Starz (STRZA) Christopher P. Albrecht on Q2 2016 Results - Earnings Call Transcript

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Starz (NASDAQ:STRZA)

Q2 2016 Earnings Call

July 28, 2016 5:00 pm ET

Executives

Courtnee Chun Ulrich - Vice President-Investor Relations

Christopher P. Albrecht - President and Chief Executive Officer

Scott D. MacDonald - Chief Financial Officer

Analysts

Ryan Fiftal - Morgan Stanley & Co. LLC

Vasily Karasyov - CLSA Americas LLC

Zack Silver - FBR Capital Markets & Co.

Kevin Lee Hon Siong - Stifel, Nicolaus & Co., Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2016 Earnings Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded, Thursday, July 28.

I'd now like to turn the conference over to Courtnee Chun, Senior Vice President of Investor Relations. Please go ahead.

Courtnee Chun Ulrich - Vice President-Investor Relations

Thank you, and welcome to the Starz 2016 Second Quarter Earnings Call. This call includes certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements about the proposed transaction with Lionsgate, statements about the anticipated synergies and benefits of the proposed transaction, revenue growth, new service offerings and original programming, new packing and new distribution platforms for our programming, subscriber growth, international distribution opportunities, the suspension of our stock repurchase plan, expectations regarding 2016 programming expense, expectations regarding advertising and marketing costs, and other matters that are not historical facts.

These forward-looking statements involve many risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such statements. These forward-looking statements speak only as of the date of this call, and Starz expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in Starz's expectations with regard thereto, or any change in events, conditions or circumstances on which any such statement is based.

Please refer to the publicly filed documents of Starz, including our most recent Forms 10-K and 10-Q, for additional information about Starz and about the risks and uncertainties related to Starz's business, which may affect the statements made in this presentation.

During today's call, we will discuss certain non-GAAP financial measures, including adjusted OIBDA. The required definition and reconciliation can be found at the end of the PowerPoint, which you can find on our web site.

Now I'd like to introduce Starz's President and CEO, Chris Albrecht.

Christopher P. Albrecht - President and Chief Executive Officer

Thanks, Courtnee. We appreciate you joining us again and for your continued interest in Starz. With me is Scott MacDonald, Starz's Chief Financial Officer.

I'll start by highlighting the agreement we recently entered into with Lionsgate. We believe this transaction is a transformative moment for our company and an excellent deal for our stockholders for a number of reasons. I'll highlight a few of them.

Financially this delivers real value for Starz shareholders, offering a significant premium to Starz at the time of the announcement. We also expect substantial synergy opportunities to drive incremental value for shareholders.

Strategically Lionsgate is a very well regarded producer of content, and together with Starz we will form the largest independent film and television company in the world. We will have real opportunities to extend globally the reach of that content across multiple distribution platforms.

Operationally Starz will maintain a separate identity and continue to build on the great brand equity created with our growing subscriber fan base. Our strategy remains intact, and we'll continue to make progress against our stated target of 80 to 90 episodes of compelling and diverse original programming per year.

In addition, I have tremendous respect for the leadership of Lionsgate and the enthusiasm they have for this acquisition. Jon Feltheimer, Michael Burns and their team have built the first major Hollywood studio in decades. We have similar entrepreneurial cultures and a shared vision of the future of the entertainment industry, which we believe will create very attractive opportunities for our combined company.

I'd now like to turn to the operational results for Starz. Starz Networks performed well in the second quarter, delivering strong financial results. Revenue growth accelerated to 3% year-over-year as compared to 1.8% year-over-year growth in the previous quarter. We also established a new record-high number of Starz subscribers, which hit 24.2 million in the quarter, up 200,000 from the prior. Our other premium service, STARZ ENCORE, experienced a decline in subscribers due to operational challenges faced by some of our larger distributors.

Our entire programming slate continues to perform well, and we are very proud to shift our schedule so that our original series air on Sunday nights, which is where the best of premium television premieres. Our top-rated series Power shattered ratings for its third season premiere, and established new viewership records for a STARZ Original series. According to Nielsen data, Power's Season 3 premiere was among the most watched for a premium series so far in 2016, second only to Game of Thrones, and grew more than 350% in viewers since its first season, which is a metric of success very few shows enjoy.

It also delivered on our strategy to focus on diverse audiences by garnering the most African-American viewers on premium pay television in the past decade. Power has become part of the cultural zeitgeist for its millions of fans, and we are very pleased to have recently completed a two-season renewal that will take us through season five.

Earlier in the quarter, Outlander and The Girlfriend Experience experienced strong growing viewership across multiple platforms and demonstrated that our original programming is making Starz a must have and must watch service for consumers.

During Comcast's Xfinity Long Watchathon this past spring, Starz had 3 of the top 10 most watched programs including Outlander, The Girlfriend Experience and Black Sails. We are proud to have recently greenlit Outlander for the next two books.

Our critically acclaimed comedy series with three time NBA World Champion LeBron James, Survivor's Remorse, continues to win raves from critics and performed well with viewers. The third season Survivor's Remorse premiere episode telecast more than doubled its season two premier episode viewership and netted the highest ever premier night viewership for a STARZ Original comedy series.

Starz is already building for the second of Ash Versus Evil Dead, which returns in the fall, as well as for our comedy series Blunt Talk, which stars Patrick Stewart. Movies remain a big part of the Starz and STARZ ENCORE offerings across all platforms and we are very pleased to have the Star Wars: The Force Awakens begin its premiere PLAY TV windows exclusive on STARZ on September 10.

We have been focused on our direct to consumer efforts, leveraging additional platforms to distribute Starz content. Our domestic Amazon Starz business has been very strong since launching in December 2015. Likewise the new STARZ app is proving to be an enormous value proposition for consumers, especially with our industry first features like download capability. We made additional investments in the app, bringing Roku and Android TV compatibility into the fold. Expect more to come on this front in 2016.

Our STARZ PLAY Arabia investment continues to see growth, having officially launched in Egypt and Saudi Arabia and bringing the number of countries and territories served in the region to 19.

At Starz Distribution, we were very pleased to enter into a multi-territory content licensing deal with Amazon that will bring The Girlfriend Experience to its customers in the UK, Germany, Austria and Japan underscoring our ability to monetize our content and reach a broader range of consumers around the world in an efficient and profitable manner.

I will now turn the call over to Scott to discuss the financials.

Scott D. MacDonald - Chief Financial Officer

Thanks, Chris. For the second quarter Starz consolidated revenue was $402.6 million. Operating income was $105.4 million and adjusted OIBDA was $127.4 million. At Starz Networks, second quarter revenue increased 3% to $343.1 million due to higher effective rates partially offset by lower average subscriptions due to video household losses at certain distributors.

Adjusted OIBDA increased 8% to $132.1 million due to the increase in revenue and lower programming costs, partially offset by marketing costs associated with the launch of our new STARZ app, and higher litigation costs. The transaction with Lionsgate is not anticipated to have an impact on our total programming expense for the year. We continue to expect total programming expense for 2016 to remain in line with last year.

During Q2 2016, we incurred $9.5 million of merger-related costs. Starz Networks' cash paid for investments in films and television programs decreased $9.7 million, to $61.5 million, due to a decrease in the number of original series in production during the current quarter.

At Starz Distribution, second quarter revenue decreased $18.4 million to $60 million, and adjusted OIBDA decreased $6.6 million, to a loss of $4.6 million, primarily as the result of fewer significant new releases from the Weinstein Company. In Q2 2016, we released Jane Got A Gun, REGRESSION, and War & Peace, as compared to Paddington, Big Eyes and Immigrant in Q2 2015. Bad debt related to the Super Channel bankruptcy in Canada also contributed to the decline in adjusted OIBDA.

During the second quarter, Starz Distribution's cash paid per investment in films and television programs decreased $50.9 million to $2.8 million, primarily due to timing of payments for the Weinstein Company titles.

From May 1 through June 30, 2016, we bought back approximately 900,000 shares of our common stock, for $23.7 million, at an average price of $26.75. Since January 14, 2013, when our stock began trading, we have repurchased 29.8 million shares or 24.5% of our outstanding shares. In future quarters, we will not be buying back our common stock, as we are prohibited from such purchases under the Lionsgate merger agreement.

At June 30, we had $352 million drawn under our revolving credit facility with $648 million of borrowing capacity remaining. Our leverage stood at approximately 2.5 times adjusted OIBDA. We are currently coordinating with Lionsgate on the filing of the joint proxy statement for the merger. As a result, we will file our 10-Q for the second quarter of 2016 very soon after the proxy statement is filed.

Now I'll turn the call back to Chris.

Christopher P. Albrecht - President and Chief Executive Officer

Thanks, Scott. In summary, this was a very exciting quarter for Starz, both in our operating performance and in our future prospects with the announced Lionsgate transaction.

Now I open the call for your questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Ryan Fiftal with Morgan Stanley.

Ryan Fiftal - Morgan Stanley & Co. LLC

Congratulations to you and the team on completing the deal. Two questions, if I can. So, first maybe going back to the strategic merits of the deal. Chris, can you maybe elaborate a little more on why you think the combination makes Starz a stronger network? And maybe what are the things that you're excited about that you can do as a combined entity that you really couldn't do as a standalone?

Christopher P. Albrecht - President and Chief Executive Officer

Sure. One of the things that kind of baffles me is how many people don't get it. Look, I could make a long, long list of benefits that accrue to both companies in this transaction, starting with the fact that there's going to be a great team in the CEO suite starting with Jon Feltheimer and Michael, and I'm joining there. I'm in for the long run. I'm excited about this. I look forward to creating a partnership with Jon. I look forward to putting together these two terrific companies that are at exciting points.

Just in a very simple, basic way of thinking, we're in the content IP creation business and the distributing and monetization of those rights that come along with that IP.

Well, first of all, we're going to be a magnet for talent. Aside from the experience and the relationships and the know-how, the track record, we're going to have the financial wherewithal to do many more things than we've done before. The merged company is just going to be able to far more effectively attract content. And honestly, the Lionsgate guys, together with the library they have, are going to do a better job of monetizing that content than we're able to do as a standalone company. That's pretty important. Lionsgate is also going to be a perfect partner for shows that may need partners. And we won't need to look elsewhere. It's going to allow us to better manage things in a more effective way. And I think that's important.

They're also going to be strong partners in building exciting new, domestic and international digital businesses, which can capitalize on what I think will be the volume of content creation and deep library stuff that's available. But I also look at it. It's like a show. You start with a great idea, which is combining these companies. You got great executive producers, which are the people that I just mentioned. You put a great staff in the room. And then you go about and do your work. And aside from putting together what I think will be a really successful enterprise, there are so many things that not only are we thinking about putting down on pages and things that you'll read about when this S4 gets filed but there's also the kind of – I use this word because I really believe it happened in our business. The kind of magic that gets created when you just put a lot of smart people in a room with a good business model and the means and the wherewithal to execute.

So I'm looking forward to the S4 getting filed, it's a joint filing. Scott said we're not going to talk about it now and that's going to explain a lot of things, but boy, there are so many things that we're going to be able to do together.

If we didn't believe in this comb- we were doing pretty well on our own. If we didn't believe that this combination was going to make us much stronger, I guarantee you, the management and the board of this company would not have made this transaction. So I have no doubt that this is just the beginning of something terrific.

Ryan Fiftal - Morgan Stanley & Co. LLC

Great. Well, that's really helpful. Thank you. The other thing I wanted to ask was on the new distribution platforms. I'm guessing some of the revenue acceleration we saw this quarter was some of the success you've seen there. So, I guess, now that you have more than one distribution platform. So, you've done wholesale through Amazon and now you're doing a little more direct to consumers through your app. So maybe can you compare/contrast those kind of two different ways of getting at the consumer and what you see are the advantages of both? Thank you.

Christopher P. Albrecht - President and Chief Executive Officer

Yeah, sure. You know the first thing I would say is that if we just look at the two together, what stands out clear as a bell is there are people who want the Starz services and will buy them, will pay money for them, will pay money every month for them if they can access them in innovative packaging which translates into affordable ways. This strategy of rolling out our shows, we had Outlander and Girlfriend Experience, which coincided with the launch of the app, you know, we've got some anecdotal information from Amazon on that. Even though it's not part of this quarter, Power, boy, it lived up to its name with regard to the impact that it had on those businesses for us. Looking forward just came out of a marketing and press meeting on the launch of Ash vs Evil Dead, which is another whole different fan base and another whole different audience that would clamor to get programs like this if they could access them.

So, you know, the difference in Amazon is they are selling us on top of a product that is I think their primary business. Having said that, I think they are extremely pleased. I have said before, they are one of the great retailers in the world. While we were waiting for this call we saw their quarterly earnings report, which dwarfed the earnings of most companies in a lifetime and they're excited about this. There was a meeting here yesterday to talk about the future of this relationship and it couldn't have gone better.

We're really pleased with our app. The response has been great. This is the first inning of this. It's not even the first, it's half of the first inning on this stuff and we're learning a lot. We're going to be leaning into it more. We've been pragmatic and we've been disciplined, but the results that we've seen so far show us that we're certainly making the right decisions around these opportunities. The opportunities in this world far outweigh any challenges that are presented by us stepping off into the future.

Ryan Fiftal - Morgan Stanley & Co. LLC

Okay. Thank you.

Operator

Your next question comes from Vasily Karasyov with CLSA.

Vasily Karasyov - CLSA Americas LLC

Thank you very much. Chris, I have a question about the Network's revenue. It seems like this is the first quarter where you grow at this rate for more than a year. Would it be correct to say that the impact from DIRECTV is behind us at this point? And then I have a quick one on programming cost.

Christopher P. Albrecht - President and Chief Executive Officer

When I mentioned the decline in the STARZ ENCORE subscribers and I mentioned the operational challenges faced by distributors, you know, what we're seeing in the field is we're seeing, for instance, two large platforms merging into one. There's a fallout from that. They are in the middle of that. We're not singled out in that in that transition by any means, but they are not finished with it. You've seen the results reported by some other of our large distributors. So there's a lot of forces at work here.

I think the revenue results speak to the fact that the opportunities are outweighing the challenges, and we believe that that's what will continue to happen. And the things that we can control are the things that, again, we're leaning into and we are working with our distribution partners all the time to point to the value that they can see in supporting the wider distribution of STARZ. So the AT&T DIRECTV story is still evolving as we watch them transform their two companies into one.

And programming cost, you had a question? Yeah, programming cost you had a question?

Vasily Karasyov - CLSA Americas LLC

Yeah. The question is, seems like for the network the programming costs were pretty even from Q1 to Q2. Can give some idea of what the progression will be Q3, Q4?

Christopher P. Albrecht - President and Chief Executive Officer

Well, I would just say before – I'm going to let Scott answer. But we've said before that we expect that year-over-year the cost to be relatively the same. So that's --

Vasily Karasyov - CLSA Americas LLC

Correct. For full year.

Christopher P. Albrecht - President and Chief Executive Officer

-- as you look at our business year-over-year, but Scott, do you want to add anything?

Scott D. MacDonald - Chief Financial Officer

Sure. I mean, we expect costs to be in line with last year on an overall basis when you get to the end of the year. I think if you remember fourth quarter of 2015 was a pretty heavy quarter for our program expense on the original side as we had our mini-series that was a higher cost show in Flesh and Bone that aired during Q4 of 2015. We don't have that this year. So what you're going to see is a third quarter being a little higher than the prior year and fourth quarter being a little lower. But all in all, we'll be in line with -- on a total annual basis with what we saw in 2015.

Vasily Karasyov - CLSA Americas LLC

Very helpful. Thank you.

Christopher P. Albrecht - President and Chief Executive Officer

Thanks, Vasily.

Operator

Your next question comes from Ben Mogil with Stifel.

Christopher P. Albrecht - President and Chief Executive Officer

Hi, Ben. Well, Ben thought we weren't going to answer questions. I'm surprised he's asking one. Ben, are you there?

Operator

That question was withdrawn. Your next question comes from Barton Crockett with FBR Capital Markets.

Zack Silver - FBR Capital Markets & Co.

This is Zack Silver on behalf of Barton Crockett. My first question is on programming costs for 2017 and 2018, specifically in regard to the Disney deal. We were just curious if we can expect to see any meaningful portion of those Disney costs dropping to the EBITDA line.

Christopher P. Albrecht - President and Chief Executive Officer

Well, look, we're not going to – we've had this question so many times, I'm not sure how I can answer it differently. We look at what it's going to take to sustain and grow our network. We look at the resources, the revenue from our business. We apply that against what we think the needs are to accomplish that task, to create shareholder value.

The Disney output deal in and of itself -- we've been transitioning from a movie-only service to an original programming and a movie service and we've been doing it while still carrying two full studio slates. So we're going to be hopefully, in a combination with Lionsgate, we'll look to apply the same rationale and thinking as we look at how we're going to spend our money. But we don't have Disney in a pile somewhere going this little bunny goes here. This little bunny goes there, and the rest drops to the bottom line. We just look at it as revenue versus expense.

Zack Silver - FBR Capital Markets & Co.

Okay. Great. That's very helpful. And then the second one for Scott. You said there was some litigation costs in the quarter. I was wondering if you could break out the size of those litigation costs for us?

Christopher P. Albrecht - President and Chief Executive Officer

A lot. A lot. Dick Wolf is going to do a new show called Law and Starz. How many unfounded lawsuits can one company get hit with? A lot. Too much. A waste of time. Yes, Scott. (23:03).

Scott D. MacDonald - Chief Financial Officer

I think I would agree with that. It's a few million dollars and it's associated with the shareholder litigation that we had that was, I guess, resolved at the end of Q1. And then we obviously have the Keno Thomas matter that's ongoing. And then I'd would suffice it to say it's a few million dollars.

Zack Silver - FBR Capital Markets & Co.

Okay. Great. Thanks guys and congrats on a good quarter.

Christopher P. Albrecht - President and Chief Executive Officer

Thank you.

Operator

The next question comes from Ben Mogil with Stifel.

Kevin Lee Hon Siong - Stifel, Nicolaus & Co., Inc.

Hi. This is actually Kevin Lee for Ben. Thank you for taking my question. Just a quick one on – I guess it's just a follow up to Ryan's on more or less the over the top stuff. So quick question on the subscriber growth that you saw year-over year call it the 700,000 subs at Starz or call it 200,000 sequentially. How many of those can you actually attribute to probably the OTT platform? And then just as a follow up do you have any thoughts on, call it, the pricing power – OTT pricing power given Netflix's comments last week around churn in pricing? Thank you.

Christopher P. Albrecht - President and Chief Executive Officer

We are very happy, very pleased with the results that we're seeing in our digital businesses. Both Amazon business and our OTT app. Obviously, we count them all in terms of subscribers and certainly that's been very helpful with regard to the operational difficulties that we've talked about regarding some of our larger distributors.

I think if you just kind of did the math and you said well, those operational difficulties go away, hard to know whether people that are rolling off there are going to – you know, we don't have people's names and addresses of former MVPD subscribers but, you know, I think aggregately – both incrementally and aggregately this is a good story for us. I didn't see the Netflix – I don't know what the Netflix comments were. So, if you repeat them to me, I'll try and give you an intelligent answer.

Kevin Lee Hon Siong - Stifel, Nicolaus & Co., Inc.

I think at Netflix it was more round how high churn was given the ungrandfathering of the price increase, call it the $7.99 to $9.99 plan and they were surprised by how high churn was.

Christopher P. Albrecht - President and Chief Executive Officer

Yeah. So look, right now all I can say is we have low churn. And I don't know what the Netflix churn rate is compared to ours. Churn obviously is a big part of any subscription business and a lot of that isn't people necessarily leaving. It's people on the MVPD start changing addresses and stuff. Being in these digital businesses particularly in our own direct-to-consumer app we are going to be able to have lot more and a lot more helpful information regarding how we create stickiness around the app. IT'S hard for me to compare what they said to what we're experiencing. Obviously, we're just out of the gate and they've been out on the field for a while.

Kevin Lee Hon Siong - Stifel, Nicolaus & Co., Inc.

Perfect. Thank you very much.

Christopher P. Albrecht - President and Chief Executive Officer

Next?

Operator

There are no further questions.

Christopher P. Albrecht - President and Chief Executive Officer

Okay. Well, thank you very much, and thank you for your continued interest in Starz.

Operator

Thank you for your participation. This concludes today's conference call. You may now disconnect your lines.

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