BLOCKBUSTER INC - FORM 10-Q

Attached files

file	filename
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 - BLOCKBUSTER INC	dex312.htm
EX-10.1 - AMENDED AND RESTATED EMPLOYMENT AGREEMENT - BLOCKBUSTER INC	dex101.htm
EX-32.2 - FURNISHED CERTIFICATION OF CFO PURSUANT TO SECTION 906 - BLOCKBUSTER INC	dex322.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 - BLOCKBUSTER INC	dex311.htm
EX-32.1 - FURNISHED CERTIFICATION OF CEO PURSUANT TO SECTION 906 - BLOCKBUSTER INC	dex321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 4, 2010

¨ 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

BLOCKBUSTER INC.

(Exact name of registrant as specified in its charter)

Delaware

52-1655102

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

1201 Elm Street

Dallas, Texas 75270

Telephone 214-854-3000

(Address, including zip code, and telephone number,

including area code, of registrant’s principal executive offices)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No x

Number of shares of common stock outstanding at August 6, 2010:

Class A common stock, par value $.01 per share: 146,761,668

Class B common stock, par value $.01 per share: 72,000,000

BLOCKBUSTER INC.

INDEX TO FORM 10-Q


		Page
	PART I—FINANCIAL INFORMATION

Item 1.	Financial Statements	3

	Consolidated Statements of Operations (Unaudited)—Thirteen and Twenty-Six Weeks Ended July 4, 2010 and July 5, 2009	3

	Consolidated Balance Sheets (Unaudited)—July 4, 2010 and January 3, 2010	4

	Consolidated Statements of Cash Flows (Unaudited)—Twenty-Six Weeks Ended July 4, 2010 and July 5, 2009	5

	Notes to Consolidated Financial Statements (Unaudited)	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	29

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	59

Item 4.	Controls and Procedures	60

	PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	61

Item 1A.	Risk Factors	61

Item 3.	Defaults Upon Senior Securities	62

Item 6.	Exhibits	63

PART I—FINANCIAL INFORMATION

Item 1.

Financial Statements

BLOCKBUSTER INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In millions, except per share amounts)


	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009			July 4, 2010			July 5, 2009
Revenues:
Base rental revenues	$	510.0		$	638.2		$	1,108.7		$	1,343.1
Previously rented product (“PRP”) revenues		96.3			133.5			217.2			271.8

Total rental revenues		606.3			771.7			1,325.9			1,614.9
Merchandise sales		177.6			204.9			392.7			441.6
Other revenues		4.4			5.2			9.1			11.2

		788.3			981.8			1,727.7			2,067.7

Cost of sales:
Cost of rental revenues		224.5			280.9			494.6			590.8
Cost of merchandise sold		132.2			158.0			299.3			360.7

Total cost of sales		356.7			438.9			793.9			951.5

Gross profit		431.6			542.9			933.8			1,116.2

Operating expenses:
General and administrative		433.5			487.3			917.9			965.2
Advertising		9.3			24.6			30.3			36.1
Depreciation and intangible amortization		26.5			32.6			52.7			66.3

		469.3			544.5			1,000.9			1,067.6

Operating income (loss)		(37.7	)		(1.6	)		(67.1	)		48.6
Interest expense		(32.1	)		(28.8	)		(65.3	)		(46.3	)
Interest income		0.1			0.8			0.1			1.0
Other items, net		0.7			(5.7	)		(0.9	)		(6.5	)

Income (loss) from continuing operations before income taxes		(69.0	)		(35.3	)		(133.2	)		(3.2	)
Benefit (provision) for income taxes		0.6			(1.4	)		(0.5	)		(6.9	)

Income (loss) from continuing operations		(68.4	)		(36.7	)		(133.7	)		(10.1	)
Income (loss) from discontinued operations, net of tax		(0.3	)		(0.2	)		(0.4	)		0.9

Net income (loss)		(68.7	)		(36.9	)		(134.1	)		(9.2	)
Preferred stock dividends		(0.6	)		(2.8	)		(2.3	)		(5.6	)

Net income (loss) applicable to common stockholders	$	(69.3	)	$	(39.7	)	$	(136.4	)	$	(14.8	)

Net income (loss) per common share:
Basic and diluted
Continuing operations	$	(0.32	)	$	(0.21	)	$	(0.65	)	$	(0.08	)
Discontinued operations		—			—			—			—

Net income (loss)	$	(0.32	)	$	(0.21	)	$	(0.65	)	$	(0.08	)

Weighted-average common shares outstanding:
Basic and diluted		217.7			193.6			210.3			193.2

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

BLOCKBUSTER INC.

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In millions, except per share amounts)


	July 4, 2010			January 3, 2010
Assets
Current assets:
Cash and cash equivalents	$	64.3		$	188.7
Receivables, less allowances of $4.8 and $6.0 for 2010 and 2009, respectively		55.0			79.4
Merchandise inventories		222.4			298.5
Rental library, net		286.7			340.7
Deferred income taxes		13.6			13.6
Prepaid and other current assets		149.8			139.1

Total current assets		791.8			1,060.0
Property and equipment, net		208.5			249.4
Deferred income taxes		94.8			114.6
Intangibles, net		6.5			7.7
Restricted cash		35.6			58.5
Other assets		18.7			48.1

	$	1,155.9		$	1,538.3

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	160.5		$	300.8
Accrued expenses		377.6			407.7
Current portion of long-term debt		598.2			101.6
Current portion of capital lease obligations		5.3			6.1
Deferred income taxes		98.8			118.6

Total current liabilities		1,240.4			934.8
Long-term debt, less current portion		300.0			836.0
Capital lease obligations, less current portion		16.9			19.9
Other liabilities		49.4			61.9

		1,606.7			1,852.6

Commitments and contingencies (Note 5)
Stockholders’ equity (deficit):
Preferred stock, par value $0.01 per share; 100 shares authorized; 0.032 and 0.146 shares issued and outstanding for 2010 and 2009, respectively, with a liquidation preference of $1,000 per share		31.9			145.9
Class A common stock, par value $0.01 per share; 400 shares authorized; 146.8 and 122.4 shares issued and outstanding for 2010 and 2009		1.5			1.3
Class B common stock, par value $0.01 per share; 500 shares authorized; 72.0 shares issued and outstanding for 2010 and 2009		0.7			0.7
Additional paid-in capital		5,496.8			5,377.0
Accumulated deficit		(5,921.0	)		(5,786.9	)
Accumulated other comprehensive loss		(60.7	)		(52.3	)

Total stockholders’ equity (deficit)		(450.8	)		(314.3	)

	$	1,155.9		$	1,538.3

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

BLOCKBUSTER INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In millions)


	Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009
Cash flows from operating activities:
Net income (loss)	$	(134.1	)	$	(9.2	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and intangible amortization		52.7			68.6
Rental library purchases		(194.9	)		(226.4	)
Rental library amortization		248.0			253.2
Non-cash share-based compensation		0.7			4.4
Deferred taxes and other		7.9			7.9
Changes in operating assets and liabilities:
Change in receivables		23.3			52.8
Change in merchandise inventories		69.0			140.0
Change in prepaid and other assets		13.1			38.7
Change in accounts payable		(135.9	)		(179.7	)
Change in accrued expenses and other liabilities		(37.4	)		(123.3	)

Net cash provided by (used in) operating activities		(87.6	)		27.0

Cash flows from investing activities:
Capital expenditures		(10.6	)		(14.0	)
Change in restricted cash		22.9			(123.9	)
Other investing activities		1.0			0.7

Net cash provided by (used in) investing activities		13.3			(137.2	)

Cash flows from financing activities:
Proceeds from credit agreement		—			381.4
Repayments on credit agreement		—			(281.1	)
Repayments on senior secured notes		(45.0	)		—
Cash dividends on preferred stock		—			(2.8	)
Debt financing costs		—			(40.3	)
Capital lease payments		(2.9	)		(4.2	)

Net cash provided by (used in) financing activities		(47.9	)		53.0

Effect of exchange rate changes on cash		(2.2	)		1.3

Net decrease in cash and cash equivalents		(124.4	)		(55.9	)
Cash and cash equivalents at beginning of period		188.7			154.9

Cash and cash equivalents at end of period	$	64.3		$	99.0

Supplemental cash flow information:
Cash payments for interest	$	57.0		$	36.4
Cash payments for income taxes	$	7.0		$	14.2

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Note 1—Basis of Presentation

Blockbuster Inc. and its subsidiaries (“Blockbuster,” “we,” “us” or “our”) primarily operate and franchise entertainment-related stores in the United States and a number of other countries. We offer movies and video games for in-store rental, sale and trade and sell other entertainment-related merchandise. We also offer an online service of rental and sale of movies delivered by mail, digital delivery through blockbuster.com and BLOCKBUSTER On Demand and physical delivery through vending kiosks.

We operate our business in two segments. The Domestic segment consists primarily of all U.S. store operations and by-mail subscription service operations, as well as vending kiosks and the digital delivery of movies through blockbuster.com and other electronic devices. The International segment is comprised of all non-U.S. store operations, including operations in Europe, Latin America, Australia, Canada, Mexico and Asia.

In the opinion of management, the accompanying unaudited consolidated financial statements include all recurring adjustments and normal accruals necessary for a fair statement of our financial position and our results of operations and cash flows for the dates and periods presented. Results for interim periods are not necessarily indicative of the results to be expected during the remainder of the current year or for any future period. All significant intercompany accounts and transactions have been eliminated in consolidation.

We incurred a net loss from operations for the twenty-six weeks and fiscal year ended July 4, 2010 and January 3, 2010, respectively, had negative working capital as of July 4, 2010, and had a stockholders’ deficit as of July 4, 2010 and January 3, 2010. In addition, the increasingly competitive industry conditions under which we operate have negatively impacted our results of operations and cash flows and may continue to do so in the future. These factors raise substantial doubt about our ability to continue as a going concern. The accompanying unaudited financial statements have been prepared on the basis of accounting principles applicable to a going concern, which contemplates the realization of assets and extinguishment of liabilities in the normal course of business.

These unaudited consolidated financial statements should be read in conjunction with the more detailed audited consolidated financial statements for the fiscal year ended January 3, 2010, included in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”). Accounting policies used in the preparation of these unaudited consolidated financial statements are consistent in all material respects with the accounting policies described in the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K.

Fair Value of Financial Instruments

At July 4, 2010, our carrying value of financial instruments approximated fair value except for our $300.0 million aggregate principal amount of 9% senior subordinated notes due 2012 (the “Senior Subordinated Notes”) and our 11.75% senior secured notes due 2014 (the “Senior Secured Notes” or the “Notes”). The estimated fair values of our Senior Subordinated Notes and Senior Secured Notes at July 4, 2010 and January 3, 2010, are based on trading activity in active markets.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

A summary of the carrying values and the fair values of our Senior Secured Notes and our Senior Subordinated Notes is as follows:


	July 4, 2010						January 3, 2010
	Principal Amount		Carrying Value		Fair Value		Principal Amount		Carrying Value		Fair Value
Senior Secured Notes	$	630.0	$	598.2	$	400.1	$	675.0	$	637.6	$	641.3
Senior Subordinated Notes	$	300.0	$	300.0	$	19.1	$	300.0	$	300.0	$	168.0

Year-to-date in fiscal 2010 and 2009, no financial instruments were held or issued for trading purposes.

Store Closures

As of July 4, 2010 and January 3, 2010, the liability related to lease terminations and store closure reserves was $20.2 million and $8.1 million, respectively. We made payments of $10.4 million and $23.6 million in rent and lease termination costs during the thirteen and twenty-six weeks ended July 4, 2010, respectively. There have been no significant adjustments to previously accrued store closure costs during 2010.

The following table presents operating expenses related to store closures during the thirteen and twenty-six weeks ended July 4, 2010 and July 5, 2009:


	Thirteen Weeks Ended				Twenty-Six Weeks Ended
	July 4, 2010		July 5, 2009		July 4, 2010		July 5, 2009
Closed store accruals and lease termination costs	$	14.2	$	2.5	$	34.5	$	3.6
Accelerated depreciation		1.5		0.8		5.2		3.1

Total store closure expense	$	15.7	$	3.3	$	39.7	$	6.7

Severance Charges

The following table presents the activity in severance liability for the twenty-six weeks ended July 4, 2010 and July 5, 2009:


	Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009
Beginning balance	$	5.6		$	4.7
Expense incurred and accrued		12.3			3.7
Adjustments to accruals		(0.6	)		(0.4	)
Amount paid		(11.7	)		(5.6	)

Ending balance	$	5.6		$	2.4

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Comprehensive Income (Loss)

Comprehensive income (loss) for the thirteen and twenty-six weeks ended July 4, 2010 and July 5, 2009 was as follows:


	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009			July 4, 2010			July 5, 2009
Net income (loss)	$	(68.7	)	$	(36.9	)	$	(134.1	)	$	(9.2	)
Foreign currency translation adjustment, net of tax		(11.2	)		21.9			(8.4	)		19.8

Total comprehensive income (loss)	$	(79.9	)	$	(15.0	)	$	(142.5	)	$	10.6

Income Taxes

As of July 4, 2010 the liability for uncertain tax positions was approximately $3.0 million and is reflected in “Other liabilities” on our Consolidated Balance Sheets. If recognized, this amount would result in a positive effect on our effective tax rate.

The following is a summary of our domestic tax returns and whether or not they remain subject to the amended and restated tax matters agreement (the “Tax Matters Agreement”) with Viacom/CBS and examination by the Internal Revenue Service (“IRS”):


Jurisdiction	Tax Year(s) Ending	Open	IRS Audit Complete	Currently Being Audited	Subject to Tax Matters Agreement with Viacom/CBS
Domestic	09/30/2004 and prior	No	Yes	N/A	Yes
Domestic	12/31/2004	No	Yes	N/A	No
Domestic	12/31/2005	Yes	N/A	No	No
Domestic	12/31/2006	Yes	N/A	No	No
Domestic	12/31/2007	Yes	N/A	No	No
Domestic	12/31/2008	Yes	N/A	No	No
Domestic	12/31/2009	Yes	N/A	No	No


Jurisdictions	Closed Tax Years	Open Tax Years	Years Under Examination
Canada	2000 and prior	Post 2000	2001-2005
Italy	2004 and prior	Post 2004	N/A
Mexico	2003 and prior	Post 2003	N/A
United Kingdom	2004 and prior	Post 2004	N/A

Interest expense and penalties related to our uncertain tax positions have been reflected as a component of income tax expense in our Consolidated Statements of Operations. As of July 4, 2010, we had recorded liabilities of approximately $0.7 million associated with accrued interest and penalties related to uncertain tax positions.

Net Income (Loss) Per Share

Basic net income (loss) per share (“EPS”) is computed by dividing the net income (loss) applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted EPS adjusts the basic weighted average number of common shares outstanding by the assumed exercise of Blockbuster stock options, vesting of restricted shares and restricted share units, and shares issuable under the

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

conversion feature of our Series A convertible preferred stock, as defined below, using the if-converted method only in periods in which such effect would have been dilutive on income before cumulative effect of change in accounting principle. Options to purchase 11.4 million and 17.5 million shares of Class A common stock were outstanding as of July 4, 2010 and July 5, 2009, respectively. Additionally, 1.6 million and 1.9 million restricted shares and restricted share units that are convertible into shares of Class A common stock were outstanding as of July 4, 2010 and July 5, 2009, respectively. For the thirteen and twenty-six weeks ended July 4, 2010 and July 5, 2009, the inclusion of all stock options, all restricted shares and restricted share units and all shares of Series A convertible preferred stock would be anti-dilutive and were therefore excluded from the computation of the weighted-average shares for diluted EPS.

Our Board of Directors has determined not to declare or pay a dividend on our shares of Series A convertible preferred stock with respect to the six consecutive quarterly periods beginning on February 15, 2009 and ending on August 14, 2010. Dividends on the Series A convertible preferred stock are cumulative and began to accumulate on May 15, 2009, of which $3.1 million of accumulated dividends is recorded on our Consolidated Balance Sheets in “Accrued liabilities” as of July 4, 2010. Under Delaware law, we can only pay dividends on our shares of capital stock out of our surplus, or, if we do not have a surplus, out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. For these purposes a surplus can be defined as the excess at any given time of a company’s net assets over capital, which is the aggregate par value of the outstanding shares of capital stock. We currently have a negative surplus and have no net profits for fiscal 2009 or fiscal 2010 to date. Under Delaware law, we are unable to pay dividends on shares of our capital stock, whether in cash or in shares of common stock, for so long as such negative surplus exists or until we generate sufficient net profits.

Upon our failure to pay dividends on the Series A convertible preferred stock on six dividend payment dates (whether consecutive or not), holders of the Series A convertible preferred stock will be entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available therefore, dividends at the rate per annum equal to the stated annual dividend rate of 7 1/2% plus 1.0% on and after such sixth dividend payment date until we have paid all accumulated and unpaid dividends in full. Following such payment of unpaid dividends, the dividend rate will revert to 7 1/2% per annum; provided, however, that upon any further failure to pay dividends, the dividend rate will again increase by 1.0% to 8 1/2% per annum until we have again paid all accumulated and unpaid dividends in full. In addition, upon our failure to pay dividends for six quarterly dividend periods (whether or not consecutive), holders of the Series A convertible preferred stock who currently have very limited voting rights, will have certain additional voting rights, including the right to elect two additional directors to our Board of Directors, such additional directors to serve until we have paid all accumulated and unpaid dividends in full. In the first quarter of 2010, 74,214 shares of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 15.3 million shares of our Class A common stock. This included 0.9 million shares of our Class A common stock as settlement for accumulated dividends on the converted shares through the date of conversion. In the second quarter of 2010, an additional 39,825 shares of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 8.3 million shares of our Class A common stock. This included 0.6 million shares of our Class A common stock as settlement for accumulated dividends on the converted shares through the date of conversion.

Recent Accounting Pronouncements

In October 2009, the FASB issued guidance for multiple-deliverable revenue arrangements which eliminates the residual method of revenue allocation and requires revenue to be allocated based on an element’s estimated selling price if vendor-specific or other third party evidence of value is not available. This guidance should be

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

Note 2—Liquidity and Long-Term Debt

We generate cash from operations predominantly from the rental and retail sale of movies and games, and most of our revenue is received in cash and cash equivalents. Working capital requirements, including rental library purchases and normal capital expenditures, are generally funded with cash from operations.

On October 1, 2009, we completed the sale of $675.0 million aggregate principal amount of 11.75% Senior Secured Notes due 2014 at an issue price of 94.0%. The Notes were sold in a private offering to qualified institutional investors in accordance with Rule 144A, and to persons outside the U.S. pursuant to Regulation S under the Securities Act of 1933, as amended. The Notes are senior secured obligations and are guaranteed by our domestic subsidiaries (the “Guarantors”). The Notes and the guarantees are secured by first-priority liens on substantially all of our assets and the Guarantors’ assets.

We used substantially all of the net proceeds of the Notes to repay all indebtedness outstanding under our revolving credit facility, Term Loan B and our Canadian credit facility, as discussed below, as well as to fund fees and expenses of the transaction. We used the remaining net proceeds for general corporate purposes. For further detail on the Notes, see discussion under “Senior Secured Notes” below.

We are currently pursuing certain recapitalization opportunities with our senior secured and senior subordinated noteholders as well as other potential strategic investors intended to substantially lessen our debt obligations and provide additional capital for the ongoing operation of our business. While we pursue these recapitalization opportunities, we are operating under a cash management strategy to enhance and preserve liquidity. This ongoing cash management strategy limits many of our operational and strategic initiatives designed to grow our business over the long term. Since the end of fiscal 2009, we have successfully completed certain elements of our cash management strategy, including, among other things:

•

enhanced payment terms with several of the major studios by granting a lien on and security interest in substantially all of our Canadian assets;

•

optimized our store portfolio by closing 507 underperforming domestic company-operated stores and renegotiated leases on 673 domestic company-operated stores in the first and second quarters of 2010;

•

reduced our inventory levels for movies, games and consumer electronics;

•

eliminated our letter of credit requirements for lease guarantees;

•

implemented new movie rental terms and pricing in our domestic stores, including the March 1, 2010 implementation of a new policy in our company-operated stores, whereby an additional daily rate is charged for each day a member chooses to keep the rental following the initial rental period; and

•

reengineered our corporate, field overhead and distribution organizations and processes to increase efficiency and reduce our operating costs.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Other elements of our cash management plan that we continue to pursue include, among other things:

•

managing our working capital through optimization of inventory levels by continuing to sell underperforming rental inventory;

•

further reducing our selling, general and administrative expenses in fiscal 2010;

•

minimizing our capital expenditures by eliminating, delaying or curtailing discretionary and non-essential spending for fiscal 2010; and

•

lengthening the cycle of payables to certain vendors.

We are obligated to make the next interest payment on our Senior Subordinated Notes on September 1, 2010. However, any payment in respect of our Senior Subordinated Notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement and the Forbearing Holders will no longer be obligated to forbear from enforcing their rights and remedies in respect of the amortization and interest payment defaults and would have the ability to declare the entire amount owed under the Senior Secured Notes immediately due and payable. While we have not made a formal determination regarding the September 1, 2010 interest payment on the Senior Subordinated Notes, there is a substantial likelihood that such payment will not be made as scheduled. If we do not make the interest payment on the Senior Subordinated Notes when due and such failure is not remedied within 30 days, the holders of the Senior Subordinated Notes will have the ability to declare the entire amount owed under such notes immediately due and payable.

Debt Balances


	July 4, 2010		January 3, 2010
Current portion
Senior Secured Notes, interest rate of 11.75%	$	598.2	$	101.6
Current portion of capital lease obligations		5.3		6.1

		603.5		107.7

Non-current portion
Senior Secured Notes, interest rate of 11.75%		—		536.0
Senior Subordinated Notes, interest rate of 9.0%		300.0		300.0

Total long-term debt, less current portion		300.0		836.0
Capital lease obligations, less current portion		16.9		19.9

		316.9		855.9

Total	$	920.4	$	963.6

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

As we would not have been in compliance with the terms of the Indenture absent the Forbearance Agreement and would have been unable to comply with the terms of the original forbearance terms without the extension obtained on August 12, 2010, we have reclassified all the remaining carrying amount and debt issue costs related to the Senior Secured Notes from non-current to current as of July 4, 2010. As of July 4, 2010, unamortized debt issue costs for the Senior Secured Notes were $20.1 million and were classified as “Prepaid and other current assets.” If the Senior Secured Notes are refinanced in a transaction that is required to be accounted for as an extinguishment of debt or the outstanding balance is called by the noteholders, unamortized debt costs at the refinancing or demand date would be required to be expensed in the period of refinancing or demand.

Senior Secured Notes

As discussed above, we completed the sale of $675 million aggregate principal amount of our 11.75% Senior Secured Notes on October 1, 2009. We used substantially all of the net proceeds of the Notes to repay all indebtedness outstanding under our revolving credit facility, Term Loan B and our Canadian credit facility, as discussed below, as well as to fund fees and expenses of the transaction. We used the remaining net proceeds for general corporate purposes.

The Notes bear interest at a rate of 11.75% and mature on October 1, 2014. Interest on the Notes is payable on January 1, April 1, July 1 and October 1 of each year through maturity, beginning on January 1, 2010. As of July 4, 2010 and January 3, 2010, we had $630.0 million and $675.0 million, respectively, aggregate principal outstanding on the Notes.

The Notes were issued pursuant to an Indenture, dated as of October 1, 2009 (the “Indenture”), between Blockbuster Inc., the Guarantors and U.S. Bank National Association, as trustee. There are no maintenance covenants with respect to our financial performance. However, the Indenture does contain transaction-based restrictive covenants, including but not limited to, limitations on us and our restricted subsidiaries to:

•

sell certain assets which secure the Notes;

•

create liens on certain assets to secure debt;

•

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

•

enter into sale and leaseback transactions.

Additionally, during such time that the Notes do not receive a rating of BBB- or higher from Standard & Poor’s Rating Services (“Standard & Poor’s”) and a rating of Baa3 or higher from Moody’s Investors Service, Inc. (“Moody’s”), in each case with a stable or better outlook, the Indenture limits our ability and the ability of our restricted subsidiaries to:

•

incur additional indebtedness or issue certain preferred shares;

•

pay cash dividends, repurchase our capital stock or make other restricted payments;

•

create liens on certain assets to secure debt;

•

make certain investments;

•

make capital expenditures in excess of $70 million in fiscal 2010 and $80 million each following year through fiscal 2014;

•

agree to certain restrictions on the ability of restricted subsidiaries to make payments to us;

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

•

enter into certain transactions with our affiliates; and

•

designate our subsidiaries as Unrestricted Subsidiaries.

The downgrades in our credit ratings subject us to more restrictive covenants under the Indenture and such ratings have changed significantly during the past six months. On January 21, 2010, Standard & Poor’s changed our outlook to poor from stable. On February 17, 2010, Standard & Poor’s downgraded our corporate credit rating to CCC from B-, with a negative outlook and lowered our Notes to CCC from a B rating. On March 2, 2010, Moody’s downgraded both our probability of default rating and our corporate family rating to Caa3 from Caa1, with a negative outlook. On March 18, 2010, Standard & Poor’s downgraded our corporate credit rating to CC from CCC, with a negative outlook. On July 2, 2010, Standard & Poor’s downgraded our corporate rating to SD from CC and downgraded our Notes to D from CC, and Moody’s downgraded our probability of default rating to Ca/LD from Caa3 and our corporate family rating to Ca from Caa3. On July 13, 2010, Standard & Poor’s downgraded our corporate rating to D from SD.

Prior to October 1, 2014, we may redeem some or all of the Notes at a redemption price equal to 100% of the principal amount plus accrued and unpaid interest, if any, to the date of redemption plus a “make-whole” premium.

In addition, at any time and, on or prior to October 1, 2012, we may redeem up to 35% of the original principal amount of the Notes with the net cash proceeds from certain equity offerings, as defined, at a redemption price equal to 111.75% of the principal amount of the Notes, plus accrued and unpaid interest, if any, to the date of redemption.

On each January 1, April 1, July 1 and October 1 commencing January 1, 2010, we are required to redeem 3.333% of the aggregate original principal amount of the Notes at a redemption price of 106% of the principal amount thereof (“Mandatory Redemption”), plus accrued and unpaid interest, if any, to the applicable date of redemption. If we redeem or repurchase Notes other than through a Mandatory Redemption, all remaining Mandatory Redemptions will be reduced.

On July 1, 2010, we entered into a forbearance agreement with holders of approximately 70% of the outstanding principal amount of the Notes (the “Forbearing Holders”), which was subsequently amended and restated on August 12, 2010 (the “Forbearance Agreement”). Based on the terms of the Forbearance Agreement, the Forbearing Holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the Indenture with respect to our failure on July 1, 2010, (i) to redeem a portion of the Notes pursuant to the Indenture and the Notes (the “Amortization Payment Default”) and (ii) to pay interest on the Notes (the “Interest Payment Default”). The Forbearance Agreement is effective until the earliest of (i) September 30, 2010, (ii) the occurrence or existence of any Default or Event of Default (each as defined in the Indenture) other than the Amortization Payment Default or Interest Payment Default, and (iii) the occurrence of certain other events as described in the Forbearance Agreement. The Forbearance Agreement contains covenants by us to, among other things: (i) retain and continue to employ a chief restructuring officer who will assist with all restructuring initiatives, and (ii) provide to the Trustee and to counsel and the financial advisors to the Forbearing Holders (a) a 13-week treasury cash flow forecast no later than Thursday of each week, (b) executive summary reports no later than Thursday of each week, and (c) periodic financial reports each month no later than twenty-one days after the end of the prior month. We also agreed to weekly telephonic and written communication with counsel and the financial advisors to the Forbearing Holders to review, among other things, the weekly reports and to provide updates on strategic processes.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Upon the occurrence of a change of control (as defined in the Indenture), any holder of the Notes will have the right to require us to repurchase all or any part of the Notes of such holder at a purchase price in cash equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase.

If more than $25.0 million of the aggregate principal amount of our Senior Subordinated Notes are outstanding on May 31, 2012, then holders of the Notes will have the right to require us to repurchase all or any part of their Notes at a purchase price in cash equal to 100% of their principal amount, plus accrued and unpaid interest to the repurchase date. In addition, if for any fiscal year, commencing with the fiscal year ended January 3, 2010, we have excess cash flow (as defined in the Indenture), we will be required within 120 days after the end of such fiscal year to make an offer to repurchase Notes, for an aggregate amount equal to 50% of excess cash flow for such fiscal year (subject to reduction by a credit for Notes optionally repurchased by us during such fiscal year), at a purchase price in cash equal to 100% of the principal amount of the Notes, plus accrued and unpaid interest, if any, to the date of purchase.

If we or our restricted subsidiaries sell assets following the issue date under certain circumstances, we will be required to use 100% of the first $100 million of the net proceeds and 75% of additional net proceeds to make an offer to all holders to purchase Notes, at an offer price in cash in an amount equal to 100% of the principal amount of the Notes and such other indebtedness, plus accrued and unpaid interest to the date of purchase.

The Indenture contains customary events of default. If an event of default occurs and is continuing, the trustee or holders of at least 25% in principal amount of the outstanding Notes may declare the principal of premium, if any, and accrued and unpaid interest, if any, on all the Notes to be due and payable immediately. Certain events of bankruptcy or insolvency are events of default which shall result in the Notes being due and payable immediately upon the occurrence of such events of default.

The Notes were not registered under the Securities Act and, unless so registered, may not be offered or sold in the United States absent an applicable exemption from registration requirements.

In connection with the sale of the Notes, on October 1, 2009, we and the Guarantors entered into a Collateral Agreement (the “Collateral Agreement”) with U.S. Bank National Association, as collateral agent. Pursuant to the Collateral Agreement, the Notes and the guarantees are secured by a first-priority lien, subject to permitted liens, on substantially all of our assets and the Guarantors’ assets securing our credit agreement immediately prior to the issue date of the Notes, including, but not limited to, all accounts receivable, plant, property and equipment (but excluding certain owned and all leased real property), inventory, intangible assets and the capital stock of any domestic subsidiary and certain foreign subsidiaries held by us of any Guarantor (but limited to 65% of the voting stock of any such first-tier foreign subsidiary).

As described above, we are currently pursuing certain modifications to our capital structure that are likely to impact the Notes. The holders of the Notes have formed a noteholder committee, have retained advisors, with which we are engaged in negotiations, and continue to conduct due diligence on us. We can give no assurance that we will successfully execute the recapitalization initiatives we are currently pursuing or any others, and our ability to do so could be adversely affected by numerous factors, including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures. It is possible that even a successful and efficient implementation of the recapitalization initiatives we are pursuing will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Senior Subordinated Notes

On August 20, 2004, we issued $300.0 million aggregate principal amount of 9% Senior Subordinated Notes due September 1, 2012. As of July 4, 2010, $300.0 million of principal was outstanding under the Senior Subordinated Notes. We may redeem all or a portion of the Senior Subordinated Notes at any time at certain redemption prices. Interest accrues on the Senior Subordinated Notes from August 20, 2004, and is payable on March 1 and September 1 of each year. Any payment in respect of the Senior Subordinated Notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement and the Forbearing Holders will no longer be obligated to forbear from enforcing their rights and remedies in respect of the Amortization Payment Default and the Interest Payment Default and would have the ability to declare the entire amount owed under the Senior Secured Notes immediately due and payable. While we have not made a formal determination regarding the September 1, 2010 interest payment on the Senior Subordinated Notes, there is a substantial likelihood that such payment will not be made as scheduled. If we do not make the interest payment on the Senior Subordinated Notes when due and such failure is not remedied within 30 days, the holders of the Senior Subordinated Notes will have the ability to declare the entire amount owed under the Senior Subordinated Notes immediately due and payable. As there has been no event of default on the Senior Subordinated Notes as of July 4, 2010, the carrying amount of this debt and its related debt issue costs have not been reclassified from non-current to current.

Amended Credit Facility and Cash Collateralized Letters of Credit

On August 20, 2004, in connection with our divestiture from Viacom, we entered into a credit agreement with a syndicate of lenders providing for: (i) a five-year $500.0 million revolving credit facility, a portion of which was reserved for issuance of letters of credit to Viacom (the “Viacom Letters of Credit”); (ii) a five-year $100.0 million term loan A (the “Term Loan A”); and (iii) a seven-year $550.0 million term loan B (the “Term Loan B”).

We entered into various amendments and restatements to our credit agreement on November 4, 2005, April 10, 2007 and July 2, 2007. On April 2, 2009, we further amended our credit agreement to include commitments from certain of our lenders and certain new lenders to (a) replace the existing revolving credit facility with a $250.0 million revolving credit facility with a maturity date of September 30, 2010 and (b) amend certain financial and other covenants in our credit facility (the “Amended Revolver”). Borrowings under the Amended Revolver bore interest at an alternate base rate (with a floor of 4.5%) plus 9% or at LIBOR (with a floor of 3.5%) plus 10%, at our discretion, which interest payments were due and payable monthly. On May 11, 2009, the Amended Revolver was closed and funded.

Through May 11, 2009, we were required to make prepayments on the credit facilities in an aggregate amount equal to 50% of annual excess cash flow, as defined by our credit agreement. Such payments were due at the end of the first quarter of the following year. In fiscal 2008, we generated excess cash flow, as defined by our credit agreement, and made a prepayment of $25.1 million on April 6, 2009. Additionally, we were required to make prepayments on the credit facilities related to sales of store operations and property and equipment, as defined by our credit agreement.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

outstanding, but all financial and substantially all negative covenants in the credit agreement have been eliminated (although the credit agreement continues to have customary covenants, events of default and other provisions applicable to letter of credit facilities of this type). The existing letters of credit thereunder will continue to be secured by cash collateral to the extent such letters of credit remain outstanding. All letters of credit under our credit agreement are currently scheduled to expire between August 12, 2010 and November 15, 2010, although the credit agreement provides for the extension, amendment or renewal of certain of such letters of credit.

Note 3—Stock and Share-Based Payments

For the thirteen weeks ended July 4, 2010 and July 5, 2009, we recognized $0.7 million and $2.4 million, respectively, of share-based compensation expense related to stock options, restricted shares and restricted share units. For the twenty-six weeks ended July 4, 2010 and July 5, 2009, we recognized $0.7 million and $4.4 million, respectively, of share-based compensation expense related to stock options, restricted shares and restricted share units.

During the twenty-six weeks ended July 4, 2010, no stock options were granted or exercised and 6.0 million stock options were cancelled, due mainly to the expiration of 5.0 million options previously outstanding to our former CEO. In addition, 1.0 million restricted shares or restricted share units were granted, 1.0 million restricted shares and restricted share units were vested, and no restricted shares and restricted share units were cancelled. As of July 4, 2010, 11.4 million stock options and 1.6 million restricted shares and restricted share units remained outstanding.

The unamortized compensation expense, net of estimated forfeitures, related to restricted shares, restricted share units and stock options issued and outstanding as of July 4, 2010 will be recognized in future periods as follows:


	Restricted Shares and Restricted Share Units		Stock Options		Total
Twenty-six week period ending January 2, 2011	$	0.2	$	0.1	$	0.3
Year ending January 1, 2012 and thereafter		0.3		0.1		0.4

Total	$	0.5	$	0.2	$	0.7

Note 4—Related Party Transactions

On March 29, 2007, Strauss Zelnick, a member of our Board of Directors, was appointed chairman of the board of directors of Take-Two Interactive Software, Inc. (“Take-Two”), a global publisher, developer and distributor of interactive games software, hardware and accessories and a party to considerable commercial transactions with us. On February 15, 2008, Take-Two announced the appointment of Mr. Zelnick as executive chairman. In addition, ZelnickMedia Corporation (“ZelnickMedia”), of which Mr. Zelnick is a founder and principal owner, entered into a management agreement with Take-Two on March 30, 2007, as amended on July 26, 2007 and February 14, 2008, pursuant to which ZelnickMedia provides financial and management consulting services to Take-Two. Mr. Zelnick is entitled during the term of the management agreement to serve as chairman of Take-Two’s board of directors and will also have the authority during such term to hire and/or terminate the chief executive officer and chief financial officer of Take-Two, subject to the approval of Take-Two’s compensation committee. We paid Take-Two $2.3 million and $4.9 million for the thirteen and twenty-six weeks ended July 4, 2010, and $0.8 million and $3.3 million for the thirteen and twenty-six weeks ended July 5, 2009, respectively,

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

pursuant to our commercial arrangements with Take-Two. At July 4, 2010, our Consolidated Balance Sheets included $0.2 million reduction for vendor credits from Take-Two recorded in “Accounts payable.” At January 3, 2010, our Consolidated Balance Sheets included less than $0.1 million of accrued revenue-share expenses for Take-Two recorded in “Accrued expenses” and $1.7 million recorded in “Accounts payable.”

We have entered into a broker service agreement, effective as of October 1, 2009, with Frank Crystal & Company whereby Frank Crystal & Company will serve as our exclusive insurance broker of record through October 1, 2010. James W. Crystal, who was a member of our Board of Directors until June 25, 2010, is Chairman and Chief Executive Officer of Frank Crystal & Company, a full service insurance brokerage and services company. We paid Frank Crystal & Company less than $0.1 million for the thirteen and twenty-six weeks ended July 4, 2010. We do not have any payables to or receivables from Frank Crystal & Company as of July 4, 2010.

Note 5—Commitments and Contingencies

Blockbuster was a defendant in 12 lawsuits filed by customers in nine states and the District of Columbia between November 1999 and April 2001. These putative class action lawsuits alleged common law and statutory claims for fraud and deceptive practices and/or unlawful business practices regarding our extended viewing fee policies for customers who chose to keep rental product beyond the initial rental term. Some of the cases also alleged that these policies imposed unlawful penalties and resulted in unjust enrichment for us. In January 2002, the 136^thJudicial District Court of Jefferson County, Texas entered a final judgment approving a national class settlement (the “Scott settlement”). Under the approved settlement, we paid $9.25 million in plaintiffs’ attorneys’ fees during the first quarter of 2005 and made certificates available to class members for rentals and discounts through November 2005. One additional extended viewing fee case in the United States is inactive and subject to dismissal pursuant to the Scott settlement. In addition, there is one case, filed on February 18, 1999 in the Circuit Court of Cook County, Illinois, Chancery Division, Cohen v. Blockbuster, not completely resolved by the Scott settlement. Marc Cohen, Uwe Stueckrad, Marc Perper and Denita Sanders assert common law and statutory claims for fraud and deceptive practices, unjust enrichment and unlawful penalties regarding Blockbuster’s extended viewing fee policies. Such claims were brought against Blockbuster, individually and on behalf of all entities doing business as Blockbuster or Blockbuster Video. Plaintiffs seek relief on behalf of themselves and other plaintiff class members including actual damages, attorneys’ fees and injunctive relief. By order dated April 27, 2004, the Cohen trial court certified plaintiff classes for U.S. residents who incurred extended viewing fees and/or purchased unreturned videos between February 18, 1994 and December 31, 2004, and who were not part of the Scott settlement or who do not have a Blockbuster membership with an arbitration clause. In the same order, the trial court certified a defendant class comprised of all entities that have done business in the United States as Blockbuster or Blockbuster Video since February 18, 1994. On August 15, 2005, the trial court denied Blockbuster’s motion to reconsider the trial court’s certification of plaintiff classes. On September 26, 2007, the Illinois Appellate Court remanded the trial court’s decision to certify plaintiff classes back to the trial court for reconsideration of our motion to decertify plaintiff classes. Plaintiffs did not petition the Illinois Supreme Court for leave to appeal. On March 14, 2008, upon reconsideration the trial court granted Blockbuster’s motion to decertify plaintiff classes and decertified both plaintiff and defendant classes. We believe the plaintiffs’ position in Cohen is without merit and we intend to vigorously defend ourselves in the lawsuit. In addition, two putative class action lawsuits are pending against Blockbuster in Canada. William Robert Hazell filed an action in the Supreme Court of British Columbia on August 24, 2001 against Viacom Entertainment Canada Inc., Viacom, Blockbuster Canada Inc. and Blockbuster. The case asserts claims for unconscionability, violations of the trade practices act, breach of contract and high handed conduct. The relief sought includes actual damages, disgorgement, and exemplary and punitive damages. Douglas R. Hedley filed an action in the Court of Queen’s

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Bench, Judicial Centre of Regina, in Saskatchewan on July 19, 2002. The case asserts claims of unconscionability, unjust enrichment, misrepresentation and deception, and seeks recovery of actual damages of $3 million, disgorgement, declaratory relief, punitive and exemplary damages of $1 million and attorneys’ fees. We believe the plaintiffs’ positions in all of these cases are without merit and, if necessary, intend to vigorously defend ourselves.

On May 20, 2009, Nicholas Lampone filed a putative class action in the Superior Court of Los Angeles County, California alleging Blockbuster’s “no late fees” program is a breach of contract and violates California’s consumer protection and unfair competition statutes prohibiting unfair, unlawful and deceptive business practices. Plaintiff sought class certification, restitution, injunctive relief, general damages, special damages, compensatory damages, punitive damages, equitable relief, attorneys’ fees, interest, and costs. Blockbuster removed the case to the United States District Court for the Central District of California. On April 22, 2010, plaintiff Lampone dismissed his claims with prejudice.

Blockbuster is a defendant in one remaining lawsuit arising out of the Blockbuster and Facebook websites. On August 12, 2008, Sean Lane, Mohannaed Sheikha, Sean Martin, Ali Sammour, Mohammaed Zidan, Sara Karrow, Colby Henson, Denton Hunker, Firas Sheikha, Hassen Sheikha, Linda Stewart, Tina Tran, Matthew Smith, Erica Parnell, John Conway, Austin Muhs, Phillip Huerta, Alicia Hunker, and Megan Lynn Hancock (a minor, through her parent Rebecca Holey) filed a putative class action complaint under the VPPA, the Electronic Communications Privacy Act (“ECPA”), the Computer Fraud and Abuse Act (“CFAA”), California’s Consumer Legal Remedies Act, and California’s Computer Crime Law in the United States District Court for the Northern District of California. Plaintiffs assert claims against Facebook, Inc., Blockbuster Inc., Fandango, Inc., Hotwire, Inc., STA Travel, Inc., Overstock.com, Inc., Zappos.com, Inc., Gamefly, Inc., and John Does 1-40, corporations. Plaintiffs are purporting to act on behalf of every Facebook member who visited one or more of Facebook’s affiliates’ websites and engaged in activities that triggered the Facebook affiliates’ websites to communicate with Facebook regarding the activity from November 6, 2007 to December 5, 2007. Plaintiffs claim Blockbuster violated the VPPA, ECPA, and CFAA by allegedly violating the plaintiffs’ privacy through their activities on the Blockbuster and Facebook websites. Plaintiffs seek class certification, injunctive and equitable relief, statutory damages, attorneys’ fees, and costs. On March 17, 2010, the court approved a settlement on behalf of the putative class of plaintiffs. The settlement is funded and supported by Facebook and requires no contribution from Blockbuster. On May 27, 2010, the court entered final judgment dismissing the case with prejudice. In June 2010, several separate appeals of the final judgment were filed by persons objecting to the terms of the settlement. We believe that the claims are without merit and should it become necessary, we intend to vigorously defend ourselves.

Blockbuster is subject to various other legal proceedings in the course of conducting our business, including our business as a franchisor. Although we believe that these proceedings are not likely to result in judgments that will have a material adverse effect on our business, we cannot predict the impact of future developments affecting our outstanding claims and litigation.

Note 6—Discontinued Operations

During the third quarter of 2009, we completed the sale of Xtra-vision Limited (“Xtra-vision”), a 184 store entertainment retailer in Ireland, to Birchhall Investments Limited, an affiliate company of NCB Group Limited (“Buyer”), pursuant to which the Buyer acquired all of the outstanding capital stock of Blockbuster Holdings Ireland, our wholly-owned subsidiary and the parent company of Xtra-Vision. The operations of Xtra-vision have been classified as discontinued operations, and its results of operations are reflected under “Income (loss) from discontinued operations” in our consolidated financial statements.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

The following table summarizes the results of discontinued operations, which includes immaterial amounts from previous divestitures:


	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009			July 4, 2010			July 5, 2009
Revenues	$	—		$	37.6		$	—		$	73.9
Income (loss) before income taxes (includes loss on sale)	$	(0.3	)	$	(0.2	)	$	(0.4	)	$	1.0
Provision for income taxes		—			—			—			(0.1	)

Income (loss) from discontinued operations	$	(0.3	)	$	(0.2	)	$	(0.4	)	$	0.9

Note 7—Segment Information

We operate our business in two reportable business segments: Domestic and International. Segments have been identified based on how management makes operating decisions, assesses performance and allocates resources. Management reviews asset information on a global basis, not by segment.

The Domestic segment is comprised of all U.S. store operations and by-mail subscription service operations in addition to vending kiosks and the digital delivery of movies through blockbuster.com. The International segment is comprised of all non-U.S. store operations, including operations in Europe, Latin America, Australia, Canada, Mexico and Asia.


	Domestic Segment		International Segment			Unallocated Corporate			Total
Thirteen weeks ended July 4, 2010
Revenues	$	540.3	$	248.0		$	—		$	788.3
Operating income (loss)		2.0		(11.0	)		(28.7	)		(37.7	)
Depreciation and intangible amortization		18.1		5.9			2.5			26.5
Net capital expenditures		4.4		1.6			0.6			6.6

Thirteen weeks ended July 5, 2009
Revenues	$	712.0	$	269.8		$	—		$	981.8
Operating income (loss)		28.6		2.5			(32.7	)		(1.6	)
Depreciation and intangible amortization		24.5		6.7			1.4			32.6
Net capital expenditures		3.3		0.9			1.3			5.5

Twenty-six weeks ended July 4, 2010
Revenues	$	1,188.1	$	539.6		$	—		$	1,727.7
Operating income (loss)		9.9		(10.2	)		(66.8	)		(67.1	)
Depreciation and intangible amortization		36.9		11.9			3.9			52.7
Net capital expenditures		6.7		2.5			1.4			10.6

Twenty-six weeks ended July 5, 2009
Revenues	$	1,518.2	$	549.5		$	—		$	2,067.7
Operating income (loss)		89.4		13.3			(54.1	)		48.6
Depreciation and intangible amortization		50.1		13.4			2.8			66.3
Net capital expenditures		9.3		2.2			2.5			14.0

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Note 8—Condensed Consolidating Financial Statements

Our Senior Subordinated Notes were issued by Blockbuster Inc., which conducts the majority of our domestic operations. All domestic subsidiaries have provided, on a senior subordinated basis, a joint and several guarantee of the Senior Subordinated Notes. Our domestic subsidiaries consist primarily of our distribution center. There are no significant restrictions on the parent company’s ability to obtain funds from any of the guarantor subsidiaries in the form of a dividend or loan. The notes are not guaranteed by our foreign subsidiaries. Additional information regarding our Senior Subordinated Notes is included in Note 2 above.

Blockbuster Inc. and its non-guarantor subsidiaries are parties to various intercompany agreements that affect the amount of operating expenses reported in the following condensed consolidating statements of operations and corresponding amounts in the condensed consolidating balance sheets and condensed consolidating statements of cash flows. Among other things, management fees are charged to the non-guarantor subsidiaries relating to the use of tradenames, information systems and other corporate overhead. An allocation of corporate overhead expenses has also been made to our guarantor subsidiaries. These intercompany amounts are eliminated in consolidation.

We file a consolidated U.S. federal income tax return. All income taxes are allocated in accordance with our tax matters agreement with Viacom.

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

The following financial information presents condensed consolidating statements of operations, balance sheets and statements of cash flows for Blockbuster Inc., all guarantor subsidiaries, all non-guarantor subsidiaries and the eliminations necessary to arrive at the information for Blockbuster on a consolidated basis. The information has been presented as if Blockbuster Inc. accounted for its ownership of the guarantor and non-guarantor subsidiaries using the equity method of accounting.


	Statement of Operations for the Thirteen Weeks Ended July 4, 2010
	Blockbuster Inc.			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Consolidated Blockbuster Inc.
Revenues:
Rental revenues	$	460.2		$	—	$	146.1		$	—		$	606.3
Merchandise sales		76.9			—		100.7			—			177.6
Other revenues		9.4			11.7		0.7			(17.4	)		4.4

		546.5			11.7		247.5			(17.4	)		788.3

Cost of sales:
Cost of rental revenues		171.5			—		53.0			—			224.5
Cost of merchandise sold		55.8			—		76.4			—			132.2

		227.3			—		129.4			—			356.7

Gross profit		319.2			11.7		118.1			(17.4	)		431.6

Operating expenses:
General and administrative		315.6			11.6		123.7			(17.4	)		433.5
Advertising		4.3			—		5.0			—			9.3
Depreciation and intangible amortization		20.6			—		5.9			—			26.5

		340.5			11.6		134.6			(17.4	)		469.3

Operating income (loss)		(21.3	)		0.1		(16.5	)		—			(37.7	)
Interest (expense) income, net		(31.9	)		—		(0.1	)		—			(32.0	)
Other items, net		0.4			—		0.3			—			0.7

Income (loss) before income taxes		(52.8	)		0.1		(16.3	)		—			(69.0	)
Provision for income taxes		(0.5	)		—		1.1			—			0.6
Equity in income (loss) of affiliated companies, net of tax		(15.3	)		—		—			15.3			—

Income (loss) from continuing operations		(68.6	)		0.1		(15.2	)		15.3			(68.4	)
Income from discontinued operations, net of tax		(0.1	)		—		(0.2	)		—			(0.3	)

Net income (loss)	$	(68.7	)	$	0.1	$	(15.4	)	$	15.3		$	(68.7	)

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Statement of Operations for the Thirteen Weeks Ended July 5, 2009
	Blockbuster Inc.			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Consolidated Blockbuster Inc.
Revenues:
Rental revenues	$	609.8		$	—	$	161.9		$	—		$	771.7
Merchandise sales		97.8			—		107.1			—			204.9
Other revenues		11.8			17.1		0.4			(24.1	)		5.2

		719.4			17.1		269.4			(24.1	)		981.8

Cost of sales:
Cost of rental revenues		227.2			—		53.7			—			280.9
Cost of merchandise sold		78.7			—		79.3			—			158.0

		305.9			—		133.0			—			438.9

Gross profit		413.5			17.1		136.4			(24.1	)		542.9

Operating expenses:
General and administrative		366.2			17.1		128.1			(24.1	)		487.3
Advertising		19.3			—		5.3			—			24.6
Depreciation and intangible amortization		26.0			—		6.6			—			32.6

		411.5			17.1		140.0			(24.1	)		544.5

Operating income (loss)		2.0			—		(3.6	)		—			(1.6	)
Interest (expense) income, net		(28.6	)		—		0.6			—			(28.0	)
Other items, net		(5.8	)		—		0.1			—			(5.7	)

Income (loss) from continuing operations before income taxes		(32.4	)		—		(2.9	)		—			(35.3	)
Provision for income taxes		(0.2	)		—		(1.2	)		—			(1.4	)
Equity in income (loss) of affiliated companies, net of tax		(4.3	)		—		—			4.3			—

Income (loss) from continuing operations		(36.9	)		—		(4.1	)		4.3			(36.7	)
Income (loss) from discontinued operations, net of tax		—			—		(0.2	)		—			(0.2	)

Net income (loss)	$	(36.9	)	$	—	$	(4.3	)	$	4.3		$	(36.9	)

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Statement of Operations for the Twenty-Six Weeks Ended July 4, 2010
	Blockbuster Inc.			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Consolidated Blockbuster Inc.
Revenues:
Rental revenues	$	1,011.4		$	—	$	314.5		$	—		$	1,325.9
Merchandise sales		170.0			—		222.7			—			392.7
Other revenues		21.8			27.3		1.6			(41.6	)		9.1

		1,203.2			27.3		538.8			(41.6	)		1,727.7

Cost of sales:
Cost of rental revenues		380.9			—		113.7			—			494.6
Cost of merchandise sold		131.3			—		168.0			—			299.3

		512.2			—		281.7			—			793.9

Gross profit		691.0			27.3		257.1			(41.6	)		933.8

Operating expenses:
General and administrative		673.6			27.3		258.6			(41.6	)		917.9
Advertising		19.5			—		10.8			—			30.3
Depreciation and intangible amortization		40.8			—		11.9			—			52.7

		733.9			27.3		281.3			(41.6	)		1,000.9

Operating income (loss)		(42.9	)		—		(24.2	)		—			(67.1	)
Interest (expense) income, net		(64.9	)		—		(0.3	)		—			(65.2	)
Other items, net		(1.2	)		—		0.3			—			(0.9	)

Income (loss) before income taxes		(109.0	)		—		(24.2	)		—			(133.2	)
Provision for income taxes		(1.7	)		—		1.2			—			(0.5	)
Equity in income (loss) of affiliated companies, net of tax		(23.2	)		—		—			23.2			—

Income (loss) from continuing operations		(133.9	)		—		(23.0	)		23.2			(133.7	)
Income from discontinued operations, net of tax		(0.2	)		—		(0.2	)		—			(0.4	)

Net income (loss)	$	(134.1	)	$	—	$	(23.2	)	$	23.2		$	(134.1	)

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Statement of Operations for the Twenty-Six Weeks Ended July 5, 2009
	Blockbuster Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated Blockbuster Inc.
Revenues:
Rental revenues	$	1,292.6		$	—		$	322.3		$	—		$	1,614.9
Merchandise sales		216.0			—			225.6			—			441.6
Other revenues		24.6			34.6			0.9			(48.9	)		11.2

		1,533.2			34.6			548.8			(48.9	)		2,067.7

Cost of sales:
Cost of rental revenues		484.8			—			106.0			—			590.8
Cost of merchandise sold		193.3			—			167.4			—			360.7

		678.1			—			273.4			—			951.5

Gross profit		855.1			34.6			275.4			(48.9	)		1,116.2

Operating expenses:
General and administrative		728.4			34.7			251.0			(48.9	)		965.2
Advertising		26.0			—			10.1			—			36.1
Depreciation and intangible amortization		53.0			—			13.3			—			66.3

		807.4			34.7			274.4			(48.9	)		1,067.6

Operating income (loss)		47.7			(0.1	)		1.0			—			48.6
Interest (expense) income, net		(46.6	)		—			1.3			—			(45.3	)
Other items, net		(7.2	)		—			0.7			—			(6.5	)

Income (loss) from continuing operations before income taxes		(6.1	)		(0.1	)		3.0			—			(3.2	)
Provision for income taxes		(2.3	)		—			(4.6	)		—			(6.9	)
Equity in income (loss) of affiliated companies, net of tax		(0.8	)		—			—			0.8			—

Income (loss) from continuing operations		(9.2	)		(0.1	)		(1.6	)		0.8			(10.1	)
Income (loss) from discontinued operations, net of tax		—			—			0.9			—			0.9

Net income (loss)	$	(9.2	)	$	(0.1	)	$	(0.7	)	$	0.8		$	(9.2	)

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Balance Sheet as of July 4, 2010
	Blockbuster Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Consolidated Blockbuster Inc.
Assets
Current assets:
Cash and cash equivalents	$	30.8		$	0.1		$	33.4	$	—		$	64.3
Receivables, net		36.2			—			18.8		—			55.0
Intercompany receivables		—			0.8			38.8		(39.6	)		—
Merchandise inventories		97.2			—			125.2		—			222.4
Rental library, net		208.1			—			78.6		—			286.7
Deferred income taxes		—			—			13.6		—			13.6
Prepaid and other current assets		113.5			—			36.3		—			149.8

Total current assets		485.8			0.9			344.7		(39.6	)		791.8
Property and equipment, net		157.1			—			51.4		—			208.5
Deferred income taxes		85.8			—			9.0		—			94.8
Investment in subsidiaries		271.3			—			—		(271.3	)		—
Intangibles, net		6.0			—			0.5		—			6.5
Restricted cash		35.1			—			0.5		—			35.6
Other assets		17.2			—			1.5		—			18.7

	$	1,058.3		$	0.9		$	407.6	$	(310.9	)	$	1,155.9

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	103.7		$	1.4		$	55.4	$	—		$	160.5
Intercompany payables		39.6			—			—		(39.6	)		—
Accrued expenses		320.9			0.4			56.3		—			377.6
Current portion of long-term debt		598.2			—			—		—			598.2
Current portion of capital lease obligations		4.7			—			0.6		—			5.3
Deferred income taxes		85.8			—			13.0		—			98.8

Total current liabilities		1,152.9			1.8			125.3		(39.6	)		1,240.4
Long-term debt, less current portion		300.0			—			—		—			300.0
Capital lease obligations, less current portion		16.8			—			0.1		—			16.9
Other liabilities		39.4			—			10.0		—			49.4

		1,509.1			1.8			135.4		(39.6	)		1,606.7
Total stockholders’ equity (deficit)		(450.8	)		(0.9	)		272.2		(271.3	)		(450.8	)

	$	1,058.3		$	0.9		$	407.6	$	(310.9	)	$	1,155.9

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Balance Sheet as of January 3, 2010
	Blockbuster Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Consolidated Blockbuster Inc.
Assets
Current assets:
Cash and cash equivalents	$	125.8		$	0.5		$	62.4	$	—		$	188.7
Receivables, net		53.3			—			26.1		—			79.4
Intercompany receivables		—			1.6			15.9		(17.5	)		—
Merchandise inventories		149.3			—			149.2		—			298.5
Rental library, net		246.4			—			94.3		—			340.7
Deferred income taxes		—			—			13.6		—			13.6
Prepaid and other current assets		100.5			—			38.6		—			139.1

Total current assets		675.3			2.1			400.1		(17.5	)		1,060.0
Property and equipment, net		187.4			—			62.0		—			249.4
Deferred income taxes		105.6			—			9.0		—			114.6
Investment in subsidiaries		283.9			—			—		(283.9	)		—
Intangibles, net		7.1			—			0.6		—			7.7
Restricted cash		58.0			—			0.5		—			58.5
Other assets		46.4			—			1.7		—			48.1

	$	1,363.7		$	2.1		$	473.9	$	(301.4	)	$	1,538.3

Liabilities and Stockholders’ Equity (Deficit)
Current liabilities:
Accounts payable	$	207.3		$	2.5		$	91.0	$	—		$	300.8
Intercompany payables		17.5			—			—		(17.5	)		—
Accrued expenses		334.4			0.4			72.9		—			407.7
Current portion of long-term debt		101.6			—			—		—			101.6
Current portion of capital lease obligations		5.7			—			0.4		—			6.1
Deferred income taxes		105.6			—			13.0		—			118.6

Total current liabilities		772.1			2.9			177.3		(17.5	)		934.8
Long-term debt, less current portion		836.0			—			—		—			836.0
Capital lease obligations, less current portion		19.9			—			—		—			19.9
Other liabilities		50.0			—			11.9		—			61.9

		1,678.0			2.9			189.2		(17.5	)		1,852.6
Total stockholders’ equity (deficit)		(314.3	)		(0.8	)		284.7		(283.9	)		(314.3	)

	$	1,363.7		$	2.1		$	473.9	$	(301.4	)	$	1,538.3

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Statement of Cash Flows for Twenty-Six Weeks Ended July 4, 2010
	Blockbuster Inc.			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated Blockbuster Inc.
Net cash provided by (used in) operating activities	$	(60.6	)	$	(0.4	)	$	(26.6	)	$	—	$	(87.6	)

Investing activities:
Capital expenditures		(8.1	)		—			(2.5	)		—		(10.6	)
Change in restricted cash		22.9			—			—			—		22.9
Other investing activities		1.0			—			—			—		1.0

Net cash provided by (used in) investing activities		15.8			—			(2.5	)		—		13.3

Financing activities:
Repayments on senior secured notes		(45.0	)		—			—			—		(45.0	)
Capital lease payments		(2.7	)		—			(0.2	)		—		(2.9	)
Intercompany loans		(2.5	)		—			2.5			—		—

Net cash provided by (used in) financing activities		(50.2	)		—			2.3			—		(47.9	)

Effect of exchange rate changes on cash		—			—			(2.2	)		—		(2.2	)

Net decrease in cash and cash equivalents		(95.0	)		(0.4	)		(29.0	)		—		(124.4	)
Cash and cash equivalents at beginning of period		125.8			0.5			62.4			—		188.7

Cash and cash equivalents at end of period	$	30.8		$	0.1		$	33.4		$	—	$	64.3

BLOCKBUSTER INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)


	Statement of Cash Flows for Twenty-Six Weeks Ended July 5, 2009
	Blockbuster Inc.			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations		Consolidated Blockbuster Inc.
Net cash provided by (used in) operating activities	$	56.1		$	0.5	$	(29.6	)	$	—	$	27.0

Investing activities:
Capital expenditures		(11.8	)		—		(2.2	)		—		(14.0	)
Change in restricted cash		(118.6	)		—		(5.3	)		—		(123.9	)
Other investing activities		0.5			—		0.2			—		0.7

Net cash provided by (used in) investing activities		(129.9	)		—		(7.3	)		—		(137.2	)

Financing activities:
Proceeds from credit agreement		360.0			—		21.4			—		381.4
Repayments on credit agreement		(281.1	)		—		—			—		(281.1	)
Cash dividends		(2.8	)		—		—			—		(2.8	)
Debt financing costs		(39.8	)		—		(0.5	)		—		(40.3	)
Capital lease payments		(4.1	)		—		(0.1	)		—		(4.2	)
Intercompany loans		11.3			—		(11.3	)		—		—

Net cash provided by (used in) financing activities		43.5			—		9.5			—		53.0

Effect of exchange rate changes on cash		—			—		1.3			—		1.3

Net decrease in cash and cash equivalents		(30.3	)		0.5		(26.1	)		—		(55.9	)
Cash and cash equivalents at beginning of period		92.5			0.1		62.3			—		154.9

Cash and cash equivalents at end of period	$	62.2		$	0.6	$	36.2		$	—	$	99.0

Item 2.

Managements’ Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Dollars in Millions)

Overview

Blockbuster Inc. is a leading global provider of in-home rental and retail movie and game entertainment, with over 5,800 stores in the United States, its territories and 16 other countries as of July 4, 2010. Our mission is to provide our customers with the most convenient access to media entertainment, including movie and game entertainment delivered through multiple distribution channels such as our stores, by-mail, vending kiosks and digital devices. We believe Blockbuster offers customers a value-priced entertainment experience, combining the broad product depth of a specialty retailer with local neighborhood convenience.

While the overall media entertainment industry has remained stable over the past few years, it has experienced a channel shift primarily driven by the emergence of new methods of distribution. Recognizing that shift, we have broadened our focus beyond DVD rental to providing convenient access to media entertainment across four channels of distribution:

•

in-store,

•

by-mail,

•

vending kiosks, and

•

digital devices.

2010 Strategic Objectives

Stores—Focus on improving the customer shopping experience by:

•

successfully restructuring studio contracts to ensure new movies continue to be released to Blockbuster customers for rental the same day-and-date the movies are first made available to the public for purchase;

•

enhancing merchandising initiatives;

•

introducing Direct Access, which allows in-store customers to access our by-mail inventory and have movies and games shipped directly to their homes; and

•

providing exclusive products.

By-Mail—Optimize our by-mail distribution channel by:

•

launching a new co-branded by-mail offering called DVDs by Mail in July 2010, through a marketing partnership with Comcast, that allows Comcast customers to access our by-mail service;

•

enhancing our product offering through the addition of video game rentals in all domestic markets in August 2010;

•

expansion of Blu-ray and integration of the digital delivery channel into our by-mail platform; and

•

continuing to actively pursue third-party relationships, alliances, and/or joint ventures to expand our by-mail business.

Vending kiosks—Focus on this distribution channel through an alliance with NCR, which has already deployed approximately 6,000 kiosks and plans to deploy at least 7,500 kiosks by the end of 2010.

Digital—Continue to expand our digital presence using methods such as:

•

strategic alliances with consumer electronic device manufacturers and infrastructure providers;

•

the launch of mobile streaming via the T-Mobile HTC HD2 Smartphone during the first quarter and Verizon Droid X by Motorola in the second quarter; and

•

enhanced features and capabilities for our blockbuster.com website.

Cost management and liquidity—We will continue to closely monitor our costs and continue seeking operational efficiencies and additional cost reduction opportunities. Our focus has been and will continue to be on cost reductions and liquidity enhancing efforts through:

•

the continued closure of less profitable stores, of which 507 domestic company-owned stores were closed in the first two quarters, resulting in over $34 million of store closure costs; and

•

lease renegotiations to generate significant reductions in future store occupancy costs, of which approximately 1,000 domestic leases are targeted for renegotiation during 2010.

Outlook

For the remainder of 2010, we continue to be committed to our goal of preserving liquidity and optimizing our capital structure while continuing our transformation to a multi-channel platform. Further, we expect to continue facing the challenges of increased industry competition and fragmentation as well as balancing the decline of a single channel with the ascension of emerging channels, such as vending and digital. Our plans for the remainder of 2010 continue to include stores as a key component of our multi-channel offering although a domestic same-store sales decline in the range of high single digits is contemplated. Factors contemplated in our current plans for the remainder of 2010 that we expect to mitigate these and other challenges include modification of our domestic stores movie rental terms and pricing, implementation of additional studio windows, industry factors such as Hollywood/Movie Gallery store closures, better execution of our rental games offering, a balanced slate of movie releases, and merchandising improvements including Blockbuster Premieres. However, there can be no assurance regarding these matters given increased competition, which has negatively impacted our ability to accurately forecast our results of operations and cash position and may result in deterioration of our revenues beyond what we anticipate. Further deterioration would negatively impact our anticipated revenues, profitability and cash flows from operations. Our expectations with respect to our performance over the remainder of 2010 are subject to a number of assumptions, many of which are outside our control, such as the rate at which customers are shifting preferences in entertainment delivery channels, competitive pressures, the slate and timing of movie releases by major studios and no significant contraction in our trade terms.

During the remainder of 2010, we will continue to take actions to improve liquidity. We expect to reduce general and administrative expenses, continue to rationalize the domestic store portfolio and work to divest international assets. In addition, our 2010 global capital expenditures will remain at maintenance levels of approximately $30 million, and we will continue to manage working capital. We also continue to explore a variety of strategic alternatives to strengthen our capital structure and position us for success in our transformational efforts. We are currently in discussions with our senior secured and senior subordinated noteholders as well as potential strategic parties in an effort to restructure our balance sheet and acquire additional capital funding. Consistent therewith, the senior secured and senior subordinated noteholders have formed committees, have retained advisors, with which we are engaged in negotiations, and continue to conduct due diligence on us. We can give no assurance that we will successfully execute the recapitalization initiatives we are currently pursuing or any others, and our ability to do so could be adversely affected by numerous factors, including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures. See “Item 1A. Risk Factors—We are currently pursuing certain recapitalization initiatives in an effort to improve our capital structure. It is possible that even a successful and efficient implementation of one or more of these initiatives will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code.” See also “Liquidity and Capital Resources” below for further discussion of our operational plan to preserve liquidity.

On July 1, 2010, the New York Stock Exchange (the “Exchange”) notified us that, due to our noncompliance with the Exchange’s continued listing standards relating to minimum trading price and market capitalization, trading on the Exchange of our Class A common stock and Class B common stock (the “common stock”) would be suspended prior to the opening on July 7, 2010. As a result, effective July 7, 2010, our common stock trades on the Pink OTCQB market, which could negatively affect the market for our common stock as well as impair our ability to raise additional financing. See “Item 1A. Risk Factors—Our common stock is no longer listed on a national securities exchange and is quoted only on the Pink Sheets, which could negatively affect our stock price and liquidity.” See also “Liquidity and Capital Resources” below for further discussion of our delisting from the Exchange.

Although we continue to face extremely challenging conditions, we remain dedicated to repositioning and transforming Blockbuster into a multi-channel brand by increasing our points of presence through alliances for vending and digital distribution and by offering our customers the most convenient access to media entertainment. Through our alliance with NCR, we expect at least 7,500 Blockbuster Express kiosks by the end of 2010. We also plan to grow the by-mail channel and further expand availability of our digital offering through BLOCKBUSTER On Demand. By leveraging our brand to deliver content through multiple channels, we believe we have positioned ourselves to be a leading provider of convenient access to media entertainment. Through the planned integration of our stores, by-mail, vending kiosks and digital services, we intend to utilize a centralized customer database, realize supply chain efficiencies and ultimately deliver a superior customer experience. We believe this multi-channel capability differentiates us from our competitors and will help position us to meet the challenges of operating in the rapidly changing media entertainment industry.

Results of Operations

Consolidated Results

The following table sets forth a summary of consolidated results of certain operating and other financial data.


	Thirteen Weeks Ended						Twenty-Six Weeks Ended
	July 4, 2010			July 5, 2009			July 4, 2010			July 5, 2009
Statement of Operations Data:
Revenues	$	788.3		$	981.8		$	1,727.7		$	2,067.7
Cost of sales		356.7			438.9			793.9			951.5

Gross profit		431.6			542.9			933.8			1,116.2
Operating expenses		469.3			544.5			1,000.9			1,067.6

Operating income (loss)		(37.7	)		(1.6	)		(67.1	)		48.6
Interest expense		(32.1	)		(28.8	)		(65.3	)		(46.3	)
Interest income		0.1			0.8			0.1			1.0
Other items, net		0.7			(5.7	)		(0.9	)		(6.5	)

Income (loss) from continuing operations before income taxes		(69.0	)		(35.3	)		(133.2	)		(3.2	)
Benefit (provision) for income taxes		0.6			(1.4	)		(0.5	)		(6.9	)

Income (loss) from continuing operations		(68.4	)		(36.7	)		(133.7	)		(10.1	)
Income (loss) from discontinued operations, net of tax (1)		(0.3	)		(0.2	)		(0.4	)		0.9

Net income (loss)	$	(68.7	)	$	(36.9	)	$	(134.1	)	$	(9.2	)

Cash Flow Data:
Cash flows provided by (used in) operating activities	$	(36.8	)	$	114.2		$	(87.6	)	$	27.0
Cash flows provided by (used in) investing activities	$	(6.0	)	$	(129.1	)	$	13.3		$	(137.2	)
Cash flows provided by (used in) financing activities	$	(1.4	)	$	4.3		$	(47.9	)	$	53.0

Other Data:
Depreciation and intangible amortization	$	26.5		$	32.6		$	52.7		$	66.3
EBITDA (2)	$	(11.2	)	$	31.0		$	(14.4	)	$	114.9

Margins:
Rental margin (3)		63.0	%		63.6	%		62.7	%		63.4	%
Merchandise margin (4)		25.6	%		22.9	%		23.8	%		18.3	%
Gross margin (5)		54.8	%		55.3	%		54.0	%		54.0	%

Worldwide Store Data:
Same-store revenues increase (decrease) (6)
Rental revenues		(9.9	)%		(10.7	)%		(8.0	)%		(11.1	)%
Merchandise sales		(11.4	)%		(26.1	)%		(10.1	)%		(15.1	)%
Total revenues		(10.2	)%		(14.7	)%		(8.5	)%		(12.1	)%
Company-operated stores at end of period		4,661			5,656			4,661			5,656
Franchised stores at end of period		1,147			1,473			1,147			1,473
Total stores at end of period		5,808			7,129			5,808			7,129


	Total Number	Avg Sq. Footage	Total Sq. Footage
		(in thousands)	(in thousands)
Real Estate Data at July 4, 2010:
Domestic
Company-operated stores	3,023	5.6	16,784
Distribution centers	39	N/A	1,119
Corporate / regional offices	8	N/A	400
International
Company-operated stores	1,638	3.2	5,255
Distribution centers	8	N/A	178
Corporate / regional offices	6	N/A	88

(1)	During August 2009 we sold Xtra-vision, our Ireland subsidiary. These operations have been classified as discontinued operations.

(2)	EBITDA is a non-GAAP financial measure. See “Non-GAAP Information—Reconciliation of EBITDA” that follows.

(3)	Rental gross profit (rental revenues less cost of rental revenues) as a percentage of rental revenues.

(4)	Merchandise gross profit (merchandise sales less cost of merchandise sold) as a percentage of merchandise sales.

(5)	Gross profit as a percentage of total revenues.

(6)

A store is included in the same-store revenues calculation after it has been opened and operated by us for more than 52 weeks. An acquired store becomes part of the same-store base in the 53rd week after its acquisition and conversion. The percentage change is computed by comparing total net revenues for same-stores at the end of the applicable reporting period with total net revenues from these same-stores for the comparable period in the prior year. The same-store revenues calculation includes only those revenues generated by our in-store distribution channel and does not include the impact of foreign currency exchange. The method of calculating same-store revenues varies across the retail industry; therefore, our method of calculating same-store revenues may not be the same as other retailers’ methods.

Segments

We operate our business in two reportable segments: Domestic and International. We identify segments based on how management makes operating decisions, assesses performance and allocates resources.

•

The Domestic segment is comprised of all U.S. store operations and by-mail subscription service operations in addition to vending kiosks and the digital delivery of movies through blockbuster.com and BLOCKBUSTER On Demand. As of July 4, 2010, we had 3,425 stores operating under the BLOCKBUSTER brand in the United States and its territories, of which 402 stores were operated through our franchisees. We also had 5,300 vending kiosks operating under the BLOCKBUSTER Express brand in the United States and its territories at that date.

•

The International segment is comprised of all non-U.S. store operations including operations in Europe, Latin America, Australia, Canada, Mexico and Asia. As of July 4, 2010, we had 2,383 stores operating under the BLOCKBUSTER brand and other brand names owned by us located in 16 markets outside of the United States. Of these stores, 745 stores were operated through our franchisees. In Canada, Italy, Mexico and Denmark, we also operate freestanding and store-in-store game locations under the GAME RUSH brand. On August 28, 2009, we completed the sale of our subsidiary in Ireland. The results for Ireland have been classified as discontinued operations for all periods presented.

The following table is a summary of operating income (loss) by business segment.


	Domestic Stores		International			Unallocated/ Corporate			Total
Statement of Operations Data:
Thirteen Weeks Ended July 4, 2010
Revenues	$	540.3	$	248.0		$	—		$	788.3
Cost of sales		227.4		129.3			—			356.7

Gross profit		312.9		118.7			—			431.6
Operating expenses		310.9		129.7			28.7			469.3

Operating income (loss)	$	2.0	$	(11.0	)	$	(28.7	)	$	(37.7	)

Thirteen Weeks Ended July 5, 2009
Revenues	$	712.0	$	269.8		$	—		$	981.8
Cost of sales		306.0		132.9			—			438.9

Gross profit		406.0		136.9			—			542.9
Operating expenses		377.4		134.4			32.7			544.5

Operating income (loss)	$	28.6	$	2.5		$	(32.7	)	$	(1.6	)


	Domestic Stores		International			Unallocated/ Corporate			Total
Statement of Operations Data:
Twenty-Six Weeks Ended July 4, 2010
Revenues	$	1,188.1	$	539.6		$	—		$	1,727.7
Cost of sales		512.3		281.6			—			793.9

Gross profit		675.8		258.0			—			933.8
Operating expenses		665.9		268.2			66.8			1,000.9

Operating income (loss)	$	9.9	$	(10.2	)	$	(66.8	)	$	(67.1	)

Twenty-Six Weeks Ended July 5, 2009
Revenues	$	1,518.2	$	549.5		$	—		$	2,067.7
Cost of sales		678.1		273.4			—			951.5

Gross profit		840.1		276.1			—			1,116.2
Operating expenses		750.7		262.8			54.1			1,067.6

Operating income (loss)	$	89.4	$	13.3		$	(54.1	)	$	48.6

Thirteen Weeks Ended July 4, 2010 Compared with Thirteen Weeks Ended July 5, 2009

Domestic Segment. The following table is a summary of domestic stores results of operations.


	Thirteen Weeks Ended July 4, 2010				Thirteen Weeks Ended July 5, 2009				Increase/(Decrease)
	Amount		Percent of Revenue		Amount		Percent of Revenue		Dollar			Percent
Revenues:
Rental revenues:
Movies	$	351.8	65.2	%	$	452.6	63.6	%	$	(100.8	)	(22.3	)%
Games		37.9	7.0	%		47.4	6.7	%		(9.5	)	(20.0	)%
Previously rented product (“PRP”)		70.5	13.0	%		109.9	15.4	%		(39.4	)	(35.9	)%

Total rental revenues		460.2	85.2	%		609.9	85.7	%		(149.7	)	(24.5	)%

Merchandise sales:
Movies		27.9	5.1	%		34.2	4.8	%		(6.3	)	(18.4	)%
Games		13.8	2.6	%		21.3	3.0	%		(7.5	)	(35.2	)%
General merchandise		35.2	6.5	%		42.2	5.9	%		(7.0	)	(16.6	)%

Total merchandise sales		76.9	14.2	%		97.7	13.7	%		(20.8	)	(21.3	)%

Royalties and other		3.2	0.6	%		4.4	0.6	%		(1.2	)	(27.3	)%

Total revenues		540.3	100.0	%		712.0	100.0	%		(171.7	)	(24.1	)%

Cost of sales:
Cost of rental revenues		171.6	31.8	%		227.1	31.9	%		(55.5	)	(24.4	)%
Cost of merchandise sold		55.8	10.3	%		78.9	11.1	%		(23.1	)	(29.3	)%

		227.4	42.1	%		306.0	43.0	%		(78.6	)	(25.7	)%

Gross profit		312.9	57.9	%		406.0	57.0	%		(93.1	)	(22.9	)%

Operating expenses:
General and administrative:
Stores		262.9	48.7	%		297.1	41.8	%		(34.2	)	(11.5	)%
Corporate and field		25.6	4.7	%		36.6	5.1	%		(11.0	)	(30.1	)%

Total general and administrative		288.5	53.4	%		333.7	46.9	%		(45.2	)	(13.5	)%

Advertising		4.3	0.8	%		19.2	2.7	%		(14.9	)	(77.6	)%
Depreciation and intangible amortization		18.1	3.3	%		24.5	3.4	%		(6.4	)	(26.1	)%

		310.9	57.5	%		377.4	53.0	%		(66.5	)	(17.6	)%

Operating income (loss)	$	2.0	0.4	%	$	28.6	4.0	%	$	(26.6	)	(93.0	)%

EBITDA (1)	$	20.1	3.7	%	$	53.1	7.5	%	$	(33.0	)	(62.1	)%

Margins:
Rental margin	$	288.6	62.7	%	$	382.8	62.8	%	$	(94.2	)	(24.6	)%
Merchandise margin	$	21.1	27.4	%	$	18.8	19.2	%	$	2.3		12.2	%
Gross margin	$	312.9	57.9	%	$	406.0	57.0	%	$	(93.1	)	(22.9	)%


	Thirteen Weeks Ended July 4, 2010		Thirteen Weeks Ended July 5, 2009
Same-store revenues increase/(decrease)
Rental revenues	(9.1	)%	(13.3	)%
Merchandise revenues	(21.7	)%	(37.9	)%
Total revenues	(11.0	)%	(17.8	)%
Other:
Ending by-mail subscriber count	1.2		1.6

(1)	EBITDA is a non-GAAP financial measure. See “Non-GAAP Information—Reconciliation of EBITDA” that follows.

Domestic—Rental revenues

•

Rental revenues decreased mainly as a result of:

•

a $27.3 million decrease in same-store base rental revenues driven by decreased active store members partially offset by price increases primarily on catalog inventory in certain stores and implementation of additional daily rate (“ADR”), described below;

•

a $24.9 million decrease in by-mail revenues as a result of a 29.3% decline in average by-mail subscribers;

•

a decline in company-operated stores of 727, or 19.4%, during the last four quarters; and

•

a $39.4 million decline in PRP revenues, driven by lower per unit prices as well as fewer auto-sales and re-stocking fees as a result fewer stores.

•

On March 1, 2010, we implemented a new policy in our company-operated stores, whereby ADR is charged for each day a member chooses to keep the rental following the initial rental period. The member will be charged the additional daily rate for up to 10 days, then the rental will be converted to an automatic sale. ADR and extended viewing fees were $58.2 million and $14.9 million during the second quarter of 2010 and 2009, respectively. We expect that future revenues generated from ADR charges will represent a larger percentage of domestic rental revenue than it has in previous periods.

•

Although we expect the in-store movie rental industry to continue declining in 2010, the factors we expect to mitigate these challenges are modification of our domestic stores’ movie rental terms and pricing, implementation of studio windows, industry factors such as Hollywood/Movie Gallery store closures, better execution of our rental games offering, a balanced slate of movie releases and merchandising improvements including Blockbuster Premieres.

Domestic—Merchandise sales

•

Merchandise sales decreased mainly as a result of:

•

a $6.3 million decrease in same-store game sales as a result of a significant reduction in games merchandise inventory levels and reduced store traffic;

•

a $15.2 million bulk sale of games to a third-party game wholesaler during the second quarter of 2009, as opposed to an $11.5 million bulk sale of games to a third party during the second quarter of 2010; and

•

a decline in company-operated stores discussed above;

•

partially offset by higher per-unit prices.

Domestic—Cost of sales

•

Rental cost of goods sold decreased due to:

•

reduced estimated costs for our by-mail offering of $14.9 million due to reduced product purchases and lower shipping costs, resulting from the decline in by-mail subscribers as well as fewer free in-store exchanges for Total Access customers;

•

reduced sales;

•

a decrease in rental inventory purchases; and

•

a reduction in PRP cost of goods sold due to lower inventory carrying values and reduced sales mentioned above.

•

Merchandise cost of goods sold decreased $23.1 million due to the decline in sales mentioned above.

Domestic—Gross profit

•

Rental gross margin percentage remained relatively flat over prior year.

•

Merchandise gross margin improved from 19.2% to 27.4% due mainly to a $7.7 million gain on the bulk sale of games to a third party in the second quarter of 2010, versus a net gain of only $2.7 million recorded for a bulk sale of games in the second quarter of 2009.

Domestic—Operating expenses

•

Store general and administrative expense decreased $34.2 million mainly due to our focus on cost-savings measures, which include reducing store labor hours, renegotiating leases and closing less profitable stores.

•

Corporate and field general and administrative expense, which includes expenses incurred at the field and regional levels for store operations along with our by-mail offering, decreased $11.0 million primarily due to our cost-savings measures.

•

During the second quarter, we closed 219 domestic company-operated stores and recorded $14.2 million in store closure expenses, excluding depreciation. We do not currently plan to close a significant number of our domestic stores in the remainder of 2010.

•

Advertising expense decreased $14.9 million as a result of decreased general advertising in the second quarter.

International Segment. The following table is a summary of international results of operations.


	Thirteen Weeks Ended July 4, 2010					Thirteen Weeks Ended July 5, 2009				Increase/(Decrease)
	Amount			Percent of Revenue		Amount		Percent of Revenue		Dollar			Percent
Revenues:
Rental revenues:
Movies	$	108.2		43.6	%	$	126.0	46.8	%	$	(17.8	)	(14.1	)%
Games		12.1		4.9	%		12.2	4.5	%		(0.1	)	(0.8	)%
PRP		25.8		10.4	%		23.6	8.7	%		2.2		9.3	%

Total rental revenues		146.1		58.9	%		161.8	60.0	%		(15.7	)	(9.7	)%

Merchandise sales:
Movies		29.7		12.0	%		28.8	10.6	%		0.9		3.1	%
Games		46.2		18.6	%		52.9	19.6	%		(6.7	)	(12.7	)%
General merchandise		24.8		10.0	%		25.5	9.5	%		(0.7	)	(2.7	)%

Total merchandise sales		100.7		40.6	%		107.2	39.7	%		(6.5	)	(6.1	)%

Royalties and other		1.2		0.5	%		0.8	0.3	%		0.4		50.0	%

Total revenues		248.0		100.0	%		269.8	100.0	%		(21.8	)	(8.1	)%

Cost of sales:
Cost of rental revenues		52.9		21.3	%		53.8	20.0	%		(0.9	)	(1.7	)%
Cost of merchandise sold		76.4		30.8	%		79.1	29.3	%		(2.7	)	(3.4	)%

		129.3		52.1	%		132.9	49.3	%		(3.6	)	(2.7	)%

Gross profit		118.7		47.9	%		136.9	50.7	%		(18.2	)	(13.3	)%

Operating expenses:
General and administrative		118.8		47.9	%		122.3	45.3	%		(3.5	)	(2.9	)%
Advertising		5.0		2.0	%		5.4	2.0	%		(0.4	)	(7.4	)%
Depreciation and intangible amortization		5.9		2.4	%		6.7	2.5	%		(0.8	)	(11.9	)%

		129.7		52.3	%		134.4	49.8	%		(4.7	)	(3.5	)%

Operating income (loss)	$	(11.0	)	(4.4	)%	$	2.5	0.9	%	$	(13.5	)	(540.0	)%

EBITDA (2)	$	(5.1	)	(2.1	)%	$	9.2	3.4	%	$	(14.3	)	(155.4	)%

Margins:
Rental margin	$	93.2		63.8	%	$	108.0	66.7	%	$	(14.8	)	(13.7	)%
Merchandise margin	$	24.3		24.1	%	$	28.1	26.2	%	$	(3.8	)	(13.5	)%
Gross margin	$	118.7		47.9	%	$	136.9	50.7	%	$	(18.2	)	(13.3	)%


	Thirteen Weeks Ended July 4, 2010		Thirteen Weeks Ended July 5, 2009
Same-store revenues increase/(decrease) (1)
Rental revenues	(11.8	)%	(1.2	)%
Merchandise revenues	(4.1	)%	(14.3	)%
Total revenues	(8.8	)%	(7.1	)%

(1)	Changes in international same-store revenues do not include the impact of foreign currency exchange.

(2)	EBITDA is a non-GAAP financial measure. See “Non-GAAP Information—Reconciliation of EBITDA” that follows.

International—Rental revenues

•

Rental revenues decreased primarily due to:

•

a same-store movie rental decrease of 15.4%, with Canada and the United Kingdom contributing the majority of the decrease, driven by reduced traffic; and

•

a decline in company-operated stores of 268, or 14.1%, during the last four quarters; and

•

a $7.1 million decrease in ADR and extended viewing fees driven by reduced traffic discussed above;

•

offset by a favorable foreign currency exchange impact of $5.4 million, with Canada and the United Kingdom contributing the majority of the impact.

•

ADR and extended viewing fees were $16.7 million and $23.8 million during the second quarter of 2010 and 2009, respectively.

International—Merchandise sales

•

Merchandise sales decreased primarily due to:

•

a same-store game sales decrease of 9.1%, with decreased sales in the United Kingdom and Canada offset by Mexico due to increased competition offering lower prices; and

•

the reduced store count discussed above;

•

offset by a favorable foreign currency exchange impact of $0.1 million.

International—Cost of sales

•

We experienced a decrease in rental and merchandise cost of sales primarily due to the decrease in sales discussed above;

•

offset by an unfavorable foreign currency exchange impact of $2.3 million, with Canada and the United Kingdom contributing the majority of the impact;

International—Gross margin

•

Rental margin and merchandise gross margins remained relatively flat due to the decreases in sales and foreign currency exchange impacts discussed above.

International—Operating expenses

•

Operating expenses decreased primarily due to:

•

a $3.6 million decrease in compensation expense due to a reduction in head count, excluding the impact of foreign currency exchange; and

•

a $3.0 million decrease in occupancy expense driven by our decline in store count discussed above, excluding the impact of foreign currency exchange;

•

offset by a $1.2 million increase in general and administrative costs, excluding the impact of foreign currency exchange; and

•

an unfavorable foreign currency exchange impact of $2.8 million.

Unallocated Corporate. The following table is a summary of corporate operating expenses that are not allocated to either business segment.


	Thirteen Weeks Ended				Increase/(Decrease)
	July 4, 2010		July 5, 2009		Dollar			Percent
General and administrative	$	26.2	$	31.3	$	(5.1	)	(16.3	)%
Depreciation and intangible amortization		2.5		1.4		1.1		78.6	%

Operating expenses	$	28.7	$	32.7	$	(4.0	)	(12.2	)%

Operating expenses decreased primarily due to:

•

a decrease in general and administrative expense due to:

•

a $4.1 million decrease in corporate compensation expense, primarily driven by a reduction in head count, a decline in non-store personnel severance and reduced stock compensation expense of $1.7 million; and

•

a $1.1 million decrease in professional fees, due primarily to our cost-savings measures offset partially by increased professional fees related to our recapitalization activities.

•

We expect to incur significant professional fees associated with our recapitalization activities in the remainder of 2010, but cannot reasonably estimate the amount at this time.

Additional Consolidated Results.

•

Interest expense increased $3.3 million.

•

Expense for interest payments increased due to higher average interest rates and higher average debt balances on our long-term debt during the quarter;

•

offset by a $4.0 million decrease in non-cash interest related to the amortization of debt financing costs and amortization of discount on the Senior Secured Notes.

Twenty-Six Weeks Ended July 4, 2010 Compared with Twenty-Six Weeks Ended July 5, 2009

Domestic Segment. The following table is a summary of domestic stores results of operations.


	Twenty-Six Weeks Ended July 4, 2010				Twenty-Six Weeks Ended July 5, 2009				Increase/(Decrease)
	Amount		Percent of Revenue		Amount		Percent of Revenue		Dollar			Percent
Revenues:
Rental revenues:
Movies	$	761.7	64.0	%	$	968.8	63.9	%	$	(207.1	)	(21.4	)%
Games		85.1	7.2	%		101.7	6.7	%		(16.6	)	(16.3	)%
Previously rented product (“PRP”)		164.6	13.9	%		222.1	14.6	%		(57.5	)	(25.9	)%

Total rental revenues		1,011.4	85.1	%		1,292.6	85.2	%		(281.2	)	(21.8	)%

Merchandise sales:
Movies		70.4	5.9	%		85.3	5.5	%		(14.9	)	(17.5	)%
Games		19.3	1.6	%		43.3	2.9	%		(24.0	)	(55.4	)%
General merchandise		80.3	6.8	%		87.4	5.8	%		(7.1	)	(8.1	)%

Total merchandise sales		170.0	14.3	%		216.0	14.2	%		(46.0	)	(21.3	)%

Royalties and other		6.7	0.6	%		9.6	0.6	%		(2.9	)	(30.2	)%

Total revenues		1,188.1	100.0	%		1,518.2	100.0	%		(330.1	)	(21.7	)%

Cost of sales:
Cost of rental revenues		381.0	32.0	%		484.7	32.0	%		(103.7	)	(21.4	)%
Cost of merchandise sold		131.3	11.1	%		193.4	12.7	%		(62.1	)	(32.1	)%

		512.3	43.1	%		678.1	44.7	%		(165.8	)	(24.5	)%

Gross profit		675.8	56.9	%		840.1	55.3	%		(164.3	)	(19.6	)%

Operating expenses:
General and administrative:
Stores		552.2	46.5	%		601.9	39.6	%		(49.7	)	(8.3	)%
Corporate and field		57.3	4.8	%		72.8	4.8	%		(15.5	)	(21.3	)%

Total general and administrative		609.5	51.3	%		674.7	44.4	%		(65.2	)	(9.7	)%

Advertising		19.5	1.6	%		25.9	1.7	%		(6.4	)	(24.7	)%
Depreciation and intangible amortization		36.9	3.1	%		50.1	3.3	%		(13.2	)	(26.3	)%

		665.9	56.1	%		750.7	49.4	%		(84.8	)	(11.3	)%

Operating income (loss)	$	9.9	0.8	%	$	89.4	5.9	%	$	(79.5	)	(88.9	)%

EBITDA (1)	$	46.8	3.9	%	$	139.5	9.2	%	$	(92.7	)	(66.5	)%

Margins:
Rental margin	$	630.4	62.3	%	$	807.9	62.5	%	$	(177.5	)	(22.0	)%
Merchandise margin	$	38.7	22.8	%	$	22.6	10.5	%	$	16.1		71.2	%
Gross margin	$	675.8	56.9	%	$	840.1	55.3	%	$	(164.3	)	(19.6	)%


	Twenty-Six Weeks Ended July 4, 2010		Twenty-Six Weeks Ended July 5, 2009
Same-store revenues increase/(decrease)
Rental revenues	(7.6	)%	(12.8	)%
Merchandise revenues	(17.3	)%	(21.5	)%
Total revenues	(9.2	)%	(14.2	)%
Other:
Ending by-mail subscriber count	1.2		1.6

(1)	EBITDA is a non-GAAP financial measure. See “Non-GAAP Information—Reconciliation of EBITDA” that follows.

Domestic—Rental revenues

•

Rental revenues decreased mainly as a result of:

•

a $56.9 million decrease in same-store base rental revenues driven by a decrease in active store members partially offset by price increases primarily on catalog inventory in certain stores and implementation of additional daily rate (“ADR”), described below;

•

a $57.1 million decrease in by-mail revenues as a result of a 29.2% decline in average by-mail subscribers;

•

a decline in company-operated stores of 727, or 19.43%, during the last four quarters; and

•

a decline in PRP revenues as a result of heavily discounted prices in stores which were being liquidated during the first quarter of 2010, partially offset by an increase in units sold and reduced store traffic and lower per unit prices during the second quarter of 2010.

•

On March 1, 2010, we implemented a new policy in our company-operated stores, where ADR is charged for each day a member chooses to keep the rental following the initial rental period. The member will be charged the additional daily rate for up to 10 days, then after, the rental will be converted to an automatic sale. ADR and extended viewing fees were $91.9 million and $28.6 million during the first half of 2010 and 2009, respectively. We expect that future revenues generated from ADR charges will represent a larger percentage of domestic rental revenue than it has in previous periods.

•

Although we expect the in-store movie rental industry to continue declining in 2010, the factors we expect to mitigate these challenges are modification of our domestic stores movie rental terms and pricing, implementation of studio windows, industry factors such as Hollywood/Movie Gallery store closures, better execution of our rental games offering, a balanced slate of movie releases and merchandising improvements including Blockbuster Premieres.

Domestic—Merchandise sales

•

Merchandise sales decreased mainly as a result of:

•

a $20.3 million decrease in same-store game sales as a result of a significant reduction in games merchandise inventory levels and reduced store traffic;

•

a $14.9 million decrease in movie sales due primarily to price reductions in the current year on select titles and reduced inventory levels;

•

a $2.2 million decline in same-store sales of general merchandise primarily resulting from lower unit prices and reduced inventory levels; and

•

a decline in company-operated stores discussed above;

Domestic—Cost of sales

•

Rental cost of goods sold decreased due to:

•

reduced estimated costs for our by-mail offering of $39.8 million due to reduced product purchases and lower shipping costs, resulting from the decline in by-mail subscribers as well as fewer free in-store exchanges for Total Access customers; and

•

a decrease in sales discussed above; offset by

•

non-recurring contractual settlements with vendors in the first quarter of prior year of $3.3 million.

•

Merchandise cost of goods sold decreased $62.1 million due to the decline in sales and company-operated stores mentioned above and a $16.7 million obsolescence adjustment in the first quarter of 2009 for price reductions related to the bulk sale of games to a third-party wholesaler offset by an increase in consignment cost of sales.

Domestic—Gross profit

•

Rental gross margin percentage remained relatively flat over prior year.

•

Merchandise gross margin increased from 10.5% to 22.8% primarily due to the $7.7 million gain on bulk sale of games to a third party in the second quarter of 2010, versus the $14.0 million net loss on the bulk sale of games to a third party in the first half of 2009.

Domestic—Operating expenses

•

Store general and administrative expense decreased $49.7 million mainly due to our focus on cost-savings measures, which include reducing store labor hours, renegotiating leases and closing less profitable stores.

•

Corporate and field general and administrative expense, which includes expenses incurred at the field and regional levels for store operations along with our by-mail offering, decreased $15.5 million primarily due to our cost-savings measures.

•

During the first half of 2010, we closed 507 domestic company-operated stores and recorded $34.5 million in store closure expenses, excluding depreciation.

•

Advertising expense decreased $6.4 million as a result of decreased general advertising in the second quarter offset by increased advertising for our online operations and general advertising early in the first quarter.

International Segment. The following table is a summary of international results of operations.


	Twenty-Six Weeks Ended July 4, 2010					Twenty-Six Weeks Ended July 5, 2009				Increase/ (Decrease)
	Amount			Percent of Revenue		Amount		Percent of Revenue		Dollar			Percent
Revenues:
Rental revenues:
Movies	$	237.0		44.0	%	$	248.4	45.2	%	$	(11.4	)	(4.6	)%
Games		24.9		4.6	%		24.2	4.4	%		0.7		2.9	%
PRP		52.6		9.7	%		49.7	9.0	%		2.9		5.8	%

Total rental revenues		314.5		58.3	%		322.3	58.6	%		(7.8	)	(2.4	)%

Merchandise sales:
Movies		66.0		12.3	%		61.9	11.3	%		4.1		6.6	%
Games		105.2		19.5	%		112.1	20.4	%		(6.9	)	(6.2	)%
General merchandise		51.5		9.5	%		51.6	9.4	%		(0.1	)	(0.2	)%

Total merchandise sales		222.7		41.3	%		225.6	41.1	%		(2.9	)	(1.3	)%

Royalties and other		2.4		0.4	%		1.6	0.3	%		0.8		50.0	%

Total revenues		539.6		100.0	%		549.5	100.0	%		(9.9	)	(1.8	)%

Cost of sales:
Cost of rental revenues		113.6		21.1	%		106.1	19.4	%		7.5		7.1	%
Cost of merchandise sold		168.0		31.1	%		167.3	30.4	%		0.7		0.4	%

		281.6		52.2	%		273.4	49.8	%		8.2		3.0	%

Gross profit		258.0		47.8	%		276.1	50.2	%		(18.1	)	(6.6	)%

Operating expenses:
General and administrative		245.5		45.5	%		239.2	43.5	%		6.3		2.6	%
Advertising		10.8		2.0	%		10.2	1.9	%		0.6		5.9	%
Depreciation and intangible amortization		11.9		2.2	%		13.4	2.4	%		(1.5	)	(11.2	)%

		268.2		49.7	%		262.8	47.8	%		5.4		2.1	%

Operating income (loss)	$	(10.2	)	(1.9	)%	$	13.3	2.4	%	$	(23.5	)	(176.7	)%

EBITDA (2)	$	1.7		0.3	%	$	26.7	4.9	%	$	(25.0	)	(93.6	)%

Margins:
Rental margin	$	200.9		63.9	%	$	216.2	67.1	%	$	(15.3	)	(7.1	)%
Merchandise margin	$	54.7		24.6	%	$	58.3	25.8	%	$	(3.6	)	(6.2	)%
Gross margin	$	258.0		47.8	%	$	276.1	50.2	%	$	(18.1	)	(6.6	)%


	Twenty-Six Weeks Ended July 4, 2010		Twenty-Six Weeks Ended July 5, 2009
Same-store revenues increase/(decrease) (1)
Rental revenues	(9.0	)%	(5.1	)%
Merchandise revenues	(4.6	)%	(9.2	)%
Total revenues	(7.2	)%	(6.9	)%

(1)	Changes in international same-store revenues do not include the impact of foreign currency exchange.

(2)	EBITDA is a non-GAAP financial measure. See “Non-GAAP Information—Reconciliation of EBITDA” that follows.

International—Rental revenues

•

Rental revenues decreased primarily due to:

•

a same-store movie rental decrease of 10.9%, with Canada contributing the majority of the decrease, driven by reduced traffic, partially offset by an increase in same-store movie rentals in the United Kingdom and Mexico as a result of a higher volume of transactions; and

•

a decline in company-operated stores of 268, or 14.1%, during the last four quarters; and

•

a $2.5 million decrease in ADR and extended viewing fees, primarily due to the reduced traffic discussed above;

•

offset by a favorable foreign currency exchange impact of $25.2 million, with Canada and the United Kingdom contributing the majority of the impact.

•

ADR and extended viewing fees were $35.9 million and $38.4 million during the first half of 2010 and 2009, respectively.

International—Merchandise sales

•

Merchandise sales decreased primarily due to:

•

a same-store game sales decrease of 8.4%, with decreased sales in all major markets due to increased competition offering lower prices; and

•

the reduced store count discussed above;

•

offset by a favorable foreign currency exchange impact of $11.7 million, with Canada and the United Kingdom contributing the majority of the impact.

International—Cost of sales

•

We experienced an unfavorable foreign currency exchange impact of $18.7 million, with Canada and the United Kingdom contributing the majority of the impact;

•

offset by a decrease in rental and merchandise cost of sales primarily due to the decrease in sales discussed above.

International—Gross margin

•

Rental margin and merchandise gross margin declined primarily due to the decreases in revenues offset by the foreign currency exchange impacts discussed above.

International—Operating expenses

•

Operating expenses increased primarily due to:

•

an unfavorable foreign currency exchange impact of $17.9 million;

•

offset by a $5.0 million decrease in compensation expense due to a reduction in head count, including a $1.5 million increase in severance, excluding the impact of foreign currency exchange;

•

a $4.2 million decrease in occupancy expense driven by our decline in store count discussed above, excluding the impact of foreign currency exchange; and

•

a $2.9 million decrease in depreciation and amortization, excluding the impact of foreign currency exchange.

Unallocated Corporate. The following table is a summary of corporate operating expenses that are not allocated to either business segment.


	Twenty-Six Weeks Ended				Increase/(Decrease)
	July 4, 2010		July 5, 2009		Dollar		Percent
General and administrative	$	62.9	$	51.3	$	11.6	22.6	%
Depreciation and intangible amortization		3.9		2.8		1.1	39.3	%

Operating expenses	$	66.8	$	54.1	$	12.7	23.5	%

Operating expenses increased primarily due to:

•

an increase in general and administrative expense due to:

•

settlement of a $12.6 million future liability for $5.0 million, which resulted in a $7.6 million release of liabilities in the first quarter of 2009;

•

a $5.4 million increase in professional fees due primarily to $9.5 million in professional fees related to our recapitalization activities partially offset by our cost-savings measures; and

•

a $2.8 million increase in corporate compensation expense, driven by non-store personnel severance in the first quarter offset slightly by a reduction in head count and reduced stock compensation expense of $3.3 million.

•

We expect to incur significant professional fees associated with our recapitalization activities in the remainder of 2010, but cannot reasonably estimate the amount at this time.

Additional Consolidated Results.

•

Interest expense increased $19.0 million.

•

Expense for interest payments increased $20.5 million due to higher average interest rates and higher average debt balances on our long-term debt during the quarter;

•

offset by a $0.4 million decrease in non-cash interest related to the amortization of debt financing costs and amortization of discount on the Senior Secured Notes.

Non-GAAP Information—Reconciliation of EBITDA.


	Domestic Stores		International			Unallocated/ Corporate			Total
Reconciliation of EBITDA:
Thirteen Weeks Ended July 4, 2010
Operating income (loss)	$	2.0	$	(11.0	)	$	(28.7	)	$	(37.7	)
Interest (expense) income, net (1)		—		—			(32.0	)		(32.0	)
Other items, net (1)		—		—			0.7			0.7
Provision for income taxes (1)		—		—			0.6			0.6
Income (loss) from discontinued operations, net of tax (1)		—		—			(0.3	)		(0.3	)

Net income (loss)		2.0		(11.0	)		(59.7	)		(68.7	)
Adjustments to reconcile net income (loss) to EBITDA:
Interest (expense) income, net		—		—			32.0			32.0
Other items, net		—		—			(0.7	)		(0.7	)
Provision for income taxes		—		—			(0.6	)		(0.6	)
Income (loss) from discontinued operations, net of tax		—		—			0.3			0.3
Depreciation and intangible amortization		18.1		5.9			2.5			26.5

EBITDA	$	20.1	$	(5.1	)	$	(26.2	)	$	(11.2	)

Thirteen Weeks Ended July 5, 2009
Operating income (loss)	$	28.6	$	2.5		$	(32.7	)	$	(1.6	)
Interest (expense) income, net (1)		—		—			(28.0	)		(28.0	)
Other items, net (1)		—		—			(5.7	)		(5.7	)
Provision for income taxes (1)		—		—			(1.4	)		(1.4	)
Income (loss) from discontinued operations, net of tax (1)		—		—			(0.2	)		(0.2	)

Net income (loss)		28.6		2.5			(68.0	)		(36.9	)
Adjustments to reconcile net income (loss) to EBITDA:
Interest (expense) income, net		—		—			28.0			28.0
Other items, net		—		—			5.7			5.7
Provision for income taxes		—		—			1.4			1.4
Income (loss) from discontinued operations, net of tax		—		—			0.2			0.2
Depreciation and intangible amortization		24.5		6.7			1.4			32.6

EBITDA	$	53.1	$	9.2		$	(31.3	)	$	31.0


	Domestic Stores		International			Unallocated/ Corporate			Total
Reconciliation of EBITDA:
Twenty-Six Weeks Ended July 4, 2010
Operating income (loss)	$	9.9	$	(10.2	)	$	(66.8	)	$	(67.1	)
Interest (expense) income, net (1)		—		—			(65.2	)		(65.2	)
Other items, net (1)		—		—			(0.9	)		(0.9	)
Provision for income taxes (1)		—		—			(0.5	)		(0.5	)
Income (loss) from discontinued operations, net of tax (1)		—		—			(0.4	)		(0.4	)

Net income (loss)		9.9		(10.2	)		(133.8	)		(134.1	)
Adjustments to reconcile net income (loss) to EBITDA:
Interest (expense) income, net		—		—			65.2			65.2
Other items, net		—		—			0.9			0.9
Provision for income taxes		—		—			0.5			0.5
Income (loss) from discontinued operations, net of tax		—		—			0.4			0.4
Depreciation and intangible amortization		36.9		11.9			3.9			52.7

EBITDA	$	46.8	$	1.7		$	(62.9	)	$	(14.4	)

Twenty-Six Weeks Ended July 5, 2009
Operating income (loss)	$	89.4	$	13.3		$	(54.1	)	$	48.6
Interest (expense) income, net (1)		—		—			(45.3	)		(45.3	)
Other items, net (1)		—		—			(6.5	)		(6.5	)
Provision for income taxes (1)		—		—			(6.9	)		(6.9	)
Income (loss) from discontinued operations, net of tax (1)		—		—			0.9			0.9

Net income (loss)		89.4		13.3			(111.9	)		(9.2	)
Adjustments to reconcile net income (loss) to EBITDA:
Interest (expense) income, net		—		—			45.3			45.3
Other items, net		—		—			6.5			6.5
Provision for income taxes		—		—			6.9			6.9
Income (loss) from discontinued operations, net of tax		—		—			(0.9	)		(0.9	)
Depreciation and intangible amortization		50.1		13.4			2.8			66.3

EBITDA	$	139.5	$	26.7		$	(51.3	)	$	114.9

(1)	Management reviews these items on a global basis, not by segment.

We define earnings before interest, taxes, depreciation and amortization (“EBITDA”) as net income (loss) before interest (expense) income, impairment charges, income taxes and depreciation and amortization, as well as discontinued operations and other items, net, which are not included in income (loss) from operations. EBITDA for the first half of fiscal 2010 decreased $129.3 million. This decrease is primarily attributable to the variances discussed above.

EBITDA is not a measure of operating performance or liquidity under US GAAP and should not be considered as substitutes for net income, cash flows from operating activities or other income or cash flow statement data. We have included information concerning EBITDA because we believe investors find this information useful as a reflection of the resources available for strategic opportunities including, among others, to invest in our business, make strategic acquisitions and to service debt. Management also uses EBITDA to review the performance of our business directly resulting from our retail operations and for budgeting and field operations compensation targets.

Liquidity and Capital Resources

General

On October 1, 2009, we completed the sale of $675.0 million aggregate principal amount of 11.75% senior secured notes due 2014 (the “Senior Secured Notes” or the “Notes”) at an issue price of 94.0%. The Notes were sold in a private offering to qualified institutional investors in accordance with Rule 144A, and to persons outside the U.S. pursuant to Regulation S under the Securities Act of 1933, as amended. The Notes are senior secured obligations and are guaranteed by our domestic subsidiaries (the “Guarantors”). The Notes and the guarantees are secured by first-priority liens on substantially all of our assets and the Guarantors’ assets.

We used substantially all of the net proceeds of the Notes to repay all indebtedness outstanding under our revolving credit facility, Term Loan B and our Canadian credit facility, as discussed below, as well as to fund fees and expenses of the transaction. For further detail on the Notes, see discussion under “Senior Secured Notes” below.

•

enhanced payment terms with several of the major studios by granting a lien on and security interest in substantially all of our Canadian assets;

•

optimized our store portfolio by closing 507 underperforming domestic company-operated stores and renegotiated leases on 673 domestic company-operated stores in the first and second quarters of 2010;

•

reduced our inventory levels for movies, games and consumer electronics;

•

eliminated our letter of credit requirements for lease guarantees;

•

reengineered our corporate, field overhead and distribution organizations and processes to increase efficiency and reduce our operating costs.

Other elements of our cash management plan that we continue to pursue include, among other things:

•

managing our working capital through optimization of inventory levels by continuing to sell underperforming rental inventory;

•

further reducing our selling, general and administrative expenses in fiscal 2010;

•

minimizing our capital expenditures to approximately $30 million by eliminating, delaying or curtailing discretionary and non-essential spending for fiscal 2010; and

•

lengthening the cycle of payables to certain vendors.

Additionally, on July 1, 2010, we entered into a forbearance agreement with the holders of approximately 70% of the outstanding principal amount of the Senior Secured Notes (the “Forbearing Holders”), which was subsequently amended and restated on August 12, 2010, whereby such holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the indenture governing the Senior Secured Notes with respect to our failure on July 1, 2010 to redeem a portion of the Senior Secured Notes and to pay interest on the Senior Secured Notes (the “Forbearance Agreement”). Absent any default or the occurrence of certain events, the Forbearance Agreement will be effective until September 30, 2010. See “Item 1A. Risk Factors—We have entered into a forbearance agreement with the holders of our senior secured notes under which such holders have agreed to forbear from taking any action to enforce their rights and remedies in connection with our failure to pay the July 1, 2010 amortization and interest payment obligations under the notes. Should we be in default of the forbearance agreement or should the holders of the notes not agree to further extend such forbearance agreement, the entire amount owed under the senior secured notes could be declared immediately due and payable.”

We are obligated to make the next interest payment on our $300.0 million aggregate principal amount of 9% senior subordinated notes due September 1, 2012 (the “Senior Subordinated Notes”) on September 1, 2010. However, any payment in respect of our Senior Subordinated Notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement and the Forbearing Holders will no longer be obligated to forbear from enforcing their rights and remedies in respect of the amortization and interest payment defaults and would have the ability to declare the entire amount owed under the Senior Secured Notes immediately due and payable. While we have not made a formal determination regarding the September 1, 2010 interest payment on the Senior Subordinated Notes, there is a substantial likelihood that such payment will not be made as scheduled. If we do not make the interest payment on the Senior Subordinated Notes when due and such failure is not remedied within 30 days, the holders of the Senior Subordinated Notes will have the ability to declare the entire amount owed under such notes immediately due and payable. See “Item 1A. Risk Factors—Any payment in respect of our senior subordinated notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement. We are currently obligated to make an interest payment on the senior subordinated notes on September 1, 2010. There is a substantial likelihood that such payment will not be made as scheduled, in which event after a 30-day cure period, the holders of the senior subordinated notes could declare the entire amount owed under such notes immediately due and payable.”

Based on our current internal forecasts, our cash flows over the next 12 months will not be sufficient to fund anticipated cash requirements over the next 12 months for minimum capital expenditures, working capital purposes including rental library purchases, and payments of principal and interest on borrowings including the significant amortization payments required on the Senior Secured Notes and interest payments on the Senior Subordinated Notes. In addition, increased competition continues to make it more difficult to accurately forecast our results of operations and cash position, so our revenues may deteriorate beyond what we anticipate. Our current plan for the remainder of 2010 contemplates a domestic same-store sales decline in the high-single digits. Each 1% change in our domestic same-store rental revenues represents an approximately $10 million change in operating income (loss). A greater same-store sales decline than reflected in our plan would negatively impact our anticipated revenues, results of operations and cash flows. If we cannot meet our capital needs using cash on hand and cash from operations as our current forecasts suggest and are unable to recapitalize our debt and equity structure, we may have to take other actions such as modifying our business plan to close additional stores, pursuing additional external liquidity generating events, seeking additional financing to the extent available, further reducing or delaying capital expenditures or filing for protection under the U.S. Bankruptcy Code. We can give no assurance that we will successfully execute the recapitalization initiatives we are currently pursuing or any others, and our ability to do so could be adversely affected by numerous factors, including changes in the

economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures. It is possible that even a successful and efficient implementation of the recapitalization initiatives we are pursuing will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code. See “Item 1A. Risk Factors—We are currently pursuing certain recapitalization initiatives in an effort to improve our capital structure. It is possible that even a successful and efficient implementation of one or more of these initiatives will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code.”

We rely upon vendor financing in managing our liquidity. As a result, if our trade creditors were to impose unfavorable terms on us, it would negatively impact our ability to obtain products and services on acceptable terms and operate our business. In such event, our ability to maintain optimal product in-stock and availability levels would be adversely affected, and our results of operations and financial performance would suffer. As noted above, we have renegotiated our agreements with certain of our largest vendors and pledged our Canadian assets to help ensure continued supply of product from these vendors.

Adverse future developments regarding our pending and any future legal proceedings and other contingencies may also have a material adverse impact on our liquidity and results of operations. See Note 5 to our consolidated financial statements for further discussion of these items.

Exchange Delisting

On November 17, 2009, we received notice from the Exchange that we were not in compliance with the Exchange’s continued listing standard that requires the average closing price of our common stock to be no less than $1.00 per share over a consecutive 30 trading-day period, and on March 24, 2010, we received notice from the Exchange that we were not in compliance with the Exchange’s continued listing standard that requires our average global market capitalization to be no less than $75 million over a consecutive 30 trading-day period. In an effort to cure these deficiencies, our Board of Directors authorized a conversion of our Class B common stock into Class A common stock as well as a reverse stock split. The conversion and reverse stock split each did not, however, receive the requisite stockholder approval at our 2010 annual meeting of stockholders. As a result, on July 1, 2010, the Exchange notified us that trading on the Exchange of our common stock would be suspended prior to the opening on July 7, 2010. We did not appeal the Exchange’s decision, and they have filed an application with the Securities and Exchange Commission to strike our common stock from listing.

Effective July 7, 2010, our Class A common stock and Class B common stock trade exclusively on the Pink OTCQB market (the “Pink Sheets”) under the symbols BLOKA and BLOKB, respectively. The Pink Sheets is a significantly more limited market than the Exchange, and the quotation of our common stock on the Pink Sheets may result in a less liquid market available for existing and potential stockholders to trade shares of our common stock. This could further depress the trading price of our common stock and could also have a long-term adverse effect on our ability to raise capital. We cannot make assurances as to if or when we will be in a position to relist our common stock on a nationally-recognized securities exchange. See “Item 1A. Risk Factors—Our common stock is no longer listed on a national securities exchange and is quoted only on the Pink Sheets, which could negatively affect our stock price and liquidity.”

Capital Structure


	July 4, 2010		January 3, 2010
Current portion
Senior Secured Notes, interest rate of 11.75%	$	598.2	$	101.6
Current portion of capital lease obligations		5.3		6.1

		603.5		107.7

Non-current portion
Senior Secured Notes, interest rate of 11.75%		—		536.0
Senior Subordinated Notes, interest rate of 9.0%		300.0		300.0

Total long-term debt, less current portion		300.0		836.0
Capital lease obligations, less current portion		16.9		19.9

		316.9		855.9

Total	$	920.4	$	963.6

Senior Secured Notes

As discussed above under “General,” we completed the sale of $675 million aggregate principal amount of our 11.75% Senior Secured Notes on October 1, 2009. We used substantially all of the net proceeds of the Notes to repay all indebtedness outstanding under our revolving credit facility, Term Loan B and our Canadian credit facility, as discussed below, as well as to fund fees and expenses of the transaction. We used the remaining net proceeds for general corporate purposes.

•

sell certain assets which secure the Notes;

•

create liens on certain assets to secure debt;

•

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

•

enter into sale and leaseback transactions.

•

incur additional indebtedness or issue certain preferred shares;

•

pay cash dividends, repurchase our capital stock or make other restricted payments;

•

create liens on certain assets to secure debt;

•

make certain investments;

•

make capital expenditures in excess of $70 million in fiscal 2010 and $80 million each following year through fiscal 2014;

•

agree to certain restrictions on the ability of restricted subsidiaries to make payments to us;

•

enter into certain transactions with our affiliates; and

•

designate our subsidiaries as Unrestricted Subsidiaries.

The following table sets forth the quarterly minimum principal payments on our long-term debt as of July 4, 2010. These payments do not include interest or redemption premiums on the Mandatory Redemptions.


	Senior Secured Notes		Senior Subordinated Notes		Total Payments Due
Remainder of 2010:
Third quarter		45.0		—		45.0
Fourth quarter		22.5		—		22.5

	$	67.5	$	—	$	67.5

Fiscal 2011:
First quarter	$	22.5	$	—	$	22.5
Second quarter		22.5		—		22.5
Third quarter		22.5		—		22.5
Fourth quarter		22.5		—		22.5

	$	90.0	$	—	$	90.0

Fiscal 2012:
First quarter	$	22.5	$	—	$	22.5
Second quarter		22.5		—		22.5
Third quarter		—		300.0		300.0
Fourth quarter		45.0		—		45.0

	$	90.0	$	300.0	$	390.0

Fiscal 2013:
First quarter	$	22.5	$	—	$	22.5
Second quarter		22.5		—		22.5
Third quarter		22.5		—		22.5
Fourth quarter		22.5		—		22.5

	$	90.0	$	—	$	90.0

Fiscal 2014:
First quarter	$	22.5	$	—	$	22.5
Second quarter		22.5		—		22.5
Third quarter		247.5		—		247.5
Fourth quarter		—		—		—

	$	292.5	$	—	$	292.5

On July 1, 2010, we entered into a Forbearance Agreement with holders of approximately 70% of the outstanding principal amount of the Notes (the “Forbearing Holders”), which was subsequently amended and restated on August 12, 2010. Based on the terms of the Forbearance Agreement, the Forbearing Holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the Indenture with respect to our failure on July 1, 2010, (i) to redeem a portion of the Notes pursuant to the Indenture and the Notes (the “Amortization Payment Default”) and (ii) to pay interest on the Notes (the “Interest Payment Default”). The Forbearance Agreement is effective until the earliest of (i) September 30, 2010, (ii) the occurrence or existence of any Default or Event of Default (each as defined in the Indenture) other than the Amortization Payment Default or Interest Payment Default, and (iii) the occurrence of certain other events as described in the Forbearance Agreement. The Forbearance Agreement contains covenants by us to, among other things: (i) retain and continue to employ a chief restructuring officer who will assist with all restructuring initiatives, and (ii) provide to the Trustee and to counsel and the financial advisors to the Forbearing Holders (a) a 13-week treasury cash flow forecast no later than Thursday of each week, (b) executive summary reports no later than Thursday of each week, and (c) periodic financial reports each month no later than twenty-one days

after the end of the prior month. We also agreed to weekly telephonic and written communication with counsel and the financial advisors to the Forbearing Holders to review, among other things, the weekly reports and to provide updates on strategic processes. As we would not have been in compliance with the terms of the Indenture absent the Forbearance Agreement and would have been unable to comply with the terms of the original forbearance terms without the extension obtained on August 12, 2010, we have reclassified all the remaining carrying amount and debt issue costs related to the Senior Secured Notes from non-current to current as of July 4, 2010. As of July 4, 2010, unamortized debt issue costs for the Senior Secured Notes were $20.1 million and are classified as “Prepaid and other current assets.” If the Senior Secured Notes are refinanced in a transaction that is required to be accounted for as an extinguishment of debt or the outstanding balance is called by the noteholders, unamortized debt costs at the refinancing or demand date would be required to be expensed in the period of refinancing or demand. See “Item 1A. Risk Factors—We have entered into a forbearance agreement with the holders of our senior secured notes under which such holders have agreed to forbear from taking any action to enforce their rights and remedies in connection with our failure to pay the July 1, 2010 amortization and interest payment obligations under the notes. Should we be in default of the forbearance agreement or should the holders of the notes not agree to further extend such forbearance agreement, the entire amount owed under the senior secured notes could be declared immediately due and payable.”

The Notes were not registered under the Securities Act and, unless so registered, may not be offered or sold in the United States absent an applicable exemption from registration requirements.

See “Item 1A. Risk Factors—We are currently pursuing certain recapitalization initiatives in an effort to improve our capital structure. It is possible that even a successful and efficient implementation of one or more of these initiatives will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code.” See also “Item 1A. Risk Factors—Risks Relating to Our Liquidity and Indebtedness” included in our Annual Report on Form 10-K for the fiscal year ended January 3, 2010 for further information.

Senior Subordinated Notes

Amended Credit Facility and Cash Collateralized Letters of Credit

certain financial and other covenants in our credit facility (the “Amended Revolver”). Borrowings under the Amended Revolver bore interest at an alternate base rate (with a floor of 4.5%) plus 9% or at LIBOR (with a floor of 3.5%) plus 10%, at our discretion, which interest payments were due and payable monthly. On May 11, 2009, the Amended Revolver was closed and funded.

Concurrently with the closing of the sale of the Senior Secured Notes and the repayment of our revolving credit facility and Term Loan B on October 1, 2009, we entered into a second amendment agreement to our credit agreement (the “Amendment”), pursuant to which all liens securing the Amended Revolver were released, except for the cash collateral securing outstanding letters of credit. Pursuant to the Amendment, the credit agreement was converted to a letter of credit facility. The letters of credit outstanding under the Amended Revolver remain outstanding, but all financial and substantially all negative covenants in the credit agreement have been eliminated (although the credit agreement continues to have customary covenants, events of default and other provisions applicable to letter of credit facilities of this type). The existing letters of credit thereunder will continue to be secured by cash collateral to the extent such letters of credit remain outstanding. All letters of credit under our credit agreement are currently scheduled to expire between August 12, 2010 and November 15, 2010, although the credit agreement provides for the extension, amendment or renewal of certain of such letters of credit.

Consolidated Cash Flows

Operating Activities. Net cash flows from operating activities decreased $114.6 million to $87.6 million of cash used in operating activities in the first half of 2010 from $27.0 million of cash provided by operating activities in the first half of 2009, primarily due to cash used to fund losses from operations.

•

Net income adjusted for non-cash items decreased $149.7 million, driven by a decline in gross profit.

•

Purchases of rental and merchandise inventories decreased due to a decrease in store customer traffic and fewer company operated stores.

•

Payables and accrued liabilities decreased $173.3 million in the first half of 2010 as compared to $303.0 million in the first half of 2009, due to a significant paydown of vendor balances in the first quarter of 2009.

Investing Activities. Net cash flows from investing activities increased $150.5 million to $13.3 million of cash provided by investing activities in the first half of 2010 from $137.2 million used in investing activities in the first half of 2009, due mainly to changes in restricted cash.

Financing Activities. Net cash flows from financing activities decreased $100.9 million to $47.9 million of cash used in financing activities in the first half of 2010 from $53.0 million of cash provided by financing activities in the first half of 2009. This change was primarily due to:

•

net proceeds of $100.3 million from our revolving credit agreement in the first half of 2009 as compared to $45.0 million repayments on our Senior Secured Notes in the first quarter of 2010;

•

partially offset by a $40.3 million decrease in cash paid for debt financing costs related to our debt refinancing in May 2009.

Other Information

Recent Accounting Pronouncements

See Note 1 to the consolidated financial statements for a discussion of recently issued accounting pronouncements.

Disclosure Regarding Forward-Looking Information

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may also be included from time to time in our other public filings, press releases, our website and oral and written presentations by management. 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 “may,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “projects,” “targets,” “seeks,” “could,” “intends,” “foresees” or the negative of such terms or other variations on such terms or comparable terminology. Similarly, statements that describe our strategies, initiatives, objectives, plans or goals are forward-looking.

These forward-looking statements are based on management’s current intent, belief, expectations, estimates and projections regarding our company and our industry. These statements are not guarantees of future performance and involve risks, uncertainties, assumptions and other factors that are difficult to predict and that could cause actual results to vary materially from what is expressed in or indicated by such forward-looking statements. In that event, our business, financial condition, results of operations or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments. These risks, uncertainties, assumptions and other factors include, among others:

(i)

We are currently pursuing certain recapitalization initiatives. We can give no assurance that we will successfully execute these recapitalization initiatives or any others, and our ability to do so could be adversely affected by numerous factors, including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures. It is possible that even a successful and efficient implementation of the recapitalization initiatives we are pursuing will require us to make a pre-packaged, pre-arranged or other type of filing for protection under Chapter 11 of the U.S. Bankruptcy Code. Our seeking relief under the U.S. Bankruptcy Code, whether or not such relief leads to a quick emergence from Chapter 11, could materially adversely affect the relationships between us and our existing and potential customers, employees, suppliers, partners and others, and could result in very little recovery to our existing security holders. Further, our ability to timely and efficiently emerge from Chapter 11 could be negatively impacted by inter-creditor disputes and other contingencies beyond our control, and our business model upon emergence from a bankruptcy filing may be altered. If we were unable to implement a plan of reorganization or if sufficient debtor-in-possession financing were not available, we could also be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code.

(ii)

The increasingly competitive industry conditions under which we operate has negatively impacted our results of operations and cash flows and may continue to in the future. These factors have raised substantial doubt about our ability to continue as a going concern.

(iii)

The Senior Secured Notes and Senior Subordinated Notes require significant amortization and other debt service payments. We may not be able to make such payments as they become due, which would result in an event of default under the indentures governing such notes. Were this to occur, we might not have, or be able to obtain sufficient cash to pay our accelerated indebtedness.

(iv)

If our operating results decline we may not be able to generate sufficient cash flows to meet our liquidity needs.

(v)

Our level of indebtedness may make it more difficult for us to pay our debts as they become due and more necessary for us to divert our cash flow from operations to debt service payments.

(vi)

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control, and any failure to meet our debt service obligations could harm our business, financial condition and results of operations.

(vii)

Restrictive covenants in the indenture governing our Senior Subordinated Notes and the indenture governing the Senior Secured Notes may limit our current and future operations, particularly our ability to respond to changes in our business or to pursue our business strategies.

(viii)

Past and potential further downgrades in our debt ratings may adversely affect our margins, liquidity, competitive position and access to capital markets.

(ix)

The tightening or elimination of credit terms by studios could result in increased up-front cash commitments that we may be unable to sustain on a long-term basis and adversely impact optimal product in-stock and availability levels.

(x)

Revenues generated from our in-store home video and game rentals and sales are projected to continue to decline. Such decline has in the past and may in the future adversely affect our business and our ability to implement our strategic initiatives, particularly when considering sustained decreases in consumer spending attributable to the unprecedented decline in overall economic conditions, the reversal of which cannot be accurately determined.

(xi)

We may not achieve all of the expected benefits from our cost saving initiatives.

(xii)

Our common stock is no longer listed on a national securities exchange and is quoted only on the Pink Sheets, which may negatively affect on our stock price and liquidity.

(xiii)

The loss of key management personnel and possible difficulties in retaining or replacing such personnel under current circumstances could affect our ability to achieve our operational goals and cost saving initiatives.

(xiv)

Other factors which may have material adverse effects, as described in our filings with the Securities and Exchange Commission, including the detailed factors discussed under the heading “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended January 3, 2010.

Readers of this report are cautioned not to place undue reliance on these forward-looking statements because, while we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate. Further, the forward-looking statements included in this report and those included from time to time in our other public filings, press releases, our website and oral and written presentations by management are only made as of the respective dates thereof, and we undertake no obligation to update publicly any forward-looking statement in this report or in other documents, our website or oral statements for any reason, even if new information becomes available or other events occur in the future.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to various market risks including interest rates on our debt and foreign exchange rates, and we monitor these risks throughout the normal course of business. Significant fluctuations in our interest rates or foreign exchange rates could cause us to adjust our financing and operating strategies to mitigate these risks. As of July 4, 2010 and July 5, 2009, we did not have any interest rate or foreign exchange hedging instruments in place.

Interest Rate Risk

On October 1, 2009, we issued fixed rate senior secured debt and repaid all of our variable rate debt under our credit facilities. As we no longer have the ability to borrow variable rate debt under our credit facilities, we have no significant market interest rate risk impacting our future results of operations, financial position and cash flows.

Foreign Exchange Risk

Operating in international markets involves exposure to movements in currency exchange rates. Currency exchange rate movements typically also reflect economic growth, inflation, interest rates, government actions and other factors. As currency exchange rates fluctuate, translation of the statements of operations of our international businesses into U.S. dollars may affect year-over-year comparability and could cause us to adjust our financing and operating strategies. Revenues would have decreased by $5.5 million and $37.0 million and operating income would have decreased by $0.3 million and $0.4 million, respectively, for the thirteen and twenty-six weeks ended July 4, 2010 if foreign exchange rates for the quarter had been consistent with exchange rates in the prior year.

Our operations outside the United States, mainly in Europe and Canada, constituted 31.5% and 27.5% of our total revenues for the thirteen weeks ended July 4, 2010 and July 5, 2009, respectively, and 31.2% and 26.6% of our total revenues for the twenty-six weeks ended July 4, 2010 and July 5, 2009, respectively. Consequently, we have foreign exchange rate exposure to movements in exchange rates primarily for the British Pound, the Euro and the Canadian Dollar.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) designed to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s (“SEC”) rules and forms, and that this information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that, because of inherent limitations, our disclosure controls and procedures, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the disclosure controls and procedures are met.

In connection with the preparation of this Quarterly Report on Form 10-Q, our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as required by Rule 13a-15(b) of the Exchange Act), as of July 4, 2010. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) were effective to provide reasonable assurance as of July 4, 2010.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting that occurred during the thirteen weeks ended July 4, 2010 that has materially affected, or is likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1.

Legal Proceedings

Information regarding our material legal proceedings is set forth in Note 5 to our consolidated financial statements, “Commitments and Contingencies,” in Item 1 of Part I of this Quarterly Report on Form 10-Q, which information is incorporated herein by reference.

Item 1A.

Risk Factors

The risk factors set forth below should be read in conjunction with “Risks Relating to Our Liquidity and Indebtedness,” “Risks Relating to Our Business Operations,” “Risks Relating to Our Common Stock,” and “Other Business Risks” as discussed in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended January 3, 2010.

We are currently pursuing certain recapitalization initiatives in an effort to improve our capital structure. It is possible that even a successful and efficient implementation of one or more of these initiatives will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

We are experiencing liquidity constraints and have amortization and other debt service requirements. As such, we are currently in discussions with our senior secured and senior subordinated noteholders as well as other strategic parties in an effort to restructure our balance sheet and acquire additional capital funding. We can give no assurance that we will successfully execute the recapitalization initiatives we are currently pursuing or any others, and our ability to do so could be adversely affected by numerous factors, including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures. It is possible that even a successful implementation of the recapitalization initiatives we are pursuing will require us to make a filing for protection under Chapter 11 of the U.S. Bankruptcy Code. Our seeking relief under the U.S. Bankruptcy Code, whether or not such relief leads to a quick emergence from Chapter 11, could materially adversely affect the relationships between us and our existing and potential customers, employees, suppliers, partners and others, and could result in very little recovery to our existing security holders. Further, our ability to timely and efficiently emerge from Chapter 11 could be negatively impacted by inter-creditor disputes and other contingencies beyond our control, and our business model upon emergence from a bankruptcy filing may be altered. If we were unable to implement a plan of reorganization or if sufficient debtor-in-possession financing were not available, we could also be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code.

We have entered into a forbearance agreement with the holders of our senior secured notes under which such holders have agreed to forbear from taking any action to enforce their rights and remedies in connection with our failure to pay the July 1, 2010 amortization and interest payment obligations under the notes. Should we be in default of the forbearance agreement or should the holders of the notes not agree to further extend such forbearance agreement, the entire amount owed under the senior secured notes could be declared immediately due and payable.

On July 1, 2010, we entered into a forbearance agreement with the holders of approximately 70% of the outstanding principal amount of our senior secured notes (the “Forbearing Holders”), which was subsequently amended and restated on August 12, 2010 (the “Forbearance Agreement”). Based on the terms of the Forbearance Agreement, the Forbearing Holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the indenture governing the notes with respect to our failure on July 1, 2010, (i) to redeem a portion of the notes pursuant to the indenture and the notes (the “Amortization Payment Default”) and (ii) to pay interest on the notes (the “Interest Payment Default”). The Forbearance Agreement is effective until the earliest of (i) September 30, 2010, (ii) the occurrence or existence of any Default or Event of Default (each as defined in the indenture governing the notes) other than the Amortization Payment

Default or Interest Payment Default, and (iii) the occurrence of certain other events as described in the Forbearance Agreement. In the event that we default under, or are unable to obtain a further extension of, the Forbearance Agreement, the entire amount owed under the senior secured notes could be declared immediately due and payable. If this amount is accelerated, we cannot assure you that our assets will be sufficient to repay in full the money owned to our debt holders. If we are unable to repay our debt upon an acceleration event, we may be forced to file for protection under the U.S. Bankruptcy Code.

Any payment in respect of our senior subordinated notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement. We are currently obligated to make an interest payment on the senior subordinated notes on September 1, 2010. There is a substantial likelihood that such payment will not be made as scheduled, in which event after a 30-day cure period, the holders of the senior subordinated notes could declare the entire amount owed under such notes immediately due and payable.

Any payment in respect of our senior subordinated notes during the term of the Forbearance Agreement will constitute a termination event under the Forbearance Agreement and the Forbearing Holders will no longer be obligated to forbear from enforcing their rights and remedies in respect of the Amortization Payment Default and the Interest Payment Default and would have the ability to declare the entire amount owed under the senior secured notes immediately due and payable. While we have not made a formal determination regarding the September 1, 2010 interest payment on the senior subordinated notes, there is a substantial likelihood that such payment will not be made as scheduled. If we do not make the interest payment on the senior subordinated notes when due and such failure is not remedied within 30 days, the holders of such notes will have the ability to declare the entire amount owed under the notes immediately due and payable. If this amount is accelerated, we cannot assure you that our assets will be sufficient to repay in full the money owned to our debt holders. If we are unable to repay our debt upon an acceleration event, we may be forced to file for protection under the U.S. Bankruptcy Code.

Our common stock is no longer listed on a national securities exchange and is quoted only on the Pink Sheets, which could negatively affect our stock price and liquidity.

In November 2009 and March 2010, we received notice from the New York Stock Exchange (the “Exchange”) that we were not in compliance with certain of the Exchange’s continued listing standards. We failed to regain compliance with these continued listing standards, and on July 1, 2010, the Exchange notified us that trading on the Exchange of our Class A common stock and Class B common stock (together, the “common stock”) would be suspended prior to the opening on July 7, 2010. We did not appeal the Exchange’s decision, and they have filed an application with the Securities and Exchange Commission to strike our common stock from listing.

Item 3.

Defaults Upon Senior Securities

On July 1, 2010, a $42.4 million principal and interest payment was due to be paid on our Senior Secured Notes, consisting of $22.5 million of principal, $18.5 million of interest and $1.4 million of redemption premium. Instead of making the scheduled payment, on July 1, 2010, we entered into a forbearance agreement with holders of approximately 70% of the outstanding principal amount of the Notes (the “Forbearing Holders”), which was

subsequently amended and restated on August 12, 2010 (the “Forbearance Agreement”). Based on the terms of the Forbearance Agreement, the Forbearing Holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the Indenture with respect to our failure on July 1, 2010, (i) to redeem a portion of the Notes pursuant to the Indenture and the Notes (the “Amortization Payment Default”) and (ii) to pay interest on the Notes (the “Interest Payment Default”). The Forbearance Agreement is effective until the earliest of (i) September 30, 2010, (ii) the occurrence or existence of any Default or Event of Default (each as defined in the Indenture) other than the Amortization Payment Default or Interest Payment Default, and (iii) the occurrence of certain other events as described in the Forbearance Agreement. The Forbearance Agreement contains covenants by us to, among other things: (i) retain and continue to employ a chief restructuring officer who will assist with all restructuring initiatives, and (ii) provide to the Trustee and to counsel and the financial advisors to the Forbearing Holders (a) a 13-week treasury cash flow forecast no later than Thursday of each week, (b) executive summary reports no later than Thursday of each week, and (c) periodic financial reports each month no later than 21 days after the end of the prior month. We also agreed to weekly telephonic and written communication with counsel and the financial advisors to the Forbearing Holders to review, among other things, the weekly reports and to provide updates on strategic processes.

Item 6.

Exhibits

The Exhibit Index on page 65 of this Quarterly Report on Form 10-Q lists the exhibits that are filed or furnished, as applicable, as part of this Quarterly Report on Form 10-Q.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


BLOCKBUSTER INC.

By:		/s/ THOMAS M. CASEY
		Thomas M. Casey Executive Vice President and Chief Financial Officer (on behalf of the Registrant and in his capacity as principal financial officer)

Date: August 13, 2010

EXHIBIT INDEX

We are incorporating certain exhibits listed below by reference from other Blockbuster filings with the Securities and Exchange Commission, which we have identified in parentheses after each applicable exhibit.


Charter Documents

3.1		Second Amended and Restated Certificate of Incorporation of Blockbuster Inc. (see Current Report on Form 8-K, filed on October 8, 2004).

3.2		Certificate of Amendment of Second Amended and Restated Certificate of Incorporation of Blockbuster Inc. (see Current Report on Form 8-K, filed on May 10, 2007).

3.3		Amended and Restated Bylaws of Blockbuster Inc. (see Current Report on Form 8-K, filed on October 8, 2004).

3.4		Amendment to Amended and Restated Bylaws of Blockbuster Inc. (see Current Report on Form 8-K, filed on May 10, 2007).

Instruments Defining Rights of Security Holders

4.1		Specimen Class A Common Stock Certificate of Blockbuster Inc. (see Quarterly Report on Form 10-Q for the period ended September 30, 1999, filed on November 15, 1999).

4.2		Specimen Class B Common Stock Certificate of Blockbuster Inc. (see Quarterly Report on Form 10-Q for the period ended June 30, 2004, filed on August 9, 2004).

4.3		Indenture, dated August 20, 2004, among Blockbuster Inc., the subsidiary guarantors named on the signature pages thereto and The Bank of New York Trust Company, N.A., as trustee, with respect to the 9% Senior Subordinated Notes due 2012 (see Amendment No. 2 to Registration Statement on Form S-4 (333-116617), as amended, filed on August 24, 2004).

4.4		First Supplemental Indenture, dated December 22, 2004, among Blockbuster Inc., the subsidiary guarantors named on the signature pages thereto and The Bank of New York Trust Company, N.A., as trustee, with respect to the 9% Senior Subordinated Notes due 2012 (see Registration Statement on Form S-4 (333-122485), filed on February 2, 2005).

4.5		Certificate of Designations for Blockbuster Inc.’s 7¹/ 2% Series A Cumulative Convertible Perpetual Preferred Stock (see Current Report on Form 8-K, filed on November 15, 2005).

4.6		Registration Rights Agreement dated November 15, 2005, among Blockbuster Inc. and the Initial Purchasers named therein with respect to Blockbuster Inc.’s 7¹/2% Series A Cumulative Convertible Perpetual Preferred Stock (see Annual Report on Form 10-K for the fiscal year ended December 31, 2005, filed on March 15, 2006).

Executive Officer Employment and Separation Agreement

10.1	*	Amended and Restated Employment Agreement between Blockbuster Inc. and Thomas Casey, effective May 17, 2010.


Other Exhibits

31.1	*	Certification pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	*	Certification pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1	*	Furnished Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	*	Furnished Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

*	Filed or furnished herewith, as applicable.

BLOCKBUSTER INC - FORM 10-Q - August 13, 2010

Attached files

BLOCKBUSTER INC Reports

Also read