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EX-4.9 - OMNIBUS REALLOCATION AGREEMENT - BLOCKBUSTER INCdex49.htm
EX-4.7 - SENIOR SECURED REVOLVING CREDIT AGREEMENT - BLOCKBUSTER INCdex47.htm
EX-4.8 - AMENDMENT NO. 1 TO SENIOR SECURED REVOLVING CREDIT AGREEMENT - BLOCKBUSTER INCdex48.htm
EX-32.2 - SECTION 906 EVP AND CFO CERTIFICATION - BLOCKBUSTER INCdex322.htm
EX-32.1 - SECTION 906 COB AND CEO CERTIFICATION - BLOCKBUSTER INCdex321.htm
EX-31.2 - SECTION 302 EVP AND CFO CERTIFICATION - BLOCKBUSTER INCdex312.htm
EX-31.1 - SECTION 302 COB AND CEO CERTIFICATION - BLOCKBUSTER INCdex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

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

For the quarterly period ended October 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 No.)

1201 Elm Street

Dallas, Texas 75270

Telephone 214-854-3000

(Address, including zip code, and telephone number,

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

 

 

Not Applicable

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

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  ¨

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

Yes  ¨    No  ¨

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

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

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

Yes  ¨    No   x

Number of shares of common stock outstanding at November 5, 2010:

Class A common stock, par value $.01 per share: 147,370,491

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

 

 

 


Table of Contents

 

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

INDEX TO FORM 10-Q

 

          Page  
   PART I—FINANCIAL INFORMATION   

Item 1.

  

Financial Statements

     3   
  

Consolidated Statements of Operations (Unaudited)—Thirteen and Thirty-Nine Weeks Ended October 3, 2010 and October 4, 2009

     3   
  

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

     4   
  

Consolidated Statements of Cash Flows (Unaudited)—Thirty-Nine Weeks Ended October 3, 2010 and October 4, 2009

     5   
  

Notes to Consolidated Financial Statements (Unaudited)

     6   

Item 2.

  

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

     35   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     61   

Item 4.

  

Controls and Procedures

     62   
   PART II—OTHER INFORMATION   

Item 1.

  

Legal Proceedings

     63   

Item 1A.

  

Risk Factors

     63   

Item 3.

  

Defaults Upon Senior Securities

     66   

Item 6.

  

Exhibits

     66   

 

2


Table of Contents

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In millions, except per share amounts)

 

     Thirteen Weeks
Ended
    Thirty-Nine Weeks
Ended
 
     October 3,
2010
    October 4,
2009
    October 3,
2010
    October 4,
2009
 

Revenues:

        

Base rental revenues

   $ 470.8      $ 581.8      $ 1,570.3      $ 1,920.8   

Previously rented product (“PRP”) revenues

     99.9        129.0        326.3        404.9   
                                

Total rental revenues

     570.7        710.8        1,896.6        2,325.7   

Merchandise sales

     161.4        195.0        554.1        636.6   

Other revenues

     4.5        4.7        13.6        15.9   
                                
     736.6        910.5        2,464.3        2,978.2   
                                

Cost of sales:

        

Cost of rental revenues

     191.1        247.1        685.7        837.9   

Cost of merchandise sold

     119.1        141.8        418.4        502.5   
                                

Total cost of sales

     310.2        388.9        1,104.1        1,340.4   
                                

Gross profit

     426.4        521.6        1,360.2        1,637.8   
                                

Operating expenses:

        

General and administrative

     405.0        475.9        1,322.9        1,441.1   

Advertising

     10.6        19.0        40.9        55.1   

Depreciation and intangible amortization

     28.3        36.9        81.0        103.2   
                                
     443.9        531.8        1,444.8        1,599.4   
                                

Operating income (loss)

     (17.5     (10.2     (84.6     38.4   

Interest expense

     (28.0     (31.8     (93.3     (78.1

Loss on extinguishment of debt

     —          (29.9     —          (29.9

Interest income

     0.5        0.1        0.6        1.1   

Other items, net

     (1.2     (1.2     (2.1     (7.7
                                

Income (loss) from continuing operations before reorganization items and income taxes

     (46.2     (73.0     (179.4     (76.2

Reorganization items, net

     (5.5     —          (5.5     —     

Benefit (provision) for income taxes

     (1.8     (2.9     (2.3     (9.8
                                

Income (loss) from continuing operations

     (53.5     (75.9     (187.2     (86.0

Income (loss) from discontinued operations, net of tax

     —          (38.2     (0.4     (37.3
                                

Net income (loss)

     (53.5     (114.1     (187.6     (123.3

Preferred stock dividends

     (0.6     (2.7     (2.9     (8.3
                                

Net income (loss) applicable to common stockholders

   $ (54.1   $ (116.8   $ (190.5   $ (131.6
                                

Net income (loss) per common share:

        

Basic and diluted

        

Continuing operations

   $ (0.25   $ (0.40   $ (0.89   $ (0.49

Discontinued operations

     —          (0.20     —          (0.19
                                

Net income (loss)

   $ (0.25   $ (0.60   $ (0.89   $ (0.68
                                

Weighted-average common shares outstanding:

        

Basic and diluted

     220.0        194.8        213.5        193.7   
                                

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

 

3


Table of Contents

 

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In millions, except per share amounts)

 

     October 3,
2010
    January 3,
2010
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 120.7      $ 188.7   

Receivables, less allowances of $5.1 and $6.0 for 2010 and 2009, respectively

     48.1        79.4   

Merchandise inventories

     207.6        298.5   

Rental library, net

     259.6        340.7   

Deferred income taxes

     13.7        13.6   

Prepaid and other current assets

     116.3        139.1   
                

Total current assets

     766.0        1,060.0   

Property and equipment, net

     197.9        249.4   

Deferred income taxes

     79.6        114.6   

Intangibles, net

     6.4        7.7   

Restricted cash

     35.7        58.5   

Other assets

     36.4        48.1   
                
   $ 1,122.0      $ 1,538.3   
                

Liabilities and Stockholders’ Equity (Deficit)

    

Current liabilities:

    

Accounts payable

   $ 72.1      $ 300.8   

Accrued expenses

     254.3        407.7   

Debtor-in-possession credit agreement

     20.0        —     

Current portion of long-term debt

     —          101.6   

Current portion of capital lease obligations

     0.6        6.1   

Deferred income taxes

     83.7        118.6   
                

Total current liabilities

     430.7        934.8   

Long-term debt, less current portion

     —          836.0   

Capital lease obligations, less current portion

     0.1        19.9   

Other liabilities

     22.5        61.9   

Liabilities subject to compromise (Note 2)

     1,160.7        —     
                
     1,614.0        1,852.6   
                

Commitments and contingencies (Note 11)

    

Stockholders’ equity (deficit):

    

Preferred stock, par value $0.01 per share; 100 shares authorized; 0.030 and 0.146 shares issued and outstanding for 2010 and 2009, respectively, with a liquidation preference of $1,000 per share

     30.3        145.9   

Class A common stock, par value $0.01 per share; 400 shares authorized; 147.1 and 122.4 shares issued and outstanding for 2010 and 2009

     1.5        1.3   

Class B common stock, par value $0.01 per share; 500 shares authorized; 72.0 shares issued and outstanding for 2010 and 2009

     0.7        0.7   

Additional paid-in capital

     5,498.1        5,377.0   

Accumulated deficit

     (5,974.5     (5,786.9

Accumulated other comprehensive loss

     (48.1     (52.3
                

Total stockholders’ equity (deficit)

     (492.0     (314.3
                
   $ 1,122.0      $ 1,538.3   
                

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

 

4


Table of Contents

 

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In millions)

 

     Thirty-Nine Weeks
Ended
 
     October 3,
2010
    October 4,
2009
 

Cash flows from operating activities:

    

Net income (loss)

   $ (187.6   $ (123.3

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

    

Depreciation and intangible amortization

     81.0        106.1   

Reorganization items, net of cash payments

     1.0        —     

Rental library purchases

     (265.1     (347.3

Rental library amortization

     349.7        376.2   

Loss on sale of store operations

     —          38.7   

Non-cash share-based compensation

     0.9        6.2   

Deferred taxes and other

     9.0        15.7   

Loss on extinguishment of debt

     —          29.9   

Changes in operating assets and liabilities:

    

Change in receivables

     31.1        55.6   

Change in merchandise inventories

     90.3        138.7   

Change in prepaid and other assets

     30.6        9.5   

Change in accounts payable

     (150.0     (181.5

Change in accrued expenses and other liabilities

     (34.7     (150.5
                

Net cash provided by (used in) operating activities

     (43.8     (26.0
                

Cash flows from investing activities:

    

Capital expenditures

     (16.7     (19.9

Change in restricted cash

     22.8        (65.8

Proceeds from sale of store operations

     —          13.4   

Other investing activities

     1.3        0.9   
                

Net cash provided by (used in) investing activities

     7.4        (71.4
                

Cash flows from financing activities:

    

Proceeds from debtor-in-possession credit agreement

     20.0        —     

Proceeds from senior secured notes

     —          634.5   

Proceeds from credit agreement

     —          381.4   

Repayments on credit agreement

     —          (864.4

Repayments on senior secured notes

     (45.0     —     

Cash dividends on preferred stock

     —          (2.8

Debt financing costs

     (2.7     (61.1

Capital lease payments

     (4.1     (8.9
                

Net cash provided by (used in) financing activities

     (31.8     78.7   
                

Effect of exchange rate changes on cash

     0.2        4.8   
                

Net decrease in cash and cash equivalents

     (68.0     (13.9

Cash and cash equivalents at beginning of period

     188.7        154.9   
                

Cash and cash equivalents at end of period

   $ 120.7      $ 141.0   
                

Supplemental cash flow information:

    

Cash payments for interest

   $ 57.6      $ 67.7   

Cash payments for income taxes

   $ 9.6      $ 19.2   

The accompanying notes are an integral part

of these unaudited consolidated financial statements.

 

5


Table of Contents

 

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(Tabular dollars in millions, except per share amounts)

Note 1—Description of Business and Basis of Presentation

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

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

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

These unaudited consolidated financial statements should be read in conjunction with the more detailed audited consolidated financial statements for the fiscal year ended January 3, 2010, included in our Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”). Accounting policies used in the preparation of these unaudited consolidated financial statements are consistent in all material respects with the accounting policies described in the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K. As noted below, we have adopted the provisions of reorganization accounting during the third quarter of 2010, which does not change our existing accounting policies.

Certain reclassifications, which did not impact net income, have been made to prior period amounts to conform to the current period presentation. These include the reclassification of $2.7 million and $6.8 million from base rental revenues to previously rented product revenues for the thirteen and thirty-nine weeks ended October 4, 2009, respectively. These reclassifications do not reflect a material change in the information previously presented in our Consolidated Statements of Operations.

Reorganization under Chapter 11 of the United States Bankruptcy Code

On September 23, 2010 (the “Petition Date”), Blockbuster Inc. and certain of its domestic affiliates (collectively, the “Debtors”) filed voluntary petitions for relief under chapter 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The reorganization cases (the “Chapter 11 Cases”) are being jointly administered as Case No-14997 (BRL) under the caption “In re Blockbuster Inc., et al.” The Debtors continue to operate their business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. Our remaining subsidiaries, including our non-U.S. subsidiaries, have been excluded from the Chapter 11 Cases and continue to operate their businesses without supervision from the Bankruptcy Court and are not subject to the requirements of the Bankruptcy Code. Our international operations in Canada, Denmark, Italy, Mexico, Uruguay and the United Kingdom are conducting business as usual. However, since the Petition Date, Blockbuster Inc. has ceased to

 

6


Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

provide funding to support our operations in Argentina, which have experienced continued shortfalls in operating cash flows for some time. As a result, it is anticipated that such subsidiary will file for its own liquidation proceedings in Argentina.

The Chapter 11 Cases were filed in response to the challenges of rapidly increasing industry competition and fragmentation, significant debt amortization and other debt service obligations, and ongoing cost-savings measures designed to enhance and preserve liquidity that placed constraints on our ability to fully implement operational and strategic initiatives, all of which adversely impacted our results of operations, cash flows and liquidity over the past several years. As part of the Chapter 11 Cases and as discussed further below, we anticipate the development and implementation of a plan of reorganization to restructure our capital structure and business operations. Confirmation of a plan of reorganization could materially alter the classifications and amounts reported in our consolidated financial statements, which do not give effect to any adjustments to the carrying values of assets or amounts of liabilities that might be necessary as a consequence of confirmation of such plan, or the effect of any operational changes that may be implemented. Further information regarding the Chapter 11 Cases can be found in Note 2 below.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (the “FASB”) issued guidance for multiple-deliverable revenue arrangements which eliminates the residual method of revenue allocation and requires revenue to be allocated based on an element’s estimated selling price if vendor-specific or other third party evidence of value is not available. This guidance should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

Note 2—Voluntary Reorganization under Chapter 11

Operation and Implication of the Chapter 11 Cases

Under Section 362 of the Bankruptcy Code, the filing of a bankruptcy petition automatically stays most actions against a debtor, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over property of the debtor. Accordingly, although commencement of the Chapter 11 Cases triggered defaults on substantially all of our debt obligations, creditors are stayed from taking any actions as a result of such defaults. Absent an order of the Bankruptcy Court, substantially all pre-petition liabilities are subject to settlement under a plan of reorganization. As a result of the Chapter 11 Cases, the realization of assets and the satisfaction of liabilities are subject to uncertainty. Debtors operating as debtors-in-possession under the Bankruptcy Code may, subject to approval of the Bankruptcy Court, sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in our consolidated financial statements. Further, a confirmed plan of reorganization or other arrangement may materially change the amounts and classifications in a Debtor’s historical consolidated financial statements.

Subsequent to the Petition Date, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor certain pre-petition obligations generally designed to stabilize the Debtors’ operations including certain employee wage and benefit obligations, cash management, tax matters, certain customer programs and payment of pre-petition claims of certain vendors deemed critical to the Debtors’ ongoing business, including certain movie studios and game vendors. The Debtors are paying, and intend to continue paying, claims arising

 

7


Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

after the Petition Date in the ordinary course of business. We have retained, pursuant to Bankruptcy Court approval, legal and financial professionals to advise the Debtors on the Chapter 11 Cases and certain other professionals to provide services and advice to the Debtors in the ordinary course of business. From time to time, the Debtors may seek Bankruptcy Court approval to retain additional professionals.

The U.S. Trustee for the Southern District of New York (the “U.S. Trustee”) has appointed an official committee of unsecured creditors (the “UCC”). The UCC and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court on all matters affecting the Debtors. There can be no assurance that the UCC will support the Debtors’ positions on matters to be presented to the Bankruptcy Court in the future or on any plan of reorganization, once proposed. Disagreements between the Debtors and the UCC could protract the Chapter 11 Cases, negatively affect the Debtors’ ability to operate and delay the Debtors’ emergence from the Chapter 11 Cases.

We have incurred and expect to continue to incur significant costs associated with our reorganization and the Chapter 11 Cases. The amount of these expenses is expected to significantly affect our financial position and results of operations, but we cannot accurately predict the effect the Chapter 11 Cases will have on our business at this time.

Plan of Reorganization

For the Debtors to successfully emerge from the Chapter 11 Cases, we must obtain the Bankruptcy Court’s approval of a plan of reorganization, which will enable the Debtors to transition from the Chapter 11 Cases into ordinary course operations out of bankruptcy. In connection with the plan of reorganization, the Debtors must also obtain a new credit facility, or “exit financing.” Our ability to obtain such approval and financing will depend on, among other things, the timing and outcome of various ongoing matters in the Chapter 11 Cases. A plan of reorganization determines the rights and satisfaction of claims of various creditors and security holders, and is subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on which the plan of reorganization is confirmed.

Although the Debtors have not filed a joint plan of reorganization or a related disclosure statement with the Bankruptcy Court, the Debtors intend to propose a plan in accordance with the terms of the Plan Term Sheet and Plan Support Agreement (together, the “Proposed Plan”) dated as of September 22, 2010, by and between the Debtors and certain of their senior secured noteholders (the “Consenting Noteholders”). The Debtors anticipate filing the Proposed Plan on or about November 30, 2010, unless otherwise extended by agreement of the Consenting Noteholders. Following submission of the Proposed Plan, the Debtors will take all actions necessary to obtain approval for it from the Bankruptcy Court on or before March 15, 2011. Generally, the Proposed Plan provides, among other things, mechanisms for (i) settlement of claims against the Debtors’ estates; (ii) treatment of our existing equity and debt holders; (iii) provision for exit financing; and (iv) certain corporate governance and administrative matters pertaining to our reorganized company.

We continue to have ongoing discussions with the Consenting Noteholders regarding the Proposed Plan and will continue to do so until the Proposed Plan is filed with the Bankruptcy Court. The Proposed Plan is subject to revision prior to submission to the Bankruptcy Court based upon those continuing discussions, and thereafter in response to creditor claims and objections and the requirements of the Bankruptcy Court or the Bankruptcy Code. There can be no assurance that we will be able to secure approval of the Proposed Plan by the Bankruptcy Court, or that the Proposed Plan will be accepted by our lenders or the Unsecured Creditors Committee, in which instance the lenders have the right to terminate the DIP Credit Agreement (as defined below).

 

8


Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Financing During Pendency of the Chapter 11 Cases

During the pendency of the Chapter 11 Cases, the Debtors are funding operations pursuant to an order of the Bankruptcy Court permitting the Debtors’ use of cash collateral and entry into a $125 million Senior Secured Super-Priority Debtor-in-Possession Revolving Credit Agreement (as amended, the “DIP Credit Agreement,” discussed below). As of October 3, 2010, the Debtors had borrowed $20.0 million under the DIP Credit Agreement, and may borrow additional amounts from time to time subject to certain limitations and restrictions set forth in the DIP Credit Agreement. Our non-Debtor subsidiaries are not included in the Chapter 11 Cases and, as a result, are not borrowers under the DIP Credit Agreement; they continue to fund their operations principally with cash generated from operating activities and, in certain limited circumstances where so permitted by the lenders under the DIP Credit Agreement, funds from Blockbuster Inc.

Since approval of the DIP Credit Agreement, the Debtors have focused on executing their strategic and operating initiatives and ensuring the smooth transition of their business in Chapter 11. However, there can be no assurance that cash on hand, cash generated through operations and other available funds will be sufficient to meet our reorganization or ongoing cash needs or that we will remain in compliance with all the necessary terms and conditions of the DIP Credit Agreement or that the lending commitments under the DIP Credit Agreement will not be terminated by the lenders.

Vendor Agreements

On March 31, 2010, in order to secure the obligations of Blockbuster Inc. under its trade agreements with Twentieth Century Fox Home Entertainment LLC, Sony Pictures Home Entertainment Inc. and Warner Home Video (collectively, the “Studios”), Blockbuster Canada Co., our indirect wholly-owned subsidiary (“BB Canada”), entered into (i) a guarantee agreement (the “Guarantee”) in favor of Home Trust Company (the “Trustee”) for the benefit of the Studios, pursuant to which BB Canada irrevocably guaranteed the obligations of Blockbuster Inc. under such trade agreements; (ii) a general security agreement (the “Security Agreement”) in favor of the Trustee for the benefit of the Studios pursuant to which BB Canada granted a lien on and security interest in substantially all of its assets; and (iii) a collateral trust agreement among the Studios and the Trustee pursuant to which the Trustee was appointed to act as collateral trustee for the Studios to hold, receive, maintain, administer and distribute the collateral at any time delivered to the Trustee and to enforce the security documents and all interests, rights, powers and remedies of the Trustee with respect thereto or thereunder and the proceeds thereof (collectively, the “Security Documents”). In return each of the Studios agreed to new payment terms for current and future deliveries of home entertainment offerings under their current trade agreements. The Security Documents contain customary representations, warranties, affirmative and negative covenants and other customary terms and conditions.

Pursuant to the requirements of the Guarantee and Security Agreement, upon commencement of the Chapter 11 Cases, the Debtors were required to obtain authority from the Bankruptcy Court to continue to pay the Studios in the ordinary course of business pursuant to their respective trade agreements, including payments for obligations incurred prior to the commencement of the Chapter 11 Cases. In exchange for obtaining such authority, the Studios agreed to continue shipping under the terms of their existing trade agreements and during the pendency of the Chapter 11 Cases. Failure to obtain such authority, however, would constitute an event of default under the Security Documents. On September 27, 2010, the Debtors obtained such authority on an interim basis and on October 27, 2010, the Debtors received final approval of their request for such authority.

 

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Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Going Concern

We incurred a net loss from operations for the thirty-nine weeks and fiscal year ended October 3, 2010 and January 3, 2010, respectively, had negative working capital as of October 3, 2010, and had a stockholders’ deficit as of October 3, 2010 and January 3, 2010. In addition, our recent Chapter 11 filing and the increasingly competitive industry conditions under which we operate have negatively impacted our results of operations and cash flows and may continue to do so in the future. These factors raise substantial doubt about our ability to continue as a going concern.

The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern and contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. Our ability to continue as a going concern is contingent upon our ability to comply with the financial and other covenants contained in the DIP Credit Agreement, the Bankruptcy Court’s approval of our plan of reorganization and our ability to successfully implement such plan and obtain exit financing, among other things. As a result of the Chapter 11 Cases, the realization of assets and the satisfaction of liabilities are subject to uncertainty. While operating as debtors-in-possession under Chapter 11, the Debtors may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or as otherwise permitted in the ordinary course of business (and subject to restrictions contained in the DIP Credit Agreement), for amounts other than those reflected in the accompanying consolidated financial statements. Further, the plan of reorganization could materially change the amounts and classifications of assets and liabilities reported in the historical consolidated financial statements. The accompanying consolidated financial statements do not include any adjustments related to the recoverability and classification of assets or the amounts and classification of liabilities or any other adjustments that might be necessary should we be unable to continue as a going concern or as a consequence of the Chapter 11 Cases.

Financial Reporting in Reorganization

As a result of the Chapter 11 Cases, we have adopted the provisions of reorganization accounting, which does not change the application of US GAAP with respect to the preparation of our financial statements. However, this guidance does require that financial statements, for periods including and subsequent to a Chapter 11 filing, distinguish between transactions and events that are directly associated with the reorganization proceedings and the ongoing operations of the business, as well as additional disclosures. Effective September 23, 2010, expenses, gains and losses directly associated with the reorganization proceedings are reported as reorganization items, net in the accompanying Consolidated Statements of Operations for the thirteen and thirty-nine weeks ended October 3, 2010. In addition, liabilities subject to compromise in the Chapter 11 Cases are distinguished from fully secured liabilities not expected to be compromised and from post-petition liabilities in the accompanying consolidated balance sheet as of October 3, 2010. Where there is uncertainty about whether a secured claim is undersecured or will be impaired under the plan, we have classified the entire amount of the claim as a liability subject to compromise. Such liabilities are reported at amounts expected to be allowed, even if they settle for lesser amounts. These claims remain subject to future adjustments, which may result from: negotiations; actions of the Bankruptcy Court; disputed claims; rejection of executory contracts and unexpired leases; the determination as to the value of any collateral securing claims; proofs of claim; or other events.

Liabilities Subject to Compromise

As described above, certain claims against the Debtors in existence prior to the Chapter 11 Cases (“pre-petition liabilities”) may be subject to compromise or other treatment under the plan of reorganization and are

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

reflected as liabilities subject to compromise in the accompanying consolidated balance sheet. These amounts reflect our current estimates of pre-petition liabilities that are subject to restructuring in the Chapter 11 Cases. A summary of liabilities subject to compromise as of October 3, 2010 is presented in the following table:

 

Debt subject to compromise:

  

11.75% Senior Secured Notes, due 2014

   $ 600.7   

9.0% Senior Subordinated Notes, due 2012

     300.0   

Capital lease obligations

     17.6   

Accrued interest

     53.8   

Accounts payable

     62.0   

Occupancy related accruals

     47.7   

Liabilities for store closures and asset retirement obligations

     41.1   

Other accrued liabilities

     37.8   
        

Liabilities subject to compromise

   $ 1,160.7   
        

We are in default under certain of our pre-petition debt obligations, including the principal amount of our 9.0% Senior Subordinated Notes due 2012 (the “Senior Subordinated Notes”), under which we failed to make our scheduled interest payment on September 1, 2010. Additionally, on July 1, 2010, we entered into a forbearance agreement with the holders of approximately 70% of the outstanding principal amount (the “Forbearing Holders”) of our 11.75% Senior Secured Notes, due 2014 (the “Senior Secured Notes”), which was subsequently amended and restated on August 12, 2010, whereby such holders agreed to, among other things, forbear from taking any action to enforce certain of their rights or remedies under the indenture governing the Senior Secured Notes with respect to our failure on July 1, 2010 to redeem a portion of the Senior Secured Notes and to pay interest on the Senior Secured Notes (the “Forbearance Agreement”). The Forbearance Agreement remained in effect until the Chapter 11 Cases commenced on the Petition Date.

Reorganization Items, Net

Reorganization items, net include expenses, gains and losses directly related to the Debtors’ reorganization proceedings. A summary of reorganization items, net for the thirteen and thirty-nine weeks ended October 3, 2010 is presented in the following table:

 

DIP Credit Agreement financing fees

   $ 2.7   

Additional insurance coverage during bankruptcy

     1.8   

Professional fees

     1.0   
        

Reorganization items, net

   $ 5.5   
        

Contractual Interest Expense

Effective as of September 23, 2010, we ceased recording interest expense on outstanding pre-petition debt classified as liabilities subject to compromise. Contractual interest expense represents amounts due under the contractual terms of outstanding debt, including debt subject to compromise. For the period from September 23, 2010 through October 3, 2010, contractual interest expense related to liabilities subject to compromise of $3.3 million has not been recorded as it is not expected to be an allowed claim under the Chapter 11 Cases.

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Pre-Petition Claims

On October 22, 2010 the Debtors filed statements and schedules with the Bankruptcy Court setting forth the assets and liabilities of each of the Debtors as of the Petition Date. The statements and schedules are available at www.kccllc.net/blockbuster. On November 10, 2010, the Bankruptcy Court entered an order approving December 22, 2010 as the “Bar Date” in the Chapter 11 Cases for general creditor, non-governmental claims, which is the legal deadline by which any creditor must file a proof of claim in the Chapter 11 Cases. In accordance with that order, on or before November 15, 2010, the Debtors will mail proofs of claim forms to all known creditors, including, without limitation, their current and former employees, vendors and other parties with whom the Debtors have previously conducted business. Recipients disagreeing with the Debtors’ valuation of claims may file discrepancies with the Bankruptcy Court and differences between amounts recorded by the Debtors and claims filed by creditors will be evaluated and resolved as a part of the Chapter 11 Cases. However, the Bankruptcy Court will ultimately determine liability amounts, if any, that will be allowed for all claims.

The resolution of such claims could result in a material adjustment to our financial statements. Additionally, a confirmed plan of reorganization could also materially change the amounts and classifications reported in the consolidated financial statements, which do not give effect to any adjustments to the carrying value of assets or amounts of liabilities that might be necessary as a consequence of confirmation of a plan of reorganization.

Condensed Combined Debtor-in-Possession Financial Information

In accordance with the requirements of reorganization accounting, the financial statements below represent the condensed combined financial statements of the Debtors only and are prepared on the same basis as the accompanying consolidated financial statements. These condensed combined financial statements are presented as if the Debtors accounted for their investments in the non–Debtor subsidiaries using the equity method of accounting.

 

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Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Statement of Operations for the Thirteen Weeks Ended October 3, 2010

 

Revenues:

  

Rental revenues

   $ 413.5   

Merchandise sales

     55.7   

Other revenues

     10.6   
        
     479.8   
        

Cost of sales:

  

Cost of rental revenues

     140.6   

Cost of merchandise sold

     40.3   
        
     180.9   
        

Gross profit

     298.9   
        

Operating expenses:

  

General and administrative

     290.7   

Advertising

     6.0   

Depreciation and intangible amortization

     22.9   
        
     319.6   
        

Operating income (loss)

     (20.7

Interest (expense) income, net

     (27.5

Other items, net

     (1.1
        

Income (loss) before reorganization items and income taxes

     (49.3

Reorganization items, net

     (5.5

Provision for income taxes

     (0.6

Equity in income (loss) of non-Debtor subsidiaries, net of tax

     1.9   
        

Net income (loss)

   $ (53.5
        

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Balance Sheet as of October 3, 2010

 

Assets

  

Current assets:

  

Cash and cash equivalents

   $ 52.0   

Receivables, net

     29.5   

Amounts due from non-Debtor subsidiaries, net

     10.1   

Merchandise inventories

     87.0   

Rental library, net

     187.5   

Prepaid and other current assets

     76.6   
        

Total current assets

     442.7   

Property and equipment, net

     148.6   

Deferred income taxes

     70.6   

Investments in non-Debtor subsidiaries

     286.3   

Intangibles, net

     6.0   

Restricted cash

     35.2   

Other assets

     34.5   
        
   $ 1,023.9   
        

Liabilities and Stockholders’ Equity (Deficit)

  

Current liabilities:

  

Accounts payable

   $ 30.5   

Accrued expenses

     194.7   

DIP Credit Agreement

     20.0   

Deferred income taxes

     70.7   
        

Total current liabilities

     315.9   

Other liabilities

     12.2   

Liabilities subject to compromise

     1,160.7   

Liabilities to non-Debtor subsidiaries subject to compromise

     27.1   
        
     1,515.9   

Total stockholders’ equity (deficit)

     (492.0
        
   $ 1,023.9   
        

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Statement of Cash Flows for the Thirty-Nine Weeks Ended October 3, 2010

 

Net cash provided by (used in) operating activities

   $ (70.6
        

Investing activities:

  

Capital expenditures

     (13.1

Change in restricted cash

     22.8   

Other investing activities

     1.2   
        

Net cash provided by (used in) investing activities

     10.9   
        

Financing activities:

  

Repayments on senior secured notes

     (45.0

Proceeds from DIP Credit Agreement

     20.0   

Debt financing costs

     (2.7

Capital lease payments

     (3.8

Intercompany loans

     16.9   
        

Net cash provided by (used in) financing activities

     (14.6
        

Net decrease in cash and cash equivalents

     (74.3

Cash and cash equivalents at beginning of period

     126.3   
        

Cash and cash equivalents at end of period

   $ 52.0   
        

Note 3—Restructuring Activities

Store Closures

As of October 3, 2010 and January 3, 2010, the liability related to lease terminations and store closure reserves was $21.4 million and $8.1 million, respectively, of which $19.5 million was classified as liabilities subject to compromise as of October 3, 2010. Prior to the Petition Date, we made payments of $7.2 million and $30.8 million in rent and lease termination costs during the thirteen and thirty-nine weeks ended October 3, 2010, respectively. There have been no significant adjustments to previously accrued store closure costs during 2010.

The following table presents operating expenses related to store closures during the thirteen and thirty-nine weeks ended October 3, 2010 and October 4, 2009:

 

     Thirteen Weeks Ended      Thirty-Nine Weeks Ended  
     October 3,
2010
     October 4,
2009
     October 3,
2010
     October 4,
2009
 

Closed store accruals and lease termination costs

   $ 8.0       $ 1.7       $ 42.5       $ 5.3   

Accelerated depreciation

     5.5         6.3         10.7         9.4   
                                   

Total store closure expense

   $ 13.5       $ 8.0       $ 53.2       $ 14.7   
                                   

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Severance Charges

As of October 3, 2010 the liability related to severance was $3.5 million, of which $1.1 million is classified as “Liabilities subject to compromise” on our Consolidated Balance Sheets. The following table presents the activity in severance liability for the thirty-nine weeks ended October 3, 2010 and October 4, 2009:

 

     Thirty-Nine Weeks Ended  
     October 3,
2010
    October 4,
2009
 

Beginning balance

   $ 5.6      $ 4.7   

Expense incurred and accrued

     13.3        6.3   

Adjustments to accruals

     (0.5     (0.6

Amount paid

     (14.9     (6.7
                

Ending balance

   $ 3.5      $ 3.7   
                

Note 4—Debt

Pre-Petition Debt

As discussed in Note 2 above, due to the Chapter 11 Cases, as of the Petition Date substantially all of our pre-petition debt is in default and has been reclassified to “Liabilities subject to compromise” on our consolidated balance sheet at October 3, 2010, including the Senior Secured Notes and the Senior Subordinated Notes. Refer to our January 3, 2010 Annual Report on Form 10-K for detailed information related to pre-petition debt and information related to the covenants and restrictions associated with the pre-petition debt.

DIP Credit Agreement

On September 23, 2010, Blockbuster Inc., as borrower entered into a Senior Secured, Super-Priority Debtor-in-Possession Revolving Credit Agreement with our Debtor-subsidiaries signatory thereto (“Subsidiary Guarantors”), the lenders signatory thereto (the “DIP Lenders”) and Wilmington Trust FSB, as agent (the “Agent”). Pursuant to the terms of the DIP Credit Agreement, (i) the DIP Lenders have agreed to lend up to $125 million in the form of revolving loan advances, (ii) the Subsidiary Guarantors agreed to guarantee our obligations thereunder and Blockbuster Inc., and (iii) the Subsidiary Guarantors agreed to secure their obligations under the loan documents by granting the Agent, for the benefit of the Agent and the DIP Lenders, a first-priority security interest in and lien upon all of Blockbuster Inc.’s and the Subsidiary Guarantors’ existing and after-acquired personal and real property. We will have the option to have interest on the loans provided under the DIP Credit Agreement accrue at an index rate (a function of the then-applicable base rate) or the then-applicable LIBOR rate (with a floor of 2.0%), plus a margin of 8.5% and 7.5%, respectively. The DIP Credit Agreement limits, among other things, our and the Subsidiary Guarantors’ ability to (i) incur indebtedness, (ii) incur or create liens, (iii) dispose of assets, (iv) prepay subordinated indebtedness and make other restricted payments, (v) enter into sale and leaseback transactions and (vi) modify the terms of any subordinated indebtedness and certain material contracts of Blockbuster Inc. and the Subsidiary Guarantors. In addition to standard obligations, the DIP Credit Agreement provides (w) a periodic delivery of our budget that must be approved by a requisite number of DIP Lenders set forth in the DIP Credit Agreement, (x) specific milestones that we must achieve by specific target dates, (y) maintain an EBITDA (as defined in the DIP Credit Agreement) of $85 million for the fiscal year ending 2010 and (z) repay the revolver at one point between December 1, 2010 and January 14, 2011, such that

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

the outstanding revolver loans shall be less than $25 million. We paid the Agent a customary agency administration fee in connection with the DIP Credit Agreement, and will pay the DIP Lenders an unused amount fee and commitment fee as set forth in the DIP Credit Agreement. We are required to prepay or repay the facility in the event we receive proceeds from dispositions or sale of assets as specified in the DIP Credit Agreement, receive proceeds from the issuance of equity, or, if the aggregate amount of unrestricted cash on hand exceeds $25 million during December, or exceeds $20 million any time thereafter, such amount in excess of the foregoing.

We had borrowed $20.0 million under the DIP Credit Agreement as of October 3, 2010, and may borrow additional amounts from time to time subject to certain limitations and restrictions set forth in the DIP Credit Agreement. Borrowings under the DIP Credit Agreement are to be used to finance working capital, capital expenditures, to pay certain pre-petition obligations and for other general corporate purposes in accordance with an approved budget. We believe that amounts available under the DIP Credit Agreement, the provision for exit financing, plus cash generated from operations will be sufficient to fund anticipated cash requirements over the next 12 months for minimum capital expenditures, and for working capital purposes including rental library purchases.

The DIP Credit Agreement matures and terminates on the earliest to occur of (i) April 30, 2011 and (ii) the acceleration of the obligations upon the continuation of an event of default; provided that we may elect to convert all then outstanding revolving loan advances into the Exit Credit Facility, or upon one of certain specified occurrences or alternative dates relating to the pendency, administration or conversion of the Chapter 11 Cases, each as set forth in the DIP Credit Agreement (such date, the “Termination Date”). All outstanding revolving loan advances under the DIP Credit Agreement are automatically due and payable in full on the Termination Date. In addition to standard events of default, the DIP Credit Agreement provides events of default specific to the Chapter 11 Cases, failure to provide a business plan, failure to provide updates to the approved budget, and breaches under certain material contracts that result in termination thereof.

On October 27, 2010, the parties to the DIP Credit Agreement entered into an Amendment No. 1 to Senior Secured, Super-Priority Debtor-in-Possession Revolving Credit Agreement (the “First Amendment to DIP Credit Agreement”), which, among other things, amended the DIP Credit Agreement in the following particulars: (a) the commitment fee payable by the Debtors to the DIP Lenders became payable in full to the Agent upon entry of the Final Order on October 27, 2010, and payable in turn from the Agent to the DIP Lenders party to the Omnibus Reallocation Agreement (as defined below) on the October 28, 2010 effective date of the Reallocation Agreement; and (b) certain definitions, including those for the First and Third Milestone Dates were revised.

On October 28, 2010, the DIP Lenders and certain additional holders of the Senior Secured Notes not parties to the DIP Credit Agreement (the “Incoming Lenders”), entered into an Omnibus Reallocation Agreement (the “Reallocation Agreement”) pursuant to which, among other things, (i) the Incoming Lenders were offered the opportunity to become lenders under the DIP Credit Agreement; (ii) the proportionate share of each DIP Lender’s funded amount under the DIP Credit Agreement was adjusted based upon such DIP Lender’s increased or decreased funding commitment and new funds committed by Incoming Lenders.

 

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Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Debt Balances

 

     October 3,
2010
     January 3,
2010
 

Current portion

     

DIP Credit Agreement, interest rate of 10.5% at October 3, 2010

   $ 20.0       $ —     

Senior Secured Notes, interest rate of 11.75%

     —           101.6   

Current portion of capital lease obligations

     0.6         6.1   
                 
     20.6         107.7   
                 

Non-current portion

     

Senior Secured Notes, interest rate of 11.75%

     —           536.0   

Senior Subordinated Notes, interest rate of 9.0%

     —           300.0   
                 

Total long-term debt, less current portion

     —           836.0   

Capital lease obligations, less current portion

     0.1         19.9   
                 
     0.1         855.9   
                 

Liabilities subject to compromise

     

Senior Secured Notes, interest rate of 11.75%

     600.7         —     

Senior Subordinated Notes, interest rate of 9.0%

     300.0         —     

Capital lease obligations

     17.6         —     
                 
     918.3         —     
                 

Total

   $ 939.0       $ 963.6   
                 

Additionally, we have recorded $20.0 million of deferred financing costs related to our Senior Secured Notes and our Senior Subordinated Notes which are currently recorded in “Other assets” on our Consolidated Balance Sheets as of October 3, 2010.

Note 5—Fair Value of Financial Instruments

At October 3, 2010, our carrying value of financial instruments approximated fair value except for our $300.0 million aggregate principal amount of our Senior Subordinated Notes and $630 million aggregate principal amount of our Senior Secured Notes. The estimated fair values of our Senior Subordinated Notes and Senior Secured Notes at October 3, 2010 and January 3, 2010 are based on trading activity in active markets and may not represent the current fair values.

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

 

     October 3, 2010      January 3, 2010  
     Principal
Amount
     Carrying
Value
     Fair
Value
     Principal
Amount
     Carrying
Value
     Fair
Value
 

Senior Secured Notes

   $ 630.0       $ 600.7       $ 352.8       $ 675.0       $ 637.6       $ 641.3   

Senior Subordinated Notes

   $ 300.0       $ 300.0       $ 9.8       $ 300.0       $ 300.0       $ 168.0   

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

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Note 6—Stock and Share-Based Payments

For the thirteen weeks ended October 3, 2010 and October 4, 2009, we recognized $0.2 million and $1.8 million, respectively, of share-based compensation expense related to stock options, restricted shares and restricted share units. For the thirty-nine weeks ended October 3, 2010 and October 4, 2009, we recognized $0.9 million and $6.2 million, respectively, of share-based compensation expense related to stock options, restricted shares and restricted share units.

During the thirty-nine weeks ended October 3, 2010, no stock options were granted or exercised and 7.8 million stock options were cancelled, due mainly to the expiration of 5.0 million options previously outstanding to our former CEO. In addition, 1.0 million restricted shares or restricted share units were granted, 1.0 million restricted shares and restricted share units were vested, and no restricted shares and restricted share units were cancelled. As of October 3, 2010, 9.5 million stock options and 1.3 million restricted shares and restricted share units remained outstanding.

The $0.01 million of unamortized compensation expense, net of estimated forfeitures, related to restricted shares, restricted share units and stock options issued and outstanding as of October 3, 2010 will be recognized in the fourth quarter of fiscal 2010.

Note 7—Income Taxes

As of October 3, 2010 the liability for uncertain tax positions was approximately $3.1 million and is reflected in “Liabilities subject to compromise” on our Consolidated Balance Sheets. If recognized, this amount would result in a positive effect on our effective tax rate.

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

 

Jurisdiction

   Tax Year(s) Ending    Open    IRS Audit
Complete
   Currently
Being
Audited
   Subject to
Tax Matters Agreement with
Viacom/CBS

Domestic

   09/30/2004 and prior    No    Yes    N/A    Yes

Domestic

   12/31/2004    No    Yes    N/A    No

Domestic

   12/31/2005    Yes    N/A    No    No

Domestic

   12/31/2006    No    N/A    No    No

Domestic

   12/31/2007    Yes    N/A    No    No

Domestic

   12/31/2008    Yes    N/A    No    No

Domestic

   12/31/2009    Yes    N/A    No    No

 

Jurisdictions

  

    Closed Tax Years    

  

    Open Tax Years    

  

Years Under Examination

Canada

   2000 and prior    Post 2000    2001-2005

Italy

   2004 and prior    Post 2004    N/A

Mexico

   2003 and prior    Post 2003    N/A

United Kingdom

   2004 and prior    Post 2004    N/A

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Interest expense and penalties related to our uncertain tax positions have been reflected as a component of income tax expense in our Consolidated Statements of Operations. As of October 3, 2010, we had recorded liabilities of approximately $0.8 million associated with accrued interest and penalties related to uncertain tax positions.

Note 8—Comprehensive Income (Loss)

Comprehensive income (loss) for the thirteen and thirty-nine weeks ended October 3, 2010 and October 4, 2009 was as follows:

 

     Thirteen Weeks Ended     Thirty-Nine Weeks Ended  
     October 3,
2010
    October 4,
2009
    October 3,
2010
    October 4,
2009
 

Net income (loss)

   $ (53.5   $ (114.1   $ (187.6   $ (123.3

Foreign currency translation adjustment, net of tax

     12.6        8.0        4.2        27.8   
                                

Total comprehensive income (loss)

   $ (40.9   $ (106.1   $ (183.4   $ (95.5
                                

Note 9—Net Income (Loss) Per Share and Dividends

Basic net income (loss) per share (“EPS”) is computed by dividing the net income (loss) applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted EPS adjusts the basic weighted average number of common shares outstanding by the assumed exercise of Blockbuster stock options, vesting of restricted shares and restricted share units, and shares issuable under the conversion feature of our Series A convertible preferred stock, as defined below, using the if-converted method only in periods in which such effect would have been dilutive on income before cumulative effect of change in accounting principle. Options to purchase 9.5 million and 16.9 million shares of Class A common stock were outstanding as of October 3, 2010 and October 4, 2009, respectively. Additionally, 1.3 million and 6.1 million restricted shares and restricted share units that are convertible into shares of Class A common stock were outstanding as of October 3, 2010 and October 4, 2009, respectively. For the thirteen and thirty-nine weeks ended October 3, 2010 and October 4, 2009, the inclusion of all stock options, all restricted shares and restricted share units and all shares of Series A convertible preferred stock would be anti-dilutive and were therefore excluded from the computation of the weighted-average shares for diluted EPS.

Our Board of Directors has determined not to declare or pay a dividend on our shares of Series A convertible preferred stock with respect to the six consecutive quarterly periods beginning on February 15, 2009 and ending on August 14, 2010. Dividends on the Series A convertible preferred stock are cumulative and began to accumulate on May 15, 2009, of which $3.4 million of accumulated dividends is recorded on our consolidated balance sheet in “Liabilities subject to compromise” as of October 3, 2010. Under Delaware law, we can only pay dividends on our shares of capital stock out of our surplus, or, if we do not have a surplus, out of net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. For these purposes a surplus can be defined as the excess at any given time of a company’s net assets over capital, which is the aggregate par value of the outstanding shares of capital stock. We currently have a negative surplus and have no net profits for fiscal 2009 or fiscal 2010 to date. Under Delaware law, we are unable to pay dividends on shares of our capital stock, whether in cash or in shares of common stock, for so long as such negative surplus exists or until we generate sufficient net profits.

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Upon our failure to pay dividends on the Series A convertible preferred stock on six dividend payment dates (whether consecutive or not), holders of the Series A convertible preferred stock will be entitled to receive, when, as and if declared by our Board of Directors, out of funds legally available therefore, dividends at the rate per annum equal to the stated annual dividend rate of 7 1/2% plus 1.0% on and after such sixth dividend payment date until we have paid all accumulated and unpaid dividends in full. Following such payment of unpaid dividends, the dividend rate will revert to 7 1/2% per annum; provided, however, that upon any further failure to pay dividends, the dividend rate will again increase by 1.0% to 8 1/2% per annum until we have again paid all accumulated and unpaid dividends in full.

In addition, as a result of our failure to pay dividends for six quarterly dividend periods, holders of the Series A convertible preferred stock have the right, subject to certain procedural requirements, to elect two additional directors to our Board of Directors. If elected, such additional directors would be entitled to serve until all accumulated and unpaid dividends have been paid in full; however, upon approval by the Bankruptcy Court of our proposed plan of reorganization, the term of any such directors will terminate and the new board of directors contemplated by such plan will be established.

In the thirteen weeks ended October 3, 2010, 1,550 shares of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 0.3 million shares of our Class A common stock. This included approximately 34,000 shares of our Class A common stock as settlement for accumulated dividends on the converted shares through the date of conversion. In the thirty-nine weeks ended October 3, 2010, 115,589 shares of our Series A convertible preferred stock were converted, resulting in the issuance of approximately 23.9 million shares of our Class A common stock. This included 1.5 million shares of our Class A common stock as settlement for accumulated dividends on the converted shares through the date of conversion. Pursuant to a final order entered by the Bankruptcy Court, further conversions of the Series A convertible preferred stock into common stock or other form of equity ownership in the Debtors are prohibited during the pendency of the Bankruptcy Cases.

Note 10—Related Party Transactions

On March 29, 2007, Strauss Zelnick, a member of our Board of Directors, was appointed chairman of the board of directors of Take-Two Interactive Software, Inc. (“Take-Two”), a global publisher, developer and distributor of interactive games software, hardware and accessories and a party to considerable commercial transactions with us. On February 15, 2008, Take-Two announced the appointment of Mr. Zelnick as executive chairman. In addition, ZelnickMedia Corporation (“ZelnickMedia”), of which Mr. Zelnick is a founder and principal owner, entered into a management agreement with Take-Two on March 30, 2007, as amended on July 26, 2007 and February 14, 2008, pursuant to which ZelnickMedia provides financial and management consulting services to Take-Two. Mr. Zelnick is entitled during the term of the management agreement to serve as chairman of Take-Two’s board of directors and will also have the authority during such term to hire and/or terminate the chief executive officer and chief financial officer of Take-Two, subject to the approval of Take-Two’s compensation committee. We paid Take-Two $4.0 million and $8.9 million for the thirteen and thirty-nine weeks ended October 3, 2010, and $0.9 million and $2.7 million for the thirteen and thirty-nine weeks ended October 4, 2009, respectively, pursuant to our commercial arrangements with Take-Two. At October 3, 2010, our Consolidated Balance Sheets included $0.9 million reduction for vendor credits from Take-Two recorded in “Accounts payable.” At January 3, 2010, our Consolidated Balance Sheets included less than $0.1 million of accrued revenue-share expenses for Take-Two recorded in “Accrued expenses” and $1.7 million recorded in “Accounts payable.”

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

We entered into a broker service agreement, effective as of October 1, 2009, with Frank Crystal & Company whereby Frank Crystal & Company served as our exclusive insurance broker of record through October 1, 2010. James W. Crystal, who was a member of our Board of Directors until June 25, 2010, is Chairman and Chief Executive Officer of Frank Crystal & Company, a full service insurance brokerage and services company. We paid Frank Crystal & Company $0.6 million and $0.7 million for the thirteen and thirty-nine weeks ended October 3, 2010, respectively. Frank Crystal & Company is no longer a related party at October 3, 2010.

Note 11—Commitments and Contingencies

The Chapter 11 Cases

On September 23, 2010, the Debtors filed voluntary petitions for relief under Chapter 11. The Chapter 11 Cases are being jointly administered as Case No-14997 (BRL). The Debtors continue to operate their business as debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. Refer to Note 2 above for details on the Chapter 11 Cases.

Under Section 362 of the Bankruptcy Code, the filing of a bankruptcy petition automatically stays most actions against a debtor, including most actions to collect indebtedness incurred prior to the Petition Date or to exercise control over property of the debtor. Unless the bankruptcy court orders otherwise, substantially all pre-petition liabilities are subject to settlement under a plan of reorganization.

Section 365 of the Bankruptcy Code provides a process by which the Debtors may assume, assume and assign or reject certain pre-petition executory contracts (contracts that are not fully performed by either party) subject to the approval of the Bankruptcy Court and certain other conditions. Essentially, a rejection of a contract by the Debtors is a court-authorized breach of contract and, subject to certain exceptions, relieves the Debtors of further obligations under that contract, but creates a deemed pre-petition claim for damages by the party whose contract is rejected. Such parties may file claims in the Bankruptcy Court for damages. Generally, the assumption, or assumption and assignment, of an executory contract requires a debtor to cure all prior defaults under that contract and to provide the other party with adequate assurance of the debtor’s future performance under the contract. A plan of reorganization determines the rights and satisfaction of claims of various creditors and security holders, and is subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on with the plan of reorganization is confirmed. At this time, it is not possible to accurately predict the effect the Chapter 11 Cases will have on our business.

Litigation and Claims

Blockbuster was a defendant in 12 lawsuits filed by customers in nine states and the District of Columbia between November 1999 and April 2001. These putative class action lawsuits alleged common law and statutory claims for fraud and deceptive practices and/or unlawful business practices regarding our extended viewing fee policies for customers who chose to keep rental product beyond the initial rental term. Some of the cases also alleged that these policies imposed unlawful penalties and resulted in unjust enrichment for us. In January 2002, the 136th Judicial District Court of Jefferson County, Texas entered a final judgment approving a national class settlement (the “Scott settlement”). Under the approved settlement, we paid $9.25 million in plaintiffs’ attorneys’ fees during the first quarter of 2005 and made certificates available to class members for rentals and discounts through November 2005. One additional extended viewing fee case in the United States is inactive and subject to

 

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(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

dismissal pursuant to the Scott settlement. In addition, there is one case, filed on February 18, 1999 in the Circuit Court of Cook County, Illinois, Chancery Division, Cohen v. Blockbuster, not completely resolved by the Scott settlement. Marc Cohen, Uwe Stueckrad, Marc Perper and Denita Sanders assert common law and statutory claims for fraud and deceptive practices, unjust enrichment and unlawful penalties regarding Blockbuster’s extended viewing fee policies. Such claims were brought against Blockbuster, individually and on behalf of all entities doing business as Blockbuster or Blockbuster Video. Plaintiffs seek relief on behalf of themselves and other plaintiff class members including actual damages, attorneys’ fees and injunctive relief. By order dated April 27, 2004, the Cohen trial court certified plaintiff classes for U.S. residents who incurred extended viewing fees and/or purchased unreturned videos between February 18, 1994 and December 31, 2004, and who were not part of the Scott settlement or who do not have a Blockbuster membership with an arbitration clause. In the same order, the trial court certified a defendant class comprised of all entities that have done business in the United States as Blockbuster or Blockbuster Video since February 18, 1994. On August 15, 2005, the trial court denied Blockbuster’s motion to reconsider the trial court’s certification of plaintiff classes. On September 26, 2007, the Illinois Appellate Court remanded the trial court’s decision to certify plaintiff classes back to the trial court for reconsideration of our motion to decertify plaintiff classes. Plaintiffs did not petition the Illinois Supreme Court for leave to appeal. On March 14, 2008, upon reconsideration the trial court granted Blockbuster’s motion to decertify plaintiff classes and decertified both plaintiff and defendant classes. On September 23, 2010, Blockbuster filed a voluntary petition for relief under Chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the Southern District of New York (Case No. 10-14997). Blockbuster’s voluntary Chapter 11 bankruptcy filing has automatically stayed this case. We believe the plaintiffs’ position in Cohen is without merit and we intend to vigorously defend ourselves in the lawsuit. In addition, two putative class action lawsuits are pending against Blockbuster in Canada. William Robert Hazell filed an action in the Supreme Court of British Columbia on August 24, 2001 against Viacom Entertainment Canada Inc., Viacom, Blockbuster Canada Inc. and Blockbuster. The case asserts claims for unconscionability, violations of the trade practices act, breach of contract and high handed conduct. The relief sought includes actual damages, disgorgement, and exemplary and punitive damages. Douglas R. Hedley filed an action in the Court of Queen’s Bench, Judicial Centre of Regina, in Saskatchewan on July 19, 2002. The case asserts claims of unconscionability, unjust enrichment, misrepresentation and deception, and seeks recovery of actual damages of $3 million, disgorgement, declaratory relief, punitive and exemplary damages of $1 million and attorneys’ fees. We believe the plaintiffs’ positions in all of these cases are without merit and, if necessary, intend to vigorously defend ourselves.

Blockbuster is a defendant in one remaining lawsuit arising out of the Blockbuster and Facebook websites. On August 12, 2008, Sean Lane, Mohannaed Sheikha, Sean Martin, Ali Sammour, Mohammaed Zidan, Sara Karrow, Colby Henson, Denton Hunker, Firas Sheikha, Hassen Sheikha, Linda Stewart, Tina Tran, Matthew Smith, Erica Parnell, John Conway, Austin Muhs, Phillip Huerta, Alicia Hunker, and Megan Lynn Hancock (a minor, through her parent Rebecca Holey) filed a putative class action complaint under the VPPA, the Electronic Communications Privacy Act (“ECPA”), the Computer Fraud and Abuse Act (“CFAA”), California’s Consumer Legal Remedies Act, and California’s Computer Crime Law in the United States District Court for the Northern District of California. Plaintiffs assert claims against Facebook, Inc., Blockbuster Inc., Fandango, Inc., Hotwire, Inc., STA Travel, Inc., Overstock.com, Inc., Zappos.com, Inc., Gamefly, Inc., and John Does 1-40, corporations. Plaintiffs are purporting to act on behalf of every Facebook member who visited one or more of Facebook’s affiliates’ websites and engaged in activities that triggered the Facebook affiliates’ websites to communicate with Facebook regarding the activity from November 6, 2007 to December 5, 2007. Plaintiffs claim Blockbuster violated the VPPA, ECPA, and CFAA by allegedly violating the plaintiffs’ privacy through their activities on the Blockbuster and Facebook websites. Plaintiffs seek class certification, injunctive and equitable relief, statutory

 

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(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

damages, attorneys’ fees, and costs. On March 17, 2010, the court approved a settlement on behalf of the putative class of plaintiffs. The settlement is funded and supported by Facebook and requires no contribution from Blockbuster. On May 27, 2010, the court entered final judgment dismissing the case with prejudice. In June 2010, several separate appeals of the final judgment were filed by persons objecting to the terms of the settlement. On September 23, 2010, Blockbuster filed a voluntary petition for relief under Chapter 11 in the United States Bankruptcy Court for the Southern District of New York (Case No. 10-14997). On September 28, 2010, the United States Court of Appeals for the Ninth Circuit issued an order staying the appeals as to defendant Blockbuster only. We believe that the claims are without merit and should it become necessary, we intend to vigorously defend ourselves.

On September 30, 2008, Ellen Dufrain filed a putative class action against Blockbuster in the Superior Court of Los Angeles County, California alleging failure to fully reimburse California-based managers for work expenses and unfair business practices. Plaintiff seeks class certification, unpaid work expenses, an accounting, injunctive relief, declaratory relief, equitable relief, interest, costs, and attorney’s fees. On March, 9, 2010, plaintiff filed an amended complaint adding a new claim for statutory penalties. On April 8, 2010, Blockbuster removed the case to the United States District Court for the Central District of California. On May 17, 2010, the case was remanded back to the Superior Court of Los Angeles County, California. By order dated September 8, 2010, the trial court certified two classes; one class of all California-based store-level management employees employed from September 30, 2004 through the date of judgment to whom Blockbuster failed to fully reimburse mileage expenses for the use of their personal vehicle while performing company business, and another class of those who were subjected to unlawful, unfair or fraudulent business acts or practices. On September 23, 2010, Blockbuster filed a voluntary petition for relief under Chapter 11 in the United States Bankruptcy Court for the Southern District of New York (Case No. 10-14997). Blockbuster’s voluntary Chapter 11 bankruptcy filing has automatically stayed this case. We believe that the claims are without merit and we intend to vigorously defend ourselves.

Other Contingent Matters

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

Note 12—Discontinued Operations

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

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

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

 

     Thirteen Weeks Ended     Thirty-Nine Weeks Ended  
     October 3, 2010      October 4, 2009     October 3, 2010     October 4, 2009  

Revenues

   $ —         $ 25.5      $ —        $ 99.4   

Income (loss) before income taxes (includes loss on sale)

   $ —         $ (38.2   $ (0.4   $ (37.4

Provision for income taxes

     —           —          —          0.1   
                                 

Income (loss) from discontinued operations

   $ —         $ (38.2   $ (0.4   $ (37.3
                                 

Note 13—Segment Information

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

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

 

     Domestic
Segment
     International
Segment
    Unallocated
Corporate
    Total  

Thirteen weeks ended October 3, 2010

         

Revenues

   $ 472.3       $ 264.3      $ —        $ 736.6   

Operating income (loss)

     2.7         10.0        (30.2     (17.5

Depreciation and intangible amortization

     21.6         5.4        1.3        28.3   

Net capital expenditures

     4.1         1.1        0.9        6.1   

Thirteen weeks ended October 4, 2009

         

Revenues

   $ 621.2       $ 289.3      $ —        $ 910.5   

Operating income (loss)

     12.2         8.9        (31.3     (10.2

Depreciation and intangible amortization

     29.1         6.1        1.7        36.9   

Net capital expenditures

     3.5         1.8        0.6        5.9   

Thirty-nine weeks ended October 3, 2010

         

Revenues

   $ 1,660.4       $ 803.9      $ —        $ 2,464.3   

Operating income (loss)

     12.6         (0.2     (97.0     (84.6

Depreciation and intangible amortization

     58.5         17.3        5.2        81.0   

Net capital expenditures

     10.8         3.6        2.3        16.7   

Thirty-nine weeks ended October 4, 2009

         

Revenues

   $ 2,139.4       $ 838.8      $ —        $ 2,978.2   

Operating income (loss)

     101.6         22.2        (85.4     38.4   

Depreciation and intangible amortization

     79.2         19.5        4.5        103.2   

Net capital expenditures

     12.8         4.0        3.1        19.9   

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

Note 14—Condensed Consolidating Financial Statements

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

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

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

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

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

 

      Statement of Operations for the Thirteen Weeks Ended October 3, 2010  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminations     Consolidated
Blockbuster Inc.
 

Revenues:

           

Rental revenues

   $ 413.5      $ —         $ 157.2      $ —        $ 570.7   

Merchandise sales

     55.7        —           105.7        —          161.4   

Other revenues

     10.6        8.5         1.1        (15.7     4.5   
                                         
     479.8        8.5         264.0        (15.7     736.6   
                                         

Cost of sales:

           

Cost of rental revenues

     140.6        —           50.5        —          191.1   

Cost of merchandise sold

     40.3        —           78.8        —          119.1   
                                         
     180.9        —           129.3        —          310.2   
                                         

Gross profit

     298.9        8.5         134.7        (15.7     426.4   
                                         

Operating expenses:

           

General and administrative

     290.7        8.5         121.5        (15.7     405.0   

Advertising

     6.0        —           4.6        —          10.6   

Depreciation and intangible amortization

     22.9        —           5.4        —          28.3   
                                         
     319.6        8.5         131.5        (15.7     443.9   
                                         

Operating income (loss)

     (20.7     —           3.2        —          (17.5

Interest (expense) income, net

     (27.5     —           —          —          (27.5

Other items, net

     (1.1     —           (0.1     —          (1.2
                                         

Income (loss) before reorganization items and income taxes

     (49.3     —           3.1        —          (46.2

Reorganization items, net

     (5.5     —           —          —          (5.5

Provision for income taxes

     (0.6     —           (1.2     —          (1.8

Equity in income (loss) of affiliated companies, net of tax

     1.9        —           —          (1.9     —     
                                         

Net income (loss)

   $ (53.5   $ —         $ 1.9      $ (1.9   $ (53.5
                                         

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Statement of Operations for the Thirteen Weeks Ended October 4, 2009  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminations     Consolidated
Blockbuster Inc.
 

Revenues:

           

Rental revenues

   $ 541.2      $ —         $ 169.6      $ —        $ 710.8   

Merchandise sales

     76.2        —           118.8        —          195.0   

Other revenues

     11.8        16.2         0.5        (23.8     4.7   
                                         
     629.2        16.2         288.9        (23.8     910.5   
                                         

Cost of sales:

           

Cost of rental revenues

     192.8        —           54.3        —          247.1   

Cost of merchandise sold

     54.1        —           87.7        —          141.8   
                                         
     246.9        —           142.0        —          388.9   
                                         

Gross profit

     382.3        16.2         146.9        (23.8     521.6   
                                         

Operating expenses:

           

General and administrative

     352.9        16.2         130.6        (23.8     475.9   

Advertising

     13.6        —           5.4        —          19.0   

Depreciation and intangible amortization

     30.7        —           6.2        —          36.9   
                                         
     397.2        16.2         142.2        (23.8     531.8   
                                         

Operating income (loss)

     (14.9     —           4.7        —          (10.2

Interest (expense) income, net

     (61.3     —           (0.3     —          (61.6

Other items, net

     (6.3     —           5.1        —          (1.2
                                         

Income (loss) from continuing operations before income taxes

     (82.5     —           9.5        —          (73.0

Provision for income taxes

     (0.7     —           (2.2     —          (2.9

Equity in income (loss) of affiliated companies, net of tax

     7.7        —           —          (7.7     —     
                                         

Income (loss) from continuing operations

     (75.5     —           7.3        (7.7     (75.9

Income (loss) from discontinued operations, net of tax

     (38.6     —           0.4        —          (38.2
                                         

Net income (loss)

   $ (114.1   $ —         $ 7.7      $ (7.7   $ (114.1
                                         

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Statement of Operations for the Thirty-Nine Weeks Ended October 3, 2010  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminations     Consolidated
Blockbuster Inc.
 

Revenues:

           

Rental revenues

   $ 1,424.9      $ —         $ 471.7      $ —        $ 1,896.6   

Merchandise sales

     225.7        —           328.4        —          554.1   

Other revenues

     32.4        35.8         2.7        (57.3     13.6   
                                         
     1,683.0        35.8         802.8        (57.3     2,464.3   
                                         

Cost of sales:

           

Cost of rental revenues

     521.5        —           164.2        —          685.7   

Cost of merchandise sold

     171.6        —           246.8        —          418.4   
                                         
     693.1        —           411.0        —          1,104.1   
                                         

Gross profit

     989.9        35.8         391.8        (57.3     1,360.2   
                                         

Operating expenses:

           

General and administrative

     964.3        35.8         380.1        (57.3     1,322.9   

Advertising

     25.5        —           15.4        —          40.9   

Depreciation and intangible amortization

     63.7        —           17.3        —          81.0   
                                         
     1,053.5        35.8         412.8        (57.3     1,444.8   
                                         

Operating income (loss)

     (63.6     —           (21.0     —          (84.6

Interest (expense) income, net

     (92.4     —           (0.3     —          (92.7

Other items, net

     (2.3     —           0.2        —          (2.1
                                         

Income (loss) before reorganization items and income taxes

     (158.3     —           (21.1     —          (179.4

Reorganization items, net

     (5.5     —           —          —          (5.5

Provision for income taxes

     (2.3     —           —          —          (2.3

Equity in income (loss) of affiliated companies, net of tax

     (21.3     —           —          21.3        —     
                                         

Income (loss) from continuing operations

     (187.4     —           (21.1     21.3        (187.2

Income from discontinued operations, net of tax

     (0.2     —           (0.2     —          (0.4
                                         

Net income (loss)

   $ (187.6   $ —         $ (21.3   $ 21.3      $ (187.6
                                         

 

29


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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Statement of Operations for the Thirty-Nine Weeks Ended October 4, 2009  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated
Blockbuster Inc.
 

Revenues:

          

Rental revenues

   $ 1,833.8      $ —        $ 491.9      $ —        $ 2,325.7   

Merchandise sales

     292.2        —          344.4        —          636.6   

Other revenues

     36.5        50.7        1.4        (72.7     15.9   
                                        
     2,162.5        50.7        837.7        (72.7     2,978.2   
                                        

Cost of sales:

          

Cost of rental revenues

     677.7        —          160.2        —          837.9   

Cost of merchandise sold

     247.4        —          255.1        —          502.5   
                                        
     925.1        —          415.3        —          1,340.4   
                                        

Gross profit

     1,237.4        50.7        422.4        (72.7     1,637.8   
                                        

Operating expenses:

          

General and administrative

     1,081.2        50.9        381.7        (72.7     1,441.1   

Advertising

     39.6        —          15.5        —          55.1   

Depreciation and intangible amortization

     83.7        —          19.5        —          103.2   
                                        
     1,204.5        50.9        416.7        (72.7     1,599.4   
                                        

Operating income (loss)

     32.9        (0.2     5.7        —          38.4   

Interest (expense) income, net

     (107.9     —          1.0        —          (106.9

Other items, net

     (13.7     —          6.0        —          (7.7
                                        

Income (loss) from continuing operations before income taxes

     (88.7     (0.2     12.7        —          (76.2

Provision for income taxes

     (3.0     —          (6.8     —          (9.8

Equity in income (loss) of affiliated companies, net of tax

     6.9        —          —          (6.9     —     
                                        

Income (loss) from continuing operations

     (84.8     (0.2     5.9        (6.9     (86.0

Income (loss) from discontinued operations, net of tax

     (38.5     —          1.2        —          (37.3
                                        

Net income (loss)

   $ (123.3   $ (0.2   $ 7.1      $ (6.9   $ (123.3
                                        

 

30


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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Balance Sheet as of October 3, 2010  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
     Eliminations     Consolidated
Blockbuster Inc.
 

Assets

           

Current assets:

           

Cash and cash equivalents

   $ 51.9      $ 0.1      $ 68.7       $ —        $ 120.7   

Receivables, net

     29.5        —          18.6         —          48.1   

Intercompany receivables

     10.6        —          17.0         (27.6     —     

Merchandise inventories

     87.0        —          120.6         —          207.6   

Rental library, net

     187.5        —          72.1         —          259.6   

Deferred income taxes

     —          —          13.7         —          13.7   

Prepaid and other current assets

     76.6        —          39.7         —          116.3   
                                         

Total current assets

     443.1        0.1        350.4         (27.6     766.0   

Property and equipment, net

     148.6        —          49.3         —          197.9   

Deferred income taxes

     70.6        —          9.0         —          79.6   

Investment in subsidiaries

     285.5        —          —           (285.5     —     

Intangibles, net

     6.0        —          0.4         —          6.4   

Restricted cash

     35.2        —          0.5         —          35.7   

Other assets

     34.5        —          1.9         —          36.4   
                                         
   $ 1,023.5      $ 0.1      $ 411.5       $ (313.1   $ 1,122.0   
                                         

Liabilities and Stockholders’ Equity (Deficit)

           

Current liabilities:

           

Accounts payable

   $ 30.3      $ 0.2      $ 41.6       $ —        $ 72.1   

Intercompany payables

     —          0.5        —           (0.5     —     

Accrued expenses

     194.5        0.2        59.6         —          254.3   

DIP Credit Agreement

     20.0        —          —           —          20.0   

Current portion of capital lease obligations

     —          —          0.6         —          0.6   

Deferred income taxes

     70.7        —          13.0         —          83.7   
                                         

Total current liabilities

     315.5        0.9        114.8         (0.5     430.7   

Capital lease obligations, less current portion

     —          —          0.1         —          0.1   

Other liabilities

     12.2        —          10.3         —          22.5   

Liabilities subject to compromise

     1,187.8        —          —           (27.1     1,160.7   
                                         
     1,515.5        0.9        125.2         (27.6     1,614.0   

Total stockholders’ equity (deficit)

     (492.0     (0.8     286.3         (285.5     (492.0
                                         
   $ 1,023.5      $ 0.1      $ 411.5       $ (313.1   $ 1,122.0   
                                         

 

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BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Balance Sheet as of January 3, 2010  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
     Eliminations     Consolidated
Blockbuster Inc.
 

Assets

           

Current assets:

           

Cash and cash equivalents

   $ 125.8      $ 0.5      $ 62.4       $ —        $ 188.7   

Receivables, net

     53.3        —          26.1         —          79.4   

Intercompany receivables

     —          1.6        15.9         (17.5     —     

Merchandise inventories

     149.3        —          149.2         —          298.5   

Rental library, net

     246.4        —          94.3         —          340.7   

Deferred income taxes

     —          —          13.6         —          13.6   

Prepaid and other current assets

     100.5        —          38.6         —          139.1   
                                         

Total current assets

     675.3        2.1        400.1         (17.5     1,060.0   

Property and equipment, net

     187.4        —          62.0         —          249.4   

Deferred income taxes

     105.6        —          9.0         —          114.6   

Investment in subsidiaries

     283.9        —          —           (283.9     —     

Intangibles, net

     7.1        —          0.6         —          7.7   

Restricted cash

     58.0        —          0.5         —          58.5   

Other assets

     46.4        —          1.7         —          48.1   
                                         
   $ 1,363.7      $ 2.1      $ 473.9       $ (301.4   $ 1,538.3   
                                         

Liabilities and Stockholders’ Equity (Deficit)

           

Current liabilities:

           

Accounts payable

   $ 207.3      $ 2.5      $ 91.0       $ —        $ 300.8   

Intercompany payables

     17.5        —          —           (17.5     —     

Accrued expenses

     334.4        0.4        72.9         —          407.7   

Current portion of long-term debt

     101.6        —          —           —          101.6   

Current portion of capital lease obligations

     5.7        —          0.4         —          6.1   

Deferred income taxes

     105.6        —          13.0         —          118.6   
                                         

Total current liabilities

     772.1        2.9        177.3         (17.5     934.8   

Long-term debt, less current portion

     836.0        —          —           —          836.0   

Capital lease obligations, less current portion

     19.9        —          —           —          19.9   

Other liabilities

     50.0        —          11.9         —          61.9   
                                         
     1,678.0        2.9        189.2         (17.5     1,852.6   

Total stockholders’ equity (deficit)

     (314.3     (0.8     284.7         (283.9     (314.3
                                         
   $ 1,363.7      $ 2.1      $ 473.9       $ (301.4   $ 1,538.3   
                                         

 

32


Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Statement of Cash Flows for Thirty-Nine Weeks Ended October 3, 2010  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations      Consolidated
Blockbuster Inc.
 

Net cash provided by (used in) operating activities

   $ (70.2   $ (0.4   $ 26.8      $ —         $ (43.8
                                         

Investing activities:

           

Capital expenditures

     (13.1     —          (3.6     —           (16.7

Change in restricted cash

     22.8        —          —          —           22.8   

Other investing activities

     1.2        —          0.1        —           1.3   
                                         

Net cash provided by (used in) investing activities

     10.9        —          (3.5     —           7.4   
                                         

Financing activities:

           

Repayments on senior secured notes

     (45.0     —          —          —           (45.0

Proceeds from DIP Credit Agreement

     20.0        —          —          —           20.0   

Debt financing costs

     (2.7     —          —          —           (2.7

Capital lease payments

     (3.8     —          (0.3     —           (4.1

Intercompany loans

     16.9        —          (16.9     —           —     
                                         

Net cash provided by (used in) financing activities

     (14.6     —          (17.2     —           (31.8
                                         

Effect of exchange rate changes on cash

     —          —          0.2        —           0.2   
                                         

Net decrease in cash and cash equivalents

     (73.9     (0.4     6.3        —           (68.0

Cash and cash equivalents at beginning of period

     125.8        0.5        62.4        —           188.7   
                                         

Cash and cash equivalents at end of period

   $ 51.9      $ 0.1      $ 68.7      $ —         $ 120.7   
                                         

 

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Table of Contents

BLOCKBUSTER INC.

(DEBTOR-IN-POSSESSION)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

(Tabular dollars in millions, except per share amounts)

 

 

     Statement of Cash Flows for Thirty-Nine Weeks Ended October 4, 2009  
     Blockbuster
Inc.
    Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
    Eliminations      Consolidated
Blockbuster Inc.
 

Net cash provided by (used in) operating activities

   $ 8.4      $ 0.4       $ (34.8   $ —         $ (26.0
                                          

Investing activities:

            

Capital expenditures

     (15.9     —           (4.0     —           (19.9

Change in restricted cash

     (65.3     —           (0.5     —           (65.8

Proceeds from sale of store operations

     —          —           13.4        —           13.4   

Other investing activities

     0.6        —           0.3        —           0.9   
                                          

Net cash provided by (used in) investing activities

     (80.6     —           9.2        —           (71.4
                                          

Financing activities:

            

Proceeds from senior secured notes

     634.5        —           —             634.5   

Proceeds from credit agreement

     360.0        —           21.4        —           381.4   

Repayments on credit agreement

     (841.0     —           (23.4     —           (864.4

Cash dividends

     (2.8     —           —          —           (2.8

Debt financing costs

     (60.6     —           (0.5     —           (61.1

Capital lease payments

     (8.8     —           (0.1     —           (8.9

Intercompany loans

     5.1        —           (5.1     —           —     
                                          

Net cash provided by (used in) financing activities

     86.4        —           (7.7     —           78.7   
                                          

Effect of exchange rate changes on cash

     —          —           4.8        —           4.8   
                                          

Net decrease in cash and cash equivalents

     14.2        0.4         (28.5     —           (13.9

Cash and cash equivalents at beginning of period

     92.5        0.1         62.3        —           154.9   
                                          

Cash and cash equivalents at end of period

   $ 106.7      $ 0.5       $ 33.8      $ —         $ 141.0   
                                          

 

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Item 2. Managements’ Discussion and Analysis of Financial Condition and Results of Operations

(Tabular Dollars in Millions)

Overview

Blockbuster Inc. is a leading global provider of in-home rental and retail movie and game entertainment, with over 5,550 stores in the United States, its territories and 16 other countries as of October 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.

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

 

   

in-store,

 

   

by-mail,

 

   

vending kiosks, and

 

   

digital devices.

Voluntary Reorganization under Chapter 11 of the U.S. Bankruptcy Code

On September 23, 2010 (the “Petition Date”), Blockbuster Inc. and certain of its domestic affiliates (collectively, the “Debtors”) filed voluntary petitions for relief under chapter 11 (“Chapter 11”) of the United States Code (the “Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York (the “Bankruptcy Court”). The reorganization cases (the “Chapter 11 Cases”) are being jointly administered as Case No-14997 (BRL) under the caption “In re Blockbuster Inc., et al.” The Debtors continue to operate their business as “debtors-in-possession” under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of Chapter 11 and orders of the Bankruptcy Court. Our remaining subsidiaries, including our non-U.S. subsidiaries, have been excluded from the Chapter 11 Cases and continue to operate their businesses without supervision from the Bankruptcy Court and are not subject to the requirements of the Bankruptcy Code. Our international operations in Canada, Denmark, Italy, Mexico, Uruguay and the United Kingdom are conducting business as usual. However, since the Petition Date, Blockbuster Inc. has ceased to provide funding to support our operations in Argentina, which have experienced continued shortfalls in operating cash flows for some time. As a result, it is anticipated that such subsidiary will file for its own liquidation proceedings in Argentina.

The Chapter 11 Cases were filed in response to the challenges of rapidly increasing industry competition and fragmentation, significant debt amortization and other debt service obligations, and ongoing cost-savings measures designed to enhance and preserve liquidity that placed constraints on our ability to fully implement operational and strategic initiatives, all of which adversely impacted our results of operations, cash flows and liquidity over the past several years. As part of the Chapter 11 Cases and as discussed further below, we anticipate the development and implementation of a plan of reorganization to restructure our capital structure and business operations. Confirmation of a plan of reorganization could materially alter the classifications and amounts reported in our consolidated financial statements, which do not give effect to any adjustments to the carrying values of assets or amounts of liabilities that might be necessary as a consequence of confirmation of such plan, or the effect of any operational changes that may be implemented.

Operation and Implication of the Chapter 11 Cases

Under Section 362 of the Bankruptcy Code, the filing of a bankruptcy petition automatically stays most actions against a debtor, including most actions to collect indebtedness incurred prior to the Petition Date or to

 

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exercise control over property of the debtor. Accordingly, although commencement of the Chapter 11 Cases triggered defaults on substantially all of our debt obligations, creditors are stayed from taking any actions as a result of such defaults. Absent an order of the Bankruptcy Court, substantially all pre-petition liabilities are subject to settlement under a plan of reorganization. As a result of the Chapter 11 Cases, the realization of assets and the satisfaction of liabilities are subject to uncertainty. Debtors operating as debtors-in-possession under the Bankruptcy Code may, subject to approval of the Bankruptcy Court, sell or otherwise dispose of assets and liquidate or settle liabilities for amounts other than those reflected in our consolidated financial statements. Further, a confirmed plan of reorganization or other arrangement may materially change the amounts and classifications in a Debtor’s historical consolidated financial statements.

The accompanying consolidated financial statements have been prepared assuming that we will continue as a going concern and contemplate the realization of assets and the satisfaction of liabilities in the normal course of business. Our ability to continue as a going concern is contingent upon our ability to comply with the financial and other covenants contained in the DIP Credit Agreement (as hereinafter defined), the Bankruptcy Court’s approval of our plan of reorganization and our ability to successfully implement such plan and obtain a commitment for exit financing, among other things. The accompanying consolidated financial statements do not include any adjustments related to the recoverability and classification of assets or the amounts and classification of liabilities or any other adjustments that might be necessary should we be unable to continue as a going concern or as a consequence of the Chapter 11 Cases. For further information, see Notes 1, 2 and 4 to our consolidated financial statements.

Subsequent to the Petition Date, the Debtors received approval from the Bankruptcy Court to pay or otherwise honor certain pre-petition obligations generally designed to stabilize the Debtors’ operations including certain employee wage and benefit obligations, cash management, tax matters, certain customer programs and payment of pre-petition claims of certain vendors deemed critical to the Debtors’ ongoing business, including certain movie studios and game vendors. The Debtors are paying, and intend to continue paying, claims arising after the Petition Date in the ordinary course of business. We have retained, pursuant to Bankruptcy Court approval, legal and financial professionals to advise the Debtors on the Chapter 11 Cases and certain other professionals to provide services and advice to the Debtors in the ordinary course of business. From time to time, the Debtors may seek Bankruptcy Court approval to retain additional professionals.

The U.S. Trustee for the Southern District of New York (the “U.S. Trustee”) has appointed an official committee of unsecured creditors (the “UCC”). The UCC and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court on all matters affecting the Debtors. There can be no assurance that the UCC will support the Debtors’ positions on matters to be presented to the Bankruptcy Court in the future or on any plan of reorganization, once proposed. Disagreements between the Debtors and the UCC could protract the Chapter 11 Cases, negatively affect the Debtors’ ability to operate and delay the Debtors’ emergence from the Chapter 11 Cases.

We have incurred and expect to continue to incur significant costs associated with our reorganization and the Chapter 11 Cases. The amount of these expenses is expected to significantly affect our financial position and results of operations, but we cannot accurately predict the effect the Chapter 11 Cases will have on our business at this time.

Plan of Reorganization

For the Debtors to successfully emerge from the Chapter 11 Cases, we must obtain the Bankruptcy Court’s approval of a plan of reorganization, which will enable the Debtors to transition from the Chapter 11 Cases into ordinary course operations out of bankruptcy. In connection with the plan of reorganization, the Debtors must also obtain a new credit facility, or “exit financing.” Our ability to obtain such approval and financing will depend on, among other things, the timing and outcome of various ongoing matters in the Chapter 11 Cases. A plan of reorganization determines the rights and satisfaction of claims of various creditors and security holders, and is subject to the ultimate outcome of negotiations and Bankruptcy Court decisions ongoing through the date on which the plan of reorganization is confirmed.

 

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Although the Debtors have not filed a joint plan of reorganization or a related disclosure statement with the Bankruptcy Court, the Debtors intend to propose a plan in accordance with the terms of the Plan Term Sheet and Plan Support Agreement (together, the “Proposed Plan”) dated as of September 22, 2010, by and between the Debtors and certain of their senior secured noteholders (the “Consenting Noteholders”). The Debtors anticipate filing the Proposed Plan on or about November 30, 2010, unless otherwise extended by agreement of the Consenting Noteholders. Following submission of the Proposed Plan, the Debtors will take all actions necessary to obtain approval for it from the Bankruptcy Court on or before March 15, 2011. Generally, the Proposed Plan provides, among other things, mechanisms for (i) settlement of claims against the Debtors’ estates; (ii) treatment of our existing equity and debt holders; (iii) provision for exit financing; and (iv) certain corporate governance and administrative matters pertaining to our reorganized company.

We continue to have ongoing discussions with the Consenting Noteholders regarding the Proposed Plan and will continue to do so until the Proposed Plan is filed with the Bankruptcy Court. The Proposed Plan is subject to revision prior to submission to the Bankruptcy Court based upon those continuing discussions, and thereafter in response to creditor claims and objections and the requirements of the Bankruptcy Court or the Bankruptcy Code. There can be no assurance that we will be able to secure approval of the Proposed Plan by the Bankruptcy Court, or that the Proposed Plan will be accepted by our lenders or the Unsecured Creditors Committee, in which instance the lenders have the right to terminate the DIP Credit Agreement (discussed below).

Financing During Pendency of the Chapter 11 Cases

During the pendency of the Chapter 11 Cases, the Debtors are funding operations pursuant to an order of the Bankruptcy Court permitting the Debtors’ use of cash collateral and entry into a $125 million Senior Secured Super-Priority Debtor-in-Possession Revolving Credit Agreement (as amended, the “DIP Credit Agreement,” discussed below). As of October 3, 2010, the Debtors had borrowed $20.0 million under the DIP Credit Agreement, and may borrow additional amounts from time to time subject to certain limitations and restrictions set forth in the DIP Credit Agreement. Our non-Debtor subsidiaries are not included in the Chapter 11 Cases and, as a result, are not borrowers under the DIP Credit Agreement; they continue to fund their operations principally with cash generated from operating activities and, in certain limited circumstances where so permitted by the lenders under the DIP Credit Agreement, funds from Blockbuster Inc.

Since approval of the DIP Credit Agreement, the Debtors have focused on executing their strategic and operating initiatives and ensuring the smooth transition of their business in Chapter 11. However, there can be no assurance that cash on hand, cash generated through operations and other available funds will be sufficient to meet our reorganization or ongoing cash needs or that we will remain in compliance with all the necessary terms and conditions of the DIP Credit Agreement or that the lending commitments under the DIP Credit Agreement will not be terminated by the lenders.

Bankruptcy Reporting Requirements

Additional information on the Chapter 11 Cases, including access to documents filed with the Bankruptcy Court and other general information about the Chapter 11 Cases, is available at http://www.kccllc.net/blockbuster. In accordance with our agreement with the U.S. Trustee, we will submit monthly operating reports to the Bankruptcy Court during the pendency of the Chapter 11 Cases. These monthly reports are prepared according to the requirements of the Bankruptcy Code and the Operating Guidelines of the U.S. Trustee. While we believe that these reports provide then-current information required under the Bankruptcy Code, they are nonetheless unconsolidated, unaudited, prepared in a format different from that used in our consolidated financial statements filed under the securities laws and are only prepared for the combined Debtor entities. Accordingly, we believe that the substance and format of the materials does not allow meaningful comparison with our regular publicly disclosed consolidated financial statements. Moreover, the materials filed with the Bankruptcy Court have not been prepared for the purpose of providing a basis for an investment decisions relating to our securities.

 

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Outlook

Business Operations

For the remainder of 2010, we continue to be committed to our goal of transformation to a multi-channel platform while ensuring a smooth transition of our business in Chapter 11. Further, we expect to continue facing the challenges of increased industry competition and fragmentation as well as balancing the decline of a single channel with the ascension of emerging channels, such as vending and digital. Factors contemplated in our current plans for the remainder of 2010 that we expect to mitigate these and other challenges include simplification of our domestic stores movie rental terms and pricing, launch of a significant marketing program to drive store traffic and by-mail subscriber growth during the peak holiday season, implementation of additional studio windows, a balanced slate of movie releases, and merchandising improvements including Blockbuster-exclusive products. However, there can be no assurance regarding these matters given increased competition, which has negatively impacted our ability to accurately forecast our results of operations and cash position and may result in deterioration of our revenues beyond what we anticipate. Further deterioration of revenues beyond what is contemplated in our current plans for the remainder of 2010 would negatively impact our anticipated revenues, profitability and cash flows from operations. Our expectations with respect to our performance over the remainder of 2010 are subject to a number of assumptions, many of which are outside our control, such as the rate at which customers are shifting preferences in entertainment delivery channels, our ability to reach acceptable terms with the studios for the provision of film content for each of our distribution channels, competitive pressures, the slate and timing of movie releases by major studios, the effectiveness of our planned fourth quarter advertising campaign and customer preference for entertainment during the holiday season, impact of bankruptcy proceedings and no significant contraction in our trade terms. There can be no assurance that our planned strategic and operational initiatives for the fourth quarter of 2010 will be successful or that the DIP Lenders or the Bankruptcy Court will approve the Proposed Plan, and under such circumstances we could be forced to consider other alternatives to maximize potential recovery for our various creditor constituencies, including a possible sale of the company or certain of its material assets, pursuant to section 363 of the Bankruptcy Code.

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

Exchange Delisting

On July 1, 2010, the New York Stock Exchange (the “Exchange”) notified us that, due to our noncompliance with the Exchange’s continued listing standards relating to minimum trading price and market capitalization, trading on the Exchange of our Class A common stock and Class B common stock (the “common stock”) would be suspended prior to the opening on July 7, 2010. As a result, effective July 7, 2010, our common stock trades on the Pink OTCQB market. As a result of the Chapter 11 Cases, we believe that our outstanding equity securities will have no value and will be canceled under any plan of reorganization. As a result, we urge that caution be exercised with respect to existing and future investments in any of our currently outstanding securities.

 

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Fresh-Start Reporting

If we qualify for such accounting treatment, we intend to apply fresh-start reporting upon emergence from Chapter 11. The application of fresh-start reporting will result in fair value adjustments to our assets and liabilities and in a new basis of accounting. Fresh-start reporting is dependent on the provisions of our plan of reorganization and the amount and fair value of our assets and liabilities as of the emergence date.

 

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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.

 

    Thirteen Weeks Ended     Thirty-Nine Weeks Ended  
    October 3, 2010     October 4, 2009     October 3, 2010     October 4, 2009  

Statement of Operations Data:

       

Revenues

  $ 736.6      $ 910.5      $ 2,464.3      $ 2,978.2   

Cost of sales

    310.2        388.9        1,104.1        1,340.4   
                               

Gross profit

    426.4        521.6        1,360.2        1,637.8   

Operating expenses

    443.9        531.8        1,444.8        1,599.4   
                               

Operating income (loss)

    (17.5     (10.2     (84.6     38.4   

Interest expense

    (28.0     (31.8     (93.3     (78.1

Loss on extinguishment of debt

    —          (29.9     —          (29.9

Interest income

    0.5        0.1        0.6        1.1   

Other items, net

    (1.2     (1.2     (2.1     (7.7
                               

Income (loss) from continuing operations before reorganization items and income taxes

    (46.2     (73.0     (179.4     (76.2

Reorganization items, net

    (5.5     —          (5.5     —     

Benefit (provision) for income taxes

    (1.8     (2.9     (2.3     (9.8
                               

Income (loss) from continuing operations

    (53.5     (75.9     (187.2     (86.0

Income (loss) from discontinued operations, net of
tax (1)

    —          (38.2     (0.4     (37.3
                               

Net income (loss)

  $ (53.5   $ (114.1   $ (187.6   $ (123.3
                               

Cash Flow Data:

       

Cash flows provided by (used in) operating activities

  $ 43.8      $ (53.0   $ (43.8   $ (26.0

Cash flows provided by (used in) investing activities

  $ (5.9   $ 65.8      $ 7.4      $ (71.4

Cash flows provided by (used in) financing activities

  $ 16.1      $ 25.7      $ (31.8   $ 78.7   

Other Data:

       

Depreciation and intangible amortization

  $ 28.3      $ 36.9      $ 81.0      $ 103.2   

EBITDA (2)

  $ 10.8      $ 26.7      $ (3.6   $ 141.6   

Adjusted EBITDA (2)

  $ 30.0      $ 32.6      $ 64.3      $ 165.1   

Margins:

       

Rental margin (3)

    66.5     65.2     63.8     64.0

Merchandise margin (4)

    26.2     27.3     24.5     21.1

Gross margin (5)

    57.9     57.3     55.2     55.0

Worldwide Store Data:

       

Same-store revenues increase (decrease) (6)

       

Rental revenues

    (6.1 )%      (12.2 )%      (7.4 )%      (11.5 )% 

Merchandise sales

    (15.5 )%      (21.1 )%      (11.7 )%      (16.0 )% 

Total revenues

    (8.6 )%      (14.4 )%      (8.5 )%      (12.6 )% 

Company-operated stores at end of period

    4,461        5,365        4,461        5,365   

Franchised stores at end of period

    1,076        1,405        1,076        1,405   

Total stores at end of period

    5,537        6,770        5,537        6,770   

 

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

Real Estate Data at October 3, 2010:

        

Domestic

        

Company-operated stores

     2,864         5.5         15,895   

Distribution centers

     39         N/A         1,119   

Corporate / regional offices

     8         N/A         400   

International

        

Company-operated stores

     1,597         3.2         5,110   

Distribution centers

     8         N/A         176   

Corporate / regional offices

     6         N/A         88   

 

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

 

(2) EBITDA and adjusted EBITDA are non-GAAP financial measures. See “Non-GAAP Information—Reconciliation of EBITDA and Adjusted EBITDA” that follows.

 

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

 

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

 

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

 

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

Segments

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

 

   

The Domestic segment is comprised of all U.S. store operations and by-mail subscription service operations in addition to vending kiosks and the digital delivery of movies through blockbuster.com and BLOCKBUSTER On Demand. As of October 3, 2010, we had 3,231 stores operating under the BLOCKBUSTER brand in the United States and its territories, of which 367 stores were operated through our franchisees. We also had 6,789 vending kiosks operating under the BLOCKBUSTER Express brand in the United States and its territories at that date.

 

   

The International segment is comprised of all non-U.S. store operations including operations in Europe, Latin America, Australia, Canada, Mexico and Asia. As of October 3, 2010, we had 2,306 stores operating under the BLOCKBUSTER brand and other brand names owned by us located in 16 markets outside of the United States. Of these stores, 709 stores were operated through our franchisees. In Canada, Italy, Mexico and Denmark, we also operate freestanding and store-in-store game locations under the GAME RUSH brand. On August 28, 2009, we completed the sale of our subsidiary in Ireland. The results for Ireland have been classified as discontinued operations for all periods presented.

 

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

 

     Domestic
Stores
     International     Unallocated/
Corporate
    Total  

Statement of Operations Data:

         

Thirteen Weeks Ended October 3, 2010

         

Revenues

   $ 472.3       $ 264.3      $ —        $ 736.6   

Cost of sales

     180.8         129.4        —          310.2   
                                 

Gross profit

     291.5         134.9        —          426.4   

Operating expenses

     288.8         124.9        30.2        443.9   
                                 

Operating income (loss)

   $ 2.7       $ 10.0      $ (30.2   $ (17.5
                                 

Thirteen Weeks Ended October 4, 2009

         

Revenues

   $ 621.2       $ 289.3      $ —        $ 910.5   

Cost of sales

     247.1         141.8        —          388.9   
                                 

Gross profit

     374.1         147.5        —          521.6   

Operating expenses

     361.9         138.6        31.3        531.8   
                                 

Operating income (loss)

   $