Starz Entertainment Corp (STRZ) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Lions Gate Entertainment Third Quarter Analyst and Investor Call. At this time all lines are in a listen-only mode. Later there will be an opportunity for questions. Instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to turn the conference over to Head of Investor Relations and Corporate Communications, Peter Wilkes. Please go ahead.

Good morning. Jon Feltheimer, our CEO, will be giving opening remarks. We will be joined on the call by Michael Burns, our Vice-Chairman; Jim Keegan, our CFO; Greg Arvesen, our Chief Accounting Officer; and Marni Weishofer, EVP of Corporate Development. After Jon’s remarks we will open up to Q&A, first from analysts, then from investors. The matters discussed in this call include forward-looking statements, and these statements are subject to a number of risks and uncertainties. Actual results in the future could differ materially and adversely from those described in the forward-looking statements as a result of various important factors. Jon.

Thanks, Peter. Good morning, everybody, and thanks for joining us today. It’s been a really busy, productive, and successful three months for Lions Gate. We completed what we believe is a transforming merger in record time. Let me review the timetable that got us there and then talk about fiscal 2005. As I do, I believe that it will be hard to argue the fact that Lions Gate has become the premier independent filmed entertainment company.

On October 8th we raised $74 million in gross proceeds from a common stock offering, setting the stage for the Artisan acquisition. We signed the Artisan deal on October 24, 2003. On December 3rd we completed the placement of $60 million in senior subordinated convertible debentures, which helped finalize the financing of the transaction. We closed the Artisan deal on December 15th, 48 days after we announced it. Seven days later, on December 22nd, we moved into our new offices and on January 6th we were fully functioning as one company. Once the merger had been completed, and as we anticipated on the last call, we didn’t uncover any surprises. On the contrary, all of our expectations have been met or exceeded so far.

In terms of cost savings, we’re on budget with our first-year estimate of $20 million plus of net G&A savings. In terms of revenue synergies, we’ve been offered huge advances and margin improvements from a number of existing and prospective vendors who are competing for the combined business. We’ve been in extended conversations with various distribution partners about extending or improving those deals. In terms of personnel, I’ve been very impressed with the quality of the Artisan employees. As a matter of fact, overall, of the 30 division and unit heads going forward, 18 come from Lions Gate and 12 from Artisan. In terms of the Artisan library, there have been no surprises. Our combined 8,000-film library will throw off over $200 million in revenue this fiscal year. This is major studio-level library generation. The new organization itself is running very smoothly. We are reducing headcount by 141 people, roughly one-third of the total workforce. We’ve integrated Lions Gate’s and Artisan’s information systems and we’ve moved our physical plant, all without a pause in productivity, which I believe is a testament not only to how well, and I should probably add how long, we had planned for this merger, but also to the quality of our executives.

In order to simplify our corporate structure, reduce my direct reports, and allow Michael and me to focus even more intensively on strategy and growth, I am naming Steve Beeks, who is also joining us here today, the President of Lions Gate Entertainment, Inc. Steve was the driving force behind Artisan’s home entertainment business, which he grew from $115 million to $300 million in annual revenues in four years. Steve will be supervising all of our joint home entertainment businesses, including Family Home Entertainment, which is run by Glenn Ross, as well as taking on additional corporate operations.

Wayne Levin, our General Counsel, has also been given added responsibilities as Executive Vice-President of Corporate Operations, and in that role will be reporting to Beeks. In addition, we have signed many of our key executives to new long-term deals giving us the necessary continuity. These deals will be part of an announcement that we will issue shortly, outlining our entire infrastructure going forward.

Before I talk to you about how we see our core businesses going forward, let me give you an overview of third-quarter financials. The quarter has been affected by three areas of unusual and non-recurring activity. In this quarter we’re taking charges of $11 million from CineGroupe and $8 million due to the Artisan integration, and our P&A and video-marketing costs are $7 million higher than originally forecast because of the recent box office successes of our films.

We had a non-cash write-down of CineGroupe’s assets due to their filing for protection under Canadian bankruptcy law. CineGroupe took a conservative look at the effect of their potential restructuring on the carrying value of their assets and as a result wrote off $9.9 million. CineGroupe had an additional $1 million in operating losses during the quarter. We believe if the organization plan is accepted, CineGroupe will emerge a relatively debt-free and far stronger company, able to continue as a valuable strategic partner for Lions Gate Family Home Entertainment. Second, we had $8 million in unusual costs due to relocation of the physical plant, severance, and other aspects of our integration with Artisan.

Finally, as you know, on the last call we forecast $30 million in domestic box for the five Lions Gate films at the end of calendar ’03; Cabin Fever, The Cooler, Girl With A Pearl Earring, Shattered Glass, and Wonderland. Those films will actually do about $40 million in box office, so we have spent an additional $7 million in theatrical and video P&A, maximizing their success, which is expensed now, but will be more than recouped later as we report their full theatrical DVD and other ancillary revenues. Let me note that we’re already beginning to see that activity at the top line where revenues for the quarter were $77 million, up 26% from the prior year quarter.

Let me talk to you about how we see our core businesses going forward into fiscal ’05, which will be our first full year of operations with the merged company. As I describe our merged operations, I think you’ll see why we’re so excited about our future. On the feature side our slate is the broadest and deepest we have ever had. The Punisher, Havana Nights: Dirty Dancing, Man-Thing, Eulogy, and Stage Beauty have been added to Godsend, Final Cut, Dogville, and The Cookout as part of a slate of 16 theatrical releases that we have conservatively budgeted to do $130 million at the U.S. box office as a base case scenario compared to $50 million budgeted box office last year.

We expect the four already-anticipated wide releases, The Punisher, Godsend, Havana Nights, and Open Water, to do a minimum of $80 million at the domestic box office with at least another $50 million coming from our 12 platform releases during the year, some of which may eventually go wide.

We’re off to a great start. The Cooler and Girl With A Pearl Earring earned four Academy Award nominations, giving us 17 in the past six years, more than any other independent studio. We platformed both films, timing them well for the award season and getting a good boost at the box office from their Oscar nominations.

We have strong promotional tie-ins, including Revlon, J-Records, Univision, and AOL Latina for Havana Nights, which features Diego Luna from Y Tu Mama Tambien, and newcomer Romola Garai. It opens on over 2,000 screens nationwide in ten days. Dogville, starring Academy Award winner Nicole Kidman gives us an A-list star in a modestly budgeted acquisition that will be released in March, and it is already generating critical acclaim and provocative newspaper commentary across the country.

We have two big releases in April; The Punisher, based upon the extremely popular Marvel™ character, starring Thomas Jane and John Travolta, going out on over 2,500 screens April 16th ; and Godsend, starring Robert DeNiro, to be released in theaters nationwide two weeks later.

We believe strongly in these films and will be supporting them with significant P&A over the next ten weeks. We’ve discussed before that the enhanced cash flow from the combined companies will allow us more flexibility to reach a little higher when presented with the right opportunities. As an example, on the motion picture side, we’re looking at one or two extra wide releases each year and stepping up to somewhat increased P&A on selected films, such as The Punisher, when they have potential, not only at the box office, but right through our DVD, pay TV, and library food chain, not to mention long-term branded franchise opportunities. In that respect I’m pleased to announce that we’ve almost finalized an agreement with Marvel for The Punisher sequel, and don’t be surprised if there are additional announcements in the near future about Marvel/Lions Gate projects.

We’re also very excited about the rest of our fiscal ’05 slate, nearly all of which is already in the can. Later in the spring we have Eulogy, starring Ray Romano, Debra Winger and Zooey Deschanel, which played extremely well at Sundance. For the late summer and early fall we’re releasing The Cookout, an urban comedy with Academy Award nominee Queen Latifah and a very strong ensemble cast. You may have seen the trailer the past two weeks together with Barber Shop 2. We also have our in-house production, Final Cut, starring Academy Award winner Robin Williams, Mira Sorvino, and Jim Caviezel and another film based on a Marvel franchise character, Man Thing. Our holiday release schedule is already set with Stage Beauty, starring Billy Crudup, Claire Danes, and Rupert Everett, and one of our new projects, Beyond the Sea, the Bobby Darin story starring another A-list talent, Kevin Spacey, along with Kate Bosworth and John Goodman.

Other new projects include, as mentioned before, Open Water, which came out of Sundance with big feature stories in Newsweek, Entertainment Weekly, and was recently referred to as our Blair Fish Project; Fierce People with Diane Lane, directed by Griffin Dunne; and three films that fall within Lions Gate’s horror family, House of 1,000 Corpses 2, or as I’ve referred to it, House of 2,000 Corpses, from Rob Zombie; Haute Tension from new horror director Alex Aja; and Saw, a movie we recently acquired as a negative pick up and has tested to huge results. As you can see, we have a number of upcoming films where we have the opportunity to go wide as we evaluate our dates and our competition. We’re sticking to A-list talent on our slate and we’re sticking to our business model while giving ourselves the chance to take a few more big swings at the plate each year.

We’ve budgeted $95 million in theatrical P&A for fiscal ’05 compared to $60 million in budgeted P&A for fiscal ’04. That’s a 60% increase in P&A, which we expect to yield a minimum increase of 120% in theatrical box. These numbers will resonate through our ancillary results, particularly given the strength of our home video business because, as we anticipated, the combination of Lions Gate and Artisan’s video businesses is going to be explosive.

Lions Gate Home Entertainment currently ranks number eight in the industry with a 4.35% market share, right behind MGM at 5%. Cabin Fever, which debuted at number three on the DVD sales charts three weeks ago, and House of the Dead, both top-ten on all of the national charts this week, are good examples of why.

Lions Gate Family Home Entertainment is number four in the industry with 6.6% of the business. We’re number one in fitness, a tremendous growth area, with 22% of the top 50 titles led by Denise Austin. And we see a great opportunity for even larger market share as our bigger feature films move through their video window, along with growth we anticipate in terms of music videos, more fitness and family product, and even video games.

We intend to use our deep retail sales capacity to leverage into other areas where we will compete in our typically atypical way. Overall we expect $390 million in revenue out of our video businesses alone in fiscal ’05 and once again, I’d like to emphasize the ever-greater diversity of our product with 400 different titles contributing more than $100,000 in the past calendar year.

Our television business continues to grow and diversify. We’re going into our third year of the Dead Zone for USA Networks and have new programming for ABC Family, Lifetime, USA, and Discovery Networks. I’d particularly like to point out our two-hour pilot for USA Networks, Frankenstein, directed by Texas Chainsaw Massacre director Marcus Nispel, and our new pilot for Lifetime, The Coven, from producer Gale Ann Hurd.

We will continue to be an industry leader in supplying one-hour dramas, movies, mini-series, and non-fiction programming to the top cable networks. The branded cable universe continues to expand and search for fresh, original product and our television production business will continue to grow with it.

But perhaps one of our greatest areas of future growth lies in the video-on-demand business. As a content supplier we still don’t use VOD numbers in our bank’s library valuation on which our borrowing base is calculated. As a distributor we are partnered with Microsoft, Blockbuster, and European cable giant UPC as one of two major VOD companies delivering feature films via the Internet.

This calendar year CinemaNow will do over $5 million of revenue from subscription and pay-per-view customers and that number could get a lot higher. We have just introduced a new Web site in order to allow download to own video and are negotiating with at least one studio to license their content for this service. Video-on-demand is here to stay and as we move into the on-demand digital world it is difficult to question the likelihood that CinemaNow will be a very important, strategic distribution channel for Lions Gate and that our 55% piece of this pipeline will become an increasingly valuable financial asset for our company.

So, two months into our merger it is clear that we’re not changing our overall approach. We’re not changing the basic model that got us this far, achieving the goals of our five-year business plan a year early. For example, Open Water is a $2 million acquisition that will be one of our wide-release pictures; and Fierce People, another Lions Gate production with a big star, Diane Lane, will cost a fraction of what it would cost at a big studio.

Our industry continues to be in consolidation mode and we are now well positioned to capitalize on all of the opportunities created by our status as a premier independent consolidator over the past four years. So how does that position us financially going forward? Given the integration of Artisan and the combination of two full film and video slates, the fourth quarter will have substantially higher P&A than usual, close to $45 million in theatrical P&A during the quarter. Although we’re not prepared to give fourth quarter guidance due to purchase accounting details pertaining to the merger that are still being discussed, EBITDA will be negative in the quarter.

However, as we move through fiscal ’05 and achieve the benefits of our first full year of merged operations, we are projecting revenues of $650 million with free cash flow after debt service of $80 million. We expect our free cash flow generation to be so strong that the plan is to pay down $150 million in debt in the next 30 months. Revenues from our library will be an important and consistent factor in our ability to generate this cash flow. Again, we expect in fiscal ’05 alone over $200 million from the library.

In terms of EBITDA, in the acquisition of Artisan we added $220 million in library value to our balance sheet. This library has been fully paid for in the transaction. We are still resolving the non-cash, step-up amortization formula for the library and, therefore, can’t currently project EBITDA under U.S. GAAP, which we are adopting as of April 1 st . However, I can say that using the straight-line amortization, as we have typically done, and as applies to the Trimark transaction, our EBITDA and earnings per share estimates would be in line with the Street’s expectations.

We’ve been concentrating on free cash flow for the last year and I believe now more than ever with ongoing changes in reporting requirements for film amortization, purchase accounting, as well as the frontloading of P&A expenses, that free cash flow is the best metric with which to judge our performance and the best benchmark for our operating goals.

In addition to concentrating on free cash flow, we’re continuing to improve our capital structure as well. This past Friday we announced to our remaining preferred shareholders from the year 2000 financing that we were converting their preferred. This will save us $800,000 a year and we are continuing to take advantage of the fact that the average cost to service our debt is approximately 5%. Our current availability is $95.6 million and our contingent receivables, or backlog, are $108.7 million, up from $59.8 million last quarter.

The recent offer by Comcast for Disney is a good indication to us that our strategy is correct… that consolidating cash-producing libraries and the creation of a powerful distribution alternative to the major studios would result in a self-sufficient, attractive, not easily replicable asset. While, obviously, we’re not Disney, there has never been an independent studio with the breadth, the depth, and the content of Lions Gate today. That’s why our employees are so motivated and the industry is so enthusiastic and why we’re so excited going into the future. We welcome all of your questions.

Our first question comes from Lowell Singer with SG Cowen. Please go ahead.

A few questions. Can you give us some sense, you talked about Q4 P&A and you talked about theatrical P&A, on a run rate basis in fiscal ’05 and ’06, where you think your overall P&A spending will be? Second question, you said that you’re forecasting $80 million in box office for the four wide releases. I’m trying to get some idea of how sensitive the model would be on a profitability basis based on deviation from that number, so I’m wondering if you can give us any guidance on that. If the films did $100 million or $120 million or if they did $60 million what that would do to the earnings of the company?

And finally, I’m just wondering if you can clarify some of the library revenue comments. I think you said there was about $200 million in library revenue on a combined basis. You also talked about $390 million from the video business, so I’m wondering if you can just define the different terms so we can sort of get our arms around everything that’s being done on video? Thanks.

In terms of run rate going forward, the total P&A, meaning including video, is dependent upon the success of the pictures. In terms of the business model that we ran for the Artisan acquisition, the run rate in terms of theatrical P&A is reasonably consistent for the entire five-year business plan. We don’t ramp up much beyond where we are in terms of the number of wide releases. The number of overall releases, I believe, in the third year we move to 18 or 19 releases and a few more direct to video titles, but over the five-year plan we don’t greatly increase our theatrical P&A much at all. If we have tremendous success in our wide release pictures, obviously that will encourage us to go a little bit further, but I would say basically the slate, as we’ve laid it out, stays reasonably the same for at least the next two or three years.

Sensitivities in terms of box office, there are some reasonable sensitivities because of the leverage one gets from the box office through the food chain, so obviously, we take advantage of that in success, as we talked about going from $30 million on the last five pictures to $40 million. On the down side, it really would be much the same, so I think we better perform and we better hit our numbers. Obviously, we always like to leave a little room for up side. We think we’ve been conservative on those pictures. Frankly, I think The Punisher alone could do well over $50 million, but again, we want to be conservative because of exactly what you’re talking about, which is that there is leverage in those numbers.

In terms of the library, it’s really pretty simple. We define library the same way that we always have, six months after each individual window. The $380 million is the total video revenue coming from all of our businesses, both library and new. Some of the library revenue of the $200 million comes from television sales worldwide. I don’t have that breakout right now, but you can assume, therefore, that the $380 million of video is not minus $200 million in terms of what the fresh product is; it’s considerably more than that. I just don’t have that breakout.

Thanks.

Thank you. Our next question comes from Robert Routh with Natexis Bleichroeder. Please go ahead.

A few quick questions. First, obviously, as a result of the potential for step-up accounting rules, as MGM saw when they acquired the Orion library, which can influence your EBITDA, it seems as though investors probably would like a clearer sense as to how that does not impact, in any way, shape, or form, your actual cash flow generation. Because the way we look at it is if we put your company on a multiple of actual free cash flow using the $80 million number that you just threw out to us, the company is trading at a multiple of about ten to 11 times forward free cash flow, which seems relatively low considering that some of your peers are trading at about 18 to 20 times forward.

I’m wondering if you can comment a little bit on how that accounting treatment can impact your EBITDA and not your free cash flow and also, what the company plans to do going forward to get your multiple more in line with the comparables in your industry in the public markets?

Robert, it’s Michael. The $80 million that Jon referred to, that really is the matrix that we want to be judged by. That’s after debt service. That’s $80 million of pure free cash flow. It’s up to guys like you and the other analysts that follow us to put the multiple on that, but we are cognizant of the fact that we need to go out and tell the story to institutional investors and to the marketplace and also pick up additional research coverage, but we’re endeavoring to do that. But again, you’ve got it right on the nose that it really is a pure free cash flow number that we’re focusing on and it’s just up to us to go out and tell the story.

And then as far as that free cash flow number, I’m wondering if you can give us any sense as to how sustainable you think that is going forward and also, if you could comment a little bit on your plans with respect to CineGroupe? At this point do you plan on keeping it or possibly divesting it? Plans with respect to the studio operations, which I’ve noticed in the last couple of quarters you haven’t broken out separately, which is something you used to do; the question is are they still as strategic given the size of the film library as they once were?

Then I was wondering if you could comment a little bit on the deal that you announced with Cinema Now recently regarding bringing VOD to the television, as opposed to the PC?

CineGroupe, obviously, looking at the combined companies and with our 29% equity share, is not a significant contributor, but what we have is such a dynamic family home entertainment business now that we’ve put these two companies together; we are playing with so many great brands, our relationship particularly with Mattel, that it’s our feeling that CineGroupe could be a very strong potential animation partner for us going forward. It is all really dependent upon whether the bank and the court accept our reorganization plan. If they do going forward and we can do it in a way that we can understand a long-term value then we are going to go forward with it and if not, we will definitely be out of it.

Jim, do you want to talk about the studio?

The 10-Q will be filed today. It’s footnote number nine, breakout segment information. It’s buried in the footnotes, but we do get full visibility on the segment profitability of our studio. Currently the studio for the nine months ended December 31, 2003 had $4.9 million of our revenue and basically contributed about $3.2 million of EBITDA. Again, that will be fully disclosed when you see the 10-Q today.

It’s a very reliable cash flow, Robert. That’s why we’ve held on to the studio. On your last point, the announcement you’re referring to, it’s something I think I’ve been talking about, really, for the last three or four quarters, which is the fact that technology is going to be creating a seamless connection between the Internet and peoples’ televisions, peoples’ media centers. That’s what’s going on right now. What’s interesting again, and that’s why I’m talking about Cinema Now today, not only are the revenues starting to move up, but broadband is starting to become ubiquitous and

people are starting to realize at the end of the day that there is actually more flexibility and more diversity from the content that they can bring now through their television set from broadband than satellite or even digital cable.

So we’re very excited about the new developments. We do believe that CinemaNow can be an amazing pipe for us, clearly in terms of being a distributor and, as I said before, just in terms of being a content supplier and getting additional revenues from our product.

Just two follow-up questions. First, MGM has recently mentioned that they’re interested in getting a new distributor possibly for their Orion library and doing something with United Artists. It would seem, given your content and your distribution capability, especially pro forma for Artisan, that this would be a natural fit for you as long as the terms would be amenable to both parties. I’m just curious as to whether or not that would be something that you would be interested in if it was to come to your doorstep in the future?

Second question. Just going back to my first question dealing with the multiple of free cash flow, this is more for Jim; if I do my math right and put you on the same multiple as some of your peers at the high teens/low 20s, that puts your stock at about low double-digits. Would that be correct?

Robert, we’re not going to do the model for you, but yes. If you’re talking about a free cash flow multiple of 20, we’re certainly trading for significantly less than that.

I do want to answer your other question, by the way, I’m sorry, Robert, about the future. What I tried to emphasize today going into a little more detail in terms of all of our numbers from operations, particularly video, what I wanted to emphasize is how much of our revenue is coming from product that we’ve already created or what I would call ongoing businesses. When I talk about 400 films generating over $100,000, those businesses aren’t going away. Dirty Dancing continues to sell over 100,000 units every month. So clearly, both in terms of operations and financially, this merger has given us incredible flexibility and I think that we have been emphasizing right from the beginning, when we talked about the possibility of this merger, we talked about the fact that these two companies together, both because of the cost savings, because of the revenue synergies, and because of the operating fit of these two assets, would be throwing off a tremendous amount of free cash.

So as long as we continue to have the consistent portion of revenue generation being larger than the new product I think that we’re going to have consistent free cash flow for many years.

Robert, one more thing as far as answering your question about the Orion library; we are fully up and running. We are looking at every opportunity to leverage our infrastructure.

Thank you very much.

Thank you. We’ll now move on to Gordon Hodge with Thomas Weisel. Please go ahead.

Just a question, again, on P&A: You mentioned that you had a budget, I think of $65 million, was it, or $60 million last year. I guess that was just theatrical, if I’m not mistaken. My guess is you’re probably over that budget given that you’ve decided to spend to support the film success that you’ve had. Is that correct? What would the final P&A number be for the year? Then if you could give a sense for what your home video P&A budget is for ’05 that would be great. Then if there’s any way to provide a sense for what, on a calendar year basis, Artisan did in terms of revenue and EBITDA last year, that would be helpful as well.

Currently the theatrical P&A that we’ve incurred for the nine months is about $46 million, for the nine months at 12/31/03. We anticipate for the Artisan titles… we’ll add about another $15 million for those Lions Gate titles that we had budgeted to release this quarter, bringing us up to $60 million of P&A almost strictly for the Lions Gate titles. The Artisan titles, The Punisher and Havana Nights will have in the neighborhood –

We’re not going to give a specific number, but those are obviously two very wide releases. I’m sorry, Gordon. Are you asking about our fiscal ’05?

A little of both, actually, but I mainly just wanted to see whether you were above budget on P&A for ’04. I gather it’s maybe just the $7 million that you talked about in the press release, but I wanted to know –

That’s basically right. As I said, the fourth quarter is going to be unusual in that we are combining the two slates and adding one big picture that we wouldn’t have had, which is Havana Nights, as well as some Punisher P&A. Going forward, I gave you the number that we were budgeting for our theatrical P&A.

And that’s combined, right? The $95 million?

Yes, that’s combined. Michael, do you want to address the marketing for video?

Video marketing will be in the $75 million range approximately for our next year, ’05, for the combined company.

Great. Any sense of what Artisan did sort of on a standalone basis last year, calendar year?

I don’t think we have a breakout on that, Gordon.

Then one last question, just on CinemaNow, just to refresh our memory, I think you wrote that down, what, a year ago or so? It sounds like that may have been a conservative move. It sounds like you’ve got some high hopes for that. Are they self-funding? What’s their situation?

They’re right now about cash break-even. They’re going to go out now for a $6 million to $8 million round, so that they can push ahead further in terms of marketing particularly and making sure that they have the studio content going forward. But it’s pretty amazing in four years of operation they’ve spent $10 million.

Thanks.

As we put out the Q later today you’ll see some pro forma was added in some of the Artisan revenues for the three and nine months.

That will be helpful. Thanks.

Thank you. We now have a follow up from Robert Routh. Please go ahead.

I have a few quick follow-ups: First, could you give us an update as to your NOL or your cash tax situation? Last time I checked I assume you guys don’t have any cash tax payments in the future, but I just wanted to double check and be sure that that was still the case.

Second, I wanted to confirm that the company is planning, at least at this point, to take the lion’s share of any charges related to the integration of Artisan, etc. in the fourth quarter of ’04 so that in ’05 we can look at it as a clean slate going forward, because I think that’s how most investors are going to look at it and I just wanted to confirm that that is management’s intention.

Finally, I was wondering if, given the massive size of the library that you have now, do you have any intentions to pare back on certain titles that you feel you don’t need and actually sell them to other third parties as a way to generate incremental revenues off some titles that right now or in the future you don’t plan on focusing on?

I’m going to jump in on the last one. We’re not planning on selling any titles. We’re acquirers as opposed to sellers, Robert.

Jim wants to comment about the NOLs.

NOLs, again, at the end of last year will be a little higher, but we had $66.4 million of NOLs on the U.S. side. We had $32.2 million of NOLs on the Canadian side; that’s in U.S. dollars. The NOLs will continue to be that. I do not anticipate being a taxpayer in the near future, but we’re analyzing that.

On your other point, I think you’ve hit on exactly what we’re doing. We had two companies that, as I’ve said before, are amazing fits together, but they had two different philosophies in terms of how they looked at development, two different slates. What we’re doing is we’re putting all of that together in the third and fourth quarter and we’re taking a very conservative look at the combination, so we’re taking a conservative look at our development costs, both here and in Canada. We’re taking a write-down on capital costs. We’re converging one system with another, particularly with our general ledger. We are looking at inventory; both companies had different ways of looking at inventory, residuals, participation, and we are ultimately getting one system together so that by fiscal ’05 we are fully going forward as a fully merged company with just one philosophy and I guess you would say in your words, a very clean company.

Thank you very much.

And obviously, we all know fiscal ’05, for us, starts in six weeks.

Thank you. We now have a question from Tom Bishop with BI Research. Please go ahead.

One question I had was this Open Water really fascinates me and I’m wondering when you plan to release that and if you have some rough idea of the theaters? I think you said you planned a national release.

Yes. It’s sort of, while we can’t use that line don’t go in the water, it’s going to be over the summer. It’s going to be in that time frame both here and internationally. I didn’t mention earlier on Open Water we not only acquired it for the U.S., but we acquired it for the world for $2 million. We’re already anticipating $3 million of international sales; so really, we’re getting this movie for free. We think it’s going to be an amazing find for us.

For those of you who don’t know and haven’t read about it, this is based upon a story of two SCUBA divers, a man and a woman, who are left behind by their dive boat and they are left in shark infested waters for over 24 hours. What makes it, as we said before, kind of the Blair Fish Project is they didn’t use mechanical sharks. They didn’t have the money, so they took two actors, put them in wet suits with some chain mail underneath, but their hands and their heads were exposed, and they put them in shark infested waters. I’m obviously not going to tell everybody how it ends, but it’s a pretty amazing story; not only the movie, but of how it was made and we are expecting that to be in the summer.

What is the share count at this point?

It’s 100 million shares when you take back the convertible preferred and you add that to the current number of shares outstanding. That’s a round number for you, Tom.

But actually outstanding at the moment, do you have that?

90 million shares outstanding if you look at the equity table. Yes, it’s 90 million shares and it’s actually another 11 when you add the convert back to it, which is at $5.40.

Then the last question was Man Thing; I keep hearing that in general, but this film, is it in the can? It exists? Is it slated for late summer like I’ve heard? It’s been a little vague in my mind.

It is still currently slated for early summer. I’m looking at it today, actually, the most recent cut. We’ll finalize the release date probably within the next four to eight weeks.

Thank you.

Thank you. We do have a follow up from Gordon Hodge. Please go ahead.

This kind of continues, I think, with Robert’s question about how you’re amortizing the Artisan library. I think you said it was $220 million or something was the library value.

That’s right.

You would typically depreciate that, what, over 20 years on a straight line basis or something?

Approximately.

Is the question then just how you realize the value there and the way it’s depreciated or is there a question that the value is actually more than that? Maybe just walk through that again.

Current accounting rules basically require we split the library as two pieces, those released within three years and those that are greater than three years past due. That’s how the SoP002 defines it and the rules basically say you’re supposed to amortize your library in relation to the estimated revenues and so the straight line method has been as you determine that the estimated revenues on a library for more than three years tend to be more flat and level, so we’re looking and analyzing our revenues right now on those titles greater than three years and trying to come up with the relative, basically, revenue by year so that we can amortize the cost in the same relationship to the revenue.

But was the comment that if you did it on a straight-line basis you’re comfortable with the Street estimates? Is that how the math works?

That’s correct.

Then lastly, how do you define free cash flow? I gather it’s just cash from operations minus capital expenditures, but I just want to make sure.

That’s correct. After debt service.

Thank you.

Thank you. Our next question comes from Jim Devlin with Raymond James. Please go ahead.

Congratulations on the stock trading at a 52-week high. Just a couple of quick questions. Have you guys had the combined library of Artisan and Lions Gate evaluated or appraised recently?

We’re currently, as part of our bank facility, having it looked at right now.

Will you get back to the Street with that when that’s all wrapped up?

I’m not at liberty to divulge that actually. It’s basically confidential.

It’s done yearly, Jim, by the bank. They hire an outside appraiser. They do a very conservative approach on unsold rights and discounted cash flows back.

Now, the other thing is you guys talk about the value creation proposition in that library. How many movies, wide releases did you do last year and then, I guess, ancillary, lesser films? How are you ramping that number or are you ramping that number going into this year?

I think Jon talked about that, but you’re talking about four to five wide releases this year. The horror genre is not necessarily a platform and not necessarily a wide release, but we’re talking about growing both of those businesses marginally in fiscal ’05.

What we will sometimes do when we look at something like Open Water where, as I said, we have not only no negative cost going into the picture, but actually a profit going in, we can afford to be a little more aggressive because frankly, if we’re doing our job even half way right, Jim, a company will always get their P&A expense back. So we really believe at the end of the day that you can’t really look at it when you hear wide release and you can’t say they’re doing business like the studios. Our widest release ever, which will be The Punisher, won’t probably have 50% of the P&A attached to it that a studio would in releasing the picture. The other thing that we’re doing is as we’re looking at our smaller platform releases and we’re making sure more than ever that they have stars attached to them so that we believe we’re looking for $10 million of box office on every picture that we acquire and every picture that we make so that when we talk about 12 platform releases for $5 million at box office, we think we’re being pretty conservative. Those include pictures like the Kevin Spacey picture, which was a pretty expensive picture, a $22 million picture that we’re putting in $3 million for. I don’t want to have people thinking that when we talk about wide releases or larger pictures that we’re talking about competing with the studios because, at the end of the day, our business is quite different.

And just two quick ones: You guys said you would believe that the library’s combined value would generate basically about $200 million annually in sales at this point?

We’re saying in excess of $200 million, Jim. We’re not getting that specific.

When companies typically sell libraries is it done on a multiple of cash flow or revenue?

We’re not going to get into specifics of models and metrics like that, but that’s certainly something that the analysts have talked about in their research reports.

Then one last one was what’s the total debt load at quarter end?

Outstanding bank debt at the end of the quarter is $269 million of bank debt. Then we have production loans of $13 million; subordinated notes around $47.8 million; and long-term debt’s about $42 million. These are normally the components we would look at.

Thanks, guys.

Thank you. Our next question comes from Alec Robinson with Putnam Lovell. Please go ahead.

Actually, that previous question answered some of my concerns, but I wondered if you could actually go into some detail, given that you anticipate paying back, I think you said, $150 million in debt over the next 30 months and how you’ll approach which debt to pay down and what we should expect to see over the next period of time?

That’s correct; it is $150 million over the next 30 months. Don’t forget in some of our films we do some German tax shelter financing that is term debt; that we will be paying that back. It’s also a little misleading, what Jim said before, because the subordinated notes, the convertible preferred that we placed, that $60 million, that’s a seven-year term. We’re obviously anticipating that ultimately converting to equity and not being debt on our balance sheet. So we will continue to pay down our bank facility, as well as our German tax shelter financing and our production loans as well. And we have a $5 million note due in 2005 that will be paid off also.

Does the $150 million number that you throw out not include the convert or net of conversion is that $90 million in debt reduction?

That does not include the convert. We’re actually looking at paying down $150 million of our bank debt. Actually, some of the other debt may get paid down as well, meaning the production loans as the pictures come in, as well as the German tax shelter. I think that’s what Michael was trying to say.

Thank you very much.

Thank you. Our next question comes from Mike Einhorn, private investor. Please go ahead.

As a rule of thumb, you mentioned $3 million international sales for Open Water. Is there a general rule of thumb as far as when the $3 million is booked do you participate in any box office revenue overseas? What’s the general structure of these deals, if you can at all elaborate?

Sure. These almost invariably are not buyouts. They’re actually advances from foreign distributors. In terms of when we book them, we book them when we have what’s called a notice of delivery, but really, essentially, it’s when the picture is ready to be exploited in those territories and that is typically at the same time that we are putting it out theatrically. But basically, it’s when delivery is accepted.

In terms of the deals, as I say, they are advances, which means when a picture performs beyond our budget we tend to, just as we have with Monster’s Ball, numerous other pictures that we’ve had, we get overages as well.

Cabin Fever DVD sales, according to the chart of video business you dropped out of the top 20 ending the 8 th . I did some legwork around to the local Wal-Marts, Targets, and the rest of the retailers and they don’t have Cabin Fever in stock. It hasn’t been ordered. They blame it on the studio. Can you elaborate on that?

Mr. Beeks? I’m glad in his first meeting here that Mr. Beeks gets a good question.

Thanks for indoctrinating me that way. This is Steve Beeks. I think what you’re seeing, you’re seeing a byproduct of the success of the picture and I think also, even though what you’re seeing is a lot of out-of-stock with Wal-Mart, you’re also seeing the value of the merger given that Cabin Fever was originally placed in Wal-Mart under the arrangement which Lions Gate was operating prior to the merger, which means to say without … under the roof. A byproduct of that is the fact it wasn’t placed as aggressively because it was being placed by a third party, so part of the reason is that the company with which Lions Gate was doing business, which is Anderson Merchandising, which is a great company, they don’t have the same at stake that we do here, so it was placed a little bit less aggressively.

I think also, everybody was surprised by the success of the picture. Wal-Mart was surprised. We weren’t surprised, but Anderson was surprised and so we’ve been catching up with that since it started, but it has been incredibly successful. We’ve been chasing it ever since with a tremendous sell through.

You might want to talk about, Steve, just how quick the turnaround is now with the VMI system as we are stocking.

Just so you know, one of the values of the VMI system is that we can, in effect, ship to virtually every single Wal-Mart store as often as three times a week and in some cases we’ll be shipping overnight. That was the case with Cabin Fever. After the first-day sales we were over-nighting product to the stores where it was selling out. That’s been going on ever since Cabin Fever hit the street. We get POS data nightly.

It’s too bad because it’s like a salesman going on the road. It just seems like they were out of product. The Wal-Mart rep told me that they sold 20 copies within 24 hours of Cabin Fever. I was a little taken back.

That’s true and it’s great to have that kind of success. It’s a great problem, but therein also lies a little bit of the limitation to the fact that there’s only so much shelf space available at Wal-Mart and there are some constraints with which we need to live with regard to our relationship with Wal-Mart. We just happen to have a picture that’s been incredibly successful and, as I said, we are shipping to some Wal-Mart stores up to three times a week just to try to keep them in stock.

Great. Jon, a question for you. Can you comment on Pinocchio 3000? In your comment can you tell me if it’s still a go? I understand Christal is releasing the movie in Canada. Will LGF have any distributorship involved? If it is a go, what is your feeling about the movie?

We’re still waiting for the final print. Frankly, they’ve taken longer than I expected to deliver the picture. There actually have been a number of places of interest in terms of the picture outside of Artisan, which parenthetically, before we merged, Artisan made an offer for the picture. I really don’t want to comment until I see the final print. So I’ll wait until I see the final product. What I’ve seen so far looked really good.

We’re talking about Pinocchio 3000?

That’s right.

One last question. When you look at Artisan and you look at Lions Gate, they have the two biggest kick off or noted movies that spiral as far as the film industry, Blair Witch and Monster’s Ball, two of the most outstanding features of the film world. You look at Lions Gate right now, I don’t know how to say this, but what is the identity of Lions Gate now? Where are you placing Lions Gate? Not too many people know about Lions Gate, yet, like I say, you and Artisan have two films, which have mustered attention in the film industry unbelievably.

That’s a tough question to answer. I mean from point of view in the industry I can tell you everyone has heard of Lions Gate. I can tell you in terms of the talent, in terms of the writers, directors, we’re starting to get agents calling us saying, “We’ve got the next film from,” I don’t want to mention the name because we just got one last week, “The next major director movie” and it’s obviously not a huge franchise movie. “We’re coming to you first exclusively. We’re coming to you before Fox Searchlight. We’re coming to you before Focus.” I’m surprised you would say that.

I think obviously, as we continue to grow, we get more and more people who are converts to us, but we believe we’re doing the job the same way we have always talked about. We’re doing it steadily. We’ve evolving our brand. I think it’s pretty clear we stand for being the premier independent entertainment company, plain and simple. So we will continue to define that brand. We actually have already, I think as you’ve heard from this analyst call, we are calling ourselves Lions Gate. We have immediately gotten past the two different brands. We’ve made that clear to the community already. We’re coming up with our new logo and some other branding strategy, but I think, Mike, that our name is growing substantially.

Now, I will tell you there is no studio out there, maybe Disney would be the exception in terms of family, that I think really means anything of and by itself. I think at the end of the day we’re all going to be defined by our content and by the success of our content and we intend to succeed by that measure.

Thank you. We now have a question from Greg Spiegel with Pilot Advisors. Please go ahead.

I had a couple of quick housekeeping items. I apologize if they’ve been asked already. The definition of free cash flow is operating cash flow less debt service; is that correct?

Less fixed assets too -- CAPEX.

What’s the interest expense embedded in that number?

For upcoming?

Yes. In that free cash flow number what are you assuming interest expense is for ’05?

It’s approximately 5% on our outstanding balance. Our credit facility with the bank is two and three-quarters over LIBOR.

Then you had mentioned something about EBITDA and earnings per share. I think the comment was that you are comfortable with the range of estimates. Could you just share with us what those estimates are?

They’re actually listed. You can look in the research reports. There are several analysts that follow us and you can see some of those reports for a consensus on our Web site. What we said was that if we took a straight-line depreciation method on the Artisan transaction like we did with Trimark, we said we would be comfortable with the consensus for the earnings per share and EBITDA numbers that are out there.

So that’s $0.35 and approximately $65 million to $70 million of EBITDA?

As I said, we’re not commenting on specific numbers out there, but, you could take a look at what the analysts are saying. [note: please see p. 8, paragraph 2 of transcript which discusses need to resolve non-cash, step-up amortization for library before management is prepared to project EBITDA under U.S. GAAP.

Thanks.

Thank you. We now have a question from the line of Jack Mui with Context Capital. Please go ahead.

Just a question on the free cash flow again: How much of that is coming from the library?

Could you repeat that question?

How much of the $80 million of free cash flow that you guys are projecting for ’05 is coming from the library?

A significant percentage. That’s really actually a hard question to answer. I mean we do blended margins. We could break out the margins on library, but given that it’s across video, which is different margins than TV sales, I don’t think we can do it on this call.

By the way, in response to the last question, the interest component that we factored into our free cash flow number is about $15 million.

Thanks, guys.

Thank you. We now have a question from Richard Scott, private investor. Please go ahead.

I think this question is probably best for Peter Wilkes. It is apparent by the response to the stock today that the Street certainly understands the dynamics of this quarter’s results versus what were estimated, but there was a very wide discrepancy in terms of previous estimates for the quarter by analysts. Most of the consensus that I saw were actually for $0.02 a share earnings versus a loss of $0.36 actual. Obviously, moving forward as a cleaner company, the Street is not going to tolerate wide discrepancies in estimated earnings. What can you tell us about your ability to forecast more accurately moving forward and to be more in line with analyst estimates going forward?

Richard, thanks for my moment in the sun, but I’m going to bounce this over to Michael.

Obviously, the Artisan transaction was a defining transaction for the company. It’s not something that’s going to happen every quarter. I would say that in the past we’ve been very consistent about hitting our numbers. We had extraordinary and non-recurring items in this particular quarter and we recognize, and certainly, obviously, CineGroupe is a non-recurring and non-cash item, but I will say that we do recognize that the Street is looking for visibility. We try to be as specific as possible, as we could as far as box office guidance, as well as top-line revenue. We’re going to endeavor to do the best we can to hit our numbers. It’s obvious the film business, like many other businesses, is an art, projecting box office, as opposed to a science, but we’re going to do the best we can to make sure that we put out there very specific numbers when possible.

Thank you.

Thank you. We also have a question from Dustin Foster, a private investor. Please go ahead.

First of all a question on Havana Nights, please. How does your partnership affect the percentage of your income that you’ll derive from the box office receipts? Also, how does the partnership affect your contribution to the P&A costs for the film, as best as you can let us know?

In terms of the overall deal, it is a straight 50/50 deal, a typical partnership, everything into one pot and we split. Costs come off the top. We split everything. There are no fees. Obviously, we’re looking to take advantage of the relationship that Miramax has with Disney, meaning the Buena Vista International Distribution, but everything will be broken down as a full partnership.

Forgetting costs just for a moment, let’s say if there’s a $50 million box office to Havana Nights it would be as though you had a $25 million box office and didn’t have a partnership if you could forget the cost aspect for the moment; is that basically correct?

You can’t look at it that way because we could either overperform in the domestic market or they could overperform the international market, and it still goes into the pot, so you can’t really look at it that way.

As far as Shattered Glass is concerned, I know you guys made a couple of hundred prints. It went out to a couple of hundred screens and it didn’t hold very long at all, maybe a week at most. If you had to do it over again in terms of Shattered Glass would you promote it differently? Would you distribute it differently? What went wrong, although I know you’re going to say that ultimately through DVD it will be a profitable film? But given the Best Supporting Actor, Peter Sarsgaard, and all of the buzz that it had, what would you do differently, if you had the opportunity, in promoting it?

You know, we do what we call a post-game show on every single picture that we release. The dilemma that we had with that picture was that we had two other pictures that we were going to put through in award season, The Cooler and Girl With A Pearl Earring, and both of them are performing extremely well. They’re going to be very profitable pictures for us. We had to put out Shattered Glass a little bit early and I don’t think it got the full advantage of the award season buzz. We always knew when we green lit the picture that it was going to get great critical review, great interest from writers. Frankly, we never thought it was going to be a really big picture, although we think we made a terrific picture. We think it’s going to be a great addition to our library. The only thing I would say is had we not had two other pictures we probably would have released it a little bit later.

Would you have maybe saved yourself the 200-screen distribution also looking back since that was just money spent that didn’t hold in the different cities?

We actually spent very little money and I think what we should point out is sometimes the decision that we make having to do with how much money that we spend in terms of P&A has to do not only with the performance that we expect in theatrical, but the more money we spend in terms of our theatrical P&A, it tends to be reflected ultimately in the success of video. And frankly, often we’ll spend a little bit less in terms of video marketing because we’ve created more awareness in terms of the theatrical. Regardless of that, I think we spent less than $2 million on theatrical P&A, so there was not a big spend there.

Finally, maybe I misunderstood, but when you said you’re looking for $10 million box office from every subsequent film you do and that it will have some star power did you mean every film that you’re going to buy or produce yourself will have those requirements? Does that mean you wouldn’t do then Open Water in the future or something like that or did I misunderstand the requirements for which films you’re talking about that have to have $10 million box office and some star drawing power?

What I was trying to say was on the platform releases, which I think I said we were looking at 12 for this year, that we are basically creating as a target for ourselves $10 million because we want all of these pictures ultimately to be able to move the needle a little bit. On the other hand, in terms of what we are looking at budget wise, we’re looking at $5 million a picture for those platform releases.

Thanks a lot.

Thank you. We do have another follow-up from Robert Routh. Please go ahead.

Just two other quick questions: Given how difficult it is to predict the relative success or failure of a theatrical release and given the slate that you do have upcoming, which seems to be the most solid you’ve had ever, I’m just curious if you can confirm or deny; is it true that Lions Gate Films has never had a money losing film other than Rules Of Attraction or have there been others?

Second, I’m wondering what your plans are with respect to the direct-to-home business going forward. Obviously, you have a lot of sequel opportunities that I can see in the future.

I would say that right now on our books in addition to Rules, and we were talking about the last 30 pictures, I actually haven’t dug in before that and I certainly can’t speak to every picture that Artisan has done, the other picture right now that we are currently looking at as a loss picture, it’s very, very minimal, is Wonderland. However, I would say that the performance so far in the home video market has been extremely high and I actually would say that I am projecting it now becoming a profitable picture. So I guess the answer is yes.

I’m sorry. What was your other question, Robert?

The other question is if you could just comment a little bit on what the opportunities you see in the direct-to-home business being for you given the sequel opportunities, etc., especially your negotiating with Marvel; it would seem as though you have a lot of opportunities there and you didn’t really touch too much on it. I’m wondering what the company’s philosophy on that is going forward.

I’ll take the Marvel part last. I’ve spent a lot of time recently in rekindling what, for me, has been probably an 18-year relationship with Marvel. Marvel Productions reported to me back at New World and particularly in terms of my relationship with Avi Arad, who is a real genius… I would say again that I expect a number of potential new developments in regards to Marvel, whether that would be a direct-to-video or whether that would be additional theatrical projects, I think I’ll leave that to Marvel to go to the next step and announce things. That’s a tremendous relationship for our company.

In terms of sequels, I think there are numerous franchises, House of 1,000 Corpses, Cabin Fever, Cube, I could go through the list, Leprechaun, where we have significant opportunity for ongoing video franchises, but I would say actually, the performance of a number of them leaves me to believe that some will be theatrical as well. I mean if you look at House of 1,000 Corpses, that was a picture that we put out for $2.5 million initial P&A spend to 600 theaters and the reason was very simple. We knew exactly who that audience was and we knew how to target them and we had Rob Zombie behind us as a marketing brand. I think any time we have that built-in brand actually we have a great opportunity to do our efficient kind of theatrical release and do particularly well.

In terms of overall, I would say of the video releases not pertaining to fitness, not pertaining to family, you’re talking about probably 70 to 80 will be direct-to-video releases out of about 100 pieces of product we’ll release in video this year.

Thank you very much.

Thank you. We have time for one more question and that will come from Brian Kiss with Kettle Hill Capital Management. Please go ahead.

Could you please reconcile for me your free cash flow guidance of $80 million versus this comfort level of $65 million to $70 million of EBITDA, please?

Cash flow is different. Under the accounting rules EBITDA is defined; you have amortization of film costs. As Jon indicated, the value of the Artisan library, the $220 million, has already been paid for. That money is out. Then we must amortize that expense, which is all above EBITDA. So I’m amortizing an expense, which has no cash impact. That’s what the issue is.

You said before in the call what the revenue and EBITDA of the Artisan was last year this past fiscal year?

We have not.

You didn’t disclose that?

The pro forma is in the 10-Q.

Thank you so much.

Thank you all for joining us. We’ll talk to you in three months.

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