<PAGE>
As filed with the Securities and Exchange Commission on December 14, 1999
Registration No. 333-
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- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
FORM S-4
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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BLOCKBUSTER INC.
(Exact name of registrant as specified in its charter)
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<C> <S> <C>
Delaware 7841 52-1655102
(State or other jurisdiction of (Primary Standard (I.R.S. Employer
incorporation or organization) Industrial Identification Number)
Classification
Code Number)
</TABLE>
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1201 Elm Street
Dallas, Texas 75270
(214) 854-3000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
--------------
Edward B. Stead
Executive Vice President, General Counsel and Secretary
Blockbuster Inc.
1201 Elm Street
Dallas, Texas 75270
(214) 854-3000
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
--------------
Copies to:
Stephen T. Giove Michael D. Fricklas
Shearman & Sterling Senior Vice President,
599 Lexington Avenue General Counsel and
New York, New York 10022 Secretary
(212) 848-4000 Viacom Inc.
1515 Broadway
New York, New York 10036
(212) 258-6000
--------------
Approximate date of commencement of proposed sale to the public: Upon
completion of the exchange offer referred to in this document.
If the securities being registered on this Form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box: [_]
If this Form is filed to register additional securities for an offering
under Rule 462(b) under the Securities Act of 1933, as amended, please check
the following box and list the Securities Act registration statement number of
the earlier effective registration statement for the same offering: [_]
If this Form is a post-effective amendment filed under Rule 462(d) under the
Securities Act of 1933, as amended, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering: [_]
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CALCULATION OF REGISTRATION FEE
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Proposed Maximum
Title of Each Class of Amount to be Aggregate Offering Amount of
Securities to be Registered Registered(1) Price(2) Registration Fee
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<S> <C> <C> <C>
Class A Common Stock, $.01 par value............ 144,000,000 $2,092,500,038 $552,421
</TABLE>
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(1) The maximum number of shares of class A common stock of Blockbuster Inc.
offered in exchange for shares of class A common stock, par value $.01 per
share, and class B common stock, par value $.01 per share, of Viacom Inc.,
as described in the Prospectus-Offer to Exchange filed as part of this
Registration Statement.
(2) Estimated solely for purposes of calculating the registration fee and
computed under Rule 457(f)(1) under the Securities Act of 1933, as amended,
based on $52.21875, the average of the high and low sale prices of Viacom
class B common stock reported on the New York Stock Exchange Composite Tape
on December 7, 1999 for the shares of Viacom class A and class B common
stock to be received by Viacom in exchange for shares of Blockbuster class
A common stock.
--------------
The Registrant hereby amends this Registration Statement on such date or
dates as may be necessary to delay its effective date until the Registrant
shall file a further amendment that specifically states that this Registration
Statement shall thereafter become effective in accordance with Section 8(a) of
the Securities Act of 1933, as amended, or until the Registration Statement
shall become effective on such date as the Commission, acting pursuant to said
Section 8(a), may determine.
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<PAGE>
PROSPECTUS-OFFER TO EXCHANGE
Viacom Inc.
Offer to Exchange
Shares of Class A Common Stock
of
Blockbuster Inc.,
which are owned by Viacom,
for each share of
Class A Common Stock or Class B Common Stock
of
Viacom Inc.
THIS EXCHANGE OFFER WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY TIME, ON
, 2000, UNLESS THIS EXCHANGE OFFER IS EXTENDED.
Viacom shareholders who elect to participate in this exchange offer will
receive from Viacom shares of Blockbuster class A common stock for each
share of Viacom class A or class B common stock tendered.
----------------
The terms and conditions of this exchange offer are described in this
document, which you should read carefully. Neither Viacom, Blockbuster nor any
of their respective directors or officers makes any recommendation as to
whether you should participate in this exchange offer. You must make your own
decision after reading this document and consulting with your advisors.
----------------
The shares of Blockbuster class A common stock are listed and traded on the
New York Stock Exchange under the symbol "BBI." The shares of Viacom class A
and class B common stock are listed and traded on the New York Stock Exchange
under the symbols "VIA" and "VIA.B," respectively.
----------------
Investing in shares of Blockbuster class A common stock involves risks. See
"Risk Factors" beginning on page 16.
----------------
Neither the Securities and Exchange Commission nor any state securities
regulators have approved or disapproved of these securities or determined if
this document is truthful or complete. Any representation to the contrary is a
criminal offense.
Viacom has retained the services of as information agent to assist you
in connection with this exchange offer. You may call at (toll
free) in the United States to request additional documents and to ask any
questions or at (collect) elsewhere.
----------------
The Dealer Manager for this exchange offer is:
, 2000
<PAGE>
TABLE OF CONTENTS
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Page
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Questions And Answers about this Exchange Offer........................... 3
Summary................................................................... 8
Risk Factors.............................................................. 16
Risk Factors Relating to Blockbuster's Business and Industry............ 16
New Technologies May Reduce Public Demand for Blockbuster's Products... 16
Blockbuster's Industry Would Lose a Significant Competitive Advantage
if the Movie Studios Adversely Change Their Current Distribution
Practices............................................................. 17
Blockbuster's Internet Revenues Could be Adversely Affected if
Blockbuster is Unable to Compete Effectively in the E-Commerce Market
for Its Products...................................................... 18
Because Margins on Sell-through Products Are Lower Than Rental Margins,
Blockbuster Could Be Materially Adversely Affected If a Greater
Proportion of Newly Released Movies Were Initially Priced as a Sell-
through Product in the United States and Consumers Desired to Own
These Movies.......................................................... 18
Significant Benefits Would Be Lost and Blockbuster Would Be Materially
Adversely Affected If Blockbuster's Revenue-Sharing Agreements Were
Materially Adversely Changed or Discontinued.......................... 18
If the Average Sales Price for the Previously Viewed Tapes Obtained
Under Revenue-Sharing Is Not at or Above an Expected Price,
Blockbuster's Expected Gross Margins May Be Adversely Affected........ 19
Blockbuster Has Had Limited Experience with its New Business Model and
Cannot Assure You That it Will Operate Profitably in the Future Under
this New Model........................................................ 19
Blockbuster May Be Unable to Fully Execute its New Store Expansion..... 19
Blockbuster Cannot Assure You as to the Profitability of Newly Added
Stores................................................................ 20
Newly Opened Stores May Adversely Affect the Profitability of Pre-
existing Stores....................................................... 20
Blockbuster May Be Liable for Lease Payments Related to Blockbuster
Music Stores.......................................................... 20
Blockbuster Could Be Materially and Adversely Affected if its
Centralized Domestic Distribution Center is Shut Down................. 20
As a Participant in the Home Video Industry, Blockbuster Is Subject to
Governmental Regulation Particular to its Industry.................... 21
Blockbuster's Historical Consolidated Financial Information May Not Be
Representative of its Results as a Separate Company................... 21
Risk Factors Relating to the Shares of Blockbuster Class A Common
Stock.................................................................. 21
Blockbuster Cannot Predict the Effect that the Separation Will Have on
the Price of its Class A Common Stock................................. 21
Blockbuster's Anti-takeover Provisions May Delay or Prevent a Change of
Control of Blockbuster, Which Could Adversely Affect the Price of
Blockbuster Common Stock.............................................. 21
Blockbuster's Stock Price May Fluctuate Significantly Following the
Separation of Blockbuster from Viacom, and You Could Lose All or Part
of Your Investment as a Result........................................ 22
Risk Factors Relating to the Separation of Blockbuster from Viacom...... 22
Tendering Shareholders May Receive a Reduced Premium or May Not Receive
Any Premium at All in this Exchange Offer............................. 22
The Internal Revenue Service May Treat the Separation of Blockbuster
from Viacom as Taxable to Viacom and its Shareholders if
Representations Made to the Internal Revenue Service Were Inaccurate
or if Viacom has not Complied with Undertakings it has Made to the
Internal Revenue Service.............................................. 22
Cautionary Statement Concerning Forward-Looking Statements................ 24
Separation of Blockbuster from Viacom..................................... 25
This Exchange Offer....................................................... 27
Price Range of Shares of Viacom Class A and Class B Common Stock and
Dividends................................................................ 36
Price Range of Shares of Blockbuster Class A Common Stock and Dividends... 37
</TABLE>
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Viacom Selected Consolidated Financial Data................................ 38
Viacom Unaudited Pro Forma Combined Condensed Financial Data............... 39
Viacom Unaudited Pro Forma Combined Condensed Statements of Operations..... 40
Viacom Unaudited Pro Forma Combined Condensed Balance Sheet................ 42
Blockbuster Selected Consolidated Historical Financial and Operating Data.. 48
Blockbuster Unaudited Pro Forma Consolidated Financial Data................ 50
Blockbuster Pro Forma Consolidated Statements of Operations (Unaudited).... 52
Blockbuster Pro Forma Consolidated Balance Sheet (Unaudited)............... 54
Management's Discussion and Analysis of Financial Condition and Results of
Operations of Blockbuster................................................. 55
Viacom's Business.......................................................... 71
Blockbuster's Industry Overview............................................ 74
Blockbuster's Business..................................................... 78
Blockbuster's Management................................................... 101
Related Party Transactions................................................. 111
Principal Stockholders of Shares of Blockbuster Class A and Class B Common
Stock..................................................................... 118
Description of Blockbuster Capital Stock................................... 119
Comparison of Rights of Holders of Shares of Viacom Class A and Class B
Common Stock and Blockbuster Class A Common Stock......................... 125
Description of Blockbuster's Credit Agreement.............................. 129
Shares Eligible For Future Sale............................................ 131
United States Federal Income Tax Consequences.............................. 132
Legal Matters.............................................................. 133
Experts.................................................................... 133
Where You Can Find More Information........................................ 134
Index to Consolidated Blockbuster Financial Statements..................... F-1
Schedule A--Transactions Concerning Shares of Viacom Class A and Class B
Common Stock.............................................................. A-1
</TABLE>
2
<PAGE>
QUESTIONS AND ANSWERS
ABOUT THIS EXCHANGE OFFER
Explanatory Note
Viacom has not decided to commence this exchange offer at this time.
Viacom's decision to commence this exchange offer is dependent on, among other
things, the satisfaction of the following conditions:
. the approval of Viacom's board of directors;
. an improvement in the market price of Blockbuster class A common stock
to a price range exceeding $20.00 per share; and
. the receipt of a supplemental private letter ruling from the Internal
Revenue Service confirming that this exchange offer will be tax-free to
Viacom and its shareholders taking into account the proposed merger
between Viacom and CBS.
This document has been filed with the Securities and Exchange Commission so
that Viacom can be in a position to commence this exchange offer as soon as
possible after these conditions are satisfied. Unless otherwise noted,
disclosures in this document have been made as though the above conditions
have been satisfied. Therefore, you should not rely on this document in making
any investment decision regarding Viacom or Blockbuster until it is declared
effective by the SEC.
Q1. Why has Viacom decided to separate Blockbuster from Viacom?
A1.On , Viacom's board of directors approved a plan to establish
Blockbuster as an independent, stand-alone entity with objectives separate
from those of the other businesses of Viacom. Both Viacom and Blockbuster
believe that the separation of Blockbuster from Viacom will provide numerous
benefits to each company, the most important of which are listed below.
. Resolution of competitive conflicts involving Blockbuster and Paramount
Pictures. Paramount Pictures Corporation, a Viacom affiliate, is in the
motion picture business and competes with other movie studios. As a
result, Blockbuster believes that the other movie studios, which supply
Blockbuster with its movies, consider Blockbuster's affiliation with
Paramount Pictures as a conflict of interest. Similarly, because
Paramount Pictures supplies movies to Blockbuster's competitors in the
video rental market, Viacom believes that Blockbuster's competitors, who
are Paramount Pictures customers, view Paramount Pictures as having a
conflict of interest. Separating Blockbuster from Viacom will eliminate
these competitive concerns.
. Increase in operating and strategic focus. Viacom and Blockbuster have
significantly different strengths and operating strategies. Viacom, as a
diversified, content-oriented media business, is focused on creating and
capitalizing upon content and brands. Blockbuster, as a home video
business, is focused on consumer retailing. After the separation, each
company believes it will be able to focus its managerial and financial
resources on developing and growing its core businesses.
. Facilitation of Blockbuster's expansion and growth. Viacom and
Blockbuster believe that the separation will enhance Blockbuster's
ability to engage in future acquisitions in which Blockbuster's stock is
issued as consideration. Although there are no specific plans, Viacom
and Blockbuster also believe that the separation will facilitate future
partnerships, alliances and other arrangements between Blockbuster and
other entities.
. Provision of effective incentives for Blockbuster employees. The
separation will allow Blockbuster to provide incentives to its
employees, such as additional Blockbuster stock options, that are more
closely linked to Blockbuster's performance and are not affected by the
results of Viacom's other businesses.
3
<PAGE>
Q2. How will the relationship between Blockbuster and Viacom change after
this exchange offer is completed?
A2. The separation of Blockbuster from Viacom is intended to establish
Blockbuster as a stand-alone entity. Consequently, Blockbuster will provide
all of its own management, financial, tax, accounting, legal and other
resources, some of which were previously provided by Viacom. In addition, all
the directors designated by Viacom to serve on the board of directors of
Blockbuster will resign.
Q3. Why did Viacom choose this exchange offer as the way to separate
Blockbuster from Viacom?
A3. Viacom believes this exchange offer is a tax efficient way to achieve
the goals outlined in Q1 above. It also allows you to adjust your investment
between Viacom and Blockbuster on a tax-free basis. This exchange offer is
also tax-free to Viacom.
Q4. May I participate in this exchange offer?
A4. Any holder of Viacom class A or class B common stock, including holders
of Viacom class A or class B common stock that is held through a Viacom or
Blockbuster employee benefit plan, may participate in this exchange offer.
Q5. How many shares of Blockbuster class A common stock will I receive for
each share of Viacom class A or class B common stock that I tender?
A5. You will receive shares of Blockbuster class A common stock for
each share of Viacom class A or class B common stock that you tender and do
not withdraw in this exchange offer. This relationship between the number of
shares of Blockbuster class A common stock that you will receive in exchange
for each share of Viacom class A or class B common stock that you tender is
referred to as the exchange ratio.
Q6. What is the anticipated premium?
A6. Based on the closing trading prices for shares of Viacom class A and
class B common stock and Blockbuster class A common stock on , 2000, the
exchange ratio of would result in a % and % premium for the
Viacom class A and class B common stock, respectively. That is, tendering
Viacom shareholders will receive shares of Blockbuster class A common stock
with a market value greater than the market value of the shares of Viacom
class A or class B common stock being tendered. Because market prices for
shares of Blockbuster class A common stock and Viacom class A and class B
common stock will fluctuate over the course of this exchange offer, the size
of the premium, if any, will also fluctuate over the course of this exchange
offer. Viacom also cannot predict the prices at which shares of Blockbuster
class A common stock or Viacom class A or class B common stock will trade in
the future.
You can calculate the anticipated premium expressed as a percentage using
the following formula:
( (exchange ratio) x (price of one share of )
( Blockbuster class A common stock) )
(-------------------------------------------------------------- - 1) x 100
((price of one share of Viacom class A or class B common stock) )
For example: Assume a price of $ per share of Viacom class A or class B
common stock and a price of $ per share of Blockbuster class A common stock.
At an exchange ratio of shares of Blockbuster class A common stock for
each share of Viacom class A or class B common stock, the premium would be
about %. The closing trading prices on the NYSE on , 2000 for shares
of Viacom class A and class B common stock and Blockbuster class A common
stock were , and , respectively.
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Q7.How many shares of Blockbuster class A common stock are being offered by
Viacom in this exchange offer?
A7.Viacom is offering to exchange all of the 144 million shares of
Blockbuster common stock that it owns in this exchange offer. Viacom currently
owns 144 million shares of Blockbuster class B common stock. Immediately prior
to completion of this exchange offer, all of Viacom's 144 million shares of
Blockbuster class B common stock will convert into 144 million shares of
Blockbuster class A common stock. After completion of this exchange offer, no
shares of Blockbuster class B common stock will be outstanding.
Q8.Are there any conditions regarding Viacom's obligation to complete this
exchange offer?
A8.Yes. Viacom does not have to complete this exchange offer unless the
conditions outlined on pages 33-34 are satisfied or waived. In particular,
Viacom will not complete this exchange offer unless at least shares of
Blockbuster class A common stock that Viacom owns are exchanged in this
exchange offer.
Q9.How many shares of Viacom common stock will be accepted if this exchange
offer is completed?
A9.The number of shares of Viacom common stock that will be accepted if
this exchange offer is completed is between and shares.
. shares, or %, of Viacom common stock as of , 2000, will be
accepted if Viacom exchanges shares. This is the minimum number of
shares of Blockbuster common stock that Viacom has indicated it would
exchange in this exchange offer.
. shares, or %, of Viacom common stock as of , 2000, will be
accepted if Viacom exchanges all of the 144 million shares of
Blockbuster common stock that it owns in this exchange offer.
and shares would represent % and %, respectively, of Viacom
common stock outstanding as of , 2000, excluding Viacom common stock
owned by National Amusements, Inc., Viacom's largest shareholder, who is not
participating in this exchange offer.
Q10.What happens if the number of shares of Viacom common stock tendered is
between and shares?
A10.In this case, all of the remaining shares of Blockbuster common stock
held by Viacom will be distributed to all remaining Viacom shareholders,
including National Amusements, in a pro rata spin-off.
Q11.What happens if more than shares of Viacom common stock are
tendered?
A11.If more than shares of Viacom common stock are tendered in the
aggregate, all shares of Viacom common stock that are properly tendered will
be accepted for exchange on a pro rata basis. This is referred to as
proration. An exception to the above is that tenders by shareholders who
beneficially own "odd-lots," that is, fewer than 100 shares of Viacom common
stock, may elect not to be subject to proration. Proration for each tendering
shareholder will be based on the number of shares of Viacom common stock
tendered by that shareholder in this exchange offer, and not on that
shareholder's aggregate ownership of Viacom. Any shares not accepted for
exchange as a result of proration will be returned to tendering shareholders
in book-entry form. Viacom will announce its preliminary determination of the
extent to which tenders will be prorated by press release promptly after this
exchange offer expires. This determination is referred to as the preliminary
proration factor. Viacom expects to announce its final determination of the
extent to which tenders will be prorated by press release about seven business
days after this exchange offer expires. This determination is referred to as
the final proration factor.
5
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Q12.When does this exchange offer expire?
A12.The period during which you are permitted to tender your shares of
Viacom class A or class B common stock in this exchange offer will expire at
12:00 midnight, New York City time, on , 2000, unless Viacom extends the
expiration of this exchange offer. You must tender your shares prior to
expiration if you wish to participate. Viacom may terminate this exchange
offer in the circumstances described in "This Exchange Offer -- Extension of
Tender Period; Termination; Amendment."
Q13.How do I participate in this exchange offer?
A13.The procedures you must follow to participate in this exchange offer
will depend on whether you hold your shares of Viacom class A or class B
common stock in certificated form, through a bank or broker or through a
Viacom or Blockbuster employee benefit plan. For specific instructions about
how to participate, see "This Exchange Offer -- Procedures for Tendering
Shares of Viacom Class A or Class B Common Stock."
Q14.Can I tender only a portion of my Viacom class A or class B common
stock in this exchange offer?
A14.Yes. You may tender none, some or all of your Viacom class A or class B
common stock.
Q15.What do I do if I want to retain my Viacom class A or class B common
stock?
A15.If you want to retain your Viacom class A or class B common stock, you
do not need to take any action.
Q16.Can I change my mind after I tender my Viacom class A or class B common
stock?
A16.Yes. You may withdraw your tendered shares at any time before this
exchange offer expires. If you change your mind again, you can retender your
Viacom class A or class B common stock by following the tender procedures
again prior to the expiration of this exchange offer.
Q17. How soon can I expect delivery of my Blockbuster class A common stock?
A17.Viacom will deliver its shares of Blockbuster class A common stock by
book-entry transfer as soon as practicable after acceptance of shares of
Viacom common stock in this exchange offer and determination of the final
proration factor.
Q18.Will I be taxed on the shares of Blockbuster that I receive in this
exchange offer?
A18.On August 3, 1999, the Internal Revenue Service issued a private letter
ruling that held this exchange offer and any subsequent spin-off will be tax-
free to Viacom and its shareholders for United States federal income tax
purposes. However, the proposed merger between Viacom and CBS was not
contemplated at the time this private letter ruling was issued. As a result,
Viacom obtained a supplemental private letter ruling on confirming that
the proposed merger will not adversely affect the tax-free status of this
exchange offer or any subsequent spin-off of Blockbuster class A common stock
held by Viacom. The private letter rulings issued in August and do not
address state, local or foreign tax consequences which may be applicable to
Viacom shareholders. You should consult your tax advisor as to your particular
tax consequences.
Q19.Why is National Amusements not participating in this exchange offer?
A19.In accordance with the private letter rulings Viacom received from the
Internal Revenue Service, National Amusements cannot participate in this
exchange offer.
6
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Q20.Are there any appraisal rights for holders of Viacom stock or
Blockbuster class A common stock?
A20.There are no appraisal rights available to Viacom shareholders or
Blockbuster stockholders in connection with this exchange offer.
Q21.Who should I call if I have questions or want copies of additional
documents?
A21.You may call the information agent, , at (toll free) in the
United States to ask any questions or to request additional documents,
including copies of this document, or (collect) elsewhere.
7
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SUMMARY
As used in this document, unless the context requires otherwise, (1)
references to Viacom include Viacom Inc., its consolidated subsidiaries and its
ownership interest in equity affiliates and (2) references to Blockbuster
include Blockbuster Inc., its consolidated subsidiaries and its ownership
interest in equity affiliates. Unless the context otherwise indicates, Viacom
has assumed throughout this document that this exchange offer is fully
subscribed and that all shares of Blockbuster class A common stock held by
Viacom are distributed through this exchange offer. This summary highlights
selected information from this document but may not contain all the information
that is important to you. To fully understand this exchange offer and for a
more complete description of the legal terms of this exchange offer, you should
read carefully this entire document and the documents to which Viacom has
referred you. To find out how to obtain copies of these documents, see "Where
You Can Find More Information."
Viacom
Viacom is a diversified entertainment company with operations in five
segments other than its home video operations. Viacom's operations in its home
video business is being separated from Viacom pursuant to this exchange offer.
These five segments are:
(1) Networks
. The Networks segment operates MTV: MUSIC TELEVISION(R), SHOWTIME(R),
NICKELODEON(R), NICK AT NITE(R), VH1 MUSIC FIRST(R) and TV LAND(R),
among other program services.
(2) Entertainment
. The Entertainment segment, which includes PARAMOUNT PICTURES(R),
PARAMOUNT TELEVISION(R), PARAMOUNT STATIONS GROUP and SPELLING
ENTERTAINMENT GROUP INC., produces and distributes theatrical motion
pictures and television programming and operates or programs 19
broadcast television stations.
(3) Parks
. The Parks segment, through PARAMOUNT PARKS(R), owns and operates five
theme parks and a themed attraction in the United States and Canada.
(4) Publishing
. The Publishing segment publishes and distributes consumer books and
related multimedia products under such imprints as SIMON &
SCHUSTER(R).
(5) Online
. The Online segment provides online music and children's destinations
featuring entertainment, information, community tools and e-commerce.
Viacom's principal executive office is located at 1515 Broadway, New York,
New York, 10036 and its telephone number is (212) 258-6000.
Proposed Merger with CBS
Viacom recently announced that its board of directors and the board of
directors of CBS have agreed to merge their two companies. Viacom has entered
into a merger agreement with CBS. The proposed merger was approved by Viacom
and CBS shareholders on , 1999. Subject to various regulatory approvals,
the merger is expected to be completed in the first half of 2000.
8
<PAGE>
CBS
CBS is one of the largest radio and television broadcasters in the United
States. CBS operates its business through its Television, Cable and Infinity
segments. The Television segment consists of CBS' 16 owned and operated
television stations and the CBS television network, and also includes CBS'
Internet businesses. CBS acquired television broadcast station KTVT-TV Dallas-
Fort Worth, Texas on October 12, 1999. CBS acquired King World Productions,
Inc., the distributor of a number of shows, including "The Oprah Winfrey Show,"
on November 15, 1999. The Cable segment includes CBS' cable networks,
consisting of The Nashville Network, Country Music Television and two regional
sports networks. The Infinity segment corresponds to Infinity Broadcasting
Corporation (NYSE: INF), which conducts CBS' radio and outdoor advertising
business. Infinity acquired Outdoor Systems, Inc., a leading outdoor
advertising company in North America, on December 7, 1999.
CBS' Internet businesses include its operation of the Internet sites CBS.com
and Country.com, as well as its investments in SportsLine.com, Inc.,
MarketWatch.com, Inc. and other Internet businesses.
Blockbuster
Overview
Blockbuster is the world's leading retailer of rentable home videocassettes,
DVDs and video games, with about 6,900 stores in the United States and 25 other
countries as of September 30, 1999. Blockbuster operates primarily under the
highly recognized BLOCKBUSTER brand name, which, according to The Gallup
Organization, achieves nearly 100% recognition with active movie renters in the
United States. Based on 1998 industry estimates from Paul Kagan Associates,
Inc., a video industry analyst, Blockbuster estimates that its company-operated
and franchised stores attained a U.S. market share in excess of 27%, over three
times greater than that of its nearest competitor. Its customer transaction
database contains information on over 101 million U.S. and Canadian member
accounts. Blockbuster estimates that about 59% of the U.S. population lives
within three miles of one of its stores. Blockbuster's revenues in 1998
increased 17.5% from 1997, with about 79% of these revenues generated in the
United States and about 21% generated outside of the United States. Blockbuster
believes that over 1 billion movies and video games have been rented worldwide
from its stores or its franchisees within the last 12 months, and of these
rental transactions about 750 million were generated from its U.S. company-
operated stores. For the year ended December 31, 1998, Blockbuster and its
franchisees recorded worldwide revenues of about $4.7 billion, which includes
$3.9 billion from its company operations and $0.8 billion from its franchised
stores.
Business Model
Under the management team led by John F. Antioco, Blockbuster's chairman,
president and chief executive officer, Blockbuster developed and implemented a
new business model that focuses on its core rental business and has
significantly improved customer satisfaction. Most significantly, Blockbuster
has entered into domestic revenue-sharing agreements with all of the major
Hollywood movie studios. For titles purchased under these agreements,
Blockbuster has agreed to share its U.S. rental revenue with the studios for a
limited period of time. Blockbuster believes that these agreements have
significant benefits to Blockbuster, including:
. substantially increasing the number of newly released videos in its
stores to better satisfy customer demand;
. contributing to an increase in revenues resulting from an increase in
the total number of transactions and the number of videocassettes rented
per transaction; and
. aligning the studios' economic interests more closely with Blockbuster's
because the studios share a portion of the rental revenue with
Blockbuster for a period of time.
Under Blockbuster's new business model, quarterly domestic same store rental
revenues increased 8.6%, 17.5%, 20.0%, 20.5%, 23.1%, 12.9% and 11.0% in the
seven quarters ended September 30, 1999 compared to the comparable quarters in
the prior years.
9
<PAGE>
Internet Strategy
Blockbuster believes that the growth of the Internet and the increasing
availability of broadband distribution offer opportunities for Blockbuster to
capitalize on emerging home entertainment technologies. In particular,
Blockbuster believes it is well-positioned to leverage its strong brand name,
existing infrastructure and extensive expertise in the video/entertainment
industry to create the premier online video and entertainment destination.
In November 1999, Blockbuster relaunched its website, www.blockbuster.com.
The relaunched site has enhanced both the breadth and depth of
blockbuster.com's entertainment-related news and information and e-commerce
offerings and capabilities.
In addition, on November 3, 1999, Blockbuster entered into a strategic
alliance with America Online Inc. The terms of this alliance provide for a co-
branded America Online/Blockbuster website on America Online's Entertainment
Channel. America Online and Blockbuster also agreed to extensive cross-
marketing and promotional activities and to jointly develop broadband content
and delivery. As part of the alliance, America Online, subject to terms and
conditions, will acquire about a 2.75% interest in blockbuster.com for $30
million in cash.
Blockbuster's principal executive office is located at 1201 Elm Street,
Dallas, Texas 75270 and its telephone number is (214) 854-3000.
10
<PAGE>
Viacom Summary Historical and Pro Forma Financial Data
The summary historical and pro forma financial data presented below have
been derived from, and should be read together with, Viacom's audited
consolidated financial statements and the accompanying notes included in its
annual report on Form 10-K for the year ended December 31, 1998 and the
unaudited interim consolidated financial statements and the accompanying notes
included in its quarterly report on Form 10-Q for the period ended September
30, 1999, which are incorporated by reference in this document.
The pro forma financial information is derived from and should be read
together with the information provided in the section, "Viacom Unaudited Pro
Forma Combined Condensed Financial Data," including the notes thereto. The
Viacom pro forma financial information gives effect to the transactions listed
below:
. The separation of Blockbuster through this exchange offer. Solely for
purposes of the pro forma financial data, it has been assumed that
Viacom would exchange all 144 million shares of Blockbuster common stock
that it owns at an exchange ratio of about 3.59 shares of Blockbuster
common stock for each share of Viacom common stock, which would result
in about 40 million shares of Viacom common stock being exchanged. This
exchange ratio is based upon the December 9, 1999 closing market prices
of $15.50 for Blockbuster class A common stock and $55.625 for Viacom
class B common stock and assumes that no premium is being offered by
Viacom. This exchange ratio may not be indicative of the actual exchange
ratio.
. The proposed merger with CBS, giving pro forma effect to the following:
-- CBS' acquisition of CBS Radio, Inc., formerly American Radio Systems
Corporation, in June 1998;
-- Infinity's initial public offering in December 1998;
-- CBS' acquisition of King World Productions in November 1999; and
-- Infinity's acquisition of Outdoor Systems in December 1999.
The unaudited pro forma combined condensed statement of operations data for
the nine months ended September 30, 1999 and the year ended December 31, 1998
are presented as if the separation of Blockbuster from Viacom and all other
transactions described above had occurred on January 1, 1998. The unaudited pro
forma combined balance sheet data at September 30, 1999 is presented as if the
separation of Blockbuster from Viacom and all other transactions described
above had occurred on September 30, 1999.
The summary unaudited pro forma combined financial data is for illustrative
purposes only and does not indicate the operating results or financial position
that would have been achieved had the separation of Blockbuster from Viacom and
all other transactions been completed as of the dates indicated or of the
results that may be obtained in the future. In addition, the data does not
reflect synergies that might be achieved from combining the operations of
Viacom and CBS.
11
<PAGE>
Viacom Summary Historical and Pro Forma Financial Data
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma Combined
--------------------------
Nine Months Nine Months
Year Ended or At Ended or At Year Ended Ended or At
December 31, September 30, December 31, September 30,
----------------------- --------------- ------------ -------------
1996 1997 1998 1998 1999 1998 1999
------- ------- ------- ------ ------- ------------ -------------
(unaudited) (unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ 9,684 $10,685 $12,096 $8,754 $ 9,286 $16,682 $12,406
Operating income........ 1,197 685 752 455 881 1,041 1,085
Earnings (loss) from
continuing operations
before income taxes.... 410 1,179 137 (28) 573 98 584
Earnings (loss) from
continuing operations.. 152 374 (44) (133) 239 (451) (152)
Earnings (loss) from
continuing operations
per common share:
Basic.................. .13 .44 (.10) (.25) .33 (.32) (.11)
Diluted................ .13 .44 (.10) (.25) .32 (.32) (.11)
Balance Sheet Data:
Total assets............ $28,834 $28,289 $23,613 $24,268 $70,558
Total long-term debt,
net of current
portion................ 9,856 7,423 3,813 6,142 9,372
Shareholders' equity.... 12,587 13,384 12,050 10,918 42,771
</TABLE>
12
<PAGE>
Unaudited Comparative Per Share Data
The following table presents historical and pro forma per share data for
Viacom giving effect to the completion of this exchange offer at an assumed
exchange ratio of about 3.59 shares of Blockbuster common stock for each share
of Viacom common stock and to the proposed Viacom/CBS Merger. The pro forma
columns reflect the assumed exchange of about 40 million shares of Viacom
common stock. This exchange ratio may not be indicative of the actual exchange
ratio. The table should be read in conjunction with Viacom's historical
consolidated financial statements and notes thereto and with Viacom's unaudited
pro forma condensed combined financial statements and notes thereto, appearing
elsewhere in this document, as of and for the nine months ended September 30,
1999 and the year ended December 31, 1998.
<TABLE>
<CAPTION>
Nine Months Ended or At Twelve Months Ended or At
September 30, 1999 December 31, 1998
---------------------------------- ----------------------------------
Pro Forma Pro Forma
Viacom Viacom
as Adjusted as Adjusted
Pro Forma for Pro Forma for
Viacom Blockbuster Viacom Blockbuster
as Adjusted Separation as Adjusted Separation
for And for And
Viacom Blockbuster Viacom/CBS Viacom Blockbuster Viacom/CBS
Historical Separation Merger Historical Separation Merger
---------- ----------- ----------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Earnings (loss) from
continuing operations
per common share:
Basic................. $ .33 $ .43 $ (.11) $ (.10) $.47 $(.32)
Diluted............... .32 .42 (.11) (.10) .46 (.32)
Book value per common
share:
Basic................. $15.67 $8.82 $29.12 $17.34
Diluted............... 15.40 8.66 28.88 17.07
Cash dividends per
common share........... -- -- -- -- -- --
</TABLE>
13
<PAGE>
Blockbuster Summary Consolidated Historical and Pro Forma Financial Data
The summary consolidated historical and pro forma financial data presented
below have been derived from, and should be read together with, Blockbuster's
audited consolidated financial statements and unaudited interim consolidated
financial statements and notes thereto, the "Blockbuster Unaudited Pro Forma
Consolidated Financial Data" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations of Blockbuster," included
elsewhere in this document.
<TABLE>
<CAPTION>
Pro Forma As Adjusted
for Recapitalization and
Initial Public Offering
---------------------------------
Year Ended or At Nine Months Ended or Year Ended Nine Months Ended or
December 31, At September 30, December 31, At September 30,
----------------------- ---------------------- ------------ --------------------
1996 1997 1998 1998 1999 1998(1) 1999(1)
------ ------ ------ ---------- ---------- ------------ --------------------
(unaudited) (unaudited)
(In millions, except per share amounts and worldwide store data)
<S> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data(2):
Revenues................ $2,942 $3,314 $3,893 $ 2,807 $ 3,268 $3,893 $3,268
Gross profit............ 1,928 1,953 1,937 1,296 1,998 1,937 1,998
Operating income
(loss)(3).............. 267 (215) (359) (385) 81 (359) 81
Income (loss) before
income taxes........... 249 (269) (395) (402) (6) (474) 9
Net income (loss)....... 78 (318) (337) (324) (62) (385) (53)
Net income (loss) per
share--basic and
diluted(4)............. $ .54 $(2.21) $(2.34) $ (2.25) $ (.42) $(2.20) $ (.30)
Weighted average shares
outstanding--basic and
diluted(4)............. 144 144 144 144 150 175 175
Balance Sheet Data:
Cash and cash
equivalents............ $ 59 $ 130 $ 99 $ 84 $ 122 $ 122
Rental library, net..... 676 735 441 418 501 501
Intangibles, net........ 6,310 6,193 6,056 6,087 6,016 6,016
Total assets............ 8,795 8,731 8,275 8,281 8,325 8,325
Long-term debt, less
current portion(5)..... 249 331 1,715 355 1,157 1,157
Stockholders'
equity(5).............. 7,784 7,618 5,638 7,103 6,179 6,179
Cash Flow Data:
Cash flows from
operating
activities(6).......... $ 985 $ 991 $1,235 $ 907 $ 724
Cash flows used for
investing
activities(6).......... (1,235) (1,188) (1,022) (741) (903)
Cash flows from (used
for) financing
activities(6).......... 209 269 (241) (209) 202
Other Data:
EBITDA(7)(8)(9)......... $ 599 $ 208 $ 24 $ (100) $ 373
Net income (loss) plus
intangible
amortization, net of
tax(9)(10)(11)......... 240 (155) (173) (201) 61
Amortization of
intangibles............ 166 169 170 127 129
Depreciation............ 166 254 213 157 163
Capital expenditures.... 324 262 175 109 267
Worldwide Store Data:
Company-operated stores
at end of period....... 4,472 5,105 5,283 5,223 5,746
Franchised and joint
venture stores at end
of period.............. 845 944 1,098 1,010 1,114
Total stores at end of
period................. 5,317 6,049 6,381 6,233 6,860
Same store revenues
increase
(decrease)(12)......... 5.1% (1.8)% 13.3% 12.7% 10.3%
</TABLE>
See footnotes on the following page.
14
<PAGE>
- --------
(1) For information regarding the pro forma adjustments made to Blockbuster's
historical financial data, see "Blockbuster Unaudited Pro Forma
Consolidated Financial Data."
(2) The statement of operations data for the periods presented do not fully
reflect the trends in Blockbuster's business as Blockbuster had
significantly different business models during these periods resulting in
significant charges. As a result, Blockbuster's statement of operations
data for the periods presented are not comparable.
(3) Operating income (loss) reflects: (1) the $50 million restructuring charge
recorded in 1996 primarily related to Blockbuster's corporate relocation
and elimination of third-party distributors; (2) $220 million of the $250
million charge recorded in 1997 primarily related to inventory write-
downs, closure of underperforming stores and additional expenses
associated with Blockbuster's corporate relocation; and (3) the $424
million charge recorded in 1998 related to a change in accounting for
videocassette and video game rental amortization. The following table
presents operating income (loss) excluding the impact of these special
item charges:
<TABLE>
<CAPTION>
1996 1997 1998
---- ----- -----
<S> <C> <C> <C>
Operating income (loss).................................. $267 $(215) $(359)
Impact of special item charges........................... 50 220 424
---- ----- -----
Operating income, excluding special item charges......... $317 $ 5 $ 65
</TABLE>
(4) As described in note 1 to Blockbuster's consolidated financial statements
for the three years ended or at December 31, 1998, Blockbuster was
recapitalized to provide for class A common stock and class B common
stock. In accordance with SEC Staff Accounting Bulletin No. 98, the
capitalization of Blockbuster class B common stock has been retroactively
reflected for the purposes of presenting historical net income (loss) per
share for periods prior to its initial public offering. Pro forma weighted
average shares outstanding reflect all shares of (a) Blockbuster class B
common stock issued and outstanding which are beneficially owned by Viacom
and which will be automatically converted into the same number of
Blockbuster class A common stock immediately prior to the consummation of
this exchange offer and (b) Blockbuster class A common stock issued in
Blockbuster's initial public offering, as if these shares had been
outstanding since the beginning of each respective period.
(5) This reflects the December 31, 1998 declaration of a $1.4 billion dividend
payable to Viacom International Inc. in the form of an interest-bearing
promissory note.
(6) For information regarding the cash flows data, see the consolidated
statements of cash flows and the interim consolidated statements of cash
flows.
(7) EBITDA represents net income (loss) before equity in loss of affiliated
companies (net of tax), benefit (provision) for income taxes, interest
income, interest expense, other items (net), depreciation and amortization
of intangibles. EBITDA may differ in the method of calculation from
similarly titled measures used by other companies.
(8) EBITDA includes: (1) the $50 million restructuring charge recorded in 1996
primarily related to Blockbuster's corporate relocation and elimination of
third-party distributors; (2) the $175 million effect on EBITDA of the
$250 million charge recorded in 1997 primarily related to inventory write-
downs, closure of underperforming stores and additional expenses
associated with Blockbuster's corporate relocation; and (3) the $424
million charge recorded in 1998 related to a change in accounting for
videocassette and game rental amortization. See notes 3 and 4 of
Blockbuster's consolidated financial statements for the three years ended
or at December 31, 1998 included elsewhere in this document.
(9) "EBITDA" and "net income (loss) plus intangible amortization, net of tax"
are presented here to provide additional information about Blockbuster's
operations. These items should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, cash flow and
other measures of financial performance prepared in accordance with
generally accepted accounting principles.
(10) Net income (loss) plus intangible amortization, net of tax, includes: (1)
the $50 million restructuring charge recorded in 1996 primarily related to
Blockbuster's corporate relocation and elimination of third-party
distributors; (2) the $250 million charge recorded in 1997 primarily
related to inventory write-downs, closure of underperforming stores and
additional expenses associated with Blockbuster's corporate relocation;
and (3) the $424 million charge recorded in 1998 related to a change in
accounting for videocassette and game rental amortization. See notes 3 and
4 of Blockbuster's consolidated financial statements for the three years
ended or at December 31, 1998 included elsewhere in this document.
(11) Intangible amortization, net of tax, included in this item is primarily
related to goodwill.
(12) A store is included in the same store revenue calculation after it has
been opened and operated by Blockbuster for more than 52 weeks. An
acquired store becomes part of the same store base in the 53rd week after
its acquisition and conversion to the Blockbuster format. The percentage
change is computed by comparing total net revenues for same stores as
defined above at the end of the applicable reporting period with total net
revenues from these same stores for the comparable period in the prior
year.
15
<PAGE>
RISK FACTORS
You should consider carefully all of the information set forth or
incorporated by reference in this document and, in particular, the following
risk factors in considering whether or not to tender your shares of Viacom
class A or class B common stock under this exchange offer.
The risk factors have been separated into three groups:
. risks that relate to Blockbuster's business and industry;
. risks that relate to Blockbuster class A common stock; and
. risks that relate to the separation of Blockbuster from Viacom.
In addition, the risks described below are not the only ones facing
Blockbuster. The risks described below are considered to be the most material.
However, there may be additional risks that are viewed as not material or are
not presently known.
If any of the events described below were to occur, Blockbuster's business,
prospects, financial condition, results of operations and/or cash flows could
be materially adversely affected. When reference is made to something that
could or will have a material adverse effect on Blockbuster, it is meant that
it could or will have one or more of these effects. In any such case, the
price of shares of Blockbuster class A common stock could decline, and you
could lose all or part of your investment in Blockbuster.
In addition, for a discussion of additional uncertainties associated with
(1) the Viacom and Blockbuster businesses and (2) forward-looking statements
in this document, see "Cautionary Statement Concerning Forward-Looking
Statements."
Risk Factors Relating to Blockbuster's Business and Industry
New Technologies May Reduce Public Demand for Blockbuster's Products
New digital technologies, such as near-video-on-demand and video-on-demand
and others, could have a material adverse effect on Blockbuster. This is
especially true if:
. newly released movies are made widely available by the studios to these
technologies at the same time or before they are made available to video
stores for rental; and
. these technologies are widely accepted by consumers.
The widespread availability of additional channels on satellite and digital
cable systems may significantly reduce public demand for Blockbuster's
products. Recent advances in direct broadcast satellite and cable technologies
may adversely affect public demand for video store rentals. If direct
broadcast satellite and digital cable were to become widely available and
accepted, this could cause a smaller number of movies to be rented if viewers
favor the expanded number of conventional channels and expanded programming,
including sporting events, offered through these services. If this were to
occur, it could have a material adverse effect on Blockbuster. Direct
broadcast satellite providers transmit numerous channels of programs by
satellite transmission into subscribers' homes. Recently developed technology
has presented cable providers with the opportunity to use digital technology
to transmit many additional channels of programs over cable lines to
subscribers' homes.
16
<PAGE>
In addition, because of this increased availability of channels, direct
broadcast satellite and digital cable providers have been able to enhance
their pay-per-view business by:
. substantially increasing the number and variety of movies they can offer
their subscribers on a pay-per-view basis; and
. providing more frequent and convenient start times for the most popular
movies.
This is referred to within Blockbuster's industry and by others as near-video-
on-demand. If near-video-on-demand were to become more widely available and
accepted, pay-per-view purchases could significantly increase. Near-video-on-
demand allows the consumer to avoid trips to the video store for rentals and
returns of movies which also eliminates the chance they will incur an extended
viewing fee. However, newly released movies are currently made available by
the studios for rental prior to being made available on a near-video-on-demand
basis. Near-video-on-demand also does not allow the consumer to start, stop
and rewind the movie. Increases in the size of this pay-per-view market could
lead to an earlier distribution window for movies on pay-per-view if the
studios perceive this to be a better way to maximize their revenue.
Blockbuster may eventually have to compete with the widespread availability
of video-on-demand, which may significantly reduce the demand for
Blockbuster's products. Some digital cable providers have begun implementing
technology that transmits movies on demand with interactive capabilities such
as start, stop and rewind. This is referred to within Blockbuster's industry
and by others as video-on-demand. Video-on-demand is currently available in
some markets. However, video-on-demand competes with other uses of cable
infrastructure, such as the ability to provide internet access and basic
telephone services, some of which may provide higher returns for operators.
Video-on-demand could have a material adverse effect on Blockbuster if:
. video-on-demand could be profitably provided at a reasonable price; and
. newly released movies were made available at the same time, or before,
they were made available to the video stores for rental.
Blockbuster's Industry Would Lose a Significant Competitive Advantage if
the Movie Studios Adversely Change Their Current Distribution Practices
A significant competitive advantage that the video rental industry
currently enjoys over most other movie distribution channels except theatrical
release is the early timing of the video store distribution "window." This
window is exclusive against most other forms of non-theatrical movie
distribution, such as pay-per-view, premium television, basic cable and
network and syndicated television. The length of the window for movie rental
varies, typically ranging from 30 to 90 days for domestic video stores and
from 120 to 180 days for international video stores. Thereafter, movies are
made sequentially available to television distribution channels.
Blockbuster could be materially adversely affected if:
. the video store windows were no longer the first following the
theatrical release;
. the length of the video store windows were shortened; or
. the video store windows were no longer as exclusive as they are now;
because newly released movies would be made available earlier on these other
forms of non-theatrical movie distribution. As a result, consumers would no
longer need to wait until after the video store distribution window to view a
newly released movie on these other distribution channels.
Although Blockbuster believes that the studios have a significant interest
in maintaining a viable home video rental industry, because the order, length
and exclusivity of each window for each distribution channel is determined
solely by the studio releasing the movie, Blockbuster cannot predict the
impact, if any, of any future decisions by the studios.
17
<PAGE>
Blockbuster's Internet Revenues Could be Adversely Affected if Blockbuster
is Unable to Compete Effectively in the E-Commerce Market for its Products
E-commerce is a new and rapidly evolving market. As a result of the growth
of e-commerce, Blockbuster has increased its product offerings over the
Internet. However, the demand for Blockbuster's products on the Internet is
new and unproven, and there is uncertainty regarding demand for these products
in the future. Several factors could adversely affect Blockbuster's e-commerce
business generally, including:
. obtaining the right, on acceptable terms, from movie studios to
electronically distribute a sufficient quantity of movies over the
Internet;
. obtaining the right, on acceptable terms, to electronically deliver
these movies over the Internet from cable system operators and other
entities who own the broadband distribution systems necessary for the
distribution of movies;
. the technological ability to distribute movies over the Internet on a
cost-effective basis;
. the widespread adoption by consumers of technology which is adequate to
receive and display movies in a manner which is acceptable to them;
. Blockbuster's ability to attract customers to its Internet site and meet
their expectations with respect to site content, pricing, service,
product selection, navigation and other features; and
. competition from other companies offering to rent or sell videocassettes
or electronically deliver movies over the Internet.
Because Margins on Sell-through Products Are Lower Than Rental Margins,
Blockbuster Could Be Materially Adversely Affected if a Greater Proportion
of Newly Released Movies Were Initially Priced as a Sell-through Product in
the United States and Consumers Desired to Own These Movies
Sell-through retail margins are generally lower than rental margins. Some
of Blockbuster's competitors, such as mass merchandisers, warehouse clubs and
Internet sites, can distribute and sell these sell-through movies at lower
costs and/or may operate at lower margins than can Blockbuster. As a result,
Blockbuster's sell-through business, which is described below, in the United
States represented only 7.0% of Blockbuster's domestic revenues for 1998.
Blockbuster believes its profitability would be adversely affected if it did
not derive most of its revenues from the higher margin rental business.
Although Blockbuster believes that industry economics will dictate that most
new releases on videocassettes will continue to be initially priced for
rental, Blockbuster could be materially adversely affected if:
. a greater proportion of either release format were initially priced as
sell-through merchandise in the United States; and
. consumers desired to own, and not rent, these movies.
In general, studios initially price their movies at prices that are too
high to generate significant consumer demand for purchase. Recently, however,
the studios have released a limited number of movies at prices intended to
generate consumer demand to purchase these movies rather than rent them. This
is referred to as sell-through pricing. Movies priced for sell-through are not
generally subject to Blockbuster's revenue-sharing agreements. However, if
enough consumers desired to rent rather than own these sell-through priced
movies, the adverse effect of sell-through may be offset, in part or in full,
by the improved margins Blockbuster would obtain from renting sell-through
movies because these movies have low initial wholesale prices and are not
generally subject to revenue-sharing.
Significant Benefits Would Be Lost and Blockbuster Would Be Materially
Adversely Affected if Blockbuster's Revenue-Sharing Agreements Were
Materially Adversely Changed or Discontinued
If Blockbuster's revenue-sharing agreements are materially adversely
changed or discontinued, significant benefits, as described in the summary of
this prospectus-offer to exchange, would be lost. This in turn would have a
material adverse effect on Blockbuster.
Historically, Blockbuster generally paid the major studios or their
licensees between $60 and $70 per videocassette for major theatrical releases
that were priced for rental in the United States. In 1998, Blockbuster
18
<PAGE>
entered into revenue-sharing agreements with the major studios in the United
States. These agreements generally have terms ranging from two to five years.
For titles purchased under these agreements, Blockbuster pays only a minimal
up front cost per videocassette and agrees to share Blockbuster's U.S. rental
revenue with the studios for a limited period of time. In addition,
Blockbuster agrees to take a minimum number of copies of each movie title that
is released by a studio in any U.S. movie theater. Blockbuster also agrees to
take, in some cases, a minimum number of movies that are not released by a
studio in any U.S. movie theater.
If the Average Sales Price for the Previously Viewed Tapes Obtained Under
Revenue-Sharing Is Not at or Above an Expected Price, Blockbuster's
Expected Gross Margins May Be Adversely Affected
Under Blockbuster's revenue-sharing agreements, Blockbuster expects to earn
revenues in two ways:
. revenues resulting from the rental of the videocassettes; and
. revenues resulting from the sales of the previously viewed tapes to the
public after the end of their useful lives as rental products.
To achieve Blockbuster's expected gross margins, Blockbuster needs to sell
these previously viewed tapes at or above an expected price. If the average
sales price of these previously viewed tapes is not at or above this expected
price, Blockbuster's gross margins under Blockbuster's revenue-sharing
agreements may be adversely affected.
As a result of revenue-sharing, Blockbuster will need to sell significantly
more previously viewed tapes than in the past. Even though revenue-sharing was
not fully implemented during all of 1998, domestically, Blockbuster sold about
17.6 million previously viewed tapes in 1998, as compared to 1997 when
Blockbuster sold about 7.8 million previously viewed tapes, which represents a
126% increase. Blockbuster sold about 22.7 million previously viewed
videotapes for the nine months ended September 30, 1999, as compared to the
nine months ended September 30, 1998 when Blockbuster sold about 11.2 million
previously viewed videotapes, which represents a 103% increase. Blockbuster
cannot assure you that Blockbuster will be able to sell, on average, these
previously viewed tapes at or above the expected price because Blockbuster
does not have extensive experience in selling previously viewed tapes in these
quantities.
Other factors that affect or may affect Blockbuster's ability to sell these
previously viewed tapes at expected prices, include:
. consumer desire to own the particular movie; and
. the number of previously viewed tapes available for sale by others to
the public.
In addition, after the expiration of the video store distribution window,
the sales of previously viewed tapes also compete with newly released videos
which are priced for sell-through.
Blockbuster Has Had Limited Experience with its New Business Model and
Cannot Assure You That it Will Operate Profitably in the Future Under this
New Model
Because Blockbuster has had limited experience with its new business model,
Blockbuster cannot assure you that it will have net income in future periods.
Beginning in the second quarter of 1997, Blockbuster developed its new
business model to refocus on Blockbuster's core rental business. Blockbuster
has experienced significant losses during this transitional period.
Blockbuster had net losses of $318.2 million in 1997 and $336.6 million in
1998. Blockbuster also had net losses of $3.4 million, $39.9 million and $19.1
million for the first, second and third quarters of 1999, respectively.
Blockbuster May Be Unable to Fully Execute its New Store Expansion
Although Blockbuster believes that it has personnel and other resources
required to implement its store expansion goals, Blockbuster cannot assure you
that it will be able to execute its new store expansion within the
19
<PAGE>
expected time frame. If Blockbuster is unable to execute this expansion, it
would be detrimental to its goals of increasing market share, increasing same
store revenues and applying the benefits of its size. Blockbuster intends to
proceed with a significant expansion. Blockbuster expects to add about 500 new
company-operated stores in the United States in each of 2000 and 2001. In
addition, over the next two years, Blockbuster expects to add:
. about 400 new franchise stores in the United States;
. about 225 new company-operated stores in markets outside the United
States; and
. about 130 new franchise and/or joint venture stores in markets outside
the United States.
In order to meet Blockbuster's store expansion goals within this two-year
period, it will be required to invest considerable time in implementing these
plans.
Blockbuster Cannot Assure You as to the Profitability of Newly Added Stores
In connection with Blockbuster's growth strategy, it may add new company-
operated stores in markets, regions or countries where it has limited or no
operating history. As a result, Blockbuster cannot assure you that:
. these newly added stores will achieve revenue or profitability levels
comparable to those of Blockbuster's existing stores; or
. that these stores will achieve such revenue or profitability levels
within the time periods estimated by Blockbuster.
Newly Opened Stores May Adversely Affect the Profitability of Pre-existing
Stores
Blockbuster expects to open smaller company-operated stores in markets
where we already have significant operations in order to maximize its market
share within these markets. Although Blockbuster has a customized store
development approach, it cannot assure you that these smaller newly opened
stores will not adversely affect the revenues and profitability of those pre-
existing stores in any given market.
Blockbuster May Be Liable for Lease Payments Related to Blockbuster Music
Stores
In October 1998, about 380 BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. If
Wherehouse defaults with respect to these leases, related losses could
adversely affect Blockbuster's future operating income because Blockbuster has
agreed to indemnify Viacom with respect to any amount paid under these
guarantees. Blockbuster estimates that, as of the time of the sale to
Wherehouse, it was contingently liable for about $84 million with respect to
base rent for the remaining term of these leases if Wherehouse defaults on all
of these leases. This amount has not been discounted to present value.
Blockbuster's contingent liability will vary over time depending on the lease
terms remaining. Blockbuster has not recorded any reserves related to this
contingent liability in its consolidated financial statements.
Blockbuster Could Be Materially and Adversely Affected if its Centralized
Domestic Distribution Center Is Shut Down
Blockbuster's domestic distribution system is centralized. This means that
Blockbuster ships nearly all of the products to its U.S. company-operated
stores, including newly released videos purchased under the revenue-sharing
agreements, through its distribution center. If Blockbuster's distribution
center is shut down for any reason it could incur significantly higher costs
and longer lead times associated with distributing its videocassettes and
other products to its stores.
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As a Participant in the Home Video Industry, Blockbuster Is Subject to
Governmental Regulation Particular to its Industry
Any finding that Blockbuster has been or is in noncompliance with respect
to the laws affecting its business could result in, among other things,
governmental penalties or private litigant damages which could have a material
adverse effect on Blockbuster. Blockbuster is subject to various
international, U.S. federal and state laws that govern the offer and sale of
its franchises because it acts as a franchisor. In addition, because
Blockbuster operates video stores and develops new video stores, it is subject
to various international, U.S. federal and state laws that govern, among other
things, the disclosure and retention of its video rental records and access
and use of its video stores by disabled persons, and is subject to various
state and local licensing, zoning, land use, construction and environmental
regulations. Furthermore, changes in existing laws, including environmental
and employment laws, new laws or increases in the minimum wage may increase
Blockbuster's costs. Blockbuster's obligation to comply with, and the effects
of, the above governmental regulations are increased by the magnitude of its
operations.
Blockbuster's Historical Consolidated Financial Information May Not Be
Representative of its Results as a Separate Company
Since September 1994, Blockbuster's operations have been conducted by
various entities that Viacom owns directly or indirectly. Following
Blockbuster's initial public offering and prior to the completion of this
exchange offer, Viacom is providing financial, administrative and other
resources while Blockbuster makes the transition to operate as an independent
public company. In addition, the financial information included in this
document may not necessarily reflect Blockbuster's results of operations,
financial position and cash flows in the future or what the results of
operations, financial position or cash flows would have been had Blockbuster
been a separate, stand-alone entity during the periods presented. The
historical results of operations included in this document does not reflect
many significant changes that have occurred in Blockbuster's capital
structure, funding and operations as a result of its separation from Viacom
and Blockbuster's initial public offering. For additional information, see
"Related Party Transactions," "Blockbuster Unaudited Pro Forma Consolidated
Financial Data" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations of Blockbuster."
Risk Factors Relating to the Shares of Blockbuster Class A Common Stock
Blockbuster Cannot Predict the Effect that the Separation Will Have on the
Price of its Class A Common Stock
Blockbuster cannot predict the effect that this exchange offer will have on
the price of the Blockbuster class A common stock. As result of the separation
of Blockbuster from Viacom, Viacom will distribute about 144 million shares of
Blockbuster class A common stock it holds in connection with this exchange
offer, representing about 82.3% of the equity value of Blockbuster.
Blockbuster's Anti-takeover Provisions May Delay or Prevent a Change of
Control of Blockbuster, Which Could Adversely Affect the Price of
Blockbuster Common Stock
The existence of some provisions in Blockbuster's corporate documents and
Delaware law may delay or prevent a change in control of Blockbuster, which
could adversely affect the price of Blockbuster class A common stock.
Blockbuster's certificate of incorporation and bylaws contain some provisions
that may make the acquisition of control of Blockbuster more difficult,
including provisions relating to the nomination, election and removal of
directors and limitations on actions by Blockbuster stockholders. In addition,
Delaware law also imposes some restrictions on mergers and other business
combinations between Blockbuster and any holder of 15% or more of its
outstanding class A common stock. See "Description of Blockbuster Capital
Stock" for a summary of these anti-takeover provisions.
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In addition, Viacom and Blockbuster have entered into a tax matters
agreement, which will require, among other things, that, until two years after
the completion of this exchange offer, Blockbuster cannot voluntarily enter
into certain transactions, including any merger transaction or any transaction
involving the sale of its capital stock, without Viacom's consent. In
addition, Blockbuster has agreed under this tax matters agreement to indemnify
Viacom for any tax liability incurred as a result of the failure of this
exchange offer and any subsequent spin-off to qualify as a tax-free
transaction due to a takeover of Blockbuster or any other transaction
involving Blockbuster's capital stock, assets or businesses, regardless of
whether such transaction is within Blockbuster's control. See "Related Party
Transactions -- Agreements Between Blockbuster and Viacom Relating to
Blockbuster's Initial Public Offering or the Separation of Blockbuster from
Viacom -- Tax Matters Agreement."
Blockbuster's Stock Price May Fluctuate Significantly Following the
Separation of Blockbuster from Viacom, and You Could Lose All or Part of
Your Investment as a Result
Blockbuster class A common stock may significantly fluctuate following this
exchange offer. These factors, some or all of which are beyond Blockbuster's
control, include:
. actual or anticipated fluctuations in Blockbuster's operating results;
. changes in expectations as to Blockbuster's future financial performance
or changes in financial estimates of securities analysts;
. success of Blockbuster's operating and growth strategies;
. operating and stock price performance of other comparable companies; and
. realization of any of the risks described in these Risk Factors.
In addition, the stock market recently has experienced extreme volatility
that often has been unrelated or disproportionate to the operating performance
of particular companies. These broad market and industry fluctuations may
adversely affect the trading price of Blockbuster class A common stock,
regardless of Blockbuster's actual operating performance.
Risk Factors Relating to the Separation of Blockbuster from Viacom
Tendering Shareholders May Receive a Reduced Premium or May Not Receive Any
Premium in this Exchange Offer
Viacom cannot predict the size of the premium or whether there will be any
premium received by shareholders who participate in this exchange offer.
Accordingly, if you tender Viacom class A or class B common stock, you may
receive a premium that is less than the premium on the commencement of this
exchange offer or you may not receive any premium. The premium described in
this document is based on the market prices for shares of Viacom class A and
class B common stock and Blockbuster class A common stock immediately prior to
the commencement of this exchange offer. Any premium received by the Viacom
shareholders participating in this exchange offer will depend on the prices
for shares of Viacom class A or class B common stock and Blockbuster class A
common stock. Viacom cannot predict the prices at which shares of Viacom class
A or class B common stock or Blockbuster class A common stock will be trading
at the exchange offer expiration date or the prices at which these shares will
trade in the future.
The Internal Revenue Service May Treat the Separation of Blockbuster from
Viacom as Taxable to Viacom and its Shareholders if Representations Made to
the Internal Revenue Service Were Inaccurate or if Viacom has not Complied
With Undertakings it has Made to the Internal Revenue Service
Viacom has received private letter rulings from the Internal Revenue
Service to the effect that, for United States federal income tax purposes,
this exchange offer and any subsequent spin-off will be tax-free to Viacom and
its shareholders. Viacom and its shareholders that receive shares of
Blockbuster class A common stock
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could be subject to a material amount of taxes as a result of this exchange
offer, or any subsequent spin-off, if the undertakings made to the Internal
Revenue Service in connection with obtaining the rulings are not complied
with, or if the representations made to the Internal Revenue Service in
connection with obtaining the rulings are determined to be inaccurate.
Blockbuster will be liable to Viacom for any corporate level taxes incurred by
Viacom to the extent such taxes are attributable to specified actions or
failures to act by Blockbuster, or to specified transactions involving
Blockbuster following this exchange offer and any subsequent spin-off. For a
description of material United States federal income tax consequences to
Viacom shareholders of this exchange offer and any subsequent spin-off, see
"United States Federal Income Tax Consequences." For a summary of Viacom's and
Blockbuster's potential tax liabilities if the transaction is held to be
taxable, see "Related Party Transactions -- Agreements Between Blockbuster and
Viacom Relating to Blockbuster's Initial Public Offering or the Separation of
Blockbuster from Viacom -- Tax Matters Agreement."
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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This document and the documents incorporated by reference into this
document contain both historical and forward-looking statements. All
statements other than statements of historical fact are, or may be deemed to
be, 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.
These forward-looking statements are not based on historical facts, but rather
reflect Viacom's and Blockbuster's current expectations concerning future
results and events. These forward-looking statements generally can be
identified by use of statements that include phrases such as "believe,"
"expect," "anticipate," "intend," "plan," "foresee," "likely," "project,"
"estimate," "will," or other similar words or phrases and variations thereof.
Similarly, statements that describe Viacom's or Blockbuster's strategy for
growth, product development, market position, expenditures or financial
results are or may be forward-looking statements. Viacom and Blockbuster have
based many of these forward-looking statements on current expectations,
estimates and projections about each company and the home video and media
industries in general. These forward-looking statements involve known and
unknown risks, uncertainties and other factors that may cause the actual
results, performance or achievements of Viacom or Blockbuster to be different
from any future results, performance and achievements expressed or implied by
these statements. You should review carefully all information, including the
financial statements and the notes to the financial statements included or
incorporated by reference into this document.
For a discussion identifying some important factors that could cause actual
results to vary materially from those anticipated in the forward-looking
statements, see "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations of Blockbuster." Also, see
Viacom's and Blockbuster's SEC filings, including the cautionary statements
included in Viacom's Annual Report on Form 10-K for the year ended December
31, 1998, and Viacom's and Blockbuster's Quarterly Reports on Form 10-Q for
the quarter ended September 30, 1999. These factors, including the risk
factors described in this document, are not necessarily all of the important
factors that could cause actual results to differ materially from those
expressed in any of Viacom's and Blockbuster's forward-looking statements.
Other unknown or unpredictable factors also could have material adverse
effects on Viacom's and Blockbuster's future results.
The forward-looking statements included in this document are made only as
of the date of this document and under section 27A of the Securities Act and
section 21E of the Exchange Act, Viacom and Blockbuster do not have any
obligation to publicly update any forward-looking statements to reflect
subsequent events or circumstances. Viacom and Blockbuster cannot assure you
that projected results or events will be achieved.
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SEPARATION OF BLOCKBUSTER FROM VIACOM
Explanatory Note
Viacom has not decided to commence this exchange offer at this time.
Viacom's decision to commence this exchange offer is dependent on, among other
things, the satisfaction of the following conditions:
. the approval of Viacom's board of directors;
. an improvement in the market price of Blockbuster class A common stock
to a price range exceeding $20.00 per share; and
. the receipt of a supplemental private letter ruling from the Internal
Revenue Service confirming that this exchange offer will be tax-free to
Viacom and its shareholders taking into account the proposed merger
between Viacom and CBS.
This document has been filed with the SEC so that Viacom can be in a position
to quickly commence this exchange offer as soon as possible after these
conditions are satisfied. Unless otherwise noted, disclosures in this document
have been made as though the above conditions have been satisfied. Therefore,
you should not rely on this document in making any investment decision
regarding Viacom or Blockbuster until it is declared effective by the SEC.
Overview
In December 1998, following a thorough review of the various alternatives
for divesting Viacom's home video business, Viacom's board of directors
approved an initial public offering of Blockbuster. On August 16, 1999,
Blockbuster completed its initial public offering, selling to the public 31
million shares of its class A common stock, representing about 17.7% of its
total shares outstanding and about 4.1% of the total voting power of
Blockbuster. Viacom, through its ownership of all the 144 million shares of
Blockbuster class B common stock outstanding, retained about 82.3% of the
total equity value in, and about 95.9% of the combined voting power of,
Blockbuster.
Viacom will divest its ownership interest in Blockbuster through this
exchange offer. Immediately prior to the closing of this exchange offer, the
144 million shares of Blockbuster class B common stock that Viacom owns will
convert into 144 million shares of Blockbuster class A common stock.
Accordingly, Viacom will distribute shares of Blockbuster class A common stock
in this exchange offer. If fewer than all of the shares of Blockbuster class A
common stock held by Viacom are distributed because too few shares of Viacom
class A and class B common stock are tendered, Viacom will distribute its
remaining shares of Blockbuster class A common stock in a pro rata spin off to
all of its shareholders, including National Amusements.
The separation of Blockbuster from Viacom is intended to establish
Blockbuster as a stand-alone entity with objectives separate from those of
Viacom's other businesses. Viacom and Blockbuster believe that the separation
of Blockbuster from Viacom will provide numerous corporate benefits to each
company, the most important of which are listed below.
. Resolution of competitive conflicts involving Blockbuster and Paramount
Pictures. Paramount Pictures Corporation, a Viacom affiliate, is in the
motion picture business and competes with other movie studios. As a
result, Blockbuster believes that the other movie studios, which supply
Blockbuster with its movies, consider Blockbuster's affiliation with
Paramount Pictures as a conflict of interest. Similarly, because
Paramount Pictures supplies movies to Blockbuster's competitors in the
video rental market, Viacom believes that Blockbuster's competitors, who
are Paramount Pictures customers, view Paramount Pictures as having a
conflict of interest. Separating Blockbuster from Viacom will eliminate
these competitive concerns.
. Increase in operating and strategic focus. Viacom and Blockbuster have
significantly different competitive strengths and operating strategies.
Viacom, as a diversified, content-oriented media business, is focused on
creating and capitalizing upon content and brands. Blockbuster, as a
home video business, is focused on consumer retailing. After the
separation, each company believes it will be able to focus its
managerial and financial resources on developing and growing its core
businesses.
. Facilitation of Blockbuster's expansion and growth. Viacom and
Blockbuster believe that the separation will enhance Blockbuster's
ability to engage in future acquisitions in which Blockbuster's
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own stock is issued as consideration. Although there are no specific
plans, Viacom and Blockbuster also believe that the separation will
facilitate future partnerships, alliances and other arrangements
between Blockbuster and other entities.
. Provision of effective incentives for Blockbuster employees. The
separation will allow Blockbuster to provide incentives to its
employees, such as additional Blockbuster stock options, that are more
closely linked to Blockbuster's performance and are not affected by the
results of Viacom's other businesses.
Effects of this Exchange Offer
If this exchange offer is completed, Viacom will no longer own any of the
outstanding stock of Blockbuster. Accordingly, Viacom's balance sheet and
income statement will no longer reflect the assets and the results of
operations of Blockbuster, and Viacom's total market capitalization will
decrease.
You will be affected by this exchange offer as follows:
. holders who tender all of their shares of Viacom will, if all such
shares are accepted for exchange, no longer have any ownership interest
in Viacom;
. holders who tender some, but not all, of their shares of Viacom will
have a diminished ownership interest in Viacom and an increased
ownership interest in Blockbuster; and
. holders who do not tender any of their shares of Viacom under this
exchange offer will have an increased ownership interest, on a
percentage basis, in Viacom.
Persons who remain Viacom shareholders after this exchange offer will own
shares in a company that no longer owns the Blockbuster home video rental
business.
No Appraisal Rights
Appraisal is a statutory remedy available to corporate minority
shareholders who object to extraordinary actions taken by their corporation.
This remedy allows dissenting shareholders to require the corporation to
repurchase their stock at a price equivalent to its value immediately prior to
the extraordinary corporate action. No appraisal rights are available to
Viacom shareholders in connection with this exchange offer.
Regulatory Approvals
No filings under the Hart-Scott-Rodino Antitrust Improvements Act of 1976
are required in connection with this exchange offer generally. If you decide
to participate in this exchange offer and consequently acquire enough shares
of Blockbuster class A common stock to exceed the $15 million threshold stated
in the regulations under this act, and if an exemption under those regulations
does not apply, Viacom and you would be required to make filings under this
act. A filing requirement could delay the exchange until the notification and
waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act have
been observed.
Accounting Treatment
The shares of Viacom class A and class B common stock that Viacom receives
in this exchange offer will be recorded as a decrease in Viacom's
shareholders' equity, reflecting the decrease in Viacom common stock
outstanding at the market value of the shares of Blockbuster class A common
stock distributed as of the expiration date. Any difference between the fair
market value and the net book value of Blockbuster at the commencement of this
exchange offer will be recognized as a gain or loss on disposal of
discontinued operations for accounting purposes.
Any shares of Blockbuster class A common stock that are distributed through
a subsequent spin-off will be accounted for as a dividend through a direct
charge to retained earnings. The amount of the dividend will be equal to
Viacom's net carrying value of the shares of Blockbuster class A common stock
distributed.
Viacom's disposition of its shares of Blockbuster class A common stock will
not in and of itself affect the financial position or results of operations of
Blockbuster.
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THIS EXCHANGE OFFER
Terms of this Exchange Offer
Viacom is offering to exchange shares of Blockbuster class A common
stock for each share of Viacom class A or class B common stock that is validly
tendered on the terms and subject to the conditions described below by 12:00
midnight, New York City time, on , , 2000. Viacom may extend this
deadline under specified circumstances. The last day on which tenders will be
accepted, whether on , 2000 or any later date to which this exchange
offer may be extended, is referred to as the expiration date. Viacom
shareholders may tender all, some or none of their shares.
If your shares are held in a Viacom or Blockbuster employee benefit plan,
you may have an earlier cut-off date to decide to tender these shares of
Viacom class A or class B common stock in order to allow the trustees or plan
administrators sufficient time to process all the instructions and submit them
to the exchange agent prior to expiration of this exchange offer. Please
carefully review the instructions being sent to you from the trustees or
administrators of the plans to determine the cut-off date.
Viacom will accept up to total shares of Viacom class A and class B
common stock for exchange. This number of shares multiplied by the exchange
ratio equals the 144 million shares of Blockbuster class A common stock held
by Viacom. If more than shares of Viacom class A and class B common stock
are validly tendered, the tendered shares will be subject to proration when
this exchange offer expires. Viacom's obligation to complete this exchange
offer is subject to important conditions that are described under the heading
"-- Conditions for Completion of this Exchange Offer."
In determining the exchange ratio, Viacom considered, among other things:
. recent market prices on the NYSE for shares of Viacom class A and class
B common stock and Blockbuster class A common stock; and
. advice from the dealer manager as to what exchange ratio might induce
Viacom shareholders to tender Viacom class A or class B common stock in
this exchange offer so that all of the shares of Blockbuster class A
common stock held by Viacom immediately prior to the completion of this
exchange offer will be distributed.
Viacom is sending this document and related documents to:
. persons who held either shares of Viacom class A or class B common stock
on or about , 2000. On that date, there were about and
shares of Viacom class A and class B common stock outstanding,
respectively, which were held of record by about total shareholders.
. persons who hold shares in a Viacom or Blockbuster employee benefit
plan.
. brokers, banks and similar persons whose names or the names of whose
nominees appear on its shareholder list or, if applicable, who are
listed as participants in a clearing agency's security position listing
for subsequent transmittal to beneficial owners of Viacom class A and
class B common stock.
Proration; Tenders for Exchange by Holders of Fewer than 100 Shares of Viacom
Class A or Class B Common Stock
If on the expiration date, Viacom shareholders have validly tendered more
than shares of Viacom class A and class B common stock so that more than
144 million shares of Blockbuster class A common stock would be distributed,
Viacom will accept on a pro rata basis all shares tendered and not withdrawn,
except for tenders of odd-lots, as described below.
Except as otherwise provided in this paragraph, beneficial holders of an
aggregate of less than 100 shares of Viacom class A and class B common stock
who validly tender all of their shares will not be subject to
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proration if more than shares of Viacom class A and class B common stock
are tendered in this exchange offer. Beneficial holders of 100 or more shares
of Viacom class A and class B common stock are not eligible for this
preference, even if these holders have separate stock certificates or accounts
representing fewer than 100 shares of Viacom class A or class B common stock.
Any beneficial holder of less than 100 shares of Viacom class A or class B
common stock who wishes to tender all of these shares must complete the box
captioned "Odd-Lot Shares" on the letter of transmittal and, if applicable, on
the notice of guaranteed delivery. If your odd-lot shares are held by a broker
for your account, you can contact them and request the preferential treatment.
If your odd-lot shares are held in a Viacom or Blockbuster employee benefit
plan, you can direct the trustee and request this preferential treatment.
Viacom will announce preliminary results of this exchange offer, including
the preliminary proration factor, if any, by press release promptly after the
expiration date. Because of the difficulty in determining the number of shares
of Viacom class A and class B common stock validly tendered for exchange,
Viacom expects that the final results, including final proration factor, if
any, will not be determined until about seven business days after the
expiration date.
Fractional Shares
Holders may tender fractional shares of Viacom class A or class B common
stock in this exchange offer. Any fractional shares of Viacom class A or class
B common stock or of Blockbuster class A common stock resulting from the
exchange of shares of Viacom class A or class B common stock will be
distributed to holders by book-entry transfer. See "-- Book-Entry Accounts."
Exchange of Shares of Viacom Class A or Class B Common Stock
If all of the conditions of this exchange offer are met, Viacom will
exchange shares of Blockbuster class A common stock for each properly tendered
share of Viacom class A or class B common stock that was not properly
withdrawn or deemed withdrawn prior to the expiration date, except as
described in "-- Proration; Tenders for Exchange by Holders of Fewer than 100
Shares of Viacom Class A or Class B Common Stock" and "-- Extension of Tender
Period; Termination; Amendment." Viacom may, subject to the rules under the
Securities Exchange Act of 1934, delay accepting or exchanging any of the
shares of Viacom class A or class B common stock in order to comply in whole
or in part with any applicable law. For a description of Viacom's rights to
delay, terminate or amend this exchange offer, see "-- Extension of Tender
Period; Termination; Amendment."
If Viacom notifies the exchange agent either orally or in writing that it
has accepted the tenders of Viacom shares for exchange, the exchange of these
shares will be complete. Promptly following Viacom's announcement of any final
proration factor, the exchange agent will deliver the tendered shares of
Viacom class A or class B common stock to Viacom. Simultaneously, the exchange
agent, as agent for the tendering shareholders, will receive from Viacom the
shares of Blockbuster class A common stock that correspond to the number of
shares of Viacom class A or class B common stock tendered. The exchange agent
will then credit such shares to book-entry accounts maintained by the transfer
agent for the benefit of the holders.
If any tendered shares of Viacom class A or class B common stock are not
exchanged for any reason, or if fewer shares are exchanged due to proration,
these unexchanged or untendered shares will be credited to book-entry accounts
for the shares maintained by the transfer agent for the benefit of the
holders.
Holders who tender their shares of Viacom class A or class B common stock
for exchange will generally not be obligated to pay any transfer tax in
connection with this exchange offer, except in the circumstances described
under "Stock Transfer Taxes" as set forth in the letter of transmittal. Viacom
will not pay interest under this exchange offer, regardless of any delay in
making the exchange or crediting or delivering shares.
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Procedures for Tendering Shares of Viacom Class A or Class B Common Stock
To tender your shares of Viacom class A or class B common stock, you must
complete the following procedures before the expiration date:
If you have stock certificates for your shares of Viacom class A or class B
common stock, you should send to the exchange agent by registered mail, return
receipt requested, the following documents:
. a completed and executed letter of transmittal indicating the number of
shares to be tendered and any other documents required by the letter of
transmittal; and
. the actual certificates representing the shares of Viacom class A or
class B common stock.
The exchange agent's address is listed on the back cover of this document.
The certificate must be endorsed or accompanied by an appropriate stock power
if:
. a certificate representing shares of Viacom class A or class B common
stock is registered in the name of a person other than the signer of a
letter of transmittal;
. delivery of shares of Blockbuster class A common stock is to be made to
Blockbuster's transfer agent on behalf of a person other than the
registered owner; or
. shares of Viacom class A or class B common stock not accepted for
exchange are to be delivered to its transfer agent on behalf of a person
other than the registered owner.
The signature on the letter of transmittal must be guaranteed by an
eligible institution unless the shares of Viacom class A or class B common
stock tendered under the letter of transmittal are tendered (a) by the
registered holder of the shares tendered and such holder has not completed the
box entitled "Special Issuance Instructions" in Section II of the letter of
transmittal or (b) for the account of an eligible institution. An eligible
institution is a member of a registered national securities exchange or a
member of the National Association of Securities Dealers, Inc. or a commercial
bank or trust company having an office or a correspondent in the United
States. Most banks and financial institutions are eligible institutions.
If you hold Viacom class A or class B common stock through a broker, you
should follow the instructions sent to you separately by your broker. You
should not use the letter of transmittal to direct the tender of your shares
of Viacom class A or class B common stock. Your broker must notify The
Depository Trust Company and cause it to transfer the shares into the exchange
agent's account in accordance with The Depository Trust Company's procedures.
The broker must also ensure that the exchange agent receives an agent's
message from The Depository Trust Company confirming the book-entry transfer
of your shares of Viacom class A or class B common stock. An agent's message
is a message, transmitted by The Depository Trust Company and received by the
exchange agent, that forms a part of a book-entry confirmation, which states
that The Depository Trust Company has received an express acknowledgment from
the participant in The Depository Trust Company tendering the shares that such
participant has received and agrees to be bound by the terms of the letter of
transmittal.
If you are an institution which is a participant in the Depository Trust
Company's book-entry transfer facility, you should follow the same procedures
that are applicable to persons holding shares through a broker as described
above.
If you hold Viacom class A or class B common stock as a participant in a
Viacom or Blockbuster employee benefit plan, you should follow the
instructions sent to you separately by the plan trustees, the administrator of
the plan or other authorized persons. You should not use the letter of
transmittal to direct the tender of Viacom class A or class B common stock.
You may direct the plan trustee to tender none, some or all of the Viacom
class A or class B common stock in your employee benefit plan account.
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Participants in the following employee benefit plans may be eligible to
participate in this exchange offer:
. Viacom Investment Plan;
. Blockbuster Investment Plan;
. Spelling Entertainment Group Inc. (401(k)) Savings Plan; and
. Savings and Investment Plan for Collective Bargaining Employees of
Viacom Broadcasting of Missouri, Inc.
Trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity who
sign the letter of transmittal, notice of guaranteed delivery or any
certificates or stock powers must indicate the capacity in which they are
signing and must submit evidence of their power to act in that capacity unless
waived by Viacom.
If you validly tender your shares of Viacom class A or class B common stock
and Viacom accepts your shares, there will be a binding agreement between you
and Viacom on the terms and subject to the conditions set forth in this
document and in the accompanying letter of transmittal. A person who tenders
shares of Viacom class A or class B common stock for his or her own account
violates federal securities law unless the person owns those shares of Viacom
class A or class B common stock tendered.
An independent fiduciary has been appointed by Viacom to determine whether
to tender the shares of Viacom class A or class B common stock held in
Viacom's defined benefit pension plan. If you participate in Viacom's defined
benefit pension plan you do not need to do anything.
Do not send letters of transmittal and certificates for Viacom class A or
class B common stock to Viacom, Blockbuster, or .
Viacom's Interpretations are Binding
Viacom will determine at its own discretion all questions as to the form of
documents, including notices of withdrawal, and the validity, form,
eligibility, including time of receipt, and acceptance for exchange of any
tender of shares of Viacom class A or class B common stock. This determination
will be final and binding on all tendering shareholders. Viacom reserves the
absolute right to:
. reject any and all tenders of any shares of Viacom class A or class B
common stock not properly tendered;
. waive any defects or irregularities in the tender of shares of Viacom
class A or class B common stock or any conditions of this exchange offer
either, provided the waiver of the condition does not make this exchange
offer a taxable event to Viacom or its shareholders, before or after the
expiration date; and
. request any additional information from any record or beneficial owner
of the shares of Viacom class A or class B common stock that Viacom
deems necessary.
Neither Viacom, Blockbuster, , , , nor any other person will be
under any duty to notify tendering shareholders of any defect or irregularity
in tenders or notices of withdrawal.
Lost or Destroyed Certificates
If your certificate representing shares of Viacom class A or class B common
stock has been mutilated, destroyed, lost or stolen and you wish to tender
your shares, please call the at . You will receive an affidavit
to complete, and you will be informed of the amount needed to pay for a surety
bond for your lost shares. Upon receipt of the completed affidavit and surety
bond payment and the completed letter of transmittal, your Viacom class A or
class B common stock will be included in this exchange offer. If you wish to
participate in this exchange offer, you will need to act quickly to ensure
that the lost certificates can be replaced and delivered to the exchange agent
prior to expiration of this exchange offer.
30
<PAGE>
Guaranteed Delivery Procedure
If you wish to tender your shares of Viacom class A or class B common stock
but the shares are not immediately available, or time will not permit the
shares or other required documentation to reach the exchange agent before the
expiration date, or the procedure for book-entry transfer cannot be completed
on a timely basis, you may still tender your shares of Viacom class A or class
B common stock if:
. the tender is made through an eligible institution;
. the exchange agent receives from the eligible institution before the
expiration date a properly completed and duly executed notice of
guaranteed delivery, substantially in the form provided by Viacom; and
. the exchange agent receives the certificates for all physically tendered
shares of Viacom class A or class B common stock, in proper form for
transfer, or a book-entry confirmation, as the case may be, and a
properly completed letter of transmittal, or a facsimile of a letter of
transmittal and all other documents required by the letter of
transmittal, within three NYSE trading days after the date of execution
of the notice of guaranteed delivery.
You may deliver the notice of guaranteed delivery by hand, facsimile
transmission or mail to the exchange agent and you must include a guarantee by
an eligible institution in the form set forth in the notice.
Withdrawal Rights
You may withdraw tenders of shares of Viacom class A or class B common stock
at any time prior to the expiration date and, unless Viacom has accepted your
tender as provided in this document, after the expiration of 40 business days
from the commencement of this exchange offer. If Viacom:
. delays its acceptance of the shares of Viacom class A or class B common
stock for exchange;
. extends this exchange offer; or
. is unable to accept the shares of Viacom class A or class B common stock
for exchange under this exchange offer for any reason,
then, without prejudice to Viacom's rights under this exchange offer, the
exchange agent may, on our behalf, retain the shares of Viacom class A or class
B common stock tendered, and such shares may not be withdrawn except as
otherwise provided in this document, subject to provisions under the Securities
Exchange Act of 1934 that provide that an issuer making this exchange offer
shall either pay the consideration offered or return tendered securities
promptly after the termination or withdrawal of this exchange offer.
For a withdrawal to be effective, a written notice of withdrawal must be
received by the exchange agent at one of its addresses set forth on the back
cover of this document. The notice of withdrawal must:
. specify the name of the person having tendered the shares of Viacom
class A or class B common stock to be withdrawn;
. identify the number of shares of Viacom class A or class B common stock
to be withdrawn; and
. specify the name in which physical certificates of shares of Viacom
class A or class B common stock are registered, if different from that
of the withdrawing holder.
If certificates for the shares of Viacom class A or class B common stock
have been delivered or otherwise identified to the exchange agent, then, before
the release of such certificates, the withdrawing holder must also submit the
serial numbers of the particular certificates to be withdrawn, and a signed
notice of withdrawal with signatures guaranteed by an eligible institution
unless such holder is an eligible institution.
If the shares of Viacom class A or class B common stock have been tendered
pursuant to the procedure for book-entry transfer, any notice of withdrawal
must specify the name and number of the account at The Depository Trust Company
to be credited with the withdrawn shares and otherwise comply with the
procedures of such facility.
31
<PAGE>
Any shares of Viacom class A or class B common stock withdrawn will be
deemed not to have been validly tendered for exchange for purposes of this
exchange offer. Properly withdrawn shares may be retendered by following one of
the procedures described under "-- Procedures for Tendering Shares of Viacom
Class A or Class B Common Stock" at any time on or before the expiration date.
Except as otherwise provided above, any tender of shares of Viacom class A
or class B common stock made under this exchange offer is irrevocable.
Book-Entry Accounts
Physical certificates representing shares of Blockbuster class A common
stock or shares of Viacom class A or class B common stock will not be issued
pursuant to this exchange offer. Rather than issuing physical certificates for
either shares of Viacom class A or class B common stock returned due to
proration or shares of Blockbuster class A common stock, the exchange agent
will credit such shares to book-entry accounts maintained by the transfer agent
for the benefit of the respective holders. This method of holding stock
eliminates the need for actual stock certificates to be issued, facilitates the
holding of fractional shares, and eliminates the requirements for physical
movement of stock certificates at the time of sale. Promptly following the
crediting of shares to your respective book-entry accounts, you will receive a
Stock Distribution Statement from the exchange agent evidencing your holdings,
as well as general information on the book-entry form of ownership.
You are not required to maintain a book-entry account and you may obtain a
stock certificate for all or a portion of your shares of Viacom class A or
class B common stock or Blockbuster class A common stock received as part of
this exchange offer at no cost to you. Instructions describing how you can
obtain stock certificates will be included with the Stock Distribution
Statement mailed to you. However, stock certificates for fractional shares will
not be issued by either Viacom or Blockbuster. If you request stock
certificates and you hold fractional shares, any fractional shares will be sold
for your account by the transfer agent, which will then deliver to you a
certificate for the whole number of shares you own and the proceeds from the
sale of the fractional shares.
Extension of Tender Period; Termination; Amendment
Viacom expressly reserves the right, at its sole discretion, for any reason,
including the non-satisfaction of any of the conditions for completion set
forth below, to extend the period of time during which this exchange offer is
open or to amend this exchange offer in any respect, including changing the
exchange ratio. Viacom also expressly reserves the right to extend the period
of time during which this exchange offer is open in the event this exchange
offer is under-subscribed, that is, fewer than shares of Viacom class A and
class B common stock are tendered. In any of these cases, Viacom will make a
public announcement of the extension or amendment.
If Viacom materially changes the terms of or information concerning this
exchange offer, Viacom will extend this exchange offer. The SEC has stated
that, as a general rule, it believes that an offer should remain open for a
minimum of five business days from the date that notice of the material change
is first given. The length of time will depend on the particular facts and
circumstances. Subject to the preceding paragraph, this exchange offer will be
extended so that it remains open for a minimum of ten business days following
the announcement if:
. Viacom increases or decreases the number of shares of Blockbuster class
A common stock offered in exchange for each share of Viacom class A or
class B common stock, the number of shares of Viacom class A or class B
common stock eligible for exchange, the minimum condition discussed
below, or the dealer manager or solicitation fee, and
. this exchange offer is scheduled to expire within ten business days of
announcing an increase or decrease.
32
<PAGE>
If any of the conditions indicated in the next section have not been met,
Viacom reserves the right, at its sole discretion, so long as shares of Viacom
class A or class B common stock have not been accepted for exchange, to delay
acceptance for exchange of or exchange for any such shares or to terminate this
exchange offer and not accept for exchange any such shares.
If Viacom extends this exchange offer, is delayed in accepting any shares of
Viacom class A or class B common stock or is unable to accept for exchange any
such shares under this exchange offer for any reason, then, without affecting
Viacom's rights under this exchange offer, the exchange agent may, on Viacom's
behalf, retain all of the shares of Viacom class A or class B common stock
tendered. These shares may not be withdrawn except as provided in "--
Withdrawal Rights." Viacom's reservation of the right to delay acceptance of
any shares of its class A or class B common stock is subject to applicable law,
which requires that Viacom pay the consideration offered or return the shares
deposited promptly after the termination or withdrawal of this exchange offer.
Viacom will issue a press release or other public announcement no later than
9:00 a.m., New York City time, on the next business day following any
extension, amendment, non-acceptance or termination of the previously scheduled
expiration date.
Conditions for Completion of this Exchange Offer
Viacom will not complete this exchange offer unless at least shares of
Viacom class A or class B common stock are validly tendered and not withdrawn.
This number of shares, referred to as the "minimum condition," represents about
% of the outstanding shares of Viacom class A and class B common stock as of
, 2000, or about % if shares of Viacom class A and class B common
stock held by National Amusements are excluded from this calculation, and is
enough shares to ensure that at least % of the shares of Blockbuster class A
common stock owned by Viacom are exchanged under this exchange offer.
Viacom also may not accept shares for exchange and may terminate or not
complete this exchange offer if:
. any action, proceeding or litigation seeking to enjoin, make illegal or
delay completion of this exchange offer or otherwise relating in any
manner to this exchange offer is instituted or threatened;
. any order, stay, judgment or decree is issued by any court, government,
governmental authority or other regulatory or administrative authority
and is in effect, or any statute, rule, regulation, governmental order
or injunction shall have been proposed, enacted, enforced or deemed
applicable to this exchange offer, any of which would or might restrain,
prohibit or delay completion of this exchange offer or impair the
contemplated benefits of this exchange offer to Viacom or Blockbuster;
. the Internal Revenue Service notifies Viacom that any private letter
ruling issued in connection with this exchange offer has been withdrawn
or invalidated in whole or in part or Viacom's board of directors
determines that any of the representations and assumptions underlying
the ruling or any portion of it is not true and correct in all respects;
. any of the following occurs and the adverse effect of such occurrence
shall, in Viacom's reasonable judgment, be continuing:
--any general suspension of trading in, or limitation on prices for,
securities on any national securities exchange or in the over-the-
counter market in the United States,
--any extraordinary or material adverse change in U.S. financial
markets generally, including, without limitation, a decline of at
least twenty percent in either the Dow Jones Average of Industrial
Stocks or the Standard & Poor's 500 Index from , 2000,
--a declaration of a banking moratorium or any suspension of payments
in respect of banks in the United States,
33
<PAGE>
--any limitation, whether or not mandatory, by any governmental entity
on, or any other event that would reasonably be expected to
materially adversely affect, the extension of credit by banks or
other lending institutions,
--a commencement of a war or other national or international calamity
directly or indirectly involving the United States, which would
reasonably be expected to affect materially and adversely, or to
delay materially, the completion of this exchange offer, or
--if any of the situations above exist at the time of commencement of
this exchange offer, the situation deteriorates materially; or
. any event or events occur that have resulted or may result, in Viacom's
sole judgment, in an actual or threatened change in the business
condition, income, operations, stock ownership or prospects of Viacom
and its subsidiaries, taken as a whole, or of Blockbuster and its
subsidiaries, taken as a whole, or in the anticipated tax treatment of
this exchange offer.
If any of the above events occurs, Viacom may:
. terminate this exchange offer and as promptly as practicable return all
tendered shares of Viacom class A or class B common stock to tendering
shareholders;
. extend this exchange offer and, subject to the withdrawal rights
described in "-- Withdrawal Rights, " retain all tendered shares of
Viacom class A or class B common stock until the extended exchange offer
expires;
. amend the terms of this exchange offer; or
. waive the unsatisfied condition, provided the waiver of the condition
does not make this exchange offer a taxable event to Viacom or its
shareholders, and, subject to any requirement to extend the period of
time during which this exchange offer is open, complete this exchange
offer.
These conditions are for the sole benefit of Viacom. Viacom may assert
these conditions with respect to all or any portion of this exchange offer
regardless of the circumstances giving rise to them. Viacom may waive any
condition in whole or in part at any time at its sole discretion. Viacom's
failure to exercise its rights under any of the above conditions does not
represent a waiver of these rights. Each right is an ongoing right which may
be asserted at any time. Any determination by Viacom concerning the conditions
described above will be final and binding upon all parties.
If a stop order issued by the SEC is in effect with respect to the
registration statement of which this exchange offer is a part, Viacom will not
accept any shares of Viacom class A or class B common stock tendered and will
not exchange shares of Blockbuster class A common stock for any shares of
Viacom class A or class B common stock.
Fees and Expenses
is acting as the dealer manager in connection with this exchange
offer. will receive a fee of $ for its services as dealer manager,
in addition to being reimbursed by Viacom for its reasonable out-of-pocket
expenses, including attorneys' fees, in connection with this exchange offer.
is also acting as Viacom's financial advisor in connection with this
exchange offer, for which is receiving customary compensation. The
foregoing fees will be payable if and when this exchange offer is completed.
has provided investment banking services to Viacom and Blockbuster in the
past for which received customary compensation.
Viacom and Blockbuster have each agreed to indemnify against
specified liabilities related to this transaction, including civil liabilities
under the federal securities laws, and to contribute to payments which
may be required to make in respect thereof. However, in the opinion
of the
34
<PAGE>
SEC, such indemnification is against public policy as expressed in the
Securities Act of 1933, and is, therefore, unenforceable. may from
time to time hold shares of Viacom class A or class B common stock in its
proprietary accounts, and to the extent it owns shares in these accounts at the
time of this exchange offer, may tender these shares.
All questions as to the validity, form, and eligibility, including time of
receipt of notices of solicited tenders will be determined by the exchange
agent and Viacom, in the exchange agent's and Viacom's discretion,
respectively, which determination will be final and binding. Neither the
exchange agent nor any other person will be under any duty to give notification
of any defects or irregularities in a notice of solicited tender or incur any
liability for failure to give such notification.
No broker, dealer, bank, trust company or fiduciary shall be deemed to be
Viacom's agent or the agent of Blockbuster, , or for
purposes of this exchange offer.
Viacom has retained to act as the information agent and to
act as the exchange agent in connection with this exchange offer. The
information agent may contact holders of shares of Viacom class A or class B
common stock by mail, telephone, facsimile transmission and personal interviews
and may request brokers, dealers and other nominee stockholders to forward
materials relating to this exchange offer to beneficial owners. The information
agent and the exchange agent each will receive reasonable compensation for
their respective services, will be reimbursed for reasonable out-of-pocket
expenses and will be indemnified against liabilities in connection with their
services, including liabilities under the federal securities laws.
Neither the information agent nor the exchange agent has been retained to
make solicitations or recommendations. The fees they receive will not be based
on the number of shares of Viacom class A or class B common stock tendered
under this exchange offer; however, the exchange agent will be compensated in
part on the basis of the number of letters of transmittal received and the
number of stock distribution statements distributed.
Viacom will not pay any fees or commissions to any broker or dealer or any
other person, other than , for soliciting tenders of shares of Viacom
class A or class B common stock under this exchange offer. Viacom will, upon
request, reimburse brokers, dealers, commercial banks and trust companies for
reasonable and necessary costs and expenses incurred by them in forwarding
materials to their customers.
Legal Limitation
This document is not an offer to sell and it is not soliciting any offer to
buy any shares of Blockbuster class A common stock in any jurisdiction in
which, except as provided below, the offer or sale is not permitted. Viacom is
not aware of any jurisdiction in the United States where the making of this
exchange offer or its acceptance would not be legal. If Viacom learns of any
jurisdiction where making this exchange offer or its acceptance would not be
permitted, Viacom currently intends to make a good faith effort to comply with
the relevant law. If, after such good faith effort, Viacom cannot comply with
such law, Viacom will determine whether this exchange offer will be made to and
whether tenders will be accepted from or on behalf of persons who are holders
of shares of Viacom class A or class B common stock residing in the
jurisdiction.
In any jurisdiction where the securities or blue sky laws require this
exchange offer to be made by a licensed broker or dealer, this exchange offer
may be made on our behalf by one or more registered brokers or dealers licensed
under the laws of such jurisdiction.
35
<PAGE>
PRICE RANGE OF SHARES OF VIACOM CLASS A AND
CLASS B COMMON STOCK AND DIVIDENDS
Shares of Viacom class A and class B common stock are listed and traded on
the NYSE under the symbols "VIA" and "VIA.B," respectively. Viacom class A and
class B common stock were listed and traded on the American Stock Exchange
until April 8, 1999. On February 25, 1999, Viacom's board of directors
declared a 2-for-1 common stock split, to be effected in the form of a
dividend. The additional shares were issued on March 31, 1999 to shareholders
of record on March 15, 1999. All common share and per share amounts have been
adjusted to reflect the stock split for all periods presented.
The following tables contain, for the periods indicated, the high and low
sale prices per share of Viacom class A and class B common stock as reported
on the NYSE composite tape or the American Stock Exchange composite tape, as
applicable.
<TABLE>
<CAPTION>
Viacom Class A Viacom Class B
Common Stock(/1/) Common Stock(/1/)
------------------ -------------------
High Low High Low
-------- -------- ------- ---------
<S> <C> <C> <C> <C>
1997
First Quarter.................. $18 9/16 $16 $18 15/16 $16
Second Quarter................. 17 23/32 12 5/8 18 12 5/8
Third Quarter.................. 17 3/8 13 3/4 17 9/16 13 5/8
Fourth Quarter................. 20 7/8 13 21 1/8 13 1/4
1998
First Quarter.................. $27 1/8 $19 15/16 $27 17/32 $20 1/4
Second Quarter................. 30 1/2 26 1/8 30 5/8 26 13/32
Third Quarter.................. 34 11/16 24 5/8 35 24 3/4
Fourth Quarter................. 36 29/32 25 7/16 37 1/8 25 163/512
1999
First Quarter.................. $45 1/2 $35 5/16 $45 15/16 $35 3/8
Second Quarter(/2/)............ 48 3/4 36 11/16 49 3/16 36 5/8
Third Quarter.................. 49 5/8 38 7/16 48 3/4 38 9/16
Fourth Quarter (through
December 10, 1999)............ 56 7/16 40 5/16 56 3/8 39 13/16
</TABLE>
- --------
(1) Viacom has not declared cash dividends on its class A or class B common
stock and has no present intention of doing so.
(2) As of April 8, 1999, Viacom class A and class B common stock ceased
trading on the American Stock Exchange and commenced trading on the NYSE.
The number of holders of record of shares of Viacom class A and class B
common stock as of , 2000 was and , respectively.
On December 10, 1999, the last full day of trading prior to the initial
filing of the registration statement of which this document is a part, the
closing price per share of Viacom class A and class B common stock as reported
on the NYSE composite tape was $55 1/4 and $55 1/16, respectively. You should
obtain current market quotations for Viacom class A and class B common stock
before deciding to tender.
36
<PAGE>
PRICE RANGE OF SHARES OF BLOCKBUSTER
CLASS A COMMON STOCK AND DIVIDENDS
The shares of Blockbuster class A common stock are listed and traded on the
NYSE under the symbol "BBI." Blockbuster class A common stock began trading on
August 11, 1999 following its initial public offering. The following table
contains, for the periods indicated, the high and low sale prices per share of
Blockbuster class A common stock as reported on the NYSE composite tape and the
cash dividends per share of Blockbuster class A common stock:
<TABLE>
<CAPTION>
Cash
High Low Dividends
---- ---- ---------
<S> <C> <C> <C>
1999
Third Quarter (from August 11, 1999)........... $16 7/8 $12 7/16 $ --
Fourth Quarter (through December 10, 1999)..... 17 1/8 11 3/8 0.02(/1/)
</TABLE>
- --------
(1) On October 20, 1999 Blockbuster's board of directors declared a cash
dividend of $0.02 per share of Blockbuster class A and class B common
stock, payable November 22, 1999, to its stockholders of record at the
close of business on November 1, 1999. The total dividend payment was
about $3.5 million, of which Viacom International Inc. was paid about $2.9
million.
The number of holders of record of shares of Blockbuster class A common
stock as of , 1999 was . Viacom currently owns all of the outstanding
shares of Blockbuster class B common stock, and immediately prior to this
exchange offer, Viacom will own more than 80% of the equity value of
Blockbuster. Immediately prior to the completion of this exchange offer, each
share of Blockbuster class B common stock that Viacom owns will be converted
into one share of Blockbuster class A common stock. Accordingly, Viacom will be
distributing Blockbuster class A common stock in this exchange offer.
On December 10, 1999, the last full day of trading prior to the initial
filing of the registration statement of which this document is a part, the
closing price per share of Blockbuster class A common stock as reported on the
NYSE composite tape was $15 3/4. You should obtain current market quotations
for the shares of Blockbuster class A common stock before deciding to tender
your shares of Viacom class A or class B common stock.
Blockbuster has paid and currently intends to pay a quarterly dividend of
$0.02 per share on Blockbuster common stock. Blockbuster's board of directors
is free to change Blockbuster's dividend practices from time to time and to
decrease or increase the dividend paid, or to not pay a dividend, on
Blockbuster's common stock on the basis of results of operations, financial
condition, cash requirements and future prospects and other factors deemed
relevant by Blockbuster's board of directors. Furthermore, Blockbuster's credit
agreement limits its ability to pay dividends. See "Description of
Blockbuster's Credit Agreement."
37
<PAGE>
VIACOM SELECTED CONSOLIDATED FINANCIAL DATA
(In millions, except per share amounts)
The selected consolidated financial data presented below have been derived
from, and should be read together with, Viacom's audited consolidated
financial statements and the accompanying notes included in its annual report
on Form 10-K for the year ended December 31, 1998 and the unaudited interim
consolidated financial statements and the accompanying notes included in its
quarterly report on Form 10-Q for the quarterly period ended September 30,
1999, which is incorporated by reference in this document. The historical
financial data presented below include the results of Paramount Communications
Inc. after its acquisition by Viacom on March 11, 1994 and the results of
Blockbuster Entertainment Corporation after its acquisition by Viacom on
September 29, 1994.
<TABLE>
<CAPTION>
Nine Months
Ended or At
Year Ended or At December 31, September 30,
---------------------------------------- ---------------
1994 1995 1996 1997 1998 1998 1999
------- ------- ------- ------- ------- ------ -------
Statement of Operations
Data: (unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $ 4,486 $ 8,700 $ 9,684 $10,685 $12,096 $8,754 $ 9,286
Operating income........ 354 1,247 1,197 685 752 455 881
Earnings (loss) from
continuing operations.. 19 88 152 374 (44) (133) 239
Net earnings (loss)..... 90 223 1,248 794 (122) (141) 201
Net earnings (loss)
attributable to common
stock.................. 15 163 1,188 734 (150) (186) 189
Earnings (loss) per
common share:
Basic:
Earnings (loss) from
continuing
operations............ (.14) .04 .13 .44 (.10) (.25) .33
Net earnings (loss).... .04 .22 1.63 1.04 (.21) (.26) .27
Diluted:
Earnings (loss) from
continuing
operations............ (.13) .04 .13 .44 (.10) (.25) .32
Net earnings (loss).... .03 .22 1.62 1.04 (.21) (.26) .27
Balance Sheet Data:
Total assets............ $28,274 $28,991 $28,834 $28,289 $23,613 $24,268
Total long-term debt,
net of current
portion................ 10,402 10,712 9,856 7,423 3,813 6,142
Shareholders' equity.... 11,792 12,094 12,587 13,384 12,050 10,918
</TABLE>
38
<PAGE>
VIACOM UNAUDITED PRO FORMA COMBINED CONDENSED FINANCIAL DATA
General
The following unaudited pro forma combined condensed balance sheet of
Viacom as of September 30, 1999 gives effect to the Viacom pro forma events
(as described below), as if such events occurred on September 30, 1999. The
unaudited statements of operations are presented as if the Viacom pro forma
events had occurred at the beginning of the earliest period presented.
The Viacom pro forma events are:
. The separation of Blockbuster through this exchange offer. Solely for
purposes of the pro forma financial data, it has been assumed that
Viacom would exchange all 144 million shares of Blockbuster common stock
that it owns at an exchange ratio of about 3.59 shares of Blockbuster
common stock for each share of Viacom common stock, which would result
in about 40 million shares of Viacom common stock being exchanged. This
exchange ratio is based on the December 9, 1999 closing market prices of
$15.50 for Blockbuster class A common stock and $55.625 for Viacom class
B common stock and assumes that no premium is being offered by Viacom.
This exchange ratio may not be indicative of the actual exchange ratio;
and
. The proposed merger with CBS, giving pro forma effect to the following:
-- CBS' acquisition of CBS Radio, Inc., formerly American Radio Systems
Corporation in June 1998;
-- Infinity's initial public offering in December 1998;
-- CBS' acquisition of King World Productions in November 1999; and
-- Infinity's acquisition of Outdoor Systems in December 1999.
In the opinion of Viacom's management, all adjustments and/or disclosures
necessary for a fair presentation of the pro forma data have been made. These
unaudited pro forma combined condensed financial statements are presented for
illustrative purposes only and are not necessarily indicative of the operating
results or the financial position that would have been achieved had the Viacom
pro forma events been consummated as of the dates indicated or of the results
that may be obtained in the future.
These unaudited pro forma combined condensed financial statements and notes
thereto should be read in conjunction with:
. Viacom's consolidated financial statements and the notes thereto as of
and for the year ended December 31, 1998, and Management's Discussion
and Analysis of Financial Condition and Results of Operations included
in Viacom's annual report on Form 10-K for the year ended December 31,
1998 which is incorporated by reference in this document;
. Viacom's consolidated financial statements and the notes thereto as of
and for the nine month period ended September 30, 1999, on Form 10-Q
which is incorporated by reference in this document;
. Blockbuster's consolidated financial statements and interim consolidated
financial statements and the notes thereto as of and for the year ended
December 31, 1998, and for the nine month period ended September 30,
1999, respectively, presented elsewhere in this document; and
. The unaudited CBS pro forma financial information as of and for the nine
month period ended September 30, 1999 and for the year ended December
31, 1998, as set forth in the Joint Proxy Statement/Prospectus and
Registration Statement on Form S-4 filed by Viacom on November 24, 1999,
which is incorporated by reference into this document.
39
<PAGE>
VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma
Viacom
Pro Forma as Adjusted for
Viacom Blockbuster
Less: Other as Adjusted CBS Viacom/CBS Separation And
Viacom Blockbuster Separation for Blockbuster Pro Forma Merger Viacom/CBS
Historical Separation(/1/) Adjustments Separation Combined(/4/) Adjustments Merger
---------- --------------- ----------- --------------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues............... $9,286 $3,268 $ 91(/2/) $6,109 $6,297 $ -- $12,406
Operating expenses..... 6,007 2,410 89(/2/) 3,686 3,605 -- 7,291
Selling, general and
administrative........ 1,712 485 7(/2/) 1,234 1,009 -- 2,243
Depreciation and
amortization.......... 616 292 -- 324 839 424 (/5/b) 1,587
Restructuring charge... 70 -- -- 70 -- -- 70
Residual costs of
discontinued
businesses............ -- -- -- -- 130 -- 130
------ ------ ---- ------ ------ ----- -------
Operating income....... 881 81 (5) 795 714 (424) 1,085
Other income (expense),
net................... 3 2 -- 1 5 -- 6
Interest income
(expense), net........ (311) (89) (7)(/2/) (229) (217) (61)(/5/b) (507)
------ ------ ---- ------ ------ ----- -------
Earnings (loss) from
continuing operations
before income taxes... 573 (6) (12) 567 502 (485) 584
Income tax (expense)
benefit............... (295) (52) 5 (/3/) (238) (393) 24 (/5/c) (607)
Equity in loss of
affiliated companies,
net of tax............ (38) (4) -- (34) (28) -- (62)
Minority interest...... (1) -- -- (1) (66) -- (67)
------ ------ ---- ------ ------ ----- -------
Earnings (loss) from
continuing
operations............ 239 (62) (7) 294 15 (461) (152)
Cumulative convertible
preferred stock
dividend requirement
and premium on
repurchase of
preferred stock....... (13) -- -- (13) -- -- (13)
------ ------ ---- ------ ------ ----- -------
Net earnings (loss)
from continuing
operations
attributable to common
stock................. $ 226 $ (62) $ (7) $ 281 $ 15 $(461) $ (165)
====== ====== ==== ====== ====== ===== =======
Earnings (loss) from
continuing operations
per common share:
Basic................. $ 0.33 $ 0.43 $ (0.11)
Diluted............... $ 0.32 $ 0.42 $ (0.11)
Weighted average shares
outstanding:
Basic................. 695 (40)(/2/) 655 812 (/5/a) 1,467
Diluted............... 709 (40)(/2/) 669 812 (/5/a) 1,467
</TABLE>
See accompanying notes to unaudited Viacom pro forma combined condensed
financial statements.
40
<PAGE>
VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Pro Forma
Pro Forma Viacom
Viacom as Adjusted for
as Adjusted Blockbuster
Less: Other for CBS Viacom/CBS Separation And
Viacom Blockbuster Separation Blockbuster Pro Forma Merger Viacom/CBS
Historical Separation(/1/) Adjustments Separation Combined(/4/) Adjustments Merger
---------- --------------- ----------- ----------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues................ $12,096 $3,893 $118 (/2/) $8,321 $8,361 $ -- $16,682
Operating expenses...... 8,506 3,320 114 (/2/) 5,300 5,242 -- 10,542
Selling, general and
administrative......... 2,061 549 17 (/2/) 1,529 1,335 -- 2,864
Depreciation and
amortization........... 777 383 -- 394 1,113 565 (/5/b) 2,072
Residual costs of
discontinued
businesses............. -- -- -- -- 163 -- 163
------- ------ ---- ------ ------ ----- -------
Operating income
(loss)................. 752 (359) (13) 1,098 508 (565) 1,041
Other income (expense),
net.................... (57) (13) -- (44) 38 -- (6)
Interest income
(expense), net......... (599) (24) 94 (/2/) (485) (363) (89)(/5/b) (937)
(4)(/2/)
------- ------ ---- ------ ------ ----- -------
Earnings (loss) from
continuing operations
before income taxes.... 96 (396) 77 569 183 (654) 98
Income tax (expense)
benefit................ (139) 59 (31)(/3/) (229) (320) 36 (/5/c) (513)
Minority interest....... (1) -- -- (1) (35) -- (36)
------- ------ ---- ------ ------ ----- -------
Earnings (loss) from
continuing operations.. (44) (337) 46 339 (172) (618) (451)
Cumulative convertible
preferred stock
dividend requirement
and discount on
repurchase of preferred
stock.................. (27) -- -- (27) -- -- (27)
------- ------ ---- ------ ------ ----- -------
Net earnings (loss) from
continuing operations
attributable to common
stock.................. $ (71) $ (337) $ 46 $ 312 $ (172) $(618) $ (478)
======= ====== ==== ====== ====== ===== =======
Earnings (loss) from
continuing operations
per common share:
Basic.................. $ (0.10) $ 0.47 $ (0.32)
Diluted................ $ (0.10) $ 0.46 $ (0.32)
Weighted average shares
outstanding:
Basic.................. 709 (40)(/2/) 669 812 (/5/a) 1,481
Diluted................ 709 (40)(/2/) 678 812 (/5/a) 1,481
</TABLE>
See accompanying notes to unaudited Viacom pro forma combined condensed
financial statements.
41
<PAGE>
VIACOM UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
AS OF SEPTEMBER 30, 1999
(In millions)
<TABLE>
<CAPTION>
Pro Forma
Viacom
Pro Forma as Adjusted for
Viacom Blockbuster
Less: as Adjusted Viacom/CBS Separation And
Viacom Blockbuster Other Separation for Blockbuster CBS Pro Forma Merger Viacom/CBS
Historical Separation(/1/) Adjustments(/2/) Separation Combined(/4/) Adjustments Merger
---------- --------------- ---------------- --------------- ------------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS:
Cash and cash
equivalents.... $ 674 $ 122 $ -- $ 552 $ 524 $ (474)(/5/b) $ 602
Customer
receivables,
net............ 1,677 114 8 1,571 1,477 -- 3,048
Other current
assets......... 2,631 403 (4) 2,224 1,245 450 (/5/b) 3,919
------- ------ ------- ------- ------- -------- -------
Total current
assets......... 4,982 639 4 4,347 3,246 (24) 7,569
Property and
equipment,
net............ 3,316 1,098 -- 2,218 3,055 -- 5,273
Goodwill and
other
intangibles,
net............ 11,424 6,016 -- 5,408 23,951 22,596 (/5/b) 51,955
Other noncurrent
assets......... 4,546 572 8 3,982 2,027 (340)(/5/b) 5,761
92 (/5/b)
------- ------ ------- ------- ------- -------- -------
Total assets.... $24,268 $8,325 $ 12 $15,955 $32,279 $ 22,324 $70,558
======= ====== ======= ======= ======= ======== =======
LIABILITIES AND
SHAREHOLDERS'
EQUITY:
Current portion
of long-term
debt........... $ 131 $ 22 $ -- $ 109 $ 189 $ -- $ 298
Accounts
payable,
accrued
expenses and
other.......... 4,054 737 50 3,367 2,078 (106)(/5/b) 5,314
(25)(/5/b)
------- ------ ------- ------- ------- -------- -------
Total current
liabilities.... 4,185 759 50 3,476 2,267 (131) 5,612
Long-term debt.. 6,142 1,314 -- 4,828 3,904 575 (/5/b) 9,372
65 (/5/b)
Other noncurrent
liabilities.... 1,924 73 -- 1,851 5,547 8 (/5/b) 7,406
------- ------ ------- ------- ------- -------- -------
Total
liabilities.... 12,251 2,146 50 10,155 11,718 517 22,390
------- ------ ------- ------- ------- -------- -------
Minority
interest in
equity of
consolidated
subsidiaries... 1,099 1,093 -- 6 5,391 -- 5,397
Shareholders'
Equity:
Common stock.... 7 -- -- 7 802 8 (/5/a) 15
(802)(/5/b)
Additional paid-
in capital..... 10,260 5,769 2,854 7,345 14,759 36,725 (/5/a) 44,493
(2,232) 200 (/5/a)
2,232 223 (/5/b)
(14,759)(/5/b)
Common stock
held in
treasury, at
cost........... (1,432) -- -- (1,432) (1,683) 1,683 (/5/b) (1,432)
Retained
earnings....... 2,115 (637) 12 (140) 1,957 (1,957)(/5/b) (319)
(50) (179)(/5/b)
(2,854)
Accumulated
other
comprehensive
income (loss).. (32) (46) -- 14 (665) 665 (/5/b) 14
------- ------ ------- ------- ------- -------- -------
Total
shareholders'
equity......... 10,918 5,086 (38) 5,794 15,170 21,807 42,771
------- ------ ------- ------- ------- -------- -------
Total
liabilities and
shareholders'
equity......... $24,268 $8,325 $ 12 $15,955 $32,279 $ 22,324 $70,558
======= ====== ======= ======= ======= ======== =======
</TABLE>
See accompanying notes to unaudited Viacom pro forma combined condensed
financial statements.
42
<PAGE>
NOTES TO VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS
(Tables in millions, except share and per share amounts)
(1) Separation of Blockbuster
This column reflects the deconsolidation of Blockbuster Inc.
(2) Transaction Loss and Other Separation Adjustments
Viacom will recognize a gain or loss in connection with this exchange offer
based upon the fair market value of Viacom common stock exchanged for
Blockbuster common stock. Assuming an exchange ratio of about 3.59 shares of
Blockbuster common stock for each share of Viacom common stock exchanged,
about 40 million shares of Viacom common stock would be exchanged for the 144
million shares of Blockbuster common stock that is owned by Viacom. In
addition, Viacom would recognize a non-recurring loss on disposal of
discontinued operations of about $2.9 billion. This loss on disposal is not
reflected in the pro forma results of operations. The assumed exchange ratio
is based on the December 9, 1999 closing market price of $55.625 per share of
Viacom class B common stock and $15.50 per share of Blockbuster class A common
stock. This exchange ratio may not be indicative of the actual exchange ratio.
The calculation of the estimated loss on the transaction is summarized
below:
<TABLE>
<S> <C>
Estimated consideration received for Blockbuster common
stock........................................................ $ 2,232
Net book value of Blockbuster at September 30, 1999........... (5,086)
-------
(2,854)
Estimated transaction costs................................... (50)
-------
Estimated loss................................................ $(2,904)
=======
</TABLE>
The adjustments made to revenues and operating expenses in the pro forma
combined condensed statements of operations and adjustments to inventory and
accounts receivable in the pro forma combined condensed balance sheet are the
result of the reversal of intercompany transactions which were previously
eliminated by Viacom in its consolidated historical financial statements.
The adjustments made to general and administrative expense of $7 million
for the nine months ended September 30, 1999 and $17 million for the year
ended December 31, 1998 principally reflect the reversal of allocated overhead
charges included in Blockbuster's results of operations which were included in
Viacom's consolidated historical financial statements.
The adjustments made to interest expense of $7 million for the nine months
ended September 30, 1999 and $4 million for the year ended December 31, 1998
represent the reversal of intercompany interest expense included in
Blockbuster's results of operations which were previously eliminated by Viacom
in its consolidated historical financial statements. The decrease in interest
expense of $94 million for the year ended December 31, 1998 is due to the
assumed interest savings associated with the reduction of Viacom's outstanding
debt resulting from the assumed January 1, 1998 repayment of promissory notes
issued by Blockbuster to Viacom. The promissory notes were issued on December
31, 1998 and therefore the related 1999 interest income and expense had been
accrued by Viacom and Blockbuster.
Pro forma earnings (loss) from continuing operations per common share are
based on the weighted average of common shares outstanding, reduced by about
40 million common shares assumed to be exchanged in this transaction, and
increased by about 812 million shares assumed to be issued by Viacom in the
proposed Viacom/CBS Merger. For both periods presented, the weighted average
common shares outstanding used in
43
<PAGE>
NOTES TO VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- (Continued)
(Tables in millions, except share and per share amounts)
calculating diluted loss from continuing operations per common share for "Pro
Forma Viacom as adjusted for Blockbuster Separation and Viacom/CBS Merger" do
not include the impact of Viacom stock options, as they are antidilutive.
(3) Income tax effect
Income tax expense on the pro forma results of operations is calculated at
a 40 percent marginal tax rate.
(4) CBS Pro Forma Combined
The unaudited pro forma combined condensed balance sheet as of September
30, 1999 is presented as if the merger of CBS and King World, and the Outdoor
Systems acquisition had occurred on September 30, 1999. The unaudited pro
forma condensed statements of operations for the nine months ended September
30, 1999 and the year ended December 31, 1998 are presented as if the merger
of CBS and King World, the acquisitions of American Radio by CBS and of
Outdoor Systems by Infinity and the Infinity initial public offering had
occurred on January 1, 1998.
The CBS unaudited pro forma combined condensed financial statements are
presented using the purchase method of accounting for the merger of CBS and
King World, the acquisitions of CBS Radio, Inc., formerly American Radio
Systems Corporation, by CBS, and of Outdoor Systems, Inc., by Infinity
Broadcasting Corporation.
These unaudited CBS pro forma combined financial statements have been
derived from, and should be read in conjunction with, CBS' audited
consolidated financial statements and the accompanying notes included in its
annual report on Form 10-K for the year ended December 31, 1998, as amended by
Form 10-K/A, the unaudited interim consolidated financial statements and the
accompanying notes included in its quarterly report on Form 10-Q for the
period ended September 30, 1999 and the unaudited pro forma combined condensed
financial statements for these periods included in the Joint Proxy
Statement/Prospectus and the Registration Statement on Form S-4 filed by
Viacom November 24, 1999, which are incorporated by reference into this
document.
44
<PAGE>
NOTES TO VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- (Continued)
(Tables in millions, except share and per share amounts)
(5) Pro Forma Merger Adjustments
(a) Consideration
Pursuant to the Viacom/CBS merger agreement, holders of CBS common stock
will receive 1.085 shares of Viacom class B common stock for each CBS share of
common stock issued and outstanding at the completion of the merger. The total
number of CBS shares issued and outstanding during the period subsequent to
the merger announcement but prior to its completion is not anticipated to
fluctuate from the ordinary course. For purposes of the unaudited pro forma
combined condensed financial statements, the $45.225 per share value of Viacom
class B common stock to be issued was calculated based on its average market
price per share from September 2, 1999 through September 9, 1999.
<TABLE>
<S> <C>
Total estimated CBS common shares outstanding (including shares to be
issued to King World shareholders)................................... 748.6
Exchange Ratio........................................................ 1.085
-------
Estimated Viacom class B common shares to be issued................... 812.2
=======
Purchase Consideration:
Estimated value of Viacom class B common stock to be issued (812.2
shares at $45.225 per share):
Common stock, $.01 par value........................................ $ 8
Additional paid-in capital.......................................... 36,725
Estimated fair value of CBS stock options to be assumed by Viacom..... 200
-------
Estimated net increase in Viacom equity............................... $36,933
=======
</TABLE>
(b) Merger
To record the excess purchase price over the net tangible and identifiable
intangible assets acquired in connection with the merger as described above:
<TABLE>
<S> <C>
Estimated net increase in Viacom equity.............................. $36,933
Less: Shareholders' equity of CBS Pro Forma Combined at September 30,
1999
Common stock....................................................... (802)
Additional paid-in capital......................................... (14,759)
Common stock held in treasury...................................... 1,683
Retained earnings/Accumulated other comprehensive loss............. (1,292)
Adjustments:
Add: Liability for conversion of CBS stock options, net of deferred
taxes............................................................. 833
-------
Excess purchase price over net tangible and identifiable intangible
assets acquired..................................................... 22,596
Identifiable intangible assets acquired.............................. 23,951
-------
Excess purchase price over net tangible assets acquired.............. $46,547
=======
Incremental amortization expense of excess purchase price over net
tangible and identifiable intangible assets acquired:
Twelve month amortization.......................................... $ 565
=======
Nine month amortization............................................ $ 424
=======
</TABLE>
45
<PAGE>
NOTES TO VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- (Continued)
(Tables in millions, except share and per share amounts)
The above pro forma adjustments are based on preliminary estimates. The
final allocation of the purchase price will be determined after the completion
of the merger and will be based on appraisals and a comprehensive final
evaluation of the fair value of CBS' tangible and identifiable intangible
assets acquired and liabilities assumed at the time of the merger. For the
purpose of these unaudited pro forma combined condensed financial statements,
amortization of the excess purchase price over tangible net assets acquired of
approximately $46.5 billion is computed on a straight-line basis using useful
lives as follows: $37.5 billion (40 years), $6.6 billion (30 years) and $2.4
billion (10 years).
Generally accepted accounting principles currently require that acquired
intangible assets be amortized over periods not to exceed 40 years. Viacom
believes that the intangible assets acquired from CBS included in the 40-year
category are comprised principally of the franchises, FCC licenses, and
trademarks of CBS. These are assets with indefinite lives which have
historically appreciated in value over time. In addition, Viacom intends to
continue to expand the combined company's existing lines of business, develop
new businesses by leveraging the well known franchises, trademarks and
products of Viacom and CBS, and take advantage of synergies that exist between
Viacom and CBS to further strengthen existing lines of business. Viacom
believes that it will benefit from the merger for an indeterminable period of
time of at least 40 years and, therefore, a 40-year amortization period for
the $37.5 billion portion of the excess purchase consideration is appropriate.
After the completion of the merger, Viacom will complete valuations and other
studies of the significant assets, liabilities and business operations of CBS
as of the time of the merger. Using this information, Viacom will make a final
allocation of the purchase consideration, including allocation to tangible
assets and liabilities, indentifiable intangible assets and goodwill.
Accordingly, depreciation and amortization, as presented in the pro forma
combined condensed statements of operations for the year and nine months ended
December 31, 1998 and September 30, 1999, may fluctuate significantly from the
preliminary estimate when the final appraisals of tangible and intangible
assets are completed.
The following table presents the incremental reduction to pro forma net
income (loss) from continuing operations attributable to common stock and pro
forma net income (loss) from continuing operations per common share resulting
from the allocation of each $1 billion of purchase consideration to assets
with useful lives of thirty, twenty, or ten years rather than the forty year
life reflected in the pro forma financial statements.
<TABLE>
<CAPTION>
30 years 20 years 10 years
-------- -------- --------
<S> <C> <C> <C>
Impact on pro forma net income (loss) from
continuing operations attributable to common
stock:
For the twelve month period...................... $ (8) $ (25) $ (75)
====== ====== ======
For the nine month period........................ $ (6) $ (19) $ (56)
====== ====== ======
Impact on pro forma net income (loss) from
continuing operations per common share:
For the year ended December 31, 1998............. $(0.01) $(0.02) $(0.05)
====== ====== ======
For the nine months ended September 30, 1999..... $ -- $(0.01) $(0.04)
====== ====== ======
</TABLE>
Limited rights to receive cash in lieu of Viacom options exist for the
majority of the historical CBS stock options outstanding prior to the
announcement of the merger. To reflect the liability associated with these
stock options, these unaudited pro forma combined condensed financial
statements assume that the options will be settled in cash for approximately
$1.4 billion. Accordingly, the issuance of long-term debt of $575 million and
adjustments to reflect the use of cash and investments, classified as other
noncurrent assets, of $474 million and $340 million, respectively, have been
recorded in the pro forma balance sheet to reflect the financing and funding
46
<PAGE>
NOTES TO VIACOM UNAUDITED PRO FORMA COMBINED
CONDENSED FINANCIAL STATEMENTS -- (Continued)
(Tables in millions, except share and per share amounts)
of such obligations at the effective time of the merger. In addition, related
interest expense of $58 million and $85 million for the nine months of 1999
and the twelve months of 1998, respectively, have been recorded in the
unaudited pro forma combined condensed statements of operations. Deferred
taxes have been provided for on the respective book and tax basis differences
at a 40 percent marginal tax rate. Additional options with a fair value of
$200 million either do not contain these limited rights or are options related
to underlying shares which cannot be disposed of for some designated period of
time, and, as such, have been reflected as an adjustment to additional paid-in
capital within shareholders' equity.
Viacom has entered into agreements with the two deputy chairmen of Viacom
regarding the terms of their resignations upon the effective time of the
merger. Accordingly, the pro forma balance sheet includes a charge as a
reduction to retained earnings of $179 million, net of tax benefit of $119
million, which principally reflects the stock options granted to them over the
life of their employment with Viacom as well as cash payments in accordance
with their resignation agreements. The tax benefit assumes a 40 percent
marginal tax rate. The pro forma statement of operations includes a charge for
the incremental interest expense associated with the increase in long-term
debt.
(c) Income Tax Expense
Income tax expense on the pro forma results of operations and the pro forma
adjustments, excluding non-deductible goodwill amortization, is calculated at
a 40 percent marginal tax rate.
(d) Items not included in the Unaudited Pro Forma Merger Adjustments
The preceding unaudited pro forma merger adjustments do not include any
adjustments for the following:
. any operating efficiencies and cost savings that may be achieved with
respect to the combined companies;
. upon closing of the merger, the combined companies may incur integration
related expenses as a result of the elimination of duplicate facilities
and functions, operational realignment and related workforce reductions.
Such CBS costs would generally be recognized as a liability assumed as
of the merger date resulting in additional goodwill while Viacom related
costs would be recognized as an expense through the statements of
operations;
. transactions between Viacom and CBS, including transactions between
Viacom and companies proposed to be acquired by CBS, have not been
eliminated in the unaudited pro forma combined condensed financial
statements, as the amounts are not material for the periods presented;
. transaction costs related to the merger are not expected to have a
material impact on these unaudited pro forma combined condensed
financial statements; and
. in connection with the merger, some radio and television stations may
have to be divested in order to comply with current FCC regulations.
Also, Viacom may be required to reduce or divest its interest in the
United Paramount Network to comply with FCC rules limiting the common
ownership of some television networks. Generally, any gains or losses
associated with disposition of historical Viacom assets would be
recognized through the statements of operations while the gain or loss
on the disposition of historical CBS assets would likely be recognized
as an adjustment to goodwill.
(6) Reclassifications
Some reclassifications have been made to conform to the unaudited pro forma
combined condensed financial statements presentation.
47
<PAGE>
BLOCKBUSTER SELECTED CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA
The following table sets forth Blockbuster's selected consolidated
historical financial and operating data as of the dates and for the periods
indicated. The selected statement of operations and balance sheet data for the
years ended December 31, 1996 through 1998 are derived from Blockbuster's
audited consolidated financial statements. The selected statement of
operations data for the nine months ended September 29, 1994, the three months
ended December 31, 1994, the year ended December 31, 1995 and the nine months
ended September 30, 1998 and 1999 and the selected balance sheet data as of
December 31, 1994 and 1995 and September 30, 1998 and 1999 are derived from
Blockbuster's unaudited consolidated financial statements prepared by
Blockbuster, which in Blockbuster's opinion, include all normal, recurring
adjustments necessary for a fair presentation of the financial position at
such dates and the results of operations for such respective periods. The
financial information herein may not necessarily reflect Blockbuster's results
of operations, financial position and cash flows in the future or what its
results of operations, financial position and cash flows would have been had
it been a separate, stand-alone entity during the periods presented.
48
<PAGE>
BLOCKBUSTER SELECTED CONSOLIDATED HISTORICAL
FINANCIAL AND OPERATING DATA -- (Continued)
The following data should be read in conjunction with, and are qualified by
reference to, the consolidated financial statements and related notes thereto,
"Blockbuster Unaudited Pro Forma Consolidated Financial Data" and related
notes and "Management's Discussion and Analysis of Financial Condition and
Results of Operations of Blockbuster" included elsewhere in this document.
<TABLE>
<CAPTION>
Nine Months
Nine Months Three Months Ended or At
Ended Ended or At Year Ended or At December 31, September 30,
September 29, December 31, -------------------------------------- ----------------
1994(/1/) 1994 1995 1996(/2/) 1997(/3/) 1998(/4/) 1998(/4/) 1999
------------- ------------ ------ --------- --------- --------- --------- ------
(In millions, except per share
amounts and worldwide store data)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $1,468 $ 546 $2,403 $2,942 $3,314 $3,893 $2,807 $3,268
Gross profit............ 1,031 431 1,705 1,928 1,953 1,937 1,296 1,998
Operating expenses...... 743 274 1,275 1,661 2,168 2,296 1,681 1,917
Operating income
(loss)................. 288 157 430 267 (215) (359) (385) 81
Interest expense, net,
and other items........ (17) (2) (11) (18) (54) (36) (17) (87)
Income (loss) before
income taxes........... 271 155 419 249 (269) (395) (402) (6)
Benefit (provision) for
income taxes........... (127) (72) (228) (167) (30) 59 80 (52)
Equity in income (loss)
of affiliated
companies, net of tax.. 2 -- (48) (4) (19) (1) (2) (4)
Net income (loss)....... 146 83 143 78 (318) (337) (324) (62)
Net income (loss) per
share--basic and
diluted (5)............ $ .58 $ .99 $ .54 $(2.21) $(2.34) $(2.25) $ (.42)
Weighted average shares
outstanding--basic and
diluted (5)............ 144 144 144 144 144 144 150
Balance Sheet Data:
Cash and cash
equivalents............ $ 55 $ 100 $ 59 $ 130 $ 99 $ 84 $ 122
Rental library, net..... 291 520 676 735 441 418 501
Intangibles, net........ 6,147 6,531 6,310 6,193 6,056 6,087 6,016
Total assets............ 8,250 8,571 8,795 8,731 8,275 8,281 8,325
Long-term debt, less
current portion (6).... 296 168 249 331 1,715 355 1,157
Stockholders' equity
(6).................... 7,275 7,737 7,784 7,618 5,638 7,103 6,179
Worldwide Store Data:
Company-operated stores
at end of period....... 3,067 3,692 4,472 5,105 5,283 5,223 5,746
Franchised and joint
venture stores at end
of period.............. 1,002 821 845 944 1,098 1,010 1,114
Total stores at end of
period................. 4,069 4,513 5,317 6,049 6,381 6,233 6,860
Same store revenues
increase
(decrease)(7).......... 5.1% (1.8)% 13.3% 12.7% 10.3%
</TABLE>
- -------
(1) The statement of operations data for the nine months ended September 29,
1994 represents Blockbuster Entertainment Corporation as an independent
company relating solely to the videocassette and video game rental
business prior to its acquisition by Viacom. In September 1994,
Blockbuster Entertainment Corporation merged with and into Viacom. All
financial data subsequent to September 29, 1994 reflects Viacom's basis
of accounting established in purchase accounting effective with Viacom's
acquisition and now reflected on Blockbuster's consolidated financial
statements.
(2) During 1996 Blockbuster recognized a restructuring charge of $50 million
primarily relating to Blockbuster's corporate relocation and elimination
of third party distributors.
(3) During 1997 Blockbuster recognized charges totaling $250 million
primarily related to inventory write-downs, closure of underperforming
stores, write-offs attributable to international joint ventures and
additional expenses incurred in connection with Blockbuster's corporate
relocation.
(4) During 1998 Blockbuster changed its method of amortizing its
videocassette and video game rental inventory. This newly adopted method
represents a more accelerated method of amortization. The adoption of
this new method of amortization was accounted for as a change in
accounting estimate effected by a change in accounting principle and,
accordingly, Blockbuster recorded a non-cash charge of $424 million
recognized as cost of sales.
(5) As described in note 1 to Blockbuster's consolidated financial
statements, Blockbuster was recapitalized to provide for class A common
stock and class B common stock. In accordance with SEC Staff Accounting
Bulletin No. 98, the capitalization of the class B common stock has been
retroactively reflected for the purposes of presenting historical net
income (loss) per share for periods prior to the initial public offering.
Pro forma weighted average shares outstanding reflect all shares of class
B common stock issued and outstanding which are owned by Viacom and the
class A common stock issued in Blockbuster's initial public offering, as
if these shares had been outstanding since the beginning of each
respective period.
(6) This reflects the December 31, 1998 declaration of a $1.4 billion
dividend payable to Viacom International Inc. in the form of an interest-
bearing promissory note.
(7) A store is included in the same store revenue calculation after it has
been opened and operated by Blockbuster for more than 52 weeks. An
acquired store becomes part of the same store base in the 53rd week after
acquisition and conversion. The percentage change is computed by
comparing total net revenues for same stores as defined above at the end
of the applicable reporting period with total net revenues from these
same stores for the comparable period in the prior year.
49
<PAGE>
BLOCKBUSTER UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL DATA
Blockbuster's unaudited pro forma consolidated statements of operations for
the year ended December 31, 1998 and the nine months ended September 30, 1999,
and the unaudited pro forma consolidated balance sheet as of September 30,
1999 have been prepared based on Blockbuster's consolidated financial
statements and interim consolidated financial statements and related notes
presented elsewhere in this document. This data is based on various
assumptions and includes the adjustments explained in the related notes. The
unaudited pro forma consolidated results of operations assume that these
transactions occurred as of the beginning of the periods presented. To the
extent that these events are not reflected in Blockbuster's historical balance
sheet, the unaudited pro forma balance sheet assumes that these transactions
occurred as of September 30, 1999.
On December 31, 1998, Blockbuster declared a dividend payable to Viacom
International Inc. in the form of an interest-bearing promissory note of $1.4
billion. Additionally, in the first quarter of 1999, promissory notes were
issued to Viacom International Inc. in the aggregate principal amount of about
$77 million in order to obtain funds for the acquisition of video stores.
Prior to this exchange offer, the following transactions occurred:
. Blockbuster entered into a $1.9 billion credit agreement;
. Blockbuster borrowed about $1.6 billion under Blockbuster's credit
agreement and the proceeds were used as follows:
(1) to pay about $65 million which is a portion of the purchase price
to Viacom's affiliates to acquire Blockbuster's non-U.S. operations
that it did not already own;
(2) to repay the $1.4 billion promissory note evidencing the dividend
payable by Blockbuster to Viacom International Inc. and about $77
million in promissory notes evidencing the amount payable by
Blockbuster to Viacom International Inc. in connection with the
acquisition of video stores;
(3) to pay about $43 million in accrued and unpaid interest due to
Viacom under the $1.4 billion and about $77 million promissory
notes referred to above; and
(4) to pay the fees and expenses of about $15 million relating to the
origination of Blockbuster's credit agreement; and
. Blockbuster's initial public offering of its class A common stock on
August 10, 1999. The initial public offering consisted of 31 million
shares of Blockbuster class A common stock issued at a price of $15 per
share which resulted in net proceeds of $443 million after deducting
underwriting discounts and commissions, but before offering expenses.
These proceeds were used to reduce Blockbuster's debt outstanding under
its credit agreement. Through Viacom's ownership of 100% of the shares
of Blockbuster class B common stock, representing a total of 144 million
shares, Viacom owned about 82% of Blockbuster common stock representing
about 96% of the combined voting power of common stock of Blockbuster at
the completion of Blockbuster's initial public offering.
This exchange offer and any subsequent spin-off of any remaining Blockbuster
common stock owned by Viacom as a result of under subscription of shares in
this exchange offer, will have no impact on Blockbuster's historical financial
position or results of operations.
See "Description of Blockbuster's Credit Agreement" and "Related Party
Transactions -- Agreements Between Blockbuster and Viacom Relating to
Blockbuster's Initial Public Offering or the Separation of Blockbuster from
Viacom."
50
<PAGE>
BLOCKBUSTER UNAUDITED PRO FORMA
CONSOLIDATED FINANCIAL DATA -- (Continued)
Blockbuster's unaudited pro forma consolidated financial data do not
purport to represent what its results of operations or financial position
would actually have been if its initial public offering and the other
transactions described above had in fact occurred on such dates or to project
Blockbuster's results of operations or financial position for any future date
or period. This data should be read in conjunction with the consolidated
financial statements and related notes, the interim consolidated financial
statements and the related notes and "Management's Discussion and Analysis of
Financial Condition and Results of Operations of Blockbuster" included
elsewhere in this document.
Blockbuster believes the estimates and assumptions used to prepare its
unaudited pro forma consolidated financial data provide a reasonable basis for
presenting the significant effects of this exchange offer and the transactions
discussed above, and that the pro forma adjustments give appropriate effect to
the estimates and assumptions and are properly applied in Blockbuster's
unaudited pro forma consolidated financial data.
51
<PAGE>
BLOCKBUSTER PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Year Ended December 31, 1998
------------------------------------------------------------------------
Pro Forma
Adjusted for
Initial Public Recapitalization
Blockbuster Recapitalization Offering and Initial
Historical Adjustments Pro Forma Adjustments Public Offering
----------- ---------------- --------- -------------- ----------------
(In millions, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues................ $3,893 $ $3,893 $ $3,893
Cost of sales........... 1,956 1,956 1,956
Operating expenses,
excluding amortization
of intangibles(/1/).... 2,126 2,126 2,126
Amortization of
intangibles............ 170 170 170
------ ------ ------ --- ------
Operating income
(loss)................. (359) (359) (359)
(108)(/2/)
Interest expense and
other items, net....... (36) (3)(/3/) (147) 32 (/5/) (115)
------ ------ ------ --- ------
Income (loss) before
income taxes........... (395) (111) (506) 32 (474)
Benefit (provision) for
income taxes........... 59 43 (/4/) 102 (12)(/6/) 90
Equity in loss of
affiliated companies,
net of tax............. (1) (1) (1)
------ ------ ------ --- ------
Net income (loss)....... $ (337) $(68.0) $ (405) $20 $ (385)
====== ====== ====== === ======
Net income (loss) per
share--basic
and diluted............ $(2.34) $(2.20)
====== ======
Weighted average shares
outstanding--basic and
diluted................ 144 175 (/7/)
====== ======
<CAPTION>
Nine Months Ended September 30, 1999
------------------------------------------------------------------------
(In millions, except per share amounts)
<S> <C> <C> <C> <C> <C>
Revenues................ $3,268 $ $3,268 $ $3,268
Cost of sales........... 1,270 1,270 1,270
Operating expenses,
excluding amortization
of intangibles(/1/).... 1,788 1,788 1,788
Amortization of
intangibles............ 129 129 129
------ ------ ------ --- ------
Operating income
(loss)................. 81 81 81
(7)(/2/)
Interest expense and
other items, net....... (87) (1)(/3/) (95) 23 (/5/) (72)
------ ------ ------ --- ------
Income (loss) before
income taxes........... (6) (8) (14) 23 9
Benefit (provision) for
income taxes........... (52) 3 (/4/) (49) (9)(/6/) (58)
Equity in loss of
affiliated companies,
net of tax............. (4) (4) (4)
------ ------ ------ --- ------
Net income (loss)....... $ (62) $ (5) $ (67) $14 $ (53)
====== ====== ====== === ======
Net income (loss) per
share--basic
and diluted............ $(0.42) $(0.30)
====== ======
Weighted average shares
outstanding--basic and
diluted................ 150 $ 175 (/7/)
====== ======
</TABLE>
See accompanying notes to unaudited Blockbuster pro forma consolidated
statements of operations.
52
<PAGE>
Notes to Unaudited Blockbuster Pro Forma Consolidated Statements of Operations
- --------
(1) Blockbuster believes that additional general and administrative expenses
resulting from the addition of personnel to fulfill certain functions
previously provided by Viacom will not differ materially from the
allocated general and administrative expenses from Viacom.
(2) This reflects additional interest expense primarily relating to the
funding of the $1.6 billion in borrowings under Blockbuster's credit
agreement to fund promissory notes payable to Viacom International Inc.
and the partial funding of the purchase from Viacom's affiliates of the
non-U.S. operations of Blockbuster's business that Blockbuster did not
already own. The additional interest expense was calculated assuming the
average bank borrowings were outstanding at the beginning of each
respective period, and an average annual interest rate of 7.3% for the
year ended December 31, 1998 and 6.8% for the nine months ended September
30, 1999. These amounts were reduced by the historical debt interest cost
of $8.4 million for the year ended December 31, 1998 and $77.3 million for
the nine months ended September 30, 1999. This rate represents the average
of the one-month LIBOR rate as of the end of each month in each respective
period plus 1.75%.
(3) This represents amortization of deferred bank fees incurred in connection
with Blockbuster's credit agreement.
(4) This reflects the income tax benefit associated with adjustments described
in footnotes (2) and (3) above.
(5) This reflects the reduction in interest expense as a result of the use of
all of the net proceeds of the initial public offering to repay $443
million of the average borrowings under Blockbuster's credit agreement. If
interest rates were to increase or decrease by 0.125 of 1%, Blockbuster's
related interest expense would be expected to increase or decrease by
about $1.5 million annually or $0.4 million quarterly.
(6) This reflects the income tax provision associated with the adjustment in
footnote (5) above.
(7) The pro forma basic net income (loss) per share includes both the class A
common stock issued in connection with Blockbuster's initial public
offering and class A common stock resulting from the conversion by Viacom
of Blockbuster class B common stock immediately prior to this exchange
offer.
53
<PAGE>
BLOCKBUSTER PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1999
(UNAUDITED)
<TABLE>
<CAPTION>
Exchange
Offer Pro Forma
Historical Adjustments as Adjusted
------------- ------------- -------------
(In millions, except per share amounts)
<S> <C> <C> <C>
Assets
Current assets:
Cash and cash
equivalents.............. $ 122 $ -- $ 122
Receivables, net.......... 114 -- 114
Merchandise inventories... 254 -- 254
Prepaid assets............ 149 -- 149
------------- ----------- -------------
Total current assets.... 639 -- 639
Rental library, net....... 501 -- 501
Deferred income taxes..... 3 -- 3
Property and equipment,
net...................... 1,098 -- 1,098
Intangibles, net.......... 6,016 -- 6,016
Other assets.............. 68 -- 68
------------- ----------- -------------
$ 8,325 $ -- $ 8,325
============= =========== =============
Liabilities and
Stockholders' Equity
Current liabilities:
Accounts payable.......... $ 369 $ -- $ 369
Accrued expenses.......... 360 -- 360
Current portion of long-
term debt................ 157 -- 157
Current portion of capital
lease obligations........ 22 -- 22
Deferred income taxes..... 8 -- 8
------------- ----------- -------------
Total current
liabilities............ 916 -- 916
Long-term debt less
current portion.......... 1,040 -- 1,040
Capital lease obligations,
less current portion..... 117 -- 117
Other liabilities......... 73 -- 73
------------- ----------- -------------
2,146 -- 2,146
------------- -------------
Commitments and
contingencies
Stockholders' equity:
Preferred stock, par value
$.01 per share; 100.0
shares authorized; no
shares issued or
outstanding.............. -- -- --
Class A common stock, par
value $.01 per share;
400.0 shares authorized,
31.0 shares issued and
outstanding.............. 1 1 (/1/) 2
Class B common stock, par
value $.01 per share,
500.0 shares authorized,
144.0 shares issued and
outstanding.............. 1 (1)(/1/) --
Additional paid-in
capital.................. 6,227 -- 6,227
Retained earnings
(deficit)................ (4) -- (4)
Accumulated other
comprehensive loss-
foreign currency
translation adjustment... (46) -- (46)
------------- ----------- -------------
Total stockholders'
equity................. 6,179 -- 6,179
------------- ----------- -------------
$ 8,325 $ -- $ 8,325
============= =========== =============
</TABLE>
- --------
(1) This reflects the conversion of 144 million shares of Blockbuster class B
common stock owned by Viacom into shares of Blockbuster class A common
stock immediately prior to this exchange offer. This represents 100% of
Viacom's shares in Blockbuster. There is no other effect of this exchange
offer on the capital structure of Blockbuster.
54
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS OF BLOCKBUSTER
The following discussion and analysis should be read in conjunction with
the consolidated financial statements and related notes thereto appearing
elsewhere in this offering memorandum.
General
Blockbuster entered into the video rental business in 1985 and is the
world's leading retailer of rentable home videocassettes, DVDs and video
games. Blockbuster's 6,900 stores offer a wide selection of entertainment
products for rent or purchase. Blockbuster's business model was significantly
modified in 1997 to refocus on videocassette rental, improving the customer
experience and satisfying customer demand earlier for newly released videos.
During 1998, Blockbuster's customers' responses were very favorable with a
revenue increase of 17.5%, an increase in same store revenues of 13.3% and an
increase in domestic rental transactions of about 14% on a same store basis as
compared to 1997.
The consolidated financial statements for the periods presented do not
fully reflect the trends in Blockbuster's business as it had significantly
different business models during these periods. In addition, the periods
presented include significant charges which relate to these business model
changes. As a result and as further explained below, Blockbuster's results of
operations for those periods are not comparable.
In connection with Blockbuster's merger with Viacom in 1994, Blockbuster
valued its videocassette rental library at fair market value, which formed the
basis for subsequent amortization of this inventory over a period of up to 36
months. Such fair market value proved, on average, to be lower than the cost
of rental videocassettes acquired after the merger. As a result, amortization
was lower with respect to rental videocassettes acquired in the 1994 merger
than rental videocassettes purchased after the merger. This lower amortization
favorably affected results in 1996 and, to a lesser extent, in 1997.
Amortization in 1996 and in 1997 also increased as a result of increased
purchases of videocassettes.
In 1996, Blockbuster decided to offer not only Blockbuster's traditional
video rental and related merchandise but various other merchandise categories,
including clothing, books and magazines. Blockbuster also decided to move its
corporate headquarters from Ft. Lauderdale, Florida to Dallas, Texas and to
build an 850,000 square foot distribution center to handle its existing and
new products and eliminate third party distribution. These changes resulted in
a $50.2 million charge.
Following significant management changes in 1997, Blockbuster determined
that the new merchandise lines that had been added in 1996 were not as
profitable as its core rental business. As a result, Blockbuster refocused its
merchandise lines and in the second quarter of 1997, Blockbuster's recorded
charges amounting to $250 million, $100.8 million of which related to a
reduction in the carrying value of some of its retail merchandise inventory.
In recognizing that Blockbuster could not purchase enough videocassettes at
the "full" cost to satisfy customer demand without significantly increasing
its risk, Blockbuster changed its business model. In 1998, in order to
increase the quantity and selection of newly released video titles and satisfy
its customers' demand for newly released videos earlier, Blockbuster entered
into revenue-sharing agreements with the major movie studios. Prior to
Blockbuster's change to a revenue-sharing business model, its videocassette
rental library was purchased at "full" cost, generally between $60 and $70 per
videocassette for major theatrical releases that were priced for rental in the
United States. The implementation of revenue-sharing dramatically affected
Blockbuster's cost of sales as it changed its business model from a primarily
fixed to a primarily variable cost approach. Starting in the second quarter of
1998, revenue-sharing payments to the movie studios became a significant
component of Blockbuster's cost of sales. In addition, Blockbuster shortened
the period over which it amortizes the up front cost of acquiring most newly
released videocassettes to three months. In connection with this change in
method of accounting for its videocassette rental library, Blockbuster
recorded a $424.3 million charge to reflect a reduction in the carrying value
of this library.
55
<PAGE>
Blockbuster has a substantial amount of intangible assets on its
consolidated financial statements. As of September 30, 1999, Blockbuster had
net intangible assets of $6,015.8 million, which represented about 72% of its
total assets and about 97% of its stockholders' equity. Blockbuster's
intangible assets consist primarily of goodwill. This goodwill was primarily
created when Viacom acquired Blockbuster's business and operations in 1994 for
a purchase price in excess of the fair market value of its tangible net assets
at that time. This goodwill was originally recorded on Viacom's financial
statements in connection with Viacom's acquisition of Blockbuster's business
and operations and is now recorded as an asset on Blockbuster's consolidated
financial statements. This goodwill generally represents the BLOCKBUSTER name.
Blockbuster evaluates on a regular basis whether or not events and
circumstances have occurred to indicate that all or a portion of the carrying
amount of these intangible assets may require an adjustment or a change to the
amortization period.
Results of Operations
The following table sets forth results of operations and other financial
data.
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30
-------------------------------- ------------------
1996 1997 1998 1998 1999
--------- --------- --------- -------- --------
(In millions, except margin and worldwide store
data)
<S> <C> <C> <C> <C> <C>
Statement of Operations
Data:
Revenues................ $ 2,942.1 $ 3,313.6 $ 3,893.4 $2,806.6 $3,267.5
Cost of sales........... 1,013.7 1,360.5 1,956.4 1,510.1 1,269.6
--------- --------- --------- -------- --------
Gross profit............ 1,928.4 1,953.1 1,937.0 1,296.5 1,997.9
Operating expenses...... 1,660.8 2,167.7 2,296.2 1,681.0 1,916.5
--------- --------- --------- -------- --------
Operating income
(loss)................. 267.6 (214.6) (359.2) (384.5) 81.4
Interest expense........ (22.0) (30.8) (27.7) (21.1) (90.6)
Interest income......... 3.6 3.7 4.0 3.3 1.8
Other items, net........ -- (27.6) (11.8) 0.4 1.5
--------- --------- --------- -------- --------
Income (loss) before
income taxes........... 249.2 (269.3) (394.7) (401.9) (5.9)
Benefit (provision) for
income taxes........... (167.4) (30.0) 59.4 80.0 (52.4)
Equity in loss of
affiliated companies,
net of tax............. (4.0) (18.9) (1.3) (1.8) (4.1)
--------- --------- --------- -------- --------
Net income (loss)....... $ 77.8 $ (318.2) $ (336.6) $ (323.7) $ (62.4)
========= ========= ========= ======== ========
Cash Flow Data:
Cash flows from
operating activities... $ 985.0 $ 991.3 $ 1,234.5 $ 906.5 $ 724.2
Cash flows used for
investing activities... (1,235.1) (1,188.1) (1,022.2) (740.9) (902.8)
Cash flows from (used
for) financing
activities............. 208.8 269.3 (241.1) (208.9) 201.8
Other Data:
Depreciation............ $ 165.5 $ 253.8 $ 212.7 $ 156.8 $ 163.1
Amortization of
intangibles............ 166.2 168.7 170.2 127.3 128.7
EBITDA(1)............... 599.3 207.9 23.7 (100.4) 373.2
Net income (loss) plus
intangible
amortization,
net of tax(1)(2)....... $ 239.6 $ (155.0) $ (172.5) $ (200.6) $ 60.8
Margins:
Rental margin(3)........ 74.1% 69.6% 54.6% 50.2% 66.0%
Merchandise margin(4)... 19.3 7.4 19.8 18.7 22.5
Gross margin(5)......... 65.5 58.9 49.8 46.2 61.1
Worldwide Store Data:
Same store revenues
increase
(decrease)(6).......... 5.1% (1.8)% 13.3% 12.7% 10.3%
Total stores at end of
period................. 5,317 6,049 6,381 6,233 6,860
</TABLE>
- --------
(1) "EBITDA" and "Net income (loss) plus intangible amortization, net of tax"
are presented here to provide additional information about Blockbuster's
operations. These items should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, cash flow and
other measures of financial performance prepared in accordance with
generally accepted accounting principles. EBITDA may differ in the method
of calculation from similarly titled measures used by other companies.
(2) Intangible amortization, net of tax, included in this item is primarily
related to goodwill.
56
<PAGE>
(3) Rental gross profit as a percentage of rental revenues.
(4) Merchandise gross profit as a percentage of merchandise revenues.
(5) Gross profit as a percentage of total revenues.
(6) This represents the increase (decrease) over the prior comparable period.
Special Item Charges
During the fourth quarter of 1996, Blockbuster recorded a $50.2 million
restructuring charge associated with the relocation of its headquarters to
Dallas, Texas and the elimination of third party distributors.
During the second quarter of 1997, Blockbuster recorded a $250 million
special item charge principally associated with a write-down of excess
inventory of $100.8 million, operating charges for domestic and international
reorganization, store closings and additional corporate relocation costs. This
special item charge also included write-offs attributable to Blockbuster's
joint venture operations in Japan recorded as equity in loss of affiliated
companies, net of tax.
During the second quarter of 1998, Blockbuster recorded a $424.3 million
special item charge associated with a change in the method of accounting for
videocassettes and video game rental inventory.
The following is a summary of the impact of the above-described special
item charges on Blockbuster's operating results during the periods presented.
<TABLE>
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
---------------------------- ------------------
1996 1997 1998 1998 1999
-------- -------- -------- -------- --------
(In millions)
<S> <C> <C> <C> <C> <C>
Operating income (loss)...... $ (50.2) $ (220.3) $ (424.3) $ (424.3) --
Net income (loss)............ (30.1) (174.7) (273.1) (273.1) --
Excluding the above-described special item charges, operating results would
have been as follows:
<CAPTION>
Nine Months Ended
Year Ended December 31, September 30,
---------------------------- ------------------
1996 1997 1998 1998 1999
-------- -------- -------- -------- --------
(In millions)
<S> <C> <C> <C> <C> <C>
Revenues..................... $2,942.1 $3,313.6 $3,893.4 $2,806.6 $3,267.5
Cost of sales................ 1,013.7 1,259.7 1,532.1 1,085.8 1,269.6
-------- -------- -------- -------- --------
Gross profit................. 1,928.4 2,053.9 2,361.3 1,720.8 1,997.9
Operating expenses........... 1,610.6 2,048.2 2,296.2 1,681.0 1,916.5
-------- -------- -------- -------- --------
Operating income, excluding
special item charges........ $ 317.8 $ 5.7 $ 65.1 $ 39.8 $ 81.4
======== ======== ======== ======== ========
</TABLE>
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Revenues. Revenues of $3,267.5 million for the nine months ended September
30, 1999 increased $460.9 million, or 16.4%, from $2,806.6 million for the
nine months ended September 30, 1998. The increase in revenues was primarily
due to increases in worldwide same store revenues of 10.3% for the nine months
ended September 30, 1999 as compared to the corresponding period of 1998 and
an increase in the number of systemwide stores of 627 to 6,860 at September
30, 1999 from 6,233 at September 30, 1998. The increase in same store revenues
was principally due to increases in the number of domestic rental transactions
of 6.5%, on a same store basis, and increased sales of previously viewed
videotapes, for the nine-month period ended September 30, 1999 as compared to
the corresponding period of the prior year.
Rental revenue growth of $449.3 million, or 19.2%, for the nine months
ended September 30, 1999 was the principal reason for the increase in total
revenue. The increase in rental revenue was primarily due to the increase in
the number of company-operated stores of 523 and the increase in rental
transactions driven by:
57
<PAGE>
. a substantial increase in the quantity and selection of newly released
videos provided through revenue sharing agreements;
. the impact of Blockbuster's advertising campaigns aimed at marketing the
improved customer experience;
. the implementation of more competitive pricing and rental terms.
Rental revenues include base rental fees and extended viewing fees.
Extended viewing fees of $516.4 million for the nine months ended September
30, 1999 increased $90.8 million, or 21.3%, from $425.6 million for the
comparable nine months ended September 30, 1998 due to the increase in rental
transactions and the number of company-operated stores. As a percentage of
total revenues, extended viewing fees increased to 15.8% for the nine-month
period of 1999 as compared to 15.2% in 1998. Base rental fees and extended
viewing fees vary from market to market.
Merchandise sales declined $9.5 million, or 2.2%, for the nine months ended
September 30, 1999 compared to the nine months ended September 30, 1998. The
decrease in merchandise sales was primarily related to Blockbuster's
allocation of more retail shelf space to previously viewed videotapes.
Cost of Sales. Cost of sales of $1,269.6 million for the nine-month period
ended September 30, 1999 decreased $240.5 million from $1,510.1 million for
the nine months ended September 30, 1998. Cost of sales as a percentage of
total revenues for the nine-month period ended September 30, 1999 decreased to
38.9% from 53.8% for the comparable nine-month period of 1998. Excluding the
special item charge of $424.3 million in the second quarter of 1998, cost of
sales for the nine-month period increased $183.8 million, or 16.9%, primarily
due to an increase in cost of rental revenues of $207.2 million for the nine
months ended September 30, 1999. As a percentage of revenues, cost of sales
excluding the special item charge increased to 38.9% for the nine months ended
September 30, 1999 as compared to 38.7% for the comparable nine month period
of 1998.
Gross Profit. Gross profit of $1,997.9 million for the nine months ended
September 30, 1999 increased $701.4 million, from $1,296.5 million in the nine
months ended September 30, 1998. For the nine months ended September 30, 1999,
gross profit as a percentage of total revenues increased to 61.1% from 46.2%
in the comparable nine months ended September 30, 1998. Gross margin for the
nine months ended September 30, 1998 and 1999 are not comparable because of
the change in accounting implemented in the second quarter of 1998 related to
Blockbuster's new business model.
Operating Expenses. Total operating expenses of $1,916.5 million for the
nine months ended September 30, 1999 increased $235.5 million from $1,681.0
million for the nine months ended September 30, 1998, primarily due to an
increase in the number of company-operated stores of 523 to 5,746 at September
30, 1999 from 5,223 at September 30, 1998. Total operating expenses decreased
as a percentage of total revenues to 58.7% in 1999 from 59.9% in 1998. The
increases in total operating expenses resulted from the following:
General and Administrative Expense. General and administrative expense,
which includes expenses incurred at the store and corporate level,
decreased as a percentage of total revenues to 44.1% in the nine months
ended September 30, 1999 from 45.3% in the nine months ended September 30,
1998 reflecting the benefits of leveraging Blockbuster's cost structure to
an increasing revenue base. General and administrative expense of $1,441.8
million in the nine months ended September 30, 1999, increased $170.3
million from $1,271.5 million in the nine months ended September 30, 1998.
The dollar increase for the nine months ended September 30, 1999 primarily
resulted from compensation increases of $90.8 million related to hiring
additional personnel to support Blockbuster's store growth and increased
store traffic. Occupancy costs increased $36.9 million largely as a result
of an increase in the number of company-operated stores. Other corporate
and store expenses increased $42.6 million due primarily to the growth of
Blockbuster's business.
Advertising Expense. Advertising expenses of $182.9 million for the nine
months ended September 30, 1999 increased $57.5 million from $125.4 million
in the nine months ended September 30, 1998. As a
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<PAGE>
percentage of total revenues, advertising expense increased to 5.6% in the
nine months ended September 30, 1999 from 4.5% in the nine months ended
September 30, 1998. These increases reflect Blockbuster's planned increased
investment in advertising and marketing which began in the second quarter
of 1998.
Interest Expense. Interest expense of $90.6 million for the nine months
ended September 30, 1999 increased $69.5 million as compared to $21.1 million
for the nine months ended September 30, 1998. The increase was primarily
attributable to interest expense associated with approximately $1.6 billion
indebtedness to Viacom relating to a promissory note issued by Blockbuster as
a dividend to Viacom International Inc. and advances by Viacom to Blockbuster
for various acquisitions.
Benefit (Provision) for Income Taxes. Blockbuster recognized a provision
for income taxes of $52.4 million for the nine months ended September 30, 1999
as compared to a benefit for income taxes of $80.0 million for the nine months
ended September 30, 1998. The fluctuation in the provision is primarily due to
the tax benefit associated with the special item charge recorded in the second
quarter of 1998.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
income (loss) of affiliated companies, net of tax was a loss of $4.1 million
for the nine months ended September 30, 1999 as compared to a loss of $1.8
million for the nine months ended September 30, 1998 primarily due to
increased losses in Blockbuster's joint venture operations in Italy.
Net Income (Loss). For the reasons described above, the net loss of $62.4
million for the nine months ended September 30, 1999 reflects a reduction in
net loss of $261.3 million from a net loss of $323.7 million for the nine
months ended September 30, 1998.
Comparison of 1998 to 1997
Revenues. Revenues of $3,893.4 million in 1998 increased $579.8 million, or
17.5%, from $3,313.6 million in 1997 largely as a result of a 13.3% growth in
Blockbuster's same store revenues which increased primarily as a result of an
increase of about 14% in its domestic rental transactions on a same store
basis and the net addition of 178 company-operated stores. Revenue growth
consisted primarily of increases in rental transactions driven by:
. a substantial increase in the quantity and selection of newly released
videos provided through revenue-sharing agreements;
. the impact of Blockbuster's advertising campaigns aimed at marketing the
improved customer experience;
. the implementation of more competitive pricing and rental terms; and
. the increased popularity of game rentals.
Extended viewing fees of $583.9 million in 1998 increased $180.1 million,
or 44.6%, from $403.8 million in 1997 largely as a result of increases in
rental transactions and fee increases in January 1998, which were partially
offset by longer base rental periods. As a percentage of total revenues,
extended viewing fees increased to 15.0% in 1998 from 12.2% in 1997.
Merchandise sales also contributed to revenue growth increasing $24.0
million, or 4.0%, over the prior year largely as a result of the video release
of Titanic, an increase in the number of company-operated stores and improved
merchandising campaigns in some markets.
Cost of Sales. Cost of sales of $1,956.4 million in 1998 increased $595.9
million from $1,360.5 million in 1997. Cost of sales as a percentage of total
revenues increased to 50.2% in 1998 from 41.1% in 1997. Excluding the special
item charges of $424.3 million in 1998 and $100.8 million in 1997, cost of
sales increased $272.4 million primarily as a result of revenue-sharing
payments to movie studios and cost of merchandise sales.
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<PAGE>
Commencing on April 1, 1998, Blockbuster substantially increased its purchases
of videocassette rental product through revenue-sharing arrangements with the
movie studios. Pursuant to Blockbuster's new business model and its change in
accounting method adopted on April 1, 1998, revenue-sharing payments are
expensed as incurred and the cost of rental product amortization has been
accelerated. Payments made pursuant to Blockbuster's revenue-sharing
agreements increased $314.3 million in 1998 as compared to 1997. Partially
offsetting the increased expense due primarily to revenue-sharing is a
decrease in rental tape amortization of $88.3 million. This decrease is due to
the decline in the up front costs of rental product purchased pursuant to
revenue-sharing. Blockbuster's total cost of merchandise sold of $495.5
million increased $46.4 million in 1998 from $449.1 million in 1997.
Gross Profit. Gross profit as a percentage of revenues, or gross margin,
decreased to 49.8% in 1998 from 58.9% in 1997. Excluding the special item
charges of $424.3 million in 1998 and $100.8 million in 1997, gross profit
decreased as a percentage of revenues to 60.6% in 1998 from 62.0% in 1997.
Gross margins for 1998 and 1997 are not comparable because of the special item
charges recorded in the second quarter of each year and the change in
accounting implemented in the second quarter of 1998 related to Blockbuster's
new business model. Merchandise margins declined in 1998 as compared to 1997
due to increased markdowns and promotional activities during 1998.
Operating Expenses. Total operating expenses of $2,296.2 million in 1998
increased $128.5 million from $2,167.7 million in 1997. Total operating
expenses as a percentage of total revenues decreased to 59.0% in 1998 from
65.4% in 1997. The increase in total operating expenses resulted from the
following:
General and Administrative Expense. General and administrative expense,
which includes expense incurred at the store and corporate level, decreased
as a percentage of total revenues to 44.5% in 1998 from 48.5% in 1997.
Excluding the special item charge of $74.4 million related to relocation
and occupancy costs in 1997, general and administrative expense of $1,732.3
million in 1998 increased $201.0 million from $1,531.3 million in 1997 due
to compensation increases of $81.3 million, a $73.9 million increase in
other corporate and store expenses and a $45.8 million increase in
occupancy cost. Store labor cost increased because of an increase in the
number of store personnel, the increase in the number of company-operated
stores and an increase in minimum wage from $4.75 per hour to $5.15 per
hour which became effective in September 1997. The increase in the number
of store personnel reflects Blockbuster's commitment to better serve its
customers and support its revenue growth. The increase in occupancy cost
was primarily attributable to an increase in the number of stores.
Advertising Expense. Advertising expense of $181.0 million in 1998
increased $41.5 million from $139.5 million in 1997. As a percentage of
total revenues, advertising expense increased to 4.6% in 1998 from 4.2% in
1997. This increase was primarily due to additional promotional and
advertising activity in order to increase customer awareness of the greater
quantity and selection of newly released videos, Blockbuster's improved
customer service, and the improved selection of BLOCKBUSTER FAVORITES.
Depreciation. Depreciation expense of $212.7 million in 1998 decreased
$41.1 million from $253.8 million in 1997. Excluding the special item
charge of $45.1 million in 1997 associated with domestic and international
reorganization and store closings, depreciation expense increased $4.0
million in 1998 from 1997 reflecting net store growth.
Excluding the 1998 and 1997 special item charges, total operating expenses
increased $248.0 million in 1998 from 1997.
Interest Expense. Interest expense of $27.7 million in 1998 decreased $3.1
million from $30.8 million in 1997.
Other Items, Net. Other items of $11.8 million in 1998 decreased $15.8
million from $27.6 million in 1997 largely due to the recognition of non-cash
expenses of $10.5 million and $27.1 million in 1998 and 1997, respectively, to
write-down non-strategic investments to their net realizable value.
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<PAGE>
Benefit (Provision) for Income Taxes. Blockbuster recognized a benefit for
income taxes of $59.4 million in 1998 as compared to a provision for income
taxes of $30.0 million in 1997. This change was primarily attributable to the
mix of domestic and foreign income or losses. Blockbuster did not recognize a
benefit for foreign losses, as it is more likely than not that the benefit
will not be realized. Goodwill associated with Viacom's acquisition of
Blockbuster's business and operations and which is now recorded on
Blockbuster's financial statements is not amortizable for tax purposes.
Excluding the non-deductible amortization of intangibles, the annual effective
tax rates would have been 24.6% in 1998 and (25.8%) in 1997.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
loss of affiliated companies, net of tax, decreased primarily due to the fact
that Blockbuster recognized a pre-tax charge of $29.4 million in 1997
associated with its investment in its Japanese joint venture.
Net Income (Loss). For the reasons described above, net loss of $336.6
million in 1998 increased $18.4 million from a loss of $318.2 million in 1997.
Excluding the special item charges in 1998 and 1997, net loss declined $80.0
million to $63.5 million in 1998 from $143.5 million in 1997.
Comparison of 1997 to 1996
Revenues. Revenues of $3,313.6 million in 1997 increased $371.5 million, or
12.6%, from $2,942.1 million in 1996 principally due to the net addition of
633 company-operated stores over the prior year but was offset by a 1.8%
decline in same store revenues and a lower number of rental transactions.
Rental revenues increased $277.1 million, or 11.6%, driven by the increase in
company-operated stores but were much lower than anticipated as a result of
fewer active customers and rental transactions.
Extended viewing fees of $403.8 million in 1997 increased $59.2 million, or
17.1%, from $344.6 million in 1996 primarily as a result of increases in
rental transactions. As a percentage of total revenues, extended viewing fees
increased to 12.2% in 1997 from 11.7% in 1996.
Merchandise sales increased $102.7 million, or 20.9%, over the prior year
due to improved product offerings in Blockbuster's significant international
markets.
Cost of Sales. Cost of sales of $1,360.5 million in 1997 increased $346.8
million from $1,013.7 million in 1996. Cost of sales as a percentage of total
revenues increased to 41.1% in 1997 from 34.5% in 1996. Excluding the special
item charge of $100.8 million in 1997, cost of sales increased $246.0 million
primarily due to an increase of amortization expense in 1997 as compared to
1996 resulting from a smaller percentage of Blockbuster's amortization expense
in 1997 being attributable to the lower cost of videocassette rental library
acquired in 1994.
Gross profit. Gross profit as a percentage of total revenues, or gross
margin, decreased to 58.9% in 1997 from 65.5% in 1996. Excluding the special
item charge of $100.8 million in 1997, gross profit decreased to 62.0% in 1997
from 65.5% in 1996. Gross margins for 1997 and 1996 are not comparable because
of the special item charges recorded in the second quarter of 1997.
Operating Expenses. Total operating expenses of $2,167.7 million in 1997
increased $506.9 million from $1,660.8 million in 1996. Total operating
expenses as a percentage of total revenues increased to 65.4% in 1997 from
56.4% in 1996. The increase in total operating expenses resulted from the
following:
General and Administrative Expense. General and administrative expense
as a percentage of total revenues increased to 48.5% in 1997 from 39.5% in
1996. Excluding the $74.4 million special item charge in 1997, general and
administrative expense of $1,531.3 million in 1997 increased $367.7 million
from $1,163.6 million in 1996 due to compensation increases of $135.2
million, a $111.5 million increase in other corporate and store expenses
and a $121.0 million increase in occupancy cost. The increase in
compensation expense was due primarily to increases in the minimum wage in
late 1996 from $4.25 per hour to $4.75 per hour and in late 1997 from $4.75
per hour to $5.15 per hour and an increase in the number of company-
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<PAGE>
operated stores. In addition, in connection with Blockbuster's relocation
to Dallas, Blockbuster incurred higher salary expense due to the hiring of
temporary employees until positions were filled in Dallas. Blockbuster also
paid higher salaries overall due to the strong labor demand in the Dallas
market. The increase in occupancy cost was primarily attributable to an
increase in the number of stores.
Advertising Expense. Advertising expense of $139.5 million in 1997
increased $24.2 million from $115.3 million in 1996. As a percentage of
total revenues, advertising expense increased to 4.2% in 1997 from 3.9% in
1996. This increase was primarily due to increased promotions designed to
increase customer traffic.
Depreciation. Depreciation expense of $253.8 million in 1997 increased
$88.3 million from $165.5 million in 1996. Excluding the $45.1 million
special item charge in 1997, depreciation expense increased $43.2 million
in 1997 principally due to the purchases of equipment, fixtures and
leasehold improvements associated with Blockbuster's store growth and the
accelerated depreciation on the warehouse equipment located at its former
distribution center in Garland, Texas.
Restructuring Charge. Blockbuster incurred a $50.2 million restructuring
charge in 1996 associated with the relocation of its headquarters to
Dallas, Texas and the elimination of third party distributors.
Excluding the 1997 and 1996 special item charges, total operating expenses
increased $437.6 million in 1997 from 1996.
Interest Expense. Interest expense of $30.8 million in 1997 increased $8.8
million from $22.0 million in 1996. This increase is primarily due to an
increase in interest bearing debt owed to Viacom incurred to help finance
Blockbuster's international operations.
Other Items, Net. Other items of $27.6 million in 1997 reflect a non-cash
write-down of investments to their estimated net realizable value. During
1997, as part of Blockbuster's strategic initiatives, management made the
decision to dispose of investments that did not relate to Blockbuster's core
business.
Benefit (Provision) for Income Taxes. Blockbuster recognized provisions for
income taxes of $30.0 million in 1997 and $167.4 million in 1996. The decrease
was primarily attributable to the mix of domestic and foreign income or
losses. Blockbuster did not recognize a benefit for foreign losses, as it is
more likely than not that the benefit will not be realized. In addition,
goodwill associated with Viacom's acquisition of Blockbuster's business and
operations and which is now reflected on Blockbuster's financial statements is
not amortizable for tax purposes. Excluding the non-deductible amortization of
intangibles, the annual effective tax rates would have been (25.8)% in 1997
and 41.8% in 1996.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. Equity in loss
of affiliated companies, net of tax, increased $14.9 million in 1997 over the
prior year. This increase was primarily due to a pre-tax charge of $29.4
million in 1997 associated with Blockbuster's investment in its Japanese joint
venture.
Net Income (Loss). For the reasons described above, in 1997, Blockbuster
recognized a net loss of $318.2 million as compared to net income of $77.8
million in 1996. Excluding the special item charges in 1997 and 1996, 1997
reflects a net loss of $143.5 million as compared to net income of $107.9
million in 1996.
General Economic Trends, Quarterly Results of Operations and Seasonality
Blockbuster anticipates that its business will be affected by general
economic and other consumer trends. Blockbuster's business is subject to
fluctuations in future operating results due to a variety of factors, many of
which are outside of its control. These fluctuations may be caused by, among
other things:
. the number, timing and performance of new or acquired stores;
. public acceptance and interest in newly released videos;
. Blockbuster's mix of products rented and sold;
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<PAGE>
. Blockbuster's expansion into new markets and geographic locations;
. additional and existing competition and their pricing actions;
. marketing programs and new release acquisition costs;
. seasonality, particularly in April and May, due in part to improved
weather and Daylight Savings Time, and in September and October, due in
part to the start of school and the introduction of new television
programs;
. special events, such as the Olympics and the World Cup;
. changing technologies; and
. other factors affecting retailers in general.
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The following table sets forth quarterly statement of operations data for
the eleven quarters ended September 30, 1999. This quarterly information
includes the special item charges recognized in the second quarter of each of
1997 and 1998 discussed above and described in notes 3 and 4 of Blockbuster's
consolidated financial statements and, in Blockbuster's opinion, includes all
normal recurring adjustments necessary for a fair presentation of the
information for the periods covered. This data should be read in conjunction
with the consolidated financial statements and the notes thereto. The
quarterly operating results are not necessarily indicative of the operating
results for any future period.
<TABLE>
<CAPTION>
Quarter Ended
-----------------------------------------------
March 31 June 30(1) September 30 December 31
-------- ---------- ------------ -----------
(In millions, except percentage amounts)
<S> <C> <C> <C> <C>
1997
Revenues...................... $ 823.8 $ 765.3 $ 817.7 $ 906.8
Gross profit.................. 538.3 370.5 504.5 539.8
Operating income (loss)....... 71.2 (263.6) (14.8) (7.4)
Net income (loss)............. (19.3) (227.3) (37.8) (33.8)
Net income (loss) plus
intangible amortization, net
of tax....................... 21.5 (186.5) 3.0 7.0
Same store revenues increase
(decrease) (2)............... (1.2)% (2.3)% (1.5)% (1.0)%
1998
Revenues...................... $ 931.2 $ 890.0 $ 985.4 $1,086.8
Gross profit.................. 604.6 100.2 591.7 640.5
Operating income (loss)....... 67.0 (456.9) 5.4 25.3
Net income (loss)............. 15.8 (318.0) (21.5) (12.9)
Net income (loss) plus
intangible amortization, net
of tax....................... 56.8 (277.0) 19.6 28.1
Same store revenues increase
(2).......................... 7.6% 12.6% 18.2% 14.5%
1999
Revenues...................... $1,113.0 $1,041.7 $1,112.8
Gross profit.................. 671.2 645.3 681.4
Operating income (loss)....... 48.6 4.2 28.6
Net income (loss)............. (3.4) (39.9) (19.1)
Net income (loss) plus
intangible amortization, net
of tax....................... 37.8 1.0 22.0
Same store revenues increase
(2).......................... 17.0% 9.9% 5.7%
</TABLE>
- --------
(1) The table below presents the second quarter of 1997 and 1998 excluding
special item charges:
<TABLE>
<CAPTION>
Quarter Ended
--------------
June 30,
--------------
1997 1998
------ ------
(In millions)
<S> <C> <C>
Revenues................................................ $765.3 $890.0
Gross profit............................................ 471.3 524.5
Operating income (loss)................................. (43.3) (32.6)
Net income (loss)....................................... (52.6) (44.9)
Net income (loss) plus intangible amortization, net of
tax.................................................... (11.8) (3.9)
</TABLE>
(2) This represents the increase (decrease) over the prior comparable period.
Liquidity and Capital Resources
Liquidity Prior to and Upon Blockbuster's Separation from Viacom
Prior to Blockbuster's initial public offering of class A common stock, its
capital investments and acquisitions were financed with a combination of cash
flow from operations and advances from Viacom.
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Blockbuster generates cash from operations predominantly from the rental of
videocassettes and it has substantial operating cash flow because most of its
revenue is received in cash and cash equivalents. Prior to Blockbuster's
initial public offering, Viacom deposited sufficient cash in Blockbuster's
bank accounts to meet its daily obligations and withdrew excess funds from
those accounts. These transactions were included in advances from Viacom in
the consolidated balance sheets and consolidated statements of cash flows. The
amounts owed to Viacom prior to Blockbuster's initial public offering were
capitalized into Viacom's net equity investment.
Excess operating cash flow and additional funding from Viacom was used
primarily for opening and acquiring new stores, the refurbishment, remodeling
and relocation of exiting stores and the purchase of videocassette inventory.
Prior to Blockbuster's initial public offering its capital structure was
established which replaced its reliance on Viacom's cash management system. At
the time of Blockbuster's initial public offering, all cash accounts were
settled and, since such time, it has no longer participated in Viacom's cash
management system. As such, no further amounts will be deposited in or
withdrawn from Blockbuster's accounts by Viacom.
In October 1998, BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. The
remaining lease terms expire on various dates through 2007. Blockbuster has
agreed to indemnify Viacom with respect to any amount paid under these
guarantees. At the time of the sale, the contingent liability for base rent
was about $84 million on an undiscounted basis, with respect to these
guarantees. Blockbuster has not recognized any reserves related to this
contingent liability. If Wherehouse defaults, related payments could be funded
from operating cash flow.
Blockbuster expects to fund its future anticipated cash requirements,
including the anticipated cash requirements for capital expenditures, joint
ventures, commitments and payments of principal and interest on any
borrowings, with internally generated funds, in addition to various external
sources of funds which may be available to it. The external sources of funds
include Blockbuster's credit agreement and amendments thereto and may include
future issuances of debt, equity or other securities. Blockbuster believes
that such internally and externally generated funds will provide it with
adequate liquidity and capital necessary for the next twelve months.
At September 30, 1999, Blockbuster was in compliance with all financial
covenants under its credit agreement.
Cash Flows
Operating Activities. Net cash flows from operating activities decreased
$182.3 million from $906.5 million for the nine months ended September 30,
1998 to $724.2 million for the nine months ended September 30, 1999 primarily
due to an increase in revenue sharing payments of $245.8 million resulting
from the increased use of revenue sharing in 1999. Revenue sharing payments
reduce cash flow from operating activities. However, this reduction is
partially offset by a decline in videocassette purchases included in investing
activities. In addition, a decrease in accounts payable of $78.9 million
compared to an increase of $32.6 million for the same period in 1998
contributed to a decrease in cash flow provided by operating activities. These
decreases to operating cash flows were partially offset by a decrease in
inventory in the amount of $25.1 million as compared to an increase in the
corresponding period in 1998 of $5.4 million and a decrease in net deferred
income taxes in the amount of $85.0 million as compared to an increase in the
corresponding period in 1998 of $39.4 million.
Investing Activities. Net cash used for investing activities increased
$161.9 million from $740.9 million for the nine months ended September 30,
1998 to $902.8 million for the nine months ended September 30, 1999 as a
result of a $157.9 million increase in capital expenditures for new store
openings and store remodeling in 1999 and a $85.8 million increase in cash
used for store acquisitions. These increases were partially offset by a
decrease in the cost of rental library purchases, as the percentage of product
purchased through revenue sharing increased in 1999 as compared to 1998.
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The major components of investing activities are detailed below:
<TABLE>
<CAPTION>
Nine Months
Ended September
Year Ended December 31, 30,
------------------------------- ----------------
1996 1997 1998 1998 1999
--------- --------- --------- ------- -------
(In millions)
<S> <C> <C> <C> <C> <C>
Cash flows from investing
activities:
Rental library
purchases............... $ (751.5) $ (860.2) $ (818.1) $(611.7) $(543.1)
Capital expenditures..... (323.7) (262.2) (175.0) (108.8) (266.7)
Cash used for
acquisitions............ (154.4) (79.0) (34.2) (25.1) (110.9)
Proceeds from sales of
store operations........ -- -- -- -- 18.9
Other.................... (5.5) 13.3 5.1 4.7 (1.0)
--------- --------- --------- ------- -------
Net cash flow from (used
for) investing
activities................ $(1,235.1) $(1,188.1) $(1,022.2) $(740.9) $(902.8)
========= ========= ========= ======= =======
</TABLE>
Blockbuster's capital expenditures include store equipment and fixtures,
remodeling of some existing stores, implementation and upgrading of office and
store technology and the opening of new store locations. Each new store
opening requires initial capital expenditures, including leasehold
improvements, inventory, equipment and costs related to site locations, lease
negotiations and construction permits. Blockbuster plans to evaluate and
pursue new sites within the video rental industry in both the United States
and in international markets and will require capital and/or ongoing
infrastructure enhancements to support its expansion strategies in developing
markets and for acquisitions.
Blockbuster currently anticipates that capital expenditures of about $384.8
million will be incurred in 1999, of which $221.3 million is anticipated to
relate to new, relocated and remodeled stores and the conversion of acquired
stores, $40.5 million is anticipated to relate to an upgraded store point of
sale system to provide better service to its customers, and the balance of
which relates to general corporate purposes. Blockbuster expects the total
investment per new store to approximate $0.4 million, which includes rental
and merchandise inventory, leasehold improvements, signage and furniture,
fixtures and equipment. However, the cost of opening a new store can vary
based on size, construction costs in a particular market and other factors.
Financing Activities. Net cash flow from financing activities increased
$410.7 million to $201.8 million in the nine months ended September 30, 1999
as compared to the use of funds of $208.9 million in the nine months ended
September 30, 1998.
On December 31, 1998, Blockbuster declared a $1.4 billion dividend in the
form of a promissory note to Viacom International Inc. In the first quarter of
1999, Blockbuster issued other promissory notes of about $77 million to Viacom
International Inc. relating to Blockbuster's purchase of video stores. On June
23, 1999 Blockbuster paid these notes including accrued and unpaid interest
with the proceeds of the borrowings under the credit agreement described
below.
On June 21, 1999, Blockbuster entered into a $1.9 billion unsecured credit
agreement with a syndicate of banks. This credit agreement is comprised of a
$700 million revolver due July 1, 2004, a $600 million term loan due in
quarterly installments beginning April 1, 2002 and ending July 1, 2004, and a
$600 million revolver due June 19, 2000, which was subsequently permanently
reduced with proceeds from the initial public offering. Interest rates are
based on the prime rate or LIBOR at Blockbuster's option at the time of
borrowing. A varying commitment fee is charged on the unused amount of the
revolver. On June 23, 1999, Blockbuster borrowed $1.6 billion under its credit
agreement, all of which was used to:
. pay a portion of the purchase price to Viacom's affiliates to acquire
the non-U.S. operations of Blockbuster's business that it did not
already own;
. repay debt owed to Viacom International Inc. and its affiliates; and
. pay fees and expenses related to the origination of its credit
agreement.
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Blockbuster's credit agreement is intended to replace its reliance on
Viacom's centralized cash management system. At September 30, 1999,
Blockbuster had available $260.0 million of its borrowing capacity under its
credit agreement.
On August 10, 1999 Blockbuster sold to the public 31 million shares of its
class A common stock for $15 per share. Proceeds from the offering aggregated
$430.7 million, net of underwriting discounts and commissions of $22.1 million
and offering expenses of $12.2 million. The gross proceeds from the offering,
net of underwriting discounts and commissions, $442.9 million, were used to
pay down the short-term revolving loan due June 19, 2000.
On October 20, 1999 Blockbuster's board of directors declared a cash
dividend of $0.02 per share of class A and class B common stock, payable
November 22, 1999, to its stockholders of record at the close of business on
November 1, 1999. The total dividend payment was about $3.5 million, of which
Viacom International Inc. was paid about $2.9 million.
On November 3, 1999 Blockbuster and America Online, Inc. announced a three-
year strategic alliance. As part of the agreement, America Online will make a
$30 million investment, representing about 2.75% ownership, in Blockbuster.com
that will be used for, among other things, joint development of broadband
content and delivery. If an initial public offering of Blockbuster.com is not
completed within 18 months of the closing of the transaction, America Online
will have the option to recover its investment plus cost of capital.
Blockbuster believes that cash flow from operations, its current credit
agreement and future borrowings will provide it with adequate liquidity and
capital necessary to continue to fund its daily operations and expansion
strategy in the next two to three years. Depending upon its growth
opportunities and other factors, Blockbuster may, from time to time, consider
the issuance of debt, equity or other securities, to refinance debt or to use
for general corporate purposes. However, Blockbuster cannot assure you that it
will be able to access capital markets in the future on terms that will be
satisfactory to it.
Other Financial Measurements: Working Capital
At September 30, 1999, Blockbuster had cash and cash equivalents of $122.0
million. Working capital, however, reflected a deficit of $277.2 million due
to the accounting treatment of Blockbuster's videocassette rental library.
Videocassette rental inventories are accounted for as noncurrent assets and
are excluded from the computation of working capital. The acquisition cost of
videocassette rental inventories, however, is reported as a current liability
and, accordingly, is included in the computation of working capital.
Consequently, Blockbuster believes working capital is not as significant a
measure of financial condition for companies in the home video industry as it
is for companies in some other industries. Because of this accounting
treatment, Blockbuster may, from time to time, operate with a working capital
deficit.
Availability of Foreign Net Operating Losses
Foreign net operating losses, which are fully reserved, may not be
available to Blockbuster after the split-off. At December 31, 1998,
Blockbuster's foreign net operating losses were $42.5 million.
Quantitative and Qualitative Disclosures about Market Risk
Blockbuster is exposed to various market risks including interest rates on
its debt and foreign exchange rates.
Interest Rate Risk
Historically, Blockbuster has had no material interest rate risk associated
with debt used to finance its operations due to limited borrowings and its
relationship with Viacom. However, on June 23, 1999, Blockbuster
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borrowed $1.6 billion, comprised of $400 million borrowed under the long-term
revolver, $600 million borrowed under the term loan, and $600 million under
the short-term revolver. Total outstanding borrowings at September 30, 1999
were $1,197.1 million. Interest rates are based on the prime rate in the
United States or LIBOR (plus a margin based on leverage ratios) at
Blockbuster's option at the time of borrowing. The weighted average interest
rate at September 30, 1999 for these borrowings was 7.2%. Blockbuster
anticipates managing its future interest rate exposure by using a mix of fixed
and floating interest rate debt and, if appropriate, financial derivative
instruments.
Foreign Exchange Risk
Operating in international markets involves exposure to movements in
currency exchange rates. Currency exchange rate movements typically also
reflect economic growth, inflation, interest rates, government actions and
other factors. As currency exchange rates fluctuate, translation of the
statements of operations of Blockbuster's international businesses into U.S.
dollars may affect year-over-year comparability and could cause Blockbuster to
adjust its financing and operating strategies. As of September 30, 1999,
Blockbuster had not entered into any foreign currency hedging activities.
Blockbuster anticipates managing its future foreign exchange risk by using
foreign currency forward contracts to hedge against foreign currency exchange
fluctuations. The purpose of any contracts entered into will be to reduce any
adverse fluctuations in earnings and cash flows associated with the foreign
exchange rate fluctuations.
On January 1, 1999, eleven member countries of the European Union
established fixed conversion rates between their existing, or local,
currencies and one common currency, the euro. The euro trades on currency
exchanges and may be used in business transactions. Conversion to the euro
eliminates currency exchange risk between the participating member countries.
Beginning January 2002, new euro-denominated bills and coins will be issued,
and local currencies will be withdrawn from circulation.
Blockbuster's operations outside the United States constitute 19.2% of its
total revenues. Blockbuster's operations in Europe constitute 9.6% of its
total revenues. The majority of these sales are from Great Britain, which has
not adopted the euro.
Numerous issues are raised by the euro currency conversion including the
need to adapt computer and financial systems and business processes and
equipment. Due to these uncertainties, Blockbuster cannot reasonably estimate
the long-term effects one common currency may have on pricing, costs, and the
resulting impact, if any, on Blockbuster's financial condition or results of
operations.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") effective for fiscal years beginning after
June 15, 2000. Blockbuster anticipates that, due to its limited use of
derivative instruments, the adoption of SFAS 133 effective January 1, 2001
will not have a material effect on its financial statements.
Year 2000 Compliance
Overview
The widespread use of computer programs that rely on two-digit dates to
perform computations and decision-making functions may cause computer systems
to malfunction prior to or in the year 2000 and lead to significant business
delays and disruptions in the United States and internationally. Blockbuster
has implemented a year 2000 program in order to identify, assess and mitigate
its year 2000 risks. As part of its program, Blockbuster has hired independent
consultants to assist in the review and oversight of its program, as well as
to perform some testing operations. In addition, Blockbuster has established a
project management team to monitor its program.
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Blockbuster has reviewed its year 2000 issues based upon three areas:
applications, infrastructure, and business partners.
Applications cover the software systems resident on mainframe, mid-range,
network and personal computers. Blockbuster defines an application as one or a
collection of programs directly related to a common system. For example, a
financial application may include all the general ledger and accounts
receivable software code used to process information. In addition,
Blockbuster's applications have been segregated into critical and non-critical
applications. Critical applications are software systems which, if not
operational, could have a material impact on Blockbuster's business
operations.
Infrastructure includes computers, data and voice communications networks,
and other equipment which use embedded chip processors such as inventory
movement systems, telephone systems and others.
Business partners include franchisees, third party vendors, customers and
other service providers whose systems may interface with Blockbuster or whose
own operations are important to Blockbuster's daily operations.
These three areas have been addressed using a five-phase program:
inventory, assessment, remediation, testing and contingency planning.
. Phase 1 inventories the respective applications, hardware and business
partners.
. Phase 2 assesses the possible impact of a year 2000 error on the
continuing operation of each identified application, hardware system or
business partner relationship and subsequently determines the risk of
year 2000 noncompliance to operations and assigns priorities.
. Phase 3 establishes and implements specific plans for the remediation of
applications and hardware systems and for the determination of business
partners' compliance.
. Phase 4 tests each application and hardware system and reviews business
partners' compliance under the plans established in phase 3, to ensure
that year 2000 issues no longer exist.
. Phase 5 establishes and implements contingency plans in the event
internal or external systems are not compliant.
Changes may occur to Blockbuster's operations during the implementation of
its year 2000 program or subsequent to the completion of each phase.
Therefore, Blockbuster may periodically revise its plans. Blockbuster
continues to review and test systems for year 2000 compliance as changes
occur.
State of Readiness
Blockbuster's year 2000 progress, as of October 31, 1999, is as follows:
Applications
Blockbuster has completed the inventory, assessment, remediation and
testing phases with respect to all 16 critical domestic and six critical
international applications which primarily relate to point-of-sale,
warehousing and distribution and finance/payroll. Blockbuster has completed
the inventory and assessment phases of all non-critical worldwide
applications. Substantially all of the non-critical worldwide applications
have been remediated and tested. The remaining applications are scheduled for
completion through the remainder of 1999.
Infrastructure
Blockbuster has completed the domestic and international inventory,
assessment, remediation and testing phases with respect to all hardware
systems.
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Business Partners
During the course of business operations, Blockbuster relies on third party
business partners to distribute products and to provide services. These
business partners include financial institutions, governmental agencies and
utilities. The disruption of the ability to receive services or to distribute
Blockbuster's products could adversely affect its financial condition.
Although Blockbuster has little or no control over the remediation and testing
of these third party systems, it is taking appropriate action to determine the
level of year 2000 compliance of third parties. These actions include, but are
not limited to, requesting written confirmation of a business or business
system's year 2000 compliance; directly meeting with business management; and
performing additional independent tests. Blockbuster has identified 11
critical business partners and has requested written confirmation from all of
these partners as to their year 2000 compliance. Each of these 11 business
partners has responded to Blockbuster's request for information. One has
indicated it is year 2000 compliant and the others have indicated they expect
to be year 2000 compliant before December 31, 1999.
Blockbuster has substantially completed the inventory and assessment phase
of its business partners and has tested for compliance of all of its critical
business partners. The determination of third party year 2000 compliance will
continue through the end of the year.
Contingency Plans and Risks
As the remediation, testing and review of each application, infrastructure
item and business partner occurs, Blockbuster is determining the need for
contingency plans. Where appropriate, plans addressing both operational and
technical alternatives are being developed. This phase has begun and will
continue through the end of 1999.
Blockbuster's goal is to achieve timely and substantial year 2000
compliance, with remediation work assigned based upon how critical each system
is to its business. Due to the general uncertainty inherent in the year 2000
problem, resulting in part from the uncertainty of compliance by third parties
upon which Blockbuster relies, it is unable to determine at this time what the
consequences of the year 2000 problem will be. Blockbuster's year 2000 program
can only minimize, but cannot eliminate, the risks of third party non-
compliance. If Blockbuster, or one of these third parties upon which it
relies, fails to adequately address the year 2000 problem, it could disrupt
Blockbuster's business. The possible consequences of a failure include
incomplete or inaccurate accounting, recording or processing of rentals and
sales of videocassettes, video games and other products and the reporting of
this information; delays or failures in ordering, shipment and distribution of
videocassettes, video games and other products; the creation of uncertainty
about Blockbuster's customer database; or inability to consummate credit and
debit card and check transactions. Blockbuster will continue to devote the
necessary resources to complete its year 2000 program and contingency plans
and believes that such completion will significantly mitigate operational and
financial risks.
Costs
Costs of Blockbuster's year 2000 program have been expensed as incurred.
The estimated costs to complete Blockbuster's year 2000 program is currently
expected to total $11.5 million, $10.6 million of which has been incurred
through October 29, 1999. Blockbuster does not expect this to have a material
adverse effect on its results of operations, financial position or liquidity.
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VIACOM'S BUSINESS
Viacom is a diversified entertainment company with operations in five
segments other than its home video operations. Viacom's operations in its home
video business are being separated from Viacom pursuant to this exchange
offer. These five segments are:
. Publishing
. Networks
. Online
. Entertainment
. Parks
Networks
Viacom owns and operates advertiser-supported basic cable television
program services and premium subscription television program services in the
United States and internationally. Viacom's MTV Networks division includes
such owned and operated program services as:
. MTV: MUSIC TELEVISION in the United States, Europe and Latin America;
. NICKELODEON in the United States, Latin America, Scandinavia, Japan and
the Commonwealth of Independent States;
. NICK AT NITE in the United States;
. VH1 Music First in the United States, United Kingdom and Germany;
. MTV's spin-off, MTV2 in the United States and Europe; and
. TV LAND in the United States.
Viacom's MTV Networks division also participates in program services as a
joint venturer, including MTV in Asia and Brazil and NICKELODEON in the United
Kingdom and Australia.
Viacom's Showtime Networks Inc. subsidiary owns and operates SHOWTIME, THE
MOVIE CHANNEL(TM), and FLIX(R), and is a joint venture partner in and manager
of the SUNDANCE CHANNEL(R). Also, Viacom is a joint venture partner in:
. COMEDY CENTRAL(R), an advertiser-supported basic cable program service
in the United States;
. GULF DTH LDC, a satellite direct-to-home platform offering programming
in the Middle East; and
. NOGGIN(TM), a subscription-supported, non-commercial children's
educational program service, which is distributed by cable and satellite
and includes a related online service.
Entertainment
The principal businesses of Viacom's Entertainment segment are:
. PARAMOUNT PICTURES, which produces, acquires and distributes feature-
length motion pictures;
. PARAMOUNT HOME VIDEO, which distributes motion pictures and television
product produced by Paramount and third parties on videocassette and
disc in the U.S. and Canada;
. PARAMOUNT TELEVISION, VIACOM PRODUCTIONS, SPELLING TELEVISION and BIG
TICKET TELEVISION, which produce, acquire and distribute series,
miniseries, specials and made-for-television movies primarily for
network television, first-run syndication, pay television and basic
cable television;
. THE PARAMOUNT STATIONS GROUP, which owns and operates 17 television
stations and programs two additional stations pursuant to local
marketing agreements;
. FAMOUS PLAYERS, which owns and operates movie theatres in Canada; and
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. FAMOUS MUSIC, a music publisher.
Additionally, Viacom has joint venture interests in television
broadcasting, international motion picture and video distribution and
television programming services, including:
. UNITED PARAMOUNT NETWORK, in which Viacom is a 50% joint venture
partner. Pursuant to current FCC regulations, Viacom may not be
permitted to maintain its 50% ownership interest together with ownership
of the CBS network;
. UNITED INTERNATIONAL PICTURES (UIP); Viacom owns a one-third interest in
this venture which distributes Paramount's, Universal's and MGM's motion
pictures outside the U.S. and Canada. MGM announced this year that it
intends to withdraw from UIP effective October 31, 2000;
. UNITED CINEMAS INTERNATIONAL (UCI); Viacom owns a 50% interest in this
venture which owns and operates movie theatres in Europe, Latin America
and Asia;
. CINEMA INTERNATIONAL B.V. (CIBV), in which Viacom currently is a 50%
joint venture partner but has agreed to become the sole owner, which
distributes Paramount's motion pictures on videocassette and disc
outside the U.S. and Canada and acquires and distributes motion pictures
and television product produced by third parties; and
. Various international television programming services, including the
Movie Channel Middle East and the Paramount Comedy Channel in the UK.
Parks
Through PARAMOUNT PARKS, Viacom owns and operates five regional theme parks
and a themed attraction in the United States and Canada. Each of the theme
parks features attractions based on Viacom's intellectual properties.
Publishing
Through SIMON & SCHUSTER, Viacom publishes and distributes consumer
hardcover books, trade paperbacks, mass-market paperbacks, children's books,
audiobooks, electronic books and CD-ROM products in the United States and
internationally. SIMON & SCHUSTER's flagship imprints include SIMON &
SCHUSTER, POCKET BOOKS, SCRIBNER, and THE FREE PRESS. SIMON & SCHUSTER also
develops special imprints and publishes titles based on MTV, NICKELODEON and
PARAMOUNT PICTURES products. SIMON & SCHUSTER distributes its products
directly and through third parties. SIMON & SCHUSTER also delivers content and
sells products on Internet websites operated by various imprints or linked to
individual titles.
Online
Viacom operates Internet sites which are targeted to the current audiences
of its various MTV, VH1 and NICKELODEON program services, including NOGGIN, as
well as to new audiences who do not receive cable or direct-to-home satellite
services. In addition to providing entertainment and information on such
Internet sites, Viacom also sells its own, licensed and third party
merchandise.
Proposed Merger with CBS
Viacom recently announced that its board of directors and the board of
directors of CBS have agreed to merge their two companies. Viacom has entered
into a merger agreement with CBS. The proposed merger was approved by Viacom
and CBS shareholders on , 1999. Subject to various regulatory approvals,
the merger is expected to be completed in the first half of 2000.
CBS' Business
CBS is one of the largest radio and television broadcasters in the United
States. CBS operates its businesses through its Television, Cable and Infinity
segments. The Television segment consists of CBS' 16 owned and
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operated television stations, which are located in seven of the nation's ten
largest markets, and the CBS television network. The CBS television network
operations are subdivided into five areas: entertainment; news; sports;
enterprises, which produces, distributes and markets first-run and off-network
programming; and new media consisting of CBS' Internet businesses. CBS' Cable
segment consists of CBS' cable networks, including The Nashville Network,
Country Music Television and two regional sports networks and a global
provider of satellite services to broadcast, cable and corporate networks.
The Infinity segment corresponds to CBS' majority owned subsidiary,
Infinity Broadcasting Corporation, which conducts CBS' radio and outdoor
advertising businesses.
Infinity Broadcasting Corporation owns and operates about 160 AM and FM
radio stations located in 35 markets. TDI Worldwide, Inc., a wholly owned
subsidiary of Infinity, is one of the largest outdoor advertising companies in
the United States and sells space on various media, including buses, trains,
train platforms and terminals throughout commuter rail systems and on painted
billboards and phone kiosks. On December 7, 1999, Infinity acquired Outdoor
Systems, Inc. Outdoor Systems is a leading outdoor advertising company in
North America, operating bulletin, poster, mail and transit advertising
display faces in the United States, Canada and Mexico.
CBS' Internet businesses, which consist primarily of its operation of the
Internet sites CBS.com and Country.com, also include CBS' minority investments
in three public companies, SportsLine.com, Inc. (NASDAQ: SPLN), which
publishes several sports Internet sites, including CBS.SportsLine.com,
MarketWatch.com, Inc. (NASDAQ: MKTW), which publishes the Internet site
CBS.MarketWatch.com and Medscape Inc. (NASDAQ: MSCP), which publishes a
consumer health Internet site. CBS' other Internet investments include
Storerunner, Inc., Office.com, Inc., Switchboard, Inc., ThirdAge Media, Inc.,
Webvan, Inc., Jobs.com, Inc., Women's Consumer Network LLC, RX.com, Inc. and
Wrenchead.com, Inc., as well as its majority interest in the Internet portal
operated by iWon, Inc. CBS has also entered into an agreement to acquire an
equity interest in Big E Entertainment (NASDAQ: BIGE), which operates
Hollywood.com.
In addition to the acquisitions listed above, on November 15, 1999, CBS
acquired King World Productions, Inc. King World is the distributor of a
number of shows, including "The Oprah Winfrey Show," "Wheel of Fortune,"
"Jeopardy!" and "Hollywood Squares."
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BLOCKBUSTER'S INDUSTRY OVERVIEW
Domestic Home Video Industry
According to Paul Kagan Associates, the U.S. videocassette and DVD rental
and sales industry grew from $15.7 billion in revenue in 1997 to $17.1 billion
in 1998 and is expected to reach $21.5 billion in 2002. Paul Kagan Associates
estimates that, in 1998, 83.5 million, or 81.5%, of the 102.5 million total
U.S. households owned a VCR. The number of VCRs that were sold in the United
States in 1998 was estimated by Paul Kagan Associates to be 20.3 million, an
11.8% increase from 1997, which represents the largest number of VCRs sold in
any single year. In addition, Paul Kagan Associates estimates that about
900,000 DVD players were sold in the United States during 1998. According to
Paul Kagan Associates, the VCR and DVD markets will continue to grow as the
number of multi-VCR households is expected to increase from 37.4 million in
1998 to 46.0 million by 2002 and the number of VCRs and DVD players sold in
2002 is expected to reach 23.2 million.
As part of a November 1997 survey, the Video Software Dealers Association
revealed that each week nearly one-quarter of all U.S. households make a trip
to a video store, and each month almost three-fourths of all U.S. households
with children rent at least one videocassette. Blockbuster believes that the
following factors, among others, make video rental a preferred medium of
entertainment for millions of customers:
. the opportunity to browse among a very broad selection of movies;
. the control over viewing, such as the ability to control start, stop,
pause, fast-forward and rewind;
. the opportunity to view recently released movies prior to their
availability for viewing in the home through other mediums such as pay-
per-view, pay television, basic cable television and network and
syndicated television; and
. the opportunity to entertain one or more people for a reasonable price.
The home video industry is highly fragmented. However, the home video
industry has experienced consolidation in recent years, as video store chains
have gained significant market share from single store operators. Based upon
information disclosed by Video Store Magazine and Paul Kagan Associates, the
five largest video store chains had a 41% market share of all U.S. consumer
video rentals in 1998. Dun & Bradstreet, as cited by the Video Software
Dealers Association, estimates that by the first quarter of 1999 there were
about 24,590 independent video stores in the United States, down from about
26,960 in the first quarter of 1998. Blockbuster estimates that in the middle
of 1999 about 49% of all locations that rented video titles were operated by
single store owners. In addition, based on information from the Video Software
Dealers Association, more than 14,000 single store operators generated annual
revenues of less than $220,000 in 1998. Blockbuster believes that small stores
and chains in the home video industry will continue to consolidate with
national and regional chains and that such consolidation will offer
Blockbuster numerous acquisition opportunities. Blockbuster believes that
there are several competitive advantages in being a large home video chain,
including marketing efficiencies, brand recognition, access to more copies of
each videocassette through direct revenue-sharing agreements, sophisticated
information systems, greater access to prime real estate locations, greater
access to capital, and competitive pricing made possible by size and operating
efficiencies. Even if there is significant consolidation, however, Blockbuster
expects that the home video industry will remain fragmented.
Historically, the major studios or their licensees released movies to video
stores at wholesale prices generally between $60 and $70 per videocassette for
major theatrical releases that were priced for rental in the United States.
The studios still release movies at relatively high wholesale prices unless
the movie is subject to a revenue-sharing agreement or a quantity discount
program or is designated by the studios as a sell-through movie. The studios
attempt to maximize total revenue from newly released video titles by
maintaining the high wholesale price during the first four months to one year
after a movie is released. Thereafter, in order to promote sales to consumers,
the major studios release the movies at a substantially lower price, generally
at retail for about $10 to $20 per videocassette.
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Since the late 1980s, revenue-sharing agreements have been available to
home video chains and independent video dealers through deals brokered by
distributors such as Rentrak Corporation and SuperComm, Inc. More recently,
the major studios have entered into revenue-sharing agreements directly with
several large video chains. For titles purchased under these new agreements,
video stores share with the studios an agreed-upon percentage of the video
stores' rental revenue for a limited period of time in exchange for minimal
up-front payments for the videocassettes by the video stores. This percentage
generally declines over a period of weeks following the initial release of the
movie. The video stores also agree to take a minimum number of copies of each
movie that is released by a studio in any U.S. movie theater. The video stores
may also agree to take a minimum number of movies that are not released by a
studio in any U.S. movie theater. The revenue-sharing agreements, subject to
limitations and exceptions, allow the video stores to sell previously viewed
tapes to their customers.
Blockbuster believes that the revenue-sharing agreements have the following
significant benefits to participating video stores:
. they provide these stores with the opportunity to substantially increase
the quantity and selection of newly released video titles that they
stock;
. they increase revenues as a result of the increase in total number of
transactions per store and number of videocassettes rented per
transaction; and
. they align the studios' economic interests more closely with the
interests of the video stores.
In addition, Blockbuster believes that revenue-sharing has increased the
revenues received on an annual basis by the studios through increased rental
activity on new releases as well as greater distribution and revenues on non-
hit movies through minimum output provisions.
In addition to wholesale pricing and revenue-sharing agreements, studios
release some movies at relatively low initial prices, which generally are sold
by retailers for $10 to $20 per videocassette. Because the wholesale price is
relatively low and these movies are not subject to the revenue-sharing
agreements, retailers generally purchase these movies primarily for sale and
such movies are referred to as sell-through movies. These typically consist of
movies for children and other movies that have unique characteristics or other
mass ownership appeal, such as The Rugrats Movie and Titanic.
International Home Video Industry
According to Paul Kagan Associates, the potential market for home video
rentals is growing at a faster pace outside the United States than within the
domestic market. According to Paul Kagan Associates, the number of households
outside of the United States and Canada which own a VCR is expected to grow
from about 264 million in 1996 to about 353 million by 2001. As of September
30, 1999, Blockbuster operated in 25 countries outside of the United States.
Some of the attributes of the home video industry outside of the United
States are similar to those of the home video industry within the United
States. For example, the major studios generally release movies outside of the
United States according to the same sequential windows as the release of
movies within the United States, though the international windows tend to last
for a longer period of time. In general, however, the home video industry
outside of the United States does not mirror the home video industry within
the United States. For example, most countries have different systems of
supply and distribution of movie titles. Revenue-sharing agreements, which
have proliferated within the U.S. home video industry among large home video
chains, generally have not yet spread into markets outside of the United
States. In addition, competition in most international markets generally tends
to be more fragmented, with few large home video chains.
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Movie Studio Dependence on Video Rental Industry
According to Paul Kagan Associates, total U.S. movie studio and independent
supplier revenue in the United States grew at a compound annual rate of about
9.8% per year from $9.7 billion in 1994 to $14.1 billion in 1998. Paul Kagan
Associates also indicates that the video rental industry is the largest single
source of U.S. revenue to U.S. movie distributors, representing about $6.8
billion, or 48.2%, of the $14.1 billion of movie revenue in 1998. The
following table represents Paul Kagan Associates' estimates of revenues of
total movie distributor revenue which were made publicly available in the
fourth quarter of 1999.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
(In millions)
<S> <C> <C> <C> <C> <C>
U.S. home video......................... $ 4,586 $ 5,231 $ 6,152 $ 6,306 $ 6,811
Other U.S. revenue...................... 5,069 6,020 6,690 7,161 7,240
------- ------- ------- ------- -------
Total U.S. revenue.................... 9,655 11,251 12,842 13,467 14,051
------- ------- ------- ------- -------
International home video................ $ 3,412 $ 4,192 $ 4,432 $ 4,406 $ 4,436
Other international revenue............. 5,477 6,052 7,439 8,049 8,999
------- ------- ------- ------- -------
Total international revenue........... 8,889 10,244 11,871 12,455 13,435
------- ------- ------- ------- -------
Total revenue....................... $18,544 $21,495 $24,713 $25,922 $27,486
======= ======= ======= ======= =======
</TABLE>
Of the many movies produced by major studios and released in the United
States each year, relatively few are profitable for the studios based on box
office revenues alone. In addition to purchasing box office hits, video rental
stores, including those operated by Blockbuster, purchase movies on
videocassette and DVD that were not successful at the box office, thus
providing the movie studios with a reliable source of revenue for almost all
of their movies. Blockbuster believes that the consumer is more likely to view
movies which were not box office hits on a rented videocassette or DVD than on
most other formats because video rental stores provide an inviting opportunity
to browse and make an impulse choice among a very broad selection of movie
titles. In addition, Blockbuster believes the relatively low cost of video
rentals encourages consumers to rent films they might not pay to view at a
theater.
Historically, new technologies have led to the creation of additional
distribution channels for movie studios. Movie studios seek to maximize their
revenues by releasing movies in sequential release date "windows" to various
movie distribution channels. After the initial theatrical release, studios
make their movies available to video stores for a specified period of time.
This window is exclusive against most other forms of non-theatrical movie
distribution, such as pay-per-view, premium television, basic cable and
network and syndicated television. The current length of the window for video
stores varies, typically ranging from 30 to 90 days for domestic video stores
and from 120 to 180 days for international video stores. Thereafter, movies
are made sequentially available to other television distribution channels.
This method of sequential release allows the movie studios to increase their
total revenue while minimizing the adverse effect on the revenue derived from
previously established channels. With the advent of revenue-sharing and the
incremental revenues associated with such agreements, most movie studios have
lengthened the video rental window for many box office hits.
Home Video Game Industry
The home video game industry has historically been affected by changing
technology, limited hardware platform life cycles and hit-or-miss software
titles. In addition, video games typically generate most of their rental
revenue during the first twelve months after their release. Blockbuster
believes that during this time period, the differential between the retail
price and a rental price of a new video game is typically high enough to make
rentals an attractive alternative to the customer. According to Adams Media
Research and VidTrac, the total domestic home video game market generated
about $2.0 billion in software sales and $495 million in rental revenue in
1997. These markets grew to about $2.7 billion and about $800 million in 1998,
respectively, which
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represents a 36.8% and 61.7% increase, respectively. Adams Media Research
estimates that video game software sales will reach about $3.4 billion in
2002, a 25% increase over the $2.7 billion in software sales in 1998.
Based upon estimates of Gerard Klauer Mattison & Co., Inc., Blockbuster
believes that most of the recent growth in the home video game industry has
been fueled by the success of Sony PlayStation(TM) and Nintendo 64(TM) and
their respective video games. As of March 31, 1999, the installed base of Sony
PlayStation and Nintendo 64 within the United States was about 15.7 million
and 10.6 million units, respectively. We expect that the home video game
industry will continue to grow with the anticipated U.S. introduction of Sony
PlayStation II(TM) in the fall of 2000.
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BLOCKBUSTER'S BUSINESS
Blockbuster is the world's leading retailer of rentable home
videocassettes, DVDs and video games, with about 6,900 stores in the United
States and 25 other countries as of September 30, 1999. Blockbuster operates
primarily under the highly recognized BLOCKBUSTER brand name, which, according
to The Gallup Organization, achieves nearly 100% recognition with active movie
renters in the United States. Blockbuster's U.S. Internet site,
www.blockbuster.com, provides information about its stores and products,
delivers content regarding certain movies and entertainment programs and
serves as its electronic commerce venue. Blockbuster's revenues in 1998
increased 17.5% from 1997, with about 79% of these revenues generated in the
United States and about 21% generated outside of the United States.
Blockbuster believes that over 1 billion movies and video games have been
rented worldwide from its stores or its franchisees within the last 12 months,
and of these rental transactions about 750 million were generated from its
U.S. company-operated stores. For the year ended December 31, 1998,
Blockbuster and its franchisees recorded worldwide revenues of about $4.7
billion, which includes $3.9 billion from its company operations and $0.8
billion from its franchised stores.
Blockbuster's business and operations were previously conducted by
Blockbuster Entertainment Corporation, which was incorporated in Delaware in
1982 and entered the movie rental business in 1985. By 1993, Blockbuster
Entertainment Corporation became interested in expanding its business more
broadly into entertainment. In that year, Viacom agreed to acquire Paramount
Communications Inc. in a merger transaction. Following that agreement, an
unsolicited offer was made by a third party to acquire Paramount
Communications. In response, Viacom increased the value of its offer and
offered a significantly greater proportion of cash. In connection with this
increase, in October 1993, Blockbuster Entertainment Corporation agreed to
acquire $600 million of Viacom's convertible preferred stock to assist Viacom
in responding to the unsolicited offer. By January 1994, Viacom and the third
party had each further increased their respective offers for Paramount
Communications. In order to facilitate the increase in Viacom's offer for
Paramount Communications, in January 1994, Viacom entered into an agreement
with Blockbuster Entertainment Corporation pursuant to which Blockbuster
Entertainment Corporation agreed to be acquired by and merged with and into
Viacom. This merger provided Viacom with access to Blockbuster Entertainment
Corporation's considerable financial resources. The board of directors of
Blockbuster Entertainment Corporation determined that this merger was
consistent with, and in furtherance of, the long-term business strategy of
Blockbuster Entertainment Corporation at that time and was in the best
interests of its stockholders. Specifically, according to the proxy statement
filed by Blockbuster Entertainment Corporation, its board of directors
believed that the merger would provide an opportunity for the stockholders of
Blockbuster Entertainment Corporation to be stockholders of a fully integrated
entertainment and communications company. They believed that this combined
company would be competitive globally and better positioned for strategic
growth in many significant fields of the entertainment and communications
industries, especially if these industries continued to consolidate.
Accordingly, the board of directors of Blockbuster Entertainment Corporation
voted for, and recommended that the stockholders of Blockbuster Entertainment
Corporation vote in favor of, the merger. The aggregate purchase price paid on
September 29, 1994 for Blockbuster Entertainment Corporation, which included
businesses that have since been disaggregated, was about $7.6 billion. At the
time of Blockbuster's initial public offering, the aggregate value of
Blockbuster's common stock was about $2.6 billion. Blockbuster had about $1.2
billion of debt outstanding under its credit agreement after the proceeds from
its initial public offering net of underwriting discounts and commissions were
used to repay a portion of its credit agreement.
Since the merger and prior to Blockbuster's initial public offering,
Blockbuster's business and operations were conducted by various indirect
subsidiaries of Viacom. In the "Management's Discussion and Analysis of
Financial Condition and Results of Operations of Blockbuster" section,
Blockbuster discusses the general development of its business over the last
several years. In this section, Blockbuster describes its current business
model and strategy. Over the year and one-half period prior to its initial
public offering, Blockbuster's business and operations were either (1) merged
into Blockbuster Inc. or (2) purchased by Blockbuster Inc. and/or one of its
subsidiaries. Blockbuster Inc., an indirect subsidiary of Viacom, was
incorporated under a different name on October 16, 1989 in Delaware.
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Blockbuster's brand recognition and leading market position have allowed it
to create one of the strongest entertainment franchises in the United States.
Based on 1998 industry estimates from Paul Kagan Associates, Blockbuster
estimates that its company-operated and franchised stores attained a U.S.
market share in excess of 27%, over three times greater than that of its
nearest competitor. Blockbuster has developed this leading position based on a
business model which Blockbuster believes provides its customers with superior
convenience, selection and service at attractive prices. Blockbuster estimates
that about 59% of the U.S. population lives within three miles of one of its
stores. In addition, Blockbuster's customer transaction database contains
information on over 101 million U.S. and Canadian member accounts, of which
about 45 million were active in the last twelve months ended September 30,
1999.
Of the 25 markets in which Blockbuster operates outside the United States,
Blockbuster held leading market positions in Great Britain, Canada and the
Republic of Ireland and Northern Ireland during 1998. Historically, the
international video retailing markets have been highly fragmented with varying
distribution patterns in each market.
In 1997, John F. Antioco was recruited to serve as Blockbuster's chairman,
president and chief executive officer, selected in part for his significant
multi-store retail experience. Under the management team led by Mr. Antioco,
Blockbuster began to develop a new business model that refocused on its core
rental business. When substantially implemented in the second quarter of 1998,
this business model led to a significant improvement in customer satisfaction.
Most significantly, Blockbuster entered into domestic revenue-sharing
agreements with various motion picture studios. The studios include the six
major motion picture studios: Buena Vista Home Video, a division of the Walt
Disney Company; Columbia Tri-Star Home Video Inc.; 20th Century Fox Home
Entertainment Inc.; Paramount Pictures Corporation, a Viacom affiliate;
Universal Studios Home Video; and Warner Home Video. These agreements are
generally referred to as output agreements, because they require Blockbuster
to distribute most of the rental titles released on videocassette by these
studios. The quantity of each title obtained is generally determined by a
contractual formula.
Blockbuster refers to these agreements as revenue-sharing agreements
because they provide that Blockbuster will share its U.S. rental revenue from
the videos with the studio for a stated period of time, generally 26 weeks.
These agreements enable Blockbuster to provide the most popular newly released
video titles to its customers more quickly, in greater quantity and on a more
efficient basis. Blockbuster believes these agreements also have the following
significant benefits:
. substantially increasing the number of newly released videos in its
stores to better satisfy customer demand;
. contributing to an increase in revenues resulting from an increase in
the total number of transactions and the number of videocassettes rented
per transaction; and
. aligning the studios' economic interests more closely with Blockbuster's
because they share a portion of the rental revenue with Blockbusters for
a period of time.
In addition to revenue-sharing, Blockbuster has made other changes that
have increased its same store revenues while providing enhanced revenue
opportunities for the studios. Some of these other changes include improving
its product allocation system to more effectively allocate newly released
videos among its stores based upon the likelihood of rental frequency by store
and improving its direct marketing programs and advertising campaigns.
Reflecting this turnaround, quarterly domestic same store rental revenues
increased 8.6%, 17.5%, 20.0%, 20.5%, 23.1%, 12.9% and 11.0% in the seven
quarters ended September 30, 1999 compared to the comparable quarters in the
prior years.
Business Model
Blockbuster's current business model is designed to increase customer
traffic and transaction size by improving customer satisfaction and to
ultimately generate higher sales volume per store. Blockbuster believes
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its business model gives it an advantage over other large home video chains
and a significant advantage over its single-store competitors. Blockbuster is
applying key elements of its business model to its international operations.
The key elements of its business model are discussed below.
Broad Selection and Large Number of Movies
Blockbuster strives to be the leader in satisfying customer demand by
stocking each of its stores with more copies and a wider variety of newly
released movies than its competitors. In large part, its revenue-sharing
agreements and its ability to self-distribute have allowed Blockbuster to
implement this strategy in the United States. For the year ended December 31,
1998, which reflects nine months under its new business model, Blockbuster
obtained on average more than 150% more copies of each videocassette per store
and about 24% more video titles than the prior year. In addition to newly
released video titles, Blockbuster acquires and offers a broad selection of
time-tested popular movies and a wide variety of independent and lower-cost
movies that are generally only available at its stores for a specified period
of time.
Blockbuster's goal is to stock each of its stores with a selection and
quantity of merchandise that is optimal for that store. Using its customer
transaction database, Blockbuster determines on a store-by-store basis the
number of copies of each new release that is to be offered by each store.
Blockbuster's objective is to stock the top 1,000 most commonly rented popular
movies as part of its BLOCKBUSTER FAVORITES. In addition, Blockbuster uses its
customer transaction database to periodically review each store's inventory of
BLOCKBUSTER FAVORITES and identify movie titles within this category that have
not been rented for a period of time. Blockbuster offers these previously
viewed tapes for sale and replaces them with movies that Blockbuster believes
its customers are more interested in renting.
Convenient and Visible Stores of Optimal Size and Location
Blockbuster maintains a strong presence throughout the United States, with
an estimated 59% of the U.S. population living within three miles of one of
its stores. Blockbuster's experienced store development team can quickly
identify the optimal sites for its new stores within its targeted markets
through the use of its extensive real estate and customer transaction
databases. Blockbuster has developed three distinct store formats that are
tailored to maximize its penetration in each market. These three formats
include its "new" traditional store format, which is about 4,800 square feet,
its seam store format, which is about 2,500-3,500 square feet, and its store-
in-store format, which is about 1,000-1,200 square feet. In addition to
stores, Blockbuster has begun to deploy video vending machines on an
experimental basis.
In 1998, Blockbuster began a comprehensive program to remodel its company-
operated stores worldwide. Blockbuster expects to fit most of its company-
operated stores with new interior signage. Blockbuster also expects to remodel
the interior and exterior of some of its company-operated stores in order to
enhance its customers' shopping experience.
Superior and Consistent Customer Service
Blockbuster focuses on providing superior service to all of its customers.
An essential aspect of continuing to improve customer service has been
Blockbuster's focus on improving the in-store experience of each customer.
Blockbuster has worked to improve the quality of its staff through
recruitment, compensation, training and employee appreciation and incentive
programs. These programs encourage and empower its store employees to gain
experience and product knowledge in order to effectively meet the needs of
Blockbuster's customers. In addition, Blockbuster's domestic customers are
eligible to participate in its BLOCKBUSTER REWARDS premium membership program,
which allows its customers to earn free rentals. Blockbuster's most active
customers are automatically enrolled in the BLOCKBUSTER REWARDS Gold program,
which offers additional free rental benefits and the ability to reserve
movies. These programs are designed to develop customer loyalty by encouraging
Blockbuster's customers to rent movies only from its stores.
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Competitive Pricing
Blockbuster's goal is to optimize on a store-by-store basis the price at
which Blockbuster rents its video titles. In 1998, Blockbuster initiated a
dual pricing strategy that differentiated pricing between newly released video
titles and BLOCKBUSTER FAVORITES, whereby the BLOCKBUSTER FAVORITES were
priced lower than the newly released video titles. Blockbuster believes that
its customers perceive this two-tiered pricing as more appropriate in light of
the differences between the demand for the newly released video titles and the
BLOCKBUSTER FAVORITES. Blockbuster's customer transaction database provides
Blockbuster with the ability to adjust its overall pricing strategy for each
U.S. store based on local market conditions, including local prices
established by its competitors. In addition, Blockbuster has implemented a new
policy in its company-operated stores, setting the base rental term of its
BLOCKBUSTER FAVORITES, its video games and some of its newly released video
titles to a period ranging from two to five evenings. Blockbuster's customers
may keep the videocassette for a period longer than the base rental term for
extended viewing. There is a base rental fee for the base rental term and an
extended viewing fee for the extended viewing term. The base rental fees and
the extended viewing fees may vary from market to market.
National Advertising and Marketing Programs
Blockbuster's large U.S. store base and its extensive customer database
enable it to be the only home video chain that actively maintains a national
advertising and marketing program, including network television, national
promotions and local television and radio. For the year ended December 31,
1998, Blockbuster incurred about $181 million in advertising expenses. In
addition, some of Blockbuster's business partners, including the studios,
allow Blockbuster to direct a significant amount of their advertising
expenditures. Furthermore, the studios incur additional expenditures to
promote their newly released movies.
Blockbuster's advertising and marketing provide information regarding one
or more key points of difference between Blockbuster and the competition.
Blockbuster has pursued an aggressive advertising and marketing campaign in
order to promote awareness of the BLOCKBUSTER name. Blockbuster's primary goal
is to make its name so recognizable that any time a person wishes to rent a
movie, he or she will first consider coming to one of Blockbuster's stores.
Blockbuster's advertising and marketing tries to convey the message that a
visit to one of its stores will allow the customer to experience the magic of
the movies.
Use the Customer Transaction Database
Blockbuster has developed and utilized an extensive customer transaction
database with over 101 million U.S. and Canadian member accounts. This
database enables Blockbuster to effectively operate and market its business.
For example, Blockbuster is able to directly communicate with its customers on
a targeted and customized basis relating to its products and programs.
Blockbuster is also able to stock each of its company-operated stores with the
quantity and selection of merchandise that is optimal to that store.
Self-Distribution Capabilities
Blockbuster has constructed and launched a highly automated distribution
center in McKinney, Texas that allows it to distribute substantially all of
its products to its domestic company-operated stores. Blockbuster believes
that its distribution center gives it a significant competitive advantage over
its competitors that use third party distributors because Blockbuster is able
to process and distribute a greater quantity of products while reducing costs
and improving service to its stores. In particular, Blockbuster mechanically
repackages its newly released videos to make them suitable for rental at its
stores. Previously, this activity had been performed manually at each store.
In addition, Blockbuster's distribution center gives it the capacity to
accommodate its planned store expansion without incurring significant
expenditures. For example, between 1997 and the end of 1999, Blockbuster will
have tripled the number of videocassettes processed and distributed to its
stores. Blockbuster also believes these distribution capabilities were a major
factor in its ability to successfully implement its revenue-sharing agreements
to provide superior movie selection to its customers.
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Growth Strategy
Blockbuster believes that its growth strategy will further establish it as
the leading home video chain in the world. Blockbuster's goal is to increase
its systemwide U.S. market share from 27%, for the year ended December 31,
1998, to over 40% within the next two and one-half years, and to significantly
increase its market share in those countries outside the United States where
Blockbuster believes it is profitable to do so. Blockbuster believes that its
growth objectives can be met because:
. the home video industry is highly fragmented both in the United States
and internationally;
. consolidation has already begun and will continue; and
. the advantages created by Blockbuster's new business model position it
to increase its market share.
As explained more fully below, Blockbuster's growth will principally be driven
by an increase in its same store revenues, an expansion of both its company-
operated and franchisee-operated store base in the United States and
internationally and by spreading its expenses over a larger revenue base.
Increase Same Store Revenues
By implementing each element of its business model, Blockbuster believes
that it will increase same store revenues by:
. increasing the number of movies or video games that a customer rents on
each visit to its stores;
. continuing to increase its active customer base as it increases its
market share;
. increasing the number of times that active customers visit its stores;
. expanding its offering of rentable home entertainment, such as DVDs and
video games; and
. further increasing the quantity of videocassettes in its stores.
Expand Domestic Store Base
Based on Blockbuster's current store prototypes, it believes that the
potential exists for 4,000 additional new traditional video stores in the
United States. Blockbuster has added about 475 new company-operated stores in
the United States in 1999 and about 500 new company-operated stores in the
United States in each of 2000 and 2001. Blockbuster plans to open most of
these new stores in the 70 largest markets in the United States. With the use
of its extensive customer transaction database and real estate database, its
experienced store development team identifies markets with growth
opportunities and responds to these opportunities with the appropriate store
location and store format, which store format ranges from about 1,000 to 4,800
square feet. Blockbuster believes that through its site selection process and
flexible store formats, its new stores will generate sufficient revenue to
recover its capital investment in a short period of time without significantly
reducing the revenues of its existing stores.
Expand International Store Base
Blockbuster's international strategy is focused on expanding in markets in
which it already has an established market position and in less mature
markets. Although, as of September 30, 1999, Blockbuster operated stores in 25
markets outside of the United States, about 89.8% of its international rental
revenue was generated by its top seven international markets. These markets
are Great Britain, Canada, Australia, the Republic of Ireland together with
Northern Ireland, Mexico, Spain and Argentina. Blockbuster believes that the
growth opportunities in these markets are significant because they are highly
fragmented and its market share in each of these countries is generally
estimated by Blockbuster to be less than 40%. Blockbuster expects to open
about 200 new company-operated stores in these seven markets over the next two
years. Blockbuster also plans to open about 25 new company-operated stores
over the next two years in international markets other than its top seven
markets. As in the United States, Blockbuster uses different store prototypes
in response to local real estate and market conditions. In addition,
Blockbuster has developed and uses a new country entry model that targets
development of a specified range of a number of company-operated stores and
franchised stores, at which point economies of scale can be used to reduce
corporate overhead costs and national advertising expenses.
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Expand Worldwide Franchise Program
Over the next two years, Blockbuster expects to add about 200 franchised
stores per year to its franchised U.S. store base and about 65 franchised
stores per year to its international store base. This includes joint ventures
in which Blockbuster owns a minority interest. Blockbuster also intends to
convert company-operated stores in smaller markets into franchised stores by
selling these stores to franchisees. These franchisees would also commit to
develop additional new franchised stores in their respective markets. As of
September 30, 1999, Blockbuster's franchisees operated 708 U.S. franchised
stores and 406 international franchised and joint venture stores. For the year
ended December 31, 1998, Blockbuster had revenues of $60.7 million relating to
its franchise operations, or about 1.6% of its 1998 revenues. In order to
accomplish this objective, Blockbuster has refined its franchise approval
process, hired personnel exclusively dedicated to the development of new
franchises and launched a campaign to attract prospective franchisees. In
order to increase the attractiveness of its U.S. franchise program,
Blockbuster has made its revenue-sharing arrangements with the studios
available to its U.S. franchisees, which will provide them with an option to
increase their quantity and selection of movies.
Apply the Benefits of Greater Size
Blockbuster's leading market position enables it to derive significant
economies of scale and operating efficiencies that are not necessarily
available to its smaller competitors. Blockbuster is able to achieve
efficiencies on both a store level basis and a systemwide basis. On a store
level basis, the increase in the volume of transactions and the consequent
increase in revenues per store as a result of Blockbuster's business model
provides it with the opportunity to reduce its labor costs as a percentage of
revenues. On a systemwide basis, Blockbuster believes that it can reduce its
distribution costs and selling, general and administrative expenses as a
percentage of its revenues.
Pursue Strategic Acquisitions
For the year ended December 31, 1998, Blockbuster acquired 51 video stores.
Thus far in 1999, Blockbuster has acquired or is under contract to acquire
about 193 video stores. Blockbuster will continue to review potential
acquisitions, including acquisitions of video rental chains and stores
operated by its franchisees as well as acquisitions in complementary
businesses that will enable it to take advantage of the highly recognized
BLOCKBUSTER brand name, its extensive customer transaction database and its
existing distribution system.
Pursue New Technologies and Products
Blockbuster believes that the growth of the Internet and the increasing
availability of broadband distribution offers significant opportunities for
Blockbuster to capitalize on emerging home entertainment technologies. In
particular, Blockbuster believes it is well-positioned to leverage its strong
brand name, existing infrastructure and extensive expertise in the
video/entertainment industry to create the premier online video and
entertainment destination.
In November 1999, Blockbuster relaunched its website, www.blockbuster.com.
The relaunched site enhanced both the breadth and depth of blockbuster.com's
entertainment-related news and information and e-commerce offerings and
capabilities.
In addition, on November 3, 1999, Blockbuster entered into a strategic
alliance with America Online. The terms of this alliance provide for a co-
branded America Online/Blockbuster website on America Online's Entertainment
Channel. America Online and Blockbuster also agreed to extensive cross-
marketing and promotional activities and to jointly develop broadband content
and delivery. As part of the alliance, America Online, subject to terms and
conditions, will acquire about a 2.75% interest in blockbuster.com for $30
million in cash.
In addition, Blockbuster has already tracked the success of DVDs in the
marketplace and has introduced DVDs for rental and sale in about 3,600
domestic stores and in some markets outside of the United States.
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Customer Transaction Database
Blockbuster has developed and utilizes an extensive customer transaction
database with over 101 million U.S. and Canadian member accounts. This
database has tracked customer names, addresses, phone numbers, transaction
histories, demographic information and, recently, e-mail addresses.
Blockbuster also maintains customer transaction databases in each of the
countries in which it operates outside of the United States and Canada. As of
September 30, 1999, the following chart summarizes the number of its
systemwide U.S. and Canadian member accounts that have been active for the
periods shown:
[Bar graph which shows that:
1. about 16.2 million customers rented or purchased a product from one of our
stores within the last 30 days;
2. about 28.9 million customers rented or purchased a product from one of our
stores within the last three months;
3. about 36.4 million customers rented or purchased a product from one of our
stores within the last six months;
4. about 41.5 million customers rented or purchased a product from one of our
stores within the last nine months;
5. about 45.3 million customers rented or purchased a product from one of our
stores within the last year; and
6. about 101.5 million customers rented or purchased a product from one of our
stores.]
Blockbuster considers its customer transaction database to be one of its
core assets, which it currently uses to:
. communicate with and market directly to its customers on a national
basis;
. develop programs to reward its most loyal customers;
. strategically locate potential new store sites based on demographics and
unique trade areas; and
. customize and improve the allocation of merchandise on a store-by-store
basis, based on local demographics and prior rental history of its
customers.
Over time, Blockbuster believes it will use the information it collects and
the relationships it has developed with its customers through its database to:
. evaluate new industry trends such as DVDs and the digital broadcast
system;
. further develop and enhance its promotional and marketing strategy
through e-mail and other channels of distribution;
. help customers choose and rent movies by analyzing their previous
viewing history;
. promote its internet site and services; and
. capitalize on new home delivery systems for filmed entertainment as
these systems become economically viable.
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Merchandising
Blockbuster offers a wide selection of movies and video games for rent and
purchase. Blockbuster stocks each of its company-operated stores with the
quantity and selection of merchandise that it believes is optimal for that
particular store.
The breakdown of the domestic revenues generated from the rental and sale
of such products for the year ended December 31, 1998 is as follows:
[Pie graph which shows a breakdown of our domestic revenue as follows:
1. about 71.1% of our domestic revenues was generated by movie rentals;
2. about 9.4% of our domestic revenues was generated by video game rentals;
3. about 5.2% of our domestic revenues was generated by previously viewed
tapes and previously played video game sales;
4. about 7.0% of our domestic revenues was generated by sell-through movie
sales; and
5. about 7.3% of our domestic revenues was generated from the rental and sale
of other items.]
Videocassette and Videocassette Player Rentals. Blockbuster's typical
traditional domestic store generally carries about 5,550 different movie
titles available for rent, which include about 650 newly released video titles
and about 4,900 BLOCKBUSTER FAVORITES. About 81% of 1998 domestic rental
revenues were from the rentals of newly released movies. In some of its
stores, Blockbuster rents videocassette players. Under its revenue-sharing
agreements, Blockbuster is able to make available a substantial number of
additional copies of each newly released video in order to satisfy its
customers' demand shortly after the movie is released. In addition,
Blockbuster is able to offer substantially more newly released video titles
which increases the variety of movies available in its stores. Blockbuster's
average customer rents about two movies and/or video games every time he or
she visits one of its stores. Blockbuster's stores outside of the United
States generally carry fewer movies due to their smaller store sizes.
Videocassette Sales. Blockbuster generally offers sell-through movies for
sale for about $10 to $20 per videocassette. These typically consist of:
. classic movies that Blockbuster believes have ownership appeal;
. childrens' movies; and
. new releases that are priced for sell-through.
Blockbuster also offers for sale previously viewed tapes to the public
after the end of their useful lives as rental products. These previously
viewed tapes are generally rewrapped and are sold at low prices.
DVDs and DVD Players. Blockbuster currently rents between 200 and 500
different DVD titles in about 3,600 domestic stores and in some markets
outside of the United States. The number of DVD titles available for rent
varies based on the type and location of store. Blockbuster also rents DVD
players in these stores.
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Video Games and Video Game Consoles. Blockbuster rents video games for use
with Sony PlayStation(TM), Nintendo(TM) and other video game platforms in all
of its domestic stores and many of its international stores. In these stores,
Blockbuster also sells previously played video games and new video games, such
as Pokemon, and rents the video game consoles. In addition, Blockbuster sells
new video games in most of its stores in markets outside of the United States.
Other Products. For the convenience of its customers, Blockbuster sells VCR
accessories, such as blank videocassettes and videocassette cleaning
equipment, and a limited selection of snacks and beverages in all of its
stores. Occasionally, Blockbuster sells licensed products to complement its
selection of movies. Also, Blockbuster sells music compact discs and cassette
tapes in some of its stores and on its U.S. Internet site.
Stores and Store Operations
Site Selection. Blockbuster has developed a comprehensive model that it
uses to find suitable locations for company-operated stores and markets for
franchise stores. Blockbuster seeks to locate its company-operated stores in
geographic areas with population and customer concentrations that enable it to
better allocate available resources and manage operating efficiencies in
inventory management, advertising, marketing, distribution, training and store
supervision. Blockbuster is targeting the remaining markets for the
opportunity to develop franchises. Accordingly, Blockbuster is targeting the
70 largest markets in the United States to develop company-operated stores,
and it is targeting the remaining markets for new franchise development.
Within each targeted market, Blockbuster identifies potential sites for new
and replacement stores by evaluating market dynamics, some of which include
population demographics, psychographics, customer penetration levels and
competition. Blockbuster uses its extensive real estate database and customer
transaction database to continuously monitor market conditions and select
strategic store locations. Blockbuster's experienced store development team is
capable of securing store leases and preparing sites for operation, a process
that typically takes about six months. Blockbuster uses its knowledge of
market areas and relies upon the familiarity of its brand name to enhance its
ability to obtain prime store locations, negotiate favorable lease terms with
landlords and enter into multiple store leases.
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Store Development. For the periods presented, the following table
summarizes opened stores, acquired stores, closed stores, and sold stores.
Blockbuster's Worldwide Store Count Information
<TABLE>
<CAPTION>
Number of Number of
Company-Operated Franchised and/or
Stores Joint Venture Stores Total Stores
------------------------- ------------------------- -------------------------
Domestic Internat'l Total Domestic Internat'l Total Domestic Internat'l Total
-------- ---------- ----- -------- ---------- ----- -------- ---------- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Stores at 12/31/94 2,065 1,002 3,067 725 277 1,002 2,790 1,279 4,069
Opened 313 142 455 86 56 142 399 198 597
Acquired 195 165 360 -- 3 3 195 168 363
Closed (33) (154) (187) (18) (29) (47) (51) (183) (234)
Sold (3) -- (3) (150) (129) (279) (153) (129) (282)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/95 2,537 1,155 3,692 643 178 821 3,180 1,333 4,513
Opened 367 211 578 78 92 170 445 303 748
Acquired 200 98 298 2 -- 2 202 98 300
Closed (36) (58) (94) (17) (10) (27) (53) (68) (121)
Sold (2) -- (2) (71) (50) (121) (73) (50) (123)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/96 3,066 1,406 4,472 635 210 845 3,701 1,616 5,317
Opened 345 163 508 82 94 176 427 257 684
Acquired 57 258 315 7 -- 7 64 258 322
Closed (114) (69) (183) (14) (10) (24) (128) (79) (207)
Sold (7) -- (7) (19) (41) (60) (26) (41) (67)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/97 3,347 1,758 5,105 691 253 944 4,038 2,011 6,049
Opened 174 165 339 53 141 194 227 306 533
Acquired 46 5 51 -- 21 21 46 26 72
Closed (70) (121) (191) (24) (10) (34) (94) (131) (225)
Sold -- (21) (21) (22) (5) (27) (22) (26) (48)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 12/31/98 3,497 1,786 5,283 698 400 1,098 4,195 2,186 6,381
Opened 296 146 442 54 63 117 350 209 559
Acquired 153 12 165 41 -- 41 194 12 206
Closed (54) (49) (103) (8) (45) (53) (62) (94) (156)
Sold (41) -- (41) (77) (12) (89) (118) (12) (130)
----- ----- ----- ---- ---- ----- ----- ----- -----
Stores at 9/30/99 3,851 1,895 5,746 708 406 1,114 4,559 2,301 6,860
===== ===== ===== ==== ==== ===== ===== ===== =====
</TABLE>
Blockbuster plans to open most of its new company-operated stores in the 70
largest markets in the United States. Based upon its current store model,
Blockbuster believes that there is the potential for 4,000 additional new
traditional video stores in the United States.
Outside the United States, Blockbuster plans to open most of its new
company-operated stores in the seven markets in which it already has a
significant presence. In addition, Blockbuster plans to add franchised and
joint venture stores in other international markets.
Store Format. In the past, Blockbuster has sought to locate stores in sites
that were convenient and visible to the public. Blockbuster intends to
continue to conveniently locate its stores by incorporating an "appropriate"
store format using its extensive customer transaction database and real estate
database to maximize revenues without significantly decreasing the revenues of
its nearby stores. To do so, Blockbuster has designed three store formats:
. New Traditional Stores. These stores are about 4,800 square feet and
have been or will be constructed in markets in which store-to-population
ratios are low and in which Blockbuster believes market
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conditions are optimal. On average, each new traditional store carries
about 500 different newly released titles and about 4,000 total copies
of a combination of videocassettes and DVDs and about 4,000 different
BLOCKBUSTER FAVORITES and about 5,200 total copies of a combination of
videocassettes and DVDs.
. Seam Stores. These stores are about 2,500-3,500 square feet and have
been or will be constructed in order to compete:
-- in markets that are located in between its traditional stores without
significantly decreasing the market shares of those traditional
stores; and
-- in rural areas.
On average, each seam store carries about 500 different newly released
titles and about 3,600 total copies of a combination of videocassettes
and DVDs and about 2,800 different BLOCKBUSTER FAVORITES and about 3,300
total copies of a combination of videocassettes and DVDs.
. Store-in-stores. These stores are about 1,000-1,400 square feet and have
been or will be constructed within a department store, supermarket or
other store. This strategy is being pursued to further expand
Blockbuster's presence and meet demand in mature markets in which it
already has a strong presence. On average, each store-in-store carries
about 400 different newly released titles and about 1,800 total copies
of a combination of videocassettes and DVDs and about 1,600 different
BLOCKBUSTER FAVORITES and about 1,900 total copies of a combination of
videocassettes and DVDs.
Blockbuster also periodically examines whether the formats of its existing
stores are optimal for their location and may downsize or relocate existing
stores as opportunities arise.
Store Layout. Blockbuster designs its stores to provide a recognizable
distinctive format offering an extensive selection of products in an
attractive design aimed at capturing the magic of the movies. Blockbuster
believes that its trademark blue and yellow colors, which dominate most of its
stores, make them easily recognizable to video rental customers. The internal
layout of its stores allows its customers to easily distinguish new video
releases, BLOCKBUSTER FAVORITES, DVDs, video games and other products. Each
domestic store typically contains a perimeter wall, an internal area and a
check-out area.
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Below is a graphic of Blockbuster's new store layout.
[Diagram of Blockbuster's internal store layout.]
Store Operations. Blockbuster's U.S. company-operated stores generally
operate under substantially similar hours of operation. Domestic stores are
open 365 days a year, with daily hours generally from 10:00 a.m. to 12:00
midnight. The hours of operation for franchised stores vary widely depending
on the franchise. Typically, each U.S. store employs 15 people, including two
assistant store managers and one store manager. A large part of the in-store
experience depends upon the knowledge of the staff. Blockbuster carries out
periodic customer service audits at all of its stores to understand, satisfy
and exceed its customers' expectations. In addition, as store traffic and same
store revenues have increased, Blockbuster has been able to achieve
significant labor savings through higher productivity. Blockbuster has
achieved additional labor savings because its distribution center efficiently
packages videocassettes, a task that was previously done manually.
International store operations vary by country.
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Store Locations. At September 30, 1999, in the United States and its
territories, Blockbuster operated 3,851 stores and its franchisees operated
708 stores. The following map sets forth the number of domestic stores
Blockbuster operated, including stores operated by its franchisees, as of
September 30, 1999:
[Map of U.S.A. and its territories showing our total number of stores
(Company-operated and franchised stores) in each state and territory as
follows:]
TOTAL
STATE OF TERRITORY(1) STORES(2)
- ------------------------------------------------------------- ------------
- --
ALABAMA............................................................... 51
ALASKA................................................................ 13
ARIZONA............................................................... 85
ARKANSAS.............................................................. 18
CALIFORNIA............................................................ 543
COLORADO.............................................................. 105
CONNECTICUT........................................................... 56
DELAWARE.............................................................. 10
DISTRICT OF COLUMBIA.................................................. 7
FLORIDA............................................................... 342
GEORGIA............................................................... 182
HAWAII................................................................ 19
IDAHO................................................................. 9
ILLINOIS.............................................................. 214
INDIANA............................................................... 73
IOWA.................................................................. 26
KANSAS................................................................ 51
KENTUCKY.............................................................. 43
LOUISIANA............................................................. 69
MAINE................................................................. 5
MARYLAND.............................................................. 112
MASSACHUSETTS......................................................... 106
MICHIGAN.............................................................. 151
MINNESOTA............................................................. 48
MISSISSIPPI........................................................... 31
MISSOURI.............................................................. 90
MONTANA............................................................... 7
NEBRASKA.............................................................. 27
NEW HAMPSHIRE......................................................... 19
NEW JERSEY............................................................ 102
NEW MEXICO............................................................ 24
NEW YORK.............................................................. 269
NEVADA................................................................ 42
NORTH CAROLINA........................................................ 111
NORTH DAKOTA.......................................................... 6
OHIO.................................................................. 160
OKLAHOMA.............................................................. 57
OREGON................................................................ 72
PENNSYLVANIA.......................................................... 149
PUERTO RICO........................................................... 41
RHODE ISLAND.......................................................... 25
SOUTH CAROLINA........................................................ 64
SOUTH DAKOTA.......................................................... 5
TENNESEEE............................................................. 73
TEXAS................................................................. 484
UTAH.................................................................. 46
VERMONT............................................................... 5
VIRGINIA.............................................................. 119
VIRGIN ISLANDS........................................................ 2
WASHINGTON............................................................ 97
WEST VIRGINIA......................................................... 12
WISCONSIN............................................................. 75
WYOMING............................................................... 5
GUAM.................................................................. 2
DOMESTIC STORE TOTAL 4,559
At September 30, 1999, outside of the United States, Blockbuster operated
1,895 stores, and its franchisees and joint ventures in which Blockbuster owns
a minority interest operated 406 stores. The following table sets forth, by
country, the number of stores Blockbuster operated and stores its franchisees
operated as of September 30, 1999.
<TABLE>
<CAPTION>
Number of Number of
Company-Operated Franchised and/or
COUNTRY Stores Joint Venture Stores Total(1)(2)
- ------- ---------------- -------------------- -----------
<S> <C> <C> <C>
Great Britain............... 662 -- 662
Canada...................... 349 -- 349
Ireland (Republic) and
Northern Ireland........... 216 -- 216
Australia................... 132 84 216
Mexico...................... 154 6 160
Italy....................... -- 146 146
Spain....................... 103 4 107
Brazil...................... -- 72 72
Chile....................... 58 -- 58
Taiwan...................... 79 -- 79
Argentina................... 63 -- 63
Denmark..................... 47 -- 47
China (Hong Kong)........... 19 -- 19
Portugal.................... -- 15 15
Colombia.................... -- 14 14
</TABLE>
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<TABLE>
<CAPTION>
Number of Number of
Company-Operated Franchised and/or
COUNTRY(1) Stores Joint Venture Stores Total(1)(2)
- ---------- ---------------- -------------------- -----------
<S> <C> <C> <C>
Venezuela.................... -- 12 12
Israel....................... -- 12 12
New Zealand(3)............... 11 -- 11
Thailand..................... -- 11 11
Peru......................... -- 9 9
Ecuador...................... -- 6 6
Panama....................... -- 8 8
El Salvador.................. -- 4 4
Uruguay...................... 2 -- 2
Poland....................... -- 3 3
----- --- -----
International Store Total.... 1,895 406 2,301
===== === =====
</TABLE>
- --------
(1) This does not include stores leased or owned but not operating.
(2) In addition to the stores listed in the chart, as of September 30, 1999,
there were 50 video vending machines being tested in Spain, Canada, Great
Britain and Italy.
(3) In November, 1999, Blockbuster converted its 11 company-operated stores to
franchised stores in New Zealand.
Advertising and Marketing
Worldwide, in the year ended December 31, 1998, Blockbuster incurred about
$181 million in advertising expenses, which include about $142 million in the
United States and about $39 million internationally. In addition, some of
Blockbuster's business partners, including the studios, allow Blockbuster to
direct a significant amount of their advertising expenditures. Furthermore,
the studios also incur additional expenditures to promote their newly released
movies.
National and Local Advertising Campaign. In 1998, Blockbuster launched a
national advertising campaign in order to support its business model.
Blockbuster is the only home video chain that actively maintains a national
advertising campaign. This campaign consists of network and local television,
local advertising and local radio. Blockbuster uses its customer transaction
database to target its direct mailings at different customer groups.
Blockbuster expects to incur about $233 million in advertising expenses in
1999, an increase of about 30%. Blockbuster expects this increase to include
more television, outdoor and transit advertising.
The design of Blockbuster's national and local advertising campaign is
based upon its proprietary research. This is done on a national basis, and
Blockbuster also focuses its efforts on a local basis in order to adjust to
each local environment. Blockbuster obtains information from its customer
transaction database, its real estate database and outside research agencies.
Blockbuster has concentrated on the following factors to formulate and adjust
its advertising:
. its market share;
. its level of store development and brand awareness relative to its
competitors within the relevant market;
. local demographics; and
. other local competitive issues.
Blockbuster's advertising campaign focuses on the two areas discussed
below.
. Out-of-Store Advertising. Blockbuster advertises on television, transit
and other like media. Blockbuster also uses its research to customize
its direct mailings to address overall demographic trends and individual
customer transaction history.
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. In-Store Advertising. Blockbuster uses leading edge graphics and visual
merchandising in its stores in order to give its customers the feeling
that a trip to its stores captures the magic of the movies.
Innovative Marketing Programs. Because of Blockbuster's large store base
and its leading brand awareness throughout the United States and many other
markets, Blockbuster has been able to implement the following programs in the
United States and the same or similar programs in many of its international
markets.
. New Release Guarantees. Because of the substantial number of copies of
videocassettes that Blockbuster is able to provide in its stores,
Blockbuster is able to offer a guarantee that some of its selected newly
released video titles will be in stock or the customer will receive a
coupon that can be redeemed for a free rental of that movie within the
following 30 days.
. National Promotions. In 1999, Blockbuster executed several one-of-a-kind
national promotional events, each several weeks in duration, designed to
attract customers and increase the number of times that active customers
visit its stores due to the event's novelty and "prize" appeal. To date,
these are the only nationally advertised events in Blockbuster's
industry. For example, in its "Trip-a-day Giveaway" program, each day
between January 19, 1999 and March 1, 1999, Blockbuster gave a different
customer a free trip to places such as Las Vegas or the Cannes Film
Festival. In addition, for the last five years, Blockbuster has
sponsored the internationally televised BLOCKBUSTER ENTERTAINMENT
AWARDS, in which over 25 million votes were cast in 58 categories in its
stores and on its U.S. website in 1999. On June 16, 1999, the
BLOCKBUSTER ENTERTAINMENT AWARDS was televised within the United States
to a television audience of over 6 million households and has been or is
scheduled to be televised in over 60 other countries.
. BLOCKBUSTER REWARDS Program. This premium membership program is designed
to offer benefits to its customers and enhance customer loyalty by
encouraging its customers to rent movies only from its stores. The
program was implemented in February of 1999 and as of September 30,
1999, there were about 5.2 million U.S. customer accounts enrolled in
the BLOCKBUSTER REWARDS program. In general, for a $9.95 fee,
Blockbuster's customers can join the BLOCKBUSTER REWARDS program and
earn free movie or video game rentals, exclusive promotional offers and
other benefits. Some high-volume renters are automatically enrolled as
BLOCKBUSTER REWARDS Gold members, which earns them additional benefits
such as additional free movie or video game rentals and the ability to
reserve movies by telephone. Blockbuster has recently implemented a
version of this program in Canada.
. BLOCKBUSTER GIFTCARDS. Blockbuster's national point-of-sale system in
the United States allows it a unique opportunity to offer its customers
the opportunity to purchase stored value BLOCKBUSTER GIFTCARDS which can
be redeemed at any of its stores nationwide. The BLOCKBUSTER GIFTCARD is
a plastic prepaid card available in amounts ranging from $5 to $50. Some
of the cards have attractive designs, such as movie images, and are
marketed as "Limited Edition Cards." The BLOCKBUSTER GIFTCARDS are also
currently available in Great Britain, Canada and Mexico. For the year
ended December 31, 1998, Blockbuster sold $121 million of BLOCKBUSTER
GIFTCARDS, which was a 16.9% increase in sales compared to the year
ended December 31, 1997.
. Cross-Promotional Marketing Programs. On an ongoing basis, since 1997,
Blockbuster has implemented cross-promotional marketing programs with
such other well-known companies as Coca-Cola, Taco Bell, American
Airlines, MCI Worldcom, Pizza Hut, General Motors and Burger King. As a
result of Blockbuster's participation in these programs, Blockbuster
benefits from marketing done by its business partners that features
Blockbuster's brand.
. Community Service. Blockbuster also sponsors and promotes leadership
events in many of the communities in which Blockbuster operates. For
example, as part of Blockbuster's "Community Service Videos" program,
Blockbuster provides free videocassettes in some of its stores on
subjects, such as breast cancer. Blockbuster also offers annually its
KIDPRINT program in most of its U.S. stores. Under this complimentary
program, parents can have a staff member videotape their child's
mannerisms, appearance and voice for emergency identification purposes.
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Internet: www.blockbuster.com
In November 1999, Blockbuster relaunched blockbuster.com. The relaunch
introduced several new features that Blockbuster believes will increase site
traffic and provide a more compelling experience for online users. Some of
these features include:
. increased e-commerce offerings and capabilities;
. entertainment news and information;
. information about movies;
. integrated promotions between Blockbuster's in-store and online
businesses; and
. suggestions of movies based upon a customer's evaluation of selected
films.
In addition, Blockbuster operates several other Internet sites that target
international audiences and leverage Blockbuster's brand name and presence in
non-U.S. markets. For a complete discussion of Blockbuster's online strategy,
see "-- Growth Strategy -- Pursue New Technologies and Products."
Suppliers
The following is a description of the suppliers of Blockbuster's domestic
company-operated stores and its franchised stores. Blockbuster's international
stores are supplied by a variety of suppliers.
Suppliers of Videocassettes and DVDs
Company-operated Stores. Blockbuster's U.S. stores receive a substantial
portion of their videocassettes under the revenue-sharing agreements.
Blockbuster has entered into domestic revenue-sharing agreements with, among
others, all of the major studios. Under these agreements, Blockbuster shares
its U.S. rental revenues with the studios for a limited period of time,
generally 26 weeks.
In addition to this revenue-sharing component, common to each agreement is
some provision for disposition of the video products at the conclusion of the
rental period. This may involve sale of the product by Blockbuster as a
previously viewed tape, return of the tape to the studio, destruction of the
tape, or some combination of these elements.
Most revenue-sharing agreements also have a minimum payment requirement,
all or part of which is associated with either the number of videocassettes
Blockbuster purchases or domestic box office receipts and the then current
number of its stores. Such agreements also generally require Blockbuster to
take a minimum number of copies of each qualifying movie released by the
supplier.
This revenue-sharing concept is relatively new to Blockbuster and its
industry, and Blockbuster believes the terms of these agreements are critical
to its competitive position. While the terms of Blockbuster's revenue-sharing
agreement vary from studio to studio, Blockbuster believes, based on various
assumptions, that the overall economic revenue-sharing model is designed to
achieve gross margins of about 60% on the rental product Blockbuster obtains
under these agreements. Blockbuster cannot assure you, however, that it can
achieve such gross margins under its revenue-sharing agreements. None of these
agreements is exclusive to Blockbuster and the studios are free to enter into
similar or better agreements with its competitors.
The agreements with the studios expire by their terms at various times over
the next three and one-half years beginning in the fourth quarter of the year
2000. Blockbuster has already renewed one of the agreements with a studio and
is currently engaged in negotiations with another studio to extend its
agreement.
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For most of Blockbuster's revenue-sharing videocassettes, the major studios
send the master videocassettes to a duplicator for copying and then they are
shipped to Blockbuster's distribution center. In addition, Blockbuster
purchases sell-through movies, direct-to-video movies and movies sold at
traditional wholesale prices, as well as DVDs, from major studios, independent
studios and independent suppliers, generally pursuant to negotiated
agreements.
Franchised Stores. Blockbuster requires each franchisee to comply with
guidelines that set forth the minimum amount and selection of movies to be
kept in its store's inventory. Franchisees typically obtain videocassettes and
DVDs from their own suppliers. However, if Blockbuster has purchased the
exclusive distribution rights to a movie, the franchisee may obtain that movie
from Blockbuster. Blockbuster has made its revenue-sharing arrangements with
the studios available to its U.S. franchisees, which will provide them with an
option to increase their quantity and selection of movies.
Other Suppliers
Suppliers of Video Games. For Blockbuster's company-operated stores,
Blockbuster purchases video game software primarily from five suppliers: Sony,
Nintendo, Midway, Acclaim, and Electronic Arts. These suppliers deliver the
video game software and video game accessories to Blockbuster's distribution
center. Blockbuster then distributes the video game software and video game
accessories to its stores. Franchisees are responsible for obtaining video
games from their own suppliers.
Suppliers of VCRs, DVD Players and Video Game Consoles. In Blockbuster's
company-operated stores, Blockbuster purchases its VCRs primarily from Ingram
Entertainment Incorporated, DVD players primarily from Phillips Electronics
and video game consoles primarily from Phillips Sales and Nintendo.
Franchisees are responsible for obtaining VCRs, DVD players and video game
consoles from their own suppliers.
Suppliers of Food and Beverages and Accessories. Other than Blockbuster's
specially branded microwave popcorn and accessories, which are distributed by
its U.S. distribution center, suppliers distribute all of Blockbuster's snacks
and beverages directly to its company-operated stores. Franchisees are
responsible for obtaining snacks and beverages and accessories from their own
suppliers.
Distribution and Inventory Management
In the first quarter of 1998, Blockbuster began operation of its new,
state-of-the-art distribution center in McKinney, Texas, which is near its
corporate headquarters. Blockbuster's 850,000 square foot distribution center
is a highly automated, centralized facility that Blockbuster uses to restock
products, repackage videocassettes and process returns, as well as to provide
some office space. It supports all of Blockbuster's company-operated stores in
the United States. As of September 30, 1999, Blockbuster employed about 795
employees at its distribution center. Blockbuster's distribution center
operates six days a week, 24 hours a day.
Distribution. At Blockbuster's distribution center, it receives
substantially all of its videocassettes and video games. Blockbuster
repackages the newly released videocassettes to make them suitable for rent at
its stores, a process which had previously been done manually by its store
employees before Blockbuster built its distribution center. In addition,
Blockbuster repackages previously viewed tapes to make them available for
sale. Blockbuster's distribution center is also designed to be able to handle
individual customer orders, which would be necessary if Blockbuster decided to
distribute its products sold on its U.S. Internet site directly to its
customers. Currently, its Internet sales are distributed by independent
distributors.
Blockbuster distributed, and its company-operated stores received, about 86
million units of its products last year from its distribution center. About
34.5 million of those units were videocassettes repackaged for rental at its
stores. The distribution center has allowed Blockbuster to significantly
decrease its distribution costs compared to the costs it previously incurred
using third-party distributors. While Blockbuster currently processes a high
volume of products due to the successful implementation of its revenue-sharing
agreements, Blockbuster
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can support a significant increase in sales volume without significant
additional investment. As Blockbuster adds more volume to its distribution
center, Blockbuster will be able to further take advantage of its cost
efficiencies. The February 1999 issue of Modern Materials Handling, a leading
trade publication, has recognized its distribution center for its
"distribution excellence."
Blockbuster uses a network of third-party warehouses for delivery to its
stores. Blockbuster ships its products to these warehouses, located
strategically throughout the United States, which in turn deliver them to its
stores. Franchisees generally obtain their products directly from suppliers,
except for accessories, supplies and movies to which Blockbuster has exclusive
distribution rights, which domestic franchisees receive from its distribution
center. Distribution of Blockbuster's products to its stores in markets
outside the United States is coordinated through its international offices.
Inventory Management. Because Blockbuster has a centralized distribution
center, it is able to keep strict control over the amount and flow of its
products at any given time. Blockbuster scans all products as they enter, flow
through and exit its distribution center.
Once Blockbuster's products reach its stores, Blockbuster focuses on strict
inventory control. Blockbuster's sophisticated inventory management system is
integrated with its point-of-sale system, which allows Blockbuster to manage
its inventory on a store-by-store basis. Blockbuster allocates its products to
its stores based on the transaction history of each store, and Blockbuster
monitors its stores' in-stock positions. Blockbuster also typically takes
physical inventory at each store on a monthly basis.
Management Information Systems
Blockbuster believes that the accurate and efficient management of
purchasing, inventory and sales records is important to its future success.
Blockbuster maintains information, updated daily, regarding revenues, current
and historical sales and rental activity, demographics of store customers and
videocassette rental patterns. This information can be organized by store,
region, state, country or for all operations.
Blockbuster maintains a satellite-based national point-of-sale system in
the United States, which is linked with a datacenter located in its
distribution center. The point-of-sale system tracks all of its products
distributed from the distribution center to each store using scanned bar code
information. All rental and sales transactions are recorded by the point-of-
sale system when scanned at the time of customer checkout. At the end of each
day, the point-of-sale system transmits store data from operations to the
datacenter and the customer transaction database by satellite.
All of Blockbuster's company-operated stores, except in Hong Kong, the
Republic of Ireland and Northern Ireland, and most of its franchisees use
Blockbuster's point-of-sale system upon opening or conversion into a company-
operated store. Within the next two and one-half years, Blockbuster currently
plans to update the computers and the software that run the point-of-sale
system in order to decrease the overhead costs of each store and speed up the
checkout process. Blockbuster currently has a direct link via satellite with
most of its domestic company-operated stores and by the end of 1999,
substantially all of its company-operated stores in Canada will also be linked
via satellite. Also by the end of 1999, many of Blockbuster's domestic
franchised stores will be linked via satellite.
In addition, Blockbuster has established processes for evaluating and
managing the risks and costs that may arise as a result of year 2000 software
failures. Blockbuster has substantially completed its year 2000 program.
Blockbuster has completed its inventory, assessment, remediation, and testing
phase of all critical applications and infrastructure. Blockbuster has
contacted its critical business partners as to their year 2000 readiness. One
business partner has stated it is year 2000 compliant and the others have
indicated they expect to be year 2000 compliant before December 31, 1999.
Where appropriate, Blockbuster is determining the need for contingency plans
and addressing both operational and technical alternatives. This phase has
begun and will continue through the end of 1999. Blockbuster does not
anticipate that it will incur significant operating expenses or be required
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to invest heavily to improve its computer systems in order to be year 2000
compliant, and Blockbuster does not anticipate that business operations will
be disrupted. See "Risk Factors -- Risk Factors Relating to Blockbuster's
Business and Industry -- We May Be Adversely Affected if Blockbuster's Year
2000 Remediation Efforts Are Not Successful" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations of Blockbuster."
Franchise Operations
At September 30, 1999, Blockbuster's franchisees operated 708 stores in the
United States and its franchisees and minority-operated joint ventures
operated 406 stores internationally. Blockbuster's franchisees generally are
responsible for obtaining their own supplies and coordinating their own
distribution system. However, as a result of making revenue-sharing agreements
available to its U.S. franchises in the fourth quarter of 1999, Blockbuster
expects some of its U.S. franchisees to participate in its revenue-sharing
agreements. Accordingly, U.S. franchisees would rely upon Blockbuster's
distribution center to receive some portion of their videocassettes. Using
Blockbuster's distribution center would allow Blockbuster's franchisees to
share in the cost savings that Blockbuster's distribution center provides to
Blockbuster.
Under its current U.S. franchising program, Blockbuster enters into a
development agreement and a franchise agreement with the franchisee. Pursuant
to the terms of a typical development agreement, Blockbuster grants the
franchisee the right to develop one or a specified number of stores at an
approved location or locations within a defined geographic area and within a
specified time. Blockbuster generally charges the franchisee a development fee
in advance for each store to be developed during the term of the development
agreement. The typical franchise agreement is a long-term agreement that
governs the operations of the store. Blockbuster generally requires the
franchisee to pay Blockbuster a one-time franchise fee and continuing royalty
fees, service fees and monthly payments for maintenance of the proprietary
software. In addition, Blockbuster provides optional product and support
services to its franchisees for which Blockbuster sometimes receives fees.
Blockbuster requires its franchisees to contribute funds for national
advertising and marketing programs and also requires that franchisees spend an
additional amount for local advertising. Each franchisee has sole
responsibility for all financial commitments relating to the development,
opening and operation of its stores, including rent, utilities, payroll and
other capital and incidental expenses. Blockbuster employs people to inspect
its franchised stores.
Blockbuster cannot assure you that its franchisees will be able to achieve
profitability levels in their businesses sufficient to pay Blockbuster's
franchise fees. Furthermore, Blockbuster cannot assure you that it will be
successful in marketing and selling new franchises or that any new franchisees
will be able to obtain desirable locations and acceptable leases.
International Operations
Blockbuster is the leading international retailer of rentable home movies
and video games. As a result, Blockbuster believes it is well positioned to
take advantage of the overall growth in the home video industry outside of the
United States. As of September 30, 1999, Blockbuster had 2,301 stores
operating under "BLOCKBUSTER" and other names located throughout 25 markets
outside of the United States. Of these stores, 406 were operated through
Blockbuster's franchisees and/or joint ventures in which Blockbuster owns a
minority interest.
Blockbuster has focused on seven priority markets outside of the United
States. Based on the number of stores, Blockbuster's largest market is Great
Britain. Blockbuster began operations in Great Britain in 1989 and, through
acquisitions, has grown to 662 locations, excluding video vending machines, as
of September 30, 1999. Blockbuster began operations in Canada, its second
largest market, in 1990 and has grown to 349 stores, as of September 30, 1999.
In the Republic of Ireland and Northern Ireland, Blockbuster's third largest
market, it acquired Xtra-vision PLC in 1997 and continues to operate under the
XTRA-VISION brand name due to its strong local brand awareness. As of
September 30, 1999, Blockbuster has 216 stores in the Republic of Ireland
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and Northern Ireland. In addition, Blockbuster began operations in Mexico in
1991, Australia in 1993, Spain in 1995 and Argentina in 1995. For a complete
listing of all of Blockbuster's operations outside of the United States, see
the chart set forth in "-- Stores and Store Operations -- Store Locations."
Blockbuster maintains offices for each major region and most of the
countries in which it operates in order to manage, among other things:
. store development and operations;
. marketing; and
. the purchasing, supplying and distribution of each store's products.
The international home video and video game industry varies from country to
country due to, among other things:
. political and economic systems and risks; and
. legal standards and regulations, such as those relating to foreign
ownership rights, unauthorized copying, intellectual property rights,
labor and employment matters, trade regulation and business practices,
franchising and taxation.
Thus, because of all of these variables, Blockbuster cannot assure you that
it can operate profitably in these international markets.
Competition
Blockbuster operates in a highly competitive environment. Blockbuster
believes its most significant competition comes from (a) non-videocassette
providers of home viewing entertainment and (b) video stores and other
retailers that rent or sell movies.
Competition with Non-videocassette Providers of Home Viewing
Entertainment. These providers include direct broadcast satellite, cable,
digital terrestrial, network and syndicated television. Blockbuster believes
that its most significant competitive risk in this area comes from direct
broadcast satellite and digital cable television. Further growth in the direct
broadcast satellite and digital cable subscriber bases could cause a smaller
number of videocassettes and DVDs to be rented if viewers were to favor the
expanded number of conventional channels and expanded programming, including
sporting events, offered through these services. See "Risk Factors -- Risk
Factors Relating to Blockbuster's Business and Industry -- The widespread
availability of additional channels on satellite and digital cable systems may
significantly reduce public demand for its merchandise." Direct broadcast
satellite, digital cable and "traditional" cable providers not only offer
numerous channels of conventional television, but they also offer pay-per-view
movies, which permit a subscriber to pay a fee to see a selected movie.
Competition with Video Stores and Other Retailers that Rent or Sell
Movies. These retailers include, among others:
. local, regional and national video stores;
. mass merchant retailers;
. supermarkets, pharmacies and convenience stores; and
. Internet sites.
Blockbuster believes that the principal factors it faces in competing with
video stores are:
. convenience and visibility of store locations;
. quality, quantity and variety of titles;
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. pricing; and
. customer service.
Other Competition. In some markets, Blockbuster also competes against the
illegal duplication and sales of movies and video games. In addition to all of
the modes of competition discussed above, Blockbuster competes for the general
public's entertainment dollar and leisure time activities with, among others,
movie theaters, Internet-related activities, live theater and sporting events.
Blockbuster cannot assure you that competing pressures it faces will not
have a material adverse effect on its company.
See "Risk Factors -- Risk Factors Relating to Blockbuster's Business and
Industry -- Blockbuster's Business May Be Materially Adversely Affected by New
Technologies" for a discussion of competitive risks related to new technology.
Properties
Blockbuster's corporate headquarters are located at 1201 Elm Street,
Dallas, Texas 75270 and consist of about 219,239 square feet of space leased
pursuant to an agreement that expires on June 30, 2007. The distribution
center is located at 3000 Redbud Blvd., McKinney, Texas 75069 and consists of
about 850,000 square feet of space leased pursuant to an agreement that
expires on December 31, 2012. Blockbuster has set up its payroll and benefits
center in Spartanburg, South Carolina.
Blockbuster has several main offices that manage its international
operations. Blockbuster has offices in: Uxbridge, England; Plantation,
Florida; Toronto, Ontario; Melbourne, Australia; and Taipei, Taiwan. In
addition, for most countries in which Blockbuster has company-operated stores,
it maintains an office to coordinate its operations within that country.
Blockbuster leases substantially all of its existing store sites, including
buildings and improvements. These leases generally have a term of five to ten
years and provide options to renew for between ten and fifteen additional
years. Blockbuster expects that most future stores will also occupy leased
properties.
Intellectual Property
Blockbuster owns a number of trademarks, trade names and service marks,
including, among others, BLOCKBUSTER (R), BLOCKBUSTER VIDEO (R), BLOCKBUSTER
FAVORITES (TM), BLOCKBUSTER GIFTCARD (R), BLOCKBUSTER GIFTCARDS (R),
BLOCKBUSTER REWARDS (TM), BLOCKBUSTER ENTERTAINMENT AWARDS (R), KIDPRINT,
BLOCKBUSTER MUSIC (R), XTRA-VISION and the blue and yellow ticket stub and the
blue and yellow awning outside its stores. In addition, Blockbuster owns the
rights to the "blockbuster.com" Internet domain name. Blockbuster considers
its intellectual property rights to be among its most valuable assets.
Legal Proceedings
On July 21, 1999, Ruben Loredo, doing business as Five Palms Video,
purporting to act as a class representative on behalf of himself and all
others similarly situated, filed a complaint in the District Court of Bexar
County, Texas, against Blockbuster. Blockbuster removed the case to the United
States District Court for the Western District of Texas, and the plaintiff has
filed a motion to have the case remanded to the state court. Discovery is
stayed while the court considers the motion to remand. The plaintiff asserts
that by entering into and operating under its revenue-sharing agreements,
Blockbuster has attempted to and conspired with the studios to monopolize and
restrain competition in the market for the retail rental of videocassettes.
The plaintiff is seeking triple the amount of his alleged actual damages and
triple the amount of alleged actual damages of those similarly situated, under
the Texas Free Enterprise and Antitrust Act. The dollar amount that the
plaintiff is
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alleging as the actual damages to himself and those similarly situated is not
set forth in his complaint. Blockbuster believes that the plaintiff's position
is completely without merit, and Blockbuster intends to vigorously defend
itself in the litigation.
In addition, another party, purporting to act as a class representative on
behalf of itself and all others similarly situated, filed a substantially
similar complaint in the United States District Court for the Western District
of Texas against Viacom and the studios' home video subsidiaries that have
operated under these revenue-sharing agreements with Blockbuster. This
plaintiff is seeking triple the amount of the alleged actual damages to itself
and triple the amount of alleged actual damages of those similarly situated,
as well as preliminary and permanent injunctive relief prohibiting any
unlawful attempt or conspiracy to monopolize the market for the retail rental
of videocassettes. If Viacom is required to pay any damage award as a result
of this litigation, Viacom may seek indemnification for its losses from
Blockbuster under the release and indemnification agreement. See "Related
Party Transactions -- Agreements Between Blockbuster and Viacom Relating to
Blockbuster's Initial Public Offering or the Separation of Blockbuster from
Viacom -- Release and Indemnification Agreement."
Blockbuster is subject to various other legal proceedings in the course of
conducting its business, including its business as a franchisor. However,
Blockbuster believes that these proceedings are not likely to result in
judgments that will have a material adverse effect on its business.
Regulation
Domestic Regulation
Blockbuster is subject to various federal, state and local laws that govern
the access and use of its video stores by disabled people and the disclosure
and retention of video rental records. Blockbuster also must comply with
various regulations affecting its business, including state and local
advertising, consumer protection, credit protection, licensing, zoning, land
use, construction, environmental and minimum wage and other labor and
employment regulations.
Blockbuster is also subject to the Federal Trade Commission's Trade
Regulation Rule entitled "Disclosure Requirements and Prohibitions Concerning
Franchising and Business Opportunity Ventures" and state laws and regulations
that govern (1) the offer and sale of franchises and (2) franchise
relationships. If Blockbuster wants to offer and sell a franchise, it is
required by the rule mentioned above to furnish each prospective franchisee a
current franchise offering circular prior to the offer or sale of a franchise.
In addition, a number of states require that Blockbuster, as a franchisor,
comply with that state's registration or filing requirements prior to offering
or selling a franchise in the state and to provide a prospective franchisee
with a current franchise offering circular complying with the state's laws,
prior to the offer or sale of the franchise. Although Blockbuster cannot make
any assurances, it intends to maintain a franchise offering circular that
complies with all applicable federal and state franchise sales and other
applicable laws. However, if Blockbuster is unable to comply with federal
franchise sales and disclosure laws and regulations, Blockbuster will be
unable to offer and sell franchises anywhere in the United States. In
addition, if Blockbuster is unable to comply with the franchise sales and
disclosure laws and regulations of any state that regulates the offer and sale
of franchises, Blockbuster will be unable to offer and sell franchises in such
state.
Blockbuster is required to update its franchise offering circular annually,
as well as to amend it during the course of the year, to reflect material
changes regarding its franchise offering and to comply with changes in
disclosure requirements. The occurrence of any such material changes may, from
time to time, require Blockbuster to stop offering and selling franchises
until its franchise offering circular is updated and amended. Blockbuster
cannot assure you that its franchising program will not be adversely affected
because compliance with applicable law necessitates that it cease offering and
selling franchises in some states until its franchise
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offering circular is revised, updated and approved by the applicable
authorities, or because of its failure or inability to comply with existing or
future franchise sales and disclosure laws.
Blockbuster is also subject to a number of state laws and regulations that
regulate some substantive aspects of the franchisor-franchisee relationship,
including:
. those governing the termination or non-renewal of a franchise agreement,
such as requirements that:
(a) "good cause" exist as a basis for such termination; and
(b) a franchisee be given advance notice of, and a right to cure, a
default prior to termination;
. requirements that the franchisor deal with its franchisees in good
faith;
. prohibitions against interference with the right of free association
among franchisees; and
. those regulating discrimination among franchisees in charges, royalties
or fees.
Compliance with federal and state franchise laws is costly and time-
consuming, and Blockbuster cannot assure you that it will not encounter
difficulties or delays in this area or that it will not require significant
capital for franchising activities.
International Regulation
Blockbuster is subject to various international laws that govern the
disclosure and retention of video rental records. For example, the laws
pertaining to the use of the customer database in some markets outside of the
United States are more restrictive than the relevant laws in the United
States.
Blockbuster must comply with various regulations affecting its business,
including advertising, consumer protection, credit protection, franchising,
licensing, zoning, land use, construction, environmental, labor and employment
regulations.
Similar to the United States, some foreign countries have franchise
registration and disclosure laws affecting the offer and sale of franchises
within their borders and to their citizens. They are not often as extensive
and onerous as laws and regulations applicable in the United States. However,
as in the United States, failure to comply with such laws could limit or
preclude Blockbuster's ability to expand through franchising in those
countries.
Employees
As of September 30, 1999, Blockbuster employed about 95,500 persons,
including about 75,300 persons employed within the United States and about
20,200 persons employed outside of the United States. Within the United
States, about 72,600 were employed in domestic company-operated stores and
2,700 were employed in various other operations, including Blockbuster's
corporate, administrative and distribution functions. Of the total number of
U.S. employees, about 18,300 were full-time and 57,000 were part-time.
Blockbuster believes that its employee relations are good.
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BLOCKBUSTER'S MANAGEMENT
Executive Officers and Directors
Set forth below is information concerning the current executive officers
and directors of Blockbuster. There are no family relationships among any
officers or directors. The ages listed below are as of November 30, 1999.
<TABLE>
<CAPTION>
Name Age Position
- ---- --- -------------------------------------------------------------------------
<S> <C> <C>
John F. Antioco......... 50 Chairman of the Board of Directors, President and Chief Executive Officer
Mark T. Gilman.......... 35 Executive Vice President and Chief Development and Franchising Officer
James Notarnicola....... 48 Executive Vice President and Chief Marketing Officer
Alva J. Phillips........ 55 Executive Vice President and Chief Information Officer
Michael K. Roemer....... 51 Executive Vice President, Domestic Video Operations
Edward B. Stead......... 52 Executive Vice President, General Counsel and Secretary
Nigel Travis............ 49 Executive Vice President and President, Worldwide Retail Operations
Dean M. Wilson.......... 41 Executive Vice President, Merchandising
Larry J. Zine........... 44 Executive Vice President and Chief Financial Officer
Philippe P. Dauman...... 45 Director
Thomas E. Dooley........ 43 Director
Linda Griego............ 52 Director
John L. Muething........ 78 Director
Sumner M. Redstone...... 76 Director
</TABLE>
John F. Antioco has served as chairman of the board of directors, president
and chief executive officer of Blockbuster since 1997. From 1996 until 1997,
Mr. Antioco served as president and chief executive officer for Taco Bell
Corporation. Mr. Antioco served as chairman of the board of directors of The
Circle K Corporation, an operator of convenience stores, from 1995 until 1996,
and as its president and chief executive officer from 1993 until 1996. Mr.
Antioco joined Circle K as chief operating officer in 1991. Mr. Antioco serves
as chairman of the board of directors of Main Street & Main Inc. and as a
director for CSK Auto Corporation.
Mark T. Gilman has served as executive vice president and chief development
and franchising officer of Blockbuster since July 1999. Mr. Gilman served as
executive vice president of real estate-franchising and new business
development of Blockbuster from 1997 until 1999, and served as senior vice
president, strategic systems of Blockbuster from 1996 until 1997. Prior to
joining Blockbuster, during 1996, Mr. Gilman served as senior vice president,
development, for Hollywood Entertainment Corporation, a national retail video
chain, where he was responsible for domestic development and construction.
From 1994 until 1996, Mr. Gilman served as director of operations development
for Wal-Mart Corporation, where he was responsible for developing real estate
and merchandising systems.
James Notarnicola has served as executive vice president and chief
marketing officer of Blockbuster since June 1998 and served as executive vice
president of marketing and administration of Blockbuster from 1997 until 1998.
From 1978 until 1997, Mr. Notarnicola served in many capacities at 7-Eleven
Inc., which was formerly known as The Southland Corporation, including vice
president of marketing, from 1995 until 1997, and general manager of
advertising and promotion, from 1990 until 1995.
Alva J. Phillips has served as executive vice president and chief
information officer of Blockbuster since 1997 and served as senior vice
president of information services of Blockbuster from 1995 until 1997. From
1993 until 1995, Mr. Phillips was employed by Integrated Systems Solutions
Corporation, a wholly owned subsidiary of International Business Machines
Corporation, where he served as project manager for the Eckerd Corporation
account and oversaw, among other matters, the development and implementation
of a satellite-based store communications system. From 1988 until 1993, Mr.
Phillips served as senior vice president of management information services
for Rite Aid, where he was responsible for developing in-store pharmacy,
merchandising and distribution systems to support the company's 2,600 store
locations.
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Michael K. Roemer has served as executive vice president, domestic video
operations of Blockbuster since 1998 and served as senior vice president,
domestic video operations, of Blockbuster from 1997 until 1998. From 1995
until 1997, Mr. Roemer served as an independent consultant for such major
companies as Frito Lay, where he assisted with new product development,
distribution and business process planning. Prior to consulting, Mr. Roemer
worked at 7-Eleven Inc., from 1966 to 1995. From 1993 until 1995, in his
capacity as senior vice president of merchandising for 7-Eleven, Mr. Roemer
oversaw merchandising operations of 7-Eleven stores in the United States and
Canada.
Edward B. Stead has served as executive vice president and general counsel
of Blockbuster since 1997, and as secretary of Blockbuster since 1999. From
1988 until 1996, Mr. Stead served in various capacities with Apple Computer,
Inc., including vice president and general counsel, from 1989 until 1995, vice
president, general counsel and secretary, from 1993 until 1995, and senior
vice president, general counsel and secretary, from 1995 to 1996. Prior to
joining Apple, Mr. Stead served as senior vice president, general counsel and
secretary of Cullinet Software, Inc. Mr. Stead also served as a member of the
legal advisory board of the National Association of Securities Dealers from
1993 until 1997 and has been a member of the American Law Institute since
1996.
Nigel Travis has served as executive vice president and president,
worldwide retail operations, of Blockbuster since 1998 and served as
president, international operations of Blockbuster from 1997 until 1998. From
1994 until 1997, Mr. Travis served in various other capacities for
Blockbuster, including senior vice president, Europe. Prior to joining
Blockbuster, Mr. Travis served as senior vice president and managing director,
Europe, the Middle East and Africa, for Burger King Corporation. Mr. Travis, a
British national, serves as senior non-executive director of Limelight PLC in
the United Kingdom. Mr. Travis was elected as a director of the Video Software
Dealers Association in July 1999.
Dean M. Wilson has served as executive vice president, merchandising, of
Blockbuster since 1998. From 1995 until 1998, Mr. Wilson held a number of
positions with Blockbuster, including senior vice president-general
merchandising manager, vice president-retail and director of product
international. Mr. Wilson's experience in the video industry spans over 16
years, with positions in the retail, distribution and studio aspects of the
business. Prior to joining Blockbuster, from 1990 until 1995, Mr. Wilson was
employed by Trans World Entertainment, a music and video retailer, where he
served as divisional merchandise manager of video. Mr. Wilson began his retail
career in the executive training programs with May Company and Dayton Hudson.
Larry J. Zine has served as executive vice president and chief financial
officer of Blockbuster since 1999. From 1996 until 1999, Mr. Zine served as
chief financial officer for Petro Stopping Centers, L.P., where he was
responsible for all operations. During 1999, Mr. Zine also served as president
of Petro. From 1981 until 1996, Mr. Zine worked for The Circle K Corporation,
an operator of convenience stores, and was named executive vice president and
chief financial officer in 1988.
Philippe P. Dauman was elected as a director of Blockbuster in January
1995. Mr. Dauman has been deputy chairman of Viacom since January 1996 and its
executive vice president since 1994. From 1993 until 1998, Mr. Dauman also
served as general counsel and secretary of Viacom. Mr. Dauman is a director of
National Amusements, Inc. and Lafarge Corporation.
Thomas E. Dooley was elected as a director of Blockbuster in May 1999. Mr.
Dooley has been deputy chairman of Viacom since 1996 and its executive vice
president since 1994. From 1992 until 1994, Mr. Dooley served as senior vice
president, corporate development, of Viacom.
Linda Griego was elected as a director of Blockbuster in July 1999. Since
December 1997, Ms. Griego has served as president of Zapgo Entertainment
Group, L.L.C., a television programming production company. Ms. Griego has
also served as the managing general partner of Engine Co. No. 28, a restaurant
operation, since 1988. From 1994 to 1997, Ms. Griego served as president and
chief executive officer of Rebuild LA, Inc., an economic development
corporation. Ms. Griego also served as Deputy Mayor for the City of Los
Angeles, California from 1991 until 1993.
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John L. Muething was elected as a director of Blockbuster in July 1999. Mr.
Muething has been of counsel to the Cincinnati, Ohio law firm of Keating,
Muething & Klekamp since 1986. He also served as a director of Spelling
Entertainment Group Inc. from 1992 until June 1999.
Sumner M. Redstone was elected as a director of Blockbuster in May 1999.
Mr. Redstone has been the chairman of the board of Viacom since 1987 and its
chief executive officer since 1996. Mr. Redstone has served as chairman of the
board of National Amusements, Inc. since 1986 and its president and chief
executive officer since 1967.
Composition of the Board of Directors of Blockbuster
The board of directors of Blockbuster currently has six members, including
the chairman of the board of directors, Mr. Antioco, three individuals who are
currently executive officers and directors of Viacom, Messrs. Dauman, Dooley
and Redstone, and two outside directors, Ms. Griego and Mr. Muething.
Blockbuster's board of directors is divided into three classes serving
staggered terms. Directors in each class have been elected to serve for three-
year terms and until their successors are elected or qualified. Each year, the
directors of one class will stand for election as their terms of office
expire. The Class I directors, Messrs. Dauman and Dooley, have terms of office
expiring in 2000; the Class II directors, Messrs. Muething and Redstone, have
terms of office expiring in 2001; and the Class III directors, Mr. Antioco and
Ms. Griego, have terms of office expiring in 2002. Messrs. Dauman, Dooley and
Redstone will resign from Blockbuster's board of directors following the
completion of this exchange offer. Blockbuster intends to elect new directors
to replace the departing directors immediately prior to the exchange offer.
Committees of the Board of Directors of Blockbuster
The board of directors of Blockbuster has appointed an audit committee, a
compensation committee and a senior executive compensation committee.
Audit Committee. The functions of the audit committee, which consists of
Ms. Griego and Mr. Muething, include:
. reviewing the adequacy of the system of internal accounting controls;
. reviewing the results of the independent accountants' annual audit;
. determining the duties and responsibilities of the internal audit staff;
. reviewing the scope and results of internal auditing procedures;
. reviewing the audit reports submitted by both the independent
accountants and the internal audit staff; and
. annually recommending independent accountants.
Compensation Committee. The compensation committee consists of Mr. Dauman,
Mr. Dooley, Ms. Griego, Mr. Muething and Mr. Redstone. Except with respect to
matters entrusted to the senior executive compensation committee, the
functions of the compensation committee currently include:
. reviewing general compensation strategy;
. reviewing the terms of employment agreements for executives earning over
a specified amount; and
. administering the compensation and benefit plans, other than the 1999
long-term management incentive plan and senior executive short-term
incentive plan.
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Senior Executive Compensation Committee. The functions of the senior
executive compensation committee, which consists of Ms. Griego and Mr.
Muething, currently include:
. reviewing and approving compensation for executives if their
compensation is, or may become, subject to Section 162(m) of the
Internal Revenue Code, including the terms of employment agreements for
such executives;
. administering the senior executive short-term incentive plan,
determining the executives who will participate in the plan,
establishing performance targets and determining specific bonuses for
the participants; and
. administering the 1999 long-term management incentive plan and approving
individual grants under this plan.
Compensation Committee Interlocks and Insider Participation
In fiscal 1998, Blockbuster did not have a compensation committee or any
other committee serving a similar function. Decisions as to the compensation
of the executive officers were made by the senior executive compensation
committee or the compensation committee of the board of directors of Viacom,
as applicable.
Compensation of Directors
Directors who do not serve as officers or employees of Viacom or
Blockbuster are called outside directors and are entitled to receive
directors' fees and are eligible to participate in Blockbuster's 1999 long-
term management incentive plan described below.
Directors' Fees. Outside directors receive the following fees:
. an annual retainer of $40,000 for membership on Blockbuster's board of
directors: $20,000 of which is paid in cash and $20,000 of which is paid
in Blockbuster class A common stock that is non-transferable for one
year after it is paid;
. a per meeting attendance fee of $1,000 for each meeting of Blockbuster's
board of directors; and
. a per meeting attendance fee of $1,000 for each meeting of the audit
committee, compensation committee and senior executive compensation
committee, but only if the meeting is held on a day different from the
day of the meeting of Blockbuster's board of directors and the committee
member has to travel to participate in the committee meetings. Only one
fee will be paid for attendance at more than one committee meeting held
on the same day.
Equity-Based Compensation. At the time of Blockbuster's initial public
offering, each of the outside directors received a one-time grant of stock
options to purchase 10,000 shares of Blockbuster class A common stock pursuant
to Blockbuster's 1999 long-term management incentive plan at a per share
exercise price equal to $15, the initial public offering price of a share of
Blockbuster class A common stock in Blockbuster's initial public offering. The
options will vest in four equal installments, beginning on the first
anniversary of the date of the grant. In addition, Ms. Griego and Mr. Muething
received a grant of two options for each share of Blockbuster class A common
stock that they purchased pursuant to Blockbuster's directed share program
effected in connection with Blockbuster's initial public offering. As a
result, Ms. Griego and Mr. Muething received grants of options to purchase an
additional 4,000 and 5,000 shares, respectively. These options will vest in
five equal installments, beginning on the first anniversary of the date of
grant.
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Stock Ownership of Certain Beneficial Owners and Blockbuster's Directors and
Executive Officers
The following table sets forth the number of shares of each class of
Blockbuster and Viacom common stock beneficially owned on November 30, 1999 by
each of Blockbuster's directors, Blockbuster's executive officers named in the
summary compensation table below, each person or group known to beneficially
own more than five percent of outstanding Blockbuster common stock and all of
Blockbuster's directors and executive officers as a group. Except as otherwise
noted, the individual director or executive officer had sole voting and
investment power with respect to such securities.
<TABLE>
<CAPTION>
Beneficial Ownership of Equity Securities
------------------------------------------------------------------------
Title of Number of Number of Percent
Name Equity Security Equity Shares Option Shares(1) of Class
- ---- -------------------------- ------------- ---------------- --------
<S> <C> <C> <C> <C>
John F. Antioco......... Viacom class A common -- -- *
Viacom class B common 5,010(2)(3) 181,466 *
Blockbuster class A common 66,766 -- *
Blockbuster class B common -- -- *
Philippe P. Dauman...... Viacom class A common 2,380(3) -- *
Viacom class B common 29,778(3) 1,490,000 *
Blockbuster class A common 5,000 -- *
Blockbuster class B common -- -- *
Thomas E. Dooley........ Viacom class A common 4,866(3) -- *
Viacom class B common 17,286(3) 1,464,000 *
Blockbuster class A common 5,000 -- *
Blockbuster class B common -- -- *
Linda Griego............ Viacom class A common -- -- *
Viacom class B common -- -- *
Blockbuster class A common 3,333(4) -- *
Blockbuster class B common -- -- *
John L. Muething........ Viacom class A common -- -- *
Viacom class B common -- -- *
Blockbuster class A common 3,833 -- *
Blockbuster class B common -- -- *
James Notarnicola....... Viacom class A common -- -- *
Viacom class B common 75(3) -- *
Blockbuster class A common 5,000 -- *
Blockbuster class B common -- -- *
Gary J. Peterson (5).... Viacom class A common -- -- *
Viacom class B common 741(3) -- *
Blockbuster class A common 6,250 -- *
Blockbuster class B common -- -- *
Sumner M. Redstone...... Viacom class A common 93,658,988(6) -- 67.7%
Viacom class B common 104,334,988(6) 2,583,333 18.7%
Blockbuster class A common -- -- *
Blockbuster class B common 144,000,000(7) -- 100%
Edward B. Stead......... Viacom class A common -- -- *
Viacom class B common -- -- *
Blockbuster class A common 12,000 -- *
Blockbuster class B common -- -- *
Nigel Travis............ Viacom class A common 40 -- *
Viacom class B common 374 11,000 *
Blockbuster class A common 10,666 -- *
Blockbuster class B common -- -- *
Viacom Inc.............. Blockbuster class B common 144,000,000(7) -- 100%
1515 Broadway
New York, N.Y. 10036
Capital Group
International, Inc..... Blockbuster class A common 3,167,000 -- 10.2%
11100 Santa Monica
Boulevard
Los Angeles, CA 90025
(8)
Capital Guardian Trust
Company................ Blockbuster class A common 3,100,000 -- 10.0%
11100 Santa Monica
Boulevard
Los Angeles, CA 90025
(9)
Current directors and
officers as a group
other than Messrs.
Dauman, Dooley and
Redstone (twelve
persons)(10)........... Viacom class A common 40 -- *
Viacom class B common 8,816(3)(11) 192,466 *
Blockbuster class A common 168,264(12) -- *
Blockbuster class B common -- -- *
</TABLE>
105
<PAGE>
- --------
*Less than 1%.
(1) This includes shares subject to options to purchase such shares that, on
November 30, 1999, were unexercised but were exercisable within a period
of 60 days from that date. All figures in this column regarding Viacom
common stock reflect an adjustment for Viacom's two-for-one common stock
split effected in March 1999. These shares are excluded from the column
headed "Number of Equity Shares."
(2) This includes 5,000 shares that are held jointly with Mr. Antioco's
spouse.
(3) This includes shares and rights equal in value to shares held through
Viacom's 401(k) and/or excess 401(k) plans as of December 31, 1998.
(4) This includes 2,000 shares that are held jointly with Ms. Griego's spouse.
(5) Pursuant to a severance agreement dated December 6, 1999, Mr. Peterson
ceased serving as executive vice president and chief operations officer
effective December 10, 1999, and effective January 31, 2000, his
employment with Blockbuster will terminate.
(6) Except for 160 shares of each class of Viacom common stock owned directly
by Mr. Redstone, all of these shares are owned of record by National
Amusements. Mr. Redstone is the chairman and the beneficial owner of the
controlling interest in National Amusements and, accordingly, beneficially
owns all such shares.
(7) Consists of shares of common stock indirectly owned by Viacom and
attributed to Mr. Redstone due to his beneficial ownership and control of
National Amusements as disclosed in footnote (6) above.
(8) This is based on a Schedule 13G filed with the SEC on September 10, 1999
by Capital Group International, Inc. and Capital Guardian Trust Company.
According to the Schedule 13G, Capital Guardian International, Inc.
disclaims beneficial ownership of such shares because it does not have
investment power or voting power over any of the securities. However,
Capital Group International, Inc. may be deemed to beneficially own such
securities by virtue of it being the parent holding company of a group of
investment management companies that hold investment power and voting
power over the securities. Of the 3,167,000 shares deemed beneficially
owned, Capital Group International, Inc. has reported deemed sole voting
power with respect to 2,258,800 shares and sole dispositive power with
respect to all of the 3,167,000 shares.
(9) This is based on a Schedule 13G filed with the SEC on September 10, 1999
by Capital Group International, Inc. and Capital Guardian Trust Company.
Of the 3,100,000 shares beneficially owned, Capital Guardian Trust
Company has reported sole voting power with respect to 2,191,800 shares.
According to the Schedule 13G, Capital Guardian Trust Company disclaims
beneficial ownership of such securities.
(10) This includes Mr. Peterson's ownership interest. See footnote (5) above.
(11) In addition to the 5,000 shares disclosed in footnote (2) above, this
includes 1,000 shares that are held by another executive officer jointly
with his spouse.
(12) In addition to the 2,000 shares disclosed in footnote (4) above, this
includes 10,750 shares that are held by other executive officers jointly
with their spouses.
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<PAGE>
Compensation of Executive Officers
Summary Compensation Table. The following summary compensation table sets
forth information regarding compensation for fiscal 1998 paid to the chief
executive officer of Blockbuster and each of the four other most highly
compensated executive officers of Blockbuster who were serving as such on
December 31, 1998.
<TABLE>
<CAPTION>
Long-Term
Compensation
Annual Compensation Awards
------------------------------------------- ------------
Other Securities All
Annual Underlying Other
Name and Principal Salary Bonus Compensation Options Compensation
Position Year ($) ($)(1) ($)(2) (#)(3) ($)
- ----------------------- ---- --------- --------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
John F. Antioco........ 1998 1,200,000 4,750,000(4) -- 196,320 323(5)
Chairman of the Board
of Directors,
President and Chief
Executive Officer
James Notarnicola...... 1998 374,363 300,000 -- 10,000 2,615(6)
Executive Vice
President and Chief
Marketing Officer
Gary J. Peterson(7).... 1998 397,500 300,000 -- 5,000 5,895(6)
Executive Vice
President and Chief
Operations Officer
Edward B. Stead........ 1998 369,923 282,050 19,127(8) -- --
Executive Vice
President, General
Counsel and Secretary
Nigel Travis........... 1998 361,483(9) 386,618 159,109(9)(10) 10,000 45,234(11)
Executive Vice
President and
President, Worldwide
Retail Operations
</TABLE>
- --------
(1) This reflects bonus earned during fiscal 1998. In some instances, all or
a portion of the bonus was paid during the next fiscal year.
(2) In accordance with the rules of the SEC, perquisites totaling less than
$50,000 have been omitted.
(3) This reflects options to acquire shares of Viacom class B common stock.
All figures in this column reflect an adjustment for Viacom's two-for-
one common stock split effected in March 1999.
(4) $1.0 million of Mr. Antioco's 1998 bonus amount represents the 1998
installment of his sign-on bonus.
(5) This consists of Blockbuster's contributions to Viacom's 401(k) plan.
(6) This consists of Blockbuster's contributions to Viacom's 401(k) and
excess 401(k) plans.
(7) Pursuant to a severance agreement dated December 6, 1999, Mr. Peterson
ceased serving as executive vice president and chief operations officer
effective December 10, 1999, and effective January 31, 2000, his
employment with Blockbuster will terminate.
(8) This consists of reimbursement for taxes.
(9) Mr. Travis was transferred from Blockbuster's U.K. payroll to its U.S.
payroll in August 1998. Payments made in British pounds have been
converted to U.S. dollars using an average conversion rate from January
1998 through July 1998 of 1.64897 U.S. dollars to 1.00 British pound.
(10) This includes $96,219 relating to relocation expenses, $47,285 of
reimbursement for taxes, and other executive perquisites, none of which
exceeds 25% of the total perquisites reported as other annual
compensation.
(11) This consists of employer contributions to Blockbuster's U.K. defined
contribution and supplemental plans, but does not include amounts
accrued but not contributed to Mr. Travis' account during 1998. Amounts
disclosed reflect a conversion from British pounds to U.S. dollars at an
average conversion rate for 1998 of 1.65655.
Option Grants During 1998 Fiscal Year. The following table provides
information related to options to purchase Viacom class B common stock granted
during fiscal 1998 to the executive officers named in the summary compensation
table above.
<TABLE>
<CAPTION>
Individual Grants
---------------------------------------------------------
Number of % of Total
Shares of Viacom Options Exercise
Class B Common Granted to or Base
Stock Underlying Employees in Price Grant Date
Options(1) Fiscal 1998(2) ($/Sh)(3) Expiration Date Present Value($)(4)
---------------- -------------- --------- --------------- -------------------
<S> <C> <C> <C> <C> <C>
John F. Antioco......... 196,320(5) 1.45 30.5625 August 20, 2008 2,549,961
James Notarnicola....... 10,000(5) 0.07 30.5625 August 20, 2008 129,888
Gary J. Peterson(6)..... 5,000(5) 0.04 30.5625 August 20, 2008 64,944
Edward B. Stead......... -- -- -- -- --
Nigel Travis............ 10,000(5) 0.07 30.5625 August 20, 2008 129,888
</TABLE>
- --------
(1) All share numbers have been adjusted to reflect Viacom's two-for-one
common stock split that was effected in March 1999.
(2) This reflects the percentage of total grants to all of Viacom's
employees. The percentage of total grants to all of the employees of
Blockbuster were as follows: Mr. Antioco, 38.77%; Mr. Notarnicola, 1.98%;
Mr. Peterson, 0.99%; Mr. Stead, 0%; and Mr. Travis, 1.98%.
107
<PAGE>
(3) Exercise prices that were originally equal to the fair market value of
Viacom class B common stock on the date of grant have been adjusted to
reflect Viacom's two-for-one common stock split that was effected in
March 1999.
(4) This is based on the Black-Scholes option pricing model adapted for use
in valuing executive stock options. The actual value, if any, an
executive may realize will depend on the excess of the stock price over
the exercise price on the date the option is exercised. There is no
assurance that the value realized by an executive will be at or near the
value estimated by the Black-Scholes option pricing model. The grant date
values presented in the table were determined, in part, using the
following assumptions. No adjustments were made for non-transferability
or risk of forfeiture:
<TABLE>
<CAPTION>
Expected volatility............................................... 32.73%
<S> <C>
Risk-free rate of return.......................................... 5.45%
Dividend yield.................................................... 0.00%
Time of exercise.................................................. 6 years
</TABLE>
The approach used in developing the assumptions upon which the Black-
Scholes valuation was done is consistent with the requirements of the
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-
Based Compensation."
(5) The options become exercisable with respect to one-third of the shares
covered thereby on each of August 20, 2000, 2001 and 2002.
(6) Pursuant to a severance agreement dated December 6, 1999, Mr. Peterson
ceased serving as executive vice president and chief operations officer
effective December 10, 1999, and effective January 31, 2000, his
employment with Blockbuster will terminate.
Option Exercises During 1998 Fiscal Year and Fiscal Year End Option
Values. The following table provides information related to:
. options to purchase Viacom common stock exercised during fiscal 1998 by
Blockbuster's executive officers named in the summary compensation table
above; and
. the number and value of options to purchase Viacom class B common stock
held at December 31, 1998 by such executive officers.
<TABLE>
<CAPTION>
Number of Securities Value of Unexercised
Underlying Unexercised In-the-Money
Options as of Options as of
December 31, 1998(1)(2) December 31, 1998($)
------------------------- -------------------------
Shares
Acquired on Value
Name Exercise(#)(2) Realized($) Exercisable Unexercisable Exercisable Unexercisable
- ---- -------------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John F. Antioco......... -- -- -- 1,196,320 -- 23,013,810
James Notarnicola....... -- -- -- 90,000 -- 1,804,375
Gary J. Peterson(3)..... 9,666(4) 145,594 -- 124,334 -- 2,584,201
Edward B. Stead......... -- -- -- 100,000 -- 2,156,250
Nigel Travis............ 18,250(5) 94,193 6,000 102,000 117,000 2,044,625
</TABLE>
- --------
(1) This reflects options to acquire Viacom class B common stock.
(2) All figures in these columns reflect an adjustment for Viacom's two-for-
one common stock split effected in March 1999.
(3) Pursuant to a severance agreement dated December 6, 1999, Mr. Peterson
ceased serving as executive vice president, chief operations officer
effective December 10, 1999, and effective January 31, 2000, his
employment with Blockbuster will terminate.
(4) This reflects the exercise of options to acquire 9,666 shares of Viacom
class B common stock.
(5) This reflects the exercise of options to acquire 2,060 shares of Viacom
class A common stock and 16,190 shares of Viacom class B common stock.
Pension Plans
Defined Benefit Pension Plan. Blockbuster participates in a non-
contributory qualified defined benefit pension plan and an excess pension plan
for some of Blockbuster's highly compensated employees, both sponsored by
Viacom. Blockbuster employees became eligible to participate in these plans
effective January 1, 1996, with credit for past service on and after September
29, 1994 for eligibility and vesting purposes. An eligible employee will
receive a benefit at retirement that is based upon the employee's number of
years of benefit service and average annual compensation, including salary and
bonus, for the highest 60 consecutive months out of the final 120 months
immediately preceding retirement. Under the terms of the excess pension plan,
such compensation is limited to the greater of base salary as of December 31,
1995 or $750,000. The benefits under Viacom's excess pension plan are not
subject to the Internal Revenue Code provisions that limit the compensation
used to determine benefits and the amount of annual benefits payable under
Viacom's qualified pension plan. At this time, Blockbuster does not intend to
sponsor a defined benefit plan or an excess benefit plan following the
completion of this split-off, but expects that their employees will cease to
participate in Viacom's plans at December 31, 1999. It is anticipated that
Viacom will retain the accrued liability for benefits under these plans for
Blockbuster's employees. All Blockbuster employees who are actively employed
by Blockbuster and participating in the defined benefit pension plan or the
excess benefit pension plan on December 31, 1999 will become fully vested in
their accrued benefits in these plans on that date.
108
<PAGE>
The following table illustrates, for representative average annual
pensionable compensation and years of benefit service classifications, the
annual retirement benefit that would be payable to employees under both the
non-contributory defined benefit pension plan and the excess pension plan if
they retired in 1998 at age 65, based on the straight-life annuity form of
benefit payment and not subject to deduction or offset.
Pension Plan Table
<TABLE>
<CAPTION>
Years of Service
-----------------------------------------------
Remuneration 5 10 15 20 25 30
- ------------ ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
$150,000........................ $12,347 $24,694 $37,041 $49,387 $61,734 $74,081
300,000........................ 25,472 50,944 76,416 101,887 127,359 152,831
450,000........................ 38,597 77,193 115,791 154,387 192,984 231,581
600,000........................ 51,722 103,444 155,166 206,887 258,609 310,331
750,000........................ 64,847 129,694 194,541 259,387 324,234 389,081
900,000........................ 77,972 155,944 233,916 311,887 389,859 467,831
</TABLE>
The number of years of benefit service that have been credited, as of
December 31, 1998, for Messrs. Antioco, Notarnicola, Peterson and Stead are
six months, six months, two years and four months, respectively. Mr. Travis
does not participate in either of Viacom's pension plan or excess pension
plan.
Employment and Severance Agreements
Mr. Antioco's employment agreement provides that he will be employed as
chairman and chief executive officer of Blockbuster until June 15, 2002 at an
annual salary of $1.3 million, which will be pro-rated for the balance of
1999, and thereafter at an annual salary of $1.0 million. Mr. Antioco will
also receive deferred compensation, payable the year after he ceases to be an
executive officer of Blockbuster, in an amount equal to $355,000 for 2000,
$455,000 for 2001 and $230,000 for the portion of 2002 during the employment
term. Mr. Antioco's target bonus, which is payable upon satisfaction of
performance objectives determined each year by Blockbuster's senior executive
compensation committee, is set at 125% of his base salary and deferred
compensation. In accordance with the agreement Mr. Antioco received, upon the
completion of Blockbuster's initial public offering, 1 million options to
purchase Blockbuster class A common stock at a per share exercise price of
$15. These options will vest over a five-year period, beginning on the first
anniversary of the date of grant. In addition, on each of the first and second
anniversaries of the offering, Mr. Antioco will receive a grant of options to
purchase Blockbuster class A common stock, issued at fair market value at the
time of grant, with an aggregate exercise price equal to $6.0 million for each
annual grant. These options will vest over a four-year period, beginning on
the first anniversary of the date of grant. In the event of the termination of
Mr. Antioco's employment without cause or voluntary termination for good
reason during the employment term, he will be entitled to receive salary,
target bonus, deferred compensation and agreed-upon benefits for the balance
of the employment term, subject to mitigation after the first eighteen months,
and his stock options, including options that would have been granted or that
have not vested by the date of termination, will be exercisable for at least
six months after the date of termination, but not beyond the expiration date
of such stock options.
The employment agreements of each of Messrs. Notarnicola, Stead and Travis
are substantially similar. Mr. Notarnicola's agreement provides that he will
be employed as chief marketing officer until May 31, 2001 at an annual salary
of $420,000, subject to an annual merit increase during the first quarter of
each year. Mr. Stead's agreement provides that he will be employed as
executive vice president, general counsel and secretary until September 2,
2001 at an annual salary of $375,000, subject to an annual merit increase
during the first quarter of each year. Mr. Travis' agreement provides that he
will be employed as president, retail operations until May 31, 2002 at a
salary of $465,000 for the twelve-month period ending May 31, 2000 and
$505,000 for the twelve-month period ending May 31, 2001, and at a salary to
be determined for the twelve-month period ending May 31, 2002. Each of these
agreements provides for an annual target bonus of 50% of base salary, which is
payable upon satisfaction of performance objectives. Each of these agreements
provides that, in the event of the
109
<PAGE>
executive's termination of employment without cause or for good reason during
the employment term, he will be entitled to receive his salary and target
bonus and certain benefits for the balance of the employment term, subject to
mitigation after the first twelve months, and his stock options, including
options that would have vested during the employment term, will be exercisable
for six months after the date of termination, but not beyond the expiration of
such stock options.
Mr. Peterson entered into a severance agreement with Blockbuster, dated
December 6, 1999, under which Mr. Peterson ceased serving as executive vice
president and chief operations officer effective December 10, 1999, and
effective January 31, 2000, his employment with Blockbuster will terminate.
Under this agreement, Mr. Peterson will receive payment of his current salary
of $420,000 through January 31, 2001 and his 1999 bonus payable under
Blockbuster's short-term incentive plan. In addition, any outstanding Viacom
stock options that are exercisable or would have vested on or before May 31,
2002 will vest on January 31, 2000 and may be exercised for six months
following such date of termination. Any outstanding Blockbuster stock options
will expire on the date of termination. Mr. Peterson will also be fully vested
in his accrued benefit in the Viacom defined benefit pension plan. The
agreement contains provisions preventing competition and solicitation through
May 31, 2002 and disclosure of confidential information indefinitely.
1999 Long-Term Management Incentive Plan
In connection with Blockbuster's initial public offering, Blockbuster
adopted the 1999 long-term management incentive plan. Under this plan,
Blockbuster may award stock options, stock appreciation rights, restricted
shares, restricted share units and phantom shares to its employees, as well as
to its non-employee directors and advisors. To date, only stock options have
been awarded. Stock options generally have a term of ten years. The senior
executive compensation committee, as administrator of the plan, determines,
among other things, the vesting schedule of each grant, including performance
requirements, if any, and may, in its discretion, accelerate the vesting
schedule of any award. At the time of Blockbuster's initial public offering,
Messrs. Antioco, Notarnicola, Peterson, Stead and Travis were granted
1,133,332; 495,000; 397,500; 324,000 and 391,332 options, respectively, to
purchase Blockbuster class A common stock pursuant to this plan. These numbers
include options granted in connection with a program whereby executive
officers received a grant of two options for each share of Blockbuster class A
common stock that they purchased pursuant to Blockbuster's directed share
program effected in connection with its initial public offering. The exercise
price of these options is equal to $15, the initial public offering price.
These options will vest in five equal installments, beginning on the first
anniversary of the date of grant. For information regarding options granted to
Blockbuster's non-employee directors at the time of Blockbuster's initial
public offering, see "-- Compensation of Directors."
110
<PAGE>
RELATED PARTY TRANSACTIONS
Blockbuster has set forth below a summary description of the material
agreements between Blockbuster and Viacom (1) relating to Blockbuster's
initial public offering and this exchange offer and (2) relating to other
matters not concerning Blockbuster's initial public offering or this
separation. Some of these agreements have been filed with the SEC as exhibits
to the registration statement of which this document is a part.
Agreements Between Blockbuster and Viacom Relating to Blockbuster's Initial
Public Offering or the Separation of Blockbuster from Viacom
Initial Public Offering and Split-off Agreement
General. Viacom has entered into an initial public offering and split-off
agreement with Blockbuster, which governs its respective rights and duties
with respect to some offerings of shares of Blockbuster class A common stock
and other securities, including Blockbuster's initial public offering and this
exchange offer, and sets forth certain covenants Blockbuster agreed to for
various periods following its initial public offering and this exchange offer.
Offerings of Securities of Blockbuster and this Exchange Offer. Blockbuster
has agreed to cooperate with Viacom in all respects to accomplish:
. any primary offerings of shares of Blockbuster class A common stock and
other securities prior to the separation of Blockbuster from Viacom; and
. this exchange offer.
Blockbuster has also agreed that, at Viacom's direction, Blockbuster will
promptly take all actions necessary or desirable to effect these transactions,
including the registration under the Securities Act of Viacom's shares of
Blockbuster capital stock. Viacom has the sole discretion to determine whether
to proceed with all or part of this exchange offer and all terms and
conditions of this exchange offer.
Expenses. In general, unless otherwise provided for in the initial public
offering and split-off agreement or any other agreement, Viacom and
Blockbuster will pay their respective costs and expenses incurred in
connection with any offering of Blockbuster's securities prior to the
separation of Blockbuster from Viacom, including Blockbuster's initial public
offering, and this exchange offer.
. Expenses Relating to Primary Offerings of Securities of
Blockbuster. Blockbuster has generally agreed to pay all costs and
expenses relating to any primary offerings of shares of Blockbuster
class A common stock and other Blockbuster securities prior to the
separation of Blockbuster from Viacom, including Blockbuster's initial
public offering.
. Expenses Relating to this Exchange Offer. Viacom has generally agreed to
pay all costs and expenses relating to this exchange offer.
Access to Information. Generally, Viacom and Blockbuster have agreed to
provide each other with, upon written request and subject to specified
conditions, and for a specified period of time, access to information relating
to the assets, business and operations of the requesting party. Viacom and
Blockbuster have agreed to keep their books and records for a specified period
of time. Also, Viacom and Blockbuster have agreed to cooperate with the other
party to allow access to each other's employees, to the extent they are
necessary, to discuss and explain all requested information mentioned above
and with respect to any claims brought against the other relating to the
conduct of Blockbuster's business prior to completion of the separation of
Blockbuster from Viacom.
111
<PAGE>
Covenants. Blockbuster has agreed that, for so long as Viacom is required
to consolidate its results of operations and financial position, Blockbuster
will:
. provide Viacom with financial information regarding Blockbuster and its
subsidiaries;
. provide Viacom with copies of all quarterly and annual financial
information and other reports and documents Blockbuster intends to file
with the SEC prior to such filings, as well as final copies upon filing,
and to actively consult with Viacom with respect to any changes made to
these reports;
. provide Viacom with copies of Blockbuster's budgets and financial
projections, as well as the opportunity to meet with Blockbuster's
management to discuss such budgets and projections;
. consult with Viacom regarding the timing and content of earnings
releases and cooperate fully and cause Blockbuster's accountants to
cooperate fully with Viacom in connection with any of Blockbuster's
public filings;
. not change its auditors without Viacom's prior written consent, and use
its reasonable best efforts to enable its auditors to complete their
audit of Blockbuster's financial statements such that they will date
their opinion the same date that they date their opinion on Viacom's
financial statements;
. provide to Viacom and its auditors all information required for Viacom
to meet its schedule for the filing and distribution of Viacom's
financial statements;
. make Blockbuster's books and records available to Viacom and Viacom's
auditors, so that they may conduct reasonable audits relating to
Blockbuster's financial statements;
. adhere to specified accounting standards;
. agree with Viacom on any changes to Blockbuster's accounting policies;
and
. agree with Viacom regarding Blockbuster's accounting estimates and
principles.
Other Covenants. The initial public offering and split-off agreement also
provides that for so long as Viacom beneficially owns 50% or more of
outstanding shares of Blockbuster class A common stock, Blockbuster may not
take any action or enter into any commitment or agreement that may reasonably
be anticipated to result, with or without notice and with or without lapse of
time, or otherwise, in a contravention, or an event of default, by Viacom of:
. any provision of applicable law or regulation, including but not limited
to provisions pertaining to the Internal Revenue Code, or the Employee
Retirement Income Security Act of 1974, as amended;
. any provision of Viacom's certificate of incorporation or by-laws;
. any credit agreement or other material instrument binding upon Viacom;
or
. any judgment, order or decree of any governmental body, agency or court
having jurisdiction over Viacom or any of its assets.
Assignment and Assumption. Under the initial public offering and split-off
agreement, Viacom International Inc., a Viacom affiliate, has assigned to
Blockbuster its rights and obligations under the agreement related to the sale
of the BLOCKBUSTER MUSIC video stores to Wherehouse. Blockbuster has agreed to
accept this assignment.
Assignment of Employment Agreements. The initial public offering and split-
off agreement provides that Viacom will assign to Blockbuster immediately
before the completion of this exchange offer any and all employment agreements
between Blockbuster Entertainment Group, a Viacom business unit, and the
employees who are parties to those agreements.
Options. Blockbuster granted to Viacom International Inc. a continuing
option, assignable to Viacom and any of its subsidiaries, to purchase, under
specified circumstances, additional shares of Viacom class B common
112
<PAGE>
stock or any shares of Viacom nonvoting capital stock. These options may be
exercised immediately prior to the issuance of any of Blockbuster's equity
securities, other than in Blockbuster's initial public offering:
. with respect to shares of Blockbuster class B common stock, only to the
extent necessary to maintain Viacom's then-existing percentage of equity
value and combined voting power of Blockbuster's two outstanding classes
of common stock; and
. with respect to shares of nonvoting capital stock, to the extent
necessary to own 80% of each outstanding class of such stock.
The purchase price of the shares of Blockbuster class B common stock purchased
upon any exercise of the options, subject to specified exceptions, is based on
the market price of Blockbuster class A common stock. The purchase price of
nonvoting capital stock is the price at which such stock may be purchased by
third parties. This option terminates when Viacom or its affiliates own less
than 45% of the equity of Blockbuster.
Indemnification Procedures. The initial public offering and split-off
agreement sets forth the procedures that Blockbuster and Viacom are to
undertake if either of them demand to be indemnified by the other under any
indemnification right given in any of the agreements between Blockbuster and
Viacom relating to Blockbuster's initial public offering or this exchange
offer, other than the tax matters agreement referred to below.
Release and Indemnification Agreement
Viacom and Blockbuster entered into a release and indemnification agreement
under which Viacom and Blockbuster agreed to indemnify each other and Viacom
and Blockbuster agreed to release each other with respect to some matters.
Indemnification Relating to Blockbuster's Assets, Businesses and
Operations. Blockbuster agreed to indemnify and hold harmless Viacom and some
of its affiliates and their respective officers, directors, employees, agents,
heirs, executors, successors and assigns against any payments, losses,
liabilities, damages, claims and expenses and costs arising out of or relating
to:
. Blockbuster's past, present and future assets, businesses and operations
and other assets, businesses and operation or managed by Blockbuster or
persons previously associated with Blockbuster, except for assets,
businesses and operations of Paramount Parks Inc., Spelling
Entertainment Group Inc. and its subsidiaries, including Republic
Entertainment Inc. and Worldvision Inc., Showtime Networks Inc., Virgin
Interactive Entertainment Limited and Virgin Interactive Entertainment
Inc.; and
. payments, expenses and costs that Viacom paid to a third party
associated with the transfer of Blockbuster's assets, businesses and
operations from some of Viacom's entities to Blockbuster and its
subsidiaries.
Viacom similarly agreed to indemnify Blockbuster and some of their
affiliates, and Blockbuster and its respective officers, directors, employees,
agents, heirs, executors, successors and assigns for Viacom's past, present
and future assets, businesses and operations, except for assets, businesses
and operations for which Blockbuster agreed to indemnify Viacom. In addition,
the transition services agreement, the registration rights agreement and the
tax matters agreement referred to below provide for indemnification between
Viacom and Blockbuster relating to the substance of such agreements.
Indemnification Relating to Blockbuster's Initial Public Offering and Other
Offerings. Blockbuster generally agreed to indemnify Viacom and some of
Viacom's affiliates against all liabilities arising out of any material untrue
statements and omissions in any prospectus and any related registration
statement filed with the SEC relating to Blockbuster's initial public offering
or any other primary offering of shares of Blockbuster class A common stock or
Blockbuster's other securities prior to the completion of this exchange offer.
However, Blockbuster's indemnification of Viacom does not apply to information
relating to Viacom, excluding information relating to Blockbuster. Viacom
agreed to indemnify Blockbuster for this information.
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Indemnification Relating to this Exchange Offer. Blockbuster generally
agreed to indemnify Viacom and some of its affiliates against all liabilities
arising out of any material untrue statements and omissions in this document
and any and all related registration statements and/or other documents filed
with the SEC in connection with this exchange offer. However, Blockbuster's
indemnification of Viacom does not apply to information relating to Viacom,
excluding information relating to Blockbuster. Viacom agreed to indemnify
Blockbuster for this information.
Release Relating to Actions by Viacom Related to Viacom's and Blockbuster's
Assets, Businesses and Operations. Except for the rights and obligations of
Blockbuster and Viacom, which relate to the agreements between Blockbuster and
Viacom relating to Blockbuster's initial public offering or the separation of
Blockbuster from Viacom, Blockbuster released Viacom and some of its
subsidiaries and affiliates and their respective officers, directors,
employees, agents, heirs, executors, successors and assigns for all losses for
any and all past actions and failures to take actions relating to
Blockbuster's and Viacom's assets, businesses and operations. Viacom similarly
released Blockbuster.
Transition Services Agreement
Viacom and Blockbuster entered into a transition services agreement under
which Viacom provides Blockbuster with agreed-upon cash management,
accounting, legal, management information systems, financial and tax services
and employee benefit plan and insurance administration. These services may be
changed upon agreement between Blockbuster and Viacom. Blockbuster will pay
Viacom a fee for these services equal to Viacom's cost in providing these
services which will initially be equal to about $150,000 per month. The fee
will be payable monthly in arrears, 15 days after the close of each month.
Blockbuster believes that the fee for these services is no less favorable than
could be obtained by Blockbuster internally or from someone who had not
controlled Blockbuster. Blockbuster agreed to pay or reimburse Viacom for any
out-of-pocket payments, costs and expenses associated with these services. The
transition services agreement expires upon the completion of this exchange
offer. Blockbuster cannot assure you that it will be able to provide these
services internally or find a third party provider on acceptable terms, if at
all, after the expiration of the transition services agreement.
Registration Rights Agreement
Viacom and Blockbuster entered into a registration rights agreement which
requires Blockbuster upon Viacom's request to use Blockbuster's reasonable
best efforts to register under the applicable federal and state securities
laws any of the shares of Blockbuster's equity securities of or owned by
Viacom for sale in accordance with Viacom's intended method of disposition,
and will take such other actions as may be necessary to permit the sale in
other jurisdictions, subject to specified limitations. Viacom also has the
right to include the shares of Blockbuster's equity securities Viacom
beneficially owns in other registrations of these equity securities that
Blockbuster initiates. Except for Blockbuster's legal and accounting fees and
expenses, the registration rights agreement provides that Viacom generally
pays all or its pro rata portion of out-of-pocket costs and expenses relating
to each such registration that Viacom requests or in which it participates.
Subject to specified limitations, the registration rights will be assignable
by Viacom and its assigns. The registration rights agreement contains
indemnification and contribution provisions that are customary in transactions
similar to those contemplated by this document.
Tax Matters Agreement
After the completion of Blockbuster's initial public offering, Blockbuster
and some of its subsidiaries continued to be included in Viacom's consolidated
group for U.S. federal income tax purposes and Viacom's combined, consolidated
or unitary group for various state and local income tax purposes (the
"consolidated group"). Viacom and Blockbuster entered into a tax matters
agreement whereby for the taxable years and portions thereof prior to August
16, 1999, Viacom has and will pay all taxes for the consolidated group,
including any liability resulting from adjustments to tax returns relating to
such taxable years or portions thereof.
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Blockbuster and its subsidiaries will continue to be liable for all taxes that
are imposed on a separate return basis or on a combined, consolidated or
unitary basis on a group of companies that includes only Blockbuster and its
subsidiaries.
The tax matters agreement requires Viacom and Blockbuster to make payments
to each other equal to the amount of income taxes which would be paid by
Blockbuster, subject to some adjustments, as if Blockbuster and each of its
subsidiaries included in the consolidated group were to file its own combined,
consolidated or unitary, or, where only one of Blockbuster's entities is
included in the consolidated group, separate, federal, state and local income
tax returns for any taxable year or portion thereof beginning after August 16,
1999 in which Blockbuster is included in the consolidated group. This would
include any amounts determined to be due as a result of a redetermination of
the tax liability of the consolidated group arising from an audit or
otherwise. With respect to some tax items attributable to periods following
August 16, 1999 during which Blockbuster is included in the consolidated
group, such as foreign tax credits, alternative minimum tax credits, net
operating losses and net capital losses, Blockbuster has a right of
reimbursement or offset, which is determined based on the extent to which, and
the time at which, such credits or losses could have been used by Blockbuster
or its subsidiaries if Blockbuster had not been included in the consolidated
group. This right to reimbursement or offset continues regardless of whether
Blockbuster is a member of the consolidated group at the time the attributes
could have been used. Blockbuster is only entitled to reimbursement for
carryback items that it could use on a stand alone basis to the extent that
such items result in an actual tax savings for the consolidated group. The tax
matters agreement also requires Blockbuster, if so requested by Viacom, to
surrender some tax losses of Blockbuster's subsidiaries that are resident in
the United Kingdom for 1998 and earlier years to Viacom's United Kingdom
subsidiaries without any right to compensation. Blockbuster also agreed to pay
Viacom an amount equal to any tax benefit Blockbuster receives from the
exercise of Viacom's stock options by Blockbuster's employees, including in
years that Blockbuster is no longer included in Viacom's consolidated group.
Blockbuster will also pay Viacom the amount of any income taxes with respect
to income tax returns that include only Blockbuster, which returns, as
described below, will be filed by Viacom.
Viacom continues to have all the rights of a parent of a consolidated group
filing consolidated federal income tax returns. Viacom has similar rights
provided for by applicable state and local law with respect to a parent of a
combined, consolidated or unitary group. Viacom is the sole and exclusive
agent for Blockbuster in any and all matters relating to income taxes of the
consolidated group. Viacom has sole and exclusive responsibility for the
preparation and filing of all income tax returns or amended returns with
respect to the consolidated group. Viacom has the sole right to contest or
compromise any asserted tax adjustment or deficiency and to file, litigate or
compromise any claim for refund on behalf of the consolidated group, except
that Viacom is not entitled to compromise any such matter in a manner that
would affect Blockbuster's liability under the tax matters agreement without
Blockbuster's consent, which may not be withheld unreasonably. Under the tax
matters agreement, Viacom has similar authority with regard to income tax
returns that Blockbuster files on a separate basis and related tax
proceedings. Viacom's authority with respect to periods during which
Blockbuster is included in the consolidated group will continue to apply even
with respect to tax returns that are filed and for proceedings that are
conducted after this exchange offer and any subsequent spin-off, which relate
to such periods. This agreement may result in conflicts of interest between
Viacom and Blockbuster.
Provided that Viacom continues to beneficially own, directly or indirectly,
at least 80% of the combined voting power and the value of Blockbuster's
outstanding capital stock, Blockbuster will be included for federal income tax
purposes in the consolidated group of which Viacom is the common parent. It is
the present intention of Viacom and its subsidiaries to continue to file a
single consolidated federal income tax return. In certain circumstances, some
of Blockbuster's subsidiaries also will be included with some of Viacom's
subsidiaries, other than Blockbuster's subsidiaries, in combined, consolidated
or unitary income tax groups for state and local tax purposes. Each member of
the consolidated group for federal income tax purposes will be liable for the
federal income tax liability of each other member of the consolidated group.
Similar principles will apply with respect to members of a combined group for
state and local tax purposes. Accordingly, although the tax matters agreement
will allocate tax liabilities between Viacom and Blockbuster during the period
in which Blockbuster
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is included in the consolidated group, Blockbuster could be liable for the
federal income tax liability of any other member of the consolidated group in
the event any such liability is incurred, and not discharged, by such other
member. The tax matters agreement provides, however, that Viacom will
indemnify Blockbuster to the extent that, as a result of being a member of the
consolidated group, Blockbuster will become liable for the federal income tax
liability of any other member of the consolidated group, other than
Blockbuster's subsidiaries.
On August 3, 1999, Viacom received a private letter ruling from the
Internal Revenue Service to the effect that this exchange offer and any
subsequent spin-off would be a tax-free transaction to Viacom and its
shareholders for U.S. federal income tax purposes. However, the proposed
merger between Viacom and CBS was not contemplated at the time that this
private letter ruling was issued. As a result, Viacom submitted a request for
a supplemental private letter ruling to confirm that the proposed merger would
not adversely affect the tax-free status of this exchange offer and any
subsequent spin-off. The supplemental private letter ruling was issued on
, 2000. In connection with seeking such rulings, some representations have
been made to the Internal Revenue Service regarding Blockbuster's business. In
the tax matters agreement, Blockbuster agrees that during the two-year period
following the completion of this exchange offer Blockbuster and its
subsidiaries will not enter into some types of transactions, including sales
of assets, mergers, liquidations, stock issuances, and stock redemptions,
without Viacom's consent unless Viacom receives a ruling from the Internal
Revenue Service or an opinion of counsel to the effect that such transaction
will not adversely affect the tax-free status of this exchange offer and any
subsequent spin-off. Blockbuster is generally responsible for, among other
things, any taxes imposed on Viacom or its subsidiaries as a result of this
exchange offer and any subsequent spin-off failing to qualify as a tax-free
transaction on account of any breach of Viacom's representations or agreements
caused by any action or failure to act by Blockbuster or its subsidiaries or
any transaction involving Blockbuster, or Blockbuster's subsidiaries', assets,
stock or business following this exchange offer and any subsequent spin-off,
regardless of whether such transaction is within Blockbuster's control.
Other Agreements
Revenue-Sharing
Blockbuster has a revenue-sharing agreement with Paramount Pictures, a
Viacom affiliate. Under this agreement, which expires in August 2003,
Blockbuster has agreed to pay, for a limited period of time, an agreed-upon
percentage of Blockbuster rental revenue for Paramount Pictures videocassettes
priced for rental and to make a minimum payment for these tapes. This
percentage declines after a period of weeks following the initial release of
the movie. Blockbuster has agreed to take a minimum number of copies of each
qualifying movie released by Paramount Pictures. The agreement allows
Blockbuster to sell the previously viewed tapes to its customers, although
Paramount Pictures has the right to prevent Blockbuster from selling a portion
of such tapes in exchange for a fee. Blockbuster's total purchases from
Paramount Pictures, including purchases under this agreement, were $7.6
million, $77.5 million and $110.1 million for the years ended December 31,
1996, 1997 and 1998, respectively.
Promotional Services and Customer Database Services and License Agreement
Blockbuster has entered into a U.S. promotional services and customer
database services and license agreement with MTV Networks, an affiliate of
Viacom. Under this agreement, for one year, Blockbuster will provide some
promotional and database services to MTV Networks and grant a U.S. license to
MTV Networks to use Blockbuster's U.S. customer database internally and/or to
sublicense the database for internal use to affiliates of MTV Networks that
are direct or indirect wholly owned subsidiaries of Viacom and to MTV Networks
Online and its direct and indirect affiliates for internal use so long as
Viacom is in control of MTV Networks Online and its affiliates. In return, MTV
Networks will pay Blockbuster $4.5 million each quarter for four quarters
starting the third quarter of 1999 for a total of $18 million plus costs. In
addition, during this one year period, MTV Networks will have an option to pay
Blockbuster an additional $5 million to extend in perpetuity the license to
use the customer database. If MTV Networks exercises this option, it will
provide Blockbuster, for internal use, with access to MTV Networks' Leisure
Time Study, a proprietary study of how
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consumers choose among the increasing number of media, entertainment and other
leisure time activities available to them. At any time, Blockbuster has the
right to terminate this option or MTV Networks' perpetual license for a fee of
$25 million. In such event, Blockbuster's access to MTV Networks' Leisure Time
Study also terminates.
Other Agreements
There are various other agreements between Blockbuster and Viacom and its
affiliates, which Blockbuster believes are not material to its company.
Blockbuster believes the terms of these agreements approximate those which
would be available from third parties.
Other Related Party Transactions
Midway Games
Mr. Redstone and National Amusements, Inc. own an aggregate of about 25.2%
of the common stock of Midway Games Inc. During the 1996, 1997 and 1998 fiscal
years, Blockbuster paid about $8.4 million, $12.5 million and $19.1 million,
respectively, for purchases of home video games from Midway. Blockbuster
believes that the terms of these purchases were no less favorable to
Blockbuster than would have been obtainable from parties in which there was no
such ownership interest. Blockbuster expects to purchase video games from
Midway in the future.
Notes and Dividends
On December 31, 1998, Blockbuster declared a dividend in the form of a
promissory note in the principal amount of $1.4 billion to Viacom
International Inc. In the first quarter of 1999, Blockbuster also issued
promissory notes in the aggregate principal amount of about $77 million to
Viacom International Inc. in order to obtain funds for an acquisition of video
stores. Blockbuster paid these promissory notes, together with any accrued and
unpaid interest, with the proceeds of the borrowings under its credit
agreement. In addition, on October 20, 1999, Blockbuster's board of directors
declared a cash dividend of $0.02 per share of its class A and class B common
stock payable November 22, 1999. The total dividend payment was about $3.5
million, of which Viacom International Inc. was paid about $2.9 million.
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PRINCIPAL STOCKHOLDERS OF SHARES OF
BLOCKBUSTER CLASS A AND CLASS B COMMON STOCK
Viacom currently owns all of the 144 million shares of Blockbuster class B
common stock outstanding and immediately prior to the completion of this
exchange offer, Viacom will own more than 80% of the equity value of
Blockbuster. Immediately prior to the completion of this exchange offer, each
share of Blockbuster class B common stock that Viacom owns will be converted
into one share of Blockbuster class A common stock. Upon completion of this
exchange offer, National Amusements will beneficially own less than 10% of the
outstanding Blockbuster class A common stock. Blockbuster is not aware of any
person or group that will beneficially own more than 5% of the outstanding
shares of Blockbuster class A common stock following the completion of this
exchange offer other than Capital Group International, Inc. and Capital
Guardian Trust Company. See "Blockbuster's Management -- Stock Ownership of
Certain Beneficial Owners and Blockbuster's Directors and Executive Officers."
If less than shares of Viacom class A and class B common stock are validly
tendered and accepted pursuant to this exchange offer, National Amusements
will beneficially own 5% or more of the outstanding shares of Blockbuster
class A common stock following the completion of this exchange offer.
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DESCRIPTION OF BLOCKBUSTER CAPITAL STOCK
The following description is only a summary of the material provisions of
Blockbuster's amended and restated certificate of incorporation and bylaws.
See the more detailed provisions of (1) Blockbuster's certificate of
incorporation and bylaws, copies of which are filed with the SEC as exhibits
to the registration statement of which this document is a part and (2)
applicable law.
Blockbuster's authorized capital stock consists of 1 billion shares of
capital stock, of which
. 400 million shares are designated as class A common stock, par value
$.01 per share;
. 500 million shares are designated as class B common stock, par value
$.01 per share; and
. 100 million shares of preferred stock, par value $.01 per share, of
which no shares of preferred stock are outstanding as of the date
hereof.
Of the 400 million shares of common stock designated as class A common stock,
31 million shares, or about 17.7% of the equity value of Blockbuster, was sold
in Blockbuster's initial public offering which was completed on August 16,
1999. Of the 500 million shares of common stock designated as class B common
stock, 144 million shares, or about 82.3% of the equity value of Blockbuster,
is outstanding and currently held by Viacom. Each of the class A common stock
and the class B common stock constitutes a series of common stock under the
General Corporation Law of the State of Delaware. Immediately prior to the
completion of this exchange offer, each share of Blockbuster class B common
stock that Viacom owns will be converted into one share of Blockbuster class A
common stock. See "-- Conversion."
Common Stock
Voting rights. Holders of class A common stock and holders of class B
common stock generally have identical rights, except:
. holders of class A common stock are entitled to one vote per share; and
. holders of class B common stock are entitled to five votes per share;
with respect to each matter presented to Blockbuster stockholders on which the
holders of common stock are entitled to vote. The holders of class A common
stock and class B common stock are not entitled to cumulate their votes in the
election of directors. Generally, all matters to be voted on by Blockbuster's
stockholders must be approved by a majority, or, in the case of election of
directors, by a plurality, of the votes entitled to be cast by all shares of
class A common stock and class B common stock present in person or represented
by proxy, voting together as a single class. In particular, amendments to
Blockbuster's certificate of incorporation must generally be approved by a
majority of the combined voting power of both classes of common stock, voting
together as a single class. However, the approval of 75% of the combined
voting power is required to amend some provisions of Blockbuster's certificate
of incorporation and bylaws as described below. In addition, amendments to
Blockbuster's certificate of incorporation that would alter or change the
powers, preferences or special rights of either class of common stock so as to
affect them adversely also must be approved by a majority of the votes
entitled to be cast by the holders of the shares affected by the amendment,
voting as a separate class. Holders of class A common stock are not entitled
to vote on any change in the powers or other rights of the class B common
stock that would not adversely affect the rights of class A common stock. For
example, any provision for the conversion of the class B common stock into
class A common stock on a one-for-one basis is not considered to adversely
affect the rights of the class A common stock.
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Dividends. Holders of class A common stock and class B common stock will
share equally in any dividend declared by Blockbuster's board of directors,
subject to any preferential rights of any outstanding preferred stock.
Dividends consisting of shares of class A common stock and class B common
stock may be paid only as follows:
. shares of class A common stock may be paid only to holders of shares of
class A common stock, and shares of class B common stock may be paid
only to holders of class B common stock; and
. shares shall be paid proportionally with respect to each outstanding
share of class A common stock and class B common stock.
Conversion. If Blockbuster issues 20% or less of the value of the
outstanding shares, including shares issued in Blockbuster's initial public
offering, of its class A and class B common stock prior to the completion of
this exchange offer, each share of its class B common stock will automatically
convert into one share of class A common stock immediately prior to the
completion of this exchange offer. Accordingly, the 144 million class B common
stock held by Viacom will be converted to class A common stock immediately
before the completion of this exchange offer.
Other rights. In the event of a liquidation, dissolution or winding-up of
Blockbuster, all holders of common stock, regardless of class, are entitled to
share ratably in any assets available for distributions to holders of shares
of common stock.
The outstanding shares of Blockbuster common stock are, and the shares of
class A common stock being offered to you will be, upon your payment, validly
issued, fully paid and nonassessable.
Preferred Stock
Blockbuster's board of directors is empowered, without approval of
Blockbuster's stockholders, to cause shares of preferred stock to be issued
from time to time in one or more series, with the numbers of shares of each
series and the designations, preferences and relative, participating,
optional, dividend and other special rights of the shares of each such series
and the qualifications, limitations, restrictions, conditions and other
characteristics thereof as fixed by Blockbuster's board of directors. Among
the specific matters that may be determined by Blockbuster's board of
directors are:
. the designation of each series;
. the number of shares of each series;
. the rate of dividends, if any;
. whether dividends, if any, shall be cumulative or noncumulative;
. the terms of redemption, if any;
. the rights of the series in the event of any voluntary or involuntary
liquidation, dissolution or winding-up of the affairs of Blockbuster;
. rights and terms of conversion or exchange, if any;
. restrictions on the issuance of shares of the same series or any other
series, if any; and
. voting rights, if any.
Blockbuster's board of directors may, without stockholder approval, issue
preferred stock with voting and other rights that could adversely affect all
of the rights of the holders of class A common stock and class B common stock,
including, but without limitation, their voting power. Blockbuster has no
present plans to issue any shares of preferred stock. The ability of
Blockbuster's board of directors to issue preferred stock without stockholder
approval could have the effect of delaying, deferring or preventing a change
in control of Blockbuster or the removal of Blockbuster's existing management.
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Limitation on Liability of Directors
Blockbuster's certificate of incorporation provides that its directors will
not be personally liable to Blockbuster or its stockholders for monetary
damages for breach of fiduciary duty as a director, except for liability
imposed by law, as in effect from time to time:
. for any breach of the director's duty of loyalty to Blockbuster or its
stockholders;
. for any act or omission not in good faith or which involved intentional
misconduct or a knowing violation of law;
. for unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of Delaware corporate law; or
. for any transaction from which the director derived an improper personal
benefit.
The inclusion of this provision in Blockbuster's certificate of
incorporation may have the effect of reducing the likelihood of derivative
litigation against its directors and may discourage or deter Blockbuster or
its stockholders from bringing a lawsuit against Blockbuster's directors for
breach of their duty of care, even though such an action, if successful, might
otherwise have benefitted Blockbuster and its stockholders.
Anti-takeover Effects of Some of the Provisions of Blockbuster's
Certificate of Incorporation and Bylaws and Section 203 of Delaware Corporate
Law
Some of the provisions of Blockbuster's certificate of incorporation and
bylaws and Section 203 of Delaware corporate law could have the following
effects, among others:
. delaying, deferring or preventing a change in control;
. delaying, deferring or preventing the removal of Blockbuster's existing
management;
. deterring potential acquirors from making an offer to Blockbuster's
stockholders; and
. limiting Blockbuster's stockholders' opportunity to realize premiums
over prevailing market prices of its class A common stock in connection
with offers by potential acquirors.
This could be the case, notwithstanding that a majority of Blockbuster's
stockholders might benefit from such a change in control or offer. The
following is a summary of these provisions.
Some of the Provisions of Blockbuster's Certificate of Incorporation and
Bylaws
Classified board of directors. Blockbuster's certificate of incorporation
and bylaws provide for its board of directors to be divided into three classes
of directors serving staggered three-year terms. Each class, to the extent
possible, will be equal in number. The size of Blockbuster's board of
directors will not be less than three nor more than twelve. Each class holds
office until the third annual stockholders' meeting for election of directors
following the most recent election of such class, except that the initial
terms of the three classes expire in 2000, 2001 and 2002, respectively.
Directors, and not stockholders, fix the size of Blockbuster's board of
directors. Blockbuster's certificate of incorporation and bylaws provide that
the number of directors shall be fixed from time to time exclusively pursuant
to a resolution adopted by a majority of Blockbuster's board of directors, but
in no event shall it consist of less than three nor more than twelve.
Directors are removed for cause only. Blockbuster's certificate of
incorporation and bylaws provide that, on or after the time when Viacom and
its affiliates no longer own more than a majority of the combined voting power
of Blockbuster's outstanding common stock, which is referred to as the
"trigger date," Blockbuster's directors may be removed only for cause by the
affirmative vote of the holders of at least a majority of the combined voting
power of Blockbuster's outstanding voting common stock. To the extent
permitted by the laws of the state of Delaware, "cause" shall be determined by
Blockbuster's board of directors. However, prior to the trigger date,
Blockbuster's directors may be removed with or without cause.
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Board vacancies to be filled by remaining directors, and not
stockholders. Blockbuster's certificate of incorporation and bylaws provide
that any vacancies on its board of directors will be filled by the affirmative
vote of the majority of the remaining directors, even if less than a quorum,
or by a sole remaining director. In any event, no vacancy shall be filled by
Blockbuster's stockholders.
No stockholder actions by written consent. Blockbuster's bylaws provide
that, on or after the trigger date, stockholders may not act by written
consent in lieu of a meeting. However, prior to the trigger date, stockholders
may act by written consent.
No special meetings called by stockholders. Blockbuster's bylaws provide
that, on or after the trigger date, special meetings of the stockholders may
not be called by the stockholders and instead may be called only by
. any officer at the request of a majority of Blockbuster's board of
directors;
. Blockbuster's chairman; or
. Blockbuster's chief executive officer.
However, prior to the trigger date, special meetings may be called by
holders of at least the majority of the combined voting power of Blockbuster's
outstanding common stock.
Advance notice for stockholder proposals. Blockbuster's bylaws contain
provisions requiring that advance notice be delivered to Blockbuster of any
business to be brought by a stockholder before an annual meeting and providing
for procedures to be followed by stockholders in nominating persons for
election to Blockbuster's board of directors. Generally, such advance notice
provisions require that the stockholder must give written notice to
Blockbuster not less than 120 calendar days before the date Blockbuster's
proxy statement was released to stockholders in connection with Blockbuster's
previous year's annual meeting. Blockbuster's bylaws provide that the notice
must set forth specific information regarding the stockholder and each
director nominee by the stockholder or other business proposed by the
stockholder. Blockbuster's certificate of incorporation and bylaws provide
that as long as Blockbuster beneficially owns 30% or more of the combined
voting power of the outstanding common stock, Blockbuster is exempt from the
foregoing provision.
Supermajority vote required to amend specified provisions. Blockbuster's
certificate of incorporation and bylaws provide that the provisions described
above may only be amended by holders of at least 75% of the combined voting
power of Blockbuster's outstanding common stock.
Section 203 of Delaware Corporate Law
Blockbuster's company is a Delaware corporation and subject to Section 203
of Delaware corporate law. Generally, Section 203 prohibits a publicly held
Delaware company from engaging in a "business combination" with an "interested
stockholder" for a period of three years after the time such stockholder
became an interested stockholder unless, as described below, specified
conditions are satisfied. Thus, it may make acquisition of control of
Blockbuster more difficult. The prohibitions in Section 203 of Delaware
corporate law do not apply if:
. prior to the time the stockholder became an interested stockholder, the
board of directors of the corporation approved either the business
combination or the transaction which resulted in the stockholder
becoming an interested stockholder;
. upon consummation of the transaction, which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the time
the transaction commenced; or
. at or subsequent to the time the stockholder became an interested
stockholder, the business combination is approved by the board of
directors and authorized by the affirmative vote of at least 66 2/3% of
the outstanding voting stock that is not owned by the interested
stockholder.
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Under Section 203 of Delaware corporate law, a "business combination"
includes:
. any merger or consolidation of the corporation with the interested
stockholder;
. any sale, lease, exchange or other disposition, except proportionately
as a stockholder of such corporation, to or with the interested
stockholder of assets of the corporation having an aggregate market
value equal to 10% or more of either the aggregate market value of all
the assets of the corporation or the aggregate market value of all the
outstanding stock of the corporation;
. transactions resulting in the issuance or transfer by the corporation of
stock of the corporation to the interested stockholder;
. transactions involving the corporation, which have the effect of
increasing the proportionate share of the corporation's stock of any
class or series that is owned by the interested stockholder; or
. transactions in which the interested stockholder receives financial
benefits provided by the corporation.
Under Section 203 of Delaware corporate law, an "interested stockholder"
generally is:
. any person that owns 15% or more of the outstanding voting stock of the
corporation;
. any person that is an affiliate or associate of the corporation and was
the owner of 15% or more of the outstanding voting stock of the
corporation at any time within the three-year period immediately prior
to the date on which it is sought to be determined whether or not such
person is an interested stockholder; and
. the affiliates or associates of either of the above-stated person
categories.
Because Viacom owned more than 15% of Blockbuster's voting stock before it
became a public company in Blockbuster's initial public offering, Section 203
of Delaware corporate law by its terms is currently not applicable to business
combinations with Viacom even though Viacom owns 15% or more of Blockbuster's
outstanding stock. If any other person acquires 15% or more of Blockbuster's
outstanding stock, such person will be subject to the provisions of Section
203 of the Delaware corporate law.
Under some circumstances, Section 203 of Delaware corporate law makes it
more difficult for an "interested stockholder" to effect various business
combinations with Viacom for a three-year period, although Blockbuster's
stockholders may elect to exclude Viacom from the restrictions imposed
thereunder. By virtue of Viacom's beneficial ownership of Blockbuster's class
B common stock, Viacom is in a position to elect to exclude Blockbuster from
the restrictions under Section 203. Currently, Viacom has indicated to
Blockbuster that it has no intention to do so.
Transactions with Interested Parties
Blockbuster's certificate of incorporation includes provisions addressing
potential conflicts of interest between Blockbuster and Viacom and Viacom's
non-Blockbuster-related subsidiaries and other similar entities. In addition,
Blockbuster's certificate of incorporation includes provisions regulating and
defining Viacom's conduct as it may involve Blockbuster and Viacom and
Blockbuster's and Viacom's subsidiaries, directors and officers. Blockbuster's
certificate of incorporation provides that no contract or transaction:
. between Blockbuster and Viacom or any of Viacom's non-Blockbuster-
related subsidiaries and other similar entities; or
. between Blockbuster and any entity in which one or more of Blockbuster's
directors or officers has a financial interest, which Viacom refers to
as a "related entity;" or
. between Blockbuster and any director or officer of Blockbuster, Viacom,
any of Viacom's subsidiaries or any related entity;
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shall be void or voidable solely because:
. Viacom, any non-Blockbuster-related subsidiary or other similar entity
of Viacom or any related entity, or any of Viacom's or its directors or
officers are parties to the contract or transaction; or
. any of those directors or officers is present at or participates in the
meeting of the board of directors or committee thereof that authorizes
the contract or transaction.
Corporate Opportunities
Blockbuster's certificate of incorporation provides that, except as Viacom
may otherwise agree in writing, neither Viacom nor any non-Blockbuster-related
subsidiary or other similar entity of Viacom shall have a duty to refrain from
engaging directly or indirectly in the same or similar business activities or
lines of business as Blockbuster's.
The foregoing provisions of Blockbuster's certificate of incorporation as
they relate to Viacom shall expire on the date that Viacom and its
subsidiaries no longer own at least 20% of the combined voting power of
Blockbuster's outstanding common stock and no person who is a director or
officer of Blockbuster is also a director or officer of Viacom or its
subsidiaries.
Transfer Agent and Registrar
First Chicago Trust Company of New York, a division of EquiServe, L.P., is
the transfer agent and registrar for Blockbuster class A common stock.
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COMPARISON OF RIGHTS OF HOLDERS OF SHARES OF VIACOM CLASS A AND CLASS B COMMON
STOCK AND BLOCKBUSTER CLASS A COMMON STOCK
Upon completion of this exchange offer, Viacom shareholders who exchange
their shares of Viacom class A or class B common stock for Blockbuster class A
common stock will become stockholders of Blockbuster. These holders' rights
will continue to be governed by Delaware law and will be governed by
Blockbuster's amended and restated certificate of incorporation and bylaws.
Because Blockbuster and Viacom are both organized under the laws of Delaware,
differences in the rights of a stockholder of Blockbuster from those of Viacom
shareholders arise principally from provisions of the certificates of
incorporation and bylaws of each of Blockbuster and Viacom.
The following is a summary of the material differences between the
companies' certificates and bylaws. The summary is not a complete statement of
the rights of stockholders of the two companies or a complete description of
the specific provisions referred to below. The summary is qualified in its
entirety by reference to Viacom's and Blockbuster's governing corporate
instruments which you should read. Copies of Viacom's and Blockbuster's
governing corporate instruments have been filed with the SEC. To find out
where you can get copies of these documents, see "Where You Can Find More
Information."
AUTHORIZED CAPITAL STRUCTURE AND LIQUIDATION RIGHTS OF BLOCKBUSTER AND VIACOM
(AS OF DECEMBER 1, 1999)
<TABLE>
<CAPTION>
LIQUIDATION
CLASS OF SECURITY AUTHORIZED OUTSTANDING PREFERENCE
- ----------------- ----------- ------------- --------------
<S> <C> <C> <C>
Blockbuster class A common stock 400 million 31.0 million None
Blockbuster class B common stock 500 million 144.0 million None
Blockbuster preferred stock 100 million None Not applicable
Viacom class A common stock 500 million 138.3 million None
Viacom class B common stock 3 billion 559.1 million None
</TABLE>
- -------------------------------------------------------------------------------
SHAREHOLDER RIGHTS BLOCKBUSTER VIACOM
- -------------------------------------------------------------------------------
Dividend Policy...... Blockbuster has no legal Viacom has no legal or
or contractual obligation contractual obligation to
to pay dividends. pay dividends. Viacom has
Blockbuster has paid and not and does not expect to
currently intends to pay a declare and pay any cash
quarterly dividend of dividends in the
$0.02 per share on its foreseeable future.
shares of class A common
stock. Blockbuster's board
of directors is free to
change Blockbuster's
dividend practices from
time to time and to
decrease or increase the
dividend paid, or to not
pay a dividend, on
Blockbuster's common stock
on the basis of results of
operations, financial
condition, cash
requirements and future
prospects and other
factors deemed relevant by
Blockbuster's board of
directors. Furthermore,
Blockbuster's Credit
Agreement limits its
ability to pay dividends.
See "Description of
Blockbuster's Credit
Agreement."
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- --------------------------------------------------------------------------------
SHAREHOLDER RIGHTS BLOCKBUSTER VIACOM
- --------------------------------------------------------------------------------
Voting, Generally.... Blockbuster class A common Viacom class A common
stock stock
. 1 vote per share. . 1 vote per share.
. Plurality vote for . Plurality vote for
directors. directors.
. Majority vote for most . Majority vote for most
other matters. other matters.
. For more details, see Viacom class B common
"Description of Capital stock
Stock -- Common . Except as required by
Stock -- Voting Delaware law, this
Rights." class has no voting
rights or powers.
Stockholder Action
by Written Consent... The Blockbuster Under Delaware law, unless
stockholders may not take the certificate of
action by written consent incorporation provides
after Viacom no longer otherwise, a stockholder
owns a majority of the action may be taken if
combined voting power of written consents are
outstanding Blockbuster received from the holders
common stock. of the minimum number of
votes that would be
necessary to authorize
that action at a meeting
at which all the shares
entitled to vote for that
action were present and
voted. Viacom's restated
certificate of
incorporation does not
restrict your ability to
act by written consent.
Board of Directors
Number of Directors
and Size of Board.... Blockbuster's amended and Viacom's restated
restated certificate of certificate of
incorporation allows incorporation allows
between three and twelve between three and 20
directors to serve on directors to serve on
their board. Blockbuster's their board. Viacom's
bylaws authorize the board bylaws authorize the board
to set the number of to set the number of
directors within the directors within the
parameters set by the parameters set by the
amended and restated restated certificate of
certificate of incorporation.
incorporation.
Blockbuster's board has Viacom's board has set the
set the number of number of directors at
directors at six. ten.
Term of Office....... Each director serves for Each director serves for a
three years. The directors one year term.
are divided into three
classes and one-third
expires each year.
Removal of After Viacom no longer Any or all of Viacom's
Directors............ owns a majority of the directors may be removed
combined voting power of with or without cause by
outstanding Blockbuster Viacom shareholders who
common stock, directors represent a majority of
may be removed only for all of the aggregate
cause by the affirmative voting power of
vote of the holders of at outstanding Viacom shares.
least a majority of the
combined voting power of However, any director may
outstanding Blockbuster be removed by a majority
common stock. vote of Viacom's board if
either:
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- --------------------------------------------------------------------------------
SHAREHOLDER RIGHTS BLOCKBUSTER VIACOM
- --------------------------------------------------------------------------------
. the director fails to
meet the qualifications
stated in the by-laws
for election as a
director; or
. the director is in
breach of any agreement
between himself or
herself and Viacom
relating to his or her
service as a director
or employee of Viacom.
Vacancies............ These shall be filled by These shall be filled by
the board only, by the board only, by
majority vote, even if majority vote, even if
less than a quorum is less than a quorum is
present. present.
Advance Notice
Procedures for a
Stockholder In general, a stockholder There are no provisions
Proposal............. wishing to nominate a regarding advance notice
director or raise another of director nominations or
proposal must notify shareholder proposals.
Blockbuster in writing no
less than 120 days prior to
the date Blockbuster's
proxy statement was
released to its
stockholders in connection
with Blockbuster's previous
year's annual meeting of
stockholders.
This notice must contain
specific information
concerning the person to be
nominated or the matters to
be brought before the
meeting and concerning the
stockholder submitting the
proposal.
Viacom is exempt from these
provisions as long as
Viacom beneficially owns
30% or more of the combined
voting power of outstanding
Blockbuster common stock.
Calling of Special
Meeting of After Viacom no longer Special meetings of Viacom
Shareholders......... owns a majority of the shareholders may be called
combined voting power of by the:
outstanding Blockbuster . majority vote of the
common stock, special board of directors;
meetings of Blockbuster . chairman of the board
stockholders may not be of directors;
called by Blockbuster . vice chairman of the
stockholders. These board of directors;
meetings may be called
only by: . president, or
. chairman of the board,
. any officer at the vice president of the
request of a majority board, president or
of Blockbuster's board secretary at the
of directors; request of shareholders
representing at least
. Blockbuster's chairman; 50.1 percent of
or outstanding Viacom
common stock entitled
. Blockbuster's chief to vote.
executive officer.
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- --------------------------------------------------------------------------------
SHAREHOLDER RIGHTS BLOCKBUSTER VIACOM
- --------------------------------------------------------------------------------
<TABLE>
<S> <C> <C>
Amendment............... Amendments to provisions of Amendments to provisions of
Blockbuster's amended and Viacom's restated certificate
restated certificate of of incorporation and amendments
incorporation and amendments to to provisions of its bylaws by
provisions of its bylaws by Viacom shareholders do not
Blockbuster stockholders require any supermajority vote,
relating to the following except as provided by law.
matters require 75% of the
combined voting power of
outstanding Blockbuster common
stock:
</TABLE>
. stockholder action by
written consent;
. number of directors;
. expiration of terms
(classified board);
. vacancies on the board;
. removal of directors;
. advance notice
procedures for a
stockholder proposal;
. special meetings;
. the amendment
provisions.
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<PAGE>
DESCRIPTION OF BLOCKBUSTER'S CREDIT AGREEMENT
The following is a summary of the material provisions of Blockbuster's
credit agreement. A copy of Blockbuster's credit agreement is filed with the
SEC as an exhibit to this registration statement of which this document is a
part.
On June 21, 1999, Blockbuster entered into a $1.9 billion credit agreement
with a syndicate of lenders. Blockbuster's credit agreement is comprised of
three tranches. Tranche A is a $700 million revolving loan maturing on July 1,
2004. Tranche B is a $600 million term loan also maturing on July 1, 2004.
Tranche C is a $600 million revolving loan which matures on June 19, 2000. On
June 23, 1999, Blockbuster borrowed $1.6 billion under this credit agreement.
On August 16, 1999, Blockbuster used the net proceeds from its initial public
offering of about $443 million, net of underwriting discounts and commissions,
to repay a portion of the $600 million revolving loan maturing on June 19,
2000. These proceeds permanently reduce Blockbuster's commitments under its
credit agreement from $1.9 billion to approximately $1.46 billion.
Blockbuster used the borrowings under its credit agreement:
. to pay about $65 million which is a portion of the purchase price to
Viacom's affiliates to acquire the non-U.S. operations of Blockbuster's
business that Blockbuster did not already own;
. to repay a promissory note issued by Blockbuster to Viacom International
Inc. as a dividend in the principal amount of $1.4 billion plus accrued
and unpaid interest;
. to repay promissory notes issued by Blockbuster to Viacom International
Inc. in the aggregate principal amount of about $77 million plus accrued
and unpaid interest for an acquisition of video stores;
. to pay the fees and expenses of about $15 million related to the
origination of Blockbuster's credit agreement to the syndicate of
lenders; and
. for working capital and general corporate purposes.
Blockbuster's credit agreement contains provisions for the mandatory
prepayment of loans as follows:
. If Blockbuster issues equity securities, unless Blockbuster is
Investment Grade, as defined in its credit agreement, Blockbuster will
be required to use 25% of the net cash proceeds to repay the Tranche A
loan and Tranche B loan, on a pro rata basis, until $400 million of
these loans have been repaid;
. If Blockbuster incurs indebtedness in a capital market transaction,
unless Blockbuster is investment grade, Blockbuster is required to use
75% of the net cash proceeds to repay the Tranche A and Tranche B loans,
on a pro rata basis, until $400 million, including amounts repaid from
an issuance of equity as stated above, have been repaid; and
. If Blockbuster sells assets, other than to franchisees, Blockbuster will
be required to use 50% of the net cash proceeds from such sales over
$100 million, to repay the Tranche A and Tranche B loans, on a pro rata
basis, until $500 million of the loans have been repaid.
Borrowings under Blockbuster's credit agreement accrue interest at a rate
equal to the interest rates prevailing on the date of determination in the
London interbank market for the interest period selected by Blockbuster, plus
a margin over this rate. The margin and the commitment fees on the undrawn
portion of the facility vary based on specified leverage ratios.
Blockbuster's credit agreement contains customary covenants for Blockbuster
not to, among other things:
. grant liens;
. merge;
. sell substantially all of its assets;
. enter into speculative interest rate or currency hedges;
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<PAGE>
. incur debt above $175 million at the subsidiary level;
. pay dividends on or repurchase Blockbuster class A common stock or make
other distributions, in each case other than dividends of $90 million,
$115 million, $130 million, $145 million and $160 million in the first
five years following the completion of Blockbuster's initial public
offering, respectively;
. transfer assets to subsidiaries; and
. invest in or make loans to any business, other than investments or loans
that are reasonably related to the operation or growth of Blockbuster's
core rental business.
Blockbuster is also required to comply with financial covenants with respect
to: (1) maximum leverage ratio and (2) a minimum fixed charge coverage ratio.
Blockbuster's credit agreement also contains some customary affirmative
covenants.
Events of default under Blockbuster's credit agreement include, among
others: failure to pay principal and interest when due, breach of some of the
representations and warranties, failure to perform or observe some of the
covenants, bankruptcy, and a change of control. Under Blockbuster's credit
agreement, a change of control includes:
. control of 50% or more of outstanding Blockbuster common stock by
persons other than Viacom or National Amusements;
. Blockbuster's board of directors ceases to be controlled by
Blockbuster's continuing directors; or
. Blockbuster enters into a merger or purchase agreement which cedes power
to control Blockbuster's management or policies prior to consummation of
the merger or purchase, as applicable.
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<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Shares of Blockbuster class A common stock distributed to Viacom
shareholders will be freely transferable, except for shares received by
persons who may be deemed to be "affiliates" of Blockbuster under the
Securities Act. Affiliates generally include individuals or entities that
control, are controlled by, or are under common control with, Blockbuster. The
directors and principal executive officers of Blockbuster, as well as
significant stockholders of Blockbuster will be affiliates. Affiliates of
Blockbuster may sell their shares of Blockbuster class A common stock only
under an effective registration statement under the Securities Act or an
exemption from the registration requirements of the Securities Act.
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<PAGE>
UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of the material United States federal income tax
consequences relating to this exchange offer and any subsequent spin-off. The
summary is based on the Internal Revenue Code, the Treasury regulations
promulgated thereunder, and interpretations of the Code and Treasury
regulations by the courts and the Internal Revenue Service, all as they exist
as of the date of this prospectus-offer to exchange. This summary does not
discuss all tax considerations that may be relevant to Viacom shareholders in
light of their particular circumstances, nor does it address the consequences
to Viacom shareholders subject to special treatment under the United States
federal income tax laws, such as tax-exempt entities, non-resident alien
individuals, foreign entities, foreign trusts and estates and beneficiaries
thereof, persons who acquire such shares of Viacom common stock pursuant to
the exercise of employee stock options or otherwise as compensation, insurance
companies, and dealers in securities. In addition, this summary does not
address the United States federal income tax consequences to Viacom
shareholders who do not hold their Viacom common stock as a capital asset.
This summary does not address any state, local or foreign tax consequences.
Viacom shareholders are urged to consult their tax advisors as to the
particular tax consequences to them of this exchange offer and any subsequent
spin-off.
Internal Revenue Service Ruling and Federal Income Tax Consequences.
Viacom has received rulings from the Internal Revenue Service to the effect
that, for United States federal income tax purposes, this exchange offer and
any subsequent spin-off will qualify under Section 355 of the Code as a
distribution that is tax-free to Viacom and its shareholders. Viacom and
Blockbuster will not be able to rely on the rulings if any factual
representations made to counsel or the Internal Revenue Service are incorrect
or untrue in any material respect or any undertakings made to the Internal
Revenue Service are not complied with. Neither Viacom nor Blockbuster is aware
of any facts or circumstances that would cause any such representations to be
incorrect or untrue in any material respect.
Nevertheless, if Viacom completes this exchange offer and any subsequent
spin-off and, notwithstanding the rulings, this exchange offer and any
subsequent spin-off are held to be taxable for United States federal income
tax purposes, both Viacom and its shareholders that receive Blockbuster common
stock could be subject to a material amount of taxes as a result of this
exchange offer and any subsequent spin-off. Blockbuster will be liable to
Viacom for any such corporate level taxes incurred by Viacom to the extent
such taxes are attributable to specified actions or failures to act by
Blockbuster, or to specified transactions involving Blockbuster following this
exchange offer and any subsequent spin-off. For a description of Viacom's and
Blockbuster's obligations in connection with obtaining the ruling and
potential tax liabilities if this exchange offer and any subsequent spin-off
is held to be taxable, see "Related Party Transactions -- Agreements Between
Blockbuster and Viacom Relating to Blockbuster's Initial Public Offering or
the Separation of Blockbuster from Viacom -- Tax Matters Agreement."
The rulings provide that for United States federal income tax purposes:
. no gain or loss will be recognized by, and no amount will be included in
the income of, Viacom shareholders upon their receipt of shares of
Blockbuster common stock in this exchange offer and any subsequent spin-
off;
. the aggregate basis of Blockbuster common stock and Viacom common stock
in the hands of the Viacom shareholders, immediately following this
exchange offer, will be the same as the basis of Viacom common stock
held by Viacom shareholders immediately before the exchange offer,
allocated in proportion to the relative fair market values of each at
the time of the exchange offer; and
. the holding period of the shares of Blockbuster common stock received by
Viacom shareholders in this exchange offer and any subsequent spin-off
will include the holding period of the shares of Viacom common stock
with respect to which the shares of Blockbuster common stock were
received.
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<PAGE>
The private letter rulings do not specifically address tax basis issues
with respect to holders of shares of Viacom common stock who have blocks of
such common stock with different per share tax bases. Such holders are urged
to consult their tax advisors regarding the possible tax basis consequences to
them of this exchange offer and any subsequent spin-off.
United States Treasury regulations require each of the Viacom shareholders
that receive shares of Blockbuster common stock in this exchange offer and any
subsequent spin-off to attach to the shareholder's United States federal
income tax return for the year in which such stock is received a detailed
statement setting forth such data as may be appropriate in order to show the
applicability of Section 355 of the Code to this exchange offer and any
subsequent spin-off. Within a reasonable time after this exchange offer and
any subsequent spin-off, Viacom will provide its shareholders who participate
in this exchange offer and its shareholders who receive shares of Blockbuster
class A common stock in any subsequent spin-off with the information necessary
to comply with such requirement, and will provide information regarding the
allocation of tax basis described above.
Viacom shareholders are urged to consult their tax advisors as to the
particular tax consequences of this exchange offer and any subsequent spin-
off, including the application of state, local and foreign tax laws and any
changes in federal tax laws that occur after the date of this prospectus-offer
to exchange.
LEGAL MATTERS
The validity of the shares of Blockbuster class A common stock and certain
legal matters with respect to the transaction will be passed upon for Viacom
and Blockbuster by Shearman & Sterling, New York, New York. Certain tax
matters will be passed upon for Viacom and Blockbuster by Paul, Weiss,
Rifkind, Wharton & Garrison. will represent the dealer manager.
EXPERTS
Blockbuster's consolidated financial statements as of December 31, 1997 and
1998 and for each of the three years in the period ended December 31, 1998
included in this document and Viacom's consolidated financial statements
incorporated in this document by reference to Viacom's Annual Report on Form
10-K for the year ended December 31, 1998 have been so included and
incorporated in reliance on the reports of PricewaterhouseCoopers LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
The consolidated financial statements and the related financial statement
schedule of CBS, as of December 31, 1998 and 1997 and for each of the years in
the three year period ended December 31, 1998, incorporated by reference in
this document from CBS' Form 10-K, as amended by Form 10-K/A, for the year
ended December 31, 1998, have been audited by KPMG LLP, independent auditors,
as stated in their reports, which are incorporated in this document by
reference, and have been so incorporated in reliance upon the reports of such
firm given upon their authority as experts in accounting and auditing.
The consolidated financial statements of King World Productions, Inc., as
of August 31, 1999 and 1998 and for each of the years in the three year period
ended August 31, 1999, incorporated by reference in this document from CBS'
Form 8-K dated November 22, 1999, have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto and is incorporated by reference in this document in reliance upon the
authority of said firm as experts in giving said report.
133
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
Viacom and Blockbuster are subject to the informational requirements of the
Securities Exchange Act of 1934 and each accordingly files reports and other
information with the SEC. Reports, proxy statements and other information
filed by Viacom or Blockbuster with the SEC can be inspected and copied at the
public reference facilities maintained by the SEC at Room 1024, 450 Fifth
Street, N.W., Washington, D.C. 20549 or at its regional offices located at
Suite 1400, Northwestern Atrium Center, 500 West Madison Street, Chicago,
Illinois 60661 and at Seven World Trade Center, 13th Floor, New York, New York
10048, and copies of these materials can be obtained from the Public Reference
Section of the SEC, 450 Fifth Street, N.W., Washington, D.C. 20549, at
prescribed rates, or by calling the SEC at 1-800-SEC-0330. In addition, the
SEC maintains an Internet site that contains reports, proxy statements and
other information regarding registrants that file electronically, such as
Viacom and Blockbuster. The address of the SEC's Internet site is
http://www.sec.gov.
Blockbuster has filed a registration statement on Form S-4 under the
Securities Act of 1933, of which this document forms a part, to register with
the SEC the shares of Blockbuster class A common stock to be issued to Viacom
shareholders in this exchange offer and whose shares of Viacom class A or
class B common stock are accepted for exchange. Viacom will file a Schedule
13E-4 Issuer Tender Offer Statement with the SEC with respect to this exchange
offer. This prospectus constitutes Viacom's offer to exchange, in addition to
being a prospectus of Blockbuster. This document does not contain all the
information set forth in the registration statement or in the Schedule 13E-4,
selected portions of which are omitted in accordance with the rules and
regulations of the SEC. For further information pertaining to Viacom,
Blockbuster and the Blockbuster class A common stock, reference is made to the
registration statement and its exhibits. Statements contained in this document
or in any document incorporated in this document by reference as to the
contents of any contract or other document referred to within this document or
other documents that are incorporated by reference are not necessarily
complete and, in each instance, reference is made to the copy of the
applicable contract or other document filed as an exhibit to the registration
statement or otherwise filed with the SEC. Each statement contained in this
document is qualified in its entirety by reference to the underlying
documents.
Viacom class A and class B common stock are listed on the NYSE and were
previously listed on the American Stock Exchange. Reports, proxy statements
and other information concerning Viacom can be inspected at the offices of the
NYSE, 20 Broad Street, New York, New York 10005 and the American Stock
Exchange, 86 Trinity Place, New York, New York 10006. Blockbuster class A
common stock is listed on the NYSE. Reports, proxy statements and other
information concerning Blockbuster can also be inspected at the offices of the
NYSE.
This document incorporates documents by reference that are not included as
part of this document. Viacom and Blockbuster undertake to provide, without
charge, to each person, including any beneficial owner of Viacom class A
common stock, Viacom class B common stock and Blockbuster class A common
stock, to whom a copy of this document has been delivered, upon written or
oral request, a copy of any and all of the documents that have been
incorporated into this document by reference, other than exhibits to those
documents unless the exhibits are specifically incorporated into this document
by reference. Requests for these documents should be directed to Viacom Inc.,
1515 Broadway, 53rd Floor, New York, New York 10036, Attention: Investor
Relations, phone number: (212) 258-6700. In order to ensure timely delivery of
requested documents, requests should be made by , 2000.
The following documents, which have been filed with the SEC by Viacom (File
No. 1-9553) and CBS (File No. 1-977), are incorporated into this document by
reference:
Viacom
(a) the Annual Report on Form 10-K of Viacom for the fiscal year ended
December 31, 1998:
(b) the Viacom Quarterly reports on Form 10-Q for the periods ended
March 31, 1999, June 30, 1999 and September 30, 1999;
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<PAGE>
(c) the Current Reports on Form 8-K of Viacom filed May 18, 1999, June
24, 1999, September 8, 1999, as amended, and October 12, 1999;
(d) the definitive Proxy Statement filed on April 16, 1999, in
connection with Viacom's 1999 Annual Meeting;
(e) the Joint Proxy Statement/Prospectus and Registration Statement on
Form S-4 filed by Viacom on November 24, 1999, relating to the proposed
merger of Viacom and CBS; and
(f) the Issuer Tender Offer Statement on Schedule 13E-4 filed on
, 1999.
CBS
(a) the Annual Report on Form 10-K, as amended by Form 10-K/A, of CBS
for the fiscal year ended December 31, 1998;
(b) the CBS Quarterly report on Form 10-Q, as amended by Form 10-Q/A,
for the period ended March 31, 1999, the CBS Quarterly report on Form 10-Q
for the period ended June 30, 1999 and the CBS Quarterly report on Form 10-
Q for the period ended September 30, 1999;
(c) the Current Reports on Form 8-K of CBS filed January 29, 1999,
February 5, 1999, April 1, 1999, April 13, 1999, April 30, 1999, June 4,
1999, June 28, 1999, July 30, 1999, August 4, 1999, September 8, 1999,
September 15, 1999, October 8, 1999 (in respect of the Viacom/CBS merger),
October 12, 1999, October 29, 1999, November 2, 1999, November 5, 1999 and
November 22, 1999;
(d) the Current Report on Form 8-K of CBS filed on November 22, 1999
which includes King World's consolidated financial statements and the notes
thereto as of August 31, 1999 and 1998 and for the three years ended August
31, 1999;
(e) the description of CBS common stock contained in CBS' registration
statement on Form 10 dated May 15, 1935; and
(f) the definitive Proxy Statement filed on March 25, 1999; in
connection with CBS' 1999 Annual Meeting.
All documents filed by Viacom and CBS pursuant to Section 13(a), 13(c), 14
or 15(d) of the Exchange Act, after the date of this document and prior to the
expiration of this exchange offer are incorporated by reference into this
document and are considered a part of this document from the date of filing of
those documents.
Any statement contained within this document or in any document
incorporated by reference will be deemed to be modified or superseded for
purposes of this document to the extent that the statement contained in this
document or in any subsequently filed document that also is or is deemed to be
incorporated by reference in this document modifies or supersedes that
statement. Statements so modified or superseded will not be deemed, except as
so modified or superseded, to constitute a part of this document.
No person has been authorized to give any information or to make any
representation other than as contained in this document in connection with the
Blockbuster class A common stock to be issued in connection with this exchange
offer and, if given or made, the information or representation must not be
relied upon as having been authorized. This document does not constitute an
offer to exchange securities in any jurisdiction in which, or to any person to
whom, it would be unlawful to make such an offer. Neither the delivery of this
document nor any distribution of the securities offered hereunder shall, under
any circumstances, create any implication that there has been no change in the
affairs of Viacom or Blockbuster since the date of this document or that the
information contained in this document is correct as of any time subsequent to
that date. All information in this document regarding Viacom has been provided
by Viacom, and all information regarding Blockbuster has been provided by
Blockbuster.
135
<PAGE>
BLOCKBUSTER INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
Audited Consolidated Financial Statements:
<S> <C>
Report of Independent Accountants....................................... F-2
Consolidated Statements of Operations--Years Ended December 31, 1996,
1997 and 1998.......................................................... F-3
Consolidated Balance Sheets--at December 31, 1997 and 1998.............. F-4
Consolidated Statements of Changes in Stockholder's Equity--Years Ended
December 31, 1996, 1997 and 1998....................................... F-5
Consolidated Statements of Cash Flows--Years Ended December 31, 1996,
1997 and 1998.......................................................... F-6
Notes to Consolidated Financial Statements.............................. F-7
Interim Consolidated Financial Statements (Unaudited):
Interim Consolidated Statements of Operations (Unaudited) for the Nine
Months Ended September 30, 1998 and 1999............................... F-25
Interim Consolidated Balance Sheets--at December 31, 1998 and September
30, 1999 (Unaudited)................................................... F-26
Interim Consolidated Statements of Changes in Stockholders' Equity
(Unaudited)--for the Nine Months Ended September 30, 1999.............. F-27
Interim Consolidated Statements of Cash Flows (Unaudited)--for the Nine
Months Ended September 30, 1998 and 1999............................... F-28
Notes to Interim Consolidated Financial Statements (Unaudited).......... F-29
</TABLE>
Some supplementary financial statement schedules have been omitted because the
information required to be set forth therein is either not applicable or is
shown in the consolidated financial statements or notes thereto.
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Viacom Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of changes in stockholder's
equity, and of cash flows present fairly, in all material respects, the
financial position of Blockbuster Inc. at December 31, 1997 and 1998, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Dallas, Texas
May 4, 1999, except as to the fourth paragraph of
Note 1 which is as of August 3, 1999
F-2
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Rental revenues............................... $2,386.9 $2,664.0 $3,219.6
Merchandise sales............................. 491.3 594.0 618.0
Other revenues................................ 63.9 55.6 55.8
-------- -------- --------
2,942.1 3,313.6 3,893.4
-------- -------- --------
Cost of sales:
Cost of rental revenues....................... 617.2 810.6 1,460.9
Cost of merchandise sold...................... 396.5 549.9 495.5
-------- -------- --------
1,013.7 1,360.5 1,956.4
-------- -------- --------
Gross profit.................................. 1,928.4 1,953.1 1,937.0
Operating expenses:
General and administrative.................... 1,163.6 1,605.7 1,732.3
Advertising................................... 115.3 139.5 181.0
Depreciation.................................. 165.5 253.8 212.7
Amortization of intangibles................... 166.2 168.7 170.2
Restructuring charge.......................... 50.2 -- --
-------- -------- --------
1,660.8 2,167.7 2,296.2
-------- -------- --------
Operating income (loss)......................... 267.6 (214.6) (359.2)
Interest expense.............................. (22.0) (30.8) (27.7)
Interest income............................... 3.6 3.7 4.0
Other items, net.............................. -- (27.6) (11.8)
-------- -------- --------
Income (loss) before income taxes............... 249.2 (269.3) (394.7)
Benefit (provision) for income taxes.......... (167.4) (30.0) 59.4
Equity in loss of affiliated companies, net of
tax.......................................... (4.0) (18.9) (1.3)
-------- -------- --------
Net income (loss)............................... $ 77.8 $ (318.2) $ (336.6)
======== ======== ========
Net income (loss) per share:
Basic and diluted............................. $ 0.54 $ (2.21) $ (2.34)
======== ======== ========
Weighted average shares outstanding:
Basic and diluted............................. 144 144 144
======== ======== ========
Unaudited pro forma net income (loss) per share:
Basic and diluted............................. $ (2.20)
========
Unaudited pro forma weighted average shares
outstanding:
Basic and diluted............................. 175
========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED BALANCE SHEETS
(In millions)
<TABLE>
<CAPTION>
December 31,
------------------
1997 1998
-------- --------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents................................ $ 129.6 $ 99.0
Receivables, less allowances of $22.3 (1997) and $22.7
(1998).................................................. 114.8 124.8
Merchandise inventories.................................. 281.3 277.4
Deferred income taxes.................................... 6.7 --
Prepaid assets........................................... 95.5 130.5
-------- --------
Total current assets................................... 627.9 631.7
Rental library, net........................................ 734.5 441.2
Deferred income taxes...................................... 31.3 92.5
Property and equipment, net................................ 1,085.2 995.3
Intangibles, net........................................... 6,192.7 6,055.6
Other assets............................................... 59.4 58.5
-------- --------
$8,731.0 $8,274.8
======== ========
Liabilities and Stockholder's Equity
Current liabilities:
Accounts payable......................................... $ 362.4 $ 448.6
Accrued expenses......................................... 267.0 361.8
Current portion of capital lease obligations............. 36.7 22.2
Deferred income taxes.................................... -- 13.6
Short-term borrowings.................................... 47.0 --
-------- --------
Total current liabilities.............................. 713.1 846.2
Notes payable to Viacom.................................... 175.8 1,576.4
Capital lease obligations, less current portion............ 155.5 138.8
Other liabilities.......................................... 69.0 75.5
-------- --------
1,113.4 2,636.9
-------- --------
Commitments and contingencies (Note 12)
Stockholder's equity:
Viacom's net equity investment........................... 7,666.5 5,695.8
Accumulated other comprehensive loss-foreign currency
translation adjustment.................................. (48.9) (57.9)
-------- --------
Total stockholder's equity............................. 7,617.6 5,637.9
-------- --------
$8,731.0 $8,274.8
======== ========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
(In millions)
<TABLE>
<CAPTION>
Accumulated
Viacom's Other Total
Net Equity Comprehensive Comprehensive Stockholder's
Investment Income (Loss) Income (Loss) Equity
---------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Balance at January 1,
1996..................... $7,754.1 $(16.9) $7,737.2
Net income................ 77.8 $ 77.8 77.8
Other comprehensive income
(loss):
Cumulative translation
adjustment............. 9.8 9.8 9.8
-------
Total comprehensive
income............... $ 87.6
=======
Net contribution to
Viacom................... (40.4) (40.4)
-------- ------ --------
Balance at December 31,
1996..................... 7,791.5 (7.1) 7,784.4
Net loss.................. (318.2) $(318.2) (318.2)
Other comprehensive income
(loss):
Cumulative translation
adjustment............. (38.6) (38.6) (38.6)
Reclassification of
foreign currency
translation gain
realized............... (3.2) (3.2) (3.2)
-------
Total comprehensive
loss................. $(360.0)
=======
Net receipt from Viacom... 193.2 193.2
-------- ------ --------
Balance at December 31,
1997..................... 7,666.5 (48.9) 7,617.6
Net loss.................. (336.6) $(336.6) (336.6)
Other comprehensive income
(loss):
Cumulative translation
adjustment............. (9.0) (9.0) (9.0)
-------
Total comprehensive
loss................. $(345.6)
=======
Dividend payable to
Viacom................... (1,400.0) (1,400.0)
Net contribution to
Viacom................... (234.1) (234.1)
-------- ------ --------
Balance at December 31,
1998..................... $5,695.8 $(57.9) $5,637.9
======== ====== ========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In millions)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)........................... $ 77.8 $ (318.2) $ (336.6)
Adjustments to reconcile net income (loss)
to net cash flow provided by operating
activities:
Depreciation and amortization............. 948.9 1,222.4 1,518.8
Deferred income taxes..................... 26.7 121.5 (8.1)
Write-down of investments................. -- 27.1 10.5
Restructuring charge...................... 50.2 -- --
Equity in loss of affiliated companies,
net of tax............................... 4.0 18.9 1.3
Other..................................... -- (0.3) --
Change in operating assets and liabilities:
Increase in receivables................... (39.5) (7.8) (10.9)
Increase in merchandise inventories....... (73.1) (51.4) (0.4)
Increase in prepaid and other assets...... (20.3) (15.6) (40.0)
Increase (decrease) in accounts payable... 49.0 (41.4) 67.9
Increase (decrease) in accrued expenses
and other liabilities.................... (38.7) 36.1 32.0
--------- --------- ---------
Net cash flows provided by operating
activities................................... 985.0 991.3 1,234.5
--------- --------- ---------
Cash flows from investing activities:
Rental library purchases.................... (751.5) (860.2) (818.1)
Capital expenditures........................ (323.7) (262.2) (175.0)
Cash used for acquisitions.................. (154.4) (79.0) (34.2)
Proceeds from sale of property and
equipment.................................. -- 19.1 0.3
Investments in affiliated companies......... (5.5) (5.8) 4.8
--------- --------- ---------
Net cash flow used in investing activities.... (1,235.1) (1,188.1) (1,022.2)
--------- --------- ---------
Cash flows from financing activities:
Net borrowings on (repayments of) credit
facility................................... 25.8 22.3 (46.6)
Proceeds from term loan..................... -- -- 46.6
Net borrowings from notes due to Viacom..... 69.7 106.1 0.6
Capital lease payments...................... (24.9) (33.2) (34.8)
Advances from (repayments to) Viacom, net... 138.2 174.1 (206.9)
--------- --------- ---------
Net cash flow provided by (used in) financing
activities................................... 208.8 269.3 (241.1)
--------- --------- ---------
Effect of exchange rate changes on cash....... (0.4) (1.5) (1.8)
--------- --------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. (41.7) 71.0 (30.6)
Cash and cash equivalents at beginning of
year......................................... 100.3 58.6 129.6
--------- --------- ---------
Cash and cash equivalents at end of year...... $ 58.6 $ 129.6 $ 99.0
========= ========= =========
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Tabular dollars in millions, except per share amounts)
Note 1 -- Description of Business and Basis of Presentation
The business and operations of Blockbuster Inc. (collectively, the
"Company" or "Blockbuster") consists of various wholly owned entities owned
directly or indirectly by Viacom International Inc. which is a wholly owned
subsidiary of Viacom Inc. ("Viacom"). During 1998, Viacom announced its
intention that Blockbuster would offer in an initial public offering a portion
of its common stock. This initial public offering is Viacom's first step in
the planned divestiture of Blockbuster Inc. The Company owns, operates and
franchises videocassette rental and sales stores in the United States and a
number of foreign countries. The Company offers pre-recorded videocassettes
primarily for rental and also offers titles for purchase on a "sell-through"
(retail) basis. In addition, the Company offers video games for rental and
sale and sells certain other entertainment-related merchandise.
The Company's business and operations were originally conducted by
Blockbuster Entertainment Corporation which was incorporated in Delaware in
1982 and entered the movie rental business in 1985. On September 29, 1994,
Blockbuster Entertainment Corporation was merged with and into Viacom. Since
the merger and during the period covered by the accompanying consolidated
financial statements, operations of the Company were conducted by various
subsidiaries of Viacom. Viacom's acquisition of the Company in 1994 was
accounted for as a purchase, and accordingly, its basis in the acquired assets
and liabilities has been pushed down to Blockbuster. Viacom's initial
investment and all subsequent cash advances, with the exception of cash
advanced to fund the Company's international operations, have been classified
as contributed capital and no interest expense or income has been allocated to
the Company in the accompanying consolidated financial statements.
As a part of the Reorganization Transactions (see discussion below), the
Company purchased stock and/or assets from affiliates of Viacom with cash
funded by the bank credit agreement or contributed by Viacom in order to
acquire certain international operations of the Company. Advances from Viacom
to Blockbuster to fund these operations have been treated as intercompany
notes in the accompanying consolidated financial statements. Any difference
between the recorded intercompany notes payable to Viacom and the ultimate
amount of the purchase price for the stock or assets of these operations will
be recognized as an adjustment to stockholder's equity.
Prior to the Company's initial public offering (the "Offering") the
following transactions were completed: (1) in late 1998 numerous U.S.
subsidiaries of Viacom International Inc., a wholly owned subsidiary of
Viacom, each of which were directly or indirectly involved in the Company's
operations, were merged with and into the Company, (2) on December 31, 1998
the Company declared a $1.4 billion dividend payable to Viacom International
Inc. which has been reflected as an interest-bearing note in the accompanying
consolidated balance sheet, (3) effective on or about June 23, 1999, the
Company purchased certain international operations of the Company from
affiliates of Viacom, (4) effective June 21, 1999, the Company entered into a
term and revolving credit agreement with a syndicate of lenders which was used
to fund debt owed to Viacom and to pay a portion of the purchase price to
acquire certain international operations from affiliates of Viacom, and (5)
effective August 3, 1999, the Company was recapitalized with Class A common
stock and Class B common stock of which 144,000,000 shares of Class B common
stock were simultaneously issued to Viacom International Inc. in exchange for
100 shares of common stock of the Company. These transactions are collectively
referred to as the Reorganization Transactions.
The Company expects to offer Class A common stock in the Offering.
Immediately following the Offering, Viacom will own none of the outstanding
shares of the Class A common stock and 100% of the outstanding shares of the
Class B common stock, which will represent no less than 80% of the combined
voting interest of the Company's then outstanding common stock. Viacom has
expressed its current intention to achieve a complete
F-7
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 1 -- Description of Business and Basis of Presentation -- (continued)
separation between the Company and itself through a subsequent stock split-off
or other back-up distribution. Viacom has the sole discretion to determine the
timing and all terms of the split-off or other back-up distribution, and is
under no obligation to effect such separation. There can be no assurance as to
whether or when such a separation will occur, or as to the terms of such
separation.
The accompanying consolidated financial statements are presented on a
carve-out basis and reflect the historical results of operations, financial
position and cash flows of the Company including entities owned by Blockbuster
or purchased from affiliates of Viacom in the case of certain of its
international operations. In this context, no historical direct ownership
relationship existed among all the various entities comprising Blockbuster;
accordingly, Viacom and its subsidiaries' net investment in Blockbuster is
included in stockholder's equity in the consolidated financial statements.
For all periods presented, certain expenses reflected in the consolidated
financial statements include allocation of corporate expenses from Viacom (see
Note 10). All such costs and expenses have been deemed to have been paid by
the Company to Viacom in the period in which the costs were recorded.
Allocations of current income taxes receivable or payable are deemed to have
been remitted, in cash, by or to Viacom in the period the related income taxes
were recorded. Management believes that the foregoing allocations were made on
a reasonable basis; however, the allocations of costs and expenses do not
necessarily indicate the costs that would have been or will be incurred by the
Company on a stand-alone basis. Also, the consolidated financial statements
may not necessarily reflect the financial position, results of operations and
cash flows of the Company in the future or what the financial position,
results of operations or cash flows would have been if the Company had been a
separate, stand-alone company during the periods presented.
Note 2 -- Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could subsequently differ from those
estimates.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and investments of more than 50% in subsidiaries and other entities.
Investments in affiliated companies over which the Company has a significant
influence or ownership of more than 20% but less than or equal to 50% are
accounted for under the equity method. Investments of 20% or less are
accounted for under the cost method. All significant intercompany transactions
have been eliminated.
Cash and Cash Equivalents
Cash equivalents are defined as short-term (original maturities of three
months or less) highly liquid investments.
Merchandise Inventories
Merchandise inventories consist primarily of prerecorded videocassette
retail inventory, video games and confectionery items and is stated at the
lower of cost or market. Merchandise inventory costs are determined using the
weighted average method, the use of which approximates the first-in, first-out
basis.
F-8
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 2 -- Summary of Significant Accounting Policies -- (continued)
Rental Library, Net
Effective April 1, 1998, Blockbuster adopted an accelerated method of
amortizing the videocassette and game rental library in order to more closely
match expenses in proportion with anticipated revenues from revenue sharing
agreements (see Note 3).
Rental library and related accumulated amortization at December 31 are as
follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Rental library............................................ $1,742.8 $2,011.5
Less: accumulated amortization............................ 1,008.3 1,570.3
-------- --------
Rental library, net....................................... $ 734.5 $ 441.2
======== ========
</TABLE>
Rental amortization expense, excluding the charge (see Note 3),
approximated $617.2 million (1996), $799.9 million (1997) and $711.6 million
(1998).
Property and Equipment
Property and equipment is stated at cost. Depreciation expense is computed
principally by the straight-line method over the estimated useful lives as
follows:
<TABLE>
<S> <C>
Building................................................... 25 to 31.5 years
Building improvements...................................... 10 years
Leasehold improvements..................................... 4 to 10 years
Equipment and other........................................ 3 to 10 years
Furniture and fixtures..................................... 3 to 10 years
</TABLE>
Balances of major classes of assets and accumulated depreciation at
December 31 are as follows:
<TABLE>
<CAPTION>
1997 1998
-------- -------
<S> <C> <C>
Land, building and building improvements................... $ 64.6 $ 56.3
Leasehold improvements..................................... 563.2 637.7
Equipment and other........................................ 347.6 386.2
Furniture and fixtures..................................... 308.7 294.0
Capital leases............................................. 244.4 248.3
-------- -------
Total.................................................... 1,528.5 1,622.5
Less: accumulated depreciation............................. 443.3 627.2
-------- -------
Property and equipment, net $1,085.2 $ 995.3
======== =======
</TABLE>
Maintenance and repair costs are charged to expense as incurred.
Improvements that extend the useful life of the assets are capitalized.
Depreciation expense, including capital lease amortization, was $165.5 million
(1996), $253.8 million (1997) and $212.7 million (1998). Depreciation expense
related to capital leases was $31.7 million (1996), $30.6 million (1997) and
$29.7 million (1998).
F-9
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 2 -- Summary of Significant Accounting Policies -- (continued)
Intangibles
Intangible assets at December 31 consist of the following:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Goodwill.................................................. $6,721.5 $6,752.7
Trademarks................................................ 11.7 11.8
-------- --------
Total................................................... 6,733.2 6,764.5
Less: accumulated amortization............................ 540.5 708.9
-------- --------
Intangibles, net $6,192.7 $6,055.6
======== ========
</TABLE>
The cost of acquired businesses in excess of the fair value of tangible
assets and liabilities acquired ("goodwill"), which principally relates to
Viacom's acquisition of the Company and the resulting pushdown of goodwill
associated with the transaction, is amortized using the straight-line method
over estimated useful lives not exceeding 40 years. Amortization expense
related to intangible assets was $166.2 million (1996), $168.7 million (1997)
and $170.2 million (1998).
Trademarks are amortized on a straight-line basis over the estimated
remaining economic lives, not exceeding 40 years.
Fair Value of Financial Instruments
At December 31, 1997 and 1998, the Company's carrying value of financial
instruments approximates fair value due to the short-term maturities of these
instruments or variable rates of interest. During 1996, 1997 and 1998, no
financial instruments were held or issued for trading purposes.
Impairment of Long-Lived Assets
In 1996, the Company adopted Statement of Financial Accounting Standards
("SFAS") 121 ("SFAS 121"), "Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to be Disposed Of." SFAS 121 requires that the Company
assess long-lived assets (primarily property, plant and equipment and
goodwill) for impairment whenever there is an indication that the carrying
amount of the assets may not be recoverable. Recoverability is determined by
comparing the forecasted undiscounted cash flows generated by these assets to
the assets' net carrying value. The amount of impairment loss, if any, will
generally be measured as the difference between the net book value of the
assets and their estimated fair value. Impairment review of long-lived assets
associated with the Company's stores is performed on a market-by-market basis.
Advertising Expenses
Advertising costs are expensed the first time the advertising takes place.
Gift Card Liability
Gift card liabilities are recorded at the time of sale with the costs of
designing, printing and distributing the cards recorded as expense as
incurred. The liability is relieved and revenue recognized upon redemption of
the gift cards at any Blockbuster video store.
F-10
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 2 -- Summary of Significant Accounting Policies -- (continued)
Revenue Recognition
Revenues are generally recognized at the time of sale or rental. Rental
revenue includes sales of previously viewed videocassettes and previously
played video games.
Foreign Currency Translation and Transactions
The financial statements of the Company's foreign operations were prepared
in their respective local currencies and translated into U.S. dollars for
reporting purposes. The assets and liabilities are translated at exchange
rates in effect at the balance sheet date, while results of operations are
translated at average exchange rates for the respective periods. The
cumulative effects of exchange rate changes on net assets are included as a
part of accumulated other comprehensive loss in 1996, 1997 and 1998. Net
foreign currency transaction gains and losses were not significant for any of
the years presented, except for 1997, in which the Company recognized a gain
of approximately $8.0 million, which is included in general and administrative
expenses in the Consolidated Statements of Operations.
Hedging Activity
The Company has historically been considered in Viacom's overall risk
management strategy. As a part of this strategy, Viacom uses certain financial
instruments to reduce its exposure to adverse movements in foreign-exchange
rates. Viacom allocates to the Company the income and expense associated with
certain of these financial instruments used to hedge foreign currency
movements. Allocated net expense and the related notional amounts for these
financial instruments were immaterial in all years presented.
The Company is exposed to credit loss in the event of nonperformance by
counterparties to the financial instrument contracts. However, the Company
does not anticipate nonperformance by the other parties and no material loss
would be expected from their nonperformance.
Capitalized Software Costs
The Company capitalizes qualifying costs related to developing or obtaining
internal-use software. Capitalization of costs begins after the conceptual
formulation stage has been completed. Capitalized costs are depreciated over
the estimated useful life of the software which ranges between three and five
years. Capitalized costs at December 31, 1997 and 1998 totaled $10.6 million
and $11.1 million, net of accumulated depreciation of $7.0 million and $10.5
million, respectively. In January 1998, the American Institute of Certified
Public Accountants (the "AICPA") issued Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 becomes effective for all fiscal years
beginning after December 15, 1998. The Company's policy falls within the
guidelines of SOP 98-1.
Start-Up Costs
In April 1998, the AICPA issued Statement of Position 98-5, "Reporting on
the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 becomes effective for
all fiscal years beginning after December 15, 1998. The Company's policy falls
within the guidelines of SOP 98-5.
Income Taxes
Income taxes are provided based on the liability method of accounting
pursuant to SFAS 109, "Accounting for Income Taxes" ("SFAS 109"). Deferred
income taxes are recorded to reflect the tax benefit and
F-11
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 2 -- Summary of Significant Accounting Policies -- (continued)
consequences of future years' differences between the tax bases of assets and
liabilities and their financial reporting basis. The Company records a
valuation allowance to reduce deferred tax assets if it is more likely than
not that some portion or all of the deferred tax assets will not be realized.
Net Income (Loss) Per Share
As described in Note 1, the Company was recapitalized to provide for Class
A common stock and Class B common stock. In accordance with SEC Staff
Accounting Bulletin No. 98, the capitalization of Class B common stock has
been retroactively reflected for the purposes of presenting historical net
income (loss) per share for periods prior to the Offering.
Unaudited pro forma basic and diluted net income (loss) per share includes
the shares of both Class A and Class B common stock assumed to be outstanding
as of the date of the Offering. Unaudited pro forma basic and diluted net
income (loss) per share are the same since there are currently no Company
options outstanding. Pro forma basic and diluted net income (loss) per share
have been presented for the most recent annual period.
Comprehensive Income (Loss)
Effective January 1, 1998 the Company adopted SFAS 130, "Reporting
Comprehensive Income" ("SFAS 130"), effective for fiscal years beginning after
December 15, 1997. SFAS 130 establishes standards for reporting and display of
comprehensive income (loss) and its components in financial statements.
Comprehensive income is defined as the change in equity (net assets) of a
business enterprise during a period from transactions and other events and
circumstances from non-owner sources. It consists of net income (loss) and
other gains and losses affecting stockholder's equity that, under generally
accepted accounting principles, are excluded from net income, such as
unrealized gains and losses on investments available for sale, foreign
currency translation gains and losses and minimum pension liability. Currency
translation is the only item of other comprehensive income impacting the
Company. There is no tax effect associated with comprehensive income (loss) as
the foreign currency translation adjustments are associated with operations
located in foreign jurisdictions with operating losses.
Segment Information and Pension Disclosures
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information" ("SFAS 131"), effective for fiscal years
beginning after December 15, 1997. SFAS 131 establishes revised standards for
public companies relating to the reporting of financial and descriptive
information about their operating segments in financial statements. In
February 1998, the FASB issued SFAS 132, "Employer's Disclosures about
Pensions and Other Post Retirement Benefits" ("SFAS 132"), which is effective
for fiscal years beginning after December 15, 1997. SFAS 132 standardizes the
disclosure requirements for pension and other post-retirement benefits and
requires additional information on benefit obligations and the fair value of
plan assets. Implementation of SFAS 131 and SFAS 132 have not had a material
effect on the consolidated financial statements as currently presented.
Recent Accounting Pronouncements
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133"). This new accounting standard
will require that derivative instruments be measured at fair value
F-12
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 2 -- Summary of Significant Accounting Policies -- (continued)
and recognized in the balance sheet as either assets or liabilities, as the
case may be. The treatment of changes in the fair value of a derivative (i.e.,
gains and losses) will depend on its intended use and designation. Gains and
losses on derivatives designated as hedges against the cash flow effect of a
forecasted transaction will initially be reported as a component of
comprehensive income and, subsequently, reclassified into income when the
forecasted transaction affects income. Gains and losses on all other forms or
derivatives will be recognized in income in the period of change. The Company
will adopt SFAS 133 effective January 1, 2001 and anticipates that its
adoption will not have a material effect on its consolidated financial
statements.
Note 3 -- Change in Accounting Method for Rental Library
Effective April 1, 1998, Blockbuster adopted an accelerated method of
amortizing videocassette and game rental library. Blockbuster has adopted this
new method of amortization because it has implemented a new business model,
including revenue sharing agreements with Hollywood studios, which has
dramatically increased the number of videocassettes in the stores and is
satisfying consumer demand over a shorter period of time. Revenue sharing
allows Blockbuster to purchase videocassettes at a lower product cost than the
traditional buying arrangements, with a percentage of the net rental revenues
shared with the studios over a contractually determined period of time. As the
new business model results in a greater proportion of rental revenue over a
shorter period of time, Blockbuster has changed its method of amortizing
rental library in order to more closely match expenses in proportion with the
anticipated revenues to be generated therefrom.
Pursuant to the new accounting method, the Company records base stock
videocassettes (generally less than five copies per title for each store) at
cost and amortizes a portion of these costs on an accelerated basis over three
months, generally to $8 per unit, with the remaining base stock videocassette
cost amortized on a straight-line basis over 33 months to an estimated $4
salvage value. The cost of non-base stock videocassettes (generally greater
than four copies per title for each store) are amortized on an accelerated
basis over three months to an estimated $4 salvage value. Video games are
amortized on an accelerated basis over a 12-month period to an estimated $10
salvage value. Revenue sharing payments are expensed when revenues are earned
pursuant to the applicable contractual arrangements.
The new method of accounting has been applied to the rental library that
was held at April 1, 1998. The adoption of the new method of amortization has
been accounted for as a change in accounting estimate effected by a change in
accounting principle and, accordingly, the Company recorded a non-cash pre-tax
charge of $424.3 million to cost of rental revenues. The charge represents an
adjustment to the carrying value of the rental tapes due to the new method of
accounting.
The Company believes that the new amortization method developed for
Blockbuster's new business model will result in a better matching of revenue
and expense recognition. Under the new model, cost of sales attributable to
videocassettes is comprised of revenue sharing payments, which are expensed
when the related revenue is recognized, amortization of product costs and
residual values of previously viewed tapes and games upon sale.
Prior to April 1, 1998 videocassette rental library was recorded at cost
and amortized over its estimated economic life. Base stock videocassettes
(generally 1 to 4 copies per title for each store) were amortized over 36
months on a straight-line basis. Non-base stock videocassettes (generally the
fifth and succeeding copies per title for each store) were amortized over six
months on a straight-line basis. Video game library was amortized on a
straight-line basis over a period of 12 to 24 months.
F-13
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 4 -- Special Item Charges and Restructuring
During the second quarter of 1997, the Company shifted its strategic
emphasis from retailing a broad assortment of merchandise to focusing on its
core rental business. Rationalization of the retail product lines such as sell
through video, confectionery items, literature, music and fashion merchandise
allowed the Company to devote more management time and attention, as well as
retail floor selling space, to its rental video and game business. In
addition, as part of its efforts to improve the performance of its operations,
the Company adopted a plan to close consistently underperforming stores
primarily located in the United States, United Kingdom and Australia and to
exit the German market. The Company also recognized a charge associated with
its joint venture operations in Japan.
As a result, the Company recorded a pre-tax charge of approximately $250
million (the "Charge"). The Charge consisted principally of $100.8 million
recognized as cost of merchandise sold for a reduction in the carrying value
of excess merchandise inventories, $69.6 million for the reorganizing of
operations and closing of underperforming stores and $39.3 million recognized
as general and administrative expenses, primarily related to additional
relocation costs incurred in connection with the move of the Company's
employees, corporate offices and data center from Fort Lauderdale, Florida to
Dallas, Texas. In addition, the Charge consisted of $29.4 million, recognized
as part of the equity in loss of affiliated companies, associated with the
Company's debt guarantee of joint venture operations in Japan. Through
December 31, 1998, the Company has fully satisfied its obligations related to
the debt guarantee.
The $69.6 million charge is comprised of a $41.8 million non-cash
impairment charge associated with long-lived assets and a $27.8 million charge
for lease exit obligations. These amounts have been recognized as depreciation
expense and general and administrative expense, respectively. Through December
31, 1998, the Company has paid and charged approximately $12.8 million against
the lease exit obligations.
Also in the second quarter of 1997, as part of the Company's strategic
initiatives, management made the decision to dispose of certain investments
that did not relate to the Company's core business. The Company recognized a
non-cash charge of $27.1 million to write down these non-strategic investments
to their net realizable value. This charge is reflected in "Other items, net"
in the Consolidated Statements of Operations.
During 1998, the Company revised its estimate of net realizable value
associated with certain investments referred to above. An additional provision
of approximately $10.5 million was recognized in the fourth quarter to reflect
this change in estimate and was included in "Other items, net."
During the fourth quarter of 1996, the Company adopted a plan to relocate
its corporate headquarters from Fort Lauderdale to Dallas and eliminate third
party distributors. As a result of such plan, the Company recognized a
restructuring charge of approximately $50.2 million. The restructuring charge
reflects a $25.0 million reserve for estimated severance benefits payable to
approximately 650 employees who did not relocate to Dallas. The Company,
through the restructuring charge, also recognized $11.6 million of other costs
of exiting Fort Lauderdale (primarily related to the disposition of its
corporate headquarters) and $13.6 million for eliminating third party
distributors. The Company's relocation to Dallas was completed during the
second quarter of 1997 at which time the Company recorded additional period
costs associated with the move, as discussed above. Through December 31, 1998,
the Company paid and charged approximately $25.0 million against the severance
liability and approximately $11.4 million against the Fort Lauderdale exit
costs.
F-14
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 5 -- Stock Option Plans
Certain of the Company's employees have been granted Viacom stock options
under Viacom's Long-term Incentive Plans (the "Plans"). The purpose of the
Plans is to benefit and advance the interests of Viacom by rewarding certain
key employees for their contributions to the financial success of Viacom and
thereby motivating them to continue to make such contributions in the future.
The Plans provide for fixed grants of equity-based interests pursuant to
awards of phantom shares, stock options, stock appreciation rights, restricted
shares or other equity-based interests and for subsequent payments of cash
with respect to phantom shares or stock appreciation rights based, subject to
certain limits, on their appreciation in value over stated periods of time.
The stock options generally vest over a four to six year period from the date
of grant and expire 10 years after the date of grant.
The Company has adopted the disclosure-only provisions of SFAS 123,
"Accounting for Stock-Based Compensation". In accordance with the provisions
of SFAS 123, the Company applies Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" and related interpretations in
accounting for the Plans and accordingly, does not recognize compensation
expense for its stock option plans because Viacom typically does not issue
options at exercise prices below the market value at date of grant. Had
compensation expense for Viacom's stock option plans applicable to the
Company's employees been determined based upon the fair value at the grant
date for awards consistent with the methodology prescribed by SFAS 123, the
Company's consolidated pretax income would have decreased by $1.6 million
($1.0 million after tax or $0.01 per basic and diluted share), $2.2 million
($1.4 million after tax or $0.01 per basic and diluted share) and $4.1 million
($2.6 million after tax or $0.02 per basic and diluted share) in 1996, 1997
and 1998, respectively. These pro forma effects may not be representative of
expense in future periods since the estimated fair value of stock options on
the date of grant is amortized to expense over the vesting period. Additional
options may be granted in future years. Options issued prior to January 1,
1995 were excluded from the computation.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Expected dividend yield (a)............................. -- -- --
Expected stock price volatility......................... 32.65% 31.75% 32.72%
Risk-free interest rate................................. 6.43% 6.04% 5.46%
Expected life of options (years)........................ 6.0 6.0 6.0
</TABLE>
- --------
(a) Viacom has not declared any cash dividends on its common stock for any of
the periods presented and has no present intention of so doing.
On February 25, 1999, the Board of Directors of Viacom declared a 2-for-1
common stock split, effected in the form of a dividend. The additional shares
were issued on March 31, 1999 to shareholders of record on March 15, 1999. All
stock options and per share amounts have been adjusted to reflect the stock
split for all periods presented.
The weighted-average fair value of each option as of the grant date was
$8.13, $6.59 and $12.89 in 1996, 1997 and 1998, respectively.
F-15
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 5 -- Stock Option Plans -- (continued)
The following table summarizes stock option activity under the various plans
as it relates to Blockbuster's employees:
<TABLE>
<CAPTION>
Options Weighted-Average
Outstanding Exercise Price
----------- ----------------
<S> <C> <C>
Balance at December 31, 1995.................... 20,398,918 $15.49
Granted....................................... 1,155,600 18.23
Exercised..................................... 7,039,854 15.15
Canceled...................................... 1,333,634 16.90
----------
Balance at December 31, 1996.................... 13,181,030 15.77
Granted....................................... 2,596,000 15.32
Exercised..................................... 2,778,348 14.58
Canceled...................................... 2,766,482 15.76
----------
Balance at December 31, 1997.................... 10,232,200 15.98
Granted....................................... 506,320 30.31
Exercised..................................... 7,102,920 14.39
Canceled...................................... 414,356 16.00
----------
Balance at December 31, 1998.................... 3,221,244 $21.75
========== ======
</TABLE>
The following table summarizes information concerning currently outstanding
and exercisable Viacom stock options issued to Blockbuster employees at
December 31, 1998:
<TABLE>
<CAPTION>
Outstanding Exercisable
----------------------------------------- ----------------------
Remaining Weighted- Weighted-
Range of Contractual Average Average
Exercise Prices Options Life (Years) Exercise Price Options Exercise Price
- --------------- --------- ------------ -------------- ------- --------------
<S> <C> <C> <C> <C> <C>
$10 to $15 20,000 8.62 $14.94 -- --
15 to 20 2,340,540 8.47 15.46 23,398 $17.50
20 to 25 14,000 9.01 21.47 -- --
25 to 30 -- -- -- -- --
30 to 35 487,320 9.61 30.57 -- --
3 to 25 (a) 359,384 (a) 4.16 14.29 359,384 14.29
--------- -------
3,221,244 382,782
========= =======
</TABLE>
- --------
(a) Represents information for options assumed with the Viacom acquisition of
Blockbuster.
F-16
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 6 -- Accrued Expenses
The Company's accrued expenses consist of the following:
<TABLE>
<CAPTION>
At December
31,
-------------
1997 1998
------ ------
<S> <C> <C>
Accrued compensation.......................................... $ 42.7 $ 55.9
Accrued gift card liability................................... 46.7 65.9
Accrued sales tax............................................. 27.8 24.5
Accrued property tax.......................................... 27.0 38.9
Accrued revenue sharing -- 38.0
Restructuring reserve......................................... 23.4 14.2
Store closure reserves........................................ 25.3 15.0
Assigned music liabilities (see Note 10) -- 43.7
Other......................................................... 74.1 65.7
------ ------
$267.0 $361.8
====== ======
</TABLE>
Note 7 -- Debt
Effective February 1996, the Company, along with three other Viacom
affiliates, entered into a Cdn $75 million credit facility, secured by Viacom.
The Company had outstanding approximately Cdn $65.8 million of bankers
acceptances as of December 31, 1997 ($47.0 million at December 31, 1997
exchange rates). Interest on outstanding borrowings is equal to the Canadian
bankers acceptance rate plus 40 basis points, 3.5% and 5.1% at December 31,
1996 and 1997, respectively. Interest expense related to the Canadian facility
was $.3 million and $2.0 million for the years ended December 31, 1996 and
1997, respectively.
In March 1998, the Company entered into a ten-year term loan for Cdn $65.8
million to repay the existing credit facility. In June 1998, the note was sold
to a Viacom affiliate and, accordingly, is reflected as part of notes payable
to Viacom.
Funds advanced by Viacom to the Company to fund certain international
operations have been recognized as intercompany loans. These intercompany
loans will be purchased and retired by the Company with borrowings from the
Company's credit agreement as part of its Reorganization Transactions as
described in Note 1. Interest expense charged by Viacom approximated $4.1
million, $10.1 million and $8.4 million for the years 1996, 1997 and 1998,
respectively, and reflects market-based rates.
Interest expense related to capital leases was $17.6 million, $18.7 million
and $18.5 million for the years ended December 31, 1996, 1997 and 1998,
respectively. See Note 12 for further information regarding capital lease
obligations.
On December 31, 1998, the Company declared a dividend in the form of an
interest-bearing (London Interbank Offered Rate "LIBOR" plus 1%, 6.12% at
December 31, 1998) promissory note to Viacom International Inc. in the
principal amount of $1.4 billion.
Note 8 -- Viacom's Net Equity Investment
Viacom funds the working capital requirements of the Company based upon a
centralized cash management system. The Viacom's net equity investment
includes accumulated equity as well as any non-interest-bearing
F-17
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 8 -- Viacom's Net Equity Investment -- (continued)
payable and receivable due to/from Viacom resulting from cash transfers and
other intercompany activity. Viacom generally does not charge the Company
interest on intercompany balances except for intercompany debt associated with
certain foreign operations (see Note 7).
Note 9 -- Other Items, net
<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Write-down of investments (Note 4)........................ $ -- $27.1 $10.5
Other..................................................... -- .5 1.3
----- ----- -----
Total other items, net.................................... $ -- $27.6 $11.8
===== ===== =====
</TABLE>
Note 10 -- Related Party Transactions
Viacom provides the Company with certain general and administrative
services, including insurance, legal, treasury, financial and other corporate
functions. The allocation of expenses was generally based on actual costs
incurred and such costs were apportioned to the Company based upon the average
of certain specified ratios of revenues and net assets. The charges for such
services were $9.8 million (1996), $9.2 million (1997) and $12.5 million
(1998). Management believes that the methodologies used to allocate these
charges are reasonable, however, these allocations of costs and expenses do
not necessarily indicate the cash and expenses that would have been or will be
incurred by the Company on a stand-alone basis. Viacom also pays insurance
premiums on behalf of the Company for certain worker's compensation, property,
general liability and group insurance policies. Insurance expense related to
these policies was $13.2 million (1996), $13.3 million (1997) and $16.0
million (1998) and is reflected as a component of general and administrative
expenses in the Consolidated Statements of Operations. See Note 13 for pension
plan and additional employee benefit costs charged by Viacom to the Company.
These services between Viacom and the Company will continue after the Offering
pursuant to the transition services described below.
Blockbuster and Viacom will enter into a transition services agreement
whereby Viacom will provide the Company cash management, accounting,
management information systems, legal, financial and tax services as well as
employee benefit plan and insurance administration. These services may change
upon agreement between Viacom and the Company. The fee for these services will
approximate Viacom's cost and could be subject to adjustment. The Company has
agreed to pay or reimburse Viacom for any out-of-pocket payments, costs and
expenses associated with these services. The services agreement expires upon
the closing of a split-off or backup distribution.
The Company, through the normal course of business, is involved in
transactions with companies owned by or affiliated with Viacom or certain of
its board members. The Company purchases certain videocassettes for rental and
sale directly from Paramount Pictures Corporation. Total purchases were $7.6
million, $77.5 million and $110.1 million for the years ended December 31,
1996, 1997 and 1998, respectively. The Company purchases certain home video
games from Midway Games Inc. Total amounts paid for purchases were $8.4
million, $12.5 million and $19.1 million for the years ended December 31,
1996, 1997 and 1998, respectively.
In conjunction with the sale by a related party of Blockbuster Music
("Music") to Wherehouse Entertainment, Inc. ("Wherehouse"), the Company
assumed certain liabilities as a result of the disposition of
F-18
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 10 -- Related Party Transactions -- (continued)
Blockbuster Music with a corresponding reduction to Viacom's net equity
investment. The nature of these liabilities was predominantly for obligations
related to closed Music stores excluded from the sale and to a lesser extent
certain transaction costs and various costs to complete the transition of
operations from Music to Wherehouse. These liabilities at the date of
assignment aggregated approximately $67 million of which $43.7 million remains
in current liabilities at December 31, 1998.
All other transactions with companies owned by or affiliated with Viacom
did not have a material impact on the financial position or results of
operations presented herein. See Note 7 regarding intercompany loans related
to the Company's international operations.
Note 11 -- Income Taxes
The Company has been included in consolidated federal, state and local
income tax returns filed by Viacom. However, the tax benefit (expense)
reflected in the Consolidated Statements of Operations and deferred tax assets
and liabilities reflected in the Consolidated Balance Sheets have been
prepared as if such benefits were computed on a separate return basis. The
current income tax liabilities for the periods presented have been satisfied
by Viacom. Any tax losses generated by the Company have been utilized by
Viacom to reduce its consolidated taxable income. These amounts have been
reflected in Viacom's net equity investment in the Consolidated Balance
Sheets.
The Company and Viacom will enter into a tax matters agreement which
provides that subsequent to the Offering the Company will continue to be
included in the Viacom U.S. federal consolidated income tax return and certain
consolidated, combined and unitary state tax returns. The tax matters
agreement requires the Company and Viacom to make payments to each other equal
to the amount of income taxes which would be paid by the Company, subject to
certain adjustments, if the Company had filed a stand-alone return for any
taxable year or portion thereof beginning after the date of this offering in
which the Company is included in the Viacom group. With respect to certain tax
attributes such as net operating losses, tax credits and capital losses, the
Company will have the right of reimbursement or offset, which will be
determined based on the extent such tax attributes could be utilized by the
Company if it had not been included in the Viacom group. The right to
reimbursement or offset will arise regardless of whether the Company is a
member of the Viacom group at the time the attributes could have been used.
The tax matters agreement also requires the Company, if so requested by
Viacom, to surrender certain tax losses of our subsidiaries that are resident
in the United Kingdom for 1998 and earlier years to Viacom's United Kingdom
Operations without any rights to compensation.
The tax matters agreement specifies that Viacom will indemnify the Company
against any and all tax adjustments to Viacom's consolidated federal and
consolidated, combined and unitary state tax returns from September 29, 1994
through the date of the Offering.
The net operating loss carryforwards at December 31, 1998 are primarily
attributable to domestic ($8.2 million) and foreign ($42.5 million)
subsidiaries of the Company. These losses are subject to certain restrictions
and limitations in accordance with domestic and foreign tax laws. A valuation
allowance has been provided primarily related to foreign loss carryforwards
and certain foreign restructuring reserves as the Company believes that it is
more likely than not that these tax benefits will not be realized. Of the
total amount, $27.5 million has no expiration date, $0.7 million expires in
1998, $1.1 million expires in 1999 and $21.4 million expires thereafter.
F-19
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 11 -- Income Taxes -- (continued)
Losses accounted for under the equity method of accounting are shown net of
tax in the Consolidated Statements of Operations. Included in equity in loss
of affiliated companies, net of tax of $4.0 million (1996), $18.9 million
(1997) and $1.3 million (1998) are tax benefits of $0.5 million and $12.7
million for 1996 and 1997, respectively, and a tax provision of $0.2 million
for 1998.
Income (loss) before income taxes are attributable to the following
jurisdictions:
<TABLE>
<CAPTION>
Year Ended December
31,
------------------------
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
United States...................................... $283.3 $(167.3) $(313.6)
Foreign............................................ (34.1) (102.0) (81.1)
------ ------- -------
$249.2 $(269.3) $(394.7)
====== ======= =======
</TABLE>
Components of the income tax benefit (expense) are as follows:
<TABLE>
<CAPTION>
Year Ended December
31,
----------------------
1996 1997 1998
------- ------ -----
<S> <C> <C> <C>
Current:
Federal............................................ $(119.1) $ 89.7 $51.2
State and local.................................... (19.4) 3.4 3.0
Foreign............................................ (3.5) (1.6) (2.9)
------- ------ -----
(142.0) 91.5 51.3
Deferred............................................. (25.4) (121.5) 8.1
------- ------ -----
$(167.4) $(30.0) $59.4
======= ====== =====
</TABLE>
A reconciliation of the U.S. federal statutory tax rate to the Company's
effective tax rate on income (loss) before income taxes is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------
1996 1997 1998
------- -------- --------
<S> <C> <C> <C>
Statutory U.S. tax provision (benefit)
rate....................................... 35.0% (35.0)% (35.0)%
Amortization of non-deductible goodwill..... 24.1 23.5 15.6
State and local taxes, net of federal tax
benefit.................................... 1.7 (1.6) (4.1)
Effect of foreign operations................ 7.1 23.9 8.6
Other, net.................................. (.7) .3 (.1)
------- -------- --------
Effective tax provision (benefit) rate...... 67.2% 11.1% (15.0)%
======= ======== ========
</TABLE>
F-20
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 11 -- Income Taxes -- (continued)
The following is a summary of the deferred tax accounts in accordance with
SFAS 109:
<TABLE>
<CAPTION>
December 31,
--------------
1997 1998
------ ------
<S> <C> <C>
Deferred tax assets:
Reserves and accrued liabilities........................... $ 39.8 $ 38.6
Book-tax basis differences in rental library and other
assets.................................................... -- 60.1
Book-tax basis differences in investments.................. 17.9 10.7
Net operating loss carryforwards........................... 50.2 50.7
------ ------
Total deferred tax assets.................................. 107.9 160.1
Less: Valuation allowance.................................. (67.1) (67.6)
------ ------
Net deferred tax assets.................................... 40.8 92.5
------ ------
Deferred tax liabilities:
Deferred expenses.......................................... -- (13.6)
Book-tax basis differences in rental library and other
assets.................................................... (2.8) --
------ ------
Total deferred tax liabilities............................. (2.8) (13.6)
------ ------
Total net deferred tax assets.............................. $ 38.0 $ 78.9
====== ======
</TABLE>
Note 12 -- Commitments and Contingencies
The Company has long-term noncancelable lease commitments for various real
and personal property and office space which expire at various dates. Certain
leases contain renewal and escalation clauses. Generally, leases are five to
ten years with extended renewal options.
At December 31, 1998, minimum rental payments under noncancelable leases
are as follows:
<TABLE>
<CAPTION>
Operating Capital
--------- -------
<S> <C> <C>
1999...................................................... $ 369.9 $ 47.6
2000...................................................... 319.3 39.3
2001...................................................... 262.6 32.0
2002...................................................... 210.8 28.0
2003...................................................... 183.2 27.0
2004 and thereafter....................................... 601.5 43.8
-------- ------
Total minimum lease payments.............................. $1,947.3 $217.7
========
Less amount representing interest......................... (56.7)
------
Present value of net minimum payments..................... $161.0
======
</TABLE>
Rent expense was $269.8 million (1996), $355.3 million (1997) and $409.8
million (1998). Subtenant rental income was $5.0 million (1996), $4.8 million
(1997) and $5.6 million (1998). Future minimum lease payments have not been
reduced by future minimum subtenant rental income of $30.6 million. No
contingent rentals were paid during the three years ended December 31, 1998.
In October 1998, Music stores were sold to Wherehouse. Certain of the
leases transferred in connection with this sale had previously been guaranteed
either by Viacom or its affiliates. The remaining lease terms expire
F-21
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 12 -- Commitments and Contingencies -- (continued)
through various dates through 2007. Blockbuster has agreed to indemnify Viacom
with respect to any amount paid under these guarantees. At the time of sale,
the contingent liability for base rent approximated $84 million, on an
undiscounted basis, with respect to these guarantees. The Company has not
recognized any reserves related to this contingent liability in the
accompanying consolidated financial statements. If Wherehouse defaults,
related losses could materially affect future operating income.
Pursuant to the tax matters agreement, the Company will generally be
responsible for, among other things, any taxes imposed on Viacom or its
Subsidiaries as a result of the split-off failing to qualify as a tax-free
transaction on account of any breach of the Company's representations or
agreements or any action or failure to act by the Company or any transaction
involving the Company's assets, stock or business (regardless of whether such
transaction is within its control) following the split-off.
The Company is a defendant from time to time in lawsuits incidental to its
business. Based on currently available information, the Company believes that
resolution of these known contingencies would not have a material adverse
impact on the Company's financial statements or liquidity. However, there can
be no assurances that future costs would not be material to results of
operations or liquidity of the Company for a particular future period. In
addition, the Company's estimates of future costs are subject to change as
circumstances change and additional information becomes available during the
course of litigation.
Note 13 -- Pension Plans and Other Employee Benefits
Viacom has a noncontributory defined benefit pension plan covering
substantially all of its employees, including the employees of the Company
during 1996, 1997 and 1998. Retirement benefits are based principally on years
of service and salary. Viacom also offers participation in a 401(k) savings
plan to the employees of the Company and has charged the Company for pension
and 401(k) savings plan expenses of $4.6 million (1996), $4.6 million (1997)
and $5.3 million (1998).
Viacom also provides other employee benefits to the Company's employees,
including certain postemployment benefits, medical, dental, life and
disability insurance costs.
Management believes that the methodologies used to allocate pension and
other employee benefit charges to the Company are reasonable.
Viacom intends to spin off a Blockbuster Entertainment Investment Plan from
the Viacom Investment Plan, the provisions of which will mirror those of the
Viacom Investment Plan. The Company will continue to invest matching
contributions in Viacom's Class B common stock.
Note 14 -- Acquisitions
During 1996, 1997 and 1998, the Company acquired or invested in several
businesses that own and operate videocassette rental stores. The aggregate
purchase price, consisting of cash consideration, for these businesses
approximated $154.4 million (1996), $79.0 million (1997) and $34.2 million
(1998) and was primarily allocated to video rental library, property and
equipment, and intangible assets.
All acquisitions were accounted for under the purchase method and,
accordingly, the operating results of the acquired businesses are included in
the consolidated results of operations of the Company since their respective
date of acquisition. Pro forma results of operations have not been presented
due to the immateriality of the acquisitions.
F-22
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 15 -- Equity Investments
The Company has a 50% interest in a joint venture located in Japan which
owns and operates videocassette rental stores. As discussed in Note 4, during
1997 the Company recognized a charge of $29.4 million (approximately $17.6
million net of tax) related to debt guarantees in recognition of the joint
venture's financial condition. The Company has also recognized its
proportionate share of this joint venture's net operating loss to the extent of
its investment which were as follows: $11.9 million (1996) and $12.1 million
(1997). Through December 31, 1998, the Company had fully satisfied its
obligations related to its Japan debt guarantees. As of December 31, 1997 and
1998, the Company had no remaining net investment in its Japan joint venture
and intends to dispose of its interest in this joint venture in 1999.
Note 16 -- Supplemental Cash Flow Information
Cash flows from operating activities included cash payments as follows:
<TABLE>
<CAPTION>
Year Ended
December 31,
-----------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Cash payments for interest................................ $17.9 $20.4 $27.2
Supplemental schedule of non-cash financing and investing
activities:
Retail stores acquired under capitalized leases......... $40.6 $14.4 $ 3.8
</TABLE>
On December 31, 1998, the Company declared a cash dividend in the amount of
$1.4 billion payable to Viacom in the form of an interest-bearing promissory
note to Viacom International Inc.
All income tax obligations have been satisfied by Viacom as the Company has
been included in Viacom's consolidated tax return.
Note 17 -- Operations by Geographic Area
The Company operates in one industry segment: rental and retail sales of
videocassettes, video games and other entertainment related merchandise. The
principal geographic areas of the Company's operations are the United States
and Europe. Operations in Latin America, Australia, Canada and Asia are
classified in "International-all other".
F-23
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Tabular dollars in millions, except per share amounts)
Note 17 -- Operations by Geographic Area -- (continued)
The following table shows revenues and long-lived assets by geographic
area. Transfers between geographic areas were not significant.
<TABLE>
<CAPTION>
Year Ended or at December
31,
--------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Revenues:
United States.................................. $2,427.9 $2,611.5 $3,090.1
Europe......................................... 259.1 355.9 427.9
International-all other........................ 255.1 346.2 375.4
-------- -------- --------
Total revenues............................... $2,942.1 $3,313.6 $3,893.4
======== ======== ========
Long-lived assets(1):
United States(2)............................... $7,484.6 $7,395.5 $6,942.2
Europe......................................... 371.2 380.9 362.8
International-all other........................ 306.4 295.4 245.6
-------- -------- --------
Total long-lived assets...................... $8,162.2 $8,071.8 $7,550.6
======== ======== ========
</TABLE>
- --------
(1) Includes all non-current assets, except deferred income taxes.
(2) Includes substantially all intangible assets.
Note 18 -- Quarterly Financial Data (unaudited)
Summarized quarterly financial data for 1997 and 1998 appears below:
<TABLE>
<CAPTION>
First Second Third Fourth Total
Quarter Quarter Quarter Quarter Year
------- ------- ------- -------- --------
1997(1)
<S> <C> <C> <C> <C> <C>
Revenue........................ $823.8 $ 765.3 $817.7 $ 906.8 $3,313.6
Gross profit................... $538.3 $ 370.5 $504.5 $ 539.8 $1,953.1
Net income (loss).............. $(19.3) $(227.3) $(37.8) $ (33.8) $ (318.2)
Net income (loss) per share:
Basic and diluted............. $(0.13) $ (1.58) $(0.26) $ (0.23) $ (2.21)
<CAPTION>
1998(2)
<S> <C> <C> <C> <C> <C>
Revenue........................ $931.2 $ 890.0 $985.4 $1,086.8 $3,893.4
Gross profit................... $604.6 $ 100.2 $591.7 $ 640.5 $1,937.0
Net income (loss).............. $ 15.8 $(318.0) $(21.5) $ (12.9) $ (336.6)
Net income (loss) per share:
Basic and diluted............. $ 0.11 $ (2.21) $(0.15) $ (0.09) $ (2.34)
</TABLE>
- --------
(1) The second quarter of 1997 included a pre-tax charge of approximately $250
million principally representing a reduction in the carrying value of
excess retail inventory and a reserve for the reorganization of
international operations and closing of under performing stores in
domestic and international markets as well as additional expenses
associated with the Company's corporate relocation (see Note 4). In
addition, the Company recognized a non-cash charge of $27.1 million to
write down certain non-strategic investments to their estimated net
realizable value.
(2) The second quarter of 1998 included a $424.3 million charge for a change
in estimate effected by a change in accounting principle for rental
library. During the fourth quarter of 1998, the Company revised its
estimate of net realizable value associated with the planned disposition
of certain non-strategic investments and recognized an additional
provision of approximately $10.5 million (See Notes 3 and 4).
F-24
<PAGE>
BLOCKBUSTER INC.
INTERIM CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------
1998 1999
-------- --------
<S> <C> <C>
Revenues:
Rental revenues.......................................... $2,341.4 $2,790.7
Merchandise sales........................................ 423.0 413.5
Other revenues........................................... 42.2 63.3
-------- --------
2,806.6 3,267.5
-------- --------
Cost of sales:
Cost of rental revenues.................................. 1,166.1 949.0
Cost of merchandise sold................................. 344.0 320.6
-------- --------
1,510.1 1,269.6
-------- --------
Gross profit............................................. 1,296.5 1,997.9
Operating expenses:
General and administrative............................... 1,271.5 1,441.8
Advertising.............................................. 125.4 182.9
Depreciation............................................. 156.8 163.1
Amortization of intangibles.............................. 127.3 128.7
-------- --------
1,681.0 1,916.5
-------- --------
Operating income (loss).................................... (384.5) 81.4
Interest expense......................................... (21.1) (90.6)
Interest income.......................................... 3.3 1.8
Other items, net......................................... 0.4 1.5
-------- --------
Income (loss) before income taxes.......................... (401.9) (5.9)
Benefit (provision) for income taxes..................... 80.0 (52.4)
Equity in income (loss) of affiliated companies,
net of tax.............................................. (1.8) (4.1)
-------- --------
Net income (loss).......................................... $ (323.7) $ (62.4)
======== ========
Net income (loss) per share:
Basic and diluted........................................ $ (2.25) $ (0.42)
======== ========
Weighted average shares outstanding:
Basic and diluted........................................ 144.0 149.8
======== ========
Unaudited pro forma net income (loss) per share:
Basic and diluted........................................ $ (0.36)
========
Unaudited pro forma weighted average shares outstanding:
Basic and diluted........................................ 175
========
</TABLE>
See notes to unaudited interim consolidated financial statements.
F-25
<PAGE>
BLOCKBUSTER INC.
INTERIM CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents......................... $ 99.0 $ 122.0
Receivables, less allowances of $22.7 (1998) and
$10.4 (1999)..................................... 124.8 114.1
Merchandise inventories........................... 277.4 254.2
Prepaid assets.................................... 130.5 148.9
-------- --------
Total current assets............................ 631.7 639.2
Rental library, net................................. 441.2 500.6
Deferred income taxes............................... 92.5 2.6
Property and equipment, net......................... 995.3 1,098.5
Intangibles, net.................................... 6,055.6 6,015.8
Other assets........................................ 58.5 68.7
-------- --------
$8,274.8 $8,325.4
======== ========
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................. $ 448.6 $ 368.6
Accrued expenses.................................. 361.8 360.0
Current portion of long-term debt................. -- 157.1
Current portion of capital lease obligations...... 22.2 22.2
Deferred income taxes............................. 13.6 8.5
-------- --------
Total current liabilities....................... 846.2 916.4
Notes payable to Viacom............................. 1,576.4 --
Long-term debt, less current portion................ -- 1,040.0
Capital lease obligations, less current portion..... 138.8 117.3
Other liabilities................................... 75.5 72.7
-------- --------
2,636.9 2,146.4
-------- --------
Commitments and contingencies (Note 7)
Stockholders' equity:
Preferred stock, par value $.01 per share; 100.0
shares authorized; no shares issued or
outstanding...................................... -- --
Class A common stock, par value $.01 per share;
400.0 shares authorized; 31.0 shares issued and
outstanding...................................... -- 0.3
Class B common stock, par value $.01 per share;
500.0 shares authorized; 144.0 shares issued and
outstanding...................................... -- 1.4
Additional paid-in capital........................ -- 6,227.1
Retained earnings (deficit)....................... -- (4.1)
Viacom's net equity investment.................... 5,695.8 --
Accumulated other comprehensive loss--foreign
currency translation adjustment.................. (57.9) (45.7)
-------- --------
Total stockholders' equity...................... 5,637.9 6,179.0
-------- --------
$8,274.8 $8,325.4
======== ========
</TABLE>
See notes to unaudited interim consolidated financial statements.
F-26
<PAGE>
BLOCKBUSTER INC.
INTERIM CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
1999
-------------------
Shares Amounts
-------- ----------
<S> <C> <C>
Class A common stock:
Balance, beginning of year............................... -- $ --
Initial public offering, net proceeds.................... 31.0 0.3
------- ----------
Balance, end of period................................... 31.0 $ 0.3
------- ----------
Class B common stock:
Balance, beginning of year............................... -- $ --
Issuance of Class B common stock to Viacom............... 144.0 1.4
------- ----------
Balance, end of period................................... 144.0 $ 1.4
======= ==========
Additional paid-in capital:
Balance, beginning of year............................... $ --
Issuance of Class B common stock to Viacom............... 5,796.7
Initial public offering, net proceeds.................... 430.4
----------
Balance, end of period................................... $ 6,227.1
==========
Viacom's net equity investment:
Balance, beginning of year............................... $ 5,695.8
Other transactions with Viacom, net...................... 160.6
Net income (loss) prior to initial public offering....... (58.3)
Issuance of Class B common stock to Viacom............... (5,798.1)
----------
Balance, end of period................................... $ --
==========
Accumulated other comprehensive loss:
Balance, beginning of year............................... $ (57.9)
Other comprehensive income (loss)--foreign currency
translation adjustment.................................. 12.2
----------
Balance, end of period................................... $ (45.7)
==========
Retained earnings (deficit):
Balance, beginning of year............................... $ --
Net income (loss) subsequent to initial public offering.. (4.1)
----------
Balance, end of period................................... $ (4.1)
==========
Total stockholders' equity............................... $ 6,179.0
==========
</TABLE>
See notes to unaudited interim consolidated financial statements.
F-27
<PAGE>
BLOCKBUSTER INC.
INTERIM CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
1998 1999
-------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss)....................................... $ (323.7) $ (62.4)
Adjustments to reconcile net income (loss) to net cash
flow provided by operating activities:
Depreciation and amortization......................... 1,238.3 783.2
Deferred income taxes................................. (39.4) 85.0
Equity in loss of affiliated companies, net of tax.... 1.8 4.1
Gain on sales of store operations..................... -- (8.3)
Change in operating assets and liabilities:
(Increase) decrease in receivables.................... (7.7) 10.7
(Increase) decrease in merchandise inventories........ (5.4) 25.1
Increase in prepaid and other assets.................. (31.6) (27.7)
Increase (decrease) in accounts payable............... 32.6 (78.9)
Increase (decrease) in accrued expenses and other
liabilities.......................................... 41.6 (6.6)
-------- ---------
Net cash flow provided by operating activities............ 906.5 724.2
-------- ---------
Cash flows from investing activities:
Rental library purchases................................ (611.7) (543.1)
Capital expenditures.................................... (108.8) (266.7)
Cash used for acquisitions.............................. (25.1) (110.9)
Proceeds from sales of store operations................. -- 18.9
Investments in affiliated companies..................... 4.7 (1.0)
-------- ---------
Net cash flow used in investing activities................ (740.9) (902.8)
-------- ---------
Cash flows from financing activities:
Proceeds from new credit agreement...................... -- 1,665.0
Repayments on new credit agreement...................... -- (467.9)
Proceeds from term loan................................. 46.6 --
Repayment of term loan.................................. (46.6) --
Net borrowings from (repayments of) notes due to
Viacom................................................. 34.2 (1,576.4)
Net proceeds from the issuance of common stock.......... -- 430.7
Capital lease payments.................................. (26.4) (26.4)
(Repayments to) capital contribution from Viacom, net... (216.7) 176.8
-------- ---------
Net cash flow (used in) provided by financing activities.. (208.9) 201.8
-------- ---------
Effect of exchange rate changes on cash................... (2.2) (0.2)
-------- ---------
Net (decrease) increase in cash and cash equivalents...... (45.5) 23.0
Cash and cash equivalents at beginning of year............ 129.6 99.0
-------- ---------
Cash and cash equivalents at end of period................ $ 84.1 $ 122.0
======== =========
Supplemental cash flow information:
Cash payments for interest.............................. $ 17.5 $ 81.0
Non-cash investing and financing activities:
Property and equipment acquired under capitalized
leases................................................. $ 3.7 $ 5.2
</TABLE>
See notes to unaudited interim consolidated financial statements.
F-28
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions)
Note 1 -- Basis of Presentation
Blockbuster Inc. and its subsidiaries (the "Company" or "Blockbuster") own,
operate and franchise videocassette rental and sales stores in the United
States and a number of foreign countries. The Company offers pre-recorded
videocassettes primarily for rental and also offers titles for purchase on a
"sell-through" (retail) basis. In addition, the Company offers video games for
rental and sale and sells certain other entertainment-related merchandise.
The consolidated financial statements and related notes for the nine month
periods ended September 30, 1998 and 1999 and as of December 31, 1998 and
September 30, 1999 have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission ("SEC"). The
consolidated financial statements for the periods prior to the Company's
initial public offering discussed below (the "Offering") are presented on a
carve-out basis and reflect the historical results of operations, financial
position and cash flows of the Company, including entities owned by
Blockbuster or purchased from affiliates of Viacom Inc. ("Viacom") in the case
of certain of its international operations. In this context, no historical
direct ownership relationship existed among the various entities comprising
Blockbuster prior to the Offering; accordingly, Viacom and its subsidiaries'
net investment in Blockbuster was included in Viacom's net equity investment
in the consolidated financial statements.
As a part of the reorganization transactions (discussed below), the Company
purchased stock and/or assets from affiliates of Viacom with cash funded by a
bank credit agreement or contributed by Viacom in order to acquire certain
international operations of the Company. Advances from Viacom to Blockbuster
to fund these operations were historically treated as intercompany notes in
the accompanying consolidated financial statements. The difference between the
recorded intercompany notes payable to Viacom and the ultimate amount of the
purchase price for the stock or assets of these operations was recognized as
an adjustment to stockholders' equity (see Note 4).
Prior to the Offering, the following transactions were completed: (1) in
late 1998, numerous U.S. subsidiaries of Viacom International Inc., a wholly
owned subsidiary of Viacom, each of which were directly or indirectly involved
in the Company's operations, were merged with and into the Company, (2) on
December 31, 1998, the Company declared a $1.4 billion dividend payable to
Viacom International Inc. which was reflected as an interest-bearing note in
the accompanying December 31, 1998 consolidated balance sheet, (3) effective
June 21, 1999, the Company entered into a term and revolving credit agreement
with a syndicate of lenders which was used to repay debt owed to Viacom and to
pay a portion of the purchase price to acquire certain international
operations from affiliates of Viacom, (4) effective on or about June 23, 1999,
the Company purchased certain international operations of the Company from
affiliates of Viacom, (5) effective August 3, 1999, the Company was
recapitalized with Class A common stock and Class B common stock of which
144,000,000 shares of Class B common stock were simultaneously issued to
Viacom International Inc. in exchange for 100 shares of common stock of the
Company (which represented all of the issued and outstanding common stock of
the Company at that time) and, (6) effective on the Offering date,
Blockbuster's intercompany cash transactions with Viacom were capitalized into
Viacom's net equity investment.
On August 10, 1999 the Company sold shares of Class A common stock to the
public which began trading on the New York Stock Exchange on August 11, 1999.
The Offering consisted of 31,000,000 shares of Class A common stock sold at a
price to the public of $15 per share. Proceeds from the Offering aggregated
$430.7 million, net of underwriting discounts and commissions of $22.1 million
and Offering expenses of $12.2 million. The gross proceeds from the Offering,
net of underwriting discounts and commissions, $442.9 million, were used to
pay down the Company's short-term revolver due June 19, 2000 (see Note 6).
Subsequent to the Offering,
F-29
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 1 -- Basis of Presentation -- (continued)
through Viacom International Inc.'s ownership of 100 percent of the Company's
Class B common stock, Viacom owns approximately 82 percent of the Company's
common stock representing approximately 96 percent of the combined voting
power of all classes of voting stock of Blockbuster. The holders of Class A
and Class B common stock generally have identical rights, except that holders
of Class A common stock are entitled to one vote per share while holders of
Class B common stock are entitled to five votes per share on matters to be
voted on by stockholders.
In the opinion of management, the accompanying financial statements include
all recurring adjustments and normal accruals necessary to present fairly the
Company's financial position and its 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.
These financial statements should be read in conjunction with the more
detailed audited financial statements for the year ended December 31, 1998,
included in the Company's prospectus dated August 10, 1999.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Net Income (Loss) Per Share
Effective August 3, 1999, as discussed above, the Company was recapitalized
to provide for Class A common stock and Class B common stock. In accordance
with SEC Staff Accounting Bulletin No. 98, the capitalization of Class B
common stock has been retroactively reflected for the purposes of presenting
net income (loss) per share for the periods prior to the Offering.
Unaudited pro forma basic and diluted net income (loss) per share includes
the shares of both Class A and Class B common stock outstanding as of the date
of the Offering. Unaudited pro forma basic and diluted net income (loss) per
share are the same since the Company options granted in connection with the
Offering have an exercise price equal to the initial offering price. Pro forma
basic and diluted net income (loss) per share have been presented for the most
recent interim period.
Comprehensive Income (Loss)
Comprehensive income (loss) for the nine months ended September 30 was as
follows:
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------
1998 1999
--------- --------
<S> <C> <C>
Net income (loss)......................................... $ (323.7) $ (62.4)
Foreign currency translation adjustment................... (16.9) 12.2
--------- --------
Total comprehensive income (loss)......................... $ (340.6) $ (50.2)
========= ========
</TABLE>
F-30
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 2 -- Change in Accounting Method for Rental Library
Effective April 1, 1998, Blockbuster adopted an accelerated method of
amortizing its videocassette and game rental library. Blockbuster adopted this
new method of amortization because it implemented a new business model,
including revenue sharing agreements with Hollywood studios, which
dramatically increased the number of videocassettes in the stores and is
satisfying consumer demand over a shorter period of time. Revenue sharing
allows Blockbuster to purchase videocassettes at a lower product cost than the
traditional buying arrangements, with a percentage of the net rental revenues
shared with the studios over a contractually determined period of time. As the
new business model results in a greater proportion of rental revenue over a
shorter period of time, Blockbuster changed its method of amortizing rental
library in order to more closely match expenses in proportion with the
anticipated revenues to be generated therefrom.
Pursuant to the new accounting method, the Company records base stock
videocassettes (generally less than five copies per title for each store) at
cost and amortizes a portion of these costs on an accelerated basis over three
months, generally to $8 per unit, with the remaining base stock videocassette
cost amortized on a straight-line basis over 33 months to an estimated $4
salvage value. The cost of non-base stock videocassettes (generally greater
than four copies per title for each store) are amortized on an accelerated
basis over three months to an estimated $4 salvage value. Video games are
amortized on an accelerated basis over a 12-month period to an estimated $10
salvage value. Revenue sharing payments are expensed when revenues are earned
pursuant to the applicable contractual arrangements.
The new method of accounting was applied to the rental library that was
held at April 1, 1998. The adoption of the new method of amortization was
accounted for as a change in accounting estimate effected by a change in
accounting principle and, accordingly, the Company recorded a non-cash pre-tax
charge of $424.3 million to cost of rental revenues in the second quarter of
1998. The charge represented an adjustment to the carrying value of the rental
tapes due to the new method of accounting.
The Company believes that the new amortization method developed for
Blockbuster's new business model results in a better matching of revenue and
expense recognition. Under the new model, cost of sales attributable to
videocassettes is comprised of revenue sharing payments, which are expensed
when the related revenue is recognized, amortization of product costs and
residual values of previously viewed tapes and games upon sale.
Prior to April 1, 1998, the videocassette rental library was recorded at
cost and amortized over its estimated economic life. Base stock videocassettes
(generally 1 to 4 copies per title for each store) were amortized over 36
months on a straight-line basis. Non-base stock videocassettes (generally the
fifth and succeeding copies per title for each store) were amortized over six
months on a straight-line basis. Video game library was amortized on a
straight-line basis over a period of 12 to 24 months.
Note 3 -- Related Party Transactions
Effective with the Offering, Blockbuster and Viacom have entered into a
transition services agreement whereby Viacom is providing the Company with
cash management, accounting, management information systems, legal, financial
and tax services as well as employee benefit plan and insurance
administration. These services may change upon agreement between Viacom and
the Company. The fee for these services approximates Viacom's cost and could
be subject to adjustment. The Company has agreed to pay or reimburse Viacom
for any out-of-pocket payments, costs and expenses associated with these
services. The services agreement expires upon
F-31
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 3 -- Related Party Transactions -- (continued)
the closing of a split-off or similar transaction. Prior to the Offering the
allocation of these expenses was generally based on actual costs incurred by
Viacom. The charges for such services were $9.0 million and $7.7 million for
the nine months ended September 30, 1998 and 1999, respectively.
Viacom also pays certain insurance premiums on behalf of the Company.
Insurance expense related to these premiums was $11.9 million and $9.1
million, respectively, for the nine months ended September 30, 1998 and 1999.
Viacom also has a noncontributory defined benefit pension plan in which the
Company's employees are covered and provides other employee benefits. The
Company's employees participated in Viacom's 401(k) savings plan until April
1999. At that time the Company set up its own 401(k) savings plan that mirrors
the Viacom 401(k) savings plan. The Company continues to invest matching
contributions in Viacom's Class B common stock. Viacom has charged the Company
$3.8 million and $4.2 million for pension and 401(k) savings plan expenses for
the nine months ended September 30, 1998 and 1999, respectively.
Viacom generally does not charge the Company interest on intercompany
balances except for intercompany debt associated with certain foreign
operations, the note associated with the $1.4 billion dividend payable to
Viacom International Inc. and the notes associated with the acquisition of
franchise operations discussed in Note 4. Interest expense related to
intercompany debt for the nine months ended September 30, 1998 and 1999 was
$5.6 million and $49.1 million, respectively. There was no related party
interest expense for the three months ended September 30, 1999.
The Company, through the normal course of business, is involved in
transactions with companies owned by or affiliated with Viacom. The Company
purchases certain videocassettes for rental and sale directly from Paramount
Pictures Corporation. Total purchases were $86.2 million and $76.6 million,
respectively, for the nine months ended September 30, 1998 and 1999. The
Company also purchases certain home video games from Midway Games, Inc. Total
amounts paid for purchases were $13.4 million and $9.8 million for the nine
months ended September 30, 1998 and 1999, respectively.
In conjunction with the sale by a related party of Blockbuster Music
("Music") to Wherehouse Entertainment, Inc. ("Wherehouse"), the Company
assumed certain liabilities as a result of the disposition of Music with a
corresponding reduction to Viacom's net equity investment. The nature of these
liabilities was predominantly for obligations related to closed Music stores
excluded from the sale and, to a lesser extent, certain transaction costs and
various costs to complete the transition of operations from Music to
Wherehouse. These liabilities at the date of assignment aggregated
approximately $67 million of which $21.5 million remains in current
liabilities at September 30, 1999.
All other transactions with companies owned by or affiliated with Viacom
did not have a material impact on the financial position or results of
operations presented herein.
Note 4 -- Notes Payable to Viacom
On December 31, 1998, the Company declared a cash dividend in the amount of
$1.4 billion payable to Viacom International Inc. in the form of an interest-
bearing promissory note. On January 24, 1999, Blockbuster
F-32
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 4 -- Notes Payable to Viacom -- (continued)
acquired 69 stores from a franchisee which was funded with the proceeds of two
notes payable to Viacom which approximated $77 million. These notes bore
interest at LIBOR plus 1% and were repaid with proceeds from the Company's new
credit agreement on or about June 23, 1999 as discussed in Note 6.
On or about June 23, 1999, the Company purchased certain of its
international operations from affiliates of Viacom. The total amount paid for
the international operations was $222 million. Approximately $65 million of
funds under the Company's new credit agreement, as discussed in Note 6, was
used towards the purchase price. The remaining $157 million was paid with cash
from Viacom and has been recognized as a capital contribution in Viacom's net
equity investment.
Note 5 -- Sales of Store Operations
During the nine months ended September 30, 1999, Blockbuster sold certain
stores to franchisees for $14.9 million and $8.3 million as part of the
Company's strategy to maintain an optimal mix of Company-operated and
franchised stores. As a result of these sales, Blockbuster received $14.2
million and $4.7 million in cash and $0.7 million and $3.6 million in notes
receivable and recognized gains of $6.0 million and $2.3 million, as a
reduction of general and administrative expenses. The principal and accrued
interest on the notes are due on June 30, 2000 and October 25, 2004,
respectively and bear interest at prime plus 1% (8.250% at September 30, 1999)
and 9%, respectively.
Note 6 -- Credit Agreement
On June 21, 1999, Blockbuster entered into a $1.9 billion unsecured credit
agreement (the "Blockbuster Credit Agreement") with a syndicate of banks. The
Blockbuster Credit Agreement is comprised of a $700 million revolver due July
1, 2004, a $600 million term loan due in quarterly installments beginning
April 1, 2002 and ending July 1, 2004, and a $600 million revolver due June
19, 2000, which was subsequently reduced with proceeds from the Offering as
described below. Interest rates are based on the prime rate or LIBOR at
Blockbuster's option at the time of borrowing. A varying commitment fee is
charged on the unused amount of the revolver.
The Blockbuster Credit Agreement contains covenants, which among other
things, relate to the payment of dividends, repurchase of Blockbuster's common
stock or other distributions and also require compliance with financial
covenants with respect to a maximum leverage ratio and a minimum fixed charge
ratio.
On June 23, 1999, Blockbuster borrowed $1.6 billion, comprised of $400
million borrowed under the long-term revolver, $600 million borrowed under the
term loan, and $600 million under the short-term revolver. The weighted
average interest rate at September 30, 1999 for these borrowings was 7.2%. The
proceeds of the borrowings were used to pay amounts owed to Viacom.
Blockbuster has repaid $442.9 million of the short-term revolver through
proceeds from the Offering. These proceeds permanently reduced Blockbuster's
commitments under the Blockbuster Credit Agreement from $1.9 billion to
approximately $1.46 billion.
Note 7 -- Commitments and Contingencies
Certain leases transferred in connection with the sale of Music to
Wherehouse had previously been guaranteed either by Viacom or its affiliates.
The remaining lease terms expire on various dates through 2007. Blockbuster
has agreed to indemnify Viacom with respect to any amount paid under these
guarantees. At the
F-33
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 7 -- Commitments and Contingencies -- (continued)
time of the sale, the contingent liability for base rent approximated $84
million, on an undiscounted basis, with respect to these guarantees. The
Company has not recognized any reserves related to this contingent liability
in the accompanying consolidated financial statements. If Wherehouse defaults,
related losses could materially affect future operating income.
Pursuant to a tax matters agreement entered into between the Company and
Viacom effective as of the consummation of the Offering, the Company is
generally responsible for, among other things, any taxes imposed on Viacom or
its subsidiaries as a result of the split-off or other similar transaction
failing to qualify as a tax-free transaction on account of any breach of the
Company's representations or agreements or any action or failure to act by the
Company or any transactions involving the Company's assets, stock or business
(regardless of whether such transaction is within its control) following the
split-off or similar transaction.
On July 21, 1999, Ruben Loredo, doing business as Five Palms Video,
purporting to act as a class representative on behalf of himself and all
others similarly situated, filed a complaint in the District Court of Bexar
County, Texas, against Blockbuster. Blockbuster removed the case to the United
States District Court for the Western District of Texas, and the plaintiff has
filed a motion to have the case remanded to the state court. The plaintiff
asserts that by entering into and operating under the Company's revenue-
sharing agreements, the Company has attempted to and conspired with the
studios to monopolize and restrain competition in the market for the retail
rental of videocassettes. The plaintiff is seeking triple the amount of his
alleged actual damages and triple the amount of alleged actual damages of
those similarly situated, under the Texas Free Enterprise and Antitrust Act.
The dollar amount that the plaintiff is alleging as the actual damages to
himself and those similarly situated is not set forth in his complaint. The
Company believes that the plaintiff's position is completely without merit,
and the Company intends to vigorously defend itself in the litigation.
In addition, another party, purporting to act as a class representative on
behalf of itself and all others similarly situated, filed a substantially
similar complaint in the United States District Court for the Western District
of Texas against Viacom and the studios' home video subsidiaries that have
operated under these revenue-sharing agreements with Blockbuster. This
plaintiff is seeking triple the amount of alleged actual damages to itself and
triple the amount of alleged actual damages of those similarly situated, as
well as preliminary and permanent injunctive relief prohibiting any unlawful
attempt or conspiracy to monopolize the market for the retail rental of
videocassettes. If Viacom is required to pay any damage award as a result of
this litigation, Viacom may seek indemnification for its losses from the
Company pursuant to the terms of a release and indemnification agreement
entered into between the Company and Viacom effective as of the consummation
of the Offering.
The Company is a defendant from time to time in other lawsuits incidental
to its business. Based on currently available information, the Company
believes that resolution of these known contingencies would not have a
material adverse impact on the Company's financial statements or liquidity.
However, there can be no assurances that future costs would not be material to
results of operations or liquidity of the Company for a particular period. In
addition, the Company's estimates of future costs are subject to change as
circumstances change and additional information becomes available during the
course of litigation.
Note 8 -- Long-Term Management Incentive Plan
On July 15, 1999, Blockbuster's Board of Directors adopted the 1999 Long-
Term Management Incentive Plan (the "Plan") for the benefit of its employees
and directors. The Company applies Accounting Principles
F-34
<PAGE>
BLOCKBUSTER INC.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)
(Unaudited)
(Tabular dollars in millions)
Note 8 -- Long-Term Management Incentive Plan -- (continued)
Board Opinion 25 "Accounting for Stock Issued to Employees" and related
interpretations in accounting for its stock-based compensation plan. An
aggregate of 25,000,000 shares of Class A common stock is reserved for
issuance under the Plan, which provides for the issuance of stock-based
incentive awards, including stock options to purchase shares of Class A common
stock, stock appreciation rights, restricted shares of Class A common stock,
restricted share units and phantom shares. Options to purchase 11,481,908
shares of Class A common stock were granted under the Plan effective as of
August 11, 1999. The exercise price of these options was equal to the initial
public offering price. The options will generally vest over a five year period
beginning on the first anniversary of the date of the grant.
Note 9 -- Subsequent Events and Other Matters
On October 20, 1999, the Board of Directors declared a cash dividend of
$0.02 per share of Class A and Class B common stock, payable November 22,
1999, to stockholders of record at the close of business on November 1, 1999.
The total dividend payment will approximate $3.5 million of which
approximately $2.9 million will be paid to Viacom International Inc.
On November 3, 1999 the Company and America Online, Inc. ("America Online")
announced a three-year strategic alliance. As part of the agreement, America
Online will make a $30 million investment, representing approximately 2.75%
ownership, in Blockbuster.com that will be used for, among other things, joint
development of broadband content and delivery. If an initial public offering
of Blockbuster.com is not completed within 18 months of the closing of the
transaction, America Online will have the option to recover its investment
plus cost of capital.
Viacom has announced that, subject to Viacom board approval, which will be
based on an assessment of market conditions, and the receipt of a supplemental
tax ruling from the Internal Revenue Service reflecting a proposed merger
between Viacom and CBS Corporation ("CBS"), it intends to split-off
Blockbuster by offering to exchange all of its shares of Blockbuster for
shares of Viacom's common stock. Viacom has no obligation to effect the split-
off either before or after the merger. Viacom has indicated that it cannot
give any assurance as to whether or not or when the split-off will occur or as
to the terms of the split-off if it does occur, or whether or not the split-
off, if it does occur, will be tax-free.
F-35
<PAGE>
SCHEDULE A
TRANSACTIONS CONCERNING SHARES OF VIACOM
CLASS A AND CLASS B COMMON STOCK
Neither Viacom, nor any of its subsidiaries, nor, to Viacom's knowledge,
any of its executive officers or directors or associates of any of these
companies, has engaged in any transaction involving shares of Viacom class A
or class B common stock during the period of forty business days prior to the
date of this document except for the following transactions by certain of
Viacom's executive officers:
CLASS A COMMON STOCK
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
DATE OF OF OF PRICE PER
PERSON EFFECTING TRANSACTION TRANSACTION SHARES TRANSACTION SHARE
- ---------------------------- ----------- ------ ----------- ---------
<S> <C> <C> <C> <C>
CLASS B COMMON STOCK
<CAPTION>
NUMBER DESCRIPTION
DATE OF OF OF PRICE PER
PERSON EFFECTING TRANSACTION TRANSACTION SHARES TRANSACTION SHARE
- ---------------------------- ----------- ------ ----------- ---------
<S> <C> <C> <C> <C>
</TABLE>
A-1
<PAGE>
Manually signed facsimile copies of the letter of transmittal will be
accepted. The letter of transmittal, certificates for shares of Viacom class A
or class B common stock and any other required documents should be sent or
delivered by each Viacom shareholder or his or her broker, dealer, commercial
bank, trust company or other nominee to the exchange agent at one of the
following addresses:
If by mail: If by overnight courier: If by hand:
If by facsimile transmission:
(For eligible institutions only)
( ) -
or
( ) -
Facsimile confirmation number
( ) -
You may direct any questions and requests for assistance to the information
agent or the dealer manager at their respective addresses and telephone
numbers and locations listed below. Additional copies of this document, the
letter of transmittal and other exchange offer material may be obtained from
the information agent or the dealer manager listed below. You may also contact
your broker, dealer, commercial bank or trust company for assistance
concerning this exchange offer.
The information agent for this exchange offer is:
United States and Canada
or
Call Toll-Free ( ) -
Outside United States and Canada
( ) - (Collect)
The dealer manager for this exchange offer is:
( ) -
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law provides, in summary,
that directors and officers of Delaware corporations are entitled, under
certain circumstances, to be indemnified against all expenses and liabilities,
including attorneys' fees, incurred by them as a result of suits brought
against them in their capacity as a director or officer, if they acted in good
faith and in a manner they reasonably believed to be in or not opposed to the
best interests of the company, and, with respect to any criminal action or
proceeding, if they had no reasonable cause to believe their conduct was
unlawful; provided that no indemnification may be made against expenses in
respect of any claim, issue or matter as to which they shall have been
adjudged to be liable to the company, unless and only to the extent that the
court in which such action or suit was brought shall determine upon
application that, despite the adjudication of liability but in view of all the
circumstances of the case, they are fairly and reasonably entitled to
indemnity for such expenses which the court shall deem proper. Any such
indemnification may be made by the company only as authorized in each specific
case upon a determination by the stockholders or disinterested directors that
indemnification is proper because the indemnitee has met the applicable
standard of conduct.
The Registrant's Amended and Restated Certificate of Incorporation provides
that to the fullest extent permitted by the laws of the State of Delaware, as
the same may be amended from time to time, a director of the Registrant shall
not be personally liable to the Registrant or its stockholders for monetary
damages for breach of fiduciary duty as a director.
The Registrant's Amended and Restated Certificate of Incorporation and
Bylaws provide for indemnification of its directors and officers to the
fullest extent permitted by Delaware law, as the same may be amended from time
to time.
In addition, the Registrant maintains liability insurance for its directors
and officers.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits.
See the Exhibit Index.
(b) Financial Statement Schedules.
The schedules have been omitted because of the absence of circumstances
under which they could be required.
ITEM 22. UNDERTAKINGS
The undersigned Registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, as amended (the
"Securities Act"), each filing of the Registrant's annual report under Section
13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") (and, where applicable, each filing of an employee benefit
plan's annual report under Section 15(d) of the Exchange Act), that is
incorporated by reference in this Registration Statement shall be deemed to be
a new registration statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the initial
bona fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant under the foregoing provisions, or otherwise, the Registrant
II-1
<PAGE>
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities
Act and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the Registrant will, unless
in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the
Securities Act and will be governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes to respond to requests for
information that is incorporated by reference into the Prospectus-Offer to
Exchange under Item 4, 10(b), 11 or 13 of this Form, within one business day
of receipt of such request, and to send the incorporated documents by first
class mail or other equally prompt means. This includes information contained
in documents filed subsequent to the effective date of this Registration
Statement through the date of responding to the request. The undersigned
Registrant hereby undertakes to supply by means of a post-effective amendment
all information concerning a transaction, and the company being acquired
involved therein, that was not the subject of and included in this
Registration Statement when it becomes effective.
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being made,
a post-effective amendment to this Registration Statement:
(a) To include any Prospectus-Offer to Exchange required by Section
10(a)(3) of the Securities Act;
(b) To reflect in the Prospectus-Offer to Exchange any facts or
events arising after the effective date of the Registration Statement
(or the most recent post-effective amendment thereof) which,
individually or in the aggregate, represent a fundamental change in the
information set forth in this Registration Statement. Notwithstanding
the foregoing, any increase or decrease in volume of securities offered
(if the total dollar value of securities offered would not exceed that
which was registered) and any deviation from the low or high end of the
estimated maximum offering range may be reflected in the form of the
Prospectus-Offer to Exchange filed with the Securities and Exchange
Commission under Rule 424(b) if, in the aggregate, the changes in
volume and price represent no more than 20 percent change in the
maximum aggregate offering price set forth in the "Calculation of
Registration fee" table in the effective registration statement; and
(c) To include any material information with respect to the plan of
distribution not previously disclosed in this Registration Statement or
any material change to such information in this Registration Statement.
(2) That, for the purpose of determining any liability under the
Securities Act, each such post-effective amendment shall be deemed to be a
new Registration Statement relating to the securities offered therein, and
the offering of such securities at that time shall be deemed to be the
initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
Registrant certifies that it has duly caused this Registration Statement on
Form S-4 to be signed on its behalf by the undersigned, thereunto duly
authorized, in Dallas, Texas on December 14, 1999.
BLOCKBUSTER INC.
By: /s/ Edward B. Stead
----------------------------------
Edward B. Stead
Executive Vice President,
General Counsel and
Secretary
POWER OF ATTORNEY
The undersigned Directors and Officers of Blockbuster Inc. hereby constitute
and appoint Edward B. Stead as true and lawful attorney-in-fact for the
undersigned, with full power of substitution and resubstitution, for and in the
name, place and stead of the undersigned, to sign and file with the Securities
and Exchange Commission under the Securities Act of 1933, as amended (the
"Securities Act"), any and all amendments (including post-effective amendments)
and exhibits to this Registration Statement, any related registration statement
and its amendments and exhibits filed pursuant to Rule 462(b) under the
Securities Act and any and all applications and other documents to be filed
with the Securities and Exchange Commission pertaining to the registration of
the securities covered hereby or under any related registration statement or
any amendment hereto or thereto, with full power and authority to do and
perform each and every act and thing requisite and necessary or desirable,
hereby ratifying and confirming all that such attorney-in-fact or its
substitute shall lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act, this Registration
Statement has been signed below by the following persons in the capacities
indicated.
<TABLE>
<CAPTION>
Signature Title Date
--------- ----- ----
<S> <C> <C>
/s/ John F. Antioco Chairman, President and December 14, 1999
______________________________________ Chief Executive Officer
John F. Antioco
/s/ Larry J. Zine Executive Vice President, December 14, 1999
______________________________________ Chief Financial Officer
Larry J. Zine and Chief Accounting
Officer
/s/ Philippe P. Dauman Director December 14, 1999
______________________________________
Philippe P. Dauman
/s/ Thomas E. Dooley Director December 14, 1999
______________________________________
Thomas E. Dooley
/s/ Linda Griego Director December 14, 1999
______________________________________
Linda Griego
/s/ John L. Muething Director December 14, 1999
______________________________________
John L. Muething
/s/ Sumner M. Redstone Director December 14, 1999
______________________________________
Sumner M. Redstone
</TABLE>
II-3
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
----------- ------------------------------------------------------------------
<C> <S>
*****3.1 Amended and Restated Certificate of Incorporation of the
Registrant.
****3.2 Bylaws of the Registrant.
***4.1 Specimen of the certificate representing the class A common stock.
*5.1 Opinion of Shearman & Sterling as to the legality of the class A
common stock.
*8.1 Opinion of Paul, Weiss, Rifkind, Wharton & Garrison regarding tax
matters.
******10.1 Initial Public Offering and Split-Off Agreement among the
Registrant, Viacom International Inc.
and Viacom Inc.
******10.2 Release and Indemnification Agreement between the Registrant and
Viacom Inc.
******10.3 Transition Services Agreement between the Registrant and Viacom
Inc.
******10.4 Registration Rights Agreement between the Registrant and Viacom
Inc.
******10.5 Tax Matters Agreement between the Registrant and Viacom Inc.
****+10.6 Revenue-Sharing Agreement, dated as of November 21, 1997, between
the Registrant and Buena Vista Home Entertainment, Inc.
****+10.7 Revenue-Sharing Agreement, dated as of September 29, 1998, between
the Registrant and Twentieth Century Fox Home Entertainment, Inc.
****+10.8 Revenue-Sharing Agreement, dated as of August 25, 1998, between
the Registrant and Columbia TriStar Home Video, Inc.
****+10.9 Direct Revenue-Sharing Adjustable License Agreement, dated as of
October 13, 1998, between the Registrant and Universal Studios
Home Video.
****+10.10 Revenue-Sharing Agreement, dated as of January 20, 1999, between
the Registrant and Warner Home Video, a division of Time Warner
Entertainment Company, L.P.
****+10.11 Revenue-Sharing Term Sheet, dated as of July 29, 1999, between the
Registrant and Paramount Home Video.
****10.12 Employment Agreement between the Registrant and John F. Antioco,
dated July 15, 1999.
****10.13 Employment Agreement between Blockbuster Entertainment Group, a
business unit of Viacom Inc., and Jim Notarnicola, dated June 1,
1998.
****10.14 Employment Agreement between Blockbuster Entertainment Group, a
business unit of Viacom Inc., and Edward B. Stead, dated September
2, 1997.
****10.15 Amendment to the Employment Agreement between Blockbuster
Entertainment Group, a business unit of Viacom Inc., and Edward B.
Stead, dated December 1, 1998.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibit
---------- -------------------------------------------------------------------
<C> <S>
****10.16 Employment Agreement between Blockbuster Entertainment Group, a
business unit of Viacom Inc., and Nigel Travis, dated June 1, 1998.
****10.17 Amendment to the Employment Agreement between Blockbuster
Entertainment Group, a business unit of Viacom Inc., and Nigel
Travis, dated December 1, 1998.
*****10.18 Blockbuster Inc. 1999 Long-Term Management Incentive Plan.
****10.19 Blockbuster Inc. Senior Executive Short-Term Incentive Plan.
**10.20 Credit Agreement, dated as of June 21, 1999, between the Registrant
and the banks named therein.
*10.21 Promotional Services and Customer Database Services and License
Agreement between the Registrant and MTV Networks, a division of
Viacom International Inc.
****21.1 List of Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
23.3 Consent of KPMG LLP.
23.4 Consent of Arthur Andersen LLP.
*23.5 Consent of Shearman & Sterling (included in its opinion in Exhibit
5.1).
*23.6 Consent of Paul, Weiss, Rifkind, Wharton & Garrison (included in
its opinion in Exhibit 8.1).
24.1 Power of Attorney (included on signature page of this Registration
Statement).
*27.1 Financial Data Schedule (June 30, 1999).
*99.1 Form of letter of transmittal.
*99.2 Form of notice of guaranteed delivery.
*99.3 Form of letter from the dealer manager to brokers, dealers,
commercial banks, trust companies and other nominees.
*99.4 Form of letter to clients for use by brokers, dealers, commercial
banks, trust companies and other nominees.
*99.5 Form of letters from trustees or administrators of investment plans
of Viacom or affiliates of Viacom.
</TABLE>
- --------
<TABLE>
<C> <S>
* To be filed by amendment.
** Incorporated by reference to the Registrant's Amendment No. 2 to the
Registration Statement on Form S-1 filed with the Securities and
Exchange Commission on July 2, 1999.
*** Incorporated by reference to the Registrant's Amendment No. 3 to the
Registration Statement on Form S-1 filed with the Securities and
Exchange Commission on July 19, 1999.
**** Incorporated by reference to the Registrant's Amendment No. 4 to the
Registration Statement on Form S-1 filed with the Securities and
Exchange Commission on July 30, 1999.
***** Incorporated by reference to the Registrant's Amendment No. 5 to the
Registration Statement on Form S-1 filed with the Securities and
Exchange Commission on August 3, 1999.
****** Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q for the quarter ended September 30, 1999 filed with the Securities
and Exchange Commission on November 15, 1999.
+ Exhibits for which the Registrant has received confidential treatment
for certain portions. The confidential material in such exhibits has
been redacted and separately filed with the Securities and Exchange
Commission as part of its Registration Statement on Form S-1, as
amended.
</TABLE>
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in this Registration Statement on Form S-4 of our
report dated May 4, 1999, except as to the fourth paragraph of Note 1 which is
as of August 3, 1999, relating to the consolidated financial statements of
Blockbuster Inc., which appears in such Registration Statement. We also consent
to the reference to us under the heading "Experts" in such Registration
Statement.
/s/ PricewaterhouseCoopers LLP
- ------------------------------
Dallas, Texas
December 13, 1999
<PAGE>
EXHIBIT 23.2
Consent of Independent Accountants
----------------------------------
We hereby consent to the incorporation by reference in this Registration
Statement on Form S-4 of Blockbuster Inc. of our report dated February 8, 1999,
except for the first paragraph of Note 2, which is as of February 25, 1999,
relating to the financial statement schedule appearing in Viacom Inc.'s Annual
Report on Form 10-K for the year ended December 31, 1998. We also consent to the
reference to us under the heading "Experts" in such Registration Statement.
/s/ PricewaterhouseCoopers LLP
------------------------------
New York, New York
December 13, 1999
<PAGE>
EXHIBIT 23.3
CONSENT OF INDEPENDENT AUDITORS
We consent to the use of our report dated January 27, 1999,
appearing on page 21 of CBS Corporation's Form 10-K/A and page 55 of CBS
Corporation's Form 10-K for the year ended December 31, 1998, incorporated by
reference in this registration statement and the reference to our firm under the
heading "Experts" in this registration statement.
/s/ KPMG LLP
- ------------
New York, New York
December 10, 1999
<PAGE>
EXHIBIT 23.4
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference in this registration statement on Form S-4 of our report dated
November 18, 1999 with respect to the consolidated balance sheets of King World
Productions, Inc. as of August 31, 1999 and 1998, and the related consolidated
statements of income, stockholders' equity and cash flows for each of the years
in the three year period ended August 31, 1999, which report appears in the Form
8-K of CBS Corporation, and to all references to our firm included in this
registration statement.
/s/ Arthur Andersen LLP
-----------------------------
New York, New York
December 10, 1999
