Twenty-First Century Fox's (FOXA) CEO James Murdoch on Q4 2016 Results - Earnings Call Transcript

| About: Twenty-First Century (FOXA)

Twenty-First Century Fox Inc. (NASDAQ:FOXA)

Q4 2016 Earnings Conference Call

August 03, 2016 04:30 PM ET

Executives

Reed Nolte - EVP IR

Lachlan Murdoch - Executive Chairman

James Murdoch - CEO

John Nallen - Senior EVP & CFO

Analysts

Ben Swinburne - Morgan Stanley

Jessica Reif Cohen - Bank of America

Richard Greenfield - BTIG

Doug Mitchelson - UBS

Michael Nathanson - Moffett Nathanson

Todd Juenger - Sanford Bernstein

Alexia Quadrani - JP Morgan

Anthony DiClemente - Nomura

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Twenty-First Century Fox Fourth Quarter 2016 Earnings Release Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time [Operator Instructions]. As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Mr. Reed Nolte, Executive Vice President, Investor Relations.

Reed Nolte

Thank you very much, Operator. Hello everyone and welcome to our fourth quarter fiscal 2016 earnings conference call. On the call today are Lachlan Murdoch, Executive Chairman; James Murdoch, Chief Executive Officer; and John Nallen, our Chief Financial Officer. First, we will give some prepared remarks on the most recent quarter and year and we'll be happy to take questions from the investment community.

This call may include certain forward-looking information with respect to Twenty-First Century Fox's business and strategy. Actual results could differ materially from what is said. The Company's Form 10-K for the twelve months ended June 30, 2016, identifies risks and uncertainties that could cause actual results to differ and these statements are qualified by the cautionary statements contained in such filings.

Additionally, this call will include certain non-GAAP financial measurements. The definition of and the reconciliation of such measures can be found in our earnings release and our 10-K filing. Finally, please note that certain financial measures used in this call, such as segment operating income before depreciation and amortization, often referred to as EBITDA, and adjusted earnings per share are expressed on a non-GAAP basis. The GAAP to non-GAAP reconciliation of these non-GAAP measures is included in our earnings release.

And with that, I'm pleased to turn it over to Lachlan.

Lachlan Murdoch

Thanks Reed, good afternoon everyone. As you can see from today's earnings release, we have delivered a solid fiscal year performance, driven by increases in affiliate revenues in both our domestic and international businesses, as well as gains in advertising revenue. Despite continued foreign exchange headwinds and a particularly difficult comparison, we have grown our adjusted EBITDA and revenues for the year.

But before James and I provide further commentary on our financial results, let me first say a few words about Fox News which has been the news over recent weeks. Two weeks ago we received and accepted Roger Ailes' resignation as the CEO of the business, and our father took up the responsibility of leading Fox News as Chairman and acting CEO. Throughout this process, we have moved quickly and decisively to protect the business, to protect its employees and to protect a unique and important voice, Fox News Broadcast.

There is no one more dedicated or more able to transition Fox News to new leadership than its founder. As acting CEO, he joins an existing team that is extraordinarily strong and equally devoted to its success. The Fox News Channel is on track to have its highest rated year ever and has lead all of basic cable in both primetime and total day for three full months this calendar year.

In fact, 2016 has been a pivotal year for the entire company. We executed well against our strategic objectives delivering standout creative output, advancing innovation for customers and further driving improvements and how we monetize our content. We have managed succession at both the top of the company and in our divisions, allowing us to drive fundamental changes throughout the business. From the film studio to the network, from National Geographic to Star TV, across all our businesses, we are intensely focused on capturing the valuable opportunities that new technologies and emerging mediums present us. And these opportunities are significant. Downstream innovation has meaningfully increased both choice and consumption for consumers.

Demand for premium content including live sports, news and scripted entertainment has never been stronger. In this environment, value will continue to accrue to the strongest video brands and to the distinctive story telling that defines Fox. The strengthening of our talent brands has been at the center of our strategy. Over the last couple of years, increased programming investment across our portfolio, as well as the launches of FSX, Fox Sports 1 and Star Sports are now bearing fruit.

The dividends these investments are yielding are clear. As our core brands are fundamental to emerging streaming services like Sony and Sling TV, as well as Hulu's forthcoming service, which we expect will launch early next year. These services understand and value the emergence of the core bundle that our brands underpin. These and other emerging platforms will aggregate the best channels at reduced cost, offering unsurpassed user experience and economics to the consumer while substantially increasing the number of distributors competing for our content.

And today we are excited to welcome Time Warner to Hulu as a shareholder. Since developing that year of Hulu 10 years ago, Hulu has grown from strength to strength and now serves over 11 million subscribers. Time Warner's investment is a testament to all that the Hulu business has achieved, and we are confident Time Warner's brand will play an important role in Hulu's ongoing success.

The handful of content creators with the [indiscernible] that we have clearly have the advantage in a world where technological innovation is opening the door for new distribution. In 2016, we once again demonstrated our ability to consistently create content that delivers audience and acclaim. For example, our film studio set on a first time director broke a box-office record with Deadpool which gross $760 million on a modest production budget.

Our television studio delivered three of the season's top four broadcast series, and we are recognized with a total of 144 Emmy nominations across primetime and sports. But I'd be remiss if I didn't also recognize that while you need to measure the film business over a multi-year cycle, the recent three sequels we released clearly fell short of the expectations we had going into them. It is our goal to be far more consistent with this output.

As I said earlier, the opportunities ahead of us are significant, and the pursuing and participating in these opportunities we view our balance sheet underpinned by our strong credit rating to be a strategic asset of the company to be deployed towards the highest long-term return initiatives. With that in mind, today we announced a 20% increase to our annualized dividend and an additional buyback authorization of $3 billion.

However, we will be highly selective on the deployment of capital towards this authorization over the next 12 months. Our priority and how we annually allocate our capital will be to invest in a creative long-term growth opportunities. To investing in our existing business, new initiatives or acquisitions with both financial and strategic benefits. We are very focused on using our capital toward sustained long-term growth. But to the extent that opportunities do not emerge, we have the flexibility to use excess cash towards buybacks as we did with the $8 billion we received from the sale of the Sky businesses.

I'll now turn it over to John.

John Nallen

Thanks, Lachlan, and good afternoon. Let me start with the full year financial results focusing on total company adjusted revenue and adjusted EBITDA which excludes in the prior year the DBS businesses we sold to Sky.

For the full year, total adjusted revenues were $27.3 billion, up 1% over last year, and up 4% excluding the negative impact from foreign exchange. These increase were from higher revenues at both our cable networks and television segments partially offset by reductions at our film business.

Total segment adjusted EBITDA for the full year was $6.6 billion, a 2% increase over a year ago, led by the cable network segment, partially offset by lower results at our film segment. Overall, unfavorable foreign currency rates reduced our EBITDA results by approximately $380 million and reduced our growth rate by six percentage points.Reported income from continuing operations attributable to shareholders this year was $2.8 billion or $1.42 per share, while adjusted EPS was $1.73 this year compared to last year's $1.72.

Now turning to the fourth quarter results. Revenues increased 7% over last year and we're up 9% excluding foreign exchange led by double-digit growth at our cable network segment. Total segment EBITDA for the fourth quarter was $1.45 billion, a 6% decline from a year ago which primarily reflects the expected lower contributions from our film segment in an approximately $50 million negative impact from foreign exchange which contributed over half of the quarterly decline.

From a bottom line perspective, we reported EPS of $0.30 in the fourth quarter, while adjusted EPS was $0.45, up $0.15 from the comparable $0.39 last year. Included in this year's adjusted result is a $0.07 per share tax benefit resulting from a ruling we received.

So now let me provide some additional context on the performance at our operating segments in the fourth quarter, starting with the cable network segment. The total segment EBITDA of $1.2 billion was basically even with last year on revenue growth of 10%. Excluding an approximately $40 million negative impact from currency rates, segment EBITDA grew 3% in the quarter.

Domestic cable revenues increased 10% in total, from affiliate fee growth of 6% and 13% advertising growth. The advertising growth reflect higher ratings and pricing at Fox News and our National Sports Channel, as well as a two percentage point benefit from this year's consolidation of the acquired National Geographic Businesses.

EBITDA at our domestic channels increased 7%, reflecting the strong revenue growth, partially offset by contractual sports right increases and streaming rights costs at the RSNs, higher political costs at Fox News and the inclusion of approximately $25 million of EBITDA losses from the recently acquired NatGeo Businesses, principally resulting from acquisition related items recorded during this quarter.

Fourth quarter reported international cable revenues grew 10%, driven by a 9% increase in reported affiliate revenues which were up 19% excluding currency impacts. Reported international advertising revenues were 6% lower than last year as negative foreign currency movements more than offset low single-digit local advertising growth. Additionally, content revenues doubled, reflecting this indication of soccer rights and the Outcast series outside of our markets.

Reported international EBITDA decreased 25% over the prior year, reflecting the higher revenue offset by cost from new sports rights, digital expansion initiatives and increased marketing. The international EBITDA decline reduces by half when factoring out the negative impact of currency movements.

Turning to our television segment. Fourth quarter EBITDA was $31 million above last year, largely reflecting a 9% increase in the Fox Broadcast Network's entertainment advertising revenues from higher pricing, as well as increased non-linear and retransmission consent revenues. These revenue gains were partially offset by increased entertainment programming and marketing expenses. At the film segment, we reported fourth quarter EBITDA of $164 million, $105 million below last year. This anticipated decline was primarily driven by the inclusion of significant releasing costs for the newest X-Men, Independence Day and Ice Age theatrical releases, as well as Mike and Dave.

From a capital standpoint, we ended the fiscal year with $4.4 billion in cash and approximately $19.7 billion in debt. During the fiscal year, we delivered $5.5 billion in capital returns to shareholders, and as of today we completed slightly over 90% of our $5 billion share repurchase authorization. We expect to complete the balance of this authorization over the year. The absolute level of capital returns to shareholders has been robust over the last three years, well-exceeding our annual cash flow generation and has us now sitting at the upper limit of our stated gross set target of 2.5 to 3 times.

So as we look to fiscal 2017, there were a few items worth drawing attention to on which we have visibility. At our cable networks, we have 15% to 20% of our domestic subscriber base coming up for renewal annually over the next couple of years with the next round of renewals scheduled for early calendar 2017. Therefore, the pace of our domestic affiliate fee rate growth should accelerate in the back half of our fiscal year.

On the cable network's cost side, while we don't have any major news sports right kicking in next year, we'll have the extra five months of expenses from the acquired NatGeo businesses, and as James will discuss we'll invest around $200 million toward the refresh of the NatGeo Global Programming and the expansion of original series at FX.

Turning to the television segment. The upcoming year's revenue and costs will be influenced by two main factors, our broadcast of Super Bowl LI and the Election Cycle. Excluding the Super Bowl, segment expenses are anticipated to increase in the mid-single digit range led by planned increases, international sports contracts and by slightly higher marketing investments at the Fox Network to support a higher volume of new series.

Aggregate retransmission revenues are expected to continue to grow at a low double-digit annual pace. Additionally, as of today except for Sterling, spot rates for the major currencies that we operate in are roughly similar for the average exchange rates we experienced for the entirety of fiscal 2016. On its phase, if this rates hold for the full year that would suggest a nominal impact from foreign exchange on our fiscal '17 full year EBITDA results. At the moment, the most significant impact to our results from the decline in Sterling would be our translation of Sky's equity earnings.

So two final items to call out. First, our reported tax rate is expected to approach the full U.S. statutory rate next year. And second, as Lachlan mentioned, today we increased our dividend and announced the new buyback authorization of $3 billion which is open-ended as to its timeframe and we'll be very selective in deploying [ph] over the next 12 months.

And with that, let me turn it over to James.

James Murdoch

Thanks very much, John and Lachlan, and hello to all of you and thanks again for joining us. We made a lot progress over the last year, but much remains to be done. I wanted to just highlight a few key things and give you a sense of what we're super focused on and then we can cover whatever you want in the Q&A after.

First of all, as I said last quarter, we want to make our programming and products more available not less, and we want to grow our capabilities in monetizing these brands and programs with our partners. And we want to enable our customer experience for our viewers that is truly simple and great. Our work with Hulu is a key part of this as is our licensing to other MVPDs over the top or otherwise. We want to be flexible in our approach though to deliver the best experience to customers and the most value to our partners and shareholders.

Our progress, just last year, puts us in a strong position in this regard. Our focus on product innovation and on insuring our brands and content to new services as they proliferate our drivers of future growth. But it's fair to say that across the board from our organization structure to our commercial capability from creative investment to talent recruitment, we're moving at a fast pace today and are focused on improving our operations worldwide. We've restructured the leadership team at Fox Networks Group, embarked on leadership transition at the field studio, streamlined the cost space across the business, completed the integration of the three Skies, completed the integration of the newly acquired National Geographic businesses, completed the acquisition and integration of [indiscernible] and completed and integrated Shine into the new Endemol Shine Group.

Now this past year we've seen a flurry of MNA activity in the sector, and I want to be clear, please pay attention to what we've chosen and choose not to do. While we never rule out opportunities to invest inorganically, we've set a high bar with respect to how we intend to use capital and that bar will remain high.

In this coming year, while we certainly have challenges, we couldn't be more excited about where these businesses are and what they can achieve. Fox Sports is looking forward to one of its best years ever. We start the year with strong ratings for baseball at the RSNs and we expect this NFL season including Super Bowl LI on Fox to be as good as ever. And Fox Sports 1 already having overtaken ESPN2 in prime across all demos including total viewers is just starting to hit its stride.

A full revamp of the National Geographic Channel's creative output starting in this autumn and continuing with mega documentary, One Strange Rock, and scripted programming like The Upcoming Genius. Early response from advertisers and critics couldn't be more enthusiastic as we start to see with a fully aligned business, organized around a global super brand like National Geographic is capable of.

At FX, we're expanding from 15 to 18 original scripted series. These include Atlanta from Donald Glover; Taboo with Tom Hardy; Legion which is set in the X-Men universe and is created by Fargo show runner Noah Hawley; and Trust from the Slumdog Millionaire team of Danny Boyle, Simon Beaufoy and Christian Colson.

It's clear we have work to do at the film studio. Some of our major releases as Lachlan did not meet expectations, and that means we're starting the year with a bit of a hill decline. So we're energized about our upcoming pipeline with releases such as Miss Peregrine's School for Peculiar Children, War of the Planet of the Apes, Kingsman 2, Assassin's Creed, Hidden Figures and Birth of a Nation, all in the next 12 months. Just as work has accelerated and a much anticipated next installment of Jim Cameron's Avatar.

Profit gross at Star in India is accelerating. The business is in rude health and the peak investment years are behind us as profitability towards our target progresses. We'll continue to invest in Hotstar, our over the top mobile video service, with over $50 million active users currently, we see this is a key opportunity to achieve real leadership in an important category. In addition, we plan to expand its service beyond India this year targeting the global South Asian Diaspora.

Sky in its three European markets is making great progress as the business broadens, opens up new customer segments and develops more products and services growing its customer base, revenues and profits. And domestically Hulu's velocity is picking up too. With over 11 million paying subs and exciting new live on demand service set to launch in early '17. With Disney, Time Warner, Fox and more to come, participating in this groundbreaking new product, we're very excited about Hulu's future. And we also saw strong advertising demand in this year's upfront with revenue growth driven by healthy pricing and volume increases across broadcast and cable. We also expect to build upon last year's momentum in non-linear advertising gains.

So in summary, it's an exciting time. The vibrant downstream market is emerging which will help drive affiliate income and advertising innovation in the future. The overall TV advertising picture is healthy. Our creative output is strong, notwithstanding some disappointments in the film company.

And lastly, the most importantly, the talent inside the businesses is tremendous and focused on delivering growth. In an era of constant change are -- for the status quo is our greatest strength.

Now we'd like to take your questions.

Question-and-Answer Session

Operator

Thank you very much. [Operator Instructions] First question will come from Ben Swinburne with Morgan Stanley. Please go ahead.

Benjamin Swinburne

Thank you. Good afternoon. James, just picking up on India. Can you give us a sense for what Star delivered in the fiscal year that just closed as we think about that $500 million target that you've laid out for '18, are you still unfazed for that? And just going back to the film studio if you don't mind, I think you guys had your toughest years since '11 in terms of EBITDA contribution. What are you doing among the things you can control or impact, what are you and the team doing at the studio to try to improve profitability there, acknowledging that obviously it's a hedge-driven business and there's a creative element to all of this stuff? Thank you.

James Murdoch

Thanks, Ben. So first of all on Star, look fiscal '16 was very strong, actually as you know in the previous year we invested 100% of the profit to the business, the entertainment business into the growth of the sports business, but that's really turned now. So for this last fiscal year, the Star business overall inclusive of sports delivered just north of $200 million of EBITDA, and we think that puts us in a really good pace for our '18 and '20 targets. So we're really pleased with that performance and I think as we see the investments really start to pay off there and the velocity of the business continue, it's on track. With respect to the film studio, I think one of the things that Lachlan said in his remarks about consistency is really important. It's about consistency of creative output. It's about really focusing on having the best partners we can have, and in the process in terms of the decisions on production starts, on new products, et cetera, really functioning more consistently and better.

And I think as I mentioned earlier we've embarked on leadership transition there. There are changes in the future that we want to make, but fundamentally as you said it's a hedge-driven business. We need to be more consistently great in a marketplace that's competitive as it is. When it's hard to get a family off the couch and out to the theater. So we had some great success in the year. I look back at The Martian or Deadpool or things like that, things that are distinctive that are where we can take risks, where we're doing things that maybe other studios aren't doing, and provide something really different in the market place. I think the slate coming up is very promising, but it's going to be tough to judge the film studio in one quarter, it's really a period of time.

John Nallen

I think that's right, James, and I think that have to remember that the studio was part of the voluntary buyout program last year, so there are significant amount of cost savings that will underpin its results. But ultimately it's about having a higher standard for story-telling and men making better movies.

Benjamin Swinburne

Thank you, both.

John Nallen

Thank you, Ben. Next question please, operator.

Operator

Thank you. That will come from Jessica Reif Cohen with Bank of America. Please go ahead.

Jessica Reif Cohen

Thank you, a couple of questions. On Hulu what else do you need to launch? I think, James, you mentioned that more content will come in. Are they coming in as investors or just part of the package and how should we think about demand for a lower price OTC service?

John Nallen

Thanks, Jessica. Look as I mentioned, Hulu, we do expect more partners, more content companies, more programmers and brands to be represented in the new Hulu service. Hulu is in discussions with a number of those potential providers and suppliers currently. And as those come to completion and we are closer to a launch of the service I know Hulu will be communicating about that. There are no discussion currently about addition equity investment. We think we've got a great set of partners in this business and we're very excited about it. So I think over the next number of months as we see complete some of the supply agreements, you'll see more detail around the content offering and the full breath of it, which we think is exciting. I think it's important to note that we do think that in this rebundling that's going on there's significant demand for great television, there's significant demand for a great customer experience, and we want to be able to deliver it at the lowest price that we can. Fundamentally, that limits Hulu's ability, right? To just go and pay everything for a lot of program, we have to focus on what's the programming that really, really matters and what's going to drive consumption and what are people going to love. So I think it will be, as I described it before, kind of a core package, a core bundle there. And we want to have a great entry point for customers to come in. It's not to say that premium offerings won't be there. Hulu's been a very successful seller of Showtime as a premium add-on to its product today, and we would expect agreements like that to continue to be announced as well.

Jessica Reif Cohen

And then, a couple of other questions. Given the importance of Fox News to the company, can you give us any color on any central strategic shifts or will it be business as it is? And then one follow up on Star. On Hotstar, is there anything you can say about what Indian consumers are actually watching the most and what do you think about the monetization potential of that service?

James Murdoch

So Jessica, I'll start with Fox News. It seems this year will be one of the best years if not the best year for Fox News ever. There is no desire or need to shift the position that it has in the market. It's a very successful business and we are just undergoing a transition to the new leadership. That should not flag at all a transition of the underlying positioning or the strategy of the channel.

John Nallen

And Jessica, with respect to Hotstar, it's interesting, in the beginning we saw pretty severe sort of volatility and spike, largely around sports viewership on the Hotstar platform to when there was a big cricket tournament or something like that. But gradually over the last year what's really built and gotten much more momentum is scripted programming, it's Indian scripted programming in multiple languages, and that's really driving, that's been the most gratifying and to see more consistent viewership of that and that's really a big, big part of the volume now, and it's the fastest way growing part of the volume on a consistent basis, local Indian scripted programming at a very high volumes. So there's a lot of shows, full series stocks, all of that sort of stuff of that many, many thousands of hours that we produce there every year.

James Murdoch

Thank you, Jessica. Operator, next question please.

Operator

Thank you. The next question will come from Stephen [ph] with Royal Bank of Canada. Please go ahead.

Unidentified Analyst

Yes, thank you very much. Just a couple of questions, maybe first on the -- side. I think you may be communicated in the past willingness to keep more in the house for the foreseeable future. We've seen a couple of deals, American Crime Stories, also Homeland, I was wondering if you could just update us on your strategy. And then also on the RSN, there's been some articles lately about the strength of the ratings at RSN. You called that some of the streaming cost you've now got. I was wondering if you could let us know maybe what percentage of your RSN you now have exclusive streaming rights and if there will be a pricing revenue upside tail that we'll see on that in the future.

James Murdoch

Thanks, Stephen. Look as I mentioned in the remarks before, we do want to be flexible in terms of our licensing and we want to do something that makes sense. The recent American Crime Story agreement with Netflix, we thought it just made a lot of sense. It's an anthology series, so sequential stacking of multiple seasons is less crucial because it's not serialized across seasons, but we were able to secure the current season in full stack and avoid or not give up the kind of hold backs that have been characterized in some of these agreements in the past. So we think it makes a lot of sense for customers watching American Crime Story on FX or on FX Now, and that so you have the in season stacked for the current season. And it was just a very, very attractive agreement for subsequent seasons for us and for our partners in the show. So you think you don't want to be too orthodox about it, but I think the important thing here was it preserves the customer experience that we're seeking to deliver, and for an anthology series like this. We thought it was just a great deal for the company and for shareholders. But I certainly doesn't see any shift in strategy on how we deal with.

Lachlan Murdoch

And then the streaming rights on the RSNs for the MLB and the NBA are in place authenticated in market streaming rights. And we think that's a great part of their value proposition. Look, these are channels and brands that absolutely are enormously successful from a viewing perspective in their markets. If I look at all the MLB teams in the first half of the season so far, I think 10 MLB teams were rated number one in primetime in their markets on nights that they play and half of those teams are our Fox RSNs. So we combine that with streaming opportunities. When we combine that we will be able to do any sort of TV everywhere type environment. We can ask one of their core value propositions to our MVPD partners, both existing MVPDs and future MVPDs.

James Murdoch

Thank you, Stephen. Operator, next question please.

Operator

It will come from Richard Greenfield with BTIG. Please go ahead.

Richard Greenfield

Hi, wanted to ask a question on, I know you're still negotiating with other partners for the Hulu virtual MVPD, but just wondering how do you think about the importance of having all four broadcast networks? Can a Hulu launch be successful if you don't have CBS? And I guess along that same theme, if you don't have all of your affiliates on board for the launch and you only have the O&Os, will it basically be like what Sony View and Sling where its next day access versus the live linear and will you move forward or will you wait until you have all the affiliates in all four broadcast networks on board? And then just a quick housekeeping. I think someone said earlier that Hulu now has over 11 million subs. At the Hulu upfront back in May, Mike Hopkins had said that by the end of the month that you have over 12 million subscribers. So just tracking, did the number decline from May until now? I just wanted to follow up on that. Thanks.

James Murdoch

Thanks, Rich. So first of all just to note. Hulu is in negotiations with a variety of suppliers as I mentioned, around the new MVPD and wouldn't be right to comment on. Any of those negotiations that Hulu is having with those suppliers, not that we're having. But I would say it's a balance between putting together, you want to put together something that is a core proposition, something that's really going to drive consumption and demand and what the prices are. And without commenting on a particular potential supplier, I would say that you mentioned specifically CBS, customers have access to an Ala Carte CBS all access products, so I don't think that's necessarily, I think that does have an impact on how you would think about price and what you'd be willing to do to have it there. But I don't think any one particular network, given where we are today with Disney and Time Warner and the Fox products there, I don't think any one particular network has hold up value at this point. I think it's a great proposition today. We'd like to make it better.

Lachlan Murdoch

And Rich, just to answer your question on the 11 million subscribers versus the 12 million subscribers. My understanding is that the difference is the 11 million is paying subscribers and the 12 million includes, it's slightly over 11, but the 12 million includes promotional viewers.

Richard Greenfield

So essentially we could just say between May and now, Hulu's been roughly flat from a subscriber's standpoint?

Lachlan Murdoch

It's been up a touch actually. But it's less than a million, so we're rounding.

James Murdoch

Thank you, Rich. Operator, queue the next question please.

Operator

Thank you. That will come from Doug Mitchelson with UBS. Please go ahead.

Doug Mitchelson

Thanks so much. I was hoping that you would talk a little bit more about the growth outlook for the Fox Networks Group, especially with realignment. I mean if you look at paid TV in Latin America, it's not growing like it used to and Europe is struggling on the advertising side of it right now. It seems that we've been focused a lot on Star growth on the last couple of years. Anything on Fox Network Group growth outlook would be helpful. Thanks.

James Murdoch

Thanks, Doug. Look, I think one of the things that Fox Network Group International cable assets have been particularly impacted by currency as well as it got knocked around a little bit by some of the advertising challenges particularly if I look from Italy to Turkey, to Brazil, all of these places are pretty challenged and have been over the last year. So I think it's a little bit of a mix tag. We have a lot of confidence in the overall growth of the paid TV universe in a lot of these markets. As I mentioned I think a few quarters ago, probably Southeast Asia, a little bit slower than it was before, but Latin America very strong. And we feel pretty good about that, but I think it's been disproportionately impacted by currencies and sort of patchy, or rather a mix add environment generally in those places.

Doug Mitchelson

And then I guess a follow up. With the change in Sterling, there's been a lot of questions swirling around, strategic interest in Sky. I think in the past you talked about 39% stake is a bit sub-optimal, you serve better off on in all are none. Any change in your outlook for how you think about Sky going forward?

James Murdoch

No, look I'll just, I understand the question and I'll just, I guess it's just like a quarterly update on the lack of a change of view, and look this is not something, we just don't want to get into commenting on what is largely idle speculation and hypothetical.

Doug Mitchelson

Thank you.

James Murdoch

Next question please, operator.

Operator

Thank you. It will come from Michael Nathanson with MoffettNathanson. Please go ahead.

Michael Nathanson

Thanks. I have one for James or Lachlan and then one for John. James or Lachlan, it sounds like you guys want to keep your powder dry for M&A, but kind of high bar for [ph] deals. We look at your strategic footprint, where do you think the gaps are in terms of your assets and what types of assets would you be evaluating, that's one. And then for, John, there's a lot of moving pieces on expenses and cable nets, and basically internationally. Could you use a range of what you think growth with the expenses between the U.S. and internationally for '17?

James Murdoch

Let me start by just saying I think it's important to know what James said in his prepared comments which is it is we'd ask you to look at what we've chosen not to do. We'd be incredibly disciplined I think for a few years now in terms of our M&A and what we're willing to pay for businesses that may or may not have some strategic value. I think you know particularly when we look at what some of those businesses have traded for. We're quite happy with where we are today. So moving forward, we're going to be very careful with our capital. We'll be in a position over the next few months and year. We're going to rebuild our balance sheet to be in a healthy position but we'll be opportunistic with how we use.

Lachlan Murdoch

With just areas that we think about and reiterate some of the stuff that we've said in the past, Michael, but you know we do believe in investing upstream. We really believe in content assets. We think that there's an incredible amount of demand for great story telling around the world. And where we've been able to, where we have been able to find inorganic opportunities in that regard that are attractive front returns for shareholders and for the company, we've done that and that's around from [indiscernible] in India all the way to Manhattan with the Yes Network. So I think there are places where they are naturals for us, but it's all a question of value and about returns and making sense. The other place that I think we talked about in the past as well is what are the company's capabilities? In their capabilities, are they monetizing these brands, or really building brands? But we have no kind of sort of checklist or god-forbid a shopping list. We really do think, as Lachlan said, we feel great about the assets we have. We're really focused on operating them with our whole team as well as we can and really driving this business forward with a great footprint around the world and some of the greatest creative assets on the planet, we believe.

James Murdoch

And Michael, outside of the items I called out for '17, the technical point about having the extra months of NatGeo and the initiatives that James referred to. The expense growth at the rest of the cable will be actually below we experienced in the current year. And those are really just normalized increases from sports contracts, from programming investments particularly around political and Fox News. And separately, we continue the initiative of growing Star, so its digital investment around Hotstar and some of its channel will increase. So that's the background on cable.

Lachlan Murdoch

Thank you, Michael. Operator, next question please.

Operator

Thank you. That will come from Todd Juenger with Sanford Bernstein. Please go ahead.

Todd Juenger

Hi, thanks. It's the risk of being very pedestrian. Just a couple of, I guess, housekeeping type of questions. So the first, on domestic affiliate fees plus 6% I think was the number. I think that's a little deceleration sequentially from the first quarter. Correct me if I'm wrong. And just want to know if there's anything we can learn from that? Does that, I know you have a particular group of networks, but is there anything about the paid TV universe or some declines or just specific pricing rollover from you guys that we can, we think about the significance of that number. The second question is similar. James, with your comment on the international advertising. Just I guess really want to ask from this quarter, I think if we take the math from the press release, it looks like maybe a plus 1% constant currency. Obviously that seems like a normally lower numbers than usual. I just want to make sure we can understand anything specific that drove that in as we think about the forecast for that, how are you feeling this quarter. Thanks.

John Nallen

So Todd, I will cover the first one on affiliate fees. It was, you're right it was decelerated, 6% versus 7%, truth be told. With about $10 million more in affiliate revenue we would have been at 7%, so the difference between 6% and 7% was quite small. And often times in these quarters it's mixed. It's how the Telco's lost versus how the MVPDs gain and that really is a factor hovering around that difference. And then in international ads...

James Murdoch

Yes, so first of all, yes it was a smaller number than it has been, and I'd say there is three factors for that. The first one is just weakness in Europe. So in some of the stronger ad market for us, it was fine. The U.K. was okay. But Italy was not, and Turkey was a problem as well. They have a larger advertising waiting to Turkey, believe it or not, just because of the free to air channel there which is a larger ad business than some of the other international cable channels that's all lumped into that segment. And then at Star, we definitely had sort of change in the marketplace there, a little bit where some of the e-commerce money that was spending very heavily in the comparison quarters in the year before. Notably flip cart and snap deal really reduced their spending quite dramatically. So they had grown to be one of the top sectors in advertising there, and just went away. And the e-commerce money that continues to be spent was at Amazon, and that was very spread out more around sports assets, so we didn't get the full benefit of that. There's some in the cricket, but really the IPO got a lot of Amazon's money as well. So there was just a change there in the marketplace. We don't think it's anything more than that, just comparison with those big spenders ameliorating their spending.

Lachlan Murdoch

Just also just to add on to John's comments on the affiliate fees that as you mentioned before we do expect as we began in the affiliate renewals in the second half of the year for those affiliate fees to accelerate again.

James Murdoch

Thank you, Todd. Queue next question please, operator.

Operator

Thank you. That will come from Alexia Quadrani with JPMorgan. Please go ahead.

Alexia Quadrani

Thank you. Given your ongoing investment in Hulu, how likely are you can take other virtual MVPDs are expected to launch, I guess just sort of maybe address how you balance the financial, perhaps the strategic benefit of being part of competing sort of the streaming bundles? And then just a quick follow up if you can maybe address the domestic ad market, how the upfront went and underlying health of the ad market in TV and cable.

James Murdoch

Thanks, Alexia. I think, I don't think there's any issue with us being a minority investor in Hulu, one MVPD and license into a very vibrant downstream market. So we've obviously, in the last quarter I think we talked about our agreements with Sling and the inclusion of all of our brands in that product, and we obviously like Sony's View service as well, and we would seek to do more. So I think that, there's hasn't been a problem in terms of licensing in our view. Our goal here is we want to see the most competitive downstream market we can. We do think great value can be created in Hulu and our investment in that we're very confident about. But we don't think that any of those things are mutually exclusive.

And just so you know we sell our programming across Europe to multiple MVPDs from particularly Liberty Global, KPN, others, et cetera, while the Sky business is where a major investor and competes vigorously in a lot of those markets. So I think it's just, a good example is India whereSky [ph], we're a significant investor there but we distribute across all of the MVPDs, satellite, cable [ph]. So I think it's consistent with our practice and it's always benefitted us and benefitted customers fundamentally to have more competition downstream. We saw that when Direct TV and Dish really started to grow again really properly in the U.S. many years ago. We've definitely seen that across Latin America. We saw where the Telco's expanding the market, and we think the digital MVPD, kind of universe is going to expand the market again. So we feel pretty good about that.

John Nallen

As for the upfront; we couldn't be happier with the strength of the upfronts. We would now fundamentally completed them all. It's been the strongest upfront we've had in years. CPM pricing is in the high, a very high single-digit if you blend both the network and the cable businesses, and volume increases are up in the mid-single digits. So we couldn't be happier with them. Also the scatter market remains very strong, sort of mid-single digit which I think those are the strength of the advertising market today.

James Murdoch

Thank you, Alexia.

Alexia Quadrani

Thank you.

James Murdoch

Operator, we have time for one last question please.

Operator

Thank you, sir. That will come from Anthony DiClemente with Nomura. Please go ahead.

Anthony DiClemente

Just a housekeeping for John, thanks. On international, I think constant currency affiliates in growth was 19% in the quarter. Can you help us with what sort of international affiliates growth in next year that we might expect? Can you kind of keep that up? And then one for James, just one thing we're starting to hear more about is lower ad loads on cable. I think NatGeo's lowering its number of ad units. What's your appetite for doing that in a more widespread fashion, and what kind of premium CPMs do you get on the remaining ad spots, just in terms like how much higher can the ad pricing be for reduced ad loads format, and then other than sort of that CPM inflation? Maybe you could just talk about what are their benefits you might see or you might expect to see with reduced ad load strategy? Thanks.

James Murdoch

On the international affiliate fee. You're looking in any one particular quarter, you always have ins and outs, but for the year we averaged 15% constant currency growth in international. And the mid-teens kind of growth is generally what we're looking for next year as well.

John Nallen

And then Anthony, on the ad load side. I think first of all, I think relative to some of our cable competitors, I think we've historically and currently generally had lower ad loads. So we do think that's a part of the product experience. It's part of the way that we manage the business. But to the extent that you continue to lower them, it really depends on pricing. We make that call kind of an ongoing basis. I would say that where we see dramatically lower ad loads is in the streaming environment, and the CPM increases our substantial and it makes abundant sense to do that where we can target things better, where we can really innovate in terms of those things. But I think generally speaking for a lot of customers and for more, I do think more, some of our competitors out there when I look across the overall kind of dial for cable choices, I think ad loads have been pretty high on a lot of channels, and they're probably right to reduce them.

Anthony DiClemente

Thanks very much.

James Murdoch

I think that's all the time for questions we have. So thank you very much, everyone, for joining the call and for listening.Thanks, everyone.

Reed Nolte

And if you have any questions, please feel free to give me a call or Mike Petrie. Thank you.

Operator

Thank you, and ladies and gentlemen, this conference will be available after 6:30 PM Eastern Time this evening running through August 17 at midnight. You may access your AT&T Executive playback service at any time by dialing 800-475-6701 and entering the access code of 397194. International participants may dial 320-365-3844. Once again those phone numbers are 800-475-6701 and 320-365-3844 using the access code of 397194. That does conclude your conference call for today. We do thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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