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Martha Stewart Living Omnimedia, Inc. (NYSE:MSO)

Q2 2012 Earnings Call

July 30, 2012 8:30 am ET

Executives

Katherine Nash – Vice President - Communications and Investor Relations

Lisa Gersh – President and Chief Executive Officer

Kenneth L. West – Chief Financial Officer

Analysts

Michael Kupinski – Noble Financial Capital Markets

David Bank – RBC Capital Markets

Michael A. Kupinski – Noble Financial Capital Markets

Operator

Good morning and welcome to the Martha Stewart Living Omnimedia Second Quarter 2012 Earnings Conference Call and webcast. Your host for today’s call are President and Chief Executive Officer, Lisa Gersh and Chief Financial Officer, Ken West.

All participants will be in a listen-only mode until the question-and-answer session of the call. At the request of Martha Stewart Living Omnimedia, this call is being recorded, anyone with objection should disconnect at this time.

At this time it is my pleasure to introduce, Katherine Nash, VP of Communications and Investor Relations of Martha Stewart Living Omnimedia. Katherine, you may begin when ready.

Katherine Nash

Thank you and good morning everyone. Welcome to Martha Stewart Living Omnimedia's second quarter 2012 earnings conference call.

Before we begin, let me remind you that discussions will contain forward-looking statements, which are made pursuant to the Private Securities Litigation Reform Act of 1995 as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties which are difficult to predict. Actual future results and trends may differ materially from what is forecast in forward-looking statements, due to a variety of factors, many of which are described in our SEC filings. Also, non-GAAP numbers are reconciled to GAAP in an attachment to our press release, which appears on our website at marthastewart.com.

Thank you, and now I'll turn the call over to Lisa.

Lisa Gersh

Thank you Katherine and good morning everyone. Our second quarter results were pretty much in line with our expectations.

Highlights include strong margins in Merchandising, as well as continued solid revenue growth and a modest profit in Broadcasting. Our Publishing results were weaker as we communicated they would be. More important is how we see the second half of the year as we execute on all of our turnaround plans, and I'll update you on where we are across each of our businesses. After that, I'll turn the call over to Ken and then we’ll take your questions.

I’d like to start with Merchandising. We had a solid quarter overall with adjusted EBITDA margins about 70%. Leading contributors to revenue growth in the quarter included J.C. Penney, where we continue our early design work as we prepare for the launch of that partnership in the first quarter of 2013. The Martha Stewart Home Office line with Avery sold exclusively at Staples in the United States, and now, the UK and strong performance in our pet’s line at Petsmart. Overall, our growth was offset by softness of the Home Depot relative to our expectations primarily in the soft flooring category.

I’d like to focus for a moment on recent developments with respect to J.C. Penney. First, we announced the substantial expansion of the commercial partnership, including additional product categories and an increase in the minimum guarantee. We will now receive a minimum of about $288 million over the course of the 10 year agreement, an increase of $110 million from what was originally planned. The opportunity to amend this agreement has been in place since the beginning. The decision to act on it now is a reflection of the great opportunities we and J.C. Penney see as the relationship builds.

The second development stems in the litigation underway with Macy’s. As you know, on July 13, the court granted Macy’s request for preliminary injunction with respect to certain categories of products. I want to take the opportunity here to clarify a few facts about this ruling and how it relates to our business with both Macy’s and J.C. Penney.

First, MSLO will be launching our products both in-store and online with J.C. Penney in the first quarter of 2013 as planned. Nothing about this ruling changes that. This case is primarily a contract dispute over how certain products are branded and sold, not about the validity of the partnership with J.C. Penney.

Second, the minimum guarantee under the J.C. Penney commercial agreement including the increase we just announced is not directly affected by the ruling. We are planning to be in J.C. Penney stores with a wide array of products for consumers early next year. And we are in ongoing development of categories and products as we typically are with all of our partners.

Now, let’s turn to publishing, our performance was largely in line with what we anticipated. We’ve talked in recent calls about our aggressive strategy to improve publishing performance. It is our largest business by revenue and turning it around is key to restoring profitability at MSLO in the near-term. Over the first three months of the year, we completed a transformation of our ad sales team bringing in considerable talent and setting our course to sell our print and digital inventory in the right way to engage marketers.

We are also supporting this team with an editorial strategy designed to broaden the categories they can sell. With the full team now in place and engaging in the advertising community, we are now receiving feedback on our plans and what we can expect to accomplish. On a number of levels we feel good about the engagement the team has secured in the marketplace and the response marketers are having as we modify our print and digital offerings. But on the financial level the turnaround we are seeking will not unfold as quickly as we would like.

There are a couple of reasons for this; one is the challenging print and ad environment that we all know about. And two, more unique to MSLO, it’s become clear that prior MSLO’s efforts of the company were weaker than we understood going in.

The team appears to be making progress on this front. We’ve seen some of the nation’s largest advertisers, some of them who use to do business with MSLO and no longer do and some who never have, now come to the table and give us confidence that we will be doing business with them in 2013. We are gaining traction, but rebuilding these relationships and cultivating new ones is a process, while we still see Q4 improvement in publishing, overall we are now looking to the first part of 2013 for us to begin reaching our performance goals.

In broadcasting, the second quarter marked the conclusion of live program and production at the company and the end of the quarter marked the conclusion of our studio lease. This resulted in lower revenue, which was expected and positive adjusted EBITDA, which was a better result than expected.

I do want to make brief mention of The Martha Stewart Show, as it prepares to end its seven-year run with its final episode scheduled for September 14. This is an extremely high quality program and it’s going out on an appropriate note securing a Daytime Emmy nomination in the Outstanding Lifestyle Program category. We also saw an uptick in ratings in this quarter. We are very proud of the work we have done in this show over the last seven years.

Looking ahead, we are excited about the opportunities we see to remake our video business. Producing quality how-to video content is a strong competency at MSLO. We think we are well suited to deliver this content across multiple formats especially in our mind, and we hope to share some updates on our progress with you soon.

TV remains a priority too, and we are looking forward to the fall debut of Martha Stewart's Cooking School on PBS. We were able to shoot all contracted episodes for the show in the studio prior to the quarter’s end.

As we continue to redefine the shape of our future video business, we are confident that we can and will operate the segment profitability while it continues to be a megaphone for the brand.

Before handing it to Ken, I’ll wrap up by saying, while the pace of publishing recovery isn’t what we planned for earlier this year, I am confident that the path we are on in each of our business is the right one to deliver long-term sustainable growth and profitability for MSLO.

We are making progress on our strategies and we’re managing the business aggressively with the commitment to getting results.

With that, I’ll turn it over now to Ken.

Kenneth P. West

Thank you, Lisa. Summarizing our second quarter results, total revenue was $47.9 million, a decrease from the $54.9 million a year ago as largely expected and reflect lower publishing and broadcasting revenue, which more than offset growth in merchandising revenue.

Our adjusted EBITDA loss narrowed to $0.3 million from about $0.6 million last year. And operating loss of $2.9 million was up slightly from $2.5 million in the last year. The higher operating loss this quarter reflects approximately, $0.8 million in restructuring charges predominantly related to the sensational program introduction within our broadcasting business, which is excluded from adjusted EBITDA.

This charge was more than offset by improved operating performance. Basic and diluted net loss per share was $0.04 compared with $0.05 last year. Taking a closer look at our segment results for the second quarter, publishing revenue was $28.8 million compared to $34.1 million in the prior year’s quarter.

Print advertising sales decreased $3.3 million and digital advertising decreased $0.6 million. Revenue was down a bit from our expectation, but overall we anticipated a challenging quarter as our new advertising sales team comes together and executing plans, rebuilt momentum in sales.

Looking at specific titles and performance within publishing, all of our titles except for wedding saw lower pages and slightly lower rates in the quarter. Martha Stewart Weddings saw an increase in pages and we also benefited from an SIP, Real Weddings in the period, which helped both in advertising and in newsstand.

Total circulation revenue was down slightly due primarily to lower subscription revenue per copy from Martha Stewart Living. And as anticipated publishing’s adjusted EBITDA was a loss of $4.6 million compared with $1.6 million loss in the prior year’s quarter.

Broadcasting segment revenue was $4.6 million compared to $7.8 million in the second quarter of 2011. This decline reflects decreased levels of new programming as we begin to transform the shape of this business. Broadcasting adjusted EBITDA totaled $1.2 million compared to $0.4 million, adjusted EBITDA loss in the year ago quarter. Our cost structure is set to improve now that our studio lease has included.

Our merchandising segment, grew revenues 12% to $14.5 million in the second quarter, the growth drivers included J.C. Penney and the Martha Stewart Home Office line as well as strength in our pets business. Revenue growth was solid, but lighter than we had anticipated due to the softness at the Home Depot that Lisa referenced.

Merchandising adjusted EBITDA grew 21% over last year evidencing continued profitable improvement. In fact as noted by Lisa, our adjusted EBITDA margin hit 71% in the quarter. Adjusted EBITDA from corporate were the loss of $7.2 million in the quarter, including legal fees related to Macy's litigation of approximately $1 million and in total corporate EBITDA was basically flat with the prior year.

Total corporate expenses in the quarter were $8.6 million compared to $8.9 million in the prior year second quarter. On our balance sheet, as June 30, we had $55.5 million cash, cash equivalents and short-term investments and no debt. So now let’s turn to our outlook.

In publishing, we’re planning for Q3 revenue to be roughly flat for the second quarter and EBITDA loss to be substantially higher. This is a function of challenged ad sales as well as the impact of the full expense load of our new sales teams and timing associated with our subscription marketing activities. We continue to anticipate improvement in Q4 revenue and positive adjusted EBITDA, but not to the levels previously forecast and therefore this improvement will not be enough to offset the cumulative anticipated loss for the first nine-months.

In broadcasting, we have said that revenue will be substantially lower throughout the year with the conclusion of the Hallmark agreement by the end of the third quarter. I have previously said, we would deliver breakeven EBITDA performance in the second half and our results in the second quarter strengthened the likelihood that we will deliver on that objective.

Third quarter merchandising revenue is expected to approximate the amount recognized in last year’s third quarter, but with slightly higher margins due to anticipated continued softness in flooring at the Home Depot. This segment is expected to deliver its best results in the fourth quarter as usual and we now anticipate a full year EBITDA margin of approximately 70% versus 62% last year.

Given the outlook in publishing in particular, we are anticipating a third quarter consolidated adjusted EBITDA loss that will be significantly higher on both a sequential and year-over-year basis, before recovering to profitability in the fourth quarter. As we think about the year-end total, there are three new developments that we’ve mentioned this morning that impacts our outlook.

By way of summary, those are the delayed ramp of our planned turnaround in publishing, a continuation of the softness and lightened sales we saw at the Home Depot this quarter and higher ongoing legal expenses. These factors will exclude us from reaching our prior target of generating positive net income for the full year. However, from the progress we are seeing in key areas across our businesses, which had enabled us to deliver positive consolidated adjusted EBITDA, which have marked substantial performance improvement over 2011.

That concludes our prepared comments. Thank you for joining us on our call today. I’ll now turn it back to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from the line of Michael Kupinski with Noble Financial.

Michael Kupinski – Noble Financial Capital Markets

Thank you and thanks for taking my question. I was wondering if you can drill down to your merchandizing revenue forecast or outlook, talking a little bit about the Home Depot, obviously there is some new product introductions there and I was just wondering if you can give us a sense of what your thoughts are on the new products, where – if you can talk a little bit about where you’re seeing the softness? And then also if you could just chat a little bit about to what Macy’s did in the quarter and the prospect for the outlook in the second half there, if there is any particular product shortfalls or things that you are planning on introducing in the Macy’s in the second half?

Kenneth P. West

Good morning, Michael, this is Ken. Let me take the second question first then we will to the Home Depot. With respect to Macy’s, we have had solid performance in principally all categories with Macy’s. So let’s focus specifically more on my comment that I addressed just before in my prepared remarks about the Home Depot.

We do have some new categories that are being introduced at the Home Depot, principally the holidays and we’re expecting some good results from that. But the softness that we saw in this quarter and we expect it to continue slightly relates to the soft flooring. And the Home Depot is actually starting to market that specifically now and we’re looking forward to some improvements in that area.

Michael Kupinski – Noble Financial Capital Markets

And then, I guess, if we look at the – I know that at the Home Depot, you don’t have minimum guarantees, but what do you have in the pipeline in terms of other than holidays, are there other things that you’re planning on to introduce as you go into 2013? Can you give us a little outlook in terms of the product opportunities there?

Lisa Gersh

We recently – good morning, Michael, it’s Lisa. We recently introduced craft furniture into the stores at the Home Depot, previously they had been in there, catalog of company, but now they’ve moved it into store and we’re very excited and looking forward to how that product will do.

Michael Kupinski – Noble Financial Capital Markets

And in terms of the J.C. Penney’s, does the injunction affect the opportunities in terms of the design work that you’re doing for them, does that hold-off any opportunities there in the merchandizing revenue forecast for the next quarter?

Lisa Gersh

Well, just take a step back; we have no merchandizing revenue from J.C. Penney.

Michael Kupinski – Noble Financial Capital Markets

You have style revenue, right?

Lisa Gersh

In the fourth quarter, we do have design revenue and the court’s injunction will not impact the design revenue at all.

Michael Kupinski – Noble Financial Capital Markets

Okay. And then in terms of the production distribution editorial and that number obviously was a lot lower than I was expecting. How much of that is due to what you had already anticipated or what you have done in terms of the cost cutting versus just some variable cost in terms of just lower pages and paper cost, and so forth. I was wondering if you can just kind of breakout for me a little bit what the – what you have done in terms of the publishing division in terms of reduced cost?

Kenneth P. West

Mike, that’s a very good question. So there is a combination of both timing of some expenses and some permanent reductions that you’ve seen both in Q1 and now Q2. We expect some of those to – certainly the permanent ones will continue to be a benefit to the company’s operating results. But the timing associated with circulation and marketing, drops, that will occur in the third quarter principally. And then again in the fourth, which we did not experience in the first and the second those are seasonal marketing plans and they are continuous. So, and as you also noted to the extent if our pages sold in advertising are lower than originally anticipated or lower than our prior period then we will have less pages to print. So those are also variable.

Michael Kupinski – Noble Financial Capital Markets

Okay. Thanks. I’ll let others to ask questions as well. Thank you.

Kenneth P. West

Thanks Mike.

Operator

Your next question comes from the line of David Bank with RBC Capital Markets.

David Bank – RBC Capital Markets

Hi, thank you, good morning. A couple of questions, but first one relates to the broadcasting side, and it sounds like broadcasting certainly versus our estimates, profitability wise did quite a bit better than we had been expecting and I thought a bit better than the tone you gave on the last call. So maybe I was sort of parsing words too much, but it seems like there was a lot of known’s in that business, you knew when the lease was going to expire, you probably knew what your costs were, so what was the delta, what was the surprise if there was one?

And the second is, going back to something that Ken said, which was you sort of feel like you’re on track for the breakeven in the second half of the year for that business, after just posting pretty nice profitability, so – why would you see any declines, I guess, I mean, if you’re aiming for breakeven you probably would have wanted to stay in the business, which I don’t think is the case, because you’re making more money being in the business in 2Q. So, I’m kind of curious about your thoughts there.

And the last question is, thanks for taking so many questions. On the merchandizing side, there is so many moving parts over the past couple of years, which came or coming out and different partners coming in, but the overall growth rates, really haven’t changed that much and I am thinking, what is your long-term kind of same partnership growth rate expectation and if you blue sky, what could come in because that’s probably the real driver in the long-term, right. You could see how you could easily cripple along 10% to 20% for a quite a bit of time’s great merchandizing business. Are there any new categories, kind of blue sky that you guys have ever kicked around that seem like they could be, big sort of legs or big new things. So thanks for taking so many questions.

Kenneth P. West

David, I don’t know if have recalled all of your questions, but let’s see which ones I can address, one at a time. As far as our TV outlook for the second half, and you had a question as to whether we could stay in, just break evens or slightly improved or such. We’ve talked about the Cooking School, which is going to go on air in Q4. And we don’t anticipate that to be a big revenue or profit generator, but certainly it is a positive contributor to the operations of the business, and we know that our investment in staffs is minimal, it’s a developing staff for the back half of the year. So that’s what we see so far for the back half, no significant revenue generators, but no big losses, or no losses in the future as far as with merchandising new category…

David Bank – RBC Capital Markets

But Ken, so why would you have done better in 2Q, and there is a business you’re essentially shutting down. And you are going to do, you’re sort of doing better with it going on than you're in the second half given those comments, when it's going to be down, so why get out of it then?

Lisa Gersh

Other sense of the question about the second quarter are waiting for higher than we had forecasted from the second quarter, therefore, the revenue is higher than we had originally projected, that really is the difference. We intend to be in the video business going forward, we have a different approach from past, we will not have a large production company at our company, but we will be in the business of producing video and having our talent, our very special talent Martha, Emeril and others on television, but the model that we will use to go that that will be different than maintaining an entire production crew. It doesn't mean we can’t do a production, we can put one up and take it down, but we can also partner with others to create productions using outside production companies. We will get video as a very strong and always have megaphone for the brand, and in the new world of lower barriers to entry on video, we intend to be in that business, but with a very different cost structure.

David Bank – RBC Capital Markets

Okay.

Kenneth P. West

We’ll take new category…

Lisa Gersh

In terms of merchandising, we do see a number of new categories. We're not going to discuss them at this point on this call, but we do see another, a number of new categories and we also continue to see growth in our existing categories. As we've talked about in the past, we continue to look at international, and we've now brought on a new executive to focus on the development of international opportunities, so we see growth in our business going forward and growth in our existing business with our existing partners like we have with the Home Depot by adding a much fuller holiday collection and as I just mentioned, the craft furniture line.

David Bank – RBC Capital Markets

Okay, thanks. Thanks for taking so many questions.

Kenneth P. West

Thanks David.

Operator

(Operator Instructions) We do have a follow-up question from the line of Michael Kupinski with Noble Financial Group.

Michael A. Kupinski – Noble Financial Capital Markets

Thanks, so just to drill down on the merchandizing, in terms of the new potential product categories and things like that, would that potentially open up new retail distribution partners or those planned for the existing retail partners?

Lisa Gersh

Michael, I would say that there are both opportunities – there are both with existing retail partners and with our new retail partners as well.

Michael A. Kupinski – Noble Financial Capital Markets

And I appreciate the clarification on the Macy’s lawsuit and the expectation for the – in terms of the minimum guarantees and so forth. You did say, that you didn’t feel that the J.C. Penney’s guarantee that were directly impacted by the lawsuit, I was just wondering if – in terms of the prospect of – although the nature of the injunctions so far, if the nature of the injunction so far is continue to say for instance going into next year, in terms of certain product categories that we would not be able to sell or lease under the branded name, would that effect the minimum guarantee as we go into next year for J.C. Penney?

Lisa Gersh

Let me say two things, first, the nature of the order that was entered by the judge, it has two things you should be aware of, one is, it is a preliminary injunction, meaning it is not a final ruling. That’s issue number one. Number two is, when a court issues a preliminary injunction, the parties are generally directed to settle an order which would then very specifically detail the terms of the order which has not happened yet. We expect that to happen shortly, but we have not had an order settled by the judge yet. So in essence it’s premature to make any further statements about other than what I said in my remarks.

Michael A. Kupinski – Noble Financial Capital Markets

Thanks for the clarification. I was wondering in terms of looking at the international opportunities. Do you have certain benchmarks of when you anticipate that you would see some sort of international distribution agreement?

Kenneth P. West

Michael, we anticipate that 2013 will be the initial exploitation abroad, but until we have a little bit more clarity further into the year, we’ll probably issue some kind of press release when we see the biggest deal in front of us, but nothing until then. Okay?

Michael A. Kupinski – Noble Financial Capital Markets

Okay, great. Thank you.

Kenneth P. West

Thanks Mike.

Lisa Gersh

Thank you.

Operator

At this time there are no further questions. Thank you ladies and gentlemen for your participation in today’s conference call. You may now disconnect.

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