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Viacom, Inc. (NASDAQ:VIA)

Q4 2006 Earnings Call

March 1, 2007 8:30 am ET

Executives

James Bombassei - Senior Vice President, Investor Relations

Sumner M. Redstone - Chairman of the Board

Philippe P. Dauman - President, Chief Executive Officer, Director

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

Jack Tortoroli - Controller and Chief Accounting Officer

Analysts

Doug Mitchelson - Deutsche Bank

Michael Nathanson - Sanford Bernstein

Spencer Wang - Bear Stearns

Anthony Noto - Goldman Sachs

Jessica Reif-Cohen - Merrill Lynch

Benjamin Swinburne - Morgan Stanley

Imran Khan - JP Morgan

Kathy Styponias - Prudential Equity Group

Gordon Hodge - Thomas Weisel Partners

Presentation

Operator

Good day, everyone and welcome to the Viacom fourth quarter and full year 2006 earnings release teleconference. Today’s call is being recorded. At this time, I would like to turn the call over to the Senior Vice President of Investor Relations, Mr. Jim Bombassei. Please go ahead, sir.

James Bombassei

Good morning, everyone. Thank you for taking the time to join us for our fourth quarter and full year 2006 earnings call. Joining me for today’s discussion are: Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Tom Dooley, our Chief Administrative Officer and CFO; and Jack Tortoroli, our Controller and Chief Accounting Officer.

Please note that in addition to our press release, we have slides containing supplemental information available on our website.

Before we begin, let me remind you that statements made on this call relating to matters which are not historical facts are forward-looking statements. These forward-looking statements reflect our current expectations but involve risks and uncertainties that may cause our actual results, performance or achievements to be different from that expressed or implied by these statements. Risks and uncertainties are discussed in our filings with the SEC.

Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release or on the Viacom website.

Now I would like to turn the call over to Sumner.

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Sumner M. Redstone

Good morning, everyone. We thank you for joining us. Viacom delivered solid results in 2006 and I am extremely proud of the progress that Philippe and his team have made in such a short time. Philippe has indeed moved quickly; he has moved decisively, making all the right moves. We are taking advantage of our strength, being smart about how we invest our resources and building a solid future for Viacom with a higher level of performance for shareholders. I do look forward with anticipation to the continued progress we will make in 2007 and in the years ahead.

Now I will turn it over to Philippe.

Philippe P. Dauman

Thank you, Sumner, as always for your kind words, and thank you everyone for joining us today for our fourth quarter 2006 earnings call. I have served as CEO of Viacom for about six months now and I can tell you that I am as enthusiastic today as I was on my first day, not only because of the great strength we have but also because we have been able to accomplish a lot in such a short period of time.

This company has so many leading brands responsible for some of the best entertainment content in the market and as a result, we maintain vibrant relationships with the most sought-after consumer audiences. What we accomplished and the actions we took in the fourth quarter and continuing in the early part of this year build on this foundation and will enhance our ability to fully capitalize on our core strengths.

I will be the first to say that we are facing challenges. Without question, we are passing through a period of substantial transformation. That is precisely why we are putting an intensified focus on execution in all areas, including building on our leading position in original content, strategic positioning, financial planning and operations. We are thinking creatively about the ways in which we sell our content. We are expanding our partnerships and we are broadening our distribution horizons and we are putting in place the organizational structure required for this transformation. The benefits of this process will become increasingly evident as we progress through 2007.

As far as our business outlook, over the next three years, we expect to deliver low double-digit annual percentage growth in diluted earnings per share.

Today, I would like to take you through our overall performance and talk about many of the recent changes we have made in the organization and how they fit into our strategy. I will give you an update on the significant progress we are making in digital and I will talk about the investments we are making to continue to create the most compelling content for our audiences. Tom Dooley will follow with a look at the numbers in more detail.

Both Tom and I will refer in our financial review to bottom line numbers that are adjusted to provide a meaningful comparison with the previous year. Adjusted results exclude discrete net charges related to Viacom corporate senior management changes, international restructuring charges, and net discrete tax credits. Further detail on this can be found in our earnings release.

Let’s talk first about our top line performance. Consolidated revenues were up 19% for the year and 32% for the quarter. Media Networks revenues were up 7% for the year and 4% for the quarter. While the fourth quarter ad sales growth in our Media Networks segment was not as high as we would have liked, we have already instituted changes that will over the course of the year create a more efficient and responsive organization with the ability to accelerate our growth. I will talk more about that in a moment.

We already have pretty high visibility into ad sales results for the first quarter and we see a dramatic improvement in the growth rate from the fourth quarter and also a nice increase compared with our growth rate in the first quarter of last year.

The Filmed Entertainment division generated extremely robust results, with revenues up 46% for the year and 100% for the quarter. These results demonstrate the favorable impact of the DreamWorks acquisition and the successful turnaround of Paramount that is now underway.

For the full year 2006, again all as adjusted, operating in come rose 10% to $2.86 billion from pro forma 2005 results of $2.6 billion. Net earnings from continuing operations for the full year increased 10% to $1.48 billion compared to pro forma 2005 net earnings of $1.35 billion. Net earnings per diluted share from continuing operations for the year was $2.07, up 16% from pro forma 2005 of $1.79.

As noted in our earnings release, these results meet or exceed our previously issued business outlook for the full year 2006.

Now I would like to talk about some of the changes we are making as we reinvent our company for the future. In addition to changes to our senior executive team, we recently announced a significant staff reduction within the Media Networks segment domestically and internationally. The objective of this reduction is to fine-tune how we operate. We are reallocating our resources, reducing our spending in some areas so that we can increase investment in other areas.

Under Judy McGrath’s leadership, we have taken steps to reorganize certain brands to increase collaboration between sister properties. A great example of this is the formation of the MTV Networks Entertainment Group, which we announced in December, bringing together our men’s and adults demographics.

As we have previously discussed, we are proceeding as planned with the reevaluation of the more than 160 territories in which we operate around the world. We have reduced our equity participation in a number of small markets and have increased our ownership in other larger markets, with greater growth potential. We will continue to look for opportunities to optimize our presence in this manner.

We just announced this morning a restructuring program at MTV Networks International to better position our international group for the next phase of its growth. The restructuring extends our localization strategy and mobilizes our resources to build our multi-platform brand portfolios in priority markets. We expect all these changes will result in an incremental 1,000 to 1,500 basis points of margin improvement in our international operations by 2008.

Our new direction for famous music represents another opportunity to more efficiently redeploy our capital. This company has substantial value that is not a core asset and we are now in the process of exploring strategic alternatives. This kind of realistic approach to our organizational model is an essential component to our plans for reshaping this company.

Now I want to return to the area of advertising sales. We made a series of announcements yesterday at MTV Networks related to changes in our advertising sales organization. We announced a new structure for the U.S. sales division that realigns our brands to demo-specific clusters to enhance client focus and to better serve the advertising community. And we reformatted our up-front process at MTV Networks to increase interaction between advertisers and agencies on the one hand and our multi-platform brands on the other.

We also instituted a new structure in our affiliate sales and marketing group under new leadership that will fully coordinate our affiliate sales and marketing efforts across MTV Networks and BET Networks.

Now I would like to spend a few minutes updating you on our digital expansion. Viacom's online properties continue to grow rapidly, registering more than 40 million unique visitors in December, 2006 and ranking as the number one online entertainment destination and the tenth most popular overall destination on the web.

There are two primary pillars to our strategy. First, we are accelerating the growth of our internal initiatives, building a growing stable of digital properties and virtual worlds. Second, we will continue to selectively pursue both partnerships and small acquisitions that strengthen our capabilities and distribution footprint and we will integrate the acquisitions into the fabric of our organization so that we can generate maximum value as quickly as possible. We are the first major media company to launch a series of virtual worlds that seamlessly integrate television programming with emerging virtual world technology.

Nicktropolis, a new virtual destination for kids, is an excellent example. Nicktropolis is a completely new multimedia community that offers kids the opportunity to engage in a virtual world filled with their favorite web-based activities.

Like several other initiatives that we are pursuing, Nicktropolis is a part of a larger strategy to bring immersive entertainment experiences to our audiences and to build communities around our content across every kind of platform.

Virtual Laguna Beach and Virtual Hills, our first two initiatives in immersive virtual entertainment, now boast over 360,000 registered users, even without the kind of promotion we will bring to bear as we go forward with more sophisticated platforms.

Engagement model in these immersive experiences is very appealing for both the user and the advertiser. Our viewers can watch the show online, go on to mtv.com to watch the after-show and other related features, then go into Virtual Laguna Beach to actually live the show.

We have also rebuilt our largest sites to accommodate more advertising units, more content and better features. Based on our initial tests, these changes lead to more time spent on our sites, more marketing opportunities for advertisers, and more revenue. For example, mtv.com’s monthly unique visitors in January increased over 55% year on year and comedycentral.com was up over 90%.

Our properties receive high CPMs in digital. We are selling premium content in a branded environment that generates high-quality uniques and premium value for our advertisers. Our digital ad sales results reflect this growth and premium positioning.

MTV Networks digital ad revenues were up nearly 60% in the fourth quarter. We also grew the total number of our digital advertisers by 60% in the quarter. Our revenue from digital only clients grew two-and-a-half fold, and we hit a record high sell-through across the majority of our sites.

Based on the progress we are making across these various digital initiatives, we are confident that we will achieve our previously announced goal of $500 million in digital revenues in 2007, the majority of which will be ad sales.

We announced only a few weeks ago a landmark deal with Juice, the world’s first broadcast quality Internet television service. Juice is the next generation in broadband video technology and we are extremely proud to be a founding partner with them at launch.

Juice will allow users to have free access to thousands of programs and channels not readily available on the web. Viewers will be able to watch ad-supported programming from many of Viacom's brands on their computers, with high-quality video and advanced television viewing features.

Viacom will keep the vast majority of revenues associated with advertising related to our content and we are optimistic about its prospects for success right out of the gate.

We are also expanding our relationship with other digital partners. iTunes has proven to be a fantastic platform and in 2006 alone, consumers downloaded more than 11 million episodes of MTV Networks programming from iTunes. Over the last several months, we have also been selling BET and Paramount library product on iTunes.

Wireless video is an area where we have established a strong leadership position and an area that represents a promising growth opportunity. We have done a number of major deals across the globe and have developed a number of exciting programming innovations. These include an innovative mobile wireless access portal from Paramount, a multi-year licensing agreement with Media Flow, the first MTV branded mobile content subscription service, the integration of mobile commerce into BET’s music programming, and a made-for-mobile programming deal with AT Mobile.

Fundamental to our digital strategy is protecting the value of our content online. I think you are all aware that we issued a large-scale takedown notice to Google and YouTube a few weeks ago. We are heartened by the broad industry support of this action. Since we issued the takedown notice, video streaming traffic on our sites has increased dramatically. This is an important validation of our strategy.

Before I wrap up, I would like to touch on our ratings performance and then talk for a few moments about the investments we are making in new programming to nourish the growth of our major brands. We did experience some ratings challenges across some of our largest brands in the fourth quarter. We have a new line up of programming on air and in the development pipeline that we believe will put our ratings back on track. Let me offer a couple of examples.

Nickelodeon’s latest live action series, The Naked Brothers Band, which debuted to record consumer response, just announced its highest ratings to date, putting the program at the top of the charts as the number one rated kids and tween show on all of cable, and we are seeing the same big impact across our platforms.

The first single from The Naked Brothers Band series, Crazy Car, received almost 25,000 downloads in iTunes in just two weeks of release. On Turbo, the Naked Brothers Band generated almost 15 million streams between January 1 and February 4, and the launch of the online game, Ready to Rock, on January 15th has generated over 2.6 million game plays.

We think, based on its early performance on TV and other platforms, The Naked Brothers Band has the potential to become a major new franchise for Nickelodeon.

Similarly, we believe Nick’s new user-generated programming block called Me TV, is the next step in convergent entertainment for a multi-platform generation of kids and a substantial growth opportunity.

Nick will also launch in March a new Flash animated comedy series named El Tigre, the Adventures of Manny Rivera. Initial reviews are very positive on this new series and we are very excited about the potential for success.

At MTV, we are continuing an aggressive programming schedule and greenlight strategy. Already in the last few weeks, MTV has premiered eight new series and in the next three months will introduce another seven. VH1 also had several noteworthy program launches recently, including acceptable.tv and I Love New York, which debuted as the network’s highest-rated series premier ever.

Meanwhile, Comedy Central is emerging as a major growth brand for us. Thank you, John Stewart and Stephen Colbert. We just launched Comedy Central in Germany last month and it is off to a great start. 2006 was Comedy Central’s most-watched year in history and the first quarter is shaping up to be the best quarter ever in terms of overall in the ratings for the network.

At BET, which is coming off its highest rated year ever, Deborah Lee and her team have announced the creation of 10 new series, which represents the most significant new programming commitment in the history of the network.

Paramount made substantial progress on the creative front during 2006. Moving forward, we are taking a multi-year strategic approach to creative and financial development and diversification. Brad Gray has made organizational changes to drive this process and he has a very talented management team in place.

DreamWorks, under the leadership of Stephen Spielberg, David Geffen, and Stacy Snider, achieved great success this past year, culminating with Dreamgirls, which brought home an Oscar for Best Supporting Actress. DreamWorks is now a valuable part of Paramount and the Viacom family.

Paramount has strong creative momentum and a great over lineup for 2007, including Shrek the Third from DreamWorks Animation; Hot Rod, a story about an accident prone daredevil with Andy Sanberg; this summer’s tent-pole, Transformers, produced by Stephen Spielberg; Stardust, with an all-star cast including Robert DeNiro, Sienna Miller, and Michelle Pfeiffer; and Beowulf, with Angelina Jolie and Anthony Hopkins.

2006 was a great start for our Vantage specialty film label, which released Babel and An Inconvenient Truth, both of which brought home Oscar awards. Over the next several years, we will also strengthen the brand identity of our Nickelodeon and MTV film labels and bring to fruition a vibrant BET Films label.

In addition, we are pursuing strategic development of new sources of revenue for the studio, including digital revenues through deals of the type we did with Apple iTunes and Bit Torrent, a Paramount TV business, and a made-for-DVD movie business.

To wrap up, we are implementing a number of improvements that will have both a short and long term benefits and in particular, will smooth our transition to a truly multi-platform company. We are reinvigorating our core linear business through more investment in programming, increased coordination of our ad sales efforts, both across networks and between linear and digital ad sales, and we are doing all this as we strengthen and accelerate our growth in digital.

With that, I would like to turn the call over to my long-time friend and partner, who is doing a magnificent job as my Chief Financial and Administrative Office, Tom Dooley. Tom.

Thomas E. Dooley

Thank you, Philippe. You should all have our earnings release and web presentation summarizing our fourth quarter and full year 2006 results. Our 10-K will be filed with the SEC shortly and be available after the call.

What I would like to do now is take you through our fourth quarter financial results and our segment performance in a little more detail, and then I will discuss our business outlook.

Fourth quarter results were good overall. Revenues were up 32% to $3.6 billion from $2.7 billion last year. As Philippe noted earlier, bottom line numbers that I will refer to in the remainder of my remarks, are adjusted to provide a comparable basis to last year.

Let me talk about our segments, starting with our Media Networks group. Media Networks revenues were $2.1 billion, up 4% from the fourth quarter of ’05. Overall, acquisitions represented primarily by the consolidation of Nick U.K. and MTV Japan and some of our strategic acquisitions, such as Atom Entertainment and Harmonix, contributed $78 million in the quarter. So essentially, a great deal of our growth was due to the acquisitions.

Let’s take a look at how this breaks down. Worldwide advertising revenues rose 6% to $1.3 billion, with acquisitions contributing to four points of that reported growth. Domestic ad revenues grew 4%. As Philippe mentioned, domestic ad revenues came in lower than we expected, primarily because of ratings shortfall at Nick at Nite and TVLand and, to a lesser extent, at MTV.

We also experienced weakness in certain advertising categories, such as video games and beverages. The softness in video games was a temporary issue, as advertisers pulled back when they ran out of product in the fourth quarter. We are happy to report they are back strongly in Q1.

Affiliate revenue growth was strong and was up 14% to $532 million. Domestic fees were up almost 9%, with increases in subs the key driver. International fees increased 46% as a result of new channel launches across several international markets and acquisitions contributing 27 points to reported growth.

Ancillary revenues declined 15% in the quarter to $289 million, principally due to a comparatively weaker mix of titles. Media Networks’ operating income, excluding international restructuring charges of $15 million, was $810 million, up 6% versus ’05 results of $762 million. Incremental stock option expense reduced Media Networks’ OI by 100 basis points.

Philippe talked about the steps we are taking to centralize our operations, better align our sales forces, and reposition our international businesses for profitable growth. As a result of these actions, we expect to incur approximately $70 million in restructuring costs in 2007, of which $50 million will be charged against Q1 results.

Now let’s turn to the Filmed Entertainment segment. Filmed Entertainment revenues doubled to $1.6 billion in the quarter with DreamWorks, the distribution of DreamWorks Animation, and the DreamWorks live-action library films contributing revenues of $560 million. The balance of the growth was driven by Paramount’s 2006 releases, which delivered $500 million in revenues in the quarter, from such films as Mission Impossible 3, World Trade Center, and Jackass 2, compared to the 2005 releases, which contributed only $331 million in revenues in Q405.

Revenues from the Paramount catalog were also up 4% compared with Q4 last year, with classics such as Titanic and MI2 driving that growth. And at Vantage, the successful release of films such as Babel and An Inconvenient Truth contributed $45 million to the quarter.

Filmed Entertainment operating income was $86 million in the quarter, or $126 million higher than the adjusted pro forma 2005 operating loss of $40 million. The improvement was driven by the comparative performance of our 2006 and 2005 releases, as well as catalog, partially offset by incremental overhead expenses, including the DreamWorks acquisition expense.

For the total company, Viacom's operating income was up 28% in the quarter to $856 million, compared to the fourth quarter of ’05 results of $670 million. Incremental equity-based compensation expense in the quarter reduced operating income by $21 million. Media Networks was up 6% in the quarter and Filmed Entertainment contributed an incremental $126 million to the growth in operating income.

Fourth quarter 2006 net earnings from continuing operations increased 62% to $456 million compared to 2005 net earnings of $282 million. The growth in operating income and a lower tax expense driven by a lower effective tax rate was partially offset by higher interest costs associated with our increased debt load.

On a diluted basis, net earnings per share from continuing operations in the quarter were $0.65, showing a 76% improvement versus last year.

Let me turn to cash flow and our capital structure. We generated $2.1 billion of free cash flow for the full year of 2006. This includes a $500 million increase in our asset securitization program. If you strip out the asset securitization benefit, free cash flow grew 8% compared to 2005.

As for debt, in 2006, we rebalanced our capital structure principally through a series of bond offerings. We also took advantage of favorable financing rates and increased our securitized receivable by $500 million to $950 million in total.

At December 31, 2006, our total debt outstanding including capital leases increased to $.6 billion compared with $5.8 billion at December 31, 2005. The incremental year-over-year debt was driven by share repurchases of $2.35 billion and net acquisitions of $723 million, offset by the cash we generated from operations.

Those are the highlights for 2006. Now let’s turn to our outlook.

As Philippe mentioned earlier, over the next three years, we expect to deliver low double-digit annual percentage growth in diluted earnings per share from continuing operations. This outlook is based off 2006 adjusted diluted net earnings per share of $2.07, and excludes the restructuring charges I mentioned earlier of approximately $70 million. Let me add a little more background.

First, as Philippe mentioned, we are navigating through a long-term strategy that will involve seasonal and quarterly business variations. Second, we believe that growth in EPS and our stock price is the best indicator of our long-term performance. That is what Philippe and I are focused on, that is what our senior management is focused on, and that is what our Board is focused on.

In addition to the three-year outlook in EPS, we intend to keep you informed about critical short-term factors impacting our performance along the way. We will use the quarterly calls to update you on our progress.

Let me talk for a moment about the major contributors to our outlook. Inside Media Networks, restructuring charges will negatively impact the first quarter. Offsetting that, domestic ad sales growth in the first quarter has strengthened significantly. The advertisers have come back strong and we are confident that first quarter 2007 domestic ad sales growth will exceed first quarter growth of 2006. We have long-term affiliate deals in place and continue to expect solid growth from that revenue stream.

We expect to deliver $500 million in digital revenues by the end of this year and obviously expect significant growth beyond that in the years thereafter. This will be comprised mostly of revenues derived from the digital properties associated with our major brands.

We have significant consumer merchandising and licensing businesses and have a full pipeline of new opportunities ahead, with new properties such as Avatar, Backyardigans, and Diego.

However, we are investing in new programming to grow our brands and expand our consumer reach. This investment in new programming and the restructuring charges will reduce Media Networks margins in the first and second quarter. However, over the long term, we believe we can maintain or improve margins as we drive cost efficiencies to fund the reinvestments we will make in our businesses.

A good example of this is the smarter deployment of capital across our international organization. Through that, we expect to deliver 1,000 to 1,500 basis points improvement in our international operating margins.

Turning to Paramount, we are releasing 27 films this year, including eight from the Vantage label and two from DreamWorks Animation. We are releasing six films in the first quarter versus five last year. Of those five films last year, only three had meaningful P&A costs. As a result, we project P&A costs to be roughly $150 million over last year’s first quarter.

In addition, in the second quarter, we have P&A costs associated with the major releases of DreamWorks Animation’s Shrek 3 and the Paramount/DreamWorks joint venture, Transformers. These will negatively impact our first-half profit performance compared to 2006. Keep in mind that these are timing issues, as the majority of the revenues and profits from these pictures will be recognized in the third and fourth quarters.

In addition, please note that when we acquired DreamWorks on January 31st of last year, we received the full ownership benefit of the live action library, which provided us with approximately $40 million of operating income until we sold the library in May.

In terms of incremental option expense, you should expect this to continue to build over the next several years until we reach our normal run-rate in 2009. In 2007, the increase in equity-based compensation expense will have approximately a $0.03 impact on diluted earnings per share.

On the tax front, our 2006 adjusted effective tax rate was 38%, which reflects an almost 440 basis point improvement over the prior year. We will continue to pursue strategic tax planning opportunities to lower our income tax rates, but are currently projecting 38% for the outlook horizon.

We will continue to drive operating cash flow growth in line with our operating income growth. In terms of leverage, we foresee maintaining a 2.7 times to 3 times leverage ratio on a go-forward basis.

We continue to believe one of the best uses of our free cash flow is buying back our stock. This year we expect the buy-back level and the timing to be in line with free cash flow generation and accordingly, it will be weighed toward the back-half of the year.

Finally, regarding earnings per share, we expect 2007 growth will be weighted to the back-half of the year.

Wrapping up, we have instituted a lot of changes throughout the organization in recent months to enhance the revenue generation and improve the long-term margins. One thing remains the same: Viacom is a terrific company with unique assets and substantial growth potential. We look forward to working with everyone here to unlock that potential and continue to increase shareholder values in the months and years ahead.

Thank you, everyone, for joining us today. Now I would like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will go to Doug Mitchelson with Deutsche Bank Securities.

Doug Mitchelson - Deutsche Bank

I am just trying to parse into some of the ad numbers that you gave. Could you give us a sense of what scatter pricing is relative to the up-front? With all of the organizational changes you have made, as you look forward to the up-front, can you comment on two things: one, what would you like the ratings currency to be this year? At last year’s live only, certainly caused an impact on some of the ad revenues for cable and broadcast networks. Secondly, you expect to have a healthier up-front in terms of CPM gains than you had last year?

Philippe P. Dauman

As far as the scatter market, we are seeing high-single digit improvements in scatter pricing. As far as the ratings currency question, yes, we would like -- there is going to be a change. We are going to have DVR ratings data this year that we will be working with, as well as commercial ratings. We are going to be very comfortable with that change. We are looking at our advertising costs, for example. We are going to have shorter advertising costs in a lot of our programming, so we think our programming strategy will be well-adapted to that change. What was your last question?

As far as the up-front we have, as we announced yesterday, developed a new approach to the up-front, which I think is consistent with the way the cable industry is moving, to make it more of a year-round effort, which is going to be much more targeted on industry groups, on individual consumers. It will make great use of our tremendous front in the research area and marketing area and we will be geared toward providing complete market solutions to our advertising clients, and that plays very well to our strengths and our multi-platform development.

Doug Mitchelson - Deutsche Bank

Have you started any conversations with advertisers as to what the right ratings currency might be going forward?

Thomas E. Dooley

Yes, we have had several conversations at high levels with both the agencies and the advertisers. In fact, that is what led us to develop this notion of a rolling up-front, which would accommodate and facilitate the cycles that the advertisers themselves are experiencing. It is not driven by the traditional up-front timing.

Doug Mitchelson - Deutsche Bank

Do they agree that live only might not be the right currency?

Thomas E. Dooley

It depends on who you talk to. I think that subject is still up for debate.

Operator

We will go to Michael Nathanson with Sanford Bernstein.

Michael Nathanson - Sanford Bernstein

I have two. One is you say that domestic ad growth in this quarter was only 4% and the trends are improving, so I wonder, given as March 1st, how fast could first quarter be? What do you think is a sustainable level of growth for cable network advertising? That is the first question.

Philippe P. Dauman

What I said in my remarks is that we expect the first quarter -- the first quarter is not over. We have great visibility to it, so it is going to be a much higher rate of growth than we had in the fourth quarter and as we said, it will be nicely higher than the first quarter growth of last year. I will leave it at that on that question.

As far as the rest of the year, obviously we do not have much visibility so far, but we are very well-positioned, both through our greater focus in the way we are approaching advertising sales and the way we have reorganized our group, as well as our increased investment in programming, which will both support and grow our ratings. We have tremendous momentum in a lot of our networks, notably Comedy Central is just on fire.

Michael Nathanson - Sanford Bernstein

I was going to say, Philippe, do you want to -- you obviously do not want to quantify when you say substantially higher the first quarter?

Philippe P. Dauman

I think I have given you a pretty good indication.

Michael Nathanson - Sanford Bernstein

Okay. Let me turn to the second question, which is you have done a great job in cable margins in ’06, and your guidance in international is very clear. But if you extract all that, looking at domestic margins again with a need for investment in programming and digital, do you think domestic margins could sustain flat year over year?

Philippe P. Dauman

We are trying to keep our margins pretty much flat and what we have done throughout this restructuring is to create greater efficiencies, and as I mentioned, what we are doing is taking costs out that do not show up on the screen, do not show up in generating revenues, and we are taking those cost savings and putting it into revenue-generating activities. That is why we are investing in more programming, we are investing in development of our digital assets, which over the long-term will pay great dividends, in my opinion.

Operator

We will go to Spencer Wang with Bear Stearns.

Spencer Wang - Bear Stearns

Two questions also. First, Tom, you mentioned that you feel like buying back stock is the best use of your cash right now. Should we just expect a continued share buy-back or would you consider something more aggressive, like a tender?

A second question is with respect to your leverage ratio, I think you finished ’06 under 2.5 times leverage, which was below your target leverage ratios. How much should we expect in terms of acquisitions in ’07? Thanks.

Thomas E. Dooley

In terms of the buy-back, we are going to continue the program as we have been currently running it. We will take the free cash flow that is generated throughout the quarter or the period and use a portion of that to allocate towards the buy-back. That will be -- we will consistently be in the market as much as we can, fulfilling that program.

As far as acquisitions, we do not have any material acquisitions forecast for 2007, and the leverage ratio, the way we calculate the leverage ratio is a little different than you do. We have to include some other things in terms of capitalized leases and what not, so our number is a little bit higher, in the 2.7, 2.75 range. But that is just a mathematical definition of it. As we have said on the call, based on the way we calculate it, 2.7 to 3 is the target range for the company.

Philippe P. Dauman

Let me pick up for a minute on the acquisition issue that Tom touched on. I think we have tremendous opportunity to develop our properties internally, particularly in the digital area. I am very happy with the portfolio we have. I think we are doing tremendous work in building them, so that is going to be our focus and we are going to focus on executing well across those properties. So we may make small acquisitions that fit into our businesses but that is not a major part of our strategy as we head into ’07.

Operator

We will go to Anthony Noto with Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. Philippe, I have two questions. The first question is on your core growth excluding digital and excluding acquisitions, and the second question is on YouTube and Google.

On the first question, if you back out your acquisitions and then back out your growth in digital, is your core business excluding those two things growing in the fourth quarter on a year-over-year basis?

Philippe P. Dauman

Yes, it is growing. Obviously digital is contributing to a higher rate of growth because that is -- the revenue side, that is certainly a fast-growing part of our business and we are looking to double our digital revenues this year. But our core continues to grow and I want to focus on reinforcing the core and growing that. We are not going to let up on our core as we develop our digital activity.

Anthony Noto - Goldman Sachs

And then the second question is --

Thomas E. Dooley

Just to comment on that, as we go down the road in the future, I think it is going to be harder and harder to segregate the digital and the traditional growth. Two-thirds -- two-thirds of our digital ad sales growth are sold in tandem with the regular online growth as a unit package negotiation with the advertiser. I just want you guys to keep that in mind. They are melding together faster and faster as we go quarter to quarter.

Anthony Noto - Goldman Sachs

I think the genesis of my question is that obviously there were some ratings issues this quarter that you highlight in your domestic growth as 4%, including acquisitions and less than that. I was just trying to get to the sense of whether the core was declining, so your growth rate may not actually pick up as you grow digital. That was really what I was trying to get at, but it sounds like your core is growing.

The second question I have is I have spent the last couple of months going on YouTube and Google and just counting the number of videos in the top 100 on both sites that are what I would call head content, content from established media companies. What I have is out of the top 100 videos over the last couple of months on both sites, less than five of those videos, or less than 5%, have actually been from what I would call established media companies. It seems like YouTube and Google and Yahoo! have built their video audiences on the back of user-generated content, while the perception is that they are really reliant on copyrighted material, and while copyrighted material is being consumed on the site, it is not within the 100 top videos over the last couple of months on either site.

So why would you want to do a deal with them? Why wouldn’t you just continue to build your own properties and be a principal with your own product and not help reinforce their audience reach? Thanks.

Philippe P. Dauman

As far as Google YouTube, obviously within the last couple of months, there has been about a month where we have required them to take down over 100,000 of our clips that were appearing on YouTube. Before that takedown, in fact our content, which has been a dominant factor in the professional content that was appearing there because of the nature of our content appealing to that young demographic, our content in fact during the period we were up there was a substantial part of the traffic there.

That being said, as I mentioned in my remarks, we are very pleased to have more traffic now since we took down our content from YouTube on our own site because we are able to monetize that for our own pockets as opposed to having somebody else monetize at our expense.

We are pleased with the actions we have taken. At the same time, we are interested in entering into deals that provide distribution for our content in a controlled way that respects our copyright and we think we can generating incremental revenues that way, which is why we recently entered into the deal with Juice that I mentioned, where we think there is great opportunity, great consumer experience, it meets all of our criteria for protection of content, control of our advertising relationships, as well as linking back to our sites. We think that deal will provide more traffic for our own sites, which we can again monetize.

We are looking at this very strategically, as we have in the history of many decades of looking at every window that has developed for the content. We love being a pure content company. I think strategically, that is a great place to be no matter what the distribution platform there is.

By the way, when you think about digital, don’t just think about the computer. We are a strong leader in providing content around the world on mobile phones as that develops. That is a fast-growing -- it is small now, but fast-growing and we will be a major player in that marketplace.

Operator

We will go to Jessica Reif-Cohen with Merrill Lynch.

Jessica Reif-Cohen - Merrill Lynch

A question on international. You guys talked about improving margins by 10% to 15%. What are the international margins now? What was it in 2006? Can you be more specific about advertising trends in international in the first quarter, and particularly the key markets, like Germany, the U.K.? Thanks.

Philippe P. Dauman

As far as the margins in international, we do not break out our specific margins but suffice it to say that our margins in ’06 were to me unacceptably low and for that reason, we embarked on this restructuring program, which candidly was somewhat overdue. We will drive that business as I mentioned so we have that margin improvement in 2008 and we will not stop there.

I view international as a major source of long-term growth for this company and I want to make that growth profitable.

As far as advertising trends, as we go into ’07 in our major markets, we see some developing strength in Germany. In the U.K., we have strength in our comedy and children’s properties. There is some weakness in the music category and part of what we did over there is we moved over our very successful management team that was running our comedy suite in the U.K. We moved them over to our music suite, so I expect to see some improvement there.

Japan is a developing market. We consolidated that. That is also a potential good source of growth and the market and the economy there are performing pretty well. So in our core markets, we are seeing some signs with a mixed bag, depending on the networks in the U.K.

Thomas E. Dooley

Jessica, in the first quarter, on a consolidated basis, mid-20s growth in ad sales is what it is looking like right now, but that includes some joint venture consolidations. On a pure organic basis, we are looking at mid-single digit kind of growth.

Operator

We will go next to Benjamin Swinburne with Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

I wanted to ask one question on the film side and then come back to a prior question on YouTube online. Where does Viacom come out on windows and the debate over day-in-date releases and the increasing use of new releases on VOD, as well as PC downloads of films? How do you see this evolving and how do you maximize your revenue as this business model evolves?

Second, in the cable satellite world, I think for every dollar of ARPU that comes out of the home, maybe $0.30 is going to the content industry. But it would seem online you would have a chance to extract significantly better economics from the average, either ad dollar or subscription dollar coming out. How do you guys see this evolving online? Maybe you could talk a little bit about your Juice deal and how that business model might work over time? Thank you.

Philippe P. Dauman

As far as windows in the movie business, obviously we have done quite well in having sequential windows for our motion picture product, so on an overall basis, we like to preserve windows.

In the area of video-on-demand, we are looking at some tightening of windows as it relates to that. We are in the midst of an experiment with other studios, at Comcast which is still running them. We will see the results of that and we will evaluate where we go in the VOD area as far as that is concerned.

Certainly online for the studios, for the download business. Clearly the margins, the lower cost of the margins are better on that, so as that develops, that is certainly a good business for us.

The Juice economics again, as I mentioned earlier, we have a -- we cannot disclose all of the details of the terms of that deal but we are getting a very, very satisfactory share of ad revenues, as well as more traffic, not only on Juice itself but the ability to send that traffic back to our sites, which we can then monetize again and of course we take 100% of that ad revenue.

We like that deal and we are talking to a number of other new and existing companies about potential deals that work for us. We are always happy to supplement our distribution channels.

Thomas E. Dooley

As volume picks up in that business, you will see the incremental margins improve dramatically, reflective of the splits.

Operator

We will go next to Imran Khan with JP Morgan.

Imran Khan - JP Morgan

Two questions; number one, I was trying to -- you gained $500 million digital revenue this year and growth substantially next year. I was wondering if you could give us some sense of what kind of profitability we might see from that digital revenue.

Secondly, you said that your traffic growth was significant after you asked Google to take out your content. I was wondering if you could quantify what kind of video downloads you were seeing. Thank you.

Philippe P. Dauman

As far as profitability of digital revenues, we have had to spend money to build up our digital ad sales force to really put in place the people to enhance the user experience, but now when we get to this $500 million revenue number as the year progresses, those incremental revenues have very good margins associated with them. That is what we needed to do. We needed to get to a size such that we can really use the platform that we have built.

So the incremental revenues are very profitable and we expect that to go forward. That being said, as Tom said, increasingly it will be hard to separate, particularly in the ad sales area, to separate linear and digital.

Thomas E. Dooley

In terms of the kind of growth that we have experienced on our own online sites, Comedy is up over 90%, Nickelodeon is up in the 30s, and mtv.com was up in the mid-50s percentage growth as a result, in the period after we did the takedown, so we are driving a lot more traffic to our sites and a lot of them are related to downloads of the shows that we made available there.

Operator

We go next to Kathy Styponias with Prudential.

Kathy Styponias - Prudential Equity Group

Two questions as well. First, with respect to the changes that you have made in your ad sales structure, I was wondering if you can give us a little bit more detail as to how it differs from what you were doing before, because just the brief comments that you gave, I do not understand how it is different than what you did before. Is this more along the lines of something that Discovery did a while ago called power block, where you are basically trying to sell demos across all your networks? Because I think they were not all that successful in doing that. So I am just wondering how or why you would think you would be successful in that regard.

Then, if Sumner is still there, I have a question for Sumner as well. As things evolve and as Viacom and the new management team basically makes the changes that they are trying to make, if it turns out that things are not successful, would you consider selling the company or perhaps combining it again with CBS? Thanks.

Sumner M. Redstone

I wouldn’t even -- the hypothesis that you put forward that things are not successful. As I said, I think I made a great move in putting Philippe and Tom there. They are the best leaders in the industry, so I am not going to even consider the possibility that things will not work out and no, I have no intention of selling this company. I love the company. I love the management. I love Philippe and Tom and the gang and the company is not for sale.

Philippe P. Dauman

Thank you, Sumner. As far as the changes in the ad sales, what we did is not similar to what others did in whole. We made changes that adapt to our cable network structure, so when we say we are attacking certain demographics, we have grouped some of our networks in different ways. For example, just one example, we have put in one cluster, entertainment, we put Comedy Central, Spike, Country Music Television and TV Land as one cluster.

As we dealt with our advertisers and, as Tom said, we consulted with our advertisers before doing that, we looked at what their needs were and where they were looking for cross-network placements of their advertising. We are also tying in our marketing efforts and our research efforts more closely with our ad sales efforts. We are also educating our entire ad sales force on the digital opportunities that exist, because more and more, and I have personally experienced this as I have met with some chief marketing officers over the last couple of months, more and more, our clients are looking for integrated solutions where they touch their customers, our consumers, more closely and we are uniquely positioned to do that for them.

So what we have done is just structured our ad sales forces to meet the demands of the advertisers and listen to them and we have addressed their needs. I think it will be a very successful way for us to drive ad sales going forward.

Thomas E. Dooley

Kathy, for the most part, the traditional up-front was constructed on the broadcast cycle of how they introduced programs, when they premier programs. We are introducing new programs pretty much every quarter throughout the year and in some cases on some channels, we are changing programs out month to month to month. As we do that and add those new programs, there are new opportunities to go to advertisers and create promotional programs built around that. Essentially, we have gone to a rolling up-front concept which will address both demand certain advertisers have. Advertisers have changed the way they buy advertising to a large extent. They are buying later in the game and they are changing their plans at the last minute. We experienced it with the video game people in the fourth quarter. Their advertising as they had planned to spend was significant. They had to back down on it. They said don’t worry, we want to come back in the first quarter. They made a commitment in the first quarter and it shifted out. We accommodated them and that is the kind of notion that drove us to build this new model.

Operator

We have time for one more question. We will go to Gordon Hodge with Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

Just a quick follow-up on your scatter comments. I gather you said scatter is running up high singles. I gather that is scatter versus up-front. I am curious if you could comment on scatter versus scatter trends.

Second question is on the $500 million in digital revenues this year, does that incorporate any meaningful contribution from what I think might be a highly anticipated game release from Harmonix later this year? Thanks.

Philippe P. Dauman

As far as the second question, the digital revenues, it is a mix. As I said, the majority is advertising revenues. We have transactional revenues. We have mobile revenues. We have revenues coming out of Paramount and we are going to have Harmonix revenues as we go forward. I am very comfortable with the $500 million number as we go ahead. Obviously I want to see if we can get to that number this year and next year really drive through through all of our businesses.

Thomas E. Dooley

The scatter over scatter, as Philippe indicated earlier in his remarks, we believe that it will be stronger than the first quarter of last year in terms of its relative growth.

Gordon Hodge - Thomas Weisel Partners

Okay, but your comments earlier were scatter versus up-front, the high singles improvement?

Thomas E. Dooley

Yes.

Philippe P. Dauman

Thank you everyone for joining us and have a good day.

Operator

That does conclude today’s teleconference. Thank you for your participation and have a good day.

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