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 September 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 October 20, 2011

Common Stock, $0.001 par value   30,776,459

 

 

 


Table of Contents

COINSTAR, INC.

FORM 10-Q

INDEX

 

PART I - FINANCIAL INFORMATION    Page
Item 1.    Financial Statements (unaudited):   
   Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010    1
   Consolidated Statements of Net Income for the Three and Nine Months Ended September 30, 2011 and 2010    2
   Consolidated Statements of Stockholders’ Equity for the Three and Nine Months Ended September 30, 2011    3
   Consolidated Statements of Cash Flows for the Three and Nine Months Ended September 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    25
Item 3.    Quantitative and Qualitative Disclosures about Market Risk    37
Item 4.    Controls and Procedures    37
PART II - OTHER INFORMATION   
Item 1.    Legal Proceedings    38
Item 1A.    Risk Factors    39
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)

 

              September 30,      
2011
            December 31,    
2010
 

Assets

       

Current Assets:

       

Cash and cash equivalents (Note 4)

  $     255,300     $     183,416  

Accounts receivable, net of allowances of $1,160 and $1,131

      22,276         25,958  

DVD library

      122,209         140,324  

Deferred income taxes

      17,256         13,644  

Prepaid expenses and other current assets

      15,930         14,736  

Assets of business held for sale

      -          110,316  
   

 

 

     

 

 

 

Total current assets

      432,971         488,394  

Property and equipment, net

      489,221         444,687  

Notes receivable

      24,397         -   

Deferred income taxes

      11,597         59,696  

Goodwill and other intangible assets

      275,268         277,322  

Other long-term assets

      16,347         12,612  
   

 

 

     

 

 

 

Total assets

  $     1,249,801     $     1,282,711  
   

 

 

     

 

 

 

Liabilities and Stockholders’ Equity

       

Current Liabilities:

       

Accounts payable

  $     143,203     $     161,551  

Accrued payable to retailers

      97,300         96,764  

Other accrued liabilities

      119,738         108,422  

Current callable convertible debt

      -          173,146  

Current portion of long-term debt

      14,485         7,523  

Current portion of capital lease obligations

      12,227         17,233  

Liabilities of business held for sale

      -          68,662  
   

 

 

     

 

 

 

Total current liabilities

      386,953         633,301  

Long-term debt and other long-term liabilities

      360,934         167,276  

Capital lease obligations

      10,288         12,158  
   

 

 

     

 

 

 

Total liabilities

      758,175         812,735  

Commitments and contingencies (Note 15)

      -          -   

Debt conversion feature

      -          26,854  

Stockholders’ Equity:

       

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

      -          -   

Common stock, $0.001 par value - 60,000,000 and 45,000,000 authorized; 35,125,093 and 34,813,203 shares issued; 30,752,939 and 31,815,085 shares outstanding

      473,249         434,169  

Treasury stock

      (153,425       (90,076

Retained earnings

      174,340         101,979  

Accumulated comprehensive loss

      (2,538       (2,950
   

 

 

     

 

 

 

Total stockholders’ equity

      491,626         443,122  
   

 

 

     

 

 

 

Total liabilities and stockholders’ equity

  $     1,249,801     $     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    
September 30,
      For the Nine Months Ended    
September 30,
 
          2011         2010         2011        

 

2010

 

Revenue

   $      465,617     $     380,187     $     1,324,917     $     1,045,665  

Expenses:

                 

Direct operating(1)

        310,101         255,449         917,687         722,204  

Marketing

        7,723         7,811         20,697         16,375  

Research and development

        3,239         1,699         7,539         4,928  

General and administrative

        40,076         37,655         114,795         101,053  

Depreciation and other (1)

        38,154         30,626         106,918         93,054  

Amortization of intangible assets

        685         756         2,055         2,620  

Litigation settlement

        -          -          -          5,379  
     

 

 

     

 

 

     

 

 

     

 

 

 

Total expenses

        399,978         333,996         1,169,691         945,613  
     

 

 

     

 

 

     

 

 

     

 

 

 

Operating income

        65,639         46,191         155,226         100,052  

Other income (expense):

                 

Foreign currency and other, net

        (553       (130       (1,004       (177

Interest income

        1,008         48         1,200         135  

Interest expense

        (6,424       (8,741       (20,078       (27,167
     

 

 

     

 

 

     

 

 

     

 

 

 
        (5,969       (8,823       (19,882       (27,209
     

 

 

     

 

 

     

 

 

     

 

 

 

Income from continuing operations before income taxes

        59,670         37,368         135,344         72,843  

Income tax expense

        (22,544       (15,969       (51,915       (29,364
     

 

 

     

 

 

     

 

 

     

 

 

 

Income from continuing operations

        37,126         21,399         83,429         43,479  

Loss from discontinued operations, net of tax

        -          (1,894       (11,068       (4,165
     

 

 

     

 

 

     

 

 

     

 

 

 

Net income

   $      37,126     $     19,505     $     72,361     $     39,314  
     

 

 

     

 

 

     

 

 

     

 

 

 

Basic earnings (loss) per share:

                 

Continuing operations

   $      1.23     $     0.68     $     2.72     $     1.38  

Discontinued operations

        -          (0.06       (0.36       (0.13
     

 

 

     

 

 

     

 

 

     

 

 

 

Basic earnings per share

   $      1.23     $     0.62     $     2.36     $     1.25  
     

 

 

     

 

 

     

 

 

     

 

 

 

Diluted earnings (loss) per share:

                 

Continuing operations

   $      1.18     $     0.66     $     2.61     $     1.35  

Discontinued operations

        -          (0.06       (0.35       (0.13
     

 

 

     

 

 

     

 

 

     

 

 

 

Diluted earnings per share

   $      1.18     $     0.60     $     2.26     $     1.22  
     

 

 

     

 

 

     

 

 

     

 

 

 

Weighted average shares used in basic per share calculations

        30,224         31,411         30,608         31,364  

Weighted average shares used in diluted per share calculations

        31,596         32,382         31,957         32,179  

(1) “Direct operating” excludes depreciation and other of $30.1 million and $89.4 million for the three and nine months ended September 30, 2011 and $26.7 million and $83.5 million for the three and nine months ended September 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, June 30, 2011

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

Proceeds from exercise of options, net

     26,591          780          -           -           -           780  

Adjustments related to tax withholding for share-based compensation

     (1,424        (57        -           -           -           (57

Share-based payments expense

     3,468          869          -           -           -           869  

Tax benefit on share-based compensation expense

     -           117          -           -           -           117  

Net income

     -           -           -           37,126          -           37,126  

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

     -           -           -           -           (832        (832
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

BALANCE, September 30, 2011

     30,752,939     $      473,249     $      (153,425   $      174,340     $      (2,538   $      491,626  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 
                                                 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

     74,335          2,182          -           -           -           2,182  

Adjustments related to tax withholding for share-based compensation

     (38,467        (1,749        -           -           -           (1,749

Share-based payments expense

     276,022          9,362          -           -           -           9,362  

Tax benefit on share-based compensation expense

     -           2,431          -           -           -           2,431  

Debt conversion feature

     -           26,854          -           -           -           26,854  

Repurchases of common stock and ASR program

     (1,374,036        -           (63,349        -           -           (63,349

Net income

     -           -           -           72,361          -           72,361  

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

     -           -           -           -           (122        (122

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

     -           -           -           -           547          547  

Unrealized losses on short-term investments net of tax benefit of $8

     -           -           -           -           (13        (13
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

BALANCE, September 30, 2011

     30,752,939     $      473,249     $      (153,425   $      174,340     $      (2,538   $      491,626  
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

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
September 30,
             For the Nine Months    
Ended
September 30,
 
          2011          2010          2011          2010  

Operating Activities:

                    

Net income

   $      37,126     $      19,505     $      72,361     $      39,314  

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

                    

Depreciation and other

        38,154          30,626          106,918          93,054  

Amortization of intangible assets and deferred financing fees

        1,581          1,264          3,966          4,144  

Share-based payments expense

        869          3,090          9,362          10,876  

Excess tax benefits on share-based payments

        (117        (65        (2,431        (6,290

Deferred income taxes

        20,966          10,525          46,915          19,280  

Loss (income) from discontinued operations, net of tax

        -           1,894          11,068          4,165  

Non-cash interest on convertible debt

        1,648          1,519          4,857          4,477  

Other

        (327        109          150          364  

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

                    

Accounts receivable

        (1,274        1,057          3,678          1,627  

DVD library

        (3,362        (7,580        18,115          619  

Prepaid expenses and other current assets

        3,893          1,496          (2,191        (3,170

Other assets

        (805        1,088          (1,371        2,087  

Accounts payable

        (2,160        733          (21,322        20,086  

Accrued payable to retailers

        (11,635        (8,302        521          (4,076

Other accrued liabilities

        5,222          8,010          11,043          42,068  
     

 

 

      

 

 

      

 

 

      

 

 

 

Net cash flows from operating activities from continuing operations

        89,779          64,969          261,639          228,625  

Investing Activities:

                    

Purchases of property and equipment

        (46,902        (48,135        (134,779        (132,474

Proceeds from sale of property and equipment

        201          765          552          1,032  

Proceeds from sale of businesses, net

        -           -           12,221          26,078  

Equity investment

        -           -           (2,320        -   
     

 

 

      

 

 

      

 

 

      

 

 

 

Net cash flows from investing activities from continuing operations

        (46,701        (47,370        (124,326        (105,364

Financing Activities:

                    

Principal payments on capital lease obligations and other debt

        (5,072        (8,860        (22,145        (28,203

Borrowing from term loan

        175,000          -           175,000          -   

Principal payments on term loan

        (2,187        -           (2,187        -   

Net payment on revolving line of credit

        (125,000        (75,000        (150,000        (75,000

Financing costs associated with new credit facility

        (4,196        -           (4,196        -   

Excess tax benefits related to share-based payments

        117          65          2,431          6,290  

Repurchases of common stock and ASR program

        -           (49,245        (63,349        (49,245

Proceeds from exercise of stock options

        842          709          2,182          27,959  
     

 

 

      

 

 

      

 

 

      

 

 

 

Net cash flows from financing activities from continuing operations

        39,504          (132,331        (62,264        (118,199

Effect of exchange rate changes on cash

        (810        899          (165        48  
     

 

 

      

 

 

      

 

 

      

 

 

 

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

        81,772          (113,833        74,884          5,110  

Cash flows from discontinued operations:

                    

Operating cash flows

        -           20,926          9,678          8,054  

Investing cash flows

        -           (17,504        (12,678        (12,133

Financing cash flows

        -           -           -           (166
     

 

 

      

 

 

      

 

 

      

 

 

 
        -           3,422          (3,000        (4,245

Increase (decrease) in cash and cash equivalents

        81,772          (110,411        71,884          865  

Cash and cash equivalents:

                    

Beginning of period

        173,528          257,133          183,416          145,857  
     

 

 

      

 

 

      

 

 

      

 

 

 

End of period

   $      255,300     $      146,722     $      255,300     $      146,722  
     

 

 

      

 

 

      

 

 

      

 

 

 

Supplemental disclosure of cash flow information from continuing operations:

                    

Cash paid during the period for interest

   $      5,528     $      8,811     $      14,721     $      22,543  

Cash paid during the period for income taxes

   $      1,769     $      830     $      3,697     $      2,735  

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

                    

Purchases of property and equipment financed by capital lease obligations

   $      2,005     $      129      $      9,708     $      1,764   

Purchases of property and equipment included in ending accounts payable

   $      13,951     $      16,249     $      13,951     $      16,249  

Non-cash consideration received from sale of Money Transfer Business

   $      -      $      -      $      20,976     $      -   

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    8

Note 4

   Cash and Cash Equivalents    9

Note 5

   Property and Equipment    9

Note 6

   Goodwill and Other 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    15

Note 11

   Business Segments    15

Note 12

   Debt and Other Long-Term Liabilities    18

Note 13

   Derivative Instruments    20

Note 14

   Fair Value    21

Note 15

   Commitments and Contingencies    22

Note 16

   Subsequent Event    24

 

5


Table of Contents

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 operations 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 operations or cash flows.

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. The adoption of ASU 2011-02 in the third quarter of 2011 did not have a material impact on our financial position, results of operations or cash flows.

 

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Accounting Pronouncements Not Yet Effective

In May 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 U.S. 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. While ASU 2011-05 will require us to change the manner in which we present other comprehensive income and its components on a retrospective basis, 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.

In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment” (“ASU 2011-08”). ASU 2011-08 simplifies the goodwill impairment assessment by permitting a company to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying amount before applying the two-step goodwill impairment test. If the conclusion is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the company would be required to conduct the current two-step goodwill impairment test. Otherwise, it would not need to apply the two-step test. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011 and early adoption is permitted. We plan to adopt ASU 2011-08 in the fourth quarter of 2011 in connection with our goodwill impairment assessment and do not believe our adoption 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 consolidated 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 September 30, 2011, are as follows:

 

             Kiosks            

        Locations        

    redbox

     34,400     28,400

    Coin

     19,500     19,300
  

 

 

   

 

     53,900     47,700
  

 

 

   

 

 

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

Money Transfer Business (the “Money Transfer Business”)

On June 9, 2011, we completed the sale transaction of our Money Transfer Business to Sigue Corporation (“Sigue”). We received $19.5 million in cash and a note receivable of $29.5 million (the “Sigue Note”). In addition, we may be required to provide an additional loan to Sigue for up to $5.0 million with terms consistent with the Sigue 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. See Note 14: Fair Value for additional details about the Sigue Note.

We estimated the fair value of the Sigue 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 or the stated value on the face of the Sigue Note. The discount rate used in our fair value estimate was the market rate for similar risk profile companies and represented our best estimate of default risk. During the third quarter and year to date periods ended September 30, 2011, we recognized $0.9 million of interest income base on the imputed interest rate of the Sigue Note.

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
September 30,
        Nine Months  Ended
September 30,
 

Dollars in thousands

              2011                         2010                         2011                         2010          

Revenue:

               

Money Transfer Business

  $     -      $     24,346     $     47,716     $     69,985  

E-Pay Business

      -          -          -          8,732  
   

 

 

     

 

 

     

 

 

     

 

 

 
  $     -      $     24,346     $     47,716     $     78,717  
   

 

 

     

 

 

     

 

 

     

 

 

 

Pre-tax gain (loss) from discontinued operations:

               

Money Transfer Business

  $     -      $     (4,011   $     654     $     (9,459

E-Pay Business

      -          -          -          (132
   

 

 

     

 

 

     

 

 

     

 

 

 
  $     -      $     (4,011   $     654     $     (9,591
   

 

 

     

 

 

     

 

 

     

 

 

 

Gain (loss) on disposal activities:

               

Money Transfer Business

  $     -      $     (967   $     (11,070   $     (13,170

E-Pay Business

      -          -          -          12,184  
   

 

 

     

 

 

     

 

 

     

 

 

 
  $     -      $     (967   $     (11,070   $     (986
   

 

 

     

 

 

     

 

 

     

 

 

 

Loss from discontinued operations before income tax

  $     -      $     (4,978   $     (10,416   $     (10,577

Income tax (expense) benefit

      -          3,084         (652       6,412  
   

 

 

     

 

 

     

 

 

     

 

 

 

Loss from discontinued operations, net of tax

  $     -      $     (1,894   $     (11,068   $     (4,165
   

 

 

     

 

 

     

 

 

     

 

 

 

Amount of goodwill and other intangible assets disposed

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

 

 

     

 

 

     

 

 

     

 

 

 

Included in income tax expense from discontinued operations for the nine months ended September 30, 2011, was $4.1 million related to the estimated current value of a worthless stock deduction taken in 2009 in connection with our divestiture of the entertainment business, which was sold in the third quarter of 2009.

 

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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 nine months ended September 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 September 30, 2011 and December 31, 2010 were $66.1 million and $72.5 million, respectively that we identified for settling our accrued payable to our retailer partners in relation to our Coin kiosks, which, prior to the second quarter of 2011 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 $30.4 million and $41.6 million at September 30, 2011 and December 31, 2010, respectively.

NOTE 5: PROPERTY AND EQUIPMENT

Dollars in thousands

          September 30,    
2011
            December 31,
2010
 

Machines

  $     869,349     $     791,014  

Computers, servers, and software

      101,022         49,603  

Office furniture and equipment

      5,138         3,845  

Vehicles

      9,619         10,661  

Leasehold improvements

      15,093         11,047  
      

 

 

     

 

 

 

Property and equipment, at cost

      1,000,221         866,170  

Accumulated depreciation and amortization

      (511,000       (421,483
      

 

 

     

 

 

 
   Property and equipment, net   $     489,221     $     444,687  
   

 

 

     

 

 

 

 

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NOTE 6: GOODWILL AND OTHER INTANGIBLE ASSETS

Our goodwill totaled $267.7 million at September 30, 2011 and there were no changes to our goodwill balance during the first nine months of 2011.

The gross amount of our other intangible assets and the related accumulated amortization were as follows:

 

Dollars in thousands

   Amortization
Period
           September 30,    
2011
         December 31,
2010
 

Retailer relationships

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

Accumulated amortization

          (6,448        (4,606
       

 

 

      

 

 

 
          6,896          8,738  

Other

   5 and 40 years        1,890          1,890  

Accumulated amortization

          (1,268        (1,056
       

 

 

      

 

 

 
          622          834  
       

 

 

      

 

 

 

Intangible assets, net

     $      7,518     $      9,572  
       

 

 

      

 

 

 

Amortization expense was as follows:

             Three Months Ended    
September  30,
             Nine Months Ended    
September  30,
 

Dollars in thousands

       2011          2010          2011          2010  

Retailer relationships

  $      614     $      685     $      1,843     $      2,408  

Other

       71          71          212          212  
    

 

 

      

 

 

      

 

 

      

 

 

 

Total amortization of intangible assets

  $      685     $      756     $      2,055     $      2,620  
    

 

 

      

 

 

      

 

 

      

 

 

 

Expected future amortization is as follows:

 

Dollars in thousands

       Retailer
Relationships
         Other  

Remainder of 2011

  $      613     $      70  

2012

       2,457          81  

2013

       2,250          14  

2014

       1,432          14  

2015

       12          14  

Thereafter

       132          429  
    

 

 

      

 

 

 

Total expected amortization

  $      6,896     $                  622  
    

 

 

      

 

 

 

 

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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  
 

Authorized repurchase - as of January 1, 2011

  $      74,486  

Board Authorization

       250,000  

Proceeds from the exercise of options

       2,182  

Repurchase from open market

       (13,349

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

       (50,000
    

 

 

 

Authorized repurchase - as of September 30, 2011

  $      263,319  
    

 

 

 

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 our equity compensation plans.

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

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.

 

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  
  

 

 

           

 

 

 

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 September 30, 2011, there were 3.0 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    
September  30,
             Nine Months Ended    
September  30,
 
        

 

2011

         2010          2011          2010  

Share-based payments expense:

                   

Share-based compensation - stock options

  $      697     $      739     $      2,200     $      2,485  

Share-based compensation - restricted stock

       1,778          1,006          5,479          4,352  

Share-based payments for DVD arrangements

       (1,606        1,390          1,683          4,211  
    

 

 

      

 

 

      

 

 

      

 

 

 

Total

  $      869     $      3,135     $      9,362     $      11,048  
    

 

 

      

 

 

      

 

 

      

 

 

 

Deferred tax benefit on share-based payments

  $      866     $      570     $      2,696     $      2,308  
         September 30, 2011  
         Unrecognized  Share-
Based
Payments Expense
   Weighted-Average
Remaining Life
 

Unrecognized share-based payments expense:

              

Share-based compensation - stock options

       $      4,617          1.6 years   

Share-based compensation - restricted stock

            14,290          1.9 years   

Share-based payments for DVD arrangements

            5,474          3.1 years   
         

 

 

           

Total

       $      24,381            
         

 

 

           

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 the current year 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:

 

         Nine Months Ended    
September 30, 2011
  

Expected term (in years)

       7.3  

Expected stock price volatility

       42.8 %

Risk-free interest rate

       2.8 %

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

     93          45.78  

Exercised

     (74        29.37  

Cancelled, expired, or forfeited

     (50        30.17  
  

 

 

      

OUTSTANDING, September 30, 2011

     1,072          30.79  
  

 

 

      

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

 

         Options
  Outstanding  
         Options
  Exercisable  
 

Number

       1,072          506  

Weighted average per share exercise price

  $      30.79     $      27.42  

Aggregate intrinsic value

  $      10,594     $      6,178  

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 installments 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

     320          45.57  

Vested

     (150        33.37  

Forfeited

     (44        36.26  
  

 

 

      

NON-VESTED, September 30, 2011

     540          39.92  
  

 

 

      

 

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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”). During the third quarter of 2011, our agreement with Sony was amended whereby; (i) the scheduled vesting of certain shares of restricted stock was extended from August 1, 2011 to August 1, 2012 and (ii) the number of weeks we can offer Sony content was extended from 26 weeks to 52 weeks. Information related to the shares of restricted stock granted as part of these agreements as of September 30, 2011, is as follows:

 

           Granted                  Vested                  Unvested            Remaining
    Vesting Period    

Sony

     193,348        19,335        174,013      2.8 years

Paramount

     200,000        20,000        180,000      3.3 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  
September 30,
       Nine Months Ended  
September 30,
 
     2011      2010      2011      2010  

Weighted average shares used for basic EPS

     30,224        31,411        30,608        31,364  

Dilutive effect of stock options and other share-based awards

     616        453        579        433  

Dilutive effect of convertible debt

     756        518        770        382  
  

 

 

    

 

 

    

 

 

    

 

 

 

Weighted average shares used for diluted EPS

     31,596        32,382        31,957        32,179  
  

 

 

    

 

 

    

 

 

    

 

 

 

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

     129        22        103        462  
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Table of Contents

NOTE 10: COMPREHENSIVE INCOME

Comprehensive income was as follows:

 

            Three Months Ended    
September  30,
 

Dollars in thousands

      2011         2010  

Net income

  $     37,126     $     19,505  

Foreign currency translation adjustment, net of tax expense of $0 and $61

      (832       1,052  

Interest rate cash flow hedges, net of tax expense of $0 and $519

      -          812  

Unrealized gains on short-term investments, net of tax benefit of $0 and $3

      -          3  
   

 

 

     

 

 

 

Comprehensive income

  $     36,294     $     21,372  
   

 

 

     

 

 

 
         Nine Months Ended
September 30,
 

Dollars in thousands

      2011         2010  

Net income

 

$

    72,361     $     39,314  

Foreign currency translation adjustment, net of tax expense of $0 and $56

      (122       (871

Interest rate cash flow hedges, net of tax expense of $349 and $1,348

      547         2,109  

Unrealized gains (losses) on short-term investments, net of tax expense (benefit) of $(8) and $3

      (13       3  
   

 

 

     

 

 

 

Comprehensive income

 

$

    72,773     $     40,555  
   

 

 

     

 

 

 

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 has been allocated to our redbox segment and is 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 third 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.

 

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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, which were 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.

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. Unallocated general and administrative expenses relate to share-based compensation.

 

Three Months Ended September 30, 2011

           redbox              Coin              New
Ventures
         Corporate
  Unallocated  
               Total        

Revenue

  $      389,801     $      75,506     $      310     $      -      $      465,617  

Expenses:

                        

Direct operating

       271,678          37,580          681          162          310,101  

Marketing

       5,466          1,985          259          13          7,723  

Research and development

       2          1,449          1,711          77          3,239  

General and administrative

       29,156          6,613          2,084          2,223          40,076  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Segment operating income (loss)

       83,499          27,879          (4,425        (2,475        104,478  

Less: depreciation and amortization

       (30,910        (7,924        (5        -           (38,839
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Operating income (loss)

       52,589          19,955          (4,430        (2,475        65,639  

Other expense

       -           -           -           (553        (553

Interest expense, net

       -           -           -           (5,416        (5,416

Income (loss) from continuing operations

                        
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

before income taxes

  $      52,589     $      19,955     $      (4,430   $      (8,444   $      59,670  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Three Months Ended September 30, 2010

       redbox          Coin          New
Ventures
         Corporate
Unallocated
         Total  

Revenue

  $      305,365     $      74,669     $      153     $      -      $      380,187  

Expenses:

                        

Direct operating

       217,982          37,053          350          64          255,449  

Marketing

       5,024          2,440          342          5          7,811  

Research and development

       -           1,578          59          62          1,699  

General and administrative

       28,711          5,726          1,650          1,568          37,655  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Segment operating income (loss)

       53,648          27,872          (2,248        (1,699        77,573  

Less: depreciation and amortization

       (23,955        (7,468        41          -           (31,382
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Operating income (loss)

       29,693          20,404          (2,207        (1,699        46,191  

Other expense

       -           -           -           (130        (130

Interest expense, net

       -           -           -           (8,693        (8,693

Income (loss) from continuing operations

                        
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

before income taxes

  $      29,693     $      20,404     $      (2,207   $      (10,522   $      37,368  
    

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

 

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Table of Contents

Nine Months Ended September 30, 2011

            redbox                  Coin              New
  Ventures  
         Corporate
  Unallocated  
         Total  

Revenue

   $      1,116,007     $      207,934     $      976     $      -      $      1,324,917  

Expenses:

                         

Direct operating

        808,197          106,632          2,483          375          917,687  

Marketing

        15,870          4,254          540          33          20,697  

Research and development

        64          4,695          2,548          232          7,539  

General and administrative

        83,539          17,065          7,152          7,039          114,795  
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Segment operating income (loss)

        208,337          75,288          (11,747        (7,679        264,199  

Less: depreciation and amortization

        (85,368        (22,746        (859        -           (108,973
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Operating income (loss)

        122,969          52,542          (12,606        (7,679        155,226  

Other expense

        -           -           -           (1,004        (1,004

Interest expense, net

        -           -           -           (18,878        (18,878

Income (loss) from continuing operations

                         
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

before income taxes

   $      122,969     $      52,542     $      (12,606   $      (27,561   $      135,344  
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Nine Months Ended September 30, 2010

        redbox          Coin          New
Ventures
         Corporate
Unallocated
         Total  

Revenue

   $      840,312     $      204,949     $      404     $      -      $      1,045,665  

Expenses:

                         

Direct operating

        616,744          103,968          869          623          722,204  

Marketing

        11,291          4,614          457          13          16,375  

Research and development

        -           4,480          277          171          4,928  

General and administrative

        75,161          15,573          4,464          5,855          101,053  

Litigation settlement

        -           5,379          -           -           5,379  
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Segment operating income (loss)

        137,116          70,935          (5,663        (6,662        195,726  

Less: depreciation and amortization

        (69,942        (22,089        (3,643        -           (95,674
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Operating income (loss)

        67,174          48,846          (9,306        (6,662        100,052  

Other expense

        -           -           -           (177        (177

Interest expense, net

        -           -           -           (27,032        (27,032
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

Income (loss) from continuing operations before income taxes

   $      67,174     $      48,846     $      (9,306   $      (33,871   $      72,843  
     

 

 

      

 

 

      

 

 

      

 

 

      

 

 

 

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    
September  30,
        Nine Months Ended    
September  30,
 
         2011             2010             2011             2010      

Wal-Mart Stores Inc.

     17.4     19.0     17.6     19.9

Walgreen Co.

     16.0     14.0     15.8     13.4

The Kroger Company

     11.4     11.2     11.3     10.4

 

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NOTE 12: DEBT AND OTHER LONG-TERM LIABILITIES

 

Dollars in thousands

           September 30,    
2011
         December 31,
2010
 

Revolving line of credit

 

$

     -      $      150,000  

Term loan

       172,813          -   

Convertible debt

       178,004          173,146  

redbox rollout agreement

       5,220          10,791  

Asset retirement obligation

       8,533          7,305  

Other long-term liabilities

       10,849          6,703  
    

 

 

      

 

 

 
       375,419          347,945  

Less:

         

Current portion of term loan

       (9,844        -   

Current portion of callable convertible debt

       -           (173,146

Current portion of redbox rollout agreement

       (4,641        (7,523
    

 

 

      

 

 

 

Total long-term debt and other long-term liabilities

 

$

     360,934     $      167,276  
    

 

 

      

 

 

 

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, which consisted of a revolving line of credit. 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 a revolving line of credit. On July 15, 2011, we borrowed $175.0 million under the term loan facility, a portion of which was utilized to pay down the revolving line of credit balance under the prior credit facility of $120.0 million. Fees paid for the New Credit Facility of $4.2 million were included within other long-term assets on our Consolidated Balance Sheets and are being amortized over the 5-year life of the New Credit Facility. In addition, $0.9 million of unamortized deferred finance fees related to the prior credit facility were carried over to the new revolving credit facility arrangement. Deferred financing costs are amortized 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 borrowings 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. During the third quarter of 2011, we made principal payments of $2.2 million on the term loan. 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 interest rate on amounts outstanding under the term loan at September 30, 2011 was 1.73%.

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, capital expenditures, investments, and mergers, dispositions and acquisitions, among other restrictions. In addition, the New Credit Facility 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 September 30, 2011, we were in compliance with the covenants of the New Credit Facility.

 

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Table of Contents

Convertible Debt (the “Notes”)

The aggregate outstanding principal of the Notes is $200.0 million. The Notes bear interest at a fixed rate of 4% per annum, payable semi-annually in arrears on each March 1 and September 1, beginning March 1, 2010, and mature on September 1, 2014. The effective interest rate at issuance was 8.5%. As of September 30, 2011, we are in compliance with all covenants.

The Notes become convertible (the “Conversion Event”) when the closing price of our common stock exceeds 130% of the Notes’ conversion price for more than 20 trading days during the 30 consecutive trading days prior to each quarter-end date. 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. As of September 30, 2011, the Conversion Event was not met and the Notes remained classified as a long-term liability on our Consolidated Balance Sheets. In addition, since the Notes were not convertible at September 30, 2011, the $26.9 million debt conversion feature that was classified as temporary equity at December 31, 2010 was reclassified to common stock as of September 30, 2011.

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

 

              Three Months Ended    
September 30,
     Nine Months  Ended
September 30,
 
              2011                   2010              2011                   2010      

Contractual interest expense

   $      2,000      $      2,000        6,000      $      6,000  

Amortization of debt discount

        1,648           1,519        4,857           4,477  
     

 

 

       

 

 

    

 

 

       

 

 

 

Total interest expense related to the Notes

   $      3,648      $      3,519        10,857      $      10,477  
     

 

 

       

 

 

    

 

 

       

 

 

 

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

 

Year

       

Non-cash

Interest Expense

Remainder of 2011

   $    1,694

2012

      7,108

2013

      7,712

2014

      5,483
     

 

Total

   $    21,997
     

 

 

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Table of Contents

NOTE 13: DERIVATIVE INSTRUMENTS

Interest Rate Swaps

As of September 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 as our interest rate swap agreement with Wells Fargo Bank for a notional amount of $150.0 million expired on March 20, 2011. 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 September 30, 2011

       

 

       
 

Interest Rate Swap Contracts

  $     -      $     -   

Three Months Ended September 30, 2010

       

 

       
 

Interest Rate Swap Contracts

  $     1,331      $     (1,608

Nine Months Ended September 30, 2011

       

 

       
 

Interest Rate Swap Contracts

  $     896     $     (889
Nine Months Ended September 30, 2010        

 

       
 

Interest Rate Swap Contracts

  $     3,457      $     (4,516

 

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Table of Contents

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:

 

   

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.

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 September 30, 2011

          Level 1                 Level 2                 Level 3      

Money market funds and certificates of deposit

  $     30,373     $     -     $     -  

Fair Value at December 31, 2010

                             

Money market funds and certificates of deposit

  $     41,598     $     -     $     -  

Interest rate swap liability

  $     -     $     (896   $     -  

Assets held for sale, net of liabilities 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 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 for our old credit facility 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 nine months ended September 30, 2011.

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

We recognize or disclose the fair value of certain assets such as notes receivable and non-financial assets, primarily long-lived assets, goodwill, intangible assets and certain other assets in connection with impairment evaluations. All of our nonrecurring valuations use significant unobservable inputs and therefore fall under Level 3 of the fair value hierarchy.

Notes 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 (the “Sigue Note”). We recorded the Sigue Note at its estimated fair value of approximately $21.0 million. The estimated fair value of the Sigue Note was based on the future note payments discounted at a market rate for similar risk profile companies, which represented our best estimate of default risk, and was not an exit price based measure of fair value or the stated value on the face of the Sigue Note. See Note 3: Discontinued Operations, Sale of Assets and Assets Held for Sale for additional information about the sale of our Money Transfer Business.

 

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Table of Contents

We recognize interest income on the Sigue Note on an accrual basis unless it is determined that collection of all principal and interest is unlikely. We assess the credit quality of the Sigue Note on a quarterly basis through review of Sigue’s financial condition, credit rating and the economic and regulatory condition of the industry in which it operates. Based on our assessment at September 30, 2011, there were no indications of deteriorating credit quality of the Sigue Note, accordingly, an allowance for credit losses was not established.

Long-Lived Assets, Goodwill and Other Intangible Assets

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.

Fair Value of Other Financial Instruments

The carrying value of our cash and cash equivalents, accounts receivable, accounts payable, and our revolving line of credit approximate their fair values due to their short-term nature.

We estimate the fair value of our convertible debt outstanding using the market rate for similar high-yield debt. The estimated fair value of our convertible debt was $178.6 million and $180.9 million at September 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.

NOTE 15: COMMITMENTS AND CONTINGENCIES

Letters of Credit

As of September 30, 2011, we had four irrevocable standby letters of credit that totaled $5.5 million. These standby letters of credit, which expire at various times through 2011 and 2012, are used to collateralize certain obligations to third parties. As of September 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 has 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. We moved to dismiss this complaint on July 15, 2011. On October 6, 2011, the court issued an order granting in part and denying in part our motion to dismiss. The order dismissed numerous allegations, including allegations that our October 28, 2010 revenue and earnings guidance was false and misleading. The order also dismissed all claims against three of our officers. 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

 

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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 has been established as it is 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. On August 12, 2011, defendants moved to dismiss the federal action on the ground that the plaintiffs had not made a pre-litigation demand on our Board of Directors and had not demonstrated that such a demand would have been futile. A hearing on this motion is scheduled for November 8, 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 has been established as it is 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. Since the filing of the complaint, Blake Boesky has been replaced by a different named plaintiff, Jiah Chung, and an amended complaint has been filed alleging disclosures of personally identifiable information, in addition to plaintiffs’ claims of retention of such information. Plaintiffs are seeking statutory damages, injunctive relief, attorneys’ fees, costs of suit, and interest. The court has consolidated the cases. The court has denied redbox’s motion to dismiss the plaintiffs’ claims involving retention of information, and is still considering redbox’s motion to dismiss plaintiffs’ claims involving disclosure of information. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it is 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, and these two cases have been consolidated. At the same time, the plaintiffs substituted Nicolle DiSimone as the named plaintiff in the Mehrens case, redbox has moved to dismiss each of the three cases, and the parties are briefing the plaintiffs’ motion for class certification in the DiSimone and Sinibaldi cases. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it is 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.

 

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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. In August 2011, we received the final tax assessment and issued a $1.2 million tax payment. As a result of this final tax assessment and payment, the additional $6.0 million is no longer considered to be a possible exposure.

During the second quarter of 2011, we recorded a loss contingency in the amount of $4.0 million related to a supply agreement under which we operated during 2011 and 2010 on our Consolidated Statements of Income. Based on currently available information, our best estimate of the aggregate range of reasonably possible losses is from $0 to $9.3 million. During the third quarter of 2011, we increased the loss contingency by $5.3 million and, as of September 30, 2011, the amount accrued within other current liabilities on our Consolidated Balance Sheets was $9.3 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.

NOTE 16: SUBSEQUENT EVENT

In October, 2011, we entered into an amendment to the revenue sharing license agreement with Paramount which provided, among other things, that: (i) Paramount waived its current termination right to end the licensing arrangement at the end of 2011, (ii) Paramount receives two one year extensions following the initial five-year agreement term, which ends at the end of 2014 (each exercised extension would provide for a grant of 50,000 shares of restricted stock vesting at the beginning of each extension), (iii) the content license period was extended from 26 weeks to 52 weeks and (iv) Paramount was granted 100,000 shares of restricted stock which will vest according to the vesting schedule of the current restricted stock purchase agreement with Paramount.

 

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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 1A of Part II of this Quarterly Report on Form 10-Q, and the Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, and in Item 1A 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 September 30, 2011, compared with the quarter and year-to-date periods ended September 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 third 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, which were 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 rent a video 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 fees charged for products or services offered 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 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.

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                                 Nine Months Ended                       

Dollars in thousands

        September 30,             Change            September 30,             Change  
              2011                     2010                 $      %                2011                     2010                 $      %  

Revenue

   $      465,617      $           380,187      $           85,430        22.5   $           1,324,917      $           1,045,665      $           279,252        26.7

Operating income

   $      65,639      $           46,191      $           19,448        42.1   $           155,226      $           100,052      $           55,174        55.1

Income from continuing operations

   $      37,126      $           21,399      $           15,727        73.5   $           83,429      $           43,479      $           39,950        91.9

Diluted earnings per share from continuing operations

   $      1.18      $           0.66      $           0.52        78.8   $           2.61      $           1.35      $           1.26        93.3

Revenue increased $85.4 million, or 22.5%, during the third quarter and $279.3 million, or 26.7%, year-to-date primarily due to new kiosk installations and same store sales growth in our redbox segment - refer to the redbox segment discussion.

 

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Operating income increased $19.4 million, or 42.1%, during the third quarter and $55.2 million, or 55.1%, 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 $15.7 million, or 73.5%, during the third quarter and $40.0 million, or 91.9%, year-to-date primarily due to the following:

 

   

Higher operating income in our redbox segment; and

 

   

Decreased interest expense related to principal payments made on our revolving credit facility during the third quarter of 2010 and the expiration of our interest rate swap agreement during the first quarter of 2011 – refer to interest expense discussion; partially offset by

 

   

Increased income tax expense primarily due to higher pretax income offset by lower effective tax rate – 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 the grants to movie studios 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                                 Nine Months Ended                        

Dollars in thousands

      September 30,           Change           September 30,           Change  
            2011                     2010                 $         %               2011                     2010                     $             %  

Direct operating

  $     162       $        64       $        98          153.1     $        375       $        623       $        (248       (39.8 )% 

Marketing

      13         5         8         160.0       33         13         20         153.8

Research and development

      77         62         15         24.2       232         171         61         35.7

General and administrative

      2,223         1,568         655         41.8       7,039         5,855         1,184         20.2
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Total

  $     2,475       $        1,699       $        776         45.7     $        7,679       $        6,662       $        1,017         15.3
   

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Our quarter and year-to-date unallocated share-based compensation expense increased primarily due to an increase in the number, and fair value of, restricted stock awards granted.

 

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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                                 Nine Months Ended                  

Dollars in thousands,

except rental amounts

 

      

 

September 30,

          Change           September 30,           Change  
       2011           2010           $         %           2011           2010           $         %  

 

Revenue

   $     389,801       $        305,365       $        84,436         27.7     $        1,116,007       $        840,312       $        275,695         32.8

Direct operating

       271,678         217,982         53,696         24.6       808,197         616,744         191,453         31.0

Marketing

       5,466         5,024         442         8.8       15,870         11,291         4,579         40.6

Research and

    development

       2          -          2          0.0       64         -          64         0.0

General and

    administrative

       29,156         28,711         445         1.5       83,539         75,161         8,378         11.1
    

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Segment operating income

       83,499         53,648         29,851         55.6       208,337         137,116         71,221         51.9

Depreciation and

    amortization

       30,910         23,955         6,955         29.0       85,368         69,942         15,426         22.1
    

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Operating income

   $     52,589       $        29,693       $        22,896         77.1     $        122,969       $        67,174       $        55,795         83.1
    

 

 

     

 

 

     

 

 

         

 

 

     

 

 

     

 

 

     

Operating income as a percentage of revenue

       13.5       9.7               11.0       8.0        

Same store sales growth

       13.0       17.2               14.9       13.3        

Effect of change in revenue from same store sales growth

   $     38,820       $        32,938       $        5,882         17.9     $        121,916       $        70,376       $        51,540         73.2

Ending number of kiosks

       34,400         28,500         5,900         20.7       34,400         28,500         5,900         20.7

Total rentals (in thousands)

       177,905         142,711         35,194         24.7       509,168         385,959         123,209         31.9

Net revenue per rental

   $     2.19       $        2.13       $        0.06         2.8     $        2.19       $        2.15       $        0.04         1.9

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

Revenue increased $84.4 million, or 27.7%, primarily due to the following:

 

   

$45.6 million from new kiosk installations; and

 

   

$38.8 million from same store sales growth of 13.0%; reflecting the benefit of a

 

   

$0.06 increase in net revenue per rental primarily due to continued growth in video game rentals, which were rolled out nationally in June 2011, and Blu-ray rentals both of which have higher per night rental amounts.

Operating income increased $22.9 million, or 77.1%, as our revenue growth exceeded growth in our direct operating expenses, which, as a percent of revenue, decreased 170 basis points from 71.4% during 2010 to 69.7% during 2011. Changes in the components of operating income are as follows:

 

   

$84.4 million increase in revenue from new kiosk installations, same store sales growth and increased net revenue per rental; partially offset by

 

   

$53.7 million increase in direct operating expenses attributable to the revenue growth, which resulted in higher DVD and game product costs, revenue share and payment card fees and increased kiosk field operations expenses. These increases were partially offset by lower restricted stock expense due to a lower market price of our common stock on the last day of the period. As our installed kiosk base continues to increase, we are able to better utilize our existing field resources and lower the servicing costs per kiosk;

 

   

$7.0 million increase in depreciation and amortization expense due to growth in the installed kiosk base, as well as the continued build-out of our technology infrastructure, partially offset by $0.6 million in 2010 related to the 2010 closure of DVDXpress branded kiosks; and a

 

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$0.4 million increase in general and administrative expenses from supporting overall business growth and increased data center costs.

Nine months ended September 30, 2011 compared with nine months ended September 30, 2010:

Revenue increased $275.7 million, or 32.8%, primarily due to the following:

 

   

$153.8 million from the addition of new kiosk installations; and

 

   

$121.9 million from same store sales growth of 14.9%; reflecting the benefit of a

 

   

$ 0.04 increase in net revenue per rental primarily due to continued growth in video game rentals, which were rolled out nationally in June 2011, and Blu-ray rentals both of which have higher per night rental amounts.

Operating income increased $55.8 million, or 83.1%, primarily due to the following:

 

   

$275.7 million increase in revenue from new kiosk installations, same store sales growth and increased net revenue per rental; partially offset by

 

   

$191.5 million increase in direct operating expenses due to higher DVD product costs to support the revenue growth, including higher than optimal DVD product costs related to purchases of December 2010 and January 2011 titles, as well as increased game product costs in support of our national rollout in June 2011, higher revenue share and payment card fees and increased kiosk field operations expenses. These increases were partially offset by lower restricted stock expense due to a lower market price of our common stock on the last day of the period;

 

   

$15.4 million increase in depreciation and amortization expense due to continued build-out of our technology infrastructure, as well as growth in the installed kiosk base and an increase in expenses related to the closure and redeployment of underperforming kiosks, partially offset by a $6.1 million charge in 2010 related to the closure of DVDXpress branded kiosks;

 

   

$8.4 million increase in general and administrative expenses from supporting overall business growth, increased data center costs and strengthening of our infrastructure. We continue to leverage our general and administrative expenses, which, as a percent of revenue, decreased 140 basis points from 8.9% during 2010 to 7.5% during 2011; and a

 

   

$4.6 million increase in marketing due to affiliate programs, search engine marketing, and promotional email, as well as additional studio marketing during 2011.

Recent Events

 

   

During the third quarter of 2011, our agreement with SPHE Scan Based Trading Corporation (“Sony”) was amended whereby; (i) the scheduled vesting of certain shares of restricted stock was extended from August 1, 2011 to August 1, 2012 and (ii) the number of weeks we can offer Sony content was extended from 26 weeks to 52 weeks.

 

   

On October 26, 2011, we entered into an amendment to the revenue sharing license agreement with Paramount Home Entertainment, Inc. (“Paramount”) which provided, among other things, that; (i) Paramount waived its current termination right to end the licensing arrangement at the end of 2011, (ii) Paramount receives two one year extensions following the initial five-year agreement term, which ends at the end of 2014 (each exercised extension would provide for a grant of 50,000 shares of restricted stock vesting at the beginning of each extension), (iii) the content license period was extended from 26 weeks to 52 weeks and (iv) Paramount was granted 100,000 shares of restricted stock which will vest according to the vesting schedule of the current restricted stock purchase agreement with Paramount.

 

   

On October 27, 2011, we announced that the daily rental fee for renting a standard formatted DVD would increase to $1.20 from $1.00. The daily rental fee of our video game and Blu-ray rentals will remain unchanged. The price increase is primarily a result of higher operating expenses, including increased debit card interchange fees. We expect this price increase to be partially offset by a decrease in demand at the higher price point and will continue to evaluate what the full impact will be to our segment operating income.

 

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Coin

 

        Three Months Ended                               Nine Months Ended                        

Dollars in thousands,

 

except transaction amounts

      September 30,         Change          September 30,          Change  
   

 

    2011     

            2010              $          %              2011                    2010                $          %  

 

Revenue

 

$

        75,506     $     74,669     $     837          1.1   $          207,934    

$

     204,949     $      2,985          1.5

 

Direct operating

      37,580         37,053         527           1.4        106,632          103,968          2,664          2.6

 

Marketing

      1,985         2,440         (455        (18.6 )%         4,254          4,614          (360        (7.8 )% 

 

Research and development

      1,449         1,578         (129        (8.2 )%         4,695          4,480          215           4.8

 

General and administrative

      6,613         5,726         887           15.5        17,065          15,573          1,492          9.6

 

Litigation

      -          -          -           0.0        0           5,379          (5,379        0.0
   

 

 

     

 

 

     

 

 

           

 

 

      

 

 

      

 

 

      

 

Segment operating income

      27,879         27,872         7           0.0        75,288          70,935          4,353          6.1

 

Depreciation and amortization

      7,924         7,468         456           6.1        22,746          22,089          657           3.0
   

 

 

     

 

 

     

 

 

           

 

 

      

 

 

      

 

 

      

 

Operating income

 

$

    19,955      $     20,404     $     (449        (2.2 )%    $      52,542    

$

     48,846     $      3,696          7.6
   

 

 

     

 

 

     

 

 

           

 

 

      

 

 

      

 

 

      

 

Operating income as a percentage of revenue

      26.4       27.3                 25.3        23.8          

 

Same store sales growth

      1.0       7.9                 2.4        5.3          

 

Ending number of kiosks

      19,500         18,900         600           3.2        19,500          18,900          600          3.2

 

Total transactions (in thousands)

      20,355         20,507         (152        (0.7 )%         56,392          57,608          (1,216        (2.1 )% 

 

Average transaction size

 

$

    38.50     $     37.70     $     0.80          2.1   $      38.30    

$

     37.20     $      1.10          3.0

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

Revenue increased $0.8 million, or 1.1%, primarily due to a $0.80 increase in the average transaction size to $38.50 driven by growth in larger than average coin to voucher transactions, as well as strengthening of our coin to prepaid product transactions, which typically have a larger transaction size than coin to voucher transactions. The increase in average transaction size was partially offset by a decline in total transactions of 152,000. Same store sales during the period increased by 1.0%.

Operating income decreased $0.4 million, or 2.2%, primarily due to the following:

 

   

$0.8 million increase in revenue from higher average transaction size and same store sales growth; and a

 

   

$0.5 million decrease in marketing expenses due to lower advertising spend; offset by a

 

   

$0.5 million increase in direct operating expenses due to higher revenue share from revenue growth as well as increased revenue share rates with certain retail partners as a result of long-term contract renewals and higher kiosk field operations expenses, partially offset by lower coin processing related expenses; and a

 

   

$0.5 million and $0.9 million increases in depreciation and amortization expense and general and administrative expenses, respectively, due to higher allocated expenses from our shared service support function to support overall business growth and strengthening of our infrastructure.

Nine months ended September 30, 2011 compared with nine months ended September 30, 2010:

Revenue increased $3.0 million, or 1.5%, 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 $38.30, partially offset by a 1,216,000 decline in total transactions. Same store sales increased by 2.4%.

Operating income increased $3.7 million, or 7.6%, primarily due to the following:

 

   

$5.4 million decrease in litigation expenses from the settlement of patent litigation with ScanCoin expensed during the first quarter of 2010;

 

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$3.0 million increase in revenue from higher coin counting transaction fees, average transaction size and same store sales growth; and a

 

   

$0.4 million decrease in marketing expenses due to lower advertising spend; partially offset by a

 

   

$2.7 million increase in direct operating expenses due to higher revenue share from revenue growth, as well as increased revenue share rates with certain retail partners as a result of long-term contract renewals and higher kiosk field operations, partially offset by lower coin processing related expenses, including a credit received in 2011 for previously-processed mutilated coin, and lower allocated expenses from our shared service support function due to reduced customer service levels;

 

   

$0.7 million and $1.5 million increase in depreciation and amortization expense and general and administrative expenses, respectively, due to higher allocated expenses from our shared service support function to support overall business growth and strengthening of our infrastructure and expense related to an international tax assessment; and a

 

   

$0.2 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                             Nine Months Ended                    

Dollars in thousands

       September 30,     Change     September 30,           Change  
             2011                    2010                $     %               2011                    2010                $     %  

Revenue

   $     310     $          153     $          157       102.6   $          976     $          404     $          572       141.6

Direct operating

       681         350         331       94.6       2,483         869         1,614       185.7

Marketing

       259         342         (83     (24.3 )%        540         457         83       18.2

Research and development

       1,711         59         1,652       2800.0       2,548         277         2,271       819.9

General and administrative

       2,084         1,650         434        26.3       7,152         4,464         2,688       60.2
    

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

   

Segment operating loss

       (4,425       (2,248       (2,177     96.8       (11,747       (5,663       (6,084     107.4

Depreciation and amortization

       5          (41       46        (112.2 )%        859         3,643         (2,784     (76.4 )% 
    

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

   

Operating loss

   $     (4,430   $          (2,207   $          (2,223     100.7   $          (12,606   $          (9,306   $          (3,300     35.5
    

 

 

     

 

 

     

 

 

       

 

 

     

 

 

     

 

 

   

The increase in revenue during the third quarter and year-to-date are primarily due to an increased number of kiosks for new and existing self-service concepts.

Three months ended September 30, 2011 compared with the three months ended September 30, 2010:

Operating loss increased $2.2 million, or 100.7%, during the third quarter primarily due to the following:

 

   

$1.7 million increase in research and development expenditures associated with the design of new self-service concepts;

 

   

$0.4 million increase in general and administrative expenses due to increased headcount to support growth of existing self-service concepts, as well as the start-up of new self-service concepts; and a

 

   

$0.3 million increase in direct operating expenses due to increased volume driven by the addition of self-service concepts to test markets.

Nine months ended September 30, 2011 compared with the nine months ended September 30, 2010:

Operating loss increased $3.3 million, or 35.5%, year-to-date primarily due to the following:

 

   

$2.7 million increase in general and administrative expenses due to increased headcount to support growth of existing self-service concepts, as well as the start-up of new self-service concepts, higher allocated costs from our shared service support functions and a $0.5 million charge associated with exiting one of our self-service concept test programs during the second quarter of 2011;

 

   

$2.3 million increase in research and development expenditures associated with the design of new self-service concepts; and a

 

   

$1.6 million increase in direct operating expenses due to a $0.7 million charge for purchases of additional prototype kiosks, which we expense as acquired during the piloting phase, as well as the addition of self-service concepts to test markets; offset by a

 

   

$2.8 million decrease in depreciation and amortization expense 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 from 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                                Nine Months Ended                        

Dollars in thousands

       September 30,          Change          September 30,          Change  
           2011                    2010                    $              %          2011          2010          $          %  

Cash interest expense

  $      3,657     $      6,581     $      (2,924        (44.4 )%    $      12,802     $      20,791     $      (7,989        (38.4 )% 

Non-cash interest expense

       2,767          2,160          607          28.1        7,276          6,376          900          14.1
    

 

 

      

 

 

      

 

 

           

 

 

      

 

 

      

 

 

      

Total interest expense

  $      6,424     $      8,741     $      (2,317        (26.5 )%    $      20,078     $      27,167     $      (7,089        (26.1 )% 
    

 

 

      

 

 

      

 

 

           

 

 

      

 

 

      

 

 

      

The decrease in interest expense during the third quarter and year-to-date were primarily due to lower average debt balances from net payments on our revolving credit facility as well as the expiration of the interest rate swap in 2011; partially offset by increases in non-cash interest expense from our convertible debt discount.

Income Tax Expense

Our effective tax rate from continuing operations was 38.4% and 40.3% for the nine months ended September 30, 2011 and 2010, respectively. The decrease in our effective tax rate was attributable primarily to higher levels of 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
September 30,
         Nine Months Ended
September 30,
 

Dollars in thousands

 

       2011

 

         2010

 

         2011

 

         2010

 

 

Income from continuing operations

  $      37,126     $      21,399     $      83,429     $      43,479  

Depreciation, amortization, and other

       38,839          31,382          108,973          95,674  

Interest expense, net

       5,416          8,693          18,878          27,032  

Income taxes

       22,544          15,969          51,915          29,364  

Share-based payment expense(1)

       869          3,090          9,362          10,876  
    

 

 

      

 

 

      

 

 

      

 

 

 

Adjusted EBITDA from continuing operations

  $            104,794     $            80,533     $            272,557     $          206,425  
    

 

 

      

 

 

      

 

 

      

 

 

 

 

(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 increase in our adjusted EBITDA from continuing operations for both periods was primarily due to improvements in the results of our redbox segment. 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 net cash flows from operating activities from continuing operations, to free cash flow from continuing operations:

 

          Three Months Ended          Nine Months Ended  
          September 30,    September 30,  

Dollars in thousands

        2011          2010          2011          2010  

Net cash provided by operating activities from continuing operations

   $      89,779     $      64,969     $      261,639     $      228,625  

Purchase of property and equipment

        (46,902        (48,135        (134,779        (132,474
     

 

 

      

 

 

      

 

 

      

 

 

 

Free cash flow from continuing operations

   $      42,877     $      16,834     $      126,860     $      96,151  
     

 

 

      

 

 

      

 

 

      

 

 

 

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 $33.0 million during the first nine months of 2011 primarily due to the following:

 

   

$33.0 million increase in net income to $72.4 million primarily due to increased operating income in our redbox segment; and

 

   

$50.7 million increase in non-cash expenses to $180.8 million primarily due to increased depreciation on kiosks, higher deferred income taxes, and increased losses from discontinued operations; offset by a

 

   

$50.7 million decrease in working capital changes to $8.5 million primarily due to the pay down of accounts payable and the addition of fewer accrued liabilities; partially offset by lower purchases for our DVD library.

Cash from Investing Activities from Continuing Operations

We used $124.3 million of net cash in our investing activities from continuing operations during the first nine months of 2011 primarily due to the following:

 

   

$134.8 million used for purchases of property and equipment for kiosks and corporate infrastructure, particularly information technology; and

 

   

$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 $62.3 million of net cash in our financing activities from continuing operations during the first nine months of 2011 primarily due to the following:

 

   

$150.0 million used to pay-off our revolving line of credit under our old credit facility;

 

   

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

 

   

$24.3 million used for principal payments on our capital lease obligations, term loan and other long-term debt; offset by

 

   

$175.0 million in term loan borrowings under our new credit facility.

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 September 30, 2011, our cash and cash equivalent balance was $255.3 million, of which $66.1 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 $189.2 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

      

September 30,

        2011        

       

  December 31,  

2010

Revolving line of credit

 

$

   -    $    150,000

Term loan

     172,813       -

Convertible debt (Face value)

     200,000       200,000
    

 

     

 

Total debt

 

$

   372,813    $    350,000
    

 

     

 

On July 15, 2011, we entered into a new credit facility (the “New Credit Facility”), which replaced our prior credit facility, which consisted of a $400 million revolving line of credit. The New Credit Facility provides for a 5-year, $175.0 million senior secured term loan and a $450.0 million senior secured 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 annual 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.

Convertible Debt (the “Notes”)

The aggregate outstanding principal of the Notes is $200.0 million. The Notes bear interest at a fixed rate of 4% per annum, payable semi-annually in arrears on each March 1 and September 1, beginning March 1, 2010, and mature on September 1, 2014. The effective interest rate at issuance was 8.5%. As of September 30, 2011, we are in compliance with all covenants.

The Notes become convertible (the “Conversion Event”) when the closing price of our common stock exceeds 130% of the Notes’ conversion price for more than 20 trading days during the 30 consecutive trading days prior to each quarter-end date. 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

 

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increases as the market price of our common stock increases. As of September 30, 2011, the Conversion Event was not met and the Notes remained classified as a long-term liability on our Consolidated Balance Sheets. In addition, since the Notes were not convertible at September 30, 2011, the $26.9 million debt conversion feature that was classified as temporary equity at December 31, 2010 was reclassified to common stock as of September 30, 2011.

Letters of Credit

As of September 30, 2011, we had four irrevocable standby letters of credit that totaled $5.5 million. These standby letters of credit, which expire at various times through 2011 and 2012, are used to collateralize certain obligations to third parties. As of September 30, 2011, no amounts were outstanding under these standby letter of credit agreements.

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. In August 2011, we received the final tax assessment and issued a $1.2 million tax payment. As a result of this final tax assessment and payment, the additional $6.0 million is no longer considered to be a possible exposure.

During the second quarter of 2011, we recorded a loss contingency in the amount of $4.0 million related to a supply agreement under which we operated during 2011 and 2010 on our Consolidated Statements of Income. Based on currently available information, our best estimate of the aggregate range of reasonably possible losses is from $0 to $9.3 million. During the third quarter of 2011, we increased the loss contingency by $5.3 million and, as of September 30, 2011, the amount accrued within other current liabilities on our Consolidated Balance Sheets was $9.3 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 $18.1 million has been incurred and capitalized during 2011;

 

   

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 September 30, 2011; and

 

   

A new credit facility, which replaced our prior credit facility, consisting of a $175.0 million term loan and a $450.0 million revolving line of credit. See Long-Term Debt in Liquidity and Capital Resources for additional information.

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 September 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 has 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. We moved to dismiss this complaint on July 15, 2011. On October 6, 2011, the court issued an order granting in part and denying in part our motion to dismiss. The order dismissed numerous allegations, including allegations that our October 28, 2010 revenue and earnings guidance was false and misleading. The order also dismissed all claims against three of our officers. 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 has been established as it is 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. On August 12, 2011, defendants moved to dismiss the federal action on the ground that the plaintiffs had not made a pre-litigation demand on our Board of Directors and had not demonstrated that such a demand would have been futile. A hearing on this motion is scheduled for November 8, 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 has been established as it is 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.

 

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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. Since the filing of the complaint, Blake Boesky has been replaced by a different named plaintiff, Jiah Chung, and an amended complaint has been filed alleging disclosures of personally identifiable information, in addition to plaintiffs’ claims of retention of such information. Plaintiffs are seeking statutory damages, injunctive relief, attorneys’ fees, costs of suit, and interest. The court has consolidated the cases. The court has denied redbox’s motion to dismiss the plaintiffs’ claims involving retention of information, and is still considering redbox’s motion to dismiss plaintiffs’ claims involving disclosure of information. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it is 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, and these two cases have been consolidated. At the same time, the plaintiffs substituted Nicolle DiSimone as the named plaintiff in the Mehrens case, redbox has moved to dismiss each of the three cases, and the parties are briefing the plaintiffs’ motion for class certification in the DiSimone and Sinibaldi cases. We believe that the claims against us are without merit and intend to defend ourselves vigorously in this matter. Currently, no accrual has been established as it is 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

There have been no material changes from risk factors previously disclosed in our 2010 Form 10-K and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011.

 

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

The following table summarizes information regarding shares repurchased during the quarter ended September 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 (2)

 

7/1/11 - 7/31/11

   246    $           48.86      -    $           262,937  

8/1/11 - 8/31/11

   481    $           45.59      -    $           263,134  

9/1/11 - 9/30/11

   697    $           41.21      -    $           263,319  
  

 

     

 

 

    

 

     
   1,424    $           44.01      -    $           263,319  
  

 

     

 

 

    

 

     

 

(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 programs approved by our Board of Directors as described in Note 7: Repurchases of Common Stock in the Notes to Consolidated Financial Statements. 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 our new credit facility.

(2)

Dollars in thousands

 

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Item 6. Exhibits

 

  4.1   Second Amendment to Restricted Stock Purchase Agreement, dated as of August 29, 2011, between Coinstar, Inc. and Sony.
  10.1*   Equity Grant Program for Nonemployee Directors Under the 2011 Incentive Plan.
  10.2*   Form of Stock Option Grant Notice and form of Stock Option Agreement under the 2011 Incentive Plan for Option Grants made to Nonemployee Directors.
  10.3*   Form of Notice of Restricted Stock Award and form of Restricted Stock Award Agreement under the 2011 Incentive Plan for Awards made to Nonemployee Directors.
  10.4*   Form of Stock Option Grant Notice and form of Stock Option Agreement under the 2011 Incentive Plan for Option Grants made to the CEO, COO or CFO.
  10.5*   Form of Stock Option Grant Notice and form of Stock Option Agreement under the 2011 Incentive Plan for Option Grants made to Executives other than the CEO, COO or CFO.
  10.6*   Form of Notice of Restricted Stock Award and form of Restricted Stock Award Agreement under the 2011 Incentive Plan for Awards made to the CEO, COO or CFO.
  10.7*   Form of Notice of Restricted Stock Award and form of Restricted Stock Award Agreement under the 2011 Incentive Plan for Awards made to Executives other than the CEO, COO or CFO.
  10.8   Second Amended and Restated Credit Agreement, dated July 15, 2011, among Coinstar, Inc., as borrower, Bank of America, N.A., as administrative agent, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wells Fargo Securities, LLC, as joint lead arrangers and joint book managers, Wells Fargo Bank, National Association, as syndication agent, HSBC Bank USA, National Association, Royal Bank of Canada and U.S. Bank National Association, as co-documentation agents, as well as other lenders that are parties thereto. (1)
  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 the Registrant’s Periodic Report on Form 8-K filed on July 21, 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
     October 27, 2011

 

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