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Executives

Kellie Nugent – Director of Investor Relations

James W. Keyes – Chairman of the Board & Chief Executive Officer

Thomas M. Casey – Chief Financial Officer & Executive Vice President

Analysts

[Tony Weibel] – JMS

Stacey Widlitz – Pali Capital

Richard Ingrassia – Roth Capital Partners

Arvind Bhatia – Sterne Agee

Karru Martinson – Deutsche Bank

Marla Backer – Research Associates

Emily Shanks – Barclays Capital

Charles Wolf – Needham & Co.

Analyst for Carla Casella – JP Morgan

Blockbuster, Inc. (BBI) F4Q08 Earnings Call March 19, 2009 4:30 PM ET

Operator

Welcome to Blockbuster’s fourth quarter and fiscal year 2008 financial results conference call. (Operator Instructions) I will now turn the call over to Kellie Nugent, Blockbuster’s Director of Investor Relations. Please go ahead.

Kellie Nugent

Thank you participants for joining us today to discuss Blockbuster’s fourth quarter and fiscal year 2008 financial results. With me on today’s call are Jim Keyes, Chairman and CEO and Tom Casey, Executive Vice President and CFO. As the operator mentioned, this conference call is being recorded. It is also being broadcast live in VOIP mode over the Internet and may be accessed within Blockbuster’s website at www.blockbuster.com.

After the market closed today, Blockbuster issued a press release regarding its financial results for the fourth quarter and fiscal year ended January 4, 2009. By now everyone should have access to the press release and the financial tables. However, if you do not they are available via the company’s Investor Relations website at investors.blockbuster.com.

Please be advised that matters discussed in today’s teleconference contain forward-looking statements relating to the company’s operations, business outlook, financial and operational strategies and goals including expectations regarding the company’s financial performance in 2009 and other matters that do not strictly relate to historical or current facts. These remarks fall within the meaning of the Private Securities Litigation Reform Act of 1995. We caution you that such statements are in fact predictions that are subject to risks and uncertainties that could cause actual events or results to differ materially.

Additional risks and uncertainties that could cause actual results to differ materially from these forward-looking statements may be found in the company’s filings with the Securities and Exchange Commission including our upcoming form 10K. Forward-looking statements are based on the company’s beliefs as of today, Thursday, March 19, 2009. Blockbuster undertakes no obligation or responsibility to publicly update any forward-looking statements for any reason except as required by law even if new information becomes available or other events occur in the future.

Additionally, in the company’s press release and during this teleconference management will discuss certain measures and information in both GAAP and non-GAAP terms. A reconciliation of GAAP to non-GAAP is provided in the financial tables following the text of the release.

I will now turn the call over to Blockbuster’s Chairman and CEO, Jim Keyes.

James Keyes

Thank you Kellie and good afternoon everyone. Thank you for joining us today. To begin there are three key items that I would like to highlight. First, we are very pleased to report that we have reached an agreement with JP Morgan and two of the largest holders of our $350 million revolving credit to amend and extend that credit facility through September 30, 2010. The commitments from these lenders represent about 65% of the expected aggregate principle amount which will be approximately $250 million. We are working towards funding of that agreement within the next 60 days and we will file our 10K no later than April 6 to allow time to complete this financing.

It is likely that our financial statements and our auditors report will include reference to going concern risk until our financing is complete our liquidity is assured. Management is committed to doing everything in our power to preserve and to grow shareholder value. We have been working hard to replace this revolving credit facility and what we found is that the high cost of funds in today’s credit markets has indeed created a challenge. We are confidence, however, that the company has adequate liquidity within the existing facility to allow us the time necessary to explore every possible source of existing and new funding to achieve the lowest possible cost of capital.

The proposed refinancing plans will not be inexpensive but are designed to provide the liquidity necessary to continue our business transformation.

The second key point is that Blockbuster is a cash machine. Over 20 million customers each month choose Blockbuster for their family entertainment needs and we are indeed a high volume, small transaction business offering great entertainment value to the mainstream customer. We are not a highly levered company, less than three times EBITDA, with free cash flow before working capital of about $110 million in 2008 which facilitated our expansion into retail games and movies to diversify our store offerings.

The third key point is that Blockbuster is a vital distribution channel for the entertainment industry and in particular the movie studios who receive over $1 billion in domestic revenues from our nearly 40% share of the video rental industry. The studios have a strategic interest in our success as do others in the entertainment industry. For game companies, for example, Blockbuster represents one of the strongest distribution channels for growth.

I am pleased to report renewed focus on the core rental business and diversification into retail, movies and games led to a successful turnaround in the business in 2008. Amid a challenging retail environment Blockbuster was able to increase domestic same store sales by 6.4% achieving positive full-year same store sales for both domestic retail and rental segments of our business for the first time in eight years.

Additionally, we achieved adjusted net income of $79.3 million during the year and achieved adjusted EBITDA of $319.1 million, exceeding our raised guidance range of $300-315 million and representing an increase of almost 77% year-over-year. In addition to these financial achievements we made significant progress with our efforts to transform the stores into full-service entertainment destinations.

We remodeled some 600 domestic locations including the installation of new concept prototypes. We launched an aggressive Blue Ray offering including rental and retail movies and Blue Ray players and we significantly increased the number of new products and services we offer including event ticketing, games, consumer electronics and licensed merchandise. As a result, key domestic store operating metrics improved year-over-year with, for example, revenues per store visit up 14%, gross profit up over 1%, paying customers per store up 1%, total net revenue per square foot up 7.2% and net paid rental rate improving some 6% from $3.53 in 2007 to $3.73 in 2008.

We believe these results demonstrate the viability and sustainability of our business model and it encourages our strategy to focus on the continued diversification of our business. In 2009 our three-pronged strategy will remain:

One, focusing on our rental business with improved pricing and in-stock availability. Two, expanding our retail offerings though with lower working capital through improved inventory management and the use of consigned product. Three, pursuing digital opportunities, although pursuing those through collaboration and alliances that require little investment but leverage our brand equity.

A few of the plans behind these strategies include: One, introducing new consumer friendly pricing which is called Choose Your Terms. It is an offering already in about 600 stores and we plan to roll it out to all corporate stores over the next few months providing the consumer value of new daily rates alongside the convenience of weekly and monthly offerings. A second program that we have is enhancing our loyalty. Blockbuster Rewards, our in-store loyalty programs today have six million members and we plan to keep these members and add new customers through the introduction of new benefits that will reward them as they shop with us in store, online and through digital download, rental and retail.

Blockbuster being a multi-channel retailer has the unique opportunity to offer our customers the full diversity of offerings and loyalty programs to accomplish that. Another initiative is to improve our by-mail offerings. We have enhanced the Blockbuster.com website, improved the service by enhancing features such as eliminating due dates from in-store exchanges, etc. and recently announced that we plan to offer by-mail game rentals making us the only online service to offer both movies and games.

Next we are expanding our digital offering through Blockbuster On-Demand. We continue to work to make Blockbuster branded content widely available on connected devices through smart partnerships with device manufacturers and through service providers. We have recently announced alliances with companies like Sonic Solutions, Cinema Now, Two Wire, etc. and we are working on providing compelling, cinematic digital solutions for our members through a number of these strategic alliances with more to be announced in the coming weeks and months.

More strategically we are licensing our international assets outside of North America. We continue to proactively pursue the disposition and licensing of our international assets and believe this strategy will allow the company to redeploy capital and reduce our debt while still retaining our brand presence across some 20 countries. One target for the redeployed capital will be debt reduction and once our cost of capital returns to a more normalized level our store remodel plans. We are pleased with the testing of new store concepts and in Reno, for example, where we introduced a Blockbuster media brand and remodeled all of the stores in the market with a new look and diversified product offering our rental revenues are up 8% and our total net revenues up 11% with active members up 6%, all versus control.

Very exciting progress in the diversification and continued improvement in Blockbuster. We are glad to be able to announce progress in our refinancing to get us back on track with our strategic initiatives and in summary, as I mentioned at the opening of the call we believe that our 2008 full year results demonstrate the viability of our core rental offering and underscore the progress we have made to diversify the company into the multi-channel provider of media entertainment.

Beginning in 2007 and for most of 2008 we operated the business for growth but in light of this macro economic environment and the constraint in the capital markets we believe it is prudent to adopt a slightly different posture with regard to growth and investment opportunities. As a result, we will expect somewhat lower revenue comparables this year. However, we plan to post strong EBITDA results. Tom will talk a little bit further to those expectations and provide some guidance for 2009.

With that let me hand the call to Tom Casey for a more detailed review of our refinancing and our quarterly review of financial results. Tom?

Thomas Casey

Jim touched on the highlights of the refinancing and we will be filing an 8K shortly with more detail so I will focus on the fourth quarter results and 2009 guidance and move quickly to Q&A. Starting with the top line, worldwide same store revenue increased 3.7% and total revenue declined 11.6% principally due to the 53rd week in 2007 and the strengthening of the U.S. dollar as well as the decline in our by mail business.

Consolidated revenues were also impacted by the closure and sale of 167 company operated stores. Gross profit for the fourth quarter was $682.3 million compared to $797.1 million in the same period a year ago. There again, the 53rd week in 2007 caused the decline along with the strengthening of the U.S. dollar. Excluding those effects gross profit dollars were about flat.

Operating expenses increased to a little over $1 billion because of a $435 million non-cash charge for the impairment of goodwill and other long assets. Every year we compare the cumulative value of our operating segments, both domestic and international to the equity value of the company. Because the stock has been severely depressed over the past several months we had to write down our goodwill which I mentioned during the third quarter conference call.

G&A decreased $118.7 million to $524.2 million from $642.9 million due to aggressive cost cutting. Advertising expense for the fourth quarter totaled $27.2 million representing a 22.5% decrease compared to a year ago. Fourth quarter EBITDA was $130.9 million representing an increase of $11.8 million compared to $119 million during the fourth quarter of last year and adjusted EBITDA for the fourth quarter was 136.2, basically flat year-over-year.

Regarding the balance sheet, Blockbuster ended the fourth quarter 2008 with $140.9 million in cash and cash equivalents. Cash provided by operating activities during the quarter increased $6.9 million to $152.1 million as compared to $145.2 million in cash from operating activities from the same period a year ago.

On March 11, we accessed our available borrowing capacity of $60 million in principle amount of the revolver as a precaution against prevailing economic conditions and ongoing uncertainty in the credit markets and as a cushion in the event that we require incremental capital in the coming months to meet typical or unanticipated working capital for general corporate and operating needs.

Turning to 2009, I will take a moment to provide an update on the buckets of our cash maximization plan. First, during 2009 we intend to further reduce G&A by over $200 million. This excludes the effects of foreign currency exchange rate changes and inflation. The ongoing cost reductions will include a reduction in company wide compensation, lease cost savings and outsourcing initiatives. As we have discussed in the past we incur annual domestic lease expense of approximately $400 million. We are working with KPMG and our landlords to reduce occupancy costs and keep store closures at a minimum. We are generally pleased with the landlord response to date but much more work remains to be done in the coming weeks.

Consistent with developing a presence in a new business segment in 2008 we added approximately $90 million in merchandise inventories. We ramped retail products including games, confection, licensed merchandise and consumer electronics. In 2009 we plan to reduce inventory while preserving our retail initiatives.

In CapEx we reduced CapEx by $80 million from 2008 while preserving investments in our POS servers, event ticketing kiosks and nominal store maintenance and we will defer major renovations such as Rock the Block. So for the majority of 2009 we will keep CapEx and maintenance level in a range of $30 million.

So as a result of our focused efforts to reduce costs and maximize cash in 2009 we believe we will experience somewhat lower total revenue comps but solid year-over-year adjusted EBITDA growth to the range of $305-325 million. This corresponds to a GAAP financial measure of operating income of $164-184 million and net income in the range of $40-60 million.

With that I will pass the call back to the operator who will facilitate the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of [Tony Weibel] – JMS.

[Tony Weibel] – JMS

I was hoping you could comment on what happens if that last lender does not renew and do you reserve the right to self pay down some of the debt?

Thomas Casey

We are moving forward with a $250 million program that we expect to complete in the next several days. I think it would be inappropriate to speculate on what happens if we don’t get the full $250 million. I think it is noteworthy that our current revolver size is $350 million and we are stepping down to $250 million. It is our belief that is adequate to meet the liquidity needs of the company.

James Keyes

We might also add that all of the existing lenders don’t have to participate because of the reduction in size of the facility so we think this allows some of our lenders who may need to exit the facility for one reason or another to be able to leave and have others either step up or stay in.

[Tony Weibel] – JMS

What happens if the going concern language is included from the auditors as you talked about? Can you step us through what you can do to work on that?

James Keyes

The most important thing for us is to talk to all of our stakeholders and make sure they understand where we are which is aggressively what we will be doing. We have been doing that all along. We have been spending a lot of time with the studios and our various suppliers making sure they are completely informed and comfortable with our liquidity position. We think that frankly there will be a lot of companies in a similar situation receiving opinions of this sort and given the tightness of the credit markets these days we are not going to be alone. We think that people will be taking them very seriously but also hopefully looking beyond to the liquidity situation of the company. As we referenced before we are very comfortable with where we have been, felt that we had the time to take the time and frankly we are mostly concerned about the cost of capital. We want to be sure we get the best facility in place that allows us the best cost of capital for the balance sheet going forward.

[Tony Weibel] – JMS

With regard to the current rental trends, how much of the decline in the domestic rentals are because of the title strength versus any other secular drivers out there or competitive drivers?

James Keyes

I was anticipating that question. I think this says it all. Number one, we think the single biggest driver in the current marketplace the last few months has been title strength and this week is a classic example. Box office is down 56% this week versus the previous year. I think the titles say it all. This week we are proud to offer Punisher, War Zone and Elegy which are good movies but stacked up against last year’s Enchanted, Atonement and I Am Legend. I think that kind of says it all. We have been facing this the last couple of months. Good movies but not great box office hits that we have had. At the same time we have seen unprecedented theatrical strength. As you know this is great for our business in about three months. When it is going on it represents a draw in particular on Friday and Saturday nights for those people who decide to go to the theaters so see Slum Dog Millionaire, Watchmen, Paul Blart Mall Cop and so that has had an effect on us for the first quarter as well.

Operator

The next question comes from Stacey Widlitz – Pali Capital.

Stacey Widlitz – Pali Capital

If you could just maybe help us understand you did close to 320 in EBITDA in 2008. You are talking about $200 million in cuts for this year yet your EBITDA guidance is about flat. If you could just help us maybe connect the dots. Are you looking for maybe a much more conservative inventory position that might hurt comps because you are being conservative? What is the real disconnect there? Then if you could also maybe comment on if you are seeing less revenue sharing deals become available to you because of the current financial situation or if there has been very little response from the studios?

James Keyes

I’ll give you a high level explanation and then Tom can give you a bit more detail. From 40,000 feet we are in the middle of a refinancing. We want to put together the most conservative case possible for our lenders. Given this marketplace we wanted to be sure that we could pound the table and achieve these results. The one thing you can count on is cost reduction. We can proactively reduce costs. What you can’t count on is top line growth. So we presented a case that allowed us the liquidity necessary to meet our obligations through those proactive measures that we could take. Now as the year progresses I can assure you our plan is to get back to focus on top line growth and we will be investing as liquidity allows in additional advertising and additional store level initiatives. The net of this is that we believe we have presented a conservative case by reflecting lower comps and a more aggressive cost management plan because it is more controllable. Tom would you like to add to that?

Thomas Casey

I think that is the right answer. The good news about our capital structure and our cost structure is that it is controllable. $200 million of cost is less than 10% of our SG&A. It is balanced across all of our operating costs and is in our control to execute on if top line would be soft, as Jim highlighted.

Stacey Widlitz – Pali Capital

How far are you into, you talked about plan B if you couldn’t get financing. Are we already well into plan B just in case or where do we stand there if you could comment?

James Keyes

We wanted to be prudent going in. Financing was not assured and is not assured. We wanted to make sure we had done all of the controllable things that could be done. Mostly what we have sacrificed is growth of retail so we have pulled back on inventory but mostly retail inventory for only the first quarter as we try to get our refinancing plans in place. We have been relatively aggressive in finding cost reductions in other areas. Lease costs for example, this just represents in this economic environment frankly a great opportunity. We have some $400 million in lease expense and so to set out to renegotiate every one of those leases one by one to accomplish what would be let’s say a 10% reduction if we were able to accomplish a 10% reduction it is a $40 million savings. In that $200 million are those kinds of things.

Primarily non-consumer facing opportunities like rent reduction that allow us to just become more efficient and use this economy to leverage our opportunity to cut costs.

Operator

The next question comes from Richard Ingrassia – Roth Capital Partners.

Richard Ingrassia – Roth Capital Partners

If the revised facility is going to be at 65% of principle, how much can you say of Q4 and Q1 free cash flow will go to pay down the remaining near-term debt including the term loan that is due in August?

Thomas Casey

How much? Well, how can I answer that. First, just to level set everybody we have obviously fourth quarter and first quarter of the year are the cash generative quarters of the year. We are not giving guidance for the first quarter but you can see the cash flow that we generated in the fourth quarter of the year. The $152 million cash from operations. Then if you look at what is coming due this year, the first quarter is about $43 million of total amortization payments. It includes an excess cash flow number to the term of about $25 million. $8.6 million of amortization. You basically have $78 million of amortization payments in fiscal 2009.

Then we have obviously the revolver coming due in August. So those are the numbers you need to think about.

Richard Ingrassia – Roth Capital Partners

Jim, maybe you can just dive a little deeper in your strategic intent of expanding sales of non-core products in stores because some will look at your efforts to sell consoles for example and say it is going to be difficult for you to compete with Amazon or the big box retailers there. Similarly to capture more gamers versus Game Stop, etc. Give us your thinking of your strategy overall at the store level.

James Keyes

The whole point is that we don’t intend or have to compete with Amazon or Best Buy or anybody else for game consoles. The idea with Blockbuster is the convenience, the impulse shop. We have very thin inventory. We will carry one or two deep in the game console and 3-4 SKUs and the idea is if someone buys their game console with us there is a greater likelihood they will also buy their games with us and stay with us. Perhaps buy their accessories and we can make a little money on that. So it is not that we see this as a terrific profit opportunity as much as it is sort of a convenience opportunity or a consumer loyalty opportunity to keep all of their business in house with Blockbuster and that was our intent. On the game side though it is a bit of a different approach. When it comes to gaming we think the trend in gaming is towards more casual gaming. That is the suburban soccer mom that is already in the store today getting her movies also stopping by the game section and renting or buying Guitar Hero, Rock Band, perhaps Wii Fit. These games really fit, this new generation of games that is much of a broader demographic is much more consistent with the Blockbuster customer. We think that is a great opportunity.

It doesn’t cause us to necessarily go head to head with Game Stop because of the uniqueness of our offering. Our rental model versus the trade in model is one that we think will appeal to the mainstream consumer who doesn’t want to get into the trading business necessarily but perhaps would like to rent a game for their children to try. At $60 a throw I think I would prefer to have my kids try a game for a couple of weeks before I actually buy it for them. This is the model that we are presenting to consumers as a value proposition at Blockbuster.

Richard Ingrassia – Roth Capital Partners

On competition, if I were to say that the amount of marketing pressure you applied in the DVD by mail business in 2008 was say a two on a scale of 1-10, what would you say it will rank in 2009?

James Keyes

The good news in our by mail business is we have finally found a way that we can achieve profitability in the business and satisfy our customers. We think we have got a great consumer proposition, a unique consumer proposition and the opportunity to exchange in store as a Blockbuster by mail customer myself I can tell you I never want to see the movies that come by mail. When they come in the mail I always want to take them down and change them out for something I really want to see because I am a terrible planner in advance. We think that consumer proposition is compelling and will allow us to grow the business. We had a lot of work to do last year to fix the business and fix the profitability of the business. Things I mentioned earlier when someone brought in an in-store exchange, for example, we had that exchanged product subject to the terms of the store so they brought it in for an exchange and they had to return it in two days. Now we are letting our customers have the ability to let our customers treat that exchange as if it was a by-mail copy. That is a great service.

We traded that off with other things like we were too generous in some cases in allowing our customers to exchange a movie in store and then immediately trade our [cues] so at any given time our customer could have had six copies of movies outstanding. That is a very costly proposition. It literally costs us twice as much to serve the same customer as Netflix. As result by modifying some of those programs we are able to put some of our resources in place to better satisfy the customer.

The net of all this is we feel we are positioned to be able to grow that by mail business. We don’t know what the cost of that growth is because frankly we don’t know how big that mark is and we don’t want to try to aggressively steal share from Netflix. We think that would be an expensive proposition. There will be better places to deploy our cash. On the other hand to the extent we can grow that business organically by finding other places to fish and by leveraging the unique points of differentiation with Blockbuster’s ability to exchange in-store we think there is a great opportunity to expand that business in 2009 and hope to be able to report on promising results as the year continues.

Operator

The next question comes from Arvind Bhatia – Sterne Agee.

Arvind Bhatia – Sterne Agee

First of all can you talk about the CapEx and the free cash flow estimates for 2009 that correspond to your guidance on EBITDA? Then I recall back in December you had mentioned the revolver need would be something in the $150-200 million range. What you are talking about now is about $250 million. Help me understand kind of the delta there. Lastly, you talked about Q1 slate. I wonder if you have any more insight into Q2 at this point given where we are.

James Keyes

I’ll start with the last question and then turn it over to Tom for the first question about CapEx and free cash flow. As it relates to our funding and revolver needs, we talked about a more aggressive plan of self funding when we talked in the third quarter up to a reduced need of perhaps $150-250 million. That scale from complete self funding up to $250 million depends on how draconian you want to approach the business. If you really wanted to aggressively divest the assets, if you wanted to aggressively close stores, very aggressively trim costs and reshape the business you could be on the lower end of that scale.

The $250 million case says that we are not necessarily going to be aggressive in growing the retail side of the business for example. We are going to try and grow retail through more consignment and more collaboration. We are not going to invest heavily on the digital side of the business this year. We will do that through more partnerships for example. If we do those kinds of things we believe we can continue the transformation of the company with $250 million and not be quite so draconian. Even though $200 million cost cut sounds harsh, as Tom said it is only 10% of our total SG&A. So it is not really that severe in the grand scheme of things.

Tom would you like to go over the question of free cash flow?

Thomas Casey

On cash flow I am glad you asked the question because it is important to understand. As Jim said the company really is a strong cash generator and cash machine. If you just go through a calculation of EBITDA less CapEx less interest and taxes the way I would guide you to that is take the mid point of our guidance for 2009 at $315 and subtract our maintenance CapEx at $30. Then round our 2008 interest to 75 and then take off our 2008 tax which is mostly international tax at 25 it is $185 million of free cash flow which is a terrific number relative to our debt.

Arvind Bhatia – Sterne Agee

Jim, how about the movie slate in Q2?

James Keyes

We are pretty excited about the second quarter slate. We have things like Slum Dog Millionaire, Paul Blart, Watchmen, Just Not That Into You, although I haven’t seen that myself, Yes Men. There are some great titles coming out. Really the key to the second quarter as we have said we were a bit more conservative in the first quarter by design. But I will call your attention to what happened in 2008. The results in 2008 in our per same store retail and rental it was driven primarily through our inventory position, our in-stock position which was a significant change. As you know we had it up to 60-65% in stock which still is wildly short of what it should be for a retailer. We should be striving for 100% in stock. That ability to get in stock in 2008 we carried on our backs largely. The studios helped us and supported us but we bore a lot of the costs for that. Our working capital increased pretty significantly for both movies and games as we diversified into retail offerings in movies and games and filled the shelf for rentals.

For us to continue back on that growth trajectory we are going to have to be in stock back at that 60-65% level or ideally to push it even higher more towards 100%. We are very actively working with the studios and with the game companies to be the ultimate retail consumer as their customer not Blockbuster. As long as we are the customer and we are buying content from that studio or from that game company then the ultimate retail consumer may not get what they want because they may be out of stock. We would have to manage inventory based on what we can afford. If we can fill the shelves the studio will benefit, the game company will benefit, Blockbuster will benefit. Why? Because ultimately the retail customer is going to be always satisfied with in stock availability of their favorite movies and games.

That is what we are striving for. We are having great conversations with the studios and the game companies. I am very thankful for the year 2008 to have been able to demonstrate that this really does work. It creates a win-win for both the studio and the company and hopefully you will be seeing more. In a nut shell, sorry I know a long answer but the simple answer to the results in Q2 will depend on the continued support and cooperation of our studios and our game providers to be able to keep our inventories in stock.

Arvind Bhatia – Sterne Agee

Would you venture a guess on same store sales trends in Q1 and Q2? The first half if you will? Do you think rentals domestically could be flattish or we should be thinking more along the lines of Q4 against the economy, etc?

James Keyes

I have already said the first quarter you should expect a little bit of softness versus our trends last year because of both the movie slate, far superior theatrical performance in the quarter, and our efforts to be a bit more conservative to manage our cash position during the quarter. The second quarter really we have the title slate to be able to do very well in the second quarter assuming that we are able to get back on track with full shelves of both rental and retail. Then it is safe to assume we will be able to get back on track with positive sales trends as well.

Arvind Bhatia – Sterne Agee

How about the kiosk business? Obviously we are seeing Red Box’s everywhere. They are growing rapidly now and other competitors. Are you starting to take advantage of kind of your own test to conclude you want to be in that business? Just help us understand how your strategy with respect to that particular type of business.

James Keyes

We actually like the vending business. We are glad our friends at Red Box proved it out. It is a good consumer proposition. We think we have a unique opportunity. It is similar in a sense to Netflix. If you think about the Netflix opportunity versus Blockbuster our uniqueness is our ability to go multi-channel. To say get it by mail, exchange it in the store. You have always got what you want. The same thing applies when it comes to our unique opportunities in vending. If we make a vending model successful we can actually fill our shelves with greater quantities and use some of that excess inventory to replenish our vending kiosks that are in the vicinity of the store. We can even use our store labor to replenish more quickly so that you are never out of stock on the preferred titles.

That is an opportunity we are testing presently. We have partnered as we said before with NCR. NCR has publicly said they are planning to be very aggressive with us in their deployment of units so you will see us as the year progresses providing what we think is a superior offering with greater unit capacity, hopefully a broader selection of titles and our units frankly will be deployed with an eye to the future with digital download capability. Hence the importance of our relationship with NCR as a technology partner.

Operator

The next question comes from Karru Martinson – Deutsche Bank.

Karru Martinson – Deutsche Bank

When I look at the next step here we have the extension on the 23rd. Hopefully we get the filing of the 10K on April 6 but we are going to have the need for a waiver. What is the timeframe that you need to get that waiver completed?

Thomas Casey

It is before we file the 10K over the next let’s say by March 27 or so.

Karru Martinson – Deutsche Bank

So there is no kind of grace period. It has to be done no later than April 6 when you would file the 10K?

Thomas Casey

There is a grace period. If for some reason we were not to be successful in the amendment there is a 30 day grace period following notice of event of default.

Karru Martinson – Deutsche Bank

You need to get that waiver from the term loan holders, correct?

Thomas Casey

From the holders of the credit facility.

Karru Martinson – Deutsche Bank

That is a simple majority, correct?

Thomas Casey

That is correct.

Karru Martinson – Deutsche Bank

You said you had $60 million drawn on the revolver. I was wondering if you could kind of give us a liquidity update on how much cash you have right now as you go into these negotiations? Where do you stand?

Thomas Casey

I didn’t say $60 million drawn. I said drew which was the available capacity under our revolving credit facility as of March 11. We did that as a precautionary measure as I stated earlier. We don’t disclose cash balances and debt balances through the quarter but I will just tell you that we have adequate liquidity together with the reduced revolver size to fund the business.

Karru Martinson – Deutsche Bank

When we look at the dispositions you talked about is there a time table for perhaps exiting some of these countries where you are targeting the license? What is the size and scale of that?

James Keyes

Time table is as quickly as practical. I want to emphasize though this is not a fire sale by any means. We are not putting these assets up for sale and selling them to the highest bidder or first comer. Our ideal strategy here is to find good business partners and we have actually marketed it in that sense. So what we are looking for us as an example a cable company, a telecom company in country looking for retail presence to supplement their existing retail presence but also looking for a branded video on demand service which we can offer via Blockbuster On Demand. We think that our delivery capabilities in many cases will be superior to some that those partners in country could have and our vision for this is to be able to make the Blockbuster brand which is already recognized across already 20 countries to be able to make that brand transform into a digital offering perhaps a superior video on demand offering and find that kind of partner in country that will not only allow us to redeploy the cash from that country but also provide a continuing revenue stream through royalty payments going forward. And provide the capital necessary to grow the brand in that market. It is an ideal scenario. It is one I have great familiarity with in my previous role with 7-11 we were very successful with international licensing as a vehicle for better deploying assets in other countries and I think in this case it works exceptionally well.

The only hold up in terms of timing are these credit markets and the challenges that everybody faces in raising the capital. I can assure you we have had interested parties. We have had offers for several of these businesses that we have entertained. Those offers are a bit more challenged now as those companies also look at their balance sheet and are waiting out these credit markets or trying to deal with the higher cost of capital today. So the timing really is hopefully during this year we will see some action on some of the markets and if we get improvement in the capital markets we could see action in all of the markets.

Karru Martinson – Deutsche Bank

Just to segue from there into the digital library side, what are you seeing in terms of that business? Have you grown that library? Have download rates increased? What is the outlook there?

James Keyes

We think it is a great future business. It is very, very slow in its early stages and I don’t think we are alone there. I think even though we are hearing a lot about the continued development of product in customers with Apple, Amazon, Netflix, etc. it is still relatively a small market. I think the projections, Adams research for example is projecting the video on demand business including cable video on demand which by far dominates this number to be about $2.5 billion in 2011. A very small portion, less than $500 million of that would be attributable to the digital video on demand as in Blockbuster On Demand. So still very small. Very exciting though. We are in a very unique position to transform our customer’s longer term. We do plan, as I mentioned in our loyalty program to offer incentives to our customers both in store and by mail to participate in digital downloads. We will be baking Blockbuster On Demand into a lot more devices in the coming years.

Operator

The next question comes from Marla Backer – Research Associates.

Marla Backer – Research Associates

Are there any other opportunities, you announced a few months back a deal for live event ticket sales within the Blockbuster stores and I think a big driver of that deal as you said at the time was to drive store traffic. Are there any other potential partnerships or licensing deals that you see down the road to further that strategy of driving store traffic?

James Keyes

There are. We are only limited by our imaginations in the ability to do this. We are pursuing a number of those kinds of opportunities. I will give you a couple, or one small example. The Texas State Lottery for example has gone to their own vending concept where they are making it easier for retailers so retailers don’t have to bog down the check out lines. It actually is a very slow process if you are waiting behind three people getting lottery tickets on Saturday night. So they have created a vending machine. It is a stand alone unit. We are actually talking with them about deploying those in Blockbuster stores. That would provide that extra footfall traffic of people that know we are in the lottery business.

In Reno we are testing very successfully the fountain business. The opportunity for our stores to provide both cold and hot beverages in a self service format has proven to be very popular in those Reno stores. It is another opportunity again to partner though with somebody else. Both of those opportunities are examples of how we like to go forward if we can partner with the Lottery Commission and let someone else deploy the capital for these vending machines in our stores that is a good traffic builder without our expense. If we can partner with a soft drink company to provide fountain equipment at their capital expense and then share the revenue and we will build traffic and take a smaller piece of the margin opportunities by enhancing the traffic capabilities of the stores.

A couple of examples. Lots of opportunities.

Marla Backer – Research Associates

Getting back, one other question on the same store comp on the rental side. Intuitively it would seem in this kind of economic environment there would be a substitution down towards rentals and away from higher ticket entertainment options. Are you seeing anything within the store to suggest that once the title slate improves you will actually benefit from that kind of a trend?

James Keyes

We have the same assumption and we went back historically to our data and external data to see what happens during recessionary periods. 2000, 2001, we went back to the 1990’s and we went back to the 1980’s. There seems to be a common pattern here. It would appear based on the previous trends that the initial reaction of the consumer is actually the opposite. The customer takes awhile to rediscover the value of renting. So the media actually we are already seeing at retail particularly in the numbers that have been quoted industry wide customers have slowed down their retail purchases of DVD’s. What we are seeing on the rental side is customers who used to rent four and maybe only watched two now are more likely to rent just the 2-3 they know they are going to watch. So we are seeing the average rental per transaction slightly soften.

What we have found historically though is that the longer the recessionary period the greater the improvement in rentals. What logically that would indicate is it does take a while for customers to rediscover that rental is a great value. We are trying to help that along. Our new pricing initiative offers a daily rate that in all of our testing last year was perceived to be a price decrease, a significant price decrease in the eyes of the customer so we think they will respond very favorably to the value of rental especially with this new pricing program that we will be putting on the street.

Marla Backer – Research Associates

Where do you see the industry right now in terms of market share shift? Do you think that mom and pops are suffering greatly in this kind of an environment? Do you think there is some exiting by them? Are you gaining market share or do you think that things are relatively stagnant on the market share front right now?

James Keyes

My guess is that we gained market share last year. We saw rentals increase and we were pleased with the overall trends in spite of fewer stores. I would guess that the mom and pops are under quite a bit of pressure. There are new entries into the market place. Netflix has continued to grow. They do quite a good job obviously in their offering and Red Box has grown very aggressively on the vending side so there will probably be some market share shift. We are not overly alarmed by that as it relates to Blockbuster because as we continue to diversify the store we intend to less rely on core rental business over time and frankly there is some positive that comes out of this as vending expands and as Netflix continues to grow it increases the awareness and popularity of DVD rental movies and we think the overall tide can rise for everybody.

So probably see a shifting in the marketplace. We think that the mom and pops are more likely than the larger players to suffer in this environment and the larger players to the extent we can all find unique ways to differentiate ourselves will continue to thrive. It is still a very fragmented industry.

Operator

The next question comes from Emily Shanks – Barclays Capital.

Emily Shanks – Barclays Capital

I was hoping you could comment around what your success has been around these reductions. Have you made any progress on that yet and how are your landlords responding thus far?

James Keyes

I cited some facts that are pertinent to that process. We have approximately $400 million a year in domestic rents with a remaining lease term of 2.5 years. So that is a good set of facts to go forward with in this market place. I would say we are pleased with our progress so far and we have a group of 30-40 people working on that and they have been working since January. I will leave it at that. We are pleased with the progress and it is an important opportunity for us.

Emily Shanks – Barclays Capital

So is it fair to say you are still basically in discussions with all of these landlords?

James Keyes

Of course. Yes.

Emily Shanks – Barclays Capital

Just to be clear around the commitment from JP Morgan and the two other lenders for, it sounds like if I am doing my math right, about $162.5 million. Are those signed commitment letters that you have?

James Keyes

Yes.

Emily Shanks – Barclays Capital

Can you speak about what your expectation is for proceeding on that revolver?

James Keyes

No. Not at this point. As I referenced earlier there will be an 8K filed tomorrow that will have more details on the financing but it wouldn’t be appropriate to comment at this time.

Emily Shanks – Barclays Capital

Do you have amendments or consents in hand from those lenders for the waiver of the going concern qualification?

Thomas Casey

That would be part of the amendment process.

Operator

The next question comes from Charles Wolf – Needham & Co.

Charles Wolf – Needham & Co.

How big is your installed base of by mail subscribers now?

James Keyes

We haven’t been disclosing the by mail subscribers because we really don’t segment any longer only by mail. We have in store subscription, by mail subscription, we are working on digital subscription and so we haven’t been reporting that for awhile. It is safe to say it has declined slightly from the last reported number. I cant remember what we reported last, a couple million a little over two million subscribers I guess was the last reported amount. It has declined slightly from previous levels as we have basically tried to manage it for stability. Until we fix the core business proposition and the systems supporting it.

Charles Wolf – Needham & Co.

In the past you have discussed the various rental pricing schemes that you have put in place to get the ASP’s up. I was wondering if you could discuss what you have learned from that and what you are doing now. I noticed you did mention you had a dollar a day or some price like that, one scheme, but what other ones are you employing?

James Keyes

What we have found is two things. The customers respond very favorably to daily rates. That is encouraging for us because the old model frankly allowed our customers to rent a movie for two days and keep it for 30 with a nominal charge, a $1 charge for a restocking fee. The daily rate is perceived by the customer, we are delighted to find it is perceived by the customer as a significant reduction in price and since the rules are clear the longer they keep it the better it is for us and it provides flexibility for them.

In our case we were a little concerned about going straight to a daily rated because of the baggage that the company has had historically over late fees. Frankly we didn’t want people to feel that we were going back to a late fee. It is not at all punitive when you look at a straight daily charge. So to temper that concern over daily rates that some customers may have, we offered a weekly rate. So instead of the old 2-3 day rental we bumped that up to 5 days and let customers keep it for a full week. So what you will see us roll out is this program we call Choose Your Terms that really offers our customers three ways to rent their movies. They can get it by day, which is a great value if you plan to return it tomorrow. They can rent it by week if you want the convenience of keeping it for awhile. That is particularly applicable to video games for example. You wouldn’t want to rent a game for one night you would want to rent it for a week. Or you can have the by month subscription and some of our customers prefer the flexibility by month.

That program is what we have deployed now in some 600 stores and as we speak are rolling out to most of the rest of the system. What we have found is it drives traffic. It drives transactions in our stores which is very encouraging and something we haven’t seen that kind of growth in transactions for quite some time. It also helps in our inventory balance because frankly one of the things that caused us to be out of stock in the last few years was that we were so liberal in our policies with our no late fees customers kept our new releases too long. So with the daily rate they bring it back on an average of two days or less and that allows us to have to buy fewer copies to fill the shelves and keep the shelves full.

All of this is very positive for our business. Frankly the challenge with rolling out the new terms is that for the first month or two months in any given market you do experience a bit of a dip in revenues as the customer trades down to daily. Now over time that revenue base comes back and comes back nicely as you increase transactions and increase traffic with the popularity of the program. So we have been a little bit prudent and frankly have dragged our feet given the refinancing needs for the first quarter in more aggressive deployment of that new pricing program until our refinancing was secure and we were able to put more and more markets on with that natural first month or two dip in revenue.

Probably more than you wanted. Sorry for the long answer but that is where we are.

Charles Wolf – Needham & Co.

I just thought of a third question. Maybe Tom can answer it. I assume the term loan will be paid off on August 20?

Thomas Casey

Yes.

Operator

The next question comes from [Tony Weibel] – JMS.

[Tony Weibel] – JMS

The pricing plans you just finished talking about is that contemplated in the guidance that you have talked about to some level? Any resulting benefits for instance you might see from margins in getting content back or any kind of pricing lift it gives you?

Thomas Casey

Frankly we have been conservative in looking at the benefits of that. So we view that as upside to our guidance.

[Tony Weibel] – JMS

On the kiosk comp question you had earlier is there any established goal you have and is it part of your plan to actually see savings through the use of kiosks?

James Keyes

Over time. Our immediate goal is to increase the level of convenience and be competitive with other offers that are in the market place. We want to get out there and put them outside of locations but there is a great opportunity for us as we go forward to be able to have a smaller store, an urban store and support that store with a kiosk either inside or even outside of that physical location. It provides great flexibility for us going forward. We haven’t announced any definitive goals. We are still in the final stages of testing and ready to deploy but haven’t with our partners announced any specific goals other than I referenced NCR’s objective that they have talked about which is some 10,000 units in the next 12-18 months.

[Tony Weibel] – JMS

So we will see deployment of kiosks this year?

James Keyes

You will.

[Tony Weibel] – JMS

What would it take, this is kind of a longer term question but what would it take to have you reverse some of the things you are talking about putting in place here between the cost cuts and the lower inventory build? Is that just a temporary thing until you get through August or how long should we think about that kind of impairing the growth side of the equation?

James Keyes

I think it is safe to say in this marketplace everyone is managing cash. Everyone is managing for prudent liquidity decisions that will manage liquidity going forward given the reality of [inaudible.] You will see us continue to do that through this year. Now, as conservative as this plan is we still are pleased with the progress we have been making in the transformation and we want to continue growing this business so the more top line growth we get because we are successful with our studio partners in filling shelves and getting customers to respond favorably the more you will see us invest in advertising and other initiatives that perhaps we have been a little bit more conservative with.

So really we have this plan built for quite a bit of flexibility. It starts out as very conservative, cost management plan driven to maximize cash availability and liquidity but the more successful we are once we have our financing in place and the more top line growth we are able to enjoy you will see us loosen up on some of those cash conservation measures and be spending more from an investment perspective inside the stores and online.

[Tony Weibel] – JMS

What would you like to see out of the capital structure for the company? Do you envision a point where Blockbuster carries a lighter debt balance or is this just a function of just getting through this tough credit environment?

James Keyes

The first thing I would like to see is a rational cost of capital. Someone asked what the cost of this was going to be and all I can tell you is it is going to be expensive. This is not unique to Blockbuster. Everybody is doing financing right now are paying some irrational prices for credit in the marketplace. We don’t think that is going to continue forever. We do hope to get back to an opportunity to restructure our balance sheet at some point with more of a practical cost of capital and who knows when these credit markets will turn and we have that opportunity but that is what we are setting our sights on to get through this financing, to be able to bridge to another time when we will be able to access the capital markets in a more practical and more rational way.

So that is the first objective. As far as levers we are at less than three times EBITDA now. I would like to see us get down closer to two or slightly below for the longer term. We believe we have an opportunity to do that. Some of the cash conservation measures and focus on liquidity that we have the good news is that it is going to provide a discipline for the company to more aggressively pay down debt. That is our objective. Particularly with the cost of capital we are facing. We will be very motivated to de-lever here in the next 12-18 months.

Operator

The final question is from the line of Carla Casella – JP Morgan.

Analyst for Carla Casella – JP Morgan

Can you give us what percent of your rental revenue is revenue sharing with the studios versus buying inventory outright? How much would that go up as you try to conserve cash? Does it vary in store versus online? My other question was on Blue Ray disc prices, we recently read an article these prices are coming down at retail and what have you seen? Have you lowered prices? How do margins compare on Blue Ray versus DVD?

James Keyes

First on the question of revenue sharing about a year and a half ago when we began this initiative to work with the studios to find ways to get in stock we went from 50% of the business on revenue share, maybe slightly below 50% in 2007 to in the past year we were very successful we think in working with most all the studios in getting up over 80% of our business on revenue share. Both in store and online.

The next step, the next evolution in the revenue sharing concept is to take it even to a higher level because even with traditional revenue share deals there are still pretty high minimum guarantees so we share revenues let’s say above $10-12 per unit, per stick. That is better than an $18 per stick straight wholesale price but it still requires quite a bit of working capital commitment to have a $10-14 minimum guarantee. The ideal scenario for us that we are working both with studios and with gaming companies is to use us as a distribution conduit. In other words to lay inventory in, not on full consignment but at the physical cost. The $1 per stick or $1.50 per stick. If we could do that it would allow us with significantly less cash and less capital deployed to fill the shelves and that would give us an opportunity to share a bigger percentage of the revenue with the studio and the game company.

Our argument with both the studios and game companies is that all we are is a distribution conduit and to the extent we can do a better job with them in filling the shelves they again will enjoy better results from the ultimate retail customer because the ultimate retail customer will have a full assortment of games, a full assortment of their favorite new release movies.

So that is the plan to go from where we are today to a bit more aggressive but we think a more collaborative revenue sharing model with our straight providers. To the extent we can do that it has huge favorable implications on the working capital requirements of the company and also on the ability for us to satisfy our customer.

Analyst for Carla Casella – JP Morgan

The Blue Ray prices coming down at retail? How your margins are on Blue Ray versus DVD?

James Keyes

They have come down slightly but I would say the flip side of this is we saw last year very aggressive use of loss leaders both in standard def and Blue Ray with companies like Circuit City for example out there offering product at substantially below cost. What we have found in the last few months is that some of the competition has backed off that more aggressive pricing. Yes there has been a little bit of softening of Blue Ray but we don’t think it will continue to soften as aggressively as it had toward the end of last year and we still think Blue Ray represents a great opportunity. It is a classic extension of the DVD rental life cycle. The higher retail price point and this economic environment Blue Ray rental is a great way for customers to enjoy the optimal high definition movie experience but at a great value. A great consumer value. You will see us continue to very proactively and very aggressively work on expanding the Blue Ray audience out there.

Operator

There are no further questions at this time. I will hand the call back over to Mr. Keyes for any closing remarks.

James Keyes

Thank you. I would especially like to in closing thank our employees, our shareholders, all our stakeholders for the continued support of Blockbuster. We have accomplished a lot as you heard in the year 2008. That doesn’t mean we are free of a tremendous amount of work going forward. We are still in the process of transforming this business and these capital markets made it just a bit more challenging but we are pleased with the progress we have made and really look forward to sharing our success with you in the year 2009. So before we disconnect I would like to remind you of one last thing. We are scheduled to participate in the Telsey Advisory Group Consumer Conference scheduled on April 1 here in New York. I look forward to seeing you at that event. Thank you very much for your participation.

Operator

Thank you all for participating in today’s conference call. You may now disconnect.

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Source: Blockbuster, Inc. F4Q08 (Qtr End 01/04/09) Earnings Call Transcript
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