Starz Entertainment Corp (STRZ) 2007 Q2 法說會逐字稿

Welcome to the fiscal 2007 second quarter analyst conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Peter Wilkes, Senior Vice President of Investor Relations. Please go ahead.

Thank you for joining us this morning. Jon Feltheimer, our CEO will begin with opening remarks. We'll then open the call to questions from our analysts. The 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 those described in the forward-looking statements as a result of various important factors including risk factors set forth in lines in the 10-K filed with the SEC on June 14, 2006. The Company undertakes no information to publicly release the results of any revisions of these forward-looking statements that may be made to reflect any future events or circumstances. Jon?

Good morning, everyone. Thank you for joining us for our Q2 earnings conference. I have with me our Lions Gate path today, Michael Burns our Vice Chairman; Steve Beeks, our President; Jim Keegan, our Chief Financial Officer; and Rick Prell, our Chief Accounting Officer. What we're going to talk about today is the performance and quite frankly overperformance of our core businesses and several exciting new developments. This past quarter was one of continued growth for Lions Gate and it reflects three of our most important goals, investing in our product and business for the future, maintaining a healthy balance sheet, and continuing to throw off substantial, sustainable free cash flow as we continue to invest and grow. I'll touch on our balance sheet first and then talk about our ongoing investments and how we see them paying off down the road financially and strategically.

On October 15, we called the $60 million 4 and 7/8% convert which will save us $2.9 million in interest expense annually and will reduce our subdebt from 385 million to $325 million which will have a fixed blended coupon rate of 3.31%. Therefore, at the close of the quarter with $200 million in cash on hand and no corporate bank debt, we are generating interest income from our available cash that is about equal to the interest expense we're paying on our debt. We believe that our balance sheet is in the best shape it's ever been. Our challenge, of course, is to maintain a balance sheet of this quality at the same time we continue to invest substantially in the growth and expansion of our business. I'm confident we can continue to meet this challenge. Part of meeting the challenge is continued generation of strong free cash flow. In this quarter, we threw off $24 million in positive free cash flow. As you know, our free cash flow swings substantially from quarter to quarter, but this certainly puts us within the range of our annualized free cash flow running rate.

Let's look at some of the drivers of that free cash flow. The very strong box office performance of Saw III caps a run of four straight wide releases that have outperformed our internal expectations and will each generate a substantial return on investment. We are looking to keep that level of success going with the next three wide releases that will round out our fiscal year. Our first family entertainment theatrical release, Happily Never After on January 5. The next film in our highly successful franchise, Tyler Perry's Daddy'S Little Girls on Valentine's Day and the inspirational drama Pride starring Academy Award nominee Terrence Howard and Bernie Mac on March 23.

As you know, we're not trying to hit the ball out of the park with our films. We continue to look for exactly the kind of releases we've been doing releases. Films like Crank, Employee of the Month, and the Descent. Which will each do 25 to $30 million at the North American box office. As we showed in our slides at the Merrill Lynch conference recently illustrating the business model for Crank, these types of films can generate very significant profits and over a 50% return on investment at those box office levels.

While our profitable film model doesn't demand being number one at the box office, when we do get a number one $33 million opening weekend with a film like Saw III, we'll obviously take it. It's particularly significant in the context of our growth into new markets that Saw III was number one and grossed $8 million in its first week at the U.K. box office distributed through Lions Gate U.K. In addition to the U.K., Saw III opened at number one in Brazil, Argentina, Romania and other territories including Australia, a territory that we're exploring for self-distribution at this moment. To be more specific, Simon Franks, the architect of the red bus growth strategy is moving to Australia to create our Australian Felt distribution plan with further announcements to be forthcoming. One year after our investment in the acquisition of red bus, the U.K. film and video distribution company and its full integration into our operations as Lions Gate U.K. is proving to be a very successful growth business for us. We expect that Saw III alone will generate approximately $2 million more in ultimate value through our self-distribution in the U.K.

However, the flipside is that as we measure long-term value creation against short-term profitability, releasing our slate in the U.K. will, as it does with our domestic slate generate a short-term loss as we expense our P&A. An example of this would be Employee of the Month where we will experience a 2 to $3 million negative swing in this fiscal year from its U.K. release. However, we are creating value in the long run.

In terms of investing in growth, next year's slate has more self-produced films, more wide releases, and more star-driven vehicles. It also has some incrementally higher production budgets, but we are balancing all of this and mitigating risk by taking equity partners and creating production subsidies and various financial structures. As a result, we believe that we're going to be able to grow our slate in a disciplined manner and still maintain and even grow our margins. Our slate coming together for fiscal 2008 reflects this approach with the action film Rogue starring Jet Li and Jason Statham. Our next big team comedy, Good Luck, Chuck, starring Dane Cook and Jessica Alba. Hostel II which just finished shooting in Iceland will be wrapping production in Prague. 3:10 to Yuma from Relativity, the remake of a classic western starring Russell Crowe and Christian Bail, directed by James Mangold and currently shooting in New Mexico. A remake of the Japanese hit horror film The Eye from Cruise/Wagner.

The next film in our Larry the Cable Guy Franchise, Delta Farce. The Condemned, starring Stone Cold Steve Austin from our WWE partners. Bug, the psychological horror film from director Billy Friedcan starring Ashley Judd. Two big family entertainment films, the live action Bratz, a franchise we just announced and I will be discussing more in a moment and Food fight. And the next film in our Saw franchise, Saw IV from our Partners Mark Berg and Orrin Coolis as well as the fourth film in our Tyler Perry franchise, as well as several films such as Trade and Away from Her. Our lineup really has a look of a major studio slate except for the budget and it's exactly the franchise driven portfolio approach that Michael and I have been planning for the past six and a half years. In fact, in addition to our three big franchises, Saw, Tyler Perry, and Hostel, we're in discussions to move forward now on Punisher II as well.

We have two or three significant events to talk about in television. As you know, we have invested in our largest slate of new programming ever with 12 prime time television series. This slate is significantly backloaded and although the numbers are clearly evident in our record filmed entertainment backlog, you'll see the majority of our television revenue coming in during the back half of the fiscal year. We just received a fourth season renewal of Wildfire from ABC family, a remarkably early renewal for a season whose third season doesn't even start until January, giving us enough episodes now for syndication and a back end. We're finalizing the third season pick up of Weeds and when you look at DVD sales and iPod downloads, we think there is significant second cycle potential for Weeds making it our first television series with real hit value on the back end.

Speaking of syndication, perhaps the most significant news coming out of our television business is our investment in the acquisition of Debar Mercury in July. Within a month of that acquisition, we announced Tyler Perry's House of Pain television series for first run syndication and this one series alone could generate between 100 and $200 million in syndication revenues over the next few years, helping to drive the continued growth of our television business, which already contributes one-fourth of our positive free cash flow. In addition, Debar Mercury has just concluded a deal to syndicate Family Feud with Free Mantle Entertainment. Giving Debar with Tyler Perry, South Park, Dead Zone, Far Scape, the revolution film packages and now Family Feud, one of the great portfolios of distribution rights in the syndication business. As we projected, our home entertainment business continues to be strong and our library is on track to again generate in excess of $200 million in annual revenue, with improving P&L contribution margins due to better inhouse product mix and our sharpened focus on repromotions of key library titles.

We just announced that we will release the third of our successful Marvel direct to video titles, Ironman in January 2007 following on the footsteps of the strong performances of Ultimate Avengers I and II. But the big news for our family home entertainment business today is our announcement that we're creating a new home for Bratz in filmed entertainment. We're partnering with a leading consumer products entertainment company MGA Entertainment to release three animated direct to DVD features in North America with the first title in the series Bratz Fashion Pixies slated for release in spring 2007. We're partnering with producers Abi Arad, Steven Paul, and MGA Entertainment to also launch the first live action feature film based on the Bratz characters, which will begin shooting in February of 2007 and which we will distribute in the U.S. next summer. Our Bratz deal reflects our continuing investment in brands that bring long-term value.

While we continue to distribute the existing Barbie library titles, we have been looking for a brand to replace the new releases. In Bratz, not only have we found a growing, exciting, and popular new brand, but anticipate significantly higher margins on our Bratz titles than we generated on Barbie. Another significant area in which we're investing this year is FEARNet, our branded horror channel with partners Comcast and Sony. We just signed our contracts and FEARNet may be officially released to the media as early as today, although most of you are already aware of its Halloween launch. Since that launch, the results are even better than we expected. FEARNet has become the third most watched VoD site on Comcast. It achieved 3.2 million views in its first few days surpassing our goals for the first month. FEARNet.com has immediately become the number one horror destination, again, surpassing our monthly goals in uniques and page views in one week with 1 million plus page views and 400,000 video views.

In terms of how FEARNet fits into the financial plan for fiscal 2007, as you know, we've be in lengthy conversations with Comcast and Sony about FEARNet and we obviously didn't know when and whether the deal was going to close. We're thrilled that it has as well as with our early results, as I just mentioned. We believe this initiative will drive very high returns over time. We are one-third equity participant in the deal, which means we'll be incurring one-third of the expenses associated with the launch over the next two to three years. While it's too early to put precise numbers on it for this year, we do believe that we'll be expensing in the low to mid-single digit $1 million range this year. We expect that when we report next quarter, we'll have better clarity on the specific FEARNet number, including revenue we will be receiving from our Comcast licensing agreement that will offset a portion of this loss. What we can tell you now is that if not for FEARNet and some non-cash items, mainly stock option expenses tied to long-term contract renewals, we would likely be raising our guidance for all of our metrics at this time.

As I stated at the beginning of my remarks, our challenge is to balance our investment in new businesses that will create long-term value, generate long-term profits, and establish the foundation for long-term growth and consistent, sustainable free cash flow year in and year out against quarter to quarter results in the short-term. We will refine our guidance on the next call when our picture slate should be set for the year and we will have more information on two potential slate financings that should have a positive impact on our free cash flow numbers for this year. I'm now pleased to open the call to your questions.

[OPERATOR INSTRUCTIONS] Our first question is from Lowell Singer, please go ahead.

Thanks. Good morning. I have a couple questions for you. First, the EBITDA or earnings number was below the consensus estimate for the quarter and I'm sensing there is some timing issues there. Can you talk a little about what that might have been? And second, on FEARNet, can you give us an update -- I know you've launched it as a VOD channel. Where are you in your discussions with cable and satellite operators about potentially launching it as a vertical channel. And you sort of mentioned attractive long-term returns. Can you be more specific on what you think this venture could add over time? Thanks.

Why don't I start with FEARNet. We certainly are working right now on a plan that could create a linear component with our partners, but what's exciting about this and where the business is going is the business certainly has changed and if you look at the performance of Sprout on VoD in terms of Comcast, very, very successful right now, particularly in terms of the advertising. So we built a model really with VoD as far as we're concerned is linear programming that's just time shifted and creating opportunity for consumers they didn't have before digital. We believe we can make a very successful business out of it without a linear component. As a matter of fact, what'scurrently in the plan with a ten-time residual value after the tenth year, I believe it's a 28% return on investment is what we are looking at, but we do continue to -- we do continue to look at the possibility of a linear plan for both satellite, cable, as well as teleco potential partners. Jim, would you drill down a little on the numbers?

Sure. Lowell, in this quarter, we incurred approximately $17 million of prints and advertising costs associated with Employee of the month and Saw III that are incurred prior to the actual release, so that created a straight to the bottom line net income expense.

As you know, Lowell, timing is one of the reasons we don't go quarter to quarter in terms of guidance.

Can I just -- really two quick follow-ups. First, the FEARNet business plan, does that assume just a VoD channel?

The current business plan we have assumes VoD and Internet.

And Internet, okay. And one other quick question. You talked about Happily Never After I think that's a CG film. Obviously that space has become more competitive over the last couple of years. What's your exposure to that film, what sort of outlook do you have internally for that film in the marketplace?

Well, we have said numerous times when we launch our family films that we're going to do it with a Lions Gate model, not a typical studio model. And we think there's great opportunity in between these huge blockbuster animated movies to do pictures that are much smaller budget or that we have much less exposure. Happily Never After is a film that we have virtually no exposure going in. We didn't pay for the production, we put a small amount of finishing funds into as well as possibly a small amount of the P&A, but most of the P&A and almost all of the production has been paid for by somebody else. We would be delighted with Hoodwinked level of performance, but honestly anything in the 15 to $20 million total box office range for that picture would be extremely profitable for us.

Thanks a lot.

Okay.

Thank you. Our next question is from Michael Savner, please go ahead.

Thanks. I actually just want to follow-up on Lowell's question for just a second on the P&A spending in the quarter. As we look into the end of the year, and the movies coming out in January, I think Hostel and Happily Never After coming after. Would you assume that a lot of that benefit from Employee of the Month and Saw is it then going to flow through to this quarter? Because you seem comfortable with the guidance that's out there. That would seem to imply there's going to be a big pretax income and EBITDA boost in the third and fourth quarter to get you to that guidance. Conceptually, I guess that makes sense, but I just want to make sure we're thinking about it correctly. And then Felt, just one quick follow-up, I think one of your last prepared comments about FEARNet and some spending that wasn't going to be offset, I'm sorry, I missed part of that. Could you just tell us what spending, that couple million dollars you were talking about? I would appreciate it. Thanks.

First of all, Hostel is not in the fiscal year. Hostel may have been earlier in the year, but I'm not really sure. It's moved out, we actually moved Tyler Perry into the fiscal year, interestingly enough. That will probably be about a $9 million hit in the year, but we're overperforming in all of our other divisions and all of our other motion pictures, so that will be made up. You're exactly right, the performance for the rest of the year in terms of motion pictures should be very strong and be able to make up for the preexpensing, if you will of that P&A. I didn't quite get your question about FEARNet. I didn't get what you missed.

Actually I want to clarify, I wasn't talking about the fiscal year, I was talking about the fiscal third quarter. Are we going to see a pickup in EBITDA in the fiscal third quarter benefiting from the expensing of some of the P&A on Employee of the Month and Saw, so we should see a big recovery in EBITDA in the fiscal third quarter. I wasn't talking about the year. The last one, your prepared comments at the very end you said there were a couple million dollars, I thought you said associated with FEARNet, but we can go offline if I miss heard.

The answer is yes, there will be a pickup or benefit from that in the third quarter and what I believe I said is we're expecting low to mid-single digits expensing from FEARNet, but we have to refine that number. as well. Part of our deal is licensing for their VoD as well as for the channel itself and there's a question of timing when that will come in as an offset. So that's where the refining guidance for next quarter will come from.

Got it. Thanks very much.

You're welcome.

Thank you. Our next question is from Tom Eagan. Please go ahead.

Thank you. If you already mentioned this, apologies, but on Saw III, will the home video revenue, will that all come in in Q4 or will some of that come in Q1 of '08? And then secondly, might we -- when might we see some of the TV syndication revenue? Might we see that in Q4 of this year?

This is Steve Beeks, on the Saw III revenue, the home entertainment revenue will come in Q4 -- a portion of it will be in Q4 and a portion of it will be in Q1 and some of it will dribble out into Q2 of the next fiscal year.

In terms of TV, TV syndication for shows like Dead Zone that will be fiscal '08. All of the Tyler Perry revenues that I talked about and most of the Debar revenues and profitability will begin next year. Debar will probably do over $50 million of revenue in fiscal 2008, taking what we expect TV revenues to be, over $200 million. But almost all of that -- this year, actually, we'll probably take a small integration charge on Debar-Mercury, but going forward, it looks to be very profitable and as I said, loss of revenue coming in starting in '08.

Thanks.

You're welcome.

Thank you. Our next question is from Jolanta Masojada. Go ahead.

Could you talk about the expectations for the investment in film and TV programs for the remainder of the year? You had a reasonable increase during the quarter. And secondly, can you talk about how the longevity of the Saw franchise is working out, and do you think there will be a change in the cost structure of future sequels?

I'll answer Saw and then I'll turn it over to Jim to drill down on the investment of film. Obviously this is an unusual franchise. Typically you might budget 20% off each franchise until it becomes direct to video. Instead, the producers, Mark Berg and Orrin Coolis is working with us here at Lions Gate, particularly Peter Block, our head of co-productions and acquisitions and Jason Constantine have done really an amazing job and we're still hoping that Saw III will hit the Saw II numbers, which were up some 20 odd percent from Saw I. So I think unlike many franchises, this one is really appealing to the audience. We keep growing it, we keep improving the production, but in terms of Part B of your question, other than royalties and participation paid to our participants, the actual overall production from Saw II to Saw III went up very slightly and we don't expect really any further acceleration of that. What I think part of what's going on here, not only is the quality of Saw continuing and production values improving with great directors like Darren Bousman, but I think we have become a staple on Halloween. That's very unusual. So we have two brands going, one is Saw and the other is Saw on Halloween. That's where we're going to be again next year, which again is very difficult for these producers and our team to get these ready and have the quality that they have, but we will be there again next Halloween. Jim, do you want to drill down on investment and film and television?

Sure. You indicated our investment in film and television for the first six months of both years, 157 last year,164 this year. So we're somewhat tracking similarly. But what I would anticipate for the end of the year on net cash out, where last year was actually net cash out of the 285 increased investment in film, we also had some liabilities where we hadn't paid the cash. 200 million went out last year, I would anticipate this year on that same methodology of approximately 200 million this year.

Okay.

Our next question is from Gordon Hodge. Please go ahead.

Yes, good morning. Just wondering, Steve, if you could give us a sense of what the library sales were in the quarter and then pricing trends. That would be great. And then I think you mentioned that the -- if I heard correctly, the Dead Zone syndication revenue was not likely to fall this year, but next. I just want to confirm that. And also curious on the -- didn't look like you shipped any Dead Zone episodes this quarter. Just curious if we should expect that in the future? Thanks.

We're not giving you the actual number, our library sales are up year to year the first half of the year. That's obviously a good sign. In terms of wholesale prices, our overall wholesale average prices have increased. As a matter of fact, on new theatrical releases, we recently increased our wholesale price by just about $0.50, which is a testament to the strength of our product in the marketplace. And even in terms of the deep catalog, while there had been a trend downward in our average wholesale price, it has stabilized over the last few quarters.

On Dead Zone?

Dead Zone, there will definitely be more episodes, but they will hit next fiscal year.

Got it. Thanks.

Thank you. Our next question is from Barton Crockett. Please go ahead.

Okay, great. Thank you very much. Let me see. A couple of questions, if I could. One is on the backlog, which went up. I was wondering if you could give us a bit of a breakdown so we can understand better the margin implications of this between some of the lower margin stuff, like the TV production and some of the higher margin stuff like TV syndication or TV rights or international presale. That's one question. The other thing is. If you could just take through us an explanation of the variance between the EBITDA loss of about 12 million and the free cash flow profit of 24 million, what drove that disparity. Thank you.

Sure. First of all, on the backlog, approximately $80 million of our $247 million of backlog is from the TV product. So for the rest is from the motion picture division. So that will give you some sort of idea between the blends between the margins that will come off of that. Secondarily, looking at the difference between the free cash flow and EBITDA, I guess I'd like to point out that our profit for our motion picture division is up this year, actually for the first six months negative $15 million for motion pictures last year. We're now positive $11 million this year. Our divisions were performing.

Does that answer your question? Or do you want Jim to drill down more on the free cash flow?

Doesn't really get at it. If you could drill down on it more, that would be great.

Let's go. If you look at my loss of $14 million and adjust that for the non-cash amortization items, like primarily investment in film you'll come down to a $38 million positive number, as you add back the amortization. We invested this quarter in films approximately 66 million, money going into Crank, Saw III, Daddy's Little Girl, Weeds that's actual cashout. Cost me 66 million. The flip side, then you have the changes of the working capital contributing about 55 million, primarily coming from increases in accounts payable with costs associated with titles, unreleased titles and AP for Employee of the Month and Saw III, increases in deferred revenue of about 13.9 coming from Wild Fire, Crank, and Assault Mall, a decrease in AR of about 6.6 million which generated more free cash flow. Those are actually the components that will drive the free cash flow numbers.

Okay, great. That's helpful. Thank you.

Thank you. And our next question is from David Miller. Please go ahead.

Hi. A couple question. Steve Beeks, if you're on the call, you didn't mention the library-oriented number, but can you talk about how library-oriented free cash flow margins came in in the quarter? And are you pleased with the improvement there year over year? And then Felt in the television business, in this year's fiscal Q2, what percentage of the eleven new series began airing episodes in the quarter? And then I have a follow-up, thanks.

David, our library revenue in the first half of the year, revenue contributions, P&L margin, and the free cash flow generated by the library are all up compared year to year in the first six months. So, yes, we are satisfied with those -- with the results in the first half of the year and as John mentioned before, we're on track to hit 200 million and generate and hit our projection of $70 million plus in free cash flow for the full year coming out of the library.

In terms of airing, David, I'd have to go back and look at the list. As you know, most of the new series we talked about are all back loaded into third and fourth quarter, and when we deliver, it's not when we air it that we report, it's when we deliver. So I'd have to go back over the new show we're doing with Mr. T. hit this past, well, this past month. I'm not even sure that's in the quarter -- the deliveries would have been in the quarter. You asked about airing--.

You could do delivery, if you have the delivery number, that would be great, too. Do you happen to have a delivery number, in terms of what percentage were delivered?

Episodes delivered?

Yes.

We'll have to do that offline with you.

That's fine. And then just a quick follow-up Fel, I just want to make sure I heard you correctly, you're reiterating all guidance benchmarks for the year, but you're reserving the right to guide up next quarter when you just have a better sense of the economic contribution from FEARNet, I just want to make sure I heard you correctly?

No, I don't think I said it that way. What I laid out is that we will be -- given that we closed the deal now, that we will most likely be taking a loss in the fiscal year that's unbudgeted. For FEARNet, what we're still trying to figure out is what that is and how much mitigation we have against the licensing money and when that will come in. Overall, I would say the commitment that we have to FEARNet is around -- over the next three years is around $13 million or so. That's our commitment to fund over the next two or three years. In terms of overall licensing deal with Comcast, we'll come to probably a number larger than that. There may be some opportunity costs attached to that, but again, a tremendous amount of that investment will be mitigated by incremental licensing. So what I said is that we are definitely overperforming in our core business and our plan is to try to make up any non-cash, nonrecurring, or unbudgeted mostly FEARNet losses through that overperformance, but it's just too early to forecast.

Okay, great. Thanks very much.

Thank you. [OPERATOR INSTRUCTIONS] Our next question is from Alan Gould.

Good morning, thank you. I've got two questions. First, following up on FEARNet, when you're talking about licensing, I expect you're talking about licensing your movies on to the channel. Do you expect it to be dollars per movie or a piece of the VoD advertising stream or Internet advertising stream that those movies are generating now that that's trackable. And second question is with respect to TV, Jon, can you give us any preliminary thoughts what the off network syndication revenues per episode could be for a Weeds, for a Wild Fire, for a Dead Zone or any of your other promising series?

Yes. In terms of FEARNet, actually, there's two components to what we're doing with Comcast. One's a licensing agreement with the channel and that's not on a speculative basis there's a firm number per year for five years for that, it's not based upon advertising, and there's a second component which we're still working out with them licensing for their other VoD platforms, so those are the two components, but there'll be firm numbers attached, not speculative based upon ratings or advertising or views. And the second is the numbers are very wide disparity of cable to cable syndication for something that's just a moderate performer could be as low as 50 to $100,000 and I honestly belove if Weeds continues the way it's going and is the kind of hit that Sopranos or Sex In the City are you could easily be talking about well over $0.5 million an episode.

Thank You.

Our next question is from Eric Handler.

Two questions. One, can you give us a sense what your digital revenue was for the quarter? Meaning digital downloads from any of the VoD platforms across the Internet, and how that compares to the prior two quarters? And then also, Steve, can you give us a sense of your G&A going forward. Are you kind of returning to a normalized, let's say, $15 million level or should we look for 20 million plus over the next couple of quarters?

In terms of the digital question, Eric, at last count, we're in various stages of discussion, active negotiation or actually in business with 29 entities that are either now or will be engaged in digital delivery of some sort. As we mentioned before, we have great deals now with Cinema Now, MovieLink, and Amazon and probably two or three more deals announced in the next few weeks. The revenues on our titles from all of the retailers currently in the business are up quarter to quarter. And iTunes, for example, revenue downloads is up 35% from the prior quarter and part of that, of course, fueled somewhat by the fact the second season is on air. Revenue from Cinema Now is up over 100%. A significant amount of that growth is coming from their download to burn capability. We're now providing them with select titles for download to burn on a day and date basis with the release of the film on DVD I think that's going to spur their business on. The first film for which we allowed day and date delivery was an American Haunting which we released two weeks ago. We mentioned in the past, we project digital delivery, including electronic sell-through of VoD and downloads burn to account for approximately 10 to 15% or more of the home entertainment market by the year 2010. Virtually all of this business will not only be accretive but will also result in overall growth and home entertainment pie and will also be at much higher margins when you compare it to packaged media due to the lower cost of the supply chain.

Great.

I'll take the overhead question. You've seen the overhead number go up. We've had a couple of increases with the LG UK, in Denmark, that will help a slight increase, but the real increase you'll see is coming from our stock appreciation rights, stocks option expense, and SARS expense. Those items are now flowing through at a fairly high level. You might see a slight uptick from those non-cash stock appreciation option expenses.

Great, thank you.

Thank you. Our next question is from Andy Nasr. Please go ahead.

What kind of numbers do you need to see at FEARNet before you contemplate a linear offering, and I was wondering if you could tell us how many upcoming wide releases are included in the MGM production obligations portion of film obligations and how you see that number changing over time? And my last question, is that is it safe to say that TV margins will kick up in fiscal 2008 due to the Debar contribution and syndication revenues?

Jim, why don't you go first?

What I what I envision happening in the MG portion of the film obligation that the net cashout for the year will be the same, but it's possible -- okay, I do not anticipate the participation obligation varying much year to year, I see that as fairly constant. And I see the MG and other portion, it actually could go up within the year, but the offset to that is the increase investment in film. So it's somewhat cash neutral. I've put a liability on the books there until the film is delivered and if actually not, I don't pay for it. But I put it on the books. So MGs may go up, but actual cash out will remain constant.

In terms of FEARNet, we already have been working on a linear plan and that plan going forward is not really contingent upon numbers. When you said number, if you mean the success on VoD or on broadband. It's more contingent upon a business model that we all feel, the three partners feel make sense and that really will be all about weather direct TV and EchoStar and the telecos and mostly Time Warner all believe and agree that this is an exciting venture for linear, not just VoD. Again, our deal with Comcast mirrors a typical linear channel in the sense of subscriber fees after a short free period and so we believe we have a very, very successful economic model without a linear channel. In terms of TV margins, I think two things are happening--one is, obviously as we move to with Wild Fire, with Weeds, with Dead Zone, a syndicatable number of episodes, our margins are going to improve as we increase the ultimate -- or even add an ultimate where we don't have one for the back end. And the second thing is, if TV's been typically around a 10% margin business, Debar's numbers probably will look closer to 20%. So if we add 50% plus revenue, I can pretty much assure you that our overall TV margins will be going up.

Great, thank you.

Thank you. Our next question is from David Bank. Please go ahead.

Thanks. Good morning. I guess a little follow-up on the free cash flow reconciliation. If you could drill down -- what we've got for the quarter is the sort of net combined impact of payables, receivables, and deferred revenues of 55 million. Jim, could you -- I know you gave us a little bit of color on it, but particularly the payables number is contributing about $34 million of free cash in a quarter where total free cash is 24 million. Could you tell us how the payable number is sort of likely -- are we going to see that kind of decline in the next quarter or can you give us a little bit of sense on payables and deferred revenue for maybe the next quarter or two? And the second question is, we were -- for us we were a little light on the theatrical, the TV contribution in theatrical. Part of what you guys sited in the press release was the strength of Lord of War and the mix in particular aside from Saw II and Waiting. And I thought those movies weren't particularly blowaway box office movies. So what was it -- why were they such big drivers on the TV theatrical side?

First, I'll address your accounts payable question. If you go back to the same quarter comparable last year, because we don't do comparative balance sheets, AP September '05, was 151.3 we're obviously 159.4. AP in December went up to 187 of last year. I might anticipate a similar flow of AP this year to last year. So I would actually anticipate possibly a growth in the AP and then it held constant at that level. March '06 was 188.8. I could see AP continuing to grow. It's really due to the timing of the releases and the P&A expense. The second note, please take note of the large backlog number we have. We'll have lots of cash coming in generated from that backlog. The backlog, as I indicated before is like 80 million TV. The balance is obviously coming from motion picture. The motion picture backlog primarily from the show time revenues. That will come in in large lump sum cash sums.

You're saying the AP could conceivably continue to contribute similar levels to the cash flow statement, but the backlog starts to generate additional cash?

I'm actually saying we were hurt by AP alone, I'm saying AP year to year will probably end up about the same place March 31, '06 to March 31, '07.

If I understood the other question, and Jim, correct me if I'm wrong, but as we've said numerous times before, it's interesting that in the short run losses, failed pictures or what we call NRVs hurt us much more than the success actually helps us in the short run. So with the pictures you talked about in terms of In the Mix, we wrote off In the Mix previously so then as we get revenue in down the road, obviously, it becomes very profitable revenue for us. And actually, Lord of War, people focused so much on the box office. Lord of War is a very, very profitable picture for us, very high return on investment, very profitable picture because it's performed so significantly in terms of home video.

But that's true on the profit line, but I thought you guys got paid as a function of a multiple of the box office. So that's why I just -- you know -- you said strong theatrical titles, was there a revenue outperformance versus what you would have expected given the box office--?

Yes, yes, that's actually right.

Okay.

Our conversion rate is something we talk about a lot. Our overall conversion rate right now is about 1.19 compared to studios at about 1.05. And if you continue to see the mix of product that we have, we are very focused on that over conversion. Because as I said before, we're not trying to win the box office race every single weekend. And Steve, what is the -- what is the final conversion rate on Lord of War?

Lord of War converted approximately 180%, 182% when you compare DVD revenue to box office. Very high performance. And actually Waiting, the other picture that you mentioned, will approach the same number. So huge overperformance on both of those pictures.

Yes. I remember when Jim Kramer was excoreating us for changing our business model by doing Lord of War because we paid a little bit more, and it was true, we did pay a little bit more for the MG, the minimum guarantee than we had typically paid before, but again there was a method to our madness. We knew -- we had examined the record of Nick Cage at video and his conversion is extremely high. This was not unanticipated of us. This was kind of an expectation of ours. We performed slightly lower at the box office than we expected, but a really pretty much the way we expected in terms of the conversion rate in video.

Okay. Thanks for the explanation, guys.

You're welcome.

Thank you. Our next question is from Matthew Harrigan. Please go ahead.

Can you talk a little bit about the perspective equity partners you may be taking on some of the inhouse production? I assume you're retaining complete autonomy on the market decisions and such because your template for the business is different than other people's. I assume it's probably more, I don't want to say hedge funds, but people other than other studios. And secondly, I know it's harder to move the numbers now that you're a much larger company, but I assume that some of that is implicit commentary that the festival business is just really tough now, so many people competing for films and you're looking for a little bit more kick internally.

Okay. The words in the entertainment business, complete autonomy, that doesn't play because we -- well we treat our producers and all of our creative partners as partners in the marketing. But, yes, I don't believe we have any deals where we just stand by and let the money sort of dictate what we do in terms of marketing. We've got a deal, for example, that was recently announced with Sam Nazirian, who's delivering a number of pictures, including Pride for us. The deal is all very -- some pay for part of the equity, all of the equity, some pay for part of the P&A, and some pay for actually all of the P&A. So each deal is differently, but essentially we do maintain the control of the marketing and there are -- we mentioned, we mentioned at the end of my remarks that we have been exploring some very interesting slate financing deals that include both equity and P&A and I hope to be able to discuss very shortly some of those with you. In terms of the festivals, I'll let Michael answer that.

Hey, Matthew. With all the influx of money whether it be hedge funds or slate financing or private equity coming in, that's the good news for us. It's important to note, when we go to a festival and it wasn't this way about six or seven years ago, we are invited into every negotiation for every picture. And remember, that when you look at a festival like Sundance with over 6 or 7,000 pictures submitted for consideration, where maybe they will pick 80 pictures and then 10 of those pictures you'll hear of, five of those will go on to do box office. What I'll tell you, it's the usual suspects that are invited into bid for those pictures and we've had great success, frankly because of our track record and our reputation for not overspending and actually having back ends for the profit participants. So that's turned out to be a great competitive advantage for us.

I'm already a FEARNet user, so congratulations on that.

Thank you.

Thank you. Our next question is from Michael Kelman. Please go ahead.

Thanks. Hi. Could you talk a little bit about your intentions with the image entertainment stake now that the Board meeting has been completed? And then, also on a similar front, clearly you've demonstrated an appetite for doing these small tuck-in acquisitions like Red Bus and Debar-Mercury. Can you talk about other areas you may have interest in that could help round out your portfolio of assets?

It's Michael, I'll take the image stake. We didn't win the proxy battle, although I thought that as far as the unaffiliated voters that we were pleased with the percentage that we received. We still have our image stake. We're consistently evaluating what to do with that. And all can I say in very specific answer is to stay tuned there.

In terms of other investments or areas that we're looking at, as I said today, one thing that we're mostly likely going to do is self-distribute in Australia. It was always part of the plan, English speaking makes a lot of sense to us. We're sending a great entrepreneur over there, Simon Franks to work on it, we're already well ahead with our plans there and I think that's going to be an exciting new expansion into another market for us. We're looking at some interesting PD assets. Again, one of the things that we did over the last three years was build a diversification of our free cash flow of our revenues from television. It's a business I know pretty well. Don't be surprised if you see us playing in that area as well, and numerous other things including, we're always look for great library and we're always looking for great partnerships.

Great. Thank you.

You're welcome.

We have time for one more question. We'll go to the line of David Joyce.

Can you just help us think about the home video drivers for the next quarter and through the rest of the year in terms of the timing of some of the bigger pictures that would feed into that. Some other notable direct to DVD?

Sure, this is Steve Beeks, Mike. Over the next couple of quarters, the films that John mentioned before will be coming to DVD. The descent will be released on December 26. And then in the final quarter in Q4 we'll be releasing Crank, Employee of the Month, and Saw III. The biggest direct to video, direct to DVD release in the fourth quarter will be Ironman which is the third in the Marvel franchise. The first two have been successful beyond our expectations and we expect the same kind of success with Ironman. Those are the bigger releases coming up for the next few months.

All right, thank you.

Thank you, everybody. We'll see you next quarter.

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