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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 releaseteleconference. Today's call is being recorded. At this time, I would like to turnthe 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 tojoin us for our third quarter earnings call. Joining me for today's discussionare Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; TomDooley, our Chief Administrative Officer and CFO; Jacques Tortoroli, ourController and Chief Accounting Officer.

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

Before we begin, let me remind you that statements made onthis call relating to matters which are not historical fact are forward-lookingstatements. 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 bythese statements. Risks and uncertainties are discussed in our filings with theSEC.

Reconciliations for non-GAAP financial information discussedon 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 theresults we delivered in the third quarter. The progress that Philippe and theentire Viacom team are making across the company is impressive, not only in itsbreadth, but in its pace.

We are extending the reach of our premier entertainmentbrands across every street in nearly every country and territory all around theworld. We are developing new experiences, providing more opportunities forconsumers and our marketing partners to engage with our brands. We are taking advantageof all these new areas with unprecedented speed. We are capitalizing on thestrength of our brands and the new revenue streams, which are clearly beingcreated by the revolution in consumer technology which is taking place allaround us.

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

Since rejoining the management ranks a little more than ayear ago, Philippe and Tom have added to their already remarkable track recordof achievement. Across the company, their strategic leadership is aninspiration. It is in inspiring innovation. It is creating collaboration, andit is promoting efficiency.

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

With that, of course, let me turn it over to my friend andCEO, 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 quarterresults. The results we reported today reflect the substantial progress we havemade this year in further leveraging the value of our world-class entertainmentbrands.

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

This morning I would like to highlight our recent progressand share with you some of our plans to enhance and extend the monetization ofour brands, both within our core operations and through new ventures. I willstart with a brief review of our quarterly results and spend a few minutestalking about how we are innovating our media networks business fromprogramming to advertising, to our growing digital business and new revenuestreams.

Our Filmed Entertainment group has enjoyed tremendous successthis 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 ofthe year in more detail. Then we will be happy to take your questions.

I am very pleased with the results we delivered in the thirdquarter, which were strong at the top and bottom lines. As discussed in ourpress release, our reported profit results included some discrete items fromboth 2007 and 2006, so during our discussions today we will refer to theadjusted 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, updouble-digits. We also had double-digit advertising revenue growth in ourinternational business.

Scatter prices so far in the fourth quarter are also upstrong double-digits. While it is still very early in the quarter, as of todaydomestic ad sales growth in the fourth quarter looks to be comparable to thethird quarter.

Worldwide affiliate fees grew 14% in the quarter, drivenprincipally by rate increases across our core channels and also by subscribergrowth. Ancillary revenues rose 7% on the strength of Guitar Hero 2 royalties. At the Paramount Motion Picturegroup, our revenues increased 57% to $1.3 billion. The DreamWorks Paramountblockbuster Transformers was theprimary 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 fromcontinuing operations were $0.65, a 27% increase over our results in thirdquarter '06. We continue to be well positioned to deliver low double-digitannual 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 pastyear, we have undergone significant changes in our organization and emphasis.We are moving fast, thinking big, and doing what we have never done before tocapitalize on opportunities generated by the rapid-fire pace of change in themedia conception patterns of our audiences.

On the organizational front, the restructuring initiatedearly this year is nearing completion. We have a powerful global platform onwhich to build our brands broadly, and we have set the stage to accelerate ourgrowth and improve our returns internationally. Over time, we expect ourinternational business to become an increasingly important part of the Viacomstory.

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

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

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

On MTV, The HillsSeason 3 is the number one original series on cable and broadcast TV in itstime period for the shows core 12-34 demographic. We've extended his brandonline with the successful virtual world, The Hill. Life of Ryan, with skateboarder Ryan Sheckler, is the highest-ratednew series for MTV in the 12-34 demo and will launch a second season in thefirst quarter of '08. Making the Band 4 rankednumber one in its time slot across all cable and the live season finale reachedmore than 5.5 million viewers and was the most watched telecast for the nightacross all television.

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

VH1 continues to strike the right chord with its audiencesas it closed out its 21st consecutive quarter of growth in total viewers. Theaudiences showed up in impressive numbers for new shows Rock of Love and Scott BaioIs 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 strongratings last month.

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

Spike TV's young adult male audiences continuing to make The Ultimate Fighting Championship aratings success. In fact, amongst Spike's core demo, the UFC Live fightsconsistently outperform other professional sporting events, including MajorLeague Baseball, the NBA, the NHL, and NASCAR. We have just extended ourstrategic partnership, keeping the UFC on Spike through 2011.

COMEDY CENTRAL also signed extensions with two of its mostpopular 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 powerhousebrand for us and we are thrilled to have Jon at COMEDY CENTRAL. We alsoreaching an agreement with the creators of South Park through 2011. South Park is a significant driver of ratings, addollars, and ancillary revenues, which we intend to grow further.

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

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

MTV.com streamed more than 17 million video streams and had8.7 million unique visitors the day after the show, which is more visitors thanthe entire week preceding show, which itself was our highest previous week.

MTV Mobile had the most single day video streams ever, morethan 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 ourother 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 apremium value to advertisers.

Advertisers increasingly want more effective ways to reachtheir consumers and we're working with them to develop integrated marketingsolutions to engaged consumers on their own terms. Our expertise in engagementis becoming a real point of differentiation for us and allowing us to furtherbuild on the premium CPMs we already garner.

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

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

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

Our convergent deals go beyond simply selling advertisingacross platforms. They're using technology to create new experiences to engageaudiences. For example, MTV and Pepsi have combined their creative ingenuityand 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 tofull episodes on MTV's new fashion website, which in turn moves the audienceback to the television show, keeping viewers engaged and constantly reinforcingthe brands.

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

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

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

MTV Networks is launching dozens of new content-richwebsites 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 meaningfulexperience for consumers and a more valuable proposition for advertisers.

One of the best examples is the TheDailyShow.com which welaunched last month. Consumers will be able to view the complete programlibrary, more than 13,000 video clips. They will also have the ability to use avariety of innovative widgets and can access RSS feeds. They can embed video intheir own blog or homepage, recommend and rate the clips, and connect with oneanother. Major national advertisers are lined up to participate in thisexciting new space.

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

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

As I discussed during our last call, we're continuing toexpand 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 particularinterests, such as our Nickelodeon brands on Nicktropolis, or the lifestyles ofour cast found in Virtual Newport Harbor.

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

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

In the console arena, we will be launching the critically acclaimedgaming Rock Band from Harmonix, which we acquired last year. Available for Xbox360 and PlayStation 3 on November 20, and PlayStation 2 on December 18, RockBand takes the consumer experience to a new level and extends it by making newdigitally distributed content available for purchase online every week.

As our online audience base grows, we are developingsubscription-based services as yet another way to monetize our content. We havealready launched MyNoggin.com, a personalized, premium subscription service forpreschoolers and their parents, that features curriculum-based learning throughgame play. We also introduced a paid item business on Neopets. Consumers canpay for virtual items through PayPal or purchase prepaid cards at Target. GameNation 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 totouch on today -- consumer products, video-on-demand, branded hotels andcruises, digital downloads, theme parks, and more. Suffice it to say that weare seeking out every opportunity to make our entertainment brands ubiquitousin 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 inthird quarter, led by the huge success of the DreamWorks Paramount productionof Transformers, which, after adecade in development, has emerged as a true global franchise with significantlong-term value. Having earned more than $700 million at the global box officeand helped to push Paramount intothe 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 andDreamWorks' Kite Runner and Sweeney Todd, starring Johnny Depp.

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

We will also release LoveGuru, a comedy starring Mike Myers, and TheCurious Case of Benjamin Button, starring Brad Pitt. Paramountwill 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 Winsletin Revolutionary Road. Nickelodeon Movies will be releasing The Spiderwick Chronicles and MTV ispartnering with Vantage on How She Move.

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

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

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

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

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

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

Tom Dooley

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

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

We believe that adjusted results which exclude significantnon-recurring charges and the after-tax gain on the sale of Famous Musicreported in discontinued operations, are a better indicator of our coreperformance.

As Philippe mentioned, third quarter revenues increased 24%from last year to $3.3 billion and adjusted fully-diluted earnings per sharefrom continuing operations for the third quarter was up 27% to $0.65, comparedwith $0.51 for the third quarter of 2006. I will mentioned here that ourfully-diluted earnings per share from continuing operations in the quarterincludes a $0.01 benefit due to a 60 basis point reduction in our full yeareffective 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 inoperating income compared with an operating loss of $8 million last year, withrevenues up 57%. Media Networks adjusted operating income was up 3% andrevenues 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 foreignexchange 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 from3% in the second quarter. Domestic advertising revenues were up 5%, led bygrowth at Spike TV, MTV, TV Land, and VH1. These gains were driven by stronggrowth in the video game, music and electronics categories.

Reported international advertising revenues grew 21%, withnet acquisitions contributing 6 percentage points of the growth and foreignexchange contributing 8 percentage points of growth. Therefore, the organicinternational advertising revenue growth was 7%. This was primarily driven bystrength in the UK and German marketplaces.

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

Ancillary revenues were up 7% in the quarter to $237million. Domestic ancillary revenue was up 5%, driven by Guitar Hero 2 royaltiesand increased digital revenues. This was partially offset by lower home videorevenues 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 andincreased home video revenues.

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

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

Turning to Filmed Entertainment, third quarter revenues wereup 57% to $1.3 billion, while operating income improved by $80 million to $72million. Theatrical revenues more than doubled in the quarter to $490 milliondriven by the worldwide performance of Transformersand 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 principallyreflected a greater number of releases in 2007 than 2006 and higher revenuesfrom Blades of Glory, Disturbia, and Shooter. TV license fees were up 19%, or $48 million, principallyreflecting the mix and availability of titles. Current year titles include The Terminal, Shark Tale, and Meet theFockers.

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

Now I would like to highlight a few points about capital andcash flow. Free cash flow was just over $1 billion for the nine months endedSeptember 30, up 40% from the comparable period in 2006. The increase wasprincipally 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 aggregatepurchase 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 continuingoperations. I also want to remind you that our guidance excludes $80 million offull year 2007 pretax restructuring charges, as well as the year-to-date 2007net after-tax benefit of $87 million from non-operating gains and discrete taxbenefits.

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 isexpected to be comparable to the third quarter. Rock Band, our new Harmonixgame, goes to market later this month. We expect it to be a significantcontributed to domestic ancillary revenue growth in the quarter. However, therelative operating margin on those sales will be lower than the overalloperating margin for Media Networks.

In Filmed Entertainment, as you know, our quarterly resultscan be significantly impacted by the timing, number, and mix of theatricalreleases and associated P&A expense. Looking at our fourth quarter, weexpect approximately $250 million of incremental worldwide theatrical and homeentertainment P&A. Notable releases include Beowulf on November 16, SweeneyTodd in December, as well as the release of DreamWorks Animation's Bee Movie, which is coming out today. Alarge 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 thequarter from our DVD releases as well as films released in prior quarters.Accordingly, we expect Paramount to deliver solid growth in operating incomecompared with the fourth quarter of 2006.

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

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

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

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

Question-and-AnswerSession

Operator

Your first question comes from Anthony Noto - Goldman Sachs.

Anthony Noto - Goldman Sachs

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

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

Then when you were at our conference in September we talkedabout 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 areexperiencing nice growth in our efforts, particularly as we add sites, addfunctionality. As I mentioned in my remarks, increasingly our digital ad salesare part of convergent deals along with our on-air. So as we go forward, weexpect to see growth continuing. Obviously with more monthly unique visitors,more functionality, more advertising opportunities, we expect to continue thatgrowth, by the way, on a global basis. But it will be increasingly difficult tobreak 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 veryencouraged as I mentioned, by the success of many of our new shows. We have agood development pipeline of new shows and, of course, new seasons of the hitsthat we are rolling out.

We are, as everyone else is, subject to general marketconditions, but we certainly feel very optimistic in terms of what we can do aswe go forward. As far as our pay television discussions, they continue and wehave 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 revenuegrowth and specifically the subscriber growth? I think you said one-third ofthe growth was from subscriber growth in the U.S.,which would be about 4%. Your stats seem to suggest that even the more maturechannels like MTV and Nick are growing over 4% in the third quarter. Can youjust 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 expectthat to be in '08?

Tom Dooley

Affiliate revenue growth, actually the big channels are notgrowing as fast as you are projecting there. What you're seeing is we have gota lot of channels that we've introduced over the years that are actually addingto the subscriber growth and are coming in both with additional subs and atnice rate increases.

So that is also one of the big drivers that I think explainssome of the math and makes it a little bit clearer to you understanding it. Youjust have to keep in mind that there are a lot of other channels that we havelaunched and gotten out there and are becoming both profitable channels in theViacom 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 deminimus amount of working capital being deployed in TV productions. We aredoing this on a very, very cash-efficient basis so between this year and nextyear, I would say it's less than $30 million or $50 million, depending upon theopportunities that comes our way.

Spencer Wang - Bear Stearns

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

Spencer Wang - Bear Stearns

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

Philippe Dauman

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

Tom Dooley

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

Operator

Your next question comes from Michael Nathanson - Sanford Bernstein.

MichaelNathanson - Sanford Bernstein

I have two questionsfocused on investment spending. The first is you're starting to see the ratingsimprovement at your networks, but I wonder year-to-date, what is the rate ofprogramming spending growth? Do you think that this spending trend willcontinue into the future?

Philippe Dauman

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

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

We are also, as I mentioned in remarks, focusing on how wecan 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 powerjust in the supply area and other ways we do our shows. When we have a hit wecan, particularly with the nature of our shows, we can order more shows,multiple seasons. There are ways to drive efficiency in the programming costs, justas we're driving efficiency in all aspects of our business.

MichaelNathanson - Sanford Bernstein

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

Philippe Dauman

Again, we look for efficiency in all that we do. Buildingthe studio, which we had to ramp up over the last year or two, is a long-termprocess as I mentioned before. From a strategic point of view, I would like tosee the foundation of our studio -- when I say foundation, I mean a very majorpart of our output for many, many years to come -- to be built on our brandslike MTV, like Nickelodeon, like BET, like some of our other brands; on thedistribution 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 Ibelieve less risk at a competitive edge. Then we can add to that the projectsby great directors like Steven Spielberg, Martin Scorsese, J.J. Abrams, wholooks to be a very prolific producer for us. We have to, as you suggest, bejudicious and disciplined in the number and mix of our releases over time. Thisis a process that we are going through.

Operator

Your next question comes from Doug Mitchelson - DeutscheBank.

Doug Mitchelson - Deutsche Bank

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

Then as part of that, as you experiment with MTV inparticular this fall, which tends to have the biggest fall-off among yournetworks, what have you been able to accomplish to lower that commercial ratingfall-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 headinto '08. We have fantastic retention in many of our networks, for exampleNickelodeon, where we have virtually no drop-off, and several others.

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

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

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

So we have several initiatives in place to increaseengagement within our commercial pods and we're of course very focused on thecommercials themselves that we put in, getting involved in some of theproduction and working with our advertisers to make sure that the advertisingis compelling.

So we are quite comfortable as we move forward in this newenvironment.

Doug Mitchelson - Deutsche Bank

Is it safe to assume that during this upfront you had apretty good idea of what the commercial ratings issues were and you soldthrough those during the upfront?

Philippe Dauman

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

So we're focused on both improving the ratings in ourprograms and then making our commercial pods more engaging. The combination ofthe 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. Canyou give us some sense of what kind of initiative you are taking and how shouldthink about international markets going forward?

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

Philippe Dauman

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

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

As far as affiliate fees, those are steady-state growthnumbers 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 ourbrands, which represent 25% of viewership, but a much, much smaller percentageof 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 tofollow-up on that, in the second quarter our international margins were highsingle-digits and now they have moved into low double-digits in the thirdquarter.

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 thatasset? Obviously you guys have been building hundreds of websites now, so asyou look forward and as you look out to the next couple of years, how do youstrike the balance in respect of third party partners like Yahoo! and Joost, aswell as the MTV brands? How do you see that asset unfolding?

Another question for Sumner. In the past, I think you havealluded 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 thatissue?

Philippe Dauman

As far as Flux goes,we are rolling it out across our sites. As you know, we have about 300 sitesright 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 attentionof their friends. We will have linkbacks to other sites that we believe willincrease traffic. Increased traffic will mean more inventory for ouradvertising partners.

At the same time, we continue to work with many third-partypartners to distribute our content and we see more and more opportunities whichyou 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, MTVand others, internally but we also are making our content open to our partners.

Sumner Redstone

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

Operator

Your next question comes from Rich Greenfield - PaliCapital.

Rich Greenfield - Pali Research

Just a quick question in terms of the home video landscape. Transformers obviously opened upincredibly well. Wondering whether that was in your mind title-specific or isthis a larger comment to the health of the home video market? Maybe you couldspeak 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 thinkabout the business prospects for that investment? Thanks.

Philippe Dauman

As far as the homevideo landscape, you are quite right to point out the great out of the boxsuccess of Transformers. In the moviebusiness, big hits yield big numbers and there is clearly a thirst for thatkind of product. The great thing about a franchise like that is it is a globalfranchise. 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 businessto the extent we can.

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

Tom Dooley

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

Operator

Your next question comes from Alan Gould - NatixisBleichroeder.

Alan Gould - Natixis Bleichroeder

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

Secondly, I believe you were saying in the past that theinternational is about $1 billion of revenue at the Media Networks. Do youstill 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 weare very well positioned on an overall basis, starting with the studio. We,along with other studios, have obviously been preparing for the possibility ofa strike. We have a good pipeline of movies that are already produced or inproduction, which will not be affected. In the long term, it depends how longthe strike goes on.

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

Tom Dooley

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

Alan Gould - Natixis Bleichroeder

So most of the costswere taken care of in 2007?

Tom Dooley

Yes, sir.

Operator

Your final question comes from Benjamin Swinburne - MorganStanley.

BenjaminSwinburne - Morgan Stanley

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

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

Philippe Dauman

Benjamin, weobviously look at all the opportunities that present themselves out there. We,for example, looked at Oxygen, which just traded to NBC Universal, but we arevery disciplined in how we look at it. That is our core business, we have tolook 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 thatfocus is showing great signs of paying off. As we look at acquisitions, we aremost interested in highly-targeted acquisitions that fit into our corebusinesses, whether it be in the U.S.or around the world. Again, the acquisitions we look at tend to the very smallin amount and very strategic.

Jim Bombassei

Thank you all very much. We appreciate your time thismorning.

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