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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, 2001
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:
Name of Each Exchange on
Title of Each Class 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. [_]
As of March 8, 2002, 34,019,354 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 $802,078,371, based on the
closing price of $23.69 per share of class A common stock as reported on the
New York Stock Exchange composite tape on that date.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual meeting of stockholders of
the registrant to be held during 2002 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........................................................................... 16
Item 3. Legal Proceedings.................................................................... 16
Item 4. Submission of Matters to a Vote of Security Holders.................................. 17
PART II
Item 5. Market for Our Common Equity and Related Stockholder Matters......................... 18
Item 6. Selected Financial Data.............................................................. 18
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 25
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. 72
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 73
Item 11. Executive Compensation............................................................... 73
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 73
Item 13. Certain Relationships and Related Transactions....................................... 73
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................... 74
PART I
Item 1. Business
BLOCKBUSTER OVERVIEW
Blockbuster Inc. is the world's leading provider of rentable home
videocassettes, DVDs and video games, with nearly 8,000 stores in the United
States, its territories and 26 other countries as of December 31, 2001.
According to research conducted for Blockbuster, our BLOCKBUSTER(R) brand
achieves nearly 100% recognition with active movie renters in the United
States. During 2001, we implemented a number of key initiatives to strengthen
our core business and drive growth in profitability, while continuing to make
progress with initiatives designed to leverage our brand and capitalize on new
revenue streams. Reflecting these improvements, our worldwide revenues
increased to over $5.1 billion in 2001. Of these revenues, 80.0% were generated
in the United States and 20.0% were generated outside of the United States.
INDUSTRY OVERVIEW
Domestic Home Video--Movies
According to Paul Kagan Associates, at-home movie consumer spending in the
United States increased from about $21.3 billion in 2000 to about $22.2 billion
in 2001 and is projected to increase to about $38.6 billion by 2010. The U.S.
retail home video industry, which includes the rental and sale of movies on
videocassette ("VHS") and DVD, represented about $20.3 billion of the 2001
revenues. The remainder of the revenues were generated by consumer purchases of
movies through pay-per-view and other specialized cable and satellite services.
Although Kagan expects the U.S. retail home video industry to decline as a
percentage of overall at-home movie consumer spending over the next ten years,
we believe that the DVD format, with its superior sound and picture quality,
will drive continued growth in the industry. According to Kagan estimates, the
number of U.S. DVD households nearly doubled during 2001 to close to a quarter
of U.S. television households. Kagan projects that this will increase to nearly
49% of U.S. television households by the end of 2003 and over 75% of U.S.
television households by the end of 2009.
We believe that the combination of the following factors, among others,
continue to make VHS and DVD rental a preferred medium of entertainment for
millions of customers:
. the value gained through the ability to entertain 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, some DVDs offer extra features such as outtakes, director
commentary and the ability to skip directly to scenes, rather than
fast-forwarding and rewinding. The DVD format, unlike the VHS format, also
allows for several language tracks on the same disk.
A competitive advantage that the U.S. retail home video industry currently
enjoys over most other movie distribution channels, except theatrical release,
is the early timing of its "distribution window." As discussed below under
"--Movie Studio Dependence on the Retail Home Video Industry," the retail home
video industry is a critical source of revenue to U.S. movie distributors. In
order to maximize this revenue, studios make their movies available to home
video retailers, including Blockbuster, for specified periods of time after
their initial theatrical release. This distribution window is typically
exclusive against most other forms of non-theatrical movie distribution, such
as pay-per-view, premium television, basic cable and network and syndicated
television.
1
The length of this exclusive distribution window for home video retailers
varies, but has typically ranged from about 45 to 60 days for domestic video
retailers. Thereafter, movies are made sequentially available to television
distribution channels.
Currently, there is also a "rental window" for most VHS titles. Studios have
traditionally released VHS titles that they want to promote primarily for
rental at relatively high wholesale prices. As rental demand subsides, the
studios reduce the pricing in order to promote sales to consumers. The period
during which the VHS titles are released at higher prices is commonly referred
to as the "rental window," because the prices are too high to generate consumer
demand for purchasing them. In contrast, although studios are releasing movies
to home video retailers on DVD at the same time as they are releasing the same
movies on VHS, studios have not created a rental window for movies released on
DVD. Rather, the studios are releasing movies on DVD at relatively low initial
prices, called "sell-through" pricing, and are promoting DVDs for both purchase
and rental from the beginning of the distribution window. Studios have
traditionally reserved sell-through pricing on VHS product for titles that have
mass ownership appeal, such as children's movies or movies that generate high
box office returns.
The traditionally higher wholesale pricing of VHS product promoted for
rental has made it difficult for video retailers to purchase enough copies of
new VHS releases to satisfy consumer demand. As a result, major studios have
entered into VHS revenue-sharing and copy depth arrangements directly with
several video retailers, including us. These arrangements, which are discussed
under "Our Business--Merchandising," have enabled participating home video
retailers to minimize up-front costs and thereby substantially increase the
quantity and selection of newly released VHS movies that they are able to
stock. In exchange, video stores generally share with the studios an
agreed-upon percentage of the video stores' VHS rental revenues on a per
transaction basis for a limited period of time. Although some studios have
begun entering into DVD revenue-sharing arrangements, the current sell-through
pricing for DVDs has enabled video retailers such as Blockbuster to purchase
substantial quantities of DVDs with or without these arrangements.
We believe that the studios' promotion of DVDs for both sale and rental has
served to accelerate consumer interest in the format. However, it has also
served to increase competition from mass merchant retailers, as discussed under
"Cautionary Statements--Cautionary Statements Relating to Our Video Store
Business--Our Business Could be Negatively Affected by Changes in the Studios'
Pricing Policies."
International Home Video--Movies
According to Kagan, the international retail home video industry has also
significantly benefited from consumer interest in the DVD format and its
multiple language capabilities. 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 sequential
distribution windows. 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, competition in many of
our international markets tends to be more fragmented.
2
Movie Studio Dependence on the Retail Home Video Industry
According to Kagan estimates, the retail home video industry is the largest
source of U.S. revenue to U.S. movie distributors, representing about $9.3
billion, or 46.5%, of the $20.0 billion of revenue in 2001. The following table
represents Kagan's estimates of total movie distributor revenue, including
revenues from theatrical releases.
Year Ended December 31,
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1997 1998 1999 2000 2001
------- ------- ------- ------- -------
(in millions)
U.S. retail home video revenue
(rental and sale)............... $ 6,306 $ 6,811 $ 7,206 $ 8,146 $ 9,305
U.S. theatrical revenue........... 2,937 3,275 3,790 4,175 4,416
Other U.S. revenue*............... 4,456 4,792 5,339 5,767 6,293
------- ------- ------- ------- -------
Total U.S. revenue............. 13,699 14,878 16,335 18,088 20,014
------- ------- ------- ------- -------
International retail home video
revenue (rental and sale)....... $ 4,406 $ 4,436 $ 4,650 $ 4,957 $ 5,363
International theatrical revenue.. 3,289 3,684 3,608 3,464 3,325
Other international revenue*...... 4,545 5,265 5,989 6,483 7,105
------- ------- ------- ------- -------
Total international revenue.... 12,240 13,385 14,247 14,904 15,793
------- ------- ------- ------- -------
Total revenue.............. $25,939 $28,263 $30,582 $32,992 $35,807
======= ======= ======= ======= =======
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* Includes revenues from network TV and syndication, pay TV, basic cable,
pay-per-view, direct broadcast satellite, video-on-demand, and hotels and
airlines, as well as revenues from merchandise licensing.
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 VHS 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 that were not box office hits on a
rented videocassette or DVD than through most other post-theatrical
distribution channels 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 VHS and DVD
rentals encourages consumers to rent films they might not pay to view at a
theater or desire to own.
Retail Home Video Game Rental Industry
The retail home video game rental industry has traditionally been affected
by changing technology, limited hardware platform lifecycles and consumer
interest in software titles. The industry typically grows with the introduction
of new hardware platforms and games, but tends to slow prior to the
introduction of new platforms, as consumers hold back their purchases in
anticipation of new platform and game enhancements. This pattern was evidenced
over the last two years with the anticipated launches of Sony PlayStation 2 in
2000 and Nintendo GameCube and Microsoft Xbox in 2001. According to VidTrac,
domestic game rental revenues grew only 4.3% in 2000 and declined 31.0% in
2001, reflecting the impact of shortages of Sony PlayStation 2 hardware upon
its release in the fourth quarter of 2000 and delayed launches of the Nintendo
GameCube and Microsoft Xbox hardware platforms to the fourth quarter of 2001.
However, industry experts predict that the introduction of these platforms will
now contribute to a growth cycle. We believe the game rental industry will play
an important role in this growth cycle, due in part to the relatively high
purchase prices for games and hardware. Video games typically generate most of
their rental revenue during the first twelve months after their release. We
believe that during this time period, the difference between the retail price
and the rental price of a new video game is typically high enough to make
rentals an attractive alternative for customers.
3
OUR BUSINESS
Blockbuster is the world's leading provider of rentable home videocassettes,
DVDs and video games, with nearly 8,000 stores in the United States, its
territories and 26 other countries as of December 31, 2001. Our BLOCKBUSTER
brand achieves nearly 100% recognition with active movie renters in the United
States. This brand recognition and leading market position have allowed us to
create one of the strongest entertainment franchises in the United States.
During 2001, we implemented initiatives designed to strengthen our core
business, drive growth in profitability, leverage our brand and capitalize on
new revenue streams. We also continued to increase our market share of the
domestic video rental business. Reflecting these improvements, our 2001
worldwide revenues increased about 4.0% from 2000, with 80.0% of the worldwide
revenues generated in the United States and 20.0% generated outside of the
United States.
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 four consecutive years of same store revenue growth and believe that
our unique combination of core assets, such as our highly recognized global
brand, our expansive customer and store base and our substantial marketing
skills, position us for continued growth. The key elements of our business
model are discussed below.
Continued Profitable Growth in Our Core Business
During 2001, we undertook a number of key initiatives to strengthen our core
business and drive growth in profitability, including re-merchandising our
stores to capitalize on the higher margin, fast-growing DVD format and
dedicating more of our sales area to the next generation of video games and new
business initiatives.
DVD. Our goal is to exploit every opportunity to deliver increased
revenues as a result of the high-growth DVD format and to solidify our
position as the world's leading renter of DVDs. Currently, our average DVD
rental margin is higher than our average VHS rental margin.
In order to promote the DVD format, during 2001, we began selling DVD
players in our stores worldwide and introduced innovative DVD marketing
promotions, such as guaranteeing key title availability on DVD, packaging
rental cards with the purchase of a DVD player and offering DVD rental
passes. We intend to continue promoting the DVD format through direct mail,
advertising and online efforts.
Games. Our goal is to capitalize on the next generation of video games.
We believe that the introduction of three new platforms, the growing
consumer base and the multi-functionality of some of the new systems provide
a significant growth opportunity. We plan to continue to expand our copy
depth and title selection, with the goal of not only being the leading
provider of rentable games, but also becoming a leading game destination. As
the nation's leading renter of games, we believe that our brand, marketing
ability, physical store presence and extensive database will enable us to
enter into new gaming areas.
In order to increase game rental awareness in our stores, we have offered
numerous game promotions, including game rental passes, free game rentals
with proof of purchase on any new game system, and sweepstakes for new game
systems. We have also begun guaranteeing availability of selected new games.
In addition, we have begun selling games hardware in approximately 3,000 of
our U.S. stores and in some international markets.
Other Initiatives. We continue to explore other ways to maximize the use
of our store space to generate incremental profit. We have established
ourselves as one of the leading retailers of DIRECTV System equipment and
DIRECTV(R) programming packages in the United States. At the same time,
through our marketing programs, we have used this business to generate
incremental traffic to our stores. In addition, during 2001, we introduced a
third-party store-within-a-store concept in approximately 130 of our stores.
4
Although we decided not to proceed with a national roll-out of the concept,
we were able to evaluate customer receptiveness to a consumer entertainment
products offering. As a result of this evaluation and our experience with
sales of DVD players and other consumer entertainment products, we are
developing a plan to offer an assortment of consumer entertainment products
that complement our core business, leverage the use of our store space and
require minimal capital investment.
Disciplined Store Growth
Our expansive store presence, strong market share and customer transaction
and real estate databases enable us to grow 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 databases allow
our 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.
Leveraging of Our Core Assets
We have attained a strong store presence throughout the United States, with
an estimated 64% of the U.S. population living within a ten-minute drive of one
of our stores. 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. During 2001, we established our
brand in the pay-per-view business when we began co-branding pay-per-view movie
channels on DIRECTV. We intend to continue to leverage 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.
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. 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.
We also offer a broad selection of time-tested popular movies, or "BLOCKBUSTER
FAVORITES," and a wide variety of independent movies. In response to consumer
demand, during 2001, we re-merchandised our stores to accommodate an expanded
DVD selection. DVD rental revenues represented 18.5% of our rental revenues in
2001, compared to 6.9% in 2000, and increased to 23.4% of our rental revenues
in the fourth quarter of 2001. We also expanded our quantity and selection of
games. Game rental revenues represented 10.6% of our rental revenues in 2001,
compared to 11.6% in 2000, but increased to 11.7% of our rental revenues in the
fourth quarter of 2001. We expect DVD and game rental revenues to contribute to
revenue growth and increase as a percentage of our overall rental revenues.
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 rented movies for sale and replace them with movies that we believe
our customers are more interested in renting. We also sell some previously
rented new release movies.
5
We rent video games for use with Sony PlayStation and PlayStation 2,
Nintendo 64, Microsoft Xbox, Nintendo GameCube and Game Boy Advance 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 rented video
games. In addition, we sell new video games in most of our stores in markets
outside of the United States and anticipate selling new games domestically
later this year. We also rent video game consoles, as well as DVD players, in
most of our domestic company-operated stores and sell other complementary
products. In addition, during 2001, we began selling DVD players in stores
worldwide.
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
markets in which we already have a significant presence, as discussed under
"--International Operations," below. In addition, we plan to add franchise
and/or 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 concentration 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 2001, we opened 277 company-operated stores
(including 181 domestically and 96 internationally) and closed or sold 119
company-operated stores (including 61 domestically and 58 internationally), for
a net addition of 158 company-operated stores worldwide. We also opened or
purchased 178 franchise or joint venture stores (including 88 domestically and
90 internationally) and closed or sold 32 franchise or joint venture stores
(including 25 domestically and 7 internationally), for a net addition of 146
franchise and joint venture stores worldwide. Overall, domestically and
internationally, we had a net addition of 304 stores.
Store Format. We seek to place stores in locations 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 and real estate databases 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 may vary depending on the
franchise but, generally, the franchisees follow corporate store hours. Our
U.S. stores employ an average of 14 people, including two assistant store
managers and one store manager. International store operations vary by country.
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Store Locations. At December 31, 2001, in the United States and its
territories, we operated 4,393 stores and our franchisees operated 981 stores.
The following map sets forth the number of domestic stores we operated,
including stores operated by our franchisees, as of December 31, 2001.
[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 STORES
- ------------------------------------------------------- ---------
ALABAMA ..................................................... 64
ALASKA ...................................................... 16
ARIZONA ..................................................... 120
ARKANSAS .................................................... 21
CALIFORNIA .................................................. 668
COLORADO .................................................... 122
CONNECTICUT ................................................. 57
DELAWARE .................................................... 12
DISTRICT OF COLUMBIA ........................................ 7
FLORIDA ..................................................... 393
GEORGIA ..................................................... 186
HAWAII ...................................................... 22
IDAHO ....................................................... 12
ILLINOIS .................................................... 251
INDIANA ..................................................... 103
IOWA ........................................................ 27
KANSAS ...................................................... 57
KENTUCKY .................................................... 71
LOUISIANA ................................................... 81
MAINE ....................................................... 5
MARYLAND .................................................... 134
MASSACHUSETTS ............................................... 123
MICHIGAN .................................................... 176
MINNESOTA ................................................... 58
MISSISSIPPI ................................................. 41
MISSOURI .................................................... 103
MONTANA ..................................................... 11
NEBRASKA .................................................... 32
NEW HAMPSHIRE ............................................... 19
NEW JERSEY .................................................. 135
NEW MEXICO .................................................. 31
NEW YORK .................................................... 278
NEVADA ...................................................... 55
NORTH CAROLINA .............................................. 124
NORTH DAKOTA ................................................ 6
OHIO ........................................................ 182
OKLAHOMA .................................................... 69
OREGON ...................................................... 96
PENNSYLVANIA ................................................ 193
PUERTO RICO ................................................. 39
RHODE ISLAND ................................................ 26
SOUTH CAROLINA .............................................. 71
SOUTH DAKOTA ................................................ 8
TENNESSEE ................................................... 92
TEXAS ....................................................... 536
UTAH ........................................................ 55
VERMONT ..................................................... 5
VIRGINIA .................................................... 132
VIRGIN ISLANDS .............................................. 2
WASHINGTON .................................................. 142
WEST VIRGINIA ............................................... 17
WISCONSIN ................................................... 79
WYOMING ..................................................... 6
GUAM ........................................................ 3]
7
At December 31, 2001, outside of the United States, we operated 2,019
stores, and our franchisees and joint venture in which we own a minority
interest operated 588 stores. The following table sets forth, by country, the
number of stores operated by us and stores operated by our franchisees and
joint venture as of December 31, 2001.
Number of
Number of Franchised and/or
Company-Operated Joint Venture
COUNTRY (1) Stores Stores Total(1)(2)
- ----------- ---------------- ----------------- -----------
Great Britain.................................... 678 -- 678
Canada........................................... 361 -- 361
Australia........................................ 127 145 272
Mexico........................................... 224 5 229
Ireland (Republic) and Northern Ireland.......... 203 -- 203
Italy............................................ -- 182 182
Spain............................................ 108 7 115
Taiwan........................................... 80 21 101
Brazil........................................... -- 84 84
Argentina........................................ 81 1 82
Chile............................................ 73 -- 73
Denmark.......................................... 60 -- 60
Thailand......................................... -- 24 24
New Zealand...................................... -- 23 23
China (Hong Kong)................................ 21 -- 21
Portugal......................................... -- 18 18
Colombia......................................... -- 14 14
Venezuela........................................ -- 14 14
Israel........................................... -- 13 13
Panama........................................... -- 10 10
Peru............................................. -- 10 10
El Salvador...................................... -- 8 8
Ecuador.......................................... -- 5 5
Guatemala........................................ -- 3 3
Uruguay.......................................... 3 -- 3
Costa Rica....................................... -- 1 1
----- --- -----
International Store Total........................ 2,019 588 2,607
===== === =====
- --------
(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, 2001,
there were 96 video vending machines in Great Britain and Spain.
Marketing and Advertising
We design our marketing and advertising campaigns to take advantage of
opportunities in the marketplace, thereby maximizing 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 marketing and advertising campaigns 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;
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. local demographics; and
. other local competitive issues.
This enables us to focus our resources in areas that generate the best
return on investment. In addition, our large store base and leading brand
awareness allow us to implement programs such as BLOCKBUSTER REWARDS,
BLOCKBUSTER GIFTCARDS, cross-promotional marketing programs and national
promotional events.
Worldwide, in the year ended December 31, 2001, we incurred $220.4 million
in advertising expenses, which includes $172.2 million in the United States and
$48.2 million internationally. In addition, some of our business alliances,
including the studios, allow us to direct a significant amount of their home
video 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, 2001, our franchisees operated 981 stores in
the United States and our franchisees and joint venture in which we own a
minority interest operated 588 stores internationally. Our franchisees
generally are responsible for obtaining their own supplies and coordinating
their own distribution system unless they participate under our U.S. VHS
revenue-sharing arrangements. Accordingly, the franchisees participating in a
U.S. VHS revenue-sharing arrangement may rely upon our distribution center to
receive some portion of their VHS products.
Under our current U.S. franchising program, we enter into a development
agreement and subsequent franchise agreement(s) 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, among other things, maintenance of our proprietary
software. In addition, we provide optional programs and 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 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 provider of rentable home movies and video
games. As of December 31, 2001, we had 2,607 stores operating under the
BLOCKBUSTER brand and other brand names owned by us located throughout 26
markets outside of the United States. Of these stores, 588 were operated
through our franchisees and our joint venture in which we own a minority
interest. In 2001, 20.0% of our worldwide revenues were generated outside the
United States, compared to 19.3% in 2000 and 19.4% in 1999. During 2001, we
expanded our presence in Central America through franchising arrangements in
Costa Rica and Guatemala. We expect our international store growth over the
next several years to approach our domestic store growth.
Our global presence allows us to capitalize on opportunities worldwide, as
we continue to extend our U.S. concepts to our international markets. We
believe this gives us an advantage over competitors that are solely
9
dependent on their domestic business. During 2001, our international business
continued to grow, with Canada, Ireland, the United Kingdom and Mexico
accomplishing double digit or near double digit same store revenue growth. We
intend to focus our store growth in these major markets. As with our U.S.
operations, we are also implementing initiatives designed to increase existing
store profitability.
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.
Blockbuster.com
Our primary focus for blockbuster.com is to support our stores and drive
store revenues through promotional offers. During 2001, we reduced the site's
e-commerce offerings and instead focused on other features such as:
. 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.
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 and Purchasing Arrangements
The following is a description of the suppliers to our domestic
company-operated and franchised stores and our purchasing arrangements. Our
international stores are supplied by a variety of suppliers.
Company-Operated Stores. Our U.S. company-operated stores receive a
substantial portion of their VHS rental product under our revenue-sharing
arrangements. For titles acquired under our U.S. VHS revenue-sharing
arrangements, we share an agreed upon percentage of our U.S. VHS rental
revenues with the studios for a limited period of time, generally 26 weeks, in
exchange for minimal fixed payments. This percentage may decline over a period
of weeks following the initial release of the movie. In addition to this
revenue-sharing component, common to each arrangement is some provision for the
disposition of the VHS products at the conclusion of the rental period. This
may involve sale of the product by us as a previously rented videotape, return
of the videotape to the studio, destruction of the videotape, or some
combination of these elements. In addition, we may be required to purchase a
minimum amount of a studio's output. Because VHS rental product that is not
subject to revenue-sharing is typically released to video retailers at higher
wholesale prices, revenue-sharing enables us to substantially increase the
quantity and selection of newly released VHS titles that we would otherwise be
able to stock. Most of the international countries in which we operate have
different systems of supply and distribution of movie titles. VHS
revenue-sharing arrangements are not as significant to our business as they
have been historically, due to the increasing importance of DVD product to our
business.
Historically, we have typically purchased DVDs directly from the studios
through normal purchasing arrangements due to their lower sell-through pricing;
however, we have begun purchasing some DVD product through revenue-sharing
arrangements.
We purchase our video game hardware and software, as well our VCRs, DVD
players and other complementary products, from a variety of suppliers.
10
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 our VHS revenue-sharing arrangements, the franchisee may obtain
that movie from us. During 2001, some of our franchisees also began
participating in our DIRECTV offering.
Distribution and Inventory Management
We receive substantially all of our movies and video games at our 850,000
square foot state-of-the-art distribution center in McKinney, Texas. The
distribution center is a highly automated, centralized facility that we use to
mechanically repackage newly released movies to make them suitable for rental
at our stores. We also use our distribution center to restock products and
process returns, as well as to provide some office space. We use a network of
third-party delivery agents for delivery of products to our U.S. stores. We
ship our products to these delivery agents, located strategically throughout
the United States, which in turn deliver them to our stores.
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, 2001, we employed about 850 employees at our
distribution center.
Franchisees generally obtain their products directly from their suppliers,
except for some 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.
All of our U.S. company-operated stores and franchisees use our
point-of-sale system and most of our international stores use our point-of-sale
system. Our national point-of-sale system in the United States is linked with a
data center 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 domestic 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 data center and the customer transaction database.
Competition
We operate in a highly competitive environment. We believe our most
significant competition comes from (a) video stores and other retailers that
rent or sell movies and (b) providers of direct delivery home viewing
entertainment.
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;
11
. toy and entertainment retailers;
. supermarkets, pharmacies and convenience stores; and
. Internet sites.
We believe that the principal factors we face in competing with video stores
are:
. convenience and visibility of store locations;
. quality, quantity and variety of titles in the desired format;
. pricing; and
. customer service.
As discussed under "Cautionary Statements--Cautionary Statements Relating to
Our Video Store Business--Our Business Could be Negatively Affected by Changes
in the Studios' Pricing Policies," the studios' promotion of DVDs for both sale
and rental has served to increase competition from mass merchant retailers.
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 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, we
have entered the direct broadcast satellite market through our alliance with
DIRECTV and have tested an entertainment-on-demand service. Further growth in
the direct broadcast satellite and digital cable subscriber bases could cause a
smaller number of movies to be rented if viewers were to favor the expanded
number of conventional channels and expanded programming, including sporting
events, offered through these services. Direct broadcast satellite, digital
cable and "traditional" cable providers not only offer numerous channels of
conventional television, they also offer pay-per-view movies, which permit a
subscriber to pay a fee to see a selected movie, and other specialized movie
services. See "Cautionary Statements--Cautionary Statements Relating to Our
Video Store Business--The widespread availability of additional channels on
satellite and digital cable systems may significantly reduce public demand for
our products."
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 to each prospective franchisee a current
12
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;
. 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 our customer transaction 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, and 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.
13
Historical Information
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. As of
March 8, 2002, Viacom, through its ownership of 144 million shares of our class
B common stock, owned common stock representing about 81% of our equity value
and about 95% of the combined voting power of our outstanding common stock.
Intellectual Property
We own, or have applications pending with respect to, various trademarks,
trade names and service marks, including, among others, BLOCKBUSTER(R),
BLOCKBUSTER VIDEO(R), BLOCKBUSTER FAVORITES(R), BLOCKBUSTER GIFTCARD(R),
BLOCKBUSTER GIFTCARDS(TM), BLOCKBUSTER REWARDS(R), blockbuster.com(R),
BLOCKBUSTER PRE-VIEWED(R), BRINGING ENTERTAINMENT HOME(R), THE GIFT OF
ENTERTAINMENT(R), KIDPRINT(R), MAKE IT A BLOCKBUSTER NIGHT(R), QUIK DROP(R),
XTRA-VISION(R), our Torn 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.
Employees
As of December 31, 2001, we employed about 89,100 persons, including about
65,100 persons employed within the United States and about 24,000 persons
employed outside of the United States. Of the total number of U.S. employees,
about 20,900 were full-time and about 44,200 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 8,
2002.
Name Age Position
- ---- --- --------
John F. Antioco................. 52 Chairman of the Board of Directors and Chief Executive Officer
James Notarnicola............... 50 Executive Vice President and Chief Marketing Officer
Michael K. Roemer............... 53 Executive Vice President and Chief Operations Officer, North
America Operations
Nick Shepherd................... 43 Executive Vice President, Merchandising and Chief Concept
Officer
Edward B. Stead................. 55 Executive Vice President, General Counsel and Secretary
Nigel Travis.................... 52 President and Chief Operating Officer
Dean M. Wilson.................. 44 Executive Vice President Content, Worldwide
Chris Wyatt..................... 45 Executive Vice President and President, International
Larry J. Zine................... 47 Executive Vice President, Chief Financial Officer and Chief
Administrative Officer
John F. Antioco has served as our chairman of the board of directors and
chief executive officer since 1997 and served as our president from 1997 until
September 2001. From 1996 until 1997, Mr. Antioco served as president and chief
executive officer for Taco Bell Corporation. Mr. Antioco serves as chairman of
the board of
14
directors of Main Street & Main Incorporated and, through March 31, 2002, 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.
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.
Michael K. Roemer has served as our executive vice president and chief
operations officer, North America operations, since 2001 and served as our
executive vice president and chief operations officer, USA store operations,
from December 1999 until 2001. Mr. Roemer also served as our executive vice
president, domestic video operations, from 1998 until 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. Mr. Roemer
serves on the Board of Governors for the Children's Miracle Network.
Nick Shepherd has served as our executive vice president, merchandising, and
chief concept officer since October 2001 and served as our senior vice
president and chief concept officer from April 2001 until September 2001. Mr.
Shepherd, a British national, also served as our senior vice president,
international, from 1998 until 2001 and as vice president and managing director
of our U.K. business from 1995 until 1998.
Edward B. Stead has served as our executive vice president and general
counsel since 1997 and as our secretary since 1999. Mr. Stead has also served
as our executive vice president, business development, since September 2001.
From 1988 until 1996, Mr. Stead served in various capacities with Apple
Computer, Inc., including senior vice president, general counsel and secretary.
Mr. Stead is a member of the legal advisory board of the New York Stock
Exchange.
Nigel Travis has served as our president and chief operating officer since
September 2001 and served as our executive vice president and president,
worldwide stores division, from December 1999 until 2001. Mr. Travis served as
our executive vice president and president, worldwide retail operations, from
1998 until 1999 and 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. Mr. Travis, a British national,
serves as a director of The Bombay Company, Inc. and is also a director of the
Video Software Dealers Association.
Dean M. Wilson has served as our executive vice president content,
worldwide, since 2001 and served as our executive vice president and chief
merchandising officer, worldwide, from December 1999 until 2001. Mr. Wilson
served as our executive vice president, merchandising, from 1998 until 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.
Chris Wyatt has served as our executive vice president and president,
international, since October 2001 and served as our president, international,
from March 2001 until October 2001. Mr. Wyatt, a British national, served as
our senior vice president, international, from 1999 until 2001, and as our
senior vice president, international finance, from 1998 until 1999. Mr. Wyatt
also served as our finance director, Europe, from 1996 until 1998.
Larry J. Zine has served as our executive vice president and chief financial
officer since 1999 and as our chief administrative officer since September
2001. 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. Mr. Zine currently
serves as a director of Petro.
15
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 country head offices in Dublin, Ireland;
Toronto, Canada; Melbourne, Australia; Taipei, Taiwan; and Mexico City, Mexico.
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 fifteen years and provide options to renew for
between five 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 arrangements 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 arrangements with Blockbuster. These
plaintiffs sought 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. In March 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. One of the plaintiffs has voluntarily dismissed his claims, leaving
three plaintiffs in the Texas federal court action. They assert, among other
things, that Blockbuster, Viacom, and the studios conspired to fix the prices
of videos to retailers and distributors, engaged in discriminatory pricing, and
conspired to restrain competition. They are seeking triple the amount of the
alleged actual damages to themselves. In January 2001, the same plaintiffs, in
addition to other individual plaintiffs, filed a similar complaint in
California in a Los Angeles County Superior Court seeking class certification
and monetary damages. In January 2002, the California court also denied the
plaintiffs' request for class certification. 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 each 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
16
California law. The dollar amount that plaintiffs sought as damages to
themselves and those similarly situated was not set forth in the complaint. In
January 2001, the trial court judge certified a class. In January 2002, the
court entered a final order approving the parties' proposed settlement
agreement, which provides for a California state class and does not admit
liability by any party. Under the settlement, the maximum settlement amount
Blockbuster will be required to pay is $12 million.
Blockbuster is a defendant in over 23 putative class action lawsuits filed
by customers in state courts in Illinois, California, Ohio, Maryland, Texas,
New York, New Jersey, Delaware, Massachusetts, Washington, D.C., Florida and
Pennsylvania between February 1999 and December 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. In April
2001, Blockbuster reached a preliminary settlement in two of the Texas cases
which provides for a national settlement class and does not admit liability.
The Texas court signed an order approving an addendum to the settlement
agreement on May 30, 2001, and on January 22, 2002 entered a final judgment
approving the settlement. Under the approved settlement, Blockbuster will make
certificates available to class members for rentals and discounts and would pay
up to $9.25 million in attorneys' fees in connection with the settlement.
Notices of Appeal were filed by two different parties objecting to the
settlement. On April 23, 2001, an Illinois state court denied Blockbuster's
motion to stay the case before it based on the settlement in Texas. On April
25, 2001, the same Illinois state court entered a provisional order, subject to
further review and final determination, certifying plaintiff and defendant
classes in order that putative class counsel in Illinois would have an
opportunity to be heard regarding the national class settlement. On September
13, 2001, the Illinois Supreme Court denied Blockbuster's petition for leave to
appeal the Illinois trial court's denial of the motion to stay. On January 22,
2002, the plaintiffs in the Illinois action filed an amended complaint. On
February 6, 2002, Blockbuster filed a motion to dismiss the complaint.
Blockbuster believes the plaintiffs' positions in these cases are without merit
and, if the settlement reached in Texas is not approved, Blockbuster intends to
vigorously defend itself in any litigation.
We are subject to various other legal proceedings in the course of
conducting our business, including our business as a franchiser. 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.
17
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)
-------- -------- ------------
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
Cash
High Low Dividends(1)
-------- -------- ------------
Year Ended December 31, 2001
Quarter Ended March 31, 2001........ $15.1000 $ 8.1875 $0.02
Quarter Ended June 30, 2001......... $22.0000 $14.0000 $0.02
Quarter Ended September 30, 2001.... $23.1500 $15.0500 $0.02
Quarter Ended December 31, 2001..... $28.6600 $21.0000 $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 8, 2002 was 277. Viacom currently owns all of the outstanding shares of
our class B common stock and about 81% 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, 1997 through 2001 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.
18
BLOCKBUSTER SELECTED CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA
The following data should be read in conjunction with, and is qualified by
reference to, the consolidated financial statements and related notes, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this document.
Year Ended or At December 31,
---------------------------------------------------------
1997(1) 1998(2) 1999 2000(3) 2001(4)
-------- -------- -------- -------- --------
(In millions, except per share amounts and worldwide data)
Statement of Operations Data:
Revenues.............................................. $3,313.6 $3,893.4 $4,463.5 $4,960.1 $5,156.7
Operating income (loss)............................... $ (214.6) $ (359.2) $ 121.7 $ 75.7 $ (219.6)
Net loss.............................................. $ (318.2) $ (336.6) $ (69.2) $ (75.9) $ (240.3)
Net loss per share--basic and diluted(5).............. $ (2.21) $ (2.34) $ (0.44) $ (0.43) $ (1.37)
Dividends per share................................... $ -- $ -- $ 0.02 $ 0.08 $ 0.08
Weighted average shares outstanding--basic and
diluted (5)......................................... 144.0 144.0 156.1 175.0 175.6
Balance Sheet Data:
Cash and cash equivalents............................. $ 129.6 $ 99.0 $ 119.6 $ 194.2 $ 200.2
Total assets.......................................... $8,731.0 $8,274.8 $8,540.8 $8,548.9 $7,752.4
Long-term debt, including capital leases, less current
portion............................................. $ 331.3 $1,715.2 $1,138.4 $1,136.5 $ 546.4
Stockholders' equity.................................. $7,617.6 $5,637.9 $6,125.0 $6,008.4 $5,748.7
- --------
(1) During 1997, we recognized charges totaling $250 million primarily related
to merchandise 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.
(2) During 1998, we changed our method of amortizing our videocassette and
video game rental inventory. This newly adopted method represented 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 in cost of rental revenues.
Additionally, during 1998 we declared a $1.4 billion dividend payable to
Viacom International Inc., in the form of an interest-bearing promissory
note, which was paid off in 1999 with proceeds from long-term borrowings
and is reflected in long-term debt and stockholders' equity.
(3) As described in Note 3 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.
(4) As described in Notes 3 and 11 to our consolidated financial statements, in
2001 we recognized charges of $195.9 million in cost of sales, $54.5
million in incremental selling, general and administrative expenses, $2.6
million in depreciation expense and $1.9 million in equity in income (loss)
of affiliated companies related to the execution of a strategic
re-merchandising plan to allow for an expansion of store space for DVD and
other strategic product offerings. Additionally, as described in Note 4 to
our consolidated financial statements, in 2001 we changed our accounting
estimates related to our rental library. As a result of the changes in
estimate, cost of rental revenues was $141.7 million higher during 2001
then it would have been under the previous method.
(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.
19
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
Our Video Business Would Lose a Competitive Advantage if the Movie Studios Were
to Adversely Change Their Current Distribution Practices.
A competitive advantage that home video retailers currently enjoy over most
other movie distribution channels, except theatrical release, is the early
timing of the video retailer "distribution window." After the initial
theatrical release, studios make their movies available to video retailers for
specified periods of time. This distribution 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 length of this exclusive distribution window for home video
retailers varies, but has typically ranged from 45 to 60 days for domestic
video stores. Thereafter, movies are made sequentially available to television
distribution channels.
Our business could be negatively affected if:
. the video retailer distribution windows were no longer the first following
the theatrical release;
. the length of the video retailer distribution windows were shortened; or
. the video retailer distribution 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 retailer distribution window to view
a newly released movie on these other distribution channels. According to
Kagan, an increasing number of movies are being released to pay-per-view at the
shorter end of the distribution window.
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 Business Could be Negatively Affected by Changes in the Studios' Pricing
Policies.
We cannot control or predict with certainty studio pricing policies. As
discussed under "Business--Industry Overview--Domestic Home Video--Movies,"
studios have traditionally released VHS titles that they want to promote
primarily for rental at relatively high wholesale prices. The period during
which VHS titles are released at higher prices, or "rental window," has
benefited the rental industry because the prices are too high to generate
consumer demand for purchasing them.
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The studios have not created a rental window for movies released on DVD.
Rather, the studios release DVDs at lower sell-through prices, which we believe
has served to accelerate consumer interest in the format. It has also generated
higher margins for us than VHS revenue-sharing product, due to the lower cost
associated with DVDs. However, this pricing has resulted in competition from
mass merchant retailers at an earlier stage than is the case for VHS product,
as mass merchant retailers are able to purchase DVDs for sale to consumers at
the same time as video retailers purchase both DVDs and videocassettes for
rental. This has increased consumer interest in purchasing movies on DVD and
has reduced the advantage to home video retailers of the VHS rental window. We
believe the increased consumer interest is due in part to consumer interest in
building their DVD libraries of classic films and that studios will remain
dependent on the rental industry for titles that are not box office hits.
However, our business could be negatively affected if consumers desire to
purchase, rather than rent, movies. We believe our profitability could be
negatively affected if we did not derive most of our revenues from our rental
business, as our sell-through margins are generally lower than our rental
margins. Some of our competitors may sell movies at lower, or even below
wholesale, prices and/or may operate at lower margins than we do. As a result,
our U.S. sell-through business represented only 14.3% of our revenues for 2001.
If the Average Sales Price for Our Previously Rented Product is Not at or Above
an Expected Price, Our Expected Gross Margins May Be Adversely Affected.
To achieve our expected gross margins, we need to sell our previously rented
product at or above an expected price. If the average sales price of our
previously rented product is not at or above this expected price, our gross
margins may be adversely affected. At the same time, it is important that we
maximize our overall rental stream through our allocation of store space. We
may need to turn our inventory of previously rented product more quickly in the
future in order to make room in our stores for additional DVDs and other
initiatives, such as our consumer entertainment products offerings. Therefore,
we cannot assure you that in the future we will be able to sell, on average,
our previously rented product at or above the expected price.
Other factors that could affect our ability to sell our previously rented
product at expected prices include:
. consumer desire to own the particular movie; and
. the amount of previously rented product available for sale by others to
the public.
In addition, our sales of previously rented DVDs compete with sales of newly
released DVDs that are priced for sell-through.
We Are Dependent on the Introduction of New and Enhanced Game Platforms and
Software to Attract and Retain our Video Game Rental Customers
The home video game industry has traditionally been very cyclical.
Historically, the lifestyle for game platforms has been about five years, with
a limited number of platforms achieving success at any given time. The industry
typically grows with the introduction of new hardware platforms and games, but
tends to slow prior to the introduction of new platforms, as consumers hold
back their purchases in anticipation of new platform and game enhancements. Our
video games business is therefore dependent on the introduction of new and
enhanced game platforms and software in order to attract and retain our video
game customers. Delays in introduction or slower than expected hardware or
software shipments could negatively affect our 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 negative 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 home
video retailers for rental; and
21
. 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. 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 negative 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.
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 on demand with interactive capabilities such as
start, stop and rewind. In addition, some cable providers are introducing
subscription video-on-demand, which allows consumers to pay a flat fee per
month for access to a selection of content with fast-forward, stop and rewind
capabilities. 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. We have previously
tested an 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 negative
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 home video retailers 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.
22
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.
We have added an expanded selection of products and services in our stores
such as DIRECTV and consumer electronics. 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.
Newly Opened Stores May Adversely Affect the Profitability of Pre-existing
Stores.
We expect to open smaller company-operated stores in markets where we
already have significant operations in order to maximize our market share
within these markets. Although we have a customized store development approach,
we cannot assure you that these smaller newly opened stores will not adversely
affect the revenues and profitability of those pre-existing stores in any given
market.
We May Be Liable for Lease Payments Related to BLOCKBUSTER MUSIC Stores.
In October 1998, about 380 BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. If
Wherehouse defaults with respect to these leases, related losses could
adversely affect our future operating income because we have agreed to
indemnify Viacom with respect to any amount paid under these guarantees. We
estimate that, as of the time of the sale to Wherehouse, we were contingently
liable for about $84 million with respect to base rent for the remaining
initial terms 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. Certain leases may
be extended beyond the initial term and remain subject to the guarantee. We are
therefore dependent upon Wherehouse's ability to satisfy the terms and
conditions of the leases, which is based in part upon the overall financial
condition of Wherehouse. Adverse changes in the financial condition of
Wherehouse would increase the risk that we would be required to honor the
guarantees. We have not recognized 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 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 movies and other products to our stores.
As a Participant in the Retail 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. The international home video and
video game industry varies from country to country due to, among other things,
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
23
practices, franchising and taxation, and format and technical standards.
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 RELATIONSHIP WITH VIACOM
We Will Be Controlled by Viacom As Long as It Owns a Majority of the Combined
Voting Power of Our Two Classes of Common Stock, and Our Other Stockholders
Will Be Unable to Affect the Outcome of Stockholder Voting During This Time.
We are currently controlled by Viacom. We have two classes of common stock:
. class A common stock, which entitles the holder to one vote per share; and
. class B common stock, which entitles the holder to five votes per share,
on all matters submitted to our stockholders. Viacom owns in excess of a
majority of the combined voting power of our outstanding common stock. As a
result, Viacom is able to determine the outcome of all corporate actions
requiring stockholder approval. Because Viacom has the ability to control us,
it has the power to act without taking the best interests of our 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 effect 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, the acquisition of movies from Paramount Pictures Corporation, an
indirect subsidiary of Viacom, Viacom's control of our tax matters for
years in which we are consolidated with Viacom for tax purposes and the
agreements between Viacom and us that would apply in the event we are
split off from Viacom;
. 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.
24
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.
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.
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 appearing elsewhere in this
document.
General
Blockbuster Inc. is the world's leading provider of rentable home
videocassettes, DVDs and video games, with nearly 8,000 stores in the United
States, its territories and 26 other countries as of December 31, 2001. We
25
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. During 2001, we implemented a number of key initiatives to
strengthen our core business and drive growth in profitability, while
continuing to make progress with initiatives designed to strengthen and
leverage our brand and capitalize on new revenue streams.
Our business during 2001 was impacted by trends in the DVD and games
industries. According to Kagan estimates, the number of U.S. DVD households
nearly doubled during 2001. In addition, DVD was officially declared the
fastest growing consumer electronics device in the history of consumer
electronics by the Consumer Electronics Association. The continuing trend with
respect to the DVD format translated into significant growth in our DVD rental
business during 2001. During the fourth quarter of 2000, DVD rental revenues
were 9.5% of total rental revenues. By the fourth quarter of 2001, DVD rental
revenues had increased to 23.4% of total rental revenues. We expect that the
DVD format will continue to gain market acceptance, and that the industry trend
will continue to positively impact our DVD rental revenues, as we believe that
DVD will follow the historical pattern of VHS and increasingly become a rental
format. The retail home video game rental industry has traditionally been
affected by changing technology, limited hardware platform lifecycles and
consumer interest in software titles. The introduction of three new game
platforms began to have an impact on our game rental revenues in the fourth
quarter of 2001. Game rentals at the end of 2001 increased significantly from
2000, driven by rentals of Nintendo GameCube, Microsoft Xbox and Sony
PlayStation 2 games. We expect the new game platforms to continue to have a
positive impact on our game rental revenues; however, we expect revenues
generated by older game platforms to decline, as the newer platforms support
games that generally have much better graphics and functionality than the
previous generation of games. Overall, we expect game rental revenues, which
were 10.6% of our total rental revenues during 2001, to contribute to revenue
growth and grow as a percentage of rental revenue during 2002.
During 2001, to capitalize on the higher margin and rapidly growing DVD
rental format, as well as the opportunities provided by new game platforms and
other strategic product offerings, we completed a re-merchandising of our
stores. The re-merchandising plan included an expansion in DVD copy depth and
selection and a reconfiguration of our stores to highlight the digital format,
as well as other strategic product offerings. To accommodate the increase in
DVDs and other products in our stores, we disposed of approximately 30% of our
VHS rental library in our stores, certain VHS merchandise inventory primarily
located in our distribution center and certain games from our rental library in
our stores. This initiative was designed to maintain customer satisfaction and
is intended to solidify our DVD leadership position. In addition, we believe
our overall rental margins should be enhanced by this plan, as currently, our
average DVD rental margin is higher than our average VHS rental margin.
Currently, we purchase the majority of our DVDs under a sell-through pricing
model. However, we are also currently purchasing some DVDs pursuant to DVD
revenue-sharing arrangements, and we may enter into additional revenue-sharing
arrangements during 2002. If more of our DVDs are purchased under
revenue-sharing arrangements, we expect that our DVD rental revenues and gross
profit would continue to increase, while our DVD rental gross margin would
decline. With our anticipated growth in DVD rental revenues as a percentage of
total rental revenues, we expect VHS rental revenues to decline as a percentage
of total rental revenues. We continually evaluate our product mix in our stores
in order to optimize revenues and gross profits from our stores.
We continue to explore other ways to maximize the use of our store space to
generate incremental profit. We have established ourselves as one of the
leading retailers of DIRECTV System equipment and DIRECTV(R) programming
packages in the United States. At the same time, through our marketing
programs, we have used this business to generate traffic in our stores. In
addition, during 2001, we introduced a third party store-within-a-store concept
in approximately 130 of our stores. Although we decided not to proceed with a
national rollout of the concept, we were able to evaluate customer
receptiveness to a consumer electronics offering. As a result of this
evaluation and our experience with sales of DVD players and other entertainment
products, we are developing a plan to offer an assortment of consumer
entertainment products that complement our core business, leverage the use of
our store space and require minimal capital investment.
26
Critical Accounting Policies
The preparation of our consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires us to
make estimates and judgments that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the
balance sheet date, as well as the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, we evaluate our estimates,
including those related to the revenues generated by customer programs and
incentives, revenues generated by multiple-element transactions, useful lives
and residual values of our rental library, accruals related to revenue-sharing
titles subject to performance guarantees, merchandise inventory reserves,
income taxes, impairment of our long-lived assets and contingencies. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from these estimates under different assumptions or conditions.
Our accounting policies are generally straightforward. We believe the
following accounting policies, among others, require our more significant
judgments and estimates:
. Rental revenues and merchandise sales are generally recognized at the time
of rental or sale. Rental revenues are generated from the rental of VHS
tapes, DVDs, video games and from any eventual sale of previously rented
VHS tapes, DVDs and video games. Revenues generated from rental
transactions include revenues received in connection with the initial
rentals of product, as well as revenues received in connection with any
continuations of such rentals past the initial rental period, as
contemplated by our membership agreement. Under our convenience policy,
which we implemented in February 2000, a customer pays for the initial
rental at the time the product is rented and agrees to pay for any
continuation of the rental beyond the initial rental period. Generally,
when a customer elects to keep rental product beyond the initial rental
period, the customer's rental is successively continued for the same
number of days and at the same price as the initial rental period, until
such point as the product is purchased under the terms of the membership
agreement or is returned.
We have agreements with certain companies that allow these companies to
purchase free rental cards from us, which can then be awarded at their
discretion. We analyze our historical redemption rates for similar award
programs as a basis for the estimate of the rentals that will not be
redeemed on a program- by-program basis. We defer revenue for the
estimated number of free rental cards that will ultimately be redeemed and
recognize the amount deferred as revenue upon redemption. Revenue for
estimated non-redemptions are generally recognized when the cards are
issued. If the actual number of free rentals redeemed is significantly
different than our estimate, an adjustment to the revenue recorded may be
required.
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 membership period.
From time to time, we sell multiple goods and or services as a bundled
package. We allocate revenue under such arrangements based on the fair
value of each element, to the extent objectively determinable, and
recognize revenue upon delivery or consummation of the separable earnings
process attributable to each element.
. We amortize the cost of our rental library, which includes videocassettes,
DVDs and games, over periods ranging from three months to twelve months to
an estimated residual value ranging from $2 to $5 per unit, according to
the product category. We continually evaluate the estimates surrounding
the useful lives and residual values used in amortizing our rental
library. Changes to these estimates resulting from changes in consumer
demand may impact the carrying value of our rental library and our rental
margins.
27
For instance, during the current year, consumers increased their rentals
of DVDs while their demand for VHS rental product declined. In addition,
new game platforms made games formatted for older game platforms obsolete.
As a result, we shifted our product mix within our stores toward a much
higher proportion of DVDs, while we reduced the proportion of VHS product.
We also shifted our mix of game products by increasing the proportion of
games made for newer game platforms and decreasing the proportion of games
made for older game platforms. Accordingly, and as discussed below in
Notes 3 and 4 to our consolidated financial statements, we changed our
estimates regarding useful lives and residual values for VHS products and
game products, which resulted in increased amortization expense during
2001.
. The costs of rental product purchased pursuant to revenue-sharing
arrangements typically include a lower initial product cost and a
percentage of the net rental revenues to be shared with the studios over
an agreed period of time. Additionally, certain titles have performance
guarantees. The up-front costs are amortized on an accelerated basis and
revenue-sharing payments pursuant to the applicable arrangement are
expensed as the related revenue is earned. We analyze titles that are
subject to performance guarantees and recognize an estimated expense for
under-performing titles throughout the applicable period based upon our
analysis of the estimated shortfall. These estimates are revised monthly
upon actual results, which can differ from our estimates and result in an
adjustment to cost of sales.
. Our merchandise inventory is stated at the lower of cost or market. We
include an allocation of costs incurred in our distribution center to
prepare products for our stores in the cost of our merchandise inventory.
We record adjustments to the value of inventory primarily for estimated
obsolete or excess inventory equal to the difference between the carrying
value of inventory and the estimated market value based upon assumptions
about future demand and market conditions. If future demand or actual
market conditions are less favorable than those projected by management,
additional inventory adjustments may be required. Our accrual for shrink
is based on the actual historical shrink results of our most recent
physical inventories adjusted, if necessary, for current economic
conditions. These estimates are compared to actual results as physical
inventory counts are taken and reconciled to the general ledger. We have
not experienced significant fluctuations in our historical shrink rates,
however, shrink has increased with the introduction and increased demand
for DVD product. DVD product is more susceptible to shrink due to its
portability and popularity. We continue to design and implement controls
at our stores to lower our shrink results, especially in relation to our
DVD product.
. We rec