Domestic Operations
Physical Delivery
• In-store-As of January 6, 2008, we had 4,855 stores operating under the BLOCKBUSTER brand in the United States and its territories. Of these stores, 850 stores were operated through our franchisees. Our stores offer movie and game rental and new and traded movie and game product to our customers, including the addition of Blu-Ray DVDs to our product offerings in 2007. Additionally, approximately 400 of these locations include a game store-in-store concept operating under the GAME RUSH® brand.
• By-mail-We offer an Internet-based subscription service that allows customers to rent DVDs by mail and offers substantially more titles than our individual stores, including a wide array of both new release and catalog DVDs. This service gives some customers the option of exchanging their DVDs through the mail or returning them to a nearby participating BLOCKBUSTER store in exchange for free in-store movie rentals through a program called BLOCKBUSTER Total AccessTM. In addition, some by-mail customers receive free in-store rental coupons each month, which may be used toward movie or game rentals. We believe that this by-mail rental offering allows us to attract and retain additional customers by providing them with the convenience of renting movies online or in-store, and allows us to reach customers located in geographic areas where we do not presently have convenient store locations.
• Vending-We are exploring the growing vending channel as an opportunity to expand physical distribution of media entertainment. Vending machines are automated fixed capacity machines that enable the browsing and dispensing of a limited catalog of media entertainment. We recognize vending as an area of opportunity and are currently in the process of testing and evaluating solutions that would allow us to offer vending as an added form of convenience to customers.
Digital Delivery
• Download to PC-During 2007, we purchased all of the outstanding membership interests of Movielink, LLC ("Movielink"), an online movie downloading business with one of the largest libraries of digital content for both rental and sale. We are currently integrating Movielink's offering into the Blockbuster.com website. This will allow us to capitalize on the rapidly growing filmed entertainment downloading market and provide additional entertainment delivery choices to meet our customers' needs.
• Other alternatives-We are committed to providing convenient access to media entertainment and are continually seeking out alternative methods to deliver on this mission. With the convergence of media content and electronic devices, we are exploring further opportunities to digitally deliver content to our customers, including the development of digital delivery kiosks in our stores and leveraging strategic partners to digitally deliver entertainment content to our customers' homes and electronic and portable devices.
International Operations
As of January 6, 2008, we had 2,975 stores in 21 markets outside of the United States operating under the BLOCKBUSTER brand and other brand names we own. Of these stores, 907 stores were operated through our franchisees. In the Republic of Ireland and Northern Ireland, we operate under the XTRA-VISION® brand name due to its strong local brand awareness. In Canada, Italy, Mexico and Denmark, we also operate freestanding and store-in-store game locations under the GAME RUSH brand. During both 2007 and 2006, 35% of our worldwide revenues were generated outside of the United States. Our international operations have historically been more dependent on retail sales and, in particular, the retail game industry.
We disposed of two groups of international operations in 2007:
• In the second quarter, we sold our freestanding game locations which operated under the brand name GAMESTATION®. The sale of these stores has resulted in decreased total merchandise sales and decreased merchandise sales as a percent of international revenues during 2007.
• In the fourth quarter, we sold our Australian subsidiary, coupled with a master franchise license.
We plan to continue selectively licensing some of our international markets as this will allow us to retain our brand's presence while redeploying capital. Longer term, a strong licensed presence in each country can significantly establish the BLOCKBUSTER brand, facilitate growth, and set the stage for a future digital offering.
We maintain offices for each major region and most of the countries in which we operate in order to manage, among other things, (i) store development and operations, (ii) marketing, and (iii) the purchase, supply and distribution of product. Additional information regarding our revenues and long-lived assets by geographic area and financial data by segment is included in Note 13 to the consolidated financial statements.
INDUSTRY OVERVIEW
Domestic Media Entertainment Industry
We define our market as the media entertainment market.
While the overall domestic media entertainment industry grew in 2007 and the movie rental market is forecasted to continue that growth in 2008, there have been channel and product shifts, primarily driven by introduction of next-generation game consoles as well as the emergence of new channels of distribution for filmed entertainment, such as by-mail delivery, vending, and digital. We believe we are well-positioned to capitalize on the next-generation game console launches and the associated broadening of the consumer demographic. We have also taken steps to help ensure Blockbuster's viability across the filmed entertainment category, and we expect to outperform the industry in many areas in 2008.
Movies
A competitive advantage that the U.S. retail home video industry has traditionally enjoyed over most other movie distribution channels, except theatrical release, is the early timing of its "distribution window." Currently, studios distribute their filmed entertainment content three to six months after theatrical release to the home video market; seven to eight months after theatrical release to pay-per-view and video-on-demand ("VOD"); one year after theatrical release to satellite and cable; and two to three years after theatrical release to basic cable and syndicated networks. Recently, there has been increasing experimentation by studios and various movie content aggregators and retailers with the traditional distribution window, including simultaneous VOD and DVD releases. For example, although movie selections tend to be limited at present, customers can now download to their computers certain available movies on the same day that the movie's DVD is released by the studios nationwide in retail stores for rental or sale. In some cases consumers can also burn the downloaded movie to a blank DVD for playback in a DVD player, allowing them to watch the movies on their TVs or portable devices. We expect that the movie studios will continue to assess the traditional release windows and it is possible that the studios may decide to alter the traditional home video retailer distribution window for an increasing number of movies, particularly in connection with simultaneous VOD distribution of movies and DVD release dates. However, we also believe that the studios have a vested interest in maintaining the home video distribution window in a manner that allows them to maximize revenues generated by the retail home video industry.
Games
According to estimates by Jupiter Research, hardware and accessory sales revenues in the United States increased by 50.6% in 2007. In addition, game software sales and rentals in the United States by 23.7% in 2007. These increases were largely due to the rapid growth of portable gaming systems, particularly the Nintendo DS Lite, and the recent introduction of new, more advanced hardware platforms, including the Xbox 360, the Sony PlayStation 3 and the Nintendo Wii.
Many next-generation hardware platforms, including Sony PlayStation 2 and 3 and Microsoft Xbox and Xbox 360, utilize a DVD software format and have the potential to serve as multi-purpose entertainment centers by doubling as players for DVD movies and compact discs. For example, the Sony PlayStation 3 consoles are equipped to play high-definition Blu-ray DVDs. In addition, Sony PlayStation 3 and PSP, Nintendo DS and Wii and Microsoft Xbox 360 all provide Internet connectivity.
Sales of video game software generally increase as next-generation platforms mature and gain wider acceptance. Historically, when a new platform is released, a limited number of compatible game titles are immediately available, but the selection grows rapidly as manufacturers and third-party publishers develop and release game titles for that new platform. With respect to game rentals, we believe that the difference between the retail price and the rental price of a popular new video game title is typically high enough to make rentals an attractive alternative for customers. We also believe rental pricing provides both a testing ground for consumers considering a game purchase and an attractive alternative for customers who do not want to buy a game on an older format as they evaluate the purchase of a next generation hardware platform.
While the typical electronic game enthusiast is male and between the ages of 14 and 35, the electronic game industry is broadening its appeal across all demographics, especially with the introduction of Nintendo Wii. In addition, the availability of used video game products for sale has enabled a lower-economic demographic, that may not have been able to afford the considerably more expensive new video game products, to participate in the video game industry.
International Home Video Industry-In-Home Movies
Some of the attributes of the home video industry outside of the United States are similar to those of the home video industry within the United States. For example, the major studios generally release movies outside of the United States according to sequential distribution windows. However, other attributes of the home video industry outside of the United States do not necessarily mirror the home video industry within the United States. For example, most countries have different systems of supply and distribution of movies, and competition in many of our international markets tends to be more fragmented. In addition, under the laws of some countries and trading blocs (e.g., the European Union), home video retailers must obtain the right to rent videos to consumers through a licensing arrangement or a "purchase-with-the-right-to-rent" arrangement. Studios may charge these home video retailers more for product purchased for rental than product purchased solely for sale to consumers. This is commonly referred to as "two-tiered pricing," and affects our European operations. Two-tiered pricing not only results in increased competition from mass merchant retailers in those countries and trading blocs, it also creates increased competition with video rental outlets that operate in violation of the two-tiered pricing contractual limitations by renting product purchased at the lower retail price. The potential impact of studio pricing decisions is discussed under "Item 1A. Risk Factors-Changes in studio pricing policies have resulted in increased competition, in particular from mass merchant retailers, which has impacted consumer rental and purchasing behavior. We cannot control or predict future studio decisions or resulting consumer behavior, and future changes could negatively impact our profitability." The international home video industry also faces high levels of piracy. Although piracy is also a concern in the United States, it is having a more significant adverse affect on the rental and retail video industry in international markets.
