Fox Corporation - Class A (FOXA) — Q4 2019 Earnings Call Transcript

Thank you very much, operator. Hello, everyone, and welcome to our fourth quarter fiscal 2019 earnings conference call. Joining me on the call today are Lachlan Murdoch, Executive Chairman and Chief Executive Officer; John Nallen, Chief Operating Officer; and Steve Tomsic, our CFO. First, Lachlan and Steve will give some prepared remarks on the most recent quarter and fiscal year, and then we'll be happy to take questions from the investment community. Please note that this call may include forward-looking statements regarding Fox's financial performance, operating results, strategy, among other things. These statements are based on management's current expectations, and actual results could differ materially from what is stated as a result of certain factors identified on today's call in the company's SEC filings, including the company's registration statement on Form 10 and subsequent quarterly reports on Form 10-Q. Additionally, this call will include certain non-GAAP financial measures. Reconciliations of non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our earnings release and our SEC filings, which are available in the Investor Relations section of our website. With that, I'll turn the call over to Lachlan.

Thank you for joining us today on Fox Corporation's year-end earnings call. As we conclude a fiscal year, we are beginning our growth journey and hitting important milestones. We have just reported solid financial results and completed a successful advertising upfront. We’re making progress on our distribution renewals and have an impressive content lineup across our linear and digital channels, positioning us well for our first full fiscal year in 2020. For fiscal 2019, we achieved remarkable financial results, posting 12% revenue growth and 8% EBITDA growth. Our revenue increase was driven by double-digit gains in both affiliate and advertising revenues, with affiliate revenue making up about half of our annual revenue. Despite ongoing subscriber declines, we managed to grow affiliate revenue by 12% in fiscal 2019. We've successfully renewed distribution arrangements with our partners without much fuss throughout the various cycles, and this past year was no different. We were able to adjust affiliate rates, particularly in the Television segment, securing multiple renewals. The remaining portion of our revenue primarily comes from advertising, where we saw a 10% growth in fiscal 2019, driven by the addition of Thursday Night Football and a record gross political revenue exceeding $185 million at the FOX Stations Group, significantly surpassing the previous record from the Obama-Romney election. A notable highlight this year was a 24% increase in digital advertising revenues, particularly with FoxNews.com showing 46% growth alone. Our advertising partners are clearly backing our programming strategy, as this year's advertising upfront was one of our strongest in years, leading to higher pricing across entertainment, sports, and news. Specifically for Fox, the strength of our offerings has attracted advertisers who appreciate our ability to deliver highly engaged audiences at scale. Throughout our focused portfolio, we saw rewards from our continued investment in content. In entertainment, we achieved significant pricing increases and volume growth, with similar results in sports and news. Early indicators show encouraging volume and pricing trends for the Super Bowl as well. Currently, we are benefiting from a robust television advertising market, fueled by renewed interest from marketers in prime time and sports programming. Much of our revenue is closely linked to the FOX broadcast network, which is supported by vital sports and entertainment content along with local programming provided daily across America. Our network stands out with premium advertising and retransmission revenue rates due to its wide array of content genres that capture varied audiences, making it one of the top four channels nationally. While we recognize the power of sports, we are not aiming to transform Fox into a dedicated sports channel. Our focus is on keeping the FOX Network vibrant and attuned to our audiences. This is why we are investing in original entertainment programming, especially when such originality attracts a market premium across our revenue streams, as demonstrated by our advertisers during the recent upfront. We are pursuing a strategy to grow our owned content portfolio to create long-term value for Fox, being strategic and deliberate in our approach. Part of this includes a new co-production model that allows us an equity stake in nearly all new network shows, alongside boosting our internal content-creation capabilities through SideCar and our recent acquisition of Bento Box, an animation company known for producing Bob's Burgers. Bento Box will help us access new talent and generate original IP to drive long-term value. Our Sunday schedule illustrates our commitment to animation, as we have launched more animated hits than anyone else, showcasing its stability and appeal across our platforms. Beyond the network, we are also enhancing our direct-to-consumer initiatives. FOX News is expanding its significant multi-platform presence beyond traditional linear channels and has a strong foothold in direct-to-consumer news. Our digital properties at FOX News attract over 100 million unique users monthly, leading news engagement with over 3 billion page views. We are enhancing our D2C capabilities with the launch of Fox Nation, a video-on-demand service. On the sports side, we’ve initiated pay-per-view boxing with events showing significant purchase increases. Overall, our digital portfolio attracts over 200 million unique users monthly along with substantial content consumption. Our progress continues with key investments aimed at expanding our brand reach. In May, we partnered with the Stars Group for Fox Bet, a media and sports wagering initiative, which we plan to launch before the upcoming football season. We view sports wagering as a significant long-term value opportunity for Fox. Recently, we also reached an agreement to acquire 67% of Credible Labs, a direct-to-consumer personal finance marketplace, providing us with a strategic adjacency to our extensive news audiences while tapping into a rapidly growing market. This investment aligns with our digital properties and is designed to accelerate Credible's growth. Operationally, we’re entering fiscal 2020 with strong momentum. FOX News remains the leading cable news network for 17 consecutive years, and FOX Sports is a top performer in live sports viewership. Our FOX Television Stations continue to expand local news coverage, becoming leaders in profitable daytime programming, and we are excited about upcoming additions like WWE SmackDown and the Super Bowl. We plan to invest $200 million to $250 million in our platforms this fiscal year to enhance our digital properties and programming initiatives. These investments are expected to drive future growth and long-term value. We are optimistic about our growth trajectory and progress, believing Fox is poised to capitalize on the evolving industry landscape with a dynamic collection of leading brands and compelling content. Before I hand over to Steve, I need to address the legal claim we, along with other broadcast networks, filed against Locast recently. Simply put, Locast is a rogue streaming service that violates copyright laws for commercial gain. Its claim of being a nonprofit with no commercial advantage is unfounded. Locast operates for the clear benefit of the companies backing it. We are confident in the merit of our claim against Locast, which reinforces the value of our brands and the content they deliver.

Thanks, Lachlan. Good afternoon. We are pleased with our first full fiscal quarter as a stand-alone company. As Lachlan mentioned, we delivered both healthy top line and EBITDA growth, with this financial momentum setting us up very well for fiscal 2020. Let me now take you through our financial results for the fiscal year as well as the fourth quarter, along with providing some financial markers for the future. Our full year results saw total revenues grow 12% to $11.4 billion. Our revenue growth was broad-based, with affiliate revenues increasing 12%, led by retransmission revenue growth of the Television segment. Advertising revenue was up 10% on the back of our inaugural season of Thursday Night Football, which added 5 percentage points of advertising revenue growth, coupled with the record year of political advertising at our Television Stations. Within this advertising revenue growth, we were also encouraged with our digital progress, with digital advertising representing close to $500 million or 10% of total company advertising revenue. Finally, we delivered strong growth in content revenue, which we record as part of our other revenue line, supported by the digital licensing of network entertainment programming. Total full year segment EBITDA was $2.7 billion, an increase of 8% from last year, reflecting 8% growth at the Cable segment and 24% growth at the Television segment. At this point, it is worth remembering that when looking at our full year fiscal 2018 numbers as well as the first three quarters of our fiscal 2019 results, that these results have been prepared on a so-called carve-out basis. As such, they include allocations of 21st Century Fox overhead and shared service costs in accordance with SEC guidance, which as we have said in the past, understate the costs required to support Fox as a stand-alone business. We estimate that the total recurring costs beyond the amounts formulaically allocated to our published financial statements should range between $225 million and $250 million on an annual basis. Illustratively, if we took 75% of these incremental costs into account, they would have reduced our fiscal 2019 EBITDA by approximately $180 million. Net income attributable to stockholders was $1.6 billion this year or $2.57 a share, while adjusted EPS was $2.63 versus $2.50 last year. Again, both of these absolute values and the year-on-year comparison are influenced by the differences in allocated shared services and overhead costs. Turning to the fourth quarter. Total company reported revenues were $2.5 billion, up 5% over last year, reflecting revenue growth across all operating segments. Total segment EBITDA was $709 million, an 11% increase over the $640 million generated a year ago, led by higher contributions from the Television and Cable segments. This growth was partially offset by higher corporate expenses reported in the other segment, which now more properly reflect the full cost of operating as a stand-alone public company. From a bottom line perspective, net income attributable to stockholders of $450 million or $0.73 a share was lower than the $0.76 per share in the prior year quarter, while adjusted EPS of $0.62 was down 7% over last year. These reductions principally reflect increased interest in income tax expenses from our operating as a stand-alone public company. Our effective tax rate for the quarter was a touch above the more normalized mid-20% range we expect to have going forward. So now turning to the performance of our operating segments for the quarter, where Cable Network's EBITDA of $602 million was up 4% on revenue growth of 2%. The revenue increase was led by affiliate fee growth of 3%, supported by higher average rates across all our brands, partially offset by a net decrease in pay television subscribers. Ad revenues decreased slightly by 1%, reflecting lower contributions from the Women's FIFA World Cup in the current year as compared to the men's tournament in the prior year. The ad revenue decrease at the national sports networks was partially offset by the continued strength of FOX News, led by digital and advertising growth. EBITDA at our Cable segment increased 4% over the prior year, reflecting the higher revenues and a stable cost base as digital investments at FOX News were offset by lower sports rights expenses related to the FIFA World Cup and the absence of UFC programming in the current year quarter. At the Television segment, EBITDA was $214 million, an increase of $103 million from the prior year quarter, reflecting revenue growth of 5% and expense declines of 4%. The revenue growth was led by an 18% increase in affiliate revenue growth, which in turn was driven by programming fee growth from non-owned station affiliates. This growth is consistent with the overall TV affiliate revenue trajectory we laid out at our Investor Day in May, where we expect to deliver revenues of approximately $2.65 billion by calendar year 2022. In line with our expectations, advertising revenues in the quarter were down by 8%, reflecting difficult comparisons to the quarter a year ago, which included political revenues at the local stations related to the 2018 midterm elections and more FIFA World Cup matches. When viewing the segment as a whole, the advertising revenue decline was substantially offset by increased digital content licensing revenues. The decrease in expenses reflects lower sports rights resulting from fewer FIFA World Cup matches and NASCAR races in the quarter, as well as lower entertainment programming costs due to fewer hours of original programming in the current quarter. The strong overall P&L results generated free cash flow, which we calculate as net cash provided by operating activities, less cash invested in property, plant and equipment of over $800 million in this quarter and $2.3 billion for the year, representing a 115% and 85% conversion of EBITDA to free cash flow, respectively. And finally, from an overall balance sheet perspective, we ended the quarter with $3.2 billion in cash and $6.8 billion in debt. Looking ahead into fiscal 2020, there are a few key items I would draw your attention to, many of which we had previously outlined at our Investor Day. Firstly, Lachlan has already outlined the targeted set of initiatives that will impact EBITDA in fiscal 2020. In addition, it is also worth remembering the changes in our major broadcast events that will affect year-on-year comparability, the single largest being our broadcast of Super Bowl LIV in February, which from a year-over-year EBITDA perspective will largely be neutralized by the combined effects of other cyclical events, such as an off-cycle political year, one less NFC divisional playoff game, and the absence of the FIFA World Cup. As we look at the cadence of fiscal 2020, we would note that our Q2 P&L results this coming year will be impacted by higher sports expenses at the network, reflecting the contractual annual escalators on the NFL and college football contracts, and the addition of WWE rights as well as lower political advertising revenue at our local television stations when compared to the prior year. Looking across our group-wide other revenue category, we expect to post solid revenue growth in our Cable and other segments, supported by the increasing Fox Nation subscription revenues, the expansion of our pay-per-view boxing business, growth in content revenues, and a full year of revenues associated with operating our L.A. operations. Meanwhile, these gains will be at least partially offset by reductions in other revenue in our Television segment. As we have previously disclosed, we expect shared services and corporate expenses reported in the other segment to increase significantly as we will be operating as a stand-alone public company for the full year as compared to only one quarter in fiscal 2019. On a full fiscal year basis, we expect the other segment to be a net EBITDA cost in the mid- to high-$300 million range. This includes a little over $50 million of stock-based compensation expense associated with the initial shareholder alignment plan award, which will temporarily impact our P&L in fiscal 2020 and 2021. From a cash flow standpoint, we expect very robust conversion of EBITDA to free cash flow. Here, we expect very low working capital usage and cash tax savings of approximately $370 million resulting from the tax basis step-up obtained as a result of the Fox Corp. spin, while our capital expenditure will increase to fund the build of our new broadcast center in Phoenix. Before concluding, I'd like to reiterate that we remain committed to a balanced capital allocation strategy, balancing between organic investments, strategic M&A and shareholder returns of capital. As part of this strategy, you will have seen that we just declared our second semiannual dividend of $0.23 a share and continue to expect to have a share buyback authorization in place in advance of our Annual Shareholder Meeting in November.

Thanks, Steve. Now operator, we'd be happy to take questions from the investment community.

I'll ask one to John or Steve. So the first question, when you look at the cadence of affiliate fee growth at Cable, it decelerated from 13 to 11 to 4 to 3. And the question people have with new companies, what drove that deceleration, and when you look ahead to the new fiscal year, what's the cadence of the 38% of the new deals coming due to maybe reaccelerate that growth? So that's one. And then, Lachlan, for you, is I get the Bento Box acquisition, but why is Credible a good fit for you? Like what expertise do you bring to it that perhaps we're missing from the outside?

Right. I'll answer that now. We'll start with Steve on the deceleration of cadence.

Yes. Regarding Cable, as we mentioned during the Investor Day, we view affiliate relationships as grouped together. Therefore, the distinction between Cable and Television is not as significant for us since we negotiate all contracts collectively. For Q4 compared to Q4, we experienced a growth rate of 7% across our entire portfolio, and we expect to maintain or exceed that growth rate into fiscal 2020. The reason for the sequential decline in Cable throughout the fiscal year is due to comparison with previous deal expirations. As we enter new agreements, our main focus will be on securing a larger share of fair value from our retransmission. Consequently, you will notice that the substantial future growth will remain concentrated in the Television segment rather than in the Cable segment.

Great. Regarding Credible, we are extremely enthusiastic about the opportunities it presents. Our main asset is not merely our expertise in advertising or affiliate revenue, although our teams excel in those areas and are achieving remarkable results. Instead, our key resource lies in the strong engagement we maintain with our audiences in news, sports, and entertainment. As we expand our digital platforms, we are witnessing this engagement transition from traditional formats to direct digital channels, which allows us to monetize that engagement through new models. Earlier this year, we saw the potential of entering the sports gaming market, recognizing it as a significant long-term opportunity due to the high correlation between the sports audience and the sports-betting demographic. The same logic applies to Credible in the news sector. We have conducted extensive research on our news audience, which is not limited to cable news but includes nearly 1,000 hours of local news we produce weekly. This audience strongly aligns with Credible's target demographic in the financial marketplace. Our news audience tends to be slightly older, more likely to be homeowners, and generally more educated, characteristics that match those of individuals seeking mortgages and refinancing loans. Therefore, we see a tremendous opportunity by combining Credible’s services with our audience and digital platforms, starting with FOX Business and expanding to our other news outlets.

Lachlan, I wanted to revisit your comment regarding digital advertising at $500 million, which is experiencing healthy growth. Could you provide more details on what this business entails? Specifically, how much of it might come from video compared to display? How sustainable do you believe this growth rate will be, particularly as we enter what is expected to be a highly active political year next year, since that tends to bolster the overall advertising business across the company? Additionally, do you have any updates on the evaluation process for the buyback plans? This is a significant focus for investors, especially in light of the recent acquisitions you've announced.

On the digital advertising front, we're very pleased with its growth and believe we can push it even further. We have over 200 million unique users of our digital products and about 10 billion views. For example, on FoxNews.com, we are now achieving over 100 million page views per day. Even on a slower day like yesterday, we recorded 90 million page views. We believe we can monetize those page views effectively. We have developed the sites and content more quickly than we have monetized those views, so we expect to drive that further.

And Ben, just to pick up on that, it's a pretty good spread where we get our digital advertising revenue from across FOX News, the entertainment side of things, both directly, and by Hulu digital video views as well as FSGO. So it's a good spread from where we get it from, but we think that sort of the tip of the spear in terms of growth will continue to be FOX News going forward.

And Ben, it's John. On the question on the buyback, as we said at the Investor Day, the independents are spending time with their advisers. We expect, as we did then, that there will be a conclusion and an announcement around the buyback framework just around the time of our Annual General Meeting. There's been no change to that timetable.

So on advertising, Lachlan, it was very helpful to get that color on how you did in the upfront. It's so strong. What are the drivers besides lack of ratings in the industry in general? And can you talk a little bit about how you're selling differently with everything under Marianne's umbrella? Is everything cross-platform now? And then on the gaming, can you give us some color or factors to consider on how this will ramp? Is it all dependent on state-by-state legislation? What else will drive it? How quickly can you ramp?

Thank you, Jessica. We believe this year has seen the strongest advertising upfront in 17 years, showing remarkable strength in both pricing and volume. The scatter market has performed even better since the upfront, with pricing premiums in the double digits compared to our upfront sales, translating to pricing in the low 20s over last year. This growth is happening across various categories, not just one. We’re witnessing strong performance from streaming platforms as they transition to digital advertising. The pharmaceutical sector is also doing well again, after a brief pause to address regulatory requirements, and they are particularly strong in the scatter market. The finance sector remains robust as well. Additionally, we’re starting to see significant gaming revenue from local stations in states like New York and Philadelphia as more states legalize online gambling, which offers us a great revenue opportunity beyond our partnership with TSG. We’re also excited about our Super Bowl sales, with pricing significantly improved compared to our last Super Bowl a few years ago. Regarding your question about gaming and the TSG partnership, Steve, do you want to take that?

Yes. And just I think that the ramp of it, Jessica, really is dependent on the state-by-state legislation and having that open up or liberalize. And so that really drives the actual sort of operationalization of that within the joint venture in terms of opening up that state access. But in the meantime, we obviously have a partnership with brand royalty and all the rest, that will have a modest positive impact on our P&L through the course of this year.

I should say, one of the things we're going to do is, as mentioned before, the football season begins, we'll be launching a national free-to-play game and which is legal across the country in every state. But certainly, we hope to put the brand out there and to begin to establish the business.

Steve, you mentioned very robust free cash flow and you also mentioned 85% conversion for the full year last year. Should we take that 85% to be consistent with very robust? And then, Lachlan or John, Fox Nation has come up a few times on this call, and I think it was mentioned that growth in subscriptions was a driver. Any context you can give us around sort of size and scale of that business, where you think you can get it to? And then subscription subscribers, is that the right metric we should be looking at?

Thanks, Doug. Regarding free cash flow, I believe 85% might be somewhat high compared to our expectations for conversion in the current fiscal year. The main factor that will slightly hinder us compared to the last quarter is the development of the Phoenix broadcast center. As I mentioned at Investor Day, we anticipate capital expenditures to be in the low to mid-single digits as a percentage of revenue, and this will place us closer to the upper end of that range.

On Fox Nation, it is performing very well. It is still early, having launched just this past November. As a subscription video-on-demand service, subscription is the key part of its identity, and subscribers are a critical metric we are closely monitoring. We have not spent any external marketing dollars yet, but we plan to allocate an appropriate amount for external marketing within the EBITDA investment that Steve mentioned earlier, which will begin in the fall. The encouraging aspect is that the conversion rate from trialists to paid subscribers is exceptionally high, and if we can sustain that conversion rate while increasing the number of trialists in the fall, it will become a very successful business.

I have two questions. Lachlan, you brought up Locast, so I just want to ask you, can you walk us through the timeline? Now that this is filed, what's next? And then I understand a permanent injunction was requested, not a temporary one. So just curious as to why that was. And then, second, for Steve, with your capital allocation policy, is there a certain percent of free cash flow that you're sort of setting aside each year to specifically allocate to M&A? Or is what you are investing in truly just opportunistic as things come up?

Thank you very much, Marci, and I'll turn over to Steve for your second question. On Locast, I fleshed out as much as I could do what I could say in my kind of prepared comments, and I hope I was punchy enough. I tried to be. But on legal advice and seeing if this case is now sort of before the courts, I'm better off not to add anything to those comments. But, Steve?

And Marci, just on capital allocation. We're going to stay flexible. We will be balanced, but we're not going to have a strict percentage of free cash flow that's dedicated to M&A. We'll be looking at, let's say, just opportunities across organic M&A and also best use of capital in terms of returning an amount to shareholders and sort of review that periodically. The notion that we would dedicate x percent of our free cash flow is not the way we'd operate.

Lachlan, if you could maybe talk generally about the soft ratings that we've seen in the news network business really in the last couple of months, not just obviously Fox, but just across the industry, what you attribute it to. Is it news fatigue, and I guess how quickly do you think it can turn around? And then on the subscriber side, I'm sorry if I missed it, but could you give us the sub decline number and maybe a little color on how different these negotiations are now that you don't have the RSNs?

I'll answer the last part first, which is that they are easier. Starting from the beginning, news ratings have softened when compared year-on-year. However, historically, I still believe they are incredibly high. We are currently in an extraordinary news cycle, and FOX News has lost fewer ratings or a smaller audience compared to our competitors. Therefore, we remain the number one network and expect to maintain that position for quite a while. I do think there may be some news fatigue, but it's important to remember that this time last year, we were also experiencing an extraordinary news cycle. We are very pleased that the hard work of the team at FOX News has kept both their prime time lineup and their all-day ratings strong, even with some talent changes. We are genuinely happy with FOX News's performance. Regarding subscriber declines, we are seeing an overall decline of about 1%. This includes our smaller networks, such as Fox Sports 2 and BTN. Therefore, we are down approximately 1% in total subscriber numbers. However, when we analyze the market and estimate figures, including the growth of digital MVPDs, we believe the overall market is down around 3%.

At this point, we're out of time. I thank everybody for joining today's call. If you have any further questions, please give Dan Carey or me a call. Thank you.