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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, 2000
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 share New York Stock Exchange
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 16, 2001, 31,014,696 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 $419,961,551, based on the
closing price of $13.64 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 2001 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............................................................................. 17
Item 3. Legal Proceedings...................................................................... 17
Item 4. Submission of Matters to a Vote of Security Holders.................................... 18
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters........................... 19
Item 6. Selected Financial Data................................................................ 19
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.. 30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................. 42
Item 8. Financial Statements and Supplementary Data............................................ 43
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure... 69
PART III
Item 10. Directors and Executive Officers of the Registrant..................................... 70
Item 11. Executive Compensation................................................................. 70
Item 12. Security Ownership of Certain Beneficial Owners and Management......................... 70
Item 13. Certain Relationships and Related Transactions......................................... 70
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K....................... 71
PART I
Item 1. Business
BLOCKBUSTER OVERVIEW
Blockbuster Inc. is the world's leading retailer of rentable home
videocassettes, DVDs and video games, with close to 7,700 stores in the United
States, its territories and 25 other countries as of December 31, 2000.
According to The Gallup Organization, our BLOCKBUSTER(R) brand achieves nearly
100% recognition with active movie renters in the United States. During 2000,
while our core video store business continued to grow, we also extended our
business and our brand into additional home entertainment distribution
channels.
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. Subsequent to
the merger, 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 in August 1999, 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. In 1999,
Viacom announced that it intended to split-off Blockbuster by offering to
exchange all of its shares of Blockbuster common stock for shares of Viacom's
common stock. The split-off was subject to approval by Viacom's Board of
Directors and an assessment of market conditions. Viacom has stated that it no
longer has any plans for the split-off of Blockbuster.
Beginning in the fourth quarter of 1999, we began reporting in two segments:
(i) home videocassette, DVD and video game rental and retailing, which we refer
to as our video segment, and (ii) new media (formerly called new technologies).
Information relating to our segments is included in Management's Discussion and
Analysis of Financial Condition and Results of Operations and Note 17 to our
Consolidated Financial Statements included in this document.
Intellectual Property
We own, or have applications pending with respect to, a number of
trademarks, trade names and service marks, including, among others,
BLOCKBUSTER(R), BLOCKBUSTER VIDEO(R), BLOCKBUSTER FAVORITES(TM), BLOCKBUSTER
GIFTCARD(R), BLOCKBUSTER GIFTCARDS(TM), BLOCKBUSTER REWARDS(R), BLOCKBUSTER
ENTERTAINMENT AWARDS(R), blockbuster.com(R), BLOCKBUSTER Pre-Viewed(R),
KIDPRINT(R), THE GIFT OF ENTERTAINMENT(R), BRINGING ENTERTAINMENT HOME(TM),
XTRA-VISION, our ticket design in blue and yellow and in black and white, and
the blue and yellow awning outside our stores. In addition, we own the rights to
the "blockbuster.com" Internet domain name, among others. We consider our
intellectual property rights to be among our most valuable assets.
INDUSTRY OVERVIEW
Domestic Home Video--Movies
According to Paul Kagan Associates, at-home movie consumer spending in the
United States increased from $10.1 billion in 1990 to $20.6 billion in 2000 and
is projected to increase to $31.1 billion by 2010. The U.S. retail home video
industry represented about $19.3 billion of the 2000 revenues, according to
Kagan, but is expected to decline as a percentage of overall at-home movie
consumer spending over the next ten years. Although close to 90% of U.S.
households with a television already own a VCR, we believe that consumer
1
interest in DVD as a new rental format could offset the effect that this high
penetration rate is expected to have on growth in VHS rental. According to
Kagan, the number of U.S. DVD households more than doubled during 2000 and is
expected to grow to over 65 million by 2010.
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 addition,
since August of 2000, two of our chain store competitors have filed for Chapter
11 bankruptcy protection, and a third has sold all of its stores.
We believe that the combination of the following factors, among others,
continue to make video rental a preferred medium of entertainment for millions
of customers:
. the opportunity to entertain one or more people at home for a reasonable
price;
. the opportunity to browse among a very broad selection of movies; and
. the ability to control the viewing experience, such as the ability to
start, stop, pause, fast-forward and rewind.
In addition, a significant competitive advantage that the video rental
industry currently enjoys over most other movie distribution channels except
theatrical release is the early timing of its 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 about 45-
60 days for domestic video stores. Thereafter, movies are made sequentially
available to television distribution channels.
We believe the implementation in 1998 of revenue-sharing arrangements
directly with the studios has also benefited the video rental industry.
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 initially release VHS movies at relatively high wholesale prices
unless the movie is subject to a revenue-sharing arrangement or a quantity
discount program or is designated as a "sell-through" movie. Sell-through
movies typically consist of movies for children and other movies that have
unique characteristics or other mass ownership appeal, such as Toy Story 2 and
Erin Brockovich. Because the studios release these movies at relatively low
initial prices, or "sell-through" pricing, retailers generally purchase these
movies primarily for sale. The studios also eventually reduce the cost of VHS
movies that are initially priced only for rental in order to promote sales to
consumers.
For titles acquired under U.S. revenue-sharing agreements, video stores
generally 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 may
decline over a period of weeks following the initial release of the movie. The
video stores may 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 resulted in the
following significant benefits to participating video stores:
. they have provided these stores with the opportunity to substantially
increase the quantity and selection of newly released video titles that
they stock;
. they have increased revenues as a result of the increase in total number
of transactions per store and number of videocassettes rented per
transaction; and
. they have aligned the studios' economic interests more closely with the
interests of the video stores.
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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.
These revenue-sharing arrangements generally do not currently apply to DVDs.
However, unlike traditional VHS wholesale purchasing arrangements, DVDs are
currently typically released at sell-through prices ranging from about $15 to
$25. In addition, unlike VHS movies, the majority of DVDs are currently
released for sale at the same time as they are released for rental.
International Home Video--Movies
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 States, though the windows in many of the international
countries tend to last for a longer period of time. However, other attributes
of the home video industry outside of the United States do not necessarily
mirror the home video industry within the United States. For example, most
countries have different systems of supply and distribution of movie titles. In
addition, although revenue-sharing agreements have been introduced into many
international markets, they are not yet as common as they are within the U.S.
home video industry. In addition, competition in many of our international
markets tends to be more fragmented, with few large home video chains.
Movie Studio Dependence on Video Rental Industry
According to Kagan, total U.S. movie studio and independent supplier revenue
in the United States grew at a compound annual rate of about 8.2% per year from
$13.0 billion in 1996 to $17.8 billion in 2000. Kagan also indicates that the
video rental industry is the largest single source of U.S. revenue to U.S.
movie distributors, representing about $7.9 billion, or 44.3%, of the $17.8
billion of revenue in 2000. The following table represents Kagan's estimates of
total movie distributor revenue.
Year Ended December 31,
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1996 1997 1998 1999 2000
------- ------- ------- ------- -------
(in millions)
U.S. home video (rental and retail).... $ 6,152 $ 6,306 $ 6,811 $ 7,206 $ 7,900
Other U.S. revenue..................... 6,883 7,393 8,067 9,129 9,948
------- ------- ------- ------- -------
Total U.S. revenue................... 13,035 13,699 14,878 16,335 17,848
------- ------- ------- ------- -------
International home video............... $ 4,432 $ 4,406 $ 4,436 $ 4,650 $ 4,770
Other international revenue............ 7,298 7,834 8,949 9,712 10,383
------- ------- ------- ------- -------
Total international revenue.......... 11,730 12,240 13,385 14,362 15,153
------- ------- ------- ------- -------
Total revenue...................... $24,765 $25,939 $28,263 $30,697 $33,001
======= ======= ======= ======= =======
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 and DVD rentals encourages consumers
to rent films they might not pay to view at a theater.
3
Home Video Game Industry
The home video game industry has historically been affected by changing
technology, limited hardware platform lifecycles and hit-or-miss software
titles. According to VidTrac, the total domestic home video game market
generated about $800 million in rental revenue in 1998. This market grew to
about $880 million in 1999, which represented a 10.0% increase. However, the
cyclical nature of the video game industry was evidenced during 2000. According
to VidTrac, domestic rental revenue for the home video game market increased
only 4.3% to about $919 million in 2000. According to industry experts, the
slower growth in 2000 was driven by an anticipated increase in platform options
during 2001 and shortages of Sony PlayStation 2 hardware, which was not
released until the fourth quarter. Despite the slowdown in the home video game
industry during 2000, we expect 2001 to be a pivotal year in the industry due
to increasing household penetration of PlayStation 2 and the anticipated
introduction of Nintendo's GameCube and Game Boy Advance and Microsoft's Xbox
during 2001.
OUR BUSINESS
Blockbuster is the world's leading retailer of rentable home videocassettes,
DVDs and video games, with close to 7,700 stores in the United States, its
territories and 25 other countries as of December 31, 2000. According to The
Gallup Organization, our BLOCKBUSTER brand achieves nearly 100% recognition
with active movie renters in the United States. Our worldwide revenues in 2000
increased 11.1% from 1999, with about 80.7% of the worldwide revenues generated
in the United States and about 19.3% generated outside of the United States.
Our brand recognition and leading market position have allowed us to create
one of the strongest entertainment franchises in the United States. During
2000, while continuing to increase our market share of the domestic video
rental business, we also leveraged our brand and expanded into additional
distribution channels. We have developed our 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
70% of the U.S. population lives within a ten-minute drive of one of our
stores. In addition, our customer transaction database contains information on
more than 51 million U.S. and Canadian member accounts that were active in the
year ended December 31, 2000.
In 1997, 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
generally 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. These agreements have enabled us
to satisfy consumer demand for the most popular newly released video titles in
greater quantity and on a more efficient basis and have resulted in the
benefits discussed under "--Industry Overview--Domestic Home Video--Movies"
above.
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 projected rental frequency by store and
improving our direct marketing programs and advertising campaigns. Reflecting
these improvements, domestic same store rental revenues increased 16.9%, 11.4%
and 4.1% in 1998, 1999 and 2000, respectively.
4
Business Model
Our business model is designed to deliver long-term sustainable growth in
our core business and to use our capital and resources in areas of business
that we believe will provide incremental growth and return on investment. We
have had three consecutive years of same store revenue growth and believe we
can capitalize on the continued growth in our core video store business by
exploring additional home entertainment distribution channels that provide
incremental revenue and gross profit opportunities. We believe our unique
combination of core assets such as our highly recognized global brand, our
expansive customer and store base and our substantial marketing skills give us
an advantage over other video retailers, including large chain stores as well
as single-store competitors. In addition, our global presence allows us to
capitalize on opportunities worldwide. The key elements of our business model
are discussed below.
Continued Customer Satisfaction Enhancements
We strive to be the leader in satisfying customer demand by stocking each of
our stores with the selection, quantity and format of merchandise desired by
our customers. In 1998, we implemented revenue-sharing arrangements directly
with major motion picture studios in response to consumer demand for more newly
released videos. These arrangements, combined with our self-distribution
capabilities, have allowed us to stock each of our U.S. stores with a quantity
and variety of newly released videocassettes that is necessary to satisfy
customer demand. We have continued to manage our merchandise mix in response to
changing consumer demands such as the significant increase in demand for DVDs
over the past year. DVDs represented about 10.1% of our net domestic rental
revenues during the fourth quarter of 2000. Based on our expectation that
demand for DVDs will continue to grow, we expect DVDs to represent 20-25% of
our net domestic rental revenues by the end of 2001. We also continue to focus
on providing superior service to our customers through enhancements to the in-
store experience. For example, as part of our initiative to improve speed-of-
service, we launched online rental reservations in two markets during 2000,
and, assuming consumer acceptance, we intend to roll out this program
nationally in 2001.
Increased Store Profitability
Blockbuster has attained a strong store presence throughout the United
States, with an estimated 70% of the U.S. population living within a ten-minute
drive of one of our stores. During 2000, we also continued to increase our
system-wide U.S. video rental market share as a result of our ability to
satisfy our customers. We are able to derive significant economies of scale and
operating efficiencies on our increasing revenue base that are not necessarily
available to our store-based competitors. We are able to achieve efficiencies
on both a store-level basis and a system-wide basis as a result of our business
model, which is designed to reduce our labor costs, distribution costs and
general and administrative expenses as a percentage of our revenues.
As a result of our expansive store presence, our strong market share and the
continued consolidation in the home video rental industry, we intend to improve
the profitability of our existing stores while growing our store base in a
disciplined manner. We plan to add most of our new stores in markets that we
believe provide the greatest opportunity for incremental growth. Our customer
transaction and real estate databases enable our experienced store development
team to assess
. which markets are most likely to offer growth opportunities with minimal
cannibalization of our existing stores;
. whether the store growth in any particular market should be effected
through new or franchised stores or through acquisition; and
. the appropriate store format, in the case of new company-operated stores.
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.
We continue to explore ways to maximize the use of our store space to
generate incremental profit. In September 2000, as part of our model to
increase store profitability, we began marketing and soliciting
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DIRECTV System equipment and DIRECTV(R) programming packages in about 3,800 of
our U.S. store locations and, within a few months, established ourselves as one
of the leading retailers of DIRECTV in the United States. At the same time,
through our marketing programs, we used this business to generate traffic to
our stores. We believe that this achievement demonstrates that our stores can
support home entertainment products beyond our traditional core offerings. In
February 2001, we entered into a strategic alliance with RadioShack Corporation
for the purpose of introducing a RadioShack store-within-a-store concept inside
BLOCKBUSTER stores. We intend to introduce RadioShack stores-within-a-store in
130 of our stores during 2001 as proof of concept.
Leveraging of our Core Assets
Our extensive advertising and marketing capabilities allow us to promote
awareness of the BLOCKBUSTER brand and our initiatives to satisfy consumer
demands. Our ultimate objective is to make our name so recognizable and our
strengths so visible that consumers will see no reason to go elsewhere for the
products and services that we offer. 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. During
2000, in order to convey Blockbuster's ability to respond to consumer demand
for DVD and to position ourselves as the ultimate destination for DVD rentals,
we marketed our DVD Satisfaction Guarantee program and our DVD Rental Pass. Our
customer transaction database, along with programs like our BLOCKBUSTER REWARDS
premium membership program, also enable us to directly communicate with our
customers on a targeted and customized basis about products and programs of
interest to them. Our goal is to continue to increase our one-to-one marketing
efforts, with BLOCKBUSTER REWARDS being a key component of that objective.
We have also leveraged our core business assets to extend our brand to new
home entertainment distribution channels that position us to share in the
projected growth in the overall home entertainment industry. In late 2000, we
launched a technical trial of our entertainment-on-demand service in four U.S.
markets. During 2001, we plan to co-brand with DIRECTV its pay-per-view movie
service, which would establish our brand in the pay-per-view segment of the
home entertainment industry.
Merchandising
We offer a wide selection of movies and video games for rent and purchase.
Our goal is to stock each of our stores with a selection, quantity and format
of merchandise that is customized for that store. The breakdown of net domestic
revenues generated from the rental and sale of such products for the year ended
December 31, 2000 was as follows:
[Pie graph which shows a breakdown of domestic revenue follows:
1. Movie rentals: 71.9%
2. Video game rentals: 9.2%
3. Previously viewed tapes, DVDs and video game sales: 7.3%
4. Sell-through movie sales: 5.7%
5. Other: 5.9%]
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Using our customer transaction database, we determine on a store-by-store
basis the number of copies of each newly released movie that is to be offered
by each U.S. store. About 69.1% of 2000 net domestic rental revenues were from
the rentals of newly released movies on videocassette. We also offer a broad
selection of time-tested popular movies, or "BLOCKBUSTER FAVORITES," and a wide
variety of independent and lower-cost movies that currently are generally
exclusively available at our stores for a specified period of time. In response
to consumer demand, during 2000, we significantly increased our DVD inventory,
including both new releases and BLOCKBUSTER FAVORITES. DVD rentals represented
about 7.5% of net domestic rental revenues in 2000 and about 10.1% of net
domestic rental revenues in the fourth quarter of 2000.
Our customer transaction database allows us 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 movies for sale and replace them with movies that we believe
our customers are more interested in renting. We also sell some previously
viewed new release movies.
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. In addition, we sell new video games in most of our stores in markets
outside of the United States. We also rent video game consoles, as well as VHS
and DVD players, in most of our domestic company-operated stores and sell other
complementary products.
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 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. Our franchise program
provides us with an additional avenue for expanding our consumer reach. 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, as discussed
under "--International Operations," below. In addition, we plan to add
franchise and joint venture stores in other international markets.
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.
Store Development. During 2000, we increased our number of U.S. and
international company-operated stores by 303 and 72, respectively, and our U.S.
and international franchise and joint venture stores by 95 and 54,
respectively.
Store Format. We seek to locate stores in spots that are 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
generally operate one of three store formats. Our traditional store format is
more than 4,000 square feet and is used in markets in which store-to-population
ratios are low and in which we believe market conditions are optimal. We use a
smaller store format to compete (i) primarily in rural areas or (ii) in markets
that are located between our traditional stores without significantly
decreasing the market shares of those traditional stores. We also use a store-
in-store format within department stores, supermarkets and other stores in
order 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 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,
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each U.S. store employs 11 people, including three assistant store managers and
one store manager. International store operations vary by country.
Store Locations. At December 31, 2000, in the United States and its
territories, we operated 4,273 stores and our franchisees operated 918 stores.
The following map sets forth the number of domestic stores we operated,
including stores operated by our franchisees, as of December 31, 2000:
[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................................................... 58
ALASKA.................................................... 15
ARIZONA................................................... 108
ARKANSAS.................................................. 18
CALIFORNIA................................................ 641
COLORADO.................................................. 120
CONNECTICUT............................................... 56
DELAWARE.................................................. 11
DISTRICT OF COLUMBIA...................................... 7
FLORIDA................................................... 374
GEORGIA................................................... 189
HAWAII.................................................... 21
IDAHO..................................................... 11
ILLINOIS.................................................. 249
INDIANA................................................... 91
IOWA...................................................... 27
KANSAS.................................................... 55
KENTUCKY.................................................. 66
LOUISIANA................................................. 74
MAINE..................................................... 5
MARYLAND.................................................. 132
MASSACHUSETTS............................................. 120
MICHIGAN.................................................. 168
MINNESOTA................................................. 54
MISSISSIPPI............................................... 37
MISSOURI.................................................. 97
MONTANA................................................... 10
NEBRASKA.................................................. 31
NEW HAMPSHIRE............................................. 19
NEW JERSEY................................................ 125
NEW MEXICO................................................ 28
NEW YORK.................................................. 284
NEVADA.................................................... 52
NORTH CAROLINA............................................ 121
NORTH DAKOTA.............................................. 6
OHIO...................................................... 176
OKLAHOMA.................................................. 68
OREGON.................................................... 89
PENNSYLVANIA.............................................. 186
PUERTO RICO............................................... 41
RHODE ISLAND.............................................. 26
SOUTH CAROLINA............................................ 71
SOUTH DAKOTA.............................................. 8
TENNESSEE................................................. 85
TEXAS..................................................... 542
UTAH...................................................... 51
VERMONT................................................... 5
VIRGINIA.................................................. 127
VIRGIN ISLANDS............................................ 2
WASHINGTON................................................ 132
WEST VIRGINIA............................................. 17
WISCONSIN................................................. 77
WYOMING................................................... 6
GUAM...................................................... 2]
8
At December 31, 2000, outside of the United States, we operated 1,981
stores, and our franchisees and joint ventures in which we own a minority
interest operated 505 stores. The following table sets forth, by country, the
number of stores operated by us and stores operated by our franchisees and
joint ventures as of December 31, 2000.
Number of
Number of Franchised and/or
Company-Operated Joint Venture
COUNTRY (1) Stores Stores Total(1)(2)
- ----------- ---------------- ----------------- -----------
Great Britain.................. 674 -- 674
Canada......................... 353 -- 353
Australia...................... 133 112 245
Ireland (Republic) and Northern
Ireland....................... 212 -- 212
Mexico......................... 199 4 203
Italy.......................... -- 169 169
Spain.......................... 105 5 110
Taiwan......................... 86 8 94
Brazil......................... -- 73 73
Argentina...................... 80 -- 80
Chile.......................... 62 -- 62
Denmark........................ 55 -- 55
China (Hong Kong).............. 19 -- 19
Thailand....................... -- 26 26
New Zealand.................... -- 22 22
Portugal....................... -- 16 16
Colombia....................... -- 14 14
Venezuela...................... -- 13 13
Israel......................... -- 12 12
Peru........................... -- 10 10
Panama......................... -- 8 8
Ecuador........................ -- 5 5
El Salvador.................... -- 6 6
Uruguay........................ 3 -- 3
The Philippines................ -- 2 2
----- --- -----
International Store Total...... 1,981 505 2,486
===== === =====
- --------
(1) This does not include non-operating stores that are leased or owned.
(2) In addition to the stores listed in the chart, as of December 31, 2000,
there were 91 video vending machines being tested in Great Britain, Spain
and Italy.
Marketing and Advertising
We design our marketing and advertising campaigns to maximize the leverage
of our marketing and advertising expenditures. We obtain information from our
customer transaction database, our real estate database and outside research
agencies to formulate and adjust our advertising based on:
. our market share;
. our level of store development and brand awareness relative to our
competitors within the relevant market;
. our evaluation of new industry trends;
. local demographics; and
. other local competitive issues.
9
Our large store base and leading brand awareness have enabled us to
implement programs such as BLOCKBUSTER REWARDS, BLOCKBUSTER GIFTCARDS, cross-
promotional marketing programs and national promotional events, including the
internationally televised BLOCKBUSTER ENTERTAINMENT AWARDS. In addition, we
have recently expanded our new release guarantee program to selected DVD
titles.
Worldwide, in the year ended December 31, 2000, we incurred about $215.3
million in advertising expenses, which includes about $159.4 million in the
United States and about $55.9 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, which we
believe drives consumers to our stores.
Franchise Operations
We believe our franchising program is an effective way to expand our
consumer reach. At December 31, 2000, our franchisees operated 918 stores in
the United States and our franchisees and minority-owned joint ventures
operated 505 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. franchisees in the fourth quarter of 1999, some of our U.S.
franchisees are now participating in our revenue-sharing agreements.
Accordingly, these U.S. franchisees rely upon our distribution center to
receive some portion of their videocassettes.
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 a permitted location or
locations within a defined geographic area and within a specified time. We
generally charge the franchisee a development fee at the time of execution of
the development agreement 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 our 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.
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, 2000, we had 2,486 stores operating under the
BLOCKBUSTER brand and other brand names owned by us located throughout 25
markets outside of the United States. Of these stores, 505 were operated
through our franchisees and joint ventures in which we own a minority interest.
About 19.3% of our worldwide revenues in 2000 were generated outside the United
States.
Our global presence allows us to capitalize on opportunities worldwide. We
believe this gives us a competitive advantage over competitors that are solely
dependent on their domestic business. During 2000, we continued to extend the
reach of our revenue-sharing model in some of our international markets.
10
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 have grown to 674 locations, excluding
video vending machines, as of December 31, 2000. We began operations in Canada,
our second largest international market, in 1990 and have grown to 353 stores,
as of December 31, 2000. We began operations in Mexico in 1991 and opened our
200th company-operated store in January 2001. In Australia, we began operations
in 1993 and have grown to 245 company-operated and franchised stores as of
December 31, 2000. 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, 2000, we had 212 stores
in the Republic of Ireland and Northern Ireland. In addition, we have operated
in Spain and Argentina since 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, and format and technical standards.
Thus, because of all of these variables, we cannot assure you that we can
operate profitably in these international markets.
Blockbuster.com
Our primary focus for blockbuster.com is to support our stores and drive
store revenues through promotional devices. During 2000, we reduced the site's
e-commerce offerings and instead focused on other features such as:
. 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, during 2000, we integrated our online capabilities with our
store systems and launched a two-market pilot of our online rental reservations
system. This system, which we intend to roll out on a national basis in 2001,
would allow consumers to search a store's inventory, reserve a title and pre-
pay through our site. We are also exploring initiatives designed to integrate
the capabilities of blockbuster.com with our future entertainment-on-demand
services.
As part of a cost reduction initiative, we are outsourcing some of our
infrastructure services, including our e-commerce function, to third-party
providers.
Suppliers
The following is a description of the suppliers to our domestic company-
operated and franchised stores. Our international stores are supplied by a
variety of suppliers.
11
Company-operated Stores. Our U.S. company-operated stores receive a
substantial portion of their videocassettes under our revenue-sharing
agreements. We typically purchase DVDs directly from the studios under normal
business arrangements.
Under our revenue-sharing arrangements, 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 the 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.
We believe the terms of our revenue-sharing 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 our
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 major studios expire by their terms at
various times over the next two years.
For most of our revenue-sharing videocassettes, the major studios send the
master videocassettes to a duplicator for copying and then the copies are
shipped to our distribution center. In addition, we purchase sell-through
movies, direct-to-video movies and movies sold at traditional wholesale prices
from major studios, independent studios and independent suppliers, generally
pursuant to normal business arrangements. We purchase our video game hardware
and software, as well our VCRs, DVD players and other complementary products,
from a variety of suppliers.
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 and are also responsible for obtaining some of the other
complementary products from their own suppliers. However, if we have purchased
the exclusive distribution rights to a movie or if a franchisee 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 provides them with an option to
increase their quantity and selection of movies. During 2001, we anticipate
that some of our franchisees will also begin participating in our DIRECTV
offering.
Distribution and Inventory Management
In the first quarter of 1998, we began operation of our 850,000 square foot
state-of-the-art distribution center in McKinney, Texas, which is near our
corporate headquarters. The 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. We believe our
distribution center gives us a significant 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 services to our
stores. The distribution center supports all of our company-operated stores in
the United States and operates six days a week, 24 hours a day. As of December
31, 2000, we employed about 890 employees at our distribution center.
At our distribution center, we receive substantially all of our
videocassettes and video games. We mechanically repackage the newly released
videocassettes to make them suitable for rent at our stores, a
12
process that had previously been handled manually by our store employees. We
expect to begin repackaging newly released DVDs for rental during 2001. 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 for 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.
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 rental patterns. This
information can be organized by store, region, state, country or for all
operations.
Most of our company-operated stores and franchisees use our point-of-sale
system. Our national point-of-sale system in the United States 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 U.S. 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.
Competition
We operate in a highly competitive environment. We believe our most
significant competition comes from (a) providers of direct delivery home
viewing entertainment and (b) video stores and other retailers that rent or
sell movies.
Competition with Providers of Direct Delivery Home Viewing Entertainment.
These providers include direct broadcast satellite, cable, digital terrestrial,
network and syndicated television. We believe that a significant competitive
risk to our video store business comes from direct broadcast satellite, digital
cable television and high-speed Internet access. In response to this
competition, in 2000, we entered the direct broadcast satellite market through
our alliance with DIRECTV and began testing our entertainment-on-demand
service. 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. 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. See "Cautionary Statements--The widespread availability of
additional channels on satellite and digital cable systems may significantly
reduce public demand for our products."
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;
13
. quality, quantity and variety of titles;
. pricing; and
. customer service.
Other Competition. In some markets, we also compete against the illegal
duplication and sale 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 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 that 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;
14
. 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, 2000, we employed about 95,800 persons, including about
74,200 persons employed within the United States and about 21,600 persons
employed outside of the United States. Of the total number of U.S. employees,
about 21,500 were full-time and about 52,700 were part-time. We believe that
our employee relations are good.
Executive Officers of the Registrant
The following information regarding our executive officers is as of March
26, 2001.
Name Age Position
- ---- --- ----------------------------------------------------
John F. Antioco....... 51 Chairman of the Board of Directors, President and
Chief Executive Officer
Mark T. Gilman........ 37 Executive Vice President and President, New Media
Division
James Notarnicola..... 49 Executive Vice President and Chief Marketing Officer
Michael K. Roemer..... 52 Executive Vice President and Chief Operations
Officer, North America Operations
Edward B. Stead....... 54 Executive Vice President, General Counsel and
Secretary
Nigel Travis.......... 51 Executive Vice President and President, Worldwide
Stores Division
Dean M. Wilson........ 43 Executive Vice President and Chief Merchandising
Officer, Worldwide
Larry J. Zine......... 46 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. Mr. Antioco is also a member of the board
of governors of the Boys & Girls Clubs of America.
15
Mark T. Gilman has served as our executive vice president and president, new
media division, since April 2000 and served as our executive vice president and
chief worldwide development officer, store operations, from December 1999 until
April 2000. Mr. Gilman also 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.
Michael K. Roemer has served as our executive vice president and chief
operations officer, North America operations, since March 2001 and served as
our executive vice president and chief operations officer, USA store
operations, from December 1999 until March 2001. Mr. Roemer also 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 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. Mr. Roemer currently serves as a director of Brazos
Country Foods, Inc.
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 senior
vice president, general counsel and secretary. Prior to joining Apple, Mr.
Stead held positions with Cullinet Software, Inc. and International Business
Machines Corporation. Mr. Stead currently serves on the board of directors of
the Mexican American Legal Defense and Education Fund and is also a member of
the legal advisory board of the New York Stock Exchange.
Nigel Travis has served as our executive vice president and president,
worldwide stores division, 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 a director of The Bombay Company, Inc. Mr. Travis is also a
director of the Video Software Dealers Association.
Dean M. Wilson has served as our executive vice president and chief
merchandising officer, worldwide, 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
16
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. Mr. Zine currently serves as a director of MMH Holdings, Inc.
and Petro.
Item 2. Properties
Our corporate headquarters are located at 1201 Elm Street, Dallas, Texas
75270 and consist of about 240,000 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 an office in Uxbridge, England that manages most of our
international operations. We also have head offices in Dublin, Ireland;
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. 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.
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 asserted, 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. 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. In April 2000, Ruben Loredo voluntarily dismissed the
state court action without prejudice, and Ruben Loredo and Blockbuster were
added as parties plaintiff and defendant, respectively, in the federal court
action. In January 2000, the federal court plaintiffs added California state
law claims to the pending federal antitrust claims. On March 16, 2001, the
federal judge in the United States District Court for the Western District of
Texas denied the plaintiffs' request for class certification of both the
federal and California claims. In January 2001, the same plaintiffs, in
addition to other individual plaintiffs, filed a similar complaint in
California state court seeking monetary damages. In addition to any damage
award to which Blockbuster might be directly subject, if Viacom is required to
pay any damage award as a result of the federal or state court action, Viacom
may seek indemnification for its losses from Blockbuster under the release and
indemnification agreement entered into between Viacom and Blockbuster.
Blockbuster believes the plaintiffs' positions in both actions are without
merit and intends to vigorously defend itself in the litigation.
17
On May 7, 1999, Lynn Adams, Khristine Schoggins, and Debbie Lenke,
purporting to act as class representatives on behalf of themselves and for a
class comprised of certain Blockbuster store managers who worked in California,
filed a complaint in District Court in Orange County, California against
Blockbuster. The plaintiffs claim that they should be classified as non-exempt
and are thus owed overtime payments under California law. The dollar amount
that plaintiffs seek as damages to themselves and those similarly situated is
not set forth in the complaint. In January 2001, the trial court judge
certified a class. In February 2001, the California Court of Appeals denied
Blockbuster's petition for a writ of mandate. Blockbuster's petition for review
is pending before the Supreme Court of California. Blockbuster believes the
plaintiffs' position is without merit and intends to vigorously defend itself
in the litigation.
Blockbuster is a defendant in 13 putative class action lawsuits filed by
customers in state courts in Illinois, California, Ohio, Maryland, Texas and
New York between February 1999 and March 2001. These cases allege common law
and statutory claims for fraud and/or deceptive practices and/or unlawful
business practices regarding Blockbuster's policies for customers who choose to
keep rental product beyond the initial rental term. Some of the cases also
allege that these policies impose unlawful penalties and/or result in unjust
enrichment. The dollar amounts that plaintiffs seek as damages to themselves
and those similarly situated are not set forth in the complaints. Blockbuster
believes the plaintiffs' positions in these suits are without merit and intends
to vigorously defend itself in the litigation.
We are subject to various other legal proceedings in the course of
conducting our business, including our business as a franchisor. However, we
believe that these proceedings are not likely to result in judgments that will
have a material adverse effect on our business.
Item 4. Submission of Matters to a Vote of Security Holders
None.
18
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(1)
-------- -------- ------------
Fiscal Year Ended December 31, 1999
Quarter Ended September 30, 1999 (from
August 11, 1999)............................ $16.8750 $12.4375 $ --
Quarter Ended December 31, 1999............... $17.1250 $11.3750 $0.02
Cash
High Low Dividends(1)
-------- -------- ------------
Fiscal Year Ended December 31, 2000
Quarter Ended March 31, 2000.................. $14.8750 $ 9.2500 $0.02
Quarter Ended June 30, 2000................... $11.6250 $ 8.8750 $0.02
Quarter Ended September 30, 2000.............. $12.0625 $ 8.4375 $0.02
Quarter Ended December 31, 2000............... $ 9.9375 $ 6.8750 $0.02
- --------
(1) 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 16, 2001 was 273. 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 2000 are derived from Blockbuster's
audited consolidated financial statements. 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.
19
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,
-------------------------------------------------
1996(1) 1997(2) 1998(3) 1999 2000(4)
-------- -------- -------- -------- --------
(In millions, except per share amounts and
worldwide data)
Statement of Operations
Data:
Revenues................... $2,942.1 $3,313.6 $3,893.4 $4,463.5 $4,960.1
Operating income (loss).... 267.6 (214.6) (359.2) 121.7 75.7
Net income (loss).......... $ 77.8 $ (318.2) $ (336.6) $ (69.2) $ (75.9)
Net income (loss) per
share--basic and
diluted(5)................ $ 0.54 $ (2.21) $ (2.34) $ (0.44) $ (0.43)
Dividends per share........ $ -- $ -- $ -- $ 0.02 $ 0.08
Weighted average shares
outstanding--basic and
diluted(5)................ 144.0 144.0 144.0 156.1 175.0
Balance Sheet Data:
Cash and cash equivalents.. $ 58.6 $ 129.6 $ 99.0 $ 119.6 $ 194.2
Total assets............... 8,794.6 8,731.0 8,274.8 8,540.8 8,548.9
Long-term debt, including
capital leases, less
current portion(6)........ 249.0 331.3 1,715.2 1,138.4 1,136.5
Stockholders' equity(6).... 7,784.4 7,617.6 5,637.9 6,125.0 6,008.4
Worldwide Store Data:
Company-operated stores at
end of year............... 4,472 5,105 5,283 5,879 6,254
Franchised and joint
venture stores at end of
year...................... 845 944 1,098 1,274 1,423
Total stores at end of
year...................... 5,317 6,049 6,381 7,153 7,677
Same store revenue increase
(decrease)(7)............. 5.1% (1.8)% 13.3% 8.3% 5.6%
- --------
(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 5 to our consolidated financial statements, we
recognized a non-cash charge of $31.6 million in the fourth quarter of
2000, related to the impairment of certain hardware and capitalized
software costs in our new media segment. This charge is reflected in
depreciation expense.
(5) 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 1999. 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.
(6) 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.
(7) 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.
20
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. Specific
forward-looking statements can be identified by the fact that they do not
relate strictly to historical or current facts and include, without limitation,
words such as "expect," "may," "estimate," "anticipate," "will," "believe,"
"intend," "plan," "future," "could," and similar expressions and variations
thereof. Similarly, statements that describe our objectives, plans or goals are
forward-looking. Our forward-looking statements are based on management's
current intent, belief, expectations, estimates and projections regarding our
company and our industry. Forward-looking statements are not guarantees of
future performance and involve risks, uncertainties, assumptions and other
factors that are difficult to predict, including those discussed below.
Therefore, actual results may vary materially from what is expressed in or
indicated by our 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.
CAUTIONARY STATEMENTS RELATING TO OUR VIDEO STORE BUSINESS
We Cannot Predict the Impact That New or Improved Technologies May Have on Our
Video Store Business.
New digital technologies, such as video-on-demand and other new
technologies, could have a material adverse effect on our video store business.
In particular, our video store business could be impacted 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 content, including
movies, specialty programming and sporting events, offered through these
services. If this were to occur, it could have a material adverse effect on our
video store business. Direct broadcast satellite providers transmit numerous
channels of programs by satellite transmission into subscribers' homes. In
addition, cable providers are taking advantage of digital technology to
transmit many additional channels of television programs over cable lines to
subscribers' homes.
Because of the 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.
If these enhanced pay-per-view services become more widely available and
accepted, pay-per-view purchases could significantly increase. Pay-per-view
allows the consumer to avoid trips to the video store for rentals and returns
of movies, which also eliminates the chance they will incur additional costs
for keeping a movie beyond its initial rental term. However, newly released
movies are currently made available by the studios for rental prior to being
made available on a pay-per-view basis. Pay-per-view also does not allow the
consumer to start, stop and rewind the movie or fully control start times.
Increases in the size of the 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.
21
Our video store business 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
and a limited number of Internet content providers have begun implementing
technology referred to as "video-on-demand." This technology transmits movies
and other entertainment content with interactive capabilities such as start,
stop and rewind. In addition to being available from a small number of cable
providers, video-on-demand has been introduced over the Internet, as high-speed
Internet access has greatly increased the speed and quality of viewing content,
including feature-length films, on personal computers. Through technical trials
in four markets, we have tested our entertainment-on-demand service, which
delivered video-on-demand to consumers' television sets via digital subscriber
lines and fiber optic connections. The future of video-on-demand services,
including services provided by us, is uncertain, however. Video-on-demand could
have a material adverse effect on our video store business 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 new technology that could have an effect on our video store business
is the personal video recorder. A personal video recorder allows consumers to
automatically and digitally 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 Video Rental Business Would Lose a Significant Competitive Advantage if the
Movie Studios Were to Adversely Change Their Current Distribution Practices.
A significant competitive advantage that the video store industry currently
enjoys over most other movie distribution channels except theatrical release is
the early timing of the video store distribution "window." After the initial
theatrical release, studios make their movies available to video stores for
specified periods of time. This window is exclusive against most other forms of
non-theatrical movie distribution, such as pay-per-view, video-on-demand,
premium television, basic cable and network and syndicated television. The
current length of the window for video stores varies, typically ranging from 45
to 60 days for domestic video stores and longer for international video stores.
Thereafter, movies are made sequentially available to television distribution
channels.
Our video store business 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.
We believe that the studios have a significant interest in maintaining a
viable video rental industry. However, 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 Video Store Business Could be Adversely Impacted by Labor Conditions
Affecting the Motion Picture Industry
Our video store business is dependent on the availability of motion pictures
produced by writers and actors subject to collective bargaining agreements.
Labor conditions in the motion picture industry could result in work stoppages
that could adversely affect our ability to acquire new titles and, therefore,
could have an adverse impact on our revenues.
22
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 we can. As a result, our sell-through
business, which is described below, in the United States represented only 10.9%
of our domestic revenues for 2000. 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 VHS 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 were to
desire to rent rather than own these sell-through priced movies, the adverse
effect of sell-through might 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.
Prior to implementing our revenue-sharing agreements, 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.
These agreements generally have terms ranging from two to five years. For
titles purchased under these agreements, we generally 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 generally 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.
The revenue-sharing arrangements provide us with significant benefits, as
discussed in "Item 1. Business--Industry Overview--Domestic Home Video--
Movies." If our revenue-sharing agreements are materially adversely changed or
discontinued, we will lose these benefits. We would likely either have to
purchase videocassette at high wholesale prices or we would purchase only sell-
through movies, which would also be available for sale to consumers. This would
have a material adverse effect on our video store business.
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.
23
Due to the terms of our current revenue-sharing arrangements and the
resulting increase in volume of videocassettes that we obtain, we need to sell
significantly more previously viewed videotapes than we did previously. During
2000, we sold about 34.6 million previously viewed videotapes, a 343.6%
increase over 1997. We anticipate that we will need to turn our inventory of
previously viewed videotapes more quickly in the future in order to make room
in our stores for additional DVDs and other new initiatives, such as our
strategic alliance with RadioShack. For more information on our new store
initiatives, we refer you to "Item 1. Business--Our Business--Business Model."
Therefore, we cannot assure you that in the future we will be able to sell, on
average, our previously viewed videotapes at or above the expected price.
Other factors that could affect our ability to sell these previously viewed
videotapes at expected prices include:
. consumer desire to own the particular movie;
. the number of previously viewed videotapes available for sale by others
to the public; and
. the increasing popularity of the DVD format.
In addition, after the expiration of the video store distribution window,
the sales of previously viewed videotapes also compete with newly released
videos that are priced for sell-through.
We Have Had Limited Experience with Our New Store Initiatives and Cannot Assure
You When or If These Initiatives Will Have a Positive Impact on Our
Profitability.
During the past year, we have announced our intention to offer an expanded
selection of products and services in our stores. During the fall of 2000, we
began selling DIRECTV in our company-operated stores, and in February 2001, we
announced a strategic alliance that would place RadioShack stores within our
stores. For more information on these initiatives, we refer you to "Item 1.
Business--Our Business--Business Model." The implementation of these and other
similar initiatives in our stores may involve significant investments by us of
time and money. Because we have limited experience with these new initiatives,
we cannot assure you that they will be successful or profitable either over the
short or long term.
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 could be detrimental to our goals that
relate to increasing our market share and leveraging our store base. We expect
to add 200-250 company-operated stores over the course of 2001, the majority of
which will be domestic. 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 or increase the number of
stores we plan to open.
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.
24
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.
Our Business Model is Substantially Dependent on the Functionality of Our
Centralized Domestic Distribution Center.
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 were to become non-operational
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 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.
CAUTIONARY STATEMENTS RELATING TO OUR NEW MEDIA BUSINESS
Our New Media Business Could be Adversely Affected if Blockbuster is Unable to
Compete Effectively in the Digital Market for its Products.
Digital delivery of content is a new and rapidly evolving market. In
response to the growth of digital delivery systems, we tested our
entertainment-on-demand service for the digital delivery of movies to
consumers' homes. In the future, we may explore introducing a more widely
available, commmercial version of our entertainment-on-demand service and also
other means of delivering digital entertainment into consumers homes. However,
the demand for entertainment-on-demand services is new and unproven, and there
is uncertainty regarding demand for these products in the future. Several
factors could adversely affect our ability to deliver movies digitally,
including:
. obtaining the right, on acceptable terms, from movie studios to
electronically distribute a sufficient quantity of movies by digital
means;
. obtaining the right, on acceptable terms, to electronically deliver
movies and other entertainment digitally from local telephone companies,
cable system operators and other entities who own the broadband
distribution systems necessary for the distribution of digital
entertainment;
25
. the technological ability to distribute entertainment digitally on a
cost-effective basis;
. the widespread adoption by consumers of technology that is adequate to
receive and display digital content in a manner which is acceptable to
them;
. our ability to attract customers to our entertainment services and meet
their expectations with respect to content, pricing, service, navigation
and other features; and
. competition from other companies offering to electronically deliver
movies on-demand over the Internet or by other digital means.
Our Ability to Deliver Entertainment-on-Demand and Other New Media Services Is
Dependent Upon Our Relationships with Technology Providers.
We do not have all of the necessary technology or expertise to deliver our
Internet, entertainment-on-demand or other New Media services without the use
of third parties. Therefore, our New Media businesses, including our Internet
site, are and will be largely dependent on our ability to create and maintain
good business relationships with technology providers. We cannot assure you
that we will be able to reach commercially reasonable terms with all of our
potential technology providers. We cannot assure you that any existing
relationships with technology providers will not be terminated by either party
or that we will be able to renew existing agreements on satisfactory terms. If
we are unable to reach agreements with necessary technology providers, or if
our agreements with technology providers are terminated and we are unable to
replace their services, we cannot assure you that we will be able to operate
our New Media businesses according to our current expectations.
Dependence on third-party technology providers also means that we may not be
able to accurately predict or control all aspects of the timing or expense
related to our New Media businesses. If our technology providers are unable to
complete their work in accordance with our deadlines, our services could be
unexpectedly interrupted or delayed. In addition, our estimates and
expectations with respect to the expenses associated with our New Media
businesses are in part dependent on the information provided to us by our
technology providers. To the extent that our technology providers encounter
unexpected expenses, we may be required to share in those costs or change the
specifications for our services. Our contracts with our technology providers
may permit us to recover damages from technology providers who fail to meet
deadlines or to estimate costs accurately, but we cannot assure you that those
amounts will be sufficient to compensate us fully for our losses.
Third-Party Infringement Claims Against Us or Our Technology Providers Could
Result In Delays in New Services, the Loss of Customers or Costly and Time-
Consuming Litigation.
There has been a substantial amount of litigation in the Internet and
broadband technology industry regarding intellectual property rights. It is
possible that in the future third parties may claim that the technology used to
operate our current or future New Media businesses infringe their intellectual
property rights. We expect that providers of digital entertainment services
will increasingly be subject to infringement claims as the number of products
and services and competitors in that industry grows and the functionality of
products in different industry segments overlaps.
Any such claims against us, with or without merit, could be time-consuming,
result in costly litigation, cause interruptions or delays in our services or
require us or our technology providers to enter into royalty or licensing
agreements in order to secure continued access to required technology. Royalty
or licensing agreements, if required, may not be available on terms acceptable
to us and our technology providers. Claims of intellectual property
infringement may also require us to pay significant damages or subject us to an
injunction against the operation of part or all of our New Media businesses.
Any successful claim of intellectual property infringement against us could
have an immediate and significant impact on our ability to carry on our New
Media businesses.
26
If Our Intellectual Property Is Not Protected Adequately, We May Be Less
Competitive in the Market.
As our New Media businesses expand, we are becoming increasingly dependent
on technology. Our success in these new businesses depends in large part on
protecting intellectual property developed or acquired by us. We rely upon a
combination of trademark, copyright, patent and trade secret laws to protect
our rights in our intellectual property. We may license our intellectual
property and impose restrictions on our licensees' ability to utilize those
assets. In addition, we seek to avoid disclosure of our trade secrets,
including but not limited to requiring those persons with access to our
proprietary information to execute confidentiality agreements with us.
On a regular basis, we review our intellectual property to determine whether
we should apply for patent protection on certain assets. If we decide to apply
for patents, it is possible that no patents will issue from the patent
applications. It is also possible that any patents that we do obtain may be
invalid or unenforceable. It is also possible that any patent issued to us may
not provide us with any competitive advantages. Moreover, we may not develop
future proprietary products or technologies that are patentable, and the
patents of others may seriously limit our ability to conduct our business. In
this regard, we have not performed any comprehensive analysis of patents of
others that may limit our ability to conduct our business.
Our efforts to protect our proprietary rights may not succeed. Copyright and
trade secret laws afford only limited protection for our proprietary rights.
Unauthorized parties may be able to copy aspects of our products or services or
to obtain and use information that we regard as confidential and proprietary.
Policing unauthorized use of our intellectual property is difficult. In
addition, the laws of some foreign countries do not protect our proprietary
rights to as great an extent as the laws of the United States. Our means of
protecting our proprietary rights may not be adequate and our competitors may
independently develop similar technology, duplicate our products and services
or design around patents issued to us or our technology providers. We may not
be able to detect infringement or enforce our patent or other rights and, as a
result, our competitive position in the market may suffer.
CAUTIONARY STATEMENTS RELATING TO OUR RELATIONSHIP WITH VIACOM
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. Effective with our initial public
offering in August 1999, we entered into a transition services agreement with
Viacom pursuant to which Viacom is currently providing us with certain
financial, administrative and other resources. Prior to our initial public
offering, certain costs and expenses reflected in our consolidated financial
statements included allocations of corporate expenses from Viacom. These and
other allocations of costs and expenses do not necessarily indicate the costs
that would have been or would be incurred by us as a separate, stand-alone
entity. Also, the financial information included in this Form 10-K may not
necessarily reflect our financial position, results of operations, and cash
flows in the future or what the financial position, results of operations, and
cash flows would have been had we been a separate, stand-alone entity during
the periods presented. For additional information, we refer you to
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 1 to our Consolidated Financial Statements.
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
27
. 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 other
stockholders 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. This in turn may have an adverse affect on
the price of our class A common stock.
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.
Four of Our Directors May Have Conflicts of Interest Because They Are Also
Directors or Executive Officers of Viacom.
Four members of our board of directors are directors and/or 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.
28
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 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
requires, among other things, that 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.
29
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 Inc. is the world's leading retailer of rentable home
videocassettes, DVDs and video games, with close to 7,700 stores in the United
States, its territories and 25 other countries as of December 31, 2000. During
2000, while our core video business continued to grow, we extended our business
and our brand into additional home entertainment distribution channels, as
discussed below.
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. In 1999,
Viacom announced that it intended to split-off Blockbuster by offering to
exchange all of its shares of Blockbuster common stock for shares of Viacom's
common stock. The split-off was subject to approval by Viacom's Board of
Directors and an assessment of market conditions. Viacom has stated that it no
longer has any plans for the split-off of Blockbuster.
We implemented a new business model in 1998 in recognition that we could not
purchase enough videocassettes at the "full" cost to satisfy customer demand
without significantly increasing our risk. In order to increase the quantity
and selection of newly released video titles and satisfy our customers' demand
for newly released videos, we entered into revenue-sharing agreements with the
major motion picture 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 newly released
videocassettes to three months. In connection with this change in method of
accounting for our videocassette and video game rental library, we recorded a
$424.3 million charge in 1998 to reflect a reduction in the carrying value of
this library.
We strive to be the leader in satisfying customer demand by stocking each of
our stores with the selection, quantity and format of merchandise desired by
our customers. We have continued to manage our merchandise mix in response to
changing consumer demands such as the significant increase in demand for DVDs
over the past year. DVDs represented about 10.1% of our net domestic rental
revenues during the fourth quarter of 2000. Based on our expectation that
demand for DVDs will continue to grow, we expect DVDs to represent 20-25% of
our net domestic rental revenues by the end of 2001.
In 2000, we announced a multi-year agreement with DIRECTV to expand our
traditional video rental business for the first time to pay-per-view via the
DIRECTV service and to cross market each other's products. We receive a
commission for each DIRECTV system and service sold by us through our stores
and through other channels, as well as a monthly residual based on the number
of active DIRECTV customers acquired through us. Since the September 2000
launch of DIRECTV sales in approximately 3,800 of our stores, we have sold over
100,000 DIRECTV systems, quickly establishing ourselves as one of the nation's
leading retailers of DIRECTV systems. We receive a portion of the pay-per-view
revenue generated by customers we acquire for DIRECTV. Additionally, as part of
the agreement, we will receive a portion of the incremental revenues generated
by some of DIRECTV's pay-per-view movie channels upon our co-branding, which we
expect to occur in 2001.
In 2001, we entered into a strategic alliance with RadioShack Corporation
under which RadioShack will operate store-within-a-store areas inside selected
Blockbuster locations. In 2001, the companies will launch
30
Phase I of the strategic alliance in approximately 130 of our stores in at
least four markets. At the end of Phase I, the companies will determine whether
they will proceed to Phase II, which would be a rollout of the concept to as
many stores as possible in the United States, anticipated to occur during 2002.
RadioShack will pay a license fee to us for each location and both companies
will share in the operating income (loss), as defined, generated by the store-
within-a-store areas.
We have a substantial amount of intangible assets on our consolidated
financial statements. As of December 31, 2000, we had net intangible assets of
$5,809.2 million, which represented 68.0% of our total assets and 96.7% of our
stockholders' equity. Our intangible assets consist primarily of goodwill. 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
Beginning in the fourth quarter of 1999, we began reporting in two segments:
(i) home videocassette, DVD and video game rental and retailing, which we refer
to as our video segment, and (ii) new media (formerly new technologies).
(i) Video
As of December 31, 2000, the video segment operated 6,254 video stores
and its franchisees and/or joint ventures operated 1,423 video stores
located throughout the United States, its territories and 25 other
countries.
(ii) New Media
Through our new media segment, we operate our Internet site,
blockbuster.com, and our Digital Networks division, which is
responsible for exploring various forms of electronic entertainment
delivery, including entertainment-on-demand.
We evaluate performance based on many factors. Two of the primary measures
that we use are EBITDA and operating income (loss). EBITDA is defined as net
loss before equity in income (loss) of affiliated companies (net of tax),
benefit (provision) for income taxes, interest income (expense), depreciation,
amortization of intangibles and other items, net. Our EBITDA measure may differ
in the method of calculation from similarly titled measures used by other
companies. Operating income is defined as income before interest income
(expense), equity in income (loss) of affiliated companies (net of tax) and
benefit (provision) for income taxes.
31
The following table sets forth summarized financial information relating to
our segments:
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
(In millions)
Revenues
Video........................................... $3,893.4 $4,463.3 $4,959.1
New media....................................... -- 0.2 1.0
-------- -------- --------
Total revenues................................ $3,893.4 $4,463.5 $4,960.1
======== ======== ========
EBITDA(1)
Video........................................... $ 23.7 $ 520.6 $ 588.2
New media....................................... -- (6.6) (53.4)
-------- -------- --------
Total EBITDA.................................. $ 23.7 $ 514.0 $ 534.8
======== ======== ========
Operating income (loss)
Video........................................... $ (359.2) $ 128.7 $ 172.5
New media....................................... -- (7.0) (96.8)
-------- -------- --------
Total operating income (loss)................. $ (359.2) $ 121.7 $ 75.7
======== ======== ========
- --------
(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 (loss), net
income (loss), cash flow and other measures of financial performance
prepared in accordance with generally accepted accounting principles.
32
Results of Operations
Consolidated Results
The following table sets forth consolidated results of operations and other
financial data.
Year Ended December 31,
-------------------------------
1998 1999 2000
--------- --------- ---------
(In millions, except margin
and worldwide store data)
Statement of Operations Data:
Revenues..................................... $ 3,893.4 $ 4,463.5 $ 4,960.1
Cost of sales................................ 1,956.4 1,762.5 2,036.0
--------- --------- ---------
Gross profit................................. 1,937.0 2,701.0 2,924.1
Operating expenses........................... 2,296.2 2,579.3 2,848.4
--------- --------- ---------
Operating income (loss)...................... (359.2) 121.7 75.7
Interest expense............................. (27.7) (119.3) (116.5)
Interest income.............................. 4.0 3.2 7.3
Other items, net............................. (11.8) (0.2) 1.7
--------- --------- ---------
Income (loss) before income taxes............ (394.7) 5.4 (31.8)
Benefit (provision) for income taxes......... 59.4 (71.8) (45.4)
Equity in income (loss) of affiliated
companies, net of tax....................... (1.3) (2.8) 1.3
--------- --------- ---------
Net loss..................................... $ (336.6) $ (69.2) $ (75.9)
========= ========= =========
Cash Flow Data:
Cash flows from operating activities......... $ 1,234.5 $ 1,142.8 $ 1,320.8
Cash flows used for investing activities..... (1,022.2) (1,258.1) (1,056.8)
Cash flows from (used in) financing
activities.................................. (241.1) 137.2 (187.2)
Other Data:
Depreciation................................. $ 212.7 $ 220.5 $ 279.0
Amortization of intangibles.................. 170.2 171.8 180.1
EBITDA(1).................................... 23.7 514.0 534.8
Net loss plus intangible amortization, net of
tax(1)(2)................................... $ (172.5) $ 94.8 $ 93.3
Margins:
Rental margin(3)............................. 54.6% 66.0% 64.4%
Merchandise margin(4)........................ 19.8 21.0 21.4
Gross margin(5).............................. 49.8 60.5 59.0
Worldwide Store Data:
Same store revenues increase(6).............. 13.3% 8.3% 5.6%
Total system-wide stores at end of period.... 6,381 7,153 7,677
- --------
(1) "EBITDA" and "Net loss plus intangible amortization, net of tax" are
presented here to provide additional information about our operations.
These items should be considered in addition to, but not as a substitute
for, or superior to, operating income (loss), net income (loss), 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 sales.
(5) Gross profit as a percentage of total revenues.
(6) A store is included in the same store revenues 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 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.
33
Non-Cash Charges
During the second quarter of 1998, we recorded a $424.3 million non-cash
charge associated with a change in the method of accounting for videocassettes
and video game rental library. During the fourth quarter of 2000, we determined
that the carrying value of certain hardware and capitalized software components
of our new media segment, primarily related to the e-commerce portion of
blockbuster.com, exceeded the estimated undiscounted future cash flows to be
generated by those assets. As a result, we recorded an impairment charge of
approximately $31.6 million. This charge is included in depreciation expense in
the Consolidated Statements of Operations for the year ended December 31, 2000.
The following is a summary of the impact of the above-described non-cash
charges on our operating results:
Year Ended December 31,
--------------------------------
1998 1999 2000
-------- -------- --------
Effect on operating income (loss)......... $ (424.3) $ -- $ (31.6)
Effect on net loss........................ (273.1) -- (19.0)
Excluding the above described non-cash charges, operating results would have
been as follows:
Year Ended December 31,
---------------------------
1998 1999 2000
-------- -------- --------
Revenues.................................. $3,893.4 $4,463.5 $4,960.1
Cost of sales............................. 1,532.1 1,762.5 2,036.0
-------- -------- --------
Gross profit.............................. 2,361.3 2,701.0 2,924.1
Operating expenses........................ 2,296.2 2,579.3 2,816.8
-------- -------- --------
Operating income, excluding non-cash
charges.................................. $ 65.1 $ 121.7 $ 107.3
======== ======== ========
Comparison of 2000 to 1999
Revenues. Revenues of $4,960.1 million in 2000 increased $496.6 million, or
11.1%, from $4,463.5 million in 1999. The increase in revenues was primarily
due to increases in worldwide same store revenues of 5.6% and a net increase in
the number of company-operated stores of 375 to 6,254 at December 31, 2000 from
5,879 at December 31, 1999. The increase in worldwide same store revenues was
principally due to a 4.3% increase in same store revenues from our domestic
operations and an 11.6% increase in same store revenues from our international
operations. The increase in domestic same store revenues was primarily driven
by an increase in video rental revenues, which include both VHS and DVD rental
revenues.
Rental Revenues. Rental revenues, which also includes sales of
previously viewed products, of $4,161.7 million in 2000 increased $403.2
million, or 10.7%, from $3,758.5 million in 1999. The increase in rental
revenues was primarily due to an increase in domestic same store rental
revenues of 4.1%, the net increase in the number of company-operated stores
of 375 and an increase in international same store rental revenues of
15.5%. The increase in domestic same store rental revenues was primarily
driven by an increase in video rental revenues, which include both VHS and
DVD rental revenues. Also contributing to the increase were (i) an increase
in the average domestic rental spend per customer and (ii) a favorable box
office advantage between titles that became available in 2000 as compared
to the titles that became available in 1999. In addition, worldwide
previously viewed product sales, which includes sales of previously viewed
videotapes, video games and DVDs, increased 17.0% for the year ended
December 31, 2000 as compared to the year ended December 31, 1999. For the
year ended December 31, 2000, revenues generated by rental product that was
kept beyond the initial rental period were $795.8 million, or 16.0% of
total revenues, compared to $692.6 million, or 15.5% of total revenues for
1999.
Merchandise Sales. Merchandise sales of $704.8 million in 2000 increased
$89.7 million, or 14.6%, from $615.1 million in 1999. The primary reasons
for the increase in merchandise sales were (i) the net increase in the
number of company-operated stores of 375 and (ii) an increase in sales of
DVDs.
34
Cost of Sales. Cost of sales of $2,036.0 million in 2000 increased $273.5
million, or 15.5%, from $1,762.5 million in 1999. Cost of sales as a percentage
of total revenues increased to 41.0% in 2000 from 39.5% in 1999. The increase
in cost of sales was primarily due to the net increase in the number of
company-operated stores of 375. The increase in cost of sales as a percentage
of revenues was primarily due to (i) the increase in revenues generated through
revenue-sharing arrangements as a percentage of our total revenues, as revenue-
sharing arrangements on average have lower gross margins than do traditional
buying arrangements, (ii) a decrease in margins on game rentals, as several
platforms are nearing the end of their lifecycles, and (iii) a decrease in
margins on previously viewed product sales generated by lower average unit
selling prices as a result of increased copy depth. We are continually
evaluating our product mix and product offerings, as well as related strategic
alliances, to try to optimize our stores' revenues and gross profit. In 2000,
we began marketing and soliciting DIRECTV system equipment and DIRECTV(R)
programming packages in our stores, and since our September 2000 launch, we
have sold over 100,000 DIRECTV systems. In February 2001, we entered into a
strategic alliance with RadioShack under which RadioShack will operate store-
within-a-store areas inside selected Blockbuster locations. After the initial
rollout of the RadioShack store-within-a-store in 2001, we will determine
whether we will proceed with a nationwide rollout. Additionally, we intend to
continue to increase our stores' depth of DVDs in response to accelerated
consumer acceptance of the DVD format. Our initiatives to optimize our stores'
revenues and gross profit may cause us to alter the product mix in our stores.
This may cause us to rationalize our stores' existing product mix, which could
result in a non-cash charge.
Gross Profit. Gross profit of $2,924.1 million in 2000 increased $223.1
million, or 8.3%, from $2,701.0 million in 1999. For 2000, gross profit as a
percentage of total revenues decreased to 59.0% from 60.5% in 1999. The
decrease in gross margin percentage was due to the increase in cost of sales as
a percentage of revenues described above.
Operating Expenses. Total operating expenses of $2,848.4 million in 2000
increased $269.1 million, or 10.4%, from $2,579.3 million in 1999. Excluding
the impairment charge of approximately $31.6 million, total operating expenses
of $2,816.8 million increased $237.5 million, or 9.2%, from $2,579.3 million in
1999. This increase was primarily due to a net increase of 375 company-operated
stores and the increase in total operating expenses related to our new media
segment of $57.8 million to $64.8 million in 2000 from $7.0 million in 1999.
The new media operating expenses increased from 1999 to 2000 primarily due to
2000 being the first full year of operations for blockbuster.com. Excluding the
impairment charge, total operating expenses decreased as a percentage of total
revenues to 56.8% in 2000 from 57.8% in 1999 due to better leveraging of our
video segment operating expenses over an increased revenue base. We expect
operating expenses as a percentage of revenues to continue to decline in 2001.
Excluding the impairment charge, the increase in total operating expenses also
resulted from the following:
General and Administrative Expense. General and administrative expense,
which includes expenses incurred at the store, regional, and corporate
levels and expenses relating to our new media business, remained consistent
as a percentage of total revenues at 43.8% for both 2000 and 1999. General
and administrative expense of $2,174.0 million in 2000 increased $220.8
million, or 11.3%, from $1,953.2 million in 1999. The dollar increase in
2000 resulted from compensation increases of $107.4 million related to
additional personnel needed to support our store growth, DIRECTV
initiatives, and our new media business. Occupancy costs increased $55.2
million largely as a result of an increase in the number of company-
operated stores. Other corporate and store expenses increased $58.2 million
due primarily to the growth of our business, including our DIRECTV and new
media initiatives, and a decrease in the net gain recognized on the
refranchising of stores of approximately $18.2 million from 1999 to 2000.
Advertising Expense. Advertising expense of $215.3 million in 2000
decreased $18.5 million, or 7.9%, from $233.8 million in 1999. As a
percentage of total revenues, advertising expense decreased to 4.3% in 2000
from 5.2% in 1999. These decreases reflect our planned decrease in general
promotional advertising. We are now focusing our advertising dollars on
specific brand advertising, direct marketing vehicles such as BLOCKBUSTER
REWARDS(TM), our alliance with DIRECTV, and other targeted consumer
advertising.
35
Depreciation Expense. Depreciation expense of $279.0 million in 2000
increased $58.5 million, or 26.5%, as compared to $220.5 million in 1999.
Excluding the impairment charge of $31.6 million, depreciation expense of
$247.4 million in 2000 increased $26.9 million, or 12.2%, as compared to
$220.5 million in 1999. The increase in depreciation expense was primarily
attributable to the net increase of 375 company-operated stores.
Interest Expense. Interest expense of $116.5 million in 2000 decreased $2.8
million, or 2.3%, as compared to $119.3 million in 1999. The decrease in
interest expense was due to lower capital lease levels and lower debt levels,
partially offset by the higher interest rates on our credit facility compared
to the interest rates on the notes payable to Viacom, which were outstanding
through June 23, 1999.
Provision for Income Taxes. We recognized a provision for income taxes of
$45.4 million in 2000 as compared to $71.8 million in 1999. The 2000 and 1999
provisions reflect 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, in which we incurred losses, in our
1999 and 2000 tax provisions as it is currently more likely than not that the
benefit will not be realized. The provision for income taxes decreased due to
lower earnings before taxes and lower operating losses from foreign
jurisdictions. 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. Equity in
income of affiliated companies, net of tax of $1.3 million in 2000 increased
$4.1 million as compared to a loss of $2.8 million in 1999, primarily due to an
increase in income from our joint venture operations in Italy.
Net Loss. For the reasons described above, the consolidated net loss of
$75.9 million in 2000 reflects an increase in net loss of $6.7 million, or
9.7%, from a net loss of $69.2 million in 1999. Excluding the impairment
charge, the consolidated net loss of $56.9 million reflects a decrease in net
loss of $12.3 million from a net loss of $69.2 million in 1999. Excluding the
new media segment, the net loss of $14.7 million reflects a decrease in net
loss of $50.2 million from a net loss of $64.9 million in 1999.
SEGMENT RESULTS
Video
Video revenues of $4,959.1 million in 2000 increased $495.8 million, or
11.1%, from $4,463.3 million in 1999. The increase in revenues was primarily
due to increases in worldwide same store revenues of 5.6% and a net increase in
the number of company-operated stores of 375. The increase in worldwide same
store revenues was principally due to an increase in the average domestic
rental spend per customer, a 4.3% increase in same store revenues from our
domestic operations and an 11.6% increase in same store revenues from our
international operations. The increase in domestic same store revenues was
primarily driven by an increase in video rental revenues, which include both
VHS and DVD rental revenues.
Operating income increased $43.8 million, or 34.0%, to $172.5 million in
2000 from $128.7 million in the prior year. Results for 2000 reflect the
increased revenues discussed above and the leveraging of our operating expenses
over an increased revenue base. Video operating expenses as a percentage of
total video revenues decreased to 55.5% in 2000 from 57.6% in 1999 due to
better leveraging of our video segment operating expenses over an increased
revenue base.
New Media (formerly New Technologies)
New media revenues of $1.0 million in 2000 consisted primarily of sales
through the Internet of sell-through videocassettes and DVDs. Operating loss
for our new media segment was $96.8 million in 2000, as compared to an
operating loss of $7.0 million in 1999. Excluding the impairment charge,
operating loss was
36
$65.2 million in 2000. The operating loss increased from 1999 to 2000 primarily
due to 2000 being the first full year of operations for blockbuster.com. The
loss reflects costs incurred to advertise our website, to hire additional
people to support the website, to enhance the website's functionality and to
negotiate and structure new ventures related to our entertainment-on-demand
services, which are currently in the development stage. During the fourth
quarter of 2000, we shifted the focus of our Internet site, blockbuster.com
from e-commerce offerings to other features designed to support our stores and
drive store revenues. We refer you to "Item 1. Business--Our Business--
Blockbuster.com." We are outsourcing segments of our website development and
maintenance related to our e-commerce business. We expect costs associated with
our new media segment in 2001 to be about 30% lower than the full year 2000
excluding the impairment charge, primarily due to our outsourcing of segments
of our website development and maintenance related to our e-commerce business
and lower marketing costs. Also, during 2000, we integrated our online
capabilities with our store systems and launched a two-market pilot of our
online rental reservations system. We are also exploring initiatives designed
to integrate the capabilities of blockbuster.com with our future entertainment-
on-demand services.
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 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 Revenues. Rental revenues 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.
Merchandise Sales. 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.
Cost of Sales. Cost of sales of $1,762.5 million in 1999 decreased $193.9
million, or 9.9%, 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
37
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, or 39.4%, 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, or 12.3%, 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, or 12.8%, 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 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.
Advertising Expense. Advertising expense of $233.8 million in 1999
increased $52.8 million, or 29.2%, 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 reflected 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.
38
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
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, or 97.7%,
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 Media (formerly New Technologies)
New media 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 media 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.
Liquidity and Capital Resources
Liquidity and Capital Resources
We generate cash from operations predominantly from the rental and retail
sale 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.
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, as well as with funds available under our credit
facility. We believe that these two sources of funds will provide us with
adequate liquidity and capital necessary for the next twelve months. However,
we may seek to issue debt and/or equity securities in the future to the extent
we determine that the issuance of securities would serve to maximize our
capital structure or would otherwise be advantageous to our company.
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 terms of these leases 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.
39
Capital Structure
On June 21, 1999, we entered into a $1.9 billion unsecured credit agreement
with a syndicate of banks. The credit agreement initially was 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, which was paid down and retired during
2000, as discussed below. Interest rates under the credit agreement 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 (.25% at December 31, 2000).
The credit agreement contains certain restrictive covenants, which, among
other things, relate to the payment of dividends, 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, 2000, the Company was in compliance with all
financial covenants under the credit agreement.
On June 23, 1999, we 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 proceeds of the
borrowings were used to pay amounts owed to Viacom. We repaid $442.9 million of
the short-term revolver through proceeds from our initial public offering. We
repaid the remaining $157.1 million of the short-term revolver during the year
ended December 31, 2000. These payments permanently reduced our borrowing
capacity under the credit agreement from $1.9 billion to $1.3 billion. We had
$278.0 million of available borrowing capacity under the long-term revolver at
December 31, 2000. The weighted average interest rate at December 31, 2000 for
these borrowings was 8.0%.
We entered into two additional lines of credit with banks for an aggregate
of $75.0 million in the fourth quarter of 1999. There were no outstanding
amounts under these two lines of credit at December 31, 2000.
Consolidated Cash Flows
Operating Activities. Net cash flows from operating activities increased
$178.0 million, or 15.6%, from $1,142.8 million for the year ended December 31,
1999 to $1,320.8 million for the year ended December 31, 2000. The most
significant reason for the increase was an improvement in income before
depreciation and amortization, which increased by $120.6 million. An $82.8
million increase in net cash provided by changes in operating assets and
liabilities also contributed to the increase in net cash flows from operating
activities.
Investing Activities. Net cash used in investing activities decreased $201.3
million from $1,258.1 million in 1999 to $1,056.8 million in 2000 primarily as
a result of a decrease in capital expenditures of $152.9 million and a $78.0
million decrease in cash used for store acquisitions, partially offset by a
$31.3 million decrease in proceeds from sales of store operations. Our capital
expenditures decreased primarily due to an upgrade of the store point-of-sale
system that occurred during 1999 and fewer new store openings in 2000 than in
1999. The decrease in cash used for acquisitions was primarily due to a large
acquisition of 69 stores from a franchisee in the first quarter of 1999.
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
acquisitions and our expansion strategies in developing markets. We currently
expect to add approximately 200 to 250 net new stores in 2001. We currently
anticipate that capital expenditures of about $150.0 million will be incurred
in 2001 in the video segment, and capital
40
expenditures of about $11 million will be incurred in 2001 in the new media
segment. The projected decrease in capital spending from 2000 is due primarily
to planned decreases in (i) expenditures in our new media segment and (ii) new
store builds. The anticipated decrease in new store builds is due to the change
in the competitive landscape.
Financing Activities. Net cash used in financing activities for the year
ended December 31, 2000 of $187.2 million represented a $324.4 million decrease
from net cash provided by financing activities of $137.2 million in 1999. The
decrease in cash flows from financing activities was primarily attributable to
items associated with our initial public offering in 1999, including: (i) net
proceeds of $430.1 million from our initial public offering, and (ii) capital
contributions of $157 million made by Viacom for the purchase of certain of our
international operations from affiliates of Viacom in connection with our
initial public offering. These items were partially offset by net debt
repayments during 1999 of $389.3 million, compared to 2000 when we paid down
debt by $142.9 million.
Other Financial Measurements: Working Capital
At December 31, 2000, we had cash and cash equivalents of $194.2 million.
Working capital, however, reflected a deficit of $323.7 million due to the
accounting treatment of our rental library. Our rental library is accounted for
as a non-current asset and is excluded from the computation of working capital.
Liabilities associated with the acquisition costs of rental product, however,
are reported as current liabilities and, accordingly, are 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
our United Kingdom subsidiaries for 1998 and earlier years to Viacom without
any compensation. At December 31, 2000 our foreign net operating loss tax
assets, which are fully reserved, were $51.1 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, a distinct
seasonal pattern to the home video and video games business, particularly
weaker business in April and May, due in part to improved weather and Daylight
Savings Time, and in September and October, due in part to the start of school
and the introduction of new television programs, and those factors set forth
above under "Cautionary Statements."
Market Risk
We are exposed to various market risks including interest rates on our 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 $1.6 billion.
Total outstanding borrowings at December 31, 2000 under this credit agreement
were $1,022.0 million. Interest rates are based on the prime rate in the United
States or LIBOR (plus a margin based on leverage
41
ratios) at our option at the time of borrowing. The weighted average interest
rate at December 31, 2000 for these borrowings was 8.0%. In March 2001, we
entered into two interest rate swaps with Viacom in order to obtain a fixed
interest rate with respect to $400 million of our outstanding floating rate
debt. The swaps fixed $200 million of our outstanding debt at an interest rate
of 5.0135% for two years and the other $200 million at an interest rate of
5.1190% for two and one-half years. Our effective interest rates also include a
LIBOR spread, currently 1.25%, which is subject to change under the terms of
our credit agreement. The swaps are subject to termination in the event that
(i) Viacom ceases to own greater than 80% of our outstanding common stock or
(ii) we no longer have any obligations under the term loan portion of our
credit agreement.
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 our international businesses into U.S. dollars may
affect year-over-year comparability and could cause us to adjust our financing
and operating strategies. Operating income would have increased by an
additional $2.8 million if foreign exchange rates in 2000 were consistent with
1999.
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between their existing, or local, currencies
and one common currency, the Euro. The transition period for the introduction
of the Euro will be between January 1, 1999 and June 30, 2002. 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.
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 constituted 19.3% of our total
revenues in 2000. Our operations in Europe constituted 9.5% of our total
revenues. The majority of these sales are from Great Britain, which had not
adopted the Euro in 2000.
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. We adopted SFAS 133 effective January 1, 2001, and its adoption
resulted in an immaterial effect on our financial statements.
We adopted the provisions of SEC Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements" in the fourth quarter of 2000. We also
adopted Emerging Issues Task Force Issue No. 99-19, Reporting Revenue Gross as
a Principal Versus Net as an Agent, in the fourth quarter of 2000. The effect
of the adoption of these standards was immaterial.
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."
42
Item 8. Financial Statements and Supplementary Data
BLOCKBUSTER INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
----
Audited Consolidated Financial Statements:
Report of Independent Accountants....................................... 44
Consolidated Statements of Operations--Years Ended December 31, 1998,
1999 and 2000.......................................................... 45
Consolidated Balance Sheets--at December 31, 1999 and 2000.............. 46
Consolidated Statements of Changes in Stockholders' Equity and
Comprehensive Loss--Years Ended December 31, 1998, 1999 and 2000....... 47
Consolidated Statements of Cash Flows--Years Ended December 31, 1998,
1999 and 2000.......................................................... 48
Notes to Consolidated Financial Statements.............................. 49
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.
43
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, 1999 and
2000, and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America. 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 of America 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 our opinion.
PricewaterhouseCoopers LLP
Dallas, Texas
February 9, 2001
44
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
Revenues:
Rental revenues................................ $3,219.6 $3,758.5 $4,161.7
Merchandise sales.............................. 618.0 615.1 704.8
Other revenues................................. 55.8 89.9 93.6
-------- -------- --------
3,893.4 4,463.5 4,960.1
-------- -------- --------
Cost of sales:
Cost of rental revenues........................ 1,460.9 1,276.5 1,481.9
Cost of merchandise sold....................... 495.5 486.0 554.1
-------- -------- --------
1,956.4 1,762.5 2,036.0
-------- -------- --------
Gross profit................................... 1,937.0 2,701.0 2,924.1
-------- -------- --------
Operating expenses:
General and administrative..................... 1,732.3 1,953.2 2,174.0
Advertising.................................... 181.0 233.8 215.3
Depreciation................................... 212.7 220.5 279.0
Amortization of intangibles.................... 170.2 171.8 180.1
-------- -------- --------
2,296.2 2,579.3 2,848.4
-------- -------- --------
Operating income (loss).......................... (359.2) 121.7 75.7
Interest expense............................... (27.7) (119.3) (116.5)
Interest income................................ 4.0 3.2 7.3
Other items, net............................... (11.8) (0.2) 1.7
-------- -------- --------
Income (loss) before income taxes................ (394.7) 5.4 (31.8)
Benefit (provision) for income taxes........... 59.4 (71.8) (45.4)
Equity in income (loss) of affiliated
companies, net of tax......................... (1.3) (2.8) 1.3
-------- -------- --------
Net loss......................................... $ (336.6) $ (69.2) $ (75.9)
======== ======== ========
Net loss per share:
Basic and diluted.............................. $ (2.34) $ (0.44) $ (0.43)
======== ======== ========
Weighted average shares outstanding:
Basic and diluted.............................. 144.0 156.1 175.0
======== ======== ========
Cash dividends per common share.................. $ -- $ 0.02 $ 0.08
======== ======== ========
See notes to consolidated financial statements.
45
BLOCKBUSTER INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
December 31, December 31,
1999 2000
------------ ------------
Assets
Current assets:
Cash and cash equivalents.......................... $ 119.6 $ 194.2
Receivables, less allowances of $11.4 (1999) and
$8.6 (2000)....................................... 130.8 185.8
Merchandise inventories............................ 281.3 242.2
Prepaid assets and other current assets............ 180.9 177.3
-------- --------
Total current assets............................. 712.6 799.5
Rental library....................................... 577.6 646.7
Receivable from Viacom............................... 41.1 134.9
Property and equipment, net.......................... 1,148.3 1,079.4
Intangibles, net..................................... 5,975.9 5,809.2
Other assets......................................... 85.3 79.2
-------- --------
$8,540.8 $8,548.9
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable................................... $ 499.4 $ 592.7
Accrued expenses................................... 422.5 473.7
Current portion of long-term debt.................. 157.1 8.0
Current portion of capital lease obligations....... 29.7 24.8
Deferred taxes..................................... 22.7 24.0
-------- --------
Total current liabilities........................ 1,131.4 1,123.2
Long-term debt, less current portion................. 1,030.0 1,039.0
Capital lease obligations, less current portion...... 108.4 97.5
Deferred taxes....................................... 72.3 207.2
Other liabilities.................................... 73.7 73.6
-------- --------
2,415.8 2,540.5
-------- --------
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, par value $.01 per share; 100.0
shares authorized; no shares issued or
outstanding....................................... -- --
Class A common stock, par value $.01 per share;
400.0 shares authorized; 31.0 shares issued and
outstanding....................................... 0.3 0.3
Class B common stock, par value $.01 per share;
500.0 shares authorized; 144.0 shares issued and
outstanding....................................... 1.4 1.4
Additional paid-in capital......................... 6,180.3 6,166.4
Retained deficit................................... (10.9) (86.8)
Accumulated other comprehensive loss--foreign
currency translation adjustment................... (46.1) (72.9)
-------- --------
Total stockholders' equity....................... 6,125.0 6,008.4
======== ========
$8,540.8 $8,548.9
======== ========
See notes to consolidated financial statements.
46
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
LOSS
(In millions)
Year ended December 31,
---------------------------------------------------
1998 1999 2000
---------------- ---------------- ---------------
Shares Amount Shares Amount Shares Amount
------ --------- ------ --------- ------ --------
Class A common stock:
Balance, beginning of
year................... -- $ -- -- $ -- 31.0 $ 0.3
Initial public offering,
net proceeds........... -- -- 31.0 0.3 -- --
----- --------- ----- --------- ----- --------
Balance, end of year.... -- $ -- 31.0 $ 0.3 31.0 $ 0.3
===== ========= ===== ========= ===== ========
Class B common stock:
Balance, beginning of
year................... -- $ -- -- $ -- 144.0 $ 1.4
Issuance of class B com-
mon stock to Viacom.... -- -- 144.0 1.4 -- --
----- --------- ----- --------- ----- --------
Balance, end of year.... -- $ -- 144.0 $ 1.4 144.0 $ 1.4
===== ========= ===== ========= ===== ========
Additional paid-in capi-
tal:
Balance, beginning of
year................... $ -- $ -- $6,180.3
Issuance of class B com-
mon stock to Viacom.... -- 5,754.0 --
Initial public offering,
net proceeds........... -- 429.8 --
Issuance of class A com-
mon stock.............. -- -- 0.1
Cash dividends.......... -- (3.5) (14.0)
--------- --------- --------
Balance, end of year.... $ -- $ 6,180.3 $6,166.4
========= ========= ========
Viacom's net equity in-
vestment:
Balance, beginning of
year................... $ 7,666.5 $ 5,695.8 $ --
Dividend payable to
Viacom................. (1,400.0) -- --
Other transactions with
Viacom, net............ (234.1) 118.0 --
Net loss prior to ini-
tial public offering... (336.6) (58.3) --
Issuance of class B com-
mon stock to Viacom.... -- (5,755.5) --
--------- --------- --------
Balance, end of year.... $ 5,695.8 $ -- $ --
========= ========= ========
Accumulated other compre-
hensive loss:
Balance, beginning of
year................... $ (48.9) $ (57.9) $ (46.1)
Other comprehensive in-
come (loss):
Foreign currency
translation.......... (9.0) 11.8 (26.8)
--------- --------- --------
Balance, end of year.... $ (57.9) $ (46.1) $ (72.9)
========= ========= ========
Retained deficit:
Balance, beginning of
year................... $ -- $ -- $ (10.9)
Net loss subsequent to
initial public offer-
ing.................... -- (10.9) (75.9)
--------- --------- --------
Balance, end of year.... $ -- $ (10.9) $ (86.8)
========= ========= ========
Total stockholders' eq-
uity .................. $ 5,637.9 $ 6,125.0 $6,008.4
========= ========= ========
Comprehensive loss:
Net loss................ $ (336.6) $ (69.2) $ (75.9)
Other comprehensive in-
come (loss):
Foreign currency
translation.......... (9.0) 11.8 (26.8)
--------- --------- --------
Total comprehensive
loss................... $ (345.6) $ (57.4) $ (102.7)
========= ========= ========
See notes to consolidated financial statements.
47
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
Year Ended December 31,
-------------------------------
1998 1999 2000
--------- --------- ---------
Cash flows from operating activities:
Net loss.................................... $ (336.6) $ (69.2) $ (75.9)
Adjustments to reconcile net loss to net
cash flow provided
by operating activities:
Depreciation and amortization............. 1,518.8 1,067.4 1,194.7
Deferred taxes............................ (8.1) 173.9 136.2
Write-down of investments................. 10.5 -- --
Equity in (income) loss of affiliated com-
panies, net of tax....................... 1.3 2.8 (1.3)
Gain on sales of store operations......... -- (19.9) (1.7)
Gain on sale of non-core investment....... -- -- (1.9)
Common stock issued to non-employee direc-
tors..................................... -- -- 0.1
Change in operating assets and liabilities:
Increase in receivables................... (10.9) (7.3) (56.4)
Increase in receivable from Viacom........ -- (41.1) (93.8)
(Increase) decrease in merchandise inven-
tories................................... (0.4) (5.2) 35.8
(Increase) decrease in prepaid and other
assets................................... (40.0) (58.0) 12.9
Increase in accounts payable.............. 67.9 59.3 101.4
Increase in accrued expenses and other li-
abilities................................ 32.0 40.1 70.7
--------- --------- ---------
Net cash flow provided by operating
activities................................... 1,234.5 1,142.8 1,320.8
--------- --------- ---------
Cash flows from investing activities:
Rental library purchases.................... (818.1) (808.7) (810.0)
Capital expenditures........................ (175.0) (374.4) (221.5)
Cash used for acquisitions.................. (34.2) (111.7) (33.7)
Proceeds from sale of property and equip-
ment....................................... 0.3 1.7 1.7
Proceeds from sales of store operations..... -- 36.1 4.8
Proceeds from sale of non-core investment... -- -- 7.1
Investments in affiliated companies......... 4.8 (1.1) (5.2)
--------- --------- ---------
Net cash flow used in investing activities.... (1,022.2) (1,258.1) (1,056.8)
--------- --------- ---------
Cash flows from financing activities:
Proceeds from credit agreement.............. -- 1,750.0 125.0
Repayments on credit agreement.............. -- (562.9) (290.1)
Proceeds from term loan..................... (46.6) -- --
Repayment of term loan...................... 46.6 -- --
Proceeds from equipment term loan........... -- -- 26.5
Repayments on equipment term loan........... -- -- (4.3)
Net borrowings from (repayments to) Viacom.. 0.6 (1,576.4) --
Net proceeds from the issuance of common
stock...................................... -- 430.1 --
Cash dividends.............................. -- (3.5) (14.0)
Capital contributions from (repayments to)
Viacom, net................................ (206.9) 134.1 --
Capital lease payments...................... (34.8) (34.2) (30.3)
--------- --------- ---------
Net cash flow provided by (used in) financing
activities................................... (241.1) 137.2 (187.2)
--------- --------- ---------
Effect of exchange rate changes on cash....... (1.8) (1.3) (2.2)
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. (30.6) 20.6 74.6
Cash and cash equivalents at beginning of
year......................................... 129.6 99.0 119.6
--------- --------- ---------
Cash and cash equivalents at end of year...... $ 99.0 $ 119.6 $ 194.2
========= ========= =========
See notes to consolidated financial statements.
48
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular dollars in millions except per share amounts)
Note 1--Basis of Presentation
Blockbuster Inc. and its subsidiaries (the "Company" or "Blockbuster")
operate and franchise entertainment related stores in the United States and a
number of other countries. The Company offers pre-recorded videocassettes and
DVDs primarily for rental and also offers titles for purchase on a "sell-
through" (retail) basis. In addition, the Company offers video games for rental
and sale and sells 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 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 included an allocation of corporate expenses
from Viacom. All such costs and expenses were 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 were 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 for
the periods prior to the Offering may not necessarily reflect the results of
operations or cash flows of the Company in the future or what the 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. in the form of an interest-bearing note, (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 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.
49
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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 the Company's borrowing capacity (see Note 10).
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 using the equity method. Investments of 20% or less are accounted
for using 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 pre-recorded 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).
Rental amortization expense approximated $711.6 million (1998), excluding
the charge in 1998 (see Note 3), $675.1 million (1999), and $735.6 million
(2000).
50
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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:
1999 2000
-------- --------
Land, building and building improvements.................. $ 49.2 $ 47.3
Leasehold improvements.................................... 755.8 781.5
Equipment and other....................................... 549.3 600.2
Furniture and fixtures.................................... 321.5 332.9
Capital leases............................................ 250.2 210.7
-------- --------
Total................................................... 1,926.0 1,972.6
Less: accumulated depreciation............................ 777.7 893.2
-------- --------
Property and equipment, net............................... $1,148.3 $1,079.4
======== ========
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 $212.7 million
(1998), $220.5 million (1999) and $279.0 million (2000). Depreciation expense
related to capital leases was $29.7 million (1998), $24.0 million (1999) and
$23.5 million (2000).
Sales of store 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.
Retirements and disposals are recorded by removing the cost and accumulated
depreciation from the asset and accumulated depreciation accounts with any
remaining net book value reflected as increased depreciation 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 acquired ("goodwill"), and
principally relate to Viacom's acquisition of the Company in 1994.
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
51
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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 $170.2 million (1998),
$171.8 million (1999) and $180.1 million (2000).
Intangible assets at December 31 consist of the following:
1999 2000
-------- --------
Goodwill................................................. $6,807.8 $6,816.1
Other intangibles (trademarks and reacquired franchise
rights)................................................. 25.0 25.9
-------- --------
Total.................................................. 6,832.8 6,842.0
Less: accumulated amortization........................... 856.9 1,032.8
-------- --------
Intangibles, net......................................... $5,975.9 $5,809.2
======== ========
Impairment of Long-Lived Assets
The Company assesses long-lived assets (primarily property 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 (see Note 5). 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.
Fair Value of Financial Instruments
At December 31, 1999 and 2000, the Company's carrying value of financial
instruments approximated fair value due to the short-term maturities of these
instruments or variable rates of interest. During 1998, 1999 and 2000, 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, 2000, 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 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 1998, 1999 and 2000. Net foreign currency transaction
gains and losses were not significant for any of the years presented.
Rental Revenue and Merchandise Sales
Revenues are generally recognized at the time of sale or rental. Rental
revenue includes sales of previously rented product, including video tapes,
DVDs and video games.
52
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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
as revenue over the period benefited.
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.
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 Loss Per Share
Basic loss per share ("EPS") is computed by dividing the net loss applicable
to common shares by the weighted average number of common shares outstanding
during the period. Diluted EPS adjusts the basic
53
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
weighted average number of common shares outstanding by the assumed conversion
of convertible securities and exercise of stock options only in periods in
which such effect would have been dilutive. Options to purchase approximately
13.7 million shares of class A common stock were outstanding as of December 31,
2000 and were excluded from the computation of the weighted average shares for
diluted EPS because their inclusion would be anti-dilutive. The table below
presents a reconciliation of weighted average shares used in the calculation of
basic and diluted EPS:
Year Ended December 31,
-----------------------
1998 1999 2000
------- ------- -------
Weighted average shares for basic EPS................... 144.0 156.1 175.0
Incremental shares for stock options.................... -- -- --
------- ------- -------
Weighted average shares for diluted EPS................. 144.0 156.1 175.0
======= ======= =======
Comprehensive Loss
Comprehensive 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 loss and other gains
and losses affecting stockholders' equity that, under generally accepted
accounting principles, are excluded from net 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 loss as the foreign currency translation
adjustments are associated with operations located in foreign jurisdictions
with operating tax losses.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"), effective for fiscal years
beginning after June 15, 2000, as amended by Statements 137 and 138 in June
1999 and June 2000, respectively. These statements require companies to
recognize all derivatives as either assets or liabilities on the balance sheet
and measure those instruments at fair value. The statements also established
new accounting rules for hedging instruments which, depending on the nature of
the hedge, require that changes in the fair value of the derivatives either be
offset against the change in fair value of assets, liabilities or firm
commitments through earnings, or be recognized in other comprehensive income
until the hedged item is recognized in earnings. Blockbuster adopted SFAS 133,
as amended, on January 1, 2001, which resulted in an immaterial impact on its
consolidated results of operations and financial position.
The Company adopted the provisions of SEC Staff Accounting Bulletin No. 101,
"Revenue Recognition in Financial Statements" in the fourth quarter of 2000.
The Company also adopted Emerging Issues Task Force Issue No. 99-19, "Reporting
Revenue Gross as a Principal versus Net as an Agent," in the fourth quarter of
2000. The effect of the adoption of these standards was not material.
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
54
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
the number of videocassettes in the stores and is satisfying consumer demand
over a shorter period of time. Revenue-sharing allows Blockbuster to acquire
videocassettes at a lower initial 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, 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 is amortized on an accelerated basis over
three months to an estimated $4 salvage value. Video games and base-stock DVDs
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 amortization method developed for
Blockbuster's business model results in better matching of revenue and expense
recognition. Under Blockbuster's model, cost of sales attributable to rental
product is comprised of revenue-sharing payments, which are expensed when the
related revenue is recognized, amortization of product costs and residual
values of previously rented product upon sale.
Note 4--Special Item Charges
During 1997, the Company recognized a $27.8 million charge for lease exit
obligations in conjunction with a store closure program. Through December 31,
2000, the Company has paid and charged approximately $22.4 million against the
lease exit obligations.
During 1998, the Company revised its estimate of net realizable value
associated with certain, non-strategic investments which were originally
written down by $27.1 million in 1997. An additional provision related to one
of the investments of approximately $10.5 million was recognized in the fourth
quarter of 1998 to reflect this change in estimate and was included in "Other
items, net." During 2000, the Company recognized a pre-tax gain of $1.9 million
included in "Other items, net," upon the sale of this investment.
Note 5--New Media Impairment Charge
During the fourth quarter of 2000, the Company determined that the carrying
value of certain hardware and capitalized software components of its new media
segment, primarily related to the e-commerce portion of blockbuster.com,
exceeded the estimated undiscounted future cash flows to be generated by those
assets. As a result, the Company recorded an impairment charge of approximately
$31.6 million. This charge is included in depreciation expense in the
Consolidated Statements of Operations for the year ended December 31, 2000.
55
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
Note 6--Stock Option Plans
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation" ("SFAS 123"). 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
$4.1 million ($2.6 million after tax or $0.02 per basic and diluted share),
$12.3 million ($7.5 million after tax or $0.05 per basic and diluted share)
and $21.9 million ($13.1 million after tax or $0.08 per basic and diluted
share) in 1998, 1999 and 2000, respectively. These pro forma effects may not
be representative of expense in future periods 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 granted in 1999 generally vest over a five-year period from the date
of grant and generally expire 10 years after the date of grant and outstanding
stock options granted in 2000 generally vest over a four-year period from the
date of grant and generally 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 2000
---- ----
Expected dividend yield (a)...................................... 0.6% 1.0%
Expected stock price volatility.................................. 45.0% 45.0%
Risk-free interest rate.......................................... 6.2% 6.1%
Expected life of options (years)................................. 7.0 7.0
- --------
(a) Management's current intention is to pay 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 in 1999 and $5.63 in 2000.
56
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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
Granted....................................... 4,695,235 11.04
Exercised..................................... -- --
Cancelled..................................... 2,235,173 14.47
----------
Balance at December 31, 2000.................... 13,695,541 $13.72
==========
The following table summarizes information concerning currently outstanding
and exercisable Blockbuster stock options issued to Blockbuster employees and
directors at December 31, 2000:
Outstanding Exercisable
------------------------------------------------- --------------------------
Range of Remaining Contractual Weighted-Average Weighted-Average
Exercise Price Options Life (Years) Exercise Price Options Exercise Price
-------------- ---------- --------------------- ---------------- --------- ----------------
$11 4,349,665 9.6 $11.00 -- $ --
13 to 15 9,345,876 8.7 14.99 1,923,326 14.99
---------- ---------
13,695,541 1,923,326
========== =========
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:
1998 1999
---- ----
Expected dividend yield (b)...................................... -- --
Expected stock price volatility.................................. 32.7% 29.6%
Risk-free interest rate.......................................... 5.5% 6.1%
Expected life of options (years)................................. 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.
The weighted-average fair value of each option as of the grant date was
$12.97 and $19.89 in 1998 and 1999, respectively.
57
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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, 1997....................... 10,232,200 $14.65
Granted.......................................... 506,320 30.31
Exercised........................................ 7,102,920 14.39
Cancelled........................................ 414,356 16.00
----------
Balance at December 31, 1998....................... 3,221,244 17.51
Granted.......................................... 40,000 42.13
Exercised........................................ 634,052 14.88
Cancelled........................................ 153,198 15.02
----------
Balance at December 31, 1999....................... 2,473,994 18.74
Granted.......................................... -- --
Exercised........................................ 409,440 15.78
Cancelled........................................ 119,320 20.77
----------
Balance at December 31, 2000....................... 1,945,234 $19.24
==========
The following table summarizes information concerning currently outstanding
and exercisable Viacom stock options held by Blockbuster employees at December
31, 2000:
Outstanding Exercisable
--------------------------------------------------- ------------------------
Range of Remaining Contractual Weighted-Average Weighted-Average
Exercise Price Options Life (Years) Exercise Price Options Exercise Price
-------------- --------- --------------------- ---------------- ------- ----------------
$10 to $15 15,000 6.62 $14.94 5,000 $14.94
15 to 20 1,342,068 6.56 15.33 519,401 15.33
30 to 35 425,654 7.64 30.56 140,761 30.56
35 to 45 40,000 8.25 42.69 -- --
3 to 25(c) 122,512(c) 2.65 15.56 122,512 15.56
--------- -------
1,945,234 787,674
========= =======
- --------
(c) Represents information for options assumed with the Viacom acquisition of
Blockbuster.
Note 7--Accrued Expenses
The Company's accrued expenses consist of the following:
At December
31,
-------------
1999 2000
------ ------
Accrued compensation.......................................... $ 70.1 $ 88.3
Accrued gift card liability................................... 89.3 98.8
Accrued taxes other than income taxes......................... 82.9 82.5
Accrued revenue-sharing....................................... 56.7 107.4
Store closure reserves........................................ 15.4 14.8
Assigned Music liabilities.................................... 18.9 13.3
Deferred reward card revenue.................................. 14.5 15.8
Other......................................................... 74.7 52.8
------ ------
$422.5 $473.7
====== ======
58
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
Note 8--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
primarily for the periods prior to the Offering and during the transitional
period subsequent to the Offering. 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. The charges for services were $12.5
million (1998), $7.7 million (1999) and $1.8 million (2000).
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 $16.0 million (1998),
$10.4 million (1999) and $2.0 million (2000) 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 9 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 and DVDs for rental and sale directly from
Paramount Pictures Corporation ("Paramount") and Showtime Networks, Inc.
("Showtime"). Total purchases from Paramount were $110.1 million, $112.0
million and $129.9 million for the years ended December 31, 1998, 1999 and
2000, respectively. Total purchases from Showtime were $4.9 million and
$4.2 million for the years ended December 31, 1999 and 2000, respectively.
There were no purchases from Showtime in 1998. The Company also purchases
certain home video games from Midway Games, Inc. Total amounts paid for
purchases were $19.1 million, $15.7 million and $5.6 million for the years
ended December 31, 1998, 1999 and 2000, respectively.
In 1999, the Company entered into a U.S. promotional and customer database
services and licenses agreement with MTV Networks ("MTVN"), a business unit of
Viacom. Pursuant to this agreement, for one year, Blockbuster agreed to 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 MTVI Group, L.P. and its direct and
indirect affiliates for internal use. In return, MTVN paid Blockbuster $18
million. MTVN had an option to extend in perpetuity the license to use the
customer database. Blockbuster had recognized revenue from this transaction
over the estimated useful life of the agreement, which was expected to exceed
one year. During the third quarter of 2000, MTVN elected not to exercise this
option and, as a result, Blockbuster has no further obligation to MTVN.
Accordingly, the remaining deferred revenue of $12.3 million was recognized in
the third quarter of 2000 and is reflected in "Other revenues" in the
Consolidated Statements of Operations for the year ended December 31, 2000.
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
59
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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 $13.3 million remains in current liabilities
at December 31, 2000.
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.
Note 9--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 10.
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 10. 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 $8.4 million and $49.1
million for the years 1998 and 1999, respectively.
Note 10--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 was 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, which was paid down during 2000. The repayment of the short-term
revolver permanently reduced the borrowing capacity under the Blockbuster
Credit Agreement from $1.9 billion to $1.3 billion. Interest rates under the
Blockbuster Credit Agreement 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
(.25% at December 31, 2000).
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
60
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
fixed charge coverage ratio. At December 31, 2000, the Company was in
compliance with all financial covenants under the Blockbuster Credit Agreement.
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 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. The
Company repaid the remaining $157.1 million of the short-term revolver during
the year ended December 31, 2000. The Company had $278.0 million of available
borrowing capacity under the long-term revolver at December 31, 2000. The
weighted average interest rate at December 31, 2000 for these borrowings was
8.0%.
Blockbuster entered into two additional lines of credit with banks for an
aggregate of $75.0 million in the fourth quarter of 1999. There were no
outstanding amounts under these two lines of credit at December 31, 2000.
In April 2000, the Company borrowed $26.5 million in order to finance the
purchase of certain equipment. The financing bears interest at 8.0%, is payable
in monthly installments through April 2005, and is secured by a lien on the
equipment. At December 31, 2000, the Company has $22.2 million outstanding
under this financing.
Short-term debt consists of the following:
At December 31,
-----------------
1999 2000
-------- --------
Short-term revolving credit facility, interest rate 7.9%
at December 31, 1999..................................... $ 157.1 $ --
Current maturities of equipment term loan, interest rate
of 8.0%, payable monthly through April 2005, secured by
certain equipment........................................ -- 6.7
Current maturities of all other obligations............... -- 1.3
-------- --------
Total current portion of long-term debt................. $ 157.1 $ 8.0
======== ========
Long-term debt, excluding current maturities, consists of the following:
At December 31,
-----------------
1999 2000
-------- --------
Term loan, interest rate 7.8% at December 31, 1999 and
7.9% at December 31, 2000 due in quarterly installments
beginning April 2002..................................... $ 600.0 $ 600.0
Long-term revolving credit facility, interest rate 8.0% at
December 31, 1999, and 8.0% at December 31, 2000, due
July 2004................................................ 430.0 422.0
Equipment term loan, interest rate of 8.0%, payable
monthly through April 2005, secured by certain
equipment................................................ -- 15.5
All other obligations..................................... -- 1.5
-------- --------
Total long-term debt.................................... $1,030.0 $1,039.0
======== ========
61
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
Maturities on debt are as follows:
2001................................................................ $ 8.0
2002................................................................ 158.8
2003................................................................ 279.3
2004................................................................ 599.9
2005................................................................ 1.0
--------
$1,047.0
========
Interest expense related to capital leases was $18.5 million, $16.0 million
and $13.9 million for the years ended December 31, 1998, 1999 and 2000,
respectively. See Note 12 for further information regarding capital lease
obligations.
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 closing of 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. Included in the Receivable from Viacom balance in
the accompanying Consolidated Balance Sheets were income tax receivables of
$130.9 million and $41.1 million as of December 31, 2000 and 1999,
respectively. 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,
2000 are primarily attributable to domestic $(8.2) million and foreign
subsidiaries $(51.1) 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
62
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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,
$21.7 million has no expiration date, $1.6 million expires in 2001 and $36.0
million expires thereafter.
Income (loss) accounted for under the equity method of accounting is shown
net of tax in the Consolidated Statements of Operations. Included in equity in
income (loss) of affiliated companies, net of tax of $(1.3) million (1998),
$(2.8) million (1999) and $1.3 million (2000) are a tax provision of $0.2
million for 1998, a tax benefit of $0.4 million for 1999 and a tax provision of
$0.8 million for 2000.
Income (loss) before income taxes are attributable to the following
jurisdictions:
Year Ended December 31,
-------------------------
1998 1999 2000
------- ------- -------
United States................................... $(313.6) $ 28.5 $ (32.1)
Foreign......................................... (81.1) (23.1) 0.3
------- ------- -------
$(394.7) $ 5.4 $ (31.8)
======= ======= =======
Components of the income tax benefit (provision) are as follows:
Year Ended December 31,
-------------------------
1998 1999 2000
------- ------- -------
Current:
Federal....................................... $ 51.2 $ 95.4 $ 86.1
State and local............................... 3.0 14.0 7.9
Foreign....................................... (2.9) (7.3) (3.2)
------- ------- -------
51.3 102.1 90.8
Deferred........................................ 8.1 (173.9) (136.2)
------- ------- -------
$ 59.4 $ (71.8) $ (45.4)
======= ======= =======
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,
-------------------------
1998 1999 2000
------- ------- -------
Statutory U.S. tax benefit (provision).......... $ 138.2 $ (1.9) $ 11.1
Amortization of non-deductible goodwill......... (61.5) (58.4) (58.4)
State and local taxes, net of federal tax
benefit........................................ 16.2 0.5 1.5
Effect of foreign operations.................... (33.9) (9.8) (0.8)
Other, net...................................... 0.4 (2.2) 1.2
------- ------- -------
Tax benefit (provision)......................... $ 59.4 $ (71.8) $ (45.4)
======= ======= =======
63
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
The following is a summary of the deferred tax accounts in accordance with
SFAS 109:
Year Ended
December 31,
----------------
1999 2000
------- -------
Deferred tax assets:
Reserves and accrued liabilities....................... $ 15.9 $ 18.4
Book-tax basis differences in investments.............. 19.7 20.5
Net operating loss carryforwards....................... 55.9 59.3
------- -------
Total deferred tax assets.............................. 91.5 98.2
Less valuation allowance............................... (72.8) (76.2)
------- -------
Net deferred tax assets................................ 18.7 22.0
------- -------
Deferred tax liabilities:
Deferred expenses...................................... (22.7) (24.0)
Book-tax basis differences in rental library and other
assets................................................ (91.0) (229.2)
------- -------
Total deferred tax liabilities......................... (113.7) (253.2)
------- -------
Total net deferred tax liabilities..................... $ (95.0) $(231.2)
======= =======
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, 2000, minimum rental payments under non-cancellable leases
are as follows:
Operating Capital
--------- -------
2001....................................................... $ 453.7 $ 36.5
2002....................................................... 397.2 32.0
2003....................................................... 359.5 28.1
2004....................................................... 270.7 22.7
2005....................................................... 190.4 18.6
2006 and thereafter........................................ 513.6 26.9
-------- ------
Total minimum lease payments............................... $2,185.1 $164.8
========
Less amount representing interest.......................... 42.5
------
Present value of net minimum payments...................... $122.3
======
Rent expense was $409.8 million (1998), $454.0 million (1999) and $475.9
million (2000). Subtenant rental income was $5.6 million (1998), $7.4 million
(1999) and $12.5 million (2000). Future minimum lease payments have not been
reduced by future minimum subtenant rental income of $75.9 million.
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.
64
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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 a 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 a
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 asserted, 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. 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. In April 2000, Ruben Loredo voluntarily dismissed the
state court action without prejudice, and Ruben Loredo and Blockbuster were
added as parties plaintiff and defendant, respectively, in the federal court
action. In January 2000, the federal court plaintiffs added California state
law claims to the pending federal antitrust claims. On March 16, 2001, the
federal judge in the United States District Court for the Western District of
Texas denied the plaintiffs' request for class certification of both the
federal and California claims. In January 2001, the same plaintiffs, in
addition to other individual plaintiffs, filed a similar complaint in
California state court seeking monetary damages. In addition to any damage
award to which Blockbuster might be directly subject, if Viacom is required to
pay any damage award as a result of the federal or state court action, Viacom
may seek indemnification for its losses from Blockbuster under the release and
indemnification agreement entered into between Viacom and Blockbuster.
Blockbuster believes the plaintiffs' positions in both actions are without
merit and intends to vigorously defend itself in the litigation.
On May 7, 1999, Lynn Adams, Khristine Schoggins, and Debbie Lenke,
purporting to act as class representatives on behalf of themselves and for a
class comprised of certain Blockbuster store managers who worked in California,
filed a complaint in District Court in Orange County, California against
Blockbuster. The plaintiffs claim that they should be classified as non-exempt
and are thus owed overtime payments under California law. The dollar amount
that plaintiffs seek as damages to themselves and those similarly situated is
not set forth in the complaint. In January 2001, the trial court judge
certified a class. In February 2001, the California Court of Appeals denied
Blockbuster's petition for a writ of mandate. Blockbuster's petition for review
is pending before the Supreme Court of California. Blockbuster believes the
plaintiffs' position is without merit and intends to vigorously defend itself
in the litigation.
Blockbuster is a defendant in 13 putative class action lawsuits filed by
customers in state courts in Illinois, California, Ohio, Maryland, Texas and
New York between February 1999 and March 2001. These cases allege common law
and statutory claims for fraud and/or deceptive practices and/or unlawful
business practices regarding Blockbuster's policies for customers who choose to
keep rental product beyond the initial rental term. Some of the cases also
allege that these policies impose unlawful penalties and/or result in unjust
enrichment. The dollar amounts that plaintiffs seek as damages to themselves
and those similarly situated are not set forth in the complaints. Blockbuster
believes the plaintiffs' positions in these suits are without merit and intends
to vigorously defend itself in the litigation.
65
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
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 through December 31, 1999. 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 through April 1999. At that time, the Company set up its
own 401(k) savings plan that generally mirrors the Viacom 401(k) savings plan.
Account balances in the Viacom plan were transferred to the new Blockbuster
401(k) savings plan. Through June 30, 2000, the Company invested matching
contributions in Viacom's Class B Common Stock. On July 1, 2000, the Company
began investing matching contributions in Blockbuster's class A common stock.
The Company incurred pension and 401(k) savings plan expenses of $5.3
million (1998), $5.6 million (1999) and $1.6 million (2000) related to the
plans discussed above.
Management believes that the methodologies used to allocate pension charges
to the Company are reasonable.
Note 14--Sales of Store Operations to Franchisees
In 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 for the year ended December 31, 1999, as a reduction of
general and administrative expenses.
In 2000, Blockbuster sold certain stores to franchisees for $5.7 million. As
a result of these sales, Blockbuster received $4.8 million in cash, $0.9
million in notes receivable and recognized a net gain of $1.7 million as a
reduction of general and administrative expenses.
Note 15--Acquisitions
During 1998, 1999 and 2000, 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
$34.2 million (1998), $111.7 million (1999) and $33.7 million (2000) 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.
66
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
Note 16--Supplemental Cash Flow Information
Cash flows from operating activities included cash payments as follows:
Year Ended December
31,
-------------------
1998 1999 2000
----- ------ ------
Cash payments for interest............................. $27.2 $109.3 $112.6
Supplemental schedule of non-cash financing and
investing activities:
Notes received from sales of store operations (see
Note 14)............................................ $ -- $ 30.3 $ 0.9
Retail stores acquired under capital leases.......... 3.8 11.8 14.6
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 so long as we are controlled by Viacom;
however, after all applicable net operating loss carryforwards have been
utilized, and the Company's income tax receivable from Viacom has been
eliminated, to the extent the Company will have a tax liability on a stand-
alone basis, such amounts will be remitted to Viacom.
Note 17--Operating Segments and Geographic Area
Beginning in the fourth quarter of 1999, Blockbuster began reporting in two
segments: (i) home videocassette, DVD and video game rental and retailing,
which Blockbuster refers to as the video segment, and (ii) new media (formerly
called new technologies).
(i) Video
As of December 31, 2000, the video segment operated 6,254 video stores
and its franchisees and/or joint ventures operated 1,423 video stores
located throughout the United States, its territories and 25 other
countries.
(ii) New Media
Through the new media segment Blockbuster operates its Internet site,
blockbuster.com, and the Digital Networks division, which is
responsible for exploring various forms of electronic entertainment
delivery including entertainment-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 income (expense), equity in income (loss) of
affiliated companies (net of tax), other items, net and benefit (provision) for
income taxes.
67
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
The following tables set forth the Company's financial results by operating
segments.
Year Ended December 31,
----------------------------
1998 1999 2000
-------- -------- --------
Revenues:
Video...................................... $3,893.4 $4,463.3 $4,959.1
New media.................................. -- 0.2 1.0
-------- -------- --------
Total revenues........................... $3,893.4 $4,463.5 $4,960.1
======== ======== ========
Operating income (loss):
Video...................................... $ (359.2) $ 128.7 $ 172.5
New media(1)............................... -- (7.0) (96.8)
-------- -------- --------
Total operating income (loss)............ $ (359.2) $ 121.7 $ 75.7
======== ======== ========
Depreciation and amortization (including tape
amortization):
Video...................................... $1,518.8 $1,067.0 $1,151.3
New media(1)............................... -- 0.4 43.4
-------- -------- --------
Total depreciation and amortization...... $1,518.8 $1,067.4 $1,194.7
======== ======== ========
Total assets:
Video...................................... $8,274.8 $8,505.0 $8,538.9
New media.................................. -- 35.8 10.0
-------- -------- --------
Total assets............................. $8,274.8 $8,540.8 $8,548.9
======== ======== ========
Capital expenditures:
Video...................................... $ 175.0 $ 341.1 $ 203.5
New media.................................. -- 33.3 18.0
-------- -------- --------
Total capital expenditures............... $ 175.0 $ 374.4 $ 221.5
======== ======== ========
- --------
(1) As described in Note 5, we recognized a charge of $31.6 million related to
the impairment of certain hardware and capitalized software costs in our
new media segment. This charge is reflected in depreciation expense.
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,
--------------------------
1998 1999 2000
-------- -------- --------
Revenues:
United States.................................. $3,090.1 $3,596.8 $4,003.3
Europe......................................... 427.9 440.5 469.7
International-all other........................ 375.4 426.2 487.1
-------- -------- --------
Total revenues............................... $3,893.4 $4,463.5 $4,960.1
======== ======== ========
Long-lived assets(1):
United States(2)............................... $6,942.2 $7,145.2 $7,004.7
Europe......................................... 362.8 357.3 337.5
International-all other........................ 245.6 284.6 272.3
-------- -------- --------
Total long-lived assets...................... $7,550.6 $7,787.1 $7,614.5
======== ======== ========
- --------
(1) Includes all non-current assets, except deferred income taxes and Viacom
receivable.
(2) Includes substantially all of the Company's intangible assets.
68
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(Tabular dollars in millions except per share amounts)
Note 18--Quarterly Financial Data (unaudited)
Summarized quarterly financial data for 1999 and 2000 appears below:
First Second Third Fourth Total
Quarter Quarter Quarter Quarter(1) Year
-------- -------- -------- ---------- --------
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 loss................... $ (3.4) $ (39.9) $ (19.1) $ (6.8) $ (69.2)
Net loss per share: basic
and diluted............... $ (0.02) $ (0.28) $ (0.12) $ (0.04) $ (0.44)
2000
Revenue.................... $1,211.1 $1,214.4 $1,193.8 $1,340.8 $4,960.1
Gross profit............... $ 714.7 $ 713.0 $ 721.7 $ 774.7 $2,924.1
Net loss................... $ (4.1) $ (27.9) $ (19.3) $ (24.6) $ (75.9)
Net loss per share: basic
and diluted............... $ (0.02) $ (0.16) $ (0.11) $ (0.14) $ (0.43)
- --------
(1) As described in Note 5, we recognized an impairment charge of $31.6 million
in the fourth quarter of 2000 related to the impairment of certain hardware
and capitalized software costs in our new media segment. This charge is
reflected in depreciation expense.
Note 19--Subsequent Events (unaudited)
On January 30, 2001, the Board of Directors declared a cash dividend of
$0.02 per share on class A and class B common stock, payable March 12, 2001, to
stockholders of record at the close of business on February 19, 2001. The total
dividend payment was approximately $3.5 million of which approximately $2.9
million was paid to Viacom International Inc.
In February 2001, the Company entered into a strategic alliance with
RadioShack Corporation under which RadioShack will operate store-within-a-store
areas inside selected Blockbuster locations. In 2001, the companies will launch
Phase I of the strategic alliance in approximately 130 Blockbuster stores in at
least four markets. At the end of Phase I, the companies will determine whether
they will proceed to Phase II, which would be a rollout of the concept to as
many stores as possible in the United States, anticipated to occur during 2002.
RadioShack will pay a license fee to Blockbuster for each location and both
companies will share in the operating income (loss), as defined, generated by
the store-within-a-store areas.
In March 2001, the Company entered into two interest rate swaps with Viacom
in order to obtain a fixed interest rate with respect to $400 million of its
outstanding floating rate debt. The swaps fixed $200 million of the Company's
outstanding debt at an interest rate of 5.0135% for two years and the other
$200 million at an interest rate of 5.1190% for two and one-half years. The
Company's effective interest rates also include a LIBOR spread, currently
1.25%, which is subject to change under the terms of the Blockbuster Credit
Agreement. The swaps are subject to termination in the event that (i) Viacom
ceases to own greater than 80% of the Company's outstanding common stock or
(ii) the Company no longer has any obligations under the term loan portion of
the Blockbuster Credit Agreement.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.
None.
69
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 2001 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 2001 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 2001 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 2001 Annual Meeting of Stockholders under the heading "Certain
Relationships and Related Transactions," which information is incorporated
herein by reference.
70
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 43 of this Form
10-K.
(b) Financial Statement Schedules.
None.
(c) Exhibits.
3.1 Amended and Restated Certificate of Incorporation of Blockbuster Inc.(1)
3.2 Bylaws of Blockbuster Inc.(2)
4.1 Specimen Class A Common Stock Certificate of Blockbuster Inc.(3)
10.1 Initial Public Offering and Split-Off Agreement among Blockbuster Inc.,
Viacom International Inc. and Viacom Inc.(3)
10.2 Release and Indemnification Agreement between Blockbuster Inc. and Viacom
Inc.(3)
10.3 Transition Services Agreement between Blockbuster Inc. and Viacom Inc.(3)
10.4 Registration Rights Agreement between Blockbuster Inc. and Viacom Inc.(3)
10.5 Tax Matters Agreement between Blockbuster Inc. and Viacom Inc.(3)
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 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)+
10.10 Revenue-Sharing Term Sheet, dated as of July 29, 1999, between Blockbuster
Inc. and Paramount Home Video.(1)+
10.11 Employment Agreement between Blockbuster Inc. and John F. Antioco, dated
July 15, 1999.(1)(5)
10.12 Employment Agreement between Blockbuster Inc. and Alva J. Phillips, Jr.,
commencing November 23, 1999.(4)(5)
10.13 Addendum to the Employment Agreement between Blockbuster Inc. and Alva J.
Phillips, Jr., dated December 20, 2000.(4)(5)
10.14 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Alva J. Phillips, Jr., dated as of January 1,
1998.(2)(5)
10.15 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Alva J. Phillips, Jr., dated
December 1, 1998.(2)(5)
10.16 Employment Agreement between Blockbuster Inc. and Michael K. Roemer,
commencing December 27, 1999.(4)(5)
10.17 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Michael K. Roemer, dated as of June 1, 1998.(4)(5)
10.18 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Michael K. Roemer, dated
December 1, 1998.(4)(5)
71
10.19 Employment Agreement between Blockbuster Inc. and Nigel Travis, commencing
December 27, 1999.(4)(5)
10.20 Addendum to the Employment Agreement between Blockbuster Inc. and Nigel
Travis, dated December 18, 2000.(4)(5)
10.21 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Nigel Travis, dated June 1, 1998.(1)(5)
10.22 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Nigel Travis, dated December 1,
1998.(1)(5)
10.23 Employment Agreement between Blockbuster Inc. and Larry Zine, commencing
November 23, 1999.(4)(5)
10.24 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Larry Zine, dated April 1, 1999.(3)(5)
10.25 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Larry Zine, dated April 2,
1999.(3)(5)
10.26 Blockbuster Inc. 1999 Long-Term Management Incentive Plan.(1)(5)
10.27 Blockbuster Inc. Senior Executive Short-Term Incentive Plan.(1)(5)
10.28 Credit Agreement, dated as of June 21, 1999, between Blockbuster Inc. and
the banks named therein.(1)
21.1 List of Subsidiaries of Blockbuster Inc.(4)
23.1 Consent of PricewaterhouseCoopers LLP.(4)
- --------
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration Statement
on Form S-1 (333-77899) and incorporated herein by reference.
(2) Previously filed as an exhibit to Blockbuster Inc.'s Annual Report on Form
10-K for the fiscal year ended December 31, 1999, and incorporated herein
by reference.
(3) 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.
(4) Filed herewith.
(5) 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 on Form 8-K
None.
72
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 28, 2001
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, March 28, 2001
____________________________________ President and Chief
John F. Antioco Executive Officer
(Principal Executive
Officer)
By: /s/ Larry J. Zine Executive Vice President and March 28, 2001
____________________________________ Chief Financial Officer
Larry J. Zine (Principal Financial and
Accounting Officer)
By: /s/ Philippe P. Dauman Director March 28, 2001
____________________________________
Philippe P. Dauman
By: /s/ Linda Griego Director March 28, 2001
____________________________________
Linda Griego
By: /s/ Mel Karmazin Director March 28, 2001
____________________________________
Mel Karmazin
By: /s/ John L. Muething Director March 28, 2001
____________________________________
John L. Muething
By: /s/ Sumner M. Redstone Director March 28, 2001
____________________________________
Sumner M. Redstone
By: /s/ Fredric G. Reynolds Director March 28, 2001
____________________________________
Fredric G. Reynolds
73
EXHIBIT INDEX
3.1 Amended and Restated Certificate of Incorporation of Blockbuster Inc.(1)
3.2 Bylaws of Blockbuster Inc.(2)
4.1 Specimen Class A Common Stock Certificate of Blockbuster Inc.(3)
10.1 Initial Public Offering and Split-Off Agreement among Blockbuster Inc.,
Viacom International Inc. and Viacom Inc.(3)
10.2 Release and Indemnification Agreement between Blockbuster Inc. and Viacom
Inc.(3)
10.3 Transition Services Agreement between Blockbuster Inc. and Viacom Inc.(3)
10.4 Registration Rights Agreement between Blockbuster Inc. and Viacom Inc.(3)
10.5 Tax Matters Agreement between Blockbuster Inc. and Viacom Inc.(3)
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 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)+
10.10 Revenue-Sharing Term Sheet, dated as of July 29, 1999, between Blockbuster
Inc. and Paramount Home Video.(1)+
10.11 Employment Agreement between Blockbuster Inc. and John F. Antioco, dated
July 15, 1999.(1)(5)
10.12 Employment Agreement between Blockbuster Inc. and Alva J. Phillips, Jr.,
commencing November 23, 1999.(4)(5)
10.13 Addendum to the Employment Agreement between Blockbuster Inc. and Alva J.
Phillips, Jr., dated December 20, 2000.(4)(5)
10.14 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Alva J. Phillips, Jr., dated as of January 1,
1998.(2)(5)
10.15 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Alva J. Phillips, Jr., dated
December 1, 1998.(2)(5)
10.16 Employment Agreement between Blockbuster Inc. and Michael K. Roemer,
commencing December 27, 1999.(4)(5)
10.17 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Michael K. Roemer, dated as of June 1, 1998.(4)(5)
10.18 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Michael K. Roemer, dated
December 1, 1998.(4)(5)
10.19 Employment Agreement between Blockbuster Inc. and Nigel Travis, commencing
December 27, 1999.(4)(5)
10.20 Addendum to the Employment Agreement between Blockbuster Inc. and Nigel
Travis, dated December 18, 2000.(4)(5)
10.21 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Nigel Travis, dated June 1, 1998.(1)(5)
10.22 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Nigel Travis, dated December 1,
1998.(1)(5)
10.23 Employment Agreement between Blockbuster Inc. and Larry Zine, commencing
November 23, 1999.(4)(5)
10.24 Employment Agreement between Blockbuster Entertainment Group, a business
unit of Viacom Inc., and Larry Zine, dated April 1, 1999.(3)(5)
10.25 Amendment to the Employment Agreement between Blockbuster Entertainment
Group, a business unit of Viacom Inc., and Larry Zine, dated April 2,
1999.(3)(5)
10.26 Blockbuster Inc. 1999 Long-Term Management Incentive Plan.(1)(5)
10.27 Blockbuster Inc. Senior Executive Short-Term Incentive Plan.(1)(5)
10.28 Credit Agreement, dated as of June 21, 1999, between Blockbuster Inc. and
the banks named therein.(1)
21.1 List of Subsidiaries of Blockbuster Inc.(4)
23.1 Consent of PricewaterhouseCoopers LLP.(4)
- --------
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration Statement
on Form S-1 (333-77899) and incorporated herein by reference.
(2) Previously filed as an exhibit to Blockbuster Inc.'s Annual Report on Form
10-K for the fiscal year ended December 31, 1999, and incorporated herein
by reference.
(3) 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.
(4) Filed herewith.
(5) 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.