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Executives

Brad Edwards - IR

Roger Werner - President and CEO

Tom Allen - EVP and CFO

Analysts

Michael Kupinski - Noble Financial

Outdoor Channel Holdings Inc. (OUTD) Q3 2010 Earnings Call November 3, 2010 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2010 Outdoor Channel Holdings Incorporated earnings conference call. (Operator Instructions)

I would now like to turn the presentation over to your host for today's call, Mr. Brad Edwards.

Brad Edwards

Thank you, operator, and good afternoon, everyone. Before we begin, please recognize that certain statements on this conference call are not historical fact. They may be deemed therefore to be forward-looking statements under the Private Securities Litigation Reform Act of 1995.In particular, statements about future results expected to be obtained from the company's current strategic initiatives are forward-looking statements. Many important factors may cause the company's actual results to differ materially from those discussed in any such forward-looking statements. These risks and uncertainties are described in further detail in the company's filings with the SEC. You are directed to these filings for more detailed information. Outdoor Channel Holdings undertakes no obligation to publicly update or revise its forward-looking statements.

Please also note that we will be discussing non-GAAP financial measures within the meaning of the SEC rules. The company believes that earnings before interest, taxes, depreciation and amortization or EBITDA adjusted for the effects of share-based compensation expense and acquisition and integration costs provides greater comparability regarding its ongoing operating performance. This information is not intended to be considered in isolation or as a substitute for net income or loss calculated in accordance with the U.S. GAAP.

A reconciliation of the company's U.S. GAAP information to EBITDA adjusted for the effects of share-based compensation expense and acquisition and integration costs is provided in the table attached to the company's 2010 third quarter earnings release distributed earlier today and available on the Investor Relations section of the company's website at www.outdoorchannel.com.

Outdoor Channel is Nielsen rated. Nielsen Media Research is the leading provider of television audience measurements and advertising information services worldwide. Please note that Nielsen estimates regarding Outdoor Channel subscriber base are made by Neilson Media Research and are theirs alone and does not represent opinions, forecasts or predictions of Outdoor Channel Holdings or its management. The company does not by its reference to date imply its endorsement of or concurrence with such information.

Finally, we've allotted one hour for today's conference call. Outdoor Channel's President and CEO, Roger Werner, will begin with a brief overview of the ongoing progress being made with strategic initiatives being implemented at Outdoor Channel. Tom Allen, Outdoor Channel's Executive Vice President and Chief Financial Officer, will then provide an overview of the financial results for the 2010 third quarter. Then we will open up the call for a Q&A session. And as usual, Outdoor Channel's Chief Operating Officer, Tom Hornish, is also here with us and will participate in the Q&A.

With that said, I'd now turn the call over to Roger Werner.

Roger Werner

Thanks, Brad, and welcome everybody to the call. During this quarter, Outdoor Channel's total revenues increased almost 8% due to strong advertising growth year-over-year. We also generated significant improvement in the Channel's bottomline results.

On a consolidated basis, our revenues were impacted by the planned shrinkage at Winnercomm as we work through the year-over-year impact of our efforts to downsize and refocus that segment on a higher margin business. And we're seeing good progress there which I'll update you on in a couple of minutes.

In the Channel, total ad revenues increased a nice 14% in the third quarter with increases coming on all categories except the long-form infomercial category, which as we've told you in the past is pretty flat.

We also experienced a solid triple-digit increase in our online ad revenues, and the efforts we're making to further strengthen and build out outdoorchannel.com are bearing fruit as more and more advertisers recognize the quality and targeted nature of this site.

We believe we're in a strong position to drive future ad sales growth. Year-over-year, we've expanded our distribution as well as invested in our traditional and online content offerings. We're now 100% HD and we broadcast more unique and compelling original outdoor programming than any competing network. We possess an established category leadership position across all our distribution platforms, which presents a very efficient appealing marketing channel for our advertising partners.

Turning to distribution for a moment, our reported subscriber revenue was down 5% in the quarter due to the impact of changes in our reserves for potential MFN liabilities with some of our distributors. These types of accruals have been a part of our relationship with the distributors and have occurred in the past. As we've said in previous calls, they tend to fluctuate. And these are items that we can't unilaterally control, but we always tend to take the conservative view towards accounting for these.

So we're working to resolve that issue. And if and when we're successful, we'll be able to reverse these accruals.

On our estimated Nielsen household universe for November is now 35 million homes. We worked hard to expand the network's distribution base over the past year, and our affiliate has secured a number of key system launches and tier migrations. And we're in ongoing discussions with a number of distribution partners with the goal of further growing that base.

Some recent positives on this front included a move to more broadly distribute digital preferred tiers across Comcast systems in both Houston and some in Colorado. We picked up about 315,000 subs from these moves are pleased to be reaching more viewers in these areas, which as you can understand are sort of good areas for outdoor enthusiasts.

However, while we mostly benefit from these tier migrations over the years, sometimes they do work against us and this week we had one in Orlando where we were moved to a sports tier from digital basic on a Bright House system, resulting in approximately 550,000 reduced subscriber reach.

Looking beyond the U.S. during the quarter, we secured two international carriage agreements, or appropriately, just formalized two agreements that had been in development. In August, we reached an exclusive agreement with Chello Zone, a subsidiary of Liberty Global's international group, which extends our footprint into Europe and the Middle East.

Chello Zone will have access to our complete library of HD content and will launch a customized feed which will be branded Outdoor Channel. We also reached a multi-year distribution agreement with a company called Multi Channels Asia, or MCA, which MCA will have exclusive access to distribute and market Outdoor Channel in Asia, Australia, New Zealand and India.

Through this partnership, our network is currently available on over 1.5 million homes in seven different countries in its initial rollout. While these international expansions will not produce any meaningful incremental earnings in the short term, they do expand our brand footprint and we believe will provide opportunities for measurable upside in the medium to longer term.

Finally, concluding with the distribution remarks, our HD offering continues to generate nice growth. Our HD feed now exceeds 8 million total subscribers, which is great progress from last year at this time when we were serving only about two and 2.7 million homes.

We have secured 530 system launches year-to-date across 48 broadcast markets. So, as I say, nice progress there.

Moving to content, we've taken steps in recent months to secure virtually all of our Fan Favorite programs, our leading franchises, through multi-year commitments that include on-air, online and international rights. As part of these agreements, we've locked up some of the industry's marquee names including our pal, Ted Nugent, Jim Shockey and Michael Waddell among many others.

While we continue to invest in new content over time, this stable programming and talent remains extremely popular with our target audience and we consider it core to our brand. We recently joined forces with thePlatform to utilize their online video play and content management systems.

Outdoorchannel.com currently averages over 1 million unique visitors each month, making it one of the very largest in the category. And we've built quite a sizeable library of exclusive video content for this companion product as well.

Now, as for Winnercomm, our production services subsidiary, as I mentioned earlier the revenue decrease at Winnercomm was in line with our plan, and it was all of our efforts to sharpen that division's focus and to really place the emphasis on higher margin core business-related revenues. We made solid headway in improving its profitability this year by pursuing that approach.

Both Winnercomm's margins and excluding some one-time litigation costs, its adjusted EBITDA improved during the quarter, and we believe we turned the corner with this division. One of Winnercomm's key businesses as you know, is the Skycam aerial camera unit. We believe this is really a unique asset, and we are not alone in that belief.

Some of you might have noticed recently that Skycam system was deployed during Major League Baseball championship series as well as the World Series. This is a first for Skycam and we believe it demonstrates the growing appeal of that product to networks and professional sports leagues, and we are looking for bigger and better things from that product line in the future.

Turning to marketing and into 2011 for a minute, we anticipate continued growth in the advertising sales for the business, and we will be continuing to focus on leveraging the core franchise and generating those increased ad sales as the market improves. We will support our ad sales efforts through increased investment in both our core programming and new programming, and importantly through expanded promotion or increased promotion of all of that programming.

Evidence for this increase already has appeared in the third quarter. You see that that line item has pumped up. Look for that to continue and we go into 2011 and the fourth quarter of course of this year. We continue to have an unwavering commitment to being the biggest and the best in our category, both online and on-air, and that increased marketing expense reflects that commitment.

In conclusion, we continue to stay the course. We remain on track to post decent growth for the full year. The advertising market's demonstrating some resilience in an ongoing recovery. And we're pleased with the progress we're making in building out our digital business and sharpening the Winnercomm division's strategic focus.

Lastly, our financial condition continues to remain very strong with $61 million in cash on the balance sheet and no debt. We've also maintained our financial flexibility and will continue to invest in our business while also carefully looking for additional ways to reward shareholders.

At this point, I'm going to turn the call over to our CFO, Tom Allen, who can review the third quarter results in some greater detail. Tom.

Tom Allen

Thanks, Roger. As we noted in the release today, our third quarter produced very strong results compared to the third quarter of 2009. Unlike a few channel units, revenues increased 8%, and coupled with a 19% decrease in cash-based SG&A costs, we delivered an EBITDA adjusted per share-based comp of $5.9 million again at the Legacy Channel.

Advertising revenue there, led by strong increases in our online, time-buy and short form components increased 14%. Subscriber fees declined 5% as Roger said, reflecting some further adjustments in our MFN liabilities during the quarter. Our production services unit total revenues as expected decreased 15% year-over-year, but our margins grew a point to 23% from 22% a year earlier. And third quarter margins, up 23%, grew from our 16% gross margin for the first six months of this year.

On a nine-month basis, our margins at our production services unit now stand at 19% compared to 11% for the 2009 year-to-date period. Our production services unit's SG&A expense declined 7% despite an increase of $327,000 in legal expenses related to our ongoing legal actions against Actioncam over unfair business practices, trade secrets and copyright violation. Despite that drag on its operating results, our production services unit still managed to generate positive EBITDA adjusted for share-based comp of $115,000.

On a consolidated basis, revenues declined 3%, but on lower costs, we were able to generate 41% increase in EBITDA, again adjusted for share-based comp. Our net income for the quarter was $2.4 million, generating basic and diluted EPS of $0.10 per share.

Other notes regarding our consolidated operating results for the quarter. Total cost of services declined 10% to $9.6 million, primarily due to the expected reduction in Winnercomm activity, net of increased costs in our online unit and programming costs. During the third quarter, we increased our advertising and promotion spend by 16% compared to Q3 '09 to support the season and series launches of several key shows for us and to better position our programming as we entered the seasonally stronger back half of our year.

We have continued to step up our advertising spend, as Roger mentioned, to aggressively promote our programming fair into the fourth quarter. Consolidated SG&A expenses for the quarter were down significantly, driven primarily by reduced cash executive compensation bonus, lower professional fees, as well as lower share based comp expense.

Depreciation and amortization for the quarter was $748,000 compared to $928,000 for the second quarter of this year, with the reduction coming on more assets becoming fully depreciated, the price and of service over the past year. Capital expenditures for the quarter were $329,000 bringing our nine month total to $943,000, and we expect that our full year CapEx will end up at around somewhere between $1.2 million to $1.4 million.

We've continued to maintain a healthy and debt-free balance sheet. Again reiterating what Roger said, we have $61 million of cash and marketable securities. We generated $3.6 million in operating cash during the third quarter. Our working capital stands at nearly $73 million, and shareholder equity stands at approximately $140 million.

Finally, we expect to file our 10-Q with the SEC later this week, probably Thursday or Friday.

And that concludes our formal remarks. Now Roger, Tom Hornish and I will be happy to take any questions you have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Kupinski from Noble Financial.

Michael Kupinski - Noble Financial

The step up in advertising on the year going to be spending here, does that relate to any competitive pressures or are you seeing any weakness in ratings? Can you just talk a little bit about the ratings outlook and the performance there?

Roger Werner

I think it reflects a couple of things. First, as we went through '09 and earlier this year, with the economy being in kind of rough shape and ad sales being under pressure, we obviously look to the cost side of the business to reduce expenditures and operate as efficiently as we could. So in a sense, we're restoring some of the, what I would call to normalized levels some of the spending that we would expect to do.

Now, had we had any softness in ratings? Yes, we have. In the first half of this year, ratings were off a little bit. We continue to deliver growth in the total audience numbers that we promise to advertisers. But Neilson has had some blips this year in the mail demo delivery. It's affected us, and you probably read in the (trades), it's affected other networks as well. We don't have a definitive kind of resolution of that. Neilson's trying to figure out exactly what happened. And we don't control their numbers, but we continue to work with them to try to figure out what happened.

But yes, I think part of the increased spending just reflects what we would consider an appropriate response. We are committed as I said to remaining the biggest and the best. And that means audience delivery as well as distribution footprint and program quality and all the other metrics you'd expect us to try to be a leader in.

Michael Kupinski - Noble Financial

And a normalize level, Roger, with advertising, as a percent of revenues, what would be normalized?

Roger Werner

As a percent of revenues, Mike, our actual promotional spend.

Tom Allen

Mike, I got to think about it, that's percentage of the Legacy Channel or total?

Michael Kupinski - Noble Financial

The Legacy business.

Tom Allen

We don't know that there is a particular benchmark, Mike. I do know that we obviously have a couple of things going as Roger mentioned. We also have firming rates; just we are seeing firming rates on our sell side. Obviously, advertising rates, when we go to buy it are firming from where they were a year ago.

I don't think it was that long ago we were probably spending $5 plus million a year on advertising costs and our revenues were probably lower than they were now. I don't think we are looking at returning to that level of spend as a percentage of ad revenues. But I guess the quick answer is, we don't have benchmark per se. We kind of, this is just-in-time buying from our (vendors) when we look at the kind of quarter-by-quarter in terms of where we think the opportunities are to buy advertising and to see obviously the linkage between what we are spending and hopefully rating.

Michael Kupinski - Noble Financial

Well, and the other aspect there is, that advertising level was better than expected. Was it just general improvement in the total of the business across all groups? Did you benefit from any spillover from maybe the effect of limited TV inventory due to the political advertising? And if you can just talk about the pace of business going into the fourth quarter. You're already seeing the trends in the third quarter continuing to the fourth even after going into the December timeframe.

Roger Werner

Tom Allen, feel free to jump in to and amplify this. We're generally seeing a firming in the advertising marketplace. The outlook for the first quarter of 2011 continues to be good. We did see this year a little shift of endemic business from the fourth into the third. So we're booking some business a little earlier this year than we might have left. But we're on track to continue to grow in the fourth quarter to show growth for the year year-over-year.

Political advertising for us was not probably that much of a factor quite honestly. I don't know that we could feel it or measure it. But as we've said, the overall marketplace has firmed up partly as a result of political spending, no doubt. And it probably just didn't have much of a quantifiable effect on us.

Michael Kupinski - Noble Financial

Winnercomm's comes revenues were a little bit better than expected. Did you not cut certain businesses as much as expected or retained more contracts than you expected? Any additional color that might have there, especially as we go into the fourth quarter?

Roger Werner

Well, for Winnercomm as a whole, we have had some upside on the SkyCam business, as I mentioned. We picked up a few more football games and baseball and a few other odds and ends there. So they are having a good year. And, Tom, I don't know if there is anything else remarkable that we want to report on the other side of Winnercomm.

Tom Hornish

I think to some extent, it's a tailing off of stuff that we don't want to continue, but it's still in that transition period that are may not yet down to the rates that you might otherwise expect with the reorganization? So still in the transition period, and it might be higher than it would be on a steady-state basis.

Michael Kupinski - Noble Financial

And just go back to the Nielsen universe numbers, I know that they're not your numbers, but they were slightly down from the last quarter. What are your internal numbers showing? Are they increasing at this point? Is the gap still narrowing? Any thoughts on your internal numbers?

Roger Werner

I think, Mike, the GAAP would be still narrowing a bit, and our internal sub-numbers would continue to grow. Any given month or even any given quarter, there may not be a direct linkage between what we're seeing in terms of actual paying subscriber growth and what Nielsen shows in their universe estimate.

Michael Kupinski - Noble Financial

And finally, over $61 million free cash flows increasing into the fourth quarter, can you discuss plan for your uses of cash?

Roger Werner

We have a full range of options and we're evaluating all of them as we go towards the end of the year. And as I said, the range of options is driven by management's desire to try the provide tangible rewards to the shareholders that we have and that have stuck with us. So we are looking at a variety of things, Mike, none of which I can comment on specifically at the moment.

Operator

(Operator Instructions) Your next question is a follow-up question from the line of Michael Kupinski from Noble Financial.

Michael Kupinski - Noble Financial

I want to review your internet revenues real quick. Earlier you mentioned that you're looking at $1 million to $1.5 million in internet revenues for the full year and that you're anticipating to be breakeven. Can you just give us an update on your thoughts on the internet revenues?

Roger Werner

Yes, Mike, we will do better than $1.5 million this year, it looks like now. And would we be at breakeven? We'll be within range of it. We won't necessarily be at breakeven. I think we'll still be below that. But breakeven is not necessarily the objective here. What we are trying to do is to build the business and sustain our leadership position in that business as the digital media side of the company evolves.

So we will continue to invest and spend in that business, but try to keep revenues in some balance with the expenditures, so that we're not running serious deficits, let's put it that way. I can't really give you too much more precision. Tom Allen, do you have anything you want to add to that?

Tom Allen

I think your description about where we think we'll end up for the year is accurate. For the quarter, we actually did show a small profit, which may be the first quarter ever for online group. Part of that revenue hit that we got from the third quarter, Mike, and probably still over into the early part of the fourth quarter was the fact that (Detroit) launched three new truck models this model year, which obviously you can imagine is a perfect fit with our demographics. So we've benefited from that not only on online, but also probably on the short-form ad sales.

Michael Kupinski - Noble Financial

It seems like the domestic auto companies who were normally an advertiser Outdoor Channel, is that a switch for you guys, isn't it?

Tom Hornish

Well, we've been trying to expand the national components of our short form for a couple of years, and our sales guys have done a great job of expanding that business. As you know, kind of the filler time for us in terms of that inventory is DR business, which is kind of lowest priced inventory. So to the extent we can expand our national business, which is still not priced at the same levels that our endemic are, we certainly changed the mix of our business and increased our revenue.

And as Roger mentioned, I think to a certain extent, we benefited from a higher mix of endemic than we have in the prior year third quarter, as some of those endemic advertisers pushed some of their advertising spend up into the back half of the third quarter from the front half of the fourth.

Michael Kupinski - Noble Financial

And with business pacing up a little bit, can you just talk a little bit about rates as you go into the fourth quarter and certainly into the first quarter of next year? You kind of indicated that you're getting a little visibility now going into the first quarter. So can you just give us some thoughts about going into 2011?

Roger Werner

Yes, we anticipate being able to raise rates, Mike. We anticipate some inflation in the CPMs. Again, I don't want to give you a forecast. That's more precise than that at the moment. But the market does look firm. Our mix of business is becoming bigger and broader. As Tom said, we now have more non-endemic business that is higher value than the direct response that were to fill those slots previously. So in general, a situation where prices continue to inflation somewhat.

Michael Kupinski - Noble Financial

And in terms of your distribution contracts, I was just wondering if you could give any thoughts on what's going on there? And then do you have any partners that are coming up on contracts within the next year or so?

Roger Werner

I'll answer the back half of that question first. No, Mike, everybody is under a contract. And as you pointed out, DIRECTV was signed to a renewal a couple of months ago. And Dish Network is under contract with us, and they are a good customer and continue to pay their bills. So we are moving down the road with them.

We're in continuous discussion with all of our distributors about expanding distribution and perhaps improving terms of the deal or finding other opportunities that will help us grow those relationships.

But there is nothing all that remarkable to report at the moment on any of these guys specifically. And as you know, we typically don't report very much of a specific nature because of confidentiality agreements associated with all of those distribution relationships.

Tom Hornish

In general, I think we talked about we've now staggered the expiration of the affiliation agreement. So it's an ongoing process that some will roll off and hopefully be renewed, but there is nothing anything specific that we could talk about, because it's just kind of normal course of business to do those renewals.

Michael Kupinski - Noble Financial

You indicated that some of the endemics were having some issues following the price increases that you had earlier and that you weren't in the back half of this year, not really anticipating much because of the fact that endemics were a little price sensitive. Are they starting to become less price-sensitive at this point? What are we looking for from that perspective?

Roger Werner

I think, Mike, the simple answer is, yes, a little bit. Their business is improving along with the overall economy, and the advertising sales marketplace is getting a little healthier and the prices are getting a little firmer and so forth. So, yes, the answer, yes, a little bit.

Michael Kupinski - Noble Financial

As we look at the subscriber fee revenue line going into the fourth quarter, certainly there is some noise in the third quarter revenue line. Were we to look at something in a more normalized revenue like let's say $4.8 million range, or should we look for more something in the range of the $4.2 million that you reported.

Roger Werner

Tom, why don't you take a crack at that? And again, I'm not sure how much guidance we can provide here, but you may want to make a comment on the variability of these MFN accruals. They come and go.

Tom Hornish

It does come and go, Mike. So it's really hard to predict. And then we talked about that last quarter a little bit. But assuming the kind of status quo and we don't have any resolution with any of the MFN accruals, then we're pretty close to this quarter. It might be up a little bit because of annual rate increases and everything, but nominal on a CPI type of basis or something like that.

Operator

There are no further questions at this moment. This does conclude the question-and-answer portion of the call. I'd like to turn the call over to management for closing remarks.

Roger Werner

Thank you all for attending. We look forward to speaking with you when we report our fourth quarter. And I think we'll sign off.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

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