10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

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

For the fiscal year ended January 3, 2010.

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

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

1201 Elm Street

Dallas, Texas 75270

(214) 854-3000

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Class A Common Stock, $.01 par value per share   New York Stock Exchange
Class B Common Stock, $.01 par value per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

As of July 2, 2009, which was the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates was $91,899,497, based on the closing price of $0.68 per share of Class A common stock and $0.37 per share of Class B common stock as reported on the New York Stock Exchange composite tape on that date.

As of March 5, 2010, 137,656,687 shares of Class A common stock, $0.01 par value per share, and 72,000,000 shares of Class B common stock, $0.01 par value per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of our definitive proxy statement to be filed for our 2009 annual meeting of stockholders are incorporated by reference into Part III of this Form 10-K.

THIS ANNUAL REPORT ON FORM 10-K IS BEING DISTRIBUTED TO STOCKHOLDERS IN LIEU OF A SEPARATE ANNUAL REPORT PURSUANT TO RULE 14a-3(b) OF THE ACT AND SECTION 203.01 OF THE NEW YORK STOCK EXCHANGE LISTED COMPANY MANUAL.

 

 

 


Table of Contents

BLOCKBUSTER INC.

TABLE OF CONTENTS TO FORM 10-K

 

          Page

PART I

     

Item 1.

   Business    2

Item 1A.

   Risk Factors    21

Item 1B.

   Unresolved Staff Comments    36

Item 2.

   Properties    36

Item 3.

   Legal Proceedings    36

PART II

     

Item 5.

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  

37

Item 6.

   Selected Financial Data    40

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    41

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    76

Item 8.

   Financial Statements and Supplementary Data    77

Item 9.

   Changes In and Disagreements With Accountants on Accounting and Financial Disclosure    134

Item 9A.

   Controls and Procedures    134

Item 9B.

   Other Information    135

PART III

     

Item 10.

   Directors, Executive Officers and Corporate Governance    136

Item 11.

   Executive Compensation    136

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  

136

Item 13.

   Certain Relationships and Related Transactions, and Director Independence    137

Item 14.

   Principal Accountant Fees and Services    137

PART IV

     

Item 15.

  

Exhibits and Financial Statement Schedules

   138


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DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION

This annual report on Form 10-K contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may also be included from time to time in our other public filings, press releases, our website and oral and written presentations by management. Specific forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts and include, without limitation, words such as “may,” “expects,” “believes,” “anticipates,” “plans,” “estimates,” “projects,” “predicts,” “targets,” “seeks,” “could,” “intends,” “foresees” or the negative of such terms or other variations on such terms or comparable terminology. Similarly, statements that describe our strategies, initiatives, objectives, plans or goals are forward-looking.

These forward-looking statements are based on management’s current intent, belief, expectations, estimates and projections regarding our Company and our industry. These statements are not guarantees of future performance and involve risks, uncertainties, assumptions and other factors that are difficult to predict. Therefore, actual results may vary materially from what is expressed in or indicated by the forward-looking statements. The risk factors set forth below under “Item 1A. Risk Factors,” and other matters discussed from time to time in subsequent filings with the Securities and Exchange Commission, including the “Disclosure Regarding Forward-Looking Information” and “Risk Factors” sections of our Quarterly Reports on Form 10-Q, among others, could affect future results, causing these results to differ materially from those expressed in our forward-looking statements. In that event, our business, financial condition, results of operations or liquidity could be materially adversely affected and investors in our securities could lose part or all of their investments. Accordingly, our investors are cautioned not to place undue reliance on these forward-looking statements because, while we believe the assumptions on which the forward-looking statements are based are reasonable, there can be no assurance that these forward-looking statements will prove to be accurate.

Further, the forward-looking statements included in this Form 10-K and those included from time to time in our other public filings, press releases, our website and oral and written presentations by management are only made as of the respective dates thereof. We undertake no obligation to update publicly any forward-looking statement in this Form 10-K or in other documents, our website or oral statements for any reason, even if new information becomes available or other events occur in the future.

 

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PART I

 

Item 1. Business

BLOCKBUSTER OVERVIEW

Blockbuster Inc. is a leading global provider of rental and retail movie and game entertainment, with over 6,500 stores in the United States, its territories and 17 other countries as of January 3, 2010. Our mission is to provide our customers with the most convenient access to media entertainment, including movie and game entertainment delivered through multiple distribution channels such as our stores, by-mail, vending kiosks and digital devices. We believe Blockbuster offers customers a value-priced entertainment experience, combining the broad product depth of a specialty retailer with local neighborhood convenience.

Domestic Operations

Physical Delivery

 

   

In-Store—As of January 3, 2010, we had 4,018 stores operating under the BLOCKBUSTER® brand in the United States and its territories. Of these stores, 493 stores were operated through our franchisees. Our stores offer movie and game rental and new and traded movie and game product to our customers as well as consumer electronics. Additionally, 358 of these locations include additional branding as game concept stores operating under the GAME RUSH® brand. In 2009 we introduced Direct Access, which allows in-store customers to access our by-mail inventory and have a movie shipped directly to their homes. Also, in 2009, we launched the Blockbuster app for iPhone, which allows customers to browse our complete catalog of movies and television shows, check real-time store inventory, locate stores and build and manage their online rental queues.

 

   

By-Mail—We offer an Internet-based subscription service through blockbuster.com that allows customers to rent DVDs by mail and offers substantially more titles than our individual stores, including a wide array of both new release and catalog DVDs. This allows us to reach customers located in geographic areas where we do not have store locations. Subscribers of our BLOCKBUSTER Total Access™ program have the benefit of:

 

   

over 95,000 movie titles;

 

   

two ways to get movies with no due dates—online and in-store;

 

   

browsing movies and managing online queues through our iPhone application;

 

   

a variety of plans to meet our customers’ lifestyle and budget needs;

 

   

the convenience of thousands of participating store locations; and

 

   

video game rentals in select markets beginning in 2009.

 

   

Vending Kiosks—In 2008 we entered into an agreement with NCR to begin a Blockbuster branded vending kiosk business which offers customers a cost effective opportunity to rent DVDs at a lower daily rate. The machines currently offer DVD rentals but will allow for future applications, including digital downloads, and other services, such as sales of DVDs and video games. As of January 3, 2010, we had 2,225 kiosks operating under the Blockbuster brand in the United States and its territories.

Digital Delivery

 

   

Download to PC—During 2008, we integrated our Movielink, LLC (“Movielink”) offering with the blockbuster.com website. Movielink is an online movie downloading business with one of the largest libraries of digital content for both rental and sale, which we purchased all the outstanding membership

 

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interests of in 2007. This has allowed us to capitalize on the filmed entertainment downloading market and provide additional entertainment delivery choices to meet our customers’ needs including 24/7 access to their blockbuster.com account for downloading and watching movies as well as movie recommendations and reviews.

 

   

Consumer Electronics—We are committed to providing convenient access to media entertainment and are continually seeking out alternative methods to deliver on this mission. With the convergence of media content and electronic devices, we continue to explore further opportunities to digitally deliver content to our customers, and leverage strategic partners to digitally deliver entertainment content to our customers’ homes and electronic and portable devices. During 2009, we:

 

   

launched BLOCKBUSTER On Demand through strategic alliances with Samsung and TiVo;

 

   

announced a partnership with Motorola to bring BLOCKBUSTER On Demand to mobile devices;

 

   

introduced our iPhone app, which allows customers to search and browse our product catalog, locate stores, lookup store inventories and manage their by-mail queues; and

 

   

launched a Blockbuster-branded video-on-demand (“VOD”) service with Suddenlink Communications, a top cable broadband company.

International Operations

As of January 3, 2010, we had 2,502 stores in 17 markets outside of the United States operating under the BLOCKBUSTER brand and other brand names we own. Of these stores, 807 stores were operated through our franchisees. In Canada, Italy, Mexico and Denmark, we operate store-in-store game locations in addition to freestanding game locations in Mexico and Italy, all under the GAME RUSH brand. During 2009 and 2008, 30% and 29% of our worldwide revenues were generated outside of the United States, respectively. Our international operations have historically been more dependent on retail sales and, in particular, the retail game industry.

During the third quarter of 2009, we sold our operations in Ireland. We plan to continue to pursue the sale and/or licensing of some of our international markets as this will allow us to retain our brand’s presence while redeploying capital. Longer term, a strong licensed presence in international markets can significantly establish the BLOCKBUSTER brand, facilitate growth, and set the stage for a future digital offering.

We maintain offices for each major region and most of the countries in which we operate in order to manage, among other things, (i) store development and operations, (ii) marketing, and (iii) the purchase, supply and distribution of product. Additional information regarding our revenues and long-lived assets by geographic area and financial data by segment is included in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Segments” and Note 11 to the consolidated financial statements.

 

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INDUSTRY OVERVIEW

Domestic Media Entertainment Industry

We define our market as the media entertainment market. The estimated relative market sizes for various segments of the U.S. entertainment industry in which we compete are reflected in the following table (in millions):

 

     2009    2008

In-store rental

   $ 5,118    $ 5,674

Vending

     917      486

By-mail rental

     2,114      1,949
             

Physical film rental market

     8,149      8,109
             

Cable video-on-demand (“VOD”)

     1,277      1,094

Digital VOD

     142      71

Subscription VOD

     265      200
             

Digital film rental market

     1,684      1,365
             

Total film rental market

     9,833      9,474
             

Physical retail

     13,008      14,516

Digital retail

     617      403
             

Film retail market

     13,625      14,919
             

Game hardware

     7,194      7,832

Game software

     9,916      10,998

Game accessories

     2,555      2,578
             

Total game market

     19,665      21,408
             

Total U.S. media entertainment market

   $ 43,123    $ 45,801
             

The foregoing estimates and projections have been compiled from reports and information published by Adams Media Research, with respect to filmed entertainment, and NPD Group, with respect to game entertainment.

The overall domestic media entertainment industry declined 5.8% in 2009. The movie rental market is forecasted to grow in 2010, while the overall industry is forecasted to decline due to a low cyclical period for new game platform releases. There are continuing channel and product shifts, primarily driven by introduction of next-generation game console release cycles as well as the emergence of new channels of distribution for movie entertainment, such as by-mail delivery, vending, and digital. We believe we have positioned the company to capitalize on the emerging channels for movie entertainment and the broadening of the consumer demographic for games.

Movies

A competitive advantage that the U.S. retail home video industry has traditionally enjoyed over most other movie distribution channels, except theatrical release, is the early timing of its “distribution window.” Currently, studios distribute their movie entertainment content three to six months after theatrical release to the home video market; seven to eight months after theatrical release to pay-per-view and VOD; one year after theatrical release to pay TV networks; and two to three years after theatrical release to basic cable and syndicated networks. Recently, some of the studios have implemented a new 28-day window after the release of movies to the retail home video industry for DVD vending and by-mail DVD delivery. These windows further solidify the competitive advantage offered by the retailers such as Blockbuster.

 

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There has been increasing experimentation by studios and various movie content aggregators and retailers with the traditional distribution window, including simultaneous VOD and DVD releases. We expect that the movie studios will continue to assess the traditional release windows and it is possible that the studios may decide to alter the traditional home video retailer distribution window for an increasing number of movies, particularly in connection with simultaneous VOD distribution of movies and DVD release dates. However, we also believe that the studios have a vested interest in maintaining the home video distribution window in a manner that allows them to maximize revenues generated by the retail home video industry.

Games

According to estimates by NPD Group, game revenues in the United States declined 8.1% in 2009 after an 19.1% increase in 2008. These trends were largely due to lower average selling price points on the newest game hardware platforms (including the Xbox 360, the Sony PlayStation 3 and the Nintendo Wii), and reduced unit sales per title for releases in 2009.

Many hardware platforms, including Sony PlayStation 2 and 3 and Microsoft Xbox and Xbox 360, utilize a DVD and/or Blu-ray software format and have the potential to serve as multi-purpose entertainment centers by doubling as players for DVD movies and compact discs. For example, the Sony PlayStation 3 consoles are equipped to play high-definition Blu-ray discs. In addition, Sony PlayStation 3 and PSP, Nintendo DS and Wii and Microsoft Xbox 360 all provide Internet connectivity.

Sales of video game software generally increase as next-generation platforms mature and gain wider acceptance. Historically, when a new platform is released, a limited number of compatible game titles are immediately available, but the selection grows rapidly as manufacturers and third-party publishers develop and release game titles for that new platform. With respect to game rentals, we believe that the difference between the retail price and the rental price of a popular new video game title is typically high enough to make rentals an attractive alternative for customers. We also believe rental pricing provides both a testing ground for consumers considering a game purchase and an attractive alternative for customers who do not want to buy a game on an older format as they evaluate the purchase of a next generation hardware platform.

While the typical electronic game enthusiast is male and between the ages of 14 and 35, the electronic game industry is broadening its appeal across all demographics, especially with the introduction of Nintendo Wii. In addition, the availability of used video game products for sale has enabled a lower-economic demographic who may not have been able to afford the considerably more expensive new video game products, to participate in the video game industry.

International Home Video Industry

Some of the attributes of the home video industry outside of the United States are similar to those of the home video industry within the United States. For example, the major studios generally release movies outside of the United States according to sequential distribution windows. However, other attributes of the home video industry outside of the United States do not necessarily mirror the home video industry within the United States. For example, most countries have different systems of supply and distribution of movies, and competition in many of our international markets tends to be more fragmented. In addition, under the laws of some countries and trading blocs (e.g., the European Union), home video retailers must obtain the right to rent videos to consumers through a licensing arrangement or a “purchase-with-the-right-to-rent” arrangement. Studios may charge these home video retailers more for product purchased for rental than product purchased solely for sale to consumers. This is commonly referred to as “two-tiered pricing,” and affects our European operations. Two-tiered pricing not only results in increased competition from mass merchant retailers in those countries and trading blocs, it also creates increased competition with video rental outlets that operate in violation of the two-tiered pricing contractual limitations by renting product purchased at the lower retail price. The potential impact of studio pricing decisions is discussed under “Item 1A. Risk Factors.” The international home video

 

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industry also faces high levels of piracy. Although piracy is also a concern in the United States, it is having a more significant adverse affect on the rental and retail video industry in international markets. Piracy is discussed further below under “Competition” and “Item 1A. Risk Factors.”

Competition

We operate in a highly competitive environment. We believe our most significant competition comes from (i) retailers that rent, sell or trade movies and games; (ii) providers of direct delivery home viewing entertainment or other alternative delivery methods of entertainment content; (iii) piracy; and (iv) other forms of leisure entertainment. In addition, many consumers maintain relationships with several different in-home entertainment providers and can shift in-home entertainment spending from one provider to another.

Competition with Retailers that Rent, Sell or Trade Movies and Games. These retailers include, among others:

 

   

mass merchant retailers, such as Wal-Mart, Best Buy and Target;

 

   

Internet sites and companies that rent or sell movies, games and other entertainment content, such as Netflix, Apple, Amazon, Gamefly and others;

 

   

supermarkets, pharmacies and convenience stores, including kiosks, such as those operated by Redbox;

 

   

toy and entertainment retailers; and

 

   

local, regional and national video and game stores, such as GameStop and Movie Gallery.

We believe that the principal factors we face in competing with retailers that rent, sell or trade movies and games are:

 

   

consumer preference between purchasing and renting movies and games;

 

   

alternative product distribution channels and the perceived convenience and ease of use of such alternative channels to the customer;

 

   

pricing;

 

   

convenience and visibility of store locations;

 

   

quality, quantity and variety of titles in the desired format;

 

   

customer service; and

 

   

value-added services, such as movie search capabilities, ratings and recommendations and community features.

Competition with Providers of Direct Delivery Home Viewing Entertainment or Other Alternative Delivery Methods of Entertainment Content. We believe that competitive risks to our business include direct broadcast satellite, digital cable television, high-speed Internet access, TiVo/DVR and other alternatives for delivering videos and entertainment content to consumers. These providers offer an expanded number of conventional channels and expanded programming, including sporting events, through these services. Direct broadcast satellite, digital cable and “traditional” cable providers not only offer numerous channels of conventional television, they also offer pay-per-view movies, which permit a subscriber to pay a fee to see a selected movie, and other specialized movie services. Many digital cable providers, Internet content providers and other companies also provide “video-on-demand,” which transmits movies and other entertainment content on demand with interactive capabilities such as start, stop and rewind. In addition, some cable providers allow a subscriber to purchase a DVD movie and watch it over the cable system while the DVD is shipped to the subscriber.

 

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The availability and ease of downloading movies over the Internet continues to grow. Apple’s video iTunes service, Amazon’s digital movie service and announcements from other companies ranging from Netflix to Intel regarding their efforts in digital delivery of content signal future growth of video entertainment delivery. Other examples of alternative delivery methods of entertainment content include personal video recorders, download-to-burn DVDs, video vending machines, download-to-burn kiosks, movie downloads to portable devices and disposable DVDs.

We also believe that other retailers are likely to enter the digital delivery space, either with their own offers or as “real estate” companies that charge a fee for access to their products.

Any consolidation or vertical integration of media companies to include both content providers and digital distributors could pose additional competitive risk to our business. Risks associated with this competition are discussed further under “Item 1A. Risk Factors.”

Piracy. We compete against the illegal copying and sale of movies and video games. Because piracy is an illegal activity, it is difficult to quantify its exact impact on the home video industry. The primary methods of piracy affecting the home video industry are:

 

   

the illegal copying of theatrical films at the time they are first run;

 

   

the illegal copying of DVDs that are authorized by the studios solely for retail sale and/or rental by authorized retailers; and

 

   

the illegal online downloading of movies.

These methods of piracy enable the low-cost sale of DVDs and free viewing and sharing of DVDs, both of which compete with rentals and sales by authorized retailers like us. Competition from piracy has increased in recent years, in particular in our international markets, due in part to developments in technology that allow for faster copying and downloading of DVDs. Piracy has had a lesser effect on the video game industry in the United States, but has been a significant hindrance to the development of the video game industry in many international markets, particularly in Latin America and Asia.

Other Competition. We also compete generally for the consumer’s entertainment dollar and leisure time with, among others:

 

   

movie theaters;

 

   

Internet browsing, online gaming and other Internet-related activities;

 

   

consumers’ existing personal movie libraries;

 

   

live theater;

 

   

sporting events; and

 

   

music entertainment.

These and other competitive pressures may have a material adverse effect on our business.

 

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OUR OPERATIONS

Stores and Store Operations

Store Operations. Our U.S. company-operated stores generally operate under relatively similar hours of operation. Domestic stores are generally open 365 days a year, with daily hours from approximately 10:00 a.m. to 10:00 p.m. and closing later on weekends. We continually assess our store hours on a store by store basis in order to maximize profitability. The hours of operation for franchised stores will vary depending on the franchisee, but generally, franchisees follow the store hours of our company-operated stores. Our U.S. company-operated stores each employ an average of 10 people, including one store manager. Staffing for franchised stores will vary and is the sole responsibility of our franchisees. International store operations vary by country, however they are comparable to U.S. practices.

Portfolio Management. Within each targeted market, we identify potential sites for new and replacement stores by evaluating market dynamics, some of which include population demographics, customer concentration levels and possible competitive factors. We seek to place stores in locations that are convenient and visible to the public. We also seek to locate our stores in geographic areas with population and customer concentrations that enable us to better allocate available resources and manage operating efficiencies in inventory management, advertising, marketing, distribution, training and store supervision. We use our extensive membership transaction and real estate databases to monitor market conditions, select strategic store locations and attempt to maximize revenues without significantly decreasing the revenues of our nearby stores. We also periodically examine whether the sizes and formats of our existing stores are optimal for their locations and may adjust the sizes of, relocate or close existing stores as conditions require.

As a result of the declining revenues and anticipated consolidation in the in-store rental industry, since 2007 we have reviewed all of our store leases and selected a number of sites to close based on various factors, including proximity to other Blockbuster and competitor locations and profitability. In 2009 we began a larger scale push to close our less profitable locations at lease ending date, along with a number of stores being closed on an accelerated basis. We have also selected a number of locations based upon certain operational and financial criteria and are engaging landlords for those locations in negotiations regarding reduced monthly lease payments, in some instances in exchange for longer lease term commitments. We cannot presently determine to what extent our efforts will be successful. Additionally, we anticipate closing or divesting a higher number of company owned store locations during 2010 than in 2009. During 2009, we also sold our subsidiary in Ireland. We will continue to explore the divestiture and/or licensing of our non-core assets, including selling and/or franchising some of our remaining international operations.

The following table sets forth our store count information for both company-operated and franchised stores, domestically and internationally, during 2009:

 

     Company-Operated     Franchised     Total  
   U.S.     Int’l.     Total     U.S.     Int’l.     Total     U.S.     Int’l.     Total  

January 4, 2009

   3,878      1,928      5,806      707      892      1,599      4,585      2,820      7,405   

Opened

   5      7      12      0      5      5      5      12      17   

Closed

   (374   (56   (430   (198   (90   (288   (572   (146   (718

Purchased/(sold)(1)

   16      (184   (168   (16   0      (16   0      (184   (184
                                                      

Net additions/(closures)

   (353   (233   (586   (214   (85   (299   (567   (318   (885
                                                      

January 3, 2010

   3,525      1,695      5,220      493      807      1,300      4,018      2,502      6,520   
                                                      

 

(1) In 2009, we sold our 184-store subsidiary in Ireland.

 

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Store Locations. At January 3, 2010, in the United States and its territories, we operated 3,525 stores and our franchisees operated 493 stores. The following table sets forth, by state or territory, the number of domestic stores operated by us and our franchisees as of January 3, 2010.

 

State or Territory

   Company-
Operated
   Franchised    Total

Alabama

   35    13    48

Alaska

   —      16    16

Arizona

   113    1    114

Arkansas

   —      16    16

California

   450    18    468

Colorado

   87    2    89

Connecticut

   30    18    48

Delaware

   13    —      13

District of Columbia

   4    —      4

Florida

   301    36    337

Georgia

   140    —      140

Guam

   2    —      2

Hawaii

   22    —      22

Idaho

   1    3    4

Illinois

   158    3    161

Indiana

   64    21    85

Iowa

   21    —      21

Kansas

   14    35    49

Kentucky

   35    24    59

Louisiana

   59    11    70

Maine

   6    —      6

Maryland

   64    2    66

Massachusetts

   61    2    63

Michigan

   129    1    130

Minnesota

   43    7    50

Mississippi

   12    21    33

Missouri

   71    10    81

Montana

   —      1    1

Nebraska

   21    1    22

Nevada

   38    1    39

New Hampshire

   18    —      18

New Jersey

   104    6    110

New Mexico

   —      7    7

New York

   165    8    173

North Carolina

   117    1    118

North Dakota

   —      6    6

Ohio

   134    —      134

Oklahoma

   57    5    62

Oregon

   63    13    76

Pennsylvania

   137    5    142

Puerto Rico

   —      12    12

Rhode Island

   11    3    14

South Carolina

   67    1    68

South Dakota

   —      7    7

Tennessee

   38    42    80

Texas

   298    101    399

 

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State or Territory

   Company-
Operated
   Franchised    Total

Utah

   42    1    43

Vermont

   8    —      8

Virgin Islands

   —      1    1

Virginia

   96    2    98

Washington

   101    2    103

West Virginia

   15    1    16

Wisconsin

   60    1    61

Wyoming

   —      5    5
              

Domestic Store Totals

   3,525    493    4,018
              

At January 3, 2010, we operated 1,695 stores outside of the United States, including game store-in-store concepts operating under the name GAME RUSH in Canada, Mexico and Denmark and 13 specialty game stand-alone stores operating under the name GAME RUSH in Mexico and Italy. In addition, our franchisees operated 807 stores outside of the United States. The following table sets forth, by country, the number of stores operated by us and by our franchisees as of January 3, 2010.

 

     Company-
Operated
   Franchised    Total

Argentina

   57    —      57

Australia

   —      305    305

Brazil

   —      175    175

Canada

   459    —      459

Chile

   —      60    60

Colombia

   —      22    22

Denmark

   70    —      70

Great Britain

   636    —      636

Guatemala

   —      5    5

Israel

   —      10    10

Italy

   149    49    198

Mexico

   321    4    325

New Zealand

   —      28    28

Panama

   —      14    14

Portugal

   —      17    17

Taiwan

   —      118    118

Uruguay

   3    —      3
              

International Store Totals

   1,695    807    2,502

United States

   3,525    493    4,018
              

Domestic and International Store Totals

   5,220    1,300    6,520
              

Franchised Operations

At January 3, 2010, 98 domestic franchisee entities operated 493 stores in the United States and 276 international franchisee entities operated 807 stores outside of the United States. Our $4.1 billion in revenues during fiscal 2009 does not include the actual revenues of our franchisees, as we only record royalty and fee revenues generated from our franchised operations. Under our current U.S. franchising program, we enter into a development agreement and subsequent franchise agreement(s) with the franchisee. Pursuant to the terms of a typical development agreement, we grant the franchisee the right to develop one or a specified number of stores at a permitted location or locations within a defined geographic area and within a specified time. We generally charge the franchisee a development fee at the time of execution of the development agreement for each store to be

 

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developed during the term of the development agreement. A development agreement is not, however, typically entered into when a franchisee acquires an existing store from us or another franchisee. The typical franchise agreement is a long-term agreement that governs, among other things, the operations of the store to protect our brand. We generally require the franchisee to pay us a one-time franchise fee and continuing royalty fees, service fees and monthly payments for, among other things, maintenance of our proprietary software. In addition, from time to time we provide optional programs and product and support services to our franchisees for which we occasionally receive fees. We also require our franchisees to contribute funds for national advertising and marketing programs and require that franchisees spend an additional amount for local advertising or other marketing efforts. The amounts our franchisees are required to contribute for national advertising and marketing efforts may change from time to time in order to allow our franchisees to invest in their business. Our international franchising program is similar in many ways to our domestic franchising program. For example, our international franchisees are generally required to pay us a one-time franchise fee and continuing royalty fees and service fees.

Our franchisees have control over all operating and pricing decisions at their respective locations. For example, our franchisees have control over whether to charge extended viewing fees and the specific rental terms underlying any elimination of extended viewing fees and over whether or not to participate in the BLOCKBUSTER Total Access program. This has resulted in variations of rental terms, selling terms and restocking fees between company-operated and franchised BLOCKBUSTER stores, as well as variations in these terms among franchised BLOCKBUSTER stores. As of January 3, 2010, 42 of our franchise stores in the United States were participating in the “no late fees” program. Many of our franchisees chose not to eliminate extended viewing fees or have returned to charging extended viewing fees due to the fact that they operate under a different business model than we do, whereby they are not able, or choose not, to purchase the additional product to support the “no late fees” program. As of January 3, 2010, substantially all of our franchisees in the United States were participating in the BLOCKBUSTER Total Access program. We also do not require our franchisees to purchase inventory from us. A franchisee has sole responsibility for all financial commitments relating to the development, opening and operation of its stores, including rent, utilities, payroll and other capital and incidental expenses.

By-Mail

Our by-mail program allows subscribers to select DVDs online, which are then shipped to them free of charge by U.S. mail. Once a subscriber has finished viewing the DVD, the subscriber may return the DVD via mail using the postage prepaid envelope that accompanied the DVD or at a participating BLOCKBUSTER store. BLOCKBUSTER Total Access takes the concept of convenient DVDs by mail a step further and gives online subscribers the option of exchanging their DVDs through the mail or at a nearby participating BLOCKBUSTER store. There are no due dates for DVDs shipped via these online programs. In 2009, we began offering game rentals to the by-mail program in select markets.

Digital

In 2007 we acquired all of the outstanding equity interests of Movielink, LLC, an online movie downloading business. Movielink lets customers download movies, television shows and other popular videos for rental or purchase. The customers can then watch the downloaded programs on their computer, television or portable electronic device. Downloaded videos that are rented may be stored for up to 30 days after the customer checks out and then watched as many times as desired during a 24-hour viewing period that commences when “Play Movie” is clicked. Movielink does not charge any subscription, membership or late fees. As of December 16, 2008, the Movielink website was discontinued and its content was incorporated into blockbuster.com, where it became available to our customers, including former Movielink customers. In 2009, we launched our BLOCKBUSTER On Demand service through Samsung and TiVo, allowing customers to buy and enjoy new movies through connected consumer electronic products.

Vending Kiosks

In 2008 we entered into an agreement with NCR to begin a Blockbuster branded vending kiosk business, expanding our overall points of distribution by placing kiosks in locations that are convenient to our customers.

 

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Vending kiosks offer customers a cost effective opportunity to rent DVDs at a low daily rate. The machines currently offer DVD rentals but will allow for future applications, including digital downloads, and other services, such as sales of DVDs and sales and rentals of video games. These kiosks are owned and operated by NCR, who controls pricing and location of the kiosks and provides most of the product.

Under our current agreement with NCR, we provide the “catalog” product (titles older than 26 weeks past their release dates) on a consignment basis and receive 50% of the net revenue for these titles. NCR is required to provide the product for newer titles, for which we receive a license fee of 1% to 10% of the net revenue, depending on the monthly revenues of the individual kiosk and the total number of kiosks deployed. The license and consignment fees received under this contract are included in “Other revenues” in our Consolidated Statements of Operations.

Marketing and Advertising

We design our marketing and advertising campaigns in order to maximize opportunities in the marketplace and thereby increase the return on our marketing and advertising expenditures. We obtain information from our membership transaction database, our real estate database and outside research agencies to formulate and adjust our marketing and advertising campaigns based on:

 

   

membership behavior and transaction trends;

 

   

consumer needs and attitudes;

 

   

our market share in the relevant market;

 

   

our financial position;

 

   

our evaluation of industry trends;

 

   

local demographics; and

 

   

other competitive issues.

This enables us to focus our resources in areas we believe will generate the best return on investment.

During 2009, we utilized new in-store and online merchandising tactics and graphics packages to make it easier for the customer to make decisions on entertainment selection and reduce walkout rate.

 

   

Games Merchandising—Relocated games product to the front of the store to ensure all customers are aware that we offer a broad selection of the latest games for rent.

 

   

BLOCKBUSTER Premieres™—Exclusive films available only to Blockbuster’s in-store and by-mail customers.

 

   

Recommends—Films with limited awareness that will deliver a quality movie watching experience.

 

   

Encores—Reminders to consumers of existing movies specifically related to current theatrical releases and topical events.

We also continued to support existing programs that provide an alternative to the programs offered by mass merchant retailers and other online subscription service providers, such as:

 

   

BLOCKBUSTER Total Access—Online subscribers’ option of exchanging their DVDs through the mail or returning them to a nearby BLOCKBUSTER store in exchange for free in-store movie rentals. We offer various priced plans with associated in-store exchange quantity offerings.

 

   

Tent-Pole Title Program—Bringing in-store and by-mail customers more copies of big box office titles to rent or to buy, supported with a significant marketing message in the store and in our customer relations management program.

 

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BLOCKBUSTER In-Store Total Access and BLOCKBUSTER Game Pass®—In-store programs that allow customers to watch or play an unlimited amount of movies or games (the number of movies or games allowed out at a time is dependent on the type of pass the customer selects) for one monthly price and keep them for whatever period of time that they desire during the term of the pass, subject to certain limitations.

 

   

BLOCKBUSTER Rewards®—A premium in-store membership program designed to offer benefits to our customers and enhance customer loyalty by encouraging our customers to rent movies and games only from our stores.

Our advertising efforts in 2009 were limited by the ongoing focus on our cash conservation strategy. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview— Strategic Objectives and Accomplishments.” We focused advertising efforts on the in-store marketing of our tent-pole title strategy, new product line introductions and traffic-driving promotions. The studios generally spend a significant amount on advertising to promote new DVD releases, from which we benefit. We anticipate that the studios will continue this spending in 2010. In addition, some of our business alliances, including some of those with the studios, allow us to direct a portion of their home video advertising expenditures. For example, we often receive cooperative advertising funds from the studios that might be used for direct mail or point-of-purchase advertising. We expect to continue our cash conservation strategy in 2010, which will maintain current advertising limitations, and may require additional limitations on advertising commitments.

Suppliers and Purchasing Arrangements

Our goal in purchasing domestic rental inventory is to design purchasing strategies with each individual studio or game publisher that will provide us with the most appropriate level of copy depth at the best available price in order to satisfy our customers’ demands and, eventually, to increase our customer traffic. In some instances, those deals involve our purchasing rental inventory on a title-by-title basis. In other instances, we may negotiate a revenue-sharing arrangement. Revenue-sharing arrangements for rental inventory generally provide for a lower initial payment in order to acquire the product. In exchange for this lower initial payment, these contracts typically include minimum purchase requirements that are based upon box office results of the title. In addition, we pay an agreed upon percentage of our rental revenues earned from that product to the studio/game vendor for a limited period of time. These revenue-sharing payments become due as the rental revenues are earned. In addition to the revenue-sharing component, most arrangements also provide for the method of disposition of the product at the conclusion of the rental cycle and/or additional payments for the early sale of unreturned product which is automatically purchased by the customer. A majority of our studio revenue sharing agreements require that a portion of the product be destroyed at the conclusion of the initial rental cycle instead of converting the product to previously rented product (“PRP”), as is our practice under traditional purchase arrangements. This shortening of the rental life cycle negatively impacts our PRP revenues. We do not currently have any revenue sharing agreements with game publishers that require us to destroy product at the conclusion of the rental cycle. While the terms of revenue-sharing arrangements are generally similar for rental movie and game software inventory, revenue-sharing arrangements for domestic rental movies are generally negotiated for all titles released during the term of the contract, while revenue-sharing arrangements for rental game software are generally negotiated on a title-by-title basis.

Our unit purchases of domestic movie rental inventory decreased 17% in 2009 as compared with 2008 while we managed the business to preserve liquidity during our refinancing. We continued to utilize revenue-sharing arrangements during 2009 to support the increase in inventory unit purchases. Purchases under revenue sharing arrangements made up 89% of our total domestic movie rental unit purchases in 2009, versus 85% in 2008. The number of domestic game software rental inventory units purchased under revenue-sharing arrangements decreased from 65% in 2008 to 41% in 2009, however our tiered pricing units increased from 9% in 2008 to 43% in 2009. Tiered pricing is pricing received from publishers that allows for a lower initial purchase price based on the number of units purchased. Tiered pricing is usually offered in conjunction with a revenue sharing offer, giving the buyer and publisher starting points for negotiation on our game rental buys.

 

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In our international markets, 56% of our movie and game rental inventory units are purchased on a title-by-title basis directly from the studios or through sub-wholesalers appointed by the studios to distribute the studios’ product in particular countries. The remainder of our international rental product is purchased under revenue-sharing arrangements similar to those discussed above. Our purchasing arrangements vary by country and studio depending on factors such as the availability of the rental window and revenue-sharing terms.

New retail movie and game inventory is purchased from the studios, game publisher or their designated sub-wholesalers on a title-by-title basis. We also acquire certain retail movie and game inventory through our trading programs, which provide for a low per unit upfront payment to the supplier with the balance being paid upon the sale of such unit to the consumer. We purchase general merchandise that is complementary to our rental and retail movie and video game inventory, such as confection, game and other accessories and consumer electronics, from a variety of suppliers on a product-by-product basis.

We require each franchisee to comply with basic guidelines that set forth the minimum amount and selection of movies to be kept in its store inventory. Franchisees typically obtain movies and games from their own suppliers and are also responsible for obtaining some of the other complementary products from their own suppliers. However, if we have purchased the distribution rights to a movie or if a franchisee participates with us under our revenue-sharing arrangements, the franchisee may obtain the applicable product from us.

Distribution and Inventory Management

In the United States, we currently receive substantially all of our movies and games for our U.S. company-operated stores at our 850,000 square foot distribution center in McKinney, Texas. The distribution center is a highly automated, centralized facility that we use to mechanically repackage newly-released movies to make them suitable for rental at our stores. We also use our distribution center to restock products and process returns, as well as to provide some office space. We use a network of third-party delivery agents for delivery of products to our U.S. stores. We ship our products to these delivery agents, located strategically throughout the United States, which in turn deliver them to our stores. The distribution center supports substantially all of our company-operated stores in the United States and operates 24 hours a day, five days a week. As of January 3, 2010, we employed 910 employees at our distribution center. We are currently evaluating various alternatives to optimize our distribution network, including the potential outsourcing of these distribution center operations.

In addition to our distribution center in McKinney, Texas, we also have 38 distribution centers spread strategically throughout the United States to support our by-mail subscription service. These distribution centers are spread across the country because we use the United States Postal Service to distribute our by-mail product, and the closer the distribution center is to a customer, the faster our customers receive the product and the faster it is made available for rental again once our customers mail them back. Additionally, to expedite the delivery of product to our by-mail customers, we currently transport product from our 38 distribution centers to a total of 52 different mail entry points, which enables us to reach over 90% of our online subscriber base within one business day. Each distribution center operates 16 hours a day, 5 days a week and employs approximately 10 people, including one distribution center manager.

Franchisees generally obtain their products directly from third-party suppliers, except for their point-of-sale systems’ hardware and software, some accessories and supplies, movies for which we have exclusive distribution rights and movies for franchisees that participate in our franchisee revenue-sharing programs, which domestic franchisees receive from our distribution center. We have negotiated new agreements with the studios that allow us to consolidate our purchases for our by-mail business with those of our stores.

In our international markets, our stores generally receive rental product directly from the studios or sub-wholesalers. Retail product is generally distributed through a central warehouse for the market or through a third-party distributor.

 

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Management Information Systems

We believe that accurate and efficient management of purchasing, inventory and sales data is important to our future success. We maintain information, updated daily, regarding revenues, current and historical sales and rental activity, demographics of store customers and rental patterns. This information can be organized by store, market, region, state, country or for all operations.

All of our BLOCKBUSTER branded company-operated stores use our point-of-sale system. Our national point-of-sale system in the United States is linked with centralized systems at our corporate data center. The point-of-sale system tracks all of our products shipped from the central distribution center to each U.S. store using scanned bar code information. All domestic rental and sales transactions are recorded by the point-of-sale system when scanned at the time of customer checkout. At the end of each day, the point-of-sale system transmits store data from operations to the data center and the membership transaction database.

Our online services use internally developed software that provide a web based storefront and customer portal, supporting retail, digital and by mail customer transactions. Our supply chain system focuses on optimizing product inventory against customer demand to ensure timely delivery of products to our customers. These systems support multiple business aspects of online, such as analytics, content and merchandising, marketing, acquisition and retention. Customers are able to purchase DVDs, games, gift subscriptions, gift cards, and movie downloads on blockbuster.com

During 2009 we completed several information technology initiatives to improve multi-channel offerings to our customers, reduce cost and develop the infrastructure for our digital offerings. By leveraging our multi-channel capabilities customers are able to see real-time inventories in any US store from blockbuster.com, iPhone or mobile website. Stores increased their ability to rent DVDs through the Direct Access program. Direct Access enables stores to ship any of 95,000 titles from our warehouses directly to a customer’s residence. Customers can also view their store rental activity such as items rented, due dates and return dates online at blockbuster.com.

In December 2009 we launched an iPhone application which is currently available in the Apple app store. The iPhone app allows customers to search and browse our product catalog, locate stores, lookup store inventories and manage their by-mail queues. A mobile enhanced website was also launched in December that supports other Smartphone devices such as Blackberry, Windows Mobile and Android.

Through multiple strategic sourcing initiatives and consolidation of third-party infrastructure providers we were able to significantly reduce costs while providing greater flexibility, reliability and increased responsiveness for our customers. Hardware and software infrastructure components were added to enable our digital offerings to be delivered to a variety of consumer electronic, mobile and computing devices. Additionally, in 2009, we deployed enhancements and increased functionality to our backend systems that support our TiVo and Samsung partnerships and their related devices, positioning the technology to accommodate multiple points of presence and endpoints.

Regulation

Domestic Regulation

We are subject to various federal, state and local laws that govern the access to and use of our video stores by disabled customers and the disclosure, retention and security of customer records and information, including laws pertaining to the use of our membership transaction database. We also must comply with various regulations affecting our business, including federal, state or local securities, advertising, consumer protection, credit protection, franchising, licensing, zoning, land use, construction, second-hand dealer, environmental, health and safety, minimum wage, labor and employment, trading activities and other regulations.

 

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We are also subject to the Federal Trade Commission’s Trade Regulation Rule entitled “Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures” and state laws and regulations that govern the offer and sale of franchises and franchise relationships. If we want to offer and sell a franchise, we are required to furnish to each prospective franchisee a current franchise disclosure document prior to the offer or sale of a franchise. In addition, a number of states require us to comply with registration or filing requirements prior to offering or selling a franchise in the state and to provide a prospective franchisee with a current franchise disclosure document complying with the state’s laws, prior to the offer or sale of the franchise. We intend to maintain a franchise disclosure document that complies with all applicable federal and state franchise sales and other applicable laws. However, if we are unable to comply with federal franchise sales and disclosure laws and regulations, we will be unable to offer and sell franchises anywhere in the United States. In addition, if we are unable to comply with the franchise sales and disclosure laws and regulations of any state that regulates the offer and sale of franchises, we will be unable to offer and sell franchises in that state.

We are also subject to a number of state laws and regulations that regulate some substantive aspects of the franchisor-franchisee relationship, including:

 

   

those governing the termination or non-renewal of a franchise agreement, such as requirements that:

 

  (a) “good cause” exist as a basis for such termination; and

 

  (b) a franchisee be given advance notice of, and a right to cure, a default prior to termination;

 

   

requirements that the franchisor deal with its franchisees in good faith;

 

   

prohibitions against interference with the right of free association among franchisees; and

 

   

those regulating discrimination among franchisees in charges, royalties or fees.

International Regulation

We are subject to various international laws that govern the disclosure, retention and security of customer records and information. For example, the laws pertaining to the use of our membership transaction database in some markets outside of the United States are more restrictive than the relevant laws in the United States and may restrict data flow across international borders.

We must also comply with various other international regulations affecting our business, including advertising, consumer protection, access to and use of our video stores by disabled customers, credit protection, film and game classification, franchising, licensing, zoning, land use, construction, second-hand dealer, environmental, health and safety, minimum wage and other labor and employment regulations. Some foreign countries have copyright and other intellectual property laws that differ from the laws of the United States. These laws may prevent or limit certain types of business activity in the affected markets.

Similar to the United States, some foreign countries have franchise registration and disclosure laws affecting the offer and sale of franchises within their borders and to their citizens. They are often not as extensive and onerous as U.S. laws and regulations. However, as in the United States, failure to comply with such laws could limit or preclude our ability to expand in those countries through franchising or could affect the enforceability of franchise agreements.

Compliance with any of the domestic or international regulations discussed above is costly and time-consuming, and we may encounter difficulties, delays or significant costs in connection with such compliance.

Historical Information

Our business and operations were previously conducted by Blockbuster Entertainment Corporation, which was incorporated in Delaware in 1982 and entered the movie rental business in 1985. Blockbuster Inc., formerly

 

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an indirect subsidiary of Viacom Inc. (“Viacom”), was incorporated under a different name on October 16, 1989 in Delaware. On September 29, 1994, Blockbuster Entertainment Corporation was merged with and into Viacom. Subsequent to the merger, our business and operations were conducted by various indirect subsidiaries of Viacom. Over the year and a half prior to our initial public offering in August 1999, our business and operations were either (1) merged into Blockbuster Inc. or (2) purchased by Blockbuster Inc. and/or one of its subsidiaries. In October 2004, Blockbuster Inc. split off from Viacom and became a fully independent company.

Intellectual Property

Trademarks. We own various existing trademark registrations and have trademark applications pending registration with respect to our services and products offered worldwide. These include BLOCKBUSTER®, BLOCKBUSTER VIDEO®, TORN TICKET Logos, blockbuster.com® , BLOCKBUSTER Total Access™ word mark and logo, BLOCKBUSTER GiftCard/s®, BLOCKBUSTER Game Pass® and BLOCKBUSTER Movie Pass® word marks and logos, BLOCKBUSTER Night®, BLOCKBUSTER Online®, BLOCKBUSTER Rewards® word mark and logo, MAKE IT A BLOCKBUSTER NIGHT®, and the related BLOCKBUSTER Family of Marks, GAME RUSH® word mark and logo, MyQ Logo®, MyQ At A Glance Logo®, MOVIE STORE AT YOUR DOOR®, ONLINE RENTING WITHOUT THE WAIT®, RENTING IS BETTER THAN EVER®, THE GIFT OF ENTERTAINMENT®, QUIK DROP®, MOVIECLIQUE®, and MOVIELINK® word mark and logo, among others, and trade dress elements including, but not limited to, the blue and yellow awning outside our stores. In addition, we own the domain name registration for “blockbuster.com” and the related BLOCKBUSTER “Family of Domain Names” for top level and country domain names, plus a wide variety of other domain name registrations worldwide. We consider our intellectual property rights to be among our most valuable assets.

Copyrights. In addition to our own intellectual property rights, the scope of the rights of those who own copyrights in the products we rent also are of importance to us. The copyright “first sale” doctrine provides that, in the United States, the owner of a legitimate copy of a copyrighted work may, without the consent of the copyright owner, sell, rent or otherwise transfer possession of that copy. The first sale doctrine does not apply to sound recordings or computer software (other than software made for a limited purpose computer, such as a video game platform) for which the U.S. Copyright Act vests the right to control the rental of the copy in the copyright holder. The first sale doctrine does not exist in most countries outside of the United States where the copyright owner retains the rental rights to a copyrighted work. In these countries, home video retailers must obtain the right to rent videos to consumers through a licensing arrangement or a “purchase-with-the-right-to-rent” arrangement. Studios may charge these home video retailers more for product purchased for rental than product purchased solely for sale to consumers. This is commonly referred to as “two-tiered pricing” and is discussed further above under “Industry Overview— International Home Video Industry.” The potential impact of studio pricing decisions in countries where two-tiered pricing is allowed is discussed under “Item 1A. Risk Factors—Risks Relating to Our Business Operations.” The risk of changes in U.S. and international copyright laws is discussed under “Item 1A. Risk Factors—Other Business Risks.”

Seasonality

Historically, there has been a distinct seasonal pattern to the home movie and video games business, with slower business in May, due in part to improved weather and Daylight Saving Time, and in September and October, due in part to the start of school and the introduction of new television programs. December has historically been our highest revenue month, while January and February also contribute higher revenues. Although we expect these months to continue to make the largest contributions to our revenues, we believe the strength of rental revenues in these months has been and will continue to be negatively affected, to some degree, by consumers purchasing DVDs during the holiday season. Additionally, while we have diversified our product offerings in an effort to partially mitigate the impact of seasonality and weather conditions on our business, they are expected to continue to impact our business and our period-to-period financial results in the future. While we believe the current worldwide economic downturn will impact our future operational trends, we cannot predict the timing or extent to which this will occur.

 

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Employees

As of January 3, 2010, we employed approximately 48,000 persons, including 32,000 within the United States and 16,000 outside of the United States. Of the total number of U.S. employees, approximately 9,000 were full-time, 21,000 were part-time and 2,000 were seasonal employees. We believe that our employee relations are good.

Directors and Executive Officers of the Registrant

The following information regarding our directors and executive officers is as of February 26, 2010.

 

Name

   Age   

Position

James W. Keyes

   54    Chairman of the Board of Directors and Chief Executive Officer

Edward Bleier

   80    Director

Robert A. Bowman

   54    Director

Jackie M. Clegg

   47    Director

James W. Crystal

   72    Director

Gary J. Fernandes

   66    Director

Jules Haimovitz

   59    Director

Strauss Zelnick

   52    Director

Thomas M. Casey

   51    Executive Vice President and Chief Financial Officer

Thomas Kurrikoff

   46    Senior Vice President

Kevin Lewis

   39    Senior Vice President

Rod McDonald

   49    Vice President, Secretary and General Counsel

Doug McHose

   39    Senior Vice President

Set forth below is a description of the background of each of our directors and executive officers.

James W. Keyes has served as our Chairman of the Board of Directors and Chief Executive Officer since July 2007. Mr. Keyes served as President and Chief Executive Officer of 7-Eleven, Inc. from 2000 to 2005. Prior to his service as President and Chief Executive Officer, he was Executive Vice President and Chief Operating Officer of 7-Eleven, Inc. from 1998 to 2000 and Chief Financial Officer of 7-Eleven, Inc. from 1996 to 1998. Since his departure from 7-Eleven, Inc., Mr. Keyes has been Chairman of Key Development, LLC, a private investment firm.

Edward Bleier was elected as a director of Blockbuster in May 2005. Mr. Bleier was with Warner Bros. Entertainment Inc., New York, New York, from October 1969 to January 2005, where he served, partly, as President of Domestic Pay-TV, Cable and Networks Features, encompassing feature films, TV programming, animation, network sales, video-on-demand and consumer marketing. Mr. Bleier is a member of the board of directors of RealNetworks, Inc. and CKX, Inc. He is also Chairman Emeritus of the Center for Communication and the Academy of the Arts Guild Hall, serves as a trustee of the Charles A. Dana Foundation and The Bleier Center for Television and Popular Culture at Syracuse University and is a member of the Council on Foreign Relations.

Robert A. Bowman was appointed as a director of Blockbuster in December 2004. He has served as President and CEO of Major League Baseball Advanced Media LP, the interactive media and Internet company of Major League Baseball, since 2000. Mr. Bowman serves as President of the Michigan Education Trust and is a member of the board of directors of World Wrestling Entertainment Inc., The Warnaco Group Inc. and Take-Two Interactive Software, Inc.

Jackie M. Clegg was appointed as a director of Blockbuster in July 2003. She serves as Managing Partner of Clegg International Consultants, LLC, an international strategic consulting firm she founded in September 2001. In July 2001, Ms. Clegg stepped down as Vice Chairman and First Vice President of the Export-Import Bank of

 

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the United States, financier to foreign buyers of U.S. goods and services, after serving in that role since June 1997. She also served as its Chief Operating Officer from January 1999 through fiscal year 2000. Ms. Clegg also serves on the board of directors and audit committees of Brookdale Senior Living Inc., Cardiome Pharma Corp. and Javelin Pharmaceuticals Inc. (chair). Ms. Clegg also serves on the board of directors of the Chicago Mercantile Exchange.

James W. Crystal was appointed as a director of Blockbuster in February 2007. Mr. Crystal currently serves as Chairman and Chief Executive Officer of Frank Crystal & Company, a privately owned insurance brokerage firm, and has served in such capacities since 1958. Mr. Crystal also serves as Vice Chairman, trustee and member of the executive committee and Co-Chairman of the audit committee of Mt. Sinai Medical Center. In addition, he serves on the board of directors of Stewart & Stevenson LLC, a publicly traded company where he also serves on the audit committee, Banco de Caribe, ENNIA Caribe Holding, N.V., Auto Resources, Inc. and Atlantic International Insurance Co., Ltd.

Gary J. Fernandes was appointed as a director of Blockbuster in December 2004. He has served as Chairman of FLF Investments, a family business involved with the acquisition and management of commercial real estate properties and other assets, since 1999. Since his retirement as Vice Chairman from Electronic Data Systems Corporation in 1998, he founded Convergent Partners, a venture capital fund focusing on buyouts of technology enabled companies. In addition, from 2000 to 2001, Mr. Fernandes served as Chairman and CEO of GroceryWorks.com, an internet grocery fulfillment company. In November 1998, he founded Voyagers The Travel Store Holdings, Inc., a chain of travel agencies, and was President and sole shareholder of Voyagers. Mr. Fernandes serves on the board of directors of BancTec, Inc. and CA, Inc. He is also a member of the board of governors of the Boys & Girls Clubs of America and serves as a trustee for the O’Hara Trust and the Hall-Voyer Foundation.

Jules Haimovitz was appointed as a director of Blockbuster in May 2006. Mr. Haimovitz currently serves as President of Haimovitz Consulting Group. From 2002 to 2007, Mr. Haimovitz served as Vice Chairman and Managing Partner of Dick Clark Productions Inc., a producer of programming for television, cable networks and syndicators. From June 1999 to July 2004, Mr. Haimovitz served in various capacities at Metro Goldwyn Mayer Inc., including President of MGM Networks Inc., a wholly-owned subsidiary, Executive Consultant to the CEO, and Chair of the Library Task Force. From July 1997 to February 1999, he served as President and Chief Operating Officer of King World Productions, Inc., a worldwide distributor of first-run programming. Mr. Haimovitz has also served in executive positions at Diva Systems Corporation, ITC Entertainment Group, Spelling Entertainment Inc. and Viacom Inc. Mr. Haimovitz is on the board of directors of Infospace, Inc., a publicly traded company, and GNet Productions. Mr. Haimovitz serves on the audit committee of Infospace, Inc.

Strauss Zelnick was elected as a director of Blockbuster in May 2005. Mr. Zelnick founded ZelnickMedia Corporation, an investment and advisory firm specializing in media and entertainment, in 2001. ZelnickMedia holds interests in an array of media enterprises, providing general management and strategic advisory services in the United States, Canada, Europe, Asia and Australia. From 1998 to 2000, Mr. Zelnick served as President and Chief Executive Officer of BMG Entertainment, Inc., a music and entertainment unit of Bertelsmann A.G. Mr. Zelnick served as President and Chief Executive Officer of BMG’s North American business unit from 1994 through 1998. Mr. Zelnick currently serves as Chairman of the Boards of Directors of Take-Two Interactive Software, Inc., CME, Inc., and ITN Networks, Inc. Mr. Zelnick is also a director of Naylor Publications.

Thomas M. Casey has served as our Executive Vice President and Chief Financial Officer since September 2007. From 1999 until the commencement of his employment at Blockbuster, Mr. Casey served as managing director for Deutsche Bank Securities, Inc. where he was responsible for the bank’s retail industry relationships in North America and served as a strategic financial advisor to some of the world’s largest companies in the retail entertainment, food and drug, convenience store, food wholesale and foodservice industries. Prior to Deutsche Bank, Mr. Casey held positions with Citigroup, Merrill Lynch and Dillon Read & Co.

 

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Thomas Kurrikoff is a Senior Vice President responsible for financial planning, real estate, supply chain and international operations. Mr. Kurrikoff joined Blockbuster in December 2003 and has held several positions including Senior Vice President of North American Operations, Senior Vice President of Worldwide Finance and Senior Vice President and U.S. Controller. Prior to joining Blockbuster, Mr. Kurrikoff was Chief Operations Officer at Boston’s Pizza in 2003. Mr. Kurrikoff also held various finance roles at Pizza Hut Inc. and Burger King Corporation.

Kevin Lewis has served as a Senior Vice President since January 2009. He is responsible for the development and execution of the company’s initiatives to deliver Blockbuster-branded content to consumers via both established and emerging technologies such as direct-to-home connected devices, set-top boxes, portable video players, DVD vending machines, digital kiosks and by-mail subscription. Before joining Blockbuster, Mr. Lewis served as the Chief of Strategy and New Business Development for Philips Consumer Lifestyle and held several leadership positions during a ten-year career at the Boston Consulting Group.

Rod McDonald is Vice President, Secretary and General Counsel. Mr. McDonald joined Blockbuster in April 2008 as Vice President, Assistant Secretary and Associate General Counsel for Corporate and Securities. Prior to joining Blockbuster, Mr. McDonald served as General Counsel for Brinks Home Security, Inc. and Pizza Inn, Inc.

Douglas McHose has served as a Senior Vice President since November 2009. He leads physical operations, general merchandising, games, franchises and store marketing. Prior to his employment at Blockbuster, Mr. McHose was Senior Vice President of Store Operations for Shopko, a chain of retail stores based in Wisconsin. He was also a Territory Vice President for Best Buy and a District Manager for Payless ShoeSource.

Available Information, Investor Relations and Certifications

We file annual, quarterly and current reports, information statements and other information with the Securities and Exchange Commission (“SEC”). The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is http://www.sec.gov.

The address of our Internet website is www.blockbuster.com, and the Investor Relations section of Blockbuster’s website may be accessed directly at http://investor.blockbuster.com. Through links on the Investor Relations portion of our website, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. Such material is made available through our website as soon as reasonably practicable after we electronically file the material with, or furnish it to, the SEC. The information contained on our website does not constitute part of this annual report on Form 10-K.

Stock Transfer Agency

American Stock Transfer & Trust Company, LLC

59 Maiden Lane

New York, NY 10038

Questions and inquiries via telephone or AST’s website:

(800) 937-5449

http://www.amstock.com

 

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Independent Registered Public Accounting Firm

PricewaterhouseCoopers LLP

2001 Ross Avenue

Suite 1800

Dallas, TX 75201

Stock Listing

Blockbuster Inc. Class A and Class B common stock trades on the New York Stock Exchange under the symbols BBI and BBI.B, respectively.

 

Item 1A. Risk Factors

In addition to the information set forth elsewhere in this report, including under Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the factors described below should be considered carefully in making any investment decisions with respect to our securities. These factors could materially affect our business, financial condition, results of operations or liquidity and cause investors in our securities to lose part or all of their investments.

Risks Relating to Our Liquidity and Indebtedness

We incurred a net loss from operations in the year ended January 3, 2010 and have a stockholders’ deficit as of January 3, 2010. In addition, the increasingly competitive industry conditions under which we operate has negatively impacted our results of operations and cash flows and may continue to in the future. These factors raise substantial doubt about our ability to continue as a going concern.

Our plans with respect to addressing these matters are discussed in greater detail under “Item 7. Management’s Discussion and Analysis of Financial Conditional and Results of Operations—Liquidity and Capital Resources” and in Note 1 to our consolidated financial statements. Our future viability is dependent on our ability to execute these plans successfully. If we fail to do so for any reason, we would not have adequate liquidity to fund our operations, would not be able to continue as a going concern and could potentially be forced to seek relief through a filing under U.S. Bankruptcy Code.

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

Our ability to make the required amortization and other debt service payments under the senior secured notes depends on our ability to generate sufficient cash flows from operating activities. We cannot assure you that our future cash flow will be sufficient to service our indebtedness and to meet the other obligations of our business. If we are unable to generate sufficient cash flow from operations to meet our debt service commitments through, or are unable to refinance or restructure our indebtedness prior to, maturity, we would be in default of the indenture governing the senior secured notes and the indenture governing our senior subordinated notes, which could require us to pursue a restructuring of our indebtedness or file for protection under the U.S. Bankruptcy Code.

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

We rely upon cash on hand and cash from operations to fund our cash requirements for working capital, including rental library purchases, capital expenditures, commitments and payments of principal and interest on borrowings. Our ability to generate cash from operations has been negatively impacted by competitive industry

 

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conditions, rapidly changing consumer preferences for acquisition of video and game entertainment, and the current state of the global economy. We expect that these factors will continue to have a negative impact on our business for the foreseeable future. Our current fiscal 2010 plan contemplates a domestic same-store sales decline in the range of mid-single digits to high single digits. Further deterioration would negatively impact our results of operations and cash flows.

We recently completed a number of external liquidity generating events, including the divestiture of some of our international operations. Our ability to complete additional divestitures is subject to a number of conditions, many of which are outside of our control. For example, each transaction is dependant on the execution of a definitive agreement with a willing buyer on terms mutually acceptable to both parties and the subsequent satisfaction of each of the conditions to such divestitures. Although we are in active discussions with a number of parties with respect to such transactions, we have not executed any definitive agreements at this time. As a result, we can provide you with no assurances that we will complete any such transactions or, if we do complete any such transaction, what the terms and conditions of such transaction will be. Under certain circumstances, we will be required to use the net proceeds of these divestitures to make an offer to repurchase the senior secured notes.

We are in the process of developing and initiating certain operational and business strategies to attempt to maximize our cash and cash equivalents over the near term. One initiative we are pursuing involves an exchange of all or part of our senior subordinated notes for Class A common stock. We also may seek certain modifications to the senior secured notes from the holders thereof. Consistent with this approach, the holders of the senior secured notes and the senior subordinated notes have been contacted and have formed respective note holder committees, have retained advisors and are conducting due diligence. Assuming that we can reach agreement with such holders on the terms of an exchange, we will seek to implement an exchange during the latter part of the second quarter or early part of the third quarter of this year, depending on the timing of SEC clearance of the exchange documentation and when we receive, if necessary, shareholder approval. In connection with pursuing an exchange, we will also be involved in discussions with holders of our Series A convertible preferred stock regarding the possible conversion of such Series A convertible preferred stock into our Class A common stock. We can give no assurance that we can successfully execute an exchange and preferred stock conversion strategy or any of the other strategies we are pursuing and our ability to do so could be significantly impacted by numerous factors including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures as well as the certificate of designations governing our Series A convertible preferred stock. It is possible that a successful and efficient implementation of an exchange or any of the other strategies we are pursuing will require us to make a pre-packaged, pre-arranged or other type of filing for protection under Chapter 11 of the U.S. Bankruptcy Code.

If we cannot meet our capital needs using cash on hand and cash from operations, in addition to the actions set forth above, we may have to take actions such as modifying our business plan to close additional stores, pursuing additional external liquidity generating events, seeking additional financing to the extent available, further reducing or delaying capital expenditures, further restructuring our existing indebtedness or filing for protection under the U.S. Bankruptcy Code.

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

Our aggregate principal indebtedness under the senior secured notes and the senior subordinated notes was $975.0 million as of January 3, 2010. Our debt service obligations could have an adverse impact on our earnings and cash flows for as long as the indebtedness is outstanding.

Our indebtedness could have significant consequences for our business. For example, it could:

 

   

make it more difficult for us to pay our debts as they become due during general adverse economic and market or industry conditions because any related decrease in revenues could cause us to not have sufficient cash flows from operations to make our scheduled debt payments;

 

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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate, including limiting our ability to invest in certain strategic initiatives, and, consequently, place us at a competitive disadvantage to our competitors;

 

   

require a substantial portion of our cash flows from operations to be used for debt service payments, thereby reducing the availability of our cash flows to fund working capital requirements including inventory, capital expenditures, acquisitions and other general corporate purposes; and

 

   

cause our trade creditors to change their terms for payment on goods and services provided to us, thereby negatively impacting our ability to receive products and services on acceptable terms.

Additionally, we could incur additional indebtedness in the future and, if new debt is added to our current debt levels, the risks above could intensify. Additional debt would further increase the possibility that we may not generate sufficient cash to pay, when due, interest on and other amounts due in respect of our indebtedness, and would further reduce our funds available for operations, working capital, capital expenditures, acquisitions and other general purposes. Additional debt may also decrease our ability to refinance or restructure our indebtedness, and further limit our ability to adjust to changing market conditions. If we or our subsidiaries add new debt to our current debt levels, the related risks that we and they now face could increase.

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

Our ability to make payments on and to refinance our indebtedness and to fund working capital needs and planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other factors that are beyond our control.

If our business does not generate sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs, we may need to refinance or restructure all or a portion of our indebtedness on or before the maturity thereof, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse effect on our operations. We engaged Rothschild Inc. in February 2009 to assist us with evaluating capital structure alternatives, including recapitalization opportunities that may include a restructuring of our outstanding debt or equity securities. With respect to our restructuring options, as noted above, we are pursuing an exchange of all or part of our senior subordinated notes for Class A common stock and in connection therewith will be involved in discussions with holders of our Series A convertible preferred stock regarding the possible conversion of such Series A convertible preferred stock into Class A common stock. We may also seek certain modifications to the senior secured notes from the holders thereof. However, we may not be able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance our indebtedness will depend on the condition of the capital markets, the terms of our existing debt agreements and our financial condition at such time. Any refinancing of our debt could be at higher interest rates and may require us to comply with more restrictive covenants, which could further restrict our business operations. The terms of existing or future debt instruments, including the indenture governing the senior secured notes and the certificate of designations governing our Series A convertible preferred stock, may limit or prevent us from taking any of these actions. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on commercially reasonable terms or at all. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance or restructure our obligations on commercially reasonable terms or at all, would have an adverse effect, which could be material, on our business, financial condition and results of operations, as well as on our ability to satisfy our obligations in respect of the senior secured notes and the senior subordinated notes.

 

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In addition, if we are unable to meet our debt service obligations, our debt holders would have the right following a cure period to cause the entire principal amount of our debt, including the senior secured notes and the senior subordinated notes, to become immediately due and payable. If the amounts outstanding under these instruments are accelerated, we cannot assure you that our assets will be sufficient to repay in full the money owed to our debt holders. If we are unable to repay our debt upon acceleration we may be forced to file for protection under the U.S. Bankruptcy Code.

Restrictive covenants in the indenture governing our senior subordinated notes and the indenture governing the senior secured notes may limit our current and future operations, particularly our ability to respond to changes in our business or to pursue our business strategies.

The indentures governing the senior secured notes and the senior subordinated notes contain, and any future indebtedness of ours may contain, a number of restrictive covenants that impose significant operating and financial restrictions, including restrictions on our ability to take actions that we believe may be in our interest. The indentures governing the senior secured notes and the senior subordinated notes, among other things, limit our ability to:

 

   

incur additional indebtedness and guarantee indebtedness;

 

   

pay dividends on or make distributions in respect of capital stock or make certain other restricted payments or investments;

 

   

enter into agreements that restrict distributions from restricted subsidiaries;

 

   

sell or otherwise dispose of assets, including capital stock of restricted subsidiaries;

 

   

enter into transactions with affiliates;

 

   

create or incur liens;

 

   

enter into sale/leaseback transactions;

 

   

merge, consolidate or sell substantially all of our assets;

 

   

make investments and acquire assets; and

 

   

make certain payments on indebtedness.

The restrictions contained in the indentures governing the senior secured notes and the senior subordinated notes could adversely affect our ability to:

 

   

finance our operations;

 

   

make needed capital expenditures;

 

   

make strategic acquisitions or investments or enter into alliances;

 

   

withstand a continued and sustained downturn in our business or the economy in general;

 

   

engage in business activities, including future opportunities, that may be in our interest; and

 

   

plan for or react to market conditions or otherwise execute our business strategies.

Our ability to obtain future financing or to sell assets could be adversely affected because a very large majority of our assets have been secured as collateral for the benefit of the holders of the senior secured notes. In addition, our financial results, our substantial indebtedness, our credit ratings and the declining in-store rental industry in which we operate could adversely affect the availability and terms of our financing. Further, uncertainty surrounding our ability to finance our obligations could result in unfavorable terms from our trade creditors. In addition, there are other situations where our debt may be accelerated and we may be unable to repay such debt. Any of these scenarios could adversely impact our liquidity and results of operations or force us to seek further restructuring of our indebtedness or file for protection under the U.S. Bankruptcy Code.

 

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

The major debt-rating agencies routinely evaluate our debt and rate our debt according to a number of factors, among which are, our perceived financial strength and transparency with rating agencies and timeliness of financial reporting. On January 21, 2010, Standard & Poor’s changed our outlook to poor from stable due to deteriorating market conditions. On February 17, 2010, Standard & Poor’s downgraded our corporate credit rating to CCC from B-, with a negative outlook, and lowered our Notes to CCC from a B rating. On March 2, 2010, Moody’s downgraded both our probability of default rating and our corporate family rating to Caa3 from Caa1, with a negative outlook. Further downgrades in our credit ratings could adversely affect our ability to access capital in the future upon acceptable terms and conditions.

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

Given our liquidity limitations and uncertainty surrounding our ability to finance our obligations, we are currently in discussions with several of the large studios regarding the credit terms for our inventory purchases. If the studios tighten their credit terms or if studios eliminate their provision of credit to us altogether, this could result in up-front cash commitments that we may be unable to sustain on a long-term basis given our debt service and other business obligations. In such event, our ability to maintain optimal product in-stock and availability levels would be adversely affected and our financial results would suffer. Because we no longer have the ability to borrow under a revolving credit facility, an inability to meet our obligations with respect to our inventory purchases may result in our need to file for protection under the U.S. Bankruptcy Code.

We are currently in discussions with several major studios to maintain or improve our existing credit terms by pledging our unencumbered Canadian assets as collateral for our domestic studio payables. As an alternative, we may borrow against our unencumbered Canadian assets. However, there can be no assurance that we can execute either alternative.

If we are unable to successfully implement our operational and business strategies, if we are unable to reach agreements with our debt holders to restructure a sufficient portion of our debt, or if the major studios tighten or eliminate credit terms, we may voluntarily seek relief under the U.S. Bankruptcy Code.

We are currently experiencing significant liquidity constraints and have sizable amortization and other debt service requirements. Should we not be able to generate sufficient cash flow from operations and should the studios tighten or eliminate credit terms, we may determine that it is in the Company’s best interests to voluntarily seek relief through a pre-packaged, pre-arranged or other type of filing under Chapter 11 of the U.S. Bankruptcy Code, including prior to the time we would otherwise be required to do so in an acceleration event. Seeking relief under the U.S. Bankruptcy Code, if such relief does not lead to a quick emergence from Chapter 11, could materially adversely affect the relationships between us and our existing and potential customers, employees, suppliers, partners and others. Further, if we were unable to implement a plan of reorganization or if sufficient debtor-in-possession financing were not available, we could be forced to liquidate under Chapter 7 of the U.S. Bankruptcy Code.

 

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Risks Relating to Our Business Operations

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

In fiscal 2009, revenues generated by our domestic segment decreased by 20.4% and our domestic same-store revenues decreased by 15.6%. We believe that such declines were caused primarily by (i) increased competition from retail mass merchant sales of low-priced DVDs, by-mail rentals, kiosk and vending rental and sales and other sources of in-home entertainment such as digital video recorders and other devices that are capable of downloading content for in-home viewing; (ii) competition from other forms of leisure entertainment; and (iii) the sustained decreases in consumer spending attributable to the unprecedented decline in overall economic conditions. Further declines in our in-store home video rentals and sales will negatively impact our business and our ability to implement our strategic initiatives.

We cannot predict the impact that the following may have on our business: (i) new or improved technologies or video formats, (ii) alternative methods of content delivery, or (iii) changes in consumer behavior facilitated by these technologies or formats and alternative methods of content delivery. We also compete generally for the consumer’s entertainment dollar and leisure time.

Advances in technologies such as video-on-demand, digital downloading, new video formats, or alternative methods of content delivery or certain changes in consumer behavior driven by these or other technologies and methods of delivery could have a negative effect on our business. In particular, our business could be adversely impacted if:

 

   

newly released movies were to be made widely available by the studios to these technologies or these formats at the same time or before they are made available to home video retailers for rental; and

 

   

these technologies or new formats were to be widely accepted by consumers.

Although we are pursuing, and may pursue in the future, initiatives related to alternative methods of content availability and delivery and believe that certain of these initiatives may be successfully integrated into our business model, we have limited experience with certain of these initiatives and cannot assure that they will be successful or profitable.

Many satellite providers, digital cable providers and Internet content providers have implemented, or are in the process of implementing, video-on-demand and digital downloading services for movies. These services can transmit a consumer’s movie selection nearly instantaneously and with interactive capabilities, such as start, stop, fast-forward and rewind, to the consumer’s television, computer or portable electronic device, thereby offering consumers the convenience of watching a movie with DVD-like control but without trips to the video store for rentals and returns. Although we are providing our own digital delivery services through BLOCKBUSTER On Demand, consumers may adopt our competitors’ video-on-demand and digital downloading services because of convenience, availability or cost.

The availability of content through video-on-demand, digital downloading and other technologies may reduce the demand for our products or otherwise negatively affect our business. Any method for delivery of entertainment content that serves as an alternative to obtaining product or services from our stores or our by-mail DVD rental service can impact our business. Examples of delivery methods that have impacted, or could impact, our business include:

 

   

personal video recorders,

 

   

video-on-demand,

 

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download-to-burn DVDs,

 

   

video vending machines and download-to-burn kiosks, and

 

   

video downloads to portable devices and personal computers.

Our video store business could be negatively affected if these alternative delivery methods were to become more widely available and accepted. This is because a smaller number of movies may be rented or sold if viewers were to favor the alternative delivery methods and expanded content, including movies, specialty programming and sporting events, offered through these services. Additionally, increases in the size of video-on-demand or digital downloading usage by consumers could lead to an earlier distribution window for movies on video-on-demand or by digital download if the studios were to perceive this to be a better way to maximize their revenues.

Moreover, technology and consumer offerings continue to develop, and we expect that new or enhanced technologies and consumer offerings will be available in the future. We may pursue certain of those technologies and consumer offerings if we believe they offer a sustainable customer proposition, are accretive to earnings and can be successfully integrated into our business model. However, we cannot predict consumer acceptance of these delivery channels or their impact on our business.

We also compete generally for the consumer’s entertainment dollar and leisure time with, among others, (i) movie theaters; (ii) Internet browsing, online gaming and other Internet-related activities; (iii) consumers’ existing personal movie libraries; (iv) live theater; (v) sporting events; and (vi) music entertainment. Our results can therefore fluctuate depending on the desirability of other forms of entertainment.

There can be no assurance that we will fully develop an ability to respond to changing consumer preferences, including with respect to new technologies and alternative methods of content delivery, to effectively adjust our product mix, service offerings and marketing and merchandising initiatives, or to selectively develop and maintain strategic alliances for products and services that meet and anticipate advances in technology and market trends.

We have implemented and expect to continue to implement initiatives that are designed to enhance efficiency, customer convenience and our product offerings. In doing so, we are competing in markets for products and services that are highly competitive and subject to evolving industry standards and rapid adoption of technical innovation and product enhancements by competitors. The implementation of new initiatives has involved, and will continue to involve, significant investments by us of time and money and could be adversely impacted by (i) our inability to timely implement and maintain the necessary information technology systems and infrastructure to support shifts in consumer preferences and any corresponding changes to our operating model, including continued support for our initiatives, and (ii) the extent and timing of our continued investment of incremental operating expenses and capital expenditures to continue to develop and implement our initiatives and our corresponding ability to effectively control overall operating expenses and capital expenditures.

We are currently pursuing certain initiatives that are related to digital content distribution, kiosk vending and consumer electronic devices. In these areas we face substantial competition from companies that have significant technical, marketing, distribution and other resources, as well as established hardware, software, and digital supplier relationships. We expect competition to intensify as competitors individually and collaboratively adopt new technologies to offer integrated solutions in these areas. We cannot assure you that our initiatives will be profitable or successful in attracting and retaining customers. Our ability to effectively and timely prioritize and implement our initiatives will also affect when and if they will have a positive impact on our profitability.

If the average sales and rental prices for our product are not at or above expected prices, our expected gross margins may be adversely affected.

To achieve our expected revenues and gross margins, we need to sell and rent, as applicable, our product, including previously rented, retail and rental (whether in-store, by-mail or digitally) product at or above expected

 

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prices. If the average sales or rental prices of such product are not at or above these expected prices, our revenues and gross margins may be adversely affected.

It is also important that we maximize our gross margins through our allocation of store space. We may need to turn our inventory of previously rented and retail product more quickly in the future in order to make room in our stores for additional DVDs, new customer proposition initiatives or to downsize the store. Therefore, we cannot assure you that in the future we will be able to rent or sell, on average, our product at or above the expected price.

Other factors that could affect our ability to rent or sell our product at expected prices include:

 

   

consumer desire to rent any of our movies and games;

 

   

consumer desire to own a particular movie or game;

 

   

the amount of product available for rental or sale by others to the public; and

 

   

changes in the price of product by the studios or changes by other retailers, particularly mass merchant retailers.

We have recently entered into licensing and content distribution arrangements and are seeking other alliances for non-store distribution channels that represent a significant component of our business strategy. If we are unable to realize the anticipated benefits of these alliances, our business may be adversely affected.

We depend upon our licensees and other third parties for the management, production and operation of the products and services for which they license our brand name or make our video library available for rent or purchase. Any revenue or profits from these arrangements are substantially dependent on the willingness and ability of these licensees and other parties to devote their financial resources and manufacturing and marketing capabilities to commercialize products and services that use our brand and video library. For example, while NCR has announced that it expects to have over 10,000 kiosks under the BLOCKBUSTER Express brand name by mid-year 2010, NCR is under no obligation to install or continue to operate these kiosks and may elect to discontinue doing so at any time. If we have a disagreement with any of these licensees and other parties with respect to the operation of our strategic alliances and are unable to resolve these disagreements, or if these licensees or other parties are unwilling or unable to devote financial resources to commercialize products using our brand name and video library, we may not be able realize the anticipated benefits of these alliances and our business could be adversely affected.

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

In 2009, we undertook a number of cost saving initiatives to increase EBITDA while reducing our general and administrative expenses, which resulted in over $300 million in general and administrative cost savings. We closed under-performing stores during 2009 and plan to close additional under-performing stores either upon lease expiration or on an accelerated basis, which we expect will cumulatively produce an additional annualized EBITDA benefit. We expect to incur substantial lease termination charges in connection with these store closings. In addition, we have taken advantage of additional opportunities to reduce general and administrative expenses in the first quarter of 2010. We have made certain assumptions in estimating the anticipated impact of our cost saving initiatives. These assumptions may turn out to be incorrect due to a variety of factors. For example, the expected EBITDA benefit from closing stores on an accelerated basis gives effect to the elimination of historical losses from these stores and assumes that 25% of the revenues from the closed stores are shifted to our remaining open stores. It is possible that our remaining stores may not realize revenue increases as a result of store closures. In addition, our ability to realize the expected benefits from these initiatives are subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. Some of our cost saving measures may not have the impact on our profitability that we currently project. If we are unsuccessful in implementing these initiatives or if we do not achieve our expected results, it may adversely impact our results of operations and cash flows.

 

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Our financial results are impacted by seasonality, including the adverse impact caused by improved weather conditions.

There is a distinct seasonal pattern to the home video and video games business, with slower business in May, due in part to improved weather and Daylight Saving Time, and in September and October, due in part to the start of school and the introduction of new television programs. The month of December has historically been our highest revenue month. While we expect this month to continue to make the largest contribution to our rental revenues, we believe the strength of rental revenues in this month has been and will continue to be negatively affected, to some degree, by competitive pressures, changes in consumer preferences for accessing filmed entertainment, and consumers purchasing DVDs during the holiday season. Although our by-mail and in-store rental subscription offerings have helped us mitigate, to some extent, the impact of seasonality and weather conditions on our business by providing a more steady revenue stream across all months, seasonality and weather are expected to continue to impact our business and our period-to-period financial results in the future.

Our revenues could be adversely affected due to the variability in consumer appeal of the movie titles and game software released for rental and sale, as well as the effect of game platform cycles.

The quality of movie titles and game software released for rental and sale is not within our control, and our results of operations have from time to time reflected the variability in consumer appeal for such items. We cannot assure you that future releases of movie titles and game software will appeal to consumers and, as a result, our revenues and profitability may be adversely affected.

Our financial results could be adversely affected if we are unable to manage our inventory effectively or if we are unable to reach agreements with service, product and content providers on favorable commercial terms, including such matters as copy depth and uses of product.

Our purchasing decisions are influenced by many factors, including, among others, gross margin considerations and supplier product return policies. While much of our retail movie product in the United States, but not outside the United States, is returnable to vendors, our investments in retail movie inventory may result in excess inventories in the event anticipated sales fail to materialize. In addition, returns of our games inventory, which is prone to obsolescence risks because of the nature of the industry, are subject to negotiation with vendors.

Our purchasing decisions also involve predictions of consumer demand. While the historical growth of our in-store and by-mail subscription programs and the free in-store rentals provided by our BLOCKBUSTER Total Access program have increased consumer demand for our products, these programs have increased the complexity of our purchasing decisions. In addition, the prevalence of multiple game platforms adds to the difficulty of accurately predicting consumer demand with respect to video games. The nature of and market for our products, particularly games and DVDs, also makes them prone to risk of theft and loss.

Our operating results could therefore suffer if we are not able to:

 

   

obtain or maintain favorable terms from our suppliers with respect to such matters as copy depth, use of product, including without limitation fulfillment of by-mail orders, and product returns;

 

   

maintain adequate copy depth to maintain customer satisfaction;

 

   

control shrinkage resulting from theft or loss; or

 

   

avoid significant inventory excesses that could force us to sell products at a discount or loss.

Further, as discussed above, uncertainty surrounding our ability to finance our obligations has in the past caused some of our trade creditors to impose increasingly less favorable terms and future uncertainty could similarly result in unfavorable terms from our trade creditors.

 

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Our business would lose a competitive advantage if the movie studios were to shorten or eliminate the home video retailer distribution window or otherwise adversely change their current practices with respect to the timing of the release of movies to the various distribution channels.

A competitive advantage that home video retailers currently enjoy over most other movie distribution channels, except theatrical release, is the early timing of the home video retailers’ distribution window. After the initial theatrical release of a movie, the studios’ current practice is to generally make their movies available to home video retailers (for rental and retail, including by mass merchant retailers) for specified periods of time. This distribution window has traditionally been exclusive against most other forms of non-theatrical movie distribution, such as pay-per-view, video-on-demand, digital downloads, premium television, basic cable, and network and syndicated television. Thereafter, movies are made sequentially available to television distribution channels. The studios’ traditional practices with respect to the distribution windows could change at any time.

Our business could be negatively affected if:

 

   

the home video retailer distribution windows were no longer the first following the theatrical release;

 

   

the length of the home video retailer distribution windows were shortened; or

 

   

the home video retailer distribution windows were no longer as exclusive as they are now.

This is because newly released movies would be made available earlier on these other forms of non-theatrical movie distribution, and consumers might no longer need to wait until after the home video retailer distribution window to view a newly released movie on one or more of these other distribution channels. In such event, we would need to address additional competition. According to industry statistics, more movies are now being released to pay-per-view, video-on-demand or digital downloads at the shorter end of the home video retailer distribution window range than at the longer end. In addition, many of the major movie studios have entered into various ventures to provide video-on-demand or similar services of their own. Increased studio participation in or support of these types of services could impact their decisions with respect to the timing and exclusivity of the home video retailer distribution window.

We believe that the studios have a significant interest in maintaining a viable home video retail industry. For example, Warner Bros. entered into licensing agreements with Netflix and Redbox in January and February of 2010, respectively, whereby Netflix and Redbox agreed not to rent new release Warner Bros. DVDs until 28 days after such DVDs are first made available for retail sale. At present, however, none of the other studios has entered into, and there can be no assurance that in the future any other studio will enter into, similar arrangements with Netflix and/or Redbox. While arrangements such as this may benefit our business, recently, there has been increasing experimentation by studios and various movie content aggregators and retailers with the traditional distribution windows, including simultaneous video-on-demand and DVD releases. Because the order, length and exclusivity of each window for each distribution channel are determined solely by the studio releasing the movie, we cannot predict the impact of any future decisions by the studios. In addition, any consolidation or vertical integration of media companies to include both content providers and digital distributors could pose a risk to the continuation of the home video retailer distribution window.

Changes in studio pricing policies have resulted in increased competition, in particular from mass merchant retailers, which has impacted consumer rental and purchasing behavior. We cannot control or predict future studio decisions or resulting consumer behavior, and future changes could negatively impact our profitability and cash flows.

The studios’ current practice is generally to sequentially release their movies to different distribution channels. After the initial theatrical release of a movie, studios generally make their movies available to home video retailers (for rental and retail, including by mass merchant retailers) for a specified period of time. This distribution channel is typically exclusive against other forms of non-theatrical movie distribution, including cable and satellite distribution, and is commonly referred to as the home video retailers’ “distribution window.”

 

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Historically, at the beginning of a particular movie title’s distribution window, the movie would be priced to home video retailers based on the applicable studio’s decision to promote the movie to the consumer either primarily for rental, or for both rental and sale, at the beginning of the distribution window. In order to promote a movie title primarily for rental at the beginning of the distribution window, a studio would initially release the title to home video retailers at a price that was too high to enable them to sell the title to consumers at an affordable price. As rental demand subsided, the studio would reduce the pricing for the movie, which would then enable retailers to sell the title to consumers at an affordable price. The time during which the studios released the title at the higher pricing was commonly referred to as the “rental window.” Currently, substantially all DVD titles are initially released to home video retailers at a price that is low enough to allow them to offer movies at affordable prices to the consumer from the beginning of the home video retailers’ distribution window. This method of pricing is commonly referred to as “sell-through” pricing, and has improved our ability to purchase rental product at lower prices. However, the studios’ sell-through pricing policy has also led to increasing competition from other retailers, in particular mass merchants such as Wal-Mart, Best Buy and Target. It has also led to increased competition from online retailers. These other retailers are able, due to the lower sell-through prices, to purchase DVDs for sale to consumers at the same time as traditional home video retailers, who, like us, purchase product for rental. In addition, some retailers lower their sales prices in order to increase overall traffic to their stores or businesses, and mass merchants may be more willing to sell at lower, or even below wholesale, prices to drive traffic and thereby increase sales of their other inventory items. All of these factors have increased consumer interest in purchasing DVDs, which has resulted in increased competition and reduced the significance of the historical rental window.

We believe that the increased consumer purchases of movies have been due in part to consumer interest in building DVD libraries of classic movies and personal favorites and that the studios will remain dependent on traditional home video retailers to generate revenues for the studios from titles that are not classics or current box office hits. We therefore believe the importance of the video rental industry to the studios will continue to be a factor in studio pricing decisions. However, we cannot control or predict studio pricing policies with certainty, and we cannot assure you that consumers will not, as a result of further decreases in studio sell-through pricing and/or sustained or further depressed pricing by competitors, increasingly desire to purchase rather than rent movies. Personal DVD libraries could also cause consumers to rent or purchase fewer movies in the future. Our profitability could, therefore, be negatively affected further if, in light of any such consumer behavior, we were unable to (i) maintain or increase our rental business; (ii) replace gross profits from generally higher-margin rentals with gross profits from increased sales of generally lower-margin sell-through product; or (iii) otherwise positively affect gross profits, such as through price increases or cost reductions. Our ability to achieve one or more of these objectives is subject to risks, including the risk that we may not be able to compete effectively with other DVD retailers, some of whom may have competitive advantages such as the pricing flexibility described above or favorable consumer perceptions regarding value.

Our profitability is also dependent on our ability to enter into arrangements with the studios that effectively balance cost considerations and the number of copies of a title stocked by us. As discussed previously, given our liquidity limitations and uncertainty surrounding our ability to finance our obligations, we are currently in discussions with several of the larger studios regarding the credit terms for our inventory purchases. Each type of arrangement provides different advantages and challenges for us. Our profitability could be negatively affected if studios were to make other changes in their pricing policies, which could include changes in revenue-sharing arrangements, pricing or rental windows for DVDs or expanded exploitation by studios of international two-tiered pricing laws, which allow studios to charge different prices for movies intended for rental to consumers, as opposed to sale. In addition, we cannot predict what use the studios might make of current or future alternative supply methods, such as downloading to stores or consumers, or what impact the use of such supply chain changes by us or our competitors might have on our profitability or cash flows from operations.

 

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Industry consolidation in the in-store home video rental industry has occurred and may continue. If we are not successful in capitalizing on this industry consolidation, our financial results may be adversely affected.

Based upon current industry projections, we believe that over-capacity exists in the video rental market and that, as a result, many video stores, including some of our own stores, will be forced to continue to close in the future. If we are unable to capitalize on the store closings of our competitors, we may be unable to grow our market share and our financial results may be adversely affected. In addition, we have historically closed underperforming video stores and will continue to consider the closure of underperforming stores. We closed 374 domestic company-owned stores in fiscal 2009. We are currently reviewing many of our store leases and evaluating certain sites to close or downsize based on store profitability. We expect to close approximately 500 to 545 domestic company-operated stores in 2010, of which 273 have already been closed in January and February 2010.

Investment in new business strategies and initiatives could disrupt our ongoing business and present risks not originally contemplated.

We have invested, and in the future may invest, in new business strategies and initiatives. Such opportunities may also involve significant risks and uncertainties, including distraction of management from current operations, insufficient revenue to offset expenses associated with the strategy or initiative, inadequate return of capital, and unidentified issues not initially contemplated or discovered. No assurance can be given that such strategies and initiatives will be successful and will not have a material adverse effect on our financial condition and operating results.

For certain of our customer proposition initiatives we may rely on third-party digital content, which may not be available to us on commercially reasonable terms or at all.

In addition to offering our own digital content from time to time we may contract with third parties to offer their digital content through our stores or alternative aggregation and content delivery products and services. In those cases, we could pay substantial fees to obtain rights to offer such content. Our licensing arrangements with these third-party content providers may be short-term and may not guarantee the continuation or renewal of these arrangements on reasonable terms. Some third-party content providers may also offer competing products and services, or offer similar content to our competitors, and could take action to make it more difficult for us to license their content in the future. If we are unable to continue to offer a wide variety of content at reasonable prices with acceptable usage rules, or continue to expand our systems and platforms and customer offerings for these relatively new customer proposition initiatives, our financial condition and operating results may be materially adversely affected.

Third-party content providers may require that we provide certain digital rights management and other security solutions. If these requirements change we may have to develop or license new technology to provide such solutions. There is no assurance that we will be able to develop or license such solutions at a reasonable cost and in a timely manner.

Any failure or inadequacy of our information technology infrastructure could harm our business.

The capacity, reliability and security of our information technology hardware and software infrastructure and our ability to expand and update this infrastructure in response to our changing needs are important to the continued implementation of our new customer proposition initiatives, as well as the operation of our business generally. To avoid technology obsolescence and enable future cost savings and customer enhancements, we are continually updating our information technology infrastructure. In addition, we intend to add new features and functionality to our products, services and systems that could result in the need to develop, license or integrate additional technologies. Our inability to add additional software and hardware or to upgrade our technology infrastructure could have adverse consequences, which could include the delayed implementation of our new

 

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customer proposition initiatives, service interruptions, impaired quality or speed of the users’ experience and the diversion of development resources. Our failure to provide new features or functionality to our systems also could result in these consequences. We may not be able to effectively upgrade and expand our systems, or add new systems, in a timely and cost effective manner and we may not be able to smoothly integrate any newly developed or purchased technologies with our existing systems. These difficulties could harm or limit our ability to improve our business. In addition, any failure of our existing information technology infrastructure could result in significant additional costs to us. Certain of our information technology services and support functions are performed by third parties. Service interruptions, contract disputes or the effect of general market conditions on these service providers could adversely impact the availability and reliability of service and support.

Our business model is substantially dependent on the functionality of our distribution centers.

Our domestic distribution system for our store-based operations is centralized. We ship a substantial portion of the products to our U.S. company-operated stores through our distribution center. We also have 38 regional U.S. distribution centers to support our by-mail service. If our distribution centers became non-operational for any reason, we could incur significantly higher costs and longer lead times associated with distributing our movies and other products. In international markets, we utilize a variety of distribution methodologies with similar risks to those in the United States.

Risks Relating to Our Common Stock

The significantly depressed price of our common stock may continue not only as a result of challenging market conditions but also any change in sentiment in the market regarding our operations, business model, business prospects or ability to pay our debt obligations as they become due.

The price at which our common stock has traded in recent periods has fluctuated greatly, and most recently has declined significantly. The price may continue to be volatile due to a number of factors including the following, some of which are beyond our control:

 

   

variations in our operating results;

 

   

variations between our actual operating results and the expectations of securities analysts, investors and the financial community;

 

   

announcements of developments affecting our business, systems or expansion plans of others;

 

   

competition, including the introduction of new competitors, their pricing strategies and services;

 

   

perceptions regarding the current and long-term viability of our business model and the success of ongoing and proposed strategic initiatives;

 

   

market volatility in general; and

 

   

the operating results of our competitors.

As a result of these and other factors, investors in our common stock may not be able to resell their shares at or above their original purchase price.

Following certain periods of volatility in the market price of our securities, we have become the subject of securities litigation. We may experience more of such litigation following future periods of volatility. This type of litigation may result in substantial costs and a diversion of management’s attention and resources.

We may not be able to remain in compliance with the New York Stock Exchange’s continued listing criteria.

Our Class A and Class B common stock are traded on the New York Stock Exchange (the “Exchange”) and are thereby subject to certain continued listing criteria established by the Exchange in order to maintain listing on

 

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the Exchange. Among such criteria is the requirement that common stock maintain a $1.00 minimum average closing price. If the average closing price of the Class A common stock is below $1.00 for any consecutive 30-trading-day period, the Class A and Class B stock could be delisted and moved to the Exchange’s ARCA electronic exchange.

The price at which the Class A stock has traded in recent periods has fluctuated greatly, and most recently has declined significantly, trading at prices below $1.00. In November 2009, we were notified by the Exchange that our Class A common stock did not satisfy the Exchange’s continued listing standard that requires the average closing price of a listed security to be no less than $1.00 per share over a consecutive 30-trading-day period. Under the Exchange’s rules, we have through the date of our 2010 annual meeting, which is expected to take place on May 26, 2010, within which to cure this deficiency. If we fail to cure this deficiency, the Exchange could begin the delisting process for our Class A and Class B common stock.

With the sustained decrease in the trading price of our Class A common stock our market capitalization has been reduced such that, if our share price continues to decline or it does not experience a sustained increase, there is a possibility that we may not be able to remain in compliance with Exchange requirements for minimum average market capitalization for listed companies.

If we are unable to maintain the Exchange listing for the Class A and Class B stock as a result of our failure to continue to comply with these requirements or any other minimum listing requirement, the Class A and Class B shares may be perceived as a less desirable investment, negatively affecting the market for the stock, which could decrease our ability to issue new stock and attract further equity investment. A delisting could also enhance the perception of the Company’s financial distress among our lenders, trade creditors, business partners, vendors, analysts and the media, which could cause some of our trade creditors to impose increasingly less favorable terms and make it more difficult for us to obtain future financing and develop strategic alliances.

Other Business Risks

Our success depends largely on our ability to attract and retain key personnel. If we lose key senior management or are unable to attract and retain the talent required for our business, our operating results could suffer.

Our performance depends in part on the ability of our senior management team to coalesce, motivate our employees and address the changes presented by our dynamic industry and the challenging economic conditions. Additionally, we rely upon the continued service and availability of skilled personnel in technical, operations and staff positions. Our employment agreements with James W. Keyes, our Chairman of the Board of Directors and Chief Executive Officer, and Thomas M. Casey, our Executive Vice President and Chief Financial Officer, are set to expire on July 1, 2010 and September 11, 2010, respectively. The unexpected future loss of services of Mr. Keyes, Mr. Casey, or any other member of our senior management team could have an adverse effect on our business. We will need to attract and retain additional qualified personnel and develop, train and manage management-level employees. We have relied on equity awards as one means for recruiting and retaining highly skilled talent. Accounting regulations requiring the expensing of stock options have resulted in increased stock-based compensation expense, which could cause us to reduce the number of stock-based awards issued to employees and could negatively affect our ability to attract and retain key personnel. Additionally, significant adverse volatility in our stock price has resulted in the exercise price of our outstanding stock options exceeding the underlying stock’s market value, thus lessening the effectiveness of retaining employees through stock-based awards. In addition, recent cost containment initiatives affecting our compensation practices that have been adopted in response to the current economic environment will also impact our ability to attract and maintain personnel to some extent, depending upon the length of time during which these initiatives remain in effect. As a result of these factors, we cannot assure you that we will be able to continue to attract and retain personnel as needed in the future.

 

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We are subject to governmental regulation particular to the retail home video industry and changes in U.S. or international laws may adversely affect us.

Any finding that we have been, or are, in noncompliance with respect to, or otherwise liable under, the laws affecting our business could result in costs, including, among other things, governmental penalties or private litigant damages, which could have a material adverse effect on us. We are subject to various international and U.S. federal and state laws that govern the offer and sale of our franchises because we act as a franchisor. In addition, because we operate video stores and develop new video stores, we are subject to various international and U.S. federal and state laws that govern, among other things, the disclosure and retention of our video rental records and access to and use of our video stores by disabled persons, and are subject to various international, U.S. federal, state and local advertising, consumer protection, credit protection, franchising, licensing, zoning, land use, construction, trading activities, second-hand dealer, minimum wage and labor and other employment regulations, as well as laws and regulations relating to the protection and cleanup of the environment and health and safety matters. The international home video and video game industry varies from country to country due to, among other things, legal standards and regulations, such as those relating to foreign ownership rights; unauthorized copying; intellectual property rights; movie ratings, which in many countries are legal standards unlike the voluntary standards of the United States; labor and employment matters; trade regulation and business practices; franchising and taxation; environmental matters; and format and technical standards. Our obligation to comply with, and the effects of, the above governmental regulations are increased by the magnitude of our operations.

Changes in existing laws, adoption of new laws or increases in the minimum wage may increase our costs or otherwise adversely affect us. For example, the repeal or limitation in the United States of certain favorable copyright laws would have an adverse impact in the United States on our rental business. Similarly, the adoption or expansion of laws in any other country to allow copyright owners to charge retailers more for rental product than for sell-through product could have an adverse impact on our rental business in that country.

We are subject to business risks of international operations.

We derive a material portion of our revenue through our international operations. For fiscal 2009, revenues from our international operations constituted 29.7% of our total revenues. As a result, our financial condition and operating results could be significantly affected by risks associated with international activities, including economic and labor conditions, political instability, tax laws (including U.S. taxes on foreign operations), and changes in the value of the U.S. dollar relative to local currencies. Margins on the sale and rental of our products in foreign countries could be materially adversely affected by foreign currency exchange rate fluctuations and by international trade regulations.

We are subject to various litigation matters that could, if judgments were to be rendered against us, have an adverse effect on our operating results.

We are subject to various legal proceedings and claims that have arisen in the ordinary conduct of our business and are not yet resolved and additional claims may arise in the future. Results of legal proceedings cannot be predicted with certainty. Regardless of its merit, litigation may be both time consuming and disruptive to our operations and cause significant expense and diversion of management attention. In recognition of these considerations, we may from time to time enter into material settlements. Should we fail to prevail in certain matters, or should several of these matters be resolved against us in the same reporting period, we may be faced with significant monetary damages or injunctive relief that could materially adversely affect a portion of our business and might materially affect our financial condition and operating results. See Note 8 to the consolidated financial statements for a discussion of certain pending material litigation matters relating to our business.

 

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Provisions in our charter documents and Delaware law could make it more difficult to acquire our Company.

Our second amended and restated certificate of incorporation (“certificate of incorporation”) and amended and restated bylaws (“bylaws”) contain provisions that may discourage, delay or prevent a third party from acquiring us, even if doing so would be beneficial to our stockholders. Our bylaws limit who may call special meetings of stockholders to any officer at the request of a majority of our Board of Directors, the Chairman of the Board or the Chief Executive Officer of the Company. Our certificate of incorporation and bylaws provide that the bylaws may be altered, amended or repealed by the Board of Directors.

Pursuant to our certificate of incorporation, the Board of Directors may by resolution establish one or more series of preferred stock, having such number of shares, designation, relative voting rights, dividend rates, liquidation or other rights, preferences and limitations as may be fixed by the Board of Directors without any further stockholder approval. Such rights, preferences, privileges and limitations as may be established could have the effect of impeding or discouraging the acquisition of control of us, which could adversely affect the price of our equity securities.

In addition, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder.

 

Item 1B. Unresolved Staff Comments

None.

 

Item 2. Properties

Our corporate headquarters are located at 1201 Elm Street, Dallas, Texas 75270 and consist of 242,615 square feet of space leased pursuant to an agreement that expires on June 30, 2017. Our primary distribution center is located at 3000 Redbud Blvd., McKinney, Texas 75069 and consists of about 850,000 square feet of space leased pursuant to an agreement that expires on December 31, 2012. We have set up our payroll and benefits center in Spartanburg, South Carolina. We also lease and operate 38 by-mail distribution centers spread strategically throughout the United States to support our domestic by-mail rental service.

We have country head offices in Buenos Aires, Argentina; Toronto, Canada; Uxbridge, England; Milan, Italy; Herlev, Denmark; and Mexico City, Mexico. For most countries in which we have company-operated stores, we maintain offices to manage our operations within that country.

We lease substantially all of our existing store sites. Within the United States, Canada and Mexico, these leases generally have a term of three to five years. The leases in our European markets generally have a term of twenty to thirty years. We expect that most future stores will also occupy leased properties.

 

Item 3. Legal Proceedings

Information regarding our material legal proceedings is set forth in Note 8 to the consolidated financial statements, in Item 8 of Part II of this Form 10-K, which information is incorporated herein by reference.

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The shares of Blockbuster Class A and Class B common stock are listed and traded on the New York Stock Exchange, or “NYSE,” under the symbols “BBI” and “BBI.B,” respectively. Our Class A common stock began trading on August 11, 1999, following our initial public offering and our Class B common stock began trading on October 14, 2004, in conjunction with our divestiture from Viacom Inc. (“Viacom”). The following table contains, for the periods indicated, the high and low sales prices per share of our Class A and Class B common stock as reported on the NYSE composite tape and the cash dividends per share of our Class A and Class B common stock:

 

     Blockbuster Class A
Common Stock

Sales Price
   Blockbuster Class B
Common Stock

Sales Price
   Cash Dividends
per share of
Common Stock(1)
       High            Low            High            Low       

Year Ended January 4, 2009:

              

Quarter Ended April 6, 2008

   $ 3.70    $ 2.66    $ 3.49    $ 2.25    $ —  

Quarter Ended July 6, 2008

   $ 3.55    $ 2.38    $ 2.92    $ 1.92    $ —  

Quarter Ended October 5, 2008

   $ 3.19    $ 1.86    $ 2.44    $ 1.09    $ —  

Quarter Ended January 4, 2009

   $ 2.00    $ 0.72    $ 1.59    $ 0.18    $ —  

Year Ended January 3, 2010:

              

Quarter Ended April 5, 2009

   $ 1.71    $ 0.13    $ 1.15    $ 0.08    $ —  

Quarter Ended July 5, 2009

   $ 1.26    $ 0.61    $ 0.68    $ 0.34    $ —  

Quarter Ended October 4, 2009

   $ 1.56    $ 0.58    $ 0.89    $ 0.30    $ —  

Quarter Ended January 3, 2010

   $ 1.14    $ 0.60    $ 0.65    $ 0.32    $ —  

 

(1) We have not declared a dividend on our common stock since the second quarter of 2005. Our negative surplus, as defined by Delaware Corporation Law, and covenants under our senior secured notes currently prohibit us from declaring a dividend. Therefore, we do not anticipate declaring a dividend on our common stock in the near future.

The terms of our debt agreements, as discussed in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” limit our ability to pay dividends and repurchase common stock. Subject to these limitations, our Board of Directors may change our dividend practices from time to time and decrease or increase the dividend paid, or not pay a dividend, on our common stock based on factors such as results of operations, financial condition, cash requirements and future prospects and other factors deemed relevant by our Board of Directors.

The number of holders on record of shares of our Class A and Class B common stock as of March 5, 2010 was 1,102 and 778, respectively.

On November 20, 2009, we announced that our Board of Directors authorized a combination of our shares of Class A common stock and Class B common stock into a single class of shares of common stock. Blockbuster’s dual class capital structure was originally established in connection with Blockbuster’s prior ownership by Viacom. We believe that elimination of the dual class capital structure will improve the market liquidity of our common stock for our stockholders and end confusion regarding the differences between the two classes of common stock. The combination will be subject to obtaining the requisite stockholder approvals at Blockbuster’s annual stockholders’ meeting in 2010 and will not take effect until such approvals are obtained. Our Board of Directors may explore additional alternatives with respect to our capital structure if necessary to cure the price condition deficiency.

In addition, on November 17, 2009, we were notified by the Exchange that we are not currently in compliance with the Exchange’s continued listing standard that requires the average closing price of our common stock be no less than $1.00 per share over a consecutive 30 trading-day period. Under Exchange rules, we have through the date of our 2010 annual meeting, which is expected to take place on May 26, 2010, within which to

 

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cure this deficiency. During this time our common stock will continue to be listed and traded on the Exchange, subject to compliance with other Exchange continued listing requirements. If we have not cured the price condition deficiency by the end of the cure period or if we are not able to remain in compliance with any other Exchange listing criterion, our common stock would be subject to delisting by the Exchange.

For information regarding our equity compensation plans, refer to the proxy statement to be filed for our 2010 annual meeting of stockholders incorporated by reference into Item 12 of Part III of this Form 10-K.

Stock Performance Graphs

The following stock performance graphs and related information shall not be deemed “soliciting material” or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, except to the extent that Blockbuster specifically incorporates it by reference into such filing.

The following graph compares the cumulative total stockholder return on our Class A common stock over the five-year period ended January 3, 2010, the cumulative total return during such period of the Standard and Poor’s 500 Stock Index (“S&P 500 Index”) and the Hemscott Industry Group Index 743-Music & Video Stores (“Hemscott Group Index”). The comparison assumes $100 was invested on December 31, 2004 in our Class A common stock and in each of the foregoing indices and assumes reinvestment of dividends. The stock performance shown on the graph below represents historical stock performance and is not necessarily indicative of future stock price performance.

LOGO

 

     12/04    12/05    12/06    1/08    1/09    1/10

Blockbuster Inc. Class A common stock

   100.00    39.48    55.69    36.00    13.68    7.05

Hemscott Group Index*

   100.00    91.46    91.15    78.67    75.74    130.31

S&P 500 Index

   100.00    104.91    121.48    128.16    80.74    102.11

 

* The Hemscott Group Index consists of the following issuers: Blockbuster Inc. (Class A common stock); Hastings Entertainment, Inc.; Interlink-US-Network, Ltd.; Netflix, Inc.; Trans World Entertainment Corporation; and Xinhua China Ltd.

 

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The following graph compares the cumulative total stockholder return on our Class B common stock over the five-year period ended January 3, 2010, the cumulative total return during such period of the S&P 500 Index and the Hemscott Group Index. The comparison assumes $100 was invested on December 31, 2004 in our Class B common stock and in each of the foregoing indices and assumes reinvestment of dividends. The stock performance shown on the graph below represents historical stock performance and is not necessarily indicative of future stock price performance.

LOGO

 

     12/04    12/05    12/06    1/08    1/09    1/10

Blockbuster Inc. Class B common stock

   100.00    37.97    55.87    33.64    7.98    6.73

Hemscott Group Index*

   100.00    91.46    91.15    78.67    75.74    130.31

S&P 500 Index

   100.00    104.91    121.48    128.16    80.74    102.11

 

* The Hemscott Group Index consists of the following issuers: Blockbuster Inc. (Class A common stock); Hastings Entertainment, Inc.; Interlink-US-Network, Ltd.; Netflix, Inc.; Trans World Entertainment Corporation; and Xinhua China Ltd.

Related Stockholder Matters

Our Board of Directors determined not to declare or pay a dividend on our shares of Series A convertible preferred stock with respect to the four consecutive quarterly periods beginning on February 15, 2009 and ending on February 14, 2010. Dividends on the Series A convertible preferred stock are cumulative and began to accumulate on May 15, 2009, of which $8.3 million has been accumulated as of January 3, 2010. If we fail to pay dividends on the Series A convertible preferred stock for six quarterly dividend periods (whether or not consecutive), the dividend rate payable on the Series A convertible preferred stock will increase by 1.0% until all accumulated and unpaid dividends on the Series A convertible preferred stock have been paid in full. In addition, if we fail to pay dividends on the Series A convertible preferred stock for six quarterly dividend periods (whether or not consecutive), the size of our Board of Directors will be increased by two and the holders of the Series A convertible preferred stock will have the right to vote to fill the two vacancies created thereby until all accumulated and unpaid dividends on the Series A convertible preferred stock have been paid in full, at which time the Board of Directors will return to its previous size. Our ability to pay cash dividends on the Series A

 

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convertible preferred stock is restricted under the terms of the indenture governing our senior secured notes and by Delaware Corporation Law. In February 2010, 74,214 shares, or 51% of the previously outstanding balance, of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 15.5 million shares of our Class A common stock.

 

Item 6. Selected Financial Data

The following table sets forth our selected consolidated historical financial data as of the dates and for the periods indicated. The selected consolidated statement of operations and balance sheet data for fiscal years 2005 through 2009 are derived from our consolidated financial statements. The financial information herein may not necessarily reflect our results of operations, financial position and cash flows in the future.

BLOCKBUSTER SELECTED CONSOLIDATED HISTORICAL

FINANCIAL DATA

The following data should be read in conjunction with, and is qualified by reference to, the consolidated financial statements and related notes, and “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this document.

 

    Fiscal Year Ended or at Year End  
    2009(1)     2008     2007(2)     2006(3)     2005(4)  
    (In millions, except per share amounts)  

Statement of Operations Data:

         

Revenues

  $ 4,062.4      $ 5,065.4      $ 5,314.0      $ 5,337.6      $ 5,551.1   

Gross profit

  $ 2,178.2      $ 2,630.3      $ 2,773.7      $ 2,959.0      $ 3,082.0   

Impairment of goodwill and other long-lived assets(5)

  $ 369.2      $ 435.0      $ 2.2      $ 5.1      $ 341.9   

Operating income (loss)(6)

  $ (355.2   $ (304.3   $ 27.3      $ 60.3      $ (396.9

Income (loss) from continuing operations

  $ (517.6   $ (382.9   $ (84.2   $ 53.1      $ (555.4

Income (loss) per common share from continuing operations—basic and diluted

  $ (2.72   $ (2.06   $ (0.50   $ 0.22      $ (3.02

Income (loss) from discontinued operations, net of tax(7)

  $ (40.6   $ 8.8      $ 10.4      $ (2.6   $ (28.5

Net income (loss)

  $ (558.2   $ (374.1   $ (73.8   $ 50.5      $ (583.9

Preferred stock dividends(8)

  $ (11.1   $ (11.3   $ (11.3   $ (11.3   $ —     

Net income (loss) applicable to common stockholders

  $ (569.3   $ (385.4   $ (85.1   $ 39.2      $ (583.9

Net income (loss) per common share—basic and diluted

  $ (2.93   $ (2.01   $ (0.45   $ 0.21      $ (3.18

Cash dividends per common share

  $ —        $ —        $ —        $ —        $ 0.04   

Weighted average shares outstanding—basic

    194.1        191.8        190.3        187.1        183.9   

Weighted average shares outstanding—diluted

    194.1        191.8        190.3        189.0        183.9   

Balance Sheet Data:

         

Cash and cash equivalents

  $ 188.7      $ 154.9      $ 184.6      $ 394.9      $ 276.2   

Total assets

  $ 1,538.3      $ 2,154.5      $ 2,733.6      $ 3,134.6      $ 3,184.0   

Long-term debt, including capital leases

  $ 855.9      $ 611.3      $ 703.0      $ 899.5      $ 1,121.6   

Stockholders’ equity (deficit)

  $ (314.3   $ 214.3      $ 655.7      $ 723.3      $ 637.6   

 

(1) During fiscal 2009, we recorded a $41.9 million loss on the sale of our Ireland operations, which is included in discontinued operations.
(2) During fiscal 2007, we recorded an $81.5 million gain on sale of Gamestation and a $6.3 million gain on sale of our Australian subsidiary, both of which are included in Operating income (loss).
(3) During fiscal 2006, we recorded $111.9 million in tax benefits resulting from the resolution of multi-year income tax audits.
(4) During fiscal 2005, we recorded a valuation allowance of $101.6 million on our deferred tax assets in various jurisdictions.

 

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(5) We have recognized non-cash charges to impair goodwill and other long-lived assets. See Note 2 to the consolidated financial statements for a discussion of impairment charges.
(6) During fiscal 2009, 2008, 2007, 2006 and 2005, we recognized $7.3 million, $14.1 million, $14.6 million, $25.5 million and $39.1 million, respectively, of compensation expense related to share-based compensation.
(7)

During fiscal 2006, we completed the divestiture of Movie Brands Inc. and MOVIE TRADING CO.® in addition to closing all of our store locations in Spain. In January 2007, we completed the sale of RHINO VIDEO GAMES®. In August 2009, we completed the sale of our operations in Ireland. These operations have been classified as discontinued operations for all periods presented.

(8) During the third quarter of fiscal 2005, we completed a private placement of Series A cumulative convertible perpetual preferred stock. The first dividend payment was declared and paid in the first quarter of 2006. Our Board of Directors determined not to declare or pay a dividend on our shares of Series A convertible preferred stock with respect to the four consecutive quarterly periods beginning on February 15, 2009 and ending on February 14, 2010. Dividends on the Series A convertible preferred stock are cumulative and began to accumulate on May 15, 2009, of which $8.3 million has been accumulated as of January 3, 2010. See “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.”

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Dollars in Millions)

Unless otherwise noted, the following discussion and analysis relates only to results from continuing operations. The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes appearing elsewhere in this Form 10-K. We have the intent and ability to take actions necessary for the Company to continue as a going concern, as discussed herein, and accordingly our consolidated financial statements have been prepared assuming that we will continue as a going concern. We incurred a net loss from operations in the year ended January 3, 2010 and have a stockholders’ deficit as of January 3, 2010. In addition, the increasingly competitive industry conditions under which we operate has negatively impacted our results of operations and cash flows and may continue to in the future. These factors raise substantial doubt about our ability to continue as a going concern. Management’s plans concerning these matters are also discussed under “Liquidity and Capital Resources” below and in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Fiscal Year

Beginning on January 1, 2007, we changed our fiscal year from a calendar year ending on December 31st to a 52/53 week fiscal year ending on the first Sunday following December 30th. Fiscal 2009 and 2008 include the 52 weeks ended January 3, 2010 and January 4, 2009, respectively, while fiscal 2007 includes the 53 weeks ended January 6, 2008.

Overview

Blockbuster Inc. is a leading global provider of in-home rental and retail movie and game entertainment, with over 6,500 stores in the United States, its territories and 17 other countries as of January 3, 2010. We also offer rental and retail movie entertainment through the Internet and by mail in the United States.

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

 

   

in-store,

 

   

by-mail,

 

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vending kiosks, and

 

   

digital devices.

Strategic Objectives and Accomplishments

During the first three quarters of 2009, we temporarily changed our strategy to manage the business for cash conservation. This temporary business strategy was necessary due to the upcoming debt maturities and challenging financial market conditions. On October 1, 2009, we completed the offering of $675 million of senior secured notes, using most of the proceeds to repay all of our remaining credit facilities. After the closing of our senior secured notes offering, we began to refine and implement our new strategy for distribution channels as well as to react to the changes in our market place.

Stores—Focus on improving the customer shopping experience by:

 

   

working to restructure studio and publisher contracts to improve the depth and breadth of product availability across all product lines;

 

   

enhancing merchandising initiatives;

 

   

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

 

   

providing exclusive products; and

 

   

increasing store remodeling efforts in select locations.

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

 

   

enhancing our product offering through the addition of video game rentals in select markets, expansion of Blu-ray and integration of the digital delivery channel into our by-mail platform; and

 

   

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

Vending kiosks—Focus on this distribution channel through an alliance with NCR, which has already deployed over 2,000 kiosks and plans to deploy a total of 10,000 kiosks by the end of 2010.

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

 

   

strategic alliances with consumer electronics device manufacturers and infrastructure providers, including Samsung, Motorola, T-Mobile, TiVo, Suddenlink and Vizio; and

 

   

enhanced features and capabilities for our blockbuster.com website.

Cost management and liquidity—We have reduced annualized worldwide general and administrative costs by more than $300 million in 2009 through the elimination of staffing and operational redundancies in our in-store, online and corporate support structure as well as through operational improvements. We will continue to closely monitor our costs and continue seeking operational efficiencies and cost reduction opportunities. Our focus has been and will continue to be on cost reductions and liquidity enhancing efforts through:

 

   

the continued closure of less profitable stores, of which 430 company-owned stores were closed in 2009, and 500 to 545 are planned to close domestically in 2010, of which 273 stores were closed in January and February 2010, resulting in over $20 million of store closure costs in the first eight weeks of fiscal 2010;

 

   

lease renegotiations to generate significant reductions in future store occupancy costs, through which approximately 1,500 domestic leases were renegotiated during 2009;

 

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elimination of the remaining letters of credit related to leases guaranteed by our former parent, Viacom Inc., which the majority were completed in 2009 and the remainder completed in January 2010; and

 

   

the ongoing pursuit of the sale and licensing of our international assets while maintaining an international brand presence overseas.

Key Financial Points for 2009

 

   

Reported net loss of $558.2 million, driven by non-cash impairment charges to our goodwill and other long-assets of $369.2 million, a decline in gross profit, increased interest expense, and a loss on sale of our Ireland operations; partially offset by reductions in operating expenses.

 

   

Closed the private offering of $675 million of senior secured notes and used the proceeds to repay all of our remaining credit facilities.

 

   

Consolidated same-store revenues decreased 13.1% due to increased competition and lower store traffic during the economic and industry downturn.

 

   

Total gross profit margin improved to 53.6% from 51.9% as compared to the prior year.

 

   

General and administrative expenses decreased by $306.6 million, compared to prior year, mainly due to continued cost reduction initiatives, a favorable foreign currency impact and a 7% decline in company-operated stores, excluding the sale of our stores in Ireland.

Outlook

In 2010, our goal is to preserve liquidity and optimize our capital structure while we continue the transformation to a multi-channel platform. Over the next 12 to 18 months, we expect to continue facing the challenges of the macroeconomic environment, increased industry competition and fragmentation, and balancing the decline of a single channel with the ascension of emerging channels, such as vending and digital. As we look at our plans for 2010, stores remain a key component of our multi-channel offering. Our current 2010 plan contemplates a domestic same-store sales decline in the range of mid-single digits to high single digits. Factors contemplated in our current 2010 plan that we expect to mitigate these challenges are modification of our domestic stores movie rental terms and pricing, implementation of studio windows, industry factors such as Hollywood/Movie Gallery store closures, better execution of our rental games offering, a balanced slate of movie releases and merchandising improvements including Blockbuster Premieres. However, there can be no assurance regarding these matters given the current state of the global economy and aggressive new competition, both of which have negatively impacted our ability to accurately forecast our results of operations and cash position, and which may result in deterioration of our revenues beyond what we anticipate. Further deterioration would negatively impact our anticipated revenues, profitability and cash flows from operations. The expectation to achieve planned financial results is subject to a number of assumptions, many of which are outside our control, such as the state of the global economy, competitive pressures, and no significant contraction in our trade terms.

For the full year 2010, we will continue to take actions to improve liquidity. We expect to further reduce general and administrative expenses by over $200 million, continue to rationalize the domestic store portfolio and work to divest international assets. In addition, our 2010 global capital expenditures will remain at maintenance levels of approximately $30 million and we will aggressively manage working capital. We will also continue to explore a variety of strategic alternatives to strengthen our capital structure to position us for success in our transformational efforts. We are in the process of developing and initiating certain operational and business strategies to attempt to maximize our cash and cash equivalents over the near term. One initiative we are pursuing involves an exchange of all or part of our senior subordinated notes for Class A common stock. We also may seek certain modifications to the senior secured notes from the holders thereof. Consistent with this approach, the holders of the senior secured notes and the senior subordinated notes have been contacted and have formed respective note holder committees, have retained advisors and are conducting due diligence. Assuming that we can reach agreement with such holders on the terms of an exchange, we will seek to implement an

 

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exchange during the latter part of the second quarter or early part of the third quarter of this year, depending on the timing of SEC clearance of the exchange documentation and when we receive, if necessary, shareholder approval. In connection with pursuing an exchange, we will also be involved in discussions with holders of our Series A convertible preferred stock regarding the possible conversion of such Series A convertible preferred stock into our Class A common stock. We can give no assurance that we can successfully execute an exchange and preferred stock conversion strategy or any of the other strategies we are pursuing and our ability to do so could be significantly impacted by numerous factors including changes in the economic or business environment, financial market volatility, the performance of our business, and the terms and conditions of our various debt agreements and indentures as well as the certificate of designations governing our Series A convertible preferred stock. It is possible that a successful and efficient implementation of an exchange or any of the other strategies we are pursuing will require us to make a pre-packaged, pre-arranged or other type of filing for protection under Chapter 11 of the U.S. Bankruptcy Code. See “Liquidity and Capital Resources” below for further discussion of our operational plan to preserve liquidity.

Although we still face challenging conditions, we continue to reposition and transform Blockbuster into a multi-channel brand by increasing our points of presence through alliances for vending and digital distribution and by offering our customers the most convenient access to media entertainment. Through our alliance with NCR, we expect an additional 7,000 Blockbuster Express kiosks to be added in 2010. We also plan to grow the by-mail channel and further expand availability of our digital offering through BLOCKBUSTER On Demand. By leveraging our brand to deliver content through multiple channels, we have positioned ourselves to be a leading provider of convenient access to media entertainment. Through the planned integration of our stores, by-mail, vending kiosks and digital services, we intend to utilize a centralized customer database, realize supply chain efficiencies and ultimately deliver a superior customer experience. This multi-channel capability differentiates us from our competitors and positions us to meet the challenges of operating in the rapidly changing media entertainment industry.

 

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Results of Operations

Consolidated Results

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

 

     Fiscal Year Ended  
   January 3,
2010

(52 weeks)
    January 4,
2009

(52 weeks)
    January 6,
2008

(53 weeks)
 
       (In millions, except worldwide store data)      

Statement of Operations Data:

      

Revenues

   $ 4,062.4      $ 5,065.4      $ 5,314.0   

Cost of sales

     1,884.2        2,435.1        2,540.3   
                        

Gross profit

     2,178.2        2,630.3        2,773.7   

Operating expenses(1)

     2,533.4        2,934.6        2,746.4   
                        

Operating income (loss)

     (355.2     (304.3     27.3   

Interest expense

     (111.6     (72.9     (88.2

Loss on extinguishment of debt

     (29.9     —          —     

Interest income

     1.3        2.4        6.4   

Other items, net(2)

     (10.4     16.3        (1.3
                        

Income (loss) before income taxes

     (505.8     (358.5     (55.8

Benefit (provision) for income taxes

     (11.8     (24.4     (28.4
                        

Income (loss) before discontinued operations

     (517.6     (382.9     (84.2

Income (loss) from discontinued operations, net of tax(3)

     (40.6     8.8        10.4   
                        

Net income (loss)

   $ (558.2   $ (374.1   $ (73.8
                        

Cash Flow Data:

      

Cash flows provided by (used in) operating activities

   $ 29.3      $ 51.0      $ (56.2

Cash flows provided by (used in) investing activities

   $ (74.9   $ (116.5   $ 76.7   

Cash flows provided by (used in) financing activities

   $ 72.4      $ 49.4      $ (241.0

Other Data:

      

Depreciation and intangible amortization

   $ 144.1      $ 146.6      $ 180.3   

Impairment of goodwill and other long-lived assets

   $ 369.2      $ 435.0      $ 2.2   

Margins:

      

Rental margin(4)

     63.4     61.8     60.4

Merchandise margin(5)

     21.2     20.7     23.6

Gross margin(6)

     53.6     51.9     52.2

Worldwide Store Data:

      

Same-store revenues increase (decrease)(7)

      

Rental revenues

     (11.1 )%      0.1     (6.1 )% 

Merchandise sales

     (17.9 )%      14.6     11.6

Total revenues

     (13.1 )%      3.9     (2.3 )% 

Company-operated stores at end of year

     5,220        5,806        6,073   

Franchised stores at end of year

     1,300        1,599        1,757   

Total stores at end of year

     6,520        7,405        7,830   

 

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     Total
Number
   Avg Sq.
Footage
   Total Sq.
Footage
          (in thousands)    (in thousands)

Real Estate Data at January 3, 2010:

        

Domestic

        

Company-operated stores

   3,525    5.5    19,503

Distribution centers

   39    N/A    1,121

Corporate/regional offices

   8    N/A    400

International

        

Company-operated stores

   1,695    3.2    5,439

Distribution centers

   6    N/A    170

Corporate/regional offices

   6    N/A    80

 

(1) Operating expenses include:

 

   

non-cash charges to impair goodwill and other long-lived assets totaling $369.2 million, $435.0 million and $2.2 million for fiscal years 2009, 2008 and 2007, respectively; and

 

   

a gain on sale of Gamestation of $81.5 million for fiscal 2007.

 

(2) Other items, net include the impact of foreign currency exchange gains and losses related primarily to intercompany loans denominated in currencies other than the U.S. dollar. The impact was a loss of $10.5 million in 2009, and a gain of $15.5 million in 2008.
(3) During August 2009 we sold Xtra-vision, our Ireland subsidiary. During January 2007, we completed the sale of RHINO VIDEO GAMES. These operations have been classified as discontinued operations.
(4) Rental gross profit (rental revenues less cost of rental revenues) as a percentage of rental revenues.
(5) Merchandise gross profit (merchandise sales less cost of merchandise sold) as a percentage of merchandise sales.
(6) Gross profit as a percentage of total revenues.
(7) A store is included in the same-store revenues calculation after it has been opened and operated by us for more than 52 weeks. An acquired store becomes part of the same-store base in the 53rd week after its acquisition and conversion. The percentage change is computed by comparing total net revenues for same-stores at the end of the applicable reporting period with total net revenues from these same-stores for the comparable period in the prior year. The same-store revenues calculation does not include the impact of foreign exchange or by-mail subscription revenue. The method of calculating same-store revenues varies across the retail industry; therefore, our method of calculating same-store revenues may not be the same as other retailers’ methods.

Comparison of Fiscal 2009 (52 Weeks) to Fiscal 2008 (52 Weeks)

 

   

Revenues decreased $1.0 billion as a result of declining same-store comparables, lower by-mail subscribers, 7% fewer company operated stores and an unfavorable foreign currency exchange impact.

 

   

Cost of sales decreased $551 million due to the decline in revenues and a favorable foreign currency exchange impact.

 

   

Gross profit decreased $452 million due to the reasons stated above, while gross margin percentage improved from 51.9% to 53.6%, primarily from an increase in domestic rental margin and international merchandise margin, as discussed in their respective segment comparisons.

 

   

Operating expenses decreased $401 million due to reduced general and administrative expenses from store closures, other cost savings initiatives and a lower impairment charge in 2009 as compared to the prior year.

 

   

Interest expense increased $38.7 million.

 

   

Non-cash interest increased $19.4 million related to the amortization of debt financing costs.

 

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Cash interest increased $19.3 million due to higher average debt balances and higher average interest rates on our long-term debt.

 

   

We recorded a $29.9 million loss on extinguishment of debt related to the write-off of debt financing costs for our amended revolving facility in the third quarter of fiscal 2009.

 

   

The variance in other items, net, is primarily related to foreign currency exchange on intercompany loans denominated in currencies other than U.S. dollars.

 

   

Discontinued operations for fiscal 2009 include a $41.9 million loss on the sale of our Ireland operations.

Comparison of Fiscal 2008 (52 Weeks) to Fiscal 2007 (53 Weeks)

 

   

Revenues decreased $249 million due to reduced international merchandise sales as we sold 217 Gamestation stores in 2007, lower store and by-mail rental revenues and one less week in the fiscal year, partially offset by increased domestic games sales as we expanded games software, hardware and accessories to all domestic stores.

 

   

Cost of sales decreased $105 million mainly as a result of the decline in revenues and fewer free in store exchanges for BLOCKBUSTER Total Access (“Total Access”), partially offset by increased domestic games merchandise sales.

 

   

Gross profit decreased $143 million due to the reasons discussed above, while gross margin percentage remained relatively flat as merchandise margin declined due to the domestic increase in game sales which carry a lower margin, offset by a decrease in costs for Total Access in-store exchanges.

 

   

Operating expenses increased $188 million mainly as a result of a fiscal 2008 impairment for goodwill and other long-lived assets, partially offset by reduced general and administrative expenses from store closures and other cost savings initiatives.

 

   

Interest expense decreased primarily due to lower average interest rates during 2008.

 

   

The variance in other items, net, is primarily related to foreign currency exchange on intercompany loans denominated in currencies other than U.S. dollars.

Segments

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

 

   

The Domestic segment is comprised of all U.S. store operations and by-mail subscription service operations in addition to vending kiosks and the digital delivery of movies through blockbuster.com and BLOCKBUSTER On Demand. As of January 3, 2010, we had 4,018 stores operating under the BLOCKBUSTER brand in the United States and its territories, of which 493 stores were operated through our franchisees. We also had 2,225 kiosks operating under the BLOCKBUSTER brand in the United States and its territories at that date.

 

   

The International segment is comprised of all non-U.S. store operations including operations in Europe, Latin America, Australia, Canada, Mexico and Asia. As of January 3, 2010, we had 2,502 stores operating under the BLOCKBUSTER brand and other brand names owned by us located in 17 markets outside of the United States. Of these stores, 807 stores were operated through our franchisees. In Canada, Italy, Mexico and Denmark, we also operate freestanding and store-in-store game locations under the GAME RUSH brand. During 2008, we sold our Chilean subsidiary coupled with a license agreement. On August 28, 2009, we completed the sale of our subsidiary in Ireland. The results for Chile have been included in continuing operations through the period in which it was sold, but the results for Ireland have been classified as discontinued operations for all periods presented.

 

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

 

     Domestic     International     Unallocated/
Corporate
    Total  

Statement of Operations Data:

        

Fiscal Year Ended January 3, 2010

        

Revenues

   $ 2,857.7      $ 1,204.7      $ —        $ 4,062.4   

Cost of sales

     1,259.9        624.3        —          1,884.2   
                                

Gross profit

     1,597.8        580.4        —          2,178.2   

Operating expense

     1,774.9        645.0        113.5        2,533.4   
                                

Operating income (loss)

   $ (177.1   $ (64.6   $ (113.5   $ (355.2
                                

Fiscal Year Ended January 4, 2009

        

Revenues

   $ 3,590.8      $ 1,474.6      $ —        $ 5,065.4   

Cost of sales

     1,673.4        761.7        —          2,435.1   
                                

Gross profit

     1,917.4        712.9        —          2,630.3   

Operating expenses

     2,143.3        646.4        144.9        2,934.6   
                                

Operating income (loss)

   $ (225.9   $ 66.5      $ (144.9   $ (304.3
                                

Fiscal Year Ended January 6, 2008

        

Revenues

   $ 3,607.9      $ 1,706.1      $ —        $ 5,314.0   

Cost of sales

     1,638.9        901.4        —          2,540.3   
                                

Gross profit

     1,969.0        804.7        —          2,773.7   

Operating expenses

     1,907.9        655.6        182.9        2,746.4   
                                

Operating income (loss)

   $ 61.1      $ 149.1      $ (182.9   $ 27.3   
                                

 

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Comparison of Fiscal 2009 (52 Weeks) to Fiscal 2008 (52 Weeks)

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

 

    Fiscal Year Ended
January 3, 2010

(52 Weeks)
    Fiscal Year Ended
January 4, 2009

(52 Weeks)
    Increase/
(Decrease)
 
  Amount     Percent of
Revenue
    Amount     Percent of
Revenue
    Dollar     Percent  

Revenues:

           

Rental revenues:

           

Movies

  $ 1,763.6      61.7   $ 2,272.4      63.4   $ (508.8   (22.4 )% 

Games

    200.2      7.0     219.9      6.1     (19.7   (9.0 )% 

Previously rented product (“PRP”)

    455.3      15.9     492.7      13.7     (37.4   (7.6 )% 
                                     

Total rental revenues

    2,419.1      84.6     2,985.0      83.2     (565.9   (19.0 )% 
                                     

Merchandise sales:

           

Movies

    174.2      6.1     227.4      6.3     (53.2   (23.4 )% 

Games

    60.2      2.1     155.0      4.3     (94.8   (61.2 )% 

General merchandise

    187.5      6.6     200.1      5.6     (12.6   (6.3 )% 
                                     

Total merchandise sales

    421.9      14.8     582.5      16.2     (160.6   (27.6 )% 
                                     

Royalties and other

    16.7      0.6     23.3      0.6     (6.6   (28.3 )% 
                                     

Total revenues

    2,857.7      100.0     3,590.8      100.0     (733.1   (20.4 )% 
                                     

Cost of sales:

           

Cost of rental revenues

    910.3      31.9     1,196.9      33.3     (286.6   (23.9 )% 

Cost of merchandise sold

    349.6      12.2     476.5      13.3     (126.9   (26.6 )% 
                                     
    1,259.9      44.1     1,673.4      46.6     (413.5   (24.7 )% 
                                     

Gross profit

    1,597.8      55.9     1,917.4      53.4     (319.6   (16.7 )% 
                                     

Operating expenses:

           

General and administrative:

           

Stores

    1,187.2      41.6     1,338.2      37.2     (151.0   (11.3 )% 

Corporate and field

    138.1      4.8     178.3      5.0     (40.2   (22.5 )% 
                                     

Total general and administrative

    1,325.3      46.4     1,516.5      42.2     (191.2   (12.6 )% 
                                     

Advertising

    67.2      2.4     85.9      2.4     (18.7   (21.8 )% 

Depreciation and intangible amortization

    112.4      3.9     105.9      2.9     6.5      6.1

Impairment of goodwill and other long-lived assets

    270.0      9.4     435.0      12.2     (165.0   (37.9 )% 
                                     
    1,774.9      62.1     2,143.3      59.7     (368.4   (17.2 )% 
                                     

Operating income (loss)

  $ (177.1   (6.2 )%    $ (225.9   (6.3 )%    $ 48.8      (21.6 )% 
                                     

Margins:

           

Rental margin

  $ 1,508.8      62.4   $ 1,788.1      59.9   $ (279.3   (15.6 )% 

Merchandise margin

  $ 72.3      17.1   $ 106.0      18.2   $ (33.7   (31.8 )% 

Gross margin

  $ 1,597.8      55.9   $ 1,917.4      53.4   $ (319.6   (16.7 )% 

 

     Fiscal Year Ended
January 3, 2010
(52 Weeks)
    Fiscal Year Ended
January 4, 2009
(52 Weeks)
 

Same-store revenues increase/(decrease)

    

Store only:

    

Rental revenues

   (12.8 )%    1.2

Merchandise revenues

   (26.2 )%    37.4

Total revenues

   (15.6 )%    6.4

Other:

    

Ending by-mail subscriber count

   1.4      2.1   

 

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Table of Contents

Domestic—Rental revenues

 

   

Rental revenues decreased mainly as a result of:

 

   

a $276.8 million decrease in same-store base rental revenues driven by decreased active store members;

 

   

by-mail revenues decreased $155.3 million as a result of a 31.5% average decline in by-mail subscribers;

 

   

a decline in company-operated stores of 353, or 9.1%, during the last four quarters, due primarily to the continued selective closure of less profitable stores; and

 

   

a $24.4 million decrease in same-store PRP revenues, which includes the favorable impact of increased PRP sales related to 245 stores which were being liquidated at year end.

 

   

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

Domestic—Merchandise sales

 

   

Merchandise sales decreased mainly as a result of:

 

   

a $98.3 million, or 67.3%, decrease in same-store game sales as a result of a significant reduction in games merchandise inventory levels and reduced store traffic;

 

   

a $42.2 million, or 19.7%, decrease in same-store movie sales as a result of reduced store traffic and a product mix shift, as we sold more catalog titles in 2009 and fewer new release movies; and

 

   

a decline in company-operated stores discussed above;

 

   

slightly offset by a $15.2 million bulk sale of games to a third-party game wholesaler.

Domestic—Cost of sales

 

   

Rental cost of goods sold decreased due to:

 

   

reduced estimated costs for our by-mail offering of $146 million due to reduced product purchases and lower shipping costs, resulting from the decline in by-mail subscribers as well as fewer free in-store exchanges for Total Access customers;

 

   

a decrease in rental inventory purchases; and

 

   

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

 

   

Merchandise cost of goods sold decreased $126.9 million due to the decline in sales mentioned above.

Domestic—Gross profit

 

   

Rental gross margin increased from 59.9% to 62.4% due to lower product buys as a result of our managing the business to preserve liquidity during the majority of the year.

 

   

Merchandise gross margin decreased from 18.2% to 17.1% due to increased promotional credits on general merchandise and a $14.0 million net loss on the bulk sale of games mentioned above, partially offset by a change in product mix. As a percentage of sales, there has been a decrease in games hardware and software sales which contribute lower gross margin.

 

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Table of Contents

Domestic—Operating expenses

 

   

Store general and administrative expense decreased $151.0 million mainly due to our focus on cost-savings measures, which include reducing store labor hours, renegotiating leases and closing less profitable stores.

 

   

Corporate and field general and administrative expense, which includes expenses incurred at the field and regional levels for store operations along with our by-mail offering, decreased $40.2 million primarily due to our cost-savings measures.

 

   

During 2009 we incurred $14.0 million in store closure expenses, excluding depreciation, of which $7.9 million related to stores closed during early 2010. We expect to incur a greater amount of these expenses in 2010, primarily in the first quarter, as we continue to selectively close store locations. We closed 374 domestic locations in 2009 and expect another 500-545 domestic store closures in 2010. In January and February 2010 we closed 273 domestic company owned store locations for which we have recorded over $20 million in store closure expenses, excluding depreciation, in the first eight weeks of fiscal 2010 in addition to the $7.9 million noted above. We have also identified an additional 150 domestic stores which will close in April, for which we expect to incur significant store closure costs. Historically we have incurred a broad range of costs on individual locations and cannot accurately estimate the amount that will be incurred for these additional store closures.

 

   

Advertising expense decreased $18.7 million as a result of a $29.7 million decrease in by-mail advertising, partially offset by increased store radio and television advertising during the fourth quarter of 2009 of $11.4 million.

 

   

Impairment of goodwill and other long-lived assets had the single largest impact on our operating expense decrease over prior year, with a 2009 impairment charge of $270.0 million compared to a $435.0 million impairment charge in 2008. For further discussion, see “Critical Accounting Estimates” below and Note 2 to our consolidated financial statements.

 

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Table of Contents

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

 

     Fiscal Year Ended
January 3, 2010

(52 Weeks)
    Fiscal Year Ended
January 4, 2009

(52 Weeks)
    Increase/
(Decrease)
 
   Amount     Percent of
Revenue
    Amount    Percent of
Revenue
    Dollar     Percent  

Revenues:

             

Rental revenues:

             

Movies

   $ 512.7      42.6   $ 621.5    42.1   $ (108.8   (17.5 )% 

Games

     51.5      4.3     52.7    3.6     (1.2   (2.3 )% 

PRP

     102.6      8.5     127.1    8.6     (24.5   (19.3 )% 
                                     

Total rental revenues

     666.8      55.4     801.3    54.3     (134.5   (16.8 )% 
                                     

Merchandise sales:

             

Movies

     141.6      11.8     162.9    11.0     (21.3   (13.1 )% 

Games

     282.4      23.4     366.5    24.9     (84.1   (22.9 )% 

General merchandise

     110.2      9.1     135.0    9.2     (24.8   (18.4 )% 
                                     

Total merchandise sales

     534.2      44.3     664.4    45.1     (130.2   (19.6 )% 
                                     

Royalties and other

     3.7      0.3     8.9    0.6     (5.2   (58.4 )% 
                                     

Total revenues

     1,204.7      100.0     1,474.6    100.0     (269.9   (18.3 )% 
                                     

Cost of sales:

             

Cost of rental revenues

     220.3      18.3     249.8    17.0     (29.5   (11.8 )% 

Cost of merchandise sold

     404.0      33.5     511.9    34.7     (107.9   (21.1 )% 
                                     
     624.3      51.8     761.7    51.7     (137.4   (18.0 )% 
                                     

Gross profit

     580.4      48.2     712.9    48.3     (132.5   (18.6 )% 
                                     

Operating expenses:

             

General and administrative

     495.7      41.3     580.7    39.3     (85.0   (14.6 )% 

Advertising

     24.2      2.0     31.8    2.2     (7.6   (23.9 )% 

Depreciation and intangible amortization

     25.9      2.1     33.9    2.3     (8.0   (23.6 )% 

Impairment of goodwill and long-lived assets

     99.2      8.2     —      0.0     99.2      N/A   
                                     
     645.0      53.6     646.4    43.8     (1.4   (0.2 )% 
                                     

Operating income (loss)

   $ (64.6   (5.4 )%    $ 66.5    4.5   $ (131.1   (197.1 )% 
                                     

Margins:

             

Rental margin

   $ 446.5      67.0   $ 551.5    68.8   $ (105.0   (19.0 )% 

Merchandise margin

   $ 130.2      24.4   $ 152.5    23.0   $ (22.3   (14.6 )% 

Gross margin

   $ 580.4      48.2   $ 712.9    48.3   $ (132.5   (18.6 )% 

 

     Fiscal Year Ended
January 3, 2010
(52 Weeks)
    Fiscal Year Ended
January 4, 2009
(52 Weeks)
 

Same-store revenues increase/(decrease)(1)

    

Rental revenues

   (5.0 )%    (2.8 )% 

Merchandise revenues

   (9.4 )%    2.4

Total revenues

   (7.0 )%    (0.4 )% 

 

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

 

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Table of Contents

International—Rental revenues

 

   

Rental revenues decreased primarily due to:

 

   

a same-store movie rental decrease of 9.0%, with Canada contributing the majority of the decrease, driven by price decreases due to increased competition and reduced traffic, partially offset by an increase in same-store movie rentals in the United Kingdom as a result of reduced pricing which drove a higher volume of transactions; and

 

   

a decline in company-operated stores of 49, or 2.5%, during the last four quarters;

 

   

offset by a same-store game rental increase of 6.2% due to the ramp-up of the Game Rush store-in-stores rolled out in 2008.

 

   

We experienced an unfavorable foreign currency exchange impact of $78.6 million, with the United Kingdom and Canada contributing the majority of the impact.

International—Merchandise sales

 

   

Movie sales decreased primarily due to:

 

   

a same-store sales decrease of 3.0%, with the majority of the negative impact from Canada due to increased low-price competition from big box retailers, partially offset by positive same-store sales in the United Kingdom where price reductions have positively impacted gross sales; and

 

   

the reduced store count discussed above.

 

   

Game sales, including sales of new and traded games software, hardware consoles and accessories decreased in total due to:

 

   

a same-store sales decrease of 14.1%, with decreased sales in all major markets except Mexico due to a decreased emphasis on games sales as compared to the ramp up in prior years and increased competition offering lower prices; and

 

   

the reduced store count discussed above.

 

   

We experienced an unfavorable foreign currency exchange impact of $55.2 million, with the United Kingdom contributing the majority of the impact.

International—Cost of sales

 

   

Rental and merchandise cost of sales decreased primarily due to the decrease in revenues discussed above.

 

   

We experienced a favorable foreign currency exchange impact of $64.3 million, with the United Kingdom contributing the majority of the impact.

International—Gross margin

 

   

Rental margin decreased due to the price decreases discussed above.

 

   

Merchandise gross margin increased due to a decreased games sales, which contribute a lower margin than movies sales.

International—Operating expenses

 

   

Operating expenses decreased primarily due to:

 

   

a $13.6 million or 4.7% decrease in compensation expense due to a reduction in head count, excluding the impact of foreign currency exchange;

 

   

a $5.6 million or 7.1% decrease in general and administrative costs driven by our cost-savings measures, excluding the impact of foreign currency exchange;

 

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Table of Contents
   

a $5.1 million or 15.9% decrease in advertising spend; and

 

   

a favorable foreign currency exchange impact of $68.1 million.

 

   

We incurred a $99.2 million charge for the impairment of goodwill and other long-lived assets. For further discussion, see “Critical Accounting Estimates” below and Note 2 to our consolidated financial statements.

 

   

In the third and fourth quarters of 2009, we paid $20.0 million to modify certain store leases in the United Kingdom in order to remove Viacom as a guarantor of those leases. This action was taken in order to reduce the letters of credit required for these lease guarantees, and thereby release restrictions on over $50 million of cash required to collateralize those letters of credit under our amended credit facility. No other modifications were made to the leases. While we accounted for these payments as lease modification costs, these payments were unusual in nature with unique business circumstances given that our intent was to increase liquidity through the reduction of restricted cash necessary to secure letters of credit. As of January 3, 2010:

 

   

$4.3 million had been expensed for closed stores;

 

   

$2.1 million was recorded as a value-added tax receivable;

 

   

$1.1 million had been amortized to rent expense; and

 

   

$12.5 million remained as a non-current asset on our consolidated balance sheet to be amortized to rent expense over the remaining lives of the related leases. The average remaining life of these leases at January 3, 2010 was approximately 8.5 years.

We also considered treating the transaction as debt financing costs. This treatment would have resulted in interest expense of $17.9 million for the third and fourth quarters of 2009 and a value added tax receivable of $2.1 million as of January 3, 2010.

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

 

     Fiscal Year Ended    Increase/
(Decrease)
 
   January 3,
2010

(52 Weeks)
   January 4,
2009

(52 Weeks)
   Dollar     Percent  

General and administrative

   $ 107.7    $ 138.1    $ (30.4   (22.0 )% 

Depreciation and intangible amortization

     5.8      6.8      (1.0   (14.7 )% 
                        

Operating expenses

   $ 113.5    $ 144.9    $ (31.4   (21.7 )% 
                        

Operating expenses decreased primarily due to:

 

   

a $16.1 million decrease in corporate compensation expense, related primarily to cost-savings measures of $9.3 million and reduced stock compensation expense of $6.8 million;

 

   

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

 

   

a $7.5 million reduction in professional fees, due to reduced legal settlements and our continued cost-savings measures;

 

   

partially offset by a $3.8 million increase in outsourcing fees.

 

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Table of Contents

Comparison of Fiscal 2008 (52 Weeks) to Fiscal 2007 (53 Weeks)

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

 

    Fiscal Year Ended
January 4, 2009

(52 Weeks)
    Fiscal Year Ended
January 6, 2008

(53 Weeks)
    Increase/
(Decrease)
 
    Amount     Percent of
Revenue
    Amount   Percent of
Revenue
    Dollar     Percent  

Revenues:

           

Rental revenues:

           

Movies

  $ 2,272.4      63.4   $ 2,389.3   66.3   $ (116.9   (4.9 )% 

Games

    219.9      6.1     220.6   6.1     (0.7   (0.3 )% 

PRP

    492.7      13.7     527.3   14.6     (34.6   (6.6 )% 
                                   

Total rental revenues

    2,985.0      83.2     3,137.2   87.0     (152.2   (4.9 )% 
                                   

Merchandise sales:

           

Movies

    227.4      6.3     221.2   6.1     6.2      2.8

Games

    155.0      4.3     47.4   1.3     107.6      227.0

General merchandise

    200.1      5.6     177.9   4.9     22.2      12.5
                                   

Total merchandise sales

    582.5      16.2     446.5   12.3     136.0      30.5
                                   

Royalties and other

    23.3      0.6     24.2   0.7     (0.9   (3.7 )% 
                                   

Total revenues

    3,590.8      100.0     3,607.9   100.0     (17.1   (0.5 )% 
                                   

Cost of sales:

           

Cost of rental revenues

    1,196.9      33.3     1,314.3   36.4     (117.4   (8.9 )% 

Cost of merchandise sold

    476.5      13.3     324.6   9.0     151.9      46.8
                                   
    1,673.4      46.6     1,638.9   45.4     34.5      2.1
                                   

Gross profit

    1,917.4      53.4     1,969.0   54.6     (51.6   (2.6 )% 
                                   

Operating expenses:

           

General and administrative:

           

Stores

    1,338.2      37.2     1,402.5   38.9     (64.3   (4.6 )% 

Corporate and field

    178.3      5.0     230.3   6.4     (52.0   (22.6 )% 
                                   

Total general and administrative

    1,516.5      42.2     1,632.8   45.3     (116.3   (7.1 )% 
                                   

Advertising

    85.9      2.4     150.5   4.2     (64.6   (42.9 )% 

Depreciation and intangible amortization

    105.9      2.9     122.4   3.3     (16.5   (13.5 )% 

Impairment of goodwill and other long-lived assets

    435.0      12.2     2.2   0.1     432.8      N/A   
                                   
    2,143.3      59.7     1,907.9   52.9     235.4      12.3
                                   

Operating income (loss)

  $ (225.9   (6.3 )%    $ 61.1   1.7   $ (287.0   (469.7 )% 
                                   

Margins:

           

Rental margin

  $ 1,788.1      59.9   $ 1,822.9   58.1   $ (34.8   (1.9 )% 

Merchandise margin

  $ 106.0      18.2   $ 121.9   27.3   $ (15.9   (13.0 )% 

Gross margin

  $ 1,917.4      53.4   $ 1,969.0   54.6   $ (51.6   (2.6 )% 

 

     Fiscal Year Ended
January 4, 2009
(52 Weeks)
    Fiscal Year Ended
January 6, 2008
(53 Weeks)
 

Same-store revenues increase/(decrease)

    

Store only

    

Rental revenues

   1.2   (7.2 )% 

Merchandise revenues

   37.4   (3.7 )% 

Total revenues

   6.4   (6.9 )% 

Other:

    

Ending by-mail subscriber count

   2.1      2.8   

 

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Table of Contents

Domestic—Rental revenues

 

   

Rental revenues decreased mainly as a result of:

 

   

a $60 million decline in by-mail revenues driven by a 26% average decline in by-mail subscribers, which is more than offset by related cost reductions described below under “Domestic—Gross profit;”

 

   

an estimated $55 million decrease due to the 53rd week included in fiscal 2007 results; and

 

   

a 3.2% decline in company-operated stores, due primarily to the continued selective closure of unprofitable stores;

 

   

offset by the favorable impact of price increases, which contributed to a same-store revenue increase of $28.7 million or 1.2%.

Domestic—Merchandise sales

 

   

Same-store game sales increased $108.0 million or 244.9%, representing the favorable impact of:

 

   

the expansion of games software, hardware and accessories to all stores;

 

   

cross-merchandising games hardware, software and accessories to prominent positions in our stores; and

 

   

a 37% higher average selling price per unit of games software due to an increase in games software sold for next generation game platforms that carry a higher average selling price than the older game platforms sold in 2007.

 

   

Same-store general merchandise sales, which include sales of confections and other movie and game-related products, increased $30.3 million or 18.2% due to:

 

   

our strategy of having an assortment of licensed merchandise product available for major theatrical releases; and

 

   

the roll-out of framed entertainment posters to our stores during the first quarter of 2008.

 

   

The following partially offset the increases to merchandise sales discussed above:

 

   

the decline in company-operated stores discussed above; and

 

   

an estimated $11 million decrease in total merchandise sales due to the 53rd week included in fiscal 2007 results.

Domestic—Cost of sales

 

   

Rental cost of goods sold decreased due to

 

   

the decline in rental revenues;

 

   

offset by reduced estimated costs for our by-mail offering of $150 million, including the favorable impact of approximately 50% fewer free in-store exchanges for Total Access subscribers; and

 

   

favorable nonrecurring contractual settlements with vendors of $15.1 million.

 

   

Merchandise cost of goods sold increased due to higher sales resulting from our investment in merchandise inventory.

 

   

Total cost of goods sold decreased an estimated $29 million due to the 53rd week included in fiscal 2007 results.

 

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Domestic—Gross profit

 

   

Rental gross margin increased due to the reasons above.

 

   

Merchandise gross margin decreased from 27.3% to 18.2% due to a change in product mix. As a percentage of sales, there has been an increase in games hardware and software sales which, due to the competitive prices at which we are selling them, negatively impacted our overall merchandise gross margin. In addition, DVD margin decreased due to more competitive consumer pricing.

 

   

The 53rd week included in fiscal 2007 results accounted for approximately $37 million of the decrease in total gross profit.

Domestic—Operating expenses

 

   

Stores general and administrative expense decreased mainly due to our focus on closing less profitable stores and renegotiating leases, leading to decreased occupancy costs and store labor costs from prior year.

 

   

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

 

   

Advertising expense, which includes by-mail subscriber acquisition costs, decreased 42.9% due to a reduction in our advertising spend to promote Total Access.

 

   

Depreciation and intangible amortization decreased 13.5% primarily due to certain store assets becoming fully depreciated in addition to the decreased store count discussed above.

 

   

Impairment of goodwill and other long-lived assets had the single largest impact on our operating expense increase over prior year, with a 2008 impairment charge of $435.0 million compared to a $2.2 million impairment charge in 2007. For further discussion, see “Critical Accounting Estimates” below and Note 2 to our consolidated financial statements.

 

   

The 53rd week included in fiscal 2007 resulted in a reduction of approximately $29 million in total operating expenses.

 

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

 

     Fiscal Year Ended
January 4, 2009

(52 Weeks)
    Fiscal Year Ended
January 6, 2008

(53 Weeks)
    Increase /
(Decrease)
 
   Amount    Percent of
Revenue
    Amount     Percent of
Revenue
    Dollar     Percent  

Revenues:

             

Rental revenues:

             

Movies

   $ 621.5    42.1   $ 689.9      40.3   $ (68.4   (9.9 )% 

Games

     52.7    3.6     53.9      3.2     (1.2   (2.2 )% 

PRP

     127.1    8.6     122.6      7.2     4.5      3.7
                                     

Total rental revenues

     801.3    54.3     866.4      50.7     (65.1   (7.5 )% 
                                     

Merchandise sales:

             

Movies

     162.9    11.0     190.1      11.2     (27.2   (14.3 )% 

Games

     366.5    24.9     481.2      28.2     (114.7   (23.8 )% 

General merchandise

     135.0    9.2     133.4      7.8     1.6      1.2
                                     

Total merchandise sales

     664.4    45.1     804.7      47.2     (140.3   (17.4 )% 
                                     

Royalties and other

     8.9    0.6     35.0      2.1     (26.1   (74.6 )% 
                                     

Total revenues

     1,474.6    100.0     1,706.1      100.0     (231.5   (13.6 )% 
                                     

Cost of sales:

             

Cost of rental revenues

     249.8    17.0     269.7      15.8     (19.9   (7.4 )% 

Cost of merchandise sold

     511.9    34.7     631.7      37.0     (119.8   (19.0 )% 
                                     
     761.7    51.7     901.4      52.8     (139.7   (15.5 )% 
                                     

Gross profit

     712.9    48.3     804.7      47.2     (91.8   (11.4 )% 
                                     

Operating expenses:

             

General and administrative

     580.7    39.3     654.6      38.5     (73.9   (11.3 )% 

Advertising

     31.8    2.2     40.0      2.3     (8.2   (20.5 )% 

Depreciation and intangible amortization

     33.9    2.3     42.5      2.5     (8.6   (20.2 )% 

Gain on sale of Gamestation

     —      0.0     (81.5   (4.8 )%      81.5      (100.0 )% 
                                     
     646.4    43.8     655.6      38.5     (9.2   (1.4 )% 
                                     

Operating income (loss)

   $ 66.5    4.5   $ 149.1      8.7   $ (82.6   (55.4 )% 
                                     

Margins:

             

Rental margin

   $ 551.5    68.8   $ 596.7      68.9   $ (45.2   (7.6 )% 

Merchandise margin

   $ 152.5    23.0   $ 173.0      21.5   $ (20.5   (11.8 )% 

Gross margin

   $ 712.9    48.3   $ 804.7      47.2   $ (91.8   (11.4 )% 

 

     Fiscal Year Ended
January 4, 2009
(52 Weeks)
    Fiscal Year Ended
January 6, 2008
(53 Weeks)
 

Same-store revenues increase/(decrease)(1)

    

Rental revenues

   (2.8 )%    (2.8 )% 

Merchandise revenues

   2.4   23.3

Total revenues

   (0.4 )%    7.5

 

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

 

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International—Rental revenues

 

   

Movie rental revenues decreased primarily due to:

 

   

a decline in company-operated stores of 7.3% during the last four quarters due primarily to the continued selective closure of less profitable stores;

 

   

a same-store sales for movie rentals decrease of 3.4%, impacted by a price decrease in select European markets due to competition from low retail prices and reduced traffic due to the economic downturn; and

 

   

a decrease in movie rental transactions due to competition from more popular TV offerings compared to 2007.

 

   

Rental mix changed with more customers purchasing PRP due to increased promotional activity designed to move older product. Our international markets purchase a majority of their rental product under traditional purchase agreements and therefore their PRP title availability is not as limited by revenue sharing agreements as it is domestically.

 

   

The 53rd week included in fiscal 2007 results accounted for approximately $14 million of the decrease in total rental revenues.

 

   

We experienced an unfavorable foreign currency exchange impact of $10.4 million.

International—Merchandise sales

 

   

Movie sales decreased primarily due to:

 

   

a same-store sales decrease of 10.1% due to the economic downturn, fewer large box office titles, and increased competition primarily in the United Kingdom and Canada; and

 

   

the reduced store count as discussed above.

 

   

Game sales, including sales of new and traded games software, hardware consoles and accessories decreased in total due to:

 

   

the sale of 217 Gamestation stores during the second quarter of 2007, which accounted for an estimated $150 million of the decrease; and

 

   

the reduction in company-operated stores mentioned above;

 

   

offset by a same-store games sales increase of 12.4% due to increased inventory levels in all of our international markets and the successful roll out of our Game Rush store-in-store concept to many stores in our Latin American and European markets.

 

   

We experienced an unfavorable foreign currency exchange impact of $34.6 million.

 

   

The 53rd week included in fiscal 2007 results accounted for approximately $16 million of the decrease in total merchandise sales.

International—Royalties and other revenues

 

   

We received $25 million in connection with the termination and relicensing of our Brazilian franchise in 2007.

International—Cost of sales

 

   

Rental cost of sales decreased primarily due to the decrease in revenues discussed above.

 

   

Merchandise cost of sales decreased primarily due to the decrease in revenues discussed above, with the sale of Gamestation contributing $117 million to the decrease.

 

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The 53rd week included in fiscal 2007 results accounted for approximately $17 million of the total decrease.

 

   

We experienced an unfavorable foreign currency exchange impact of $29.2 million.

International—Gross margin

 

   

Rental margin remained relatively flat while merchandise gross margin increased due to a shift towards higher margin movie sales with the sale of Gamestation.

 

   

The 53rd week included in fiscal 2007 results accounted for approximately $13 million of the total decrease in gross profit.

International — Operating expenses

 

   

Operating expenses decreased primarily due to:

 

   

a $41.6 million or 11.1% decrease in compensation expense due to a reduction in head count, excluding the impact of foreign currency exchange;

 

   

an estimated $30 million decrease due to the sale of 217 Gamestation stores in 2007;

 

   

a $23.3 million or 8.9% decrease in occupancy costs driven by the reduction in company-operated stores discussed above, excluding the impact of foreign currency exchange;

 

   

the impact of 53rd week included in 2007 results of $12 million; and

 

   

a favorable foreign currency exchange impact of $3.3 million;

 

   

offset by the 2007 gain on the sale of Gamestation of $81.5 million and the gain on sale of our operations in Australia of $6.3 million, which is recorded as a reduction to general and administrative expenses.

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

 

     Fiscal Year Ended    Increase/
(Decrease)
 
   January 4,
2009
(52 Weeks)
   January 6,
2008
(53 Weeks)
   Dollar     Percent  

General and administrative

   $ 138.1    $ 167.5    $ (29.4   (17.6 )% 

Depreciation and intangible amortization

     6.8      15.4      (8.6   (55.8 )% 
                        

Operating expenses

   $ 144.9    $ 182.9    $ (38.0   (20.8 )% 
                        

Operating expenses decreased primarily due to:

 

   

a reduction in general and administrative expense due to:

 

   

a $14.2 million or 74.7% reduction in severance costs;

 

   

a $12.6 million or 19.7% reduction in other general and administrative expenses primarily related to professional fees; and

 

   

a $9.2 million or 12.9% decrease in corporate compensation expense, related primarily to our 2007 changes in senior management;

 

   

offset by an estimated $6.0 million increase in our outsourcing costs; and

 

   

a reduction of depreciation expense due to certain assets becoming fully depreciated.

 

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Liquidity and Capital Resources

General

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

We incurred a net loss from operations for the year ended January 3, 2010 and have a stockholders’ deficit as of January 3, 2010. In addition, the increasingly competitive industry conditions under which we operate have negatively impacted our results of operations and cash flows and may continue to do so in the future. These factors raise substantial doubt about our ability to continue as a going concern.

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

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

As a result of the October 2009 refinancing and the implementation of our plan to aggressively manage liquidity (discussed below), we expect cash on hand and cash from operations will be sufficient to fund our anticipated cash requirements for minimum capital expenditures, working capital purposes including rental library purchases, as well as commitments and payments of principal and interest on borrowings for at least the next twelve months. However, there can be no assurance regarding these matters given the current state of the global economy and aggressive new competition, both of which have negatively impacted our ability to accurately forecast our results of operations and cash position, and which may result in deterioration of our revenues beyond what we anticipate. Our current fiscal 2010 plan contemplates a domestic same-store sales decline in the range of mid-single digits to high single digits. Each 1% change in our domestic same-store rental revenues represents approximately an $11 million change in operating income (loss). Further deterioration would negatively impact our anticipated revenues, results of operations and cash flows. This expectation to achieve planned financial results is subject to a number of assumptions, many of which are outside our control, such as the state of the global economy, competitive pressures, and no significant contraction in our trade terms.

Prior to completion of our refinancing in October 2009, we implemented a cash management strategy to enhance and preserve as much liquidity as possible. This cash management strategy temporarily limited some of our operational and strategic initiatives designed to grow our business over the long term. After the completion of our refinancing in October 2009, we increased our inventory levels to support higher in-stock availability and increased our advertising in an effort to improve top-line performance. However, we did not realize the desired return on these investments, and as a result, our results of operations and liquidity were negatively impacted. While we do plan to return to our business transformation strategy in 2010, we will be limited in our pursuit of this strategy while we continue to manage our liquidity. We plan to manage our liquidity under an operational plan that contemplates, among other things:

 

   

managing our working capital through optimization of inventory levels by:

 

   

selling underperforming rental inventory; and

 

   

aligning our product buys more effectively with anticipated store customer traffic;

 

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further reducing our general and administrative expenses by approximately $200 million by, among other things:

 

   

closing underperforming domestic company-operated stores; and

 

   

restructuring and reengineering our organization and processes to increase efficiency and reduce our operating costs by $70 million for fiscal 2010 resulting in a reduction of corporate overhead, domestic stores field overhead and domestic stores general and administrative expenses

 

   

reducing domestic advertising expenses by approximately $15 million to $20 million for fiscal 2010;

 

   

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

 

   

continuing store portfolio optimization, which includes:

 

   

closing underperforming domestic company-operated stores in order to realize an expected benefit to operating income/(loss) derived from the transfer of revenue from closed stores to nearby stores and the avoidance of store operating losses, offset partially by the cost of negotiated settlements of remaining lease obligations and/or the incurrence of dead rent and other occupancy costs on closed stores; and

 

   

renegotiating leases;

 

   

modifying our domestic stores’ movie rental terms and pricing;

 

   

exploring our options with respect to borrowing against unpledged assets in certain international markets;

 

   

lengthening the cycle of payables to certain vendors;

 

   

successfully eliminating our letter of credit requirements for lease guarantees during the first quarter of 2010;

 

   

aggressively pursuing options for the divestiture of certain non-core assets, including selling and/or licensing some of our international operations;

 

   

temporarily ceasing payment of preferred stock dividends; and

 

   

exploring various recapitalization opportunities, which may include an exchange of all or part of our senior subordinated notes for Class A common stock or the conversion of our Series A convertible stock into Class A common stock.

We cannot make assurances as to whether any of these actions can be effected on a timely basis, on satisfactory terms or maintained once initiated, and even if successful, our liquidity plan will limit certain of our operational and strategic initiatives designed to grow our business over the long term. Furthermore, if we are unable to generate sufficient cash flow from operations to service our indebtedness or otherwise fund our operations, or if we are unable to restructure our outstanding debt and/or equity securities, we could be forced to file for protection under the U.S. Bankruptcy Code.

We rely upon vendor financing in managing our liquidity. As a result, if our trade creditors were to impose unfavorable terms on us, it would negatively impact our ability to obtain products and services on acceptable terms and operate our business. In such event, our ability to maintain optimal product in-stock and availability levels would be adversely affected and our results of operations and financial performance would suffer.

We are currently in discussions with several major studios to maintain or improve our existing credit terms by pledging our unencumbered Canadian assets as collateral for our domestic studio payables. As an alternative, we may borrow against our unencumbered Canadian assets. However, there can be no assurance that we can execute either alternative.

 

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Adverse future developments regarding our pending and any future legal proceedings and other contingencies may also have a material adverse impact on our liquidity and results of operations. See Note 8 to our consolidated financial statements for further discussion of these items.

Contractual Obligations

As described more fully in Notes 6 and 8 to the consolidated financial statements, at January 3, 2010, our contractual obligations were as follows:

 

Contractual Obligations(1)

   < 1 Year    1-3 Years    3-5 Years    After 5 Years    Total

Operating leases

   $ 427.9    $ 575.3    $ 235.1    $ 104.0    $ 1,342.3

Capital lease obligations(2)

     7.6      10.5      7.0      7.2      32.3

Purchase obligations(3)

     168.3      41.4      10.7      5.3      225.7

Revenue-sharing obligations(4)

     75.2      —        —        —        75.2

Long-term debt

     112.5      480.0      382.5      —        975.0

Interest expense on long-term debt(5)

     105.7      178.0      72.9      —        356.6

Preferred stock dividends(6)

     19.2      21.9      21.9      —        63.0
                                  
   $ 916.4    $ 1,307.1    $ 730.1    $ 116.5    $ 3,070.1
                                  

 

(1) Due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at January 3, 2010, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authority. Therefore, $2.5 million of unrecognized tax benefits, including accrued interest, have been excluded from the contractual obligations table above. See Note 7 to the consolidated financial statements for a discussion on income taxes.
(2) Includes both principal and interest.
(3) Purchase obligations include agreements to purchase goods or services as of January 3, 2010 that are legally binding on us and that specify all significant terms, including fixed or minimum quantities to be purchased, fixed, minimum or variable price provisions and the approximate timing of the transaction. Purchase obligations that can be cancelled without penalty have been excluded. In addition, these amounts exclude revenue-sharing obligations, which are included on the “Revenue-sharing obligations” line above, and outstanding accounts payable or accrued liabilities. For information about outstanding accounts payable and accrued liabilities, see the Consolidated Balance Sheets and Note 4 to the consolidated financial statements.
(4) As of January 3, 2010, we were party to revenue-sharing arrangements with various studios. These arrangements are frequently renegotiated and terms change and vary accordingly. These contracts include minimum purchase requirements, based upon the box office results of the title, at a lower initial product cost as compared to traditional purchases. In addition, these contracts require net rental revenues to be shared with the studios over an agreed upon period of time. We have included an estimate of our contractual obligation under these agreements for minimum purchase requirements and performance guarantees for the period in which they can reasonably be estimated, which is usually two to four months in the future. Although these contracts may extend beyond the estimated two to four month period, we cannot reasonably estimate these amounts due to the uncertainty of purchases that will be made under these agreements. The amounts presented above do not include revenue-sharing accruals for rental revenues recorded during fiscal 2009. For information on revenue-sharing accruals for fiscal 2009 and 2008, see Note 4 to the consolidated financial statements.
(5) Calculated based on scheduled payments of our outstanding balances as of January 3, 2010. See Note 6 to the consolidated financial statements for further discussion.
(6)

These amounts were calculated based on the number of shares outstanding as of January 3, 2010. Our shares of preferred stock do not mature; therefore, amounts are provided for the next five years only. Through the first quarter of 2009, our policy had been to pay these quarterly dividends in cash. However, we may choose to pay dividends in shares of our Class A common stock or to not declare dividends for some quarters. Any unpaid quarterly dividends will accumulate until declared and paid. Our Board of Directors determined not

 

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to declare or pay a dividend on our shares of Series A convertible preferred stock with respect to the four consecutive quarterly periods beginning on February 15, 2009 and ending on February 14, 2010. Dividends on the Series A convertible preferred stock are cumulative and began to accumulate on May 15, 2009, of which $8.3 million has been accumulated as of January 3, 2010. See Note 3 to our consolidated financial statements for further information. In February 2010, 74,214 shares, approximately 51% of the previously outstanding balance, of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 15.5 million shares of our Class A common stock.

Capital Structure

The following table sets forth the carrying values of our long-term debt and capital lease obligations:

 

     January 3,
2010
   January 4,
2009

Current portion

     

Credit Facilities:

     

Revolving credit facility

   $ —      $ 120.0

Term A loan facility

     —        18.6

Term B loan facility

     —        59.4

Senior Secured Notes, interest rate of 11.75%

     101.6      —  
             

Total current portion of long-term debt

     101.6      198.0

Current portion of capital lease obligations

     6.1      8.5
             
     107.7      206.5
             

Non-current portion

     

Credit Facilities:

     

Term B loan facility

     —        283.0

Senior Secured Notes, interest rate of 11.75%

     536.0      —  

Senior Subordinated Notes, interest rate of 9.0%

     300.0      300.0
             

Total long-term debt, less current portion

     836.0      583.0

Capital lease obligations, less current portion

     19.9      28.3
             
     855.9      611.3
             

Total

   $ 963.6