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November 12, 2007

Good Signs From Lionsgate

Lionsgate reported another confusing quarter. Revenues blew away expectations but so did expenses. EBITDA was a big negative number but the company reported over $21 million in free cash flow. The press release was vague and the simultaneously issued 10-Q did not directly address the absolute figures but instead focused on percentages. All that said the numbers and their implication for the rest of LGF's fiscal year ending March 2008 are positive. Guidance was not formally raised but management said the company is on track to exceed its revenue and free cash flow guidance by 10%. This forecast assumes that three films to be released in the March quarter perform to expectations, a not unreasonable view given the box office targets articulated on the call. Finally, management was able to provide an acceptable explanation for why free cash flow and operating cash flow will converge next year. This is an ongoing point of contention for LGF and will be a comfort to investors....

....For 2Q08, LGF reported an EPS loss of 47 cents vs. consensus of a 32 cents loss in a range of -26 cents to -40 cents. Revenues dramatically exceeded expectations at $343 million vs. consensus of $281 million. Expenses soared as well which is why the EPS number was poor despite the big revenue upside. The issue here seems to be largely timing related. First, LGF had a couple of major movie releases in October (Saw 4 and the latest Tyler Perry film) which incurred some marketing expense in the September quarter. Second, and probably more importantly, LGF had to report 100% of the expenses related to films financed by partners through a film financing vehicle even though it is responsible for just 50% of the expenses. The income statement has no offset for this but the cash flow statement does which helps explain the free cash flow figure.

Leaving aside LGF's confusing accounting, the quarter saw several films meet or beat expectations, several box office flops from earlier this year over index in home video, and the promised acceleration in the TV production business where LGF delivered twice the hours of shows than it did a year ago. These items suggest that the second half surge in free cash flow promised by management is highly likely to occur. This is good news for LGF investors.

However, one lingering issue which came up on the conference call a few times is how the company will grow its free cash flow. The timing differences and confusing accounting will stabilize next fiscal year as LGF will have completed the expansion of its film and TV production. The question I don’t have an answer to and one where I am not willing to accept management commentary is how the free cash flow will grow without another step up in production and the near-term losses it creates. At a run rate of over $100 million in free cash flow LGF shares are reasonably valued. However, barring sale of the company, without growth in free cash flow with easier to understand accounting I do not see the shares moving significantly higher. As a result, I plan to remain on the sidelines even as the performance of LGF's films and TV shows is resolving some of my prior concerns.

Posted by Steve Birenberg at November 12, 2007 09:37 AM in LGF