DHX Media Ltd. (NASDAQ:DHXM) Q3 2016 Results Earnings Conference Call May 16, 2016 8:00 AM ET
Nancy Chan-Palmateer - Director, Investor Relations
David Reagan - EVP, Corporate Development
Michael Donovan - Executive Chairman
Dana Landry - CEO
Keith Abriel - CFO
Aravinda Galappathige - Canaccord Genuity
Bentley Cross - TD Securities
Deepak Kaushal - GMP Securities
Drew McReynolds - RBC Capital Markets
Adam Shine - National Bank Financial
Doug Creutz - Cowen and Company
Robert Peters - Credit Suisse
David McFadgen - Cormark Securities
Good morning, my name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the DHX Media Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session [Operator Instructions].
Thank you. I would now like to turn the call over to Nancy Chan-Palmateer, Director, Investor Relations. You may begin your conference.
Thank you, operator, and thank you everyone for joining us this morning. On the call with us today are Michael Donovan our Executive Chairman; Dana Landry our Chief Executive Officer, Keith Abriel, our Chief Financial Officer and David Reagan, our Executive Vice President of Strategy and Corporate Development.
Before we proceed, we have some standard cautionary statements. The matters discussed in this call include forward-looking statements under applicable securities laws with respect to DHX, including, but not limited to, statements regarding DHX's library, the goals of the company, the business strategies and operational activities of DHX, and timing therefore.
The use of proceeds from the company's recent part deal equity public offering, and issuance of senior unsecured notes and the allocation of other resources of the company, the growth and financial and operating performance of DHX, its subsidiaries and investments and the markets and industries in which the company operates. Such statements are based on information currently available and is subject to a number of risks and uncertainties. Actual results or events in the future could differ materially and adversely from those described in the forward-looking statements as a result of various important factors, including the Risk Factors set out in company's MD&A and the Company's Annual Information Form, which also form part of the company's annual report on Form 40-F
With that, I turn it over to our Executive Chairman, Michael Donovan. Michael?
Thank you, Nancy, and thanks everyone for dialing in today. Three days from now, on May 19, DHX Media will mark the 10th Anniversary of its Initial Public Offerings. DHX was launched in 2006 with a vision to become a global leader in children's and family content.
Over the last 10 years, as the demand for such content has increased, fueled in large part by the global proliferation of on-demand services, DHX has grown from a market cap of $76 million from its IPO to approximately today $1 billion.
Our annual revenues have grown from $60 million during that period to approximately $300 million today and we have expanded our library 10-fold to become the world's largest independent library of children's and family content.
Our shows such as Teletubbies, [Next Class], the Inspector Gadget and many others are carried around the world by all leading broadcasters and streaming platforms. Most recently Nick Junior in the United States announced they will premier the new Teletubbies on May 30 in that country. This is a tremendous milestone for the brand. We'll introduce the series to millions of children across the U.S. a whole new generation.
Meanwhile, the U.K.'s leading critical broadcaster CBeebies has ordered a second season of the new Teletubbies. We reported that the series has become one of their most popular shows since they premiered in November.
I am very proud of what we've accomplished thus far at DHX and look forward to many more years of providing engaging high-quality children's content to the world.
And with that, I'll hand it over to Dana. Dana?
Thank you, Michael and thanks everyone for joining us this morning. It is indeed an exciting time to be celebrating our 10th Anniversary of going public this week as Michael mentioned.
If you'll indulge me, I'll look back and I'll read a small excerpt from our IPO release; on May 19, 2006, we stated we plan to grow the Group by a combination of merchandizing and licensing agreements, developing new programs, exploiting the worldwide television market where we already have a good footprint as well as through the home entertainment market.
We also plan to pursue selective acquisitions and enter the market for new digital platform content, particularly given the used market's appetite for digital media. I think you'll agree that we've delivered on that plan and that a decade ago, through Michael's leadership and direction we had -- we were able to have the vision to see the trends for the future.
Going forward, we intend to build on our achievements by investing in content and seeking out those trends that will strengthen the company on the global stage for years to come.
We're very excited about our future that sees DHX Media continuously adapting its creative process and business strategies to meet the ongoing evolution and technologies and platforms that will allow children and their families to enjoy our content.
Over the last decade, three key imperatives have driven our growth. The first is creating engaging, high quality content for kids and family. Second is distribution of our content worldwide to pursue growth across all media platforms and third is leveraging our content to create high profile global brands with increased merchandizing and licensing potential. These imperatives have served us well and we plan to continue to be guided by them.
Going forward we aim to produce more hit brands that generate returns across all of our business lines. Grow our presence in emerging markets, expand into new content platforms and anticipate and meet the demands of evolving technologies and markets.
That brief summary provides a picture of what we see as our potential. Our successful strategy to date has been to become the go-to company for children’s content and we plan to continue building on that strategy in the years to come.
As seen by our results today, it is the strategy that is delivering strong returns. Revenues for Q3 2016 were $84 million, our second highest quarterly revenue to date on record. Adjusted EBITDA for Q3 was our highest ever recorded in a single quarter by the company at $33 million and gross margin grew to $51 million compared to $45 million for Q3 2015.
Keith will take a deeper dive into the quarterly numbers in a moment, but I’d like to also touch on some highlights from our nine month metrics. Revenues for the first nine months of fiscal 2016 were $230 million, up 19% over the same period for fiscal 2015.
Adjusted EBITDA was $79 million for the first nine months for fiscal 2016, an increase of 17% over the same period last year and gross margin grew to $129 million, an increase of 20% over the first nine months of 2015.
So year-to-date shows continued our strong momentum and of course what’s behind results like these is high quality kid’s content, which our library possesses.
We continue to grow our library in Q3 by adding 63.5 hours of proprietary content. We announced commissions for three original animated series this quarter; Chuck's Choice, Space Ranger Roger and Season 2 of Inspector Gadget, which collectively represents almost 60.5 hours of proprietary content and reflects just a portion of our robust development and production slate.
Our top rated shows continue strong demand for major digital and linear customers. Netflix has ordered 20 more episodes of Degrassi Next Class, Nickelodeon Premiere, our latest live action twin show, The Other Kingdom in April. Michael mentioned earlier that Teletubbies rolled out in the U.S. at the end of this month and also the brands popularity in the U.K.
Not only is Teletubbies a hit on TV in the U.K. but Teletubbies toys which launched in the U.K. in January are one of the best selling new properties to hit the U.K. toy market this year with a few of our products cracking into the top 10 only after a few months and we’re also enjoying strong continuing commitment from retailers across the product range.
With 16 broadcasters and more than 65 global licensing deals signed to date, Teletubbies is a superb example of how DHX can monetize brands. We're also growing an online audience, both for own content and third party brand owners through WildBrain and we're extremely excited of the unavailing of that a few weeks ago.
WildBrain is our multi platform kids network, dedicated to connecting content owners with advertisers on platforms such as YouTube, Dailymotion and others. The network which is attracting 715 million monthly views is a reflection of how we are benefiting from and leveraging the migration of content delivery to digital media platforms.
Through WildBrain, we are delivering kids content to the new on-demand generation through the mobile platforms that kids prefer. In the first nine months of fiscal 2016, WildBrain generated approximately $13 million in gross revenue and as more and more kids continue consuming content on mobile devices we believe WildBrain represents a significant growth opportunity for DHX.
Another way we are expanding our content lineup is positioning -- and positioning the company for long-term growth is through strategic partnerships on world-leading brands to generate new high quality content for distribution around the world and to participate in consumer product offerings for such properties.
As recently announced we've expanded our strategic partnership with Mattel, I should say pardon me, to a fifth property Rainbow Magic, a brand which enjoys enormous popularity with girls around the world driven by an extensive publishing program.
We aim to grow this global growth published brand with new content, toys and other merchandise for platform's participation across multiple stream, revenue streams. The Rainbow Magic deal builds on the partnership we announced last December around the celebrated Mattel Brand's Bob the Builder, Fireman Sam, Little People and Polly Pocket, which we expect to be accretive for DHX for fiscal 2017. Deals such as these, levers a strong and highly complementary relationship that exists between DHX and Mattel.
Going forward, we have ambitious and extending plans for DHX, to help execute on our strategies and achieve our goals we recently closed an equity offering for $65 million and we have also issued a top up of $50 million in senior unsecured notes to repay some indebtedness under our senior secured credit facilities.
We will use these proceeds as we have in the past to deliver growth organically, through strategic alliances and acquisitions. I would remind listeners, the last time the company issued new equity was on -- from treasury, was in November 2013 in the 2.5 years since then our share price and market cap have doubled and our revenues are on track to have tripled by the end of this year.
The recent capital raises strengthen our balance sheet, so that we can continue to move quickly on other opportunities as they arise. DHX is building for the long term. We believe that monetizing kids content holds tremendous potential for the future.
At DHX we produce high quality, world-renowned kids and family content. We license that content to broadcasters and video-on-demand platforms worldwide, including our own channels in Canada and we grow brands from our content through merchandizing and licensing worldwide.
We built the company over the last 10 years that is poised for continued strong growth for years to come.
With that, I will turn the call to Keith.
Thank you, Dana and thanks to everyone for dialing in today. Management is pleased to report its Q3 fiscal 2016 results today.
Revenues for Q3 2016 were $84.1 million down 2% from $85.6 million for Q3 2015. The decrease in the quarter was largely a result of distribution revenues in Q3 2015 having included approximately $12.8 million in streaming photography, approximately $6 million to $8 million of which represented a catch-up from the prior year.
Q3 2016 adjusted EBITDA was $32.7 million up $2.9 million or 10% over $29.8 million for Q3 2015. Gross margin for Q3 2016 was $50.5 million, an increase in absolute dollars of $5.7 million or 13% compared to $44.8 million for Q3 2015.
The overall gross margin for Q3 2016 at 60% of revenue was above the midpoint of management’s quarterly expectations as reported in the prior MD&A in Q2 2016.
It was the result of strong margins for DHX Television, which at 71% were above the high end of management’s expectations and higher than expected margins for net producer and service fee revenues, offset by slightly lower than expected distribution margins and lower proprietary production margins as the proprietary production delivery mix for the quarter contained a higher than normal percentage of live action shows, which typically carry lower margins.
Net income for the quarter was $10.2 million or $0.08 basic and diluted earnings per share, compared to net income of $18 million or $0.15 basic and $0.14 diluted earnings per share for Q3 2015.
Proprietary production revenues for Q3 2016 were $12.1 million, a decrease of 20% compared to $15 million for Q3 2015, partially a result of certain titles being delivered early in Q2 of 2016 as we noted on our call last quarter.
For Q3 2016, the company added 63 proprietary half hours to the library up 5% versus 60 proprietary half hours for Q3 2015. For Q3 2016, distribution revenues were down 21% to $23.9 million from $30.5 million for Q3 2015.
A tough comparison as previously mentioned Q3 2015, distribution revenues included $12.8 million in streaming revenues for Degrassi, approximately $6 million to $8 million of which represented a catch-up from Calendar 2014. Management continues to see strong annual growth from new digital customers, platforms and territories.
DHX television revenues for Q3 2016 were down 23% to $15.7 million from $20.4 million from Q3 2015. This was within management's expected range based on the Q2 2016, MD&A. Management has slightly reduced its annual revenue expectations for DHX television.
M&L-owned revenues for Q3 2016 were $10.4 million, up 63% compared to $6.4 million for Q3 2015. For Q3 2016, M&L-owned revenues included $3.65 million from the 22 city Canadian lag of the next step while driven for compared to Q2 2015, which included combined revenues of $2 million for the next step live tour and Yo Gabba Gabba! LIVE! Shows.
Excluding the live tour revenues management was very pleased with the M&L-owned revenues for Q3 2016, which were up 52% as the company continue to recognize revenues related to the non-refundable minimum guarantees associated with Teletubbies in the Night Gardens and Twirlywoos.
M&L-owned revenues were above the midpoint of management's quarterly expectations based on the Q2 2016 MD&A, largely a result of the quarterly timing of recognizing certain of the minimum guarantees.
M&L represented revenues for Q3 2016, increased $3.9 million to $7.4 million compared to Q2 2015 at $3.5 million and were above the high end of management’s previously reported expectations from the Q2 2016 MD&A. As a result, management has increased its annual revenue expectations for M&L.
Revenues from producer and service fees came in at $14.2 million from Q4, Q3 2016, an increase of 71% versus the $8.2 million for Q3 2015. This was at the high end of management’s expectations and as a result, we’ve increased our annual revenue expectations for this particular business line.
Turning to SG&A, cost for Q3 2016 increased 18% to $19.3 million, compared to $16.4 million for Q3 2015. This reflects increased levels of SG&A associated with DHX’s brands, DHX’s distribution. DHX brand and DHX distribution's management has continued to add resources in these areas to take advantage of the M&L opportunities associated with Teletubbies and Twirlywoos and the global expansion of digital distribution platforms including opportunities in China.
Resources have also been added and will continue to be added to grow the company’s recently unveiled WildBrain multiplatform kids network. The Q3 2016 SG&A also includes accruals for certain contractually required incentives, a direct result of the strong year-to-date performance of CPOG, the company’s M&L represented business unit.
SG&A includes $1.5 million in non-cash share based compensation, the result of the accelerated vesting of certain stock options based on performance. When adjusted, cash SG&A at $17.8 million was slightly above the top end of management’s quarterly SG&A expectations.
Management has reaffirmed its favorable outlook for fiscal 2016 with ranges presented in our Q3 MD&A and targeting a midpoint of $302.5 million in revenue and 59% gross margin for the fiscal year.
For further specifics on our Q3 2016 results as well as additional information on management’s fiscal 2016 outlook and various other information including our reconciliation of GAAP and non-GAAP financial measures I would refer to you -- I refer you to the company’s 2016 Q3 MD&A, which was posted on SEDAR and EDGAR this morning.
I’ll now turn it back to Dana.
Thank you, Keith. After 10 strong years of execution, we're for the future. We have the proven track record of delivering on our commitments. We've taken action to strengthening our capital structure so that we can take advantage of opportunities as they arise. We are building a company for the future while delivering strong results.
With that, we'll turn the call over to the operator for questions from analysts.
Thank you. [Operator Instructions] Your first question comes from the line of Aravinda Galappathige with Canaccord. Your line is open.
Good morning. Thanks for taking my question. I'll start with the Squad side, I was wondering maybe Dana you can comment on the composition of the Squad sales, the transition we’re seeing historically most of the sales was in those bundled deals where you sold X number of titles all in one to say Netflix or Amazon, obviously moved this -- movement in that towards the more title by title sales.
I was wondering if you can just talk to that and how that's driving the growth and the average pricing and where you see that going on a go-forward basis?
Great, thanks Aravinda. Thanks for that question. Good morning. So yes, exactly -- the trend we're seeing is exactly as your question would dictate. Right now what we’re seeing is from Netflix, Amazon and others, we’re seeing a real trend towards originals and I think this really is being driven by the fact that they've both come out publicly recently to just saying that kids is providing a real stickiness to their subscriber base.
And so in the past I think they're less than 25% of their entire content spend has been allocated to kids. Now they're ramping that up considerably and I think they're in excess of 30 new shows that they're out there basically commissioning as we speak.
So what that is presenting is a major opportunity for us in the original department and really the high as we've discussed in the past, the A titles are getting a much higher per half hour fee from those Squad platforms. And so we're seeing a bit of a transition from a lot of library deals in the past to fewer deals, but higher price point for the original content.
And we’re servicing that trend move from I think a year or two ago, we had in excess of 65% of our distribution revenues were related to library titles and I think that's probably moving more towards 50-50 ratio and going forward we think it might even imburse back to serve a 60-40 on the original side.
Great. Thanks for that. And just switching gears to Teletubbies, the comments you made about the initial product sales in general, wondering if you can provide a little bit more clarity, when you said it's like -- you said it's one of the strongest performing children's toys at the initial stages.
Just wondering what comparisons you're looking at and related to that, can you just remind us what the path is from here? When is the North American launch scheduled for you?
Right, yes, thanks for that question Aravinda. Yes, so -- we're about two and half months into the launch. The industry standard out there is MPd. So a lot of the licensing revenues and sourcing is coming from those statistics, but right now today, we're in the top 10 on a few different product lines and certainly in the top -- we're in the top five actually of new product launches in the U.K. and there is only at the moment, and less than 10 skews out there in the market for a great period of time.
We now have many, many skews that are in the market as of last month and we're looking forward to results -- further better results in the next quarter or so and what I would say on the U.K. is we're off to a very fast start and all of our licensees are extremely excited and we're all keenly gearing up obviously for Christmas.
The other thing I would repeat here is we've got strong commitment from U.K. retailers, which of course is a huge boost to the whole cycle for us in actually achieving success in the toy market. It's great we've got the product out there, but you got to get the commitment and we're seeing that as well.
The second part of your question on the North America and the rest of the world, toy rollout, Canada will see some product come into the market in summer of 2016. Now remember we usually typically like to have six months to nine months of lag between the show gets on the year in the particular territory before toys come out and so you'll see that 6 to 12 month lag happen once if the show is starting to broadcast in each of the territories and the next start of the territory that everyone on the call is looking towards is the U.S.
As Michael said, we're very pleased now that Nick Junior has rolled out the launch date, which is May 30 I believe in 2016, so very soon. We're obviously expecting big things out of the Teletubbies and there we're getting great commitment and interest from Nick Junior which has in part moved out forward.
And then the toys will come in early 2017 after we've had it in the market for I guess it's stayed eight months or so. So this is really a 2017 story and on into '18.
Great. Just two more quick ones for me. I'll ask them back to back. Number one, with respect to WildBrain, the Multi-Platform Network, I was wondering if you can -- not sure if you can comment on it, but I was wondering if you can talk to the prospect of given the valuations we're seeing for these entities, given what DreamWorks has been doing.
Is there a likelihood or maybe a thought around spinning out or selling a stake, a minority stake to crystallize that value? And then number two, on the production spend, I was wondering either Dana or Keith, if you can just talk to the way you see the cash production spend headed in 2017, thanks?
Okay. So I'll take the first one and do a top level on the second and I'll turn to Keith for any follow-up. So on WildBrain, all things are on table. One of the reasons that we've unveiled it obviously is to get the brand out there to a greater extent number one, but also to explore things like strategic partnerships.
We felt quite bluntly that we weren’t getting proper value for WildBrain. It's valiant part of DHX. Right now it's currently trading at a multiple of the EBITDA that we'll be generating in that particular piece of the business. We think that obviously the prospects are much greater.
So we're exploring all things and including potential strategic partnership and also growing inorganically on our own. We now have some resources as a result of our recent capital top-ups that will provide us some fuel there we think. So stay tuned. It's an exciting area.
Mobile we think is a huge space for us and really why we're excited about this is obviously the brand it's building and more eyeballs or the eyeballs are increasing, with increasing eyeball's ad revenue, potential goes up hugely and new platforms like Facebook and Daily Motion, which are looking to launch, which we're looking forward to really some great upside there and then lastly of course consumer products potential we think with respect to that business.
With respect to, I'll move on to your second question production spend, right now I think we're net for the first nine months or around $50-ish million of investment in content around the slate. This has been the factor this year that has been a very heavy year.
Number one, we're transitioning from our old arrangement to our new one, which require investment heavily and in particularly live action where family channel we feel needs to be -- continue to be going forward. So there is a really heavy spend there.
And number two, we also saw some opportunity on our own just in terms of live action. So right now Keith will get into the numbers of shows, but we've got many, many live action shows that are going. What happens on live action of course is it's a heavy spend upfront and it happens within a couple of months versus animation, which is typically over a couple years and much more predictable and stay as she goes.
And the last item is really is we're seeing a real opportunity in the platforms as we talked about earlier and the question with respect to Netflix for growth and as we're seeing that, we want to take advantage to capture further market share, but growing our library doing what more of what we do well, which is growing our strong kids brands, which we think will pay off dividends in the long run through multiple revenue sources, but particularly in consumer products. And Keith I don't know if you want to add to that.
Sure, yes, just a couple things to Dana's point, we had nine shows with deliveries in Q3. That number and we had another, we had 11 shows in progress at March 31 that had what I would say material spend on them. That number will come down a little bit for Q4 and then begin to reverse as we ramp into the normal production season into Q1.
Great. Thanks a lot. I'll pass the line.
Your next question comes from the line of Bentley Cross with TD Securities. Your line is open.
Good morning, gentlemen. I just wanted to ask initially about the growth outlook. Traditionally you talked about kind of the 10% and 10% mix of 10% organic 10% acquisition. Just wondering as we're looking out to the future, is that kind of still the way you're thinking.
Yes absolutely Bentley. I think that as the company has evolved, in the past those would have been company specific opportunities like we did on either for say Cookie Jar or Epitome or even Nerd Corps. Now what we're seeing though is opportunities on the acquisition side, really more on the platforms expansion and the strategic alliance side.
Very much those opportunities are continued and have accelerated in the last 60 days or so and what I would say is really the focus really is more on specific brands, global brands, things to round out and broaden the portfolio. As we talked about in the past, the Girls category is an area of interest for us to expand into and we've made good progress with some development shows and our two -- two of the five properties that we have from Mattel in Polly Pocket and Rainbow Magic.
But we're also seeing some really interesting opportunities and I would say stay tuned in that regard because I think we're pretty excited about where the future will go there. Upon the organic side, yes absolutely we're seeing great opportunities for growth and they all really are sort of three core areas for us, which is content, platforms and new territories.
And related to that, just reading between the lines there, I know your commentary on acquisitions driven by increased pricing in the market. Is it harder to get those deals done and still be accretive than it was two, three years ago?
It's interesting, obviously it's kind of an interesting moment in the cycle. I think our view is that the prime, the absolute prime assets are to you point going at extremely prime prices. As evidenced, the DreamWorks deal at somewhere between 18 to 19 times announced 10 days or so ago.
So we're seeing high prices for the absolute prime and we are in that prime category. We don’t really need to grow our library for the sake of just critically mass now.
I think on perhaps on some of the private ends, there are some opportunities for accretive deals and we think that really the angle for us there would be in the territories, expanding in the territories to help broaden our existing platform, but also into -- in the new areas, which is things like mobile and some consumer products opportunities which I think -- we think there is some really interesting accretive deals to be done there as well.
Okay. And then sticking with the theme of growth, obviously CPLG has done tremendously this year, but obviously those serve as very difficult comps next year given the pipeline and the fact that probably Minions is not going to be the same type of hit it was this year, should we still expect growth for that business next year?
Well, growth in merchandizing in revenue, licensing revenue absolutely, but on the proprietary side, obviously we haven't formulated our guidance yet. We'll do so in the next few months, but looking into the future I would say, you're right that Minions will be hard to expect tremendous growth in the CPLG business.
Having said that, we don’t think it will decline to any great degree and we’re still evaluating, but yet that will provide at a bit of a tough comp, but we think that the Teletubbies M&L, Twirlywoos M&L and many other things that we're developing in our own slate will make it up and then some and obviously on the margin side in the long term that’s a much better bank for our buck.
Okay. And last one just a housekeeping one for Keith, what FX rates you are assuming in your guidance Keith?
We basically have assumed about one in a quarter.
Okay. Thank you.
Thank you, Bentley.
Your next question comes from the line of Deepak Kaushal with GMP Securities. Your line is open.
Hi, good morning guys. Can you hear me okay?
Yes Deepak. Good morning.
Hi. So I had a couple questions, I'll try to be brief, first just to follow-up on the WildBrain opportunity, did I hear correctly that it was $30 million year-to-date and that’s I guess that’s roughly double year-over-year is that correct?
Yes, that’s nine months yeah.
Okay. Does that now include more than just YouTube? Can you offer a breakdown? I know that you have a similar deal in China with CCTV. Is that part of this venture?
We have some early new platforms, but there is really nothing material in there. Most of that -- that’s all YouTube right now.
Okay. But it's safe to understand then that all of your Ad bought business would be kind of under the banner of WildBrain is that correct?
That’s correct. That’s correct yeah and obviously those platforms have launched and we're very excited about those going forward including Facebook as well in addition to the opportunities you mentioned.
Okay. And can you offer any kind of further insight or details on the split between six and variable cost is this business profitable or one might be the crossover point for profitability in that period?
Fixed and variable cost on WildBrain?
Yes on WildBrain.
Yes, the fixed cost rate now we have we’re -- we’ve got the great advantage that all of this is library content at this point. So, it’s basically 95% plus cash margins for what the net that we get from YouTube obviously.
We’ve ramped up to Keith's point in past SG&A quarterly updates, we’ve ramped up to the tune, I think we’re running at $3 million or $4 million annually I think in SG&A related to that particularly category and so we’re looking to ramp that up a little bit.
So, right now it’s very profitable, but we think that there is a real opportunity for growth there. So we’ll -- this will be a big area of focus for us and obviously for our guidance for the next quarter.
Okay. Great. And I guess going forward do you expect to split between your own content and third party contents just the 50-50 evenly split and presumably then that implies the margin for third party content slightly lower than your own content, how should we think about the margin performance this quarter?
Well, I think that the split its settled in at 50-50, but I think that there is the opportunity that we’re seeing on the content side from a capacity perspective particularly when you look at the strategic partnership we have with Mattel and DreamWorks.
We will be using some of that capacity for rights, content that we have rights and additional revenue streams on. So, we think that’s probably going to grow probably there were 64 or maybe even a 70-30 from a proprietary perspective.
On the -- if you’re asking, your question was the gross margin for the particular category. Obviously production revenue it varies show by show, but I think historically the production revenue margins for both have been relatively similar, the big upside obviously on the original shows is rights for the future, which obviously will generate revenues and margins for years to come.
Okay. Great. Great, that's helpful. I guess what I leading towards is when we look at this business versus other multi channel networks whether it's on YouTube or other platforms, you guys bring a large library of own content in these relationships with Mattel and DreamWorks.
Should we expect higher margins for your business relative to some of these other multichannel networks, whether its sports or kids related or whatever?
Yes, absolutely, absolutely. That’s a huge -- that’s a huge competitive advantage that we have over all of them at the moment because it’s a 100% owned by DHX. WildBrain own its content, which most of these channels don’t rent it. So, its huge advantage going forward.
Great. And am I correct to understand also that you will be negotiating the advertising rates directly with the advertisers rather than the platform. So you'll be assuming that responsibility on behalf of the Ad platform like YouTube is that correct?
Well, that is -- that is a likely outcome. It's not something that we are currently doing but it's something that we’re looking at in terms of potential to increase the Ad dollars. A better curation, a better matching of our content to directly to advertiser.
So, whether we go to the step of having our own sales team or whether we get more embedded with the platforms and work to curate, yet to determined. We’re looking at both of those potentials.
Okay. Great. That’s helpful. We'll watch that business very carefully and closely going forward. The second category question I wanted to ask, you offered a great history of where you've come from over the last 10 years.
In that period of time how have your average return expectations changed or increased on your production? Clearly you're getting more participation revenue streams on the M&L side and the distribution side and even live action side.
Yeah, absolutely I think the model has evolved greatly. I think that in the beginning thanks for that question. We were focused on getting the infrastructure, the four pillars, or at least three pillars and then the TV being a bit of a bonus pillar, but the three pillars being content and vertical integration the studios, distribution and then obviously licensing as the third.
And so those are -- those were the areas that we invested in heavily early on which from a infrastructure play meant that the return on those equity was lower in the early years. We had a good track record over the last three, four years as those -- the platforms have expanded and we’ve had great margins and obviously distribution licensing, so those have increased to a great degree.
I think going forward to your point we've now clearly established that we can produce content for the global market. In the beginning I think folks that we were just going to be delivering singles and perhaps the odd double, to use a baseball analogy, but we absolutely now can deliver homeruns and I believe we have a couple already that were -- that are in our portfolio and more to come.
So, margins obviously will go up tremendously and therefore the return on equity we think has huge potential going forward.
Okay. So margins going up, now I guess in the same vein, now that you have more participation on this longer tail, does the amortization when you -- of the new content that you create, does that -- has that extended, has that changed materially or do you expect the margins to ramp up as you started them?
The gaps dictates what the amortization terms are. So, that those haven’t changed from day one. What changes is really your future revenue potential, what Keith probably touched a minute about the ultimate revenues and those really is again you can’t really estimate those until you have a history and so now that we have a history and increasing new platforms and new distribution opportunities then, yes there is an ability to also project and then to hit those projections.
One of the great things that we’ve done is we’ve hit our projections for many, many years going back to basically day one. So, we were very good at estimating and exceeding those expectations.
So as new platforms come on, those represent new opportunities for revenue which ultimately you still -- your costs have to be amortized over the same period of time, but your revenue base is increasing. So margins therefore have gone up and should continue.
Okay. So on the cost side, the amortization period of the cost side in the number of years hasn’t changed materially?
Okay. So the margins should go up as you captured those great. Very helpful, Thanks again guys. Looking forward to Q4 later in the summer.
Your next question comes from the line of Drew McReynolds with RBC. Your line is open.
Thanks very much. Good morning.
Good morning Drew. Welcome Drew.
Yeah, thanks. So Dana just three kind of big picture from my end, first just when you look at what Comcast is proposing to do with the DreamWorks Animation, does that impact your relationship down the road with them in anyway?
Second just can you provide an update on just the television ratings at DHX Television? And then lastly, when you look at your territories that you're targeting where you see the greatest potential?
Obviously you made some announcements in China over the last several months, which are the unexploited but large potential territories that you see let’s say over the next, two three years. Thank you.
Okay. Great. Thanks. So, relationship with Comcast and DreamWorks with Comcast we think that the relationship is still significant going forward. Obviously with DreamWorks they've filled in a bit of a gap with respect to kids content although their content really is within film category and really didn’t cross over too much with respect to ours. So really we think there is a big opportunity in preschool and drills going forward with Comcast and really many other platforms.
On the DreamWorks side, I actually just had a phone call with the CFO last week. So, it’s business as usual on the commercial side. So we think there is some real interesting ways to partner going forward and we don’t really see any, any -- certainly no downside on that, if anything upside given that obviously they’ll have a much bigger balance sheet and more focused long term strategy then they had as a single relatively small public.
So, that’s on a relationship side. On the TV rating side, look on the linear world, TV ratings across all kids platforms have gone down. There isn’t -- I don't think anyone in all of North America that has been saved.
In Canada what’s really happened is an interesting certain dynamic of three new channels coming into the network in addition to our channels. Obviously the Disney channels all came on stream as well and really I think what is the bigger factor is those -- the same number of kids although having said that, not really the same number of kids, that decreasing number of kids on the linear world and more that we're seeing growth obviously on the -- going to the on-demand platforms.
So, a small pool if you like of viewers, viewership potential, which is now being split over not 10 channels, but now 13 channels and so everyone’s pretty well down now. Our ratings, there is a bit of a transition going on. Obviously we always knew that this is going to be the case and in the long run we're very optimistic with our strategy in developing long term content because we're seeing great ratings globally.
So we’re very optimistic. Right now there is that transition period, which we're working through. The good news on our side as we've got, as we mentioned in our MD&A, we got all of our long term big three contracts locked in for years to come. So, it provides a really nice stable subscription revenue base for years to come, which gives us some opportunity to work on the ratings and we’re very optimistic on that side.
To your third question territories unexploited, China is the big one. We really, really, really feel that we had some discussions recently over the last week that there -- them moving off the one child policy, some statistics are there should be within relatively short period of time, the incremental 20 million new kids come into that market and our programming being preschool, we think we’re just right in the sweet spot.
And we also think that the, the government is getting pressured to loosen up the content to some degree and we think that the kids category is one that’s the least politically motivated and so we think has the best potential for the future.
We’re aggressively trying to figure out the right partners of how to go to market. One of the big things obviously in China is assessed of IP and so we really feel strongly that the real partnership of the local presence that has the wherewithal, the desire and the ability to enforce things like that, shutdown the fees and move towards a more original authentic licensing program, we think that there is a real appetite for that in China.
Also I think India is another category, territory which is usually complex. It’s more than a billion people in India, which have grown up on mobile devices and Smartphones. We’re thinking that that could be a potential opportunity as well. So those are the two big ones.
Thanks very much.
Your next question comes from the line of Adam Shine with National Bank Financial. Your line is open.
Thanks a lot. All my questions have been answered already. Thanks.
Your next question comes from the line of Doug Creutz with Cowen and Company. Your line is open.
Okay. Thanks for taking my question. If just look at the broader market for television content, I think the number of shows in the air and defining that broadly to include on linear stuff has doubled over the last six years and there has been some debate about whether ultimately that’s a sustainable level of investment really hasn’t doubled.
If you look at your specific vertical the Kids category, how would you say the growth rate in the supply -- in the industry has compared to that over the last six years to the extent that's been faster or slower, what's driving that? Thanks.
Thanks Doug and welcome. On our side really with us in particular the vast majority of what we do is animation. So it’s been slower to come on stream for a multiple number of reasons, but the biggest one is that animation takes a couple of years to develop and then two years to produce. So there is a bit of a time lag in respect to that. So there is many people like us that are out ramping up.
Number two Kids has always been if you go back to all the other cycles, there has been kind of the last one to come along and arguably in other cycles never really developed and that was because most TV literally was always focused on advertising and kids in particular in most jurisdictions, there is regulations around advertising the kids.
And so it was always an abandoned, but yet in the wholesale there was tremendous demand because as we’re seeing for those on the call that have kids or no kids, they are increasingly going to the on-demand world, which is increasing the appetite or content throughout the world.
And so really I think this is -- you hit on exactly why we set up DHX in the early day and then I think why there is tremendous upside potential still going forward whereas some of the other the genre has the content has -- the supply I would say has met demand at this point. We still think there is a gap at least for the next little while.
Okay. Thanks. That is very helpful.
Your next question comes from the line of Robert Peters with Credit Suisse. Your line is open.
Hi, thanks for taking my question. Dana, may be if we just at the Mattel deal, I think obviously you guys have already seen some additional expansion from the original shows announced.
Just wondering how should we think about the run rate investment level with your relationship with Mattel are we at -- where do you kind of see that peaking or more importantly are we at the point where we're couple quarters out from the run rate investment or are we there already?
No, we're definitely a couple of quarters out from the run rate investment peaking. We started developing on the original four that we picked up in December and one of those actually was a show that was already going on in our studio little people so, that certainly that investment has been ongoing and this probably ramped.
But with respect to the other three shows, we're looking at building those out. The thing that you have to note of course is that development typically is a minimum of six months to up to two years now. We won't probably take the full two years on any one of these shows including Rainbow Magic.
But there is a bit of a lag time and we think that by the time that this reaches its peak, some of the other initiatives that we had in terms of live action growth, that we've seen in terms of our content spend we'll be pulling back. So, we think we’ll get to a relatively steady state say three, four quarters out.
Perfect. Thank you. And with that deal I think Rainbow Magic was particularly interesting given its not -- it's not something that has had a TV property before. Do you see more opportunities to do some of that where it's not necessarily a kind of rebooting of a very popular series but more of a taking a new property and bringing it through.
Absolutely, I think that one of the real opportunities that we have is we have our own library that we are mining, but as we got more and more not only with Mattel, but other large licensing IP holders, we’re seeing that more and more of them are acknowledging that we need scale in content creation and distribution which is the absolute critical piece.
And just because you're good at making toys or whatever it might be, it doesn’t necessarily mean that you’re great at making and distributing kids content. It’s one of the areas that obviously has huge strength for us and so we really think that there is a lot of these strength on strength relationships that we can use going forward to build.
Perfect, thank you and maybe one last question switching to distribution side of the business and apologies if this is kind of already been addressed but I was just wondering if you could give us an update on kind of the pricing trends you’re seeing on the digital distribution side in terms of like perhaps particularly as we are seeing less episodes coming out of the library?
Yes we touched on it a little bit off the top, but happy to answer it again. Pricing what I would say on is the prime shows are pricing at increasing -- the prices are increasing at a pretty rapid pace. In some cases those prices are in excess of 100% of the budget and we see that accelerating at least for the next few quarters.
With respect to library, it’s growing, but not at the same pace. I think for us really it’s a point that came up in the last question is the mix is moving more from the past where we did a number of library deals to more balanced perhaps you point where the future will be which is ultimately going to say 60-40 on the original slate to the library.
Perfect. Thank you very much.
Your next question comes from the line of Bentley Cross with TD Securities. Your line is open.
Hi guys, I just wanted to follow up on margin expectations. Dana you had highlighted the potential to see margins increase over time but at the same time if we see more originals versus current library deals, to me that would suggest that margins would actually fall. Just wondering if you could help me reconcile those two ideas?
Well short term you’re right absolutely. Over the next 12 months, you would see some compression but in the long run prime wins and prime assets tend to have much longer tail and therefore ultimately have more value in the library going forward. So there is a bit of a reconciling between the current amortization policy versus building for the future.
Your next question comes from the line of David McFadgen with Cormark Securities. Your line is open.
Thank you. I have a couple of questions. Could you give us the actual number of license source that you have for Teletubbies right now?
65 global David.
65 okay. And now that you've completed the bond offering, are the debt covenants expected to change or are they staying the same?
No change to the debt covenants. We were at 2.9 times. Obviously we'll have flexibility going forward to take a look at that because in terms of the number of -- the amount will be well below.
Okay. And then you talked about ratings for Family Channel, you acknowledged that they're down, but can you give us how much they are down year-to-date and you talked about the fact that your three largest distributors you've signed distribution agreements with them.
So they're locked in, but are there any ones that are coming up for over the next 12 to 24 months?
Well I'll deal with the second one first. So there is always -- we have around eight or nine customers in that business and they all come up from time to time. The three big ones which represent 85% of the overall revenue base are locked in and yes, there will be some of the small but mighty ones that will come up over the next couple of years.
But we -- touch points on all those and we're quite optimistic that from -- in terms of a where we're going to be offered is in a similar place to where we are now. Where we're seeing the future obviously we've offered some reduction with respect to the locking down on the big guys that we expect that some of that will be happening in the smaller guys too.
As we've mentioned, we've already updated our annual guidance, so we're pretty comfortable and we think that that's a really relatively stable revenue base going forward.
On the rating side, we've seen and I would say in the double-digits in terms of some decline. As you know rating is a very difficult one to kind of pin down because some shows are rating as well as they've always been in terms of next step and we're seeing some real uptick in terms of some of the live action stuff and so some of those are still rating number one and increasing, but overall I would say we're down in the 10-ish%.
Okay. And then just on WildBrain, you talked about the fact that most of the content is library content, but I think you said 95% margin. We think a lot of those shows still have some book value on your balance sheet that you have to amortize?
Yes they would in terms of when I said cash margin is around 95%, the amortization obviously would go back to what the normal rates are. So it's not going to be that high. It maybe 65% in terms of the P&L.
But that doesn’t -- that still gives you the extra 30 points in cash flow to invest in the rest of the business.
Okay. Okay. That's it for me. Thank you.
There are no further questions. I'll turn the call back over to the presenters for closing remarks.
Thank you very much for joining us today. If you have any further questions, please feel free to reach out. Thank you.
This concludes today's conference call. You may now disconnect.
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