MSG Networks Inc.
Q3 2018 Earnings Call Transcript

Published: 5 May 2018

[Operator:]

Good morning. My name is Kristy, and I will be your conference operator today. At this time, I would like to welcome everyone to MSG Networks’ Fiscal 2018 Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I will now turn the call over to Ari Danes, Investor Relations. Please go ahead, sir.

[Ari Danes:]

Thanks, Kristy. Good morning. And welcome to MSG Networks’ fiscal 2018 third 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 with 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 a 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 five and six 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 eight of the earnings release, we provide a reconciliation of net cash provided by operating activities from continuing operations to free cash flow. With that, I will now turn the call over to Andrea.

[Andrea Greenberg:]

Thank you, Ari, and good morning. For the fiscal third quarter, our company delivered approximately $187 million in revenue and $86 million in adjusted operating income, with our financial results highlighted by the ongoing growth of our affiliate revenue base. Our financial performance continues to be driven by our exclusive local content, including approximately 500 live professional games each year, as well as in-depth team coverage and critically acclaimed original programming. All of which has enabled MSG Networks to build an unparalleled presence in our country’s largest media market. Last month, the 2017, 2018 regular seasons for our NBA and NHL teams concluded with the New Jersey Devils qualifying for the playoffs. MSG Networks aired three of the Devils’ first round playoff games, along with comprehensive pre and post-game coverage. In March, we kicked off the 23rd season of Major League Soccer’s New York Red Bulls on MSG Networks, with games airing all summer long and into the fall. And we look forward to another exciting regular season of the WNBA’s New York Liberty, which begins May 20th with the team’s first game against the Chicago Sky. MSG Networks also continues to serve as the regional sports home of the New York Giants and Buffalo Bills, and over the past month, featured in-depth, expanded NFL Draft coverage, including a live telecast from the draft in Dallas just last week. During the third quarter, we continued to produce critically-acclaimed original program that broadened our engagement with viewers, including new episodes of People Talking Sports And Other Stuff, as well as Beginnings, building on our MSG Shorts programming block. We were also excited to have recently partnered with Knicks Gaming, the official e-sports team of the New York Knicks and the NBA 2K League on a new weekly show airing all summer long. Debuting next week, the show which provides fans with behind the scenes look at the e-sports team during their inaugural season will allow us to further build viewer engagement with a passionate and growing fan base, mainly comprised of highly sought after millennials. Last month, our ongoing commitment to programming excellence was once again recognized with 10 New York Emmy Awards, which brings our total to 152 Emmys over the past 10 years, more than any other network or station in the New York area over that time. While we have continued to innovate with new and varied content, advertising revenue this past quarter was impacted by lower rating, which we believe reflected the on ice and on core performance of certain of our teams. That said, advertising demand for live local sports remains robust and coupled with the incremental advertising opportunities we are developing, we remain confident in the long-term outlook for advertising revenue. These opportunities include our branded content initiatives, as well as our street front digital boards, which are high impact vehicle to showcase our brands, content and partners. In addition, we believe advertising demand for MSG GO, our live streaming and on-demand platform represents an attractive long-term opportunity. As we have previously discussed, our highly valuable content has also led to new digital distribution. We continue to explore additional opportunities that appropriately value and package our networks, and 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 decline in our third quarter as compared with the prior year period. While this year-over-year percentage rate of decline slightly increased as compared to our fiscal second quarter, it has considerably improved relative to where we were last year at this time. In summary, we have made meaningful progress towards achieving our key objectives for the fiscal year. We are on pace for another year of solid financial results. We have driven increased distribution on digital platform, renewed affiliation agreements in the ordinary course and we continue to expand our programming in an effort to broaden our viewership. As we look ahead, we remain confident that we are well-positioned to generate ongoing 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 third quarter. Total revenues of $186.6 million increased $3.3 million or approximately 2%. This included a $4.9 million increase in affiliate revenue and a $2.2 million decline in advertising revenue. Year-over-year increase in affiliate revenue was primarily due to higher affiliate rates, partially offset by the impact of a low single-digit percentage decline in subscribers. The decline in advertising revenue was primarily due to a higher net increase in deferred revenue related to ratings guarantees, partially offset by other net advertising revenue increases. Direct operating expenses of $80.3 million increased 6% or $4.8 million as compared with the prior year period. The increase was primarily due to higher rights fees expense and to a lesser extent an increase in other programming related costs. The increase in rights fees expense primarily reflects a step up in expense related to the renewal of our rights agreement with the Buffalo Sabres, annual contractual rate increases and additional league fees relating to streaming rights. These increases were partially offset by a shift in the timing of the recognition of certain other rights fees expense. The increase in other programming related costs was driven by several items, including the impact of Sabres and Bills programming for our Western New York viewers initiated as part of our expanded long-term partnership with Pegula Sports and Entertainment. SG&A expenses of $23.4 million increased approximately $1.7 million or 8% as compared with the prior year period. This was primarily due to higher advertising and marketing costs, and to a lesser extent other net increases. Adjusted operating income of $85.7 million declined $2.7 million or 3% as compared with the prior year period. This decline was primarily due to higher direct operating expenses, lower advertising revenues and to a lesser extent increased SG&A expenses, partially offset by the increase in affiliate and other revenues. Turning to taxes, I would note that our 33% GAAP tax rate for the quarter primarily reflects a blended federal corporate tax rate of 28% and the net impact of state local income taxes, as well as the tax impact of other smaller items. The 28% rate is based on the number of days 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 the new federal tax rate of 21%. However, we anticipate that our fiscal 2018 fourth quarter GAAP tax rate will be higher than our rate for the third quarter as a result of certain adjustments, which are necessary to reflect the impact of Tax Reform becoming effective at the midpoint of our fiscal year. And finally, and importantly, effective January 1, 2018, we anticipate at least a 20% reduction in 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. Reported free cash flow from continuing operations for the nine months ending March 31, 2018 was $163.4 million. With respect to our balance sheet, as of March 31, 2018, total cash and cash equivalents were $194.6 million. Total debt outstanding was $1.22 billion and our $250 million revolver remained undrawn at quarter’s end. As of March 31, 2018, net debt was approximately $1.02 billion and our net leverage ratio declined to 3.1 times trailing 12 months adjusted operating income. Our average interest rate for the quarter was approximately 3.1%. During the fiscal third quarter we made principal payments of $68.75 million, which included a mandatory payment of $18.75 million in accordance with the terms of our credit agreement, as well as a $50 million voluntary prepayment. Our credit facility provides for a total of $75 million in mandatory principal payments over the next 12 months. And in terms of the company’s stock repurchase program, while we did not repurchase stock during the third quarter, we did begin to repurchase stock during our fiscal fourth quarter. We will provide our buyback activity with our fourth -- for our fourth quarter when we report fiscal 2018 year end results in August. We are committed to utilizing the $150 million authorization and plan to remain disciplined and opportunistic with our share repurchases. We will continue to update you with our progress on a quarterly basis. I’ll now turn the call back over to Ari.

[Ari Danes:]

Thanks, Bret. Kristy, can we open up the call for questions?

[Operator:]

Sure. [Operator Instructions] And your first question comes from Bryan Goldberg of Bank of America.

[Bryan Goldberg:]

Yeah. Thank you. I was hoping to get your latest perspective on subscriber trends in the industry at large. The first quarter results we have seen reported by the traditional and streaming pay-TV distributors so far. How indicative are they or what’s going on in your New York market area? What are the puts and takes we should be aware of that would make New York very differently than the industry?

[Andrea Greenberg:]

Hi, Bryan. It’s Andrea. I’ll take that one. Well, as you know, we are a regional service in a very unique and a very competitive market in terms of video distribution. So our subscriber trends here may not necessarily track the national subscriber trends that you’ve been seeing. And as we said in our prepared remarks, our year-over-year percentage rate have decline, only slightly increased in our fiscal third quarter as compared to the second quarter. Important to know that the rate of decline has considerably improved to where we were a year ago this time. And just for your purposes, without getting into subscriber specifics, a little more color, the results that we have reported today include the impact of fuboTV, which launched in October, but don’t yet reflect a full quarter of DIRECTV NOW, which launched at the end of December. We think just generally that fuboTV and DIRECTV NOW are well-positioned for growth in this market.

[Bryan Goldberg:]

Yeah. Just to follow up on that, with fuboTV and DIRECTV NOW or just OTT more broadly, I know it’s early days. But what are you seeing so far right now in your market in New York. New York household is more likely to over index or under index on VMVP adoption?

[Adam Levine:]

This is Adam. Bryan, I’ll take that one. I think we -- it’s hard for us to really comment about New York compared to other markets. But I think when we think about the opportunity, I mean, we have seen some heavy marketing from OTT players including DIRECTV NOW in this market. And we think that there is an opportunity in the New York VMA for these types of platforms, because of the difficulty traditional players have entering sort of buildings where they have to wire the buildings. So sort of an OTT opportunity that we think there is a real opportunity for those players in that sense.

[Andrea Greenberg:]

And as Adam said, I think, DIRECTV NOW has just begun a full marketing campaign. I am seeing it all over the place…

[Adam Levine:]

Yeah.

[Andrea Greenberg:]

… in New York market specifically.

[Adam Levine:]

Which included, I think, references to our services…

[Andrea Greenberg:]

Correct.

[Adam Levine:]

… being included in the platform.

[Bryan Goldberg:]

Okay. Great. Thank you.

[Operator:]

Your next question is from Brandon Ross of BTIG.

[Brandon Ross:]

Hi. Good morning. Thanks for taking the questions. Just following up on the last discussion there on virtual MVPDs. Clearly, they’re taking real share from the facilities base and you’ve signed a couple of virtual MVPD deals, as you mentioned, but there are still several big ones out there, whether it’s YouTube or Hulu or Sling that you haven’t announced. What’s the biggest point of friction in getting a deal done with those guys, is it price, is peering, is it MSNs, what has been the hold up so far and then I have a follow up? Thanks.

[Adam Levine:]

Okay. It’s Adam. I’ll take that one as well. So I can’t really sort of get into the specifics on our discussions with other virtual MVPDs. But, I guess, I sort of use the opportunity to reiterate that we are pleased with the progress we have made in digital distribution since we acquired the rights just about a year ago. So since that time we were not only able to expand our distribution of MSG GO to include all of the major distributors in the marketplace, but also to get the two launches on both DIRECTV NOW and fuboTV during our fiscal second quarter, so that’s relatively recent for us. For the other opportunities, I mean, I wouldn’t necessarily characterize anything as friction. I would just say, we are focused on sort of all those opportunities to increase distribution. We are pursuing the additional opportunities, of course, we want to make sure that our content is appropriately valued and any deals make sense for our overall business. We are in discussions with a number of those operators, and I think, yeah, I just say we, of course, believe in the power of our product and we are seeing a number of those OTT providers align their brands with live professional sports content in a meaningful way. Specifically the NBA and NHL, so I think that to us is indicative of the importance that they’re placing on that kind of content. And I would also add that we believe our content is important for any operator that sort of seeks to compete for subscribers in this highly competitive marketplace.

[Andrea Greenberg:]

And just following up on what Adam has just articulated. That’s generally why we feel we are well-positioned for continued affiliate…

[Adam Levine:]

Yeah.

[Andrea Greenberg:]

… revenue growth in this market, we are renewing traditional deals. We have indicated that we have renewed a variety of them this year, including one with major affiliate, we have increased our digital distribution, MSG GO as Adam said, OTT as Adam said. And we continue to pursue additional opportunities, particularly with operators that as Adam indicated are aligned with sports as a brand defining offering.

[Brandon Ross:]

Great. And then maybe just for Brett on the buyback, you didn’t buyback any stock in the quarter. It sounds like you started to earlier in this quarter. With the stock now significantly off its highs, do you really plan to step on the gas here, how much does the stock price just generally influence your decision of how much stock to buyback and when? Thanks.

[Bret Richter:]

Sure, Brandon. I don’t want to create any expectations with regards to the volume of the buyback going forward. There are multiple elements to the equation as you know and certainly the stock price is one of them. I think it’s important that we focus that we have had this tool in our toolbox really just for the third quarter this year. The authorization was late in our second quarter. We took the opportunity in our third quarter to allocate some capital to pay down some debt. We initiated the buyback in our fourth quarter and we will continue to analyze our capital allocation options and apply capital as we think appropriate at the time. What is really speaks to though is that the company has significant resources and significant cash flow to allocate to these opportunities and certainly benefit for us going forward to have our new authorization in place.

[Brandon Ross:]

Thanks.

[Operator:]

Thank you. Our next question is from Michael Morris of Guggenheim Securities.

[Michael Morris:]

Thank you. Good morning, guys. I have two questions. I’ll start with the first and it’s again on your relationship with the virtual MVPDs. And my question is, are there limitations in terms of how much of the subscriber base of a virtual MVPD can take a tear that doesn’t include MSG networks or could 100% of a particular MVPD to the extent that they have a tier that doesn’t include you, could 100% of that subscriber base take a tier that doesn’t include you without you being compensated and how does that compare to your existing sort of traditional distribution partnerships and then I have a second one?

[Adam Levine:]

Okay. This is Adam. I’ll take that one. So I can’t really get into details of our agreements with the OTT distributors. But, I guess, with some of them we see the entry level peer, including fuboTV is includes the RSN who are 100% distributed on fuboTV. So, with DIRECTV NOW, what I would say is that we are comfortable with the terms of the agreement. It includes value and packaging terms that are consistent with our pre-existing distribution with DIRECTV. It includes appropriate protections for our packaging of our services, and I guess, I would just add that it’s been our experience that the OTT agreements are generally consistent with our traditional deals in terms of contractual protections, including with respect to packaging.

[Michael Morris:]

Okay. Great. That’s helpful. And then on a different question, I am curious if you can speak to your ability to deliver individual games, particularly via streaming kind of on a pay per view basis. I’d imagine it’s probably early of this discussion, but fundamentally, do your current distribution relationships prevent you from pursuing a business model like that and how would you kind of view the pros and cons of making individual games available if you can do it?

[Adam Levine:]

So I’ll take a shot at this one. Our distribution agreements, in terms of the affiliation agreements, I think, we have a flexibility to sort offer products. However, we think is appropriate. We think we have the flexibility to maximize the value of our programming in the marketplace. We are always looking at put new and innovative offerings. But I’d also say we are very comfortable with our current business model and we continue to believe we can drive revenue and AOI growth, and strong free cash flow generation. But, yeah, there would be sort of pros and cons to evaluate for any sort of new offering to the impact on our current distribution and the opportunity of that particular offering.

[Andrea Greenberg:]

Yeah. And we are always looking at new opportunities to drive growth in our business. So if at any point in time a different type of packaging makes sense we will pursue it.

[Michael Morris:]

Great. Thank you both.

[Operator:]

Thank you. Our next question is from John Janedis of Jefferies.

[John Janedis:]

Thank you. A couple for me also, one is, you spoke to the advertising weakness and I was wondering as you think about some of the new initiatives. To what extent are those dependent on team performance, are you getting any lift from the original programming and when do you expect to see a more visible impact from MSG GO? And then, separately, can you help us quantify the impact of the NHL playoffs comp on a revenue and ALI basis, and how should we think about the contribution from the Devils? Thanks.

[Andrea Greenberg:]

I’ll take the first. Yes, is the answer to your question? We are seeing -- we are making tremendous progress in securing non-rating based partnerships with key partners. It’s been as we have indicated one of our key initiatives for this year for our branded content initiative through MSG GO packages, through our digital boards, outdoor has been a big plus for us this year. Our multi-element partnership deals with our friends across the street that we have talked about, so all of this allows us to enjoy advertising revenue growth without being specifically tied to ratings. That said, we do have some ratings-based deals in the market and this quarter as you’ve seen, ratings for Knicks and Rangers were a mixed bag for us, and at the end of season on court and last performance did in fact impact our ratings on our advertising revenue results. But maybe not as much as you might anticipate, because of we have had success in driving these new initiatives.

[Adam Levine:]

Okay. I will just…

[John Janedis:]

Can I ask on that…

[Adam Levine:]

Go ahead and then I’ll take your second question.

[John Janedis:]

Yeah. One quick question, just in terms of the non-ratings based component, is that still, maybe I am making up a number, but it’s in the maybe the 25% range or is it higher?

[Andrea Greenberg:]

Yeah. We are not going to quantify it. Suffice it to say though that we are focused on it and we are happy with the progress we have made in this fiscal year.

[Adam Levine:]

And John, with regards to your second question on the playoffs and you rightly point out, it’s a fiscal fourth quarter event for us. I want to give you a little color but what I don’t want to do is one breakdown one element of the fourth quarter, which we will obviously report in August nor breakdown sort of the profitability on a per playoff game basis. But, I think, importantly, last year we had five Ranger playoff games in the fourth quarter and this year we had three Devil playoff games, so that at least give you a launching off point for an estimate.

[John Janedis:]

Okay. Thanks a lot.

[Operator:]

Thank you. Our next question is from Alexia Quadrani of JPMorgan.

[Alexia Quadrani:]

Hi. Thank you. Just a couple of questions on the cost side, your SG&A growth was like it has accelerated a bit a little in the quarter. I think you called out earlier in the prepared remarks sort of higher marketing and advertising expenses. I guess any color you can provide on that, and more specifically, in on the outlook for look ahead and sort of also on the direct OpEx for League fees related to -- is that related to streaming and is it sort of a one-time cost given the distribution of some of the virtual MVPDs?

[Bret Richter:]

Sure, Alexia. Let me see if I can help there. I just want to grab hold of the word use growth. I think we had higher SG&A in the quarter. We highlighted that the most significant component in that was additional advertising and marketing expense that we dedicated towards the promotion of our content programming. But with regards to a trend or a growth rate, I think, more importantly, if you look back over the last several quarters we have held costs pretty tight and I think we manage costs very effectively at the company. In any given quarter, you may see us allocate a few dollars towards one purpose or another and in this quarter they jump out on a percentage basis. I don’t think in the overall scope of the company are of any magnitude. With regards to direct costs, they are recurring, the streaming fees and the step up in our Sabres rights, but these costs will normalize on a go forward basis. Just on the calendar, it’s this fiscal year where our investment in the NHL rights, which we signed, I think, it was the third quarter late last year and the new Sabres deal start to hit our P&Ls. So as we lap those new deals next year you’ll see some normalization.

[Alexia Quadrani:]

All right. Thank you very much.

[Ari Danes:]

Kristy, we will take one last caller.

[Operator:]

Sure. Your final question is from David Joyce of Evercore.

[David Joyce:]

Thank you. Few just quick ones. The first on the advertising side, I appreciate that you’ve been diversifying your ad streams there. But can you help us think about how much the Knicks and Rangers contribute to the ad revenue? Second, just a quick clarification, I think, you said, you had a traditional distributor renewal recently, was that there in the March quarter?

[Andrea Greenberg:]

Well, I think, the last quarter we said we had a major distributor. So we close that last quarter. Adam, on Knicks and Rangers.

[Adam Levine:]

Yeah. The Knicks and Rangers are, of course, a significant portion of our overall advertising, if for nothing else you certainly see it in the seasonality of our advertising where it drops off in the fourth quarter and it’s really the second quarter and third quarter every year, which is the bulk of our advertising revenue. In the performance of the teams could impact ratings and ratings can impact how we have to book deferred revenue. I think, this quarter we highlighted that it was an increase in deferred revenue that dragged down our advertising. Just last quarter it was a reduction in deferred revenue as we were able to recognize some of the revenue that we deferred, which contributed towards advertising revenue in a positive way. So, while in any given quarter you may see fluctuation in this and certainly those teams are big parts, we’d expect to ultimately continue to work with our advertisers and recognize the revenue associated with the ratings guarantees over time.

[Andrea Greenberg:]

And I also think it’s important to note just to put a pin on it that the demand for advertising in this market for our teams remained strong.

[David Joyce:]

Thanks. And just finally on your affiliate mix, traditional and virtual -- and the virtual MVPDs, are you starting to sense any different kind of trends in subscriber additions or churn or are affiliates there? Thank you.

[Bret Richter:]

I think it’s -- I think Andrea referenced that these are relatively new launches. So it’s sort of too early for us and I am not sure we really get into the specifics of any one individual affiliate. But I think this past quarter we had a full quarter of subscriber results for fubo and the partial quarter for DIRECTV NOW on the subscriber numbers that we have we reported and so, I think, we are looking forward to them growing, but I don’t think we will dissect it beyond that.

[David Joyce:]

Great. Thank you.

[Operator:]

Thank you. I’ll now turn the call back over to Ari Danes for any additional or closing remarks.

[Ari Danes:]

Thank you for joining us. We look forward to speaking with you on our next earnings call. Have a good day.

[Andrea Greenberg:]

Thanks everyone.

[Operator:]

Thank you. This does conclude today’s conference call. You may now disconnect.