Starz Entertainment Corp (STRZ) 2006 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the fiscal 2006 second quarter earnings analyst 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.

[OPERATOR INSTRUCTIONS]

I would like to turn the conference over to the head of Investor Relations, Peter Wilkes.

Please go ahead, sir.

Good morning. Thanks for joining our call.

Jon Feltheimer, our CEO, Michael Burns, our Vice Chairman, Steve Beeks. our President. Jim Keegan, our CFO, are on the call for Lions Gate. John and Steve will lead off with remarks, and then we'll open the call to Q&A from our analysts and investors.

I would like to remind everybody that matters discussed on this call include forward-looking statements. Such statements are subject to a number of risks and uncertainties. Actual results in the future could differ materially and adversely from these forward-looking statements as a result of various risk factors set forth in Lions Gate's form 8-K filed with the SEC on June 29, 2005.

I'd now like to turn the call over to our CEO, Jon Feltheimer.

Jon.

Good morning. Thanks as usual for getting up early with us. This is good timing for our conference call. We're excited to talk about our second half of the year theatrical, television, and video slate. As usual, our business is significantly back-loaded. It's also a good time to answer the many questions that have been discussed in the industry in regards to the home video business, and in that respect, I have asked Steve Beeks to spend some time this morning addressing that significant component of our business.

I'd like to start this call with a Latin phrase -- veni, vidi, vici -- we came, we definitely saw, and we conquered. We're obviously pleased with the success of "Saw II," but not only because "Saw II" will be very profitable and the validation of powerful ongoing franchise, but the because it's also a validation of our business plan and strategy.

One of our goals is not only to create franchises with lasting value, but to create franchises for large niches where we can excel and that we can dominate to make repeatable businesses out of typically an under-served audience. "Saw II" is on it's way to 80 million-plus at the box office, 50% growth from the original, in a supposedly soft market. However, we don't necessarily want to have the biggest, most expensive mainstream horror film at the box office. We want to continue to create horror franchises that bear Lions Gate's distinctive signature, that reach out to a very specific audience and can be renewed and replenished year in and year out.

Even though "Saw II" is the most recent and highly visible example of our success, it's our third successful film in a row following "Waiting" and "Lord of War." In fact, five of our seven wide releases fiscal year-to-date, will be profitable. Films like "Waiting," "Lord of War," and "The Devil's Rejects," although not as widely heralded as our franchises, are the singles and the doubles that are our bread and butter. If our next three wide releases, "In the Mix," "Hostile," and "Medea's Family Reunion," perform to our expectations, eight of ten of our wide-release films this year will be successful, a batting average that reinforces the organic growth of our theatrical business with an increasing number of wide-releases.

"Saw II" is the first release in the back half of the fiscal year, that we believe could again take us to more than $300 million in domestic box office growth, even without "Farenheit 911." Our next three wide-releases showcase three of the biggest names in entertainment -- Usher, Quentin Tarantino and Tyler Perry. As I previously reported, our positioning studies on Usher and testing of "In the Mix" and it's marketing materials have been extremely positive. We have, therefore, taken the opportunity to renegotiate our partnership with 20th Century Fox, and have sold the international rights retaining all of the North American rights for ourselves. This will result in approximately $9 million more P&A investment for us in the fiscal year. The film is tracking very well, on its way toward as November 23 nationwide release for the five-day Thanksgiving holiday weekend, and its awareness is benefiting from piggy-backing it's trailer on "Saw II" in theatres. We believe our additional risks will be rewarded.

On January 13, we have an exciting new addition to our fiscal '06 slate. "Hostile" is a Quentin Tarantino presentation. directed by Eli Roth, who made "Cabin Fever" for us. The combination of the two is obviously a great pedigree. As a powerful and bizarre horror film right in our sweet spot, it offers good upside potential with limited risks due to our partnership with Sony. We've also been running "Hostile" trailers with "Saw II."

We're looking to the next film from Tyler Perry, "Madea's Family Reunion," released nationwide on February 24, the same weekend that worked so well for "Diary of a Mad Black Woman" this past year, to build on "Diary's" theatrical and DVD success and further cement our Tyler Perry franchise.

While the Tyler Perry film is the most obvious franchise in the group, it's worth noting we almost never do one-off's. We don't release any product without first deciding how we can build it into a long-term brand if it succeeds. As an example, we're currently finalizing the sequel to "Waiting," and have already locked up a new dance project to star Usher from "In the Mix" producer John Dellaverson.

We follow "Medea" with "Akeelah and the Bee" on April 28, a terrific one-two punch for the African-American family audience, and a film that is testing as well with all audiences 13 and over, as any film in Lions Gate's history. The bigger pictures that, just like "Saw II," the rest of our fiscal 2006 release slate and the fiscal 2007 portfolio that has rapidly coming into place, reflect the execution of the strategy I've discussed, targeting the large niches that we believe we can dominate with a sustainable competitive advantage.

Our releases over the next 12 months in the horror space will solidify our leadership in that genre, within an upcoming slate that includes "Hostile," "See No Evil," starring WWE superstar, Kane, on May 19, the provocative festival winner "Hard Candy," now set for April 14, and "Skin Walker," the retelling of the classic werewolves tale, featuring Stan Winston's special effects. We believe that our horror slate is the strongest in the business. We're also assuming that together with the Twisted Picture principles, we've done a great job building this franchise that we will product a fantastic "Saw III" that will satisfy our audience, be true to the brand, and will be ready to sit in its rightful place on Halloween, 2006.

As with the genre space, our urban films need not be the largest or most expensive, but they will be a focused and cross-promoted group of pictures. With "In The Mix", "Madea's Family Reunion," "Akeelah and the Bee", LL Cool J's first movie under his Lions Gate deal, which is an urban fatal attraction, by the writer of "Swimfan", "Kidnapped" our urban home alone picture. "American Radio", directed by Gary Hardwick, and "Manhood" with another African-American faith-based icon [Preslow Dollar], we believe that the urban genre is another niche that we can lead with cost effectively produced and efficiently targeted product.

In keeping with this strategy of targeting under-served niche audiences, we have just created and are announcing today, a joint venture with Jim McNamara, with whom I worked in his roll as CEO of Telemundo, the spearhead of feature film and DVD initiatives aimed at the fastest growing segment of the US population today, the Latino market.

Although there are approximately 42 million Latinos in the United States who already contribute to a booming television market with some of the highest rated shows on the air, no studio has previously produced or released a slate of Spanish language feature films, specifically aimed at this audience. We intend to release not one, but six to eight theatrical titles in the next 18 months that reflect the same mass appeal themes that have made Telenovela, the Univision, and the Telemundo so popular.

We'll kick off this slate with the January 27 release of "La Mujer De Mi Hermano," starring Barbara Mori, and perhaps the hottest actress in the Spanish language community today, and an icon from Spanish language Telenovela's "Rubi". "La Mujer" has already generated 200,000 admissions since its release at the box office in Mexico just last week.

In short, we plan to generate content for a huge pool of potential Latin movie goers in the U.S. that mirrors the same approach we've taken to delivering products to meet the large and growing appetite of our African-American faith-based and horror genre audiences.

With leadership in the areas I've just described, coupled with the debut feature film from our family entertainment division, "Food Fight," with the action thriller "Crank" starring Jason Statham; two strong new teen comedies, "Employee of the Month" with Dane Cook of "Waiting"; and "The Prom," produced by Neal Moritz; with "Basketcase," starring Luke Wilson, Cedric the Entertainer, and Woody Harrelson, from 2929 Productions; and two upcoming films from our Marvel partnership, "The Punisher 2" and "Black Widow," we already have a great deal of our 2007 slate in place.

We've been equally active on the television side. "Weeds" is a smash hit for Showtime, but it's also an example of how we're quietly recapturing margins in our core business, as with our recently completed RedBus acquisition. Less than a year ago, we hired one senior executive to spearhead the international sales of our new TV product.

If you remember, most of our new television product before was sold by other studios. For example, "Missing" by Sony, and "Dead Zone" by Paramount. This addition to our team has been very successful. As an example, "Weeds" has been sold to 125 countries worldwide, and in addition to becoming the highest rated series on Showtime, "Weeds" is a hit in Australia, the U.K., and Canada, and we will only be paying ourselves for distribution.

We're anticipating a second season order eminently, and once again, we've created product that, like "Crash" this spring, and "Saw II" this fall, is commercially successful, controversial, generating terrific heat within our industry and bears the distinctive Lions Gate financial, strategic, and creative signature. Most importantly, we believe that "Weeds" is another franchise in the making that can potentially drive business opportunities throughout the Lions Gate family.

Going forward, we're going to continue to be the dominant independent supplier of television for the cable business. In addition to the ongoing series -- "Missing", "Dead Zone", "Wildfire", and "Weeds" -- four series on four different networks, we are currently in production on four pilots and one pilot special for five different networks. "The Dresden Files," a two-hour backdoor pilot for Sci-Fi Channel, with executive producer, Nick Cage, think "Rockford Files" meets "Harry Potter" in this private eye series with a fourth generation wizard of this center.

"Talk To Me," from mega-producer Dean Devlin, who produced "Independence Day" and prolific TV show runner, Billy Finkelstein has a one-hour drama for TNT that revolves around high-stakes world of hostage negotiations in New York City. It's intended as a companion to TNT's highly successful drama series, "The Closer".

Rebecca Gayheart will star as "Scarlett," a successful horror writer who sees supernatural beings and uses her encounters as a basis for her novels in a pilot for Lifetime, executive produced by Arnold Rifkin and Bruce Willis. "Pity the Fool" is a one-hour reality television pilot for TV Land with Mr. T -- yes, Mr. T -- answering the calls and letters of people with various conflicts in the inimitable T style.

Answering letters is also at the heart of "Dear Santa," a one-hour holiday special premiering on Fox on December 9, in conjunction with the US Post Office. In addition to it's potential as a long-running Evergreen series on Fox, "Dear Santa" also underscores the rapid growth of our music publishing business under recently hired executive, Jay Farris. An album is being produced in conjunction with the special featuring songs by Alicia Keys, Nick Lachey, and American Idol finalist, Vonzell Solomon, along with four Christmas classics, and we have just shipped 600,000 CD's from newly created Lions Gate Records, which will be on sale at more than 18,000 post offices and the U.S. Postal Service website.

"Dear Santa" a good example of the kinds of new models that are being created in the film's entertainment arena, and the kind of model that it takes a, entrepreneurial company to take advantage of. The show is being fully client supplied by Full Circle Entertainment, a division of Omnicom, with integrated responses including Dodge, 7-11, and the U.S. Post Office, and most of the profit from this special, and, by the way, we hope a series as well, will come from the CD sales.

I know that like domestic box office attendance, which I've already touched upon, the state of the DVD market is a subject of great interest today. Steve Beeks will provide you with an overview of our DVD and library businesses in a few minutes. Although I don't want to steal his thunder, I will depress his remarks by noting that we just released "The Devil's Rejects" on DVD in a special two-disk package the day before yesterday. We're already 25% sold through on the first day at the major retail chains, and we are already shipping replenishment orders to several of them.

Another sign of our continuing momentum, we will release four high-profile, wide-released theatrical titles on DVD in the fourth quarter -- "Saw II", "Lord of War", "Waiting", and "In the "Mix," along with "The Ultimate Avengers," the first title in our Marvel-directed video series. And by the way, I've just seen the "Avengers," and [Ovie] and his team have done a fantastic job.

Steve?

Thank you.

Good morning, everyone.

I want to talk a little bit about the state of the DVD industry in general, what's happening with library sales, wholesale prices, and a bit about our position with new technologies, but first, let me give you a few highlights from our business recently.

First, we anticipate a 10% growth in our overall home entertainment revenue for this fiscal year, driven primarily by our recent theatrical releases. As Jon adjust just said, on Tuesday of this week, we released "The Devil's Rejects," which, as you may remember, generated just over $15 million in it's theatrical run. We shipped 1.25 million units for street date, about one-half of those going to mass merchants. 27% of the units stocked at mass were sold-through at the end of the first day; we've already shipped over 70,000 additional units, indicating that we were, indeed, conservative in our initial placement.

Given the horror stories, no pun intended, as we have heard regarding recent titles in the marketplace, we will continue to conservatively allocate our shipments. We anticipate that we will ultimately ship approximately 1.6 million units of "Rejects" over the first three months. Being ever opportunistic and riding the crest of the wake from the theatrical success of "Saw II", we released a special edition DVD of the original "Saw" film, which was released two weeks prior to the opening of "Saw II". We've now shipped a total of about 180,000 units, of those, 63% have already been sold through to consumers. That number is all the more impressive given the fact that the original DVD of "Saw" is still on the shelves and that 75,000 units of that version have also been sold through since the special edition was released.

"Crash" continues to sell well, having shipped 2.8 million units with 80% sold through, and results of "High Tension", which shipped just under 550,000 units and has sold through at 80%, indicates that horror films still do quite well, even when the box office is low.

In general, we have found that our theatrical pictures, which tend to have box office performance below $70 or $80 million, and in our genres, continue to sell through about as well as they have in the past. Yet, we also have been allocating our shipments on a conservative basis in an attempt to avoid the surprises that have hit other DVD releases lately. So far, we've been successful.

Our latest Barbie title, "Barbie and the Magic of Pegasus," shipped a total of 1.5 million units, and has sold through at 60% during the first seven weeks with the prime holiday shopping season yet to start. We also recently announced that we have signed two more Barbie movies with Mattel, the "Barbie Diaries" and "Mermaidia," both of which will be released in the first half of the next calendar year.

Our television-to-DVD product has also been healthy. "Saturday Night Live" had a particularly good year. "The Dead Zone" and "Moonlighting" also both had successful releases. We're about to announce the second release of "Moonlighting". We're releasing the first DVD set of "Missing", one of our series, and we will soon be releasing DVD's of a couple of our new shows, "Weeds" and "Wildfire".

Well, that's some of the good news, now let me address some of the overriding market factors and the issues we're facing.

First of all, the market for family entertainment product, with the exception of larger franchise titles, such as "Barbie", "Clifford", or ''Care Bears", is acting soft. Some of the smaller titles such as could "Koala Brothers", "Inspector Gadget", "Maya and Miguel", and "Miss Spider" have gotten off to slow starts in the past few weeks. While that experience is not unlike the results being experienced by similar titles in the market , we intend to focus in the future on titles with high franchise awareness.

Such is our previously announced series of animated features with Marvel and "Doodlebops", which is airing in the morning slot on the Disney Channel to good ratings, This is still a healthy growing market for the right product. We just intend to focus on fewer programs with higher immediate awareness.

There's been a lot of ink regarding the slowdown of the DVD business, which isn't necessarily unexpected given the DVD hardware penetration rate, particularly as it impacts the library business. We're still on target to generate approximately $200 million in library revenue by the end of this year.

Last year was front-loaded with many of our successful library promotions taking place in the first half, and this year, many of the larger promotions are scheduled for the latter half of the year. The first half of this year also included a one-time catalog return from the Best Buy distribution center as we converted to a VMI just-in-time relationship with them, which served to temporarily depress the net catalog sales number for the first quarter.

Now there has been some downward pressure on wholesale prices for catalog, and we've been forced to lower prices along with everyone else. However, even with this downward pressure, we have been able to increase our contribution margin, which is essentially revenue less direct expenses, by over 1% by addressing manufacturing, distribution, and marketing costs. Even with this improvement in contribution margin, we expect that our operating margin from the catalog will be in the 21% range for the year, versus our historical average of more like 25%, but we know why that happened and believe that ratio will come back up in the future.

The operating margin is the amount of contribution margin we get to keep on a particular title, which may vary from title to title, based on the deal for that picture. It isn't really as much about product margin as it is about the mix of product we're promoting at any time. The operating margin from a library can vary from period to period, depending on what it's selling and on what we're focusing. While we were intent as usual on generating library revenue, and we had such a banner year with some of the new library additions, such as the Tyler Perry catalog, we focused less on the core library on which we keep more of the contribution margin.

So, while many studios have been criticized for overworking their libraries and dumping prices. In a sense, we've been giving ours a bit of a vacation. The core library is just as profitable as it has been in the recent past, and on a contribution margin basis, and we have more catalog promotions planned in the coming months and next year.

Also, this is the last year of distribution of the Republic Library, which has just reverted to Paramount. We enjoyed a relatively high fee on the that library, but as part of the deal, we were not allowed to lower wholesale prices in the final year of the deal. Because of that, the pricing on these titles is not competitive as wholesale prices dropped.

Going forward, as many of the successful theatrical pictures distributed by the Company become catalog titles, especially the genres and franchise pictures, which tend to have a longer sales house life, they will become a larger portion of our catalog sales. These -- these are pictures that either we own or, from which, we have a larger participation, increasing our operating margin from catalog revenue and increasing the overall blended margin from our library.

We also want to expand our reach with DVD distribution. We're planning on getting more aggressive about expanding our penetration into alternate retail channels such as grocery and drug. As Jon mentioned, we are opening a brand new distribution channel with our project "Dear Santa", by placing the CD in post offices around the country. This is not only the first project to tap this distribution channel, but it opens up possibilities of distributing other products as well. We will also begin releasing titles in high-definition Blu-Ray format sometime in the first half of the next fiscal year.

As we have stated before, increasing the library is one of our key goals, and as we do that, we intend to increase the number of titles for which we control alternative forms of distribution, such as VOD and electronic delivery. That was part of the rationale behind the Modern Library acquisition this year, a result of which was the consolidation of the VOD rights for the Vestron Library.

We will continue to aggressively look to acquire and accumulate VOD and electronic delivery rights to titles and libraries. We already own VOD rights to half of our library, and that percentage will grow over time. We're currently in discussion with Comcast, In-Demand, Time-Warner, Netflix, Starz, Amazon, and others, all of which have been developing VOD and/or electronic delivery platforms. We're also developing our strategy of just how to tackle the wireless and mobile phone space, which is just getting started. It will be a large market in the future, one way or another.

There are going to be some exciting new avenues to distribute programming, and they all will have large appetites.

Thank you, Steve.

Okay, let's talk about acquisitions.

I know that many of you often have questions about the type and size of acquisitions we're targeting and the rationale for each our proposed acquisitions. In growing our content business, we are continually reviewing a portfolio of potential deals as it verses our portfolio of film and entertainment product.

To move forward, the acquisitions that we have value in, have certain common denominators, they're generally accretive to our free cashflow and bottom line earnings within their first year. They must be consistent with our strategy of building on our leadership as the dominant content player in the independent space, and they must bring an additional component to our portfolio of businesses -- Trimark brought with it's home video operations in Cinema Now; Artisan and it's family entertainment business, strong pay television deal, and large catalog. Modern expanded VOD rights in 323 library titles; and RedBus is footprint in one of the largest international markets.

And acquisitions must meet Lions Gate arithmetic -- one plus one equals greater than two, reflecting our commitment to only those acquisitions where we believe that the combined entity resulting from the transaction will be greater and more valuable to our shareholders than the sum of it's parts. The initiatives I've described -- ongoing creation of new annuity franchises to stabilize our earnings and accelerate our free cashflow generation, support the growth of core businesses and expansion into complementary businesses such as music publishing, documentaries, family entertainment feature films, and digital channel opportunities.

Our last quarter's results take us to 406 million at the top line and $35 million in free cashflow for the first six months. Our cash position remains strong as we continue to have a zero balance on our credit facility, and as we mentioned in our press release, we have a large film entertainment backlog of $129 million.

Our ongoing investment in new product and theatrical marketing expense has continued to effect the timing of EBITDA, which continues to significantly lag free cashflow by more than $60 million to the first six months.

In the past two years, as we continue to grow our film entertainment pipeline as the only pure plate content studio, we've been focusing the [street] on free cashflow as the most efficient way to measure the return from this growth.

In terms of guidance, we've had a fair amount of ground to make up from soft summer releases. "Saw II", goes a long way to leveling the playing field. We are, therefore, raising our free cashflow guidance to over $100 million. We're also revising upward our revenue projection to over $850 million.

However, given the two, and still possibly three additional theatrical releases for the second half of the year, the restructuring of the Fox partnership on "In the Mix," the integration of the RedBus results, and the moving product mix within our catalog sales, we do not are sufficient visibility to discuss whether our EBITDA and net income guidance should be revised. We'll try to give you that visibility as soon as possible.

Thank you for your participation, and the floor is now open for questions.

[OPERATOR INSTRUCTIONS]

Our first question comes from Robert Routh from Jefferies.

Go ahead please.

Good morning, guys.

Just one quick question -- MGM, under [inaudible], switched to using free cashflow as the true measure of how to value a film studio. To us, that really made a lot of sense given that the that company never had EBITDA.

I was wondering how you think a film studio should be valued today, because it seems as though more and more investors are hung up on metrics that make no sense, like EBITDA, which, in your business, don't seem to make sense. So, I guess, in other words, how do you look at yourselves internally, and how do you think investors should look at you in terms of valuing your stock on the public market going forward?

Okay, this will probably be a long answer, Robert, I would say.

It's interesting, MGM was probably the closest studio to us in terms of being a pure content play. So I really don't want to discuss whether EBITDA was a good metric for the various conglomerates who get so much more of their revenue from other businesses, other than films and entertainment, but we believe for a company like ours, a free cashflow is a much better metric for a number of reasons, which, perhaps, I haven't really discussed before. So I'll go into it a little bit in depth.

One is that a free cash is obviously free cash. It's money in, money out, as opposed to EBITDA whose metric is really very much influenced by management's estimates of ultimates. Obviously, we change our ultimate virtually every quarter. We actually do it more often than that, but we have, between our catalog new releases, we're talking about 1,000 different titles.

Once you have written off a film, once you've taken an NRV on a film, actually as things change, we actually can never take that back again. And if you compare our business to typical retailers or manufacturers whose cost of goods is always really pure cash, in our business, that's not the case. We have non-cash -- non-cash items that go into our cost of goods. So for all of those reasons, we believe that free cash, cash in and out, is the best metric of our business.

Okay. Great.

And just one quick follow-up -- previously, you had guided to over $100 million in free cashflow for your expectation for 2007. I'm wondering, given how successful you've been in '06, whether or not you can give us any further color -- updates -- on what you're expecting for '07, in terms of growth over the revised guidance you just gave us today for free cashflow for this year?

We've got so many -- so much new product in terms of our film, video, and television that we just don't have the visibility right now.

Okay. Great.

Thank you very much.

Thank you.

Our next question is from Lowell Singer with SG Cowen.

Please go ahead.

Thanks.

Good morning, guys.

I have a couple questions. Felt, two for you -- sounds like you're doing ten wide releases this year. That's obviously up from where you were a couple of years ago. What do you think the run rate is in future years -- number of wide releases?

Second, can you give us some sense as to what your expectations are for "In the Mix", "Hostile", and "Madea's Family Reunion" in the context of the $850 million revenue guidance that you've updated this morning, just so we can evaluate how you're tracking against the guidance?

And then, Steve, for you, you talked about DVD pricing coming down a bit. Can you be a little bit more specific and talk numbers in terms of what you're seeing for both catalog titles and new releases?

Thanks.

Just to answer the second question for me -- I think we're looking at, for the three wide releases, between $90 to $100 million of total revenue, and to give you more visibility, I think what we're looking at for "In the Mix" is a double-digit opening. So, anything about $10 million will be solid and meet our expectations.

I think -- going forward, I think we'll keep pushing the wide releases, but I think what you're going to see is something that we're already taking advantage. We're taking advantage of it with "Hostile", we're also taking advantage of potentially with another picture that we signed a deal with, but I'm not going to announce until I see the color of their money because this is another example of somebody else putting up the P&A.

I think that as much as we can use our infrastructure that we have built, and clearly not as big as the other studios, but we have a very deep infrastructure here in terms of our theatrical distribution and marketing and our home video operation. So we want to take advantage of that, and spread it over as many wide releases as we really believe we can effectively distribute, particularly if other people will put up some of the risk, meaning the P&A money.

So, I think you could certainly look for at least ten wide releases for next year.

Steve?

On the DVD pricing pressure -- actually, the dynamics of new releases in catalog are not in synch. With the new release product, we haven't seen much, if any, pricing pressure. As a matter of fact, for us, ourselves, given the fact that we've had a lot of successful releases, we've actually been able to increase our new release pricing over the past year -- let's say. We've actually increased that by as much as $1.00 per unit, and that's obviously the mass merchant -- the product that's geared for the mass merchant sale.

At the catalog, the pricing pressure primarily coming from Wal-Mart with their DVD pricing promotions and from Target, which is becoming very aggressive about the auction process. In Wal-Mart, you're seeing a lot of the wholesale prices being driven down to in the $7.50 range, down to below $5.00.

The library products?

For library products.

Okay.

Thanks a lot.

Thank you.

We'll now go to Gordon Hodge with Thomas Weisel Partners.

Please go ahead.

Yes, good morning.

Just a couple of questions -- one, on the TV business, you shipped a lot more shows, I think, into the market than expected. I know this business can be very lumpy in terms of the deliveries of shows. What can you give us in terms of some visibility on the second half of the year, and what we should expect there?

Also, if you can comment on your direct operating expense margin, which was North -- or expenses are running North of 50% there. My guess is that the heavy weighting of TV in the mix there is probably muting your margin relative to the film business. I was wondering if you can comment on the margins?

Thanks.

Gordon, you have exactly hit on the issue in terms of direct operating costs. We had a pretty large TV quarter. I think, for the rest of the year, we're going to end up getting to over $120 million on revenues. So it'll just a little bit lighter, and part of that will be effected by the timing of the delivery of some of our pilots, but obviously, that's a growth business for us.

And, as I've stated previously, we keep the margins of that business low in terms of keeping conservative estimates of our syndication efforts for shows like "Dead Zone", and it will be interesting as we now take "Dead Zone", out for syndication, both for cable as well as for broadcast to look at the ultimates and see how that changes our estimates.

Jim, do you want to add anything in terms of direct operating costs?

Sure.

Just as you can look at the financials and see the direct operating costs of the television rope of it -- business -- they tend to run between 80% and 90%. So if you look at the blend, and the additional TV revenue, you'll see that $42 million of television revenue, I think that's probably -- from last year, same quarter up about $26 million, so 90% of that additional, I think, about $16 million is from the additional direct operating expense.

Great.

Thank you.

You're welcome.

Thank you.

Our next question from Michael Savner with Banc of America Securities.

Go ahead please.

Thanks.

Good morning.

Two questions for you -- first, just to go into the margin on the library business, to gauge a little bit better what your expectations were. I guess the 4 percentage point decrease versus what the average has been, is that where it had been expected because obviously, in about $200 million of library revenue, that's roughly $8 million, which would be somewhat meaningful to your operating income. I'm getting a sense of guidance. If that decrease in margin was already anticipated. That's the first one.

The second question, I just wanted to get a little bit more clarity, the distribution for "In the Mix," I think you said another 9 million in P&A. You said for all of North America. Maybe just a little more clear on what the distribution was before and what it is now.

And then for total P&A for "In the Mix" and "Madea's". I think you said that, in the press release, you spent about 35 million on "Lord of War" and "Devil's". So should we assume that these two films are probably -- call it 75% to 90% of that amount? If you can give that guidance, that would be helpful.

Thanks very much.

Well, Mike, first speaking to your questions regarding the library margin, I think frankly, we were caught a little bit by surprise in the change of the mix in our library sales this year . We focused a lot, as I mentioned, on some of the new successful product that'd been dropped into the catalog, as I mentioned, in particular, the Tyler Perry catalog business. We also had a big catalog promotion on Barbie. Even though they're very successful, the amount of the contribution margin that we get to keep on those particular libraries is lower than our average.

We tend to focus on those that are very successful, and we perhaps, took our eye off the ball a little bit, in terms of promoting the remainder of the library, which is, as I said, the contribution margin is essentially about the same as it always has been.

So if we do our job in the future, we anticipate that the blended operating margin of libraries should trend upward, going back up from the 21% range.

Okay.

And, on "In the Mix", if I've got your question right, I think we're going to spend around $18 million of marketing. We previously anticipated splitting that with Fox, now, as I said, we're going to have all of the pain and all of the gain from the North American release. We clearly think that's where Usher has the biggest upside. As I've said, we've also already locked him up for a second movie, and it's right in his wheel house. It's a fantastic international dance picture, so that's where the additional $9 million comes from.

And, other than that, I don't really want to break down -- obviously, we see "Madea" as being significant. I think I'd be willing to say we clearly think it's going to do over $40 million, and other than that, I don't want to break down the three pictures any more.

Okay.

Thanks very much.

Thank you.

Our next question is from Barton Crockett with JP Morgan.

Please go ahead.

Good morning. Thanks.

This is actually Robert Melacie for Barton.

Just first, quick question -- what exactly was the library revenue contribution for the quarter?

Well, we typically have -- we typically haven't broken that down, Robert. Again, what we are saying is that we will be $200 million or so, which is what we've been anticipating by the end of this fiscal year.

Okay.

I know you had broken it out in the first quarter, and that was a point of a lot of conversation. I was just hoping for a little more color there.

The second question I had was, again, with the disparity between EBITDA and free cashflow in the quarter, could you talk a little bit about what was behind that in this quarter specifically, and should we expect that trend to reverse in the back half of the year?

Okay, let's deal with your first question. We don't want a make a habit -- .

Robert, to address -- to give you a little bit of color on the library revenue in quarter-to-quarter, the reason that we really don't think it's instructive or helpful to break out library revenue by quarter, is that it's so influenced by the timing of particular promotions during the year. We don't pretend to try to anniversary promotions, or anniversary particular performing -- hot-performing -- quarters. For us, it's really about the marathon, not the sprint.

Last year, as I mentioned, we had a lot of really successful promotions in the first half of the year, in particular promotions such as "Saturday Night Live" had a huge promotion, "Reservoir Dogs" had a great promotion when "Kill Bill 2" came out, et cetera. As I said, we don't try to -- we don't try to repeat particular quarter-to-quarter or same quarter, year-over-year performance. This year, most of the bigger promotions are loaded into the back half of the year, and it's just a matter of timing in terms of how we make our plans.

Second part of your question -- Jim?

Okay, you were looking at the disparity between the free cashflow and EBITDA. What's happened, if you look at last year, you see free cashflow and EBITDA had about a $33 million disparity, and now we have about 60 million.

Just a quick analysis of how that happens, and will it continue? Yes, there will be a continuation. Although, I would anticipate that continuation to decline. Very briefly, to explain why that disparity arises, we paid $170 million, the value for the Artisan Library for the film obligations. It was split between 70 million of basically, larger films, or 100 million in library. We amortized that $100 million over 20 years. The financials for last year show that the library amortized $20 million. Cash out before the acquisition date, $20 million of amortization, no cash -- that's an immediate $20 million difference between free cashflow and EBITDA.

The second question is, if you notice, I said only amortize 100 different libraries. There's $70 million that I would ascribe to the value of the larger, newer product within the library of Artisan. That $70 million, as it will tell you in our footnotes, is amortized, generally, 81% over the first three years. Again, there's another approximately $20 million of amortization difference. So, yes, it will continue, and yes, it will decline.

20% decline.

We do believe going forward next year, maybe year after, that the disparity between EBITDA and free cashflow should start to narrow.

Great.

Thank you both very much.

Thank you.

We'll now go to David Miller with Sanders Morris Harris.

Please go ahead.

Yes, Hi.

A couple of questions -- Felt, you guys just keep knocking the cover off the ball on the television line -- television revenues just absolutely off the charts here. You had six shows on the the air in -- or I should say, I should phrase it -- you will have had six shows on the air in fiscal '06, one of which was "The Cut" that's likely not going to be renewed. Can you give us any loose guidance as to how many shows you may have on the air in fiscal '07? That would be helpful.

And then if -- Michael, if you're on the call, are you guys going to force conversion on the first traunch of converts, I believe it's the traunch with the conversion price of $5.50, $5.52, something like that -- are you going to force conversion on that paper, which will increase the share count?

Thanks.

Let me take that one first.

Hi, David.

We can't -- we don't have the ability to force conversion until a year from this upcoming January, and it is a $5.40 strike price. Assuming that the stock trades for 20 days for any 30-day period, at a level of $9.45, I think 175% of the $5.40, then we have the right to force conversion. And that will basically turn into 11 million shares, most of which, I'm assuming, is fully hedged out already. I think the bonds are trading in the 200's. So right know, at this moment in time, I would anticipate that we will be converting that $60 million to pure equity and save us about $3 million a year in interest.

On your second question, cable years are a little bit different. They're atypical from broadcast, but I think I would answer your question saying we have "Dead Zone" already on for next year. "Wildfire" picked up for next year. "Missing" -- we're discussing a pick-up right now, but given that they don't have "Strong Medicine", my guess is -- I'm pretty confident of that, and "Weeds," we're negotiating to pick up. So, that's four for four is what I'd anticipate. You might think, out of the new pilots, we doing maybe two more shows, so I believe probably six series on the air would be a good guess.

Okay.

And on the RedBus acquisition, do you expect to close that deal soon enough so that so that you can keep all UK accretion as it applies to "Saw II's" run through the UK?

Thanks.

Well, really two different questions -- the deal is closed, and we would anticipate, one of the points I made about EBITDA, which is depending upon the releases, RedBus could be either a positive or negative contributor to EBITDA in this current fiscal year.

Right.

In terms of "Saw II", if you asked be about "Saw III", I might have a different answer because we have much more flexibility, but in terms of "Saw II", that will run through a sub distributer who has been a very good partner of ours in the UK, who distributed "Saw I". So "Saw II" is going to be distributed not by RedBus, but going forward, it is definitely our intention, although it's not going to be absolutely exclusive, but it's certainly our intention that most of our product run through RedBus.

"Saw II", David, is open in the UK, and doing very, very well.

Okay, guys.

Thanks very much.

You're welcome.

We will now go to Alan Gould with Natexis.

Please go ahead.

Thank you. I've got a number of questions. First, Jim, in terms of the library, what's included in the library revenue? So, for example, would the -- at least the special edition of "Saw" be included in library revenue, or is it just stuff that's gone through a first cycle of distribution?

We define library as six months after the initial release in market, so yes, a "Saw" release would be in part, considered library. Again, six months after the initial release in the market, becomes library -- the intention is, you get it out, you do your first shot, and there's quite often a price reduction and things of that nature. Library, as we define it, is intended to pick up that second pick up.

But it would not go into, in terms of it's television run, Alan, in terms of the paid television, it's free television, it would not go into library in those mediums.

Okay.

Second, Michael, can you give a little discussion on Image, particularly Steve's comments about some of these non-big franchise titles not doing quite as well in the DVD market? What's the appeal there?

Some of the specialty items are certainly doing well. We like some of their concert DVD's. They had a great success in the "Blue Collar" DVD release. So, as far as Image, we're currently the second largest shareholder of Image. I know that we're interested in, obviously, what their business plan is and the execution going forward, but also, like ourselves, I think Image has done a pretty good job in the VOD rights, and that's certainly an interesting part of the catalog.

Okay.

Third, Jon, this move into the Latino business sounds quite intriguing. I don't know that much about that business. In TV, they have the Telenovela that they made in Mexico that they just rebroadcast in the US. Is it the same thing where they have a built-in native film business that you can just buy the rights and they make film there?

I think, Alan, actually a combination. This first film with Barbara Mori, is a film that we acquired, but it's our intention to control our destiny, and I would say, probably out of that mix of 6 to 8 projects, I would guess at least half of them we're already developing a number of scripts -- at least half of them will be projects that we actually tailor to the audience that we're trying to reach and produce ourselves.

Okay.

And last, Jim, in terms of that cash -- in terms of the free cashflow, isn't it pretty dramatically impacted, though, by some of these working capital items? For example, looks like the noncash working capital items increased 38 million in the quarter -- isn't it -- ?

The answer is yes, it will be increased with that -- by that, as you -- even as we do it, they tend to level out over time.

Okay.

Thank you very much.

Next question.

Our next question is from Matthew Harrigan with Janco Partners.

Please go ahead.

Also in the Hispanic market, it's seems like that's dramatically under-served relative to the urban element in the US, and I know that there are some foreign companies that done some interesting things, Televisa and all that with movie productions as well as in Spain. Can you quantify what you think the size of that market is in the US, and what you think the degree is that it's under-served relative to the urban market? If you look at [inaudible] when it was young, if I'm not mistaken, they were the number two network among 18 to 49 last month, and it just seems like everything is radically out of whack in terms of how that market is addressed in the US.

Yes. Well, I'm quite familiar with the market. I put together the Telemundo deal for Sony when I was there, and that's how I developed a relationship with Jim who's really one of the premier talents in terms of Spanish language programming not only in the US, but throughout all of Latin America. It gives me great confidence to believe that he will be working with the best producers in the territory to find and produce the content.

It's interesting to note that if you look at a number of markets, Miami, New York, Los Angeles, you actually might find if you look at the local broadcast stations on any given week, you actually might find two or three out of the top 20 programs total, in terms of total viewership, are often even more than that are actually Spanish language programs.

The picture with Barbara Mori, is actually the first picture that we will fully self-distribute, but actually, Jim has already a picture that's been out in the marketplace called El Vacilon, which is a picture about two New York DJ's, and while it's a smaller picture, or more provencial picture, if you will, than we were intending, and we are trying to get the home video on that. It's interesting that when the picture opened, it opened in 19 theatres in New York, and it was the second highest per theatre average only to "Saw".

So, we're intending to really make a business out of this. We've been quietly out there, acquiring Spanish language video because we think that's another under-served area, not just the theatrical area where we're going to have to spend some time educating the theaters as well as the consumer. But we believe that for the large retailers, there's a tremendous opportunity to, in terms of new product as well as Spanish language catalog, to a make a real business out of this and get into a dominant position for a long, long time.

Great. It certainly seems like an under-served niche.

Thanks.

Welcome.

We'll now go to the line of Michael Kelman with Susquehanna Investments.

Please go ahead.

Thanks.

You have a lot in the pipeline on the TV side with several different pilots coming up. I was wondering if all of these series that you'll be producing will be done profitably, or will you have to use some deficit financing on some of the new shows you're looking to create?

As a rule, we don't deficit finance our television. Through -- the way we produce our shows, working in partnership with states like Louisiana and New Mexico, in terms of tax-supported financing and provincial financing from Canada, we generally say that after early first cycle returns from international and the domestic license fee, we're in profits.

Okay.

Thank you.

Thank you.

And we have no more questions from analysts, so we'll take one or two questions from investors.

We'll go to the line of Errol Rudman with Rudman Capital.

Please go ahead.

This is Ron substituting for Errol. I was wondering for the library revenue. You talked about pricing erosion. Can you talk about unit volume and if that was declined for the first half year-over-year? And then my second question is of the $200 million in the library revenue that you're predicting for this fiscal year, what percent of that revenue is coming from motion picture releases in fiscal year 2005 and '06?

Ron, I'm prepared to talk about unit volume for the first half. Not necessary [INAUDIBLE] as your combination of revenue -- the -- have managed to reduce our costs, resulting in a higher contribution margin. Yeah. I think the answer to the second part of your question is a small piece of the overall revenues for the year will be come out of 2005 fiscal releases.

Thank you.

Welcome.

We have a question now from Berna Barshay with Ingleside Investors.

Please go ahead.

Hi, thanks for taking my call. I have a few questions. You gave us P&A estimates for "In the Mix". I was wondering if you could give us a little color for that for us on "Hostile" and "Madea". Could you comment a little bit on the film obligation line, on the liability side on the balance sheet, which is up $75 million year-over-year and what you attribute that to. Curious if "Weeds" has been renewed yet. My final question, was on [INAUDIBLE], you mentioned it is an African-American focused film. Curious, you know, why you're sort of thinking of it as a genre film? And also, whether or not you're worried at all that "Bee Season" is coming out now, a few months ahead?

Those are all good and diverse questions. I think your first question is on "Hostile" and "Madea". "Madea's" P&A will be very much like last Tyler Perry picture around $20 million. "Hostile" probably about the same. In terms of "Weeds", we're just dotting the I's and crossing the T's for a 12 episode -- a 12 episode renewal. Jim will answer the question. Film obligations on "Akeelah and the Bee", I'm not quite sure what you mean. "Akeelah" is -- got obviously a core, Urban-American family audience. In our testing, we just tested it, actually interestingly enough, tested it now three times. This weekend we tested to a primarily non-African-American audience, 70% non-African-American. Tested almost as high as it's tested before. Really huge numbers. We see this as a crossover pictures. Even in some ways like "Crash", were we relied in terms of the wide release on a core Urban audience it appealed because of the stars who were in it, we believe and refer to it as, you know, an urban, you know, African-American-family core movie. So definitely agree with you. It's definitely we see this as a big crossover picture.

And then also just on that one, I know that a [INAUDIBLE] movie is coming out. There's commercials for it now.

I think it's a very different -- from what we know of "Bee Season", it's a very, very different movie. Michael?

It's a completely different subject matter for the most part. And this -- if you can see from our trailers and teasers, get a sense for what "Akeelah" is about. Two completely different movies.

In terms of film [obligations], Jim.

That uplift is primarily attributable [INAUDIBLE] portion and about [INAUDIBLE] and I won't be specific because [INAUDIBLE]. But we have MG's payable for "Lord of War" and "Barbie", which can be somewhat substantial. Your seeing participations go up another $30 million. That's due to the success of our film's "Diary", "Saw I", "Crash", and the Tyler Perry films as well as "Alone in the Dark". We have additional participations due. See the production investments our payables go up from 10 to 29. Primarily associated with the Marvel titles we've been producing with "Madea" and those are the two components.

Okay. Thanks. That's all of my questions.

You're welcome. We'll take one more question, operator.

Thank you. That will come from Neil Waldman with Fortress. Go ahead, please.

Hi, guys. How are you doing? I have a question for Steve Beeks. Earlier in the call you mentioned that 50% of your titles are -- you have rights for VOD and Internet downloading. I wanted to get a little more granular there and understand if you have VOD and Internet downloading rights for some of your premier titles, such as, "Terminator 2", "Reservoir Dogs", "Basic Instinct", and "Total Recall". More of the prior Artisan titles. Thanks?

Neil, it's a mix. And some of those titles like "Reservoir Dogs", for instance, is a pictures that was produced by [INAUDIBLE] live and all of those kinds of pictures we control all rights. Including VOD. And perpetuity. And there are obviously other sections of the library for which we currently don't control VOD rights. Specifically address your question on "Terminator 2" and "Total Recall". We currently don't own VOD rights to those particular titles, but they represent a relatively small portion of our library. Although great titles, they are a small group of titles, don't represent a tremendous portion of revenue generated from the library.

Got it. And actually, one quick follow-up. I know you guys haven't broke out your library revenues for the quarter. Your guidance of kind of 200 million for the year. Of that 200 million just roughly speaking, how much of that library revenue is going to be coming from movies that have been released in the last 12 months, specifically by "Saw I" and "Crash"? And how much is generated from kind of the other 7,998 titles, I guess?

I think it was similar to question answered earlier. If I had to guess, less than 5% would be attributable to releases over the last 12 months.

Okay. Great.

That's it. Thanks a lot.

Thank you, everybody.

We'll look forward to talking with you again next quarter.

Thank you.

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