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Outerwall Inc. (NASDAQ:OUTR)

Q1 2014 Earnings Conference Call

May 1, 2014 17:00 ET

Executives

Angie McCabe - Vice President, Investor Relations

J. Scott Di Valerio - Acting Interim President of Redbox; CEO

Galen Smith - CFO

Analysts

Steve Dyer - Craig-Hallum Capital Group

Mike Olson -Piper Jaffray

Andy Hargreaves - Pacific Crest Securities, Inc.

Operator

Hello and welcome to the Outerwall 2014 Q1 Earnings Conference Call. My name is Eric. I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Please note that this conference is being recorded.

I'd now turn the call over to Ms. Angie McCabe. Angie, you may begin.

Angie McCabe

Thank you, Eric. And thank you all for joining us for a discussion of Outerwall's 2014 first quarter results. Our call today will be hosted by Outerwall's CEO, Scott Di Valerio; and CFO, Galen Smith. Scott and Galen will make introductory remarks and then we will open up the call for Q&A.

The earnings release and prepared remarks including supplementary slides are posted on the Investor Relations section of Outerwall's Web site at ir.outerwall.com. In addition, our first quarter 2014 10-Q is available in SEC Filings section of our IR Web site.

As a reminder, beginning in 2015, Outerwall will provide annual guidance only. The company believes annual guidance is the more relevant measurement of the business given its stage of growth and full year results capture the varying seasonal patterns of each of its businesses.

During this call, Scott and Galen may reference non-GAAP financial measures. A reconciliation of differences between GAAP and non-GAAP financial measures is provided in Appendix A of both the earnings release and the prepared remarks.

Also during this call, various remarks we may make about future expectations, plans and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from expectations, plans and prospects contemplated in these forward-looking statements as a result of various factors, including those discussed in our latest 10-K and 10-Q filings with the SEC.

I'll now turn the call over to Scott.

J. Scott Di Valerio

Thanks Angie. We appreciate everyone joining the call.

We are off to a strong start this year with solid execution. Our executive leadership team is now place with the appointments of Mark Horak, Jim Gaherity and Maria Stipp. We continue to focus on managing our businesses to deliver value and convenience to our consumers resulted in greater returns for our shareholders.

Our Redbox line of business produced better than expected revenue and segment operating profit as rentals performed better in February despite the Winter Olympics spanning three week ends.

Blu-ray continued to grow hitting 15.2% of rentals and 17.7% of revenue in the first quarter. And Redbox increased its segment operating margins by driving revenue with 38% less promotional dollars and through continued focus on optimizing cost across the business.

Our Coinstar line of business also had a strong year-to-year results despite the challenges of severe weather in several markets. Average transaction size increased to $40.76 from $39.22 and segment operating margin increased 4.6 percentage points to 33% due to the price increase we implemented in the fourth quarter and our continued focus on optimizing costs.

In our new venture segment, we continue to invest in building the infrastructure needed to scale ecoATM, or making progress in the mass merchant and grocery channels. I'm pleased with how quickly we have deployed a software solution to deal with the locked iPhone issue in the fourth quarter of 2013 and we saw collection rate improve in Q1.

We are in the process of finalizing certain kiosks installation contracts and we continue to expect that we will hit our goal of approximately 1000 to 1200 kiosks installs this year. While Galen will give more details regarding our 2014 second quarter and full year guidance.

I would like to make a few comments about our outlook. The box office for the second quarter is significantly lower than the prior year and the first quarter, which is the primary reason for the lower Redbox revenue in the second quarter. Content does improve as you move into the third quarter, but it could take a bit of time for the traditional summer rental momentum to go.

Having said that, we are confident, we can achieve our guidance for the remainder of the year. We will stay focused on launching our Blu-ray upsell at the kiosks which has been successful in driving revenue in our text with their SMS subscribers. And continually improving our CRM systems to further optimize our promotional effectiveness in driving revenue at a lower cost.

At ecoATM, we will work with mass merchant and grocery retailers to execute our plans to scale the business and install kiosks this year and invest in technology that gives us a competitive advantage through the ability to identify and price a device in real-time. As always, we remain focused on leveraging our core competencies in scaling, managing and operating automated retail businesses to grow revenue, expand margins, and increase profits.

Now, I will turn it over to Galen to talk about our financial results and guidance.

Galen Smith

Thanks Scott.

We started 2014 on a good note. With approximately $600 million in consolidated revenue up 4.7% year-over-year. At Redbox, we produced almost $516 million in revenue from rental growth of 1.2% and we had 10 of our top 25 rental days including our highest day ever in Q1.

February title performance was stronger than we anticipated despite the Winter Olympics helping to generate better than expected results. Average check was up $0.02 from Q1 2013 to $2.58 in both rentals and revenue per kiosks was up year-over-year.

At Coinstar, the price increase implemented in October 2013 contributed to segment revenue increasing to $68.8 million. New ventures which consist of ecoATM and SAMPLEit reported $16 million in revenue and we saw acceleration in revenue throughout the quarter.

We generated $117.6 million in core adjusted EBITDA from continuing operations and $1.27 of core diluted EPS from continuing operations. Core adjusted EBITDA from continuing operations benefited from the higher revenue within the Redbox segment and our ongoing focus on driving profitability across the enterprise.

Core diluted EPS from continuing operations came in $0.30 above the top end of our previous guidance primarily due to three factors. First, the tender offer completed during the quarter added $0.06 to EPS and was not included in our guidance for Q1. Second, stronger operating results at Redbox including higher revenue and lower expenses contributed $0.13. Finally, lower operating cost across enterprise contributed $0.11.

We generated $67.6 million of free cash flow in the quarter up from $7.9 million in Q1 2013 primarily driven by working capital benefits that included $24 million cash tax refund we received in Q1.

In Q1, we repurchased approximately 6 million shares for $420.8 million through a 10b5-1 plan in January and the tender offer we completed in March. We remain committed to returning to 75% to 100% of free cash flow to shareholders. This includes the $70.8 million of shares previously repurchased through the 10b5-1 plan and a tender offer upsize.

We continue to believe that share repurchase provide a compelling return for shareholders given our confidence in the business and potential new growth opportunities. We intend to be opportunistic in purchasing our shares throughout the year.

Turning to guidance, there are several assumptions behind our expectations for Q2 including a significant reduction in estimated titles and box office, which is approximately 38% lower than last year and 62% lower than Q1. Further, there are eight weeks in the quarter where two or fewer new titles and we will enter June with no new releases in the first week.

In addition, we made assumptions around the timing of installs for ecoATM which has Scott discussed could be impacted by the timing of finalized contracts. As a reminder, Q2 2013 results included a $21.7 million one-time pre-tax benefit resulting from an accounting change related to amortizing content cost to Redbox that will impact our year-over-year comparisons.

For Q2, we expect consolidated revenue between $546 million and $576 million. Core adjusted EBITDA from continuing operations between $103 million and $118 million. Core diluted EPS from continuing operations between $1.24 and $1.44.

For full year guidance, we are raising our range for core adjusted EBITDA from continuing operations by the $10 million beat in Q1. We also are raising our range for core diluted EPS from continuing operations due to the higher profitability and the share buybacks in Q1, which for the full year totals $1.41 for both items.

We continue to expect this year to be second half loaded from a revenue and profitability perspective due to the continued growth in ramping of the ecoATM business, the expected content release schedule in several initiatives that Redbox will provide additional benefits during the second half of the year.

This includes continued focus on more efficient promotional spend, the ongoing growth of Blu-ray and the impacts of VMZ rebalancing. All of these efforts are key revenue end margin growth drivers. In addition, while we have included the benefit from shares repurchased through Q1 2014, we have not included the benefit from any additional share repurchases we may complete in the remainder of this year.

We are keenly focused on creating value by driving profitability and cash flow while making the right investments for the future of the business. We started the year strong and our focused on executing on our commitments to shareholders by providing consumers with great products and services.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Steve Dyer [Craig-Hallum Capital Group]. Please go ahead.

Steve Dyer - Craig-Hallum Capital Group

Thank you. Good afternoon. If we could talk a little bit about ecoATM, I'm wondering if you give a little bit more color as to the delay kind of you are seeing in terms of the momentum of the rollout that's I guess the first part I'm waiting and follow-up.

J. Scott Di Valerio

We are making progress with the accounts in mass merchant grocery Steve. Our installations are off to a bit of a slow start – doesn't have any due with the performance of the kiosks as much as its finalizing contractual terms with the various teams. So we do feel confident that we will hit the 1200 ecoATM kiosk installs this year.

Steve Dyer - Craig-Hallum Capital Group

Okay. And then you mentioned sort of the performance of the kiosks, are you seeing a similar performance in terms of revenue per kiosk and as you were sort of – you kind of outline at the beginning, is it being consistent or is it trending one way or the other?

J. Scott Di Valerio

Yes. It's been consistent as we have kind of worked through the locked iPhone challenges in the fourth quarter that also had an impact of January revenue in the first quarter. And we continued to add on new phones, we can take back products. So we can take back as new models come out. We are seeing it perform at/or or slightly above where we thought it was going to be.

Steve Dyer - Craig-Hallum Capital Group

Great. And then on both kind of an average transaction price as well as kind of number of transactions is that fair to say?

J. Scott Di Valerio

Yes. Yes.

Steve Dyer - Craig-Hallum Capital Group

Okay. Okay. Thank you.

J. Scott Di Valerio

Thanks Steve.

Operator

Our next question comes from Mike Olson [Piper Jaffray]. Please go ahead.

Mike Olson -Piper Jaffray

Hey, good afternoon. Just want to make sure, I'm getting the math right here. You already spent $70 million on buyback of 75% to 100% of free cash flow that you returned to shareholders. I think you are guiding $220 million mid-point of free cash flow for 2014, its at the low end of the 75% to 100% it would be just maybe only to buyback and minimum of around $95 million in additional stock. Does that sound like it's in the ballpark?

J. Scott Di Valerio

That's correct.

Mike Olson -Piper Jaffray

Okay. And then is there any reason to expect that you will change your policy 2015 related to return of cash to shareholders is just too early to say at this point?

J. Scott Di Valerio

I think we look at this as an important part of our business. Our business generates a lot of free cash flow and we made the commitment to return 75% to 100%. The mix may change over time in terms of share repurchases or doing it through a potential dividend down the road. But, we want to continue to enhance shareholder value this way.

Mike Olson -Piper Jaffray

Okay. And then lastly, you mentioned one of the reasons for expected improvement in Redbox in the back half of the year would be VMZ and some of the other CRM things that you are doing. You didn't mention pricing as one of the things that would drive improvement in the revenues there, right?

J. Scott Di Valerio

Right. Mike, we always are testing and price testing whether it would be through survey and everyone's while putting test into the market on a limited basis, we will continue to do that. But, we don't have any pricing and the guidance forecast that we gave you.

Mike Olson -Piper Jaffray

Perfect. All right. Thank you.

J. Scott Di Valerio

Thanks Mike.

Operator

Our next question comes from Andy Hargreaves [Pacific Crest Securities, Inc.]. Please go ahead.

Andy Hargreaves - Pacific Crest Securities, Inc.

Thanks. Just wondered if you can just – relative to the comping of the amortization change, can you give us any guidance on what your expectation is for the gross margin in Q2 and for the full year, now that we are kind of past that?

J. Scott Di Valerio

Yes. So really this was – change was made a year ago to align our expansions with our revenue. And so we were seeing a disconnect between the two, so obviously last year we had the one-time true up of the $21.7 million in Q2 and it has moved obviously from quarter-to-quarter a bit as we add a new content, right. So with less content coming into the box, this year we don't see – we don't – or this quarter we don't expect a big change in Q2.

And then, we will move based on the content release schedule in Q3 and Q4. So we are still expected to have some impacts from quarter-to-quarter. But it's not going to be necessarily a big change from where we are at coming out of the first year.

Andy Hargreaves - Pacific Crest Securities, Inc.

Does that mean that seasonality that we have seen in previous years to be similar or?

J. Scott Di Valerio

Yes. Seasonality should be similar. But, one of the disconnects we had before – this is what we saw – and saw this as a preferable way to treat amortization was in Q4, when you had a lot of content coming into the kiosks. But some of the revenues going to be generated in different period, you had a disconnect between the two.

And so as we have seen over the last couple of quarters, the margin is more – is smoother with when the revenue is being generated. So you don't see those big changes where you are going from 55% or 56% one quarter to 63% the next quarter. It's much more even at that 58%, 59%.

Andy Hargreaves - Pacific Crest Securities, Inc.

Okay. And then, is there anyway to quantify what's the impact has been from VMZ and from the location changes that you guys have been making?

J. Scott Di Valerio

So when we were rolling out VMZ, we saw a low single-digit increase in terms of the rents were happening in the kiosks that had. As we continue to move forward, we have added some new functionality this quarter in terms of smart rebalancing, which allows us to redeploy those [discs] (ph). It's pretty early to tell because we have deployed it this quarter, what impact that we are seeing, but it is positive in terms of making sure the right movies, are at the right locations where customers want to rent them.

And so again, I think its single digits for both of those items. But we think there is continued ways to refine that in making permits that we go forward throughout the year.

Andy Hargreaves - Pacific Crest Securities, Inc.

Okay. And then last, I apologize if I just missed it. But why did EBITDA guide go up but the free cash flows doesn't. Was there an increase to the CapEx expectations?

J. Scott Di Valerio

No. The CapEx stayed the same and so just, again, are there movements in free cash flow from working capital that doesn't change. So working capital may change, therefore, you don't see the change in working – in free cash flow.

Andy Hargreaves - Pacific Crest Securities, Inc.

Got you. Thank you.

Operator

(Operator Instructions)

Angie McCabe

Eric, if there is no further questions. We would like to have Scott wrap it up.

Operator

At this time, I'm showing no further questions.

J. Scott Di Valerio

Great. Well, as we wrap up the call, I would like to leave you with three takeaways. First, we had a strong start to 2014 as demonstrated by our first quarter results. Second, we believe we are well positioned and are confident in our ability to continue to execute on key initiatives as we move through the year. And third, we will continue to generate free cash flow and take a balanced approach invest in our future and delivering returns to shareholders.

With that, thank you for joining us on the call today.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

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