Lionsgate F3Q07 (Qtr End 12/31/06) Earnings Call Transcript

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Lionsgate Entertainment Corp. (LGF)
F3Q07 Earnings Call
February 12, 2007 9:00 am ET

Executives

Peter D. Wilkes - Investor Relations
Jon Feltheimer - Co-Chairman of the Board, Chief Executive Officer
Michael Burns - Vice Chairman of the Board
Steven Beeks - President; President of Lions Gate Entertainment Inc.
James Keegan - Chief Financial Officer, Principal Accounting Officer, Chief Administrative Officer

Analysts

Lowell Singer - Cowen & Co.
David Miller - Sanders Morris Harris
Michael Savner - Banc of America Securities
Jolanta Masojada - Credit Suisse
Gordon Hodge - Thomas Weisel Partners
Jeff Logsdon - BMO Capital
Thomas W. Eagan - Oppenheimer & Co.
Barton Crockett - JP Morgan
Alan Gould - Natexis Bleichroeder Inc.
Eric Handler - Lehman Brothers
Andy Nasr - Raymond James
David Bank - RBC Capital Markets
Matthew Harrigan - Janco Partners

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the fiscal 2007 third quarter analyst conference call. (Operator Instructions)

I would now like to turn the conference over to your host, Senior Vice President of Investor Relations, Mr. Peter Wilkes. Please go ahead.

Peter D. Wilkes

Good morning. Welcome to our analyst call. We will begin with remarks from Jon Feltheimer, our CEO; Vice Chairman Michael Burns; and President Steven Beeks. Jim Keegan, our CFO, and Rick Prell, our Chief Accounting Officer, are also on the call. Matters discussed on this call include forward-looking statements. Such statements are subject to a number of risks and uncertainties. Actual results in the future could differ materially and adversely from those described in the forward-looking statements as a result of various important factors, including risk factors as set forth in our Form 10-K filed with the Securities and Exchange Commission on June 14, 2006.

The company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances.

I will now turn the call over to Jon.

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Jon Feltheimer

Thank you, Peter, and thank you all for joining us this morning. I am pleased that our financial performance and the results we released Friday for our third quarter continue to reflect the effectiveness of our business operations and the strength of our strategy. Our strong performance at all metrics should continue into the fourth quarter, and we expect that we will exceed our guidance for the full year’s results. We are therefore raising our numbers for revenue and free cash flow respectively to $950 million and $100 million. This performance is also reflected on our balance sheet, with a continued strong cash position and growing backlog.

Let’s look at some highlights from our recent performance and then Michael will bring you up to date on our film slate, and Steve will comment on our packaged goods and digital strategy.

I am pleased that as I look at the growth story in terms of our contingent receivables, or backlog, as well as international revenues to see the contribution from two of this year’s strategic acquisitions; Debmar-Mercury and Redbus. With the acquisition of the distribution rights to Family Feud, as well as the rollout of Tyler Perry’s House of Payne, Debmar-Mercury, led by Mort Marcus and Ira Bernstein, will be adding significant revenues to Lionsgate next year, with strong margins improving the overall margin of the television at the same time. We expect television revenues next year to be over $200 million.

The recent releases of Employee of the Month and Saw III are proving out our strategy for self-distribution in key territories as a way to grow value. While we expected a strong result from Saw III, its performance exceeded that of Saw I and II. But Employee of the Month’s performance, compared to expectation, was significantly higher than we forecast. In the long run, we expect to earn millions of dollars more from just these two titles than we would have selling them off to a third-party distributor.

We will continue to look at other key territories as we are doing currently in Australia. When we have the right partners, the right assets, and the right business strategy, we see international expansion as a logical growth opportunity, given our significant content pipeline.

On the verge of true measurable results for the digital and new format exploitation of our product, I am pleased that our traditional distribution channels continue to perform. We are reporting year-to-date library sales from home entertainment, international and television of $185 million, meaning we will far exceed our $200 million forecast. Steve will talk about this later, but not only are we concentrating on mining our library, but our performance of first-run DVD product continues to out-perform the industry in terms of dollars and dollar conversion rate from theatrical to home video revenue.

Television continues to be a strong performer, where Kevin Beggs and Sandra Stern and their 16-man and woman division have almost one on-air series per person. The Dresden Files recently premiered to very solid numbers for the Sci-Fi Network; 8.5 million viewers have already seen the first episode and we have received our first scripted pilot order from a broadcast network and are negotiating for a second.

But the big news for us in television is still Weeds, which is not only a hit for Showtime but has been downloaded over 600,000 times and also shipped over 400,000 box sets. We are already being pursued by networks for the back-end strip rights as well because Weeds will be a signature show for some network after its Showtime run.

This quarter reflects the continued strong performance of our feature film business. Michael will take you through what we have coming in the future. Michael.

Michael Burns

Thanks, Felt. We recently signed our President of Production, Mike Paseornek, to a new four-year contract. Mike is truly the hardest working man in show business. Why that is a bit ironic is when he first came to Lionsgate seven years ago, Mike said he wasn’t sure we would make enough movies to keep him busy. It is fair to say that is no longer his current thinking.

I am going to quickly go through our in-house production and release schedule to give you a glimpse of what is on deck for us. Finished films include: Daddy’s Little Girls, the new feature film from Lionsgate’s favorite son, Tyler Perry, comes out wide this Wednesday for Valentine’s Day; we have Pride, based on the true story of Jim Ellis, an inner-city swim coach who took a bunch of misfit kids and turned them into national swimming champions, starring Bernie Mac and Crash’s Terence Howard, another wide release on March 23rd; Ray Liotta, L.L. Cool J. and Mekhi Phifer’s Slow Burn comes out on April 13th; The Condemned, which makes Survivor look like The Sound of Music, starring Stone Cold Steve Austin, will be in wide release on April 27th; Sarah Polley’s directorial debut and Sundance star Away From Her, which we believe will be a serious 2007 award contender for us, stars Julie Christie and opens May 5th; the comic superstars of the Blue Collar Comedy Tour will storm theaters on May 11th in the armed forces comedy, Delta Farce; The Exorcist’s Billy Friedkin will get under everyone’s skin with his new film, Bug, starring Ashley Judd, crawling into theatres nationwide on May 25th; Eli Roth’s eagerly awaited sequel to gore-fest Hostel, arrives May 8th -- my late mother would be really proud; later that same month, the light-hearted horror flick Fido, currently in Berlin, will fetch audiences on May 15th; Trade, again premiered at Sundance, a provocative thriller about human trafficking, starring Kevin Kline, will see wide release this August; the huge success of the Bratz dolls will be brought to the screen when the highly anticipated animated film Bratz see theatrical release later this summer; sex romp comedy Good Luck, Chuck, starring Dane Cook and Jessica Alba, will be heating up summer screens on August 24th; Jet Li and Jason Statham are set to strike the box office when Rogue is released in September; Jessica Alba will again grace theaters for Lionsgate late this year when she stars in the supernatural horror picture, The Eye, currently shooting in New Mexico; continuing our smash-hit franchise with Twisted Pictures, we are quite optimistic Saw IV will once again own Halloween; sisters Hillary and Hailey Duff, with a star-studded cast in the animated film, Food Fight, which arrives in the aisles on November 16th; additionally, we are very excited about our releasing Abandon, Captivity, Fierce People and Skin Walkers as part of our previously announced partnership with After Dark Films.

Anticipated feature green light productions include two new Tyler Perry films, Why Did I Get Married? and Jazz-Man Blues, along with a Bernie Mac concert film, Punisher 2, Bachelor Number 2, Zane’s Addicted, Midnight Meat Train, a co-production of the follow-up to Crank with our friends at Lakeshore, a new Rambo, and Ayn Rand’s Atlas Shrugged.

All in all, the most exciting slate in our history.

While theatrical box office results certainly get the glory, home entertainment, digital, and our robust library sales remain our often unheralded star performers. Steve Beeks will talk about all. Steve.

Steven Beeks

Thank you, Michael. Fiscal ’07 has been a year that has demonstrated the continued health of the home entertainment business and has introduced new technologies that will help drive our future growth. There is definitely a rising tide in home entertainment. Results of standard definition DVD continue to be strong. High-definition DVD is starting to generate real revenue. VOD is becoming an even more important component of the picture and electronic sell-through is gaining traction.

Our theatrical titles continue to over-convert in terms of box office to DVD revenue. In Q3, we released three significant theatrical titles to DVD: American Haunting, See No Evil, and The Descent, together shipping almost 5 million units.

As I mentioned, packaged media is still very healthy. We finished out the calendar year with a DVD market share of 5.2%, and maintained the highest box office to DVD revenue conversion rate in the industry for all live action features over the past two years, with a conversion rate of 1.1 to 1 versus the industry average of 0.97.

Our titles have also performed well in the DVD rental market. In fact, Lord of War was the overall number eight DVD rental in all of 2006. This $24 million box office picture outperformed many, many pictures with far greater box office.

January, while not part of Q3, is worth mentioning, since we had a very big month in home entertainment. We released four significant DVDs and shipped a total of almost 12 million units during the month, more than any month in the company’s history. Crank, Employee of the Month, Saw III, and the Invincible Iron Man, our third direct-to-DVD animated feature with Marvel, together shipped 7.5 million units.

Each of the six theatrical titles I mentioned will over-index in box office to DVD revenue and Crank should convert at a ratio of over 150%. We have also had a very healthy sell-through rate on each of the seven titles I mentioned.

Last week, Lionsgate titles occupied six of the top 20 slots on the DVD sales chart, including Crank, Employee of the Month, Saw III, and Iron Man, which held the number three slot, as well as Saw I and Saw II, promotions for which were piggy-backed on the campaign for Saw III.

We continue, as we mention every quarter, to focus on maximizing revenue generated by our library. As Jon mentioned, we will well exceed our projection of $200 million in revenue from the library, and over $75 million in free cash flow.

There are several examples in Q3 of our continuing strategy of re-releasing special edition DVDs drawn from the library, including Saw II, Reservoir Dogs 15th Anniversary, the Punisher Extended Cut, the Van Wilder: Van Gone Wilder Edition, and the Doors 15th Anniversary Edition. We also continue to focus on special periodic promotions for the library throughout the year.

High definition packaged media is becoming a real revenue generator for the library, as well as for new release titles. There are now five Blu-Ray hardware players on the market, including the PS3, and seven studios are now actively releasing product in the Blu-Ray format. Blu-Ray software sales have now overtaken HD-DVD sales by a wide margin, outselling the latter format by a two-to-one ratio in January.

Starting with The Descent on December 26th, we have begun our release strategy of Blu-Ray releases for all our theatrical films day-in-date with standard DVD. Saw III set the industry record for first week sales of Blu-Ray on its release, and as a matter of fact, we have two of the top four titles in that category and have an 11% market share in Blu-Ray software sales since inception.

So far, we have released 18 titles in Blu-Ray and plan to have as many as 40 to 50 titles in release by the end of the calendar year. It is worth reminding you that the wholesale prices, and therefore margins, for Blu-Ray releases are substantially higher than for standard definition. Our current wholesale price for new release titles is over $23 and over $18 for library.

With the rapidly expanding number of big players getting into digital delivery, it is now positioned to become a real contributor to revenue growth for home entertainment. We now have fully launched electronic sell-through and broadband VOD deals with Cinema Now, Movie Link, Amazon, which just announced an enhancement in their service through a partnership with Tivo, Fox Interactive Media’s Direct to Drive, X-Box Live, Netflix, which is now rolling out their broadband VOD service, and walmart.com.

And, as of midnight last night, Lionsgate is the third studio to launch electronic sell-through of our library on iTunes. There are already a handful of our titles available this morning on the iTunes store site, and we will be adding many more films over the coming days and months.

Given the success Apple has had selling library films on iTunes since its launch, we are confident that this new relationship will generate meaningful and incremental revenue from our ever-expanding library.

Our VOD business overall is showing significant growth year on year, with consumers embracing the choice and control that they can exercise in terms of consuming filmed entertainment in their home. We anticipate at least 25% growth in our VOD and pay-per-view revenue this fiscal year.

As some of you know, we are participating in a two market test with Comcast and other studios in which we are offering a few films for VOD on a day-in-date basis with the DVD release. While it is still early and all the data is not yet in, the initial results indicate this could be the win-win situation for which we were hoping. The take rate for VOD buys has been significantly above what we would normally see during the standard VOD window, and so far, we have seen virtually no cannibalization of the expected sales rate of the DVD and very little impact on rentals in the test markets compared with the control market.

We are not indicating a change on our sequential windowing strategy and we will be very sensitive to our conventional retail and rental partners, but these very early results are an encouraging sign that we might well be able to expand the size of the revenue pie.

All signs in home entertainment are good. There is strength in standard definition DVD. We have had a very healthy start to Blu-Ray high definition DVD. Our VOD business is growing rapidly, and digital distribution is poised to provide a meaningful source of incremental revenue.

The landscape looks very bright for continued growth in the overall home entertainment market.

Jon Feltheimer

Thank you, Steve. We have previously characterized digital and new format revenues as just the tip of the iceberg, but we are starting to realize how big that iceberg might be. Of the 29 digital vendor deals we discussed on our last call, nine deals are already active, five are fully executed contracts pending launch, and the rest are still in process.

Our bet on content continues to pay off. As we look at the media landscape, billions of dollars are being invested around the world in new platforms: mobile, broadband, fiber, satellite, and it is being spent to deliver content; on-demand or subscription, pay-per-view or advertiser supported, and Lionsgate keeps investing in that content, creating more and more titles, adding over 200 films, video and television titles this year to complement the thousands of titles we currently distribute, and while we invest, we remain profitable and keep generating cash.

As I said earlier, we expect to exceed our guidance in terms of revenue and free cash flow. We have added some un-budgeted mostly non-cash charges due to new stock and option grants, as well as investment in FearNet. However, we believe the performance of our operating units will allow us to absorb those charges and still meet our pretax income guidance, and on an adjusted basis, significantly outperform that metric as well.

I appreciate your attention this morning and welcome the questions.

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Lowell Singer from Cowen and Company. Please go ahead.

Lowell Singer - Cowen & Co.

Thanks. Good morning. A couple of questions. Can you talk a little bit about FearNet and where you are so far, what you have seen, and what the investment is going to be over the next couple of years in that?

Second, on the television side, can you give us a roadmap for the big items that you have coming on the revenue side over the next let’s call it 15 months, the end of this fiscal year and into fiscal ’08.

Finally, Jim, can you address -- Felt said you were okay on meeting the pretax and net income number with some of these adjustments, but you will outperform it prior to the adjustments. Could you talk about what those adjustments are? Thanks.

Jon Feltheimer

In terms of FearNet, performance-wise, it is ahead of all metrics. I think we have announced previously over the first three years or so, it will probably be about a $13.5 million charge. This year we took about $1.5 million in charges that we expensed, so we are basically on plan, ahead of plan in terms all of the audience metrics and basically on plan financially. One thing I would add to that is it is interesting that in the last few months, over 40% of the free television on-demand views from the consumer on all of Comcast on-demand, has been for FearNet, which is really interesting. What it shows is when you aggregate in brand content, people know where to find it and how to find it and the usage goes up tremendously.

In terms of television, when you look at the backlog, it is interesting. We mentioned that a big part of the increase of the backlog came from Debmar-Mercury. The performance of the television business, plus Debmar, should lead us to, as I said, revenues over $200 million and the margins improving on a blended rate to over 15% or so. I think that is a pretty good sense of where TV is going.

James Keegan

In regard to the unusual items, the real unusual items are what Jon referred to in terms of the new accounting rules related to stock option grants. For instance, in the third quarter of last year, we had a benefit as we mark-to-market in the stock option expense of $2.2 million, while in the third quarter this year, we had a charge of $3.2 million. The new accounting rule, FAS-123R, require that you use a fair value for all SARs and all stock option, because it was not the case, so it is intrinsic value on the SARs last year. So that is creating an anomaly.

Lowell Singer - Cowen & Co.

Jim, what will the fiscal ’07 impact be of that change?

James Keegan

Currently, I am at about an $8.6 million charge. I guess I will annualize at another $300,000, maybe $9 million, $10 million.

Lowell Singer - Cowen & Co.

For the full year. Okay, thanks a lot.

Operator

Your next question comes from the line of Jolanta Masojada with Credit Suisse. Please go ahead. Her line has disconnected. We will move on to the line of David Miller from Sanders Morris. Please go ahead.

David Miller - Sanders Morris Harris

Good morning, gentlemen. A couple of questions. Michael, you may be somewhat hamstrung from talking about it, because I do not get the sense the deal has closed, but on the film fund, at least conceptually, can you talk about whether or not you guys are negotiating some sort of call option whereby you can buy back the film slate? It just doesn’t seem like you guys to not own the films. If you could just clarify that for us, just conceptually, that would be great, and then I have a follow-up. Thanks.

Michael Burns

Theoretically speaking, it is typical in many of or most of those film funds for the distributor to have an option to call back the copyright to the film, so again, that is a theoretical answer for you. Obviously we are currently evaluating all of our strategic alternatives, lowering our cost of capital, but we are not talking specifically about a slate fund today.

David Miller - Sanders Morris Harris

Okay, and then Felt, on Redbus, what is the decision-making process internally over there at Lionsgate with regard to which product you push through Redbus? Is it as simple as the Saws, the Hostels, you know, the franchise oriented stuff that you think is going to play well to a U.K. audience, you push that through Redbus, or is the decision-making process more complicated than that? Thanks.

Jon Feltheimer

Well, it is basically our intention to put everything that we have in the U.K. through Redbus. The acquisition is not only looking very smart in terms of maximizing the value of the content we put through but also in terms of the way we acquire product. When we acquired, for example, 3:10 to Yuma, we were able to make that deal and it is a very exciting project. The dailies look great. This is the western that we are doing with Russell Crowe and Christian Bale, James Mangold directing them. It is a serious, serious package. We were able to make the deal because we bought four territories, including the U.K., in addition to our domestic rights.

So the ability to acquire and be competitive with the major studios acquiring more than just a domestic theatrical rights or domestic distribution rights, is an important part of the decision to go forward and expand our self-distribution.

Funny enough, even the smaller movies will probably get a better return. Those are a lot of the movies that typically in some sales to third-party distributors internationally, it is difficult to make those sales. We believe because of the ability not only to do U.K. theatrical distribution but home video distribution, paid television, free television -- we can maximize the value of all of our products.

David Miller - Sanders Morris Harris

Super. Thank you very much.

Operator

Your next question comes from the line of Michael Savner from Banc of America. Please go ahead.

Michael Savner - Banc of America Securities

Good morning, thanks very much. Two questions, if I could. First, could you maybe just kind of detail quantitatively the new guidance, where the upside is coming from, if it is one or two areas specifically? It certainly sounds like there are a lot of good things going on, but as we look at the new revenue and specifically the new free cash flow number, where the bulk of that incremental cash flow is coming from would be helpful.

Second, I apologize if you already mentioned it, but the announcement this morning that your films are going to be available via iTunes, can you update us on your strategy for Cinema Now? Obviously the products are not apples-to-apples, but certainly it could signal that maybe you are backing away from that project to some degree. So comments on both those would be helpful. Thanks.

Jon Feltheimer

The great thing about the digital world and the way we approach our business is that we want to have just as in the retail space, we want multiple buyers of our product. It is very exciting to have companies like Apple and Wal-mart get into the digital space because frankly, these big players are going to help organize the digital space. But in no way does this imply backing away from more, if you will, self-owned distribution capabilities that we have.

In terms of your first question, I think probably most of the upside overall from our numbers is coming from the contribution from our theatrical slate from this year and last year. Obviously the benefit of the performance from this year’s theatrical should extend into next year as well.

Michael Savner - Banc of America Securities

Great, thanks, and maybe just one follow-up, on the first one. Did this agreement with iTunes result, or has there been any near-term change to your wholesale pricing with people like Wal-mart, or has everything been status quo?

Jon Feltheimer

I will let Steve answer that question.

Steven Beeks

As we mentioned earlier, we are currently selling library titles on iTunes and it will not impact our pricing strategy at all in the marketplace.

Michael Savner - Banc of America Securities

Thank you very much.

Operator

Next we will go to the line of Jolanta Masojada of Credit Suisse. Please go ahead.

Jolanta Masojada - Credit Suisse

Thanks very much, and sorry if I am repeating any questions. I just dropped off the line for a moment. I wondered if you could give us the details of your free cash flow expectations in the fourth quarter, specifically the continued investments in TV and film production and your expectation from amortization.

Then secondly, on the television business, with the visibility you now have into the fourth quarter, what is your expectation for the number of episodes you will be delivering?

James Keegan

I guess I’ll take that. In terms of investment in film or television programming, we have been running pretty steady. The way I look at our investment in film or television programming, I take the increase in film and television programming and I net against that the increase in film obligations. You are going to see that if you track for the full year, we are running $54 million, $55 million a quarter, I would anticipate that same level of spend in Q4.

Jon Feltheimer

In terms of television, we do not have the number of episodes. We can follow-up with you offline. Television overall, we will be delivering some of the series that might have hit earlier, [the Spike Madman], we will not deliver until ’08, so we will be a little bit light. Overall on television for the year, maybe about $10 million light revenue wise, but in terms of profitability and free cash flow, we are going to hit the internal targets that we started with.

As I say, we can follow up with you on exactly which episodes will hit in the fourth quarter.

Jolanta Masojada - Credit Suisse

Thanks very much.

Operator

Next we will go to the line of Gordon Hodge from Thomas Weisel Partners. Please go ahead.

Gordon Hodge - Thomas Weisel Partners

Good morning, just a couple of things. Just curious if you could comment about film slate financing status. Is it done in -- maybe how is it structured, if you could comment at this point.

Also, on the test with Comcast VOD, just curious how long you anticipate that test taking before you reach any firm conclusions? It sounds like you have some early feedback that is positive, but when do you call that a wrap? Thanks.

Michael Burns

I will answer the question on the overall financings that we are looking at. We really cannot comment specifically on the film slate financing. Steve, you could take the other question.

Steven Beeks

Gordon, on the Comcast day-in-date test, it is too soon to say, but I would imagine over the next few weeks, we will have a pretty good idea of the impact. Then we have to regroup and figure out what that means and what that means for whatever future tack we are going take.

Gordon Hodge - Thomas Weisel Partners

Okay, sorry, last question. I think you mentioned, did you say that you shipped 12 million DVD units in just the month of January?

Steven Beeks

Yes.

Gordon Hodge - Thomas Weisel Partners

Terrific. Thank you.

Operator

Next we will go to the line of Jeff Logsdon from BMO Capital. Please go ahead.

Jeff Logsdon - BMO Capital

Thank you. Felt, what kind of competition are you experiencing at the film shows? I know it has always been competitive. Weinstein, are they being more active? Then, kind of as a follow-on, as you look at fiscal ’08, what is the mix between self-produced and acquired product?

Jon Feltheimer

Well, as we have grown the company, we continue to want to have more and more self-produced content for a number of reasons. To start with, we want to own more and more of our movies, so as we grow, we want to have more upside from our projects. The second thing is as we develop more and more sequels, franchises, we obviously again not only want to own more of them but we also have the confidence in their performance. So when you look at Tyler Perry and you look at Saw and you look at Punisher and you look at Hostel, obviously these are all projects that we will self-produce. The blend is definitely going more towards self-produced, co-produced kinds of projects.

Michael Burns

As far as the acquisitions, when we send our acquisition to the various festivals -- Sundance, Toronto, Cannes -- it is usually the same five or six potential buyers, buyers of choice for the producers and the sales agents of those films. While I will say that if Sundance has 5,000 films that are submitted and maybe they pick 100 and you hear of 10 and two or three do business, I would say that every one of those negotiations for those hotly contested films and we are certainly one of the five or six players at that table.

Harvey has certainly reemerged and we have seen him. We actually just teamed up with him on an acquisition out of Sundance, but as far as the breadth of choices for us, that is not limited whatsoever.

Jeff Logsdon - BMO Capital

Great, thanks.

Operator

Next we will go to the line of Tom Eagan from Oppenheimer & Co. Please go ahead.

Thomas W. Eagan - Oppenheimer & Co.

Great, thank you. I guess two quick questions. First, on P&A spending, you are out about $130-plus million, nine months in. Might you still hit the $150 million guidance for the year?

Secondly, if you could talk maybe more broadly about your relationship with Comcast. They are being very aggressive with video on demand and creating all sorts of new programming. Is it possible you could expand your current relationship with FearNet? Thanks.

Jon Feltheimer

I will take number two. We actually just came back from Philadelphia last week. We are tremendously enjoying our relationship with Comcast. Steve I think was trying to be very clear about not talking about these results until they are codified, but I will say that the initial results are I think very, very positive, and I think that as we look at all of our businesses, as we look at our pay television business, as we look at every way that we window our product, I think Comcast is trying to get out in front of some of those discussions and being creative about it, and we actually think that being slightly more independent and perhaps more entrepreneurial, our ability to play with these windows perhaps is a little bit more than some others, and so Comcast is a perfect partner for us in a lot of different ways.

We are looking a the results of our channel in order to decide whether there are perhaps some other channels to do with them, but the breadth of the conversations we are having with Comcast are far greater than just should we do just one other channel. There are a lot of different things we can do together.

Jim, in terms of P&A, why don’t you take that one?

James Keegan

Sure. We are still on track to be about $150 of theatrical P&A for the year.

Thomas W. Eagan - Oppenheimer & Co.

Great. Thank you.

Operator

Your next question comes from the line of Barton Crockett from JP Morgan. Please go ahead.

Barton Crockett - JP Morgan

Great, thanks a lot. I wanted to ask a question about the free cash flow. First, putting by way of background, I recognize you guys are doing a great job on many parts of your business, particularly on the TV side, but I still have some questions about the free cash flow, which still strikes me as noisy. I was wondering if you could answer the question this way, perhaps: if you look at the contributions to your free cash flow this year from working capital, it looks like that was north of $100 million, the way I calculate it and I can go through that with you, if you would like. Additionally, growth in film obligations excluding participation and residuals, which I put under working capital, has gone up, has contributed about $65 million to free cash flow.

Now, I understand you guys have changed your model and there have been some positive benefits to working capital from that, but I am wondering: when are these contributions going to start to level out? They should at some point level out and the free cash flow should be driven more by earnings as opposed to these changes in assets and liabilities. Over the course of a year or two, one would expect these to level out, and I am just wondering when that should happen. That would be the first question.

Then, the second question, turning to the TV side which, as you highlighted at the beginning, it seems like it is doing very well, could you give us a little bit of detail on what you see in terms of syndication as a contributor to TV next year for your flagship series like Dead Zone and Weeds? Also, an update on House of Payne and the contribution you see from that. Thank you.

Jon Feltheimer

I will take two first, and then Jim can cover the free cash flow question. Television next year, fiscal ’08, should see some syndication revenues from Dead Zone. The contribution from House of Payne will be, as I said, lumped into Debmar-Mercury but I think Debmar-Mercury should contribute between call it $60 million and $80 million of revenue next year, including Tyler Perry.

Weeds is only going into its third season, so it is early for syndication revenue but I will say we have significantly upped our home entertainment forecast for Weeds and I anticipate by the time that we have done 50 episodes, I would anticipate we would be up to $400,000 or $500,000 an episode, just from home entertainment revenue, DVD revenue from Weeds alone, and that is obviously coming in quarter by quarter as we ship.

James Keegan

I will take number one. Talking about Q4, just looking at it at a high, high level, if we are going to have $100 million of free cash flow and pretax net income of $32 million, you take that delta and that is about the same delta, a little bit less of the delta we had at the end of Q3, so what that means is the free cash flow benefit from working capital should be slightly down in Q4. However, going on to the earlier part of the year, we are and have received free cash flow benefits from working capital, large influxes from our AR, large AR at the end of last year that we collected. In addition, we had some increases in deferred revenue. A lot of that, it will be reversing in my Q4 as I take that revenue for the TV in, but net net, yes, there has been an increase from the working capital. They are normal, operational, it is how the business was run as we continue to grow it.

Jon Feltheimer

Let me say it differently. Obviously the lines did cross this year. We are back to forecasting about $100 million of free cash flow and significantly higher pretax income than last year. The lines clearly did converge. However, as we continue to invest in companies which we amortize and that creates a larger variance between free cash flow and pretax income, as we continue to grow our overall business, which means we are getting a little ahead by two quarters at all times of our participations, as the company continues to grow, there will continue to be a delta the way currently we report our earnings.

Barton Crockett - JP Morgan

Okay, looking ahead, for instance, to the next fiscal year, would you expect the delta to be less than it was this year?

Jon Feltheimer

As I said, it depends on the results of our business. It depends how we grow. It depends on whether or not we buy anything else. But in general, the lines definitely are trending closer together.

Michael Burns

The increased participations, that is the good news. That is because things are working.

Barton Crockett - JP Morgan

Okay, no, I understand that things are going. It is just at some point, it should level out and I was just wondering when that might happen, but I guess it is hard to say at this point. Okay, great. Thanks a lot.

Operator

Your next question comes from the line of Alan Gould from Bleichroeder. Please go ahead.

Alan Gould - Natexis Bleichroeder Inc.

Thank you very much. I have a few questions. First, Steve mentioned $75 million of library cash flow off of your north of $200 million of revenue. Is the library margin going up from 25% to 30%, or are you really surpassing that $200 million by a large amount?

Secondly, Jon had mentioned over $200 million of TV revenue last year, and just the Debmar-Mercury revenue just mentioned. Do you recognize 100% of the syndication revenue and then subtract out a producer’s fee so it comes in at a lower margin, or do you recognize just the syndication fee at a very high margin?

Also, Jim, any idea what the tax rate will be for the fourth quarter and year?

And the last thing, could you tell us a little bit about this Australian video company that you are bidding for?

Jon Feltheimer

That is a lot of questions. I am trying to write quickly here, Alan.

Alan Gould - Natexis Bleichroeder Inc.

Do you want to start with the library?

Jon Feltheimer

On margins, you have to remember, when we talked about margin, we never really talked about cash flow margin. We have always talked about P&L, margins as a P&L metric. So I think you are getting a little confused by that.

Cash flow from the library over $75 million on a P&L basis, we are probably only recognizing close to 21%, 22%, so whatever that would be, $45 million, $50 million.

On the Debmar-Mercury, typically we recognize the revenue on a couple of instances. Where they are considered agent rather than distributor, we will only take the fee.

Tax rate, I am not qualified to answer. Jim.

James Keegan

The tax rate is going to be approximately 14.4%, and that is coming, a portion of it is from the utilization of the pre-acquisition NOLs.

Alan Gould - Natexis Bleichroeder Inc.

Is that for the year or the quarter?

James Keegan

That is for the entire year.

Jon Feltheimer

Michael is Irish, but I will have him answer the Australian question.

Michael Burns

We bid 100% for a company called Magna, and it is an English-speaking territory obviously in Australia. Obviously through our success in the U.K. with Redbus, we think this is a chance for us to possibly self-distribute, and we like the assets of that company, although we have several different alternatives if we do not go that way.

I also want to point out that we have Simon Franks down there who started the U.K., started Redbus and quite an entrepreneur, so we are optimistic that Australia is going to be a good territory for us.

Alan Gould - Natexis Bleichroeder Inc.

On House of Payne, are you acting as agent?

Michael Burns

Distributor.

Alan Gould - Natexis Bleichroeder Inc.

Distributor. Thank you.

Operator

Your next question comes from the line of Eric Handler from Lehman Brothers. Please go ahead.

Eric Handler - Lehman Brothers

Thank you very much. Your cash balance is building up very nicely. At some point, do you think about share buy-backs?

Secondly, as your film slate grows next year, it seems like there is an increasing number of distribution only type of deals. Could you just give me a sense of what is the balance that you are trying to go after in terms of self-produced films versus distribution only films?

Jon Feltheimer

As Michael said numerous times, we never would rule out stock buy-back. We are continuing to aggressively move our company forward. We have talked about international opportunities. We like having the cash balances in order to move forward our growth strategy, but we would definitely not rule out share buy-backs.

In terms of the mix of product, typically we want to, as I said earlier, we want to own as much of our slate going forward as we can. However, we are balancing that out with as we grow the company, trying to use our cash effectively. Typically what we are looking at is when we have distribution only deals is that they would be larger movies where we would take less risk but still have significant revenue and margin opportunities.

Eric Handler - Lehman Brothers

Just as one quick follow-up, as far as the M&A market is going, are you seeing more deals coming on the market now, both domestically and international than prior? How is that market looking right now?

Jon Feltheimer

I think it is fair to say that there are a lot of assets that turn over because of positions that private equity takes, so obviously they go through a cycle. That is the good news. The bad news is that in some businesses, private equity will pay a significantly higher multiple. One thing I think that at least you have seen, Eric, over the last seven years, is that we are very disciplined buyers.

Eric Handler - Lehman Brothers

Thank you.

Operator

Your next question comes from the line of Andy Nasr from Raymond James. Please go ahead.

Andy Nasr - Raymond James

Looking back over the last couple of quarters, it looks like the increase in investment and film exceeded depreciation. Can we expect those numbers to balance out over the course of the next few quarters?

My second quarter is all else being equal, looking out to next year, if you assume TV revenues of $200 million and margins of 15%, it seems like that should have a significant impact on pretax profit and narrow the difference with free cash flow. Is that right?

Jon Feltheimer

Well, again, in answer to the last question, we are narrowing, and if operations continue with no significant change and no significant new investment, we are narrowing the lines between free cash flow and earnings.

Jim, in terms of investment in film and television, why don’t you take that one?

James Keegan

I’ll take that, and you see that we are running fairly consistently. Q1, my investment in film and television programming, take my investment in film and television programming less the increase in film obligations on $59 million. Q2, do that same calculation, $57 million. Q3, $54 million. Q4, as I said before, should be in that same range.

That should remain fairly constant, and just compare that against the amortization rates that you are seeing happen of throughout 40, fairly constant. I don’t know if that answers your question, but your investment is going to remain constant and your amortization rates are going to remain at about 40% on your motion picture division and closer to 80%, 90% on the television division.

Andy Nasr - Raymond James

Okay, great. Thanks.

Operator

Next we will go to the line of David Bank from RBC Capital Markets. Please go ahead.

David Bank - RBC Capital Markets

Thanks, good morning. We have not moved to Scotland. We are still in Canada. A couple of questions, I guess. First, big picture: could you talk, given the Magna bid and the Redbus acquisition, philosophically you guys have hedged your bets a lot by pre-selling international rights. Is your philosophy there changing or is it just kind of an English language country thing, or do you see moving on to the continent at some point for distribution?

The second question is much smaller picture -- sorry, Jim. You guys have now started reporting a participation of residual line on the balance sheet as opposed to the footnote for film obligations where you used to do it, and you have it on the cash flow statement, which you never had before. Is there any change in accounting that is driving that, and can you give us the participation and residual numbers that would have been there for 1Q and 2Q07?

James Keegan

The reason I actually broke it out was, in regard to the way I answered the prior question, everybody started asking what is up with your investment in film? So I said in order to create more transparency, I broke those two items out, just trying to make your job easier. So as you then look at it, you are going to see that as you go back in time, I will give you the numbers, the film and obligation only at the end of my Q2 was approximately 166; end of my Q1, about 120. My participations -- again, this is all in the footnotes -- at the end of my Q1 was about 155, participation was 151, 152 Q2, and like 170 at the end of Q3.

David Bank - RBC Capital Markets

But Jim, what would they have been, what would the cash flow entry numbers have been? Would we get that? I went through the footnote.

James Keegan

These are the same numbers I have in the footnote. For the cash flow delta, it would just be the delta between the two. So if you look at the difference between Q1 and Q2, the 155 goes to 151, that would be our use of funds is 4, and then 151 to 170, the use of funds is 19. I mean, the source of funds was 19.

David Bank - RBC Capital Markets

Okay, so on the current cash flow, the difference between the 170.7 and the 164.2, which is the balance sheet item, that would give you $6.4 million but the cash flow statement says $1 million.

James Keegan

That is because we purchased Debmar in the current year, so that added an increase to the film obligations that does not translate through.

David Bank - RBC Capital Markets

Okay, because you purchased Debmar. Okay, sorry, guys. Sorry for the minutiae.

Jon Feltheimer

In terms of international expansion, we have a huge team right now in Berlin and they are selling movies. We like that business. We like getting the cash in. We like minimizing our risks, but our job is to measure the minimizing risk with the growth of the company, so we are looking and continue to look at all different ways of expanding our footprint. So we are doing it judiciously. Redbus was a year ago. Australia will, by the time we are up and running, be at least I am sure another six months or so, and we are not stubborn about it.

If in Australia we cannot put the model together in the right way, we will not self-distribute. So it depends, as I said in my remarks, on what access that we have, what partnerships we have and what the best strategy for each territory is. In general, our business plan has not changed at all.

Operator

You have time for two more questions. The first one comes from Matthew Harrigan from Janco Partners. Please go ahead.

Matthew Harrigan - Janco Partners

I’m sorry, my voice is really hoarse. As a corollary on the international side, can you talk about your over-indexing on digital distribution and DVDs and such? I know how well your product performs in the non-English speaking territory is partly a function of how competent the people are that you sell the rights to in marketing, and obviously some product plays well in particular markets and some product does not. Do you have any sense for how your product over-indexes or under-indexes at a market like Germany or Spain or some of the major international markets? I apologize for the hiss at the beginning of my question.

Jon Feltheimer

I think that is actually a really interesting question. I think what you are saying is that the way that we focus on certain kinds of genre here allow us to over-index in packaged media as well as in digital, where you have a lot of early adopters and again, the same kind of young audience that we typically concentrate on. I think that is a really good question in terms of how it translates into the international market.

The answer is some of it translates really well and actually, some of it doesn’t. The difficulty in certain territories with the horror stuff, the horror content is that it does not play as well in free television in certain markets. Teen comedies traditionally haven’t performed as well, and yet, of course, things change. Right now, the results of Employee of the Month in the U.K. are really extraordinary. We are going to do about $7 million at the box office there. I do believe that the teen comedies will translate better, but what the answer to that, Paul, is because it is not vague, but it is impossible to pinpoint, the answer is that we are flexible about everything we do.

So typically, a major studio only self-distributes. We look at all kinds of different deals in a territory. We look at basically three different things. One is obviously selling the product to an all rights buyer. The second is actually self-distributing. The third is what we will sometimes do and have done, for example, on Saw; we will do kind of a distribution deal without an advance where we participate to a greater extent in the returns. For example, Disney is taking Saw III in certain territories. It is really doing a great job, and we will share much more of the upside than typically if we had done an all rights third-party distribution deal with a big guarantee.

We have given ourselves a tremendous amount of flexibility in terms of dealing with how our product converts in the international market.

Operator

Your final question comes from the line of Jeff Logsdon from BMO Capital. Please go ahead.

Jeff Logsdon - BMO Capital

My question has been answered. Thank you.

Jon Feltheimer

All right. Well, thank you, everybody. We will see you on our next call.

Operator

Ladies and gentlemen, this conference will be available for replay after 9:30 Pacific Time today through February 19th. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 860068. International participants dial 320-365-3844. Those numbers once again are 1-800-475-6701, with the access code 860068. That does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.

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