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UPDATE: Blockbuster's Revenues Climbed 5.9% to $1.26 Billion in the Third Quarter

25 Oct, 2001 By: Joan Villa

Blockbuster's revenues climbed 5.9% to $1.26 billion in the third quarter and 5% to $3.8 billion year-to-date, as the chain continues shifting shelf space toward DVD while allowing some VHS revenue-sharing deals to lapse.

Same-store sales for the three months ended Sept. 30 grew 3.3% domestically and 12.5% internationally, averaging to an overall increase of 4.7% over the year-ago period, fueled by $1.08 billion in rental revenues for the quarter — 6.3% higher than last year. Blockbuster expects same-store sales to grow in the “mid single digits” in the fourth quarter.

Chairman and c.e.o. John Antioco says Blockbuster has entered into DVD revenue-sharing deals with MGM Home Entertainment and another major studio he would not reveal, while dropping its VHS agreement with Buena Vista Home Entertainment to gain “maximum flexibility for margins.” The format already captures 40% of the rental revenues on some hit releases, so “it wouldn't be a stretch” to project that DVD revenues across the board will double to 40% by the end of next year, Antioco says.

“So much of our business is shifting to DVD, VHS revenue-sharing agreements in the same terms as in the past with each and every studio no longer makes sense,” Antioco explains. “With an optional fifth year left on the agreement with Buena Vista, we elected to exercise our one-year early termination provision.”

Whether or not the studios implement higher rental pricing for DVD next year, Antioco says the chain is prepared. Sellthrough pricing produces higher rental margins, but rental pricing would likely bring revenue-sharing and lower margins with more transactions and higher sales, “which we largely believe would be a tradeoff,” he reasons.

Blockbuster, which actively pushed for a rental window in dealings with the Video Software Dealers Association and at trade events, seems to have backed off that stance.“If studios put in a DVD rental window, which isn't something we are lobbying for or against, we give back some of that margin, but we would also expect higher comps,” Antioco says.

DVD's growth has been an incentive for studios to spend more advertising dollars on the format and even plan theatrical releases around when the home video window will best maximize the movie's return, Antioco continues. “That could be the tail wagging the dog,” he adds.

The game format, at 9% of revenues, is “soft” but could grow to 12% to 14% next year as PlayStation 2 gains in market penetration and new systems are introduced, Antioco predicts. To boost the format, a holiday promotion will guarantee availability of the hottest games, he says.

Following the Sept. 11 attacks, Blockbuster experienced a few days' decline in rental revenue, then a surge in revenues for the next weeks before a return to normal levels, resulting in neutral impact, Antioco says.

However, “clearly people's behavior and mindset have been adjusted” from the events and the slowing economy, he adds. “This trend of entertainment at home in a value-conscious consumer mindset is going to bode well for video.”

In its “re-merchandising” shift toward DVD, Blockbuster took the $320 million non-cash charge announced last month and will write off another $50 million in the fourth quarter to reduce VHS inventory by about 25% and shorten the amortization of VHS tapes and games to nine months from 36 months. A $9 million charge was recorded in the quarter for management structure changes and additional labor to re-merchandise DVD front and center in Blockbuster's 7,800 stores by Thanksgiving. The company also wrote off some $27 million to settle consumer litigation over late fees and employee lawsuits concerning wages and hourly compensation.

Including the charges, Blockbuster widened its net loss to $224.9 million. However, taken without the charges, the quarter's cash earnings, calculated as net income before goodwill amortization, climbed 84.6% to $43.3 million and EBITDA (earnings before interest, income taxes, depreciation and amortization) rose 19.5% to $142.3 million.

Analyst Barry Sosnick with Fahnestock & Co. says this quarter's earnings reflect Blockbuster's ability to extract value from the company's traffic, store transactions and database, while reducing operating costs and increasing margins. He believes the chain has effectively managed floor space through alliances with DirecTV and Radio Shack, which at this point put Blockbuster as the No. 2 sales outlet for DirecTV and bring home entertainment-related electronics such as DVD players and surround-sound systems into its 127 “store-within-store” Radio Shacks.

Blockbuster's growing market share also shifts power away from content providers and toward the chain's ability to deliver consumer transactions, he says.

“This is a fundamental shift because what it's forcing the studios to do is concede on upcoming points in revenue-share deals,” Bosnick says. “What Blockbuster realizes is they have 40% market share, they own the customer, they probably control 16% to 17% of studios' profit and they don't have to be pushed around.”

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