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CTC Media, Inc. (NASDAQ:CTCM)

Q2 2014 Earnings Conference Call

July 31, 2014 08:00 ET

Executives

Irina Faritova - Head of Investor Relations

Yuliana Slashcheva - Chief Executive Officer

Nikolay Surikov - Chief Financial Officer

Lilia Omasheva - Chief, Operational Efficiency and Organizational Development

Analysts

Edward Hill-Wood - Morgan Stanley

Alexander Vengranovich - Otkritie Capital

Olga Bystrova - Credit Suisse

Anna Lepetukhina - Sberbank

Anastasia Obukhova - VTB

Irina Faritova - Head of Investor Relations

I would like to welcome to CTC Media’s Second Quarter and First Half 2014 Results Call. Joining me today to talk about our results are Yuliana Slashcheva, our Chief Executive Officer, Nikolay Surikov, Chief Financial Officer of CTC Media, and Lilia Omasheva, Chief of Operational Efficiency and Organizational Development. You will be able to follow our webcast with presentation of the slides where Yuliana will run through operational development of the company, announcements for 2014. Nikolay will comment on our financial results and Lilia will join us in Q&A.

Afterwards, we will move to Q&A session as always. We trust that you have received the early release, which was issued earlier today. If you haven’t received the copy of the press release which is available on our website at ctcmedia.ru. Please refer to the earnings release for the reconciliations of non-GAAP measures to the most comparable GAAP measures. I would also like to note that the webcast with presentation of today’s call is available on the Investor Relations section on our corporate website.

Before we begin, we would like to remind everyone on today’s call may contain certain forward-looking statements based on environments that we currently see and as such does include risks and uncertainties. Please refer to our SEC filings for more information on specific risk factors that may differ -- could cause actual – our results materially.

I would like to hand the call over to Yuliana.

Yuliana Slashcheva - Chief Executive Officer

Thank you, Irina. Thank you everybody for joining the call today. I will go to our key operational highlights first, before I pass the word to Nikolay Surikov, who will cover the financials. As all you know the first half of the year has been dominated by a number of major political economical and social happenings in our market which of course influence our business because TV always reflects what is going on in the country and what is happening. However, I should say that we have done pretty well despite all these difficulties and have delivered another period of successful development. We remain on the track with our long-term strategies and move forward being very certain of what we do.

Our Russian advertising revenues were up 7% in ruble terms, during the first six months of this year, and we increased our share in the Russian TV advertising market, the CTC Media as a group has increased its share. I hope that all of you are looking at the webcast presentation. If not, as Irina said, you can find it later on our website, but we have all this information there. As you see, we have outperformed the Russian TV advertising market both in the second quarter and the first half of the year, despite of the audience share loss, which was first of all due to the increase of the audience share of the channels broadcasting news. This made the biggest influence over our audience. However, in revenues we have outperformed the market. Our Everest advertising sales house fully sold out all national inventory during the period, and our full-year inventory is now more than 95% committed at higher average prices than in 2013. We have also expanded our customer base, and attracted new advertises despite the less favorable market conditions which is a very big issue for us because we are always of course, try to keep our existing big advertisers, but we are always in the constant search for the new comers and that’s a really good results of the period.

We have also expanded – sorry we are speaking about our big advertisers, our top 25 advertisers who are with us for many years increased their CTC Media inventory demand by 20% in first half of 2014. We have also increased the premium sponsorship which now is about 8% to 10% of our general advertising revenue and increase was around 32% in this first half of 2014 which is also a very important piece for us because sponsorship is more marginal for us than just direct advertising. It’s more creative, it demands more thinking and more proposals from our sides like creative proposals, however brings us more revenues.

Another important event that have happened during this second quarter is that getting together with the other market participants and during a lot of lobbying activities during the last year, we have managed to postponed the full launch of second TV digital multiplex from 2015 to 2019. This is a huge achievement that we will have a significant impact on current and future CTC Media Group and financial performance in the long-term period. And, we will enable the cost optimization. We will discuss it in more details later on this call. I will give you some figures and fact about the muliplex.

Another thing which is important is the CTC Love, our fourth channel. That was launched successfully in the beginning of the second quarter. And this is very actively in the moment, is very well on its way and it’s actually even that’s the plan which we had in our minds when we were launching the channel. Technical penetration of the channel increased up to 25% already, normally three and a half months since it was launched. So, we do cover 25% of the Russian market. By this channel, I mean the audience, the technical penetration, and we already gained more than 30% of penetration in Moscow and 40% in St. Petersburg. We successfully started the sales of CTC Love to advertisers and already committed almost $1 million for the advertising for this year, for this particular new channel.

In September, we are going to start negotiations with the TNS Gallup regarding CTC Love measurement in TNS panel and we’ll start selling the advertising by GRPs. At the moment we are selling it by minutes, as on every channel which is now sold by GRPs are not measured. So, from autumn we will start measuring, TNS will start measuring the channel. In September, we were also planned to look on our first initial audience share data, and according to the figures which we’ll see, we will clarify the target audience for this channel on how it will be sold. We continue to realize our long-term strategy in centralization of production and content acquisition, as I announced it all the conference calls I was talking about it, that I do see it as a crucial issue for CTC Media to centralize certain main key function and that’s what we do.

We are proud that we have new people joining our Company, Ruslan Sorokin joined us as an Executive Producer. Ruslan is very well positioned TV producer who used to have his own production company which have done a lot of very bright projects for the Channel One and for other channel. And now Ruslan has joined us. And also we announced the joining of Maria Smirnova, as a Head of Content Production Acquisition and Sales. She joined us in the second quarter and is already very well incorporated in our business. Maria was heading one of the main divisions of Sony in Russia for 10 years before that. We are looking forward to reinforcing of our content pipeline in 2015 and beyond with the help of this new people joining the company.

We also moving very well in our Transmedia field. Our Transmedia business has further expanded our online audiences and extended our leadership in new distribution technologies across multiple delivery platforms. Among the highest were the Q2 launch of Russia’s project based on MARVEL, MARVEL content is the project we have done together with Disney which engaged approximately €5 million into the project which is a huge number and could be easily compared to the coverage we usually get from TV. And that gets us additional ways of monetization of this coverage in future. We have launched and made a first try of the digital launch of our new sketchcom prior to TV launch, that was the first time we have ever done that. The sketchcom was called Students, it’s a comedy and it was available free of charge on our websites on CTC Media, ctc.ru and on in the key social networks such as Odnoklassniki, VKontakte, Mail.ru and others.

And the first month of this sketchcom are being on digital has brought us 1.3 million viewers that which is actually more than we get the viewers in Moscow and the Moscow region. So, that shows that those figures show us that we should go further and we are on the right track and we should find and we’re already finding and developing right now the new ways of monetization of this ownership and on this huge amount of new audience which we are able to attract. We are also working on several other breakthrough projects to provided integrated television and online broadcasting. We also made four of our TV serials available to Hulu subscribers this year actually it was this in the second quarter. And among them, we have sports drama Molodezhka, dramedy Ranetki, mystery thriller “The day after” and crime drama “Lavrova’s Method.”

We’re evaluating further expansion opportunities for our international distributions and are currently negotiating with other video platforms and aggregators in the US and Europe. That’s – these developments are very important for us because if you remember in our strategy, I was highlighting that I see it as a one of the main developments for CTC Media is to get additional revenue resources for the Company because I do think that’s also one of the crucial issues for our further development. Now, I’m moving to our audience share development. If you are watching the presentation, then it is applied for. During the first six months of the year, the audience shares of our core Russian channels were influenced by a shift of focus towards news broadcasters on Ukraine. Attention of the US viewers was also captured by 2014 Olympic games in the Q1 and the – in the first quarter in World Cup, in the second quarter.

However, these events increased the overall TV viewership and helped us to offset the reduction in the audience shares and monetize our advertising inventory to a large extent.

We observe the continued audience fragmentation in the second quarter of 2014. Also made – and it also had an impact of course on our activity and our audience shares. All national free-to-air TV channels in Russia were challenged by increased competition from smaller non-free-to-air and local TV channels viewership in our audience in our key audience for CTC channel which is “10-45 all”. It increased from 18.6 % in the second quarter of 2013 to 20.1% in second quarter of 2014. So, it’s a very significant increase of the viewership of the smaller cable and satellite channels in our key audience. Despite this increased competition, nearly every one of our premieres secured a higher than average audience share, including Last of the Magikyans, we had the share of 12.4, Two Fathers - Two Sons, with the share 11 and Dark World Equilibrium with a share of 12.1%.

For CTC channel, we have also faced tough comparison with the last year when audience share in Q2, 2013 reached 11.6% which was actually very high for the channel. So, the comparison days was essential. CTC channel maintained its place as the third most-watched broadcaster in Russia in its target demographic audience of 10-45. We planned to launch a strong lineup of premieres content for the second quarter of the year and are confident that this should improve our share performance through the end of the year. We do have an essential pipeline over which you will all see starting from – already from August of this year. The Domashny channel’s target audience share decreased year-on-year in the second quarter of 2014 from 3.5% to 3.3%, which is a very slight decrease. If you keep in mind that all the entertainment channels had a decrease because to the reasons – due to the reasons which I already mentioned above. But also, Domashny of course reflecting the effect of the audience fragmentation and another fact is that with the new General Manager and General Producer for Domashny channel, we are making the audience of Domashny younger, adding some new programs and of course the change even the very slight change of the audience is always difficult for the channel.

And in the first year, it always brings a small reduction of the audience which will then be much, much more improved after we go through this period of changes. I should say that we have strengthened the horizontal programming grid on Domashny very significantly, and increased the audience share in prime time with most effective monetization of these two (inaudible). Domashny is continuing to strengthen its demographic profile and growing its core female audience segment. As I already said, rejuvenating the channel in general. Proportional women 25, 45 years old increased by 5 percentage points in its target demographic over the first half of 2015. Currently we see a promising upward trend in the audience share. In July, the channel reached its maximum of 3.9% of the audience in its target demographics.

Speaking about Peretz, couple of words about Peretz. Peretz’s target audience share was down year to year in the second quarter 2014 from 2.3% to 1.9%, really in reality Peretz is the most – this channel which was mostly hit by the switch to the news broadcasters, because that’s the channel for male, for men and the men tend to watch news much more. And it’s because of Peretz is down, they are like extreme fight and reality it’s very hard to keep the viewers and the channel when the real war is going on and the news always show that. So, that’s of course attracted a lot of audience of our – the Peretz audience to the news channel. But, we do improve the programming grid on Peretz as well. As I promised before, it’s moving more towards the concept of the truTV more assimilated with digital and with the internet and a number of new projects already appeared on Peretz in the second quarter of the majority of the new programs and the truTV concept will appear in autumn in this third and fourth quarter.

We proceed with the launch of this programming and I think in the fall, you will be able to see that already. Current audience share performance shows that the recover is on its way, audience share was 2.1 in June and improved to 2.2 in July. So, I think we’re on the right track with the new programming grid and more cutting-edge and dynamic programs. Now, I move to the digital partnership and special projects. And here, we had a strong line up of special projects during the period. I have already mentioned the MARVEL, the Disney MARVEL project and online premiere of sketchcom Students. We are also working on the other projects at the moment. The test version of SecondScreen for Molodezhka application has been completed, so it seems like we will get the first ones on the market to launch the real SecondScreen on TV. This a unique thing for Russia and for the media industry because it was never done before.

The launch was planned simultaneously with the second season of Molodezhka series in autumn. We are now negotiating finalizing our negotiations about the direct partnership with the largest Russian video content aggregators, and largest Russian so-called gateways to the internet with some of them, we have already reached the agreement and signed up and with others, we are working on it, and we do the technical integration with a biggest platforms and biggest gateways. Our video now, our video content is already available on Odnoklassniki. The partnership with Yandex starts in the fall of 2014. Our distribution of videos through the aggregator code platform at the main social networks VKontakte, should begin already in August-September of 2014. A number of special projects with Rambler are in development and are planned to be launched in the fall of 2014. And we have also agreed on all commercial terms with the company which is producing games called Game Insight, that develops the game based on the script of Molodezhka series.

The game development is in progress now and its – the launch is set for September 2014. So, this will be also something very new for the market. We will launch the first game completely devoted and completed release it to the very famous series. Update in the multiplex is something you probably are very interested mostly interested in. As I already mentioned earlier, the rollout program of the second digital multiplex has been modified, modified which will have a significant impact on current and future CTC’s Group’s financial performance in the long-term period. We have done – we have put a lot of efforts in these achievement since I’ve joined in August last year, actually it will be – I should have started with that, it’s now a year since I’ve joined the company. And we have done a lot to lobby this reach during this year. So, we’re very proud of this success and very proud of the financial efforts it will have over the company.

The following changes took place, instead of 100% of infrastructure rollout in 2015, beginning on the second half of 2014, there are a main regulator series launches broadcasting in features with population more than 50,000 people in the second multiplex. Over the period between 2015 and 2018, RTRS construct broadcasting infrastructure in cities with population more than 10,000 people but doesn’t put this infrastructure into operation which is very fine for us because we do seeing that in our major audience is in the cities, 50,000 plus. So, it’s very helpful for us and very economically motivated.

In 2018, RTRS constructs broadcasting infrastructure in cities with population less than 10,000 people but doesn’t put this infrastructure into operation yet. Starting from 2019, RTRS put into operation broadcasting units in cities with population less than 50,000 people. As a result of the above mentioned changes, the cost of broadcasting in the second multiplex has been significantly reduced over the next five years. We now expect the inclusion of CTC and Domashny channels in the second multiplex to cost us up to RUB185 million net of VAT in 2014 compared to the previous forecast of almost RUB900 million. We will therefore see the optimization of more than RUB500 of operating cost with this optimization contributing more than RUB4 billion to our cash flow by 2019.

Now, I pass the word to – that’s all from the operational highlights. I will pass the word to Nikolay Surikov, the CFO of CTC Media to cover the financial highlights. And then, I will get back to you to give you the guidance to the end of the year. Thank you. Nikolay?

Nikolay Surikov - Chief Financial Officer

Thank you very much Yuliana. Good afternoon to all. Let’s move on to our financial performance. Current situations significantly impacted our reported financial results. During the second quarter of this year, as the Russian ruble depreciated by 10% and 11% during six months period, year-on-year against the dollar. Approximately 99% of our total revenue and around 70% of our costs are ruble denominated. For the six months period, our group total revenues were up 4% year-on-year in ruble terms $2,370 million.

Group advertising revenues were up 7% year-on–year in ruble terms to over $367 million. This result was obtained despite the airing of Sochi Olympics and World Cup on the state-owned channels in February and June and the shift of viewers’ attention to news broadcasts about the Ukrainian crisis. CTC Channel operating revenues for six months grew 5%, and advertising revenues were up 8% ruble terms, principally due to estimated growth of the Russian television, ad market, and increased sponsorship revenues partially offset by decrease in target audience share year-on-year. Domashny channel’s operating revenues for six months were up 6% and advertising revenues were up 7% in ruble terms, principally again due to the growth of the Russian television ad market, and increased sponsorship revenues, partially again offset by decrease in target audience share year-on-year.

Now, Peretz channel. Operating revenue for six months were down 3% and advertising revenues were down 2% in ruble terms, principally due to decrease in audience share year-on-year in both three and six months period partially offset by effect of the estimated growth of the Russian television ad market. Channel 31 in Kazakhstan, operating revenues for the first half of the year in U.S. dollar terms were down 22% year-on-year and down 8% in tenge terms principally due to overall decrease in our ratings, reflecting decline in Kazakh television viewership, and the estimated decrease in the overall television advertising market in Kazakhstan.

Our digital media revenue now represents around 1% of our total revenue and showed 42% growth in ruble terms in the second quarter, and 50% growth in the first half of the current year. Our OIBDA for the first half of the year was up 6% in ruble terms and reached $101.4 million with the OIBDA margin of 27.4% which is 0.4 percentage points higher year-on-year. Our total operating expenses were up 3% in ruble terms for both three months and six months period ended June, 2014. Direct operating expenses were up 21% in ruble terms in the first six months, largely as a result of increases in transmission costs, reflecting growth of digital transmission fees for second multiplex and annual raises in salaries plus an increase in (inaudible) costs reflecting annual raises and increased headcount in front office.

SG&A expenses were down 2% in ruble terms of the quarter but was up 8% in the first half of the year reflecting mainly a year-on-year decrease in advertising expenses in the second quarter of 2014 due to timing of the advertising campaigns at CTC and Domashny channels and increase in compensation payable to Video International year-on-year in the three and six months ended June 2014, due to temporary change of advertising revenue structure, which is the base for compensation calculation. Programming costs for six months period were up 21% in ruble terms, reflecting the timing effect of the launch of the Peretz in the season in April 2014, and a more expensive programming mix at CTC channel.

Important message here is that our advertising revenue growth rate was significantly higher for the same period, this means that the growth of the gross margin from the (inaudible). Stock-based compensation expense decreased by $2.9 million for the six months period as the result of re-measuring of the equity based cash incentive awards granted to employees under our 2009 Stock Incentive Plan at their fair value, and as the result of decrease in share price in 2014.

Our effective tax rate was approximately 31% in the three and six months periods, this year – while last year it was around 36, reflecting the change in the approach to the recognition of foreign tax benefits that were available for offset against US taxes based on a comprehensive examination of certain positions taken in our historical US income tax filings. This approach was applied for the recognition of such tax benefits starting from the third quarter of last year. As a result, our first half net income was up 10% year-on-year in ruble terms and to $57.9 million.

Now moving on to our cash flow. Our net cash flow from duration activities for six months was up year-on-year to $50 million reflecting the joint net effect of higher cash received from advertising sales and highest spending on the acquisition of programming in ruble terms speaking in ruble terms. Net cash used in financing activities amounted to $58.5 million in the first half of year and primarily reflected the payment of $40.7 million in cash dividends to the Company’s stockholders, $3.5 million in dividends paid to minority shareholders of the Group’s subsidiaries and $13.8 million increase in other non-current assets, which represents dividends to one of our stockholders that were blocked due to US sanctions imposed on Bank Rossiya.

We therefore generated $47.8 million of free cash flow during the first half of the year comparing to $47 million in the same period of last year and ended the period with net cash of $190.3 million compared to $142.4 million as of the end of June last year. Our Board of Directors currently intend to pay first dividend of $0.7 per share were up to approximately $109 million in the aggregate in 2014 with a 11% year-on-year increase and for declared a cash dividend of $0.175 per share for approximately $27 million in aggregate to be paid upon or about September 26, to the shareholders of record as of September 5.

Now, back to you Yuliana. Yuliana, now back to you.

Yuliana Slashcheva - Chief Executive Officer

Yes, I’m here. So, actually I needed to excuse myself because of that I’m traveling in the moment, and so I’m not handling the call as usually from the CTC Media office. I’m doing it from the mobile phone. So, the connection can be not so well all the time but I’m trying to stick to one place, not to move much so in order you can hear me well. The guidelines, sorry the guidance for this year. We expect the Russian TV advertising market to grow by up to 5% in 2014 and we aim to outperform this growth with our Russian TV advertising revenues. We expect comparatively less growth in our total revenue due to the significant decrease in sub licensing revenue to Ukraine. We are working on partnership through the key websites and several breakthrough projects in Russia to provide integrated television and online broadcasting as I already mentioned when I was speaking about Transmedia and digital.

And we continue to expect to grow our revenues from digital business lines by 30%, 35% in 2014. CTC Media will also continue to invest in content, but we anticipate that the programming expenses will grow at a lower rate than its total revenues and it lower pace than in 2013 due to our optimization program and centralization of production and acquisition, as also was mentioned before. Changes in the federal digitalization program will significantly reduce our expenditures starting already from this year, I also mentioned it before. Considering multiplex related savings, we have upgrade anticipated – upgrade is anticipated OIBDA margin from 28% to 30%. Our Board of Directors currently intends to pay cash dividends which Nikolay already mentioned of $0.7 per share or up to approximately $109 million in the aggregate with a 11% year-on-year increase and has declared a cash dividend of $0.175 per share for approximately $27 million in the aggregate to be paid in September.

We expect capital expenditure of up to $10 million and anticipated effective tax rate in the range of 30%, 35%. We are also fully committed to creating a long-term sustainable shareholder value and will continue to implement our strategy announced in November of last year. That’s it on my side. I think we can now switch to the questions. As I already said before, that I might have the connection which is not very good. So, it’s not always that I may hear the questions. I will rely here and my colleagues in CTC Media office on the call to help me with answering the questions. Thank you.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Edward Hill-Wood from Morgan Stanley. Please go ahead.

Edward Hill-Wood - Morgan Stanley

Hi. Good afternoon, everyone. I have two questions, please. Firstly on the multiplex change, you’ve outlined the potential charge for 2014. I was wondering whether or not we have any greater visibility on the final – the amount of likely final payment in 2019 which was previously outlined at $26 million or so for the channel, whether or not there is any update on that particular number? And secondly, just on advertising, the official advertising guidance has been reduced a little bit in this statement. Could you just provide some color on current negotiations and how you see the third quarter shaping up in terms of advertising market whether or not you’re saying that 5% is going to be or up to 5% is potentially at risk for the full year? Thank you.

Yuliana Slashcheva

Okay. Here is that I start with the second question answering myself and then I will ask Nikolay Surikov to answer to give the details on the multiplex payments. So, regarding the advertising market, here we are totaling it down for ourselves. If you remember in the beginning of the year and even in the end of last year, our guidance was higher, we started with above 5%. However digital international which was our main seller in the market from the very beginning was forecasting it to be less or at the level of 5%. Anyway, at the moment, we do think why would give forecast is because we see only the current situation, it has predict what will happen in the fourth quarter. We know that in the second quarter, some of the budgets actually about 2% of our budgets were moved to the second half of the year.

So, we really hope that this budgets will come to the channels and not disappear. For the third quarter, there the sales grow well and we saw a very optimistic trend in July. I think that they happened due to the World Cup mainly but then they would change by slightly negative trend, pessimistic trend, in August because July and August our market growth was very, very different, July was high, August was low, the sales in September, for September growing well now. So, that is why we stick to I would say optimistic for a cost of up to 5% because we see it in our current sales. How the situation will change in the end of this Q3 or Q4, it’s hard to predict at the moment. But, generally we don’t see any bad trends, any like seriously negative trends, and that is why we don’t see a very high risk of the change of this forecasted growth. However, we are living in a very unstable economically, politically sorry imposed environment now. Nikolay, can you answer the question regarding the payments for multiplex in next year.

Nikolay Surikov

Yes, yes. Speaking about multiplex, starting from the next year 2015, we pay for all transmitters which cover cities 60,000 plus for the full year. The percentage trends for the next year and up to 2018 will be calculated on an annual basis according to the rate that RTRS will set by 1st October, the prior year. But, we can now assume that based on the agreed terms, according to the information received from the regulators, our annual expense in this period, 2015-2018 will be in the range of RUB250 million, RUB300 million for those channels. Speaking about the next year like 2019 and beyond, multiplex payments are now – it’s really hard to predict but they are expected to be broadly in line with the previous market expectations of around RUB1 billion for channel, adjusted on the inflation rate by that time.

Edward Hill-Wood - Morgan Stanley

Okay. So, just to be clear on that. So, you’ve got – from the $5 million this year, we’d expect somewhere between RUB250, RUB300 2015-16, maybe ramping up 17 around 18 and then finally to finish with $1 trillion in ’19, right?

Yuliana Slashcheva

Yes. What is not clear for us at the moment is 2019. This year when the digitalization will be fully rolled out, this year is still unclear and we are still talking to RTRS about that. And, I think we will not know any exact figures on 2019 within next at least one year. But, all the years until ’18 are more or less clear, but all the information we are based on is the information which we get from RTRS as a main regulator. So, according to them, the figures which Nikolay just outlined would be actual.

Edward Hill-Wood - Morgan Stanley

Okay. Well, that sounds like very good news. Okay. Thank you.

Yuliana Slashcheva

Yes, sure.

Operator

Thank you. The next question comes from the line of Alexander Vengranovich, from Otkritie Capital. Please go ahead.

Alexander Vengranovich - Otkritie Capital

Hi, guys. Good afternoon. I have a question regarding you profitability guidance for this year. So, if we compare the figures on an adjusted basis, let assume some 2.5 percentage points as far as I understand, reduction of the profitability, of which approximately like little bit more than 0.5% due to the multiplex cost. While, I’m just wondering where do you expect that the remaining part of the costs to increase. So, should we expect to increase as a percentage of sales of SG&A or it should be of a question of increasing some direct operation expenses because as far as I understand, programming rights as percentage of sales as you’re guiding should be going down, that’s why supporting the margin.

Yuliana Slashcheva

Thank you. Nikolay, is that right I mean the percentage.

Nikolay Surikov

(Technical Difficulty)

Yuliana Slashcheva

Sorry.

Nikolay Surikov

Sorry. Say it again.

Yuliana Slashcheva

Your graph to the figures, I can give the explanation but can you address the figures just mentioned about the decease of the profitability?

Nikolay Surikov

Yes, yes, of course. We can comment and I already mentioned it that our direct operating expenses were up, largely as a result of increasing transmission cost due to multiplex and due to increase in transmission in cities plus we have increase in salaries and employee related benefits reflecting annual raise in increased headcount allow to have some general and administrative expenses raised related to inflation for example the rent related expenses.

Alexander Vengranovich - Otkritie Capital

Okay. So, to understand correctly…

Yuliana Slashcheva

But generally, we should mention that generally we have a very essential optimization program going on through the whole year and that decreases a lot of other expenses from the level that which they were planned. But, the main difference in the profitability I think which you now observe is related to the decrease of the revenues which we will get from or get a significant decrease in the revenues from Ukraine sales as I told you. I think it’s a very essential teaser we were getting 2% of our revenues from sublicensing to Ukraine. And, we expect it maybe be in the best on 0.5% this year.

Alexander Vengranovich - Otkritie Capital

Okay. Do I understand it correctly that the improvements of your guidance is fully related to the reduction of the multiplex cost this year and your other cost items haven’t changed in the quarter?

Yuliana Slashcheva

No, it is not correct because if it was – or if the improvement was only due to the multiplex, you would actually see a decrease in profitability because of – as I told you, we were losing about up to 50 million in process, in the revenues sorry from Ukraine sublicensing and we have almost fully compensated it by their optimization program and the reduction of the number of costs due to the centralization process and optimization program itself. So, the situation now is very balanced because otherwise you would have noted a decrease in profitability because of the revenue loss.

Alexander Vengranovich - Otkritie Capital

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Olga Bystrova from Credit Suisse. Please go ahead.

Olga Bystrova - Credit Suisse

Yes, good afternoon. Couple of questions actually to follow up on the profitability guidance. I didn’t quite understand whether the improvement from 20, 30 range to 30% is attributed to only your expectations for the multiplex cost but also your cost control programs. That would be nice if you could comment again on that. And the second question is also a follow up in multiplex. But you were also talking about prepayment for construction of digital infrastructure. So, is that safe to assume that on top of 200, 300 OpEx per annum in ’15 ’18 you will also that scheduled for advance payments for construction and that will be cash flow expense, not OpEx. And there also maybe on top of that you could comment if how would you expect analog transmission cost to fade given that you would be providing services on digital already in cities 50 plus. And I think the final question is when you talked about digital strategy in the project, can you talk a little bit about the business model and the economics that you are going to have in those projects with Yandex, VK, Rambler gaming sites to the extent you can. Thank you very much.

Yuliana Slashcheva

Okay. I will answer the first and the third question. And I will ask Nikolay and the colleagues to answer the second one regarding multiplex again. So, the improvement of OIBDA is related to two phase as you perfectly understood that it’s related to the improvement of the multiplex payments. Though, there are some – still payments which we will take this year, we will do this year higher than the – that what we have paid last year. So, in comparison to 2013, we do have expenses related to – more expenses, these are related to multiplex. Anyway, the reduction, that the profit – the improvement of profitability is because of the multiplex savings and because of the cost reduction program which is in place during the whole year because as I mentioned, otherwise their profitability will not be able to improve that well because we are having a significant losses from Ukraine sublicensing revenues.

So, we needed to compensate it by very expensive cost reduction and cost savings programs within the company during the whole year. Now, coming to monetization. At the moment, on our monetization scheme which we are planning to use with all them – with all their media aggregators and their platform except for the gaming company because it’s a separate issue, it’s an A ward (ph) it’s an advertising driven model. So, we will be selling the advertising and all these special projects we do together and do the advertising slots prior to the video to watching any video content which will be placed on their platform. When it comes to some special events like the one we are doing with the PepsiCo called the (inaudible) Transmedia project and we are proud to say that we have signed two more and are negotiating another two Transmedia projects with the big companies at the moment.

Those projects are covered by sponsors, they are completely covered by like the money which the company is for whom we create the project bring to us. So, that lies in the sponsorship revenues. And the third type of monetization is when we do something with the gaming companies is kind of service, digital service companies. In this case, we do revenue share like with gaming side, they fully pay for their game themselves and that is why they first monetize it to cover their expenses and we only get 10% of their revenues since the game is launched. When they fully compensate their expenses, we share 50 to 50 all the revenues. And that will be done with all the service companies with whom we do joint projects.

Olga Bystrova - Credit Suisse

Okay. Thank you. Before we go into multiplex explanation, just a follow up on this to how – I mean you are definitely focusing quite a lot and quite successfully on the cost efficiencies. Are you concerned given that you have quite a few sort of content projects outstanding, how confident are you that you will be able to have program expenses under control, I mean is there any risk there that we should keep in mind. And on this monetization model, just want to confirm that this is not going to be – this is only going to be with let’s say with the Yandex, VK, et cetera, excluding gaming business, it will maybe advertising driven model not content cost driven model?

Yuliana Slashcheva

Yeah, yeah, it will be. For now, for this year, it will be advertising driven model expect for gaming companies and all other service companies, it would be not on the gaming, we are talking to the dating company to the travels online operators. In this case, the joint projects with this kind of companies, we will do revenues share, for the rest, it will be advertising driven. For this year, what we are working now the possible model of monetization of the content based on the content cost model, but I think we will not launch them until next year because it’s still, we still need to do, it was a very serious analysis around how to sell content on the best way.

And so on your first question was about programming expense, yes why do – why we are confident we can control the programming expense and keep them under normal level of growth the last year it’s because as I mentioned, in frames of our centralization program, we have already centralized all the production and acquisition of content under one department which is now being headed by very strong professional, Maria Smirnova, from Sony. And we already so sure to a plan to the end of the year and already absolutely confident that our program expenses will stay in the frames of what was budgeted and grow slower than it was growing last year just because of more effective management of the rights.

Olga Bystrova - Credit Suisse

Okay. Thank you. And on the multiplex?

Yuliana Slashcheva

Moving on to multiplex now, Nikolay?

Nikolay Surikov

Yes, yes. Speaking about the multiplex, just to remind you that this advances that we are going to pay to RTRS for a construction of infrastructure in the cities 50,000 minus, it will be shown in our balance sheet as an advance as a long-term advance prepayment rather than our P&L. So, again coming back to our first release, we mentioned that in aggregate for two channels, we expect to advance approximately RUB390 million this year, RUB644 million next year, RUB271 million in 2016, RUB68 million in 2017 and RUB51 million in 2018. So, in total, this will give us RUB1.4 billion of advances by the end of 2018 and this advances will be used to offset the payment that we are going to make in 2019 and beyond for the actual services rendered to us by RTRS. Speaking about analogue expenses, as you know we already disclosed that for this year, I expect expense for analogue transmission for all three channels was around 25 million. And, as of now, for the next year, we do not see any like reasons to change it significantly apart from usual inflation that we are having this year.

Olga Bystrova - Credit Suisse

But you are – are you going to fade sort of are you going to – as you’re launching transmission in cities 50 plus. Now, are you going to fade some of the analogue cost there or not to offset you new digital costs?

Nikolay Surikov

The thing is that, it’s more important to understand what is the consumption of our audience of the digital signal so we can have the digital signal available, but the audience is not consuming it because their set-top boxes are not in place. So, the reason spark – the TV set spark is also in rental source we will see. It will depend on the actual penetration of the consumption rather than technical penetration of the signal.

Olga Bystrova - Credit Suisse

Okay. Thank you.

Operator

Thank you. The next question comes from the line of Anna Lepetukhina from Sberbank. Please go ahead.

Anna Lepetukhina - Sberbank

Yeah. I just wanted to ask what was the cost, how much you spent on digital transmission in first half of this year, if you can disclose. And also, I’m sorry to dwell on this profitability guidance, but to me, it looks downgrade rather than upgrade because your previous guidance was 32% without multiplex cost. Now, you managed to decrease digital transmission cost by almost four times, but you’re guiding now at the low end of your previous range. So, is it because you now expect lower advertising revenues or there is something else because these cost optimization also in place, it seems that margins should be better. Thank you.

Yuliana Slashcheva

Nikolay, can you comment on this segment?

Nikolay Surikov

Yes, yes. I will comment maybe on the – I will start from the first part. So, for the six months period, our transmission related expenses are actually half of the guidance that we gave for the year, so it was around RUB90 million for both channels. Now speaking about the guidance for the year, you’re right that we gave before 32 without multiplex, but you should also bear in mind that we have significant decrease in the revenue from Ukraine, so that’s why heading back, the optimization effect which will have on our cost-cutting and cost optimization program, this is giving finally our 50% guidance. So, mathematically, it works.

Anna Lepetukhina - Sberbank

Okay. But, can I just follow up, you gave guidance I mean after first half results or first quarter results and basically the situation with Ukraine was it is now and sublicensing revenues was already going down and therefore you assume this trend, I believe in your profitability guidance or things are getting worse or in terms of sublicensing revenues or you didn’t anticipate it to be so down so much down like that?

Yuliana Slashcheva

Yes. We didn’t expect it to be so much down by the period. As I said it was actually 2% f our revenues last year and we expect it to be the best 0.5% of our revenues this year. So, you can calculate how big is the difference in the losses from sublicensing. And another thing which is – which has worsened down of course it’s the amount of GRPs because of the audience share of our channels was challenged by broadcasting channels we had an underperformance of GRPs which we couldn’t expect when we’re giving the guidance, that is why – that’s another reason but that’s I would say we’re having minimum losses from this one or from this point maybe it’s like – I can’t tell you the figure, maybe Nikolay can, but it’s minimum for what we lose. Mostly we lose it from Ukrainian sublicensing fees and actually we’re giving the guidance 30 plus 32. So, now without multiplex payments at all, now with multiplex payments which we will be as we said around $6 million anyway this year. We are giving the figure of ’13. So, I don’t think it’s really a decrease counting on the fact of the revenue losses which are not related to us.

Anna Lepetukhina - Sberbank

Okay. Thank you. And just one more question. In terms of TV ad market, you’re saying up to 5%, in your expectation, is that it is closer to 5% or closer to flat just when you assume more OIBDA margin of 30%, just for understanding?

Yuliana Slashcheva

In our forecast, at the moment, it will be – I would say it will be closer to 5% but we are usually quite optimistic about the market and how our capacity to sell because like video international is giving us the low – little low forecast. They are very accurate in predictions but they say 3 to 5 or 2 to 5 even. So, that is why – for us to say for sure. As I mentioned in the beginning, we really can’t predict the Q4. We moreover see Q3 and that give us the feeling how market should be up to 5, closer maybe to 4 or 5. But, we don’t see the Q4 yet.

Anna Lepetukhina - Sberbank

Thank you.

Operator

Thank you. The next question comes from the line of Anastasia Obukhova, from VTB. Please go ahead.

Anastasia Obukhova - VTB

Hi, good evening. I have number of questions. Would you provide please the current revenue breakdown coming from cities with population of less than 10,016. What percentage of revenue do they generate for top line? The second question, could you please estimate the monitory impact from getting this additional audience as a result of the digitalization per annum from 2014 to 2019. The third one, do you have any idea on economics of multiplex construction. So, how many new stations will be built? How many of them are modernized and what the new audience – in there maybe number of US or potential real actual viewers, not just technical penetration but the real viewers can be – will be able to effect.

The fourth one, TNT audience share, despite this channel’s entertainment its audience share improved quarter-on-quarter like CTC once and I’m looking at four plus data of course. What make you be kind of lagging behind the trend of your key competitor. Optimization, in which regard do you consider the optimization and because the programming, your program cost is up this quarter and you are launching many projects, so you need probably more ad expense. So, does it regard to staff optimization, if so, in which sectors? Admin, production, marketing, media team, et cetera. And the sixth question what is your buying power in this joint projects you’re launching because as far as I understand that not all your kind of contracts are really security of key rights, in for example, promoting your -- selling your content in internet. And the seventh one, why don’t you spend the money you are currently spending on dividends on just increasing the vertical of during the real good in-house production? Thank you.

Yuliana Slashcheva

Nikolay, I think that most of these questions come to you. I like to answer the last question to you and Lilia, Lilia Omasheva, who is an Executive Director of CTC and in charge of CTC Media and in charge of Optimization Program. So, she can answer all the questions regarding optimization. I can answer the last question regarding the production facilities investing the money on dividends on the production facilities. It’s a big call, there are several reasons, first of all is that our shareholders make the decision of how they do want to spend the money the company is earning and that’s the decision of the Board.

I can assume the reasons they are having for that at the moment, but first of all we are building in very in-house strong in-house producing center already and working very closely on a competitive basis with a big number of production companies. The main thing is as I was telling before to create ideas internally and then on competitive basis, choose those who can produce already our ideas, because ideas cost maximum, and ideas give you the rights – the amount of rights that you need. And the second reason is the turbulence in the market, it’s very – if you speak about non-organic investments now, then this year was quite and stable and I think that could be the reason of why the Board and the shareholders do not want to – didn’t want to invest until the situation becomes clear because the production companies were looking at and it’s not like a secret that we do from the different production companies.

They are very well positioned and these production companies and the investments will be very, very essential and in acquiring them. So, that is why we are looking at different economically confident and economically reasonable models of building our production. And don’t plan any serious efforts acquisitions this year, due to these reasons. I also would like to comment on TNT, the data I have in front of my eyes is covering from Gallup Media, TNS Gallup is covering first and second quarters and the half of the year. The audience share of TNT dropped by 0.5 % in their target audience 40 and 44. So, all the entertainment channels dropped, not just CTC, maybe CTC dropped – drop was a little bit higher than for example the drop of TNT, TNT dropped 05.5% and CTC around 1 percentage points. But, that is also easily explained because our audience CTC channel’s audience 10-45 is the audience of families, families with kids which are very responsible for – those are most responsible people for their lives, the lives of their families, the country in general even.

And those people switched to watching news much more than the audience of TNT where if you look on the demographics and their like age and social description of the audience, those are young couples without kids, most usually not married. Those people are not just – dependent on what is generally happening in the country and around the country. So, they don’t switch to a news channel as much as our audience does. So, this is the two questions I handled and Nikolay and Lilia will take another five. Nikolay?

Nikolay Surikov

Thank you, Ana. Speaking about the viewership in smaller cities such as we’d like to remind you that the current measurement panel of TNS covers cities only of 100,000 plus. So, that’s why now there is no any official data on viewership in the cities lower than 100,000 plus. So, the same reason is that we cannot comment right now on the additional revenue the potential we can earn from these cities in the period before 2019 because first of all, there is any issue with consumption as I said already of the digital signal by our audience. So, right now, it’s not so big because the people are using in regions maybe not so more than TV sets the set-top boxes are not yet widely spread, the signal – the digital signal is not yet fully – is not fully covering the cities 50,000 plus.

So, as a result, right now we even don’t have this information and as I mentioned, we need to wait the change of the measurement panel which is planned to be done in 2019. So, before these changes in the panel, we will not be able to comment on additional revenue in the periods before 2019. Speaking about the periods after 2019, again, right now there is negotiations within the industry how to approach this additional inflation that all channels in the second multiplex will receive. But again, it’s five years to come. So, right now it’s too early to say and to comment how much additional revenue the whole industry will receive from additional penetration.

Speaking about the third question about transmitters and technical infrastructure, first we had details from our carriers about the construction projects, we know the number of towers that they are going to build, the number of transmitters, but this is kind of huge profile with the numbers of each city, I don’t think that we need to comment about it right now. So, if you have any specific questions about regions and the number of infrastructural objects that are going to be built, we can provide I think to our IR team. Now, I will pass the word to Lilia to speak about optimization.

Lilia Omasheva

Yes, hello. Our optimization program is mainly concentrated on the few pillars. One of them is as Yuliana mentioned before is the centralization of many functions. Among those, and the main ones are marketing, PR, very important, content, acquisition and content production function. As a result of this centralization, we will increase our efficiency and get more comfortable with this function especially our programming expense. Also, we do a lot of work on optimization of the legal structure, and review and challenge of the processes and its efficiency and automation of the processes. All these measures allow us to decrease both headcount as well as salary and payroll expenses as well as employee-related and administration expenses. I should summarize it that all these optimization measures that we are doing right now will allow us this year mostly fully compensate the decrease in sublicensing revenue in the Ukraine.

Anastasia Obukhova - VTB

Okay. Thank you.

Operator

Thank you. That’s the end of the Q&A session. So, I will now hand the call back to Irina Faritova, for any concluding comments. Thank you.

Irina Faritova - Head of Investor Relations

Thank you all for joining us on today’s call. And, we’re looking forward to speaking to you in the future. Good bye for now.

Yuliana Slashcheva - Chief Executive Officer

Yes. Thank you. Bye.

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Source: CTC Media's (CTCM) CEO Yuliana Slashcheva on Q2 2014 Results - Earnings Call Transcript

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