Viacom Inc. (NASDAQ:VIAB) Q1 2017 Results Earnings Conference Call February 9, 2017 8:30 AM ET
Jim Bombassei - SVP, IR
Bob Bakish - President and CEO
Wade Davis - CFO
Doug Mitchelson - UBS
John Janedis - Jefferies
Alexia Quadrani - JP Morgan
Ben Swinburne - Morgan Stanley
Richard Greenfield - BTIG
Michael Morris - Guggenheim Securities
Kannan Venkateshwar - Barclays
Anthony DiClemente - Nomura Instinet
Good day and welcome to the Viacom First Quarter 2017 Earnings Release Teleconference. Today’s call is being recorded. At this time, I would like to turn the call over to Senior Vice President of Investor Relations Mr. Jim Bombassei. Please go ahead, sir.
Good morning, everyone and thank you for taking the time to join us for our December quarter earnings call. Joining me for today’s discussion are Bob Bakish, our President and CEO; and Wade Davis, our Chief Financial Officer.
Please note that in addition to our press release, we have slides and trending schedules containing supplemental information available on our website. I want to refer you to page number two 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.
Today’s remarks will focus on adjusted results. Reconciliation for non-GAAP financial information discussed on this call can be found in our earnings release or on our website.
And now, I’ll turn the call over to Bob.
Thanks, Jim, and thanks to everyone for joining us today. It’s early days in our effort to chart a new course for Viacom, but I’m happy to say, we made solid initial progress financially and operationally in the first quarter, and we made excellent progress on our go forward strategy.
Financially, we generated good momentum in the quarter including a return to revenue growth in our Media Networks and Filmed Entertainment segments. An increase in affiliate revenue and strength in our international operations drove top line growth in our Media Networks, while a stronger slate at Paramount drove greater returns at the box office. Of course, we still have work to do. Operating income declined in the quarter due largely to increased programming expenses at the networks and marketing costs at Paramount.
Operationally, we’ve quickly made strides against our most-immediate priorities in my first two months on the job. First, and broadly speaking, we’ve done a lot of work strengthening the management team. With important new leadership announcements across Paramount Pictures, our domestic networks Viacom International Media Networks and U.S. distribution. Second and speaking of U.S. distribution, beginning the work of strengthening our distribution partnerships has been a key area of focus. I’ve been spending time with a number of these clients and the team under new leadership is already at work pursuing broader, more forward thinking partnerships that reinforce the value of the pay TV ecosystem and our brands, and the take advantage of some assets that previously were not part of the equation.
Third, MTV has been a key focus where already our new leadership is making progress. The new team is working quickly to stabilize the grid and provide a stronger foundation from which to launch new series as it continues to jump start the development pipeline. Fourth, over Paramount, our new COO is now in the lot and we completed an important agreement with Shanghai Film Group and Huahua Media, giving Paramount two new strategic partners in China and a deal that we estimate could bring as much as $1 billion of slate funding to the studio. On a related note, I would like to extend a well-deserved word of congratulations to the studio for receiving 18 Oscar nominations for seven of its 2016 releases.
That said, the financial performance of the studio in that quarter was a significant disappointment. But nevertheless, we will continue to be very focused on strengthening Paramount, particularly as we evolve our strategy; more on that in a bit. Finally, we rapidly unlocked value from our Telefe acquisition, boosting rating significantly with the new Nick Jr. block, driving MTV up in the rankings with a hit new series that airs daily across MTV and Telefe, and bringing a major new consumer product to advertiser to our pay networks.
As we strengthened our team and attacked our media priorities, I also engaged dozens of our top leaders around the Company to develop an overall go forward strategy for Viacom, a strategy that captures the opportunities we see to better harness the power of our portfolio, strengthen our relationships with our partners, and enhance our ability to create great content, and one that will strengthen the Company overall and return us to growth.
We presented to and received resounding support from the Viacom Board on that strategy earlier this week, and I want to share with you the highlights today. But before I do, let’s turn it over to Wade for a look at the financials.
Thanks Bob, and good morning. We’re pleased to report our financial results for the December quarter of fiscal 2017 which are highlighted by our progress along certain key operating metrics and initiatives. In the quarter, we returned to revenue growth at both Media Networks and Filmed Entertainment and we saw significant improvement in free cash flow generation. We also took steps to extend our near-term maturities to enhance our liquidity profile, and we entered into a multiyear slate financing deal which helps derisk Paramount’s current and future slate and reduce the capital we deploy in the film business.
In addition, on slide five of our earnings presentation, we have provided a breakdown of Media Networks domestic versus international revenue. So, we hope you find the additional disclosure helpful. With that, I’ll turn to our operating results.
In terms of consolidated results, Viacom generated revenue of $3.3 billion, a 5% increase over the prior year, and adjusted operating income of $748 million. We generated adjusted earnings per share of $1.04. Our return to top line growth was driven by growth in domestic affiliate revenues, continued strength at our international operations, and robust theatrical revenues. We also generated operating free cash flow of $113 million in the quarter, an improvement of $265 million versus the prior year.
Slide four of our web deck provides a financial overview of our Media Networks segment. Revenues for the quarter increased by 1% to $2.6 billion while adjusted operating income declined to $987 million. Worldwide advertising revenues declined 2% while affiliate revenues increased 2% and ancillary revenues increased 20%. Excluding a two-percentage-point unfavorable impact from foreign exchange and a one-percentage-point positive impact from the November acquisition of Telefe, worldwide revenues increased 2%.
Slide five of our web deck provides a breakdown of our Media Networks’ domestic and international revenue performance. Domestic revenues largely flat at $2.1 billion, and we had another strong quarter at our international operations as revenues increased by 5% to $534 million. On an organic basis, if we exclude a 13-percentage-point unfavorable foreign currency impact and eight-percentage-point positive impact from the Telefe acquisition, international revenue grew 10%.
At our domestic Media Networks business, we saw return to growth in affiliate revenues as well as strong growth in ancillary revenues. The growth of 2% in domestic affiliate revenues reflects rate increases and the impact of SVOD and OTT agreements, partially offset by a modest decline in pay TV subscribers. The 10% increase in domestic ancillary revenues was driven by higher home video revenue.
Domestic advertising declined 3% in the quarter, consistent with our guidance of 500 basis-point sequential improvement. International advertising revenues increased 1% in the quarter. Organically, if we exclude a 15-percentage-point unfavorable impact from foreign currency and a 10-percentage-point positive impact from the acquisition of Telefe, international advertising revenues grew 6%, reflecting the continued strength in Europe.
International affiliate revenues increased 3%. Excluding a 9-percentage-point unfavorable impact from foreign currency, international affiliate revenues increased 12%. The growth reflects the impact of rate increases, subscriber growth, and new channel launches as well as higher revenues from SVOD and OTT arrangements.
International ancillary revenues were up 33% due primarily to strong growth in our international consumer products business as well as program sales resulting from our acquisition of Telefe. Growth in consumer products was driven by the strength of our kids’ brands, including Paw Patrol and Blaze and the Monster Machines.
Worldwide expenses increased 6% in the quarter; within operating expenses, programming expenses up 6% while distribution and other expense decreased 3%. SG&A expense increased 9% in the quarter. Excluding a 2-percentage-point increase attributable to Telefe, worldwide expenses increased 4%. The increase in programming expense in the quarter was principally driven by our investment in original programming. The increase in SG&A costs was principally due to the higher incentive compensation accrual.
Overall, we are pleased with the progress we’re making at Media Networks. With the changes we’ve made so far as well as the strategy for the brands that Bob will outline, we believe that our Media Networks are well-positioned for future growth.
Now, turning to Paramount. As I mentioned earlier, we have taken steps to derisk the 2017 slate and enhance cash flow through our slate financing. It is a three-year agreement with an option for a fourth with Shanghai Film Group and Huahua Media to fund 25% of our slate. This agreement will help us to derisk the entire 2017 slate since it’s retroactive to the beginning of the fiscal year. The agreement also provides for the potential co-production of Chinese films.
Now, turning to our results for the quarter. Filmed Entertainment revenues increased 24%, principally driven by gains in theatrical and ancillary revenues. Slide six of the earnings presentation provides the breakdown of Filmed Entertainment revenues. Theatrical revenues increased 104% or $192 million due to our current quarter releases, including Jack Reacher: Never Go Back; Ally, Arrival, Office Christmas Party and Fences. Ancillary revenues increased 86% to $78 million, driven by the impact of the film slate financing in the quarter.
Filmed Entertainment generated an adjusted operating of loss of $180 million in the quarter, reflecting higher print and advertising costs related to the release of our Q1 fiscal 2017 theatrical releases.
Now turning to taxes. The adjusted effective tax rate was 30.8% compared to 32.8% in the prior year. This is driven by the mix of domestic and international income. Slide 10 of the earnings presentation provides the components of free cash flow. For the quarter, we generated $113 million of operating free cash flow, a $265 million improvement versus the prior year. The improvement in free cash flow versus the prior year was principally due to lower working capital utilization, reflecting the timing of film and programming spend.
Now, looking at our debt on slide nine. It remains principally fixed rate with an average cost at quarter end of 4.5%. We had $12.3 billion of total debt and $443 million cash and cash equivalents. At the end of the quarter, our leverage ratio was 4.1 times.
During the quarter, we took several steps to address our near-term maturities and liquidity needs. In October, we issued $400 million of 2.25% senior notes due 2022 and $900 million of 3.45% senior notes due 2026. The proceeds were used to redeem $400 million outstanding of our 2.5% December 2016 notes and the $500 million outstanding of our 3.5% April 2017 notes. One of our top priorities is to strengthen our balance sheet and optimize our capital structure to support our long-term strategic initiatives. Accordingly, in terms of capital allocation, we plan to use our excess free cash flow and other actions to delever in order to preserve our investment grade rating.
Now, let’s turn to some of the factors impacting the remainder of fiscal 2017. In terms of advertising, we continue to see strong demand in the scatter market, which bodes well for the upfront. Looking forward, we expect the shift of the Easter holiday into the June quarter of this year will have a negative impact of around 100 basis points on the March quarter domestic ad sales performance. Excluding this impact, we anticipate March quarter domestic ad sales performance would be similar to December quarter.
As for domestic affiliate revenues, in terms of March quarter, we expect to see revenue growth in the low single digits. For the full year, we continue to expect that the growth rate for Media Networks programming expense will be in the mid to high single digits including factoring in the impact of the acquisition of Telefe.
For the full year, Media Networks SG&A expense, we expect the organic growth rate will be in the mid single digits. However, including the acquisition of Telefe, reported SG&A expense will grow in the high single digits primarily due to onetime integration costs. Media Networks performance in the December quarter benefitted from the growth in revenues as well as the timing of expenses as certain show launches moved out of the quarter. Accordingly, given the timing of shows coming on air as well as the onetime cost associated with the integration of Telefe, we anticipate programming and SG&A expense growth to be weighted to the March quarter.
At Filmed Entertainment, our December quarter benefitted from slate financing and the box office performance of certain of our releases. In the March quarter-to-date, some of the box office performance has been somewhat soft; so the benefits we saw in the December quarter will not flow through for the year.
In terms of taxes, for 2017, we’re forecasting a book tax rate of approximately 31%. We will refine this as we go through the year and get a better sense of the domestic versus international profitability mix.
Looking forward, we are excited to execute on the strategic plan that Bob will be outlining for you. Changes at Media Networks are already starting to generate early returns. We are focused on returning key revenue streams to growth, improving our earnings, and driving free cash flow generation. We expect to continue to see improvement as we execute on our strategic plan.
With that, I would like to turn the call back over to Bob.
Thanks, Wade. Now, let’s get into the strategy. Having undertaking a comprehensive review of our business, we arrived at four underlying needs for Viacom. We need more focus. We have to align the Company against areas where we can have the greatest impact. We need to be distinct. Our brands, content and culture must truly be unique and differentiated. We need to unlock the benefits of our scale. We need to better harness the power of our portfolio and grow our competitive strength. And finally, we need to be more adaptable. We need to flex the market shifts, create new opportunities, and strengthen partnerships.
With these in mind, we’ve established a new five-point strategic plan. We will, one, put the full power of Viacom behind six flagship brands; two, revitalize and elevate our approach to content and talent development; three deepen partnerships to drive traditional revenue streams; four, make big moves in the digital world and the physical world; and five, continue to optimize and energize our organization.
First, let’s talk about flagship brands: A strategic shift we are making to better allocate resources and capture broader opportunities for our brands with the biggest upside. So, what constitutes a flagship brand? A flagship brand must have a compelling, valuable and distinct brand promise; it must resonate with the target audience or in a genre that is big enough to matter; it must have a rich offering comprised largely of wholly-owned content; it must be global; and it must have the ability to deliver at for points of distribution, linear television, digital, off channel, and theatrical. So, here are the flagship six: Nickelodeon, Nick Jr., MTV, BET, Comedy Central and Paramount. I am excited to say, we will bring a set of our TV brands to film and our film brand to TV in a major way.
With regards to the first part, TV brands to film. We plan for each of our flagship brands to contribute 1 to 2 cobranded films to the Paramount slate each year with the brand and the studio working collaboratively to source and develop projects for the studio to ultimately green light. As we do all this, note that a significant part of the slate will remain under the Paramount brand with the focus on franchises and tentpoles among other projects.
Let’s look at this approach through the lens of Nickelodeon, a case study of what a flagship brand looks like when firing on all cylinders. The network has firmly established its dominance on TV with kids, finishing the 2016 calendar year as a number one network for kids and basic cable’s top entertainment network. Nick was number one in the December quarter with every major kids demo, 2 to 11, 2 to 5, and 6 to 11 where it notched its first win in more than five years, and it shows no signs of slowing down, with the content pipeline of more than 650 episodes a year, almost entirely wholly-owned, highly exportable content across live action, animation and pre-school. All of that IP sees a multi-billion dollar consumer products business at retail and a growing stable of live tours and events. And as part of our new strategy, I am pleased to announce that Nickelodeon and Paramount are moving forward on a new slate of four films through 2020 that will leverage existing and introduce new Nickelodeon IP.
The first of these films, Amusement Park, an animated feature with Jennifer Garner and Mila Kunis will premier in theatres in summer of 2018 and it will get a TV series on Nick, the following year. And there are additional films including those associated with existing Nickelodeon franchises right behind it.
So, the strategy is not just an idea, we are already moving on it, and know that we are currently putting a structure in place to operationalize this approach across our flagship brands and the studio.
I am also excited to announce that we will be bringing the Paramount brand to TV in a big way by rebranding our U.S. Spike Network in 2018 as the Paramount Network. Adopting the Paramount name and fortifying its programming is a natural way for Spike to strengthen its position as a major general entertainment network which will enhance our adult audience delivery and enable us to grow this important sector of the ad market.
Internationally, we’ve been very successful in capitalizing on the marquee Paramount brand to offer general entertainment channels that feature high-quality programming, movies and documentaries. In fact, the Paramount channel is already the largest ad supported movie channel in the world.
Now, I want to be clear that Viacom has some very important and high-performing brands beyond the flagship six, branded networks that hold strong positions in their categories and maintaining diverse and loyal followings. They will not go away, but they don’t necessarily have global or theatrical potential, and they won’t benefit from an increased resource commitment. We see these as reinforcing brands. And VH1, Logo, TV Land, and CMT have already been realigned within our organization to reinforce the flagship six.
Moving to our next strategic point, maximizing our approach to content and talent development. Historically, Viacom’s brands were set up and operated in a very distributed siloed manner. In the past decade, we’ve inched towards a more holistic approach, but have never fully committed to it in the way we must to be successful in this environment. So, we are going to change that, beginning by prioritizing investment to the flagship six, then sharpening creative filters and program and to make sure the brands remain distinct and complementary, accelerating global opportunities and implementing a more holistic approach to scheduling, marketing and digital. As we do that, we will increase the volume of originals and push more aggressively into new format and life. And we want to share ideas more aggressively across borders for our flagship brands. Nickelodeon is already very established in this model, and MTV is moving quickly with MTV U.S. now developing several MTV U.K. formats.
We also need to transform the way we work with talent. We need to do a much better job of keeping our homegrown talent in the Viacom ecosystem, creating new opportunities for our starts across networks and at Paramount with our new branded film slates. Comedy Central is launching 10 new series this year, more than it ever has, representing the biggest influx of new talent to the brand since it introduced the likes of Amy Schumer and Key & Peele.
We are acutely focused on providing divorce opportunities for this talent to create and grow their careers under our roof. Trevor Noah is a great example. The daily show lapped the year on a ratings high with its most watched and highest rated quarter ever for Trevor among total viewers and adults 18 to 49. We are collaborating across our portfolio to drive greater growth to Trevor, harnessing greater support from our domestic networks and localizing the format internationally.
Our third strategic area of focus is deepening partnerships to drive traditional revenue streams. To drive the scale, strength and flexibility we need, we need to emphasize partnership more than this Company ever has. With the traditional MVPDs, we are focused on cultivating true strategic partnerships that reposition our brands and push the industry forward, rather than the transactional relationships restricted to zero sum economic negotiation. To that end, we are focused on leveraging our data, products, ad sales, and marketing expertise to help grow their businesses. We will also reinforce the pay TV ecosystem by being highly selective in striking agreements with over the top distributors, confining those deals to largely library content. We do want to support the success of virtual MVPDs, as we have with partners like Sling and DIRECTV Now, and embrace their roles as catalyst for innovation.
In ad sales, we’ll build up our leadership in data-driven products and branded entertainment, but we will also create more value through tighter alignment across the portfolio. For instance, we are heading into the upfront with the most comprehensive cross-portfolio package Viacom has ever offered, a product we call Epic. It spans 9 networks, 20 tentpoles and 60 returning series.
Moving on to the fourth point, we are going to make big moves in the digital and the physical world. In digital, short-form video has clearly emerged as a dominant medium. And because it is video, it is an area where we have inherent strength and capabilities. But like another areas, our lack of a holistic unified approach to short-form content development and distribution, has held up back. To fix this, we are creating a new business unit focused on producing short-form content, both original IP and leveraging our brands. We will aggressively grow short-form output at our flagship brands for distribution by both our owned and operated, as well as third party platforms. This will allow Viacom to better serve increasing demand from our advertisers for this kind of inventory and better support our brands.
We also want to create more and stronger expressions of our brands in the physical world. This is a necessary and valuable tool for marketing, talent development and extending our consumer connections, and it is an incremental business. Take MTV outside the U.S. for example. Last year, over 1 million people went to an MTV event. That’s great for the brand, and we made money doing it, and we’re working to expand and grow this business.
Comedy Central in the U.S., for example, will enter the festival space this summer in partnership with Superfly, the company behind Bonnaroo. This is a big opportunity for Comedy Central to grow its standing as a dominant comedy brand in the U.S., and it creates greater opportunities for Comedy Central’s roster of emerging standup comedians, many of whom moved into our development pipeline with new series.
We also think there is a big opportunity to grow Bellator. And rebranding Spike to the Paramount Network will help us capitalize on that. Taken together, we believe these digital and physical opportunities represent important incremental revenue streams, and they reinforce our brand and IP.
And fifth and finally, we are continuing to optimize and energize our organization. We are rethinking our operations to allow for better collaboration across our portfolio as well as more holistic relationships with our partners. And as we do this, we have the opportunity to realign the organization to build future growth.
We are also very-focused on culture, and establishing a shared vision and values that elevate the very best of what Viacom has offered in its proud successful history. It’s a history that I am confident we will build on. By staying focused as a portfolio but flexible in our approach to the market, we will build scale, be even more competitive, and evolve Viacom into the premier portfolio of global multi-platform entertainment brands.
As we do, we’ll be focused on driving growth and earnings and free cash flow as key metrics of our progress, and on delivering value for our shareholders. Thank you for your continued support.
And with that, let me turn it over to questions.
[Operator Instructions] And we will take our first question from Doug Mitchelson with UBS.
Thanks so much. Bob, you covered a lot of ground. I probably have 20 or 30 questions. So, why don’t I just start with one high level and leave it to others. What do you see as the biggest execution hurdles in this revitalization strategy laid out?
Thanks, Doug. I think the reality is we now have a clear path forward, which we as a management team, are absolutely convinced will create value and competitive advantage for the Company. That said, there are a lot of pieces we have to execute on. And whether that’s putting in place a new structure at Paramount to enable the expansion or really the development of the brand, the film slate, whether that’s moving quickly with the Paramount Network rebrands, whether that’s implementing a new approach in terms of our distribution strategy and relationships, it really does come down to a set of execution. But, I believe we have the team in place; and obviously, we’ll continue to look to supplement that team to get the work done. And again, it is an executable plan, and it is -- we are not focused on creating some new unknown thing. We just need to execute, and I’m confident we can do it.
If I can just follow up with how long do you think before you believe the Company will really hit to stride over this plan?
What I’ve been focused on since day one is forward movement in the Company, and that will absolutely remain a focus. Now some things can happen relatively quickly, some things take a little more time. For example, a film from the day it’s conceived to the day it releases, you look at it like 2, 2.5 years. So that does take some time. Thankfully, we have some Nickelodeon products already in the pipeline that we could all get behind and move on. Other things will happen more quickly. I continue to be pleased with the MTV U.S. journey for example. And if you look at what’s going on there, clearly, we’ll be talking about a whole new slate in the upfront; that we’ll be launching in the fourth fiscal quarter. So, that is a much more nearer term opportunity. But again, overall, you can think of that as a steady march towards a revitalized Viacom, and you will see continued progress.
Thank you, very interesting.
From a financial perspective, you can expect to see strong growth in the second half of the year. So, a lot of things that Bob’s talked about strategies that are underway, you’ll start to see reflected in the -- or you will continue to see reflected in the financial performance.
We’ll take our next question from John Janedis with Jefferies.
Thank you. Bob, can you talk a little bit more about the rebrand to the Paramount, I guess network. How much of an incremental investment should we expect, and what kind of window does it provide to attract new advertisers or categories? And then, I guess more broadly, as you know, domestic Media Networks have an under margin pressure. Based on the new strategy, can you talk maybe more about the path forward in terms of margin improvement?
Sure. So, let me start by saying that the strategy overall from a financial standpoint on the cost base is about prioritization and remix. So, on a total Company basis or total Media Networks basis, we are not talking about a significant increase in aggregate spending. Now, going to the Paramount Network in particular, Paramount Network will benefit from an increased commitment of resources within Media Networks. That will enable a couple of things. One, but fundamentally, will enable a stronger program in slate including original production. However, I want to note that one of the inherent appeals of this strategy is one of benefitting from scale. In other words, scripted programming will be a significant part of the Paramount Network slate as it comes to life in 2018. It will benefit from a concentration of some of the scripted stuff we’ve been doing on across the house. So, that’s one of the things you will see.
Spike, soon to be rebranded the Paramount Network, already has a significant amount of film product on it, and we already as Viacom, have a significant amount of Paramount product under license, but we’re going to be moving some stuff around. So that -- and the last thing I would say about the Paramount Network is, today what we’re doing is we’re announcing our going forward strategy. We’re actually -- we communicated to the Board on Monday, I am communicating it via Facebook Live to all employees later today. So, there is a small group of people that are aware of the Paramount Network strategy but really starting today is when we do the detailed work on bringing that what I believe, great general entertainment network to life. And so, there will be -- we will be building that plan; you’ll be learning more; we’ll be talking about it in the marketplace and obviously driving towards a rebrand as we said, in 2018, early 2018.
As for the broader Media Networks, the other part of your question, again, the strategy is about emphasizing these flagship brands where we believe there is incremental opportunity, not only within their traditional media network space but beyond that will benefit the P&L. And we will shift some resources around from the reinforcing networks. But in aggregate, again, there won’t be an increase in spending.
I don’t know, Wade, if you want to add anything?
Yes. I think the question about margin expansion and when we’ll begin to see that. We’re going to be continuing to invest in effecting the strategy that Bob described. In particular, there are going to be programming investments and shifts into Q3 and Q4. So, we had set those investments to start paying off, and you’ll start to see margin expansion in the fourth quarter.
And just sorry, the other thing you did ask about was the ad category impact, if you will, relationship with Paramount Network. If you look at Spike, it has a, I’ll call it, a GE type ad base. So, it has relationships and spending from a range of clients. However, because the Paramount Network will up our general entertainment gain including ultimately deliver larger audiences, it’s a key path forward for expanding our share of the adult market. And we believe that’s an important growth driver for Media Networks and therefore Viacom.
We’ll take our next question from Alexia Quadrani with JP Morgan.
Hi. Thank you, and thanks Bob for all that color, and congratulations; nice to see such a positive turn in results here. Just sort of following up on your comments on the flagship six brands and the rebranding of Spike, have you discussed sort of this new strategy with the distributors? I think you just said you’re sort of early days in this announcement, but I wanted to know if that’s something you guys do ahead of time or is that just something you address when the renewals come up for at a later date? And then I have a follow-up.
Sure. Alexia, the answer is yes. We started conversations with our distributors early this week. In fact, I had a conversation with a CEO of one of the largest MVPDs, last Friday, and I talked about this strategic move. It’s important to note that from a contractual standpoint, there are no issues with this. It is a rebrand of Spike, the definition of Spike includes movies and the likes. There is no contractual problems, but we wanted to talk -- we wanted our key clients to hear from us first, and that’s what we did. We also by the way had conversations with many agencies and some key advertising accounts over the last two days, and we have gotten very positive feedback on this strategic move.
And then, just a follow-up on the affiliate growth, I think you highlighted SVOD and OTT helping drive the domestic affiliate growth, I think maybe total. Can you elaborate, I guess on how significant those deals are? And in general, what is your strategy you’re thinking going forward about further SVOD deals?
So, from an overall affiliate standpoint, we expect low to mid single digit growth for the full year. We also expect the growth rate to -- again, consistent with some of the other trends in the business, see a slight compression from where we are in the first quarter and then really an acceleration in the second half of the year that will land us in that kind of low to mid single digit range. SVOD is not going to be a significant part of our affiliate revenue, as it has been in the past. And so, again, we feel very confident in that level of growth and those dynamics.
We’ll take our next question from Ben Swinburne with Morgan Stanley.
Thank you. Good morning. Bob, have you had a chance, and maybe if not, how are you thinking about new virtual and MVPDs and your new network strategy? And I guess what I’m thinking is, does it -- are you considering the idea and is it an opportunity to sort of bring six core networks to new streaming platforms in a way that you -- this changes relationship with your distribution partners and creates maybe a better opportunity for Viacom to participate in some of those platforms and at least I think the consensus, as you -- Viacom is not participating? Just curious how the rebrand may affect you thinking on new platforms, as you move forward, if it’s significant?
Yes. I think it’s fair to say, we’ve thought about a lot in terms of the context for developing the strategy. And I think the point is actually bigger than what you suggest, which is if you think about the impact of OTT on the market, on an international basis, you can argue that given current pay TV penetration levels, OTT should be a positive catalyst for growth in penetration and reach. In the U.S., it’s hard to make that argument. In fact, the more likely outcome and one outcome that I think is increasingly talked about is, it’s a negative impact on price at different tiers of opportunities come to market for consumers. As that happens, there is a very compelling market opportunity in the development of an entertainment pack. And if you look at the flagship six, the flagship six is essentially the strongest entertainment pack you could get in the market, because you have preschool, kids, young adults, you have comedy, you’ve got African-Americans and you’re going to have a general marquee general entertainment network. And if you look at viewing shares and the like, that’s a very significant cornerstone.
And so, I believe ultimately, the market will embrace that. Now, if you look at the UK as an example where big basic essentially doesn’t exist, Sky runs packs. And you look at pack penetration, what you will see is that sports penetration is 52%, which actually is higher than I thought it would be. Entertainment pack penetration is 100%. And so, you look at the evolution of the market going forward, probably with MVPDs as a catalyst but with -- probably the MVPDs -- OTT plays as a catalyst, but ultimately MVPD is not far behind, it’s hard to imagine that you don’t see the emergence of this entertainment pack tier. And I think the flagship brands are ideally suited to ensure that Viacom greatly benefits from that development.
Makes sense. And then, I’ll just ask Wade a couple of quick follow-ups. But on your comment on the affiliate revenue, where I think you suggested that the March quarter would be slower than the December quarter. Was that a worldwide or domestic comment? I just wanted to ask if you could clarify. And then, could you just help us, what was the impact of the co-financing agreement in the quarter? I think you said ancillary revenues. Did it have any benefit to working capital in the quarter? When you talk about derisking 2017, maybe be a little more specific about what that means financially for us. Thanks.
From an affiliate standpoint, my comment was really related to domestic. On a worldwide basis, we’re going to be flat going into the second quarter. And so, obviously, it’s going to be slightly higher growth internationally to offset the slightly lower growth domestically. I am sorry. Can you just repeat the question about working capital?
Yes. You guys have generally talked about this co-financing deal at Paramount, derisking the slate. And I think you mentioned the ancillary revenues in the quarter benefitted from the financing. I think we’re all looking for a little more specifics on how that agreement impacts the numbers, both in the quarter but just maybe generally for the year, even if it’s directionally, is it helping free cash flow?
It’s going to significantly help free cash flow. In fact, the overall picture at Paramount with respect to free cash flow is impressive. The combination of the films -- the slate financing activities that we were able to execute, plus strong spend management, you’re going to see an unwind of the cash loses from last year and a return to positive cash flow in that segment. So, that’s a change of well over $1 billion in free cash flow. So, it’s not just the slate financing but is driving the improvement in free cash flow at Paramount because we are very-focused on this and undertaking a number of other actions.
In terms of the impact in the quarter, it had a positive -- as we noted around ancillary revenues, it had a positive impact on ancillary revenues, as well as operating income, but not really much of an impact on cash in the quarter.
We’ll take our next question from Richard Greenfield with BTIG.
Hi. I just wanted to follow up on the last question about virtual MVPs and kind of what you call entertainment bundles. Some of your peers that I listen to, someone like Disney’s Chairman, Bob Iger, they talk to with the every bundle that’s going to be created, smaller bundles being focused around sports and that you can’t have a bundle without sports. Do you think we’re going to have a non-sports bundle at the low prices and high value that you’ve mentioned during 2017? And, what do you think the catalyst is for that to actually come about? I mean, is there a leading candidate who might actually launch one of those that you’re talking to? And then, just in terms of programming, I think your head of scripted programming in MTV left; you expanded your relationship with the Jersey Shore creators. It seems like there is a meaningful shift away from scripted towards reality. I would just love to better understand your thinking there and what are you trying to accomplish and why?
Sure, Rich. So, to your first question, I believe they will absolutely become an entertainment pack. Whether that will launch in 2017 or not, we’ll see. There’s lots of conversations going around. I’m not going to name check any particular companies, but certainly there is activity in the marketplace.
On your question of MTV and its shift, you’re right. I’ve talked about this in some other forums. But, MTV U.S. embarked on a very heavy scripted programming strategy some years back versus MTV international did not for a variety of reasons. Ultimately, the scripted strategy for MTV on a large scale basis didn’t really work. And there is no question that under Chris’s -- Chris McCarthy’s leadership -- he is bringing back a better balance to MTV including a real push on reality, which is very attractive to the audience, has very compelling economics for us and is really right from a brand filter perspective too. At the same time, there are other elements of the MTV story. Music is another element of the MTV story, and live is going to be a third element of the MTV story. We have recently started to do some live packaging of our franchises on MTV on the weekends. And that live rollout will continue because we see a real opportunity and we are getting good early traction from a ladies and audience perspective. The last thing I would say is that as we do these three things, scripted is not going to go away, it still has a place on the grid with the brand, if you will, but it’s just the balance is going to shift.
And does it shift into things, I mean like you’re seeing syndication pulling out something like Friends, which seems to skew you a bit more female than probably MTV has been in while? Do you think you end up syndicating content or using syndicated content as a way to be in the scripted business more than developing the content yourself?
So, couple of things. One is, when I talk to Chris about Friends, I was a little skeptical initially, but he showed me the research that actually the demographic is very -- has a strong connection to the show, and it’s working well for us. It is also, just to be clear, a bridge strategy. We needed to reset MTV in a variety of ways and we saw an opportunity to take a lot of episodes of a show that’s out there that had appealed to our target consumers from a research perspective and use it, which we are. Friends is now -- there is two other hours of Friends, I think from 6 to 8 on MTV and that’s working well. But, it’s also a bridge to get us time to implement a news slate of shows, which Chris and the team are actively working on and will begin coming to air in fiscal Q4.
We’ll take our next question from Michael Morris with Guggenheim Securities.
Thank you. Good morning. Two questions, if I could. First, you just mentioned Chris McCarthy’s work over at MTV. He had success at VH1. And I think part of the success that I have heard you reference before is the use of data from your set-top box relationships and things like that to inform programming decisions. I was hoping you could expand on that a little bit. Is that a factor that’s a new factor in your confidence in getting the right programming in front of the right people and how does that actually work? And then my second question is on the film financing partnership. If you could share anymore details. By all accounts, it looks like a great situation for the Company, as you look to move forward in that segment. But, I would assume, you have to give something up in order to strike that partnership. So, how should investors be thinking of whether you gave up upside or whether it’s particular markets that perhaps you don’t participate in anymore? Thanks.
Yes. So, to your first question, just to be clear, scheduling is about data and analysis, in a way always has been. And so, what we’re seeing is a continued evolution of bringing facts to the table, if you will, to improve scheduling decisions. So, the comment is really about scheduling the network. It’s not about program development; whether it’s set-top boxes or any other kind of data, so just to be clear. And your second question, I am not sure I fully understood the question. Can you just recap it?
Sure, absolutely. So, in order to strike the film partnership, you have a cash infusion or financing infusion…
Okay, I get the question. So, you mean the slate financing deal?
So, what it is, it’s -- we essentially sold 25% interest in the slate; it’s a multi-year deal, to these two entities. And therefore, they participate in the economic return on the film. They did not buy a set of markets or something like that which you might -- I mean, yes, there are deals like that typically in the television space and also the film space, but that’s not what this is. This is selling the 25% interest in the slate.
And so, it’s a situation where should the films outperform, that’s where your upside is limited versus not participating in let’s say the Chinese market for example?
No. We expect, in some instances get some operational and distribution benefit through our partnership with these entities. This is, as Bob said, this is an outright sale of the 25% interest in the entire slate with a couple of exceptions.
For example, we as Viacom still participate in the economic value created from these films in China. And actually, we believe this deal enhances that potential value, given the strategic presence of these companies in that market. But we didn’t sell them the China window; we sold them essentially a global participation in the film.
We’ll take our next question from Kannan Venkateshwar with Barclays.
Thank you. Bob, just a question on the bottom channels outside the top six. Is there an opportunity on the cost side near-term to optimize the cost base? And if you could give us some sense of what that opportunity looks like, that would be great. And secondly, just wanted to clarify a point on the Paramount cash flow turnaround; $1 billion, I may have missed this, $1 billion, is it over the period of the financing deal or is this over a shorter or longer timeframe? It would be great if you would clarify that, Wade? Thanks.
Yes. $1 billion is over a term, it’s three years or so; we draw it as we need it. And Wade, I don’t know…
I am sorry. Just to clarify, there might be some confusion, because we’ve got two $1 billion numbers bouncing around. So, what Bob just was referring to is what we believe the amount of funding, financing that we’ll receive out of this agreement over the three-year term. What I referenced was over a $1 billion of year-over-year improvement by the end of this fiscal year, in Paramount’s free cash flow. So, the two things are somewhat related. And as much as some of the $1 billion from the slate financing is coming into this year and improving some amount of Paramount’s free cash flow year-over-year, but I want to be very clear that that’s not the only element that is driving the improvement of over a$1 billion in year-over-year cash flow improvement upcoming.
And then, to your first question on the reinforcing networks, I would say a couple of things. One is, again, there are strong networks that are included in this category, networks like TV Land, like CMT, VH1 that have real prospects going forward. They are not though global prospects; they are not film prospects, hence the segmentation. As we implement the flagship six strategy, we will be looking at resources, and we will do some inevitable shift in resources. But again, you should not interpret this as a light switch move of a whole bunch of networks going away, because that’s not what this is about. This is about focusing resources to drive the highest possible performance of these flagship six plans, both on a consumer connection level, which benefits -- which is driven by multi-platform exposure and increased content commitment et cetera. But, it’s not a light switch turning off a whole bunch of networks.
We’ll take our final question from Anthony DiClemente with Nomura Instinet.
Thank you very much. I just wanted to ask about, again, the flagship six, kind of a follow-up on that strategy, and the implications for that in terms of negotiations with your distributors. Bob, you said it a second ago that it’s not a light switch for those to be kind of shutting down. But, over time, over a longer period of time, is the idea that as the value proposition improves for the flagship six, that affiliate fees for those networks specifically will go up? It’s, I guess, hard to argue that affiliates use per network for like a VH1 will go up, if you’re deemphasizing that. So, I just wanted to get the long-term economic implications of the flagship six strategy with your affiliate agreements.
Yes. So, look, it’s very early days to get into a very specific financial discussion around how components of the P&L may evolve over the next X years. Suffice it to say, we believe the strategy strengthens Viacom’s position across a range of considerations on a going forward basis. We believe it will, among other things, benefit our distribution clients by making these brands stronger and having their consumers serve even better. And by the way, by having these non-television attributes, it also provides us opportunities to work with our distribution clients in different ways. For example, as Nickelodeon has this increasing life in the physical world, there is an opportunity for subscribers to MVPDs, either on a Sweepstakes or some other basis to enjoy those experiences. As you get into film business, there is opportunities for consumers of pay TV to get some unique experiences. So, there is a variety of opportunities that are a function of this strategy. And again, our overall focus with respect to distribution -- and that seems to be at the core of your question, is now working to broaden and strengthen our partnership with these very important clients.
Just to follow up on the economics. Historically, we’ve really always gotten paid for the portfolio. And this is a move that’s designed to strengthen the portfolio. These networks, as Bob said, are not going to go away; they are going to move into supporting roles, helping to strengthen the flagship six which we think again is going to strengthen the portfolio and create more opportunities. And just to reference what Bob said earlier, as we move potentially towards entertainment packs and products like that, this will be a must have element, cornerstone of the entertainment viewership in the pay TV landscape. So, again, it’s really about the portfolio as a whole, portfolio management, and we’re confident that that’s going to be a better value proposition overall.
And just to add one other sort of element to the discussion, a number people have asked me, why did CMT and TV Land move under Spike, now the Paramount Network? And the answer is very simple which is all three of those networks have pretty balanced male, female audiences targeted adult demographics and therefore, we believe can benefit in terms of co-management. And that’s another example of our assets being a way to support the flagship six. It doesn’t necessarily mean all the other things get rebranded to flagship six. I don’t want anyone to think that. But it means, working as a portfolio to reinforce an overall strategy that will strengthen our position, again, across a variety of dimensions.
We want to thank everybody for joining us for our earnings call.
This does conclude today’s conference call. Thank you all for your participation. And you may now disconnect.
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