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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 001-15153
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BLOCKBUSTER INC.
(Exact name of registrant as specified in its charter)
DELAWARE 52-1655102
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
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1201 Elm Street
Dallas, Texas 75270
(214) 854-3000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
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Class A Common Stock, $.01 par value per New York Stock Exchange
share
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 Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
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 the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 15, 2000, 31,004,160 shares of class A common stock, $.01 par
value per share, and 144,000,000 shares of class B common stock, $.01 par value
per share, were outstanding. The aggregate market value of the registrant's
common stock held by non-affiliates was about $339,137,172 (based on the
closing price of $11.00 per share of class A common stock as reported on the
New York Stock Exchange composite tape on that date. (For purposes of
determination of the above-stated amounts, only directors, executive officers
and 10% or greater stockholders of the registrant have been deemed affiliates.)
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual meeting of stockholders of
the registrant to be held during 2000 are incorporated by reference into Part
III of this Form 10-K.
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BLOCKBUSTER INC.
INDEX TO FORM 10-K
Page
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PART I
Item 1. Business...................................................... 1
Item 2. Properties.................................................... 25
Item 3. Legal Proceedings............................................. 26
Item 4. Submission of Matters to a Vote of Security Holders........... 26
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters.. 27
Item 6. Selected Financial Data....................................... 27
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.................................... 37
Item 7a. Quantitative and Qualitative Disclosure About Market Risk..... 51
Item 8. Financial Statements and Supplementary Data................... 52
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 79
PART III
Item 10. Directors and Executive Officers of the Registrant............ 79
Item 11. Executive Compensation........................................ 79
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................... 79
Item 13. Certain Relationships and Related Transactions................ 79
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K.......................................................... 80
PART I
Item 1. Business
Blockbuster Overview
Blockbuster Inc., which may be referred to as Blockbuster, we, us or our, is
the world's leading retailer of rentable home videocassettes, DVDs and video
games, with about 7,200 stores in the United States, its territories and 26
other countries as of December 31, 1999. We operate primarily under the highly
recognized BLOCKBUSTER(R) brand, which, according to The Gallup Organization,
achieves nearly 100% recognition with active movie renters in the United
States.
Our business and operations were previously conducted by Blockbuster
Entertainment Corporation, which was incorporated in Delaware in 1982 and
entered the movie rental business in 1985. On September 29, 1994, Blockbuster
Entertainment Corporation was merged with and into Viacom Inc. Since the merger
and prior to our initial public offering in August 1999, our business and
operations were conducted by various indirect subsidiaries of Viacom. Over the
year and one-half period prior to our initial public offering, our business and
operations were either (1) merged into Blockbuster Inc. or (2) purchased by
Blockbuster Inc. and/or one of its subsidiaries. Blockbuster Inc., an indirect
subsidiary of Viacom, was incorporated under a different name on October 16,
1989 in Delaware.
Viacom, through its ownership of 144 million shares of our class B common
stock, owns common stock representing about 82% of our equity value and about
96% of the combined voting power of our outstanding common stock. On December
14, 1999, we filed with the SEC a registration statement on Form S-4 relating
to a possible split-off from Viacom pursuant to an offering by Viacom to
exchange all of the shares of Blockbuster's common stock that it owns in
exchange for shares of Viacom common stock. We refer to this transaction as the
exchange offer. Viacom has not decided to commence this exchange offer to date.
Viacom has announced that, subject to the approval of its Board of Directors,
which will be based on an assessment of market conditions, and the receipt of a
supplemental private letter ruling from the Internal Revenue Service reflecting
the anticipated merger between Viacom and CBS, Viacom intends to effect the
exchange offer. However, Viacom has said it does not intend to commence the
exchange offer unless our class A common stock price improves to a price range
exceeding $20.00 per share.
Beginning in the fourth quarter of 1999, we began operating in two segments:
(i) home video, DVD and video game rental and retailing, which we refer to as
our video segment, and (ii) new technologies.
(i) Video
Through our video segment, we operate 5,879 video stores and our
franchisees and/or joint ventures operate 1,274 video stores located
throughout the United States, its territories and 26 other countries.
(ii) New Technologies
Through our new technologies segment, we operate our Internet site,
blockbuster.com, and our newly formed division, Digital Networks, which
is responsible for exploring various alternative forms of electronic
entertainment delivery including video-on-demand.
Financial information relating to our segments is included in Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Note 18 to our Consolidated Financial Statements included in this document.
Intellectual Property
We own a number of trademarks, trade names and service marks, including,
among others, BLOCKBUSTER(R), BLOCKBUSTER VIDEO(R), BLOCKBUSTER FAVORITES(TM),
BLOCKBUSTER
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GIFTCARD(R), BLOCKBUSTER GIFTCARDS(TM), BLOCKBUSTER REWARDS(TM), BLOCKBUSTER
ENTERTAINMENT AWARDS(R), KIDPRINT(R), BLOCKBUSTER MUSIC(R), XTRA-VISION and the
blue and yellow ticket stub and the blue and yellow awning outside our stores.
In addition, we own the rights to the "blockbuster.com" Internet domain name.
We consider our intellectual property rights to be among our most valuable
assets.
Industry Overview
Domestic Home Video Industry
According to Paul Kagan Associates, the U.S. videocassette and DVD rental
and sales industry grew from $17.1 billion in revenue in 1998 to a projected
$18.5 billion in 1999 and is projected to reach $22.8 billion in 2005. Paul
Kagan Associates estimates that, in 1999, 85.9 million, or 85.9%, of the 100
million total U.S. television households owned a VCR. The number of VCRs that
were sold in the United States in 1999 was estimated by Paul Kagan Associates
to be 20.5 million, which represents the largest number of VCRs sold in any
single year. In addition, the Consumer Electronics Manufacturers Association
estimates that about 4.1 million DVD players were sold to dealers in the United
States during 1999. According to Paul Kagan Associates, the VCR and DVD markets
will continue to grow as the number of multi-VCR households is expected to
increase from 39.7 million in 1999 to 51.4 million by 2005 and the number of
DVD households is projected to reach 31.0 million in 2005.
As part of its Annual Report on the Home Video Market 1998, the Video
Software Dealers Association revealed that each week some 50 million consumers
make a trip to a video store, and almost 60% of the U.S. households owning at
least one VCR rent videos at least a couple of times each month. We believe
that the following factors, among others, make video rental a preferred medium
of entertainment for millions of customers:
. the opportunity to browse among a very broad selection of movies;
. the control over viewing, such as the ability to control start, stop,
pause, fast-forward and rewind; and
. the opportunity to entertain one or more people at home for a reasonable
price.
In addition, a significant competitive advantage that our industry currently
enjoys over most other movie distribution channels except theatrical release is
the early timing of our distribution "window." After the initial theatrical
release, studios make their movies available to video stores for a specified
period of time. This window is exclusive against most other forms of non-
theatrical movie distribution, such as pay-per-view, premium television, basic
cable and network and syndicated television. The current length of the window
for video stores varies, typically ranging from 30 to 90 days for domestic
video stores and from 120 to 180 days for international video stores.
Thereafter, movies are made sequentially available to television distribution
channels.
The home video industry is highly fragmented. However, the home video
industry has experienced consolidation in recent years, as video store chains
have gained significant market share from single store operators. In the past
two years, there has been about a 14% reduction in the total number of video
stores operating in the United States. We believe that small stores and chains
in the home video industry will continue to consolidate with national and
regional chains and that such consolidation will offer us numerous acquisition
opportunities. We believe that there are several competitive advantages in
being a large home video chain, including marketing efficiencies, brand
recognition, access to more copies of each videocassette through direct
revenue-sharing agreements, sophisticated information systems, greater access
to prime real estate locations, greater access to capital, and competitive
pricing made possible by size and operating efficiencies. Even if there is
significant consolidation, however, we expect that the home video industry will
remain fragmented.
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Historically, the major studios or their licensees released movies to video
stores at wholesale prices generally between $60 and $70 per videocassette for
major theatrical releases that were priced for rental in the United States. The
studios still release movies at relatively high wholesale prices unless the
movie is subject to a revenue-sharing agreement or a quantity discount program
or is designated by the studios as a sell-through movie. The studios attempt to
maximize total revenue from newly released video titles by maintaining the high
wholesale price during the first four months to one year after a movie is
released. Thereafter, in order to promote sales to consumers, the major studios
release the movies at a substantially lower price, generally at retail for
about $10 to $20 per videocassette.
Since the late 1980s, revenue-sharing agreements have been available to home
video chains and independent video dealers through deals brokered by
distributors such as Rentrak Corporation and SuperComm, Inc. More recently, the
major studios have entered into revenue-sharing agreements directly with
several large video chains. For titles purchased under these agreements, video
stores share with the studios an agreed-upon percentage of the video stores'
rental revenue for a limited period of time in exchange for minimal fixed
payments for the videocassettes by the video stores. This percentage generally
declines over a period of weeks following the initial release of the movie. The
video stores also agree to take a minimum number of copies of each movie that
is released by a studio in any U.S. movie theater. The video stores may also
agree to take a minimum number of movies that are not released by a studio in
any U.S. movie theater. The revenue-sharing agreements, subject to limitations
and exceptions, allow the video stores to sell previously viewed videotapes to
their customers.
We believe that the revenue-sharing agreements have the following
significant benefits to participating video stores:
. they provide these stores with the opportunity to substantially increase
the quantity and selection of newly released video titles that they
stock;
. they increase revenues as a result of the increase in total number of
transactions per store and number of videocassettes rented per
transaction; and
. they align the studios' economic interests more closely with the
interests of the video stores.
In addition, we believe that revenue-sharing has increased the revenues
received on an annual basis by the studios through increased rental activity on
new releases as well as greater distribution and revenues on non-hit movies
through minimum output provisions.
In addition to wholesale pricing and revenue-sharing agreements, studios
release some movies at relatively low initial prices, which generally are sold
by retailers for $10 to $20 per videocassette. Because the wholesale price is
relatively low and these movies are not subject to the revenue-sharing
agreements, retailers generally purchase these movies primarily for sale and
such movies are referred to as sell-through movies. These typically consist of
movies for children and other movies that have unique characteristics or other
mass ownership appeal, such as The Rugrats Movie and Titanic.
International Home Video Industry
According to Paul Kagan Associates, the potential market for home video
rentals is growing at a faster pace outside the United States than within the
domestic market. According to Paul Kagan Associates, the number of households
outside of the United States which own a VCR is expected to grow from about 315
million in 1999 to about 390 million by 2005. As of December 31, 1999, we
operated in 26 countries outside of the United States.
Some of the attributes of the home video industry outside of the United
States are similar to those of the home video industry within the United
States. For example, the major studios generally release movies outside of the
United States according to the same sequential windows as the release of movies
within the United
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States, though the international windows tend to last for a longer period of
time. In general, however, the home video industry outside of the United States
does not mirror the home video industry within the United States. For example,
most countries have different systems of supply and distribution of movie
titles. Although revenue-sharing agreements, which have proliferated within the
U.S. home video industry among large home video chains, are starting to be
gradually introduced into markets outside of the United States, they are not
yet common in such markets. In addition, competition in most international
markets generally tends to be more fragmented, with few large home video
chains.
Movie Studio Dependence on Video Rental Industry
According to Paul Kagan Associates, total U.S. movie studio and independent
supplier revenue in the United States grew at a compound annual rate of about
6.2% per year from $11.3 billion in 1995 to $15.2 billion in 1999. Paul Kagan
Associates also indicates that the video rental industry is the largest single
source of U.S. revenue to U.S. movie distributors, representing about $7.4
billion, or 48.5%, of the $15.2 billion of movie revenue in 1999. The following
table represents Paul Kagan Associates' estimates of revenues of total movie
distributor revenue which were made publicly available in the fourth quarter of
1999.
Year Ended December 31,
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1995 1996 1997 1998 1999
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(in millions)
U.S. home video......................... $ 5,231 $ 6,152 $ 6,306 $ 6,811 $ 7,389
Other U.S. revenue...................... 6,020 6,690 7,161 7,240 7,837
------- ------- ------- ------- -------
Total U.S. revenue.................... 11,251 12,842 13,467 14,051 15,226
------- ------- ------- ------- -------
International home video................ $ 4,192 $ 4,432 $ 4,406 $ 4,436 $ 4,480
Other international revenue............. 6,052 7,439 8,049 8,999 10,015
------- ------- ------- ------- -------
Total international revenue........... 10,244 11,871 12,455 13,435 14,495
------- ------- ------- ------- -------
Total revenue....................... $21,495 $24,713 $25,922 $27,486 $29,721
======= ======= ======= ======= =======
Of the many movies produced by major studios and released in the United
States each year, relatively few are profitable for the studios based on box
office revenues alone. In addition to purchasing box office hits, video rental
stores, including those operated by us, purchase movies on videocassette and
DVD that were not successful at the box office, thus providing the movie
studios with a reliable source of revenue for almost all of their movies. We
believe that the consumer is more likely to view movies which were not box
office hits on a rented videocassette or DVD than on most other formats because
video rental stores provide an inviting opportunity to browse and make an
impulse choice among a very broad selection of movie titles. In addition, we
believe the relatively low cost of video rentals encourages consumers to rent
films they might not pay to view at a theater.
Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenues by releasing movies to various movie distribution channels in the
sequential release date "windows" discussed above. This method of sequential
release allows the movie studios to increase their total revenue while
minimizing the adverse effect on the revenue derived from previously
established channels. With the advent of revenue-sharing and the incremental
revenues associated with such agreements, most movie studios lengthened the
video rental window for many box office hits.
Home Video Game Industry
The home video game industry has historically been affected by changing
technology, limited hardware platform life cycles and hit-or-miss software
titles. In addition, video games typically generate most of their rental
revenue during the first twelve months after their release. We believe that
during this time period, the
4
differential between the retail price and the rental price of a new video game
is typically high enough to make rentals an attractive alternative to the
customer. According to Arcadia Investment Corp. and VidTrac, the total domestic
home video game market generated about $3.7 billion in software sales and about
$800 million in rental revenue in 1998. These markets grew to about $4.3
billion and about $880 million in 1999, respectively, which represents a 16.2%
and 10.0% increase, respectively. Arcadia Investment Corp. projects that video
game software sales will remain relatively steady through 2001.
Based upon estimates of Gerard Klauer Mattison & Co., Inc., we believe that
most of the recent growth in the home video game industry has been fueled by
the success of Sony PlayStation(R) and Nintendo 64(R) and their respective
video games. Arcadia Investment Corp. recently reported that as of the end of
1999, the installed base of Sony PlayStation within the United States was about
21.0 million, and Nintendo has stated that as of the end of 1999, the installed
base of Nintendo 64 within the United states was about 14.0 million units. We
expect that the home video game industry will continue to grow with the
anticipated U.S. introduction of Sony PlayStation 2(TM) in the fall of 2000.
Video
Blockbuster is the world's leading retailer of rentable home videocassettes,
DVDs and video games, with about 7,200 stores in the United States, its
territories and 26 other countries as of December 31, 1999. We operate
primarily under the highly recognized BLOCKBUSTER brand, which, according to
The Gallup Organization, achieves nearly 100% recognition with active movie
renters in the United States. Our revenues in 1999 increased 14.6% from 1998,
with about 80.6% of these revenues generated in the United States and about
19.4% generated outside of the United States. We believe that over 1 billion
movies and video games have been rented worldwide from our stores or our
franchisees within the last 12 months, and of these rental transactions about
770 million were generated from our U.S. company-operated stores. For the year
ended December 31, 1999, we and our franchisees recorded worldwide revenues of
about $5.4 billion, which includes $4.5 billion from our company operations and
$0.9 billion from our franchised stores.
Our brand recognition and leading market position have allowed us to create
one of the strongest entertainment franchises in the United States. Based on
industry data, we estimate that our company-operated and franchised stores
increased their market share of the domestic video rental business by three to
five percentage points in 1999. We have developed this leading position based
on a business model that we believe provides our customers with superior
convenience, selection and service at attractive prices. We estimate that about
61% of the U.S. population lives within three miles of one of our stores. In
addition, our customer transaction database contains information on over 48
million U.S. and Canadian member accounts that were active in the twelve months
ended December 31, 1999.
In 1997, John F. Antioco was recruited to serve as our chairman, president
and chief executive officer, selected in part for his significant multi-store
retail experience. Under the management team led by Mr. Antioco, we began to
develop a new business model that refocused on our core rental business. When
substantially implemented in the second quarter of 1998, this business model
led to a significant improvement in customer satisfaction. Most significantly,
we entered into domestic revenue-sharing agreements with various motion picture
studios. The studios include the six major motion picture studios: Buena Vista
Home Video, a division of the Walt Disney Company; Columbia Tri-Star Home Video
Inc., a Sony Corporation subsidiary; 20th Century Fox Home Entertainment Inc.;
Paramount Pictures Corporation, a Viacom subsidiary; Universal Studios Home
Video; and Warner Home Video. These agreements are generally referred to as
output agreements, because they require us to distribute most of the rental
titles released on videocassette by these studios. The quantity of each title
obtained is generally determined by a contractual formula.
We refer to these agreements as revenue-sharing agreements because they
provide that we will share our U.S. rental revenue from the videos with the
studio for a stated period of time, generally 26 weeks. These
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agreements enable us to provide the most popular newly released video titles to
our customers more quickly, in greater quantity and on a more efficient basis.
Therefore, we believe these agreements also have the following significant
benefits:
. substantially increasing the number of newly released videos in our
stores to better satisfy customer demand;
. contributing to an increase in revenues resulting from an increase in
the total number of transactions and the number of videocassettes rented
per transaction; and
. aligning the studios' economic interests more closely with ours because
they share a portion of the rental revenue with us for a period of time.
In addition to revenue-sharing, we have made other changes that have
increased our same store revenues while providing enhanced revenue
opportunities for the studios. Some of these other changes include improving
our product allocation system to more effectively allocate newly released
videos among our stores based upon the likelihood of rental frequency by store
and improving our direct marketing programs and advertising campaigns.
Reflecting this turnaround, domestic same store rental revenues increased 16.9%
and 11.4% in 1998 and 1999 respectively.
Business Model
Our current business model is designed to increase customer traffic and
transaction size by improving customer satisfaction and to ultimately generate
higher sales volume per store. We believe our business model gives us an
advantage over other large home video chains and a significant advantage over
our single-store competitors. We are applying key elements of our business
model to our international operations. The key elements of our business model
are discussed below.
Broad Selection and Large Number of Movies
We strive to be the leader in satisfying customer demand by stocking each of
our stores with more copies and a wider variety of newly released movies than
our competitors. In large part, our revenue-sharing agreements and our ability
to self-distribute have allowed us to implement this strategy in the United
States. At December 31, 1999, we had on average 285% more copies of each
videocassette per store and about 59% more video titles compared to December
31, 1997. In addition to newly released video titles, we acquire and offer a
broad selection of time-tested popular movies and a wide variety of independent
and lower-cost movies that are generally exclusively available at our stores
for a specified period of time.
Our goal is to stock each of our stores with a selection and quantity of
merchandise that is customized for that store. Using our customer transaction
database, we determine on a store-by-store basis the number of copies of each
new release that is to be offered by each store. We also make available for
sale some new release movies as previously viewed videotapes. With respect to
BLOCKBUSTER FAVORITES, our objective is to stock the top 1,000 most commonly
rented popular movies. In addition, we use our customer transaction database to
periodically review each store's inventory of BLOCKBUSTER FAVORITES and
identify movie titles within this category that have not been rented for a
period of time. We offer these previously viewed videotapes for sale and
replace them with movies that we believe our customers are more interested in
renting.
Convenient and Visible Stores of Optimal Size and Location
We maintain a strong presence throughout the United States, with an
estimated 61% of the U.S. population living within three miles of one of our
stores. Our experienced store development team can quickly identify the optimal
sites for our new stores within our targeted markets through the use of our
extensive real estate and customer transaction databases. We have developed
three distinct store formats that are tailored to maximize our penetration in
each market. These three formats include our "new" traditional store format,
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which is about 4,800 square feet, our seam store format, which is about 2,500-
3,500 square feet, and our store-in-store format, which is about 1,000-1,200
square feet. In addition to stores, we have deployed a small number of video
vending machines on an experimental basis.
In 1998, we began a comprehensive program to remodel our company-operated
stores worldwide. We expect to continue the process of fitting most of our
company-operated stores with new interior signage. We also expect to continue
remodeling the interior and exterior of some of our company-operated stores in
order to enhance our customers' shopping experience.
Superior and Consistent Customer Service
We focus on providing superior service to all of our customers. An essential
aspect of continuing to improve customer service has been our focus on
improving the in-store experience of each customer. We have worked to improve
the quality of our staff through recruitment, compensation, training and
employee appreciation and incentive programs. These programs encourage and
empower our store employees to gain experience and product knowledge in order
to effectively meet the needs of our customers. In addition, our domestic
customers are eligible to participate in BLOCKBUSTER REWARDS, our premium
membership program, which allows customers to earn free rentals. Our most
active customers are automatically enrolled in BLOCKBUSTER REWARDS Gold, which
offers additional free rental benefits and the ability to reserve movies. These
programs are designed to develop customer loyalty by encouraging our customers
to rent movies only from our stores.
Competitive Pricing
Our goal is to optimize on a store-by-store basis the price at which we rent
our video titles. In 1998, we initiated a dual pricing strategy that
differentiated pricing between newly released video titles and BLOCKBUSTER
FAVORITES, whereby the BLOCKBUSTER FAVORITES were priced lower than the newly
released video titles. We believe that our customers perceive this two-tiered
pricing as more appropriate in light of the differences between the demand for
the newly released video titles and BLOCKBUSTER FAVORITES. Our customer
transaction database provides us with the ability to adjust our overall pricing
strategy for each U.S. store based on local market conditions, including local
prices established by our competitors. In October 1998, we implemented a new
policy in our company-operated stores, setting the base rental term of our
BLOCKBUSTER FAVORITES, our video games and some of our newly released video
titles to a period ranging from two to five evenings. In addition, in February
2000, we implemented a new convenience policy in the majority of our company-
operated stores, pursuant to which the base rental term of our BLOCKBUSTER
FAVORITES, our video games and some of our newly released video titles were
extended to a period ranging from two to five days. As a result, our customers
can keep a videocassette for a period of 12 hours longer. In addition, our
customers may keep the videocassette for a period longer than this base rental
term for extended viewing. There is a base rental fee for the base rental term
and an extended viewing fee for the extended viewing term. The base rental fees
and the extended viewing fees may vary from market to market.
National Advertising and Marketing Programs
Our large U.S. store base and our extensive customer database enable us to
be the only home video chain that actively maintains a national advertising and
marketing program, including network television, national promotions and local
television and radio. For the year ended December 31, 1999, we incurred about
$233.8 million in net advertising expenses. In addition, some of our business
partners, including the studios, allow us to direct a significant amount of
their advertising expenditures. Furthermore, the studios incur additional
expenditures to promote their newly released movies.
Our advertising and marketing provide information regarding one or more key
points of difference between us and the competition. We have pursued an
aggressive advertising and marketing campaign in order
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to promote awareness of the BLOCKBUSTER brand. Our primary goal is to make our
name so recognizable that any time a person wishes to rent a movie, he or she
will first consider coming to one of our stores. Our advertising and marketing
tries to convey the message that a visit to one of our stores will allow the
customer to experience the magic of the movies.
Use the Customer Transaction Database
We have developed and utilized an extensive customer transaction database
with over 48 million U.S. and Canadian member accounts that have been active in
the last twelve months. This database enables us to effectively operate and
market our business. For example, we are able to directly communicate with our
customers on a targeted and customized basis relating to our products and
programs. We are also able to stock each of our company-operated stores with
the quantity and selection of merchandise that is customized for that store.
Self-Distribution Capabilities
We have constructed and launched a highly automated distribution center in
McKinney, Texas that allows us to distribute substantially all of our products
to our domestic company-operated stores. We believe that our distribution
center gives us a significant competitive advantage over our competitors that
use third-party distributors because we are able to process and distribute a
greater quantity of products while reducing costs and improving service to our
stores. In particular, we mechanically repackage our newly released videos to
make them suitable for rental at our stores. Previously, this activity had been
performed manually at each store. In addition, our distribution center gives us
the capacity to accommodate our planned store expansion without incurring
significant expenditures. For example, between 1997 and the end of 1999, we
more than tripled the number of videocassettes processed and distributed to our
stores. We also believe these distribution capabilities were a major factor in
our ability to successfully implement our revenue-sharing agreements to provide
superior movie selection to our customers.
Growth Strategy
We believe that our growth strategy will further establish us as the leading
home video chain in the world. Our goal is to increase our system-wide U.S.
market share to over 40% within the next two years, and to significantly
increase our market share in those countries outside the United States where we
believe it is profitable to do so. We believe that our growth objectives can be
met because:
. the home video industry is highly fragmented both in the United States
and internationally;
. consolidation has already begun and will continue; and
. the advantages created by our new business model position us to increase
our market share.
As explained more fully below, our growth will principally be driven by an
increase in our same store revenues, an expansion of both our company-operated
and franchisee-operated store base in the United States and internationally and
by spreading our expenses over a larger revenue base.
Increase Same Store Revenues
By implementing each element of our business model, we believe that we will
increase same store revenues by:
. increasing the number of movies or video games that a customer rents on
each visit to our stores;
. continuing to increase our active customer base as we increase our
market share;
. increasing the number of times that active customers visit our stores;
8
. expanding our offering of rentable home entertainment, such as DVDs and
video games; and
. further increasing the quantity of videocassettes in our stores.
Expand Domestic Store Base
Based on our current store prototypes, we believe that the potential exists
for 4,000 additional video stores in the United States. We added 596 new
company-operated stores in the United States in 1999 and expect to add 100-125
per quarter on average over the course of 2000. However, we will be reviewing
our expansion plans on a quarter-by-quarter basis and, depending on the market
share gains, returns on our investment and other factors, we may reduce the
number of stores we plan to open. We plan to add most of these new stores in
the 70 largest markets in the United States. With the use of our extensive
customer transaction database and real estate database, our experienced store
development team identifies markets with growth opportunities and responds to
these opportunities with the appropriate store location and store format, which
store format generally ranges from about 1,000 to 4,800 square feet. We believe
that through our site selection process and flexible store formats, our new
stores will generate sufficient revenue to recover our capital investment in a
short period of time without significantly reducing the revenues of our
existing stores.
Expand International Store Base
Our international strategy is focused on expanding in markets in which we
already have an established market position and in less mature markets.
Although, as of December 31, 1999, we operated and franchised stores in 26
markets outside of the United States, about 91.1% of our international rental
revenue was generated by our top seven international markets. These markets are
Great Britain, Canada, Australia, the Republic of Ireland together with
Northern Ireland, Mexico, Spain and Argentina. We believe that the growth
opportunities in some of these markets are significant because they are highly
fragmented and our market share in most of these countries is estimated by us
to be less than 40%. We also plan to add 150-200 new company-operated stores
over the next two years in our international markets. As in the United States,
we use different store prototypes in response to local real estate and market
conditions. In addition, we have developed and use a new country entry model
that targets development of a specified range of a number of company-operated
stores and franchised stores, at which point economies of scale can be used to
reduce corporate overhead costs and national advertising expenses on a store-
by-store basis.
Expand Worldwide Franchise Program
Over the next two years, we expect to add about 400 franchised stores to our
franchised U.S. store base and about 130 franchised stores to our international
store base. This includes joint ventures in which we own a minority interest.
We also intend to convert company-operated stores in smaller markets into
franchised stores by selling these stores to franchisees. These franchisees
would also commit to develop additional new franchised stores in their
respective markets. As of December 31, 1999, we had 823 franchised stores in
the United States and 451 franchised and/or joint venture stores in our
international markets. For the year ended December 31, 1999, we had franchise
fees of $57.7 million relating to our franchise operations, or about 1.3% of
our 1999 consolidated revenues. In order to accomplish this objective, we have
refined our franchise approval process, hired personnel exclusively dedicated
to the development of new franchises and launched a campaign to attract
prospective franchisees. In order to increase the attractiveness of our U.S.
franchise program, we have made our revenue-sharing arrangements with the
studios available to our U.S. franchisees, which will provide them with an
option to increase their quantity and selection of movies.
Apply the Benefits of Greater Size
Our leading market position enables us to derive significant economies of
scale and operating efficiencies that are not necessarily available to our
smaller competitors. We are able to achieve efficiencies on both a store level
basis and a system-wide basis. On a store level basis, the increase in the
volume of transactions and the
9
consequent increase in revenues per store as a result of our business model
provides us with the opportunity to reduce our labor costs as a percentage of
revenues. On a systemwide basis, we believe that we can reduce our
distribution costs and general and administrative expenses as a percentage of
our revenues.
Pursue Strategic Acquisitions
For the year ended December 31, 1999, we acquired 165 video stores
worldwide. We will continue to review potential acquisitions, including
acquisitions of video rental chains and stores operated by our franchisees as
well as acquisitions in complementary businesses that will enable us to take
advantage of the highly recognized BLOCKBUSTER brand, our extensive customer
transaction database and our existing distribution system.
Refranchising
We have developed a comprehensive model that we use to evaluate which
locations should be company-operated and which locations should be franchise
stores. We seek to locate our company-operated stores in geographical areas
with population and customer concentrations that enable us to better allocate
available resources and manage operating efficiencies in inventory management,
advertising, marketing, distribution, training and store supervision. We
target the remaining markets for the opportunity to develop franchises.
Accordingly, we are targeting the 70 largest markets in the United States to
develop company-operated stores, and we are targeting the remaining markets
for franchises. As part of this evaluation, we sold 122 stores in 1999 to
franchisees in the United States.
Customer Transaction Database
We have developed and utilize an extensive customer transaction database
with over 48 million U.S. and Canadian member accounts that have been active
in the last 12 months. This database has tracked customer names, addresses,
phone numbers, transaction histories, demographic information and, recently,
e-mail addresses. We also maintain customer transaction databases in each of
the countries in which we operate outside of the United States and Canada.
We consider our customer transaction database to be one of our core assets,
which we currently use to:
. communicate with and market directly to our customers on a national
basis;
. develop programs to reward our most loyal customers;
. strategically locate potential new store sites based on demographics and
unique trade areas; and
. customize and improve the allocation of merchandise on a store-by-store
basis, based on local demographics and prior rental history of our
customers.
Over time, we believe we will use the information we collect and the
relationships we have developed with our customers through our database to:
. evaluate new industry trends such as DVDs and the digital broadcast
system;
. further develop and enhance our promotional and marketing strategy
through e-mail and other channels of distribution;
. help customers choose and rent movies by analyzing their previous
viewing history;
. promote our Internet site and services; and
. capitalize on new home delivery systems for filmed entertainment as
these systems become economically viable.
10
Merchandising
We offer a wide selection of movies and video games for rent and purchase.
We stock each of our company-operated stores with the quantity and selection of
merchandise that we have customized for that particular store.
The breakdown of net domestic revenues generated from the rental and sale of
such products for the year ended December 31, 1999 is as follows:
[Pie graph which shows a breakdown of domestic revenue follows:
1. about 70.1% of our domestic revenues was generated by movie rentals;
2. about 11.1% of our domestic revenues was generated by video game rentals;
3. about 7.1% of our domestic revenues was generated by previously viewed
tapes, DVD's and previously played video game sales;
4. about 4.8% of our domestic revenues was generated by sell-through movie
sales; and
5. about 6.9% of our domestic revenues was generated from other items.]
Videocassette and Videocassette Player Rentals. Our new traditional domestic
store generally carries about 4,500 different movie titles available for rent,
which include about 500 different newly released video titles and about 4,000
different BLOCKBUSTER FAVORITES titles. About 78% of 1999 net domestic rental
revenues were from the rentals of newly released movies. In some of our stores,
we rent videocassette players. Under our revenue-sharing agreements, we are
able to make available a substantial number of additional copies of each newly
released video in order to satisfy our customers' demand shortly after the
movie is released. In addition, we are able to offer substantially more newly
released video titles, which increases the variety of movies available in our
stores. Our average customer rents about two movies and/or video games every
time he or she visits one of our stores. Our stores outside of the United
States generally carry fewer movies due to their smaller store sizes.
Videocassette Sales. We generally offer sell-through movies for sale for
about $10 to $20 per videocassette. These typically consist of:
. classic movies that we believe have ownership appeal;
. childrens' movies; and
. new releases that are priced for sell-through.
We also offer for sale previously viewed videotapes to the public after the
end of their useful lives as rental products. These previously viewed
videotapes are generally re-wrapped and are sold at low prices.
DVDs and DVD Players. We currently rent between 200 and 500 different DVD
titles in about 3,600 domestic stores and in some markets outside of the United
States. The number of DVD titles available for rent varies based on the type
and location of store. We also rent DVD players in some of these stores.
Video Games and Video Game Consoles. We rent video games for use with Sony
PlayStation, Nintendo and other video game platforms in the majority of our
domestic stores and many of our international stores. In these stores, we also
sell previously played video games and rent the video game consoles. In
addition, we sell new video games in most of our stores in markets outside of
the United States.
11
Other Products. For the convenience of our customers, we sell VCR
accessories, such as blank videocassettes and videocassette cleaning equipment,
and a limited selection of snacks and beverages in all of our stores.
Occasionally, we sell licensed products to complement our selection of movies.
Also, we sell music compact discs and cassette tapes in some of our stores and
on our U.S. Internet site.
Stores and Store Operations
Site Selection. We have developed a comprehensive model that we use to find
suitable locations for company-operated stores and markets for franchise
stores. We seek to locate our company-operated stores in geographic areas with
population and customer concentrations that enable us to better allocate
available resources and manage operating efficiencies in inventory management,
advertising, marketing, distribution, training and store supervision. We are
targeting the remaining markets for the opportunity to develop franchises.
Accordingly, we are targeting the 70 largest markets in the United States to
develop company-operated stores, and we are targeting the remaining markets for
new franchise development.
Within each targeted market, we identify potential sites for new and
replacement stores by evaluating market dynamics, some of which include
population demographics, psychographics, customer penetration levels and
competition. We use our extensive real estate database and customer transaction
database to continuously monitor market conditions and select strategic store
locations. Our experienced store development team is capable of securing store
leases and preparing sites for operation, a process that typically takes about
six months. We use our knowledge of market areas and rely upon the familiarity
of our brand name to enhance our ability to obtain prime store locations,
negotiate favorable lease terms with landlords and enter into multiple store
leases.
Store Development. For the periods presented, the following table summarizes
opened stores, acquired stores, closed stores, and sold stores.
Blockbuster's Worldwide Store Count Information
Number of Franchised
Number of Company- and/or Joint Venture
Operated Stores Stores Total Stores
------------------------- ------------------------- -------------------------
Domestic Internat'l Total Domestic Internat'l Total Domestic Internat'l Total
-------- ---------- ----- -------- ---------- ----- -------- ---------- -----
Stores at 12/31/94...... 2,065 1,002 3,067 725 277 1,002 2,790 1,279 4,069
Opened................ 313 142 455 86 56 142 399 198 597
Acquired.............. 195 165 360 -- 3 3 195 168 363
Closed................ (33) (154) (187) (18) (29) (47) (51) (183) (234)
Sold.................. (3) -- (3) (150) (129) (279) (153) (129) (282)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/95...... 2,537 1,155 3,692 643 178 821 3,180 1,333 4,513
Opened................ 367 211 578 78 92 170 445 303 748
Acquired.............. 200 98 298 2 -- 2 202 98 300
Closed................ (36) (58) (94) (17) (10) (27) (53) (68) (121)
Sold.................. (2) -- (2) (71) (50) (121) (73) (50) (123)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/96...... 3,066 1,406 4,472 635 210 845 3,701 1,616 5,317
Opened................ 345 163 508 82 94 176 427 257 684
Acquired.............. 57 258 315 7 -- 7 64 258 322
Closed................ (114) (69) (183) (14) (10) (24) (128) (79) (207)
Sold.................. (7) -- (7) (19) (41) (60) (26) (41) (67)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/97...... 3,347 1,758 5,105 691 253 944 4,038 2,011 6,049
Opened................ 174 165 339 53 141 194 227 306 533
Acquired.............. 46 5 51 -- 21 21 46 26 72
Closed................ (70) (121) (191) (24) (10) (34) (94) (131) (225)
Sold.................. -- (21) (21) (22) (5) (27) (22) (26) (48)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/98...... 3,497 1,786 5,283 698 400 1,098 4,195 2,186 6,381
Opened................ 505 187 692 90 99 189 595 286 881
Acquired.............. 153 12 165 122 11 133 275 23 298
Closed................ (63) (65) (128) (10) (47) (57) (73) (112) (185)
Sold.................. (122) (11) (133) (77) (12) (89) (199) (23) (222)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/99...... 3,970 1,909 5,879 823 451 1,274 4,793 2,360 7,153
===== ===== ===== ==== ==== ===== ===== ===== =====
12
We plan to open most of our new company-operated stores in the 70 largest
markets in the United States. Based upon our current store model, we believe
that there is the potential for 4,000 additional video stores in the United
States.
Outside the United States, we plan to open most of our new company-operated
stores in the seven markets in which we already have a significant presence. In
addition, we plan to add franchised and joint venture stores in other
international markets.
Store Format. In the past, we have sought to locate stores in sites that
were convenient and visible to the public. We intend to continue to
conveniently locate our stores by incorporating an "appropriate" store format
using our extensive customer transaction database and real estate database to
maximize revenues without significantly decreasing the revenues of our nearby
stores. To do so, we have designed three store formats:
. New Traditional Stores. These stores are about 4,800 square feet and
have been or will be constructed in markets in which store-to-population
ratios are low and in which we believe market conditions are optimal.
. Seam Stores. These stores are about 2,500-3,500 square feet and have
been or will be constructed in order to compete:
-- in markets that are located in between our traditional stores
without significantly decreasing the market shares of those
traditional stores; and
-- in rural areas.
Notwithstanding the difference in size from a new traditional store, seam
stores carry on average about the same number of different newly released
titles as a new traditional store.
. Store-in-stores. These stores are about 1,000-1,400 square feet and have
been or will be constructed within a department store, supermarket or
other store. The purpose of this format is to further expand our
presence and meet demand in mature markets in which we already have a
strong presence.
We also periodically examine whether the formats of our existing stores are
optimal for their location and may downsize or relocate existing stores as
opportunities arise.
Store Layout. We design our stores to provide a recognizable distinctive
format offering an extensive selection of products in an attractive design
aimed at capturing the magic of the movies. We believe that our trademark blue
and yellow colors, which dominate most of our stores, make them easily
recognizable to video rental customers. The internal layout of our stores
allows our customers to easily distinguish new video releases, BLOCKBUSTER
FAVORITES, DVDs, video games and other products. Each domestic store typically
contains a perimeter wall, an internal area and a check-out area.
Store Operations. Our U.S. company-operated stores generally operate under
substantially similar hours of operation. Domestic stores are generally open
365 days a year, with daily hours generally from 10:00 a.m. to 12:00 midnight.
The hours of operation for franchised stores vary widely depending on the
franchise. Typically, each U.S. store employs 15 people, including two
assistant store managers and one store manager. A large part of the in-store
experience depends upon the knowledge of the staff. We carry out periodic
customer service audits at all of our stores to understand, satisfy and exceed
our customers' expectations. In addition, as store traffic and same store
revenues have increased, we have been able to achieve significant labor savings
through higher productivity. We have achieved additional labor savings because
our distribution center efficiently packages videocassettes, a task that was
previously done manually. International store operations vary by country.
13
Store Locations. At December 31, 1999, in the United States and its
territories, we operated 3,970 stores and our franchisees operated 823 stores.
The following map sets forth the number of domestic stores we operated,
including stores operated by our franchisees, as of December 31, 1999:
[Map of U.S.A. and its territories showing our total number of stores
(company-operated and franchised stores) in each state and territory as
follows:]
TOTAL
STATE OF TERRITORY(1) STORES(2)
- ---------------------------------------------- -----------
ALABAMA.................................................... 53
ALASKA..................................................... 13
ARIZONA.................................................... 90
ARKANSAS................................................... 18
CALIFORNIA................................................. 579
COLORADO................................................... 112
CONNECTICUT................................................ 56
DELAWARE................................................... 10
DISTRICT OF COLUMBIA....................................... 7
FLORIDA.................................................... 354
GEORGIA.................................................... 187
HAWAII..................................................... 20
IDAHO...................................................... 9
ILLINOIS................................................... 227
INDIANA.................................................... 75
IOWA....................................................... 27
KANSAS..................................................... 52
KENTUCKY................................................... 47
LOUISIANA.................................................. 71
MAINE...................................................... 5
MARYLAND................................................... 123
MASSACHUSETTS.............................................. 108
MICHIGAN................................................... 162
MINNESOTA.................................................. 49
MISSISSIPPI................................................ 32
MISSOURI................................................... 93
MONTANA.................................................... 7
NEBRASKA................................................... 30
NEW HAMPSHIRE.............................................. 19
NEW JERSEY................................................. 104
NEW MEXICO................................................. 25
NEW YORK................................................... 275
NEVADA..................................................... 47
NORTH CAROLINA............................................. 113
NORTH DAKOTA............................................... 6
OHIO....................................................... 169
OKLAHOMA................................................... 63
OREGON..................................................... 81
PENNSYLVANIA............................................... 161
PUERTO RICO................................................ 41
RHODE ISLAND............................................... 25
SOUTH CAROLINA............................................. 68
SOUTH DAKOTA............................................... 5
TENNESSEE.................................................. 73
TEXAS...................................................... 515
UTAH....................................................... 46
VERMONT.................................................... 5
VIRGINIA................................................... 121
VIRGIN ISLANDS............................................. 2
WASHINGTON................................................. 115
WEST VIRGINIA.............................................. 13
WISCONSIN.................................................. 78
WYOMING.................................................... 5
GUAM....................................................... 2
DOMESTIC STORE TOTAL 4,793
14
At December 31, 1999, outside of the United States, we operated 1,909
stores, and our franchisees and joint ventures in which we own a minority
interest operated 451 stores. The following table sets forth, by country, the
number of stores we operated and stores our franchisees operated as of December
31, 1999.
Number of
Number of Franchised and/or
Company-Operated Joint Venture
COUNTRY (1) Stores Stores Total(1)(2)
- ----------- ---------------- ----------------- -----------
Great Britain.................. 666 -- 666
Canada......................... 349 -- 349
Australia...................... 133 84 217
Ireland (Republic) and Northern
Ireland....................... 216 -- 216
Mexico......................... 168 6 174
Italy.......................... -- 158 158
Spain.......................... 103 5 108
Taiwan......................... 81 3 84
Brazil......................... -- 73 73
Argentina...................... 64 -- 64
Chile.......................... 59 -- 59
Denmark........................ 49 -- 49
China (Hong Kong).............. 19 -- 19
Thailand....................... -- 18 18
New Zealand.................... -- 17 17
Portugal....................... -- 16 16
Colombia....................... -- 14 14
Venezuela...................... -- 12 12
Israel......................... -- 12 12
Peru........................... -- 9 9
Panama......................... -- 8 8
Ecuador........................ -- 6 6
El Salvador.................... -- 6 6
Poland......................... -- 3 3
Uruguay........................ 2 -- 2
The Philippines................ -- 1 1
----- --- -----
International Store Total...... 1,909 451 2,360
===== === =====
- --------
(1) This does not include stores leased or owned but not operating.
(2) In addition to the stores listed in the chart, as of December 31, 1999,
there were 57 video vending machines being tested in Spain, Canada, Great
Britain and Italy.
Advertising and Marketing
Worldwide, in the year ended December 31, 1999, we incurred about $233.8
million in advertising expenses, which includes about $185.9 million in the
United States and about $47.9 million internationally. In addition, some of our
business partners, including the studios, allow us to direct a significant
amount of their advertising expenditures. Furthermore, the studios also incur
additional expenditures to promote their newly released movies.
National and Local Advertising Campaign. In 1998, we launched a national
advertising campaign in order to support our business model. We are the only
home video chain that actively maintains a national advertising campaign. This
campaign consists of network and local television, local advertising and local
radio. We use our customer transaction database to target our direct mailings
at different customer groups. We expect to incur about $186.0 million in net
domestic advertising expenses in 2000, an increase of about 0.1%.
15
During 2000 we plan to spend less on promotional, local store and presence
advertising and more on:
. Product focused advertising;
. Direct marketing vehicles such as BLOCKBUSTER REWARDS;
. Marketing our database to other businesses; and
. Advertisement of our new technologies segment.
The design of our national and local advertising campaign is based upon our
proprietary research. This is done on a national basis, and we also focus our
efforts on a local basis in order to adjust to each local environment. We
obtain information from our customer transaction database, our real estate
database and outside research agencies. We have concentrated on the following
factors to formulate and adjust our advertising:
. our market share;
. our level of store development and brand awareness relative to our
competitors within the relevant market;
. local demographics; and
. other local competitive issues.
Our advertising campaign focuses on the two areas discussed below.
. Out-of-Store Advertising. We advertise on television, transit and other
like media. We also use our research to customize our direct mailings to
address overall demographic trends and individual customer transaction
history.
. In-Store Advertising. We use leading edge graphics and visual
merchandising in our stores in order to give our customers the feeling
that a trip to our stores captures the magic of the movies.
Innovative Marketing Programs. Because of our large store base and our
leading brand awareness throughout the United States and many other markets, we
have been able to implement the following programs in the United States and the
same or similar programs in many of our international markets.
. New Release Guarantees. Because of the substantial number of copies of
videocassettes that we are able to provide in our stores, we are able to
offer a guarantee that some of our selected newly released video titles
will be in stock or the customer will receive a coupon that can be
redeemed for a free rental of that movie within the following 30 days.
. National Promotions. In 1999, we executed several one-of-a-kind national
promotional events, each several weeks in duration, designed to attract
customers and increase the number of times that active customers visit
our stores due to the event's novelty and "prize" appeal. To date, these
are the only nationally advertised events in our industry. In addition,
for the last five years, we have sponsored the internationally televised
BLOCKBUSTER ENTERTAINMENT AWARDS, in which over 25 million votes were
cast in 58 categories in our stores and on our U.S. website in 1999. On
June 16, 1999, the BLOCKBUSTER ENTERTAINMENT AWARDS was televised within
the United States to a television audience of over 6 million households
and has been televised in over 60 other countries.
. BLOCKBUSTER REWARDS Program. This premium membership program is designed
to offer benefits to our customers and enhance customer loyalty by
encouraging our customers to rent movies only from our stores. The
program was implemented in February of 1999 and as of December 31, 1999,
there were about 5.6 million U.S. customer accounts enrolled in
BLOCKBUSTER REWARDS. In general, for a $9.95 fee, our customers can join
BLOCKBUSTER REWARDS and earn free movie or video game rentals, exclusive
promotional offers and other benefits. Some high-volume renters are
automatically enrolled as BLOCKBUSTER REWARDS Gold members, which earns
them additional
16
benefits such as additional free movie or video game rentals and the
ability to reserve movies by telephone. We have recently implemented
versions of this program in Canada and Mexico.
. BLOCKBUSTER GIFTCARDS. Our national point-of-sale system in the United
States allows us a unique opportunity to offer our customers the
opportunity to purchase stored value BLOCKBUSTER GIFTCARDS which can be
redeemed at any of our stores nationwide. BLOCKBUSTER GIFTCARD is a
plastic prepaid card available in amounts ranging from $5 to $50. Some
of the cards have attractive designs, such as movie images, and are
marketed as "Limited Edition Cards." BLOCKBUSTER GIFTCARDS are also
currently available in Great Britain and Canada. BLOCKBUSTER GIFTCARD
sales increased 6.0% to $119.6 in 1999 from $112.8 million in 1998,
excluding sales by BLOCKBUSTER MUSIC, which was sold in October 1998.
. Cross-Promotional Marketing Programs. On an ongoing basis, since 1997,
we have implemented cross-promotional marketing programs with such other
well-known companies as Coca-Cola, Taco Bell, American Airlines, MCI
Worldcom, Pizza Hut, General Motors, American Online and Burger King. As
a result of our participation in these programs, we benefit from
marketing done by our business partners that features our brand.
. Community Service. We also sponsor and promote leadership events in many
of the communities in which we operate. For example, as part of our
"Community Service Videos" program, we provide free videocassette
rentals in some of our stores on subjects such as breast cancer. We also
offer annually our KIDPRINT program in most of our U.S. stores. Under
this complimentary program, parents can have a staff member videotape
their child's mannerisms, appearance and voice for emergency
identification purposes.
New technologies
We believe that the growth of the Internet and the increasing availability
of broadband distribution offers significant opportunities for us to capitalize
on emerging home entertainment technologies. In particular, we believe we are
well-positioned to leverage our strong brand name, existing infrastructure and
extensive expertise in the video/entertainment industry to create the premier
online video and entertainment destination.
In order to capitalize on these opportunities, in November 1999, we re-
launched our website, blockbuster.com. The re-launched site has enhanced both
the breadth and depth of blockbuster.com's entertainment-related news and
information and e-commerce offerings and capabilities. Some of the site's new
features include:
. increased e-commerce offerings and capabilities;
. entertainment news and information;
. information about movies;
. integrated promotions between our in-store and online businesses; and
. suggestions of movies based upon a customer's evaluation of selected
films.
In addition, in November 1999, we announced a strategic alliance with
America Online. The terms of this alliance provide for a co-branded America
Online/Blockbuster website on America Online's Entertainment Channel. America
Online and Blockbuster also agreed to extensive cross-marketing and promotional
activities and to jointly develop broadband content and delivery. As part of
the alliance, America Online, subject to terms and conditions, will acquire
about a 2.75% interest in blockbuster.com for $30 million in cash.
17
During 2000, we intend to integrate our online capabilities with our store
systems, which will allow consumers to search a store's inventory, reserve a
title and pre-pay through our site.
As part of our new technologies segment, we have also established a digital
networks group, through which we are exploring emerging forms of electronic
entertainment delivery, including, among others, video-on-demand, near video-
on-demand, movie downloading, subscription video-on-demand and games-on-demand.
Suppliers
The following is a description of the suppliers of our domestic company-
operated stores and our franchised stores. Our international stores are
supplied by a variety of suppliers.
Suppliers of Videocassettes and DVDs
Company-operated Stores. Our U.S. stores receive a substantial portion of
their videocassettes under the revenue-sharing agreements. We have entered into
domestic revenue-sharing agreements with, among others, all of the major
studios. Under these agreements, we share our U.S. rental revenues with the
studios for a limited period of time, generally 26 weeks.
In addition to this revenue-sharing component, common to each agreement is
some provision for disposition of the video products at the conclusion of the
rental period. This may involve sale of the product by us as a previously
viewed videotape, return of the videotape to the studio, destruction of the
videotape, or some combination of these elements.
Most revenue-sharing agreements also have a minimum payment requirement, all
or part of which is associated with either the number of videocassettes we
purchase or domestic box office receipts and the then current number of our
stores. Such agreements also generally require us to take a minimum number of
copies of each qualifying movie released by the supplier.
This revenue-sharing concept is relatively new to us and our industry, and
we believe the terms of these agreements are critical to our competitive
position. While the terms of our revenue-sharing agreements vary from studio to
studio, we believe, based on various assumptions, that the overall economic
revenue-sharing model is designed to achieve gross margins of about 60% on the
rental product we obtain under these agreements. We cannot assure you, however,
that we can achieve such gross margins under our revenue-sharing agreements.
None of these agreements are exclusive to us and the studios are free to enter
into similar or better agreements with our competitors.
The agreements with the studios expire by their terms at various times over
the next three and one-half years beginning in the fourth quarter of the year
2000. We have already renewed one of the agreements with a studio and are
currently engaged in negotiations with other studios to extend their respective
agreements with us.
For most of our revenue-sharing videocassettes, the major studios send the
master videocassettes to a duplicator for copying and then they are shipped to
our distribution center. In addition, we purchase sell-through movies, direct-
to-video movies and movies sold at traditional wholesale prices, as well as
DVDs, from major studios, independent studios and independent suppliers,
generally pursuant to negotiated agreements.
Franchised Stores. We require each franchisee to comply with guidelines that
set forth the minimum amount and selection of movies to be kept in its store's
inventory. Franchisees typically obtain videocassettes and DVDs from their own
suppliers. However, if we have purchased the exclusive distribution rights to a
movie or if a franchise participates with us under the revenue-sharing
agreements, the franchisee may obtain that movie from us. We have made our
revenue-sharing arrangements with the studios available to our U.S.
franchisees, which will provide them with an option to increase their quantity
and selection of movies.
18
Other Suppliers
Suppliers of Video Games. For our company-operated stores, we purchase video
game software primarily from six suppliers: Sony, Nintendo, Midway, Acclaim,
Electronic Arts and Sega. These suppliers deliver the video game software and
video game accessories to our distribution center. We then distribute the video
game software and video game accessories to our stores. Franchisees are
responsible for obtaining video game software and video game accessories from
their own suppliers.
Suppliers of VCRs, DVD Players and Video Game Consoles. In our company-
operated stores, we purchase our VCRs primarily from Ingram Entertainment
Incorporated, DVD players primarily from Phillips Electronics and video game
consoles primarily from Phillips Sales and Nintendo. Franchisees are
responsible for obtaining VCRs, DVD players and video game consoles from their
own suppliers.
Suppliers of Food and Beverages and Accessories. Other than our specially
branded microwave popcorn and accessories, which are distributed by our U.S.
distribution center, suppliers distribute all of our snacks and beverages
directly to our company-operated stores. Franchisees are responsible for
obtaining snacks and beverages and accessories, other than our specially
branded popcorn and accessories, from their own suppliers.
Distribution and Inventory Management
In the first quarter of 1998, we began operation of our new, state-of-the-
art distribution center in McKinney, Texas, which is near our corporate
headquarters. Our 850,000 square foot distribution center is a highly
automated, centralized facility that we use to restock products, repackage
videocassettes and process returns, as well as to provide some office space. It
supports all of our company-operated stores in the United States. As of
December 31, 1999, we employed about 940 employees at our distribution center.
Our distribution center operates six days a week, 24 hours a day.
Distribution. At our distribution center, we receive substantially all of
our videocassettes and video games. We repackage the newly released
videocassettes to make them suitable for rent at our stores, a process which
had previously been done manually by our store employees before we built our
distribution center. In addition, we repackage previously viewed tapes to make
them available for sale. Currently, our Internet sales are distributed by
independent distributors.
We distributed, and our company-operated stores received, about 86.5 million
units of our products last year from our distribution center. About 52.3
million of those units were videocassettes repackaged for rental at our stores.
The distribution center has allowed us to significantly decrease our
distribution costs compared to the costs we previously incurred using third-
party distributors. While we currently process a high volume of products due to
the successful implementation of our revenue-sharing agreements, we can support
a significant increase in sales volume without significant additional
investment. As we add more volume to our distribution center, we will be able
to further take advantage of our cost efficiencies. The February 1999 issue of
Modern Materials Handling, a leading trade publication, has recognized our
distribution center for its "distribution excellence."
We use a network of third-party warehouses for delivery to our U.S. stores.
We ship our products to these warehouses, located strategically throughout the
United States, which in turn deliver them to our stores. Franchisees generally
obtain their products directly from suppliers, except for accessories, supplies
and movies to which we have exclusive distribution rights, which domestic
franchisees receive from our distribution center. Distribution of our products
to our stores in markets outside the United States is coordinated through our
international offices.
Inventory Management. Because we have a centralized distribution center, we
are able to keep strict control over the amount and flow of our products at any
given time. We scan all products as they enter, flow through and exit our
distribution center.
19
Once our products reach our stores, we focus on strict inventory control.
Our sophisticated inventory management system is integrated with our point-of-
sale system, which allows us to manage our inventory on a store-by-store basis.
We allocate our products to our stores based on the transaction history of each
store, and we monitor our stores' in-stock positions. We also typically take a
physical inventory at each store on a monthly basis.
Management Information Systems
We believe that the accurate and efficient management of purchasing,
inventory and sales records is important to our future success. We maintain
information, updated daily, regarding revenues, current and historical sales
and rental activity, demographics of store customers and videocassette rental
patterns. This information can be organized by store, region, state, country or
for all operations.
We maintain a satellite-based national point-of-sale system in the United
States, which is linked with a datacenter located in our distribution center.
The point-of-sale system tracks all of our products distributed from the
distribution center to each store using scanned bar code information. All
rental and sales transactions are recorded by the point-of-sale system when
scanned at the time of customer checkout. At the end of each day, the point-of-
sale system transmits store data from operations to the datacenter and the
customer transaction database by satellite.
All of our company-operated stores, except in Hong Kong, the Republic of
Ireland and Northern Ireland, and most of our franchisees use our point-of-sale
system upon opening or conversion into a company-operated store. Within the
next two years, we currently plan to update the computers and the software that
run the point-of-sale system in order to decrease the overhead costs of each
store and speed up the checkout process. We currently have a direct link via
satellite with most of our domestic company-operated stores and substantially
all our Canadian stores. In addition, about 25% of our domestic franchised
stores are currently linked via satellite.
Franchise Operations
At December 31, 1999, our franchisees operated 823 stores in the United
States and our franchisees and minority-operated joint ventures operated 451
stores internationally. Our franchisees generally are responsible for obtaining
their own supplies and coordinating their own distribution system. However, as
a result of making revenue-sharing agreements available to our U.S. franchises
in the fourth quarter of 1999, we expect some of our U.S. franchisees to
participate in our revenue-sharing agreements. As of December 31, 1999, 23
franchisees were participating in the revenue-sharing agreements made available
to them. Accordingly, U.S. franchisees would rely upon our distribution center
to receive some portion of their videocassettes. Using our distribution center
would allow our franchisees to share in the cost savings that our distribution
center provides to us.
Under our current U.S. franchising program, we enter into a development
agreement and a franchise agreement with the franchisee. Pursuant to the terms
of a typical development agreement, we grant the franchisee the right to
develop one or a specified number of stores at an approved location or
locations within a defined geographic area and within a specified time. We
generally charge the franchisee a development fee in advance for each store to
be developed during the term of the development agreement. The typical
franchise agreement is a long-term agreement that governs the operations of the
store. We generally require the franchisee to pay us a one-time franchise fee
and continuing royalty fees, service fees and monthly payments for maintenance
of the proprietary software. In addition, we provide optional product and
support services to our franchisees for which we sometimes receive fees. We
require our franchisees to contribute funds for national advertising and
marketing programs and also require that franchisees spend an additional amount
for local advertising. Each franchisee has sole responsibility for all
financial commitments relating to the development, opening and operation of its
stores, including rent, utilities, payroll and other capital and incidental
expenses. We employ people to inspect our franchised stores and to advise our
operators.
20
We cannot assure you that our franchisees will be able to achieve
profitability levels in their businesses sufficient to pay our franchise fees.
Furthermore, we cannot assure you that we will be successful in marketing and
selling new franchises or that any new franchisees will be able to obtain
desirable locations and acceptable leases.
International Operations
We are the leading international retailer of rentable home movies and video
games. As of December 31, 1999, we had 2,360 stores operating under the
BLOCKBUSTER brand and other brand names located throughout 26 markets outside
of the United States. Of these stores, 451 were operated through our
franchisees and/or joint ventures in which we own a minority interest.
We have focused on seven priority markets outside of the United States.
Based on the number of stores, our largest market is Great Britain. We began
operations in Great Britain in 1989 and, through acquisitions, have grown to
666 locations, excluding video vending machines, as of December 31, 1999. We
began operations in Canada, our second largest market, in 1990 and have grown
to 349 stores, as of December 31, 1999. In Australia, our third largest market,
we began operations in 1993 and have grown to 217 company-operated and
franchisee stores as of December 31, 1999. In the Republic of Ireland and
Northern Ireland, we acquired Xtra-vision PLC in 1997 and continue to operate
under the XTRA-VISION brand due to its strong local brand awareness. As of
December 31, 1999, we had 216 stores in the Republic of Ireland and Northern
Ireland. In addition, we began operations in Mexico in 1991 and Spain and
Argentina in 1995.
We maintain offices for each major region and most of the countries in which
we operate in order to manage, among other things:
. store development and operations;
. marketing; and
. the purchasing, supplying and distribution of each store's products.
The international home video and video game industry varies from country to
country due to, among other things:
. political and economic systems and risks; and
. legal standards and regulations, such as those relating to foreign
ownership rights, unauthorized copying, intellectual property rights,
labor and employment matters, trade regulation and business practices,
franchising and taxation.
Thus, because of all of these variables, we cannot assure you that we can
operate profitably in these international markets.
Competition
We operate in a highly competitive environment. We believe our most
significant competition comes from (a) non-videocassette providers of home
viewing entertainment and (b) video stores and other retailers that rent or
sell movies.
Competition with Non-videocassette Providers of Home Viewing
Entertainment. These providers include direct broadcast satellite, cable,
digital terrestrial, network and syndicated television. We believe that our
most significant competitive risk in this area comes from direct broadcast
satellite and digital cable television. Further growth in the direct broadcast
satellite and digital cable subscriber bases could cause a smaller number of
videocassettes and DVDs to be rented if viewers were to favor the expanded
number of conventional channels and expanded programming, including sporting
events, offered through these services. See
21
"Cautionary Statements--The widespread availability of additional channels on
satellite and digital cable systems may significantly reduce public demand for
our products." Direct broadcast satellite, digital cable and "traditional"
cable providers not only offer numerous channels of conventional television,
but they also offer pay-per-view movies, which permit a subscriber to pay a fee
to see a selected movie.
Competition with Video Stores and Other Retailers that Rent or Sell
Movies. These retailers include, among others:
. local, regional and national video stores;
. mass merchant retailers;
. supermarkets, pharmacies and convenience stores; and
. Internet sites.
We believe that the principal factors we face in competing with video stores
are:
. convenience and visibility of store locations;
. quality, quantity and variety of titles;
. pricing; and
. customer service.
We believe we currently compete with other on-line retailers primarily with
respect to "sell through" titles.
Other Competition. In some markets, we also compete against the illegal
duplication and sales of movies and video games. In addition to all of the
modes of competition discussed above, we compete for the general public's
entertainment dollar and leisure time activities with, among others, movie
theaters, Internet-related activities, live theater and sporting events.
We cannot assure you that competing pressures we face will not have a
material adverse effect on our company.
Regulation
Domestic Regulation
We are subject to various federal, state and local laws that govern the
access and use of our video stores by disabled people and the disclosure and
retention of video rental records. We also must comply with various regulations
affecting our business, including state and local advertising, consumer
protection, credit protection, licensing, zoning, land use, construction,
environmental and minimum wage and other labor and employment regulations.
We are also subject to the Federal Trade Commission's Trade Regulation Rule
entitled "Disclosure Requirements and Prohibitions Concerning Franchising and
Business Opportunity Ventures" and state laws and regulations that govern (1)
the offer and sale of franchises and (2) franchise relationships. If we want to
offer and sell a franchise, we are required by the rule mentioned above to
furnish each prospective franchisee a current franchise offering circular prior
to the offer or sale of a franchise. In addition, a number of states require
that we, as a franchisor, comply with that state's registration or filing
requirements prior to offering or selling a franchise in the state and to
provide a prospective franchisee with a current franchise offering circular
complying with the state's laws, prior to the offer or sale of the franchise.
Although we cannot make any assurances, we intend to maintain a franchise
offering circular that complies with all applicable federal and state franchise
sales and other applicable laws. However, if we are unable to comply with
federal franchise
22
sales and disclosure laws and regulations, we will be unable to offer and sell
franchises anywhere in the United States. In addition, if we are unable to
comply with the franchise sales and disclosure laws and regulations of any
state that regulates the offer and sale of franchises, we will be unable to
offer and sell franchises in such state.
We are required to update our franchise offering circular annually, as well
as to amend it during the course of the year, to reflect material changes
regarding our franchise offering and to comply with changes in disclosure
requirements. The occurrence of any such material changes may, from time to
time, require us to stop offering and selling franchises until our franchise
offering circular is updated and amended. We cannot assure you that our
franchising program will not be adversely affected because compliance with
applicable law necessitates that we cease offering and selling franchises in
some states until our franchise offering circular is revised, updated and
approved by the applicable authorities, or because of our failure or inability
to comply with existing or future franchise sales and disclosure laws.
We are also subject to a number of state laws and regulations that regulate
some substantive aspects of the franchisor-franchisee relationship, including:
. those governing the termination or non-renewal of a franchise agreement,
such as requirements that:
(a) "good cause" exist as a basis for such termination; and
(b) a franchisee be given advance notice of, and a right to cure, a
default prior to termination;
. requirements that the franchisor deal with its franchisees in good
faith;
. prohibitions against interference with the right of free association
among franchisees; and
. those regulating discrimination among franchisees in charges, royalties
or fees.
Compliance with federal and state franchise laws is costly and time-
consuming, and we cannot assure you that we will not encounter difficulties or
delays in this area or that we will not require significant capital for
franchising activities.
International Regulation
We are subject to various international laws that govern the disclosure and
retention of video rental records. For example, the laws pertaining to the use
of the customer database in some markets outside of the United States are more
restrictive than the relevant laws in the United States.
We must comply with various regulations affecting our business, including
advertising, consumer protection, credit protection, franchising, licensing,
zoning, land use, construction, environmental, labor and employment
regulations.
Similar to the United States, some foreign countries have franchise
registration and disclosure laws affecting the offer and sale of franchises
within their borders and to their citizens. They are not often as extensive and
onerous as laws and regulations applicable in the United States. However, as in
the United States, failure to comply with such laws could limit or preclude our
ability to expand through franchising in those countries.
Employees
As of December 31, 1999, we employed about 89,700 persons, including about
70,800 persons employed within the United States and about 18,900 persons
employed outside of the United States. Within the United States, about 68,000
were employed in domestic company-operated stores and about 2,800 were employed
in various other operations, including our corporate, administrative and
distribution functions. Of the total number of U.S. employees, about 18,500
were full-time and about 52,300 were part-time. We believe that our employee
relations are good.
23
Executive Officers of the Registrant
The following information regarding our executive officers is as of March
15, 2000.
Name Age Position
---- --- --------
John F. Antioco.... 50 Chairman of the Board of Directors, President and
Chief Executive Officer
Mark T. Gilman..... 36 Executive Vice President and Chief Worldwide
Development Officer, Store Operations
James Notarnicola.. 48 Executive Vice President and Chief Marketing Officer
Alva J. Phillips... 55 Executive Vice President and Chief Information Officer
Michael K. Roemer.. 51 Executive Vice President and Chief Operations Officer,
USA Store Operations
Edward B. Stead.... 53 Executive Vice President, General Counsel and
Secretary
Nigel Travis....... 50 Executive Vice President and President, Worldwide
Store Operations
Dean M. Wilson..... 42 Executive Vice President and Chief Merchandising
Officer, Worldwide Store Operations
Larry J. Zine...... 45 Executive Vice President and Chief Financial Officer
John F. Antioco has served as our chairman of the board of directors,
president and chief executive officer since 1997. From 1996 until 1997, Mr.
Antioco served as president and chief executive officer for Taco Bell
Corporation. Mr. Antioco served as chairman of the board of directors of The
Circle K Corporation, an operator of convenience stores, from 1995 until 1996,
and as its president and chief executive officer from 1993 until 1996. Mr.
Antioco joined Circle K as chief operating officer in 1991. Mr. Antioco serves
as chairman of the board of directors of Main Street & Main Incorporated and as
a director for CSK Auto Corporation.
Mark T. Gilman has served as our executive vice president and chief
worldwide development officer, store operations, since December 1999 and served
as our executive vice president and chief development and franchising officer
from July 1999 until December 1999. Mr. Gilman served as our executive vice
president of real estate-franchising and new business development from 1997
until 1999, and served as our senior vice president, strategic systems, from
1996 until 1997. Prior to joining us, during 1996, Mr. Gilman served as senior
vice president, development, for Hollywood Entertainment Corporation, a
national retail video chain, where he was responsible for domestic development
and construction. From 1994 until 1996, Mr. Gilman served as director of
operations development for Wal-Mart Corporation, where he was responsible for
developing real estate and merchandising systems.
James Notarnicola has served as our executive vice president and chief
marketing officer since June 1998 and served as our executive vice president of
marketing and administration from 1997 until 1998. From 1978 until 1997, Mr.
Notarnicola served in many capacities at 7-Eleven Inc., which was formerly
known as The Southland Corporation, including vice president of marketing from
1995 until 1997 and general manager of advertising and promotion from 1990
until 1995.
Alva J. Phillips has served as our executive vice president and chief
information officer since 1997 and served as our senior vice president of
information services from 1995 until 1997. From 1993 until 1995, Mr. Phillips
was employed by Integrated Systems Solutions Corporation, a wholly owned
subsidiary of International Business Machines Corporation, where he served as
project manager for the Eckerd Corporation account and oversaw, among other
matters, the development and implementation of a satellite-based store
communications system. From 1988 until 1993, Mr. Phillips served as senior vice
president of management information services for Rite Aid, where he was
responsible for developing in-store pharmacy, merchandising and distribution
systems.
Michael K. Roemer has served as our executive vice president and chief
operations officer, USA store operations, since December 1999 and served as our
executive vice president, domestic video operations, from 1998 until December
1999. From 1997 until 1998, Mr. Roemer served as our senior vice president,
domestic video operations. From 1995 until 1997, Mr. Roemer served as an
independent consultant for such major
24
companies as Frito Lay, where he assisted with new product development,
distribution and business process planning. Prior to consulting, Mr. Roemer
worked at 7-Eleven Inc. from 1966 to 1995. From 1993 until 1995, in his
capacity as senior vice president of merchandising for 7-Eleven, Mr. Roemer
oversaw merchandising operations of 7-Eleven stores in the United States and
Canada.
Edward B. Stead has served as our executive vice president and general
counsel since 1997 and as our secretary since 1999. From 1988 until 1996, Mr.
Stead served in various capacities with Apple Computer, Inc., including vice
president and general counsel from 1989 until 1995, vice president, general
counsel and secretary from 1993 until 1995, and senior vice president, general
counsel and secretary from 1995 to 1996. Prior to joining Apple, Mr. Stead
served as senior vice president, general counsel and secretary of Cullinet
Software, Inc. Mr. Stead is currently a member of the legal advisory board of
the New York Stock Exchange. Mr. Stead also served as a member of the legal
advisory board of the National Association of Securities Dealers from 1993
until 1997 and has been a member of the American Law Institute since 1996.
Nigel Travis has served as our executive vice president and president,
worldwide store operations, since December 1999 and served as our executive
vice president and president, worldwide retail operations, from 1998 until
December 1999. Mr. Travis served as our president, international operations,
from 1997 until 1998. From 1994 until 1997, Mr. Travis served in various other
capacities for us, including senior vice president, Europe. Prior to joining
us, Mr. Travis served as senior vice president and managing director, Europe,
the Middle East and Africa, for Burger King Corporation. Mr. Travis, a British
national, serves as senior non-executive director of Limelight PLC in the
United Kingdom. Mr. Travis was elected as a director of the Video Software
Dealers Association in July 1999.
Dean M. Wilson has served as our executive vice president and chief
merchandising officer, worldwide store operations, since December 1999 and
served as our executive vice president, merchandising, from 1998 until December
1999. From 1995 until 1998, Mr. Wilson held a number of positions with us,
including senior vice president-general merchandise manager, vice president-
retail and director of product international. Mr. Wilson's experience in the
video industry spans over 16 years, with positions in the retail, distribution
and studio aspects of the business. Prior to joining us, from 1990 until 1995,
Mr. Wilson was employed by Trans World Entertainment, a music and video
retailer, where he served as divisional merchandise manager of video. Mr.
Wilson began his retail career in the executive training programs with May
Company and Dayton Hudson.
Larry J. Zine has served as our executive vice president and chief financial
officer since 1999. From 1996 until 1999, Mr. Zine served as chief financial
officer for Petro Stopping Centers, L.P., where he was responsible for all
operations. During 1999, Mr. Zine also served as president of Petro. From 1981
until 1996, Mr. Zine worked for The Circle K Corporation, an operator of
convenience stores, and was named executive vice president and chief financial
officer in 1988.
Item 2. Properties
Our corporate headquarters are located at 1201 Elm Street, Dallas, Texas
75270 and consist of about 219,239 square feet of space leased pursuant to an
agreement that expires on June 30, 2007. The distribution center is located at
3000 Redbud Blvd., McKinney, Texas 75069 and consists of about 850,000 square
feet of space leased pursuant to an agreement that expires on December 31,
2012. We have set up our payroll and benefits center in Spartanburg, South
Carolina.
We have several main offices that manage our international operations. We
have offices in: Uxbridge, England; Toronto, Ontario; Melbourne, Australia; and
Taipei, Taiwan. In addition, for most countries in which we have company-
operated stores, we maintain an office to coordinate our operations within that
country.
We lease substantially all of our existing store sites, including buildings
and improvements. These leases generally have a term of five to ten years and
provide options to renew for between ten and fifteen additional years. We
expect that most future stores will also occupy leased properties.
25
Item 3. Legal Proceedings
On July 21, 1999, Ruben Loredo, doing business as Five Palms Video,
purporting to act as a class representative on behalf of himself and all others
similarly situated, filed a complaint in the District Court of Bexar County,
Texas, against Blockbuster. The plaintiff asserts, among other things, that by
entering into and operating under its revenue-sharing agreements with the major
motion picture studios, Blockbuster has attempted to and conspired with the
studios to monopolize and restrain competition in the market for the retail
rental of videocassettes in violation of Texas law. The plaintiff is seeking
triple the amount of his alleged actual damages and triple the amount of
alleged actual damages of those similarly situated, all under the Texas Free
Enterprise and Antitrust Act. The dollar amount that the plaintiff is alleging
as the actual damages to himself and those similarly situated is not set forth
in his complaint. Blockbuster believes that the plaintiff's position is
completely without merit, and Blockbuster intends to vigorously defend itself
in the litigation.
In addition, three other parties, purporting to act as class representatives
on behalf of themselves and all others similarly situated, filed a
substantially similar complaint in the United States District Court for the
Western District of Texas against Viacom and major motion picture studios and
their home video subsidiaries that have operated under these revenue-sharing
agreements with Blockbuster. These plaintiffs are seeking triple the amount of
the alleged actual damages to themselves and triple the amount of alleged
actual damages of those similarly situated, as well as preliminary and
permanent injunctive relief prohibiting any unlawful attempt or conspiracy to
monopolize the market for the retail rental of videocassettes. If Viacom is
required to pay any damage award as a result of this litigation, Viacom may
seek indemnification for its losses from Blockbuster under the release and
indemnification agreement.
Blockbuster is subject to various other legal proceedings in the course of
conducting its business, including its business as a franchisor. However,
Blockbuster believes that these proceedings are not likely to result in
judgments that will have a material adverse effect on its business.
Item 4. Submission of Matters to a Vote of Security Holders
None.
26
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters
The shares of Blockbuster class A common stock are listed and traded on the
NYSE under the symbol "BBI." Our class A common stock began trading on August
11, 1999 following our initial public offering. The following table contains,
for the periods indicated, the high and low sales prices per share of our class
A common stock as reported on the NYSE composite tape and the cash dividends
per share of our class A common stock:
Cash
High Low Dividends
---------- ----------- ---------
Fiscal Year Ended December 31, 1999
Quarter Ended September 30, 1999 (from
August 11, 1999).......................... $16 7/8 $12 7/16 $ --
Quarter Ended December 31, 1999............ $17 1/8 $11 3/8 0.02(1)
- --------
(1) On October 20, 1999 our board of directors declared a cash dividend of
$0.02 per share of our class A and class B common stock, payable November
22, 1999, to our stockholders of record at the close of business on
November 1, 1999. The total dividend payment was about $3.5 million, of
which Viacom International Inc. was paid about $2.9 million.
We have paid and currently intend to pay a quarterly dividend of $0.02 per
share on our common stock. Our board of directors is free to change our
dividend practices from time to time and to decrease or increase the dividend
paid, or to not pay a dividend, on our common stock on the basis of results of
operations, financial condition, cash requirements and future prospects and
other factors deemed relevant by our board of directors. Furthermore, our
credit agreement limits our ability to pay dividends to $90 million, $115
million, $130 million, $145 million and $160 million in the first five years
beginning in August 1999.
The number of holders of record of shares of our class A common stock as of
March 15, 2000 was 169. Viacom currently owns all of the outstanding shares of
our class B common stock and more than 82% of the equity value of Blockbuster.
The shares of our class B common stock are not listed nor traded on any stock
exchange or other market.
Item 6. Selected Financial Data
The following table sets forth Blockbuster's selected consolidated
historical financial and operating data as of the dates and for the periods
indicated. The selected statement of operations and balance sheet data for the
years ended December 31, 1996 through 1999 are derived from Blockbuster's
audited consolidated financial statements. The selected statement of operations
data for the year ended December 31, 1995 and selected balance sheet data as of
December 31, 1995 are derived from Blockbuster's unaudited consolidated
financial statements prepared by Blockbuster, which in Blockbuster's opinion,
include all normal, recurring adjustments necessary for a fair presentation of
the financial position at such dates and the results of operations for such
respective periods. The financial information herein may not necessarily
reflect Blockbuster's results of operations, financial position and cash flows
in the future or what its results of operations, financial position and cash
flows would have been had it been a separate, stand-alone entity during the
periods presented.
27
BLOCKBUSTER SELECTED CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA
The following data should be read in conjunction with, and are qualified by
reference to, the consolidated financial statements and related notes thereto,
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this document.
Year Ended or At December 31,
------------------------------------------------
1995 1996(1) 1997(2) 1998(3) 1999
-------- -------- -------- -------- --------
(In millions, except per share amounts and
worldwide data)
Statement of Operations
Data:
Revenues.................... $2,403.3 $2,942.1 $3,313.6 $3,893.4 $4,463.5
Operating income (loss)..... 430.2 267.6 (214.6) (359.2) 121.7
Net income (loss)........... $ 142.9 $ 77.8 $ (318.2) $ (336.6) $ (69.2)
Net income (loss) per share-
basic and diluted (4)...... $ 0.99 $ 0.54 $ (2.21) $ (2.34) $ (0.44)
Dividends per share......... $ -- $ -- $ -- $ -- $ 0.02
Weighted average shares
outstanding-basic and
diluted (4)................ 144.0 144.0 144.0 144.0 156.1
Balance Sheet Data:
Cash and cash equivalent.... $ 100.3 $ 58.6 $ 129.6 $ 99.0 $ 119.6
Total assets................ 8,570.9 8,794.6 8,731.0 8,274.8 8,540.8
Long-term debt, including
capital leases, less
current portion (5)........ 168.3 249.0 331.3 1,715.2 1,138.4
Stockholders' equity (5).... 7,737.2 7,784.4 7,617.6 5,637.9 6,125.0
Worldwide Store Data:
Company-operated stores at
end of year................ 3,692 4,472 5,105 5,283 5,879
Franchised and joint venture
stores at end of year...... 821 845 944 1,098 1,274
Total stores at end of
year....................... 4,513 5,317 6,049 6,381 7,153
Same store revenue increase
(decrease) (6)............. 5.1% (1.8)% 13.3% 8.3%
- --------
(1) During 1996 we recognized a restructuring charge of $50.2 million primarily
relating to our corporate relocation and elimination of third party
distributors.
(2) During 1997 we recognized charges totaling $250 million primarily related
to inventory write-downs, closure of under-performing stores, write-offs
attributable to international joint ventures and additional expenses
incurred in connection with our corporate relocation.
(3) During 1998 we changed our method of amortizing our videocassette and video
game rental inventory. This newly adopted method represents a more
accelerated method of amortization. The adoption of this new method of
amortization was accounted for as a change in accounting estimate effected
by a change in accounting principle and, accordingly, we recorded a non-
cash charge of $424.3 million recognized as cost of sales.
(4) As described in note 1 to our consolidated financial statements, we were
recapitalized to provide for class A common stock and class B common stock.
In accordance with SEC Staff Accounting Bulletin No. 98, the capitalization
of the class B common stock has been retroactively reflected for the
purposes of presenting historical net income (loss) per share for periods
prior to the initial public offering. Pro forma weighted average shares
outstanding reflect all shares of class B common stock issued and
outstanding which are owned by Viacom and the class A common stock issued
in our initial public offering, as if these shares had been outstanding
since the beginning of each respective period.
(5) This reflects the December 31, 1998 declaration of a $1.4 billion dividend
payable to Viacom International Inc. in the form of an interest-bearing
promissory note.
(6) A store is included in the same store revenue calculation after it has been
opened and operated by us for more than 52 weeks. An acquired store becomes
part of the same store base in the 53rd week after acquisition and
conversion. The percentage change is computed by comparing total net
revenues for same stores as defined above at the end of the applicable
reporting period with total net revenues from these same stores for the
comparable period in the prior year.
28
CAUTIONARY STATEMENTS
This annual report on Form 10-K contains "forward-looking statements" within
the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. You can
identify these statements by the fact that they do not relate strictly to
historical or current facts. They include words such as " anticipate," "will,"
"expect," "estimate," " believe," "intend," "plan," "could," "may," "future"
and similar expressions and variations thereof. Forward-looking statements
relating to such matters as our financial condition and operations are based on
our management's current intent, belief or expectations regarding us and our
industry. These forward-looking statements are not guarantees of future
performance and involve risks, uncertainties and assumptions that are difficult
to predict. In addition, some forward-looking statements are based upon
assumptions as to future events that may not prove to be accurate. Therefore,
actual outcomes and results may differ materially from what is expressed or
forecasted in such forward-looking statements. We undertake no obligation to
update publicly any forward-looking statement for any reason, even if new
information becomes available or other events occur in the future.
A variety of factors, including those set forth below, could cause our
actual results to differ materially from the anticipated results or other
expectations expressed in our forward-looking statements. There may be
additional risks that we do not currently view as material or that are not
presently known.
New Technologies May Reduce Public Demand for Our Products
New digital technologies, such as near-video-on-demand and video-on-demand,
and other new technologies, could have a material adverse effect on us. This is
especially true if:
. newly released movies are made widely available by the studios to these
technologies at the same time or before they are made available to video
stores for rental; and
. these technologies are widely accepted by consumers.
The widespread availability of additional channels on satellite and digital
cable systems may significantly reduce public demand for our products. Recent
advances in direct broadcast satellite and cable technologies may adversely
affect public demand for video store rentals. If direct broadcast satellite and
digital cable were to become more widely available and accepted, this could
cause a smaller number of movies to be rented if viewers were to favor the
expanded number of conventional channels and expanded programming, including
sporting events, offered through these services. If this were to occur, it
could have a material adverse effect on us. Direct broadcast satellite
providers transmit numerous channels of programs by satellite transmission into
subscribers' homes. Recently developed technology has presented cable providers
with the opportunity to use digital technology to transmit many additional
channels of programs over cable lines to subscribers' homes.
In addition, because of this increased availability of channels, direct
broadcast satellite and digital cable providers have been able to enhance their
pay-per-view business by:
. substantially increasing the number and variety of movies they can offer
their subscribers on a pay-per-view basis; and
. providing more frequent and convenient start times for the most popular
movies.
This is referred to within our industry and by others as near-video-on-
demand. If near-video- on-demand were to become more widely available and
accepted, pay-per-view purchases could significantly increase. Near-video-on-
demand allows the consumer to avoid trips to the video store for rentals and
returns of movies, which also eliminates the chance they will incur an extended
viewing fee. However, newly released movies are currently made available by the
studios for rental prior to being made available on a near-video-on-demand
basis. Near-video-on-demand also does not allow the consumer to start, stop and
rewind the movie. Increases in
29
the size of this pay-per-view market could lead to an earlier distribution
window for movies on pay-per-view if the studios perceive this to be a better
way to maximize their revenue.
We may eventually have to compete with the widespread availability of video-
on-demand and similar technologies, which may significantly reduce the demand
for our products. Some digital cable providers have begun implementing
technology that plays movies on demand with interactive capabilities such as
start, stop and rewind. This is referred to within our industry and by others
as video-on-demand. Video-on-demand is currently available in some markets.
However, video-on-demand competes with other uses of cable infrastructure, such
as the ability to provide Internet access and basic telephone services, some of
which may provide higher returns for operators. Video-on-demand could have a
material adverse effect on us if:
. video-on-demand could be profitably provided at a reasonable price; and
. newly released movies were made available at the same time, or before,
they were made available to the video stores for rental.
Another similar technology has recently been developed that allows consumers
to automatically record programs to create a customized television line-up for
viewing at any time. This technology also enables consumers to pause, rewind,
instant replay and playback in slow motion any live television broadcast. We
cannot predict the impact that this new technology will have on our business.
Our Industry Would Lose a Significant Competitive Advantage if the Movie
Studios Were to Adversely Change Their Current Distribution Practices
A significant competitive advantage that our industry currently enjoys over
most other movie distribution channels except theatrical release is the early
timing of our distribution "window." After the initial theatrical release,
studios make their movies available to video stores for a specified period of
times. This window is exclusive against most other forms of non-theatrical
movie distribution, such as pay-per-view, premium television, basic cable and
network and syndicated television. The current length of the window for video
rentals varies, typically ranging from 30 to 90 days for domestic video stores
and from 120 to 180 days for international video stores. Thereafter, movies are
made sequentially available to television distribution channels.
We could be materially adversely affected if:
. the video store windows were no longer the first following the
theatrical release;
. the length of the video store windows were shortened; or
. the video store windows were no longer as exclusive as they are now;
because newly released movies would be made available earlier on these other
forms of non-theatrical movie distribution. As a result, consumers would no
longer need to wait until after the video store distribution window to view a
newly released movie on these other distribution channels.
Although we believe that the studios have a significant interest in
maintaining a viable home video rental industry, because the order, length and
exclusivity of each window for each distribution channel is determined solely
by the studio releasing the movie, we cannot predict the impact, if any, of any
future decisions by the studios.
Our Internet Revenues Could be Adversely Affected if Blockbuster is Unable to
Compete Effectively in the E-Commerce Market for its Products
E-commerce is a new and rapidly evolving market. As a result of the growth
of e-commerce, we have increased our product offerings over the Internet.
However, the demand for our products on the Internet is new and unproven, and
there is uncertainty regarding demand for these products in the future. Several
factors could adversely affect our e-commerce business generally, including:
. obtaining the right, on acceptable terms, from movie studios to
electronically distribute a sufficient quantity of movies over the
Internet;
30
. obtaining the right, on acceptable terms, to electronically deliver
these movies over the Internet from cable system operators and other
entities who own the broadband distribution systems necessary for the
distribution of movies;
. the technological ability to distribute movies over the Internet on a
cost-effective basis;
. the widespread adoption by consumers of technology which is adequate to
receive and display movies in a manner which is acceptable to them;
. our ability to attract customers to our Internet site and meet their
expectations with respect to site content, pricing, service, product
selection, navigation and other features; and
. competition from other companies offering to rent or sell videocassettes
or electronically deliver movies over the Internet.
Because Margins on Sell-through Products Are Lower Than Rental Margins, We
Could Be Materially Adversely Affected if a Greater Proportion of Newly
Released Movies Were Initially Priced as a Sell-through Product in the United
States and Consumers Desired to Own These Movies
Sell-through retail margins are generally lower than rental margins. Some of
our competitors, such as mass merchandisers, warehouse clubs and Internet
sites, can distribute and sell these sell-through movies at lower costs and/or
may operate at lower margins than can we. As a result, our sell-through
business, which is described below, in the United States represented only 5% of
our domestic revenues for 1999. We believe our profitability would be adversely
affected if we did not derive most of our revenues from the higher margin
rental business. Although we believe that industry economics will dictate that
most new releases on videocassettes will continue to be initially priced for
rental, we could be materially adversely affected if:
. a greater proportion of either release format were initially priced as
sell-through merchandise in the United States; and
. consumers desired to own, and not rent, these movies.
In general, studios initially price their movies at prices that are too high
to generate significant consumer demand for purchase. Recently, however, the
studios have released a limited number of movies at prices intended to generate
consumer demand to purchase these movies rather than rent them. This is
referred to as sell-through pricing. Movies priced for sell-through are not
subject to our revenue-sharing agreements. However, if enough consumers desired
to rent rather than own these sell-through priced movies, the adverse effect of
sell-through may be offset, in part or in full, by the improved margins we
would obtain from renting sell-through movies because these movies have low
initial wholesale prices and are not generally subject to revenue-sharing.
Significant Benefits Would Be Lost and We Would Be Materially Adversely
Affected if Our Revenue-Sharing Agreements Were Materially Adversely Changed or
Discontinued
If our revenue-sharing agreements are materially adversely changed or
discontinued, significant benefits, as described in "Item 1. Business--Industry
Overview--Domestic Home Video Industry" would be lost. This in turn would have
a material adverse effect on us.
Historically, we generally paid the major studios or their licensees between
$60 and $70 per videocassette for major theatrical releases that were priced
for rental in the United States. In 1998, we entered into revenue-sharing
agreements with the major studios in the United States. These agreements
generally have terms ranging from two to five years. For titles purchased under
these agreements, we pay only a minimal fixed cost per videocassette and agree
to share our U.S. rental revenue with the studios for a limited period of time.
In addition, we agree to take a minimum number of copies of each movie title
that is released by a studio in any U.S. movie theater. We also agree to take,
in some cases, a minimum number of movies that are not released by a studio in
any U.S. movie theater.
31
If the Average Sales Price for the Previously Viewed Videotapes Obtained Under
Revenue-Sharing Is Not at or Above an Expected Price, Our Expected Gross
Margins May Be Adversely Affected
Under our revenue-sharing agreements, we expect to earn revenues in two
ways:
. revenues resulting from the rental of the videocassettes; and
. revenues resulting from the sales of the previously viewed videotapes to
the public after the end of their useful lives as rental products.
To achieve our expected gross margins, we need to sell these previously
viewed videotapes at or above an expected price. If the average sales price of
these previously viewed videotapes is not at or above this expected price, our
gross margins under our revenue-sharing agreements may be adversely affected.
As a result of revenue-sharing, we will need to sell significantly more
previously viewed videotapes than in the past. Even though revenue-sharing was
not fully implemented during all of 1998, domestically we sold about 17.6
million previously viewed videotapes in 1998, as compared to 1997 when we sold
about 7.8 million previously viewed videotapes which represents about a 126%
increase. We sold about 29.8 million previously viewed videotapes in 1999,
which represents a 69% increase over 1998. We cannot assure you that we will be
able to sell, on average, these previously viewed videotapes at or above the
expected price since we do not have extensive experience in selling previously
viewed videotapes in these quantities.
Other factors that affect our ability to sell these previously viewed
videotapes at expected prices, include:
. consumer desire to own the particular movie; and
. the number of previously viewed videotapes available for sale by others
to the public.
In addition, after the expiration of the video store distribution window,
the sales of previously viewed videotapes also compete with newly released
videos which are priced for sell-through.
We Have Had Limited Experience with Our New Business Model and Cannot Assure
You That We Will Operate Profitably in the Future Under This New Model
Because we have had limited experience with our new business model, we
cannot assure you that we will have net income in future periods. Beginning in
the second quarter of 1997, we developed our new business model to refocus on
our core rental business. We have experienced significant losses during this
period. We had net losses of $318.2 million in 1997, $336.6 million in 1998 and
$69.2 million in 1999.
We May Be Unable to Fully Execute our New Store Expansion
Although we believe that we have personnel and other resources required to
implement our store expansion goals, we cannot assure you that we will be able
to execute our new store expansion within the expected time frame. If we are
unable to execute this expansion, it would be detrimental to our goals of
increasing market share, increasing same store revenues and applying the
benefits of our size. We intend to proceed with a significant expansion. We
expect to add about 100 to 125 company-operated stores in the United States per
quarter on average over the course of 2000 and 2001. However, we will be
reviewing our expansion plans on a quarter-by-quarter basis and, depending on
the market share gains, returns on our investment and other factors, we may
reduce the number of stores we plan to open. In addition, over the next two
years, we expect to add:
. about 400 new franchised stores in the United States;
. about 150 to 200 new company-operated stores in markets outside the
United States; and
. about 130 new franchise and/or joint venture stores in markets outside
the United States.
32
In order to meet our store expansion goals within this two-year period, we
will be required to invest considerable time in implementing these plans.
We Cannot Assure You as to the Profitability of Newly Added Stores
In connection with our growth strategy, we may add new company-operated
stores in markets, regions or countries where we have limited or no operating
history. As a result, we cannot assure you that:
. these newly added stores will achieve revenue or profitability levels
comparable to those of our existing stores; or
. that these stores will achieve such revenue or profitability levels
within the time periods estimated by us.
Newly Opened Stores May Adversely Affect the Profitability of Pre-existing
Stores
We expect to open smaller company-operated stores in markets where we
already have significant operations in order to maximize our market share
within these markets. Although we have a customized store development approach,
we cannot assure you that these smaller newly opened stores will not adversely
affect the revenues and profitability of those pre-existing stores in any given
market.
We May Be Liable for Lease Payments Related to BLOCKBUSTER MUSIC Stores
In October 1998, about 380 BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. If
Wherehouse defaults with respect to these leases, related losses could
adversely affect our future operating income because we have agreed to
indemnify Viacom with respect to any amount paid under these guarantees. We
estimate that, as of the time of the sale to Wherehouse, we were contingently
liable for about $84 million with respect to base rent for the remaining term
of these leases if Wherehouse defaults on all of these leases. This amount has
not been discounted to present value. Our contingent liability will vary over
time depending on the lease terms remaining. We have not recorded any reserves
related to this contingent liability in our consolidated financial statements.
We Could Be Materially and Adversely Affected if Our Centralized Domestic
Distribution Center Is Shut Down
Our domestic distribution system is centralized. This means that we ship
nearly all of the products to our U.S. company-operated stores, including newly
released videos purchased under the revenue-sharing agreements, through our
distribution center. If our distribution center is shut down for any reason we
could incur significantly higher costs and longer lead times associated with
distributing our videocassettes and other products to our stores.
As a Participant in the Home Video Industry, We Are Subject to Governmental
Regulation Particular to Our Industry
Any finding that we have been or are in noncompliance with respect to the
laws affecting our business could result in, among other things, governmental
penalties or private litigant damages which could have a material adverse
effect on us. We are subject to various international, U.S. federal and state
laws that govern the offer and sale of our franchises because we act as a
franchisor. In addition, because we operate video stores and develop new video
stores, we are subject to various international, U.S. federal and state laws
that govern, among other things, the disclosure and retention of our video
rental records and access and use of our video stores by disabled persons, and
are subject to various state and local licensing, zoning, land use,
construction and environmental regulations. Furthermore, changes in existing
laws, including environmental and
33
employment laws, new laws or increases in the minimum wage may increase our
costs. Our obligation to comply with, and the effects of, the above
governmental regulations are increased by the magnitude of our operations.
Our Historical Consolidated Financial Information May Not Be Representative of
Our Results as a Separate Company
Since September 1994, our operations have been conducted by various entities
owned directly or indirectly by Viacom. Viacom is currently providing
financial, administrative and other resources while we make the transition to
operate as an independent public company. In addition, the financial
information included in this Form 10-K may not necessarily reflect our results
of operations, financial position and cash flows in the future or what the
results of operations, financial position or cash flows would have been had we
been a separate, stand-alone entity during the periods presented. The
historical results of operations included in this Form 10-K do not reflect many
significant changes that have occurred in our capital structure, funding and
operations as a result of our separation from Viacom and our initial public
offering. For additional information, we refer you to "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
We Will Be Controlled by Viacom As Long as It Owns a Majority of the Combined
Voting Power of Our Two Classes of Common Stock, and Our Other Stockholders
Will Be Unable to Affect the Outcome of Stockholder Voting During This Time
We are currently controlled by Viacom. We have two classes of common stock:
. class A common stock, which entitles the holder to one vote per share;
and
. class B common stock, which entitles the holder to five votes per share,
on all matters submitted to our stockholders. Viacom owns in excess of a
majority of the combined voting power of our outstanding common stock. As a
result, Viacom is able to determine the outcome of all corporate actions
requiring stockholder approval. Because Viacom has the ability to control us,
it has the power to act without taking the best interests of our company into
consideration. For example, Viacom can control decisions with respect to:
. the direction and policies of our company, including the election and
removal of directors;
. mergers or other business combinations involving us;
. the acquisition or disposition of assets by us;
. future issuances of our common stock or other securities;
. the incurrence of debt by us;
. the payment of dividends, if any, on our common stock; and
. amendments to our certificate of incorporation and bylaws.
Any of these provisions could be used by Viacom for its own advantage to the
detriment of our other stockholders and our company. This in turn may have an
adverse affect on the price of our class A common stock.
Viacom has no obligation to complete the split-off. On December 14, 1999, we
filed with the SEC a registration statement on Form S-4 relating to a possible
split-off from Viacom pursuant to an offering by Viacom to exchange all of the
shares of Blockbuster common stock it owns in exchange for Viacom common stock.
Viacom has not decided to commence the exchange offer to date. Viacom's
decision to commence the exchange offer is dependant on, among other things,
the satisfaction of the conditions discussed above under "Item 1. Business-
Blockbuster Overview." Viacom has the sole discretion to determine the timing
and all
34
terms of any possible split-off and is under no obligation to effect a split-
off. We cannot assure you as to whether or not or when a split-off will occur,
or as to the terms of a split-off. If Viacom does not complete a split-off,
Viacom will continue to control us.
There Are Potential Conflicts of Interest with Respect to Our Relationship with
Viacom Because Viacom Controls Us and Our Business Objectives May Differ
Because Viacom controls us and our business objectives may differ, there are
potential conflicts of interest between Viacom and us regarding, among other
things:
. our past and ongoing relationship with Viacom, including, but not
limited to, Viacom's control of our tax matters for years in which we
are consolidated with Viacom for tax purposes, the acquisition of
videocassettes from Paramount Pictures Corporation, an indirect
subsidiary of Viacom, and the agreements between Viacom and us relating
to any possible split-off;
. potential competitive business activities; and
. sales or distributions by Viacom of all or part of its ownership
interest in our company.
We cannot assure you that we will be able to resolve any potential conflicts
or that, if resolved, we would not be able to receive a more favorable
resolution if we were dealing with someone who was not controlling us.
Three of Our Directors May Have Conflicts of Interest Because They Are Also
Directors and Executive Officers of Viacom
Three members of our board of directors are directors and executive officers
of Viacom. These directors have obligations to us as well as to Viacom and may
have conflicts of interest with respect to matters potentially or actually
involving or affecting us. Our certificate of incorporation contains provisions
designed to facilitate resolution of these potential conflicts, which we
believe will assist our directors in fulfilling their fiduciary duties to our
stockholders. These provisions do not, however, eliminate or limit the
fiduciary duty of loyalty of our directors under applicable Delaware law.
Subject to applicable Delaware law, stockholders in our company are deemed to
have notice of and have consented to these provisions of our certificate of
incorporation. Although these provisions are designed to resolve such conflicts
between us and Viacom fairly, we cannot assure you that any conflicts will be
so resolved.
We Cannot Predict the Effect that a Split-off Would Have on the Price of Our
Common Stock
We cannot predict the effect that a split-off would have on the price of our
class A common stock. A split-off could involve the distribution of about
144,000,000 shares of our common stock by Viacom to its stockholders who
participate in the exchange offer representing about 82% of the equity value of
our company. All of those shares would be eligible for immediate resale in the
public market, other than any shares held by our affiliates. Viacom has the
sole discretion to determine the timing, structure and terms of a split-off or
other distribution of its shares of our common stock.
Conversely, if a split-off, including the exchange offer or other similar
transaction is not completed, Viacom will have the right to require us to
register its shares of our common stock under the U.S. securities laws for sale
in the public market. Sales by Viacom or others of substantial amounts of our
common stock in the public market, or the perception that such sales might
occur, could have a material adverse effect on the price of our class A common
stock.
There May Be an Adverse Effect on the Price of Our Class A Common Stock Due to
Disparate Voting Rights of Our Class A Common Stock and Our Class B Common
Stock and, Possibly, Differences in the Liquidity of the Two Classes
The differential in the voting rights of the class A common stock and class
B common stock could adversely affect the price of the class A common stock to
the extent that investors or any potential future
35
purchaser of our common stock ascribe value to the superior voting rights of
the class B common stock. The holders of class A common stock and class B
common stock generally have identical rights except that holders of class A
common stock are entitled to one vote per share while holders of class B common
stock are entitled to five votes per share on all matters to be voted on by
stockholders. Holders of class A common stock and class B common stock are
entitled to separate class votes on amendments to our certificate of
incorporation that would alter or adversely affect the powers, preferences or
special rights of the shares of their respective classes. In addition, it is
possible that differences in the liquidity between the two classes may develop,
which could result in price differences.
Our Anti-takeover Provisions May Delay or Prevent a Change of Control of Our
Company, Which Could Adversely Affect the Price of Our Common Stock
The existence of some provisions in our corporate documents and Delaware law
may delay or prevent a change in control of our company, which could adversely
affect the price of our common stock. Our certificate of incorporation and
bylaws contain some provisions that may make the acquisition of control of our
company more difficult, including provisions relating to the nomination,
election and removal of directors and limitations on actions by our
stockholders. In addition, Delaware law also imposes some restrictions on
mergers and other business combinations between us and any holder of 15% or
more of our outstanding common stock. Viacom, however, is generally exempted
from these provisions and will have special rights so long as it owns at least
a majority of the combined voting power of our two outstanding classes of
common stock.
In addition, we have entered into a tax matters agreement with Viacom, which
will require, among other things, that, until two years after the completion of
the split-off, we cannot voluntarily enter into certain transactions, including
any merger transaction or any transaction involving the sale of our capital
stock, without the consent of Viacom. In addition, we have agreed under this
tax matters agreement to indemnify Viacom for any tax liability incurred as a
result of the failure of the split-off to qualify as a tax-free transaction due
to a takeover of our company or any other transaction involving our capital
stock, assets or businesses, regardless of whether or not such transaction is
within our control.
36
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes thereto appearing elsewhere
in this document.
General
Blockbuster entered into the video rental business in 1985 and is the
world's leading retailer of rentable home videocassettes, DVDs and video games.
With about 7,200 system-wide stores we offer a wide selection of entertainment
products for rent or purchase. Our business model was significantly modified in
1997 to refocus on videocassette rental, improving the customer experience and
satisfying customer demand earlier for newly released videos. During 1998 and
1999, our customers' responses were very favorable with revenue increases of
17.5% and 14.6%, increases in same store revenues of 13.3% and 8.3%, and an
increase in domestic rental transactions of 14.0% and 3.4% on a same store
basis.
The consolidated financial statements for the periods presented do not fully
reflect the trends in our business as we had significantly different business
models during these periods. In addition, 1997 and 1998 include significant
charges which relate to these business model changes. As a result and as
further explained below, our results of operations for those periods are not
comparable.
In connection with our merger with Viacom in 1994, we valued our
videocassette rental library at fair market value, which formed the basis for
subsequent amortization of this inventory over a period of up to 36 months.
Such fair market value proved, on average, to be lower than the cost of rental
videocassettes acquired after the merger. As a result, amortization was lower
with respect to rental videocassettes acquired in the 1994 merger than rental
videocassettes purchased after the merger. This lower amortization favorably
affected results in 1996 and, to a lesser extent, in 1997. Amortization in 1996
and in 1997 also increased as a result of increased purchases of
videocassettes.
In 1996, we decided to offer not only our traditional video rental and
related merchandise but various other merchandise categories, including
clothing, books and magazines. We also decided to move our corporate
headquarters from Ft. Lauderdale, Florida to Dallas, Texas and to build an
850,000 square foot distribution center to handle our existing and new products
and eliminate third party distribution. These changes resulted in a $50.2
million charge.
Following significant management changes in 1997, we determined that the new
merchandise lines that had been added in 1996 were not as profitable as our
core rental business. As a result, we refocused our merchandise lines and in
the second quarter of 1997, we recorded charges amounting to $250 million,
$100.8 million of which related to a reduction in the carrying value of some of
our retail merchandise inventory.
In recognizing that we could not purchase enough videocassettes at the
"full" cost to satisfy customer demand without significantly increasing our
risk, we changed our business model. In 1998, in order to increase the quantity
and selection of newly released video titles and satisfy our customers' demand
for newly released videos earlier, we entered into revenue-sharing agreements
with the major movie studios. Prior to our change to a revenue-sharing business
model, our videocassette rental library was purchased at "full" cost, generally
between $60 and $70 per videocassette for major theatrical releases that were
priced for rental in the United States. The implementation of revenue-sharing
dramatically affected our cost of sales as it changed our business model from a
primarily fixed to a primarily variable cost approach. Starting in the second
quarter of 1998, revenue-sharing payments to the movie studios became a
significant component of our cost of sales. In addition, we shortened the
period over which we amortize the fixed cost of acquiring most newly released
videocassettes to three months. In connection with this change in method of
accounting for our videocassette rental library, we recorded a $424.3 million
charge to reflect a reduction in the carrying value of this library.
We have a substantial amount of intangible assets on our consolidated
financial statements. As of December 31, 1999, we had net intangible assets of
$5,975.9 million, which represented about 70.0% of our total assets and about
97.6% of our stockholders' equity. Our intangible assets consist primarily of
goodwill.
37
This goodwill was primarily created when Viacom acquired our business and
operations in 1994 for a purchase price in excess of the fair market value of
our tangible net assets at that time. This goodwill was originally recorded on
Viacom's financial statements in connection with Viacom's acquisition of our
business and operations and is now recorded as an asset on our consolidated
financial statements. This goodwill generally represents the BLOCKBUSTER brand.
We evaluate on a regular basis whether or not events and circumstances have
occurred to indicate that all or a portion of the carrying amount of these
intangible assets may require an adjustment or a change to the amortization
period.
Business Segment Information
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement No. 131, "Disclosures about Segments of an Enterprise and Related
Information" effective for fiscal years beginning after December 15, 1997. We
adopted Statement No. 131 in 1998 but had only one reportable segment.
Beginning in the fourth quarter of 1999, we began operating in two segments:
(i) home video, DVD and video game rental and retailing, which we refer to as
our video segment, and (ii) new technologies.
(i) Video
Through our video segment, we operate 5,879 video stores and our
franchisees and/or joint ventures operate 1,274 video stores located
throughout the United States, its territories and 26 other countries.
(ii) New Technologies
Through our new technologies segment, we operate our Internet site,
blockbuster.com, and our newly formed division, Digital Networks, which
is responsible for exploring various forms of electronic entertainment
delivery including video-on-demand.
We evaluate performance based on many factors. Two of the primary measures
are EBITDA and operating income. EBITDA is defined as net income (loss) before
equity in loss of affiliated companies (net of tax), benefit (provision) for
income taxes, interest income, interest expense, other items (net),
depreciation and amortization of intangibles. EBITDA may differ in the method
of calculation from similarly titled measures used by other companies.
Operating income is defined as income before interest, equity in loss of
affiliated companies (net of tax), other items and income taxes.
The following table sets forth summarized financial information relating to
our segments.
Year Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
(In millions)
Revenues
Video........................................... $3,313.6 $3,893.4 $4,463.3
New technologies................................ -- -- 0.2
-------- -------- --------
Total revenues................................ $3,313.6 $3,893.4 $4,463.5
======== ======== ========
EBITDA (1)
Video........................................... $ 207.9 $ 23.7 $ 520.6
New technologies................................ -- -- (6.6)
-------- -------- --------
Total EBITDA.................................. $ 207.9 $ 23.7 $ 514.0
======== ======== ========
Operating income (loss)
Video........................................... $ (214.6) $ (359.2) $ 128.7
New technologies................................ -- -- (7.0)
-------- -------- --------
Total operating income (loss)................. $ (214.6) $ (359.2) $ 121.7
======== ======== ========
- --------
(1) "EBITDA" is presented here to provide additional information about
Blockbuster's operations. EBITDA should be considered in addition to, but
not as a substitute for or superior to, operating income, net income, cash
flow and other measures of financial performance prepared in accordance
with generally accepted accounting principles.
38
Results of Operations
Consolidated Results
The following table sets forth consolidated results of operations and other
financial data.
Year Ended December 31,
--------------------------------
1997 1998 1999
--------- --------- ---------
(In millions, except margin
and worldwide store data)
Statement of Operations Data:
Revenues.................................... $ 3,313.6 $ 3,893.4 $ 4,463.5
Cost of sales............................... 1,360.5 1,956.4 1,762.5
--------- --------- ---------
Gross profit................................ 1,953.1 1,937.0 2,701.0
Operating expenses.......................... 2,167.7 2,296.2 2,579.3
--------- --------- ---------
Operating income (loss)..................... (214.6) (359.2) 121.7
Interest expense............................ (30.8) (27.7) (119.3)
Interest income............................. 3.7 4.0 3.2
Other items, net............................ (27.6) (11.8) (0.2)
--------- --------- ---------
Income (loss) before income taxes........... (269.3) (394.7) 5.4
Benefit (provision) for income taxes........ (30.0) 59.4 (71.8)
Equity in loss of affiliated companies, net
of tax..................................... (18.9) (1.3) (2.8)
--------- --------- ---------
Net income (loss)........................... $ (318.2) $ (336.6) $ (69.2)
========= ========= =========
Cash Flow Data:
Cash flows from operating activities........ $ 991.3 $ 1,234.5 $ 1,142.8
Cash flows used for investing activities.... (1,188.1) (1,022.2) (1,258.1)
Cash flows from (used for) financing
activities................................. 269.3 (241.1) 137.2
Other Data:
Depreciation................................ $ 253.8 $ 212.7 $ 220.5
Amortization of intangibles................. 168.7 170.2 171.8
EBITDA(1)................................... 207.9 23.7 514.0
Net income (loss) plus intangible
amortization, net of tax(1)(2)............. $ (155.0) $ (172.5) $ 94.8
Margins:
Rental margin(3)............................ 69.6% 54.6% 66.0%
Merchandise margin(4)....................... 7.4 19.8 21.0
Gross margin(5)............................. 58.9 49.8 60.5
Worldwide Store Data:
Same store revenues (decrease) increase(6).. (1.8)% 13.3% 8.3%
Total system-wide stores at end of period... 6,049 6,381 7,153
- --------
(1) "EBITDA" and "Net income (loss) plus intangible amortization, net of tax"
are presented here to provide additional information about Blockbuster's
operations. These items should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, cash flow and
other measures of financial performance prepared in accordance with
generally accepted accounting principles. EBITDA may differ in the method
of calculation from similarly titled measures used by other companies.
(2) Intangible amortization, net of tax, included in this item is primarily
related to goodwill.
(3) Rental gross profit as a percentage of rental revenues.
(4) Merchandise gross profit as a percentage of merchandise revenues.
(5) Gross profit as a percentage of total revenues.
(6) A store is included in the same store revenue calculation after it has been
opened and operated by us for more than 52 weeks. An acquired store becomes
part of the same store base in the 53rd week after its acquisition and
conversion. The percentage change is computed by comparing total net
revenues for same stores at the end of the applicable reporting period with
total net revenues from these same stores for the comparable period in the
prior year.
39
Special Item Charges
During the second quarter of 1997, we recorded a $250 million special item
charge principally associated with a write-down of excess inventory of $100.8
million, operating charges for domestic and international reorganization, store
closings and additional corporate relocation costs. This special item charge
also included write-offs attributable to our joint venture operations in Japan
recorded as equity in loss of affiliated companies, net of tax.
During the second quarter of 1998, we recorded a $424.3 million special item
charge associated with a change in the method of accounting for videocassettes
and video game rental inventory.
The following is a summary of the impact of the above-described special item
charges on our operating results during the periods presented.
Year Ended December 31,
------------------------
1997 1998
----------- -----------
Operating income (loss).......................... $ (220.3) $ (424.3)
Net income (loss)................................ (174.7) (273.1)
Excluding the above described special item charges, operating results would
have been as follows:
Year Ended December 31,
------------------------
1997 1998
----------- -----------
Revenues......................................... $ 3,313.6 $ 3,893.4
Cost of sales.................................... 1,259.7 1,532.1
----------- -----------
Gross profit..................................... 2,053.9 2,361.3
Operating expenses............................... 2,048.2 2,296.2
----------- -----------
Operating income, excluding special item
charges......................................... $ 5.7 $ 65.1
=========== ===========
Comparison of 1999 to 1998
Revenues. Revenues of $4,463.5 million in 1999 increased $570.1 million, or
14.6%, from $3,893.4 million in 1998. The increase in revenues was primarily
due to increases in worldwide same store revenues of 8.3% in 1999 as compared
to the corresponding period in 1998 and an increase in the number of company-
operated stores of 596 to 5,879 at December 31, 1999 from 5,283 at December 31,
1998. The increase in same store revenues was principally due to increases in
the average domestic rental fee, the increased number of domestic rental
transactions of 3.4% and increased sales of previously viewed videotapes for
the year ended December 31, 1999 as compared to the corresponding period of the
prior year.
Rental revenue of $3,758.5 million in 1999, which also includes sales of
previously viewed videotapes and extended viewing fees, increased $538.9
million, or 16.7%, from $3,219.6 million in 1998. The increase in rental
revenue was primarily due to the increase in the number of company-operated
stores of 596, an increase in the average domestic rental fee and the increase
in rental transactions.
Previously viewed product sales, which includes previously viewed
videotapes, video games and DVDs, increased 48.4% to $285.0 million in 1999
from $192.0 million in 1998, primarily driven by operating a full year under
the revenue-sharing model which produces a much larger quantity of previously
viewed videotapes available for sale than our previous business model. As a
percentage of total revenues, sales of previously viewed product increased to
6.4% for 1999 as compared to 4.9% in 1998.
Extended viewing fees of $692.6 million in 1999 increased $108.7 million, or
18.6%, from $583.9 million in 1998 due to the increase in same store rental
transactions and the number of company-operated stores. As a percentage of
total revenues, extended viewing fees increased to 15.5% for 1999 as compared
to 15.0% in 1998. Base rental fees and extended viewing fees vary from market
to market.
40
Merchandise sales declined $2.9 million, or 0.5%, in 1999 compared to 1998.
The two primary reasons for the decrease in merchandise sales were (i) our
efforts to refocus the sale of music CDs from all company-operated stores in
1998 to an average of 1,100 stores in 1999 and (ii) the video release of
Titanic in the third quarter of 1998. The decrease in CD sales and sell-through
videocassettes was mostly offset by increases in sales of DVD titles, increased
sales of licensed merchandise and increased confection sales.
As expected our same store revenue increases were in the mid-to-low single
digits in the third and fourth quarters of 1999 as we began comparing against
previous quarters that were operating under the revenue-sharing model. We
expect our same store revenue increases for fiscal 2000 to be more consistent
with the third and fourth quarter of 1999, as presented below in "General
Economic Trends, Quarterly Results of Operations and Seasonality."
Cost of Sales. Cost of sales of $1,762.5 million in 1999 decreased $193.9
million from $1,956.4 million in 1998. Cost of sales as a percentage of total
revenues in 1999 decreased to 39.5% from 50.2% in 1998. Excluding the special
item charge of $424.3 million in the second quarter of 1998, cost of sales for
the year increased $230.4 million, or 15.0%, primarily as a result of an
increase in revenue resulting in an increase in revenue-sharing payments of
$276.4 million and increased costs of sales associated with previously viewed
videotapes of $74.0 million, partially offset by a decrease in the amortization
of rental product of $110.5 million and decreased cost of merchandise sales of
$9.5 million. Commencing on April 1, 1998, we substantially increased our
purchases of videocassette rental product through revenue-sharing arrangements
with the movie studios. The increases in purchases under the revenue-sharing
model have significantly increased our costs associated with revenue-sharing
payments which are expensed as the associated rental revenue is earned. The
increase in revenue-sharing payments was partially offset by a decrease in the
amortization of rental product. The decrease in rental product amortization was
due to the decline in the fixed costs of rental product purchased under the
revenue-sharing agreements. The decrease in merchandise cost of sales was
primarily due to decreased sales of sell-through videos as compared to the
prior year, which included the release of Titanic, and decreased sales of music
CDs which have traditionally had lower margins than our other retail products.
Gross Profit. Gross profit of $2,701.0 million in 1999 increased $764.0
million, from $1,937.0 million in 1998. For 1999, gross profit as a percentage
of total revenues increased to 60.5% from 49.8% in 1998. Excluding the special
item charge of $424.3 million in 1998, gross profit as a percent of revenue was
60.5% for 1999 versus 60.6% for 1998.
Operating Expenses. Total operating expenses of $2,579.3 million in 1999
increased $283.1 million from $2,296.2 million in 1998, primarily due to a net
increase in the number of company-operated stores of 596 to 5,879 at December
31, 1999 from 5,283 at December 31, 1998. Total operating expenses decreased as
a percentage of total revenues to 57.8% in 1999 from 59.0% in 1998. The
increases in total operating expenses resulted from the following:
General and Administrative Expense. General and administrative expense,
which includes expenses incurred at the store, regional and corporate
level, decreased as a percentage of total revenues to 43.8% in 1999 from
44.5% in 1998 reflecting the benefits of leveraging our cost structure to
an increasing revenue base. General and administrative expense of $1,953.2
million in 1999 increased $220.9 million from $1,732.3 million in 1998. The
dollar increase in 1999 primarily resulted from compensation increases of
$128.0 million related to additional personnel needed to support our store
growth and increased store traffic. Occupancy costs increased $52.1 million
largely as a result of an increase in the number of company-operated
stores. Other corporate and store expenses increased $40.8 million due
primarily to the growth of our business.
During 1999 we began selling some of our company-operated stores to
existing and new franchisees in markets where their expertise can be
leveraged to improve our overall operating performance, while retaining
ownership of key U.S. and international markets. We expect that the loss of
store level profits from the disposal of these stores will be largely
mitigated by increased franchisee fees from stores franchised, lower field
and general and administrative expenses and reduced interest costs due to
the
41
reduction of debt from the after-tax cash proceeds from our refranchising
activities. Included as a reduction of general and administrative expenses
in 1999 was $19.9 million of refranchising gains. We plan on continuing our
refranchising efforts in 2000.
Advertising Expense. Advertising expense of $233.8 million in 1999
increased $52.8 million from $181.0 million in 1998. As a percentage of
total revenues, advertising expense increased to 5.2% in 1999 from 4.6% in
1998. These increases reflect our planned increased investment in
advertising and marketing principally due to additional media, direct mail
and other promotions related to our various programs such as BLOCKBUSTER
REWARDS, Million Dollar Days and other programs.
Interest Expense. Interest expense of $119.3 million in 1999 increased
$91.6 million as compared to $27.7 million in 1998. The increase was primarily
related to debt incurred under our new credit agreement in order to repay
Viacom about $1.6 billion in connection with promissory notes issued by us for
the payment of a dividend to Viacom International Inc. and advances by Viacom
to us for various acquisitions.
Benefit (Provision) for Income Taxes. We recognized a provision for income
taxes of $71.8 million in 1999 as compared to a benefit for income taxes of
$59.4 million in 1998. The fluctuation in the provision is primarily due to the
tax benefit associated with the special item charge recorded in the second
quarter of 1998. The 1999 and 1998 provision reflects permanent differences
resulting from the non-deductibility of goodwill amortization associated with
Viacom's acquisition of us in 1994 and tax operating losses from certain
foreign countries. We did not recognize a benefit for these foreign
jurisdictions, which incurred losses, in our 1999 tax provision, as it is
currently more likely than not that the benefit will not be realized. We review
our net operating losses on a country by country basis and may determine in the
future that some or all of the net operating losses generated in the past will
be utilized in the future.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
income (loss) of affiliated companies, net of tax was a loss of $2.8 million in
1999 as compared to a loss of $1.3 million in 1998 primarily due to increased
losses in our joint venture operations in Italy.
Net Income (Loss). For the reasons described above, the net loss of $69.2
million in 1999 reflects a reduction in net loss of $267.4 million from a net
loss of $336.6 million in 1998.
SEGMENT RESULTS
Video
Our video segment consists of rentable home videos, DVDs, video games and
retail product. Video revenues increased $569.9 million, or 14.6%, for the
year, primarily due to increases in rental revenues of 16.7% and a net increase
of 772 system-wide video stores in operation. Same store revenues increased
8.3% over the prior year as a result of increases in the average domestic
rental fee, a 3.4% increase in domestic rental transactions and increased sales
of previously viewed videotapes.
Operating income increased $487.9 million to $128.7 million in 1999 from a
loss of $359.2 million in the prior year. Results for 1998 reflect the
implementation of a new business model and a special item charge in the second
quarter of $424.3 million to adjust the carrying value of videocassettes and
game rental inventory under a new method of amortization. Excluding the impact
of the 1998 charge, video's operating income increased $63.6 million to $128.7
million in 1999 from $65.1 million in 1998, primarily due to the increased
revenues discussed above and leveraging our operating expenses to an increased
revenue base. Our operating expenses as a percentage of total video revenues
decreased from 59.0% in 1998 to 57.6% for the same period of 1999.
New Technologies
Our new technologies segment consists of Internet video sales,
entertainment-related news and information, and e-commerce offerings and is
also focused on developing relationships and infrastructure
42
needed to deliver digital video services across multiple networks to multiple
devices. On November 22, 1999, we re-launched blockbuster.com as a strategic
first step towards delivery of premium entertainment options to our customers.
New technologies revenues of $0.2 million in 1999 consisted primarily of sales
through the Internet of sell-through videocassettes and previously viewed
videotapes and commissions from the sale of BLOCKBUSTER GIFTCARDS.
Operating loss for our new technology business segment was $7.0 million.
This loss reflects start-up costs incurred to advertise our new website, hire
additional people to support the new website and consulting and maintenance
costs to bring the website up to full functionality. We expect to incur
continued losses in the immediate future with this segment.
Comparison of 1998 to 1997
Revenues. Revenues of $3,893.4 million in 1998 increased $579.8 million, or
17.5%, from $3,313.6 million in 1997 largely as a result of a 13.3% growth in
our same store revenues which increased primarily as a result of an increase of
about 14% in our domestic rental transactions on a same store basis and the net
addition of 178 company-operated stores. Revenue growth consisted primarily of
increases in rental transactions driven by:
. a substantial increase in the quantity and selection of newly released
videos provided through revenue-sharing agreements;
. the impact of our advertising campaigns aimed at marketing the improved
customer experience;
. the implementation of more competitive pricing and rental terms; and
. the increased popularity of game rentals.
Extended viewing fees of $583.9 million in 1998 increased $180.1 million, or
44.6%, from $403.8 million in 1997 largely as a result of increases in rental
transactions and fee increases in January 1998, which were partially offset by
longer base rental periods. As a percentage of total revenues, extended viewing
fees increased to 15.0% in 1998 from 12.2% in 1997.
Merchandise sales also contributed to revenue growth increasing $24.0
million, or 4.0%, over the prior year largely as a result of the video release
of Titanic, an increase in the number of company-operated stores and improved
merchandising campaigns in some markets.
Cost of Sales. Cost of sales of $1,956.4 million in 1998 increased $595.9
million from $1,360.5 million in 1997. Cost of sales as a percentage of total
revenues increased to 50.2% in 1998 from 41.1% in 1997. Excluding the special
item charges of $424.3 million in 1998 and $100.8 million in 1997, cost of
sales increased $272.4 million primarily as a result of revenue-sharing
payments to movie studios and cost of merchandise sales. Commencing on April 1,
1998, we substantially increased our purchases of videocassette rental product
through revenue-sharing arrangements with the movie studios. Pursuant to our
new business model and our change in accounting method adopted on April 1,
1998, revenue-sharing payments are expensed as incurred and the cost of rental
product amortization has been accelerated. Payments made pursuant to our
revenue-sharing agreements increased $314.3 million in 1998 as compared to
1997. Partially offsetting the increased expense due primarily to revenue-
sharing is a decrease in rental tape amortization of $88.3 million. This
decrease is due to the decline in the fixed costs of rental product purchased
pursuant to revenue-sharing. Our total cost of merchandise sold of $495.5
million increased $46.4 million in 1998 from $449.1 million in 1997.
Gross Profit. Gross profit as a percentage of revenues, or gross margin,
decreased to 49.8% in 1998 from 58.9% in 1997. Excluding the special item
charges of $424.3 million in 1998 and $100.8 million in 1997, gross profit
decreased as a percentage of revenues to 60.6% in 1998 from 62.0% in 1997.
Gross margins for 1998 and 1997 are not comparable because of the special item
charges recorded in the second quarter of each year
43
and the change in accounting implemented in the second quarter of 1998 related
to our new business model. Merchandise margins declined in 1998 as compared to
1997 due to increased markdowns and promotional activities during 1998.
Operating Expenses. Total operating expenses of $2,296.2 million in 1998
increased $128.5 million from $2,167.7 million in 1997. Total operating
expenses as a percentage of total revenues decreased to 59.0% in 1998 from
65.4% in 1997. The increase in total operating expenses resulted from the
following:
General and Administrative Expense. General and administrative expense,
which includes expense incurred at the store, regional and corporate level,
decreased as a percentage of total revenues to 44.5% in 1998 from 48.5% in
1997. Excluding the special item charge of $74.4 million related to
relocation and occupancy costs in 1997, general and administrative expense
of $1,732.3 million in 1998 increased $201.0 million from $1,531.3 million
in 1997 due to compensation increases of $81.3 million, a $73.9 million
increase in other corporate and store expenses and a $45.8 million increase
in occupancy cost. Store labor cost increased because of an increase in the
number of store personnel, the increase in the number of company-operated
stores and an increase in minimum wage from $4.75 per hour to $5.15 per
hour which became effective in September 1997. The increase in the number
of store personnel reflects our commitment to better serve its customers
and support its revenue growth. The increase in occupancy cost was
primarily attributable to an increase in the number of stores.
Advertising Expense. Advertising expense of $181.0 million in 1998
increased $41.5 million from $139.5 million in 1997. As a percentage of
total revenues, advertising expense increased to 4.6% in 1998 from 4.2% in
1997. This increase was primarily due to additional promotional and
advertising activity in order to increase customer awareness of the greater
quantity and selection of newly released videos, our improved customer
service, and the improved selection of BLOCKBUSTER FAVORITES.
Depreciation. Depreciation expense of $212.7 million in 1998 decreased
$41.1 million from $253.8 million in 1997. Excluding the special item
charge of $45.1 million in 1997 associated with domestic and international
reorganization and store closings, depreciation expense increased $4.0
million in 1998 from 1997 reflecting net store growth.
Excluding the 1998 and 1997 special item charges, total operating expenses
increased $248.0 million in 1998 from 1997.
Interest Expense. Interest expense of $27.7 million in 1998 decreased $3.1
million from $30.8 million in 1997.
Other Items, Net. Other items of $11.8 million in 1998 decreased $15.8
million from $27.6 million in 1997 largely due to the recognition of non-cash
expenses of $10.5 million and $27.1 million in 1998 and 1997, respectively, to
write-down non-strategic investments to their net realizable value.
Benefit (Provision) for Income Taxes. We recognized a benefit for income
taxes of $59.4 million in 1998 as compared to a provision for income taxes of
$30.0 million in 1997. This change was primarily attributable to the mix of
domestic and foreign income or losses. We did not recognize a benefit for
foreign losses, as it is more likely than not that the benefit will not be
realized. Goodwill associated with Viacom's acquisition of our business and
operations and which is now recorded on our financial statements is not
amortizable for tax purposes. Excluding the non-deductible amortization of
intangibles, the annual effective tax rates would have been 24.6% in 1998 and
(25.8%) in 1997.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
loss of affiliated companies, net of tax, decreased primarily due to the fact
that we recognized a pre-tax charge of $29.4 million in 1997 associated with
our investment in our Japanese joint venture.
Net Income (Loss). For the reasons described above, net loss of $336.6
million in 1998 increased $18.4 million from a loss of $318.2 million in 1997.
Excluding the special item charges in 1998 and 1997, net loss declined $80.0
million to $63.5 million in 1998 from $143.5 million in 1997.
44
Liquidity and Capital Resources
Liquidity Prior to and Upon Our Separation from Viacom
Prior to our initial public offering of class A common stock, our capital
investments and acquisitions were financed with a combination of cash flow from
operations and advances from Viacom. We generate cash from operations
predominantly from the rental of videocassettes, video games, and DVDs and we
have substantial operating cash flow because most of our revenue is received in
cash and cash equivalents. Prior to our initial public offering, Viacom
deposited sufficient cash in our bank accounts to meet our daily obligations
and withdrew excess funds from those accounts. These transactions were included
in advances from Viacom in the consolidated balance sheets and consolidated
statements of cash flows. The amounts owed to Viacom prior to our initial
public offering were capitalized into Viacom's net equity investment.
Excess operating cash flow, additional funding from Viacom and borrowings
under our credit facility were used primarily for opening and acquiring new
stores, the refurbishment, remodeling and relocation of existing stores and the
purchase of videocassette inventory. Prior to our initial public offering, our
capital structure was established which replaced our reliance on Viacom's cash
management system. At the time of our initial public offering, all cash
accounts were settled and, since such time, we have no longer participated in
Viacom's cash management system. As such, no further amounts will be deposited
in or withdrawn from our accounts by Viacom.
In October 1998, BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. The
remaining lease terms expire on various dates through 2007. We have agreed to
indemnify Viacom with respect to any amount paid under these guarantees. At the
time of the sale, the contingent liability for base rent was about $84 million
on an undiscounted basis, with respect to these guarantees. We have not
recognized any reserves related to this contingent liability. If Wherehouse
defaults, related payments are expected to be funded from operating cash flow.
Related losses due to default could materially affect future operating income.
We expect to fund our future anticipated cash requirements, including the
anticipated cash requirements for capital expenditures, joint ventures,
commitments and payments of principal and interest on any borrowings, with
internally generated funds, in addition to various external sources of funds
which may be available to us. The external sources of funds include our credit
agreement and amendments thereto and may include future issuances of debt,
equity or other securities. However, we cannot assure you that we will be able
to access capital markets in the future on terms that will be satisfactory to
us. We believe that such internally and externally generated funds will provide
us with adequate liquidity and capital necessary for fiscal 2000.
Consolidated Cash Flows
Operating Activities. Net cash flow provided by operating activities
decreased $91.7 million, or 7.4%, from $1,234.5 million in 1998 to $1,142.8
million in 1999 primarily due to incremental interest expense of $91.6 million
and an increase in revenue-sharing payments of $276.4 million. The increase in
interest expense was attributable to our increased level of debt in 1999 under
our new credit agreement due primarily to a payment of $1.6 billion to Viacom
relating to a promissory note issued by us as a dividend to Viacom
International Inc. and advances by Viacom to us for various acquisitions. The
increase in revenue-sharing payments was primarily due to the increase in
company-operated stores. Changes in operating assets and liabilities decreased
net cash flow provided by operating activities by $60.8 million, primarily due
to the tax receivable from Viacom of $41.1 million and an increase in prepaid
revenue-sharing payments of $20.6 million. These decreases to operating cash
flows were partially offset by a decrease in net deferred taxes.
Investing Activities. Net cash used in investing activities increased $235.9
million, from $1,022.2 million in 1998 to $1,258.1 million in 1999 as a result
of a $199.4 million increase in capital expenditures primarily for
45
new store openings and store remodeling in 1999 and a $77.5 million increase in
cash used for store acquisitions. These were offset by $36.1 in proceeds from
sales of store operations.
The major components of investing activities are detailed below:
1997 1998 1999
--------- --------- ---------
(in millions)
Cash flows from investing activities:
Rental library purchases.................... $ (860.2) $ (818.1) $ (808.7)
Capital expenditures........................ (262.2) (175.0) (374.4)
Cash used for acquisitions.................. (79.0) (34.2) (111.7)
Proceeds from sale of property and
equipment.................................. 19.1 0.3 1.7
Proceeds from sales of store operations..... -- -- 36.1
Investment in affiliated companies.......... (5.8) 4.8 (1.1)
--------- --------- ---------
Net cash flow used in investing activities.... $(1,188.1) $(1,022.2) $(1,258.1)
========= ========= =========
Our capital expenditures include store equipment and fixtures, remodeling of
some existing stores, implementation and upgrading of office and store
technology and the opening of new store locations. Each new store opening
requires initial capital expenditures, including leasehold improvements,
inventory, equipment and costs related to site locations, and construction
permits. We plan to evaluate and pursue new sites within the video rental
industry in both the United States and in certain international markets and
will require capital and/or ongoing infrastructure enhancements to support our
expansion strategies in developing markets and for acquisitions.
We currently anticipate that capital expenditures in excess of $200.0
million will be incurred in 2000 in the video segment.
We currently anticipate that capital expenditures of about $40.0 million
will be incurred in 2000 in the new technologies segment.
Financing Activities. Net cash flow provided by financing activities
increased $378.3 million to $137.2 million in 1999 as compared to the use of
funds of $241.1 million in 1998.
On December 31, 1998, we declared a $1.4 billion dividend in the form of a
promissory note to Viacom International Inc. In the first quarter of 1999, we
issued other promissory notes of about $77 million to Viacom International Inc.
relating to our purchase of video stores. On June 23, 1999 we paid these notes
including accrued and unpaid interest with the proceeds of the borrowings under
the credit agreement described below.
Items affecting financing activities for 1999 were as follows:
On June 21, 1999, we entered into a $1.9 billion unsecured credit
agreement with a syndicate of banks. This credit agreement is comprised of
a $700 million long-term revolver due July 1, 2004, a $600 million term
loan due in quarterly installments beginning April 1, 2002 and ending July
1, 2004, and a $600 million short-term revolver due June 19, 2000. Interest
rates are based on the prime rate or LIBOR at our option at the time of
borrowing. A variable commitment fee based on the total leverage ratio is
charged on the unused amount of the revolver (0.4% for 1999). On June 23,
1999, we borrowed $1.6 billion under our credit agreement, all of which was
used to:
. pay a portion of the purchase price to Viacom's affiliates to acquire
the non-U.S. operations of our business that we did not already own;
. repay debt owed to Viacom International Inc. and its affiliates; and
. pay fees and expenses related to the origination of our credit
agreement.
We repaid $442.9 million of the short-term revolver through net proceeds
from our initial public offering. These proceeds permanently reduced our
commitments under our credit agreement from $1.9 billion to approximately
$1.46 billion.
46
Our credit agreement was designed and used to replace our reliance on
Viacom's centralized cash management system. At December 31, 1999, we had
$270.0 million of available borrowing capacity under our credit agreement.
As of December 31, 1999, we had $157.1 million outstanding under the short-
term revolver which is due on June 19, 2000. We expect to fund this
obligation by various external sources, including additional borrowings
under the revolver due July 1, 2004, an amendment to our existing credit
agreement, or the issuance of debt securities.
Our credit agreement contains certain restrictive covenants, which,
among other things, relate to the payment of dividends, the repurchase of
our common stock or other distributions and also require compliance with
certain financial covenants with respect to a maximum leverage ratio and a
minimum fixed charge coverage ratio. At December 31, 1999 we were in
compliance with all financial covenants under our credit agreement. Our
credit agreement allows up to an additional $75 million in other debt.
During 1999 we also entered into two additional lines of credit with
banks. In August 1999, we secured a one-year line of credit of $45.0
million from Bank of New York. In October 1999, we secured a one-year line
of credit of $30.0 million from Bank of America. Neither line had an
outstanding balance at December 31, 1999.
On August 10, 1999 we sold to the public 31 million shares of our class
A common stock for $15 per share. Proceeds from the offering aggregated
$430.1 million, net of underwriting discounts and commissions of $22.1
million and offering expenses of $12.8 million. Of the gross proceeds from
the offering, $442.9 million was used to pay down the short-term revolving
loan due June 19, 2000 and permanently reduced our borrowing capacity.
On November 22, 1999 we paid a dividend of $3.5 million, of which Viacom
International Inc. was paid about $2.9 million. On February 15, 2000, our
board of directors declared a cash dividend of $0.02 per share of class A
and class B common stock, payable March 20, 2000, to our stockholders of
record at the close of business on February 28, 2000. The total dividend
payment was about $3.5 million, of which Viacom International Inc. was paid
about $2.9 million.
On November 3, 1999 Blockbuster and America Online announced a three-year
strategic alliance. As part of the agreement, America Online will make a $30
million investment, representing about 2.75% ownership, in blockbuster.com that
will be used for, among other things, joint development of broadband content
and delivery. If an initial public offering of blockbuster.com is not completed
within 18 months of the closing of the transaction, America Online will have
the option to recover its investment plus cost of capital.
As we continually evaluate our strategic alternatives for our new
technologies business to maximize the value to our stockholders we may provide
for additional financing either through our own investments, investment by
strategic partners, or an initial public offering of an equity interest, or
other possibilities.
Other Financial Measurements: Working Capital
At December 31, 1999, we had cash and cash equivalents of $119.6 million.
Working capital, however, reflected a deficit of $418.8 million due to the
accounting treatment of our videocassette rental library. Videocassette rental
inventories are accounted for as non-current assets and are excluded from the
computation of working capital. The acquisition cost of videocassette rental
inventories, however, is reported as a current liability and, accordingly, is
included in the computation of working capital. Consequently, we believe
working capital is not as significant a measure of financial condition for
companies in the home video industry as it is for companies in some other
industries. Because of this accounting treatment, we may, from time to time,
operate with a working capital deficit.
Availability of Foreign Net Operating Losses
As more fully discussed in Note 11 to the Consolidated Financial Statements
we are required, if so requested by Viacom, to surrender certain tax losses of
the United Kingdom subsidiaries for 1998 and earlier
47
years to Viacom without any compensation. At December 31, 1999 our foreign net
operating loss tax assets, which are fully reserved, were $47.7 million.
General Economic Trends, Quarterly Results of Operations and Seasonality
We anticipate that our business will be affected by general economic and
other consumer trends. Our business is subject to fluctuations in future
operating results due to a variety of factors, many of which are outside of our
control. These fluctuations may be caused by, among other things, those factors
set forth above under "Cautionary Statements."
48
The following table sets forth consolidated quarterly statement of
operations data for the twelve quarters ended December 31, 1999. This
consolidated quarterly information includes the special item charges recognized
in the second quarter of each of 1997 and 1998 discussed above and described in
notes 3 and 4 of Blockbuster's consolidated financial statements and, in our
opinion, includes all normal recurring adjustments necessary for a fair
presentation of the information for the periods covered. This data should be
read in conjunction with the consolidated financial statements and the notes
thereto. The quarterly operating results are not necessarily indicative of the
operating results for any future period.
Quarter Ended
-----------------------------------------------
March 31 June 30(1) September 30 December 31
-------- -------- ------------ -----------
(In millions, except percentage amounts)
1997
Revenues...................... $ 823.8 $ 765.3 $ 817.7 $ 906.8
Gross profit.................. 538.3 370.5 504.5 539.8
Operating income (loss)....... 71.2 (263.6) (14.8) (7.4)
Net income (loss)............. (19.3) (227.3) (37.8) (33.8)
Net income (loss) plus
intangible amortization, net
of tax....................... 21.5 (186.5) 3.0 7.0
Same store revenues increase
(decrease) (2)............... (1.2)% (2.3)% (1.5)% (1.0)%
1998
Revenues...................... $ 931.2 $ 890.0 $ 985.4 $1,086.8
Gross profit.................. 604.6 100.2 591.7 640.5
Operating income (loss)....... 67.0 (456.9) 5.4 25.3
Net income (loss)............. 15.8 (318.0) (21.5) (12.9)
Net income (loss) plus
intangible amortization, net
of tax....................... 56.8 (277.0) 19.6 28.1
Same store revenues increase
(2).......................... 7.6% 12.6% 18.2% 14.5%
1999
Revenues...................... $1,113.0 $1,041.7 $1,112.8 $1,196.0
Gross profit.................. 671.2 645.3 681.4 703.1
Operating income (loss)....... 48.6 4.2 28.6 40.3
Net income (loss)............. (3.4) (39.9) (19.1) (6.8)
Net income (loss) plus
intangible amortization, net
of tax....................... 37.8 1.0 22.0 34.3
Same store revenues increase
(2).......................... 17.0% 9.9% 5.7% 2.8%
- --------
(1)The table below presents the second quarter of 1997 and 1998 excluding
special item charges:
Quarter Ended
June 30,
--------------
1997 1998
------ ------
(In millions)
Revenues................................................ $765.3 $890.0
Gross profit............................................ 471.3 524.5
Operating income (loss)................................. (43.3) (32.6)
Net income (loss)....................................... (52.6) (44.9)
Net income (loss) plus intangible amortization, net of
tax.................................................... (11.8) (3.9)
(2) This represents the increase (decrease) over the prior comparable period.
Market Risk
Blockbuster is exposed to various market risks including interest rates on
its debt and foreign exchange rates. In the normal course of business we employ
established policies and procedures to manage these risks.
Interest Rate Risk
Historically, we have had no material interest rate risk associated with
debt used to finance our operations due to limited borrowings and our
relationship with Viacom. However, on June 23, 1999, we borrowed
49
$1.6 billion, comprised of $400 million borrowed under the long-term revolver,
$600 million borrowed under the term loan, and $600 million under the short-
term revolver. Total outstanding borrowings at December 31, 1999 were $1,187.1
million. Interest rates are based on the prime rate in the United States or
LIBOR (plus a margin based on leverage ratios) at our option at the time of
borrowing. The weighted average interest rate at December 31, 1999 for these
borrowings was 7.9%. We anticipate managing our future interest rate exposure
by using a mix of fixed and floating interest rate debt and, if appropriate,
financial derivative instruments. We are primarily vulnerable to changes in
LIBOR which is the rate currently used in existing agreements, however, we do
not believe this exposure to be material. A one percentage point increase or
decrease in LIBOR would affect our interest expense by $11.9 million on an
annual basis.
Foreign Exchange Risk
Operating in international markets involves exposure to movements in
currency exchange rates. Currency exchange rate movements typically also
reflect economic growth, inflation, interest rates, government actions and
other factors. As currency exchange rates fluctuate, translation of the
statements of operations of Blockbuster's international businesses into U.S.
dollars may affect year-over-year comparability and could cause Blockbuster to
adjust its financing and operating strategies.
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between thier existing, or local, currencies
and one common currency, the Euro. The Euro trades on currency exchanges and
may be used in business transactions. Conversion to the Euro eliminates
currency exchange risk between the participating member countries. Beginning
January 2002, new Euro-denominated bills and coins will be issued, and local
currencies will be withdrawn from circulation.
Numerous issues are raised by the Euro currency conversion including the
need to adapt computer and financial systems and business processes and
equipment. Due to these uncertainties, we cannot reasonably estimate the long-
term effects one common currency may have on pricing, costs, and the resulting
impact, if any, on our financial condition or results of operations. However,
we believe that we have and will continue to take appropriate steps to assess
and address Euro conversion issues and currently do not expect that our
business will be adversely affected by such conversion in any material respect.
Our operations outside the United States constitute 19.4% of our total
revenues. Our operations in Europe constitute 9.9% of our total revenues. The
majority of these sales are from Great Britain, which has not adopted the Euro.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") effective for fiscal years beginning after
June 15, 2000. Blockbuster anticipates that, due to its limited use of
derivative instruments, the adoption of SFAS 133 effective January 1, 2001 will
not have a material effect on its financial statements.
Year 2000
Overview
The widespread use of computer programs that rely on two-digit dates to
perform computations and decision making functions may have caused computer
systems to malfunction prior to or in the year 2000 ("Y2K") and may lead to
significant business delays and disruptions in the United States and
internationally. We have completed our program to identify and mitigate Y2K
risks. To date, we have not encountered any disruptions related to the Y2K
issue. We cannot provide any assurances, however, that our business partners
have not been or will not be affected in any manner. As a result, we will
continue to monitor our own Y2K compliance and that of our business partners
and we do not expect to encounter any significant disruptions in the future.
50
Contingency Plans and Risks
As part of the Y2K program, the remediation, testing and review of each
application, infrastructure item and business partners occurred, and we
evaluated the need for contingency plans. Because the systems have been found
to be Y2K compliant, a contingency plan has not been deemed necessary. However,
we will continue to devote the necessary resources to monitor any possible
disruptions caused by the Y2K issue.
We incurred $11.6 million of costs relating to this program, which were
expensed as incurred.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Response to this item is included in "Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations--Market Risk."
51
Item 8. Financial Statements and Supplementary Data
BLOCKBUSTER INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Audited Consolidated Financial Statements:
Report of Independent Accountants....................................... 53
Consolidated Statements of Operations--Years Ended December 31, 1997,
1998 and 1999.......................................................... 54
Consolidated Balance Sheets--at December 31, 1998 and 1999.............. 55
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Income--Years Ended December 31, 1997, 1998 and 1999..... 56
Consolidated Statements of Cash Flows--Years Ended December 31, 1997,
1998 and 1999.......................................................... 57
Notes to Consolidated Financial Statements.............................. 58
Some supplementary financial statement schedules have been omitted because
the information required to be set forth therein is either not applicable or
is shown in the consolidated financial statements or notes thereto.
52
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Blockbuster Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of changes in stockholders' equity and
comprehensive income, and of cash flows present fairly, in all material
respects, the financial position of Blockbuster Inc. at December 31, 1998 and
1999, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 1999, in conformity with
accounting principles generally accepted in the United States. 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
auditing standards generally accepted in the United States 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.
/s/ PricewaterhouseCoopers LLP
Dallas, Texas
February 8, 2000
53
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
Year Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
Revenues:
Rental revenues................................ $2,664.0 $3,219.6 $3,758.5
Merchandise sales.............................. 594.0 618.0 615.1
Other revenues................................. 55.6 55.8 89.9
-------- -------- --------
3,313.6 3,893.4 4,463.5
-------- -------- --------
Cost of sales:
Cost of rental revenues........................ 810.6 1,460.9 1,276.5
Cost of merchandise sold....................... 549.9 495.5 486.0
-------- -------- --------
1,360.5 1,956.4 1,762.5
-------- -------- --------
Gross profit................................... 1,953.1 1,937.0 2,701.0
-------- -------- --------
Operating expenses:
General and administrative..................... 1,605.7 1,732.3 1,953.2
Advertising.................................... 139.5 181.0 233.8
Depreciation................................... 253.8 212.7 220.5
Amortization of intangibles.................... 168.7 170.2 171.8
-------- -------- --------
2,167.7 2,296.2 2,579.3
-------- -------- --------
Operating income (loss).......................... (214.6) (359.2) 121.7
Interest expense............................... (30.8) (27.7) (119.3)
Interest income................................ 3.7 4.0 3.2
Other items, net............................... (27.6) (11.8) (0.2)
-------- -------- --------
Income (loss) before income taxes................ (269.3) (394.7) 5.4
Benefit (provision) for income taxes........... (30.0) 59.4 (71.8)
Equity in loss of affiliated companies, net of
tax........................................... (18.9) (1.3) (2.8)
-------- -------- --------
Net income (loss)................................ $ (318.2) $ (336.6) $ (69.2)
======== ======== ========
Net income (loss) per share:
Basic and diluted.............................. $ (2.21) $ (2.34) $ (0.44)
======== ======== ========
Weighted average shares outstanding:
Basic and diluted.............................. 144.0 144.0 156.1
======== ======== ========
See notes to consolidated financial statements.
54
BLOCKBUSTER INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
December 31, December 31,
1998 1999
------------ ------------
Assets
Current assets:
Cash and cash equivalents.......................... $ 99.0 $ 119.6
Receivables, less allowances of $22.7 (1998) and
$11.4 (1999)...................................... 124.8 130.8
Merchandise inventories............................ 277.4 281.3
Prepaid assets and other current assets............ 130.5 180.9
-------- --------
Total current assets............................. 631.7 712.6
Rental library....................................... 441.2 577.6
Deferred taxes....................................... 92.5 --
Tax receivable from Viacom........................... -- 41.1
Property and equipment, net.......................... 995.3 1,148.3
Intangibles, net..................................... 6,055.6 5,975.9
Other assets......................................... 58.5 85.3
-------- --------
$8,274.8 $8,540.8
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable................................... $ 448.6 $ 499.4
Accrued expenses................................... 361.8 422.5
Current portion of long-term debt.................. -- 157.1
Current portion of capital lease obligations....... 22.2 29.7
Deferred taxes..................................... 13.6 22.7
-------- --------
Total current liabilities........................ 846.2 1,131.4
Notes payable to Viacom.............................. 1,576.4 --
Long-term debt, less current portion................. -- 1,030.0
Capital lease obligations, less current portion...... 138.8 108.4
Deferred taxes....................................... -- 72.3
Other liabilities.................................... 75.5 73.7
-------- --------
2,636.9 2,415.8
-------- --------
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, par value $.01 per share; 100.0
shares authorized; no share issued or
outstanding....................................... -- --
Class A common stock, par value $.01 per share;
400.0 shares authorized; 31.0 shares issued and
outstanding....................................... -- 0.3
Class B common stock, par value $.01 per share;
500.0 shares authorized; 144.0 shares issued and
outstanding....................................... -- 1.4
Additional paid-in capital......................... -- 6,180.3
Retained earnings (deficit)........................ -- (10.9)
Viacom's net equity investment..................... 5,695.8 --
Accumulated other comprehensive loss--foreign
currency translation adjustment................... (57.9) (46.1)
-------- --------
Total stockholders' equity....................... 5,637.9 6,125.0
-------- --------
$8,274.8 $8,540.8
======== ========
See notes to consolidated financial statements.
55
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME
(In millions)
Year ended December 31,
-------------------------------------------------
1997 1998 1999
--------------- --------------- ---------------
Shares Amount Shares Amount Shares Amount
------ -------- ------ -------- ------ --------
Class A common stock:
Balance, beginning of
year..................... -- $ -- -- $ -- -- $ --
Initial public offering,
net proceeds ............ -- -- -- -- 31.0 0.3
--- -------- --- -------- ----- --------
Balance, end of year...... -- $ -- -- $ -- 31.0 $ 0.3
=== ======== === ======== ===== ========
Class B common stock:
Balance, beginning of
year..................... -- $ -- -- $ -- -- $ --
Issuance of class B common
stock to Viacom.......... -- -- -- -- 144.0 1.4
--- -------- --- -------- ----- --------
Balance, end of year...... -- $ -- -- $ -- 144.0 $ 1.4
=== ======== === ======== ===== ========
Additional paid-in capital:
Balance, beginning of
year..................... $ -- $ -- $ --
Issuance of class B common
stock to Viacom.......... -- -- 5,754.0
Initial public offering,
net proceeds............. -- -- 429.8
Cash dividends............ -- -- (3.5)
-------- -------- --------
Balance, end of year...... $ -- $ -- $6,180.3
======== ======== ========
Viacom's net equity
investment:
Balance, beginning of
year..................... $7,791.5 $7,666.5 $5,695.8
Dividend payable to
Viacom................... -- (1,400.0) --
Other transactions with
Viacom, net.............. 193.2 (234.1) 118.0
Net income (loss) prior to
initial public offering.. (318.2) (336.6) (58.3)
Issuance of class B common
stock to Viacom.......... -- -- (5,755.5)
-------- -------- --------
Balance, end of year...... $7,666.5 $5,695.8 $ --
======== ======== ========
Accumulated other
comprehensive loss:
Balance, beginning of
year..................... $ (7.1) $ (48.9) $ (57.9)
Other comprehensive income
(loss):
Foreign currency trans-
lation................. (38.6) (9.0) 11.8
Reclassification of for-
eign currency transla-
tion gain realized..... (3.2) -- --
-------- -------- --------
Balance, end of year...... $ (48.9) $ (57.9) $ (46.1)
======== ======== ========
Retained earnings (deficit):
Balance, beginning of
year..................... $ -- $ -- $ --
Net income (loss)
subsequent to initial
public offering.......... -- -- (10.9)
-------- -------- --------
Balance, end of year...... -- -- (10.9)
======== ======== ========
Total stockholders'
equity................... $7,617.6 $5,637.9 $6,125.0
======== ======== ========
Comprehensive income (loss):
Net income (loss)......... $ (318.2) $ (336.6) $ (69.2)
Other comprehensive income
(loss):
Foreign currency trans-
lation................. (38.6) (9.0) 11.8
Reclassification of for-
eign currency
translation gain real-
ized................... (3.2) -- --
-------- -------- --------
Total comprehensive income
(loss)................... $ (360.0) $ (345.6) $ (57.4)
======== ======== ========
See notes to consolidated financial statements.
56
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Year Ended December 31,
-------------------------------
1997 1998 1999
--------- --------- ---------
Cash flows from operating activities:
Net income (loss)........................... $ (318.2) $ (336.6) $ (69.2)
Adjustments to reconcile net income (loss)
to net cash flow provided by operating
activities:
Depreciation and amortization............. 1,222.4 1,518.8 1,067.4
Deferred taxes............................ 121.5 (8.1) 173.9
Write-down of investments................. 27.1 10.5 --
Equity in loss of affiliated companies,
net of tax............................... 18.9 1.3 2.8
Gain on sales of store operations......... -- -- (19.9)
Other..................................... (0.3) -- --
Change in operating assets and liabilities:
Increase in receivables................... (7.8) (10.9) (7.3)
Tax receivable from Viacom................ -- -- (41.1)
Increase in merchandise inventories....... (51.4) (0.4) (5.2)
Increase in prepaid and other assets...... (15.6) (40.0) (58.0)
Increase (decrease) in accounts payable... (41.4) 67.9 59.3
Increase in accrued expenses and other
liabilities.............................. 36.1 32.0 40.1
--------- --------- ---------
Net cash flow provided by operating
activities................................... 991.3 1,234.5 1,142.8
--------- --------- ---------
Cash flows from investing activities:
Rental library purchases.................... (860.2) (818.1) (808.7)
Capital expenditures........................ (262.2) (175.0) (374.4)
Cash used for acquisitions.................. (79.0) (34.2) (111.7)
Proceeds from sale of property and
equipment.................................. 19.1 0.3 1.7
Proceeds from sales of store operations..... -- -- 36.1
Investments in affiliated companies......... (5.8) 4.8 (1.1)
--------- --------- ---------
Net cash flow used in investing activities.... (1,188.1) (1,022.2) (1,258.1)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from new credit agreement.......... -- -- 1,750.0
Repayments on new credit agreement.......... -- -- (562.9)
Proceeds from term loan..................... 22.3 (46.6) --
Repayment of term loan...................... -- 46.6 --
Net borrowings from (repayments to) Viacom.. 106.1 0.6 (1,576.4)
Net proceeds from the issuance of common
stock...................................... -- -- 430.1
Cash dividends.............................. -- -- (3.5)
Capital lease payments...................... (33.2) (34.8) (34.2)
Capital contributions from (repayments to)
Viacom, net................................ 174.1 (206.9) 134.1
--------- --------- ---------
Net cash flow provided by (used in) financing
activities................................... 269.3 (241.1) 137.2
--------- --------- ---------
Effect of exchange rate changes on cash....... (1.5) (1.8) (1.3)
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. 71.0 (30.6) 20.6
Cash and cash equivalents at beginning of
year......................................... 58.6 129.6 99.0
--------- --------- ---------
Cash and cash equivalents at end of year...... $ 129.6 $ 99.0 $ 119.6
========= ========= =========
See notes to consolidated financial statements.
57
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular amounts in millions except per share amounts)
Note 1 -- Basis of Presentation
Blockbuster Inc. and its subsidiaries (the "Company" or "Blockbuster")
operate and franchise videocassette rental and sales stores in the United
States and a number of other countries. The Company offers pre-recorded
videocassettes primarily for rental and also offers titles for purchase on a
"sell-through" (retail) basis. In addition, the Company offers DVDs and video
games for rental and sale and sells certain other entertainment-related
merchandise.
The consolidated financial statements for the periods prior to the Company's
initial public offering (the "Offering") are presented on a carve-out basis and
reflect the historical results of operations, financial position and cash flows
of the Company, including entities owned by Blockbuster or purchased from
affiliates of Viacom Inc. ("Viacom") in the case of certain of its
international operations. In this context, no historical direct ownership
relationship existed among some of the various entities comprising Blockbuster
prior to the Offering; accordingly, Viacom and its subsidiaries' net investment
in Blockbuster was included in Viacom's net equity investment in the
consolidated financial statements prior to the Offering.
As a part of the reorganization transactions (discussed below), the Company
purchased stock and/or assets from affiliates of Viacom with cash funded by a
bank credit agreement or contributed by Viacom in order to acquire certain
international operations of the Company. Advances from Viacom to Blockbuster to
fund these operations were historically treated as intercompany notes in the
accompanying consolidated financial statements. The difference between the
recorded intercompany notes payable to Viacom and the ultimate amount of the
purchase price for the stock or assets of these operations was recognized as an
adjustment to stockholders' equity.
For all periods prior to the Offering, certain expenses reflected in the
consolidated financial statements include allocation of corporate expenses from
Viacom. All such costs and expenses have been deemed to have been paid by the
Company to Viacom in the period in which the costs were recorded. Allocations
of current income taxes receivable or payable are deemed to have been remitted,
in cash, by or to Viacom in the period the related income taxes were recorded.
Management believes that the foregoing allocations were made on a reasonable
basis; however, the allocations of costs and expenses do not necessarily
indicate the costs that would have been or will be incurred by the Company on a
stand-alone basis. Also, the consolidated financial statements may not
necessarily reflect the financial position, results of operations and cash
flows of the Company in the future or what the financial position, results of
operations or cash flows would have been if the Company had been a separate,
stand-alone company during the periods presented.
Prior to the Offering, the following transactions were completed: (1) in
late 1998, numerous U.S. subsidiaries of Viacom International Inc., a wholly
owned subsidiary of Viacom, each of which were directly or indirectly involved
in the Company's operations, were merged with and into the Company, (2) on
December 31, 1998, the Company declared a $1.4 billion dividend payable to
Viacom International Inc. which was reflected as an interest-bearing note in
the accompanying December 31, 1998 consolidated balance sheet, (3) effective
June 21, 1999, the Company entered into a term and revolving credit agreement
with a syndicate of lenders which was used to repay debt owed to Viacom and to
pay a portion of the purchase price to acquire certain international operations
from affiliates of Viacom, (4) effective on or about June 23, 1999, the Company
purchased certain international operations of the Company from affiliates of
Viacom, (5) effective August 3, 1999, the Company was recapitalized with class
A common stock and class B common stock of which 144,000,000 shares of class B
common stock were simultaneously issued to Viacom International Inc. in
exchange for 100 shares of common stock of the Company (which represented all
of the issued and
58
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
outstanding common stock of the Company at that time) and, (6) effective on the
Offering date, Blockbuster's intercompany cash transactions with Viacom were
capitalized into Viacom's net equity investment.
On August 10, 1999 the Company sold to the public 31 million shares of
class A common stock for $15 per share. Proceeds from the Offering aggregated
$430.1 million, net of underwriting discounts and commissions of $22.1 million
and Offering expenses of $12.8 million. Of the gross proceeds from the
Offering, $442.9 million was used to pay down the short-term revolving loan due
June 19, 2000 and permanently reduced our borrowing capacity (See Note 9).
Subsequent to the Offering, through Viacom International Inc.'s ownership of
100 percent of the Company's class B common stock, Viacom owns approximately 82
percent of the Company's common stock representing approximately 96 percent of
the combined voting power of all classes of voting stock of Blockbuster. The
holders of class A and class B common stock generally have identical rights,
except that holders of class A common stock are entitled to one vote per share
while holders of class B common stock are entitled to five votes per share on
matters to be voted on by stockholders.
Note 2 -- Summary of Significant Accounting Policies
Use of Estimates
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 subsequently differ from those
estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and investments of more than 50% in subsidiaries and other entities.
Investments in affiliated companies over which the Company has a significant
influence or ownership of more than 20% but less than or equal to 50% are
accounted for under the equity method. Investments of 20% or less are accounted
for under the cost method. All significant intercompany transactions have been
eliminated.
Cash and Cash Equivalents
Cash equivalents are defined as short-term (original maturities of three
months or less) highly liquid investments.
Merchandise Inventories
Merchandise inventories consist primarily of prerecorded videocassette
retail inventory, DVDs, video games, licensed merchandise and confectionery
items and are stated at the lower of cost or market. Merchandise inventory
costs are determined using the weighted average method, the use of which
approximates the first-in, first-out basis.
Rental Library
Effective April 1, 1998, Blockbuster adopted an accelerated method of
amortizing its videocassette and game rental library in order to more closely
match expenses in proportion with anticipated revenues from the revenue-sharing
business model (see Note 3).
59
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Rental amortization expense approximated $799.9 million (1997), $711.6
million (1998), excluding the charge in 1998 (Note 3), and $675.1 million
(1999).
Property and Equipment
Property and equipment is stated at cost. Depreciation expense is computed
principally by the straight-line method over the estimated useful lives as
follows:
Building................................................... 25 to 31.5 years
Building improvements...................................... 10 years
Leasehold improvements..................................... 4 to 10 years
Equipment and other........................................ 3 to 10 years
Furniture and fixtures..................................... 3 to 10 years
Balances of major classes of assets and accumulated depreciation at December
31 are as follows:
1998 1999
-------- --------
Land, building and building improvements.................. $ 56.3 $ 49.2
Leasehold improvements.................................... 637.7 755.8
Equipment and other....................................... 386.2 549.3
Furniture and fixtures.................................... 294.0 321.5
Capital leases............................................ 248.3 250.2
-------- --------
Total................................................... 1,622.5 1,926.0
Less: accumulated depreciation............................ 627.2 777.7
-------- --------
Property and equipment, net............................... $ 995.3 $1,148.3
======== ========
Maintenance and repair costs are charged to expense as incurred.
Improvements that extend the useful life of the assets are capitalized.
Depreciation expense, including capital lease amortization, was $253.8 million
(1997), $212.7 million (1998) and $220.5 million (1999). Depreciation expense
related to capital leases was $30.6 million (1997), $29.7 million (1998) and
$24.0 million (1999).
Retirements, sales and disposals of assets are recorded by removing the cost
and accumulated depreciation from the asset and accumulated depreciation
accounts with any resulting gain or loss reflected in general and
administrative expense.
Store Closures
Reserves for store closures are established by calculating the present value
of the remaining lease obligation, adjusted for estimated subtenant agreements
or lease buyouts, if any, and are expensed along with any leasehold
improvements. Store furniture and equipment are either transferred at
historical cost to another location or written down to their net realizable
value and sold.
Intangible Assets
Intangible assets include the cost of acquired businesses in excess of the
fair market value of tangible assets and liabilities arising from the
allocation of purchase prices ("goodwill"), which principally relates to
Viacom's acquisition of the Company in 1994, and the resulting pushdown of
goodwill with the transaction.
60
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Blockbuster's intangible assets are stated at historical allocated cost less
accumulated amortization. Blockbuster amortizes intangible assets on a
straight-line basis as follows: for goodwill, over the estimated useful life,
not exceeding 40 years; for trademarks, over the estimated remaining economic
life, not exceeding 40 years; and for reacquired franchise rights, not
exceeding 20 years, the life of the franchise agreement.
Amortization expense related to intangible assets was $168.7 million (1997),
$170.2 million (1998) and $171.8 million (1999).
Intangible assets at December 31 consist of the following:
1998 1999
-------- --------
Goodwill................................................. $6,752.7 $6,807.8
Other intangibles (trademarks and reacquired franchise
rights)................................................. 11.8 25.0
-------- --------
Total.................................................. 6,764.5 6,832.8
Less: accumulated amortization........................... 708.9 856.9
-------- --------
Intangibles, net......................................... $6,055.6 $5,975.9
======== ========
Impairment of Long-Lived Assets
The Company assesses long-lived assets (primarily property, plant and
equipment and goodwill) for impairment whenever there is an indication that the
carrying amount of the assets may not be recoverable. Recoverability is
determined by comparing the forecasted undiscounted cash flows generated by
these assets to the assets' net carrying value. The amount of impairment loss,
if any, will generally be measured as the difference between the net book value
of the assets and their estimated fair value. Impairment review of long-lived
assets associated with the Company's stores is performed on a market-by-market
basis and country-by-country basis.
Capitalized Software Costs
The Company capitalizes qualifying costs related to developing or obtaining
internal-use software. Capitalization of costs begins after the conceptual
formulation stage has been completed. Capitalized costs are amortized over the
estimated useful life of the software which ranges between three and five
years. Amortization expense for 1998 and 1999 was $4.4 million and $3.9
million, respectively.
Fair Value of Financial Instruments
At December 31, 1998 and 1999, the Company's carrying value of financial
instruments approximates fair value due to the short-term maturities of these
instruments or variable rates of interest. During 1997, 1998 and 1999, no
financial instruments were held or issued for trading purposes.
The Company's receivables do not represent significant concentrations of
credit risk at December 31, 1999, due to the wide variety of customers, markets
and geographic areas to which the Company's products and services are sold.
Foreign Currency Translation and Transactions
The financial statements of the Company's foreign operations were prepared
in their respective local currencies and translated into U.S. dollars for
reporting purposes. The assets and liabilities are translated at exchange rates
in effect at the balance sheet date, while results of operations are translated
at average exchange
61
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
rates for the respective periods. The cumulative effects of exchange rate
changes on net assets are included as a part of accumulated other comprehensive
loss in 1997, 1998 and 1999. Net foreign currency transaction gains and losses
were not significant for any of the years presented, except for 1997, in which
the Company recognized a gain of approximately $8.0 million, which is included
in general and administrative expenses in the Consolidated Statements of
Operations.
Rental Revenue and Merchandise Sales
Revenues are generally recognized at the time of sale or rental. Rental
revenue includes sales of previously viewed videotapes, DVDs and previously
played video games.
Franchise Fees
The Company executes franchise agreements covering retail locations which
provide the terms of the arrangement with the franchisee. The franchise
agreements generally require an initial fee, an area development fee for each
store opened and continuing fees based upon a percentage of sales.
The Company recognizes initial fees as revenue when all initial services, as
required by the franchise agreement, have been substantially performed. Area
development fees are recognized upon the opening of the applicable franchise
store and when all services related to such store as required by the franchise
agreement have been substantially performed. Continuing fees based upon a
percentage of sales are recognized when earned.
Direct costs of sales and servicing of franchise agreements are charged to
expense as incurred.
BLOCKBUSTER REWARDS Revenue
Blockbuster's premium membership program is designed to enhance customer
loyalty by encouraging customers to rent movies only from Blockbuster. For an
annual fee, a customer can join the BLOCKBUSTER REWARDS program and earn free
movie or video game rentals. The fee, less direct costs, is recognized ratably
over the period benefited and is included in other revenue.
Advertising Expenses
Advertising costs are expensed the first time the advertising takes place.
Media (television and print) placement costs are expensed in the month the
advertising appears.
Gift Card Liability
Gift card liabilities are recorded at the time of sale with the costs of
designing, printing and distributing the cards recorded as expense as incurred.
The liability is relieved and revenue is recognized upon redemption of the gift
cards at any BLOCKBUSTER store.
Refranchising Gains (Losses)
Refranchising gains (losses) include gains or losses on sales of company-
operated stores to franchisees. The Company includes direct administrative
costs of refranchising in the gain or loss calculation. Gains (losses) are
recognized on store refranchising as a component of general and administrative
expense. Gains are recognized when the sale transaction closes, the franchisee
has a minimum amount of the purchase price in at-risk equity and when the
Company is satisfied that the franchisee can meet its current obligations.
62
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Income Taxes
Income taxes are provided based on the liability method of accounting.
Deferred taxes are recorded to reflect the tax benefit and consequences of
future years' differences between the tax bases of assets and liabilities and
their financial reporting basis. The Company records a valuation allowance to
reduce deferred tax assets if it is more likely than not that some portion or
all of the deferred tax assets will not be realized.
Net Income (Loss) Per Share
Basic income (loss) per share has been computed using the weighted average
number of shares of common stock of the Company (inclusive of class A and class
B common stock) outstanding for each period presented. The dilutive effect of
stock options is included in the calculation of diluted income (loss) per share
using the treasury stock method.
The calculation of basic and diluted income (loss) per share is summarized
as follows:
Year Ended December 31,
---------------------------
1997 1998 1999
-------- -------- -------
Basic income (loss) per share:
Net income (loss)................................. $ (318.2) $ (336.6) $ (69.2)
-------- -------- -------
Weighted average common shares outstanding (1).... 144.0 144.0 156.1
Basic earnings (loss) per share...................... $ (2.21) $ (2.34) $(0.44)
======= ======= ======
Diluted income (loss) per share:
Net income (loss).................................... $(318.2) $(336.6) $(69.2)
------- ------- ------
Weighted average common shares outstanding (1)....... 144.0 144.0 156.1
Incremental shares assuming dilution (2)............. -- -- --
------- ------- ------
Weighted average common shares assuming dilution..... 144.0 144.0 156.1
======= ======= ======
Diluted earnings (loss) per share.................... $ (2.21) $ (2.34) $(0.44)
======= ======= ======
- --------
(1) Effective August 3, 1999, as discussed in Note 1, the Company was
recapitalized to provide for class A common stock and class B common stock.
In accordance with SEC Staff Accounting Bulletin No. 98, the capitalization
of class B common stock has been retroactively reflected for the purposes
of presenting net income (loss) per share for the periods prior to the
Offering.
(2) Options to purchase 11,235,479 shares of class A common stock were
outstanding at December 31, 1999 but were not included in the computation
of diluted income (loss) per share because the options' exercise price was
greater than the average market price of the Company's common stock. No
Blockbuster options were outstanding prior to August 11, 1999, the
effective date of the Company's Offering.
Comprehensive Income (Loss)
Comprehensive income (loss) is defined as the change in equity (net assets)
of a business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It consists of net income (loss) and
other gains and losses affecting stockholders' equity that, under generally
accepted accounting principles, are excluded from net income (loss), such as
unrealized gains and losses on investments available for sale, foreign currency
translation gains and losses and minimum pension liability. Currency
translation is the only item of other comprehensive income impacting the
Company. There is no tax effect associated with comprehensive income (loss) as
the foreign currency translation adjustments are associated with operations
located in foreign jurisdictions with operating tax losses.
63
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). This new accounting standard
will require that derivative instruments be measured at fair value and
recognized in the balance sheet as either assets or liabilities, as the case
may be. The treatment of changes in the fair value of a derivative (i.e., gains
and losses) will depend on its intended use and designation. Gains and losses
on derivatives designated as hedges against the cash flow effect of a
forecasted transaction will initially be reported as a component of
comprehensive income and, subsequently, reclassified into income when the
forecasted transaction affects income. Gains and losses on all other forms or
derivatives will be recognized in income in the period of change. The Company
will adopt SFAS 133 effective January 1, 2001 and anticipates that its adoption
will not have a material effect on its consolidated financial statements.
Note 3 -- Change in Accounting Method for Rental Library
Effective April 1, 1998, Blockbuster adopted an accelerated method of
amortizing its videocassette and game rental library. Blockbuster adopted this
new method of amortization because it implemented a new business model,
including revenue-sharing agreements with Hollywood studios, which dramatically
increased the number of videocassettes in the stores and is satisfying consumer
demand over a shorter period of time. Revenue-sharing allows Blockbuster to
purchase videocassettes at a lower product cost than the traditional buying
arrangements, with a percentage of the net rental revenues shared with the
studios over a contractually determined period of time. As the new business
model results in a greater proportion of rental revenue over a shorter period
of time, Blockbuster changed its method of amortizing rental library in order
to more closely match expenses in proportion with the anticipated revenues to
be generated therefrom.
Pursuant to the new accounting method, the Company records base stock
videocassettes (generally less than five copies per title for each store) at
cost and amortizes a portion of these costs on an accelerated basis over three
months, generally to $8 per unit, with the remaining base stock videocassette
cost amortized on a straight-line basis over 33 months to an estimated $4
salvage value. The cost of non-base stock videocassettes (generally greater
than four copies per title for each store) are amortized on an accelerated
basis over three months to an estimated $4 salvage value. Video games and DVD's
are amortized on an accelerated basis over a 12-month period to an estimated
$10 and $4 salvage value, respectively. Revenue-sharing payments are expensed
when revenues are earned pursuant to the applicable contractual arrangements.
The new method of accounting was applied to the rental library that was held
at April 1, 1998. The adoption of the new method of amortization was accounted
for as a change in accounting estimate effected by a change in accounting
principle and, accordingly, the Company recorded a non-cash pre-tax charge of
$424.3 million to cost of rental revenues in the second quarter of 1998. The
charge represented an adjustment to the carrying value of the rental tapes due
to the new method of accounting.
The Company believes that the new amortization method developed for
Blockbuster's new business model results in a better matching of revenue and
expense recognition. Under the new model, cost of sales attributable to
videocassettes is comprised of revenue-sharing payments, which are expensed
when the related revenue is recognized, amortization of product costs and
residual values of previously viewed tapes and games upon sale.
Prior to April 1, 1998, the videocassette rental library was recorded at
cost and amortized over its estimated economic life. Base stock videocassettes
(generally 1 to 4 copies per title for each store) were amortized over 36
months on a straight-line basis. Non-base stock videocassettes (generally the
fifth and succeeding copies per title for each store) were amortized over six
months on a straight-line basis. Video game library was amortized on a
straight-line basis over a period of 12 to 24 months.
64
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Note 4 -- Special Item Charges and Restructuring
During the second quarter of 1997, the Company shifted its strategic
emphasis from retailing a broad assortment of merchandise to focusing on its
core rental business. Rationalization of the retail product lines such as sell
through video, confectionery items, literature, music and fashion merchandise
allowed the Company to devote more management time and attention, as well as
retail floor selling space, to its rental video and game business. In addition,
as part of its efforts to improve the performance of its operations, the
Company adopted a plan to close consistently under-performing stores primarily
located in the United States, United Kingdom and Australia and to exit the
German market. The Company also recognized a charge associated with its joint
venture operations in Japan.
As a result, the Company recorded a pre-tax charge of approximately $250
million (the "Charge"). The Charge consisted principally of $100.8 million
recognized as cost of merchandise sold for a reduction in the carrying value of
excess merchandise inventories, $69.6 million for the reorganizing of
operations and closing of under-performing stores and $39.3 million recognized
as general and administrative expenses, primarily related to additional
relocation costs incurred in connection with the move of the Company's
employees, corporate offices and data center during 1998 from Fort Lauderdale,
Florida to Dallas, Texas. In addition, the Charge consisted of $29.4 million,
recognized as part of the equity in loss of affiliated companies, associated
with the Company's debt guarantee of joint venture operations in Japan. The
Company had fully satisfied its obligations related to the debt guarantee as of
December 31, 1998.
The $69.6 million charge is comprised of a $41.8 million non-cash impairment
charge associated with long-lived assets and a $27.8 million charge for lease
exit obligations. These amounts have been recognized as depreciation expense
and general and administrative expense, respectively. Through December 31,
1999, the Company has paid and charged approximately $19.9 million against the
lease exit obligations.
Also in the second quarter of 1997, as part of the Company's strategic
initiatives, management made the decision to dispose of certain investments
that did not relate to the Company's core business. The Company recognized a
non-cash charge of $27.1 million to write down these non-strategic investments
to their net realizable value. This charge is reflected in "Other items, net"
in the Consolidated Statements of Operations.
During 1998, the Company revised its estimate of net realizable value
associated with certain investments referred to above. An additional provision
of approximately $10.5 million was recognized in the fourth quarter to reflect
this change in estimate and was included in "Other items, net."
Note 5 -- Stock Option Plans
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation." In accordance with the provisions of
SFAS 123, the Company applies Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for the plans and accordingly, does not recognize compensation
expense for stock option plans because Blockbuster and Viacom typically do not
issue options at exercise prices below the market value at date of grant.
Had compensation expense for Viacom's and Blockbuster's stock option plans
applicable to the Company's employees been determined based upon the fair value
at the grant date for awards consistent with the methodology prescribed by SFAS
123, the Company's consolidated pretax income would have decreased by $2.2
million ($1.4 million after tax or $0.01 per basic and diluted share), $4.1
million ($2.6 million after tax or $0.02 per basic and diluted share) and $12.3
million ($7.5 million after tax or $0.05 per basic and diluted share) in 1997,
1998 and 1999. These pro forma effects may not be representative of expense in
future periods
65
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
since the estimated fair value of stock options on the date of grant is
amortized to expense over the vesting period, and additional options may be
granted in future years. Options issued prior to January 1, 1995 were excluded
from the computation.
Blockbuster Long-Term Management Incentive Plan
On July 15, 1999, Blockbuster's Board of Directors adopted the Blockbuster
Inc. 1999 Long-Term Management Incentive Plan (the "Plan") for the benefit of
its employees and directors. An aggregate of 25,000,000 shares of class A
common stock was reserved for issuance under the Plan, which provides for the
issuance of stock-based incentive awards, including stock options to purchase
shares of class A common stock, stock appreciation rights, restricted shares of
class A common stock, restricted share units and phantom shares. The purpose of
the Plan is to benefit and advance the interests of Blockbuster by rewarding
certain key employees and non-employee directors for their contributions to the
financial success of Blockbuster and thereby motivating them to continue to
make such contributions in the future. Outstanding stock options generally vest
over a five-year period from the date of grant and expire 10 years after the
date of grant.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
1999
----
Expected dividend yield (a)............................................ 0.6%
Expected stock price volatility........................................ 45.0%
Risk-free interest rate................................................ 6.2%
Expected life of options (years)....................................... 7.0
- --------
(a) Management's current intention is to pay quarterly dividends of $0.02 per
share each quarter on both class A common stock and class B common stock.
The weighted-average fair value of each option as of the grant date was
$7.98.
The following table summarizes stock option activity pursuant to
Blockbuster's stock option plan:
Options Weighted-Average
Outstanding Exercise Price
----------- ----------------
Balance at December 31, 1998.................... -- $ --
Granted....................................... 11,573,108 14.99
Exercised..................................... -- --
Cancelled..................................... 337,629 15.00
----------
Balance at December 31, 1999.................... 11,235,479 $14.99
==========
The following table summarizes information concerning currently outstanding
and exercisable Blockbuster stock options issued to Blockbuster employees and
directors at December 31, 1999:
Outstanding Exercisable
------------------------------------------------- ------------------------
Range of Remaining Contractual Weighted-Average Weighted-Average
Exercise Prices Options Life (Years) Exercise Price Options Exercise Price
- --------------- ---------- --------------------- ---------------- ------- ----------------
$13.50
to
$15.00 11,235,479 9.7 $14.99 -- $ --
66
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Viacom's Long-term Incentive Plan
Certain of the Company's employees have been granted Viacom stock options
under Viacom's Long-term Incentive Plans (the "Viacom Plans"). The purpose of
the Viacom Plans is to benefit and advance the interests of Viacom by rewarding
certain key employees for their contributions to the financial success of
Viacom and thereby motivating them to continue to make such contributions in
the future. The Viacom Plans provide for fixed grants of equity-based interests
pursuant to awards of phantom shares, stock options, stock appreciation rights,
restricted shares or other equity-based interests and for subsequent payments
of cash with respect to phantom shares or stock appreciation rights based,
subject to certain limits, on their appreciation in value over stated periods
of time. The stock options generally vest over a four to six-year period from
the date of grant and expire 10 years after the date of grant.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
1997 1998 1999
---- ---- ----
Expected dividend yield (b)................................ -- -- --
Expected stock price volatility............................ 31.8% 32.7% 29.6%
Risk-free interest rate.................................... 6.0% 5.5% 6.1%
Expected life of options (years)........................... 6.0 6.0 7.5
- --------
(b) Viacom has not declared any cash dividends on its common stock for any of
the periods presented and has no present intention of so doing.
On February 25, 1999, the Board of Directors of Viacom declared a 2-for-1
common stock split, effected in the form of a dividend. The additional shares
were issued on March 31, 1999 to stockholders of record on March 15, 1999. All
Viacom stock options and per share amounts have been adjusted to reflect the
stock split for all periods presented.
The weighted-average fair value of each option as of the grant date was
$6.58, $12.97 and $19.89 in 1997, 1998 and 1999, respectively.
The following table summarizes stock option activity under Viacom's various
plans as it relates to Blockbuster's employees:
Options Weighted-Average
Outstanding Exercise Price
----------- ----------------
Balance at December 31, 1996....................... 13,181,030 $15.77
Granted.......................................... 2,596,000 15.32
Exercised........................................ 2,778,348 14.58
Cancelled........................................ 2,766,482 15.76
----------
Balance at December 31, 1997....................... 10,232,200 15.98
Granted.......................................... 506,320 30.31
Exercised........................................ 7,102,920 14.39
Cancelled........................................ 414,356 16.00
----------
Balance at December 31, 1998....................... 3,221,244 21.75
Granted.......................................... 40,000 42.13
Exercised........................................ 634,052 14.88
Cancelled........................................ 153,198 15.02
----------
Balance at December 31, 1999....................... 2,473,994 $24.26
==========
67
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
The following table summarizes information concerning currently outstanding
and exercisable Viacom stock options issued to Blockbuster employees at
December 31, 1999:
Outstanding Exercisable
------------------------------------------ ------------------------
Remaining
Range of Contractual Weighted-Average Weighted-Average
Exercise Prices Options Life (Years) Exercise Price Options Exercise Price
- --------------- --------- ------------ ---------------- ------- ----------------
$10 to $15 15,000 7.62 $14.94 -- --
15 to 20 1,760,188 7.18 15.35 257,251 $15.39
30 to 35 480,320 8.55 30.56 -- --
35 to 45 40,000 9.25 42.13 -- --
3 to 25(c) 178,486(c) 3.60 10.93 178,486 10.93
--------- -------
2,473,994 435,737
========= =======
- --------
(c) Represents information for options assumed with the Viacom acquisition of
Blockbuster.
Note 6--Accrued Expenses
The Company's accrued expenses consist of the following:
At December
31,
-------------
1998 1999
------ ------
Accrued compensation.......................................... $ 55.9 $ 70.1
Accrued gift card liability................................... 65.9 89.3
Accrued sales tax............................................. 24.5 31.0
Accrued property tax.......................................... 38.9 51.9
Accrued revenue-sharing....................................... 38.0 56.7
Restructuring reserve......................................... 14.2 --
Store closure reserves........................................ 15.0 15.4
Assigned Music liabilities.................................... 43.7 18.9
Deferred reward card revenue.................................. 1.2 14.5
Accrued interest payable...................................... .3 8.2
Accrued self-insurance........................................ 6.4 6.4
Other....................................................... 57.8 60.1
------ ------
$361.8 $422.5
====== ======
Note 7--Related Party Transactions
Effective with the Offering, Blockbuster and Viacom entered into a
transition services agreement whereby Viacom is providing the Company with cash
management, accounting, management information systems, legal, financial and
tax services as well as employee benefit plan and insurance administration.
These services may change upon agreement between Viacom and the Company. The
fee for these services approximates Viacom's cost and could be subject to
adjustment. The Company has agreed to pay or reimburse Viacom for any out-of-
pocket payments, costs and expenses associated with these services. The
services agreement expires upon the closing of a split-off or similar
transaction. Prior to the Offering, the allocation of these expenses was
generally based on actual costs incurred by Viacom. The charges for services
were $9.2 million (1997), $12.5 million
68
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
(1998) and $7.7 million (1999). Management believes that the methodologies used
to allocate the charges was reasonable, however, these allocations of costs and
expenses do not necessarily indicate the cash and expenses that would have been
or will be incurred by the Company on a stand-alone basis.
Prior to the Offering Viacom paid certain insurance premiums on behalf of
the Company for certain worker's compensation, property, general liability and
group insurance policies. Insurance expense related to these policies was
$13.3 million (1997), $16.0 million (1998) and $10.4 million (1999) and is
reflected as a component of general and administrative expenses in the
Consolidated Statements of Operations. See Note 13 for pension plan and
additional employee benefit costs charged by Viacom to the Company.
Viacom generally did not charge the Company interest on intercompany
balances except for intercompany debt associated with certain foreign
operations, the note associated with the $1.4 billion dividend payable to
Viacom International Inc. and the notes associated with the acquisition of
franchise operations. See Note 8 for interest expense charged by Viacom to the
Company.
The Company, through the normal course of business, is involved in
transactions with companies owned by or affiliated with Viacom. The Company
purchases certain videocassettes for rental and sale directly from Paramount
Pictures Corporation. Total purchases were $77.5 million, $110.1 million and
$112.0 million for the years ended December 31, 1997, 1998 and 1999,
respectively. The Company also purchases certain home video games from Midway
Games, Inc. Total amounts paid for purchases were $12.5 million, $19.1 million
and $15.7 million for the years ended December 31, 1997, 1998 and 1999,
respectively.
The Company entered into a U.S. promotional and customer database services
and licenses agreement with MTV Networks ("MTVN"), an affiliate of Viacom.
Pursuant to this agreement, for one year, Blockbuster will provide certain
promotional and database services to MTVN and grant a U.S. license to MTVN to
use the Company's U.S. customer database internally and/or sublicense the
database for internal use to affiliates of MTVN that are direct or indirect
wholly-owned subsidiaries of Viacom and to MTVN Online and its direct and
indirect affiliates for internal use so long as Viacom is in control of MTVN
Online and such affiliates. In return, MTVN will pay Blockbuster a total of
$18 million plus costs, of which $4.5 million was received in 1999.
In addition, during this one year period, MTVN will have an option to pay an
additional $5 million to extend in perpetuity the license to use the customer
database. If MTVN exercises this option, it will provide Blockbuster, for
internal use, with access to MTVN's Leisure Time Study, a proprietary study of
how consumers choose among the increasing number of media, entertainment and
other leisure time activities available to them. At any time, the Company has
the right to terminate this option or MTVN's perpetual license for a fee of $25
million. In such event, the Company's access to MTVN's Leisure Time study also
terminates.
In conjunction with the sale by a related party of Blockbuster Music
("Music") to Wherehouse Entertainment, Inc. ("Wherehouse"), the Company assumed
certain liabilities as a result of the disposition of Music with a
corresponding reduction to Viacom's net equity investment. The nature of these
liabilities was predominantly for lease obligations associated with closed
Music stores excluded from the sale and, to a lesser extent, certain
transaction costs and various costs to complete the transition of operations
from Music to Wherehouse. These total liabilities at the date of assignment
aggregated approximately $67 million of which $18.9 million remains in current
liabilities at December 31, 1999.
All other transactions with companies owned by or affiliated with Viacom did
not have a material impact on the financial position or results of operations
presented herein.
69
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Note 8--Notes Payable to Viacom
In March 1998, the Company entered into a ten-year term loan for Cdn $65.8
million to repay the existing credit facility. In June 1998, the note was sold
to a Viacom affiliate and, accordingly, was reflected as part of notes payable
to Viacom which was subsequently retired.
Funds advanced by Viacom to the Company to fund certain international
operations were recognized as intercompany loans. These intercompany loans were
purchased and retired by the Company with borrowings from the Company's credit
agreement as part of its reorganization transactions as described in Note 1.
On December 31, 1998, the Company declared a cash dividend in the amount of
$1.4 billion payable to Viacom International Inc. in the form of an interest-
bearing promissory note. On January 24, 1999, Blockbuster acquired 69 stores
from a franchisee which was funded with the proceeds of two notes payable to
Viacom which approximated $77 million. These notes bore interest at LIBOR plus
1% and were repaid with proceeds from the Company's new credit agreement on or
about June 23, 1999 as discussed in Note 9.
On or about June 23, 1999, the Company purchased certain of its
international operations from affiliates of Viacom. The total amount paid for
the international operations was $222 million. Approximately $65 million of
funds were provided under the Company's new credit agreement, as discussed in
Note 9. The remaining $157 million was paid with cash from Viacom and has been
recognized as a capital contribution in Viacom's net equity investment.
Interest expense charged by Viacom approximated $10.1 million, $8.4 million
and $49.1 million for the years 1997, 1998 and 1999, respectively, and reflects
market-based rates.
Note 9--Credit Agreement and Other Debt
On June 21, 1999, Blockbuster entered into a $1.9 billion unsecured credit
agreement (the "Blockbuster Credit Agreement") with a syndicate of banks. The
Blockbuster Credit Agreement is comprised of a $700 million long-term revolver
due July 1, 2004, a $600 million term loan due in quarterly installments
beginning April 1, 2002 and ending July 1, 2004, and a $600 million short-term
revolver due June 19, 2000, which was subsequently reduced with proceeds from
the Offering as described below. Interest rates are based on the prime rate or
LIBOR at Blockbuster's option at the time of borrowing. A variable commitment
fee based on the total leverage ratio is charged on the unused amount of the
revolver (0.4% for 1999).
The Blockbuster Credit Agreement contains certain restrictive covenants,
which among other things, relate to the payment of dividends, repurchase of
Blockbuster's common stock or other distributions and also require compliance
with certain financial covenants with respect to a maximum leverage ratio and a
minimum fixed charge coverage ratio.
On June 23, 1999, Blockbuster borrowed $1.6 billion, comprised of $400
million borrowed under the long-term revolver, $600 million borrowed under the
term loan, and $600 million under the short-term revolver. The weighted average
interest rate at December 31, 1999 for these borrowings was 7.9%. The proceeds
of the borrowings were used to pay amounts owed to Viacom. Blockbuster repaid
$442.9 million of the short-term revolver through proceeds from the Offering.
These proceeds permanently reduced Blockbuster's commitments under the
Blockbuster Credit Agreement from $1.9 billion to approximately $1.46 billion.
The Company had $270.0 million of available borrowing capacity under the
Blockbuster Credit Agreement at December 31, 1999.
70
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
During 1999 the Company also entered into two additional lines of credit
with banks. In August 1999, the Company secured a one-year line of credit of
$45.0 million from Bank of New York. In October 1999, the Company secured a
one-year line of credit of $30.0 million from Bank of America. Neither line had
an outstanding balance at December 31, 1999. These lines of credit are used for
back up for the Blockbuster Credit Agreement and may be used for general
corporate purposes.
Short-term debt consists of the following:
At December 31,
------------------
1998 1999
--------- --------
Short-term revolving credit facility, interest rate 7.9%
at December 31, 1999, due June 2000..................... $ -- $ 157.1
========= ========
Long-term debt consists of the following:
At December 31,
------------------
1998 1999
--------- --------
Notes payable to Viacom, weighted average interest rate
6.2% at
December 31, 1998, retired with proceeds from the
Blockbuster Credit Agreement in June 1999............... $1,576.4 $ --
Term loan, interest rate 7.8% at December 31, 1999, due
in quarterly Installments beginning April 2002.......... -- 600.0
Long-term revolving credit facility, interest rate 8.0%
at December 31, 1999, due July 2004..................... -- 430.0
--------- --------
Total long-term debt................................... $ 1,576.4 $1,030.0
========= ========
Maturities on debt are as follows:
2000..................................................... $ 157.1
2001..................................................... --
2002..................................................... 150.0
2003..................................................... 275.0
2004..................................................... 605.0
---------
$ 1,187.1
=========
Interest expense related to capital leases was $18.7 million, $18.5 million
and $16.0 million for the years ended December 31, 1997, 1998 and 1999,
respectively. See Note 12 for further information regarding capital lease
obligations.
Note 10--Viacom's Net Equity Investment
Prior to the Offering, Viacom funded the working capital requirements of the
Company based upon a centralized cash management system. Viacom's net equity
investment included accumulated equity as well as any non-interest-bearing
payable and receivable due to/from Viacom resulting from cash transfers and
other intercompany activity. Viacom generally did not charge the Company
interest on intercompany balances except for intercompany debt associated with
certain foreign operations, the note associated with the $1.4 billion dividend
payable to Viacom International Inc. and the notes associated with the
acquisition of franchise operations. Prior to the Offering, Viacom's net equity
investment was recapitalized into the Company's class B common stock.
71
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Note 11--Income Taxes
The Company is included in consolidated federal, state and local income tax
returns filed by Viacom. However, the tax benefit (provision) reflected in the
Consolidated Statements of Operations and deferred tax assets and liabilities
reflected in the Consolidated Balance Sheets have been prepared as if such
benefit (provision) were computed on a separate return basis. The current
income tax liabilities for the periods presented prior to the Offering were
paid by Viacom. Any tax losses generated by the Company have been utilized by
Viacom to reduce its consolidated taxable income. Accordingly, these amounts
were reflected in Viacom's net equity investment in the Consolidated Balance
Sheets.
The Company and Viacom have entered into a tax matters agreement which
provides that subsequent to the Offering on August 16, 1999 the Company will
continue to be included in the Viacom federal consolidated income tax return
and certain consolidated, combined and unitary state tax returns. The tax
matters agreement requires the Company to make payments to Viacom equal to the
amount of income taxes which would be paid by the Company, subject to certain
adjustments, if the Company had filed a stand-alone return for any taxable year
or portion thereof beginning after August 16, 1999 in which the Company is
included in the Viacom group. With respect to tax attributes such as net
operating losses, tax credits and capital losses, the Company will have the
right of reimbursement or offset, which will be determined based on the extent
such tax attributes could be utilized by the Company if it had not been
included in the Viacom group. The right to reimbursement or offset will arise
regardless of whether the Company is a member of the Viacom group at the time
the attributes could have been used. There is also a requirement for the
Company, if so requested by Viacom, to surrender certain tax losses of United
Kingdom subsidiaries for 1998 and earlier years to Viacom without any
compensation.
The tax matters agreement specifies that Viacom will indemnify the Company
against any and all tax adjustments to Viacom's consolidated federal and
consolidated, combined and unitary state tax returns from September 29, 1994
through August 16, 1999.
The Company's tax effected net operating loss carryforwards at December 31,
1999 are primarily attributable to domestic ($8.2 million) and foreign
subsidiaries ($47.7 million). These losses are subject to certain restrictions
and limitations in accordance with domestic and foreign tax laws. A valuation
allowance has been provided primarily related to foreign loss carryforwards and
certain foreign deferred tax assets as the Company believes that it is more
likely than not that these tax benefits will not be realized or will be subject
to surrender to Viacom without compensation. The Company continually reviews
the net operating losses on a country by country basis and may determine in the
future that some or all of the net operating losses generated in the past will
be utilizable in the future. Of the total tax effected net operating losses,
$21.0 million has no expiration date, $0.9 million expires in 2000 and $34.0
million expires thereafter.
Losses accounted for under the equity method of accounting are shown net of
tax in the Consolidated Statements of Operations. Included in equity in loss of
affiliated companies, net of tax of $18.9 million (1997), $1.3 million (1998)
and $2.8 million (1999) are a tax benefit of $12.7 million for 1997, a tax
provision of $0.2 million for 1998 and a tax benefit of $0.4 for 1999.
Income (loss) before income taxes are attributable to the following
jurisdictions:
Year Ended December
31,
------------------------
1997 1998 1999
------- ------- ------
United States...................................... $(167.3) $(313.6) $ 28.5
Foreign............................................ (102.0) (81.1) (23.1)
------- ------- ------
$(269.3) $(394.7) $ 5.4
======= ======= ======
72
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Components of the income tax benefit (provision) are as follows:
Year Ended December
31,
----------------------
1997 1998 1999
------ ------ ------
Current:
Federal........................................... $ 89.7 $ 51.2 $ 95.4
State and local................................... 3.4 3.0 14.0
Foreign........................................... (1.6) (2.9) (7.3)
------ ------ ------
91.5 51.3 102.1
Deferred............................................ (121.5) 8.1 (173.9)
------ ------ ------
$(30.0) $ 59.4 $(71.8)
====== ====== ======
The following table reconciles the income tax benefit (provision) at the
expected U.S. statutory rate to that in the financial statements:
Year Ended December
31,
----------------------
1997 1998 1999
------ ------ ------
Statutory U.S. tax benefit (provision).............. $ 94.3 $138.2 $ (1.9)
Amortization of non-deductible goodwill............. (63.3) (61.5) (58.4)
State and local taxes, net of federal tax benefit... 4.2 16.2 0.5
Effect of foreign operations........................ (64.4) (33.9) (9.8)
Other, net.......................................... (0.8) 0.4 (2.2)
------ ------ ------
Tax benefit (provision)............................. $(30.0) $ 59.4 $(71.8)
====== ====== ======
The following is a summary of the deferred tax accounts in accordance with
SFAS 109:
Year Ended
December 31,
-------------
1998 1999
----- ------
Deferred tax assets:
Reserves and accrued liabilities.......................... $38.6 $ 15.9
Book-tax basis differences in rental library and other
assets................................................... 60.1 --
Book-tax basis differences in investments................. 10.7 19.7
Net operating loss carryforwards.......................... 50.7 55.9
----- ------
Total deferred tax assets................................. 160.1 91.5
Less: Valuation allowance................................. (67.6) (72.8)
----- ------
Net deferred tax assets................................... 92.5 18.7
----- ------
Deferred tax liabilities:
Deferred expenses......................................... (13.6) (22.7)
Book-tax basis differences in rental library and other
assets................................................... -- (91.0)
----- ------
Total deferred tax liabilities............................ (13.6) (113.7)
----- ------
Total net deferred tax assets (liabilities)............... $78.9 $(95.0)
===== ======
73
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Note 12--Commitments and Contingencies
The Company has long-term non-cancellable lease commitments for various real
and personal property and office space which expire at various dates. Certain
leases contain renewal and escalation clauses. Generally, leases are five to
ten years with extended renewal options.
At December 31, 1999, minimum rental payments under non-cancellable leases
are as follows:
Operating Capital
--------- -------
2000....................................................... $ 411.4 $ 42.7
2001....................................................... 355.7 34.4
2002....................................................... 304.1 29.9
2003....................................................... 272.9 26.1
2004....................................................... 197.3 20.7
2005 and thereafter........................................ 652.8 34.8
-------- ------
Total minimum lease payments............................... $2,194.2 $188.6
========
Less amount representing interest.......................... 50.5
------
Present value of net minimum payments...................... $138.1
======
Rent expense was $355.3 million (1997), $409.8 million (1998) and $454.0
million (1999). Subtenant rental income was $4.8 million (1997), $5.6 million
(1998) and $7.4 million (1999). Future minimum lease payments have not been
reduced by future minimum subtenant rental income of $98.4 million. No
contingent rentals were paid during the three years ended December 31, 1999.
In October 1998, Music stores were sold to Wherehouse. Certain leases
transferred in connection with the sale of Music to Wherehouse had previously
been guaranteed either by Viacom or its affiliates. The remaining lease terms
expire on various dates through 2007. Blockbuster has agreed to indemnify
Viacom with respect to any amount paid under these guarantees. At the time of
the sale, the contingent liability for base rent approximated $84 million, on
an undiscounted basis, with respect to these guarantees. The Company has not
recognized any reserves related to this contingent liability in the
accompanying consolidated financial statements. If Wherehouse defaults, related
losses could materially affect future operating income.
Pursuant to a tax matters agreement entered into between the Company and
Viacom effective as of the consummation of the Offering, the Company is
generally responsible for, among other things, any taxes imposed on Viacom or
its subsidiaries as a result of the split-off or other similar transaction
failing to qualify as a tax-free transaction on account of any breach of the
Company's representations or agreements or any action or failure to act by the
Company or any transactions involving the Company's assets, stock or business
(regardless of whether such transaction is within its control) following the
split-off or similar transaction.
On July 21, 1999, Ruben Loredo, doing business as Five Palms Video,
purporting to act as a class representative on behalf of himself and all others
similarly situated, filed a complaint in the District Court of Bexar County,
Texas, against Blockbuster. The plaintiff asserts, among other things, that by
entering into and operating under its revenue-sharing agreements with the major
motion picture studios, Blockbuster has attempted to and conspired with the
studios to monopolize and restrain competition in the market for the retail
rental of videocassettes in violation of Texas law. The plaintiff is seeking
triple the amount of his alleged actual damages and triple the amount of
alleged actual damages of those similarly situated, all under the Texas Free
Enterprise and Antitrust Act. The dollar amount that the plaintiff is alleging
as the actual damages to himself and those similarly situated is not set forth
in his complaint. Blockbuster believes that the plaintiff's position is
completely without merit, and Blockbuster intends to vigorously defend itself
in the litigation.
74
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
In addition, three other parties, purporting to act as class representatives
on behalf of themselves and all others similarly situated, filed a
substantially similar complaint in the United States District Court for the
Western District of Texas against Viacom and major motion picture studios and
their home video subsidiaries that have operated under these revenue-sharing
agreements with Blockbuster. These plaintiffs are seeking triple the amount of
the alleged actual damages to themselves and triple the amount of alleged
actual damages of those similarly situated, as well as preliminary and
permanent injunctive relief prohibiting any unlawful attempt or conspiracy to
monopolize the market for the retail rental of videocassettes. If Viacom is
required to pay any damage award as a result of this litigation, Viacom may
seek indemnification for its losses from Blockbuster under the release and
indemnification agreement.
The Company is a defendant from time to time in other lawsuits incidental to
its business. Based on currently available information, the Company believes
that resolution of these known contingencies would not have a material adverse
impact on the Company's financial statements or liquidity. However, there can
be no assurances that future costs would not be material to results of
operations or liquidity of the Company for a particular period. In addition,
the Company's estimates of future costs are subject to change as circumstances
change and additional information becomes available during the course of
litigation.
Note 13--Pension Plans and Other Employee Benefits
Viacom has a noncontributory defined benefit pension plan in which the
Company's employees were covered up through December 31, 1999. Retirement
benefits were based principally on years of service and salary. Effective
January 1, 2000, Blockbuster ceased to be a participating employer in Viacom's
pension plan.
The Company's employees were also offered participation in Viacom's 401(k)
savings plan until April 1999. At that time the Company set up its own 401(k)
savings plan that mirrors the Viacom 401(k) savings plan. Account balances in
the Viacom plan were transferred to the new Blockbuster 401(k) savings plan.
The Company invests matching contributions in Viacom's class B common stock.
Viacom has charged the Company for pension and 401(k) savings plan expenses
of $4.6 million (1997), $5.3 million (1998) and $5.6 million (1999).
Viacom and the Company also provide other employee benefits to the Company's
employees, including medical, dental, life and disability insurance costs.
Management believes that the methodologies used to allocate pension and
other employee benefit charges to the Company are reasonable.
Note 14--Sales of Store Operations to Franchisees
During 1999, Blockbuster sold certain stores to franchisees for $66.4
million as part of the Company's strategy to maintain an optimal mix of
company-operated and franchised stores. As a result of these sales, Blockbuster
received $36.1 million in cash and $30.3 million in notes receivable and
recognized a net gain of $19.9 million, as a reduction of general and
administrative expenses. These notes are classified as other current assets and
other assets in the Company's Consolidated Balance Sheet and were $3.4 million
and $26.7 million, respectively at December 31, 1999. Interest on these notes
range from prime plus 1% to 11.2%. Maturity dates range from June 2000 to
December 2009 with payments made on a monthly basis.
75
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Note 15--Acquisitions
During 1997, 1998 and 1999, the Company acquired several businesses that
own and operate videocassette rental stores. The aggregate purchase price,
consisting of cash consideration and notes for these businesses approximated
$79.0 million (1997), $34.2 million (1998) and $111.7 million (1999) and was
primarily allocated to video rental library, property and equipment and
intangible assets.
All acquisitions were accounted for under the purchase method and,
accordingly, the operating results of the acquired businesses are included in
the consolidated results of operations of the Company since their respective
date of acquisition. Pro forma results of operations have not been presented
due to the immateriality of the acquisitions.
Note 16--Equity Investments
The Company had a 50% interest in a joint venture located in Japan which
owned and operated videocassette rental stores. As discussed in Note 4, during
1997 the Company recognized a charge of $29.4 million (approximately $17.6
million net of tax) related to debt guarantees in recognition of the joint
venture's financial condition. The Company recognized its proportionate share
of this joint venture's net operating loss to the extent of its investment of
$12.1 million in 1997. Through December 31, 1998, the Company had fully
satisfied its obligations related to its Japan debt guarantees. As of December
31, 1997 and 1998, the Company had no remaining net investment in its Japan
joint venture and disposed of its interest in this joint venture in 1999.
Note 17--Supplemental Cash Flow Information
Cash flows from operating activities included cash payments as follows:
Year Ended
December 31,
------------------
1997 1998 1999
----- ----- ------
Cash payments for interest.............................. $20.4 $27.2 $109.3
Supplemental schedule of non-cash financing and
investing activities:
Notes received from sale of store operations (Note
14).................................................. $ -- $ -- $ 30.3
Retail stores acquired under capital leases........... 14.4 3.8 11.8
On December 31, 1998, the Company declared a cash dividend in the amount of
$1.4 billion payable to Viacom in the form of an interest-bearing promissory
note to Viacom International Inc.
All income tax obligations prior to the offering have been satisfied by
Viacom as the Company has been
included in Viacom's consolidated tax return. Subsequent to the offering, the
Company will continue to be included in Viacom's consolidated tax return until
the split-off; however, to the extent the Company will have a tax liability on
a stand-alone basis, such amounts will be remitted to Viacom.
Note 18--Operating Segments and Geographic Area
Beginning in the fourth quarter of 1999, Blockbuster began operating in two
segments: (i) home video, DVD and video game rental and retailing, which
Blockbuster refers to as the video segment, and (ii) new technologies.
(i) Video
Through the video segment, Blockbuster operates 5,879 video stores
and its franchisees and/or joint ventures operate 1,274 video stores
located throughout the United States.
76
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
(ii) New Technologies
Through the new technologies segment, Blockbuster operates the
Internet site, blockbuster.com, and the newly formed division, Digital
Networks, which is responsible for exploring various forms of
electronic entertainment delivery including video on demand.
The Company's reportable operating segments have been determined in
accordance with the Company's internal management structure, which is organized
based on products and services. The Company evaluates performance based on many
factors. One of the primary measures is operating income. Operating income is
defined as income before interest, equity in loss of affiliated companies,
other items and income taxes.
The following tables set forth the Company's financial results by operating
segments.
Year Ended December 31,
----------------------------
1997 1998 1999
-------- -------- --------
Revenues:
Video...................................... $3,313.6 $3,893.4 $4,463.3
New technologies........................... -- -- 0.2
-------- -------- --------
Total revenues........................... $3,313.6 $3,893.4 $4,463.5
======== ======== ========
Operating income (loss):
Video...................................... $ (214.6) $ (359.2) $ 128.7
New technologies........................... -- -- (7.0)
-------- -------- --------
Total operating income (loss)............ $ (214.6) $ (359.2) $ 121.7
======== ======== ========
Depreciation and amortization (including tape
amortization):
Video...................................... $1,222.4 $1,518.8 $1,067.0
New technologies........................... -- -- 0.4
-------- -------- --------
Total depreciation and amortization...... $1,222.4 $1,518.8 $1,067.4
======== ======== ========
Total assets:
Video...................................... $8,731.0 $8,274.8 $8,505.0
New technologies........................... -- -- 35.8
-------- -------- --------
Total assets............................. $8,731.0 $8,274.8 $8,540.8
======== ======== ========
Capital expenditures:
Video...................................... $ 262.2 $ 175.0 $ 341.1
New technologies........................... -- -- 33.3
-------- -------- --------
Total capital expenditures............... $ 262.2 $ 175.0 $ 374.4
======== ======== ========
77
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular amounts in millions except per share amounts)
Information regarding the Company's operations by geographic area is
presented below. The principal geographic areas of the Company's operations are
the United States and Europe. Operations in Latin America, Australia, Canada
and Asia are classified in "International-all other." Intercompany transfers
between geographic areas are not significant.
Year Ended or at December
31,
--------------------------
1997 1998 1999
-------- -------- --------
Revenues:
United States.................................. $2,611.5 $3,090.1 $3,596.8
Europe......................................... 355.9 427.9 440.5
International-all other........................ 346.2 375.4 426.2
-------- -------- --------
Total revenues............................... $3,313.6 $3,893.4 $4,463.5
======== ======== ========
Long-lived assets(1):
United States(2)............................... $7,395.5 $6,942.2 $7,145.2
Europe......................................... 380.9 362.8 357.3
International-all other........................ 295.4 245.6 284.6
-------- -------- --------
Total long-lived assets...................... $8,071.8 $7,550.6 $7,787.1
======== ======== ========
- --------
(1) Includes all non-current assets, except deferred income taxes and Viacom
tax receivable.
(2) Includes substantially all of the Company's intangible assets.
Note 19--Quarterly Financial Data (unaudited)
Summarized quarterly financial data for 1998 and 1999 appears below:
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
-------- -------- -------- -------- --------
1998(1)
Revenue..................... $ 931.2 $ 890.0 $ 985.4 $1,086.8 $3,893.4
Gross profit................ $ 604.6 $ 100.2 $ 591.7 $ 640.5 $1,937.0
Net income (loss)........... $ 15.8 $ (318.0) $ (21.5) $ (12.9) $ (336.6)
Net income (loss) per share:
basic and diluted.......... $ 0.11 $ (2.21) $ (0.15) $ (0.09) $ (2.34)
1999
Revenue..................... $1,113.0 $1,041.7 $1,112.8 $1,196.0 $4,463.5
Gross profit................ $ 671.2 $ 645.3 $ 681.4 $ 703.1 $2,701.0
Net income (loss)........... $ (3.4) $ (39.9) $ (19.1) $ (6.8) $ (69.2)
Net income (loss) per share:
basic and diluted.......... $ (0.02) $ (0.28) $ (0.12) $ (0.04) $ (0.44)
- --------
(1) The second quarter of 1998 included a $424.3 million charge for a change in
estimate effected by a change in accounting principle for rental library.
During the fourth quarter of 1998, the Company revised its estimate of net
realizable value associated with the planned disposition of certain non-
strategic investments and recognized an additional provision of
approximately $10.5 million. See Notes 3 and 4 for further discussion on
these items.
Note 20--Subsequent Events (unaudited)
On February 15, 2000, the Board of Directors declared a cash dividend of
$0.02 per share on class A and class B common stock, payable March 20, 2000, to
stockholders of record at the close of business on February 28, 2000. The total
dividend payment was approximately $3.5 million of which approximately
$2.9 million was paid to Viacom International Inc.
78
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
The information required by this item regarding our directors is set forth
in our Proxy Statement for our 2000 Annual Meeting of Stockholders under the
heading "Election of Directors," which information is incorporated herein by
reference. The information required by this item regarding our executive
officers is set forth under the heading "Executive Officers of the Registrant"
in Part I of this Form 10-K, which information is incorporated herein by
reference.
Item 11. Executive Compensation.
The information required by this item is set forth in our Proxy Statement
for our 2000 Annual Meeting of Stockholders under the heading "Executive
Compensation," which information is incorporated herein by reference.
Information contained in the Proxy Statement under the headings "Executive
Compensation-Report of the Senior Executive Compensation Committee on Executive
Compensation" and "Comparative Performance Graph" is not incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by this item is set forth in our Proxy Statement
for our 2000 Annual Meeting of Stockholders under the heading "Security
Ownership of Certain Beneficial Owners and Management," which information is
incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information required by this item is set forth in our Proxy Statement
for our 2000 Annual Meeting of Stockholders under the heading "Certain
Relationships and Related Transactions," which information is incorporated
herein by reference.
79
PART IV
ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) Financial Statements.
See Index to Consolidated Financial Statements on page 52 of this Form
10-K.
(b) Financial Statement Schedule
See Index to Consolidated Financial Statements on page 52 of this Form
10-K.
(c) Exhibits.
3.1 Amended and Restated Certificate of Incorporation of Blockbuster Inc. (1)
3.2 Bylaws of Blockbuster Inc. (3)
4.1 Specimen Class A Common Stock Certificate of Blockbuster Inc. (2)
10.1 Initial Public Offering and Split-Off Agreement among Blockbuster Inc., Viacom International Inc.
and Viacom Inc.(2)
10.2 Release and Indemnification Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.3 Transition Services Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.4 Registration Rights Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.5 Tax Matters Agreement between Blockbuster Inc and Viacom Inc. (2)
+10.6 Revenue-Sharing Agreement, dated as of November 21, 1997, between Blockbuster Inc. and
Buena Vista Home Entertainment, Inc. (1)
+10.7 Revenue-Sharing Agreement, dated as of September 29, 1998, between Blockbuster Inc. and
Twentieth Century Fox Home Entertainment, Inc. (1)
+10.8 Revenue-Sharing Agreement, dated as of August 25, 1998, between Blockbuster Inc. and
Columbia TriStar Home Video, Inc. (1)
+10.9 Direct Revenue-Sharing Adjustable License Agreement, dated as of October 13, 1998, between
Blockbuster Inc. and Universal Studios Home Video. (1)
+10.10 Revenue-Sharing Agreement, dated as of January 20, 1999, between Blockbuster Inc. and
Warner Home Video, a division of Time Warner Entertainment Company, L.P. (1)
+10.11 Revenue-Sharing Term Sheet, dated as of July 29, 1999, between Blockbuster Inc. and
Paramount Home Video. (1)
10.12 Employment Agreement between Blockbuster Inc. and John F. Antioco, dated July 15, 1999. (1) (4)
10.13 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Mark T. Gilman, dated December 16, 1996. (3) (4)
10.14 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Mark T. Gilman, dated May 12, 1997. (3) (4)
10.15 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Mark T. Gilman, dated December 1, 1998. (3) (4)
10.16 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Alva J. Phillips, Jr., dated as of January 1, 1998. (3) (4)
10.17 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Alva J. Phillips, Jr., dated December 1, 1998. (3) (4)
10.18 Retention Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc., and
Joe Phillips, dated June 22, 1998(3) (4)
80
10.19 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Nigel Travis, dated June 1, 1998. (1) (4)
10.20 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Nigel Travis, dated December 1, 1998. (1) (4)
10.21 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Larry Zine, dated April 1, 1999. (3) (4)
10.22 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Larry Zine, dated April 2, 1999. (3) (4)
10.23 Blockbuster Inc. 1999 Long-Term Management Incentive Plan. (1) (4)
10.24 Blockbuster Inc. Senior Executive Short-Term Incentive Plan. (1) (4)
10.25 Credit Agreement, dated as of June 21, 1999, between Blockbuster Inc. and the banks named therein.
(1)
10.26 Form of Promotional Services and Customer Database Services and License Agreement between the
Registrant and MTV Networks, a division of Viacom International Inc. (1)
21.1 List of Subsidiaries of Blockbuster Inc. (3)
23.1 Consent of PricewaterhouseCoopers LLP. (3)
27.1 Financial Data Schedule. (3)
- --------
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration Statement
on Form S-1 (333-77899).
(2) Previously filed as an exhibit to Blockbuster Inc.'s Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1999, and
incorporated herein by reference.
(3) Filed herewith.
(4) The exhibit is a management contract or compensatory plan or arrangement.
+ Exhibits for which Blockbuster Inc. has received confidential treatment for
certain portions. The confidential material in such exhibits has been
redacted and separately filed with the Securities and Exchange Commission as
part of Blockbuster Inc.'s Registration Statement on Form S-1 (333-77899),
as amended.
(d) Reports of Form 8-K
None.
81
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
BLOCKBUSTER INC.
/s/ John F. Antioco
By: _________________________________
John F. Antioco
Chairman of the Board,
President and Chief Executive Officer
March 24, 2000
Date: _______________________________
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
By: /s/ John F. Antioco Chairman of the Board, President March 24, 2000
__________________________________ and Chief Executive Officer
John F. Antioco (Principal Executive Officer)
By: /s/ Larry J. Zine Executive Vice President and March 24, 2000
__________________________________ Chief Financial Officer
Larry J. Zine (Principal Financial and
Accounting Officer)
By: /s/ Philippe P. Dauman Director March 24, 2000
__________________________________
Philippe P. Dauman
By: /s/ Thomas E. Dooley Director March 24, 2000
__________________________________
Thomas E. Dooley
By: /s/ Linda Griego Director March 24, 2000
__________________________________
Linda Griego
By: /s/ John L. Muething Director March 24, 2000
__________________________________
John L. Muething
By: /s/ Sumner M. Redstone Director March 24, 2000
__________________________________
Sumner M. Redstone
EXHIBIT INDEX
3.1 Amended and Restated Certificate of Incorporation of Blockbuster Inc. (1)
3.2 Bylaws of Blockbuster Inc. (3)
4.1 Specimen Class A Common Stock Certificate of Blockbuster Inc. (2)
10.1 Initial Public Offering and Split-Off Agreement among Blockbuster Inc., Viacom International Inc.
and Viacom Inc.(2)
10.2 Release and Indemnification Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.3 Transition Services Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.4 Registration Rights Agreement between Blockbuster Inc. and Viacom Inc. (2)
10.5 Tax Matters Agreement between Blockbuster Inc and Viacom Inc. (2)
+10.6 Revenue-Sharing Agreement, dated as of November 21, 1997, between Blockbuster Inc. and
Buena Vista Home Entertainment, Inc. (1)
+10.7 Revenue-Sharing Agreement, dated as of September 29, 1998, between Blockbuster Inc. and
Twentieth Century Fox Home Entertainment, Inc. (1)
+10.8 Revenue-Sharing Agreement, dated as of August 25, 1998, between Blockbuster Inc. and
Columbia TriStar Home Video, Inc. (1)
+10.9 Direct Revenue-Sharing Adjustable License Agreement, dated as of October 13, 1998, between
Blockbuster Inc. and Universal Studios Home Video. (1)
+10.10 Revenue-Sharing Agreement, dated as of January 20, 1999, between Blockbuster Inc. and
Warner Home Video, a division of Time Warner Entertainment Company, L.P. (1)
+10.11 Revenue-Sharing Term Sheet, dated as of July 29, 1999, between Blockbuster Inc. and
Paramount Home Video. (1)
10.12 Employment Agreement between Blockbuster Inc. and John F. Antioco, dated July 15, 1999. (1) (4)
10.13 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Mark T. Gilman, dated December 16, 1996. (3) (4)
10.14 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Mark T. Gilman, dated May 12, 1997. (3) (4)
10.15 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Mark T. Gilman, dated December 1, 1998. (3) (4)
10.16 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Alva J. Phillips, Jr., dated as of January 1, 1998. (3) (4)
10.17 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Alva J. Phillips, Jr., dated December 1, 1998. (3) (4)
10.18 Retention Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc., and
Joe Phillips, dated June 22, 1998(3) (4)
10.19 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Nigel Travis, dated June 1, 1998. (1) (4)
10.20 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Nigel Travis, dated December 1, 1998. (1) (4)
10.21 Employment Agreement between Blockbuster Entertainment Group, a business unit of Viacom Inc.,
and Larry Zine, dated April 1, 1999. (3) (4)
10.22 Amendment to the Employment Agreement between Blockbuster Entertainment Group, a business unit
of Viacom Inc., and Larry Zine, dated April 2, 1999. (3) (4)
10.23 Blockbuster Inc. 1999 Long-Term Management Incentive Plan. (1) (4)
10.24 Blockbuster Inc. Senior Executive Short-Term Incentive Plan. (1) (4)
10.25 Credit Agreement, dated as of June 21, 1999, between Blockbuster Inc. and the banks named therein.
(1)
10.26 Form of Promotional Services and Customer Database Services and License Agreement between the
Registrant and MTV Networks, a division of Viacom International Inc. (1)
21.1 List of Subsidiaries of Blockbuster Inc. (3)
23.1 Consent of PricewaterhouseCoopers LLP. (3)
27.1 Financial Data Schedule. (3)
- --------
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration Statement
on Form S-1 (333-77899).
(2) Previously filed as an exhibit to Blockbuster Inc.'s Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1999, and
incorporated herein by reference.
(3) Filed herewith.
(4) The exhibit is a management contract or compensatory plan or arrangement.
+ Exhibits for which Blockbuster Inc. has received confidential treatment for
certain portions. The confidential material in such exhibits has been
redacted and separately filed with the Securities and Exchange Commission as
part of Blockbuster Inc.'s Registration Statement on Form S-1 (333-77899),
as amended.