Outerwall (OUTR) Erik E. Prusch on Q1 2016 Results - Earnings Call Transcript

| About: Outerwall Inc. (OUTR)

Outerwall, Inc. (NASDAQ:OUTR)

Q1 2016 Earnings Call

April 28, 2016 5:30 pm ET

Executives

Rosemary Moothart - Director-Investor Relations

Erik E. Prusch - Chief Executive Officer & Director

Galen C. Smith - Chief Financial Officer

Analysts

Darren P. Aftahi - ROTH Capital Partners

Michael Olson - Piper Jaffray & Co (Broker)

Operator

Good afternoon, ladies and gentlemen. Welcome to Outerwall's 2016 First Quarter Earnings Conference Call. My name is John and I will be your host operator on this call. Please note that this call is being recorded today, Thursday, April 28, 2016, at 2:30 PM Pacific Time. A replay will be available after the call ends today through May 12. Details on how to access the replay are available on Outerwall's earnings press release.

Following the company's remarks, we will conduct a question-and-answer session. Instructions will be provided at that time. I would now like to turn the meeting over to your host for today's call, Rosemary Moothart, Director of Investor Relations at Outerwall. Please go ahead.

Rosemary Moothart - Director-Investor Relations

Thanks, John. Welcome to Outerwall's 2016 first quarter conference call. Our CEO, Erik Prusch and CFO, Galen Smith, will host today's call. Erik and Galen will make introductory remarks and then we'll open up for Q&A.

The first quarter press release and prepared remarks are posted on the Investor Relations section of Outerwall's website at ir.outerwall.com. The 10-Q was filed earlier today and is also posted in the SEC Filings section. During the call, year-over-year comparisons we make will be Q1 2016 versus Q1 2015, unless we state otherwise. In addition, Erik and Galen may reference non-GAAP financial measures. Definitions and reconciliations of differences between GAAP and non-GAAP financial measures are provided in Appendix A of both the earnings release and the prepared remarks.

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

I'll now turn the call over to Erik.

Erik E. Prusch - Chief Executive Officer & Director

Thanks, Rosemary. Thank you everyone for joining and for your ongoing interest in Outerwall. During the quarter, we achieved consolidated revenue of $536 million, a sequential improvement from the $527 million in Q4. In addition, we generated $54 million in free cash flow this quarter and core diluted EPS of $2.44. These results are a testament to the significant value our businesses offer to our millions of loyal customers and retail partners and demonstrate our continued ability to generate solid cash flow and core EPS.

Looking across our business results for the first quarter, we were pleased with the stabilization we saw in the business with Redbox delivering sequential growth in revenue and rentals. Redbox revenue was $421 million, which is up sequentially from the $407 million of revenue in Q4 2015. Rentals were up from Q4 with a stronger average check as we benefited from higher game rentals and lower promotional spend.

Further, we saw a sequential increase in our high frequency renters or HFRs due to our ongoing efforts to engage and retain customers coupled with new content introduced during the quarter. Beyond movies, our new release game rentals continue to perform well across our network of kiosks. Specifically, popular new generation titles from Q4 2015 helped to drive rentals in the quarter. In fact, we conducted a field survey in March that emphasized high marks in customer satisfaction and indicated the majority of customers, roughly 80%, see game rentals as a way to influence their purchasing decisions. Clearly, we're filling a try before you buy market need and we will continue to invest in the right titles across consoles to take advantage of this market opportunity and support the needs of our customers.

In addition, our popular Play Pass loyalty program grew more than 100% year-over-year to nearly 4 million customers with membership increasing sequentially by 19%. Loyal Play Pass members continue to be some of our most valuable customers representing 13% of all rentals and 50% of all online transactions.

Looking ahead, Redbox remains a very large and compelling business with one of the strongest brands in home entertainment, providing new movie releases and games to millions of consumers. We continue to believe that this will be the case for many years to come.

Turning now to Coinstar, the business produced a solid quarter with $72 million in revenue, which underscores the ongoing strength in the overall core business and solid execution in U.S. and international markets. As such, we continue to look opportunistically overseas. We're seeing positive results from our newest test in Spain with transactional volumes that meet our expected ramp. And we are preparing to expand to additional test locations. Taking our proven business model and expanding outside of the U.S., Canada, the UK and Ireland, where products like Coinstar are absent, remains a fantastic opportunity. We continue to expect international expansion to be a growth driver in 2017 and beyond.

Turning to our ecoATM line of business, during Q1, we made substantial progress integrating the two businesses, which is evident in the results. EcoATM segment revenue increased $22 million or 113% year-over-year with Gazelle contributing $21.2 million. Average selling prices or ASPs increased 9%, reflecting higher ASPs in the direct-to-consumer channel and increased collections of higher value devices.

Important to note that we're committed to driving a more efficient business. For instance, we're focusing on direct operating savings by having multiple channels collect and sell devices. As reflected in our quarterly results, we have significantly narrowed our losses, demonstrating our progress toward segment operating income profitability for 2016.

With that, I'll turn it over to Galen.

Galen C. Smith - Chief Financial Officer

Things, Erik. Our 2016 first quarter results reflect solid execution in managing our businesses for profitability and generating cash flow. As a result, we delivered core adjusted EBITDA from continuing operations of $108 million, core diluted earnings per share from continuing operations of $2.44 and free cash flow of $54 million.

During the quarter, we identified additional opportunities to reduce expenses. For example, we made organizational changes that will reduce G&A expense going forward by $9.7 million on an annualized basis. The restructuring related activities resulted in approximately $3.3 million in one-time G&A expenses, which have been allocated to the lines of business and are included in segment restructuring and related costs. We did experience an increase in G&A expenses in Q1 as a result of the shareholder activism activity during the quarter.

In the first quarter, we continued to demonstrate our commitment to returning capital to investors. We paid $5 million in quarterly dividends and opportunistically repurchased $57 million in face value of our 2019 and 2021 senior notes for $45 million, reducing our long-term financial obligations by taking advantage of a dislocation in the market.

In total, we reduced outstanding debt by over 9% this quarter and finished with a net leverage ratio of 1.72 times, slightly lower than Q4 2015. As previously announced, we increased our quarterly dividend by 100% in the second quarter, underscoring our confidence in the ongoing prospects for the company. We will continue to return significant free cash flow to investors with a preference for dividends and opportunistic debt retirement.

Turning now to first quarter segment operating results, Redbox performance in Q1 2016 was in line with expectations. In Q1 2015, Redbox benefited from the price increase that occurred in Q4 2014, which drove the highest quarterly revenue in its history. In contrast, during Q1 2016, the benefit from the price increase was much smaller as consumer behavior settled in at a different level as we went throughout 2015.

Rentals and revenue were also impacted by sector decline, in line with expectations of 15% to 20%, which contributed to the large difference in year-over-year comparisons. However, we are encouraged that on a sequential basis, Redbox key metrics were up, including rentals, revenue, net revenue per rental, operating income, operating margin and gross margin.

Gross margin was 54.4%, a year-over-year decrease of 510 basis points. As mentioned, Q1 2015 Redbox gross margin benefited from record revenue and favorable mix of content. In Q1 2016, gross margin was negatively impacted by 220 basis points due to amortization from the Q4 2015 overbuy. Sequentially, gross margin increased 230 basis points.

Redbox segment operating margin was 20%, a decrease from 23.6% in Q1 2015, reflecting lower revenue and gross margin. Operating margin also included the allocation of one-time restructuring costs. Excluding these costs, segment operating margin would have been 20.6%. Sequentially, segment operating margin increased 460 basis points.

We continue to aggressively search for opportunities and take decisive actions to optimize Redbox's largely variable cost structure. We're reviewing every component, including adjusting the number of kiosks to align with demand which will drive lower content and servicing costs, refining content agreements, aligning head count with operating results, improving our supply chain, and reducing operating expenses. While we continue to make progress in Q1, we believe there is room for more.

Turning now to Coinstar, segment operating income increased $2 million to $25 million and operating margin increased 150 basis points to 34%. The increases reflect strength in the core U.S. business and ongoing expense management to create efficiencies. ecoATM Q1 2016 segment results include the operating results of Gazelle. For comparison purposes, Q1 2015 results do not. During Q1, we made substantial progress integrating the two businesses which is evident in the results.

We had $8.5 million in identified synergies for 2016 we're in the process of achieving. For instance, we're moving the servicing of ecoATM kiosks from a third-party to our Redbox field team which will improve quality, lower cost, and increase uptime. Segment operating loss decreased by $2.6 million or 31% year-over-year. We're on track with our expectations to achieve ecoATM segment operating profitability for 2016.

Turning now to guidance, for the full year 2016, we expect core adjusted EBITDA from continuing operations between $340 million and $380 million, core diluted earnings per share of between $5.35 and $6.55 impacted by the benefit in Q1 from the bond repurchases and free cash flow between $140 million and $190 million.

For Redbox, Q2 2016 box office is expected to be $3 billion, an increase of $912 million or 43% compared with Q2 2015 with three more titles. Star Wars: The Force Awakens represents $934 million or almost one-third of the box office in the quarter, which explains much of the increase year-over-year. If not for Star Wars, box office in the quarter would be down by 1%. We remain focused on continuing to manage our business for profitability and cash flow and returning capital to create value for shareholders.

Before we move to Q&A, let me turn it back over to Erik for a few additional comments.

Erik E. Prusch - Chief Executive Officer & Director

Thank you, Galen. Prior to opening the call for Q&A, I'd like to discuss a series of recent actions that demonstrate our strong and unwavering commitment for our shareholders and to creating significant shareholder value at Outerwall. First, as Galen mentioned, we doubled our quarterly cash dividend to $0.60 per share. This move is consistent with our strategic priorities of returning significant free cash flow to investors.

Second, the Outerwall board initiated a formal process to explore strategic and financial alternatives to maximize shareholder value. The process is actively moving forward and we will evaluate all options thoughtfully and carefully with the support of our financial and legal advisors. As I hope you can appreciate, we will not be making any further public comments about this process until we complete our evaluation.

Third, we entered into a cooperation agreement with one of our large shareholders. We appreciate the open and constructive dialog we have had with our shareholders. We also welcome the additional perspectives to our board as we continue to evaluate options to maximize shareholder value and manage our business for profitability and cash flow.

That concludes my prepared remarks. I'd like to remind everyone that the purpose of today's call is to discuss our first quarter results. And I ask you to please limit your questions to our earnings announcement.

With that, I'll turn the call back to the operator for the Q&A portion of the call.

Question-and-Answer Session

Operator

Thank you. Our first question comes from the line of Darren Aftahi from ROTH.

Darren P. Aftahi - ROTH Capital Partners

Hey, guys. Thanks for taking my questions. Just a few, if I may. First, Erik, did I catch you, did you give the Gazelle revenue number in Q1? If you didn't, I'd love to know what that was. Two, it looks like you shifted your capital allocation strategy. I know you emphasize share repurchases. Now it seems like you've skewed that towards dividends and debt repayments when opportunistic. I am kind of curious about the rationale of that.

And then, thirdly, I think in your prepared remarks, you said you still expect a 15% to 20% decline in rentals year-on-year. I'm just curious, with the Summer Olympics basically being a void and also there being an election this year, it seemed like last Summer Olympics there was a pretty sizable time when high frequency renters came back to the box office or excuse me, to the kiosks in the fourth quarter. What kind of gives you confidence in that 15% to 20% number, just given you're at minus 20% for the first quarter? Thank you.

Erik E. Prusch - Chief Executive Officer & Director

So thanks for the list of questions, Darren. Yes, we did say that Gazelle contributed $21.2 million in Q1. As far as -

Galen C. Smith - Chief Financial Officer

Yeah. As far as the allocation, we did make the distinction going back to last earnings call, Darren, that as we thought about how we can allocate capital, based on the bond repurchases we did in Q4, that we'd also look for us to be opportunistic there as well. And so obviously we saw a great opportunity in Q1. We retired $57 million of face value for $45 million, reducing our debt significantly, over 9% debt reduction in the quarter between bond repurchases and paying down our revolver. So, yes, that's a key part of our strategy going forward.

And the last question, I think, was on the Redbox rental decline. Obviously, you go back 2012, we were lapping a very significant quarter for Q3 in 2011. And as you look at what we're comping against this year, it's a lot easier comp. So if you think about Q1 and Q2 of 2016, there are harder comps related to 2015. As you move into Q3 and Q4, they start to get to the easier comps. And so again, while we do expect obviously a decline in Q3, we've also got an easier comp that we're going up against.

Darren P. Aftahi - ROTH Capital Partners

Great. Thanks, guys.

Erik E. Prusch - Chief Executive Officer & Director

Thank you.

Operator

Our next question comes from the line of Mike Olson from Piper Jaffray.

Michael Olson - Piper Jaffray & Co (Broker)

Hey. Good afternoon. A couple questions. Are you seeing some of the Redbox customers that may be lost during the period of weak titles slate in the middle of last year coming back now that the slates have improved to some degree? Or is it just impossible to measure that?

And then, secondly, how do you look at Star Wars here? How do you think it will do at Redbox? Do you think this is going to be like Avatar where everyone saw in the theater and is buying the movie or do you think it will see some outsized volume from this movie versus an average title? Thank you.

Erik E. Prusch - Chief Executive Officer & Director

So, as far as the first question is concerned, we did see a nice little pop in terms of customers coming back in Q1. We saw some nice strength in terms of our HFR customers or high frequency customers. We also saw some nice developments in terms of our marketing initiatives. Emails were up and our ability to engage customers were up. So, those were all pointing in the right direction. We felt confidence that the programs that we're running in Q1 matched with the slate real well. And, therefore, we saw a nice pop in revenue from Q4.

Galen C. Smith - Chief Financial Officer

And on Star Wars, I mean, it's pretty similar to what we've seen previously with big titles. I mean, it's always very title specific. So, when you had the biggest movie of all time, you don't expect it to be a big renter. It will be something that people saw at the theater or something that they purchase for their library. But, obviously, we do think it's an important title for us to have available to consumers. It is generating rentals. But it does explain a lot of the box office that we had in Q2 2016.

Michael Olson - Piper Jaffray & Co (Broker)

Thank you.

Operator

The Q&A session has concluded. And I will turn the call over to Mr. Erik Prusch, CEO.

Erik E. Prusch - Chief Executive Officer & Director

Thank you, operator. Outerwall is a vibrant and strong company with compelling brands, millions of loyal customers, and an unrivaled network of more than 60,000 network kiosks. We remain focused on managing our businesses for profitability, optimizing cash flow, controlling expenses, and executing on our plans. And we're delivering on each of these fronts. I'm optimistic about where we can take Outerwall as we continue to strengthen our businesses. Together with our talented and dedicated employees, I'm confident we will continue to deliver value to our shareholders. Thank you for your time.

Operator

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

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