Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended June 30, 2010

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-22555

 

 

COINSTAR, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		94-3156448
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)
1800 114th Avenue SE, Bellevue, Washington		98004
(Address of principal executive offices)		(Zip Code)

(425) 943-8000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		x		Accelerated filer		¨
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class		Outstanding at July 23, 2010
Common Stock, $0.001 par value		32,718,140

 

 

 

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COINSTAR, INC.

FORM 10-Q

Index

 

PART I. FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited):
		Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009 (unaudited)		Page 3
		Consolidated Statements of Net Income for the three and six months ended June 30, 2010 and June 30, 2009 (unaudited)		Page 4
		Consolidated Statement of Equity and Comprehensive Income for the three and six months ended June 30, 2010 (unaudited)		Page 5
		Consolidated Statements of Cash Flows for the three and six months ended June 30, 2010 and June 30, 2009 (unaudited)		Page 6
		Notes to Consolidated Financial Statements for the three and six months ended June 30, 2010 and June 30, 2009 (unaudited)		Page 7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 20
Item 3.		Quantitative and Qualitative Disclosures about Market Risk		Page 33
Item 4.		Controls and Procedures		Page 34
PART II. OTHER INFORMATION
Item 1.		Legal Proceedings		Page 34
Item 1A.		Risk Factors		Page 34
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds		Page 36
Item 6.		Exhibits		Page 37
SIGNATURE				Page 38

 

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PART I. FINANCIAL INFORMATION

 

Item 1.

Financial Statements

COINSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

		June 30,				December 31,
		2010				2009
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	132,607			$	61,280
Cash in machine or in transit			48,401				57,141
Cash being processed			76,125				73,875
Accounts receivable, net of allowance for doubtful accounts of $953 and $4,379 at June 30, 2010 and December 31, 2009, respectively			19,458				61,371
DVD library and inventory			87,328				104,367
Deferred income taxes			11,295				12,350
Prepaid expenses and other current assets			19,413				20,364
Assets of business held for sale			77,945				0
Total current assets			472,572				390,748
PROPERTY AND EQUIPMENT, NET			416,228				400,289
DEFERRED INCOME TAXES			90,731				99,195
OTHER ASSETS			14,453				17,172
INTANGIBLE ASSETS, NET			11,013				30,893
GOODWILL			267,750				284,502
ASSETS OF BUSINESS HELD FOR SALE			24,100				0
TOTAL ASSETS		$	1,296,847			$	1,222,799
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Accounts payable		$	108,650			$	118,918
Accrued payable to retailers and agents			96,402				131,103
Other accrued liabilities			104,331				91,413
Current portion of long-term debt			7,157				6,812
Current portion of capital lease obligations			23,162				26,396
Liabilities of business held for sale			59,309				0
Total current liabilities			399,011				374,642
LONG-TERM DEBT AND OTHER			409,551				409,423
CAPITAL LEASE OBLIGATIONS			14,072				26,326
DEFERRED TAX LIABILITY			17				17
TOTAL LIABILITIES			822,651				810,408
COMMITMENTS AND CONTINGENCIES
EQUITY:
Preferred stock, $0.001 par value—Authorized, 5,000,000 shares; no shares issued and outstanding at June 30, 2010 and December 31, 2009			0				0
Common stock, $0.001 par value—Authorized, 60,000,000 shares at June 30, 2010 and 45,000,000 at December 31, 2009; 34,643,176 and 33,002,865 issued and 32,717,095 and 31,076,784 shares outstanding at June 30, 2010 and December 31, 2009, respectively			448,955				406,333
Retained earnings			70,780				50,971
Treasury stock			(40,831	)			(40,831	)
Accumulated other comprehensive loss			(4,708	)			(4,082	)
Total stockholders’ equity			474,196				412,391
TOTAL LIABILITIES AND EQUITY		$	1,296,847			$	1,222,799

See notes to consolidated financial statements

 

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COINSTAR, INC.

CONSOLIDATED STATEMENTS OF NET INCOME

(in thousands, except per share data)

(unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
REVENUE		$	342,356			$	253,844			$	665,478			$	466,597
EXPENSES:
Direct operating (1)			241,796				174,871				466,755				318,401
Marketing			5,934				3,696				8,564				6,683
Research and development			1,805				1,299				3,229				2,556
General and administrative			31,876				25,977				63,398				50,364
Depreciation and other (1) (2)			30,627				21,293				62,428				40,569
Amortization of intangible assets			985				882				1,864				1,756
Litigation settlement			0				0				5,379				0
Income from operations			29,333				25,826				53,861				46,268
OTHER INCOME (EXPENSE):
Foreign currency (loss) gain and other, net			(30	)			17				(47	)			(31	)
Interest income			85				4				87				36
Interest expense			(9,158	)			(8,615	)			(18,426	)			(15,113	)
Income from continuing operations before income taxes			20,230				17,232				35,475				31,160
Income tax expense			(7,389	)			(6,702	)			(13,395	)			(10,729	)
Income from continuing operations			12,841				10,530				22,080				20,431
Income (loss) from discontinued operations, net of tax			526				(3,572	)			(2,271	)			(7,883	)
Net income			13,367				6,958				19,809				12,548
Less: Net income attributable to non-controlling interests			0				0				0				(3,627	)
NET INCOME ATTRIBUTABLE TO COINSTAR, INC		$	13,367			$	6,958			$	19,809			$	8,921
BASIC EARNINGS PER SHARE:
Basic earnings per share from continuing operations attributable to Coinstar, Inc		$	0.40			$	0.35			$	0.70			$	0.57
Basic earnings (loss) per share from discontinued operations attributable to Coinstar, Inc			0.02				(0.12	)			(0.07	)			(0.27	)
Basic earnings per share attributable to Coinstar, Inc		$	0.42			$	0.23			$	0.63			$	0.30
DILUTED EARNINGS PER SHARE:
Diluted earnings per share from continuing operations attributable to Coinstar, Inc		$	0.39			$	0.35			$	0.69			$	0.56
Diluted earnings (loss) per share from discontinued operations attributable to Coinstar, Inc			0.02				(0.12	)			(0.07	)			(0.26	)
Diluted earnings per share attributable to Coinstar, Inc		$	0.41			$	0.23			$	0.62			$	0.30
WEIGHTED SHARES OUTSTANDING:
Basic			31,731				30,117				31,340				29,525
Diluted			32,938				30,575				32,077				29,893

 

(1)	“Direct operating” above excludes depreciation and other of $26.9 million and $56.5 million for the three and six months ended June 30, 2010 and $16.8 million and $35.4 million for the three and six months ended June 30, 2009.

(2)	“Depreciation and other” includes $2.1 million and $8.5 million of loss from the write-down as well as the acceleration of depreciation of certain revenue generating kiosks for the three and six months ended June 30, 2010.

See notes to consolidated financial statements

 

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COINSTAR, INC.

CONSOLIDATED STATEMENT OF EQUITY AND COMPREHENSIVE INCOME

Three and Six Months Ended June 30, 2010

(in thousands, except share data)

(unaudited)

 

							Retained Earnings			Treasury Stock				Accumulated Other Comprehensive Loss				Total				Comprehensive Income
		Common Stock
		Shares		Amount
BALANCE, March 31, 2010		31,509,691		$	411,654		$	57,413		$	(40,831	)		$	(8,441	)		$	419,795
Proceeds from exercise of stock options, net		1,003,348			25,176														25,176
Stock-based compensation expense		4,056			2,382														2,382
Shares issued for DVD agreement		200,000			2,231														2,231
Tax benefit on stock-based compensation expense					7,512														7,512
Net income								13,367											13,367			$	13,367
Foreign currency translation adjustments net of tax benefit of $87															2,876				2,876				2,876
Interest rate hedges on long-term debt net of tax expense of $549															857				857				857
BALANCE, June 30, 2010		32,717,095		$	448,955		$	70,780		$	(40,831	)		$	(4,708	)		$	474,196			$	17,100
BALANCE, December 31, 2009		31,076,784		$	406,333		$	50,971		$	(40,831	)		$	(4,082	)		$	412,391
Proceeds from exercise of stock options, net		1,139,445			27,511														27,511
Stock-based compensation expense		300,866			5,092														5,092
Shares issued for DVD agreement		200,000			2,823														2,823
Tax benefit on stock-based compensation expense					7,196														7,196
Net income								19,809											19,809			$	19,809
Foreign currency translation adjustments net of tax benefit of $5															(1,923	)			(1,923	)			(1,923	)
Interest rate hedges on long-term debt net of tax expense of $829															1,297				1,297				1,297
BALANCE, June 30, 2010		32,717,095		$	448,955		$	70,780		$	(40,831	)		$	(4,708	)		$	474,196			$	19,183

See notes to consolidated financial statements

 

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COINSTAR, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

		Three Months								Six Months
		Ended June 30,								Ended June 30,
		2010				2009				2010				2009
OPERATING ACTIVITIES:
Net income		$	13,367			$	6,958			$	19,809			$	12,548
Adjustments to reconcile net income to net cash provided by operating activities from continuing operations:
Depreciation and other			30,627				21,293				62,428				40,569
Amortization of intangible assets and deferred financing fees			1,493				1,202				2,880				2,262
Non-cash stock-based compensation for employees			2,339				1,942				4,964				4,737
Share-based payments for DVD agreement			2,231				0				2,823				0
Excess tax benefit on share-based awards			(5,477	)			(92	)			(6,225	)			(125	)
Deferred income taxes			5,607				2,747				8,755				4,489
(Gain) loss from discontinued operations, net of tax			(526	)			3,572				2,271				7,883
Non-cash interest on convertible debt			1,499				0				2,958				0
Other			33				(106	)			229				126
Cash provided (used) by changes in operating assets and liabilities from continuing operations:
Accounts receivable			931				8,814				570				8,431
DVD library			(148	)			749				8,199				(7,514	)
Prepaid expenses and other current assets			(1,354	)			6,870				(4,666	)			5,787
Other assets			76				91				999				371
Accounts payable			(3,577	)			(12,133	)			19,353				(9,848	)
Accrued payable to retailers			10,134				10,355				4,226				(1,104	)
Other accrued liabilities			47,396				(19,297	)			27,808				(48,852	)
Net cash provided by operating activities from continuing operations			104,651				32,965				157,381				19,760
INVESTING ACTIVITIES:
Purchase of property and equipment			(52,822	)			(38,288	)			(84,339	)			(73,276	)
Proceeds from sale of electronic payment services business			26,078				0				26,078				0
Proceeds from sale of property and equipment			230				59				267				152
Net cash used by investing activities from continuing operations			(26,514	)			(38,229	)			(57,994	)			(73,124	)
FINANCING ACTIVITIES:
Principal payments on capital lease obligations and other debt			(10,668	)			(5,858	)			(19,343	)			(11,693	)
Net borrowings on credit facility			0				18,000				0				73,000
Borrowings on term loan			0				87,500				0				87,500
Financing costs associated with revolving line of credit and convertible debt			0				(1,329	)			0				(3,234	)
Cash used to purchase remaining non-controlling interests in Redbox			0				(92,270	)			0				(102,353	)
Excess tax benefit on share-based awards			5,477				92				6,225				125
Proceeds from exercise of stock options			25,023				1,841				27,250				2,260
Net cash provided by financing activities from continuing operations			19,832				7,976				14,132				45,605
Effect of exchange rate changes on cash			(354	)			3,050				(851	)			2,829
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS, CASH IN MACHINE OR IN TRANSIT, AND CASH BEING PROCESSED FROM CONTINUING OPERATIONS			97,615				5,762				112,668				(4,930	)
CASH FLOWS FROM DISCONTINUED OPERATIONS:
Operating cash flows			(26,279	)			6,840				(14,115	)			7,455
Investing cash flows			(32,716	)			(2,269	)			(33,550	)			(4,486	)
Financing cash flows			(145	)			(887	)			(166	)			(1,822	)
			(59,140	)			3,684				(47,831	)			1,147
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS, CASH IN MACHINE OR IN TRANSIT, AND CASH BEING PROCESSED			38,475				9,446				64,837				(3,783	)
CASH AND CASH EQUIVALENTS, CASH IN MACHINE OR IN TRANSIT, AND CASH BEING PROCESSED:
Beginning of period			218,658				178,806				192,296				192,035
End of period		$	257,133			$	188,252			$	257,133			$	188,252

See Note 13 for supplemental cash flow information.

See notes to consolidated financial statements

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

NOTE 1: ORGANIZATION, BUSINESS, AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Description of company: We are a leading provider of automated retail solutions offering convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers. Our core offerings in automated retail include our DVD and Coin businesses. Our DVD services consist of self-service DVD kiosks where consumers can rent or purchase movies. Our Coin services consist of self-service coin-counting kiosks where consumers can convert their coin to cash, a gift card or an e-certificate, among other options. We were incorporated in Delaware on October 12, 1993. As of June 30, 2010, we had approximately 26,900 DVD kiosks in 24,000 locations and 19,000 coin-counting kiosks (approximately 12,000 of which are enabled to provide electronic payment products and services) in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants.

Sale of electronic payment services business (the “E-Pay Business”): On May 25, 2010, we sold our subsidiaries comprising the E-Pay Business to InComm Holdings, Inc. and InComm Europe Limited (collectively “InComm”). We have presented the disposition of our E-Pay Business as well as the operating results from our E-Pay Business under discontinued operations in our Consolidated Statements of Net Income for all periods presented. See further discussion in Note 5.

Assets of business held for sale and discontinued operations: We define a business component as held for sale if it meets the criteria of assets held for sale within FASB ASC 360, Property, Plant, and Equipment, at the balance sheet date. We define a business component that is held for sale or disposed of to be discontinued operations if its operations and cash flows are clearly distinguishable from the rest of the entity; its operations and cash flows have been or will be eliminated from ongoing operations of the entity as a result of disposal; and we have no significant involvement in the operations of the component after disposal. During the second quarter of 2010, as part of our consideration of strategic alternatives we committed to a plan to sell our Money Transfer business. As a result, we classified the assets and liabilities of the Money Transfer business as held for sale and reported the results as discontinued operations. See further discussion in Note 5.

Basis of presentation: The unaudited consolidated financial statements of Coinstar included herein reflect all adjustments, consisting only of normal recurring adjustments that, in the opinion of management, are necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods presented.

Principles of consolidation: The accompanying Consolidated Financial Statements include the accounts of Coinstar, Inc., our wholly-owned subsidiaries, companies in which we have a controlling interest, and other entities in accordance with FASB ASC 810-10. Investments in companies of which we may have significant influence, but not a controlling interest, are accounted for using the equity method of accounting. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of estimates: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These judgments are difficult since matters that are inherently uncertain directly impact their valuation and accounting. Actual results may vary from management’s estimates and assumptions.

Revenue recognition: We recognize revenue as follows:

 

•

Net revenue from DVD movie rentals is recognized on a ratable basis during the term of a consumer’s rental transaction. Revenue from a direct sale out of the kiosk of previously rented movies is recognized at the time of sale. On rental transactions for which the related DVDs have not yet been returned to the kiosk at month-end, revenue is recognized with a corresponding receivable recorded in the balance sheet, net of a reserve for potentially uncollectible amounts. We record revenue net of refunds and applicable sales taxes collected from consumers; and

 

•

Coin-counting revenue, which is collected from either consumers or card issuers (in stored value card or e-certificate transactions), is recognized at the time the consumers’ coins are counted by our coin-counting kiosks. Cash deposited in kiosks that has not yet been collected is referred to as cash in machine and is reported in our Consolidated Balance Sheets under the caption “Cash in machine or in transit.” Our revenue represents the fee charged for coin-counting.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

Interest rate swap: During the first quarter of 2008, we entered into an interest rate swap agreement with Wells Fargo bank for a notional amount of $150.0 million to hedge against the potential impact on earnings from an increase in market interest rates associated with the interest payments on our variable-rate revolving credit facility. In the fourth quarter of 2008, we entered into another interest rate swap agreement with JP Morgan Chase for a notional amount of $75.0 million to hedge against the potential impact on earnings from an increase in market interest rates associated with the interest payments on our variable-rate revolving credit facility. One of our risk management objectives and strategies is to lessen the exposure of variability in cash flow due to the fluctuation of market interest rates and lock in an interest rate for the interest cash outflows on our revolving debt. Under the interest rate swap agreements, we receive or make payments on a monthly basis, based on the differential between a specific interest rate and one-month LIBOR. The interest rate swaps are accounted for as cash flow hedges in accordance with FASB ASC 815-30 as of June 30, 2010 and December 31, 2009. The cumulative net change in the fair value of the swaps, which was $3.2 million, was recorded in other comprehensive income, net of tax of $1.3 million, with the corresponding adjustment to “Other accrued liabilities” in our Consolidated Financial Statements. We reclassify a corresponding amount from “Accumulated other comprehensive income” to “Interest expense” in the Consolidated Statements of Net Income as the interest payments are made. Estimated losses in “Accumulated other comprehensive income” of approximately $3.2 million are expected to be reclassified into earnings as a component of “Interest expense” over the next twelve months. The net gain or loss included in our Consolidated Statements of Net Income representing the amount of hedge ineffectiveness was inconsequential. The term of the $75.0 million swap is through October 28, 2010. The term of the $150.0 million swap is through March 20, 2011. The following table provides information about our interest rate swaps:

 

				Fair value
		Balance sheet classification		June 30, 2010			December 31, 2009
				(in thousands)
Interest rate swap		Other accrued liabilities		$	3,248		$	5,374

Recent accounting pronouncements: In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2010-06 (“ASU 2010-06”), Improving Disclosures about Fair Value Measurements. ASU 2010-06 provides amendments to FASB ASC 820-10 that requires new fair value disclosures and clarifies existing fair value disclosures required under FASB ASC 820-10. The new disclosures and clarifications of existing disclosures are effective for interim and annual reporting periods beginning after December 15, 2009, except for certain disclosures about purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The adoption of the new provisions within ASU 2010-06 did not have a material impact on our consolidated financial position, results of operations, cash flows, or disclosures.

NOTE 2: PROPERTY AND EQUIPMENT

 

		June 30,				December 31,
		2010				2009
		(in thousands)
Machines		$	748,856			$	694,904
Computers			37,429				34,948
Office furniture and equipment			4,867				13,137
Vehicles			10,750				11,629
Leasehold improvements			6,264				4,150
Property and equipment, at cost			808,166				758,768
Accumulated depreciation and amortization			(391,938	)			(358,479	)
Property and equipment, net		$	416,228			$	400,289

The amounts above as of December 31, 2009 include approximately $3.3 million and $10.5 million of net property and equipment for the E-pay Business that was sold on May 25, 2010 and for the Money Transfer business classified as held for sale as of June 30, 2010, respectively.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

During the first quarter of 2010, we wrote off the carrying value of $3.2 million and $0.7 million for the first generation of our coffee kiosks and our DVDXpress branded kiosks, respectively. In addition, we adjusted the useful life of both types of kiosks, resulting in increased depreciation expense and other of $2.1 million and $4.6 million, respectively, for the three and six months ended June 30, 2010.

NOTE 3: STOCK-BASED COMPENSATION PLANS AND SHARE BASED PAYMENTS

Stock-based compensation

Stock-based compensation is accounted for in accordance with the provisions of FASB ASC 718, Stock Compensation. Under FASB ASC 718, the fair value of stock awards is estimated at the date of grant using the Black-Scholes-Merton option valuation model. Stock-based compensation expense is reduced for estimated forfeitures and is amortized over the vesting period.

The following table summarizes stock-based compensation expense, and the related deferred tax benefit for stock option and award expense:

 

		Three Months						Six Months
		Ended June 30,						Ended June 30,
		2010			2009			2010			2009
		(in thousands )						(in thousands )
Stock-based compensation expense		$	2,339		$	1,942		$	4,964		$	4,737
Related deferred tax benefit			759			748			1,689			1,592

Stock options: The following summarizes the weighted average valuation assumptions and grant date fair value of options granted during the periods shown below:

 

		Six Months
		Ended June 30,
		2010				2009
Expected term (in years)			7.3				3.7
Expected stock price volatility			43	%			40	%
Risk-free interest rate			3.2	%			1.5	%
Expected dividend yield			0.0	%			0.0	%
Estimated fair value per option granted		$	15.38			$	9.27

The expected term of the options represents the estimated period of time from grant until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on historical volatility of our stock for a period at least equal to the expected term. The risk-free interest rate is based on the implied yield available on United States Treasury zero-coupon issues with an equivalent expected term. We have not paid dividends in the past and do not plan to pay any dividends in the foreseeable future.

During 2010, we granted stock options to our executives and our board of directors. These stock options expire 10 years from the date of grant. As a result of this change, we revised the expected term assumption in our Black-Scholes-Merton valuation model.

Stock options are granted to our executives and board of directors under the 2000 Amended and Restated Equity Incentive Plan and the 1997 Amended and Restated Equity Incentive Plan (the “1997 Plan”). Options awarded vest annually over 4 years and 2010 grants expire after 10 years. Options awarded in previous years vest annually over 4 years and expire after 5 or 10 years. Shares of common stock are issued upon exercise of stock options.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

The following table presents a summary of the stock option activity for the six months ended June 30, 2010:

 

		Shares (in thousands)			Weighted average exercise price
OUTSTANDING, Beginning of year		2,408			$	27.04
Granted		148				30.61
Exercised		(1,139	)			24.79
Cancelled, expired or forfeited		(69	)			30.07
OUTSTANDING, June 30, 2010		1,348				29.18
EXERCISABLE, June 30, 2010		498				27.08

As of June 30, 2010, total unrecognized stock-based compensation expense related to unvested stock options was approximately $7.0 million. This expense is expected to be recognized over a weighted average period of approximately 1.8 years. During the first six months of 2010, the total intrinsic value of stock options exercised was approximately $21.6 million. At June 30, 2010, there were 3.0 million shares of unissued common stock reserved for issuance under all the stock plans of which 1.7 million shares were available for future grants.

Restricted stock awards: Restricted stock awards are granted to certain employees and non-employee directors under the 1997 Plan and vest annually over 3 or 4 years and one year, respectively. During 2010 we expanded the pool of employees receiving restricted stock awards. The restricted shares require no payment from the grantee. The fair value of the awards is based on the market price on the grant date and is recorded on a straight-line basis over the vesting period or based on performance conditions.

The following table presents a summary of the restricted stock award activity for the six months ended June 30, 2010:

 

		Shares (in thousands)			Weighted average grant date fair value
NON-VESTED, Beginning of year		201			$	23.70
Granted		342				32.08
Vested		(105	)			29.95
Forfeited		(20	)			29.82
NON-VESTED, June 30, 2010		418				31.40

Compensation expense related to our restricted stock awards totaled approximately $3.3 million for the first six months of 2010 compared with approximately $2.3 million for the first six months of 2009. As of June 30, 2010 total unrecognized stock-based compensation expense related to unvested restricted stock awards was approximately $9.2 million. This expense is expected to be recognized over a weighted average period of approximately 2.1 years. During the first six months of 2010 the total fair value of restricted stock awards vested was approximately $3.8 million.

Share-based payments

Sony

As part of a copy depth license agreement with SPHE Scan Based Trading Corporation (“Sony”), a subsidiary of Sony Pictures Home Entertainment Inc., we granted Sony 193,348 shares of restricted stock in July 2009. As of June 30, 2010, 19,335 shares were vested and the remaining shares will be vested in the next 4.1 years in accordance with our agreement with Sony. Share-based payment expense totaled $1.0 million and $1.6 million for the three and six months ended June 30, 2010, respectively, related to the agreement with Sony and is recorded to direct operating expenses in the Consolidated Statements of Net Income and the estimated unvested expense related to this agreement totaled $5.1 million at June 30, 2010.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

Paramount

On June 15, 2010, Paramount Home Entertainment Inc. (“Paramount”) exercised its option to extend the term of the revenue sharing license agreement between Paramount and our Redbox subsidiary (see Note 8 for further discussion). As a result of the extension, we granted Paramount 200,000 shares of restricted stock, of which 20,000 shares vested upon Paramount’s exercise of the extension. The remaining 180,000 shares will be vested in the next 4.5 years in accordance with our agreement with Paramount. During the second quarter of 2010, we recorded share-based payment expense of $1.2 million related to the agreement with Paramount to direct operating expenses in the Consolidated Statements of Net Income and the estimated unvested expense related to this agreement totaled $7.6 million at June 30, 2010.

NOTE 4: INCOME PER SHARE

Basic earnings per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed by dividing the net income available to common stockholders for the period by the weighted average number of common and potential common shares outstanding (if dilutive) during the period. Potential common shares are composed of incremental common shares issuable upon the exercise of stock options and vesting of certain non-vested restricted stock awards and the conversion features of our convertible debt we issued in the third quarter of 2009. Potential common shares are included in the calculation of diluted earnings per share to the extent such shares are dilutive.

The following table sets forth the computation of basic and diluted earnings per share for the periods indicated:

 

		Three Months							Six Months
		Ended June 30,							Ended June 30,
		2010			2009				2010				2009
		(in thousands)							(in thousands)
Numerator:
Income from continuing operations		$	12,841		$	10,530			$	22,080			$	20,431
Income (loss) from discontinued operations, net of tax			526			(3,572	)			(2,271	)			(7,883	)
Net income			13,367			6,958				19,809				12,548
Less: Net income attributable to non-controlling interests			0			0				0				(3,627	)
Net income attributable to Coinstar, Inc		$	13,367		$	6,958			$	19,809			$	8,921
Denominator:
Weighted average shares for basic calculation			31,731			30,117				31,340				29,525
Dilutive impact from stock options, share awards and convertible debt			1,207			458				737				368
Weighted average shares for diluted calculation			32,938			30,575				32,077				29,893

For the six months ended June 30, 2010, options and certain restricted stock awards totaling approximately 0.7 million shares of common stock were excluded from the computation of earnings per common share because their impact would be antidilutive. The antidilutive impact of options and restricted stock awards was not significant for the three months ended June 30, 2010. For the three and six months ended June 30, 2009, options and restricted stock awards totaling approximately 1.3 million and 1.4 million shares, of common stock, respectively, were excluded from the computation of earnings per common share because their impact would be antidilutive. For the three and six months ended June 30, 2010, approximately 0.6 million shares and 0.3 million shares of common stock, respectively, related to the conversion feature of our convertible debt were included in the calculation of earnings per share because the average closing price of our common stock of $46.11 during the second quarter of 2010 was above the initial contractual conversion price of $40.29.

NOTE 5: DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE

Sale of Entertainment Business

On September 8, 2009, we sold our subsidiaries comprising our Entertainment Business to National Entertainment Network, Inc (“National”) for nominal consideration. We have presented the disposition of our Entertainment Business as well as the operating loss from our Entertainment Business under discontinued operations in our Consolidated Statements of Net Income for all periods presented. The following table sets forth the components of discontinued operations on the Consolidated Statements of Net Income related to the Entertainment Business.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

		Three Months							Six Months
		Ended June 30,							Ended June 30,
		2010			2009				2010			2009
		(in thousands)							(in thousands)
Entertainment Business revenue		$	0		$	31,920			$	0		$	64,307
Operating loss			0			(3,156	)			0			(5,897	)
Income tax benefit			0			1,160				0			2,182
Loss from discontinued operations, net of tax		$	0		$	(1,996	)		$	0		$	(3,715	)

Sale of E-Pay Business

On May 25, 2010, we sold our subsidiaries comprising our E-Pay Business to InComm for an aggregate purchase price of $40.0 million. The purchase price is subject to a post-closing net working capital adjustment. We have presented the disposition of our E-Pay Business as well as the operating results from our E-Pay Business under discontinued operations in our Consolidated Statements of Net Income for all periods presented. Our continuing cash flows from the E-Pay Business after the disposal are expected to be insignificant. The following table sets forth the components of discontinued operations on the Consolidated Statements of Net Income related to the E-payment Business.

 

		Three Months								Six Months
		Ended June 30,								Ended June 30,
		2010				2009				2010				2009
		(in thousands)								(in thousands)
E-Pay Business revenue		$	3,220			$	6,051			$	8,732			$	12,134
Operating income including gain on sale of $12.2 million in 2010			12,122				534				12,052				995
Income tax expense from sale of E-Pay Business			(4,289	)			0				(4,289	)			0
Income tax benefit (expense)			673				(302	)			703				(546	)
Income from discontinued operations, net of tax		$	8,506			$	232			$	8,466			$	449

Money Transfer Business

As part of exploring strategic alternatives for our Money Transfer business, we committed to a formal plan to sell the Money Transfer business and in the second quarter of 2010 have met the requirements to account for the Money Transfer business as assets held for sale. As a result, we measured our Money Transfer business assets and liabilities at fair value less costs to sell and classified the assets and liabilities as held for sale at June 30, 2010. In addition, the following two conditions that require a component of a business classified as held for sale be reported in discontinued operations for our Money Transfer business have been met:

 

1.

The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction; and

 

2.

The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

Our continuing cash flows from the Money Transfer business after the disposal are expected to be insignificant. We have presented the operating results from our Money Transfer business under discontinued operations in our Consolidated Statements of Net Income for all periods presented. The following table sets forth the components of discontinued operations on the Consolidated Statements of Net Income related to the Money Transfer business.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

		Three Months								Six Months
		Ended June 30,								Ended June 30,
		2010				2009				2010				2009
		(in thousands)								(in thousands)
Money Transfer revenue		$	24,213			$	22,153			$	45,639			$	42,084
Operating loss (a)			(13,143	)			(2,303	)			(17,650	)			(6,424	)
Income tax benefit (a)(b)			5,163				495				6,913				1,807
Loss from discontinued operations, net of tax		$	(7,980	)		$	(1,808	)		$	(10,737	)		$	(4,617	)

 

(a)	A non-cash charge of $12.2 million from the write-down of assets held for sale to estimated fair value less estimated cost to sell was recorded in the second quarter of 2010.

(b)	As a result of classifying our Money Transfer business as discontinued operations, we have recognized an estimated tax benefit of $5.6 million for both the three and six months ended June 30, 2010.

The major classes of “Assets of business held for sale” and “Liabilities of business held for sale” on the Consolidated Balance Sheet at June 30, 2010 were as follows (corresponding amounts at December 31, 2009 are also noted for comparative purpose, but have not been reclassified on the balance sheet as of that period):

 

		June 30, 2010			December 31, 2009
		(in thousands)
Cash and cash equivalents		$	30,977		$	40,657
Accounts receivable, net			34,706			28,092
Other current assets			12,262			10,004
Property, plant, and equipment			9,333			10,513
Goodwill and other assets			14,767			28,370
Total assets of business held for sale		$	102,045		$	117,636
Accounts payable and payable to agents		$	48,114		$	39,410
Accrued liabilities			11,195			15,225
Total liabilities of business held for sale		$	59,309		$	54,635
Net assets and liabilities of business held for sale		$	42,736		$	63,001

NOTE 6: BUSINESS SEGMENT INFORMATION

FASB ASC 280, Segment Reporting, requires that companies report separately in the financial statements certain financial and descriptive information about segment revenues, income and assets. The method for determining what information is reported is based on the way that management organizes the operating segments for making operational decisions and assessments of financial performance. Our chief operating decision maker is considered to be the Chief Executive Officer (“CEO”). We sold our E-Pay Business in May 2010 and we reclassified our Money Transfer business to assets of business held for sale. At June 30, 2010 we reflected both the E-Pay Business and the Money Transfer business as discontinued operations for all periods presented. As a result, our business segments are now DVD services and Coin services.

 

		Three Months						Six Months
		Ended June 30,						Ended June 30,
		2010			2009			2010			2009
		(in thousands)						(in thousands)
Revenue:
DVD services		$	271,929		$	188,925		$	535,058		$	343,622
Coin services			70,427			64,919			130,420			122,975
Consolidated revenue		$	342,356		$	253,844		$	665,478		$	466,597

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

Our operating costs included in our shared service functions, which consist primarily of sales, corporate executive management, finance, legal, human resources, and information technology, are allocated to our segments. We continually evaluate the shared service allocation methods used for segment reporting purposes, and this may result in changes to segment allocations in future periods.

In addition, our CEO manages our business by evaluating the financial results of our operating segments, focusing primarily on segment revenue and segment operating income before depreciation, amortization and other, and stock compensation expense and share-based payments (“segment operating income”). We also review depreciation and amortization allocated to each segment. We utilize segment revenue and segment operating income because we believe they provide useful information for effectively allocating resources among business segments, evaluating the health of our business segments based on metrics that management can actively influence, and gauging our investments and our ability to service, incur or pay down debt. Specifically, our CEO evaluates segment revenue and segment operating income from continuing operations, and assesses the performance of each business segment based on these measures, as well as, among other things, the prospects of each of the segments and how they fit into the Company’s overall strategy. Our CEO then decides how resources should be allocated among our business segments.

The following table summarizes our income from operations, by segment for the periods indicated:

 

		Three Months								Six Months
		Ended June 30,								Ended June 30,
		2010				2009				2010				2009
		(in thousands)								(in thousands)
Operating income before depreciation/amortization and stock-based compensation/share-based payments:
DVD services		$	39,049			$	24,157			$	83,480			$	45,056
Coin services			26,466				25,786				42,460				48,274
Subtotal			65,515				49,943				125,940				93,330
Depreciation, amortization and other			(31,612	)			(22,175	)			(64,292	)			(42,325	)
Stock-based compensation and share-based payments			(4,570	)			(1,942	)			(7,787	)			(4,737	)
Consolidated income from operations		$	29,333			$	25,826			$	53,861			$	46,268

The following table summarizes depreciation, amortization and other by segment for the periods indicated:

 

		Three Months						Six Months
		Ended June 30,						Ended June 30,
		2010			2009			2010			2009
		(in thousands)						(in thousands)
DVD services		$	23,906		$	14,738		$	46,077		$	27,907
Coin services			7,706			7,437			18,215			14,418
Depreciation, amortization and other		$	31,612		$	22,175		$	64,292		$	42,325

The following table summarizes total assets by segment for the periods indicated:

 

		June 30,			December 31,
		2010			2009
		(in thousands)
Total assets:
DVD services		$	500,865		$	491,818
Coin services			533,206			509,144
E-payment services			0			43,007
Money transfer services			0			117,636
Assets of business held for sale			102,045			0
Unallocated corporate assets			160,731			61,194
Consolidated assets		$	1,296,847		$	1,222,799

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

The table above includes assets associated with the E-Pay Business as of December 31, 2009. E-Pay Business assets are not included as of June 30, 2010 as the business was sold in May 2010. “Assets of business held for sale” above represents amounts for our Money Transfer business which is classified as a business held for sale as of June 30, 2010 and is included to reconcile the table to our Consolidated Balance Sheet. Unallocated assets in the table above include cash and cash equivalents.

The following table summarizes total goodwill by segment for the periods indicated:

 

		June 30, 2010			December  31, 2009
		(in thousands)			(in thousands)
Total goodwill, by segment, for the period indicated:
DVD services		$	111,399		$	111,399
Coin services			156,351			156,351
Money transfer services			0			7,713
E-payment services			0			9,039
Consolidated goodwill		$	267,750		$	284,502

Our DVD and Coin services are primarily located within retailers. The following retailers accounted for 10% or more of our consolidated revenue from continuing operations:

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Wal-Mart Stores Inc		19.6	%		23.1	%		20.4	%		20.0	%
Walgreen Co		13.3	%		10.3	%		13.0	%		8.1	%
The Kroger Company		10.8	%		5.9	%		10.0	%		5.4	%
McDonald’s USA		6.7	%		10.8	%		7.2	%		10.1	%

NOTE 7: DVD LIBRARY AND INVENTORY

DVD library and inventory is comprised of DVDs held for rental and, prior to the sale of our E-Pay Business, inventory included purchased items ready for resale.

DVDs are initially recorded at cost and are amortized to “Direct operating expense” in the Consolidated Statements of Net Income over an assumed useful life to their estimated salvage value. Estimated salvage value is based on the amounts that we have historically recovered on disposal of the DVDs. The amortization charges are recorded on an accelerated basis, reflecting higher rentals of the DVD in the first few weeks after release, and substantially all of the amortization expense is recognized within one year of the assumed life of the DVDs. The value of the DVD library was $87.3 million and $95.6 million as of June 30, 2010 and December 31, 2009, respectively.

E-Pay inventory was $8.8 million as of December 31, 2009, and there was no E-Pay inventory as of June 30, 2010.

NOTE 8: DVD LICENSE AGREEMENTS

Paramount agreement

On June 15, 2010, Paramount exercised its option to extend the term of the revenue sharing license agreement (the “Paramount Agreement”) between Paramount and our Redbox subsidiary to December 31, 2014. As per the terms of the original agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Redbox will continue to receive delivery of the titles by the “street date,” the first date on which the DVDs are available to the general public for home entertainment purposes, whether on a rental or sell-through basis. At Paramount’s discretion, the Paramount Agreement may be terminated earlier on December 31, 2011. As a result of the

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

extension, we granted 200,000 shares of restricted stock to Paramount of which 20,000 shares vested upon Paramount’s decision to extend the term of the agreement, and the remaining shares vest over the term of the Paramount Agreement. Redbox estimates that it would pay Paramount approximately $433.7 million during the term of the Paramount Agreement. Annual commitments under this agreement are expected to be $31.7 million in 2010, $92.3 million in 2011, $100.2 million in 2012, $103.5 million in 2013, and $106.0 million in 2014.

Universal Studios agreement

On April 22, 2010, our Redbox subsidiary entered into a rental revenue sharing agreement (the “Universal Studios Agreement”) with Universal Studios Home Entertainment LLC (“Universal Studios”). Redbox estimates that it would pay Universal Studios approximately $82.8 million during the term of the Universal Studios Agreement, which is expected to last from April 22, 2010 through April 21, 2012. Annual commitments under this agreement are expected to be $23.2 million in 2010, $42.7 million in 2011, and $16.9 million in 2012.

Under the Universal Studios Agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Under the Universal Studios Agreement, Redbox will make the DVDs available for rental 28 days after the “street date,” the earliest date established by Universal Studios on which the DVDs are initially made available to the general public, whether on a rental or sell-through basis. In addition, and pursuant to the terms of the Universal Studios Agreement, Redbox agreed to dismiss with prejudice its lawsuit against Universal Studios relating to Redbox’s access to Universal Studios titles.

20th Century Fox agreement

On April 22, 2010, our Redbox subsidiary entered into a disc output lease and rental agreement (the “Fox Agreement”) with 20th Century Fox Home Entertainment LLC (“Fox”). Redbox estimates that it would pay Fox approximately $394.5 million during the term of the Fox Agreement, which is expected to last from April 22, 2010 through April 21, 2015. However, at Fox’s discretion, the Fox Agreement may expire earlier on April 21, 2013. Annual commitments under this agreement are expected to be $36.1 million in 2010, $69.6 million in 2011, $80.2 million in 2012, $84.8 million in 2013, $91.0 million in 2014, and $32.8 million in 2015.

Under the Fox Agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Under the Fox Agreement, Redbox will make the DVDs available for rental 28 days after the “retail street date,” the earliest date established by Fox on which the DVDs are initially made available to the general public, whether on a rental or sell-through basis. In addition, and pursuant to the terms of the Fox Agreement, Redbox agreed to dismiss with prejudice its lawsuit against Fox relating to Redbox’s access to Fox titles.

NOTE 9: LONG TERM DEBT

 

		June 30, 2010			December 31, 2009
		(in thousands)
Revolving line of credit (matures November 2012)		$	225,000		$	225,000
Convertible debt (matures September 2014)			170,066			167,109
Long-term debt		$	395,066		$	392,109

Convertible debt

In September 2009, we issued $200 million aggregate principal amount of 4% Convertible Senior Notes (the “Notes”) for proceeds, net of expenses, of approximately $193.3 million. The Notes bear interest at a fixed rate of 4% per annum, payable semi-annually in arrears on each March 1 and September 1, beginning March 1, 2010. The Notes mature on September 1, 2014. The effective interest rate on the Notes is 8.5%.

The Notes are convertible, upon the occurrence of certain events or maturity, into cash up to the aggregate principal amount of the Notes and shares of our common stock, in respect of the remainder, if any, of the conversion obligation in excess of the aggregate principal amount. The initial conversion rate is 24.8181 shares of Common Stock per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $40.29 per share of Common Stock.

We have separately accounted for the liability and the equity component of the Notes in accordance with FASB ASC 470-20, Debt with Conversion and Other Options. As our Notes were not actively traded in the market at the time of issuance fair value was estimated using a discounted cash flow analysis, based on the borrowing rate for similar types of borrowing

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

arrangements. Upon issuance, we recorded a liability of $165.2 million based on the estimated fair value of the Notes, and the residual of $34.8 million was recorded to equity. The transaction costs of $6.7 million directly related to the issuance were proportionally allocated to the liability and equity components. The total we recorded to equity upon issuance was $20.1 million after a deferred tax liability of $13.5 million and $1.2 million of transaction costs.

As of June 30, 2010, the fair value of our Notes was approximately $174.7 million, the carrying value of our Notes was $170.1 million and the amount recorded to equity was $20.4 million after a deferred tax liability of $13.2 million and $1.2 million of transactions costs. The unamortized debt discount as of June 30, 2010 was $29.9 million and the amortization of the debt discount will be recognized as non-cash interest expense. We recorded $4.0 million in interest expense in the first six months of 2010 related to the contractual interest coupon of the Notes. We recorded $3.0 million in non-cash interest expense in 2010 related to the amortization of the debt discount. The unamortized debt discount will be recognized as non-cash interest expense over the remaining periods in the amount of $3.0 million in 2010, $6.6 million in 2011, $7.1 million in 2012, $7.7 million in 2013, and $5.5 million in 2014.

Letters of credit

As of June 30, 2010, we had four irrevocable standby letters of credit that totaled $12.6 million. These standby letters of credit, which expire at various times through 2010, are used to collateralize certain obligations to third parties. We expect to renew these letters of credit. As of June 30, 2010, no amounts were outstanding under these standby letter of credit agreements.

Redbox Rollout Agreement

In November 2006, our Redbox subsidiary and McDonald’s USA entered into a Rollout Purchase, License and Service Agreement (the “Rollout Agreement”) giving McDonald’s USA and its franchisees and franchise marketing cooperatives the right to purchase DVD rental kiosks to be located at selected McDonald’s restaurant sites for which Redbox subsequently received proceeds. The proceeds under the Rollout Agreement are classified as debt and the interest rate is based on similar rates that Redbox has with its kiosk sale-leaseback transactions. The payments made to McDonald’s USA over the contractual term of the Rollout Agreement, which is five years, will reduce the accrued interest liability and principal. The future payments made under this Rollout Agreement contain a minimum annual payment of $2.1 million as well as the variable payouts based on this license fee earned by McDonald’s USA and its franchisees. As of June 30, 2010, debt associated with the Rollout Agreement of $14.3 million was included in current and long-term debt in our Consolidated Balance Sheets. As of June 30, 2010, included in “Other accrued liabilities” in our Consolidated Balance Sheets was accrued interest associated with the Rollout Agreement of $2.4 million.

NOTE 10: FAIR VALUE

The carrying amounts for cash and cash equivalents, our receivables and our payables approximate fair value, which is the amount for which the instrument could be exchanged in a current transaction between willing parties. The fair value of our revolving line of credit approximates its carrying amount.

FASB ASC Subtopic 820-10, guidance for fair value measurement and disclosure, establishes a hierarchy that prioritizes fair value measurements based on the types of inputs used for the various valuation techniques. The levels of the hierarchy are described below:

 

•

Level 1: Observable inputs such as quoted prices in active markets for identical assets or liabilities;

 

•

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly; these include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active;

 

•

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

The following tables present our financial assets and liabilities that have been measured at fair value as of June 30, 2010 and December 31, 2009, and indicate the fair value hierarchy of the valuation inputs utilized to determine such fair value. We use a market approach as our valuation technique for items in the table.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

		Balance as of June 30, 2010
		(in thousands)
		Level 1			Level 2			Level 3
Revolving credit facility			0		$	225,000		0
Convertible debt			0			170,066		0
Cash and cash equivalents		$	100,196			0		0
Interest rate swap liability			0			3,248		0
Short-term investments			85			0		0

 

		Balance as of December 31, 2009
		(in thousands)
		Level 1			Level 2			Level 3
Revolving credit facility			0		$	225,000		0
Convertible debt			0			167,068		0
Cash and cash equivalents		$	9,496			0		0
Interest rate swap liability			0			5,374		0
Short-term investments			85			0		0

The interest rate swap liability is included in “Other accrued liabilities” and short-term investments is included in “Prepaid expenses and other current assets” in our Consolidated Balance Sheets. The cash and cash equivalents amount above represents amounts invested in money market accounts.

NOTE 11: CONTINGENCIES

In April 2007, we received a request for arbitration filed by ScanCoin before the Arbitration Institute of the Stockholm Chamber of Commerce regarding ownership of intellectual property related to an agreement between Coinstar and ScanCoin dated April 23, 1993. In October 2007, we filed a claim in United States District Court for the Northern District of Illinois against ScanCoin North America alleging that it is infringing on a patent we own relating to self-service coin kiosks. In April 2010, we agreed to pay ScanCoin $3.3 million, and in return, the parties agreed to a mutual release of all claims and to dismiss the Swedish arbitration and the U.S. case without prejudice. ScanCoin recognized Coinstar’s ownership of all patents and patent applications at issue in the arbitration. In addition, the parties granted each other mutual covenants not to sue on certain patents, and Coinstar provided ScanCoin a covenant not to sue on certain other patents in connection with certain of ScanCoin’s business and in a non-retail field of use. The $3.3 million settlement amount, along with an additional $2.1 million in legal costs previously capitalized on the basis of anticipation of a successful defense, was expensed during the first quarter of 2010 and is recorded in the line “Litigation settlement” in the Consolidated Statements of Net Income.

In October 2008, our Redbox subsidiary filed a complaint against Universal Studios in the U.S. District Court for the District of Delaware. Redbox asserted antitrust, copyright misuse, and tortious interference claims, in response to distribution terms implemented or proposed by Universal Studios that would have prohibited us from receiving delivery of their DVD titles until several weeks following their release for sale. Pursuant to the terms of the Universal Studios Agreement, on April 22, 2010, Redbox agreed to dismiss its complaint against Universal Studios with prejudice. Redbox also filed separate complaints against Fox and Warner Home Video (“Warner”) in August 2009, alleging substantially similar claims to those in the Universal Studios litigation. In November 2009, Redbox filed amended complaints against Fox and Warner, supplementing its original complaints with additional claims of tortious interference and unfair competition. Pursuant to the terms of the agreements with Warner and Fox, on February 16, 2010 and April 22, 2010, respectively, Redbox agreed to dismiss its complaints against Warner and Fox with prejudice.

In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a class action complaint against our Redbox subsidiary in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. The plaintiff alleges that, among other things, Redbox charges consumers illegal and excessive late fees in violation of the Illinois Consumer Fraud and Deceptive Business Practices Act and other state statutes. In November 2009, Redbox removed the case to the U.S. District Court for the Southern District of Illinois. In February 2010, this court remanded the case to the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. In May 2010, the state court denied Redbox’s motion to dismiss the plaintiff’s claims, and also denied the plaintiff’s motion for partial summary judgment. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter.

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Three and Six Months Ended June 30, 2010 and 2009

(unaudited)

 

NOTE 12: PURCHASE OF REMAINING NON-CONTROLLING INTERESTS IN REDBOX

Effective on January 18, 2008, when we exercised our option to acquire a majority ownership interest in the voting equity of Redbox and our ownership interest increased from 47.3% to 51.0%, we began consolidating Redbox’s financial results into our Consolidated Financial Statements. On February 26, 2009, we purchased the remaining outstanding interests of Redbox, and Redbox became a wholly-owned subsidiary of Coinstar at that time.

NOTE 13: SUPPLEMENTAL CASH FLOW INFORMATION

The following table provides supplemental cash flow information for the period indicated for our continuing operations:

 

		Three Months Ended June 30,							Six Months Ended June 30,
		2010			2009				2010			2009
		(in thousands)							(in thousands)
CASH FLOW INFORMATION FOR CONTINUING OPERATIONS:
Cash paid during the period for interest		$	6,520		$	6,602			$	10,409		$	11,390
Cash paid during the period for income taxes			1,599			505				2,134			918
NONCASH INVESTING AND FINANCING ACTIVITIES FROM CONTINUING OPERATIONS:
Non-cash consideration for purchase of Redbox non-controlling interest		$	0		$	(90,297	)		$	0		$	59,301
Purchase of vehicles financed by capital lease obligations			1,023			295				1,635			1,393
Non-cash leasehold improvement additions			2,364			0				2,364			0

 

Non-cash consideration for purchase of Redbox non-controlling interest was negative in the second quarter of 2009 due to cash paid subsequent to the initial purchase of Redbox in the first quarter of 2009.

 

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and related Notes included elsewhere in this Quarterly Report on Form 10-Q. Except for the consolidated historical information, the following discussion contains forward-looking statements that involve risks and uncertainties, such as our objectives, expectations and intentions. Our actual results could differ materially from results that may be anticipated by such forward-looking statements and discussed elsewhere herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and those discussed under “Risk Factors” in Item IA of Part II of this Quarterly Report on Form 10-Q and in Item IA of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2009 (the “Form 10-K”). Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to revise any forward-looking statements in order to reflect events or circumstances that may subsequently arise. Readers are urged to carefully review and consider the various disclosures made in this report and in our other reports filed with the SEC that attempt to advise interested parties of the risks and factors that may affect our business, prospects and results of operations.

Overview

We are a leading provider of automated retail solutions offering convenient products and services that benefit consumers and drive incremental retail traffic and revenue for retailers. Our core offerings in automated retail include our DVD and Coin businesses. Our DVD services consist of self-service DVD kiosks where consumers can rent or purchase movies. Our Coin services consist of self-service coin-counting kiosks where consumers can convert their coin to cash, a gift card or an e-certificate, among other options. As of June 30, 2010, we had approximately 26,900 DVD kiosks in 24,000 locations and 19,000 coin-counting kiosks in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants.

Recent events

Sale of electronic payment services business (“E-Pay Business”)

On May 25, 2010, we sold our subsidiaries comprising our E-Pay Business to InComm Holdings, Inc. and InComm Europe Limited (collectively “InComm”) for an aggregate purchase price of $40.0 million. The purchase price is subject to a post-closing net working capital adjustment. Our continuing cash flows from the E-Pay Business after the disposal are expected to be insignificant. We have presented the disposition of our E-Pay Business as well as the operating results from our E-Pay Business under discontinued operations in our Consolidated Statements of Net Income for all periods presented.

Money Transfer Business

As part of exploring strategic alternatives for our Money Transfer business, we committed to a formal plan to sell the Money Transfer business and in the second quarter of 2010 have met the requirements to account for the Money Transfer business as assets held for sale. As a result, we measured our Money Transfer business assets and liabilities at fair value less costs to sell and classified the assets and liabilities as held for sale at June 30, 2010. In addition, the following two conditions that require a component of a business classified as held for sale be reported in discontinued operations for our Money Transfer business have been met:

 

1.

The operations and cash flows of the component have been (or will be) eliminated from the ongoing operations of the entity as a result of the disposal transaction; and

 

2.

The entity will not have any significant continuing involvement in the operations of the component after the disposal transaction.

Our continuing cash flows from the Money Transfer business after the disposal are expected to be insignificant. We have presented the operating results from our Money Transfer business under discontinued operations in our Consolidated Statements of Net Income for all periods presented.

Paramount agreement

On June 15, 2010, Paramount Home Entertainment Inc. (“Paramount”) exercised its option to extend the term of the revenue sharing license agreement (the “Paramount Agreement”) between Paramount and our Redbox subsidiary to December 31, 2014. As per the terms of the original agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Redbox will continue to receive delivery of the titles by the “street date,” the first date on which the DVDs are available to the general public for home entertainment purposes, whether

 

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on a rental or sell-through basis. At Paramount’s discretion, the Paramount Agreement may be terminated earlier on December 31, 2011. As a result of the extension, we granted 200,000 shares of restricted stock to Paramount which vest over the remaining term of the agreement.

Universal Studios agreement

On April 22, 2010, our Redbox subsidiary entered into a rental revenue sharing agreement (the “Universal Studios Agreement”) with Universal Studios Home Entertainment LLC (“Universal Studios”). Under the Universal Studios Agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Under the Universal Studios Agreement, Redbox will make the DVDs available for rental 28 days after the “street date,” the earliest date established by Universal Studios on which the DVDs are initially made available to the general public, whether on a rental or sell-through basis. In addition, and pursuant to the terms of the Universal Studios Agreement, Redbox agreed to dismiss with prejudice its lawsuit against Universal Studios relating to Redbox’s access to Universal Studios titles.

20th Century Fox agreement

On April 22, 2010, our Redbox subsidiary entered into a disc output lease and rental agreement (the “Fox Agreement”) with 20th Century Fox Home Entertainment LLC (“Fox”). Under the Fox Agreement, Redbox agrees to license minimum quantities of theatrical and direct-to-video DVDs for rental at each location that has a DVD-rental kiosk owned and/or operated by Redbox in the United States. Under the Fox Agreement, Redbox will make the DVDs available for rental 28 days after the “retail street date,” the earliest date established by Fox on which the DVDs are initially made available to the general public, whether on a rental or sell-through basis. In addition, and pursuant to the terms of the Fox Agreement, Redbox agreed to dismiss with prejudice its lawsuit against Fox relating to Redbox’s access to Fox titles.

Management of Business Segments

We sold our E-Pay Business in May 2010 and we reclassified our Money Transfer business to assets of business held for sale and discontinued operations in the second quarter of 2010, and as a result, our business segments are now DVD services and Coin services:

 

•

DVD services – We offer self-service DVD rentals through 26,900 kiosks in 24,000 locations where consumers can rent or purchase movies. Our DVD kiosks are installed primarily at leading grocery stores, mass merchants, drug stores, restaurants, and convenience stores. Our DVD kiosks supply the functionality of a traditional video rental store, yet typically occupy an area of less than ten square feet. Consumers use a touch screen to select their DVD, swipe a valid credit or debit card, and receive their movie(s). The process is designed to be fast, efficient and fully automated with no membership fees. DVD services revenue is generated primarily through fees charged to rent a DVD. In retailers with high performing DVD kiosks we may add another kiosk to drive additional revenue and provide a broader product offering.

 

•

Coin services – We offer self-service coin-counting services. We own and service all of our coin-counting kiosks, providing a convenient and trouble-free service to retailers. We own and operate more than 19,000 coin-counting machines in the United States, Canada, Puerto Rico, Ireland, and the United Kingdom (approximately 12,000 of which are enabled to provide electronic payment products and services). Coin-counting revenue is generated through transaction fees from our consumers and retailers.

We manage our business by evaluating the financial results of these segments, focusing primarily on segment revenue and segment operating income from continuing operations before depreciation, amortization and other, and stock compensation expense and share-based payments (“segment operating income”). Segment operating income contains the internally allocated costs including the shared service functions, which consist primarily of corporate executive management, sales, finance, legal, human resources, and information technology. We also review depreciation and amortization allocated to each segment.

We utilize segment revenue and segment operating income because we believe they provide useful information for effectively allocating resources among business segments, evaluating the health of our business segments based on metrics that management can actively influence, and gauging our investments and our ability to service, incur or pay down debt. Specifically, our CEO evaluates segment revenue and segment operating income, and assesses the performance of each business segment based on these measures, as well as, among other things, the prospects of each of the segments and how they fit into our overall strategy. Our CEO then decides how resources should be allocated among our business segments. For

 

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example, if a segment’s revenue decreases more than expected, our CEO may consider allocating less financial or other resources to that segment in the future. We continually evaluate the shared service allocation methods used for segment reporting purposes, and this may result in changes to segment allocations in future periods.

See Note 6 of the Consolidated Financial Statements for additional information regarding business segments.

Strategy

Our strategy is based upon leveraging our core competencies in the automated retail space to provide the consumer with convenience and value and to help retailers drive incremental traffic and revenue. Our competencies include success in building strong consumer and retailer relationships, and in deploying, scaling and managing kiosk businesses. We build strong consumer relationships by providing valuable self-service products and services in convenient locations. We build strong retailer relationships by providing retailers with turnkey solutions that complement their businesses without significant outlays of time and financial resources.

We expect to continue devoting significant resources to our automated retail strategy, developing the information technology systems and technology infrastructure necessary to support our products and services, and adding administrative personnel to support our growing organization. We expect to continue evaluating new marketing and promotional programs to increase use of our products and services.

Purchase of the remaining non-controlling interests in Redbox

Effective on January 18, 2008, when we exercised our option to acquire a majority ownership interest in the voting equity of Redbox and our ownership interest increased from 47.3% to 51.0%, we began consolidating Redbox’s financial results into our Consolidated Financial Statements. On February 26, 2009, we purchased the remaining outstanding interests of Redbox. Redbox is now a wholly-owned subsidiary of Coinstar.

Results of Operations

Summary of operating results

Total revenue/Total operating income

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Total consolidated revenue		$	342.4			$	253.8			$	88.6		34.9	%		$	665.5			$	466.6			$	198.9		42.6	%
Total consolidated income from operations		$	29.3			$	25.8			$	3.5		13.6	%		$	53.9			$	46.3			$	7.6		16.4	%
Income from operations as a % of Total Revenue			8.6	%			10.2	%									8.1	%			9.9	%

Three months ended June 30, 2010 compared to three months ended June 30, 2009

The increase in our total consolidated revenue for the second quarter of 2010 compared with the second quarter of 2009 was driven primarily by our DVD services segment, which accounted for $83.0 million of the change as a result of an increase in the number of DVD installed kiosks in our retailers’ locations as well as increased rentals from our existing installed kiosks. The number of our DVD kiosks installed was 26,900 at June 30, 2010, representing a net increase of 9,000 kiosks from June 30, 2009. In addition, same store sales for our DVD services segment grew by approximately $6.5 million, or 3.5% and net revenue per transaction increased to $2.17 in the second quarter of 2010 compared with $2.04 during the prior year quarter.

The increase in our consolidated income from operations for the second quarter of 2010 compared to the second quarter of 2009 was driven primarily by the increase in our net segment operating income of $15.5 million, $14.8 million of which came from the DVD segment, offset by the increase in depreciation, amortization and other expense of $9.4 million and the increase in stock-based compensation and share-based payments expense of $2.7 million. The increase in depreciation, amortization and other expense was primarily due to the increase in installations of DVD kiosks and $2.0 million of increased depreciation and amortization expense resulting from a change in the estimated useful lives of DVDXpress kiosks. Share-based payment expense increased due to $1.0 million related to our copy depth license agreement with SPHE Scan Based Trading Corporation (“Sony”), a subsidiary of Sony Pictures Home Entertainment Inc., that we entered into in July 2009 and $1.2 million related to shares granted in the second quarter of 2010 to Paramount upon its exercise of the option to extend the term of the revenue sharing license agreement between Paramount and our Redbox subsidiary. Our segment operating income and depreciation, amortization and other expense is discussed individually for each segment below.

 

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Adjusted earnings, before interest, taxes, depreciation and amortization, and other from continuing operations (“adjusted EBITDA from continuing operations”), a non-GAAP measure, totaled $65.5 million for the second quarter of 2010, compared with $50.0 million for the second quarter of 2009. Adjusted EBITDA from continuing operations increased during the current year quarter primarily due to the year-over-year increases in consolidated revenue and segment operating income. Income from continuing operations, the comparable GAAP measure to adjusted EBITDA from continuing operations, totaled $12.8 million in the second quarter of 2010 compared with $10.5 million in the second quarter of 2009. The increase is due to increased segment operating income in the current year period as discussed above. See “Non-GAAP Financial Measures” section below for our reconciliation of adjusted EBITDA from continuing operations to income from continuing operations.

Six months ended June 30, 2010 compared to six months ended June 30, 2009

The increase in our total consolidated revenue for the first six months of 2010 compared with the first six months of 2009 was driven primarily by our DVD services segment which accounted for $191.5 million of the change as a result of an increase in the number of DVD installed kiosks in our retailers’ locations as well as increased rentals from our existing installed kiosks. The number of our DVD kiosks installed was 26,900 at June 30, 2010, representing a net increase of 9,000 kiosks from June 30, 2009. In addition, same store sales for our DVD services segment grew by approximately $37.4 million, or 11.1% and net revenue per transaction increased to $2.16 in the first six months of 2010 compared with $2.02 during the first six months of 2009.

The increase in our consolidated income from operations for the first six months of 2010 compared to the first six months of 2009 was driven primarily by the favorable results from our net segment operating income of $32.6 million, of which $38.4 million of the increase was provided by our DVD services segment, offset by the increase in depreciation, amortization and other expense of $22.0 million and the increase in stock-based compensation and share-based payments expense of $3.0 million. The increase in depreciation, amortization and other expense was primarily due to the increase in installations of DVD kiosks, $5.2 million of increased depreciation and amortization expense resulting from a change in the estimated useful lives of certain DVDXpress kiosks and $3.3 million in disposal costs of coffee kiosks during the first six months of 2010. Share-based payment expense increased due to $1.6 million related to our copy depth license agreement with Sony that we entered into in July 2009 and $1.2 million related to shares granted in the second quarter of 2010 to Paramount upon its exercise of the option to extend the term of the revenue sharing license agreement between Paramount and our Redbox subsidiary. Our segment operating income and depreciation, amortization and other expense is discussed individually for each segment below.

Adjusted EBITDA from continuing operations totaled $125.9 million for the first six months of 2010, compared with $93.3 million for the first six months of 2009. Adjusted EBITDA from continuing operations increased during the current year period primarily due to the year-over-year increases in consolidated revenue and segment operating income. Income from continuing operations, the comparable GAAP measure to adjusted EBITDA from continuing operations, totaled $22.1 million in the first six months of 2010 compared with $20.4 million in the first six months of 2009. The increase is primarily due to increased depreciation in the current year period as discussed above. See “Non-GAAP Financial Measures” section below for our reconciliation of adjusted EBITDA from continuing operations to income from continuing operations.

Segment Revenue/Operating income (loss)/Depreciation, amortization and other

DVD services

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
DVD services revenue		$	271.9			$	188.9			$	83.0		43.9	%		$	535.1			$	343.6			$	191.5		55.7	%
DVD services operating income		$	39.0			$	24.2			$	14.8		61.2	%		$	83.5			$	45.1			$	38.4		85.1	%
Operating income as a % of segment revenue			14.3	%			12.8	%									15.6	%			13.1	%

Three months ended June 30, 2010 compared to three months ended June 30, 2009

The increase in DVD services revenue for the second quarter of 2010 compared with the second quarter of 2009 was primarily driven by the increase in the number of rentals resulting from new kiosk placements. Also contributing to the growth in DVD revenue was an increase in net revenue per transaction to $2.17 in the second quarter of 2010 compared with

 

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$2.04 during the prior year quarter, as well as an increase in the volume of rentals from existing installed kiosks with same store sales growing by approximately $6.5 million, or 3.5%. The same store sales growth rate was negatively impacted by the transitional effects of contractual delays in procuring DVD content from certain studios. The recently signed agreements with Warner Home Video (“Warner”), Universal Studios and Fox make DVDs available for rental 28 days after a title’s “street date” (the earliest date established by the studio on which the title’s DVDs are initially made available to the general public on a rental or sell-through basis). Despite the negative impact on same store sales growth from the product delays, this product is procured at a lower per unit cost than product acquired through third party distributors and product purchased by our field team through third party retailers and we expect these agreements to have a favorable impact on our operating income margins.

The DVD services segment operating income increased for the second quarter of 2010 as compared with the prior year quarter, primarily reflecting the favorable impact of the growth in segment revenue. The increase in DVD services segment operating income as a percentage of revenue for the second quarter of 2010 compared with the second quarter of 2009 reflects the favorable effects of leveraging general and administrative expenses over the increased revenue base, offset in part by increased spending on national marketing programs, including radio advertising, search engine marketing and social media outlets. Gross margin as a percentage of revenue for our DVD services segment totaled 56.4% for the second quarter of 2010 compared with 57.4% for the second quarter of 2009. Gross margin for our DVD services segment is computed as segment revenue, less DVD product costs which includes the share-based payment expense associated with restricted stock that has been granted to certain studios under the supply agreements. The decline in gross margin was due in part to the share-based payment expense, as well as a decrease in DVD salvage values.

Our DVD content has been acquired from three primary sources: through direct supply agreements with certain studios, through third party distributors, and from purchases made through third party retailers by our field team. Upon entering into the previously announced DVD supply agreements with Warner, Universal and Fox, we no longer use our field team to purchase DVD content from third party retailers. Our direct supply agreements with studios provide for a lower initial product cost than a purchase from a distributor; however, we typically cannot re-sell this product at the end of its rental term resulting in no salvage value. Some of the direct supply agreements provide that a percentage of the rental revenue be shared with the movie studios. The cost of DVDs procured through direct supply agreements with movie studios comprised 93% and 23% of the total cost of DVD purchases during the second quarters of 2010 and 2009, respectively.

If we do not have a direct supply agreement with a movie studio, we purchase DVD content from distributors. These purchases are at a higher initial product cost than the direct supply agreements with movie studios; however, we attempt to re-sell the product at the end of its rental term. Over the last two years, we have experienced steady declines in the salvage values of product purchased from distributors. As we have entered into several direct supply agreements with movie studios, the cost of DVDs procured through purchases from distributors has declined substantially from the prior year and comprised 6% of the total cost of DVD purchases during the second quarter of 2010, compared with 76% for the second quarter of 2009.

In the instances where a movie studio previously restricted the distribution of DVDs to our DVD services segment, our field team procured the product from third party retailers or wholesale distributors. The DVDs purchased through these alternative procurement sources were acquired at a higher cost and typically in less advantageous quantities than our other two procurement sources. The cost of DVDs acquired through the alternative procurement sources comprised 1% of the total cost of DVD purchases during the second quarters of 2010 and 2009. In February 2010, we entered into a DVD licensing agreement with Warner and in April 2010, we entered into the Universal Studios Agreement and the Fox Agreement. As a result of these agreements, there are no movie studios restricting the distribution of DVDs to our DVD services segment.

Six months ended June 30, 2010 compared to six months ended June 30, 2009

The increase in DVD services revenue for the first six months of 2010 compared with the first six months of 2009 was primarily driven by the increase in the number of rentals resulting from new kiosk placements. Also contributing to the growth in DVD revenue was an increase in the volume of rentals from existing installed kiosks with same store sales growing by approximately $37.4 million, or 11.1%, as well as an increase in net revenue per transaction to $2.16 in the first six months of 2010 compared with $2.02 during the first six months of the prior year.

The DVD services segment operating income increased for the first six months of 2010 as compared with the first six months in the prior year reflecting the favorable impact of the growth in segment revenue. The increase in DVD services segment operating income as a percentage of revenue for the first six months of 2010 compared with the first six months of 2009 primarily reflects the favorable effects of leveraging general and administrative expenses over the substantially higher revenue base. Gross margin as a percentage of revenue for our DVD services segment totaled 57.7% for the first six months of 2010 compared with 58.4% for the first six months of 2009. The decline in gross margin was due in part to the share-based payment expense associated with restricted stock that has been granted to certain studios under the supply agreements, as well as a decrease in DVD salvage values.

 

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The cost of DVDs procured through direct supply agreements with movie studios comprised 90% and 28% of the total cost of DVD purchases during the first six months of 2010 and 2009, respectively. The cost of DVDs procured through purchases from distributors comprised 5% and 70% of the total cost of DVD purchases during the first six months of 2010 and 2009, respectively. The cost of DVDs procured through the alternative procurement sources comprised 5% and 2% of the total cost of DVD purchases during the first six months of 2010 and 2009, respectively.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
DVD services depreciation, amortization and other		$	23.9			$	14.7			$	9.2		62.6	%		$	46.1			$	27.9			$	18.2		65.2	%
Depreciation, amortization and other as a % of segment revenue			8.8	%			7.8	%									8.6	%			8.1	%

DVD services segment depreciation, amortization and other increased both in the second quarter of 2010 compared with the second quarter of 2009 and during the first six months of 2010 compared to the first six months of 2009 primarily due to depreciation expense associated with the net installation of 9,000 DVD kiosks over the last four quarters. Additionally, in the first quarter of 2010, we revised the estimated useful lives of certain DVDXpress kiosks. The change in estimated useful lives resulted in additional depreciation expense of $2.0 million in the second quarter of 2010 and $5.2 million in the first six months of 2010.

Coin services

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng				% Chng
Coin services revenue		$	70.4			$	64.9			$	5.5		8.5	%		$	130.4			$	123.0			$	7.4			6.0	%
Coin services operating income		$	26.5			$	25.8			$	0.7		2.7	%		$	42.5			$	48.3			$	(5.8	)		-12.0	%
Operating income as a % of segment revenue			37.6	%			39.8	%									32.6	%			39.3	%

Three months ended June 30, 2010 compared to three months ended June 30, 2009

The increase in Coin services revenue for the second quarter of 2010 compared with the second quarter of 2009 was primarily driven by an increase in our coin-counting transaction fee from 8.9% to 9.8% that took effect for most of our coin-counting kiosks in the first quarter of 2010. Same store sales growth was 7.9% during the second quarter of 2010 for the Coin services segment, compared with a negative 4.3% in the prior year period.

The increase in Coin services segment operating income for the second quarter of 2010 compared with the second quarter of 2009 was primarily driven by the increased revenue, offset by increased costs associated with higher revenue including field operations, revenue share, and incremental personnel-related costs in the general and administrative function to support the higher revenues.

The decrease in Coin services segment operating income as a percentage of revenue was primarily driven by increased percentage in operating expenses due in part to the higher field operations resulting from kiosk repair and maintenance costs, increased revenue share expense and transactional tax expense as a percentage of revenue in the second quarter of 2010 compared with the prior period.

Six months ended June 30, 2010 compared to six months ended June 30, 2009

The increase in Coin services revenue for the first six months of 2010 compared with the first six months of 2009 was primarily driven by the increase in our coin-counting transaction fee. Excluding currency fluctuations, Coin services revenue increased by $6.7 million (or 5.4%) for the second quarter of 2010 compared with the prior year period.

The decrease in Coin services segment operating income for the first six months of 2010 compared with the first six months of 2009 was primarily driven by $5.4 million in costs we incurred due to our patent settlement with ScanCoin in April 2010. The $3.3 million settlement amount, along with an additional $2.1 million in legal costs previously capitalized in anticipation of a successful defense of the patents, was expensed during the first quarter of 2010.

 

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The decrease in Coin services segment operating income as a percentage of revenue was primarily driven by the patent settlement and increased percentage in operating expenses due in part to the higher field operations resulting from kiosk repair and maintenance costs, increased revenue share expense and transactional tax expense as a percentage of revenue in the first six months of 2010 compared with the prior year period.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Coin services depreciation, amortization and other		$	7.7			$	7.4			$	0.3		4.1	%		$	18.2			$	14.4			$	3.8		26.4	%
Depreciation, amortization and other as a % of segment revenue			10.9	%			11.4	%									14.0	%			11.7	%

Depreciation, amortization and other was consistent in the second quarter of 2010 for the Coin services segment compared with the second quarter of 2009. Depreciation, amortization and other expenses increased in the first six months of 2010 for the Coin services segment compared with the first six months of 2009 primarily due to the $3.2 million disposal of coffee kiosks in the first quarter of 2010 included in our Coin segment, which is included in depreciation expense.

Expenses

Direct Operating Expenses

Our direct operating expenses consist primarily of (1) amortization of our DVD library, (2) transaction fees and commissions we pay to our retailers, (3) credit card fees and coin pick-up, transportation and processing expenses, and (4) field operations support. Variations in the percentage of transaction fees and commissions we pay to our retailers may result in increased expenses. Such variations are based on certain factors, such as total revenue, long-term non-cancelable contracts, installation of our kiosks in high traffic and/or urban or rural locations, new product commitments, or other criteria.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Direct operating expenses		$	241.8			$	174.9			$	66.9		38.3	%		$	466.8			$	318.4			$	148.4		46.6	%
as a % of Total Revenue			70.6	%			68.9	%									70.1	%			68.2	%

Direct operating expenses increased for the second quarter of 2010 and the first six months of 2010 compared with the prior year periods primarily due to the growth of DVD services revenue, resulting in increased product costs as well as the operating expenses associated with the increased revenue. The total increase in direct operating expenses for our DVD services segment for the second quarter of 2010 compared with the second quarter of 2009 was $65.4 million, of which approximately $62.5 million was driven by the increase in DVD services revenue. The total increase in direct operating expenses for our DVD services segment for the first six months of 2010 compared with the first six months of 2009 was $144.8 million, of which approximately $142.4 million was driven by the increase in DVD services revenue. Direct operating expenses for our Coin services segment increased $1.5 million and $3.6 million for the three and six months ended June 30, 2010, respectively compared to the prior year periods. The increases for the Coin services segment were due to higher revenue related to the fee increases resulting in higher direct operating expenses.

The direct operating expenses as a percentage of revenue increased by 1.7% and 1.9% during the second quarter of 2010 and the first six months of 2010 compared with the prior year periods. These increases were driven mainly by higher DVD product costs including the share-based payment expense associated with restricted stock that was granted to Sony in July 2009 and Paramount in June 2010.

Marketing

Our marketing expenses represent our cost of advertising, traditional marketing, on-line marketing, and public relations efforts in national and regional advertising and major international markets.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Marketing		$	5.9			$	3.7			$	2.2		59.5	%		$	8.6			$	6.7			$	1.9		28.4	%
as a % of Total Revenue			1.7	%			1.5	%									1.3	%			1.4	%

Marketing expenses increased for the second quarter of 2010 and the first six months of 2010 compared with the prior year periods due to increased spending in our DVD segment. During the second quarter of 2010, we introduced certain national marketing programs for our DVD segment through radio advertising, search engine marketing and social media outlets.

 

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Research and Development

Our research and development expenses consist primarily of the development costs of our kiosk software, network applications, machine improvements, and new product development. Research and development expenses represent expenditures to support development and design of our complementary new product ideas and to continue our ongoing efforts to enhance our existing products and services.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Research and development		$	1.8			$	1.3			$	0.5		38.5	%		$	3.2			$	2.6			$	0.6		23.1	%
as a % of Total Revenue			0.5	%			0.5	%									0.5	%			0.6	%

Research and development expenses were relatively consistent for 2010 periods as compared with 2009 periods.

General and Administrative

Our general and administrative expenses consist primarily of executive management, finance, management information system, human resources, legal, facilities, risk management, as well as administrative support for field operations.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
General and administrative		$	31.9			$	26.0			$	5.9		22.7	%		$	63.4			$	50.4			$	13.0		25.8	%
as a % of Total Revenue			9.3	%			10.2	%									9.5	%			10.8	%

General and administrative expenses increased during the second quarter of 2010 and the first six months of 2010 in order to sustain the growth of the DVD services segment. In addition, we incurred increased costs for our shared services function to support our DVD and Coin services segments.

Litigation settlement

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Litigation settlement		$	0.0			$	0.0			$	0.0		0.0	%		$	5.4			$	0.0			$	5.4		100.0	%
as a % of Total Revenue			0.0	%			0.0	%									0.8	%			0.0	%

During the first quarter of 2010 we recognized $5.4 million in costs due to our patent litigation settlement with ScanCoin in April 2010. The $3.3 million settlement amount, along with an additional $2.1 million in legal costs previously capitalized in anticipation of a successful defense of the patents, was expensed during the first quarter of 2010.

Depreciation and Other

Our depreciation and other expenses consist primarily of depreciation charges on our installed kiosks as well as on computer equipment and leased automobiles.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Depreciation and other		$	30.6			$	21.3			$	9.3		43.7	%		$	62.4			$	40.6			$	21.8		53.7	%
as a % of Total Revenue			8.9	%			8.4	%									9.4	%			8.7	%

Depreciation and other expenses increased in the second quarter of 2010 compared with the second quarter of 2009 primarily due to the net installation of 9,000 DVD kiosks and the change in useful lives of DVDXpress kiosks resulting in additional depreciation of $2.0 million in the second quarter of 2010.

Depreciation and other expenses increased in the first six months of 2010 due to the net installation of DVD kiosks and the change in estimated useful lives of DVDXpress kiosks and the disposal of coffee kiosks. The change in DVD kiosk useful lives resulted in additional depreciation of $5.2 million and the disposal of coffee kiosk added $3.3 million in depreciation.

 

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Amortization of Intangible Assets

Our amortization expense consists of amortization of intangible assets, which are mainly comprised of the value assigned to our acquired retailer relationships and, to a lesser extent, internally developed software.

 

		Three Months Ended June 30,														Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng			% Chng			2010				2009				$ Chng			% Chng
Amortization of intangible assets		$	1.0			$	0.9			$	0.1		11.1	%		$	1.9			$	1.8			$	0.1		5.6	%
as a % of Total Revenue			0.3	%			0.4	%									0.3	%			0.4	%

Amortization expense remained consistent for the second quarter and first six months of 2010 compared to the prior year periods.

Other Income and Expense

 

		Three Months Ended June 30,															Six Months Ended June 30,
(In millions, except percentages)		2010				2009				$ Chng				% Chng			2010				2009				$ Chng				% Chng
Interest expense		$	(9.2	)		$	(8.6	)		$	(0.6	)		7.0	%		$	(18.4	)		$	(15.1	)		$	(3.3	)		21.9	%
Non-controlling interests		$	0.0			$	0.0			$	0.0			0.0	%		$	0.0			$	(3.6	)		$	3.6			-100.0	%

Interest expense increased for the second quarter of 2010 compared with the second quarter of 2009 due to higher interest rates net of hedging, partially offset by increased interest expense due to higher average debt balances in the second quarter of 2009. Interest expense increased for the first six months of 2010 compared with the prior year period due to higher interest rates and higher average debt balances during the 2010 period.

Non-controlling interest for the first six months of 2009 represents the operating results, net of tax, for the 49% stake in Redbox that we did not own prior to our purchase of the remaining non-controlling interests in Redbox in February 2009.

Income Tax Expense

The effective tax rate from continuing operations attributable to Coinstar, Inc. was 36.5% and 38.9% for the second quarters ended June 30, 2010 and 2009, respectively. The effective tax rate from continuing operations attributable to Coinstar, Inc. was 37.8% and 39.0% for the six months ended June 30, 2010 and 2009, respectively. These rates differ from the federal statutory rate primarily due to incentive stock options. The effective tax rate was lower in the current year periods due to an increase in incentive stock option exercises compared with the prior year periods.

Liquidity and Capital Resources

Cash and Liquidity

A significant portion of our business involves collecting and processing large volumes of cash, most of it in the form of coins. We present three categories of cash on our balance sheet: cash and cash equivalents, cash in machine or in transit, and cash being processed.

As of June 30, 2010, we had cash and cash equivalents, cash in machine or in transit, and cash being processed totaling $257.1 million. This consisted of cash and cash equivalents immediately available to fund our operations of $132.6 million, cash in machine or in transit of $48.4 million and cash being processed of $76.1 million (which relates to our coin retailer payable liability as recorded in “accrued payable to retailers” in the Consolidated Balance Sheets). Working capital was $73.6 million as of June 30, 2010, compared with working capital of $16.1 million as of December 31, 2009. The increase in working capital was primarily due to the timing of payments to our vendors and retailers.

 

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Net cash provided by operating activities from continuing operations

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
		(in millions)								(in millions)
OPERATING ACTIVITIES:
Net income		$	13.4			$	7.0			$	19.8			$	12.5
Adjustments to reconcile net income to net cash provided by operating activities from continuing operations:
Depreciation and other			30.6				21.3				62.4				40.6
Amortization of intangible assets and deferred financing fees			1.5				1.2				2.9				2.3
Non-cash stock-based compensation for employees			2.3				1.9				5.0				4.7
Share-based payments for DVD agreement			2.2				0				2.8				0
Excess tax benefit on share-based awards			(5.5	)			(0.1	)			(6.2	)			(0.1	)
Deferred income taxes			5.6				2.7				8.8				4.5
(Gain) loss from discontinued operations, net of tax			(0.5	)			3.6				2.3				7.9
Non-cash interest from convertible debt			1.5				0				3.0				0
Other			0.0				(0.1	)			0.2				0.1
Subtotal of adjustments			37.7				30.5				81.2				60.0
Cash provided by changes in operating assets and liabilities			53.6				(4.5	)			56.4				(52.7	)
Net cash provided by operating activities from continuing operations		$	104.7			$	33.0			$	157.4			$	19.8

The increase in net cash provided by operating activities from continuing operations for the second quarter of 2010 compared with the second quarter of 2009 was due to an increase in cash provided by working capital of $58.1 million, the increase in adjustments to reconcile net income to net cash provided by operating activities of $7.2 million and the $6.4 million increase in net income. The increase in net cash provided by operating activities from continuing operations for the first six months of 2010 compared with the first six months of 2009 was due to an increase in cash provided by working capital of $109.1 million, the $21.2 million increase in adjustments to reconcile net income to net cash provided by operating activities, and the $7.3 million increase in net income.

Cash provided by working capital increased for both the three and six months ended June 30, 2010 compared to the prior year periods due to an increase in miscellaneous accruals, including studio-related accruals and accrued payroll bonuses. Cash provided by working capital also increased during both periods for 2010 due to the timing of payments to vendors. Adjustments to reconcile net income to net cash provided by operating activities increased during both periods in 2010 primarily due to the increase in depreciation expense.

Net cash used by investing activities from continuing operations

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
		(in millions)								(in millions)
INVESTING ACTIVITIES:
Purchase of property and equipment		$	(52.8	)		$	(38.3	)		$	(84.3	)		$	(73.3	)
Proceeds from sale of E-Pay Business			26.1				0				26.1				0
Proceeds from sale of fixed assets			0.2				0.1				0.3				0.2
Net cash used by investing activities from continuing operations		$	(26.5	)		$	(38.2	)		$	(57.9	)		$	(73.1	)

Our cash used by investing activities from continuing operations decreased during both the three and six months ended June 30, 2010 compared with the prior year periods primarily due to proceeds from the sale for our E-Pay business during the second quarter of 2010, partially offset by increased purchases of property and equipment for corporate infrastructure, particularly information technology.

 

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Net cash provided by financing activities from continuing operations

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
		(in millions)								(in millions)
FINANCING ACTIVITIES:
Principal payments on capital lease obligations and other debt		$	(10.7	)		$	(5.9	)		$	(19.3	)		$	(11.7	)
Net borrowings on credit facility			0				18.0				0				73.0
Borrowings on term loan			0				87.5				0				87.5
Financing costs associated with revolving line of credit and convertible debt			0				(1.3	)			0				(3.2	)
Cash used to purchase remaining non-controlling interests in Redbox			0				(92.3	)			0				(102.4	)
Excess tax benefit on share-based awards			5.5				0.1				6.2				0.1
Proceeds from exercise of stock options			25.0				1.8				27.3				2.3
Net cash provided by financing activities from continuing operations		$	19.8			$	7.9			$	14.2			$	45.6

Principal payments on capital lease obligations and other debt was higher during the three and six months ended June 30, 2010 as compared with the prior year periods due to an increase in our capital lease obligation balances year-over-year. Proceeds from the exercise of stock options was higher during the three and six months ended June 30, 2010 as compared with the prior year periods due to increased exercise activity. The excess tax benefit on share-based awards for the three and six months ended June 30, 2010 reflects the increased exercise activity. Excess tax benefits were not significant in 2009 in accordance with FASB ASC 718 as we were in a taxable loss position.

Free cash flow from continuing operations

Free cash flow from continuing operations, a non-GAAP measure, totaled a positive $51.8 million for the three months ended June 30, 2010 compared to negative $5.3 million in the prior year quarter. Free cash flow from continuing operations totaled a positive $73.0 million for the six months ended June 30, 2010 compared to negative $53.5 million in the prior year period. The increase in the current year periods compared with the prior year periods was due to increased net operating cash flow from continuing operations, offset by increased purchases of property and equipment, both of which are discussed above. See “Non-GAAP Financial Measures” section below for our definition of free cash flow from continuing operations and a reconciliation of free cash flow from continuing operations to net cash provided by operating activities.

Long-term debt

 

		June 30, 2010			December 31, 2009
		(in thousands)
Revolving line of credit (matures November 2012)		$	225,000		$	225,000
Convertible debt (matures September 2014)			170,066			167,109
Long-term debt		$	395,066		$	392,109

Convertible debt

In September 2009, we issued $200 million aggregate principal amount of 4% Convertible Senior Notes (the “Notes”) for proceeds, net of expenses, of approximately $193.3 million. The Notes bear interest at a fixed rate of 4% per annum, payable semi-annually in arrears on each March 1 and September 1, beginning March 1, 2010. The Notes mature on September 1, 2014. The effective interest rate on the Notes is 8.5%.

We have separately accounted for the liability and the equity component of the Notes in accordance with FASB ASC 470-20, Debt with Conversion and Other Options. As our Notes were not actively traded in the market at the time of issuance fair value was estimated using a discounted cash flow analysis, based on the borrowing rate for similar types of borrowing arrangements. Upon issuance, we recorded a liability of $165.2 million based on the estimated fair value of the Notes, and the residual of $34.8 million was recorded to equity. The transaction costs of $6.7 million directly related to the issuance were proportionally allocated to the liability and equity components. The total we recorded to equity upon issuance was $20.1 million after a deferred tax liability of $13.5 million and $1.2 million of transaction costs.

As of June 30, 2010, the fair value of our Notes was approximately $174.7 million, the carrying value of our Notes was $170.1 million and the amount recorded to equity was $20.4 million after a deferred tax liability of $13.2 million and $1.2 million of transactions costs. The unamortized debt discount as of June 30, 2010 was $29.9 million and the amortization of the debt discount will be recognized as non-cash interest expense. We recorded $4.0 million in interest expense in the first six months of 2010 related to the contractual interest coupon of the Notes. We recorded $3.0 million in non-cash interest expense

 

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in 2010 related to the amortization of the debt discount. The unamortized debt discount will be recognized as non-cash interest expense over the remaining periods in the amount of $3.0 million in 2010, $6.6 million in 2011, $7.1 million in 2012, $7.7 million in 2013, and $5.5 million in 2014.

As of June 30, 2010 we were in compliance with all covenants.

Letters of Credit

As of June 30, 2010, we had four irrevocable standby letters of credit that totaled $12.6 million. These standby letters of credit, which expire at various times through 2010, are used to collateralize certain obligations to third parties. We expect to renew these letters of credit. As of June 30, 2010, no amounts were outstanding under these standby letter of credit agreements.

Interest rate swap

During the first quarter of 2008, we entered into an interest rate swap agreement with Wells Fargo bank for a notional amount of $150.0 million to hedge against the potential impact on earnings from an increase in market interest rates associated with the interest payments on our variable-rate revolving credit facility. In the fourth quarter of 2008, we entered into another interest rate swap agreement with JP Morgan Chase for a notional amount of $75.0 million to hedge against the potential impact on earnings from an increase in market interest rates associated with the interest payments on our variable-rate revolving credit facility. One of our risk management objectives and strategies is to lessen the exposure of variability in cash flow due to the fluctuation of market interest rates and lock in an interest rate for the interest cash outflows on our revolving debt. Under the interest rate swap agreements, we receive or make payments on a monthly basis, based on the differential between a specific interest rate and one-month LIBOR. The interest rate swaps are accounted for as cash flow hedges as of June 30, 2010 and December 31, 2009. The cumulative net change in the fair value of the swaps was $3.2 million and was recorded in other comprehensive income, net of tax of $1.3 million, with the corresponding adjustment to “Other accrued liabilities” in our Consolidated Financial Statements. We reclassify a corresponding amount from “Accumulated other comprehensive income” to “Interest expense” in the Consolidated Statement of Net Income as the interest payments are made. Estimated losses in accumulated other comprehensive income of approximately $3.2 million are expected to be reclassified into earnings as a component of interest expense over the next twelve months. The net gain or loss included in our Consolidated Statement of Net Income representing the amount of hedge ineffectiveness was inconsequential. The term of the $75.0 million swap is through October 28, 2010. The term of the $150.0 million swap is through March 20, 2011.

Redbox Rollout Agreement

In November 2006, our Redbox subsidiary and McDonald’s USA entered into a Rollout Purchase, License and Service Agreement (the “Rollout Agreement”) giving McDonald’s USA and its franchisees and franchise marketing cooperatives the right to purchase DVD rental kiosks to be located at selected McDonald’s restaurant sites for which Redbox subsequently received proceeds. The proceeds under the Rollout Agreement are classified as debt and the interest rate is based on similar rates that Redbox has with its kiosk sale-leaseback transactions. The payments made to McDonald’s USA over the contractual term of the Rollout Agreement, which is five years, will reduce the accrued interest liability and principal. The future payments made under this Rollout Agreement contain a minimum annual payment of $2.1 million as well as the variable payouts based on this license fee earned by McDonald’s USA and its franchisees. As of June 30, 2010, debt associated with the Rollout Agreement of $14.3 million was included in current and long-term debt in our Consolidated Balance Sheets. As of June 30, 2010, included in “Other accrued liabilities” in our Consolidated Balance Sheets was accrued interest associated with the Rollout Agreement of $2.4 million.

Capital Resources

We believe our existing cash, cash equivalents and amounts available to us under our credit facility will be sufficient to fund our cash requirements and capital expenditure needs for at least the next 12 months. After that time, the extent of additional financing needed, if any, will depend on the success of our business. If we significantly increase installations beyond planned levels or if coin-counting kiosk or DVD kiosk volumes generated are lower than historical levels, our cash needs may increase. Furthermore, our future capital requirements will depend on a number of factors, including consumer use of our services, the timing and number of machine installations, the number of available installable machines, the type and scope of service enhancements and the cost of developing potential new product, service offerings, and enhancements and cash required to fund future acquisitions.

 

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Non-GAAP Financial Measures

Non-GAAP measures may be provided as a complement to results provided in accordance with United States generally accepted accounting principles (“GAAP”). Non-GAAP measures are not a substitute for measures computed in accordance with GAAP. Our non-GAAP measures may be different from the presentation of financial information by other companies.

We use the non-GAAP measure adjusted EBITDA from continuing operations. We have disclosed this measure so that users of the financial statements have the same financial data that management uses in making comparisons to our historical operating results and analyzing our underlying performance. Our management believes that adjusted EBITDA from continuing operations provides additional information to users of the financial statements regarding our ability to service, incur or pay down indebtedness. In addition, management uses adjusted EBITDA from continuing operations to internally evaluate performance and manage operations. Because adjusted EBITDA calculations may vary among other companies, the adjusted EBITDA from continuing operations figures presented in our discussion of Results of Operations section above may not be comparable with similarly titled measures of other companies. Adjusted EBITDA from continuing operations is not meant to be considered in isolation or as a substitute for U.S. GAAP financial measures. The difference between adjusted EBITDA from continuing operations and income from continuing operations, which is the most comparable GAAP financial measure, is that adjusted EBITDA from continuing operations excludes the impact of net interest expense, income taxes, depreciation, amortization and other certain non-cash charges including any write-off from early retirement of debt, goodwill impairment, and stock-based compensation and share-based payments from continuing operations. The table below provides a reconciliation of adjusted EBITDA from continuing operations to income from continuing operations for the periods presented.

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2010			2009			2010			2009
Income from continuing operations		$	12,841		$	10,530		$	22,080		$	20,431
Depreciation, amortization and other			31,612			22,175			64,292			42,325
Interest expense, net			9,073			8,611			18,339			15,077
Income taxes			7,389			6,702			13,395			10,729
Stock-based compensation and share-based expense			4,570			1,942			7,787			4,737
Adjusted EBITDA from continuing operations		$	65,485		$	49,960		$	125,893		$	93,299

In addition, from time to time, we use the non-GAAP financial measure “free cash flow from continuing operations.” The difference between free cash flow from continuing operations and net cash provided by operating activities, which is the most comparable GAAP financial measure, is that free cash flow from continuing operations reflects the impact of capital expenditures. Our management believes that free cash flow from continuing operations provides better cash flow information regarding our ability to service, incur or pay down indebtedness and repurchase our common stock. Free cash flow from continuing operations is not meant to be considered in isolation or as a substitute for U.S. GAAP financial measures. The table below provides a reconciliation of free cash flow from continuing operations to income from continuing operations for the periods presented.

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2010				2009				2010				2009
Net cash provided by operating activities from continuing operations		$	104,651			$	32,965			$	157,381			$	19,760
Purchase of property and equipment			(52,822	)			(38,288	)			(84,339	)			(73,276	)
Free cash flow from continuing operations		$	51,829			$	(5,323	)		$	73,042			$	(53,516	)

 

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Contractual Obligations

There have been no material changes during the period covered by this report and as of June 30, 2010, outside of the ordinary course of our business, to the contractual obligations specified in the table of contractual obligations included in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our 2009 Form 10-K with the exception of the following:

 

•

On February 12, 2010, our Redbox subsidiary entered into a rental revenue sharing agreement with Warner in which Redbox estimates that it would pay Warner approximately $124.0 million during the term of the Warner Agreement, which is expected to last from February 1, 2010 through January 31, 2012. Annual commitments under this agreement are expected to be $54.0 million in 2010 and $70.0 million in 2011.

 

•

On April 22, 2010, our Redbox subsidiary entered into a rental revenue sharing agreement with Universal Studios, and Redbox estimates that it would pay Universal Studios approximately $82.8 million, during the term of the Universal Studios Agreement, which is expected to last from April 22, 2010 through April 21, 2012. Annual commitments under this agreement are expected to be $23.2 million in 2010, $42.7 million in 2011, and $16.9 million in 2012.

 

•

On April 22, 2010, Redbox entered into a disc output lease and rental agreement with Fox, and Redbox estimates that it would pay Fox approximately $394.5 million, during the term of the Fox Agreement, which is expected to last from April 22, 2010 through April 21, 2015. However, at Fox’s discretion, the Fox Agreement may expire earlier on April 21, 2013. Annual commitments under this agreement are expected to be $36.1 million in 2010, $69.6 million in 2011, $80.2 million in 2012, $84.8 million in 2013, $91.0 million in 2014, and $32.8 million in 2015.

 

•

On June 15, 2010, Paramount exercised its option to extend the term of the revenue sharing license agreement between Paramount and our Redbox subsidiary to December 31, 2014. As a result, Redbox estimates that it would pay Paramount approximately $433.7 million during the term of the Paramount Agreement. Annual commitments under this agreement are expected to be $31.7 million in 2010, $92.3 million in 2011, $100.2 million in 2012, $103.5 million in 2013, and $106.0 million in 2014.

Seasonality

We have historically experienced seasonality in our revenue with higher revenue in the second half of the year than in the first half of the year. Our DVD product line experiences lower revenue in April and May due in part to improved weather and Daylight Saving Time, and in September and October, due in part to the beginning of the school year and the introduction of the new television season. The year-end and summer holiday months have historically been the highest rental months for DVD services. Our Coin product line generally experiences its highest revenue in the second half of the year due to increased retailer foot traffic and holiday shopping in the fourth quarter and an increase in consumers’ desire for disposable income in the summer months.

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with U.S. GAAP. Preparation of these statements requires management to make judgments and estimates. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the present circumstances. A summary of significant accounting policies and a description of accounting policies that are considered critical may be found in our Form 10-K at Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. There have been no material changes to the critical accounting policies previously disclosed in our 2009 Form 10-K.

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

We are subject to the risk of fluctuating interest rates in the normal course of business, primarily as a result of our credit agreement with a syndicate of lenders led by Bank of America, N.A. and investment activities that generally bear interest at variable rates. Because our investments have maturities of three months or less, and our credit facility interest rates are based upon either the LIBOR, prime rate or base rate plus an applicable margin, we believe that the risk of material loss is low and that the carrying amount of these balances approximates fair value.

Based on the balance of our outstanding revolving line of credit of $225.0 million as of June 30, 2010, an increase or decrease in interest rates over the next year would not affect our interest expense due to our interest rate swap arrangements. We have hedged our interest rate risk by entering into two interest rate swaps with notional amounts of $150.0 million and $75.0 million, respectively. The interest rate swaps convert our variable one-month LIBOR rate financing into a fixed interest rate financing. These fixed interest rate swaps reduce the effect of fluctuations in the market interest rates. The term of the $150.0 million swap is through March 20, 2011. The term of the $75.0 million swap is through October 28, 2010.

We are further subject to the risk of foreign exchange rate fluctuation in the normal course of business as a result of our operations in the United Kingdom, Ireland, Europe, Canada, and Mexico.

 

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Item 4.

Controls and Procedures

We maintain a set of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Management, with the participation of our chief executive officer and chief financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report and has determined that such disclosure controls and procedures are effective.

We also maintain a system of internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act). No changes in our internal control over financial reporting occurred during the quarter ended June 30, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

Item 1.

Legal Proceedings

In April 2007, we received a request for arbitration filed by ScanCoin before the Arbitration Institute of the Stockholm Chamber of Commerce regarding ownership of intellectual property related to an agreement between Coinstar and ScanCoin dated April 23, 1993. In October 2007, we filed a claim in United States District Court for the Northern District of Illinois against ScanCoin North America alleging that it is infringing on a patent we own relating to self-service coin kiosks. In April 2010, we agreed to pay ScanCoin $3.3 million, and in return, the parties agreed to a mutual release of all claims and to dismiss the Swedish arbitration and the U.S. case without prejudice. ScanCoin recognized Coinstar’s ownership of all patents and patent applications at issue in the arbitration. In addition, the parties granted each other mutual covenants not to sue on certain patents, and Coinstar provided ScanCoin a covenant not to sue on certain other patents in connection with certain of ScanCoin’s business and in a non-retail field of use.

In October 2008, our Redbox subsidiary filed a complaint against Universal Studios in the U.S. District Court for the District of Delaware. Redbox asserted antitrust, copyright misuse, and tortious interference claims, in response to distribution terms implemented or proposed by Universal Studios that would have prohibited us from receiving delivery of their DVD titles until several weeks following their release for sale. Pursuant to the terms of the Universal Studios Agreement, on April 22, 2010, Redbox agreed to dismiss its complaint against Universal Studios with prejudice. Redbox also filed separate complaints against Fox and Warner in August 2009, alleging substantially similar claims to those in the Universal Studios litigation. In November 2009, Redbox filed amended complaints against Fox and Warner, supplementing its original complaints with additional claims of tortious interference and unfair competition. Pursuant to the terms of the agreements with Warner and Fox, on February 16, 2010 and April 22, 2010, respectively, Redbox agreed to dismiss its complaints against Warner and Fox with prejudice.

In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a class action complaint against our Redbox subsidiary in the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. The plaintiff alleges that, among other things, Redbox charges consumers illegal and excessive late fees in violation of the Illinois Consumer Fraud and Deceptive Business Practices Act and other state statutes. In November 2009, Redbox removed the case to the U.S. District Court for the Southern District of Illinois. In February 2010, this court remanded the case to the Circuit Court for the Twentieth Judicial Circuit, St. Clair County, Illinois. In May 2010, the state court denied Redbox’s motion to dismiss the plaintiff’s claims, and also denied the plaintiff’s motion for partial summary judgment. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter.

 

Item 1A.

Risk Factors

Other than the risk factors discussed below, there have been no material changes from risk factors previously disclosed in our Form 10-K. As a result of the sale of our E-Pay Business, risk factors previously disclosed related to the E-Pay Business are no longer relevant.

Our inability to receive delivery of DVDs on the date of their initial release to the general public, or shortly thereafter, for home entertainment viewing could adversely affect our DVD services business.

Traditionally, businesses that rent movies in physical formats such as DVDs have enjoyed a competitive advantage over other movie distribution rental channels because of earlier timing of the distribution window for physical formats by movie

 

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studios. After the initial theatrical release of a movie, the major studios generally have made their movies available on physical formats for a 30- to 45-day release window before release to other movie distribution rental channels, such as pay-per view, video-on-demand, premium television, basic cable, and network and syndicated television. Increasingly, however, major studios have experimented with compressing the window between DVD and video-on-demand release or with releasing movies in each channel simultaneously. Additionally, in some cases, major studios have staggered releases of DVDs such that a movie might be less available for rental until as much as 28 days after the DVD becomes available for purchase at a retail outlet.

However, certain movie studios have changed or are changing and other movie studios could change their practices, including shortening or discontinuing altogether, or otherwise restricting, movie distribution windows, including simultaneous video-on-demand/computer downloads/online streaming and DVD releases or making video-on-demand/computer downloads/online streaming available prior to DVD release. For example, there have been recent announcements that certain movie studios have made new release titles available on video-on-demand or for online purchase on the same date as the DVD release. Further, certain studios have implemented or announced their intention to implement policies to lengthen the time that certain video retailers, including those providing movies on physical formats, must wait before renting movies following their initial release on DVD to retailers. For example, our Redbox subsidiary has entered into arrangements with Warner Home Video, Universal Studios Home Entertainment LLC and 20^th Century Fox Home Entertainment LLC that include delayed rental windows. Entering into these studio licensing arrangements that contain a delayed rental window may decrease consumer satisfaction and consumer demand, and we may lose consumers to our competitors that offer DVD titles without a delayed rental window. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

If we do not manage our DVD inventory effectively, our business, financial condition and results of operations could be materially and adversely affected.

A critical element of our DVD services business model is to optimize our inventory of DVD titles and copy depth to achieve satisfactory availability rates to meet consumer demand while also maximizing margins. If we do not timely acquire sufficient DVD titles, due to, for example, not correctly anticipating demand, intentionally acquiring fewer copies than needed to fully satisfy demand or the lack of available titles, we may not appropriately satisfy consumer demand, which could decrease consumer satisfaction and we could lose consumers to competitors. Conversely, if we attempt to mitigate this risk and acquire a larger number of copies to achieve higher availability rates for select titles or a wider range of titles, our inventory utilization would become less efficient and our margins for DVD services would be adversely affected. Our ability to accurately predict consumer demand as well as market factors, such as our ability to obtain satisfactory distribution arrangements, may impact our ability to timely acquire appropriate quantities of certain DVD titles. In addition, if we are unable to obtain or maintain favorable terms from our suppliers with respect to such matters as timely movie access, copy depth and product returns, among others, or if the price of DVDs increases or decreases generally or for certain titles, our inventories may become unbalanced and our margins may be adversely affected. Further, the delay in our ability to rent certain studios’ DVD titles pursuant to a delayed rental window may negatively affect consumer satisfaction and demand, and we could lose consumers to our competitors because of the timing of our inventory. In addition, if we are unable to comply with or lack the necessary internal controls to ensure appropriate documentation and tracking of DVD inventory, we may, among other things, violate certain of our studio licensing arrangements, be forced to pay a fee for unaccounted for DVDs and be susceptible to risks to theft and misuse of property, any of which may negatively affect our margins in the DVD services business. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.

For example, we have entered into licensing agreements with Sony Pictures Home Entertainment, Lionsgate Films and Paramount Home Entertainment under which we agreed to license minimum quantities of theatrical and direct-to-video DVDs for rental at our kiosks. Under these agreements, the studios agreed to provide delivery of their DVDs by the “street date,” the first date on which the DVD releases are available to the general public for home entertainment purposes on a rental basis (and in the case of Paramount Home Entertainment, on either a rental or sell-through basis). The terms of these agreements run through the end of 2014), but each of the movie studios have options to terminate the agreements in the second half of 2011 pursuant to the terms of the respective agreements. In addition, we have a licensing arrangement with Warner Home Video, Universal Studios Home Entertainment LLC and 20^th Century Fox Home Entertainment LLC that make DVDs available for rental 28 days after the street date (whether on a rental or sell-through basis). Our business, financial condition and results of operations could be materially and adversely affected if these agreements do not provide the expected benefits to us. For example, if the titles or format provided are not attractive to our consumers, we will be required to purchase too many copies of undesirable titles or an undesirable format, possibly in substantial amounts, which could adversely affect our DVD services business by decreasing consumer demand for offered DVD titles and consumer satisfaction with our services or negatively impacting margins. If studios that do not have a delayed rental window elect to delay the general release of DVDs to the rental market for significant periods after they are released for retail sales, demand

 

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for rental of these titles may be adversely affected. If consumers chose to rent these DVD titles from our competitors, purchase the DVD titles rather than rent from us, or find our DVD title selection unbalanced or unappealing, our business, operating results and financial condition could be materially and adversely affected. In addition, we have incurred and may incur additional non-cash increases to operating expenses amortized over the terms of any such arrangements that also could have a dilutive impact on our stockholders, such as the issuance of equity under certain of our studio contracts or to the extent we enter into similar arrangements with other movie studios in the future. Further, if some or all of these agreements prove beneficial but are early terminated, we could be negatively impacted. Moreover, if we cannot maintain similar arrangements in the future with these or other studios or distributors, or these arrangements do not provide the expected benefits to us, our business could suffer.

Litigation, arbitration, mediation, regulatory actions, investigations or other legal proceedings could result in material rulings, decisions, settlements, fines, penalties or publicity that could adversely affect our business, financial condition and results of operations.

Our business has in the past been, and may in the future continue to be, party to class actions, regulatory actions, investigations, arbitration, mediation and other legal proceedings. The outcome of such proceedings is often difficult to assess or quantify. Plaintiffs, regulatory bodies or other parties may seek very large or indeterminate amounts of money from us or substantial restrictions on our business activities, and the results, including the magnitude, of lawsuits, actions, settlements, decisions and investigations may remain unknown for substantial periods of time. The cost to defend, settle or otherwise finalize lawsuits, regulatory actions, investigations, arbitrations, mediations or other legal proceedings may be significant and such proceedings may divert management’s time. In addition, there may be adverse publicity associated with such developments that could decrease consumer acceptance of our products and services. As a result, litigation, arbitration, mediation, regulatory actions or investigations involving us or our affiliates may adversely affect our business, financial condition and results of operations.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Under the terms of our credit facility, we are permitted to repurchase up to (i) $25.0 million of our common stock plus (ii) proceeds received after November 20, 2007, from the issuance of new shares of capital stock under our employee equity compensation plans. However, our board of directors has only authorized the repurchase of up to $22.5 million of our common stock plus additional shares equal to the aggregate amount of net proceeds received after January 1, 2003, from our employee equity compensation plans. As of June 30, 2010, this authorization allowed us to repurchase up to $68.7 million of our common stock.

The following table summarizes information regarding shares repurchased during the quarter ended June 30, 2010:

 

		Total Number of Shares Repurchased (1)		Average Price  Paid per Share			Total Number of Shares Purchased as part of the Publicly Announced Repurchase Plans		Maximum Approximate Dollar Value of Shares that May Yet  be Purchased Under the Programs
4/1/10 - 4/30/10		705		$	34.37		0		$	54,357,558
5/1/10 - 5/31/10		1,921		$	55.36		0		$	66,723,195
6/1/10 - 6/30/10		33		$	53.02		0		$	68,672,121
		2,659		$	49.77		0		$	68,672,121

 

(1)	Represents shares tendered for tax withholding on vesting of restricted stock awards. None of these transactions are included against the dollar value of shares that may yet be purchased under the programs.

On June 25, 2010, we issued 200,000 shares of unregistered restricted common stock to Paramount in connection with Paramount exercising its option to extend the term of the revenue sharing license agreement between Paramount and our Redbox subsidiary on June 15, 2010 as discussed in Note 8 to our Consolidated Financial Statements included in this Form 10-Q. The issuance of the common stock was exempt from registration pursuant to the Securities Act of 1933, as amended (the “Securities Act”) by virtue of Section 4(2) and/or Regulation D promulgated thereunder as a transaction not involving a public offering. We believe that the issuance is exempt from the registration requirements of the Securities Act on the basis that: (1) Paramount represented it was an accredited investor as defined under the Securities Act; (2) there was no general solicitation; and

 

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(3) Paramount represented that it was purchasing such shares for its own account and not with a view towards distribution. The shares of common stock carry a legend stating that the shares are not registered under the Securities Act and therefore cannot be resold unless they are registered under the Securities Act or unless an exemption to registration is available.

 

Item 6.

Exhibits

 

Exhibit Number		Description
4.1		Restricted Stock Purchase Agreement, dated June 15, 2010, between Coinstar, Inc. and Paramount Home Entertainment Inc.
10.1*		Offer Letter between Coinstar, Inc. and Saul M. Gates. (1)
31.1		Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
31.2		Certification of Chief Financial Officer pursuant to Section 302(a) of the Sarbanes-Oxley Act of 2002.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS**		XBRL Instance Document
101.SCH**		XBRL Taxonomy Extension Schema Document
101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB**		XBRL Taxonomy Extension Label Linkbase Document
101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document

 

*	Includes a management contract or compensatory plan or arrangement.

**

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.

(1)	Incorporated by reference to the Registrant’s Form 8-K filed on May 3, 2010 (File Number 000-22555).

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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