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Executives

Paul Davis - CEO

Gregg Kaplan - COO

Galen Smith - CVP, Finance and Treasury

Scott Di Valerio - CFO

Analysts

Alan Robinson - Royal Bank of Canada

John Kraft - D.A. Davidson

Eric Wold - Merriman Curhan Ford

Bob Evans - Craig-Hallum Capital

Steven Frankel - Brigantine

Ari Black -Thomas Weisel Partners

Coinstar Inc. (CSTR) Q4 2009 Earnings Call February 11, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Coinstar, Incorporated conference call. My name is Chanel and I'll be your coordinator for today. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions).

I will now turn the conference to your host for today's call, Miss. Rosemary Moothart, Director of Investor Relations. Please proceed.

Rosemary Moothart

Thank you, Chanel. Good afternoon everyone and welcome to our 2009 fourth quarter conference call. The speakers on the call will be Coinstar’s CEO, Paul Davis; and our COO, Gregg Kaplan. Also with us today are Scott Di Valerio, who will assume the role of CFO on March 2nd and Galen Smith, Corporate V.P. Finance and Treasurer. Paul will provide an overview of Coinstar's key accomplishments in 2009 and discuss how the company is positioned for continued success in 2010.

Gregg will discuss the businesses in more detail including 2010 initiatives. And then turn it back to Paul for a review of financial results and guidance. For the call today we have posted a slide presentation that Paul and Gregg will reference during their remarks. You will find a link on the home page of the investor relations section of our website. We’ve also posted the fourth quarter press release which provides a reconciliation of differences between the GAAP and non-GAAP financial measures that we may refer to during the call. The investor update we filed as an 8K earlier today is also posted on our website.

During this call various remarks we make about future expectations, plans and prospects of 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 recent 10Q filed with the SEC. And now I will turn the call over to Paul.

Paul Davis

Thanks Rosemary. Good afternoon and thank you for joining us on the call today. 2009 was the year of significant accomplishments for our company especially in light of some of the headwinds we faced. They are summarized on slide 3 and I would like to review a few of them with you beginning with the key financial highlights. Coinstar achieved an important milestone for the company surpassing $1 billion in revenue for the first time in our history, an increase of 50%.

We produced adjusted EBITDA of $203 million up 35% and we generated $0.91 of EPS from continuing operations which includes a non cash impairment charge of $0.15 per share related to our money transfer business that we took in the fourth quarter as a result of our annual goodwill impairment testing. Our business achievements underscore the strong consumer retail partner relationships that position us for long-term profitability. We added over 8700 DVD kiosks in 2009 giving us 22,400 kiosks at year end. We had over $365 million rentals and our share of the DVD rental market continued to grow ending the year at 16.8% up from 9% at the beginning go of 2009.

In our Coin business we installed over 800 kiosks and completed our Wall-Mart rollout and for the fourth year in a row we received a highly coveted 4th Wall Category Manager of the year award from Progressive Grocer. We expanded our partnerships with leading retailers in the supermarket, convenience, mass and drug channels. At Redbox we secured a number of key long-term relationships including rollouts at Kroger, ATB and 7/11 stores.

In our Coin business, both same Mart and Morrison's entered into new five year contracts and we are working to extend the number of retailers who have coin contract terms longer than three years. Also during 2009 we signed our first formal agreements with studios ensuring content for our consumers from Sony, Lionsgate, Paramount, Summit and Inciricle Entertainment.

Following a very successful 2009 I would like to share with you our three areas of focus in 2010 that you see on slide four. Each quarter you can count on us updating you on our progress in these three very important areas.

First delight and engage consumers. Our core businesses are built on providing consumers with a convenient and viable experience and we will continue to engage consumers through enhanced new services and offerings the coming year. We believe there is ample opportunity in all of our businesses whether it's DVD or Coin to enhance our consumer engagement.

For instance the Redbox, iPhone App is one of the most popular free apps with over 900,000 downloads since its launch in November of 2009. Gregg will share additional details on some of our plans for 2010.

Second, strengthened our partner relationships. Our partners include our retailers and our suppliers. We value these relationships and plan to enhance and expand them in 2010.

Third, generate profitable growth. As I've mentioned 2009 was a great financial year for Coinstar and our business is clearly winning with consumers and retailers. In 2010, we plan to continue to drive financial performance exemplified by revenue growth, free cash flow generation, improved ROIC and increased value for our shareholders. Our focus on consumers, partners and profitability will allow us to build on our current momentum and have a very successful 2010.

And now I would now like to turn the call over to Gregg to share additional details for the coming year.

Gregg Kaplan

Thanks Paul and good afternoon everyone. Today I'll discuss the exciting 2010 plans for our core businesses Coin and DVD. Let me begin with coin on slide six. The Coin business is an extremely solid business with healthy cash flow. It is been built over the years leveraging a strong patent portfolio that provides an effective barrier to entry. A few statistics on the current Coin business, at the end of 2009, we have 19,200 kiosks deployed in the U.S. Canada, U.K. and Ireland. During the year we processed over $2.9 billion in coin, and generated $258.8 million in revenue and $88.6 million in operating profit equating to a 34% margin.

We continue to be the leader in the self-service coin processing market by wide margin. In short, the coin business is a strong business which continues to produce healthy and stable cash flow. However, there remains a significant opportunity for the coin business. At any point in time, there is between $7 billion and $10 billion coin circulation which means we don’t process approximately 60% of the available coin. If we are to capture this untapped opportunity we need to become more creative, more innovative and more consumer focused. We need to think about our business less as simply coin counting and more as converting coins into commerce.

To that end I would like to share our plans for 2010 and beyond. Some of these initiatives are well developed while are others are currently in a testing phase. Regardless of stage we believe this is the most robust pipeline of growth opportunities that Coin business has had for quite a long time.

Turning to slide 7, our strategy can be summarized in 6 points of ours. First keep our installed base of machine flat in 2010 and drive growth to increasing transactions and our existing machine rather than relying on adding new machine to support our growth. We believe the key to growth for coin right now is same store sales and ROIC not new locations. Second implement a fee increase across all markets to enable us to drive profitability and to reinvest in the business.

Third expand beyond the limited traditional gift card alternatives that formed the basis of our current Coin to Card program and offer broader options to consumers to convert their coins into commerce often in (inaudible). Fourth we refresh the look and feel of the kiosks through improvements in the user interface and the new look for our machines.

Fifth market our machines effectively with the goal of driving profitability not just revenue and with greater involvement from our product partners and finally to support these initiatives, strengthen the platform by making strategic investments in our kiosks technology and infrastructure. We believe that in 2010 these initiatives will deliver at least 5% same-store sales growth the first positive comp for coin in two years.

Let me provide more details on some of these initiatives. Let’s discuss the fee increase. As you may recall from previous conference calls, our last U.S. fee increased occurred over 10 years ago. In those 10 years we’ve seen the CPI increase by over 43% yet our fee has stayed the same.

On March 1, 2010 our fee will increase from 8.9% to 9.8% in the U.S. and from 9.8% to 11.9% in Canada. You might ask will we see a volume drop due to the fee increase? We don’t believe we will. We have already taken our UK consumer fee from 7.9% to 8.9% following a 12 month market evaluation and all indications in our market tests and research indicate no impact to volume. In addition we have already communicated the fee increase to our retail partners and to date we have had positive support from them.

Moving to innovation on slide eight, there are several programs I would like to highlight. We had an excellent fourth quarter in coin to card program in terms of growth yet this portion of our business is still relatively small. We believe we will attract more consumers especially those averse to paying a fee by increasing the options available to them. Given that we're now focusing on three areas, expanded coin to card. We believe that adding more flexible coin to card options has the potential to be a game changer.

During the fourth quarter we began according to Albertsons gift card pilot in approximately 75 Albertson stores in the Seattle area. So far it has shown great results. In just 12 weeks this card has become the number one coin to card choice in those locations and has led to an increase in total coin volume with only marginal cannibalization of our existing card offerings. Helping retailers keep a larger portion of the $2.9 million processed in their stores is a significant win for them.

We believe other retailer owned card programs like this in which the card offering is spent on everyday necessity such as groceries we'll have the meaningful impact on bringing new consumers to Coinstar. Coin to commerce, we are also looking beyond traditional gift cards to broader consumer commerce opportunities which may hold completely untapped potential. For example we could offer consumers the ability to deposit coin into established financial accounts pay bills or use the coin kiosk as a way of accessing cash from deposit accounts. Stay tune for more details.

Greater card partner support; the growing number of our online retail partners who historically relied on credit and debit card transactions have now begun to focus on the cash consumer. During the fourth quarter, Amazon became our first card partner to market Coinstar promotion with both the presence on the website and e-mail to their consumers. We expect additional partners to follow suite in 2010. To increase consumer engagement, we recently formed a rapid prototyping team that is responsible for the development of new features and enhance the consumer experience, drive repeat usage.

The first enhancement developed by the team was the addition of a simple consumer capture tool. We believe a consumer's e-mail address can open the door to providing personalized user experience. Based on pilot results, we would expect to add over 250,000 consumer e-mail addresses per month. This team is also developing functionality, we call the split transaction. The Coinstar machine would count the coins first and then allow consumers to split the transaction between options such as cash voucher, gift card, online account or charitable donation.

Today consumers must choose how to spend their coin before discounted. We believe the split transaction feature will offer enhanced usability and drive more visits. Turning to slide nine, we're also testing an enhanced kiosk look and feel. Our look has not changed for nearly eight years, and we fear our familiar green machine can sometimes fade into the background. As a result we tasked our design team with the goal of coming up with some out of the box design which will stand out in the credit grocery store. We will be testing five new kiosk panel designs during the first quarter of 2010 and evaluating the results to determine their potential for roll out. We also plan to increase our focus on consumer marketing as you see in slide 10. We believe that consumer marketing can play an important role as we target new fee resisting consumers and remind current consumers that we are their most convenient coin conversion solution.

With the average consumer converting their coin less than twice a year we will test the use of marketing to establish and support our value proposition. Together we believe these initiatives will translate into positive same store sales for the first time since 2008. And now I would like to move on to our DVD business beginning on slide 12. As Paul mentioned earlier this was a very successful year for Redbox. We saw increasingly strong consumer engagement for instance on slide 13 you will see that our market share at the end of the year was 16.8% up from 9.0% at the beginning of 2009 and we gained while our brick and mortar competitors lost share.

We added an average of approximately 500,000 email addresses each month in 2009 ending with over $14 million. We communicate regularly with our SMS text message users currently over 1.2 million. We averaged over 1 million DVD rentals per day in 2009. On slide 14 our net promoters scored at 83%remains higher than many iconic brands demonstrating how our consumers continue to love our offerings. At the same time it was a year that had many challenges. In the fourth quarter we moved from a work round with one studio to a work around with three studios.

Our field team did a tremendous job in securing as many work around copies as possible, yet we often did not have enough copies to meet all the consumer demands. In fact we believe that the lower supply copies may decreased revenue in the quarter by as much as $15 to $25 million. In addition the work around typically cost us an incremental $1 to $2 per DVD due to increased supply chain costs and higher retail prices. Work around also impacted our same store sales growth which was 21% for the quarter.

We have said for several years that no retail business is able to maintain same store sales in the 50% to 80% range we once had. The maturing of the business would naturally bring that number down. So while our comps continue to very strong we do expect the maturing of our business will decrease same store sales in the coming years.

Turning to installations 2010 will mark another year of kiosk growth with plans for 7000 to 8000 kiosk installs. As with previous years, demand for installations far exceeds the number we will actually install. We believe the 7000 to 8000 figure allows us to meet a good portion of retailer demands all the while meeting our strict IRR hurdles. With this in mind as is worth noting that we have already sold a majority of our expected installations for the year.

At the same time we are closely monitoring density in all the markets in which kiosks are installed. Even in our most dense markets our machines generate attractive IRRs. The high density markets do have slightly lower IRRs than the average kiosk but they are still well in excess of our cost to capital.

Slide 15 illustrates our rapid growth in kiosks installed which demonstrates that we are clearly winning with the consumer at a time when our competitors are rapidly shutting stores around the country. In fact while our competitors were closing approximately 1800 of their stores over the last year we installed 8700 additional kiosks. As the store closures continue to accelerate we believe we can capture a meaningful portion of these displaced consumers with our valuable and convenient DVD rental options.

The future looks extremely bright for Redbox. We strongly believe that physical DVD will be the preferred medium of home entertainment for many years to come. As studios continue to develop high content entertainment such as Blu-Ray and 3-D movies Redbox is well positioned to be the delivery mechanism of choice due to our ability to deliver content to a broad base of consumers very inexpensively through our physical kiosk presence. Our kiosks eliminate the challenges of time and bandwidth that would be necessary for consumers to directly access this content in their homes.

We should also point out that Redbox's growth is not dependent upon a flat or growing DVD rental market. We believe that Redbox will continue to take share and be a leader in DVD rental market even as that market eventually plans and as our competitors continue to close doors.

Despite our confidence that Redbox's fiscal DVD rental business will sustain it for quite a long time, we recognize that there will be a gradual shift to digital and we will not be watching from the sidelines. We believe digital represents a great way for loyal Redbox customers to access wider variety of title and we can effectively offer in our kiosk. Over time, Redbox customers have said to us, we love Redbox and usually rent new releases, but there are times when we want to watch an old classic, can you offer that? Digital is a great way for us to offer that alternative. We began testing digital downloads in 2009 and will use 2009 to continue testing.

Again stay tuned for more details. Before I hand it back to Paul, I'd like to take a few minutes to update you on our automated retail strategy. Back in when we founded Redbox, we thought there were great consumer and retailer trends to support a broad automated retail business and hope that some point we could pursue it. With Redbox to success together with the stable and strong cash flows from coin, we believe that time is now. We're very strong core competencies in kiosk development, deployment and operations.

Additionally, we have strong relationships with many of the best known retailers in the world. Upon those competencies and relationships, we believe we can build new automated retail businesses which provide great products and services to retailers and consumers. As it currently stands, we've three of these businesses in market test, two more moving towards the market test in 2010 and the pipeline that will enable us to launch several additional tests every year. As with any new business, then will some will succeed and some will fail.

We will use the same discipline that help us build coin and Redbox into successful businesses and will shut new ideas down quickly if they don't hit necessary target. At this time, we're not yet ready to provide details about these pilots, but we will share a more when we're ready to roll each one out. And now I'll turn the call back to Paul for a review of financial results.

Paul Davis

Thanks Gregg. 2009 was a fantastic financial year for Coinstar, as I mentioned at the beginning of my remarks. Turning to slide 17, I would like to point out a few highlights from Q4. Consolidated revenue was $328 million up 44%. Revenue growth was primarily driven by Redbox reflecting the continued expansion of our footprint in growth at existing machines. Adjusted EBITDA from continuing operations was $55.5 million up 26% while total net income was $5.5 million and GAAP EPS on a fully diluted basis was $0.18. These results include the $0.14 non cash impairment charge related to our money transfer business.

Now let’s dig a little further beginning with expenses. On a consolidated basis for the fourth quarter direct operating expenses were $234.3 million or 71.4% of revenue. The increase in direct operating expenses on an absolute basis was primarily driven by the growth of DVD revenue. As a percentage of revenue fourth quarter direct operating expenses increased largely as a result of declines in DVD salvage values and the impact of the work around purchases which as Gregg mentioned not only increased costs but also had a negative impact on revenue.

Marketing expenses were $6.2 million or 1.9% of revenue and G&A expenses were $30.5 million or 9.3% of revenue. For the year direct operating expenses were $793.4 million or 69.3% of revenue. The dollar increase was due to the significant growth in the business as in the fourth quarter comparison the increase in direct operating expense as a percentage of revenue was driven by decreases in DVD salvage values and the effects of the work around purchases. Marketing expenses were $22.8 million or 2% of revenue and G&A expenses were $127 million or 11.1% of revenue. These were both down as a percentage of revenue compared to 2008 as we experienced leverage from scaling of the business.

Slides 18 and 19 summarized the results in our business segment. In discussing the result I will refer to segment operating profit or loss which we define as segment operating profit or loss prior to depreciation, amortization, stock based compensation and share based expenses. For DVD Q4 revenue was $231.8 million, 73%. 2009 revenue was $773.5 million, up 99%. For DVD the growth in revenue for the quarter and the full year reflects the continued expansion of our footprint as well as growth at existing machines. In the fourth quarter revenue was negatively impacted due to challenges of securing sufficient quantities of work around titles.

Q4s segment operating profit was $36.8 million or a 15.9% margin, down 1.1 percentage points. 2009 segment operating profit was $128 million or a 16.6% margin, a 2 percentage point decline. For DVD decreases in segment operating margins were due to declining DVD salvage values and the impact of the studio workarounds. For coin, Q4 revenue was flat compared to prior year at $66.4 million. 2009 revenue was $258.8 million for the year, down about 1%. For the quarter and the year coin revenue was primarily affected by two factors. First coin transactions were down but in line with many of our retail partners. Second the volume of coin in circulation has decreased due to the recent decline in coin production at the mint and an increase in coin inventory as I said both related economy. Q4 segment operating profit was $21.9 million or a 33% margin down 3.5 percentage points.

2009 segment operating profit was $88.6 million or 34.2% margin down 1.4 percentage points. Segment operating comps in Q4 in the full-year were affected by the same factors at affected revenue. The full-year is also impacted by exchange rate fluctuations. For money transfer Q4 volume was $23.1 million up 9.5%. 2009 revenue was $87.7 million up slightly. Q4 segment operating loss was $10.1 million or a negative 43.7% margin. And for the full-year, it was $19.1 million or a negative 21.8% margin inclusive of the $7.4 million non-cash impairment charge I mentioned earlier.

For e-pay Q4 revenue was $6.7 million up nearly 5%. 2009 revenue was $24.8 million up 1.2%. Q4 segment operating profit was $0.2 million or 3% margin. 2009 segment operating loss was negative $1.1 million or a negative 4.4% margin. Looking below the operating profit line for Q4, interest expense was $9.8 million including $1.4 million of non-cash interest expense. Our effective tax rate for continued operations for the quarter was 42.8%. For the year, interest expense was $34.3 million driven by an increase in debt used to purchase the remaining stake of Redbox earlier in the year. This includes $1.9 million of non-cash interest expense related to the convertible notes we issued in Q3 to provide Coinstar with a sustainable capital structure.

Our effective tax rate for continued operations for the year was 39.3%. Cash taxes paid for the year were $1.3 million. There are a couple of highlights on the balance sheet as of December 31st our outstanding revolving line of credit was $225 million a decrease of $10 million from the prior quarter. CapEx was driven by investment in 8700 DVD in more than 800 Coin kiosks that were rolled out the year. Total CapEx for the year was $153.5 million which includes $124.8 million per DVD and $21.2 million for Coin. Total CapEx for the quarter was $48.3 million which includes $40.6 million per DVD and $5.4 million for our coin business.

Now let’s review the guidance for 2010 that we provided in the investor update that we filed as an 8K earlier today. I will summarize the key points here that you see on slide 20. It's important to note that our corporate allocations for 2010 will be different than 2009 with a majority of the allocation going to DVD as it continues to become a larger part of our overall business.

In addition our guidance reflects certain assumptions we’ve made related to our studio relationships and our supply chain, including the impact on revenue and costs related to challenges in securing DVD content. Our guidance also reflects the number and time in the plan kiosk installations. Approximately one third of our planned DVD installations will occur in Q1 and as they ramp we expect our results to build momentum as the year progresses, particularly as we move into the second half of the year.

For the full year 2010 we expect consolidated revenue opportunity $1.465 to $1.565 billion. Consolidated EBITDA of $250 million to $265 million and GAAP EPS of $1.50 to $1.65 on a fully diluted basis. Average shares outstanding between $31.4 million and $31.6 million and an effective tax rate of approximately 41.5%. Due to the strong year ahead we expect to generate $40 million to $60 million of free cash flow which we define as operating cash flow less capital expenditures. This is driven by the ongoing cash flow generation of our coin business as well as the DVD business turning free cash flow positive for the year 2010.

We currently expect to use our free cash flow to de-lever but we'll maintain flexibility to make strategic investments throughout the year. We expect CapEx for the full year in the range of $152 million to $174 million. This includes for the coin business CapEx for new kiosks in the range of $8 million to $10 million. We plan to increase full unit swaps from 250 to 500 which is reflected in new machine CapEx. In addition there are several hundred kiosks redeployed each year due to store closures or removals. As we replace these locations with new ones the associated CapEx is included in our new machine CapEx estimate.

We expect maintenance CapEx in the range of $10 million to $13 million. Over the last few years a significant portion of the cash flow generated by the coin business went to funding other businesses. To ensure a strong stable platform we are increasing our coin maintenance CapEx this year. For the DVD business CapEx in the range of $115 million to $125 million largely used to fund our 7000 to 8000 new kiosks.

We currently expense any replacement parts as necessary. Corporate CapEx of $15 million to $20 million which is primarily for investments in IT and new businesses. Before we move to Q&A, I'm very pleased to introduce Scott Di Valerio to all of you. Scott joined us four weeks ago, and will be taking over as CFO on March 2. Scott brings extensive management, finance and operational experience and as they welcome edition to our executive management team.

Scott Di Valerio

Thanks Paul. I'm very excited to be joining the company, working with you and Gregg to drive business forward in creating increased shareholder value. I was attracted to Coinstar for several reasons. First, the coin business is well established. As we heard earlier in the call, there is an opportunity to generate increase profitable growth in the years to come. Second, Redbox has and will continue to have great growth prospects as the company meets the home entertainment needs of the consumers and finally there are a number of exciting, new automated retail businesses in the pipeline that can generate future financial growth. Again, it's great to be part of the Coinstar team and now back to you, Paul.

Paul Davis

With that I'd like to go ahead and open the line for questions.

Question-and-Answer-Session

Operator

(Operator instructions). Your first question comes from the line of Alan Robinson of Royal Bank of Canada.

Alan Robinson - Royal Bank of Canada

My first question relates to the DVD rental business. Just generally speaking when we look, I don't know you are somewhat precluded from speaking at length on this matter, but when you look at the work around you have in place with certain studios. Generally speaking what is preventing you from striking agreements with the hold out studios that would allow you to perhaps offer titles you know a little bit after the street date perhaps you know a month or so after the street date could you just give us an idea that you are thinking there.

Gregg Kaplan

Yeah this is Gregg, obviously we certainly are always interested in discussions with any studios both the ones we are working with as well as the ones we are not in our experience sometimes those are long and difficult discussions so that’s essentially the issue for us right now. I can’t really comment specifically on individual deals or specifics of the deals.

Alan Robinson - Royal Bank of Canada

Are you able to give the sense of what you are able to offer the studios in terms of negotiations just from a sort of from a qualitative point of view in terms of the information perhaps you are able to provide the studios with respect to the rental trends that are for movies, can you give us an idea of that.

Paul Davis

Yeah this is Paul. There are a number of things that we can offer to studios you know first if you just look at the traffic that goes past our stores kiosk each week it upwards to $200 million consumers so the studios that work with us we have the opportunity just based upon our connection with consumers we talked earlier about having your $14 million email addresses and our ability to text directly to our consumers there are at least 40% of our consumers we’ve learned over the last few months they will have a try before they buy so they like to rent it first, they like to move it and they come back and buy it so on that front in terms of you know a real benefit for the studios beyond just buying the movies you know either wholesale or through the stores and the work around its really an opportunity for us to grow their new product sales, is one. The second thing for some of the studios that we've done the copy deals with after we live the useful life. So the title comes into the box and we turn it a number of times then we will destroy titles to avoid them from going back out into the street which is a benefit to them. We don’t like being in the used product business, nor do they.

Alan Robinson - Royal Bank of Canada

And then just switching over to the coin business, intrigued by your price increases but if I just look thorough the numbers it looks like on coin your projecting a 10% fee increase than translates to a 5% overall coin business increase in revenues. So I guess my question is are you assuming this will cause a shrinkage of 5% in terms of the volumes of customers that come to your machines?

Paul Davis

It’s a good question. We didn’t experience anything like that in the UK First that’s a full year number. So we're not actually rolling this out until the first part of March. So you have to factor in a couple of months there where we actually might be in the negative territory on the comps and it’s a bit of a guess because we're trying to extrapolate what happened in the UK and in some of our feedback from consumers but we think 5% is a good number to build the budget around.

Alan Robinson - Royal Bank of Canada

Okay so I guess reading between the lines I could expect there might be a little higher than that if you don’t get any customer attrition.

Paul Davis

That’s fair. That’s not what we're getting to. We're seeing 5% but you can draw your own conclusion.

Alan Robinson - Royal Bank of Canada

And then can you share with us how many of your current coin customers have contracts that will expire within three years, what kind of percentage is it? Is it half? Is it a third? Can you give us a rough idea of those?

Paul Davis

I don’t know that we've ever disclosed any of the details on our contracts. We mentioned and we will update every quarter as new contracts, and we extend it over to long haul, but I don't think we publicly have now disclosed that.

Operator

Your next question comes from the line of John Kraft of D.A. Davidson.

John Kraft - D.A. Davidson

Impressive results given the particulars of the situation right now, Gregg, I just wanted to go back, actually the follow-up on something Alan just asked regarding the fee increases in coin, did I hear you correctly, did I hear you say that the merchant partners that you've talked to like Amazon and Starbucks have not given you push back presumably, this fee increases is going to drive more consumers towards that cash to card product?

Gregg Kaplan

No. actually, let me clarify when we said during the call that we had already communicated this to our retail partners. What we meant there were the partners such as Wal-Mart, Kroger, etcetera and to date, they have all been supportive of that communication.

John Kraft - D.A. Davidson

But that presumably would not be the group that's going to want to push back on something like that. They would support that, I would think.

Gregg Kaplan

That's why we want to make sure that we did communicate to them and so far they have been supportive, and that was the key constituent that we wanted to check with as their customers are also our customers.

John Kraft - D.A. Davidson

Okay, but presumably you're not going to lose any of the coin to card retail partners?

Paul Davis

Yeah. We've had early discussions with because I think what you're really asking John is those people that would be funding the fee on a fee free transaction. Would they take issue with us, and we won't go into the particulars negotiations with these online or retail partners but we don’t we will have any attrition there. In fact its almost the opposite. We actually had interest in other parties that would be interested in partnering with us just because they are really starting to realize the potential with our consumer base.

John Kraft - D.A. Davidson

Got you I mean obviously the trends are starting to look better in Coin. I mean I guess separately are you able to tell whether the incremental customer is the new customers are those that are using the coin to card or I mean its simply an awareness thing I would presume.

Paul Davis

Yeah we certainly have seen some increase in usage of coin to card particularly over the last several months we did do some test marketing over the last portion of the year that seemed to have encouraging results. Having said that it is also a small base and there’s a lot more marketing and code offerings that we need to introduce in order to continue to drive that piece.

John Kraft - D.A. Davidson

Fair enough. And can you comment at all on the legal costs that you spent in Q4 and or may be just how that might compare to what the quarterly run rate would be in 2010 and your guidance.

Galen Smith

We have not broken that out. Its not come to a point where its material not to do so its baked into our guidance but again right now we are not going to break that out separately.

John Kraft - D.A. Davidson

Okay fair enough and Galen since you are there how about tax rate expectations for 2010.

Galen Smith

Yeah tax rate is 41.5% for 2010.

John Kraft - D.A. Davidson

41.5, okay great guys' thanks.

Operator

Your next question comes from the line of Eric Wold of Merriman Curhan Ford.

Eric Wold - Merriman Curhan Ford

Couple of quick questions, one, yeah I know you probably had a 15.9% EBITDA margin for Q4 on the DVD business. Given at that I want to include kind of two of the three months for the workarounds for the two additional studios do you have a sense of kind of what that might have been kind of a pro forma basis. Was it for all three months?

Galen Smith

Eric this is Galen. No we did not calculate that and provide that. What came in as you mentioned right at the end of October, the last week there with the two additional ones but we did not calculate that.

Eric Wold - Merriman Curhan Ford

And then kind of looking at your guidance for 2010 on the DVD side, can you give us a sense of what EBITDA margins you are assuming for the year. Are you assuming that kind of what you've been experiencing since the end of October to now kind of continues as it is, it gets worse, it gets better, any sense there?

Galen Smith

Yeah we are not providing EBITDA guidance for the year. Again with our consolidated EBITDA that we are talking about we have included what our assumptions are related to our supply chain and to the relationships and so that’s all bate in there but we're not going to break out today what the EBITDA margins are.

Eric Wold - Merriman Curhan Ford

And then just lastly, not as a specific percentage but just conceptually are you assuming things just kind of continue as they are right now or it gets better or worse?

Paul Davis

Obviously we can't comment a lot there because you know the litigation can go very deep with where we stand with the studios. I will tell you that we're, the one thing I will say is that we are optimistic that we can work through this and its in, we're working hard to try to get past this.

Eric Wold - Merriman Curhan Ford

Okay and then last question on the DVD side, I'll let someone top in. When you gave the number about the estimate, you might have lost about $15 million to $25 million of revenue due to lack of copy disks. Can you give us how you came to that number? Do you get a sense the consumers are going to a kiosk looking for a specific title, not seeing it and walking away and not going to choosing something else?

Paul Davis

Yeah. I'll take a shot and then Gregg can jump in. As you know because we have a great value proposition, so a lot of the people did show up at our box, aren’t necessarily looking for specific title. Though actually go there and then decide at the point of purchase. And for those people that have a specific title in their mind, and they go there and we don't have that. Yeah, you do lose a little bit. We have a pretty good hand that's that based on our research as to what we think the range of that might be, but there's still a very high percentage of what happens. There is a fair bit of switching where person if they had a title mind because it’s a dollar, it is a great value for entertainment, they will switch to something else. It might be selected on their wish list.

Gregg Kaplan

So Eric, Gregg here, just a follow-up on Paul's point. The actual sort of calculation that will go through to get to that estimate is what we know on a title-by-title basis, what we would purchase in a scenario where we have unlimited access to copies, we calculate the difference between that and what we actually did purchase and then make an estimate of how many turns we likely would have had on our occurred title basis. And then we have to make a guess to the substitution factor that Paul just mentioned because if somebody shows up they don't get their first choice. There is a higher percentage of them that will go for their second or third choice, and but we have a decent idea of what that looks like, and that once you work through all of that, that's how you come to that $15 million to $25 million number.

Operator

Your next question comes from the line of Bob Evans of Craig-Hallum Capital.

Bob Evans - Craig-Hallum Capital

Good afternoon and thanks for providing a level of detail that you've provided. First, can you comment a little bit more in terms of availability of content more recently there's been a lot of press as it relates to perhaps the AVD limits that Wal-Mart target other areas but our checking has any care that you know just to you know those are pretty lose limits can you give us a sense of have things changed much more recently than what you’ve experienced it the fourth quarter.

Unidentified Company Representative

Yeah it hasn’t gotten easier. I wouldn’t want to misconstrue that it's where we were in the fourth quarter with the recent limits that Wal-Mart put on its made us we are having to work a lot harder and lot smarter. I mean there are lots of different channels and lots of stores out there that sell new releases and we are able to leverage our feed on the street to secure that but we are really trying to put our arms around the impact and we start in Q4 and we will see some impact this clearly in this year but we’ve had to make some guesstimates on where we will end up with the various studio relationships and we’ve built these all of that into our forecast for the next year.

Bob Evans - Craig-Hallum Capital

Okay thanks and then can you may be this is a question for Galen but D&A expense where are you looking to be for the year?

Galen Smith

Bob I don’t know that we’ve broken that out separately I can follow-up with you.

Bob Evans - Craig-Hallum Capital

Okay that's fair enough and then also I don’t know some of all commented just how should I know you are not giving specific quarterly guidance but I know Q1 will tend to is seasonally down how should we think about kind of Q1 seasonality relative to Q4.

Unidentified Company Representative

Yeah it’s a good question Bob you know we obviously didn’t give Q1 guidance today but what you should see over the course of the year is really the strength of the year will really be in the second half because we are adding a high you know a lot of kiosk in the first quarter, we have to work around issues that we talked about. This is number of things that we say, the second half be much stronger than the first half.

Bob Evans - Craig-Hallum Capital

Okay and did you say a third of your kiosk installations are going to be in Q1 for DVD?

Unidentified Company Representative

Yeah that’s correct.

Bob Evans - Craig-Hallum Capital

So let's about you should take the midpoint ballpark 2500?

Unidentified Company Representative

Yeah.

Bob Evans - Craig-Hallum Capital

Okay, very good. And should we think about this guidance that you've given as kind of a base case guidance and if you are able to do other, come to some studio resolution or upside to that I guess or how should we view the guidance?

Gregg Kaplan

We've had to make a number of assumptions on we're well end up with studios, we're well end up with product supply, coin contracts, all of that. So there are a multitude of assumptions built into this and they're always in any forecast there are plusses and minuses. We just feel like this is something, this is a good range that you should build through your spreadsheets on.

Bob Evans - Craig-Hallum Capital

And final question, do you believe you have enough data either on delayed window or potential price increased to make kind of good rational decisions as it relates to the studio negotiations. Have you tested long enough to know where your levers are?

Unidentified Company Representative

We're getting smarter every month. We believe, we at least now know that windows and we've tested a multitude of different windows that there is some impact on the top line. So if you do lose some top line, any sort of a range when we have the studios you would have show some sort of significant cards reduction in order to make that work. And once again, every month it goes by we're getting a better and better hand that looks like.

On pricing, Redbox is just autonomous with value. Do we believe there is some pricing elasticity with the brand? Yes, is it the right time to make that play, that we're still working on and we're trying to sort through, but what's good is that we're trying to put more science into it versus art and every month we're getting smarter and smarter and what that might look like.

Operator

Your next question comes from the line of Ari Black of Thomas Weisel Partners.

Ari Black -Thomas Weisel Partners

Just wanted to dig into the impact, that $15 to $25 million impact of the work around on revenue is it safe to assume or is it reasonable to assume that 10% impact would basically be a good range for what the impact would be under a 30 day delay with those studios?

Paul Davis

I think at this point, I don't think we're going to comment on with the output of our research was on the Windows whether it would be several days or several weeks, we're obviously in the midst of litigation and other kinds of discussions and for the moment, we're not going to comment.

Ari Black -Thomas Weisel Partners

And wondering if you could comment on Disney's comments from its recent conference call, basically that they are looking into the windowing of home video products, is there any reason why we should be concerned by this comment, any insight you can give us there?

Paul Davis

We don't have a lot of comment. I know that there is been all sorts of comments in the (inaudible) press just Lionsgate just yesterday I think they talked about you know endorsing the relationship they have with us on sort of a day in date arrangement so we’ve kind of tried to get out of commenting on other people’s comments because I think each all these things are trying to determine their best path forward.

Ari Black -Thomas Weisel Partners

Okay and wondering if you could comment on what’s happening with previously viewed DVD prices.

Gregg Kaplan

This in Gregg as they have for the last year plus of course they do continue to decline and that’s baked into the guidance that Paul and Galen went through little while ago.

Unidentified Company Representative

And one thing I would like to add on that is as you know its becoming less and less of an issue for us as we increase the number of copies of that deal because we are baking that into the price that we are getting.

Ari Black -Thomas Weisel Partners

Okay there might be a lot of disconnect in my thinking but with the impact of the work around with the declining prices it seems like your margins should have come down a lot more and the increase of $1 to $2 on the DVD side what am I missing is it just the maturity of the kiosks improving the productivity or is there something else.

Gregg Kaplan

It would be a function of yes as the kiosk ramp will continue to perform well as well as the number of turns we are able to get out of each DVD.

Paul Davis

Yeah you have things in both directions going in both directions. You do start to get as we scale you start to get some leverage which allows the margin to go north. The offset would be the impact of additional work around cost and the resell price on previously viewed dropping. So the net of that is what we’ve parked in our guidance for 2010.

Ari Black -Thomas Weisel Partners

Okay that helps and then just finally can you update us on the strategic review. I think last call you said that you hope to come to a resolution in the first half of 2010?

Paul Davis

So when you say strategic review you're talking about money transfer and epay?

Ari Black -Thomas Weisel Partners

Exactly

Paul Davis

Yup. Yeah, we've talked about looking at strategic alternatives for both businesses and we are, we still believe that we should have some resolution in the first half of 2010.

Operator

Your next question comes from the line of Steven Frankel of Brigantine.

Steven Frankel - Brigantine

Could you give us an update on the Paramount relationship?

Paul Davis

Well I'll take a shot at it and Grey can jump in. As you know we had a deal that went through I think middle of December which was extended through the end of June and we have a real positive relationship with Paramount. We continue to work with them and test a number of different things, impact on a new product sales, we're testing different kinds of window arrangements etcetera and really not in a position to give a lot of detail on how that’s progressing but once again a real positive relationship and we value that partnership.

Steven Frankel - Brigantine

Great and on the increased degree of difficulty on the workarounds, do you think you have seen the worst of it as of, here we are in mid February or it gets tougher as you go through Q1?

Gregg Kaplan

I think the estimates that we laid out for the fourth quarter are a pretty good estimate of how we'd see things going forward in terms of our ability to secure these titles. The good news is that our folks out in the field get better and better on a regular basis of securing these copies and in smarter at how they are able to get these copies, so I guess I would say yeah, that feels like a pretty good estimate.

Steven Frankel - Brigantine

And let me just try to press it one other way. Should Q1 be the bottom in margins in DVD?

Paul Davis

Most likely.

Operator

Your next question comes from the line of Bob Evans of Craig-Hallum Capital.

Bob Evans - Craig-Hallum Capital

Up so quickly. The DVD business, I think one time as I mentioned before it might be free cash flow positive 2010 is that still the case?

Paul Davis

Yes.

Bob Evans - Craig-Hallum Capital

And can you give us any sense, I know you broke up the segment, profit, loss and money transferred analytic business, you're trying to suffer. Can you give us a sense of EBITDA to that business about excluding the charge or perhaps in what type of EBITDA you might be looking for 2010 either look back or go forward whichever?

Paul Davis

That's a good question. I don't think we've disclosed that, and we're not prepared to do that today either.

Gregg Kaplan

Bob, segment operating profits and losses relatively closed proxy for EBITDA and you can just make the adjustment for the impairment charge that we've announced for Q4.

Operator

That concludes the Q&A session, and I just want to call over to Mr. Paul Davis.

Paul Davis

As we embark on 2010, I don't want to sight of the accomplishments made possible by the work of the entire Coinstar team during 2009. By many measures, Coinstar had a tremendous year creating value for our consumer's retail partners and shareholders. 2010 will build on this momentum as we continue to delight and engage consumers through the innovation of Redbox in our coin business, strengthen our partner relationships including securing a supply chain and make decisions that enable us to grow profitability and generate free cash flow. All of this points to our continued leadership and automated retail. We look forward to updating you on our progress next quarter. Thank you for taking time to join us on the call today.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Coinstar Inc. Q4 2009 Earnings Call Transcript
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