Starz Entertainment Corp (STRZ) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing and welcome to the fiscal 2007 third-quarter analyst conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session; instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder this conference is being recorded.

I would now like to turn the conference over to your host, Senior Vice President of Investor Relations, Mr. Peter Wilkes. Please go ahead.

Good morning. Welcome to our analyst call. We will begin with remarks from Jon Feltheimer, our CEO; Vice Chairman, Michael Burns; and President Steve Beeks. Jim Keegan, our CFO and [Rick Krouse], our Chief Accounting Officer, are also on the call.

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 as set forth in our Form 10-K filed with the Securities and Exchange Commission on June 14, 2006. The company undertakes no obligation to publicly release the result of any revisions to these forward-looking statements that may be made to reflect any future events or circumstances.

I will now turn the call over to Jon.

Thank you, Peter, and thank you all for joining us this morning. I'm pleased that our financial performance and the results we released Friday for our third quarter continue to reflect the effectiveness of our business operations and the strength of our strategy. Our strong performance in all metrics should continue into the fourth quarter and we expect that we will exceed our guidance for the full year's results.

We are therefore raising our numbers for revenue and free cash flow respectively to $950 million and $100 million. This performance is also reflected on our balance sheet with a continued strong cash position and growing backlog.

Let's look at some highlights from our recent performance and then Michael will bring you up-to-date on our film slate and Steve will comment on our packaged goods and digital strategy. I'm pleased that as I look at the growth story in terms for our contingent receivables or backlog as well as international revenues to see the contribution from two of this year's strategic acquisitions, Debmar-Mercury and Redbus.

With the acquisition of the distribution rights to Family Feud as well as the rollouts of Tyler Perry's House Of Pain, Debmar-Mercury led by Mort Marcus and Ira Bernstein will be adding significant revenues to Lions Gate next year with strong margins improving the overall margin of the television business at the same time. We expect television revenues next year to be over $200 million.

The recent releases of Employee of the Month and Saw III are proving out our strategy for self distribution in key territories as a way to grow value. While we expected a strong result from Saw III, its performance exceeded that of Saw I and II. But Employee of the Month's performance compared to expectation was significantly higher than we forecast. In the long run we expect to earn millions of dollars more from just these two titles than we would have selling them off to a third-party distributor.

We will continue to look at other key territories as we are doing currently in Australia when we have the right partners, the right assets and the right business strategy. We see international expansion as a logical growth opportunity given our significant content pipeline.

On the verge of true measurable results for the digital and new format exploitation of our product, I'm pleased that our traditional distribution channels continue to perform. We are reporting year-to-date library sales from home entertainment international and television of $185 million, meaning we will far exceed our $200 million forecast.

Steve will talk about this later but not only are we concentrating on mining our library but our performance of first-run DVD product continues to outperform the industry in terms of dollars and dollar conversion rates from theatrical to home video revenue.

Television continues to be a strong performer where Kevin Beggs and Sandra Stern and their 16-man and woman division have almost one on-air series per person. The Dresden Files recently premiered to very solid numbers for the Sci Fi Network; 8.5 million viewers have already seen the first episode and we received our first scripted pilot order from a broadcast network and are negotiating for a second.

But the big news for us in television is still Weeds which is not only a hit for Showtime but has been downloaded over 600,000 times and also shipped over 400,000 box sets. We are already being pursued by networks for the back-end strip rights as well because Weeds will be a signature show for some network after its Showtime runs.

This quarter reflects the continued strong performance of our feature film business. Michael will take you through what we have coming in the future. Michael?

Thanks. We recently signed our President of Production, Mike Paseornek to a new four-year contract. Mike is truly the hardest working man in show business. Why that is a bit ironic is when we first came to Lions Gate seven years ago, Mike said he wasn't sure we'd make enough movies to keep him busy. It's fair to say that is no longer his current thinking.

I'm going to quickly go through our in-house production and release schedule to give you a glimpse of what is on deck for us. Finished films include, Daddy's Little Girls, the new feature film from Lions Gate; Favorite Son Tyler Perry comes out wide this Wednesday for Valentine's Day. We have Pride based on the true story of Jim Ellis, an inner city swim coach who took a bunch of misfit kids and turned them into national swimming champions starring Bernie Mac and Crash's Terence Howard, another wide release on March 23rd; Ray Liota, LL Cool J and Mekhi Phifer, Slow Burn comes out on April 13.

The Condemned which makes Survivor look like the Sound of Music starring Stone Cold Steve Austin will be in wide release on April 27th. Sarah Polley's direct hurdle debut and Sundance Darling away from her which we believe will be a serious 2007 award contender for us stars Julie Christie and opens May 5th.

The comic superstars of the Blue Collar Comedy Tour will storm theaters on May 11th in the armed forces comedy, Delta Farce. The Exorcist's Billy Friekin will get under everyone's skin with his new film Bugs starring Ashley Judd crawling into theaters nationwide on May 25th. Eli Roth's eagerly awaited sequel to gore fest Hostel arrives May 8th -- my late mother would be really proud.

Later that same month, the lighthearted horror flick, Fido, currently in Berlin, will fetch audiences on May 15th. Trade, again premiered at Sundance, a provocative thriller about human trafficking starring Kevin Kline, will see wide release this August. The huge success of the Brass Dolls will be brought to the screen when the highly anticipated animated film brass sees theatrical release later this summer. The sex romp comedy, Good Luck Chuck, starring Dane Cook and Jessica Alba will be heating up summer screens on August 24th.

Jet Lee and Jason Statham are set to strike the box office when Rogue is released in September. Jessica Alba will again grace theaters for Lions Gate later this year when she stars in the supernatural horror picture, The Eye, currently shooting in New Mexico.

Continuing our smash hit franchise with Twisted Pictures, we are quite optimistic Salt IV will once again own Halloween. Sisters Hillary and Haylie Duff with a star-studded cast of animated film, Food Fight, which arrive from the Isles on November 16th. Additionally, we are very excited about our releasing Abandoned, Captivity, Fierce People and Skin Walkers as part of our previously announced partnership with After Dark Films.

Anticipated featured Greenlight Productions include two new Tyler Perry films, Why Did I Get Married and Jazzman Blues along with a Bernie Mac concert film, Punisher 2, Bachelor 2, Zane's Addicted, Midnight Meat Train, a coproduction of the follow-up to Crank with our friends at Lakeshore, a new Rambo and Ayan Rand's Atlas Shrugged. All in all the most exciting slate in our history.

While theatrical box office results certainly get the glory, home entertainment, digital and our robust library sales remain are often unheralded star performers. Steve Beeks will talk about all. Steve?

Thank you, Michael. Fiscal '07 has been a year that has demonstrated the continued health of the home entertainment business and has introduced new technologies that will help drive our future growth. There's definitely a rising tide in home entertainment. Results of standard definition DVD continue to be strong, high-definition DVD is starting to generate real revenue. VOD is becoming an even more important component of the picture and electronic sell-through is gaining traction.

Our theatrical titles continue to over convert in terms of box office to DVD revenues. In Q3 we released three significant theatrical titles to DVD, American Haunting, See No Evil and The Descent, together shipping almost 5 million units.

As I mentioned, packaged media is still very healthy. We finished out the calendar year with a DVD market share of 5.2% and maintained the highest box office to DVD revenue conversion rate in the industry for all live-action features over the past two years with a conversion rate of 1.1 to 1 versus the industry average of 0.97.

Our titles have also performed well in the DVD rental market. In fact, Lord of War was the number -- was the overall number eight DVD rental in all of 2006. This $24 million box office picture outperformed many, many pictures with far greater box office.

January, while not part of Q3 is worth mentioning since we had a very big month in home entertainment. We released four significant DVDs and shipped a total of almost 12 million units during the month, more than in any month in the company's history. Crank, Employee of the Month, Saw III and the Invincible Ironman, our third direct to DVD animated feature with Marvel, together shipped 7.5 million units. Each of the six theatrical titles I mentioned will over index in box office to DVD revenue and Crank should convert at a ratio of over 150%.

We've also had a very healthy sell-through rate on each of the seven titles I mentioned. Last week Lions Gate titles occupied six of the top 20 slots on the DVD sales charts including Crank, Employee of the Month, Saw III and Iron Man, which held the number three slot, as well as Saw I and Saw II, promotions for which were piggybacked on the campaign for Saw III.

We continue, as we mention every quarter, to focus on maximizing revenue generated by our library. As John mentioned we will well exceed our projection of $200 million in revenue from the library and over $75 million in free cash flow.

There are several examples in Q3 of our continuing strategy of rereleasing special edition DVDs drawn from the library including Saw II; Reservoir Dog's 15th anniversary; The Punisher, Extended Cut; the Van Wilder, Van Gone Wilder edition; and the Doors' 15th anniversary edition. We also continue to focus on special periodic promotions for the library throughout the year.

High-definition packs to media is becoming a real revenue generator for the library as well as for new release titles. There are now five Blue-ray hardware players in the market including the PS-3 and seven studios are now actively releasing product in the Blue-ray format. Blue-ray software sales have now overtaken HD DVD sales by a wide margin outselling the latter format by a 2 to 1 ratio in January.

Starting with The Descent on December 26th, we've begun our release strategy of Blue-ray releases for all our theatrical films, day and date with standard DVD. Saw III set the industry record for the first week sales of Blue-ray on its release and as a matter fact we have two of their top four titles in that category and have an 11% market share in Blue-ray software sales since inception. So far we've released 18 titles in Blue-ray and plan to have as many as 40 to 50 titles in release by the end of the calendar year.

It's worth reminding that the wholesale prices and therefore margins for Blue-ray releases are substantially higher than for standard definition. The current wholesale price for new released titles is over $23 and over $18 for library. With the rapidly expanding number of big players getting into digital delivery, it is now positioned to become a real contributor to revenue growth for home entertainment.

We now have fully launched electronic sell-through in broadband VOD deals with CinemaNow; Movielink; Amazon, which just announced an enhancement in their surge through a partnership with TiVo; Fox Interactive Media's Direct to Drive; Xbox Live; NetFlix, which is now rolling out their broadband VOD service and Wal-Mart.com. And as of midnight last night, Lions Gate is the third studio to launch electronic sell-through of our library on iTunes. There are already a handful of our titles available this morning on the iTunes store site and we will be adding many more films over the coming days and months.

Given the success Apple has had selling library films and iTunes since its launch, we are confident that this new relationship will generate meaningful and incremental revenue from our ever expanding library.

Our VOD business overall is showing significant growth year-on-year with consumers embracing the choice and control that they can exercise in terms of consuming film entertainment in their home. We anticipate at least 25% growth in our VOD and pay-per-view revenue this fiscal year.

As some of you know we are participating in a two market test with Comcast and other studios in which we are offering a few films for VOD on a day and day basis with the DVD release. While it is still early and all of the data is not yet in, the initial results indicate this could be the win-win situation for which we were hoping. The take rate for VOD buys has been significantly above what we would normally see during the standard VOD window. And so far we have seen virtually no cannibalization of the expected sales rate of the DVD and very little impact on rentals in the test markets compared with the control markets.

We are not indicating a change on our sequential windowing strategy and we will be very sensitive to our conventional retail and rental partners but these very early results are an encouraging sign that we might well be able to expand the size of the revenue pie.

All signs in home entertainment are good; their strength in standard definition DVD, we have had a very healthy start to Blue-ray high-definition DVD. Our VOD business is growing rapidly and digital distribution is poised to provide a meaningful source of incremental revenue. The landscape looks very bright for continued growth in the overall home entertainment market.

Thank you, Steve. We have previously characterized digital and new format revenues as just the tip of the iceberg but we're starting to realize how big that iceberg might be. Of the 29 digital vendor deals we discussed on our last call, nine deals are already active, five are fully executed contracts pending launch and the rest are still in process.

Our bet on continent continues to pay off. As we look at the media landscape, billions of dollars are being invested around the world in new platforms, mobile, broadband, fiber satellite and its being spent to deliver content, on demand or subscription, pay-per-view or advertiser supported and Lions Gate keeps investing in that content creating more and more titles, adding over 200 film video and television titles this year to complement the thousands of titles we currently distribute. And while we invest we remain profitable and keep generating cash.

As I said earlier, we expect to exceed our guidance in terms of revenue and free cash flow. We have added some unbudgeted mostly non-cash charges to the new stock and option grants as well as investment in FEARnet. However, we believe the performance of our operating units will always to absorb those charges and still meet our pretax income guidance and on an adjusted basis significantly outperform that metric as well.

I appreciate your attention this morning and welcome the questions.

(OPERATOR INSTRUCTIONS) Lowell Singer from Cowen & Company.

Good morning. A couple of questions. Felt, can you talk a little bit about FEARnet and where you are so far? What you've seen and what the investment is going to be over the next couple of years in that?

Second on the television side, can you give us a roadmap for the big items that you have coming on the revenue side over the next let's call it 15 months, the end of this fiscal year into fiscal '08?

And then finally, Jim, can you address -- Felt said you were okay on meeting to pretax net income number with some of these adjustments, but you'll outperform it after the adjustment -- or prior to the adjustments. Can you talk about what those adjustments are? Thanks.

Thanks, Lowell. In terms of FEARnet, performance wise ahead of all metrics. I think we've announced previously over the first three years or so it will probably be about a $13.5 million charge. This year we took about $1.5 million in charges that we expensed. So we are basically on plan, ahead of plan in terms of all of the audience metrics and basically on plan financially.

And one thing I would add to that is that it is interesting that in the last few months over 40% of the free television On-Demand views from the consumer on all of Comcast On-Demand has been for FEARnet which is really interesting. What it shows is when you aggregate in brand content, people know where to find it and how to find it and the usage goes up tremendously.

In terms of television, when you look at the backlog its interesting we mentioned that a big part of the increase of the backlog came from Debmar-Mercury; the performance of the television business plus Debmar should lead us to as I say revenues over $200 million and the margins improving on a blended rate to over 15% or so. I think that is a pretty good sense of where TV is going.

And in regards to the unusual items, the real unusual items are what Jon referred to in terms of the new accounting rules that relate to stock option grants. For instance, in the third quarter we have -- of last year we had a benefit as we mark-to-marketed the stock option expense of $2.2 million, while in the third quarter this year we had a charge of $3.2 million. The new accounting rules, FAS 123(R), require that you use a fair value for all Sars and all stock options, which was not the case. It was intrinsic value on the Sars last year. So that is creating an anomaly.

Jim, what will the fiscal '07 impact be of that change?

Currently I'm at about an $8.6 million charge. I guess I will annualize that another $300,000, maybe 9, $10 million.

For the full year. Okay, thanks a lot.

Jolanta Masojada from Credit Suisse. Her line has disconnected. David Miller from Sanders Morris.

Good morning, gentlemen. A couple of questions. Michael, you may be somewhat hamstrung from talking about it because I don't get the sense the deal has closed but on the film fund, at least conceptually can you talk about whether or not you guys are negotiating some sort of call option whereby you can buy back the film slate? It just doesn't seem like you guys to not own the films. If you could just clarify that for us just conceptually that would be great. And then I have a follow-up. Thanks.

Theoretically speaking it is typical and many of or most of those film funds for the distributor to have an option to call back the copyrights of the film. So again, that is a theoretical answer for you and obviously we are currently evaluating all of our strategic alternatives lowering our cost of capital. But we're not talking specifically about a slate fund today.

Okay, and then Felt, on Redbus what is the decision-making process internally over there at Lions Gate with regard to which product you push through Redbus? Is it as simple as the Saws, the Hostels, the franchise oriented stuff that you think is going to play well to a UK audience? Do you push that through Redbus or is the decision-making process more complicated than that? Thanks.

Well, it's basically our intention to put everything that we have in the UK through Redbus. The acquisition is not only looking very smart in terms of maximizing the value of the content we put through but also in terms of the way we acquire product.

When we acquired for example 3:10 to Yuma, we were able to make that deal. It's a very exciting project. The dailies look great. This is the Western that we're doing with Russell Crowe and Christian Bale, James Mangold directing. It is a serious, serious package. We were able to make the deal because we bought four territories including the UK in addition to our domestic rights. And so the ability to acquire and be competitive with the major studios acquiring more than just the domestic theatrical rights or domestic distribution rights is an important part of the decision to go forward and expand our sales distribution.

Funny enough even the smaller movies will probably get a better return. Those are a lot of the movies that typically in some sales to third party distributors internationally it's difficult to make those sales. And we believe because we have the ability not only to do domestic -- I mean UK theatrical distribution but home video distribution, pay television, free television, we can maximize the value of all of our product.

Super. Thank you very much.

Michael Savner from Banc of America.

Good morning. Thanks very much. Two questions if I could. First, can you maybe just kind of detail quantitatively the new guidance where the upside is coming from if it is one or two areas specifically because certainly still think there is a lot of good things going on. But as we look at the new revenue and specifically the new free cash flow number where the bulk of that incremental cash flow is coming from would be helpful?

Second, I apologize if you'd already mentioned it. But the announcement this morning that your films are going to be available via iTunes, can you then update us on your strategy for CinemaNow? Obviously the products are not apples to apples but certainly it could signal that maybe you are backing away from that project to some degree? So maybe comments on both of those would be helpful. Thanks.

The great thing about the digital world and the way we approach our business is that we want to have just as in the retail space, we want multiple buyers of our product. It is very exciting to have companies like Apple and Wal-Mart get into the digital space because frankly these big players are going to help organize the digital space. But in no way does this imply backing away from more if you will self-owned distribution capabilities that we have.

In terms of your first question, I think probably most of the upside overall from our numbers is coming from the contribution from our theatrical slate from this year and last year. And obviously the benefit of the performance from this year's theatrical should extend into next year as well.

Great. Thanks. And maybe just one follow-up then on the first one. Did this agreement with iTunes result or has there been any near-term change to your wholesale pricing with people like Wal-Mart or has everything been status quo?

I will let Steve answer that question.

Thanks.

Mike, as we mentioned earlier we are currently selling library titles at iTunes and it will not impact our pricing strategy at all in the marketplace.

Thank you very much.

Jolanta Masojada from Credit Suisse.

Thanks very much and sorry if I'm repeating any question, I just dropped off the line for a moment. I wondered if firstly you could give us the details of your free cash flow expectations in the fourth quarter specifically the continued investments in TV and film production and your expectation from amortization?

And then just taken beyond the television business, with the visibility you now have into the fourth quarter, what is your expectation for the number of episodes you will be delivering?

In terms of the investment in film and television programming, we've been running pretty steady. The way I look at your investment on film and television programming I take the increase in film and television programming and I net against that the increase in film obligations. And you're going to see that if you track for the full year running 54, $55 million a quarter, I would anticipate that same level of spend in Q4.

In terms of television, we don't have the number of episodes. We can follow up with you off-line. Television overall we will be delivering some of the series that might have had earlier. Kill Pitt for Spike Mad Men won't deliver until '08. So we will be a little bit light overall on television for the year maybe about $10 million light revenue wise but in terms of profitability and free cash flow we're going to hit the internal targets that we started with. As I say we can follow up with you on exactly which episodes will hit in the fourth quarter.

Thanks very much.

Gordon Hodge from Thomas Weisel Partners.

Good morning. Just a couple of things. Just curious if you could comment about film slate financing, status, is it done and what -- maybe how is it structured if you can comment at this point? And then also on the Comcast VOD, just curious how long do you anticipate that test taking before you reach any firm conclusions? It sounds like you have some early feedback that is positive. But when do you call that a wrap? Thanks.

Gordon, Michael answered a question on the overall financings that we're looking at. We really can't comment specifically on the film slate financing. And Steve you could take the other question.

Gordon, onto the Comcast day and day tests, (technical difficulty) but I would imagine over the next few weeks we will have a pretty good idea of the impact. And then we've got to regroup and figure out what that means and what that means for whatever future tact we're going to take.

Okay and then sorry last question. I think you mentioned, did you say that you shipped 12 million DVD units in just the month of January?

Yes.

Terrific. Pinkie.

Jeff Logsdon from BMO Capital.

Felt, what kind of competition are you experiencing at the film shows? I know it has always been competitive -- Weinstein, are they being more active? And then kind of as a follow-on, as you look at fiscal '08, what is the mix between self-produced and acquired product?

As we've grown the company, we continue to want to have more and more self produced content for a number of reasons. To start with, we want to own more and more of our movies. So as we grow we want to have more upside from our projects. The second thing is as we develop more and more sequels, franchises -- we obviously again not only want to own more of them but we also have the confidence in their performance. So when you look at Tyler Perry and you look at Saw and you look at Punisher and you look at Hostel, obviously these are all projects that we will self produce. So the blend is definitely going more towards self-produced, co-produced kinds of projects.

I'll take the next one. Jeff, it's Michael. As far as the acquisitions, when we send our acquisition team to the various festivals Sundance, Toronto, Caans, it is usually the same five or six potential buyers; buyers of choice for the producers and the sales agents of those films. While I will say that if Sundance has 5000 films that are submitted and maybe they pick 100 and you hear of 10 and two or three do business, I would say that every one of those negotiations for the hotly contested films were certainly one of the five or six players at that table.

Harvey has certainly reemerged and we've seen him. We actually just teamed up with him on an acquisition out of Sundance. But as far as the breadth of choices for us, that is not limited whatsoever.

Great. Thanks.

Tom Eagan from Oppenheimer & Co.

Thank you. I guess two quick questions. First on P&A spending, you're at about $130 million plus nine months in. Might you still hit the 150 million guidance for the year? And then secondly, if you could talk maybe more probably about your relationship with Comcast. They are being very aggressive with video on-demand and creating all sorts of new programming. Is it possible you could expand your current relationship with the Internet?

I will take number two. We actually just came back from Philadelphia last week. We are tremendously enjoying our relationship with Comcast. Steve, I think, was trying to be very clear about not talking about these results till they're all codified, but I will say that the initial results are I think very, very, very positive. And I think that as we look at all of our businesses, as we look at our paid television business, as we look at every way that we window our product, I think Comcast is trying to get out in front of some of those discussions and being creative about it. And we actually think that being slightly more independent and perhaps more entrepreneurial, our ability to play with these windows perhaps is a little bit more than some others.

So Comcast is a perfect partner for us in a lot of different ways. We are looking at the results of our channel in order to decide whether there is perhaps some other channels to do with them. But the breadth of the conversations that we are having with Comcast are far greater than just should we do just one other channel. There's a lot of different things we can do together.

Jim, in terms of P&A, why don't you take that one?

Sure. We are still on track to be about $150 million of theatrical P&A for the year.

Great, thank you.

Barton Crockett from JPMorgan.

Great, thanks a lot. I wanted to ask a question about the free cash flow, and first putting by way of background I recognize you guys are doing a great job on many parts of your business, particularly on the TV side. But I still have some questions about the free cash flow, which still strikes me as noisy. I was wondering if you could answer the question this way perhaps.

If you look at the contributions to your free cash flow this year from working capital, it looks like that was north of $100 million, the way I calculate it, and I can go through that with you if you'd like. Additionally, growth in film obligation, excluding participations and residuals which I put in the working capital, has gone up -- has contributed about $65 million to free cash flow. Now I understand you guys have changed your model and there have been some positive benefits to working capital from that. I'm wondering when are these contributions going to start to level out? They should at some point level out and the free cash flow should be driven more by earnings as opposed to these changes in assets and liabilities.

Over this course of a year or two, one would expect these to level out. I'm just wondering when that should happen. So that would be the first question. And then the second question, turning to the TV side which as I highlighted at the beginning, seems like it's doing very well. Could you give us a little bit of detail on what you see in terms of syndication as a contributor to TV next year for your flagship series like Dead Zone and Weeds? And also an update on House of Pain and the contribution you see from that. Thank you.

I'll will take two first and then Jim can cover the free cash flow question. Television next year, fiscal '08 should see some syndication revenues from Dead Zone. The contribution from House of Pain will be as I say lumped into Debmar-Mercury but I think Debmar-Mercury should contribute between call it 60 and $80 million of revenue next year including Tyler Perry.

And Weeds, Weeds is only going into its third season so it is early for syndication revenue. But I will say we have significantly upped our home entertainment forecast for Weeds. And I anticipate by the time that we have done 50 episodes, I would anticipate we will be up to $400,000 or $500,000 an episode just from home entertainment revenue, DVD revenue from Weeds alone. And that is obviously coming in quarter-by-quarter as we ship.

Okay, I will take number one. Barton, talked about Q4, just looking at a high, high level if we're going to have $100 million of free cash flow and pretax net income of $32 million, you take that delta and it is about the same delta a little bit less than the delta we had at the end of Q3. What that means is the free cash flow benefit from working capital should be slightly down in Q4.

However, going onto the earlier part of the year we are and have received free cash flow benefits from working capital, large influxes from our AR, large AR in the last year that we collected. In addition, we've had some increases in deferred revenue. A lot of that will be reversing in my Q4 as I take that revenue for the TV in. But net net, yes, there has been an increase from that working capital, their normal operational and how the business will run as we continue to grow it.

Let me say it differently. Obviously the lines did cross this year. We're back to forecasting about $100 million of free cash flow and significantly higher pretax income then last year. The lines clearly did converge. However, as we continue to invest in companies which we amortize and that creates a larger variance between free cash flow and pretax income, as we continue to grow our overall business which means we are getting a little ahead by two quarters at all times of our participations. As the Company continues to grow there will continue to be a delta the way currently we report earnings.

Okay. I mean ahead for instance to the next fiscal year would you expect the delta to be less than it was this year?

As I say, it depends on the results of our business. It depends how we grow. It depends on whether or not we buy anything else. But in general the lines definitely are trending closer together.

Barton, it's Michael. The increased participations, that is the good news. That is because things are working.

Okay. No I understand that things are going. It's just at some point it should level out and I was just wondering when that might happen? But I guess it is hard to say at this point. Okay, great. Thanks a lot.

Alan Gould from Bleichroeder.

Thank you very much. I've got a few questions. First, Steve mentioned $75 million of library cash flow off of your north of $200 million of revenue. Is library margin going up from 25% to 30% or are you really surpassing that $200 million by a large amount?

And secondly, John had mentioned over $200 million of TV revenue last year and just the Debmar-Mercury revenue just mentioned. Do you recognize 100% of the syndication revenue and then subtract that of producer's fee so it comes in a lower margin? Or do you recognize just the syndication fee at a very high margin?

And then also, Jim, any idea what the tax rate will be for the fourth quarter and year?

And last thing, can you tell us a little bit about this Australian video company that you are bidding for?

That is a lot of questions. I'm trying to write quickly here, Alan.

Do you want to start with the library --?

On margins, you have to remember when we've talked about margin, we've never really talked about cash flow margin, we've always talked about P&L margin and the P&L metric. And so I think you're a little confused by that. So cash flow from the library over $75 million. On a P&L basis, we're probably only recognizing close to 21, 22%. So whatever that would be, 45, $50 million.

On the Debmar-Mercury, typically we recognize the revenue on a couple of instances where they are considered agent rather than distributor. We will only take the fee. Tax rate, I'm not qualified to answer. Jim?

Tax rate is going to be approximately 14.4% and that is coming a portion of it is from those utilization of the pre-acquisition NOLs.

Is that for the year or the quarter?

That is for the entire year.

And Michael is Irish so I will have to answer the Australian question.

We bid 100% for a company called Magna. And it's an English-speaking territory obviously in Australia and obviously through our success in the UK with Redbus, we think this is a chance for us to possibly self distribute and we like the assets of that company although we have several different alternatives if we don't go that way.

Also I want to point out that we have Simon Franks down there who started the UK -- started Redbus and quite an entrepreneur. So we are optimistic that Australia is going to be a good territory for us.

On House of Pain, are you acting as agent?

Distributor.

Distributor, thank you.

Eric Handler from Lehman Brothers.

Thank you very much. Guys, your cash balance is building up very nicely. At some point do you think about share buybacks?

And then secondly as your film slate grows next year, it seems like there's an increasing number of distribution only type deals. Could you just give me a sense of what is the balance that you are trying to go after in terms of self-produced films versus distribution only films?

As Michael said numerous times, we never would rule out stock buyback. We are continuing to aggressively move our company forward. We've talked about international opportunities. We like having the cash balances in order to move forward our growth strategy but we would definitely not rule out share buybacks.

In terms of the mix of product, typically we want to, as I said earlier, we want to own as much of our slate going forward as we can. However, we are balancing that out with as we grow the company trying to use our cash effectively. Typically what we are looking at is when we have distribution only deals that they would be larger movies where we would take less risk but still have significant revenue and margin opportunities.

And just as one quick follow-up, as far as the M&A market is going, are you seeing more deals coming on the market now both domestically and international than prior or how is that market looking right now?

I think it is fair to say that there are a lot of assets that turn over because of positions that private equity takes. So obviously they go through a cycle. That is the good news. The bad news is that in some businesses, private equity will pay a significantly higher multiple and one thing I think that at you've seen, Eric, over the last seven years that we are very disciplined buyers.

Thank you.

Andy Nasr from Raymond James.

Looking back over the last couple of quarters it looks like the increase and investment in film exceeded depreciation. Can we expect those numbers to balance out over the course of the next two quarters?

And my second question is, all else being equal looking out to next year if you assume TV revenues of $200 million and margins of 15%, it seems like that should have a significant impact on pretax profit and narrow the difference of free cash flow. Is that right?

Well again, in answer to the last question, we are narrowing and if operations continue with no significant change and no significant new investment, we are narrowing the lines between free cash flow and earnings.

Jim, in terms of investment in film and television, why don't you take that one?

I will take that. You are seeing that we are running fairly consistently, Q1, my investment in film and television programming take my investment in film and television programming less the increase in film obligations on $59 million; Q2, do that same calculation with $57 million; Q3, you're $54 million; Q4 as I said before, it should be about 55 -- in that same range. So that should remain fairly constant and just compare that against the amortization rates that you are seeing happen throughout -- fairly constant.

I don't know if that answers your question. But your investment is going remain constant and your amortization rates are going to remain at about 40% on your motion picture division and closer to 80% to 90% on the television division.

Thanks.

David Bank from RBC Capital Markets.

Good morning. We haven't moved to Scotland, we're still in Canada. A couple of questions I guess sort of first big picture. Guys, could you talk given the Magna bid and the Redbus acquisition, philosophically you guys have hedged your bets a lot by pretty selling international rights. Is your philosophy there changing or is it just kind of an English language country thing or do you see moving onto the continent at some point for distribution?

And the second question is much smaller picture, sorry, Jim. You guys have now started reporting a participation and residual line on the balance sheet as opposed to the footnote for film obligations where you used to do it and you have it on the cash flow statement which you never had before. Is there any change in accounting that is driving that? And can you give us the participation and residual numbers that would have been there for 1Q and 2Q '07?

The reason I actually broke it out in the regards like the way I answered the prior question, everybody started asking, you know, what is up with your investment in films? So I said in order to create more transparency I broke those two items out just trying to make your job easier. So as you then look at it, you're going to see that as you go back in time I will give even numbers, the film obligations only at the end of my Q2 was about approximately 166 and of my Q1 about 120. My participations -- again this is all in the footnotes, at the end of my Q1 was about 155, participations 151, 152 Q2 and to like 170 at the end of Q3.

But, Jim, what would they have been -- what would the cash flow entry numbers have been? Would we get the other ones from the footnote?

These are the same numbers out on the footnote so the cash flow deltas would just be the deltas between the two. For instance, if you look at the difference between Q1 and Q2, the 155 goes to 151. That would be on use of funds of 4 and than 151 to 170 to the use of funds of 19. I mean the source of funds of 19.

But -- so on the current cash flow the difference between the 170.7 and the 164.2, which is the balance sheet item, that would give you $6.4 million but the cash flow statement says $1 million.

That is because we purchased Debmar in the current year. So that added an increase to the film obligations that doesn't translate through.

Okay, because you purchased Debmar. Okay, guys. Sorry for the minutiae. Can you go (multiple speakers) 30,000 feet in the sky now?

In terms of international expansion, look, we have a huge team right now in Berlin and they are selling movies. We like that business. We like getting the cash in. We like minimizing our risk. But our job is to measure the minimizing risk for the growth of the company. So we are looking and continue to look at all different ways of expanding our footprint.

And so we're doing it judiciously. Redbus was a year ago. Australia will by the time we're up and running be at least I'm sure another six months or so. And we're not stubborn about it. If in Australia we can't put the model together in the right way, we will not self distribute. So it depends as I said in my remarks on what assets that we have, what partnerships we have and what the best strategy for each territory is in general, our business plan hasn't changed at all.

Thanks, guys.

Matthew Harrigan from Janco Partners.

I'm sorry, my voice is really hoarse. As a corollary on the international side, can you just -- you are over indexing on digital distribution and DVDs and such. And I know how well your product performs and the non-English territory is partly a function of how competent the people are that you sell the rights to in marketing. And obviously some product plays well in particular markets and some product doesn't. Do you have any sense for how your product over indexes or under indexes in a market like Germany or Spain or some of the major international markets? I apologize for the hiss at the beginning of my question.

I think that is actually a really interesting question. I think what you are saying is that the way that we focus on certain kinds of genre here allow us to over indexed in packaged media as well as in digital where you have a lot of early adopters and again the same kind of a young audience that we typically concentrate on. I think that is a really good question in terms of how it translates into the international market.

The answer is, some of it translates really well and actually some of it doesn't. The difficulty in certain territories would be horror stuff, in horror content is that it doesn't play as well on free television in certain markets. Teen comedies traditionally haven't performed as well and yet of course things change right now the results of Employee of the Month in the UK are really extraordinary. We're going to do about $7 million at the box office there. And I do believe that teen comedies will translate better.

But what the answer to that all is because it is not vague but it is impossible to pinpoint, the answer is that we are flexible about everything we do. So typically a major studio only self distributes. We look at all kinds of different deals in the territory. We look at basically three different things, one is obviously selling the product to an all rights buyer. The second is actually self-distributing. The third is what we will sometimes do and have done for example on Saw, we will do kind of a distribution deal without an advance where we participate to a greater extent in the returns.

So for example Disney is taking Saw III in certain territories. They are really doing a great job and we will share much more of the upside than typically if we had done an all rights third-party distribution deal with a big guarantee. So we have given ourselves a tremendous amount of flexibility in terms of dealing with how our product converts in international market.

Great, thank you.

Jeff Logsdon from BMO Capital.

My question has been answered. Thank you.

Thank you everybody. We will see you on our next call.

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