Brickell Biotech, Inc.
Q3 2007 Earnings Call Transcript

Published: 3 Nov 2007

[Operator:]

Welcometo the Blockbuster Incorporated 2007 third quarter earnings conferencecall. (Operator Instructions) I wouldnow like to turn the conference over to Mrs. Angelika Torres, Director ofInvestor Relations.

[Angelika Torres:]

Goodmorning and welcome to Blockbuster’sthird quarter earnings call. Today’searnings call may include forward-looking statements relating to our operationsand business outlook, financial and operational strategies and goals, and othermatters that do not strictly relate to historical or current facts. Actualresults may differ materially from those projected in the forward-lookingstatements. For additional informationregarding the forward-looking statements and factors that could cause actualresults to differ materially, please refer to the cautionary statements intoday’s earnings release and our public Securities and Exchange Commissionfilings, including our upcoming form 10-Q. Today’searnings call may also include discussion of certain non-GAAP financialmeasures. Please refer to today’searnings release for the required reconciliation to the most directlycomparable GAAP financial measures and other related disclosures. Our earnings release is available on ourwebsite at www.blockbuster.com under the link for investor relations. With that I will now turn the call over toJim Keyes, our Chief Executive Officer.

[James W. Keyes:]

Goodmorning. Today I will plan to discusssome of our strategic priorities that we outlined in the last call. We made a lot of progress on thosepriorities. Following that Tom Casey,our CFO, will cover the details of the financial results of the quarter, whichI believe you will agree, begin to show some progress toward improvingBlockbuster’s financial stability. I’dlike to take this opportunity, though, to once again welcome Tom to theteam. And you will be hearing more fromhim in a few minutes. Onour last earnings call, we highlighted a number of objectives for the first 100days of our transformation. We’re verypleased with the accomplishments across the broad range of areas, and one ofthe first priorities was the establishment of a new leadership team. We’re pleased with the development of thatteam including our newest member Eric Peterson, our general counsel; Tom Caseyour CFO, and two resources that I recruited from my old 7-Eleven team, DavePodeschi, our Senior Vice President of Merchandising and Logistics and KeithMorrow our CIO. This team has alreadyhit the ground running and is aggressively working on Blockbuster’stransformation. Whilebuilding a new management team we also completed a total reorganization andreduction of costs. There were manyopportunities as you can imagine for improving efficiency throughout theorganization, eliminating layers, flattening various organizations; for example we now have only three layers ofmanagement between the CEO and the store manager and additionally my directreports have increased from four to about twelve. Both moves designed to acceleratecommunications throughout the organization and to eliminate nonessential workand streamlining, which allowed for a reduction of over 400 positions and isexpected to produce $45 million in cost savings on an annualized basis. Thismorning’s press reported we plan on job cuts but I want to assure you thatnecessary actions to achieve the $45 million in savings have already beentaken. And as we bring more focus andmore technology to our business I do believe there will be further costreduction opportunities. We continue toexplore areas that we’re outsourcing, perhaps of certain functions could helpprovide both cost reduction and improved efficiency, and we’ll keep you updatedas we have further progress in that area. Anotherobjective in the first 100 days was to complete a thorough assessment of ourtechnology spending. As you know ouronline business has been the focus of aggressive new investment during the pastfew years. But before continuing on thatpath it was important to understand and thoroughly assess that strategicdirection. Thatassessment made us even more committed to Total Access and the competitiveadvantage that it provides by allowing us to marry the convenience of physicaldistribution through the stores with electronic distribution online. It has also caused us though to redefine theTotal Access program to better meet the convenience needs of all of ourcustomers. So accordingly, wemodified our approach to the online business. What had been an online model was really not a digital solutionpreviously; it was more of a competitive response to the demand for by-maildelivery of DVDs. In fact we creditNetflix with the development of that niche, but recognize that our pursuit ofby-mail subscribers was a bit over-zealous. Clearly our spending onthat one channel was exceeding our returns. So frankly we believe we fueled much of the growth in the by-marketchannel during the past three quarters by aggressively promoting Total Accesssubscriptions, and particularly promoting it in our stores. As a result we did achieve a significantboost in subscriber count but we attracted some of the most price-sensitive andthe heaviest consumption customers with our offer of free in-storeexchanges. Ouraggressive growth proved the competitive strength of Total Access but it alsodemonstrated the cost.Our objective must be profitable growth, and toward thatobjective we made two deliberate moves

[Thomas M. Casey:]

AsJim said our third quarter results demonstrate progress toward improvingBlockbuster’s financial stability. Before reviewing the specifics of our third quarter results, I wouldlike to first review our financial priorities. Sothe top financial stories for the quarter are the decisive actions we took toimprove online profitability, and implementation of a $45 million costreduction plan. In the first twoquarters of 2007 Blockbuster experienced significant declines in profitabilitydue to investment in Total Access. Theactions taken during the third quarter are reflected in a $47.3 millionincrease in rental gross profit from the second quarter of this year. AsJim said, the company’s emphasis is on growing the overall customer basethrough its stores, through the mail and eventually through digital delivery ofcontent. Going forward we willconcentrate and report on growth of our total membership. Asfor year-over-year comparison of results I’ll start with revenue. And the revenue story is best explained on asame-store sales basis because of the significant change to our store base. Since September 30, 2006, Blockbuster sold or closed 526 storesworldwide. Included in that 526 storenumber are 217 Gamestation stores sold in the U.K. for $150 million. That sale was consistent with our focus on improving domestic operationsand delevering. Currentlywe’re in the process of developing an overall asset management plan and as partof that, evaluating various new store formats as Jim said, as well as change inthe competitive landscape. We havedecided to limit additional store closures until we have that plan inplace. Soworldwide same-store sales increased 3.5% as strong growth in online rentalrevenue and international games retail outpaced declines in domestic in-storemovie rentals. Online revenue grew122.4% from $64.7 million to $143.9 million and now comprises 11.6% ofBlockbuster total revenue. Internationalretail comps increased 28.2% as a result of strong sales of games, particularlyHalo 3 inmany of our international markets. Ourgross profit decreased by approximately $76 million relative to the thirdquarter of 2006 and the key drivers of year-over-year change are as follows

[Operator:]

Your first question comesfrom Carla Casella – JP Morgan.

[Carla Casella:]

Goodmorning. I have a couple questionsrelated to the game side of the business. Third quarter was clearly strong because of Halo. I know that fourth quarter last year probablywas strong driven by the game boxes. Isthere any way looking to fourth quarter this year, we can try and segment outhow much of last year’s fourth quarter was the game boxes versus new software? And/or your outlook for new software for thisquarter?

[James W. Keyes:]

Weare in the position for the fourth quarter of trying to assess all of theelements of our in-store business, with gaming being one of the mostimportant. I can’t give you thebreakdown now, perhaps Angelika can work with you after the call to morespecifically answer the question about last year fourth quarter. But all I can tell you at this point for thefourth quarter, we will be looking at some opportunities that are differentfrom the past, relative to both equipment and games. But please keep in mind this is much more ofa transitionary quarter for us as we do more testing than we do rollout of anyparticular program.

[Carla Casella:]

Okay. And then on the freein-store exchanges, that $29 million this quarter, was that after changing thepricing structure or should we see that number continue to come down?

[James W. Keyes:]

Thatnumber probably will continue to change. Remember we put the pricing changes in place during the quarter and sothere was a bit of a trend of fact as a result. So you will see continued change.

[Carla Casella:]

Okay. And then just two store-related questions

[James W. Keyes:]

Wehave seen some overlap. I’d say probablythe majority of the closings that we’ve seen have been in a direct overlapsituation. So of course there is somebenefit there. In terms of our storeopenings or closings we are again stepping back and reassessing that assetplan. You won’t see much change for thenext couple of quarters in our openings or closings as we try to work with thisnew approach that we’re taking to the asset and try to get as much learnings asquickly as we can about what we can do to transform the store. Inother words, basically we’ve been closing stores on the basis of purely EBITDAresults on a per store basis. The waywe’re looking at the stores going forward is more a question of dirt strengthand does that store represent incremental opportunity with the differentbusiness approach that we are going to take. So you will see still some lease expiration action and things likethat. But as far as a proactive plan toclose additional poor performers, we’re going to step back for a bit until wecan reassess the business model.

[Carla Casella:]

Can you say at this pointwhat percentage of the stores are unprofitable?

[James W. Keyes:]

Wecan’t. I don’t think we’ve disclosed inthe past. We had taken an action - Ibelieve it was just prior to the close of the second quarter - to announce some250 closures or something like that. Those were primarily the unprofitable stores that that action was takenon. Since then, our effort has been nowto continue to assess dirt strength but also to step back from the business modeland try to redefine what the stores could produce rather than what they hadproduced historically.

[Operator:]

Your next question isfrom the line of Tony Wible - Citigroup.

[Tony Wible:]

I was hoping we couldstart off by just looking at some of the macro trends. If we looked at the online rental industrythis quarter on a net basis it looks like the ads actually struck while thedomestic same-store sales for you guys is actually up positive, which I thinkthat is an inflection point. Would yousay that that is more of a sign that we’re seeing more maturity in the onlineor do you think that’s more a function of just your marketing spend?

[James W. Keyes:]

Youknow that is precisely why we decided last quarter to step back. We think it’s going to take a couple ofquarters to really assess what will be happening in this channel shift thatwe’ve seen for the last year or two. Andby us for the last three quarters so aggressively promoting the by-mail channel,we believe we were driving a lot of that incremental business. Steppingback from it now gives us an opportunity for one or two quarters to reallyassess how much of that demand will shift or has already shifted to the by-mailchannel, which we think will continue to be an important convenience offeringfor our customers and one certainly that we want to participate in. SoI think to quickly answer your question, it’s too early to tell. I think the next couple of quarters will bevery important to us, but as you have heard as I went through our variousstrategies, we are even more optimistic and aggressive now in pursuing ourin-store opportunities and our future penetration of digital opportunities.

[Tony Wible:]

Couldyou speak specifically about your marketing plans for the later part of thefourth quarter and into 2008? Do youanticipate an ad campaign that would be targeted more towards one or the other,either in-store or Total Access?

[James W. Keyes:]

Ithink what you will see is more of our marketing efforts try to capture theTotal membership. In other words, as Imentioned Total Access really is a wonderful platform for us to build on, butour early focus of Total Access was more channel-directed. It was aimed at that by-mail subscriber. Aswe realized how popular the crossover was, where by-mail subscribers were, themajority of them were utilizing the in-store exchange capability, we recognizedthat our Total membership platform really is the advantage of Blockbuster andgoing forward you will see us put our marketing efforts more toward overallmembers and leveraging the flexibility of those members to access their mostconvenient method of access to media via either in-store, by-mail or evenonline.

[Tony Wible:]

Onlya couple more questions here. I guess ifyou could comment on just your comfort level with the current covenants thatare out there?

[Thomas M. Casey:]

As I was going throughthe discussion of results, we reiterate what we said at end of the secondquarter with respect to our comfort.

[Tony Wible:]

Andas far as the new store formats go and your comments on outsourcing, would youconsider partnering for getting some of the new store formats that you proposedor are you looking to invest on your own into those new formats?

[James W. Keyes:]

Ithink you will see a little of both. Weare going to be experimenting in a lot of different ways with different formatsand potentially with different alliance partners. There are merits associated with bothdirections and until we actually get some stores in place we won’t know which ofthose paths will be the preferred. Soyou will see a little of both.

[Operator:]

Your next question isfrom the line of Barton Crockett - JP Morgan.

[Barton Crockett:]

Iwanted to follow up on the covenant discussion first. I know you guys aren’t guiding veryspecifically but you are saying that you are comfortable with the covenants of $165million in the last 12 months for the full year. Because there is so much uncertainty aboutwhat rental really is going to be in any given quarter and since you obviouslydo have a better view on what you’re going to do in G&A and advertisingspending, can you give us a sense of what kind of range of gross profit you’dneed to deliver to get you in compliance with the covenant, and if you believeyou would have any flexibility to negotiate any exemptions there if you neededto?

[James W. Keyes:]

We’renot going to get into detail on the elements of our financial outlook goingforward. I can tell you, though, thatboth the third quarter and the fourth quarter our level of comfort that Tomreiterated was based on that balance between the spending that we had beendoing and the opportunity to continue to generate profits from our corebusiness. Andso what we have tried to do is to manage more effectively that balance. In the second quarter we were veryaggressively spending on a growth plan, as you know, that we modified. Going forward I’d say rather than going togross profit percent or even revenue growth, our comfort for both the third quarter and now looking forward to thefourth quarter is really more dictated by the confidence that we have that wecan dial up or down our level of growth spending going forward.

[Barton Crockett:]

Youmentioned something about international licensing opportunities. I was wondering if you could you elaboratethere. It sounds like what you weresaying if I recall correctly was you see opportunities to maybe exit somemarkets with your company-owned stores and replace those with franchisees. But I didn’t get a sense of the timing or themagnitude of what you are looking at. Youguys have a substantial international operation so I was wondering if you couldgive us a bit more detail on the timing and the magnitude of the opportunitiesthat you see there?

[James W. Keyes:]

WellI’d like to give you more specifics but we are in the process of completingthat assessment now country–by-country, going through the relative strengthsand weaknesses of each individual market and trying to assess possible partnersfor licensing. The key to licensing as Ihave discovered in past experiences, finding that right partner that can giveyou the brand presence and growth opportunity in any given market place. Sowe will be telling you more here in the next two quarters about specificsaround some of those country plans. Butfor now all I can say is that we’re assessing every market that we’re in as apotential candidate outside of North America. North America I can say we do plan to stayfor now with a direct operation but outside of North America we will beassessing country-by-country those plans and bringing you more informationabout it going forward.

[Operator:]

Your next question isfrom the line of Stacey Widlitz - Pali Research.

[Stacey Widlitz:]

Youmentioned in stock, what kind of opportunity do you think there is? In other words, what percentage of customersdo you think are walking out with nothing, disappointed? And then also, can you talk a little bitabout the retail business and how your competitive stance will be going intoholiday? Will you match prices fromdiscounters? What will your stance be going forward on that?

[James W. Keyes:]

Sure. Well I’ll preface my remarks by saying I aman old retailer and I am horrified by out-of-stocks in any format. And so when I look at our industry, I’vealways been as a customer surprised that we have so few of the top releases onthe shelf. This is not unique toBlockbuster; it’s pretty consistent across at least the physical distributionchannels of video rental in the past. And as a customer I found it very annoying. NowI’m in a position to do something about it. I’m finding it’s not as easy to fix because the supply chain issues aresignificant. The way product gets tomarket; the cost structure; whether it’s revenue share or a straight-uppurchase, etcetera, needs to be addressed. Whatwe’ve found internally is that we complicated this matter ourselves when weembarked on programs like Total Access that provided free exchange. You can imagine where the free exchangecustomers went. They went straight tothe wall for the top new releases which put further pressure on our in stockposition. I can tell you it isunsatisfactory today. We see that as agreat opportunity to restore the relevance of our business propositionin-store. Ifyou think about the window of opportunity that we have relative to otherchannels, there has been a lot of discussion about perhaps those windowsnarrowing or closing someday. One couldargue we are not taking advantage of that window today unless we’re instock. Because if you do want one of thosereleases you have to be able to rely on Blockbuster to be able to be in stockon those releases during the first two or three weeks of their release to themarket place. So to me it represents oneof the most significant opportunities that we have in returning to thefundamentals of our core business. Thesecond question you had was relative to retail and will we be more aggressivein matching the prices on the street for our competitors. The simple answer is no, you’re not likely tosee us being more aggressive on retail pricing. We believe that the opportunity that Blockbuster represents isconvenient access to media entertainment. And convenience represents hopefully a value to our customers that goesbeyond just a pure price play. Yes,customers can always buy a DVD cheaper at Wal-Mart or maybe even Best Buy, butthe question is will they be willing to pay a little more for the convenienceof purchasing it when they are already in a Blockbuster store. Agreat example that I can give you is Shrek 3 that will be coming up for theholiday season. Normally we would haveloaded in the stores somewhere between 10 and 20 copies. We will be puttingmany more copies at retail into the stores. We probably will charge a premium to some of the other retailers in themarketplace who may be even using this product as a loss leader. But we do believe that the purchase of aproduct of a title like Shrek is likely to have 80% retail versus about 20%rental. Inthe past we haven’t taken advantage of that retail opportunity and thattranslated into an opportunity cost at the store for the first three weeks ofthe release. This year we will be outthere more proactively retailing Shrek 3 and hoping that the customer iswilling to pay a convenience premium for the availability of that title.

[Operator:]

Your final question isfrom the line of Marla Backer - Research Associates.

[Marla Backer:]

Goodmorning. I wanted to follow up on thediscussion that we were just having about retail and pricing. So I apologize if I missed it but you talkedbefore about Transformers as an example. Can you tell us what the price point on Transformers was?

[James W. Keyes:]

Wetested various price points for Transformers, I believe they were in the rangeof $19.99 to $21.99. The purpose of thatwas to try to get a better understanding of the elasticity model surroundingretail. Candidly we haven’t been veryeffective in retail in the past and so much of this move into the retail spaceis an experiment to determine how much elasticity really is there, how muchdemand there will be, how many copies we can support in each store and managingthat inventory balance correctly, etcetera. There is a little bit of trial and error for the first few quarters aswe try to learn more and more about that space.

[Marla Backer:]

Iknow that some of the other retailers, the Best Buys as you mentioned,Wal-Marts, do special promotional packaging on those titles like theShreks. Would that be something that youwould consider doing, a special package just targeted for the Blockbustervenue?

[James W. Keyes:]

Itis an opportunity. I can’t give you anyspecifics around plans that we have, but you will see us working on moreexclusive arrangements to find unique packaging, unique product available atBlockbuster and leveraging our scale. Weare one of the largest in the business and we do have this advantage of 2million customers a day through our stores. If we can leverage that traffic and be a better partner of the studios,and frankly I’m not sure they saw us as the best retail partner in thepast. But we think we can better partnerwith them to help on theatrical release and that in turn, that will also helpus in the stores. So more to come onthat.

[Marla Backer:]

Andthen my last question is along that same line of exclusivity from studios. You talked earlier about the Weinsteinrelationship. But it is my understandingthat the Weinstein titles are pretty widely available in other rentalvenues. So how successful would youreally say that that promotional campaign has been, to have quote-unquoteexclusive access to the Weinstein titles and would you consider trying to getother exclusive relationships such as that one?

[James W. Keyes:]

TheWeinstein program was somewhat unique in our industry. And we have learned a lot. They and we have learned a lot about thatrelationship and continue to refine it going forward. I think as with any industry you’re going tofind diverting, you will find competitors doing anything that they can do toget access to product that is not otherwise available and so it’s not ssurprise that that is the case here. Butit is also manageable and going forward I think you’ll find that what we willuse, what we’ve learned with that relationship to help improve it going forwardand to continue to make that a stronger point of differentiation forBlockbuster.

[Operator:]

Ms. Torres, are there anyfinal remarks?

[Angelika Torres:]

Jim?

[James W. Keyes:]

Wejust appreciate everyone’s continued support. We know that we are in a period of transition here. Hope you will bear with us as we continue totransform the business but we will try to be as transparent as possible goingforward in terms of both the strategies and eventually providing a little moreclarity around some of the financial benefits that we hope to gain as wetransform the business. So thank youvery much for your continued support and we look forward to sharing with youmore to come.

[Angelika Torres:]

Thank you. If you want to, give me a call if you haveany follow-up questions.