NEW YORK ( TheStreet) -- There's no denying that Blockbuster ( BBI) is listing -- and Blockbuster CEO James Keyes, to his credit, didn't attempt to deny it during an exclusive interview with TheStreet.

Competition from Netflix ( NFLX) and Coinstar's ( CSTR) Redbox, has intensified, stealing market share away from Blockbuster and forcing it to rethink its entire operational strategy.
James Keyes
Blockbuster CEO James Keyes

In an effort to cut costs, Blockbuster previously said it plans to shutter 20% of their stores by 2011, leaving about 3,200 stores from 4,356 locations in the fall.

It's easy to see why Blockbuster needs to resort to such measures. Last month, the company revealed that fourth-quarter earnings came in lower-than-expected due to weak holiday sales. As a result, it now expects a loss of $183 million to $193 million for fiscal 2009.

And earlier this week, Blockbuster took another blow when billionaire investor Carl Icahn said he was retiring from the company's board of directors. Icahn said he was resigning because of Institutional Shareholder Services guidelines regarding the number of directorships a person can hold.

Blockbuster's stock has paid the price, losing 71% since its 52-week high of $1.56.

Elsewhere in the sector, privately-held Movie Gallery filed for bankruptcy this week and said it would close nearly 800 stores. The news was viewed, by the markets, as a positive for Blockbuster -- based on the elimination of Blockbuster's competition. But it also could foreshadow Blockbuster's fate.

In light of all this, TheStreet spoke with CEO James Keyes to see just how he plans to revive the company and fend off bankruptcy, which experts debate could come this year. Keyes took the reins at Blockbuster in 2007 and previously served as chief executive of convenience store 7 Eleven.

TheStreet: What happened over the holiday season?

Keyes: The fourth quarter for us is very important, especially the last two weeks. This year we saw an opportunity to leverage our availability of new releases like Harry Potter and the Hangover, so we upped our inventory and invested more in advertising. We thought Netflix and Redbox would be unable to keep these titles in stock so we would have an advantage over the competition. It turns out, both were able to secure enough inventory and other retailers sold them way below cost. As a result, December was not what we hoped.

TheStreet: How will Blockbuster compete with rivals going forward?

Keyes: The heart of our business was never about renting VHS tapes. It was providing the easiest access to media and entertainment. The definition of entertainment has changed dramatically, moving way beyond movies alone. Retailers must adapt or die. We are currently in the process of making that adaption.

We are building a multi-platform approach to business. Netflix introduced a new form of convenience with DVDs by mail. We mirrored that and took it one step further, allowing the added convenience of shoppers being able to return DVDs in the store. There is cross-channel opportunity here.

While vending machines have been around for 20 years, Redbox took current technology and updated the system. We, too, saw it as a legit form of convenient access to entertainment so we created Blockbuster Express. We use NCR technology and made the kiosks future-proof. This means if DVDs go away, the kiosks can be transformed with digital download capability. We had 2,500 of these kiosks at the end of 2009 and plan to roll out 10,000 more by the end of this year.

Digital is what we are most excited about ... and our acquisition of Movie Link two years ago is the base for Blockbuster on Demand.

How are you funding these new initiatives?

We managed business in 2008 successfully for growth, seeing our first same-store sales increases in many years. But we were forced in 2009, along with most other retailers, to manage the business conservatively. We changed our focus to preserving liquidity. We managed to push our amortization over to the next four years and have the necessary capital to move forward.

Blockbuster said it expects to have cash and cash equivalents of $247.2 million, which includes about $59 million in restricted cash. It also previously announced that it eliminated the remaining $23.7 million in letters of credit related to its former parent Viacom ( VIA).

TheStreet: Why have these new initiatives not been advertised to the consumer? When will they be available for mainstream use?

Keyes: The last thing we want to do in a remodel is put a "for sale" sign on the lawn. These initiatives are not ready to be unveiled. By the end of this year we will have scale in DVD vending and 10 million people will be digitally connected.

TheStreet: What is the future of Blockbuster's brick-and-mortar locations?

Keyes: We have two opportunities with the physical stores. We can do a better job in the current market to get the titles people want. For example, Netflix has a 28-day window before it can begin offering new releases like The Blind Side. We will stock it immediately when it is released. This should help stores in the long term.

There is also the opportunity to diversify stores. The gaming business is the fastest growing unit for us. Renting a game is a good alternative for parents who have kids and want them to try out the game first before spending $50 on it. We both rent and sell video games, making us a one-stop shop.

The trick is how quickly can we diversify stores and how quickly will revenues from kiosks and other initiatives bear fruit? If those revenues don't come quick enough or we can't diversify the stores fast enough we may have to close more locations.

TheStreet: Is there any chance Blockbuster would do away with stores altogether?

Keyes: We can never say never. There is always the possibility to go completely store-less. But the DVD, in our view, is the same as the CD. A good chunk of CDs are still sold in stores, and we think the same will be true for DVDs. There will still be demand for physical stores.

TheStreet: Do you think Blockbuster is too late to the game to recover? How would you respond to naysayers who are predicting Blockbuster's bankruptcy?

Keyes: Hindsight is always 20-20. Would I like to not be in the situation I am now in? Of course. I wish that I was part of this turnaround sooner. But we are moving in the right direction.

Remodeling your home is a pretty frightening experience, especially when you are still living in it. It's expensive and you have to do without things you once had. Outside looking in it's not a pretty site.

I have lived through this process before at 7 Eleven. The problems at Blockbuster mirror those the convenient store faced. 7 Eleven was all but written off, as was the convenience channel. We had to adapt and we did. Now the convenience channel is thriving. I am in the same position today. I have seen it play out before and know the story and how it can be successful.

-- Reported by Jeanine Poggi in New York.

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