<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ___________
Commission File Number 001-15153
BLOCKBUSTER INC.
(Exact name of registrant as specified in its charter)
Delaware 52-1655102
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1201 Elm Street
Dallas, Texas 75270
Telephone (214) 854-3000
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes X No
----- -----
Number of shares of common stock outstanding at November 1, 2000:
Class A common stock, par value $.01 per share: 31,011,114
Class B common stock, par value $.01 per share: 144,000,000
<PAGE>
BLOCKBUSTER INC.
INDEX TO FORM 10-Q
<TABLE>
<CAPTION>
PART I--FINANCIAL INFORMATION
Page
----
Item 1. Consolidated Financial Statements
<S> <C>
Consolidated Statements of Operations (Unaudited)--for the Three Months and Nine Months ended
September 30, 1999 and September 30, 2000........................................................... 3
Consolidated Balance Sheets--at December 31, 1999 and September 30, 2000 (Unaudited).................. 4
Consolidated Statements of Cash Flows (Unaudited)--for the Nine Months ended September 30,
1999 and September 30, 2000......................................................................... 5
Notes to Consolidated Financial Statements (Unaudited)................................................ 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........... 14
Item 3. Quantitative and Qualitative Disclosures About Market Risk...................................... 24
PART II--OTHER INFORMATION
Item 1. Legal Proceedings............................................................................... 25
Item 6. Exhibits and Reports on Form 8-K................................................................ 25
</TABLE>
2
<PAGE>
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In millions, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
1999 2000 1999 2000
----------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Rental revenues...................................... $ 951.4 $ $1,019.0 $ 2,790.7 $ 3,072.8
Merchandise sales.................................... 138.9 146.1 413.5 478.6
Other revenues....................................... 22.5 28.7 63.3 67.9
----------- ------------ ----------- -----------
1,112.8 1,193.8 3,267.5 3,619.3
----------- ------------ ----------- -----------
Cost of sales:
Cost of rental revenues.............................. 322.8 364.2 949.0 1,097.3
Cost of merchandise sold............................. 108.6 107.9 320.6 372.6
----------- ------------ ----------- -----------
431.4 472.1 1,269.6 1,469.9
----------- ------------ ----------- -----------
Gross profit......................................... 681.4 721.7 1,997.9 2,149.4
----------- ------------ ----------- -----------
Operating expenses:
General and administrative........................... 489.6 552.5 1,441.8 1,601.1
Advertising.......................................... 63.2 50.1 182.9 165.7
Depreciation......................................... 56.8 57.4 163.1 180.7
Amortization of intangibles.......................... 43.2 44.0 128.7 132.5
----------- ------------ ----------- -----------
652.8 704.0 1,916.5 2,080.0
----------- ------------ ----------- -----------
Operating income......................................... 28.6 17.7 81.4 69.4
Interest expense..................................... (30.7) (29.0) (90.6) (88.0)
Interest income...................................... 0.7 1.6 1.8 5.2
Other items, net..................................... 1.7 0.4 1.5 2.5
----------- ------------ ----------- -----------
Income (loss) before income taxes........................ 0.3 (9.3) (5.9) (10.9)
Provision for income taxes........................... (17.7) (10.1) (52.4) (40.7)
Equity in income (loss) of affiliated
companies, net of tax............................. (1.7) 0.1 (4.1) 0.3
----------- ------------ ----------- -----------
Net loss................................................. $ (19.1) $ (19.3) $ (62.4) $ (51.3)
=========== ============ =========== ===========
Net loss per share:
Basic and diluted.................................... $ (0.12) $ (0.11) $ (0.42) $ (0.29)
=========== ============ =========== ===========
Weighted average shares outstanding:
Basic and diluted.................................... 161.2 175.0 149.8 175.0
=========== ============ =========== ===========
Cash dividends per common share.......................... $ - $ 0.02 $ - $ 0.06
=========== ============ =========== ===========
</TABLE>
See notes to unaudited consolidated financial statements.
3
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED BALANCE SHEETS
(In millions, except per share amounts)
<TABLE>
December 31, September 30,
1999 2000
------------ ------------
(Unaudited)
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents........................................................... $ 119.6 $ 127.9
Receivables, less allowances of $11.4 (1999) and $9.4 (2000)....................... 130.8 143.2
Merchandise inventories............................................................. 281.3 214.4
Prepaid assets and other current assets............................................. 180.9 192.7
------------ ------------
Total current assets............................................................. 712.6 678.2
Rental library........................................................................ 577.6 602.9
Tax receivable from Viacom............................................................ 41.1 96.9
Property and equipment, net........................................................... 1,148.3 1,078.9
Intangibles, net...................................................................... 5,975.9 5,854.6
Other assets.......................................................................... 85.3 74.7
------------ ------------
$ 8,540.8 $ 8,386.2
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable.................................................................... $ 499.4 $ 409.8
Accrued expenses.................................................................... 422.5 379.6
Current portion of long-term debt................................................... 157.1 118.6
Current portion of capital lease obligations........................................ 29.7 19.9
Deferred taxes...................................................................... 22.7 24.5
------------ ------------
Total current liabilities........................................................ 1,131.4 952.4
Long-term debt, less current portion.................................................. 1,030.0 1,066.5
Capital lease obligations, less current portion....................................... 108.4 102.1
Deferred taxes........................................................................ 72.3 158.1
Other liabilities..................................................................... 73.7 76.0
------------ ------------
2,415.8 2,355.1
------------ ------------
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 0.3
Class B common stock, par value $.01 per share; 500.0 shares authorized; 1.4 1.4
144.0 shares issued and outstanding...............................................
Additional paid-in capital.......................................................... 6,180.3 6,169.9
Retained deficit.................................................................... (10.9) (62.2)
Accumulated other comprehensive loss - foreign currency translation adjustment...... (46.1) (78.3)
------------ ------------
Total stockholders' equity....................................................... 6,125.0 6,031.1
------------ ------------
$ 8,540.8 $ 8,386.2
============ ============
</TABLE>
See notes to unaudited consolidated financial statements.
4
<PAGE>
BLOCKBUSTER INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In millions)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-------------------------
1999 2000
---------- --------
<S> <C> <C>
Cash flows from operating activities:
Net loss............................................................................ $ (62.4) $ (51.3)
Adjustments to reconcile net loss to net cash flow provided by operating
activities:
Depreciation and amortization.................................................... 783.2 843.3
Deferred taxes................................................................... 85.0 87.6
Equity in (income) loss of affiliated companies, net of tax...................... 4.1 (0.3)
Gain on sales of store operations, net........................................... (8.3) (1.7)
Gain on sale of non-core investment.............................................. - (1.9)
Common stock issued to non-employee directors.................................... - 0.1
Change in operating assets and liabilities:
(Increase) decrease in receivables............................................... 10.7 (13.9)
Increase in tax receivable from Viacom........................................... - (55.8)
Decrease in merchandise inventories.............................................. 25.1 63.1
Increase (decrease) in prepaid and other current assets and other assets......... (27.7) 0.9
Decrease in accounts payable..................................................... (78.9) (77.0)
Decrease in accrued expenses and other liabilities............................... (6.6) (26.3)
---------- --------
Net cash flow provided by operating activities........................................ 724.2 766.8
---------- --------
Cash flows from investing activities:
Rental library purchases............................................................ (543.1) (561.7)
Capital expenditures................................................................ (266.7) (128.0)
Cash used for acquisitions.......................................................... (110.9) (33.7)
Proceeds from sales of store operations............................................. 18.9 4.8
Proceeds from sale of non-core investment........................................... - 7.1
Investments in affiliated companies................................................. (1.0) (4.0)
---------- --------
Net cash flow used in investing activities............................................ (902.8) (715.5)
---------- --------
Cash flows from financing activities:
Proceeds from credit agreement...................................................... 1,665.0 83.0
Repayments on credit agreement...................................................... (467.9) (108.0)
Proceeds from equipment term loan................................................... - 26.5
Repayments on equipment term loan................................................... - (3.5)
Repayment of notes due to Viacom.................................................... (1,576.4) -
Net proceeds from the issuance of common stock...................................... 430.7 -
Cash dividends...................................................................... - (10.5)
Capital lease payments.............................................................. (26.4) (26.6)
Capital contributions from Viacom, net.............................................. 176.8 -
---------- --------
Net cash flow provided by (used in) financing activities.............................. 201.8 (39.1)
---------- --------
Effect of exchange rate changes on cash............................................... (0.2) (3.9)
---------- --------
Net increase in cash and cash equivalents............................................. 23.0 8.3
Cash and cash equivalents at beginning of period...................................... 99.0 119.6
---------- --------
Cash and cash equivalents at end of period............................................ $ 122.0 $ 127.9
========== ========
Supplemental cash flow information:
Cash payments for interest.......................................................... $ 81.0 $ 83.7
========== ========
Noncash investing and financing activities:
Property and equipment acquired under capitalized leases............................ $ 5.2 $ 10.5
========== ========
</TABLE>
See notes to unaudited consolidated financial statements.
5
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
Note 1--Basis of Presentation
Blockbuster Inc. and its subsidiaries (the "Company" or "Blockbuster") operate
and franchise videocassette rental and sales stores in the United States and a
number of other countries. The Company offers pre-recorded videocassettes
primarily for rental and also offers titles for purchase on a "sell-through"
(retail) basis. The Company also offers DVDs and video games for rental and sale
and sells certain other entertainment-related merchandise.
The consolidated financial statements for the periods prior to the Company's
initial public offering (the "Offering") are presented on a carve-out basis and
reflect the historical results of operations, financial position and cash flows
of the Company, including entities owned by Blockbuster or purchased from
affiliates of Viacom Inc. ("Viacom") in the case of certain of its international
operations. In this context, no historical direct ownership relationship existed
among some of the various entities comprising Blockbuster prior to the Offering;
accordingly, Viacom and its subsidiaries' net investment in Blockbuster was
included in Viacom's net equity investment in the consolidated financial
statements prior to the Offering.
As a part of the reorganization transactions (discussed below), the Company
purchased stock and/or assets from affiliates of Viacom with cash funded by a
bank credit agreement or contributed by Viacom in order to acquire certain
international operations of the Company. Advances from Viacom to Blockbuster to
fund these operations were historically treated as intercompany notes in the
consolidated financial statements. The difference between the recorded
intercompany notes payable to Viacom and the ultimate amount of the purchase
price for the stock or assets of these operations was recognized as an
adjustment to stockholders' equity.
For all periods prior to the Offering, certain expenses reflected in the
consolidated financial statements include an allocation of corporate expenses
from Viacom. All such costs and expenses have been deemed to have been paid by
the Company to Viacom in the period in which the costs were recorded.
Allocations of current income taxes receivable or payable are deemed to have
been remitted, in cash, by or to Viacom in the period the related income taxes
were recorded. Management believes that the foregoing allocations were made on
a reasonable basis; however, the allocations of costs and expenses do not
necessarily indicate the costs that would have been or will be incurred by the
Company on a stand-alone basis. Also, the consolidated financial statements for
the periods prior to the Offering may not necessarily reflect the financial
position, results of operations and cash flows of the Company in the future or
what the financial position, results of operations or cash flows would have been
if the Company had been a separate, stand-alone company during the periods
presented.
Prior to the Offering, the following transactions were completed: (1) in late
1998, numerous U.S. subsidiaries of Viacom International Inc., a wholly owned
subsidiary of Viacom, each of which were directly or indirectly involved in the
Company's operations, were merged with and into the Company, (2) on December 31,
1998, the Company declared a $1.4 billion dividend payable to Viacom
International Inc. which was reflected as an interest-bearing note in the
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 to the public 31 million shares of 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, as of September 30, 1999. Of the gross
proceeds from the Offering, $442.9 million was used to pay down the short-term
revolver due December 14, 2000 as discussed in Note 6, and permanently reduced
the Company's borrowing capacity. Subsequent to the Offering, through Viacom
International Inc.'s ownership of 100 percent of the Company's class B common
stock, Viacom owns approximately 82 percent of the Company's common stock
representing approximately 96 percent of the combined voting power of all
classes of voting stock of Blockbuster. The holders of class A and class B
common stock generally have
6
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
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 consolidated 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 unaudited consolidated financial statements should be read in
conjunction with the more detailed audited consolidated financial statements for
the year ended December 31, 1999, included in the Company's Annual Report on
Form 10-K as filed with the Securities and Exchange Commission (the "SEC") on
March 24, 2000. Accounting policies used in the preparation of these unaudited
consolidated financial statements are consistent in all material respects with
the accounting policies described in the Notes to Consolidated Financial
Statements included in the Company's Form 10-K.
Use of Estimates
The preparation of consolidated 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 Loss Per Share
Basic loss per share ("EPS") is computed by dividing the net loss applicable
to common shares by the weighted average of common shares outstanding during the
period. Diluted EPS adjusts the basic weighted average of common shares
outstanding by the assumed conversion of convertible securities and exercise of
stock options only in periods in which such effect would have been dilutive.
Options to purchase approximately 14.3 million shares of class A common stock
were outstanding as of September 30, 2000 and were excluded from the computation
of the weighted average shares for diluted EPS because their inclusion would be
anti-dilutive. The table below presents a reconciliation of weighted average
shares used in the calculation of basic and diluted EPS:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- ---------------------------------
1999 2000 1999 2000
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Weighted average shares for basic EPS...................... 161.2 175.0 149.8 175.0
Incremental shares for stock options & warrants............ - - - -
--------------- --------------- --------------- ---------------
Weighted average shares for diluted EPS.................... 161.2 175.0 149.8 175.0
=============== =============== =============== ===============
</TABLE>
7
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
Comprehensive Loss
Comprehensive loss for the three months and nine months ended September 30 was
as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ----------------------------
1999 2000 1999 2000
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net loss...................................................... $(19.1) $(19.3) $(62.4) $(51.3)
Foreign currency translation adjustment....................... 5.7 (8.6) 12.2 (32.2)
------------ ------------ ------------ ------------
Total comprehensive loss...................................... $(13.4) $(27.9) $(50.2) $(83.5)
============ ============ ============ ============
</TABLE>
Note 2--Related Party Transactions
Effective with the Offering, Blockbuster and Viacom entered into a transition
services agreement whereby Viacom is providing the Company with certain cash
management, accounting, management information systems, legal, financial and tax
services as well as employee benefit plan and insurance administration, as
needed. The fee for these services approximates Viacom's cost and could be
subject to adjustment. The services agreement expires upon the closing of a
split-off or similar transaction. Prior to the Offering, the allocation of
expenses related to services provided by Viacom was generally based on actual
costs incurred by Viacom. The charges for such services for the three and nine
months ended September 30, 1999 were $1.3 million and $7.7 million,
respectively. Management believes that the methodologies used to allocate the
charges were reasonable, however, these allocations of costs and expenses do not
necessarily indicate the costs and expenses that would have been or will be
incurred by the Company on a stand-alone basis.
Prior to the Offering, Viacom paid certain insurance premiums on behalf of the
Company for certain workers compensation, property, general liability and group
insurance policies. Insurance expense related to these policies for the three
and nine months ended September 30, 1999 was $2.0 million and $9.1 million,
respectively, and is reflected as a component of general and administrative
expenses in the Consolidated Statements of Operations.
Viacom has a noncontributory defined benefit pension plan in which the
Company's employees were covered through December 31, 1999. Effective January 1,
2000, Blockbuster ceased to be a participating employer in Viacom's pension
plan. The Company's employees were also offered participation in Viacom's 401(k)
savings plan through April 1999. At that time the Company set up its own 401(k)
savings plan that generally mirrors the Viacom 401(k) savings plan. Account
balances in the Viacom plan were transferred to the new Blockbuster 401(k)
savings plan. Through June 30, 2000, the Company invested matching contributions
in Viacom's class B common stock. On July 1, 2000, the Company began investing
matching contributions in Blockbuster's class A common stock. Viacom charged the
Company $1.5 million and $4.2 million for pension and 401(k) savings plan
expenses for the three and nine months ended September 30, 1999, respectively.
Viacom charged the Company $0.7 million and $2.2 million for 401(k) savings plan
expenses for the three and nine months ended September 30, 2000, respectively.
Viacom generally has not charged 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 3. The notes payable to Viacom were refinanced on June 23,
1999 with a third party credit agreement as more fully discussed in Note 6.
Interest expense related to intercompany debt was $49.1 million for the nine
months ended September 30, 1999. There was no related party interest expense
for the three months ended September 30, 1999 or for any period in 2000.
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 an affiliate
of Paramount Pictures Corporation. Total purchases were $43.1 million and $20.8
million for the three months ended September 30, 1999 and 2000, respectively,
and $76.6 million and $110.2 million for the nine months ended
8
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
September 30, 1999 and 2000, respectively. The Company also purchases certain
home video games from Midway Games, Inc. Total purchases were $0.1 million and
$2.1 million for the three months ended September 30, 1999 and 2000,
respectively, and $9.8 million and $3.9 million for the nine months ended
September 30, 1999 and 2000, respectively.
In 1999, the Company entered into a U.S. promotional and customer database
services and licenses agreement with MTV Networks ("MTVN"), a business unit of
Viacom. Pursuant to this agreement, for one year, Blockbuster agreed to provide
certain promotional and database services to MTVN and granted a U.S. license to
MTVN to use the Company's U.S. customer database internally and/or sublicense
the database for internal use to affiliates of MTVN that are direct or indirect
wholly-owned subsidiaries of Viacom and to MTVi Group, L.P. and its direct and
indirect affiliates for internal use. In return, MTVN paid Blockbuster $18
million. MTVN had an option to extend in perpetuity the license to use the
customer database. Blockbuster had recognized revenue from this transaction over
the estimated useful life of the agreement, which was expected to exceed one
year. During the third quarter of 2000, MTVN elected not to exercise this option
and, as a result, Blockbuster has no further obligation to MTVN. Accordingly,
the remaining deferred revenue of $12.3 million was recognized in the third
quarter of 2000 and is reflected in "Other revenues" in the Consolidated
Statements of Operations for the three and nine months ended September 30, 2000.
All other transactions with companies owned by or affiliated with Viacom did
not have a material impact on the financial position or results of operations
presented herein.
Note 3--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 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
were provided under the Company's new credit agreement, as discussed in Note 6.
The remaining $157 million was paid with cash from Viacom and was recognized as
a capital contribution by Viacom during the second quarter of 1999.
Note 4--Disposition
On May 4, 2000, the Company completed the sale of Golf & Games, an amusement
and theme park located in Florida, for approximately $7.1 million in cash. The
Company recorded a pre-tax gain of $1.9 million from the sale. This gain is
reflected as a component of "Other items, net" in the Consolidated Statement of
Operations for the nine months ended September 30, 2000.
Note 5--Sales of Store Operations
During the three and nine months ended September 30, 1999, Blockbuster sold
certain stores to franchisees for $8.3 million and $23.2 million, respectively,
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 $4.7
million and $18.9 million in cash and $3.6 million and $4.3 million in notes
receivable and recognized net gains of $2.3 million and $8.3 million for the
three and nine months ended September 30, 1999, respectively, as a reduction of
general and administrative expenses.
During the nine months ended September 30, 2000, Blockbuster sold certain
stores to franchisees for $5.7 million. As a result of these sales, Blockbuster
received $4.8 million in cash, $0.9 million in notes receivable and recognized a
net gain of $1.7 million as a reduction of general and administrative expenses.
Blockbuster did not sell any stores to franchisees during the three months ended
September 30, 2000.
9
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
Note 6--Credit and Debt Agreements
On June 21, 1999, Blockbuster entered into a $1.9 billion unsecured credit
agreement (the "Blockbuster Credit Agreement") with a syndicate of banks. The
Blockbuster Credit Agreement is comprised of a $700 million long-term revolver
due July 1, 2004 and a $600 million term loan due in quarterly installments
beginning April 1, 2002 and ending July 1, 2004. The Blockbuster Credit
Agreement also includes a $600 million short-term revolver, which was reduced
with proceeds from the Offering, and was originally due on June 19, 2000. The
Blockbuster Credit Agreement was amended during the second quarter of 2000 by
extending the due date of the short-term revolver to the earlier of (i) December
14, 2000 or (ii) the date that Blockbuster is no longer a subsidiary of Viacom.
Interest rates under the Blockbuster Credit Agreement are based on the prime
rate or LIBOR at Blockbuster's option at the time of borrowing. A variable
commitment fee based on the total leverage ratio is charged on the unused amount
of the revolver (.25% at September 30, 2000).
The Blockbuster Credit Agreement contains certain restrictive covenants,
which, among other things, relate to the payment of dividends, repurchase of
Blockbuster's common stock or other distributions and also require compliance
with certain financial covenants with respect to a maximum leverage ratio and a
minimum fixed charge coverage ratio. At September 30, 2000, the Company was in
compliance with all financial covenants under the Blockbuster Credit Agreement.
On June 23, 1999, Blockbuster borrowed $1.6 billion, comprised of $400 million
borrowed under the long-term revolver, $600 million borrowed under the term
loan, and $600 million borrowed under the short-term revolver. The proceeds of
the borrowings were used to pay amounts owed to Viacom. Blockbuster repaid
$442.9 million of the short-term revolver through proceeds from the Offering.
The Company repaid an additional $45.0 million of the short-term revolver during
the nine months ended September 30, 2000. These payments permanently reduced
Blockbuster's capacity under the Blockbuster Credit Agreement from $1.9 billion
to approximately $1.4 billion, by reducing the borrowing capacity under the
short-term revolver to $112.1 million. As of September 30, 2000, the Company had
$112.1 million outstanding under the short-term revolver. Blockbuster expects to
fund the repayment of the short-term revolver by using either internally
generated cash or additional borrowings under the long-term revolver. The
Company had $250.0 million of available borrowing capacity under the long-term
revolver at September 30, 2000. The weighted average interest rate at September
30, 2000 for these borrowings was 8.1%.
Blockbuster entered into two additional lines of credit with banks for an
aggregate of $75.0 million in the fourth quarter of 1999. There were no
outstanding amounts under these two lines of credit at September 30, 2000.
In April 2000, the Company borrowed $26.5 million in order to finance the
purchase of certain equipment. The financing bears interest at 8.0%, is payable
in monthly installments through April 2005, and is secured by a lien on the
equipment. At September 30, 2000, the Company had $23.0 million outstanding
under this financing.
Note 7--Commitments and Contingencies
In October 1998, BLOCKBUSTER MUSIC stores ("Music") were sold to Wherehouse
Entertainment Inc. ("Wherehouse"). Certain leases transferred in connection with
the sale of Music to Wherehouse had previously been guaranteed either by Viacom
or its affiliates. The terms of these leases expire on various dates through
2007. Blockbuster agreed to indemnify Viacom with respect to any amount paid
under these guarantees. At the time of the sale, the contingent liability for
base rent approximated $84 million, on an undiscounted basis, with respect to
these guarantees. The Company has not recognized any reserves related to this
contingent liability in the accompanying consolidated financial statements. If
Wherehouse defaults, related losses could materially affect future operating
income.
Pursuant to a tax matters agreement entered into between the Company and
Viacom effective as of the consummation of the Offering, the Company is
generally responsible for, among other things, any taxes imposed on Viacom or
its subsidiaries as a result of a split-off from Viacom 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
10
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
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 May 7, 1999, Lynn Adams, Khristine Schoggins, and Debbie Lenke, purporting
to act as class representatives on behalf of themselves and all others similarly
situated, filed a complaint in District Court in Orange County, California
against Blockbuster. The plaintiffs seek to certify a class comprised of
certain Blockbuster store managers who worked in California who claim that they
should be classified as non-exempt and are thus owed overtime payments under
California law. The dollar amount that plaintiffs seek as damages to themselves
and those similarly situated is not set forth in the complaint. Blockbuster
believes the plaintiffs' position is without merit and intends to vigorously
defend itself in the litigation.
Blockbuster is a defendant in nine putative class action lawsuits filed by
customers in state courts in Illinois, California, Ohio and Texas between
February of 1999 and August of 2000. These cases allege common law and
statutory claims for fraud and/or deceptive practices and/or unlawful business
practices regarding Blockbuster's policies for customers who choose to keep
rental product beyond the initial rental term. Some of the cases also allege
that these policies impose unlawful penalties and/or result in unjust
enrichment. The dollar amounts that plaintiffs seek as damages to themselves
and those similarly situated are not set forth in the complaints. Blockbuster
believes the plaintiffs' positions in these suits are without merit and intends
to vigorously defend itself in the litigation.
As discussed in the Company's Annual Report on Form 10-K filed with the SEC on
March 24, 2000, 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. In addition, as discussed in the Company's
Form 10-K, a substantially similar complaint with different class
representatives is pending in the United States District Court for the Western
District of Texas against Viacom and major motion picture studios and their home
video subsidiaries that have operated under revenue-sharing agreements with
Blockbuster. Since the filing of the Company's Form 10-K, Ruben Loredo
voluntarily dismissed the state court action without prejudice, and Ruben Loredo
and Blockbuster have been added as parties plaintiff and defendant,
respectively, in the federal court action. In addition to any damage award to
which Blockbuster might be directly subject, if Viacom is required to pay any
damage award as a result of the federal court action, Viacom may seek
indemnification for its losses from Blockbuster under the release and
indemnification agreement entered into between Viacom and the Company.
Blockbuster believes that the plaintiff's position is without merit, and
Blockbuster intends to vigorously defend itself in the litigation.
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 consolidated 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--Operating Segments and Geographic Area
Beginning in the fourth quarter of 1999, Blockbuster began reporting in two
segments: (i) home video, DVD and video game rental and retailing, which
Blockbuster refers to as the video segment, and (ii) new media (formerly called
new technologies).
(i) Video
As of September 30, 2000, the video segment operated 6,172 video stores and
its franchisees and/or joint ventures operated 1,347 video stores located
throughout the United States, its territories and 25 other countries.
11
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
(ii) New Media
Through the new media segment, Blockbuster operates its Internet site,
blockbuster.com, and its Digital Networks division, which is responsible
for exploring various forms of electronic entertainment delivery including
video-on-demand.
The Company's reportable operating segments have been determined in accordance
with the Company's internal management structure, which is organized based on
products and services.
The following table sets forth the Company's financial results by operating
segments:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- -----------------------------
1999 2000 1999 2000
--------------- --------------- ------------- ------------
(In millions)
<S> <C> <C> <C> <C>
Revenues:
Video..................................................... $ 1,112.8 $ 1,193.7 $ 3,267.5 $ 3,618.7
New media................................................. - 0.1 - 0.6
--------------- --------------- ------------- --------------
Total revenues......................................... $ 1,112.8 $ 1,193.8 $ 3,267.5 $ 3,619.3
=============== =============== ============= ==============
Operating income (loss):
Video..................................................... $ 30.0 $ 33.5 $ 82.8 $ 114.8
New media................................................. (1.4) (15.8) (1.4) (45.4)
--------------- --------------- ------------- --------------
Total operating income................................. $ 28.6 $ 17.7 $ 81.4 $ 69.4
=============== =============== ============= ==============
Depreciation and amortization (including tape amortization):
Video..................................................... $ 250.2 $ 278.4 $ 783.1 $ 835.1
New media................................................. 0.1 3.0 0.1 8.2
--------------- --------------- ------------- --------------
Total depreciation and amortization.................. $ 250.3 $ 281.4 $ 783.2 $ 843.3
=============== =============== ============= ==============
Interest expense:
Video..................................................... $ 30.7 $ 27.5 $ 90.6 $ 84.5
New media................................................. - 1.5 - 3.5
--------------- --------------- ------------- --------------
Total interest expense................................. $ 30.7 $ 29.0 $ 90.6 $ 88.0
=============== =============== ============= ==============
Net loss:
Video..................................................... $ (18.2) $ (8.6) $ (61.5) $ (20.9)
New media................................................. (0.9) (10.7) (0.9) (30.4)
--------------- --------------- ------------- --------------
Total net loss......................................... $ (19.1) $ (19.3) $ (62.4) $ (51.3)
=============== =============== ============= ==============
</TABLE>
Note 9--Other Matters
On May 4, 2000, CBS Corporation merged with and into Viacom, with Viacom being
the surviving corporation.
Viacom has announced that it intends to split-off Blockbuster, subject to the
approval of Viacom's Board of Directors, which will be based on an assessment of
market conditions. Viacom intends to split-off Blockbuster by offering to
exchange all of its shares in Blockbuster for shares of Viacom's common stock.
However, Viacom has previously said that it does not intend to commence the
offer unless the Blockbuster class A common stock improves to a price range
significantly above its current value. Viacom has no obligation to effect the
split-off. Viacom has received a private letter ruling from the Internal
Revenue Service to the effect that such a split-off, if effected in accordance
with the representations made in Viacom's request for the ruling, would be tax
free to Viacom and its stockholders.
On July 19, 2000, Blockbuster and Enron Broadband Services ("Enron"), a
wholly-owned subsidiary of Enron Corp., announced a 20 year, exclusive agreement
to deliver a Blockbuster entertainment service, initially featuring movies on-
demand, via the Enron Intelligent Network. Under the agreement, the Company
will provide content for the Blockbuster on-demand service and market such
service to its customer base. Enron will encode and stream the entertainment
over its global broadband network infrastructure, provision bandwidth on demand
and store the entertainment content. Blockbuster intends to introduce its
movies on-demand service on a trial basis in some U.S.
12
<PAGE>
BLOCKBUSTER INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Tabular amounts in millions, except per share amounts)
cities by year-end, and expects to extend the service to other domestic and
international markets beginning in 2001. The Company believes that, by
leveraging the assets of its new alliances, the Company will be able to develop
this strategy to stream broadband content without the need for outside
investments in the near term. As a result, the Company does not currently intend
to sell an interest in blockbuster.com, including the previously contemplated
sale to America Online, Inc.
On July 26, 2000, options to purchase 4,641,555 shares of class A common stock
were granted to employees under the Blockbuster Inc. 1999 Long-Term Management
Incentive Plan. The exercise prices of these options range from $11.00 to
$15.00, with $11.00 being equal to the closing share price of the class A common
stock on July 26, 2000. The options generally vest over a four-year period,
beginning on the first anniversary of the date of grant.
On September 27, 2000, options to purchase 87,500 shares of class A common
stock were granted to employees under the Blockbuster Inc. 1999 Long-Term
Management Incentive Plan. The exercise price of these options is $11.00, which
is greater than the closing share price of the class A common stock on September
27, 2000. The options vest annually with respect to 25% of the shares covered
thereby beginning on July 26, 2001.
On September 27, 2000, the Company's Board of Directors declared a cash
dividend of $0.02 per share on the Company's class A and class B common stock,
payable December 4, 2000, to stockholders of record at the close of business on
November 13, 2000. The total dividend payment will be approximately $3.5
million, of which approximately $2.9 million will be paid to Viacom
International Inc.
13
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's discussion and analysis of the consolidated results of operations
and financial condition should be read in conjunction with the Consolidated
Financial Statements and the related Notes.
Business Segment Information
Our reportable operating segments have been determined in accordance with our
internal management structure, which is organized based on products and
services. Beginning in the fourth quarter of 1999, we began reporting in two
segments: (i) home video, DVD and video game rental and retailing, which we
refer to as our video segment, and (ii) new media (formerly called new
technologies).
(i) Video
As of September 30, 2000, our video segment operated 6,172 video stores and
our franchisees and/or joint ventures operated 1,347 video stores located
throughout the United States, its territories and 25 other countries.
(ii) New Media
Through our new media segment, we operate our Internet site,
blockbuster.com, and our Digital Networks division, which is responsible
for exploring various forms of electronic entertainment delivery including
video-on-demand.
We evaluate performance based on many factors. Two of the primary measures
are EBITDA and operating income. EBITDA is defined as net loss before equity in
income (loss) of affiliated companies (net of tax), benefit (provision) for
income taxes, interest income (expense), depreciation, amortization of
intangibles and other items, net. EBITDA may differ in the method of
calculation from similarly titled measures used by other companies. Operating
income is defined as income before interest income (expense), equity in income
(loss) of affiliated companies (net of tax) and benefit (provision) for income
taxes.
The following table sets forth summarized financial information relating to
our segments:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -------------------------------
1999 2000 1999 2000
-------------- ------------- ------------- -------------
(In millions)
<S> <C> <C> <C> <C>
Revenues:
Video.................................................. $ 1,112.8 $ 1,193.7 $ 3,267.5 $ 3,618.7
New media.............................................. - 0.1 - 0.6
-------------- ------------- ------------- -------------
Total revenues..................................... $ 1,112.8 $ 1,193.8 $ 3,267.5 $ 3,619.3
============== ============= ============= =============
EBITDA(1):
Video.................................................. $ 129.9 $ 132.1 $ 374.5 $ 419.9
New media.............................................. (1.3) (13.0) (1.3) (37.3)
-------------- ------------- ------------- -------------
Total EBITDA....................................... $ 128.6 $ 119.1 $ 373.2 $ 382.6
============== ============= ============= =============
Operating income (loss):
Video.................................................. $ 30.0 $ 33.5 $ 82.8 $ 114.8
New media.............................................. (1.4) (15.8) (1.4) (45.4)
-------------- ------------- ------------- -------------
Total operating income............................. $ 28.6 $ 17.7 $ 81.4 $ 69.4
============== ============= ============= =============
</TABLE>
(1) "EBITDA" is presented here to provide additional information about our
operations. EBITDA should be considered in addition to, but not as a
substitute for or superior to, operating income, net income, cash flow and
other measures of financial performance prepared in accordance with
generally accepted accounting principles.
14
<PAGE>
Results of Operations
Consolidated Results
The following table sets forth consolidated results of operations for the
three months and nine months ended September 30, 1999 and 2000 and other
financial and store data:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- -----------------------------------
1999 2000 1999 2000
-------------- -------------- -------------- ----------------
(In millions, except margin and worldwide store data)
<S> <C> <C> <C> <C>
Statement of Operations Data:
Revenues................................................. $ 1,112.8 $ $1,193.8 $ $3,267.5 $ 3,619.3
Cost of sales............................................ 431.4 472.1 1,269.6 1,469.9
-------------- -------------- -------------- --------------
Gross profit............................................. 681.4 721.7 1,997.9 2,149.4
Operating expenses....................................... 652.8 704.0 1,916.5 2,080.0
-------------- -------------- -------------- --------------
Operating income......................................... 28.6 17.7 81.4 69.4
Interest expense......................................... (30.7) (29.0) (90.6) (88.0)
Interest income.......................................... 0.7 1.6 1.8 5.2
Other items, net......................................... 1.7 0.4 1.5 2.5
-------------- -------------- -------------- --------------
Income (loss) before income taxes........................ 0.3 (9.3) (5.9) (10.9)
Provision for income taxes............................... (17.7) (10.1) (52.4) (40.7)
Equity in income (loss) of affiliated companies, net of
tax..................................................... (1.7) 0.1 (4.1) 0.3
-------------- -------------- -------------- --------------
Net loss................................................. $ (19.1) $ (19.3) $ (62.4) $ (51.3)
============== ============== ============== ==============
Cash Flow Data:
Cash flows from operating activities..................... $ 724.2 $ 766.8
Cash flows used for investing activities................. (902.8) (715.5)
Cash flows from (used for) financing activities.......... 201.8 (39.1)
Other Data:
Depreciation............................................. $ 56.8 $ 57.4 $ 163.1 $ 180.7
Amortization of intangibles.............................. 43.2 44.0 128.7 132.5
EBITDA(1)................................................ 128.6 119.1 373.2 382.6
Net loss plus intangible amortization, net of tax(1)(2).. $ 22.0 $ 22.6 $ 60.8 $ 74.5
Margins:
Rental margin(3)......................................... 66.1% 64.3% 66.0% 64.3%
Merchandise margin(4).................................... 21.8% 26.1% 22.5% 22.1%
Gross margin(5).......................................... 61.2% 60.5% 61.1% 59.4%
Worldwide Store Data:
Same store revenues increase(6).......................... 5.7% 1.5% 10.3% 5.0%
Total stores at end of period............................ 6,860 7,519 6,860 7,519
</TABLE>
----------------
(1) EBITDA and Net loss plus intangible amortization, net of tax are presented
here to provide additional information about our operations. These items
should be considered in addition to, but not as a substitute for, or
superior to, operating income, net income, cash flow and other measures of
financial performance prepared in accordance with generally accepted
accounting principles. EBITDA may differ in the method of calculation from
similarly titled measures used by other companies.
(2) Intangible amortization, net of tax, included in this item is primarily
related to goodwill.
(3) Rental gross profit as a percentage of rental revenues.
(4) Merchandise gross profit as a percentage of merchandise revenues.
(5) Gross profit as a percentage of total revenues.
(6) A store is included in the same store revenue calculation after it has been
opened and operated by us for more than 52 weeks. An acquired store
becomes part of the same store base in the 53rd week after its acquisition
and conversion. The percentage change is computed by comparing total net
revenues for same stores at the end of the applicable reporting period with
total net revenues from these same stores for the comparable period in the
prior year.
15
<PAGE>
Three Months Ended September 30, 2000 Compared to Three Months Ended September
30, 1999.
Revenues. Revenues of $1,193.8 million for the three months ended September
30, 2000 increased $81.0 million, or 7.3%, from $1,112.8 million for the three
months ended September 30, 1999. The increase in revenues was primarily due to a
net increase in the number of company-operated stores of 426 to 6,172 at
September 30, 2000 from 5,746 at September 30, 1999, and an increase in
worldwide same store revenues of 1.5% for the three months ended September 30,
2000 as compared to the corresponding period in 1999. Also contributing to the
increase was the recognition of the remaining $12.3 million of deferred revenue
related to our U.S. promotional and customer database services and licenses
agreement, which is detailed in Note 2 in the Notes to Consolidated Financial
Statements. The increase in same store revenues was principally due to an 11.0%
increase in same store revenues from our international operations.
Rental Revenues. Rental revenues of $1,019.0 million for the three
months ended September 30, 2000, which also includes sales of previously
viewed products, increased $67.6 million, or 7.1%, from $951.4 million for the
three months ended September 30, 1999. The increase in rental revenues was
primarily due to the net increase in the number of company-operated stores of
426. Increases in worldwide same store previously viewed product sales of
16.9% and increases in worldwide same store rental revenues of 0.9% also
contributed to the increase in rental revenues. The increase in worldwide same
store rental revenues was driven by a 13.2% increase in international same
store rental revenues primarily due to an increase in revenue from countries
implementing revenue-sharing, offset by a 1.4% decrease in domestic same store
rental revenues, which was caused by an unfavorable box office for titles that
became available in the three months ended September 30, 2000 as compared to
stronger titles that became available in the comparable period of 1999.
Previously viewed product sales, which includes previously viewed videotapes,
video games and DVD's, increased 19.6% for the three months ended September
30, 2000 as compared to the three months ended September 30, 1999. For the
three months ended September 30, 2000, revenues generated by rental product
that was kept beyond the initial rental period were $191.0 million, or 16.0%
of total revenues, compared to $172.3 million, or 15.5% of total revenues for
the same period of 1999.
Merchandise Sales. Merchandise sales of $146.1 million for the three
months ended September 30, 2000 increased $7.2 million, or 5.2%, from $138.9
million for the three months ended September 30, 1999. The primary reasons
for the increase in merchandise sales were the net increase in the number of
company operated stores of 426 and increased sales of DVDs, offset by
decreased sales of videotapes.
Cost of Sales. Cost of sales of $472.1 million for the three months ended
September 30, 2000 increased $40.7 million, or 9.4%, from $431.4 million for the
three months ended September 30, 1999. Cost of sales as a percentage of total
revenues increased to 39.5% for the three months ended September 30, 2000 from
38.8% for the three months ended September 30, 1999. The increase in cost of
sales as a percentage of revenues was primarily due to (i) an increase in DVD
rentals as a percentage of rental revenues corresponding with a decrease in
rental revenues from our non revenue-sharing titles as a percentage of rental
revenues, as rentals of non revenue-sharing titles generally have a higher gross
margin percentage than the DVD rentals; (ii) lower average unit selling prices
as a result of increased copy depth for previously viewed products and (iii) an
increase in international revenues generated through revenue-sharing
arrangements as a percentage of international revenues, as revenue-sharing
arrangements on average have lower gross margins than traditional buying
arrangements. Revenues and margins generated by domestic revenue sharing titles
remained relatively consistent as a percentage of revenues in the third quarters
of 2000 and 1999. We are continually evaluating our product mix to try to
optimize our stores' revenues and gross profit. With the anticipated accelerated
consumer acceptance of DVD and other forms of home entertainment, we may
increase our stores' depth of DVDs and other home entertainment products. This
may result in a transition in the composition of our stores inventory to allow
for more DVDs, or other forms of home entertainment, depending on the speed of
adoption by consumers. The increase in cost of sales as a percentage of revenues
noted above was partially offset by a decrease in cost of sales as a percentage
of revenues from our merchandise sales. This decrease was primarily driven by a
shift in product sales to higher margin products. We expect our annual product
margin to be consistent with the nine months ended September 30, 2000.
Gross Profit. Gross profit of $721.7 million for the three months ended
September 30, 2000 increased $40.3 million, from $681.4 million for the three
months ended September 30, 1999. For the three months ended September 30, 2000,
gross profit as a percentage of total revenues decreased to 60.5% from 61.2% for
the three months ended September 30, 1999. The decrease in gross margin was due
to the increase in cost of sales described above, partially offset by the
recognition of the remaining $12.3 million of deferred revenue related to our
U.S. promotional and customer database services and licenses agreement.
16
<PAGE>
Operating Expenses. Total operating expenses of $704.0 million for the three
months ended September 30, 2000 increased $51.2 million, or 7.8%, from $652.8
million for the three months ended September 30, 1999. This increase was
primarily due to a net increase of 426 company-operated stores and those
expenses that are incremental operating expenses associated with our new media
segment. Advertising and training costs incurred to market and solicit DIRECTV
System equipment and DIRECTV(R) programming packages in our stores also
contributed to the increase in operating expenses. Operating expenses associated
with our new media segment, which included allocations for operating expenses
from our video segment, increased from $1.4 million for the three months ended
September 30, 1999 to $15.9 million for the three months ended September 30,
2000. Total operating expenses increased slightly as a percentage of total
revenues from 58.7% for the three months ended September 30, 1999 to 59.0% for
the three months ended September 30, 2000. Specifically, the increase in total
operating expenses resulted from the following:
General and Administrative Expense. General and administrative expense,
which includes expenses incurred at the store, regional and corporate levels
and relating to our new media business, increased as a percentage of total
revenues to 46.3% for the three months ended September 30, 2000 compared to
44.0% for the same period of 1999. General and administrative expense of
$552.5 million for the three months ended September 30, 2000 increased $62.9
million from $489.6 million for the three months ended September 30, 1999. The
dollar increase for the three months ended September 30, 2000 resulted from
compensation increases of $27.9 million related to additional personnel needed
to support our store growth, our DIRECTV sales initiatives and our new media
business; a $14.2 million increase in occupancy costs due to the increase in
the number of company-operated stores and the addition of a number of store
leases that were previously treated as capitalized leases and became operating
leases during the third quarter of 2000; and a $20.8 million increase in other
corporate and store expenses due primarily to the growth of our business and
support of our new media segment.
Advertising Expense. Advertising expense of $50.1 million for the three
months ended September 30, 2000 decreased $13.1 million, or 20.7%, from $63.2
million for the three months ended September 30, 1999. As a percentage of
total revenues, advertising expense decreased to 4.2% for the three months
ended September 30, 2000 from 5.7% for the three months ended September 30,
1999. These decreases reflect our planned decrease in general promotional
advertising. We are now focusing our advertising dollars on specific brand
advertising and direct marketing vehicles such as BLOCKBUSTER REWARDS(TM) and
targeted consumer advertising.
Depreciation Expense. Depreciation expense of $57.4 million for the three
months ended September 30, 2000 increased $0.6 million as compared to $56.8
million for the same period of 1999. The increase in depreciation expense was
primarily attributable to the net increase of 426 company-operated stores and
depreciation expense added by our new media segment related to computer
hardware, computer software and software licenses. Those increases were
offset by the discontinuation of depreciation expense on certain capitalized
lease assets that became fully depreciated during the third quarter.
Interest Expense. Interest expense of $29.0 million for the three months
ended September 30, 2000 decreased $1.7 million compared to $30.7 million for
the same period of 1999. The decrease in interest expense was due to lower
capital lease obligations and lower debt levels, offset by higher average
interest rates on our credit facility for the three months ended September 30,
2000 as compared to the three months ended September 30, 1999.
Provision for Income Taxes. We recognized a provision for income taxes of
$10.1 million for the three months ended September 30, 2000 as compared to $17.7
million for the three months ended September 30, 1999. The 2000 and 1999
provisions reflect permanent differences resulting from the non-deductibility of
goodwill amortization associated with Viacom's acquisition of us in 1994 and tax
operating losses from certain foreign countries. We did not recognize a benefit
for these foreign jurisdictions, in which we incurred losses, in our 1999 and
2000 tax provisions. The provision for income taxes decreased due to lower
operating losses from foreign jurisdictions.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
income of affiliated companies, net of tax was $0.1 million for the three months
ended September 30, 2000 as compared to a loss of $1.7 million for the three
months ended September 30, 1999, primarily due to an increase in income from our
joint venture operations in Italy.
Net Loss. The consolidated net loss of $19.3 million for the three months
ended September 30, 2000 reflects an increase in net loss of $0.2 million from a
net loss of $19.1 million for the third quarter of 1999. Excluding the losses
incurred by our new media business in the third quarters of 1999 and 2000, our
net loss decreased by $9.6 million from $18.2 million to $8.6 million.
17
<PAGE>
SEGMENT RESULTS
Video
-----
Our video segment consists of rentable home videos, DVDs, video games and
retail products. Video revenues of $1,193.7 million for the three months ended
September 30, 2000 increased $80.9 million, or 7.3%, from $1,112.8 million for
the three months ended September 30, 1999. The increase in revenues was
primarily due to a net increase in the number of company-operated stores of 426
and an increase in worldwide same store revenues of 1.5% for the three months
ended September 30, 2000 as compared to the corresponding period in 1999. Also
contributing to the increase was the recognition of the remaining portion of
deferred revenue related to our U.S. promotional and customer database services
and licenses agreement. The increase in same store revenues was principally due
to an 11.0% increase in same store revenues from our international operations.
Operating income increased $3.5 million to $33.5 million for the three months
ended September 30, 2000 from $30.0 million in the prior year. Results for the
three months ended September 30, 2000 reflect the increased revenues discussed
above. Our operating expenses as a percentage of total video revenues decreased
to 57.7% for the three months ended September 30, 2000 from 58.6% for the same
period in 1999.
New Media
---------
Our new media segment consists of Internet video sales, entertainment-related
news and information, and e-commerce offerings and is also focused on developing
relationships and infrastructure needed to deliver digital video services across
multiple networks to multiple devices. On November 22, 1999, we re-launched
blockbuster.com as a strategic first step towards delivery of premium
entertainment options to our customers. We began incurring expenses related to
the new media segment during the third quarter of 1999 in advance of our re-
launch of blockbuster.com. New media revenues of $0.1 million for the three
months ended September 30, 2000 consisted primarily of sales through the
Internet of sell-through videocassettes and DVDs.
Operating loss for our new media segment was $15.8 million for the three
months ended September 30, 2000, as compared to an operating loss of $1.4
million for the three months ended September 30, 1999. This loss reflects costs
incurred to advertise our new website, to enhance the website's functionality
and to negotiate and structure new ventures related to our entertainment-on-
demand service currently in the development stage. Blockbuster.com is an
integral part of our New Media segment and is expected to become an extension of
our stores through online rental reservations. We expect this segment to incur
continued losses in the immediate future. As a result, we are continually
evaluating capitalized costs associated with our new media segment. Total costs
capitalized, net of depreciation, were $35.0 million as of September 30, 2000.
Nine Months Ended September 30, 2000 Compared to Nine Months Ended September 30,
1999.
Revenues. Revenues of $3,619.3 million for the nine months ended September 30,
2000 increased $351.8 million, or 10.8%, from $3,267.5 million for the nine
months ended September 30, 1999. The increase in revenues was primarily due to a
net increase in the number of company-operated stores of 426 and increases in
worldwide same store revenues of 5.0% for the nine months ended September 30,
2000 as compared to the corresponding period in 1999. The increase in worldwide
same store revenues was principally due to an increase in the average domestic
rental fee, an 11.7% increase in same store revenues from our international
operations, and a 10.3% increase in domestic merchandise same store revenues.
Rental Revenues. Rental revenues of $3,072.8 million for the nine months
ended September 30, 2000, which also includes sales of previously viewed
products, increased $282.1 million, or 10.1%, from $2,790.7 million for the
nine months ended September 30, 1999. The increase in rental revenues was
primarily due to the net increase in the number of company-operated stores of
426 and an increase in international same store rental revenues of 12.5%.
Also contributing to the increase were (i) an increase in the average domestic
rental fee and (ii) a favorable box office advantage between titles that
became available in the nine months ended September 30, 2000 as compared to
the titles that became available in the comparable period of 1999. In
addition, previously viewed product sales, which includes previously viewed
videotapes, video games and DVD's, increased 14.0% for the nine months ended
September 30, 2000 as compared to the nine months ended September 30, 1999.
For the nine months ended September 30, 2000, revenues generated by rental
product that
18
<PAGE>
was kept beyond the initial rental period were $586.7 million, or 16.2% of
total revenues, compared to $516.4 million, or 15.8% of total revenues for the
same period of 1999.
Merchandise Sales. Merchandise sales of $478.6 million for the nine months
ended September 30, 2000 increased $65.1 million, or 15.7%, from $413.5
million for the nine months ended September 30, 1999. The three primary
reasons for the increase in merchandise sales were (i) an increase in sales of
DVDs, (ii) an increase in the sales of blank tapes and other accessories, and
(iii) an increase in confection sales.
Cost of Sales. Cost of sales of $1,469.9 million for the nine months ended
September 30, 2000 increased $200.3 million, or 15.8%, from $1,269.6 million for
the nine months ended September 30, 1999. Cost of sales as a percentage of total
revenues in 2000 increased to 40.6% for the nine months ended September 30, 2000
from 38.9% for the nine months ended September 30, 1999. The increase in cost of
sales as a percentage of revenues was primarily due to (i) the increase in
revenues generated through revenue-sharing arrangements as a percentage of our
total revenues, as revenue-sharing arrangements on average have lower gross
margins than do traditional buying arrangements, (ii) a decrease in margins on
game rentals, as several platforms are nearing the end of their lifecycles,
(iii) a decrease in margins on previously viewed product sales generated by
lower average unit selling prices as a result of increased copy depth and (iv)
the increase in merchandise sales as a percentage of total revenues from 12.7%
of total revenues for the nine months ended September 30, 1999 to 13.2% of total
revenues for the nine months ended September 30, 2000, as merchandise sales have
lower gross margins than rental revenues. We are continually evaluating our
product mix to try to optimize our stores' revenues and gross profit. With the
anticipated accelerated consumer acceptance of DVD and other forms of home
entertainment, we may increase our stores' depth of DVDs and other home
entertainment products. This may result in a transition in the composition of
our stores' inventory to allow for more DVDs, or other forms of home
entertainment, depending on the speed of adoption by consumers.
Gross Profit. Gross profit of $2,149.4 million for the nine months ended
September 30, 2000 increased $151.5 million, from $1,997.9 million for the nine
months ended September 30, 1999. For 2000, gross profit as a percentage of total
revenues decreased to 59.4% from 61.1% for the nine months ended September 30,
1999. The decrease in gross margin was due to the increase in cost of sales
described above.
Operating Expenses. Total operating expenses of $2,080.0 million for the nine
months ended September 30, 2000 increased $163.5 million, or 8.5%, from $1,916.5
million for the nine months ended September 30, 1999. This increase was
primarily due to a net increase of 426 company-operated stores and those
expenses that are incremental operating expenses associated with our new media
segment. Operating expenses associated with our new media segment, which
included allocations for operating expenses from our video segment, increased
from $1.4 million for the nine months ended September 30, 1999 to $46.0 million
for the nine months ended September 30, 2000. Total operating expenses decreased
as a percentage of total revenues to 57.5% for the nine months ended September
30, 2000 from 58.7% in the nine months ended September 30, 1999 due to better
leveraging of our video segment operating expenses over an increased revenue
base, offset by the incremental operating expenses attributable to our new media
segment. The increase in total operating expenses resulted from the following:
General and Administrative Expense. General and administrative expense,
which includes expenses incurred at the store, regional, and corporate levels
and relating to our new media business, remained relatively consistent as a
percentage of total revenues at 44.2% for the nine months ended September 30,
2000 compared to 44.1% for the same period of 1999. General and administrative
expense of $1,601.1 million for the nine months ended September 30, 2000
increased $159.3 million from $1,441.8 million for the nine months ended
September 30, 1999. The dollar increase for the nine months ended September
30, 2000 resulted from compensation increases of $78.5 million related to
additional personnel needed to support our store growth and to support our new
media business. Occupancy costs increased $37.5 million largely as a result of
an increase in the number of company-operated stores. Other corporate and
store expenses increased $43.3 million due primarily to the growth of our
business and support of our new media segment.
Advertising Expense. Advertising expense of $165.7 million for the nine
months ended September 30, 2000 decreased $17.2 million, or 9.4% from $182.9
million for the nine months ended September 30, 1999. As a percentage of total
revenues, advertising expense decreased to 4.6% for the nine months ended
September 30, 2000 from 5.6% for the nine months ended September 30, 1999.
These decreases reflect our planned decrease in general promotional
advertising. We are now focusing our advertising dollars on specific brand
advertising and direct marketing vehicles such as BLOCKBUSTER REWARDS(TM) and
targeted consumer advertising.
Depreciation Expense. Depreciation expense of $180.7 million for the nine
months ended September 30, 2000 increased $17.6 million as compared to $163.1
million for the same period of 1999. The increase in depreciation expense was
primarily attributable to the net increase of 426 company-operated stores. In
addition
19
<PAGE>
our new media segment added $8.1 million to depreciation expense for the nine
months ended September 30, 2000 related to computer hardware, computer
software and software licenses.
Interest Expense. Interest expense of $88.0 million for the nine months ended
September 30, 2000 decreased $2.6 million as compared to $90.6 million for the
same period of 1999. The decrease in interest expense was due to lower capital
lease levels and lower debt levels, offset by the higher interest rates on our
credit facility compared to the interest rates on the notes payable to Viacom,
which were outstanding through June 23, 1999.
Provision for Income Taxes. We recognized a provision for income taxes of
$40.7 million for the nine months ended September 30, 2000 as compared to $52.4
million for the nine months ended September 30,1999. The 2000 and 1999
provisions reflect permanent differences resulting from the non-deductibility of
goodwill amortization associated with Viacom's acquisition of us in 1994 and tax
operating losses from certain foreign countries. We did not recognize a benefit
for these foreign jurisdictions, in which we incurred losses, in our 1999 and
2000 tax provisions. The provision for income taxes decreased due to lower
operating losses from foreign jurisdictions.
Equity in Income (Loss) of Affiliated Companies, Net of Tax. The equity in
income of affiliated companies, net of tax was $0.3 million for the nine months
ended September 30, 2000 as compared to a loss of $4.1 million for the nine
months ended September 30, 1999, primarily due to an increase in income from our
joint venture operations in Italy.
Net Loss. The consolidated net loss of $51.3 million for the nine months ended
September 30, 2000 reflects a decrease in net loss of $11.1 million from a net
loss of $62.4 million for the nine months ended September 30, 1999. Excluding
the losses incurred by our new media business in the first nine months of 2000,
our net loss decreased by $40.6 million from $61.5 million to $20.9 million.
SEGMENT RESULTS
Video
-----
Video revenues of $3,618.7 million for the nine months ended September 30,
2000 increased $351.2 million, or 10.7%, from $3,267.5 million for the nine
months ended September 30, 1999. The increase in revenues was primarily due to a
net increase in the number of company-operated stores of 426 and increases in
worldwide same store revenues of 5.0% for the nine months ended September 30,
2000 as compared to the corresponding period in 1999. The increase in worldwide
same store revenues was principally due to an increase in the average domestic
rental fee, an 11.7% increase in same store revenues from our international
operations, and a 10.3% increase in domestic merchandise same store revenues.
Operating income increased $32.0 million to $114.8 million for the nine months
ended September 30, 2000 from $82.8 million in the prior year. Results for the
nine months ended September 30, 2000 reflect the increased revenues discussed
above and the leveraging of our operating expenses over an increased revenue
base. Our operating expenses as a percentage of total video revenues decreased
to 56.2% for the nine months ended September 30, 2000 from 58.6% for the same
period in 1999.
New Media
---------
On November 22, 1999, we re-launched blockbuster.com as a strategic first step
towards delivery of premium entertainment options to our customers. New media
revenues of $0.6 million for the nine months ended September 30, 2000 consisted
primarily of sales through the Internet of sell-through videocassettes and DVDs.
Operating loss for our new media segment was $45.4 million for the nine months
ended September 30, 2000, as compared to an operating loss of $1.4 million for
the nine months ended September 30, 1999. This loss reflects costs incurred to
advertise our new website, hire additional people to support the new website, to
enhance the website's functionality and to negotiate and structure new ventures
related to our video-on-demand service currently in the development stage.
Blockbuster.com is an integral part of our New Media segment and is expected to
become an extension of our stores through online rental reservations. We expect
this segment to incur continued losses in the immediate future.
20
<PAGE>
Liquidity and Capital Resources
-------------------------------
Consolidated Cash Flows
Operating Activities. Net cash flows from operating activities increased
$42.6 million, or 5.9%, from $724.2 million for the nine months ended September
30, 1999 to $766.8 million for the nine months ended September 30, 2000. The
most significant reason for the increase was an improvement in operating income
which resulted in a decrease of net losses of $11.1 million ($71.2 million
excluding depreciation and amortization), offset by a $31.6 million increase in
net cash used by changes in operating assets and liabilities.
Investing Activities. Net cash used in investing activities decreased $187.3
million from $902.8 million for the nine months ended September 30, 1999 to
$715.5 million in the comparable period of 2000 primarily as a result of a
decrease in cash used for store acquisitions of $77.2 million and a $138.7
million decrease in capital expenditures, offset by an $18.6 million increase in
rental library purchases. Our capital expenditures decreased primarily due to
an upgrade of the store point of sale system that occurred during 1999 and fewer
new store openings in 2000 compared to the same period of 1999. The decrease in
cash used for acquisitions was primarily due to a large acquisition of 69 stores
from a franchisee in the first quarter of 1999.
Financing Activities. Net cash used in financing activities for the nine
months ended September 30, 2000 of $39.1 million represented a $240.9 million
decrease from net cash provided by financing activities of $201.8 million in
1999. The decrease in cash flows from financing activities was primarily
attributable to (i) net proceeds of $430.7 million received through September
30, 1999 from our initial public offering, (ii) Viacom funding approximately
$77.0 million to us in the first quarter of 1999 for the acquisition of 69
stores from a franchisee, (iii) capital contributions of $157 million made by
Viacom during 1999 for the purchase of certain of our international operations
from affiliates of Viacom in connection with our initial public offering and
(iv) cash dividends of $10.5 million paid in 2000. These items were partially
offset by collective net repayments related to our notes due to Viacom and
credit agreement during 1999, of $379.3 million.
Capital Structure
On June 21, 1999, we entered into a $1.9 billion unsecured credit agreement
with a syndicate of banks. This credit agreement is comprised of a $700 million
long-term revolver due July 1, 2004 and a $600 million term loan due in
quarterly installments beginning April 1, 2002 and ending July 1, 2004. The
credit agreement also includes a $600 million short-term revolver, which was
reduced with proceeds from our initial public offering, and was originally due
on June 19, 2000. The credit agreement was amended during the second quarter of
2000 by extending the due date of the short-term revolver to the earlier of (i)
December 14, 2000 , or (ii) the date that we are no longer a subsidiary of
Viacom. Interest rates under the credit agreement are based on the prime rate
or LIBOR at our option at the time of borrowing. A variable commitment fee
based on the total leverage ratio is charged on the unused amount of the
revolver (.25% at September 30, 2000).
The credit agreement contains certain restrictive covenants, which, among
other things, relate to the payment of dividends, repurchase of our common stock
or other distributions and also require compliance with certain financial
covenants with respect to a maximum leverage ratio and a minimum fixed charge
coverage ratio. At September 30, 2000 we were in compliance with all financial
covenants under the credit agreement.
On June 23, 1999, we borrowed $1.6 billion, comprised of $400 million borrowed
under the long-term revolver, $600 million borrowed under the term loan, and
$600 million borrowed under the short-term revolver. The proceeds of the
borrowings were used to pay amounts owed to Viacom. We repaid $442.9 million of
the short-term revolver through proceeds from our initial public offering. We
repaid an additional $45.0 million of the short-term revolver during the nine
months ended September 30, 2000. These payments permanently reduced our capacity
under the credit agreement from $1.9 billion to approximately $1.4 billion, by
reducing the borrowing capacity under the short-term revolver to $112.1 million.
As of September 30, 2000, we had $112.1 million outstanding under the short-term
revolver. We expect to fund the repayment of the short-term revolver by using
either internally generated cash or additional borrowings under the long-term
revolver. We had $250.0 million of available borrowing capacity under the long-
term revolver at September 30, 2000. The weighted average interest rate at
September 30, 2000 for these borrowings was 8.1%.
We entered into two additional lines of credit with banks for a total of $75.0
million in the fourth quarter of 1999. There were no outstanding amounts under
these two lines of credit at September 30, 2000.
In April 2000, we borrowed $26.5 million in order to finance the purchase of
certain equipment. The financing bears interest at 8.0%, is payable in monthly
installments through April 2005, and is secured by a lien on the equipment. At
September 30, 2000, we had $23.0 million outstanding under this financing.
21
<PAGE>
The following table sets forth our current portion of long-term debt:
<TABLE>
<CAPTION>
At December 31, At September 30,
1999 2000
-------------- ---------------
<S> <C> <C>
Short-term revolving credit facility, interest rate 7.9% at December 31, 1999
and September 30, 2000, due December 2000....................................... $ 157.1 $ 112.1
Equipment term loan, interest rate 8.0% payable monthly through April 2005,
secured by certain equipment.................................................... - 6.5
-------------- ---------------
Total current portion of long-term debt.......................................... $ 157.1 $ 118.6
============== ===============
</TABLE>
The following table sets forth our long-term debt, less current portion:
<TABLE>
<CAPTION>
At December 31, At September 30,
1999 2000
-------------- ---------------
<S> <C> <C>
Term loan, interest rate 7.8% and 8.1% at December 31, 1999 and September 30,
2000, respectively, due in quarterly installments beginning April 2002.......... $ 600.0 $ 600.0
Long-term revolving credit facility, interest rate 8.0% and 8.1% at December 31,
1999 and September 30, 2000, respectively, due July 2004........................ 430.0 450.0
Equipment term loan, interest rate 8.0% payable monthly through April 2005,
secured by certain equipment.................................................... - 16.5
-------------- ---------------
Total long-term debt............................................................. $ 1,030.0 $ 1,066.5
============== ===============
</TABLE>
Liquidity Prior to and Upon Blockbuster's Separation from Viacom
Prior to our initial public offering of class A common stock, our capital
investments and acquisitions were financed with a combination of cash flow from
operations and advances from Viacom. We generate cash from operations
predominantly from the rental of videocassettes, video games, and DVDs and we
have substantial operating cash flow because most of our revenue is received in
cash and cash equivalents. Prior to our initial public offering, Viacom
deposited sufficient cash in our bank accounts to meet our daily obligations and
withdrew excess funds from those accounts. These transactions were included in
capital contributions from Viacom, net in the Consolidated Statements of Cash
Flows. The amounts owed to Viacom prior to our initial public offering were
capitalized into Viacom's net equity investment.
Excess operating cash flow, additional funding from Viacom (prior to our
initial public offering) and borrowings under our credit facility were used
primarily for opening and acquiring new stores, the refurbishment, remodeling
and relocation of existing stores and the purchase of videocassette inventory.
Prior to our initial public offering, our capital structure was established
which replaced our reliance on Viacom's cash management system. At the time of
our initial public offering, all cash accounts were settled and, since such
time, we have no longer participated in Viacom's cash management system. As
such, no further amounts will be deposited in, or withdrawn from, our accounts
by Viacom.
In October 1998, BLOCKBUSTER MUSIC stores were sold to Wherehouse
Entertainment Inc. Some of the leases transferred in connection with this sale
had previously been guaranteed either by Viacom or its affiliates. The remaining
terms of these leases expire on various dates through 2007. We have agreed to
indemnify Viacom with respect to any amount paid under these guarantees. At the
time of the sale, the contingent liability for base rent was about $84 million
on an undiscounted basis, with respect to these guarantees. We have not
recognized any reserves related to this contingent liability. If Wherehouse
defaults, related payments are expected to be funded from operating cash flow.
Related losses due to default could materially affect future operating income.
We expect to fund our future anticipated cash requirements, including the
anticipated cash requirements for capital expenditures, joint ventures,
commitments and payments of principal and interest on any borrowings, with
internally generated funds as well as with funds available under our credit
agreement. We believe that these two sources of funds will provide us with
adequate liquidity and capital necessary for the next twelve months. We may,
however, seek to issue debt and/or equity securities in the future to the extent
we determine that the issuance of securities would serve to maximize our capital
structure or would otherwise be advantageous to our company.
22
<PAGE>
Other Financial Measurements: Working Capital
At September 30, 2000, we had cash and cash equivalents of $127.9 million.
Working capital, however, reflected a deficit of $274.2 million due to the
accounting treatment of our rental library. Rental inventories are accounted
for as non-current assets and are excluded from the computation of working
capital. The acquisition cost of rental inventories, however, is reported as a
current liability and, accordingly, is included in the computation of working
capital. Consequently, we believe working capital is not as significant a
measure of financial condition for companies in the home video industry as it is
for companies in some other industries. Because of this accounting treatment, we
may, from time to time, operate with a working capital deficit.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133") effective for fiscal years beginning after June
15, 2000. We anticipate that, due to our limited use of derivative instruments,
the adoption of SFAS 133 effective January 1, 2001 will not have a material
effect on our consolidated financial statements.
Disclosure Regarding Forward-Looking Information
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended. Specific
forward-looking statements can be identified by the fact that they do not relate
strictly to historical or current facts and include, without limitation,
statements relating to: our new media initiatives such as entertainment-on-
demand and online rental reservations; our financial expectations relating to
these and other new media initiatives; our expectations regarding product mix;
our expectations regarding liquidity, including our anticipated needs for, and
sources of, funds; our plans for managing exposure to interest and currency
exchange rate fluctuations; and our expectations and intentions relating to
outstanding litigation. Our forward-looking statements are based on management's
current intent, belief, expectations, estimates and projections regarding our
company and our industry. Forward-looking statements are not guarantees of
future performance and involve risks, uncertainties, assumptions and other
factors that could cause actual results to vary materially from those expressed
in or indicated by the forward-looking statements. These factors include, among
others: the timely and effective development and integration of new technology
relating to our new media initiatives; the ability to reach agreements with
service, product and content providers on acceptable commercial terms and the
success of these alliances and agreements in developing new products and
services relating to our new media initiatives; the application of laws related
to intellectual property rights; consumer interest in, and demand for, newly
released videos and other Blockbuster product and service offerings, including
on-demand services; the impact of competitive product and service offerings and
pricing; the impact of technological shifts on our business and our ability to
respond to changing consumer preferences; the effect of game platform cycles;
the degree of future currency and interest rate fluctuations; the impact of
unkown or unforseen developments affecting our outstanding litigation; and other
factors as set forth under the heading "Cautionary Statements" in our Annual
Report on Form 10-K for the fiscal year ended December 31, 1999.
23
<PAGE>
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to various market risks including interest rates on our debt
and foreign exchange rates. In the normal course of business we employ
established policies and procedures to manage these risks.
Interest Rate Risk
Historically, we have had no material interest rate risk associated with debt
used to finance our operations due to limited borrowings and our relationship
with Viacom. However, on June 23, 1999, we borrowed $1.6 billion under our
credit facility. Total outstanding borrowings at September 30, 2000 under this
credit agreement were $1,162.1 million. Interest rates are based on the prime
rate in the United States or LIBOR (plus a margin based on leverage ratios) at
our option at the time of borrowing. The weighted average interest rate at
September 30, 2000 for these borrowings was 8.1%. We anticipate managing our
future interest rate exposure by using a mix of fixed and floating interest rate
debt and, if appropriate, financial derivative instruments. We are primarily
vulnerable to changes in LIBOR, however, we do not believe this exposure to be
material. A one percentage point increase or decrease in LIBOR would affect our
annual interest expense by approximately $11.6 million.
Foreign Exchange Risk
Operating in international markets involves exposure to movements in currency
exchange rates. Currency exchange rate movements typically also reflect economic
growth, inflation, interest rates, government actions and other factors. As
currency exchange rates fluctuate, translation of the statements of operations
of our international businesses into U.S. dollars may affect year-over-year
comparability and could cause us to adjust our financing and operating
strategies.
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.
Numerous issues are raised by the Euro currency conversion including the need
to adapt computer and financial systems and business processes and equipment.
Due to these uncertainties, we cannot reasonably estimate the long-term effects
one common currency may have on pricing, costs, and the resulting impact, if
any, on our financial condition or results of operations. However, we believe
that we have and will continue to take appropriate steps to assess and address
Euro conversion issues and currently do not expect that our business will be
adversely affected by such conversion in any material respect.
Our operations outside the United States constitute 19.4% of our total
revenues. Our operations in Europe constitute 9.4% of our total revenues. The
majority of these sales are from Great Britain, which has not adopted the Euro.
24
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On May 7, 1999, Lynn Adams, Khristine Schoggins, and Debbie Lenke, purporting
to act as class representatives on behalf of themselves and all others similarly
situated, filed a complaint in District Court in Orange County, California
against Blockbuster. The plaintiffs seek to certify a class comprised of certain
Blockbuster store managers who worked in California who claim that they should
be classified as non-exempt and are thus owed overtime payments under California
law. The dollar amount that plaintiffs seek as damages to themselves and those
similarly situated is not set forth in the complaint. Blockbuster believes the
plaintiffs' position is without merit and intends to vigorously defend itself in
the litigation.
Blockbuster is a defendant in nine putative class action lawsuits filed by
customers in state courts in Illinois, California, Ohio, and Texas between
February of 1999 and August of 2000. These cases allege common law and
statutory claims for fraud and/or deceptive practices and/or unlawful business
practices regarding Blockbuster's policies for customers who choose to keep
rental product beyond the initial rental term. Some of the cases also allege
that these policies impose unlawful penalties and/or result in unjust
enrichment. The dollar amounts that plaintiffs seek as damages to themselves
and those similarly situated are not set forth in the complaints. Blockbuster
believes the plaintiffs' positions in these suits are without merit and intends
to vigorously defend itself in the litigation.
No material developments have occurred in our other legal proceedings
previously reported in our Annual Report on Form 10-K filed with the Securities
and Exchange Commission on March 24, 2000, as updated in our Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission on May 15, 2000.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Amended and Restated Certificate of Incorporation of
Blockbuster Inc. (1)
3.2 Bylaws of Blockbuster Inc. (2)
4.1 Specimen Class A Common Stock Certificate of Blockbuster
Inc. (3)
10.1 Letter Agreement, dated as of June 15, 2000, among Blockbuster
Inc., Citibank, N.A., and Viacom Inc. (4)
27.1 Financial Data Schedule. (4)
________
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration Statement
on Form S-1 (File No. 333-77899) and incorporated herein by reference.
(2) Previously filed as an exhibit to Blockbuster Inc.'s Annual Report on Form
10-K for the fiscal year ended December 31, 1999, and incorporated herein
by reference.
(3) Previously filed as an exhibit to Blockbuster Inc.'s Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1999, and
incorporated herein by reference.
(4) Filed herewith.
(b) Reports on Form 8-K
None.
25
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
BLOCKBUSTER INC.
Date: November 14, 2000 By: /s/ Larry J. Zine
-----------------------------------------
Larry J. Zine
Executive Vice President and Chief
Financial Officer
(on behalf of the Registrant and in his
capacity as principal financial officer)
26
<PAGE>
INDEX TO EXHIBITS
3.1 Amended and Restated Certificate of Incorporation of Blockbuster
Inc. (1)
3.2 Bylaws of Blockbuster Inc. (2)
4.1 Specimen Class A Common Stock Certificate of Blockbuster Inc. (3)
10.1 Letter Agreement, dated as of June 15, 2000, among Blockbuster Inc.,
Citibank, N.A., and Viacom Inc. (4)
27.1 Financial Data Schedule. (4)
________
(1) Previously filed as an exhibit to Blockbuster Inc.'s Registration
Statement on Form S-1 (File No. 333-77899) and incorporated herein by
reference.
(2) Previously filed as an exhibit to Blockbuster Inc.'s Annual Report on
Form 10-K for the fiscal year ended December 31, 1999, and incorporated
herein by reference.
(3) Previously filed as an exhibit to Blockbuster Inc.'s Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1999, and
incorporated herein by reference.
(4) Filed herewith.
27
