Blockbuster, Inc. F1Q09 Earnings Call Transcript

May.14.09 | About: Blockbuster Inc. (BBI)

Blockbuster, Inc. (BBI) F1Q09 Earnings Call May 14, 2009 4:30 PM ET

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

Analyst for Rich Ingrassia – Roth Capital Partners

Arvind Bhatia – Sterne Agee

Analyst for Tony Wible – Janney Montgomery Scott

[Karu Martison] – Deutsche Bank

Marla Backer – Research Associates

Carla Casella – J.P. Morgan

Analyst for Emily Shanks – Barclays Capital

Operator

Welcome to Blockbuster’s first quarter 2009 financial results conference call. At this time, all participants are in a listen only mode. At the conclusion of management’s prepared remarks, instructions will be given for the question and answer session. (Operator Instructions) As a reminder, this conference call is being recorded today, Thursday, May 14, 2009.

I will now turn the call over to Kellie Nugent, Blockbuster’s Director of Investor Relations.

Kellie Nugent

Thank you participants for joining us today to discuss Blockbuster’s first quarter 2009 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 voice mode over the Internet and maybe accessed within Blockbuster’s website within Blockbuster.com.

After the market closed today Blockbuster issued a press release regarding its financial results for the first quarter ended April 6, 2009. By now everyone should have access to the press release, the financial tables and the PowerPoint slides which were filed in an 8K with the SEC. However, if you do not they are available via the company’s website or at SEC.gov.

Please be advised that matters discussed in today’s teleconference contain forward-looking statements relating to the company’s operations and 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.

We caution you that such statements are in fact predictions that are subject to risk and uncertainties that could cause actual events or results to differ materially. Additional risks and uncertainties that could cause actual events or results to differ materially from these forward-looking statements may be found in the company’s filings with the Securities & Exchange Commission on Form 10K or Form 10Q which is being filed today.

Forward-looking statements are based on the company’s beliefs as of today, Thursday, May 14, 2009. Blockbuster undertakes no obligations or responsibility to publically update any forward-looking statements for any reason except as required by law even as new information becomes available or other events occur in the future.

Additionally, in the company’s press release, PowerPoint slides 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 press release and in the tables following the slides.

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

James W. Keyes

I hope you’ll agree that we’ve got some very good news to report. First and foremost, we completed funding this week of our $250 million credit facility and added a $21 million asset backed loan for our Canadian subsidiary. We also reported net income for the first quarter of $27.7 million and adjusted EBITDA of about $100 million which gave us confidence to reiterate full year adjusted EBITDA guidance of $305 to $325 million.

We remain on track to reduce SG&A by over $200 million during fiscal 2009. We remain also committed to the diversification of our stores and are on track towards development of the multichannel platform for the Blockbuster brand. Regarding our financing, we’re very pleased of course to have successfully completed the funding and would again like to thank our lenders for their continued confidence and support.

We realize that this agreement is expensive, however, the reduction of available liquidity among traditional loan investors combined with a challenging economic environment has made it very difficult for many firms to extend maturities hence, the reduction in facility size and increased interest and fees. The refinancing provides a twofold opportunity for us, an aggressive amortization schedule allows us to improve the balance sheet and leverage ratios, also allowing us to reduce debt by over $400 million in the next two years.

This will require timely and prudent actions that are necessary to build a cost effective platform for the Blockbuster of the future. The financing also represents a bridge to that future when the cost of capital is frankly not as punitive. The current facility allows the flexibility to refinance at any time in the next two years without penalty. With the refinancing behind us we look forward to returning our focus to the operational aspects of our business.

Looking at the first quarter, the challenging economic environment and our careful management of cash contributed to solid EBTIDA but did cause us to postpone our continued progression of same store sales increases. Last year, as you know, we were very pleased to put together four consecutive quarters of improved same store sales. As expected, given the economic environment and the uncertainty around the credit markets, we knew that trajectory would not be possible to continue in 2009.

For example, I’ll share a few of the internal and external factors that affected our top line results during the quarter. First, the internal factors, with fewer and generally weaker titles to choose from along with the preservation of working capital that we had to do we ordered substantial lower quantities of film versus last year so unit availability frankly was down by over 20% and as a result we experienced sales that were more comparable to the 2007 levels when our strategy was similar to that.

I’m pleased to report that we are now back on track with our in stock plans. This week, for example, we have over 200 copies of the film Taken and expect to be 100% in stock going in to this weekend. We’ve also rolled out during the quarter our choose your terms pricing to over 600 stores. In all markets, the addition of a daily price option has resulted in increased traffic versus control. There is however, short term dilutive impact on revenues as customers elect the lower cost daily price. As we continue to roll out this new consumer proposition, there will be a near term, slightly dilutive impact on sales but a corresponding favorable improvement in traffic.

Those are the internal factors that had some impact on our sales in the quarter but there were also external factors that affected our business and first and foremost and the strongest impact we believe was frankly box office and box office in two ways. As mentioned during the last quarterly report a slate of very lackluster rental titles combined with unprecedented strength in theatrical box office which made theater a more popular alternative for movie watchers during the quarter.

In 2009 for example, the movie theaters are experiencing a record breaking year. Theatrical attendance is up 14% with six films breaking $100 million this year compared to just two films for the same period in 2008. We estimate that nearly 3 million more people are going to the movies each week in 2009 predominately on weekends and this has been pulling traffic from Blockbuster stores especially on those important weekend nights.

The good news is that these titles beginning in May will be hitting our shelves and we’re cautiously optimistic that we will enjoy favorable rental demand in the back half of the year with titles like Paul Blart Mall Cop, Watchmen, Star Trek and many, many more. In terms of the economic environment, as we’ve seen in other recessionary periods, these early affect on video store rental is somewhat unfavorable as existing customers pull back on their discs per visit.

While experiencing this effect in the first quarter, we believe that historically customers rediscover the value of rental as this recessionary trend continues over time. Our introduction of daily pricing is intended to provide that value offering to stimulate improved traffic and our more aggressive advertising coming up during this quarter and next will remind customers of the great value of the rental offering and remind them of their favorite Blockbuster brand.

Competitive pressure, another external factor; clearly Redbox and Netflix are both factors in our competitive landscape but we’re confident that our multichannel platform and the strength of the Blockbuster brand will provide the most robust consumer proposition over time. We believe that the most impact on sales during the first quarter was those factors other than competitive pressure and just as a frame of reference, in Canada for example, where we have no significant by mail or no vending competitor at all rental revenues were still down some 7.5% for the quarter really reflecting that different strategy that we had in particular relative to unit availability.

No single company we believe can offer customers the variety of ways to access media entertainment that Blockbuster can so whether through our offerings in store, by mail, through vending or digital, Blockbuster customers will know that they can access media entertainment in the way that’s most convenient to them. To that point, frankly, we’re very glad the first quarter and our refinancing our behind us.

While we have proactively modified our tactics for the year in response to these market trends, our strategy remains the same. We remain fully committed to our multiplatform offering and I’ll outline a few of the initiatives associated with these important platforms going forward. First, we believe that the stores are the important foundation of our multichannel offering. The future of those stores required diversification in to other forms of media entertainment like video games, event ticketing, etc.

Rather than direct investment in working capital for the diversification of our stores through expanded retail products for example, we’re turning more to consigned products whether a new line of movie themed sunglasses that we have launching very soon for the summer or a collaboration with CE manufacturers on Blu-ray players and game consoles. Improving the relevance of our store base also requires a commitment to preserving the core rental business.

In spite of even more aggressive competition we believe that the depth and breadth of rental offerings will continue to make Blockbuster the destination of choice for movie lovers. We’re very pleased with the cooperation of studio partners as we find new ways to create win/win agreements that allow us to minimize working capital while maximizing our in stock presence especially on tent pole titles.

To enhance the breadth of our movie offerings, we’ve just launched a brand new and exciting program called Blockbuster premiers with a title we launched this week called Baby On Board starting Justin Bateman, John Corbett and Heather Graham. This is a brand new initiative that will introduce exclusive new movies pre-retail to our customers and a new distribution channel for the filmmaker. It also provides a new opportunity for movie discovery for our customers.

Movie matchmaking is really in the DNA of Blockbuster and while vending and digital represent exciting new channel opportunities for Blockbuster as well, nothing can replace the community and the customer service of our people in our stores. To that second initiative, that second platform, our Blockbuster by mail subscription initiative has been quietly but significantly improving during the past year. Continued improvements in the website, the rental, now retail product offerings and more recently the testing of games by mail.

Our long term plan is to grow the by mail subscription business not by head-to-head marketing versus Netflix but through leveraging our multichannel offering and through strategic alliances. Speaking of alliances and vending, our alliance with NCR for vending remains on track. We’re very pleased with the progress of this initiative and remain excited about the additional points of presence that vending offers with hopes of more than 3,000 units to be branded Blockbuster by the end of this year.

Our collaboration with NCR is a very good example of the kind of strategic alliance that will allow for expansion of our multichannel consumer proposition. Without direct investment in vending machines or kiosks we’ll be able to expand the Blockbuster brand and provide customers with seamless access to their favorite movies, in store, by mail or now at their corner store via vending.

Our digital initiatives both Blockbuster.com and the Blockbuster On Demand will continue to expand our physical points of distribution and digital points of distributions now to millions of homes through strategic alliances with collaboration with cable, telecom, satellite providers in discussion with all three as well as integration with manufacturers of consumer electronics and consumer link devices.

Our recently announced deals with CinemaNow to become their retail brand and with Tivo to include Blockbuster On Demand service are both examples of these kinds of strategic alliance opportunities. Blockbuster customers have come to expect that we’ll have the best and the newest movies. We believe that our ala carte digital movie library meets those expectations and that it compares quite favorably to digital subscription alternatives that offer only older titles. While we may supplement our digital library with subscription offering in the future, we believe that our current ala carte service is one that meets the competitive needs and will continue to satisfy the customer.

So, while focusing on the refinancing needs during the first quarter, I can assure you that we never lost sight of the opportunity. That opportunity to transform Blockbuster in to the preferred provider of convenient access for media entertainment whenever, wherever and however the customer wants it. With that, I’ll hand the call over to Tom who will provide liquidity updates, a look at our post funding capital structure and share a little more color on the quarter.

Thomas M. Casey

I’ll focus my comments on discussion of our completed refinancing and the company’s liquidity. After this call there should be no doubt that we have sufficient liquidity to continue the transformation of Blockbuster through 2010 and beyond. My comments will be focused on slides that we filed this afternoon and they’re available on our website. You may want to follow along.

So, at the end of the first quarter we had $881 million of debt and only modest leverage at 2.7 times debt to EBITDA. The only issue we faced really was the maturing of our $350 million revolving credit facility in an extremely difficult financing market. Fortunately, we were able to complete and amendment and extension of $250 million of the revolving credit facility on May 11th. The transactions at funding included paying the remaining $205 million balance and then collateralizing $118 million of letters of credit.

In addition, we achieved three additional sources of liquidity in April and May. First, as Jim had mentioned we arranged a $21 million, US dollar term loan through Callidus Corporation. Secondly, we sold $60 million of excess games inventory in pruning of our games retail inventory and thirdly, we settled a litigation bond that further enhanced our liquidity.

So, if you start with the consolidated cash balance at the end of the first quarter of $107 million the funding resulted in a consolidated cash balance pro forma for the funding of $47 million at the end of the first quarter. Then, since April 5th cash from operations has further enhanced liquidity and consolidated cash balances is now closer to where it was pre-funding. A key takeaway here is that we have ample liquidity.

If you talk about our capital structure post funding, our leverage remains at a modest level with the new interest rate on the revolver at historically high levels we’ll certainly evaluate refinancing as the debt markets improve. So, in addition to the strong cash flow from operations we’re pursuing three specific additional sources of liquidity in 2009. We’re evaluating store closure plans which could provide over $25 million in liquidity and significantly enhance EBTIDA. Secondly, a $118 million of cash is tied up in collateralization of LCs.

The largest piece of that is $75 million that’s in connection with lease guarantees from Viacom on approximately 131 stores. We’re working to eliminate those guarantees with good success in conjunction with our successful lease renegotiation program. There’s a liquidity enhancement here well in excess of $25 million. Then the third is that we’re exploring asset sales in our international markets outside North America and making good progress on those initiatives. These divestitures would likely provide aggregate proceeds in excess of $100 million.

The debt amortization schedule if you look at that, our expectation is to reduce debt to under $500 million by the end of 2010 and to explain this you should start with our pro forma consolidated cash of $47 million at the end of the first quarter pro forma for the fundings and then enhance that by the cash from operations since April 5th. Then, take the midpoint of our adjusted EBITDA guidance of $315 and then subtract the interest, taxes and cap ex on page seven of our financial table.

From that you would calculate a free cash flow number before working capital of $162 million consistent with the midpoint of our adjusted EBITDA guidance. In addition, we plan to manage working capital more efficiently by the way we’re buying retail and rental product and in 2009 there’s the normal seasonal cash benefit for the remainder of 2009 and so [inaudible] together with 2010 we expect to be contributing to cash.

So, when you run the math on those three points we expect to amortize over $400 million of debt between now and the end of 2010. Then, as a further cushion to our amortization requirements we have the 2009 liquidity opportunities I just mentioned which should exceed $150 million. Then finally, in the event that the debt markets continue to improve, we would likely refinance and term out our debt maturities at lower costs.

So, we’re filing our 10Q today and I’ll leave the normal discussion to changes in financial results to Q&A.

Kellie Nugent

With that operator, we’ll open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Rich Ingrassia – Roth Capital Partners.

Analyst for Rich Ingrassia – Roth Capital Partners

A question on the cap ex, under the amended credit facility I believe you’re restricted to $30 million for FY ’09 and then $40 million for FY ’10. Could you just give us a reasonable maintenance cap ex figure?

Thomas M. Casey

That is basically maintenance cap ex level.

Analyst for Rich Ingrassia – Roth Capital Partners

How does that push back the transition to the rock the Block model?

Thomas M. Casey

The rock the Block model, we’re pleased with the progress that we’ve made but let’s face it, in these capital markets, very few companies are going to be expanding initiatives that generate 12% to 15% internal rate of return when the cost of capital is significantly higher than that. So, we like many other companies are going to be on the sidelines waiting for credit markets to return to more normal levels.

As we referenced in this new facility, we have the opportunity to refinance should the credit markets improve without penalty. So, for a while, rock the Block is on the sidelines. But, I did mention and I want to call your attention to the other initiatives, the digital initiatives and the vending initiatives are both set up to engage strategic alliance partners with significantly better balance sheets that ours. NCR for example, is a very strong cash position and is very anxious to invest in the vending and partner with us to leverage the strength of our brand. So, we don’t think it’s going to hold us back at all. We’re temporarily going to postpone the store initiatives but full speed ahead on our vending initiatives and our digital initiatives.

Analyst for Rich Ingrassia – Roth Capital Partners

Also, could you elaborate on the initial response to you’ve had to the video games by mail program you announced in February?

James W. Keyes

It’s in one market and it’s a relatively limited offering. So, we really don’t have much to say about it now. We’re learning a lot from it and we do hope to expand it but it’s too early to give any results.

Operator

Your next question comes from Arvind Bhatia – Sterne Agee.

Arvind Bhatia – Sterne Agee

I just quickly wanted to understand the international divestiture a little bit more. You talked about a $100 million potentially from such a sale. What kind of EBITDA impact would that be? And, is that already contemplated in to the 2009 guidance? I guess what I’m getting at is if you were successful in selling some of the international assets would we then at that point expect EBITDA guidance to be changed?

Thomas M. Casey

It’s not factored in to the EBITDA guidance. It’s not deducted out. It’s not something that we’re counting on but we’re pleased with the responses we’ve received so far.

James W. Keyes

But, we don’t anticipate an adverse effect on EBITDA as a result of our international asset sales.

Arvind Bhatia – Sterne Agee

Jim, can you talk about where you are on the pricing front, how you see that progressing from this point on? What kind of results have you seen and what do you think will happen now?

James W. Keyes

Pricing is a real conundrum for us because we are anxious to roll. We’ve learned a lot over the 12 or 18 month period that we were testing various modules and we’re excited by it. It’s a great consumer proposition but the reality is when you go from an average of $4.49 for a new release to a daily price which is very relevant to the consumer right now especially in this economy, when you take your library down in particular which we can afford to do, that’s where we have the greatest profit margins in the center of our store, the slow moving higher margin center of the store. When we take that down for example in many of our test cells we’ve done $0.99 per day it’s actually a very attractive offering for the customer and the good news is many customers take advantage of it and our traffic goes up.

The bad news is, it’s temporarily dilutive on revenues as the customer trades down from new releases to more BSI. We think that, and it does in our test markets correct itself over time as traffic improve and as more people migrate back to the popular new releases at a higher price, even at a higher daily price. We have not in most markets taken our new releases down. We don’t believe that the new release is stimulated by price as much as it is availability so our strategy on our daily prices is to keep our new releases at a little higher price point, significantly higher price point. Something that is much more comparable to the average two day term to what we get today.

The net of all this is that while we’re excited about it, given the liquidity challenges we faced in the first quarter that were solely related to the uncertainties around the refinancing, we pulled back on the more aggressive roll out of that program. Now, we have recently rolled out another several hundred stores and we do plan to proceed somewhat more conservatively with an eye to managing our cash needs and our cash expectations so that we don’t move too quickly and dilute revenues.

Arvind Bhatia – Sterne Agee

Just trying to understand the guidance, the EBITDA guidance obviously, you’ve got the G&A cuts, $200 million run rate as you mentioned, you’re guiding for essentially flattish EBITDA so obviously I assume you’re building negative same store sales for most of the year? I mean Q1 was obviously negative. I’m just trying to understand how you’re thinking for the rest of the year given what you know on the title schedule, etc. so we can reconcile the flat EBITDA guidance in light of the G&A cuts.

James W. Keyes

Well, as I said the most significant impact in the first quarter is the unit availability. We have measured all of the various factors as they relate to our unit sales and the strongest correlation by far is unit availability. It’s even stronger correlation than box office. Of course, they’re a little bit related because when the box office is weaker we buy less. But, let’s face it, what does the customer want when the walk in the store, they expect new releases. Given the challenges in the first quarter we didn’t want to take any chances in the event that our refinancing was delayed or whatever happened.

We didn’t want to take any chances with our cash position and therefore were very conservative on our ordering. We don’t expect that to continue. We do think that both title strength is improved for the balance of the year and we’ve definitely been able to step up our unit availability with better arrangements from the studios that help us manage our working capital more efficiently while staying in stock. And, frankly, our daily terms help our in stock position because as we roll out more and more stores, when customers do opt for the daily terms there’s a corresponding working capital advantages as people bring them back more quickly.

Specifically to the titles coming up, we’ve got some good things. In the current period Taken, Paul Blart Mall Cop, New in Town, He’s Just Not That In To You. Period six Gran Torino, Tyler Perry’s Madea Goes To Jail, Confessions Of A Shopaholic. Period seven, we’ve got Watchmen, Fast N’ Furious, some really good strong titles coming up for the summer. It should be a better rental slate than we had last summer and we’re cycling against the Olympics which as you know was a horrible title slate last year.

So, we are cautiously optimistic let’s say about sales trends for the balance of the year. But, we’re being practical as well. We know that there is more aggressive competition out there now and we know that we are not going to be spending the money inside the store to remodel but we’ve got a lot of other offsetting initiatives with our Blockbuster premiers program, etc. that we believe will stabilize sales and frankly, we’re going to try to get them back in the positive range but we’re not counting on that in our $329 million model.

Arvind Bhatia – Sterne Agee

Let me just ask one last one, Jim if you look at your franchisees and you compare their performance and let’s say that our franchisees were very comparable to your corporate stores, in other words they’ve taken on many of the same strategies and they’re not capital constrained, what was their performance and how do you look at that and say, “Alright this is where the normal performance would have come in had we not had the liquidity issue.”

James W. Keyes

Domestic stores?

Arvind Bhatia – Sterne Agee

Yes.

James W. Keyes

In terms of sales?

Arvind Bhatia – Sterne Agee

Same store sales performance. We’re trying to get to a number without the liquidity issue this quarter where would same store sales have ended up?

James W. Keyes

That’s impossible to answer. I think it would be extremely hard given the title slate that we were given this quarter to have had positive sales. How negative would they have been, I don’t know. Canada as we said, excluding competition Canada was down 7.5% so that takes one variable out. Beyond that what can you say it was a very, very weak title slate in the first quarter and we had real challenges in the economy and with theatrical drop, good theatrical box office pulling customers out. So, I wish I could help you more but that’s all we know.

Operator

Your next question comes from Analyst for Tony Wible – Janney Montgomery Scott.

Analyst for Tony Wible – Janney Montgomery Scott

I was just kind of wondering if you could follow up on what you guys were talking about for international asset sales? What level of interest are you seeing out there and are the Canadian stores on the table as well?

James W. Keyes

We’ve been public for some time about pursuing alternatives for international assets outside of North America and that’s all we can really comment on at this time. We have a standard process under way there’s good businesses and independent from the US and outside North America completely unencumbered with debt. All I can say is it would be inappropriate to comment further as we’re in the middle of a process.

Tony Wible – Janney Montgomery Scott

Can you guys also talk about how you see the various theatrical window shifting going forward? The release windows?

James W. Keyes

I’m not sure I understand your question.

Tony Wible – Janney Montgomery Scott

How do you kind of see the duration, the number of months it’s going to take to go from theater to DVD release?

James W. Keyes

How the window is going to change?

Tony Wible – Janney Montgomery Scott

Yes.

James W. Keyes

We’re not really anticipating any big changes in windows. As you know, there was some testing of video on demand window collapsing with the DVD and retail window. We don’t really see that continuing in a dramatic way. Some of the studios that were testing it have backed off some of that more aggressive collapse of the windows. Frankly, we think there’s so much revenue generation between video store rental and retail for the studios it’s unlikely that they’ll be too aggressive in collapsing those because those discrete windows represent great pockets of incremental revenue for them.

Now, over time, as that does happen, as the video on demand window does perhaps tighten or close, we’ll be the beneficiary of that as well because it’s going to make our Blockbuster on demand product day-in-day with our stores. So, there’s an upside to that as well for us, something that we’re not overly concerned about.

Operator

Your next question comes from [Karu Martison] – Deutsche Bank.

[Karu Martison] – Deutsche Bank

Just so that we’re clear, as we go forward here we should not be seeing the same magnitude of a comp decline as you due the investment in the in stock, correct?

Thomas M. Casey

We should not see the same magnitude that we have experienced because of the improved in stock, that’s correct or that’s our assumption anyway.

James W. Keyes

Our rental comps are closely correlated to our in stock availability which will improve in the quarters ahead.

[Karu Martison] – Deutsche Bank

In terms of the gross profit domestically for the merchandise, we were down significantly year-over-year. I’m sorry if I missed it but, what were the drivers there?

James W. Keyes

One of the big changes there was the write off we took in connection with the sales of games retail inventory which was $16.7 million.

[Karu Martison] – Deutsche Bank

Then, when we look at these partnerships that you’re talking about cable, satellite, telephone, what’s the time table here? Is this something that is a 2009 or somewhere down the road?

James W. Keyes

This is I would say a bit farther down the road. We are in active discussions with all of the infrastructure providers for various forms of collaboration but, I wouldn’t expect anything in the immediate future. It would be great if we could get something sooner than later but this whole industry is developing and I think what it comes down to is will individual companies be successful developing their own platform or are the more successful consumer offerings going to be those who collaborate.

We see that collaboration model as one that certainly makes more sense for us given our balance sheet constrains and given the strength of our brand. We think we can be a very good partner for others out there who want to develop this important channel.

[Karu Martison] – Deutsche Bank

In terms of the kind of lease initiatives, what kind of progress are you seeing there in renegotiating your leases and just also with I guess exiting stores as 20% of your leases come up each year?

Thomas M. Casey

We’re very pleased with the results of our lease optimization program. The landlords have cooperated and we’re ahead of track on expectations. It would be inappropriate to give a specific number but I think we’ve said before that our annual domestic rent is roughly $400 million with the average remaining lease term of 2.5 years and you can make your own assumption about a reasonable expectation for reduction. We feel good about where we are on that.

[Karu Martison] – Deutsche Bank

I guess on that same vein, with the cash collateralization of the LCs how much of this is still the old Viacom leases that need to be secured? Is that kind of $118 number that you guys gave in the slide deck here kind of where that basket will be?

Thomas M. Casey

$75 of the $118 is Viacom lease guarantees on $131 stores. As part of our lease program we’re working very hard to reduce that and to eliminate it entirely. We don’t want to make any promises as to the timing but we’re making good progress.

Operator

Your next question comes from Marla Backer – Research Associates.

Marla Backer – Research Associates

I’m interested in hearing a little more color if you can provide it on the kiosk strategy because since Redbox seems to already have a little bit of a head start on its roll out I guess do you feel that you’re starting out at a position of perhaps having to come up with them the Blockbuster brand notwithstanding?

James W. Keyes

Marla, just let me put a frame of reference around that, Redbox recently signed deals with a couple of large convenience store operators. There are 125,000 convenience stores in the United States. They’ve signed up with operators that control perhaps 10,000, 15,000 of those convenience stores in the United States. There are a lot of opportunities at retail, the same goes for big box retailers, the same goes for grocery. We don’t think there’s going to be any absence of real estate at all.

I think the bigger concern that we’ve got is frankly how many boxes the marketplace will support. We think they’re going to experience the same thing that Blockbuster experienced at some point which is once we have some 7,000 or 8,000 stores we started looking at some cannibalization of our own stores. At some point the market for kiosks will become saturated.

We don’t think we’re there yet, we think Blockbuster has plenty of opportunity to go in next door, perhaps take some of that business or even replace the existing provider with a better offering. What do we bring to the table in terms of that better offering? Well, first of all we’ve got the Blockbuster brand and there are still millions of people that carry the Blockbuster card and they are members and will see that as an advantage to be able to have one account to be able to move from store to vending conveniently and easily.

We also think that our solution with NCR as our provider is going to be a superior offering. We have new technology in those boxes that provides greater capacity, almost double the unit capacity of the Redbox machine. We have rental and retail available. We also are looking at games as an opportunity in our machines. So, our machine will be more of a miniature version of a Blockbuster, full service capability rental, retail, games, movies.

We’re looking at these boxes with the future basically future proofing the boxes making them digitally enabled so that when there is a transition and people are now accepting Blockbuster On Demand on their set-top box, or through their game console the can also have a convenient way to load their content by going to their local vending machine, their Blockbuster branded kiosk. We’re very excited about the ability to compete head-to-head and are not at all concerned about the availability of retail offerings going forward.

Marla Backer – Research Associates

But then just so I understand, we should expect that the channel strategy will be very similar to Redboxes because in the past you’ve also spoken a little bit about airports being a possible venue which seemed to make sense. But, basically we should expect that there will be a lot of similarity between the channels that you’re pursuing and those that Redbox pursues?

James W. Keyes

Well, a similarity but let me characterize the difference. The same as our Netflix strategy, we’re not going to compete with them head-to-head on Internet banner ads, we’re not going to win that game, that’s their only game. They’re going to spend $60 million as they did last quarter, we’re going to spend a fraction of that because it doesn’t make sense for us, we have better places to spend our money.

We also have other ways to compete with various offerings that we think that are better so that on the online business for example, our customers can sign up for the ability to exchange the movies in our stores conveniently and easily, we think that’s a competitive advantage. So, when it comes to vending you’ll see us do the same thing. Rather than go head-to-head and battle it out for Wal-Mart stores, you’ll see our vending solution do more leveraging of the cross channel capabilities.

Wow, it’s a more convenient thing for me as a customer for example to have my movies be able to be exchanged either in store or in the machine as a long term vision. We’ve got the opportunity to go outside of the traditional retail venues in to as you referenced airports, colleges, those kinds of things which we think are good locations for vending.

Frankly, the way we’re looking at our vending operation versus theirs is our vending approach would be more satellite operations for the store. So, if the store is the mother ship, the vending will provide satellite opportunities and simply make it more convenient for customers who aren’t perhaps on this night anxious for the entire breadth and depth of our assortment but just want a quick movie and they can drive down the street but hopefully, they will also use the store on a regular basis.

So, we see the vending as a fill in opportunity, a higher level of convenience which is the core of our business for our customers. So, it definitely compliments what we already do and that that compliment will be how we best compete with Redbox.

Marla Backer – Research Associates

I have one last question on a different topic because unfortunately you had to constrain spending and cap ex in the first quarter and your inventory levels were a little bit lower than they have been in recent quarters, do you think that we’ll see a lag now while you build up your inventory again? By the lag do you think customers may say to themselves, “Well, you know Blockbuster was out of stock on this title three weeks ago so I’m not even going to bother to go to Blockbuster, I’ll go elsewhere.” Before customers become reeducated to the fact that your inventory levels are back up?

James W. Keyes

It’s a reasonable expectation that you can’t just flip a switch and have customers who may have been disappointed in January or February with our inventory availability expect that now we’re going to be in stock on this month’s movies or on Taken for example. So, it’s disappointing that we had to take our foot off the accelerator on the inventory situation but we don’t think it will take long to get those customers back and, we’re stepping up our advertising to be able to address that point and be able to remind our customers that we are there for them. So, the temporary setback, unfortunate that we had to do it but we think we will be back. Could there be a lag in the second quarter as a result? Possibly, a little bit of a lag but, as I said we weren’t expecting to get immediately back in to the positive ranks.

Put this in the frame of reference, we started on this aggressive inventory in stock strategy in July of ’07 when the new management team came to Blockbuster and set up that strategy. It took us about two quarters, if you recall it took us actually one quarter to get almost even, the fourth quarter of ’07 we were just about even with the previous year and by the first quarter of ’08 we broke in to the positive ranks, by the second quarter we were strongly positive. So, there is a pretty quick response from the consumer when you’ve got what they want and we’re confident that we will see it.

Operator

Your next question comes from Carla Casella – J.P. Morgan.

Carla Casella – J.P. Morgan

A couple of questions, on the rent savings that you’re targeting is that part of the $200 million in SG&A savings?

Thomas M. Casey

Yes.

Carla Casella – J.P. Morgan

What’s the cost of the Callidus loan, the new Canadian loan?

Thomas M. Casey

The interest rate is 18%.

Carla Casella – J.P. Morgan

Is it floating or fixed?

Thomas M. Casey

It’s fixed.

Carla Casella – J.P. Morgan

Then with the game industry obsolescence right down that you took, do you see that because of the nature of the business going forward now that you are more games or was this a specific over purchase in certain inventory or something else that you could point to?

James W. Keyes

I would say that we were a little over zealous in our desire anyway to roll games to all 4,500 of our stores or something domestically last year. The game business is one that we believe is a great future opportunity for us but it is even more working capital intensive than the movie business. Now, this is a very frustrating thing for us because the cost to put a game on the shelves is some $40 when $35 of that is intellectual property and it only costs a couple of bucks to stamp out a game on a disc and put in on the shelves and get it in to our stores.

So, it’s unfortunate that we are seen as the ultimate customer by the game manufacturers because all we are is a distribution channel and if our shelves aren’t full the ultimate consumer doesn’t have what it wants, they can’t get the access to the depth and breadth of product assortment. We’re working that through with the game manufacturers to try and come up with new and different ways. Ultimately, the ideal situation in this kind of distribution channel would be a consignment model but that is a real challenge for the multilayer gaming industry where you have royalties to everybody from the NFL to the console manufactures to the game company itself.

So, it’s a challenge and as a result we’ve decided to be a bit more conservative because it did consume, our aggressive roll out of games did consume a lot of working capital in the past year and we want to develop the gaming business but we’re going to develop it in a more prudent fashion now going forward hence, the more aggressive write down of our obsolete games. We’re being a little more selective in which stores get how much inventory in the early days. So, bottom line you’ll see us grow it but you’ll see us grow it at a bit more measured pace going forward.

Thomas M. Casey

I would just add to give you some more color on it, in 2008 our game retail inventory was up by a factor of three. We’re pairing that back by about 40% so it’s still above ’07. On the whole the game business is doing well, game rentals is comping positively.

Carla Casella – J.P. Morgan

Then your sales of previously rented products were down pretty significantly, was that all part of the less inventory buys this year?

James W. Keyes

A combination of less inventory buys but also our previously viewed, we are partnering with the studios to try and come up with new ways to put product on the shelf. We don’t think previously viewed is good for the studio, for us, for the industry frankly because it puts a lot of cheap movies on the street and it detracts from the popularity of rental and ultimately from the popularity of retail when you can buy a recently seen movie at $6 which is some of what you’re seeing more and more of in the market place.

So, we’re actually working with the studios proactively to limit the amount of previously viewed product that we put on the street. That has had an impact on our sales. The trade off is if we can cut a deal with the studios that helps us fill our shelves with rental inventory, particularly tent pole titles, we think there’s a better tradeoff that ultimately will be better off, higher rents on tent pole titles, less reliance on previously viewed product.

Operator

Your next question comes from Analyst for Emily Shanks – Barclays Capital.

Analyst for Emily Shanks – Barclays Capital

First, just regarding the accounts payable decline, I wanted to clarify one thing, was that drop in the quarter due primarily to conservative ordering and should we expect the levels of accounts payable to ramp up as we go forward?

Thomas M. Casey

Normal pattern of seasonality is for the accounts payable to decline in the first quarter. This first quarter though there was a greater than normal decrease. We really aggressively managed our vendor payables to make sure that they were all current as we were out renegotiating leases and as rumors of liquidity were out in the marketplace. We wanted to make sure that was not an issue so that contributed to the decrease that you see that’s beyond normal seasonality. We also have related to our rev share agreements if you do traditional buys in a weak slate, the combination of those contribute to the reduction as well.

Analyst for Emily Shanks – Barclays Capital

Should we then expect levels to kind of come up to more normalized levels going forward on a [inaudible] year-over-year basis in the next couple of quarters or do you think we’ll see a lower level overall generally for the year?

Thomas M. Casey

We would expect a return to more normal patterns.

Analyst for Emily Shanks – Barclays Capital

As far as the kiosks go and digital delivery, I was wondering how far out do you see that service as being something that is part of the kiosks? Are we looking a year out, three years out, where do you see that timeline being?

James W. Keyes

Here’s the challenge, the technology is available today. We’ve actually got it in stores, I think about 10 stores piloting a digital download capability out of a kiosk. So, it works, it works quite well, customers love it, it is just encumbered by the lack of consistency among the studios on the encryption necessary to secure that intellectual property. There’s a lot of content that is available now, there are a lot of TV shows for example, all of the movies in the studio that Mark Cuban has, he does not secure his content and all of that content for example would be available if we wanted to provide it to the customers, could be available virtually right away.

Over time though for this to be commercially viable and something that the consumer really wants we have to get the studios to agree and collaborate on what that necessary standard will be. We’re hoping that happens during the next year, that they come together and decide on a consistent standard for some form of flash media so you could actually walk up to one of these machines, put your thumb drive in and load down one of the currently available video on demand movies.

That would be a great thing, put it in your PC, take it home and put it in your set-top box, or whatever. We think it’s the ultimate next step in portability from DVDs and a great use of digital content. So, when the timing of that will be is really dependent more on the studios and their ability to get consistency and for them to collaborate on standards. Meanwhile, you’ll see us slowly begin to progress with non-secure product in a very minor way basically that just makes it available to the customer. We hope to have more of those units beyond our preliminary pilot available later on this year.

Analyst for Emily Shanks – Barclays Capital

Can that format, say the flash drive, can that support Blu-ray quality or is Blu-ray still something that’s only available through a disc?

James W. Keyes

We think for a reasonable period of time the best way to get Blu-ray quality will be the disc. The file size necessary for that high definition is going to make it difficult for even most forms of flash media. You’d have to have a very expensive form of flash media if you did to be able to download that kind of file. So, the nice thing about that is we think that Blu-ray does have a good opportunity for us in particular to extend the lifecycle of the physical disc. This is good for us, it’s good for us right now online because unlike our competition we don’t charge a higher price for Blu-ray.

It’s good for us in vending because we will provide some assortment of Blu-ray in vending, our competitor doesn’t. It’s definitely good for our stores because the store will have the broadest assortment of Blu-ray rental titles available anywhere. So, a good thing for us in the short term that it is a difficult digital solution when it comes to high def.

Operator

Your final question comes from Carla Casella – J.P. Morgan.

Carla Casella – J.P. Morgan

On the slide that you showed about the funding activity, I don’t see anything in there about the free cash flow sweep. Was the free cash flow payment counted in this or would that be something that was made after this schedule?

Thomas M. Casey

It was made after the schedule. It was done the day after the end of the quarter.

Carla Casella – J.P. Morgan

So, the $47 million in cash would have been before making the payment for the free cash flow sweep?

Thomas M. Casey

Right.

Carla Casella – J.P. Morgan

And that was $25 million payment to [term B], is that correct?

Thomas M. Casey

Correct. As I said, it’s important to understand that the cash from operations significantly enhanced that number since.

Operator

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

James W. Keyes

Before closing my team here tells me that in response to a question previously I made reference to a specific EBITDA target rather than the range that we had provided. If that’s the case, I misspoke, I meant to refer to our guidance range of $305 to $325 million. I just want to make sure that we’re clear on that. I apologize for any misunderstanding that I may have caused but when I referenced specific EBITDA targets I meant to reference the range of $305 to $325 million for the year 2009.

I guess if there are no further questions then, we want to thank you today for your questions, for your continued support of Blockbuster. As you can tell we remain excited about the business, the opportunities that lay ahead. We look forward to sharing business updates with you in the future. Before I disconnect I’d like to remind you that our annual stockholders meeting will be held on May 28th and we’re scheduled to participate in Sterne Agee’s consumer conference in San Francisco on June 16th. We look forward to seeing you at either or both events. Thank you again for joining us today. I’ll turn it over to the operator to close the call.

Operator

This concludes today’s conference call. You may now disconnect.

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