Viacom, Inc. (NYSE:VIA)
Q2 2008 Earnings Call
July 29, 2008 4:30 pm ET
Jim Bombassei – Sr. VP IR
Sumner Redstone - Chairman
Philippe Dauman – President & CEO
Thomas Dooley – CFO & CAO
Mark Wienkes - Goldman Sachs
Michael Nathanson - Sanford Bernstein
Jason Bazinet – Citigroup
Benjamin Swinburne - Morgan Stanley
Richard Greenfield – Pali Research
Jessica Reif-Cohen – Merrill Lynch
Douglas Mitchelson – Deutsche Bank
Imran Khan – JP Morgan
Jason Helfstein - Oppenheimer
Michael Morris - UBS
Good day everyone and welcome to the Viacom second quarter 2008 earnings release teleconference. 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.
Good afternoon everyone. Thank you for taking the time to join us for our second quarter earnings call. Joining me for today’s discussion are Sumner Redstone, our Chairman; Philippe Dauman, our President and CEO; Thomas Dooley, our Chief Administrative Officer and CFO; and Jimmy Barge, our Controller and Head of Tax and Treasury.
Please note that in addition to our press release we have slides containing supplemental information available on our website. Before we begin let me refer you to page number one 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 or on our website.
And now I would like to turn the call over to Sumner.
Good afternoon everyone, I thank you for joining us today. The past few months as you know have been challenging times for many companies and the media industry is not immune to the negative impact of the current economy.
I understand the frustration of shareholders, indeed to a greater degree then many who have recently seen business prospects, share prices fall and are falling victim to the broader economic [inaudible]. However I have also witnessed more than a few economic cycles so I also know there is opportunity even in difficult times, companies that have strong and enduring attributes such as vibrant brands, a global reach and the visionary and seasoned management.
Companies like Viacom; they will be ultimately the winners. There are a multitude of reasons for optimism of Viacom, as we look out over the horizon both near and long-term. And many of these Philippe will discuss on this call today. But my optimism is fueled by a highly competitive landscape and the unprecedented pace of technological innovation both of which will result in escalating growth opportunities for companies with the right assets and the right capabilities.
I’m sure it’ll come as no surprise to anyone that I believe that companies that possess the very best content, they will ultimately emerge as the winners and of course, there is no better example of that kingly capability then Viacom. That’s why Paramount is the number one studio in [inaudible] this year. That’s why we have powerful global media networks that are top performers in countries around the world.
And that’s why MTV gains have a runaway hit franchise in Rock Band. And most important Philippe, Thomas and the rest of the leadership team remain intensely focused on implementing the right plans that will make the most of those successes and many others and unlock the full portfolio of our portfolio. They are capitalizing on size and shifts in the media today to cultivate new and attractive sources of revenue for tomorrow.
That’s how we will continue to deliver greater value to all of you, our shareholders. And now Philippe, it’s yours.
Thank you Sumner and good afternoon everyone. I am pleased that you could join us today. Over the course of the second quarter like many companies, Viacom was faced with an increasingly challenging economic environment which resulted in a slowdown in advertising overall. Nevertheless as you see from our second quarter results, the diversity of our revenue streams provides us with greater stability then others.
In addition to consistently solid affiliate and ancillary revenue growth, increasingly solid performance of our motion picture business continues to help us mitigate challenges on the advertising front. Furthermore we move forward with several initiatives to improve efficiencies and protect our operating margins. As a result we delivered solid double-digit growth in operating income and diluted earnings per share the second quarter as compared with the prior year’s adjusted results.
With the short-term outlook for the economy difficult to predict, we are continuing to improve our organization and business processes across the company. These enduring changes will enable us to continue to succeed in the near-term and as the economy recovers we will be better positioned to capitalize on the opportunities that will emerge in the marketplace.
Importantly we remain on track to deliver double-digit EPS growth for the full year 2008. Today we will cover the following areas: a quick review of our second quarter results; a few highlights from our media networks business including an update on our successful upfront; Paramount has had a terrific first half of the year and I’ll touch on our upcoming plans; finally Thomas will take you through our numbers and discuss the drivers behind those results. Then we will be happy to take your questions.
Let’s begin with our financial results, our reported results in 2007 included some one-time items so unless specifically noted otherwise Thomas and I will refer to growth rates on an adjusted basis. Our consolidated revenues were up 21% in the second quarter to $3.9 billion. Revenues in our media network segment rose 11% for the quarter. On a worldwide basis advertising revenues were up 2%. We saw significant slowdown in our domestic advertising revenues this past quarter which nonetheless did grow 1%.
Despite a strong upfront which I’ll address in a moment, the volume in a scatter market did soften during the second quarter and this softness is continuing so far this quarter. On a more positive note affiliate fees grew 12% for the quarter driven by both rates and subscriber increases across our core channels. Worldwide ancillary revenues rose an impressive 62% with Rock Band continuing to be the biggest driver of our growth.
Next year we expect Rock Band to begin to generate increasingly meaningful bottom line results as well. Our film entertainment segment delivered strong top line growth with revenues up 35% for the quarter to $1.8 billion. The growth was driven by an impressive 84% jump in theatrical revenues. Better than expected top line growth resulted in a $64 million improvement in Paramount’s operating income year-over-year.
Viacom’s overall reported operating income increased 13% to $792 million for the second quarter primarily driven by upsides at Paramount. Diluted EPS were $0.64, a 19% increase over the adjusted results in Q2 of 2007. So for the first half of 2008 we delivered solid double-digit growth at both the top and bottom line, revenues were up 18% and reported operating income increased 19%.
While the economy overall and the soft advertising market do present challenges we have and will continue to demonstrate our ability to manage our businesses well and deliver on our financial commitments. We have taken steps to reduce costs and streamlined certain operations and there is more work to be done in this regard.
We remain committed to investing in our brands, our programming, our games and our development of multiple growing revenue streams for the long-term health of the business. We remain on target to generate strong free cash flow and we will continue to return value to our shareholders by repurchasing shares under our stock buyback program.
Now let’s talk about or media network segment, in the near-term the growth in our domestic advertising business has slowed significantly. However our affiliate and ancillary businesses are performing well. In fact they’re generating double-digit growth with a solid outlook ahead. The primary question we’ve received in recent weeks is what happened in the ad market?
Mid-way through the second quarter scatter volume for several of our networks dropped off. Advertisers in a few categories, such as retail, automotive, and certain consumer goods pulled back their on air spending as they adjusted their own operating plans and product launches. Low ratings at a few of our networks also contributed to the softness.
At the same time audiences continued to drift away from broadcast channels generally migrating to cable networks that skewed to an older demographic and the advertising dollars that were still in play followed those [inaudible]. That did benefit some of our networks such as TV Land and particularly Nick at Nite, but the trend did not benefit some of our other networks that cater to younger demographics.
Looking ahead we do see potential opportunities to counter this trend as we enter the back to school season and prepare for major tent pole events in our networks such as the season premier of The Hill and the Video Music Awards in September. Also we are targeting new advertiser categories to replace those whose circumstances dramatically changed in the last few months.
The successful advertising upfront we just completed which will be part of the mix beginning in the fourth quarter of this year, confirms the value of the connections we forge with our audiences. We entered the upfront discussions armed with several key assets. Most of our networks have delivered solid ratings growth year-over-year, and our overall ratings year-to-date were up 5% in their respective core demographics.
We are also continuing to invest in original and acquired programming and we are leading the marketplace and accelerating our efforts in the development of customized and integrated marketing opportunities. All of these factors helped us to secure double-digit growth in volume and high single-digit price increases in the adult upfront.
Part of this year’s kid’s upfront Nickelodeon already had completed a significant portion of its business through multi year marketing deals. Nick was able to add to this base growing revenue through share gains and increasing business from key categories including video games and movie studios as well as wireless, a new category for them.
With a steady infusion of new programming including breakout hits iCarly and The Mighty Bee, Nickelodeon is widening its lead over the other two children’s networks and holds the number one spot in virtually every kids demo; kids two to 11, two to five, six to 11 and tweens. This past quarter Nick grew its tween delivery by 5% expanding its lead over the second place network to 16%.
Additional landscape continues to evolve and we are capturing more opportunities then ever before. We are driving more traffic to our 340 plus online properties. We are capitalizing on the explosive growth of social networking by integrating more social behavior across our major sites in virtual worlds. We are making great progress in rolling out [flux] to connect our networks with [fluxes] external member site.
When it comes to online casual games our portfolio is already number one in the US and number two in the world. Growth in the global games market is projected to outpace every other media segment and online casual games will grow the fastest. Over the next several years we intend to ride that wave leveraging existing properties and creating original demo-focused game offerings.
The story on our affiliate sales and ancillary businesses illustrates the advantage of having multiple revenue streams. Our affiliate sales teams have delivered double-digit revenue growth for the past nine quarters and we believe this growth will continue. Our networks are must-haves. Think Nickelodeon, BET, Comedy Central, MTV and so many more and moreover our networks are a great bargain.
While we deliver well over 20% of the audience to ad-supported cable, our share of affiliate fees is less than half that. In fact, we have several networks that are significantly under valued relative to their audience delivery. One of our top priorities is to increase rates while providing greater value to our distributors and narrow that gap.
As competition between cable carriers, satellite and Telco increases they will continue to seek programming and services that will distinguish their offerings. Simply having technology as it become ubiquitous across distributors will not be enough. Compounding programming and increasingly unique consumer experiences will be the differentiating factors that drive subscriber growth for our partners.
Our expertise in monetizing the content on new and emerging distribution platforms will also fuel our long-term growth. Let me give you a few examples. Our cable networks content constitutes over 35% of all free VOD orders but we occupy just 10% of our partner in shelf space. In our increasingly “I want it now” culture, VOD will continue to grow and we will build on our success with packages that add value for our partners and add revenues for us.
Analysts predict that the mobile advertising market in the US will grow at very high double-digit growth rates over the next several years and Viacom is already the largest provider of video content on mobile. We are also building on our number one position in online casual gaming in the US by moving rapidly into mobile games. Nickelodeon’s addicting games has launched a series of mini games called Quickies exclusive of the Verizon Wireless network. And a new iPhone [app] store features the South Park Imagination Land game and will feature games based on hit Paramount movies like Days of Thunder, Saturday Night Fever, School of Rock and Top Gun.
Ancillary sales are another revenue stream that continues to be a valuable asset for us as we exploit our most successful programming and characters through an array of opportunities. Importantly we also have the opportunity to build brands from scratch. For example the Rock Band franchise is brand building at its finest and it’s a story we can and will replicate.
We start with an incredible product that appeals to multiple demographics. We tap into our legacy of music [tieration] to build a whole new platform for experiencing music. And then we leverage all of our properties to build this brand. Since the launch we’ve shipped 4.8 million units, propelling MTV games to a top five video game publisher in North America. We are in the second wave of our European launch and with the release of Rock Band for the Nintendo Wii the game can now be played on all major video game systems.
Adding to the success of a secondary revenue stream from song downloads, 18 million paid downloads to date at an accelerating rate now is a million downloads every nine days and our library of music continues to grow. Rock Band 2 will be launched this fall exclusively on Xbox 360 with numerous new features including a huge and eclectic song list and online modes to build an even larger community around the brand.
We will launch on other game systems later in the year. This brand is still in its infancy. Over the next several years you will see us broaden its sphere of influence by moving it to other genres and capitalizing on new marketing opportunities. Looking at consumer products more broadly our international markets offer fertile ground for cultivating these businesses. We are aggressively pursuing opportunities to expand into new areas and capitalizing on channel launches to create demand for our products as we build our brands in new locations around the world.
Just last week we launched Nick Arabia, the first global kids media brand to create a free to air ad [inaudible] service across the region and Nickelodeon’s 50th global channel. Nick Poland and Nick Africa also launched earlier this month and Nick Jr. was introduced in six countries across Latin America. Each of these launches included an integrated plan for developing a robust consumer products business.
In addition to selling merchandise we are exploring new ventures such as recreation experiences that will expand the relationship our audiences have with our brand and provide new revenue streams for us. This past spring Nickelodeon celebrated the successful launch of Nick Universe in Malls America. Last month Nickelodeon opened the largest Nick branded theme park land outside the US at Movie Park near Düsseldorf, Germany. And next month the first Nickelodeon branded cruise will set sail in the Caribbean.
Finally we are continuing to evaluate the processes of our cable networks. We have made great strides in improving the efficiency of our organization but we know there is more that can be done. Our focus is on areas that do not impact the continued development of great content and experiences that grow our brands and relationships with our consumers. These actions will provide immediate benefit and over the longer term great efficiencies will translate into faster growth.
Now let’s move to our film entertainment segment, Paramount has enjoyed terrific theatrical success so far this year. For the second year in a row it generated more than $1 billion in box office both domestically and internationally in record times. The studio also holds the number one spot in domestic market share. Iron Man with $315 million in domestic box office marks the beginning of another great franchise. Indiana Jones and The Kingdom of The Crystal Skull also was about $315 million of domestic box office and worldwide box office of $750 million has introduced a whole new generation to these adventure series.
In fact the tremendous anticipation for the film generated during the quarter, a nice boost in sales of our Indiana Jones Library titles domestically and internationally. And DreamWorks Animation’s Kung Fu Panda is the top animated film with about $210 million of domestic and over $500 million of worldwide box office.
Over the past year and a half I have spoken numerous times about how the economics of the motion picture industry need to be evaluated on a multi year timeframe as a movie progresses through various windows. Paramount released a number of strong films in 2007 and this year is shaping up to be the second consecutive year of strong box office success for Paramount.
But we are still early in the cycle of the studio’s financial comeback. The profits from the breakout films will continue to cascade through our P&L for some time. Paramount’s pay-per-view and on-demand business is driven by growing portfolio of diversified distribution partners ranging from satellite to cable to the internet, both domestically and around the globe. While the share of total revenue today is relatively small we are expecting significant annual double-digit growth in these revenues in the coming years.
As we demonstrated in the second quarter we intend to build on our bottom line growth by taking specific steps to remove certain costs from the studio. For example we consolidated the marketing distribution physical production departments at Paramount Vantage with those of Paramount Pictures. This move will result in annual savings of several million dollars in marketing spend and overhead expense.
Looking ahead we have several strong titles slated for release during the remainder of the year starting with next month’s release of DreamWorks Tropic Thunder which boasts an all-star cast including several surprise cameos. Other major films include The Curious Case of Benjamin Button and DreamWorks Animation’s Madagascar, Escape to Africa.
Overall I am optimistic about our future growth plans throughout Viacom. Thomas and I just completed our long range planning meetings with each of our divisions. With new thinking and innovative approaches the growth opportunities that exist across our organization and affiliate partnerships, consumer products, licensing, online and mobile platforms, games, movies, recreation, our increasingly important and fast growing international businesses, and yes, advertising are very exciting.
These opportunities will allow us to grow our core businesses and accelerate our plans to diversify our revenues. While we are in a period of transition, there has never been a better time to be in the content business. Consumers today have a voracious appetite for content and we have the capabilities to satiate that hunger across every platform and every geography. As the leading pure play content company in the world with multiple strong brands, Viacom has the vision, the opportunity, the people and the assets to achieve our objectives and to continue to grow value for our shareholders.
Now I’ll turn it over to my partner Thomas.
Thank you Philippe and good afternoon everyone. I hope you’ve all had a chance to review our earnings release and web presentation summarizing our second quarter results. Our 10-Q will be filed shortly with the SEC and should be available later this evening.
This afternoon I’m going to take you through our second quarter results in more detail and I’ll update you on the key factors impacting our outlook for the balance of the year. My remarks will focus on our results from continuing operations as compared to last year’s adjusted results as discussed in our earnings press release.
As you will recall last year’s second quarter results included $11 million in restructuring charges at MTV networks, the gain on the sale of our interest in MTV Russia as well as a write-off of our investment in [inaudible]. We believe that adjusted results are a better indicator of our core performance.
Now turning to our performance in the quarter, despite a challenging environment Viacom’s revenues, operating income and earnings per share all grew double-digits. I’m going to focus most of my remarks on the segment results and I will start with the media networks group.
The media networks group continues to generate strong top line growth with revenues up 11% to $2.1 billion in the second quarter. If you would like to follow along using the web deck, page nine provides a breakdown of media networks revenue growth. Worldwide advertising revenues rose 2% in the second quarter to $1.2 billion. Domestic advertising revenues increased 1% reflecting recent softness in the overall ad market.
As Philippe mentioned softness in the second half of the quarter put pressure on ad sales growth. It is important to note that we achieved a domestic ad sales base of slightly more than $1 billion. Each percentage point of growth equal approximately $10 million so it only takes a drop in the expected scatter volume of $20 million or $30 million to notch down the growth rate.
We continue to work closely with our key advertisers and their agencies to navigate this difficult economic environment. International advertising grew 10% over 2007. Foreign exchanged contributed 10 percentage points to growth in the quarter. Also the first quarter of 2007 included ad revenues of our India operations which we now deconsolidate after having entered into a joint venture with TV18 in India.
This deconsolidation had a 3% adverse impact on international advertising comps. The organic growth was 4% driven primarily by ratings performance, as well as ad market growth in Europe and Latin America offset by some softness in the Asian markets. Worldwide affiliate revenues grew 12% to $656 million with foreign exchange benefits contributing 1% of the worldwide growth. Domestic affiliate revenues increased 11%. About 60% of the growth in domestic revenues came from rate increases while 40% of the growth came from increased subscribers at both our core and our digital channels.
International affiliate revenues increased 19% on a reported basis with eight percentage of that growth driven by foreign exchange benefits and the deconsolidation of India having a negative 2% impact. Organic growth of 13% was driven by both subscriber and rate increases principally in Europe. Worldwide ancillary revenues grew 62% in the quarter to $307 million. Domestic ancillary revenues were up 46% reflecting the continued success of Rock Band including the rollout on the Nintendo Wii platform in June.
International ancillary revenues increased 94% in the quarter with 5% of the gain being attributable to foreign exchange. The rollout in late May of Rock Band in the UK, France and Germany were the key drivers with higher licensing revenues also contributing. This past Friday we launched Rock Band in Italy, Sweden, Switzerland, Belgium, Netherlands and Luxemburg and tomorrow we will launch in Spain.
Media networks operating income for the quarter was up 3% to $765 million from last year’s adjusted results. The operating margin declined from 39% in 2007 to 36% in 2008. Two-thirds of the decline was due to lower effective margins on Rock Band revenues and approximately one-third of the decline was related to increased programming investments.
Now turning to filmed entertainment, second quarter revenues were up 35% to $1.8 billion and operating income was $86 million which is a $64 million improvement from last year. Page 11 of the web presentation provides a breakdown of filmed entertainment revenues. Theatrical revenues increased 84% to $805 million versus 2007. Growth in theatrical revenues was driven by the worldwide success of Indiana Jones and The Kingdom of The Crystal Skull, Iron Man and Kung Fu Panda as compared to Shrek, The Third in the second quarter of last year. This quarter’s releases were illustrative of Paramount’s strategy of developing their slate around key franchises.
We look forward to the release of the sequels to Transformers next year and Iron Man in 2010. Home entertainment revenues increased $67 million or 12% versus the first quarter of 2007. Home entertainment revenues reflect increased revenues from third party distribution agreements including our new CBS distribution agreement which requires gross revenue treatment. It also reflects increased revenues from our catalogue titles driven by the re-issue of the first three Indiana Jones titles.
Partially offsetting this were lower revenues from this year’s home entertainment releases which included Cloverfield and The Spiderwick Chronicles. TV license fees grew 4% to $300 million reflecting higher pay-per-view and video on-demand revenues. The $64 million improvement in films entertainment operating income reflects profit contributions from Iron Man, and the Indiana Jones Trilogy DVD release. In addition 2007 second quarter included a significant amount of pre-release spending associated with the July 3rd, 2007 release of Transformers, with no comparable major release in the early third quarter of 2008.
Free cash flow and share buybacks are also critical to the conversation. Page five of the web deck provides a presentation of the components of free cash flow. There was a cash use of $182 million in the second quarter. The principal drivers were working capital and cash taxes. The working capital use of $469 million in the quarter was largely due to the acceleration of this year’s film production to the first half of the year so that the bulk of our 2009 would be completed by the June 30th expiration of the SAG contracts.
Cash taxes increased $197 million in the quarter principally due to 2008 tax payments being spread more evenly over the year then 2007 tax payments which were weighted more to the second half of the year. For the full year we continue to believe that free cash flow will be comparable to last year excluding the one-time capital expenditure of $75 million to $100 million related to relocating several of our cable channels into new office space.
The acceleration of this year’s film production and the launch of Rock Band in Europe on the Wii in the first half of the year will result in the timing of our free cash flow to be weighted to the third and fourth quarters of 2008. In terms of leverage at the end of the quarter we had $9.2 billion of debt and capital leases outstanding and our leverage ratio was 2.9x.
We continued to return capital to our shareholders through out share repurchase program in the second quarter. During the quarter we repurchased 12 million shares for an aggregate purchase price of $446 million and had 623 million shares outstanding at the end of the quarter.
Now turning to our guidance for the three year period from 2008 through 2010 we continue to expect to deliver low double-digit annual growth and diluted net earnings per share from continuing operations. This outlook is based on adjusted earnings and reflects growth from 2007 adjusted diluted net earnings per share from continuing operations of $2.36.
Now I want to cover a couple of trends impacting our performance for the balance of the year that have not already been addressed. The timing of our programming investment as well as the continued rollout of Rock Band internationally will put pressure on media network margins in the third quarter versus last year. This will weight the second half growth in media networks operating income and margins to the fourth quarter of the year.
In filmed entertainment last year’s quarter benefited from the worldwide release of Transformers and the fact that a significant amount of the P&A on this film was expensed in the second quarter of 2007 thereby generating significant profits in the third quarter. We will have no comparable circumstance in 2008’s third quarter so the studio will face difficult bottom line comparisons on a year-to-year basis. We do however see healthy growth in profits at the studio in the fourth quarter.
Wrapping up in a challenging environment we generated strong top and bottom line results. For the first six months of 2008 we have grown revenues 18%, operating income 12% and diluted earnings per share 23%. We are committed to investing for the long-term growth and continue to make strategy investments in our brands and key franchises. At the same time in the third quarter of last year we saw the slowing economic environment and put in place a number of cost saving initiatives.
This is enabling us to operate with greater efficiency in order to protect our core margins. The company’s fundamentals remain strong and we are optimistic about both our current and long-term outlook. We remain focused on growing organically by continuing to develop our brand and franchises.
Thank you for listening and now we will turn the call over to questions.
(Operator Instructions) Your first question comes from the line of Mark Wienkes – Goldman Sachs
Mark Wienkes – Goldman Sachs
Can you walk us through the affiliate fee step-ups towards—across the networks for the next couple of years? Where are the big buckets of opportunity on that side?
On the overall package of our networks we are as I mentioned in my remarks significantly under valued. But probably the ones that really stand out are Comedy Central which is coming off a number of very long-term affiliate agreements that were forged a decade or so ago when Comedy Central had not reached the status it has today nor the viewership it has today, and Nickelodeon which is a dominant force in kids television and we think there is opportunity for growth there.
Across our portfolio of networks there is opportunity that should drive growth as we provide value over many years to come.
Mark Wienkes – Goldman Sachs
No specifics in terms of the approximate size of the opportunity over 2009, 2010, 2011?
As we’ve indicated we expect to continue to see double-digit growth in our affiliate revenues for the foreseeable future.
Mark Wienkes – Goldman Sachs
Any sort of anecdotes you could provide with respect to the commentary about the erosion of viewers from broadcast toward cable, skewing toward the older networks just from an advertiser category perspective that you didn’t see in the quarter?
Well there are a number of advertisers who reach for—all the demo most of our networks other than TV Land and Nick at Nite principally target younger demos that just aren’t served by broadcast so as those dollars fall off they are principally going to older skewing cable networks.
The pharmaceuticals are driving it, the financial services companies are driving it and those are the guys that are spending big money and coming into cable aggressively.
Your next question comes from the line of Michael Nathanson - Sanford Bernstein
Michael Nathanson - Sanford Bernstein
Folks are struggling definitely with the domestic ad growth number this quarter and I wondered it would be helpful for more color on the growth rates by demographic, if you can actually burrow down and look at what was kid’s growth or maybe teen growth this quarter?
As I indicated obviously we did quite well in the older demo networks. We had a lot of the softness really related to the I’d say the, not so much the young kids, but that in between demographic group. It’s very category-specific. I’d mentioned a few of the categories that were primarily impacted, probably automotive which I’ve mentioned before which probably was across the media industry. Certain specific categories in consumer goods so it was really—a lot of it had to do with specific issues going on with specific advertisers.
Michael Nathanson - Sanford Bernstein
Has kids been holding back the growth rate the past couple of quarters or teens, is there maybe a mix issue, you’re not getting the older demographics which--
As we look forward and looking at the strategy of Viacom obviously we’re very strong in the younger demographics. We think that’s a very important demographic for advertisers. We are planning to introduce new categories of advertisers to this demographic and it being very important to their marketing plans. But also we are looking to enter more significantly into demographics where we have a lower presence. For that reason we’ve introduced original programming on TV Land for example which has been very successful thus far and that will allow us to target more older skewing advertising dollars as we go forward with that.
We have some great growing brands like Spike which is a male oriented brand that covers several demos, young men but also older skewing demographics during certain program blocks. So we are working to target demos where we are not as dominant as we are in kids. So over the long-term strategically that should also assist our growth looking forward.
But over the long-term you have different product cycles where different products targeting different demographic groups become stronger and weaker. For many, many years everyone was saying there’s no point in targeting an older 50 plus audience and now 50 plus has become very strong basically driven by pharmaceutical Industries and the financial services industries which are specifically targeting the baby boomer demo. As Philippe said we’re diversifying to take advantage of that stream and at the same time we look at new ways to modify it against our existing things. From time to time you have quarters where the amount of product targeting a specific demo does get weak but over time that tends to work itself out year in year out.
Your next question comes from the line of Jason Bazinet – Citigroup
Jason Bazinet – Citigroup
On media networks operating income margins I think you mentioned that about two-thirds of the margin compression year-over-year stemmed from Rock Band, when do you think that can begin to be a contributor to margins or at least less of a drag?
It’ll be less of a drag as we roll forward here. It’s sort of mid to low single-digit this year and it builds or maybe doubles maybe year after year after year. So I think that’s kind of some of the rough guidance as to how you might want to look at Rock Band’s margins as it grows and that’s strictly a function as we get the penetration of the units and shift from selling a very low margin unit into the focus more on the download business which has a relatively higher margin.
Your next question comes from the line of Benjamin Swinburne - Morgan Stanley
Benjamin Swinburne - Morgan Stanley
You talked about the upfront results and the success there which was true for a lot of cable networks and we’re in that time of year right now where those commitments should start turning into firm orders while at the same time it sounds like everyone is looking at their budgets increasingly critically, I wonder if you have any confidence at this point or talk about how much of the commitments you saw on the MTV side you think will turn into firm orders because it would suggest that the ad trends you saw in the second quarter and probably into the third quarter get better as we head into the next broadcast season and maybe you think that’s an overly optimistic view. And then just to go back, I think you mentioned this last quarter, the timing of the cash flows this year, should we assume that buybacks will be larger in the second half then the first half which is what we saw last year but given the timing of the production spend would be true again this year?
As far as the upfront we are having a good upfront in both the adult and kids category as I mentioned but what we don’t know about is where the economy is going to be headed as we go into the next season and how that will impact the scatter market. But every indication we have assisted by the multi platform delivery that we’re able to discuss with our clients and by the continually enhanced integrated marketing opportunities we provide. So the business we’re riding looks good, very solid, good categories, what the impact of the scatter market on overall ad sales will be a function of the overall economy.
On the buybacks we’re pretty much a consistent buyer month after month after month. We don’t weight it to the lower cash the higher cash flow, we maintain a consistent position month after month throughout the year so it’s not something that goes up or down relative to cash flow.
Your next question comes from the line of Richard Greenfield – Pali Research
Richard Greenfield – Pali Research
Given what happened from the time you gave an updated comment at one of the conferences in terms of domestic ad spend, what should we be thinking about for third quarter right now? A similar level to Q2 in terms of that weakness or should it actually be a lower number and then a bounce back in Q4 as you begin to benefit from the upfronts? And then just specifically on Nickelodeon there’s some stuff out today related to the FTC’s decision or commentary on marketing to kids, it sounds a little less threatening then its been in the past in terms of amends that have been made by advertisers, just wondering how much that’s hurt you in Nickelodeon over the last couple of years and to the extent that it doesn’t get worse, how much of an opportunity is that over the next 12 to 18 months?
As far as the ad spending going forward it is very early in the third quarter so we’re just not going to make any predictions. I mentioned in my remarks that the softness in the scatter market continues. I mentioned we are taking different steps to address it and to introduce new advertisers to replace the ones who dropped off over the last couple of months and we do have some nice tent pole events coming up. Again given the state of the economy it’s just very hard to predict.
But we are aggressively out there trying to make the best of the ad dollars that are available for us. As far as the FTC report we’ve been at the forefront in this effort. We are working; we have been working for some time with our food advertisers. We promote healthy choices. We’ve done a lot of, for many years we’ve been leaders in public service programming on Nickelodeon. We have a Let’s Just Play program where we actually have no advertising on and no programming for several hours on a given day urging kids to go out and play. We are not licensing starting in January 2009 our characters to non-healthful products and we don’t take soda advertising. We haven’t as a matter of policy taken soda advertising on Nickelodeon which is one of the categories that has been addressed in the report.
So this is an opportunity as you suggest as the marketers review their own product line for us to work with them as they promote healthful choices whether it’s at the supermarket or in the quick service restaurants or otherwise. So we are working with them on new marketing campaigns to promote healthful choices for kids.
Richard Greenfield – Pali Research
Can you just comment on taking political advertising for the first time?
There’s been a lot of attention to this Presidential race particularly in the demos we serve. A lot of interest in this campaign. We thought with the appropriate standards, we still review the advertising that is submitted to us that we should take on the advertising and so far we have run some advertising that’s—some on the Republican side, some on the Democratic side. It’s not a huge opportunity for us since most political ad buying is on local media but it is an opportunity which we’re taking advantage of and particularly for our demographics that’s very interested in this year’s Presidential election.
Your next question comes from the line of Jessica Reif-Cohen – Merrill Lynch
Jessica Reif-Cohen – Merrill Lynch
You mentioned a few times that you are cutting costs, I was wondering if you could say what your target is in total and by division and will there by any restructuring charges and second what sort of advertising of international advertising comes from the UK and then can you give us an update on that new pay TV service?
As far as the cost cutting, we’ve been ahead of the curve there and just tightening our organization. It’s been a continual process really since we’ve gotten here. We specifically identified a number of the efficiencies we drove our international organization. We’ve applied some of the same methods domestically. We’ve been very careful in new hires but the overall mandate by the way has been that I don’t want to see any cost cutting that will impact what we put on the various screens we serve or affect or brands.
We do not anticipate taking any restructuring charges this year. We are doing this as ordinary course of business and part of making us more efficient and I believe this period will make us much stronger as we emerge. Most recently we laid out specifically we did at Paramount Vantage but it’s really become ordinary of business to just drive more efficiency in the system.
As far as international advertising UK is our most important territory and we have good vitality, several of our networks ad sales are also an area we have to watch closely in international markets but UK, Germany, those are big advertising markets for us.
It can go up and down but it’s approximately a third.
As far as the pay service, we are continuing as time passes obviously we are getting into more detailed stages of our discussions with potential distributors. We are having very productive meetings and furthering those discussions. We have nothing to announce at this time and when we conclude deals we will be making announcements as we make them.
Your next question comes from the line of Douglas Mitchelson – Deutsche Bank
Douglas Mitchelson – Deutsche Bank
On advertising I’m trying to square the soft scatter volume in 2Q and 3Q with your commentary regarding the strong upfront and so when you look at the upfront and how strong it was by advertiser or category and you look at the scatter weakness are the guys who are soft and scattered now coming back big in the upfront which of course would make us worry that that upfront might be at risk of sticking?
I would say when you look at our upfront we have some of the traditional categories that we’ve been doing business with whether it’s the motion picture studios, the QSRs, wireless, all the ones that we’ve been engaged with for a long time are continuing to be the core of our upfront sales. Again I think we’ve benefited through our integrated marketing plans and a lot of the advertisers want to make sure that they’re working with us on a programmatic basis across many of our shows and events during the season. And that’s probably been a driver but we don’t break it down as you suggest by advertiser.
Douglas Mitchelson – Deutsche Bank
So the guys who are soft in scatter were also either soft in upfront or not a driving factor and your upfront I guess is what I’m trying to--
Well some of the advertisers who were the softest or in some cases disappeared from scatter are companies that have in some cases significant overall difficulties that have been publicized who are reviewing their total spend in all categories including advertising. So they have not been necessarily big players in the upfront marketplace.
Your next question comes from the line of Imran Khan – JP Morgan
Imran Khan – JP Morgan
Going back to this advertising category could you give us some qualitative color what percentage of your domestic advertising revenue is coming from the categories that you are seeing weakness like automotive and hypothetically if DreamWorks and Paramount were to separate how much in SG&A savings would you expect do you think you would go back to pre DreamWorks deal levels?
On the advertising question we just don’t breakdown the categories in that way. As far as in the hypothetical situation where DreamWorks concludes its deal as reported with Reliance of India clearly there would be on a going forward basis in that situation some savings in our overhead as well as our marketing distribution development spend. And clearly we would focus on the strategy we’ve articulated before of putting out, over the course of many years, a group of releases that is focused on our brands and our franchises. So the savings would be significant.
I just don’t think we can comment on the magnitude of the savings or the timing of those savings. It would be highly speculative.
Your next question comes from the line of Jason Helfstein – Oppenheimer
Jason Helfstein – Oppenheimer
Given your success with Rock Band is the company contemplating any other game related acquisitions either developer or publisher?
Rock Band is a great franchise and we have a great group Working Harmonics which is the company we acquired which developed Rock Band. There’s a lot for us to do in growing out that franchise. We could look at other game opportunities that have that kind of linkage to some of our brands but that’s not a major focus for us. Certainly we’re not looking to make any major acquisitions in the gaming area. The other big area in gaming for us is casual games where we have a very strong presence. We’re growing that organically.
There could be really, really small acquisitions in that space that we might look at but very small in terms of what the value of the acquisitions would be just compliment our activities there. But we are totally focused right now on growing this great franchise and there are just so many new applications and brands that we can lay on the Rock Band franchise that that’s where the opportunity is for us at this point.
Your final question comes from the line of Michael Morris - UBS
Michael Morris – UBS
In your prepared remarks on media nets you referenced lower ratings at a few of the networks and that you were trying to counter that with new seasons or new programs, could you talk about which networks maybe you’re seeing the weakness at and than also where you are in terms of programming spend if its something that’s still increasing at a double-digit rate as you try to counter the lower ratings or where a steady state in terms of programming and spend increases should be year-over-year? And then on the film side I understand the challenge with Transformers next quarter and the timing of P&A but when you talked about what influenced this quarter you didn’t mention Indiana Jones or Kung Fu Panda, you referenced the Indiana Jones DVD Trilogy and Iron Man, I was wondering if or when you expect benefit from those two titles and then also when you expect to see or if you expect to see impact from Transformers on television?
As far as the ratings issues again we’re talking about temporary softness, in some cases it relates to when we launch a new season of a show. For example if you look at MTV we have the new season of The Hill is debuting next month, that’s a huge series for us, we didn’t have that last month so we have these seasonal dislocations on a channel like MTV. But of course MTV and the addition of The Hill has the big tent pole Video Music Awards on September 7th so that will correct itself.
And then we’ve had some weakness in BET as an example and that had to do with the transition that we’ve effectuating and having BET less reliant on acquired programming and rolling in new original programming and as I said previously this has been a multi year program which we are in the midst of. So again we are working to that end.
As far as the programming spend we are going pretty steady state and as I’ve said in other calls we are looking at the mix of programming. We are looking to put on more original programming as some of the older acquired programming rolls off.
It has historically been noted our second and third quarter we usually ramp up the programming expense in the fourth quarter as when a lot of the revenue associated with that programming investment comes back in and smoothes out the margin for the year. That’s something that you should keep in mind as you look forward.
On the Iron Man and Indy should be—Iron Man hits at the end of the third quarter and Indy hits in the fourth quarter in terms of DVD. Kung Fu Panda would hit in the fourth quarter. And Transformers on TV will be, that will be over a long window, the revenue impact of that we’re not going to break that out.
Michael Morris – UBS
You’re waiting for the DVD releases for Kung Fu Panda and Indy for the financial impact, no impact during the box office window?
We’ve already had, we did include in the theatrical window, and the theatrical release of both Indiana Jones and Kung Fu Panda really drove through the second quarter principally. But we didn’t have that Transformers comparable from last year both on the cost side which was in the second quarter last year because P&A for the very early July release of Transformers, the P&A spending took place in the second quarter so that the revenues were not encumbered by the P&A spending in last year’s third quarter. That’s the difference.
The industry accounting doesn’t match the expense to the revenue.
We want to thank everyone for joining us for our second quarter earnings call.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: firstname.lastname@example.org. Thank you!