Warner Bros. Discovery Inc (WBD) — Q2 2019 Earnings Call Transcript

Good morning, everyone. Thank you for joining us for Discovery's second quarter 2019 earnings call. Joining me today are David Zaslav, our President and Chief Executive Officer; Gunnar Wiedenfels, our Chief Financial Officer; and JB Perrette, President and CEO, Discovery Networks International. You should have received our earnings release, but if not, feel free to access it on our website at corporate.discovery.com. On today's call, we will begin with some opening comments from David and Gunnar, and then we will open the call for David, Gunnar, and JB to take questions. Before we start, I would like to remind you that comments today regarding the company's future business plans, prospects, and financial performance are forward-looking statements that we make pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are made based on management's current knowledge and assumptions about future events and may involve risks and uncertainties that could cause actual results to differ materially from our expectations. In providing projections and other forward-looking statements, the company disclaims any intent or obligation to update them. For additional information on important factors that could affect these expectations, please see our Annual Report for the year ended December 31, 2018, and our subsequent filings made with the U.S. Securities and Exchange Commission. And with that, I will turn the call over to David.

Good morning and welcome everyone to our Q2 earnings conference call. Discovery had a strong quarter, with healthy operating and financial results, with the benefits of the Scripps acquisition flowing through all areas of our global business, while making significant strides across a number of our strategic initiatives around the world. We are on solid financial footing and remain extremely well-positioned to continue our pivot toward the streaming and direct-to-consumer marketplace, where we see exciting opportunities to aggregate and super-serve global fan communities. For the quarter, we met or exceeded all of our core guidance metrics, with accelerating revenue growth both domestically and internationally. This quarter, our numbers are 6, 5, 5, and 3. We achieved 6% domestic advertising growth, 5% domestic affiliate fee growth, 5% international advertising growth, and 3% international affiliate fee growth. It's one great set of numbers, the company is operating on all cylinders, and I'm very proud of the team and this quarter's performance. And we anticipate another quarter of healthy growth in Q3, which Gunnar will take you through in detail. We've got a nice tailwind at our back, and I believe we are performing at the top end of the television advertising business domestically and perhaps even globally. The television industry is far from dead, here or abroad. Contrary to what many believe, we are getting real meaningful growth from the core TV business around the world, and it feels sustainable. And our position with the industry has never been stronger. And I believe we are poised to grow like no other. HDTV, Food, TLC, ID, and OWN are the top networks in America for women. These networks have made us the number one media company for women aged twenty-five to fifty-four across all of television, with a 16% share. A huge accomplishment and meaningful testament to our creative storytellers, our strategy, and our network leadership. This past Sunday night, nearly 35% of the female audience was watching one of our networks. To be clear, there are a lot of great scripted content from any number of great media companies. Really amazing stuff from Disney, Warner, NBC, CBS, and Amazon, but it's across an incredibly crowded, expensive, and competitive landscape. But there was only one company playing at our level in the other 50% of the content pie, and that's Discovery Inc. We have the highest quality and recognizable brands that audiences love and tune into more than any other media company, including networks that have the highest length of view and engagement on television. And it's been a hugely successful calling card for us with advertisers, which led to a robust and comprehensive upfront sales season, delivering record numbers behind healthy CPM increases, reinforced by the prominence and resonance of our brands, the value of our brand-safe and mobile-first apps, and traction for new sales products, like Discovery Premier, which was sold in the upfront for the first time and has had super traction within the industry. On-the-go, we're seeing great traction across all of our apps setting records in total daily streams, much of which doesn't get picked up fully by Nielsen. For Shark Week alone, we've seen over one million streams each day. The performance of this best-in-class platform serves as a great example of how well our content travels within a mobile-first ecosystem, as well as to younger demographics. Internationally, our operating momentum feels stronger than it has been in quite some time, driven by growth in our global audience share across all key regions, continued pay-TV subscriber growth, positive reception to the continued integration of Scripps content, while at the same time promising launches of Food and HD branded lifestyle networks, particularly in Latin America and Europe. I'm pleased to note that our linear share of market across our top ten international countries was on average up a healthy 5% in the quarter, with growth in six of the top ten markets, two of which were up double digits. And our audience delivery was up an average of 4% across the top ten. These are terrific results, and they're really helping to sustain our overall international momentum. This tailwind, at a time when there are still real pockets of macro headwinds, positions us well if and when certain markets and economies stabilize. Strategically, Discovery has made a differentiated bet with a different portfolio of IP and assets. We own virtually all of our IP across all territories and platforms in genres that have great utility and functionality. We have many of the most beloved and iconic brands on the planet, in people's passion areas: home, food, travel, cars, crime, natural history, science, and live sporting events like the Olympic Games, the PGA Tour, Grand Slam Tennis, and cycling. We produce over 8,000 new hours of original real-life programming a year, with unrivaled scale in our genres. A powerful content engine, at a time when the value of IP in our industry has never been more strategically important. Globally, we have nearly 500 free-to-air and pay-TV channels with roughly ten to twelve in every key market around the globe. The combination of our strong and trusted brands and huge reach for marketing and top-of-funnel promotion, we believe, gives us a real head start when it comes to building a direct-to-consumer portfolio around immersive experiences. Our strategy and approach have been focused on doing that across three broad consumer categories: sports, lifestyle, and factual. First in sports, we have three main products: the Eurosport player across all of Europe, Golf TV, a fully global platform, and a global cycling network. Within lifestyle, we are working on three different subscription-based offerings, all with different product cycles. First, Motor Trend focused on car lovers; second, our new multi-platform Magnolia joint venture with Chip and Joanna Gaines that we are building with plans to launch in 2020, and things are going terrifically well. We also continue to actively look at the food and cooking space and look forward to talking to you more about our plans in that category over the coming months. Within factual, our soon-to-launch service which brings together the very best of Discovery and BBC real-life content will offer a comprehensive view and immersive interactive experience across this important family-friendly vertical around the globe. Additionally, there are three important products in Europe that speak to the breadth and depth of our direct-to-consumer strategies globally. One, the TVN player in Poland, which is the number one SVOD product in all of Poland. Dplay in the Nordics, our Hulu-like AVOD and SVOD offering, which has enjoyed robust growth over the last year. And three, Joyn in Germany, our venture with ProSieben, which has gotten off the ground in May to a very solid start. Overall, our ambitions are to create strong multi-platform ecosystems, driving opportunities for multiple revenue streams from advertising, subscription revenue, and sponsorships, as well as e-commerce retail, as well as instruction across a growing suite of direct-to-consumer platforms and regions. Underpinning these efforts is our evolving technology stack, which under the direction of Peter Faricy and his team is being repositioned to drive a better consumer experience, range of efficiencies, and functionality that will allow us to dramatically reduce the resources and time to market for existing and new products. As many of you will remember, we got Peter from Amazon, where he spent over a decade building the Amazon marketplace. We remain excited about both where our business is today and where we are headed. We are maximizing our position within the core linear ecosystem, generating stable revenue and free cash flow growth, while at the same time appropriately and judiciously investing to position ourselves for future growth. At a time of rapid and structural change for our industry, we recognize there are risks but also great opportunities, and we believe we are as well-positioned as any global player to capture viewers as they migrate to alternative platforms. And while we are still in the very early stages of launching our global direct-to-consumer verticals, we believe they will provide us with a solid long-term runway. With that, we are assertively leaning in where we see opportunities to leverage our breadth, depth, and functionality of IP such as in food and home, where we believe that there are many unique ways to reshape our vertical know-how into a more direct and distinctive relationship with our passionate fans around the world. With that, thank you very much. And I'd like to turn the call over to Gunnar to take you through our financials.

Thank you, David, and thank you everyone for joining us today. I am extremely pleased with our very strong second-quarter operational and financial performance, which demonstrated an acceleration across every one of our four core revenue metrics, as well as the progress we are making strategically as we continue to transform and pivot Discovery. We are performing at a high level and still at the very early stages of leaning into the many unique and differentiated growth opportunities we see in front of us. And as such, we are delivering top-of-industry performance and enjoying the benefits of our scale and presence in the U.S. complemented by our breadth of global distribution, which is uniquely supporting our efforts to build direct-to-consumer and streaming products that power people's passions. I'd like to share some financial highlights from our second quarter. As always, my comments will be in constant currency terms for our international business and for the total company unless otherwise stated. And foreign exchange did have a material impact on some of our metrics this quarter. Please refer to our earnings release filed earlier this morning for a more comprehensive view of all the drivers of our second-quarter financial results. In the second quarter, Discovery again achieved very strong operating performance with 6% U.S. advertising growth, 5% U.S. affiliate growth, 5% international ad growth, which included a one-month impact from the consolidation of the three networks acquired from U.K. TV, which added roughly one percentage point of growth, and 3% international affiliate growth. We also grew total company adjusted OIBDA 7%, a function of our strong revenue growth and the benefit of an 8% decline in U.S. expenses modestly offset by an 8% increase in international costs, which we've previously noted would begin to increase as we invest in our growth businesses. Additionally, we reported $596 million of free cash flow in the second quarter of 2019, bringing our trailing 12 months of free cash flow to $2.9 billion still, accounting for roughly $200 million of cash restructuring costs. This allowed us to end the quarter with a net leverage ratio of 3.3 times. Now, let me share some forward-looking commentary starting with the four key revenue drivers for the third quarter of 2019. First, for U.S. advertising growth, it is expected to be in the 3% to 5% range driven by similar dynamics in pricing, monetization, and ratings, as usual. Remember though, we are facing a slightly more difficult comp against last year's 5% growth in the third quarter. Also, please keep in mind, there are some high-profile events this quarter on the Discovery Channel like Serengeti which premieres this Sunday night that will be a key factor in our ratings driven contribution this quarter. If you live in New York City, you've no doubt seen a bus or billboard promotion, we are all very excited about this series. Second, U.S. affiliate from today's perspective is likely to grow 5% again in the third quarter. This assumes no major change in subscriber trends beyond what we have seen up until now, and while there are indeed a number of both headwinds and tailwinds, we can reaffirm our full-year guidance of U.S. affiliate revenue growth in the mid-single-digit range, particularly given our best-in-industry representation across the virtual distribution platforms. Third, we expect international advertising growth to nicely accelerate, driven by share growth in our top markets and contributions from our digital investments. We also expect a full quarter of contribution from the U.K. TV Lifestyle business, which should add an additional two to three percentage points of growth, thus international advertising is expected to grow at least high single digits in Q3. Finally, international affiliate growth is expected to be up mid-single digits as we've seen continued improvement in the underlying subscriber trends across a number of markets, aided by continued monetization of our digital streaming products and investments in new channel launches in several markets. Turning to total company guidance, we continue to expect another year of healthy free cash flow growth in 2019 even after making the necessary investments to build out our direct-to-consumer portfolio and the previously noted step-up in CapEx from such items as global real estate consolidation and transformation projects related to technology infrastructure and software development. The cadence and magnitude of our investment profile will be determined by the ultimate opportunity set across new and existing initiatives and the level of success-based spending we will need to support these initiatives. Accordingly, our view on the puts and takes behind our ultimate full-year free cash flow has not changed versus what we laid out last quarter. As such, growth will be based on adjusted OIBDA growth and lower cash restructuring charges, partially offset by increased investments in direct-to-consumer, higher CapEx, and higher cash taxes. We continue to expect a negative impact of our D2C investments on full-year 2019 adjusted OIBDA totaling roughly $300 million to $400 million depending on the timing of the rollout of these investments. And though we again enjoyed another quarter of total company margin improvement, which in Q2 was 100 basis points, as we've previously noted, the expected ramp in our digital investment spending will flow through more heavily in the second half of the year. With respect to the step-up, Peter and his team are creating a more robust global technology platform to better serve all of our global direct-to-consumer and streaming businesses. We will discuss this in incremental detail later in the year as we proceed further. However, in terms of scale and scope, our digital products currently operate on over a dozen different owned and operated platforms and depend upon a dozen third-party platforms. Streamlining this will materially boost the functionality and consumer experience as well as the efficiency and speed to market. Dplay, our broad general entertainment AVOD and SVOD app that is very popular in the Nordics, is a great example of how much improvement this new technology can produce. Dplay was among the first existing services to migrate to our new platform, and we've delivered a marked improvement in consumer experience and reduced churn, resulting in strong subscriber growth, up nearly 150% year-over-year in the second quarter. Importantly, I believe it is worth calling out once again the acceleration in revenue growth that we're seeing, particularly across our International segment, is in large part a function of both a stable core linear business as well as early traction we are seeing from our direct-to-consumer and streaming initiatives. Moving on to taxes. As we had previewed, there was a one-time non-cash $455 million tax benefit in the second quarter, which made our second-quarter book tax rate negative 38%. With that, we now expect our 2019 full-year book tax rate to be in the mid-single digits. Remember, this was a non-cash benefit and there is no impact on our cash taxes or to our free cash flow. Regarding capital allocation, our priorities have not changed. There is still two. Number one, optimize leverage, and within our 3 to 3.5 times net leverage range, we currently plan to continue to prudently delever towards the lower end of this range over time. Number two, concurrently, we will continue to evaluate value-enhancing investments along with strategic M&A. Finally, we will opportunistically return excess capital to shareholders. Before I close, let me quantify the expected impact that foreign exchange will have on our 2019 results. Given the movement of the dollar at current spot rates, FX is now expected to negatively impact revenues by roughly $185 million to $195 million and OIBDA by $80 million to $90 million versus our 2018 reported results. In closing, I am very pleased with both the operating performance of the company, our financials, and outlook as we continue to generate healthy free cash flow from our stable core business and embrace our global pivot towards direct-to-consumer media. Thank you again for your time this morning. And now David, JB, and I will be happy to answer any questions that you may have.

I have two questions. First for David, can we discuss the U.S. advertising market? It's incredibly strong, and besides pricing, there seem to be several ways you can take advantage of it. You mentioned monetizing digital content and possibly some inventory. Could you elaborate on what you can leverage and what is driving demand? It appears there is significant growth or potential growth in non-advertising platforms like Disney Plus. Is this encouraging advertisers to return to more traditional media? For Gunnar or JB, the international expenses have significantly increased, which you mentioned. Can you provide more details on the benefits you expect to gain over time from the tech platforms and anything else worth highlighting?

Thanks, Jessica. Well, look the upfront was very strong and leading up to it scatter was strong and it was accelerating. I think a piece of it is that, and I spent a lot of time talking to the agencies as we try and kind of lift ourselves up to where we see broadcast in the high '50s and low '60s and we are still getting CPMs that are much lower. The ability to really sell product, advertisers are finding that television is still one of the most - is the most effective platform to do that, and so I think there is a move back. In addition to that, there is a feeling of safety, what are you next to? What are you buying? Who is the talent that you're buying? What’s the environment that you are buying? You can do that on television and in digital, there is a fear of that. The overall narrative for a lot of these digital companies has changed. And so I think that sets an overall environment that's more positive, but for us this is a big moment for our company. I said, I've said for a while that we have the top four channels in America for women and no one's ever done that before: ID, TLC, Food, and HGTV, and the number one channel for African American women with OWN. We have worked hard to do that. When you put it all together, we are now the number one TV company in America, in terms of the women we reach, the time they spend with us, it's Discovery. As a guy that started out in the cable business and looked to broadcast when I was in New Jersey looking over the river, this is really a big moment, bigger than really great broadcast companies where the centerpiece of their companies are ABC and NBC and CBS. The reach that we have with women and be able to go into upfront with that reach with safe brands—brands that people wake up and want to watch before they go to sleep—they want to watch it and the other thing that we have that we’re not proud of but we’re trying to drive is that even though we're the number one place to reach women, the most effective demo our CPM is less than half of the broadcasters going into the upfront. We've really worked hard on developing some new products. We have Discovery Premier, which is a unique product, which is much higher than our traditional CPM, but why would you spend money on a broadcaster and get a 0.8 when you can come to us and get a six rating on a given night or a five rating or seven rating? We made some progress with that. We're also the only media company, I believe, that has really effective authenticated apps and the reason for that is people won't generally go to these general interest services and download them to spend time with them—they go to those channels for series and they go to the broadcasters for series. The idea that we're doing over one million streams on Discovery and millions of streams where people are getting up and spending time with Food, HGTV, and ID, and the average age is in their '20s and the length of time is quite high. Overall, we have great safe brands. We have the largest share of women and the advertisers also recognize—and this is something I've been saying for a long time—we expect that our share is going to continue to grow that broadcast is sustainably declining in a double-digit fashion. A lot of those broader services that have reruns and that are competing with the scripted series and scripted movie businesses, more and more the only place to go for quality content that you could see live is us. We had a great upfront, and I think you're going to see some meaningful growth flowing through for the next year, and we feel really good about it. At this moment, scatter remains strong, and for the moment, TV is back, and I think we are the lead horse in that game. We're not taking for granted where the world is. That's one of the reasons why we're investing so much in IP with a leader in IP globally, and we're deploying that IP around the world, and you will see that, and you'll see us invest in that for more sustainable long-term growth. Gunnar?

Yes, good morning, Jessica. So listen, I could not be happier with the financial profile that you are seeing in this quarter. We're making a lot of progress and we're doing exactly what we said we were going to do. We continue to benefit from cost synergies. It was another quarter of margin increase, even though I had already spoken about that coming to an end at some point, and I had guided to $300 million to $400 million of negative impact from our startup investments in the digital space, and we're seeing some of that kicking in. Peter Faricy is coming up on his first year; a lot of the initiatives are picking up speed. To your question on the international expenses, that's what's reflected in that expense number. Golf TV has started its global rollout. There’s obviously IP amortization coming through, and digital in general, Dplay, we're pushing. You also had the consolidation of UK TV kicking in for one month—that's added on a like-for-like basis a little bit of expenses. But bottom line is we're making these investments as initiatives start to accelerate, and you're already seeing some impact on the revenue side as well. The very strong numbers in the second quarter, 5% in ad sales growth, 3% on the affiliate side, and maybe you just heard—we're guiding to an acceleration for both metrics. Obviously to some extent, it is driven by the first—contributions from those digital investments. So it's really working very well for us.

I guess, first off, David, maybe a bigger picture question. You've done such a fantastic job with the Scripps acquisition and continue to see the benefits clearly in this quarter and the outlook. I guess, I'd love to hear your thoughts on the scale, the need for scale, longer term. Do you have the portfolio to compete with some of these larger players, some of which you referenced in your opening comments, or do you feel it would make sense to continue to look for acquisitions or potentially a merger with someone else to be more competitive? Just I'd love to hear your updated thoughts on the current environment and Discovery's positioning. And then secondly, just a bit more specific. TLC has been really strong. Ratings are a little softer. Discovery, I guess, any more color you can give there? Are you looking at Serengeti as sort of a delta to maybe change the rating trends in that channel? And any other programming in Discovery maybe Discovery Channel we should look forward to?

Thanks, Alexia. The Scripps transaction has really exceeded our expectations on all levels, and you see that in our free cash flow, you see that in the fact that together their quality, together with our quality on the leadership side, on the content side—that's what makes us the number one TV company in America for women and positions us to continue to grow in a meaningful way. When I think of scale, I guess, I think of it two ways. One, we're the largest player in the international space. We're probably the only one; JB will give you a little bit more color making over $1 billion. But we’re— as the Disney and Comcast deals with Rupert show that the need to view the world as more than just the U.S. and be global. We have infrastructure in every country. We have content in every country. We have credibility and brands and IP in every country. Scale, I think we have a leader outside the U.S., and we're also the leader in sport and the quantity of sports that we have, etc. So on a scale side in terms of international and sport, we are the bigger guy, and there are a lot of players that are going to want to try and catch up to us. In terms of the genres we've chosen, we feel great about it right now. Everybody's going after scripted movies; it's creating an environment that gives us more and more opportunity. I've said this before that I think where our share is going to accelerate; there are so many choices for scripted series and scripted movies. You now have four or five offerings between $6 and $15, then you have the broadcasters and the big entertainment services. To play in that space, they're going to have to get bigger and bigger, and each of them is already kind of indicated they don't have enough IP. They need more stuff; they need more and more and more, and they're talking to us about giving them more, but we're not doing any of that right now. We like owning all of our IP. We like the fact that we have great female-friendly content, male content in our genres in the area of food; we are the dominant player in the world. In the area of home, we are the dominant player in the world. In the area of natural history, together with the fact that we bought the entire BBC library globally for more than the next decade, we have the majority of science and natural history. We are the dominant player in the world. In crime, we are the leader. So it depends on how you define things; we’re number one for women and are the leader in each of these quality categories that we have chosen. And then we've picked new categories, which is character different categories, which is Oprah and Chip and Joanna Gaines. We think we're going to continue to grow as the ecosystem continues to have challenges. I think that challenge is going to be what do I want to watch? Where do I get the next scripted series? How many of them do I have stacked up? This 50% of what people watch is that stuff; the other 50% is us. That's why I think our share is going to continue to grow, and that's why I think from our perspective, what we're trying to do to scale up is buy more stuff—get more IP from the BBC, do Golf Digest, and lock in Tiger Woods globally with us—it’s about getting reinforcing in our genres. No one else is playing in our space, so we think we're in a very good position. On TLC, Howard Lee is having a great run. Two years ago we were dealing with the TLC that was down for a period of 24 months. Nancy Daniels, Howard Lee, and I dug in; this is what we do for a living. We have improved our leadership team now, even more with Kathleen Finch and a lot of the great people from Scripps. These channels are going to go up and down. We got a great team now with Discovery that we have a lot of confidence in. Serengeti, if you haven't seen it, is I think the best thing we have seen and some of the best natural history content globally that we pushed out. We put it on Discovery; we actually took the last two minutes before Serengeti started on Sunday and we did a 2-minute promo across every one of our channels. If you're watching Food, HGTV, ID, we could do that, no one does. At 8 o'clock, turn now to Serengeti on Discovery. It did very well; we're going to get more of the L3, but it did very well. Discovery is back in its core natural history with all of our BBC IP and Planet Earth, Frozen Planet, Walking with Dinosaurs, Woolly Mammoths; we are really compelling and formidable.

Thank you for the additional detail on some of your streaming initiatives. I wanted to dig in on one of them if I could, which is the PGA streaming service, because I believe you're in the first year of your 12-year arrangement. I think you went live and potentially in up to eight markets. So I wonder if you could just share some of the early learnings in this first year and how that deal is progressing?

Sure, it's going very well. I'm going to see Jay Monahan tomorrow morning over at Liberty. What led us to this is the fact that we had the Eurosport player and we were going direct to consumer for several years. We've learned a lot about that business, and one of them is that you need a lot of content. The actual live sports IP you need local and you need something that people can always read about or learn about or transact with. After a lot of work, JB and I came to this conclusion that if we could get Golf, it's the best IP in the world because it's 52 weeks a year; it's four days a week of loads of IP and 50% of the PGA Tour is local. Then we added the European Tour, the Asian Tour, the Latin American Tour. And then we did Golf Digest where you can go in and read about any golf course and figure out where to take a vacation. We are doing very well. Some of our bigger markets are going to be coming up in the first year. In three years from now, we'll have everywhere in the world outside the U.S., but we're also attacking the U.S. now as well with Golf Digest and Tiger. JB just thoughts on direct to consumer because I think what led us to Golf is a lot of what you're doing in the international space?

Well I think on the golf piece particularly, Drew, the great news there is also it’s a bit of a two-for-one. We have the great traction that Alex and the team have developed on the product itself in our direct-to-consumer app. And as you said, it’s early days, but we're seeing great traction and pickup in the first six months of the year as the product is launched. And it's also helping us on our core traditional business, which I know you've heard us talk about—the fact that in markets like Japan and Spain where those markets were up earlier this year. Not only do we expand our relationship on the direct-to-consumer side, but we leveraged it for our entire portfolio to expand and strengthen with great revenue on our core. We have other key markets like Korea, for example, to come up next year, and that's a market that today in the Discovery legacy business is way underserved. It's a very small market for us, and we're using those conversations there to see if we can actually develop additional channel opportunities in our core business. You're seeing that two-for-one opportunity of great digital and direct-to-consumer traction that will take more time and accelerate over time. But also, a more immediate impact of helping our core business through traditional affiliate relationships and broadcast relationships in those markets which are allowing us to launch and accelerate the growth in a couple of those markets.

And if I could get a follow-up for Gunnar, I wanted to ask about U.S. networks margins. For the past few quarters, it’s been hitting 60% of EBITDA margins here. Historically, this is a business that had more typically been caught in the mid-50s, maybe even low 50s in certain years. I understand your comments about Serengeti and some content, but as we look out over say the next 12 to 24 months, is this a business that you think or segment that you think could hover in that high 50s, maybe even low 60% vicinity?

Yes, look, I mean Drew, a couple of points. Number one, we have been enjoying massive cost synergies from the integration with Scripps and obviously a lot of the U.S. footprint was sort of one-for-one overlap. So that's why you're seeing such a significant share of our cost out hit the U.S. Number two is, I made this comment a little earlier already; we got to look at this from a total company basis because as we went through our transformation, we have shifted around a little bit in the cost base. So a lot of the expenses that JB is now carrying on the D&I segment are going to be leveraged as we roll out those products on a global basis. For 2019, the investments are somewhat D&I-heavy, and that's going to even out as we move forward. So again, I could not be happier with where we are.

Thanks so much. I guess a couple of questions. First, David, you teased us at the end of your prepared remarks with comments on food and home being reshaped into distinct and direct relationships with fans around the world. So if you could talk about the opportunities you see in that regard, and I think for both you and Gunnar, look, when you start to roll forward to the end of the year, you'll be at the bottom of your leverage target range. I think you've talked about this sort of run rate approaching $3 billion of free cash flow annually. When you look at the next year, that means $3 billion plus of excess capacity. Are you seeing strategic opportunities to invest that on an inorganic basis? You've certainly been looking for a while. So, any thoughts on that would be helpful? Thanks.

Okay. Look, I think directionally in terms of the industry, this is another area where things are moving our way. You talk to Hans and he’s talking about 5G. You talk to Randall; he is driving 5G. What is 5G? 5G is not about being able to download a movie in six seconds versus seven seconds; it's about providing real utility and value in the home. The question is, okay, now that we've got it, what do we do with it? This is where the content that we have. If whoever can own the kitchen is going to own the home and where the people spend money? They spend it in the home. They spend it on their home office, on their living room, on their kids' room. We have these genres with food and cooking and with HG, and now DIY will be relaunching as Magnolia with Chip and Joanna Gaines. We have the greatest experts in both of these areas. Content needs to be curated; purchases need to be curated. If you look at what everyone else is doing with scripted series and scripted movies, they're creating fantastic, robust, better than ever viewing experiences, scripted movies and series, and that's great. You can watch Fleabag, which by the way is one of the all-time hits on Amazon. So all you can do is view it. That's great; you can view it and laugh or cry, but that's it. Our content has a real ability to view and do or view and transact. So imagine a world where you've got a lot of people fighting for subscribers that people pay a monthly fee for and all they can do is view, but our content has subscribers, and they can also transact. That's true in food, it's true in home, it's true in golf, it's true in cycling. If you go back to the world that Malone helped create in terms of full circle—100 channels, and then he has HSN and QVC that he owned—but in running QVC and HSN and creating a lot of shareholder value along the way, it was completely inefficient. A lot of the people that were on food at home were going over and trying to get an audience to come over and spend time with them on QVC or HSN and buy stuff that they really wanted and needed to be curated. We can do that over time, and we're fighting like hell to do it. We can aggregate these passion groups, and not only they will view with us, but they're going to be able to do it with us. We view the home and 5G as we're having discussions with everyone how to take all of our expertise and create some real utility. I would say, stay tuned, but the Holy Grail to aggregate audiences globally that have a passion and then to be able to have them hit a button and go on to a golf vacation, buy the golf clubs that they love, where Tiger is wearing, or get a recipe and get all the groceries. So that's what we're working on. We're working real hard on it, and stay tuned.

Well, yes. Let me start; I mean you made reference to leverage and the free cash flow. So just before David answers the M&A question, I continue to be super excited about our free cash flow development. You saw that we have $2.9 billion at the end of Q2 still after $200 million of cash restructuring. I've also spoken to the sort of key puts and takes for the rest of the year. A good part of the cash tax increase has already come through in the first half, whereas some of the CapEx increase in digital investments are going to kick in a little more in the second half of the year. But bottom line is feeling good, and we really only just started on free cash flow improvement. As you saw, our leverage has come down slightly from 3.5 to now 3.3. That's probably not a bad thing in the current environment, so we're happy with that progress as well. Regarding M&A, our hand is very happy, but obviously, we continue to evaluate strategic opportunities. But David, is there anything else you want to add?

We're always looking opportunistically, but we don't see anything significant at this point. Bruce Campbell and JB or we kick the tires on everything. The UKTV deal was quite good for us; maybe JB can update on that and what you are looking at some of the things that you think could make sense.

We do see opportunities as you know. Part of our strategy as we've bought the Scripps assets is to really try and take HG and food around the world, and we see there is an opportunity there. We have selectively looked at bringing in either assets that help us rebrand UKTV's an example will bring in food and home channels into the portfolio on a consolidated basis, rebrand them as HG and Food Network, and then take those off and really try and drive that with the Scripps content as the bedrock of it. There are additional channel opportunities which we're looking at selectively to accelerate the core where we can buy channel positions or slots to get some of those channels launched in additional markets, in addition to organic ways that we're doing it. We do see opportunities on the sort of smaller mid-scale to tuck-in and roll in some things that we think can help accelerate our core business.

There are some smaller players that are coming to JB and saying they have a lot of infrastructure and cost here. There are some things that we could do to get. In some cases, you've created advertising country-by-country advertising groups and tucked-in some smaller players that we've gotten the benefit of CPM. There are others that want us to do things for them, who want to tuck-in with us because it's tough to be playing in this space in 200 countries when you don't have a lot of scales.

David or JB, when you look at your D2C portfolio. I think you've got four services in the market, and I think you've listed out seven in your prepared remarks. I was just curious how you think about the longer-term strategy. Are you looking to sort of build specific verticals and tie those verticals back to your linear brands, or were you also thinking about potentially pulling some of these together, for example, the Magnolia, food, and cooking factual stuff into a single app? I'm just wondering how you think about how the universe evolves, given the explosion of these kinds of streaming services around the world and also how you think about putting these to the U.S. or if you view the U.S. market as sort of fundamentally different given the maturity of the pay-TV model here. Then just on the same topic, maybe for Gunnar on the numbers. Can you help us at all to think about that $300 million to $400 million as we roll into next year? I don't know if you have line of sight there yet or want to talk about it, but do you expect to start scaling that cost base or do you expect investments to ramp and lean in more? Any color at this point would be helpful.

Well, look, I've talked a lot about us aggregating IP and being the leading global IP company. We now have a company that's growing mid-single in its core business, even against us investing significantly and holding on, as Gunnar says. As you see the BBC Natural History Library, most of the PGA, and the European Tour, and most of the golf in the world, and a lot of the cycling. We've been adding up this IP because we believe being above the globe is going to give us a huge opportunity. To create significant value, if some of it works in ways that we think we could create real businesses that you guys give a huge multiple to. We have been trying a lot of things, and we learned a lot. What we're doing different than anybody else is we have core New Media and Digital people running these businesses now. We brought in the best product people from Amazon over here. We have over 100 engineers. We have a whole team that we’re building in Redmond. We see that as a real separate company that is going to disrupt our industry, but we're not going to disrupt ourselves by getting somebody who ran Eurosport to now build the Eurosport player and build our golf business. We're hiring the people that are disrupting us. This gives us one advantage but JB a little bit of color on your side.

Yeah, I think Ben, to your question and to the early question also about how we see scale. The reality is we don't look at—in the traditional lens, we look at our competitors as the normal lot that we talk about the Disney’s and NBC the CBS. In the direct-to-consumer world, all of them are trying to build out these supermarkets of video, and it's very expensive and so far very cash flow negative. Our strategy in that space is frankly less about them as competitors and more about building out what we look at as much more specialty stores. In those specialty stores, unlike them, we're building out services that are only watch; we are watch, play, learn, buy, and that's how we see ourselves as very different. We do see ourselves as having a portfolio of these—some may be over time 10 million, 20 million, 30 million, 40 million, 50 million subs. Some may be single-digit million subs. But that portfolio in aggregate, we think has huge potential when you roll it out globally.

And then Ben, on your second question regarding scaling digital expenses, it's obviously a little bit too early to talk about guidance for next year. But a couple of points I want to make that we have spoken about in the past. We will be flexible here, and we're not afraid to get behind what's working if we won’t something. But just the same way, we've also pulled back on some other products where we didn't see the progress that we needed to get comfortable with additional investments. Expect us to be aggressive if we're onto something and very careful where we're not seeing the progress that we need. If you look at it from a top-down perspective, spending somewhere between 5% and 10% of our underlying a little bit up for future growth doesn't sound crazy. It's not betting the farm, but it's enough to potentially make a difference sooner rather than later.

Yes, makes sense. Thanks for the color, everybody.

The last point is the cost of driving these. I've talked about this before but we have all these channels; we have free-to-air channels with equivalent of NBC and CBS in a number of markets in Europe. We have 10 to 12 cable channels everywhere. So people are watching us in these affinity groups already, and we have scale. We don't have to go out and buy and tell people to sign up for a particular product. We can be promoting it from the ground up, which I think is a real helper. In a really confusing environment, the real question for the future is curation. What the hell do I do? I got a choice of everything. You have all the media saying come to me; I've got great movies in great scripted. Let me tell you about this next great scripted series I have and spending a ton of money in order to tell people, hey come to Amazon; I got Fleabag, The Crown is back—resubscribe or don't churn. For us, we have this ability to create a massive funnel, and we have already done it with Eurosport.com. We are the leader around in Europe, what people come and they hang out with us for free. We think that could be a huge thing if we aggregate people that love these affinity groups and advertise it and put sponsors on it and then go up to the next level and you pay.

I have a couple for David, JB. First one is, you guys called out the growth in international viewing share, and I wonder how much of that share can you attribute to the Scripps integration? I know that was one of the assumptions you had, the Scripps content would help. So anything you should share about what you've seen with Scripps is content internationally? And then could you quantify for international how big is that, is the benefit from those international players that you've developed? So is that becoming a meaningful driver of the growth that you're now talking about?

For the international share and audience growth is really driven by two or three factors. Number one is our core organic content, we've been working hard to try and improve the performance of it. Local commissioning, better investment reviews on content commissioning and re-commissioning. We're seeing stronger performance of our organic particularly local content in some of our biggest markets. The second is we’ve obviously been a year into making the Scripps content work hard, largely initially on our own networks to try and strengthen and see how we can actually introduce audiences. Because I think part of this that people forget is a lot of this content types in some markets where the content was not yet seen; you need to introduce it. We've seen this in Latin America, where we had the Scripps content actually licensed on our networks for several years, and it took almost 18 to 24 months initially in those markets several years ago to get the audiences introduced to it—accustomed to it and then liking it. We've seen continuous improvements in the performance of the content on our existing networks. That's the second sort of key driver. The third is we are obviously now seeing opportunities to launch whole channels, which you've seen us do in Germany. We're obviously rebranding in the UK with the UK TV assets. We've launched a series of channels; we have commitments for more launches in Latin America for HG and food to get those channels almost 50% plus distributed across the market. We're seeing a big opportunity there. The monetization is coming, I'd say we've only seen the beginning of it because at the end of the day, we've seen the beginning of it from a licensee perspective in the markets where we launched those channels as pay. The audience improvements where we put the content on our existing networks. But what we haven't seen yet, which Dave talked about where the team here do so well is the strength of these assets is the endemic categories that they own and the ability from an advertising perspective to sell sponsorship and high CPM packages to these endemic categories. That's the piece that we're continuing to rework and we see great upside over the next several quarters as we get better and better internationally at selling that endemic category uniquely now that we have the channels of the product working better over time.

Can I add one point, Michael? If you remember back when we closed the deal, we talked about this international Scripps opportunity as sort of three layers. The first layer being the cost savings that we got very quickly; then utilizing the content on our existing platforms. We said launching the networks was going to take some time. We're now at the point where we're actually seeing some of that happening and contributing to our numbers.

Just two quick one. One, on David, you were talking before about the importance of bringing in Peter Faricy because things like churn and subscriber acquisition are new. I guess as you look back over the last year, what are you learning? How do you keep a subscriber for the full year? And how are you starting to think about what to charge for a service relative to the lifetime value given churn at all the things that go on in a direct-to-consumer subscription business?

We learned a lot. The way people consume content on a small screen is very different. You don't go to a TV and rub your finger on it and expect it to get an update. When you get up in the morning and you're paying for something, you expect to see something. So one of the things that we learned very early on is that you need IP; it needs to be updated regularly. We also began to understand that the definition of IP is different than what we thought. We thought it’s just professional content; it's Planet Earth, then it's Frozen Planet or it's live content on the PGA or the U.S. Open. One of the other reasons is that they are passionate about the particular area they are in. The reason we bought Golf Digest and the reason that we did the deal with Tiger and the reason that we have a lot of the PGA players working with us is the short-form content that they create every day. What they're eating for breakfast, what they're working on, what they hate about their game, or content that their caddies take of them hitting practice shots or trick shots. That's all IP. What they're worried about in writing is IP. One of the—what Peter had to build and what we're building, we brought one of the best technical people over from Amazon, is our Chief Technology Officer—is this idea of one global platform that we can use for natural history, for golf, for science. We're investing up, but it's a lifetime global value that we can put on that. We learned you need to multi-publish through the day; we learned you need real usable bite-sized content in addition to the long-form content, so Golf Digest is a great example of people are hanging around. They want to see what are the best clubs, what are the best drivers, they want to take a planning lesson, or they want to learn about where to take a golf vacation in Australia. Golf Digest has all of that. When we bought that, we got the authority on golf in the world, Jerry Tardy and the greatest editorial staff, and the greatest photo library on golf. We put it together with the PGA. We would have never done that before, but we understood that just owning the tours was not enough. That’s one. The second thing we learned, if you're in passion groups, we have an opportunity that the rest of those guys don't have, and that's free funnel; that’s advertiser driven and pay. Ultimately, what you might see for Natural History, what you might see for science or for golf or for cycling or for Chip and Jo is you have a funnel like Eurosport.com is free, gets 30 million people a month come there; that’s really an advertiser platform. Ultimately, maybe there are 100 million people that come to golf for free, but they are kind of pre-screened—they are there because they love golf, they want to see scores, they want to see what people are wearing, want to see what's going on in the golf world. We’ve aggregated people who love golf; that’s an advertising platform. That's like a global broadcast network for golf. We’re a global broadcast network for home; Chip and Jo are doing, and that’s free, but we make advertising dollars. That’s the new broadcast network of the future. Instead of being something for everyone, they are hanging out there and they go there all the time.

Then just a quick follow-up for Gunnar. I think you're the only media company that’s going to report Q2 with subscriber trends improving driven by vMVPD carriage deals you've signed over the last 12 months. A bunch of your peers have certainly been talking about the challenges facing the vMVPD that they raise price. I'm just curious as you look at Q2, 2019 versus Q1, 2019. If you add up all the major vMVPD, is the vMVPD universe net growing flat or actually shrinking due to the price increases? How should we think about that universe of subscribers?

It's certainly growing; again, I don't want to go into and do a lot of detail, but it's certainly growing. We’ve gone from some people calling out to have not even a year ago to best distribution in the entire affiliate landscape, both traditional and virtual, and you see that reflected in not only subscriber numbers but also our revenue growth rate.

Look, the marketplace here in the U.S., it's yearning for sports and retrans slammed down, with prices going up every year. Excluding you will pay for the sports network, then you pay for the regional sports network, and then every broadcaster also has their own sports network, and then they use sports to drive retransmission. The ratings on every one of them are going down. There is a reckoning; there’s a slam down coming, and when that slam down comes, the consumers in the U.S. are going to get the content that they want and the content that they spend time with. We will be like every other country in the world where we will have a $20 or $25 service. I don't have the services that people want and we will have a huge piece of that because we have the quality of content that people like that they're spending time with and they are not being forced to carry us. They're coming to—every one of those platforms came to us because we were the top choices of the consumers. But every one of them is being forced to carry retrans being forced to carry regional sports and forced to carry those sports networks, and there is a reckoning coming because the consumers don't like it and all of those MVPDs that are stuck with those fees are going to get pissed and it's going to come a moment when it's enough, and that's what you're seeing now; you're saying it's enough. I'm looking at the numbers and it's enough.