's stores have an initial operating lease term of five to 15 years and options to renew for between five and 15 additional years. Most operating leases require payment of property taxes, utilities, common area maintenance and insurance. Total rent expense, including related lease-required costs, incurred during 1996, 1995 or 1994 was $54.1 million, $25.3 million and $9.3 million, respectively. At December 31, 1996, the future minimum annual rental commitments under all noncancelable leases were as follows (in thousands):
Operating Capital Year Leases Leases ---- --------------- ------------- 1997 $ 65,842 $ 218 1998 65,396 131 1999 63,295 -- 2000 60,568 -- 2001 58,974 -- Thereafter 300,396 -- --------------- ------------- Total $ 614,471 349 =============== Less: interest 27 ------------- Present value 322 Less: current maturities 205 ------------- Long-term obligations $ 117 =============
F-13 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) (5) Employee Benefit Plans The Company is self-insured for employee medical benefits under the Company's group health plan. The Company maintains stop loss coverage for individual claims in excess of $50,000 and for annual Company claims which exceed $1.0 million in the aggregate. While the ultimate amount of claims incurred are dependent on future developments, in management's opinion, recorded reserves are adequate to cover the future payment of claims. Adjustments, if any, to recorded estimates resulting from ultimate payments will be reflected in operations in the period in which such adjustments are known. The Company does not maintain any retirement plans nor offer any form of post-retirement benefits. (6) Long-term Debt Long-term debt consisted of the following at December 31, 1996 and 1995 (in thousands):
1996 1995 ----------- ------------ Borrowings under bank revolving credit agreement $ 82,000 $ -- Notes payable, bearing interest at 5.75%, due January 4, 1996. Secured by assets of six acquired stores 7,000 Capital lease obligations 322 905 Other 39 66 ----------- ------------ Total long-term debt 82,361 7,971 Less: current maturities 205 7,616 ----------- ------------ Long-term debt, less current maturities $ 82,156 $ 355 =========== ============
The Company's $19 million revolving line of credit with Bank of America Oregon expired on July 2, 1995. Borrowings under the line were repaid by the expiration date. Interest expense related to borrowings under the expired line of credit was $251,000 in 1995 at an average interest rate equal to 9.8%. In December 1995, the Company executed a new $75 million revolving credit agreement with a syndicate of banks led by Bank of America National Trust & Savings Association. This facility had a maturity date of December 28, 1998 and was increased to $100 million in July of 1996. The borrowings bore interest, at the Company's option, at the bank's base rate or LIBOR plus approximately 1.25%, depending on the borrowing levels. The Company paid a fee of 0.2% per annum on the available and unused portion of the credit facility. Among other things, the revolving credit agreement required the Company to maintain a specified level of net worth, a cash flow coverage ratio, a funded debt to adjusted EBITDA ratio and minimum quarterly average per store revenue amounts and restricted the Company from incurring certain additional debt. The credit F-14 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) facility was secured by substantially all assets of the Company. There were no borrowings outstanding at any time during 1995 under this credit facility. At December 31, 1996, the Company had a $100 million revolving credit agreement with a syndicate of banks. In January 1997 the Company replaced its existing revolving credit agreement with a new $150.0 million revolving credit agreement. Under the new agreement, funds borrowed bear interest, at the Company's option, at IBOR or the bank's base rate, plus approximately 1.25%, depending on the amount of borrowings. The Company must also pay a fee of 0.3% per annum on the available and unused portion of the credit facility. Amounts outstanding under the credit line are collateralized by substantially all the assets of the Company. The availability of borrowings under the revolving credit agreement is based on the level of eligible inventory, the Company's financial performance and compliance with certain covenants and financial ratios. The credit line expires on December 28, 1998. As of December 31, 1996, $82.0 million was outstanding under the revolving credit agreement that was in place at that time. Of this amount, approximately $50.0 million was borrowed to fund the share repurchase described in Note 3 above. The Company's maturities of long-term debt for years subsequent to 1996 are as follows: 1997 - $205,000; 1998 - $82,123,000; 1999 - $13,000; 2000 - $15,000; and 2001 - $5,000. (7) Income Taxes The provision for income taxes consists of the following (in thousands):
1996 1995 1994 ------------- ------------- ------------ Current: Federal $ 8,052 $ 2,521 $ 2,652 State 2,250 456 437 ------------- ------------- ------------ Total current 10,302 2,977 3,089 ------------- ------------- ------------ Deferred: Federal 2,757 3,302 1,128 State 593 596 142 ------------- ------------- ------------ Total deferred 3,350 3,898 1,270 ------------- ------------- ------------ Total provision $ 13,652 $ 6,875 $ 4,359 ============= ============= ============
F-15 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) A reconciliation of the statutory federal income tax rate with the Company's effective income tax rate is as follows:
1996 1995 1994 -------------- --------------- -------------- Statutory federal rate 35.0% 35.0% 34.0% State income taxes, net of federal income tax benefit 4.6 3.9 3.4 Tax exempt interest income (0.3) (2.6) (1.9) Other, net 0.5 0.5 (0.6) -------------- --------------- -------------- 39.8% 36.8% 34.9% ============== =============== ==============
Deferred income taxes reflect the impact of "temporary differences" between amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws. The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities at December 31 are as follows (in thousands):
1996 1995 ------------- ------------ Deferred tax assets: Stock option exercises $ -- $ 96 Difference between assigned value and tax basis of acquired entities 591 1,249 Tax loss carry forwards 192 752 ------------- ------------ 783 2,097 Less: valuation allowance -- (752) ------------- ------------ $ 783 $ 1,345 ============= ============ Deferred tax liabilities: Depreciation $ 6,165 $ 2,162 Capital leases 1,091 822 Deferred Rent (1,225) -- Other (287) (28) ------------- ------------ $ 5,744 $ 2,956 ============= ============
During 1995, the Company established a valuation allowance related to the net operating loss carry forwards of Title Wave, a company acquired during 1995 through a stock purchase. The valuation allowance was reversed during the year ended December 31, 1996 for the recognition of a deferred asset that was previously reserved. At December 31, 1996, the Company has approximately $0.5 million of operating loss carry forwards available to reduce future income taxes which expire in varying amounts commencing in year 2009. F-16 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) (8) Shareholders' Equity Preferred Stock At December 31, 1996, the Company is authorized to issue 25,000,000 shares of preferred stock in one or more series. The Board of Directors has authority over the designations, preferences, special rights, limitations or restrictions thereof as it may determine. No shares of preferred stock have been issued. Common Stock In December 1996, the Company completed a public offering of 2,000,000 shares of its common stock. The net proceeds from the offering were approximately $34.7 million. Additionally, in January 1997, the underwriters purchased an additional 300,000 shares pursuant to the overallotment option for net proceeds to the Company of approximately $4.7 million. In July 1995, the Board of Directors and the Company's shareholders approved an increase in the number of authorized shares of common stock to 100,000,000 and effected a 2-for-1 split in the form of a stock dividend. All share and per share amounts have been given retroactive recognition in each period in the accompanying financial statements. In July 1995, the Company completed a public offering of 4,600,000 shares of its common stock. The net proceeds from the offering were approximately $95.4 million. During 1994, the Company completed two public offerings resulting in the sale of 10,152,750 shares of its common stock. The combined net proceeds were approximately $87.2 million. In March 1994, in connection with the Video Central acquisition, the Company issued stock options to purchase 339,000 shares of common stock at a price of $0.005 per share which were immediately exercisable and expire March 2, 2003. The stock options had a fair market value on the date of issuance of approximately $2.6 million, of which $2.5 million was allocated to excess of cost over net assets acquired and $100,000 was allocated to covenant not to compete. The excess of cost over net assets acquired is being amortized over 20 years and the covenant not to compete was amortized over two years. Amortization expense for the years ended December 31, 1996, 1995 and 1994 totaled $171,000, $171,000 and $143,000, respectively. F-17 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) In July 1993, the Company sold 5,175,000 shares of its common stock in an initial public offering registered under the Securities Act of 1933. The net proceeds from this offering were approximately $10.4 million. In connection with this offering, the Company issued to underwriters warrants to purchase up to an aggregate 450,000 shares of common stock at an initial exercise price of $2.80 per share. The warrants were exercised during 1994. In September 1992, the Company issued a warrant to purchase 300,000 shares of common stock for $0.035 per share effective as of the closing of the Company's initial public offering. The warrant relates to a prepaid ten-year rental contract with a supplier executed in September 1992. The original estimated value of this warrant of $350,000 and the related shares are included in common stock. The value is being amortized on a straight-line basis over 60 months. Upon completion of the Company's initial public offering, certain terms of the warrant and the related contract were amended, thereby increasing the estimated value by $350,000 which is also being amortized over 60 months. The warrant was exercised in July 1993. Amortization expense for the years ended December 31, 1996, 1995 and 1994 totaled $140,000, $140,000 and $140,000, respectively. Stock Option Plan In May 1993, the Board of Directors adopted, and the shareholders of the Company approved, the 1993 Stock Incentive Plan (the "Plan"). The Plan provides for the award of non-qualified stock options, stock appreciation rights, bonus rights and other incentive grants to employees, independent contractors and consultants. In November 1995, the Board of Directors and the Company's stockholders approved an increase in the number of shares reserved for issuance under the Plan to 5,200,000. As of December 31, 1996, options for a total of 599,687 shares were exercisable. The options are granted at fair market value as determined by the Company's Board of Directors at the date of grant. The options are exercisable over a period of up to nine years from the date of the grant. The vesting schedules for the options are from zero to five years. During 1995, the Financial Accounting Standards Board issued SFAS 123, "Accounting for Stock Based Compensation", which defines a fair value based method of accounting for an employee stock option or similar equity instrument and encouraged all entities to adopt that method of accounting for all compensation cost related to stock options issued to employees under these plans using the method of accounting prescribed by the Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees." Entities electing to remain with the accounting APB 25 must make pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting defined in this Statement has been applied. F-18 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) The Company has elected to account for its stock based compensation under Accounting Principles Board Opinion No. 25; however, as required by SFAS 123 the Company has computed for pro forma disclosure purposes the value of options granted during 1995 and 1996 using the Black-Scholes option pricing model. The weighted average assumptions used for stock option grants for 1995 and 1996 were:
1996 1995 ---- ---- Risk free interest rate 6.4% 5.4% Expected dividend yield 0% 0% Expected lives 5 years 5 years Expected volatility 60% 60%
Options were assumed to be exercised over the five-year expected life for purposes of this valuation. Adjustments are made for options forfeited prior to vesting. For the years ended December 31, 1995 and 1996, the total value of the options granted was computed as the following approximate amounts of $6.4 million and $12.4 million, respectively, which would be amortized on a straight line basis over the vesting period of the options. The weighted average fair value per share of the options granted in 1995 and 1996 are $7.93 and $4.84, respectively. If the Company had accounted for these stock options issued to employees in accordance with SFAS 123, the Company's net income and pro forma net income (in thousands) and net income per share and pro forma net income per share would have been reported as follows:
Year Ended Year Ended December 31, 1996 December 31, 1995 ------------------------------------ ---------------------------------- Net Income Earnings per Share Net Income Earnings per Share As Reported $20,630 $0.59 $9,226 $0.28 Pro Forma 18,252 0.52 8,556 0.26
The effects of applying SFAS 123 for providing pro forma disclosure for 1995 and 1996 are not likely to be representative of the effects on reported net income and earnings per share for future years since options vest over several years and additional awards are made each year. F-19 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) Activity in the Company's stock option plan is as follows:
Weighted Average Shares Exercise Price ------------- ---------------- Outstanding at December 31, 1993 618,000 $ 2.47 Granted 1,194,500 5.89 Exercised (230,600) 0.20 Cancelled (34,200) 3.35 ------------- Outstanding at December 31, 1994 1,547,700 5.38 Granted 1,297,594 15.21 Exercised (296,144) 4.55 Cancelled (375,500) 8.17 ------------- Outstanding at December 31, 1995 2,173,650 6.57 Granted 2,858,150 10.24 Exercised (126,463) 6.62 Cancelled (865,150) 15.29 ------------- Outstanding at December 31, 1996 4,040,187 $ 9.25 =============
The following table sets forth the exercise prices, the number of options outstanding and exercisable, and the remaining contractual lives of the Company's stock options at December 31, 1996:
Weighted Average Number of Options Contractual Life Exercise Price Outstanding Exercisable Remaining -------------- ----------- ----------- ---------------- $2.34-$5.67 563,250 186,750 5.96 years 6.50 1,130,337 86,837 8.05 6.66-9.67 686,600 212,000 7.30 10.00-15.00 1,221,500 114,100 8.07 15.50-19.87 438,500 -0- 8.82
(9) Legal Proceedings In January 1995, Viacom, Inc. filed a lawsuit against the Company alleging unfair competition, misappropriation of trade secrets and intentional interference with contracts in connection with the hiring of five former Blockbuster Entertainment employees. In addition, Viacom filed a separate lawsuit against two of the employees, both of whom are officers of the Company, in a Florida court alleging breach of employment agreements and misappropriation of trade secrets. In April 1996, the Company and its affected employees settled the litigation and, although the settlement required the Company and Viacom to keep the terms confidential, the effect of the settlement on the Company's results of operations and financial condition was insignificant. F-20 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) In December 1995 three complaints were filed against the Company, certain of the Company's directors and officers and certain other parties and consolidated in a single action entitled Murphy v. Hollywood Entertainment Corporation et al., case no. C95-1926-MA, U.S. District Court for the District of Oregon. The consolidated case is a class action encompassing persons who purchased common stock of the Company between June 20 through December 6, 1995. The plaintiffs alleged violation of certain federal securities laws with respect to statements made to the public and losses allegedly suffered by plaintiffs as a result of the decline in the trading price of the Company's stock. In May 1996 the court certified the class but dismissed claims based on violations of sections 11, 12(2) and 15 of the Securities Act of 1933. The remaining claims dealt with alleged violations of the Securities Exchange Act of 1934. Prior to trial, in March 1997 the parties reached a settlement, which is subject to court approval. See Note 11. (10) Quarterly Financial Data The following table sets forth certain selected quarterly financial data as previously reported, adjustments thereto to reflect the effects of the accounting changes set forth in note (1) below and as adjusted.
Selected Quarterly Financial Data (Unaudited) (In thousands, except per share data) Quarter Ended ----------------------------------------------------- 1996 March June September December Full Year - ------------------------------------------- ------------ ------------ ------------- ------------ ------------ Total revenue $ 65,073 $ 63,949 $ 75,696 $ 97,624 $ 302,342 Operating income 6,631 5,985 10,957 14,845 38,418 Net income 3,727 3,005 5,842 8,056 20,630 Net income per share 0.11 0.09 0.17 0.23 0.59 Quarter Ended ----------------------------------------------------- 1995 March June September December Full Year - ------------------------------------------- ------------ ------------ ------------- ------------ ------------ Total revenue $ 27,088 $ 29,110 $ 39,290 $ 53,942 $ 149,430 ============ ============ ============= ============ ============ Operating Income: As previously reported $ 4,084 $ 4,421 $ 5,926 Adjustments (1) (309) (20) (166) ------------ ------------ ------------- As adjusted $ 3,775 $ 4,401 $ 5,760 $ 3,601 $ 17,537 ============ ============ ============= ============ ============ Income before cumulative effect of a change in accounting principle: As previously reported $ 2,789 $ 2,740 $ 4,227 Adjustments (1) (286) (45) (134) ------------ ------------ ------------- As adjusted $ 2,503 $ 2,695 $ 4,093 $ 2,495 $ 11,786 ============ ============ ============= ============ ============ Net income (loss) As previously reported $ 2,789 $ 2,740 $ 4,227 Adjustments (1) (2,846) (45) (134) ------------ ------------ ------------- As adjusted $ (57) $ 2,695 $ 4,093 $ 2,495 $ 9,226 ============ ============ ============= ============ ============ F-21 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) Earnings per common share: Income before cumulative effect of a change in accounting principle: As previously reported $ 0.09 $ 0.09 $ 0.12 Adjustments (0.01) -- (0.01) ------------ ------------ ------------- As adjusted (2) $ 0.08 $ 0.09 $ 0.11 $ 0.07 $ 0.36 ============ ============ ============= ============ ============ Net income (loss): As previously reported $ 0.09 $ 0.09 $ 0.12 Adjustments 0.09 -- (0.01) ------------ ------------ ------------- As adjusted (2) $ 0.00 $ 0.09 $ 0.11 $ 0.07 $ 0.28 ============ ============ ============= ============ ============ - -------------- (1) During the fourth quarter of 1995, the Company changed its method of amortizing videocassette rental inventory, effective January 1, 1995. In addition, the Company changed the estimated life of the excess of cost over net assets acquired for store acquisitions completed in 1995 from 40 years to 20 years. The impact of these changes, including related income tax effects, was to reduce previously reported net income by $2.8 million, $45,000 and $134,000 for the quarters ended March, June and September 1995, respectively. A charge of $2.6 million, net of tax, relating to the cumulative effect on prior years of the change in amortization method for videocassette rental inventory was made effective as of January 1, 1995 and is included in the March 1995 change in net income described above. (2) As adjusted earnings per share for the full year exceed the sum of as adjusted earnings per share for the four fiscal quarters therein because of rounding.
(11) Subsequent Events Settlement of Securities Litigation In March 1997 the Company reached a settlement of the securities litigation initiated in December 1995. See Note 9. The settlement, which is subject to court approval, consists of warrants valued at $9 million to purchase Hollywood common stock and $6 million in cash. It is anticipated that the warrants will be issued on or about August 31, 1997, will expire on August 31, 1998, and will have an exercise price of approximately $5 per share in excess of the Company's Common Stock price at the time of issuance. The Company may, however, at its option reduce the spread between the stock price and the exercise price and/or lengthen the exercise period so long as the value of the warrants remains at $9 million on the date of issuance. The Company agreed to the settlement to avoid further litigation expense and inconvenience and to put an end to all controversy F-22 Hollywood Entertainment Corporation Notes to Consolidated Financial Statements (Continued) and claims related to the subject of litigation. In the settlement, the Company has specifically disclaimed and denied any liability or wrongdoing and that any person has suffered any harm or damage as a result of any of the matters alleged in the litigation. F-23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, as of March 22, 1997. Hollywood Entertainment Corporation By: FORREST MARK WOLFINGER --------------------------------------- Forrest Mark Wolfinger Chief Financial Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant and in the capacities indicated as of March 22, 1997. Signatures Title MARK J. WATTLES Chairman of the Board of Directors, - ----------------------------- President and Chief Executive Officer Mark J. Wattles FORREST MARK WOLFINGER Chief Financial Officer - ----------------------------- (Principal Financial and Accounting Officer) Forrest Mark Wolfinger DONALD J. EKMAN Director - ----------------------------- Donald J. Ekman JAMES N. CUTLER Director - ----------------------------- James N. Cutler RICHARD A. GALANTI Director - ----------------------------- Richard A. Galanti Exhibit Index Exhibit Sequential Number Description Page Number - ------ ----------- ----------- 3.1 1993 Restated Articles of Incorporation. (1) 3.2 Bylaws. (1) 4.1 Rights of Security Holders - See Article II of Exhibit 3.1 and Articles I and V of Exhibit 3.2. 10.1 1993 Stock Incentive Plan, as amended. (2) 10.2 Employment Agreement of Mark J. Wattles, dated February 1, 1994. (3) 10.3 Tax Indemnification Agreement dated as of February 3, 1994 between the Registrant and Mark J. Wattles and Scott D. South. (2) 10.4 Amended and Restated Revolving Credit Agreement, dated February 12, 1997, among the Registrant and a syndicate of banks led by Bank of America National Trust & Savings Association. (5) 10.5 Purchase and Sale Agreement, dated July 27, 1995, among the Registrant, Video Watch Inc., Ray Sumon and Mahmood Sohrabi. (4) 23.1 Consent of Price Waterhouse LLP (5) 23.2 Consent of Coopers & Lybrand L.L.P. (5) - ------------- (1) Incorporated by reference to the Registration Statement on Form S-1 of the Company (File No. 33-63042). (2) Incorporated by reference to the Annual Report on Form 10-K of the Company for the year ended December 31, 1995. (3) Incorporated by reference to the Registration Statement on Form S-1 of the Company (File No. 33-73966). (4) Incorporated by reference to the Company's Current Report on Form 8-K dated August 23, 1995. (5) Filed herewith. EX-10.4 2 AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT ================================================================================ AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT among HOLLYWOOD ENTERTAINMENT CORPORATION as Borrower and BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION UNITED STATES NATIONAL BANK OF OREGON UNION BANK OF CALIFORNIA, N.A. KEY BANK OF WASHINGTON BANQUE NATIONALE DE PARIS SOCIETE GENERALE THE SUMITOMO BANK, LIMITED as Lenders, and BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION d/b/a SEAFIRST BANK as Agent for the Lenders --------------------------------------------------------------------- February 12, 1997 --------------------------------------------------------------------- $150,000,000 --------------------------------------------------------------------- Arranged by BancAmerica Securities, Inc. ================================================================================ TABLE OF CONTENTS Page ---- ARTICLE I DEFINITIONS........................................................ 2 Section 1.01 Certain Defined Terms...................................... 2 Section 1.02 General Principles Applicable to Definitions......................................................... 8 Section 1.03 Accounting Terms........................................... 9 ARTICLE II THE LOANS......................................................... 9 Section 2.01 Loans...................................................... 9 Section 2.02 Manner of Borrowing a Loan.................................10 Section 2.03 Reduction of Commitments...................................10 Section 2.04 Repayment of Principal.....................................10 Section 2.05 Agent's Right to Fund......................................10 Section 2.06 Interest on Loans..........................................11 (a) General Provisions.............................................11 (b) Selection of Alternative Rate..................................11 (c) Applicable Days for Computation of Interest....................13 (d) Unavailable IBOR Rate..........................................13 Section 2.07 Compensation for Increased Costs...........................13 Section 2.08 Prepayments................................................15 Section 2.09 Notes......................................................15 Section 2.10 Manner of Payments.........................................15 Section 2.11 Fees.......................................................17 (a) Unused Commitment Fees.........................................17 (b) Loan Fee.......................................................17 (c) Agency Fees....................................................17 Section 2.12 Sharing of Payments, Etc. .................................17 Section 2.13 Withholding Taxes..........................................18 ARTICLE III CONDITIONS OF LENDING............................................18 Section 3.01 Notice of Borrowing, Promissory Notes, Etc. ...............................................................18 Section 3.02 Corporate Authority........................................18 Section 3.03 Legal Opinion..............................................19 Section 3.04 Defaults, Etc. ............................................19 Section 3.05 Perfected Security Interests...............................19 Section 3.06 Payment of Amounts Under Prior Credit Agreement...........................................................19 Section 3.07 Payment of Fees............................................19 Section 3.08 Other Information..........................................19 ARTICLE IV REPRESENTATIONS AND WARRANTIES....................................20 Section 4.01 Corporate Existence and Power..............................20 Section 4.02 Borrower's Corporate Authorization.........................20 Section 4.03 Government Approvals, Etc. ................................20 Section 4.04 Binding Obligations, Etc. .................................20 Section 4.05 Litigation.................................................20 i Section 4.06 Financial Condition........................................21 Section 4.07 Title and Liens............................................21 Section 4.08 Taxes......................................................21 Section 4.09 Laws, Orders; Other Agreements.............................22 Section 4.10 Lien Priority..............................................22 Section 4.11 Federal Reserve Regulations................................22 Section 4.12 ERISA......................................................22 Section 4.13 Patents, Licenses, Franchises..............................23 Section 4.14 Not Investment Company, Etc. ..............................23 Section 4.15 Insurance..................................................24 Section 4.16 Representations as a Whole.................................24 ARTICLE V AFFIRMATIVE COVENANTS..............................................24 Section 5.01 Use of Proceeds............................................24 Section 5.02 Payment....................................................24 Section 5.03 Preservation of Corporate Existence, Etc. .................24 Section 5.04 Visitation Rights..........................................25 Section 5.05 Keeping of Books and Records...............................25 Section 5.06 Maintenance of Property, Etc. .............................25 Section 5.07 Compliance With Laws, Etc. ................................25 Section 5.08 Other Obligations..........................................25 Section 5.09 Insurance..................................................25 Section 5.10 Financial Information......................................26 (a) Annual Audited Financial Statements............................26 (b) Quarterly Unaudited Financial Statements.......................26 (c) Quarterly Compliance Certificates..............................26 (d) Quarterly Store Financial Statements...........................27 (e) Annual Budget; Financial Projections...........................27 (f) Shareholder, SEC and Government Reports........................27 (g) Other Information..............................................27 Section 5.11 Notification...............................................27 Section 5.12 Additional Payments; Additional Acts.......................28 Section 5.13 Net Worth..................................................28 Section 5.14 Fixed Charge Coverage Ratio................................28 Section 5.15 Funded Debt to Cash Flow Ratio.............................29 Section 5.16 Average Quarterly Per Store Revenue........................29 ARTICLE VI NEGATIVE COVENANTS................................................30 Section 6.01 Liquidation, Merger, Sale of Assets........................30 Section 6.02 Funded Debt................................................30 Section 6.03 Guaranties, Etc............................................30 Section 6.04 Liens......................................................30 Section 6.05 Location of Inventory......................................30 Section 6.06 Investments................................................31 Section 6.07 Operating Lease Obligations................................31 Section 6.08 Company Asset Acquisitions.................................32 Section 6.09 Limitations on Prepayment of Subordinated Debt................................................................32 Section 6.10 ERISA Compliance...........................................32 Section 6.11 Transactions with Affiliates...............................33 Section 6.12 Change in Business.........................................33 ii Section 6.13 Accounting Change..........................................33 ARTICLE VII EVENTS OF DEFAULT................................................33 Section 7.01 Events of Default..........................................33 (a) Loan Payment Default...........................................33 (b) Other Payment Default..........................................33 (c) Breach of Warranty.............................................33 (d) Breach of Certain Covenants....................................33 (e) Breach of Other Covenants......................................33 (f) Material Adverse Changes; Extraordinary Situation......................................................34 (g) Cross-default..................................................34 (h) Voluntary Bankruptcy, Etc. ....................................34 (i) Involuntary Bankruptcy, Etc. ..................................34 (j) Insolvency, Etc. ..............................................35 (k) ERISA..........................................................35 (l) Judgment.......................................................35 (m) Government Approvals, Etc. ....................................35 (n) Change of Control..............................................36 Section 7.02 Consequences of Default....................................36 ARTICLE VIII THE AGENT.......................................................36 Section 8.01 Authorization and Action...................................36 Section 8.02 Duties and Obligations.....................................37 Section 8.03 Dealings Between Agent and Borrower........................39 Section 8.04 Lender Credit Decision.....................................39 Section 8.05 Indemnification............................................39 Section 8.06 Successor Agent............................................39 ARTICLE IX MISCELLANEOUS.....................................................40 Section 9.01 No Waiver; Remedies Cumulative.............................40 Section 9.02 Governing Law..............................................41 Section 9.03 Mandatory Arbitration......................................41 Section 9.04 Notices....................................................41 Section 9.05 Assignment and Participations..............................41 Section 9.06 Borrower's Indemnity.......................................42 Section 9.07 Severability...............................................43 Section 9.08 Survival...................................................43 Section 9.09 Conditions Not Fulfilled...................................43 Section 9.10 Entire Agreement; Amendment................................44 Section 9.11 WAIVER OF JURY TRIAL.......................................44 Section 9.12 Headings...................................................44 Section 9.13 Counterparts...............................................44 iii SCHEDULES - --------- Schedule 1 Calculations of Margins Schedule 2 Prepayment Fees Schedule 3 Participation Fees iv AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT -------------------------- THIS AMENDED AND RESTATED REVOLVING CREDIT AGREEMENT ("Agreement") is made as of February 12, 1997, by and among BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION, UNITED STATES NATIONAL BANK OF OREGON, UNION BANK OF CALIFORNIA, N.A., KEY BANK OF WASHINGTON, BANQUE NATIONALE DE PARIS, SOCIETE GENERALE, and THE SUMITOMO BANK, LIMITED, (each individually a "Lender" and collectively the "Lenders"), Bank of America National Trust & Savings Association d/b/a "SEAFIRST BANK" as agent for the Lenders (the "Agent"), and HOLLYWOOD ENTERTAINMENT CORPORATION (d/b/a "Hollywood Video"), an Oregon corporation (the "Borrower"). RECITALS -------- A. Borrower, Seattle-First National Bank, as agent, and Seattle-First National Bank, United States National Bank of Oregon and Bank of America Oregon, as lenders entered into that certain Revolving Credit Agreement dated as of December 22, 1995 providing for a total revolving credit facility in the amount of $75,000,000 (the "Revolving Credit Agreement"). B. On January 8, 1996, the parties to the Revolving Credit Agreement entered into an Amendment Number One to Revolving Credit Agreement and Amendment to Loan Documents. C. Pursuant to the terms of the Revolving Credit Agreement as so amended, certain "Additional Lenders" were to be added and the amount of the credit facility was to be increased to $100,000,000. On July 18, 1996, the Borrower, Seattle-First National Bank, as agent, Seattle First National Bank, Bank of America Oregon, United States National Bank of Oregon, Union Bank of California, N.A. and Key Bank of Washington entered into an Amendment Number Two to Revolving Credit Agreement and Amendment to Loan Documents pursuant to which Union Bank of California and Key Bank of Washington were added as "Additional Lenders" and the total committed amount of the facility was increased to $100,000,000. The Revolving Credit Agreement as amended by Amendment Number One to Revolving Credit Agreement and Amendment Number Two to Revolving Credit Agreement is referred to herein as the "Prior Credit Agreement." D. Thereafter, both Seattle-First National Bank and Bank of America Oregon were merged into Bank of America National Trust & Savings Association. E. The parties hereto now desire to further amend and restate the Prior Credit Agreement in order to provide for, among other things, an increase in the amount of the committed facility and the addition of new lenders. F. The Borrower's obligations under the Prior Credit Agreement are secured by a first lien on the accounts receivable, inventory, equipment, general intangibles, investment property and certain other personal property of the Borrower. The parties hereto desire to amend and restate the Prior Credit Agreement in accordance with the terms hereof. The parties hereto further intend that the security interests and liens previously granted shall continue as liens of first priority as security for all obligations of the Borrower under this Agreement and specifically disclaim any intent to release any security interest or lien or to satisfy any obligations secured thereby. NOW, THEREFORE, the parties hereto hereby agree to amend and restate the Prior Credit Agreement as follows: ARTICLE I DEFINITIONS ----------- Section 1.01 Certain Defined Terms. As used in this Agreement, the following terms have the following meanings: "Adjusted Base Rate" means a per annum rate of interest equal to the Base Rate (changing as such Base Rate changes) plus the Margin (changing as such Margin changes). "Agent" means Bank of America National Trust & Savings Association d/b/a "Seafirst Bank" and any successor agent selected pursuant to Section 8.06 hereof. "Applicable Interest Period" means, with respect to any Loan accruing interest at an IBOR Rate, the period commencing on the first day the Borrower elects to have such IBOR Rate apply to such Loan and ending on a day one, two, three or six months thereafter, as specified in the Interest Rate Notice given in respect of such Loan or as otherwise determined pursuant to Section 2.06(b) provided, however, that no Applicable Interest Period may be selected for a Loan if it extends beyond the Maturity Date. "Applicable Interest Rate" means for each Loan, the Adjusted Base Rate or IBOR Rate as designated by the Borrower in an Interest Rate Notice given with respect to such Loan (or portion thereof) or as otherwise determined pursuant to Section 2.06(b). 2 "Base Rate" means, for any day, the higher of: (a) 0.50% per annum above the latest Federal Funds Rate; and (b) the rate of interest in effect for such day as publicly announced from time to time by Bank of America National Trust & Savings Association in San Francisco, California, as its "reference rate." (The "reference rate" is a rate set by Bank of America National Trust & Savings Association based upon various factors including its costs and desired return and general economic conditions, and is used as a reference point for pricing some loans, which may be priced at, above, or below such announced rate.) "Base Rate Loan" means a Loan or portion thereof bearing interest at the Adjusted Base Rate. "Borrower" means Hollywood Entertainment Corporation, an Oregon corporation, and any permitted Successor or assign pursuant to Section 9.05. "Business Day" means any day other than Saturday, Sunday or another day on which banks are authorized or obligated to close in Seattle, Washington or San Francisco, California except in the context of the selection of a Loan accruing interest at the IBOR Rate or the calculation of the IBOR Rate for any Applicable Interest Period, in which event "Business Day" means any day other than Saturday or Sunday on which dealings in foreign currencies and exchange between banks may be carried on in Grand Cayman, British West Indies, and Seattle, Washington. "Capital Leases" means for any person, all obligations of such person under leases which are, or in accordance with GAAP, should be recorded as capital leases. "Code" means the Internal Revenue Code of 1986, as amended from time to time. "Collateral" means the property in which the Security Agreement creates or purports to create a security interest or other lien. "Commitment" has the meaning given in Section 2.01. "Company Asset Acquisitions" has the meaning given in Section 6.08. "Controlled Group" means all members of a controlled group of corporations and all trades or businesses (whether or not incorporated) under common control which, together with the Borrower, are treated as a single employer under Section 414(b) or 414(c) of the Code. 3 "Default" means any event which but for the passage of time or the giving of notice or both would be an Event of Default. "EBITDA" means, for any period, net income (or net loss), excluding any extraordinary gains or losses and taxes associated therewith, plus the sum of (a) interest expense, (b) income tax expense, (c) depreciation expense and (d) amortization expense, in each case determined in accordance with GAAP for such period. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended from time to time. "Event of Default" has the meaning given in Section 7.01. "Federal Funds Rate" means, for any period, a fluctuating interest rate per annum equal for each day during such period to the weighted average of the rates on overnight federal funds transactions with members of the Federal Reserve System arranged by federal funds brokers, as published for such day (or, if such day is not a Business Day, for the next preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations for such day on such transactions received by Agent from three federal funds brokers of recognized standing selected by it. "Financing Statements" means those Uniform Commercial Code financing statements satisfactory in form and substance to the Agent, naming the Agent as secured party, executed by the Borrower as debtor, in form acceptable for filing in each of the fifty states and identifying by item or type the Collateral described in the Security Agreement. "Funded Debt" means for any person (a) all indebtedness or liability of such person, without duplication, for borrowed money and all indebtedness or liability for borrowed money secured by a Lien on the assets of such person, whether or not such indebtedness or liability has been assumed by such person, (b) all indebtedness and liability of such person for Capital Leases and (c) all indebtedness or liability for borrowed money or for Capital Leases for which such person is directly or contingently liable as obligor, guarantor, or otherwise, or in respect of which such person otherwise assures a creditor against loss. "GAAP" shall have the meaning given in Section 1.03. 4 "Government Approval" means an approval, permit, license, authorization, certificate, or consent of any Governmental Authority. "Governmental Authority" means the government of the United States or any State or any foreign country or any political subdivision of any thereof or any branch, department, agency, instrumentality, court, tribunal or regulatory authority which constitutes a part or exercises any sovereign power of any of the foregoing. "IBOR Loan" means a Loan or portion thereof bearing interest at an IBOR Rate. "IBOR Rate" means, with respect to any Loan for any Applicable Interest Period, an interest rate per annum equal to the sum of (a) the Margin (changing effective as of the date of each change in the Margin) and (b) the product of (i) the Offshore Rate; and (ii) the Eurodollar Reserves in effect on the first day of such Applicable Interest Period. As used herein the "Offshore Rate" means the rate of interest per annum determined by the Agent as the rate at which dollar deposits in the approximate amount of such Loan for such Applicable Interest Period would be offered by Bank of America NT & SA's Grand Cayman Branch, Grand Cayman B.W.I. (or such other office as may be designated for such purpose by Bank of America NT & SA), to major banks in the offshore dollar interbank market at their request at approximately 11:00 a.m. (New York City time) two (2) Business Days prior to the commencement of such Applicable Interest Period. As used herein "Eurodollar Reserves" means a fraction (expressed as a decimal), the numerator of which is the number one and the denominator of which is the number one minus the aggregate of the maximum reserve percentages (including, without limitation, any special, supplemental, marginal or emergency reserves) expressed as a decimal established by the Board of Governors of the Federal Reserve System or any other banking authority to which the Lenders are subject for Eurocurrency Liability (as defined in Regulation D of such Board of Governors). It is agreed that for purposes hereof, each Loan accruing interest at the IBOR Rate shall be deemed to constitute a Eurocurrency Liability and to be subject to the reserve requirements of Regulation D, without benefit of credit or proration, exemptions or offsets which might otherwise be available to the Lenders from time to time under such Regulation D. Eurodollar Reserves shall be adjusted automatically on and as of the effective date of any change in any reserve percentage and shall apply to Applicable Interest Periods commencing after the effective date of change. "Indebtedness" means for any person (a) all items of indebtedness or liability (except capital, surplus, deferred 5 credits and reserves, as such) which, in accordance with GAAP, would be included in determining total liabilities as shown on the liability side of a balance sheet as of the date as of which indebtedness is determined, (b) indebtedness secured by any Lien, whether or not such indebtedness shall have been assumed, (c) any other indebtedness or liability for borrowed money or for the deferred purchase price of property or services for which such person is directly or contingently liable as obligor, guarantor, or otherwise, or in respect of which such person otherwise assures a creditor against loss, and (d) any other obligations of such person under Capital Leases. "Interest Rate Notice" shall have the meaning given in Section 2.06(b). "Lenders" means Bank of America National Trust & Savings Association, United States National Bank of Oregon, Union Bank of California, N.A., Key Bank of Washington, Banque Nationale de Paris, Societe Generale, The Sumitomo Bank, Limited, and any Successors thereto or permitted assigns thereof. "Lien" means, for any person, any security interest, pledge, mortgage, charge, assignment, hypothecation, encumbrance, attachment, garnishment, execution or other voluntary or involuntary lien upon or affecting the revenues of such person or any real or personal property in which such person has or hereafter acquires any interest, except (i) liens for Taxes which are not delinquent or which remain payable without penalty or the validity or amount of which is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof with appropriate reserves having been established therefor; (ii) liens imposed by law (such as mechanics' liens) incurred in good faith in the ordinary course of business which are not delinquent or which remain payable without penalty or the validity or amount of which is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof with, in the case of liens on property of the Borrower, provision having been made to the satisfaction of the Agent for the payment thereof in the event the contest is determined adversely to the Borrower; and (iii) deposits or pledges under worker's compensation, unemployment insurance, social security or other similar laws or made to secure the performance of bids, tenders, contracts (except for repayment of borrowed money), or leases, or to secure statutory obligations or surety or appeal bonds or to secure indemnity, performance or other similar bonds given in the ordinary course of business. "Loan Documents" means this Amended and Restated Revolving Credit Agreement, the Notes, the Security Agreement and all other certificates, instruments and other documents executed 6 in connection with this Agreement or the transactions contemplated hereby. "Majority Lenders" means at any time Lenders having an aggregate Percentage Interest of at least sixty-six and two thirds percent (66 2/3%). "Margin" means a per annum rate determined in accordance with Schedule 1 hereto. "Maturity Date" means December 28, 1998. "Net Income" means for any accounting period the net income of the Borrower for such period, determined in accordance with GAAP. "Net Worth" means the excess of total assets over total liabilities determined in accordance with GAAP. "Notes" has the meaning given in Section 2.09. "Officer's Certificate" means a certificate signed in the name of the Borrower by its Chairman, its President, its Executive Vice President or its Vice President and Controller. "PBGC" means the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Pension Plan" means an "employee pension benefit plan" (as such term is defined in ERISA) from time to time maintained by the Borrower or a member of the Controlled Group. "Percentage Interest" means for any Lender, at any time, the percentage that such Lender's Commitment bears to the Total Commitment. "Plan" shall mean, at any time, an employee pension benefit plan which is covered by Title IV of ERISA or subject to the minimum funding standards under Section 412 of the Code and is either (a) maintained by the Borrower or any member of a Controlled Group for employees of the Borrower or any member of such Controlled Group or (b) maintained pursuant to a collective bargaining agreement or any other arrangement under which more than one employer makes contributions and to which the Borrower or any member of a Controlled Group is then making or accruing an obligation to make contributions or has within the preceding five (5) plan years made contributions. 7 "Rental Items" means videotapes, videogames, audiotapes and related equipment to the extent that such items were acquired by Borrower for rental to its customers. "Required Notice of Borrowing" means a written request for a Loan executed by the Borrower, delivered to the Agent and containing the information set forth in Section 2.02 which shall be delivered prior to 10:00 a.m. (Seattle, Washington time), one Business Day prior to the requested date of borrowing provided, however, if the Borrower shall elect to have interest accrue on such Loan at an IBOR Rate, the Required Notice of Borrowing shall be given prior to 10:00 a.m. (Seattle, Washington time), on a Business Day at least three (3) Business Days before the requested date of borrowing. Requests for borrowing received after the designated hour will be deemed received on the next succeeding Business Day. "Security Agreement" means an Amended and Restated Security Agreement executed by the Borrower in favor of the Agent substantially in the form attached hereto as Exhibit B. "Successor" means, for any corporation or banking association, any successor by merger or consolidation, or by acquisition of substantially all of the assets of the predecessor. "Tax" means for any person any tax, assessment, duty, levy, impost or other charge imposed by any Governmental Authority on such person or on any property, revenue, income, or franchise of such person and any interest or penalty with respect to any of the foregoing. "Total Commitment" means One Hundred Fifty Million Dollars ($150,000,000) as the same may be reduced or terminated pursuant to Sections 2.03 or 7.02. "Unfunded Vested Liabilities" shall mean, with respect to any Plan, at any time, the amount (if any) by which (a) the present value of all vested nonforfeitable benefits under such Plan exceeds (b) the fair market value of all Plan assets allocable to such benefits, all determined as of the then most recent valuation date for such Plan, but only to the extent that such excess represents a potential liability of the Borrower or any member of the Controlled Group to the PBGC or the Plan under Title IV of ERISA. Section 1.02 General Principles Applicable to Definitions. Definitions given in Section 1.01 shall be equally applicable to both singular and plural forms of the terms therein defined and references herein to "he" or "it" shall be applicable to persons whether masculine, feminine or neuter. References herein to any 8 document including, but without limitation, this Agreement shall be deemed a reference to such document as it now exists, and as, from time to time hereafter, the same may be amended. References herein to a "person" or "persons" shall be deemed to be references to an individual, corporation, partnership, trust, unincorporated association, joint venture, joint-stock company, government (including political subdivisions), Governmental Authority or agency or any other entity. Section 1.03 Accounting Terms. Except as otherwise provided herein, accounting terms not specifically defined shall be construed, and all accounting procedures shall be performed, in accordance with generally accepted United States accounting principles consistently applied ("GAAP") and as in effect on the date of application. ARTICLE II THE LOANS --------- Section 2.01 Loans. Each Lender severally agrees on the terms and conditions of this Agreement to make loans ("Loans") to the Borrower from time to time on Business Days during the period beginning on the date hereof and ending on the Maturity Date, in an aggregate principal amount not exceeding at any one time the principal amount set forth opposite such Lender's name below (such Lender's "Commitment"). Lender Commitment ------ ---------- Bank of America NT & SA $ 40,000,000 United States National Bank $ 25,000,000 of Oregon Union Bank of California, N.A. $ 20,000,000 Key Bank of Washington $ 20,000,000 Banque Nationale de Paris $ 15,000,000 Societe Generale $ 15,000,000 The Sumitomo Bank, Limited $ 15,000,000 ------------ Total $150,000,000 Amounts advanced under the Prior Credit Agreement (as such term is defined in the "Recitals" hereto) which are outstanding as of the date hereof shall be deemed to have been advanced hereunder. The line of credit extended hereunder is a revolving line of credit and, subject to the terms and conditions hereof, the Borrower may borrow, repay and reborrow up the maximum principal amount of the Total Commitment at any time on or before the Maturity Date. 9 Section 2.02 Manner of Borrowing a Loan. The Borrower shall give the Agent the Required Notice of Borrowing specifying the date of the borrowing of any Loan and the amount thereof, which shall be in an amount which is an integral multiple of One Million Dollars ($1,000,000) and not less than Two Million Dollars ($2,000,000). Such notice shall be irrevocable and shall be deemed to constitute a representation and warranty by the Borrower that as of the date of the notice, the statements set forth in Article IV hereof are true and correct and that no Default or Event of Default has occurred and is continuing. On receipt of such notice, the Agent shall promptly notify each Lender by telephone (confirmed immediately by telex, facsimile transmission or cable), telex, facsimile transmission, or cable of the date of the borrowing. Each Lender shall before 12:00 noon (Seattle, Washington time), on the date of the borrowing, pay the lesser of (a) such Lender's Percentage Interest of the aggregate principal amount of the requested borrowing identified in the Required Notice of Borrowing or (b) the maximum amount such Lender is committed to advance pursuant to the terms of Section 2.01 hereof in immediately available funds to the Agent at its Commercial Loan Processing Center, Seattle, Washington. Upon fulfillment to the Agent's satisfaction of the applicable conditions set forth in Article III, and after receipt by the Agent of such funds, the Agent will promptly make such immediately available funds available to the Borrower by depositing them to the ordinary checking account maintained by the Borrower with Bank of America National Trust & Savings Association. Section 2.03 Reduction of Commitments. Upon not less than five (5) Business Days' written notice to the Agent, the Borrower may terminate the Total Commitment, in whole or in part, provided that each partial reduction of the Total Commitment shall be in an amount not less than Five Million Dollars ($5,000,000) and, provided, further, that in no event may the Total Commitment be reduced to an amount less than the then-outstanding aggregate principal balance of the Loans. Any reduction in the Total Commitment shall be deemed to be a proportionate reduction in each Lender's Commitment therein such that after making such reduction, each Lender's Commitment will be in an amount equal to its Percentage Interest (calculated immediately before the reduction of the Total Commitment) of the then-reduced Total Commitment. Section 2.04 Repayment of Principal. The Borrower shall repay to the Agent for the account of the Lenders the principal amount of each Loan on or before the Maturity Date. Section 2.05 Agent's Right to Fund. Unless the Agent shall have received notice from a Lender prior to 12:00 noon (Seattle, Washington time) on the date of any Loan that such Lender will 10 not make available to the Agent such Lender's Percentage Interest of the requested borrowing, the Agent may assume that such Lender has made such funds available to the Agent on the date of such Loans in accordance with Section 2.02 hereof and the Agent may, in reliance upon such assumption, make available to the Borrower on such date a corresponding amount. If and to the extent that such Lender shall not have so made such portion available to the Agent and if the Agent shall have advanced such portion to the Borrower, such Lender and the Borrower severally agree to pay to the Agent forthwith on demand such corresponding amount, together with interest thereon for each day from the date such amount is made available to the Borrower until the date such amount is repaid to the Agent, at (a) in the case of the Borrower, the Applicable Interest Rate (b) in the case of such Lender, the Federal Funds Rate. Any such repayment by the Borrower shall be without prejudice to any rights it may have against the Lender that has failed to make available its funds for any requested borrowing. Section 2.06 Interest on Loans. (a) General Provisions. The Borrower agrees to pay to Agent for the account of each Lender interest on the unpaid principal amount of each Loan from the date of such Loan until such Loan shall be due and payable at a per annum rate equal to the Applicable Interest Rate, and, if default shall occur in the payment when due of any such Loan, from the maturity of that Loan until it is paid in full at a per annum rate equal to two percentage points (2%) above the Base Rate (changing as the Base Rate changes). Accrued but unpaid interest on each Loan accruing interest at an IBOR Rate shall be paid on the last day of each Applicable Interest Period, on the date of any principal payment (to the extent accrued on the principal amount paid), at the Maturity Date and, additionally, in the case of such a Loan for which the Applicable Interest Period is six months, on the day that is three months after the commencement of such Applicable Interest Period. Accrued but unpaid interest on each Base Rate Loan shall be paid on the last Business Day of each calendar quarter commencing on March 31, 1997 and continuing on the last Business Day of each calendar quarter thereafter and on the date of any principal payment (to the extent accrued on the principal amount paid) and at the Maturity Date. Unpaid interest accruing on amounts in default shall be payable on demand. (b) Selection of Alternative Rate. The Borrower may, subject to the requirements of this Section 2.06(b), on at least three (3) Business Days' prior written notice elect to have interest accrue on any Loan or any portion thereof at an IBOR Rate for an Applicable Interest Period. Such notice (herein, an "Interest Rate Notice") shall be deemed delivered on receipt by Agent except that an Interest Rate Notice received by the Agent 11 after 10:00 a.m. (Seattle, Washington time) on any Business Day shall be deemed to be received on the immediately succeeding Business Day. Such Interest Rate Notice shall identify, subject to the conditions of this Section 2.06(b), the Loan or portions thereof and the Applicable Interest Period which the Borrower selects. Any such Interest Rate Notice shall be irrevocable and shall constitute a representation and warranty by the Borrower that as of the date of such Interest Rate Notice, the statements set forth in Article IV are true and correct and that no Event of Default or Default has occurred and is continuing. On receipt of such Interest Rate Notice, the Agent shall promptly notify each Lender by telephone (confirmed promptly by telex or facsimile transmission) of the information set forth in the Interest Rate Notice. Borrower's right to select an IBOR Rate to apply to a Loan or any portion thereof shall be subject to the following conditions: (i) the aggregate of all Loans or portions thereof to accrue interest at a particular IBOR Rate for the same Applicable Interest Period shall be an integral multiple of One Million Dollars ($1,000,000) and not less than Two Million Dollars ($2,000,000); (ii) the Borrower shall not have selected more than twelve (12) different IBOR Rates or Applicable Interest Periods to be applicable to portions of the Loans at any one time; (iii) an IBOR Rate may not be selected for any Loan or portion thereof which is already accruing interest at an IBOR Rate unless such selection is only to become effective at the maturity of the Applicable Interest Period then in effect; (iv) the Agent or any Lender shall not have given notice pursuant to Section 2.06(d) that the IBOR Rate selected by Borrower is not available; (v) no Default or Event of Default shall have occurred and be continuing and (vi) if the Borrower elects to have some portion (but less than all) of the Loans accrue interest at a designated IBOR Rate, the Borrower shall select a portion of each Lender's Loans to accrue interest at such rate in proportion to their respective Percentage Interests. In the absence of an effective request for the application of an IBOR Rate, the Loans or remaining portions thereof shall accrue interest at the Adjusted Base Rate. Any Interest Rate Notice which specifies an IBOR Rate but fails to identify an Applicable Interest Period shall be deemed to be a request for the designated IBOR Rate for an Applicable Interest Period of one (1) month. The Interest Rate Notice may be given with and contained in any Required Notice of Borrowing. If the Borrower delivers an Interest Rate Notice with any Required Notice of Borrowing for a Loan and the Borrower thereafter declines to take such Loan or a condition precedent to the making of such Loan is not satisfied or waived, Borrower shall indemnify the Agent and each Lender for all losses and any costs which the Agent or any Lender may sustain as a consequence thereof including, without limitation, the costs of redeployment of funds at rates lower than the cost to the Lenders of such funds. A certificate of the Agent or any Lender setting forth the amount due to it pursuant to this subparagraph (b) and 12 the basis for, and the calculation of, such amount shall, absent manifest error, be conclusive evidence of the amount due pursuant to this subparagraph (b). Payment of the amount owed shall be due within fifteen (15) days after the Borrower's receipt of such certificate. (c) Applicable Days for Computation of Interest. Computations of interest accruing at an IBOR Rate shall be made on the basis of a year of three hundred sixty (360) days, for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest is payable. Computations of interest accruing at an Adjusted Base Rate or at a rate of interest applicable after default shall be made on the basis of a year of three hundred sixty-five or three hundred sixty-six (365 or 366) days, as the case may be, in each case, for the actual number of days (including the first day but excluding the last day) occurring in the period for which such interest is payable. (d) Unavailable IBOR Rate. If any Lender determines that for any reason fair and adequate means do not exist for establishing a particular IBOR Rate or that accruing interest on any Loan at an IBOR Rate by such Lender has become unlawful, such Lender may give notice of that fact to the Agent and the Borrower and such determination shall be conclusive and binding absent manifest error. After such notice has been given and until such Lender notifies the Borrower and the Agent that the circumstances giving rise to such notice no longer exist, such IBOR Rate shall no longer be available in respect of Loans. Thereafter, any request by the Borrower to have interest accrue on a Loan at such an IBOR Rate shall be deemed to be a request for interest to accrue at the Adjusted Base Rate. If the circumstances giving rise to the notice described herein no longer exist, the Lender shall notify the Borrower and Agent in writing of that fact, and the Borrower shall then once again become entitled to request that such an IBOR Rate apply to the Loans in accordance with Section 2.06(b) hereof. Section 2.07 Compensation for Increased Costs. In the event that after the date hereof any change occurs in any applicable law, regulation, guideline, treaty or directive or interpretation thereof by any authority charged with the administration or interpretation thereof, or any condition is imposed by any authority after the date hereof or any change occurs in any condition imposed by any authority on or prior to the date hereof which: (a) subjects any Lender to any Tax, or changes the basis of taxation of any payments to any Lender on account of principal of or interest on any IBOR Loan, such Lender's Note (to the extent such Note evidences IBOR Loans) or other amounts 13 payable with respect to IBOR Loans (other than a change in the rate of tax based solely on the overall net or gross income of such Lender); or (b) imposes, modifies or determines applicable any reserve, deposit or similar requirements against any assets held by, deposits with or for the account of, or loans or commitments by, any office of any Lender in connection with its IBOR Loans to the extent the amount of which is in excess of, or was not applicable at the time of computation of, the amounts provided for in the definition of such IBOR Rate; or (c) affects the amount of capital required or expected to be maintained by banks generally or corporations controlling banks and any Lender determines the amount by which such Lender or any corporation controlling such Lender is required or expected to maintain or increase its capital is increased by, or based upon, the existence of this Agreement or of such Lender's Loans or Commitment hereunder; (d) imposes upon any Lender any other condition with respect to its IBOR Loans or its obligation to make IBOR Loans; which, as a result thereof, (i) increases the cost to any Lender of making or maintaining its IBOR Loans or its Commitments hereunder, or (ii) reduces the net amount of any payment received by any Lender in respect of its IBOR Loans (whether of principal, interest, commitment fees or otherwise), or (iii) requires any Lender to make any payment on or calculated by reference to the gross amount of any sum received by it in respect of its IBOR Loans, in each case by an amount which any such Lender in its sole judgment deems material, then and in any such case the Borrower shall pay to the Agent for the account of such Lender on demand such amount or amounts as will compensate such Lender (on an after-tax basis) for any increased cost, deduction or payment actually incurred or made by such Lender. The demand for payment by any Lender shall be delivered to both the Agent and the Borrower and shall state the subjection or change which occurred or the reserve or deposit requirements or other conditions which have been imposed upon such Lender or the request, direction or requirement with which it has complied, together with the date thereof, the amount of such cost, reduction or payment and the manner in which such amount has been calculated. The statement of any Lender as to the additional amounts payable pursuant to this Section 2.07 shall, absent manifest error be conclusive evidence of the amounts payable hereunder. The protection of this Section 2.07 shall be available to each Lender regardless of any possible contention of invalidity or inapplicability of the relevant law, regulation, guideline, treaty, directive, condition or interpretation thereof. In the 14 event that the Borrower pays any Lender the amount necessary to compensate such Lender for any charge, deduction or payment incurred or made by such Lender as provided in this Section 2.07, and such charge, deduction or payment or any part thereof is subsequently returned to such Lender as a result of the final determination of the invalidity or inapplicability of the relevant law, regulation, guideline, treaty, directive or condition, then such Lender shall remit to the Borrower the amount paid by the Borrower which has actually been returned to such Lender (together with any interest actually paid to Lender on such returned amount), less such Lender's costs and expenses incurred in connection with such governmental regulation or any challenge made by such Lender with respect to its validity or applicability. Section 2.08 Prepayments. Base Rate Loans may be repaid at any time without penalty or premium. If a Loan (or portion thereof) accruing interest at an IBOR Rate is paid prior to the end of the Applicable Interest Period a fee computed in the manner set out in Schedule 2 shall be assessed and paid at the time of such payment. Such fee shall apply in all circumstances where such a Loan (or portion thereof) is paid prior to the end of the Applicable Interest Period, regardless of whether such payment is voluntary, mandatory, or the result of the Agent's or Lenders' collection efforts. Section 2.09 Notes. The Loans shall be evidenced by promissory notes of the Borrower substantially in the form of Exhibit A hereto, with appropriate insertions, payable to the order of the Lenders, dated as of the date hereof, and for each Lender in the face amount of such Lender's Commitment (the "Notes"). Each Lender is hereby authorized to record the date and amount of Loans it makes and the date and amount of each payment of principal and interest thereon on a schedule annexed to its Note or maintained in connection therewith. Any such recordation by any Lender shall constitute prima facie evidence of the accuracy of the information so recorded; provided, however, that the failure to make any such recordation or any error in any such recordation shall not affect the obligations of the Borrower hereunder or under the Notes. Section 2.10 Manner of Payments. (a) All payments and prepayments of principal and interest on any Loan and all other amounts payable hereunder by the Borrower to the Agent or any Lender shall be made by paying the same in United States Dollars and in immediately available funds to the Agent at its Commercial Loan Service Center, Seattle, Washington not later than 10:00 o'clock a.m. (Seattle, Washington time) on the date on which such payment or prepayment shall become due. 15 (b) On each date when the payment of any interest is due hereunder or under any Note (each, a "Due Date"), the Borrower covenants to maintain on deposit in its ordinary checking account maintained at Bank of America Oregon, an amount sufficient to pay such interest in full. The Borrower irrevocably authorizes the Agent to deduct automatically all interest due on each such interest payment date from such account. The Borrower agrees to execute such other documents and instructions as may be reasonably necessary or desirable to give effect to the terms of this Section 2.10(b). In addition, the Borrower hereby authorizes the Agent and each Lender, if and to the extent any payment is not promptly made pursuant to this Agreement or any other Loan Document, to charge from time to time against any or all of the accounts of the Borrower with the Agent or any Lender or any affiliate of the Agent or any Lender any amount due hereunder or under any other Loan Document. (c) Approximately ten (10) days prior to each Due Date, the Agent shall give written notice (which may be by telegram, facsimile transmission, cable or telex) of the amounts that will be due on such Due Date. The calculation of the amounts due will be made on the assumption that no new extensions of credit or payments will be made between the date of such notice and the Due Date, and that there will be no changes in the applicable interest rate. Notwithstanding the foregoing to the contrary, amounts due on any Due Date shall be calculated in accordance with this Agreement and the failure of the Agent to give notice as provided in this Section 2.10(c) shall not affect the obligations of the Borrower hereunder or under any other Loan Document. (d) Whenever any payment hereunder or under any other Loan Document shall be stated to be due or whenever the last day of any interest period would otherwise occur on a day other than a Business Day, such payment shall be made and the last day of such interest period shall occur on the next succeeding Business Day and such extension of time shall in such case be included in the computation and payment of interest or facility fees, as the case may be, unless such extension would cause such payment to be made or the last day of such interest period to occur in the next following calendar month, in which case such payment shall be due and the last day of such interest period shall occur on the next preceding Business Day. (e) Any payment made by the Borrower hereunder shall be applied first, against fees, expenses and indemnities due hereunder; second, against interest; and thereafter, against Loan principal. 16 Section 2.11 Fees. (a) Unused Commitment Fees. At all times prior to the Maturity Date, Borrower agrees to pay to the Agent for the account of the Lenders in proportion to their Percentage Interests an unused commitment fee computed daily at the rate of .30% per annum on the unused portion of the Total Commitment payable in arrears on the last Business Day of each calendar quarter, on the Maturity Date, and on demand after default. Computations of unused commitment fees shall be made on the basis of a year of three hundred sixty (360) days for the actual number of days (including the first day but excluding the last day) occurring in the period for which such fees are payable. (b) Loan Fee. On the date of this Agreement, the Borrower agrees to pay to the Agent for the account of the Lenders a participation fee which shall be in a total amount and shall be allocated among the Lenders as set forth on the attached Schedule 3. (c) Agency Fees. The Borrower shall pay to the Agent, for its own account, agency fees in such amounts and at such times as are set forth in that certain letter agreement dated November 27, 1996, by and between the Agent, the Borrower, and BA Securities, Inc. On the date of this Agreement, the Borrower shall also pay to BancAmerica Securities, Inc. an arrangement fee in accordance with the terms of such letter agreement. Section 2.12 Sharing of Payments, Etc. Each borrowing of Loans from the Lenders under Section 2.01 will be made pro rata in accordance with each Lender's Percentage Interest. Each payment and prepayment of the Loans and each payment of interest on the Loans will be made pro rata to each Lender in accordance with its Percentage Interest. If any Lender shall obtain any payment in respect of the Borrower's obligations under this Agreement or the Notes (whether voluntary or involuntary, through the exercise of any right of set-off or otherwise) in excess of the share which it would have been entitled to receive had such payment been made to the Agent, such Lender shall forthwith notify the Agent and purchase from the other Lenders such participations in the Loans made by them as shall be necessary to cause such purchasing Lender to share the excess payment ratably with each of them, but if any of such excess payment is afterward recovered from such purchasing Lender, the purchase shall be rescinded and the purchase price restored, without interest, to the extent of such recovery. The Borrower authorizes the purchase of such participations and agrees that any Lender so purchasing a participation from another Lender may exercise all its rights to payment (including the right of set off) with respect to such participation as fully as if such Lender were the 17 direct creditor of the Borrower in the amount of such participation. Section 2.13 Withholding Taxes. If the Borrower shall be required by law to deduct or withhold any Taxes or other amounts from or in respect of any sum payable hereunder to any Lender or the Agent, then: (a) the sum payable shall be increased as necessary so that, after making all required deductions and withholdings (including deductions and withholdings applicable to additional sums payable under this Section), such Lender or the Agent, as the case may be, receives and retains an amount equal to the sum it would have received and retained had no such deductions or withholdings been made; (b) the Borrower shall make such deductions and withholdings; (c) the Borrower shall pay the full amount deducted or withheld to the relevant taxing authority or other authority in accordance with applicable law; and (d) the Borrower shall also pay to each Lender or the Agent for the account of such Lender, at the time interest is paid, such further amounts as the respective Lender specifies as necessary to preserve the after-tax yield the Lender would have received if such taxes or other withholding amounts had not been imposed. ARTICLE III CONDITIONS OF LENDING --------------------- The obligations of each Lender to deliver its Loan proceeds to the Agent and the obligation of the Agent to disburse such proceeds to the Borrower are subject to the fulfillment of the following conditions: Section 3.01 Notice of Borrowing, Promissory Notes, Etc. The Agent shall have received the Required Notice of Borrowing and the Security Agreement and the Lenders shall have received their Notes, in each case duly executed and delivered by the Borrower. Section 3.02 Corporate Authority. The Agent shall have received in form and substance satisfactory to it a certified copy of a resolution adopted by the Board of Directors of the Borrower authorizing the execution, delivery and performance of the Loan Documents together with evidence of the authority and 18 specimen signatures of the persons who have signed such Loan Documents and such other evidence of corporate authority as the Agent or any Lender shall reasonably require. Section 3.03 Legal Opinion. The Agent and the Lenders shall have received a written legal opinion in form and substance satisfactory to the Agent addressed to the Agent and the Lenders, of counsel for the Borrower, who shall be selected by the Borrower and approved by the Agent. Section 3.04 Defaults, Etc. At the date of each Loan no Default or Event of Default shall have occurred and be continuing or will have occurred as a result of the making of the Loan; and the representations and warranties of the Borrower in Article IV shall be true on and as of such date. Section 3.05 Perfected Security Interests. The Agent shall have received evidence satisfactory to it that the security interests created by the Security Agreement have been duly perfected by the filing of all Financing Statements and the taking of all such other or additional acts as the Agent may deem necessary or advisable to create a valid and perfected lien in the Collateral enforceable against all third parties in all jurisdictions to secure all obligations of the Borrower to the Agent and the Lenders under this Agreement or the other Loan Documents. The Agent shall have also received such evidence as it may require that its security interests in the Collateral have priority over any and all other security interests or other Liens therein except purchase money Liens covering only assets purchased by the Borrower in the ordinary course of business and that the Collateral is free and clear of all Liens, except as permitted by this Agreement. Section 3.06 Payment of Amounts Under Prior Credit Agreement. All accrued interest, fees and other amounts owing under the Prior Credit Agreement (as such term is defined in the "Recitals" hereto) other than the outstanding principal balance of the loans made thereunder shall have been fully paid prior to the date of this Agreement. Section 3.07 Payment of Fees. The Borrower shall have paid all accrued and unpaid fees, costs and expenses due hereunder and under that certain letter agreement referred to in Section 2.11(c) hereof. Section 3.08 Other Information. The Agent and each Lender shall have received such other statements, opinions, certificates, documents and information with respect to the matters contemplated by this Agreement as it may reasonably request. 19 ARTICLE IV REPRESENTATIONS AND WARRANTIES ------------------------------ The Borrower represents and warrants to the Agent and each Lender as follows: Section 4.01 Corporate Existence and Power. The Borrower is a corporation duly incorporated, validly existing and in good standing under the laws of the state of Oregon. The Borrower is duly qualified to do business in each other jurisdiction where the nature of its activities or the ownership of its properties requires such qualification. The Borrower has full corporate power, authority and legal right to carry on its business as presently conducted, to own and operate its properties and assets, and to execute, deliver and perform the Loan Documents. Section 4.02 Borrower's Corporate Authorization. The execution, delivery and performance by the Borrower of this Agreement and the other Loan Documents and any borrowing hereunder or thereunder have been duly authorized by all necessary corporate action of the Borrower, do not require any shareholder approval or the approval or consent of any trustee or the holders of any Indebtedness of the Borrower, except such as have been obtained (certified copies thereof having been delivered to the Agent), do not contravene any law, regulation, rule or order binding on it or its Articles of Incorporation or Bylaws and do not contravene the provisions of or constitute a default under any indenture, mortgage, contract or other agreement or instrument to which the Borrower is a party or by which the Borrower or any of its properties may be bound or affected. Section 4.03 Government Approvals, Etc. No Government Approval or filing or registration with any Governmental Authority is required for the execution, delivery and performance by the Borrower of the Loan Documents or in connection with any of the transactions contemplated thereby, except such as have been heretofore obtained and are in full force and effect (certified copies thereof having been delivered to the Agent). Section 4.04 Binding Obligations, Etc. This Agreement has been duly executed and delivered by the Borrower and constitutes, and the other Loan Documents when duly executed and delivered will constitute, the legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their respective terms. Section 4.05 Litigation. Except as reflected in the financial statements referred to in Section 4.06, there are no actions, proceedings, investigations, or claims against or 20 affecting the Borrower now pending before any court, arbitrator or Governmental Authority (nor to the knowledge of the Borrower has any thereof been threatened nor does any basis exist therefor) which if determined adversely to the Borrower would be likely to have a material adverse effect on (a) the business, operations or financial condition of the Borrower; or (b) the ability of the Borrower to perform its obligations under this Agreement and the other Loan Documents. Section 4.06 Financial Condition. The balance sheet of the Borrower as at September 30, 1996, and the related statements of income and retained earnings for the period then ended, copies of which have been furnished to the Agent and each Lender, fairly present the financial condition of the Borrower as at such date, all determined in accordance with GAAP. The Borrower did not have on such date any contingent liabilities for Taxes, unusual forward or long-term commitments or unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in the balance sheet and in the related notes. Since the date of such financial statements there has been no material adverse change in the financial condition, operations, or business of the Borrower. Section 4.07 Title and Liens. The Borrower has good and marketable title to each of the properties and assets reflected in the balance sheet referred to in Section 4.06 (except such as have been since sold or otherwise disposed of in the ordinary course of business). No assets or revenues of the Borrower are subject to any Lien except as permitted by this Agreement. All properties of the Borrower and its use thereof comply in all material respects with applicable zoning and use restrictions and with applicable laws and regulations relating to health, safety and the environment. Without limiting the foregoing, the Borrower is in material compliance with all laws and regulations relating to pollution, hazardous substances and environmental control in all jurisdictions in which the Borrower is doing business. The Borrower conducts in the ordinary course of business a review of the effect of existing laws pertaining to the environment and existing claims advanced under or in respect of environmental laws on its business, operations and properties, and, as a result thereof, the Borrower has reasonably concluded that such environmental laws and claims could not, individually or in the aggregate, reasonably be expected to have a material adverse effect on the financial condition, operations, or business of the Borrower. Section 4.08 Taxes. The Borrower has filed all tax returns and reports required of it, has paid all Taxes which are due and payable, and has provided adequate reserves for payment of any Tax whose payment is being contested. The charges, accruals and reserves on the books of the Borrower in respect of Taxes for all 21 fiscal periods to date are accurate. There are no questions or disputes between the Borrower and any Governmental Authority with respect to any Taxes except as disclosed in the balance sheet referred to in Section 4.06 or otherwise disclosed to the Agent in writing prior to the date of this Agreement. Section 4.09 Laws, Orders; Other Agreements. The Borrower is not in violation of or subject to any contingent liability on account of any laws, statutes, rules, regulations and orders of any Governmental Authority and is not in material breach of or default under any agreement to which it is a party or which is binding on it or any of its assets. Section 4.10 Lien Priority. On the date of any Loan (i) Financing Statements will have been duly filed in all places where filing is necessary, and all other or additional acts will have been taken as are necessary to perfect the Agent's security interest in the Collateral; (ii) the Security Agreement constitutes a valid and perfected lien in the Collateral enforceable against all third parties in all jurisdictions to secure all obligations of the Borrower to the Agent and the Lenders under this Agreement or any other Loan Documents; and (iii) the Agent's security interest in the Collateral has priority over any and all other security interests or other Liens therein except purchase money Liens on assets purchased by the Borrower in the ordinary course of business and the Collateral is free and clear of all Liens except for Liens permitted hereunder. Section 4.11 Federal Reserve Regulations. The Borrower is not engaged principally or as one of its important activities in the business of extending credit for the purpose of purchasing or carrying any margin stock (within the meaning of Federal Reserve Regulation U), and no part of the proceeds of any Loan will be used to purchase or carry any such margin stock or to extend credit to others for the purpose of purchasing or carrying any such margin stock or for any other purpose that violates the applicable provisions of any Federal Reserve Regulation. The Borrower will furnish to the Agent or any Lender on request a statement conforming with the requirements of Regulation U. Section 4.12 ERISA. (a) The present value of all benefits vested under all Pension Plans did not, as of the most recent valuation date of such Pension Plans, exceed the value of the assets of the Pension Plans allocable to such vested benefits by an amount which would represent a potential material liability of the Borrower or affect materially the ability of the Borrower to perform the Loan Documents. 22 (b) No Plan or trust created thereunder, or any trustee or administrator thereof, has engaged in a "prohibited transaction" (as such term is defined in Section 406 of ERISA or Section 4975 of the Code) which could subject such Plan or any other Plan, any trust created thereunder, or any trustee or administrator thereof, or any party dealing with any Plan or any such trust to the tax or penalty on prohibited transactions imposed by Section 502 of ERISA or Section 4975 of the Code. (c) No Pension Plan or trust has been terminated, except in accordance with the Code, ERISA, and the regulations of the Internal Revenue Service and the PBGC as applicable to solvent plans in which benefits of participants are fully protected. No "reportable event" as defined in Section 4043 of ERISA has occurred for which notice has not been waived or for which alternative notice procedures are permitted. (d) No Pension Plan or trust created thereunder has incurred any "accumulated funding deficiency" (as such term is defined in Section 302 of ERISA) whether or not waived, since the effective date of ERISA. (e) The required allocations and contributions to Pension Plans will not violate Section 415 of the Code. (f) The Borrower has no withdrawal liability to any trust created pursuant to a multi-employer pension or benefit plan nor would it be subject to any such withdrawal liability in excess of One Million Dollars ($1,000,000) if it withdrew from any such plan or if its participation therein were otherwise terminated. Section 4.13 Patents, Licenses, Franchises. The Borrower owns or possesses all the patents, trademarks, service marks, trade names, copyrights, licenses, franchises, permits and rights with respect to the foregoing necessary to own and operate its properties and to carry on its business as presently conducted and presently planned to be conducted without conflict with the rights of others except as disclosed in writing to the Agent prior to the date of this Agreement. Section 4.14 Not Investment Company, Etc. The Borrower is not now, and after the application by the Borrower of the proceeds of any Loan will not be, subject to regulation under the Investment Company Act of 1940, the Public Utility Holding Company Act of 1935, the Federal Power Act, the Interstate Commerce Act, any state public utilities code or any federal or state statute or regulation limiting its ability to incur Indebtedness. 23 Section 4.15 Insurance. The properties of the Borrower are insured with financially sound and reputable insurance companies which are not affiliates of the Borrower, in such amounts, with such deductibles and covering such risks as are customarily carried by companies engaged in similar businesses and owning similar properties in localities where the Borrower operates. Section 4.16 Representations as a Whole. This Agreement, the other Loan Documents, the financial statements referred to in Section 4.06, and all other instruments, documents, certificates and statements furnished to the Agent or any Lender by the Borrower, taken as a whole, do not contain any untrue statement of a material fact or omit to state any material fact necessary in order to make the statements contained herein or therein not misleading. The Borrower has disclosed to the Lenders in writing any and all facts which have a material adverse effect on the business, operations or financial condition of the Borrower or the ability of the Borrower to perform its obligations under the Loan Documents. ARTICLE V AFFIRMATIVE COVENANTS --------------------- So long as any Lender shall have any Commitment hereunder and, until payment in full of each Loan and the Notes and performance of all other obligations of the Borrower under this Agreement and the other Loan Documents, the Borrower agrees to do all of the following unless the Agent (with the consent of the Majority Lenders) shall otherwise consent in writing. Section 5.01 Use of Proceeds. The Borrower shall use the proceeds of the Loans for interim funding of new store growth and acquisitions and for its general working capital needs. Section 5.02 Payment. The Borrower will pay the principal of and interest on the Loans in accordance with the terms of this Agreement and the Notes and will pay when due all other amounts payable by the Borrower hereunder and under any other Loan Document. Section 5.03 Preservation of Corporate Existence, Etc. The Borrower will preserve and maintain its corporate existence, rights, franchises and privileges in the jurisdiction of its formation and will qualify and remain qualified as a foreign corporation in each jurisdiction where such qualification is necessary or desirable in view of its business and operations or the ownership of its properties. 24 Section 5.04 Visitation Rights. At any reasonable time, and from time to time, the Borrower will permit the Agent or any Lender to examine and make copies of and abstracts from its records and books of account, to visit its properties and to discuss the affairs, finances and accounts of the Borrower with any of its officers, directors or employees. Section 5.05 Keeping of Books and Records. The Borrower will keep adequate records and books of account in which complete entries will be made, in accordance with GAAP, reflecting all of its financial transactions. Section 5.06 Maintenance of Property, Etc. The Borrower will maintain and preserve all of its properties in good working order and condition, ordinary wear and tear excepted, and will from time to time make all needed repairs, renewals, or replacements so that the efficiency of such properties shall be fully maintained and preserved. Section 5.07 Compliance With Laws, Etc. The Borrower will comply in all material respects with all laws, regulations, rules, and orders of Governmental Authorities, except any thereof whose validity is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof and with provision having been made to the satisfaction of the Agent for the payment of any fines, charges, penalties or other costs in respect thereof in the event the contest is determined adversely to the Borrower. Without limiting the foregoing, Borrower shall conduct its operations and keep and maintain its property in compliance with all environmental laws, regulations, rules and orders except to the extent that noncompliance would not result in a material adverse effect on the business, finances or operations of the Borrower. Section 5.08 Other Obligations. The Borrower will pay and discharge all Indebtedness, Taxes, and other obligations for which the Borrower is liable or to which its income or property is subject and all claims for labor and materials or supplies which, if unpaid, might become by law a Lien upon assets of the Borrower, except (a) any thereof whose validity or amount is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof and with provision having been made to the satisfaction of the Agent for the payment thereof in the event the contest is determined adversely to the Borrower; and (b) any trade payables, arising from the purchase of inventory, which are paid in accordance with industry practice and prior to the time any collection proceeding is commenced by any vendor. Section 5.09 Insurance. The Borrower will keep in force upon all of its properties and operations policies of insurance 25 carried with responsible companies in such amounts and covering all such risks as shall be customary in the industry and as shall be reasonably satisfactory to the Agent. From time to time, on request, the Borrower will furnish to the Agent certificates of insurance or, at Agent's request, duplicate policies evidencing such coverage. Section 5.10 Financial Information. The Borrower will deliver to the Agent and the Lenders: (a) Annual Audited Financial Statements. As soon as available and in any event within ninety (90) days after the end of each fiscal year of the Borrower, the balance sheet of the Borrower as of the end of such fiscal year and the related statement of revenue and expenses, statement of shareholder's equity and statement of cash flow for such year, accompanied by the audit report thereof by independent certified public accountants selected by the Borrower and approved by the Agent (which approval shall not be unreasonably withheld or delayed, and the Agent's consent to Price Waterhouse L.L.P. being hereby given) which report shall be prepared in accordance with GAAP and shall not be qualified by reason of restricted or limited examination of any material portion of the Borrower's records and shall contain no disclaimer of opinion. (b) Quarterly Unaudited Financial Statements. As soon as available and in any event within forty-five (45) days after the end of each of the first three fiscal quarters of the Borrower, the unaudited balance sheet and statement of revenues and expenses, statement of shareholder's equity and statement of cash flow of the Borrower as of the end of such fiscal quarter (including the fiscal year to the end of such fiscal quarter), accompanied by an Officer's Certificate to the effect that such unaudited balance sheet and related statements have been prepared in accordance with GAAP and present fairly the financial position and results of operations of the Borrower as of the end of and for such fiscal quarter and that since the fiscal year-end report referred to in clause (a) there has been no material adverse change in the financial condition or operations of the Borrower as shown on the balance sheet as of said date. (c) Quarterly Compliance Certificates. As soon as available and in any event within sixty (60) days after the close of each of the first three fiscal quarters of the Borrower and within one hundred twenty (120) days after the close of each of the Borrower's fiscal years, a compliance certificate of Borrower in form reasonably acceptable to Agent that as of the close of such fiscal quarter no Default or Event of Default had occurred and was continuing, and, further, setting forth calculations demonstrating compliance as of the end of such fiscal quarter 26 with the financial covenants set forth in Sections 5.13 through 5.16 and Sections 6.02, 6.04, 6.06 and 6.07 hereof. (d) Quarterly Store Financial Statements. As soon as available and in any event within sixty (60) days after the close of each of the Borrower's fiscal quarters, the unaudited statement of financial performance for the Borrower's stores for such fiscal quarter together with same store sales comparisons accompanied by an Officer's Certificate all in form reasonably acceptable to Agent. (e) Annual Budget; Financial Projections. As soon as available and in any event within ninety (90) days after the close of each of the Borrower's fiscal years (after the fiscal year ending in 1996), the Borrower's annual operating budget and financial projections (presented in a quarterly format) for the succeeding fiscal year in form reasonably acceptable to the Agent. (f) Shareholder, SEC and Government Reports. As soon as available, all reports sent by the Borrower to its shareholders and all quarterly and annual reports filed by the Borrower with the Securities and Exchange Commission and each other Governmental Authority having jurisdiction over the Borrower. Without limiting the foregoing, the Borrower shall provide its 10-K's and 10-Q's to the Agent and the Lenders on a date not later than ninety (90) days after the fiscal year end and forty-five (45) days after the end of each of the first three fiscal quarters, respectively. (g) Other Information. All other statements, reports and other information as the Agent or any Lender may reasonably request concerning the financial condition and business affairs of the Borrower. Section 5.11 Notification. Promptly after learning thereof, the Borrower will notify the Agent and Lenders of (a) the details of any action, proceeding, investigation or claim against or affecting the Borrower, instituted before any court, arbitrator or Governmental Authority or, to the Borrower's knowledge threatened to be instituted, which, if determined adversely would be likely to have a material adverse effect on the business, operations or financial condition of the Borrower; (b) any substantial dispute between the Borrower and any Governmental Authority; (c) any labor controversy which has resulted in or, to the Borrower's knowledge, threatens to result in a strike which would materially affect the business operations of the Borrower; (d) if the Borrower or any member of the Controlled Group gives or is required to give notice to the PBGC of any "reportable event" (as defined in subsections (b)(1), (2), (5) or (6) of ss. 4043 of ERISA) with respect to any Plan (or the 27 Internal Revenue Service gives notice to the PBGC of any "reportable event" as defined in subsection (c)(2) of ss. 4043 of ERISA and Borrower obtains knowledge thereof) which might constitute grounds for a termination of such Plan under Title IV of ERISA, or knows that the plan administrator of any Plan has given or is required to give notice of any such reportable event, the notice of such reportable event given or required to be given to the PBGC; and (e) the occurrence of any Default or Event of Default. Section 5.12 Additional Payments; Additional Acts. From time to time and upon demand by the Agent, the Borrower will (a) pay or reimburse Agent and the Lenders for all Taxes imposed on this Agreement and any other Loan Document and for all expenses including reasonable out-of-pocket legal fees (including allocated charges of internal legal counsel) incurred in connection with the enforcement by judicial proceedings or otherwise of any of the rights of the Agent or the Lenders under this Agreement or any other Loan Document, (b) pay or reimburse the Agent for all expenses, including reasonable legal fees, actually incurred by the Agent in connection with the preparation of this Agreement and the other Loan Documents, the making of any Loan or the perfection of the security interests created by the Security Agreement; (c) obtain and promptly furnish to the Agent evidence of all such Government Approvals as may be required to enable the Borrower to comply with its obligations under the Loan Documents; and (d) execute and deliver all such other instruments and perform all such other acts as the Agent or any Lender may reasonably request to carry out the transactions contemplated by this Agreement and the other Loan Documents. Section 5.13 Net Worth. The Borrower shall maintain at all times a Net Worth equal to or greater than the sum of (a) Two Hundred Twenty Million Dollars ($220,000,000), and (b) seventy-five percent (75%) of the cumulative Net Income of the Borrower for all fiscal quarters ended after September 30, 1996, in which the Borrower's Net Income was greater than zero, and (c) one hundred percent (100%) of the amount, if any, by which the shareholders' equity of the Borrower has increased since September 30, 1996 as a result of the issuance of common stock or the conversion of debt securities into common stock in connection with the acquisition of another company (or some or all of the assets of another company), and (d) ninety percent (90%) of the amount, if any, by which the shareholders' equity of the Borrower has increased since September 30, 1996 as a result of all other issuances of common stock or conversions of debt securities into common stock. Section 5.14 Fixed Charge Coverage Ratio. At the end of each fiscal quarter of the Borrower, the Borrower shall maintain a Fixed Charge Coverage Ratio of not less than 2.5 to 1.0. As 28 used herein, "Fixed Charge Coverage Ratio" means, for any period, the ratio of (i) EBITDA of the Borrower for the preceding four consecutive fiscal quarters less cash income tax expense during such period; less thirty percent (30%) of all revenues received from the rental of Rental Items during such period; and plus all lease expense (other than the rent and other obligations owing in respect of Borrower's lease of stores) for such period to (ii) the sum of all interest expense for such period; the current portion of any Funded Debt of the Borrower (determined in accordance with GAAP) on the last date of such period; and all lease expense for such period (other than the rent and other obligations owing in respect of Borrower's lease of stores). Section 5.15 Funded Debt to Cash Flow Ratio. The Borrower shall maintain for each period of four consecutive fiscal quarters a ratio of Funded Debt to Cash Flow of no greater than: Period Ratio ------ ----- From the date hereof through and 2.50 to 1 including the four consecutive fiscal quarters ending December 31, 1997 For the four consecutive fiscal 2.00 to 1 quarters ending March 31, 1998 and thereafter As used herein, "Cash Flow" shall mean for any four quarter period, EBITDA for such period less thirty percent (30%) of all revenues received from the rental of Rental Items during such period plus the proceeds from sales of used Rental Items for such period to the extent that such sales proceeds are not already included in EBITDA for such period. Section 5.16 Average Quarterly Per Store Revenue. The Borrower shall maintain for each fiscal quarter an Average Quarterly Per Store Revenue of $160,000 for stores opened by the Borrower during the four consecutive fiscal quarters then ended, and an Average Quarterly Per Store Revenue of $185,000 for all other stores of the Borrower. As used herein "Average Quarterly Per Store Revenue" means, for any fiscal quarter of the Borrower, and for any classification of the Borrower's stores, the total revenue of the Borrower derived from such stores (excluding "Hollywood Video Express" locations) divided by the time-weighted average number of such stores of the Borrower open during such fiscal quarter. 29 ARTICLE VI NEGATIVE COVENANTS ------------------ So long as any Lender shall have any Commitment hereunder and until payment in full of each Loan and the Notes and performance of all other obligations of the Borrower under this Agreement and the other Loan Documents, the Borrower agrees that it will not do any of the following unless the Agent (with the consent of the Majority Lenders) shall otherwise consent in writing. Section 6.01 Liquidation, Merger, Sale of Assets. The Borrower shall not merge (except mergers where the Borrower is the surviving entity) or liquidate, dissolve or enter into any consolidation, joint venture, partnership or other combination nor sell, lease or dispose of all or any portion of its assets other than sales of inventory in the ordinary course of business. Section 6.02 Funded Debt. The Borrower shall not create, incur or become liable for any Funded Debt except (a) the Loans, (b) existing Funded Debt reflected in the balance sheets referred to in Section 4.06, (c) Funded Debt incurred in the acquisition of Rental Items to the extent incurred in the ordinary course of Borrower's business and secured solely by a purchase money Lien on the Rental Items so acquired and (d) additional Funded Debt not exceeding at any one time an amount equal to five percent (5%) of the Borrower's Net Worth. Section 6.03 Guaranties, Etc. The Borrower shall not assume, guaranty, endorse or otherwise become directly or contingently liable for, nor obligated to purchase, pay or provide funds for payment of, any obligation or Indebtedness of any other person, except by endorsement of negotiable instruments for deposit or collection or by similar transaction in the ordinary course of business. Section 6.04 Liens. The Borrower shall not create, assume or suffer to exist any Lien on any of its assets, except (a) existing Liens reflected in the balance sheets referred to in Section 4.06, or otherwise previously disclosed to the Agent and Lenders in writing, (b) Liens in favor of the Agent under the Security Agreement; (c) purchase money Liens covering videotapes or videogames purchased by the Borrower in the ordinary course of business; (d) Liens securing Indebtedness under Capital Leases; and (e) additional Liens which do not at any one time secure Indebtedness exceeding an amount equal to five percent (5%) of the Borrower's Net Worth. Section 6.05 Location of Inventory. The Borrower will not move the location of its inventory except in the ordinary course 30 of its business and will not move its inventory to any location outside of the United States. Section 6.06 Investments. The Borrower shall not make or permit to remain outstanding any loan or advance to any person or purchase or otherwise acquire the capital stock, shares, voting trust certificates, bonds, debentures, notes or instruments or other securities or evidences of indebtedness or obligations of or any interest in or make any capital contribution to any person, except that Borrower may: (a) Own, purchase or acquire (i) time deposits maturing within one year at commercial banks organized or licensed to conduct a banking business under the laws of the United States of America or any state thereof having capital, surplus and undivided profits of not less than One Hundred Million Dollars ($100,000,000); (ii) marketable general obligations of the United States or a state thereof or marketable obligations fully guaranteed by the United States; and (iii) short-term commercial paper with the highest rating of a generally recognized rating service; (b) Subject to Section 6.02, own, purchase or acquire stock, obligations or securities of any person (other than debt securities or obligations of any subsidiary of the Borrower) provided, however, that the purchase price or acquisition price (including any assumption of Indebtedness in connection with such purchase or acquisition) of all stock, obligations or securities purchased or acquired by the Company after the date hereof, in the aggregate, shall not exceed an amount equal to (a) twelve and one-half percent (12.5%) of the Borrower's Net Worth (determined as of the date of each such purchase or acquisition) less (b) the purchase or acquisition price paid or to be paid in connection with all Company Asset Acquisitions entered into by the Borrower after the date hereof; and (c) Make or permit to remain outstanding loans to affiliates, officers, stockholders or employees provided, however, that all loans made or permitted to remain outstanding pursuant to this Section 6.06(c) shall not, in the aggregate, exceed at any one time outstanding the sum of Five Hundred Thousand Dollars ($500,000). Section 6.07 Operating Lease Obligations. The Borrower shall not create or suffer to exist any obligations for the payment of rent for any property under any operating lease or agreement to lease, (a) except for rent due in respect of Borrower's lease of its stores and (b) except for rent due under operating leases (other than leases for stores) entered into in the ordinary course of business where the aggregate undiscounted 31 rental obligations (calculated on the assumption that each such lease continues until its stated termination date and without giving effect to any renewal option unless such option has been exercised) for all such leases outstanding at any time does not exceed at such time an amount equal to ten percent (10%) of the Borrower's Net Worth. Section 6.08 Company Asset Acquisitions. The Borrower shall not enter into any Company Asset Acquisition where the purchase or acquisition price of the assets (including any assumption of Indebtedness in connection with such purchase or acquisition) when taken together with (a) the purchase or acquisition price paid or to be paid in connection with all other Company Asset Acquisitions entered into by the Borrower since the date of this Agreement; and (b) the purchase or acquisition price of all stock, obligations or securities purchased or acquired by the Borrower after the date of this Agreement, would exceed an amount equal to twelve and one-half percent (12.5%) of the Borrower's Net Worth (determined as of the date of such Company Asset Acquisition). As used herein, "Company Asset Acquisition" shall mean the purchase or acquisition in bulk (or the agreement to purchase or acquire in bulk) of some or all of the assets of a person engaged in a business similar to the business of the Borrower. Section 6.09 Limitations on Prepayment of Subordinated Debt. The Borrower shall not make any payments on any Funded Debt where the payment of such Funded Debt has been subordinated in whole or in part to the payments due to Lenders hereunder or to payments due in respect of any other Indebtedness unless the payments on such subordinated Funded Debt are (a) expressly permitted under the terms of any applicable subordination or comparable agreement; (b) expressly permitted by the terms of any agreement or instrument evidencing the subordinated Funded Debt; and (c) due and payable under the terms of the agreements or instruments evidencing the subordinated Funded Debt. Section 6.10 ERISA Compliance. Neither Borrower nor any member of the Controlled Group nor any Plan of any of them will (a) engage in any "prohibited transaction" (as such term is defined in ss. 406 of ERISA or ss. 4975 of the Code; (b) incur any "accumulated funding deficiency" (as such term is defined in ss. 302 of ERISA) whether or not waived; (c) terminate any Pension Plan in a manner which could result in the imposition of a Lien on any property of Borrower or any member of the Controlled Group pursuant to ss. 4068 of ERISA; or (d) violate state or federal securities laws applicable to any Plan. Section 6.11 Transactions with Affiliates. The Borrower shall not enter into any transaction with any affiliate of the Borrower except upon fair and reasonable terms no less favorable 32 to the Borrower than would obtain in a comparable arm's-length transaction with a person not an affiliate of the Borrower. Section 6.12 Change in Business. The Borrower shall not engage in any material line of business substantially different from those lines of business carried on by the Borrower on the date hereof. Section 6.13 Accounting Change. The Borrower shall maintain a fiscal year ending on December 31 and shall not make any significant change in accounting policies or reporting practices other than changes required by GAAP or otherwise required by law. ARTICLE VII EVENTS OF DEFAULT ----------------- Section 7.01 Events of Default. The occurrence of any of the following events shall constitute an "Event of Default" hereunder. (a) Loan Payment Default. The Borrower shall fail to pay when due any amount of principal of or interest on any Loan; or (b) Other Payment Default. The Borrower shall fail to pay any other amount payable by it hereunder or under any Loan Document and such failure shall remain unremedied for five (5) days; or (c) Breach of Warranty. Any representation or warranty made or deemed made by the Borrower under or in connection with this Agreement, the other Loan Documents, or other statements executed in connection herewith or therewith shall prove to have been incorrect in any material respect when made or deemed made; or (d) Breach of Certain Covenants. The Borrower shall fail to perform or observe any covenant set forth in Sections 5.11(e), 5.13 through 5.16 and 6.01 through 6.13 hereof or Sections 6 and 9 of the Security Agreement; or (e) Breach of Other Covenants. The Borrower shall fail to perform or observe any other covenant, obligation or term of this Agreement or any other Loan Document and such failure shall remain unremedied for thirty (30) days after written notice thereof shall have been given to the Borrower by the Agent; or 33 (f) Material Adverse Changes; Extraordinary Situation. An event shall occur which results in a material adverse change in the Borrower's financial condition or operations or an extraordinary situation shall occur which gives the Lenders reasonable grounds to believe that the Borrower may not, or will be unable to, perform or observe in the normal course its obligations under the Loan Documents; or (g) Cross-default. The Borrower shall fail (i) to pay when due (whether by scheduled maturity, required prepayment, acceleration, demand or otherwise) any Indebtedness in excess of Two Million Dollars ($2,000,000) or any interest or premium thereon and such failure shall continue after the applicable grace period, if any, specified in the agreement or instrument relating to such Indebtedness, or (ii) to perform any term or covenant on its part to be performed under any agreement or instrument relating to any such Indebtedness and required to be performed and such failure shall continue after the applicable grace period, if any, specified in such agreement or instrument, if the effect of such failure to perform is to accelerate or to legally and in accordance with the applicable documents permit the acceleration of the maturity of such Indebtedness; provided, however, mere allegations of a default by the Borrower under any such agreement or instrument shall not, without more, be an Event of Default hereunder; or (h) Voluntary Bankruptcy, Etc. The Borrower shall: (i) file a petition seeking relief for itself under Title 11 of the United States Code, as now constituted or hereafter amended, or file an answer consenting to, admitting the material allegations of or otherwise not controverting, or fail timely to controvert a petition filed against it seeking relief under Title 11 of the United States Code, as now constituted or hereafter amended; or (ii) file such petition or answer with respect to relief under the provisions of any other now existing or future applicable bankruptcy, insolvency, or other similar law of the United States of America or any state thereof or of any other country or jurisdiction providing for the reorganization, winding-up or liquidation of corporations or an arrangement, composition, extension or adjustment with creditors; or (i) Involuntary Bankruptcy, Etc. An order for relief shall be entered against the Borrower under Title 11 of the United States Code, as now constituted or hereafter amended, which order is not stayed; or upon the entry of an order, judgment or decree by operation of law or by a court having jurisdiction in the premises which is not stayed adjudging the Borrower a bankrupt or insolvent under, or ordering relief against it under, or approving as properly filed a petition seeking relief against it under the provisions of any other now existing or future applicable bankruptcy, insolvency or other 34 similar law of the United States of America or any state thereof or of any other country or jurisdiction providing for the reorganization, winding-up or liquidation of corporations or any arrangement, composition, extension or adjustment with creditors, or appointing a receiver, liquidator, assignee, sequestrator, trustee or custodian of the Borrower or of any substantial part of its property, or ordering the reorganization, winding-up or liquidation of its affairs, or upon the expiration of sixty (60) days after the filing of any involuntary petition against the Borrower seeking any of the relief specified in Section 7.01(h) or this Section 7.01(i) without the petition being dismissed prior to that time; or (j) Insolvency, Etc. The Borrower shall (i) make a general assignment for the benefit of its creditors or (ii) consent to the appointment of or taking possession by a receiver, liquidator, assignee, trustee, or custodian of all or a substantial part of the property of the Borrower, or (iii) admit its insolvency or inability to pay its debts generally as they become due, or (iv) fail generally to pay its debts as they become due, or (v) take any action (or suffer any action to be taken by its directors or shareholders) looking to the dissolution or liquidation of the Borrower; or (k) ERISA. The Borrower or any member of the Controlled Group shall fail to pay when due an amount or amounts aggregating in excess of Five Hundred Thousand Dollars ($500,000) which it shall have become liable to pay to the PBGC or to a Plan under Section 515 of ERISA or Title IV of ERISA; or notice of intent to terminate a Plan or Plans (other than a multi-employer plan, as defined in Section 4001(3) of ERISA), having aggregate Unfunded Vested Liabilities in excess of Five Hundred Thousand Dollars ($500,000) shall be filed under Title IV of ERISA by the Borrower, any member of the Controlled Group, any plan administrator or any combination of the foregoing; or the PBGC shall institute proceedings under Title IV of ERISA to terminate any such Plan or Plans; or (l) Judgment. A final judgment or order for the payment of money in excess of One Million Five Hundred Thousand Dollars ($1,500,000) or its equivalent in another currency shall be rendered against the Borrower and such judgment or order shall continue unsatisfied and in effect for a period of thirty (30) consecutive days; or (m) Government Approvals, Etc. Any Government Approval or registration or filing with any Governmental Authority now or hereafter required in connection with the performance by the Borrower of its obligations set forth in this Agreement, the Security Agreement or the Notes is revoked, withdrawn or withheld or shall fail to remain in full force and 35 effect, or any act of any Governmental Authority which, in the reasonable opinion of the Agent, deprives the Borrower of any substantial right, privilege or franchise or substantially restricts the exercise thereof, and such act shall not be revoked or rescinded within thirty (30) days after it shall have become effective; or (n) Change of Control. Mark J. Wattles shall cease to be the record and beneficial owner of at least fifteen percent (15%) of each class of the outstanding voting stock of the Borrower. Section 7.02 Consequences of Default. If any of the Events of Default described in Section 7.01(h) or Section 7.01(i) shall occur, the Total Commitment and the Lenders' respective Commitments shall immediately terminate, the principal of and the interest on the Loans and all other sums payable by Borrower hereunder, under the Notes and under the other Loan Documents shall become immediately due and payable all without protest, presentment, notice or demand, all of which the Borrower expressly waives. If any other Event of Default shall occur and be continuing, then in any such case and at any time thereafter so long as any such Event of Default shall be continuing, the Agent shall at the request, or may with the consent, of the Majority Lenders immediately terminate the Total Commitment and the Lenders' respective Commitments and, if Loans shall have been made, the Agent shall at the request, or may with the consent, of the Majority Lenders declare the principal of and the interest on the Loans and the Notes and all other sums payable by the Borrower hereunder or under the Notes or any other Loan Document to be immediately due and payable, whereupon the same shall become immediately due and payable all without protest, presentment, notice, or demand, all of which the Borrower expressly waives. Also, regardless of whether the Borrower's obligations to repay the Loans shall have been accelerated pursuant to the preceding sentences, the Agent may, at its option, realize on any or all of the collateral described in the Security Agreement by exercising any remedies provided in the Security Agreement or otherwise provided by law. ARTICLE VIII THE AGENT --------- Section 8.01 Authorization and Action. Each Lender hereby appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under this Agreement as are delegated to the Agent by the terms hereof, together with such powers as are reasonably incidental thereto. The Agent shall have no duties or responsibilities except those expressly 36 set forth in this Agreement. The duties of the Agent shall be mechanical and administrative in nature; the Agent shall not have by reason of this Agreement a fiduciary relationship in respect of any Lender; and nothing in this Agreement or the other Loan Documents, expressed or implied, is intended to or shall be so construed as to impose upon the Agent any obligations in respect of this Agreement or the other Loan Documents except as expressly set forth herein. As to any matters not expressly provided for by this Agreement, including enforcement or collection of the Loans, the Agent shall not be required to exercise any discretion or take any action, but shall be required to act or to refrain from acting (and shall be fully protected in so acting or refraining) upon the instructions of the Majority Lenders, and such instructions shall be binding upon all Lenders and any holders of any Note provided that the Agent shall not be required to take any action which exposes the Agent to personal liability or which is contrary to the Loan Documents or applicable law and provided, further, that without the consent of all Lenders, the Agent shall not release any collateral securing the Borrower's obligations under the Loan Documents or change or modify the Total Commitment (other than changes made pursuant to Section 2.03), any Lender's Commitment (other than changes made pursuant to Section 2.03), the definition of "Majority Lenders", the conditions precedent set forth in Article III, the timing or rates of interest payments, the timing or amount of fees or the timing or amounts of principal payments due in respect of Loans, and provided, further, that the terms of Section 2.05, Section 2.11(c) and this Article VIII shall not be amended without the prior written consent of the Agent (acting for its own account). In the absence of instructions from the Majority Lenders, the Agent shall have authority (but no obligation), in its sole discretion, to take or not to take any action, unless this Agreement specifically requires the consent of the Lenders or the consent of the Majority Lenders and any such action or failure to act shall be binding on all the Lenders and on all holders of the Notes. Each Lender and each holder of any Note shall execute and deliver such additional instruments, including powers of attorney in favor of the Agent, as may be necessary or desirable to enable the Agent to exercise its powers hereunder. Section 8.02 Duties and Obligations. (a) Neither the Agent nor any of its directors, officers, agents or employees shall be liable for any action taken or omitted to be taken by it or any of them under or in connection with this Agreement except for its or their own gross negligence or willful misconduct. Without limiting the generality of the foregoing, the Agent (i) may treat each Lender which is a party hereto as the party entitled to receive payments hereunder until the Agent receives written notice of the assignment of such Lender's interest herein signed by such Lender 37 and made in accordance with the terms hereof and a written agreement of the assignee that it is bound hereby as it would have been had it been an original party hereto, in each case in form satisfactory to the Agent; (ii) may consult with legal counsel (including counsel for the Borrower), independent public accountants and other experts selected by it and shall not be liable for any action taken or omitted to be taken in good faith by it in accordance with the advice of such experts; (iii) makes no warranty or representation to any Lender and shall not be responsible to any Lender for any statements, warranties or representations made in or in connection with this Agreement, the other Loan Documents or in any instrument or document furnished pursuant hereto or thereto; (iv) shall not have any duty to ascertain or to inquire as to the performance of any of the terms, covenants, or conditions of the Loan Documents on the part of the Borrower or as to the use of the proceeds of any Loan or as to the existence or possible existence of any Default or Event of Default; (v) shall not be responsible to any Lender for the due execution, legality, validity, enforceability, genuineness, effectiveness, or value of this Agreement or of any instrument or document furnished pursuant hereto; and (vi) shall incur no liability under or in respect to this Agreement by acting upon any oral or written notice, consent, certificate or other instrument or writing (which may be by telegram, facsimile transmission, cable or telex) believed by it to be genuine and signed or sent by the proper party or parties or by acting upon any representation or warranty of the Borrower made or deemed to be made hereunder. The Agent may execute any of its duties under this Agreement or any other Loan Document by or through agents, employees or attorneys-in-fact and shall be entitled to advice of counsel concerning all matters pertaining to such duties. The Agent shall not be responsible for the negligence or misconduct of any agent or attorney-in-fact that it selects with reasonable care. (b) The Agent will account to each Lender for its Percentage Interest of payments of principal of, interest on and fees in respect of the Loans (other than fees payable to the Agent for its own account) which are received by the Agent from the Borrower and will promptly remit to the Lenders entitled thereto all such payments. The Agent will transmit to each Lender copies of all documents received from the Borrower pursuant to the requirements of this Agreement other than documents which by the terms of this Agreement the Borrower is obligated to deliver directly to the Lenders. (c) Each Lender or its assignee organized outside of the United States shall furnish to the Agent in a timely fashion such documentation (including, but not by way of limitation, IRS Forms Nos. 1001 and 4224) as may be required by applicable law or 38 regulation to establish such Lender's status for tax withholding purposes. Section 8.03 Dealings Between Agent and Borrower. With respect to its Commitment and the Loans made by it, the Agent shall have the same rights and powers under this Agreement and the other Loan Documents as any other Lender and may exercise the same as though it were not the Agent, and the term "Lender" shall unless otherwise expressly indicated include the Agent in its individual capacity. The Agent may accept deposits from, lend money to, act and generally engage in any kind of business with the Borrower and any person which may do business with the Borrower, all as if the Agent were not the Agent hereunder and without any duty to account therefor to the Lenders. Section 8.04 Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon the Agent or any other Lender and based upon such documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement. Each Lender also acknowledges that it will, independently and without reliance upon the Agent or any other Lender and based upon such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement. Section 8.05 Indemnification. The Lenders agree to indemnify the Agent (to the extent not reimbursed by the Borrower) ratably according to their respective Percentage Interests from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind or nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of this Agreement or any other Loan Document or any action taken or omitted by the Agent under this Agreement or any other Loan Document, except any such as result from the Agent's gross negligence or willful misconduct. Without limiting the foregoing, each Lender agrees to reimburse the Agent promptly on demand in proportion to its Percentage Interest for any out-of-pocket expenses, including legal fees, incurred by the Agent in connection with the administration or enforcement of or the preservation of any rights under this Agreement or any other Loan Document (to the extent that the Agent is not reimbursed for such expenses by the Borrower). Section 8.06 Successor Agent. The Agent may give written notice of resignation at any time to the Lenders and the Borrower and may be removed at any time with cause by the Majority Lenders. Upon any such resignation or removal, the Majority Lenders shall have the right to appoint a successor Agent. If no successor Agent shall have been so appointed by the Majority 39 Lenders and shall have accepted such appointment within thirty (30) days after the Agent's giving of notice of resignation or the Majority Lenders' removal of the Agent, then the Agent may on behalf of the Lenders, appoint a successor Agent, which shall be a bank organized under the laws of the United States or of any state thereof, or any affiliate of such bank, and having a combined capital and surplus of at least Five Hundred Million Dollars ($500,000,000). Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the retiring Agent, and the retiring Agent shall be discharged from its duties and obligations under this Agreement. Until the acceptance by such a successor Agent, the retiring Agent shall continue as "Agent" hereunder. Notwithstanding any retiring Agent's resignation or removal hereunder as Agent, the provisions of this Article VIII shall inure to its benefit as to any actions taken or omitted to be taken by it while it was Agent under this Agreement. Any company into which the Agent may be merged or converted or with which it may be consolidated or any company resulting from any merger, conversion or consolidation to which it shall be a party or any company to which the Agent may sell or transfer all or substantially all of its agency relationships shall be the successor to the Agent without the execution or filing of any paper or further act, anything herein to the contrary notwithstanding. ARTICLE IX MISCELLANEOUS ------------- Section 9.01 No Waiver; Remedies Cumulative. No failure by the Agent or any Lender to exercise, and no delay in exercising, any right, power or remedy under this Agreement or any other Loan Document shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or remedy under this Agreement or any other Loan Document preclude any other or further exercise thereof or the exercise of any other right, power, or remedy. The exercise of any right, power, or remedy shall in no event constitute a cure or waiver of any Event of Default under this Agreement or any other Loan Document nor prejudice the rights of the Agent or any Lender in the exercise of any right hereunder or thereunder. The rights and remedies provided herein and therein are cumulative and not exclusive of any right or remedy provided by law. Section 9.02 Governing Law. This Agreement and the other Loan Documents shall be governed by and construed in accordance with the laws of the State of Washington, U.S.A. 40 Section 9.03 Mandatory Arbitration. Any controversy or claim between or among the parties, including those arising out of or relating to this Agreement or Loan Documents and any claim based on or arising from an alleged tort, shall at the request of any party be determined by arbitration. The arbitration shall be conducted in accordance with the United States Arbitration Act (Title 9, U.S. Code), notwithstanding any choice of law provision in this Agreement, and under the Commercial Rules of the AAA. The arbitrator(s) shall give effect to statutes of limitation in determining any claim. Any controversy concerning whether an issue is arbitrable shall be determined by the arbitrator(s). Judgment upon the arbitration award may be entered in any court having jurisdiction. No provision of this Section 9.03 shall limit the right of any party to this Agreement to exercise self-help remedies such as setoff, foreclosure against or sale of any collateral or security, or to obtain provisional or ancillary remedies from a court of competent jurisdiction before, after, or during the pendency of any arbitration or other proceeding. The exercise of any such remedy does not waive the right of either party to resort to arbitration. Section 9.04 Notices. All notices and other communications provided for in this Agreement shall be in writing or (unless otherwise specified) by telex, facsimile transmission, telegram or cable and shall be mailed (with first class postage prepaid) or sent or delivered to each party at the address set forth under its name on the signature pages hereof, or at such other address as shall be designated by such party in a written notice to each other party. Except as otherwise specified all notices sent by mail, if duly given, shall be effective three (3) Business Days after deposit into the mails, all notices sent by a nationally recognized overnight courier service, if duly given, shall be effective one (1) Business Day after delivery to such courier service, and all other notices and communications if duly given or made shall be effective upon receipt. Section 9.05 Assignment and Participations. This Agreement shall be binding upon and inure to the benefit of the parties and their respective Successors and assigns, provided that the Borrower may not assign or otherwise transfer all or any part of its rights or obligations hereunder or under any other Loan Document without the prior written consent of the Agent and all the Lenders, and any such assignment or transfer purported to be made without such consent shall be ineffective. Any Lender may at any time sell participation interests in its Loans and Commitment to another bank or financial institution. Such sales may be made without the consent of the Agent, the Borrower or any other Lender provided, however, (a) that the selling Lender shall have provided the Borrower and the Agent with prior written notice of the proposed sale of any participation interest in any Loan or in such Lender's Commitment; and (b) that the selling 41 Lender retains the right to vote as a Lender hereunder in respect of the interest sold without being bound to obtain the consent of its participant or to exercise its rights in accordance with instructions received from its participant (except that the participant's consent can be required for proposed changes to the timing or amount of principal payments or changes to the timing, rate or amount of payments of interest or fees). Any Lender may pledge or assign all or any part of its interest under the Loan Documents for security purposes to any Federal Reserve Bank. Any Lender may assign or otherwise transfer all or any part of its interest under the Loan Documents to another bank or financial institution with the prior written consent of the Borrower and Agent which consent will not be unreasonably withheld or delayed provided, that any assignment by a Lender which assigns less than all of its Commitment shall assign at least Five Million Dollars ($5,000,000) of its Commitment and provided further that in the case of an assignment or transfer by any Lender to any affiliate of such Lender, the Borrower's consent shall not be required and the Agent's consent shall be required only as to the form of the documents under which such assignment or transfer is made). The assignee of any permitted sale or assignment (including assignments for security and sales of participations) shall have the same rights and benefits against the Borrower and otherwise under the Loan Documents (excepting however, in the case of sales of participations, the right to grant or withhold consents or otherwise vote in respect thereof) including the right of setoff, and in the case of any outright assignment (as distinguished from an assignment for security or the sale of a participation) the same obligations in respect thereof, as if such assignee were an original Lender. Except to the extent otherwise required by the context of this Agreement, the word "Lender" where used in this Agreement shall mean and include any holder of a Note originally issued to a Lender hereunder, and each such holder shall be bound by and have the benefits of this Agreement the same as if such holder had been a signatory hereto. Any outright assignment of a Lender's interest hereunder to another Lender made in conformance with the terms of this Section 9.05 shall result in a corresponding adjustment to the selling and purchasing Lenders' Commitments and Percentage Interests. Section 9.06 Borrower's Indemnity. Whether or not the transactions contemplated hereby shall be consummated, the Borrower shall pay, indemnify and hold each Lender, the Agent and each of their respective officers, directors, employees, counsel, agents and attorneys-in-fact (each, an "Indemnified Person") harmless from and against any and all liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, charges, expenses or disbursements (including reasonable attorney's fees, which may include the allocated charges of internal legal counsel) of any kind or nature whatsoever which may at any time (including at any time following repayment of the 42 Loans and the termination, resignation or replacement of the Agent or replacement of any Lender) be imposed on, incurred by or asserted against any such Indemnified Person in any way relating to or arising out of this Agreement or any other Loan Document, or the transactions contemplated hereby or thereby, or the use of any Loan proceeds, or any action taken or omitted by any such Indemnified Person under or in connection with any of the foregoing (all of the foregoing, collectively the "Indemnified Liabilities"); provided, that the Borrower shall have no obligation hereunder to any Indemnified Person with respect to Indemnified Liabilities arising from the negligence or willful misconduct of such Indemnified Person. All amounts owing under this Section 9.06 shall be paid promptly upon demand. At the election of any Indemnified Person, the Borrower shall defend such Indemnified Person in respect of any Indemnified Liabilities using legal counsel reasonably satisfactory to such Indemnified Person at the sole cost and expense of the Borrower. Section 9.07 Severability. Any provision of this Agreement or any other Loan Document which is prohibited or unenforceable in any jurisdiction shall as to such jurisdiction be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof or affecting the validity or enforceability of such provision in any other jurisdiction. To the extent permitted by applicable law, the parties waive any provision of law which renders any provision hereof prohibited or unenforceable in any respect. Section 9.08 Survival. The representations, warranties and indemnities of the Borrower in favor of the Agent and the Lenders and the representations, warranties and indemnities of the Lenders in favor of the Agent shall survive indefinitely and, without limiting the foregoing, shall survive the execution and delivery of this Agreement and the other Loan Documents, the making of any Loan, the expiration of the Total Commitment and the repayment of all Loans and other amounts due hereunder. Section 9.09 Conditions Not Fulfilled. If the Commitments are not borrowed owing to nonfulfillment of any condition precedent specified in Article III, no party hereto shall be responsible to any other party for any damage or loss by reason thereof, except that the Borrower shall in any event be liable to pay the fees, Taxes, and expenses for which it is obligated hereunder. If for any other reason the Commitment of any Lender is not borrowed neither the Agent nor any other Lender shall be responsible to the Borrower for any damage or loss by reason thereof, nor shall any other Lender or the Borrower be excused from its performance hereunder. Section 9.10 Entire Agreement; Amendment. This Agreement, together with the Exhibits and Schedules hereto and the letter 43 agreement referred to in Section 2.11(c) hereof, comprise the entire agreement of the parties and may not be amended or modified except by written agreement of the Borrower and the Agent executed in conformance with the terms of Section 8.01 hereof. No provision of this Agreement may be waived except in writing and then only in the specific instance and for the specific purpose for which given. Section 9.11 WAIVER OF JURY TRIAL. THE PARTIES HERETO WAIVE ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING TO ENFORCE OR DEFEND ANY RIGHTS UNDER OR RELATING TO THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, OR ANY AMENDMENT, INSTRUMENT, DOCUMENT OR AGREEMENT DELIVERED OR WHICH MAY IN THE FUTURE BE DELIVERED IN CONNECTION HEREWITH OR THEREWITH OR ARISING FROM ANY RELATIONSHIP EXISTING IN CONNECTION WITH THIS AGREEMENT OR ANY OTHER LOAN DOCUMENT, AND AGREE THAT (A) ANY SUCH ACTION OR PROCEEDING SHALL NOT BE TRIED BEFORE A JURY AND (B) ANY PARTY HERETO MAY FILE AN ORIGINAL COUNTERPART OR COPY OF THIS AGREEMENT WITH ANY COURT AS WRITTEN EVIDENCE OF THE CONSENT OF THE PARTIES HERETO TO THE WAIVER OF THEIR RESPECTIVE RIGHTS TO A TRIAL BY JURY. NOTHING IN THIS SECTION 9.11 IS INTENDED TO LIMIT THE TERMS OF SECTION 9.03. Section 9.12 Headings. The headings of the various provisions of this Agreement are for convenience of reference only, do not constitute a part hereof, and shall not affect the meaning or construction of any provision hereof. Section 9.13 Counterparts. This Agreement may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed shall be deemed to be an original, and all of which taken together shall constitute one and the same Agreement. ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW. 44 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed by their respective officers or agents thereunto duly authorized as of the date first above written. BORROWER: HOLLYWOOD ENTERTAINMENT CORPORATION By DONALD J. EKMAN -------------------------------------- Its Senior Vice President ------------------------------------- Address: 25600 S.W. Pkwy. Ctr. Dr. Wilsonville, OR 97070 Attn: Donald J. Ekman Telefax: (503) 677-1680 AGENT: BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION d/b/a "SEAFIRST BANK" By DORA A. BROWN -------------------------------------- Its A.V.P. ------------------------------------- By RONALD R. PARSONS -------------------------------------- Its Vice President ------------------------------------- Address: 701 Fifth Avenue Floor 16 Seattle, WA 98104 Attn: Dora A. Brown Telefax: (206) 358-0971 45 LENDERS: BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION By GORDON H. GRAY -------------------------------------- Its VP ------------------------------------- By ROBERT COUNTRYMAN -------------------------------------- Its Vice President ------------------------------------- Address: 701 Fifth Avenue Floor 12 Seattle, WA 98104 Attn: Gordon H. Gray Telefax: (206) 358-3113 AND TO 121 S.W. Morrison Suite 1700 Portland, OR 97204 Attn: Robert Countryman Telefax: 503) 275-1391 UNITED STATES NATIONAL BANK OF OREGON By DEREK RIDGLEY -------------------------------------- Its Vice President ------------------------------------- Address: 555 S.W. Oak Street Suite 400 Portland, OR 97204 Attn: Derek W. Ridgley Telefax: (503) 275-5428 46 UNION BANK OF CALIFORNIA, N.A. By ALISON AMONETTE -------------------------------------- Its Vice President ------------------------------------- Address: 400 California Street Floor 17 San Francisco, CA 94104 Attn: Alison Amonette Telefax: (415) 765-3146 KEY BANK OF WASHINGTON By KEVIN MCBRIDE -------------------------------------- Its Vice President ------------------------------------- Address: 700 Fifth Avenue Floor 48 Seattle, WA 98109 Attn: Kevin McBride Telefax: (206) 684-6035 BANQUE NATIONALE DE PARIS By KATHERINE WOLFE -------------------------------------- Its Vice President ------------------------------------- By DEBRA H. WRIGHT -------------------------------------- Its Vice President ------------------------------------- Address: 180 Montgomery Street San Francisco, CA 94104 Attn: Katherine Wolfe Telefax: (415) 296-8954 47 SOCIETE GENERALE By J. BLAINE SHAUM -------------------------------------- Its Regional Manager ------------------------------------- Address: One Montgomery Street Suite 3220 San Francisco, CA 94104 Attn: Alec Neville Telefax: (415) 989-9922 THE SUMITOMO BANK, LIMITED By J. WILLIAM BLOORE -------------------------------------- Its Vice President ------------------------------------- By CAROLE A. DALEY -------------------------------------- Its Vice President ------------------------------------- Address: Pine Street Center 100 Pine St., Ste. 3300 San Francisco, CA 94111 Attn: J. William Bloore Telefax: (415) 394-9797 48 SCHEDULE 1 CALCULATION OF MARGINS ---------------------- The "Margin" shall be adjusted as of the first day of the first full calendar month occurring after each date on which the Borrower provides the quarterly compliance certificates required under Section 5.10(c) of the Agreement and shall be computed in accordance with the following chart: Pricing Margin for use Margin for use Levels in IBOR Rate in Adjusted Base Rate - ------ ------------ --------------------- I 1.250% 0.250% II 1.500% 0.500% III 1.750% 0.750% Rates expressed in the foregoing chart are set forth on a per annum basis. From the date of the Agreement through the first day of the first full calendar month occurring after the date on which the Borrower provides the quarterly compliance certificates required under Section 5.10(c) of the Agreement in respect of the fiscal quarter ending March 31, 1997, Pricing Level I shall apply. At all times thereafter, the appropriate pricing level shall be determined in accordance with the following chart where the pricing level for each period is established based upon the ratio of Funded Debt to Cash Flow determined as of the last day of the immediately preceding fiscal quarter: Ratio of Funded Debt to Cash Flow as of End of Preceding Fiscal Quarter ("FDCFR") Pricing Level - ------------------------------------- ------------- FDCFR less than 1.75 I FDCFR greater than or equal to 1.75 but less than 2.25 II FDCFR greater than or equal to 2.25 III 49 SCHEDULE 2 PREPAYMENT FEES --------------- The amount of the fee to be paid pursuant to Section 2.08 of the Revolving Credit Agreement shall depend on the following: (1) The amount by which interest rates have changed between the Reference Date and the Prepayment Date. As used herein, "Reference Date" shall mean the date the IBOR Rate first became applicable. As used herein, "Prepayment Date" shall mean the date the Borrower, either voluntarily or involuntarily prepays any Loan or portion thereof accruing interest at the IBOR Rate. Certain U.S. Treasury rates are used as a benchmark to measure changes in interest rate levels. (a) A "reference rate" equal to the average interest rate yield at Reference Date for U.S. Government Securities having maturities of approximately ninety (90) days will be determined in the manner described below for determining applicable rates but will be established as of the Reference Date for the Applicable Interest Period. This rate represents interest rate levels at the time an IBOR Rate is selected. (b) An "applicable rate," determined as described below, represents interest rate levels as of the Prepayment Date. (2) The amount of principal paid. (3) A payment fee factor (see "payment fee factor schedule" below). The factor represents the economic loss to the Agent and Lenders resulting from a one dollar payment if rates were to drop by one percent from the time the rate was fixed. CALCULATION OF PAYMENT FEE -------------------------- If the reference rate is lower than or equal to the applicable rate, there is no payment fee. If the applicable rate is lower than the reference rate, the payment fee shall be equal to the difference between the reference rate and the applicable rate (expressed as a decimal), multiplied by the appropriate factor from the payment fee factor schedule, multiplied by the principal amount of the Loan which is prepaid. 1 Example: -------- A Loan accruing interest at an IBOR Rate with principal of $2,000,000 is fully prepaid with 2 months remaining prior to the expiration of the Applicable Interest Period. A reference rate of 7% was assigned to the Loan when the rate was fixed. The applicable rate (as determined by current 2-month U.S. Treasury rates) is 6.5%. Rates are therefore judged to have dropped by .5% since the rate was fixed, and a payment fee applies. A payment fee factor of .20 is determined from the table below, and the payment fee is computed as follows: Payment Fee = (.07 -.065) x (.20) x ($2,000,000) = $2,000 APPLICABLE RATES ---------------- The applicable rate is equal to the average interest rate yield at the time of payment or refinancing for U.S. Government Securities having maturities equivalent to the remaining portion of the Applicable Interest Period. The applicable rate shall be determined from the Federal Reserve Statistical Release (Publication H.15(519)) in the "This Week" (most recent week) column under the heading U.S. Government Securities - Treasury Bills - Secondary Market, interpolated to the nearest month. Rates listed in the Federal Reserve Statistical Release for maturities of less than one year are on a discount rate basis, and these rates shall be converted to a coupon equivalent basis, based upon a 360-day year. The Statistical Release published on Monday shall be used for calculation of payment fees payable on the following Tuesday through the following Monday, with appropriate adjustment if the day of publication changes. 2 PAYMENT FEE FACTOR SCHEDULES ---------------------------- Months Remaining in the Applicable Interest Period -------------------------- 0 1 2 3 6 --- --- --- --- --- Factors 0 .10 .20 .31 .61 If the remaining Applicable Interest Period or time prior to the scheduled maturity of the Loan is between any two time periods in the above table, interpolate between the corresponding factors to the closest month. The Agent and Lenders are not required to actually reinvest the paid principal in any U.S. Government Treasury obligations as a condition to receiving a payment fee as calculated above. 3 SCHEDULE 3 PARTICIPATION FEES ------------------ Bank of America National Trust & Savings Association $160,000 United States National Bank of Oregon $ 75,000 Union Bank of California, N.A. $ 40,000 Key Bank of Washington $ 60,000 Banque Nationale de Paris $ 30,000 Societe Generale $ 30,000 The Sumitomo Bank, Limited $ 30,000 --------- TOTAL PARTICIPATION FEE $425,000 1 EXHIBIT A REVOLVING LOAN NOTE $______________ February 7, 1997 Seattle, Washington FOR VALUE RECEIVED, the undersigned, HOLLYWOOD ENTERTAINMENT CORPORATION (d/b/a "Hollywood Video"), an Oregon corporation (the "Borrower"), hereby promises to pay to the order of ____________ ____________, a __________________________ (the "Lender") on the Maturity Date the unpaid principal balance of all Loans made by the Lender under this Note, in a maximum amount not to exceed ___________ Million Dollars ($__________), together with interest thereon from the date hereof until maturity at a per annum rate equal to the Interest Rate as defined below (changing as the Interest Rate changes), and, if default shall occur in the payment when due (whether by acceleration or otherwise) of any principal amount hereunder, from the maturity of that amount until it is paid in full at a per annum rate equal to the Base Rate (changing as the Base Rate changes), plus two percent (2%). Notwithstanding anything herein to the contrary, interest shall not accrue at a rate in excess of the maximum rate permitted by applicable law. The Borrower further agrees as follows: 1. All payments of principal and interest on this Note shall be made in immediately available funds to Bank of America National Trust and Savings Association, as the Agent for the Lender, at the Agent's Commercial Loan Service Center, Fifth Avenue Plaza Building, 13th Floor, 800 Fifth Avenue, Seattle, Washington 98104, or such other address as the Agent shall from time to time designate. 2. As used herein "Interest Rate" shall mean the Adjusted Base Rate unless the Borrower shall elect to have some or all of the loans made hereunder accrue interest at an IBOR Rate as provided in Section 2.06(b) of the Credit Agreement (as defined below). Accrued but unpaid interest on each Loan accruing interest at an IBOR Rate shall be paid on the last day of each Applicable Interest Period, on the date of any principal payment (to the extent accrued on the principal amount paid), at the Maturity Date and, additionally, in the case of such a Loan for which the Applicable Interest Period is six months, on the day that is three months after the commencement of such Applicable Interest Period. Accrued but unpaid interest on each Base Rate Loan shall be paid on the last Business Day of each calendar quarter commencing on March 31, 1997 and continuing on the last Business Day of each calendar quarter thereafter and on the date of any principal payment (to the extent accrued on the principal amount paid) and at the Maturity Date. Unpaid interest accruing on amounts in default shall be payable on demand. 3. This Note is issued under and is subject to the terms of an Amended and Restated Revolving Credit Agreement dated as of the date hereof, among Bank of America National Trust and Savings Association, as "Agent", the Lender and certain other banks as "Lenders" and the undersigned as "Borrower" (as amended from time to time, the "Restated Credit Agreement"). Capitalized terms not defined herein have the meanings set forth in the Restated Credit Agreement. 4. It is expressly provided that if any of the Events of Default defined in Sections 7.01(h) or (i) of the Restated Credit Agreement shall occur, the entire unpaid balance of the principal and interest hereunder shall be immediately due and payable in accordance with the terms of the Restated Credit Agreement. It is also expressly provided that upon the occurrence of any other Event of Default, the entire remaining unpaid balance of the principal and interest may be declared by the Agent to be immediately due and payable in accordance with the terms of the Restated Credit Agreement. 5. The Borrower may repay Base Rate Loans at any time without penalty or premium. Prepayment of any Loan bearing interest at an IBOR Rate, whether voluntary, mandatory, or as the result of the Agent's or Lender's collection efforts, shall be subject to the payment of fees as described in Section 2.08 of the Restated Credit Agreement. 6. The unpaid principal balance of the Loans made hereunder shall be the total amount advanced hereunder, less the amount of the principal payments made hereon. This Note is given to avoid the execution of an individual note for each Loan by the Lender to the Borrower. This Note evidences a revolving credit and, within the limits and on the conditions set forth in the Restated Credit Agreement, prior to the Maturity Date the Borrower may borrow, repay and reborrow hereunder. The Lender is hereby authorized to record the date and amount of each Loan it makes hereunder and the date and amount of each payment of principal and interest thereon on a schedule annexed hereto and constituting a part of this Note or maintained in connection herewith. Any such recordation by the Lender shall constitute prima facie evidence of the accuracy of the information so recorded; provided, however, that the failure to make any such recordation or any error in any such recordation shall not affect the obligations of the Borrower hereunder. 2 7. Each maker, surety, guarantor and endorser of this Note expressly waives all notices, demands for payment, presentations for payment, notices of intention to accelerate the maturity, protest and notice of protest. 8. In the event this Note is placed in the hands of an attorney for collection, or suit is brought on the same, or the same is collected through bankruptcy or other judicial proceedings, the Borrower agrees and promises to pay reasonable attorneys' fees and collection costs, including all out-of-pocket expenses and the allocated costs and disbursements of internal counsel, incurred by the Lender or the Agent. 9. This Note has been executed and delivered in and shall be governed by and construed in accordance with the internal laws of the State of Washington. The Borrower hereby irrevocably submits to the nonexclusive jurisdiction of any state or federal court sitting in Seattle, King County, Washington, in any action or proceeding brought to enforce or otherwise arising out of or relating to this Note, and hereby waives any objection to venue in any such court and any claim that such forum is an inconvenient forum. HOLLYWOOD ENTERTAINMENT CORPORATION By ________________________________ Its ____________________________ 3 Schedule 1 to Hollywood Entertainment Corporation Revolving Loan Note - -------------------------------------------------------------------------------- Applicable Amount of Unpaid Amount of Interest Interest Principal Principal Notation Date Loan Option Period Paid Balance By - -------------------------------------------------------------------------------- 4 EXHIBIT B AMENDED AND RESTATED SECURITY AGREEMENT THIS AMENDED AND RESTATED SECURITY AGREEMENT (this Agreement") is made as of this 12th day of February, 1997, by HOLLYWOOD ENTERTAINMENT CORPORATION (d/b/a "Hollywood Video"), an Oregon corporation (the "Debtor"), in favor of BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION as agent for itself, United States National Bank of Oregon, Union Bank of California, N.A., Key Bank of Washington, Banque Nationale de Paris, Societe Generale, and The Sumitomo Bank, Limited (the "Secured Party"). RECITALS A. Debtor, Seattle-First National Bank, as agent, and Seattle-First National Bank, United States National Bank of Oregon and Bank of America Oregon, as lenders entered into that certain Revolving Credit Agreement dated as of December 22, 1995 providing for a total revolving credit facility in the amount of $75,000,000 (the "Revolving Credit Agreement"). B. In connection with the Revolving Credit Agreement, Debtor executed and delivered a Security Agreement in favor of Seattle-First National Bank, as agent, dated December 22, 1995 (the "Prior Security Agreement"), pursuant to which Debtor granted Seattle-First National Bank, as agent (for the benefit of itself and the other lenders under the Revolving Credit Agreement) a security interest in certain assets to secure its obligations owing to Seattle-First National Bank, as agent, and Seattle-First National Bank, United States National Bank of Oregon and Bank of America Oregon, as lenders. C. On January 8, 1996, the parties to the Revolving Credit Agreement entered into an Amendment Number One to Revolving Credit Agreement and Amendment to Loan Documents. D. Pursuant to the terms of the Revolving Credit Agreement as so amended, certain "Additional Lenders" were to be added and the amount of the credit facility was to be increased to $100,000,000. On July 18, 1996, the Borrower, Seattle-First National Bank, as agent, Seattle First National Bank, Bank of America Oregon, United States National Bank of Oregon, Union Bank of California, N.A. and Key Bank of Washington entered into an Amendment Number Two to Revolving Credit Agreement and Amendment to Loan Documents pursuant to which Union Bank of California and Key Bank of Washington were added as "Additional Lenders" and the total committed amount of the facility was increased to $100,000,000. The Revolving Credit Agreement as amended by Amendment Number One to Revolving Credit Agreement and Amendment Number Two to Revolving Credit Agreement is referred to herein as the "Prior Credit Agreement." E. Thereafter, both Seattle-First National Bank and Bank of America Oregon were merged into Bank of America National Trust & Savings Association. F. The Debtor and the Secured Party have entered into an Amended and Restated Revolving Credit Agreement dated as of the date hereof (the "Restated Credit Agreement") which amends and restates the Prior Credit Agreement. The agreements, documents, instruments and undertakings entered into in connection with the Restated Credit Agreement, together with the Restated Credit Agreement, as the same may be amended, renewed, modified or supplemented from time to time are referred to herein as the "Restated Loan Documents." G. Pursuant to the terms of the Restated Credit Agreement, the execution and delivery of this Agreement is a material condition precedent to the Lenders' and the Agent's obligations to make and disburse loans to the Debtor thereunder. This Agreement amends and restates (but does not release) the Prior Security Agreement. NOW, THEREFORE, in consideration of the foregoing the undersigned agrees as follows: 1. Defined Terms. Capitalized terms not otherwise defined herein shall have the meanings given in the Restated Credit Agreement. 2. Continuance of Prior Security Agreement. This Agreement is intended to amend and restate the Prior Security Agreement and to continue the security interests granted thereunder and continued thereby. 3. Grant of Security Interest. The Debtor hereby confirms its prior grant of a security interest and hereby grants to the Secured Party a security interest in all its now owned or hereafter acquired goods and other personal property, including all tangible and intangible items and including without limitation the following: (a) Equipment, Etc. All of the Debtor's right, title and interest in equipment, supplies, fittings, furnishings and other items of any kind ordered, obtained, or possessed by the Debtor or for its account, whether held by the Debtor, by sellers under any contracts for the purchase of equipment or by others, together with any product into which such equipment may be processed, manufactured or assembled and together with all substitutions for said equipment and all parts, instruments, 2 accessories, alterations, modifications, replacements, additions and accessions to said equipment. (b) Inventory, Etc. All of the Debtor's right, title and interest in inventory and stock in trade of the Debtor including without limitation, videotapes, videogames, raw materials, work in progress, materials used or consumed in the Debtor's business, finished goods, returned goods and goods traded in. (c) Accounts, Contract Rights, Etc. All of the Debtor's right, title and interest in (i) all accounts, (ii) all contract rights, (iii) all chattel paper, (iv) all documents, documents of title, drafts, checks, acceptances, bonds, letters of credit, notes or other negotiable and non-negotiable instruments, bills of exchange, deposits, certificates of deposit, insurance policies and any other writings evidencing a monetary obligation or security interest in or a lease of personal property, (v) all licenses, leases, contracts or agreements, (vi) all general intangibles, including without limitation all judgments, choses in action, patents, trademarks, trade names, service marks, licenses, copyrights and the like whether registered or not, and whether or not used or to be used by the Debtor, including, with respect to all of said property, without limitation, all rights corresponding thereunder throughout the world, all renewals thereof, all license royalties with respect thereto, all claims for damages, profits and proceeds by reason of past, present and future infringements, and all rights to sue therefor, and (vii) all guarantees and other personal property securing the payment or performance of any of the foregoing. (d) Deposits and Documents. All of the Debtor's right, title, and interest in and to books, correspondence, credit files, records, invoices, and other documents, including without limitation all tapes, disks, cards, computer runs and other papers or documents in the possession or control of the Debtor; and all balances, credits, deposits, accounts or monies of or in the name of the Debtor in the possession or control of, or in transit to, the Secured Party or any Lender. (e) Fixtures. All of the Debtor's right, title, and interest in and to all fixtures affixed to or to become affixed to any real property owned, leased or operated by the Debtor or otherwise used in connection with the business or operations of the Debtor. (f) Investment Property. All of the Debtor's right, title and interest in investment property, including without limitation, all stocks, bonds, debentures, notes, bills, certificates, options, rights, shares, or other securities now or 3 hereafter owned or acquired, all dividends or distributions in respect thereof and all brokerage or commodities accounts. (g) Proceeds and Products. All proceeds (including rents, royalties, and insurance proceeds) and products of any of the Debtor's now owned or hereafter acquired goods and other personal property including without limitation the items of property described in paragraphs (a) through (f) above. The items of property described in this paragraph 2 are hereinafter referred to collectively as the "Collateral." 4. Transfer of Instruments, Etc. The Debtor agrees to transfer to the Secured Party on the date hereof all instruments (including without limitation all securities) and chattel paper now owned and to transfer to the Secured Party promptly upon receipt thereof, all instruments (including without limitation all securities) and chattel paper hereafter acquired. Without limiting the foregoing, if the Debtor shall become entitled to receive or shall receive, in connection with any of its securities, any: (i) stock certificate, including without limitation any certificate representing a stock dividend or in connection with any increase or reduction of capital, reclassification, merger, consolidation, sale of assets, combination of shares, stock split, spin-off, split-off or split-up; (ii) option, warrant, or right, whether as an addition to or in substitution or in exchange for any of its securities, or otherwise; (iii) dividend or distribution payable in property, including securities issued by other than the issuer of any of its securities; or (iv) dividends or distributions of any sort; then the Debtor shall accept the same as the Secured Party's agent, in trust for the Secured Party, and shall deliver them forthwith to the Secured Party in the exact form received, with, as applicable, the Debtor's endorsement when necessary, or appropriate stock powers duly executed in blank, to be held by the Secured Party, subject to the terms hereof, as part of the Collateral. This Security Agreement does not grant the Secured Party power to control the voting or disposition of the securities prior to default. 5. Obligations Secured. The security interest in the Collateral is given to secure the full and timely performance by the Debtor of all indebtedness, liabilities and obligations of the Debtor owing to the Secured Party or any Lender arising under or in any way in connection with the Restated Credit Agreement, the other Restated Loan Documents or any of the transactions contemplated thereby now existing or hereafter incurred (all of the foregoing are referred to collectively as the "Obligations"). 6. Ownership and Liens. The Debtor represents and warrants to the Secured Party that (a) the Debtor owns the 4 Collateral and is not prohibited by contract or otherwise from subjecting the same to the security interest created hereby; and (b) to the best of Debtor's knowledge, there are no material offsets or counterclaims or defenses to payment which may be asserted against the Debtor by the Debtor's account debtors or payment obligors in respect of the Collateral. Except as expressly permitted by the Restated Credit Agreement, the Debtor will not create or suffer to exist any Lien on the Collateral other than Liens created hereunder. The Debtor will not sell, transfer, lease or otherwise dispose of any item of Collateral except in the ordinary course of business. The Debtor will fully and punctually perform any duty required of it in connection with the Collateral and will not take any action which will impair, damage or destroy the Secured Party's rights with respect to the Collateral or hereunder or the value thereof. 7. Appointment of Agent. So long as any Obligation remains unpaid or the Lenders have any Commitments under the Restated Credit Agreement, the Debtor does hereby designate and appoint Secured Party its true and lawful attorney with power irrevocable, for it and in its name, place and stead, after an Event of Default has occurred and is continuing, to ask, demand, receive, receipt and give acquittance for any and all amounts which may be or become due or payable to the Debtor with respect to the Collateral, and in Secured Party's sole discretion to file any claim or take any action or proceeding, or either, in its own name or in the name of the Debtor, or otherwise, which the Secured Party deems necessary or desirable in order to collect or enforce payment of any and all amounts which may become due or owing with respect to the Collateral. The acceptance of this appointment by the Secured Party shall not obligate it to perform any duty, covenant or obligation required to be performed by the Debtor under or by virtue of the Collateral or to take any action in connection therewith. The Secured Party may also execute, on behalf of the Debtor, any financing statements or other instruments which in its opinion may be necessary or desirable to perfect or protect its position with respect to the Collateral. Without limiting the generality of the foregoing, the Secured Party is authorized at any time to exercise any right of the Debtor, or enforce any obligation owed to the Debtor pursuant to the terms of any agreements to which the Debtor is a party or in which it has any beneficial interest. The Secured Party may, in its sole discretion, perform any obligation of the Debtor under any of the Debtor's contracts or in respect of any of the Debtor's accounts, and any expenses incurred in such performance shall bear interest from the date incurred until repaid by the Debtor at a per annum rate equal to the interest rate applicable under the Restated Credit Agreement for amounts in default (the "Default Rate"). Any such amounts shall be secured hereby and shall be repaid by the Debtor on demand. 5 8. Taxes. The Debtor will pay before delinquency any Taxes which are or may become through assessment or distraint or otherwise a lien or charge on the Collateral and will pay any Tax which may be levied on any Obligation secured hereby, except any Tax whose validity or amount is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof and with provision having been made to the satisfaction of the Agent for the payment thereof in the event the contest is determined adversely to the Debtor. 9. Debtor's Place of Business; Location of Records and Collateral. The Debtor represents that the address set forth below its signature to this Agreement is and will remain its principal place of business and the location of its chief executive offices and the address at which it will keep its records concerning the Collateral. The Debtor represents that it has not done business under any name other than those assumed names disclosed on Schedule 1 attached hereto. From time to time, promptly upon request, the Debtor will advise the Secured Party of each location where any tangible Collateral is located. The Debtor will not move the location of its chief executive offices, and will not do business under any assumed name not disclosed on Schedule 1 hereto unless the Debtor shall have given prior written notice of such a move to the Secured Party and unless the Secured Party's security interest therein continues at all times to be perfected as a lien of first priority (subject only to purchase money Liens and statutory liens imposed by law (such as mechanics' liens) incurred in good faith in the ordinary course of business which are not delinquent or which remain payable without penalty or the validity or amount of which is being contested in good faith by appropriate proceedings upon stay of execution of the enforcement thereof with, in the case of liens on property of the Borrower, provision having been made to the satisfaction of the Agent for the payment thereof in the event the contest is determined adversely to the Borrower) enforceable against all third parties in all jurisdictions as security for full and timely performance of the Obligations. 10. Books and Records; Inspection. The Debtor agrees to maintain full and accurate books of account prepared and maintained in accordance with GAAP, to the extent applicable, covering the Collateral and to deliver, upon request, to Secured Party such of the books and records as relate to the Collateral including, without limitation, all of the invoices, shipping documents, contracts, orders, order acknowledgments, correspondence and other instruments, electronically stored materials and papers in the Debtor's possession relating to the Collateral. Secured Party (and any Lender) shall at all reasonable times have free access to the Debtor's ledgers, books of account and other written or electronic records evidencing or relating to the Collateral and the right to make and retain 6 copies or memorandum of same, and shall after the occurrence and during the continuation of an Event of Default have the right to be present at the Debtor's place of business to receive all communications and remittances relating to the Collateral. 11. Collections of Accounts. Until contrary notice is given by the Secured Party, the Debtor is specifically authorized to enforce and collect the Collateral described in Section 3(c) above in such manner as shall be commercially reasonable, to accept the return of goods and to reclaim, withhold or repossess goods as an unpaid seller. Until receipt of such notice, the Debtor agrees to collect the payments upon or from said Collateral, at the Debtor's expense, with due diligence. Upon notification by the Secured Party to the Debtor after the occurrence and during the continuation of an Event of Default to cease collecting upon said Collateral, the Secured Party will proceed to collect said Collateral in a commercially reasonable manner and may deduct from the proceeds its reasonable expenses of collection. Secured Party is authorized to receive in full satisfaction of any obligor's obligation to the Debtor a commercially reasonable sum less than the face amount thereof. The Debtor agrees that if any sums are received by it in respect to the Collateral after such notification by the Secured Party, such sums shall be received in trust by the Debtor and immediately shall be paid over by the Debtor to the Secured Party. The Debtor agrees to hold the Secured Party harmless from any claim, loss or damage caused by any failure to collect any obligation or to enforce any contract or by any act or omission on the part of the Secured Party, its agents and employees, relating to the Collateral except for Secured Party's willful misconduct or gross negligence. The covenant set forth in the preceding sentence shall survive the termination of this Agreement. 12. Maintenance of Collateral; Insurance. The Debtor will keep the tangible Collateral in good repair and the Secured Party may inspect the Collateral at reasonable times and intervals and may for this purpose enter any premises upon which the Collateral is located, including, but not limited to, the Debtor's facilities. The Debtor will continuously maintain, or cause to be continuously maintained, insurance on all tangible Collateral by an insurer approved by the Secured Party against such risks, in such amounts, and with such terms as are required of the insurance to be maintained by the Debtor under the Restated Credit Agreement. 13. Compliance With Laws. The Debtor will ensure that its use of the Collateral will comply in all material respects with all applicable laws, ordinances, and regulations of Governmental Authorities. 7 14. Waivers. This Agreement shall not be qualified or supplemented by course of dealing. No waiver or modification by Secured Party of any of the terms and conditions hereof shall be effective unless in writing signed by the Secured Party. No waiver or indulgence by the Secured Party as to any required performance by the Debtor shall constitute a waiver as to any required performance or other obligations of the Debtor hereunder. 15. Release of Collateral, Etc. The obligations of the Debtor shall not be affected by the release or substitution of any collateral or by the release of or any renewal or extensions of time to any party to any instrument, obligation or liability secured hereby or to which the Debtor is a party. The Secured Party shall not be bound to resort to or exhaust its recourse or to take any action against other parties or other collateral. The Debtor hereby waives presentment, demand, protest, notice of protest and notice of non-acceptance or non-payment with respect to any indebtedness, obligation or liability secured hereby. 16. Further Assurances. The Debtor, at its sole cost and expense, will at any time and from time to time hereafter (a) execute such financing statements and other instruments and perform such other acts as may be necessary or as Secured Party may reasonably request to establish and maintain the security interests herein granted by the Debtor to the Secured Party and the priority and continued perfection thereof; (b) obtain and promptly furnish to Secured Party evidence of all such Government Approvals as may be required to enable the Debtor to comply with its obligations under this Security Agreement; and (c) execute and deliver all such other instruments and perform all such other acts as Secured Party may reasonably request to carry out the transactions contemplated by this Security Agreement. 17. Expenses Incurred by Secured Party. The Secured Party is not required to, but may, at its option, pay any Tax, insurance premium, filing or recording fees, or other charges payable by the Debtor hereunder and any such amount shall bear interest from the date of payment until repaid at the Default Rate. Such amounts shall be repayable by the Debtor on demand and the Debtor's obligation to make such repayment shall constitute an additional Obligation secured hereby. 18. Assignment. Secured Party may transfer as collateral security the whole or any part of the Collateral to any successor Agent under the Restated Credit Agreement and all obligations, rights, powers and privileges herein provided shall inure to the benefit of the assignee to the extent of such assignment. 19. General Remedies. If an Event of Default shall occur, Secured Party shall have all remedies provided by law and, 8 without limiting the generality of the foregoing or the remedies provided in any other paragraph hereof, shall have the following remedies: (a) The remedies of a secured party under the Uniform Commercial Code; and (b) The right to make notification and pursue collection or, at Secured Party's option, to sell all or part of the Collateral and make application of all proceeds or sums due on the Collateral in accordance with the Restated Credit Agreement; and (c) The right to enter any premises where any of the Collateral is situated and take possession of such Collateral without notice or demand and without legal proceedings; and (d) The right to exercise and enforce all of the Debtor's rights under any contracts or any other agreement to which the Debtor is a party or of which the Debtor is a beneficiary; and (e) All other remedies which may be available in law or equity. At the request of Secured Party, the Debtor will assemble the tangible Collateral and make it available to Secured Party at a place designated by the Secured Party. To the extent that notice of sale shall be required by law to be given, the Debtor agrees that a period of ten (10) days from the time the notice is sent shall be a reasonable period of notification of a sale or other disposition of Collateral by the Secured Party, and that any notice or other communication from the Secured Party to the Debtor pursuant to this Agreement or required by any statute may be given to the Debtor as provided in the Restated Credit Agreement. The Debtor agrees to pay on demand the amount of all expenses incurred by the Secured Party in protecting and realizing on the Collateral and the Debtor further agrees that if this Agreement or any Obligation is referred to an attorney for protecting or defending the priority of the Secured Party's interest in the Collateral or for collecting or realizing thereon, the Debtor shall pay all of Secured Party's expenses, including without limitation, reasonable attorneys' fee and costs and expenses of title search and all court costs and costs of public officials and the Debtor further agrees that its obligation to pay such amounts shall bear interest from the date such expenditures are made by Secured Party until repaid at the Default Rate and shall be secured hereby. The Debtor agrees to pay any deficiency remaining after collection or realization by the Secured Party on the Collateral. 9 20. Securities Remedies. If an Event of Default shall occur and if the Secured Party shall elect to exercise its right to sell or otherwise dispose of all or any part of the Collateral constituting securities, the Debtor recognizes that the Secured Party may be unable or may deem it unadvisable to effect a public sale of all or a part of the securities and may be compelled to resort to one or more private sales to a restricted group of purchasers who will be obligated to agree, among other things, to acquire the securities for their own account, for investment and not with a view to the distribution or resale thereof. The Debtor acknowledges that any such private sales may be at prices and on terms less favorable to the Secured Party than those of public sales, and agrees that such private sales shall be deemed to have been made in a commercially reasonable manner and that the Secured Party shall have no obligation to delay sale of any securities to permit the issuer thereof to register such securities for public sale under the Securities Act. The Debtor will promptly deliver to the Secured Party all written notices, and will promptly give the Secured Party written notice of any other notices, received by it with respect to the securities. Following the occurrence of an Event of Default hereunder and upon request of Secured Party, the Debtor will deliver to Secured Party irrevocable proxies with respect to the securities in form satisfactory to the Secured Party. Until receipt thereof, this Agreement shall constitute the Debtor's proxy to the Secured Party or its nominee to vote all shares of the securities then registered in the Debtor's name following the occurrence of such an Event of Default. 21. Hold Harmless. The Debtor will indemnify and hold the Secured Party and the Lenders harmless from all liability, loss, damage or expense, including reasonable attorneys' fees and costs, that the Secured Party may incur resulting from, arising out of or relating to Secured Party's good faith efforts to comply with or enforce the terms of this Agreement or the Obligations. The covenants set forth in this Section 21 shall survive the termination of this Agreement. 22. Severability. In case any one or more of the provisions contained in this Agreement is invalid, illegal or unenforceable in any respect in any jurisdiction, the validity, legality and enforceability of such provision or provisions will not in any way be affected or impaired thereby in any other jurisdiction; and the validity, legality and enforceability of the remaining provisions contained herein will not in any way be affected or impaired thereby. 23. Governing Law and Venue. This Agreement shall be construed and enforced in accordance with the internal laws of the State of Washington except where the location of Collateral requires that the creation, validity, perfection, or enforcement 10 of the security interests provided for herein may be governed by the laws of the jurisdiction where such Collateral is located. The Debtor hereby irrevocably submits to the jurisdiction of any state or federal court sitting in Seattle, Washington, in any action or proceeding brought to enforce or otherwise arising out of or relating to this Agreement. 24. Successors. This Agreement inures to the benefit of the Secured Party and its successors and assigns, and shall bind the successors and assigns of the Debtor. The Debtor may not assign its rights and obligations hereunder without the prior written consent of the Secured Party. 25. Release of Security Interests. Upon the termination of each Lender's Commitment, payment in full of each Loan and the Notes and performance of all other obligations of the Borrower under this Agreement and the other Restated Loan Documents, then the Secured Party shall, upon the written request of the Debtor and at the sole cost and expense of the Debtor, execute and deliver to the Debtor change statements terminating all Financing Statements filed hereunder and shall deliver to the Debtor possession of all Collateral held by the Secured Party. As used herein "all other obligations of the Borrower" shall not include the obligation to indemnify the Agent, the Lenders, or any other indemnified party, unless (a) facts and circumstances are then known which in the reasonable opinion of the Indemnified Person, as the case may be, could reasonably be expected to give rise to an obligation owing by Borrower to make an indemnity payment; and (b) Borrower has not bonded its indemnity obligations or otherwise provided for the payment thereof in a manner satisfactory to the Indemnified Person. IN WITNESS WHEREOF, the Debtor has executed this Security Agreement as of the date and year first above written. DEBTOR: HOLLYWOOD ENTERTAINMENT CORPORATION By DONALD J. EKMAN Its Senior Vice President Address: 25600 S.W. Pkwy. Ctr. Dr. Wilsonville, OR 97070 Attn: Donald J. Ekman Telefax: (503) 677-1680 SCHEDULE - -------- Schedule 1 Assumed Business Names 11 SCHEDULE 1 ASSUMED BUSINESS NAMES 1. Hollywood Video 2. Hollywood Video Super Stores 3. Hollywood Video Express 4. Video Watch 5. Video Central 6. Video Park 7. Eastman Video 1 EX-23.1 3 CONSENT OF PRICE WATERHOUSE LLP Exhibit 23.1 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 33-80080, No. 33-81844, and No. 333-03524) of our report dated February 20, 1997, except as to Note 11, which is as of March 15, 1997 appearing on page F-1 of Hollywood Entertainment Corporation's Annual Report on Form 10-K for the year ended December 31, 1996. PRICE WATERHOUSE LLP Portland, Oregon March 28, 1997 EX-23.2 4 CONSENT OF COOPERS & LYBRAND LLP CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Hollywood Entertainment Corporation on Form S-8 (File No. 333-03524, File No. 33-81844 and File No. 33-80080) of our report, dated February 14, 1995, except for Note 3 as to which the date is March 29, 1995 on our audit of the statements of operations, changes in shareholders' equity and cash flows of Hollywood Entertainment Corporation for the year ended December 31, 1994, which report is included in this Annual Report on Form 10-K for the year ended December 31, 1996. COOPERS & LYBRAND L.L.P. Portland, Oregon March 27, 1997 EX-27.1 5 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1996 DEC-31-1996 12,849 0 25,785 0 45,255 87,121 115,812 87,115 449,783 80,728 0 0 0 238,021 0 449,783 49,717 302,342 30,707 263,924 0 0 4,136 34,282 13,652 0 0 0 0 20,630 0.59 0.59
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