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Viacom, Inc. (NASDAQ:VIA)

Q3 2007 Earnings Call

November 2, 2007 8:30 am ET

Executives

Jim Bombassei - IR

Sumner Redstone - Chairman

Philippe Dauman - President, CEO

Tom Dooley – CFO, CAO

Jacques Tortoroli – Controller, CAO

Analysts

Anthony Noto - Goldman Sachs

Spencer Wang - Bear, Stearns & Co.

Michael Nathanson - Sanford C. Bernstein & Co.

Doug Mitchelson - Deutsche Bank

Imran Khan - JP Morgan

Tuna Amobi - Standard & Poor's

Rich Greenfield - Pali Research

Alan Gould - Natixis Bleichroeder

Benjamin Swinburne - Morgan Stanley

Operator

Welcome to the Viacom third quarter 2007 earnings release teleconference. Today's call is being recorded. At this time, I would like to turn the call over to the SVP of Investor Relations, Jim Bombassei. Please go ahead, sir.

Jim Bombassei

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

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

Before we begin, let me remind you that statements made on this call relating to matters which are not historical fact 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.

Sumner Redstone

Good morning, everyone. I thank you for joining us today. I am more than pleased with the results we delivered in the third quarter. The progress that Philippe and the entire Viacom team are making across the company is impressive, not only in its breadth, but in its pace.

We are extending the reach of our premier entertainment brands across every street in nearly every country and territory all around the world. We are developing new experiences, providing more opportunities for consumers and our marketing partners to engage with our brands. We are taking advantage of all these new areas with unprecedented speed. We are capitalizing on the strength of our brands and the new revenue streams, which are clearly being created by the revolution in consumer technology which is taking place all around us.

Now I have said this before: one of the smartest moves that I and the board have ever made was to ask Philippe Dauman to assume the role of CEO at Viacom, along with our long-time colleague Tom Dooley as CFO. The rewards of that decision are becoming more and more apparent and as the future evolves, will become even more apparent.

Since rejoining the management ranks a little more than a year ago, Philippe and Tom have added to their already remarkable track record of achievement. Across the company, their strategic leadership is an inspiration. It is in inspiring innovation. It is creating collaboration, and it is promoting efficiency.

We are allocating our resources to keep our businesses strong and vibrant and to generate solid returns for our shareholders. It is the right agenda to maximize our greatest strength today and the right agenda to build the broad foundation for the Viacom of tomorrow.

With that, of course, let me turn it over to my friend and CEO, Philippe Dauman.

Philippe Dauman

Thank you, Sumner my friend, as always. Good morning, everyone. I am very pleased that you could join us today to review our third quarter results. The results we reported today reflect the substantial progress we have made this year in further leveraging the value of our world-class entertainment brands.

We have brought several important initiatives to fruition in this quarter, including the debut of a sizable slate of new programming across our networks; innovative changes in the advertising solutions we offer our marketing partners; and meaningful advancements in our digital strategy. This is an incredibly dynamic business and we are continuing to push the envelope, developing innovative content and experiences across our brands to connect with our audiences around the globe.

This morning I would like to highlight our recent progress and share with you some of our plans to enhance and extend the monetization of our brands, both within our core operations and through new ventures. I will start with a brief review of our quarterly results and spend a few minutes talking about how we are innovating our media networks business from programming to advertising, to our growing digital business and new revenue streams.

Our Filmed Entertainment group has enjoyed tremendous success this year and I will provide a preview of our promising 2008 slate. Finally, Tom will take you through our numbers and our expectations for the remainder of the year in more detail. Then we will be happy to take your questions.

I am very pleased with the results we delivered in the third quarter, which were strong at the top and bottom lines. As discussed in our press release, our reported profit results included some discrete items from both 2007 and 2006, so during our discussions today we will refer to the adjusted numbers.

Our revenues were up 24% this quarter to $3.27 billion. Worldwide revenues in Media Networks grew 9%, with advertising revenue up 7%. Domestic ad sales grew 5% in the quarter and the scatter market was strong, up double-digits. We also had double-digit advertising revenue growth in our international business.

Scatter prices so far in the fourth quarter are also up strong double-digits. While it is still very early in the quarter, as of today domestic ad sales growth in the fourth quarter looks to be comparable to the third quarter.

Worldwide affiliate fees grew 14% in the quarter, driven principally by rate increases across our core channels and also by subscriber growth. Ancillary revenues rose 7% on the strength of Guitar Hero 2 royalties. At the Paramount Motion Picture group, our revenues increased 57% to $1.3 billion. The DreamWorks Paramount blockbuster Transformers was the primary contributor to our triple-digit growth in theatrical revenues.

Adjusted net earnings from continuing operations grew 20% to $437 million, reflecting higher operating income. Adjusted diluted EPS from continuing operations were $0.65, a 27% increase over our results in third quarter '06. We continue to be well positioned to deliver low double-digit annual growth and diluted net earnings per share from continuing operations. Tom will provide more details in a few moments.

Let's move now to our Media Networks business. Over the past year, we have undergone significant changes in our organization and emphasis. We are moving fast, thinking big, and doing what we have never done before to capitalize on opportunities generated by the rapid-fire pace of change in the media conception patterns of our audiences.

On the organizational front, the restructuring initiated early this year is nearing completion. We have a powerful global platform on which to build our brands broadly, and we have set the stage to accelerate our growth and improve our returns internationally. Over time, we expect our international business to become an increasingly important part of the Viacom story.

Since our last call, we entered into a licensing agreement deal in the Ukraine, adding a local version of MTV in Hungary, and expanded our successful partnership with SKY Italia with the addition of three new channels. We also announced plans to launch MTV Arabia, which will occur this month, and Nickelodeon Arabia.

Our core business is creating great content. That is our history and it is our future. As I have discussed on previous calls, we have made a significant investment in a broad range of new programming across our networks. It is worth noting that we are also reinventing how we develop new programming. We are speeding the development of new projects and taking steps to lower programming costs in a variety of ways, such as ordering multiple seasons and syndicating more of our content.

A substantial portion of the new programming we have been working premiered in the third quarter, with more debuts ahead in the fourth quarter and beyond. Challenges remain, but the audience response to-date is very encouraging. Let's review some of the highlights.

On MTV, The Hills Season 3 is the number one original series on cable and broadcast TV in its time period for the shows core 12-34 demographic. We've extended his brand online with the successful virtual world, The Hill. Life of Ryan, with skateboarder Ryan Sheckler, is the highest-rated new series for MTV in the 12-34 demo and will launch a second season in the first quarter of '08. Making the Band 4 ranked number one in its time slot across all cable and the live season finale reached more than 5.5 million viewers and was the most watched telecast for the night across all television.

MTV is creating a buzz with new reality shows A Shot at Love with Tila Tequila, a breakout hit, as well as Pageant Place and Making Menudo, all of which premiered in October.

VH1 continues to strike the right chord with its audiences as it closed out its 21st consecutive quarter of growth in total viewers. The audiences showed up in impressive numbers for new shows Rock of Love and Scott Baio Is 45… and Single, both of which will be back for another season. The Salt-N-Pepa Show, Gotti's Way, and the return of I Love New York also debuted to strong ratings last month.

Nickelodeon continues to beat the competition in total day delivery among kids 2-11 and we are broadening our content offerings for the important tween audience with shows such as iCarly, which debuted to 13 million viewers over its premiere weekend. As the first scripted series to incorporate kid-created original content, iCarly is a true multiplatform hit. Drake and Josh Really Big Shrimp Movie and The Naked Brothers Band Movie were ratings winners for Nick, and our two new CGI-animated series, Back at the Barnyard and Tak and the Power of Juju debuted to and continue to garner strong numbers.

Spike TV's young adult male audiences continuing to make The Ultimate Fighting Championship a ratings success. In fact, amongst Spike's core demo, the UFC Live fights consistently outperform other professional sporting events, including Major League Baseball, the NBA, the NHL, and NASCAR. We have just extended our strategic partnership, keeping the UFC on Spike through 2011.

COMEDY CENTRAL also signed extensions with two of its most popular and valuable franchises. We extended the contract of Jon Stewart of The Daily Show through the end of 2010. This critically acclaimed, award-winning show continues to be a powerhouse brand for us and we are thrilled to have Jon at COMEDY CENTRAL. We also reaching an agreement with the creators of South Park through 2011. South Park is a significant driver of ratings, ad dollars, and ancillary revenues, which we intend to grow further.

BET continues to address ratings challenges by reformulating its programming with the introduction of new original series and the return of its most successful shows. This past month, BET launched three new original series, Sunday Best, Exalted, and College Hill Interns and welcomed back two critically-acclaimed favorites, American Gangster and Keyshia Cole 2: The Way It Is. Our new show, Hell Date, is a steady, strong performer.

In addition, our networks our increasing their investment in event-based multiplatform programming, something we do extremely well. The audiences that these events draw are the kind of highly-engaged consumers our marketing partners covet. I want to especially highlight our revamped MTV Video Music Awards, which aired in September. It shattered every key metric. Television ratings of the actual show were up 23% over last year. For the show itself in re-airings and related programming for the week following, the unduplicated audience reached more than 37.2 million total viewers.

MTV.com streamed more than 17 million video streams and had 8.7 million unique visitors the day after the show, which is more visitors than the entire week preceding show, which itself was our highest previous week.

MTV Mobile had the most single day video streams ever, more than double what the service typically delivers. The MTV Europe Music Awards, which aired last night from Munich, were also extended online and on mobile. Look for us to do the same with our other big events like the BET Awards, MTV Movie Awards, VH1's Hip Hop Honors, Logo Presidential Forum, BET's Hip Hop vs. America, all of which will create a deeper level of engagement by our audiences and a premium value to advertisers.

Advertisers increasingly want more effective ways to reach their consumers and we're working with them to develop integrated marketing solutions to engaged consumers on their own terms. Our expertise in engagement is becoming a real point of differentiation for us and allowing us to further build on the premium CPMs we already garner.

Let me give you a couple of examples. Nickelodeon's boy genius character, Jimmy Neutron, plays a prominent role in Chrysler's campaign for its 2008 Chrysler Town & Country van. In collaboration with Nickelodeon, Jimmy Neutron characters were integrated into Chrysler's Town & Country on-air campaign, which was seen on Nickelodeon and other cable and broadcast networks.

BET Networks is partnering with national sponsors Toyota and McDonald's, which will integrate their brands directly into the series College Hill Interns. Both brands will be the focus of specific projects cast members take on during their internships.

Convergent deals across our on-air and online platforms are another way that we are monetizing our brands and providing substantial added value to our advertisers. Today nearly 40% of all our advertising deals are convergent.

Our convergent deals go beyond simply selling advertising across platforms. They're using technology to create new experiences to engage audiences. For example, MTV and Pepsi have combined their creative ingenuity and marketing prowess to create Fashion, The Life, a web-based reality series. The show is being promoted on television through commercial pod busters during The Hills. These spots drive viewers to full episodes on MTV's new fashion website, which in turn moves the audience back to the television show, keeping viewers engaged and constantly reinforcing the brands.

As we have built our functionality, our presence and relevance in the digital arena is reaching a critical mass. We're growing our audiences and we're doing a better job of monetizing that traffic. Viacom's worldwide digital properties had 92 million unique visitors in September, an impressive 39% increase in organic traffic over September of last year.

As we provide richer content, visitors are staying longer to explore the possibilities. The average time spent per visit grew significantly since the beginning of the year. Audiences are drawn to our sites because we know how to deliver the content they are passionate about and advertisers are taking note. Year-to-date, we have parted with more than 185 new digital advertisers.

We invented fragmentation in the cable world and we believe the Internet is migrating to an even greater level of fragmentation, as consumers go directly to their favorite content. We are uniquely positioned to capitalize on this trend.

MTV Networks is launching dozens of new content-rich websites where fans can engage more deeply with specific shows or interests. Over time, we expect that number to grow to hundreds of new sites worldwide. These targeted environments allow like-minded fans to connect with one another, embed content and interact with everything they see, resulting in a more meaningful experience for consumers and a more valuable proposition for advertisers.

One of the best examples is the TheDailyShow.com which we launched last month. Consumers will be able to view the complete program library, more than 13,000 video clips. They will also have the ability to use a variety of innovative widgets and can access RSS feeds. They can embed video in their own blog or homepage, recommend and rate the clips, and connect with one another. Major national advertisers are lined up to participate in this exciting new space.

The same principles of open engagement with our audiences are being followed in the development of all our sites. We're creating a networking effect across our portfolio to enable and encourage fans to migrate from one site to another. The addition of Flux is a significant advance in our functionality. Flux is a social networking platform that allows our audiences to connect to their favorite content and communities across the web in an open, decentralized environment. A user creates a single profile that can be shared across all sites in the Flux network, freeing consumers to explore their interests and carry our branded content with them. This enhances the amount of time spent on our sites and others that are a part of this network.

We are just beginning to tap into the possibilities of the digital arena. As we continue to build our capabilities, we will develop new ventures to further monetize these world-class brands, such as Rhapsody America, our recent joint venture with RealNetworks. Rhapsody is the number one music subscription service and when debuted as the exclusive music service on Verizon's VCAST, it will be the number one music service on the mobile platform.

As I discussed during our last call, we're continuing to expand our leadership in the area of virtual worlds and casual online gaming, creating new homes for growing communities of avid fans and loyal consumers. Our virtual worlds, and we have ten of them today, are focused on particular interests, such as our Nickelodeon brands on Nicktropolis, or the lifestyles of our cast found in Virtual Newport Harbor.

On the gaming side, we're tapping into very robust growth opportunities. As of August, 45% of all Internet users worldwide accessed some gaming content online. If you look at our sites on an aggregated basis, categorized by comScore’s gaming information on online gaming, our sites collectively have grown faster than each of the top five gaming destinations and we ranked number two in the world in terms of unique visitors.

The growth in casual gaming is particularly strong in our Nickelodeon kids and family group, where gaming sites support 750 million game plays in August, a 43% increase over the same time period last year. Our virtual world, Nicktropolis.com, earned nearly 50 million game plays in August, a double-digit increase over the previous month. We're looking forward to expanding Nick's franchise to incorporate a multiplayer focus and more self-published games.

In the console arena, we will be launching the critically acclaimed gaming Rock Band from Harmonix, which we acquired last year. Available for Xbox 360 and PlayStation 3 on November 20, and PlayStation 2 on December 18, Rock Band takes the consumer experience to a new level and extends it by making new digitally distributed content available for purchase online every week.

As our online audience base grows, we are developing subscription-based services as yet another way to monetize our content. We have already launched MyNoggin.com, a personalized, premium subscription service for preschoolers and their parents, that features curriculum-based learning through game play. We also introduced a paid item business on Neopets. Consumers can pay for virtual items through PayPal or purchase prepaid cards at Target. Game Nation 2008, which is scheduled to launch on Nicktropolis in the first quarter, will also be a premium subscription service.

There's lots of brand building activity that I don’t time to touch on today -- consumer products, video-on-demand, branded hotels and cruises, digital downloads, theme parks, and more. Suffice it to say that we are seeking out every opportunity to make our entertainment brands ubiquitous in our audiences' lives and to build the foundation for long-term growth.

Let me move now to our Filmed Entertainment business. Paramount Motion Picture Group continued to deliver very strong results in third quarter, led by the huge success of the DreamWorks Paramount production of Transformers, which, after a decade in development, has emerged as a true global franchise with significant long-term value. Having earned more than $700 million at the global box office and helped to push Paramount into the number-one position in market share, Transformers' success is now extending to the home entertainment market.

We will close out the year with some great new releases, beginning with today's premier DreamWorks Animations Bee Movie with Jerry Seinfeld. Also coming up are Paramount's Beowulf with its amazing 3-D effects and DreamWorks' Kite Runner and Sweeney Todd, starring Johnny Depp.

Looking ahead, we feel very good about the breadth and depth of our 2008 movie slate. I'll give you a few of the highlights. Paramount has the highly-anticipated, but adding to its mystique, still unnamed film by J.J. Abrams due out in the first quarter and we will have two summer tent poles, the latest Indiana Jones installment directed by Steven Spielberg, and Paramount's release in association with Marvel Entertainment of Iron Man.

We will also release Love Guru, a comedy starring Mike Myers, and The Curious Case of Benjamin Button, starring Brad Pitt. Paramount will close out the year with Star Trek, a completely reconceived version of this franchise by, again, J.J. Abrams.

DreamWorks is reuniting Leonardo DiCaprio and Kate Winslet in Revolutionary Road. Nickelodeon Movies will be releasing The Spiderwick Chronicles and MTV is partnering with Vantage on How She Move.

Paramount Vantage has several other projects slated for release in 2008, including Margot at the Wedding, starring Nicole Kidman, Jack Black, and Jennifer Jason Leigh; There Will Be Blood, starring Daniel Day-Lewis; and No Country for Old Men, starring Tommy Lee Jones.

On top of that, DreamWorks Animation has two big titles scheduled for release, Madagascar 2 and Kung Fu Panda. Especially at this company, with our roots in rock-and-roll, we are really looking forward to the Paramount Classics release of Martin Scorsese's Shine A Light, starring the Rolling Stones.

Over time, we are evolving toward a diverse development model built on a solid foundation of our various brands and franchises. As we do this, we will be increasing the international distribution of our world-class filmed entertainment.

In conclusion, we continue to focus on our industry-leading ability to create world class, globally distributed content and on reinforcing and growing our highly-targeted brands. It is my privilege to lead a very talented and deep management team throughout our company.

Reinvention is what we do. We have an institutional ability to understand the evolution of our audiences and to deliver innovations to them. As we do so, I promise you we will continue to focus on execution and discipline in a world of rapid change and increasing complexity.

Now I will turn it over to my partner Tom, who will provide more details on the quarter and our outlook.

Tom Dooley

Thank you, Philippe. Good morning, everyone. I hope you have all had a chance to review our earnings release and the web presentation summarizing our third quarter results. Our 10-Q will be filed with the SEC and available later today.

I'm going to take you through our third quarter results in more detail and I will update you on the key factors impacting our outlook for the balance of the year. My remarks will focus on our adjusted results from continuing operations as discussed in our earnings press release.

We believe that adjusted results which exclude significant non-recurring charges and the after-tax gain on the sale of Famous Music reported in discontinued operations, are a better indicator of our core performance.

As Philippe mentioned, third quarter revenues increased 24% from last year to $3.3 billion and adjusted fully-diluted earnings per share from continuing operations for the third quarter was up 27% to $0.65, compared with $0.51 for the third quarter of 2006. I will mentioned here that our fully-diluted earnings per share from continuing operations in the quarter includes a $0.01 benefit due to a 60 basis point reduction in our full year effective income tax rate to 37.4%.

Adjusted operating income in the quarter was $818 million, which is up 14% versus last year. Filmed Entertainment delivered $72 million in operating income compared with an operating loss of $8 million last year, with revenues up 57%. Media Networks adjusted operating income was up 3% and revenues there were up 9%.

I will now go into some more detail on each of our segments, starting with the Media Networks group. Revenues were up 9% to $2 billion. Acquisitions contributed $33 million in net revenues in the quarter and foreign exchange contributed 1 point of revenue growth in the quarter.

Worldwide advertising revenues rose 7% year-over-year to $1.18 billion. Organic growth in worldwide advertising was 5%; that is up from 3% in the second quarter. Domestic advertising revenues were up 5%, led by growth at Spike TV, MTV, TV Land, and VH1. These gains were driven by strong growth in the video game, music and electronics categories.

Reported international advertising revenues grew 21%, with net acquisitions contributing 6 percentage points of the growth and foreign exchange contributing 8 percentage points of growth. Therefore, the organic international advertising revenue growth was 7%. This was primarily driven by strength in the UK and German marketplaces.

Affiliate revenues were up 14% to $582 million. If we exclude the benefit of acquisitions and foreign exchange, affiliate revenues were up 11%. Domestic affiliate revenues increased 11%. About one-third of the growth came from increased subscribers and two-thirds from rate increases. International affiliate growth was up 28%, with acquisitions contributing 9 points of growth and foreign exchange contributing 8 points of growth.

Ancillary revenues were up 7% in the quarter to $237 million. Domestic ancillary revenue was up 5%, driven by Guitar Hero 2 royalties and increased digital revenues. This was partially offset by lower home video revenues attributable to the 2006 release of The Chappelle Show. International ancillary revenues increased 12% in the quarter, driven by a higher consumer product licensing fees and increased home video revenues.

Media Networks' adjusted operating income for the quarter was up 3% from last year to $800 million. As we discussed in last quarter's call, we continue to invest in program content and newer initiatives, like Rock Band, to further engage our core audience. As a result, these higher expenses contributed to the segment's operating margin decline in the quarter.

MTV Networks continued work on the restructuring program announced earlier this year. The program will be completed by the end of the year, although at a revised cost estimate of approximately $80 million versus our previous estimate of approximately $70 million.

Turning to Filmed Entertainment, third quarter revenues were up 57% to $1.3 billion, while operating income improved by $80 million to $72 million. Theatrical revenues more than doubled in the quarter to $490 million driven by the worldwide performance of Transformers and our distribution of DreamWorks Animation's Shrek the Third. These two films significantly outperformed Over the Hedge and World Trade Center, released in the third quarter of last year.

Home Entertainment revenues increased $128 million, or 39% versus the third quarter of 2006 to $457 million. This performance principally reflected a greater number of releases in 2007 than 2006 and higher revenues from Blades of Glory, Disturbia, and Shooter. TV license fees were up 19%, or $48 million, principally reflecting the mix and availability of titles. Current year titles include The Terminal, Shark Tale, and Meet the Fockers.

The $80 million improvement in Filmed Entertainment operating income was principally driven by the performance of Transformers and Shrek the Third and the higher profit contributions from home entertainment, TV syndication, and network TV sales.

Now I would like to highlight a few points about capital and cash flow. Free cash flow was just over $1 billion for the nine months ended September 30, up 40% from the comparable period in 2006. The increase was principally driven by lower working capital requirements.

Our share buyback program continues to be a priority for us. Through October 25, we repurchased 43 million shares this year for an aggregate purchase price of $1.7 billion. We expect to continue to repurchase our stock, as we believe it is a great way to return value to our shareholders.

That is the review of the quarter. Now, let's look forward.

First, there is no change to our 2007 to 2009 guidance for continuing operations. I also want to remind you that our guidance excludes $80 million of full year 2007 pretax restructuring charges, as well as the year-to-date 2007 net after-tax benefit of $87 million from non-operating gains and discrete tax benefits.

Now let's turn to the trending we see in the fourth quarter. Media Networks domestic ad and affiliate sales growth for the fourth quarter is expected to be comparable to the third quarter. Rock Band, our new Harmonix game, goes to market later this month. We expect it to be a significant contributed to domestic ancillary revenue growth in the quarter. However, the relative operating margin on those sales will be lower than the overall operating margin for Media Networks.

In Filmed Entertainment, as you know, our quarterly results can be significantly impacted by the timing, number, and mix of theatrical releases and associated P&A expense. Looking at our fourth quarter, we expect approximately $250 million of incremental worldwide theatrical and home entertainment P&A. Notable releases include Beowulf on November 16, Sweeney Todd in December, as well as the release of DreamWorks Animation's Bee Movie, which is coming out today. A large part of the P&A increase is driven by the releases on DVD of Transformers and Shrek the Third.

However, we expect an operating profit benefit in the quarter from our DVD releases as well as films released in prior quarters. Accordingly, we expect Paramount to deliver solid growth in operating income compared with the fourth quarter of 2006.

As far as leverage goes, we continue to target 2.7 times to three times. In October, we sold 500 million aggregate principal amount of senior notes due 2017 and 250 million aggregate principal amounts of senior debentures due 2037, for total cash proceeds of $750 million, at what we believe are very attractive interest rates. We used the proceeds of our offerings to repay amounts outstanding under our revolver and commercial paper.

I also want to note that we anticipate fourth quarter and full year 2007 free cash flow to be impacted by incremental working capital related to the ramp up of manufacturing and distribution activities related to Rock Band's market launch later this month. This is a timing issued that will reverse early next year.

To wrap up, we are focused on monetizing our brands and diversifying our revenue streams. We continue to focus on driving our bottom line growth, particularly free cash flow and earnings per share. We look to do this by growing organically and by efficiently deploying our capital.

We feel great about the company's progress to date and how we are executing against our strategic priorities. We are excited about the opportunities in front of us and with that, thank you for listening and now we'll turn the call over to questions.

Question-and-Answer Session

Operator

Your first question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

Thank you very much. Philippe, you mentioned the improvement that you're seeing in your advertising business domestically, I was wondering if you could give us a sense for what your digital advertising growth rate is versus your non-digital?

As we go into 2008, do you think you will be able to start to leverage some of the ratings improvements that you've seen across the cable networks in a bigger way, so that we have not seen just the end of the improvement so far?

Then when you were at our conference in September we talked about the Showtime deal with CBS. I just wonder if there is any update there, given that ends at the end of 2008? Thanks.

Philippe Dauman

Thank you, Anthony. As far as digital advertising goes, we are experiencing nice growth in our efforts, particularly as we add sites, add functionality. As I mentioned in my remarks, increasingly our digital ad sales are part of convergent deals along with our on-air. So as we go forward, we expect to see growth continuing. Obviously with more monthly unique visitors, more functionality, more advertising opportunities, we expect to continue that growth, by the way, on a global basis. But it will be increasingly difficult to break it out given the role of the convergent deals that I mentioned.

As far as the general advertising commissions that we see, we are very encouraged. It all starts with ratings, obviously, and we are very encouraged as I mentioned, by the success of many of our new shows. We have a good development pipeline of new shows and, of course, new seasons of the hits that we are rolling out.

We are, as everyone else is, subject to general market conditions, but we certainly feel very optimistic in terms of what we can do as we go forward. As far as our pay television discussions, they continue and we have no update at this point.

Operator

Your next question comes from Spencer Wang - Bear Stearns.

Spencer Wang - Bear Stearns

Tom, can you talk a little bit about your affiliate revenue growth and specifically the subscriber growth? I think you said one-third of the growth was from subscriber growth in the U.S., which would be about 4%. Your stats seem to suggest that even the more mature channels like MTV and Nick are growing over 4% in the third quarter. Can you just talk about what is driving that?

I believe at the studio you're investing in TV production. Can you just size for us how much you're spending this year and what you expect that to be in '08?

Tom Dooley

Affiliate revenue growth, actually the big channels are not growing as fast as you are projecting there. What you're seeing is we have got a lot of channels that we've introduced over the years that are actually adding to the subscriber growth and are coming in both with additional subs and at nice rate increases.

So that is also one of the big drivers that I think explains some of the math and makes it a little bit clearer to you understanding it. You just have to keep in mind that there are a lot of other channels that we have launched and gotten out there and are becoming both profitable channels in the Viacom family and also add to the size and scope of our operations.

As far as TV production at this point in time, it is a de minimus amount of working capital being deployed in TV productions. We are doing this on a very, very cash-efficient basis so between this year and next year, I would say it's less than $30 million or $50 million, depending upon the opportunities that comes our way.

Spencer Wang - Bear Stearns

I was looking at your PULSE publication. It says MTV subs in the third quarter were 95.4 million versus 91.1; so that is where I was getting those numbers.

Spencer Wang - Bear Stearns

The PULSE publication is based on Nielsen statistics and Nielsen versus what we're actually paid on by the cable operators is off by somewhere in the $5 million to $10 million range. So that is why we see differences there too, but that is a difference that has been in the business for a long time.

Philippe Dauman

I might add in terms of affiliate growth, there is also Verizon and AT&T rolling out to subscribers and some portion of that is incremental to us. Also to supplement the TV production, I just want to highlight the fact that a lot of our focus in TV production going forward has to do with production for cable and we're looking at different opportunities relating to original programming that we are creating for our very own cable networks.

Tom Dooley

It is like, 5 million to 10 million subscribers of a difference on the big channels between Nielsen and what we're actually paid on.

Operator

Your next question comes from Michael Nathanson - Sanford Bernstein.

Michael Nathanson - Sanford Bernstein

I have two questions focused on investment spending. The first is you're starting to see the ratings improvement at your networks, but I wonder year-to-date, what is the rate of programming spending growth? Do you think that this spending trend will continue into the future?

Philippe Dauman

Well, as far as spending on programming, it is a priority for us but I think it is more with having to do with the mix of our programming. Over time, we want to move to more immediacy in our programming, more interactivity in our programming, and move away increasingly from syndicated programs. That is a gradual process.

There is some increase in our programming spend, but as we go forward, now that we have ramped up to this point, I see more of a change in the mix and not so much an increase in the amount of dollars that we're spending.

We are also, as I mentioned in remarks, focusing on how we can produce programming better and more efficiently. We really produce a large, large number of shows and we haven’t fully made use of our purchasing power just in the supply area and other ways we do our shows. When we have a hit we can, particularly with the nature of our shows, we can order more shows, multiple seasons. There are ways to drive efficiency in the programming costs, just as we're driving efficiency in all aspects of our business.

Michael Nathanson - Sanford Bernstein

Turning to studio, in the third quarter you had a couple disappointments like Hot Rod and Stardust, right? I wonder, have you considered reducing your output or cutting P&A going forward when you look out to 2008? I know you mentioned your slate, but I wondered how you think about the P&A investment behind that slate versus this year?

Philippe Dauman

Again, we look for efficiency in all that we do. Building the studio, which we had to ramp up over the last year or two, is a long-term process as I mentioned before. From a strategic point of view, I would like to see the foundation of our studio -- when I say foundation, I mean a very major part of our output for many, many years to come -- to be built on our brands like MTV, like Nickelodeon, like BET, like some of our other brands; on the distribution of movies under our multi-year agreement with DreamWorks Animation; our new relationship with Marvel over the next several years starting with Iron Man being released in '08.

When you have that foundation, you have more balance and I believe less risk at a competitive edge. Then we can add to that the projects by great directors like Steven Spielberg, Martin Scorsese, J.J. Abrams, who looks to be a very prolific producer for us. We have to, as you suggest, be judicious and disciplined in the number and mix of our releases over time. This is a process that we are going through.

Operator

Your next question comes from Doug Mitchelson - Deutsche Bank.

Doug Mitchelson - Deutsche Bank

Broadcasters are saying that broadcast networks are looking better relative to cable networks this season, due to the impact of commercial ratings. Cable networks tend to hold their audience less well than the broadcast networks. Do you see that as an advantage for broadcast this season?

Then as part of that, as you experiment with MTV in particular this fall, which tends to have the biggest fall-off among your networks, what have you been able to accomplish to lower that commercial rating fall-off as you prepare for the switch to C-3 ratings in this quarter? Thanks.

Philippe Dauman

As far as the C-3, we're very focused on that. It becomes more widely applicable to us as we head into '08. We have fantastic retention in many of our networks, for example Nickelodeon, where we have virtually no drop-off, and several others.

As to those networks who are more affected within our family, and that would include MTV and VH1, we are working on a number of things. First of all, we do have the tremendous advantage of being able to integrate marketing into our programming. That is why we are deepening and accelerating our focus on the integrated marketing area.

I think a great example of that on COMEDY CENTRAL, when Stephen Colbert launched his presidential campaign sponsored by Doritos. The nature of our programming really lends itself to that.

We are tackling it in several ways as far as the commercial pods themselves. We are increasing the number of pods, making them shorter. That increases consumer engagement. We have commercial threads, where we run programming elements through our commercial pods. We are going to be rolling out later this quarter commercial squeezes, where we basically have commercial elements on the bottom of the screen on our programming, which we had not done before.

So we have several initiatives in place to increase engagement within our commercial pods and we're of course very focused on the commercials themselves that we put in, getting involved in some of the production and working with our advertisers to make sure that the advertising is compelling.

So we are quite comfortable as we move forward in this new environment.

Doug Mitchelson - Deutsche Bank

Is it safe to assume that during this upfront you had a pretty good idea of what the commercial ratings issues were and you sold through those during the upfront?

Philippe Dauman

Yes, we did. Obviously there is a currency adjustment that was involved, so we had increased pricing in the upfront to make up for the commercial ratings shortfall. As we go forward, we will be judged on how we hold up against that and obviously our overall ratings, as well.

So we're focused on both improving the ratings in our programs and then making our commercial pods more engaging. The combination of the two, if we do it well, will yield good results for us.

Operator

Your next question comes from Imran Khan – JP Morgan.

Imran Khan - JP Morgan

Clearly international is a key focus for the company. Can you give us some sense of what kind of initiative you are taking and how should think about international markets going forward?

Secondly, affiliate revenue growth rate, it seems like the swing factors that you have been talking about will continue in '08, like telco or digital cable conversions. So is that fair to assume that we should see a similar kind of growth rate in the affiliate fee next year? Thank you.

Philippe Dauman

International we all believe is a great secular opportunity for this company. We have a ubiquitous MTV around the world. We are still in expansion mode with Nickelodeon. We're just beginning the roll out of COMEDY. We have VH1 in several territories and many, many other branding opportunities and as we roll out, it creates great opportunities in a lot of other areas, such as consumer products.

The restructuring that we did really creates a good platform for future growth. Our margins have been improving and now in the third quarter they are up to double-digit margins. We are very, very pleased with that progress.

As far as affiliate fees, those are steady-state growth numbers that we have going forward. We provide tremendous value to our affiliates. We are the biggest bargain in the cable universe given the strength of our brands, which represent 25% of viewership, but a much, much smaller percentage of affiliate fees.

As you know, affiliate agreements are multi-year agreements. So there's a lot of predictability in the affiliate fee growth.

Tom Dooley

Imran, just to follow-up on that, in the second quarter our international margins were high single-digits and now they have moved into low double-digits in the third quarter.

Operator

Your next question comes from Tuna Amobi - Standard & Poor's Equity.

Tuna Amobi - Standard & Poor’s

My question is on Flux. How do you intend to monetize that asset? Obviously you guys have been building hundreds of websites now, so as you look forward and as you look out to the next couple of years, how do you strike the balance in respect of third party partners like Yahoo! and Joost, as well as the MTV brands? How do you see that asset unfolding?

Another question for Sumner. In the past, I think you have alluded to perhaps revisiting the issue of recapitalization at the right time. The question is what is the trigger that is going to make you revisit that issue?

Philippe Dauman

As far as Flux goes, we are rolling it out across our sites. As you know, we have about 300 sites right now and we are in the process of rolling it out. What it will do for us, it'll make it easier for our consumers to take our content, to play with it, too embed our video content on their personal pages, to bring it to the attention of their friends. We will have linkbacks to other sites that we believe will increase traffic. Increased traffic will mean more inventory for our advertising partners.

At the same time, we continue to work with many third-party partners to distribute our content and we see more and more opportunities which you will see as we go forward in the months and the years to come.

So we are very focused on building all of our brands, MTV and others, internally but we also are making our content open to our partners.

Sumner Redstone

As far as the question you asked me, you know we consider all alternatives. The question you asked is one that from time to time I talk with Philippe and Tom and others about, but there is nothing on the front burner.

Operator

Your next question comes from Rich Greenfield - Pali Capital.

Rich Greenfield - Pali Research

Just a quick question in terms of the home video landscape. Transformers obviously opened up incredibly well. Wondering whether that was in your mind title-specific or is this a larger comment to the health of the home video market? Maybe you could speak to both new releases as well as what you are seeing in catalog?

Then also, you made an investment of $230 million, or gave a $230 million debt instruments to this new entity called Rhapsody America. I am wondering if you can explain the rationale behind that and how you think about the business prospects for that investment? Thanks.

Philippe Dauman

As far as the home video landscape, you are quite right to point out the great out of the box success of Transformers. In the movie business, big hits yield big numbers and there is clearly a thirst for that kind of product. The great thing about a franchise like that is it is a global franchise. It is bigger in terms of dollars outside the U.S. than it is in the U.S., as enormous as it is in the U.S., so that is why we really want to focus on the brand and the franchise business to the extent we can.

The catalog business, there is a lot of opportunity internationally there. I would say as you roll out in territories and as we increase our own international distribution network on an overall basis -- in the U.S. certainly -- the catalog business has been flattening. You are seeing more strength in the TV on DVD business, which of course we are taking advantage of as far as our own programming goes.

Tom Dooley

On Rhapsody, the investment that we made in Rhapsody was to reflect the contribution that we brought the table and RealNetworks brought to the table. We are very happy. We think this has a great future ahead of it in terms of a music downloads. Our partner in that includes RealNetworks and Verizon. That product should be coming out in the not too distant future and we think when it does come out, it will be a great investment for us and all the parties involved.

Operator

Your next question comes from Alan Gould - Natixis Bleichroeder.

Alan Gould - Natixis Bleichroeder

Can you tell us what impact a strike will have on each of your businesses, Writers Guild strike?

Secondly, I believe you were saying in the past that the international is about $1 billion of revenue at the Media Networks. Do you still plan on taking 10% to 15% of costs out of that next year?

Philippe Dauman

As far as the potential WGA strike is concerned, we feel we are very well positioned on an overall basis, starting with the studio. We, along with other studios, have obviously been preparing for the possibility of a strike. We have a good pipeline of movies that are already produced or in production, which will not be affected. In the long term, it depends how long the strike goes on.

As far as our television business, for the most part across our family of networks, we will have very little to no impact. Probably the couple of shows that certainly over the next few months are impacted that we have to look at are The Daily Show with Jon Stewart and Stephen Colbert, because of their topical nature. If there should be a strike, we will evaluate what we do in those time slots. Obviously as we have done before and we do normally, we will have reruns for a little while and then we will see what we do with the format.

Tom Dooley

As far as international costs go, Alan, we've probably spent this year driving a lot of the costs to the levels that we want them on a go-forward basis. Now the focus will be on driving revenue growth in the marketplaces. So we do not see us attacking or doing any future restructurings or dramatic cost shifts in the international marketplace. It is a focus on growth now.

Alan Gould - Natixis Bleichroeder

So most of the costs were taken care of in 2007?

Tom Dooley

Yes, sir.

Operator

Your final question comes from Benjamin Swinburne - Morgan Stanley.

Benjamin Swinburne - Morgan Stanley

Maybe just more strategic long-term use of capital, Philippe. Since the last quarterly call, the credit markets have come down a bit and we're seeing much less acquisition interest in media assets. Most of that interest was on the old media side, but I was wondering if you could talk about your view on buying more cable networks?

Probably no company has the scale that you do. If you look at potential assets that might go on the block over the next year or so, is that something that's interesting to you or is Viacom purely focused on online and gaming properties and stuff in the new media area?

Philippe Dauman

Benjamin, we obviously look at all the opportunities that present themselves out there. We, for example, looked at Oxygen, which just traded to NBC Universal, but we are very disciplined in how we look at it. That is our core business, we have to look at all cable networks that are available. We look at whether they fit in, whether the price is right. We are very disciplined on how we look at it.

We are primarily focused on organic growth and we think that focus is showing great signs of paying off. As we look at acquisitions, we are most interested in highly-targeted acquisitions that fit into our core businesses, whether it be in the U.S. or around the world. Again, the acquisitions we look at tend to the very small in amount and very strategic.

Jim Bombassei

Thank you all very much. We appreciate your time this morning.

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Source: Viacom Q3 2007 Earnings Call Transcript
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