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Viacom, Inc. (NASDAQ:VIA)

Q1 2007 Earnings Call

May 10, 2007 8:30 am ET

Executives

Sumner Redstone - Executive Chairman

Philippe Dauman - President, CEO

Tom Dooley - CFO

Jim Bombassei - IR

Analysts

Benjamin Swinburne - Morgan Stanley

Spencer Wang - Bear Stearns

Michael Nathanson - Sanford Bernstein

Anthony Noto - Goldman Sachs

Anthony DiClemente - Lehman Brothers

Jessica Reif-Cohen - Merrill Lynch

Richard Greenfield - Pali Research

Doug Mitchelson - Deutsche Bank

Jason Bazinet - Citigroup

Presentation

Operator

Good day, everyone and welcome to the Viacom first quarter 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.

Jim Bombassei

Good morning, everyone and thank you for taking the time to join us for our first quarter earnings call. Joining me for today's discussion are Sumner Redstone, our Chairman; Philippe Dauman, President and CEO; Tom Dooley, Chief Administrative Officer and CFO; Jacques Tortoroli, 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 Redstone

Good morning, everyone. Thank you for joining us today. We're really pleased with our solid start to 2007. Viacom's first quarter results demonstrate that under Philippe's leadership we have begun to unleash the company's true potential, particularly as we expand our presence in the digital world.

Philippe and Tom, and the rest of our team have really done a terrific job in implementing important changes at Viacom. We are revitalizing our creative capabilities. We're building on our core assets. We are fully exploiting our existing relationships and entering into new partnerships that present attractive revenue opportunities. And we are seizing our digital future, which will further accelerate our progress.

I am confident that the creative drive throughout Viacom's ranks, its strong management focus, will enable us to bring increasing value to shareholders this year and in the many years to come.

Now of course, I am pleased to turn this call over to Philippe.

Philippe Dauman

Thank you, Sumner, as always. Thank you all for joining us this morning as we review the first quarter and take you through what is coming for the remainder of the year. We're off to a solid start in 2007. The changes we have made in our organization are clearly beginning to enhance our opportunities to develop and sell our content across every platform. We are pleased with the progress we're making, but we recognize that we are still very much in the midst of our transformation. We expect the results of our work to really take shape as we move forward through 2007 and beyond.

This morning, I will discuss some key first quarter highlights. Tom will provide some additional details on our financial results and key trends that will impact our business over the next few quarters.

Let me begin with a quick review of the numbers. Consolidated revenues were up 16% in the first quarter. The 10% increase in our Media Networks segment revenues reflected a 10% gained in total worldwide advertising revenues, including 3 percentage points of growth from acquisitions. Affiliate revenues grew 14% in the quarter, benefiting from 4 points of growth due to acquisitions. Ad sales growth for the second quarter is pacing up mid-single digits.

The Film Entertainment segment delivered a 27% increase in revenues this quarter. This included incremental growth from the acquisition of DreamWorks and distribution activities for DreamWorks Animation and the DreamWorks library.

First quarter net earnings of $203 million reflected lower operating income and higher net interest expense. Our reported first quarter diluted earnings per share of $0.29 include a $0.05 per share impact from the restructuring charges. Without the impact of this expense, first quarter diluted EPS came in at $0.34. It should also be noted that this includes an incremental $11 million in after-tax expense associated with the impact of equity compensation accounting.

As we previewed in our last earnings call, our bottom line results were impacted by three primary factors: substantially higher print and advertising cost in Filmed Entertainment versus the first quarter of last year, due to the number and mix of film releases in the quarter; expenses associated with the Media Networks restructuring we effected to drive our business forward; and the budgeted increase in our original programming investment. Our restructuring and programming investments will fuel both our top and bottom line growth as we move into the back half of this year and beyond.

On the international front, ad sales revenues were up solidly. Gaining better traction across our international group is one of our top priorities, and we're now making good progress toward our objective. We're gaining strong momentum in Germany, which I visited just last week. MTV, VIVA, and Nick Germany delivered their highest quarterly ratings ever; and Comedy Central in Germany is off to a good start. The restructuring of our international Media Networks businesses announced in March is proceeding on schedule. This should provide further momentum and, as advertised, yield 10 to 15 percentage points of additional margin in 2008.

As we continue to transform this company, a simple fact remains abundantly clear, one that appealed to me from the first day I assumed this job. Viacom is in a great strategic position. We are the world's largest pure content company, with many of the world's leading entertainment brands. We produce the content of choice for the most desirable categories of consumers on a global basis. Regardless of how or where technology evolves, we have and will continue to develop the content that these audiences crave; content that moves comfortably from the TV screen to the movie screen to the computer screen to the mobile screen from the US to the UK to Germany, Russia, India, Japan and beyond.

We know we have ratings challenges at a few of our channels, such as MTV, BET, and Nick at Nite. It is important to note that most of these ratings challenges are related to weakness associated with some older and acquired programming, which we are systematically replacing with new, compelling and engaging programs, shows such as MTV's Scarred, BET's American Gangsters, and the debut of America's Funniest Home Videos on Nick at Nite. These and the substantial number of new shows and series we have invested in are just beginning to roll out and will begin to drive overall ratings as we move through the year and into next year. There are many bright spots throughout with new breakout hits and strong ratings at Nickelodeon, Comedy Central, MTV2, and VH1, just to name a few.

Under the leadership of Judy McGrath and the MTV Networks team, we have changed the way we sell to our advertising partners. Our newly restructured advertising sales group is no longer necessarily selling the ratings of an individual program or even a single network. The group has been reconstituted to maximize our focus on important demographic clusters across television, the Internet, and mobile. At the same time, we're fostering deeper relationships with our audiences by providing them with new ways to engage with the brands they love across all platforms. This deeply engaged audience and the entertainment experiences that our brands deliver translate into a premium value we can sell to our advertising partners on air, online and in the mobile world.

Today, we are selling brand connections, leveraging all of our linear and digital assets to meet the needs of our advertisers. Many of our key sales meetings include representatives from our marketing, digital, and research teams. The result is a more compelling, integrated proposition in which advertisers can interact with our highly engaged consumers on a deeper level. Let me give you just two examples, a movie and a new approach to selling one of our own events.

First, Spiderman 3, which as you know had a record-setting opening for Sony this past weekend. We orchestrated a multi-platform solution across six networks and 13 online properties to turn the premiere of the extended trailer into a main event.

Secondly, we presented Nickelodeon's 20th annual Kids Choice awards to advertisers with the same multi-platform mindset and generated tremendous results, including 41 million votes across all of Nick's digital platforms and the highest traffic ever on the day of the awards show on Nick.com. The result? The highest ratings for the show in its 20-year history, a record number of advertisers, and a new revenue high for the event. Our marketing partners recognize the effectiveness of these highly-engaging approaches to reaching consumers. It is no longer about linear versus digital. Our multi-platform clout is more valuable than any one individual screen.

On the programming front, we're developing a strong portfolio of original content across our networks. These new shows are designed to get people talking. Importantly, we believe they will help us sustain and build our ratings over the longer term. Let me run through a few examples.

MTV has announced a promising slate of new and returning series that spans a number of different genres. It also launched a new seamless format for its Thursday night programming, where the content and commercial time is fused together. Just this week, MTV announced that it is working with American Eagle Outfitters to produce a 12-episode series of 3-minute films that will replace the commercial pod on MTV's The Real World in August. Longer versions of each episode will then run on American Eagle's website, further strengthening the link between these two great brands. This kind of innovation offers significant opportunities for advertisers to integrate their brands with original MTV content.

In April, VH1 launched two new successful hits: Acceptable TV, an innovative multi-platform sketch comedy, and Charm School, which was the number 1 show on basic cable for its premiere night in the 18 to 49 demo and among total viewers. Comedy Central continues to build its brand equity across platforms with our juggernauts, The Daily Show, The Colbert Report, and South Park, with the Sarah Silverman program our latest new hit. The growing audience at ComedyCentral.com will enjoy 11 new original broadband shows that will debut over the course of the year.

Nickelodeon has taken its latest breakout hit, the Naked Brothers Band, and turned into a powerful multiplatform brand. The TV show which debuted in January is number one with kids 6 to 11 in its time period. It also has the top message board on Nick.com; and its online game, Ready to Rock, has been played 8.5 million times. We are planning a UK premiere this month, launching a CD later this year, and we have already announced a second season. We are also about to launch a dedicated Naked Brothers Band section in our kids' virtual world, Nicktropolis.

Sumner helped kick off the launch of Comedy Central Germany in January, further expanding our strong comedy business in Europe. As in the US, comedy is booming in the digital arena there. Paramount Comedy's Mobile TV channel in the UK is the number 1 channel in general entertainment.

Debra Lee and the BET Networks team are leading the charge to develop and produce 16 original series in 2007 across many genres, the majority of which will launch in the third and fourth quarters. We see big upside in this investment, since BET's original content has historically generated higher ratings than syndicated programs. College Hill 4, which is on the air now, is cable's number 1 show among African-American households this year, with viewership up 31% versus the prior season.

Moving on to Filmed Entertainment, Brad Grey and his team continue to do a great job in establishing a new direction for Paramount. We have had a very successful start to the year, with three of our films: DreamWorks' Norbit; Blades of Glory, also an MTV film; and Disturbia opening in the number 1 spot at the box office. Clearly, our acquisition of DreamWorks last year is more than delivering on its promise. We will be distributed DreamWorks Animation's much-anticipated Shrek the Third this month. Transformers, executive produced by Steven Spielberg and directed by Michael Bay, will open over the July 4th holiday. It is spectacular. Hot Rod and Stardust will open later this summer. We're also looking forward to seeing Ben Stiller in the Farrelly brothers' version of The Heartbreak Kid, among many exciting titles in the fall. Looking ahead, our entire 2007 slate and our 2008 slate are shaping up very well.

There is no doubt that Viacom is starting to hit its stride in the digital world. Thanks to this progress, I can now commit that we will reach what had been originally stated as an aspirational objective of generating $500 million in digital revenues this year. From the creation of virtual worlds and enhanced interactivity to the formation of innovative partnerships, the entire Viacom organization has embraced the need to accelerate our digital activities, and it's working.

Today, we are the number 1 online entertainment destination and the 11th most popular overall destination on the web. During the first quarter, Viacom digital welcomed an average of nearly 39 million unique visitors each month, according to comScore Media Metrix. That is a 61% increase over the first quarter of last year. ComedyCentral.com closed out the quarter with its strongest month ever. BET's mobile subscription service grew more than 130% in the first quarter to nearly 200,000 subscribers.

We have a growing portfolio of virtual worlds, all based on our most popular television programming. We see leadership in this category as a significant competitive advantage and point of differentiation in the marketplace. A virtual world brings us a completely different level of engagement with our audiences and new sources of incremental revenues. We're just beginning to tap into the possibilities that these experiences offer to our audiences and to our advertisers, migrating from traditional advertising to branded content users interact with.

For example, in virtual Laguna Beach, and soon our other virtual worlds, visitors can quench their thirst with a can of Pepsi, read a Pepsi-branded magazine, and purchased Pepsi-styled gear. Nicktropolis, our kid-targeted website and virtual world, has surpassed 3 million registered users in just three months and those users visit often, spending an average of nearly 40 minutes per week.

As I just outlined, we're doing great work with our existing properties. We are also rapidly expanding our revenue opportunities through strategic relationships with new online destinations. I should point out that these companies are seeking us out as partners of choice because of the content we can offer them.

Let me provide three examples:

One, through our partnership with Joost, we will soon deliver to audiences popular content from MTV Networks and BET Networks, as well as feature films from Paramount. This is an ideal marriage of our world-class content with the first broadcast-quality Internet television platform. There will be links to our website as well as message boards and a variety of other interactive features, which all represent opportunities to further leverage our content across platforms.

Two, we recently designated Yahoo! as the exclusive provider of sponsored search ads to all of Viacom's 33 broadband sites. This multi-year partnership is yet another way we monetize our growing online portfolio. Yahoo! is also partnering with us and Mark Burnett Productions to add a digital interactive component to the upcoming MTV Movie Awards, which airs next month. We're creating the MTV Movie Awards on Yahoo!, where participants can submit original content for the Best Movie Spoof Award and comment on the user-generated submissions.

Three, our partnership with iTunes continues to expand. During the first quarter, a Paramount movie has been the top library title downloaded every week on iTunes, including School of Rock, which is also featured in Apple's latest television campaign. MTV's The Hills Season 2 is the number 1 seller on iTunes across all MTV Networks' music brands in 2007. The show also generated more than 500,000 VOD orders to date. We are in active discussions with a number of other digital distribution and marketing partners which will further deepen the penetration of, and consumer engagement with, our content and brands.

The mobile arena is a particularly attractive market for Viacom, because so much of the programming we create is highly clippable and very conducive to the way our audiences consume entertainment today, which is on the go. Bolstering our position as the leading provider of video programming for mobile technology, all of Viacom's divisions -- MTV Networks, BET Networks, and Paramount Pictures -- added their mobile portfolios in the first quarter. Let me offer a small sampling.

MTV Networks started selling advertising across its mobile portfolio with the signing of two major charter sponsors, Pepsi and Intel. BET launched the 106th & Park's mobile fan club, extending the number 1 music video show on all of television to the mobile phone. It will feature access to exclusive content and events, further cementing our relationship with our audience. Paramount Pictures became the first film studio to create a mobile movie studio site featuring micro-sites for individual movie releases. These new relationships are helping us to accelerate an already-robust digital agenda and there is much more on the horizon.

We have realigned our company in significant ways in the last eight months. I believe we have unlocked many areas for incremental organic growth. We are still going through a period of major transformation, and we understand our challenges. We're going after those challenges aggressively, with an arsenal of the most valuable entertainment brands in the world and a strategy to win. We are providing more compelling content across every screen, intensifying the bond and engagement between our audiences and our brands. As a result, the premium value potential of our brands continues to rise.

To conclude, we are confident that we now have several drivers of long-term growth. We have a rebuilt studio operation with wind in its sails for the next few years. This gives us the opportunity to build a competitive advantage and diversify our operations without being encumbered by the past. In our Media Networks business, we have a powerful content engine with established and growing brands that is uniquely suited to grow across both linear and digital distribution channels. With a refocused international effort, we can now generate meaningful, rapidly-growing profits in our global operations. Above all, our entire management team has committed itself to focus on excellent execution across all these fronts and to produce sustainable shareholder value.

Now, speaking of excellent execution, I will turn the call over to Tom.

Tom Dooley

Thank you, Philippe and good morning, everyone. I hope you all had a chance to review our earnings release and web presentation summarizing our first quarter results. Our 10-Q will be filed with the SEC and will be available to you shortly after the call. I'm going to take you through our first quarter results in more detail and update you on the major factors impacting the balance of the year.

For the first quarter, revenues were up 16% to $2.75 billion. Operating income, however, was down $181 million to $443 million, driven by significant incremental year-over-year P&A spending at Paramount, restructuring charges at MTV Networks, and our investment in new programming at MTV and BET Networks. Diluted EPS was $0.29 on a reported basis, and $0.34 if you exclude the after-tax MTV Networks restructuring charge.

Now let me turn to each one of our segments, starting with the Media Networks. Revenues were up 10% to $1.7 billion. That included $40 million of net incremental revenues from acquisitions and a divestiture that took place last year. Worldwide advertising revenues rose 10% year over year, to $974 million, with acquisitions contributing 3 percentage points of that growth. Domestic ad revenues were up 8% led by Spike TV, Comedy Central, and VH1. These gains reflect strong growth in major ad categories such as movies, quick service restaurants, and home video.

While international ad revenues showed growth of 36%, the increase was primarily due to the impact of consolidations, which contributed 16 percentage points of growth on a comparable basis, and foreign exchange, which contributed 10 percentage points of growth.

Affiliate revenues also saw double-digit increases, growing 14% in the first quarter to $558 million. Domestic revenues grew 10%, driven by both growth in subscribers and rate increases across core channels. Once again, international revenue growth of 40% was driven by 27 percentage points of growth from consolidations and 10 percentage points of growth from favorable foreign exchange.

Ancillary revenues were up 2% to $201 million in the first quarter. Our domestic revenues grew 20% as a result of sales of Guitar Hero 2, a Harmonix game, as well as increased electronic downloads and wireless revenues. International ancillary revenues, however, were down 27%. That was largely due to the disposition of a German production studio in the fourth quarter of 2006.

Media Networks operating income was $602 million in the quarter, including the $56 million in restructuring charges, or 3% below last year. As highlighted in the presentation posted on our website, operating income before the restructuring charges increased 6% to $658 million compared to last year. We expect that the full year 2007 MTV Networks restructuring charges will be approximately $70 million. The remaining charges will be principally related to international actions and will hit primarily in the second quarter. As we indicated in our last earnings call, our operating income margins in Media Networks for the first full quarter declined primarily due to restructuring charges, incremental programming, marketing, and channel launch costs.

Turning to Filmed Entertainment, you will recall that we closed our deal with DreamWorks and DreamWorks Animation on January 31 of last year and sold the majority stake in the live action library in May 2006. Revenues in this segment were up 27% to $1.05 billion, including about $101 million in incremental revenues related to the acquisition of DreamWorks and the distribution activities for DreamWorks Animation and the live action library for the month of January. Theatrical revenues drove our growth, increasing 124% to $266 million. This was due to the number, timing and mix of releases compared to last year. We released six films in the first quarter of 2007: Freedom Writers, Norbit, Black Snake Moan, Zodiac, Shooter, and Blades of Glory; one more than last year. We also released realized higher incremental revenues in the first quarter from prior year's releases, primarily related to Dreamgirls and Charlotte's Web.

Filmed Entertainment operating income declined $157 million versus last year to a loss of $106 million. As we stated on our last call, we anticipated a significant year-over-year increase in first quarter P&A expenses. That drove the loss for the quarter. For example, one of the our most successful releases, Blades of Glory, opened during the last weekend of March with a significant P&A cost expensed in the first quarter. Substantially all of the theatrical revenue, however, for the film was recognized in the second quarter. Domestic theatrical print and advertising expenses were up $170 million in the first quarter. On a worldwide basis, P&A expenses increased $236 million.

Turning briefly to corporate, our corporate expenses were $54.3 million, up $6 million for the first quarter of 2006. All of the increase was due to the impact of equity compensation expense accounting, which was $11 million higher than last year.

Free cash flow was $308 million compared to $369 million in the first quarter last year. The $61 million decline in free cash flow principally reflects the lower operating income and net earnings, as well as modestly higher cash taxes. These items were partially offset by the timing of cash interest and lower uses of working capital. We repurchased 4.3 million shares in the first quarter for an aggregate purchase price of $174 million, and had 694.1 million average diluted common shares outstanding at the end of the quarter.

From a business outlook point of view, let's move on to our outlook for the year. First, let me confirm that there is no change to the 2007 through 2009 guidance that we gave in our last earnings call. We continue to see operating income and EPS growth for 2007 being back end weighted as we navigate through a long-term strategy that is impacted by seasonal and quarterly business factors.

I want to update you on some of the trends we see impacting our performance in the balance of the year. In Media Networks, domestic ad sales growth for the second quarter is pacing up mid-single digits as a strong scatter market is offset by last year's lower upfront base. As Philippe discussed, we continue to invest in new programming to grow our brands and to expand our consumer reach. The near-term impact will be a short-term reduction in Media Networks' overall margins. However, we are confident that these investments will allow us to improve those margins over the second half of the year.

In Filmed Entertainment, as we saw in the first quarter, results can be significantly impacted by the timing, number and mix of theatrical releases and associated P&A expense. In the balance of the year, we continue to see year-over-year increases in P&A expenses. This is particularly true in the third quarter due to the planned release of our summer tent pole, Transformers, as well as Hot Rod and Stardust.

In terms of equity compensation expense, you should expect this to continue to build over the next few years until we reach our constant run rate in 2009. The increase in equity-based compensation expense will have a full year impact of approximately $0.02 on diluted earnings per share.

As Philippe said, we still have a lot of work ahead of us, but we are making great progress. I firmly believe we are making the right investments to keep us on a path of long-term growth which will ultimately drive shareholder value. I look forward to updating you on our progress in the coming quarters.

Now we would be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

I was wondering if you could comment on the Journal's story on the investment in Korea in the theme park area? Also, we heard a lot at the Cable Show about day and date release for the DVD on the film side, with the argument being there is very little, if any, cannibalization of DVD sales. Could you guys comment sort of on your view of that business, and how you see windows changing over time, and how that impacts positively and negatively your economics?

Philippe Dauman

As far as the Korea theme park, which was announced this morning, this is a licensing deal by Paramount with Daewoo Motor Sales Corporation. We reached an agreement to explore the development of this theme park in South Korea. It would feature characters, attractions, facilities based on our motion picture library. I want to emphasize that we will be putting up no money for this park. There is no capital allocated to this. Daewoo will be responsible for raising the funding for the development and construction of the project. We receive licensing fees and payments for our planning services.

As far as windows, we are conducting experiments that relate to the VOD and DVD windows. We're running experiments with Comcast. So far in Pittsburgh and Denver where we have run those tests, on the first part of the test we haven't seen any impact in those communities on our DVD sales with having day and date. The test is still ongoing, and we will evaluate the full results of the test as we get through the next three months or so.

Tom Dooley

Too early to project what impact it will have on our businesses.

Operator

Your next question comes from Spencer Wang - Bear Stearns.

Spencer Wang - Bear Stearns

My first question is on the US ad growth in the first quarter. Was there anything unusual in the first quarter US number? In other words, was there any upfront payment from Joost or Yahoo! or the Sprint deals?

Philippe, you talked about turning around the ratings with the new programming investments. At what point are you guys expecting to actually see ratings grow to achieve your full-year targets?

Philippe Dauman

As far as the first quarter ad sales, no; this does not include unusual upfront payments from Joost or any of the other deals we announced. We saw a pretty robust scatter market in the first quarter. As I mentioned in my remarks, we also, I believe, had a much more focused and aggressive advertising sales effort which should carry us through as we go ahead, whatever environment we face in the general advertising market.

As far as ratings go, I want to emphasize that even in those networks where we recognize that we have had some recent ratings softness, all is relative. These are still historically very high ratings. On those networks where we have those issues that I mentioned, we are going to build them up over the long term. A lot of our programs, because we approved the production of a lot of these new shows as we were going through the budget process, are being developed now. Some of them are starting to roll out. So far the ones we have rolled out are performing quite well.

A larger proportion of these shows will be rolling out as we continue through the end of the year. BET, for example, has the great bulk of its new shows coming out in the third and fourth quarter. But we expect to see results starting to kick in as we get into the summer season.

Operator

Your next question comes from Michael Nathanson - Sanford Bernstein.

Michael Nathanson - Sanford Bernstein

Philippe, over the past year, you spent a lot of time talking about the profitability of cable networks. I was wondering what is being done to lift the profitability of Paramount, which is below peers? Would you ever consider reducing the film investment there?

Tom, as you can tell by the questions, investors are focused on MTV's ratings. How has the ratings weakness affected advertising growth there? Is it below the overall cable average?

Philippe Dauman

Taking the Paramount question first, I am very encouraged by the way the Paramount business is developing. First of all, we have really taken a disciplined approach to the capital we allocate to film production. We are now operating Paramount, looking ahead on a multi-year rolling basis, to look at what our production plans are, how we are financing them, how we are calendarizing the releases. So we have a very disciplined approach in place.

As I mentioned, we have what I think is a very strong slate, thanks to the combination of production entities we have within our studio. DreamWorks, of course, has put out three movies so far this year, and all three have been number 1 movies. I am not sure we can get perfection with all the releases the rest of the year, but we are certainly off to a great start. We are going to build our competitive advantage through regular releases as we go forward of MTV films, Nick films. We are, as I previously discussed, going to launch a BET films line and see where we go from there.

As we build up organically our studio releases, as the revenues from these successful movies roll forward over the next few years, assuming reasonably good performance structurally we should see growth in the business and improvement in our margins.

While we are doing that, we are also going to diversify our revenues at Paramount, without being encumbered by the past. Because we start out without having television operations, for example, we have the opportunity to produce television for cable; to have a more robust made-for-DVD operation; and we are looking at many other opportunities to increase our margins. The Korea licensing deal, which as I mentioned does not involve any cash outlay on our part and involves our getting licensing fees, again is another method of having a secure source of revenues that will improve our margins.

So I'm feeling very good about the position we are in there. I think we are on a good trajectory over the next few years. As we go ahead, I think you will see the margins improve. We're certainly improving our market share.

Tom Dooley

As far as MTV ratings go, you know, we are not going to run away from ratings. As Philippe said, we're working really hard to get new shows on that continue to drive ratings and drive ratings growth. But ratings aren't the whole story. I think when you break down MTV's ratings, you have to look at the Cume and the time spent. The Cume is consistent year to year and in some cases up. It is time spent that is down. That is to a large extent because we are driving people to other places. We are driving people to our digital worlds. The virtual worlds on MTV with MTV's Virtual Laguna Beach and MTV Hills have been having phenomenal success. Now we have got virtual Pimp My Ride. These are innovative new relationships, with more to come in the very near future. We are using them, as Philippe mentioned, to build ad partnerships.

So we are looking at the ratings thing as both an opportunity, but indicative of how the world is changing right now for everybody in this business; and how you have to extend your relationship with advertisers and extend the relationship with the consumer, and engage the consumer in conjunction with the advertiser over a wider scope .We have been very successful at it. We continue to be, I think, the lead innovator here in this regard and I think that is shown in the results that we are putting out.

Philippe Dauman

I just want to add to that. You may have noticed I used the word engagement several times in my remarks. I think that is the key. We have reach to the key demographics that advertisers around the world, by the way, want to reach. We have deeper engagement, which we have the opportunity to really build on through our digital activities including mobile, that I don't think anyone in the business has. So as Tom said, this creates great opportunities to build on our partnerships with advertisers.

Tom Dooley

A lot of our new programming is designed, as Philippe said before, in a clippable form. That is not by accident. It is very unique to us. I think it is once again an example of our innovative and creative ideas that are out there. Little Bush is hysterical; you guys are going to love it.

Operator

Your next question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Philippe, I was wondering if you could comment on the domestic advertising number. I think you said it was 8%. What was the growth rate of the non-digital advertising in the United States? As it relates to the advertising number, I was wondering if you could give us a sense, given your earlier comments, on what the CPM increases were there, as well as sell through?

Philippe Dauman

We are not going to provide a breakdown within the advertising number. I would say that advertising across the board was strong in the first quarter. As far as scatter market CPMs go, those have been very robust. We are seeing double-digit increases. As Tom said in his remarks, we are building what was a low base in the upfront sales from last year. Scatter advertising is very strong, and I think that bodes quite well as we go forward.

Anthony Noto - Goldman Sachs

One other thing that you alluded to, which I think is the case, but I just wanted to confirm: do you think there is a productivity benefit as your ratings at the cable networks improve you also see increased visitation and engagement in your online businesses? The benefits that you could see from the investments in the cable network will carry over to the online business, even though you may not necessarily intend to do that. Is it just a natural benefit?

Philippe Dauman

Unquestionably, it is a benefit. I mentioned one example, but we have several. The Naked Brothers Band show on Nickelodeon is not only achieving great ratings and a lot of buzz among kids, but on air it is driving traffic to our Nickelodeon sites; and not just traffic looking at clips from the show, or information about the Brothers, but it is leading kids to play games on our sites, it is leading them to chat about the Brothers. It is really a phenomenal multi-platform success. That is what we are looking to do with all of our shows.

The virtual world aspect, which we really do think we have the leadership position in and we have a unique ability to program is just another way to build on that. Advertisers love that. For them it is a very, very compelling proposition. It is a way for our audiences to interact with their brands in a very comfortable brand environment for these same advertisers that I think will give us a deeper relationship with the advertisers, and one that will endure.

Operator

Your next question comes from Anthony DiClemente - Lehman Brothers.

Anthony DiClemente - Lehman Brothers

Just a simple question on the ratings in terms of your expectation for margin expansion on the back end of the year. Does that require a ratings upturn? Or can you get that at current ratings levels, given what you are driving to the digital platforms?

On Paramount, with such a back-end loaded year and with it appearing that a lot is riding on your July 4 release of Transformers, do you expect growth in operating income at the Filmed Entertainment segment this year?

Philippe Dauman

Again, as far as the ratings go, I want to emphasize that while we are addressing the ratings issue, as we have discussed, we are in a very strong position throughout our portfolio. We have great areas of strength. Comedy Central is just continuing to drive its growth. We have great success from VH1. MTV, Nickelodeon are extremely solid from a branding standpoint. So we are addressing this issue not because there is a crisis at those networks where we are continually looking to improve our programming, but one just to build for the future. We do expect to see results, however, on our programming. We think that will enforce, reinforce, our growth trajectory. We are selling an engagement proposition to our advertisers, but, unquestionably, maintaining and growing our ratings will help us in that regard.

As far as margin expansion goes, I think it will be a combination of driving revenues as we go through the second half and also just flowing through the costs that we expended as part of our restructuring initiatives in the early part of the year.

As far as Paramount goes, Transformers, which is a great picture, is not the sole driver of our revenue as we go ahead. Remember, we are getting the revenue boost, I mean Blades of Glory as Tom indicated, the theatrical was released at the very end of the first quarter, the revenues are going to drive through on theatrical, DVD, and so forth as the year plays out. Shrek the Third, which is being released the end of next week, should be a very good title for us, again as we go toward the back end of the year, because upfront we have all the P&A expense.

We have a very broad, diverse portfolio. What the final result will be as far as operating income we will see. You can never predict with 100% certainty what the audiences will go see in the theaters. So I'm not going to sit here and predict exactly how it will perform. All I can say is that we have a very good portfolio of titles coming out as the year progresses.

Operator

Your next question comes from Jessica Reif-Cohen - Merrill Lynch.

Jessica Reif-Cohen - Merrill Lynch

I just want to go back to the question that Spencer asked about the digital deals. I am just curious, is there any upfront money from some of the deals you made? If there is, how will you account for it? How do you think about the ultimate revenue that you can generate from the Yahoo! deal versus maybe a Google with better monetization? Can they compensate for that?

The second question is related to ancillary revenue. Can either one of you walk through the economics of Rock Band versus Guitar Hero, and is the timing fourth quarter?

Finally increases in programming investments, will that be spread equally throughout the year or is it mostly first half driven?

Philippe Dauman

Thank you, Jessica. I am glad you didn't have ten questions. Let's see if I can remember all of the questions.

As far as the digital deals go, generally these are multi-year relationships that we're entering into. There is no funny business going on as far as recording large upfront payments. That's not the way we're doing those deals. Obviously, we don't comment on specific terms of deals and we talked to a lot of partners. As far as the Yahoo! search deal, we obviously shopped around the deals, and we have a deal structure that we can't disclose by agreement with Yahoo!, but one that we feel very comfortable with economically and one that protects us economically.

We have been quite impressed with the new platform that Yahoo! has rolled out, and we think it will prove to be quite robust. This was a deal which was the best deal from our perspective that was available, and we look forward to growing with them in that area.

As far as the Google versus Yahoo! on the search, the deal we entered into with Yahoo! is more favorable to us, significantly more favorable, than what was offered by Google.

Tom Dooley

In terms of Rock Band versus Guitar Hero, the economics are going to be driven by how many units you sold into the marketplace. You know while we were a full owner this year of the enterprise, it will happen in the fourth quarter. Principally it will be a holiday package sale. We are optimistic, but we are also going to be very cautious on how we market this product. It is new to us. We have great enthusiasm and we think it is going to be a long-term solid contributor to the company. We are not going to get into the exact economics. But basically, we are a licensor/publisher in terms of our relationship with different players here, from retail partners and distributors. So we have got high hopes for it, but we're going to be conservative in rolling it out, it is a new business for us. It has been tremendously successful and we hope to continue that success for many years to come.

Philippe Dauman

As I mentioned earlier, we are going to be rolling out a lot of the new programming as the year unfolds. Of course, this new programming is replacing older programming that was there. So in terms of the programming expense, that will be really evenly tied into revenue. Remember for a lot of our networks, the summer season and the fourth quarter are high water marks. So it is a good time to be rolling out the new programming. That is when the bulk of the advertising dollars also available.

Tom Dooley

As I mentioned before in my remarks, that the margins would be under some pressure as we rolled through the first half and third quarter and improve in the back half of the year.

Operator

Your next question comes from Richard Greenfield - Pali Research.

Richard Greenfield - Pali Research

You talked a lot about your big programming networks, but not a lot about your digital, your smaller diginets. I wonder if you can just kind of give us an update on how your strategy for the group of networks you have like MTV and VH1 Classics and what you are doing to spur those channels.

Two, if you could talk about the new MTV.com, what the rationale was and how it is going in the early days since the relaunch of the new website?

Lastly, just Tom, on a housekeeping point. Can you just review? It wasn't clear from the subscriber revenues what the total domestic and international was on an organic basis, excluding acquisitions. Thanks.

Philippe Dauman

Richard, as far as the diginets are concerned, you mentioned MTV Tres specifically. MTV Tres is a network we have very high long term hopes for. This is a network addressed to a very underserved Latino marketplace in this country. So for me this is a significant initiative, programming initiative, on our part, which I think will be a meaningful part of our future.

We are having a lot of discussions with our distribution partners about our diginets, including possibly new ones that address demographics that we currently don't serve all that deeply. The nature of the discussions we're having generally with our affiliates has been much more interesting than it has been in the past; much deeper partnerships are being developed in that arena. These conversations are taking place at, of course, our affiliate sales level as it always does but also involving many, many other players throughout the company including at the very top.

So I see great opportunity to expand the presence and build on these diginets, and in some cases purpose them to address interesting new demographics.

As far as the recent relaunch of MTV.com, which is a very, very successful site, I think it is a great new look, great new functionality. Again, it is part of our strategy to provide more interesting consumer experiences and more monetization opportunities for advertisers. So we are really quite satisfied with the way things are going.

I will turn it over to Tom for the affiliate question.

Tom Dooley

On a total company basis, that is worldwide, affiliated revenue grew 14%. If you adjust out of those numbers acquisitions and dispositions and foreign exchange, we grew about 9%. If you look at it on a domestic basis, domestic affiliate revenues, up 10%. There are no acquisitions, divestitures, or foreign exchange impact domestically. International affiliate revenue grew 40%. If you adjust out acquisitions, dispositions, and foreign exchange out of that number, international affiliate revenue grew 4%.

Richard Greenfield - Pali Research

Can you just comment on that 4%?

Tom Dooley

Mostly driven by increases in subscribers and slight increases in rates.

Operator

Your next question comes from Doug Mitchelson - Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Philippe, you talked about being in a great strategic position and that certainly rings true, since you have not been aggressively pursuing deals. But you have also not been buying back a lot of stock, at least in my view. If you use the midpoint of your leverage target, I get about $2.5 billion of excess borrowing capacity by year end and about $6 billion by the end of next year.

Could you comment on deployment of your excess capital? First, do you agree that there is a lot of excess capital? Second, do you see a strong ramp in acquisitions or share repurchases as likely or would you prefer to build a more conservative capital structure?

Philippe Dauman

Well, as we have stated before, we're looking to remain investment grade. However, you are quite right, we generate a lot of free cash flow. We are not deal driven in building our business. We have a lot of organic growth that we are investing in, with modest acquisitions that fit very closely into our businesses as we go forward. So we do expect to continue a robust buyback program. The first quarter number I believe was about $174 million of buybacks. This reflects the seasonality of our cash flow. So as you go forward in the year and our free cash flow builds, you will see a ramping up of the pace of the buyback program.

Clearly, we always want to leave room to take advantage of these small opportunities and take into account seasonality. We do have room to go. We intend to maintain a steady pace of share buybacks. We believe, particularly at these price levels for our stock, that it is a good way to build value.

Doug Mitchelson - Deutsche Bank

For clarification, in the past you have mentioned 2.5 to 3 times as a leverage target. Is that still accurate? Is that consistent with remaining investment-grade?

Philippe Dauman

That would be consistent, yes.

Tom Dooley

One thing to consider, though, is that the way the rating agencies calculate the formula is a little bit different than you might. They include a lot of other things like capitalized leases and other contingencies that you might not include in the calculation. So they get a little bit different math, but not significantly.

Doug Mitchelson - Deutsche Bank

Could you give us a ballpark total of those additions?

Tom Dooley

Yes, is almost $800 million or $900 million.

Operator

Your final question comes from Jason Bazinet - Citigroup.

Jason Bazinet - Citigroup

Given the industrial changes that are going on in the advertising market, coupled with some of the missteps last year, it seems like the major question investors have is the long-term reasonable growth rates for cable network advertising. I was just wondering, I don't really care about this year or next year, but if you hold ratings constant and strip out the digital impact, could you just comment on what you think a reasonable cable network advertising growth rate is, in aggregate?

Philippe Dauman

Jason, I think there are a couple of premises in your question which I think are going to have to change to reflect the reality of the new world. I think as we go forward we are increasingly seeing that the advertising sales proposition involves multiplatform sales. So I think going forward, particularly several years, to strip out the digital impact, as you put it, is not the right way to look at the business.

Long term, we expect that as we always have to outperform the Media Networks average and outperform our competitors. We think that that competitive edge will increase over time, because of the demographics that we serve; because of the deeper engagement that we are creating through our multi-platform activities.

It is pretty interesting to me that even with the what one could call later entry on our part into the digital world, that even today, as we sit here without the full benefit of all the initiatives we are taking, not only are we the number 1 strongest player with 25% audience reach in the advertiser-supported cable network world, number 1 in that platform, we are also number 1 when you take collectively all our sites in entertainment destinations on the web and we are number 1 not just domestically, but really around the world in video content on mobile platforms. By the way, a small base; but the fastest-growing part of all of our businesses from a revenue standpoint.

As we look ahead, we can't predict the rate at advertising growth several years out because of course it is going to be a function of the general advertising marketplace. All we can do is be the best competitively. We think we have unique attributes and unique advantages that will get us there.

Operator

That does conclude our question-and-answer session. At this time, I will turn the call back to Jim Bombassei for any additional or closing remarks.

Jim Bombassei

That concludes our first quarter earnings call. Thank you for joining us.

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