Discovery Communications' (DISCB) CEO David Zaslav on Q2 2014 Results - Earnings Call Transcript

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 |  About: Discovery Communications, Inc (DISCB)
by: SA Transcripts

Discovery Communications, Inc. (NASDAQ:DISCB)

Q2 2014 Earnings Conference Call

July 31, 2014 8:30 AM ET

Executives

Craig Felenstein – EVP, IR

David Zaslav – President and CEO

Andrew Warren – Senior EVP and CFO

Analysts

Todd Juenger – Sanford C. Bernstein

David Bank – RBC Capital Markets

Benjamin Swinburne – Morgan Stanley

Jessica Reif Cohen – Bank of America, Merrill Lynch

Anthony J. DiClemente – Nomura Securities Co. Ltd

Alexia Quadrani – JP Morgan

Michael Nathanson – MoffettNathanson LLC

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2014 Discovery Communications, Inc.’s Earnings Conference Call. My name is Mark, and I will be your operator for today. At this time all participant are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to Craig Felenstein, Executive Vice President, Investor Relations. Please proceed, Sir.

Craig Felenstein

Good morning, everyone. Thank you for joining us for Discovery Communications’ 2014 Second Quarter Earnings Call. Joining me today is David Zaslav, our President and Chief Executive Officer; and Andy Warren, our Chief Financial Officer. You should have received our earnings release, but if not, feel free to access it on our website at www.discoverycommunications.com. On today’s call, we will begin with some opening comments from David and Andy, after which, we will open the call up for your questions. (Operator Instructions)

Before we start, I would like to remind you that comments today regarding the company’s future business plans, prospects and financial performance are forward-looking statements that we make pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are made based on management’s current knowledge and assumptions about future events, and they involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our annual report for the year ended December 31, 2013, and our subsequent filings made with the U.S. Securities and Exchange Commission.

And with that, I’ll turn the call over to David.

David Zaslav

Thanks Craig. Good morning everyone and thank you for joining us. Before Andy provides some context around our second quarter results and the momentum we continue to generate across our global portfolio. I know industry consolidation is on everyone’s mind. So, I want to talk about Discovery’s market position, our overall operating performance and while I am so excited about our growth profile in both the short and long-term.

It’s a great time to be in the content business. There are more consumers assessing more content on more platforms in more countries than ever before. The consumer experience is evolving and the key to exploiting this dynamic marketplace is to capitalize on the brand and distribution strength of the company by following the same strategic formula we have employed since I came to Discovery seven years ago.

That strategy is based around four operating principals. First, invest in more content and ensure spending is focused on the screen, all screens, not just the TV screen. Second, leverage our unparalleled Beachfront real estate to build stronger, more valuable brands. Third, accelerate our strategic advantage and brand position across the global pay-TV marketplace. And lastly, build additional scale and market share in key growth markets.

Let me speak to each briefly. Increasing our content investment to build stronger brands and solidify category leadership in our programming genres is core to our gross strategy. We continue to prioritize developing must-have programming with compelling characters and storytelling while owning all the global and digital rights.

Over the past seven years, we more than tripled our overall content investment and by nurturing our audiences and super fans, we expanded our viewership across our U.S. networks by 53% now reaching between 11% and 12% of the cable audience.

The growth is even more dramatic internationally where our overall viewership has increased over 200% including our best quarter ever this past quarter. Without question people are spending more time with our content than ever before. And equally as important, given the investment we have made, we are turning that higher viewership in the sustained double-digit ad growth across the company.

Even domestically where the market is more mature, there is still plenty of room for continued ad growth and we remain confident that we will outperform over the long-term given the strength and diversity of our creative offerings to quality of our ad sales team and the potential of many of our new brands that we have built.

ID remains the perfect example of this. The channel is now the number four network for women in total day, has the longest length of tune of any network on cable or broadcast and has driven sustained double-digit audience growth since its launch in 2008.

And while we have made real progress on the pricing front over the last few years, it CPMs don’t reflect anywhere near that level of success. As the CPM gap closes with its performance, we expect multiple years of significant growth from this network alone here in the U.S. and around the world.

We are also seeing more and more companies and platforms looking for content than ever before and given our market leadership in non-fiction we are confident we can nourish this growing audience segment on multiple platforms and markets around the world for many years to come.

To further satisfy this demand for content, we have taken advantage of new opportunities to increase our global rights and ownership of valuable IP. We just acquired control of Eurosport, which includes rights to all content on all platforms in Europe.

Earlier this year, we acquired UK based producer Raw and in the second quarter we announced the 50-50 joint venture to purchase All3Media, a leading production company with a vast portfolio of properties across a wide range of genres. These acquisitions allow us to increase our content library, expand our stable of top creative leaders and exploit more formats and more IP around the world.

The second pillar of our growth profile is our sustained ability to exploit and develop our global Beachfront real estate. The great distribution Discovery has in the U.S. and around the world.

We are thoughtfully investing in new brands that identify wide space in the market and that have real potential to deliver significant audiences and drive value to our ad and affiliate partners. This strategy has worked extremely well domestically over the past seven years where we have launched more new brands than any other media company and these brands are finding real audience strength and advertisers support.

This past quarter alone, ID delivered 16% viewership growth, OWN was the number one cable network on Tuesday and Wednesday nights with African-American women, Destination America and Velocity were both up 20% in their key demo and our newest brand American Heroes channel was up almost 10%.

Most of these channels did not exists four years ago and are now positioned for substantial growth in the years ahead. And earlier this month, we announced our latest network Discovery Life which will debut in January on what is now Discovery Fit and Health.

The growth of our portfolio is also delivering significant value to our distribution partners. The deals we have completed reflect the value of our must-have content with increased annual escalators while also providing additional subscribers for some of our emerging networks. The result is faster organic affiliate growth this year than a year ago and we expect this trend to continue as we complete additional agreement in the years ahead.

On the International front, Discovery celebrated its 25th Anniversary in the second quarter and since the initial launch of Discovery Channel in 1989, the company has been steadily investing in local infrastructure, brand awareness and commercial relationships in almost every market in the world.

Today, we have an unmatched global platform with an average of eight channels in more than 230 countries reaching over 2.5 billion subscribers. We are still seeing pay-TV expand nicely with subscriber growth across the portfolio especially in countries like Brazil and India where there is increasing demand for content from burgeoning middle class.

But the real upside is turning this valuable distribution into an even a stronger content offering like we did recently with the launch of TLC in Germany and ID Extra in Simia. Having the distribution to light up new global brands and utilize content that has universal appeal is a key element driving our steady and consistent organic growth.

The third driver and our key differentiator of the company’s success is without question, our International business and unrivaled global portfolio. The company passed the key inflection point this past quarter. As a result of the organic growth of our International business coupled with the closing of our controlling interest in Eurosport, we now generate more than half of our revenue outside of the U.S.

Over the years, we have immersed ourselves in individual market dynamics and established key relationships to meet demand and deliver value to advertisers, affiliates and audiences. We have also been extremely successful in globalizing our home-grown content and brands. Two notable examples of the power of our global brands of the success of TLC and ID.

TLC now reaches 260 million subscribers in 187 countries and territories. Making TLC, the number one most distributed women’s brand in the world and ID has over 80 million subscribers in a 155 markets. And in 2014 we have taken content from Velocity and Turbo brands around the world. Now reaching nearly 40 countries and over 60 million viewers outside the U.S. and we continue to see strong interest in this category and channel.

Our investment in building stronger brands growing our distribution and opening local offices with sales teams on the ground is fueling strong organic advertising growth and we are still very much in the early innings as the driver of this growth should be sustainable for years to come.

The continued penetration of pay-TV will continue to be a catalyst as we broaden our reach and attract more ad volume and much like the U.S. where ad pricing on our younger networks is well below parry for the audiences they are generating, the discount internationally is even greater. As we closed this gap as well as the significant gap between broadcast and cable we have the opportunity to deliver consistent organic growth over the next several years.

Finally, we are always looking for ways to build scale in key markets to take advantage of our first mover advantage in many regions and continue to strengthen our portfolio and offerings. Our first priority remains driving the momentum across our existing international portfolio so, we can maximize the organic opportunity that our international platform provides, but we are also always looking for external opportunities that will further deepen our relationships with advertisers and distributors over the long-term.

We are seeing that in the Nordics as our Discovery suite of networks benefit from the increased scale we now have in the region. In addition, we couldn’t be more bullish about the opportunities we have with Eurosport which reaches more subscribers across Easter and Western Europe than ESPN in the U.S. We view sports as a form of factional entertainment and must have content that complements our existing global portfolio. It’s only been a month but we are already seeing opportunities to co-sell, co-package improve rights offerings and augment our non-fiction portfolio.

A nice example is the French Open which delivered its best ratings ever for Eurosport. In the semifinal and final matches, we’re also broadcast on Discovery Max in Spain with record ratings over 20% share.

Moving forward we will be exploiting our local infrastructure and teams to maximize the flagship Eurosport across more than 70 countries while bolstering and launching targeted Eurosport feeds into growth markets.

Eurosport will have access to Discovery’s global reach local sales expertise strong global brands season management team and the opportunity to optimize content and attract more audiences across Discovery’s suite of networks.

Discovery gains Eurosport’s must-have sports content and IP. Its live production capabilities, Pan regional sales expertise and innovative digital services. Besides Discovery there are not many media companies that have the relationships and infrastructure to take advantage of opportunities like this in markets around the world.

Overall Discovery has had a great first six months in 2014, delivering strong organic financial results while further investing in content growing our global business, creating strong brands and building scale in key growth markets around the world. With sustained momentum across our global portfolio and a relatively healthy operating environment we are well positioned to deliver additional growth in the remainder of the year.

Looking further ahead, we feel we are uniquely positioned to deliver sustained growth and build long-term shareholder value given the brands we have built and the upside our global footprint provides.

And now I will turn the call over to Andy.

Andrew Warren

Thanks, David, and thank you, everyone, for joining us today. In the second quarter we continue to execute very well on our primary financial goals of achieving solid global revenue growth, expanding base business or OIBDA margins, delivering strong adjusted earnings per share growth and returning over $500 million of capital to shareholders through our share repurchase program.

On a reported basis, total company revenue in the second quarter increased 10% led by 23% international growth which is partially offset by 2% decline at the U.S. networks through the inclusion last year of licensing revenue related to a Netflix agreement.

Excluding the impact of licensing revenue and foreign currency as well as the contribution from Eurosport following its consolidation as of the end of May. Total company revenue growth was 9%, double-digit advertising growth and high single-digit distribution growth.

Total operating expenses on a reported basis increased 12% in the second quarter primarily due to the inclusion of the Eurosport business. Excluding this acquisition, the content cost associated with the year ago licensing agreement, as well as the impact from foreign currency movements, total company expenses increased 7% versus 2Q ‘13 primarily due to increased content costs as we continue to invest in strengthening our global network portfolio.

On a reported basis, adjusted OIBDA in the second quarter increased 6%. Excluding the impact of Eurosport, foreign currency and licensing revenue, adjusted OIBDA grew 11% which resulted in margin expansion of nearly 100 basis points versus the second quarter a year ago. Net income available to Discovery Communications increased 26% to $379 million driven by the strong operating performance as well as by a $29 million gain associated with the step up value from raising an ownership interest in Eurosport to 51% and a $31 million pretax gain from the sale of our display based digital business How Stuff Works.

Additionally, the quarter included $15 million of higher equity earnings, primarily from improved results at OWN as we successfully lowered our effective tax rate by 250 basis points to just over 35%.

Note that Eurosport's contribution to net income was not significant in the quarter as the OIBDA generated was mostly offset by higher purchasing accounting amortization associated with the acquisition. The purchase price allocation to amortizable trade names, distribution contracts, broadcast licenses and other assets will result in additional amortization expense in 2014 of about $33 million and $51 million of Eurosport amortization anticipated for 2015.

Total company adjusted net income, it is a more relevant metric from a comparability and valuation perspectives as it excludes the impact from non-cash amortization of acquired intangible assets was $405 million for the second quarter of this year, a 22% improvement versus the $333 million for the second quarter of 2013. Earnings per diluted share for the second quarter was $1.09, 33% above the second quarter a year ago, while adjusted earnings per diluted share was $1.16, a 27% improvement versus 2Q 2013.

Looking at the last 12 months, adjusted net income increased 29% to $1.3 billion while the adjusted earnings per diluted share increased 35% to $3.62. Free cash flow in the second quarter of $202 million declined by $109 million versus a year ago as the strong operating performance was more than offset by higher tax payments resulting from the exploration of the accelerated content cost recovery under Section 181.

Over the last 12 months, free cash flow increased by 9% to $1.2 billion due to the stronger operating performance partially offset by the higher cash tax payments and content investments. Content spending during the second quarter excluding Eurosport increased by only mid-single-digits even as we continue to drive market share growth across the globe.

Before I move on to the divisional results, I do want to highlight they were not part of our operating free cash flow, OWN continues to increase its cash flow generation and repay Discovery $20 million in the second quarter.

Turning now to the operating units. The U.S. networks continue to perform well during the second quarter. Well on a reported basis, total domestic revenue was down 2% that was due entirely to the licensing revenue we recognized a year ago as we extended our Netflix agreement. While the licensing revenue is lumpy given that they are recognized upon delivery of the content. We are still recognizing cash flow in the current year from our existing Netflix agreement.

Organically, domestic revenues were up 4% excluding the impact of licensing revenues with advertising and distribution growth partially offset by a $7 million decline in other revenues. As I mentioned last quarter, our U.S. networks have increased their programming being shared with the international networks rather than selling to third parties. So as a result we are now generating lower content licensing sales. We anticipate a similar trend in other revenues for the remainder of this year.

Domestic advertising revenues increased 5% in the quarter as a stable pricing environment and higher delivery cost from majority of our younger networks more than offset the anticipated headwinds from the cancellation of our Everest live event and the sale of the How Stuffs Works platform.

Looking ahead to the third quarter, given the relatively stable current ad market trends with scattered pricing up high single to low double-digits from last year’s upfront negotiations. We anticipate ad sales growth will at least be in the mid-single-digit range even with the sale of How Stuff Works as well as the difficult comparison to the 12% ad sales growth we generated in the third quarter a year ago. Distribution revenue increased 6% during the second quarter excluding licensing revenue as we recognize the higher rates, we were able to secure during the latest round of a slight negotiations.

Please note that while there are organic growth rate for full year revenue will continue to be in the same range of the remainder of the year. The reported affiliate growth will continue to be impacted for both the additional licensing revenue we recognized in this third and fourth quarters of 2013 as well as on a new licensing deals we may complete during the remainder of this year.

Looking at the cost side, domestic operating expenses declined 4% from the second quarter 2013 primarily due to higher content cost a year ago associated with the licensing deal with Netflix. Last year’s second quarter also included programming and marketing cost associated with broadcasting SkyWire Live on Discovery.

Domestic adjusted OIBDA declined 1% on a reported basis versus last year’s second quarter but increased 8% excluding the impact of licensing agreements with margin expanding fully 200 basis points versus the second quarter a year ago.

Turning now to international operations. The reported results include the impact of Eurosport which for comparability purposes my following international comments referred to the results excluding this acquisition. Additionally, now that we have fully cycled through the acquisition of the SBS Nordic assets. We will today and going forward be discussing them as part of our overall organic base business.

International segment continue to deliver very strong momentum across our global operations this past quarter as revenue is expanding 15% led by 18% advertising and 10% affiliated growth. Excluding the impact of exchange rates, total revenue growth was 14% with the ad revenue increasing 17% and affiliate revenue remaining at 10%. The 17% advertising growth was broad based with double-digit increases across nearly every region head by Western Europe primarily from the continued success of our Free the Air initiatives in Italy, Spain and the UK. Latin America from increased volumes across the region and Simia from both Poland and Africa. The quarter is also include an additional eight days of results from the SBS Nordic businesses given the April 9th close the year ago. But the international business still delivered solid double-digit ad growth despite a greater than expected negative impact from the World Cup.

On the affiliated front, the 10% affiliate revenue increase in the quarter excluding currency was driven primarily by subscriber growth especially in Latin America from the continued expansion in pay television in Brazil and Mexico and in Central and Eastern Europe from additional subs at Russia and new launches in Turkey and in Middle East. Note that the affiliated growth would have been in the high single-digits excluding the additional days associated with the SBS closed timing a year ago.

Turning to the international cost side. Operating expenses were up 13% in the second quarter excluding currency primarily driven by higher content amortization and increased personnel costs as we further expand our global footprint. The additional costs also reflect the inclusion of eight extra days in the SBS Nordic business as well as higher cost during the acquisition of the Raw Production Studio in the UK.

International segment delivered 15% adjusted OIBDA growth in the second quarter, excluding foreign currency. As our international team continues to significantly grow revenues plus thoughtful investing in long term growth initiatives. Very importantly now that we are fully cycle through the acquisition of the SBS Nordic business, we expanded international organic margin by 50 basis points including SBS but excluding Eurosport and currency fluctuations.

Now focusing on our overall financial position with a strong balance sheet and sustained financial and operational momentum and given our gross leverage targets and long range free cash flow per share assumptions. We had the opportunity to both continually returning capital to shareholders and investing in our global businesses.

This past quarter, Discovery repurchased over $500 million of stock and we anticipate returning more capital to shareholders through our buybacks in 2014 that we did in 2013. Since we began buying back shares towards the end of 2010, we have spent over $5.2 billion buying back shares, reducing the outstanding share count by over $102 million shares or 24%.

Before I update our guidance for 2014, please note that current expectations include preliminary purchase accounting adjustments associated with the Eurosport transaction which may change once finalized. We will update you on our next call, if they change materially.

Currently we continue to be encouraged by the sustained momentum across our business portfolio and the robust ad sales trends in many of our global markets. We remain on track to hit our original expectations of 2014 but are narrowing the guidance ranges to reflect the delayed close of the Eurosport transaction, foreign currency headwinds versus our original expectation, the less robust U.S. ad sales environment and higher corporate cost associated with accelerated stock compensation and professional fees, therefore for the full year 2014, we now expect total revenues to be between $6.45 and $6.525 billion. Adjusted OIBDA to be between $2.6 billion and $2.65 billion, net income to be between $1.225 billion and $1.75 billion and adjusted net income of $1.34 billion to $1.4 billion.

This is the first time that we’ve ever guided adjusted net income and we will continue to do so into the future, as this critical profit metrics best underscores the true bottom line operating performance of the company.

Thank you for your time this morning. Now David and I will be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Todd Juenger from Sanford C. Bernstein. Please proceed.

Todd Juenger – Sanford C. Bernstein

Thank you very much. David thanks for your comments in the opening remarks around Eurosport and lot of the stuff that you guys have been doing over in Europe I wonder if you could expand on that a little and just think a bit longer term, when you put all of that together Eurosport, SBS, All3Media, other things you may be contemplating on there, what ultimately are you trying to build in Europe for Discovery, what sort of presence do you hope to have their overtime and any sort of indications of what sort of growth that implies if you’re successful? Thanks

David Zaslav

Thanks Todd. Well first our international business has never been stronger, last year we became the number one pay-TV media company in the world but more importantly we have more channels in more countries than any other media company and we started to populate those channels with better content, stronger brands and we’re growing market share over the last few years, 20% so a lot of the growth we are seeing in Western Europe is that the cost of getting local internationally most of that cost has been born already over the last 7 or 8 years, we have local teams throughout all of Eastern and Western Europe, Latin America and Asia and our content is getting stronger.

So even in a flat market, which is what the advertising market is like or even down in some of Eastern and Western Europe, particularly Western Europe, we’re able to grow mid-teens, high-teens early 20s and that really is about the fact that our content is resonating. What Eurosport does is it just adds more must-have content, to pick up between 1 and 4 channels in 70 countries that we’re already in and to have all that IP and to be able to bring that to the advertising market and bring it to the distribution market with almost no additional cost, we think it’s really valuable.

As important is the fact that we own all of that IP and it allows us to talk to partners about sharing content, about joint bidding for content and many of those partners will be distributors that we already have 8, 10, 12 channels with. So, we have found a lot of players in Eastern and Western Europe that are looking for to align around sports which is very attractive for us when we can package up all of our other channels and leadership.

But for us Eastern and Western Europe is a very important market, where we are finding great success but Latin America is probably our strongest market right now, we have Discovery Kids which is the number one cable network in Brazil not the number one kid’s network. But the number one cable network, we also got early to the market with Discovery Home and Health down in Latin America, we have Discovery, we have TLC, we have Animal Planet, Science, we have five of the top 20 channels in Latin America. And we’re getting a lot of organic growth down there and we’re seeing big, big growth in India. So I would say our international business has never been stronger, our leadership position has never been as advanced and it’s one of the reason why I am spending more than half of my time outside the U.S. and one of the key elements of that is, how do we take our portfolio and make sure we have more must-have content, in Latin America it’s Kids together with Discovery and women’s programming and in Eastern and Western Europe it’s our men’s and women’s programming together with sports and that’s key for us, how do we continue to build our IP but our international business right now is just accelerating.

Todd Juenger – Sanford C. Bernstein

Thanks a lot. A very quick follow-up if you don’t mind Andy on the international revenue line, there was a nice growth in the other component which looks it was attributed to production studios, maybe that was Raw or was that something else anything you can tell us what that is and whether it will recur would be great? Thanks.

Andrew Warren

Sure a big driver Todd the Eurosport licensing some of the content they have rights, they sell off some of the rights that they can’t utilize fully. So you will see that kind of be a sustained level of growth as we annualize the Eurosport acquisition.

Todd Juenger – Sanford C. Bernstein

Got it thanks.

Craig Felenstein

Next question operator please.

Operator

Your next question comes from the line of David Bank from RBC Capital Markets. Please proceed.

David Bank – RBC Capital Markets

Thank you very much. So a question about the domestic side and particularly on advertising I guess, I think Andy gave us some pretty healthy pricing and you know in some sense of the domestic ad market but your slight guidance range narrowing also kind of sighted softer advertising. So, I guess how do you reconcile the strong pricing with kind of tepid tone of ad markets and what do you think is impacting that market, I know there has been press that it was sum of weak upfront for the cable networks generally can we get your take on the upfront environment, the upfront process as well. Thank you very much.

David Zaslav

Sure, thanks David. Well first let me hit the upfront, for us the upfront looks like mid-single-digit we decided to sell less into the upfront market, the volume is not as strong as it was last year, having said that, the pricing in scatter for the past two, three years has been strong and the pricing in scatter is strong today. So, our view was given that the pricing was mid-single and that the volume was a little lighter that we didn’t want to sell into it. So we’ve held more inventory back if the scatter market performs similar to what it’s done in the last few years will have some significant upside for having that extra inventory. The advertising market in general has been good on pricing and a little bit year-over-year down on volume and for us at least we’ve decided to hold our CPMs and not go for that volume, you see some of that in the performance.

The other thing is that we’ve had some tough comps with the Olympics, the cancellation of Everest and we sold How Stuff Works which had some impact. So when you at the last few quarters for us we see and we think some deceleration of volume, some unusuals that maybe held us back a few points but we also think we’ve left some money on the table. And so Joe Abruzzese and I and the leadership team have been focusing on how do we really maximize our rating points to get more value, so I think it’s those three together.

David Bank – RBC Capital Markets

Okay. Thank you very much.

Operator

Your next question comes from the line of [Kennan] from Barclays. Please proceed.

Unidentified Analyst

Thank you. Just a couple of questions. The first is when you look at your tax rate I mean are there strategic options for you now that your revenues are more than 50% coming from international market that you could look at specially in terms of inversions and so on. And secondly in terms of Eurosport I mean what’s the kind of cost cadence that we should expect in terms of soccer is that a big priority going forward in terms of acquiring the rights.

David Zaslav

Let me do Eurosport and then Andy will talk to the where we’re in terms of tax and what our opportunities are. Eurosport is a profitable business that has significant growth built in as it is today. They have locked in tennis, winter sports, cycling and track and field and those are locked in for the next few years. And just by going into local feeds using the resources of Discovery we think we could build the brand, we could enhance the performance in a meaningful way.

So the question then since we have between one and four channels is we have a very stable and growing asset. What our options to build it, we will be disciplined, the idea of joint bidding in many of these markets can be very attractive. Often there are bidders you have two distributors bidding for content or you have a distributor bidding for content against a broadcaster and maybe in either case they don’t have enough platforms to carry all the content. And so we’ve had a lot of conversations where we can align, we can align on a disciplined basis, we could do it where we can get more must-have content which will enhance our brand but we could do it in a way that is either has good economic return in the near-term or has good economic return and allows us to pick-up all of our channels in a particular market and realign our relationship on the distribution side with the distributor.

So I think when you see us bidding on assets, you should assume that we’re looking at it and we’re only going to bid if we think that it will at the very least in the medium and long-term provide more shareholder value for us. But I would look carefully at where we joint bid because we have a lot of great distribution partners around the world and many of them are interested in taking advantage of our platforms and our infrastructure and expertise and that could be a real helper to us where we can play in sports in a way that’s effective.

There is no reason – we don’t see any reason to make a big bid to try and build the channel, we already have the channels, so it’s really a question of what do we put on it to build the brand and make more value for shareholders and make our overall portfolio stronger.

Andrew Warren

Your tax question is a very good one, one that we agree is a real opportunity for us, it’s something we’ve been very focused on for last couple of years. And if you look at the benefit that we’ve been driving so far this year, second quarter our effective tax rate was down 250 basis points. And the theory is really this as we continue to grow our content investment more-and-more of that content is being utilized outside the United States, so we’re domiciling all of that contents in places that not only do we have operations but also it is quite frankly more tax effective. So you will continue to see that reduction in effective tax rate throughout 2014 and you will see that accelerating in 2015.

So regarding your inversion question. Look for us we’re going to continue to drive our effective tax rate down as I mentioned and given our deferred tax rate stuff structures we should have cash taxes below our effective tax rate. But inversion really it comes to down to really the strategic value whatever that alignment or acquisition could be. Inversion makes a very good deal better it doesn’t make a bad deal good. And so for us it’s really all about the overall structure and leveraging the operations we have internationally.

Unidentified Analyst

Thank you.

Operator

Your next question comes from the line of Ben Swinburne from Morgan Stanley. Please proceed.

Benjamin Swinburne – Morgan Stanley

Thank you, good morning. David just picking up a little bit more on your M&A strategy and also some comments that John Malone made in the journal this week about scale and the need or the opportunity for scale. You over the last 18 months or so two years at least to us outside have diversified a bit in terms of genre, you’ve got a little more vertically integrated with TV production obviously sports some serialized drama probably SBS. Why not take the opportunity given the rate environment to continue to build scale, diversify a bit into other parts of the ecosystem and take advantage of the opportunity you have in front of you today, your guy’s one of few global players with the scale today to continue to take advantage of those things. I realize those have implications potentially for margins and growth rates which I think the market is digesting at the moment.

But do you see the opportunity and is it exciting for you to think about continuing on this path to build Discovery to be a meaningfully larger company in different kinds of businesses maybe than you were in four or five years ago?

David Zaslav

Thanks, Ben. Well first and foremost we have a great organic growth story that’s intact and accelerating outside the U.S and inside the U.S. We see growth and we look at what we’ve done over the last year and we think we can do better. Our brands are still strong, we’re growing market share here in the U.S and we could even lean harder into the ad sales market and do even better. So we think the organic growth story is very compelling for us and there is a lot of kind of easy fruit, in a lot of these markets like India, Brazil, Mexico, Eastern Europe where we have 10, 11, 12 channels and subscribers are growing significantly and more-and-more viewers are moving to cable and advertisers you want to catch those. So there is a significant piece of our organic business that we’re just well positioned on.

Having said that because we have infrastructure everywhere in the world. Local teams, selling and programming we are able to very quickly look at what’s out there and yet you are bigger in a way that we can grow faster and pick up IP and have more scale for our negotiations with advertisers and distributors is attractive but it’s all a matter of price. In the last 18 months we’ve done some acquisitions but we’ve done acquisitions that we think are really in line with our business for the SBS it’s 30% sub-fees, a lot of IP got us a lot of scale in the market, we have fair amount of synergy, we continue to take advantage of that. Eurosport which really just comes on top of our infrastructure.

So we will look but again when you see – when you take a look at scale one of the most important things we did was we went from 4% of viewership on cable both in the last 7 years to 12, the fact that we know have 14 channels and many of those channels are channels that people are spending time with and affinity groups they love, having OWN, having ID that didn’t exist to be the number two channel in day time and in late night and the number four channel for women overall. That 12% scale is very important today.

At this consolidation here in the U.S if we had 4% scale that would be real issue for us, outside the U.S the fact that we have six broadcasting networks and six cable networks in Italy gives us a – we’re the third largest player and the largest outside media company in Italy and the biggest media company in Eastern and Western Europe in terms of pay-TV, that’s important and so we do want to get bigger in Brazil, we want to get bigger in Mexico, we want to get bigger in Europe and Asia but we need to do it on a disciplined basis. And when we see our businesses growing over 20%, – 18%, 19%, 20%, 22% you can accumulate a lot of growth in a short period of time by just staying the course and doing what you are doing.

So we’re looking, we certainly have a great team and great synergy and a lot of momentum. We feel comfortable that there aren’t the right assets that we continue to scale up as it is.

Benjamin Swinburne – Morgan Stanley

That’s helpful. And does Sky Europe factor into that at all you are sort of starting to see Europe move a bit in the consolidation sort of pact the USA have?

David Zaslav

Yeah we had a very good relationship with Sky Jeremy Barrett in most cases we sell our advertising in markets around the world in the UK Sky sales our advertising so they are the biggest distributor and they our advertising, we have 15 channels in the UK we have a very strong relationship with Jeremy, we have been very effective and I think a very symbiotic with Sky Italia, with Sky Deutschland, we also have a good relationship with FoxTel in Australia. So, I think you know part of this is building relationship and those relationships are often built on how long you have been in the market, how important your content is to the viewers and so I think we are in that relationship with Newscorp by having a lot of channels, important content that matters, it allows us to partner up, so I think there is no question consolidation raises issues, the fact that we have significant scale in those markets, I think is very helpful to us.

Benjamin Swinburne – Morgan Stanley

Thank you.

Andrew Warren

And Ben from a purely financial operating perspective on your acquisition question, 2Q is an important proof point for us when we annualize SBS, you look at the overall margin profile the company up 100 basis points, international up 50 basis points, it really showed and demonstrated you know the kind of command control that we talked about, that we are going to be grow margins off the new base, when you leverage this dataset, you know our infrastructure our ability to grow both the topline and leverage our cost base.

Benjamin Swinburne – Morgan Stanley

Thanks Andy.

Operator

Your next question comes from the line of Jessica Reif Cohen From Bank of America, Merrill Lynch. Please proceed.

Jessica Reif Cohen – Bank of America, Merrill Lynch

Thank you, you mentioned early in the call that there is a CPM gap on the newer channels, so I am just wondering if you could give us a range of what you think it is, in the U.S. as well as I think you said outside the U.S. as well that you feel like you are not really monetizing to the full potential?

David Zaslav

Sure thanks Jessica. It’s in the U.S. it’s quite meaningful it – I think it’s going to take us another 2-3 years to at least on ID and we have been added on ID to get our fair share on CPM, the bad news is that it’s taking a long time, the good news is that we are making significant progress, we have really started on a very low base, I don’t think anybody expected that we would be aggregating these kind of female audiences with the length of view and scale of what ID has become.

So, we are now starting to sell it really as a must have product, we are number two in day time, number two in late night. But it’s going to take time, the good news about that, there is some built in growth, same thing with Destination America and as look at some of our growing networks that’s going to provide real growth to us, so if the market – if the markets CPM are lower you should expect to see as those channels grow higher growth from us, outside the U.S. it’s even bigger, because we just rolled out TLC 18 months ago, into almost 190 countries ID we’ve rolled into about 150 countries in the last year and we are going to roll it out to another 50 in the next 12 months and we are getting accelerated viewership on those two channels in a meaningful way, one of the real advantage as we have outside the U.S. is that you go to France and you put on a TV, you are going to Italy and you put the TV on, it’s just the much, much less competitive environment.

So as we launch – you launch a channel here in the U.S. you are one of 200 or 220 if you launch a channel in Russia in the Ukraine and Italy you are one of 50, one of 40, one of 60 and also just rationally the pay-TV market is more like it was 7, 8 years ago maybe 10 years ago in the U.S. so younger viewers are watching more of cable advertisers are starting to move over. So, we see a bigger gap.

Finally I would say that one – when you look at the U.S. subscribers are flat, viewership is flat. So, it’s a pretty tough market, the one win at our back in cable is that there is still a meaningful CPM differential between broadcast and cable and it’s becoming less and less easy to justify.

Primetime is probably the best justification, but when you look at the kind of viewership that we get on for instance ID in late night or ID during the day it’s much more difficult to do that, so I think you’ll continue to see over the next couple of years that gap not just for us but for cable versus broadcast come down.

Jessica Reif Cohen – Bank of America, Merrill Lynch

Can I just the similar question on the affiliated deals a lot similar, but internationally how often do these deals come up and how much of your distribution revenue growth is – pure sub growth and how much are we starting to see affiliates for sub increase, I know we are way behind the U.S. but what kind of increase are you seeing.

David Zaslav

Well, outside of the U.S. is a shorter cycle so it tends to be about 3 year deals and the deal work differently and we are trying to change that. Most of the growth that you are seeing is actual subscriber growth, not pricing growth and the good news we are not the only one trying to change that now. Now there are some markets that have very high growth, we are just getting on that boat and going along with the sub growth is still hell of a ride, but there are number of markets that have slowed down, we are going to take now our scale and we have whatever our 10 channels or our 14 channels in the markets and really starting to drive through pricing growth. So I think over the next few years if we are successful you will see more of pricing growth where you know historically just been sub growth.

Jessica Reif Cohen – Bank of America, Merrill Lynch

Thank you.

Craig Felenstein

Next question operator.

Operator

The next question from the line of Anthony DiClemente from Nomura. Please proceed.

Anthony J. DiClemente – Nomura Securities Co. Ltd

(inaudible) for the trajectory, international ad growth the number that’s apples-to-apples with the 17% growth that you guys put in the release, I was just wondering if you can give us that number in the 2Q excluding the unfavorable impact, the World Cup until showed we expect that 17% to actually re-accelerate given the impact of the World Cup into the second half? I have a follow-up thanks.

David Zaslav

The World Cup did have an impact on us having sent in that 17 was also few days of – there was some stuff in and some bad stuff out, if you took all that away, we would have still been well into the teens, even despite World Cup probably better than that if the World Cup wasn’t there, I don’t know Andy.

Andrew Warren

That’s correct, the – when you take some of those kind of unique items, we were still like a teen ad sales growth company internationally and we certainly expect that to continue in the third and fourth quarter, just really given the whole notion of share of wallet following share of viewership, in many of our key markets we still see our viewership and our share being much greater and our share of ad sales wallet. So, that cycle of catching up will really benefit us I think for many years to come.

Anthony J. DiClemente – Nomura Securities Co. Ltd

Thank you Andy and then David, just Liberty Global has been a partner viewer I wonder if we could get your thoughts on Liberty Global acquisition of 7% of IPV have you consider partnering with John and with Liberty Global on that, I mean it seems to me that you would make sense to part of your free to air acquisition strategy on a fundamental level and then referring to an earlier question tax level, it could have been or could be helpful in terms of potential Inversion strategy. So, just want to get maybe your or Andy thoughts on that particular asset? Thanks

David Zaslav

Well, we don’t – we are not going to comment on any specific transactions but Liberty Global John and Mike Fries have built a great company and we like working with them, we like working with Rupert and Jason and James and Jeremy on the Sky platform throughout Europe, we see ourselves as partners with all of our major distributors and we are always looking for opportunities to work with our distributors to create more scale, more distribution revenue, better advertising, CPMs but that’s it.

Anthony J. DiClemente – Nomura Securities Co. Ltd

Okay. Thank you very much.

Operator

Your next question comes from the line of Alexia Quadrani of JP Morgan. Please proceed.

Alexia Quadrani – JP Morgan

Thank you. Is there any more color you can provide on the ongoing affiliate negotiations and do you sort of believe the dynamics may change at all upon the closure of the proposed consolidation on the distribution side? And then just a follow up on the previous comment you made about CPM gap and narrowing that gap domestically, I guess any can you continue to see that now a bit with the volume right here.

David Zaslav

On the consolidation here in the U.S. First it looks like those deals are going to take meaningfully longer than expected. So I think in terms of the timing of the close of those deals it’s looking like it will be mid to at least mid-next year maybe later than that with the number of transactions that need to go through the system. And the implications of those very large consolidations. For us our focus is we’re now almost a 12% viewership on cable we were at 4 how do we drive that to ‘13, ‘14, ‘15 how do we make own stronger Discovery TLC. So certainly consolidation raises meaningfully as used where is to looking at it. We’re thinking hard about it as is all content owners in the business join to get that out. So we’ll continue to do that.

On the CPM side, it’s we’re very focused on driving CPM value and we will often hold on price and walk away from business because in the long-term getting the value that we deserve for the quality audience we provide is how we’re gone get meaningful growth. And so you probably see us at the front inline of standing on price. And it does take longer with some of the newer networks and so we’ve been working with the advertisers and we feel like the more term is been with Destination America, Velocity, ID the more they’re gone want to come back. But on the volume side we walked away from dollars there and we’ll continue to.

Alexia Quadrani – JP Morgan

Thank you.

Operator

Your next question comes from the line of Michael Nathanson from MoffettNathanson. Please proceed.

Michael Nathanson – MoffettNathanson LLC

Thanks. Let me just ask Andy. Andy, firstly you mentioned and we saw the cost were down in the US this quarter. So we look at the year as whole where do you think the right level of cost growth for US to the US for the whole year?

Andrew Warren

Yes Michael we’ve been very focused as we’ve talked about the cost structures and driving productivity and showing that we can sustain the level of profit free cash flow growth and part of that comes from just management of cost as aggressively as we can. So I think for the year, we expect kind of a mid-single-digit cost go through the U.S. net. We’ve talked about kind of on the content side be a more kind being in the mid to high and on the SG&A side kind a being low to mid. We have in the last several quarters only increased content spending growth kind of mid-single-digits which is certainly help the content profile going forward. There will be one meaningful exception to the growth rate which is the – another walk that we have in the fourth quarter. We’re excited about that and the impact that it will have on ratings in the top-line but to assume it’s a meaningful cost associated with that kind of live event.

Michael Nathanson – MoffettNathanson LLC

Okay. And then maybe I guess follow up on ad slot. Are you sort any – deals in the second half of the year within your guidance?

Andrew Warren

No we’re not. So basically where we are assuming a continuation of the current deals in place so not assuming any large deals. So for the year approximately $10 million of kind of SVOD revenue from the Netflix deal that we already had previously.

David Zaslav

Having said that, we see significant value in our basket of content. We own all of the content we put on our ‘14 channels, the quality of that content it continues to get better the characters to storytelling the diversity of audiences. So we think that content is very valuable in on all platforms including SVOD as do the SVOD providers. And we’re in discussions with all of them and if we feel that whether it’s over the next few months or longer we will have some SVOD relationships that are benefit that are mutually beneficial.

Michael Nathanson – MoffettNathanson LLC

Okay thanks, David.

Craig Felenstein

We have time for one last question operator.

Operator

Your last question comes from the line of [John Chennades] from Jefferies. Please proceed.

Unidentified Analyst

David you’ve talked about tripling of viewership share. Since last quarter’s call there is been concern about TV ratings broadly. Can you talk about the weakness, do you think it’s in your pocket on the content side of the business, the change in viewership average timing issue or something else.

David Zaslav

I think viewership on cable is pretty stable it’s not a great story in the US, it’s flat. People are spending more time watching TV in general that’s what the data says on the other hand when you added all up, it’s basically flat. So it’s you have to you need better content, we’re focusing on instead of just more content having be stronger better characters better story more on brand. But the U.S. market is a bit of a challenge, but the good news is we have very good creative team over the last few years we’ve been able to grow. The as you look at the first half of the year I think cable in general outside of us is down about five but we’re up about one.

So outside the U.S. we’re up almost 20. So it’s not easy picking here and most of the share that you get if we gain share somebody else loses share. Having said that the fact that when we own our content there are lot more buyers for it now there are number of players in over the top space that when acquire our content is SVOD. And mobile domestically in around the world that becoming more and more interested in content. And so I think the ability to grow in a big way here in the US aside from new channels which is where a lot of our growth is coming from is definitely not as easy as it used to be.

Unidentified Analyst

Thank you.

David Zaslav

Thank you everyone for joining us. If you have any follow up questions, please let us know.

Operator

Ladies and gentlemen that concludes the call. Thank you for your participation. You may now disconnect and have a great day.

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