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Viacom, Inc. (NASDAQ:VIA)

Q3 2008 Earnings Call

November 3, 2008 4:30 pm ET

Executives

Jim Bombassei - Senior Vice President, Investor Relations

Sumner M. Redstone - Executive Chairman

Philippe P. Dauman - President & Chief Executive Officer

Thomas E. Dooley - Chief Financial Officer

Analysts

Imran Khan – JP Morgan

Michael Nathanson - Sanford Bernstein

Spencer Wang - Credit Suisse

Benjamin Swinburne - Morgan Stanley

Alan Gould - Natixis Bleichroeder

John [Tinades]– Wachovia Securities

Doug Creutz - Cowen & Company

Mark Wienkes - Goldman Sachs

Jeffrey Logsdon - BMO Capital Markets

Operator

Good day everyone and welcome to the Viacom third quarter 2008 earnings release teleconference. Today’s call is being recorded. And at this time I would like to turn the call over to the Senior Vice President of Investor Relations, Mr. Jim Bombassei.

Jim Bombassei

Good afternoon everyone and thank you for taking the time to join us for our third quarter earnings call. Joining me for today’s discussion are Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Thomas Dooley, our Chief Administrative Officer and CFO; and Jimmy Barge, our Controller and Head of Tax and Treasury.

Please note that in addition to our press release we have slides containing supplemental information available on our website. Before we begin let me refer you to page number one in the Web presentation and remind you that certain statements made on this call are forward-looking statements that involve risks and uncertainties. These risks and uncertainties are discussed in more detail in our filings with the SEC. Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release or on our website.

And now I would like to turn the call over to Sumner.

Sumner M. Redstone

Good afternoon everyone and thank you for joining us. As we report our results today we do so in a time of great uncertainty. There are serious issues affecting the economy both in the United States and abroad. But, history suggests that the business of entertainment maintains positive attributes even in such difficult times. In fact, during past economic downturns, the media business has clearly outperformed the general economy. So let me assure you that Viacom, as a pure-play content company is not only well positioned but also extremely well prepared in these uncertain times.

Now, over the past two years Philippe and his team have really done an outstanding job of pursuing a smart and disciplined path. They have kept Viacom financially strong and firmly focused on the long term. They have continually cultivated the birth and growing set of branded assets and they have successfully balanced creative expansion with operational efficiency.

While no one could have foreseen the current situation, I assure you, there is no management team in the media business that has done a better job of positioning their company to weather the storm and, more important in a way, to seize the inevitable opportunities that will emerge as the economy recovers.

Now, please let me put on my National Amusements cap. Last week on the CBS teleconference call I provided an update on National Amusements’ negotiations with its lenders. For those who might not have heard that call, let me give you an accurate and realistic assessment of where we are in the process.

As has been widely reported, the talks relate to covenant agreements that were triggered by unforeseen and truly unprecedented market activity that caused a precipitous drop in the value of the overall market and in the market value, I would say, of CBS and Viacom shares.

Now National has a top team of professional advisors working with its banks and note holders to restructure the unsecured debt under the supervision of a committee of national directors who have no executive role at either CBS or Viacom. As part of its dialogue with lenders, National sold $233.0 million of CBS and Viacom non-voting shares. Now this was an extraordinary action, brought on by an unprecedented situation and let me assure you of one thing: National does not intend to sell one more share of stock in Viacom or CBS.

Also please note: National is more than just its stock holdings. Amongst its assets are a substantial and valuable theater operation, built for the most part on land which we own. Something I always insisted on, unlike most of our competitors, which means we have valuable real estate holdings throughout the country. And National includes more than 1,500 screens in the United States, in Latin America, in the United Kingdom, and Russia.

I have been advised that National talks with its lenders are very constructive. They are ongoing and I can assure you that a resolution is expected within a reasonable time frame. So I am optimistic not only about Viacom, the love of my life, of course, but also about National. In the meantime, as I said on Thursday, I know you will have questions. I ask that you hold your questions until I am in a position to comment further.

Now, Philippe, it’s your ball.

Philippe P. Dauman

As we sit here on the eve of Election Day, let me begin by saying the state of Viacom is strong. During the third quarter and beyond Viacom, like every company, had to adjust to the realities of a serious economic downturn. It was a general pull back in spending by marketers as they responded to lower consumer spending.

Throughout these uncertain times we have taken, and will continue to take, all appropriate steps to prepare for whatever challenges lie ahead. The prudent management of our balance sheet over the past two years has positioned us very well for both the short and long term. We also continue to generate significant free cash flow, which will accelerate in the fourth quarter. Most importantly, our business is centered on some of the most powerful entertainment brands in the world with leadership positions in growing markets.

We have a vibrant film studio with creative, strategic, and financial momentum. We have an unparalled array of cable network brands with multiple revenue sources, including subscription and affiliate fees, consumer products and recreation, online, mobile, and national, not local, advertising sales. We have a tiger by the tail in Rock Band and our growing games business. And across our portfolio we have a significant international presence that continues to grow.

It is vital that we continue to judiciously invest in our brands to strengthen the connection to our audiences and position ourselves for even greater success as the economy begins to recover.

As we provided a preliminary look at our numbers a few weeks ago, I am going to spend less time on a third quarter review this afternoon and more time on our plans for the future. And as always, following my comments and Tom’s review, we will be happy to take your questions.

So first a quick look at the numbers. Our reported results for the third quarter in both 2008 and 2007 include some one-time items so for the purposes of our discussion, Tom and I will refer to certain growth rates on an adjusted basis.

Consolidated revenues grew 4% in the third quarter to $3.41 billion, Media Networks revenues were up 6% for the quarter. As we previously announced, we continued to see a slowdown in our advertising revenue this past quarter, which were down 2% on a worldwide basis. Affiliate fees were up 12% for the quarter, driven by both rate and subscriber increases across our core channels.

Worldwide ancillary revenues in Media Networks grew 36% on the continuing strength of Rock Band. Film Entertainment, in the context of strong full-year momentum had a very challenging comparison to last year’s third quarter results. As Tom pointed out during our last conference call, we enjoyed the tremendous success of Transformers in the third quarter of last year but did not have a comparable 10-pull film in this year’s third quarter. As a result, theatrical revenues declined 36% year-over-year, which was a principal contributor to the segment’s operating loss for the quarter.

Viacom’s overall operating income was $689.0 million for the third quarter, a 15% decline over last year’s reported results. Adjusted net earnings from continuing operations were $339.0 million, and adjusted diluted earnings per share were $0.55, at the high end of the range we provided in our earnings preview a few weeks ago.

Now let’s move to our Media Networks. In the third quarter our Media Networks segment again delivered solid double-digit gains in both affiliate and ancillary revenues. Affiliate fees now constitute about 30% of our Media Networks revenues and just under 20% of total Viacom revenues. Demand for our networks remains strong, which translates into a stable, high-margin revenue stream that we believe will continue on its double-digit growth trajectory for years.

We are continuing to work with our affiliate partners to bring even greater value to their customers, parenting with them on new products such as HD-VOD, transaction VOD, broadband content, interactive TV games, and international channels.

The headline on our ancillary business continues to be the phenomenal success of Rock Band. We have shipped more than 7.0 million units in 13 countries around the world. 26.0 million songs have been downloaded to date and by year-end we will have a library of at least 500 songs available via disc and paid download, including some of the greatest rock legends.

Rock Band 2 has had a great start, propelling MTV games to the number 5 games publisher for the month of September.

We are bringing the full power of all Viacom assets to drive awareness and sales of this revolutionary game and intend to expand the brand to many new revenue-generating opportunities. Just last week we scored a competitive coup by entering into an exclusive partnership with the Beatles Apple Corp. to create the first ever interactive video game centered on the legendary music of the Beatles. This will be a custom game title and will provide a completely immersive experience with music that spans the Beatles’ entire career. How appropriate that we are holding MTV’s European music awards in Liverpool this week.

We will have many, many exciting announcements about this new venture in the coming months.

The entire category of video games and casual games is growing at an incredible rate across our portfolio and we are capitalizing our unique audience connections to create games that cater to all of our demos.

Now let me address the advertising business. Clearly we had our challenges in the third quarter. Our advertising business continued to feel the effects of the macroeconomic trends in the quarter. The impact was compounded at a handful of our networks where ratings were lower than expected, particularly at MTV, VH1, and BET II. I will come back to those in a moment.

As we move to the fourth quarter the advertising picture hasn’t changed much. On the positive side, we are pleased with the progress of our upfront, revenue commitments so far consistent with past years’ performances. This gives us reason to be optimistic in the longer term. Furthermore, we primarily play the national advertising market, which performs significantly better than local markets.

That said, the advertising market is clearly changed so we are taking steps to strengthen our ad sales organization by more closely aligning it with our brand, while providing clients with even stronger multi-platform solutions that work across our portfolio of brands.

Our ad sales leaders will now report directly to the presidents of each group of networks, fully integrating them into the senior management teams. This will enhance the linkage between our programming and advertising strategies across all distribution platforms. It will also help us to deliver even higher returns on investments with our marketing partners as we give them greater access to all of our strategic and creative resources.

Now I want to spend a few minutes addressing our plans for both the near and longer term, what is working, what we plan to do differently, and how we will continue to super-serve our niche audiences while also providing a bridge to connect those audiences with advertisers.

The ratings at MTV have been challenged for a variety of reasons this year. Yes, there is more competition for that young audience, but we continue to prove that we know how to reach them and we know what will engage them better than any other network. The fact is that MTV is the number one 24-hour ad-supported cable network for its core demo, 12- to 24-year-olds. In the third quarter MTV was home to three of the top 10 original series on cable for that demo.

We are at our best when we innovate and experiment, always in partnership with our audience. Look at the success of this year’s video music awards. Ratings on MTV and MTV 2 were up 23% over last year’s results. The 2008 VMA show is the highest-rated non-sports telecast in its demo on cable year-to-date. Online, VMA content was a huge traffic driver to MTV.com.

To a large degree the ratings softness at MTV lies in repeat viewership so we are attacking that issue on multiple fronts. First, we plan to increase the amount of original programming with smart, relevant, efficiently produced shows reflecting the core attributes that resonate with the millennial generation. We may also supplement this with compelling content from other parts of the world, finding the best of the best and then spreading it around the globe.

Second, we will create more reasons to tune in to hit shows for a second for third time. We are adding innovative components to engage viewers. For example, a new game called Backchannel is a chat interface that runs live online while The Hills airs. Viewers post and rate comments in a shared chat window throughout the show and the top rated ones are posted on the site’s leader board and run on air when the show repeats. This creative application engages viewers and builds community around the brand.

Finally, we are also experimenting with new ways to better serve our young audience and marketing partners. One idea is new programming blocks that serve subsets of our highly targeted niche demos. This will allow us to sell more strategically to a broader set of advertising partners.

We will also take steps to better harness all of MTV on air and online to drive viewership to our biggest television hits. For example, we can self-syndicate some of our most popular programs, airing short form recaps of hits such as America’s Best Dance Group, Exiled, or The Hills on other MTV-branded networks.

At VH1, a lack of strong new programming in the third quarter resulted in soft ratings. Fortunately we are bringing several proven franchises this quarter, such as Rock of Love, Charm School, and Celebrity Rehab, and introducing a number of compelling new bets. In the first four weeks of the quarter we have already seen the ratings trend begin to turn, as is the case, by the way, for MTV.

As we move into next year, we are taking steps to smooth out the timing of new and returning [inaudible] launches throughout the year to avoid the type of dip we experienced last quarter. We are also continuing to move up the target demo for VH1 during prime time, which will allow us to capture more the adult ad dollars.

Back down to the kids’ demo. The Nickelodeon powerhouse brand continues to expand its reach and influence across all screens and into new aspects of our audiences’ lives. We could not be more pleased. On air it continues to take share from its nearest competitor expanding its considerable lead over Disney again in the third quarter. And the family-focused strategy of Nick at Night is an unqualified and growing success.

Once again, taking a risk on a new concept has delivered one of our biggest successes in the tween sensation I Carly. This franchise is still in the early stage of expansion, both in terms of ancillary opportunities as well as geographic growth. I Carly has been a success in every geography in which it has launched around the world.

In the coming months we will launch several new promising properties on Nickelodeon, including True Jackson VP, and Penguins of Madagascar. In addition, Nickelodeon is placing big bets on three of its biggest brands, SpongeBob, Dora the Explorer, and I Carly to a whole new level. Events such as the tenth anniversary of SpongeBob next year offer unique marketing opportunities that we will exploit on air, online, in stores, and in all new ways to expand the influence and the revenue opportunities these great brands have in domestic and international markets.

Now in our entertainment group Comedy Central is firing on all cylinders. Three Emmy awards for three of our top-rated series, The Daily Show with Jon Stewart, The Colbert Report, and South Park. The Daily Show and Colbert Report continue to set ratings records. We have also successfully leverage the strength of these brands online, driving significant double-digit and even triple-digit traffic growth and very strong advertiser adoptions, southparkstudios.com, colbertnation.com, and the dailyshow.com.

What makes these shows, along with the Sarah Silverman Program and the newly launched Chocolate News, so successful is that each of them is topical, funny, and infinitely relevant. Not only in terms of content but in the way it engages audiences on multiple platforms.

As our audience has evolved we have responded with the right content and the right delivery to meet their changing needs.

Technology has fueled the demand for comedy content on a 24/7 basis. We are at the forefront of this movement and will continue to link the linear and visual world to our audience as well as our distribution and marketing partners.

With the introduction of TV Land Prime, we are amplifying the focus of this brand on those in their forties to allot new advertising categories. TV Land Prime will offer unique opportunities, including product integration, co-branded interstitials, and convergent on-air and online opportunities.

One of our rapidly growing networks, Spike, is growing it’s leadus in number one top of the line channels for men. Sports will continue to be a mainstay of Spike programming, lead by our partnership with the UFC. That will be supplemented with more original and event programming.

Finally, I also want to address BET Networks, whose ratings have been soft this year. The network is currently rebuilding its programming organization while simultaneously developing a new programming and branding strategy. Moving forward it will produce and acquire strips to impact more hours of the day. The BET organization is energized to refresh and take full advantage of a deep connection with its core audience.

Now let’s move on to the Filmed Entertainment segment. As I mentioned, Paramount had challenging year-over-year comparisons during the third quarter based on product and timing issues but their top line still grew bolstered in part by strong home-entertainment revenues. In fact, the Blue Ray Iron Man DVD, which was released on the last day of the third quarter is the number one DVD release of the year and the best selling Blue Ray disc of all time.

The bigger news out of the studio has been the refinement and implementation of a long-term, creative, and operational strategy that will yield great dividends in the years to come. Last month Paramount and DreamWorks joined jointly announced the next phase of their relationship. DreamWorks principles new company will take the lead on a number of development projects which Paramount will have the option to co-finance and co-distribute.

Steven Spielberg will produce the Transformers franchise for Paramount as planned as well as collaborate on three other Paramount films. Paramount retains all other projects in development. With the resolution of the DreamWorks relationship we were able to rationalize our film slate going forward and to further integrate our creative operations.

Paramount now plans to release up to 20 films per year which will allow it to compete more effectively in a crowded market place and reduce the capital committed this business. The slate will include 12 Paramount films and up to four releases under the Paramount Vantage label. We will also continue to distribute 2 to 4 films each year produced by DreamWorks Animation and Marvel Studios.

As a reminder, our distribution deal with DreamWorks Animation continues for all films released through 2012 and we recently reached an agreement with Marvel to distribute its next five self-produced feature films on a worldwide basis starting with Iron Man II.

We are also building on the efficiencies we generated early this year when we consolidated certain Vantage operations into Paramount. With the departure of the DreamWorks staff we have substantially lowered our overhead costs by some $50.0 million a year and solidified control of our release states and production spending.

Looking ahead, Paramount is probably in its best position in many years. It has built a robust, dynamic film pipeline, it has cultivated strong partnerships with some of the greatest creative talent, including Steven Spielberg, Martin Scorsese, J.J. Abrams, David Fincher, and so many others.

It is rapidly building a leadership position in the digital space, leveraging our current releases as well as our vast library to create new revenue streams. It is also accelerating its game strategy, which was given an additional boost with the acquisition of Screenlife in September.

We have taken significant steps to right size the organization, which will enhance the profitability of the studio going forward. And we continue to build momentum at the box office. Later this week DreamWorks Animations’ Madagascar: Escape to Africa is opening and we close out the year with a highly-anticipated film that is already generating awards buzz, starring Brad Pitt and Kate Blanchet, The Curious Case of Benjamin Button, a fascinating movie both for its story line and the incredible technology that made it possible, followed by Revolutionary Road, which reunited Leonardo DiCaprio with Kate Winslet.

To conclude, we have just completed our divisional budget meetings for next year. As always, I am impressed by the new thinking and innovative approaches of our talented executives. I am optimistic about our future growth plans and opportunities as the leading pure-play content company in the world. Our financial and operational discipline has served us well and we will continue to focus on that as we grow our core businesses and accelerate our plans to diversify our revenues, taking full advantage of our powerful brands.

Now I am very pleased to turn it over to my partner, Tom.

Thomas E. Dooley

I hope you have all had a chance to review our earnings release and Web presentation summarizing our third quarter results. Our 10-Q will be filed shortly with the SEC and should be available later this evening. This afternoon I am going to take you through our third quarter results in more detail and I will update you on the key factors impacting the fourth quarter. Also, given the current state of the credit markets I think it would be helpful for me to spend some time discussing our balance sheet and cash position.

As you will recall, last year’s third quarter results included $3.0 million in restructuring charges at MTV Networks. In addition, the third quarter for both this year and last year included discrete tax benefits of $46.0 million and $15.0 million respectively, principally related to prior year audit settlements. My remarks will exclude those items and focus on our adjusted results from continuing operations as discussed in our press release.

We believe that adjusted results are a better indicator of our core performance. Concerning to our performance in the quarter I am going to focus most of my remarks on the segment results and I will start with the Media Networks group.

Media Networks group grew revenues 6% to $2.1 billion in the third quarter. Page 9 of our Web deck provides a breakdown of Media Networks revenue growth. As we have mentioned, worldwide advertising revenues declined 2% in the quarter $1.2 billion. Domestic advertising revenues declined 3%, reflecting softness in certain categories of the ad market as well as rating declines at some of our networks.

Philippe already discussed the ratings issues so I will focus on the categories that were primarily responsible for the decline. As we said in the past, automotives led the decline, in particular the domestic automakers. This was partially offset by an increase spend by foreign carmakers. We also experienced weakness in the beverage and video game categories due to fewer new product launches. The recent Hollywood trend of releasing fewer films also negatively impacted comps.

International advertising revenues grew 8% versus last year. Foreign exchange contributed 3% to growth in the quarter. Results reflect wealth across Europe, offset by some softness in the Asian markets.

Worldwide affiliate revenues continued their double-digit growth, increasing 12% to $660.0 million. Domestic affiliate revenues increased 13%. About 60% of the growth in domestic revenues came from rate increases while 40% of the growth came from increased subscribers at both our core and our digital channels.

Increases in [inaudible] revenues also contributed to the quarter’s growth. International affiliate revenues increased 8% on a reported basis with 3% of the increase driven by foreign exchange benefits. Growth was driven by both subscriber and rate increases, principally in Europe and Latin America.

Worldwide ancillary revenues grew 36% in the quarter to $313.0 million. Domestic ancillary revenues were up 28%, reflecting the continued success of Rock Band, including the release of Rock Band 2 on Microsoft’s X-Spot platform on September 14. This growth was partially offset by declines in consumer products and home entertainment revenues.

International ancillary revenues increased 58% in the quarter. In the third quarter we continued our roll out of Rock Band in Europe, launching in Italy, Sweden, Switzerland, Belgium, the Netherlands, Luxembourg, and Spain.

Media Networks operating income for the quarter declined 4% to $761.0 million from last year’s adjusted results.

The operating margin declined from 40% in 2007 to 36% in 2008. Approximately 40% of the decline in the margin was due to the lower effective margin of Rock Band, which had a 3% operating income margin in the quarter. The remaining margin decline was due to the impact of lower advertising and consumer products revenues and programming expenses.

Now turning to Filmed Entertainment. Third quarter revenues were flat with last year at $1.3 billion. The entertainment group generated an operating loss of $19.0 million which compares to a profit of $72.0 million in last year’s third quarter. Page 11 of the Web presentation provides a breakdown of Filmed Entertainment revenues.

Worldwide theatrical revenues declined 36% to $312.0 million versus 2007. The decline in theatrical revenues reflect a difficult comparison to the worldwide performance of Transformers in the third quarter of last year.

Worldwide home entertainment revenues increased $136.0 million, or 30%, versus the third quarter of 2007. Home entertainment revenues reflect increased revenues from third-party distribution agreements, including the September release of Iron Man, which is the most successful title released on Blue Ray having already sold 850,000 units.

Home entertainment revenues also reflect our new CBS distribution agreement which requires gross revenue treatment.

TV license fees grew 16% to $342.0 million, reflecting higher pay TV and foreign syndication revenues.

The $91.0 million decline in Filmed Entertainment operating income versus the third quarter of last year reflects the difficult comparison with the July 3, 2007, worldwide release of Transformers. As we noted for you on our last call, a significant portion of Transformers print and advertising expenditures were incurred in the second quarter of last year. Profitability was also impacted by the number and timing of the current quarter’s theatrical releases.

Moving beyond the segment results, we incurred equity losses from investments of $32.0 million in the quarter. The losses in the current quarter were related to our investment in Rhapsody America as well as minority investments overseas.

Other items reflected a loss of $23.0 million, principally due to foreign exchange losses as a result of the strengthening U.S. dollar.

The reported tax rate for the quarter was 23.9%. The reported rate is impacted by the $46.0 million in discrete tax benefits. Excluding the discrete tax benefit, the year-to-date effective rate is now 36%, which is down from the second quarter as our pre-tax earnings benefit from a greater proportion of internationally generated earnings.

Now, given the difficult conditions in the credit market, a strong balance sheet, and the ability to access capital are more important than ever. Accordingly I am going to spend some time focusing on our cash flow, our debt covenants, and our upcoming funding requirements as well as our buyback program.

Free cash flow for the quarter was $564.0 million positive and year-to-date it now stands at $385.0 million positive. Page 5 of the Web deck presentation provides you with the components of free cash flow. The first half of the year marked a period of investment as we accelerated our current year’s film production and launched Rock Band in Europe and on the [inaudible]. However, in the current quarter, working capital was a $77.0 source of funds. For the full year, we continue to expect that free cash flow will be comparable to last year, excluding the one-time capital expenditure of $75.0 million to $100.0 million related to relocating several cable channels into new office space.

The fourth quarter’s cash flow will benefit from our DVD releases and lower production spending in Paramount, driven by the acceleration of our current year’s production into the first half of the year.

In terms of leverage, at the end of the quarter we had $9.0 billion in debt in capital leases outstanding and $525.0 million in cash and cash equivalents. Our leverage ratio was 2.9x. At quarter we $1.75 billion available on our $3.25 billion bank credit agreement and $20.0 million of commercial paper was outstanding at the end of the quarter.

The bank revolver expires at the end of 2010 and contains an interest coverage covenant which requires our interest coverage for the most recent four consecutive fiscal quarters to be at least 3x. As of September 30 our coverage exceeded 7x.

Looking ahead to our funding needs, we have $950.0 million in asset securitization programs which roll over toward the end of this year. We are currently in discussions with our banks and expect that we will renew them. We also had $750.0 of floating rate notes, which mature in June 2009. Given our projected cash balances, our unused capacity under our revolver, as well as our free cash flow we will generate from now until June, we are comfortable that we could refinance the notes under our existing bank line if the credit market has not recovered by that time.

Moving to our share buyback program, we continue to return capital to our shareholders through our share repurchases. During the quarter we repurchased 7.6 million shares for an aggregate purchase price of $215.0 million and at the end of the quarter we had 615.0 million shares outstanding.

Now turning to our guidance, we recently revised our outlook for 2008. We expect to deliver mid-single to low-double-digit growth in adjusted diluted earnings per share from continuing operations. This outlook is based on adjusted earnings and reflects growth from the 2007 adjusted diluted net earnings per share from continuing operations of $2.36.

I want to cover a couple of other trends impacting our performance in the fourth quarter. In Filmed Entertainment, in the fourth quarter we should see healthy growth in profit as we benefit from the DVD releases of our summer movies, including Indiana Jones and the Kingdom of the Crystal Skull and Kung Fu Panda.

We have entered into several strategic ventures with the goal to create long-term value for our shareholders. We are in the investment stage for several of these joint ventures and so going forward you should that our equity losses will be similar to the current quarter’s losses.

Wrapping up, despite the difficult economic environment we continue to execute on our strategic and operational goals. We continue to find cost efficiencies which enable us to operate more efficiently. Our strong balance sheet and ability to access capital, as well as our continued commitment to an investment grade rating, put us in a secure position to weather the current market turmoil.

We have operated with the belief that investing in our core brands and franchises in order to grow organically will product the highest returns for our shareholders. Even in these difficult economic times we continue to reallocate capital in order to invest in key strategic initiatives that will create long-term value for our shareholders.

We thank you for listening and now we will turn the call over to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Imran Khan – JP Morgan.

Imran Khan – JP Morgan

In terms of affiliate revenue, in the past you talked about double-digit growth, do you see any threat to your international affiliate revenue given the macroeconomic outlook or any kind of pressure of that distribution partnership.

And the second question is regarding in the past you have talked about double-digit earnings growth through 2010. When you offered the guidance you only talked about 2008. Can you give us some color what are you thinking in terms of 2009 and 2010?

Philippe P. Dauman

As far as affiliate revenue internationally, it is a less significant source of revenue than it is domestically in that in some markets there isn’t a tradition of paying affiliate fees. Just so you get a context overall, in the international markets it really varies market by market. But as in the U.S. where we have affiliate agreements, they are multi-year, long-term agreements. So again, affiliate revenues, even internationally, is a much smaller number relatively speaking than domestically. It also is fairly, in a macro sense, stable in that it doesn’t oscillate that much from year to year except when you enter into new long-term agreements.

As far as guidance is concerned, you have our guidance for this year. Given general economic conditions and the current uncertainty, we’re sticking to just giving guidance for the rest of this year.

Operator

Your next question comes from Michael Nathanson - Sanford Bernstein.

Michael Nathanson - Sanford Bernstein

Tom, it wasn’t clear whether or not you are going to continue the buyback into the coming quarter and next year. It looks like the business is strong from your cash generation.

Thomas E. Dooley

Right now we are committed to continue the buyback until further notice.

Michael Nathanson - Sanford Bernstein

Philippe, now that DreamWorks has left Paramount and you were talking about some of the benefits, possibly, of them leaving. Can you share some of the details about the overhead and P&A that you think you can save from having DreamWorks out of the Paramount operations?

Philippe P. Dauman

As I mentioned in my remarks, we estimate the annual overhead savings at about $50.0 million and that just results from the new DreamWorks taking a lot of the personnel that was associated with them as well as associated expenses and our ability to better integrate several departments within Paramount.

P&A savings obviously result from the new slate strategy we have which will have us release on an annual basis now that we have been able to reconfigure our release strategy, up to 20 pictures, and some years it may be a little less, depending on whether we have the full floor [inaudible] for example.

Michael Nathanson - Sanford Bernstein

If you just look back the past couple of years, I know you have increased it and you are seeing the benefits now in TV, right? Can you talk a bit about what the step up has been and what you think the P&A run rate could be.

Philippe P. Dauman

I missed the first part of your question.

Michael Nathanson - Sanford Bernstein

I just wondered if you could look at the past couple of year when you have increased your investment in P&A and now that is being maybe right size, what is the change in the core run rate.

Philippe P. Dauman

It really depends on the films that we’re issuing any particular quarter. The P&A varies depending on the films. For a major release, a big-budget picture, it tends to be higher to open the movie. On some successful sequels you don’t have to create as much awareness so you can save as compared to an initial launch of the first picture. So it really, on average, is just a function of the number of films you put out in a year. It’s roughly proportional, if you look out over multi-years periods.

Another thing we have instituted at the studio to get more efficiency is to put more discipline in all aspects of that business, including planning for P&A and adjusting it after a movie is released, where you can affect some savings if you manage it properly.

Operator

Your next question comes from Spencer Wang - Credit Suisse.

Spencer Wang - Credit Suisse

Philippe, you talked a little bit about ramping up original programming to improve ratings with the networks. I was wondering if you could speak to what type of percentage increase you expect in programming costs in 2009.

And I was wondering if you could update us on the pay TV venture in terms of the status of distribution deals and how far along you are there and should distribution not meet your objective, what the fallback plan is.

Philippe P. Dauman

As far as original programming, as I mentioned, we are going to really focus on some of the specific networks I mentioned, in particular MTV, where we had some ratings issues. We are going to increase the development of original programming but we are also going to try to offset some of that additional expense with efficiencies we have been putting in place in procurement and other areas relating directly to programming.

We generally, if you look at the overall programming spend, across our family of networks, I think it’s fair to look at it as a high single-digit increase is what we’re looking at, and what we look for are efficiencies in other non-programming areas. We believe that investing in programming, which when we build the brands, is a very effective and valuable investment for us and it also builds our other revenue streams.

As far as the pay venture, the discussions are proceeding well. They’re at an increasingly advanced stage with several distributors. The venture will make announcements as they conclude agreements but it’s fair to say that they appear to be on track for their planned October 1, 2009 launch.

Operator

Your next question comes from Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

Could you talk about your programming investments over the last couple of years at the networks level. I’m guessing that you’ve been spending high single-digit or mid-to-high or even low double-digit growth in your programming line. If you look at your past couple of 10-Qs the operating expenses, which is where I think programming is buried, is up 15% to 25%. I realize Rock Band is in there. Where I’m headed with all this is if you look at your ratings performance, it doesn’t seem like the money you’ve spent has been paying off or translating into ratings. So I’m wondering what you think needs to happen strategically with how you allocate capital or do you think that you have not, in fact, been spending enough on programming in the past and that’s why we are where we are today.

Just trying to put all of this into context and maybe as one last point, I think you are heading into some pretty big affiliate contract negotiations over the next couple of year, particularly on networks like VH1 and Comedy that might be underpaid relative to their audience delivery. How important is it to get the ratings up heading into those negotiations and is that part of your thinking on programming investments?

Philippe P. Dauman

Addressing the ratings, we have a lot of strong ratings throughout our family of networks. What I addressed specifically were those networks where we had some ratings issues in the third quarter. You mentioned VH1, VH1 in fact, until the third quarter, had had like 14 consecutive quarters of ratings growth. So in the case of VH1 this was really a one-quarter issue. And as I mentioned, we have some encouraging signs in the first few weeks of the fourth quarter.

The programming investment that we’ve made overall has been made in the context of our objective in the long term of maintaining overall margins so that as our overall revenues increase we have always traditionally invested in programming along with it. At times we apply additional investments on specific networks and it has paid off. We have a number of brands, like Nickelodeon, performing really well. Comedy Central is hitting records.

So transitioning over to your question about affiliate negotiations, we bring tremendous value to our affiliates, that we are not highly priced networks. A network like Comedy Central, which is coming off agreements that were negotiated many years ago, our Comedy Central rates are very low compared to the status that they have achieve today.

So we feel very good about the discussions, and as I mentioned in my remarks, we have a lot of value to bring to the party when we renegotiate our affiliation agreements. That gives us confidence in the overall guidance that we give of double-digit affiliate revenue growth.

Benjamin Swinburne - Morgan Stanley

And is the 9%, or the high singles for 2009 that you’re targeting for programming investment, is that an increase from where you’ve been running for the last few years, or pretty consistent?

Philippe P. Dauman

It’s in the same ballpark. Just probably modulated at the higher range and in terms of specifics we’ll see. It depends on how we allocate programming. Some of the programming expense, by the way, is continuing run off from acquired programming. You syndicate shows for multiple years on some of the networks and you have that carry-over expense so it’s not all original programming.

Operator

Your next question comes from Alan Gould - Natixis Bleichroeder.

Alan Gould - Natixis Bleichroeder

In the fourth quarter advertising, what percent is covered by the upfront sales versus what percent is covered by scatter sales?

And Tom, are you recognizing pay TV revenue in your film ultimates for your 2008 releases?

Philippe P. Dauman

In terms of our cash advertising sales, the upfront in the fourth quarter is over 70% of our overall ad sales, versus scatter.

Thomas E. Dooley

And yes, we are recognizing pay TV revenue in our ultimates.

Operator

Your next question comes from John [Tinades]– Wachovia Securities.

John [Tinades]– Wachovia Securities.

Philippe, I think you talked about targeting new advertiser categories in your last call and I’m hoping you can provide an update which categories you are focusing on and maybe the percentage of industry revenue that they might represent in total.

Philippe P. Dauman

A good example of where we are targeting new categories would be in our Nickelodeon family of channels where we have obviously kids’ viewership where you go traditional categories like toys and games as well as films addressing that audience.

We also have a lot of family viewership, both co-viewing, and as we have developed the Nick at Night programming to center around family viewing, we are targeting the kinds of advertisers that want to reach the adult demo. So it’s part of our effort to reach those categories for the Nickelodeon family of networks, for example.

Another example of what we’re doing is to try to go to sub-categories. So for example, we have what our advertising sales force refers to as the man block where they target shows that appeal men across Spike and some of our other networks and try to attract more advertising dollars from advertisers who sell products geared to men.

So it’s a combination of reaching new categories and re-slicing and dicing our inventory to maximize revenues.

John [Tinades]– Wachovia Securities.

Can you give us a sense of what the percentage of available inventories sold across your cable networks relative to a quarter or two ago and how much the CPM has changed on an average?

Thomas E. Dooley

We’re selling about the same amount of inventory that we’ve always sold. We continue to have similar sell out rates. Fourth quarter, as scatter develops, we’ll see if that continues. A little weak in the scatter in terms of volume. Pricing has been very strong.

Operator

Your next question comes from Doug Creutz - Cowen And Company.

Doug Creutz - Cowen & Company

Could you give any details you have on the Beatles game, how you’re going to be distributing it, are you going to be using a third-party distributor like you did with Rock Band. And also, where do you think the margins on that might come in.

Philippe P. Dauman

We are using Electronic Arts to distribute Rock Band, including the Beatles game.

Thomas E. Dooley

We haven’t given any margins out on it, we’re still modeling it out right now, but we expect it will be a very profitable game for us and Apple.

Operator

Your next question comes from Mark Wienkes - Goldman Sachs.

Mark Wienkes - Goldman Sachs

Taking a show like The Hills as an example, our numbers show that the average online viewing is about 1 million viewers. Well, on TV, for the first episode of viewing anyway, it’s about 2 million viewers. How much do you think that online viewing is impacting your repeat viewing and how can you monetize the online viewership.

Philippe P. Dauman

The Hills on-air viewing, by the way, has been increasing. This has been the strongest season of the hills, so we feel that the online participation of its fans is building on air. We do monetize The Hills very well. We provide packages to our advertisers that combine on-air audience with online audience as well as, in the case of The Hills we have a virtual world as well as now some small incrementive mobile ad sales relating to the show.

So when we have a big hit like that it works very well for us with advertisers. It also gives us opportunity to sell them other shows on our networks.

Mark Wienkes - Goldman Sachs

Could you talk to how much you think the video game market will be up for the music-related games, like Rock Band, this holiday period year and then internationally, or if you could give specifics like on retailer orders, shelf space, overall holiday expectations.

Philippe P. Dauman

We can’t predict what the purchases are. Now, remember, the Rock Band game is a new business for us. We first launched it mid-November of last year, so regardless of the economic environment, this will be a nice growth business for us. Now the general economy could impact how much of a growth business it is for us, and it’s just not possible for us to predict it.

All we can do is make a great game, which our people at Harmonics have done a terrific job at, with great use of our competitive advantage in securing talent and promoting the game, so we’re very optimistic about the future prospects for the game.

Mark Wienkes - Goldman Sachs

But you haven’t had any sort of negative feedback from retailers regarding shelf space allocations this year versus a year ago?

Philippe P. Dauman

A year ago it was a new game so we didn’t have that much shelf space. We have more shelf space. We’ve been launching in international territories and it’s a hot game so we’re getting very good positioning across the board. So that’s not been an issue for us.

Operator

Your next question comes from Jeffrey Logsdon - BMO Capital Markets.

Jeffrey Logsdon - BMO Capital Markets

Could you go over the film financing arrangements you have right now with the third parties, what you have left, what you think you will do in 2009 as well.

Thomas E. Dooley

We had several film financial arrangements in place that run out with about 10 films and depending on the amount of money we put in place for each film, several hundred million dollars remaining. Some are at Vantage, some are in the main studio. When we run out of those we’ll look at other alternatives in the market place, but we are quite prepared, given the reduced slate of films, to finance the films on balance sheet if necessary.

We also do a lot of cold financings with our sister companies as is the case with The Curios Case of Benjamin Button. We split that deal with Warner Brothers and we continue to explore lots of different arrangements along those lines to really focus fairly carefully on the amount of capital we have invested in the studio business.

Philippe P. Dauman

We want to thank everyone for joining us on our third quarter earnings call.

Operator

This concludes today’s conference call.

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