Lions Gate Entertainment F4Q06 (Qtr Ending Mar 31, 2006) Earnings Conference Call Transcript (LGF)

Lions Gate Entertainment (LGF)
F4Q06 Earnings Conference Call
June 15th 2006, 9:00 a.m. EST

Executives

Peter Wilkes - Head of Investor Relations
Jon Feltheimer – CEO
Michael Burns - Vice Chairman
Steve Beeks – President
Jim Eagan - Chief Financial Officer
Rick Prell - Chief Accounting and Compliance Officer

Analysts

Lowell Singer – Cowen & Co.
Jolanta Masojada– Credit Suisse
Michael Savner - Banc of America
David Miller - Sanders Morris
Gordon Hodge - Thomas Weisel Partners
Barton Crockett – JP Morgan
Andy Nasr – Raymond James
Eric Handler – Lehman Brothers
Alan Gould – Natexis Bleichroeder, Inc.
Michael Cohen – Susquehanna Financial Group
David Bank – RBC
Tom Eagan – Oppenheimer & Co.

Presentation

Operator

Ladies and gentlemen, thank you very much for standing by, and welcome to the LGF 2006 year end earnings call. (Operator Instructions) We'll now turn the call over to the Head of Investor Relations, Mr. Peter Wilkes. Please, go ahead.

Peter Wilkes

Good morning. Thank you for joining us on our fiscal year end call. We'll begin with remarks by our CEO, Jon Feltheimer; Vice Chairman Michael Burns; and President Steve Beeks. Then we'll turn the call over to questions from our analysts.

The matters discussed on this call include forward-looking statements. Such statements are subject to a number of risks and uncertainties. Actual results in the future could differ materially and adversely from those described in the forward-looking statements as a result of various important factors, including risk factors set forth in Lions Gate Form 10-K filed with the SEC on June 14, 2006. Now I'll turn the call over to Jon.

Jon Feltheimer

Good morning, everybody. Joining me this morning are Michael Burns, our Vice Chairman; President Steve Beeks; Jim Eagan our Chief Financial Officer; and Rick Prell our Chief Accounting and Compliance Officer.

Fiscal 2006 was a strong growth year for Lions Gate. We achieved new creative best with Crash winning our first ever Best Picture Academy Award. We achieved many, but not all, of our financial targets as we approached $1 billion in revenues and exceeded $100 million in free cash flow, demonstrating that we can continue to invest in the growth of our business while throwing off significant cash.

Our cash generation continues to strengthen our balance sheet. By the end of this week, we anticipate having a cash balance of more than $240 million in addition to our untapped credit facility of $215 million. That gives us over $450 million in cash and availability.

This, despite the fact that we've already paid out $32 million in cash for the acquisitions of Redbus and the Modern Library in the past year. Interestingly, Redbus now renamed Lions Gate's UK will throw off 40% of our international revenue in fiscal '07.

In addition to our $951 million in revenues, we had at the March 31st close one of the largest film entertainment backlogs in our history; $144 million in unrecorded revenues from motion pictures and television programming already under contract and not included on our balance sheet.

Our growth momentum has occurred across the board. Let's look at our overall trajectory. Revenues have grown from $376 million in fiscal 2004 to $843 million in fiscal '05 and to $951 million in '06.

Free cash flow has increased from negative $117 million in '04 to $93 million in fiscal '05 and $103 million in '06. Our domestic box office performance has gone from $84 million in '04 to $344 million in fiscal '06.

Today we're going to talk about our fiscal 2007 theatrical slate and when we do, keep in mind that we're already investing in motion picture acquisitions and productions that will continue that trajectory into fiscal '08 and '09.

Our home entertainment business has grown from $223 million in fiscal '04 to $465 million in fiscal 2005 to $527 million in fiscal '06. Television production revenues have grown from $60 million in fiscal '04, $83 million in fiscal '05 and $133 million in fiscal '06.

What these numbers show is a company on the move. We have growth at the top line and free cash flow at the box office and home video and television. We're also positioned for an earnings trajectory that should mirror and continue that growth trend.

We have the ability to continue expanding our production and distribution capabilities, invest in new product, build a library that increases in value every year, and make strategic acquisitions; while at the same time strengthen our balance sheet, draw a substantial free cash and continue to build up our cash balance.

Beyond our own organic growth, let's look at what's going on in the broader industry itself. It's true that packaged media is maturing, but in the face of that we still had our biggest year ever in home entertainment. That's the result of a number of factors:

Our proficiency in packaging and repackaging our library; our ability not to only have a growing theatrical business distributed in home entertainment, but to have a box office to DVD conversion rate higher than anybody in the industry; and the efforts we make year after year to improve efficiency in our home entertainment business.

But let's look beyond that at content and the way it's delivered today. Look at Warner Music and EMI and how digital delivery is beginning to drive their financial results. Warner Music's revenue from digital delivery is up 157% during the past year and now represents 11% of their overall revenue base. EMI Group digital sales are up 140% and approaching $200 million.

Look at our own results with the television series Weeds on iTunes. Just one television series that appears in 14 million homes recently achieved 10 of the top 50 downloads on iTunes, competing head to head successfully with series such as Lost and Desperate Housewives. Weeds has already generated around $600,000 in incremental revenue on iTunes -- just one device. With strong orders for the DVD box set coming out next month, there's absolutely no indication that its digital performance cannibalize its packaged media potential.

In addition to Weeds, we are or will be receiving revenue from Dead Zone and Wildfire on iTunes as well as from the first mobile episodes we're creating with Wildfire and ABC Family. We've begun receiving revenues from our download-to-own agreements with CinemaNow and Movie Link and are about to announce agreements with two other major electronics sell through retailers.

We've been culturally, strategically and operationally positioned from the inception of our business plan to capitalize on the higher margin revenue streams now emerging in a fragmented digital world of niche audiences clambering for content.

As a result we believe that the new digital revenue sources coming on stream will not only replace existing revenue streams from traditional media as they begin to slacken, but will soon prove incremental to them as our business plan has anticipated from day one.

As we move into fiscal '07, our objectives are to maintain strong free cash flow while continuing to build our library; improve our bottom line profitability; continue to dominant in spaces where we have a sustainable competitive advantage; leverage our content into incremental, digital media opportunities; and against this backdrop, Michael is going to take you through what this year's film slate looks like.

Michael Burns

Thanks, Jon. We believe that our theatrical slate for fiscal '07 reflects the portfolio approach which we've been building upon for the past six years. We are looking at a slate of 18 releases this year with approximately a dozen of our films going wide. Every single release epitomizes the Lions Gate model in its financial discipline, creative boldness and diversity. We are sticking to our plans.

Our '07 slate is anchored by franchises, such as Saw III, which is again shaping up as our Halloween tent pole; and despite our conservative budget assumptions, currently shows every indication of replicating the performance of its predecessors.

We continue to build on our leadership position in the horror genre and Saw III is surrounded by such other potent horror films as the terrifying Descent. The next entry in our potential Hostel franchise, Bug from acclaimed director William Friedkin; and SkinWalkers for which we partnered with special effects master Stan Winston.

The Descent, which is already an international box office smash and the best reviewed horror film of the year, is our next big nationwide release on August 4th. It is the kind of edgy R-rated horror film that fits right into our wheelhouse.

We have several strong action films on our upcoming slate as well with the wide released Crank starring Transporter’s Jason Statham; and Rogue, which just finished shooting in Vancouver with international action star Jet Lee. Rogue has the look and feel of a major studio action franchise, yet it was produced in the sweet spot of Lion Gate’s economic model. Both Crank and Rogue captured very robust foreign presales.

We also continue to strengthen our foothold in the teen comedy segment with Employee of the Month, pairing a sensational comic team with Jessica Simpson in September. We expect to build on the young audience we began to cultivate with Waiting.

We continue our powerful presence in the African-American family and faith-based films. Following on the heels of the first two films in the Tyler Perry franchise, next up we have Tyler's Daddy's Little Girl. We are planning a Martin Luther King holiday weekend wide release for PDR, Philadelphia Department of Recreation starring Terrence Howard and Bernie Mac which just completed shooting in New Orleans.

Everybody seems to be asking us what we plan to do for an encore after Crash. Our upcoming drama, Trade, starring Kevin Kline and produced by Roland Emmerich is a powerful, powerful drama about human trafficking and sex slavery from eastern Europe and Mexico in the United States. Trade is slated for release on October 13th.

Fresh off the success of last year's award-winning Grizzly Man, we have two strong documentaries on this year's slate. Leonard Cohen, I'm Your Man, and the U.S. versus John Lennon, which we will release in September. We believe that the U.S. versus John Lennon will have broad appeal for the Baby Boomer generation featuring both John Lennon and the Beatles songs.

2007 is the year we will continue to build on our core competencies: African-American families, award contenders, teen comedy, horror genres and documentary segments that we serve uniquely and efficiently. It underscores the continued organic growth of our motion picture business, at the same time reflects our continued efforts to mitigate P&A risks with several pure service deals and two other films primarily produced with third-party financing. We conservatively believe that this year’s slate will generate approximately $250 million to $300 million at the domestic box office in fiscal '07 -- a number that becomes noteworthy when you consider that at least two of our biggest feature productions are actually scheduled for release in early fiscal '08, representing what we expect to be terrific box office potential.

Of course, our theatrical slate box office will greatly influence the performance of our home entertainment business, Which Steve Beeks will now discuss.

Steve Beeks

Thanks, Mike. The DVD industry has exhibited a great deal of resiliency during the first half of this calendar year. Contrary to what you might have read in the New York Times this week, the gist of what was actually said at the conference referenced in the article that the Home Entertainment President of [DVD] Studios is that the results of the first half of the year indicate we should expect the current DVD format business to grow this year, and even probably into next year; just as high definition technology gets a foothold.

Because of that, we anticipate the home entertainment industry will actually show growth for many years to come. We are releasing our first five titles of Blu-ray DVD format at the end of this month. Those include Terminator II, Lord of War, The Punisher, Saw, and Crash. We are planning for two more releases by the end of the year, coinciding with the launch of additional Blu-ray machines and for what we think will be a strong fourth calendar quarter for the format.

The projections of growth in the home entertainment industry don't take into account avenues beyond new DVD formats. We're just looking at the very beginning of electronic sell through and the results coming in from both CinemaNow and Movie Link show increasing interest from consumers.

As Jon mentioned, we are closing deals with at least two other substantial Internet-based electronic retailers whose services will be launching in the next few months. That, we think, will spur the market even more for electronic downloads.

Another point neglected in this week’s Times article is the fact that all of these electronic sell through transactions between the studio and the electronic retailer are essentially conducted at the same price as the DVD wholesale price. Therefore our operating margin on these transactions are actually above the margin of our DVD business.

If we can draw any parallel from the music business, in which electronic downloads currently account for 20% of single sales and 5% of album sales, in the next few years this is going to be a significant contributor of revenue and margin.

Our DVD business grew at a robust 13% this past year to nearly $530 million. Fueled by strong performance of our theatrical to DVD releases, as we as continued strong performance from our library. Our DVD market share grew to 7% in the fiscal fourth quarter, only 2 percentage points below that of Paramount. That market share growth was the highest among all of the studios.

We continue to have the highest conversion rate of box office revenue to DVD revenue in the entire industry. It's actually 20% above the industry average. Our Q4 theatrical titles released on DVD – Waiting, Lord of War and Saw II -- all performed above industry average in terms of sales and with very low return rates.

Madea's Family Reunion is being released on DVD at the end of the month and the advanced retailer commitments position it to perform even better than Diary of a Mad Black Woman did at the same time last year.

Our library sales for the year were $209 million, only $2 million off the figure for 2005, even as the rights to the public library were winding down. We anticipate that next year we will also generate approximately $200 million or more from our library sales.

In the past, we have discussed the contribution margin generated by our library. While the contribution margin is still around 21%, although we anticipate that will increase over the next few months, some of the questions we have been getting on this have led us to believe that perhaps we've not been clear and I'll make sure you do not misunderstand what we mean when we discuss the margins generated by our library.

That margin number that we discussed is a P&L margin which is significantly impacted by amortization. The free cash flow margin from our library is estimated to be around 35%, meaning that our library is estimated to throw off approximately $70 million in free cash flow this year and is actually up from our estimated free cash flow of approximately $60 million in 2006.

We have ongoing and future library promotions at every major retailer and our shelf presence for new and especially library product is up. We have several library re-releases and special editions planned for this year. Only a couple of examples of this, the 20th Anniversary re-release of Dirty Dancing will be in Q4, and for the first time because of a very creative deal that we struck with two other studios, the three Terminator films will be repackaged and sold as a set. Lions Gate will be the studio selling that product.

Our supply chain management is running very efficiently. We now have a fill rate at major retail of over 98%, which is contributing to our ability to be able to maximize the value being generated from our library.

We continue to grow that library. We recently acquired the home entertainment and television rights to the 2,000 film Studio Canal library, which we will begin to release later in the year. This catalog includes television rights to films such as Crimes of the Heart, Tender Mercies and Maximum Overdrive, as well as DVD rights to titles like Bedroom Window, From the Hip and some of the greatest classic French films, including many of the Jean Benoit classics.

This agreement further strengthens our relationship with Studio Canal, who also owned the [Carico] library, which we also distribute for them. We also have verbal agreements to acquire two other substantial libraries. Those agreements are in the latter stages of drafting and we hope to have them executed within the next 30 to 45 days.

The fact that owners of these libraries are coming to us for distribution and that we can continue to add titles to our catalog speaks volumes about our strength and capabilities as a manager of libraries. We will continue to be aggressive in our quest to acquire additional libraries, adding to our position as a premier content provider.

Our TV to DVD business also continues to be strong. The Biggest Loser Workout is a top-selling fitness DVD in the industry and the sequel will be shot in July, after the next season is wrapped, for release in January. The DVD set of Weeds, Season 1 will be released in July, just in time for the premier of the second season on Showtime.

These television series, in addition to Wildfire, Missing and Dead Zone also contribute to our growing library of content and we look forward to getting other new television productions released on DVD. With that, I'll throw it back to Jon. to continue with our television.

Jon Feltheimer

Thanks, Steve. With nine prime time series scheduled to air in fiscal 2007, we're poised for continued growth this year and beyond in our television business. These series include Golden Globe winner Weeds, which has demonstrated its global appeal in the growing cloud of our distribution infrastructure with sales to more than 130 territories worldwide.

Wildfire, which continues to show our strength in reaching out to teen audiences in its third season on ABC Family; and the Dead Zone, which as you know enters syndication this fall with 67 episodes.

Our six new television series show the portfolio approach we've taken in our TV business with our first dramatic series for the broadcast networks, Hidden Palms with CW from Kevin Williamson, the creator of Dawson's Creek and the Scream franchise. Full 13 episode orders for Love Spring International on Lifetime and Dresden Files on Sci-Fi network; production beginning on Motel Man in New Mexico for an 8-hour limited series that we expect to parlay ultimately into a regular season series on Sci-Fi. I Pity the Fool starring Mr. T for TVland, and the eight episode television reality series, Dirty Dancing which we just finished shooting for WE and which will air in conjunction with our 20th anniversary theatrical and DVD re-release of the Lions Gate franchise hit film.

In spite of the fact that we keep our ultimates very low for the initial years of a television series, TV will make a significant contribution this year to our earnings and an even more significant contribution to our free cash flow.

As the tax credits we have earned in previous years are collected and we maintain our efficient production and financing on all of these shows, we're able to keep negative cash flow for new television product very low.

We also have a new deal to leverage our television content in the distribution space and although it has been signed, we probably won't be ready to discuss it until next month.

Now I would like to talk about our forecast for the year and our key assumptions. As Michael said, we are projecting $250 million to $300 million in domestic box office for our fiscal 2007 guidance. We are looking at theatrical P&A of approximately $150 million compared to fiscal 2006's $170 million. We're assuming that our fiscal 2007 slate will contribute a loss of $20 million for fiscal '07 and its first year theatrical release.

We had similar assumptions last year for our motion picture slate in terms of revenues and operating loss, and outperformed on both, turning a profit of $10 million so we certainly see some room for upside. Our box office assumptions flowed through to equally conservative assumptions on the home entertainment side of under $500 million. We are projecting $140 million in television revenues, which is also conservative because we have no TBAs in our TV budget. In other words, all of our revenue is accounted for by sold shows, so any new sales will provide a lift to revenues. As Steve said, we see library sales holding steady at $200 million.

In spite of these conservative assumptions, we expect that we will again deliver over $900 million in revenues in fiscal 2007 and more than $85 million in free cash flow. We are also anticipating a meaningful earnings growth in fiscal 2007 and are projecting pre-tax income of approximately $32 million, between 4X and 5X the level of this year's pre-tax income of $7.5 million; and better than our previous high water mark of $29 million in pre-tax income in fiscal 2005.

So we're projecting a strong year in fiscal 2007, but even more importantly, we're starting what we believe will be a very strong long-term earnings trajectory. We don't see our free cash flow coming down to earnings as these lines begin to converge. We see earnings rising to meet free cash flow.

The elements for that earnings trajectory are in place. Our TV shows are heading towards syndication and higher margin revenues; expected incremental revenues from newly acquired libraries; revenues from the digital exploitation of our content in new platforms and formats; higher margin international revenues through self-distribution in certain territories.

In terms of our theatrical business, a number of our largest titles already slated for fiscal 2008, including Rogue that Michael mentioned; Stopping Power from director Jan De Bont, director of Speed and Twister; Food Fight, our first CGI animated movie; and Good Luck, Chuck starring Dane Cooke and Jessica Alba.

So our model is working, we're generating current cash and earnings while at the same time we're investing in growth from new libraries, new distribution, and new film and television content.

Now I'd like to open the floor to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question will come from the line of Lowell Singer – Cowen & Co.

Lowell Singer – Cowen & Co.

Thanks, good morning. Can you talk a little bit about your output deal with Showtime? There have been some comments recently about the potential for the longer-term trend in those output deals to be decidedly less favorable for the studios. I'm wondering if you could address that.

Second, on the television business, can you give us some idea of what you expect to come in from the Dead Zone syndication deal? The program you're doing for the CW, has your economic model changed on that or are you still not deficit financing with regard to that series? Thanks.

Jon Feltheimer

First question is, our paid deal extends through all of our releases in calendar '08. I think overall my sense of the business is that the paid television business is a strong business; will remain strong. I think the key to their business is movies. That's what it's always been, and they're going to continue to need movies. I think we're the best deal in town in terms of those movies. Frankly, we're already in discussions about either extending or continuing our paid business well beyond 2008.

In terms of Dead Zone, always hard to know how you're going to do in syndication. But you'll see a combination of a broadcast station syndication as well as cable sale. We carry, we think, a pretty conservative ultimate on that. We think we'll have good revenue and incremental margin revenue there.

In terms of the CW, I do think our model has been much more in the cable space and definitely a short order for a series. It's hard to make the economics work, but I do believe we're going to be pretty efficient as we always are in terms of the way we produce it, where we produce it and the kind of overall financing that we use.

I can tell you that international sales have been incredibly strong, approaching $650,000 to $700,000 an episode. Again, showing the strength of our distribution as well as the kind of show that it is. So I think the model will end up being very successful.

Lowell Singer – Cowen & Co.

Okay. Thank you.

Operator

Thank you. We'll next go to the line Jolanta Masojada– Credit Suisse.

Jolanta Masojada– Credit Suisse

Thanks very much. Could you please expand on the drivers of your free cash flow estimate in terms of which components of your cash flow will be driving that?

Secondly, can you talk about your expectation of corporate costs going forward now that you are Sarbanes compliant?

Steve Beeks

The drivers of the free cash flow components on a go-forward basis, if you look at the receivables balance at the end of the year, they are very significant. You'll see a lot of cash coming in from the receivables. In addition, as Jon mentioned on the call, you'll also see the EBITDA, the cash from net earnings increasing, which is causing the free cash flow from that to come and drive up. So collection of receivables, as Jon mentioned we have $143 million of off-balance sheet receivables that will also be coming in; increased receivables and additional earnings throughout the year will drive free cash flow next year.

Jon Feltheimer

Well, we certainly have invested in our finance department and in our IS area in order to become compliant. We are certainly hoping that we can take down next year and the years beyond our professional fees, our consultant fees, and frankly some of our overhead in the finance area as we prove more and more efficient at that.

Jolanta Masojada– Credit Suisse

Thanks.

Operator

Our next question comes from Michael Savner - Banc of America.

Michael Savner - Banc of America

Hi, good morning. Thanks. Two questions, first, obviously you're not going to give guidance on EBITDA in '07, which seems reasonable. But I think, it might be useful if at least directionally you can give us a sense of what the moving pieces are that are going to compress that spread between EBITDA and free cash flow in the next fiscal year. I assume that this year you probably accrued some participations in the back half of the year, which explains a portion of the increase, but maybe some more granularity on what your expectations between the relationship of those two items is?

The second question, maybe Steve could talk a little bit about the library margin, specifically related to the Barbie distribution deal that you're no longer carrying, which I guess has some pros and cons to it. So how you make up the revenue given that's obviously a high volume product, but a low margin product. So maybe just some more color on that would be good too.

Steve Beeks

I'll answer the second question first in terms of the library margin. Specifically dealing with your question about Barbie. As you heard, we won't be distributing anymore new Barbie’s going into the future, although we will be distributing the seven Barbie titles that we have in our library. We'll continue to distribute those until those deals expire.

As you mentioned, the margin on the library business, on the Barbie business, was getting to the point where it wasn't really paying for us to continue our commitment to that line. So it was a relatively low-margin business. I don't anticipate there is going to be any detriment gong forward. I think the revenue is something that we will easily make up with some of the other things we are doing, particularly in the family area.

We are focused now on a couple, rather than a number of productions, we're focusing on a couple high-level franchises such as Doodlebops which is airing on the Disney Channel. Obviously we're focusing on the Marvel animated series which was mentioned on the last call; launched with a huge success with the Adventurers, we'll now have two or three of those films a year. We have a couple of other things that we're working on. I don't think we'll have any trouble replacing that revenue.

Michael Savner - Banc of America

Can you tell what percentage of the revenue it was in '06?

Steve Beeks

Less than 5%.

Michael Savner - Banc of America

Terrific.

Jim Eagan

On free cash flow, you’ve exactly picked up on -- part of our over performance in our fourth quarter caused us to have an increase in our film participation liability, which will indeed be paid next year. One of the reasons why free cash flow exceeded our guidance from 85 to over 100 and now back to the 85, so we're paying back some of the extra we got, next year. That’s really some of the drivers.

In addition, free cash flow next year, driven through earnings or collection of receivables -- and one thing I'd like to just have everybody note on the free cash flow. This current year I invested $284 million in investment in films and this compares to $171 million last year. So please note, everybody's looking at free cash flow, look how much we invested in free cash flow in this current year, which again will help drive our cash flow in upcoming years.

Michael Savner - Banc of America

Given all of the other assumptions in your outlook, is it fair to assume in that is a significant EBITDA increase from '06?

Michael Burns

Yes.

Michael Savner - Banc of America

Thank you, Mr. Burns.

Operator

Our next question comes from David Miller - Sanders Morris.

David Miller - Sanders Morris

Hey, guys, congratulations on the stellar results in the fourth quarter. Michael, a couple questions for you. Are you still planning on forcing conversion on the traunch of converts that's in the money? I forget what the strike price is, but that’s obviously going to structurally change your share count. Can you talk about the timing of that and what you're feelings are about that?

Also with your cash position being so flush right now, I take it that if the [Disk] situation does not go hostile and you give them the opportunity to save face with, let's just theoretically say another $4 per share all cash offer, you certainly don't want to give away your stock at these levels. You'll be paying for that asset in cash if it goes that way? I just have a couple follow-ups, thanks.

Michael Burns

Okay. The first question with regard to the $60 million convert. David, it depends on whether the price of the stock trades. The way it works is it is 175% if you trade the 20 out of 30 days at 175% of the $5.40 strike price. Then we have the right to force conversion, which would be later in this calendar year. One thing I'll say about that, obviously that would save us about $3 million in interest costs.

As far as [Disk], as you saw from the recent court results in Delaware, we are approaching that to put up our own slate of potential directors that I believe [Disk] announced that they had hired an investment banker to explore strategic alternatives. So we're obviously interested in seeing how that process moves along and interested in participating in that.

As far as giving away stock at these levels, my guess is you're probably right. With our significant cash balance, it would be more interesting to us to pay cash at the moment than to do a stock transaction.

David Miller - Sanders Morris

Just a couple of follow-ups. If you guys could just update us on what is going on structurally with a launch of the Horror Channel, that would be great.

Also, Steve, in your box office to DVD conversion assumptions, did that ratio assume DVD rental income, as well? Or is that just a box office to DVD sales figure? Thanks very much.

Steve Beeks

That conversion ratio essentially includes all consumer revenue, both rental and sell throughs. We're comparing consumer revenue DVDs to consumer revenue at box office.

David Miller - Sanders Morris

Okay. Great.

Steve Beeks

In terms of the horror platform, I would say that we're in discussion and negotiation and I would hope you might see an announcement of something in the next 8-10 weeks.

David Miller - Sanders Morris

Wonderful. Thanks very much.

Operator

Our next question comes from Gordon Hodge - Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

Good morning, just a couple questions. Just on the TV guidance, I gather that was TV production for the network shows, as opposed to TV revenues that you would enjoy on theatrical releases? I just wanted to clarify that.

Jon Feltheimer

That's correct.

Gordon Hodge - Thomas Weisel Partners

Steve I think you mentioned that you acquired the Studio Canal, at least distribution rights to some of the Studio Canal library and you have a couple of other libraries, perhaps in the hopper coming your way. Are those significant in terms of cash outlay, or are those primarily distribution deals that we should be looking forward to?

Steve Beeks

Neither of those deals will be significant in terms of the cash outlay, but I think they'll be nice additions to our library.

Gordon Hodge - Thomas Weisel Partners

Terrific. Last question: as you think about the Showtime output deals, to follow-up on that, I think it restricts your ability to offer digital downloads or electronic distribution on a subscription basis. Is that something you might think to unbundle when you renew or extend that agreement as you think about distribution on iTunes or Amazon or what have you?

Jon Feltheimer

I think you are asking a really interesting question and I really should have included that in my answer to Lowell earlier which is I think what is going to be interesting about the new negotiations that everyone is going to have in terms of their paid television business is it's really all going to be about rights. And what rights that the paid networks want included in the next round, rights that they don't currently have, what rights we may want.

I think that's where the interesting, if you will battleground, will be. But I think that's what's going to make it interesting. Again, I do believe that the pay networks, it's all about movies for them. I don't believe it's realistic to run their whole business based upon a movie to movie buying, I just don't think that's realistic at all.

As I say, I think we have a little more flexibility, perhaps than the other studios. We've had a great opportunity to look at the subscription model in terms of broadband with Cinema Now and look at new ways of distributing a theatrical product, download to own, download to burn. So I think that's what's going to be interesting about the next round of pay television deals.

Gordon Hodge - Thomas Weisel Partners

Great, thank you.

Operator

Our next question comes from Barton Crockett – JP Morgan.

Barton Crockett – JP Morgan

Thank you very much. I was wondering if you could break down for us in more detail the difference between your pre-tax income guidance and your free cash flow guidance, which is a little bit above $50 million. How much of that is film amortization, perhaps bigger than investment? Can you give us some sense there? How much of it is a contribution from working capital? How much of it is other items? If you could break that down, that would help us understand really what is happening under the covers there. Thank you.

Jon Feltheimer

Well, you know, again, because we've read a lot of your notes and talking about the quality of earnings. I would say, Barton, I'll give you two easy examples to look at, which is I would say approximately last year -- and this is why Steve made his point in the remarks about the difference between contribution margin from our library as opposed to free cash flow -- I think it's a point that's been missed by everybody up until now. The delta between the two of those is about $30 million alone. The delta this year in free cash flow and our television business, between contribution and free cash flow is probably over $10 million because of tax credits we'll be receiving.

If you just took the two of them, assume that kind of delta continues, you've got $40 million right there. So as a matter of fact, I think as we've looked at our budget as Jim has mentioned, because of the large participations we took in the fourth quarter that we accrued, I think that we're certainly looking at going the other way and paying back that working capital margin from participations in the next couple of quarters.

So I think you're looking at really a very strong quality of free cash flow in terms of this next fiscal year.

Barton Crockett – JP Morgan

Okay. So just to be clear, you guys had a large contribution this year from growth and film obligations. Next year, do you not expect that?

Steve Beeks

Next year, I would not foresee the same growth that we’ve had from film obligations.

Barton Crockett – JP Morgan

Is it going to be negative or flat or positive do you think? A big number or small number?

Steve Beeks

I would anticipate it almost neutral from your standpoint. Because I've always said, you want that number to grow, but I don't like to budget or plan for an increase in that number.

Barton Crockett – JP Morgan

All right. That's helpful, thank you very much.

Operator

Our next question comes from Andy Nasr – Raymond James.

Andy Nasr – Raymond James

Good morning. I was hoping you could update us on just some film fund initiatives or elements like output agreements? Also, I was wondering specifically you said you're producing nine series this year compared to four last year. I would have expected more of a sequential increase in TV revenues in fiscal 2007, so I was hoping you could comment on that, as well.

Jim Eagan

In terms of film fund, we are definitely in negotiation with at least two partners; two different kinds of funds and anticipate at least one of those deals closing. It could positively impact free cash flow. I don't really have a sense yet as to when they would start and whether it would affect earnings, as well.

In terms of television, as I said I'm giving a conservative projection because I have no TBAs in there, but I would say as well, a couple of those series are the CW series, Hidden Palms is a short order. The reality shows have much smaller license fees and probably a little bit lower international sales, as well.

So again, that's the current status of the business and anything that we sell through the rest of the year and produce would be incremental.

Andy Nasr – Raymond James

Thank you.

Operator

Our next question comes from Eric Handler – Lehman Brothers.

Eric Handler – Lehman Brothers

Thank you. Just in terms of your film slate, can you give us a sense of which films are distribution-only deals? Also with regard to P&A spending, are you scoring any other types of deals along the lines of the Starbucks deal with Akeelah and the Bee?

Jon Feltheimer

Well, in terms of promotional kind of tie-ins, we're trying to do them on virtually everything. The Starbucks deal was obviously reported more extensively and it certainly was a very wide promotion. We try to do them on every picture. I think certainly on Food Fight we've lined up at least three or four major advertisers to come in and major consumer product companies to come in with us. So far the movie is looking great and that will be a big one for us.

In terms of the service deals, none of the movies I believe that Michael has mentioned or that I've mentioned today are service deals. There are a number of them, but since we haven't calendared them, I'm reluctant to actually give you the names. But nothing we've talked about today.

Eric Handler – Lehman Brothers

Thank you.

Operator

Our next question comes from Alan Gould – Natexis Bleichroeder, Inc..

Alan Gould – Natexis Bleichroeder, Inc.

Thank you, I've got three questions. First for Steve. The fourth quarter video revenue was huge. I know you had some good titles going through there, but was there anything else occurring in there? Was there any other big video sales or video output type deals in there?

Second for Jim, what is this line item “unpresented bank check” in the cash flow statement and how is it different than an accounts payable? Why was it taken out of free cash flow in '06? Doesn't that automatically give you $15 million in free cash flow to start '07?

Thirdly for Jon, I was wondering if you could give us any information on [Carl Icon], his filing; if you met with him and what you think his intentions might be with the Company?

Steve Beeks

Alan, speaking to your question on the fourth quarter video. We just had a great fourth quarter. Obviously we had several theatrical films hitting the market and they all did well. We are awaiting Saw II that was released during the quarter. Obviously the Academy Award for Crash impacted sales on that dramatically, and we had a director's cut that had already been planned that came out right before the end of the quarter and we had a great fourth quarter on library.

I think in general, as I mentioned and as I think every studio mentioned last week, the first calendar quarter, our fourth fiscal quarter was a great quarter for home entertainment for library product as well as new release product.

Jim Eagan

The unpresented bank draft. The reason it's a new line, we've been focusing on managing our cash very effectively. We’ve been heavily invested in the options preferred, as you've seen in our notes. What occurred is in the accounting rules we basically cleared the cash out of our Union bank account -- I’ll be specific -- and therefore we didn't have the cash in the Union bank account, but we had I in other Merrill Lynch type accounts, but it didn't cover it.

The accounting rules forced us at the end of the year to increase cash and increase this liability. So we did not want to do anything that may look like -- our free cash flow, had we done that, would have been $117 million. Had I had that cash at the Union bank, I wouldn't have had to do the entry.

So we said, let's be very transparent, and break it out so you can see, in my humble opinion, my true free cash flow was $102 million not $117 million. For the next year guidance, starting with the $102 million, you will have at the end of the year $85 million more in free cash flow from pure raw cash coming in.

Jon Feltheimer
We have had a number of conversations with the [Icons]. I think our sense is they believe our company is undervalued. I think they put a lot of value on the library. We agree with them, as we've said often our P&L statements only include seven-year ultimates, but no terminal value on our product.

We think, again, as a 100% pure play content company we're greatly disadvantaged in terms of looking at comps based upon from an EBITDA and even from an earnings point of view. Again, I think that Mr. [Icon] believes as we do that if we can continue to throwing off cash and increasing our cash balance and building our library as you do, just comps based upon library value, I think that it does show that our stock is significantly undervalued.

Alan Gould – Natexis Bleichroeder, Inc.

Okay. Thank you, Jon.

Operator

Our next question comes from Michael Cohen – Susquehanna Financial Group.

Michael Cohen – Susquehanna Financial Group

Thanks. A little earlier you touched on the investment in programming, how it increased about $100 million this year to $285 million. Should we expect a similar level of spending in fiscal 2007, or should that number trend back down to something closer to the $200 million as you spent in the last couple of years?

Jon Feltheimer

Yes, it will trend down a little bit and I think your ballpark is about right.

Operator

Our next question comes from David Bank - RBC.

David Bank - RBC

Thank you, good morning. I'm sorry for four or five questions. The first one is when you were talking about the library and the difference between free cash flow and EBITDA, maybe how The Street was looking at it incorrectly; isn't the library the ultimate kind of steady state business? I realize you have new titles coming in every year, but you have for the most part, it really represents the closest thing to a steady state business. So why is there such a huge difference between free cash flow and EBITDA? Maybe run through them and if you can hit them afterwards.

The second question is, aside from the gain on the sale of the studio facility, unless there's something interesting going on in the capital structure, you've given us pre-tax income. The only real difference in pre-tax income and EBITDA guidance would be in depreciation and interest, essentially. Is there anything interesting going on there? Why not just give us a sense of EBITDA?

The third thing is – and this is maybe just my own misunderstanding, but -- on the theatrical box office, I think you said $250 million was about the expectation domestically? If I take your usual 45% cut of that I get to $113 million, which is below where you are this year. So I think I'm probably missing something.

The last question. Could you just clarify, I think you answered it before. A little bit north of $200 million cash investment this year in programming. What kind of amortization -- can you give us a sense of amortization that we can expect? Thanks and sorry for all of the questions.

Jon Feltheimer

Give me that last question again.

David Bank - RBC

I think you gave us a sense that cash and programming investment this year would be a little north of $200 million if I heard the last question right. Can you give us a sense of the amortization side of the equation?

Steve Beeks

David, this is Steve. I'll talk about your question with regard to the library first. Yes, the library is, in general, a steady state business, although it is within that a shifting mix and blend of product. You can see a little bit of that just from the fact that the cash flow from the library was $60 million in fiscal ’06 and projected to go to $70 million in fiscal '07. A lot of that has to do with the shifting mix of product and what we're working at the time.

So it's relatively steady state, but the big difference, as we said, between free cash flow and the P&L is primarily amortization. Issues surrounding amortization, primarily from the libraries that we’ve acquired over time, and that is a very significant amount.

Jon Feltheimer

Your second question is, we've pointed The Street away from EBITDA as not a good means of comparison before us. We're giving the pre-tax number because it's a GAAP measure and we have to give the GAAP measure. So we pointed The Street towards pre- tax and, again, we've determined the pre-tax number is the best GAAP measure that we can give.

David Bank - RBC

Is there anything we should expect different in terms of interest and depreciation next year?

Jon Feltheimer

No, I don't think so. I'm not quite sure of your question. If your question is, do we feel we're being conservative about our slate? Because your numbers are about right on that. Again, I mentioned in my remarks, we over-performed fairly significantly. If we, for example, didn't have any changes in timing, meaning moving a heavy P&A movie into fourth quarter and we did the $344 million at box that we did this year with the same slate, yes, probably our revenues overall would drop about $50 million. Again, we're forecasting to the best of our knowledge right now.

Jim Eagan

Amortization is going to fall in line with the revenues. Actually I hope that you might see a slight benefit in the motion picture amortization as we've had a couple movies that didn't perform last year and we are hopeful and anticipating that we won't have those movies under-perform next year. So a slight uplift in the motion picture amortization. The TV production amortization may be slightly better as we start to be able to realize some of the syndication revenue; not materially, but slightly better.

David Bank - RBC

So Jim, does the delta narrow? It is about a $30 million delta in terms of amortization versus cash investment in fiscal '06. Should we expect something meaningfully narrower than that next year?

Jim Eagan

I don't think it will be meaningfully narrower.

David Bank - RBC

Thank you.

Operator

Our final question comes from Tom Eagan – Oppenheimer & Co.

Tom Eagan – Oppenheimer & Co.

Two questions, one on amortization, also. I guess for Mike and Jim, on amortization how much amortization in fiscal '07 do you think is going to be from the titles in fiscal '06?

Secondly, how much of the amortization in '06 do you think was over-amortized because of the losses on titles, whether it be in the mix or high tension? Meaning, how much might the amortization be lower in fiscal '07, because you weren’t going to have those losses? Is it $20 million, is it $30 million?

On participation, maybe this is for Jon or Mike. As you negotiate with the film fund partner, how much ability to do you have to shift the participation expense over to production cost? Meaning, if a film fund is going to be spending or taking the brunt of the production cost, could you shift the participation to actors or directors whatever, to production costs and therefore have the film fund pick it up and therefore not have the expense? Thanks.

Jim Eagan

Sure. I'll start with your first one. The anticipated amortization of the '06 product in '07 is approximately $53 million. That addresses that. So you can see what there is, that's what is occurring there.

Michael Burns

As far as our participation, Tom, is that the vast majority of the deals that we make with talent in our motion picture business are back-end loaded. Meaning that only on success do we have significant participation.

What happens is, your question is interesting whether we could offset that with a film fund. It depends on the structuring of the film funds. A couple of them we are looking at would P&A only, some could be part production and part of P&A.
So we could take a look at.

Jon Feltheimer

But that's not the main reason to do the fund. The main to do the funds is frankly to shift risk. That's the bottom line, we would only do it if we see ultimately that it's improving our risk/reward profile without hurting our margin significantly.

Tom Eagan – Oppenheimer & Co.

I guess I was trying to find a way to increase the margins by lowering the participation percentage. If you could do that by shifting it towards an upfront cost. I understand it's difficult.

Regarding amortization, looking at fiscal '06 versus fiscal '07. How much do you think the fiscal '06 titles were over-amortized because of the loss of the titles?

Jon Feltheimer

What you really mean is how much the accelerated amortization over time will we be carving back and end up being earnings? I don't know Jim, do you have that broken out?

Jim Eagan

What we refer to as the NRVs or write downs, we had $16 million of NRVs in my fiscal '06 numbers. So that's where we just wrote down the film cost because we said the value of the upcoming revenues and cost is not enough to support the carrying value. So that was $15 million. In '07 we do not anticipate -- I hope there isn't much of that, if that happens again.

Jon Feltheimer

How much of that may come back to us in '07?

Jim Eagan

It's about $6 million; we think we may have some NRVs. The amount that will come back to us next year, I'm going to say it is $15 million to $20 million, it's big because we took the NRVs then and then as the [inaudible] and the in the mix perform next year on the pay TV revenues and there will be additional video, so it is $15 million plus.

Jon Feltheimer

Offline you can certainly talk to Jim specifically about it.

Tom Eagan – Oppenheimer Funds

Okay. Thank you.

Jon Feltheimer

All right. Well, thank you all very much for joining us.

Operator

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