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Blockbuster CEO Promises Profit After Q2 Loss

26 Jul, 2007 By: Erik Gruenwedel

New Blockbuster Inc. chairman and CEO Jim Keyes didn't waste time outlining his desire to reverse the financial fortunes of the Dallas-based DVD rental company.

Speaking to investors after Blockbuster posted a second-quarter (ended July 1) loss of $35.3 million, Keyes said Blockbuster stores must become more relevant to consumers and more profitable for the shareholder.

Blockbuster reported profit of $68.4 million during the same period last year.

“Clearly the rental industry is in transition,” Keyes said. “Our challenge is to successfully change the business concept and business model from comparable-store sales declines to achieving sustainable growth.”

Worldwide same-store rental revenue decreased 1.3% while domestic same-store rental revenue dropped 0.6%. Numbers include online rentals.

To help achieve relevance in the short term and match a similar move by online rival Netflix, Blockbuster announced price cuts to several of its Web-based pricing programs.

The company cut $4 from its online only Blockbuster By Mail plan to $4.99, and slashed $8 dollars from its $24.99 (to $16.99) Total Access Premium online rental, in-store return program.

Blockbuster reduced to $7.99 from $9.99 for its entry-level Total Access program. The company's most popular three movies out-at-a-time Total Access plan, which includes five in-store rentals, remained unchanged at $17.99 per month.

Subscribers can now pay $1.99 for each in-store movie rented above their monthly plan's limit.

Blockbuster said it added 600,000 subscribers in the quarter for a total of 3.6 million subs to the Total Access program.

Revenue from Total Access increased $74 million to $132.7 million, compared to $58.3 million last year.

“The significant contribution from Total Access mitigated most of the in-store rental declines this quarter,” said CFO Larry Zine. “We believe this is an impressive metric given the second quarter is traditionally a low seasonality quarter.”

However, costs associated with marketing and supporting Total Access topped $50 million in the quarter, compared to about $35 million in the first quarter, Zine said.

He said Blockbuster's second-quarter gross profit declined significantly as a result of 7.8% decrease rental margin.

“While we expected rental margin to decline this year due to investment in product necessary to support Total Access' in-store exchanges, the overwhelming popularity of the program and continued growth in subs contributed to the incremental decline,” Zine said.

As a result, Keyes said Blockbuster will attempt to develop “pro-active pricing models” that allow executives to better understand “elasticity curves” for the various rental programs.

“Pricing in our industry is both complicated and controversial,” Keyes said. “Finding better ways to offer value to our customers without having to rely on such aggressive in-store pricing presents a challenging but potentially rewarding economic opportunity.”

Keyes said Blockbuster is losing money on the heaviest Total Access users (about 20% of the subs). The plan is to derive additional economic value from these customers without alienating them.

“We don't want to lose those customers in the system,” Keyes said. “What we do want to do is find a way to capture the value from them for that rental experience. We certainly don't want to continue to subsidize that kind of usage.”

To Michael Pachter, analyst with Wedbush Morgan Securities in Los Angeles, that could mean as much as a 6% price rental increase at the store level in select markets in the next several months.

“They are going to test and see what happens,” Pachter said. “They are trying to train their subscribers to be disciplined and not do more than five in-store transactions.”

He said he doubts Total Access subscribers will be turned off considering their options — to convert to Netflix or pay in-store prices — are not as compelling.

“Where are they going to go?” he said.

He said Keyes told him he intends to operate Blockbuster as much as an entertainment convenience store as a rental store.

Pachter said Blockbuster will at a sellthrough option on new releases. When a customer can't find a rental copy, Blockbuster stores will offer to sell them one from a sellthrough stock.

Total rental revenue, including video games, topped $964 million, compared to $986 million last year.

Overall, revenue including merchandise sales and extended viewing fees (yes, they still exist, at $18 million) reached $1.26 billion compared to $1.29 billion last year.

“We were not able fully offset a reduction in rental revenue due to the closure of stores and unfavorable release schedule,” Zine said. “June was the weakest June in three years.”

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