Blockbuster Q2 2009 Earnings Call Transcript

| About: Blockbuster Inc. (BBI)
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Blockbuster Inc. (BBI) Q2 2009 Earnings Call August 13, 2009 4:30 PM ET


Kellie Nugent - Director, Investor Relations

James W. Keyes - Chairman of the Board, Chief Executive Officer

Thomas M. Casey - Chief Financial Officer, Executive Vice President


Richard Ingrassia - Roth Capital Partners

Tony Wible – Janney Montgomery Scott

Charles Wolfe - Needham & Company

Analyst for Emily Shanks - Barclays Capital


Good afternoon and welcome to Blockbuster’s second quarter 2009 financial results conference call. (Operator Instructions) I will now turn the call over to Kellie Nugent, Blockbuster’s Director of Investor Relations. Kellie, please go ahead.

Kellie Nugent

Thank you, Melissa and thank you, participants, for joining us today to discuss Blockbuster’s second quarter 2009 financial results. With me on today’s call are Jim Keyes, Chairman and CEO; and Tom Casey, Executive Vice President and CFO. As Melissa mentioned, this conference call is being recorded. It is also being broadcast live in voice mode over the Internet and maybe accessed within Blockbuster’s website at

After the market close today, Blockbuster issued a press release regarding its financial results for the second quarter ended July 5, 2009. By now everyone should have access to the press release and financial tables. However, if you do not they are available via the company’s website.

Please be advised that matters discussed in today’s teleconference contain forward-looking statements relating to the company’s operations and business outlook, financial and operational strategies and goals, including expectations regarding the company’s financial performance in 2009 and other matters that do not strictly relate to historical or current facts.

We caution you that such statements are in fact predictions that are subject to risks and uncertainties that could cause actual events or results to differ materially. Additional risks and uncertainties that could cause actual events or results to differ materially from these forward-looking statements may be found in the company’s filings with the Securities & Exchange Commission.

Forward-looking statements are based on the company’s beliefs as of today, Thursday, August 13, 2009. Blockbuster undertakes no obligation or responsibility to publicly update any forward-looking statements for any reason except as required by law, even as new information becomes available or other events occur in the future.

Additionally, in the company’s press release and during this teleconference, management will discuss certain measures and information in both GAAP and non-GAAP terms. A reconciliation of GAAP to non-GAAP is provided in the financial tables following the text of the press release.

I will now turn the call to Blockbuster’s Chairman and CEO, Jim Keyes.

James W. Keyes

Thank you, Kellie and thank you, everyone for joining us this afternoon. A little more than two years ago, we saw in Blockbuster a huge opportunity to create shareholder value. We brought in a new management team and began the process of transforming Blockbuster. A few obstacles, though, were thrown in our way, making this transformation much more difficult and specifically, it was the macroeconomic environment -- more specifically, our successful but our costly refinancing of a credit facility.

In spite of those obstacles, we’ve been able to respond to the necessary change, both short-term and long-term, and we remain confident in the opportunity at hand. The fundamental issue in our core business has been and remains the need to respond to changing consumer demands. We all know that the future consumption of entertainment content will be in digital form. Our acquisition of Movielink in 2007 and our transformation of that business into Blockbuster on-demand produced an exciting new offering that will future-proof in many ways our business.

With a digital library comparable to the Blockbuster store and availability of new releases directly to your Internet ready television, Blockbuster movies are becoming as convenient as reaching for your remote control.

The cloud of uncertainty hanging over Blockbuster for so many years was the question of timing -- how soon would the consumer adopt digital content, and what would become of the stores. We knew it was necessary to answer that question and took on the challenge of transforming the physical side of our business as a bridge to the digital future.

Step one, and the most important mission, was to establish the stability of our financial results. We saw the core rental business as a strong cash flow generator but it was burdened with inefficiencies. By driving unnecessary cost in the business and taking a more focused consumer approach, we nearly doubled EBITDA in 2008 from $190 million in 2007 to $319 million in ’08.

Step two was to demonstrate the viability and the sustainability of the store model. By fixing the fundamental problem with Blockbuster stores, which was product availability, we increased store rental comps in ’08 by diversifying the product assortment, adding games, game consoles, accessories and licensed merchandise. We produced a 6% improvement in same-store revenues, growing same-store sales for the first time in many years.

Step three in transforming the business was to respond to the changing patterns of consumer demand. New channels for physical distribution have emerged including by mail and vending. Our by-mail service was clearly popular but it was also unprofitable at the time. Since this was fundamentally another form of physical distribution, we decided it was not the best use of resources to try to buy growth in that channel and instead we stabilized the operations and now enjoy a profitable business that offers a unique level of convenience to our customers.

Vending provided a new level of convenience that could expand the market presence for Blockbuster customers. We selected NCR as the vending partner not only for their expertise as the world’s leading manufacturer of self-service devices but also because we intended to future-proof the vending channel by incorporating a server into each device to allow for digital download capabilities.

By the end of last year, we were confident that the transformational path of Blockbuster was clearly established. As an industry leader, we server over 50 million customers on whatever platform they require, recognizing the same customer may choose different platforms on different nights, whether they prefer the breadth and depth of selection in the store, the convenience of vending, a by-mail subscription, or the portability and convenience of a digital download, Blockbuster is uniquely positioned to serve that customer today and into the future.

While the path to success was clear, by the end of last year we had also encountered these two significant obstacles -- the economy and our capital structure.

Our cash flow isn’t the issue. In the second quarter, we generated over $100 million in free cash flow from the core business. Our debt isn’t the issue. We are not highly levered with a debt of approximately three times EBITDA. The challenge was simply the timing of our maturities. We needed to refinance or extend the revolving credit facility during a period when credit markets were completely frozen. We realize that the costs would be high and amortization requirements would be severe but we believed in the long-term viability of Blockbuster and saw the temporary extension of our facility as a bridge to a more favorable credit environment.

This change in capital structure did not affect our strategic direction. We are still diligently working toward the transformation of Blockbuster but it was necessary to modify our tactics until our capital structure could be improved. With the higher cost of capital and aggressive amortization schedule, it was prudent to temporarily shift our attention from top line growth to profitability -- more specifically, to the generation of free cash flow.

To preserve liquidity and maximize margin during the quarter, we reduced inventory of both retail units, down some 40%, and rental units of the hottest new releases, down as much as 28%. Temporarily during the first and second quarter, we put our plans for increased availability on hold. We made this change with the recognition that we were also facing new and very aggressive competition who are better capitalized and would likely take share from us as we pulled back.

While confident in our ability to compete across all channels, in the near-term we have chosen not to engage in aggressive measures to defend our share. We believe that our time and resources are better deployed building the infrastructure that will allow us to compete effectively over the long-term.

As a result of these internal and external factors, we saw just over a 20% decline in total revenue. In many ways, this environment has created the perfect storm, as referenced by a research report recently published on Blockbuster. This perfect storm and the temporary shift in strategy that resulted has had a silver lining -- it caused us to accelerate our business process, re-engineering and redesign, develop our multi-channel platform through collaboration with others, and forced us to become more disciplined in managing costs. As a result of these efforts, we have shown meaningful improvements in the reduction of total SG&A expenses and improved adjusted EBITDA by over 30% year over year for the quarter.

Additionally, we generated cash from operating activities and recognized positive free cash flow which marks the first time in several years that the company has generated positive free cash flow during a second quarter.

As a result though, we must be realistically conservative about the remainder of this year. Our more conservative expectations during the second half of the year combined with the anticipated sale of an international asset has caused us to modify our guidance. We now expect our adjusted EBITDA guidance to range between $270 million and $290 million.

While responding to the current situation by managing the business for free cash flow, we have not, I can assure you, taken our eye off the longer term opportunity and the need to continue the transformation of Blockbuster. I will outline a few proactive steps we are now taking to improve the business and reposition the company for longer term growth.

First, we continue to work with and receive support from our various studio partners on new and improved revenue sharing agreements. Our latest contract that we are very excited about provides for films at a $2 to $4 minimum, recoupable minimum, which more than covers the physical cost of goods and is intended to establish a profit sharing, more of a profit sharing versus the historic revenue sharing approach.

We believe this was a win-win initiative that will result in an increased number of rents and improved profit for the studios on the back end.

The opportunity in games is even greater. The unusually high per unit inventory cost of games has caused many retailers to limit availability. Ironically, the cost to stock a videogame is some $4, with the balance of $40 to $45 being the cost of intellectual property. If we can overcome this artificial obstacle to inventory management, Blockbuster can then fill the shelves with games like Beatles Rock Band, for example, coming out on September 9th. That represents a perfect fit for our entertainment seeking customers.

We thank our suppliers for their continued support and we look forward to continuing to work closely with them on new and creative arrangements.

Second, we are anticipating an improved DVD title slate in the back half of the year with titles such as Star Trek, Angles & Demons, and Transformers, and accordingly we plan to increase unit purchases during the second half of the year, leading to significant improvement and product availability when compared to the first half.

We have also launched new programs such as Blockbuster Premiers and Blockbuster Encore Presentations designed to offer proprietary or unique movie content to our customers.

Third, we are more proactively developing the vending channel through our alliance with NCR. We will have approximately 500 machines in the market by the end of August and NCR is rolling out about 50 machines per week, well on their way to deploying more than 2,500 Blockbuster branded kiosks by year-end and another 7,000 planned by August of 2010.

The controversy swirling around vending these days is in the role of hot new releases. As Blockbuster and NCR gained learnings from the vending channel, we are discovering several challenges that relate to hot new releases. First is price. While the consumer certainly enjoys the value of $0.99 movies, we are concerned that from the cost of production through the expense of retail distribution, $1 per viewing is not a sustainable industry model. A recent USAToday article, for example, said if consumers figure it’s only worth $1 to see a movie at home instead of the $4.50 or so charged by rental chains and video on demand, then it could cripple the economics of today’s movie business.

A second challenge is in-stock availability. The physical limitations of a kiosk will prevent 100% in-stock availability on hot new releases, something the customer comes to expect from Blockbuster.

And the third challenge of the channel is the flood of previously viewed product into the market. Retail sales and possibly rental comps are being hurt by the availability of low-cost, previously viewed DVDs in all kinds of retailers from drug stores to convenience.

From an up-stream perspective, we believe the market for this product is becoming saturated.

A previously announced policy by Universal, a recent announcement from Fox, and a new announcement literally within the last hour by Warner just this afternoon referenced creation of a unique vending window which we believe is complementary to Blockbuster's multi-channel approach.

A vending rental window would enhance the complementary relationship between Blockbuster stores and Blockbuster kiosks. On Fox, Universal, and now Warner titles, for example, we can be far more aggressive in filling the store shelves with product to assure 100% availability of hot new releases. After 30 to 45 days, we can then make use of that product in our vending channel at a substantially reduced cost of goods, since that product will be partially amortized. Our customers can then use Blockbuster stores for depth and breadth of selection and assurance of hot new releases being available on Friday night or Saturday night. The customer can use vending kiosks then for value and convenience.

With the growth of this vending alternative, we can be also more aggressive with store closures as we develop a longer term hub and spoke strategy. This strategy will actually increase our points of presence while reducing our real estate liability.

With an average of only 2.5 years on our leases, we have an opportunity to significantly rationalize our real estate portfolio. We plan to have fewer of the large 5,000 square foot stores, a possible increase in our small urban 2,000 square foot stores, for example, and a significant increase in vending kiosks over the next few years.

The fourth initiative is our continued expansion of our digital library and our presence through alliance and collaborations with leading consumer electronics manufacturers. We recently announced alliances with TIVO, [ARPOS], [ROBY], Macrovision, and Samsung. Through our alliance with Samsung, for example, millions of homes across America will gain access to Blockbuster on demand movies by the end of the first quarter, representing the perfect bridge between physical stores where we will sell these devices and digital delivery by providing streaming digital access to the newest hit movies. We are very excited about the opportunity to move from theory to reality in digital distribution because the customer will now notice the difference.

If the customer with their new Samsung Internet ready television should select Netflix, also available on that TV, but then choose the movie Taken, for example, that customer will be told the title is not available. What they won't be told is that title will not be available on their watch instantly feature for the next three or four years. However, that title is immediately available when they select Blockbuster on-demand, whether through adaptive streaming technology or progressive download, whichever service will provide uninterrupted viewing given the bandwidth capabilities of that household. They will be able to access their favorite new releases through Blockbuster on-demand.

We believe we have a very strong competitive advantage in the digital space and are very much looking forward to the consumer having the ability to choose. We have additional exciting deals in the pipeline and look forward to sharing details on each of those as we are able to in the next few weeks.

In summary, due to the challenging market dynamics that we have faced, combined with the uncertainty surrounding the timing of our refinancing in the last quarter, we temporarily changed our strategy to manage the business for cash, not growth. Although we gave up our short-term focus on growth, we’ve developed each additional channel as part of a continued transformation of Blockbuster. Now more than ever we believe the future for Blockbuster rests in our multi-channel capabilities. We are the only provider able to offer the convenience of stores, by mail, vending, and now digital download capabilities, a strategy that we believe will provide sustainable competitive advantage both near-term and long-term.

With that, I will hand over the call to Tom who will provide a little more detail on our financial results. Tom.

Thomas M. Casey

Thanks, Jim. Since Jim reviewed our high level results and second quarter trends, I will focus my comments on gross margin, expense reductions, working capital management, and capital structure improvement. First, top line softness was partially offset by a 480 basis point improvement in second quarter consolidated gross margin. This increase was driven by leaner purchases under our revenue sharing agreements, as well as a shift to more traditional purchases.

As Jim mentioned, adjusted EBITDA increased over 30% in the second quarter as cost reductions more than offset gross profit decline from softness in our top line. Excluding foreign exchange, we reduced G&A by $74.9 million in the second quarter. The largest components of the reduction in G&A are the decrease in overall compensation expense and lease expense reduction associated with the year-to-date closure of 146 domestic company-owned stores.

G&A reduction also includes important contributions from our successful lease cost savings and overhead reduction initiatives. We are pleased with our rent reduction program and we successfully renegotiated leases on over 1,000 domestic stores so far. We remain on track to reduce G&A by over $200 million in 2009, excluding any effects of foreign currency or inflation.

The combined -- the combination of tight expense controls and working capital management resulted in a significant positive swing in net cash from operations from the second quarter of 2008. In the second quarter of 2009, net cash provided by operations was a source of cash of $114 million as compared to a $63 million use of cash in the same period in 2008, representing a year-over-year increase of over $175 million. This improvement was primarily attributable to a shift in our operating strategy as we manage working capital to maximize cash flow.

As you may recall, in 2008 we invested in inventories in order to improve in-stock availability of rental, expand retail and games to all stores, as well as increase general merchandise levels. Relative to the second quarter of 2008, the largest decrease in our domestic merchandise inventory investments was due to a decrease in games software, hardware, and accessories.

In addition, rental library purchases decreased 28% year-on-year as we conservatively managed our domestic film rental business. Our rental library purchases for the full year of 2009 will remain lower than prior year levels, though we plan to increase our copy depth during the second half of the year to better support an improved title slate as we cycle against the 2008 Olympics and the Presidential election last year.

Finally, our accounts payable balance is relatively flat with the first quarter. Year over year, accounts payable declined 44% due to lower G&A spend and lower overall rental and merchandising inventory purchases.

Moving to liquidity, at the end of the second quarter, we had $99 million of cash and cash equivalents. The sequential cash and cash equivalents decrease of $8 million was mainly due to funding of restricted cash, which was $124 million at July 5th and is primarily used for our letters of credit. The difference in the restricted cash balance from the 118 we reported in mid-May to the 124 reported July 5th is primarily related to the Canadian ABL.

The funding of restricted cash was mostly offset by net cash from operations, which as I mentioned was $114 million.

We continue to work on liquidity enhancement initiatives that we outlined in mid-May, first with regard to our letters of credit and reduction of the $75 million LC, we’ve made great progress to eliminate the Viacom lease guarantees, which as of a few months ago affected 131 stores and that number has been significantly reduced. We are well along in the process of the LC reduction and remain confident that that initiative will be substantially completed in the third quarter of 2009.

Second liquidity enhancement initiative we discussed is the sale of international assets. There it would be inappropriate to provide public details but we are very pleased with progress. There is interest in our international assets and negotiations are underway in several markets.

Next I’d like to review Blockbuster's free cash flow, consistent with our EBITDA guidance. If you take the midpoint of our updated adjusted EBITDA range of 280, subtract taxes of $22 million, cash interest of $80 million and capital expenditures of $30 million, that gets you to a free cash flow before working capital of $148 million for the full year. We believe this free cash flow, combined with the aggressive management of working capital, internal cost containment initiatives and external liquidity events will provide sufficient liquidity for the company to meet its operational debt service needs.

Finally, we’ve been in regular dialog with our debt and equity investors and we are pleased to hear that the debt markets have improved significantly. In the months ahead, we plan to evaluate opportunities to extend or refinance our debt maturities and reduce our cost of capital.

So with that, Operator, we’ll open up for questions.

Question-and-Answer Session


(Operator Instructions) Our first question comes from Richard Ingrassia with Roth Capital Partners.

Richard Ingrassia - Roth Capital Partners

Like you said, Warner just announced they are following Fox’s and Universal’s lead there and squeezing the red box window -- can you just say a little bit more of your take there? Does the kiosk become the second run DVD platform, or do you think -- is there any chance your size will allow you to get a better shake from distributors and secure day-and-date on new releases?

James W. Keyes

Well, here’s the challenge -- you know, we’re not really sure if it’s in our best interest or ultimately the consumer’s best interest to have day-in-date on new releases in a kiosk environment. Let me give you a rough feel -- the kiosk, the current red box kiosk holds about 500 -- approximately, the ones they have deployed now holds about 500 units. Put that in the context -- for a movie like Dark Knight, we stocked as many as 400 units per store and still ran out of stock. It’s going to be very difficult to ever stay in stock on hot new releases in a kiosk environment. So if you step back from that -- and that’s particularly challenging for Blockbuster because we are trying to increase the perceived reliability of the Blockbuster experience and the availability of product to ensure 100% availability associated with the Blockbuster name, and certainly be able to deliver that promise in digital and we are working hard to deliver that promise in the store. So the kiosk, just physical limitation presents an obstacle to us.

But if you step back from this for a second and you say why is the kiosk so popular, it’s all about convenience and value today, in today’s $0.99 environment. It represents a perfect opportunity for us to fill the shelves with product in the store -- we could have 300 or 400 copies per store, virtually every title, every hot new release, and then offload several hundred of those to supply our vending and provide that value and convenience. Now, the screaming issue in the marketplace now is how important is that hot new release to the consumer? Well, I’d call everybody’s attention to the video-on-demand business, which has been very popular over the years. I think many consumers don’t see a substantial difference in the newness of video-on-demand content versus the availability of that content in store, so -- all we are really saying is these are new releases that would be available in a kiosk, perhaps not the hottest of new releases. And if that window should prevail, it’s actually a very good thing for our multi-channel approach because it not only lets us fill the shelves in the stores but it allows us to extend the tale on the rentals of those previously viewed products rather than have to sell them in the open market.

Richard Ingrassia - Roth Capital Partners

Okay, thanks, Jim, I appreciate that. And maybe just if you could -- we haven’t talked a whole lot about the ticketing partnership recently. Can you give us a little more on what’s going on there? And if it has had any impact so far?

James W. Keyes

Sure. The ticketing is an exciting example of the kinds of diversification we can have in Blockbuster. It’s one example of many efforts that we have underway to have different use occasions for the physical store itself. And to be honest with you, it’s gotten off to a pretty slow start because the nature of the Live Nation ticketing is very event centric. So when we have an event, it’s been very good for us. It fills the stores with traffic, the customers like it, we certainly like the traffic associated with it but it’s been a bit -- a peak and valley business because of the event nature of it. I think the uncertainty and what we are actually looking forward to is the possibility of expanding that relationship over time as Live Nation and Ticketmaster come together and present a broader opportunity. Now, we haven’t really advanced those discussions to this point as we wait to see how that transaction evolves but it does represent a good long-term opportunity for us to help diversify the stores.

Richard Ingrassia - Roth Capital Partners

Thank you.


Your next question comes from the line of Tony Wible with Janney Montgomery.

Tony Wible – Janney Montgomery Scott

Good evening. I was hoping we could examine a little bit the new guidance where you are taking down numbers for the back half of the year but yet at the same time, you are saying you see a better pipeline, which we agree on. How much of that takedown is asset sales versus new expenses versus something else that you might be seeing with the revenue line?

Thomas M. Casey

Tony, with respect to asset sales, it’s a very small effect on the change, so it’s principally as Jim said conservatism toward the back half of the year that we are increasing our copy depth and title strength is good in the back half and we are increasing availability and unit comps are expected to be up, just given the results so far this year we prefer to take a conservative stance.

Tony Wible – Janney Montgomery Scott

I guess I’m just trying to put those things together, that if the pipeline is looking better and it’s to the point where you want to have more copy depth, that would presumably lead cash flows to go higher rather than later -- I’m just trying to make sure I am not missing something. Is there an advertising spend that you are expecting to go up? I noticed there’s a big increase in the impression that we are seeing out there.

James W. Keyes

Tony, maybe I can build on Tom’s point just a bit more -- as he referenced, we are going to try to build unit availability in the second half. Now, the trade-off there, if you’ll recall what we did in ’08, we sacrificed margin for growth. As we’ve built unit availability, it does cost us margin as we get more aggressive in our buys. We didn’t -- we chose not to do that in the first half of this year because free cash flow was so critical in the uncertainty surrounding our refinancing.

For the second half of the year, we are making a concerted effort to improve our unit availability therefore our conservatism relates more to the margin side of the business as we recognize it. It will cost us a little bit more to fill the shelves and we want to reflect the uncertainty of how quickly the customers will come back because of that unit availability.

Now, I’ll call your attention to 2007 when we first started to fill the shelves, it took us two or three quarters to go from negative comps to positive comps with unit availability so we don’t expect we are just going to flip the switch and go from the shortfall in availability as I referenced in the first half of this year, now all of a sudden filling the shelves, it will take a couple of quarters to get those customers back.

Tony Wible – Janney Montgomery Scott

So as you fill the shelves, what kind of impact do you expect that to have on working capital and are there any other adjustments to working capital we should anticipate seeing? In other words, does the benefit you saw this quarter -- is that expected to reverse at all as we build into the holiday? Or if you can provide a little bit of color as that kind of puts into your future of providing more stock?

Thomas M. Casey

I would look at the back half of the year as similar in terms of working capital experience relative to 2006, 2007 so typically in the back half of the year, working capital is a source of cash and notwithstanding the increase in purchases that we referenced, we expect working capital in the back half to be -- I won't give you a specific number but if you go back to ’06 and ’07 and look at those numbers, that would be a good place to start.

Tony Wible – Janney Montgomery Scott

Okay, last question here -- I was hoping you could just touch on the new pricing plans. I don’t think you addressed on the call and obviously -- I would imagine it’s a little bit more of a hot topic, given what’s going on with kiosks these days. Where do you stand with that?

James W. Keyes

Well as you know, we were excited about the opportunity to put daily pricing in place. Given the success that we had in 2008, we were confident that we could absorb a small dilutive impact of going to a daily price. We weren’t as aggressive as the vending providers are out there today. We were on average between $2 and $3 per day on hot new releases. We had a $0.99 price point on our library but on hot new releases we generally, in most markets, anyway, had that higher daily price point.

What we are trying to do now is test the elasticity. We didn’t roll that out, given the focus on free cash flow in the first half. Since it was dilutive, we didn’t think it was prudent to continue rolling out that daily pricing. We are now trying to test the upper end, frankly, of the elasticity curve because what we are finding is when it comes to hot new releases, it has very little to do with price. Customers want the movie Fast and Furious, they are not going to squabble over a couple of dollars for it. It’s still a very good value versus retail and versus the theatrical, so we don’t think it’s necessary to get down to an extremely low price point.

The question is how much will the customer be willing to pay on a daily basis and how will that compete in the marketplace when we do go head-to-head with vending, so those are the learnings that we are gaining now before taking further steps to roll out a daily price.

Tony Wible – Janney Montgomery Scott

And outside of the personal shares that you guys own, are there any changes in compensation or incentive for compensation related to paying down the debt?

James W. Keyes

I’m sorry, Tony, could you --

Tony Wible – Janney Montgomery Scott

Has the board contemplated any compensation changes for -- incentive changes to compensation for paying down the debt?

James W. Keyes

No, I don’t think they have contemplated that. I would be happy to suggest that to them.

Tony Wible – Janney Montgomery Scott

All right. Thank you, guys.


Your next question comes from Charles Wolfe with Needham & Company.

Charles Wolfe - Needham & Company

Yes, I want to go back to the vending question. First, I sort of missed the number of kiosks you plan to open with NCR over the next year or so. And then second, is there going to be an explicit vending window? In other words, will the kiosk get the releases on the same day that the stores do, or do they have to wait 30 to 45 days?

James W. Keyes

Well, to the first question, we will have 500 -- we expect to have 500 branded units by the end of this month, 2,500 deployed by the end of this year; an additional 7,000 are expected with NCR but branded Blockbuster by the end of August of next year. That’s the current deployment plan.

As it relates to the window, we were actually very pleased to see the announcement today from Warner. Now, the uncertainty is the impact that this will have on the vending model. We think it will have a likely impact on the sales of vending per unit because the hottest new releases will not be available for -- between those three studios, they represent some 60% of the market. So the hottest new releases will not be available, assuming other studios don’t also declare a window. So that could have an impact on top line.

Now for Blockbuster, we think that represents though a pretty significant competitive opportunity because we already have a tremendous number of these copies in our store so if we are able to amortize, take the movie Fast and Furious, if we’re able to amortize that with rents in our stores over a 30-day period and then move that product, call it an internal transfer price of $5 versus a wholesale price of $18 or even $15, then we think we will have an opportunity to extend the life and increase the ability to amortize that title in the vending channel for yet another 30 to perhaps 60 days before we end up destroying it or selling it as previously viewed.

Frankly the problem that I discovered in this industry when I came to it two years ago is that previously viewed product had become a drug -- it had become something that Blockbuster and others relied on to bolster earnings. But it was an artificial element of our business. It was sort of a necessary evil -- what do you do with this product after you have had rents from it? The studios didn’t like it because it cannibalized retail. We were overly dependent on it, so we started working last year to eliminate our own internal reliance on previously viewed product because we didn’t think it was good for the long-term health of either Blockbuster or the industry.

When vending started to grow, it started to flood the market with previously viewed product, so it created actually a threat to the industry because of all the previously viewed product that was flooding the market and is probably having a substantial impact on the decline of retail DVDs today because of the ready availability of pretty new releases at a very, very low price available in the market today.

So the bottom line in all of this is that we actually do think the Warner announcement today was good news. We think that the three studios that have created a vending window will create a unique use occasion for vending that we think is perhaps a more appropriate use occasion for the limited capacity of those machines to have new releases but perhaps not the hottest new releases.

Charles Wolfe - Needham & Company

So just to clarify, Jim, that -- for those three studios, they will not sell movies to say red box for 30 days?

James W. Keyes

We are not sure of the details. We read the Warner announcement today ourselves and we haven’t yet received all of the details about the structure of any of these deals.

Charles Wolfe - Needham & Company

Okay, well, I’ll check out the Warner announcement. Thanks a lot.


Your next question comes from Emily Shanks with Barclays Capital.

Analyst for Emily Shanks - Barclays Capital

This is Jason [Torheo] in for Emily. On the international asset sales, I know you can't say a lot but do you still expect the transaction to close in 2009 and that proceeds will exceed $100 million? Is that guidance still relevant or has that changed at all?

James W. Keyes

Well, we said on the first quarter call that international asset sales would provide over $100 million in liquidity and that is a conservative number and as far as timing, again I can't -- I’m not at liberty to say a whole lot more than we are pleased with progress and I have to leave it at that.

Analyst for Emily Shanks - Barclays Capital

I understand. That’s great color. Appreciate it -- with regard to the kiosks, as far as digital download goes, is that something available currently or what’s the timeline on rolling that out for the kiosks?

James W. Keyes

As you know, we are testing digital download capabilities in a few stores today. We are very early. We are way ahead of both the consumer and the studios on this. The good news is that the technology is perfectly available today. It works. You can actually download a movie, a TV show to a thumb drive, to an SD card. And if you have that movie captured in a server on site, you can download that movie in a matter of minutes versus the hour or two hours it could take, depending on the bandwidth, to download that movie at home. So there’s a real advantage in digital downloads that we believe is part of the future.

The reason for our selection as I referenced with NCR is that when we deploy kiosks, the good news is we don’t have 18,000 kiosks in the market today so we can actually with NCR deploy kiosks with the server capability to house those movies on site and to be able to build in the download capability to load a thumb drive or an SD card. Now the only remaining obstacle, the technology as I referenced, works fine. The remaining obstacle is getting the studios to all agree on the consistent standards necessary for security and protection of their intellectual property. That process is underway. There are a couple of studio groups today. It’s very similar, if you will, to the challenge that we had with HD versus Blu-Ray and the studios having to agree on a format, a consistent set of standards in a format. Naturally it’s going to take some time for them to do that. We think that could take as much as a year, perhaps two years. But our hope is that the deployment of our vending machines will be built with an eye to that digital download capability so that as we deploy our own infrastructure, they will have their own, as I referenced, almost a future proof capability. They won’t just be vending machines for DVDs -- they will also be servers able to download content direct from Blockbuster on demand capabilities.

Analyst for Emily Shanks - Barclays Capital

Thanks, that is helpful. And then just lastly, on your plans to extend debt maturities, are you currently in talks with lenders now and is that something you are targeting to take care of within fiscal 2009? And then also, are you looking at just doing maybe an extension of the term loans or are you looking at new issuance? Give us some more color on that. That would be great.

James W. Keyes

I would just tell you that we are in, as I said, we are in regular dialog with our debt and equity investors. We are very pleased that the market has come back strong and just from a corporate finance one-on-one perspective, obviously you look at our capital structure and our debt amortization, it would behoove us to evaluate alternatives as they become available. And it certainly appears that the market is receptive and we look forward to continuing the dialog with our debt investors and others. But it is certainly a priority for us in the months ahead.

Analyst for Emily Shanks - Barclays Capital

Thank you very much for all the detail and good luck.


We have no more time for questions. I will now turn the call back to Jim Keyes for closing remarks.

James W. Keyes

Thank you. Well, we appreciate your continued support. I hope you will take from this call the same takeaway that we have -- basically that retail is all about responding to change, whether it’s responding to the macroeconomic environment and the need for us to shift our focus from top line growth to free cash flow, or the realistic change in consumer demand that causes us to be -- to have to be nimble. If the consumer prefers to get content via mail or via a vending machine or even via the convenience of digital download, we have to be there for them and respond to that change to be successful into the future.

I hope your takeaway from this call is that we have done the best job we could of responding to the near-term priorities -- in particularly, the importance of free cash flow and our ability to sustain the liquidity of this company to see a better day, because we do believe very strongly in the competitive advantage. The opportunity for Blockbuster to be the preferred provider of convenient access to entertainment across virtually all channels. We offer that today. We think it is not only a competitive advantage but a sustainable competitive advantage in the marketplace. I hope you will see it the same way and look forward to your continued support. Thank you very much.


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

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