Has Blockbuster (NYSE:BBI) turned a corner in its quest for video-rental supremacy? The Q1 2006 results reported yesterday seem to suggest that something is working. The $1.9 million net loss was considerably smaller than the negative $57.5 million reported last year, and the company managed positive free cash flow -- $32.9 million -- for the first time since 2004.
So far, so good, but I'm afraid the positive news ends there. These gains rode in on an ugly old warhorse called "cost cutting," and that kind of success can hurt. Revenues came in 7.7% lower for the quarter, thanks to the closing of 236 stores over the past year. In the last quarter alone, 114 US Blockbuster locations closed down.
That's certainly not a sustainable path for future growth. Cutting the fat makes your margins look better, but at some point, there will simply be no more stores to close. While some people might blame movie piracy, the general downturn in the movie business, or higher gas prices, the Blockbuster press release and SEC filing don't assign blame at all. After all, why draw attention to the beating you're taking from the competition?
CEO John Antioco does try to put a nice spin on that, looking forward to 2006 as a year of outperforming the domestic rental industry. It seems like he really meant Movie Gallery (NASDAQ:MOVI) and mom-and-pop shops nationwide, because it would be very optimistic of him to assume that his company will beat the performance of its main rival, Netflix (NASDAQ:NFLX).
Going to the video store is so late-20th-century, and Blockbuster knows it. Enter Blockbuster Online, the almost eerie carbon copy of the Netflix service. Mail-order rentals are expected to offset the bricks-and-mortar difficulties, but for that strategy to work, Blockbuster needs to try harder. Blockbuster Online contributes less to the top line than in-store popcorn and soda sales.
The quarterly addition of 100,000 new customers, adding up to 1.3 million total subscribers, pales in comparison to Netflix's 687,000 added subscribers, bringing the latter company's total to 4.87 million. Blockbuster is not used to playing the underdog, but that's where the company seems to be stuck now, with a smaller online customer base that also grows more slowly.
Who knows? Netflix's patent infringement suit against Blockbuster might be all the incentive Blockbuster needs to pull out of the mail-rental race entirely and explore other strategies.
Maybe a leaner, meaner Blockbuster can survive in the cutthroat movie rental business, but it won't be easy. It's time for management to take this more efficient infrastructure and pull its customers back into the stores. Good luck with that.
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Fool contributor Anders Bylund likes movies, but not popcorn. He owns shares in Netflix. The Fool's disclosure policy never charges late fees.
