Form 10-Q
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, 2011

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 21, 2011

Common Stock, $0.001 par value    30,737,280


Table of Contents

COINSTAR, INC.

FORM 10-Q

INDEX

 

PART I - FINANCIAL INFORMATION    Page

Item 1.

  

Financial Statements (unaudited):

  
  

Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010

   1
  

Consolidated Statements of Net Income for the Three and Six Months Ended June 30, 2011 and 2010

   2
  

Consolidated Statements of Stockholders’ Equity for the Three and Six Months Ended June 30, 2011

   3
  

Consolidated Statements of Cash Flows for the Three and Six Months Ended June 30, 2011 and 2010

   4
  

Notes to Consolidated Financial Statements

   6

Item 2.

  

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

   24

Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

   36

Item 4.

  

Controls and Procedures

   36
PART II - OTHER INFORMATION   

Item 1.

  

Legal Proceedings

   37

Item 1A.

  

Risk Factors

   38

Item 2.

  

Unregistered Sales of Equity Securities and Use of Proceeds

   40

Item 6.

  

Exhibits

   41

SIGNATURE

   42


Table of Contents

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

COINSTAR, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)

 

              June 30,      
2011
            December 31,    
2010
 

Assets

       

Current Assets:

       

Cash and cash equivalents (Note 4)

  $     173,528      $     183,416   

Accounts receivable, net of allowances of $1,193 and $1,131

      21,072          25,958   

DVD library

      118,847          140,324   

Deferred income taxes

      13,812          13,644   

Prepaid expenses and other current assets

      19,955          14,736   

Assets of business held for sale

      0          110,316   
                   

Total current assets

      347,214          488,394   

Property and equipment, net

      479,657          444,687   

Notes receivable

      23,476          0   

Deferred income taxes

      33,043          59,696   

Goodwill and other intangible assets

      275,953          277,322   

Other long-term assets

      12,533          12,612   
                   

Total assets

  $     1,171,876      $     1,282,711   
                   

Liabilities and Stockholders’ Equity

       

Current Liabilities:

       

Accounts payable

  $     148,427      $     161,551   

Accrued payable to retailers

      109,266          96,764   

Other accrued liabilities

      111,123          108,422   

Current callable convertible debt

      0          173,146   

Current portion of long-term debt

      6,007          7,523   

Current portion of capital lease obligations

      12,154          17,233   

Liabilities of business held for sale

      0          68,662   
                   

Total current liabilities

      386,977          633,301   

Long-term debt and other long-term liabilities

      319,704          167,261   

Capital lease obligations

      11,572          12,173   
                   

Total liabilities

      718,253          812,735   

Commitments and contingencies (Note 15)

      0          0   

Debt conversion feature

      0          26,854   

Stockholders’ Equity:

       

Preferred stock, $0.001 par value - 5,000,000 shares authorized; no shares issued or outstanding

      0          0   

Common stock, $0.001 par value - 60,000,000 and 45,000,000 authorized; 35,096,458 and 34,813,203 shares issued; 30,724,304 and 31,815,085 shares outstanding

      471,540          434,169   

Treasury stock

      (153,425)          (90,076)   

Retained earnings

      137,214          101,979   

Accumulated comprehensive loss

      (1,706)          (2,950)   
                   

Total stockholders’ equity

      453,623          443,122   
                   

Total liabilities and stockholders’ equity

  $     1,171,876      $     1,282,711   
                   

See accompanying Notes to Consolidated Financial Statements

 

1


Table of Contents

COINSTAR, INC.

CONSOLIDATED STATEMENTS OF NET INCOME

(in thousands, except per share data)

(unaudited)

 

            For the Three Months Ended    
June 30,
            For the Six Months Ended    
June 30,
 
        2011         2010         2011        

 

2010

 

Revenue

  $     435,228       $     342,356      $     859,300      $     665,478   

Expenses:

               

Direct operating(1)

      292,513          241,796          607,586          466,755   

Marketing

      7,857          5,934          12,974          8,564   

Research and development

      2,093          1,805          4,300          3,229   

General and administrative

      39,057          31,876          74,719          63,398   

Depreciation and other (1)

      34,805          30,627          68,764          62,428   

Amortization of intangible assets

      685          985          1,370          1,864   

Litigation settlement

      0          0          0          5,379   
   

 

 

     

 

 

     

 

 

     

 

 

 

Total expenses

      377,010          313,023          769,713          611,617   
   

 

 

     

 

 

     

 

 

     

 

 

 

Operating income

      58,218           29,333          89,587          53,861   

Other income (expense):

               

Foreign currency and other, net

      (491)          (30)          (451)          (47)   

Interest income

      112          85          192          87   

Interest expense

      (6,268)          (9,158)          (13,654)          (18,426)   
   

 

 

     

 

 

     

 

 

     

 

 

 
      (6,647)          (9,103)          (13,913)          (18,386)   
   

 

 

     

 

 

     

 

 

     

 

 

 

Income from continuing operations before income taxes

      51,571          20,230          75,674          35,475   

Income tax expense

      (20,110)          (7,389)          (29,371)          (13,395)   
   

 

 

     

 

 

     

 

 

     

 

 

 

Income from continuing operations

      31,461          12,841          46,303          22,080   

Income (loss) from discontinued operations, net of tax

      (4,722)          526          (11,068)          (2,271)   
   

 

 

     

 

 

     

 

 

     

 

 

 

Net income

  $     26,739      $     13,367      $     35,235      $     19,809   
   

 

 

     

 

 

     

 

 

     

 

 

 

Basic earnings (loss) per share:

               

Continuing operations

  $     1.03      $     0.40      $     1.50      $     0.70   

Discontinued operations

      (0.15)          0.02          (0.36)          (0.07)   
   

 

 

     

 

 

     

 

 

     

 

 

 

Basic earnings per share

  $     0.88      $     0.42      $     1.14      $     0.63   
   

 

 

     

 

 

     

 

 

     

 

 

 

Diluted earnings (loss) per share:

               

Continuing operations

  $     0.98      $     0.39      $     1.44      $     0.69   

Discontinued operations

      (0.15)          0.02          (0.34)          (0.07)   
   

 

 

     

 

 

     

 

 

     

 

 

 

Diluted earnings per share

  $     0.83      $     0.41      $     1.10      $     0.62   
   

 

 

     

 

 

     

 

 

     

 

 

 

Weighted average shares used in basic per share calculations

      30,542          31,731          30,803          31,340   

Weighted average shares used in diluted per share calculations

      32,144          32,938          32,141          32,077   

(1) “Direct operating” excludes depreciation and other of $29.7 million and $59.3 million for the three and six months ended June 30, 2011 and $27.3 million and $56.8 million for the three and six months ended June 30, 2010.

See accompanying Notes to Consolidated Financial Statements

 

2


Table of Contents

COINSTAR, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share data)

(unaudited)

 

                                                   Accumulated              
                                                   Other              
     Common Stock          Treasury           Retained               Comprehensive                  
    

 

Shares

         Amount          Stock           Earnings           Loss           Total  

BALANCE, March 31, 2011

     31,370,483       $      464,970       $      (153,425)         $      110,475        $      (1,656)         $      420,364     

Proceeds from exercise of options, net

     36,151            1,046            0              0              0              1,046     

Adjustments related to tax withholding for share-based compensation

     (2,248)             (115)             0              0              0              (115)     

Share-based payments expense

     (1,004)             5,453            0              0              0              5,453     

Tax benefit on share-based compensation expense

     0             186            0              0              0              186     

Stock repurchase under Accelerated Stock Repurchase (“ASR”) program

     (679,078)             0             0              0              0              0     

Net income

     0             0             0              26,739             0              26,739     

Foreign currency translation adj. net of tax benefit of $0

     0             0             0              0              (35)              (35)     

Loss on short-term investments net of tax benefit of $9

     0             0             0              0              (15)              (15)     
  

 

 

      

 

 

      

 

 

       

 

 

       

 

 

       

 

 

 

BALANCE, June 30, 2011

         30,724,304       $          471,540     $          (153,425)         $          137,214        $              (1,706)         $          453,623     
  

 

 

      

 

 

      

 

 

       

 

 

       

 

 

       

 

 

 
                                                   Accumulated              
                                                   Other              
     Common Stock          Treasury           Retained           Comprehensive              
    

 

Shares

         Amount          Stock           Earnings           Loss           Total  

BALANCE, December 31, 2010

     31,815,085       $      434,169       $      (90,076)         $      101,979        $      (2,950)         $      443,122     

Proceeds from exercise of options, net

     47,744            1,402            0              0              0              1,402     

Adjustments related to tax withholding for share-based compensation

     (37,043)             (1,692)             0              0              0              (1,692)     

Share-based payments expense

     272,554            8,493            0              0              0              8,493     

Tax benefit on share-based compensation expense

     0             2,314            0              0              0              2,314     

Debt conversion feature

     0             26,854            0              0              0              26,854     

Repurchases of common stock and ASR program

     (1,374,036)             0             (63,349)              0              0              (63,349)     

Net income

     0             0             0              35,235             0              35,235     

Foreign currency translation adj. net of tax expense of $0

     0             0             0              0              710             710     

Interest rate hedges on long-term debt net of tax expense of $349

     0             0             0              0              547             547     

Loss on short-term investments net of tax benefit of $8

     0             0             0              0              (13)              (13)     
  

 

 

      

 

 

      

 

 

       

 

 

       

 

 

       

 

 

 

BALANCE, June 30, 2011

     30,724,304       $      471,540       $      (153,425)         $      137,214        $      (1,706)         $      453,623     
  

 

 

      

 

 

      

 

 

       

 

 

       

 

 

       

 

 

 

See accompanying Notes to Consolidated Financial Statements

 

3


Table of Contents

COINSTAR, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

            For the Three Months    
Ended
June 30,
            For the Six Months    
Ended
June 30,
 
        2011         2010         2011         2010  

Operating Activities:

               

Net income

  $     26,739      $     13,367      $     35,235      $     19,809   

Adjustments to reconcile net income to net cash flows from operating activities from continuing operations:

               

Depreciation and other

      34,805          30,627          68,764          62,428   

Amortization of intangible assets and deferred financing fees

      1,192          1,493          2,385          2,880   

Share-based payments expense

      5,453          4,570          8,493          7,786   

Excess tax benefits on share-based payments

      (186)          (5,477)          (2,314)          (6,225)   

Deferred income taxes

      19,593          5,607          25,949          8,755   

Loss (income) from discontinued operations, net of tax

      4,722          (526)          11,068          2,271   

Non-cash interest on convertible debt

      1,626          1,499          3,209          2,958   

Other

      339          58          477          255   

Cash flows from changes in operating assets and liabilities from continuing operations:

               

Accounts receivable

      (6)          931          4,952          570   

DVD library

      (24,855)          (148)          21,477          8,199   

Prepaid expenses and other current assets

      (3,650)          (1,354)          (6,084)          (4,666)   

Other assets

      (1,156)          76          (566)          999   

Accounts payable

      23,273          (3,577)          (19,162)          19,353   

Accrued payable to retailers

      18,588          10,134          12,156          4,226   

Other accrued liabilities

      5,388          46,896          5,821          34,058   
                                       

Net cash flows from operating activities from continuing operations

      111,865          104,176          171,860          163,656   

Investing Activities:

               

Purchases of property and equipment

      (49,405)          (52,822)          (87,877)          (84,339)   

Proceeds from sale of property and equipment

      175          230          351          267   

Proceeds from sale of businesses, net

      12,221          26,078          12,221          26,078   

Equity investment

      0          0          (2,320)          0   
                                       

Net cash flows from investing activities from continuing operations

      (37,009)          (26,514)          (77,625)          (57,994)   

Financing Activities:

               

Principal payments on capital lease obligations and other debt

      (4,932)          (10,668)          (17,073)          (19,343)   

Net payments on credit facility

      (25,000)          0          (25,000)          0   

Excess tax benefits related to share-based payments

      186          5,477          2,314          6,225   

Repurchases of common stock and ASR program

               0          (63,349)          0   

Proceeds from exercise of stock options

      1,080          25,023          1,340          27,250   
                                       

Net cash flows from financing activities from continuing operations

      (28,666)          19,832          (101,768)          14,132   

Effect of exchange rate changes on cash

      (22)          (354)          645          (851)   
                                       

Increase (decrease) in cash and cash equivalents from continuing operations

      46,168          97,140          (6,888)          118,943   

Cash flows from discontinued operations:

               

Operating cash flows

      2,952          (2,934)          9,678          (12,872)   

Investing cash flows

      (13,452)          3,554          (12,678)          5,371   

Financing cash flows

      0          (145)          0          (166)   
                                       
      (10,500)          475          (3,000)          (7,667)   

Increase (decrease) in cash and cash equivalents

      35,668          97,615          (9,888)          111,276   

Cash and cash equivalents:

               

Beginning of period

      137,860          159,518          183,416          145,857   
                                       

End of period

  $     173,528      $     257,133      $     173,528      $     257,133   
                                       

Supplemental disclosure of cash flow information from continuing operations:

  

  Cash paid during the period for interest

  $     2,238      $     5,079      $     9,193      $     13,801   

  Cash paid during the period for income taxes

  $     3,422      $     1,473      $     1,928      $     1,906   

Supplemental disclosure of non-cash investing and financing activities from continuing operations:

  

  Purchases of computers financed by capital lease obligations

  $     5,637      $     0      $     7,971      $     0   

  Purchases of vehicles financed by capital lease obligations

  $     249      $     1,023      $     372      $     1,635   

  Purchases of property and equipment included in ending accounts payable

  $     1,019      $     1,294      $     6,020      $     6,862   

  Non-cash consideration received from sale of Money Transfer Business

  $     20,976      $     0      $     0      $     0   

See accompanying Notes to Consolidated Financial Statements

 

4


Table of Contents

INDEX FOR NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

         Page

Note 1

  Basis of Presentation and Principles of Consolidation    6

Note 2

  Organization and Business    7

Note 3

  Discontinued Operations, Sale of Assets and Assets Held for Sale    7

Note 4

  Cash and Cash Equivalents    9

Note 5

  Property and Equipment    9

Note 6

  Intangible Assets    10

Note 7

  Repurchases of Common Stock    11

Note 8

  Share-based Payments    12

Note 9

  Earnings Per Share    14

Note 10

  Comprehensive Income    14

Note 11

  Business Segments    15

Note 12

  Debt and Other Long-Term Liabilities    18

Note 13

  Derivative Instruments    20

Note 14

  Fair Value    20

Note 15

  Commitments and Contingencies    22

 

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COINSTAR, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1: BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION

The consolidated financial information included herein has been prepared by Coinstar, Inc. without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The unaudited consolidated financial statements of Coinstar, Inc. 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. The financial information as of December 31, 2010, is derived from our 2010 Annual Report on Form 10-K, however, certain amounts in the prior period financial statements have been reclassified to conform to our current period presentation. The consolidated financial statements included within this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and the notes thereto included in our 2010 Annual Report on Form 10-K. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

The accompanying consolidated financial statements include the accounts of Coinstar, Inc., our wholly-owned subsidiaries, and companies in which we have a controlling interest. 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.

Accounting Pronouncements Adopted During 2011

In September 2009, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standard Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements” (“ASU 2009-13”). ASU 2009-13 addresses the unit of accounting for multiple-element arrangements. In addition, ASU 2009-13 revises the method by which consideration is allocated among the units of accounting. Specifically, the overall consideration is allocated to each deliverable by establishing a selling price for individual deliverables based on a hierarchy of evidence, involving vendor-specific objective evidence, other third party evidence of the selling price, or the reporting entity’s best estimate of the selling price of individual deliverables in the arrangement. ASU 2009-13 is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. The adoption of ASU 2009-13 in the first quarter of 2011 did not have a material effect on our financial position, results of operation or cash flows.

In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements,” (“ASU 2010-06”). ASU 2010-06 amends the FASB Accounting Standards Codification Subtopic 820-10 by requiring more robust disclosures about (i) the different classes of assets and liabilities measured at fair value, (ii) the valuation techniques and inputs used, (iii) the activity in Level 3 fair value measurements, and (iv) the transfers between Levels 1, 2, and 3. The disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements, and the new disclosures over transfers in and out of Level 1 and Level 2 fair value measurements, and activity in Level 3 fair value measurements are effective for fiscal years beginning after December 15, 2010. The adoption of ASU 2010-06 in the first quarter of 2011 resulted in additional disclosures included in Note 14: Fair Value and did not have a material impact on our financial position, results of operations or cash flows.

In December 2010, the FASB issued ASU 2010-28, “Intangibles—Goodwill and Other: When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts” (“ASU 2010-28”). The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. ASU 2010-28 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. The adoption of ASU 2010-28 in the first quarter of 2011 did not have a material effect on our financial position, results of operation or cash flows.

Accounting Pronouncements Not Yet Effective

In April 2011, the FASB issued ASU No. 2011-02, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring” (“ASU 2011-02”). ASU 2011-02 amends and clarifies existing guidance for evaluating whether the restructuring of a receivable by a creditor is a troubled debt restructuring (“TDR”) and requires certain disclosures for TDRs. ASU 2011-02 is effective for the first interim or annual period beginning on or after June 15, 2011. We do not believe our adoption of ASU 2011-02 in the third quarter of 2011 will have a material impact on our financial position, results of operations or cash flows.

 

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In April 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS” (“ASU 2011-04”). ASU 2011-04 was issued to achieve common fair value measurement and disclosure requirements between GAAP and International Financial Reporting Standards. ASU 2011-04 amends current fair value measurement and disclosure guidance to include increased transparency around valuation inputs and investment categorization. ASU 2011-04 is effective for fiscal years and interim periods beginning after December 15, 2011. We do not believe our adoption of ASU 2011-04 in the first quarter of 2012 will have a material impact on our financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU 2011-05”). ASU 2011-05 allows an entity to have the option to present the components of net income and comprehensive income in either one or two consecutive financial statements. ASU 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. While the new guidance changes the presentation of comprehensive income, there are no changes to the components that are recognized in net income or other comprehensive income under current accounting guidance. ASU 2011-05 is effective for fiscal years and interim periods beginning after December 15, 2011. We do not believe our adoption of ASU 2011-05 in the first quarter of 2012 will have a material impact on our financial position, results of operations or cash flows.

Reclassifications

During the second quarter of 2011, we consolidated our cash categories into one line item, Cash and Cash Equivalents, on our Consolidated Balance Sheets to better align with how we manage our company. This reclassification had no effect on our financial position, results of operations or cash flows. See Note 4: Cash and Cash Equivalents for additional details about our cash categories.

NOTE 2: ORGANIZATION AND BUSINESS

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 redbox and Coin segments. Our redbox segment consists of self-service DVD kiosks where consumers can rent or purchase movies and rent video games. Our Coin segment consists of self-service coin-counting kiosks where consumers can convert their coin to cash, a gift card or an e-certificate, among other options. Our New Ventures segment is focused on identifying, evaluating, building, and growing innovative self-service concepts in the marketplace. Our kiosks are located primarily in supermarkets, drug stores, mass merchants, financial institutions, convenience stores, and restaurants. Our kiosk and location count as of June 30, 2011, is as follows:

 

             Kiosks                      Locations          

    redbox

     33,300         27,800   

    Coin

     18,900         18,600   
                 
     52,200      

 

 

 

46,400 

 

 

                 

NOTE 3: DISCONTINUED OPERATIONS, SALE OF ASSETS AND ASSETS HELD FOR SALE

Money Transfer Business (the “Money Transfer Business”)

On August 23, 2010, we entered into a stock purchase agreement (the “Sigue SPA”) to sell our subsidiaries comprising our money transfer business to Sigue Corporation (“Sigue”) for $18.0 million in cash and a seller’s note for $23.5 million, adjusted for the amount by which the closing net working capital of the Money Transfer Business exceeded or fell below $9.0 million. In addition, Sigue would pay us an amount equal to the amount outstanding at closing under our revolving credit arrangement (the “Swingline”) with the Money Transfer Business.

On May 31, 2011, we entered into a First Amendment to Stock Purchase Agreement (the “First Amendment”) with Sigue. Under the First Amendment, the seller’s note would be increased by the amount the closing net working capital of the Money Transfer Business exceeded $18.0 million. To the extent that the closing net working capital fell below $17.0 million, the seller’s note would be decreased by such amount. The seller’s note would not be adjusted when the closing net working capital was between $17.0 million and $18.0 million. We also agreed that the closing net working capital would not be less than $16 million. In addition, the First Amendment modified the method Sigue would pay us for the outstanding amount of the Swingline at closing. To the extent that the Swingline at closing was between $6.0 million and $14.0 million, the seller’s note would be increased by $6.0 million and Sigue would pay the remainder of the Swingline balance in cash at closing, up to $14.0 million.

 

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On June 9, 2011, we completed the transaction contemplated by the Sigue SPA and the First Amendment. In addition, we may be required to provide an additional loan to Sigue in the principal amount of up to $5.0 million, under terms consistent with the seller’s note if Sigue is required to meet certain regulatory requirements with respect to available bank deposits within 18 months following the closing of the transaction.

At closing, we received $17.0 million in cash. The deposit of $1.0 million from Sigue during 2010 was applied to the purchase price. In addition, we received $1.5 million in cash from Sigue for the Swingline payment and a seller’s note of $29.5 million, of which $6.0 million was related to the Swingline. During the second quarter of 2011, we recognized an additional loss of $5.7 million from the sale of our Money Transfer Business primarily due to the First Amendment. We estimated the fair value of the seller’s note at approximately $21.0 million, which was based on the discounted cash flows of the future note payments and was not an exit price based measure of fair value. The discount rate used in our fair value estimate was the market rate for similar risk profile companies and represented our best estimate of the default risk.

Electronic Payment Business (the “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. In addition, the purchase price was subject to a post-closing net working capital adjustment in the amount of $0.5 million, which was finalized in October 2010.

Summary Financial Information

The disposition and operating results of the Money Transfer Business and E-Pay Business are presented in discontinued operations in our Consolidated Statements of Net Income for all periods presented. The continuing cash flows from both the Money Transfer Business and the E-Pay Business after disposition are expected to be insignificant.

The following table sets forth the components of discontinued operations included in our Consolidated Statements of Net Income:

 

            Three Months Ended    
June 30,
            Six Months Ended    
June 30,
 

Dollars in thousands

      2011         2010         2011         2010  

Revenue:

               

Money Transfer Business

  $     24,102      $     24,213      $     47,716      $     45,639   

E-Pay Business

      0          3,220          0          8,732   
                                       
  $     24,102      $     27,433      $     47,716      $     54,371   
                                       

Pre-tax gain (loss) from discontinued operations:

               

Money Transfer Business

  $     498      $     (941)      $     654      $     (5,448)   

E-Pay Business

      0          (62)          0          (132)   
                                       
  $     498      $     (1,003)      $     654      $     (5,580)   
                                       

Gain (loss) on disposal activities:

               

Money Transfer Business

  $     (5,732)      $     (12,202)      $     (11,070)      $     (12,202)   

E-Pay Business

      0          12,184          0          12,184   
                                       
  $     (5,732)      $     (18)      $     (11,070)      $     (18)   
                                       

Loss from discontinued operations before income tax

  $     (5,234)      $     (1,021)      $     (10,416)      $     (5,598)   

Income tax (expense) benefit

      512          1,547          (652)          3,327   
                                       

Income (loss) from discontinued operations, net of income tax

  $     (4,722)      $     526      $     (11,068)      $     (2,271)   
                                       

Amount of goodwill and other intangible assets disposed

  $     8,037      $     9,100      $     8,037      $     9,100   
                                       

 

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Included in the income tax expense from discontinued operations for the six months ended June 30, 2011, was $4.1 million relating to the estimated current value of a worthless stock deduction taken in 2009 related to our divestiture of the Entertainment Business, which was sold in the third quarter of 2009.

On June 9, 2011, the disposed assets and liabilities of the Money Transfer Business primarily consisted of the following (in thousands):

 

Dollars in thousands

      June 9,
2011
 

Cash and cash equivalents

  $     57,893    

Accounts receivable, net

      33,185    

Other current assets

      13,560    

Property, plant and equipment, net

      4,066    

Goodwill, intangible, and other assets

      8,162    
         

Total assets

          116,866    
         

Accounts payable and payable to agents

      65,464    

Accrued liabilities

      13,062    
         

Total liabilities

      78,526    
         

Net assets sold

  $     38,340    
         

The net assets sold represent the fair value less cost to sell of the Money Transfer Business. The loss on disposal activities recognized during the six months ended June 30, 2011 was allocated to the asset disposal group including property, plant and equipment, net, goodwill, and intangible and other assets.

NOTE 4: CASH AND CASH EQUIVALENTS

Included in our cash and cash equivalents at June 30, 2011 and December 31, 2010 was $80.2 million and $72.5 million that we identified for settling our accrued payable to our retailer partners in relation to our Coin kiosks, which, prior to this quarter was presented as cash being processed in our Consolidated Balance Sheets.

Our cash equivalents, which consist of money market funds and a certificate of deposit were $30.6 million and $41.6 million at June 30, 2011 and December 31, 2010, respectively.

NOTE 5: PROPERTY AND EQUIPMENT

 

Dollars in thousands

          June 30,    
2011
        December 31,
2010
 

Machines

  $     849,518      $     791,014   

Computers

      84,883          49,603   

Office furniture and equipment

      4,626          3,845   

Vehicles

      9,977          10,661   

Leasehold improvements

      12,374          11,047   
                   

Property and equipment, at cost

      961,378          866,170   

Accumulated depreciation and amortization

          (481,721)              (421,483)   
                   

   Property and equipment, net

  $     479,657      $     444,687   
                   

 

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NOTE 6: INTANGIBLE ASSETS

The gross amount of our other intangible assets, which are included within “Goodwill and other intangible assets” in our Consolidated Balance Sheets, and the related accumulated amortization were as follows:

 

Dollars in thousands

  

Amortization
Period

               June 30,        
2011
         December 31,
2010
 

Retailer relationships

   5 and 6 years   $              13,344     $              13,344  

Accumulated amortization

          (5,834)           (4,606)   
                        
          7,510          8,738  

Other

   5 and 40 years        1,890          1,890  

Accumulated amortization

          (1,197)           (1,056)   
                        
          693          834  
                        

Intangible assets, net

     $      8,203     $      9,572  
                        

Amortization expense was as follows:

             Three Months Ended    
June  30,
             Six Months Ended    
June 30,
 

Dollars in thousands

       2011          2010          2011          2010  

Retailer relationships

  $      614      $      914      $      1,229      $      1,723   

Other

       71           71           141           141   
                                           

Total amortization of intangible assets

  $      685      $      985      $      1,370      $      1,864   
                                           

Expected future amortization is as follows:

 

Dollars in thousands

       Retailer
Relationships
         Other  

2011

  $      1,227      $      141   

2012

       2,457           81   

2013

       2,250           14   

2014

       1,432           14   

2015

       12           14   

Thereafter

       132           429   
                     

Total expected amortization

  $      7,510      $                  693   
                     

 

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NOTE 7: REPURCHASES OF COMMON STOCK

The following table presents a summary of our stock repurchases during 2011:

 

Dollars in thousands

       Board
  Authorization  
           Credit Facility  
Authorization
 

Authorized repurchase - as of January 1, 2011

  $      74,486      $      78,301   

Proceeds from the exercise of options

       1,402           1,402   

Repurchase from open market

       (13,349)           (13,349)   

Repurchase from Accelerated Stock Repurchase Agreement (“ASR Agreement”)

       (50,000)           (50,000)   
    

 

 

      

 

 

 

Authorized repurchase - as of June 30, 2011

  $      12,539      $      16,354   
    

 

 

      

 

 

 

Our repurchases will not exceed the lesser of the limit authorized by our Board or under the terms of our new credit facility. Repurchased shares become a part of treasury stock.

Board Authorization

On July 19, 2011, our Board of Directors authorized the additional repurchase of $250.0 million of our common stock plus the cash proceeds received from the exercise of stock options by our employees, officers, and directors under the equity compensation plan.

Credit Facility

On July 15, 2011, we entered into a Second Amended and Restated Credit Agreement (the “New Credit Facility”), which replaced our prior credit facility. Under the New Credit Facility, we are permitted to repurchase shares of our common stock without limitation, provided that we are in compliance with certain covenants required under the terms of the New Credit Facility. See Note 12: Debt and Other Long-Term Liabilities for additional information about the terms of the New Credit Facility.

Accelerated Stock Repurchase Program

Repurchase amounts in thousands

   Shares
    Delivered    
             Average    
Price
             Repurchase    
Amount
 

Shares received on 2/15/2011 when ASR Agreement was executed

     377,660      $      47.32      $      17,869   

Shares received on 5/19/2011 when ASR Agreement was settled

     679,078           47.32           32,131   
  

 

 

           

 

 

 
     1,056,738           $      50,000   
  

 

 

           

 

 

 

On February 15, 2011, we entered into an accelerated share repurchase agreement (the “ASR Agreement”) with Morgan Stanley & Co at a notional amount of $50.0 million. The ASR Agreement was settled on May 19, 2011. The total number of shares received under the ASR Agreement was determined based on a discount to the daily volume weighted average price of our common stock over the term of the ASR Agreement.

During the first quarter of 2011, the ASR Agreement was accounted for as an initial treasury stock transaction, and a forward stock purchase contract, which was classified as an equity instrument under the FASB accounting guidance for “Contracts in an Entity’s Own Equity,” and its effect on diluted net income per share, if any, was calculated under the reverse treasury method. As the ASR Agreement was concluded, the additional shares received were recorded as treasury shares resulting in a reduction of shares for our earnings per share calculations.

 

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NOTE 8: SHARE-BASED PAYMENTS

We grant share-based awards to our employees, non-employee directors and consultants under our 1997 Amended and Restated Equity Incentive Plan (the “1997 Plan”). The 1997 Plan permits the granting of stock options, restricted stock, restricted stock units, and performance based restricted stock. At June 30, 2011, there were 3.1 million shares of unissued common stock reserved for issuance under all the stock plans, of which 2.0 million shares were available for future grants.

Certain information regarding our share-based payments is as follows (in thousands, except per share amounts):

 

             Three Months Ended    
June  30,
             Six Months Ended    
June 30,
 
        

 

2011

         2010          2011          2010  

Share-based payments expense:

                   

Share-based compensation - stock options

  $      678      $      843      $      1,503      $      1,746   

Share-based compensation - restricted stock

       1,664           1,539           3,701           3,346   

Share-based payments for DVD arrangements

       3,111           2,229           3,289           2,821   
                                           

Total

  $      5,453      $      4,611      $      8,493      $      7,913   
                                           

Deferred tax benefit on share-based payments

  $      821      $      808      $      1,830      $      1,738   
         June 30, 2011  
         Unrecognized  Share-
Based

Payments Expense
         Weighted-Average
Remaining Life
 

Unrecognized share-based payments expense:

                   

Share-based compensation - stock options

       $      5,204           1.7 years   

Share-based compensation - restricted stock

            15,706           2.0 years   

Share-based payments for DVD arrangements

            9,016           3.3 years   
                         

Total

       $      29,926             
                         

Share-Based Compensation

Stock options

Shares of common stock are issued upon exercise of stock options.

 

  ·

Stock options are granted only to our executives and non-employee directors.

  ·

Options granted during 2011 vest annually in equal installments over 4 years, and expire after 10 years.

The following table summarizes the weighted average valuation assumptions used in the Black-Scholes-Merton Valuation model for stock options granted during 2011:

 

         Six Months Ended    
June 30,  2011
 

Expected term (in years)

     7.3   

Expected stock price volatility

     42.8%   

Risk-free interest rate

     2.9%   

Expected dividend yield

     0.0%   

 

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The following table presents a summary of stock option activity for 2011:

 

Shares in thousands

           Shares                     Weighted    
Average
Exercise

Price
 

OUTSTANDING, December 31, 2010

     1,103      $     29.41   

Granted

     92          45.60   

Exercised

     (48)          29.39   

Cancelled, expired, or forfeited

     (43)          30.03   
            

OUTSTANDING, June 30, 2011

     1,104          30.72   
            

Certain information regarding stock options outstanding as of June 30, 2011, is as follows (shares and intrinsic value in thousands):

 

        Options
  Outstanding  
        Options
  Exercisable  
 

Number

      1,104         545  

Weighted average per share exercise price

  $     30.72     $     28.81  

Aggregate intrinsic value

  $     26,534     $     14,380  

Weighted average remaining contractual term (in years)

      3.6         2.5  

Restricted stock awards

Restricted stock awards are granted to eligible employees, including executives, and non-employee directors. Awards granted to employees and executives vest annually in equal installments over four years. Non-employee director awards vest one year after the grant date. Performance-based restricted stock awards are granted to executives only, with established performance criteria approved by the Compensation Committee of the Board of Directors, once earned, and vest in equal installment over three years from the date of grant. 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 recognized on a straight-line basis over the vesting period or based on achieving performance conditions.

The following table presents a summary of restricted stock award activity for 2011:

 

Shares in thousands    Restricted
Stock Awards
        Weighted
Average
  Grant Date  
Fair Value
 
             

NON-VESTED, December 31, 2010

     414      $     32.82   

Granted

     307          45.50   

Vested

     (146)          33.03   

Forfeited

     (34)          34.96   
            

NON-VESTED, June 30, 2011

     541          39.79   
            

 

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Share-Based Payments for DVD Arrangements

We granted restricted stock as part of content license agreements with certain movie studios. The expense related to these agreements is included within direct operating expenses in our Consolidated Statements of Net Income and is adjusted based on the number of unvested shares and market price of our common stock each reporting period. During 2010 and 2009, we entered into agreements with SPHE Scan Based Trading Corporation (“Sony”) and Paramount Home Entertainment, Inc. (“Paramount”). Information related to the shares of restricted stock granted as part of these agreements as of June 30, 2011, is as follows:

 

           Granted                  Vested                  Unvested            Remaining
    Vesting Period    

  Sony

     193,348         19,335         174,013       3.1 years

  Paramount

     200,000         20,000         180,000       3.5 years
                             
     393,348         39,335         354,013      
                             

NOTE 9: EARNINGS PER SHARE

Basic earnings per share (“EPS”) is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing the net income for the period by the weighted average number of common and dilutive potential common shares outstanding during the period.

Net income used for calculating basic and diluted EPS is the same for all periods presented. The following table sets forth the computation of shares used for the basic and diluted EPS calculations (in thousands):

 

       Three Months Ended  
June 30,
       Six Months Ended  
June 30,
 
     2011      2010      2011      2010  

Weighted average shares used for basic EPS

     30,542         31,731         30,803         31,340   

Dilutive effect of stock options and other share-based awards

     594         580         561         424   

Dilutive effect of convertible debt

     1,008         627         777         313   
                                   

Weighted average shares used for diluted EPS

     32,144         32,938         32,141         32,077   
                                   

Stock options and other share-based awards not included in diluted EPS calculation because their effect would be antidilutive

     112         26         89         682   
                                   

Shares related to convertible debt not included in diluted EPS calculation as their effect would be antidilutive

     0         0         0         0   
                                   

NOTE 10: COMPREHENSIVE INCOME

Comprehensive income was as follows:

 

               Three Months Ended      
June 30,
 

Dollars in thousands

       2011          2010  

Net income

  $      26,739      $      13,367   

Net change in cumulative foreign currency translation adjustment, net of tax benefit of $0 and $87

       (35)           2,876   

Net change in unrealized loss on interest rate cash flow hedges, net of tax expense of $0 and $549

                857   

Net change in unrealized loss on short-term investments, net of tax benefit of $9 and $0

       (15)           0   
                     

Comprehensive income

  $      26,689      $      17,100   
                     

 

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                 Six Months Ended         
June 30,
 

Dollars in thousands

       2011          2010  

Net income

  $      35,235      $      19,809   

Net change in cumulative foreign currency translation adjustment, net of tax benefit of $0 and $5

       710            (1,923)   

Net change in unrealized loss on interest rate cash flow hedges, net of tax expense of $349 and $829

       547            1,297   

Net change in unrealized loss on short-term investments, net of tax benefit of $8 and $0

       (13)           0   
    

 

 

      

 

 

 

Comprehensive income

  $      36,479      $      19,183   
    

 

 

      

 

 

 

NOTE 11: BUSINESS SEGMENTS

Management, including our chief operating decision maker, who is our chief executive officer (“CEO”), evaluates the performances of our business segments primarily on segment revenue and segment operating income from continuing operations before depreciation, amortization and other, and certain share-based payments (“segment operating income”). Segment operating income contains internally allocated costs of shared service functions, including corporate executive management, business development, sales, finance, legal, human resources, information technology, and risk management. We also review depreciation and amortization allocated to each segment. Shared-based payments expense related to share-based compensation granted to executives, non-employee directors and employees is not allocated to our segments and is included in the corporate unallocated column in the analysis and reconciliation below; however, share-based payments expense related to our DVD arrangements have been allocated to our redbox segment and are included within direct operating expense. Our performance evaluation does not include segment assets.

Changes in our Organizational Structure

During the first quarter of 2011, in addition to our existing segments redbox and Coin, we added a reportable segment, New Ventures, to reflect changes in how our CEO manages our businesses and allocates resources for the future growth of the company. Our New Ventures segment consists primarily of our Coffee self-service concept and certain other self-service concepts that are under development.

As part of our new reporting structure, during the second quarter of 2011, we completed our evaluation of the reassignment of goodwill to our New Ventures segment by using a relative fair value approach that is similar to the approach used when a portion of a segment is to be disposed. We used both the income and cost methods to estimate the fair value of our New Ventures segment and both the income and market methods to estimate the fair values of our redbox and Coin segments. As a result of our evaluation, we did not assign any goodwill to our New Ventures segment because the amount was immaterial.

During the second quarter of 2011, we exited one of the self-service concepts we were testing, which was included in our New Ventures segment. Based on our materiality assessment, we consider the results of the self-service concept to be immaterial and therefore have elected not to present it as a discontinued operation in our Consolidated Statements of Net Income.

Comparability of Segment Results

We have recast prior period results for the following:

 

 

The addition of our New Ventures segment, which includes our self-service concepts, were a part of our Coin and redbox segments prior to the first quarter of 2011; and

 

 

The allocation of share-based payments made to certain movie studios as part of content agreements from corporate unallocated to direct operating in our redbox segment beginning in the first quarter of 2011.

 

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Our analysis and reconciliation of our segment information to the consolidated financial statements that follows covers our results from continuing operations, which consists of our redbox, Coin and New Ventures segments.

 

Three Months Ended June 30, 2011

           redbox                  Coin              New
    Ventures    
         Corporate
  Unallocated  
               Total        

Revenue

  $      363,862      $      71,065      $      301      $          $      435,228   

Direct operating

       255,105           35,983           1,342           83           292,513   

Marketing

       6,357           1,258           231           11           7,857   

Research and development

                1,461           550           78           2,093   

General and administrative

       28,379           5,563           2,945           2,170           39,057   
                                                      

Segment operating income (loss)

       74,017           26,800           (4,767)           (2,342)           93,708   

Less: depreciation and amortization

       (27,360)           (7,451)           (679)                     (35,490)   
                                                      

Operating income (loss)

       46,657           19,349           (5,446)           (2,342)           58,218   

Other expense

                                  (491)           (491)   

Interest expense, net

                                  (6,156)           (6,156)   

Income (loss) from continuing operations

                        
                                                      

before income taxes

  $      46,657      $      19,349      $      (5,446)      $      (8,989)      $      51,571   
                                                      

Three Months Ended June 30, 2010

       redbox          Coin          New
Ventures
         Corporate
Unallocated
         Total  

Revenue

  $      271,869      $      70,362      $      125      $          $      342,356   

Direct operating

       206,787           34,314           245           450           241,796   

Marketing

       4,435           1,412           83                    5,934   

Research and development

                1,529           218           58           1,805   

General and administrative

       23,480           5,064           1,506           1,826           31,876   
                                                      

Segment operating income (loss)

       37,167           28,043           (1,927)           (2,338)           60,945   

Less: depreciation and amortization

       (23,866)           (7,562)           (184)                    (31,612)   
                                                      

Operating income (loss)

       13,301           20,481           (2,111)           (2,338)           29,333   

Other expense

                                  (30)           (30)   

Interest expense, net

                                  (9,073)           (9,073)   

Income (loss) from continuing operations

                        
                                                      

before income taxes

  $      13,301      $      20,481      $      (2,111)      $      (11,441)      $      20,230   
                                                      

 

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Six Months Ended June 30, 2011

          redbox                  Coin             New
  Ventures  
        Corporate
  Unallocated  
        Total  

Revenue

  $     726,206      $      132,428      $     666      $         $     859,300   

Direct operating

      536,519           69,052          1,802          213          607,586   

Marketing

      10,404           2,269          281          20          12,974   

Research and development

      62           3,246          837          155          4,300   

General and administrative

      54,383           10,452          5,068          4,816          74,719   
                                                  

Segment operating income (loss)

      124,838           47,409          (7,322)          (5,204)          159,721   

Less: depreciation and amortization

      (54,458)           (14,822)          (854)                  (70,134)   
                                                  

Operating income (loss)

      70,380           32,587          (8,176)          (5,204)          89,587   

Other expense

                               (451)          (451)   

Interest expense, net

                               (13,462)          (13,462)   

Income (loss) from continuing operations

                    
                                                  

before income taxes

  $     70,380      $      32,587      $     (8,176)      $     (19,117)      $     75,674   
                                                  

Six Months Ended June 30, 2010

      redbox          Coin         New
Ventures
        Corporate
Unallocated
        Total  

Revenue

  $     534,947      $      130,280      $     251      $         $     665,478   

Direct operating

      398,762           66,915          519          559          466,755   

Marketing

      6,267           2,174          115                  8,564   

Research and development

               2,902          218          109          3,229   

General and administrative

      46,450           9,847          2,814          4,287          63,398   

Litigation settlement

               5,379                          5,379   
                                                  

Segment operating income (loss)

      83,468           43,063          (3,415)          (4,963)          118,153   

Less: depreciation and amortization

      (45,987)           (14,621)          (3,684)                  (64,292)   
                                                  

Operating income (loss)

      37,481           28,442          (7,099)          (4,963)          53,861   

Other expense

                               (47)          (47)   

Interest expense, net

                               (18,339)          (18,339)   

Income (loss) from continuing operations

                    
                                                  

before income taxes

  $     37,481      $      28,442      $     (7,099)      $     (23,349)      $     35,475   
                                                  

Significant Retailer Relationships

Our redbox and Coin kiosks 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,
 
         2011              2010              2011              2010      

Wal-Mart Stores Inc.

     17.3%         19.6%         17.8%         20.4%   

Walgreen Co.

     15.9%         13.3%         15.7%         13.0%   

The Kroger Company

     11.4%         10.8%         11.2%         10.0%   

 

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NOTE 12: DEBT AND OTHER LONG-TERM LIABILITIES

 

Dollars in thousands

           June 30,    
2011
         December 31,
2010
 

 

Revolving line of credit (matures November 2012)

  $      125,000      $      150,000   

Convertible debt

       176,355           173,146   

redbox rollout agreement

       7,124           10,791   

Asset retirement obligation

       7,993           7,305   

Other long-term liabilities

       9,239           6,688   
                     
       325,711           347,930   

Less:

         

Current portion of callable convertible debt

                (173,146)   

Current portion of redbox rollout agreement

       (6,007)           (7,523)   
                     

Total long-term debt and other

  $      319,704      $      167,261   
                     

Revolving Line of Credit

The interest rate swap associated with our revolving line of credit expired during the first quarter of 2011. For additional information see Note 13: Derivative Instruments. As of June 30, 2011, we were in compliance with all covenants.

Credit Facility

On July 15, 2011, we entered into a New Credit Facility, providing for a senior secured revolving credit facility and a senior secured term loan facility, which replaced our prior credit facility. The New Credit Facility provides for a five-year, $175.0 million term loan and a $450.0 million revolving line of credit. Subject to additional commitments from lenders, we have the option to increase the aggregate facility size by $250.0 million, which can be comprised of additional term loans and revolving line of credit. On July 15, 2011, we borrowed $175.0 million under the New Credit Facility term loan, a portion of which was utilized to pay down the existing revolver balance of $120.0 million. Fees for the New Credit Facility of $4.1 million will be amortized over the 5-year life of the New Credit Facility. We amortize deferred finance fees on a straight-line basis, which approximates the effective interest method.

The New Credit Facility matures on July 15, 2016, at which time all outstanding borrowings must be repaid. The term loan is subject to mandatory debt repayments of the outstanding amount equal to 5% in the first year, 7.5% in the second year, 10% in the third year, and 12.5% in the fourth and fifth year, with the balance due at maturity. Our obligations under the New Credit Facility are secured by a first priority security interest in substantially all of our assets and the assets of our domestic subsidiaries, as well as a pledge of a substantial portion of our subsidiaries’ capital stock.

Subject to applicable conditions, we may elect interest rates on our revolving borrowings calculated by reference to (i) the British Bankers Association LIBOR rate (“LIBOR Rate”) fixed for given interest periods or (ii) Bank of America’s prime rate (or, if greater, the average rate on overnight federal funds plus one half of one percent or the LIBOR Rate plus one percent) (the “Base Rate”), plus the margin determined by our consolidated net leverage ratio. For borrowings made under the LIBOR Rate, the margin ranges from 125 to 200 basis points, while for borrowing made under the Base Rate, the margin ranges from 25 to 100 basis points. However, for the period through the delivery of our certificate of compliance for the quarter ending December 31, 2011, the applicable LIBOR Rate margin will be fixed at 150 basis points and the applicable Base Rate margin will be fixed at 50 basis points.

The New Credit Facility contains standard negative covenants and restrictions on actions including, without limitation, restrictions on indebtedness, liens, fundamental changes or dispositions of our assets, payments of dividends or common stock repurchases, capital expenditures, investments, and mergers, dispositions and acquisitions, among other restrictions. In addition, the credit agreement requires that we meet certain financial covenants, ratios and tests, including maintaining a maximum consolidated net leverage ratio and a minimum interest coverage ratio, as defined in the New Credit Facility. As of June 30, 2011, we were in compliance with covenants under the New Credit Facility.

 

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Convertible Debt (the “Notes”)

The Notes become convertible when the closing price of our common stock exceeds 130% of the Notes conversion price for more than 20 trading days out of the period of 30 consecutive trading days ending June 30, 2011 (the “Conversion Value Measurement Period”). If the Notes become convertible and should the Note holders elect to convert, we will be required to pay them up to the full face value of the Notes in cash as well as deliver shares of our common stock for any excess conversion value. The number of potentially issued shares increases as the market price of our common stock increases during the Conversion Value Measurement Period. This conversion event is reset each quarter.

As of December 31, 2010, this early conversion event was satisfied and the Notes became convertible in the first quarter of 2011, however, none of the Note holders submitted requests for conversion. In addition, upon becoming convertible, a portion of the equity component of the callable convertible debt was considered redeemable and was reported as temporary equity under debt conversion feature in our Consolidated Balance Sheets at December 31, 2010. Since the early conversion conditions were not met as of June 30, 2011, the temporary equity was reclassified back to permanent equity and the Notes remained classified as a long-term liability on our Consolidated Balance Sheets.

The following interest expense was recorded related to the Notes (in thousands):

 

             Three Months Ended    
June  30,
         Six Months Ended    
June 30,
 
             2011                  2010              2011                  2010      

Contractual interest expense

  $      2,000      $      2,000         4,000      $      4,000   

Amortization of debt discount

       1,626           1,499         3,209           2,957   
                                         

Total interest expense related to the Notes

  $      3,626      $      3,499         7,209      $      6,957   
                                         

The remaining unamortized debt discount is expected to be recognized as non-cash interest expense is as follows (in thousands):

 

Year

       Non-cash
Interest Expense
 

Remainder of 2011

  $      3,342   

2012

       7,108   

2013

       7,712   

2014

       5,483   
          

Total

  $      23,645   
          

 

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NOTE 13: DERIVATIVE INSTRUMENTS

Interest Rate Swaps

Our interest rate swap agreement with Wells Fargo Bank for a notional amount of $150.0 million expired on March 20, 2011. As of June 30, 2011, we did not have any interest rate swap agreements outstanding 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. The fair value of the interest rate swap as of December 31, 2010 was a liability of $0.9 million, which was reversed from comprehensive income (loss) and recognized as interest expense in our Consolidated Statements of Net Income during the first quarter of 2011.

The effect of derivative instruments on our Consolidated Statements of Net Income was as follows (in thousands):

 

Derivatives in Cash Flow Hedging

Relationship

          Effective Portion    
of Derivative

Gain
Recognized in
OCI
        Effective Portion of
Derivative Gain/(Loss)
Reclassified from
Accumulated OCI into
  Income and Reclassified into  
Earnings during the Period
 

Three Months Ended June 30, 2011

       
         
 

Interest Rate Swap Contracts

  $     0      $     0   

Three Months Ended June 30, 2010

       
         
 

Interest Rate Swap Contracts

  $     1,408     $     (1,445)   
 

Six Months Ended June 30, 2011

       
           
 

Interest Rate Swap Contracts

  $     896     $     (889)   
 

Six Months Ended June 30, 2010

       
           
 

Interest Rate Swap Contracts

  $     2,128     $     (2,908)   

NOTE 14: FAIR VALUE

Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. To measure fair value, we use a three-tier valuation hierarchy based upon observable and non-observable inputs:

Factors used in determining the fair value of our financial assets and liabilities are summarized into a three-tier valuation hierarchy:

 

   

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; or

   

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

The factors or methodology used for valuing securities are not necessarily an indication of the risk associated with investing in those securities.

 

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Assets and Liabilities Measured and Reported at Fair Value on a Recurring Basis

The following table presents our financial assets and (liabilities) that are measured and reported at fair value in our Consolidated Balance Sheets on a recurring basis, by level within the fair value hierarchy (in thousands):

 

Fair Value at June 30, 2011

          Level 1                 Level 2                 Level 3      

Money market funds and certificates of deposit

  $     30,582      $         $      

Fair Value at December 31, 2010

                             

Money market funds and certificates of deposit

  $     41,598      $         $      

Interest rate swap liability

  $         $     (896)      $      

Assets held for sale

  $         $         $     43,634   

Money Market Funds and Certificates of Deposit

We determine fair value for our money market funds and certificates of deposit based on quoted market prices. The fair value of these assets is included in our cash and cash equivalents on our Consolidated Balance Sheets.

Interest Rate Swap Liability

We used a market valuation approach to value our interest rate swap derivative contracts using current market information as of the reporting date, such as the forecast of future market interest rates and implied volatility. We mitigated derivative credit risk by transacting with highly rated counterparties. Our interest rate swap agreement expired on March 22, 2011.

Assets Held For Sale

We used a market valuation approach to estimate the fair value of the Money Transfer Business, which we sold to Sigue during the second quarter of 2011. The estimated fair value of assets held for sale in the table above excluded the costs to sell of $2.0 million.

There were no changes to our valuation techniques during the six months ended June 30, 2011.

Assets and Liabilities Measured and Reported at Fair Value on a Nonrecurring Basis

Financial instruments not valued on a recurring basis include cash and cash equivalents, accounts and notes receivable, accounts payable, and our revolving line of credit, the fair values of which approximate their carrying values due to the short-term nature of these instruments.

We also measure certain non-financial assets at fair value on a nonrecurring basis, primarily long-lived assets, goodwill, intangible assets and certain other assets in connection with impairment evaluation. All of our nonrecurring valuations use significant unobservable inputs and therefore fall under Level 3 of the fair value hierarchy.

Note Receivable

During the second quarter of 2011, we financed a portion of the proceeds from the sale of our Money Transfer Business through a note receivable with Sigue. We recorded the note receivable at fair value, we estimated the fair value of the seller’s note at approximately $21.0 million, which was based on the discounted cash flows of the future note payments and was not an exit price based measure of fair value. The discount rate used in our fair value estimate was the market rate for similar risk profile companies and represented our best estimate of the default risk. See Note 3: Discontinued Operations, Sale of Assets and Assets Held for Sale for additional information about the sale of our Money Transfer Business.

During the second quarter of 2011, we performed nonrecurring fair value measurements in connection with assigning goodwill to our segments. See Note 11: Business Segments for additional information.

Convertible Debt

We estimate the fair value of our convertible debt outstanding using the market rate for similar high-yield debt. The fair value of our convertible debt was $183.2 million and $180.9 million at June 30, 2011 and December 31, 2010, respectively, and was determined based on its stated terms, maturing on September 1, 2014 and an annual interest rate of 4%. We have reported the carrying value of our convertible debt, face value less the unamortized debt discount, in our Consolidated Balance Sheets.

 

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NOTE 15: COMMITMENTS AND CONTINGENCIES

Letters of credit

As of June 30, 2011, we had three irrevocable standby letters of credit that totaled $4.6 million. These standby letters of credit, which expire at various times through 2011, are used to collateralize certain obligations to third parties. As of June 30, 2011, no amounts were outstanding under these standby letter of credit agreements.

Legal Matters

In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a putative 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 and is seeking monetary damages and other relief as appropriate. 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. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

On January 24, 2011, a putative class action complaint was filed in the U.S. District Court for the Western District of Washington against Coinstar and certain of its officers. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. Five substantially similar complaints were later filed in the same court. Pursuant to an order of the court dated March 14, 2011, these six putative class actions were consolidated as a single action entitled In re Coinstar, Inc. Securities Litigation. On April 19, 2011, the court appointed the Employees’ Retirement System of Rhode Island as lead plaintiff and approved its selection of lead counsel. A consolidated complaint was filed on June 17, 2011. Our motion to dismiss this complaint was filed on July 15, 2011.

The court has set a trial date for September 9, 2013. This case purports to be brought on behalf of a class of persons who purchased or otherwise acquired our stock during the period from October 28, 2010 to February 3, 2011. Plaintiffs allege that the defendants violated the federal securities laws during this period of time by, among other things, issuing false and misleading statements about our current and prospective business and financial results. Plaintiffs claim that, as a result of these alleged wrongs, our stock price was artificially inflated during the purported class period. Plaintiffs are seeking unspecified compensatory damages, interest, an award of attorneys’ fees and costs, and injunctive relief. We believe that the claims against us are without merit and we intend to defend ourselves vigorously in this matter. Failure by us to obtain a favorable resolution of the claims set forth in the complaints could have a material adverse effect on our business, results of operations and financial condition. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

On March 2 and 10, 2011, shareholder derivative actions were filed in the Superior Court of the State of Washington (King County), allegedly on behalf of and for the benefit of Coinstar, against certain of its current and former directors and officers. Coinstar was named as a nominal defendant. On April 12, 2011, the court consolidated these actions as a single action entitled In re Coinstar, Inc. Derivative Litigation. A third substantially similar complaint was later filed in the same court. On April 18, 2011, two purported shareholder derivative actions were filed in the U.S. District Court for the Western District of Washington. On May 26, 2011, the court consolidated the federal derivative actions and joined them with the securities class actions, captioned In re Coinstar Securities Litigation, for pre-trial proceedings. The derivative plaintiffs’ consolidated complaint was filed on July 15, 2011. The court has set a trial date for September 9, 2013. The state and federal derivative complaints arise out of many of the factual allegations at issue in the class action, and generally allege that the individual defendants breached fiduciary duties owed to Coinstar by selling Coinstar stock while in possession of material non-public information, and participating in or failing to prevent misrepresentations regarding redbox expectations, performance, and internal controls. The complaints seek unspecified damages and equitable relief, disgorgement of compensation, attorneys’ fees, costs, and expenses. Because the complaints are derivative in nature, they do not seek monetary damages from Coinstar. However, Coinstar may be required to advance the legal fees and costs incurred by the individual defendants. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

In March 2011, a California resident, Blake Boesky, individually and on behalf of all others similarly situated, filed a putative class action complaint against our redbox subsidiary in the U.S. District Court for the Northern District of

 

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Illinois. The plaintiff alleges that redbox retains personally identifiable information of consumers for a time period in excess of that allowed under the Video Privacy Protection Act, 18 U.S.C. §§ 2710, et seq. A substantially similar complaint was filed in the same court in March 2011 by an Illinois resident, Kevin Sterk. Plaintiffs are seeking statutory damages, injunctive relief, attorneys’ fees, costs of suit, and interest. The court has consolidated the cases, and redbox has moved to dismiss the plaintiffs’ claims. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

In February 2011, a California resident, Michael Mehrens, individually and on behalf of all others similarly situated, filed a putative class action complaint against our redbox subsidiary in the Superior Court of the State of California, County of Los Angeles. The plaintiff alleges that, among other things, redbox violated California’s Song-Beverly Credit Card Act of 1971 (“Song-Beverly”) with respect to the collection and recording of consumer personal identification information, and violated the California Business and Professions Code § 17200 based on the alleged violation of Song-Beverly. A similar complaint alleging violations of Song-Beverly and the right to privacy generally, was filed in March 2011 in the Superior Court of the State of California, County of Alameda, by a California resident, John Sinibaldi. A third similar complaint alleging only a violation of Song-Beverly, was filed in March 2011 in the Superior Court of the State of California, County of San Diego, by a California resident, Richard Schiff. Plaintiffs are seeking compensatory damages and civil penalties, injunctive relief, attorneys’ fees, costs of suit, and interest. Redbox has removed the Mehrens case to the U.S. District Court for the Central District of California, the Sinibaldi case to the U.S. District Court for the Northern District of California, and the Schiff case to the U.S. District Court for the Southern District of California. The Sinibaldi case subsequently was transferred to the U.S. District Court for the Central District of California, where the Mehrens case is pending. Redbox has moved to dismiss each of the three cases. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

Other Contingencies

During the quarter ended March 31, 2011, we recorded a loss contingency in the amount of $2.0 million related to certain international transactional tax exposures within general and administrative expense on our Consolidated Statements of Net Income and other accrued liabilities on our Consolidated Balance Sheets. In addition to the amount accrued, we estimated additional exposure of $6.0 million existed for which the risk of loss did not meet the probable threshold. Based upon additional information received in July 2011, the $6.0 million is no longer considered to be a possible exposure.

During the second quarter of 2011, we recorded a loss contingency of $4.0 million related to a supply agreement under which we operated during 2011 and 2010. Based on currently available information, our best estimate of the aggregate range of reasonably possible losses is from $0 to $9.0 million. As additional information becomes known, our accrual could fluctuate and impact our results of operations from period to period. If the actual loss significantly exceeds our accrual, it could materially impact our operating results in the period in which the actual loss becomes known.

 

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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, 2010 (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.

In the following discussion, unless otherwise noted, references to increases or decreases in revenue and expense items, cash flows and financial measures are based on the quarter and year-to-date periods ended June 30, 2011, compared with the quarter and year-to-date periods ended June 30, 2010.

Changes in our Organizational Structure

During the first quarter of 2011, in addition to our existing segments redbox and Coin, we added a reportable segment, New Ventures, to reflect changes in how our CEO manages our businesses and allocates resources for the future growth of the company. Our New Ventures segment consists primarily of our Coffee self-service concept and certain other self-service concepts that are under development.

As part of our new reporting structure, during the second quarter of 2011, we completed our evaluation of the reassignment of goodwill to our New Ventures segment by using a relative fair value approach that is similar to the approach used when a portion of a segment is to be disposed. We used both the income and cost methods to estimate the fair value of our New Ventures segment and both the income and market methods to estimate the fair values of our redbox and Coin segments. As a result of our evaluation, we did not assign any goodwill to our New Ventures segment because the amount was immaterial.

During the second quarter of 2011, we exited one of the self-service concepts we were testing, which was included in our New Ventures segment. Based on our materiality assessment, we consider the results of the self-service concept to be immaterial and therefore have elected not to present it as a discontinued operation in our Consolidated Statements of Net Income.

Comparability of Segment Results

We have recast prior period results for the following:

 

   

The addition of our New Ventures segment, which includes our self-service concepts, were a part of our Coin and redbox segments prior to the first quarter of 2011; and

 

   

The allocation of share-based payments made to certain movie studios as part of content agreements from corporate unallocated to direct operating in our redbox segment beginning in the first quarter of 2011.

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 redbox segment, where consumers can rent or purchase movies and rent video games from self-service kiosks, and our Coin segment, where consumers can convert their coin to cash or stored value products at self-service coin-counting kiosks. Our New Ventures segment is focused on identifying, evaluating, building, and growing innovative self-service concepts in the marketplace. Our redbox segment generates revenue primarily through fees charged to rent or purchase a DVD movie or game, and we pay retailers a percentage of our revenue. Our Coin segment generates revenue primarily through transaction fees from our consumers and product partners and we pay retailers a percentage of our revenue. Our New Ventures segment generates revenue primarily through offering products or services to customers in select test markets where we are validating the business concepts.

 

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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 are focusing on growing our core businesses and developing innovative new concepts in the automated retail space through organic growth and external investment. We will also continue to expand our use of social media to drive awareness of our offerings and continue to leverage new and innovative ideas to drive demand. In order to support growth, we also expect to continue devoting significant resources for the ongoing development of our infrastructure, including information technology systems and technology infrastructure necessary to support our products and services.

We manage our business by evaluating the financial results of our segments, focusing primarily on segment revenue and segment operating income from continuing operations before depreciation, amortization and other and share-based payments (“segment operating income”). Segment operating income contains internally allocated costs of shared service functions, including corporate executive management, business development, sales, finance, legal, human resources, information technology, and risk management. 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 example, if a segment’s revenue increases more than expected, our CEO may consider allocating more 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.

We also review same store sales which we calculate for our segments on a location basis. Most of our locations have a single kiosk, but in locations with high-performing kiosks, we may add additional kiosks to drive incremental revenue and provide a broader product offering. Same store sales reflects the change in revenue from locations that have been open for more than 13 months by the end of the reporting period compared with the same locations in the same period of the prior year.

RESULTS OF OPERATIONS

Consolidated Results

The discussion and analysis that follows covers our results from continuing operations.

 

        Three Months Ended                       Six Months Ended                

Dollars in thousands

     

June 30,

     

Change

     

June 30,

     

Change

       

    2011    

     

    2010    

     

$

     

%

     

    2011    

     

    2010    

     

$

     

%

Revenue

  $       435,228    $       342,356    $       92,872          27.1%   $       859,300    $       665,478    $       193,822          29.1%

Operating income

  $   58,218    $   29,333    $   28,885      98.5%   $   89,587    $   53,861    $   35,726      66.3%

Income from continuing operations

  $   31,461    $   12,841    $   18,620      145.0%   $   46,303    $   22,080    $   24,223      109.7%

Diluted earnings per share from continuing operations

  $   0.98    $   0.39    $   0.59      151.3%   $   1.44    $   0.69    $   0.75      108.7%

Revenue increased $92.9 million, or 27.1%, during the second quarter and $193.8 million, or 29.1%, year-to-date primarily due to new DVD kiosk installations and same store sales growth in our redbox segment - refer to the redbox segment discussion.

 

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Operating income increased $28.9 million, or 98.5%, during the second quarter and $35.7 million, or 66.3%, year-to-date primarily due to our redbox segment, where revenue growth was partially offset by increased product costs - refer to the redbox segment discussion.

Income from continuing operations increased $18.6 million, or 145.0%, during the second quarter and $24.2 million, or 109.7%, year-to-date primarily due to the following:

 

   

Higher operating income in our redbox segment as described above; and

 

   

Decreased interest expense related to principal payments made on our revolving credit facility during the third quarter of 2010 – refer to interest expense discussion; partially offset by

 

   

Increased income tax expense primarily due to higher pretax income – refer to income tax discussion.

Share-Based Payments

Our share-based payments consist of share-based compensation granted to executives, non-employee directors and employees and share-based payments granted to movie studios as part of content agreements. We grant stock options, restricted stock and performance-based restricted stock to executives and non-employee directors and grant restricted stock to our employees. We also granted restricted stock to certain movie studios as part of content agreements with our redbox segment. The expense associated with these grants is allocated to our redbox segment and included within direct operating expense. The expense associated with share-based compensation to our executives, non-employee directors and employees is part of our shared service function and is not allocated to our segments. The components of our unallocated share-based compensation expense are presented in the following table.

Unallocated Share-Based Compensation

 

        Three Months Ended                       Six Months Ended                

Dollars in thousands

     

June 30,

     

Change

     

June 30,

     

Change

       

    2011      

     

    2010      

     

$

     

%

     

    2011      

     

    2010      

     

    $    

     

%

Direct operating

  $   83    $   450    $       (367)         (81.6)%   $   213    $   559    $   (346)         (61.9)%

Marketing

    11              175.0%     20          12      150.0%

Research and development

    78      58      20      34.5%     155      109      46      42.2%

General and administrative

    2,170      1,826      344      18.8%     4,816      4,287      529      12.3%
                                           

Total

  $   2,342    $   2,338    $       0.2%   $   5,204    $   4,963    $   241      4.9%
                                           

Our year-to-date unallocated share-based compensation expense increased $0.2 million, or 4.9%, primarily due to an increase in the number of restricted stock awards granted, as well as an increase in the fair value of the grants.

 

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Segment Results

Our discussion and analysis that follows covers our results from continuing operations, which consists of our redbox, Coin and New Ventures segments. Detailed financial information about our business segments, including significant customer relationships, is provided in Note 11: Business Segments in the Notes to Consolidated Financial Statements.

redbox

 

         Three Months Ended                       Six Months Ended            

Dollars in thousands,

except rental amounts

 

      

 

June 30,

     

Change

     

June 30,

     

Change

      

 

2011

     

2010

     

$

     

%

     

2011

     

2010

     

$

     

%

 

Revenue

   $       363,862    $       271,869    $       91,993          33.8%   $       726,206    $       534,947    $       191,259          35.8%

 

Direct operating

     255,105      206,787      48,318      23.4%     536,519      398,762      137,757      34.5%

 

Marketing

     6,357      4,435      1,922      43.3%     10,404      6,267      4,137      66.0%

 

Research and development

                 0.0%     62          62      0.0%

 

General and administrative

     28,379      23,480      4,899      20.9%     54,383      46,450      7,933      17.1%
                                            

 

Segment operating income

     74,017      37,167      36,850      99.1%     124,838      83,468      41,370      49.6%

 

Depreciation and amortization

     27,360      23,866      3,494      14.6%     54,458      45,987      8,471      18.4%
                                            

 

Operating income

   $   46,657    $   13,301    $   33,356      250.8%   $   70,380    $   37,481    $   32,899      87.8%
                                            

 

Operating income as a percentage of revenue

     12.8%     4.9%             9.7%     7.0%        

 

Same store sales growth

     16.6%     3.5%             16.0%     11.1%        

 

Effect of change in revenue from same store sales growth

   $   43,946    $   6,512    $   37,434      574.8%   $   83,096    $   37,437    $   45,659      122.0%

 

Ending number of kiosks

     33,300      26,900      6,400      23.8%     33,300      26,900      6,400      23.8%

 

Total rentals (in thousands)

     166,890      123,118      43,772      35.6%     331,263      243,248      88,015      36.2%

 

Net revenue per rental

   $   2.18    $   2.17    $   0.01      0.4%   $   2.19    $   2.17    $   0.02      0.9%

Three months ended June 30, 2011 compared with three months ended June 30, 2010:

Revenue increased $92.0 million, or 33.8%, primarily due to the following:

 

   

$48.1 million increase from the addition of new kiosk installations; and

 

   

$43.9 million increase from same store sales growth of 16.6%.

Operating income increased $33.4 million, or 250.8%, primarily due to leveraging in all major expenses as a percent of revenue. Our revenue growth of $92.0 million, or 33.8%, exceeded our $48.3 million, or 23.4%, growth in direct operating expenses, which as a percentage of revenue, decreased 6.0 percentage points from 76.1% during 2010 to 70.1% during 2011. The components of the operating income increase are as follows:

 

   

$92.0 million increase in revenue as described above; partially offset by

 

   

$48.3 million increase in direct operating expenses primarily related to increased DVD product costs from the addition of new kiosks, as well as increased revenue share and payment card fees related to the revenue growth and increased kiosk field operations due primarily to a higher installed kiosk base. Our overall DVD library balance has decreased since December 2010 due to the amortization of the higher than optimal purchases of December 2010 and January 2011 titles. We continue to see reductions in the servicing costs per kiosk as we better leverage our existing field resources over a higher installed kiosk base;

 

   

$4.9 million increase in general and administrative expense related primarily to supporting overall business growth and the strengthening of our infrastructure. We continue to leverage our general and administrative expense as it decreased as a percent of revenue 0.8 percentage points from 8.6% in 2010 to 7.8% in 2011; and

 

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$3.5 million increase in depreciation and amortization expense primarily due to a larger installed kiosk base and continued build-out of our technology infrastructure, partially offset by a $2.4 million charge in 2010 related to the closure of DVDXpress branded kiosks.

Six months ended June 30, 2011 compared with six months ended June 30, 2010:

Revenue increased $191.3 million, or 35.8%, primarily due to the following:

 

   

$98.2 million increase from the addition of new kiosk installations; and

 

   

$89.6 million increase from same store sales growth of 16.0% and a $0.02 increase in net revenue per rental.

Operating income increased $32.9 million, or 87.8%, primarily due to the following:

 

   

$191.3 million increase in revenue as described above; partially offset by

 

   

$137.8 million increase in direct operating expenses primarily related to increased DVD product costs from higher than optimal purchases of December 2010 and January 2011 titles and the addition of new kiosks, as well as increased revenue share and payment card fees related to revenue growth and increased kiosk field operations due primarily to a higher installed kiosk base. Our overall DVD library balance has decreased since December 2010 due to the amortization of the higher than optimal purchases of December 2010 and January 2011 titles;

 

   

$8.5 million increase in depreciation and amortization expense primarily due to a larger installed kiosk base and continued build-out of our technology infrastructure, partially offset by a $5.6 million charge in 2010 related to the closure of DVDXpress branded kiosks;

 

   

$7.9 million increase in general and administrative expense related primarily to supporting overall business growth and strengthening of our infrastructure. Due to better leveraging of our general and administrative expense, it decreased as a percent of revenue by 1.2 percentage points from 8.7% in 2010 to 7.5% in 2011; and

 

   

$4.1 million increase in marketing, primarily on-demand generation marketing by means of search engine marketing, promotional email, and affiliate programs, as well as additional studio marketing.

 

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Coin

 

        Three Months Ended                       Six Months Ended                

Dollars in thousands,

 

except transaction amounts

     

 

June 30,

     

Change

     

June 30,

     

Change

   

 

    2011     

     

    2010     

     

$

     

%

     

    2011     

     

    2010     

     

$

     

%

 

Revenue

 

$

      71,065    $   70,362    $   703      1.0%   $       132,428    $       130,280    $   2,148      1.6%

 

Direct operating

    35,983      34,314      1,669      4.9%     69,052      66,915      2,137      3.2%

 

Marketing

    1,258      1,412      (154)       (10.9)%     2,269      2,174      95      4.4%

 

Research and development

    1,461      1,529      (68)         (4.4)%     3,246      2,902      344      11.9%

 

General and administrative

    5,563      5,064      499      9.9%     10,452      9,847      605      6.1%

 

Litigation

    0     0     0     0.0%     0     5,379          (5,379)     0.0%
                                           

 

Segment operating income

    26,800      28,043          (1,243)     (4.4)%     47,409      43,063      4,346      10.1%

 

Depreciation and amortization

    7,451      7,562      (111)     (1.5)%     14,822      14,621      201      1.4%
                                           

 

Operating income

 

$

  19,349    $   20,481    $   (1,132)     (5.5)%   $   32,587    $   28,442    $   4,145      14.6%
                                           

 

Operating income as a percentage of revenue

    27.2%     29.1%             24.6%     21.8%        

 

Same store sales growth

    1.8%     7.9%             3.3%     4.2%        

 

Ending number of kiosks

    18,900      19,000      (100)     (0.5)%     18,900      19,000      (100)         (0.5)%

 

Total transactions (in thousands)

    19,205      19,623      (418)     (2.1)%     36,037      37,101      (1,064)     (2.9)%

 

Average transaction size

 

$

  38.40    $   37.10    $   1.30      3.5%   $   38.10    $   37.00    $   1.10      3.0%

Three months ended June 30, 2011 compared with three months ended June 30, 2010:

Revenue increased $0.7 million, or 1.0%, primarily due to a $1.30 increase in the average transaction size to $38.40, offset by a decline in total transactions of 418,000. Same store sales during the period increased by 1.8%.

Operating income decreased $1.1 million, or 5.5%, primarily due to the following:

 

   

$1.7 million increase in direct operating expenses, primarily driven by higher revenue share to our retail partners as a result of both higher revenue and increases in certain revenue share rates as we renewed long-term contracts with key retailers along with higher operating costs associated with kiosk field operations driven by such factors as higher fuel costs and leased vehicle expense, partially offset by lower coin processing expense as a result of a credit received for previously-processed mutilated coin in 2011 and lower allocated expenses from our shared service support function as a result of reduced customer service costs related to the Coin segment; and

 

   

$0.5 million increase in general and administrative expenses primarily due to the increase in allocated costs from our shared service support functions resulting from increased expenses to support overall business growth and increased data center costs; partially offset by

 

   

$0.7 million increase in revenue as described above.

Six months ended June 30, 2011 compared with six months ended June 30, 2010:

Revenue increased $2.1 million, or 1.6%, primarily due to the following:

 

   

An increase in our coin counting transaction fee from 8.9% to 9.8%, which took effect for the majority of our coin-counting kiosks within the U.S. during the first quarter of 2010; and

 

   

A $1.10 increase in the average transaction size to $38.10, partially offset by a 1,064,000 decline in total transactions. Same store sales increased by 3.3%.

 

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Operating income increased $4.1 million, or 14.6%, primarily due to the following:

 

   

$5.4 million decrease in litigation expenses, driven primarily by the settlement of patent litigation with ScanCoin for $5.4 million, which was expensed during the first quarter of 2010; and

 

   

$2.1 million increase in revenue as described above; partially offset by

 

   

$2.1 million increase in direct operating expenses, primarily driven by higher revenue share to our retail partners as a result of both higher revenue and increases in certain revenue share rates as we renewed long-term contracts with key retailers along with higher operating costs associated with kiosk field operations driven by such factors as higher fuel costs and leased vehicle expense, partially offset by lower coin processing expense as a result of a credit received in 2011 for previously-processed mutilated coin and lower allocated expenses from our shared service support function as a result of reduced customer service costs related to the Coin segment;

 

   

$0.6 million increase in general and administrative expenses primarily due to the increase in allocated costs from our shared service support functions resulting from increased expenses to support overall business growth and increased data center costs; and

 

   

$0.3 million increase in research and development expenditures to both enhance our existing products and services and support the ongoing development and design of complementary new product ideas.

 

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New Ventures

 

        Three Months Ended                       Six Months Ended                

Dollars in thousands

     

June 30,

     

Change

     

June 30,

     

Change

       

    2011     

     

    2010     

     

$

     

%

     

    2011     

     

    2010     

     

$

     

%

 

Revenue

  $   301    $   125    $   176          140.8%   $   666    $   251    $   415          165.3%

 

Direct operating

    1,342      245      1,097      447.8%     1,802      519      1,283      247.2%

 

Marketing

    231      83      148      178.7%     281      115      166      144.3%

 

Research and development

    550      218      332      152.3%     837      218      619      283.9%

 

General and administrative

    2,945      1,506      1,439      95.6%     5,068      2,814      2,254      80.1%
                                           

 

Segment operating loss

    (4,767)     (1,927)     (2,840)     147.4%     (7,322)     (3,415)     (3,907)     114.4%

 

Depreciation and amortization

    679      184      495      269.0%     854      3,684     (2,830)     (76.8)%
                                           

 

Operating loss

  $   (5,446)   $   (2,111)   $       (3,335)     158.0%   $   (8,176)   $   (7,099)   $       (1,077)     15.2%
                                           

The increase in revenue during the second quarter and year-to-date is primarily due to the addition of self-service concepts as well as an increased number of kiosks for existing concepts.

Operating loss increased $3.3 million, or 158.0%, during the second quarter primarily due to the following:

 

   

$1.4 million increase in general and administrative expense primarily due to $0.5 million of costs associated with exiting one of our self-service concept test programs as well as a $0.5 million increase in payroll related expenses from increased headcount to grow existing self-service concepts as well as starting up new self-service concepts;

 

   

$1.1 million increase in direct operating expense due to a $0.7 million charge for purchases of additional prototype kiosks, which are expensed as acquired during the piloting phase, as well as the addition of self-service concepts to test markets;

 

   

$0.5 million increase in depreciation and amortization expense driven by a $0.6 million charge related to the early retirement of kiosks associated with exiting one of our self-service concept test programs; and

 

   

$0.3 million increase in research and development expenditures associated with the design of new self-service concepts.

Operating loss increased $1.1 million, or 15.2%, year-to-date primarily due to the following:

 

   

$2.3 million increase in general and administrative expense primarily due to a $0.5 million charge associated with exiting one of our self-service concept test programs, a $0.9 million increase in payroll related expenses from increased headcount to grow existing self-service concepts as well as starting up new concepts; and a $0.4 million increase due to the increase in allocated costs from our shared service support functions;

 

   

$0.9 million increase in direct operating expense due to a $0.7 million charge for purchases of additional prototype kiosks, which are expensed as acquired during the piloting phase, as well as the addition of self-service concepts to test markets;

 

   

$0.6 million increase in research and development expenditures associated with the design of new self-service concepts; offset by

 

   

$2.8 million decrease in depreciation and amortization expense primarily due to a $3.2 million charge during the first quarter of 2010 related to the disposal of our first generation coffee kiosk, offset by a $0.6 million charge in 2011 related to the early retirement of kiosks associated with exiting one of our self-service concept test programs.

 

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Interest Expense

 

        Three Months Ended                       Six Months Ended                

Dollars in thousands

     

June 30,

     

Change

     

June 30,

     

Change

       

 

    2011      

     

    2010      

     

    $    

     

%

     

2011

     

2010

     

$

     

%

 

Cash interest expense

  $   3,994    $   7,023    $       (3,029)       (43.1)%   $   9,138    $   14,210    $   (5,072)     (35.7)%

 

Non-cash interest expense

    2,274      2,135      139      6.5%     4,516      4,216      300      7.1%
                                           

 

Total interest expense

  $   6,268    $   9,158    $   (2,890)     (31.6)%   $       13,654    $       18,426    $     (4,772)       (25.9)%
                                           

The decrease in interest expense during the second quarter and year-to-date was primarily due to lower average debt balances as a result of a $100.0 million reduction on our revolving credit facility between the second quarter of 2010 and the second quarter of 2011; partially offset by increased amortization of non-cash interest expense from our convertible debt discount.

Income Tax Expense

Our effective tax rate from continuing operations was 38.8% and 37.8% in 2011 and 2010, respectively. The increase in our effective tax rate was attributable primarily to additional state income taxes offset by federal and state research and general business credits.

NON-GAAP FINANCIAL MEASURES

Non-GAAP financial measures may be provided as a complement to results 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.

Adjusted EBITDA from Continuing Operations

We use the non-GAAP measure of adjusted earnings, before interest, taxes, depreciation, amortization and other, and share-based payment expense from continuing operations (“adjusted EBITDA from continuing operations”) because 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 herein 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.

A reconciliation of adjusted EBITDA from continuing operations to income from continuing operations, the most comparable GAAP financial measure, is presented below:

 

       

Three Months Ended

     

Six Months Ended

Dollars in thousands

 

     

2011

 

     

2010

 

     

2011

 

     

2010

 

Income from continuing operations

  $   31,461    $   12,841    $   46,303    $   22,080 

 

Depreciation, amortization, and other

    35,490      31,612      70,134      64,292 

 

Interest expense, net

    6,156      9,073      13,462      18,339 

 

Income taxes

    20,110      7,389      29,371      13,395 

 

Share-based payment expense(1)

    5,453      4,568      8,493      7,786 
                       

 

Adjusted EBITDA from continuing operations

  $         98,670    $         65,483    $       167,763    $       125,892 
                       

 

(1)

Share-based payment expense includes both non-cash share-based compensation expense for executives, non-employee directors and employees as well as share-based payment expense related to DVD arrangements.

 

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The increases in our adjusted EBITDA from continuing operations were primarily due to improvements in our redbox segment results. The other components of adjusted EBITDA have been discussed previously in the results of operations section above.

Free Cash Flow from Continuing Operations

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 additional information to users of the financial statements 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:

 

        Three Months Ended   Six Months Ended
       

June 30,

 

June 30,

Dollars in thousands

 

     

2011

 

     

2010

 

     

2011

 

     

2010

 

 

Net cash provided by operating activities from continuing operations

  $   111,865    $   104,176    $   171,860    $   163,656 

 

Purchase of property and equipment

        (49,405)         (52,822)         (87,877)         (84,339)
                       

 

Free cash flow from continuing operations

  $   62,460    $   51,354    $   83,983    $   79,317 
                       

An analysis of our net cash provided by operating activities and used in investing activities from continuing operations is provided below.

LIQUIDITY AND CAPITAL RESOURCES

We believe our existing cash, cash equivalents and amounts available to us under our new 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.

Cash from Operating Activities from Continuing Operations

Our net cash from operating activities from continuing operations increased by $8.2 million during the first six months of 2011 primarily due to the following:

 

   

$15.4 million increase in net income to $35.2 million primarily due to increased operating income in our redbox segment; and

 

   

$36.9 million increase in non-cash expenses to $118.0 million primarily due to increased depreciation on kiosks, higher deferred income taxes, and increased losses from discontinued operations; offset by

 

   

$44.1 million decrease working capital changes to $18.6 million primarily due to the pay down of accounts payable and accrued liabilities; partially offset by lower purchases for our DVD library.

Cash from Investing Activities from Continuing Operations

We used $77.6 million of net cash in our investing activities from continuing operations during the first six months of 2011 primarily due to the following:

 

   

$87.9 million used for purchases of property and equipment for kiosks and corporate infrastructure, particularly information technology;

 

   

$2.3 million used for equity investments in a New Venture business; partially offset by

 

   

$12.2 million of cash proceeds from the sale of our Money Transfer Business.

 

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Cash from Financing Activities from Continuing Operations

We used $101.8 million of net cash in our financing activities from continuing operations during the first six months of 2011 primarily due to the following:

 

   

$63.3 million used to repurchase common stock, including the settlement of our accelerated stock repurchase program;

 

   

$25.0 million used to reduce our borrowings on our credit facility; and

 

   

$17.1 million used for principal payments on our capital lease obligations and other long-term debt.

Cash and Cash Equivalents

A portion of our business involves collecting and processing large volumes of cash, most of it in the form of coins. Previously, we provided three categories – (i) cash and cash equivalents, (ii) cash in machine or in transit, and (iii) cash in process, when presenting our cash in the Consolidated Balance Sheets. As a result of the growth in our redbox business, the percentage of our Coin business, relative to the overall business has decreased. We believe the previous presentation of cash, which focused more on our Coin business, became less relevant.

As of June 30, 2011, our cash and cash equivalent balance was $173.5 million, of which $80.2 million was identified for settling our payable to the retailer partners in relation to our Coin kiosks. The remaining balance of our cash and cash equivalents was $93.3 million and included bank balances and cash equivalents that are immediately available for use to support our daily liquidity needs. In addition, a portion of our cash and cash equivalent balance consists of coins in our Coin kiosks or in-transit to coin processing facilities that is not immediately available for use.

Long-Term Debt

Long-term debt was comprised of the following:

 

Dollars in thousands

     

June 30,
        2011        

     

  December 31,  
2010

Revolving line of credit

  $   125,000    $   150,000 

 

Convertible debt (Face value, matures September 2014)

    200,000      200,000 
           

 

Total debt

  $   325,000    $   350,000 
           

On July 15, 2011, we entered into a new credit facility, which replaced our prior credit facility. The new credit facility provides for a 5-year, $175.0 million term loan and a $450.0 million revolving line of credit. Subject to additional commitments from lenders, we have the option to increase the aggregate facility size by $250.0 million. The term loan is subject to mandatory debt repayments and matures on July 15, 2016, at which time all outstanding borrowings are due. The interest rate on the new credit facility is variable, based on an index plus a margin determined by our consolidated net leverage ratio. The new credit facility is secured by a first priority security interest in substantially all of our assets and the assets of our domestic subsidiaries, as well as a pledge of a substantial portion of our subsidiaries’ capital stock. The new credit facility contains certain financial covenants, ratios and tests. See Note 12: Debt and Other Long-Term Liabilities in our Notes to Consolidated Financial Statements.

We have outstanding $200.0 million in aggregate principal amount of 4% Convertible Senior Notes (the “Notes”). The Notes bear interest at a fixed rate of 4% per annum, payable semi-annually in arrears in the amount of $4 million on each March 1 and September 1, beginning March 1, 2010, and mature on September 1, 2014. The effective interest rate on the Notes was 8.5% at the time of issuance. As of June 30, 2011, we were in compliance with all covenants.

Our Notes become convertible when the closing price of our common stock exceeds 130% of the Notes’ conversion price for more than 20 trading days out of the period of 30 consecutive trading days ending June 30, 2011 (the “Conversion Value Measurement Period”). If the Notes become convertible, and should the Note holders elect to convert, we will be required to pay them up to the full face value of the Notes in cash as well as deliver shares of our common stock for any excess conversion value. The number of potentially issued shares increases as the market price of our common stock increases during the Conversion Value Measurement Period. This conversion event is reset each quarter.

 

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As of December 31, 2010, this early conversion event was satisfied and the Notes became convertible in the first quarter of 2011, and, accordingly, as of December 31, 2010, the Notes were classified as current on our Consolidated Balance Sheets. However, none of the Note holders submitted requests for conversion. As of June 30, 2011, the early conversion conditions were not met and, accordingly, the Notes were reported as a long-term liability on our Consolidated Balance Sheets.

Letters of Credit

As of June 30, 2011, we had three irrevocable standby letters of credit that totaled $4.6 million. These standby letters of credit, which expire at various times through October 6, 2011, are used to collateralize certain obligations to third parties. No amounts were outstanding under these standby letter of credit agreements on June 30, 2011.

Other Contingencies

During the quarter ended March 31, 2011, we recorded a loss contingency in the amount of $2.0 million related to certain international transactional tax exposures within general and administrative expense on our Consolidated Statements of Net Income and other accrued liabilities on our Consolidated Balance Sheets. In addition to the amount accrued, we estimated additional exposure of $6.0 million existed for which the risk of loss did not meet the probable threshold. Based upon additional information received in July 2011, the $6.0 million is no longer considered to be a possible exposure.

During the second quarter of 2011, we recorded a loss contingency of $4.0 million related to a supply agreement under which we operated during 2011 and 2010. Based on currently available information, our best estimate of the aggregate range of reasonably possible losses is from $0 to $9.0 million. As additional information becomes known, our accrual could fluctuate and impact our results of operations from period to period. If the actual loss significantly exceeds our accrual, it could materially impact our operating results in the period in which the actual loss becomes known.

CONTRACTUAL PAYMENT OBLIGATIONS

Other than the following, there have been no material changes during the period covered by this report to our contractual obligations specified in the table of contractual obligations included in our 2010 Form 10-K:

 

   

An incremental purchase commitment of approximately $30.0 million related to our enterprise resource planning project in 2011, of which approximately $11.0 million has been incurred and capitalized during 2011; and

 

   

A reclassification on our Consolidated Balance Sheets of $173.1 million of convertible debt from current liabilities at December 31, 2010 to long-term liabilities at June 30, 2011.

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 2010 Form 10-K.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

There have been no material changes in our reported market risks and risk management policies since the filing of our 2010 Form 10-K.

Item 4. Controls and Procedures

Evaluation of Disclosure 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.

Changes in Internal Control over Financial Reporting

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, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In October 2009, an Illinois resident, Laurie Piechur, individually and on behalf of all others similarly situated, filed a putative 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 and is seeking monetary damages and other relief as appropriate. 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. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

On January 24, 2011, a putative class action complaint was filed in the U.S. District Court for the Western District of Washington against Coinstar and certain of its officers. The complaint asserts claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. Five substantially similar complaints were later filed in the same court. Pursuant to an order of the court dated March 14, 2011, these six putative class actions were consolidated as a single action entitled In re Coinstar, Inc. Securities Litigation. On April 19, 2011, the court appointed the Employees’ Retirement System of Rhode Island as lead plaintiff and approved its selection of lead counsel. A consolidated complaint was filed on June 17, 2011. Our motion to dismiss this complaint was filed on July 15, 2011. The court has set a trial date for September 9, 2013. This case purports to be brought on behalf of a class of persons who purchased or otherwise acquired our stock during the period from October 28, 2010 to February 3, 2011. Plaintiffs allege that the defendants violated the federal securities laws during this period of time by, among other things, issuing false and misleading statements about our current and prospective business and financial results. Plaintiffs claim that, as a result of these alleged wrongs, our stock price was artificially inflated during the purported class period. Plaintiffs are seeking unspecified compensatory damages, interest, an award of attorneys’ fees and costs, and injunctive relief. We believe that the claims against us are without merit and we intend to defend ourselves vigorously in this matter. Failure by us to obtain a favorable resolution of the claims set forth in the complaints could have a material adverse effect on our business, results of operations and financial condition. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

On March 2 and 10, 2011, shareholder derivative actions were filed in the Superior Court of the State of Washington (King County), allegedly on behalf of and for the benefit of Coinstar, against certain of its current and former directors and officers. Coinstar was named as a nominal defendant. On April 12, 2011, the court consolidated these actions as a single action entitled In re Coinstar, Inc. Derivative Litigation. A third substantially similar complaint was later filed in the same court. On April 18, 2011, two purported shareholder derivative actions were filed in the U.S. District Court for the Western District of Washington. On May 26, 2011, the court consolidated the federal derivative actions and joined them with the securities class actions, captioned In re Coinstar Securities Litigation, for pre-trial proceedings. The derivative plaintiffs’ consolidated complaint was filed on July 15, 2011. The court has set a trial date for September 9, 2013. The state and federal derivative complaints arise out of many of the factual allegations at issue in the class action, and generally allege that the individual defendants breached fiduciary duties owed to Coinstar by selling Coinstar stock while in possession of material non-public information, and participating in or failing to prevent misrepresentations regarding redbox expectations, performance, and internal controls. The complaints seek unspecified damages and equitable relief, disgorgement of compensation, attorneys’ fees, costs, and expenses. Because the complaints are derivative in nature, they do not seek monetary damages from Coinstar. However, Coinstar may be required to advance the legal fees and costs incurred by the individual defendants. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

In March 2011, a California resident, Blake Boesky, individually and on behalf of all others similarly situated, filed a putative class action complaint against our redbox subsidiary in the U.S. District Court for the Northern District of Illinois. The plaintiff alleges that redbox retains personally identifiable information of consumers for a time period in excess of that allowed under the Video Privacy Protection Act, 18 U.S.C. §§ 2710, et seq. A substantially similar complaint was filed in the same court in March 2011 by an Illinois resident, Kevin Sterk. Plaintiffs are seeking statutory damages, injunctive relief, attorneys’ fees, costs of suit, and interest. The court has consolidated the cases,

 

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and redbox has moved to dismiss the plaintiffs’ claims. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

In February 2011, a California resident, Michael Mehrens, individually and on behalf of all others similarly situated, filed a putative class action complaint against our redbox subsidiary in the Superior Court of the State of California, County of Los Angeles. The plaintiff alleges that, among other things, redbox violated California’s Song-Beverly Credit Card Act of 1971 (“Song-Beverly”) with respect to the collection and recording of consumer personal identification information, and violated the California Business and Professions Code § 17200 based on the alleged violation of Song-Beverly. A similar complaint alleging violations of Song-Beverly and the right to privacy generally, was filed in March 2011 in the Superior Court of the State of California, County of Alameda, by a California resident, John Sinibaldi. A third similar complaint alleging only a violation of Song-Beverly, was filed in March 2011 in the Superior Court of the State of California, County of San Diego, by a California resident, Richard Schiff. Plaintiffs are seeking compensatory damages and civil penalties, injunctive relief, attorneys’ fees, costs of suit, and interest. Redbox has removed the Mehrens case to the U.S. District Court for the Central District of California, the Sinibaldi case to the U.S. District Court for the Northern District of California, and the Schiff case to the U.S. District Court for the Southern District of California. The Sinibaldi case subsequently was transferred to the U.S. District Court for the Central District of California, where the Mehrens case is pending. Redbox has moved to dismiss each of the three cases. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual had been established as it was not possible to estimate the possible loss or range of loss because this matter had not advanced to a stage where we could make any such estimate.

Item 1A. Risk Factors

Due to the sale of the Money Transfer Business, risk factors previously disclosed related to the Money Transfer Business are no longer relevant. Except as listed below, there have been no other material changes from risk factors previously disclosed in our 2010 10-K.

We have substantial indebtedness

As of June 30, 2011, $125.0 million and $176.4 million was recorded on our Consolidated Balance Sheets for our new term loan and revolving credit facility (the “New Credit Facility”) and convertible debt agreements, respectively. We may generally prepay amounts borrowed under the New Credit Facility without premium or penalty (other than LIBOR breakage costs on the term loan). The New Credit Facility bears interest at variable rates determined by prevailing interest rates and our leverage ratio. As a result, our costs of borrowing are exposed to risks of fluctuations in interest rates, as well as our financial condition and operating results, which affect our leverage ratio. Loans made pursuant to the New Credit Facility are secured by a first priority security interest in substantially all of our assets and substantially all of the assets of our domestic subsidiaries, as well as a pledge of a substantial portion of our subsidiaries’ capital stock.

This New Credit Facility may limit our ability to obtain future financings or may negatively impact our business, financial condition, results of operations and growth. Due to substantial financial leverage, we may not be able to generate sufficient cash flow to service the indebtedness, or to adequately fund our operations. Moreover, the New Credit Facility contains negative covenants and restrictions relating to such things as certain stock repurchases, liens, investments, capital expenditures, other indebtedness, payments of dividends, and fundamental changes or dispositions of our assets that could impair our flexibility to pursue growth opportunities. In addition, the New Credit Facility requires that we meet certain financial covenants, including a maximum consolidated leverage ratio and a minimum consolidated interest coverage ratio, all as defined in the New Credit Facility. If the financial covenants are not met or any other event of default occurs under the New Credit Facility, our lenders would be entitled to declare our indebtedness immediately due and payable and exercise other remedies.

Payment of increased fees to retailers or other third party service providers could negatively affect our business results.

We face ongoing pricing pressure from our retailers to increase the service fees we pay to them on DVD and coin-counting products and services or to make other financial concessions to win or retain their business. If we are unable to respond effectively to ongoing pricing-related pressures, we may fail to win or retain certain accounts. Our fee arrangements are based on our evaluation of unique factors with each retailer, such as total revenue, e-payment capabilities, long-term, non-cancelable contracts, installation of our machines and equipment in high-traffic, urban

 

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or rural locations and new product and service commitments. Together with other factors, an increase in service fees paid, or other financial concessions made, to our retailers could significantly increase our direct operating expenses in future periods and harm our business. In addition, we accept payment for DVD and game rentals through debit and credit card transactions. For these payments, we pay interchange and other fees, which may increase over time. Further, because redbox processes millions of small dollar amount transactions, and interchange fees represent a larger percentage of card processing costs compared to a typical retailer, we are relatively more susceptible to any fee increase. If interchange or other fees increase, it would raise our operating costs and lower our profit margins or require that we charge our customers more for our products.

 

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Following our Board of Directors authorization granted in December 2010, and consistent with the terms of our credit facility, we were previously permitted to repurchase up to (i) $72.5 million of our common stock plus (ii) cash proceeds received after November 20, 2007 from the exercise of stock options by our officers, directors or employees. This authorization allowed us to repurchase up to $12.5 million of our common stock as of June 30, 2011. Repurchased shares become a part of treasury stock. On July 19, 2011, our Board of Directors authorized the additional repurchase of $250.0 million of our common stock plus the cash proceeds received from the exercise of stock options by our employees, officers, and directors under an equity compensation plan. See Note 7: Repurchases of Common Stock in the Notes to Consolidated Financial Statements . On July 15, 2011, we entered into a Second Amended and Restated Credit Agreement (the “New Credit Facility”), which replaced our prior credit facility. Under the New Credit Facility, we are permitted to repurchase shares of our common stock without limitation provided that we are in compliance with certain covenants required under the terms of the New Credit Facility. See Note 12: Debt and Other Long-Term Liabilities in the Notes to Consolidated Financial Statements for additional information.

The following table summarizes information regarding shares repurchased during the quarter ended June 30, 2011:

 

   

  Total Number of  
Shares

 

Repurchased(1)

     

Average Price

 

  Paid per Share  

 

Total Number of

Shares Purchased
as Part of Publicly
Announced
Repurchase Plans

 

or Programs

     

Maximum Approximate
Dollar Value of

Shares that May Yet

be Purchased

Under the Plans or

 

Programs

4/1/11 - 4/30/11

  1,109    $   49.22    1,109    $   11,599,979

5/1/11 - 5/31/11

  811    $   52.83    811    $   12,433,856

6/1/11 - 6/30/11

  328    $   53.14    328    $   12,540,704
                 
  2,248    $   51.09    2,248    $   12,540,704
                 

(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 be purchased under the programs.

 

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Item 6. Exhibits

 

  10.1*  

Coinstar, Inc. 2011 Incentive Plan (1)

  10.2  

First Amendment to Stock Purchase Agreement dated as of May 31, 2011, by and between Coinstar, Inc., Coinstar E-Payment Services Inc., CUHL Holdings Inc., Coinstar UK Holdings Limited, and Sigue Corporation. (2)

  10.3*  

Letter Agreement between Coinstar, Inc. and Timothy Hale dated April 10, 2009.

  31.1  

Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  31.2  

Certification of Chief Financial Officer pursuant to Section 302 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.DEF**   XBRL Taxonomy Extension Definition Linkbase Document.
  101.LAB**   XBRL Taxonomy Extension Label Linkbase Document.
  101.PRE**   XBRL Taxonomy Extension Presentation Linkbase Document.

 

 

 

*

Indicates 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 Appendix A of the Registrant’s Definitive Proxy Statement on Form DEF 14A filed on April 25, 2011 (File Number 000-22555).

(2)

Incorporated by reference to the Registrant’s Periodic Report on Form 8-K filed on June 2, 2011 (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.

 

 

COINSTAR, Inc.

 

By:    

  

/s/    J. Scott Di Valerio  

     J. Scott Di Valerio
     Chief Financial Officer
     July 28, 2011

 

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