MSG Networks Inc.
Q2 2018 Earnings Call Transcript

Published: 1 Feb 2018

[Operator:]

Good morning. My name is Angela and I'll be your conference operator today. At this time, I would like to welcome everyone to the MSG Networks Earnings Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Ari Danes, Investor Relations. Please go ahead, sir.

[Ari Danes:]

Thanks, Angela. Good morning and welcome to MSG Networks' Fiscal 2018 Second Quarter Conference Call. The company's President and CEO, Andrea Greenberg, will begin this morning's call with a discussion of some of the company's operations. This will be followed by a review of financial results of Bret Richter, the company's EVP, Chief Financial Officer and Treasurer. After their prepared remarks, we will open up the call for questions. If you do not have a copy of today's earnings release, it is available in the Investors Section of the company's corporate website. Please take note of the following. Today's discussion may contain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that any such forward-looking statements are not guarantees of future performance or results and involve risks and uncertainties, and that actual results, developments and events may differ materially from those in the forward-looking statements as a result of various factors. These include financial community perceptions of the company and its business, operations, financial condition and the industry in which it operates as well as the factors described in the company's filings with the Securities and Exchange Commission, including the sections entitled Risk Factors and Management's Discussion and Analysis of Financial Condition and results of operations contained therein. The company disclaims any obligation to update any forward-looking statements that may be discussed during this call. Lastly, we will discuss certain non-GAAP financial measures on today's call. On Pages 5 and 6 of today's earnings release, we provide consolidated statements of operations and a reconciliation of operating income to adjusted operating income. In addition, on Page 8 of the earnings release, we provide a reconciliation of net cash provided by operating activities from continuing operations to free cash flow. I would now like to introduce Andrea Greenberg, President and CEO of MSG Networks.

[Andrea Greenberg:]

Thank you, Ari and good morning. With a successful first half of fiscal 2018 behind us, we remain confident that as an owner of regional sports and entertainment networks in the nation's largest media market, we are well positioned to create ongoing value for our shareholders. For our second quarter, we generated revenues of $181 million, an increase of 3% as compared to the prior year period and adjusted operating income of approximately $83 million. Looking ahead, we are confident that we are on track for another solid year of revenues, adjusted operating income and free cash flow generation. Underscoring our confidence in the strength of our business, we recently announced that our Board of Directors authorized a $150 million stock repurchase program, our first as a standalone media company. Bret will have more to share on this topic. Our results continue to be driven by the unique value we provide through our exclusive live local sports content as well as our ongoing focus on operational excellence. The breadth of our content is now on display as the 2017-18 NBA and NHL regular seasons are in full swing. Our unrivalled lineup of live game from the New York Knicks, Rangers and Islanders, New Jersey Devils and Buffalo Sabres is complemented by an exciting slate of original programming. This includes our expert pre and post-game coverage and Knicks and Rangers’ coach’s shows, which allow us to increase engagement with our viewers. To help broaden our appeal, particularly among younger viewers, this season, we introduced MSG Shorts, which we recently enhanced with the debut of two new series. [indiscernible] featuring sports stars such as LeBron James and Serena Williams speaking candidly about managing life changing financial success at a young age and My New York, showcasing professional athlete such as [indiscernible] Henrik Lundqvist, discussing what they love about playing and living in the Big Apple. We also continue to develop new sponsor integration opportunities through branded content. So far this season, we've worked with a number of our partners including Anheuser Busch, the Hospital for Special Surgery, BMW and Squarespace to produce and distribute short form content across our linear and digital channels. We are pleased with our progress on this front and plan to continue pursuing additional branded content partnerships that tell interesting stories and drive viewer engagement and incremental advertising revenue. Another priority for us this year is enhancing the distribution of our content, particularly on digital platforms. MSG Go, our life streaming and video on-demand offering is now fully distributed by all our major affiliates. The app continues to experience robust year-over-year increases in downloads and viewership as well as strong demand from sponsors. Our highly valuable content has also helped drive new digital distribution opportunities. We launched MSG and MSG+ on fuboTV in October and through a multi-year agreement signed earlier this fiscal year, we recently made MSG Networks available for OTT distribution to DIRECTV NOW subscribers in our territory. Going forward, we will continue to explore expanding our digital distribution, while seeking to ensure that any additional opportunities appropriately value and package our networks. With these new partnerships, along with our traditional affiliate relationship, we remain confident that we are well positioned for continued affiliate revenue growth. In terms of our viewing subscribers, we experienced a low single digit percentage decrease in our second quarter as compared with the prior year period. However, this year-over-year percentage rate of decline slightly improved as compared to the decrease in the fiscal 2018 first quarter. In summary, we are pleased with our achievements in the first half of fiscal 2018. Looking ahead, we remain focused on executing against our priorities to deliver solid financial results, broaden our viewership and drive enhanced distribution for our content, all of which create long term value for our shareholders. I will now turn the call over to Bret who will take you through our financial results.

[Bret Richter:]

Thank you, Andrea and good morning, everyone. I would like to start today by focusing on our results for the fiscal 2018 second quarter. Total revenues of $181.2 million increased $5.6 million or approximately 3%. This included a $4.4 million increase in affiliate revenue and a $700,000 increase in advertising revenue. The year-over-year increase in affiliate revenue is primarily due to higher affiliate rates, partially offset by the impact of a low single digit percentage decline in subscribers. The increase in advertising revenue was primarily due to a higher net decrease in deferred revenue related to ratings guarantees, partially offset by other net advertising decreases. Direct operating expenses of $78.9 million increased 13% or $9 million as compared with the prior year period. The increase was primarily due to higher rights fees expense and, to a lesser extent, higher other programming-related cost increases. The increase in rights fees expense primarily reflects annual contractual rate increases and a step-up in expense related to the renewal of our rights agreement with the Buffalo Sabres, as well as additional league fees for streaming rights and a shift in the timing of the recognition of certain other rights fees expense. The increase in other programming-related costs was primarily due to the absence of the positive impact of the finalization of a matter related to the sale of Fuse recorded in the prior year quarter. SG&A expenses of $24.3 million increased approximately $1.3 million or 6% as compared with the prior year period. This was primarily due to higher employee compensation and related benefits, which was a result of an increase in share-based compensation expense. Adjusted operating income of $82.8 million decreased $3.2 million or 4% as compared with the prior year period. This decrease was primarily due to higher direct operating expenses, partially offset by the increase in revenues. Turning to taxes, I will note that as a result of the recently enacted federal tax reform legislation, which reduced the company's federal tax rate to 21% from 35% effective January 1, 2018, fiscal 2018 second quarter income from continuing operations reflects a non-cash income tax benefit of approximately $106 million to reduce the company's net deferred tax liabilities. These liabilities primarily relate to the difference between the book basis of goodwill and other intangibles under GAAP as compared with the tax basis. With regards to the balance of fiscal year 2018, our GAAP tax rate for the third and fourth quarters will reflect a blended federal corporate tax rate of 28%. This is based on the number of days for this fiscal year that our company will be taxed at the former federal rate of 35% and the new rate of 21%. Our fiscal 2019 GAAP tax rate will fully reflect a new federal tax rate of 21%. Furthermore, as a result of the new tax reform legislation, we expect a substantial reduction in the company's cash taxes effective January 1, 2018. Specifically, we anticipate at least a 20% reduction in future cash taxes payable on income from continuing operations before income taxes as compared with amounts that would have otherwise been payable under the prior law. With respect to our balance sheet, as of December 31, 2017, total cash and cash equivalents were $201.9 million. Total debt outstanding was $1.28 billion and our $250 million revolver remained undrawn at quarter’s end. We made a mandatory principal payment of $18.75 million during the fiscal second quarter in accordance with the terms of our credit agreement. Please note that our credit facility provides for a total of $75 million in mandatory principal payments over the next 12 months. As of December 31, 2017, net debt was approximately $1.08 billion and our net leverage ratio declined to 3.2 times trailing 12-months adjusted operating income. Our average interest rate for the quarter was approximately 2.8%. Reported free cash flow from continuing operations for the six months ending December 31, 2017 was $101.1 million dollars. As Andrea mentioned, in December, our Board of Directors authorized a stock repurchase program under which we may repurchase up to $150 million of our outstanding Class A common stock. We have not yet repurchased shares under the current authorization. However, the stock repurchase program provides the company with an important capital allocation alternative and we believe that as a result of the company's ability to generate substantial free cash flow, we can maintain our financial flexibility and strong balance sheet while simultaneously executing this stock repurchase program. We will update you on our progress on a quarterly basis. I will now turn the call back over to Ari.

[Ari Danes:]

Thanks, Bret. Can we open up the call now for questions?

[Operator:]

And our first question comes from Brandon Ross with BTIG.

[Brandon Ross:]

I know you generally don't disclose the exact timing of your renewals, but there's been a lot of speculation among investors recently that you had a major deal expire. Is that indeed the case? And if so have you completed a renewal there or what’s the exact status?

[Andrea Greenberg:]

Well, as we've previously said, our affiliate deals have staggered expirations and they come up for renewal from time to time in the ordinary course of our business. While we don't disclose specifics, I will say that we have in fact recently renewed affiliate agreements with several of our distributors, including with a major distributor of ours.

[Brandon Ross:]

And could you comment on some of the more important terms of the major – the deal with the major distributor such as subscriber floors.

[Andrea Greenberg:]

Adam, you want to --?

[Adam Levine:]

Yeah. I’ll jump in on that. We can’t really get into the specifics, but I think what we're comfortable sharing is that we're pleased with the renewal terms, including the contractual protections. I think we've said before we've had success in achieving broad distribution with a variety of protections in our past and in current agreements, including these renewal agreements. And the agreements reinforce our belief in the unique nature and significant value of our programming networks and are consistent with our goal to drive continued affiliate revenue growth.

[Operator:]

Your next question comes from John Janedis with Jefferies.

[John Janedis:]

A couple of quick ones for me. First just how much of an impact the earlier start to the NBA season impact the quarter? And I think there maybe were a few more games and do you amortize your sports rights expenses at a per game basis? And then separately, Andrea, you called out other programming expense, could you give us an update around the original programming strategy? I think in the past, you’ve spoken to modest investment and I was wondering if that's changed.

[Andrea Greenberg:]

I'll take number two first and then hand it over to Bret. Our philosophy has not changed. We continue to look to invest and monetize in our programming particularly that meets our goals of attracting sort of a younger demo and broadening our PR. Our new programming initiatives, as I said in the past, are opportunistically pursued and they’re generally accretive to the bottom line. So that's our philosophy.

[Bret Richter:]

I'll take the direct expense related question. So I'm not going to call out the number specifically, but the shift in the season was large enough affecting the timing of our recognition of the rights to call out. The vast majority of our rights are recognized over the course of the year, but a certain subset of our rights are tied specifically to the season, including some of our league fees. So the earlier start of the NBA season did pull forward an amount as compared to last year. And again while not specifically qualifying it, it’s important to call out, but certainly those other items are regular contractual rate increases, the step up in the Sabres agreement, the additional digital rights were all factors as well.

[Operator:]

Your next question comes from Alexia Quadrani with JPMorgan.

[Alexia Quadrani:]

Just a couple of questions. Can you please discuss your distribution deal with DIRECTV NOW, I mean just any general color you can possibly give and maybe how the rates are deterring compared relative to your linear deal?

[Adam Levine:]

Yeah. Sure. I’ll jump in on that one. I think we say we're pleased to have reached a multi-year agreement with DIRECTV NOW. The agreement was reached earlier in the fiscal year. We launched prior to the end of our fiscal second quarter. As far as the terms, we can't really get into specific, but we would say the value and packaging is consistent with our existing distribution with DIRECTV. I think it's publicly available in terms of the tier that we're on, but I think just reinforcing on, I think the agreement reinforces the value of the live sports program we have and we certainly excited to participate in the growth of DIRECTV NOW. We saw AT&T just announced that the number of national DIRECTV NOW subscribers that they added in the last quarter sort of far outpaced the number of subscribers they lost on the DBS platform. So we think that’s a growth opportunity for us and we look forward to participating in that in future quarters.

[Alexia Quadrani:]

And then just sort of a general question on the M&A, we’re seeing so much M&A now in the media sector -- the broader media sector and I'm wondering with that sort of changing momentum, does that change your outlook at all in terms of whether you're a more aggressive buyer or seller or just to influence your outlook at all for your business?

[Andrea Greenberg:]

Yeah. Alexia, we're not going to comment on something that's speculative. But I've said in the past and continue to be really pleased with what we've accomplished here as a standalone media company financially, strategically, operationally and thrilled that we continue to deliver a strong quarterly result.

[Operator:]

Your next question comes from Michael Morris with Guggenheim Securities.

[Michael Morris:]

Two questions. First on the affiliate revenue, in the fiscal second quarter, there was an acceleration there and I'm curious as to whether either the virtual MVPD arrangements that you've reached or the renewal that Andrea you just referenced in a earlier question, whether either of those impacted that acceleration in growth in the fiscal second quarter. And then on capital allocation and the share buyback, I don't expect you would address specifically what your pace is, but can you give us any sort of structural considerations, how you look at kind of ideal leverage ratio, cash on hand, thinking about liquidity in the stock, anything like that that help how we think about modeling that going forward?

[Bret Richter:]

Sure. I’ll take think both of those, Mike. So with regards to affiliate revenue, as we've discussed in the past, I’d like to more focus on the headline than any of the individual components in the headline is for all the reasons that we've discussed, including our progress in OTT and our relationships with our distributors, we continue to grow affiliate revenue and I think that's the important point for the quarter. In terms of dissecting any individual elements, there is, as we talked about, there's always small items in the quarter, sometimes there are adjustments up or down, but this quarter and particularly our relationship with Fubo did impact the quarter modestly and is reflected in the quarter, our relationship with DIRECTV NOW had virtually no impact on the quarter, given their late December launch and we look forward to that impacting our financials on a go forward basis. With regards to capital allocation, there's no specific measures to talk to. I think the headline this quarter is that we have a very important tool in our toolbox now with regards to our stock repurchase authorization. We're conscious of looking at every element of the consideration, whether it's the leverage on the balance sheet, the cash on the balance sheet, the opportunities in the market, other opportunities. But there's really no specifics there.

[Michael Morris:]

If I could just, back on the first point and the renewal that you did specifically speak to the large partner renewal, did that in any way impact the fiscal second quarter? Is that something that happened after the quarter closed?

[Bret Richter:]

As Andrea said, we had several renewals in the quarter. The major renewal did not impact the quarter.

[Operator:]

Your next question comes from Bryan Goldberg with Bank of America.

[Bryan Goldberg:]

I was hoping you can help deconstruct a little more what happened with advertising in the quarter. I guess more specifically, what were ratings trends for the major teams? Was there any notable year-on-year change in CPMs and how does the deferred revenue component factor in in MSG co-sponsorship? And then I have a follow-up on taxes.

[Andrea Greenberg:]

On the ratings point, first let me say that we continue to see really strong demands of product. So with all our new initiatives, we're bringing in new advertisers and new money into our business. So that's all good on a go forward basis. On the ratings front specifically, so far this season, we've seen lower rating for the Rangers. We've seen pretty consistent similar ratings to last year on the Knicks and we're seeing significantly higher ratings for the Devils and the Islanders. Bret, do you want to take the second half?

[Bret Richter:]

Sure. With regards to the dollars, I don't think there's a tremendous amount to deconstruct. We were up $700,000 year-over-year. The primary contributor to that was the change in our deferred revenue liability and really what that reflects in any given quarter is to the extent we have to book additional ratings guarantees, we’ll book a liability and to the extent we resolve any ratings guarantees, we can release it to income and in this quarter, we saw a released income, which essentially explains the quarterly variance. Underneath, there's all kinds of movements, you noted the schedule. We had an impact of our Digital Video Awards, which we didn't have last year. We made some progress in certain of our products like MSG Go, but in looking at the headline, the amount is explained by the deferred revenue.

[Bryan Goldberg:]

And then on taxes, thanks for the color earlier. In looking at your second quarter book tax rate, I mean it looks like when you pull out the deferred tax liability adjustment, it looks like your book tax rate was 25% and I was wondering is that the right way to think about that? Is there other noise to consider and how does that sort of link to the 28% GAAP tax rate you talked about for the balance of fiscal ’18? And then I was wondering from a GAAP tax perspective, in fiscal ’19, is 28% the right figure to be thinking about or what would be the moving pieces in fiscal ’19?

[Bret Richter:]

Sure. Bryan, thanks for that question because we're certainly complicated by the fact that we have a June 30 year end versus taxes, which essentially reflected 12/31 year end. First of all, when we're looking at those rates, we have to be careful when we're talking about just the federal component versus our overall tax rate. With regards to the federal component, what we were highlighting is that for the first six months of this year, we have a 35% federal component and for the balance of the year, fiscal year, through June, the last six months, we’ll have a 21% component. So we're looking at a blended 28% federal tax rate for our fiscal year. When you look at our tax rate simply for the three months ending December 31, we have to make a catchup adjustment because for the first three months of the year, the quarter ending September 30, we had a 35% federal rate from a GAAP perspective. You'll see a little bit more detail of that when we file our financials, but that should explain the difference between the 28% federal rate and the rate you're seeing this quarter. There's a catchup adjustment. Overall, we're not going to speak to a specific tax rate on a go forward basis for calendar year ’18. We expect to get the full benefit of the 21% tax rate in terms of the payments that it generates and I think importantly I made a comment in our prepared remarks that we expect at least a 20% reduction in our cash taxes on a go forward basis.

[Operator:]

Your next question comes from David Miller with Loop Capital Markets.

[David Miller:]

Bret, I apologize. My audio faded out during your prepared remarks. Could you just please repeat what you said about how much advertising was up in the quarter year-over-year and also how much affiliate fees were up year-over-year and then I have a follow up? Thanks.

[Bret Richter:]

Sure. I mean it comes right off our release and we did. Advertising was up $700,000 and affiliate fee revenue was up $4.4 million.

[David Miller:]

And then Andrea, you mentioned also in your prepared remarks that subscribers came in at a low single digit decrease, though slightly improved. The slight improvement and this just follows on a couple of the other questions that were in the queue, is the slight improvement due solely to Fubo or is the slight improvement due to other factors? Thank you.

[Andrea Greenberg:]

We’re not going to get into the specifics of the ins and outs on our subscriber numbers, but again as Bret had indicated, FuboTV is included in these subscribers for this quarter and DIRECTV NOW is not. So we’ll see the further impact of DIRECTV NOW in our next fiscal quarter and we'll update our subs as we do when we file our K.

[Operator:]

Your next question comes from David Joyce with Evercore.

[David Joyce:]

A couple of questions. One, I was wondering aside from the stock buyback program, how would you plan to use your tax savings? How would you reinvest that? Would that go into rights for teams that you don’t have or from more originals. And then second question would be on your carriage deals.

[Bret Richter:]

Sure. With regards to use of cash, we're constantly thinking about ways to use the cash. If there are opportunities in the business, we’ll look at those opportunities and to the extent we think we can create return and shareholder value, we may pursue those opportunities, but that's a hypothetical question in the absence of any specific element to sort of analyze. We're always very conscious of maintaining a very strong balance sheet and we do have mandatory obligations under our credit facility. So certainly a portion of our cash will continue to go towards amortizing that facility from the mandatory obligations and whether we do more or not in the future. Time will tell. We have the stock buyback and we’d like to be flexible in case other opportunities arise.

[David Joyce:]

Thanks. And the question on the carriage agreements, we've seen some instances of re-tiering impacting other networks, how can you provide some comfort that you'll still stay in the tiers that you’re in and keep your carriage minimums, just wondering what the nuances are in negotiations these days?

[Bret Richter:]

Well, I guess without getting into the specifics of our negotiations, I think like we said, we've for years, have been focused on making sure we have appropriate protections in our contracts and we've been fortunate to have those and maintain them and we have broad distribution among all the major distributors in the marketplace and I think we said we're pleased with the terms of the renewal that we have this past year and I think that's our expectation going forward. I don’t think we have sort of much to comment beyond that.

[Operator:]

And that concludes our Q&A session. Ari, I would like to turn the call back over to you.

[Ari Danes:]

Thank you all for joining us. We look forward to speaking with you on our fiscal third quarter conference call. Have a good day.

[Operator:]

That concludes today’s conference call. You may now disconnect.