Coinstar, Inc. Q1 2008 Earnings Call Transcript

May.20.08 | About: Outerwall Inc. (OUTR)

Coinstar, Inc. (NASDAQ:CSTR)

Q1 2008 Earnings Call

May 1, 2008 5:00 pm ET

Executives

Dave Cole – Chief Executive Officer

Brian Turner – Chief Financial Officer

Analysts

Simeon Gutman – Goldman Sachs

Alan Robinson – RBC Dain Rauscher

Bob Evans – Craig-Hallum

John Craft – D.A. Davidson

Operator

Good afternoon ladies and gentlemen. Thank you for standing by. Welcome to the Coinstar Incorporated first quarter 2008 earnings conference call.

(Operator Instructions)

I would now like to turn the conference over to Brian Turner, Chief Financial Officer of Coinstar. Please go ahead Sir.

Brian Turner

Good afternoon and thank you for joining us today to discuss our results for the first quarter ended March 31, 2008. With me on the call today is Dave Cole, our CEO.

Before we get started I have to remind you that during the course of 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.

Additionally, all financial information provided for Redbox is un-audited. 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 previous 10Qs and 10ks filed with the SEC.

I would also like to point out that we will be discussing certain non-GAAP financial measures including but not limited to EBITDA, pro forma revenues and EBITDA, and adjusted earnings per share on a historical and forward-looking basis during this conference call. These are non-GAAP financial measures under Regulation G. Definitions of these non-GAAP financial measures, the importance of these measures to investors, and reconciliation’s of these measures to the most directly comparable GAAP measures can be found in today’s earnings release and related slides which are posted in the “About Us Investor Relations” section of Coinstar’s website at www.coinstar.com.

A replay of this web cast will also be available on the “About Us Investor Relations” section of our website. Let me also note that we have posted a copy of today’s prepared remarks and a series of charts mentioned in today’s call to the “About Us Investor Relations” section of our website. We encourage you to go to our website and bring up the accompanied PowerPoint slides so that you may follow along with us.

Finally, today’s call is about first quarter performance and the future of our operations and not about the current proxy contest. Over the course of the next month we will have more than enough opportunity to discuss the proxy situation with each of you. Therefore, today we ask you to confine your questions to the results of the company and we will not take questions on the proxy contest on this call.

Let me now turn the call over to our CEO, Dave Cole.

Dave Cole

Thank you Brian and good afternoon. As I look at the first quarter our 4th wall bundle performed great. As shown in Charts 1 and 2 not only did we beat consensus estimates but the better than expected results highlighted balance across our business lines. Our DVD business in particular performed very well while Coin, E-Pay and Money Transfer were all in line with our growth expectations. This was offset by softness in Entertainment which was expected.

These strong results, in my opinion, were driven by our total focus on execution of our 4th wall bundled strategy. Based on what we see now we’re confident in our ability to drive further returns for our shareholders for many years to come.

Now let’s get right to the heart of the matter; updates on WalMart, Redbox and Sales.

As many of you know we’re embarking on a very exciting period, one where we’re focused on working with WalMart to offer a broader value proposition to their customers driven by the bundling of our 4th wall products and services. At WalMart’s request, we created a plan across three of our verticals and the result is aligned with their goal of working with fewer, more sophisticated suppliers.

As stated on our last conference call the plan was to start surveying WalMart stores in the first quarter in an effort to determine the placement of Redbox and Coin units. Additionally, we were to start the de-installation of entertainment units. Since that time, we’ve surveyed the majority of WalMart stores and have developed [plantograms] for the placement of Redbox and Coin machines as well as all of the remaining entertainment units.

The survey process has gone extremely well and has set the foundation for the roll out which has started. As a result of the survey process we are very excited that WalMart has

green lighted us to install coin units in approximately 2,200 incremental stores, 10% more than we reported on our last call.

Additionally, rather than installing the coin units from May 2008 to May 2009 we committed to a faster installation schedule that starts in May 2008 and will be completed

by December 2008. Although this will not significantly affect revenues or profitability in 2008 it will allow the coin units to ramp earlier than expected which we believe will result in greater revenue and profitability in 2009 and 2010. All good news for Coin.

Second, as a result of the survey process, we are currently rolling out Redbox kiosks to the majority of the WalMart stores. Based on what we see the roll out is right on track.

Third, as stated previously we are removing or relocating approximately half of our WalMart cranes, bulk heads and kiddy rides. This is also right on track and we will complete this process in the second quarter of 2008.

So to date the execution of our WalMart relationship is proceeding exceedingly well and we believe our future prospects have never been stronger as we create convenience and value for their customers and destination traffic and profits for WalMart.

Moving to Redbox. As reflected in Redbox’s press release issued earlier today, Redbox announced their intention to file a registration statement for an initial public offering of common stock subject to market conditions. Redbox expects to file the registration statement with the SEC during the second quarter.

Redbox’s board evaluated several alternatives including a public offering, exploring

strategic partnerships and continuing operations with the current ownership structure. After examining the alternatives thoroughly the board decided that preparing for an IPO was in the best interests of Redbox and its shareholders at this time.

Due to this decision and as a result of SEC rules during the quiet period we are limited in what we can say about Redbox so we appreciate your patience as Redbox navigates the IPO process. One thing we will tell you, however, is that currently Coinstar is not contemplating selling shares in the offering that proceeds would be used by Redbox for growth and other needs and that Coinstar will not receive any proceeds from the potential IPO.

That said, we can comment on the historical financial performance of Redbox and DVDXpress combined as both are now consolidated into our financial statements. For Q1 Coinstar recorded Redbox and DVDXpress revenues of $60.5 million dollars, EBITDA of $12.2 million dollars and pre-tax income of $3.9 million dollars. This compares to that recorded in the financial statements for the first quarter of the prior year of revenue of $2.6 million dollars, EBITDA of $247,000 and pre-tax loss of $26,000.

However, that does not reflect the complete story as Redbox/DVDXpress was not consolidated for all of the first quarter of 2007. As shown in Charts 3 and 4, if we reflect Redbox and DVDXpress performance for the whole period in Q1 2008, Redbox and DVDXpress produced revenues of $71.5 million dollars, EBITDA of $12.9 million dollars and pre-tax income of $3.8 million. This compares to the first quarter of the prior year revenue of $22.5 million dollars, EBITDA of $2.7 million dollars and pre-tax income of $600,000. Certainly a stellar performance.

Moving to sales. We are increasingly seeing retailers gravitate to one partner who can develop and manage the 4th wall versus several smaller, less sophisticated partners working in one vertical. I think it’s safe to say that we’ve evolved into a clear leader in this space and the uniqueness of our product bundle and integrated approach that has delivered results.

Retailers that have responded to our model include Kroger and Supervalu, our two largest Coin customers. If you recall, they each signed new multi year Coin contracts recently. Others include Tesco, WalMart, Kmart, and Walgreen’s where we had great wins in 2007 and early 2008.

As validation of our emergence as a category captain Coinstar was named for the second year running, Category Captain for the 4th wall by Progressive Grocer. Additionally, Supervalu, the largest wholesaler in the U.S. just appointed Coinstar as the category captain for their 4th wall. With Supervalu we are expanding our relationship establishing fun and convenience zones in their Albertson’s stores. The zones have generated strong incremental sales. See Charts 5 and 6 for pictures of these new zones.

Being named category captain is just one manifestation of the success of our bundling strategy. Chart 7 reflects a sampling of other recent sales activity which includes the following: In Coin, Tesco a leading worldwide retailer which we rolled out coin units in 300 stores in 2007, expanded our Coin relationship by launching coin units in Ireland in a number of their stores. We were doubly pleased that this launch extended our coin processing technology to include the Euro. This is a first.

Sweetbay and Hannaford, two divisions of [inaudible] who added e-cert to their Coin units. All Stop & Shop and Giant of Maryland coin units were upgraded with Coin

to Card products bringing 644 Coin to Card upgrades across all retailers in Q1. Premiere West Bank was rolled out in Q1 on Coin. Loblaws, a leading Canadian retailer is launching coin in Quebec under their Provigo banner and Metro Food Basics, another Canadian retailer where we are expanding into 72 locations. Roundy’s signed a new multi year contract including adding 70 more locations.

In the DVD space, we are about to roll out the first DVDXpress kiosks in the UK with Tesco. Redbox signed a contract to install over 2,000 kiosks in Walgreen’s in which approximately 250 were already installed by March 31, 2008. Redbox/DVDXpress installed over 900 DVD kiosks in the first quarter. We signed Redbox/DVDXpress pilots or roll out agreements with 15 new convenience store chains that have over 10,000 potential locations in aggregate, all of which may or may not be appropriate locations for DVD kiosks.

Redbox/DVDXpress is installed in almost 8,000 locations at March 31st with recent sales activity with Ralleys, Price Chopper, Cub Foods, Save Mart, Giant Eagle, Hy Vee, Food Lion, Roundy’s, D’Agastino’s, Harris Teeter, Lowes Foods, Loves Travel Centers, Marks, Tops, Buhler’s, Shop Rite, Ingles, John’s Markets, Costentino’s, Food Circus, Gerlands, Penn Traffic, Winn Dixie and King Kullen, just to name a few.

In coffee, we signed coffee pilot agreements with Kroger, WalMart, A Hold and Giant Eagle. This will bring our total pilot count to almost 100 locations with most being installed in the first quarter. As stated before we will run the pilot through mid summer to determine the potential returns on the coffee locations.

In E-Pay, we will be installing in the majority of the Travel Centers of America locations. Also in EPAY we have added 11 new cards to our largest account, Walgreen’s, for their mid year [plantogram] changes and we continue to expand our product relationships in the UK gift card mall program with a wider variety of cards distributed in almost 3,400

stores including Clinton Cards, WH Smith and Somerfields.

Locations have increased 30% from 2,600 locations just three months ago. Now all of these moving parts need to be pulled together and managed and we understand that success in 2008 and beyond will be a function of our ability to execute on our opportunities.

To that point we hired Paul Davis as our COO a month ago. Paul has had a long and distinguished career and has served as President of Starbucks North American operations and key leadership roles with PepsiCo, Frito Lay and Procter and Gamble. The addition of Paul to our team is a significant positive for the company and gives me added confidence that we are on track to achieve $1 billion in revenues and $200 million in EBITDA.

In fact, given that our Coin business has accelerated along with the growth in other parts of our business we believe that the $200 million EBITDA run rate will begin in mid 2009 rather than in 2010. This is an upward revision beyond what we outlined on our last call.

With that let me turn the call over to Brian.

Brian Turner

Thanks Dave. Now let’s turn to the financial results. For the first quarter Coinstar generated $190.5 million dollars in revenue. We generated EBITDA of $34.5 million dollars. Our GAAP, fully diluted, fully taxed earnings per share was $0.10, with adjusted fully taxed, fully diluted earnings per share of $0.18.

Turning to Chart 8, revenue for the quarter totaled $190.5 million. This was comprised of $59.2 million from Coin revenue, $44.2 million from Entertainment, $20.5 million from Money Transfer, $6.1 million from EPay and $60.5 million from our DVD kiosk business.

Note that we started to consolidate Redbox results on January 18th so there is a period of 17 days where results were accounted for under the equity method. As shown in Chart 9 had we owned a majority of the business since January 1st, DVD kiosk revenue would have been $71.5 million for the first quarter and total consolidated revenues would have been $201.5 million.

EBITDA for the first quarter totaled $34.5 million, our highest ever for a first quarter. As we stated last quarter, due to the fact that a high percentage of direct and indirect costs are shared among business lines exact EBITDA by product line is only an estimate. So in that spirit Coin and Entertainment EBITDA was about $22.7 million; EPay, including Money Transfer showed a $467,000 loss for the period while DVD EBITDA was about $12.2 million.

Again, Redbox’s EBITDA was not consolidated for 17 days in Q1 but had it been, EBITDA for the business would have been $12.9 million and total EBITDA would have been $35.2 million. Another way to look at these balances income from operations by segment which is reflected in Chart 10. Looking at each business in greater detail, Coin revenue increased 8% in the first quarter to $59.2 million compared to $54.8 million a year ago.

As shown in Chart 11, the increase was driven by 113 net new installs and same store sales growth of 0.1%. This is lower same store sales growth than normal due to the high number of installations in the last twelve months. This results in the balloon effect illustrated in Chart 12, one that we’ve talked about many times.

As stated previously, based on the large number of installs in 2007 and 2008 we expect the Coin business to sustain an 8-10% growth rate each year for the next 3 years. A side note on coin is that of the 113 net new installs in the first quarter, 44 were in Canada, 28 were in the UK and 40 were in financial institutions. Because these are not in our core U.S. suburban grocery locations they should produce little or no cannibalization.

Moving to Money Transfer. With our acquisition of GroupEx in January 2008 we now have over 35,000 agents in over 140 countries. In fact, right after completing the acquisition in January GroupEx started doing business with Banamex, one of the largest financial service groups in Mexico, adding 5,000 additional payout locations. The purchase accounting for GroupEx was also completed during the period. In that regard, Coinstar received $27 million in cash as part of the acquisition making the net purchase price between $35 to $45 million.

In connection with the acquisition Coinstar recorded intangible assets of $15.3

million, which will be amortized over an average of 9 years, and goodwill of $55.7 million. These and other facts are illustrated in Charts13 and 14, but to get a better

understanding of the money transfer business I recommend you review the Money

Transfer slides posted in the Investor Relations section of our website.

Moving to EPay. As reflected in Chart 15 for the quarter we sold $120 million in face value. This resulted in revenues to Coinstar of $6.1 million. Additionally, we continue to launch our store value cards in the UK market and exited March 2008 with almost 3,400 locations. Our gift card mall has been adopted by Somerfields, WH Smith, Spar, Nisa, The Mills Group and Clinton Cards, all leading UK retailers. And we recently started pilots or are about to install in Super Drug, Zavvi Virgin Mega stores and BP locations in the UK as well as we are in negotiations with several other large UK retailers.

We still see the entire category as a uniquely scalable opportunity and we believe we have first mover advantage in the UK. Shifting to DVDs, first quarter revenues increased approximately 220% to $71.5 million. These results were driven by over 900 net installs in the first quarter and same store sales growth of approximately 49%. This comes on the

heels of 4,800 net installs and same store sales growth of approximately 27% for the full year 2007.

Our pretax income from DVD business was $3.9 million for the period. Much like the fourth quarter where we saw the business generate positive net income in November and December, DVD’s were profitable for the entire first quarter. This was a pleasant surprise given our expectations for a loss during the period.

The first quarter of 2008 exceeded our expectations and performance was driven by a variety of factors including better than expected unit economics, strong March movie titles, the television writers’ strike, and the counter-cyclical nature of DVD rentals to the economy.

Turning to entertainment. Revenues totaled $44.2 million for the first quarter, or 23.2% of our consolidated sales. This compares with $65 million or approximately 49.1% in the prior year’s quarter. In the quarter you will note that cranes, bulkheads and other equipment installed decreased from 280,000 units at December 31 to 230,000 units at the end of March. The decrease reflects the de-installation of machines from WalMart and the de-installations due to our resignations from lower performing accounts.

These two factors combined accounted for approximately half of the decrease in

Entertainment revenues. Additionally, much like the overall trend in 2007, macroeconomic and other trends affected performance which accounted for the remainder of the decline.

Moving to expenses as a percentage of revenues, direct operating expenses for the first quarter increased to 69.6% compared to the previous year’s first quarter. This was due to rising freight costs from China that were $550,000 greater than budget in the first quarter, rising Chinese handling costs which resulted in $100,000 in unexpected charges and over

$500,000 of extra Coin transportation and handling charges due to fuel increases.

General and administrative expenses increased as a percentage of revenue to 10.4% from 9.3% for the same prior year period primarily due to Money Transfer which runs at a higher G&A percentage than other lines of business due to anti-money laundering and regulatory compliance costs which is accounted for as G&A.

Depreciation and other for the first quarter totaled $17 million versus $14.5 million in the first quarter of 2007. The increase was primarily due the addition of Redbox and to the installation of 1,900 Coin units in 2007. Additionally, in 2007 we undertook a study of the useful life of the components of the Coin unit. As a result of this study and after consulting with our external auditor we concluded that the printer, monitor, door and computer components should be depreciated over 3 years and the Coin frame should be depreciated over 15 years to better approximate the useful life of the components of the Coin unit.

This change was implemented as of January 1, 2008. The effect of this change is that some components are now depreciated faster and some components over a longer life than the old method where all components were depreciated over 5 years. This change, which was anticipated when we gave guidance, resulted in slightly more than $0.01 cent of EPS in the first quarter.

Moving to interest expense. For the quarter our leveraged ratio was 2.47 which under our interest rate grid produced an average interest rate of 5.4% or Libor plus 125. During the quarter we entered into an interest rate swap for $150 million of our debt in which we swapped our floating rate debt for the next three years to a fixed rate of Libor of 3.11% plus the grid spread which at the time of the transaction equated to an overall average interest rate of 4.36%. This was a 108 basis point decrease to the average rate incurred in the first quarter.

We made this swap as we believe that rates will rise over the next three years. Based upon this our expected interest rate for the second quarter is only approximately 4.3%.

Moving to taxes. Our effective tax rate in the first quarter was 47.1% which was in-line with our expectations. At the net income line for the first quarter we reported $2.7 million or $0.10 cents GAAP earnings per fully taxed, fully diluted share. Excluding the non-cash charges detailed in our earnings release, Coinstar reported adjusted fully taxed, fully diluted earnings per share of $0.18 cents or $5 million for the period, generally in line with prior guidance. This is illustrated on Chart 16.

With respect to CapEx for Q1 which is reflected in Chart 17, the company spent $17.9 million of which the majority was for new Coin, DVDXpress or Coffee units. We did incur $2.4 million in CapEx for Entertainment in connection with the WalMart resets; however, total CapEx for Entertainment still is not expected to exceed $5.1 million for the year.

Before I turn the call back to Dave, I’d like to comment on guidance and we are going to continue to give a bit more detail. Starting with revenue, which includes consolidated revenues of Redbox beginning on January 18th and GroupEx for the full year, we are narrowing and raising our current estimated revenue range of $800-875 million to $850-900 million. This represents a 60% increase at the mid point over 2007 levels. This is reflected in Charts 18 through 21. This range is based on certain assumptions including Coin revenues growing 8-10% due to the 1,900 machines installed in 2007.

We are also raising our Coin installation guidance by 50% at the mid-point from previously 1,250-1,750 units to now 2,000-2,500 units. This is a result of the 200 unit increase for WalMart plus an additional 550 unit increase due to strong selling activity in grocery, banks, and drug stores. As a result of another strong Coin selling year we are estimating same store sales estimate of 0-3% for the year.

Because most of the installations are happening in the last two quarters of the year this will have minimal impact on 2008 Coin revenues and as such we are leaving our Coin guidance range at $265 to $275 million for 2008. We are still looking for EBITDA margins of roughly 30+%.

Shareholders have asked if we are cannibalizing sales with this high sell in. We are seeing great sell in to areas we are not fully penetrated before. The United Kingdom, Canada, banks, urban areas, populated rural areas, etc. As a result we are seeing little cannibalization of our existing suburban units.

Coin is on an absolute roll and we currently see no change on the horizon for the next couple years. Our Entertainment revenue range has not changed and is based upon certain assumptions including the paring down of lower performing accounts along

with the WalMart de-installation discussed last quarter. In fact, after these changes are made we still expect the ongoing Entertainment revenue to be $150 to $170 million in 2008 leveling off to $150 million in 2009 and 2010.

We would also expect a significant impact on our field service operations and we experienced some of that in the first quarter. As you can imagine we had Entertainment machines coming out and Coin machines being planned for, and we saw an expected $130,000 related to severance and other charges during the first period as a result of the expected transition.

This will continue into the second quarter where we expect to incur an additional

approximately $500,000 in other transition and severance charges.

Moving to EPay we’re currently looking for revenue and EBITDA to continue to increase. For 2008 we currently expect revenues inclusive of CMT and GroupEx to be between $115 and $125 million which implies an organic growth rate of 20-30%. In addition, we still expect CMT and GroupEx combined to be EBITDA positive. Overall, we currently expect EPay EBITDA inclusive of CMT and GroupEx to be between $10 and $15 million. This is the same guidance as provided on the last call.

Based on all these factors we still expect consolidated EBITDA for Coinstar to grow between 10-15% in 2008 to between $135 and $145 million. Note that although we are raising revenue expectations it’s premature to adjust our EBITDA guidance due to the fact that kiosks typically produce negative EBITDA in the first year as they ramp. This guidance is consistent with that which we communicated last quarter and we still are very pleased with this type of growth in what is clearly a transition year for the company.

With respect to CAPEX for 2008, our previous expectations are unchanged. Looking to Chart 22 we expect to spend in aggregate $70 to $80 million in 2008. This includes $39 to $42 million in new Coin Machines, $7 to $9 million on new equipment for EPAY including CMT, and $9 to $10 million on new DVDXpress and coffee units. We expect to spend $7 to $9 million upgrading and maintaining Coin units.

Note that this CapEx guidance is only for cash to be expended by Coinstar which does not include CapEx for Redbox. As we have stated before, we look to Redbox to finance CapEx expenditures on their own through operating cash flow, lease financing, commercial debt and equity before looking to Coinstar for further debt or equity

infusions.

One final thought on our growth CapEx, based on these investments and where they are being directed in 2008 versus prior years, we believe that our returns on capital will increase each year for the next three years over 2007 levels. Before addressing the second quarter specifically it’s important to remember the seasonality of our business in which Q3 and Q4 are our strongest quarters. As such it’s important that everyone’s models be adjusted for that seasonality particularly the second quarter.

We expect our tax rate to be between 50-52% for the year depending on the interaction of foreign profits and losses by country and domestic profits.

Now, let’s turn to specific guidance for the second quarter of 2008. Management estimates that revenue for the second quarter ending June 30, 2008 will range from $200 million to $210 million with GAAP earnings per fully taxed, fully diluted share will range from $0.08 to $0.15. The above estimated GAAP earnings per fully taxed, fully diluted share do not include the costs of the proxy contest.

Now turning to guidance beyond 2008. We’ll assume the economy stays about where it is today, Redbox remains consolidated, and assume that we continue to execute our WalMart opportunity as discussed. Based on these assumptions and emphasizing what Dave stated, we now believe that the $1 billion in revenues and $200 million EBITDA run rates will begin approximately six months earlier than expected around mid 2009.

I’ll now turn the call back to Dave for closing remarks.

Dave Cole

Thanks Brian. In closing I want to reiterate a few points. Coin and DVD kiosks are on a fast track due to our bundling strategy. EPay and Money Transfer continue to grow at expected rates and Entertainment, which is a smaller part of our EBITDA and earnings continue to struggle. When you sum them all up the businesses that produce 90% of our EBITDA are either performing well or meeting expectations which are great news for shareholders.

This is no accident. This is the bundle working. Second, we are very focused on executing our plan for all business lines. As part of this execution-oriented focus we currently do not anticipate any more acquisitions in 2008.

Over the last few years Coinstar has acquired several businesses that today form an integrated platform that includes Coin, Money Transfer, E-Payment, Entertainment and DVD rentals. As a result we now have a significantly larger, more stable and predictable revenue stream, strong cash flow, and significant operating leverage. Furthermore, we are solely focused on executing our business plan and we’re continuing to see success.

In particular, we have deployed over 4,650 Coin units and over 7,800 DVD kiosks in retailers globally in the last few years, signed multi year contracts or renewals with our largest customers, including WalMart, Kroger, Supervalu and Walgreen’s. We have narrowed or raised our 2008 guidance for revenue, earnings per share, and Coin units to be installed. We have increased revenue by more than 350% during the past five years to an expected $850 million to $900 million in 2008 with an expectation of $1 billion in revenues by 2010. We have more than doubled EBITDA from $59 million in 2003 to an expected $135 to $145 million in 2008 with an expectation of a $200 million EBITDA run rate beginning in mid 2009.

We repeatedly hear from our retailers that they want to reduce the number of vendors they deal with and that our bundling of products and services satisfies a real need in the marketplace. This was a major sticking point with WalMart in their effort to reinvent their store fronts. In fact, they specifically stated that they wanted to engage with our team and to help redesign and implement their front-of-store needs and we see their recent expansion of our product lines as an affirmation of our strategy from the largest retailer in the world.

So in closing, over the last four years we’ve implemented our strategy and built our

bundled offering. We are about to embark on an incredible three year plan. We are excited that our 2010 EBITDA goal has been pushed up by 6 months setting 2010 up to be even better than we previously expected.

With that we’ll open up the line for questions.

Operator?

Question-and-Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Simeon Gutman – Goldman Sachs.

Simeon Gutman – Goldman Sachs

Brian, to follow-up on your comments regarding the back half of the year with more installs, the EBITDA margin this quarter was around the 18% range and I think if you back in to what the rest of the year it is about 15 and change. I just want to confirm that is entirely to reflect greater installs. If it isn’t is there anything else on the cost side or is there conservatism that is being built into the rest of the year forecast?

Brian Turner

We reflected a couple of things. One, you are correct, it is more installs. We are planning the negative EBITDA on the first year of installations. That is true on Coin and other kiosks. That is one built in. We have also counted on fuel costs staying high through at least the summer months and so we believe fuel costs will stay high. In addition to that we are factoring in that the Chinese currency will continue to stay strong against the U.S. currency so we have factored in that. Therefore we think the cost of Chinese handling and Chinese warehouse and freight costs will continue to stay high. So all of those factors went into our thinking. That is offset by the increases in other things that is happening through the business or synergies we are achieving through greater revenues. So you combine that all together and that forms the EBITDA guidance for the year.

Simeon Gutman – Goldman Sachs

On the Coin business and again related to the comments that you are not seeing cannibalization, back to that chart that you provide which is telling and has been pretty telling over the course of history, how do you reconcile how this quarter played out? Is it just a continued lag given the amount of volume that is being added to the system? Otherwise the chart would have suggested we might have seen a slight bounce back in same store comp.

Brian Turner

You are absolutely correct. You see that in other parts of the chart where you may have a one quarter lag but overall the trends continue. We put in a lot of units in the third quarter of last year and I think we are seeing that effect still in the short term. So, I’m not too worried about where the chart is right now. The overall trends still continue to hold as far as cannibalization.

Simeon Gutman – Goldman Sachs

The 0-3% range…the back half would have to be pretty hefty. Installations are going to continue at that same pace or they are going to increase?

Brian Turner

No, they are going to increase. So last year we put 1,900 in for the full year and we just raised our installation guidance for this year to 2,000 to 2,500. So we’re expecting to put more in this year than last year which will put pressure on that chart.

Now if you take that in aggregate though that is only one part of the equation. If you take the two together and you say how fast is the business growing overall? That is the more important factor, that as we said on the call today it had been growing between 7-8% before. We expect it to grow between 8-10% each year for the next three years. That would be a good string of growth overall for the business.

Simeon Gutman – Goldman Sachs

On the return on capital comment about it decreasing over the next few years, how does the Entertainment business factor into that? I know there has been some tough cost environment. Whether or not those clean themselves out what kind of visibility makes you comfortable and how does that play into it? I assume it is still a part of that business model given that it is part of the fourth wall bundle, but how could that make or break that return on capital forecast?

Brian Turner

I think that Entertainment is becoming a smaller piece of the overall equation and so as it becomes a smaller piece it has less of an effect. We are counting on it being $150 million approximately for the next several years. So that is factored into our thinking. Certainly could it affect it around the edges? Sure. But it has become a much smaller piece of the overall ROIC or IRR equation.

Simeon Gutman – Goldman Sachs

On ePay how is the commission rate environment? Have there been a lot of changes? How does that evolve being that the market is more or less an oligopoly. Do you control your own fate there or are there some market factors you have to play with?

Brian Turner

I think we had theorized 3-4 years ago there would be commoditization within this market and that is actually what creates the competitive barrier to create the oligarchy. That is exactly what has happened. It has done that over the last four years. We see that as good. That gives us a chance to compete with the established 800 pound gorillas that were in the market long before we were in the U.S. Not the U.K. The U.K. we have first mover advantage there but we are seeing that stabilize and so if we look at the commissions it has stabilized for quite awhile now. So we think that has happened. The oligarchy has emerged and now it has just continued to grow with the growth of the industry which is 20-30% per year. We see that continuing for quite awhile, that growth rate.

Simeon Gutman – Goldman Sachs

Is there a difference in commission rate geographically between the U.K. and here?

Brian Turner

Yes there is because the U.K. is still newer. So frankly right now we get higher commissions in the U.K.

Operator

The next question comes from the line of Alan Robinson – RBC Dain Rauscher.

Alan Robinson – RBC Dain Rauscher

Just some clarification on the Redbox installations. You mentioned you were accelerating your Coin installations at WalMart. Are you planning on accelerating your DVD rental installations at WalMart also?

Brian Turner

Because of the quiet period around the SEC unfortunately I can’t provide forward guidance on that.

Alan Robinson – RBC Dain Rauscher

The costs emanating out of China, presumably these were all related to the entertainment side of the business?

Brian Turner

Yes.

Alan Robinson – RBC Dain Rauscher

Given that, you have addressed this business obviously. What are you doing to initiate price increases now for these items? Is that still on hold? I remember you were on hiatus with that for a little while.

Brian Turner

We are still on hiatus with that. We are evaluating the right time to start that back up. That has not gone out of our thinking. It is still a central part of our thinking but right now we need things to settle down a little more. Certainly you have noticed retailers’ announcements over the last couple of months. It hasn’t been especially strong.

Alan Robinson – RBC Dain Rauscher

That leads to my next question. To what extent do you feel that lower foot traffic over the quarter has impacted your Coin same store sales?

Dave Cole

I don’t believe it has negatively impacted the Coin same store sales. I think it has probably impacted the Entertainment business in that the consumer is typically making one or two trips to the store a month versus maybe what they used to do which was 3-4. So fewer trips would result in fewer Entertainment transactions.

Brian Turner

I think your question plays in to how we constructed the bundle. We very intentionally constructed the bundle to have some counter-cyclical business such as DVD and it is definitely counter-cyclical. Some non-cyclical business such as Coin, we don’t really see much cyclicality to that with the economy or lower foot traffic, and then some cyclical business with Entertainment. The jury is still out on telephony and gift cards because they are growing as an industry so fast we can’t detect the cyclical nature of them yet but common sense would tell us that telephony is probably not as cyclical and gift cards probably are a little more cyclical. I can’t believe people would give as many gift cards with a bad economy but we’ll wait and see.

Alan Robinson – RBC Dain Rauscher

You mentioned in your prepared remarks a couple of Coin counting wins with financial institutions. Are you engaging some of those financial institutions that are currently going into loan on Coin counting? Is there an opportunity there for you?

Dave Cole

I’m sorry, going into loan?

Alan Robinson – RBC Dain Rauscher

The banks that are currently offering coin counting services outside of the Coinstar brand.

Dave Cole

We are engaging in a strong sales effort connecting with banks across the country to convince them that our full-service, turnkey model is the best approach.

Alan Robinson – RBC Dain Rauscher

Do you have any day-to-day geographical areas where those banks currently are not using Coinstar? Do you have any sort of comparative data as to any potential cannibalization that their sort of business they are pulling away from your supermarket chains?

Brian Turner

Yes. As we stated before, the banks were most interested in the downtown course or the urban and then the rural. So we are not as interested in installing in suburban banks although for a bank chain of course there are certain compromises. We are not looking to cannibalize our suburban grocery stores to suburban banks.

Operator

The next question comes from the line of Bob Evans – Craig-Hallum.

Bob Evans – Craig-Hallum

First, a detail question. What was the Redbox Q1 revenue if you assume as a one one 2008?

Brian Turner

I have got Redbox and DVDXpress together. Together they are…

Bob Evans – Craig-Hallum

That is the 71.5.

Brian Turner

That is correct.

Bob Evans – Craig-Hallum

But you give a metric in the press release of 57.8 but it is as of the 17th or 18th of January. I wonder if you happen to have Redbox only for the full quarter.

Brian Turner

You know, I don’t. Not at my fingertips Bob. That would be an un-audited number anyway. I apologize but I don’t have that at my fingertips.

Bob Evans – Craig-Hallum

Back of the envelope it looks like Redbox for what you did report had an almost 20% EBITDA margin and certainly it is a good seasonality quarter but can you give us a little bit more perspective in terms of why the improvement there?

Brian Turner

Absolutely. You’ve hit on part of it which is seasonally Q1 is an okay quarter for DVD rentals because you have your movie titles on the 4-month delay there now coming out. So the ones that were introduced after Labor Day going into Thanksgiving come out. So you saw Michael Clayton, American Gangster and some other ones, which I am forgetting, that really came out in March. So March was a very strong month for them. So you would expect EBITDA margins to be higher in the first quarter. The second quarter doesn’t share that. Then the third quarter, the end of the third quarter and start of the fourth quarter, has again your summer releases starting to hit the DVD market. So we will see seasonality in DVD sales. It is tied to the release windows. For that you will see EBITDA go up and down quarter by quarter but certainly it is good to see and we were very excited to see the EBITDA margin they produced in Q1. It was higher than we expected.

Bob Evans – Craig-Hallum

So I think you had given previous discussion of EBITDA margins of being 20% plus and it would appear that would be certainly achievable if not conservative?

Brian Turner

We said in the future. We didn’t say for 2008 and again I have to be careful of the quiet period here but you can look at our last conference call script and we said what we would imply for this year and certainly it wasn’t at the 20% level yet. It was a Q1 we were very excited about.

Bob Evans – Craig-Hallum

On the $200 million EBITDA run rate timing for mid-2009, I assume that incorporates the year’s share of the 51% of Redbox. Is that correct?

Brian Turner

It includes as if Redbox is 100% consolidated just as it is now because we don’t know exactly what will happen going forward, how much will go on the IPO and things like that. We have to make certain, sort of apples-to-apples guesses at this point.

Bob Evans – Craig-Hallum

That would be kind of starting Q3 2009 is what your plan is?

Brian Turner

Yes. Exactly. Again, we don’t know the exact timing but all indications are around that time, yes.

Bob Evans – Craig-Hallum

I don’t recall if you gave us…can you give us same stores metric for Redbox?

Brian Turner

I don’t have it for Redbox specifically, but if you look at Redbox/DVD combined it was 49% in the first quarter. Obviously the vast majority of that is Redbox. Which is way up from last year which was 27%. Clearly, 49% is not sustainable. We are thrilled with that.

Bob Evans – Craig-Hallum

We shouldn’t run 49% for the next few years?

Brian Turner

We are thrilled with the unit level economic space. They have been excellent for several quarters now.

Bob Evans – Craig-Hallum

If you go to slide 11 you break out Coinstar Q1 income from operations and I believe you break out Money Transfer ePay. Basically if I read it right it is an EBITDA number.

Brian Turner

Not quite. So let’s go there. If you look at the $36.2 million that is over what EBITDA is and what the difference there is “other” income falls below the line “income from operations” and that is the only difference between that $36.2 million and EBITDA.

Bob Evans – Craig-Hallum

So it is close?

Brian Turner

It is very close.

Bob Evans – Craig-Hallum

I think you gave guidance for $10-15 million of EBITDA for Money Transfer and ePay combined. Is that right?

Brian Turner

That is correct.

Bob Evans – Craig-Hallum

So given that we are at a negative number in Q1 how do we get to that level of guidance? What changes there?

Brian Turner

Seasonality. So if you look at where gift cards are done and where Money Transfer is done they actually go around two or three similar events. One is just the fourth quarter. Most gift cards are sold in the fourth quarter. Money Transfer is at peak in the fourth quarter. The second one is around Mother’s Day. So around Mother’s Day, which has not occurred yet, you see peaks in both Money Transfer and gift cards. Then the summer months. So around vacation time when people need money transferred to them that happens. So Q1 is your weakest quarter for Money Transfer/Gift cards. There is just nothing to incent people to do it right then other than just ordinary transactions.

So the fact you have seasonally weak earnings for Money Transfer ePay in Q1 is no surprise.

Bob Evans – Craig-Hallum

And we should expect Money Transfer to be EBITDA positive on its own as well?

Brian Turner

Money Transfer we are expecting to be neutral to positive, yes. For the full year. Obviously Q4 is the big quarter.

Bob Evans – Craig-Hallum

And finally, you had commented on your test in Ireland with the Euro. Can you elaborate further on what your thoughts are in terms of Europe and potential there and maybe hint if this is something you’re going to do in the near term?

Dave Cole

We obviously see any developed country where they have coin hoarding habits as an opportunity. We clearly though Ireland was a good place to go given Tesco’s interest in having the machines in their stores. The machines are performing well and ramping up nicely but beyond that I think it is an opportunity we haven’t clearly decided on relative to Europe at this point.

Brian Turner

But certainly to your point it opens up more markets for us because now we know we have a machine that can handle the Euro.

Operator

The next question comes from the line of John Craft with D.A. Davidson.

John Craft – D.A. Davidson

I just wanted to follow-up on the last question first in regards to the Money Transfer. I know you have a lot of locations in Mexico but can you tell us what percent of your Money Transfer transactions or revenues are based on transactions to Mexico?

Brian Turner

Let’s see if I can get that for you. Why don’t we take your next question while I look?

John Craft – D.A. Davidson

The next part of that is the data out there is showing that the trends are going down as far as transaction growth to Mexico. Are you assuming that things improve to get some of these numbers for the full year? Are you assuming that things still stay weak?

Brian Turner

What you are seeing is the U.S. to Mexico trends down, not the Mexico to other country trends. What you are seeing as immigration has been cracked down on, the Mexicans that are going across border are not all going to the U.S. Given that we have a large presence in the U.K., France and Italy that is actually helping us in those countries because we are seeing some of the Mexicans who used to come to the U.S. go to Spain or go to France, places with negative population growth. So while it may hurt you in one quarter it helps you in a different quarter.

That is important because as you look at us we are more spread than say a Western Union or Moneygram. We don’t have the concentration there. So given that it doesn’t have the same effect for us. Going to your comments is that yes we have factored that in to our thinking. So what Western Union or Moneygram is seeing or we are seeing in the U.S. to Mexico quarter that is factored in to our guidance.

For your question about if you look at Group Ex and I don’t have Mexico specifically for Group Ex but I believe 60% of Group Ex is Mexico of which Group Ex is 61% of us. So if you take Mexico that would imply that Mexico is somewhere around 35-40% of total.

John Craft – D.A. Davidson

Just to clarify, that is transactions moving into Mexico regardless of whether it is U.S., U.K. or whatever?

Brian Turner

You are correct. That is transactions moving into Mexico. That is not transactions moving out of Mexico. But lets be honest, most move in.

John Craft – D.A. Davidson

Also, let me follow-up on another point in your prepared remarks about depreciation. You mentioned specifically the change…it sounded like you specifically mentioned Coin. I guess two parts to this question. Is the change in depreciation schedule going to be across all machines and if it takes coins, for example, and each machine costs $10,000 the door versus the frame is that a 50/50 split or a 90/10? How would you break that down?

Brian Turner

Excellent question. The first part is it does apply to existing machines although there is no catch up or cumulative adjustment or any of that. It is just a prospective change. Right now about 30% of our machines deployed are being depreciated which means 70% of machines this does not affect at all. So it is the 30%. The greatest effect is as we rollout units over the next couple of years. Especially we just upped our guidance and certainly it will have an effect to that. As many investors have commented to us, we know our machines. We have never retired a coin machine. Now we may have changed out the printer or we may have changed out the monitor, but we have never retired a coin machine which means we have coin machines that are 15 years old. I will tell you right now we have no intent of retiring them. Those machines are good for probably another 5 years would be my guess. But we don’t know exactly.

John Craft – D.A. Davidson

Maybe I can ask it a different way. Before each machine was five years, now on average it is a consolidated machine with all its parts is what?

Brian Turner

That is exactly where I was going. The average going forward will be more 10 years. But still not 15.

John Craft – D.A. Davidson

So just looking at the guidance for the year we can assume that $0.06 to $0.07 of that increase is due to the depreciation change?

Brian Turner

We only got slightly more than $0.01 right now. So you are estimating too high there.

John Craft – D.A. Davidson

Closer to $0.04 maybe?

Brian Turner

$0.04 or maybe $0.05. This is something that the auditors and us have been talking about because they knew that machines were lasting longer than we were depreciating them and they though we were being too conservative.

John Craft – D.A. Davidson

I think it makes sense. Last question, on some of the out-performance in Redbox you cited the strong March release titles and just addressed that. But you also cited the writers’ strike. I guess not to nit pick here, but I am curious how much if you can break that up specifically…that sort of seems like it is a one-time event and I’m not sure how you found that and what you estimate that contributed in the quarter?

Brian Turner

We think that is a lesser effect. Actually the unit economics are the most impressive so I put that as the number one effect. Certainly you have seasonality and so the movie titles were strong, which you would expect, but they were strong. The television writers’ strike, we actually don’t think it had a huge effect but just common sense would say there wasn’t a lot on TV, the economy was bad so you’re not going to take your family out to a movie…I just took my family out and it cost me $80 between the popcorn and the pop and the tickets, or you can rent a movie for $1 a night. So with some questionable TV out there…I won’t bad mouth TV too much, maybe you are more inclined to rent a movie.

John Craft – D.A. Davidson

That is fair. Actually that just reminded me of another question if I may. What you have talked about in the past as I’ve heard is these DVD machines once they get up to ¾ or so you get up to your $40,000 to $45,000 a year in revenue, is that consistent with what you are seeing with the advertising promotions, the free rental if you buy a burger at McDonalds? Is that assuming you do those things? Or does that sort of thing speed up that run rate?

Brian Turner

What we said is that you have $40,000 to $45,000 which was in the last conference call. It really happens between Q4 and Q8. So that is the second full year. You have to look at the second full year. So it isn’t over 3/4 …you have to give it a little longer. But it does ramp up. Redbox and DVDXpress both do advertising not only with McDonalds but with other chains. They will do radio advertisements. They will do free promotions. That is to get people to the machine initially when the machines are first rolled out. So does it have an effect? Yes. Do you have to do that to get to the $40,000 to $45,000? No.

Operator

The next question is a follow-up from the line of Alan Robinson – RBC Dain Rauscher.

Alan Robinson – RBC Dain Rauscher

Just a real quick question. Are your U.K. coin counting machines already set up to accept the new British coin designs that are being rolled out this summer?

Brian Turner

As you know in our machines all coins go through the same single chute and it is really a software change. That software work has already been done.

Alan Robinson – RBC Dain Rauscher

And it has been tested and the costs have been sunk presumably?

Brian Turner

As coins roll out initially we’ll have to make sure everything synchs up. It is one thing to test is in a lab. It is a whole other thing when you put it in the field. So we believe like we always have, we have been doing this for quite awhile and we have executed quite well on this. We believe we have this handled. It is built into our thinking and our guidance.

Operator

That does conclude the question-and-answer session. I would like to turn it back over to Management for any closing remarks.

Dave Cole

We want to thank you all for calling in today and we thank you for your continued interest in Coinstar. We’ll talk to you soon.

Operator

Ladies and gentlemen this concludes the Coinstar Incorporated first quarter 2008 earnings conference call. This conference will be available for replay after 6:00 p.m. ET today through May 2 at midnight. You may access the replay system at any time by dialing (303) 590-3030 or 1-800-406-7325 and entering the access code of 3864364.

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