Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Thomas Dooley - Chief Financial Officer, Chief Administrative Officer, Senior Executive Vice President and Director

Philippe Dauman - Chief Executive Officer, President and Director

Sumner Redstone - Founder and Executive Chairman

James Bombassei - Senior Vice President of Investor Relations

Analysts

Douglas Mitchelson - Deutsche Bank AG

Alan Gould - Soleil Securities Group, Inc.

Imran Khan - JP Morgan Chase & Co

Jason Bazinet - Citigroup Inc

Anthony DiClemente - Barclays Capital

Jeffrey Logsdon - BMO Capital Markets U.S.

David Miller - Caris & Company

Spencer Wang - Crédit Suisse First Boston, Inc.

Jason Helfstein - Oppenheimer & Co. Inc.

David Bank - RBC Capital Markets Corporation

Viacom (VIA.B) Q1 2010 Earnings Call April 29, 2010 8:30 AM ET

Operator

Good day, everyone, and welcome to the Viacom earnings release teleconference for the quarter ended March 31, 2010. [Operator Instructions] At this time, I would like to turn the call over to the Senior Vice President of Investor Relations, Mr. Jim Bombassei. Please go ahead, sir.

James Bombassei

Good morning, everyone, and thank you for taking the time to join us for our earnings call for the quarter ended March 31. Joining me on today's discussion are Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Tom 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 and trending schedules containing supplemental information available on our Web site. Let me refer you to Page #2 in the Web presentation and I 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 Web site.

And now, I'll turn the call over to Sumner.

Sumner Redstone

Thank you, Jim, and good morning, everyone. As you can well imagine, I am more than happy to be here today as we share the outstanding results Viacom delivered in the first quarter of 2010. Now just one year ago, we found ourselves operating in a very different, in a very difficult environment. There was, unfortunately, not a great deal of good news to be found, and even I had to reach into my reserve storage of optimism to find the few bright spots on the horizon. But even amid the doom and gloom, I had a fundamental faith in the resilience of our assets [ph] and the resourcefulness of our management team. I have always taken a long-term perspective, one that reflects the experience acquired over many years in this business and more than a few economic cycles. I knew that Viacom would not simply survive the challenges of this recession but that it would emerge stronger than ever. Without question, it has.

Now what separates Viacom from many in the entertainment industry is that our business is built on strong and growing brands. We have always understood that content is king and thus, we continue to nurture the value of our brands and to invest in the content engine that will drive our business for many, many years to come and ultimately deliver really great value for all of our shareholders.

Now already, we are seeing growing enthusiasm among our marketing and distribution partners [ph] who look to us to help them connect with consumers. New technologies offer many more ways, more ways than ever to share our branded content. And I can assure you, we will engage our audiences on every screen, on every device and in every place on this planet.

Today, our strong bottom line results reflect a clear focused strategy, unmatched creative ingenuity, expert operational guidance and an always-disciplined financial approach, and you can count on Philippe and his very capable team to continue to expand on this success and to capitalize on the many new opportunities that surely lie ahead for Viacom.

And now, I will turn this call over to Viacom's President and CEO, my forever friend, Philippe Dauman.

Philippe Dauman

Thank you very much, Sumner, and good morning, everyone. I'm pleased you could join us today. We have had a solid start to the year and our momentum is continuing to build. All of the actions we took over the past 18 months to strengthen our business are truly paying off today. With a much stronger financial position, a streamlined organizational structure and a continuing commitment to invest in content, we are poised to take advantage of new opportunities that are beginning to emerge.

The economic environment is growing stronger each day, and absent any major disruption, that progress should continue at a steady pace. As we prepare for the advertising upfront season, the overall mood of our clients is increasingly optimistic and marketing budgets are beginning to loosen up. We spent much of the past year refining our programming of several core cable networks, and while there is still much to do, I am very pleased with the progress. And we have a very strong film studio in Paramount. Structurally and creatively, it is firing on all cylinders and it now has a rich pipeline of material that will entertain moviegoers for many years to come.

This morning, I will briefly review our financial results as well as the highlights of our operational performance in our Media Networks and Filmed Entertainment segments. Given that our investment in programming continues to be a key strategic priority, I will spend some time reviewing what's coming up. Tom will provide additional detail on our results and then we'll be happy to take your questions.

Let's begin with our results. Viacom's consolidated revenues were down 4% to $2.8 billion in the March quarter due to lower Filmed Entertainment revenues, which declined 18% year-over-year. Keep in mind that we are now producing a smaller but more strategic film slate, which will likely result in lower revenues in the short term. Media Networks revenues grew 4% in the quarter. Viacom's net earnings from continuing operations increased 37% to $243 million in the past quarter, resulting in diluted earnings per share of $0.40 versus $0.29 in the prior year's first quarter. This growth was driven principally by higher operating income in our Media Networks segment.

We are also continuing to generate strong free cash flow. And we ended the March quarter with free cash flow up by $246 million versus a year ago. As I have noted several times previously, returning excess capital to our shareholders is an important objective for us. Over the next few months, we will be working closely with our board to determine the most appropriate program to return cash to shareholders.

Now on to our cable networks. Our portfolio of branded cable networks is unique in this industry. Through compelling programming, we bring together millions of viewers every day that fall into highly valuable and highly targeted demographic categories. And our audiences are very committed to their favorite programming, which is illustrated by the long-running success of shows like Nickelodeon's SpongeBob SquarePants, MTV's Real World and COMEDY CENTRAL's South Park. Our affiliate relationships are strong and we continue to expand them in ways that add value to their businesses as well as ours.

For example, we are continuing to explore how best to use new products and technologies, such as next-day VOD and dynamic ad insertion. Over the past quarter, we have continued to roll out more high-definition channels, and there is growing interest among our distributors in the idea of importing certain international sales to the U.S. We are also continuing to explore opportunities to bring 3D programming to our brands. This concept is still in a nascent stage and at this point, we are primarily looking at special events, such as major music performances for our music channels and sporting events for Spike.

Shifting now to advertising. The advertising environment is definitely on an upswing. The mood is brighter and advertisers want to get back into the marketplace to introduce new products and build market share. Our domestic ad sales were up more than 1% on a strong scatter market. Despite the fact that we are still dealing with the impact of a much lower upfront for the 2009/2010 season, our result this quarter is a five-point sequential improvement over the previous quarter, and we see a continuing upward trend.

Our work continued on the development of more original programming as well as modifying the programming slates and schedules at several of our core channels. Those networks are getting their voices back. The most notable gains were at MTV, where our audience grew 10% over the prior year. The network boasted 5 of the top 15 original cable series in its target demo of 12 to 34-year-olds: Jersey Shore, Teen Mom, 16 and Pregnant, America's Best Dance Crew and Real World: D.C. Importantly, MTV's ratings were up across nearly every day part.

These results are great. But this is still a work in progress. We have a great lineup of programming launching this quarter, including two new scripted comedies: Hard Times of RJ Berger and Warren the Ape. This week, the premiere of the final season of The Hills aired with more than a 20% improvement over last season's premier. And this weekend, we launched 10 on Top and When I was 17, two shows created specifically for the weekend. We are also looking forward to another strong performance around the MTV Movie Awards, which for the first time will allow fans around the globe to generate this year's final nominees.

Nickelodeon continued its stellar performance, with its audience up 5% in the quarter, making it Nickelodeon's biggest audience ever among total viewers. And of course, it continued to rank number one with kids and tweens expanding its lead over its competitors. In the key demo of kids 2 to 11, Nick had 6 of the top 10 programs on all television, led by SpongeBob and iCarly.

2010 Kids’ Choice Awards ranked as the second most-watched Kids’ Choice Awards ever, delivering 7.6 million viewers. And we launched two shows targeting the tween audience: Big Time Rush and Victorious. These shows are just getting started. But they are already building impressive fan bases as bona fide hits and further cementing our leadership with the tween audience.

And a powerful illustration of the success of Nick's one-brand strategy, the rebranded TeenNick and Nick Jr. networks delivered a 17% and 8% increase, respectively, in their audiences in the quarter. The strategy of consolidating its brands under the single Nickelodeon umbrella last fall as successfully reinforcing Nick's leadership as a global brand that serves the whole family.

And as with all of our networks, Nickelodeon is always looking for new ways to get its content into the hands and hearts of its audience. So in addition to having a Dora application available for the iPad launch, Nick intents to launch 20 additional iPhone apps this year.

BET continues to hit its stride, delivering another increase in its audience, up 7% year-over-year. Each of BET's major specials posted triple-digit timeslot gains versus last year. In its 10th year, the 2010 CELEBRATION OF GOSPEL was its highest rated ever and again, was television's number one gospel religious telecast. Both the BET HONORS and RIP THE RUNWAY garnered more than 2 million viewers. And BET's regular programming is also setting records. The Mo'Nique Show is the number one late-night variety show on television in black households and 106 & Park posted double-digit gains versus last year and has been the number one music variety show on cable for 11 consecutive quarters.

Coming up, BET will add original scripted programming to its already successful lineup with the sitcom THE GAME and in partnership with Queen Latifah's production company, Flavor Unit Entertainment, it will produce the scripted series LET'S STAY TOGETHER and the original movie THE COOKOUT 2.

Centric, BET Networks newly rebranded channel that launched last fall, is off to a solid start. In addition to introducing new programming to its schedule, such as THE STEVE HARVEY PROJECT, Centric will become a Nielsen-rated network in the third quarter of 2010.

We are continuing to work on the programming slates at our other networks as well, rebuilding and refining them to better reflect their audiences' evolving interests.

For example, VH1 has devised a new programming slate that is centered on three themes that resonate with its adult audience: music, celebrity and compelling real-life stories. This plan calls for the network to produce a significant number of original series this year that reflect this new direction and also happen to be more advertiser friendly. There'll be special programming blocks, such as an evening with Christina Aguilera as well as new reality series like Dad Camp. VH1 is also developing a scripted movie from Flavor Unit Entertainment.

COMEDY CENTRAL's ratings showed progressive improvement throughout the quarter with its new series, Ugly Americans, performing very well. We are also very pleased to have secured an extension of the comedic genius of Jon Stewart and Stephen Colbert, which will keep their brilliant shows on COMEDY through the 2012 election cycle and beyond. COMEDY CENTRAL has a number of new show scheduled to premiere in the coming months, including Nick Swardson's Pretend Time; Big Lake, a sitcom produced by Will Ferrell; and a new season of Tosh.0, a show that continues to deliver impressive growth.

Our International business continues to improve in both its operational and financial results. We continue to roll out our new international programming models for MTV and Nickelodeon, in which we leverage our scale around the world, while maintaining vital local connections. We also saw a strong performance across our European COMEDY CENTRAL channels, VIVA U.K. and Colors in India. The marketplace in the U.K. is beginning to strengthen. And the world outside the U.S. has finally got a taste of the Jersey Shore, as this domestic sensation rolled into 30 new countries last month.

Not let's move on to our Filmed Entertainment business. Paramount Pictures had a solid start to the year with two out of the three films we released ranking among the top five in domestic box office. We were very pleased with the strong performance of Martin Scorsese's Shutter Island, and DreamWorks Animation's HOW TO TRAIN YOUR DRAGON is continuing to pull audiences into theaters. As I already mentioned, the studio's total revenues were lower year-over-year. We did have three fewer theatrical releases, and we were lapping the very strong home entertainment release of Madagascar: Escape 2 Africa in the first quarter of 2009, while we did not have a DreamWorks Animation DVD release this past quarter.

Our film slate for the rest of 2010 looks great. We have an unmatched lineup of summer tentpoles that are about to launch. Iron Man 2 will open across the country on May 7. I can tell you that this highly anticipated sequel looks great, and we think audiences will be lining up for more Tony Stark.

A couple of weeks later, we release DreamWorks Animation's Shrek Forever After in 3D. This franchise has a well-established and huge fan base, and the film was very well received in its world premiere at the Tribeca Film Festival. And finally, the Fourth of July weekend will belong to our Nickelodeon tentpole, M. Night Shyamalan's The Last Airbender, which is also being released in 3D. And that's just the next two months. We have several major releases scheduled in the latter part of 2010 and our 2011 slate is already shaping up nicely. These film slates remain consistent with Paramount's clear strategy of releasing fewer films and focusing on franchise and branded titles.

Before I close, I also want to note the great progress at Epix. The momentum in securing broader distribution is continuing. Most recently was the announcement that DISH Network is making the network and digital service available to its customers across the country. With the addition of DISH, Epix will now be available in more than 30 million households with more announcements to come as the year progresses. This network is a great example of a next-generation entertainment service. It offers the highest-quality content exactly how viewers today want to consume it: on television, often in high definition quality, online and on their timetable. As more customers have an opportunity to experience Epix and its unique advantages, demand for this service will continue to grow.

In closing, Viacom is operating from a position of strength. Our balance sheet is strong. Our operations are efficient and getting more so. Our brands are vibrant. And our strategy is clear. We are 100% focused on developing compelling content to feed the world's insatiable appetite for entertainment. We are operating in exciting times as technology affords us more opportunities than ever to share our content with audiences around the world and to make our brands a bigger part of their lives.

Along with these opportunities comes the increasingly challenging task of protecting that content in a world in which access to the best programming is just a click away. We are making solid progress in helping all of our partners understand the new face of piracy and their role in protecting the rights of content producers. We are working closely with cable, satellite and telco distributors who are developing better tools and processes to reduce infringement on their own networks, while providing great new services to consumers.

In addition, all branches of our government are keenly aware of the importance of reducing piracy. The Obama Administration has been a strong proponent of intellectual property rights, and we look forward to continuing to work with the Administration on its strategy to reduce piracy and protect American jobs in the intellectual property industries.

Overseas, we've seen even bolder moves, as legislative and legal victories have resulted in progressive and effective IP-enforcement programs in countries such as France, the United Kingdom and Ireland. We are optimistic about this progress and believe that our vigilance on this critical issue will help us to capitalize fully on the opportunities that continue to present themselves in this new digital age.

Now I will turn over to my partner, Tom, who will provide more details on our financial results.

Thomas Dooley

Thanks, Philippe, and good morning, everyone. I hope you've all had a chance to review our earnings release and the Web presentation summarizing the results for our March quarter. Our 10-Q will be filed shortly. This morning, I'm going to take you through our results in more detail, and I'll update you to the key factors impacting the remainder of our fiscal 2010. I will also talk about our balance sheet, our leverage and our cash position. As a reminder, this year we are transitioning to a September fiscal year end. The trending schedules on our Web site should allow you to easily track the company's performance as we move through this transition.

Now let's take a look at the consolidated results. From a total company perspective, revenues declined $119 million or 4% to $2.8 billion as compared to the March quarter last year. Filmed Entertainment revenues declined 18% or $201 million as we moved towards a smaller but more strategic film slate, which resulted in lower theatrical, home entertainment and TV license revenues. Media Networks revenues increased $73 million or 4%, primarily due to higher affiliate fees and advertising revenues.

Total company expenses declined $211 million for the quarter. Filmed Entertainment expenses declined by $238 million or 20%. And Media Network expenses increased $18 million or 1%. The decline at Filmed Entertainment was primarily due to lower participation costs as well as lower print and advertising costs as a result of fewer theatrical releases. Consolidated operating income increased 21% to $534 million in the quarter.

Now let's turn to our segment results. I'll start with the Media Networks group. Media Networks revenues increased 4% to $1.9 billion in the quarter. Domestic revenues increased 1% and international revenues grew 22%. Foreign exchange had an eight percentage point favorable impact on international revenues. Page 8 of our Web deck provides a breakdown of our Media Networks revenue performance.

As Philippe mentioned, Domestic Advertising revenues grew 1% in the March quarter, which was an improvement from the December quarter's 4% decline. International advertising revenue increased 14% in the quarter, with foreign exchange favorably impacting the growth rate by nine percentage points. The growth in international revenues was driven by strength in the European and Latin American markets.

Turning to our affiliate revenues. Domestic revenues increased 7%, while international revenues increased 17%. Again, foreign exchange had an eight percentage point favorable impact on the international affiliate growth rate.

For domestic affiliate revenues, approximately 75% of the growth was from rate increases, while approximately 25% of the growth was from increased subscribers. In the March quarter of last year, we highlighted that we had a three percentage point benefit from certain nonrecurring payments. Excluding the impact of these payments, domestic affiliate revenues grew 11% in the current quarter. We expect domestic affiliate revenues to continue their double-digit growth in the June quarter. In terms of international affiliate revenues, growth for the quarter was driven by a combination of increases in subscribers, new channel launches as well as rate increases.

Moving to ancillary revenues. Domestic revenues declined 22%, while international revenues increased 46%. The decline in domestic ancillary revenues principally reflects lower Rock Band revenues. The increase in international ancillary revenues was due to higher consumer product sales and TV licensees.

Media Networks operating income of $684 million in the quarter was 9% higher than last year. The operating margin improved by approximately 160 basis points to 35% in the March quarter. If you exclude Rock Band, the core margin was 37%, which was a 100 basis point improvement from last year.

Programming expense in the quarter grew 5%. During the quarter, we launched several successful new series, including Victorious, Big Time Rush and The Buried Life. The improvement in the core margins can be educated to the growth in affiliate and advertising revenues as well as our continued focus on managing our cost structure.

Now let's turn to the Filmed Entertainment. Revenues in the quarter declined 18% to $886 million. Page 10 of the Web presentation provides a breakdown of Filmed Entertainment revenues. Our strategy of producing a smaller but more focused slate can be seen in the current quarter's results, as we released three films theatrically this quarter as compared to six films in the March quarter of last year.

Worldwide theatrical revenues in the quarter declined $16 million or 6% to $267 million. Foreign currency had a five percentage point favorable impact on the worldwide theatrical revenue growth. Worldwide home entertainment revenues decreased 34% to $297 million. Foreign currency had a four percentage point favorable impact on the results. The decrease in home entertainment revenues reflect the performance of Madagascar: Escape 2 Africa in a prior year with no comparable title this year. The current quarter benefited from the release of Up in the Air as well as the continuing sales of Star Trek, Transformers 2 and G.I. Joe.

TV license fees declined 16% to $259 million in the quarter, reflecting lower worldwide pay TV revenues. Filmed Entertainment generated an operating loss of $86 million, which was $37 million less than the operating loss of $123 million last year. The year-over-year improvement principally reflects lower print and advertising costs as a result of the fewer number of theatrical releases. Since few films were made available to our Epix pay TV joint venture during the quarter, the impact related to Epix was immaterial to Paramount's and Viacom's results.

Moving below the segment results. Total Company equity losses from investments were $28 million in the quarter. The losses in the quarter principally relate to our investments in Epix and Rhapsody America. The reported tax rate in the quarter was 36%.

Now let's turn to our cash flow, our leverage and our debt profile. We generated $382 million in free cash flow in the quarter as compared to $136 million last year. Page 4 of the Web deck provides the components of free cash flow. The increase in free cash flow was due to higher operating income and a favorable working capital variance, partially offset by higher cash tax payments.

The favorable working capital variance was principally due to reduced feature film participation payments. Our debt, for the most part, is fixed rate with an average cost of approximately 6%. To the extent we had incremental borrowings, we are funding this any commercial paper marketplace with an annual rate of about 35 basis points. We've had no variable rate borrowings outstanding at quarter end.

Our strengthened financial position has enabled us to access the capital markets on an extremely cost-efficient basis, which made it very advantageous to bring DreamWorks funding back onto our books. As a result, we again have a complete ownership of the 59 films in the DreamWorks live-action library, including titles like Meet the Fockers, War of the Worlds, Saving Private Ryan, Castaway and Gladiator. With the consolidation of DreamWorks funding, we added to our balance sheet approximately $400 million of debt.

The favorable rates available to us in the debt marketplace also made it advantageous for us to terminate our accounts receivable securitization program earlier this month. Going forward, to the extent that we have working capital needs, we will access the commercial paper marketplace or our bank line. In terms of leverage, we ended the quarter with $6.8 billion of debt in capital leases outstanding and $358 million of cash and cash equivalents.

At March 31, our $3.25 billion bank revolver was undrawn. Our leverage ratio the end of the quarter was 2x, which is at the low end of our targeted range. The only financial covenant in our bank revolver requires that interest coverage for the most recent four fiscal quarters be at least 3x. At the end of the quarter, our interest coverage was approximately 8.2x.

In summary, it has been encouraging to see continuing signs of improvement in both the economy as well as the advertising environment. The downturn was difficult but we emerged more focused and financially sound company. We are looking to build the progress we have made over the past year, as we continue to invest in our brands and our franchises in order to drive long-term growth. At the same time, we will continue to seek ways to drive efficiencies and enhance our margins. Our balance sheet is in great shape and our debt profile is secure. We will continue to focus on managing our working capital and capital expenditures in order to drive our free cash flow.

With that, I want to thank you for listening. And now, we'll turn the call over to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go next Anthony DiClemente, Barclays Capital.

Anthony DiClemente - Barclays Capital

Philippe, as your balance sheet continues to strengthen throughout the year, I was just wondering if you could remind us of your content acquisition strategy. And we've seen some content deals in the cable, pay TV space recently. And I was just wondering the types of deals that you're looking at or might consider moving forward.

Philippe Dauman

Well, the last acquisition that we made was the $60 million acquisition of the Teenage Mutant Ninja Turtles franchise, which we think will be a good one for both Nickelodeon and Paramount. And they're both working already on developing TV series and a film franchise, respectively. We continue to look at opportunities of that kind to the extent they're out there, but they're all small in amount and really just additive to our core business. So we don't see -- we continue not to see any major acquisitions in our future.

Anthony DiClemente - Barclays Capital

And then Tom, you had mentioned the recurring affiliate fee growth of 11% in the current quarter and double digit for the June quarter rather. I was wondering, how long can we expect that level of affiliate fee growth moving forward, particularly for this year and into the full year 2011?

Thomas Dooley

Well, we don't provide guidance that far out. But we are pretty comfortable with the affiliate deals that we have signed with our distribution partners that they will be able to provide us with very strong affiliate growth for the foreseeable future.

Anthony DiClemente - Barclays Capital

And those deals, if they're multi-year deals, do they decelerate? Or is it a straight-line growth trajectory built into those deals?

Philippe Dauman

Anthony, we don't disclose -- this is Philippe. We don’t disclose what the rate increase is with different affiliates, so let's just say that we're comfortable. They are, as you point out, multi-year deals. They're also layered so that we don't have a significant proportion of our deals coming to in any given year. And we're quite comfortable with the high-single digits, low-double-digit rate of growth for the foreseeable future, as Tom indicated.

Operator

And we'll go next to Spencer Wang, Credit Suisse.

Spencer Wang - Crédit Suisse First Boston, Inc.

The first maybe for Philippe on the advertising outlook. You talked about how things are probably looking sequentially better in 2Q. Was wondering if you could give us a sense of you're pacing domestically in the second quarter in the U.S. and also talk a little bit about international just given some of the issues in Europe. And my second question relates to returning capital to shareholders. Historically, Viacom has been a buyer of the stock, as opposed to paying out recurring dividend. So I guess the question is, is that the main method that the board is thinking about returning capital? And is your target leverage ratio based on gross debt or net debt?

Philippe Dauman

As far as the advertising outlook, as I indicated, the tone continues to be strong and getting stronger out there. You see it every day with new products being launched where very few products were being launched a year ago. You see a lot of competitive industries. We're seeing strength in categories such as retail, toys and games and many others. Technology categories also looked very good. So we do see continued sequential improvement but it's really too early in the quarter to give any more specific prognostication. As far as the international marketplace, Europe and Latin America have been good markets. And it's very encouraging to see the progress in the advertising market in major European territories, notably the U.K. and also Germany. As far as returning capital to shareholders, since we were out of the market since the beginning of last year in our buyback program, we looked at this with our board as a fresh opportunity to consider and put everything on the table. And we are progressing with that analysis. We are moving toward the second part of the year where we get the majority of our free cash flow. So the opportune time for us to come up with the right program of returning capital to shareholders would be over the next few months. And we'll discuss with the board and determine the how and when.

Thomas Dooley

And Spencer, the last question on our target leverage ratio is based on gross debt. And we work with all the different rating agencies as to how they define the leverage ratios and we've been working very hard to get the leverage ratio down in any way that it can be defined, including by working to eliminate guarantees that we had provided on the books, such as the guarantees that we had provided under the Blockbuster leases. They're all but eliminated on our books. So in every way you can define it, we're working to drive that leverage ratio down.

Spencer Wang - Crédit Suisse First Boston, Inc.

And it includes capital leases, Tom?

Thomas Dooley

Yes, it does.

Operator

And we'll go next to Doug Mitchelson, Deutsche Bank.

Douglas Mitchelson - Deutsche Bank AG

Philippe, Tom, further question on advertising. It's obviously encouraging that advertising's rebounding and I think we're all trying to figure out what the new normal growth might be for you, especially on the eve of the upfront. So you've had a stretch where Domestic Advertising grew less fast than peers. Do you think that was a function of your ratings performance or a function of the health of the ad categories that are that are sort of your relatively younger demographics that might be more impactful will to Viacom? And then obviously, core ratings are now proving. Do you think you'll start to narrow that gap and start grow online with peers again as you look forward?

Philippe Dauman

Doug, there certainly were ratings issues, particularly at one of our core networks, namely MTV. That's why it is so encouraging to see the great strength in MTV's ratings. I mentioned that our ratings were up 10% in MTV in the first quarter. Also, in the first four weeks of this quarter, we are continuing to increase ratings at a double-digit clip. And that's before we have some of our additional new shows being launched. So that is certainly quite encouraging as we head into the upfront season. Hits definitely drive. They drive ratings and they ultimately drive advertising sales. What will really help some of our networks will be when the motion picture category, you see the gradual increase in the number of releases as we go forward as more production activities, more mini majors putting out films like the new DreamWorks and CBS films and Summit and others because we have tremendous strength in that category and that's obviously a very important category. So as that gradually picks up, that will also give us a lift. So we're feeling very optimistic. We think the tone going to the upfront is quite strong. And it will a happier time for sellers of advertising this upfront season than it was last year.

Douglas Mitchelson - Deutsche Bank AG

On international, it seems the rebound has just begun. Do you see the potential for a return to double-digit growth, at least in a short rebound period?

Philippe Dauman

You're talking about international now?

Douglas Mitchelson - Deutsche Bank AG

Yes.

Philippe Dauman

Yes, our international business is a much lower margin business, obviously. So we do see signs of strength in key territories, international, which lag a little bit the U.S. recovery. And we're continuing to grow and launch networks abroad. So we look to bring our international margins back up into double-digit territory and view this as a source of long-term value creation for Viacom.

Operator

And we'll go next to Imran Khan, JP Morgan.

Imran Khan - JP Morgan Chase & Co

You have done a pretty good job growing your core margins and managing cost. Tom, could you please give us some color how should we think about how much cost-cutting opportunity left in the company? How should we think about the core margins going forward? And secondly, on the ancillary side of the business, I think on Rock Band's last addition you lost some money. Going forward, that you're outsourcing the hardware component, how should we think about the profitability of ancillary segment of the business?

Thomas Dooley

Yes, on the core margins going forward, we continue to look at the way we do business in the company and we continue to shift the business more to a digital focus, which does provide us with opportunities to continue to cut costs. And as we've said, we'll invest more in programming but keep a very watchful eye on our bottom line so we can drive the overall margin growth of the company into the foreseeable future. And we've been very successful at that and we will continue to do that. Rock Band, we've done a lot of things in this quarter to improve the Rock Band business. And one of them was what you've just mentioned of the outsourcing the hardware component in terms of the production and inventory management of that to a company called Mad Catz. That will substantially reduce any inventory risk we have associated with that. So those are all positive steps. And we would hope that Rock Band will move to being a profit contributor sometime in the calendar year.

Operator

And we'll go next to Alan Gould, Soleil Securities.

Alan Gould - Soleil Securities Group, Inc.

Was wondering on the Domestic Advertising, could you tell us in the first quarter, what percent of that ad revenue was generated from the upfront market? What percent was generated from the scatter market? And how does that change as we move through the year?

Philippe Dauman

Alan, as I mentioned in the previous earnings call, the upfront sales has its highest proportion in what was the first quarter of the upfront, which was the fourth calendar quarter. So it's a lesser proportion of overall advertising sales in the quarter just completed. And that trend continues. So as we go forward and particularly, as we go into the '11 fiscal year, which begins October 1 for us, we will get the benefit of the next upfront. And we are very much looking forward to that.

Alan Gould - Soleil Securities Group, Inc.

So Philippe, for the remaining two quarters of the year, should we assume less than half that ad revenue was sold in the upfront market?

Philippe Dauman

Well, we don't break it down in that way. But all I can say is that as the year progresses, there is a modestly, each quarter, diminishing portion of the inventory that's sold at the upfront prices. However, because of the strong pricing in the scatter market, you are seeing actually a historically low level of cancellations of upfront purchases. So the lower-priced inventory is not going down as a result of advertisers canceling or exercising their options.

Operator

And we'll go next to David Bank, RBC Capital Markets.

David Bank - RBC Capital Markets Corporation

I was wondering if we could get a little bit more color on Epix, some benchmarks we can look forward to. You finally got a really big national carriage deal. Any sense of some of the remaining players, when you would expect to have deals completed? And then I guess, what do you view as the, maybe either number of homes passed or number of subscribers, some kind of benchmark that'll help us figure out when you get to breakeven on the business, if you can give us some more color?

Philippe Dauman

Well, we're very pleased with the progress of Epix. As you point about, DISH is certainly a major new distributor to add to our lineup, which includes for Verizon, Cox, Charter, Mediacom, NCTC and the list will continue to grow as the year progresses. So we are very much on track to increase our distribution to the point where we will reach breakeven and beyond in the next calendar year, in 2011. Our deals, generally speaking, are structured in a way where we have a minimum level of revenue with upside potential for us, although the deals do vary from distributor to distributor based on their own -- the way they market their services, generally, and what their particular needs are. And one of the attributes that we bring to distributors is the flexibility of that base, both as a consumer platform and as a marketing opportunity for our distributor friends.

Operator

And we'll go next to Jason Bazinet with Citi.

Jason Bazinet - Citigroup Inc

Over to Paramount, I think you guys distribute quite a few films that you don't produced and some of those distribution agreements I think are expiring for various reasons. Can you just summarize those for us? And then give us a sense, do you think there's the prospect backfilling that with news studios where their distribution agreements come up? Or do you think it's more prudent for us to begin to moderate sort of the revenue and operating income you're generating from those agreements?

Philippe Dauman

Well, Jason, the two principal distribution arrangements that we have at Paramount are Marvel, which of course the producer of Iron Man 2, which is coming out at the end of next week. We have, under that agreement, up to four more titles after Iron Man 2. We don't anticipate that to be renewed given that Disney acquired Marvel. DreamWorks Animation, we have an agreement that covers titles released into 2012, with Shrek coming out in a few weeks and later this year, Megamind. It's a very fruitful relationship. I just happened to be talking to Jeffrey yesterday, and he was complimenting the Paramount organization, which is world class and top-of-class in marketing and distribution and how well HOW TO TRAIN YOUR DRAGON is holding up, such that in the fifth weekend of release, it was a number one movie and doing well internationally as well. We also do distribution for other companies, independents in various territories around the world. And we expect that to continue. As we've built up our international distribution organization, we've been disturbing a lot of local product. During this period, we've built up our own pipeline of great franchises and also building up our Nickelodeon and MTV films lineup so that either way, as the future unfolds, we have a very vibrant pipeline of what I would consider better risk-reward profile movie releases.

Operator

And we'll go next to Jason Helfstein, Oppenheimer and Company.

Jason Helfstein - Oppenheimer & Co. Inc.

Just little bit of a longer-term question as well, so seems to us that some of your competitors are being liberal in licensing their content to new distributors such as Netflix and Hulu for potentially less than fair value, which I know we're all trying to figure out what that fair value is. Can you talk about how you guys see the future of content distribution where consumers want to be on all devices, yet you want to get paid for your content?

Philippe Dauman

Well, Jason, we do view these new outlets as incremental opportunities. And we want them to be that, incremental opportunities. So we're working with live distribution partners, we're testing, we had a couple of our shows on Hulu. And we'll look forward to their new distribution strategies and models and determine in each case whether it makes sense for us to participate. So television viewings, I've said before, continues to be at all-time highs. And all these new distribution methods just allow people to spend more time consuming our content. And as time goes on, as we work with these new distribution partners on the right economic model and the right model for consumers, we think that will continue, that will drive our content business.

Jason Helfstein - Oppenheimer & Co. Inc.

I mean do you see incremental economics to your affiliation agreements to the extent the cable operators want to offer your content on an IP basis as well?

Philippe Dauman

Well yes, our content's particularly well suited for VOD and various broadband applications. Our audiences tend to be the young demographics that utilize it more than viewers of other programming. So we over-index in VOD platforms and the like. And that certainly helps us a lot in all the discussions we have with distribution partners, which is one of the reasons why we're able to enjoy the steady and high affiliate revenue growth.

Operator

And we'll go next to Jeff Logsdon, BMO Capital.

Jeffrey Logsdon - BMO Capital Markets U.S.

Question for you on the Marvel distribution agreement. Marvel had announced beyond Iron Man 2, Avengers, Captain America, Thor. Are those specific films identified through the agreement? Or is it just four more films and there could be others that are put into that mix?

Philippe Dauman

Well, those are the ones they have in the pipeline for production and those are covered under our distribution agreement. I haven't read the actual language of the distribution agreement. But those are the movies in the pipeline, which we will be distributing for Marvel.

Operator

And we'll go next to a Ben Swinburne, Morgan Stanley.

Benjamin Swinburne

I wanted to ask about the kids market the kids' upfront. There's been a lot of chatter over the last I don’t know, six, nine months about how kids' has been trending. And you guys are, I think, either in the middle of or at the beginning of the kids' upfront. Any update there on how that business has been trending and what your expectations might be for pricing even if it's qualitative? And then on the sort of TV Everywhere picture, I was curious if Viacom had a view on how they would like to have consumers' access to online content at MTV networks, if the preference would be to do that through comedycentral.com and Viacom owned and operated Web sites or if Viacom would be willing to go into either a Comcast or Time Warner Cable aggregator, for lack of a better term, online to fill out and maybe make it more easy for customers to access online content? Any thoughts there would be interesting.

Philippe Dauman

As far as the kids' market, Nickelodeon is entering into the upfront market in a position of maximum strength with growing ratings, doing extremely well in the category. I mentioned a lot of the categories, it's actually trending up as toys and games. And Nickelodeon's aim is to get increasing share of the endemic business of that kind. But Nickelodeon has also made great strides in bringing in new categories of advertisers, given its reach to the entire family, as I mentioned before in my remarks. And that allows us to bring a lot of new advertisers. So the outlook is very strong and positive for Nickelodeon as it approaches the kids' market, which is still in very, very early stages. So there's no concrete data to put out. But we're in great shape as far as the kids' market goes. As far as TV Everywhere, by the way, Epix is probably the ultimate product in the TV Everywhere arena and is really working well for our current distributors and will be a very interesting product for the future distributors who will be signing up. For the basic cable networks, where there is also an advertising component, we are working very closely with the various distributors to test it. There are technical issues. There are measurement issues. For us, it's important that Nielsen or other services do measure the viewing on non-traditional platforms so that we can -- if you can measure it, you can sell it. And as that progresses, we are willing to have our distributors provide TV Everywhere on various platforms, which we will discuss with them. You mentioned our own Web sites. Our own Web sites are also seeing nice growth in both monthly in unique viewers, time spent and the advertising market for our types of sites, our branded sites is also strengthening as we look forward.

Operator

And we'll go next to David Miller, Caris & Company.

David Miller - Caris & Company

Tom, question for you also on Epix. If MGM should file for bankruptcy and of course, it's unclear whether or not that will happen, they could end up restructuring, going alone, and I understand that. But if they should file, would you be, theoretically, interested in buying in the Epix stake that they currently hold below the line? And is that the reason you guys aren't paying a dividend yet on the sort of theorem that you want to keep your powder dry to perhaps buy in the Epix stake and you just want to wait and see what happens before you start to pay a dividend?

Thomas Dooley

Epix is very well funded by all of its partners at this point in time. We don't see any problems. And it's kind of -- it doesn't make much sense for us to hypothesize about what's going to happen there. So I don't think we don't want to comment on that. Both Lions Gate and Viacom are sufficiently in a good position to deal with as Epix's future cash needs. It's doing very well, as Philippe mentioned before, in terms of its movement towards growth profitability, breakeven profitability and cash flow breakeven. So its capital needs are not that significant on a go-forward basis, nor is the amount of money that would be involved with Epix on a go-forward basis impact our ability in terms of our intent to return cash to shareholders in any way, shape, manner or form.

Philippe Dauman

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

Operator

And that concludes today's conference. We thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Viacom Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts