High definition (HD) video has come into people’s life from movie theaters to HDTV. However, the compression of HD videos is a challenging problem due to flicker noise, caused by film grain. The flicker noise significantly limits the applicability of motion estimation (ME), which is a key factor of the efficient video compression in block-based coding standards. Due to the flicker noise, it is difficult to obtain a perfect match between a current block and a reference block. In block-based video coding standards including H.264 a given block is either encoded by inter-frame or intra-frame prediction. We propose a new coding scheme called Two-Step Coding (TSC) that utilizes both for each block. TSC first reduces the resolution of each frame by replacing each block with its DC coefficient of the DCT to the original color values. The flicker noise is greatly reduced in the obtained lower resolution frame, which we call DC frame. The key benefit is that ME becomes very efficient on DC frames, and consequently, the DC frame can be efficiently inter-frame coded. The difference between the original frame and DC frame is actually described by the AC coefficients of the DCT of the original frame. We utilize the existing H.264 tools to combine the intra-frame and inter-frame coded parts of blocks both on the encoder and decoder sides. The key benefit of the proposed TSC in comparison to the most popular standards, in particular, in comparison to H.264 lies in better utilization of inter-frame coding.. Due to flicker noise, H.264 mostly employs intra block coding on HD videos. However, it is well-known that inter-frame coding significantly outperforms intra coding in video compression rate if the temporal correllation is correctly utilized. By reducing each frame to DC frame, TSC makes it possible to apply inter-frame coding. We provide experimental data and analysis to illustrate this fact.