Starz Entertainment Corp (STRZ) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the fiscal 2006 third quarter analyst conference call.

At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions and comments. Instructions will be given at that time.

If you should require any assistance during today's call, please press star, then zero and an AT&T Operator will assist you. As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Head of Investor Relations, Mr. Peter Wilkes. Please go ahead.

Good morning. Thanks for joining us.

Jon Feltheimer, our CEO, Michael Burns, our Vice Chairman, and Steve Beeks, our President, will open with the remarks and we'll turn the call over to Q&A from our analysts.

The matters discussed in this call contain forward-looking statements. 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 including risk factors set forth in Lion Gate's Form 8-K.

These statements are made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements are made and management does not undertake any obligation to update these statements. Jon?

Good morning and thank you for joining us today. Also with us are Chief Compliance Officer, Rick Prell, and the Executive Vice President of Corporate Development, Marnie Wieshofer.

During the third quarter, we've continued to invest in a wide variety of content with great long-term value for our Company. Our new release product has been very successful with a number of recent industry-leading results.

Six Academy Award nominations for "Crash", and I should mention we're the domestic distributor for the foreign film nominee from Italy "Don't Tell", and the video distributor for documentary nominee, "Murder Ball." "Hostel", the number one movie in theatrical box office, "Lord of War," two weeks in a row the number one DVD, "Big Fat Loser" the number one title in fitness, and we recently announced the first film partnership for Starbucks with "Akeelah and the Bee."

Overall, our business is strong and our strategy remains clear and correct for us. However, despite these and other recent successes which will inure to our benefit in fiscal 2007, the negative trends that we discussed last quarter in terms of softness of the family home entertainment market and direct-to-video sales are causing our financial performance to lag our operational success by a couple of fiscal quarters, and as a result, we are lowering our year-end guidance by $15 million in both our EBITDA and free cash flow categories.

We're now guiding to $20 million for fiscal '06 EBITDA and our free cash flow guidance is $85 million.

The key negative variances from our initial projections that have dropped EBITDA from our beginning of year guidance of 63 million to current guidance of 20 million are the following: 11 million in family home entertainment DVD, 10 million in EBITDA from catalog sales, primarily reflecting the decline in margins we discussed last quarter and primarily attributable to our product mix, 8.2million in direct-to-video product, 4 million in bad debt attributable to the bankruptcy of the video retailer, Musicland, and 4 million in unusually high professional fees for this year relating to Sarbanes-Oxley compliance, IT consulting and transaction-related legal and banking fees.

If you look at just this quarter, again, as for the year, most of the variance to guidance has been related to softening in the home entertainment market. We obviously take our guidance very seriously and revising it downward twice in two months is very difficult for us.

However, given the trend in home entertainment catalog pricing and softness in the family business, we took an aggressive approach to scrutinizing and writing down some ultimates, took losses for even some unreleased product and reserved our entire Musicland receivable.

We also continue to put zero revenue from new formats and delivery systems in our ultimate. The good news is that the point of monetizing these new revenue streams is about to begin.

In the last two days, "Weeds" was the number five and number six video download on the video iPod, and it just started. Sony also announced its pricing approach to Blu-ray, and as we anticipated, the pricing was very much like it did for initial catalog pricing at the onset of DVD, or around $18 wholesale.

Steve will speak later about our approach to catalog pricing and also our approach going forward to alleviate the issues in family and direct-to-video that we have already instituted. Our guidance also reflects an additional $2 million for our Oscar campaign for "Crash."

Be believe this to be prudent investment and that "Crash" is a serious contender in every category in which it is nominated. It also reflects a timing issue for an additional $2 million expense for the video campaign of "Saw II."

"Saw II" was obviously a big success for us, but it's important to note that 80% of the film's profitability will be outside of the fiscal year, much of it in fiscal '07.

Overall, our feature slate for the year overperformed at the box office, but as usual, most of the benefit is outside of the first year window. The financial result is that we covered $27 million of misses from budget due to the accelerated amortization of "High Tension", "Undiscovered", and "In the Mix", but therefore had little cushion for the negative trends in home entertainment.

The swing from this year's negative EBITDA impact from our film slate, which we did anticipate of $15 million, will reverse in fiscal '07 to a gain of about $80 million, or almost a $100 million swing. So the key to our results for '07, particularly in our key free cash flow metric, will be the ongoing consistency and growth from our film slate.

I'd like Michael to go through our free cash flow model now.

Thanks, Jon.

There's been a lot of conversation on the Street about the sustainability of our free cash flow. I'd like to take a couple minutes to go over where our free cash flow comes from and what our levels of revenue have to be to hit approximately $100 million of free cash flow on a consistent basis.

For this exercise, the assumption is that all of the revenue incoursed by margin occurred in the same fiscal year, and obviously, that doesn't typically happen, but the tails from previous year products should balance this anticipated margin over time. When looking over our last few year's theatrical business, we have found the margin on this, our core business, to be approximately 19%.

Assuming that we have 18 theatrical releases over a given year, nine being wide releases and nine limited or platform releases, we need approximately $300 million domestic box office to generate around $600 million of total revenue on that slate of films, representing approximately $114 million of margin.

Our TV business is anticipated to throw off approximately 10 to $15 million of margin on a yearly basis, our library approximately $40 million and direct-to-video product between 5 and $10 million of profit. So with our overhead of $65 million and our net interest our debt of $10 million being deducted from that total free cash flow number, we end up with approximately $100 million of free cash flow.

Since this model is weighted heavily on our new film releases, let me now discuss what I consider to be our most exciting theatrical release slate to date.

"Madea's Family Reunion," Tyler Perry's follow-up to last year's hugely successful "Diary of a Mad Black Woman," wide release February 24th.

"Don't Tell", John mentioned it in his opening remarks, Academy Award nominee for Best Foreign Language picture, prize winner at Venice Film Festival and one of the top-grossing Italian movies for 2005. A platform release in New York, Los Angeles and San Francisco on March 17th.

"Larry the Cable Guy: Health Inspector" a laugh out loud comedy starring Larry the Comedy Guy, star of the hit Blue Collar Comedy Tour, wide release March 24th.

"La Mujer de mi Hermano," the biggest home-grown hit of Mexico last year staring Barbara Mori, a targeted release aimed at Hispanic-Americans in 200 theaters April 14th.

"Hard Candy" the Sundance Film sensation. This edgy thriller tackles the very topical subject of online predators. A platform release April 14th.

"Akeelah and the Bee." You've heard a lot about that lately. A heart-warming story about an inner city girl who competes in a national spelling bee.

This film was launched [inaudible] Angela Basset and Keke Palmer. A wide release April 28th and as you know, Starbucks is our partner on this film. I love this picture.

"See No Evil," a no holds bar horror film starring Kane, one of the biggest names in the WWE. A wide release May 19th.

Leonard Cohen, "I'm Your Man", a musical tribute to one of rocks most influential figures, [inaudible] interviews and performances by U2's Bono and the Edge among others. A platform release June 21st.

"Fierce People", a platform release starring Diane Lane and Donald Sutherland.

"The U.S. Versus John Lennon" a documentary focusing on John Lennon's quest for peace and the government's efforts to deport him. A platform release July 21st.

"The Dissent," that rare horror film, really good and scary as hell, wide release coming in theaters this August.

"Crank," a high octane action flick about a man who has to keep moving and his adrenaline running to keep the deadly poison inside him from killing him. Think of the film "Speed" where the bus is now a human body. A wide release September 1st, starring "Transporter's "Jason Statham.

"Welcome to America". We think that will be an award contender. Kevin Klein stars in this film about human trafficking and sex slavery from Eastern Europe and Mexico into the United States. A platform release at end of September.

"Saw III," oh yes, there will be even more blood the third installment of our widely successful series of movies about the infamous serial killer Jake Saw. A wide release around Halloween.

"Skinwalker," Stan Winston at his best werewolves gone wild and going wide December 1st.

And lastly "Bug," an edgy and eerie thriller about two lost souls which echoes Joseph Heller's famous line "just because you're paranoid doesn't mean they're not after you". Bug stars Ashley Judd and was directed by the acclaimed 'Exorcist" director, William Friedkin. A platform release is scheduled for late December.

To relate this back to my free cash flow model, we believe that our theatrical slate for fiscal '07 is positioned again to generate well over $300 million of domestic box office and though we will continue to invest heavily in the new content creation that is our lifeblood, the long tail from our fiscal '06 successes will contribute to our bottom line profitability in fiscal '07, which starts in six weeks.

Now we want to turn this over to Steve Beeks, who will, please excuse the expression, one might say is the keeper of the tail. Steve?

Good morning.

We're in the middle of a very successful DVD campaign on "Lord of War," which was released on January 17th, and of which we have shipped 2.8 million units. Because we initially shipped on the conservative side, 89% of the units are sold through as of this week.

The DVD was number one seller in the country during the first two weeks of release and will end up with a theatrical box office to DVD revenue conversion rate around 150%.

We recently took a look at the industry conversion rates for live action releases by all studios for the first three quarters of 2005, and our conversion rate is higher than that of any other studio. In fact, it's 50% above the average.

This is due to a number of factors, including the genres in which we generally operate as well as the box office and P&A ranges our pictures generate. We have not experienced any noticeable downturn in DVD sales for our slate of films and our new release business continues to be very healthy.

Another great example of this conversion rate is "Waiting," which was released earlier this week. We shipped 1.4 million units for the Tuesday street date and 29% sold through on day one.

So far, we have shipped an additional 170,000 units as of today and we will be shipping more tonight for Saturday delivery. This film generated $16 million in box office revenue and will overindex in terms of its conversion rate, which should approach 150% during the product's first cycle.

We released our latest edition to the fitness category, "The Biggest Loser Workout" on December 20th. The DVD is currently the top reformer in the fitness category.

We originally shipped 75,000 units and it's performed so well, we've already shipped 225,000 units and are making plans to follow it up with a second DVD some time later this year.

"Crash" continues to sell very well, especially with all the notice it is getting during the awards season. As a matter of fact, we saw a 100% increase in sales of the title the week after the Academy Award nominations were announced.

We also have a special edition planned for release soon after the Oscars broadcast, which is on March 5th.

We are having a very good second half of the year in library, as we planned, and we expect to hit or exceed our target of $200 million in library revenue for the year. The lion's share of which is represented by Home Entertainment.

The library revenue generated by DVD sales is actually projected to be about equal to last year. Any drop in library revenue will be in television, and that is purely a function of timing, dependent on when product is available, and the average price for a deep catalog on DVD has been very resilient.

We expect that to drop only $0.25 per unit this year as compared to last. But even though we have managed to keep our library prices from dropping significantly, there is always continued downward movement in library pricing industry-wide, driven in particular by two studios with very aggressive pricing programs.

There are library titles available in the market from these studios at $3.88 and $4.88. We have not had the need to follow this trend downward, and there are already some signals that these studios may be backing off these price points soon, but we will continue to monitor pricing closely.

The current margin on our library catalog, or library product, is still approximately 21% and we anticipate that our library product mix will improve over the next few quarters by focusing on a program that features titles in which we retain higher margin. We also continually have new releases that drop into the library after their initial six months, and those titles generally also have higher margins.

We already have some very significant catalog promotions in place with every major retailer starting this quarter. For instance, we have library end cap promotions at Best Buy and Circuit City for virtually the entire quarter, library corrugate promotions at K-Mart and Transworld, a horror palette at Wal-Mart in late March and a significant library presence in the check lane and DVD value spaces at Target for the quarter.

There are other catalog promotions going on and many planned for fiscal '07. In addition, we currently have seven special editions of library titles planned for next year, and that number will probably grow to around 10.

The market for new release family home entertainment product this year has been very crowded and competitive. Although our "Barbie" movies continue to perform quite well, as a matter of fact, we shipped approximately 2 million units of "Barbie and the Magic of Pegasus," and our library of family home entertainment properties have also continued to do well, such as "The Teenage Mutant Ninja Turtle" series and "Speed Racer".

However, "Inspector Gadget", "Pinocchio 3000", the "Maya and Miguel" series, the "Miss Spider" series and "Megablocks Dragons" new releases have all not performed up to our expectations.

The sheer volume of animated direct-to-video sequels of theatrical titles has virtually swamped the market, making it difficult for smaller properties to breakthrough. Now these are all projects on which we made commitments quite a while ago, long before the recent surge of releases in the market, but in fiscal 2007, we will be following a more selective strategy with fewer new releases in family home entertainment.

Our focus is limited to franchise properties that have some breakout potential. I portray this strategy as quality over quantity.

These include the "Doodlebop" series, which has replaced the "Wiggles" on the Disney Channel with great ratings and "Pepa Pig" which is a very successful series in the U.K. and is now running on Cartoon Network. We also have the Marvel animated features, the first of which we release later this month.

Also, the softness in the market for mid-level new release direct-to-video films on DVD has contributed to us missing our projections for this segment in our business. We have responded to this by limiting our forward commitments to new release direct-to-video features on which we have minimum guarantees, and we have increased the release slots given to our servicing deals through which we distribute direct-to-video product for a distribution fee at virtually no risk.

If we do make minimum guarantee commitments on direct-to-video product, it will be for a few choice projects which have very significant upside and for which we consider there to be a limited downside.

Our outstanding receivable with Musicland is approximately $4 million, for which we reserved 100%, as Jon mentioned earlier, although it is yet to be seen what actually happens with them. We believe we are a secured creditor, so there is a decent chance that we will see some recovery on that receivable.

We've also been working with Blockbuster over time to reduce their receivable, and that has been reduced from over $9 million to right around $4 million today and they are now current with us.

The next generation DVD is finally arriving and we anticipate we will be announcing our first 10 releases for Blu-ray high-definition DVD in the next week or two. And we expect that the initial release date will be before the middle of the calendar year.

Every major retailer is making room for the product and we anticipate this would be a very real business over the next year or two. And just as standard definition carried premium pricing when first introduced to the market, we expect the same in high-definition.

Our library titles will be released in an SRP of $24.98 and day and date new releases will be higher than that. This will eventually have the effect of improving the overall margins in our library.

We will also begin to see some activity being generated in the next fiscal year from digital delivery media, including VOD and electronic sell-through, although we do not project anything in our plans for that.

We are in active negotiations with several digital distribution entities, including Google, Yahoo!, Vongo, Apple, NetFlix, Amazon, CinemaNow and Movielink and we anticipate agreements with many of them soon. These new technologies are going to provide very substantial sources for revenue for new and catalogued product in future years, and as Jon mentioned, you can already download episodes of "Wildfire" and "Weeds" to the video iPod through iTunes.

We're at the very beginning of an exciting technological revolution in which consumers can access programming in many new ways, creating new avenues for us to monetize our library assets.

Incidentally, we continue to be exceedingly conservative when we prepare our ultimate pro forma forecast for films by not projecting any revenue for new technologies such as VOD, downloads and electronic sell-through. I expect that to change as we move forward as these businesses all become reality.

We expect to end the year on the upswing and are looking forward to three significant DVD releases still to come in Q4, including "Saw II," which we release next week on February 14th, the perfect bloody Valentine. We're shipping right around 4.5 million units, anticipate replenishing aggressively with up to a million additional units, given the success we had with the original "Saw" on DVD.

Our first animated feature with Marvel, ""The Ultimate Avengers" will be released one week later on February 21st with between 600,000 and 700,000 units on the market. We are supporting this with substantial consumer advertising and the initial buzz we have been getting on this indicates it should be a success.

On March 14th, we release the next Barbie movie, "Mermaidia," which is the second film in the Fairytopia franchise, the first of which was very successful when we released it last year.

The prospects for our home entertainment business are strong. Our new release business is as good as ever and our new releases are outperforming market norms.

The catalog business faces some pricing challenges, but we are on target to hit $200 million this year and the important things to note here are that next year, even without the Republic library, we believe we will still have a comparable performance.

Our library margins have stabilized and may even come up next year. We have not projected revenue for new technologies such as high-definition DVD, VOD, and electronic sell-through.

Our new release family home entertainment and direct-to-video businesses lagged this year, but we have proactively responded and expect these areas to be much more profitable next year. And high-definition DVD will be launching in the next few months at premium pricing as new delivery modes for our new product and library become a reality in the coming year.

Thank you, Steve.

I'm not going to spend too much time on television today, but I do want to mention some headlines. For the year, we'll surpass our $120 million revenue target with our four series "Weeds", "Wildfire", "Missing" and "Dead Zone," as well as four new pilots for four networks, including "Palm Springs" from "Dawson's Creek" creator, Kevin Williamson for the new CW Network, and a new eight-episode reality show "Dirty Dancing, Live the Dream" for WE.

But the most exciting development from television is the ancillary business and revenue we're developing from it. "Wildfire", ABC Family's highest rated show is becoming our "OC" in terms of music.

James Blunt quickly becoming a quick star just sang two songs on the show and we expect a number of new acts including Ashley Simpson, Aiden Hawkin and Jem to be on the show in the new future and "Wildfire" is currently moving up the charts, number 47 downloaded show on the video iPod.

And "Weeds," as I said earlier, in the last two days was the number five and six download is turning into an international hit, sold in over a hundred countries and helping to drive packaging deals and an output deal with the 9 Network in Australia.

Going forward, we're currently finalizing our budget for next year, but we believe fiscal '07 will be a very strong year for us. The $100 million swing in terms of the '06 films slate EBITDA contribution, our new release films, and the changes we have instituted to accommodate the changing packaged media environment and our growing television and digital distribution will contribute to financial results more in line with shareholder expectations.

But just as important will be the strategic value of our business as we move into the future. We walk into the digital world of digital distribution with a dazzling array of content.

People will watch episodes of television on handheld devices, and a recent survey of iPod users had 42% wanting films to download. As well, they'll gravitate to the better experience of high-def DVD and these price points will, as we've mentioned, significantly increase catalog margins.

The large and growing list of digital distributors, the internet majors, the broadband players, the telcos and cable operators all will seek the filmed entertainment we control. That we can keep throwing off 90 to $100 million of consistent free cash flow and still keep building our long tail for the soon-to-come explosion of digital demand without a big film hit or TV show is a model we believe is sustainable and we will continue to build the largest independent treasure trove of film assets.

Now, I notice we didn't mention, of course, our CFO, Jim Keegan, is with us, and I imagine that you have some questions for him this morning. We'll take question, now, please.

[OPERATOR INSTRUCTIONS] Our first question today comes from the line of Lowell Singer with SG Cowen. Please go ahead.

Thanks, good morning. Two questions.

Can you just follow-up a little bit on your comment about '07? You talked about financial results being more in line with expectations. I don't know if you're prepared to give guidance, but if not, could you at least give us some sense of where you think EBITDA could end and revenue could end in fiscal '07?

And also, could someone just talk a little bit about the Starbucks deal? I'm trying to understand a little bit better exactly what you're getting from them and exactly what you are giving to them and what the scope of the deal is. Thanks.

We are intending to do an interim call to discuss guidance as soon as we have our budget approved by our board. I hope that will be within six to eight weeks.

I did say on a previous call that I expected a big bump from this year and possibly a bump as well from '04 EBITDA. I would say I'm still confident in that statement.

In terms of Starbucks, I just came back from Seattle. I was at the shareholder meeting and introduced a film the night before for their board. Into their mocked-up store and I can tell you, it's incredibly impressive.

They will have Akeelah printed on 80 to 90 million coffee cups, there will probably be 15 to 20 different points in the store where you will see different items pertaining to Akeelah. Each and every one of them talks about the release date of April 28th.

This promotional will start on April 4th so we'll get, you know, almost four weeks of promotion with Starbucks. You'll have the music playing from the soundtrack, you'll have the soundtrack in the stores. You will have on the receipts that people get back, you'll have something mentioned about Akeelah.

It's really pretty extraordinary. Our media [bias] thinks it's worth $25 million or so. So it's very exciting. They have been a great partner. I'm very impressed with their organization.

You know, and it's an example of what we try to do thinking outside of the box. I know that the other studios have been talking to them for over a year trying to get a film going with them and this is their first one.

We move to the next question? Our next question is from the line of Robert Routh with Jefferies. Please go ahead.

Yes. Good morning, guys. Just two quick questions.

First, I was wondering if you could comment at all given your cash balance and your lack of debt because, you know, you have the preferreds out there, why the Company hasn't made any share buybacks and whether or not given where the stock is trading that's something that the board would consider at present levels?

And second question, which I think I guess is more important, is given the free cash flow of $100 million that you feel is stainable going forward and given where your stock is trading, it seems to me it almost doesn't make sense for you to be a public company at all. I'm wondering whether or not there's any chance the Company would consider going private unless the equity market's value of your stock it will be considered a more reasonable valuation level?

Robert, it's Michael. Let's take question number two first.

Obviously, we're a public company and our primary responsibility is to our shareholders, but I obviously can't comment on whether we should be a public or private company. But again it comes down to valuations. We have 50 institutions that are certainly control the majority of our stock.

The second question in regards to buying back stock, we really are limited on the times and the scope in which we can buy stock. We're certainly open to the idea of trying to make the most accretive transactions possible for our shareholders, which would include obviously looking at the repurchase of stock, when that was appropriate.

Okay, great. And just one follow-up. Is there any update you could give us on the Horror Channel formation?

I think I said on the last call we expect to launch this year, and I'll stand by that.

Okay, great. Thank you very much.

Our next question is from the line of Michael Savner with Banc of America. Please go ahead.

Good morning. Thanks. A couple of questions as well.

First going back to the library issue and probably I guess two questions within that. One, can you talk a little bit about your visibility there and kind of the issues of when you're seeing issues arise on margins and sales and the lag between when you get that data and then you can adjust for it obviously, given that you've had to move numbers down twice?

And then within that, you know, when you walk through the discrepancies or the reasons, I guess for the decline, I mean it seems like some of that stuff could be overlap, right, when you talk about family home video, but also catalog sales margins and direct-to-TV product. I mean I would assume that some titles overlap within those different categories of why there was a shortfall. So maybe some clarity there.

And then the second kind of broad question is on '07 free cash flow conversion. It'd be helpful maybe if, you know, given you've a strong backlog, I think it was about 147 million of revenue in backlog, what percentage of that will convert to free cash flow typically, and maybe using '06 as example, the backlog than you then converted to free cash flow?

I think that would help give us a good sense of what kind of the floor that, you know, your starting point on free cash flow is already there set in stone. Thanks very much.

Mike, this is Steve Beeks. I'll take the library questions first.

And the second part of that, you asked about the overlap between library and direct-to-video and family. And actually, my comments really had to do with, in terms of family home entertainment and direct-to-video softness, those really relate to the new release business.

As a matter of fact, the library part of our family home entertainment business as well as the direct-to-video product remains strong. It really is limited to the new release business, and we have, as I said, we've made some changes there.

We do have pretty good visibility, very good visibility in what's going on in the market on a virtually daily basis in terms of sales, returns, or in-stock percentage. You have to realize, a lot of this, all of the investments that we made in family home entertainment and in direct-to-video were made long ago, long before these trends in the market became a reality. So it takes some time to adjust our strategy.

We did not foresee the amount of family product we brought into the market during the holiday season, so we got surprised a little bit by that, and as I mentioned, we've got fewer investments in kind of middle-level family and direct-to-video product going in the future, which is why I believe that we'll be able to raise the profit of those two areas in the next fiscal year.

Mike, are you clear on that? The categories actually are quite distinct, family product in library category actually did well, so that was all new release product for family with no carryover.

I'll answer your second question, which is that just as I mentioned earlier, most of the benefit from current release stuff moves into the next year. I said about 20% remains in the current year.

That's actually the flip side is really pretty much the percentage for the conversion of backlog into free cash flow, so I think you could assume around 70 to 80%, which again, as Michael said, fills in the tail.

Okay, thanks.

Next we have a question from the line of David Miller with Sanders Morris Harris. Please go ahead.

Good morning, David.

Yes, good morning. A couple questions on your spending, specifically on the P&A line.

I know that you guys spend a fracture of what the majors usually spend on a typical film's P&A profile. That said, in my opinion, it just still looks like it's too much. Can you talk about what might be in store for fiscal '07 with regard to other creative means of spending, a la what you guys are doing with Starbucks, what you guys did with Sony with regard to "Hostel," other agreements of that type that could limit the P&A line and therefore enhance EBITDA?

And also, related to that, felt, I'm just curious, this is just for my own edification, why the 2 million in spending for Academy Award marketing campaign for "Crash"? That's $0.03 a share. All things being equal in terms of what you guys reported, and I just want to understand why the 2 million and why do you think that's efficient spending? Thanks very much.

Thanks. Those are all fair questions.

I'll go with "Crash" first. We believe that the valley of that $2 million spend even within the first probably six months after with the win is between 5 and $10 million, at least 300,000 video units.

As I said, I think we're a contender in every category. As a matter of fact, we will definitely get that money back one way or the other, period.

In terms of financing, yes, you will definitely see this year more "Hostel"-like deals. Those deals are actually in the works already. You will see more service deals.

You will see a larger percentage of our slate to be service deals to equalize or stabilize our earnings, and the other thing you will almost definitely see this year is you'll see a film fund not unlike a number of the majors have recently announced. Again, those are all in the works right now.

Okay. Just a quick follow-up.

Any proclamation on what you guys are going to do with the cash [inaudible] from the Bosa sale or the Bosa deal, I should say, with regard to the Soundstage deal or are you guys just going to let it sit on the balance sheet at this point?

Well, our current, David, it's Michael. Our current, we obviously have a cash position right now. We're earning about between about 4 and 5% on our cash balance.

We are again, always looking to invest that money in an accretive way, but no plans to spend that right now. It will be added to our cash balance. We'll pay off the mortgage first and then we'll put what, Jim, about 18 or $19 million on top of our cash balance.

We haven't gotten that money yet, David, so we're not going to spend it yet.

I understand. Thanks very much.

And we'll go to the line of Barton Crockett with JPMorgan. Please go ahead.

Good. Thank you very much.

I wanted to focus in a little bit on your argument about the 100 million sustainable free cash flow, which was very good to hear, but I wanted to get a little bit more detail on the margin you say, the 19% margin you said you believe you will get and have gotten across all windows from your new theatrical?

Can you give us more detail on what the expense assumptions are that go into that because it strikes me as a relatively high margin versus others in the industry and I'd like to get an idea of what you see for such things as like P&A as a percentage of theatrical revenues or participations and residuals as a percentage of all revenues and negative costs for this type of performance? Thank you.

Yes, Barton, a couple of things. One is, you got to compare us, first to the major studios for a moment. The average motion picture for a major studio plus the release cost of the picture's over $100 million.

Our productions typically are less than $10 million, and again, remember our margins are built in from a standpoint of we're pre-selling the foreign rights of those pictures, as you know, for anywhere from 65 to 80% of the production cost.

The other two-thirds of our releases are acquisitions that we buy at festivals, you know, Sundance, Telluride, Caan, Toronto, so those acquisitions are very, very small in comparison to the production costs typically of a major studio. We've increased our margins, obviously, by distributing directly in places like the U.K., and as Steve talked about, you take a look at how our movies do on DVD, that's a significant part of our margin.

Remember that when you sell a DVD to one of the big retailers, the massive retailers, you're talking about selling it to them at wholesale price in excess of $17. Fully loaded, you're talking about a couple dollars including shipping and manufacturing of that DVD. So obviously, that's a significant margin built into the product.

We sort of reverse engineered looking back at our theatrical slate. I'm talking about even the predecessor companies, Trimark, Artisan, Lions Gate, and back into what our margin is. We're comfortable at that 19% margin business.

You know, I'd like to add, we're historically in that range. So we're not really changing anything, and actually, as I just mentioned, by doing film funds and the kind of creative financing as well as service deals, we really feel that's a pretty conservative number.

And Barton? We're not going to let you off the hook. We're going to make you ask a question about working capital.

I was getting there, but I just want to be clear. So you guys aren't prepared to give us some type of benchmark of P&A as a percent of theatrical revenues or participation in residuals as a percentage of overall revenues?

Steve gave a pretty specific numbers about DVDs, Jim can [inaudible] on this call, you want to go through participations and residuals? We'll do that individually. You can certainly call Jim on that.

But as far as our wide releases, our wide releases I think it's fair to assume we're going to spend between 17 and $22 million typically, and we're talking about, call that nine times a year. Platform releases will be 2 or $3 million and then as the movie starts to work, we'll spend more money like a "Monster's Ball."

Okay. Great. And then --

For participations and amortization, I tend to look at those two numbers together because depending if I bought it or made it and it's been running 45, 48%, in that range, you might continue to see that on a go-forward basis.

Okay. Great.

And then on the working capital, can you give us a some sense of mechanically, what is implicit in your cash flow guidance for 85 million for this year, what's going to happen on the working capital lines to get us there?

Sure.

Obviously, you brought that up earlier in one of your reports. One of the largest swing components of our working capital is obviously our current payables, which you can see from our financials increased to $185 million from $151 million last quarter.

The two primary contributors of the increase were $13.4 million related to the RedBus acquisition, which in fact were their accounts payable and deferred income taxes and marketing expense for In the Mix, which we paid in January.

Working capital, as you know, it obviously rises and falls, especially as we increase the number and the occasional concentration of our wide releases over the year, but it's important to note that we expect our current payable component from working capital to shrink by $20 million by the end of the year.

Okay, good. Thank you very much.

Our next question is from the line of Gordon Hodge with Thomas Weisel Partners. Please go ahead.

Good morning, Gordon.

Good morning. A couple of questions.

I may have this in my old notes, but I'm just curious if you can give us a sense for what percentage of your home video business is made up of family entertainment, new releases and the direct-to-video?

And then when you went through your 2007 slate, you left a couple of films out that I think we have expected, one is, at least yeah expecting is "Punisher 2". I'm curious if that is still on the slate, and then hearing about a movie called "Employee of the Month," which sounds interesting, not sure if that's included in the plans for '07 or if that's later.

And then last question, as you went through the '07 sort of outlook in general, you didn't mention any syndication revenues from "Dead Zone." I'm just curious if that's something we should be looking for as well? Thanks.

Hi, Gordon, this is Steve. I'll deal with the question in home entertainment.

New release family home entertainment and direct-to-video both relatively minor portions of our overall home entertainment income. New release family home entertainment is expected to be approximately $40 million this year and new release direct-to-video is $30 million this year in revenue.

Okay. That's for fiscal '06?

We're starting to shoot "Employee of the Month" in about two weeks in New Mexico, our new favorite home, and it stars Ben Cook. I think he's the most downloaded comedian right now on iTunes.

Jessica Simpson, Zach Shepard, we would love to get it into the next fiscal year. That really just depends on delivery, but we're extremely high on that movie.

"Punisher 2", we're waiting for the next draft of the script. That will not be in the fiscal release schedule.

And "Dead Zone," station syndication will be in '07 and we're still working on the cable plan, which could be in the fiscal year.

Great. Thank you.

And we have a question from the line of Tom Eagan with Oppenheimer. Please go ahead.

Good morning, Tom.

I was hoping you could give us a little bit more color on "Hostel," and I realize you can't give details of the deal, but if you could give us some sense of what we may be expecting for the contribution to EBITDA and free cash flow from the title.

Secondly, on the Horror Channel, wondering is this more likely to be a basic channel or an On-Demand channel? And is it likely that Lions Gate will be on the hook for any cash to produce it or a partner?

And then thirdly, just to kind of continue the conversation about working capital, seemed to me that film obligations was a source of free cash flow in fiscal '06, maybe 50, 60 million or so. It looks as though that would be less likely to be less a source of cash flow in '07. If you could talk about that. Thanks.

Jim wants to address that.

Sure.

The film obligations of even sort of last call, as you've seen, actually my film obligation line went from in the last quarter 205 to 211 this quarter. The increase of 6 million between last quarter and this quarter is entirely due to the purchase of RedBus, so holding constant. I would anticipate as films perform, that that film obligation line item may remain at this level.

I've said before, I don't know that I see it going up significantly, but I don't notice it going down significantly. I anticipate the film obligation line to remain fairly constant throughout the year as films continue to perform with, you know, we like having participation liability for "Saw," "Diary," "Crash." We hope to continue to have profitable movies that have large participations.

The answer to your Horror Channel is what my expectation would be is, you know, when we talked about channel, really we keep talking about a platform programming that exists across all of the platforms, so I would see a linear component that almost serves as a barker channel for the broadband and subscription site, and we are having a number of different conversations with a number of different partners which will affect what our contribution is, but I think ultimately, our contribution to that channel on a cash basis will be quite low.

What was your first question?

It was on maybe a little bit more color on "Hostel" that I know you can't give us details of the deal, but how much 'Hostel" may contribute to cash flow and free cash flow?

I think both cash and free cash will probably be between 17 and $20 million.

Okay. Thank you.

And we have a question from the line of Alan Gould with Natexis Bleichroeder. Please go ahead.

Good morning, Alan.

Good morning. How are you guys doing?

First for Steve, can you give us more of a breakdown of that 450 to 500 million of video revenue? You gave us the new releases from family home entertainment and direct-to-video, but I mean how much is coming from new theatrical, how much is coming from TBD-to-DVDs, how much is coming from catalog?

I can breakdown most of it, I think. Of the 450 to 500 this year DVD-to-DVD portion is going to be approximately between 170, $180 million of catalog revenue.

As I mentioned, new release family is 40, new release direct-to-video was 30. Theatrical is about 200, TBD-to-DVD is a relatively small portion, around 20, between 20 and 25.

Okay.

And then Michael, if you could quickly take us, you went to that 100 million of free cash flow fairly quickly. Can you just take us through that again, starting with the 114 million of margin from the new releases down to the 100 million of free cash flow?

Sure.

If you take, the biggest component, obviously, if you take a look at our overhead, our overhead is $65 million and our net interest cost, taking in all the converted interest payments minus whatever our cash balance is, it's about $10 million. So if we're going to do $100 million in free cash flow, Alan, you're talking about that we have to cover our overhead and our interest costs, we got to come up with $175 million in margin.

Right.

So if you look at our theatrical releases doing $300 million at the box office, and frankly, in 18 theatrical releases, we're certainly hopeful that can happen. $300 million, and again, this is all based upon the premise that all of it happens in the same fiscal year.

Sure.

You take $300 million of box office, when you add up all the ancillaries, that should equate to around $600 million of revenue.

Okay.

Our business on that revenue, which is in our film business, is 19%.

Okay.

So you take that 19% times 600, you're going to see is 100-plus million dollars.

Sure.

Then you add in the direct-to-video business, which is 5 to $10 million of profit, then our TV business, call it between 10 and $15 million. Then you add in our library, take a base case of a 20% margin, which as Steve talked about, we're hopeful that that's going to sort of uptick, but you take a base case of 20% on $200 million in revenue added to library, that's another $40 million.

So that gives you a rough understanding, I hope, of what it is that we have to do to maintain that $100 million.

Okay.

And obviously, as you are releasing the same number and same quality of films year in and year out, that sort of smooths out what falls in one year versus what falls in another year?

Absolutely.

Okay. Thank you very much.

And we'll go to the line of Matthew Harrigan. If there are any additional questions or comments, please press star one.

I'll see if I can be a little less muddled than last time.

When Michael talked about the tail basically filling in for the reality that you're not generating the full operating profit on a given year's releases in that year, are you pretty much going to be steady state in fiscal 2007 in terms of filling in the gap from the tail or would you expect that to ramp up even further in the following year, you know, given that the realities of creating cash flow out of your release pipeline and the realities of the gap film accounting?

And then secondly, probably for Jon, when you look at the video game business right now, there's tremendous disruption from the console cycle. When you're clearly overindexing very nicely on the DVD side still, but when you step back and look at the entire industry, do you think there's going to be further disruptions when Blu-ray and HD-DVD actually hit the market in terms of just kind of jostling everyone around a little bit more?

A good question.

I think steady state is a funny word, but I would say that our P&A actually has stabilized, and given both the fund that we're looking at, as well as the service deals we've talked about, I would assume that the P&A next year will be essentially steady state. It could even actually go down from this year.

Couple that with what I talked about before, which is converting our contingent receivable 70 to 80% as opposed to the impact, the possible impact of our margin on the films of only being 20% or so in a year. I think actually, it's exactly what you're saying, which is we're filling in the gap creating a steady state and model from the film business.

In terms of the video game reference, I guess you could say it's true, as you look at their business that they're at an infection point as well where they're moving into a new platform and don't have the replacement revenues as we've talked about before. I do believe that these replacement revenues, now that they've started, I think everyone's jumping on board. I think it's going to move a lot faster than people thought.

I think this year we're looking at with replacement revenues of 5% of our business is going to be in Blu-ray high-def as well as VOD, and that's starting to be a significant number, and the one thing that is quite different from the video game business to ours is that the problem that they're going to have and they're having is that the development and production of new games for the new platforms for them are as much as 2, 2.5 times more expensive than their current platform, where ours isn't going to affect our development production or P&A at all.

So I think we're reaching an extremely exciting times, and we are the biggest pure-play content company out there. We're about to announce eight or nine different deals with different distribution partners, so while I think there is some similarity of the video game business, I think it's quite different.

You're certainly the fastest moving content company out there.

Thank you.

Our next question is from the line of Michael Kelman with Susquehanna Financial. Please go ahead.

Great. Thanks.

Given your recent sale of the studio lot and your expressed interest in monetizing non-core assets in order to focus on your core operations, could you maybe talk about what other assets you may consider to be non-core, specifically would your equity stake in Image Entertainment and minority interest in CinemaNow fall into this category?

And lastly, with respect to your disc shares, are there any restrictions regarding your sale of those shares in the open market if you decide to dispose of those?

Well, the answer to that last question, Michael, is no. We own common stock, but we'd obviously have to, because we file the 13-D, we'd obviously have to make the appropriate filings if in fact we decided to dispose of that, those shares.

I would say we don't view disc as non-strategic, but I will say certainly we do not intend to let our cash sit there for a long time.

CinemaNow, I think, CinemaNow is really at a critical inflection point. There's a lot of activity there, there's a lot of strategic possibilities there, and I would say under any circumstance, CinemaNow will not look the same a year from now as it does today.

Great. Thanks guys.

We have time for one final question today and it will come from the line of David Miller with Sanders Morris Harris. Please go ahead.

Just a follow-up based on your prepared remarks at the beginning of the call. I just wanted to make sure I heard correctly.

You said that projects in fiscal '06 could yield as much as 87 million in EBITDA in fiscal '07. I just want to make sure that didn't include television, number one.

And number two, that 87 million, of course, just gets chipped away slightly by whatever you guys decide the P&A budget is for fiscal '07. Am I thinking about it in the right way?

Um, no.

Okay.

We did not talk about an estimate for our new release business at all, so P&A isn't relevant to that conversation. The number I actually mentioned was $80 million. But again, what I would say, obviously, the P&A and how much we commit to it, and I know you have some sensitivity to that, clearly is what determines whether our new release slate is profitable or negative, and I would say what we're aiming for, I'm prepared to say, what we're aiming for next year is a breakeven new release schedule.

In that fiscal year.

Within the fiscal year. We're not looking to make a lot of money. Obviously, if it's more successful, if there's a real hit, don't forget, "Saw" is a hit, but we don't control as much of the back end as we normally would and would like to going forward, but if we can just breakeven on our slate, we will have a very successful year.

Got you. Okay, thank you very much.

Thank you all for joining us. I look forward to our next call.

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