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Viacom (NASDAQ:VIAB)

Q3 2012 Earnings Call

August 03, 2012 8:30 am ET

Executives

James Bombassei - Senior Vice President of Investor Relations

Sumner M. Redstone - Founder and Executive Chairman

Philippe P. Dauman - Chief Executive Officer, President and Member of The Board of Directors

James W. Barge - Chief Financial Officer and Executive Vice President of Tax & Treasury

Thomas E. Dooley - Chief Operating Officer, Senior Executive Vice President and Director

Analysts

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Richard Greenfield - BTIG, LLC, Research Division

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

Benjamin Swinburne - Morgan Stanley, Research Division

David Bank - RBC Capital Markets, LLC, Research Division

Jason B. Bazinet - Citigroup Inc, Research Division

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Vasily Karasyov - Susquehanna Financial Group, LLLP, Research Division

Alan S. Gould - Evercore Partners Inc., Research Division

Operator

Good day, and welcome to the Viacom Fiscal Year Third Quarter 2012 Earnings Release Teleconference. Today's call is being recorded. At this time, I would like to turn the call over to the Senior Vice President of Investor Relations, Mr. Jim Bombassei. Please go ahead, sir.

James Bombassei

Good morning, everyone, and thank you for taking the time to join us for our June quarter earnings call. Joining me for today's discussion are Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Tom Dooley, our Chief Operating Officer; and Jimmy Barge, our CFO.

Please note that in addition to our press release, we have slides and trending schedules containing supplemental information available on our website. I want to refer you to Page #2 in the web presentation and remind you that certain statements made on this call are forward-looking statements that involve risks and uncertainties. These risks and uncertainties are discussed in more detail in our filings with the SEC. Reconciliations for non-GAAP financial information discussed on this call can be found in our earnings release and on our website.

And now I'll turn the call over to Sumner.

Sumner M. Redstone

I'm really pleased to join you once again as we report Viacom's third quarter results. Viacom's Media Networks are vibrant, focused on developing exciting new properties, maximizing opportunities for our most popular programming, Paramount. We are also making smart, strategic and creative decisions, excellently adapting to the marketplace and providing its films with the best chance of success, But before the marketplace for entertainment content was challenging, it's dynamic and full of opportunities now more than ever. With an outstanding management team and a strong culture of reinvention and innovation, Viacom remains perfectly positioned to recognize and exploit these opportunities here and all over the world.

I could not be more confident about the future projects for Viacom. And with the lead strong leadership, we are committed, as always, to growing our business here and around the world and generating solid returns to shareholders year in and year out.

Now I'd like to turn this call over to the man I say is one of the wisest men I have ever met in my life, Philippe. And Philippe, by the way, has been a great warrior. The battle he conducted against DIRECTV was spectacular. I think that Philippe has the same passion to win that I’ve always had. And take my word for this, in the long run, Philippe will win.

Philippe P. Dauman

Thank you, Sumner, and good morning, everyone. Thank you for joining us today.

Despite challenges, Viacom made solid progress on several fronts in the third quarter of our fiscal year. Our industry-leading brands continue to grow and evolve across platforms, as well as geographic and demographic borders. We continued our sustained investment in creative content, especially at Nickelodeon and other key networks, and we are seeing promising signs that this investment will bear fruit.

Our strong audience bonds and the breadth of our network portfolio were big factors, not only in our strong performance in the recent advertising upfront, but also in our successful, albeit unnecessarily noisy, completion of an extra long-term carriage deal with DIRECTV 2 weeks ago. The DIRECTV deal keeps us firmly on the path to generate sustainable, high single to low double-digit annual affiliate revenue growth.

We are also now heading into a period where we will see growing results for our investments in international channel launches and consumer products initiatives. At the same time, Viacom's bottom line benefited from our relentless focus on operational efficiency. This tight rein on costs also serves to fortify our already strong balance sheet. As a result, Viacom remains a reliable generator of significant free cash flow even in challenging times. And we consistently make good on our commitment to return capital to our shareholders through both dividends and share repurchases. Through this unwavering strategic focus, Viacom will generate significant long-term value for our shareholders.

This morning, I will provide an overview of our financial results for the third quarter and review highlights from our divisions. Tom and Jimmy will give additional color, and then we'll take your questions.

Let's begin with the numbers. Viacom's revenues decreased 14% to $3.24 billion in the third quarter, driven primarily by the mix of our Filmed Entertainment titles and lower advertising revenues. Adjusted operating income decreased 9% to $903 million. In our Media Networks segment, revenue declined 5% and adjusted operating income declined 10% due to lower advertising and ancillary revenues. Filmed Entertainment revenues decreased 29%, reflecting the number and mix of releases in the June quarter in comparison to the same period last year, which featured substantial theatrical hits, including Transformers: Dark of the Moon, Super 8, Marvel's Thor and DreamWorks Animation's Kung Fu Panda 2. Adjusted operating income in Filmed Entertainment decreased $3 million, reflecting the revenue decline and substantially offset by lower expenses. Viacom's adjusted net earnings from continuing operations declined 12% to $512 million, and adjusted diluted earnings per share decreased 2% to $0.97 in the June quarter. Foreign exchange negatively affected earnings per share by $0.02.

In the quarter, Viacom announced a 10% increase in our quarterly dividend to $0.275 per share. Last week, our Board of Directors declared our next quarterly cash dividend to be paid October 1. The company also repurchased $700 million in stock under our share repurchase program in the third quarter, and we expect to buy back $700 million in stock this quarter, for a total of $2.8 billion in stock for the full fiscal year.

Let's move on to highlights in our divisions. Our Media Networks experienced some cyclical rating softness that we are well equipped to overcome, as we have demonstrated in the past. More than any other programmer, Viacom's networks are built for reinvention, powered by our $3 billion investment in content this fiscal year. Our networks each have clear, established brand filters, to which they are introducing more and more original content. From BET to MTV to most recently VH1, our brands are consistently able to evolve with audiences, create hits and capture the cultural conversation. For example, 50% of VH1's current primetime schedule consists of returning hits, the highest percentage in 4 years, and the networks hit ratio was up 22% of our fiscal 2011.

Domestic advertising revenues decreased 7% due to the timing of 2 key award shows, as we previously signaled in our second quarter earnings call, as well as rating softness at certain networks. This year, the Nickelodeon Kids' Choice Awards aired in the second quarter, and the BET Awards aired early in the fiscal fourth quarter. Both aired in the third quarter last year, resulting in difficult year-on-year quarterly comps.

Worldwide advertising revenues decreased 9% for the quarter due to softness in Europe. As I mentioned earlier, we concluded the June quarter by successfully completing our upfront negotiations. We are very pleased with the outcome. Despite ratings issues in Nickelodeon, we were able to maintain the same share of the kids' upfront volume as last year. Overall, our total upfront dollars were more than $2.8 billion, up from last year, and we secured solid mid-single-digit increases in pricing.

Looking at the current quarter, while it is still early and difficult to predict, we are tracking to sequential improvement in domestic advertising revenue performance. In distribution, domestic affiliate revenues decreased 1% in the third quarter, which primarily reflects the significance of additional distribution revenues recorded in the same quarter last year. Worldwide affiliate fees increased 1%. As we have discussed in the past, revenue recognition requirements relating to digital sales create bumps in our usually steady affiliate sales growth path. If you exclude the impact of digital distribution agreements, our domestic affiliate revenue growth was right on target in the high single digits. In its fourth quarter, domestic affiliate revenue growth will be in double digits.

Throughout the quarter, we continued to deepen our partnerships with our distributors on existing and emerging platforms. Notably, we increased distribution for a number of our HD simulcast, while also completing an agreement to make our programming available through Time Warner Cable's in-home streaming app.

As noted earlier, in the current quarter, we successfully completed a challenging renewal negotiation with DIRECTV, striking a long-term agreement with an initial rate increase of significantly more than 20% and healthy annual increases in excess of those we had in the expired deal for the remainder of the 7-year term. In fact, the deal we ultimately signed was materially better for Viacom than the deal that was on the table at the time that DIRECTV made the unfortunate decision to drop our networks. In addition to rate increases, we secured increased or new distribution for Nicktoons, Tr3s and several HD channels. We secured a long-term commitment from DIRECTV to distribute our channels in Latin America via PanAmericana and Sky Brazil. And we forged a long-term agreement for DIRECTV to continue to offer Paramount films on Pay Per View.

In short, we are extremely pleased with our DIRECTV agreement and only disappointed that so many of our viewers were deprived of their favorite channels for 9 long days. We certainly hope this will be the only blip in what had been until now, in my 6-year tenure, our perfect record of completing affiliate renewals with every other distributor in the U.S. or elsewhere without disruption to customers.

Also notable in the quarter, our continued strategic moves to expand our consumer products business. In the past few weeks, the first toys and merchandise based on Nickelodeon's forthcoming Teenage Mutant Ninja Turtles series debut on shelves at Toys ‘R Us. The line of action figures, vehicles and more will be available in its entirety across all retailers this month in advance of the much-anticipated series premiere in September. Products for Nickelodeon's Winx Club have also begun to roll out and will continue to hit retail stores into the fall.

Additionally, COMEDY CENTRAL recently launched COMEDY CENTRAL Enterprises, a new division that will unite and grow the network's ancillary revenue businesses, including consumer products, home videos, CDs and digital downloads, publishing and live touring for its roster of stand-up comedians.

MTV is focused on programming innovation as it continues to diversify its slate with new scripted and reality series that's built on a strong base of returning hits. In the third quarter, those hits included Teen Mom, which was the #1 cable series in the quarter in the key 12-34 demo; Teen Wolf, which was up 6% year-on-year in the quarter and Jersey Shore spinoff, Snooki & JWOWW, which was #1 in its time period across television and the demo.

In the new fiscal year, we'll start with a new season of Jersey Shore. In addition, MTV will introduce a range of reality and docu series, including Catfish, The Heights and Wait Till Next Year, as well as new scripted comedies, The Inbetweeners, Underemployed and Zach Stone is Gonna Be Famous. In addition, Teen Wolf and Awkward were recently renewed for third seasons for double their original order of episodes.

On COMEDY CENTRAL, Tosh.0 and Workaholics delivered solid performances in the third quarter, as each returned with new episodes. This fall, COMEDY CENTRAL hits the campaign trail hard with election coverage from The Daily Show with Jon Stewart and The Colbert Report, both of which remained dominant in late night. In fact, The Daily Show is the #1 late-night show in all of television with adults 18 to 49. The Daily Show and Colbert are the only 2 late-night shows to grow their viewership in the demo this broadcast season, while Jon Stewart and Stephen Colbert will remain with COMEDY CENTRAL, thanks to recent contract extensions. Beyond the campaign blitz, COMEDY CENTRAL will debut Daniel Tosh's new animated series, Brickleberry, along with new seasons of Tosh.0, South Park and Key & Peele this fall.

Despite rating softness, Nickelodeon had success with new episodes of iCarly and SpongeBob SquarePants and the original TV movie, Rags, which reached 14 million total viewers. In the current quarter, the network is beginning to show momentum. Nickelodeon premiered a new SpongeBob special, Super Spongy Square Games, on July 22 with average 3.7 million total viewers. Following the episode, Nickelodeon gave fans a sneak peek in an upcoming series, You Gotta See This!, and the episode retained the overwhelming majority of the SpongeBob audience, including 99% of teens 9 to 14. A bright spot for Nickelodeon has been its new hit game show lineup. Figure It Out premiered in the third fiscal quarter with new episodes averaging 2.2 million total viewers. And Splatalot was added to the schedule in the current quarter, which is retaining 99% of the kids 6 to 11 audience from its Figure It Out lead-in. Splatalot is also showing solid time period gains over the months prior.

In addition to new programming, we're aggressively fine-tuning the schedule to drive viewership, which is resulting in significant time period gains for a number of Nickelodeon's signature series. The recent SpongeBob special posted big gains in its time period versus a year ago and the month prior. Big Time Rush is averaging 2.2 million viewers per episode this quarter, up double digits in all key demos versus a year ago. And just last Saturday, the new -- the newest Fred movie, Camp Fred, averaged 3.5 million viewers and ranked as the #1 cable telecast for the week for teens 9 to 14.

As we've said previously, Nickelodeon is debuting 650 new episodes of original programming for the upcoming broadcast season, including more than 130 from October to December. And just today, Nickelodeon is announcing a programming slate of 14 new series, TV movies and pilots, adding live-action and animation. As we have continually seen, fresh content drives renewed and expanded engagement, particularly among young viewers. Nickelodeon is now poised for an upsurge and soon. That includes the long-awaited debut of Teenage Mutant Ninja Turtles on September 29; new episodes of animated series, including SpongeBob SquarePants, Kung Fu Panda and the Penguins of Madagascar; new episodes of live-action hits, including Big Time Rush, Victorious and the final season of iCarly; and great-event programming, including Worldwide Day of Play, The HALO Awards and a SpongeBob Christmas special.

This fall, Nick at Nite will premiere See Dad Run, a new family comedy starring Scott Baio. Nick at Nite has gained recent momentum from Friends, which is seeing a 6% increase in ratings year-over-year. Also this fall, the NickMom nightly programming block, which is being enthusiastically received by advertisers, will debut on Nick Jr. with 4 new original series.

BET continues to serve African-American audiences with a dynamic mix of scripted originals, including The Game and Let's Stay Together; big-event programming, including the BET Awards; and reliably strong unscripted series, including 106 & Park and Sunday Best. The Game and Let's Stay Together continue to anchor BET's primetime lineup as the #1 and #2 original sitcoms on cable. BET also has several original scripted and unscripted series debuting in the coming year, including sitcoms Second Generation Wayans, featuring the next generation of the Wayans family; and new late night series, Don't Sleep, hosted by journalist, T.J. Holmes.

VH1 is successfully broadening its creative mission with a wide variety of programs and formats for the network's adult-stirred target audience. In the third quarter, VH1's primetime range were up 22%, marking its fourth consecutive quarter of year-over-year primetime growth in its targeted adult demo. Looking ahead, the network has a significant number of returning hit series, including Rehab with Dr. Drew, We Have Adopted Drew [ph], T.I. & Tiny: The Family Hustle and Pop Up Video.

TV Land also has a lot to look forward to, with its hit tandem of Hot in Cleveland and Happily Divorced set to return with new episodes this fall. Just last month, Hot in Cleveland was picked up for syndication by local TV stations, serving 65% of the U.S., including 9 of the top 10 markets.

SPIKE continues to broaden its audience, expanding and diversifying its original programming with a male-skewing general entertainment filter. In the third quarter, Season 2 of SPIKE's original hit series, Auction Hunters, attracted about 1.8 million viewers on average. The network also debuted the new series, American Digger, to an average 1.1 million viewers. In October, SPIKE will look to ink big ratings with the premiere of Tattoo Nightmares from Jersey Shore creators Sally Ann Salsano and Season 2 of the hit series Ink Master, hosted by Dave Navarro.

CMT's standout performance in the third quarter came from the successful 2012 CMT Music Awards, which attracted nearly 3 million viewers. The network also continues to break through with new episodes of its hit series, My Big Redneck Vacation, and its first reality competition series, Redneck Island, which debuted in June.

Moving onto international. We continue to see some softness in the international economic environment, particularly in Europe. However, strong affiliate growth from both digital distribution and organic growth, combined with strong cost management, offset lower advertising ancillary sales in the quarter.

We continue to expand the regional success of our adult-focused business internationally, as ratings for COMEDY CENTRAL improved 27% across the board; with double-digit increases in markets, including the U.K, Germany, Spain, Poland, The Netherlands, Sweden and Hungary. The Paramount Channel performed very well in its first quarter on air and signed 120 advertisers in its first 3 months of operation despite tough economic conditions in Spain. Nickelodeon also saw ratings improved by about 5% internationally. And in an effort to drive popular content in new audiences around the world, MTV's Jersey Shore began MTV U.K.'s Geordie Shore, which is enjoying its highest-rated season so far and remains the highest-rated series in the network's history. The series is a bona fide international hit, attracting big audiences in all the other countries where it airs, particularly Spain, Australia and Ireland. Despite difficult economic times, we continue to invest. COMEDY CENTRAL is fast becoming our third global brand, and we plan on launching at least 5 additional Paramount Channels in 2013.

Let's turn now to our Filmed Entertainment division. Despite a very different mix of films in the third quarter of fiscal 2012 and the blockbuster-heavy comparable quarter last year, Paramount saw success with Titanic 3D, which has grossed more than $300 million in worldwide box office to date; and DreamWorks Animation's Madagascar 3: Europe's Most Wanted. Paramount remains on a great long-term creative path with a nimble approach to distribution, while it help give its releases maximum visibility, both in the U.S. and abroad. For example, the studio moved G.I. Joe: Retaliation out of this summer's crowded field to March 2013, allowing for a 3D conversion of the film and potential entry into the newly expanded Chinese marketplace. In addition to carefully calibrating its release strategy, Paramount continues to judiciously manage costs and effectively reduce overhead.

To conclude, the Viacoms stood firm in the third quarter of our fiscal year, confronted challenges and again delivered value for shareholders. As we move forward into a fall season that we'll see an influx of new original content across our networks, we will continue to strengthen our audience connections, giving us to a strong path to drive ratings and revenue. We'll continue to put our theatrical releases in the best possible position to succeed at the box office by aggressively pursuing new opportunities as they arise. We will operate with an unflinching eye toward operational excellence, capturing efficiencies and managing costs. And as always, we will continue to aggressively return capital to our shareholders.

With that, I'll turn it over to Jimmy.

James W. Barge

Thanks, Philippe, and good morning, everyone. I hope you've all had a chance to review our earnings release and web presentation summarizing the results of our June quarter. Our 10-Q will be filed shortly.

This morning, I'm going to take you through our operating results in more detail. My remarks will focus on adjusted results from continuing operations. Adjusted results for this year's June quarter exclude $11 million of discrete tax benefit.

Now let's take a look at our segment results. At our Media Networks segment, revenues decreased 5% to $2.3 billion in the quarter. Domestic revenues declined 5%, and international revenues were down 7%. Foreign exchange had a 4-percentage-point unfavorable impact on international revenues.

Page 10 of our web deck provides a breakdown of our Media Networks' revenue performance. As Philippe mentioned, domestic advertising revenues were down 7% in the quarter. International advertising declined 18%, with foreign exchange losses impacting the growth rate by 6 percentage points. The decline in international ad sales was primarily due to fewer production and promotional events in the quarter, as well as softness in parts of Europe.

In terms of affiliate revenues, domestic revenues decreased 1%, while international revenues increased 10%. Foreign exchange negatively impacted the international growth rate by 4 percentage points. The decline in domestic affiliate revenues reflects the greater availability of programming associated with the digital distribution agreements in the June quarter of last year, partially offset by great increases in the June quarter of this year. Excluding the impact from the digital distribution agreement, domestic affiliate revenues grew high single digits in the quarter. International affiliate growth reflects revenues from digital distribution agreements, rate in subscriber increases and new channel launches.

Worldwide ancillary revenues declined 14% in the quarter, primarily due to lower consumer product licensing and Home Entertainment revenues. Media Networks' adjusted operating income of $934 million in the quarter decreased 10% as compared to the June quarter of last year. The operating margin of 41% decreased approximately 200 basis points versus the prior year. The decrease in margin was driven by the top line decline of 5%, partially offset by a 2% decrease in expenses.

Within expenses, programming expense grew 6%, while SG&A expense declined 9%. The decrease in SG&A expense was primarily due to lower accrued incentive-based compensation expense, savings realized from our 2011 restructuring, as well as lower advertising and promotion expense primarily related to the timing of award shows.

Now moving to Filmed Entertainment. Revenues in the quarter were down 29% to $1 billion. Page 12 of the web presentation provides a breakdown of Filmed Entertainment revenues. Worldwide theatrical revenues decreased 52% to $283 million in the quarter. The decrease in theatrical revenues was principally due to lower revenues from the current quarter's releases. The June quarter of this year had 3 releases as compared to 4 releases in the June quarter of last year. Worldwide Home Entertainment revenues decreased 8% to $304 million in the quarter, primarily due to the mix of titles released in the quarter. The TV license fees declined 24% to $315 million. The decrease in TV license fees in the quarter principally reflects the number and mix of titles available in network TV and foreign syndication marketplaces. Ancillary revenues increased 44% to $104 million in the quarter, primarily due to higher digital revenues.

Filmed Entertainment generated adjusted operating income of $46 million in the quarter as compared to income of $49 million last year. Moving below operating income, total company equity income from investments was $10 million in the quarter. The income in the quarter principally relates to our investment in EPIX. The adjusted effective tax rate in the quarter was 34.5%.

With that, I'd like to turn the call over to Tom.

Thomas E. Dooley

Thanks, Jimmy. I'm going to focus my comments on our cash flow, our debt profile and the return of capital to our shareholders. I will also talk about the seasonal factors impacting the remainder of our fiscal year.

In terms of our free cash flow for the quarter, we generated $197 million in operating free cash flow in the June quarter compared to $369 million last year. Page 5 of the web deck presentation provides the components of free cash flow. The decline in operating free cash flow was principally due to lower operating income and higher cash tax payments, partially offset by lower working cap utilization. The increase in cash taxes paid was due to the sunsetting of accelerated deductions related to film and TV production.

As for our debt, for the most part, it is fixed rate, with an average cost at quarter-end of 5%. This compares to an average cost of 5.8% 12 months ago. So we continue to make great progress on lowering our average cost of debt. To the extent we have incremental borrowings, we are funding this in the commercial paper marketplace at an annual rate of approximately 40 basis points. We had no variable rate borrowings at quarter-end.

During the quarter, we took advantage of attractive rates in the public markets to maintain our leverage and our target level. We issued $300 million of 3.125% senior notes due in 2022, and an additional $100 million of 1.25% senior notes due in 2015. In terms of leverage, we ended the quarter with $8.2 billion of debt and cap leases outstanding and $774 million of cash and cash equivalents. At June 30, our $2.1 billion bank revolver was undrawn. Our leverage ratio at the end of the quarter was 2x. The only financial covenant in our bank revolver requires that interest coverage for the most recent 4 fiscal quarters be at 3x. At the end of the quarter, our interest coverage was approximately 11x.

In terms of our commitment to return capital to shareholders, between our buyback and our dividend programs, we returned a total of $833 million of capital back to our shareholders in June -- in the June quarter. Looking ahead, we are on pace to purchase approximately 700 million of our stock in the September quarter. So for our fiscal year, we will have returned a total of approximately $3.4 billion to our shareholders, which is a return on market cap of 14%.

Now I'd like to talk about some of the factors impacting the remainder of our fiscal year. As for our affiliate revenue, we are confident in our ability to grow these revenues in light of our recent renewal with DIRECTV. In the September quarter, we expect that domestic affiliate revenue will grow double digits, taking into consideration both the impact from the DIRECTV rate increase and the blackout period. Additionally, domestic advertising in the September quarter will be impacted by the blackout. This will reduce the domestic advertising growth rate by approximately 150 basis points in the quarter.

At Media Networks, we expect that programming expense will increase approximately 6% for the full year. In terms of non-programming expense, we will continue to evolve our business model to drive efficiencies throughout the organization in order to enhance our margins.

In the September quarter, Filmed Entertainment revenues will face difficult comparisons to last year's theatrical and home video performance of Transformers 3, as well as the theatrical performance of Captain America. However, the studio should generate profits comparable to the September quarter of last year, as it benefits from the carryover performance of prior quarter theatrical releases and the availability of film titles in the TV marketplace, as well as lower overhead costs.

For 2012, we continue to forecast a book tax rate of 34.5%. As for our stock buyback program, we are on track to repurchase 2.8 billion for fiscal 2012.

Looking ahead at the studio's slate and the development pipeline, in October, they'll release the fourth installment of Paranormal Activity. In November, the studio will release Flight, directed by Academy Award winner Robert Zemeckis and starring Academy Award winner Denzel Washington. In November, Paramount will be distributing DreamWorks Animation's Rise of the Guardians. For the Holidays, Paramount will release Jack Reacher, which stars Tom Cruise and is based on the bestselling book series.

As we look into 2013, the studio will be releasing sequels to existing franchises, including G.I. Joe: Retaliation in March; and the next installment of Star Trek, directed by J.J. Abrams, in May, both of which will be in 3D. In June, they'll release World War Z, which stars Brad Pitt. Looking at Paramount's developments, they have started production on Noah, which is directed by Darren Aronofsky and stars Russell Crowe; and soon, they will begin production on the new installment to the Jack Ryan series, with Chris Pine in the lead role. Paramount is also in development on the Nickelodeon-branded Teenage Mutant Ninja Turtles movie, which is being produced by Michael Bay; as well as on a sequel to Anchorman, which will reunite the original cast.

In summary, we remain focused on growing our businesses organically and using our free cash flow and the incremental capacity generated from our balance sheet to return capital to our shareholders. While we have experienced rating softness, we remain committed to investing in our brands and increasing the level of original programming on our networks in order to strengthen their competitive position. We continue to be encouraged by the incremental opportunities we see to monetize our brands and franchises on both traditional and digital platforms. The ability to secure long-term growth in our affiliation agreement and the opportunity to grow our international profitability and to develop global franchises with consumer products appeal will enhance our long-term growth. We believe our focus on organic investment, combined with disciplined management of our core structure and an aggressive capital return program, will drive value for our shareholders over the long term.

I want to thank you for listening. And now we'll turn the call over to your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll take our first question from Michael Nathanson from Nomura.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

I have one for Philippe and Tom and then one for Philippe. For the jump ball, you guys are pretty clear about giving us next quarter guidance on a affiliates see [ph] growth double digits. I wonder, knowing what you know now, all those you've done, looking to next fiscal year, do you think that double-digit run rate continues for the next fiscal year on domestics x digital? So could just comment about that for a second?

Philippe P. Dauman

Yes, Michael. We -- our guidance in general is high single-digit to low double-digit. We have confidence in that in the next fiscal year and beyond, based on agreements we've done, including the most recent one. We've tended to produce, on an annual basis, double digits, but we like to maintain our guidance of high single-digit to low double-digit. Of course, we've never delivered double digits. If the economy picks up, that'll also help us in that regard with more households subscribing to television.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

But I guess the run rate in the fourth quarter should be -- is there anything different about the rest of the -- the next few quarters after the fourth quarter run rate? That's the question.

Philippe P. Dauman

We're well on track for very high single digits, low double digits on a pretty -- on a consistent basis, annualized. Again, with the quarterly fluctuations that can be associated with the digital distribution deals, which of course, are -- require revenue recognition in quarters, so that's the only aspect that creates variability quarter-to-quarter. But we have strong affiliate revenue growth ahead on both the core and -- plus the continuation of the digital distribution.

Michael Nathanson - Nomura Securities Co. Ltd., Research Division

Okay. And then I guess one for you. You're pretty patient on this, but -- and I hate to ask you because it involves people's lives, but at what point does the question about ratings become an execution question and there's, perhaps, a change in leadership at the different networks? So at what point do you look at the personnel you have and say, "Look, it's not about the -- it's about the decision-making and not the funding or the schedule."?

Philippe P. Dauman

Well, we're very -- obviously, very, very focused on ratings issues, and it does go through cycles. And we have great leaders in our company. We have made a lot of changes in the programming departments across several of our networks, and we continue to reinfuse talent, promote talent. We've gotten into a lot of new genres at several of our networks. And we also have reached out very significantly to the outside production community in a significant way. There's a very intensive focus on content. That's what we do. And we have a culture of accountability, and we have been implementing that at the many layers of the company. And I'm confident that -- we have steps we are taking. And if you look at Nickelodeon, for example, we're really now starting -- beginning to see the fruits of what we're doing, and we have a very strong lineup coming, coming forward. I should point out, by the way, that some of our Nickelodeon brands are doing extremely well, like Nick Jr. and Team Nick [ph], the ratings are up. If you look at Nickelodeon Family, we've been moving forward. And we will -- we're also looking at how we schedule shows and what networks that will appear in. And we are aggressively pursuing this at all levels.

Operator

[Operator Instructions] And we'll take our next question from Richard Greenfield from BTIG.

Richard Greenfield - BTIG, LLC, Research Division

A couple of questions. First, just on ad trends. The comment about you're seeing sequential improvement, is that fair to say that you're seeing sequential improvement even after adjusting for the BET Awards? I think last quarter, you said that you've got a 300- to 400-basis-point negative impact in the fiscal third quarter from the loss of both events. And I think you said it was evenly split, so I think somewhere around the 150 to 200 basis points should already be helping you by having that event in the fourth fiscal quarter. Are you still seeing improvement on top of that? And then just looking at the DIRECTV battle and how that played out, how has it impacted your view on either licensing to new kind of facilities-based distributors, such as Google, or even the emerging kind of over-the-top MVPDs? Does that become more important when you look at the battles that you've just had?

Philippe P. Dauman

Thanks for your questions, Rich. As far as the ad trends, the way I look at it is that the advertising impact of the blackout, the DIRECTV blackout for those 9 days, as Tom mentioned, that impact kind of offset the BET Awards. So they canceled each other out. So we see, right now, 1 month into the quarter, and we see sequential improvement taken both into account. But they basically cancel each other out, so core sequential improvement is what we see at the moment. Obviously, we have a couple more months to go in the quarter. As far as DIRECTV, as I said, this was not -- we hate to see a blackout occur. It's never -- shall never occur in all the other renewals we've concluded. We look at distribution in a holistic way. We value all of our distribution partnerships. We evaluate what we -- what content we put on new -- so-called new distribution, additional distribution. Mobile is also emerging. And we're fairly agnostic on what foreign distribution takes as long as it's added into our business and additive to all of our partners. But -- and we've managed that pretty well so far there, and we'll continue in the path we are on. The DIRECTV renewal, which is now history, it's behind us, doesn't impact our strategy as far as that goes.

Richard Greenfield - BTIG, LLC, Research Division

Just to follow up on the first question, given all the programming investments you've made, would you be significantly disappointed if you didn't drive advertising revenues up for fiscal '13, given what you talked about from an investment standpoint?

Philippe P. Dauman

Yes, obviously, that's subject to 2 things, right? One is the general economic conditions and how that impacts the general advertising market. But I certainly expect, given our intense focus and our investment program, I shall expect to see year-on-year ratings improvement at those networks which were deeply affected this year. And so I'm confident we'll get there and that will help drive advertising improvement.

Operator

We'll take our next question from Doug Mitchelson, Deutsche Bank.

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

2, I guess, Philippe and Tom. Philippe, any update you can give us on the percentage of Nickelodeon viewing that's coming from Netflix would be interesting. But mostly, interested in any updated thoughts you have on the investor concern around kids' viewing movies online and how that might impact the company. And for Tom, you've been working hard to manage SG&A and offset the impact of some ratings softness this year. I think margins are coming at about flat for fiscal '12. So for cable networks, I guess, one, is that right? Is that more to do in the cost side? Or has the low-hanging fruit been captured?

Philippe P. Dauman

Thank you, Doug. I'll take the Nick question. The Nick viewing on Netflix has been pretty stable. As we've talked about before, there's really no significant difference, and I've spoken before about my perception of that impact. We clearly have to be where consumers are and where they are. That's why we do -- we are rolling out apps with our -- in partnership with several of our distributors. You'll see more of that in the fall. We already have it at -- with distributors like FiOS, you'll see it in Time Warner Cable, you'll see it at some of our distributors, so that our audiences can view the on-demand content, they’ll be able to view Linear in the home. Eventually, when we have measurement [ph] and other issues sorted out, they'll be able to watch it out of the home on various devices. So yes, we're very anxious to deliver content to our audiences wherever they want to view it. And I think we're -- we'll soon be able to monetize more effectively the viewing on these other devices.

Thomas E. Dooley

Yes, Doug. We're very focused on -- of course, as you guys know, I mean, the reason our margins haven't grown more than they have this year is because of the rating shortfalls and -- which has decreased the revenue growth that we have projected. Once we get the revenue to grow back on track, I think you'll get very good dramatic expansion in our margin that was continuing right up through second quarter of this year. And we feel pretty confident about that. And we've got plans in place, and we've begun process and even made investments in our systems across the company, which are -- will begin to pay dividends in the next quarter and certainly in '13 and '14. So we feel pretty good about being able to both control the cost growth factor and really find new efficiencies throughout the P&L in operations.

Douglas D. Mitchelson - Deutsche Bank AG, Research Division

I'm sure you didn't expect the first 3 questions head this way, but we're talking about 10% affiliate revenue ad growth and margin expansion next year as we sit here today.

Operator

And we'll take our next question from Ben Swinburne from Morgan Stanley.

Benjamin Swinburne - Morgan Stanley, Research Division

I wanted to ask 2 questions: maybe one on the Nick Upfront and the other on EPIX. On EPIX, can you just sort of comment on the DIRECTV terms or at least what the EPIX situation? I think the announcement was that they have the option to carry EPIX. Maybe add just a little more detail on whether you expect them to or not. And then you have Netflix. I think the over-the-top exclusivity expires this month or very shortly. What's your expectation there? Do you expect ending up going out and shopping that to other online providers? And give us a sense for what you think the opportunity is. And just on the Nick Upfront, it's such a big part of next year. You guys had the view that Nielsen had a lot to do with the ratings declines. I'm just wondering if you were able to sort of guarantee quite a bit of ratings improvement, at least flat or maybe even up, looking out because you start to lap that panel change and how that might have fit in to the overall Upfront. Just trying to get a sense for whether Nick can grow next year or if the Upfront results, given the ratings declines last year set you backward, that's going to be pretty tough?

Philippe P. Dauman

Thanks, Ben. So starting with your EPIX questions. As far as the DIRECTV options, I have a 1-year option on pre-negotiated terms to take EPIX, and the decision will be their's over the next year. We obviously think that EPIX is a highly desirable service with great movies, but it really will be up to them. And as far as the Netflix exclusivity, which is over-the-top exclusivity that is, which is expiring soon, we have -- we're not beginning discussions. We've had discussions with several parties. EPIX is doing very well. Netflix has been a great partner, great partner for EPIX, great partner for Viacom in general. And EPIX certainly drives a value for Netflix. We expect to have an announcement on the outcome of these discussions within the next couple of weeks. So you should expect the announcement from EPIX very shortly on that point. As far as the Nickelodeon Upfront, our advertisers have been very supportive of Nickelodeon. Clearly, in terms of ratings fold in the Upfront, we looked at it based on the new reality that Nickelodeon has. If the ratings will improve, there will be opportunities for us, and it's got a market.

Operator

We'll take our next question from David Bank from RBC Capital Markets.

David Bank - RBC Capital Markets, LLC, Research Division

I guess kind of a follow-up on Rich's question from before that if I look at the contract, I think, you've given in the past about both the BET Awards as well as the Kids' Choice Awards, it looks like it was something like a 350-ish-kind-of-basis-point headwind in the quarter you just reported, where you reported it down 7. And so yes, there is a 150-basis-point headwind from the impact of direct on advertising. But if you're not seeing a material -- an acceleration of kind of a couple of hundred basis points, if my math is right, then the core looks like it's decelerating. And if it's decelerating, is that a function of ratings or market? Could you just give a little bit more color around that? And maybe my math is wrong in the first place, so please correct it, if this needs.

Philippe P. Dauman

Well, I'm not quite sure I followed where you were going with that. But in terms of -- about half of the decrement in ad sales in the quarter that was just completed related to the difference in the award shows in the quarter. So that part is correct. As I mentioned earlier, the -- in this quarter that we're in, since the BET Awards were not in the comparable quarter, that's an uplift. That uplift is offset by the advertising loss during the 9 days of the DIRECTV blackout. So we're -- on a comparison with last year, we're back to apples-to-apples, if you will.

Thomas E. Dooley

Clearly, David, the ratings are creating some headwinds in terms of the advertising sales progress. And I mean, it's good -- the good news is that we're starting to see some really good performance. We're rebuilding Nickelodeon half-hour by half-hour. And as we continue to do that, that ratings performance will drive the revenue growth back to where it needs to be.

David Bank - RBC Capital Markets, LLC, Research Division

Can I just ask one follow-up as to -- in trying to understand this a little better too. What is the lag that you see between ratings impact and revenue on the way down and, hopefully, on the way up? What kind of lag do you think we see there?

Philippe P. Dauman

Right now, I mean, when you have a significant ratings shortfall, as we experienced in Nickelodeon, that, obviously, eliminates inventory we have available to sell, and you get into mako [ph] situation. That creates an inability to take advantage of the cash market. On the flip side, as that improves, that will just open up inventory for us to monetize. So we'll be able to see a pretty good short-term impact as ratings improve.

Thomas E. Dooley

Many of the networks, David, are positioned so that as soon we get the ratings, we'll be able to draw down on the liability banking and create revenue right away. So we'll come back very quickly when the ratings come back.

Operator

We'll take our next question from Jason Bazinet from Citi.

Jason B. Bazinet - Citigroup Inc, Research Division

Yes, I just had 2 quick questions. The first is, it doesn't -- I remember back in like the '06, '09 time period, we were all very nervous about Paramount and sort of was it going to flip into negative operating income. For a couple years now, and I think based on what you said on the call, you generated sort of $300 million-ish of operating income pretty consistently. Because I think we all struggle with how to model that, I was wondering if you could talk about how much of that is something that is structural, that sort of change the cost structure of Paramount as opposed to just the vagaries of how well or poorly your films do? And my second question is on the ratings. If things go according to plan, what month do you think we can begin to see ratings improve if the investments work out?

Philippe P. Dauman

Jason, as far as Paramount goes, yes, we've made very significant structural changes year after year at Paramount. And as I've said many times in meetings with investors, that's money in the bank. And as you've correctly pointed out, we're, obviously, subject to the vagaries of the film business. But we've been very [indiscernible] and very disciplined on that front as well. We -- as I've talked about before, we've modified the strategy -- the film strategy of Paramount to focus on a more limited number of releases and focusing on franchises and our brands, and that reduces the risk. We very much look at it as a risk-reward situation. And that's why our ROI has been pretty steady at Paramount, and we will endeavor to keep it that way despite the vagaries of the studio business and some of the dynamics that you all know about, such as the decrease in DVD revenue marketplace, somewhat offset by digital revenues coming in. As far as predicting months, what month or what week or whatever rating quarter, we can't -- we don't do that. What we do is we focus on building, on the programs that work, expanding them, adding new programs, and you can never predict the magnitude of a hit when it comes. When it comes, and you take a lot of it best, when it comes, you just ride it. And we, obviously, hope to improve it. We're certainly making an investment. We -- as I mentioned before, we have intensified our focus on programming talent. And our long history in the business shows that, that will -- that, will bear fruit over time. But we're not able to predict days, weeks or particular months, but the magnitude of the new programs coming on gives us reason to believe we're going to see improvement as we head into the new fiscal year.

Thomas E. Dooley

And we've already seen improvement. As we said before, half-hour by half-hour that the ink show block that Philippe referred on Nickelodeon is doing very well and beginning to put us back on track there. And we really have to rebuild it half-hour by half-hour to take market share back from the competitors. And we're doing that, and we're going to continue to do that.

Operator

We'll take our next question from Alexia Quadrani from JPMorgan.

Alexia S. Quadrani - JP Morgan Chase & Co, Research Division

Just 2 questions. First, with the DIRECTV deal concluded, can you remind us what percentage of your affiliate revenues are really locked up now for the next few years? And then just a second question on the ad market in the international advertising. I guess, how should think about that going into fiscal Q4? Is the weakness in Europe getting any worse, or it should be about the same sort of trends? And domestically, if you could just touch on how scatter -- what you're seeing in scatter in July?

Philippe P. Dauman

Alexia, let's take your questions in order. As far as affiliate revenues, the way we have conducted our renewables over the last several years, we never have more than 20% of our revenues that are up for renewal in any given year. In a year where we have a huge distributor like DIRECTV, that's kind of the high watermark, where it's close to 20%. We just went through that. It'll be a lower percentage of our revenue in the next couple of years, which was your question. So we have a nice portfolio of affiliate revenue. That's why we're able to so confidently predict the affiliate revenue growth as we go forward. We don't have a situation where we have overwhelming amount of our revenue up in a given year. As far as international advertising trends in the quarter, we expect to see some improvement in our performance in this quarter compared to the quarter we just completed. There were a lot of events that we had in prior year that didn't replicate. And in any kind of these events, very often that we look to do events that are profitable. So it's not all a revenue story. We look to have profitable events. So even though the ad revenue, they go down because of the absence of an event, it doesn't impact the profitability to that same degree because there are costs associated, obviously, with that. And that's why we've been able to grow the margins and the profitability, in addition to the other steps we're taking in the international. As far as the current scatter market, it's pretty healthy, which is, as Tom said, as our rates improve, we can take advantage of it. Scatter pricing scatter-over-scatter right now is up year-on-year, and it's significantly up over upfront. So as Tom said, we'll be able to take advantage as our ratings improve.

Operator

We'll take our next question from Vasily Karasyov from Susquehanna Financial.

Vasily Karasyov - Susquehanna Financial Group, LLLP, Research Division

I have a question on international margins. I suspect that some of the past several quarters, the international margin expansion did upset some of the advertising revenue shortfall domestically. So Philippe, you mentioned there are some issues developing in Western Europe. Do you think that's threatening the magnitude of margin expansion that you spoke about before and going into 2013?

Philippe P. Dauman

No, we're actually getting very -- I've said before that we were going to have margin in excess of 20% in the 2013 fiscal year. We're actually very close to that now, so we're actually quite confident that our margins will go into the 20%-plus territory in the new year. We've been launching a lot of new channels. So even in a tough environment, as we launch channels, we will get more revenues. We've been focused on efficiencies around the world. And we have new revenue opportunities. The affiliate revenue growth story internationally is also a really good story. So we talk a lot about domestic affiliate revenues, but the international affiliate revenue growth story is a good one. And, yes, there are some markets that are still healthy even within Europe, where we've actually had a -- the U.K. economy has been challenged. Our advertising performance in the U.K., which is a really important market, has been strong. Obviously, in Southern Europe, it's a different story right now. So we will drive our margins forward even in a difficult environment in our international business.

Vasily Karasyov - Susquehanna Financial Group, LLLP, Research Division

And if I may ask a quick follow-up. How would you explain -- how should we think about the difference in growth rates between what your international networks deliver and, let's say, Discovery or News Corp.? Is it just geographies and that they're exposed to faster growing markets like Brazil and Eastern Europe and Russia and Asia, and you're more --and you're heavier in Western Europe?

Philippe P. Dauman

Well, it's a combination of factors. We've emphasized growing some of our more adult brands like COMEDY CENTRAL, like the Paramount Channels. There are dollars available in the adult demo that we haven't been able to tap through our music and kids brands, Nickelodeon and MTV, primarily. So we have an opportunity to get at that adult demo, which will drive it. And then also, you're quite right, we are looking to expand our presence in strong developing markets like Latin America. We have a big presence in India, which is actually below the line, as you know, because it's a joint venture. We're very committed to growing that market and that -- we expect that to create significant value for Viacom as we go forward. And you'll soon hear about some other initiatives that we have in other parts of the world. So yes, the world presents a lot of opportunity for us for the long term. And I believe we will have a very significant value creation in our international networks business over the next several years.

Thomas E. Dooley

And some of those competitors are enjoying the benefit of having started new channels in those markets earlier. And as Philippe mentioned in his remarks, COMEDY CENTRAL is becoming our third global-branded network, and Paramount Channel is right behind it with 5 new channels going in 2013. As those channels get up, get revenue and get rolling, they're going to have a significant margin -- impact, and I think our revenues will enjoy the growth that comes from that.

Philippe P. Dauman

There's a rapid ramp-up on those brands. Obviously, a startup in the first year, but they pretty rapidly turn to profitability.

Thomas E. Dooley

And I think that our competitors are seeing some of that in their P&L results.

Operator

We'll take our last question from Alan Gould from Evercore Partners.

Alan S. Gould - Evercore Partners Inc., Research Division

I wanted to get back to the ratings situation again. Philippe, when the ratings became soft 3 quarters ago, you called it a short-term ratings problem. And you opened the call saying they’re cyclical rating softness. You said Nick's poised for an upsurge soon. The July ratings are down. The ratings are down, not only at Nick, but really across SPIKE, MTV, COMEDY and TV Land as well. You're spending the dollars, you're adding new episodes, you say there's been some programming management changes. What gives you the confidence that the ratings will turn? And if these ratings declines don't subside, are you confident that you'll be able to continue repurchasing stock at this rate?

Philippe P. Dauman

Well, first of all, the month of July did include the 9-day DIRECTV blackout. That it did impact our ratings. And we've compared the ratings before the blackout and after, and we've come back. So looking at July in isolation is not a good way to look at it. So if you take that impact away, we are, in fact, seeing improvement in some of our core networks. And as I said, it takes a while to create new programming. Shoot it, cast that, do all those things, it doesn't happen in 2 weeks. So we've done a lot of the work. The shows are going to be released over the next several months. And we expect to see a positive impact. And as far as the repurchase program, we are committed to it. We have been able, despite these issues that you point out, to purchase at the pace that we talked about earlier in the year, the $2.8 billion in repurchase. As Tom pointed out, when you add that to the dividend, that's a 14% return on our capitalization. And we continue to generate strong free cash flow. We continue to drive the dynamics, the margins of our business, at Paramount and the Media Networks. We will come back on the -- both the ratings and advertising front. And we will continue to return capital to shareholders over the long term year-after-year. That is our promise to our shareholders.

James Bombassei

We want to thank everyone for joining us on our June quarter earnings call.

Operator

Ladies and gentlemen, that does conclude our conference for today. We do appreciate your participation.

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