Coinstar Management Discusses Q1 2013 Results - Earnings Call Transcript

| About: Outerwall Inc. (OUTR)

Coinstar (NASDAQ:CSTR)

Q1 2013 Earnings Call

April 25, 2013 5:00 pm ET

Executives

Rosemary Moothart - Director of Investor Relations

J. Scott Di Valerio - Chief Executive Officer and Director

Galen C. Smith - Chief Financial Officer

Analysts

Darren Aftahi - Northland Capital Markets, Research Division

Michael J. Olson - Piper Jaffray Companies, Research Division

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Eric C. Wold - B. Riley Caris, Research Division

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

William Lennan

Operator

Welcome to the 2013 Quarter 1 Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Rosemary Moothart, Director of Investor Relations. Rosemary Moothart, you may begin.

Rosemary Moothart

Thank you, Adrienne. Good afternoon, and welcome to Coinstar's 2013 First Quarter Earnings Call. Our call today will be hosted by CEO, Scott Di Valerio; and CFO, Galen Smith. Scott and Galen will make introductory remarks, and the majority of our time will be allotted to Q&A.

In terms of Q1 documents, the earnings release and prepared remarks are posted on the Investor Relations section of Coinstar's website, coinstarinc.com. We posted in a separate document the slides that are incorporated into the prepared remarks, and we filed the 10-Q. Today, we also filed the preliminary proxy that included a proposal to change our corporate name to Outerwall. We expect to file the definitive proxy shortly. In the meantime, we also filed today a 10-K/A with certain compensation data and other info required to be filed within 120 days of our fiscal year end.

During this call, Scott and Galen may reference non-GAAP financial measures. A reconciliation of differences between GAAP and non-GAAP financial measures is provided in the appendix of the earnings release, which is posted on the Investor Relations website. Also during this call, various remarks we make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from expectations, plans and prospects contemplated in these forward-looking statements as a result of various factors, including those discussed in our latest 10-K and subsequent 10-Q filings with the SEC.

And now I'll turn the call over to Scott.

J. Scott Di Valerio

Thanks, Rosemary. We had a solid start to 2013. In our Redbox business, our rents were in line with our expectations. We increased our unique credit cards used to over 40 million and had our first 4 million rental night. We've been focused on improving rental frequency among our most valuable customers, and the volume of high-frequency cards renting in Q1 '13 was near an all-time high, similar to Q1 of 2012.

Our Blu-ray strategy continues to take hold, with Blu-ray increasing to over 14% of our revenue, a 65% increase year-over-year. We also extended our licensing agreement with Universal through the end of 2014 and made good progress on the CRM and loyalty system builds and processes that will begin to take hold in our third and fourth quarters.

And finally, the industry-wide decline in physical rental volumes slowed considerably in Q1, as the market has now mostly absorbed the significant reduction in brick-and-mortar rental locations.

In our Coin line of business, we added TD Canada Trust under our umbrella, extending our presence in Canada and in the financial institution channel. The coin-counting kiosk will be branded TD Canada Trust, and all 350 installations were completed by the first week of April.

Bringing Rubi to market in a broader fashion is a key focus, which we made progress toward with our kiosk production and installations ramping as we moved through the second quarter. New business ventures will be a key growth driver for us, and we will continue to bring more focus to this overall segment to be able to capture a meaningful portion of the over $16 billion market opportunity across the 6 sectors we are focused on.

And today, we announced our proposed new corporate brand, Outerwall. As we continue to grow and create new automated retail experiences, we wanted a brand that better reflects our vision and that is broad enough to embrace our growing portfolio of products and services. Our businesses have always been about pushing the walls of retail out into a new dimension. As we extend our offering, I believe Outerwall captures this.

And with that, let me turn it over to Galen.

Galen C. Smith

Thanks, Scott. Q1 2013 represents a good start to the year, as we generated approximately $575 million in consolidated revenue, including approximately $508 million at Redbox despite a challenging new release schedule that had 10 fewer new theatrical releases than in January 2012. We generated $104.2 million in core adjusted EBITDA and $0.93 of core diluted earnings per share, which included a $0.02 benefit from a lower tax rate due to 2012 R&D credits, offset by $0.04 of incremental interest expense as a result of our new senior notes.

Our free cash flow was $7.9 million, impacted by timing items, including changes in working capital, as well as a reduced benefit from deferred taxes, lowering free cash flow for the quarter. However, we expect free cash flow for the full year to be slightly better than our initial guidance provided last quarter.

A few key financial takeaways include Redbox revenue and rent per kiosk in line with our expectations in Q1. As we talked about last quarter, we expect second half revenue and rent per kiosk to be up year-over-year. We removed our last NCR kiosk in April, and the acquisition is expected to be accretive this quarter on a quarterly basis.

We raised $350 million in senior unsecured notes, with proceeds intended for general corporate purposes, including repayment of outstanding debt. To that end, we repurchased $44.6 million in face value of the convertible notes. We also repurchased 46.5 million of our common stock.

We provided context for our guidance in our prepared remarks. For Q2, we expect consolidated revenue between $555 million and $580 million; core adjusted EBITDA between $103 million and $113 million; core diluted EPS between $0.90 and $1.05. It's important to note that core diluted EPS in Q2 will be impacted by $1.8 million of operating losses and amortization of intangibles for NCR kiosks and $5.4 million of incremental interest expense. These 2 items represent approximately $0.16 of core diluted EPS impact.

For the full year, we increased the low end of the range of revenue by $10 million, primarily related to Redbox performance, and we lowered the top end of the range by $10 million for a reduction in new ventures revenue, primarily related to our decision to find strategic alternatives for our Orango business. Core adjusted EBITDA is expected to improve, with the low end of the range increasing by $10 million and the top end by $5 million due to the outperformance in Q1, as well as additional visibility into the year. We raised the low end of core diluted EPS guidance by $0.14 and the top end by $0.04, despite an incremental $0.37 of interest expense impact from the new senior notes, which is now included in guidance.

Finally, as I mentioned earlier, we increased our free cash flow guidance for the year on the top and bottom end by $5 million each to $185 million to $205 million. We are pleased in our execution this quarter, and we're focused on driving top and bottom line growth, both in the near term as well as in the years to come.

With that, we'll turn it over to Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And we have Darren Aftahi of Northland Security on the line with a question.

Darren Aftahi - Northland Capital Markets, Research Division

Just a couple. First, in terms of the assumption of higher transactions per kiosk in the back half of the year, can you maybe give us a little bit more color as to why you believe that's the case? I know you're ramping up your new disc sleeve and there are some other mechanisms, but maybe give us a little more thought process on that metric.

J. Scott Di Valerio

Yes, certainly. As we take a look at what we're doing, Darren, first off, we are -- with the VMZ, which is a vertical zone merchandising area that adds 80 discs into the kiosk, allows us to put -- leave content in the kiosk longer and without having to increase our product cost. But more importantly, we're really focused around our CRM and loyalty programs that we are building out and testing and will put in place, they'll will take hold into the market in the third and fourth quarters. As we take a look out, the physical rental market is beginning to stabilize. We believe that we can continue to grow within that marketplace quite good, given our overall market position. We have less than 50% of the market in rental units today, and we think we have great opportunity to carry out and take that up. And we expect our same-store sales to continue to improve as we move through the year and come out to a single-digit positive for the full year. All in all, we're excited about the process that we're in and the progress that we're making and the fact that our overall rentals increased across the network for the first quarter, and we increased the number of unique credit cards that transacted with the kiosk in Q1 by 1 million, over 1 million unique credit cards additional from Q4. All those things are positive signs that we're continuing to build out our consumer base and consumers are continuing to want to watch and view great new release content from Redbox.

Operator

And we have Mike Olson from Piper Jaffray in line with a question.

Michael J. Olson - Piper Jaffray Companies, Research Division

I just wanted to check in on the whole NCR integration. And you said at this point, all the kiosks are out of the system. And just where are we kind of on the spectrum of those kiosks that have switched out getting up to typical revenue per kiosk annual run rates?

J. Scott Di Valerio

Mike, we're making good progress. So we pulled the last kiosk out, as mentioned, in April. And most -- primarily, it was for the Safeway and Publix installs. And those have been performing well. And we benefited from having an installed base already, where customers were used to going to Blockbuster Express kiosks that were there, but we've seen that continue to ramp, and we're very pleased with how they're performing. So we -- that's why we have confidence that it'll be accretive this quarter.

Michael J. Olson - Piper Jaffray Companies, Research Division

Okay, cool. And for those kiosks that you were just talking about that have the additional tray or whatever, the vertical merchandising, how many of those are out there now that you have transitioned? And are you seeing any metrics on those kiosks that you can share as far as higher rentals per kiosk or anything like that?

Galen C. Smith

It's a little too early to tell, but we've got about 4,000 kiosks today that have that installed, and we're just beginning to work through how you manage inventory in those kiosks differently than others. As we move throughout the year, you'll get through almost all of the kiosks. And so we'll be able to continue to provide additional updates on what we're seeing in incremental rentals as well as profit on those in coming quarters.

Operator

And we have Andy Hargreaves from Pacific Crest Securities on line with a question.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

I just wanted to see -- can you clarify the market stabilization, just -- if I'm running the basic math off of your chart in the presentation, I get that the market is down about 15% based on your share and your transaction volumes that you guys reported. Can you just clarify that for me?

Galen C. Smith

Well, the NPD data suggests that we were having double-digit decline in physical rental volume, and that has actually stabilized to the low single digits, and so we're seeing that. Again, across our network, we have a broader -- higher number of rents across our network this quarter. And again, the market had to consume a large number of brick-and-mortars coming out of market as well as, obviously, the emphasis of the by-mail team.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Okay. Okay. And then just on the kind of the ramp that you guys are expecting in the second half. I know it comes down to the marketing effort and stuff and stabilization in the end markets. The question, I guess, is how do you have confidence in that when the rental night trend has been decelerating for several quarters?

J. Scott Di Valerio

Well, I think, a couple of things. One, as we talked about, we really focused on bringing our high-frequency customers in -- back in and getting them on frequency, and we've been successful at doing that. And we feel good, because that's obviously a good portion of our customers and also a large portion of our revenue. Secondly, we added 1 million unique credit cards that transacted with our kiosks in the first quarter over the fourth quarter, which means we're continuing to build out our consumer base. And we feel pretty good about the fact that with the CRM and the loyalty programs that we will be able to put into place, we'll be able to get our lower-frequency customers to begin to rent at a higher frequency, given some of the progress that we're doing. And as you can imagine, if you continue to build out 40 million unique credit cards, being able to get an additional transaction out of them a month or a quarter can have a significant impact on the overall business. And we believe, based on the work we're doing, that we're going to be able to do that.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

Okay. And then just last, on the kiosk installed plans. Can you give us any update on what you expect the net number for Redbox to be this year? Are you expecting to continue to take kiosks out, in other words?

J. Scott Di Valerio

We're definitely focused this year on network optimization and making sure we've got kiosks installed in the right location. It's going to move around from quarter-to-quarter. And we've got kiosk guidance for 500 to 1,000 installs, but we'll continue to evaluate what makes the most sense. We had about 20 net new installs this quarter, but that involved removing some underperforming kiosks and installing at some other ones that were very attractive. So we'll continue to monitor that, but we feel that we're, in selecting those best locations, making sure that we've got a really well-developed network to reach consumers where they want to be.

Andy Hargreaves - Pacific Crest Securities, Inc., Research Division

And the 500 to 1,000, does that -- that includes Canada as well?

Galen C. Smith

That's just the U.S. Canada is another 1,500 to 2,000 installs this year.

Operator

And we have Eric Wold from B. Riley on line with question.

Eric C. Wold - B. Riley Caris, Research Division

I'm kind of looking at -- on the install side for Redbox, obviously, net-net 0 basically this last quarter. I know you're expecting some this year. As we look into the next year, I know it's early, but would you expect any net installs next year on Redbox? And then kind of secondly on that, with all the NCR kiosks now pulled out, any updated plans on what you're looking to do there? And what is kind of the annual cost, I guess, depreciative of having those kind of sit in the warehouse?

Galen C. Smith

On the first question related to installs, it is a little early for 2014. But we're going to continue to monitor it and see if there are opportunities for us to generate the types of returns that we expect from the kiosks and there is attractive retail locations, then we'll consider installing there. So that's what we'll continue to monitor as we go throughout the year and plan for 2014. As it relates to the NCR kiosk, we're actively talking with several parties around -- outside the U.S. that would have interest in doing something with kiosks, and we'll provide an update as those move along.

Eric C. Wold - B. Riley Caris, Research Division

Okay. And then secondly on Redbox, I know it was a small uptick, but this was the first quarter where marketing expense percentage ticked up in about a -- in over a year. Any thoughts there in terms of your plans around marketing? Should we expect marketing to tick a little bit up, or now that you -- the market is becoming maybe less competitive around kiosks, can that move lower?

J. Scott Di Valerio

Eric, I think what we will do is we'll continue to drive marketing. Again, as you think about putting in CRM and the loyalty programs, and one of the things that we have been able to do as a company and you go through and you install tens of thousands of kiosks, the amount of marketing that you really have to do across those tens of thousands of kiosks isn't great as once you hit a little more stabilized, like we are today, putting in, really optimizing the network, then you really are beginning to drive people more to the kiosks and understanding, taking all that great consumer data and information that we have and converting that into merchandising and bringing them to the kiosk and letting them know what's in the kiosk when they want it and how they want it, those types of things. So I would expect that we would be spending a little bit more on marketing as we go forward to be able to drive the business and take a little bit of control of the business. But again, all that is included in what we put in, in guidance in the overall business for the second quarter, as well as out through the rest of the year.

Eric C. Wold - B. Riley Caris, Research Division

Perfect. And then just a really quick final question. I know some exhibitors have kind of been tinkering with the idea of a high-demand movie opening weekend, kind of adding a surcharge to base ticket prices when they know it's going to be full and can kind of getting that out of consumers. Now that NCR is out of there, any thoughts on kind of having some kind of variable or dynamic pricing on early releases to maybe get around -- or get around the 28-day delay with some of those studios? Or is that something you wouldn't want to toy with and stick with a single price?

J. Scott Di Valerio

I think one of the hallmarks that we have is value, convenience and simplicity. And when you begin to do a lot of dynamic pricing and the like, you lose a couple of those key core tenets. We're always evaluating it, though, looking at it, testing, those types of things, to see if it would make any sense or how are consumers consuming product, but there's nothing on the roadmap at this point.

Operator

[Operator Instructions] And then we have Ronald Bookbinder from Benchmark Company on line with a question.

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

On the comp, how much of an impact did the transition to the 28-day window for Warner Bros. have?

J. Scott Di Valerio

It has some impact because we were in transition with them in Q4, and then we had no new releases from Warner Bros in January, whereas we had 5 or 6 last year. So it definitely had some impact. What I'd tell you is that the bigger impact is coming from installing 5,800 kiosks in the second half of the year and allowing those time to ramp really in the comp days. And as we talked about, a lot of those are really strong locations between Safeway and Publix. And so those are pulling some rents from other -- the other kiosks. And I think when we installed kiosk 20,000 and then kiosk 20,001, there was less cannibalization, obviously. As we move to 45,000, 45,001, there's a bit more cannibalization, but we're able to still increase overall rents and still drive great returns in those kiosks. And so it did have some impact, but we still feel confident that we're going to get to positive single-digit comps before the end of the year.

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

And on Redbox tickets, how is the rollout going? Should we expect to see that go to more cities shortly? And is that being included in the comp? And if so, did the -- the cities that have the Redbox tickets, do they comp above the company average?

Galen C. Smith

Our plan has always been, this year, is to really dive deep in Philadelphia and Los Angeles as we get through the majority of the year and make decisions based off of where the next city should be or how we want to work the business, and we're still on that plan today. So we'll go deep in both Philadelphia and Los Angeles in -- through most of the year and then make some decisions from there. For the cities, Los Angeles and Philadelphia, where the tickets are, they are in the comps. But again, as we're scaling those businesses, they really don't have a big impact at this point on the business.

Ronald Bookbinder - The Benchmark Company, LLC, Research Division

Okay. And one last one. On the PayPal at the Coin kiosks, is PayPal going to help market as it rolls out to more kiosks? Are they going to help market to let the consumer know that the option is there?

J. Scott Di Valerio

Definitely. It's one of the great things that we saw in the test that we did in Texas was when PayPal put the marketing -- their marketing horse behind it with their customers, we saw a big lift, and they saw it as well, and a sustained one. So as we get more and more pay -- machines loaded up with PayPal on them, then you'll see some good marketing coming out, combined marketing with PayPal and our ourselves, to be able to drive that business.

Operator

And we have Bill Lennan from MCH on line with a question.

William Lennan

Just a couple from me. The first one is a clarification. I didn't see this in the release, and I was on the another call, so if I missed it, I'm sorry. Can you give us an idea what Canada DVD revenue and units were? That's part one. And then part -- the second question is, 2 forces that are going on, one is a potential positive, clearly a positive, and one is potential negative I wanted you to comment on. One, the Blockbuster store closures. They're kind of cutting into bone now, getting down about 500 stores in the U.S., and I wonder if you could talk about how much share you think is left in Blockbuster or how that's going to affect you in -- over the year? And then Netflix seems to be getting warmer to DVD, or but maybe less cold is a better description. Do you think Netflix's more benign behavior towards DVD will hurt you in any way during the year?

J. Scott Di Valerio

Great. Well, as we look at Canada, we continue to make good progress in signing new retailers in Canada. We have Loblaw's supermarkets, Petro-Canada, Giant Tiger stores, in addition to continuing our expansion with Walmart Canada. In fact, we have contracts in place for over 1,100 kiosks in Canada, so we're pleased with that progress. As you can imagine, we're not a household name yet in Canada. Redbox is not. We're working to educate the retailers and consumers, and we're learning the processes of site selection and permitting and the like, which is a little bit slower in Canada than what we've been able to put together over 10 years here in the U.S. We still expect to install between 1,500 and 2,000 kiosks this year and to have 200 to 300 locations in Q2, and on our way to that higher installation number for the full year. We'll talk a bit more about the economies as we get more kiosks in the ground out there and as the rent-and-return anywhere becomes more of a reality than a vision, because we have to get the right level of density of kiosks to make that play out well. But again, we're pleased with the direction that we're going and the progress that we're making. We've talked about this before. We don't expect the return on each Canadian kiosk to be as high as the U.S., but it's still a very attractive model in Canada, given that they're the third-largest viewer-of-entertainment country in the world. So again, good progress, and as we get more kiosks on the ground, we'll provide more detailed economics on that. Your other question around -- we think there's great opportunities in the market to continue to take market share and allow us to grow faster than any decline in the physical market. Certainly, the brick-and-mortar stores are -- the national brick-and-mortar chain stores, like Blockbuster, are down to bare bones. There were some -- certainly, in retail, there's some regional stores that are out there that have some heft, but all in all, we think we have great opportunity to take our share from where it is today, slightly below 50%, to well over that over the next couple of years, given our points of presence as well as our great value proposition and our ability to continue to merchandise and focus on our consumers so they can get their entertainment where they want, when they want it. So we think that we have great opportunities there. As you look at Netflix, your question around Netflix and the DVD space, we continue to grow market share this year, this quarter. In fact, I think we're up close to 7 points of market share in the physical unit space from where we were in Q1 of last year. We certainly took that market share from brick-and-mortar, but also from the by-mail space, so we feel confident that we'll continue to be able to do that and drive that business. Our business is really all about new releases, and our by-mail competitors are not necessarily as in-tuned or focused on the new release business versus releases that were a little bit in the older categories, so we feel good about that.

Operator

[Operator Instructions] And we have no further questions.

J. Scott Di Valerio

Great, thank you. All right. Thank you. Before we wrap up the call, I'd like to leave you with 3 takeaways from our first quarter. First, we continue to see improving customer trends at Redbox with a 47.8% market share and an increase of over 1 million unique credit cards used during the quarter to 40 million. Second, we're executing and delivering on our commitments by generating revenue and EBITDA in line with our guidance and EPS slightly above the high end, and we're optimizing our capital structure through issuing our new senior notes and repurchasing a portion of our convert. And third, we have a balanced strategy with a focus on driving shareholder value, demonstrated by our continued buyback of shares this quarter while investing in the business. With that, I'd like to thank you for joining us on the call today.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, and you may now disconnect.

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